India - Andhra Pradesh Power Sector Restructuring Project (APL 1)

Document of The World Bank Report No: 27775 IMPLEMENTATION COMPLETION REPORT (SCL-44410 PPFB-P3340) ON A LOAN IN THE AMOUNT OF US$ 210 MILLION TO THE GOVERNMENT OF INDIA FOR ANDHRA PRADESH POWER SECTOR RESTRUCTURING PROJECT (APL I) February 20, 2004 Energy and Infrastructure Unit South Asia Region  CURRENCY EQUIVALENTS (Exchange Rate Effective : February 2004) Currency Unit = Indian Rupee (Rs.) Rs. 100.00 = US$ 2.18 US$ 1.00 = Rs.45.80 FISCAL YEAR April 1 March 31 ABBREVIATIONS AND ACRONYMS APERC Andhra Pradesh Electricity Regulatory Commission APERL Andhra Pradesh Economic Reform Loan APGENCO Generation Corporation of Andhra Pradesh Ltd. APL Adaptable Program Lending APSEB Andhra Pradesh State Electricity Board APTRANSCO Transmission Corporation of Andhra Pradesh Ltd. ARR Annual Revenue Requirement CIDA Canadian International Development Agency CPDCL Central Power Distribution Compnay Ltd. CRISIL Crisil Advisory Services DEA Department of Economic Affairs DFID Department for International Development Discoms Distribution Companies ERR Economic Rate of Return EPDCL Eastern Power Distribution Compnay Ltd. FRR Financial Rate of Return FY Fiscal Year (Indian) GOAP Government of Andhra Pradesh GOI Government of India GSDP Gross State Domestic Product GWh Gigawatt hour HT High Tension KV Kilo volt kWh Kilowatt hour LT Low tension MOU Memorandum of Understanding MTFF Medium Term Fiscal Framework MU Million Unit (Unit=1kWh) NPDCL Northern Power Distribution Compnay Ltd. PMU Project Management Unit QAG Quality Assurance Group SPDCL Southern Power Distribution Compnay Ltd. T&D Transmission & Distribution Vice President: Praful C. Patel Country Director Michael F. Carter Sector Director John A. Roome Task Team Leader/Task Manager: Bhavna Bhatia  INDIA AP POWER SECTOR RESTRUCTURING PROJECT (APL I) CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 4 5. Major Factors Affecting Implementation and Outcome 14 6. Sustainability 15 7. Bank and Borrower Performance 17 8. Lessons Learned 21 9. Partner Comments 24 10. Additional Information 25 Annex 1. Key Performance Indicators/Log Frame Matrix 27 Annex 2. Project Costs and Financing 31 Annex 3. Economic Costs and Benefits 33 Annex 4. Bank Inputs 36 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 40 Annex 6. Ratings of Bank and Borrower Performance 41 Annex 7. List of Supporting Documents 42 Annex 8. Key Achievements of APERC 43 Annex 9. Financial Performance of the Power Sector 46 Annex 10. Distribution Companies - Efficiency Improvement Initiatives 49 Annex 11. Technical Assistance Support provided to Andhra Pradesh Power Sector 51 Annex 12. Transition Arrangements to Regular Operation 52 Annex 13. Andhra Pradesh's Assessment of the Implementation of APL1 53  Project ID: P049537 Project Name: AP POWER APL I Team Leader: Bhavna Bhatia TL Unit: SASEI ICR Type: Core ICR Report Date: February 20, 2004 1. Project Data Name: AP POWER APL I L/C/TF Number: SCL-44410; PPFB-P3340 Country/Department: INDIA Region: South Asia Regional Office Sector/subsector: Power (100%) Theme: Public expenditure, financial management and procurement (P); Infrastructure services for private sector development (P); Regulation and competition policy (P); Legal institutions for a market economy (P); State enterprise/bank restructuring and privatization (S) KEY DATES Original Revised/Actual PCD: 06/30/1998 Effective: 06/04/1999 03/22/1999 Appraisal: 10/05/1998 MTR: Approval: 02/18/1999 Closing: 08/31/2003 08/31/2003 Borrower/Implementing Agency: Government of India/Government of Andhra Pradesh; Government of India/Transmission Corporation of Andhra Pradesh (APTRANSCO) and power distribution companies Other Partners: Department for International Development (DfID); Canadian International Development Agency (CIDA) STAFF Current At Appraisal Vice President: Praful C. Patel Meiko Nishimizu Country Director: Michael F. Carter Edwin R. Lim Sector Director: John A. Roome Alastair J. McKechnie Team Leader at ICR: Bhavna Bhatia Mohinder P. Gulati ICR Primary Author: Bhavna Bhatia 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustainability: L Institutional Development Impact: SU Bank Performance: S Borrower Performance: S QAG (if available) ICR Quality at Entry: HS S Project at Risk at Any Time: Yes  The Project was rated "at risk" during the period January-July 2003 on account of unsatisfactory performance in the areas of financial management, procurement and non-compliance with the financial covenants. The financial management rating was upgraded after submission of entity audit reports for FY2002 by all the six power utilities. There were some delays in the procurement decisions by the executing agency during this period. A close monitoring by the project team facilitated satisfactory resolution and the procurement rating was accordingly upgraded. The companies, at the loan closure, were in partial compliance of the financial covenants. 