Ceylon - Norton Bridge Hydro and Second Granpass Thermal Power Project

r4 Ilt CESTRCTE R e p o r t N o. P-z, This report was prepared for use within the Bank. It may not be published nor may it be quoted as representing the Bank's views. The Bank accepts no responsibility for the accuracy or completeness of the contents of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMEN REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE GOVERNMENT OF CEYLON FOR THE NOR TON BRIDGE HYDRO AND SECOND GRANDPASS THERMAL POWER PROJECT April 18, 1961  INMERNATIONAL BANK FOR RECONSTRUCTION Ai\TD DEVELOPMEiNT REPORT AND RECQYLIENDATIONS OF THE PRESIDEIJT TO THE EXECUTIVE DIE2CTORS ON A PROPOSED LOAN TO TUEB GOVERNMENT OF CEYLON FOR THE NORTON BRIDGE HYDRO AND SECOND GRABDPASS THEIu'AL PO' ER PROJECT 1. I submit the following report and recommendations on a proposal for a loan in various currencies in an amount equivalent to $15 Zilliat to the Government of Ceylon for the construction of a 50 MW hydro electric power station at Norton Bridge, a 25 MdI steam unit at the Grandpass Station near Colombo and certain transmission and distribution facilities. At present the Department of Government Electrical Undertakings (DGEU) is responsible for the development and operation of the electricity system in Ceylon. PART I - HISTORICAL 2. In September 1956, the Ceylon Government asked the Bank to consider a loan for a project which comprised the `iorton Bridge hydro electric plant and a 25 M44 thermal power station at Grandpass near Colombo. A request to the Bank to finance a second 25 MS unit at the Grandpass thermal station was made in October 1960. 3. In 1954, when the Bank made its first loan for power development, the Government undertook to adopt certain measures to improve the organi- zation and efficiency of the DGEU. Progress in this respect was very slow. As a result of further discussions early in 195S, the Government decided that it would be better to establish an autonomous power authority than to attempt to remedy the situation by further reforms of the Department. In view of this decision the Bank would have preferred to postpone making a loan until the new authority was established. However, since the need for ad- ditional generating capacity was becoming urgent the Dank agreed to proceed with consideration of a loan for the first 25 MW steam unit at Grandpass. 4. This loan of $7.4 million was made to the Government on September 17, 1958. The draft legislation to establish the Ceylon Electricity Board (CEB) was sent to the Bank for comments in January 1959. At that time it was ex- pected that if the Bank were asked to finance any further expansion of the system it would be able to lend to the CEB itself. Unfortunately, the political events that culminated in the assassination of the Prime Minister in September 1959 and the subsequent period of caretaker governments prevented legislative action on the bill until the present Government was elected in late summer of 1960.  - 2 - 5. By the end of 1960 it was apparent that to avoid a power shortage in later years it would be necessary to proceed at once with the instal- lation of additional generating capacity not only at Norton Bridge, but also at the Grandpass Thermal Station. The Bank mission went to Ceylon in October to discuss with the Government the position with respect to the establishment of the CEB and was satisfied that the Government was pro- ceeding with the legislation as expeditiously as possible. In view of the assurances of the Government and the urgency of the need for power the management agreed to proceed with consideration of a loan for these projects. 6. The proposed loan would be the equivalent of 1$15 million of which $12 million would be for the Norton Bridge hydro project including trans- mission and distribution facilities, and $3 million for the second 25 MW thermal unit at Grandpass. 7. Negotiations with representatives of the Government of Ceylon and the Department of Government Electrical Undertakings (DGEU) were held in WJashington in M'larch 1961. 8. If the proposed loan is made, it would be the Bank's third loan in Ceylon and would increase the total amount lent by the Bank to about $38.9 million net of cancellations. Loans previously made are: Amount of Loan Year Borrower Purpose Net of Cancellations 1954 Government Electric Power $116,500,000 1958 Government Electric Power $_7,400,000 Total net of cancellations $23,900,000 of which has been repaid 1_46.ooo Total now outstanding $22,654,000 Amount sold $ 717,000 Net amount held by Bank $21,937. 000/ l/ Includes $7,544,305 not yet disbursed as of ivlarch 31, 1961. Both loans are effective. PART II - DESCRIPTION OF THE PROPOSED LOAN 9. Borrower: Government of Ceylon. Amount: The equivalent in various currencies of $15 million. Amortization: 44 semi-annual instalments from November 15, 1964 to May 15, 1986. Interest Rate: 5 3/4% per annum, including 1% commission. Commitment Charge: 3/4 of 1% per annum. Payment Dates: May 15 and November 15.  - 3 - PART III - LEGAL INSTRUMENTS AND LEGAL AUTHORITY 10. Attached are a draft Loan Agreeinent between the Bank and the Government of Ceylon (lNo. 1) and the report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement (No. 2). The Loan Agreement conforms generally to the pattern of previous Loan Agree- ments with the Government of Ceylon. In the preamble, the proposed Loan Agreement includes an expression of the Government's intent to establish a Ceylon Electricity Board. In addition, the Loan Agreement includes the following points not covered in previous Loan Agreements: (a) Section 5.01(b) provides that the terms of reference for consultants shall be determined in consultation with the Bank; (b) Section 5.08 provides that the Borrower shall from time to time adjust electricity rates as may be necessary; (c) Section 5.09(b) provides that the Borrower will provide the Board with funds needed to carry out the Project; (d) Pursuant to Section 7.01, certain events of default under the proposed Loan Agreement would be events of default under the previous Loan Agreement. PART IV - APPRAISAL OF THE PROPOSED PROJECT Project Description 11. The project is described in the attached report, "Appraisal Report Norton Bridge Hydro and Second Grandpass Thermal Power Project", No. TO-268b (No. 3). 12. It consists of three major parts: 1) The construction of the Norton Bridge hydro plant which includes a tunnel, about 20,000 feet long, penstocks and a power house equipped with two 25,000 kw generating units; 2) construction and installation of a second turbo- generating unit of 25,000 kw at the Grandpass power house with the necessary auxiliary equipment; 3) transmission lines and distribution facilities including construction of about 150 miles of 132 kw double circuit lines, about 200 miles of lower voltage lines, and about 200 substations.  -4- Cost of Project 13. The total cost of the project is estimated at Rs. 15L47 million (US$32.5 equivalent), made up as follows:- (in US$ million equivalent) Local Currpncv Foreign Exchange Total Norton Bridge Hydro Plant 10.7 7.4 18.1 Second Grandpass Thermal Unit 1.6 3.0 4.6 Transmission and Distribution _2 4.6 __92 17.5 15.0 32.5. 14. The foreign exchange cost would be covered fully by the proposed loan. Interest during construction will not be included in the loan. The equivalent of about $12.5 million for local currency expenditures will be provided mainly by contributions from the Government. The draft legislation establishing the CEB provides that these will be converted into equity capital once the Board has been established. The equivalent of about $5 million is expected to be provided from earnings of the DGEU and later of the Board. Justification of the ProJect 15. The project is needed to meet the estimated annual growth of the DGEU system requirements over the next five years. Although thermal back-up for the existing and proposed hydro projects will be needed ultimately in any case, construction of a second thermal unit at Grandpass is urgently required to avert a power shortage before the Norton Bridge hydro project can be completed. 16. Procurement for the Norton Bridge hydro project would be on the basis of international bidding. However, procurement for the second unit at Grandpass would be by negotiating repeat orders with the suppliers of the first unit. Since the delay which would have been caused by calling for international bids would have frustrated the purpose of installing this unit at this time; and since the contracts for the first unit were placed after keenly competitive international bidding and the same manufacturers were able to quote favorable prices for repeat orders, the management agreed to this procurement procedure after a review of the tenders. Economic Situation 17. A recort "Current Economic Position and Prospects of Ceylon", (No. FE-20a), is attached (No. 4). Ceylon's economy is characterized by the importance of its export sector, which accounts directly for over 30% of national income. Its prosperity is therefore greatly affected by changes in the prices of its exports and in the terms of trade; for the past ten years these have on the whole been good and much better than in the years immediately after the war. Today per capita income in Ceylon is much higher than in India or Pakistan and is comparable with that of most other small countries in Southeast A'sia.  - 5 - 18. However, since the war the rate of population growth has risen to 3% per annum. This has placed a growing burden on the budget in two ways. First, the Government has had to increase capital outlays to try to provide opportunities of employment for the growing labour force; for, while production has been growing at about the same rate as population, part of this growth has been due to higher productivity and there has consequently been some increase in unemployment and underemployment. Second, government capital and current expenditures have grown sub- stantially in an effort to improve social services. In addition, for most of the past ten years the Government has been providing a very large subsidy to stimulate production of rice and to keep the price to the consumer down. 19. The resulting growth in public expenditures has led twice since the war to large government deficits that have been in great part financed by Central Bank credits. With Ceylon's open economy the inflationary pressures generated thereby resulted in increased imports and the loss of reserves. In the first period, from 1952/1954, reserves were drawn down by nearly 50%; but, with the elimination of the government deficit in the next two years, import demand abated and by the end of 1956 reserves were back to their former level. The second period began in early 1957 and the loss of reserves continued unchecked until the end of 1960. The cumulative loss by that time was 70% of the January 1957 figure, bringing reserves down to about $70 million net of liabilities or less than two months' imports. 20. The fact that no corrective measures were taken until recent months can be attributed to a prolonged period of political instability. The SLFP Government elected in 1936 was a coalition Government that from the start lacked the strength to adopt appropriate measures. From the beginning of 1959 the parliamentary position became more difficult, especially after the assassination of the Prime M;inister in September of that year. There followed a period of electioneering and caretaker governments that lasted until August 1960 when the present Government was elected with a clear majority in parliament and widespread support in the country. 21. Since August the Government has adopted a number of measures to stoD the drain on reserves. Taxes have been raised substantially; some cuts in expenditures have been made; restrictions have been imposed on private credit; quantitative restrictions or prohibitive tariffs have been placed on a wide range of imports. These measures appear to have been successful in checking the loss of reserves by early 1961. 22. It is not yet clear whether the tax increases and cuts in govern- ment expenditure made to date will be sufficient to avoid comnpletely the need for further inflationary financing this year. However, the fiscal situation is undoubtedly now much closer to balance, and at the most, only moderate additional action is likely to be needed to ensure that domestic inflationary pressures will not arise in the immediate future.  -6- 23. While stability may be achieved in the short-run, the long-term problem may be more difficult to resolve. Ceylon has the potential to maintain and possibly increase the present level of per capita incomne and to maintain employment at a satisfactory level even with its high rate of population growth; but to do this would require keeping overall investmiient at least at its current level of 14% of GNP. Since external reserves cannot be further drawn down - and, indeed, should be built up -, to keep invest- ment at this level without inflation will require increasing substantially other sources of finance. Some expansion of foreign aid and loans should be possible, but an increase in the rate of domestic savings will certainly be necessary as well. However, this Government with its clear parliamentary majority should be better able to introduce the necessary fiscal measures than its immediate predecessors. Prospects for Fulfillment of Obligations 24. Financial forecasts of the operations of power systems now run by the DGEU show that revenues will be safficient to cover all operating ex- penses including adequate provision for maintenance, depreciation and debt service. Revenues would be sufficient for earning a return on net invest- ment of about 7% per annum. 25. The effectiveness of action taken by the Government during its first eight months in office to check the drain of exchange reserves en- courages confidence in the Government's ability to deal with Ceylonts financial problems and to take further corrective fiscal measures if neces- sary. i'Ioreover, Ceylon's external debt service is not high - amounting to around 3% of present export earnings and 1% of the gross national product even if all existing credit lines are utilized and service on the proposed loan included. Taking all these factors into account, I believe the Bank can proceed with this loan without undue risk. PART V - COMPLIANCE WITH THE ARTICLES OF AGREEMENT 26. I am satisfied that the proposed loan complies with the require- ments of the Articles of Agreement of the Bank. PART VI - RECOMMLENDATIONS 27. I recommend that the Bank grant a loan to the Government of Ceylon in various currencies in an amount equivalent to $15 million for a term of 25 years including a grace period of 3,- years at a rate of 5 3/4% and such other terms and conditions as are specified in the draft Loan Agreement attached and that the Executive Directors adopt a resolution to that effect in the form attached (No. 5). -ttachments W.A.B. Iliff Vice President Washington, D.C. for April 18, 1961 Eugene R. Black President