Document of The World Bank FOR OFFICIAL USE ONLY Report No: 64438-BR PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$100 MILLION TO THE STATE OF PERNAMBUCO WITH A GUARANTEE OF THE FEDERATIVE REPUBLIC OF BRAZIL FOR THE PERNAMBUCO RURAL ECONOMIC INCLUSION PROJECT February 6, 2012 Sustainable Development Department Brazil Country Management Unit Latin America and the Caribbean Region This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank’s policy on Access to Information. CURRENCY EQUIVALENTS (Exchange Rate Effective July 28, 2011) Currency Unit = Brazilian Real (R$) R$1.5563 = US$1 R$1.00 = US$0.6426 FISCAL YEAR January 1 – December 31 ABBREVIATIONS AND ACRONYMS AGEFEPE State Agency for Business Development Agência de Fomento do Estado de Pernambuco ASSECO Community Services Association Associação de Serviços Comunitários ASA The Semi-Arid Network Articulação do Semiárido CDD Community Driven Development CDS State Council for Sustainable Development Conselho Estadual de Desenvolvimento Sustentável CESCOM Consortium of Community Services Associations Consórcio de Associações de Serviços Comunitários CMDR Municipal Rural Development Council Conselho Municipal para Desenvolvimento Rural COMPESA State Water Supply and Sanitation Company Companhia Pernambucana de Saneamento CONTAG National Federation of Agricultural Workers Confederação Nacional de Trabalhadores Agrícolas CPS Country Partnership Strategy ESMF Environmental and Social Management Framework FIRR Financial Internal Rate of Return FUNASA National Health Foundation Fundação Nacional da Saúde HDI Human Development Index ICT Information and Communication Technology IPA-PE State Agronomy Institute Instituto Agronômico de Pernambuco IPM Integrated Pest Management IPPF Indigenous Peoples Planning Framework LPA Local Productive Alliance MDA Ministry of Agrarian Development Ministério de Desenvolvimento Agrário MDS Ministry of Social Development Ministério de Desenvolvimento Social NRM Natural Resource Management PDO Project Development Objective PMP Pest Management Plan PNAE National School Feeding Program Programa Nacional de Alimentação Escolar PPA Multi-year Development Plan ii Plano Plurianual de Desenvolvimento PPP Public-Private Partnerships PRONAF National Program to Strengthen Family Agriculture Programa Nacional de Fortalecimento da Agricultura Familiar ProRural State Program for Assistance to Small-Scale Producers Programa do Estado de Apoio ao Pequeno Produtor Rural PV Present Value RPF Resettlement Policy Framework RPO Rural Producer Organization RPRP Rural Poverty Reduction Project SARA State Secretary of Agriculture and Agrarian Reform Secretaria do Estado de Agricultura e Reforma Agrária SEBRAE Brazilian Agency for Micro- and Small Business Assistance Serviço Brasileiro de Apoio às Micro e Pequenas Empresas SECTMA State Secretariat of Science, Technology and Environment Secretaria do Estado de Ciência, Tecnologia e Meio Ambiente SECRE State Comptroller Secretaria da Controladoria Geral do Estado SEDAR State Secretary of Development and Regional Articulation Secretaria do Estado de Desenvolvimento e Articulação Regional SEPLAG State Secretariat of Planning and Management Secretaria do Estado de Planejamento e Gestão SIL Specific Investment Loan SOE Statement of Expenditure SRHE State Secretariat of Water Resources and Energy Secretaria do Estado de Recursos Hídricos e Energéticos TSP Technical Service Providers WHO World Health Organization Regional Vice President: Hasan Tuluy Country Director: Makhtar Diop Sector Director: Ede Jorge Ijjasz-Vasquez Sector Manager: Ethel Sennhauser Task Team Leader: Edward W. Bresnyan, Jr. iii BRAZIL Pernambuco Rural Economic Inclusion Project TABLE OF CONTENTS  1.  Strategic Context ................................................................................................................. 1  A.  Country Context ........................................................................................................ 1  B.  Sectoral and Institutional Context............................................................................. 4  C.  Higher Level Objectives to which the Project Contributes ...................................... 5  2.  Project Development Objective .......................................................................................... 6  A.  PDO........................................................................................................................... 6  3.  Project Description.............................................................................................................. 6  A.  Project components ................................................................................................... 6  B.  Project Financing ...................................................................................................... 7  C.  Lessons Learned and Reflected in the Project Design .............................................. 8  4.  Implementation ................................................................................................................... 9  A.  Institutional and Implementation Arrangements ...................................................... 9  B.  Results Monitoring and Evaluation ........................................................................ 10  C.  Sustainability........................................................................................................... 11  5.  Key Risks and Mitigation Measures ................................................................................. 12  6.  Appraisal Summary .......................................................................................................... 12  A.  Economic and Financial Analysis .............................................................................. 12  B.  Technical .................................................................................................................... 13  C.  Financial Management ............................................................................................... 13  D.  Procurement ................................................................................................................ 13  E.  Social (including safeguards) ..................................................................................... 14  F.  Environment (including safeguards) .......................................................................... 15  Annex 1: Results Framework and Monitoring.............................................................................. 16  Annex 2: Detailed Project Description ........................................................................................ 19  Annex 3: Implementation Arrangements ..................................................................................... 31  Annex 4 Operational Risk Assessment Framework (ORAF) ....................................................... 46  Annex 5: Implementation Support Plan ........................................................................................ 49  Annex 6: Team Composition ........................................................................................................ 51  Annex 7: Economic and Financial Analysis ................................................................................. 52  Annex 8: Maps .............................................................................................................................. 57  iv PAD DATA SHEET Brazil Pernambuco Rural Economic Inclusion Project PROJECT APPRAISAL DOCUMENT Latin America and the Caribbean Agriculture and Rural Development Date: February 6, 2012 Sector(s): General Agriculture (40%); Agro- industry (30%); Water Supply (20%); Information Country Director: Makhtar Diop Technology (10%). Sector Director: Ede Ijjasz-Vasquez Sector Manager: Ethel Sennhauser Theme(s): Rural Markets (40%); Technology Team Leader: Edward W. Bresnyan, Jr. Diffusion (30%); Trade Facilitation and Market Access (20%); Rural Policies and Institutions Project ID: P120139 (10%). Lending Instrument: SIL EA Category: B (Partial Assessment) Project Financing Data: Proposed terms: USD-denominated, commitment-linked IBRD Flexible Loan with a variable spread and level repayments on May 15 and November 15 of each year, beginning in 2018 through 2040, which corresponds to a 6-year Grace Period and 29-year Final Maturity, with all conversion options selected and the Premia for Caps and Collars Capitalized. [ X] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: Source Total Amount (US$M) Total Project Cost: 178.95 Local Productive Alliances: 43.70 Borrower: 35.25 Total IBRD Financing: 100.00 Borrower: State of Pernambuco Responsible Agency: State Secretariat of Agriculture and Agrarian Reform (SARA) Contact Person: José Coimbra Patriota Filho Telephone No.: 55-61-3181-3156 Fax No.: 55-61-3181-3159 Email: patriota@prorural.pe.gov.br Estimated Disbursements (Bank FY/US$ m) FY 2013 2014 2015 2016 2017 2018 2019 Annual 24.3 26.3 22.2 15.5 6.2 4.3 1.2 Cumulative 24.3 50.6 72.8 88.3 94.5 98.8 100.0 v Project Implementation Period: Six years Expected effectiveness date: July 31, 2012 Expected closing date: July 31, 2018 Does the project depart from the CAS in content or other significant ○ Yes X No respects? If yes, please explain: Does the project require any exceptions from Bank policies? ○ Yes X No Have these been approved/endorsed (as appropriate) by Bank management? ○ Yes ○ No Is approval for any policy exception sought from the Board? ○ Yes X No If yes, please explain: Does the project meet the Regional criteria for readiness for X Yes ○ No implementation? If no, please explain: Project Development Objective: The objective of the Project is to promote rural business initiatives and expansion of rural access to water and other complementary infrastructure by supporting the Borrower’s Results Management Framework. Project description: Component 1: Investments in Rural Economic Inclusion (US$109.7 million) would promote investments in rural economic inclusion in the Borrower’s territory, through the provision of support to: (a) ProRural for Business Plan preparation activities to inter alia, (i) elaborate and implement a communication strategy to strengthen Local Productive Alliances; (ii) identify and develop viable Business Plans with defined territorial strategies; (iii) train and certify local service providers on how to prepare business profiles and Business Plans, as well as on how to improve management and develop innovative financing mechanisms for the rural economy; and (iv) carry out technical studies in the areas of competitiveness, including market studies and analysis of new potential value chains; and (b) Rural Producer-based Organizations for the carrying out of productive investments, through Matching Grants, for the implementation of Productive Subprojects. Component 2: Complementary Rural Infrastructure (US$51.5 million) would promote investments in complementary rural infrastructure in the Borrower’s territory, through the provision of inter alia: (a) support to Rural Producer-based Organizations for the carrying out of complementary rural investments, through Matching Grants, for the implementation of Infrastructure Subprojects; and (b) training and the development of capacity-building initiatives to strengthen the day-to-day management of Infrastructure Subprojects, including small-scale rural water supply and sanitation systems. vi Component 3: Project Management, Supervision, Monitoring and Evaluation (US$13.2 million) would finance the provision of support for, inter alia: (i) the technical and administrative management of the Project; (ii) the development, implementation and supervision of the Environmental and Social Management Framework, the Indigenous Peoples Planning Framework, the Resettlement Policy Framework and the communication strategy; (iii) the necessary updates to ProRural’s management information system; and (iv) the design, development and implementation of an impact evaluation module to track progress on results indicators. Safeguard policies triggered? Environmental Assessment (OP/BP 4.01) X Yes ○ No Natural Habitats (OP/BP 4.04) X Yes ○ No Forests (OP/BP 4.36) X Yes ○ No Pest Management (OP 4.09) X Yes ○ No Physical Cultural Resources (OP/BP 4.11) X Yes ○ No Indigenous Peoples (OP/BP 4.10) X Yes ○ No Involuntary Resettlement (OP/BP 4.12) X Yes ○ No Safety of Dams (OP/BP 4.37) ○ Yes X No Projects on International Waterways (OP/BP 7.50) ○ Yes X No Projects in Disputed Areas (OP/BP 7.60) ○ Yes X No Conditions and Legal Covenants: Loan Agreement Reference Description of Condition/Covenant Date Due 4.01 The Operational Manual has been Effectiveness adopted through a regulation (Portaria) to be issued by the Borrower in form and substance satisfactory to the Bank. Schedule 2, Section I.A.1 The Borrower shall establish, and 45 days after thereafter maintain during the Effectiveness implementation of the Project, a Steering Committee chaired by SARA, and composed by representatives from key secretaries and organizations, as defined in the Operational Manual, responsible for providing general oversight and guidance on the strategic and multisectoral aspects of the Project. vii Schedule 2, Section I.A.2 The Borrower shall maintain within Ongoing SARA during the implementation of the Project a unit (ProRural), consisting of staff having experience and qualifications satisfactory at all times to the Bank, and responsible for overall coordination and implementation of the Project, including fiduciary responsibilities. Schedule 2, Section I.A.3 The Borrower shall: (a) prepare and Ongoing furnish to the Bank annual operating plans, satisfactory to the Bank, detailing the Project activities to be carried out during the next succeeding year, together with the respective sources of funding, by October 30 of each year during Project implementation; (b) furnish to the Bank the approved annual operating plans (including the respective sources of funding) referred to in paragraph (a) of this Section for each year in question, not later than 30 days after the approval of the Borrower's annual budget by its Legislative Assembly (Assembleia Legislativa); and (c) thereafter, implement each of said plans in a manner acceptable to the Bank. viii 1. Strategic Context A. Country Context 1. In the State of Pernambuco, rural poverty accounts for over one-third of the total state poverty, despite the rural population share of about 20%. The rural poverty headcount of roughly 45% is slightly below that of the Northeast as a whole (50%) but substantially above the Pernambuco urban headcount of 25%. Most recent measures of the Human Development Index (HDI) show Pernambuco ranked 23rd among the 27 Brazilian states, with an HDI of 0.718 (2005). Examination of the data would indicate a median rural HDI of roughly 0.600. 2. One of the reasons behind this elevated level of rural poverty is low agricultural productivity. Pernambuco is home to 5% of the country’s population and 6% of the agricultural labor force, yet generates only 2% of the Agricultural Gross Domestic Product (Ag GDP). For the staple crops of beans and rice, family farm yields are about one-half of those for non-family farms and, overall, their average yields are only one-half of those for the nation as a whole. Family farms, some 90% of total farm establishments statewide, capture only 52% of value- added agricultural production. Average annual family farm income (US$5,100) is about one- tenth of that for commercial farms, a contributing factor to a rural Gini coefficient which exceeds 0.8 (IBGE 2006). Moving forward, the challenge for Pernambuco – and for Brazil more widely – will be to increase rural productivity with “climate-smart� and inclusive growth strategies. 3. Another factor influencing rural poverty in Pernambuco is the general scarcity of water. Pernambuco is one of Brazil’s driest states, with average annual per capita water availability of 1,320 m3, equivalent to only 4% of the national average. The combined semi-arid Sertão and transitional Agreste sub-regions represent 89% of the State’s territory yet have only about 20% of its available water, with per capita annual water availability ranging from 400 m3 to 800 m3, respectively. The impact of this extremely low level of water availability is a relatively stunted irrigated area (only 3% of the state’s total agricultural area) and periodic lack of water supply to rural enterprises and households, significantly limiting the growth of commercial food processing and domestic preliminary processing. The lack of adequate rural sanitation systems is also a constraint to commercial processing, even at the level of the smaller cooperative associations. Recent data (2008) indicate that less than 10% of rural households in Pernambuco have adequate sanitation services (e.g., sewerage systems, septic tanks). 4. A third factor which exacerbates rural poverty is the lack of structural investments in transport and logistics, which reduces access to local and regional markets and thwarts market opportunities due to: (i) high transport costs; (ii) increased transport times; (iii) reduced access to fresh markets; and (iv) increased costs of off-farm inputs. Reducing these coordination costs, while achieving needed productivity gains, will be key to raising rural competitiveness. 5. From the point of view of agricultural production, there is much ground to be gained by small-scale producers in Pernambuco. Over the past decade, Brazil has become a globally competitive powerhouse in agriculture, with a nearly 70% increase in the value-added of crop production and a ten-fold increase in beef exports. Brazil is now the world leader in exports of poultry, sugar and ethanol and second worldwide in soybean exports. These impressive results attest to a strong history of capital investment and technological innovation in the sector, 1 particularly in agricultural research, focusing on commercial agriculture, which comprises 16% of total farms nationwide. However, aside from strong performance in the horticultural sector around Petrolina (primarily on irrigated parcels), agriculture in Pernambuco, particularly family agriculture, has not participated significantly in this production and export boom. 6. For these reasons, at a September 2009 meeting with Northeast Governors (and reinforced in a similar meeting in June 2011), the Bank articulated a strategic vision for continued engagement with Pernambuco and other Northeast states, emphasizing: (i) economic growth with inclusion and innovation; (ii) improved water productivity and management; and (iii) structural investments to enhance logistics and coordination. The State of Pernambuco’s 2008-2011 multi- year investment plan (PPA) and its updated PPA (2012-2015) both independently converge with this three-pronged approach by focusing on:  strengthening value chains and forging Local Productive Alliances (LPAs); 1  prioritizing expanded access to safe and reliable water for both human consumption and productive use through improved water resources development and constructing stronger water management policies and practices; and  financing structural investments to improve the enabling environment and encourage greater private investment. 7. Regarding structural investments, recent examples include the Suape Port Complex and the industrial pole of Vitoria de Santo Antão (agroprocessing); several big-ticket infrastructure projects are also planned, particularly the expansion of the BR-101 and BR-104 highways, water pipelines (Pajeu and Agreste) and irrigation canals, and the Suape-Recife-Salgueiro corridor of the Trans-Northeast railway. The State has also worked to stimulate integration across several value chains, most notably fresh fruits and vegetables, dairy, small ruminants (e.g., lamb, goat), beekeeping and aquaculture. Efforts in the small-scale dairy sector show the benefits of building LPAs: under the program Milk for All (Leite para Todos), 4,400 enterprises produced 33 million liters (2008), benefiting some 90,000 families across 154 municipalities. 8. Main Challenges Facing Local Productive Alliances: Low rural productivity in Pernambuco is tied to several constraints, among the most important of which are:  low technological innovation, in terms of product, process and organization, as well as downside risks of production losses and threats to household food security, which could be exacerbated by increasing climate variability and subsequent water scarcity;  weak market intelligence that hinders a coordinated and targeted supply response;  poor access to capital, needed to boost smallholder asset accumulation on several fronts: physical, financial, human, managerial, and social; and  disconnect between supply-driven technical assistance and the expressed demands of the family farm, both for meeting market requirements (e.g., sanitary restrictions and certification) and reducing vulnerability through climate change adaptation. 1 Local Productive Alliances are clusters consisting of: (i) Rural Producer-based Organizations; (ii) small and medium enterprises; (iii) public and private technical service providers; (iv) financial and academic institutions; and (v) NGOs, all located in the Borrower’s territory in mutually beneficial arrangements within a value chain. 