Local Government Unit Private Infrastructure Project Development Facility (Loan 1729-PHI) in the Philippines

Project Completion Report PCR: PHI 32485 Local Government Unit Private Infrastructure Project Development Facility (Loan 1729-PHI) in the Philippines June 2005

CURRENCY EQUIVALENTS Currency Unit peso/s (P) At Appraisal At Project Completion 8 November 1999 14 September 2004 P1.00 = $0.0250 $0.0178 $1.00 = P40.024 P56.200 ABBREVIATIONS ADB Asian Development Bank BOO build-own-operate BOT build-operate-transfer CCPSP Coordinating Council for Private Sector Participation CRS credit rating system DILG Department of Interior and Local Government DMC developing member country DOF Department of Finance EA Executing Agency GFI government financial institution JBIC Japan Bank for International Cooperation LBP Land Bank of the Philippines LGFSD Local Government Financial Services Department LGU local government unit ODA official development assistance PCR project completion report PDF project development facility PPA Philippine Port Authority PSP private sector participation PUD Public Utilities Department TA technical assistance TASF Technical Assistance Special Fund TCR technical assistance completion report NOTES (i) (ii) The fiscal year (FY) of the Government and its agencies ends on 31 December. In this report, "$" refers to the US dollars.

ii CONTENTS Page BASIC DATA iii I. PROJECT DESCRIPTION 1 II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Project Outputs 4 C. Project Cost 5 D. Disbursements 5 E. Project Schedule 6 F. Implementation Arrangements 8 G. Conditions and Covenants 8 H. Consultant Recruitment and Procurement 9 I. Performance of Consultants, Contractors, and Suppliers 9 J. Performance of the Borrower and Executing Agency 10 K. Performance of the Asian Development Bank 10 III. Evaluation of Performance 11 A. Relevance 11 B. Efficacy in Achievement of Purpose 11 C. Efficiency in Achievement of Outputs and Purpose 11 D. Preliminary Assessment of Sustainability 12 E. Environmental, Sociocultural, and Other Impacts 12 IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 12 A. Overall Assessment 12 B. Lessons Learned 12 C. Recommendations 14 APPENDIXES 1. Project Framework 16 2. Project Outputs 18 3. Estimated and Actual Project Costs 22 4. Chronology of Events 23 5. Organization Chart during Project Implementation 25 6. Status of Compliance with Loan Covenants 28

iii BASIC DATA A. Loan Identification 1. Country 2. Loan Number 3. Project Title 4. Borrower 5. Executing Agency 6. Amount of Loan 7. Amount of Grant 8. Project Completion Report Number B. Loan Data 1. Appraisal Date Started Date Completed 2. Loan Negotiations Date Started Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness In Loan Agreement Actual Number of Extensions 6. Closing Date In Loan Agreement Actual Number of Extensions 7. Terms of Loan Interest Rate Maturity (number of years) Grace Period (number of years) 8. Terms of Relending Interest Rate Maturity (number of years) Grace Period (number of years) Second-Step Borrower Philippines 1729 Local Government Unit (LGU) Private Infrastructure Project Development Facility Land Bank of the Philippines Land Bank of the Philippines Y314,745,000 ($3 million equivalent) $600,000 PCR: PHI 898 13 October 1998 11 December 1998 12 November 1999 12 November 1999 20 December 1999 7 March 2000 5 June 2000 5 June 2000 None 6 June 2004 14 September 2004 none Floating interest rate, based on the Asian Development Bank's market-based loan facility for Japanese yen 15 years 3 years Variable interest rate based on prevailing commercial rate maximum 5 years 1 year Local government units with commercially viable project

iv 9. Disbursements a. Dates Initial Disbursement 30 October 2002 Effective Date 5 June 2000 Final Disbursement 14 September 2004 Original Closing Date 6 June 2004 Time Interval 22.5 months Time Interval 48 months Category or Subloan Consulting Services b. Amount ($ million) Original Allocation Last Revised Allocation Amount Canceled Net Amount Available Amount Disbursed Undisbursed Balance 3 3 2.016 0.328 0.328 0 Total 3 3 2.016 0.328 0.328 0 Note: Y 314,745,000 ($3.0 million equivalent) at the time of loan appraisal. The difference between the $3.0 million and the total of $2.016 cancellation and $0.328 amount disbursed is due to exchange rate difference during the implementation. Category or Subloan Amount Value Date (Application No.) Disbursed Consulting Services: Application No. TA-001 79,117 30 October 2002 Application No. TA-002 118,830 24 April 2003 Application No. TA-003 26,834 7 May 2004 Application No. TA-004 36,473 28 June 2004 Application No. TA-005 40,552 2 September 2004 Application No. TA-006 26,501 14 September 2004 Total 328,307 C. Project Data 1. Project Cost ($ million) Cost Appraisal Estimate Actual FX LC Total FX LC Total A. Project Development 1.845 1.945 3.790 0.328 0.055 0.383 Facility B. Capacity Building in 0.548 0.177 0.725 0.566 0.129 0.695 LGU Financing Total 2.393 2.122 4.515 0.894 0.184 1.078 FX = foreign exchange, LC = local currency, LGU = local government unit.

