India - Power Utilities Efficiency Improvement Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 19075 IMPLEMENTATION COMPLETION REPORT INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) May 20, 1999 Energy Sector Unit South Asia Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Indian Rupee (Rs) Rs. 1.0 = 100 Paise At Appraisal: April 1990 Rs 18.6 = US$ 1.00 At Closing Date: June 1999 Rs 39.8 = US$ 1.00 WEIGHTS AND MVEASURES I Kilovolt (kV) = 1,000 volts (V) 1 Kilovolt ampere (kVA) = 1,000 volts-amperes (VA) 1 Kilowatt-hour (kWh) = 1,000 watt-hours 1 Megawatt-hour (MWh) = 1,000 kilowatt-hours 1 Gigawatt-hour (GWh) = 1,000,000 kilowatt-hours ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank APSEB - Andhra Pradesh State Electricity Board CEA - Central Electricity Authority DEA - Department of Economic Affairs DPL - Durgapur Project Limited EAMU - Environmental Assessment and Monitoring Unit EMCAT - Energy Management, Consulting and Training GEB - Gujarat Electricity Board GOI - Government of India HSEB - Haryana State Electricity Board IBRD - International Bank for Reconstruction and Development ICB - Inte.mational Competitive Bidding IPP - Independent Power Projects KSEB - Kerala State Electricity Board MPSEB - Madhya Pradesh State Electricity Board NCB - National Competitive Bidding OFAP - Operational and Financial Action Plan OPS - Operational Policy Statement PIF - Pre-Investment Fund PFC - Power Finance Corporation PPA - Power Purchase Agreement PSEB - Punjab State Electricity Board RBI - Reserve Bank of India RFP - Request for Proposal RFQ - Request for Qualifications ROR - Rate of Return RSEB - Rajasthan State Electricity Board SEB - State Electricity Board SGC - State Generating Corporation T&D - Transmission & Distribution TA - Technical Assistance TNEB - Tamil Nadu State Electricity Board UPSEB - Uttar Pradesh State Electricity Board USAID - United States Agency for International Development FISCAL YEAR April 1 - March 31 Vice President: Mieko Nishimizu Country Director: Edwin R. Lim Sector Manager: Alastair J. McKechnie Country Sector Team Leader: Kari Nyman Task Leader: Magdalena V. Manzo FOR OFFICIAL USE ONLY INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) IMPLEMENTATION COMPLETION REPORT TABLE OF CONTENTS Page No. PREFACE EVALUATION SUMMARY ................................................. i-v PART I: PROJECT IMPLEMENTATION ASSESSMENT A. Project Objectives.............................................1 B. Achievement of Objectives.......................................3 C. Major Factors Affecting the Project ..................................5 D. Project Sustainability......................... ..................9 E. Bank Performance............................... .................. 10 F. Borrower Performance..........................................11 G. Assessment of Outcome........................................12 H. Future Operation.............................................12 I. Key Lessons Learned.......................................... 12 PART 11: STATISTICAL TABLES Table 1: Summary of Assessment................................... 14 Table 2: Related Bank Loans/Credits................................15 Table 3: Project Timetable........................................ 16 Table 4: Loan/Credit Disbursements: Cumulative Estimated and Actual ........... 16 Table 5: Key Indicators for Project Implementation ......................16 Table 6: Key Indicators for Project Operation ..........................16 Table 7A: Studies Included in Project ........................ ............ 17 Table 71: Studies Included in Project................................. 17 Table 8A: Project Costs ..................................... ...... 18 Table S3: Project Financing ................ ........................ 18 Table 9: Economic Costs and Benefits Cuutv.l...................... ........... 18 Table 10: Status of Legal Covenants ............................. ..... 19 Table 11: Compliance with Operational Policy Statement .............. .....21 Table 12: Bank Resources: Staff Inputs ...............17.........24 Table 13: Bank Resources: Missions .......................... ....... 24 Appendix A: Aide Memoire of the ICR Mission .................. ........ 25 Appendix B: I. Borrower's Evaluation Report........................... 33 T . Borrower's Operational Plan ............................8. I This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. n IMPLEMENTATION COMPLETION REPORT INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) PREFACE This is the Implementation Completion Report (ICR) for the Power Utilities Efficiency Improvement Project in India, for which Loan 3436-IN in the amount of US$ 265 million equivalent was approved on January 28, 1992 and made effective on March 18. 1992. The Loan was closed on June 30, 1998 compared to the original closing date of December 31, 1997. Upon mutual agreement between the Government of India (GOI) and the Bank, US$ 25 million was canceled on February 18, 1997, and another US$ 25 million was canceled on March 26, 1998. Final disbursement took place on December 3, 1998, at which time a balance of US$ 6.8 million was canceled. Parallel cofinancing for the project was provided by the United States Agency for International Development (USAID). The ICR was prepared by Ms. Magdalena Manzo (Task Leader) and Ms.Vikki Ziff (Projects Assistant) of the Energy Sector Unit, South Asia Region (SASEG). It was reviewed by Mr. Kari Nyman, India Energy Team Leader and endorsed by Mr. Alastair McKechnie, Manager, SASEG. Preparation of this ICR was begun during the Bank's final supervision and completion mission in July 1998. It is based on material in the project file as well as on discussions with officials of the Power Finance Corporation (PFC), the project implementing agency, and with some of PFC's beneficiary clients. PFC contributed to the preparation of the ICR by providing statistical data, commenting on the mission's aide memoire and draft ICR, as well as through preparation of its own evaluation of the project's execution. INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) IMPLEMENTATION COMPLETION REPORT Evaluation Summary Introduction 1. The Power Utilities Efficiency Improvement Project was designed to help address several areas of inefficiencies in India's power sector which were identified in a sector study conducted by the Bank in 1989. These areas were: (i) investments in transmission and distribution (T&)) lagged investments in generation capacity; (ii) SE3 operations were characterized by poor maintenance. inadequate controls, poor communication and monitoring systems, lack of' trained staff. and unsatisfactory billing and collection systems; (iii) performance of generating plants in India was below standards; (iv) environmental operating conditions of many thermal plants were substandard; and (v) the quality of project preparation needed considerable improvement. 2. The Project was also designed to help improve the financial performance of the sector. Specifically, it was envisaged that by extending financing through the Power Finance Corporation (PFC) based on a set of lending criteria, financial discipline and commercial principles would be instilled among the borrowing SEBs. The Bank's involvement in the project was viewed as part of a continuing effort to support institutional improvement at the SEB level. It was then perceived that lending through PFC would expand the Bank's impact in the sector by having access to more SEBs in India, as opposed to direct lending by the Bank to a limited number of SEBs. More importantly, since PFC's lending operations with the SEBs would be on a frequent and continuing basis, PFC had the advantage of a close and regular contact with the SEBs, thus providing a better potential for enforcing lending conditionalities. Project Objectives and Description 3. The principal objectives of the project were to: (a) support the Government's efforts to make PFC a viable and effective instrument for effecting improvements in the power sector; (b) strengthen the operations of the beneficiary SEBs by lending only to those willing to undertake acceptable reform programs; (c) foster better use of existing power facilities by reducing constraints in the transmission and distribution (T&D) systems; (d) mitigate the adverse environmental impact of thermal plants in operation by providing adequate anti-pollution and monitoring facilities; and (e) improve the preparation of power projects and promote the development of the local consulting industry by funding pre-investment studies and engineering for power projects. 4. The project financed the following areas of activities: (a) the expansion and strengthening of T&D networks; (b) environmental upgrading of power plants; (c) engineering studies for system renovations; (d) strengthening of operations and management of SEBs; (e) institutional strengthening of PFC; and (f) creation of a Pre-Investment Fund (PIF). 11 Implementation Experience and Results 5. The project's development objectives were only partially achieved. Specifically, the objective of raising the overall financial and operating performance of participating SEBs was not achieved. On the other hand, the project resulted in the expansion of PFC's financial lending operations, in removing T&D bottlenecks to the grids, improving environmental management of power facilities, and in increasing the SEBs' institutional capacity in selected areas of utility management, project planning as well as in its dealings with private independent power producers (IPPs). 6. The financial and operational difficulties continued to be faced by India's power sector are evidenced by its continued heavy reliance on subsidy support from the states, persistent power supply shortages, and high systems and revenue losses. The expectation that the project would result in the financial strengthening of SEB operations, leading to overall improvement of the power sector, proved to be unrealistic. Just as earlier conditioned Bank assistance to SEBs failed to improve the SEBs' operational and financial performance, Bank lending through PFC did not result in commercialization of the SEBs' operations. The Bank has since recognized that such improvements are difficult to achieve in the absence of a comprehensive restructuring of India's power sector, one involving independent regulation, unbundling of services, entry of competition and expansion of ownership base. Moreover, the project did not duly take into account the extent to which state subsidies for the power industry would exacerbate tariff distortions as well as account for a growing part of state fiscal deficits. 7. The project was, however, more successful in achieving its other development as well as physical objectives. Investments in T&D are expected to result in better utilization of power facilities, which would reduce technical losses, improve system load factors, and reduce power outages and frequency drops in areas affected. Out of 52 investment schemes, 40 are completed and the remaining are over 75% completed. 8. Against the appraisal estimate of US$ 640 million, the resulting total project cost was US$ 580 million. Of the total Loan value of US$ 265 million, US$ 25 million was canceled on February 19, 1997, and another US$ 25 million was canceled on March 26, 1998. Both cancellations were largely due to project savings arising from the depreciation of the Indian Rupee and from lower contract prices. The cancellation in 1998 was also partly due to the dropping out of some sub- projects, and delays in completion of some PIF-funded activities. 9. Significant delays in procurement actions were experienced in the initial stage of the project due to the protracted period taken for the Bank and PFC to reach agreement on the commercial provisions of the tender documents. Implementation delays were also experienced due to changes in the pipeline of sub-projects after loan approval. These delays resulted in deferment of some implementation milestones set at time of appraisal, and in disbursement lags. The closing date of the Loan was extended by six months to June 30, 1998. Disbursements were completed on December 3, 1998. In total, US$ 208.2 million was disbursed, leaving a balance of US$ 6.8 million which was canceled. 10. Of the factors affecting project implementation, those subject to state government control included: (i) lack of managerial autonomy given to the SEBs; (ii) reluctance to pursue tariff reforms and delayed payment to SEBs of revenue subsidies; and (iii) failure to honor, in a timely manner, state government guarantee extended to PFC upon default by the SEB in its loan repayment. 111 11. Factors which were subject to PFC's control included: (i) The application of lending criteria including requiring sub-borrowers of the Loan to agree to implement Operational and Financial Action Plans (OFAP). The OFAPs called for improvements in tariff generation. cost accounting and control, establishment of audit and management information systems; metering, billing and collection, and T&D planning, among others. (ii) The enforcement by PFC of its Operational Policy Statement (OPS) which embodied credit evaluation principles, profitability targets, capital adequacy and other prudential norms. Compliance to the OPS was generally satisfactory, although deviations from provisions on borrower exposure limit and non-rescheduling of loan repayments subsequently occurred. (iii) Monitoring of sub-project implementation including compliance by sub-borrowers with Bank procurement procedures. 12. Factors generally subject to sub-borrowers' control included: (i) uneven attention given to implementation of various activities agreed under the OFAPs which resulted in delayed achievement of some OFAP targets; (ii) lack of counterpart funds which adversely affected payments to contractors and their timely reimbursement by PFC; (iii) inadequate project accounting systems; and (iv) weak project management and institutional capacity to efficiently handle erection and commissioning work. 13. Bank performance during project preparation and implementation was satisfactory. The Bank team gave due attention to adoption by PFC of appropriate prudential norms and credit evaluation principles in its day-to-day operations. However, while the lending approach taken was at- that time in direct response to the Government's strategy for introducing financial and operational reforms in the SEBs, on hindsight, the reform measures designed into the OFAP instruments proved to be inadequate and unsustainable. Bank lending strategy has since recognized that in order to effect more lasting improvements in the power sector, a more sweeping package of reforms than those embodied in the OFAPs was called for. 14. Borrower performance was satisfactory throughout the project. Commitment by PFC management to the project's development objectives was demonstrated at the outset in the formulation of a comprehensive OPS and associated operating guidelines and procedures. Extensive staff efforts and funding support were devoted to assist borrowing SEBs in formulating their OFAPs. Good project reporting was maintained over the five-year period. Supervision and monitoring activities involved over 200 visits to sub-borrowers, not to mention business meetings at PFC headquarters. 15. In terms of overall developmental impact on the power sector, project outcome is marginal. Despite targets set in the OFAPS, financial performance and delivery services of the SEBs did not improve. It is now widely acknowledged that within the existing regulatory and administrative framework SEBs will not be in a position to regain financial and commercial viability on their own. On the other hand, with respect to the project's other institutional development and physical components, the outcome is satisfactory. In particular, PFC's business operations grew and its financial base strengthened. Moreover, implementation of investment and study activities by the SEBs proceeded relatively well, albeit subject to delays. Summary of Findings, Future Operations, Key Lessons Learned 16. Sustainability of institutional improvements among beneficiary SEBs is unlikely unless a major restructuring of the sector is pursued at the state level. Nevertheless, with the reform agenda gaining ground among the Government leadership, and as more states adopt reform measures, iv successful implementation of the OFAPs is now more plausible than at any other time. Already, two of the loan beneficiary SEBs, i.e., Haryana SEB and! Andhra Pradesh SEB, have gone for sweeping reforms with direct assistance from the World Bank, increasing the prospect of their meeting and even exceeding, the financial and operational performance targets set in their OFAPs. Future Bank lending to state level utilities through PFC should be extended only if the participating states have adopted a reform agenda that the Bank would have otherwise promoted under its current direct lending operations with reforming state power sectors. Further, institutional capacity of PFC to manage the complex process of restructuring would have to be strengthened. 17. Despite its risky loan portfolio, sustainability of PFC's operations is likely. PFC's business is expected to continue to expand with the diversification of the Company's client base, and with the able support of a relatively stronger financial management team. Further, as more of the SEBs embrace reforms, portfolio quality is expected to improve. To preserve gains made in its financial operations, PFC would have to apply more rigor in the evaluation of the quality of its loans, strictly enforce its policies on exposures, and review and strengthen its policies on loan loss provisioning. 18. PFC continues to serve as key channel for central Government assistance to the power sector, particularly in providing financial incentives to states which agree to adopt policy reforms promoted by the Center. The Company's principal strategy is to become one of the leading sources of project finance in the sector, and to become more actively involved in private power projects by offering a wider range of financing services. But PFC's future success depends on the degree to which India's power industry is restructured into a commercial and competitive sector. It is in PFC's business interest to actively promote a more comprehensive reform agenda akin to those adopted by Orissa, Haryana and more recently by Andhra Pradesh. Moreover, PFC has developed expertise in appraising and financing transmission and distribution projects. The financial needs of the private distribution utilities that emerge from the restructured state power sectors represent a niche market, which PFC can suitably service. 