2 9. The public sector must also invest in structural investments that create the foundation for improved rural services provision and rural competitiveness, particularly in infrastructure (e.g., rural roads and water resources to improve logistics coordination), phyto-sanitary regulation and certification, information and communication technologies (ICT), and technical knowledge generation and diffusion. Meanwhile, responses from commercial actors in the rural sector are needed so that the market constraints limiting the competitiveness of family farms can be relaxed. Adoption of adequate technology, market know-how, and market linkages – all in a market-driven and timely manner - are major areas where private investment and private sector leadership are required. 10. As given in the PPA (2012-15), Pernambuco’s approach to increased rural productivity builds on the following tenets:  Regional/territorial approach: Pernambuco’s twelve administrative regions and its six Territórios da Cidadania will aid in concentrating and coordinating various Federal- and State-level programs to boost economic and social inclusion.  Climate-smart responses: The Project would stimulate innovations that jointly raise agricultural productivity, increase the efficient use of scarce water, and promote climate change resilience while reducing carbon emissions.  Innovation: Rural producers must adopt new technologies and access greater commercial intelligence in order to thrive in dynamic markets. This will require fresh learning approaches to stimulate a “rural innovation culture� conducive to competitiveness and capable of connecting education to jobs.  Collective Action: Small-scale producers, working together under a shared objective, can reduce asymmetric bargaining power in markets traditionally dominated by intermediaries. Previous Bank-financed operations in Pernambuco have fostered more than 5,000 such common interest groups, primarily composed of households engaged in small-scale production, which would be targeted under the Project.  Value chains: Rural producer-based organizations that participate in value chains can: (i) improve uptake of technological innovation through a scaled approach to technical assistance; (ii) expand access to timely commercial intelligence through interaction with downstream actors (e.g., processors, institutional buyers, freight-forwarders); and (iii) reduce individual risks through risk spreading across value chain actors.  Equity: Equity among value chain partners would be promoted through alliances (i.e. LPAs) that promote “win-win� market solutions. 11. Recent initiatives in irrigated agriculture hold promise for expanding smallholder participation in this sector. For example, the Public-Private Partnership (PPP) being forged in the Pontal irrigation perimeter mandates that at least 25% of these irrigated lands be offered to small-scale producers, preferably in a commercial alliance with larger-scale value chain participants (empresas âncoras) that occupy the remaining 75%. Additionally, existing perimeters with sizeable family farm participation (e.g., Brígida, with 1,000 family farms cultivating 3,000 irrigated hectares) can serve as test cases for constructing greater access to private and institutional markets. In sum, PPPs contribute to the overall objective of the Project by: (i) improving the efficiency of existing productive infrastructure; and (ii) increasing the economic inclusion of smallholders in verified market opportunities. 3 12. Responding to water scarcity and its persistent unreliable supply, which constrains rural economic performance and social development, the State has prioritized the water sector in its development strategy, aiming to expand access to safe and reliable water for both human consumption and productive use through: (i) improved water resources development; and (ii) stronger management policies and practices for water infrastructure and sanitation services. As climate change will further intensify moisture deficits in Pernambuco, significant adjustments in water use for food production will be required, especially in dry land areas where rain-fed agriculture dominates. Water productivity in semi-arid rain fed cropping systems is quite low, with only 10 to 30% of total rainfall actually absorbed in production. Without improvements in “crop per drop�, future shortages of water could render agriculture non-viable or propel a shift toward less reliance on annual crops and more on perennial and livestock-based production systems. Adaptation measures to moderate this scenario include:  Rainwater harvesting, to capture and conserve rainfall and improve its productivity;  ICT solutions, leveraging soils mapping, precision agriculture, climate modeling and historical rainfall time-series to inform planting and input decisions;  Crop diversification and crop biotechnology solutions, incorporating drought-tolerant crops, and, where feasible, nanotechnologies; and  Supplementary irrigation, such as next-generation drip and aspiration technologies and the reuse of treated wastewater; and  Optimization of available water for production, as in the areas that will benefit from water transfers from the Sao Francisco River. B. Sectoral and Institutional Context 13. The State of Pernambuco is implementing a Results Management Framework, known as Todos por Pernambuco (Everyone for Pernambuco), which seeks to promote and extend sustainable development geographically (toward the interior Agreste and Sertão regions) and socio-economically (targeting historically excluded groups e.g., rural poor, including indigenous peoples and Quilombolas). Over a fifteen-year planning horizon, Todos por Pernambuco proposes the following selected results:  Implementation of a territorial, integrated and participatory development approach in the State’s interior regions to augment socio-economic equity with environmental sustainability.  Promotion of greater productivity, value-added processing and fair marketing for family agriculture, including micro-enterprises, producer associations and cooperatives, by supporting marketing centers, special lines of credit, technical assistance and facilitated access to institutional markets.  Improvements in logistics infrastructure, e.g., the Port of Suape (modernization and consolidation of its physical facilities), the Port of Recife (passenger terminal and platform for cruise tourism) and the Suape-Recife-Salgueiro corridor of the Trans-Northeast railway.  Expanded investment to extend water supply and sanitation coverage throughout Pernambuco, particularly in the interior of the State, adopting new technologies for cisterns, underground dams, reservoirs and septic systems. 14. In line with this Results Management Framework, the Project would integrate actions across three dimensions: 4  at the State level, between the State Secretary of Agriculture and Agrarian Reform (SARA), and the State Secretaries of Planning (SEPLAG), Development and Regional Articulation (SEDAR); Water Resources and Energy (SRHE); Science, Technology and Environment (SECTMA); Health; Education; and the State Council for Sustainable Development (CDS);  within SARA, between its Secretariat for Family Agriculture and the Secretariat for Rural Technology and Special Programs; and  within the Project, with the convergence of various state and federal public policies and respective agencies e.g., Ministry of Agrarian Development (MDA), Ministry of Social Development (MDS), National Foundation for Health (FUNASA), the Brazilian Agricultural Research Corporation (EMBRAPA) and State Agricultural Research Institute (IPA-PE). Additionally, the Project would leverage the public sector participation in territorial planning to promote rural economic inclusion and expanded access to basic services, particularly water and sanitation. 15. The Project will also benefit from: (i) the ongoing activities of the Government Partnership Facility Grant, “Brazil - Strengthening Governance for Economic Development of Pernambuco State�, which will develop a socioeconomic strategy based on a participatory process and on a mapping of rural clusters; and (ii) the Water Partnership Program Grant, “Documentation and Dissemination of Proven Water and Sanitation Management Models for Multi Village/Small Town Schemes in Brazil� (see Annex 2). C. Higher Level Objectives to which the Project Contributes 16. The Project is an important part of both the Bank’s Brazil portfolio and its Agriculture Action Plan, Implementing Agriculture for Development (FY10-12), which outlines the scaled- up Bank commitment to raise agricultural productivity, reduce risk and vulnerability, link farmers to markets, strengthen value chains, promote vital environmental services and facilitate rural non-farm income and diversification. 17. The Bank has built a long-standing partnership with the State of Pernambuco in the rural sector through a series of loans under the Northeast Rural Poverty Reduction Program (1993- 2010). This partnership also includes: (i) the ongoing Pernambuco Sector Wide Approach (SWAp) in public sector management and education; (ii) the Recife Urban Upgrading (Prometropole) Project, supporting urban infrastructure and slum upgrading in the metropolitan area; (iii) the Pernambuco Sustainable Water Project, supporting water resource management, infrastructure and services expansion and efficiency; and (iv) a proposed Pernambuco Development Policy Loan under preparation. The Project's objective and strategy are fully in line with the World Bank Group's Country Partnership Strategy 2012-2015 (Report # 63731), discussed by the Board of Executive Directors on November 1, 2011. While the Project would contribute to the strategic objectives of the CPS, it would focus on promoting the third objective, namely promoting regional economic development through improved policies, strategic infrastructure investments, and support for the private sector in frontier, mainly rural, areas. 18. In the agriculture and natural resource management (NRM) sectors, the Project would support two key challenges outlined in the CPS, namely: (i) seizing opportunities for innovative and integrated approaches to climate-smart, inclusive economic growth, focusing on rural productivity; and (ii) addressing paradigmatic issues facing Brazil in agriculture and NRM. The 5 Project would also support the second CPS strategic objective by improving quality and expanding provision of public services, particularly water and sanitation, for low income rural households. 2. Project Development Objective A. PDO 19. The objective of the Project is to promote rural business initiatives and expansion of rural access to water and other complementary infrastructure by supporting the Borrower’s Results Management Framework. 20. PDO Level Results Indicators: (i) Participating Rural Producer-based Organizations (RPOs) successfully inserted into LPAs; (ii) Increased net revenue for participating RPOs; (iii) Rural households with access to improved water sources; and (iv) Rural households with access to improved sanitation services. Project Beneficiaries 21. Project beneficiaries would include RPOs, composed primarily of small-scale family farmers (as defined under Brazilian Law 11.326, see Annex 2) and non-agricultural producers. 3. Project Description A. Project components 22. Component 1: Investments in Rural Economic Inclusion (US$109.7 million) would promote investments in rural economic inclusion in the Borrower’s territory, through the provision of support to: (i) ProRural for Business Plan preparation activities to inter alia, (a) elaborate and implement a communication strategy to facilitate the development of LPAs; (b) identify and develop viable Business Plans with defined territorial strategies; (c) train and certify local service providers on how to prepare business profiles and Business Plans, as well as on how to improve management and develop innovative financing mechanisms for the rural economy; and (d) carry out technical studies in the areas of competitiveness, including market studies and analysis of new potential value chains; and (ii) RPOs for the carrying out of productive investments, through Matching Grants, for the implementation of Productive Subprojects. 23. Productive Subprojects, as part of eligible Business Plans, would consist of inter alia: (i) fixed capital (e.g. plant and equipment, minor small-scale infrastructure on water supply, sanitation, and electricity); (ii) working capital and (iii) technical assistance expenditure. RPOs would be responsible for a minimum of 25% of subproject financing, resourced through financial institutions (e.g., loans), own-equity capital and in-kind contributions. Productive subprojects would be further governed by procedures in the Project Operational Manual. 6 24. Component 2: Complementary Rural Infrastructure (US$51.5 million) would promote investments in complementary rural infrastructure in the Borrower’s territory, through the provision of: (i) support to RPOs for the carrying out of complementary rural investments, through Matching Grants, for the implementation of Infrastructure Subprojects; and (ii) training and the development of capacity-building initiatives to strengthen the day-to-day management of Infrastructure Subprojects, including small-scale rural water supply and sanitation systems. 25. The component would leverage the territorial strategies developed under Component 1 to support actions that span the following dimensions:  Rural Water and Sanitation: would finance small-scale rural water supply systems (including, in some cases, cisterns) and rural sanitation (including septic systems), in support of the Borrower’s goal of universalizing access to these services, particularly in the interior of Pernambuco.  Water for Productive Uses: would: (i) extend and improve the use of water for productive activities, e.g., irrigation, aquaculture and agro-industry; (ii) support activities that optimize the use of water transfers from the São Francisco River; and (iii) promote adoption of new technologies and techniques, including water re-use.  Logistics: LPAs and RPOs, in preparing territorial strategies for value chains and associated Business Plans under Component 1, would identify investments to reduce and/or eliminate bottlenecks in the flow of value-added production along the producer chain (e.g., small bridges, all-weather crossings, minor road reforms).  Investment Management: To strengthen the day-to-day management of small-scale rural water supply and sanitation systems -- both those financed under Component 2 and existing systems in rural Pernambuco – Component 2 would support training and capacity-building designed to extend recent successful management pilots (see Annex 2). 26. Component 3: Project Management, Supervision, Monitoring and Evaluation (US$13.2 million) would finance the provision of support for, inter alia: (i) the technical and administrative management of the Project; (ii) the development, implementation and supervision of the ESMF, the IPPF, the RPF and the Communication Strategy; (iii) the necessary updates to ProRural’s management information system; and (iv) the design, development and implementation of an impact evaluation module to track progress on results indicators. B. Project Financing 27. Lending Instrument: A Specific Investment Loan (SIL) of US$100.0 million is proposed. Retroactive financing of US$10.0 million would be available for eligible expenditures incurred after August 1, 2011 and, in all cases, no more than twelve months prior to the expected date of the Loan Signing. The Government of Pernambuco would provide counterpart financing in the amount of US$35.25 million. The Project would leverage additional resources from participants in Local Productive Alliances in amount estimated at US$43.7 million. 7 Project Cost and Financing Project Components IBRD GOP Sub LPA Total % Total Partners Project IBRD Cost 1. Investments in Rural Economic Inclusion 51.00 15.00 66.00 43.70 109.70 47% 2. Complementary Rural Infrastructure 39.50 12.00 51.50 - 51.50 77% 3. Project Management, Supervision, Monitoring and Evaluation 6.10 7.10 13.20 - 13.20 46% Total Baseline Costs 96.60 34.10 130.70 43.70 174.40 55% Physical contingencies 1.58 0.57 2.15 - 2.15 73% Price contingencies 1.57 0.58 2.15 - 2.15 73% Total Project Costs 99.75 35.25 135.00 43.70 178.70 56% Front-End Fee 0.25 - 0.25 - 0.25 100% Total Financing Required 100.00 35.25 135.25 43.70 178.95 56% C. Lessons Learned and Reflected in the Project Design 28. The Bank’s collective experience with operations in support of rural competitiveness in Latin America and other regions, and for natural resources management and rural poverty reduction projects in Southern and Northeastern Brazil, provides insights that have been incorporated into the project design. The Project will also build on the global lessons learned and compiled in: (i) the Bank's 2008 World Development Report on "Agriculture for Development"; and (ii) the Cusco +10 seminar (2010) regarding rural water and sanitation services in Latin America. Some of these lessons learned are described in the following: 29. Market Orientation: Verifiable market opportunities must underpin support for poor rural producers. Effective mechanisms to achieve this include: (i) focusing on existing and new markets and value chains as part of the eligibility criteria for productive investment subprojects; (ii) conducting private sector consultations during project design; and (iii) analyzing areas where the public sector can play a catalytic role, based on current and future market conditions. 30. Participation by RPOs in the selection, financing, execution, operation and maintenance of investments, in the context of LPAs (Component 1) and water and sanitation (Component 2), can generate cost savings and increase ownership, thereby improving the sustainability of these investments. Tangible RPO contributions (in cash and in-kind) are consistent with the principle of subsidiarity, thus avoiding or mitigating possible distortions induced by subproject grants. 31. Differentiated approaches to water and sanitation investments should: (i) be demand-led, capturing the specific community’s needs; (ii) be tailored to varying demographic conditions (e.g., dispersed or concentrated population); (iii) assign sufficient resources for the social, management and other inter-sectoral aspects of the intended investments (education, 8 environment, health); and (iv) promote private sector participation, particularly in market development for rural sanitation and post-investment maintenance (e.g., servicing septic tanks). 32. Value-added arrangements are viable, based on a transparent scheme with proper incentives. Successful value-added arrangements can be achieved when three key elements are present: (i) a clear and shared objective and sound balance of power and governance among all stakeholders (e.g. LPA); (ii) a shared risk mechanism; and (iii) commitment to market principles. 33. Competitiveness clusters (i.e. LPAs): To ensure success for competitiveness clusters, the following factors must be considered: (i) creating extensive partnerships among players - under a common territorial development strategy - for value chain projects; (ii) focusing on technologies for markets with high growth potential; (iii) reaching sufficient critical mass to acquire and develop state level (or national) visibility; and (iv) implementing a common territorial economic development strategy that is consistent with the state's overall development goals. 34. Multi-sectoral interventions: Integration of project activities with other rural development programs, including the simultaneous promotion of private productive investments and public socio-economic investments, enhances efficiency, project impact and sustainability. 35. Targeted Rural Producer Financial Support: Addressing temporary market failures (e.g., thin rural finance markets, high administrative costs to rural lending) through one-time matching grants, in addition to improving the policy environment and investment climate, can help economic agents manage transaction costs and risks associated with technology adoption and organizational innovation, as in the case of RPOs and agribusinesses in developing value chains. 36. Decentralization and Project Ownership: Decentralization of project implementation and supervision responsibilities to the municipal/regional level, along with the promotion of local stakeholder project ownership – specifically through the formation of territorial strategies for value chains and associated LPAs -- leads to successful project implementation and enhanced sustainability of the Project’s activities. However, the impact of a decentralized strategy requires the effective strengthening of local capacity. 4. Implementation A. Institutional and Implementation Arrangements 37. The State of Pernambuco, through SARA, would be the Borrower for the proposed loan, with the Federative Republic of Brazil serving as Guarantor. ProRural, the State’s primary rural development program and housed in SARA, would be the Project Technical Unit responsible for day-to-day project implementation, including procurement planning, financial monitoring and reporting, disbursement and internal controls, maintenance of project accounts and preparation of project management reports. 