World Bank Documentdocuments.worldbank.org/curated/en/705381468741625903/pdf/multi...AZERBAIJAN REPUBLIC ... Major related projects financed by the Bank and other development agencies

Document of

The World Bank

Report No: 20429-AZ

PROJECT APPRAISAL DOCUMENT

ONA

PROPOSED CREDIT

IN THE AMOUNT OF SDR 31.7 MILLION (US$ 42 MILLION EQUIVALENT)

TO THE

AZERBAIJAN REPUBLIC

FOR A

REHABILITATION AND COMPLETION OF IRRIGATION AND DRAINAGE INFRASTRUCTUREPROJECT

May 26, 2000

Environmentally and Socially Sustainable Development Sector UnitEurope and Central Asia Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective March 2000)

Currency Unit = Manat1 Manat = US$ 0.00023

US$ 1 = Manat 4,400

FISCAL YEARJanuary 1 December 31

ABBREVIATIONS AND ACRONYMS

ADCP Agricultural Development and Credit ProjectASCE Azerbaijan State Committee on EcologyAWC Apsheron Water CompanyCAS Country Assistance StrategyEIA Environmental Impact AssessmentEMP Environmental Management PlanERR Economic Rate of ReturnESW Economic Sector WorkFPP Farm Privatization ProjectFSU Former Soviet UnionGDP Gross Domestic ProductGIS Geographical Information SystemGOA Government of AzerbaijanHa HectareIDA International Development AssociationIsDB Islamic Development BankIEU Irrigation Exploitation UnitIFAD International Fund for Agricultural DevelopmentISF Irrigation Service FeeM&E Monitoring and EvaluationMMMC Main Mill-Mugan CollectorNEAP National Environmental Action PlanNGO Non-Governmental OrganizationO&M Operation and MaintenancePIP Project Implementation PlanPIU Project Implementation UnitPMR Project Management ReportRIDIP Rehabilitation and Completion of Irrigation and Drainage Infrastructure ProjectSAC Samur-Apsheron CanalSAIC State Amelioration and Irrigation CommitteeSOE Statement of ExpenditureTA Technical AssistanceWUA Water Users Association

Vice President: Johannes LinnCountry Manager/Director: Judy O'Connor

Sector Manager/Director: Joseph GoldbergTask Team Leader/Task Manager: Joop Stoutjesdijk

AZERBAIJANREHABILITATION AND COMPLETION OF IRRIGATION AND DRAINAGE

INFRASTRUCTURE PROJECT

CONTENTS

A. Project Development Objective Page

1. Project development objective 22. Key performance indicators 2

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 32. Main sector issues and Government strategy 43. Sector issues to be addressed by the project and strategic choices 7

C. Project Description Summary

1. Project components 72. Key policy and institutional reforms supported by the project 103. Benefits and target population 104. Institutional and implementation arrangements 11

D. Project Rationale

1. Project alternatives considered and reasons for rejection 142. Major related projects financed by the Bank and other development agencies 163. Lessons learned and reflected in proposed project design 164. Indications of borrower commitment and ownership 175. Value added of Bank support in this project 18

E. Summary Project Analysis

1. Economic 182. Financial 193. Technical 204. Institutional 215. Environment 226. Social 267. Safeguard Policies 28

F. Sustainability and Risks

1. Sustainability 292. Critical risks 30

3. Possible controversial aspects 31

G. Main Credit Conditions

1. Effectiveness Condition 312. Other 31

H. Readiness for Implementation 32

I. Compliance with Bank Policies 33

Annexes

Annex 1: Project Design Summary 34Annex 2: Project Description 38Annex 3: Estimated Project Costs 50Annex 4: Cost Benefit Analysis Summary 51Annex 5: Financial Summary 59Annex 6: Procurement and Disbursement Arrangements 60Annex 7: Project Processing Schedule 67Annex 8: Documents in the Project File 68Annex 9: Statement of Loans and Credits 69Annex 10: Country at a Glance 71

MAP(S)IBRD 30708

AZERBAIJAN

Rehabilitation and Completion of Irrigation and Drainage Infrastructure Project

Project Appraisal Document

Europe and Central Asia RegionECSSD

Date: May 26, 2000 Team Leader: Joop StoutjesdijkCountry Manager/Director: Judy M. O'Connor Sector Manager/Director: Kevin M. CleaverProject ID: P008284 Sector(s): Al - Irrigation & DrainageLending Instrument: Specific Investment Loan (SIL) Theme(s): Rural Development; Water

Poverty Targeted Intervention: N

Project Financing DataO Loan N Credit [D Grant O Guarantee O Other (Specify)

For Loans/Credits/Others:Amount (US$m): 42.0

Proposed Terms:Grace period (years): 10 Years to maturity: 35Commitment fee: 0.50% Service charge: 0.75%

Financing Plan: Source Local Foreign TotalGOVERNMENT 4.86 0.00 4.86IDA 22.10 19.90 42.00

Total: 26.96 19.90 46.86

Borrower: AZERBAIJAN REPUBLIC

Responsible agency: STATE AMELIORATION AND IRRIGATION COMMITTEE

Address: Floor V, House of Government, No. 40 Hajibaev Street, Baku 370016, Republic of AzerbaijanContact Person: Mr. Sadig Guliyev, Director of the Project Implementation UnitTel: +994-12-931868 Fax: +994-12-931868

Email: [email protected]

Estimated disbursements ( Bank FY/US$M):FY j 2001 2002 2003 2004 2005 2006

Annual 2.1 8.6 10.4 10.9 7.7 2.3Cumulative 2.1 10.7 21.1 32.0 39.7 42.0

Project implementation period: Five (5) yearsExpected effectiveness date: 12/01/2000 Expected closing date: 05/31/2006

OCS PAOFa, ,R_ LMd, 200

A. Project Development Objective

1. Project development objective: (see Annex 1)

The development objectives of the proposed Rehabilitation and Completion of Irrigation andDrainage Infrastructure Project (RIDIP) project are to: (a) prevent the decline in supplying water to BakuCity; (b) eliminate further deterioration of the supply of irrigation water to approximately 86,000 hectares(ha) along the Samur-Apsheron Canal (SAC); and (c) improve drainage and reduce water logging andsalinity on approximately 36,500 ha along Main Mill-Mugan Collector (MMMC). The project wouldeventually lead to:

* Secured water supply to Baku City at current level;* Improved agricultural production through improved irrigation water supply in the SAC

command area; and* Improved agricultural production through reduction of water logging and salinity in MMMC

catchment area.

To achieve these objectives the project would primarily carry out: (a) rehabilitation of the first 50km of SAC, including the headworks; and (b) completion of the remaining 31 km of MMMC. The projectwould also assist the State Amelioration and Irrigation Committee (SAIC) and District IrrigationExploitation Units (IEU) in the command areas of the SAC and MMMC in taking first steps towardsincreased operational efficiency through an institutional development component.

2. Key performance indicators: (see Annex l)

Progress towards the development objectives would be measured through:

A. Input Indicators

Project Expenditure for each Component:

* Component 1: Rehabilitation and Completion of Infrastructure (US$ 41.3 million);* Component 2: Institutional Development (US$ 2.0 million); and* Component 3: Project Implementation Support (US$ 2.7 million).

B. Output Indicators

Irrigation Canal System Rehabilitated (SAC) and Collector Drains Completed or Rehabilitated (MMMC)(Component 1)

* Length of irrigation canals rehabilitated (50 km of main supply canal and 260 km of inter-farmirrigation canals); and

* Length of main collector and appurtenant structures completed (31 km) and rehabilitation ofinter-farm collectors draining 36,500 ha.

Institutional Development (Component 2)

* Satisfactory completion of. (a) irrigation sub-sector review study; (b) feasibility study for the

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future expansion of the SAC system; and (c) SAC management study.

Project Implementation Unit (Component 3)

* Preparation of progress management reports (PMR);* Preparation of environmental monitoring reports;* Preparation of annual work program and annual report; and* Satisfactory completion of annual extemal audits.

C. Impact Indicators

Preventing Decline in Water Supply to Baku City

* Annual amount of water totaling 290 million m on average supplied to Baku City.

Supplying and Distributing Adequate Water in a Timely Manner

* Distribution of water in line with crop water requirements of about 6,500 m 3/ha gross at thefarm boundary;

* Conveyance and distribution efficiency to increase from 64 to 75 percent at the end ofrehabilitation (no change in on-farm and application efficiency expected under this project);

* Area irrigated annually; and* Increase in crop yield.

Improving Drainage and Reducing Water Logging and Salinity

* Area irrigated annually; ando Increase in crop yield.

B. Strategic Context1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1)Document number: 19586-AZ Date of latest CAS discussion: 09/14/99

The strategic objective of the Country Assistance Strategy (CAS) is to assist the Government ofAzerbaijan (GOA) to establish an appropriate institutional and policy framework which will steer thecountry to the path of good govemance as well as equitable development to achieve broad-based growth,employment creation and poverty alleviation. The Bank-supported three-pronged strategy consists of:

* An agenda for reform of public sector institutions;* A strengthened regulatory and business environment for private sector development,

particularly in the non-oil sectors; and* Investment in development, including targeted poverty alleviation measures.

The CAS identifies as one of the key development challenges the need to put in place productivityenhancing policies and investments in the agricultural sector, which is providing major opportunities tonon-oil business development. It is also the sector which most directly addresses poverty alleviation. TheCAS also identifies the need for continuing reforms in the coverage and delivery of services in the sector aswell as substantial investment programs, particularly in the irrigation sub-sector.

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2. Main sector issues and Government strategy:

Agricultural Reform. Agriculture is one of the major contributors to Azerbaijan's Gross DomesticProduct (GDP). During the past few years, the sector contributed between 20 and 25 percent of GDP andaround 35 percent of employment. Before Independence in 1991, Azerbaijan was a main producer ofcotton, wheat, grapes and vegetables for the Former Soviet Union (FSU) markets. Real output declinedrapidly between 1991 and 1995, when the production of grains fell by 19 percent, of cotton by 48 percent,of grapes by 66 percent and of vegetables by 43 percent. The decline in agricultural production has leveledout during the past few years, but has yet to rebound.

From 1996 to date, fundamental changes have been introduced, including the abolition of the stateorder system for agricultural products, the removal of most control on external trade in agriculturalproducts and the discontinuation of official pricing of inputs and outputs, as well as the replacement ofstate input supply and farm output marketing organizations with privately owned and managed companies.The ongoing liquidation of state and collective farms and the physical distribution of a significantproportion (to date more than 85 percent) of farm land to individual farm members is creating a privatefarm structure, with large numbers of small family holdings and private group farms.

Despite this progress made with the reform of the agricultural sector, major issues remain that slowthe transition to an efficient agricultural sector. Issues include: (i) the need to improve the legal andinstitutional framework to support a land market, promote the development of rural credit systems and touse land as collateral; (ii) the need for agro-industry restructuring, caused by over-capacity and lack ofworking capital; (iii) lack of market information; (iv) lack of agricultural diversification, with majoremphasis on the cultivation of low valued grains; (v) lack of access to credit for private farm andagro-industry enterprises; (vi) lack of advisory services and new productivity enhancing technologies; and(vii) deteriorating irrigation infrastructure.

Government is comnmitted to complete the transition to a privatized, market-based agriculturalsector and it is expected that, with the help of donors and external financiers, most of the above mentionedissues would be addressed during the next years. An Agricultural Sector Update was prepared in late1997, which raises many of the issues that affect agricultural reform and development and provides anoutline for a strategy for continuing agricultural development that should result in continued growth andrealization of the full potential of Azerbaijan's agriculture sector. The IDA financed Farm PrivatizationProject (FPP; FY97) and the Agricultural Development and Credit Project (ADCP; FY99) have activitiesin the areas of farm information and advisory services, land registration and rural credit. The coverage ofthese two projects includes the RIDIP project areas and adequate coordination mechanisms are expected tobe developed to leverage the activities under the three projects.

Irrization Sub-sector

Irrigation Sustainability. The country has favorable growing conditions for a wide variety ofcrops, the cultivation of which is largely dependent on irrigation. Almost all agricultural land is under aridor semi-arid conditions, with average annual rainfall of 200 to 350 mm, more than half of which fallsoutside the main growing season from April to September. For example, in Khachmaz in the center of theSAC project area, the mean effective rainfall during the growing season is 124 mm (40 percent of the meanannual total), while the mean reference crop evapotranspiration for the same period is 708 mm. The netirrigation requirement for beans, grapes and tomatoes are 336 mm, 320 mm and 470 mm respectively. Theonly agriculture possible without irrigation is low intensity livestock production on natural pasture severelylimited by low rainfall, which would not meet the country's food needs, much less the employment and

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income requirement of its large rural population. Consequently irrigation is a key input for reliable cropproduction.

The total area equipped for irrigation is about 1.45 million ha, covering over 80 percent of allarable land in the country. Many of the irrigation systems were developed during the FSU period with littleor no attention to economic costs and viability. SAIC is responsible for the operation and maintenance ofthe irrigation and drainage infrastructure outside the boundaries of the former state and collective farms(there were about 900 collective and 600 state farms before Independence). During the past decadeoperation and maintenance (O&M) budgets have been far below required levels, with the current budget ofSAIC estimated at about 30 percent of what is needed to properly maintain the infrastructure. Theapproved budget for SAIC during the past few years has been around 140 - 160 billion Manat (around US$35 million). Even though about 70 percent of this budget was spent on the category operation andmaintenance most of it was spent on electricity. Only 9 percent of the budget was spent on reconstructionworks. As a result, the main and distribution irrigation systems and drainage channels have not beenmaintained well and consequently infrastructure facilities are deteriorating. This has resulted in irregularand inadequate availability of irrigation water at farm level, which in turn results in yields that are muchbelow the irrigated yield potential. Similarly, lack of adequate drainage is suppressing yields and arablearea is shrinking year by year due to growing salinity and water logging conditions.

Other sub-sector issues that affect sustainability are: (i) high reliance on pumped irrigation (over500,000 ha, but mainly outside the two project areas), which for a number of farms may prove uneconomicif key expenses, such as energy and pump maintenance, are valued at their economic costs. Many pumpsare not maintained properly and more and more become increasingly inefficient to run or unoperational; (ii)the beneficiary participation is still low, in particular with regard to negligible contributions to the SAICfor water supply and delivery services (see below), as well as for the O&M of the on-farm irrigationdistribution infrastructure; (iii) on-farm distribution systems are not well suited to the new, smaller farmstructures that are emerging from privatization; and (iv) farmers lack experience in the management ofirrigation systems and remain largely unorganized.

SAIC has calculated a blend irrigation service fee (ISF) for each of the raions varying from Manat1,600 (US$ 0.36) per 1,000 mn3 to Manat 216,000 (US$ 49.1) per 1,000 m 3 . The country-wide blend ISFwould be Manat 23,800 (US$ 5.40) per 1,000 m 3 . Considering the 7.3 billion m' of water that is suppliedon average to the farms annually, the water users would contribute Manat 174 billion (US$ 39.5 million) tothe Committee's budget. Realizing the water users' low ability to pay at the moment, SAIC has set thecurrent payment level for ISF at rates varying from 5 to 15 percent of the needed tariff, which wouldprovide Manat 20.9 billion (US$ 4.75 million). Since its introduction in 1998, less than 25 percent of thisreduced amount was actually collected on an annual basis. The pilot farms of the Farm PrivatizationProject are benefiting from rehabilitation of farm distribution and drainage systems and organization ofwater users. The collection rate of ISF in these pilot farns has reached levels that are close to the requiredone and regular payments are made to SAIC for the delivery of water to the farm as agreed by contractbetween the water users and SAIC's districts exploitation units.

Long-term Vision for the Sub-sector. The Government has made a start in developing a long-termvision for the irrigation and drainage sub-sector. A program for the period up to 2010 was prepared in1995. The program identified priority irrigation and drainage schemes which require rehabilitation andcompletion and stated Government's commitment to the restructuring of SAIC and introduction of watercharges to users. Accordingly, Government has so far adopted key legislation including the law onamelioration and irrigation (June, 1996), water code (December, 1997) and resolution on establishment of

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water user associations (WUAs) and the introduction of irrigation service fee (October 1996). TheGovernment is further committed to develop a detailed implementation plan to: (a) carry out the identifiedrehabilitation and completion of irrigation and drainage facilities; (b) establish WUAs and devolve on-farmirrigation distribution facilities to WUAs; and (c) increase efficiency in managing and operating primaryand secondary irrigation and drainage facilities through restructuring of SAIC. The Government has notthe monetary resources to reverse the physical decline of irrigation systems resulting from years of neglect,nor are the existing institutions appropriate to ensure sustainability should rehabilitation be effected. Ifthere is no reform and no rehabilitation the irrigation and drainage systems will continue their terminaldecline, and Azerbaijan's agriculture will inevitably follow, which would severely affect the employmentbase in the rural areas. The vision plan has been shared with various donors and so far the IslamicDevelopment Bank (IsDB) and IDA have started supporting the Government in implementing the program.

Institutional Framework. SAIC is not only responsible for the development of policies andplanning of the irrigation sub-sector, but also for the operation and maintenance of all irrigation dams andcanal systems up to the boundaries of the former state and collective farms. The Committee comprisessome 160 organizations at all levels, yet it is still very much a centrally managed organization. TheCommittee keeps a work force in place of reportedly 22,000 people, the majority of whom is engaged in theO&M of irrigation infrastructure, which is, as indicated above, currently severely constrained by lack ofbudget. SAIC has gone through an initial restructuring and has reduced staff by around 5,000 throughdivestiture and consolidation of several institutions and departments. Further restructuring of SAIC andreduction in work force is expected to continue during the next years.

Water users remain largely unorganized and, as indicated above, contribute little to O&M. WUAshave been developed only on a pilot basis for the management and O&M of distribution systems within theformer farm areas under the IDA and IFAD financed Farm Privatization Project. So far no infrastructureoutside the former farm boundaries has been tumed over to the water users, which is understandable as thisshould only be done after strong WUAs have been established at the lowest level, i.e. within the formerstate and collective farms. Institutional arrangements have to be developed further at both Governmentagency and farm level to manage the distribution of water and maintain the irrigation networks both outsideand within the former state and collective farms.

Environment. One of the conclusions of the National Environmental Action Plan (NEAP; 1998) isthe general lack of environmental monitoring, including monitoring of land and water. Major identifiedenvironmental issues that relate to the irrigation sub-sector are: (i) ineffective water resource management;(ii) increasing areas affected by water logging and salinization; (iii) pollution of major rivers; and (iv) soilerosion due to poorly designed on-farm irrigation systems.

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3. Sector issues to be addressed by the project and strategic choices:

Irrigation Sustainability. The proposed project envisages support to Government to reestablishthe sustainability of the irrigation and drainage sub-sector. In particular, the proposed project wouldcontribute to the rehabilitation of the SAC and completion of the MMMC, both of which have beenidentified as the highest priority works in the development plan that was prepared in 1995. Further, theproject would assist SAIC in carrying out the following activities which would form the basis for thedevelopment of a long-terrn vision for the irrigation and drainage sub-sector: (a) preparing a sub-sectorreview; (b) improving operational efficiencies in SAC; and (c) carrying out a detailed feasibility study forthe long-term development plan for the SAC. The outcome of these activities would not only helpGovernment in developing its long-term vision for the sub-sector, but would also be incorporated into thedesign of an on-farm irrigation rehabilitation and restructuring project, the preparation of which is expectedto start soon.

Institutional Framework. The proposed project would provide capacity building of SAIC inproject planning, design and implementation according to international standards. It would also make astart with the restructuring of the O&M organizations in the SAC command area.

Environment. The proposed project would develop and implement a comprehensive monitoringprogram for the regular monitoring of key environmental parameters in the SAC and MMMC commandareas. It would address the environmental issues that have been identified for the sub-sector through therehabilitation and completion of irrigation and drainage infrastructure and institutional support that wouldimprove water management and reduce water logging, salinity and river pollution. The project would alsoincorporate identified mitigating measures in the design and during implementation of the sub-projects.

C. Project Description Summary

1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed costbreakdown):

The Project would constitute three components: (i) Rehabilitation and Completion of Irrigation andDrainage Infrastructure; (ii) Institutional Strengthening; and (iii) Project Implementation Support.