19. Among the key lessons learned from this project are: * Development outcome of Bank assistance to India's state power sector will likely be unsatisfactory unless sectoral issues on regulation, tariff and financial reform, and managerial autonomy are addressed through a full restructuring of the sector. Accordingly, since the mid- 90s, Bank operations at the State level involved comprehensive restructuring of the power industry, e.g., in Orissa, Haryana and Andhra Pradesh. * Project development objectives should be realistic. The project tried to address a myriad of sector issues which the modest level of project investment and technical assistance could not fully support. In an attempt to do so, loan/sub-loan conditionalities were embodied in the operational policy statement (OPS) and program (OFAP) instruments, respectively, involving numerous performance targets which required much time and effort to monitor and enforce. * For similar projects involving many beneficiaries and multiple investments, compliance with sub- loan conditions should be sought up-front at time of sub-loan approval. To the extent possible, compliance with future performance targets, e.g., as set in the OFAP, should not affect contracts execution at the risk of impairing the program. Multiplicity of loan and sub-loan conditions subjected the project to many starts and stops. * Acceptance of revenue subsidy in lieu of tariff adjustments significantly hindered tariff reform and weakened the utilities' resolve to become financially sound. State governments found it politically more expedient to extend subsidy support than to raise tariffs even at the expense of exacerbating the state fiscal deficit. V * A positive financial internal rate of return of the sub-projects should be a primary loan eligibility criterion to ensure that financial revenues can cover costs. Reliance on the OFAP to result in required tariff adjustments jeopardized viability of the investments. * A larger and robust sub-project pipeline needs to be in place before loan approval. The drop out rate for many schemes reviewed at time of appraisal was high due to failure of clients to meet the OPS eligibility criteria. In the case of the Pre-Investment Fund (PIF), it took some time before PFC was able to attract borrower interest in the Fund. Moreover, several clients did not pursue their loan proposals. * Agreement on procurement process should be in place no later than appraisal. Further, advance procurement action covering at least the first year's disbursement should be taken by time of loan approval. This helps ensure that, particularly for first-time Bank clients, there is clear understanding of the procurement guidelines of the Bank. * The threshold value for prior review of ICB packages can be increased upon evidence of creditable procurement review by the financial intermediary such as PFC. Non-ICB packages can also be made eligible for Bank financing. * Given demonstrated competency of PFC staff, and the numerous sub-loans and procurement contract packages involved, disbursements in future operations with PFC can be made on the basis of sub-loans, rather than against contract payments. INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) IMPLEMENTATION COMPLETION REPORT PART I. PROJECT IMPLEMENTATION ASSESSMENT A. PROJECT OBJECTIVES Sector Context 1. Recent decades saw commendable progress in expanding India's electricity supply. Nevertheless, demand continued to outstrip supply, adversely affecting the quality of electricity service. Power supply was characterized by frequent outages, voltage and frequency fluctuations, and high systems losses. Unreliable service, in turn, resulted in frequent industrial equipment failure and higher than necessary production costs. In 1989, the Bank conducted a study to ascertain the causes of major power system inefficiencies in India'. The study identified the following key areas of inefficiencies, and the Power Utilities Efficiency Improvement Project was designed to help address these issues: (a) Investments in transmission and distribution (T&D) have not kept pace with investments to expand generating capacity. The project supported high-priority T&D investments to alleviate constraints to evacuation of supply; (b) SEBs needed to address poor maintenance, inadequate controls and operational supervision, poor communication and monitoring systems, lack of trained staff, and unsatisfactory billing and collections. The project provided funding and technical support for the SEBs to help remedy these deficiencies; (c) The performance of generating plants in India, particularly thermal plants, was below national standards. The project included a technical assistance component to identify further opportunities for plant modernization and life extension; (d) The environmental operating conditions of many thermal plants in India were substandard. The project included a substantial component to provide funding for upgrading the environmental conditions of the SEBs' power stations; and (e) The preparation of power projects in India, particularly for hydroelectric plants, was a difficult and slow task, which ultimately retarded implementation. The quality of project feasibility studies, site investigations and pre-construction engineering also required considerable improvement. The project included a pre-investment fund to finance project preparation activities. India Power Sector Efficiency Review (in two volumes) - November 30, 1989 - Report No. 7878-IN. 2 2. An underlying factor contributing to the inadequacy and inefficiency of power supply was the lack of financial discipline in the sector. The sector was plagued by major revenue shortfalls due to tariffs set below cost of supply, hea ,y cross-subsidies arising from extremely low and/or free agricultural tariffs, and extremely poor collection performance. Commercial viability was impeded by lack of competition; state-owned utilities dominated the sector and operated with limited managerial and financial autonomy from state Governments. The sector's heavy reliance on tight state budget resources constrained power expansion and systems upgrading. Accordingly, the Project was also designed to help improve the financial performance of the sector by channeling proceeds of the Bank loan through the Power Finance Corporation (PFC). It was envisaged that PFC would extend financing based on a set of lending criteria that would foster financial discipline and commercial principles among its borrowers. Project Objectives 3. As stated in the Staff Appraisal Report (SAR), the project's objectives were to: (a) support Government efforts to make PFC a viable and effective instrument for effecting improvements in the power sector; (b) strengthen the operations of the beneficiary SEBs by lending only to those willing to undertake acceptable reform programs spelt out in financial and operational action plans (OFAPs); (c) foster better use of existing power facilities by reducing constraints in the T&D systems; (d) mitigate the adverse environmental impact of thermal plants in operation by providing adequate anti- pollution and monitoring facilities; and (f) improve the preparation of power projects and promote the development of the local consulting industry by funding pre-investment studies and engineering for power projects. 4. The implementation and physical objectives for the various project components involved: (a) the expansion and strengthening of T&D networks; (b) environmental upgrading of power plants; (c) engineering studies for system renovations; (d) strengthening of operations and management of SEBs, including billing and collection; (e) institutional strengthening of PFC; and (f) creation of a Pre- Investment Fund (PIF). Evaluation of Objectives 5. The project objectives were at that time supportive of Government of India's energy policy under its Eighth Plan (1993-97) and directly promoted specific Plan objectives of improving efficiency of energy production and use, and increasing investments in T&D relative to investments in generation. Cognizant of the need to resolve the sector's financial and institutional problems, the Government adopted measures to ensure that its discretionary funds as well as external assistance were used to effect institutional improvements in the SEBs and State Generating Corporations (SGC). The creation of the PFC was part of this strategy. It was envisaged that PFC would finance a quarter of the SEB/SGCs' financing requirements for the Eighth Plan. In line with its operational policies, PFC would lend only to utilities who have undertaken to implement OFAPs, endorsed by their respective states, aimed at improving the utilities' resource mobilization and operational efficiency. 6. The Bank's involvement in the project was also viewed as part of a continuing effort to support institutional improvement at the state level. It was then perceived that lending through PFC would expand the Bank's impact in the sector by having access to most SEBs in India, as opposed to direct lending by the Bank to a limited number of SEBs. More importantly, since PFC's lending operations with the SEBs would be on a frequent and continuing basis, PFC had the advantage of a close and regular contact with the SEBs, thus providing a better potential for enforcing lending conditionality. 3 7. The expectation that, with the adoption of OFAP-based reforms, the project would result in the improvement of the power sector and strengthening of SEB operations proved to be unrealistic. Just as earlier conditioned Bank assistance to SEBs failed to improve the SEB's operational and financial performance, Bank lending through PFC did not result in sustainable improvements and commercialization of the SEBs' operations. The Bank has since recognized that such improvements are difficult to achieve in the absence of a comprehensive restructuring of India's power sector. In the absence of such a restructuring, the institutional development objectives of the Project were ambitious. Moreover, the project did not duly take into account the extent to which power subsidies would contribute to state fiscal deficits and in depriving other development sectors of much needed state funding. 8. The project faced a multiplicity of institutional, managerial and financial risks, some of which were identified at the time of appraisal. These risks were amplified by the relatively complex structure and implementation requirements of the project. As designed, the project consisted of six components, each involving a range of activities and investments involving various beneficiaries. The investment component alone involved 52 different schemes situated in multiple sites involving 126 ICB packages of T&D equipment. The Pre-Investment Fund (PIF) component involved over 30 technical assistance sub-loans. The project was to be administered by PFC, an agency at its formative years at time of project commencement. Further, in addition to the Bank-financed activities, PFC was managing, a parallel operation financed by the Asian Development Bank (ADB) under similar terms and conditions. During the loan period, 28 OFAPs were formulated and negotiated with PFC's borrowers. It is to PFC's credit that despite the heavy demands of project management, the Company was able to carry out the Project with relative efficiency, albeit with some initial delay and midstream adjustments in the investment pipeline and implementation milestones. Further, PFC was expected to implement the project, as well as its entire operations, in accordance with an Operational Policy Statement (OPS) agreed with the Bank. The OPS contained over two dozen key financial management provisions, compliance to which was subject to regular Bank monitoring. B. ACHIEVEMENT OF OBJECTIVES 9. Overall Results. The project's development objectives were only partially achieved and with mixed results. In particular, the objective of raising the overall financial and operating performance of participating SEBs was not achieved. However, the project resulted in the financial growth and expanded lending capacity of PFC, in removing T&D bottlenecks to the grids, and in enhancing some SEBs' institutional capacity in selected areas of utility management and project planning. 10. The financial and operational difficulties continued to be faced by India's power sector are evidenced by its continued heavy reliance on state subsidy support and persistent supply shortfalls. In FY97, SEB operations required subsidies of as much as Rs 75 billion allowing them to post an average rate of return in the sector of 2.7%. Without the subsidy, only two SEBs would have operated in the black, and returns would have averaged negative 13.0% for the sector. However, because of increasing constraints in state budgetary resources, many SEBs are now facing insolvency and further deterioration of service. Systems losses continue to be excessive, cost of operations continue to run high, and power rates remain below cost of supply. While the power sector has been opened to private participation, in the absence of reforms to make the utilities creditworthy, private investments have not been readily forthcoming without Central Government assurances of counter guarantees. It has become evident that no less than a full-scale restructuring of the state power sector is required; i.e., one involving establishment of an independent regulator, tariff reforms, unbundling of services, and expansion of ownership base, including privatization of distribution services. 4 11. PFC's conditioned lending has, nevertheless, heightened the awareness among the SEBs and the State Governments of the need to improve the SEBs' creditworthiness and managerial autonomy to operate as commercial businesses. Further, difficulties in OFAP implementation created a growing appreciation of the need to embark on more far-reaching structural and regulatory reforms, tariff restructuring, and opening up of the sector to private ownership and competition. A number of the OFAPs have since been revised to include more reform-oriented activities in parallel with the Central Government's promotion of more sweeping regulatory and structural reforms in the power sector. 12. The project has been more successful in achieving its other development as well as physical objectives. Investments in T&D are resulting in better utilization of power facilities which help reduce system technical losses, improve system load factors, and reduce power outages and frequency drops in the affected service areas. These were achieved through the following investment activities: (i) removal of transmission constraints for power evacuation from power plants through construction of 132 kV, 220 kV and 400 kV substations; (ii) reinforcement of overloaded transmission lines; (iii) increase of capacity of associated substations; (iv) expansion of overloaded distribution substations; (v) reinforcement of 66kV and 33kV distribution grid; (vi) installation of capacitors and distribution transformers to improve service and reduce losses; and (vii) purchase and installation of single-phase and three-phase consumption meters for new connections or to replace defective ones. 13. Through the project, PFC financed transmission schemes involving 4,191 km of lines and 6,528 MVA of substation capacity. The Project also supported urban distribution schemes covering 23 towns involving construction of 5,546 km of distribution lines, over 2,038 MVA substation capacity, and installation of 559 capacitors. To date, out of the 52 schemes financed, 40 are completed and the remaining 12 are more than 75% completed. Scheme Type Number of Schemes Completed Near Completion Transmission 27 18 9 Urban Distribution 22 20 2 Capacitors 1 1 - Metering 1 1 - Environment 1 - 1 TOTAL 52 40 12 14. At time of appraisal, the rates of returns of various sub-projects were estimated. Pursuant to PFC's lending policy, only schemes resulting in economic rates of return (ERR) above 12 % qualified for funding. The ERRs have not been recalculated. However, given the growing shortfall in power supply and the resulting rise in the value of power, coupled with the competitive prices secured for equipment supply for the sub-projects, it is expected that the ERRs remain equally satisfactory, if not higher. On the other hand, majority of the sub-projects yielded negative financial rates of return (FRR) at time of appraisal due to the low tariff levels then prevailing. It was envisaged that through implementation of the OFAPs tariff levels would be rationalized. However, since average grid tariffs remain below cost of supply, respective FRRs for the T&D schemes are likely to be negative, except for those schemes, which serve predominantly industrial and commercial loads for which tariffs have been significantly adjusted. 15. The project also helped improve maagement of environmental performance of power plants. Under the project, PFC established an Environmental Assessment and Monitoring Unit (EAMU). The unit has since assisted SEBs in the preparation of environmental action plans for a number of 5 thermal stations. These plans are being implemented with PFC's financial assistance. In addition, through the Pre-Investment Fund (PIF), several environmental impact assessment (EIA) studies were financed, which have helped SEBs to obtain various environmental clearances for their respective projects. Although only one environmental improvement scheme was financed from proceeds of the Loan, i.e., for the Durgapur Project Limited (DPL) which involved installation of electrostatic precipitators, PFC funded over 25 schemes from its own resources. EAMU's activities with the utilities helped in securing SEBs management's attention to environmental performance issues. 16. The project, through the Pre-Investment Fund (PIF) and technical assistance support provided by USAID under its Energy Management, Consulting and Training (EMCAT) program, helped improve project preparation and strengthen institutional capacity among the SEBs. Under the PIF, 22 schemes of 31 approved activities were completed. These involved preparation of feasibility and engineering studies, information technology studies and computerization and communication schemes, environmental impact assessments, diagnostic review of utility performance, consultant services for preparation of solicitation documents and negotiations of power purchase agreements with IPPs. EMCAT provided local and international training opportunities to SEB personnel and energy officials in the areas of utility management, planning, renovation and rehabilitation and on principles of sector reforms. 17. Finally, the objective of developing PFC into a viable financing institution to support investments in India's power sector is being achieved. The achievement is particularly remarkable given the very difficult and risky market served by PFC. PFC's business operations expanded significantly since onset of the project. PFC's ability to manage its financial risks helped build up its reputation within both the domestic and international financial community, enabling PFC to mobilize commercial loans on the basis of its corporate standing. By the Loan's closing date, PFC's total funding stood at Rs 78 billion, with a net worth of Rs 25 billion. During FY1998, post-tax profits reached a record high of Rs 5.5 billion on a revenue base of Rs 11 billion, resulting in a return on net worth of 22.2%. Outstanding loans & advances position amounted to Rs 73 billion. While this business level was attained three years later than projected at time of appraisal, the delay was largely due to a prudent reining in of PFC lending during those years when its key borrowers failed to comply with sub-loan conditions. 18. However, for as long as the state power utilities are not restructured, the quality of PFC's loan portfolio remains at high risk. In order to mitigate portfolio risks, PFC started to diversify its client base in 1995 to include financially stronger centrally-owned utilities as well as private developers. PFC also expanded its business lines to include other types of financial instruments and services, which are expected to yield higher returns. C. MAJOR FACTORS AFFECTING THE PROJECT Factors generally subject to Government control 19. Power Sector Policies. Prevailing sector policies hindered the implementation of many of the financial and institutional improvements laid out in the OFAPs. The sector is thus far from becoming self-sufficient and commercially viable. The lack of commitment on the part of SEB management and state Governments to pursue tariff reforms has created further financial distortions in the sector. More of the participating states preferred to meet the 3% rate of return requirement for the SEB through subsidy support, rather than face the ire of consumers, particularly in the agricultural sector. 6 This has led to further financial losses among the SEBs over the loan period and contributed to worsening of state fiscal deficits. The cost and price distortions in SEB operations were aggravated by the non-metering of the agricultural load, resulting in gross inaccuracies in the estimation of systems losses, further masking the inefficiencies of distribution management. Industrial users burdened with bearing heavy cross-subsidies have increasingly shifted to captive generation, reducing the SEBs' sounder revenue base. For these reasons, the Government of India promulgated the Electricity Regulatory Commissions Act in July 1998, to establish the Central Electricity Regulatory Commission and to provide for State Electricity Regulatory Commissions (SERC). The SERCs would, as a minimum, assume the responsibilities of the SEBs and their respective state Governments in the setting of retail tariffs. 