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ASIAN DEVELOPMENT BANK PCR: MAL 23220

PROJECT COMPLETION REPORT

ON THE

REHABILITATION AND UPGRADING OF WATER SUPPLY SYSTEMS SECTOR PROJECT

(Loan 1197-MAL)

IN

MALAYSIA

December 2001

CURRENCY EQUIVALENTS

(as of 30 September 2001)

Currency Unit – Ringgit (RM)

At Appraisal At Project Completion (August 1992) (September 2001)

RM1.00 = $0.400 $0.26 $1.00 = RM2.50 RM3.80

ABBREVIATIONS BME – benefit monitoring and evaluation EIRR – economic internal rate of return EPU – Economic Planning Unit FIRR – financial economic rate of return NRW – nonrevenue water O&M – operation and maintenance PWD – public works department SWA – State Water Authority SWB – State Water Board SWD – State Water Department WACC – weighted average cost of capital WTP – water treatment plant

WEIGHTS AND MEASURES m3 – cubic meter km – kilometer

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December. (ii) In this report, "$" refers to US dollars.

CONTENTS

Page

BASIC DATA ii

MAP vii

I. PROJECT DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Project Outputs 2 C. Project Costs 4 D. Disbursements 4 E. Project Schedule 5 F. Implementation Arrangements 5 G. Conditions and Covenants 6 H. Consultant Requirement and Procurement 6 I. Performance of Consultants, Contractors, and Suppliers 6 J. Performance of the Borrower and the Executing Agency 7 K. Performance of the Asian Development Bank 7

III. EVALUATION OF PERFORMANCE 7 A. Relevance 7 B. Efficacy in Achievement of Purpose 7 C. Efficiency in Achievement of Outputs and Purpose 9 D. Preliminary Assessment of Sustainability 10 E. Environmental, Sociocultural, and Other Impacts 11

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 12 A. Overall Assessment 12

APPENDIXES 16

BASIC DATA A. Loan Identification 1. Country 2. Loan Number 3. Project Title 4. Borrower 5. Executing Agency 6. Amount of Loan 7. PCR Number

Malaysia 1197-MAL Rehabilitation and Upgrading of Water Supply Systems Sector Malaysia Federal Public Works Department $105.0 million PCR:MAL 675

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness – In Loan Agreement – Actual – Number of Extensions 6. Closing Date – In Loan Agreement – Actual – Number of Extensions 7. Terms of Loan – Interest Rate – Maturity (number of years) – Grace Period (number of years) 8. Terms of Relending (if any) – Interest Rate – Maturity (number of years) – Grace Period (number of years) – Second-Step Borrower

13 July 1992 24 July 1992 27 October 1992 29 October 1992 26 November 1992 20 July 1994 18 October 1994 8 September 1994 2 31 December 1997 31 December 2000 2 Variable 24 years 4 years 0% 25 years 5 years State

9. Disbursements a. Dates Initial Disbursement

14 February 1996 Final Disbursement

20 June 2001

Time Interval 5 years and 4 months

Effective Date

8 September 1994 Original Closing Date

31 December 1997

Time Interval 3 years and 3 months

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b. Amount ($ million)

Category

Original Allocation

Last Revised

Allocation

Amount

Canceled

Net Amount

Available

Amount

Disbursed

Undisbursed

Balance KEDAH 7.420 7.420 0.000 7.420 4.164 3.256 11A Civil Works 3.300 0.000 3.300 0.464 2.836 11B Equipment and Materials 3.820 0.000 3.820 3.506 0.314 11C Minor CW (Force Account) 0.100 0.000 0.100 0.186 -0.086 11D Meters Replacement (Force Account) 0.100 0.000 0.100 0.008 0.092 11E O&M Equipment and Instruments 0.100 0.000 0.100 0.000 0.100 MELAKA 10.610 10.610 0.000 10.610 10.829 -0.219 12A Civil Works 4.910 0.000 4.910 5.155 -0.245 12B Equipment and Materials 5.400 0.000 5.400 5.368 0.032 12C Minor CW (Force Account) 0.100 0.000 0.100 0.184 -0.084 12D Meters Replacement (Force Account) 0.100 0.000 0.100 0.000 0.100 12E O&M Equipment and Instruments 0.100 0.000 0.100 0.122 -0.022 NEGERI SEMBILAN 16.620 16.620 0.000 16.620 20.180 -3.560 13A Civil Works 7.820 0.000 7.820 13.176 -5.356 13B Equipment and Materials 8.500 0.000 8.500 6.817 1.683 13C Minor CW (Force Account) 0.100 0.000 0.100 0.187 -0.087 13D Meters Replacement (Force Account) 0.100 0.000 0.100 0.000 0.100 13E O&M Equipment and Instruments 0.100 0.000 0.100 0.000 0.100 PAHANG 23.690 23.690 0.000 23.690 22.969 0.721 14A Civil Works 11.190 0.000 11.190 7.885 3.305 14B Equipment and Materials 12.200 0.000 12.200 14.696 -2.496 14C Minor CW (Force Account) 0.100 0.000 0.100 0.317 -0.217 14D Meters Replacement (Force Account) 0.100 0.000 0.100 0.071 0.029 14E O&M Equipment and Instruments 0.100 0.000 0.100 0.000 0.100 PERAK 28.980 28.890 0.000 28.890 17.344 11.636 15A Civil Works 13.780 0.000 13.780 5.461 8.319 15B Equipment and Materials 14.900 0.000 14.900 11.704 3.196 15C Minor CW (Force Account) 0.100 0.000 0.100 0.179 -0.079 15D Meters Replacement (Force Account) 0.100 0.000 0.100 0.000 0.100 15E O&M Equipment and Instruments 0.100 0.000 0.100 0.000 0.100 PERLIS 3.540 3.540 0.000 3.540 2.816 0.724 16A Civil Works 1.440 0.000 1.440 0.942 0.498 16B Equipment and Materials 1.800 0.000 1.800 1.764 0.036 16C Minor CW (Force Account) 0.100 0.000 0.100 0.025 0.075 16D Meters Replacement (Force Account) 0.100 0.000 0.100 0.000 0.100 16E O&M Equipment and Instruments 0.100 0.000 0.100 0.085 0.015 TERENGGANU 14.140 14.140 0.000 14.140 10.778 3.362 17A Civil Works 6.640 0.000 6.640 3.818 2.822 17B Equipment and Materials 7.200 0.000 7.200 6.503 0.697 17C Minor CW (Force Account) 0.100 0.000 0.100 0.422 -0.322 17D Meters Replacement (Force Account) 0.100 0.000 0.100 0.000 0.100 17E O&M Equipment and Instruments 0.100 0.000 0.100 0.035 0.065 Total 105.000 105.000 0.000 105.000 89.080 15.919 Undisbursed balance of $15.919 million cancelled at project completion. 10. Local Costs (Financed) None

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C. Project Data 1. Project Cost ($ million) Item Appraisal Estimate Actual Foreign Exchange Cost 121.000 104.355 Local Currency Cost 87.000 109.539 Total 208.000 213.894 2. Financing Plan ($ million) Appraisal Estimate Actual Source Foreign Local Total Foreign Local Total Implementation Costs Borrower-Financed 0.000 87.000 87.000 0.000 109.534 109.534 ADB-Financed 105.000 0.000 105.000 89.080 0.000 89.080 Total 105.000 87.000 192.000 89.080 109.534 198.614 IDC Costs Borrower-Financed 16.000 0.000 16.000 15.274 0.000 15.274 ADB-Financed 0.000 0.000 0.000 0.000 0.000 0.000 Total 16.000 0.000 16.000 15.274 0.000 15.274

ADB = Asian Development Bank, IDC = interest during construction. 3. Cost Breakdown by Project Component ($ million)

Appraisal Estimate Actual

Component Foreign Local Total Foreign Local Total

(a) Civil Works 25.000 44.000 69.000 38.402 76.862 115.264 (b) Equipment and Materials 80.000 23.600 103.600 50.679 12.466 63.145 (c) Consulting Services 0.000 14.000 14.000 0.000 15.004 15.004 (d) Training 0.000 0.400 0.400 0.000 0.982 0.982 (e) Taxes, Duties and Land

Acquisition

0.000

5.000

5.000

0.000

4.225

4.225 (f) Interest and Other Charges

During Construction

16.000

0.000

16.000

15.274

0.000

15.274

Total 121.000 87.000 208.000 104.354 109.534 213.888 O&M = operation and maintenance.

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4. Project Schedule

Item Appraisal Estimate Actual Date of Contract with Consultants Jan 1993-Mar 1993 July 1994-Sept 1994 Completion of Engineering Designs April 1993-Dec 1994 May 1995-Mar 2001 Civil Works Contract Date of Award Oct 1993 Jun 1996 Completion of Work Jun 1996 Sept 2001 Equipment and Supplies Dates First Procurement Oct 1993 Apr 1995 Last Procurement Sept 1995 Dec 2000 Completion of Equipment Installation Dec 1996 Dec 2000 Start of Operations Completion of Tests and Commissioning - Jan 2001 Beginning of Start-Up - Jan 2001 Completion of the Project Dec 1997 Dec 2000 5. Project Performance Report (PPR) Ratings

Ratings Implementation Period Development

Objectives Implementation

Progress (i) From 8 September 1994 to 30 September 1997 Satisfactory Satisfactory (ii) From 30 September 1997 to 30 December 1997 Satisfactory Highly Satisfactory (iii) From 31 December 1997 to 31 January 1998 Satisfactory Satisfactory (iv) From 31 January 1998 to 30 March 1998 Partly Satisfactory Partly Satisfactory (v) From 31 March 1998 to 29 June 1998 Partly Satisfactory Unsatisfactory (vi) From 30 June 1998 to 29 September 1998 Satisfactory Satisfactory (vii) From 30 September 1998 to 30 December 1998 Unsatisfactory Satisfactory (viii) From 31 December 1998 to 29 April 1999 Satisfactory Unsatisfactory (ix) From 30 April 1999 to 29 June 1999 Unsatisfactory Unsatisfactory (x) From 30 June 1999 to 29 November 1999 Satisfactory Satisfactory (xi) From 30 November 1999 to 30 March 2000 Satisfactory Unsatisfactory (xii) From 31 March 2000 to 20 June 2001 Satisfactory Unsatisfactory

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D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Membersa

Fact-finding 25 May-5 Jun 1992 4 28 a-1, b-1, c-1, e-1 Appraisal 13-24 July 1992 4 28 a-1, b-1, c-1, e-1 Inception 12-16 Sept 1994 2 10 a-1, f-1 Review 10-14 Apr 1995 3 15 a-1, g-1, g-1 Review 18-20 Dec 1995 1 3 a-1 Review 11-15 Mar 1996 1 5 b-1 Review 14-19 Oct 1996 3 18 a-1, b-1, g-1 Review 28-31 May 1997 2 8 a-1, g-1 Special Loan Administration 11-13 Dec 1997 1 3 a-1 Special Loan Administration 28 Nov 1998 1 1 a-1 Review 7-18 Dec 1998 3 41 a-1, c-1, d-1 Special Loan Administration 2-8 Dec 1999 2 14 b-1, g-1 Review 4-10 May 2000 2 14 b-1, g-1 Review 30 Jan-8 Feb 2001 1 10 a-1 PCR 1-15 Aug 2001 3 58 a-1, d-1, g-1 a a-engineer, b-financial analyst, c-counsel, d-economist/consultant, e-programs officer, f-control officer, g-project

analyst b The Project Completion Review Mission comprised I.H.Keum, Project Engineer/Mission Leader; M. Fortin,

Economist/Consultant; and C.T. Fajardo, Associate Project Analyst.

I. PROJECT DESCRIPTION

1. Since 1966, the Government of Malaysia has pursued the rapid expansion of piped water supplies to urban and rural areas. Under successive five-year development plans since 1966, investments in the water supply sector have achieved a relatively high piped water supply coverage.1 However, when the 6th five-year plan (1991-1995) identified that much of the aged water supply infrastructure had reached the end of its economic life and needed to be upgraded or replaced. Therefore, aging infrastructure had to be rehabilitated to derive maximum benefit from past investments. In line with this need, the Government accorded high priority to the rehabilitation and upgrading of existing water supply systems under the 6th five-year plan. The Rehabilitation and Upgrading of Water Supply and Systems Sector Project was formulated to implement a time and area slice of the Government’s 6th five-year plan (Appraisal Report, paras. 5–7 and 22).2 2. The primary objective of the Project was to improve water supply in the project states by rehabilitating and upgrading the existing water supply systems. The rehabilitation and upgrading works were expected to increase water production capacity and efficiency of operations. Such rehabilitation and upgrading works were also expected to reduce the high levels of nonrevenue water (NRW).3 The secondary objective of the Project was upgrading sector agencies through staff training and introduction of a commercial accounting system (Appraisal Report, para. 36). The project framework prepared by the Project Completion Review (PCR) Mission is in Appendix 1. No framework was prepared at appraisal. 3. The Project comprised four major components: (i) leakage control and physical rehabilitation and/or upgrading of the existing water supply facilities, (ii) operational improvements including reduction of NRW, (iii) implementation of consulting services, and (iv) operation and maintenance (O&M) training for local personnel. Rehabilitation works were planned for 32 of 70 water districts in states in peninsular Malaysia (Appraisal Report, para. 41). 4. Anticipated outputs at appraisal included rehabilitated and upgraded water supply facilities (i.e., distribution pipes, transmission mains, storage reservoirs, and water treatment plants); increased efficiency in O&M; reduced operating costs; and improved reliability and accountability. It was also anticipated that NRW would fall from 47 percent to 27 percent although a specific NRW target was not covenanted for each water district (Appraisal Report, paras. 42–53).