v 2. Financing Plan ($ million) Cost Appraisal Estimate Actual FX LC Total FX LC Total A. Project Development Facility 1. ADB 1.845 1.155 3.000 0.328 0.000 0.328 2. LBP/LGU/BOT 0.000 0.790 0.790 0.000 0.055 0.055 Subtotal 1.845 1.945 3.790 0.328 0.055 0.383 B. Capacity Building in LGU Financing 1. ADB 0.548 0.052 0.600 0.566 0.004 0.570 2. LBP 0.000 0.125 0.125 0.000 0.125 0.125 Subtotal 0.548 0.177 0.725 0.566 0.129 0.695 Total 2.393 2.122 4.515 0.894 0.184 1.078 ADB = Asian Development Bank, BOT = build-operate-transfer, FX = foreign exchange, LBP = Land Bank of the Philippines, LC = local currency, LGU =local government unit. 3. Project Performance Report Ratings Implementation Period Development Objectives Ratings Implementation Progress From 1 Jan to 31 Dec 2000 Satisfactory Satisfactory From 1 Jan to 31 Aug 2001 Satisfactory Satisfactory From 1 Sep to 31 Oct 2001 Satisfactory Partly Satisfactory From 1 Nov to 31 Dec 2001 Satisfactory Satisfactory From 1 Jan to 28 Feb 2002 Satisfactory Satisfactory From 1 Mar to 31 Mar 2002 Partly Satisfactory Satisfactory From 1 Apr to 31 May 2002 Partly Satisfactory Partly Satisfactory From 1 Jun to 31 Dec 2002 Satisfactory Partly Satisfactory From 1 Jan to 31 Dec 2003 Satisfactory Partly Satisfactory From 1 Jan to 28 Feb 2004 Satisfactory Partly Satisfactory From 1 Mar to 31 Mar 2004 Satisfactory Satisfactory From 1 Apr to 14 Sep 2004 Partly Satisfactory Satisfactory D. Data on Asian Development Bank Missions Name of Mission Inclusive Dates No. of Persons Reconnaissance 04 24 Mar 1997 4 Mission No. of Person- Days a Specialization of Members Investment officer Senior financial analyst Programs officer Financial analyst

vi Name of Mission Follow-Up Mission 1 Inclusive Dates 13 Oct 11 Dec 1998 No. of Persons 4 No. of Person- Days a Specialization of Members Private sector specialist Programs officer Economist Financial analyst Follow up Mission 2 24 May 30 Aug 1999 3 a Private sector specialist Counsel Financial analyst Loan Review Mission 1 Loan Review Mission 2 Loan Review Mission 3 Loan Review Mission 4 24 30 Apr 2002 1 7 Governance specialist 13 May 2002 3 3 Senior financial management specialist Operations officer Economics officer 25 26 Jun 2002 2 4 Governance specialist Operations officer 1 5 Sep 2003 1 5 Governance specialist Loan Review Mission 5 Project Completion Review b 21 Jul 9 Aug 2004 16 Nov 10 Dec 2004 2 9 Senior financial management specialist Operations officer 2 20 Senior financial management specialist Operations officer a b The actual number of days for the mission cannot be computed because the mission was carried out intermittently and the corresponding mission authorization requests, if any, can no longer be traced. The project completion report was prepared by Emma Yang, senior financial management specialist, and Hermie Bustamante, operations officer.

I. PROJECT DESCRIPTION 1. In December 1999, the Asian Development Bank (ADB) approved a technical assistance (TA) loan of $3.0 million equivalent and a TA grant of $0.60 million to the Land Bank of the Philippines (LBP). The Project comprised two components: (i) Part A Project Development Facility (PDF), and (ii) Part B Capacity Building in Local Government Unit (LGU) Financing. Under Part A, a revolving credit facility was to be established in LBP to finance consulting assistance to help LGUs solicit private sector participation in local infrastructure for project preparation. The consultants were to provide services comprised Phase 1 of project feasibility preparation and Phase 2 of bidding, evaluation, negotiations with, and contract awarding to private sector participants in revenue-generating infrastructure projects. As for Part B, LBP s inhouse capabilities were to be strengthened to finance LGU infrastructure projects with private sector involvement through (i) improvement of the credit rating system by incorporating governance criteria, (ii) training in private sector modalities, (iii) development of new credit products and enhancements to catalyze private finance, and (iv) preparation for a possible future ADB credit line. The project was classified to have economic growth as primary objective, and environmentally it is considered a Category C project. 2. The rationale for establishing the project development facility was based on the government plan to devolve responsibility for providing basic infrastructure services to the LGUs. With passage of Republic Act 7160, otherwise known as the Local Government Code of 1991, the primary responsibility for providing basic infrastructure services was devolved to LGUs. But traditional sources of LGU financing (e.g., official development assistance, internal revenue allotments, and local taxes) have been insufficient to meet their infrastructure needs. Thus the Government seeks to supplement these financing sources by helping credit-worthy LGUs with viable infrastructure projects to tap private sector financial sources. This could be through straight borrowing or any of the Government s private sector participation schemes, including build-operate-transfer (BOT) or build-own-operate (BOO). 3. The project s overall goal was to support decentralization process and regional economic development through increasing private sector funding of infrastructure projects at the LGU level. Specifically the TA aimed at promoting good governance and enhancing LGU capacity to prepare and bid infrastructure projects for private sector participation. The project comprised (i) project development facility (PDF), a revolving credit facility enhancing LGU capacity to prepare and tender suitable infrastructure projects for private sector participation, and (ii) capacity building assistance to enhance the capacity of government financial institutions (GFIs) to evaluate LGU project proposals for financing. Appendix 1 gives the project framework. II. EVALUATION OF DESIGN AND IMPLEMENTATION A. Relevance of Design and Formulation 4. The project design was relevant in terms of consistency with the country s development objectives and ADB s Philippine country program and strategy. To encourage regional development and decentralization, the Government passed the LGU Code of 1991, which empowered LGUs to finance and manage their infrastructure projects. This created a significant demand for financial resources that could not be sufficiently covered by traditionally available public sector sources. To supplement the traditional sources, the Government passed Republic Act 6957 (amended by Republic Act 7718), otherwise known as the BOT Law, which allows the private sector to finance, operate, and maintain infrastructure projects of creditworthy LGUs.