Component 1: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

The project would support rehabilitation of critical main infrastructure of the Samur-ApsheronCanal System, located in the north-eastern part of the country. The System comprises a headworks acrossthe Samur river, a 182 km long main supply canal, a reservoir near Baku City, pumping stations, threesediment basins and a number of secondary canals that supply water to the irrigation areas. The System isseriously deteriorated and its vulnerability to failure threatens the continuity of both the irrigation suppliesto about 86,000 ha and the water supply to the population of the Baku-Apsheron Peninsula (SAC shouldsupply approximately 40 percent of the drinking and industrial water needs of the 2.5 million people livingon the Peninsula). Government has prepared a plan for the SAC to meet future domestic and industrialwater demands. This plan proposes new dams and a realignment of the main supply canal from km 50onwards to avoid pumping.

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The proposed project would be limited to rehabilitation of the canal system from km 0 to 50, which wouldbe compatible with any future development plan of the system beyond km 50. In particular, the projectwould: (a) rehabilitate the 50 year old Samur headworks, where past flood damage and lack of regularmaintenance jeopardize the integrity of the barrage, and replace all seriously deteriorated gates and liftinggear; (b) repair the concrete lining of the first 50 km of the main canal, with associated structures(including those to allow adequate water measurement), where deterioration arising from neglectedmaintenance has led to an unacceptable loss of water and difficulties in managing the water (The design ofthe hydraulic structures would take into account new water supply conditions after the completion of therehabilitation of the Khanarkh canal. This canal is being rehabilitated with financial assistance from theIsDB. After its completion, it will supply water to some of the irrigation areas that are now supplied by theSAC). The project may also finance an enlargement of the main supply canal, which would, however, besubject to the satisfactory completion of the feasibility study referred to in item (d) under Component 2; (c)rehabilitate sedimentation extraction works at the head of and along the SAC, based on a comprehensivestudy and elaboration of a long-term environmentally acceptable solution; (d) rehabilitate inter-farm canalsleading from the first 50 km of the main canal that supplies water to about 65,000 ha; and (e) supportdesign and construction supervision services.

Drainage is essential for many irrigation systems in Azerbaijan, but most critical in the flatlow-lying Kura-Araz and Mugan-Salyan plains totaling about 760,000 ha, where soil salinity hasdeveloped for lack of natural drainage. The Kura River runs through the center of the country. Thedevelopment plan for the construction of collector systems to drain these areas was prepared by the early1960s. The Kura left bank collector system has been completed. Developments on the right bank startedin the 1980s. Sixty km of the Main Mill-Mugan Collector has been completed and 52 km is currentlyunder construction. This leaves a 31 km missing link to complete this important project and link it to theMain Mill Karabakh Collector (MMKC). This latter Collector is now linked to the Main Shirvan Collectoron the left bank of the Kura River, which often results in overload, which is why some of the saline MMKCdrainage water is released in the Kura River during peak drainage periods. The project would supportcompletion of this last, critical link in the MMMC as follows: (a) complete the remaining 31 km of themain collector drain; (b) provide necessary road and rail bridges and aqueducts across it as well as anadjacent service road; (c) complete the siphon underpass for this drain beneath the Araz River; (d)reconstruct and rehabilitate inter-farm collectors in 36,500 ha; and (e) design and supervision services.The project would not finance irrigation infrastructure in the MMMC area. Most of the irrigation systemsin this area were developed much later than in the SAC area and have deteriorated less. With proper O&Mthe systems in the MMMC area would continue to function relatively well for the next decade or so.

Component 2: Institutional Strengthenina

The project would support institutional development to make a start with the improvement of thequality and sustainability of irrigation management. There would be four sub-components: (a) institutionalsupport for SAC management in order to develop an organization that is cost effective and efficient withstrong customer orientation and delivers quality water services that customers want and eventuallyprepared to pay for in full. The project would provide technical assistance (TA) to review the workpractices, processes and skills of the SAC management and the District Exploitation Units in the SAC area,as well as the coordination between these different offices and the water users. The TA team wouldprepare proposals to improve the management of the SAC system (which would include plans for necessaryreorganization and skill improvements), establish solid accounting and pricing principles to improvetransparency and accountability and develop and implement a management information system and asystem to improve collection of ISF. The project would initially focus on the SAC command area, but may

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introduce improvements in the MMMC area as well at a later stage; (b) preparation of an IrrigationSub-sector Review, which would be an important input for the development of a long-term sub-sectorstrategy by Government. The review would focus on the economics of irrigation and institutionaldevelopments; (c) training and study tours, covering a wide range of topics such as project administrationand modem design and operation and maintenance practices of irrigation and drainage systems. Thisactivity would provide Project Implementation Unit (PIU) and SAIC staff from headquarters and SAC andMMMC management organizations with exposure to modernized and cost-effective engineeringtechnologies and successful cases of institutional reform in the irrigation and drainage sub-sector. It isnoted that, in addition to formal training and study tours, all TA consultants would have to provideon-the-job training; and (d) preparation of a comprehensive feasibility study to review the technical,environmental, social and economic viability of the expansion in capacity of the Samur-Apsheron Canal, amajor issue bearing on long-term water resource development and expenditure in Azerbaijan.

Component 3: Project Implementation Support

This component would comprise the following four sub-components: (a) support for the PIU,covering part of the incremental staff salaries and operational expenses, as well as equipment and vehicles;(b) a technical assistance team of international specialists during the first two years of projectimplementation to advise and train the PIU staff and assist the PIU to successfully implement the project.The TA would include a long-term Technical Advisor and short-term specialists in ConstructionSupervision, Engineering Design, Procurement, Financial Management, Monitoring and Evaluation andEnvironment; (c) annual monitoring and evaluation (M&E) and environmental monitoring surveys; and (d)the annual audit of the project accounts.

Indicative Bank- % ofComponent Sector Costs % of financing Bank-

_________ _ .(US$M) Total (US$M) financingA. Rehabilitation and Completion of Al - Irrigation & 41.34 88.2 36.85 87.7Irrigation and Drainage Infrastructure Drainage

A. 1. Samur-Apsheron CanalA.2. Main Mill-Mugan Collector

B. Institutional Strengthening AG - Agency 1.98 4.2 1.98 4.7B. 1. SAC Management ReformB.2. Irrigation Sub-sector ReviewB.3. Training and Study ToursB.4. SAC Expansion Feasibility

StudyC. Project Implementation Support Other Non-sector 2.74 5.8 2.37 5.6

C. 1. PIU SpecificC.2. Technical AssistanceC.3. M&E and Environmental

MonitoringC.4. Audit Services

D. Refinancing PPF 0.80 1.7 0.80 1.9

Total Project Costs 46.86 100.0 42.00 100.0

Total Financing Required 46.86 100.0 42.00 100.0

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2. Key policy and institutional reforms supported by the project:

The project would not seek to establish new sectoral policies. It would support the Government'sprogram for the development of the sub-sector for the period up to 201 0. Besides rehabilitation andcompletion of irrigation and drainage infrastructure, it would support the introduction of refonns in theoperation and maintenance organizations of the SAC System, leading to more efficient, cost effective andequitable distribution of water and better accounting procedures. It would also support the preparation of astrategy for the sub-sector to permit future investments to focus on schemes with a long-term economicfuture.

3. Benefits and target population:

The project would directly benefit around 40,000 farm families in the 86,000 ha that are directlysupplied by the SAC System and around 15,000 farm families in the 36,500 ha of MMMC. Also, 70,000farm families would benefit less directly within the command area of the MMMC, as the advantages of theimprovements obtained by the project would affect and improve agriculture over much of the right bankcommand area. The primary project benefits would be in terms of increased crop production, based on anoverall increase in yield estimated at 25 percent after rehabilitation, due to improved water supply to thefarms in the SAC area and improved drainage conditions in the MMMC area.

During project preparation a water resources model was prepared to determine the SAC Systemreliability. The model showed that for the existing situation the reliability was low at the lower end of theSAC. The existing infrastructure can not satisfy the irrigation demand up to the commonly acceptedstandard of 75 out of 100 years (75 percent). For two typical irrigation areas in the lower part of the SACthe reliability varies from 34 to 59 percent. The reliability to supply Baku with the needed water is around59 percent, which is less than the commonly accepted 90 to 95 percent.

As a result of the project the water supply in the SAC would become more reliable in terms ofquantity and timeliness, which would result in increased water availability at farm level. The overallirrigation efficiency is currently estimated at 35 percent. In the with-project situation the overall efficiencyis expected to increase to 42 percent, because of increases in the conveyance and distribution efficiencies.This increase is due to the rehabilitation works in the canal system that would reduce the water losses andimprove the water management in the system. Benefits would also extend to the 2.5 million population ofBaku and the Apsheron Peninsula whose water supply reliability would be increased from 59 to at least 69percent and thus the risk of interruption reduced by improvements in the SAC System. Furtherimprovements in system reliability are possible through expansion of the supply canal and development ofstorage reservoirs and also through improvements of on-farm irrigation distribution and applicationefficiencies. The proposed project would carry out the most important rehabilitation requirements.Government is seeking further support from IDA for a second irrigation project that would improveon-farm efficiencies and from IDA and other donors for works below km 50 along the SAC.

The Project would support the completion of the last, critical link in the Main Mill-MuganCollector which would relieve acute drainage congestion in 36,500 ha and a less severe congestion in up to200,000 ha on both sides of the Kura River. Besides agricultural benefits, this sub-project would alsoreduce contamination of the Kura River with saline water and have a beneficial effect on fisheries andirrigation schemes in the river's lower stretches, as well as on the quality of Baku water supplies drawnfrom this source (about 40 percent of the water delivery to Baku).

Institutional improvements would result in increased capacity to prepare and implement projects

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financed by international donors and financiers, as well as more efficient use of funds and resources forO&M within the project's conmmand areas.

4. Institutional and implementation arrangements:

Project duration and location

Project implementation is anticipated to take five years, from December 2000 to November 2005,with the Credit Closing Date being May 31, 2006. The project's physical works are confined to the serviceareas of the Samur-Apsheron Canal System and the Main Mill-Mugan Collector Area. The institutionalreforms introduced would be of benefit to the whole sub-sector when replicated in other schemes.

Executing Agency and Implementation Arrangements

SAIC would have overall responsibility for implementation of the project. Responsibility forday-to-day management and administration would be delegated to a Project Implementation Unit. This PIUwas recently established in SAIC with a core staff (Director, Accountant and Procurement Specialist), withthe PIU Director reporting to the Chairman of SAIC. The PIU would have direct responsibility for allimplementation tasks, including preparation of programs, monitoring and evaluation (M&E), procurement,accountancy, disbursement, management of the Special Accounts and reporting to Government and IDA.Professional PIU staff would include, in addition to the three staff that have already been appointed, aDesign Engineer, two Construction Supervisors, an Environmental Specialist and a M&E Specialist. Theappointment of this PIU staff with qualifications and under terms of reference satisfactory to theAssociation is a condition for Credit effectiveness.

The PIU core staff would be responsible for all core activities such as procurement andfinancial management. All procurement actions would be carried out using World Bank procurementprocedures. They would also prepare all Requests for Proposals for consulting assignments. The PIUwould serve as the basis for the bid committee that would be responsible for reviewing and evaluatingprocurement packages. The bid committee would, as a minimum, be composed of the PIU Director,PIU Procurement Specialist and SAIC representative. The PIU would also be responsible for thefinancial management of the project (see below in section on Financial Management). The Engineerswould ensure that the technical aspects of the engineering design and construction work are carried outprofessionally. The M&E Specialist would be responsible for establishing a project-wide M&E systemthat would allow the PIU to track and document the progress of the projects by measuring outputs andimpacts in the project sites and pinpoint locations where the project is having difficulties. TheEnvironmental Specialist would coordinate the environmental monitoring work and ensure that projectactivities are carried out in accordance with the agreed environmental management plan. As requiredand based on the workload, the project could finance additional core and technical staff to ensure thatall activities under the project are carried out effectively. Manpower requirements would be evaluatedjointly by the Bank and Government during regular supervision missions to determine any necessarychanges.

There is limited experience in SAIC to implement investment programs supported by internationalfinancing organizations. The PIU would therefore be supported during the first two years of projectimplementation by a team of experts to provide specialist assistance on those aspects of projectimplementation and management in which the PIU staff are not experienced. As such a majorresponsibility of the TA team would be to develop institutional capacity to implement investment projects.The TA team would include a long-term Technical Advisor and a mix of short-term consultants, including

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Procurement Specialist, Environmental Specialist, M&E Specialist, Construction Supervisor and DesignEngineer. The PIU would also be supported by a Financial Management Specialists during the initialstages of project implementation in order to be trained in the use of the financial management system.

The rehabilitation and completion of the SAC and MMMC would be carried out through anestimated I1 contracts. During project preparation, the necessary works have been identified, designed andcosted up to feasibility level stage by a team of national and intemational consultants. The biddingdocuments for the first two packages, valued at about US$ 10 million, have been prepared by the sameconsultants. These two packages comprise the rehabilitation of the Samur headworks in the SAC area andthe completion of the siphon under the Araz River for the discharge of MMMC water under the river.These packages are expected to be tendered in July 2000 so that construction can start immediately afterCredit effectiveness. Other works would be designed and prepared for tendering during projectimplementation. It is expected that the sedimentation works and the rehabilitation of the SAC main supplycanal would start in 2002 and the rehabilitation of inter-farm canals in 2003. The MMMC excavation andconstruction of appurtenant works can only start in 2002 after the completion of the siphon. Rehabilitationand reconstruction of the inter-farm drains is expected to start in 2004.

The PIU would contract out the services for design and supervision to a consulting firm for theduration of the project. The main tasks of the consultants would be to: (i) prepare design reports andbidding documents, including surveys and investigations as needed, as well as the preparation of technicalspecifications, engineering estimates, bill of quantities and tender drawings; (ii) assist the PIU withconstruction supervision; and (iii) carry out specialized studies. All works would have to be carried outaccording to recognized international standards, therefore construction supervision and quality controlaccording to modem and efficient methods would be important. The consultants team would include designengineers, hydrologist, sediment specialist, costing engineer, contract specialist, construction engineers,construction inspectors, clerks and surveyors.

The consultants would assist the PIU with setting up a construction management organization forthe purpose of supervision of the construction of the different sub-projects. The consultants would providefor all personnel on site (resident engineers, inspectors, clerks, etc.) for inspection of the constructionworks, installation of equipment and the testing of construction materials, in order to ensure that the worksare implemented and goods supplied in accordance with the designs, specifications and terms andconditions of the relevant civil works and supply contracts. In particular, the consultants would assist thePIU with the following: (i) contract administration; (ii) inspection of all construction activities; (iii) testingof materials on site; (iv) testing and inspection of goods and materials; (v) off-site laboratory testing, wherenecessary; (vi) review of contractors' submittals; (vii) verification of progress payment requests; (viii)preparation of monthly progress reports; (ix) assist in contract acceptance and close-out; and (x) assist indispute resolutions, when necessary.

Sub-projects would be selected in accordance with agreed procedures and eligibility criteria and theworks would be carried out in accordance with agreed terms and conditions, all of which are spelled out inthe Development Credit Agreement.

Project oversight

An inter-ministerial Steering Commission would be established as a condition for Crediteffectiveness. It would be mandated to review progress with and provide guidance to projectimplementation, resolve problems of inter-agency coordination and review and approve the annual workplan. The Commission would be composed of the Deputy Prime Minister (chairman of the Commission),

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the Chairman of SAIC, Deputy Minister of the Ministry of Finance, Chairman or authorized representativeof the State Committee on Ecology, Deputy Minister of the Ministry of Agriculture, Chairman of theApsheron Water Supply Company and the PIU Director (secretary of the Commission). The SteeringCommission would meet twice annually or more frequently when required.

Financial Management

Financial Management Assessment. The overall responsibility for financial management of theproject would rest with the PIU. The PIU includes one accountant; although not envisaged, additionalaccountants would be recruited as required during project implementation. The Association conducted afinancial management assessment of the PIU and concluded that the project's financial managementarrangements do satisfy the Association's minimum requirements. The main feature of the projectsfinancial management arrangements is that the PIU has negotiated a contract with a local financialmanagement consultant to: (i) establish an accounting system prior to Credit effectiveness; (ii) train the PIUaccountant in the operation of that system; and (iii) oversee and be responsible for the operation of thatsystem for the first few months of the project before handing over such responsibilities to the PIU. Theselected financial management consultant already has experience of successfully establishing and operatingthe financial management system of a similarly complex IDA-financed project and therefore thisarrangement is not considered to contain any significant implementation risks.

Project Management Reports. The agreed formats of the Project Management Reports (PMRs)are included within the Project Implementation Plan (PIP) and the PIU would produce a full set of PMRsfor every calendar quarter throughout the life of the project commencing with the quarter ending June 30,2001, however, the PMRs showing details of the sources of funds, expenditures by project component,expenditures by expenditure category, and the Special Account, would be produced in respect of thequarter ending December 31, 2000 and quarterly thereafter. Project funds would be initially disbursedunder the Association's established procedures and a move to PMR-based disbursements would be made atthe mutual agreement of the Government and the Association and would be considered once the PIU isfamiliar with the project's monitoring aspects and is considered able to produce sufficiently timely andreliable project management information. A change to PMR-based disbursements would be considered byDecember 31, 2001.

Audit Arrangements. External audits by independent private auditors acceptable to theAssociation and on terms of reference acceptable to the Association, as included within the PIP, would beperformed annually throughout the life of the project. The results of the audit of the RIDIP would beavailable within six months of the end of every fiscal year and the cost of the audit would be financed bythe Credit. The appointment of the project's auditor is a condition of Credit effectiveness and the appointedauditor would be retained, subject to satisfactory performance, for the life of the project.

Annual Budget. The PIU would prepare an annual budget for project implementation bySeptember 30 each year for submission to the Association for its review, before submitting the budgetproposal to the Ministry of Finance. The PIU would maintain a Special Account for the depositing of IDAfunds and a Project Account for the Borrower to deposit counterpart funds. These accounts would beopened in a commercial bank, satisfactory to the Association.

Monitoring and Evaluation

The PIU would appoint one staff member responsible for M&E. This person would also assist theEnvironmental Specialist with the monitoring of the environmental program. The PIU would, using

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expertise of the technical assistance team, prepare a program of annual monitoring acceptable to theAssociation immediately after credit effectiveness. This program would be designed to determine theimpact of the project and would monitor at least the indices set out in the logframe analysis in Annex 1.The PIU's M&E staff member would also monitor project inputs and outputs to be presented in theQuarterly Reports.

Reportinz

Quarterly Reports. The PIU would be responsible for preparation, and submission to theAssociation, of Quarterly Reports. The reports would include progress information on: procurement,construction, technical assistance, institutional development (completion of studies, training and studytours), environmental monitoring and management, disbursement, cost estimate updates and difficultiesencountered.

Annual Work Plan. The PIU would be responsible for the preparation of an Annual Work Plan bySeptember 30 each year for submission to the Government and the Association.

Annual Report. The PIU would also be responsible for preparation of an Annual Report thatwould summarize the activities of the preceding year, but would also include the final agreed Work Planand agreed Budget for the following year. This Report would be submitted to the Association andGovernment within 30 days of the end of the Azerbaijan fiscal year.

Training Plan. Training and study tours would be carried out according to a training plan, whichthe PIU would revise semi-annually and submit to the Association for approval prior to implementation.

Other Reports. The Government would prepare, under terms of reference acceptable to theAssociation, on or about March 31, 2003, a Mid-term Report of the project, setting out progress to date,the results of the M&E surveys and proposals for project completion and achievement of its objectives.The report would be reviewed with the Association during a mid-term review mission by June 30, 2003.Also the Government would prepare an Implementation Completion Report for submittal to the Associationwithin six months of project completion.

D. Project Rationale

1. Project alternatives considered and reasons for rejection:

The following three alternatives to the proposed project were considered and rejected:

(i) Comprehensive, full system rehabilitation (as against concentration on main systems). Themost critical elements in irrigation and drainage schemes are the headworks, main canals and drains. Thesemust be in good condition to sustain irrigation services and before investment in the lower order irrigationand drainage systems can be beneficial. In the SAC, investment and development in farm distributionsystems has commenced on a pilot basis under the Farm Privatization Project which is still ongoing andinsufficient lessons have been learned so far to incorporate the findings in a large-scale project. However,it is recognized that the full benefits of investment in the main system cannot be achieved withoutcomplementary investment in the farm distribution network and development of WUAs, emphasizing theimportance of a second IDA financed irrigation project which is planned for optimum impact as it isexpected to concentrate on WUA development and on-farm irrigation rehabilitation and modernization.Such a project is expected to increase the overall irrigation efficiencies further. In the MMMC, completion

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of the missing link in the main drain is clearly the most important priority, as without this no other action isworthwhile. Finally, the financial resources of the proposed Credit are insufficient to rehabilitate andcomplete all infrastructure (including the distribution systems at former farm level) in the command areasof the SAC and the MMMC.