20. State guarantees against sector risks. PFC's priority mandate from the Government, during its initial years of operation, was to service the financial needs of SEBs and to serve as conduit of Central Government and external funding to the state power sector. PFC's clientele was thus confined to a limited number of borrowers, operating in one economic sector, and generally in poor financial health. At the same time, PFC was expected to preserve its financial stability. Thus to mitigate the heavy market risk, a structure of repayment guarantees, limits on PFC's exposures and provisions for non-rescheduling of loans, were embodied in PFC's OPS as agreed with the Bank. In practice, as some SEBs started to default in their loan repayments, PFC was unable to invoke state Government guarantees that backed the SEBs' borrowings. PFC was thus constrained to restructure a number of loan repayments. Eventual use of escrow accounts, while improving PFC's ability to collect, resulted in further tying up of SEBs' limited revenues, further constraining the SEBs' capacity to finance operations and to mobilize resources from other creditors. Recognizing the contraction of viable business opportunities with SEBs, the Government concurred with PFC to extend its financial services to central power utilities and private power sector, and to thus diversify its portfolio and product slate. Factors generally subject to implementing agency control 21. Project Management. The project involved oversight by PFC of both institutional strengthening as well as investment activities. While tracking of the progress of investment activities was relatively straightforward, the supervision of financial and institutional improvements was less tractable. Extending loans to PFC's clients required extensive preparation of individual OFAP and credit appraisal reports for each client as well as regular monitoring of OFAP implementation and sub-loan compliance. These tasks were made more arduous by the lack of ready and credible financial and operational data from the SEBs and the need to conduct diagnostic studies to assess the SEBs' and SGCs' priority institutional needs. Securing agreement by the sub-borrowers and their respective State Government required intensive and frequent follow-ups by PFC, and often involved difficult and protracted negotiations. Aside from requiring regular tariff review and adjustments, an OFAP typically called for computerization of billing and revenue collection, upgrading of inventory control and management information systems, reduction in systems losses, improved metering and load monitoring, and preparation of T&D master plans. Enforcement of the various performance targets under the OFAP became burdensome. Instead, the OFAPs served more effectively as a planning tool. Within existing structural constraints, the OFAPs yielded certain technical, productivity and skills improvements within the SEBs. For example, computerization of the billing function was pursued by 11 SEBs, and meter testing facilities were improved and over a million meters were procured and/or installed by the five SEBs availing of the loan proceeds. However, on the critical areas requiring policy commitment and support of the state Government, i.e., pricing, distribution management, and loss reduction, the results have been marginal at best. 7 22. Enforcement of Operational Policies. One of the more critical aspect of the project was the enforcement by PFC of its operational policy statement (OPS) as agreed with the Bank. The OPS embodies a set of parameters to ensure a minimum level of financial and operating performance, and guides PFC in its relationship with its clients. PFC's institutional resolve to attach adequate conditionality to its lending operations and adherence to its OPS remained adequately strong. Specifically, in order to be eligible for loan assistance. PFC required its borrowers to earn the minimum rate of return of three (3) percent as provided for in the Electricity Act. This was to be achieved through a combination of tariff increases, cost reductions and revenue subsidy support from the state budget whenever the state fails to authorize the necessary tariff adjustments. For FY97, twelve SEBs posted rates of return equivalent to 3%. However, these were largely due to state subsidies reflecting write-offs of state loans, and to a lesser extent, cash infusion. Only two SEBs had average tariffs set above their average cost of supply. On hindsight, to promote financial self- sufficiency of the SEBs, it would have been advisable for PFC (and the Bank) to require achievement of a minimum rate of return based on tariff revenue alone, i.e., excluding revenue subsidy. 23. There were a few lapses in the enforcement of the OPS. In 1995, as a result of non- compliance of two sub-clients to the 3 per cent ROR, as well as the overexposure of PFC to UPSEB, and PFC's poor recovery position, the project was rated unsatisfactory. The rating has since been restored to satisfactory as the respective State Governments were prevailed upon by PFC to release cash subsidies to the concerned borrowing SEBs, resulting in improved project disbursements. More recently, given the growing shortfall in power supply, PFC relaxed its policy on rate of return requirement with respect to loans directed towards completion of on-going generation projects. 24. When rated against the classification system agreed to between PFC and the Bank , the quality of PFC's lending portfolio is not good. As of July 1998, PFC's assets would be classified as follows: normal risk assets - 17.17%; substandard assets - 78.68%; doubtful assets - 4.04%; and loss assets - 0.11%. In contrast, based on the risk classification norms set out by the Reserve Bank of India, PFCs asset would be classified significantly better as follows: normal risk assets - 79.69%; substandard assets - 20.17%; doubtful assets - 0.14%; and no loss assets. Under the RBI norms, state guaranteed loans are regarded risk-free; even if in practice, PFC has had difficulty calling on them. 25. PFC's Institutional Development. Overall, and with the support of USAID's EMCAT program, the project was able to complete most of the institutional strengthening activities envisaged under the project. These included enhancement of PFC's management information system, preparation of administrative manuals and procedures to guide internal operations, training of PFC staff in financial, utility, and project management, power economics, upgrading of power plants and T&D planning and design. Further, a unit at PFC was established to undertake sector studies in support of corporate operations, promote the PEF, and assist SEBs in OFAP preparation. Pursuant to recommendations of organizational studies, PFC instituted a restructuring of its operational and financial management units. The finance and treasury functions were enhanced with the recruitment of additional and experienced personnel. As of the loan's closing, PFC's staff strength boasted 239 personnel, double the level at time of project appraisal. PFC has since demonstrated a strong capacity to appraise and supervise investment projects, and more recently, make inroads in banking and 2 Under this classification, the criteria used are as follows: i) normal risk assets: the borrower maintains an overall debt service coverage ratio of at least 1.0; ii) substandard assets: the debt service coverage ratio is less than one but there is no default in debt service payments to PFC; iii) doubtful assets: debt service payment is overdue more than 90 days; iv) loss assets: debt service is overdue more than 60 days after the guarantee has officially been called. In case of a law suit, debt service payment is overdue more than six months. 8 finance sector as evidenced by its successful attempts in 1997 and 1998 to raise foreign currency loans from the international financial markets at competitive rates. Factors generally subject to sub-borrower's control 26. Implementation of the OFAPs. Uneven attention was given by SEB management to implementation of the various institutional building activities agreed under the OFAPs. Accordingly, some activities were not given necessary support resulting in delays in achievement of set targets. 27. Lack of counterpart fiinds. As beneficiary SEBs continued to face liquidity problems, the funding of investment programs became increasingly dependent on limited state budgetary releases. The lack of readily available funds adversely affected payments to contractors and their timely reimbursement by PFC. To redress the problem, PFC initiated since November 1995 direct disbursement to suppliers, resulting in significant increase in Loan disbursements in succeeding years. Moreover, the inadequacy of project accounting among SEBs for Bank-financed sub-projects also made it difficult to identify the respective SEB's share of the project cost. 28. Weak project management. A number of the beneficiary SEBs were not well equipped to do erection and commissioning work on their own. The use of turnkey supply and works contracts or of composite works contract to do erection, civil works with supply of balance of materials (i.e., those not being procured through ICB) could have expedited completion of the sub-projects. Project Implementation Experience 29. Procurement. In anticipation of possible delays in procurement, during negotiations, the Government agreed with the Bank on simplified procedures for clearance of procurement action and release of foreign exchange for the project. Accordingly, processing and clearances at the Central Government level were relatively smooth; e.g., CEA review of tender specifications was not required. Moreover, model technical bid specifications were prepared and cleared with the Bank before project effectiveness. Nevertheless significant delays in procurement actions were experienced in the initial stage of the project due to the protracted period taken for the Bank and PFC (and their clients) to reach final agreement on the commercial provisions of the tender documents. The Bank erred in clearing on a piece-meal basis, revisions to the standard bidding documents (SBD) proposed by PFC over several months, and had to withdraw its earlier clearance in view of resulting inconsistencies in the overall bidding document. This resulted in a 13-month delay in starting the tendering and ordering process. However, with the Bank's clearance on November 23, 1992, progress in procurement actions has been generally satisfactory. It is to PFC's credit that despite the initial delay, the project was largely completed with only a six-month extension from its original closing date. The Bank's decision to delegate the procurement review to the Procurement, Disbursement and Audit Team (PDAT), located at the Bank's New Delhi Office, significantly helped in facilitating Bank procurement review and providing prompt response to queries from PFC and beneficiary SEBs. 30. Use of ICB procedures resulted in savings due to competitive price offers received for several packages. However, given current price levels and sources of equipment, goods and supplies, PFC suggests, that for similar projects, the threshold for ICB procurement be raised to US $1 million to allow for speedy action on some packages for standard equipment readily available locally (e.g., lightning arresters). Further, PFC recommends that Bank financing be made available for national competitive bidding (NCB) procurement as well. It is noted that a higher threshold for ICB was in effect more than a decade back and when prices were much lower, e.g., as in the Kerala Power Project (Ln2582-IN) which was approved in 1986. However, the competitive prices resulting from ICB process under Loan 3436-IN appear to outweigh the arguments for faster procurement action 9 using NCB. Nevertheless, recognizing that PFC staff has performed its procurement review function creditably, the threshold value for prior review by the Bank could be raised from US$ 200,000 to say, US$ 1 million in future operations. 31. Changes in Investment Pipeline. Implementation delays were also experienced due to changes in the sub-projects after loan approval. Disqualification of some beneficiaries identified during appraisal due to non-compliance with sub-borrower eligibility criteria resulted in the need to replace them with new beneficiaries and to appraise new sub-projects. Although in anticipation of possible non-compliance by the borrowers to the loan conditions, up to a total of US$ 303 million worth of project pipeline was built up for IBRD financing, the loan amount was still not fully utilized due to a combination of factors: significant variation in exchange rate after sub-project approvals, lower contract values realized due to competitive bid offers; and reduction in scope of some sub-projects. The delays brought about by the inclusion and exclusion and re-inclusion of schemes into the project pipeline has resulted in modification of the implementation milestones set at time of appraisal. It was originally expected that all contracts would have been effected by a specified cut-off date, end-June 1994. This date was rescheduled at PFC's request to June 1995 for the investment component, and to December 1997 for the Pre-Investment Fund component. 32. Project Costs, Savings and Cancellations. Against the appraisal estimate of US $640 million, the total project cost was US$ 580 million. Of the total Loan value of $265 million, $25 million was canceled on February 19, 1997, pursuant to DEA's request, and another $25 million was canceled on March 26, 1998. While both cancellations were largely due to project savings arising from the depreciation of the Indian Rupee and from lower contract prices, part of the cancellation in 1998 was due to the dropping of some of KSEB's schemes and foreseeable delays in completion of some PIF- funded activities. These cancellations reduced the Loan amount to $215 million. 33. Closing Date and Disbursements. Actual loan disbursements lagged behind the appraisal estimate as indicated in Table 4 due to aforementioned implementation delays. The closing date of the Loan was extended by six months to June 30, 1998. Disbursements were completed on December 3, 1998. In total, US$ 208.2 million was disbursed, leaving a balance of US$ 6.8 million to be cancelled. Thus, total cancellations amounted to US$ 56.8 million. D. PROJECT SUSTAINABILITY 34. Sustainability of sub-project investments and PIF-funded activities is likely, provided sufficient funding is available for operation and maintenance of the equipment and facilities. The quality of work of the T&D schemes financed under the Loan are satisfactory, and the SEBs have competent technical staff to operate and maintain the facilities. However, efficiency improvements arising from For instance, early in the project implementation cycle, Punjab State Electricity Board's (PSEB) schemes were dropped from the project due to PSEB's reluctance to enter into an acceptable OFAP. In July 1993, due to MPSEB's inadequate borrowing headroom, several of its sub-projects, which were to have utilized US$ 56 million of the Loan funds, were dropped from the Project. At about the same time, additional APSEB transmission sub-projects involving $30 million were identified but subsequently excluded due to APSEB's non-implementation of the minimum agricultural tariff. In December 1993, Rajasthan SEB applied for, and was found eligible, to borrow funds from the Loan. In March 1994, at the Bank's suggestions, projects of the Haryana SEB were included in the project under an Emergency OFAP. The Bank also suggested that the Kerala SEB avail of Loan 3436-IN to finance the balance of expenditures remaining unfunded after the closure of the Kerala Power Project (Ln 2582-IN). PFC was able to commit loan funds for this purpose only after KSEB signed an OFAP in September 1995. 10 the investments will not be tangible if overall system performance deteriorates due to lack of operational funds and weak management. Of particular concern are the relatively high losses in urban distribution systems due to mismanagement and poor metering facilities. 35. Sustainability of institutional improvements among beneficiary SEBs is unlikely unless a major restructuring of the sector is pursued at the state level. For instance, financial gains achieved under the OFAP would get reversed depending on the year to year resource constraints and political climate facing the State Government, affecting its decision on whether to grant cash subsidies and/or approve tariff revisions. Nevertheless, with the reform agenda gaining ground among the Government leadership, and as more states adopt reform measures, successful implementation of the OFAPs is now more plausible than at any other time. Already, two of the loan beneficiary SEBs, i.e., Haryana SEB and Andhra Pradesh SEB, have gone for sweeping reforms with direct assistance from the World Bank, increasing the prospect of their meeting and even exceeding, the financial and operational performance targets set in their OFAPs. 36. Despite its risky loan portfolio, sustainability of PFC's operations is likely in the light of its continuing mandate for promoting the Government's power policies by serving as vehicle for central Government assistance to the power sector. PFC business expansion is likely given the diversification of the Company's client base, and the support of a relatively stronger financial management team. Further, as more of the SEBs embrace reforms, portfolio quality is expected to improve. To preserve gains made in its financial operations, PFC would have to apply more rigor in the evaluation of the quality of its loans, strictly enforce its policies on exposures, and review and strengthen its policies on loan loss provisioning. E. BANK PERFORMANCE 37. Bank performance was generally satisfactory during project implementation, and was marked by close coordination with PFC management and staff from the outset. Project identification and design considerations emerged from a sector work on efficiency issues conducted by the Bank. The lending approach taken was in direct response to the Government's strategy for introducing financial and operational reforms in the state power sector through conditioned lending by PFC. Although the approach was then seen as promising compared to the disappointing results of the Bank's previous involvement in the Indian state power sector, it nevertheless proved to be short-sighted. The impact of the power sector on the state finances was not fully considered, as otherwise state subsidy support would not have been an acceptable option to generating the required minimum rate of return for the SEBs. Mo;eover, the expectation that institutional improvements in the SEBs could occur within the prevailing regulatory and administrative framework was unrealistic. At appraisal, the Bank identified the major financial and institutional risks faced by the project. In particular, due attention was given to ensuring that appropriate prudential norms, financial management systems, and credit evaluation tools were adopted by PFC in its day-to-day operations. Accordingly, the dialogue resulted in the formulation of the Operational Policy Statement (OPS) which embodied PFC's financial management principles. The Bank also reviewed the process of OFAP formulation from diagnostic studies stage to design of actual OFAP agreements between PFC and its clients. In this area, however, the Bank underestimated the difficulty of formulating, supervising and ensuring compliance of sub-borrowers to the multi-faceted OFAP agreements. 38. During project implementation, from March 1993 to June 1998, eight supervision missions were conducted. In late 1995, the Bank led a multi-donor mid-term review of the project, which included the participation of ADB and USAID. Supervision mission teams were composed of staff 11 with expertise in finance, engineering, environmental management, procurement, and economics. Several missions involved visits to beneficiary SEBs and project sites. The supervision missions reported adequately on the implementation issues, calling the attention of the Borrower, sub- borrowers, and Bank management to emerging problems, and providing advice and suggestions to resolve implementation bottlenecks. As a workable framework for state power sector restructuring emerged from various Bank-state dialogues, the Bank regularly engaged PFC management and staff in discussing the need for more comprehensive reforms. These discussions led to inclusion of the reform agenda in the training programs under the USAID/ EMCAT technical assistance component as well as reformulation, to a limited extent, of some of the OFAPs. F. BORROWER PERFORMANCE 39. Commitment by PFC management to the project's development objectives was demonstrated at project design stage with the formulation of a comprehensive Operational Policy Statement (OPS) and associated operating guidelines and procedures. To the extent practicable, PFC generally adhered to its OPS,. although there were deviations from a couple of provisions (reference Table 11). Compliance with the covenants under the Bank loan was also satisfactory. Qualified technical staff handled sub-project appraisals based on methodology worked out with the Bank at project preparation. PFC staff exerted best efforts to identify more projects and actively seek out contract packages for which sub-borrowers were willing to follow ICB procedure. PFC personnel persevered in convincing borrowers and states to agree on the OFAPs as well as in securing client interest in availing loans from the PIF to finance project preparation and other capacity building activities. 