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: Background 3.1.1 Andhra Pradesh is one of India's leading reforming states which has, since 1999 implemented several measures towards fiscal, governance and sectoral reforms. Power sector reforms are at the center-stage of the Government of Andhra Pradesh's (GOAP) overall reform program, and are a key complement to the fiscal reform program because of the sector's large demand on the budget resources. Power sector reforms are critical to remove infrastructure constraints for accelerating economic growth as well as to bring a shift in the public expenditure from power sector to social sectors and other priority areas for public expenditure. By the late nineties the state was facing both energy and peak shortages and the quality of power supply had deteriorated; the power utility's financial losses had grown to Rs 39 billion and new investments were not financible. The power subsidies had increased to 1.6 percent of the Gross State Domestic Product (GSDP) while on the other hand the combined public expenditure on health and education had declined from 4.7 percent of GSDP in FY1987 to 3.6 percent of GSDP in FY1998. In the absence of power sector reforms the need for investment support and subsidies from the government's budget would continue to grow and crowd out social sector investments. 3.1.2 A comprehensive program of power sector reforms was initiated by the GOAP in 1999. The GOAP requested the Bank for a multi-phased adaptable program lending with an indicative financing of US $ 1 billion over a period of eight to ten years to support the implementation of reforms. This project (" the Project" or "APL1") is the first in a series of the Bank's Adaptable Program Lending operations aimed at providing programmatic support ("the Program") to Andhra Pradesh for reforming the power sector. 3.1.3 The development objectives of the Program are (i) to ensure that by FY2007 the energy requirements of the state are met and that consumers are provided with reliable, high-quality and cost effective electricity supply, by creditworthy and commercially operated utilities functioning in a competitive and appropriately regulated power market, with significant private ownership and participation; and (ii) to bring about a permanent shift in the public expenditure in the power sector from a major drain on the budget to a contributor of funds for social sectors and other priority areas for public investment. The program was designed to be implemented in a phased manner : Phase I (1999-2001) establishment of legal, regulatory and institutional framework, and removal of critical bottlenecks of the power system; Phase II (2001-2003) fully functional regulatory commission and corporate entities, privatization of a part of the distribution business, partial restoration of the sector's creditworthiness and improvement in system efficiency; Phase III (2003-2005) completion of distribution privatization, consolidation of the functioning and financial performance of new power utilities; and Phase IV (2005-07) deepening of reforms to increase competition and private participation, attainment of high customer satisfaction through reduction of power deficit, and improvement in quality and efficiency of electricity services. Implementation of Phase I and part of the Phase II (fully functional regulatory commission and corporate entitiess) has been completed; - 2 -  several initiatives for improving operational efficiency and customer service are underway; and the government now plans to deepen the reforms through introduction of competition. 3.1.4 An important component of the Bank's Country Assistance Strategy (CAS) in India has been to focus on states that demonstrate a commitment to reforms, particularly in financial management, power sector administration and governance. Andhra Pradesh is one of the focus states for the Bank's lending in India. The Bank is supporting Andhra Pradesh's program of fiscal and governance reforms through the structural adjustment support under the Andhra Pradesh Economic Reform Loan , and has also financed 1 investment projects in the areas of health, child nutrition, forestry irrigation and rural roads. Project Objectives 3.1.5 The development objectives of the first Project (APL1) were (i) to initiate the reform process by establishing the new legal, regulatory, institutional framework and industry structure (including establishment of an independent Regulatory Commission, creation of the new power companies and initiation of preparatory work for privatization of the distribution business) and (ii) to remove some of the critical bottlenecks of the power system. The project objectives were consistent with the Government's priorities and the Bank's Country Assistance Strategy. The power sector reforms were aimed to reduce pressures on the state's public finances and remove sectoral constraints to the state's economic growth, thereby facilitating sustainable poverty reduction. 3.1.6 The Project design was relevant for achieving the project objectives. A two-pronged approach of parallel implementation of policy reforms and investments to remove critical bottlenecks in the power system was an appropriate design. A High Level Committee set up by the GOAP under the chairmanship of Mr. Hiten Bhaya submitted its report on the medium term reform program in April 1995. The committee recommended unbundling of vertically integrated State Electricity Board, the establishment of an regulatory independent agency, and enactment of Electricity Reforms Act in the state to provide legal basis for the implementation of reforms. The design supported the GOAP's plan for reforms laid out in its detailed "Power Sector Policy Statement" (October 1998) and thus had the required ownership. 