38. A Steering Committee (conselho gestor), chaired by SARA with representatives from: (i) the State Secretariats of Planning and Management (SEPLAG); Development and Regional Articulation (SEDAR); Water Resources and Energy (SRHE); Science, Technology and Environment (SECTMA); Education; and Health; (ii) RPO representatives; (iii) the private sector; and (iv) any other institution in addition to or in substitution of the aforementioned, as 9 agreed with the Bank and set forth in the Project Operational Manual, would guide the strategic and multi-sectoral aspects of project implementation and ensure its strategic alignment within the overall rural agenda in the Borrower’s territory. Executing Entities 39. Local Productive Alliances (LPAs) are competitiveness clusters consisting of: (i) RPOs; (ii) small and medium enterprises; (iii) technical service providers, both public and private; (iv) financial and academic institutions; and (v) NGOs, all located in the Borrower’s territory in “win-win� arrangements. In the context of territorial strategies for value chains, an LPA would identify discrete market opportunities mutually beneficial to its constituents, detailed in the form of a Business Plan, which will also include a financial feasibility assessment. LPAs would also take advantage of value-added processing, ensure compliance with sanitary standards and certification, and permit a scale response to verified market demand. 40. Rural Producer-based Organizations (RPOs) are primarily responsible for the execution and implementation of subprojects, financed with matching grants, in the context of LPA Business Plans (Component 1) and complementary rural infrastructure (Component 2), as identified through territorial strategic planning. 41. Rural Municipal Development Councils (CMDRs) are officially-recognized local representative entities which can facilitate RPO participation in LPAs, together with other representatives from the public, private and NGO sectors. The CMDR is also the main vehicle to exert social control in regard to the implementation of rural public policies and verification of RPO eligibility for access to subproject matching grants under Components 1 and 2. 42. Territorial Forums would serve to generate the territorial strategies for value chains and work with the CMDRs, LPAs, municipal governments and other actors across respective territories to: (i) harmonize municipal and territorial development planning for rural economic inclusion (Component 1) and complementary rural infrastructure (Component 2); and (ii) facilitate, through the LPAs, the execution of Business Plans. 43. ProRural manages and implements the Project, signs subproject agreements with and transfers loan resources to RPOs for investments under Components 1 and 2, and, through its eight Regional Technical Units (RTUs), supervises and monitors project activities. 44. Other Development Partners, including public sector entities, NGOs, financial institutions, research, education, and the private sector take part in territorial strategic discussions, participate in LPAs and support activities under Business Plans (Component 1) and Complementary Rural Infrastructure (Component 2). B. Results Monitoring and Evaluation 45. ProRural would have primary technical responsibility for preparation, supervision, monitoring and evaluation of the Project’s outcomes and results. Resulting monitoring would be aided with outputs from the existing MIS within ProRural. ProRural has further developed a Results Framework (Annex 1) which would guide the design and implementation of an evaluation strategy for the Project. 10 46. Based on DIME-supported inputs toward evaluation design, the Borrower would conduct an Impact Evaluation to determine whether the proposed interventions generate a significant and positive impact for the participating RPOs with respect to the following:  market access of participating RPOs (measured by sales value);  production and productivity (measured by total production and production per hectare);  quality of life and satisfaction of RPOs (measured by access to durable goods, water supply and land value); and  technology adoption by RPOs (measured by acquisition of productive capital, assimilation of innovative NRM). 47. Evaluation of project outcomes would attempt to measure both quantitative and qualitative changes in: (i) income; (ii) employment; (iii) land and water use; (iv) technical assistance provision and its effectiveness; and (v) management capacity, among participating RPOs. Evaluation of land use changes will indicate the extent to which existing agricultural land is being used more productively and sustainably by participating RPOs, and whether significant deforestation or other undesirable land use changes may be occurring. Evaluation design would attempt to capture both before-after and with-without project outcomes through the application of randomized control trials (RCTs), where possible. Terms of Reference for the evaluation design, prepared by ProRural, would be included in the Project Operational Manual. C. Sustainability 48. The Borrower has demonstrated commitment to the Project’s PDO and has confirmed the necessary fiscal space for project implementation. Consultations have been conducted across an array of stakeholders (e.g., RPOs, CMDRs, Territorial Forums, private sector producer networks, selected value chains, municipal, State and Federal governments) to both inform and verify key elements of project design. 49. Component 1 supports a business model with financing shared among RPOs, LPA partners and project-financed matching grants. It is expected that partnering Financial Institutions – after gaining successful experiences with RPOs – would take on an ever-increasing role in financing the LPAs, with market-sourced finance comprising an ever-larger share of the total Business Plan. Additionally, the participation of Financial Institutions in assessing and financing viable Business Plans would extend their client base and deepen rural financial markets in Pernambuco. In the end, successful Business Plans will generate sustainable businesses. 50. Component 2 builds on previous successful experience in Pernambuco with local-level implementation of small-scale infrastructure investments, mainly in rural water and sanitation. Past experience reinforces the importance of up-front investments in local management capacity to ensure user fees are in place for water systems (whether piped or via cisterns) to cover operation and maintenance expenditures. Recent pilot experiences in Pernambuco, including those documented in the Water Partnership Program grant, “Documentation and Dissemination of Proven Water and Sanitation Management Models for Multi Village/Small Town Schemes in Brazil�, will serve as reference points for models of decentralized, local management, thereby bolstering sustainability (see Annex 2). 11 51. Overall: Sustainability of the Project’s impact would be achieved through the Project’s support to participatory processes at every level, particularly regarding: (i) territorial forums and strategic planning; and (ii) LPAs and RPOs in defining Business Plans, including implementation and cost-sharing, thus increasing the felt ownership of financed investments. Furthermore, the roster of technical service providers established by ProRural would ensure quality design and execution of Business Plans, complementary rural infrastructure and the associated subprojects. Finally, subproject agreements – signed between RPOs and ProRural – would detail procedures for the continued operation and maintenance of these investments, drawing on lessons learned from previous Bank-financed operations in Pernambuco and recent studies in Northeast Brazil on management models for rural water and sanitation services. These activities would enhance the institutional and financial sustainability of project impacts. 5. Key Risks and Mitigation Measures 52. Stakeholder risk is deemed Low, as the political will at the municipal and state level for the Project is strong, as is also the grassroots support from existing RPOs, the private sector and financial institutions in Pernambuco, all of which have actively participated in consultations during project preparation. The State’s innovative focus on inclusive rural economic growth carries inherent institutional capacity risks of: (i) hiring and maintaining the required technical cadre to implement the proposed activities; and (ii) ensuring competent and targeted technical assistance to accompany RPOs during subproject design and execution, for which adequate resources have been assigned under Components 1 and 2. Coordination risk underlies the proposed multi-sectoral engagement (i.e., agriculture, water, health and education), which the Project Steering Committee would work to mitigate. Fiduciary risk associated with the decentralized approaches proposed under Components 1 and 2 would be mitigated by: (i) clear procedures outlined in the Project Operational Manual and broadly disseminated through a communication strategy; (ii) well-established financial management and procurement guidance developed under earlier Bank-financed operations, both in Pernambuco and elsewhere in Brazil; and (iii) targeting training in financial management and procurement for RPOs to enhance their capacity to manage subproject execution. Social and Environmental risks are well-identified in the ESMF, IPPF and RPF, with appropriate mitigation measures proposed that would be incorporated in the Project Operational Manual and monitored through the Project’s MIS. 6. Appraisal Summary A. Economic and Financial Analysis 53. As the Project will respond to the explicit demands from LPAs through territorial strategies and associated Business Plans, a detailed ex-ante cost-benefit analysis of the Project as a whole is not warranted. To obtain an ex-ante indication of the financial soundness of the types of investments likely to be supported by Component 1, indicative production models based on actual cases of LPAs and RPOs were constructed using primary and secondary information collected during project preparation and validated at appraisal. The analyzed subprojects generate Financial Internal Rates of Return (FIRRs) greater than 25% in all cases and demonstrate significant incremental contributions to rural producer income (R$403/month on average). Sensitivity analysis shows that, in general, these subprojects present robust indicators. 12 54. The economic and financial data for indicative subprojects under Component 2, obtained during field visits, permitted the calculation of Net Present Values (NPV) of both costs and benefits, Benefit/Cost Ratios (B/C) and FIRRs, as presented in Table 5, Annex 7. FIRRs and PVs were estimated using a 10-year period, and PVs using a 10% discount rate. Subproject costs include the initial investment and, in the case of water supply, annual operating costs. The financial analysis of water supply and rural sanitation subprojects shows FIRRs greater than 25% and 12%, respectively. Those of Water Supply are quite robust, presenting FIRRs above 10% even when submitted to substantial increases in costs or decreases in benefits. B. Technical 55. The Project is deemed technically sound and presents a balanced response to Pernambuco’s need for greater rural competitiveness and challenges in the area of complementary rural infrastructure. Component 1 focuses on capacity building of RPOs, via their participation in LPAs, and incentives to stimulate their joint, market-driven Business Plans. Component 2 addresses key complementary rural infrastructure vital for both improved quality of life and increased rural productivity. Component 3 provides support to improve management, supervision and evaluation of the project interventions. The following aspects also contribute to the technical soundness of the Project: (i) scaled support through RPOs, as aggregation (of production and costs) is critical for competitiveness; (ii) promotion of economic diversification and non- agricultural businesses; (iii) construction of linkages with commercial partners and markets across regions and territories; and (iv) increased focus on piloting localized management models for maintaining and administering water and other rural infrastructure. In order to foster the above strategic lines, the Project includes activities dedicated to pilots and iterative learning, in addition to capacity building and technical assistance. C. Financial Management 56. The Bank conducted a financial management assessment for the Project, in accordance with OP/BP 10.02 and the Financial Management Practices in World Bank Financed Investment, dated March 5, 2009. The purpose of the assessment was to determine whether ProRural has acceptable financial management and disbursement arrangements in place to adequately control, manage, account and report on project funds. Based on the assessment, the Financial Management Risk is rated as Moderate. The financial management arrangements, as set out for this Project, satisfy the Bank's minimum fiduciary requirements (see Annex 3). D. Procurement 57. The Bank conducted a capacity assessment of ProRural. Based on the assessment, the risk is Moderate. An action plan of mitigating measures is detailed in Annex 3. Procurement for the Project would be carried out in accordance with the World Bank’s “Guidelines: Procurement under IBRD Loans and IDA Credits� dated January 2011, and “Guidelines: Selection and Employment of Consultants by World Bank Borrowers� dated January 2011, and the provisions stipulated in the Legal Agreement and detailed in the Project Operational Manual and in the Procurement Plan. 13 58. For each contract to be financed by the proposed loan, the different procurement methods or consultant selection methods, the need for pre-qualification, estimated costs, prior review requirements, and time frame would be agreed between ProRural and the Bank in the Procurement Plan. The Procurement Plan, satisfactory to the Bank, is available on the Project’s website (www.prorural.pe.gov.br) and on the Bank’s external website. The Procurement Plan would be updated periodically in agreement with the Bank or as required to reflect actual project implementation and improvements in institutional capacity (see Annex 3). E. Social (including safeguards) 59. OP 4.10 (Indigenous People) is triggered. Indigenous peoples are both in the project area and potential project beneficiaries. Adverse effects are not expected for them under this Project. There are about 50,000 indigenous peoples in Pernambuco, comprising eleven ethnicities. The Xukuru, Pankararu, Truká, Atikum and Fulni-ô comprise 72% of this population and there are smaller numbers of the Kambiwa, Kapinawa, Pankaiuká, Pankará, Pipipã, and Tuxá peoples. Ten of the thirteen indigenous lands have been regularized. These lands are mostly located in the semi-arid region of Pernambuco. Lessons learned from a previous operation, the Rural Poverty Reduction Project (RPRP), have been incorporated in the Project's Indigenous Peoples Planning Framework (IPPF), and also in the State's Indigenous Action Plan 2010-1015. 60. ProRural conducted a social assessment that underscored the pressures and threats these indigenous peoples face regarding livelihoods (e.g., water scarcity, land shortage and degradation, encroachment and illicit activities, inadequate production technologies and barriers to their access to markets and finance) and their degree of social and economic vulnerability. Extensive consultations with all eleven ethnicities, from November 2010 through March 2011, informed the Project's IPPF, which emphasizes participatory mechanisms and demonstrates broad indigenous community support for the Project. 61. Past experience in Pernambuco with indigenous peoples include the recently-closed Bank- financed RPRP, which successfully implemented a highly participatory IPPF, established a network of collaborating governmental and nongovernmental organizations and financed fourteen indigenous community demand-driven investments that benefited about 5,000 indigenous peoples. The RPRP's IPPF included periodic consultations with indigenous peoples on planned activities and their monitoring and evaluation. Lessons learned from the RPRP are being applied under the Project. 62. The IPPF incorporates these indigenous inputs and recommendations, documents the consultation process, takes into account the differing access of potential indigenous beneficiaries to public policies and forms part of the Project Operational Manual. On July 14, 2011, the Borrower publicly disseminated the IPPF on its website (www.prorural.pe.gov.br), as did the Bank on its website (see Annex 3). 63. OP 4.12 (Involuntary Resettlement) is triggered. The Project is not expected to finance subprojects that could potentially cause significant physical displacement and economic losses. In principle, the Project would seek to avoid involuntary resettlement, wherever possible. Nonetheless, some of the potentially financed subprojects, such as rural road improvements or small-scale irrigation works, could possibly involve the relocation of people or acquisition of 14 land. It is expected that, in these cases, the potential numbers of people who might be affected would be quite small, as would any land acquisition. As actual subprojects to be financed are not yet known, a Resettlement Policy Framework (RPF) was prepared and consulted with key stakeholders in March 2011 and forms part of the Project Operational Manual. The RPF would serve as the guide to the site-specific formulation of Resettlement Action Plans (RAP), if needed. On July 14, 2011, the Borrower publicly disseminated the RPF on its website (www.prorural.pe.gov.br), as did the Bank on its website (see Annex 3). F. Environment (including safeguards) 64. The Project is Category B and triggers Operational Policies 4.01 (Environmental Assessment), 4.04 (Natural Habitats), 4.09 (Pest Management) and 4.36 (Forests). As the exact type and nature of subprojects under Components 1 and 2 would not be known ex ante, the Borrower has prepared an Environmental and Social Management Framework (ESMF). The ESMF provides guidance on: (i) identifying the potential impacts associated with the typology of project investments; (ii) minimizing potential impacts for productive and infrastructure subprojects; (iii) specifying procedures for assessing environmental and social impacts during the subproject design; and (iv) addressing identified impacts during subproject implementation. 65. The Project will encourage the control of pest populations through the integrated pest management framework within the ESMF. Nevertheless, minor amounts of pesticides would probably continue to be used in the short term by a small portion of targeted small-scale farms, which would trigger OP 4.09. The Project would encourage and support technical assistance for the adoption of organic agriculture and of proven, economically- and environmentally- sustainable Integrated Pest Management (IPM). This approach would increase farmer productivity (i.e., yields), reduce input costs and human health risk, and minimize adverse environmental impacts through the virtual elimination of pesticide use. The IPPM approach further improves the sustainability of agro-ecosystems by focusing on the knowledge and skills of farmers to better enable natural resource management. A Pest Management Plan (PMP) has been prepared and incorporated into the ESMF and would be included in the Project Operational Manual. The PMP makes use of the World Health Organization's Recommended Classification of Pesticides by Hazard and Guidelines to Classification (Geneva: WHO 1994-95). The PMP also excludes finance for formulated products that fall in WHO classes IA and IB, or formulations of products in Class II, if: (i) the country lacks restrictions on their distribution and use; or (ii) they are likely to be used by, or be accessible to, lay personnel, farmers, or others without training, equipment, and facilities to handle, store, and apply these products properly. 66. It is not expected that project implementation will have negative impacts on forest resources. Subprojects with the potential for conversion or degradation of natural forests or other natural habitats that are likely to have significant adverse environmental impacts which are sensitive, diverse, or unprecedented are ineligible. The Project also excludes activities that require commercial forest harvesting, wood extraction or firewood use in the production chain. Activities resulting in deforestation and loss of native vegetation cover will not be allowed. In sum, the ESMF assesses the most common types of intervention expected and proposes apriori mitigation measures. The ESMF includes a budget and implementation schedule, both of which for part of the Project Operational Manual. On July 14, 2011, the Borrower publicly disseminated the ESMF on its website (www.prorural.gov.br), as did the Bank in its website. 15 Annex 1: Results Framework and Monitoring COUNTRY: BRAZIL PERNAMBUCO RURAL ECONOMIC INCLUSION PROJECT Results Framework Project Development Objective (PDO): The objective of the Project is to promote rural business initiatives and expansion of rural access to water and other complementary infrastructure by supporting the Borrower’s Results Management Framework. Cumulative Target Values Data Respons- Description Core PDO Level Results Unit of Base Source/ ibility for (indicator Freq. Indicators Measure -line YR 1 YR 2 YR3 YR 4 YR5 YR6 Method- Data definition ology Collection etc.) 1. Participating RPOs # 0 12 42 83 113 138 150 Annual Project ProRural Approved successfully inserted Business MIS/ business into LPAs. Plans Annual plans imple- (cum) Reports mented by RPOs. 2. Increased net % 0 10 15 20 25 25 Annual Project ProRural Pre- and revenue for MIS/ post- participating RPOs. Annual assessment Reports of RPO income statements. 