40. Good project reporting was maintained over the five-year period. PFC's supervision and monitoring involved over 200 visits to beneficiaries in addition to business meetings at PFC headquarters. Monitoring of OFAPs entailed close and frequent contacts with clients, including high level state Government officials. Acknowledging that its investment lending and OFAP monitoring activities were often disjointed during the early part of project, PFC subsequently made strides in synchronizing the two activities through a reorganization and improvement in systems and procedures. While various implementation issues arose during much of the project period, PFC staff were pro-active in seeking solutions and in taking initiatives to remedy a number of the problems, thus mitigating further project delays. Improving customer relations was a frequent management concern. At the earlier stages of the project, PFC's lending approach was considered heavy-handed by some of its clients particularly in conjunction with OFAP negotiations. However, client relations progressively improved, as clients became more familiar with PFC's lending criteria and with more regular staff visits made to the states. 41. Financial management at PFC was initially weak for a financial institution, and suffered a setback with the absence of a full time finance director for more than two years. PFC subsequently instituted key changes in its organizational structure to strengthen its financial management capacity and to conduct its operations more along commercial business principles. In particular, the Finance group was restructured, its treasury management function considerably strengthened, and experienced and qualified director and staff recruited. Innovations in resource mobilization activities, financial services and revenue collections have since been introduced as evidenced by the successful closing of international loan syndication and maintenance of a sound overall funding position. Asset and liability management was improved and PFC now actively pursues its risk management policies on interest, currency, and liquidity. 12 G. ASSESSMENT OF PROJECT OUTCOME 42. Project outcome is mixed. Implementation of investment and technical assistance activities proceeded in a satisfactory manner, albeit subject to delays as described earlier. PFC's business operations grew and its financial base strengthened. However, financial and operating performance of SEBs remained unsatisfactory despite the OFAP agreements. It is now widely recognized that within the existing regulatory and administrative framework, SEBs will not be in a position to regain financial viability on their own. H. FUTURE OPERATION 43. PFC's business is expected to expand given the growing need for power plant investments. Today, total installed capacity in India is about 86,000 MW, representing a peak capacity shortfall of 18% and energy supply shortage of 11.5%. Under the Ninth Plan (1997 to 2002) it is estimated that over 40,000 MW of new capacity will be required to meet demand, followed by another 54,000 MW under the Tenth Plan. About half of these new investments are expected to be in the private sector. These investment opportunities represent a vast growth potential for PFC. The Company's principal strategy is to become one of the leading sources of project finance in the Indian power sector, and to become more actively involved in private power projects and expand the range of its financing- services. As a long-term strategy, PFC aims to provide a comprehensive package of financial services to the power sector, including financial advisory services and consultancy services. PFC is gearing up to provide funds of more than Rs 50 billion annually, or about 10% of the power sector's funding needs, by serving as channel for Government and multilateral fund resources, participating in consortium funding and co-financing, and developing new loan products. 44. PFC's future success depends on the degree to which India's power industry is restructured into a commercial, competitive and credit-worthy sector. A Reform Group has been created within PFC to promote reforms pursuant to recent legislative changes introduced by the Central Government calling for establishing regulatory commissions at the state level and through reformulation of the OFAPs. However, these measures are less comprehensive than those being pursued by several states such as Orissa, Haryana, and Andhra Pradesh, under their policy dialogue with the World Bank. It is in PFC's business interest to actively promote a more comprehensive reform agenda akin to those adopted by the aforementioned states as the expected financial improvements would enhance the quality of PFC's loan portfolio. 45. PFC has developed expertise in appraising and financing transmission and distribution projects. The financial needs of the private distribution utilities that emerge from the restructured state power sectors represent a niche market, which PFC can suitably service. I. KEY LESSONS LEARNED 46. Several lessons can be drawn from this project: a) Development outcome of Bank assistance to India's state power sector will likely be unsatisfactory unless sectoral issues on regulation, tariff and financial reform, and managerial autonomy are addressed through a full restructuring of the sector. 13 b) Project development objectives should be realistic. The objectives as defined were wide- ranging and required having to address many sector issues. In an attempt to do so, performance targets were built into the sub-loans/projects through the OFAPs which contained too many elements and thus difficult to enforce. Moreover, a number of the performance targets involved politically difficult actions. PFC did not have sufficient leverage as an institution to influence adoption by the states of key policy changes required. c) For complex projects involving many beneficiaries and multiple investments, compliance with sub-loan conditions should be sought up-front at time of sub-loan approval. To the extent possible, compliance with future performance targets, e.g., as set in the OFAP, should not affect contracts execution at the risk of impairing the program implementation. Multiplicity of loan and sub-loan conditions subjected the project to many starts and stops. d) Acceptance of revenue subsidies in lieu of tariff adjustments significantly hindered tariff reform and weakened the utilities' resolve to become financially sound and independent. State governments found it politically more expedient to raise subsidy support than to raise tariffs even at the expense of exacerbating the state fiscal deficit. e) Future Bank lending to PFC should be extended only if the beneficiaries adopt a reform agenda that the Bank would have otherwise required under its current direct lending operations with reforming state power sectors. Further, the capacity of PFC staff to manage the complex process of restructuring would have to be strengthened. f) The financial internal rate of return of the sub-projects should be a primary sub-loan eligibility criterion to ensure that financial revenues can cover costs. Reliance on the OFAP to result in required tariff adjustments jeopardized viability of the investments. Although commercial levels of investment return may not be possible at the outset, nevertheless, a positive financial return should be required to ensure that Bank-financed investments do not contribute to further financial losses of the beneficiaries. g) Project components should have been trimmed downed. As an offshoot of the ambitious set of project objectives, and to support the multi-dimensional program under the OFAPs, several types of investment and TA activities were included. h) A larger and robust sub-project pipeline needs to be in place before loan approval. The drop out rate among schemes was relatively high due to failure of clients to meet the OPS eligibility criteria. In the case of the PIF, it took some time before PFC was able to attract borrower interest to the Fund. i) Full agreement on procurement process and model tender documents should be in place by appraisal and advance procurement action covering at least the first year's disbursement taken by time of loan approval. This would ensure that, particularly for first-time Bank clients, there is clear understanding of the Bank's procurement guidelines. The threshold value for prior review can be increased and non-ICB packages made eligible for Bank financing. j) Use of turnkey supply and erection contracts should be considered to facilitate timely completion of sub-projects. k) Given the demonstrated competency of PFC staff, and the numerous sub-loans and procurement contract packages involved, in future operations, disbursements can be facilitated if they are made based on sub-loans, rather than against contract payments. 1) Adoption of strong financial management systems by the financial intermediary is imperative particularly when dealing with a high risk portfolio such as that managed by PFC. Improvement and professionalization of treasury management functions played a key role in preserving PFC's financial assets. 14 Part II: Statistical Tables Table 1: Summary of Assessments A. Achievement of Objectives Substantial Partial Negligible Not applicable Macroeconomic policies Sector policies Financial objectives Institutional development Physical objectives Poverty reduction Gender issues Other social objectives Environmental objectives Public sector management Private sector development Other B. Project Sustainability Likely Unlikely Uncertain Physical elements Developmental objectives C. Bank performance Highly Satisfactory Satisfactory Marginally satisfactory Deficient Identification Preparation assistance Appraisal Supervision D. Borrower performance Highly Satisfactory Satisfactory Marginally satisfactory Deficient Preparation (physical elements) Implementation ( physical elementsO Covenant compliance Operation (physical elements) E. Assessment of outcome Highly satisfactory Satisfactory Marginally satisfactory Deficient Physical elements Developmental changes 15 Table 2: Related Bank Loans/Credits Loan/Credit Title Purpose Year of Status IBRD Loans Approval Preceding Operations 1. Uttar Pradesh Power Construction of 330 MW hydro at Srinagar, 1988 Completed rehabilitation of thermal plants; and reinforcement transmission system. Institutional and financial improvements in UPSEB. 2. (First) Maharashtra Power Improve power supply through construction of 1989 Completed 500MW Koyna hydro, strengthening of Ln3096-IN transmission and distribution system. Institutional and tariff improvements. 3. Second Maharashtra Power Increase power supplies and improve the quality 1992 Completed Ln3498-IN of electricity services through construction of a 500 MW coal-fired unit at Chandrapur; 1,500 MW capacity HVDC line and the related terminal stations; and distribution reinforcement. Strengthen MSEB's finances; demand management, environmental impact management capability. Following Operations 1. Technical Assistance (TA) Support the Government's private power 1993 Completed Project for Private Power development initiative by providing states access Development to TA facility to finance engagement of experts in (Ln3630-IN) private power contracting. 2. Orissa Power Sector Support implementation of regulatory, 1996 On-going Restructuring Project institutional and tariff reforms; institutional (Ln4014-IN) development of Grid Corporation of Orissa (GRIDCO), Orissa Hydro Power Corporation and the new Regulatory Commission, Improve Orissa's power system and demand-side management, and upgrade environmental performance and management capabilities in the sector. 3.Haryana Power Sector Support the first phase of the power sector reform 1998 On-going Restructuring Project (APLI) process by establishing the new legal, regulatory (Ln4271- and institutional framework, initiating the privatization of the distribution business, and removing the most critical bottlenecks of the power system. 4,Andhra Pradesh Power Sector Support the first phase of the power sector reform 1999 On-going Restructuring Project (APLI) process. (Ln444 1-KN I____________________ I_____ I____ I_ 16 Table 3: Project Timetable Steps in project cycle Date planned Date actual Identification 04/1989 04/1989 Preparation 07/1989 07/1989 Appraisal 04/1990 04/1990 Negotiations 09/1990 09/1990 Board presentation 12//1990 01/1992 Signing 02/1992 Effectiveness 03/1992 Mid-term review 11/1995 Project completion 12/1997 06/1998 Loan closing 12/1997 06/1998 Table 4: Loan Disbursements: Cumulative Estimated and Actual Bank Fiscal Years FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 Appraisal estimate (US$ million) 15.9 47.7 100.7 174.9 206.7 259.7 265.0 265.0 Actual (US$ million) 14.0 14.0 14.7 37.8 95.3 167.7 195.0 208.2 Actual as % of estimate (%) 88.0 29.4 14.6 21.6 46.1 64.6 73.3 78.8 ate of final disbursement 12/03/98 Table 5: Key Indicators for Project Implementation Physical Component Component Estimated Actual Transmission Schemes Ckt. Km of lines 2754 4191 Transformer capacity (MVA) 1475 6528 Urban Distribution Improvement No. of Towns supported 26 23 Transformer capacity (MVA) 1041 2038 Capacitors (MVAR) 164 559 Ckt. Km. Of lines 1624 5546 Environmental Upgradation 14 plants in 8 states 1 plant Other Indicators Finalization of bid documents October 1991 November 1992 Cut-off Date of Contract Award June 30, 1994 December 31, 1997 Table 6: Key Indicators for PFC Financial Operations (in Rs Millions) Indicator SAR Actual Performance Targets OPS Targets As of loan closing date Debt to Equity Ratio Maximum 4:1 2.13 Debt Service Coverage Not lower than 1.2 2.18 Return on Capital Positive real return 15% real return Operating Levels Projected 1994-95 1994-95 1997-98 Total Equity 27,381 16,650 24,027 Total Assets 82,439 43,595 80,959 Operating Income 10,451 4,632 10,888 Net Income 3,928 1,562 4,815 Annual Loans Disbursed 22,920 7,924 20,250 17 Table 7: Studies Included in the Project A. Studies supported under EMCAT Component Study Purpose Status Impact of Study By US Consultants 1. OFAP Manual Completed Improvement in operational and financial performance. 2. PFC Library Improvement Completed Better equipped with latest Programme information on MIS 3. T&D Loss Reduction Workshop Completed Reduction in T&D Losses. 4. Organization Study of PFC Completed Reorganization of units for enhanced performance. 5. Financial Operations Management & Completed Officers from various utilities were Reporting (Workshop) introduced to the latest concepts. By Indian Experts 1. Organization Study of PFC Completed Being implemented in phases. 2. Study on Improving Indigenous Completed Information shared with State Meter Technology power utilities. 3. Computerization in Power Finance Completed PFC has an integrated accounting Corporation by M/s CMC Limited. system & MIS 4. Evaluation of benefits for HT Completed Reduction in T&D Losses and Capacitor Installation Programme. improvement in the power factor. 5. Rationalization of pay and perquisites Completed Being partly implemented. 6. Cost trends; system of cost and Completed A workshop to disseminate the benefit estimation for power projects results of the study is planned. 7. Tariff formulation for different supply Completed A workshop to disseminate the functions & different consumers. results is being planned. 8. Case study on Structural Reforms in Ongoing To learn lessons and incorporate Orissa (taken up in the month of necessary improvements in the December 1997) Reforms in other States. B. Studies Supported under the Pre-Investment Fund (PIF) Component Study Purpose Status Impact of Study I Diagnostic studies Both studies completed Helped the borrowers to formulate OFAP with PFC 2 EIA studies All the seven studies have Helped the borrower to obtain been completed Environmental clearances 3 Preparation of feasibility reports, All the nine studies have Helped the borrower to obtain Geological Investigation, and plant been completed various project clearances. layout studies 4 Design and Engineering. Of Completed Helped the borrower to Kothagundam TPS implement the Projects 5 Consultancy for Construction Completed Helped the borrower in Management Supervision of the Project 6 Information Technology Studies Completed Led to detailed design and engineering for APSEB's state wide computerization scheme. 7 Computerization and communication MPEB - scheme completed Helped borrowers to upgrade the systems and upgrading. WBSEB - supplies of computer system equipment effected 8 Consultancy of PPA, negotiations In progress Will help SEBs formulate and with IPPs I negotiate PPAs with IPPs 18 Table 8A: Project Costs Component Appraisal Estimate (Rs.m) Actual (Rs.m) Local Foreign Total Local Foreign Total Investment Schemes a. Transmission & Distribution 3809 2251 6060 12737 6932 19669 b. Plant Environment Upgrading 1018 601 1619 193 95 288 Sub-total 4827 2852 7679 12930 7027 19957 Technical Assistance a. Pre-Investment Fund 75 184 259 395 395 b. PFC Institutional Strengthening 10 10 20 56 56 c. SEB Institutional Strengthening 48 50 98 108 108 d. Studies for System Renovation 30 73 103 223 223 Sub-Total 163 317 480 782 782 Contingencies 2800 881 3681 Total Project Cost (Rs. M) 7790 4050 11840 13712 7027 20739 Total Project Cost (US$ m) 421 220 640 385 197 582 Interest During Construction 49 22 72 Not available (US$m) Total Financing Required 470 242 712 (US$m) Table 8B: Project Financing Appraisal Estimate (US$m) Actual (US$m) a/ Source Local Foreign Total Local Foreign Total IBRD 59 206 265 0 208 208 PFC 269 22 291 134 0 134 SEB 142 - 142 227 - 227 USAID - 14 14 11 11 Total d/ 470 242 712 361 219 582 a/ estimates of actual IDC are not available Table 9: Economic Costs and Benefits (Rs. Million) At appraisal, the internal economic rate of return (ERR) for the various investment schemes were estimated to be at least 12 percent. A recalculation of the ERR was not performed. However, given the increasing value of power in the face of growing supply shortages during the project period, and the competitive equipment prices secured for the sub-projects, the rates of return are expected to remain satisfactory. 19 Table 10: Status of Legal Covenants Agreement Section Covenant Present Original Revised Descnpuun of Comments type Status fulfillment fulfillment Co%enant date date LA 2.2B 03 C 03/18/1992 GOI to open and maintain in dollars a Fulfilled special deposit in Reserve Bank of India LA 3.07 03 C 03/16/1992 GOI and PFC to enter into a Fulfilled subsidiary loan agreement under terms and conditions which shall have been approved by the Bank. LA 4.01 01 C 09/30/1995 GOI/PFC to submit to the Bank not Fulfilled later than six months after the end of each fiscal year, an Auditor's report on the Special Account. LA 4.02 04 C 03/31/1995 GOI to communicate to PFC, by Fulfilled March 31 each year, the amount PFC is authorized to raise in the domestic bond market in the following year. PFC to submit G01's authorization to the Bank. LA 5.01 (e) 05 CP OPS: PFC to implement and consult Complied except for with the Bank before any material deviations in two modification is made to it. PFC to areas; said deviations provide in quarterly progress reports are acceptable to the information on any changes made by Bank. PFC Board to the OPS. PA 2 (5) 04 C 03/31/1995 GOI to communicate to PFC, by Fulfilled March 31 each year, the amount PFC is authorized to raise in the domestic bond market in the following year. PFC to submit GOI's authorization to the Bank. PA 3.02 05 C PFC to take out and maintain Fulfilled insurance. PA 4.01 (b) (i) 1 01 C 05/31/1995 PFC to submit unaudited financial Fulfilled statements, not later than two months after the end of the financial year. PA 4.01 (b) (i) 2 01 C 09/30/1995 Audited financial statements: PFC to Fulfilled submit not later than six months after the end of the financial year PA Sch 2 (1) 03 C PFC funds will not be pre-allocated; Fulfilled funds will be lent to the power utilities on the basis of a criteria agreed upon between the Bank and PFC. PA Sch 2 (2) 05 C PFC to submit to the Bank for Fulfilled approval the items intended to be financed with the proceeds of the proposed loan, under each component of the project. 