(ii) Spreading the resources over more than two irrigation systems. With a total irrigated area ofabout 1.45 million ha comprehensive rehabilitation and completion of all systems would involve a sum ofabout US$ 700 million or US$ 500 per ha, which is considerably beyond the scope of the proposed Credit.During preparation, consultants were instructed to review and identify the priorities for investment in 11schemes, covering 530,000 ha, that had been selected by Government as priority for rehabilitation andcompletion. They identified, and agreed with Government and IDA, that the SAC and MMMC wereclearly the most critical systems, with irrigation command areas that are among the most important ones inthe country and with a large part of the population that is to a large extent dependent on the SAC for itswater supply.

(iii) Full, long-tenn development of the SAC. The Government has developed a masterplanconcept for the SAC to meet the future domestic and industrial water demands of Baku and the ApsheronPeninsula as well as the agricultural needs in its service area. This is an extensive plan involvingdevelopment of new water sources, construction of new dams and reservoirs, new canals and enlargementof the existing main canal. While studies of some elements are completed, there has been nocomprehensive, overall study. The Government agreed that completing the missing studies would delayproject preparation considerably, therefore the proposed project would be limited to those stand-aloneelements for which preparation could be completed on time, and which would, at the same time, becompatible with a possible larger scheme in the future. Thus rehabilitation was limited to the headworksand first 50 km of the SAC main supply canal.

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2. Major related projects financed by the Bank and/or other development agencies (completed,ongoing and planned).

Sector lssue Proect Latest tl SupRvsio__ (Bank-finane a prjects onlyY

Implementation Development

Bank-financed Progress (IP) Objective (DO)

Deteriorated irrigation infrastructure Farm Privatization Project S Sand absence of management at farm (Credit No. 29330)level

Incomplete agricultural reform (land Agricultural Development and S Sregistration, farm advisory services) Credit Project (Credit No.and lack of rural credit 32360)

Deteriorated urban water distribution Baku Water Supply Project S Ssystems and inadequate company (Credit No. 27510)management

Other development agencies

Incomplete irrigation and drainage Construction of Maininfrastructure Mill-Mugan Collector - Phase

II (Islarnic Development Bank;ongoing - to be completed by

end of 2000)

Deteriorated SAC irrigation Rehabilitation of Khanarkhinfrastructure Canal (Islamic Development

Bank; planned for 2000)

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design:

Experience from ongoing project implementation in Azerbaijan and other FSU countries suggeststhat: (i) project scope and design should be simple in view of the country's limited implementation andcoordination capacity; (ii) a project should have few components and be focused on one or few majoractivities; (iii) rigorous economic and environmental criteria should be applied in project planning anddesign; (iv) competent and efficient local management staff is necessary and should be recruited beforeCredit effectiveness for ensuring the viability and sustainability of the project; (v) there should beappropriate technical assistance, which if not recruited in time or not at all, because of Government'sreluctance to borrow for foreign consulting services, could jeopardize effective implementation; (vi) thereshould be major emphasis on procurement and construction quality control; and (vii) projects to beundertaken in rapidly changing circumstances and with limited reliable information should be designed forflexibility at implementation.

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OED's 1994 review of World Bank Experience in irrigation as well as other Bank reports on theirrigation portfolio emphasize that: (i) irrigation projects with large command areas should be givenpreference; (ii) there is need for adequate provision of O&M; (iii) success with O&M is more likely whenirrigation agencies are autonomous; (iv) whether public or private entities provide O&M, budgetcontributions from the irrigators should remain within the area of collection; and (v) effective demandbased services are an incentive to payment of water charges.

Experience during project preparation indicates that while Azeri engineers demonstrate good basicdesign skills, they lack in their training and experience any objective assessment of alternatives andeconomic considerations, so that designs follow long established "norms" without development of modemapproaches and technologies.

The ongoing construction of the second phase of the MMMC (52 kin), supported by the IslamicDevelopment Bank, demonstrates that the local construction industry has retained its ability to undertakelarge contracts and has to some degree restructured itself and is able to participate successfully incompetitive tenders. Several Azeri contractors participated in the bidding, which was won by one of them.Also the civil works contracts under the Farm Privatization Project have been awarded to either nationalcontractors or joint ventures between Azeri and foreign contractors. The quality of work carried out by allcontractors is generally satisfactory. A weakness remains in the distinction between the responsibilitiesand roles of contractor and supervisor.

These lessons have been discussed with Government and as many as possible have been taken intoaccount in the project design. It focuses only on two of the most important and largest command areas inthe country and will only concentrate on civil works and institutional support within these areas.Government has agreed to the early recruitrnent of sufficient and qualified PIU staff, as well as acombination of qualified national and international consultants for civil works design and supervision aswell as studies. The consulting services include specialists for procurement and independent constructionsupervision, including quality control. The procurement of two works and consulting services has alreadystarted. The sub-project activities have been analyzed in detail for economic viability. The project designwill also make a start with the incorporation of the OED lessons on O&M. It will work with SAIC andSAC's regional and raion irrigation offices on improvements in the collection of users fees, to be usedwithin the SAC command area on O&M. It will also aim at improvements in water delivery services.Although the project does not envisage the establishment of a fully autonomous O&M organization withinSAC and MMMC, it will be an important aspects to be studied in the irrigation sub-sector review andstrategy.

4. Indications of borrower commitment and ownership:

The Government has actively supported and promoted this project throughout preparation. Inseveral letters both the Deputy Prime Minister and SAIC Chairman have confirmed Government'sconmmitTnent to the project and the selection of the two sub-projects. In addition, in the letter ofdevelopment policy written by the First Deputy Prime Minister for the Agricultural Development andCredit Project, Government's commitment to the rehabilitation of main and inter-farm irrigation systems isstressed.

Soon after project identification, Government requested a Project Preparation Facility (PPF) tofinance consulting services for the preparation of the necessary preparation and feasibility studies. SAICstaff has very actively participated in these studies and contributed extensively to the design of the project.

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At the time of negotiations Government requested an additional PPF to continue sub-project preparationand avoid a gap between the completion of the first PPF and expected effectiveness. Government wouldlike to use this second PPF to finance the full establishment of the PIU and short-term consulting servicesto complete the procurement process for the first two sub-projects. Government has already started withthe procurement of the first two civil works contracts and the recruitment of necessary consultants.

5. Value added of Bank support in this project:

The principal contributions of IDA support would be in the introduction of international bestpractices in design and implementation of irrigation projects, as well as appropriate institutionalarrangements for project implementation and future management, operation and maintenance ofrehabilitated and completed infrastructure. In particular, the IDA would: (i) introduce reforms in the SACsystem management structure leading to more efficient and equitable distribution of irrigation water andbetter accounting procedures; (ii) support the development of a strategy for the sub-sector to permitdevelopment to focus on schemes with a long-term economic future as well as develop a comprehensivevision for institutional reform; (iii) incorporate into the project planning and design appropriate economic,financial, social and environmental criteria; (iv) introduce stakeholder participation; (v) introduce hightechnical standards and procedures in design and construction; (vi) introduce appropriate procurementprocedures, aiming at competitive bids; and (vii) strengthen SAIC's implementation capacity.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8)

1. Economic (see Annex 4):* Cost benefit NPV=US$27.7 million; ERR = 19.9 % (see Annex 4)O Cost effectivenessO Other (specify)

The project would comprise the two sub-projects of MMMC and SAC. A separate economicanalysis has been carried out for each of these sub-projects. In general, the project's main long-termeconomic benefit would accrue from the following factors: (a) increase in yield; (b) conversion to highervalue crops; and (c) prevention of the future collapse of the irrigation facilities and subsequent decline inirrigable areas. The SAC sub-project would also yield substantial economic benefit by securing the currentlevel of drinking water for Baku through critical rehabilitation of the main water supply system. The SACis currently delivering about 40 percent of the drinking and industrial water for Baku and surroundingareas.

Agriculture in Azerbaijan is currently in a depressed situation. With the collapse of regionalmarkets and the ongoing privatization of state and collective farms, the mode of agriculture has returned tomainly subsistence farming with minimum inputs and low output. Between 1993 and 1997 average yieldsfor most crops within the project areas fell to 50 to 60 percent of those experienced before 1990.(However, it should be noted that in 1998 there was a first sign of recovery due to the availability offertilizers and plant protection chemicals and a more secure legal environment for the newly establishedfarms, which now have clear land titles.)

Scenarios for this economic analysis have been prepared conservatively, taking the above-describedinto consideration. Thus, the anticipated increase in yields and conversion to higher value crops would takeplace in full only after 1 1 to 13 years from the completion of the sub-projects, allowing for a slow recoveryof the agricultural sector (1 1 years for SAC and 13 years for MMMC). For the without-project scenario, it

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is assumed that the recovery would continue in the project area even in the face of continued deteriorationof the systems as new farmers respond to the improved market environment. Moreover, for thewith-project situation, it is assumed that farmers would be slow to take full advantage of the rehabilitationworks. In addition, it was assumed that the sub-projects would restore the irrigation area to the 1989 level,rather than the total potential irrigable area. Other assumptions specific to each of the two sub-projects aredescribed in Annex 4.

Economic Rates of Retun (ERR) estimated for the SAC and MMMC sub-projects are 23.3 and16.4 percent respectively, showing that these sub-projects would have sufficient economic viability. TheNet Present Values (NPV) discounted at 12 percent were US$ 16.3 million for the SAC sub-project andUS$ 11.4 million for MMMC.

A sensitivity analysis was carried out in order to assess the sensitivity of the project to such risksas: (a) delay by five years in achieving full benefit of irrigation, resulting from various reasons such aslimited experience in private farming and limited access to marketing; (b) reduced crop margins for tradedcrops (wheat and cotton) resulting from the appreciation of local currency by 10 percent; (c) increased costof rehabilitation (by 20 percent) due to an unexpected increase in works; (d) slower adoption of highervalue crops by farmers; and (e) lower crop prices across the board. The sensitivity analysis showed thatthese sub-projects are generally robust against these risks (refer Annex 4, Table 7).

2. Financial (see Annex 5):NPV=US$ million; FRR = % (see Annex 4)

Conventional Financial Analysis is not applicable to this project.

Fiscal Impact:

SAC. The proposed rehabilitation of the SAC System would likely reduce the expenditures on themaintenance for the irrigation infrastructure in the long run, as the planned rehabilitation works proposedfor SAC would repair the heavily deteriorated headworks, concrete canal lining and diversion structures.The amounts of sediments would also be reduced due to the project interventions, such as rehabilitation ofthe sedimentation exclusion works at the headworks. Consequently, less maintenance would be required.However, it should be noted that in the short run, the operation and maintenance expenditures of SAIC inthe SAC command area would increase, as it would resume proper maintenance which has been deferredfor a long time.

At this moment, it is difficult to estimate the true O&M cost for the SAC, because of the explicitand implicit cross subsidies within the eight Irrigation Exploitation Units along the Canal and the SACOperational Unit, all of which have parallel activities in addition to the O&M of the Canal System. UnderComponent 2 of the project, institutional support for the SAC management to assist in developingprograms to improve the canal management and develop solid accounting and pricing principles to establishtransparency and accountability are aimed at providing a more efficient and cost-effective water supply anddelivery service.

MMMC. Overall fiscal impact of the proposed works of the MMMC is difficult to estimate, but itis likely that the proposed works would not substantially change the required O&M cost. The MMMCcompletion would certainly resolve the current overload of the Main Mill-Karabakh and Main ShirvanCollectors and somewhat reduce their operation and maintenance cost. On the other hand, the proposedcompletion of MMMC would also incur new fiscal expenditures. However, as the amount of drainagewater would not be increased, the overall fiscal impacts resulting from the drainage works would not be

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substantial and completion is not expected to increase the O&M budget of the MMMC by more than 20percent. It should be noted that there would be a considerable fiscal impact in the short run, as the SAICwould resume proper operation and maintenance.

Assurance has been obtained from Government that annual O&M plans would be developed toallow for proper operation and maintenance of the SAC and MMMC systems. It is expected that initiallySAIC would receive most of the required O&M budget from State budget, but that over the years the waterusers would start paying more for the service of delivering water.

3. Technical:

The technology involved in the irrigation and drainage infrastructure would to a large extent besimilar to existing structures because the works involved are either rehabilitation of an existing system(SAC) or completion of an ongoing construction (MMMC), where the scope for incorporation ofimprovements in technology is limited for canal lining and drain excavation. Design changes would bepossible for new structures such as bridges, aqueducts, diversion structures and siphon protection.

Under the FSU all designs followed strict "norms", leaving no scope for variety or the introductionof new technologies, or even for evaluation of failures and adjustment of the design norms. Thus, whilethere is every confidence in the ability of national engineers to build good, sound structures, there is lessconfidence in the capability of design engineers to adopt least-cost solutions or to objectively consider thevalue of a component. In project preparation the question of the "heavy" engineering designs was raised,with the possibilities for cost economies derived from new design standards, but this proved of littleattraction to Azerbaijan engineers. Thus at the end of preparation, the project components remain verymuch based on the sound, but "heavy" unimaginative and rather expensive Soviet standards. The projectwould, however, expose PIU and SAIC engineers to more modem engineering in several ways: (i) thedesign and supervision consultants would have major foreign inputs in the preparation of detailed designs,which would be explicitly stated in the terms of reference; (ii) the technical assistance team would workclosely with the design engineers during the design stage of each sub-project and review designs with theaim of introducing the concepts of "least-cost" and economy; and (iii) study tours to Europe and otherareas where different technologies are in use would be organized.

A particular concern during preparation was the issue of removal of sediments from the SACcanal. The existing scheme includes de-silting measures that were unsuccessful from the start of the projectbecause of design errors. Simple rehabilitation here is clearly not a recipe for success. This issue wouldneed extensive reconsideration and possibly the introduction of a new approach or a new technology. Toaddress this issue an element of specialized technical assistance has been included in the project to ensurethat an economical, sustainable and environmentally sound sediment removal plan is developed.

The past standard of construction of major works under the FSU, such as are proposed under thisproject, have been good and there is every reason to consider that this standard would be maintained. Theongoing construction of the second phase of the Main Mill-Mugan Collector and the civil works under theFarm Priv.ization Project indicate that Azerbaijan contractors and supervisors would be able to implementmajor civil engineering works in a satisfactory manner.

Considerable effort has been made during project preparation to determine accurate unit prices forthe works. Experience of ongoing projects has been used and market surveys have been carried out todetermine material and labor costs (see Annex 2). Physical contingencies of 10 percent have been includedin the costs estimates for the civil works of MMMC and SAC. Prevailing price contingencies for local and

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foreign costs have been included as well.

4. Institutional:

4.1 Executing agencies:

The executing agency is the State Amelioration and Irrigation Committee, which is capable ofconstruction and management of major projects. SAIC was responsible for the construction of 1.45 millionha irrigation under the FSU and is currently responsible for the ongoing major construction of the secondphase of the Main Mill-Mugan Collector, financed by the Islamic Development Bank. However, it isfundamentally an engineering-based organization with a residual supply-driven, centralized governmentmentality which is not yet well adjusted to Bank funded projects. Weaknesses in project management areanticipated in four fields: (i) design issues, which are discussed in the preceding paragraph; (ii)procurement; (iii) construction supervision; and (iv) reporting and planning. However, these would mainlybe addressed at the level of the PIU, refer to the succeeding paragraph, rather than at the level of SAIC.

4.2 Project management:

Day to day management of the project would be delegated to a Project Implementation Unit,reporting to the SAIC Chairman. The PIU was recently established for the preparation of the project, butis still relatively inexperienced, both in project management and in Bank requirements and procedures. Itwould be strengthened before Credit Effectiveness by additional staff and would be supported by atechnical assistance team during the first 18 months of project implementation. The weaknesses notedabove in paragraph 4.1 apply equally to the PIU and would be addressed as follows:

* Inflexibility and reliance on old "norms" in design would be addressed by inclusion ofintemationally experienced engineers in the design work, by a technical review of designs bythe Technical Assistance team, by on-the-job training and overseas study tours;

* Procurement weaknesses are inexperience in Bank procedures and a lack of full understandingof the principles of competition, faimess and transparency, which would be addressed by directtraining of PIU procurement staff and on-site support by the Technical Assistance team, whichincludes a full-time Advisor, who should have procurement experience, as well as a short-termProcurement Advisor;

* Construction supervision weaknesses relate to a lack of understanding of the roles and legalresponsibilities of contractor, supervisor and Client in construction management, rather than totechnical standards in which Azeri engineers appear adequately trained. The TechnicalAssistance team would include a specialist in construction management whose tasks wouldinclude organization of the supervision, including the preparation of adequate guidelines, aswell as training of national staff. The Design and Supervision Consultants would includeintemationally experienced construction supervisors. On-the-job training would be reinforcedby overseas study tours; and

* Reporting and planning weaknesses in the PIU would be addressed by the Technical Advisor inthe Technical Assistance team who would be assisting the PIU Project Director in these tasks.

4.3 Procurement issues:

During the preparation of the project, an assessment of the public procurement system inAzerbaijan and capacity of implementing agency was made. Azerbaijan has a Presidential Decree onProcurement (PDP) and a Law on Tendering (LT). It also has an independent State Procurement Agency(SPA), which has as major task ensuring effective implementation of public procurement. Nevertheless,Azerbaijan is a "high risk" country from the procurement point of view. There are two reasons for this: (i)

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the country's procurement legislation is unclear and lacks harmony and consistency. It would take timebefore the provisions of the Decree and Law are transformed into practice, which would also require anadequate staffing of the SPA to actively ensure effective implementation of the PDP and LT; and (ii) theeconomic atmosphere in the country in which the law operates is not yet conducive to fair and transparentprocurement processes.

The PIU is not yet fully staffed and equipped. It has only gained limited experience in Bankprocurement procedures and practices under the PPF and PHRD Grant for project preparation. Incollaboration with the PIU, an action plan has been prepared to strengthen PIU's capacity to administerprocurement in an effective and transparent way. This plan is summarized in Annex 6. Since the generalprocurement environment in which the PIU would operate is not conducive to fair and transparencyprocurement processes, the prior review thresholds recommended are those applicable to a "high risk"country.

4.4 Financial management issues:

The financial management capacity within Azerbaijan has not been the subject of a detailed reviewby IDA. However, primarily because of other implementation considerations, any weaknesses that mayexist in the country's financial management capacity have been mitigated by the use of a specialized projectimplementing agency, the PIU, for project implementation, including its financial management, and by theBorrower's agreement to obtain the IDA's no-objection to the appointment of the project's auditors. Thespecific weaknesses of the PIU in respect of its financial management capacity would be addressed by alocal financial management consultant, however, these weaknesses neither compromise the fiduciaryresponsibilities of the Borrower nor of the Association. The selected financial management consultantalready has experience of successfully establishing and operating the financial management system of asimilarly complex IDA-financed project and therefore this arrangement is not considered to contain anysignificant implementation risks. In addition, weaknesses in the Azerbaijan banking sector would bemitigated by the use of a bank deemed eligible by the IDA to hold the project's Special Account.

5. Environmental: Environmental Category: B (Partial Assessment)5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (includingconsultation and disclosure) and the significant issues and their treatment emerging from this analysis.

Environmental Assessment. The National Environmental Action Plan (NEAP) that was preparedin 1998 identified the following environmental issues related to the irrigation sub-sector: (i) ineffectivewater resources management; (ii) increasing areas affected by waterlogging and soil salinization, caused byinefficient irrigation water management and uncompleted drainage systems; and (iii) pollution of majorrivers. The project would have a positive impact on these environmental problems. Improvements in theirrigation and drainage infrastructure would allow a more efficient use of water and better control of thedrainage water and groundwater table. The completion of the Main Mill-Mugan Collector would divertsaline drainage water away from the Kura River. Improvements in the institutional capacity to provideadequate and timely operation and maintenance would improve the water management within the commandareas. No new canals or structures that would allow increase in the water diversion or delivery capacityare envisaged. The proposed project does not include any investments in dams or involve resettlement ofpeople. A comprehensive monitoring program has been designed to monitor any impact the MMMC couldhave on surrounding areas and funds have been reserved to mitigate any negative impacts (see below inSection 5.2).

The project has been classified as Category "B" for the purpose of OP 4.01 EnvironmentalAssessment, yet a comprehensive Environmental Impact Assessment (EIA) and an EnvironmentalMonitoring and Management Plan have been prepared in 1999.