3. Rural households #famil- 0 1,260 5,040 9,450 13,230 14,500 15,000 Annual Project ProRural Households with access to ies MIS/ with project- “Improved Water (cum) Annual financed Sources�. Reports water supply (e.g., cistern, community water system, wells) 16 4. Rural households #famil- 0 504 2,016 3780 5,292 5,700 6,000 Annual Project ProRural Households with access to ies MIS/ with project- “Improved Sanitation (cum) Annual financed Services�. Reports sanitation services (fossa septica) INTERMEDIATE RESULTS Intermediate Result (Component One): 1. Participating # rural 0 900 3,000 6,000 8,500 9,250 10,500 Annual Project ProRural RPO rural producers, produc- MIS/ members, including 30% ers Annual tracked by women. (cum) Reports gender, participating in business plans. 2. Participating % 0 15 20 25 30 30 30 Annual Project ProRural RPO rural producers (cum) MIS/ members successfully Annual accessing accessing Reports PAA, institutional PNAE. markets (PAA and PNAE). 3. RPOs % 0 20 40 60 80 90 100 Annual Project ProRural RPO use of implementing (cum) MIS/ balance financial Annual sheet and management Reports income instruments in statement as subprojects. management tools. Intermediate Result (Component Two): 1. Satisfactory % 0 70 80 85 90 100 100 Annual Project ProRural Water water quality for families MIS/ supply 17 beneficiary rural (cum) Annual quality for: households. Reports (i) household connection; and (ii) cistern, as determined by Technical Working Group. 2. RPOs charging % 0 20 40 60 80 90 100 Annual Project ProRural Participating user fees for (cum) MIS/ RPOs management and Annual paying fees maintenance of Reports based on financed water water usage. supply projects. 3. RPOs with active % 0 30 50 75 100 100 100 Annual Project ProRural Participating arrangements for (cum) MIS/ RPOs with management and Annual fee- based maintenance of Reports manage- financed sanitation ment of services. sanitation services. Intermediate Result (Component Three): 1. Processing time % - 10 15 20 20 20 20 Independ- ProRural Increased required to reduction ent Audit efficiency in complete subproject Reports subprojects cycle. processing. 2. Project results # public- - 50 140 300 350 400 450 Publi- ProRural _ disseminated. cations cations 18 Annex 2: Detailed Project Description 1. Project Development Objective: The objective of the Project is to promote rural business initiatives and expansion of rural access to water and other complementary infrastructure by supporting the Borrower’s Results Management Framework. 2. PDO Level Results Indicators: PDO Level Results Indicators: (i) Participating RPOs successfully inserted into LPAs; (ii) Increased net revenue for participating RPOs; (iii) Rural households with access to improved water sources; and (iv) Rural households with access to improved sanitation services. 3. Project Beneficiaries: Project beneficiaries would include Rural Producer-based Organizations (RPOs) consisting of small-scale family farmers and non-agricultural producers. Previous Bank-financed operations in Pernambuco have fostered more than 5,000 such common interest groups, primarily composed of households engaged in small-scale production, which would be targeted under the Project (see Box 1). Smallholders or family farms, as defined under Federal Law 11.326, are those with: (i) land holdings of up to four fiscal units (módulos fiscais), which varies according to soil conditions and existing production patterns; (ii) a majority of household income earned from agriculture; (iii) primarily household labor force for on-farm activities; and (iv) on-farm activities managed by the household. Family farms are recognized legally through the issuance of documentation certifying them as eligible for participation in the Federal Program for Family Agriculture (PRONAF).2 This same documentation – an example of which would be included in the Project Operational Manual – would serve to confirm the eligibility of RPO members to participate in the Project. Box 1 Decentralized Institution-building in Pernambuco State Since its inception as a small pilot component in 1986, the Rural Poverty Reduction Project in Pernambuco (as part of a larger Program including nine Northeast States) has, over more than two decades, fostered social capital formation and empowered communities to chart their own development. Working in partnership with government, the private sector and civil society, some 5,000 Community Associations, including RPOs, have designed and implemented investments that respond to actual demand and reflect local conditions. Drawing on Bank support through four successive loans totaling some US$190.0 million, Pernambuco has forged strong municipal-level governance structures, as evidenced by the 180 Municipal Councils for Rural Development (CMDR), in which RPOs constitute majority participation. These CMDRs serve as ample forums to aid in the design of and social control for rural public policies in Pernambuco, including those under the proposed Rural Economic Inclusion Project. The challenge now is to leverage this social capital to promote asset accumulation via the territorial strategies developed across value chains and their associated business plans, which the project would support. 2 Declaration of Eligibility for PRONAF ( Declaração de Aptidão ao PRONAF - DAP). 19 Project Components: 4. Component 1: Investments in Rural Economic Inclusion (US$109.7 million, with US$51.0 million of IBRD financing) would promote investments in rural economic inclusion in the Borrower’s territory. Specifically, activities under the Component would consist of: (i) Support to Local Productive Alliances; and (ii) Productive Investments. 1a. Support to Local Productive Alliances (LPAs) - would absorb an estimated 10% of Component costs for the provision of support to ProRural for Business Plan preparation activities to inter alia, (i) elaborate and implement a communication strategy to facilitate the creation of LPAs; (ii) identify and develop viable Business Plans with defined territorial strategies; (iii) train and certify local service providers on how to prepare Business Profiles and Business Plans, as well as how to improve management and develop innovative financing mechanisms for the rural economy; and (iv) carry out technical studies in the areas of competitiveness, including market studies and analysis of new potential value chains. Outreach and promotional activities would be financed to identify the RPOs, commercial partners, financing institutions and other stakeholders, and assist them in forming sound territorial strategies and LPAs. Activities would include:  Information-sharing and networks - which would support the elaboration and implementation of communication strategies to facilitate LPA formation. The communication strategy would be encompass: (i) promotional and outreach activities toward potential LPAs, RPOs, the financial sector, institutional buyers (i.e., PNAE, PAA) commercial partners and other potential stakeholders; (ii) periodic dissemination of the progress and results of LPAs and associated RPOs through local competitiveness networks and other media (i.e. project website, radio, newspaper, etc.); and (iii) facilitating access to commercial information (e.g., prices, market intelligence) on the part of LPAs and RPOs.  Preparation of Business Plans – would provide technical and financial support to identify and develop viable Business Plans consistent with defined territorial strategies, as well as ensure quality control. Other activities would include: (i) Consultant services to assist LPAs and RPOs in preparing Business Plans; and (ii) Training of RPOs to strengthen their entrepreneurial capacities to: (a) collect and manage commercial information; (b) acquire business administrative skills (basic bookkeeping and accounting skills) and (c)identify business opportunities and partners.  Strengthening of local service providers - which would finance: (i) Training and certification of the technical service providers to acquire knowledge and skills for preparation of Business Profiles and Business Plans; (ii) Promotion of business opportunities with LPAs and RPOs (part of the communication strategy); and (iii) Training and assistance for improving management and developing innovative credit mechanisms, particularly targeting rural financial institutions.  Technical studies would also be undertaken to accumulate knowledge in key areas of competitiveness, including market studies and analyses of the new potential value chains. RPO eligibility under Component 1 would be primarily for those with: (i) demonstrated production capacity; and (ii) willingness to adopt and co-finance new technologies and processes. RPOs that are unable to meet these eligibility criteria could nonetheless be 20 expected to benefit from the Project: (i) through information sharing and networking via the LPAs; (ii) participation in workshops for entrepreneurship and business planning; and (iii) through the demonstration effect of those RPOs implementing business plans via LPAs. 1b. Productive Investments – would, with the remaining 90% of Component costs, finance the provision of support to RPOs for the carrying out of productive investments, through Matching Grants, for the implementation of Productive Subprojects. Approximately 150 feasible Business Plans would be financed, in the context of territorial strategies for value chains. In order to become eligible for the subproject matching grant, a business plan must: (i) be consistent with defined territorial strategies; (ii) demonstrate financial feasibility; (iii) entail a concrete Local Productive Alliance; and (iv) secure up-front resources from LPA partners, including the financial sector (minimum of 20 percent) to support its implementation. Subprojects would be that portion of the Local Productive Alliance’s business plan that would be: (i) financed with proceeds from the proposed Loan; (ii) implemented by eligible RPOs; and (iii) governed by subproject agreements signed between the RPOs and the Borrower. Subprojects would include fixed capital (e.g., plant and equipment, minor small-scale infrastructure), working capital and technical assistance expenditures. RPOs would be responsible for a minimum of 25% of subproject financing, resourced through financial institutions (e.g., loans), own-equity capital and in-kind contributions. Subproject finance would be further governed by procedures outlined in the Project Operational Manual. 5. Local Productive Alliances (LPAs) are competitiveness clusters consisting of: (i) RPOs; (ii) small and medium enterprises; (iii) technical service providers, both public and private; (iv) financial and academic institutions; and (v) NGOs, all located in the Borrower’s territory in “win-win� arrangements. In the context of territorial strategies for value chains, an LPA would identify discrete market opportunities mutually beneficial to its constituents, detailed in the form of a Business Plan, which will also include a financial feasibility assessment. LPAs would also take advantage of value-added processing, ensure compliance with sanitary standards and certification, and permit a scale response to verified market demand. 6. Main Outcomes: (i) up to 150 associative Business Plans executed with project support, benefiting 10,500 rural producers; and (ii) increase of 25% (end-of-project) in net revenues for participating RPOs. 7. Financing: The component will finance technical assistance and training services, workshops and information exchanges, expert services, studies and demonstration/adaptation activities, and subprojects, which could include goods (e.g., production inputs; farming, storage and processing equipment), small civil works consulting services and non-consulting services. 8. The proposed Business Plans and associated subproject matching grants will be guided by the following principles:  Productivity, value added and profitability: Permanent improvements in rural income and well-being will require that producers adopt new technologies and access greater market intelligence to more efficiently use available resources, thereby ensuring the profitability and competitiveness of their production. 21  Organizations: The small farmer, acting alone, is unlikely to effectively compete in a market dominated by intermediaries with asymmetric bargaining power and information. Conversely, participation in value-added arrangements such as LPAs can provide more stable, reliable and remunerative market access. A business plan is the instrument upon which an LPA would be formed, evaluated and supported.  Demand: There must be a specified market for the activities to be funded; they must respond to market demand.  Entrepreneurship: Traditional, low-productivity family agriculture requires a transformation toward more modern commercial agriculture, with increased factor efficiency and growth potential. A culture of formally-established businesses with contractual obligations would be fostered under the Project, within which producers with potential would assume business responsibilities. In this context, the Business Plan is the crucial instrument.  Shared risk and benefits: Value-added arrangements under LPAs provide a way for the different actors to share both the risks and associated revenues.  Enhanced share of final value: The Project targets RPOs with improved production potential, promoting increased value of production and market access through productive and commercial alliances so that they can more effectively access a higher share of final value and net revenue. 9. Through all of the above activities, the component will build capacity for rural investment and serve as a risk management tool to ease investment decision-making by lowering the barrier represented by up-front costs. It is also expected that the business planning exercise would facilitate access to credit, as RPOs would be expected to secure counterpart financing (e.g., PRONAF, private finance) to complement the subproject matching grant. 10. The complementary subproject matching grant, a one-time capital infusion, is designed to jump-start innovation and spur the adoption of new technologies and practices to enhance competitiveness and sustainable use of natural resources, including on farm irrigation adoption, expansion and improvements. Furthermore, in transforming RPOs into viable and competitive value chain participants, the Project should expand the pool of creditworthy clients for rural financial institutions and deepen the currently thin market for rural financial services and technical service provision. Several technical design elements of the Project would contribute to the long-term sustainability of the proposed activities, for example: (i) existing organizational capacity (social capital) in rural Pernambuco and activities for its further strengthening; (ii) the selection criteria for assessing business plans proposed by LPAs (based on financial feasibility, concrete value-added arrangements and clearly defined market potential); (iii) financial sector participation in the screening of Business Proposals and evaluation of Business Plans; and (iv) the Project’s overall rural competitiveness approach. Developing Value Chain Business Plans via Local Productive Alliances 11. One of the key benefits of value chain initiatives is the generation of professional business plans from a set of stakeholders organized in working groups (i.e., LPAs). Global best practice in 22 value chain development uses such working groups to generate business plans, applying the following principles:3  Strategic orientation vs. ad hoc laundry list of actions. Value chain activities are prioritized according to a business rationale that is aligned with a technical analysis of constraints and opportunities, instead of wish lists.  Trust-building via facilitated and on-going meetings vs. ad hoc meetings. Frequent working group meetings led by professional facilitators - who can be viewed as “honest brokers� - are critical to build trust and ownership among value chain stakeholders. These meetings take place over a period of time (e.g. 4-8 months) with the goal of developing the business plan. Facilitators would source industry knowledge and on-demand technical assistance. The transparent nature of working groups, plus the intervention of the facilitators, helps to mitigate the possible capture by dominant firms.  Building value chain assets vs. focusing on transaction flows. Long-term wealth creation is associated with building national or enterprise capabilities rather than flows of capital. 4 Rather than primarily focusing on transaction flows (i.e., deals), long-term value chain competitiveness is associated with strengthening assets surrounding enterprise, such as infrastructure, market research capability, certification, and business development services.  Relative competitive position vs. demand only. Market demand should inform value chain activities. However, growing demand alone is insufficient to pass the market test, a common mistake in sector-specific initiatives. Understanding the dynamics of the competition is critical, which, among other things, has implications on prices. 12. The key process elements in developing business plans are:  Value chain selection. A focused selection of value chains is consistent with lessons learned from other projects to avoid a “Christmas tree� approach and attempt to solve all barriers to growth and business climate issues.5 This focused approach seeks to draw a critical mass of complementary interventions to trigger a strong private sector response. Examples of transparent selection criteria, in consultation with local stakeholders, could include: government objectives, value-added potential, scope for deploying innovative productive technologies or techniques, implementation feasibility, market criteria, and strategy (Fig. 1). In Pernambuco, this selection process would be based on a long list of value chains already identified by ProRural. Moreover, grouping value chains by growers’ portfolio (such as fresh fruits, meat, and honey) would also be considered. 3 See two recent Bank lending operations: Cameroon’s “Competitive Value Chain Project,� Report No. 53956-CM, 2010, and Guatemala’s “Enhancing SME Development Project,� Report No. 59714-GT, 2010. See also, “Rwanda Tourism Value Chain Case Study: Guided Case Studies in Value Chain Development for Conflict-Affected Environments�, MicroREport #94, USAID. 4 See, for example, Michael Fairbank’s Seven Forms of Capital (2000) 5 Ibid. 23 Fig. 2 Sustainable  Employment Government  Potential to  Objectives  Develop MSMEs Environmental  Sustainability Value added  Niche segments potential Priority Value  Chains Quick  Implementation implementation Regional and  Market Criteria global demand Pre�conditions for  change Strategy Re�positioning  strategy  Working Group (LPA) formation. A workshop to showcase value chain selection can serve to launch the working groups, which consist of all relevant stakeholders within the value chain, including farmer and industry associations, research institutes, input providers, traders, and anchor firms. A starting group of 30-50 representatives can be divided into 3 sub-groups, such as access to finance, product development, and marketing. Institutional and policy working groups may also be formed. Regular meetings, conducted by a professional facilitator, aid the sub-groups in decision-making and agreeing on next steps, both of which are critical in building ownership around the business plans.  Business Plans. Business plans are strategic investment documents resulting from months of planning by the thematic working groups, complemented with monthly or quarterly value chain plenaries. There is a focus on building value chain assets (i.e., capabilities) for long-run competitiveness. Public vs. private nature of goods in the business plan can aid in identifying sources of finance. Subproject Cycle - Business Plans (Component 1):  Following a project dissemination campaign to create overall awareness, interested stakeholders across potentially participating LPAs would define territorial strategies across their respective value chains as the foundation for identifying discrete commercial opportunities and developing these into Business Proposals (perfil de negócio), which are submitted to ProRural; 24  Business Proposals are assessed for eligibility, according to targeting criteria set forth in the Project Operational Manual (e.g., RPO eligibility); if approved, LPAs are authorized to develop Business Proposals into Business Plans, with technical service provision as needed and financed under the Project;  Business Plans are evaluated by the Technical Committee for compliance with environmental, financial, institutional, social and technical guidelines (per the Project Operational Manual);  Subproject agreements (convênios) are signed between RPOs and ProRural to support finance of that portion of approved Business Plans implemented by RPOs, specifying the use of subproject resources, and the rights and responsibilities of each RPO;  Subproject resources are transferred to RPOs for subproject execution, according to the approved Business Plan;  RPOs contract goods, works and services, in accordance with the norms established in the Project Operational Manual, and prepare reports which they submit to ProRural to document the use of project resources transferred. 