20 Table 10: Status of Legal Covenants (continued) Agreement Section Covenant Present Odginal Revised Descrption of Comments type status flflment fNfillment Covenant due date PA Sch 2 (3) 06 C PFC undertakes to avail of financing Complied for the environmental upgrading of power plants, the power utility will prepare an environmental assessment of the candidate power station (s) and agree to implement actions needed. PA Sch 2 (4) 06 C PFC to give the Bank the opportunity Complied to comment on the first power plant environmental review of each participating SEB. PA Sch 2 (6-1) 02 C 11/16/1995 PFC to submit each year before Complied January 31, a report including PFC's current financial performance compared to the parameters set in the OPS. PA Sch 2 (6-2) 02 CD 06/30/1995 PFC to submit each year before June Complied 30, five-year financial projections showing how the OPS parameters will be attained. PA Sch 2 (7c) 05 C PFC to include in its loan agreements Fulfilled a provision to ensure that its clients meet environmental and rehabilitation standards acceptable to the Bank. PA Sch 2 (7d) 05 C 12/31/1994 PFC agreed that only sub-projects Fulfilled having complete detailed engineering and all clearances by agreed cut-off dates would be eligible for financing. PA Sch 2 (7e) 05 C 06/30/1994 12/31/1997 PFC to have all contracts financed In compliance based under the loan awarded by agreed cut- on revised cut-off off date. date for recently included schemes. PA 2.01 (a); 3.01 05 CP OPS: PFC to implement OPS and In general consult with the Bank before any compliance. material modification is made to it. PFC to provide in quarterly progress reports information on any changes made by PFC Board to the OPS. Covenant types: 1. = Accounts/audits 8. = Indigenous people 2. = Financial performance/revenue generation 9. = Monitoring, review, and reporting from beneficiaries 10. = Project implementation not covered by 3. = Flow and utilization of project funds categories 1-9 4. = Counterpart funding 11. = Sectoral or cross-sectoral budgetary or other 5. = Management aspects of the project or resource allocation executing agency 12. = Sectoral or cross-sectoral policy/ 6. = Environmental covenants regulatory/institutional action 7. = Involuntary resettlement 13. = Other 8. Present Status: C = covenant complied with CD= complied with after delay CP = complied with partially NC = not complied with 21 Table 11: Compliance with Operational Policy Statements Additionality 1. Funds provided by PFC to power sector entities constitute an additionality to the funds assigned to them through the Plan. The borrowers cannot substitute PFC's funds for earmarked allocations by the Planning Commission. Status of compliance: In compliance. PFC's loan agreements with SEBs include a clause to this effect. The Planning Commission has also issued a directive to all SEBs to this effect. PFC's funds not to be pre-allocated 2. PFC's funds are not allocated to the states. PFC's financing decisions are based solely on the merits of individual projects. Status of compliance: In compliance. Eligibility Criteria 3. PFC will assist only those SEBs and SGCs that agree to implement Operational and Financial Action Plans (OFAPs) satisfactory to PFC. Status of compliance: Since June 30, 1991, new loans are granted only when an OFAP is in place. 4. PFC will lend only to projects that meet the following criteria: a) are economically justified, with a rate of return of not less than 12%; b) are technically sound; c) technical solutions proposed must be least cost; d) are compatible with existing expansion plans; e) solutions proposed should meet GOI and State environmental impact standards; and f) schemes should have all clearances as required by State and Central agencies. Status of compliance : In compliance. However, criteria for inclusion of projects/schemes in the accelerated generation and supply program, under which PFC is receiving a subsidy from GOI and is lending at subsidized rates to the Borrower, are as follows: (a) renovation & modernization; (b) on-going generation projects; (c) missing transmission links and system improvement; and (d) grant for studies. 5. Schemes for environmental upgrading of power stations should meet acceptable engineering standards, and should be the most cost-effective means of mitigating environmental effects. Status of Compliance. In compliance. 6. Priority areas for funding are the following: (a) renovation & modernization of thermal and hydro power plants; (b) completion of on-going generation projects; (c) expansion of transmission and distribution systems; and (d) system improvement Status of compliance: In compliance. Repayment Guarantees and Exposure limits 7. PFC will extend financial assistance only to those SEBs whose State Governments have given confirmation that PFC will have priority on the SEB's surplus revenue over the loans granted by the State Governments to the SEBs, in accordance with the Electricity Act. Status of compliance : In compliance. This is provided in the guarantees signed by the State. 8. PFC's maximum exposure limits are set according to both its clients' credit worthiness and the guarantees offered (such as escrow account in addition to State guarantee), according to an agreed matrix that determines the credit risks weights to be used in calculating the maximum levels of exposure per client as a percentage of PFC's net worth. The maximum level of exposure per client is as follows : 1990-92: 35% of PFC's Net Worth; 1992-93: 30%; 1993-94: 25%; 1994-96: 20%; and 1996-98: 25% Status of compliance: Not in compliance. PFC exceeded its exposure limits in the case of 8 clients. As on end- FY98, the aggregate over-exposure for the eight borrowers corresponded to Rs. 28,686 million, with APSEB, its largest borrower exceeding by Rs 6,875 million. PFC justifies this over-exposure by referring to its policy of approving loans for borrowers, who have exceeded their limits, only in connection with projects whose implementation would result in an improved financial position for the borrower in question. 22 Table 11: Compliance with Operational Policy Statements (continued) Non-rescheduling of Loans 9. PFC's general policy is not to reschedule repayments due from its borrowers. However, the OPS allows PFC, if PFC considers it financially prudent, to provide a financial restructuring package supported by appropriate conditionality. Status of compliance : Not in compliance. As of end of FY 98, loan repayments due from five of PFC's borrowers (UPSEB, APSEB, TVNL, BSHPCL and WBPDCL) had been rescheduled and restructured through loan consolidation and conversion into monthly installments, and supported by escrow accounts and irrevocable payment instructions. Adjustability of Lending Rates 10. When PFC borrows at variable interest rates it will include provisions in its loan documents to allow its lending rates to be adjusted both on the disbursed as well as the undisbursed portion of its loans. Status of compliance : Not in compliance. Domestic currency lending of PFC is at a fixed rate of interest with the provision for adjusting lending rate on undisbursed portion. However, in foreign currency loan agreements, such clauses are being incorporated. Procurement and Disbursement Procedure 11. Funds will be made available to the borrower only when the expenditure takes place. Status of compliance : In compliance. Detailed disbursement procedures in place. Supervisions & Monitoring 12. The borrower shall furnish periodic progress reports, satisfactory to PFC, in respect to implementation of the financed project(s) and the OFAP. In addition, PFC's supervision teams will periodically visit project sites to assess progress and to provide support to the borrower as needed. Status of compliance : In compliance 13. PFC may suspend or cancel any part of a loan if the borrowing entity fails to perform any obligation under the legal agreement. PFC has developed a set of Guidelines for Application of Remedies. Status of compliance: In compliance Profitability Targets 14. PFC will endeavor to operate as a commercial entity, earning an adequate rate of return on its capital (positive in real terms), maintaining a healthy loan portfolio and building a strong financial base to enable it to borrow on attractive terms. Status of compliance: In compliance. PFC's real return on Networth for FY 98 was 15% (based on unaudited financial statement). 15. PFC's lending rates will be positive in real terms and will reflect its borrowings and operational costs, plus a margin to ensure its financially viability. Lending documents will include a provision to ensure that lending rates are adjusted to reflect this objective. Status of compliance : In compliance.4 As of end FY 98, PFC's net interest margin stood at 4.8%. Capital Adequacy 16. Initially, a maximum debt-to equity ratio of 4:1 will be maintained. The appropriateness of this ratio will be periodically revisited. Status of compliance : In compliance. As of March 31, 1998, the debt-to-equity ratio was 2.13. 4Cf. item 10, however, with regard to adjustment of rates on disbursed portion of domestic currency loans. 23 Table 11: Compliance with Operational Policy Statements (continued) Debt Service Coverage Ratio 17. PFC's operation will be managed so as to maintain a debt service coverage ratio not lower than 1:2. Status of compliance : In compliance. At the end of FY 98 the DSCR ratio stood at 2.18. Liquidity 18. PFC will maintain liquid assets equal to not less than the equivalent of the anticipated disbursements for the following three months. Status of compliance : In compliance. Foreign Exchange and Interest Rate Risks 19. PFC will not bear the interest rate and foreign exchange risks in its operations. Status of compliance: In general compliance. Co-financing operations under ADB-CFS, a World Bank TA loan and French Credit are on a back-to-back basis. Where the margin between lending and borrowing cost is adequate to cover exchange rate risk, external commercial borrowings are on-lent in Rupees with the exchange rate risk being absorbed by PFC. Guarantees 20. PFC will be lending to SEBs and SGCs only with the backing of a guarantee provided by the State Governments or commercial banks. In addition, PFC may request contingent arrangements, like escrow accounts, to be invoked in certain cases, like when the guarantees have not been honored, or the OFAPs are not being implemented to the satisfaction of PFC, or when SEBs / SGCs want to enhance their borrowing limits. Status of Compliance: In compliance. Term Transformation 21. PFC will determine the average repayment period of its loans so as to ensure that the average maturity of its assets does not exceed that of its liabilities. Status of Compliance: In compliance. There is a general match between asset and liability maturities. Guarantees provided by PFC to SEBs / SGCs 22. The provision in the preceding paragraphs relating to remedies, forex and interest rate risks, loan guarantees, etc. will equally apply to guarantees granted by PFC. Status of Compliance In compliance. PFC follows this principle in computing risk exposure limits and in requesting counter-guarantees. Accounting and Audit Systems 23. PFC will maintain its accounts in conformity with the requirements of the Companies Act (1956) and directives from the GOI. PFC's Statutory Auditor is appointed by GOI on the advice of the Comptroller and Auditor General, who may also carry out his own audit of PFC. Status of Compliance: In compliance. 24. PFC is aware of the need to develop an efficient organization staffed with competent professionals from different disciplines. To support this effort, PFC intends to maintain training programs that provide access to the latest development in the different disciplines. Status of Compliance: In compliance. Review of Polices 25. The above set of polices and procedures will be revised from time to time to reflect the changing needs in the operations of the Corporation. Status of Compliance. In general compliance. PFC drafted a revised OPS and a copy was provided to the Bank in March 1996 and Bank comments were reflected in the Aide Memoire of the Bank Supervision Mission of November 1996. 24 Table 12: Bank Resources: Staff Inputs Stage of Project Cycle Planned Actual Weeks US$ Weeks US$(000) Through Appraisal 41 120.3 Appraisal-Board 28 82.9 Board-Effectiveness 50 149.7 Supervision 168 457.6 Completion 13 50 13 30.0 TOTAL 300 840.5 Table 13: Bank Resources: Missions Performance Rating Stage of Project Cycle Month/ Number of Days in Specialized Implementation Development Types of Year Persons Field Staff Skills Status Objectives Problems Through to Appraisal 07/89 3 FA. ES. E. 00 Appraisal through 04/90 to 4 40 FA, ES, EC, E Board Approval 02/92 Supervision 1 08/92 1 14 E 2 1 PR Supervision 2 03/93 7 44 FA. E. ES, ENC 2 1 Supervision 3 05/93 8 30 FA, E, EN, ES, 2 1 D PR Supervision 4 07/93 3 3 FA, PR, ES 2 1 FP, D Supervision 5 03/94 5 30 FA, E, 00, PR 2 2 FP, SC Supervision 6 03/95 4 15 E, ES, C, 00 U U FP, SDi Supervision 7 11/95 4 20 E, FA, 00, PA S S FP, C, SDi, (Mid-Term Review) IAS Supervision 8 11/96 5 37 FA, E, EC, ES, S S FP, PCD, 00 SDi, SC Supervision 9 12/97 3 16 FA, PR, 00 S S A, CF, SD Completion 07/98 4 27 FA, E, 00, PA S S FP Specialists: PA= Financial Analyst, E = Engineer, EC= Economist, EN = Environmental Specialist, ES= Energy Specialist, 00 = Operations Officer, PR = Procurement, C = Consultant, PA = Projects Assistant Problems: A = Administrative, CF = Counterpart fund shortfall, D = Project process delay, C = Contract delays - awarding & implementation, FP = Financial performance, IAS = Implementing agency staffing, PCD = Project/component design, SC = Sub-borrower commitment, SD = Shortages and/or delay in supply of materials, SDi = Slow disbursement Ratings: 1 = No or minor problems, 2 = Moderate problems; 3 = Major problems, HS = Highly satisfactory, S = Satisfactory, U = Unsatisfactory, HU = Highly unsatisfactory, NR = Not rated/not applicable 25 Appendix A India: Power Utilities Efficiency Improvement Project (Loan 3436-IN) World Bank Supervision Mission June 30 to July 7, 1998 Aide Memoire A Bank mission visited India from June 30 to July 7, 1998 to conduct the final supervision of the Power Utilities Efficiency Improvement Project and initiate preparation of the Implementation Completion Report (ICR). The mission team was composed of Mmes. M. Manzo (Sr. Operations Officer), V. Ziff (Projects Assistant), and Messrs. S. Jansson (Private Sector Development Specialist) and V. P. Thakor (Power Engineer, Consultant). The mission would like to thank the Power Finance Corporation (PFC) and the Department of Economic Affairs for the close cooperation extended to the team. Key Mission Findings Status of Implementation. The pace of project implementation has considerably accelerated between December 1997 and June 1998. Nine investment sub-projects that were earlier reported to be lagging (four in Kerala, three in Madhya Pradesh, one in Andhra Pradesh and one for Durgapur Power Ltd.) are now progressing rapidly towards completion. There are no outstanding problems of contract execution, and deliveries of most equipment have taken place. Moreover, procurement has advanced for the West Bengal computerization and communication scheme which is being funded under the Pre- Investment Fund (PIF) component of the project. Disbursement as of June 30, 1998, the loan closing date, stood at US$ 195.4 million out of a total loan amount of $215.0 million (net of earlier cancellation of US$ 50 million). It is estimated that further disbursements from the loan, equivalent to about US$ 10 million in respect of eligible expenditures incurred before the closing date, will be made, provided withdrawal applications are received at the Bank's headquarters before close of business October 31, 1998. PFC's financial performance during FY1998 was marked by record post-tax profits amounting to Rs 5,510 million. Improved profitability was attributable to widening of the net interest margin to 4.76%, expansion of the loan portfolio by some 30%, and further reductions in effective corporate tax rate. As a result, PFC posted a healthy return on net worth of 22.2% for FY1998, or twice the level of the previous year. In FY1998, PFC continued to diversify its sources of funding by tapping the international bond market with a 12- year Euronote issue of US$ 100 million at 7.5% fixed interest rate p.a. After close of the fiscal year, PFC's continued good standing in the international debt market was evidenced by the successful syndicated loan issue of US$ 100 million that closed on June 12, 1998. The issue was priced at 115 basis points over the six months LIBOR rate for US dollars, which reflects a satisfactory pricing in view of the on-going Southeast Asian financial turmoil. The poor quality of PFC's loan portfolio, however, continues to be problematic. While PFC undertook major restructuring of the debts of several of its borrowers, subsequent rescheduling of restructured debt has had to be resorted to, e.g., loans to APSEB. Moreover, against the exposure limit defined in PFC's Operational Policy Statement (OPS), eight of PFC's borrowers have exceeded their borrowing entitlements. As of April 1, 1998, PFC's aggregate over-exposure to the eight borrowers corresponded to Rs. 28,686 million. The mission strongly recommends that to preserve recent gains made in its financial operations, PFC apply more rigor in the evaluation of the quality of its loans, 26 strictly enforce its policies on exposures, and review and strengthen its policies on loan loss provisioning and write-offs of "bad debt". Implementation Completion Report. The mission exchanged views with PFC staff and management on the overall outcome of the project, discussed a range of factors that affected the project, and the lessons learned. While preliminary assessment indicate that overall results were satisfactory, achievement of the various development objectives was mixed. The expectation that the project would result in improvements in the power sector, including improvement in the creditworthiness of participating SEBs, was not, and could not be met in the absence of major structural, tariff and regulatory reforms in the state power sector. Based on latest project information available from PFC, the mission prepared a detailed outline of the ICR for PFC's comments and data update. Subject to results of site visits to be made by Mr. V. P. Thakor to confirm status of sub-project completion, and preparation by PFC of an Operational Plan, a Completion Mission may not be required. Status of Project Implementation Investment Sub-projects. Fifty-two schemes among seven utilities were financed under the investment component. These involved 121 procurement packages, requiring over 200 contracts. The status of completion of the sub-projects is summarized below (Refer to Annex I for details): Sub-project Type Total Completed More than 75% complete Transmission 27 7 20 Urban Distribution 22 12 10 Capacitors I Metering 1 Environment 1 - 1 Total 52 21 31 During the month of July 1998, the mission would carry out visits to selected sub-project sites for physical verification of the works. For this purpose, Mr. V. P. Thakor plans to visit the following sub- projects with a representative of PFC: State Sub-project Cost in Rs. Millions Andhra Pradesh GIS Substations, Hyderabad 1523.6 Urban Distribution, Hyderabad 949.1 Gujarat 220 kV Dehgam s/s 283.9 400 kV Amreli s/s 951.0 400 kV Zerda s/s 801.6 Urban Distribution, Rajkot 78.7 Rajasthan 220 kV Bhinman s/s 195.9 220 kV Balotra s/s 276.5 Urban Distribution, Jaipur 295.2 Total Cost 5355.5 A significant portion of remaining disbursements consist of retention payments which are released after the performance of the equipment is proven. PFC requested clarification from the mission concerning the Bank's policy in respect of such payments. The mission clarified that the loan accounts will be kept open for 120 days after the closing date to process payments against expenditures that became due prior to the closing date. Under the prevailing practice, payments that did not become due before the closing date could not be processed after the closing date. 27 Pre-Investment Fund (PIF) Activities . Thirty schemes are being supported under the PIF of which 21 schemes are completed. The schemes involve a total contracted value of Rs 560 million. PFC estimates that total loan disbursements in support of the PIEF activities would amount to Rs. 400 million, or between US$ 10 million to $11 million. This amount is much higher than anticipated by the Bank mission in December 1997, and is attributable to the major progress