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation 5. The country operational strategy for Malaysia of the Asian Development Bank (ADB) at appraisal supported a (i) reduction of constraints in social and physical infrastructure, and (ii) improvement in the efficiency and productivity of the water distribution system and balanced regional development. Under this strategy, ADB’s assistance in the water supply sector was intended to provide basic social facilities that would in turn improve health and the quality of life of the people, reduce inequality of living standards within the country, and reduce poverty in the urban and rural populations. The Project was therefore highly relevant to the country operational 1 About 78 percent in 1990. 2 Loan 1197-MAL: Rehabilitation and Upgrading of Water Supply Systems Sector Project, for $105 million, approved

on 26 November 1992. 3 About 47 percent on average in the project states.

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strategy. It covered several poorer areas throughout the country in the seven states of peninsular Malaysia, and aimed to ease infrastructure constraints and reduce poverty through improvements in efficiency and productivity of the water supply systems. 6. Under the 6th five-year plan, the Government accorded high priority to rehabilitating and upgrading existing water supply systems for optimal use and improvement of the facilities. In line with this sector strategy, the Project was designed to optimize use of existing facilities and improve efficiency. Reducing high levels of NRW was another important element of this strategy. Infrastructure rehabilitation and upgrading under the Project was therefore highly relevant to the Government’s sector strategy as well. 7. Measures to promote institutional strengthening were also in line with ongoing reforms in the sector. Sector policies at appraisal were based on state jurisdiction over water supply services supported by Government financial assistance by interest-free loans to the state governments. The “user pays” principle was firmly established through universal customer metering. Tariffs set by the state governments were intended to cover operating costs, depreciation, and debt servicing costs, and to provide adequate funds for reinvestment. However, cost recovery performance was hampered by long delays between tariff adjustments. The Government promoted introduction of commercial accounting systems, corporatization, and private sector involvement in water supply as a means of improving efficiency and cost recovery. 8. Most of the sector policies prevailing at appraisal are still in effect, including universal service coverage, interest-free federal loans for capital works, statewide metering and tariff policies, and the promotion of corporatization. Since appraisal, overall service levels have increased from 78 to 95 percent, with rural coverage increasing from 66 to 89 percent. 9. The Project was formulated as a sector loan to provide maximum flexibility and facilitate project implementation. This approach was considered appropriate because (i) the sector objectives, investment plans, and policies were well developed; (ii) sector institutions were in place and capable of implementing the sector development plans and projects; and (iii) the Project included a large number of small and geographically scattered water schemes. Water districts assumed at appraisal and actually served are presented in Appendix 2. The original project objectives and overall design remained unchanged during implementation.

B. Project Outputs 10. At appraisal, anticipated project outputs comprised completion of subprojects in 32 water districts in nine states; establishment of water tariffs in participating states that would cover O&M costs, depreciation, debt services in excess of depreciation, and a portion of future expansion costs; and implementation of a commercial accounting system in each participating state (Appraisal Report, para. 102). Actual project outputs are described below. 11. The Project was eventually implemented in 24 water districts in seven states. Of the nine states at appraisal, three states (Johor, Kelantan, and Negeri Selangor) withdrew from the Project to pursue privatization of their water supply systems, and a new state, Perlis, was added. The final participating project states include Kedah, Melaka, Negeri Sembilan, Pahang, Perak, Perlis, and Terengganu. Although the total number of the subprojects under the Project was reduced, the subproject components envisaged at appraisal were implemented without modifications. 12. Infrastructure improvements under the Project include installing new or replacing 2,648 kilometers of pipes, replacing 111,000 water meters, providing new storage of 87,095 cubic meters (m3), and providing new water treatment capacity of 93,480 m3/day (Table 1). The

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largest share of investment activity as envisaged at appraisal went to replacing distribution system pipes and providing associated customer service connections and meters. Additional works that were not envisaged at appraisal included extending distribution systems to new customers, upgrading water storage reservoirs and pumping stations, constructing new reservoirs and associated transmission pipes, and upgrading and expanding two WTPs. Training in NRW control was received by 234 staff in seven states.

Table 1: Project Investments in Water Supply Infrastructure

State Replaced

Pipes (km)

New Pipes (km)

Replaced Meters

Storage Capacity

(m3)

Treatment Capacity (m3/day)

Kedah 24 246 4,000 6,810 0 Pahang 112 0 0 20,455 0 Perak 18 68 41,000 26,400 60,000 Perlis 669 1 0 6,130 0 Negeri Sembilan 1,216 0 60,000 15,800 0 Melaka 86 0 0 0 0 Terengganu 208 0 6,000 11,500 33,480 Total 2,333 315 111,000 87,095 93,480

Source: Staff estimates.

13. Following testing and commissioning of the facilities, they were transferred to the water districts within each state water authority (SWA). The Federal Public Works Department (PWD) ensured that the completed project facilities were operated and maintained efficiently in accordance with acceptable public utility practices. The Federal PWD also provided an adequate number of technical staff and supporting workforce and trained them in O&M. The PCR Mission visited several project sites and confirmed that the project facilities are being operated satisfactorily and well maintained by the SWAs. 14. At appraisal, 5 of the 13 SWAs were operating as a unit within the state PWDs, another 5 had been reorganized as state water departments (SWDs), and the remaining 3 were state water boards. Since the appraisal, the organizations of two of the seven project states have changed. The original organization of the state PWD for Pahang has been replaced by the SWD and the original SWD for Terengganu has been corporatized. The organization of Kedah, Perlis, Negri Sembilan, Melaka, and Perak has not changed. The structures of water supply authorities compared to appraisal are shown in Table 2.

Table 2: Types of Water Supply Authorities at Appraisal and Present Type Appraisal Present Branch of a Public Works

Department Kedah, Pahang, Perlis Kedah, Perlis

State Water Department Negeri Sembilan, Terengganu Pahang, Negeri Sembilan State Water Board Melaka, Perak Melaka, Perak, Corporation Terengganu

15. At appraisal, Melaka and Perak were using a commercial accounting system and Terengganu was in transition to the commercial accounting system. Since then, Terengganu has completed the shift to a commercial accounting system, and Pahang now runs commercial accounting in parallel with cash-based accounting. Over the course of the Project, about 100 staff received training in commercial accounting standards.

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C. Project Costs 16. The total project cost was estimated at $208.0 million equivalent4 including a foreign exchange cost of $121.0 million. The actual cost was $213.9 million equivalent, an overrun of $5.9 million equivalent or 2.8 percent of the original estimate. The foreign exchange cost was $104.4 million. The withdrawal of three of the nine original states resulted in reduced foreign exchange cost requirements. However, this was offset by the increased local costs of the actual subprojects. The actual civil works costs increased by $46.3 million equivalent or 67 percent while the material and equipment costs decreased by $40.5 million equivalent or 39 percent. Civil works costs increased because of unexpected complications in road excavation and restoration for subprojects involving rehabilitating distribution pipes in urban areas. The local cost of materials and equipment costs were reduced sharply due to the depreciation of the Malaysian ringgit against the United States (US) dollar during implementation. Actual costs for consulting services were substantially higher due to the extended implementation period. The actual training cost was much higher than the appraisal estimate. Actual costs for taxes, duties, and land acquisition were lower at project completion due to the reduced scope of material and equipment purchase and land acquisition. Appraisal and actual costs are compared in Table 3, and further details are provided in Appendix 3.

Table 3: Project cost at Appraisal and Actual Project Cost ($ million)

Appraisal Actual Item FX LC Total FX LC Total

Civil Works 25.0 44.0 69.0 38.4 76.9 115.3 Equipment and Material 80.0 23.6 103.6 50.7 12.4 63.1 Consulting Services - 14.0 14.0 - 15.0 15.0 Training - 0.4 0.4 - 1.0 1.0 Taxes, Duties, and Land Acquisition - 5.0 5.0 - 4.2 4.2 Interest During Construction 16.0 - 16.0 15.3 - 15.3 Total 121.0 87.0 208.0 104.4 109.5 213.9

FX = foreign exchange cost; LC = local currency cost. Note: Use of an average annual exchange rate for currency conversions may cause discrepancies in costs across tables. Source: Staff estimates. D. Disbursements 17. ADB approved a $105 million loan from its ordinary capital resources on 26 November 1992. The proceeds of the loan were relent by the Borrower (the Government of Malaysia) to the project states in accordance with the new financing policy of the Government in the water supply sector.5 18. The loan proceeds were relent either to the state governments where local implementing agencies were PWDs or SWDs, or to state water boards or water supply corporations in the states where these exist. Apart from waiving interest, the terms and conditions of relending remain unchanged. Counterpart funding from the Government was provided to the states as interest-free loans. 19. Disbursements were slow at the early stage of project implementation. With initial delays in the loan effectiveness, the first disbursement was made in the 1st quarter of 1996. The

4 In 1992 prices at an exchange rate of $1.00 = RM2.50. 5 Twenty-five years for repayment, including 5 years grace period with no interest.

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disbursement rate picked up significantly in the 1st quarter of 1997, reflecting major contract awards for materials and equipment in 1996. Subsequent delays occurred in disbursements related to overall implementation delays. Actual quarterly disbursements for the ADB-financed part of the Project are in Appendix 4. 20. At the end of the project implementation, loan savings of $15.9 million were canceled on 20 June 2001. Actual ADB financing was $89.1 million or 85 percent of the loan amount of $105.0 million. The appreciation of the US dollar against the Malaysia ringgit and the reduced number of subprojects resulted in the loan savings and cancellation. ADB loan funds financed implementation of subprojects, while the Government financed interest and other charges during construction on the ADB loan.

E. Project Schedule 21. The main events during project implementation are given in Appendix 5. The Project was scheduled to start in January 1993 and be completed by December 1996 with an implementation period of 48 months. Due to the delays in loan effectiveness, implementation actually started in September 1994, about 20 months behind schedule. A number of other unexpected difficulties delayed project implementation. Some states that were included in the Project withdrew after the privatization of their water supply systems. Project implementation was further delayed by unexpected complications in coordinating procurement activities and other implementation matters for seven states and a large number of subprojects. To address the difficulties in coordination, subprojects were prioritized and grouped into five packages (Appendix 2). Tendering for the first package commenced in June 1995. Tendering continued in a staggered fashion for other packages until June 1998. 22. The actual implementation period was 78 months, or 30 months longer than the appraisal estimate. The loan was extended twice, first to 15 December 1997 and then to 31 December 2000, with a total extension of 36 months. It was closed on 20 June 2001. The extensions were required mainly to complete unfinished works, which were considered essential to fully achieve the project objectives. The actual implementation schedule and that at appraisal are provided in Appendix 6.

F. Implementation Arrangements 23. The executing and managing agencies for the Project were those intended at appraisal. The Federal PWD through its Water Supply Branch was the Executing Agency of the Project, and in each project state, the SWA managed the Project. The district office of the SWA headed by a manager and staffed by qualified and experienced engineers and technicians carried out day-to-day implementation of the individual subprojects. Each subproject was selected and appraised by the Federal PWD with the assistance of project consultants in accordance with the criteria agreed upon between ADB and the Government. The Federal PWD also provided technical advice and support to the SWAs on design and construction supervision. The Economic Planning Unit of the Prime Minister’s Department, through its Infrastructure and Public Utilities Section, provided overall coordination and guidance of project activities. These implementation arrangements proved adequate. 24. The Project was implemented in two stages. The first stage comprised 12 water districts and second stage also comprised 12 water districts. This was a departure from the original plan of implementing all the subprojects simultaneously. In the first stage, consulting services were used to undertake system planning and evaluation studies for all water districts. Each subproject covered consulting services for preliminary and detailed engineering design, and construction supervision; government procurement of materials and equipment for civil works;

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and award of construction contracts for individual components of the subproject. Construction contracts stipulated that the contractors procure minor components such as valves and pipe fittings. Additional structural elements of the Project, such as work on meter changes in some areas, were undertaken by force account, and training activities were directly managed and implemented by government staff. 25. In the first stage, consultant recruitment and procurement were centralized at the federal level, but difficulties in coordination resulted. Therefore, on the second stage, consultants were recruited and procurement was undertaken separately by each individual project state. The decentralized project implementation arrangement required extra time at the outset but enhanced efficiency once implementation started.

G. Conditions and Covenants 26. There were no particular conditions for the effectiveness of the Loan Agreement. Compliance with the major loan covenants is reviewed in Appendix 7. No covenants were modified, suspended, or waived during implementation. All major covenants were complied with, particularly those relating to implementation arrangements, selection and approval of subprojects, training, benefit monitoring and evaluation, environment, and O&M. However, some delays occurred in compliance with some financial covenants including full cost recovery and installation of a commercial accounting system. These are discussed in detail in paras. 38–43.