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Potential negative impacts of the project would be: (i) (for the MMMC) a reduction in water inflowinto Lake Sarisu and possibly a reduction in water surface and depth, seepage losses from the newCollector and release of drainage water in a different location along the Caspian Sea; (ii) increasedagrochemical pollution and surface water contamination, resulting from increased use of pesticides andfertilizers, along with improved availability of irrigation water; (iii) indiscriminate dumping of excavatedsediment deposits and other materials from the canals, drains and structures during construction andmaintenance; and (iv) environmental damage caused by contractors during construction activities (seebelow in Section 5.2).

International Waterways. The proposed SAC and MMMC projects are located within the basinsof international waterways, therefore Operational Policy OP 7.50 "Projects on International Waterways"applies. The SAC headworks is located on the Samur River, which is a border river between Azerbaijanand Russia. GOA has duly notified Russia of its intention to rehabilitate the headworks according to theoriginal design which would not lead to an increase in the headworks capacity. Russia has agreed to theproposed rehabilitation, provided that indeed it does not lead to an increase in the headworks' capacityabove the original level.

The proposed rehabilitation works of the SAC System would not change the original capacity ofthe canal system and therefore would not have any major impact on the quality or quantity of water flowinginto the Caspian Sea. Water use by the riparian countries around the Caspian Sea would not affect theproject. The proposed works for MMMC involve the following international waterways: (a) the KuraRiver; (b) the Araz River; and (c) the Caspian Sea. The MMMC would have no impact on water flow, orits quality or quantity in the upper riparian countries, as Azerbaijan is the most downstream country.Conversely, the MMMC would not be adversely affected by the upper riparian countries' future water use,as it does not draw water from international rivers. There would also be no impact on the Caspian Sea,since the proposed completion of the MMMC would only re-route Mill-Karabakh drainage water from theleft bank of the Kura river to the right bank, but would not change its quantity or quality. By the sametoken, water use in the riparian countries around the Caspian Sea would not affect the project. Thereforethe proposed rehabilitation of the SAC System and completion of the MMMC are exempt from thenotification requirement pursuant to paragraph 7 (a) of OP 7.50.

Dam Safety. Mingechevir and Shemkir are two major dams located on the Kura River, locatedapproximately 200 kilometers upstream of the MMMC project area. Due to higher level and distance fromthese dams there is no extraordinary risk to the project facilities and the project area in case of failure ofany of these dams and the project would remain functional.

During preparation of the IDA funded Urgent Environmental Investment Project in 1998, a damsafety assessment of the two dams was carried out by the Association, which concluded that the two damsare in reasonably good condition. The following requirements were at that time considered sufficient forcompliance with the Dam Safety Policy: (a) resume independent safety inspections; (b) include operationaltests of all gates in the inspection programs; and (c) provide copies of such inspections to IDA. A safetyinspection of Shemkir dam, including operational tests of gates, was made in November 1999 by a team ofAzeri experts, and the dam was found to be in satisfactory condition. A similar inspection for Mingecheviris planned for 2000.

Relocation of People. The proposed route of the Main Mill-Mugan Collector is through state landwhich was specifically exempted from privatization in anticipation of the construction of the Collector.People would not be relocated as a result of the construction. (See also Section 7.2 below.)

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5.2 What are the main features of the EMP and are they adequate?

An Environmental Management Plan (EMP), incorporating a comprehensive monitoring plan, hasbeen prepared. It has been submitted to the Bank's Infoshop and has been annexed to the ProjectImplementation Plan (PIP). The EMP describes the mitigating measures for the four potential negativeimpacts that are described in the previous section. The Development Credit Agreement has a covenantcalling for the carrying out of the EMP.

The mitigation of potential impact (i) relates first of all to Lake Sarisu, which is a protected areathat would be affected by the sub-project. Lake Sarisu is a shallow water body and reed swamp of around6,500 ha located in the immediate project area between the MMMC and Kura River. Although only arestricted area, Lake Sarisu is nevertheless important for migratory and resident birds. Lake Sarisureceives water from different sources and has an outlet to the Kura River to discharge excess water. Itwould be affected by the proposed project, with three impacts: (a) the MMMC would cut across and reducethe natural catchment area of the lake; (b) the drainage water from an irrigated area of about 10,000 ha,which is currently pumped into the lake, would in future discharge by gravity into the new main collector;and (c) the new collector would marginally lower groundwater levels along its route and may increaseseepage losses from the lake. The consequence for Lake Sarisu would be a reduction of in-flowing waterand a possible risk of damage. A second sensitive site, the Ag-Gol Lake, a 9,173 ha protected areacontaining a shallow lake and reed swamp, was designated a RAMSAR site in 1976 for the protection ofresident and migratory birds. Although it is hydraulically linked to Lake Sarisu, which receives overflowfrom Ag-Gol, it is located more than 30 km away of the MMMC alignment and would be unaffected by theproject works.

Because of the lack of inflow-outflow data of Lake Sarisu it is as yet unclear whether the reducedwater supply would negatively affect the lake's water level and area. A comprehensive monitoring plan hasbeen designed and costed. Based on the results of the monitoring, Lake Sarisu may have to be connected toa new water source. A number of options have been considered: (i) increase the water supply to Ag-GolLake through a connection with the Main Mill-Karabakh Irrigation Canal; or (ii) connect with the Kurariver. A panel of national specialists would review the data collected in the monitoring program aroundApril 2003 to determine the necessity and scope for mitigation measures for Lake Sarisu. A financialallocation has been made in the project budget to implement such mitigation measure, if deemed necessaryafter the monitoring. The PIU would be in charge of arranging for the implementation of necessary works.

The seepage flow from the completed section of the MMMC and its impact on the immediatesurroundings would be monitored. Experience from the completed sections of the MMMC indicate thatnegligible impact should be expected from this deep-cut collector.

An additional impact of the MMMC would be the switching of about 25 m3 /s drainage water fromthe left bank outfall into the Caspian Sea to the more southem right bank outfall, about 50 km to the south.This is not considered to be a significant factor, as the southem outfall already exists and has beendischarging for a considerable time. Nevertheless, monitoring of the shore and water body near the outfallhas been included in the monitoring program.

The mitigation of identified item (ii) increased agrochemical pollution and surface watercontamination, resulting from increased use of pesticides and fertilizers, along with improved availability ofirrigation water would be addressed by agricultural advisory services that are being established under theongoing IDA supported Agricultural Development and Credit Project. The specialists of this service would

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provide extension and advisory services, as well as training in proper application techniques and timing andhandling of residues of fertilizers and pesticides. As inputs would not anymore be available at subsidizedprices as during the time of the Former Soviet Union, the actual use of pesticides, chemicals and fertilizerswould not reach the high levels as before Independence. This more careful use of fertilizers and chemicalsand the extension and advisory services is expected to keep the negative impact of increased input use to aminimum.

Items (iii) and (iv) would be addressed during sub-project design and supervision. Contractorswould be required to prevent, minimize or mitigate environmental damage. Sediments and other debriswould be displaced in an orderly manner, rather than dumped indiscriminately. There would be reuse ofsuitable excavated materials, limiting the need for old and new quarries. Where possible, existing quarrieswould be used for required additional materials. Contractors would also have to restore to quasi-originalcondition the landscape after completion of rehabilitation works and after use of quarries. The biddingdocuments would have environmental precautionary clauses.

5.3 For Category A and B projects, timeline and status of EA:Date of receipt of final draft: March 2000

The Environmental Impact Assessment Report and Environmental Management and MonitoringPlan have been submitted to the Bank's Infoshop and are available from the State Amelioration andIrrigation Committee in Baku.

5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EAreport on the environmental impacts and proposed environment management plan? Describe mechanismsof consultation that were used and which groups were consulted?

Three public consultants meetings were held during December 1999 to inform and consult localorganizations and stakeholders about the proposed project, the monitoring program and the environmentalmanagement plan and to hear their views and suggestions. One meeting took place in each of the twosub-project areas, while a third meeting took place in Baku, mainly for representatives ofNon-Governmental Organizations (NGOs) and other interested individuals and organizations. Each of themeetings was announced through advertisement in local newspapers. Brief minutes of each of the meetingshave been annexed to the Environmental Management and Monitoring Report.

5.5 What mechanisms have been established to monitor and evaluate the impact of the project on theenvironment? Do the indicators reflect the objectives and results of the EMP?

The PIU would be in charge of administering and coordinating the proposed monitoring program.It would have a full-time environmental specialist in the team. On environmental issues the PIU would notonly report to the Chairman of SAIC but also to the Chairman of the State Committee on Ecology and itwould coordinate and collaborate with governmental organization and institutes that would be involved inmonitoring work. The investment costs needed to set up the monitoring and evaluation program, includinga Geographic Information System (GIS), as well as the annual operational costs to carry out surveys andanalyze survey data have been included in the project's budget. The inclusion of the GIS would facilitate amodem data handling and an efficient environmental monitoring.

The environmental monitoring program is proposed to get an exact picture as possible of thesituation before, during and after the implementation of the MMMC and SAC projects. This allows todefine actual project impacts and to design effective mitigation measures. The program comprises annual

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campaigns of data collection (statistical data and field observations), data assessment and reporting. It isproposed to start in early 2001 before construction activities start and to last 8 to 10 years in total. Atleast, until the end of the project implementation it should be carried out by SAIC. Based on monitoringinformation, discussed in section 5.2 above, the PIU, panel of experts and other involved parties woulddecide on necessary mitigation measures for maintaining Lake Sarisu.

Pesticides, chemicals, fertilizer and salinity levels would be measured in the drainage water.Measurements would take place three times per irrigation season (March, May and September) by localsurvey teams to be organized by the PIU. They would analyze the samples with portable field kits.International thresholds would be used that would signal need for corrective actions. If the level of thedrainage water in the drains is consistently above the World Health Organization (WHO) and/or otherinternational norms, corrective measures would have to be implemented. These would include increasedtraining and extension activities and possibly reductions in the use of inputs.

During implementation contractor activities would be supervised by the PIU engineers andmonitored by the State Committee on Ecology. Any damage done by a contractor to the environmentwould have to be rectified at the expense of the contractors.

6. Social:6.1 Summarize key social issues relevant to the project objectives, and specify the project's socialdevelopment outcomes.

The anticipated social development outcomes of the project would be manifest on the macro level,strengthening the creating of the physical framework for sustainable irrigated agriculture. This is a majorinfrastructure project that would affect a large part of the Azeri population. The SAC rehabilitation worksare necessary to avoid the collapse of the existing diversion and increase the amount of water diverted forirrigation and drinking water. This sub-project would therefore reduce vulnerability. The MMMCsub-component would complete a major drainage collector that would carry water directly to the CaspianSea. It would improve the drainage in areas that already have declining yields due to waterlogging andsalinization and halt the spread of the phenomenon; this would especially be evident in the 36,500 ha thatdirectly borders the alignment of the 31 km long collector drain that would be constructed under the project.This would both decrease vulnerability and increase opportunities for different sets of farmer stakeholders.The two sub-projects are first steps in the program that would next address issues of access and socialcohesion through improvements in inter-farm and on-farm system improvements in the irrigation anddrainage infrastructure that are essential for agriculture and rural livelihoods in Azerbaijan.

The institutional initiatives in the project are directed to make irrigation management more effectiveby promoting transparency and accountability within SAC management. These initiatives would benefitfarmers by leading towards better integration of farmers in irrigation management, which would be thefocus of the proposed follow-on project. Improved water delivery to the farms involved in the FarmPrivatization Project would also strengthen the institutional changes initiated under the project at the levelof the former state and collective farms, which constitute hydrological units within the irrigation system.

The project would support development of an irrigation sub-sector review and strategy whichwould address the viability of all existing irrigation schemes and pay special attention to the social issuesassociated with the possible closure of non-viable irrigation schemes. The review is intended as adiscussion document to promote open debate and consultation on a number of issues related to theeconomics of irrigation and the social impact of irrigation in Azerbaijan. However, the project would notlead to the closure of schemes.

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A social assessment process was initiated in the two sub-project areas during the 1999 agriculturalseason. The work consisted of a survey of 1,600 households and staff of about 400 different entities(collective farms, non-agricultural and state enterprises, etc.). Tjhis stage of the social assessment wasdesigned to understand a number of issues: (i) problems with irrigation and drainage infrastructure and thecontribution of unsatisfactory water supply to low agricultural production; (ii) the extent to which thereluctance of water users to pay for water use is related to the unreliability of irrigation service andinadequacy of supply, as well as ability to pay; (iii) the extent to which water users feel the need to beinvolved in operation and maintenance of irrigation infrastructure and water management; (iv) thewillingness of water users to organize themselves; and (v) level of interest of users to take responsibility forsystem management. The results revealed that: (i) the principal problems with the existing irrigationsystems supplies are unreliable and inadequate supplies and poor and deteriorating drainage; (ii) farmerswould be willing to pay for better service; (iii) farmers are willing to be organized, but feel that they haveneither the mandate nor the skills to organize; and (iv) farmers want to have more responsibility fordecisions that affect their livelihood. These findings thus confirm the importance of the proposedinvestments, as well as the need and the focus of the proposed second project, which is expected to focus oninstitutional developments at former state and collective farm level, in order to increase users participationin operation and maintenance.

6.2 Participatory Approach: How are key stakeholders participating in the project?

During project preparation, five workshops have been held, both in the field and in Baku, at whichthe proposed project and the environmental assessment were presented to beneficiaries, concerned officials,including representatives of the environmental agencies and interested NGOs. The initial presentation ofplans for the MMMC in the early 1 980s was accompanied by consultations and public announcements,thus officials, farmers and other stakeholders were already aware of the objective of the collector drain.Consequently, the workshops were designed primarily to update information and address new issues,including environmental ones, rather than develop a basic understanding of objectives and overall activities.The workshops concluded that more detailed consultations were not necessary at this stage, where thephysical works proposed are concentrated on the major infrastructure, i.e. the headworks, main canals anddrains. It has been agreed, however, that preparation of the proposed second irrigation project would startwith more extensive and intensive consultations with various stakeholders from farmers to officials andtechnicians designed both to create a common understanding, establish priorities and initiate a participationprocess that would continue through the design and implementation of the second project to theempowerment of user groups.

6.3 How does the project involve consultations or collaboration with NGOs or other civil societyorganizations?

Two inter-district seminars were held in each of the sub-project areas during the social assessmentin each of the project areas. The results of the assessments were discussed with a wide range ofstakeholders, including farmers, heads of farms and enterprises, local administrators and local SAIC staff.Ongoing consultations would focus more attention to the scope and content of the proposed second projectthan specific design and implementation arrangements for this project, however. In addition, threeconsultation meetings were held to discuss enviromnental issues.

6.4 What institutional arrangements have been provided to ensure the project achieves its socialdevelopment outcomes?

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The principal social outcomes of the project are associated with improved drainage and increasedreliability and supply of irrigation water. These dimensions are standard concerns of the SAIC althoughdocumentation has been limited in the past and dissemination has obviously been limited in the past.Institutional development initiatives of the project would strengthen the measurement and monitoring ofwater delivery, as well as increase the transparency of record-keeping and the dissemination of information,thereby increasing accountability.

6.5 How will the project monitor performance in terms of social development outcomes?

The salient indicators of project performance are the points of interface with groups of farmers andother water users, i.e. water delivery points and drainage facilities. Consequently, system monitoring,focusing on deliveries and system performance, would serve both physical and social monitoring purposes.More detailed, sophisticated micro-level monitoring is neither relevant nor feasible within the context of theproject.

7. Safeguard Policies:7.1 Do any of the following safeguard policies apply to the project?

atolicy\ ppal ; f Iit E Environmental Assessment (OP 4.01. BP 4.01. GP 4.01) [Z Yes D NoD Natural habitats (OP 4.04. BP 4.04 GP 4.04) El Yes Z NoEl Forestry (OP 4.36, GP 4.36) El Yes 1 NoEl Pest Management (OP 4.09) El Yes Z NoEl Cultural Property (OPN 11.03) 0 Yes E NoEl Indigenous Peoples COD 4.20) O Yes 1 NoEl Involuntary Resettlement (OD 4.30) O Yes 3 NoE Safety of Dams (OP 4.37. BP 4.37) __ Yes El NoEl Projects in Intemational Waters (OP 7.50. BP 7.50. GP 7.50) Z Yes E NoEl Projects in Disputed Areas (OP 7.60, BP 7.60. GP 7.60) O Yes [Z No

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

The project would involve some land acquisition for the right of way for the MMMC, but OD 4.30does not apply because the acquisition merely consists of a transfer from the budget of one governmentalunit (primarily District and Municipality) to another unit (SAIC). The original alignment of the collectorwas set around 1983, deliberately following the borders of state and collective farms, rather thantransecting them. The right of way was approximately 200 m wide throughout the length of the section ofthe collector. Following standard procedures, the land was surveyed and parcels identified forappropriation by eminent domain. A package of approvals and agreements was submitted to the Cabinet ofMinisters, which approved the project, including land acquisition and compensation, on July 12, 1985.That approval expired two years later without action being taken. Subsequently, when the state andcollective farms were privatized in the 1990s, the land situated in the route of the collector was set aside,exempted from privatization. Consequently, the land remains in the possession of State and Municipalauthorities. Once final designs are completed, there is a very small chance that the final alignment maymove outside of the reserved area, affecting either private land or other State and Municipal land. Atpresent, however, this is not expected to occur, thus the land acquisition in the project would consist of landtransfers from one governmental agency to another. If it does, the reserved land would be substituted forthe land that is actually transferred to the SAIC. The Development Credit Agreement stipulates that noprivate land would be affected unless procedures for compensation and replacement have been reviewedand found satisfactory by the Association. This issue would be followed closely during supervision.

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F. Sustainability and Risks

1. Sustainability:

Adequate and regular maintenance, as well as effective operation of the rehabilitated or completedirrigation and drainage infrastructure would be critical for the sustainability of project benefits and shouldbe an important focus for the country. During the past years the contribution from State budget to O&Mof irrigation infrastructure has been insufficient and, as described in Section B, the contribution of waterusers towards financing the O&M of the off-farm irrigation infrastructure is still very low and is expectedto remain low during the next few years. Emphasis should first be on improving the collection rate of theexisting ISF and not focus on increasing the charge until an adequate system of collection and enforcementis in place. This also reflects concerns about the current low incomes in the rural areas and Government'sdesire not to increase charges until incomes begin to rise. Increase in ISF would be considered during theimplementation of the second Irrigation Project.

Even with higher collection rates in the project's command areas, Government would still have tomake more funds available for O&M. Assurance has been obtained from Government that SAIC shallrequest an annual budget adequate for the proper operation and maintenance of the SAC and MMMCSystems. This O&M budget and its full justification would be submitted to the Association first for itsreview, before submitting the budget proposal to the Ministry of Finance.

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2. Critical Risks (reflecting assumptions in the fourth column of Annex 1):

N022: isk Risk Ra .i; Risk Minimiztion Measuire .From Outputs to ObjectiveInsufficient budget for O&M; S Better inform and educate water users, through

training, information campaigns and promotion,that adequate contributions to the O&M ofrehabilitated or completed infrastructure arenecessary for the long-term sustainability ofirrigation infrastructure. The Water UsersAssociations Coordination Unit (establishedunder Farm Privatization Project) and theupcoming preparation activities for the proposedIrrigation II project should have a major focustowards this. The project seeks commitmentfrom government, through a covenant, that itallocates adequate funds;

Lack of farmers commitment to pay S Support for WUA development to continuehigher Irrigation Service Fee; under Farm Privatization Project and during the

preparation of the second irrigation project;

Insufficient capacity to properly operate M SAIC has retained many capable staff thatand maintain rehabilitated or completed would be able to carry out operation andinfrastructure; maintenance if sufficient funds are available;

From Components to OutputsCost overruns during project M During preparation, consultants have spentimplementation; considerable time costing the project works, and

have included a review of ongoing civil works todetermine actual unit costs for different worksand materials;

Capable contractors cannot be attracted to M Contract packages are large and may attractcarry out civil works; foreign firms. Azerbaijan contractors have

retained much of their strength and are currentlysatisfactory involved in the implementation ofsome large civil works;

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Project staff are not competent and M The short-list of consultants would be revieweddedicated; and approved by the IDA and all recruitment of

consultants would be based on competitiveprocedures. An important task of theinternational consultants would be on-the-jobtraining and knowledge transfer. National staffwould have necessary training opportunities;

Sufficient counterpart funds are not S Counterpart financing needs have been kept to aavailable; minimum. Annual review of the counterpart

fumds should be done in time and project staffwould have continuing discussions with MOF;

Overall Risk Rating 5

Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk)

3. Possible Controversial Aspects:

None.