13. Technical Service Providers (TSPs): ProRural would identify, orient and later certify qualified service providers to assist RPOs in forming LPAs, preparing Business Proposals, and developing and implementing Business Plans (including associated subprojects). TSPs could also be sourced through, among others: (i) SEBRAE; (ii) the Semi-arid Network (ASA); (ii) financial institutions e.g., Banco do Brasil, Banco do Nordeste; (iii) the recently-created State Agency for Enterprise Development (AGEFEPE); and (iv) existing research and extension agencies e.g., EMBRAPA and the State’s Research and Extension Agency (IPA), both of which are already collaborating with ProRural in the development of territorial strategies. RPOs will choose TSPs from the “Positive Long List� provided by ProRural. Results contracts would be signed between TSPs and ProRural, with inputs from respective RPOs. The “Positive Long List� would also form part of the ongoing communication and outreach strategy and be included in the Project Operational Manual. The Project would finance training-of-trainers activities targeted to TSPs to enhance their technical skills and build awareness regarding Safeguard Policies and Anti-Corruption Guidelines. 14. Technical Evaluation Committee: Business Plans would be reviewed and approved by a Technical Evaluation Committee composed of: (i) a value/chains/agribusiness specialist; (ii) environmental and social specialists; (iii) financial sector representatives; and (iv) three to four outside experts, selected on an ad hoc basis, depending on value chains represented. For those business plans comprising irrigation or other productive uses of water, the outside experts would include a water specialist. The terms of reference for the Evaluation Committee would be included in the Project Operational Manual, as would the criteria for the evaluation of Business Plans proposed by LPAs. Deliberations of the Technical Evaluation Committee would be open to the public and its final decisions would be publicly disclosed (e.g., newspapers, ProRural website: www.prorural.pe.gov.br), thereby building transparency into the evaluation and approval process of the use of public funds. 15. Component 2: Complementary Rural Infrastructure (Component Cost of US$51.5 million with US$39.5 of IBRD financing) would promote investments in complementary rural infrastructure in the Borrower’s territory, primarily through the provision of: 25 (i) Support to RPOs for the carrying out of complementary rural investments, through Matching Grants, for the implementation of Infrastructure Subprojects included in eligible Business Plans, including but not limited to: (a) the acquisition of small-scale rural water supply systems (including cisterns) and rural sanitation (including septic systems); and (b) the reduction and/or elimination of bottlenecks in the flow of value- added production along the producer chain (e.g., small bridges, all-weather crossings, minor road reforms); and (ii) Training and the development of capacity-building initiatives designed to strengthen the day-to-day management of small-scale rural water supply and sanitation systems. 16. The Component would leverage the territorial strategies developed under Component 1 to support actions that: (i) reduce social, cultural and environmental vulnerability in the participating RPOs’ communities; and (ii) complement Component 1 investments by contributing to the productivity and competitiveness of productive chains, LPAs and RPOs. 17. Consistent with accumulated experience in rural Pernambuco under ProRural’s oversight, these investments would be executed by participating RPOs, with other community members, under existing and proven community participation approaches. Technical, managerial, economic, environmental and social criteria to finance investments in water for consumption and productive uses would be defined in the Operational Manual. Water infrastructure financed under Component 2 would be a mix of demand- and supply-driven investments, as given in Table 1. Table 1: Guiding framework for Component 2 – Complementary Rural Infrastructure Water Production Consumption Infrastructure Demand-driven  Small-scale irrigation technology  Community water systems and techniques for RPOs (including cisterns) and  Improved on-farm efficiency of sanitation proposed by RPOs in irrigation and water use context of territorial strategies.  Management models Supply-driven  Complementary irrigation on  Public policies to address existing perimeters (small canals, drought-prone regions pumps, etc.)  Territorial Strategies for value  Territorial Strategies for value chains chains  PPA  Public-private partnerships in  Water basin management, irrigation incorporating RPOs including micro-basin  New technologies and techniques to interventions, soil conservation improve “crop per drop�, e.g., reuse and rehabilitation of treated wastewater and sludge, underground small dams 26 18. Investments under Component 2 would span the following dimensions:  Rural Water and Sanitation: would finance small-scale rural water supply systems (including, in some cases, cisterns) and rural sanitation (including septic systems), in support of the Borrower’s goal of universalizing access to these services, particularly in the interior of Pernambuco. The Project would target rural agglomerations and localities with 250 households or less (or some 1,000 inhabitants).6  Water for Productive Uses: would finance activities to extend and optimize the sustainable use of water to productive activities, including irrigation, aquaculture and agroindustry, through, inter alia: (i) improvement of irrigation in existing irrigated perimeters; (ii) development of irrigation in areas benefiting from water transfers from the Sao Francisco River; and (iii) development of new technologies and techniques for agricultural water use, e.g. the re-use of water in selected areas and for selected crops.7  Logistics: LPAs and RPOs, in preparing territorial strategies for value chains and associated Business Plans under Component 1, would identify investments to reduce and/or eliminate bottlenecks in the flow of value-added production along the producer chain (e.g., small bridges, all-weather crossings, minor road reforms).  Investment Management: To strengthen the day-to-day management of small-scale rural water supply and sanitation systems -- both those financed under Component 2 and existing systems in rural Pernambuco – Component 2 would support training and capacity-building to extend recent pilot experiences in Pernambuco, as well as others that are documented in the Water Partnership Program grant, “Documentation and Dissemination of Proven Water and Sanitation Management Models for Multi Village/Small Town Schemes in Brazil�, will serve as reference points for models of decentralized, local management (see Box 2). The Project Operational Manual would define typologies of management models for decentralized rural water supply and sanitation systems financed under the Project. With support from the Bank-financed Pernambuco Sustainable Water Project (Ln. 7778-BR), the State of Pernambuco is currently developing its rural water supply and sanitation policy which, upon completion, would be reflected in the Project Operational Manual. 6 The State Company for Water and Sanitation (COMPESA) targets urban agglomerations and, per State guidelines, has set a benchmark of 250 households as the minimum scale necessary for its interventions (see Box 1). 7 During implementation, the project would tap into IFC’s investment and advisory services, particularly with regard to prospective anchor enterprises under potential PPPs in irrigation, as well as with the various fee-based services (FBS) underway in the São Francisco River Basin. 27 Box 2 Piloting Decentralized Models for Water and Sanitation Services: Pernambuco Federal Law 9.433 (1997) established Brazil’s National Water Resources Policy, which calls for decentralized management approaches that include both users and local communities (Art. 1). Later, in 2007, the Federal Sanitation Policy (Law 11.445), also called for decentralized management of access to water, sanitation, drainage and solid waste in, “small localities, primarily occupied by low-income households, where other management options would be unsustainable, given the effective demand of these populations (emphasis added).� Specific to Pernambuco, the State’s Water and Sanitation Company (COMPESA) has set a minimum threshold of 250 households for inclusion in its service area. Within this policy framework, the State of Pernambuco, through the PROMATA project, has piloted a decentralized management model for water and sanitation services in agglomerations below this threshold, focused on the formation of two entities:  Community Services Associations (ASSECOs), tasked with local management of rural water and sanitation services; and  Consortium of ASSECOs (CESCOM), whose function is to link a critical mass of otherwise isolated, local ASSECOs to strengthen their management capacity and encourage scale effects in resource management. Five principles guide the model: (i) decentralized services for water treatment, maintenance, and billing; (ii) partnerships with municipal and state government; (iii) community participation; (iv) simple solutions; and (v) reduced tariffs. The model is now being implemented in 35 municipalities, with the formation of 52 ASSECOs and two CESCOMs. Early results indicate greater use of household water meters, improved fee collection and greater attention to delinquent accounts. Options pursued in other Northeast States (e.g., Ceará and Piauí with their use of the Integrated Rural Water Supply and Sanitation System - SISAR) also serve as good-practice examples of effective decentralized approaches to delivery of these services. Source: PROMATA (2011) Training and Capacity-building (Components 1 and 2) 19. Training and Technical Assistance, as a key element of the Project’s Capacity Building Plan, aims to raise the technical level of the participating RPOs to make them more competitive through access to new knowledge, technologies and methodologies, with a focus on improving supply chains. The Training Plan would perform specific activities for Component 1 (Investments in Rural Producer Alliances) and Component 2 (Complementary Rural Infrastructure) through: (i) construction and /or strengthening partnerships within government and civil society; (ii) promoting knowledge exchanges, (iii) mainstreaming of pilot approaches; and (iv) strengthening public and private participation in the overall network of cooperation and innovation in Pernambuco. Special attention would be paid to the training of indigenous peoples, 28 remote communities, youth and women. The Training Plan would specifically address the following topics:  Vocational education as a training strategy for the inclusion of young people in agricultural and non-agricultural activities, emphasizing: (i) new technologies; (ii) entrepreneurship; (iii) business management; (iv) sustainable environmental practices; and (v) other issues to improve the performance of this group.  Training and technical assistance to support RPOs in the use of innovation and quality improvement in productive chains. With this objective, the Project would focus on priority actions to: (i) train technical, managerial, financial and commercial family farmers, technicians and other participants in the process; (ii) enable CMDRs and/or territorial forums to better address the social dimensions (cultural, environmental, economic and political) of the Project in order to improve prioritization, monitoring and evaluation of business plans; (iii) qualify RPOs to work in networks of cooperation and innovation; (iv) conduct business roundtables with the participation of potential commercial partners from the private sector; (v) promote the exchange of successful experiences; (vi) support RPOs in qualifying for access to institutional markets (e.g., PNAE) and the private market; (vii) promote participation in conferences, events and trade shows; (viii) qualify RPOs for access to potential markets for investment provided by the 2014 World Cup; (ix) prepare Municipal administrations for their facilitating role in institutional markets; (x) enhance RPOs’ communication, planning, monitoring, evaluation and systematization of their enterprises; and (xi) disseminate and train RPOs and other relevant partners in the sustainable use of water for both consumption and productive uses, with an emphasis on sustainable irrigation, innovative technologies (including water re-use) and decentralized management models.  Training and advisory services to support the strengthening of RPOs in: (i) the sustainable use of natural resources, with emphasis on water for productive uses; (ii) strengthening subproject management capacity; and (iii) natural disaster prevention, including identifying and mitigating risks, mainly for floods and droughts. 20. The Project would foster partnerships with the State Secretariat of Education and the municipalities, the Secretariat of Health, SECTMA and the newly-formed State Secretariat of Entrepreneurship in order to facilitate uptake by RPOs of programs offered by these institutions to improve their level of education, health, technology and management skills. 21. The Training Plan for the Project would include, for example: (i) payment of trainers, (ii) mobilization expenditures for RPOs; (iii) resources for travel and transportation; (iv) meals; (v) lodging; (vi) educational materials and publicity, including their design, development and production; (vii) funds for equipment rental and event spaces, including logistics; and (viii) equipment to support training activities. 22. Component 3: Project Management, Supervision, Monitoring and Evaluation (Component Cost of US$13.2 million, with US$6.1 million IBRD financing) would provision of support for, inter alia: (i) the technical and administrative management of the Project; (ii) the development, implementation and supervision of the ESMF, the IPPF, the RPF and the Communication Strategy; (iii) the necessary updates to ProRural’s management information 29 system; and (iv) the design, development and implementation of an impact evaluation module to track progress on results indicators. 23. The Project Operational Manual would include all rules and norms to guide overall project implementation. The Manual would include: (i) physical performance indicators to be tracked through the Project Monitoring and Evaluation System; (ii) the criteria for targeting activities under Components 1 and 2; (iii) procurement and anti-corruption guidelines; (iv) the Environmental and Social Management Framework; (v) the Indigenous Peoples’ Planning Framework; and (vi) the Resettlement Policy Framework. 24. A user-friendly synthesis of the Project Operational Manual would be made available, as part of the overall communication strategy, to RPOs and other stakeholders. Adoption by the Borrower of a Project Operational Manual, satisfactory to the Bank, would be a condition of Loan Effectiveness. 30 Annex 3: Implementation Arrangements Project institutional and implementation arrangements 1. The State of Pernambuco, through SARA, would be the Borrower for the proposed loan, with the Federative Republic of Brazil serving as Guarantor. ProRural, the Project Technical Unit under SARA, would be responsible for day-to-day project implementation, including procurement planning, financial monitoring and reporting, disbursement and internal controls, maintenance of project accounts and preparation of project management reports. ProRural would be responsible for flow of funds and overall procurement under the Project, with RPOs responsible for procurement and financial management for subprojects, as shown in Table 1. Table 1: Summary of Project Implementation Arrangements Component Technical With support Procurement Financial 1 Supervision from: Management 1. Investments in ProRural Technical Service Rural Producer Rural rural economic Providers; Organizations; Producer inclusion Rural Producer ProRural Organizations; (subprojects) Organizations ProRural 2. Complementary ProRural Technical Service Rural Producer Rural rural infrastructure Providers; Organizations; Producer (subprojects) Rural Producer ProRural Organizations; Organizations ProRural 3. Project ProRural Financial ProRural ProRural Supervision, Institutions; Other Monitoring and Development Evaluation Partners 1 Technical Supervision includes TOR for consultants; compilation of “positive list� of TSPs and oversight of the Annual Operating Plan (POA). 2. A Steering Committee (comitê gestor), chaired by SARA with representatives from: (i) the State Secretariats of Planning and Management (SEPLAG); Regional Development (SEDAR); Water Resources and Energy (SRHE); Science, Technology and Environment (SECTMA); Education; and Health; (ii) RPO representatives; (iii) the private sector; and (iv) any other institution in addition to or in substitution of the aforementioned, as agreed with the Bank and set forth in the Project Operational Manual, would guide the strategic and multi-sectoral aspects of project implementation and ensure its strategic alignment within the overall rural agenda in the Borrower’s territory. 3. In the context of water infrastructure investments, SARA, through ProRural, would establish, with representatives from SRHE, a Technical Working Group to support, inter alia: (i) rural water and sanitation themes in the development of territorial strategies across value chains under 31 Component 1; (ii) technical analyses of proposed water-related investments under Business Plans; (iii) quality monitoring of implemented water-related subprojects; and (iv) the ongoing formulation of the State’s rural water and sanitation policy. Executing Entities 4. Local Productive Alliances (LPAs) are competitiveness clusters consisting of: (i) RPOs; (ii) small and medium enterprises; (iii) technical service providers, both public and private; (iv) financial and academic institutions; and (v) NGOs, all located in the Borrower’s territory in “win-win� arrangements. In the context of territorial strategies for value chains, an LPA would identify discrete market opportunities mutually beneficial to its constituents, detailed in the form of a Business Plan, which will also include a financial feasibility assessment. LPAs would also take advantage of value-added processing, ensure compliance with sanitary standards and certification, and permit a scale response to verified market demand. 5. Rural Producer-based Organizations (RPOs) are primarily responsible for the execution and implementation of subprojects, financed with matching grants, in the context of LPA Business Plans (Component 1) and complementary rural infrastructure (Component 2), as identified through territorial strategic planning. 6. Rural Municipal Development Councils (CMDRs) are officially-recognized local representative entities which can facilitate RPO participation in LPAs, together with other representatives from the public, private and NGO sectors. The CMDR is also the main vehicle to exert social control in regard to the implementation of rural public policies and verification of RPO eligibility for access to subproject matching grants under Components 1 and 2. 7. Territorial Forums, in which RPOs participate, would serve to generate the territorial strategies for value chains and work with the CMDRs, LPAs, municipal governments and other actors across respective territories to: (i) harmonize municipal and territorial development planning for rural economic inclusion (Component 1) and complementary rural infrastructure (Component 2); and (ii) facilitate, through the LPAs, the execution of Business Plans. 8. ProRural manages and implements the Project, signs subproject agreements with and transfers loan resources to RPOs for investments under Components 1 and 2 and, through its eight existing Regional Technical Units (RTUs), supervises and monitors project activities. 9. Other Development Partners, including public sector entities, NGOs, financial institutions, research, education, and the private sector take part in territorial strategic discussions, participate in LPAs and support activities under Business Plans (Component 1) and Complementary Rural Infrastructure (Component 2). Financial Management and Disbursement 10. Financial Management Assessment Conclusion: The Bank performed a Financial Management (FM) assessment8 of the Secretary for Agriculture and Agrarian Reform (SARA), 8 In accordance with OP/BP 10.02 and the Financial Management Practice Manual (issued by the Financial Management Sector Board in March 1, 2010). 32 the executing agency for the Project. The scope of the assessment included: (i) an evaluation of existing financial management systems to be used for project monitoring, accounting and reporting; (ii) review of staffing requirements; (iii) review of the flow of funds arrangements and disbursement methodology; (iv) review of existing internal control mechanisms; (v) discussion in regard to reporting requirements, including the format and content of Interim Financial Reports (IFRs); and (vi) review of internal and external audit arrangements. 