H. Consultant Requirement and Procurement 27. Consultants provided advisory services for subproject preparation, preliminary and detailed engineering design, and construction supervision for the Federal PWD and the project states. To avoid delays in engaging consultants, they were engaged prior to the loan approval. This facilitated smooth start-up of project implementation. The consultants were engaged following the local procurement procedures acceptable to ADB and financed using Government funds. 28. Procurement of goods and services from loan funds was made in accordance with ADB’s Guidelines on Procurement. Civil works, materials, and equipment were basically procured as appraised (Appraisal Report, Appendix 14). The Federal PWD received timely advice on any amendment to the ADB guidelines. Most contracts for civil works were awarded through local competitive bidding except for some minor civil works such as meter and valve repair and replacement, and interconnections carried out by the SWA through force accounts. There were 49 international competitive bidding contracts for procurement of materials and equipment, and 108 local competitive bidding contracts for civil works. The Federal PWD has previous experience with ADB projects, and no major problems were encountered in the packaging of contracts, preparation of the bidding documents, or evaluation of bids. No major disputes or contractual difficulties arose with any contracts.

I. Performance of Consultants, Contractors, and Suppliers 29. The performance of consultants in advising the federal PWD and the project SWAs was generally satisfactory. As the Project involved a large number of subprojects scattered all over the project states and the federal PWD and the SWA had staff constraints, consultant support was essential, particularly in projectwide monitoring and coordination. The performance of the contractors and suppliers was also generally satisfactory. However, in a few civil works contracts, contractors needed extra time to complete the work due to inexperience and/or financial difficulties. The quality of the built physical infrastructure is generally good, reflecting the satisfactory performance of consultants, contractors, and suppliers.

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J. Performance of the Borrower and the Executing Agency 30. The performance of the Borrower and the Federal PWD was generally satisfactory. The Government dealt effectively with implementation difficulties, including selecting subprojects given the available financial resources and coordinating with the many water districts. Government decisions resulted in a more appropriate number of subprojects and increased the project benefits. However, the Government could not avoid implementation delays due to unforeseen contractual and other administrative constraints relating to procurement, subloan agreements, and budgeting. Once preliminary misunderstandings concerning the form and timing of audited financial statements for the subprojects were overcome, these statements were filed in a timely manner. Staff training met expectations. Tariff reviews and measures to adopt commercial accounting were delayed.

K. Performance of the Asian Development Bank 31. The overall performance of ADB was satisfactory. The level of ADB monitoring through 142 staff days and 12 missions was adequate. ADB worked closely with the Government to resolve implementation issues, including the need to extend the loan closing date. During project implementation, ADB’s supervisory missions helped the Federal PWD and the SWAs resolve many implementation problems, particularly those relating to procurement activities and disbursement procedures. Through policy dialogue, ADB also supported full-cost tariffs, corporatization, the adoption of commercial accounts, and privatization of the operations of SWAs.

III. EVALUATION OF PERFORMANCE

A. Relevance 32. The Project is rated highly relevant. At appraisal, the Project was formulated in line with the Government development strategy for the water supply sector and ADB’s country strategy for Malaysia (paras. 5–9). The project objectives remained unchanged throughout implementation, particularly in the context of water supply system improvement and institutional capacity building. Key elements of Government policy that are still in force include universal servicing, federal funding of capital works, universal metering and user tariffs, and corporatization.

B. Efficacy in Achievement of Purpose 33. The Project partly achieved its immediate objectives. There was noticeable NRW reduction locally but not systemwide. Operational efficiency of the water supply systems has been improved by eliminating pipe bursts, controling water leakage, and freeing WTP capacities. Decisions about further corporatization and/or privatization for SWAs have been postponed. There was moderate progress in adopting of commercial accounting and considerable improvement in achieving full cost recovery tariffs. Overall, the Project is rated moderately efficacious. Details are described below.

1. Reduction of NRW 34. Total NRW by state and trend data from 1992 to 2000 are shown in Table 4. The average level of NRW for the seven states fell from 53.5 percent to 44.1 percent, a reduction of 9.4 percentage points. Details are given in Appendix 8.

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Table 4: Evaluation of NRW Levels State 1992 1995 1998 2000 Average Kedah 53.7 53.4 49.4 46.0 51.0 Melaka – – 36.0 55.3 43.8 N. Sembilan – 51.5 36.9 39.9 34.7 Pahang 59.6 35.4 46.8 45.6 51.3 Perak 48.2 42.6 42.4 40.4 44.1 Perlis – – – – – Terengganu 52.6 41.0 38.7 37.2 40.0 Average 53.5 44.8 41.7 44.1 44.1 – = not available. Source: Staff estimates.

35. At appraisal, NRW was expected to fall from 47 percent to 27 percent upon completion of the Project (a 20 percentage point reduction). Limited data at a subproject level indicate that a reduction of this magnitude has been achieved within the zones where works were completed. In the subdistrict of Chini in Pahang State, NRW fell from 43 percent in 1999 to 16 percent in 2000 after all of the street mains, service connections, and meters were replaced under the Project. A subsequent increase to 27 percent for the first six months of 2001 is attributed to failures in 300 millimeter asbestos cement transmission mains in the subdistrict. These mains are now subject to greater pressures as a result of the replacement of street mains 36. Overall, completed pipe works covered only 6.0 percent of total pipes, accounting for 10–20 percent of the total amount of works required for effective leakage control. Given the Project scope and the estimated achievements in NRW control, it is noted that the Project has achieved NRW reduction targets at a local scale and partially achieved them at a national scale.

2. Operational Efficiency 37. Operational benefits include the virtual elimination of pipe bursts and water leakage at pipe connections where pipes have been replaced. The reduction of NRW by 9.3 percent frees a total of 142,500 m3/day of water production capacity to service new customers. WTP upgrades have increased WTP production capacity by a further 93,480 m3/day. These changes translate into lower O&M costs, improved capacity to manage drought conditions, the opportunity to increase revenues through additional water sales, and the freeing of staff and resources previously dedicated to repairing frequent pipe bursts.

3. Commercial Accounts 38. Each SWA was covenanted to establish and maintain a commercial accounting system for its operations prior to project completion. Establishing a commercial accounting system was tied up with the corporatization and/or privatization process for SWAs. As discussed in para. 14, the SWA for Pahang was changed from a branch of the PWD to a SWD and the original SWD for Terengganu was corporatized as of 1 July 1999. There has been no change in Kedah, Perlis, Negri Sembilan, Melaka, and Perak. Decisions about further corporatization and/or privatization for SWAs have been postponed pending improvements in the commercial viability of SWAs. Government policy is that SWA operations are to be commercially viable as a condition of privatization. Details are given in Appendix 9. 39. Commercial accounting has been used in states where an independent water board or corporation operates the water supply system. In states where a state government operates the water supply system, SWAs still use the government cash-based accounting system. To date,

9

Melaka, Perak, and Terengganu States are using a commercial accounting system, while Pahang State is using a commercial accounting system concurrently with the government cash-based accounting system. Negeri Sembilan will adopt a commercial accounting system when the Federal Economic Planning Unit endorses its privatization proposal. Kedah and Perlis States need more time to adopt a commercial accounting system as their corporatization plan have yet to be firmed up.

4. Privatization 40. While privatization was not an identified output of the Project, it remains an important part of Government policy and is consistent with the expected output of increasing reliability and accountability in the sector (para. 4). The Government’s implementation plans for privatization have been delayed. Delays are caused by concerns that water supply operations are not yet commercially viable and that tariff adjustments to achieve viability would meet with stiff public opposition. The Federal and state governments are reluctant to increase tariffs because water is generally viewed as an essential public good that should be provided at low cost. With this attitude, the public opposes tariff increases even though the cost of water is quite low. Due to this opposition, the prevailing strategy of the state government is to improve the standards of service first in order to justify subsequent tariff increases. The strategy will work if the SWAs have sufficient funds in the absence of tariff increases to finance needed infrastructure investments. This has not been the case in many states.

5. Water Tariff Reviews 41. Each project state was covenanted to review water tariffs at periodic intervals of not more than two years and to furnish ADB the result. To the extent that it is considered practical and compatible with the economic well-being of water consumers, each state was also required to maintain tariffs at levels consistent with sound business, financial, and public utility practices. Tariffs should generate revenues adequate to cover all O&M costs, depreciation or debt services whichever is higher, and a reasonable proportion of future expansion costs. 42. All project states reviewed their water tariffs within the last two years. The Government submitted a report providing an overview of current state tariffs and related matters. Two of the seven states have adjusted their tariffs within the last five or six years while the other states have not adjusted their tariffs for a decade or more. 43. A cost recovery analysis spanning 1998 to 2000 showed that all project states except Pahang fully recover all reported operating costs and that three also recover depreciation or debt service costs (Appendix 10). While this performance seems to imply near full-cost recovery, the analysis is misleading because reported costs do not reflect the full costs of service delivery. Reported costs do not include the interest portion of debt service costs since SWAs receive interest-free loans from the Government. In addition, reported costs are based on capital plans that are not generally sufficient to replace asbestos cement pipes as quickly as is needed. Cost recovery for most of the project SWAs may be adequate for the time being but will deteriorate over time. This is due to an increasing burden of pipe replacement costs coupled with the practice of adjusting tariffs too infrequently.

C. Efficiency in Achievement of Outputs and Purpose 44. The financial internal rate of return (FIRR) exceeded the weighted average cost of capital and the economic internal rate of return (EIRR) is above 12 percent. The Project is rated efficient.

10

1. Financial Internal Rate of Return 45. The FIRR was calculated for the Project as a whole (i.e., for all subprojects combined) and for subprojects combined at the state level. The approach is essentially the same as that used at appraisal. The incremental costs include the costs of infrastructure investments and improved meter maintenance operations. The incremental revenues are associated with the sale of treated water that was previously NRW. The estimated FIRR for the project as a whole was 7.8 percent (Appendix 11). This compares favorably to a weighted average cost of capital of 5.3 percent. In the financial analysis at appraisal, the FIRRs for two subprojects were calculated to be 7.0 percent and 12.9 percent, respectively. 46. The PCR Mission’s estimates of FIRR at the state level varied from 2 to 21 percent. The highest FIRR was achieved in Perak, while the FIRRs in Melaka, Pahang, and Perlis were well below the overall project FIRR. These differences at the state level were caused primarily by cost discrepancies. The project capital cost per unit of water sold in Perak was RM2.5/m3/year while the average cost in the three states with low FIRRs was RM15.5/m3/year. These differentials will reflect the impact of various factors on cost, including customer density along service mains, topography, and expenditures on system rehabilitation that affected the quality or reliability of service but not the volume of water sales.

2. Economic Internal Rate of Return 47. The EIRR was estimated for the overall project and for combinations of subprojects in the participating states. Costs included in the EIRR analysis were adjusted to reflect the shadow exchange rate value of tradable goods. Cost savings are realized in pipe repair costs due to the elimination of pipe failures when old asbestos cement pipes are replaced. Project benefits were valued based on customer willingness-to-pay for water. The values assumed for willingness-to-pay underestimate actual willingness-to-pay since they are based on the current tariffs, which are very low. Benefits that are not valued include those associated with the reduced risk of exposure to water borne pathogens and the state-wide improvements in operations. Estimated EIRR for the project is 10.8 percent (Appendix 11). At appraisal, EIRR was not estimated.

D. Preliminary Assessment of Sustainability 48. The Project is rated less sustainable. The technical sustainability of the project facilities constructed is high. However, because tariffs are lower than full cost-recovery level for some project states, the financial sustainability is at risk. From a technical perspective, a concerted and well-planned program of pipe replacements is needed to assure that reductions in NRW in the subproject areas are not eroded by losses in adjacent service areas due to increases in water pressures. Sustainability also requires that new project assets be maintained in good working order. Project states are implementing asset management systems that will help assure that this is done. Asset management plans have been developed using the information created in the systemwide studies that were completed at the outset of the project. 49. The SWAs must resolve financial issues that jeopardize the sustainability of operations. Most of the SWAs have tariffs that recover all or most of the reported costs. But capital repairs and replacements are being deferred due to budget constraints. In this situation, tariffs are too low even if they cover all reported costs. The tariffs have not been adjusted for several years and in many cases for more than a decade. 50. The Federal PWD informed the PCR Mission that during the 8th five-year plan (2001-2005), a budget of RM290 million has been allocated for rehabilitating distribution systems. This amount represents only 10–20 percent of that requested by the states for this work. At current budget levels, the existing stock of asbestos cement pipes, which are causing most of the

11

system leakage, will not be replaced for several decades (Appendix 8). But most of these pipes are now at or near the end of their economic life. Since these pipes often represent over 50 percent of all pipes in the distribution systems, the current efforts to replace older asbestos cement pipes are inadequate and will not allow most state water authorities to sustain existing NRW levels let alone achieve national NRW targets. 51. Government commitment is needed to increase the allocation of funds to infrastructure replacement and to increase tariffs toward levels that can finance the rehabilitation and replacement of infrastructure. Such a commitment will mitigate the financial risk and improve the financial sustainability of project benefits, and must be accompanied by efforts to raise public awareness of and support for the need for tariff adjustments.

E. Environmental, Sociocultural, and Other Impacts

1. Environmental Impact 52. As expected at appraisal, the Project has had an overall positive environmental impact within and beyond the project water districts. During the project implementation, mitigation measures identified in the environmental impact assessment were undertaken as needed to prevent adverse impacts on the environment. Temporary disruption to the surroundings during construction was minimized by careful scheduling and strict site supervision. Roads were restored promptly after completing site works. As the project areas were mainly semi-urban or rural and the project components covered rehabilitation and upgrading of the existing facilities, little new wastewater will be generated from the Project and the impact of this wastewater is insignificant.