made during the last six months in advancing procurement under the West Bengal computerization and communication project. Inspection of equipment supply was completed and delivery effected. Five schemes, which involve provision of consultant services to assist SEBs in their negotiations of Power Purchase Agreements with IPPs, represent activities carried over from the Private Power Development Project (TA Loan 3630-IN). It is estimated that about US$ 100,000 would be disbursed from Loan 3436-IN for this purpose. These advisory services are expected to continue beyond June 1998 until the respective PPA negotiations are completed. The balance of funds required to complete these consultant activities would be financed from PFC's own resources. Corporate and Financial Performance 5 (Annex 2 represents highlights of PFC's financial performance for the past four years.) Income and Profitability. PFC's revenues from operations and other income in FY1998 amounted to Rs. 10,927 million, of which the earned interest on Loans & Advances amounted to Rs. 9,202 million (an increase by 49% over the previous FY). Total operating expenses amounted to Rs. 5,748 million, of which interest expenses represented Rs. 5,011 million. After adjustments and provision for income tax, this translated into a Net Profit of Rs. 5,510 million, or a 140% increase over that of the previous year. This huge increase in profits are due to a widened net interest margin (from 3.97% to 4.76%), as applied to a loan portfolio that expanded by some 30%, and a further reduction in PFC's effective tax rate. Return on Net Worth (paid-in capital + reserves) doubled from 11% in FY1997 to 22% in FY1998 , with earnings per share more than doubling from Rs. 233 to Rs. 543. The real return on Net Worth in FY1998, after accounting for inflation, was a very healthy 15%, up from 4.6 % in FY 1997. Capital & Resource Mobilization. As at end FY1998, the total paid-up Share Capital amounted to Rs. 10,305 million out of an authorized capital of Rs. 20,000 million. No further equity infusion from GOI is being contemplated for the foreseeable future. There could be an opportunity for future participation by institutional investors in PFC's equity. Total funding in FY 1998 increased by Rs. 16,672 million to Rs. 77,831 million. At end-FY, PFC's Net Worth position stood at Rs. 24,820 million, corresponding to 32% of Total Funding, which was at the same relative level as in the previous year. Total debt increased by 29% to Rs. 53,011 million, including an interest subsidy from GOI in the amount of Rs. 1,941 million. Out of total borrowings, debt from the domestic market accounted for Rs. 25,268 million, mainly in the form of tax-exempt and non-tax exempt bonds. World Bank and ADB loans through GOI stood at Rs. 12,818 million. PFC also tapped the international bond market for a 12- year Euronote issue of US$ 100 million. Together with a syndicated loan of US$75 million, that was raised in FY1997, and other foreign currency loans of Rs. 6,031 million, the aggregate Foreign Exchange Loan position at end-FY1998 stood at Rs. 12,984 million. In an effort to further diversify its funding sources, PFC has entered into a line of credit agreement with 1KB Bank of Germany, for financing of imports by various borrowers of PFC. PFC is also negotiating with other ECAs for similar arrangements. The international rating agency Moody's assigned a 'Baa3' rating to PFC's foreign currency debt, which is at the sovereign ceiling of India. At the time of the mission, however, Moody's downgraded India's sovereign debt by two notches to 'Ba2', which could affect the pricing of any long term paper that 5 As of the time of this mission, financial statements provided for FY 1998 are provisional and will be reviewed by the auditors. 28 PFC would place in the international market. Standard and Poor has recently changed the foreign currency outlook for PFC from 'stable' to 'negative'. The downgrading of PFC's debt by international rating agencies is likely to increase the average cost of PFC's funding. This factor, together with the general slowdown of the Indian economy, may contribute to an impending reversal of the trend of continued growth in PFC's business operations and profitability. Application of Funds. Outstanding Loans & Advances position increased by nearly 30% to Rs. 73,059 million, after recording net disbursements of Rs. 16,644 million, which was twice the level of net disbursements in the previous year. This reflected a strong expansion in business activity as 57 loans to 36 different borrowers were sanctioned, involving a total value of Rs 29,323 million. As of end of FY1998, PFC's largest borrowers are APSEB with loans totaling Rs. 12,811 million, MSEB with loans of Rs. 8,774 million, and RSEB with loans of Rs. 7,021 million. In an effort to diversify its client base, PFC approved Rs.4,454 million worth of loans to five private sector borrowers, although associated disbursements have yet to be made. Collection Performance and Portfolio Quality. At the end of FY1998, total loans overdue (arrears) stood at Rs 313.4 million reflecting an average collection rate over the year of 56.5%. The collection rate on new amounts due and billed over the year was posted at 99.7%, whereas the recovery rate of accounts in arrears was 26 %. The level of total arrears was controlled by consolidation and rescheduling of several problem loans and their conversion to monthly installments backed up by revenue escrow accounts in addition to the state guarantees. The respective escrow accounts are governed by tripartite agreements, under which the borrower's agent bank sets aside the required monthly amounts into the escrow from revenues collected on behalf of the borrower, in accordance with irrevocable payment instructions. The mission noted that in view of the continued financial instability of some SEBs, the pressure for rescheduling the restructured accounts would remain high, as experienced in the case of APSEB, despite the escrow arrangements and state guarantees. The quality of PFC's portfolio, therefore, continues to be a matter of serious concern. Based on the classification system agreed with the Bank, which in addition to the DSCR takes due regard to timely payments and timely auditing/annual reporting, the portfolio at end-FY1998 can be classified as follows: normal risk assets - 17.17%; substandard assets - 78.68%; doubtful assets - 4.04%; and loss assets - 0.11%. In FY1998, PFC provided for reserves for bad and doubtful debts of Rs. 88 million, raising the aggregate provision on the balance sheet to Rs.788 million at the end of the fiscal year. This represents a mere 1.1% of the loan portfolio, which would not allow PFC to cover any substantial write-offs of non- performing assets. On the other hand, using the RBI guidelines, PFC's asset would be classified significantly different as follows: normal risk assets - 79.69%; substandard assets - 20.17%; doubtful assets - 0.14%; and loss assets - 0.00%. The latter classification regard state guaranteed loans as risk-free and PFC maintains that loan loss provisioning is unnecessary as it has no non-performing assets. Operational Policy Statement (OPS). PFC is in compliance with the loan covenants and, except for certain deviations enumerated below, is in general compliance with the OPS earlier agreed with the Bank. PFC's deviations from the OPS during the last FY were in the following areas:6 6 Refer to Table 11: Compliance with Operational Policy Statement, Part II: Statistical Tables for the ICR 29 * The exposure limit was exceeded in the case of eight borrowers: APSEB, KEB, MPEB, PSEB, RSEB, TNEB, UPSEB and GRIDCO; the aggregate over-exposure to the eight borrowers corresponded to Rs. 28,686 million as of end of FY 1998. * The Operational and Financial Action Plan (OFAP) requirement for SEBs to maintain a minimum rate of return of 3 per cent was waived with regard to loans for completion of on-going generation facilities; * The OPS stipulates that lending rates are to be adjusted on both the disbursed and the undisbursed portion of its loans in order to maintain interest margins. PFC only adjusts the lending rates on the undisbursed portion on its domestic currency loans, whereas the rates on both disbursed and undisbursed portions are adjusted in the case of foreign currency loans. * The OPS provides that PFC will not reschedule loans, but in exceptional circumstances can restructure loans supported by appropriate conditionality. Accordingly, PFC consolidated and restructured several problem loans and required that they be backed up by an enhanced security package involving escrows. Unfortunately, a rescheduling of the restructured loan(s) was soon effected for APSEB; and except for the automatic transfer of escrow funds, the security arrangement was not significantly improved . Implementation Completion Report (ICR) Discussions The mission had detailed discussion of issues to be covered in the project ICR. Comparative data and information tracing project progress from time of appraisal to completion were made available by PFC. On this basis, the mission prepared a working draft of the ICR for comment and confirmation/update of facts and figures by PFC. A copy of the draft ICR would be sent by the Bank to PFC by late September for PFC's comment upon receipt by the Bank of firmer data on project costs, disbursements and completion status. The Bank would also expect to obtain PFC's evaluation report on the project on or before October 31, 1998 for attachment to the final ICR version, which is expected to be released by mid-November. For the purpose of the ICR, the mission requests PFC to prepare an operational plan as well as provide impact indicators for as many components of the project as feasible. In particular, the impact of 25 sub-projects for environmental actions would be desirable though only one of these sub-projects (Durgapur) is funded by the Bank loan and is still not completed. Similarly, the impact of the metering project in Haryana, where about 23,000 meters for H. T. consumers were replaced, should be evaluated. The effect on billing and collection due to this measure should not be difficult to assess. The mission also requested PFC to review selected efficiency indicators (in addition to financial performance) for the beneficiary SEBs. These may include frequency of outages and interruptions, T&D losses, plant load factor, billing and collection, etc. The trend in these indicators between 1992 and 1998 could indicate the beneficial impact of PFC/World Bank efforts. 30 Annex 1 Power Utilities Efficiency Improvement Project (Loan 3436-IN) Implementation Progress as of May 31, 1998 1.1 Sanctions Credit No. of Total Cost Loan Amount Donor Agency sub-projects in Rs Crores Share sanctioned WB - Investment 52 1996 1183 798 Sub-projects WB-PIF 31 150 129 67 Total 83 2146 1312 865 1.2 Procurement Status Credit Packages NIT (s) Issued Bids Opened Awards Identified No./Value No.IValue No. No./Value WB -Inv. 128/737 128/737 128 121/702 WB-PIF 45/129 45/129 41 41/64 Total 173/866 173/866 169 162/766 1.3 Physical Progress (Investment Component) Sub-project Type Total Completed More than 75% complete Transmission 27 7 20 Urban Distribution 22 12 10 Capacitors 1 1 - Metering 1 1 Environment 1 - 1 Total 52 21 31 31 Annex 2 POWER FINANCE CORPORATION LIMITED RESULTS OF FINANCIAL OPERATIONS 31/3/94 31/395 31/3/96 31/3/97 31/3/98 I Financial Highlights in 31.37 31.50 35.50 36.11 39.73 US$ million @ 2 Total Loans 1,182.21 1,347.68 1,361.69 1,562.31 1,838.89 3 Total Capital 490.37 528.41 513.04 553.67 624.72 4 Total Assets 1,380.30 1,497.05 1,494.90 1,793.52 2,041.08 5 Net Profit 47.02 49.62 55.46 62.59 138.69 6 7 Rate of Inflation in India (%) 10% 7.15% 8 9 Rupees In Millions 10 Balance Sheet 11 Cash & Cheques 650.00 300.00 - 800.00 793.00 12 Bank - ST 31.00 791.00 164.00 565.00 173.00 13 Bank Deposits 3,729.00 3,881.00 2,225.00 4,650.00 4,157.00 14 Other ST Assets 510.00 144.00 178.00 193.00 655.00 15 ST Investments 1,590.00 - 345.00 - - 16 Total Current assets 6,510.00 5,116.00 2912.00 6,208.00 5,778.00 17 Loans & advances 37,086.00 42,452.00 48,340.00 56,415.00 73,059.00 18 Provision for Bad Debts -303.00 -417.00 -560.00 -700.00 -788.00 19 Net Loans & Advances 36,783.00 42,035.00 47,780.00 55,715.00 72,271.00 20 Gross Fixed Assets 12.00 13.00 2,087.00 2,861.00 3,467.00 21 Accumulated depreciation 5.00 7.00 10.00 20.00 424.00 22 Net Fixed Assets 7.00 6.00 2,077.00 2,841.00 3,043.00 23 Total Assets 43,300.00 47,157.00 52,769.00 64,764.00 81,092.00 24 1 25 Exchange Risk Admn.Fund & 26 Borrowers Contribution 816.00 1,254.00 1,740.00 - - 27 Interest Accrued 471.00 523.00 546.00 694.00 844.00 28 Proposed Dividend 100.00 300.00 400.00 480.00 528.00 29 Other Liabilities 1,907.00 2,430.00 2,129.00 2,430.00 1,889.00 30 Total Current Liabilities 3,294.00 4,507.00 4,815.00 3,605.00 3,261.00 31 Bonds 18,543.00 18,072.00 18,902.00 22,993.00 25,268.00 32 Interest subsidy from Gol - - - - 1,941.00 33 Loans - Gol 200.00 1,600.00 4,600.00 9,400.00 12,818.00 34 Fx Loans 5,748.00 6,297.00 6,235.00 6,065.00 6,031.00 35 Syndicated Loans - - - 2,708.00 2,980.00 36 Fixed Rate Euro Notes - - - - 3,973.00 37 Public Deposit Scheme 132.00 36.00 4.00 - - 38 Total Debt 24,623.00 26,005.00 29,741.00 41,166.00 53,011.00 39 Share Capital 9,855.00 10,305.00 10,305.00 10,305.00 10,305.00 40 Share Application Money 450.00 - - - - 41 Special Reserves 3,009.00 3,873.00 4,960.00 5,850.00 8,342.00 42 Bond Redemption Reserves 2,058.00 2,453.00 2,933.00 2,933.00 2,933.00 43 General Reserves 11.00 14.00 15.00 905.00 3,240.00 44 Total Capital 15,383.00 16,645.00 18,213.00 19,993.00 24,820.00 45 Total Liabilities & Capital 43,300.00 47,157.00 52,769.00 64,764.00 81,092.00 46 47 Income Statement 48 Interest on Loans & Deposits 3,993.00 4,127.00 4,560.00 6,160.00 9,202.00 49 Income from Investments 540.00 464.00 853.00 466.00 708.00 50 Lease income - - 39.00 455.00 806.00 32 51 Other income 43.00 42.00 66.00 133.00 211.00 52 Total income 4,576.00 4,633.00 5,518.00 7,214.00 10,927.00 53 Interest Expense 2,145.00 2,179.00 2,360.00 3,207.00 5.011.00 54 Issue Expenses 0.00 0.00 63.00 309.00 66.00 55 Admn .Expenses 49.00 59.00 83.00 107.00 126.00 56 Depreciation 2.00 2.00 3.00 10.00 405.00 57 Interest Tax 118.00 120.00 138.00 200.00 52.00 58 Total Operating Expenses 2,314.00 2,360.00 2,647.00 3,833.00 5,660.00 59 Prov. For Bad Debt 113.00 114.00 143.00 140.00 88.00 60 Total Expenses 2,427.00 2,474.00 2,790.00 3,973.00 5,748.00 61 Profit for the Year 2,149.00 2,159.00 2,728.00 3,241.00 5,179.00 62 Prior period adjustments(Net) 0.00 0.00 9.00 5.00 -413.00 63 Profit Before Tax 2,149.00 2,159.00 2.719.00 3.236.00 5,592.00 64 Income Tax 674.00 596.00 750.00 976.00 82.00 65 Profit After Tax 1,475.00 1,563.00 1,969.00 2,260.00 5,510.00 66 67 Ratios 68 Liquidity Ratio 197.63% 113.51% 66.71% 172.21% 177.18% 69 Debt to Networth 160.07% 156.23% 163.30% 205.90% 213.58% 70 Debt Service coverage Ratio 200.28% 199.17% 215.34% 201.22% 219.68% (PBT) 71 Debt Service coverage Ratio 168.86% 171.82% 183.56% 170.78% 218.04% (PAT) _ 72 Capital as % of Assets 35.53% 35.30% 34.51% 30.87% 30.61% 73 74 Interest income on avg. loan 10.77% 10.38% 10.04% 11.76% 14.21% portfolio 75 Interest Exp. on borrowings 8.71% 8.38% 7.94% 7.79% 9.45% 76 Net Interest margin 2.06% 2.00% 2.11% 3.97% 4.76% 77 Admn.Exp/Avg.Total Assets 0.11% 0.13% 0.17% 0.18% 0.17% 78 Personal & Admn.Exp.as % of 79 Avg.Loan Portfolio 0.13% 0.15% 0.18% 0.20% 0.19% 80 Return on avg. paid up capital 14.97% 15.51% 19.11% 21.93% 53.47% 81 Return on avg. Assets 3.41% 3.46% 3.94% 3.85% 7.56% 33 Appendix B INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) I. BORROWER'S EVALUATION REPORT 1 INTRODUCTION The project was envisaged at the time India was facing continued power shortages equivalent to about 9% total energy and 22% peak capacity requirement even though significant progress was made in the system expansion. The demand & supply gap was attributable to technical & price inefficiencies. The tariff structure of the SEBs (State Electricity Boards) was skewed in favour of the agricultural consumers. The inability of the SEBs to recover their costs has meant that SEBs had to rely on state government subsidies to support their operations. The SEBs were plagued with problems of unsatisfactory billing & collection, poor communication & monitoring systems, poor maintenance & lack of trained manpower resulting in poor service and low cash flows. The World Bank study conducted in 1989 had highlighted deficiencies and inefficiencies in the Indian power system. The project was designed to address problems through strategic support to SEBs. The following aspects of power system development were specifically targeted :- * Investment in transmission and distribution had not kept pace with investments to expand generating capacity. * SEBs needed to alleviate poor maintenance, inadequate controls and operational supervision, poor communication and monitoring systems, lack of trained staff and unsatisfactory billing and collections. * The performance of generating plants in India, particularly thermal plants, was below acceptable standards. * The environmental operating conditions of many thermal plants in India were substandard. * The formulation of power projects in India, particularly for hydroelectric plants, was a difficult and slow task, which retarded growth. The quality of project feasibility studies, site investigations and pre-construction engineering also required considerable improvement. Eighth Five Year Plan (1993-97), envisaged bringing about reforms in working of State Utilities through stringent action. Government, however, was constrained in its ability to act unilaterally and add strings to the budgetary support provided to state sector. Added to this, budgetary constraints restricted Central Government support to the power sector. The ability of utilities to generate internal resources was hampered by the poor financial condition stemming from the operational & financial inefficiencies. It was realised that the improvement in the sector was possible only through funds linked with reform conditions. The Power Finance Corp.Ltd was brought into picture as part of Government of India's initiative for bringing the reforms in the working of State Utilities. The Project was aimed at a turn around in the sector's finances & improvement in operational & financial efficiency of the State utilities through a series of actions on tariff, billing & collection front, plant efficiency improvement, reduction in T&D losses, Load management & greater production & end use efficiency. 34 The project was proposed to address the objectives of reduction in system losses, setting the power rates closer to economic cost of supply & improved inter-state grid mechanism for reduced energy shortfall. 1.1 PROJECT OBJECTIVES The objectives of the project envisaged were :- (i) To support Government of India's efforts to make PFC a viable and effective instrument for improvements in the power sector; (ii) To strengthen the operations of the beneficiary SEBs by lending only to those willing to undertake acceptable reform programs; (iii) To foster better use of existing power facilities by reducing constraints in the transmission and distribution systems; (iv) To mitigate the adverse environmental impact of thermal plants in operation by providing adequate anti-pollution and monitoring facilities; (v) To improve the preparation of power projects and promote the development of the local consulting industry by funding pre-investment studies and engineering for power projects. 2 PROJECT DESCRIPTION The proceeds of the loan have been onlent by PFC to the five major beneficiary SEBs for transmission & distribution, capacitor, urban distribution and environmental upgradation of thermal plants. Initially, the major beneficiaries under the loan were APSEB,GEB, MPEB, DPL; later on RSEB, HSEB & KSEB were also included in December 1993, March 1994 and March 1995 respectively. Apart from financing of investment schemes of SEBs and bringing about the institutional reforms in the SEBs, the project envisaged setting up a Pre Investment Fund to finance the project preparation and other studies aimed at enhancing the performance of power utilities in the country. 