2 5. Private sector participation in LGU infrastructure has been constrained by the lack of LGU (i) capacity to prepare and tender projects for private sector participation; (ii) creditworthiness, mainly because of poor public sector governance structures and limited financing sources; and (iii) accessibility to long-term funds, because of shortcomings in the country s capital market. Thus, the Government has worked toward a financing framework to optimize and supplement the financing available to LGUs for infrastructure projects by tapping private sector sources. 6. The PDF, established under Part A, supported the Government s financing framework. It was the initial component of a larger national PDF initiative to provide project preparatory assistance to all government implementing agencies, at both national and local levels. The Government had planned to expand the PDF and get financial support from other donors. 7. The project design was in line with ADB s Philippine country strategy and program, which aimed to (i) broaden LGU institutional and financial capabilities to undertake development programs and projects, and encourage private sector participation; (ii) support human resource development and investment in basic needs; (iii) help improve the efficiency and performance of LGU infrastructure delivery; and (iv) improve self reliance and lessen LGU financial dependence on the Government. 8. The Project was not properly implemented as envisaged during conceptualization. Few LGUs identified during project preparation and implementation were properly assessed of their understanding of the PDF and BOT schemes. Most LGUs were keen to finance feasibility studies for their respective projects through grants, not loans. Thus, only 2 of the 30 identified LGUs (17 during project processing and 13 during implementation) took advantage of the PDF. Unfortunately, the first subproject was partially implemented, then subsequently canceled, because of institutional differences among participating LGUs. But implementation of the second subproject is underway, and completion is expected in the first half of 2005. But because of the decision to close the loan account in 2004, financing for this subproject was limited to Phase 1. Phase 2 is now financed by the LGU from a separate LBP loan. During implementation, six main weaknesses in project design and formulation were identified: (i) (ii) Limited facility coverage. Demand for credit to finance infrastructure was high, and LGUs were increasingly willing to borrow and assume responsibility for repayment of the loans. But most LGUs were not enthusiastic about the facility offered under the Project because (a) the PDF supported only the preparation of feasibility studies and bidding processes, but not the ensuing projects; and (b) the facility was limited only to revenue-generating projects that were deemed suitable for private sector participation. If the PDF were broadened to allow LGUs to obtain loans and undertake the infrastructure projects themselves, the take-up would probably have been far higher. But the BOT Center maintained that extending the facility would detract from the unique purpose of the BOT Law to promote private sector participation (PSP). This conceptual conflict between the target beneficiary and BOT Center was not anticipated when the Project began. Non-familiarity with the build-operate-transfer modality. LGUs were still unfamiliar with the BOT concept promoted through the PDF, and were reluctant to enter into such contracts, given the poor track record and high-profile failures at the national level. To overcome this resistance, the Project had intended as a matter of strategy to use the first one or two sub-loans as demonstration cases to

3 encourage further LGU participation. Thus, the Project would have fulfilled two purposes: to provide financing for the preparatory works, and to support policy reform to encourage partnerships of the public and private sectors. But because of delay in project implementation and the closing of the loan account in September 2004, without extension, the implementation of one of the two approved purposes was not fully completed in time to serve as a demonstration case. (iii) (iv) (v) (vi) Insufficient marketing efforts. The agencies involved in the Project LBP and the Coordinating Council for Private Sector Participation (CCPSP), which was later renamed the BOT Center by Executive Order 144 have promoted PDF through different approaches. The BOT Center tended to be more proactive in producing marketing materials and conducting orientation seminars for local government officials. But it was constrained by its limited staff and offices that were only in Manila. In contrast, LBP had a far broader reach through its regional lending centers, which were the first ports-of-call for local governments seeking financial assistance. Although the LBP headquarters had trained its staff at regional lending centers, the level of interest and understanding at the regional level remained too low to enable effective marketing of the PDF to LGUs. Availability of other and cheaper financing assistance. LGUs were reluctant to borrow for feasibility study, but wanted only to finance largely from grants or their own resources. The PDF even faced competition from other ADB projects (e.g., the Mindanao Basic Urban Services Sector), which provided grants for the feasibility study. PDF was offered at the prevailing commercial rates the fixed rate at 11% while LGUs could tap cheaper sources. LGUs generally failed to appreciate the distinction between fixed and variable rates, and simply opted for the cheaper funds. The LGUs also argued that since ADB provided the funds, the funds should be lent at concessional rates. Although LBP had expressed willingness to lower the PDF rate to make it competitive, it was only willing to give a variable, not a fixed, rate. Unacceptable processes for consultant selection. The consultants were selected by LBP in accordance with the ADB Guidelines, and the team of consultants included international experts. A fundamental reason to provide international consultancy assistance to the Borrower was to protect LGUs from unsolicited private bids, low-quality feasibility studies, and nonqualified contractors. But LGUs still questioned the consultant s selection processes, and the relatively high costs of international consultants just for feasibility studies. Discussions with potential recipients indicated that LGUs would have liked more participation in selection, and would have preferred cheaper local consultants with comparable qualifications. High market risk. The loan required the LGUs to assume full cost of the feasibility study in case there was no successful bidder for the projects. Once the project was successfully awarded, the LGU could pass the cost of the feasibility study to the winning bidder. Few LGUs would take on an expensive feasibility study in which successful bidding process was not guaranteed.