2. Social Impact 53. At appraisal, about 3.0 million people in the project districts were expected to benefit from improved water supply services, of which about 400,000 people were in less developed districts without direct access to water supply. Much of the benefit was assumed to accrue to the low-income households in rural and semi-urban communities. The actual number of beneficiaries residing in the project districts was estimated at 3.2 million in 2000. Of these, approximately 438,000 people are within the subproject areas serviced by replaced mains and other works. 54. Thus, direct beneficiaries in the subproject zones are estimated at 438,000. These beneficiaries are water customers served by the upgraded facilities. They benefit from improved pressure and a reduction in service interruptions and the associated risk of water contamination caused by pipe breaks. Within this group, about 26,000 people also benefit from improved drinking water quality resulting from treatment plant upgrades in two districts. The water quality improvements will reduce the risk to human health caused by waterborne pathogens that can enter the drinking water during system failure. People living outside of the zones directly serviced by civil works will benefit from the training of district staff in NRW control and because staff and resources once used to manage pipe breaks in the refurbished zones are available to work elsewhere in the districts. 55. The WTP capacity freed by NRW reduction in project areas is sufficient to service 113,000 new accounts in areas that are currently unserviced. Domestic accounts comprise 90 percent of the new accounts and represent approximately 460,000 people. New capacity created under the Project can service 73,000 new accounts or 300,000 people.

12

56. Subprojects are in predominantly rural areas where living standards are lower than in urban areas. A relatively high proportion of project beneficiaries therefore reside in low income households. 57. An assessment of the affordability of current water tariffs indicated that households with an average income spend up to 1.2 percent of their income on water supply services, while the proportion of income spent by poor households does not exceed 2.5 percent (Appendix 12). Affordability of water is not therefore a problem now. It may however become a problem for poor households if tariffs are increased to the levels that may be required to finance asbestos cement pipe replacements. However, various measures can be used to mitigate the affordability problem while still maintaining full-cost tariffs, including lifeline tariffs for all domestic customers or direct subsidies to poor households.

3. Other Impacts 58. The training covered preventive maintenance for WTPs and water distribution systems including leak detection, network modeling, field measurements, and instrumentation. In total, 234 staff received training in these areas. An additional 100 staff received training in commercial accounting practices. 59. SWAs have also established formal NRW programs in four of the seven states. These are permanently staffed programs. NRW program activities include detailed studies by pressure zone, zone metering, WTP metering, and ongoing sonic survey work. Training has also led to changes in maintenance programs such as the installation of pressure reducing valves and improvements in methods used to repair pipe bursts. 60. Progress has been slow in the institutional restructuring of SWAs into water boards or corporations. Changes that have been made in the organizational structure may not improve the financial performance as expected because key elements of the institutional framework involving tariff adjustments and investment planning have not been changed. After corporatization, state governments rather than independent regulatory commissions continue to make final decisions regarding tariffs. These decisions focus on social goals and give too little weight to financial and technical objectives. Investment decisions also continue to be strongly influenced by the development planning process at state and federal levels. This influence persists because governments continue to be the principle source of funding for these investments. 61. The private sector is involved in the operation of WTPs through short-term service contracts and long-term concession contracts. The private sector was not involved in financing investments under the Project using arrangements such as new concession contracts due to the approach to tariff approvals (see para. 41). Private sector involvement in the project was limited to provision of technical services through service contracts. The contracts were released as small packages in order to allow small-scale contractors an opportunity to benefit from the project. Because of the experience gained by contractors through this measure, the portion of the construction industry that serves the water supply sector has been strengthened.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS

A. Overall Assessment

62. Although the total number of subprojects was reduced, the project components were implemented largely as conceived. The completed infrastructure investments focused largely on rehabilitating distribution systems. Fewer subprojects were implemented than planned but these

13

benefited a somewhat greater number of people than originally anticipated. Operational efficiency was improved and NRW control targets were fully achieved locally but only partly achieved nationally. Institutional strengthening of SWAs through corporatization and the adoption of commercial accounting systems is progressing slowly. Training was conducted as scheduled. Project benefits that accrue to poor households are substantive. The Project was completed with a 30-month delay and a reduced number of subprojects. However, these changes did not affect the overall project performance significantly. 63. The Project is rated highly relevant, efficacious, efficient, less likely to be sustainable, and moderate with respect to institutional and other impact. Overall, the Project is rated successful as summarized in Table 5.

Table 5: Assessment of Initial Project Performance Criterion (a)

% Weight

(b)

Assessment (c)

Rating Value (d)

Weighted Ratinga (bxd)

Relevance 20 Highly relevant 3 0.60 Efficacy 25 Efficacious 2 0.50 Efficiency 20 Efficient 2 0.40 Sustainability 20 Less sustainable 1 0.20 Institutional Development

and Other Impacts 15 Moderate 1 0.15

Overall Rating 100 1.85 a Highly successful = overall weighted average (OWA) > 2.5, and no criteria less than 2; successful = OWA 1.6-2.5,

and no criteria less than 1; Less than successful = OWA 0.6-1.6, and not less than 2 criteria less than 1; unsuccessful = OWA <0.6.

Source: Staff estimates. B. Lessons Learned 64. Implementation Arrangements. When a large number of subprojects are involved in a project and each subproject requires a number of activities in sequence, i.e., design, procurement, and construction, the effect of compound delays should be properly and conservatively assessed and reflected in the appraisal implementation schedule. For a project consisting of a large number of geographically dispersed subprojects, strong central project coordination at the state rather than the central level is essential for smooth implementation and dissemination of useful information to participating water districts. 65. NRW Reduction. The anticipated NRW reduction to 27 percent by project completion was too ambitious given the small scale of the Project. Effective and sustained reduction of NRW needs a comprehensive and detailed action plan with monitoring milestones. An NRW action plan should include a substantial commitment of financial and human resources, careful planning and delineation of achievable targets, and periodic program monitoring and evaluation. In addition, information exchange among SWAs would help solve common problems associated with NRW and would reinforce NRW control efforts. Most SWAs have developed or are developing NRW control programs but implementation has been hampered by financial constraints. In light of this experience, a key focus of loan projects for NRW control should be the establishment of ongoing and sustainable NRW programs. 66. Project Performance Monitoring and Evaluation. When the Project was appraised, it was not standard practice to prepare a project performance monitoring and evaluation system including risk analysis. The experience gained under the Project highlights the importance of analyzing risks, including the detailed action plan for NRW reduction. For purposes of

14

evaluation, project targets should be logically linked to project activities and methods to monitor the achievement of these targets should be based on indicators that can be reliably measured at an appropriate scale. 67. Tariff Adjustments and Full Cost Recovery. The financial risks associated with regulated public utilities are closely tied to the regulatory policies and practices of the Government. In the current case, tariff policies are the most significant source of jeopardy for financial sustainability. It is important to anticipate this source of risk and to address it forcefully during the implementation of loan projects for public utilities. 68. Corporatization/Privatization. Decisions concerning corporatization and privatization of public utilities are complex, encompassing a range of technical, financial, socioeconomic, and political issues. The infrastructure investments under this Project do not require corporatization or privatization to be successful. Moreover, privatization was not initially identified as a project output. While the need to finance large investments may underlie a decision to privatize, corporatization and/or privatization are undertaken for a variety of other reasons, as appears to be the case in Malaysia. Under these circumstances, efforts to promote corporatization and/or privatization within the scope of an infrastructure loan project might be expected to meet with limited success. In line with this, covenants relating to commercial accounting and organizational restructuring could have been relaxed or dropped.

C. Recommendations

1. Project-Related 69. The activities requiring follow-up under the Project include the following:

(i) In consultation with the Federal Economic Planning Unit, each SWA should continue its efforts for corporatization and/or privatization. In parallel with this, each SWA should also continue to review its water tariffs regularly and increase the rates as necessary to achieve and then maintain financial sustainability. An independent commission to regulate tariffs should be established to reinforce corporatization. In line with corporatization/privatization, efforts for establishing a commercial accounting system for the remaining states should be also continued.

(ii) Public opposition to tariff increases is impeding efforts to achieve full cost recovery and sustainability. A concerted campaign of public education should be mounted to explain the status of SWAs and to promote higher tariffs for improved services.

(iii) Each SWA should continue its rehabilitation and upgrading program under Malaysia’s five-year plan, focusing on further reductions of NRW. Government should provide more financial support to NRW control programs to reflect the urgency of the current situation. In view of the complex nature of the NRW issue, NRW reduction plans should be established in every state with appropriate financial resources to effectively control and monitor NRW. NRW reduction plans should be time-bound and monitored on an annual basis to permit an evaluation of the effectiveness of the measures taken. Programs should include zone metering systems, a rolling program for regular meter change, and systematic checking and upgrading of computerized maintenance and customer billing records. In these plans, greater use should also be made of WTP production meters and pressure zone meters to facilitate accurate monitoring and evaluation of NRW impacts.

15

(iv) Each SWA should continue to monitor project benefits, including socioeconomic data, O&M, NRW-related data, project beneficiaries, and relevant financial data.

(v) If ADB selects the Project for a project performance audit review, it could be undertaken in 2003 or 2004, when full operational data on the project facilities are available.

2. General 70. Based on some key lessons learned from the Project, the following general recommendations are made for future ADB projects:

(i) The institutional and physical objectives for a sector loan project should be balanced in scale and scope to reduce the risk of an unsuccessful outcome. For example, a government agency acting as an executing agency for a sector loan project featuring physical elements that are small and local in nature may not have the resources or leverage within government to implement broad national objectives for institutional reform. This caution applies to both technical and institutional objectives.

(ii) The project benefit monitoring and evaluation plan is most likely to yield useful results if it is designed at the outset during or prior to loan negotiations. Care should be taken to develop a benefit monitoring and evaluation plan that is adequately resourced and that is based on meaningful and measurable performance indicators and feasible monitoring methodologies.

(iii) Strong emphasis on institutional strengthening, particularly concerning the central coordination, is required at the state level in future water supply projects, which have a large number of geographically dispersed subprojects.

16

APPENDIXES

Number Title Page Cited on (page, para.)

1 Project Logical Framework 17 1, 2

2 Water Districts 19 2, 9

3 Project Cost at Appraisal and Actual 20 4, 16

4 Actual Loan Disbursements 21 5, 19

5 Chronology of Events 22 5, 21

6 Implementation Progress 24 5, 22

7 Status of Compliance with Loan Covenants 25 6, 26

8 Nonrevenue Water Analysis 30 7, 34

9 Privatization and Corporatization 33 8, 38

10 Cost Recovery Analysis 37 9, 43

11 Financial and Economic Evaluation of the Project 39 10, 45

12 Assessment of Affordability of Water Supply 47 12, 57

Appendix 1, page 1

17

PROJECT LOGICAL FRAMEWORK

Design Summary Targets Project Monitoring Mechanisms Risks/Assumptions

Sector/Area Goals Improve water supply in the project states.

Sustain access to safe and adequate water supply for 3 million people, of which 0.4 million people are in less developed areas without direct access to water supply.

Socioeconomic surveys at midterm and at project completion.

Other central and state government agencies provide effective supports.

Project Objective/ Purpose

• Reduce nonrevenue water (NRW).

• NRW will be reduced from 47 percent to 27 percent by project completion.

• Quarterly progress reports.

• Review at midterm and project completion.

• Project facilities are properly designed, constructed, and operated and maintained.

• Maintenance of the project facilities is sustainable.

• Upgrade the institutional capacity of the state water authorities (SWAs).

• Training will be conducted during project implementation

• Commercial accounting system will be established and maintained by project completion.

• Regular review of tariffs.



• Corporatization/ privatization of the

SWAs completed. • Tariffs set at

appropriate levels and affordable.

Project Outputs/ Components

• Leakage control and physical rehabilitation of the existing water supply facilities including water treatment plants, transmission and distribution pipelines, service reservoirs, valves, meters, and instrumentation and control.

• 32 water districts in the 9 project states will be covered.

• Progress reports and ADB review missions.

• Adequate funding from state governments and/or SWAs.

• Consultants provide reliable engineering design.

• Effective operation and maintenance (O&M) of the project facilities.

Appendix 1, page 2

18

Design Summary Targets Project Monitoring Mechanisms Risks/Assumptions

• Operational improvements through procurement and installation of NRW reduction equipment.

• NRW will be reduced from 47 percent to 27 percent by project completion.



• Efficient O&M of the project facilities.

• O&M training.

• Training requirements will be assessed during implementation.

• ADB review of the training program prepared by the Executing Agency.

• Appropriate training program prepared and implemented.

• Improved reliability and accountability.

• Commercial accounting system will be established and maintained by project completion.

• ADB review of progress in adopting commercial accounts.

• Adoption of commercial accounting requires corporatization.

Activities • Appointment of

consulting services.

• Engagement of 1,600 person-months ($14 million) domestic consultants.


• Delays in recruitment of consultants.

• Physical infrastructure surveys, investigation, and engineering design.

• Detailed survey of existing facilities and detailed engineering design.


• Engineering design consultants competent.

• Rehabilitation and upgrading of water supply systems.

• Rehabilitation and upgrading of water supply systems in 32 water districts ($172.6 million).


• Construction companies competent.

• Administrative efforts in staff training and in the adoption of commercial accounting.

• Complete staff training in NRW control and commercial accounting.


• Adoption of commercial accounting requires corporatization.