2.1 Investment sub - projects :- The details of various schemes undertaken under the Project including the Pre investment schemes are as under; Amounts in Rs. Crores WB Investment Number of Cost of World Bank Utilisation Project Schemes Project Share Transmission 27 1143.70 554.34 488.67 Urban Distribution 22 783.47 266.00 201.00 Capacitors 01 15.31 6.00 5.75 Metering 01 24.45 13.65 12.17 Environmental 01 28.80 11.80 6.42 Total 52 1995.73 851.80 714.00 The objective of facilitating better use of existing power facilities was aimed by extensively including the transmission and distribution systems augmentation and improvement schemes under the loan. Under the loan, 4191 Ckt. Kms. of Transmission lines and 6528 MVA of Transformation capacities were supported. Distribution improvement schemes for as many as 23 cities were sanctioned where 2038 MVA of transformation capacities along with 5546 Ckt. Kms of Transmission lines and 559 MVAR capacitors were supported. These measures helped in improving the supply both in quantitative and qualitative terms. The above steps have gone a long way in improving the transfer of electricity from the existing power stations to the load centres and improving the hitherto neglected urban distribution improvement of the 23 cities. 35 2.2 Pre Investment Fund To alleviate the shortage of well-prepared projects for power sector development the loan created a Pre- Investment Fund (PIF) which would provide financing for project preparation and design. The following activities were considered for financing: - (1) Preparation of pre-feasibility/identification of power expansion (or) improvement schemes. (2) Preparation of feasibility/ detailed engineering schemes (3) Preparation of studies of institutional nature and those necessary to improve the managerial, financial (or) operational efficiency of power sector (or) power utilities. (4) Technical assistance, training necessary to implement action recommended in studies. (5) Studies necessary for system integration at regional (or) national level for improved and efficient integrated operations. (6) Studies of sectorial nature leading to improved sector wide policies and efficiency. As part of PIE activities PFC sanctioned 30 schemes amounting to Rs.1227.90 million and made disbursement totalling to Rs. 553.30 million. The details of schemes undertaken are as detailed in Annexure-I. 2.2.1 Benefits (1) Consultancy services hired for Design and Engineering and Construction Supervision have resulted in implementation of the power projects in schedule time. (2) Feasibility / Geological investigation studies carried out for various thermal and hydro projects has helped borrowers to prepare Detailed Project Reports. (3) Implementation of state-wide Computerisation and Modernisation of Communication System has resulted in improvement of billing and revenue collection, inventory control management, management information system etc. (4) Diagnostic studies have resulted in improvements in borrower's financial & operational activities. (5) International Financial / Legal / Technical Consultancy has helped the borrowers to negotiate power purchase and other related agreement with the Independent Power Producers. 2.3 Institutional Strengthening of Utilities The project also aimed at bringing the improvements in operational and financial management through a planned action plans. The assistance included provision of technical and training services, acquisition of data processing equipment, software and Operational and Financial Action Plan (OFAP). OFAP mechanism evolved in 1991 laid emphasis on improvement in performance of SEBs over a period of time through well focussed measures within the existing institutional frame-work (organisational, managerial and financial) of SEBs' operations, aimed at internal improvement in performance of SEBs. It was also recognised, SEBs within the existing framework may not be in a position to regain financial viability on their own and inevitably required State Government's commitment and support particularly for tariff revision and rationalisation, and provision of cash subsidy for achieving statutory minimum ROR of 3%. OFAPs in respect of 30 utilities (14 SEBs, 1 T&D Co., 8 SGCs, 1 Municipal run utility, 1 joint sector utility and 5 departmentally run power utility) are in place. These included five World Bank funded utilities, namely APSEB, GEB, RSEB, HSEB and MPEB. The mechanism of OFAP was got reviewed by M/s. Price Waterhouse & Co., USA, under the EMCAT Project. To standardise the formulation, implementation and monitoring mechanism an OFAP Manual was adopted in 1995, establishing linkages with the strategic planning process, prioritisation of core and 36 non-core areas and constitution of working group to supervise the implementation of the action points. The OFAP Unit was reorganised on regional basis to have better client focus with a task manager for each utility for sharper monitoring. Financial assistance to the respective utility is linked to the status of OFAP implementation. OFAP mechanism has helped in bringing about qualitative as well as quantitative improvements in the SEBs performance. The OFAP has brought about increased awareness, at all levels, of SEBs problems generated action on the part of SEBs/State Government's on many critical issues. The focus has been on enduring improvements rather than on certain financial parameters through motivating and securing willingness/commitment of the State Governments. 2.3.1 The OFAP mechanism has brought about the following improvements in SEBs operations:- * Achievement of 3% ROR and release of Subsidy * Tariff increase/Rationalisation * Capital Restructuring brought about increased profitability levels thereby reducing the dependence on subsidy. * Improved Receivables * Institutional Development brought about improvement in various functional areas of SEB's such as materials management, costing and cost control, financial and accounting systems, project planning and control, internal audit, MIS, etc. * Improved Billing & Collection systems 2.3.2 OFAP in retrospect It can be concluded in retrospect that OFAP mechanism has served the purpose by leading to increased awareness, concern and commitment to the problems being faced by the state power utilities. Significant improvements have been brought about in the operational, financial and institutional functional areas within the existing structural frame-work. The OFAP experience has led to the realisation that the deficiencies lie mainly at the State Government level, which are impeding the utilities from becoming commercially viable and self-sustainable entities. SEBs depend on the State Government's for investment plans and decisions, mobilisation of resources, tariff rates, subsidy payments and other areas ranging from procedural to policy matters. In addition, SEBs have become monolithic and monopolistic organisations with consequential managerial and operational problems. To bring enduring results and consolidate the gains the focus has to shift, as also emphasised in GOI policy, towards reform and restructuring. Reforms in the State power sector. PFC has already initiated discussions with the states of Assam, West Bengal, Meghalaya, Maharashtra, Himachal Pradesh, Tamil Nadu, Kerala, Goa, Jammu & Kashmir and Punjab for initiating reforms. State Governments. Of Assam, West Bengal, Goa, J&K and Punjab have expressed their willingness to reform their power sector with the technical and financial assistance from PFC. 37 2.4 Environmental Upgrading of Power Plants The project helped focus on the improvement in environmental upgradation in general and management of thermal power plant in particular. Under the project PFC established an Environment Assessment and Monitoring Unit (EAMU). This environmental unit, set up in PFC, established environmental upgradation plans for thermal stations in the beneficiary SEBs and helped in general improvement of environmental management in these SEBs. This Unit helped SEBs in formulation of environmental action plans for a number of thermal stations. PFC supported over 25 environmental improvement schemes with PFC financial assistance, of which one, namely Durgapur Project Ltd. was also financed from the proceed of the World Bank loan. Durgapur Power Project, environmental Improvement Scheme involved installation of Electro Static Precipitator (ESP). 3 BENEFICIARIES The investments in T&D schemes of all beneficiary SEBs have resulted in better utilisation of power facilities which helped reduction in system technical losses, improved system load factors and reduced power outages i.e. increase in reliability in the effected service areas. These benefits were achieved by removal of transmission constraints for power evacuations, reinforcement or upgradation of overloaded transmission lines including higher voltages, enhancement of transformer capacity of grid sub-stations and distribution sub-stations, reinforcement of distribution system and installation of capacitors to improve services and reduce losses. The benefits were also achieved by plugging the revenue leakage by installation of high class accuracy electronic meters for single phase and three phase consumers in particular industrial consumers. 3.1 Andhra Pradesh State Electricity Board (APSEB): 3.1.1 Transmission & Distribution Projects Under the Loan from World Bank, APSEB in association with PFC identified 8 Transmission sub projects amounting to Rs.2838 million with World Bank share of Rs.2220.70 million & 2 Urban distribution projects amounting to Rs. 1005 million with World Bank share of Rs.723.10 million. Under the loan APSEB has been able to support 1118 ckt Kms of Transmission lines & 1300 MVA of transmission capacities. Further, 280 distribution MVA, 42 distribution MVAR and 2421 distribution ckt Kms are supported. 3.1.2 Operational Financial Action Plan APSEB started booking subsidy in annual accounts. Subsidy has been released by State Government upto 1996-97 by writing off Government loans to achieve 3% RoR. During the last 6 -7 years, APSEB revised tariff five times with the last tariff increase being of the order of 37% (August '96). The gap between average tariff and average cost has been reduced and ratio of recovery against cost stood at 78% in 1996-97. Increase in average tariff without agricultural consumption were 66% during 1992-93 to 1996-97 against increase of 96% in cost of supply during the same period. State Government converted Rs. 1321 crores of SG loans into equity rationalising the capital structure to a certain extent. The outstanding receivables were decreased from 77 days sales in 1992-93 to 67 days during 1996-97. Suitable measures have also been initiated through OFAP for improvement in various other functional areas of APSEB. APSEB has computerised the billing for both HT/LT consumers. M/s NIIT developed the software & APSEB implemented this in 3 out of total 150 locations. APSEB appointed M/s 38 Tata Constancy Services for implementation of computerisation scheme. The loan provides for assistance of supply, installation & commissioning of computer hardware & accessories. The total outstanding dues have come down to 60 days of sale. 3.2 Gujarat Electricity Board (GEB): 3.2.1 Transmission & Distribution Projects Under the Loan from World Bank, GEB in association with PFC identified 7 Transmission sub projects amounting to Rs.1955 million with World Bank share of Rs.1296.30million & 5 Urban distribution projects amounting to Rs. 176 million with World Bank share of Rs.130.70 million. Under the loan GEB has been able to support 769 ckt Kms of Transmission lines & 1745 MVA of transmission capacities. Further, 110 distribution MVA and 170 distribution ckt Kms are supported. These steps yielded good return in terms of better quality of supply & low transmission losses ( Year-on- Year growth rate of -2.48%). The net energy flow into the grid has increased substantially due to investments made in transmission & distribution systems which supported the increase in energy supplied. 3.2.2 Operational Financial Action Plan Subsidy upto 1995-96 have been released by the State Government to achieve 3% RoR. With the emphasis laid on the OFAP, the GEB has revised the tariff on an annual basis. During the last 6 -7 years, GEB revised tariff nine times with the last tariff increase being of the order of 16%(October '96). This has led to reduction in the gap between average tariff and average cost. The ratio of recovery against cost increased from 72% in 1992-93 to 81% in 1996-97. Trends of increase in average tariff without agricultural consumption have matched the trends of increase in cost of supply both of which increased by average around 56% during this period. Government of Gujarat (GoG) is actively considering a proposal for conversion of Rs 2040 Crores loans into equity. The receivables of GEB, due to improvement in collection efficiency and computerisation of billing and MIS, have been kept under check. The receivables were decreased from 137 days sales in 1992-93 to 133 days during 1996-97. Suitable measures have also been initiated through OFAP for improvement in various other functional areas of GEB. GEB has computerised all 390 billing centres. covering 52 lakh consumers of all the categories. Seven additional laboratories for testing & repairing of meters have started functioning. 3.3 Haryana State Electricity Board (HSEB): 3.3.1 Transmission & Distribution Projects Under the Loan from World Bank, HSEB in association with PFC undertaken 3 Transmission sub projects amounting to Rs.235.lmillion with World Bank share of Rs.96.40million & 1 Urban distribution projects amounting to Rs. 160.20 million with World Bank share of Rs. 136.50 million. PFC has supported 135 ckt Kms transmission lines, 100 MVA transformation capacity and 320 distribution MVAR. Number of metres - 227525 have been installed by HSEB. 39 3.3.2 Operational Financial Action Plan HSEB has an agreed OFAP with PFC. It started booking subsidy to achieve an RoR of 3% for 1992-93. The Govt of Haryana (GoH) has cleared all its subsidy till 1996-97. For 1995-96 and 1996-97 GoH paid subsidy partially against State Govt loans. HSEB has been revising its tariff from time to time. The latest revision has been w.e.f. 15.6.98 for consumers other than agriculture, has been increased by almost 15%. The position of their receivables has improved from 243 days in 1992-93 to 110 days in 1996-97. GoH/HSEB has gone ahead in a big way for reforms, and HSEB has been bifurcated into Haryana Power Generation Corp. Ltd., and Haryana Vidyut Prasaran Nigam Ltd. The World Bank is providing the necessary funding for the Haryana reform project. For improving metering and energy audit, electronic meters out of 2300 nos, 1844 nos. have been installed and balance have been received at site as of August, 1998. 3.4 Madhya Pradesh Electricity Board (MPEB): 3.4.1 Transmission & Distribution Projects Under the Loan from World Bank, MPEB in association with PFC has undertaken 3 Transmission sub projects amounting to Rs.1463.00 million with World Bank share of Rs.734.00million & 7 Urban distribution projects amounting to Rs.634.00 million with World Bank share of Rs.330.80 million. Under the loan MPEB has supported 356 ckt Kms transmission lines and 560 MVA transformation capacity. Further, 149 distribution MVA, 108 distribution MVAR and 1580 distribution ckt Kms are also supported. 3.4.2 Operational Financial Action Plan MPEB started booking subsidy in annual accounts. Subsidy upto 1995-96 has been released by the State Government and for 96-97 has been released partially to achieve 3% RoR. OFAP required the MPEB to revise tariff on an annual basis. During the last 6 -7 years, MPEB revised tariff eight times with the last tariff increase being of the order of 15%(August '96). This has led to the reduction in the gap between average tariff and average cost. The ratio of recovery against cost increased from 83% in 1992- 93 to 88% in 1996-97. Increase in average tariff without agricultural consumption exceeded the increase in the cost of supply. Tariffs increased by 86% during the period 1992-93 to 1996-97 compared to 44% for the cost of supply over the same period. After constantly pursuing up with the State Government., the State Government. Converted Rs.700 crores of SG loans into equity rationalising the capital structure. Due to improvement in collection efficiency, computerisation of billing and MIS, receivables have been kept under check. The receivables decreased from 111 days sales in 1992-93 to 53 days during 1996-97. Suitable measures have also been initiated through OFAP for improvement in various other functional areas of MPEB. By availing the loan from WB/PFC, the MPEB had computerised billing of both HT & LT consumers partly by in house development and partly by entrusting work to private agencies. For better efficiency & integrated MIS the Board has considered to computerise the entire billing of HT &LT consumers in house. The computerisation of billing is part of upgradation of in house data processing facility. The LT billing in all 144 divisions have been computerised & training is being provided to executives & non- executives. 40, 3.5 Rajasthan State Electricity Board (RSEB): 3.5.1 Transmission & Distribution Projects Under the Loan from World Bank, RSEB in association with PFC has undertaken 5 Transmission sub projects amounting to Rs.914.80million with World Bank share of Rs.640. Omillion & 6 Urban distribution projects amounting to Rs.1163.00 million with World Bank share of Rs.841.50 million. Under the loan RSEB has supported 703 ckt Kms transmission lines and 413 MVA transformation capacity. Further, 691 distribution MVA, 89 distribution MVAR and 628 distribution ckt Kms are also supported. 3.5.2 Operational Financial Action Plan RSEB started booking subsidy in annual accounts. Subsidy upto 1995-96 have been released by the State Government to achieve 3% RoR. With the emphasis laid on the OFAP, the RSEB has revised the tariff on an annual basis. During the last 6 -7 years, RSEB revised tariff six times with the last tariff increase being of the order of 10% (October, 1996 and July, 1997). This has led to reduction in the gap between average tariff and average cost. The ratio of recovery against cost increased from 78% in 1992- 93 to 83% in 1995-96. Trends of increase in average tariff without agricultural consumption have matched the trends of increase in cost of supply, both of which increased by average approx.70% during this period. After constantly pursuing up with the State Government., the State Government. converted Rs.913 crores of SG loans into equity rationalising the capital structure. The receivables of RSEB, due to improvement in collection efficiency and computerisation of billing and MIS, have been kept under check. The receivables were 83 days during 1996-97. Suitable measures have also been initiated through OFAP for improvement in various other functional areas of RSEB. Under the loan RSEB has under taken the following activities:- (1) All the 23 nos meter testing labs have come into operation. (2) 12,371 nos SIP meter boxes have been installed. The impact of installation of pilfer boxes on revenue is being carried out. (3) Out of the 2080 posts of Meter Readers, 1873 posts have been filled up by redeployment and regional offices have been authorised to award bill distribution on contract basis to the extent required. (4) The time required to replace HT meters has been brought down to one month and efforts are being made to keep the sufficient stock of meters in various circle stores. 3.6 Kerala State Electricity Board (KSEB): 3.6.1 Transmission & Distribution Projects Under the Loan from World Bank, KSEB in association with PFC has undertaken 2 Transmission sub projects amounting to Rs.697.00 million with World Bank share of Rs.555.90million & 2 Urban distribution projects amounting to Rs.782.00 million with World Bank share of Rs.634.80 million. These projects were earlier covered under the World Bank Loan No: 25821N. Under the loan KSEB has supported 1110 ckt Kms transmission lines and 2410 MVA transformation capacity. Further, 808 distribution MVA and 628 distribution ckt Kms are also supported. Through the project KSEB was able to obtain the pending supplies for the contracts awarded under the earlier Bank Loan 2568-IND given directly to KSEB. The project helped KSEB in completion of transmission and distribution work in three towns. The project thus helped KSEB to evacuate power from the Lower Periyar Hydro Electric Project through the transmission lines constructed under the project. 