4 9. Capacity building for the LBP under Part B was considered essential for project implementation. The PDF program was new to both LBP and the LGUs. Thus, it was necessary that LBP familiarize with the PDF concept so it could more effectively market PDF to the LGUs. B. Project Outputs 1. Part A. Project Development Facility 10. At loan approval in December 1999, 17 potential projects were in the pipeline; another 13 subprojects had been identified during implementation. The loan was anticipated to finance as many as 10 subprojects. But only two subprojects have been approved: the Davao del Norte Integrated Water Resource Development Project, and the Modernization of Olongapo City s Public Utilities Department (PUD). The PDF funded only Phase 1 of both subprojects; their status is discussed in the following paragraphs. Appendix 2 compares project outputs at appraisal and completion, including a list of subprojects that did not materialize. (i) (ii) Davao del Norte Integrated Water Resource Development Subproject. The consultant s feasibility study was submitted to key officials of the six LGUs and the Davao provincial government for review and deliberation. But some stakeholders did not accept the feasibility study and recommendations. Concerned officials from two of the six water districts (Tagum and Panabo) rejected the institutional recommendation to discontinue the existing six water districts and combine them in a single provincial water district. Because of this, Davao del Norte and the six participating LGUs jointly agreed to pre-terminate their agreement with the consultants for implementation of Phase 2 of the subproject. Due to the termination of the feasibility study, the four water districts that accepted the consultant s recommendation had turned to local water utilities administrations for financing support and received loans from their local water utilities administrations to rehabilitate their water distribution facilities. Modenization of Olongapo City s PUD Subproject. Olongapo City accepted the consultant s report, including the recommendation for the employees separation program for those employees affected by the PUD modernization, and those who want to voluntarily leave their government positions. To make the program effective, a premium over the legal separation pay will be offered to departing employees, based on their number of government service years. Departing employees will also be paid the monetary value for their leave credits. The separation program will become effective when the distribution system is turned over to the winning bidder. The city government will absorb employees that the private operator does not employ. In consultation with LBP, the consultants services under Phase 2 of the project will no longer be financed under the ADB loan. Instead, those services will be financed by the LBPapproved loan to Olongapo. Implementation of Phase 2 will be completed in the first half of 2005. 2. Part B. Capacity Building in Financing of Local Government Units 11. Capacity building was supported by TA 3349-PHI: Capacity Building in Local Government Unit Financing. The consultant s final report was rated satisfactory, and the overall

5 rating of the TA was also successful since TCR focused on the delivery of outputs. 1 It summarized the work undertaken and the main finding, and proposed an innovative way to catalyze LGU financing through a multifaceted, market-oriented approach. Recommendations for improving LGU loan processing and administration were accepted, and LBP appreciated the regional training provided. LBP considered the credit rating system developed under the TA an excellent tool. A seminar on LGU financing and credit rating was well-attended by both the public and private banking community, and was a key mechanism for promoting the TA findings. Capacity building and training were accomplished through three 2-day regional seminars. However by reviewing the TA outcomes at the time of completion of the loan, there are concerns on the sustainability of the impacts of the TA. C. Project Cost 12. At appraisal, the project cost was estimated at $4.515 million, but the actual project cost was only $1.078 million (Table 1). Table 1: Project Cost Appraisal Actual Estimate Cost Source FX LC Total FX LC Total Part A: Project Development 1.845 1.945 3.790 0.328 0.055 0.383 Facility Part B: LBP Capacity Building 0.548 0.177 0.725 0.566 0.129 0.695 Total 2.393 2.122 4.515 0.894 0.184 1.078 FX = foreign exchange, LBP = Land Bank of the Philippines, LC = local currency. Source: Report and Recommendation of the President to the Board of Directors on a Proposed Technical Assistance Loan and Grant to the Philippines and the Land Bank of the Philippines for the LGU Private Infrastructure Project Development Facility. 13. Of the total estimated project costs of $4.515 million for Parts A and B, ADB was to provide $3.0 million equivalent as a TA loan for Part A and $0.6 million as a TA grant for Part B. LBP was to provide $0.335 million; the BOT Center, $0.250; million; and LGUs, $0.330 million. 14. Under Part A, the actual loan utilization was significantly lower than the appraisal cost estimate. The significant disparity in cost is attributed to the lesser number of approved subprojects. Only two out of the ten expected subprojects materialized, and ADB financing for both subprojects was limited to phase 1 only. On the other hand, the activities of Part B were implemented according to its schedule. The actual costs are within the estimated costs projected during appraisal. A comparison of detailed cost estimates at appraisal and actual expenditures are shown in Appendix 3. D. Disbursements 15. The arrangement for disbursement of loan proceeds is appropriate. Consultants are paid directly, based on approved billings. Such disbursements are booked to the relevant LGUs as subloan disbursement under LBP s PDF credit facility. No extension of loan closing date was made in view of ADB s decision to close the loan account on or before the Project s original loan 1 TCR was circulated to the Board on 25 July 2002. Document No. IN.176-02.