19 Appendix 2

State District State District

Johor KluangMuarSegamatKota Tinggi

Kedah Baling Kedah Baling (P1)Langkawi

Kelantan Tanah MerahPasir MasBachokGua Musang

Melaka Jasin Melaka Jasin (P1)Alor Gajah Melaka Tengah (P1)

Negeri Sembilan Seremban Negeri Sembilan Seremban (P1)Tampin Port Dickson (P1)

Pahang Raub Pahang Raub (P1)Jerantut Jerantut (P1)Bentong Bentong (P4-A)Kuala Lipis Kuala Lipis (P4-A)Pahang Tenggara Pahang Tenggara (P4-B)

Temerloh (P1)Kuantan (P4-B)Maran (P4-B)

Perak Kinta (Kampar) Perak Kinta (Kampar) (P1)Hilir Perak Hilir Perak (P2)Batang Padang Batang Padang (P2)Perak Tengah Perak Tengah (P2)Kerian Kerian (P2)Kuala KangsarManjung

Terengganu Kemaman Terengganu Kemaman (P1)Besut/Setiu Besut/Setiu (P1)Ulu Terengganu Hulu Terengganu (P3)

Kuala Terengganu (P3)Dungun/Ketengah (P3)

Perlis Perlis (P1)

Negeri Selangor Ulu LangatKuala LangatUlu Selangor

TOTAL 32 24

P1 = contract package 1; P2 = contract package 2; P3 = contract package 3; P4-A= contract package 4-A;P4-B = contract package 4-B.

At Appraisal Actual

WATER DISTRICTS

Change fromItem LC LC Appraisal Report

ADB Gov't. Gov't. Total ADB Gov't. Gov't. Total Total

1. Civil Works 25,000,000 0 44,000,000 69,000,000 38,402,188 76,861,672 115,263,860 46,263,860 (Leakage Control & DistributionRehabilitation, DistributionUpgrading & Water TreatmentPlant Rehabilitation)

2. Equipment and Materials 67,600,000 0 20,000,000 87,600,000 50,356,674 9,435,431 59,792,105 (27,807,895) (Cold Meters, Pipes & Fittings,& Valves)

3. Meters Replacement 11,200,000 0 3,200,000 14,400,000 79,599 1,615,712 1,695,311 (12,704,689)

4. O&M Equipment & Instruments 1,200,000 0 400,000 1,600,000 242,729 1,414,791 1,657,520 57,520

5. Training 0 0 400,000 400,000 0 982,462 982,462 582,462

6. Consulting Services 0 0 14,000,000 14,000,000 0 0 15,004,167 15,004,167 1,004,167

7. Taxes, Duties, & Land Acquisition 0 0 5,000,000 5,000,000 0 0 4,224,685 4,224,685 (775,315)

8. Interest During Construction 0 16,000,000 0 16,000,000 0 15,273,694 0 15,273,694 (726,306)

TOTAL 105,000,000 16,000,000 87,000,000 208,000,000 89,081,190 15,273,694 109,538,920 213,893,804 5,893,804

ADB = Asian Development Bank; FX = foreign exchange; LC = local cost; O&M = operation and maintenance.

PROJECT COST AT APPRAISAL AND ACTUAL($)

FX FXAppraisal Estimates Actual

20Appendix 3

21 Appendix 4

Quarterly Cumulative % toDisbursement Disbursement Loan

1996 I 0.065 0.065 0%II 0.000 0.065 0%III 0.565 0.630 1%IV 0.076 0.706 1%

1997 I 2.032 2.738 3%II 7.850 10.588 12%III 11.068 21.656 24%IV 5.567 27.223 31%

1998 I 3.102 30.325 34%II 5.475 35.800 40%III 8.251 44.051 49%IV 1.994 46.045 52%

1999 I 5.056 51.101 57%II 2.509 53.610 60%III 0.280 53.890 60%IV 0.000 53.890 60%

2000 I 18.482 72.372 81%II 2.695 75.067 84%III 8.757 83.824 94%IV 2.198 86.022 97%

2001 I 2.486 88.508 99%II 0.573 89.081 100%

Total 89.081

Note: No disbursement plan was prepared at appraisal.

Quarter

ACTUAL LOAN DISBURSEMENTS($ million)

ActualPeriod

Year

Appendix 5, page 1 22

CHRONOLOGY OF EVENTS

1992 Nov - Loan Approval

1994 Jul - Loan Signing Sep - Loan Effectiveness (8 Sep 1994)

1995 May - Completion of Stage I (Detailed Engineering, Investigation, Prelim. Eng Proposal/Cost Estimates) of Package 1

Jun - Completion of Stage II of Package 1 Apr-Aug - Award of Tenders of all ICB Supply Contracts under Package 1

1996 Feb - First Disbursement

1996- May } - Award of Tenders for all LCB Works Contracts under Package 1 1998 Jun }

1996 Jun - Commencement of First Supply Contract

1997 Feb - Completion of Stage I of Package 4A and 4B

Aug - Completion of Stage I of Package 3 Sep - Completion of Stage I of Package 2

1997- Jul } - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 2

1998 Aug }

1997 Jul - Award of First Contract (LCB)

1997- Dec} - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 3

1998 Oct } for ICB Tenders and Award of ICB Tenders

1997- } - Completion of Stage III (Construction) of Contract Packages 2000 Dec }

1997 Dec - Original Loan Closing Date

Dec - First Extension of Loan Closing Date from 31 December 1997 to 31 December 1999

1998 Mar - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 4A

for ICB Tenders and Award of ICB Tenders

1998 May - First Full Completion of Contract (LCB - Package 1)

1998- Jun } - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 4A

1999 Jan } for LCB Tenders and Award of LCB Tenders

1998 Jun - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 4B

for ICB Tenders and Award of ICB Tenders


1998- Sep } - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 4B

1999 Jul } for LCB Tenders and Award of LCB Tenders

1999 May} - Completion of Stage II (Detailed Engineering Design, Preparation of Tender Documents & Estimates) of Package 3

2001 Mar } for LCB Tenders and Award of Contracts

2000 Jan - Second Extension of Loan Closing Date from 31 December 1999 to 31 December 2000

Dec - Last Full Completion of Contract (LCB - Package 2) During the Implementation Period

- Loan Closing Date - Physical Completion

2001 Jun - Final Disbursement - Cancellation of Unutilized Loan Balance of $15.919 million. - Closing of the Loan Account Aug - Project Completion Review by ADB

Consultant Recruitment

Leakage/Control/Survey

Distribution System Study

Detailed Design

Tendering

Contract Awards

Construction/Installation

LEGEND:Planned

Actual

II II III IV II III IV II III IVI I II III IV I II III IV I II III IV I II III IV I II III IV1999 2000

IMPLEMENTATION PROGRESS

1993ACTIVITIES 1994 1995 1996 1997 1998

24Appendix 6


STATUS OF COMPLIANCE WITH LOAN COVENANTS

Covenant Status of Compliance

General 1. The Borrower will make available, promptly as needed,

the funds, facilities, services, land and other resources required, in addition to the proceeds of the loan, to carry out of the Project and operate and maintain its facilities. (Loan Agreement [LA], Article IV, Sec. 4.02)

Complied with.

2. The Borrower will cause competent and qualified consultants and contractors, acceptable to the Borrower and the Asian Development Bank (ADB), to be employed to an extent and upon terms and conditions satisfactory to the Borrower and the Bank. (LA, Article IV, Sec. 4.03)

Complied with.

3. The Borrower will (i) maintain, in accordance with appropriate accounting systems, separate accounts for the Project and each subproject; (ii) have such accounts and related financial statements audited annually, in accordance with sound auditing standards, by auditors acceptable to ADB; (iii) furnish to ADB as soon as available but not later than six months after the end of each related fiscal year, certified copies of the audited accounts and financial statements, and not later than nine months after the end of each related fiscal year, certified copies of the audited accounts and financial statements and the report of the auditors relating thereto, all in English; and (iv) furnish to ADB other information concerning the accounts and financial statements and the audit thereof as ADB requests. (LA, Article IV, Sec. 4.06 [b])

4. The Borrower will furnish to ADB progress reports on the Project and the operation and management of its facilities, every four months. (LA, Article IV, Sec. 4.07 [b])

Complied with. Complied with.

5. Promptly after physical completion of the Project, and

not later than three months thereafter or such later date as may be agreed for this purpose between the Borrower and ADB, the Borrower will prepare and furnish to ADB a project completion report, in form and detail as requested by ADB. (LA, Article IV, Sec. 4.07 [c])

The Federal Public Works Department submitted its project completion report in July 2001.



Criteria for Selection of Subprojects 6. Each subproject will cover one water district and may

include several water resources and water treatment plants. Each subproject will be selected by the Federal PWD in consultation with the Economic Planning Unit, on the basis of (i) need for improved water quality and/or quantity, (ii) relatively high nonrevenue water (NRW) level; (iii) unmet demand for water supply; (iv) serious operation deficiencies; (v) acceptance of the need for water tariff revisions; and (vi) minimum adverse effect on the environment. (LA, Sch. 5, para. 4 [a])

Complied with.

7. Each subproject will also have established water supplies available and have been approved by the concerned state for inclusion in the Project. (LA, Sch. 5, para 4 [b])

Complied with.

Appraisal and Approval of Subprojects

8. Each selected subproject will be appraised and reviewed

in detail by the Federal PWD in consultation with the Economic Planning Unit and with assistance from the consultants where necessary. A separate appraisal report will be prepared for each subproject. (LA, Sch. 5, para 5 [a])

Complied with.

9. Prior to any withdrawal of the proceeds of the loan for any subproject, the Borrower will have entered into with the concerned state a relending agreement for relending the proceeds of the loan and the local currency requirements. In the case of Melaka, the state and the State Water Board will have entered into a subsidiary loan agreement for onlending the proceeds of the loan and the local currency requirements. (LA, Sch. 5, para 5 [c])

Complied with.

Training 10. The Borrower will ensure that the executing agency, in

coordination with water supply authorities, will organize adequate training of trainers and selected local personnel to be involved in operation and maintenance (O&M) of water supplies facilities, preventive maintenance for water treatment plants and water distribution systems, and new technologies for pipe rehabilitation. (LA, Sch. 5, para 6 [a])

Complied with.



11. The Borrower will prepare a detailed program for training under the Project and submit the program to ADB for its review and information not later than 31 December 1993. (LA, Sch.5, para 6 [b])

Complied with.

Financial 1. Accounts Reports and Audits

12. In addition to the general requirements of Sec. 4.06 (b)

the Loan Agreement, each WSA will establish and maintain separate project accounts for expenditures incurred for each subproject. The accounts will be audited annually by the Federal PWD, which will compile an annual summary of the subproject accounts and furnish it to ADB with (i) the unaudited project accounts and related documents, within six months after the close of the relevant fiscal year; and (ii) certified copies of audited Project accounts, together with the auditors’ report in English, within nine months.

(LA, Sch. 5, para 7 [a])

Complied with.

13. The Federal PWD will collect and forward to ADB unaudited financial statements of WSAs in English, within six months after the close of each fiscal year. For states that have not yet established a commercial accounting, WSAs will submit notional financial statements duly audited by the auditor. (LA, Sch.5, para 7 [c])

Complied with.

2. Commercial Accounting System 14. The Borrower will take all steps necessary for each WSA

to (i) establish and maintain a commercial accounting system for its operations as soon as possible, but not later than the project completion date; and (ii) secure qualified accounting staff necessary to implement the commercial accounting system. (LA, Sch. 5, para 8 [a])

Complied with. This requirement has been tied up with the corporatization/privatization of the water authorities and upon corporatization/privatization, the water authority will adopt a commercial account system.

15. Qualified accountants will be made available when

necessary, to help establish the commercial accounting system and provide appropriate training to the accounting staff of WSAs. (LA, Sch. 5, para 8 [b])

Complied with.



Water Charges 16. The Borrower will ensure that each state reviews its

water charges at least every two years, and will furnish to ADB the results of the reviews. (Sch. 5, para 9 [a])

Being complied with.

17. To the extent practicable and compatible with the economic well-being of water consumers, the Borrower will ensure that each state takes all necessary measures so that the tariffs for water supply are consistent with sound business, financial and public utility practices and generate revenues adequate to cover (i) all O&M costs, (ii) depreciation or debt service charges that such charges exceed the provision for depreciation, and (iii) reasonable proportion of future expansion costs. (LA, Sch. 5, para 9 [b])

Being complied with. The current water tariffs of the project states have achieved the full cost recovery target except for Pahang. Since Pahang State is the largest state with the lowest population density, cross-subsidy could be justified in its tariff level and structure.

Benefit Monitoring and Evaluation

18. The WSAs, through their district offices, will undertake

benefit monitoring and evaluation (BME) activities to monitor and measure the actual performance and benefits envisaged in the Project formulation. The data to be collected and analyzed will include socioeconomic bench surveys, baseline data on population, O&M, NRW-related data, project beneficiaries, and relevant financial data. (LA, Sch. 5, para 10 [a])

Complied with.

19. The BME activities will be coordinated by the Federal PWD. The Federal PWD will also compile an annual summary of BME reports prepared by each WSA and submit to ADB one month after the close of the relevant fiscal year. The Federal PWD will evaluate the benefits of the Project after it has been completed in accordance with a schedule and terms of reference that are mutually agreeable to ADB and the Borrower. (LA, Sch. 5, para 10 [b])

Complied with.

Environment

20. In compliance with ADB’s and the Borrower’s environmental requirements, an initial environmental examination, and where required, an environmental impact assessment will be conducted for environmentally sensitive subprojects to mitigate expected adverse environmental impacts. (LA, Sch. 5, para 11)

Complied with.