11. FM arrangements should place emphasis on participatory governance controls common with Community Driven Development (CDD) projects. This approach takes into account local culture, norms and lower institutional capacity, and emphasizes simple procedures, with a high degree of transparency and accountability, and decision making and management responsibilities delegated to community-level organizations (i.e. RPOs). Bank rules and guidelines apply to CDD projects in the same way they do for any other project; however, their application is scaled to the project and the community’s capacity. 12. The assessment identified as a major risk the lack of appropriate financial management institutional arrangements within the RPOs. Although the FM arrangements set out at the Implementing Agency level are considered adequate, they are not fully extended to the RPO level. External audit reports of previous CDD projects have highlighted the need to enhance internal controls and reporting within the subprojects. Thus, there is a risk of insufficiently skilled local-level resources and processes to adequately design and implement subprojects. 13. To mitigate these risks, the project implementation plan includes a Technical Assistance FM component to develop specific FM processes for subprojects and their respective RPOs. SARA would identify and contract, as needed, dedicated FM staff and establish partnerships with market access initiatives (e.g., SEBRAE, NGOs, CONTAG), to strengthen the FM stream within the RPOs under Components 1 and 2, focusing mainly on internal controls, funds flow and reporting aspects, to assure that the entire FM (end-to-end) process is adequate. SARA compliance with these requirements would be reviewed throughout the project lifecycle during periodic Bank supervision. In addition, the model subproject agreements would include clauses detailing: (i) the amount of the funding; (ii) reporting requirements (financial and progress); (iii) terms and conditions of payments to RPOs; (iv) timing of payments to RPOs; and (v) financial management requirements of the RPO. 14. The overall conclusion of the assessment of SARA is that the financial management arrangements, as set out for the Project, are considered adequate. The Financial Management Risk is therefore rated as Moderate. Fiduciary Risks have been identified and mitigated as reflected in the ORAF matrix (Annex 4). Overall Financial Management Arrangements 15. Implementing Agency (staffing and institutional arrangements): SARA would have the primary fiduciary responsibilities for the Project. These responsibilities would be carried out by SARA’s financial department. The Project leverages SARA’s institutional units (i.e., ProRural) so it is not a separate project implementation unit. The primary project coordinating unit’s fiduciary responsibilities include: (i) preparing and obtaining approval of project FM arrangements; (ii) coordinating and supervising project implementation; (iii) submitting 33 disbursement requests and documentation of expenditures to the Bank; (iv) preparing and submitting project financial reports (IFRs) to the Bank; (v) preparing and providing all financial documentation and project reports requested by external auditors and Bank staff; and (vi) ensuring that all project executors are in compliance with the Project Operating Manual. 16. Staffing: SARA’s FM team is composed of qualified professionals that understand Bank policies and procedures and possess the education levels, experience, and knowledge to adequately execute them. 17. Budgeting, Accounting and FM Systems: The State of Pernambuco follows: (i) the Brazilian Accounting Rules (NBCASP), Law 4320/64 that establishes certain high-level accounting principles; and (ii) the Accounting Manual Applicable to the Public Sector (MCASP), issued under Law 10180 of February 6, 2001 and Decree 3589 of September 6, 2001. The Project would require adherence to the first set of national accounting standards applicable to the public sector (NBCASP) and the revised Accounting Manual Applicable to the Public Sector (MCASP) issued under Portaria STN 467 of August 6, 2009 beginning with Fiscal Year 2011. The last Country Financial Accountability Assessment (CFAA) for Brazil indicated that law 4320/64 was in line with international accounting standards. 18. The budget cycle includes planning and implementation of all government activities, which are reflected in the PPA, LDO, and LOA.9 All accounting records are kept by the State’s General Accounting Officer of the State Comptroller (SECRE).10 The e-FISCO system is used by all State institutions (including ProRural) that receive/transfer government funds. The e-FISCO system has been evaluated and monitored under other Bank-financed projects and is considered reliable and secure. State accounting management is under the responsibility of the Finance Secretariat-SECRE. Each secretariat (SARA for instance) has a financing unit subordinated to SECRE and responsible to make the respective payments, assuring observance of the LOA. 19. Internal Controls: The internal control environment of the Project is adequate. All transaction processing uses SARA institutions, processes and systems that provide for segregation of duties, supervision, quality control reviews, reconciliations, and independent external audits and meets the needs of the Project. Process flows are clear and well-understood by SARA personnel. All project budgeting and accounting transactions would run through the public State accounting system (e-FISCO). All payments will follow the official commitment (empenho) and payables (liquidação) and payment (pagamento) routine. These functions are carried out by the Administration and Finance Department of each spending entity. All project costs are recorded according to the Federal and State Chart of Accounts, which enables a comparison and reconciliation with the Project’s own records, recorded in the SGPR, the financial management information system. This system is used by SARA for recording project transactions, financial reporting and budget execution. The system is an integrated online system, used by SARA and the regional technical units. However, the final part of this stream is the weakest, hence the need for its enhancement by investing heavily in FM capacity building for RPOs. The proposed FM activities would ensure that the control process extends to the local 9 LDO-Lei de Diretrizes Orçamentárias (State Budget Guidelines), LOA–Lei Orçamentária Anual (Annual State Budget Law), which includes the government’s goals and programs that are approved by the State Legislative Assembly every three years, 18 months, and 12 months, respectively. 10 SECRE – Secretaria da Controladoria Geral do Estado (State Comptroller) 34 level, assuring systematically that funds control is also present for the subprojects. The Project Operational Manual would document these project processes, and serve as an important source for processing steps to be followed during project implementation. It would contain detailed procedures and guidelines for disbursements, payments, approvals, commitments, payments and reporting. 20. Fund Flow and Disbursement Arrangements: The proposed funds flow and disbursement arrangements will be streamlined within the Project to facilitate execution, avoid unnecessary incremental operational arrangements, and rely as much as possible on Public Financial Management (PFM) country systems (see Fig. 1). All payments would be made by the Treasury of the State of Pernambuco (SECRE), using the e-FISCO system, upon instructions from ProRural once payment obligations have been incurred and properly documented. Payments will be made directly from Treasury, through the issuance of an ordem bancária, to the RPOs (on a lump-sum basis for subprojects), which would then pay service providers and contractors. To make payments, the State system requires that funds be committed by source, making possible the tracking of loan disbursements to project expenditures. A subsidiary finance agreement (Convênio de Financiamento) would be signed between the RPO and ProRural, enabling the RPO to receive funds in a specific account opened exclusively for the subproject. In addition, counterpart funds are expected to be deposited to the same specific account. Fig. 1: Project Flow of Funds 21. The primary Bank disbursement method will be Advances. SARA would open a single, segregated Designated Account (DA) in its name, in the Banco do Brasil, to receive loan funds in BRL. The DA would have a Fixed Ceiling of BRL3,400,000. The frequency for reporting eligible expenditures paid from the DA will be quarterly. The Project would also be able to use the Direct Payment and Reimbursement disbursement methods, if required. Direct Payment Withdrawal Applications will be supported by Records. The Project would report on the use of Bank Advances and Reimbursements through Withdrawal Applications supported by Statement of Expenditures (SOEs) and Summary Sheets (SSs) with Records, as defined in the Bank Disbursement Letter. To prepare the Withdrawal Applications, SARA would sign off on the Withdrawal Applications, and request disbursements and/or document expenditures. For 35 subprojects, SARA would consolidate subproject execution reported by the RPOs and request disbursements and/or document expenditures on a lump-sum basis. Disbursements will be made to the RPOs, usually in one or several installments, and on the basis of physical progress. The Bank then accounts for the eligible expenditures (i.e., records that the eligible expenditures are documented) when the lump-sum is paid, so long as there are mechanisms in place by ProRural, with Bank oversight, that the subprojects are being implemented as intended. SOE threshold limits and other disbursement arrangements would be specified in the Disbursement Letter. The Minimum Application Size for Direct Payments and Reimbursements will be US$100,000 equivalent. A four-month Grace Period will be established. Disbursement Table by Expenditure Category Category Amount of the Loan Percentage of Allocated Expenditures to be (expressed in USD) financed (1) Goods, works, Non-Consulting 42,800,000 100% of the amount Services and Consultant Services disbursed under a Matching required for Productive Subprojects Grant under Part 1(b) of the Project (2) Goods, works, Non-Consulting 37,444,000 100% of the amount Services and Consultant Services disbursed under a Matching required for Infrastructure Subprojects Grant under Part 2(a) of the Project (3) Goods, Works, Consultants’ 12,906,000 100% Services, Non-Consulting Services and Training (except those covered by Categories (1) and (2) above) required for the Project (4) Operating Costs 4,000,000 50% (5) Front-end Fee 250,000 Amount payable pursuant to Section 2.03 of the Loan Agreement in accordance with Section 2.07 (b) of the General Conditions (6) Interest Rate Cap or Interest Rate 0 Amount due pursuant to Collar premium Section 2.07(c) of the Loan Agreement (7) Unallocated 2,600,000 TOTAL AMOUNT 100,000,000 22. Financial Reporting: SARA, with the support of the financial coordinator, would ensure the timely production of semesterly financial monitoring reports-IFRs, to be submitted to the Bank within 45 days after the end of each semester. These IFRs would be produced from the SGPR system and would consolidate the Project’s financial data for all components. Accordingly, the format and content of the IFRs would cover the following items: 36  IFR 1A - Sources and Uses of Funds (by disbursement category, showing the Bank’s share in the financing of expenditures, cumulative (project to-date; year-to-date and for the period) vs. budgeted expenditures, including a variance analysis;  IFR 1B - Uses of Funds by Project Activity or Component, cumulative (project-to-date; year- to-date and for the period) vs. budgeted expenditures, including a variance analysis;  IFR 1C - Reconciliation of the Designated Account. 23. External Auditing: Annual financial statements would be audited by independent auditors, satisfactory to the Bank, in accordance with acceptable auditing standards. The external audit would be conducted according to Terms of Reference acceptable to the Bank. The auditor’s report would be submitted to the Bank no later than six months after the closing of the Borrower’s fiscal year, and the annual audit would be financed out of loan proceeds. 24. Supervision Plan: The scope of project supervision would review the implementation of FM arrangements and FM performance, identify corrective actions, if necessary, and monitor fiduciary risk. It would take place every six months and include: (i) reviewing of quarterly IFRs; (ii) reviewing of the auditors’ reports and follow-up of any issues raised by auditors in the management letter, as appropriate; (iii) participation in project supervision (including visits to the subprojects – RPOs); and (iv) updating the financial management rating in the Implementation Status Report (ISR). Procurement 25. Procurement for the Project would be carried out in accordance with the World Bank’s “Guidelines: Procurement under IBRD Loans and IDA Credits�, dated January 2011, and “Guidelines: Selection and Employment of Consultants by World Bank Borrowers� dated January 2011, and the provisions stipulated in the Legal Agreement. The general description of various items under different expenditure category is described below. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for prequalification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank project team in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. 26. Procurement of Works: Under Component 1, works would be procured by Rural Producer Organizations (RPOs) following Commercial Practices (par. 3.13 of the Guidelines, and detailed below) and would include only small works to expand or adapt RPOs’ facilities, as required to implement the respective business plans. Under Component 2, works would be procured by RPOs implementing subprojects, following Community Participation in Procurement, whose procedures would be outlined in the Project Operational Manual, and would include small-scale infrastructure investments, mainly in water resources. Under Component 3, works would be procured by ProRural and would include minor works and reforms to its facilities, including those of the regional offices. 27. Procurement of Goods: Under Component 1, goods would be procured by RPOs following Commercial Practices (par. 3.13 of the Guidelines) and would include, inter alia, production inputs, farming, storage, and processing equipment, as required to implement the respective 37 business plans. Under Component 2, goods would be procured by RPOs implementing subprojects, following Community Participation in Procurement, whose procedures would be outlined in the Project Operational Manual, and would include construction material and equipment required for small-scale infrastructure investments, mainly in water resources. Under Component 3, goods would be procured by ProRural and would include, inter alia, information hardware, audio-visual equipment and other office equipment. 28. Procurement of non-consulting services: Under Component 1, non-consulting services would be procured by RPOs following Commercial Practices (par. 3.13 of the Guidelines, and detailed below) and would include, inter alia, unskilled labor and equipment installation, repair or maintenance services. Under Component 2, these services would be procured by RPOs implementing subprojects, following Community Participation in Procurement, whose procedures would be outlined in the Project Operational Manual, and would include mainly unskilled labor contracted from among community members. Under Component 3, these services would be procured by ProRural, following National Competitive Bidding (NCB) or Shopping procedures, using standard model documents approved by the Bank and included in the Project Operational Manual. Under NCB and as an alternative to Shopping, these services could be procured following reverse auction (Pregao) procedures or under Framework Agreements, as these have been reviewed and found acceptable to the Bank. 29. Selection of Consultants: Under Component 1, consulting services from firms and individuals would be selected by RPOs, under subprojects, following Commercial Practices (par. 3.13 of the Guidelines, and detailed below) or a Selection Based on the Consultant’s Qualifications and would include pre-investment activities to: (i) support technical, extension and training services to create and consolidate value-added arrangements among RPOs and other commercial stakeholders; (ii) identify potential business opportunities and prepare business proposals; (iii) prepare related business plans; and (iv) build capacity among technical service providers to enhance the quality of their services in support of RPOs’ competitiveness; and demand-driven value-added technical assistance to support the implementation by RPOs of viable business plans including, inter alia: (i) diversification and improvement of production/farming systems; (ii) agro-processing; (iii) support to meet legal environmental and sanitary requirements for market access; and (iv) marketing and logistics. 30. Under Component 2, consulting services from firms would be selected by RPOs, under subprojects, following a Selection Based on the Consultant’s Qualifications (par. 3.7 of the Guidelines) or a Single-Source Selection (par. 3.8(c) of the Guidelines); individual consultants would be selected on a single-source basis (par. 5.6(b) and 5.6(d) of the Guidelines). These services would include technical assistance and capacity building for subproject preparation, works supervision, and promotion of innovative management models for decentralized water administration and service delivery. ProRural would identify, orient and later certify qualified service providers (i.e., Positive Long List) in order to assist RPOs selection of technical service providers (see Annex 2). 31. Under Component 3, consulting services from firms would be selected by ProRural, following either a Selection Based on Quality and Cost, Selection under a Fixed Budget, Least- Cost Selection, Selection Based on the Consultant’s Qualifications, or a Single-Source Selection; 38 individual consultants would be selected following the procedures outlined in par. 5.2 and 5.3 of the Guidelines and on a single-source basis, in accordance with par. 5.6 of the Guidelines. These services would include: (i) technical and administrative management of the Project; (ii) implementation and supervision of the ESMF, the IPPF and the Project Communication Strategy; (iii) updates to ProRural's Management Information System for use in project monitoring; and (iv) design, development and implementation of an impact evaluation module to track progress on results indicators. 32. Short lists of consultants for services estimated to cost less than $500,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. 33. Training financed under the Project would include expenditures (other than those for Goods, Non-Consulting Services and Consultants’ services) incurred by the Borrower to finance reasonable transportation costs and per diem of trainees and trainers (if applicable), accommodations, catering, rental of training facilities, as well as materials and equipment under the Project. 34. Operating Costs financed by the Project would include the reasonable incremental operational costs (which would not have been incurred absent the Project), related to project monitoring and supervision incurred by ProRural under the Project, excluding expenditures for civil servant salaries and related benefits, e.g., incremental costs of the technical and administrative management staff of the Project, office equipment, supplies, and maintenance, air tickets, updates to ProRural's Management Information System for use in project monitoring, printing services, telecommunication costs, and travel costs (transportation, per diem, accommodations), leasing of facilities, utilities, maintenance of office facilities; rentals of vehicles and other equipment required for project support, and logistics services. These expenditures would be incurred following the agency’s administrative procedures, which were reviewed and found acceptable to the Bank. 35. Guidelines for use of Commercial Practices under Component 1: Component 1 would finance subprojects for “Investments in Rural Economic Inclusion�, following business plans proposed, developed and implemented by participating RPOs. The sub-grant to an RPO in support of a business plan would be, on average, US$100,000 equivalent, with an upper limit of US$200,000. Business plans are evaluated by the Technical Evaluation Committee (see Annex 2) for compliance with environmental, financial, institutional, social, technical, and fiduciary guidelines (per the Project Operational Manual). 36. The provisions described in Section I of the Guidelines apply to all procurement methods used under the Project, i.e., all principles, rules, and procedures outlined in the Guidelines apply to all contracts financed in whole or in part from Bank loans. To comply with such requirement, four main considerations should guide the use of Commercial Practices by the RPOs:  the need for economy and efficiency;  the need for quality services;  giving all eligible bidders the same information and equal opportunity to compete in providing goods, works, and services; and  the importance of transparency. 