G. Main Credit Conditions

1. Effectiveness Condition

Conditions ofproject effectiveness include:

* The PIU has been fully established within SAIC and its staff shall have been appointed withqualifications and under terms of reference satisfactory to the Association;

* Independent auditors, acceptable to the Association, shall have been appointed;* The Steering Commission shall have been appointed, composed of the Deputy Prime Minister,

the Chairinan of SAIC, Deputy Minister of the Ministry of Finance, Chairman or arepresentative authorized by the Chairman of the State Committee on Ecology, DeputyMinister of the Ministry of Agriculture, Chairman of the Apsheron Water Supply Companyand the PIU Director (Secretary); and

* The Borrower shall have opened a Project Account in a local commercial bank and shall havedeposited an amount in Manat equivalent to US$ 130,000.

2. Other [classify according to covenant types used in the Legal Agreements.]

Condition for disbursement for the Works category.

* Each design has to be approved by the Association, through submission by the PIU of asatisfactory design report.

Management:* Government will maintain a Steering Commission; and* Throughout the implementation of the project, the PIU will be maintained with a sufficient

number of staff, consultants, adequate resources and terms of reference satisfactory to theAssociation.

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Project Implementation

* Each Works contract will be designed in accordance with agreed criteria;* Each Works contract will be carried out in accordance with agreed terms and conditions;* Government will, not later than September 30 of each year, prepare and submit to the

Association, for its review, a work program and budget for activities to be carried out duringthe following fiscal year; and, immediately thereafter, finalize said program taking intoconsideration the Association's comments;

* Before submission to the Ministry of Finance, SAIC will submit to the Association for reviewthe draft annual O&M budget adequate for proper operation and maintenance of the SAC andMMMC systems;

* Training and study tours shall be carried out according to a training plan, which the PIU willrevise semi-annually and submit to the Association approval prior to implementation; and

* Incremental operating costs as a result of the project implementation will be disbursed on thebasis of an annual budget to be agreed with the Association.

Monitoring, Review and Reporting

* Government will maintain policies and procedures adequate to monitor and evaluate on anongoing basis, in accordance with indicators satisfactory to the Association, the carrying out ofthe project and the achievement of the project's objectives; and

* Government will prepare, under terms of reference satisfactory to the Association, on or aboutMarch 31, 2003, a report integrating the results of the monitoring and evaluation activities andsetting out the measures recommended to ensure the efficient completion of the project and theachievement of its objectives; and review the report with the Association, by June 30, 2003.

H. Readiness for Implementation

1 1. a) The engineering design documents for the first year's activities are complete and ready for the startof project implementation.

D 1. b) Not applicable.

1 2. The procurement documents for the first year's activities are complete and ready for the start ofproject implementation.

1 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactoryquality.

O 4. The following items are lacking and are discussed under loan conditions (Section G):

The draft bidding documents for the rehabilitation of the Samur headworks and the completion of theMMMC siphon under the Araz River have been completed.

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1. Compliance with Bank Policies

3 1. This project complies with all applicable Bank policies.O 2. The following exceptions to Bank policies are recommended for approval. The project complies with

all other applicable Bank policies.

Joop Stoutjesdijk Ke M. CleaverTeam Leader Sector Manager/Director Country Manager/Director

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Annex 1: Project Design Summary

AZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage InfrastructureProject

K'ey PerformanceHierrh of9 Objectives i . tc nIndicM rng & Evalua tono CriticaI Asumptionsi

Sector-related CAS Goal: Sector Indicators: Sectorl country reports: (from Goal to Bank Mission)1. Attainment of long-term 1.1. Contribution to GDP 1.1. Government statistics; Consistent with Banksustainable growth in from irrigated agriculture in Mission;agriculture; the project areas; 1.2. Living standards surveys;

1.3. Various sector andcountry reports, prepared on aregular basis by differentorganizations;

Project Development Outcome / Impact Project reports: (from Objective to Goal)Objective: Indicators:1. Prevent the decline in 1. 1. Annual amount of water 1.1. 1. Baku-Apsheron Water Supportive macro-economicsupplying water to Baku and supplied to Baku Water Supply Company data and framework;surrounding areas and stop Supply Company in line with annual reports;further deterioration of the average demand of 290 Continued agricultural policysupply of irrigation water in million m per year; 1.1.2. SAIC statistics; reform;the SAC command area;

1.2. Supply of irrigation 1.2.1. SAIC statistics; Related investments andwater to farms within the Technical Assistance projectsproject area adequate and financed by IDA and othertimely, in line with crop water financiers are successful;requirements of about 6,500 m3/ha gross at the farm Agricultural inputs areboundary; available at competitive prices

and prices for agricultural1.3. Conveyance and 1.3.1. SAIC statistics; products are competitive;distribution efficiency toincrease from 64 to 75 percentat the end of rehabilitation;

1.4. About 69,000 ha 1.4.1. Ministry of Agricultureirrigated annually after statistics;completion of rehabilitation ofall works; 1.4.2. PIU monitoring and

evaluation reports;

1.4.3. SAIC statistics;

1.5. Yields of 3.2 ton/ha for 1.5.1. Ministry of Agriculturewheat, 6.6 ton/ha for fruits, statistics;19.5 ton/ha for vegetables and3 ton/ha for grapes four yearsafter rehabilitation works havebeen completed;

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2. Improve drainage in the 2.1. Groundwater table below 2. 1.1. SAIC statistics;MMMC command area; 2.0 meter in project area;

2.1.2. PIU survey data;

2.2. Area irrigated annually 2.2.1. Ministry of Agricultureto be maintained at 36,500 ha statistics;after completion of theMMMC; 2.2.2. PIU monitoring and

evaluation reports;

2.2.3. SAIC statistics;

2.3. Yields of 3 ton/ha for 2.3.1. Ministry of Agriculturewheat, 2.5 ton/ha for cotton, 7 statistics;ton/ha for fodder and 15ton/ha for vegetables fouryears after the completion ofthe works;

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Keiy Pefrformance"Hier0a*hyof Objctiest indctrswd tg M6oiorng & Ealuation Cr il Asmtions

Output from each Output Indicators: Project reports: (from Outputs to Objective)component:1. Irrigation canals in the 1.1. Length of irrigation 1. 1. Annual report by SAC Sufficient budget for O&M;SAC command area canals selectively rehabilitated and SAIC on schemerehabilitated and drainage (50 km of main canal and 260 performance; Farmers committed to paychannels in the MMMC km of inter-farm canals); higher irrigation service fees;command area completed and 1.2. Annual surveys by PIU'srehabilitated; 1.2. Length of drainage M&E staff; Sufficient capacity to maintain

channels completed (31 km) rehabilitated or completedand selective rehabilitation of 1.3. PIU quarterly and annual infrastructure;collector drains on 36,500 ha. reports;

1.4. IDA supervision reports;

1.5. Mid-term report;

1.6. ImplementationCompletion report;

2. The ability of SAIC to 2.1. Development of 2.1. Annual report by SAICdevelop, operate and maintain feasibility and design studies on SAC and MMMC systemirrigation infrastructure is ready for submission to performance;improved; Government and financiers;

2.2. Annual survey by PIU's2.2. Annual O&M plans for M&E staff,the SAC and MMMCcommand areas completed; 2.3. PIU quarterly and annual

reports;2.3. Project implemented incompliance with 2.4. IDA supervision reports;Environmental ManagementPlan; 2.5. Mid-term report;

2.6. ImplementationCompletion report;

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Key PerformanceHierarchy of Objectives Indicators Monitoring & Evaluation Critical Assumptions

Project Components / Inputs: (budget for each Project reports: (from Components toSub-components: component) Outputs)

1. Rehabilitation and 1.1. US$ 41.34 million; 1.1.1. PIU Progress reports, No cost overruns duringcompletion of irrigation and including disbursement and project implementation;drainage infrastructure: procurement data;

Capable contractors can be1.1. Samur-Apsheron (US$ 22.1 million) 1.1.2. IDA supervision attracted to carry out civil

Canal; reports; works;

1.2. Main Mill-Mugan (US$ 19.3 million) Project staff are competentCollector; and dedicated;

Sufficient counterpart fundsavailable;

2. Institutional Strengthening 2.1. US$ 1.98 million; 1.2.1. PIU Progress reports,including disbursement andprocurement data;

1.2.2. IDA supervisionreports;

3. Implementation Support 3.1. US$ 2.74 million; 1.3.1. PIU Progress reports,including disbursement andprocurement data;

1.3.2. IDA supervisionreports;

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Annex 2: Project DescriptionAZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

Project

By Component:

Project Component 1 - US$41.34 million

Rehabilitation and Completion of Irrigation and Drainage Infrastructure

The project would finance physical works within the Samur-Apsheron Canal and MainMill-Mugan Collector command areas, as described below.

Samur-Apsheron Canal (SAC) System

Description and History.

The SAC is one of the most critical irrigation systems in Azerbaijan, located in the north-easternpart of the country. Not only does it supply irnigation water to about 86,000 ha along the coastal plain, butit also contributes about 40 percent of the domestic and industrial water supply to Baku and the ApsheronPeninsula with a total population of about 2.5 million. The system was first constructed in 1939 as anearth canal serving only irrigation, but was reconstructed in its current form in the 1950s. The system nowcomprises:

* Headworks, a gated barrage, abstracting water from the Samur River, subject to awater-sharing agreement with Dagistan. The water sharing agreement dated October 7, 1967is still valid and in effect. This allows for the headworks to abstract up to 889 million m' perannum, which is 81 percent of the available water at 75 percent probability. Azerbaijan'sshare is 75 percent, with the balance provided by the same structure to Dagistan;

* Offtakes at the headworks providing for 55 mr/sec to the SAC canal, 14.5 m'/sec to theKhanarkh canal and 17 m 3 /sec to Dagistan;

- Concrete lined SAC canal, capacity 55 m'/sec at the head, reducing to 25 m3/sec at the bottomend. The SAC canal is 182 km long with a total irrigated service area of 86,000 ha. Thisincludes an area of 12,700 ha currently served by the Khanarkh canal. The command area ofthe SAC canal would be reduced when rehabilitation of the Khanarkh is completed and thiscanal would assume some of the service area of the SAC, while the SAC would be used moreextensively as a water conveyance to Baku and the irrigation areas towards the end of thecanal;

* Desedimentation works at the headworks, and three sedimentation basins on the SAC canal(km 8, 12 and 120);

* Khanarkh canal. To be rehabilitated with IsDB financing; construction expected to startduring the second half of 2000 (estimated cost US$ 15 million);

* 37 offtakes on the SAC canal supplying inter-farm irrigation canals;* Jeiranbatan Reservoir, located towards the end of the SAC, providing 150 million m

(designed) live storage for Baku water supply and delivering about 10 mn3/sec to the city;* Lift pump station for 25.0 m3/sec at km 132; and* Terminal pump station at km 182 for up to 25 m 3/sec for delivery to Jeiranbatan Reservoir and

from there for Baku and 10 m'/sec for irrigation on the Apsheron Peninsula.

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Current Condition.

The system has had negligible maintenance since construction and the headworks and SAC canalare reported to have never been closed for extended periods in order to carry out rehabilitation works. Thesecurity and stability of the headworks has been compromised by flood damage to the apron and thesecondary downstream weir and there is damage to the upstream guidewalls. The steel gates are severelycorroded and are structurally unsound, all leak seriously and some are inoperable. The lifting gear issimilarly deteriorated. The body of the barrage is fundamentally sound, but water erosion has removed theprotecting cement mortar rendering, eroded the underlying concrete and has exposed reinforcement in someplaces.

The condition of the concrete lining of the SAC canal varies from satisfactory to seriouslydeteriorated but generally is in need of maintenance throughout its length. The offtake structures are alsoseriously deteriorated, with the gates and measurement facilities generally inoperable. Excessive leakagelosses and restricted conveyance capacity have resulted in an inadequate supply to the secondary inter-farmcanals and to a consequent poor irrigation service to the farms. Because of its importance the supply toBaku has been maintained over the years with an average net annual supply of 290 million mI (range of 8.5to 10.4 mr/sec), as a result of which the water shortages and unreliability of delivery are in consequencemore severe in the irrigation service area. The district irrigation exploitation units report in consequence areduction in irrigation supply from 600 million mn in 1989 to 254 million m3 in 1999, reflected in a 40percent decrease in reported irrigated area and under-irrigation of other areas.

There is a considerable sediment flow in the Samur river. According to numerous measurementscarried out near the headworks, sediment loads rise from 0.37 gr/liter in March to 5.4 gr/liter in July anddecrease to 1.6 gr/liter in October. During the winter there is insignificant sediment flow. The total annualsediment load at the headworks is about 3.6 million m 3, about 2.25 million m3 of which enters the canalsystem per year. Four sediment exclusion works and basins are in the Canal System, that were designed toexclude about 1.25 million m of sediment from the Canal System. None of the sedimentation treatmentfacilities is currently operable. The result is a high sedimentation intake and silting up of inter-farm andfarm canals and also a loss of storage in the Jeiranbatan Reservoir of around 2.5 million m 3 annually, sothat its live storage is now reportedly reduced from 150 to about 100 million m3.

The Government's Long-term Plan for the SAC System.

The Government has identified a long-term strategic plan for the SAC system to meet the growingneeds of Baku as well as the current and future irrigation demands. This plan envisages the followingelements:

* Remodeling of the Khanarkh canal to assume part of the irrigation requirements of the first 50kIn of the SAC service area;

* Rehabilitation of the first 50 km of the SAC, with some remodeling to increase its capacity;* Diversion of additional minor rivers into the SAC;* Construction of a large new dam and reservoir; and* Construction of a new high level canal, taking off from the SAC at km 50 to supply the new

reservoir, Baku and the Baku-Apsheron service area without pumping.

The Government is working towards this plan with some elements about to be constructed (part of

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the Khanarkh canal) and others being studied (the proposed new dam) under various donors. However,there has not yet been an overall comprehensive feasibility study to integrate all elements, nor theenvironmental and social studies required for the different components. Having regard to the uncertaintiesas to the overall economics of the long-term plan, the proposed RIDIP is restricted to those elements ofrehabilitation which can be justified standing alone, while still compatible with the overall scheme.

Details of Works to be Financed under this Project.

Following the strategy stated above, the project would finance the following elements:

* Rehabilitation of the headworks, comprising repairs to the apron, downstream secondary weir,upstream guide banks, the superstructure, replacement of all gates and lifting gear and safetyfacilities such as standby generator and trash screening equipment (designs and draft biddingdocuments have already been prepared);

* Construction of a new regulator for the Khanarkh canal with a capacity of 30 m 3/sec and forthe SAC with a capacity of 55 nmi/sec;

* Rehabilitation of sedimentation works based on a comprehensive study and elaboration of along-term, environmentally acceptable solution. The most important construction would be thehydraulic flushing mechanism at the head of the canal. The feasibility level design determinesthat 680,000 mi of silt can be excluded (about 30 percent of the load taken in per year);

* Rehabilitation of the first 50 km of the SAC canal with repair and replacement of the damagedconcrete lining. A survey of the canal (it was emptied for this purpose) and all hydraulicstructures took place during project preparation and all sections that either need repair orreplacement of concrete and joints have been identified on maps. The works would include20,000 m3 of concrete. (Enlargement and additional siphon barrels would not be includedunless a comprehensive feasibility study has been completed to standards acceptable to theAssociation. The proposed enlargement would be achieved by raising the canal banks, whichcan be done separately from rehabilitation without loss of economy.);

* Rehabilitation of structures over 50 km, including: (a) offtakes for the 37 secondary(inter-farm) canals, including new gates, measurement structures and remodeling to match theirservice area; and (b) deteriorated road bridges, culverts, drops and escapes;

* Rehabilitation and cleaning of the most deteriorated sections of the 37 inter-farm canals (totallength 264 kIn), including repair of critically damaged structures (also reflecting themodifications resulting from their connection to the Khanarkh Canal); and

* Design and construction supervision costs.

Table 1 shows the unit cost for the different works and materials. Table 2 presents the costsummary for the proposed works for the SAC System.

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Table 1: Unit Cost for construction works in Azerbaijan (December 1999)

CostNo Item Unit (US$)

Staff1 Engineer hour 2.192 Foreman hour 0.893 Operator of construction machine hour 0.724 Laborers, skilled hour 1.195 Laborers, unskilled hour 0.726 Secretary hour 0.307 Driver hour 1.078 Watchman hour 0.36

Construction materials1 Natural sand m3 6.822 Natural gravel m3 9.093 Crushed sand m3 35.034 Crushed gravel m3 15.235 Cobbles m3 10.566 Brick piece 0.217 Cement t 68.188 Concrete, B-10 m3 59.729 Concrete, B-15 m3 66.2110 Concrete, B-25 m3 71.6611 Reinforcement steel t 350.00

Equipment1 Concrete mixing plant day 1638.002 Compactor, dynamic 180 PS day 193.003 Compressor, 100 PS day 177.004 Cistern, 6000 L day 198.005 Concrete Pump day 72.456 Drilling rig day 198.907 Excavator, 75 PS day 235.508 Excavator, 150 PS day 283.009 Generator, 125 PS day 256.8910 Mixer, 5 m3 day 30.2011 Mixer, 10m3 day 42.9012 Tractor, 100 PS day 86.9013 Tractor, 180 PS day 138.0014 Tractor, 320 PS day 271.0015 Truck, 12t day 121.0016 Truck, 5t day 43.5017 Vibrator for concrete day 27.00

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Table 2: Summary of Investment cost for theRehabilitation of the SAC System (base cost)

Total costNo. Item (US$)

I Rehabilitation of Samur Headworks1.1 Replacement of hydro-mechanical equipment 967,3951.2 Repair aprons and dams at the intake structure 1,255,2821.3 Construction of new regulator at SAC & Khanarkh intakes 255,456

Sub-total 2,478,133

1.4 Reconstruction of the desilting plant 3,233,364

2 Rehabilitation of SAC2.1 Repair of SAC lining, structures and roads 3,286,8702.2 Enlargement of SAC Canal 2,281,2002.3 Cleaning and desilting lakes at km 8 and 12 on SAC 1,669,552

Sub-total 7,237,622

3 Rehabilitation of the secondary irrigation system3.1 Reconstruction of inter-farm systems of SAC 3,967,090

Total 16,916,209

Physical Contigencies 1,691,621Price contingencies 2,448,140

Grand Total SAC Sub-project 21,055,970

Main Mill-Mugan Collector (MMMC

Description and History.

Drainage is essential for many irrigation systems in Azerbaijan, but most critical in the flatlow-lying Kura-Araz and Mugan-Salyan plains totaling about 760,000 ha, where salinity has developed forlack of natural drainage. (The SAC system has lighter textured soils and drainage and soil salinity aremninor problems.) Rather than discharging drainage water in the Kura River, which would have increasedthe salinity level of the river water to 3 gram/liter, it was decided by Government to construct collectordrains on both the left and right bank of the Kura River. In the 1950s the Main Shirvan Collector wasconstructed to drain the left bank of the Kura River. The Main Mill-Karabakh Collector, draining theupper part of the Kura right bank area, was connected to the Main Shirvan Collector via a siphon (25 mn/sec capacity) under the Kura River. During the last decades irrigated areas on both river banks continuedto be enlarged and capacity of collectors were to be adapted accordingly. The capacity of the MainShirvan Collector is now 67 m3/sec.

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By the early 1960s plans were finalized to provide a separate collector drain for the Kura rightbank area, as it was apparent that the Shirvan Collector would be overloaded. The right bank collector,named the Main Mill-Mugan Collector was begun and the lower 60 km constructed by 1989, satisfactorilydraining the Mugan-Salyan plain into the Caspian Sea, with a designed outfall capacity of 107 m3/sec.However, this left a gap of 83 km between the head of the MMMC and the right bank Main Mill-KarabakhCollector. The Government is currently using a loan from the Islamic Development Bank to construct afurther 52 km, which is expected to be completed by the end of 2000 at a cost of US$ 16 million. Thisleaves a 31 km missing link to complete this important strategic project, before about 240,000 ha can beeffectively drained.

Current Condition.

The current drainage situation is that the Main Mill-Karabakh Collector, carrying on average 25 m3/sec, is overloading the Shirvan Collector, designed and constructed for 67 rn3/sec, which is the designdischarge of the left bank area only. In consequence drainage conditions on both banks of the Kura Riverare deteriorating, leading to waterlogging and rising salinity and as a result reduced agriculturalproductivity. About 180,000 ha on the left bank is somewhat affected, both upstream and downstream ofthe junction with the Main Mill-Karabakh Collector. A further 20,000 ha is affected on the right bank asthe Mill-Karabakh is backed up for about 20 km by the overloaded siphon under the Kura River.