Operation and Maintenance 21. The WSA concerned shall be responsible for O&M of the

Project facilities in each state. (LA, Sch. 5, para 12 [a])

Complied with.

22. To ensure that the Project facilities are operated and maintained efficiently and in accordance with sound public utility practices, the Borrower will ensure that WSAs provide an adequate number of technical staff and supporting workforce. Before completion of the Project, each WSA will review its staffing requirements for operating and maintaining the project facilities, and implement the results of the review. (LA, Sch. 5, para 12 [b])

Complied with.

23. The Borrower will cause the Federal PWD, through its Water Supply Branch, to continue to provide technical support to WSAs to ensure the O&M of the Project facilities. (LA, Sch. 5, para 12 [c])

Complied with.

Land and Water Rights 24. The Borrower will take all steps required to acquire or

make available, on a timely basis and in accordance with the Project implementation schedule, all land, rights to land and water, and riparian rights required for the Project.

(LA, Sch. 5, para 13)

Complied with.


NONREVENUE WATER ANALYSIS 1. This appendix provides background information on nonrevenue water (NRW) in the participating states: Kedah, Melaka, Negeri Sembilan, Pahang, Perak, Perlis, and Terengannu. The appendix gives further insight into the status and causes of NRW and the costs of its control. A. Nonrevenue Water Levels 2. Data on water production and sales were compiled at the state level for 1992 to 2000. These were used to develop the statistics on NRW by state in Table A8.1. NRW averages 45 percent for all states over the period and ranged from just under 30 percent to 53 percent.

Table A8.1: Total Nonrevenue Water for the State (%)

State 1992 1993 1994 1995 1996 1997 1998 1999 2000 AverageKedah 53.7 52.4 53.5 53.4 52.0 51.2 49.4 51.1 46.0 51.0Melaka – – – – – – 36.0 36.2 55.3 43.8N. Sembilan – – 55.2 51.5 43.5 35.0 36.9 38.8 39.9 34.7Pahang 59.6 58.2 57.5 35.4 56.1 54.0 46.8 46.4 45.6 51.3Perak 48.2 49.0 48.3 42.6 42.8 43.9 42.4 40.9 40.4 44.1Perlis – – – – – – – – – – Terengganu 52.6 48.5 48.7 41.0 28.9 33.0 38.7 41.1 37.2 40.0Average 53.5 52.0 52.6 44.8 44.7 43.4 41.7 42.4 44.1 44.1– = not available. Source: Staff estimates. 3. The level of NRW varies year by year but has generally decreased for the five states reporting data from 1994 (Figure A8). For these states, NRW averaged 52.6 percent in 1994 and 44.1 percent in 2000. This change constitutes a 16.3 percent reduction in the NRW level.

Figure A8: NRW by State

20%

25%

30%

35%

40%

45%

50%

55%

60%

1994 1995 1996 1997 1998 1999 2000

Kedah N. Sembilan Pahang Perak Terengganu


4. The annual variability is caused in part by weather conditions. During periods of drought, system pressures can fall due to high usage and lower levels of production if sources of supply are depleted. The lower pressure in turn lowers system leakage. B. Sources of Nonrevenue Water 5. When asked about the causes of NRW, all of the states indicated that losses in the distribution system were a major factor. Only one state suggested that theft was also significant. Information was obtained on NRW in a few water supply districts from phase one studies in Melaka and Negeri Sembilan (Table A8.2). In these districts, system leakage accounted for 80 to 86 percent of total NRW with meter error and other losses accounting for the balance. Other losses include water used for flushing mains, water used for fire fighting, and theft.

Table A8.2: Sources of NRW in Three Water Districts

Districts System Leakage

Meter Error

Other Losses Total NRW

Percentage of Total Water Production Jasin WSD, Melaka 31.3 4.4 2.5 38.2 Port Dickson WSD, N. Sembilan 39.5 4.2 5.4 49.1 Seremban WSD, N. Sembilan 47.4 4.2 3.8 55.4 Percentage of NRW Jasin WSD, Melaka 81.9 11.5 6.5 100.0 Port Dickson WSD, N. Sembilan 80.4 8.6 11.0 100.0 Seremban WSD, N. Sembilan 85.6 7.6 6.9 100.0

WSD = water supply district. Source: Staff estimates. 6. There may also be upward bias in the estimation of overall loss levels because many water treatment plants do not have meters to measure water production. In these cases, production volumes are estimated based on the operating times and rated capacity of pumps used to lift treated water into the distribution system. These calculations do not account for pump efficiency and may therefore overestimate total production levels. This in turn will yield a high estimate of NRW volumes. No estimate was made of the potential magnitude of this error. 7. System leakage includes losses at tapping points where service connections are joined to service mains, leakage through holes in the pipes, and losses when mains fail. Most of the system leakage is associated with asbestos-cement pipes that were generally laid during the 1950s to the early 1990s. These pipes are prone to failure after 20 years due to a variety of factors including weakening of pipe walls with age and poor pipe bedding conditions during construction. C. Nonrevenue Water Control Measures 8. Several states have initiated a variety of NRW control measures with the help of the Asian Development Bank loan. All states have trained their staff in NRW control. Specific technical measures that have been implemented in the water supply districts include (i) installation of pressure reducing valves, (ii) metering and assessment of individual pressure zones, (iii) increased frequency of meter change outs to every 7 years, (iv) improved approaches to the repair of pipe bursts; and (v) establishment of full-time teams for NRW control and for system surveillance to detect theft as well as other water use violations.


D. Cost of Nonrevenue Water Control 9. Pipe replacement is ongoing but most states agree that current replacement rates are too slow. From 50 to 70 percent of all the pipes in the participating states are asbestos cement. The replacement cost was estimated to assess the tariff increase that may be required to finance asbestos cement pipe replacements (Table A8.3). Assuming that 50 percent of asbestos cement pipes should be replaced over 10 years at a cost of RM200,000 per kilometer, tariff increases of RM0.3 to RM0.7 per cubic meter of water sold would be required. This is an increase of the average tariff ranging from 30 percent to 100 percent. This increase does not account for the costs of other NRW control measures such as more frequent meter changes and the establishment of leakage detection and control programs.

Table A8.3: Asbestos-Cement Pipe Inventories by State Costs for AC Pipe Replacementa State Total Pipes

(km) AC Pipes

(km) (RM million/year) (RM/m3 of sales) Kedah 7,257 – – – Melaka 3,302 1980 19.80 0.28 N.Sembilan 5,516 3947 39.47 0.40 Pahang 12,167 8308 83.08 0.72 Perak 7,502 5500 55.00 0.30 Perlis 1,594 – – – Terengannu 4,506 2229 22.29 0.38 AC = asbestos cement; km = kilometer; m3 = cubic meter. a Assumes that 50 percent of the AC pipes must be replaced within 10 years at an average cost of

RM200,000 per kilometer of pipe. Cost per cubic meter of sales is calculated assuming sale levels in 2000.

Source: Staff estimates.


PRIVATIZATION AND CORPORATIZATION 1. This appendix reviews the status of efforts relating to the corporatization and privatization of state water supply authorities (SWAs). Four types of organizational structure can be used by the state authorities as described in Table A9.1. The organizational structure of SWAs that participated in the loan project is described in Table A9.2.

Table A9.1: Organization of State Water Supply Authorities Type Description Water Supply Branch of a State Public Works Department (PWD)

• As a branch of PWD, operations and budget reflect overall priorities of PWD.

• Capital works priorities set in competition with other public works and financed out of general revenues.

• Capital investments approved and financed by state government. • Water sale revenues go into general revenues. • Tariffs set by state government. • State government accounting system (cash based accounts).

State Water Department (SWD)

• Operates as a separate department with its own operating and capital budget.

• Increased autonomy in operations. • Capital investments approved and financed by state government. • Water sale revenues go to general revenues. • Tariffs set by state government. • Government accounting system (cash based accounts).

State Water Board (SWB)

• Operates as an independent agency governed by a board of appointed directors and managed by a general manager.

• Sets own operating and capital budget. • Capital investments approved and financed in part by state government. • Water sale revenues retained by SWB. • Tariffs approved by state government. • Commercial accounting system (accrual based accounts).

Corporation (SWC) • Operates as an independent statutory corporation governed by a board of appointed directors and managed by a general manager.

• Sets own operating and capital budget. • Capital investments approved and financed in part by state government. • Water sale revenues retained by SWC. • Tariffs approved by state government. • Commercial accounting system (accrual based accounts).


Table A9.2: Types of Water Supply Authorities at Appraisal and Present

Type At Appraisal, 1992 Present, 2001 Operating Unit within a State Public Works Department (PWD)

Kedah, Pahang, Perlis Kedah, Perlis

State Water Department (SWD)

Negeri Sembilan, Terengganu

Pahang, Negeri Sembilan

State Water Board (SWB) Melaka, Perak Melaka, Perak, Corporation (SWC) Terengganu

2. At appraisal, Melaka and Perak used commercial accounts and Terengganu was in transition to commercial accounts. Since then, Terengganu has completed the shift to commercial accounting standards, and Pahang now runs commercial accounts in parallel with cash accounts. 3. No SWAs have been privatized, but the operations of several water treatment plants have been privatized, ranging from short-term service contracts covering only labor in Pahang to long-term concession contracts covering labor and capital costs in Perak. A. Government Policy on Corporatization and Privatization1 4. Under the Constitution of Malaysia, water is a state matter. The states are responsible for their own water supply operations and must take the initiative to corporatize or privatize these. Any planned course of action is first referred to the federal Government for review and consultation. 5. Privatization is a key element of the government’s overall economic development strategy. The Government promotes concessionaire-based privatization schemes for SWAs that encompass treatment works, distribution systems, billing, and customer services. This approach is favored since it allocates a greater degree of risk to the private operator and provides the operator with more incentive to manage nonrevenue water and maintain the value of fixed assets. 6. Important features of the overall privatization strategy are that (i) it emphasizes projects that stimulate growth, (ii) a streamlined implementation process is used to ensure effectiveness of the privatization program, (iii) projects targeted for privatization should first be commercially viable and should contribute to social well-being, (iv) regulatory authorities should be strengthened to protect consumer interests and foster the healthy development of privatized sectors, (v) the strategy enhances Bumiputra (i.e., ethnic Malay) participation through vendor schemes and provision of better access to capital, and (vi) it promotes wider public participation in privatized entities through public listing. 7. The Government privatization policy envisages the establishment of state water regulatory bodies with sufficient powers to enforce economic and safety regulations to ensure that the private companies adhere to the conditions in the privatization agreement. To enhance the effectiveness of the state’s regulatory mechanism, a commission will be set up at the federal 1 Based largely on written responses provide by the Federal Economic Planning Unit to questions concerning water supply sector policy.


level to advise state governments on matters relating to social obligations to be performed by the concessionaire as well as on legal matters. 8. The National Water Resources Council was set up in 1998 to pursue more effective national water management, including the coordination and implementation of interstate raw water transfers. Interstate transfers of raw water are to be funded by the federal Government with state approval. B. Constraints to Implementation 9. Privatization remains an essential part of Government policy but the implementation plans for privatization have been delayed. Delays seem to be caused by concerns that water supply operations are not yet commercially viable and tariff adjustments required for viability would meet with stiff public opposition. A privatization scheme in Kelantan was terminated with operations reverting to government control for this reason. A contributing factor to the success of privatization of the Johor water supply operation as compared to Kelantan is that the former is financially more viable because it can sell raw water to Singapore. The income from the latter can be used subsidise local consumers. C. Financial Implications of Corporatization and Privatization 10. Should a SWA be reorganized as a state water corporation, the Government still provides interest-fee loans to the corporation but in other respects the financial status of the SWA changes. Upon corporatization, SWA staff lose benefits conferred on them as government staff. In compensation all staff receive a 17.5 percent pay increase and a bonus equivalent to one year’s salary. The corporation must secure employee benefit packages in the private sector and, if profitable, they must start paying corporate income tax at a rate of 28 percent. 11. In the case of state water corporations, the Government will help finance projects that address significant social policy objectives and that require large capital expenditures. This is done to manage the level of tariffs and other charges faced by consumers. It is not clear at this time whether this policy will also apply to SWAs that are restructured as full-scale concessionaire operations. Cross-subsidization of privatized operations is however evident in operating concessions for water treatment plants. In some cases, contractual tariffs for the wholesale tariff paid to concessions exceed the domestic tariffs. D. Motivation for Privatization 12. Privatization is beneficial for a variety of reasons including gaining access to improved production and management technologies, and gaining access to a larger pool of capital funds to finance large investments. Often, governments will also pursue privatization as a means of improving the financial performance of a utility. One way in which this is achieved is by using the terms of the privatization contract to force through tariff adjustments, which would be politically untenable for a government-run operation. In contrast to this approach, the federal Government’s privatization policy does not envision privatization as a means of achieving commercial viability but rather requires commercial viability as a prerequisite for privatization. This approach places the government in a stronger bargaining position in the privatization process since the assets of the SWA will be worth more to the prospective concessionaire operator.


13. However, this approach does mean that government must introduce reforms, especially tariff reforms, in the water supply sector in order to facilitate privatization. Current tariffs have not been adjusted for a number of years and probably fail to achieve full cost recovery even if they recover all of the costs reported by the SWAs. Reported SWA costs do not include the interest portion of debt service costs and, more importantly, they are based on capital plans that for the most part do not replace aging pipes at a pace that will sustain existing standards of service. Large increases in existing tariffs are required over the next few years to do this. The tariff setting process should focus on cost recovery and long-term financial sustainability. Social objectives related to water supply services should still be pursued by means such as direct subsidies to poor households that actually need government assistance.