39 37. RPOs, as private sector enterprises, would often meet these concerns by following established commercial practices other than formal open bidding for their procurement. This is true because when RPOs seek a supplier, the important and relevant considerations include quality, performance, price, delivery, capacity, and assurance of supply. Market forces would ensure a fair and reasonable price while competitive markets would be the driving force leading to RPO’s having efficient internal operations. In addition, RPOs would buy-to-sell a product or service to raise revenues. RPOs are for-profit and have the threat of bankruptcy, which force efficiencies into their procurement process. 38. As such, RPOs’ business plans would include a built-in mechanism to prevent them from paying too much for goods and services. If they do not buy wisely, the market place is unforgiving. As actual commercial practices may vary significantly from industry to industry, one size would not fit all. Therefore, being able to accommodate terms and conditions for good procurement would be an important aspect of the business plans, requiring sound technical understanding of products, services, and industries. Therefore, business plans must contain specific criteria to measure performance of the commercial practices used. 39. Guidelines for use of Community Participation in Procurement under Component 2: Component 2 would finance “Complementary Rural Infrastructure� subprojects to support the State's efforts to extend its basic infrastructure network in rural Pernambuco, primarily: (i) access to water supply and sanitation services for both productive use and household consumption; (ii) improve water productivity; and (ii) promote innovative management models for decentralized water administration and service delivery. 40. The procedures for the procurement under these subprojects would normally include the comparison of at least 3 price quotations. However, building on the experience from projects implementing similar CDD operations in other Northeastern states, direct contracting would also be permitted when circumstances indicate this method offers an advantage over local Shopping. This advantage should be assessed on the basis of economy, efficiency, and transparency. 41. Economy could be assured by ProRural, at the time the subprojects are reviewed and final cost estimates are defined. To come up with these final figures, ProRural should survey the regional market, in the case of goods, works, and services, or consult official price databases, such as ORSE (ORSE is also used by CAR in Bahia to calculate subproject amounts) or SINAPI, for works, to establish the grant amounts required to finance the contracts under the subprojects. 42. As the RPOs would not be required to compare price quotations for works contracts, for instance, or to request prices from suppliers from out of state to which they do not have easy access, the direct contracts would be less time consuming and more efficient than the competitive process. 43. The RPOs would, however, ensure that transparency of all procurement, purchase, and/or contract decisions. To this end, it should meet collectively at the assembleias, where all issues would be publicly discussed and the democratic decisions by the majority would be duly recorded in the meeting minutes. Additional recommended actions would include using regular 40 advertisement tools that are available at the communities, such as notice boards at schools and public buildings, local radios, municipal councils, etc. 44. Assessment of the agency’s capacity to implement procurement: The Bank conducted a capacity assessment of ProRural during project preparation, and the risk is Moderate. An action plan, agreed with ProRural, is given in Table 2. 45. Procurement Plan: The Procurement Plan would provide the basis for the procurement methods used during project implementation. This Plan would be agreed with the Bank prior to negotiations and made available in the Project’s database and on the Bank’s external website. The Procurement Plan would be updated periodically in agreement with the Bank or as required to reflect the actual project implementation needs and improvements in institutional capacity. Table 2 Action Time Frame 1. ProRural to finalize procurement sections of the Project Prior to Effectiveness Operational Manual. 2. ProRural to conduct training-of-trainers for TSPs During implementation concerning Commercial Practices under Business Plans. 3. ProRural to conduct training on Bank-financed During implementation procurement for participating RPOs. 4. Evaluate RPOs’ performance in conducting During implementation Commercial Practices under Business Plans, as part of the Impact Evaluation.11 Environmental and Social (including safeguards) 46. Environment (OP/BP 4.01): The Project is Category B as the impact is limited in scope, localized, temporary and reversible. The Borrower has carried out an Environmental and Social Management Framework (ESMF). The Project implementation procedures will adopt strict environmental "screens" to ensure that approved subprojects demonstrate low potential for negative impact. The ESMF assessed the most common types of intervention expected, and proposed mitigation measures a priori. On July 14, 2011, the Borrower publicly disseminated the ESMF on its website (www.prorural.gov.br), as did the Bank in its website. 47. Natural Habitats (OP/BP 4.04): Activities under the project components should lead to positive impacts on natural habitats, through the direct protection and rehabilitation of Areas of Permanent Preservation (APP) and Legal Reserves (RL). The Project has provisions to regenerate and reforest water-producing systems (mainly riparian vegetation), benefiting also local biodiversity preservation and restoration. Subprojects resulting in any significant conversion or degradation of critical natural habitats will not be eligible. Springs and river margin areas are classified as APPs, and legally protected by Brazilian Legislation (Federal Law 4771/65). APP use for water systems development, intake and pipelines, requires specific permitting, mitigation and regeneration measures. Commercial or productive use of the reforested areas will not be allowed. 11 See Monitoring and Evaluation, para. 57. 41 48. Forests (OP/BP 4.36): Typical activities financed under the Project should support mainly small-scale rural producers and restoration activities, and should be planned and executed in such a way as to minimize or prevent negative impacts on forest areas. The Project will not allow activities resulting in deforestation and loss of native vegetation cover. The Project also excludes activities that require commercial forest harvesting, wood extraction or firewood use in the production chain. 49. The ESMF includes guidance on: (i) screening out subprojects that would negatively affect natural habitats; and (ii) maximizing sustainable management of the affected APPs to improve the health and quality of natural habitats while minimizing direct and induced adverse impacts arising from subproject activities. 50. Pest Management (OP 4.09): The Project will encourage the control of pest populations through the integrated pest management framework within the ESMF. It is expected that minor amounts of pesticides would probably continue to be used (in the short term) by a small portion of targeted small-scale farms. As such, the Project would encourage and support technical assistance for the adoption of organic agriculture and of proven, economically- and environmentally-sustainable Integrated Pest Management (IPM). This approach would increase farmer productivity (i.e., yields), reduce input costs and human health risk, and minimize adverse environmental impacts through the gradual elimination of pesticide use. The IPM approach further improves the sustainability of agro-ecosystems by focusing on the knowledge and skills of farmers to better enable natural resource management. 51. The Borrower prepared Pest Management procedures that are incorporated in the ESMF and the draft Project Operational Manual. The pest management will make use of the World Health Organization's Recommended Classification of Pesticides by Hazard and Guidelines to Classification (Geneva: WHO 1994-95). The need to use pesticides or herbicides should be indicated in each subproject, as well as the IPM measures to be adopted. When the use of pesticides or herbicides is justified, an analysis of potential negative impacts resulting from the use of these chemicals and the risks associated with the inappropriate handling or storing of their containers should be conducted. The subprojects should also include measures to reduce those risks, in compliance with Law No. 7802/89. 52. Physical Cultural Resources (OP/BP 4.11): Eligible subprojects will not support significant excavations, demolition, movement of earth, flooding or other environmental changes, nor will subprojects be located in, or in the vicinity of, a physical cultural resources site recognized by the relevant Brazilian authorities. Nonetheless, this policy is proactively triggered. Although unlikely to happen, the Borrower has screening procedures in the ESMF and draft Project Operational Manual to deal with “chance findings� of archeological material during subproject implementation. Social 53. Indigenous Peoples (OP/BP 4.10): Indigenous peoples are present in the project area and will be among the potential beneficiaries. Adverse effects are not expected for them under this Project. There are about 50,000 indigenous peoples in the State of Pernambuco comprising eleven ethnicities. The Xukuru, Pankararu, Truká, Atikum and Fulni-ô comprise 72% of this population and there are smaller numbers of the Kambiwa, Kapinawa, Pankaiuká, Pankará, 42 Pipipã, and Tuxá peoples. Ten indigenous lands are already regularized in the State, encompassing 121,414 hectares. In addition, the Pankaiuká, Pankará and Pipipã peoples are seeking recognition and/or regularization of three lands comprising more 61,000 hectares. These lands are mostly located in the semi-arid region of Pernambuco. 54. The recently-closed Bank-financed Rural Poverty Reduction Project (RPRP) in Pernambuco successfully implemented an IPPF, established a network of collaborating governmental and nongovernmental organizations, and financed fourteen indigenous demand-driven community subprojects that benefited about 5,000 indigenous peoples. The implementation of the RPRP's IPPF was highly participatory and included periodic consultations with indigenous peoples for activity planning, monitoring and evaluation. Lessons learned from the RPRP have been applied under the Project and incorporated in the State's Indigenous Action Plan 2010-1015. 55. The client conducted a new social assessment that underscored the pressures and threats these indigenous peoples face regarding their livelihoods (e.g., water scarcity, land shortage and degradation, encroachment and illicit activities, inadequate production technologies and barriers to their access to markets and finance) and their degree of social and economic vulnerability. Extensive consultations with all eleven ethnicities contributed to the preparation of a new IPPF, leading to: (i) the design of participatory mechanisms that assure the due consideration of indigenous peoples` capacities, cultures and traditional organization; and (ii) the broader indigenous community support for the Project. 56. The IPPF incorporates these indigenous inputs and recommendations, documents the consultation process, and takes into account the differing access of potential indigenous beneficiaries to public policies. On July 14, 2011, the Borrower publicly disseminated the IPPF on its website (www.prorural.pe.gov.br), as did the Bank on its website (see Annex 3). 57. Involuntary Resettlement (OP/BP 4.12): The Project is not expected to fund any subprojects that could potentially cause significant physical displacement and economic losses. In principle, the Project will seek to avoid involuntary resettlement, wherever possible. Nonetheless, some of the potential subprojects that could be financed under the Project, such as improvements and/or maintenance of rural roads or small-scale irrigation works, could possibly involve the relocation of people or acquisition of land. It is expected that, in these cases, the potential numbers of people who might be affected would be quite small and any land acquisition would be relatively small. Because the subprojects to be developed under the Project are not yet known, a Resettlement Policy Framework (RPF) was prepared, which was consulted with key stakeholders in March 2011, and publicly disseminated, and forms part of the Project Operational Manual. The RPF will serve as the guide to the site-specific formulation of Resettlement Action Plans (RAP), if needed, which in many cases would be Abbreviated Plans due to the relatively small numbers of people affected and relatively minor impacts.12 On July 14, 2011, the Borrower publicly disseminated the RPF on its website (www.prorural.pe.gov.br), as did the Bank on its website (see Annex 3). 12 Abbreviated RAPs would only be used for cases where 200 or less persons are affected, where they are not physically relocated or would lose 10% or less of productive assets. 43 Monitoring & Evaluation 58. Based on DIME-supported inputs toward evaluation design, the Project would conduct an Impact Evaluation to determine whether the proposed interventions generate a significant and positive impact for the participating RPOs with respect to the following:  market access of participating RPOs (measured by sales value);  production and productivity (measured by total production and production per hectare);  quality of life and satisfaction of RPOs (measured by access to durable goods and land value);  business management (as measured by the quality of decision-making regarding business plan implementation); 13 and  technology adoption by RPOs (measured by acquisition of productive capital, assimilation of innovative NRM, etc.). 59. Evaluation of project outcomes would measure quantitative and qualitative changes in income, employment, land and water use, inter alia, among participating RPOs. Evaluation of land use changes will indicate the extent to which existing agricultural land is being used more productively and sustainably by participating RPOs, and whether significant deforestation or other undesirable land use changes may be occurring. Evaluation design would attempt to capture both before-after and with-without project outcomes through the application of a randomized approach, where possible. Specifically, the competitive grants cycle will facilitate the formation of three groupings: (i) intervention (i.e., those RPOs with approved business plans); (ii) near control (i.e., RPOs which submitted business plans but were not approved for financing); and (iii) distant control (i.e., RPOs that did not participate in the Project). The formation of two control groups will mitigate the selection bias that can be expected, given that the demand-driven methodology of the Project requires that RPOs “opt-in� through self-selection (see Fig. 2). Fig. 2 Gross Benefits Intervention Beneficios Correction for Selection Bias é Near Control Distant Control Time 13 See para. 43. 44 60. The Bank team is working with ProRural in a detailed design of the impact evaluation (to be included in Project Operational Manual), along with a detailed Control Group identification strategy and a detailed methodology of analysis. In addition to the proposed impact evaluation:  Annual beneficiary assessments, along with quarterly project reporting through the MIS, would allow semiannual supervision missions to assess the status of obtaining key project outcomes. This evaluation process will also examine environmental variables, including: (i) the extent to which approved LPA Business Plans (and associated subprojects) contain appropriate environmental mitigation measures and whether these measures are adequately implemented; and (ii) water quality in investments financed under Component 2. During Bank supervision, learning workshops for both ProRural and Bank project staff would identify and discuss lessons learned from project implementation with project stakeholders and beneficiaries.  A Mid-term Review of project execution would be conducted by the Bank’s supervision team no later than 30 months after the first disbursement. The MTR would assess: (i) progress in achieving project outcomes; (ii) efficacy of institutional arrangements for project implementation; (iii) the Project Operational Manual, suggesting revisions and updates as warranted; (iv) preliminary results of LPA Business Plans and associated subprojects; (v) producer income increases and production cost reduction; and (vi) fulfillment of Annual Operating Plans and the Procurement Plan; and (vii) Environmental and Social Safeguard compliance.  A final evaluation would be conducted in the last semester of project execution to assess the achievement of the PDO and the expected project results. Additionally, the outputs from the final evaluation would serve as inputs toward the design for follow-up interventions, as needed, in support of rural competitiveness in Pernambuco. 45 Annex 4 Operational Risk Assessment Framework (ORAF) BRAZIL: Pernambuco Rural Economic Inclusion Project Stage: BOARD Project Stakeholder Risks Rating: Low Description: Reduced political commitment to the Risk Management: Continuous dialogue with State counterparts during Project Development Objective implementation to confirm GOP commitment. Opposition from organized producer associations Engagement with Client during multi-year plan development. Continuous Inadequate technical service provision consultation with RPOs in the project area during preparation, as well during supervision, to build consensus on PDO and methodology. SEBRAE, financial institutions, NGOs took part in project preparation and are expected to actively participate in the Project during implementation. Resp: State Government, Stage: Due Date: Status: NYD SEBRAE, financial Implementation Ongoing institutions, NGOs Implementing Agency Risks (including fiduciary) Capacity Rating: Moderate Low capacity of RPOs to prepare and implement Risk Management: Commercial partnerships with key actors in producer chains quality business plans who jointly with RPOs participate in business plan formulation and share market intelligence. Poor outreach by ProRural to target population limits SEBRAE, NGOs (CONTAG) active in market access initiatives. uptake by RPOs. Low institutional capacity to reach out to ProRural’s satisfactory implementation of JSDF TF targeting Quilombolas; Rural traditionally excluded populations (Quilombolas, Poverty Reduction Project obtained replicable and satisfactory outcomes with the Indigenous People, Women, Youth) state’s indigenous population. Resp: RPOs, Stage: Due Date: Status: NYD ProRural Implementation Ongoing 46 Governance Rating: Moderate Description: Non-adherence to project rules and Risk Management: Project operational manual widely disseminated under the guidelines project communication strategy; steering committee oversight. Strong social oversight already in place and functioning through CMDRs. Stage: Due Date: Resp: CMDRs Status: NYD Implementation Ongoing Project Risks Design Rating: Moderate Description: Subsidies to RPOs for business plans Risk Management: Project would build dialogue with financial institutions (e.g., distort rural financial markets Banco do Brasil, Banco do Nordeste) with the aim of their inclusion in business plan financing. Explore alternatives to guarantee financial risk of RPOs to improve their creditworthiness. Resp: Stage: Due Date: Status: NYD SARA/ProRural Implementation Ongoing Social & Environmental Rating: Moderate Description: Safeguard capacity building, RPO Risk Management: An ESMF and IPPF addresses safeguard compliance and capacity building, demographic distortions in proposes actions, where needed, to ensure adequate technical capacity. potential access to project benefits A social assessment and an IPPF address the main risks and restrictions that may hinder the participation of these most vulnerable social groups and proposes mitigation measures. RPOs’ capacity building, training and technical assistance will be assessed and funded, as needed, under proposed business plans. Focus of rural community infrastructure in access to water and basic sanitation should reduce the domestic workload and free women’s time for other productive economy. Resp: Stage: Due Date : Status: NYD SARA/ProRural Implementation Ongoing 47 Program & Donor Rating: Low Description: No issues. Risk Management: Stage: Due Date : Resp: Status: NYD Implementation Ongoing Delivery Monitoring & Sustainability Rating: Moderate Description: Timing of payments for business plans Risk Management: State has demonstrated previous good-practice in managing with production cycle. funds transfers to local organizations. M & E capacity of implementing agency. Bank team (including financial management specialist) share best-practice from other projects in the region. DIME support to impact evaluation design; M&E specialist on Bank team; ProRural to contract M&E specialist under Terms of Reference reviewed by the Bank. Resp: Stage: Due Date : Status: NYD SARA/ProRural Implementation Ongoing Implementation Risk Rating: Moderate 48 Annex 5: Implementation Support Plan I. Support to Implementation 1. The strategy for the implementation support (IS) draws on the risk profile of the Project (i.e., ORAF, Annex 4) and aims to enhance the client’s quality delivery of the proposed interventions. As such, the IS focuses on: (i) risk mitigation measures defined in the ORAF; and (ii) standard Bank supervision, including technical, institutional, safeguards (environment, social) and fiduciary aspects (financial management and procurement). 