6 closing date of 6 June 2004, due to slow project implementation and the anticipation that there would be no additional subprojects to be approved or implemented under the Project. LBP was advised, and concurred with ADB s decision. LBP was given a 3-month grace period to complete the payment for the consultant s remaining claims for the Olongapo City subproject. The TA loan account was closed on 14 September 2004, with a total disbursement of $0.328 million and cancelation of an unutilized loan amount of $2.518 million. E. Project Schedule 16. The Loan Agreement stipulated that both TA components were expected to commence in the first quarter of 2000. The TA loan for Part A was expected to be committed over 3 years with disbursement continuing as long as 12 months. Thereafter LBP s PDF would continue operating, financed by reflows of funds. Part B would be implemented over 18 months. Appendix 4 chronologically lists major project milestones. 17. The loan was anticipated to finance as many as 10 subprojects over 4.5 years, ending in June 2004. But the Project has experienced significant delays in implementation due to difficulties encountered by LBP and the BOT Center in getting the LGUs confirmation to avail of the TA loan facility. The latter in turn is due to the LGUs (i) lack of appreciation of the BOT/PSP policies; (ii) reluctance to access loans for pre-investment studies, especially with the availability of grants for such studies from other financing facilities; and (iii) reluctance to pursue infrastructure projects whose implementation usually goes beyond the 3-year terms of local executives. 18. Thus, the feasibility study for the first subloan to Davao del Norte was approved only in June 2002, and was completed in January 2003. Phase 2 of the consultancy assistance related to the preparation of tender documents. Evaluation and awarding were subsequently canceled because the LGUs involved in the subproject failed to agree on the amalgamation of the water districts under them. The second subloan agreement was signed by LBP and Olongapo City on 27 January 2004 for the rehabilitation and upgrading of the city s system of electrical power distribution. The feasibility study was completed and accepted by the City of Olongapo. The bidding process began in December 2004 and is expected to be completed during the first half of 2005. 19. Under Part B, the target was to have at least five LGUs subprojects appraised for possible financing by LBP, and recommendations for terms and conditions for a possible ADB credit line to LBP to finance implementation of such subprojects. The key objectives of the credit line were to (i) pioneer project financing approaches for LGU infrastructure, (ii) provide private sector developers and project proponents with long-term peso-denominated debt, (iii) serve as a catalyst for mobilizing commercial debt and equity, (iv) help develop more mature capital markets through several successful project financing operations, and (v) create a credible bridge to future use of municipal bonds and similar instruments for LGU infrastructure development. 20. Compared with the targeted five subprojects for possible ADB credit lines to LBP for financing, no subprojects were actually financed by LBP to a private developer under this program. The reasons behind it can be attributed to the following two main constraints:

7 1. Organizational constraints. These were: a. Actual implementation was constrained by the fact that some LGUs lacked the capacity to identify and submit subprojects. Such LGUs require effort and time to develop subproject proposals. b. The TA component was a misnomer. Some LGUs initially expressed interest in Private Infrastructure Project Development Facility, thinking that it was a direct financial grant rather than a loan. c. The onlending interest rate to LGUs on the PDF was higher than the internal LBP interest rate to LGUs to finance their projects. d. The LGUs perceived that official development assistance (ODA) loans entail long and tedious processing procedures and requirements. Some LGUs stated that the targeted completion time of a project would never be accomplished if financing were from ODA loans. e. Project implementation normally goes beyond the 3-year term of the local executives. Thus, previous marketing efforts were useless if newly elected executives did not support the Project. Re-marketing to create awareness of the PDF was necessary. f. LGUs were not keen on accepting international consultants imposed on them. LGUs wanted a free hand in choosing consultants because they bear the burden of paying the loans. g. Prudent private investors would not just bid on an LGU project, putting full trust on a feasibility study done by a third party unknown to them. h. The consultant for the capacity building component recommended adoption of a revised computerized credit rating system (CRS) for LGUs. But CRS was found limiting because the proposed system classifies LGUs in only two categories: good and bad. In the present LBP system, LGUs are classified as prime, high-grade, medium-grade, and poor. Furthermore, the LBPs raw data on LGUs were not in a form that can be readily used by the system. Hence, there was a need for conversion. The data needed relies heavily on a number of updated inputs to be provided by the LBP field units, the LGUs, Department of Finance (DOF), Commission on Audit, Department of National Defense, and the National Economic and Development Authority. Without updated data from those agencies, the system will be ineffective. With consistency of the present CRS to existing LBP credit policies, LBP found no urgency to adopt the recommended revised CRS. However, with limitations, the present LBP CRSs for LGUs have been sufficient to address ADB s current requirements. i. The credit line proposal was considered innovative but LBP could not immediately implement it because: (i) there was no champion in DOF to implement it, due to changes in the Government; (ii) it was too early to implement the proposal because no project had yet been prepared under the PDF; (iii) economic conditions were not conducive to its implementation; (iv) the proposal was, in some ways, too innovative; and (v) LGUs had a negative perception of BOT projects. 2. Implementation constraints. These were: a. The onlending interest rate to LGUs on the PDF was higher than the internal LBP interest rate to LGUs to finance their projects. b. Most LGUs sought only infrastructure financing. Local executives sometimes had difficulty justifying million-peso loans to their constituents