Drainage is most acutely affected in the area of about 36,500 ha around the missing link, wherepumped drainage is temporarily effected into Lake Sarisu and from there into the Kura River. Acutedrainage congestion in the Main Mill-Karabakh Collector is also temporarily relieved by discharge into theKura River. Both these temporary arrangements increase the salinity of the Kura River, impacting ondownstream fisheries, irrigation and Baku water supply. The salt content of the Kura water varies from0.6 to 1.0 gr/liter. It can still be used for irrigation with some restrictions, but the quality for drinkingwater is poor.

Completion of the MMMC would be important as this is a strategic drain, without which there canbe no further development or additional intensification of agriculture in this area.

Details of Works to be Financed under Project.

The proposed MMMC works are those necessary to complete the missing 31 km link to establish aseparate right bank outfall into the Caspian Sea and rehabilitate and improve the inter-farm collectors in theimmediate vicinity (36,500 ha). These comprise:

* Land acquisition (discussed in Section E of main report);* Construction of the 31 km missing main collector channel from the Araz River siphon to

connect with the Main Mill-Karabakh Collector. The Collector's design capacity at the siphonwould be 58 m3/sec. The collector would be trapezoidal in shape, with a general cutting depthof 7 m, bottom width varying from 16 to 30 m. Over 13 million m3 of soil would have to beexcavated;

* Service road along the MMMC;* Completion of the Araz River siphon. The barrels of the siphon would have been completed

under Islamic Development Bank funding, but the appurtenant works, comprising diversion ofthe river and associated embankments and erosion protection works, are not included in thiscontract. The design discharge of the new river bed will be 1,477 mN/sec (designs and draft

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bidding documents have already been prepared);* One railway bridge across the MMMC, with a length of 130 m;* Six road bridges across the MMMC, two for regional traffic and four for local traffic. The

length of the bridges would vary from 72 to 100 m and the width from 6.5 to 8 m. The bridgeswould be founded on piles, because of adverse soil conditions. The upper construction wouldbe made out of prefabricated concrete elements;

* Five irrigation aqueducts across the MMMC, one with a capacity of 6.15 mr/sec and the restwith a capacity of 1 m'/sec. The length would vary from 66 to 90 m. The large one isexpected to be constructed as a steel flume and the others with steel pipes. All aqueductswould be founded on steel piles;

* Reconstruction and rehabilitation of inter-farm collectors in 36,500 ha;* Environmental mitigation measures; and* Design and construction supervision costs.

Table 3 presents the cost summary for the MMMC works.

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Table 3: Summary of ConstructionCosts for the MMMC (base cost)

Total costsNo. Item (US$)

1 General1.1 Land Acquisition 774,180

2 Construction of MMMC (31km)2.1 Earth works for MMMC, incl. road 4,178,920

2.2 Bridge at 1136+60 385,1312.3 Bridge at 1226+00 173,7842.4 Bridge at 1357+65 292,6052.5 3 Bridges at 1368+00; 1410+50

1430+30=; L=72.32 m 463,3772.6 Railway Bridge 1,189,4852.7 Aqueduct Q=6.15m3/s 166,0562.8 4 Aqueducts Q=1.0m3/s 260,398

Sub-total Bridges and Aqueducts 2,930,836

3 Completion of MMMC siphon on Araz3.1 Fill of old Araz river bed (recultivation) 384,5143.2 Excavation of new Araz river bed 1,386,7373.3 Concrete side slope protection of

new Araz river at siphon 1,639,0243.4 Construction of a new Araz river bed

above the siphon 2,276,8753.5 Bridge on new Araz river at siphon 678,490

Sub-total Siphon 5,687,150

4 Rehabilitation of Inter-farm Collectors 950,000

5 Environmental Mitigating Measures 350,000

Total 14,871,086

Physical contingencies 1,487,109Price contingencies 1,957,641

Grand Total MMMC Sub-project 18,315,836

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Consulting Services

The PIU would contract out the services for design and supervision to a consulting firmn for theduration of the project. The main tasks of the consultants would be to: (i) prepare design reports andbidding documents, including surveys and investigations as needed, as well as the preparation of technicalspecifications, engineering estimates, bill of quantities and tender drawings; (ii) assist the PIU withconstruction supervision; and (iii) carry out specialized studies. All works would have to be carried outaccording to recognized international standards, therefore construction supervision and quality controlaccording to modem and efficient methods would be important. The consultants team would include designengineers, hydrologist, sediment specialist, costing engineer, contract specialist, construction engineers,construction inspectors, clerks and surveyors. The total estimated base cost for these services are US$1,640,000 (US$ 1,970,000 with contingencies).

The consultants would assist the PIU with setting up a construction management organization forthe purpose of supervision of the construction of the different sub-projects. The consultants would providefor all personnel on site (resident engineers, inspectors, clerks, etc.) for inspection of the constructionworks, installation of equipment, and the testing of construction materials, in order to ensure that the worksare imnplemented and goods supplied in accordance with the designs, specifications and terms andconditions of the relevant civil works and supply contracts. In particular, the consultants would assist thePIU with the following: (i) contract administration; (ii) inspection of all construction activities; (iii) testingof materials on site; (iv) testing and inspection of goods and materials; (v) off-site laboratory testing, wherenecessary; (vi) review of contractors' submittals; (vii) verification of progress payment requests; (viii)preparation of monthly progress reports; (ix) assist in contract acceptance and close-out; and (x) assist indispute resolutions, when necessary.

Project Component 2 - US$1.98 million

Institutional Strengthening

The project would provide institutional support to make a start with the improvement of the qualityand sustainability of irrigation management. There would be four sub-components:

Institutional Support for SAC Management

This sub-component would provide support (technical assistance and goods) for SAC managementin order to make a start with the development of an organization that is cost effective and efficient withstrong customer orientation and delivers quality water services that customers want and eventuallyprepared to pay for. The project would provide technical assistance to review the work practices, processesand skills of the SAC Management Unit (MU) and the District Irrigation Exploitation Units (IEUs) in theSAC area, as well as the coordination between these different offices and the water users. The mostimportant tasks to be carried out by the consultants would be to: (i) review the current activities carried outby the MU and IEUs and identify their core activities; (ii) review the current organizational structure of theMU and IEUs and their human resources allocated to each activity and assess organizational and capacityissues, which would be needed to be addressed to improve their performance; (iii) review the current levelof internal and external control on technical and administrative matters, identify any issues needed to beresolved to increase accountability and develop a plan for the possible reorganization of the MU and IEUs;(iv) review the current level of coordination for the water allocation among MU and IEUs and identify anyconstraints and possibility to improve their efficiency; (v) review the MU and IEUs' overall financial

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situation including the status of fixed assets, in particular, analyze the 1998 and 1999 financial statements,identify the incurred expenditures and generated revenue for each activity, provide a breakdown on aterritorial (IEU) basis; (vi) review the required operation and maintenance costs and the affordability ofirrigation water for farmers during the next five years, identify the possible saving in the operation andmaintenance from the improved efficiency and develop a realistic plan to phase out/reduce the subsidies forirrigation activities for the MU and IEUs; and (vii) identify any constraints related to the managementinformation system and design a suitable modernized management information system. The TA teamwould prepare proposals to improve the management of the SAC system (which would include plans fornecessary reorganization and skill improvements), establish solid accounting and pricing principles toimprove transparency and accountability and develop and implement a management information systemand a system to improve collection of ISF. During the second phase, the consultants would assist the SAICin implementing the recommended actions prepared and agreed during the first phase.

This sub-component would provide technical assistance (10.5 pm international and 25 pm nationalstaff) and some office equipment for the MU. The consultants would include expertise in irrigationengineering, financial analysis, public institutional building and management information system. The totalbase cost is estimated at US$ 294,000 (US$ 334,000 with contingencies).

Development of an Irrigation and Drainage Sub-sector Strategy

This sub-component would provide technical assistance to develop an irrigation and drainagesub-sector strategy, that would identify irrigation schemes with an economic potential for continuation ofirrigation and the institutional needs required to achieve this. The activities to be carried out by consultantswould include: (i) provision of an overview of the agriculture sector, establishing the context of irrigationwithin a framework of an overall macro economic policy; (ii) review of the economics of irrigation for themain irrigated crops; (iii) review the economics and finances of the other land reclamation activities such asdrainage, flood control and erosion protection; (iv) preparation of financial analyses to establish paymentcapacity and indicate a viable irrigation tariff structure; (v) determination of the needed institutionaldevelopments for a sustainable sub-sector; (vi) assessment of the social impact of anticipated systemclosures and identify alternative farming systems or other activities and appropriate transitional support forschemes to be closed; (vii) assessment of any environmental impacts consequent on closure; and (viii)defining the future scope for irrigation, development of classification criteria for existing irrigation schemesregarding economic viability and identification of schemes for priority rehabilitation.

This sub-component would provide technical assistance (7.5 pm international and 10 pm nationalstaff). The consultants would include expertise in irrigation engineering, economics, agronomy,environment and sociology. The total base cost is estimated at US$ 177,000 (US$ 200,000 withcontingencies). The services for this sub-component are expected to be tendered in one package with thepreceding sub-component.

Training and Study Tours

This sub-component would support various national and international training activities and studytours to selected countries. The planned training would cover a wide range of topics such as: projectadministration (accounting, procurement) for PIU staff and modern design and operation and maintenancepractices for irrigation and drainage systems for PIU and selected SAIC staff. Study tours would becarried out to provide PIU and SAIC staff with exposure to modernized engineering technologies andsuccessful cases of institutional reform in the irrigation and drainage sub-sector. It is noted that, inaddition to formnal training and study tours, all TA consultants would have to provide on-the-job training.

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The base cost for training and study tours is US$ 250,000 (US$ 290,000 with contingencies).

Development of a Long-term Strategy and Feasibility Study for SAC

This sub-component would provide for a comprehensive two-stage study of the potential futuredevelopment of the SAC system. It would assess irrigation, domestic, industrial and environmental waterdemands upon the SAC system, integrate all existing studies, complete missing study elements, develop along-term plan (to 2020 or other agreed horizon) and bring all feasibility studies to a level to supportrequests for future donor investment in SAC's infrastructure. The issues include the future competition forwater between agriculture and Baku, the need for protection of the upstream catchments (in the interests ofboth irrigation and water supply), the environmental needs of the lower riverine areas of the Samur and theother minor rivers of the Kusari hills and the environmental aspects of groundwater development balancedagainst river abstractions. At the same time the issue of losses within Baku require prior attention and adecision is required on the balance between Samur and Kura rivers for supply of Baku before targets canbe established for SAC's contribution to Baku. It is also clear that most of the financial and economicjustification for further development of the SAC system would depend on delivery of water to Baku. Thisstudy would link with the two study activities described above and propose the long-term futuremanagement structure and financial plan for the SAC. The study should therefore have a broad focus.About 40 international and 80 national staff pm are proposed and would include, among others, expertisein engineering, dam development, economy, agronomy, water supply, hydrology, sociology andenvironment. The base cost for this sub-component is US$ 1,000,000 (US$ 1,160,000 with contingencies).

Project Component 3 - US$ 2.74 million

Project Implementation Support

This component would comprise the following four sub-components:

Support to Project Implementation Unit

The project would finance part (70 percent) of the incremental staff salaries of the PIU, equipmentand vehicles needed to maintain the operational efficiency of the PIU office and the incremental operatingexpenses of the office and vehicles. The PIU would be staffed with a Project Director, Design Engineer,Construction Supervisor (2), Procurement Specialist, Accountant, Environmental Specialist, M&ESpecialist, Interpreter and Support Staff. The estimated base cost for the support to the PIU is US$1,040,000 (US$ 1,247,000 with contingencies).

Technical Assistance to PIU

There is limited experience in SAIC to implement investment programs supported by internationalfinancing organizations. As SAIC is increasingly sourcing financing to carry out its development program,the development of capacity to work with donors and financiers would be very important. A small team ofinternational consultants would be recruited to support the PIU during the first 18 months of projectimplementation. Most of the consultants would carry out short-term assistance, with the exception of atechnical adviser, who would be in the country for the first 18 months of project implementation. Theshort-term consultants would include specialists in construction supervision, engineering design,procurement, environment, sedimentation and monitoring and evaluation. The total estimated personmonths is 60.5 and the base cost for the services is estimated at US$ 1,084,000 (US$ 1,177,000 withcontingencies).

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Environmental and Project Monitoring

To administer and conduct the environmental monitoring program, the PIU would have a full-timeenviromnental specialist, a short-term environmental advisor and a full-time monitoring and evaluationspecialist. The advisor would be fielded during the early stage of the project to set up the M&Eenvironmental system, including a Geographical Information System (GIS). The PIU's monitoring staffwould coordinate specific regional surveys (for hydrology, geohydrology, soil quality, water quality, healthsituation and socio-economic key parameters) in the project's two command areas and as such wouldcoordinate and collaborate with governmental organization and institutes, such as State Committee onEcology and Committee of State Hydrometeorology. Annual monitoring surveys would also be conductedto determine the progress with project outputs and impacts. The base costs for the surveys is estimated atUS$ 200,000 (US$ 226,000 with contingencies)

Project audit

An audit firm for the annual audit of project accounts would be financed from Credit funds duringthe life of the project (base cost US$ 80,000; with contingencies US$ 92,000).

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Annex 3: Estimated Project CostsAZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

Project

Project Component Cost Summary

% % Total(US$ 000) Foreign Base

Local Foreign Total Exchange Costs

A. Irrigation and Drainage Infrastructure1. Technical Assistance for Design and Supervision 456.41 1,203.27 1,659.68 73 42. Rehabilitation of SamurApsheron Canal System 11,983.44 5,135.76 17,119.19 30 443. Completion of Mill Mugan Collector Drain 8,629.81 6 15,049.54 43 39

Subtotal Irrigation and Drainage Infrastructure 21,069.66 12,758.76 33,828.42 38 87B. Institutional Strengthening

Development of SAC and MMMC Management - 297.12 297.12 100 1Feasibility Study for SAC Expansion 1,012.00 1,012.00 100 3Jrrigation Subsector Review - 179.12 179.12 100Training and Study Tours - 253.00 253.00 100 1

Subtotal Institutional Strengthening - 1,741.25 1,741.25 100 4C. Project Implementation Support

1. Technical Assistance to PIUInternational Assistance to PIU - 1,097.01 1,097.01 100 3

2. Project Implementation and Administration SupportNational Professional Staff 354.60 - 354.60 - 1PIU Equipment and Office Renovation 30.67 251.08 281.94 89 1Supporl Staff 72.86 - 72.86

Subtotal Project Implementation and Administration Support 458633 251.08 709.41 35 23. Monitoring and Evaluation 161.92 40.46 202.40 20 14. Incremental Operating Cost 257.05 84.50 341.55 25 15. Project Account Auditing - 80.96 80.96 100

Subtotal Project Implementation Support 877.30 1,554.03 2,431.33 64 6D. Repayment of PPF 160.00 640.00 800.00 80 2

Total BASELINE COSTS 22,106.96 16,694.03 38,800.99 43 100Physical Contingencies 2,161.73 1,334.70 3,496.43 38 9-rice Contingencies 2,714.19 1.853.87 4,568.06 41 12

Total PROJECT COSTS 26,962.87 19,882.61 46,865.48 42 121

Project Cost Summary - Expenditure Accounts

% % Total

(US$ '000) Foreign Base

Local Foreign Total Exchange Costs

!. Investment CostsLand 783.47 - 783.47 - 2Works 19,853.05 11,578.77 31,431.82 37 81

Repayment of PPF 160.00 640.00 800.00 80 2

Goods 7.59 269.90 277.49 97 1

Consultants' Services and Training 456.41 4,080.38 4,536.80 90 12

Total Investment Costs 21,260.52 16,569.05 37,829.58 44 97

il. Recurrent Costs

Incremental Operating Cost 846.44 124.98 971.42 13 3

Total Recurrent Costs 846.44 124.98 971.42 13 3

Total BASELINE COSTS 22,106.96 16,694.03 38,800.99 43 100

Physical Contingencies 2,161.73 1,334.70 3,496.43 38 9

Price Contingencies 2,714.19 1,853.87 4,568.06 41 12

Total PROJECT COSTS 26,982.87 19,882.61 46,865.48 42 121

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Annex 4: Cost Benefit Analysis SummaryAZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

Project

A separate economic analysis was carried out for each of the two sub-projects to be financed underthe project - the Samur-Apsheron Canal and the Main Mill-Mugan Collector. In general, the project's maineconomic benefit would come from: (a) increases in yield; and (b) conversions to higher value crops. Inaddition, improvements to the SAC would secure the water supply to 40 percent of Baku's population.

Given the current crisis in Azerbaijan's agriculture sector, it is not clear whether farmers wouldresume irrigated agriculture and take full benefit of the project - and this may remain unclear for at leastthe next 3-5 years. While in the Soviet era agriculture accounted for about 30 percent of GDP and 45percent of overall employment, with the collapse of regional markets and the privatization of state andcollective farms, the mode of agriculture in Azerbaijan has returned to subsistence farming with minimuminputs and output. Output has fallen by more than two thirds since 1990 and average yields in the projectarea (for 1993-1997) fell to 50 to 60 percent of what they were in the 1980s. (However, it should be notedthat in 1998 there was a first sign of an upward trend towards increasing productivity, particularly forvegetable production, due to the better availability of fertilizers and plant protection chemicals, and due tothe improved security for newly established farms that land titles provided.)

The situation for viticulture is also steadily worsening. A number of vineyards have already beenabandoned due to the lack of marketing opportunities. Others produce only marginal yields due either to alack of maintenance or to the plant disease, Phylloxera.

In addition, the recent development of the oil and gas sector could have a serious impact on thedevelopment of agriculture. It could trigger a currency appreciation, increasing labor costs and reducingthe competitiveness of other internationally tradable commodities such as cotton and wheat. On thepositive side, however, an increase in revenue from the oil and gas sector would provide funds forrehabilitating and constructing infrastructure that would help increase rural productivity. Also, overalleconomic growth may increase the demand for seasonal fruits and vegetables. The impact of thesepossibilities on the sub-projects' overall economic viability are examined in the sensitivity analysis below.

The scenario developed in this economic analysis is rather conservative, and reflects the discussionabove. For example, increases in yields and crop conversion are assumed to take place in full not before 10years after the completion of the sub-projects. It is also assumed that the 1989 level of irrigation would berestored under the 'with-project' scenario.

Economic Rates of Return (ERR) estimated for the SAC and MMMC sub-projects are 23.3 and16.4 percent respectively, showing that these sub-projects would have sufficient economic viability. TheNet Present Values (NPV) discounted at 12 percent were US$ 16.3 million for the SAC sub-project andUS$ 11.4 million for MMMC.

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Summary of Benefits and Costs:

A. Assumptions Regarding Project Benefit

1. General

Prices for various crops have been estimated based on: (a) the World Bank commodity priceforecast for internationally traded crops (wheat, maize grain), and (b) market prices for other crops. Theresults are summarized in Table 1 below:

Table 1. EstimatedEconomic Crop Prices

Crops Price(Manat/kg)

wheat 700

cotton 1,090

fodder 196

fruits 775

grapes 750

vegetables 500

2. SAC

The SAC sub-project covers the specific area that is irrigated by the Samur-Apsheron Canalbetween the Samur River and the Velvelichay River (50 km of main canal) and the area that is or will beirrigated by the Khanarkh Canal. Most of the state and cooperative farms in the project area wereprivatized in 1997-98 and land registration was well advanced by 1999. The new farms in the project areaare very small (2-3 ha) and some forms of joint family production and cooperatives have been established.The current cropping pattern on the net irrigated land is 39 percent cereals, 25 percent fruits, 25 percentfodder crops, 5 percent vegetables and 6 percent other perennial crops (mainly grapes). The predominantcereal grown is wheat; major fruits are apples, pears and quince. Fodder crops mainly include alfalfa andmaize; vegetables include tomatoes, cucumbers, cabbage, beans, salad greens and potatoes.