3.1.7 The project was built upon the four decade long experience of operations and management of the power sector under the public ownership, while specifically recognizing that (i) the government's multiple, but often conflicting roles as a policy maker, regulator and the owner of power utilities constrained the commercialization of the sector, (ii) government's interference in the operations, management and important decision making (investment, tariffs and personnel issues) of the state owned vertically integrated power utility had led to substantial deterioration in its operational efficiency and financial viability, and (iii) the prevailing system did not promote accountability or provide incentives to the managers and staff for improving performance. The project design also incorporated the limited experience available at that time from the two Indian states where the reforms had been initiated. 3.1.8 The project objectives were important but complex and demanding for the government and the implementing agency. The pervasive politicization of the power sector, opposition to reforms from strong and powerful groups with entrenched vested interests in the business as usual and the likely resistance from the employees posed significant risk to the project outcome. Also, the reform experience in Orissa and Haryana had generated considerable opposition and had not yet shown any tangible results. In the environment of unbundling and establishment of the new companies, which could create uncertainty and unrest among the employees, implementation of investment program was quite demanding for the executing agency. The expected outcome of the financial turnaround of the sector in FY2004 and the expectations of the pace of tariff rationalization and reduction in subsidy were ambitious. - 3 -  3.2 Revised Objective: The objectives were not revised during the life of the project. 3.3 Original Components: 3.3.1. The project had following four main components: (i) Transmission system augmentation. This component provided support for capacity augmentation of overloaded transmission lines and sub-stations, construction of new sub-stations and transmission lines to meet the load growth, establishment of switching sub-stations to provide operational flexibility to the system and installation of capacitors to improve voltage and reduce system losses. (ii) Sub-transmission and distribution system strengthening. The support was envisaged for (i) installation of three phase distribution transformers to provide relief where the transformer overloading was more than 150 percent (both in urban and rural areas), and single phase distribution transformers to improve voltages at the tail end of the distribution lines, (ii) augmentation of power transformation capacity at the existing 33/11 kV sub-stations to reduce overloading, improve supply reliability and meet load growth, (iii) construction of new 33 kV lines, and (iv) installation of breakers and battery system at the existing 33/11 kV substations for better transformer protection and feeder control. (iii) Metering system improvement. This component included support for installation of better quality and high accuracy consumer meters for improving billing accuracy, feeder meters for energy accounting, boundary meters for measurement of energy exchange between the unbundled power companies, and computer systems to process data at the distribution system level. (iv) Technical assistance for reform program management, institutional development of the Regulatory Commission, corporatization, commercialization, institutional development of the new power utilities, investment planning and other technical issues. 3.3.2 In addition, US $ 11 million were retained as unallocated amount to be utilized among the above mentioned four project components. At appraisal investment schemes costing US$ 125 million were finalized (referred as APL1 main schemes) and the remaining schemes were finalized during the project implementation (referred as APL1 supplemental schemes). The bi-lateral donors DFID and CIDA through provision of grant support for technical assistance have extensively supported the project. 3.4 Revised Components: The project components were not revised. 3.5 Quality at Entry: QAG rated the project highly satisfactory for quality at entry. The ICR rating for the quality at entry is in agreement with the QAG's rating. QAG assessment stated, "well articulated development objectives appear ambitious but not unreasonable in the light of developments in Andhra Pradesh so far". Further "initial actions taken suggest strong Borrower's commitment to reforming its power sector". QAG endorsed APL to be an appropriate instrument for supporting comprehensive reform program and well suited for the Bank's dealing with reform program risks. For the appropriateness and realism of project/conditionality the QAG stated that "sequencing of conditions, specially on subsequent APLs, appear well suited, leaving the Bank room for necessary flexibility while providing a clear framework". Readiness for implementation was rated as "highly satisfactory" by the QAG. 4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: 4.1.1 The Project has been successful in meeting its development objectives to a large extent. The outcome and impact resulting from the project implementation have been significant. The financial - 4 -  performance of the power sector is improving but continues to remain highly vulnerable. This section presents the assessment of the outcomes against the objectives set for the APL1 project. Objective 1: Establishment of the new legal, regulatory, and institutional framework and preparation for distribution privatization. 4.1.2 Functional unbundling of APSEB and corporatization. Andhra Pradesh was the third state in India to enact the state Power Sector Reform Legislation (February 1999) that sets the legal foundation for reforms, regulation, industry and market structure. The vertically integrated power utility has been restructured into six corporatized entities