8 just to finance the feasibility studies, especially with no assurance that private investors would participate in the BOT. c. Project implementation normally goes beyond the 3-year terms of local executives. Thus, previous marketing efforts were useless if newly elected executives did not support the Project. Re-marketing to create awareness of the PDF was necessary. d. LGUs were not keen on accepting international consultants selected by LBP and imposed on them. LGUs wanted a free hand in choosing consultants because they bear the burden of paying the loans. e. Prudent private investors would not just bid on an LGU project, putting full trust on a feasibility study done by a third party unknown to them. f. LBP considered the enhanced CRS an excellent tool, but did not adopt it, mainly because it was inconsistent with ADB s new priorities, caused by reorganization and corresponding changes in management. LBP found it unnecessary to follow the consultant s recommendation, considering that its portfolio with LGUs had done well and its lending centers personnel were immersed with the LGUs. LBP felt that no enhanced CRS could perform better than the frequent and physical interactions of ADB and the LGU executives and staff. g. The credit line proposal was considered innovative but LBP could not immediately implement it because: (i) there was no champion in DOF to implement it, due to changes in the Government; (ii) it was too early to implement the proposal because no project had yet been prepared under the PDF; (iii) economic conditions were not conducive to its implementation; (iv) the proposal was, in some ways, too innovative; and (v) LGUs had a negative perception of BOT projects. F. Implementation Arrangements 21. The project implementation arrangements remained essentially as envisaged during appraisal. For Part A, LBP, under its Local Government Financial Services Department (LGFSD), established a PDF desk to be responsible for PDF relending operations, including coordination with LGUs through LBPs regional centers and close coordination with the BOT Center. But LBP reorganization, which resulted in transfer of original project officers and personnel, greatly hampered PDF implementation. LGFSD was dissolved and its personnel handling the PDF were transferred to other LBP branches or units. The LGUs loan-related files were transferred to the area lending centers. The BOT Center, under its LGU and Project Preparation Division, provided technical support for LBPs PDF operations. LGUs established a project unit and assigned counterpart staff and facilities for project implementation. Appendix 6 gives the organization chart for project implementation. 22. The consulting firm engaged under Part B, provided 28.6 person-months of consultancy assistance, comprising 15.6 person-months for foreign and 13.0 person-months for domestic consultants. The contract period was appropriate for the consultants to carry out their terms of reference, which were designed to provide support for the accompanying TA loan. G. Conditions and Covenants 23. The Executing Agency s (EA) compliance with the loan covenants was partly satisfactory. LBP could not effectively market the PDF because (i) LBP officers originally involved in the Project were transferred to other branches or units; and (ii) concerned officers in

9 some LBP branches were not aware of the PDF to be offered to LGUs. LBP also failed to submit the quarterly progress report within the time specified in the Loan Agreement. Appendix 7 gives detailed compliance of the EAs with the loan covenants. H. Consultant Recruitment and Procurement 24. Under Part A, an estimated 55 person-months of international and 220 person-months of domestic consulting services would be required over the 3-year implementation period. An international consulting firm would undertake the first year s PDF activities, and consultants might be engaged for the duration of project implementation. 25. In February 2001, LBP engaged an international consulting firm to help the LGU undertake the feasibility study of the identified subproject and all phases of tendering, negotiation, and awarding of contracts. The consultancy agreement covers about 18 personmonths of international and 70 person-months of domestic consulting services. The consultants were recruited in accordance with ADB s Guidelines on the Use of Consultants. 26. The total contract period for the consultants for the Davao del Norte project was 7 months. But the contract period was reduced to about 3 months because the stakeholders terminated the consultants services because they could not agree with the consultants recommendation to close their respective water districts and create a new provincial water district. For the Olongapo project, the consultants utilized a total of 3 calendar months for Phase 1, as envisaged in the contract agreement between LBP and the LGUs. 27. Under Part B, an international consulting firm was engaged to provide 15 person-months of services to LBP, to be supported by 15 person-months of domestic consulting services in the areas of LGU finance, banking, law, and information technology. The total actual inputs of the consultants were consistent with the appraisal estimate except for the domestic consultants, where the actual inputs were short by 2 person-months. The consultants procured computers and accessories with ADB s approval. The consultants turned over the equipment to LBP on completion of project implementation. I. Performance of Consultants, Contractors, and Suppliers 28. The services provided by the consulting firm engaged under Part A of the project cannot easily be measured because of the event that took place during implementation of the two subprojects. In Davao del Norte, the consultants could complete only the feasibility study, but not the second phase of the project, which involved bidding and contract award. Nonimplementation of the second phase is attributed to the refusal of two of the six LGUs to accept the consultants recommendation to consolidate the six municipal water districts into one provincial district. Because of this, the consultancy contract for Phase 2 was terminated prematurely. 29. For the second subproject, in Olongapo, the city accepted the consultants feasibility report, including its recommendations. But because implementation of Phase 2 of the project has slipped to 2005, subproject financing was limited only to Phase 1. 30. The contract for Part B LBP Capacity Building in LGU Financing was not well negotiated. The negotiations took more than a week because local representatives had no real authority to negotiate and the team leader was not involved. Thus at inception, many problems affected project implementation. The consultant team leadership and performance were not well