The SAC sub-project primarily aims to rehabilitate the upper 50 kilometers of the canal, whichdelivers water from the Samur River first to various irrigation schemes covering some 86,000 hectareslocated along the SAC, and then to the Jeiranbatan Reservoir located in the suburb of Baku, from which theBaku Water Supply Company delivers drinking water to Baku and the surrounding area. The sub-projectcomprises rehabilitation and repairs to headworks, rehabilitation of deteriorated lining of the SAC andrehabilitation of secondary canals delivering water from the SAC to on-farm irrigation facilities. Themajor economic benefits of the sub-project are: (a) an increase in agricultural incomes resulting from

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reliable irrigation water; and (b) securing the current level of water delivery to Baku and its surroundingarea. Detailed project benefits are estimated based on the assumptions presented in the next section.

3. MMMC

The area covered under sub-project MMMC is a cotton, wheat and forage producing area. Thecropping pattern on the net irrigated area is 33 percent industrial crops (mainly cotton), 45 percent cereals(mainly wheat), 21 percent forage (mainly Alfalfa and grass/hay production) and 1 percent vegetables.Yields are very low at present: 1.4 tons per hectare of cotton, 1.8 tons per hectare of wheat and 4.7 tons perhectare of forage (average 1993-1998 in Imishli district). These low yields are mainly due to: (a) soilsalinity and water logging problems; (b) low irrigation efficiency; and (c) general problems resulting fromthe transition to private farming. Some areas have already been abandoned, mainly due to soil salinity, andare now used as pasture for sheep and cattle breeding. As for most of Azerbaijan's arable land, irrigation isessential for crop production, and in the case of the MMMC project area, drainage and leaching are alsoessential because of the soil salinity and water logging problems.

The MMMC project area is a traditional irrigation area along the rivers Kura and Araz. In the1950s and 1960s, an irrigation and drainage system was constructed north and south of the Kura River.South of the river, irrigation water flows from the Mingachevir Reservoir through the Mill-Karabakh Canalto the plain. Drainage water flows to the Main Mill-Karabakh Collector, which is currently diverted to theShirvan Collector in the North via a siphon under the Kura River. The proposed MMMC sub-projectwould construct the missing link of the Main Mill-Mugan Collector (31 km), aiming to separate thedrainage system on the right and the left bank of the Kura River. This would improve the drainage at theMill-Karabakh Collector on the right bank, as well as relieve the current congestion on the left bank. TheMMMC sub-project would also rehabilitate and reconstruct interfarm drainage system in the immediatevicinity of the link. The major economic benefits of the sub-project would be: (a) an increase inagricultural production resulting from a lower water table and a corresponding reduction in salinity; and (b)some reduction of pumping costs. Detailed project benefits are estimated based on the assumptionspresented in the next section.

B. Project Costs

Project costs, including rehabilitation, operation and maintenance, have been converted toeconomic prices. In particular, efforts have been made to identify the unskilled labor component. Ashadow wage of Manat 10,000 (about US$2.00 per day) is used to convert the unskilled labor. This valueis considered reasonable, particularly given the country's high level of unemployment, which is most acutein rural areas. The following assumptions have been made to convert financial costs to economic costs.

* Standard Conversion Factor (SCF) is considered to be I (one), as apparently there is noexchange rate premium;

* The conversion factor for engineering works and for replacements is estimated at 0.95, and theO&M at 0.98, considering the involvement of unskilled labor; and

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* Incremental operation and maintenance costs are estimated at 3 percent of the investment costs.

Main Assumptions:

1. SAC

Increase in Agriculture Income. The SAC sub-project would increase the delivery of irrigationwater to areas covering some 86,000 hectares of irrigable land in eight raions. After the breakup of theSoviet Union, the regional markets collapsed, and the agriculture sector fell into disarray. The result was asharp decline in irrigation, low cost recovery, deferred maintenance and physical deterioration of theirrigation canals. Table 2 indicates a sharp decline in both the size of the irrigated area and in the amountof water delivered to the irrigated area from 1989 to 1998. Headworks, main canals and secondary canalsare badly deteriorated and it is expected that irrigation would decline even further without the proposedsub-project. In estimating the economic rate of return, the following assumptions were made, consideringthat the project aims to rehabilitate only primary and secondary canals.

* Without the project in the three raions located within the first 50 km of the SAC (Guba, Gusan andKhachnaz), the area irrigated in 2010 would represent a further decline to 80 percent of the 1998level. With the project, the area irrigated in 2010 would be an increase to 80 percent of the 1989irrigation area; and

= Without the project in the four raions located downstream of the first 50 km of the SAC (DavachiSiazan, Khizi and Apsheron), the area irrigated in 2010 would fall to 50 percent of the 1998 level.With the project, the area irrigated in 2010 would increase to 60 percent of the area irrigated in1989.

Table 2. Irrigated Area and Delivered Irrigation Water along the SAC

Rayon 1989 1989 1998 1998 Irrigated Area Irrigated AreaIrrigated Delivered Irrigated Delivered in 2010 in 2010 (withArea (ha) Water Area (ha) Water (without project)

(million m3) (million project)m3)

Guba 4,351 27.60 3,403 13.95 2,722 3,481

Gusan 15,501 99.11 7,403 29.00 5,922 12,401

Khachnaz 33,395 236.36 17,000 84.30 13,600 26,716

Davachi 20,020 129.57 9,420 57.20 4,710 12,012

Siazan NA 3,287 9.20 1,644 3,287

Khizi NA 3,140 8.20 1,570 3,140

Apsheron 13,390 117.7 8,180 51.80 4,090 8,034

TOTAL 86,657 610.34 51,883 253.65 34,258 69,071

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Yields. It is very difficult to estimate the yield increase for the project, as the information base forcrop budgets is poor. No systematic survey has been carried out since the collapse of the Soviet regime.State and collective farns are still being privatized, and there are huge variations in yields and crop budgetsamong farms. The assumptions summarized in Table 3 below were made based on information gatheredfrom the Country Economic Memorandum, local experts and field visits. It should be noted that yieldswould increase substantially even under the 'without project' (unirrigated) scenario, as farmers wouldgradually return to more serious agriculture using inputs such as fertilizer and/or pesticide.

Table 3. Yields for SAC Sub-Project at Year 2010With and Without Project (unit: t/hectare)

Current Without With ProjectProject

(irrigated) (irrigated)

Wheat 1.7 2.4 3.2

Fruits 3.7 4.6 6.6

Fodder 3.4 5.5 8.0

Vegetables 12.5 15.6 19.5

Grapes 0.7 1.5 3.0

Cropping Patterns. Cropping patterns tend to change gradually over a period of years becausefarmers are generally conservative about changing them. Conversion to higher value crops such asvegetables would occur only when farmers become confident in the reliability of irrigation water and whenmarkets for the new crops develop. Without the project, grape production would gradually be replaced byvegetables and fodder. With the project, farmers would gradually increase cropping intensity, due partly towinter wheat and vegetables.

Table 4. Cropping Patterns for SAC Sub-Project With and Without Project (percent)

Current 2010 - Without 2010 - Withthe Project the Project

Wheat 42.0 42.0 43.0

Fruit 29.6 30.0 35.0

Fodder 10.9 13.0 14.0

Vegetables 7.2 8.0 9.0

Grapes 3.9 2.0 2.0

Intensity 93.6 95.0 103.0

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Water Supply to Baku. Securing water delivery to Baku would also be a major benefit of theproject. About half of the water extracted from the Samur River would eventually be delivered to theJeiranbatan Reservoir. From the Jeiranbatan Reservoir, the Apsheron Water Company (AWC) wouldsupply water to about 40 percent of the population of greater Baku. Baku is currently suffering from ashortage of water and a reduction in water delivery resulting from deterioration of headworks and maincanals would exacerbate that shortage. However, the IDA Baku Water Rehabilitation Project is currentlyunder implementation and should help the AWC to decrease leakages so that less water would be needed.In summary, the following assumptions were used to quantify the economic benefit regarding water supplyto Baku.

* Considering the priority given to Baku's water supply, without the project SAC would stilldeliver 90 percent of the current level (270 million cubic meters) to the Jeiranbatan Reservoirat Project Year 10;

* The marginal economic benefit of water supply would be US$ 0.66 per cubic meter, convertedto 1999 prices from the quantified benefit of incremental water estimated at the appraisal of theBaku Water Rehabilitation Project; and

* Considering the current level of water leakage, it is assumed that only 50 percent of the waterdelivered to Jeiranbatan Reservoir is eventually delivered to customers.

2. MMMC

Increase in Agriculture Production

The With-Project Scenario. The MMMC sub-project would first benefit the areas adjacent to thecompleted section of the collector, some 36,500 hectares. Yields should increase substantially due to theimproved drainage. And once farmers recognize the improvement to the soil, they would very likelyincrease their use of fertilizer and eventually convert to more competitive crops. In the long term, thesub-project would also improve drainage for the entire area served by the Mill-Karabakh Collector. In thiscontext, it is assumed that the project would increase the agricultural benefit by 10 percent for an additional200,000 hectares from Year 10 onwards. For these additional 200,000 hectares, the current croppingpattem is assumed.

The Without-Project Scenario. Without the project, cropping pattems, yields, and gross marginswould decrease due to a gradual increase in salinity levels. Farmers would decrease their efforts to farmthese saline and water logged areas, and land now irrigated would gradually turn to pasture, as somefarmers would give up agriculture entirely. As a result, the irrigation area would decrease from the current36,500 hectares to about 27,000 hectares in year 2010.

Yields, irrigation areas, and cropping patterns under with- and without-project scenarios aresummarized in Tables 5 and 6 below.

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Table 5. Yields With and Without Project (unit: t/hectare)

Crops Present Without- With-Project Project

Cereals (wheat, etc.) 1.8 1.5 3.0

Industrial Crops (cotton, etc.) 1.4 1.0 2.5

Fodder (alfalfa, hay, etc.) 4.7 4.0 7.0

Vegetables 10.0 8.0 15.0

Table 6. Irrigation Area and Crop Patterns (unit: hectares)

Crops Present Without- With-Project Project

Net irrigated area (ha) 36,500 27,000 36,500

Cereals 45% 42% 42%

Cotton 33% 20% 34%

Fodder crops 21% 25% 20%

Vegetables I % 2% 4%

Additional pasture 0% 11% 0%

Total 100% 100% 100%

Sensitivity analysis / Switching values of critical items:

A sensitivity analysis was conducted in order to assess the project's response to various risks. Thefollowing risks were identified as potentially having substantial impacts on the project's economic viability.

* Scenario A: Delay in achieving the full benefit from irrigation. Considering Azerbaijan'sextremely limited experience with private farming, their current level of off-farm irrigationtechnology, the limited access to markets, and the limited availability of high quality inputs(e.g., seeds, fertilizer), the expected increase in yields may not be fully achieved. Analtemative ERR was estimated based on the assumption that the full benefit from irrigationwould be achieved after 15 years;

* Scenario B. Appreciation of the local currency. The expected boom in the oil and gasindustry may result in an appreciation of the exchange rate. This would result in a substantialdecrease in the economic prices for wheat and cotton, which are intemational commodities.

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Considering these factors, an alternative ERR was estimated, assuming that the local currencyappreciates by 10 percent;

* Scenario C. Increases in rehabilitation costs. A sensitivity analysis for an increase inrehabilitation costs was completed, examining the possibilities of additional rehabilitationworks being identified during project implementation. An alternative ERR was estimatedassuming a 20 percent increase in rehabilitation costs. (A second analysis assuming a 100percent increase in rehabilitation costs determined that the ERR would be 14.3 for SAC and9.7 for MMMC.);

* Scenario D. Slower adoption of HVCs. A sensitivity analysis was conducted to determine theimpact of farmers not converting to higher value crops due to persisting marketing problems.Under the analysis in the with-project case, an alternative ERR was estimated assuming that noadoption of HVCs takes place, and that the current cropping patterns would continue; and

* Scenario E. Lower than anticipated crop prices. To test the project's sensitivity to decreasesin overall crop prices, a sensitivity analysis was conducted assuming a 20 percent decline inprices.

Table 7 shows the results of estimated ERRs in the base case and for the sensitivity analyses. Asboth of these sub-projects aim to either rehabilitate or complete part of larger irrigation and drainagescheme and take advantage of large sunk costs, the ERRs are sufficiently high. It should be noted thatERRs for both sub-projects are still adequate under Scenarios A through D, which assume the risks oflimited marketing, higher rehabilitation costs, and appreciation of the local currency. It also should benoted that the returns for the SAC sub-project are significantly higher than the MMMC because of thebenefit of the water supply to Baku. Without the benefit to the water supply, the ERR for the SACsub-project would decrease to 17.3 percent. For Scenario E, the analysis shows some sensitivity to pricedecreases, though for both the SAC and the MMMC, the ERRs remain above the discount rate.

Table 7. Estimated ERRs and Results of Sensitivity Analyses for Both Sub-Projects (percent)

Base Case Scenario Scenario Scenario C Scenario D Scenario EA B

SAC 23.3 20.6 20.9 20.7 20.6 12.5

MMMC 16.4 14.2 13.2 14.5 15.2 15.0

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Annex 5: Financial SummaryAZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

Project

Summary of Financing in Calendar Years (starting in January)

Totals Including Contingencies (US$ ,000)2000 2001 2002 2003 2004 2005 Total

Total Investment Costs - 9,559.2 10,577.9 12,415.6 10,000.5 3,140.5 45,693.7Total Recurrent Costs - 228.2 229.5 235.2 236.5 242.4 1,171.8

Total PROJECT COSTS - 9,787.4 10,807.4 12,650.8 10,237.0 3,382.9 46,865.5EAYRT.xAs

Financing SourcesImplemenation Period

% of Total by Year 2000 2001 2002 2003 2004 2005 TotalIDA 0.0% 84.2% 92.3% 90.7% 90.6% 89.8%I 89.7%GOA 0.0% 15.8% 7.7% 9.3% 9.4% 10.2%J 10.3%Total % 0.0% 100.0% 100.0% 100.0% 100.0% 100.0%I 100%

1$(,000) 2000 2001 2002 2003 2004 2005 TotalIDA - 8,242 9,972 11,479 9,275 3,037 42,005GOA - 1,546 835 1,172 962 346 4,861Total - 9,787 10,807 12,651 10,237 3,383 46,866

From detail tablesDisbursement by World Bank, by Fiscal Year$(.000) 2001 2002 2003 2004 2005 2006 TotalIDA 2,060 8,674 10,349 10,928 7,716 2,278 42,005GOA 386 1,368 919 1,119 808 260 4,861Total 2,447 10,042 11,268 12,048 8,524 2,537 46,866

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Annex 6: Procurement and Disbursement ArrangementsAZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

Project

Procurement

General: Procurement of works and goods would be done in accordance with the Bank's"Guidelines for Procurement under IBRD loans and IDA Credits" (January 1995, revised January andAugust 1996, September 1997 and January 1999). The Borrower would use the Bank's standard biddingdocuments for goods and works, including the Bank's regional sample documents. Consulting services andtraining would be procured in accordance with the Bank's "Guidelines - Selection and Employment ofConsultants by World Bank Borrowers" (January 1997, revised September 1997 and January 1999). Forthe consulting assignments the Borrower would use the relevant Banks standard forms of contract. Anygoods, works and services not financed by the IDA would be procured in accordance with the NationalPublic Procurement Legislation. The General Procurement Notice has been published in the January 31,2000 issue of the United Nations 'Development Business'.

Procurement responsibilities: Responsibility for all procurement would rest with the PIU, whichis already in place for the implementation of the ongoing preparation of the proposed Project. A full-timeprocurement officer has recently been recruited (April 2000). In order to ensure that the PIU staff wouldbe fully informed about the RIDIP and be aware of all Bank procurement guidelines, a procurement launchworkshop is scheduled to be conducted in October 2000. During the first 18 months of projectimplementation the PIU would be assisted by a technical assistance team that includes a full-time Advisorand short-term Procurement Advisor.

Information regarding procurement administration would be collected and recorded and quarterlyreports would be sent to the IDA. These reports would also indicate: (i) revised cost estimates forindividual contracts and the total project; (ii) revised timing of procurement actions and completion time;(iii) an updated procurement plan; and (iv) compliance with aggregate limits on specified methods ofprocurement.

An assessment of PIU capacity to implement project procurement in accordance with the criteriaoutlined in Annex 3 of LACI Implementation Handbook was completed. This review addressed the legalaspects, procurement cycle management, organization and functions of the procurement unit in the PIU,support and control systems, record keeping and staffing. The review assessed the risks (institutional,political, procedural, etc.) that may negatively affect the ability of the PIU to carry out procurementprocesses. Azerbaijan has procurement legislation in place and has an independent public procurementagency. The legislation lacks harmony and consistency and it will take some time before the provisions ofthe Law are translated into practice. In addition, the economic atmosphere in the country in which the Lawoperates is not yet conducive to fair and transparent procurement processes. Therefore, it is a "high risk"country from a procurement point of view.

The prior review thresholds reconmnended are those applicable to a "high risk" country. Incollaboration with the PIU an action plan to address deficiencies has been prepared to strengthen PlU'scapacity to administer procurement in an effective and transparent way. The plan includes: (i) theprocurement officer, who was recently recruited, shall be adequately trained and acquire at least workingknowledge of the English language to effectively handle international procurement and interaction with theAssociation and contractors. The officer would participate in at least one international procurement

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training course, while he would receive on-the-job training from the PIU Advisor and Procurement Expert;(ii) a procurement book containing the Bank's standard procurement documents would be provided to thePIU soon after Board presentation; (iii) the project launch workshop which is scheduled for October 2000shall devote adequate time to updating the PIU staff procurement skills. During this workshop, thecontents of the procurement book shall be explained to the PIU procurement staff and other PIU staff; (iv)at least during the first two years of project implementation a procurement specialist would join twosupervision missions per year, not only to conduct ex-post reviews (there are few packages that are notsubject to prior-review), but especially to provide guidance and support to the PIU in carrying out theprocurement plan and activities; (v) the PIU would establish a computerized procurement monitoringsystem; and (vi) a minimum of one in every three contracts representing different procurement methods (notsubject to prior Bank review) shall be reviewed on an ex-post basis during project implementation.

Procurement methods (Table A)

Civil Works: The project would canTy out rehabilitation works of the SAC System and completionof the MMMC through an estimated 1 1 contracts. All works shall be procured through InternationalCompetitive Bidding (ICB). Office renovation would be procured under Minor Works procedures, with anaggregate value of US$ 50,000.

Goods: The goods to be financed in the project would include vehicles, office equipment, field andenvironmental monitoring equipment and fumiture. ICB shall be used for the purchase of goods estimatedto cost more than US$ 100,000 per contract. International Shopping (IS), based on a comparison of quotesfrom at least three suppliers from two eligible countries, shall be used for contracts estimated to costbetween US$ 25,000 and US$ 100,000 per package. The aggregate value for IS is not expected to exceedUS$ 126,000 (all IDA financed). National Shopping (NS) procedures shall be used for contracts estimatedto cost less than US$ 25,000 each, up to an aggregate amount of US$ 55,000 (US$ 43,000 to be financedby the IDA).

Consultant Services: PIU staff would be recruited as individual consultants, in accordance withPart V of the Consultants Guidelines (9 contracts for US$ 436,000 equivalent in aggregate; IDA to financeUS$ 305,000). The following services would be procured through Quality and Cost-Based Selection(QCBS): (i) a consulting firm to provide technical assistance to the PIU; (ii) a consulting firm for designand supervision of the SAC and MMMC; (iii) a consulting firm for the preparation of the feasibility studyfor the long-term development of the SAC system; and (iv) a consulting firm to prepare the sub-sectorreview and to assist in the institutional support program for SAC management. These four contracts wouldhave an aggregate value of US$ 4,750,000 and would be IDA financed. Audit services would be procuredthrough Least Cost method (one contract valued at US$ 92,000; IDA financed). The FinancialManagement Consultant that was recruited under the Japanese Grant for preparation activities would beoffered an extension of contract to train the PIU staff on the use of the financial management system(Single-Source Selection; US$ 43,000 - IDA financed).

Training: Training and study tours shall be carried out according to a training plan, which thePIU will revise semi-annually and submit to the IDA for approval prior to implementation. The totalestimated budget for training and study tours is US$ 290,000 (IDA financed).

Incremental Operating Costs: The project would finance incremental operating costs of aboutUS$ 740,000 (US$ 515,000 to be financed by IDA). These costs would include: (i) operation andmaintenance of equipment and vehicles used under the project; (ii) salaries and travel allowance for PIU

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staff; (iii) office rent and utilities; (iv) office supplies and telecommunication; (v) support staff expenses;and (vi) monitoring and evaluation studies for project and environment. Incremental operating costs wouldbe procured on the basis of an annual budget to be agreed with the Association.