2. Semi-annual Bank supervision (including field visits to investments financed under Components 1 and 2) would concentrate in the follows areas:  Strategic: To the extent possible, supervision missions would meet with the Project Steering Committee (comitê gestor) to: (i) review project activities; (ii) re-confirm strategic alignment of the Project’s multi-sectoral aspects; and (iii) ensure the necessary coordination across the respective stakeholders.  Technical: Supervision would concentrate on the implementation of the subproject cycle with regard to Components 1 and 2, as well as ensuring ProRural’s ability to provide quality assurance for the Project’s interventions, both centrally in Recife and throughout its twelve regional offices. Randomized field visits would serve to verify compliance with the Project Operational Manual and stimulate adjustments to project design, as needed, given results on the ground. Market chain/ private sector specialists (Component1) and water and sanitation specialists (Component 2) would complement the permanent Bank supervision team, through short-term cross-support of Bank staff and, as warranted, targeted engagement of external technical experts. Ongoing support for M & E (through DIME and contracted evaluation expertise, as needed) would continue to strengthen ProRural’s ability to both monitor project progress and assess the impact of interventions.  Safeguards. The Bank team’s Brasília-based environment and social specialists worked with and advised ProRural staff in the preparation and consultation of the ESMF for the Project; this support would continue throughout project implementation, vis-à-vis the subprojects financed under Components 1 and 2. The social specialist also worked closely with the client’s team in the preparation and consultation of the IPPF, as well as the RPF, and would continue to do so during project implementation.  Fiduciary: The Bank’s Brasília-based financial management and procurement specialists would provide timely, targeted training to RPOs and ProRural prior to project Effectiveness and through periodic supervision during project implementation. These specialists would: (i) prepare ProRural staff to work with RPOs in conducting procurement under their respective subprojects, in compliance with the Procurement and Anti-Corruption Guidelines and the Project Operational Manual; (ii) ensure the capacity of RPOs to manage flow of funds and simple accounting procedures, in line with FM guidance; and (iii) work with ProRural in building its overall financial management and procurement capacity to improve and facilitate project management. Supervision of the Project’s financial management arrangements 49 would be conducted semi-annually and, as needed, in response to client needs. Procurement supervision would also be carried out semi-annually during regularly-scheduled Bank supervision.  Client Relations: The Task Team Leader (TTL) would: (i) coordinate Bank supervision to ensure consistent project implementation, as specified in the legal documents (i.e., Loan Agreement, Project Operational Manual); and (ii) meet regularly with the client’s senior representatives (i.e., ProRural) to gauge project progress in achieving the PDO and address implementation roadblocks, as they may arise. II. Skills Mix Required Skills Needed # Staff Weeks per #Trips per Comments FY FY Task Team Leader (Supervision) 6 3 HQ-based Procurement Specialist 3 2 Country-based Financial Management Specialist 3 2 Country-based Education Specialist 2 1 Country-based Environment Specialist 3 2 Country-based Social Specialist 3 2 Country-based Monitoring/Evaluation Specialist 3 2 Country-based Water and Sanitation Specialist(s) 5 2 Country-based Legal Counsel 1 - HQ-based Market chain/ Private Sector 5 3 To be Specialist determined III. Partners Name Institution/Country Role Private-sector Various/ to be Commercial partners with RPOs in the partners determined by preparation and implementation of viable participating RPOs business plans. Financial Institutions Banco do Brasil; Complementary financing of proposed Banco do Nordeste business plans (Component 1). Water and Sanitation FUNASA, SRHE, Collaborate on design and management of partners COMPESA, ASA, PSH water-related investments (Component 2) 50 Annex 6: Team Composition World Bank staff and consultants who worked on the Project: Team Member Title Unit 1. Edward W. Bresnyan, Jr. Senior Rural Development Specialist, TTL LCSAR 2. Thadeu Abicalil Senior Water and Sanitation Specialist LCSUW 3. Alberto Costa Senior Social Specialist/ETC LCSSO 4. Abdoulaye Sy M and E Specialist/ ETC LCSSD 5. Barbara Farinelli M and E Specialist/ ETC LCSSD 6. Daniella Arruda Program Assistant LCC5C 7. Eduardo França Financial Management Specialist/STC LCSFM 8. Erick C.M. Fernandes Senior Advisor/ Climate Change LCSAR 9. Isabella Micali-Drossos Senior Counsel LEGLA 10. Judith Lisansky Senior Anthropologist LCSSO 11. Kwang Wook Kim Private Sector Development Specialist/ETC LCSPF 12. Luciano Wuerzius Procurement Specialist LCSPR 13. Luis Dias Perreira Agricultural Economist FAO/CP 14. Maria Bernadete Ribas Lange Environmental Specialist LCSEN 15. Maria de Fátima Amazonas Senior Rural Development Specialist LCSAR 16. Maria Madalena dos Santos Education Specialist/STC LCSHD 17. Mariana Montiel Senior Counsel LEGLA 18. Mario Castejon Marketing Specialist/ Ag. Economist FAO/CP 19. Miguel-Santiago da Silva Senior Finance Officer CTRLN Oliveira 51 Annex 7: Economic and Financial Analysis Introduction 1. As the Project will respond to the explicit demands from its target population vis-a-vis the nature of the investment proposals to be considered and eventually supported, a detailed ex-ante cost-benefit analysis of the Project as a whole is not warranted. 2. In the case of productive subprojects to support business plan implementation (Component 1), although strategic production chains have been pre-identified14 by ProRural and would be prioritized under the Project, it would be the interested RPOs responding to market opportunities, through their LPAs, whether directly or through potential commercial partners, that would ultimately determine the product, scope and mix of supported subprojects. Total investment would be some US$109.7 million for approximately 150 Business Plans, with some 500 subprojects. 3. In the case of complementary infrastructure subprojects (Component 2), their nature, scope and mix would also be determined in a demand-driven manner. Component 2 would finance US$51.6 million in infrastructure for some 400 subprojects (averaging US$135,000 per subproject) and would benefit around 25,000 households, with an estimated US$ 1,600 per household (see summary in Table 1). Subprojects under this component are expected to include investments in water supply for rural households, sanitation, roads and other small-scale public infrastructure. Table 1 – Summary of number and investment per subproject Total Number of Average per Number of Average per Investment Subprojects Subproject Beneficiary rural producer ($R)1 (Est.) ($R) 1 households ($R) 1 Productive 169,880,000 500 339,760 10,500 16,179 subprojects Basic Infrastructure 79,980,000 400 199,950 25,000 3,199 subprojects TOTAL 249,860,000 900 - 35,500 - 1 Conversion from USD used the official UN exchange rate (1 March 2011) of 1 USD = 1.66 BRL Ex-ante Evaluation of Productive Subprojects (Component 1) 4. In order to obtain an ex-ante indication of the financial soundness of the types of investments likely to be supported by Component 1, indicative production models based on actual cases of producer groups were constructed using primary and secondary information collected during project preparation and appraisal. More precise and representative feasibility estimates could be 14 These include: Sheep and goat production, beekeeping, bovine milk, aquaculture, fruits, handicrafts, and textile confections. 52 generated during implementation using primary information from a larger sample of subproject proposals under consideration. Standard procedures should be applied for ex-ante and ex-post subproject evaluation. 5. Indicative financial impact estimates were obtained from the aforementioned subproject models. Estimated indicators included the Net Present Value (NPV) of incremental net benefit flows – at a discount rate of 12% - and the corresponding Internal Rate of Return (IRR). Switching values15 with respect to output prices and costs were also calculated to test the robustness of the financial indicators to volatility in revenue and costs. The results of the analysis are shown in Tables 2-4. 6. Indicative RPO subproject models include:  Honey production and marketing: In this case, 27 honey-producing households increase the number of beehives (from 190 to 605) and improve production technology. Major investments in this enterprise include new hives and equipment unit for honey extraction and packaging.  Milk production and marketing: The proposal involves an associative enterprise of 260 milk producers that produce approximately 6,300 liters of milk per day. Investments essentially involve cold storage tanks and related facilities and materials.  Small ruminants breeding: 25 households reduce their flocks from 920 to 650 heads and replace existing breeders with improved goat breeds. Improved husbandry and herd genetics result in increased productivity. Investments include new breeding stock, 3 new small pens and technical assistance.  Aquaculture (Tilapia production and marketing): This subproject involves an organized group of 12 fisher-folks moving from artisanal fishing to production and marketing of Tilapia. The venture’s main investments are floating cages and technical assistance. Table 2 – Financial indicators – productive investments Total Annual Net Incremental Job creation #rural Investment Revenue NPV IRR (pers. year) producers (R$) (R$)1 (R$) benefited Honey 144,310 143,239 286,360 51% 1 27 Milk 196,970 1,690,850 513,562 >50% n/a 260 Small 190,161 84,275 134,036 47% 2 25 Ruminants2, 3 3 Aquaculture 75,880 71,603 67,515 33% 7 12 1 All costs including family labor and depreciation deducted from gross revenue. 2 The reduction in the number of heads and the planting of pasture with endemic vegetation brings additional environmental benefits to those considered in this analysis. 3 Own-labor was not monetized and accounted for in these cases as beneficiaries work virtually full-time on the respective ventures. Their remuneration is the Annual Financial Net Revenue. 15 The percentage change that reduces the NPV of incremental net benefits to zero. 53 Table 3 – Financial indicators for the examples of subprojects (per households) Total Investment Annual Financial Incremental NPV (R$) Net Revenue (R$)1 (R$) Honey 5,344 5,305 10,605 Milk 758 6,503 1,975 2 Small Ruminants 7,606 3,371 5,361 2 Aquaculture 6,323 5,967 5,626 1 All costs including family labor and depreciation deducted from gross revenue. 2 Labor costs were not included in this case as all the beneficiaries work virtually full time on this venture. Their remuneration is the Annual Financial Net Revenue. Table 4 – Sensitivity analysis of the models of the subprojects examples Switching Value Switching Value Switching Value of Output Prices* (%) Output Prices (R$) Running costs1 (%) Honey 48% Honey=4.8 R$/kg 147% Milk 6% Milk=0.71 R$/lt 19% Small Ruminants Calf=R$65/ male head 19% 49% Calf=R$81/ female head Aquaculture 5% Fish=4.06 R$/kg 7% 1 Maximum changes in estimated values of costs and benefits to keep IRR equal or above 12%. 7. The analyzed subprojects provide significant incremental income to rural producers (R$441/month on average). The sensitivity analysis shows that, in general, subprojects present robust indicators. The most sensitive models with respect to output price are those for Milk and Tilapia production. Albeit most milk is currently sold to institutional markets and thus long-term sustainability could be questioned, it provides short-term market and price security during a period in which producers could, with adequate technical assistance, improve their productivity and market skills. The Tilapia subproject has a well-diversified and sizeable market, and producers continue to increase productivity as they learn the trade. The producer group has been provided key technical assistance by the Municipality. Ex-ante evaluation of Infrastructure subprojects (Component 2) 8. The implementation of Component 2 aims at reducing the existing vulnerability and socio- economic gap facing the rural population of Pernambuco and support the creation of new opportunities for them (see Annex 3 for details). Studies such as Songco (2002) have shown that the investment in public infrastructure yields substantial improvement in the lives of the poorest, namely when these investments aim at the improvement of their existing livelihoods (Songco, 2002). Baquero et al (2006) state that the access to assets [by rural populations] enables a better risk management and a more active participation in social and political life, as well as better capacity to seize opportunities and more easily confront challenges. 9. As mentioned before, the nature of the Project’s implementation – demand driven and locally designed subprojects – does not allow for a meaningful detailed ex-ante evaluation of the Project as a whole. The models used for the following preliminary cost-benefit assessment of the infrastructure investments to be financed by Component 2 are cases drawn from the Implementation Completion and Results (ICR) report for the Rural Poverty Reduction project 54 (RPRP) of Pernambuco (July 2010). These include 14 subprojects of water supply and 8 of home sanitation. As per Annex 3 of this ICR, “there was a certain comfort level in exploring the results obtained [from the analyzed subprojects] for four basic reasons: (i) the apparent homogeneity (i.e., representativeness) of the units comprising the universe by type of subproject; (ii) the intentional decision to include subprojects considered by knowledgeable people to be moderately successful, that is, the sampled units were not limited exclusively to very successful subprojects; (iii) the STU [State Technical Unit] took care to select subprojects considered ‘typical’; and (iv) the communities composing the sample were geographically-dispersed.� It is expected that the nature of the subprojects demanded for Component 2 financing will be similar to that experienced during the RPRP. 10. The economic and financial data for the analyzed subprojects were obtained during field visits undertaken by the ProRural team, which interviewed beneficiaries and CA leaders. These data allowed calculating Present Values (NPV) of costs and benefits, Benefit/Cost Ratios (B/C) and Internal Rates of Return as presented in Table 5. IRRs and PVs were estimated using a 10- year period, and PVs using a 10% discount rate16. The costs of the subprojects include the initial investment and, in the case of Water Supply, annual operating costs. Given that both projects do not generate income, benefits were calculated on the following basis:  Water supply with household connection and cisterns: revenue for water consumption and membership fee (proxy for willingness to pay for unmeasured benefits); value of time of family members freed from having to catch water; value of incremental employment generated by water availability; value of reduced diseases and incremental investments.  Home sanitation: Total initial investment; value of reduced diseases and incremental value of the houses due to the investments received. (ICR report, 2010). Table 5 – Financial analysis of two types of Basic Infrastructure subprojects PV of PV of B/C IRR Switching Value Switching Benefits Costs Ratio Output Prices Value Op. (%)* Costs (%)1 Water R$413,601 R$122,644 3.37 >25% 67% 206% supply Home R$146,615 R$129,817 1.13 12% 3% 22% Sanitation 1 Maximum changes in estimated values of costs and benefits to keep IRR equal or above 10%. 11. The financial analysis of Water Supply and Home Sanitation subprojects showed positive results. Those of Water Supply subprojects were quite robust, presenting IRRs above 10% even when submitted to high increases in costs or decreases in benefits. Although Home Sanitation subprojects did not show results as robust as those for Water Supply, the implementation of both these types of subprojects could be justified by their impact on the wellbeing of the target population. According to UNICEF (2009) the two main causes of mortality among children under age five – acute respiratory infections and diarrheal diseases – are closely linked to poor 16 The discount rate applied is lower than that for productive subproject as investments in infrastructure usually result in additional unvalued benefits that are expected to exceed unvalued costs. 55 water, hygiene and sanitation. Additionally the UNICEF “Sanitation for All� report states that rural investment in water supply and sanitation results in lower rates of death and sickness, savings in health costs, higher worker productivity, better learning capacities of school children, increased school attendance, especially by girls, strengthened tourism, and heightened personal dignity and national pride. 12. The fact that subprojects can be justified by their impact on the wellbeing of the target population is also valid for other types of subprojects (roads and educational, health and social assistance related infrastructures) that may be implemented under Component 2. For example, according to Baquero et al (2006) education and capacity building produce positive effects on wellbeing, including in isolated rural areas (this work defends that the impacts of education tend to be more robust where migration and economic mobility is easy). Songco (2002) shows evidence of increased income in small farmers communities in several countries after the construction of an access from the community site to the closest road. References Baquero, F. Rocha J. Ortega, J. (eds.) (2006). Políticas Públicas y Desarrollo Rural en América Latina y Caribe: el papel del gasto público. FAO. Santiago. Chile. Songco, J. A. (2002). Do Rural Infrastructure Investments Benefit the Poor?. School of International and Public Affairs, Columbia University and the World Bank. Vietnam. UNICEF (2009). Community Approaches to Total Sanitation. Field Notes: UNICEF Policy and Programming in Practice. New York. USA. UNICEF (2001). Sanitation for All – Promoting Dignity and Human Rights. New York. USA. 56 57 IBRD 39094 GUYANA STATE BOUNDARIES SURINAME NORTHEAST R.B. DE VENEZUELA French REGION BOUNDARIES BRAZIL Guiana (Fr.) INTERNATIONAL BOUNDARIES STATE OF PERNAMBUCO COLOMBIA RORAIMA RURAL ECONOMIC INCLUSION PROJECT REGIONAL OFFICES OF THE STATE TECHNICAL UNIT AREA EXCLUDED FROM THE PROJECT AMAZONAS PAR� RIO GRANDE MARANHAO CEAR� DO NORTE 600 ISOHYETS IN MM PARA�BA PIAU� CLIMATIC ZONES: ACRE PERNAMBUCO RO ALAGOAS SEMI ARID ND ÔN IA TOCANTINS Area of SERGIPE REGIAO DO SEMI-ARIDO MATO Map PERU GROSSO BAHIA TRANSITIONAL ZONE AGRESTE BRASILIA BOLIVIA GOI�S COASTAL FOREST MATO MINAS ZONA DA MATA GROSSO ESP�RITO GERAS SANTO DO SUL SÃO MAIN ROADS PAULO RIO DE CHILE PARAGUAY JANEIRO MAIN CITIES PARAN� REGIONAL OFFICES SANTA RIO CATARINA STATE CAPITAL This map was produced by the Map Design Unit of The World Bank. ARGENTINA GRANDE DO SUL ATLANTIC STATE BOUNDARIES The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank OCEAN Group, any judgment on the legal status of any territory, or any URUGUAY endorsement or acceptance of such boundaries. 800 41°00' 40°30' 40°00' 39°30' 39°00' 38°30' 38°00' 37°30' 37°00' 36°30' 36°00' 35°30' 35°00' 600 0 120 100 0 Brejinho 140 0 60 0 160 0 800 Camutanga 7°30' Exú C E A R � S. José També P A R A � B A Timbaúra 800 do Egito Macaparana 7°30' 600 Araripina Goiana Tuparetama S. Vicente Ferrer Ipubi Alianca Condado Morelândia Granito Vicéncia Afogados da Itaquitinga Cedro Machados Sta. 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Bento Ribeirão 8°30' Orocó Venturosa do Una Belem Floresta Buíque Cupira de Maria Gameleira Sirinhaém Belem de são Lajedo Catende Francisco Palmares Rio Formoso Sta. Maria Jupi Panelas �gua Preta da Boa Vista Iracuraba Tupanatinga Caetes Calcado Maraial Xexeu 0 Barreiros 2200 400 40 Inajá Garanhuns Quipapa Itaparica Paranatama Itaíba Canhotinho Nova Petrolândia S. José da Reservoir 9°00' B A H I A Salao Palmeirina Coroa Grande 9°00' 20 Iati Brejão 160 1200 o 00 18 is c Tacaratu 00 anc Aguas Belas Terezinha Correntes 00 o Fr 0 14 Rio Sã Sobradinho 0 10 20 30 40 Bom Conselho 0 ATLANTIC 40 Reservoir A L A G O A S 600 KILOMETERS OCEAN Petrolina 40 1000 800 41°00' 40°30' 0 40°00' 39°30' 39°00' 38°30' 38°00' 37°30' 37°00' 36°30' 36°00' 35°30' 35°00' FEBRUARY 2012 The original had problem with text extraction. pdftotext Unable to extract text.