10 managed. There was no obvious support from a head office for review of work or support of general implementation. The consultants performance is rated as satisfactory, overall, but there was a problem. The affiliated consultant of the lead firm was rated marginal due to lapses in coordinating with the BOT Center and late submission of revisions for the final report, which significantly delayed submission of the final report. Overall, the consultant s inputs were appropriate in terms of design, quality, and quantity. J. Performance of the Borrower and Executing Agency 31. LBP s performance was considered partly satisfactory. In line with the Loan Agreement, LBP was responsible for marketing the facility, with BOT assistance. But LBP s marketing effort was insufficient, particularly at the regional level. In fact, LBP had little incentive to market the facility independently of other products that it offers. LBP mainly relied on the list of LGUs and possible projects that the BOT Center provided. 32. Both the LBP LGFSD and the BOT Center should have been provided sufficient and qualified staff and adequate resources to support the LBP PDF credit facility during TA implementation. But frequent staffing changes during implementation negated the knowledge and experience gained by those earlier assigned to the Project. 33. Before loan approval, the BOT Center assured LBP and ADB that a number of worthy projects were in the pipeline. But most projects initially identified were canceled because the sponsoring LGUs had either lost interest or could secure grant assistance from other funding agencies. The 2001 election further hampered project marketing and implementation. Thus, only two subprojects were approved before the TA loan was closed. K. Performance of the Asian Development Bank 34. ADB s overall performance is rated as partly satisfactory. ADB should have addressed deficiencies in project design and formulation immediately when they became apparent, but did not. ADB should have changed the project scope when none of the initial and subsequent subprojects materialized in 2001, and no disbursements from the loan accounts were made. 35. During early project implementation, ADB met with representatives of LBP and the consultants to discuss issues and report requirements. Five review missions were subsequently conducted. In 2001 02, ADB called tripartite monthly meetings of ADB, LBP, and the BOT Center to share information, monitor progress, and deal with current issues. The possibility of loan cancelation was discussed in country portfolio review meetings in November 2002 and April 2003. Both LBP and the BOT Center reiterated the Project s importance, and requested more time to improve project performance, which ADB approved. ADB also approved LBP's request to extend the consultants services but only until May 2004, rather than August 2004, as originally planned. Approval for contract extension was based on ADB's decision to close the loan account on or before 6 June 2004, after completing payment for consultants services for phase 1 of the Olongapo City subproject. Constant reminders to LBP were made relative to submission of quarterly progress reports.

11 III. EVALUATION OF PERFORMANCE A. Relevance 36. The overall Project is rated partly relevant. The Project s objectives and scope, as formulated at appraisal, were consistent with the Government s framework for LGU financing and ADB s sector strategy for public governance and urban development. But the Project suffered from a lack of EA ownership, and a lack of LGU interest. Deficiencies in project design and formulation contributed to the limited achievement of project targets. Thus, Part A is rated as partly relevant. As to the relevance of Part B, its design assumed successful implementation of Part A. As the implementation of Part A was limited to the financing of only two subprojects, in retrospect, Part B could not be most relevant. B. Efficacy in Achievement of Purpose 37. The Project aimed to support regional development and decentralization by facilitating private sector financing of infrastructure projects at the LGU level. Specific objectives were to promote good governance and enhance LGU capacity to prepare and bid infrastructure projects for private sector participation. To achieve the objectives, the Project was to (i) establish a project preparatory financing mechanism for LGU-level infrastructure projects, (ii) enhance GFI s LGU financing capacity, and (iii) build capacity in LGU credit/governance rating. 38. The first target was achieved to a limited extent. Although a project development facility was established and consultants were engaged, LBP approved only two LGU infrastructure subprojects. 39. Most of the Part B objectives, for capacity building, were achieved. But the Project failed to productively apply what had been learned to market the product because LBP had its own funds to offer to potential borrowers, in competition with those that the Facility offered. Thus, Part B, and the overall project is less efficacious. C. Efficiency in Achievement of Outputs and Purpose 40. The Project was inefficient in achieving its targeted outputs, which were to (i) complete feasibility studies and tender of at least 10 LGU-level infrastructure projects; (ii) train at least 10 LGUs and involve them in preparing and managing private sector projects; (iii) development of LBP s and other GFI capacity to appraise and finance projects, including expertise in credit ratings; (iv) computerize and enhance LBP s LGU financial information and credit rating systems; (v) incorporate governance rating criteria in LBP s credit rating system; and (vi) define the proposed credit line to finance implementation of the LGU private sector project, and appraise five projects. The target outputs for (i) and (ii) were marginally met, but LBP did not properly address or implement the others, as the TA consultant recommended. 41. Although LBP had undergone capacity building under Part B, that knowledge seemed to have been used to evaluate LGU projects for financing with its own funds not to market the Project. No LGUs visited at project closing were aware of the PDF. Interviews revealed that no one from LBP approached and promoted the Facility to them. Furthermore, LBPs believed that, even if they had been aware of PDF, they still would not have used it because grant funds were available to finance the feasibility study. Nor were the LGUs convinced of the privatization concept. Most still perceived that local government not the private sector should undertake public infrastructure projects.