Procurement Arrangements

Procurement MethodInternational

(US$'000) Competitive International Local Other ConsultingBidding Shopping Shopping (see footnotes) Services N.B.F. Total

A. Works 38,455.04 49.52 - 38,504.56(34,878.72) (44.57) (34,923.29)

B. Goods 117.88 126.33 54.21 - - - 298.42(117.88) (126.33) (43.37) (287.58)

C. Services1. Technical Assistance - - - 43.06 2,779.96 - 2,823.02

(43.06) (2,779.96) (2,823.02)2. Design and Supervision Assistance - - - - 1,969.59 1,969.59

(1,969.59) (1,969.59)3. Audit Services - - - 91.64 - - 91.64

(91.64) (91.64)4. Training - - - 289.70 - - 289.70

(289.70) (289.70)D. Incremental Operating Costs

1. Salaries - 435.66 - 435.66(304.96) (304.96)

2. PIU Operational Expenses - - - 736.12' - - 736.12(515.29) (515.29)

E. Land Acquisition - - - - - 916.76 916.76

F. PPF - - - 800.005 - - 800.00(800.00) (800.00)

Total 38,S72.92 126.33 103.73 1,960.83 5,185.20 916.76 46,865.48(34,996.60) (126.33) (87.94) (1,739.69) (5,054.50) - (42,005.07)

Note: Figures in parenthesis are the respective amounts financed by IDA

1. Continuaton of Contract started under Japanese Grant for provision of finanaal management services.2. Least Cost Selection for Audit Services3. Training and Study Tour; financing based on semi-annual plan.4. PIU Incremental Operationas Costs based on semi-annual plan.5. Repayment of Project Preparation Facility

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Prior review thresholds (Table B)All ICB contracts for works and goods would be subject to prior review by the Association. Also

the first two IS, the first Minor Works and the first NS contract would be subject to the Association's priorreview. This would include all documentation, including bidding documents, draft contract and evaluationreport.

For consultant services, prior review by the Association would be required for all terms ofreference irrespective of estimated contract value. Consulting firm contracts estimated to cost more thanUS$ 100,000 equivalent would be subject to the Association's prior review (review would include theRequest for Proposals, the Terms of Reference, short-list, results of evaluations and draft contracts).Contracts procured through Least-Cost Selection and Single-Source Selection will also be subject to priorreview. For contracts with individual consultants costing US$ 25,000 or more the qualifications,experience, terms of reference and terms of employment would be furnished to the Association for itsreview and approval. All other contracts would be subject to ex-post review by the Association on arandom basis.

Any training related expenses (tuition, fee, transportation, per diem, and trainers' fee) wouldrequire prior approval.

Table B: Thresholds for Procurement Methods and Prior Review

Contract Value Contracts Sobjed toThreshold Procurement Prior Review

Expenditure Category (US$ thousands) Method (US$ millions)1. Works >200 ICB 38.5

<200 NCB<50 MW 0.05

2. Goods >100 ICB 0.12<100 IS 0.06<25 NS 0.03

3. Services >100 QCBS 4.75>25 Ind. Cons. 0.44

Audit Services LC 0.09Financial Management SSS 0.04

Total value of contracts subject to prior review: US$ 44.1 million (IDAto finance US$ 40.3

million)

Overall Procurement Risk Assessment

High

Frequency of procurement supervision missions proposed: One every 6 months (includes specialprocurement supervision for post-review/audits)

Thresholds generally differ by country and project. Consult OD 11.04 "Review of ProcurementDocumentation" and contact the Regional Procurement Adviser for guidance.

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Disbursement

Allocation of credit proceeds (Table C)

The proposed IDA Credit of US$ 42.0 million equivalent would be disbursed over a period of fiveyears. The proposed closing date for the project would be May 31, 2006. A condition for disbursement ofexpenditures made in respect of Works would be that the Association has approved the design report ofeach proposed rehabilitation or completion activity. The report would have to include: (a) a description ofdesign alternatives considered; (b) a detailed description of the selected alternative; (c) design criteria andtechnical details of the proposed works; and (d) bill of quantities and cost estimates. Table C below showsthe allocation of Credit proceeds.

Table C: Allocation of Credit Proceeds

Ex::Sff; ;penditre Ctegor Amu n US$ii:m i on00X 00 -Financing Pecetage0tf0 7700

Works 33.50 90 percentGoods 0.20 100 percent of foreign expenditures, 100

percent of local expenditures (ex-factorycosts) and 80 percent of local

expenditures for other items procuredlocally

Services and Training 5.00 100 percentIncremental Operating Costs 0.50 70 percentRefund of PPF 0.80Unallocated 2.00

Total Project Costs 42.00

Total 42.00

Use of statements of expenditures (SOEs):

Project funds would be initially disbursed under the Association's established procedures.Disbursements made on the basis of Statements of Expenditures (SOEs) would be as follows for eachexpenditure category: (a) goods under contracts costing less than US$ 100,000 each; (b) works undercontracts costing less than US$ 200,000 each; (c) services under contracts less than US$ 100,000 each forconsulting firms and less than US$ 25,000 each for individual consultants; and (d) training and incrementaloperating costs, under such terms and conditions as the IDA shall specify. Supporting documentation forSOEs would be retained by the Borrower, be made available to the Association during project supervision,and be audited annually by independent auditors acceptable to the Association. Disbursements forexpenditures above these thresholds would be made against presentation of full documentation relating tothose expenditures.

Although project funds would initially be disbursed under the Association's established procedures,there is the option of disbursing on the basis of submitted Project Management Reports (PMRs). A changeto PMR-based disbursements would however only be made at the mutual agreement of the Government andthe Association and would be considered once the PIU is familiar with the project's monitoring aspects andis considered able to produce sufficiently tirnely and reliable project management information. A change toPMR-based disbursements would be considered by December 31, 2001.

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PIU's accountant would receive necessary training to properly carry out the accounting activitiesunder the Project. During the project launch workshop there would be a session on proper preparation ofwithdrawal applications, including the preparation and submission of needed supporting documents.

Special account:

To facilitate disbursements against eligible expenditures, the Goverunent would establish a SpecialAccount (SA) in a commercial bank to be operated by the PIU under terms and conditions satisfactory tothe Association. The Association would, upon request, make an authorized allocation of US$ 1.0 million.Initially the allocation would be limited to US$ 500,000, -until disbursements have reached SDR 4.0million, at which time the full authorized allocation could be claimed. Applications for the replenishmentof the SA would be submitted at least every three months and would have to be supported by the necessarydocumentation including the SA bank statement and a reconciliation of this bank statement to the projectsaccounting records. The SA would be audited annually by independent auditors acceptable to theAssociation. The PIU would maintain a separate bank account (in local currency) to receive-and manageGovernment counterpart contributions.

Financial Management

Financial Management Assessment: The overall responsibility for financial management of theproject would rest with the PIU. The PIU includes one accountant; additional accountants would berecruited as required during project implementation. The Association conducted a financial managementassessment of the PIU and concluded that the project's financial management arrangements do satisfy theAssociation's minimum requirements. The main feature of the project's financial managementarrangements is that the PITJ has negotiated a contract with a local financial management consultant to: (i)establish an accounting system prior to project effectiveness; (ii) train the PIU accountant in the operationof that system; and (iii) oversee and be responsible for the operation of that system for the first few monthsof the project before handing over such responsibilities to the PIU. The Project Implementation Plan (PIP)contains a fuller description of the project's financial management arrangements.

Financial Management Risks: The financial management capacity within Azerbaijan has not beenthe subject of a detailed review by IDA. However, primarily because of other implementationconsiderations, any weaknesses that may exist in the country's financial management capacity have beenmitigated by the use of a specialized project implementing agency, the PIU, for project implementation,including its financial management, and by the Borrower's agreement to obtain the IDA's no-objection tothe appointment of the project's auditors. The specific weaknesses of the PIU in respect of its financialmanagement capacity would be addressed by a local financial management consultant, however, theseweaknesses neither compromise the fiduciary responsibilities of the Borrower nor of the Association. Theselected financial management consultant already has experience of successfully establishing and operatingthe financial management system of a similarly complex IDA-financed project and therefore thisarrangement is not considered to contain any significant implementation risks. In addition, weaknesses inthe Azerbaijan banking sector would be mitigated by the use of a bank deemed eligible by the IDA to holdthe project's Special Account.

Project Management Reports: The agreed formats of the Project Management Reports (PMRs)are included within the PIP and the PIU would produce a full set of PMRs for every calendar quarterthroughout the life of the project commencing with the quarter ending June 30, 2001, however, the PMRsshowing details of the sources of funds, expenditures by project component, expenditures by expenditure

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category, and the Special Account, would be produced in respect of the quarter ending December 31, 2000and quarterly thereafter.

Audit Arrangements: External audits by independent private auditors acceptable to theAssociation and on terms of reference acceptable to the Association, as included within the PIP, would beperformed annually throughout the life of the project. The results of the audit of the RIDIP would beavailable within six months of the end of every fiscal year and the cost of the audit would be financed bythe Credit. The appointment of the project's auditor is a condition of project effectiveness and theappointed auditor would be retained, subject to satisfactory performance, for the life of the project.

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Annex 7: Project Processing Schedule

AZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage InfrastructureProject

Project Schedule Planned . Actal LAt final PCD Stage

Time taken to prepare the project (months)First Bank mission (identification) 01/01/95 01101/95Appraisal mission departure 09/20/99 02/28/2000Negotiations 10/20/99 05/04/2000Planned Date of Effectiveness 04/01/2000

Prepared by:

The State Amelioration and Irrigation Comrnittee, with assistance from consulting firms forengineering, environmental and social studies.

Preparation assistance:

* Japanese PHRD Grant of US$ 306,000; and* Project Preparation Facility of US$ 800,000.

Bank staff who worked on the project included:

Name Speciality-,Joop Stoutjesdijk Irrigation Engineer / Task Team Leader (since October 1999)Toru Konishi Senior EconomistThirumangalam Sampath Task Team Leader (until October 1999)Janakiram Subramaniam Financial SpecialistJoseph Goldberg Sector ManagerNaushad Khan Procurement SpecialistGurdev Singh Procurement SpecialistRanjan Ganguli Financial Management SpecialistRufiz Chirag-Zade Operations OfficerDilek Barlas Legal CounselHannah Koilpillai Disbursement OfficerNeal Mountstephens Irrigation Specialist (FAO Investment Center)Nirmala Saraswat Environmental SpecialistJenny Corso Project AssistantValencia Copeland Project AssistantRoy Southworth Program Team LeaderStan Peabody Social Scientist

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Annex 8: Documents in the Project File*AZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

Project

A. Project Implementation Plan

Project Implementation Plan, including:

* Project costs;* Procurement arrangements;* Procurement plan;* Disbursement arrangements;* Implementation Schedule; and* Terms of References.

B. Bank Staff Assessments

* Various Aide Memoires, Back-to Office Reports and Intemal Memos;o Financial Management Assessment (by Financial Management Specialist; March 31, 2000);

and* Assessment of the Capacity of the Implementation Agency to Conduct Procurement (January

2000).

C. Other

- Identification Study (3 volumes; by CES Consulting Firm; February 1998);o Feasibility Study for Samur-Apsheron Canal System and Main Mill-Mugan Collector (3

volumes; by CES Consulting Finn; December 1999);o Project Preparation Report (by CES Consulting Firm; December 1999);- Project Implementation Plan (draft by CES Consultants; December 1999);- Environmental Impact Assessment (by CES Consultants; January 2000);- Environmental Monitoring Report (by CES Consultants; January 2000);* Social Assessment Report (by Azpetsprominvest; December 1999).

*Including electronic files

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Annex 9: Statement of Loans and Credits

AZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage InfrastructureProject

Difference between expectedand actual

Original Amount in US$ Millions disbursementsProject ID FY Borrower Purpose IBRD IDA Cancel. Undisb. Orig Frm Rev'd

P035813 1999 Azerbaijan AGRI. DEV. & CREDIT 0.00 30.00 0.00 29.85 0.74 0.00

P008288 1995 Azerbaijan BAKU WATER SUPPLY 0.00 61.00 0.00 22.59 29.54 0.00

P058969 1999 Azerbaijan CULT.HERITAGE PRSRV- AZ 0.00 7.50 0.00 7.27 0.24 0.00

P057959 1999 Azerbaijan EDUCATION REFORM PROJECT 0.00 5.00 0.00 4.72 0.94 0.00

P040544 1997 Azerbaijan FARM PRIVATIZATION 0.00 14.70 0.00 5.77 3.44 0.00

P008287 1997 Azerbaijan GAS REHAB 0.00 20.20 0.00 12.30 7.80 4.58

P008283 1996 Azerbaijan INSTITUTION BUILDING 0.00 18.00 0.00 6.03 7.48 0.00

P008282 1995 Azerbaijan PETROLEUM TA 0.00 20.80 0.00 10.36 11.75 2.96

P035770 1999 Azerbaijan PiLOT RECONSTRUCTION 0.00 20.00 0.00 13.53 5.96 0.00

P055155 1998 Azerbaqjan URGENT ENV. INVEST. 0.00 20.00 0.00 19.22 4.80 0.00

Total: 0.00 217.20 0.00 131.64 72.69 7.54

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AZERBAIJANSTATEMENT OF IFC's

Held and Disbursed Portfolio31-Jul-1999

In Millions US Dollars

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic1999 Amoco Caspian 32.83 0.00 0.00 13.95 32.83 0.00 0.00 13.951998 Azerb. JV Bank 0.00 1.00 0.00 0.00 0.00 0.00 0.00 0.001997/98 Baku Coca Cola 6.42 0.00 0.00 0.00 6.42 0.00 0.00 0.001999 Early Oil Fin 15.44 0.00 0.00 6.56 15.44 0.00 0.00 6.561999 Lukoil 19.30 0.00 0.00 8.20 19.30 0.00 0.00 8.201998 SEF Azdemiryol 0.06 0.00 0.00 .0.00 0.06 0.00 0.00 0.001998 SEF Azerigaz 0.40 0.00 0.00 0.00 0.40 0.00 0.00 0.001998 SEF Rabitabank 0.40 0.00 0.00 0.00 0.35 0.00 0.00 0.001999 Turkish Petrol 13.03 0.00 0.00 5.54 13.03 0.00 0.00 5.541999 Unocal Chirag 19.40 0.00 0.00 8.24 19.40 0.00 0.00 8.24

Total Portfolio: 107.28 1.00 0.00 42.49 107.23 0.00 0.00 42.49

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic1999 Park Hyatt Baku 17500.00 0.00 0.00 0.00

Total Pending Commitment: 17500.00 0.00 0.00 0.00

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Annex 10: Country at a GlanceAZERBAIJAN: Rehabilitation and Completion of Irrigation and Drainage Infrastructure

ProjectEurope &

POVERTY and SOCIAL Central Low-Azerbalian Asia Income Development diamond'

1998Population, mid-year (millionsJ 7.9 473 3,515 Life expectancyGNP per capita (Atlas method, US$1 490 2,190 520GNP (Atles mothod, US$ billions) 3.9 1,039 1,844

Avera1e annual prowth, 1992-98 TPopulation f%) 1.2 0.1 1.7Labor force (%M 1.S 0.6 1.9 GNP | ____ Gross

Most recent estimate (latest year avatlabte, 1992-98) cpita enprimaren

PovertY (% of population below national poverty line) 68Urban Population (% of totalpopulafi0n) 57 68 31Life exoectanCv at birth (year$) 71 69 63Infant mortality (per 1.000 live births) 20 23 69Child malnutrition (% of children under S) 10 .. Access to safe waterAccess to safe water (% ofPopulation) .. .. 74Illiteracy (% of poyoulaftion age 15i) - 4 32Gross primarv enrollment (% of school-age Poopulation) 106 100 108 Azerbaijan

Mate 108 101 113 Low-income groupFemale 105 99 103

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1977 1987 S997 1998Economic ratios'

GDP (USS billions) 9.8 3.4 3 9Gross domestic investment/GDP .. .. 37.0 40.0 TradeExports of poods and serviceslGOP . .. 29.9 24.5Gross domestic savings/GDP .. .. 12.3 5,6Gross national savinsa/GDP 13.2 6.8

Current account balancelGDP -26.6 -34.8Interest pavments/GDP .. 0.0 0.3 0.2 DomescInvestmentTotal debt/GDP .. .. 14.6 15.1 SavingsTotat debt servicelexports .. .. 6.6 8.7Present value of debt/GDP .. .. 10.2Present value of debtexports -. ,, 31.9

Indebtedness1977-87 1988-98 1997 1998 1999-03

(average annual growthlGDP .. -f1.5 5.S 10.0 3.9 'U--AzerbajanGNP Per capita .. -12.5 2.9 8.7 2.7 ............ .- Low-income groupExoorts of 0oods and services .. . 53.6 22.1 6.2

STRUCTURE of the ECONOMY1977 1987 1997 1998 Growth rates of output and investment (°b)

(`% of GDP) 1500ACtriculture .. .. 22.1 20.9Industrv 42.4 46.3 ICno

Manufacturing 9.6 7.2 5ooServices 35.6 32.7 n,

Private consumption 75.6 83.4 .500 94 96 97 98

General government consumption 12.1 11.0 GDI GDP

Imports of goods and services .. .. 54.5 58.9

1977-87 1988-98 1997 1998 Growth rates of exports and imports (%)(average annual gnowth)Apriculture - -6.7 3.9 6Industry 16.8 19.9 40

Manufacturing -64.8 -17.7Services 8.9 0.9 20

Private consumption -11.3 12 7 0General government consumption 26.7 -7.4 93 94 ss ='4) 97 00

Gross domestic investment 34.8 16.1 20

Imports of goods and services .. .. 15.7 20.6 -- Exports SlsmportsGross national Droduct .. -11.5 5.9 9.9

Note: 1998 data are preliminary estimates.

The diamonds show four kev indicators in the countrv (in bold) comDared with its income-sroup averane. If data are missing, the diamond Willbe incomDlete.

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Azerbaijan

PRICES and GOVERNMENT FINANCE1977 1987 1997 1998 Inflation (%)

Domestic prices so (%S change) , 00Consumer prices .. .. 0.5 .. 1000Implicit GDP deflator .. .. 6.2 -5.7 so v

Government finance o(% of GDP, includes current,grants) 93 94 95 96 97 98

Current revenue .. .. 19.7 17.3 -500Current budget balance .. .. 0.2 -2.3 -GDP deflator CPIOverall surplus/deficit .. .. -1.7 -4.2

TRADE1977 1987 1997 1998 Export and import levels (US$ millions)

(US$ millions)Total exports (fob) .. .. 808 678 2.000

Crude oil from new fields .. .. 16 133Petroleum products .. .. 464 285 1,500Manufactures .. .. 78 57

Total imports (cif) .. .. 1,444 1,791 .1 aaFood . .. 181 175 So A Fuel and energy . . 79 63 so awnCapital goods . .. 475 791 I

92 93 94 9S 96 97 9BExport price index (1995=100) .. .. 103 66Import price index (1995=100) 99 95 C Exports U ImportsTerms of trade (1995=100) .. .. 104 69

BALANCE of PAYMENTS

(US$ millions) 1977 1987 1997 1998 Current account balance to GDP ratio (J.)

Exports of goods and services 1,150 1,010 10Imports of goods and services 2,101 2,425Resource balance -9 -13415 92

Net income - 1 1Net current transfers .. .. 45 64

Current account balance .. .. -916 -1,364

Financing items (net) 1,079 1,291Changes in net reserves -163 74 40 -

Memo:Reserves including gold (US$ millions) .. .. 467 449Conversion rate (DEC, locasllUS$) 0.2 4,451.3 4,058.3

EXTERNAL DEBT and RESOURCE FLOWS1977 1987 1997 1998

(US$ millions) Composition of total debt, 1998 (USS millions)Total debt outstanding and disbursed .. .. 504 593

IBRD .. .. 0 0 E:11 F:25IDA .. .. 116 178 | :

Total debt service 77 91 |9178IBRD IDA 1

Composition of net resource flowsOfficial grants . .. 30Official creditors .. .. 25 1Private creditors .. .. 8 17Foreign direct investment .. .. 1,051 948Portfolio equiy I 0 C: 303

World Bank program A - IBRD E - BilateralCommitments .. .. 0 40 8 - IDA 0 - Other multilateral F -PrivateDisbursements .. .. 55 63 C - IMF G -Short-termPrincipal repayments .. .- 0 0Net flows .. .. 55 63Interest payments .. .. 0 1Net transfers .. .. 55 62

Development Economics 9/22/99

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MAP SECTION

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