Items 1998 1999 2000 1998 1999 2000 1998 1999 2000

1. Water Production a. Total Annual Production ('000 m3) 268,070 274,673 293,578 110,230 116,800 118,213 137,939 150,998 165,107 b. Nonrevenue Water 49% 51% 48% 39% 35% 30% 37% 39% 40% c. Unaccounted for Water Losses ('000 m 3) 132,427 139,809 140,506 43,100 40,880 35,937 50,897 58,518 65,698 d. Billed Water ('000 m 3) 135,643 134,864 153,072 67,130 75,920 106,960 87,042 92,480 99,139

2. Average Tariff Per Cubic Meter a. Billings ('000 ringgit) 101,687 103,702 116,597 76,851 75,117 79,299 57,773 62,640 65,380 b. Average Tariff (ringgit/m3) 0.750 0.769 0.762 1.145 0.989 0.741 0.664 0.677 0.659

3. Operating and Maintenance Costs ('000 ringgit) a. Personnel 8,044 8,416 9,665 9,103 10,523 12,256 8,149 8,036 8,288 b. Power 9,667 9,580 9,989 9,370 11,329 11,866 9,825 18,054 15,630 c. Chemicals 1,415 1,679 1,386 1,410 2,018 th power) 3,802 7,455 7,436 d. Purchased Water 29,093 31,643 38,560 0 0 0 e. Maintenance and Administrative Cost 10,776 25,393 23,060 6,778 11,322 14,716 23,780 26,925 28,175 f. Other Operating & Maintenance Costs 23,392 16,776 11,623 30 0 0 0 0 0 g. Depreciation/Debt Service 15,000 15,000 15,000 27,936 29,735 29,694 13,135 13,135 13,135 h. Total Costs 97,387 108,487 109,283 54,627 64,927 68,531 58,691 73,605 72,664

4. Average Cost Per Cubic Meter a. Billed Volume (m3) 135,643 134,864 153,072 67,130 75,920 106,960 87,042 92,480 99,139 b. Average Cost per Cubic Meter (O&M costs) 0.61 0.69 0.62 0.40 0.46 0.36 0.52 0.65 0.60 c. Average Cost/Cubic Meter (O&M + Depreciation) 0.72 0.80 0.71 0.81 0.86 0.64 0.67 0.80 0.73

5. Level of Cost Recovery a. O&M 123% 111% 124% 288% 213% 204% 127% 104% 110% b. O&M + Depreciation 104% 96% 107% 141% 116% 116% 98% 85% 90%

m3 = cubic meter, O&M = operation and maintenance.Source: Water Industry Data Book; Data submitted by each state.

COST RECOVERY ANALYSIS

Melaka Negeri SembilanKedah

37Appendix 10, page 1

Items 1998 1999 2000 1998 1999 2000 1998 1999 2000 1998 1999 2000

1. Water Production a. Total Annual Production ('000 m3) 189,527 190,362 211,448 303,962 299,571 310,496 29,864 30,825 30,634 112,546 107,341 120,650 b. Nonrevenue Water 47% 46% 46% 42% 41% 40% 36% 40% 44% 29% 37% 30% c. Unaccounted for Water Losses ('000 m 3) 88,632 88,353 96,342 127,891 122,464 125,135 10,870 12,481 13,419 33,162 40,064 35,904 d. Billed Water ('000 m 3) 100,895 102,009 115,106 176,071 177,107 185,360 18,994 18,341 17,215 52,829 57,421 84,746

2. Average Tariff Per Cubic Meter a. Billings ('000 ringgit) 65,686 63,570 70,824 146,074 145,203 155,550 10,930 10,467 11,887 55,621 58,283 65,900 b. Average Tariff (ringgit/m3) 0.651 0.623 0.615 0.830 0.820 0.839 0.575 0.571 0.691 1.053 1.015 0.778

3. Operation and Maintenance Costs ('000 ringgit) a. Personnel 18,525 17,727 22,991 21,213 22,540 24,901 1,879 2,172 2,306 11,416 11,986 13,578 b. Power 16,398 18,798 27,460 6,937 7,012 7,238 3,125 2,965 2,829 11,808 12,393 13,531 c. Chemicals 3,337 3,340 th power) 2,341 2,087 1,707 845 635 638 1,580 1,420 1,386 d. Purchased Water 0 0 0 68,767 76,506 80,570 0 0 0 0 0 0 e. Maintenance and Administrative Cost 32,629 27,879 25,831 17,379 19,709 16,886 616 842 1.146 9,487 10,435 7,604 f. Other Operating & Maintenance Costs 0 0 0 0 0 0 675 349 259 1,008 1,200 974 g. Depreciation/Debt Service 26,500 26,289 28,107 24,447 27,295 28,500 3,847 3,991 4,894 4,500 4,725 48 h. Total Costs 97,389 94,033 104,388 141,084 155,149 159,802 10,987 10,954 10,927 39,799 42,159 37,121

4. Average Cost Per Cubic Meter a. Billed Volume (m3) 100,895 102,009 115,106 176,071 177,107 185,360 18,994 18,341 17,215 72,480 73,981 84,746 b. Average Cost per Cubic Meter (O&M costs) 0.70 0.66 0.66 0.66 0.72 0.71 0.38 0.38 0.35 0.49 0.51 0.44 c. Average Cost/Cubic Meter (O&M + Depreciation) 0.97 0.92 0.91 0.80 0.88 0.86 0.58 0.60 0.63 0.55 0.57 0.44

5. Level of Cost Recovery a. O&M 93% 94% 93% 125% 114% 118% 153% 150% 197% 216% 201% 177% b. O&M + Depreciation 67% 68% 68% 104% 94% 97% 99% 96% 109% 192% 178% 177%

m3 = cubic meter, O&M = operation and maintenance.Source: Water Industry Data Book; data submitted by each state.

Pahang Perak Perlis Terengganu

38Appendix 10, page 2

Appendix 11, page 1

39

FINANCIAL AND ECONOMIC EVALUATION OF THE PROJECT

1. This appendix presents the results of a financial and economic analysis of the water supply sector loan project covering five states: Kedah, Melaka, Negeri Sembilan, Pahang, Perak, Perlis, and Terengannu, in Malaysia. The analysis assessed the efficiency of the project investments by estimating the financial and economic internal rates of return for the project. The analysis is completed for the project activities alone and not for the entire operation of the water supply authorities (i.e., no utility level analysis was undertaken).

2. The Project comprised 24 subprojects, each featuring one or more of the following activities: (i) replacement of existing transmission and/or distribution pipes, (ii) installation of new transmission and/or distribution pipes, (iii) upgrading of existing or construction of new storage and pumping facilities, and (iv) upgrading of existing or construction of new water treatment facilities. Subprojects are aggregated to the level of the state for purposes of analysis. Results are provided fore each state and for all states in aggregate. Assumptions and approaches are described and findings are presented and described.

A. General Approach

1. Schedule and Forecast Period

3. The financial projections were prepared based on project construction spanning 1994 to 2001, with most works having being completed in 2000. The timing of construction expenditures is based on actual cash flows as reported in Appendix 3. Operations are forecast over a 40 year period to 2040. This forecast period reflects a conservative estimate of the expected life of replaced pipes. Benefits will likely continue beyond this period.

2. Price levels

4. The financial and economic evaluations of the Project have been carried out in real terms. The project costs are used as reported, and projections of revenues and costs are made using 2001 price levels. All prices and costs are denominated in the Malaysian ringgit. All forecasts are made in terms of constant prices for the year 2001.

3. Capital Costs

5. Actual capital costs as summarized in Appendix 3 are used in this analysis. Capital costs, denominated in Appendix 3 in United States dollars, are converted to Malaysian ringgit using average annual exchange rates. The residual value of capital works at the end of the forecast period is estimated assuming a 50 year depreciation period.

4. Annual Operating Costs

6. Changes in annual operating costs that are associated with project investments are as follows:

(i) The costs of repairing frequent pipe bursts in the asbestos cement pipes that are being replaced are eliminated. These cost savings are estimated based on data from site visits on pipe burst frequency and the time required to repair a pipe burst. The market price of labor is assumed to be RM7.9 per hour.1

1 Economist Intelligence Unit, Country Data, Malaysia.

Appendix 11, page 2

40

(ii) New costs are incurred in association with an increase in the change rate for customer meters from every 10 years to every 7 years. This cost increase is estimated as the difference in the average annual cost of meter changes between the 7 and 10 year periods.

5. Annual Revenues 7. The states have been implementing a policy of expanding water services to achieve 100 percent coverage of all urban and rural households. At the same time, population growth during 1995-1999 has averaged 2.1 percent per annum. It is therefore assumed that an excess demand for water currently exists in Malaysia. The project investments will help meet this demand in three ways: (i) asbestos cement pipes that have been replaced had high rates of leakage, and water that is saved by the elimination of this leakage is available for sale to new customers; (ii) new water production capacity to service new demand is directly created by the treatment plant investments; and (iii) transmission and distribution systems are extended to service new customers (new sales in this category are assumed to occur if the state currently has excess capacity for new customers). Sales volumes are estimated based on statistics at the state level for customer connections per kilometer of pipe, average customer water use levels, and rates of nonrevenue water loss per kilometer of pipe. Revenue projections are based on existing tariff levels. These are set by each state and apply to all customers in the state. Tariffs in place in 2001 are shown in Table A11.1.

Table A11.1: Tariff Structures for the Project States in 2001

Tariff Levels by Block, 2001 (RM/m3)

Upper Limits for Tariff Blocks (m3/month)

State 1st 2nd 3rd 4th 1st 2nd 3rd Domestic Kedah $0.40 $0.70 $0.90 $1.10 20 40 60 Melaka $0.45 $0.70 $1.10 - 15 40 - N.Sembilan $0.40 $0.55 $0.65 - 9 20 - Pahang $0.37 $0.79 $0.99 - 18 45 - Perak $0.30 $0.70 $0.90 - 10 20 - Perlis $0.40 $0.70 $1.10 - 15 40 - Terengannu $0.42 $0.65 $0.90 $1.00 20 40 60 Commercial and Industrial Kedah $1.20 $1.40 $1.80 - 10,000 50,000 - Melaka $1.40 - - - - - - N.Sembilan $1.00 $0.90 $0.85 - 100 500 - Pahang $1.45 - - - - - - Perak $1.20 $1.40 - - 10 - - Perlis $1.30 - - - - - - Terengannu $0.95 $1.15 - - 70 - - - = not available. m3 = cubic meter; RM = Malaysian ringgit. Source: Staff estimates.

8. Tariff levels used in this evaluation are provided in Table A11.2. The average price of water is used to estimate project water sale revenues in the financial internal rate of return (FIRR) analysis. The marginal price of water is used as an estimate of the customers’ willingness to pay for water supply.

Appendix 11, page 3

41

Table A11.2: Tariff Levels for the Financial and Economic Analysis

(RM/m3) State Average Price of Water Marginal Price of Water

DOM CI Totala DOM CI Totala Kedah 0.52 1.20 0.65 0.70 1.20 0.80 Melaka 0.54 1.40 0.90 0.70 1.40 0.99 N.Sembilan 0.48 0.99 0.70 0.55 0.90 0.70 Pahang 0.56 1.45 0.74 0.79 1.45 0.92 Perak 0.59 1.37 0.77 0.90 1.40 1.02 Perlis 0.55 1.30 0.65 0.70 1.30 0.78 Terengannu 0.43 0.95 0.60 0.65 0.95 0.75 CI = commercial and industrial; DOM = domestic a Prices for all customers are sales weighted average prices. Source: Staff estimates.

6. Taxes

9. There is no value-added tax (VAT) in Malaysia and a retail sales tax does not apply to sales of water. There are no taxes or subsidies on procurements for capital projects by water supply authorities. The water supply authorities that are organized as water departments or units of public works departments are not subject to corporate income taxes and the corporatized authority in Terengannu does not pay corporate income taxes because it is not earning a profit.

B. Financial Evaluation

1. Financial Internal Rate of Return

10. The FIRR for the Project was calculated over a 40 year period. The period of analysis includes a 7 year period for construction. In determining the FIRR, a residual value equal to the net value of fixed assets (i.e., total investment cost less accumulated depreciation) was used. The base case FIRR for all states combined was determined to be 7.8 percent (Table A11.3).