12 D. Preliminary Assessment of Sustainability 42. Based on the small number of LGUs that used the loan facility, and the limited interest of other LGUs, the sustainability of the PDF, in its current form, seems unlikely. Furthermore, lending competition was not only from the other donor agencies but also from LBP, which was entrusted with project implementation. E. Environmental, Sociocultural, and Other Impacts 43. The Project, which only provides funding for the preliminary costs of conducting feasibility studies, has had no direct environmental, sociocultural, or other impacts. The two subprojects entailed no land acquisition or resettlement, or environmental issues, since ADB funded only Phase 1 of the feasibility study. 44. The two LGUs assured that the feasibility studies financed under the Project complied with ADB s environmental and social guidelines, including the policy on involuntary resettlement. IV. OVERALL ASSESSMENT AND RECOMMENDATIONS A. Overall Assessment 45. Neither Part A nor Part B of the Project was properly implemented. In Part A, the Project did not take off effectively because the LGUs were unwilling to borrow for feasibility studies. Competition arose from other donor agencies, and from LBP itself, in several ways. First, a number of donor agencies offered grants to finance feasibility studies. Second, LBP offered financing for feasibility studies as part of its loan processing activities. In contrast, the fund that the Project offered was a loan. Furthermore, the loan charged interest equivalent to prevailing commercial rates, which was higher than the interest that LBP charged to its customers for loans from its own funds. 46. Part B was not successful. Although the grant was fully utilized to provide LBP staff some degree of familiarity with the processing and evaluation of LGU projects with private sector participation, LBP s subsequent marketing of the Project was not effective. ADB s closing review of the prospective projects showed that few LGUs had been aware of the PDF. Furthermore, in lieu of promoting the use of ADB funds, LBP used its own funds to finance viable projects. Although it was implemented satisfactorily, output of Part B was not sustained and it was not relevant to the development outcomes at the LGU level. 47. Part A is rated unsuccessful, while Part B is partly successful. Overall, the Project is rated unsuccessful. B. Lessons Learned 48. The Project had valid objectives, but several essential factors were overlooked during its conceptualization stage. Project implementation yielded the following major lessons learned that should impact on design and implementation of similar loans in the future: (i) Demand analysis of local government units. A thorough demand analysis of LGUs should have been conducted to ascertain target LGUs willingness to participate in the Project. To strengthen commitment, participatory approach

13 during the design of such projects is absolutely necessary. The financial capacity of the identified LGUs to enter into loan agreements of several million pesos for preparation of feasibility studies and tender documents, which might or might not transform into actual LGU infrastructure, should have been examined first. (ii) (iii) (iv) (v) (vi) Simpler implementation arrangements. Coordination between the LBP and the BOT Center during project implementation left much to be desired. Although the BOT Center was quite proactive in producing marketing materials and conducting orientation seminars for local government officials, its activities had limited impact as its staff and offices are located only in Manila. In contrast, although LBP has a far broader reach through its regional lending centers, which had been provided training, the level of interest and understanding at the LBP regional level remained low. The LBP regional representatives could have enhanced their capacities to market the product to LGUs by attending the training conducted by the BOT Center. Loan coverage and terms. The facility had limited focus in terms of activity and project eligibility. First, the facility offered loans only to finance feasibility studies and tender documents; it gave no funding for the ensuing project. Second, financing was restricted only for private sector projects and LGUs were not fully keen nor familiar or comfortable with bidding projects out. The interest of LGUs would probably have been higher if the facility had allowed financing for LGUs to develop local government infrastructure. There were also problems with the terms of lending in terms of higher interest rate and the lack of understanding of the advantages of fixed-rate borrowing. Mitigating political influence. The project design should have reflected a basic understanding of the dynamics of political cycles. Local leadership changed every 3 years, and the project selection process lay in the hands of the incumbent or newly elected local executives. More often than not, newly elected officials shelved projects that the former local executives initiated, especially if the officials belonged to different parties. Mitigating measures to alleviate the effects of political changes could have been included in the project design. For example, the project design could have minimized the risk of political interference by following the established division of work among government agencies, which designates the Department of Interior and local governments to assist in LGU infrastructure development. Furthermore, measures to alleviate negative effects of political changes could have been built into the design by adjusting the project schedule to mayoral terms. Financial channels for LGUs. Local LBP branches were usually the first agencies that the LGUs approached when seeking funds for development projects. LBP loans include the cost of a feasibility study, so LGUs prefer to use GFIs. Thus, LBP s role as a financial conduit should be carefully reviewed to minimize conflicts of interest. Earlier project termination. ADB could have insisted that the Project close in late 2002, when implementation progress was low and few potential subprojects had materialized.