Appendix 11, page 4

42

Table A11.3: FIRR Calculation (RM 2001)

FIRR = 7.8 percent Year Capital Investment,

Tradeable Capital Investment,

Nontradeable OM Cost for Meter

Replacements Project Water

Sales Revenues Net Annual Cash

Flow 1993 -193,253 0 0 0 -193,253 1994 -3,925,024 -18,879,481 0 0 -22,804,505 1995 -6,189,673 -14,851,282 0 0 -21,040,955 1996 -24,846,692 -29,737,542 0 0 -54,584,234 1997 -102,623,557 -71,794,229 0 0 -174,417,787 1998 -47,636,213 -123,561,121 0 976,920 -170,220,414 1999 -31,526,336 -68,898,135 0 976,920 -99,447,551 2000 -76,707,784 -108,161,223 -273,232 67,754,140 -117,388,099 2001 -9,182,696 -53,737,532 -273,232 67,754,140 4,560,681 2002 0 0 -273,232 67,754,140 67,480,908 2003 0 0 -273,232 67,754,140 67,480,908 2004 0 0 -273,232 67,754,140 67,480,908 2005 0 0 -273,232 67,754,140 67,480,908 2006 0 0 -273,232 67,754,140 67,480,908 2007 0 0 -273,232 67,754,140 67,480,908 2008 0 0 -273,232 67,754,140 67,480,908 2009 0 0 -273,232 67,754,140 67,480,908 2010 0 0 -273,232 67,754,140 67,480,908 2011 0 0 -273,232 67,754,140 67,480,908 2012 0 0 -273,232 67,754,140 67,480,908 2013 0 0 -273,232 67,754,140 67,480,908 2014 0 0 -273,232 67,754,140 67,480,908 2015 0 0 -273,232 67,754,140 67,480,908 2016 0 0 -273,232 67,754,140 67,480,908 2017 0 0 -273,232 67,754,140 67,480,908 2018 0 0 -273,232 67,754,140 67,480,908 2019 0 0 -273,232 67,754,140 67,480,908 2020 0 0 -273,232 67,754,140 67,480,908 2021 0 0 -273,232 67,754,140 67,480,908 2022 0 0 -273,232 67,754,140 67,480,908 2023 0 0 -273,232 67,754,140 67,480,908 2024 0 0 -273,232 67,754,140 67,480,908 2025 0 0 -273,232 67,754,140 67,480,908 2026 0 0 -273,232 67,754,140 67,480,908 2027 0 0 -273,232 67,754,140 67,480,908 2028 0 0 -273,232 67,754,140 67,480,908 2029 0 0 -273,232 67,754,140 67,480,908 2030 0 0 -273,232 67,754,140 67,480,908 2031 0 0 -273,232 67,754,140 67,480,908 2032 0 0 -273,232 67,754,140 67,480,908 2033 0 0 -273,232 67,754,140 67,480,908 2034 0 0 -273,232 67,754,140 67,480,908 2035 0 0 -273,232 67,754,140 67,480,908 2036 0 0 -273,232 67,754,140 67,480,908 2037 0 0 -273,232 67,754,140 67,480,908 2038 0 0 -273,232 67,754,140 67,480,908 2039 0 0 -386,411 67,754,140 67,367,729 2040 0 0 -386,411 67,754,140 67,367,729

Residual 130,879,269 194,273,236 325,152,505

Appendix 11, page 5

43

2. Weighted Average Cost of Capital

11. The weighted average cost of capital (WACC) was calculated in real terms. The cost of foreign debt was calculated based on a nominal interest rate of 7.3 percent and an international inflation rate of 2.4 percent per annum. The cost of foreign capital in real terms was computed to be 4.8 percent. The cost of local debt was calculated based on a nominal interest rate of 7.8 percent and a local inflation rate of 3.0 percent per annum. The cost of local capital in real terms was computed to be 5.6 percent. Neither funding source is subject to income tax. The WACC is 5.3 percent (Table A11.4). The estimated FIRR exceeds the WACC by 2.5 percentage points.

Table A11.4: Calculation of WACC

Funding Source Real Interest

Cost Amount of

Loan ($ million)Weight Weighted Percent

ADB Loan 4.8% 89.1 41.7% 2.0% Government Equity 5.6% 124.8 58.3% 3.3%

Total 213.9 5.3% ADB = Asian Development Bank. Source: Staff estimates.

3. Financial Viability 12. Four scenarios were tested to evaluate the implications of uncertainty for estimating FIRR. These are summarized in Table A11.5. The most significant elements of risk are a failure to realize the assumed levels of control for nonrevenue water (NRW) and a decline in the real price of water caused by a failure to increase tariffs. In these tests, the FIRR did not fall below the WACC.

Table A11.5: FIRR Sensitivity Analysis

Scenario FIRR (%) Comment

Reduce savings in NRW from pipe replacements by 30% 6.2 This change has a marked impact, FIRR still exceeds WACC

Reduce the cost savings associated with fewer pipe bursts by 30% 7.8 Insignificant impact

Increase the cost of meter replacements by 30% 7.8 Insignificant impact

Assume a 30% decrease in the real price of water from 2003 to 2013 6.5

Tariff levels have been fixed for several years causing the real price of water to fall. A similar decrease in the future tariff erodes FIRR

FIRR = financial internal rate of return; NRW = nonrevenue water; WACC = weighted average cost of capital. Source: Staff estimates. C. Economic Evaluation

1. Introduction 13. Key features of the economic analysis include (i) identification of incremental economic costs, (ii) identification and valuation of major economic benefits, (iii) estimation of economic costs and benefits using a domestic price numeraire, (iv) shadow pricing based on a shadow

Appendix 11, page 6

44

exchange rate factor for tradable items, (v) estimation of costs and benefits on a with and without project basis, and (vi) calculation of the economic internal rate of return (EIRR).

2. Costs 14. Economic costs have been estimated from the financial costs with the following adjustments: (i) tradable components were adjusted using a shadow exchange rate factor (SERF) estimated to be 0.96,2 (ii) the wages of unskilled and skilled labor and the market values of capital goods are assumed to equal their opportunity costs, (iii) no adjustments are required for taxes or subsidies on capital goods since none exist for the purchases by water supply authorities, (iv) the residual value of physical assets is assumed to equal the remaining book or depreciated value at the end of the evaluation period.

3. Benefits 15. Direct social benefits include the following: (i) improved water supply is provided to 438,000 people serviced by rehabilitated facilities; (ii) reductions in NRW will free 143,400 cubic meters (m3)/day of existing water treatment plant capacity and allow service for 113,000 new accounts or 460,000 people; (iii) creation of 93,480 m3/day of new water treatment plant (WTP) production capacity will allow service for 73,000 new accounts or 300,000 people; (iv) improved operational efficiency in project water districts will enhance the reliability of services for 3.2 million people in those districts; (v) institutional reforms associated with NRW control programs in 5 states and organizational restructuring in 2 states will enhance reliability and accountability of services over the long term for all customers; and (vi) the risk of health impairment due to exposure to waterborne pathogens is reduced for people served by rehabilitated facilities. Improvements in the standards of service delivery to direct beneficiaries include reductions in the frequency of service interruptions, improvement in water pressures and in the quality of piped water, and reduction in the risk of contamination of water supplies by pathogens due to distribution system failures. Only the first three categories of benefit are considered in this evaluation. The basis for valuation of benefits used in appraisal is applied here: the tariff for water is used as a proxy measure of the willingness to pay for water supply. The willingness to pay for new water supply customers is assumed to be the full domestic tariff, which varies between RM0.70 and RM1.02 across the provinces and averages RM0.85. The willingness to pay for existing customers who benefit from an improvement in the water supply service is assumed to be 20 percent of the domestic tariff. This assumption will underestimate actual willingness to pay since current tariffs are very low and represent a small proportion of household income.

4. Economic Internal Rate of Return 16. The EIRR was determined to be 10.8 percent, meeting the 10 percent threshold value for Asian Development Bank (ADB) loan projects having significant intangible benefits. This is a conservative estimate since several categories of benefit are not included and willingness to pay values are underestimated. Cash flow details are presented in Table A11.6.

2 Calculated by mission team using methodology in Appendix 16 of Guidelines for the Economic Analysis of Projects

(ADB, 1997).

Appendix 11, page 7

45

Table A11.6: EIRR Calculation (RM, 2001) EIRR = 10.8 percent

Year Capital Investment, Tradeable

Capital Investment,

NonTradeable

OM Cost for Meter

Replacements

Benefit from new

Sales

Benefit from Improved Services

Cost Savings for pipe R&M

Net Annual Value

1993 -185,523 0 0 0 0 0 -185,5231994 -3,768,023 -18,879,481 0 0 0 0 -22,647,5041995 -5,942,086 -14,851,282 0 0 0 0 -20,793,3681996 -23,852,824 -29,737,542 0 0 0 0 -53,590,3671997 -98,518,615 -71,794,229 0 0 0 108,704 01998 -45,730,764 -123,561,121 0 1,172,303 149,767 108,704 01999 -30,265,283 -68,898,135 0 1,172,303 149,767 2,948,912 -94,892,4352000 -73,639,472 -108,161,223 -265,909 82,195,441 7,637,447 2,948,912 -89,284,8052001 -8,815,388 -53,737,532 -265,909 82,195,441 7,637,447 2,948,912 29,962,9702002 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902003 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902004 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902005 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902006 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902007 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902008 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902009 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902010 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902011 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902012 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902013 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902014 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902015 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902016 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902017 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902018 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902019 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902020 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902021 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902022 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902023 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902024 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902025 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902026 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902027 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902028 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902029 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902030 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902031 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902032 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902033 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902034 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902035 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902036 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902037 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902038 0 0 -265,909 82,195,441 7,637,447 2,948,912 92,515,8902039 0 0 -376,055 82,195,441 7,637,447 2,948,912 92,405,7442040 0 0 -376,055 82,195,441 7,637,447 2,948,912 92,405,744

Residual 125,644,099 194,273,236 319,917,334EIRR = economic internal rate of return; OM = operation and maintenance.

Appendix 11, page 8

46

D. Evaluation Results by State 17. Estimates of FIRR and EIRR for each state are provided in Table A11.7. The strong performance of Perak and the weaker performance of other states may reflect differences in service conditions. For instance, both FIRR and EIRR are highly correlated with the unit capital cost of servicing customers (Table A11.8). Estimated variations in performance may also be the result of measurement error caused by the use of statewide averages of various factors to estimate impacts at a local level.

Table A11.7: Financial and Economic Performance of Subprojects Within Each State

State FIRR EIRR Kedah 8.5% 10.7% Melaka 3.5% 5.0% N.Sembilan 9.0% 9.1% Pahang 3.0% 5.1% Perak 21.3% 36.3% Perlis 1.8% 3.4% Terengannu 6.8% 9.3% Total Project 7.8% 10.8%

Table A11.8: Factors Affecting Financial Performance

State Density of Customer

connections* (#/km of pipe)

Rate of NRW* (m3/day/km of

pipe)

Water Sale per Connection*

(m3/day)

NRWa

(% of total production)

Project Capital Cost

per unit sales (RM/m3/year)

Kedah 50.1 54.0 31.1 51.0 8.21 Melaka 49.6 48.0 38.0 43.8 17.99 N.Sembilan 41.9 32.3 31.1 34.7 6.91 Pahang 26.2 29.5 31.5 51.3 16.19 Perak 57.6 43.7 28.7 44.1 2.50 Perlis 29.3 26.6 31.8 52.5 12.38 Terengannu 35.8 16.9 20.8 40.0 4.82 Total 42.7 35.8 29.7 45.5 6.88 a Average values based on responses to PCR mission questionnaire to the State WSAs. Perlis values are based

on data from earlier mission reports.

Appendix 12

5.

47

ASSESSMENT OF AFFORDABILITY OF WATER SUPPLY

1. This appendix presents the results of an analysis of the affordability of water supply to average and poor households. The approach is based on a comparison of annual household water bills to annual household income. The comparison is made for both average and poor households. Poor households are assumed to consume 80 percent of the water used by average households. Domestic tariff levels are shown in Table A12.1.

Table 12.1: Domestic Tariff Structures in 2001

State Tariff Levels by Block, 2001 (RM/m3)

Upper Limits for Tariff Blocks (m3/month)

1st 2nd 3rd 4th 1st 2nd 3rd Kedah 0.40 0.70 0.90 1.10 20 40 60Melaka 0.45 0.70 1.10 – 15 40 –N.Sembilan 0.40 0.55 0.65 – 9 20 –Pahang 0.37 0.79 0.99 – 18 45 –Perak 0.30 0.70 0.90 – 10 20 –Perlis 0.40 0.70 1.10 – 15 40 –Terengannu 0.42 0.65 0.90 1.00 20 40 60– = not applicable. Source: Staff estimates. 2. The analysis (Table A12.2) indicates that average households spend up to 1.2 percent of their income on water supply services. At current tariff levels, the proportion of income spent by poor households does not exceed 2.5 percent. The cost burden for water supply services does not therefore exceed 4 percent, a commonly used threshold value for Asian Development Bank water supply projects.

Table A12.2: Affordability Analysis Average Income Poverty Level Income

State Annual Income

(RM)

Water Use

(m3/mo)

Annual Water Bill

(RM) Cost Burden (% of income)

Annual Income

(RM)

Water Usea

(m3/mo)

Annual Water Bill

(RM) Cost Burden (% of income)

Kedah 19,344 32.67 202 1.0 6,120 26.14 148 2.4 Melaka 27,120 23.65 154 0.6 6,120 18.92 114 1.9 N.Sembilan 28,020 19.75 114 0.4 6,120 15.80 88 1.4 Pahang 17,784 32.38 216 1.2 6,120 25.90 155 2.5 Perak 20,916 25.88 184 0.9 6,120 20.71 128 2.1 Perlis 17,172 29.86 197 1.1 6,120 23.89 147 2.4 Terengannu 19,188 21.05 109 0.6 6,120 16.84 85 1.4 a Assumed to be 80 percent of the use of households with an average income. Source: Staff estimates.

3. An estimate of tariff increases that would be required to finance asbestos cement pipe replacements was provided in Appendix 8. Increases of 30 percent to 100 percent were indicated. With this level of increase, affordability would still not be a problem for average income households but could be for poor households.