3.6.2 Operational Financial Action Plan 41 KSEB started booking subsidy for achievement of 3% RoR since 1992-93. The subsidy upto the year 1994-95 has been cleared by GOK. However, subsidy for the years 1995-96 and 1996-97 are still to be cleared by GOK. KSEB has been revising tariff regularly every year and provision has been made in the tariff structure for annual increase of 10% in tariff w.r.t. all HT and EHT consumers. The receivables as on March, 1998 have been reduced to 62 days sales from 112 days sales in 1992-93. The meters of 1178 consumer out of total 1586 HT and EHT consumers have been replaced with TOD meters. Other measures have also been initiated by KSEB / GOK through OFAP for improvement in various other areas of operations. 4 BORROWERS PERFORMANCE The loan was a complex one involving 52 sub-projects of 7 beneficiaries SEBs. Qualified technical staff of PFC handled sub-project appraisal based on the procedure and methodology worked out with the Bank. Committed staff exerted best efforts to identify more sub-projects and actively sorted out by identifying procurement packages both ICBs and LCBs which sub-borrowers were willing to follow under the laid down procurement procedure. PFC project personnels have good project reporting system and maintained the same over the last 5-6 years period. PFC supervision and monitoring involved more than 200 visits to beneficiaries and to project sites in addition to meetings with sub-borrowers at PFC headquarters. With concentrated efforts completion of procurement of equipment and material involving over 120 procurement packages and resulting in over 150 contracts was successful. With the active willingness of sub-borrowers to follow ICB procedure in procurement under the project, a saving in overall cost was there in many sub-projects due to competitive prices and wider participation by the vendors. 4.1 PROBLEMS FACED Delay in clearance by WB of the model bidding documents for ICB contracts by over 13 months posed obvious problems in initial take off affecting timely completion of the loan. The Bank first gave the clearance in April, 92 but withdrew it thereafter. The final clearance was given by Bank only in the Nov. 92, whereas as per the Staff Appraisal Report, this was to be done prior to the sanction of the loan in Oct. 1991. Therefore, utilisation could effectively be started only in June-July 1994, approximately 2 year after the loan became effective. The conditions imposed by WB / PFC led to ineligibility of some of the beneficiary SEBs the resulting in re-ordering of some packages and delay in start of utilisation of loan proceeds. The loan suffered adversely due to exclusion of schemes of MPEB worth US $ 56 million WB share in July'93 due to inadequate headroom for sanction as pointed out by WB. Also, in Oct'94, schemes of APSEB having a WB share of US$ 30 million were not supported on the instance of the WB as APSEB was not imposing a minimum agricultural tariff of 50 paise per Kwh, even though this was not a conditional in the loan. In June'94, the disbursements to MPEB and GEB were stopped due to rolling back of agricultural tariff and non-payment of subsidy which resulted in negative lending limits. This was resumed only after the WB permitted disbursement in Jan'95 for GEB and March'95 in the case of MPEB. Suspension of disbursement by PFC to borrowers often resulted in diversion of supplies by contractors, which could not be readily restored. Long suspensions on contracts sometimes resulted in cancellation of contracts leading to re-tendering and revised ordering in certain cases. RSEB, HSEB and KSEB were included as beneficiaries of the loan in Dec'93, March'94 and March'95 on World Bank' instance whereas the loan became effective in March'92. The cut-off limit for ICB Contracts was kept at US $ 0.20 million. The similar limit in case of ADB loan is US $ 3 million. The low limit in case of WB loan resulted in far too many packages being routed 42 through the ICB procedures, which was time consuming. The usual time required for ICB was approximately 14 to 18 months from "Issue of NIT to Ordering". ICB bidding procedure resulted in competitive prices and low order values in packages as compared to the ones envisaged at NIT stage. Even though, it is not a constraint to project execution, but it resulted in considerable savings and limited loan utilisation in terms of US dollars. The long procurement cycle through ICB precluded inclusion of additional items at a later date to utilise the saving effected. Inspite of the above, the co-operation provided by the WB, both by the Washington Office and the local office in India, was meaningful and contributed a lot to the effective implementation of such a complex loan with a nominal delay of only 6 months. The Bank's flexibility in allowing substitution of identified sub projects, which had to be dropped due to eligibility related problems, helped in expeditious utilisation of the loan. After initial clearance of model bidding documents by World Bank, the quick response to procurement related issues by the World Banks' local office in India helped a lot in minimising the delays in procurement activities which were otherwise quite long keeping in view the Bank's ICB procedure. In addition to this periodic review missions by the Bank helped PFC as well as the beneficiaries in keeping continued focus over the investment sub projects and advice given by the WB from time to time was of immense use in solving the problems relating to borrowers' eligibility. Inclusion of HSEB as late as in March, 1994 under emergency OFAP and of RSEB in Dec.'93 and the balance works of WB loan No. 2582-IN of KSEB in Oct.'95 at the instance of the WB was instrumental in enhancing the utilisation of the loan. However, the late inclusion of these SEBs also had an adverse impact resulting, extension of the ordering cut-off date as well as of the loan closing date. In view of the complex loan package involving large no. of sub-projects and procurement packages the borrowers performance was considered above satisfactory. The desire to initiate the utilisation was reflected in the advance procurement process initiated at PFC's instance by the SEBs even before the sub- projects were approved based on the detailed appraisal. The delay in the initial utilisation was caused by the delay in the approval of ICB document by about 13 months. Much of the impact of this delay was reduced by the advance prQcurement action initiated. PFC had to pursue with the utilities and WB for acceptance of sub-projects, appraisals, approval of standard bidding documents, package procurement programmes' acceptance, preparation of tender documents, approval of award recommendations and placement of contracts spread over the first 8 to 10 quarters (Approx. 2 initial years) before the first utilisation could be started in July'94. PFC, therefore, continued to review the status of sub-projects and contracts (total 121 for WB Investment sub-Projects) with the beneficiaries to arrive at half yearly targets for the year (1st July to June). These assessments were then consolidated into quarterly assessments for the year (April to March). For facilitating sub-projects implementation, complete procurement activities, submission of claims to PFC and the loan utilisation PFC has undertaken over 200 visits, since start of the loan to various beneficiaries' Head quarters, apart from review meetings at PFC Office to review the progress with the beneficiaries. 5 BENEFITS The outcome of the loan has been positive in as much as 43 1. The transmission and distribution systems strengthening of the various beneficiaries has resulted in improved power supply position from the existing facilities. These systems would also cater to some extent in supply of additional power from the up-coming new generation facilities. 2. The mechanism of OFAP evolved in 1991 in consultation with WB has helped in identifying the problems faced by the SEBs in different functional areas and also in chalking out an actions plan to achieve the solutions in a time bound manner. As of now, 30 State Power Utilities are having OFAP in place (including 8 utilities raised OFAP in place). This has established a conducive environment wherein further investments in this sector would be productive to that extent. The above has also resulted in a cultural change in the traditional functioning of SEBs and at the same time imparted skills to the staff in order to sustain the development. 3. The technical specification and the quality of equipment procured for the above purpose is of international standards and would be of immense help in sustaining the development made for a longer period of time. 4. The beneficiaries have acquired experience in the procurement through ICB route. This has enhanced and honed their skills in the area of procurement. 5. Expertise for absorption of finance from multilateral institution has been created among the beneficiaries along with the requisite expertise. 6 LESSONS LEARNED The World Bank Loan 3436-IN to PFC was operated contemporary to ADB loan 1161-IND; and consisted of a large number of sub projects spread over a number of beneficiary States. It gave ample opportunity to PFC personnel to gain experience and expertise in the matters of loan negotiations, loan commencement activities, loan appraisals procurement, loan disbursements, project progress monitoring, and post completion review of the included sub projects. The sub loan conditionalities to the borrowers were embodied in a comprehensive operational policy of PFC and operational financial action plan for each borrower. The key lessons learnt during the operation of the loan between 1992 to 98 are summarized below :- 1) Projections for loan utilisation should be based on realistic time cycle of sub -projects formulation, loan sanctions, procurement activities and material deliveries. This would result in narrowing the gap between projected and actual utilisation of loans. 2) The sub loan conditions for specific beneficiaries making investments in multiple sub-projects should be designed in such a manner that sub projects for which loan sanctions have been made are not abandoned or delayed during implementation due to loan covenants. This would facilitate objectives of the programme by preventing the contract disruption due to loan covenants. 3) The economic internal rate of return is not adequate criteria to bring out performance improvements in the financial operations and performance of the borrowers. Financial internal rate of return of the sub-projects should be given due weightage for the sanction of loan to sub projects. 4) The limit for inviting ICB should be raised to a pragmatic level (say US $ 3 million) keeping in view the likely scenario by the end of the ordering process. 5) The ICB time cycle be reduced by adopting standard bidding document and authorising PFC to make essential modification as per need and thereby giving more responsibility to the Executive agency for speedy procurement. 44 6) Areas of the sub-projects for investments should be identified/approved at loan negotiation stage rather than approving individual sub-projects after the loan sanction. 45 Annexure-I Utility Scheme Loan Total World Bank Ln. No. Amount Utilisation Component & Date Rs.Milion Rs.Million Rs.Million 1. APSEB A Environmental Impact 31115001 Assessment (EIA) Study for 7.2.94 Vishakhapatnam TPS B Detailed feasibility Report for Vishakhapatnam TPS C Plant Layout study for Krishnapatnam D EIA study for Gas based Amalapuram TPS E EIA Study for Vemagir Gas based TPS F EIA Study for Rayalaseema TPS Stage - II G EIA Study for Ramagundam TPS Stage -II H EIA Study for Kothagudam TPS St-V Total 2.81 2.15 2.15 2 APSEB Information Technology (IT) 0.23 0.23 0.23 31115002 study for statewide 16.2.94 computerisation 3 APSEB Design & Engineering for 16.74 14.66 14.66 31115003 Kothagudam TPS St-V 10.5.94 4 APSEB A Detailed Feasibility Report for 31115004 railway siding for 11.5.94 Vishakhapatnam TPS St-II B Detailed Feasibility Report for railway siding for Krishnapatnam TPS C Detailed Feasibility transportation of coal for Krishnapatnam TPS Total 2.05 1.51 1.51 5 APSEB A Geological Investigation 31115005 Studies for Ramagundam TPS 11.5.94 B Environmental Studies for existing power stations C Detailed Project Report for mini hydel schemes 46 D Detailed Project Report for Ramagundam E Detailed Project Report for Kothagudam Total 1.12 1.12 1.12 6 APSEB State wide computerisation 381.50 80.70 4.40 31115007 scheme 20.7.94 7 RSEB Diagnostic study for RSEB 0.17 0.17 0.17 07115001 7.10.93 8 MPEB Upgradation of computer 0.70 0.45 0.00 20115001 system 27.5.94 9 GRIDCO Upgradation of 132KV Lines 13.50 2.70 0.00 48115002 for 220 KV Lines 19.8.94 10 MeSEB Diagnostic study 0.25 0.25 0.25 64115001 19.8.94 11 KSEB Consultant services for const. 100.80 74.89 74.89 Mngt in Kerala Power Projects 12 WBSEB Computerisation and 524.00 265.97 161.17 50115001 communication 2.6.95 13 HSEB Consultant services for PPA 35.50 0.00 0.00 03115001 negotiation for Hissar & 22.4.97 Yamunanagar TPS 14 GPCL Consultant service for PPA 55.20 26.30 26.30 19315002 negotiation for Pipavav, Ghoga 5.5.97 TPS 15 TNEB Consultant service for PPA 40.00 28.81 28.81 36115002 negotiation 27.5.97 16 APSEB Consultant service for PPA 27.40 27.40 27.40 31115010 negotiation 17 APSEB Consultant service for PPA 26.00 26.00 26.00 31115011 negotiation 28.10.97 _ _ __T 12 7 9_5.13 9 0 1 1 GRAND TOTAL 1227.97 553.31 369.06 47 Annexure-II Completion Status of Investment Sub-Projects Beneficiary/Type of Total Number >75% Completed Sub-Project Supported Completed APSEB -- Transmission 8 3 5 --Urban Distribution 2 2 GEB -- Transmission 7 1 6 --Urban Distribution 5 5 HSEB --Transmission 2 2 --Meters 1 1 --Capacitors I 1 MPEB -- Transmission 3 3 -Urban Distribution 7 7 RSEB -- Transmission 5 5 --Urban Distribution 6 6 KSEB -- Transmission 2 2 Urban Distribution 2 2 DPL -- Environment 1 1 ALL BENEFICIARIES -- Transmission 27 9 18 -- Urban Distribution 22 2 20 --Capacitors 1 1 -- Meters 1 1 -- Environment 1 1 TOTAL 52 12 40 48 INDIA POWER UTILITIES EFFICIENCY IMPROVEMENT PROJECT (LOAN 3436-IN) II. SUMMARY OF PFC's OPERATIONAL PLAN Background Power Finance Corporation Ltd. (PFC) was incorporated as a limited liability company under the Companies Act, 1956 on 16t July, 1986 and declared as a Public Financial Institution u/s 4A of the Companies Act in August 1990. PFC is wholly-owned by the Government of India (GOI) and acts as a Development Financial Institution (DFI) dedicated exclusively to the funding and development of the Indian Power Sector. PFC disbursed its first loan in January, 1988. Objectives PFC carries a strong mandate for developing the power sector and financial strengthening of the State utilities by providing funds linked with financial and institutional reforms. PFC also provides fund and non-fund based support to private power projects. PFC provides finance for the following: * Power generation projects both thermal and hydro electric * Power transmission and distribution systems * Renovation and modernization of power plants * System improvement and energy conservation schemes * Survey and investigation of power projects * Consultancy/Studies A major portion of funds for investment in the Power Sector in India is allocated to the State/Central power utilities through the Five Year Plan process by the Government of India. PFC's financial support to these utilities is in addition to the Plan allocation and is not pre-allocated to any state or project. The Power Utilities and Projects, which are able to meet the eligibility parameters laid down by PFC are provided finance based entirely on their merits and strengths. Services Offered PFC, as a dedicated financial institution for power sector endeavors to meet various funding needs of power sector and utilities. It maintains a diversified portfolio of fund & non-fund based products and is continuously innovating to meet the dynamic funding needs. Term Loans for * Power Projects * Financial Guarantee * Renovation & Modernization of Power Plants * Lease Financing * Energy Conservation Schemes * Bill Discounting * System Improvement * Working Capital * Consultancy Services, etc. * Loan Syndication 49 Operational Policy PFC's lending policies area set out in its Operational Policy Statement (OPS). OPS permit PFC to prioritize different categories of projects for lending. In part, this prioritization takes the form of the differential interest rates offered by PFC and it is also reflected in the project credit limits. In addition, PFC places emphasis on projects having short lead times and on-going projects, which are being hampered through lack of funds. In general, PFC aims to maximize the utilization of existing generating capacity alongside creating new generating capacity. Operational Parameters * Eligibility Criteria of the Borrowers * Credit Appraisal Process * Project Selection * Collateral Policy * Extent of Funding * Project Monitoring * Priority areas of Funding * Terms & Conditions of Loans Granted Priority Funding Areas (1) Studies, Consultancy Services & Training; (2) Research & Development Projects; (3) Capacitors & Load Dispatch; (4) Environmental Upgradation; (5) Urban Distribution, Transmission including R&M; (6) Renovation & Modernization of Generation Projects; and (7) Thermal/Hydro Generation Projects Financial Operational Plan The financial projections of the corporation are as under: 1998-99 199-99 1999-2000 2000-01 Si. No. Parameters (Rs. in million) 19920 2001 (Rs. in million) (Rs. in million) I Sanctions 24,000 39,000 64,000 2 Disbursements 18,000 27,500 45,000 3 Resource Mobilization 18,500 27,000 40,500 Future Strategy * Three-pronged focus: to diversify customer base, project base and financial instruments. Accordingly, PFC has commenced sanctioning of loans to the private sector, as well as to Government-owned utilities at the Centre. It has expanded project financing to include more project types, and has introduced new financial instruments such as leasing, bill discounting and guarantee for suppliers' credit. * PFC's main emphasis is on power sector reforms at the State Level and is now actively engaged in promoting said reforms. * Diversification of PFC's equity base with participation of institutional investors is envisaged. Current capital base is seen by PFC to be adequate, and diversification would occur only when capital expansion is required, but with GOI maintaining majority ownership. 50 OFAP Requirement 1. PFC plans to continue incorporating into all its lending operations the explicit commitment of the borrower, and of its State Government when needed, to implement actions, as agreed with PFC, aimed at improving the borrower's operational efficiency and financial performance. These actions are grouped in Operational and Financial Action Plans (OFAPs), which include specific deadlines to be closely monitored by PFC. 2. The OFAP mechanism evolved in 1991 and laid emphasis on improvement in performance of SEBs over a period of time through different measures within the existing institutional framework (organizational, managerial and financial) of SEBs' operation and ground realities prevailing then. OFAP therefore essentially aimed at internal improvement in performance of SEBs ,which was otherwise highly unsatisfactory, within structural constraints. It was recognized that SEBs within the existing framework may not be in a position to regain financial viability on their own and inevitably required State Govt.'s commitment and support for improvement measures particularly in the area of tariff revision and rationalization, and provision of cash subsidy for achieving statutory minimum ROR of 3%. The mechanism also pre-supposed lever of PFC's assistance strong enough to catalyze desired changes and further augmented by routing of multilateral/bilateral assistance to state power utilities through PFC. Implementation of OFAP 3. The process and mechanism of OFAP was reviewed by M/s. Price Waterhouse & Co., USA, under the EMCAT Project. To standardize the formulation, implementation and monitoring mechanism an OFAP Manual was adopted in 1995. Main highlights of the Manual were linkages with the strategic planning process, prioritization of core and non-core areas and constitution of working group to supervise the implementation of the action points. 4. The OFAPs are continued to be monitored regularly through quarterly progress reports, discussions by PFC Monitoring Mission visits to the Utilities. The OFAP unit was reorganized on regional basis to have better client focus with a task manager for each utility. Outstanding issues are taken up with SEBs and the State Governments at the concerned level through correspondence as well as meetings at the CMD/Director levels with State Govt.. officials and SEB Chairman from time to time. Intervention wherever considered necessary has also been sought for of the Ministry of Power. 5. Status of implementation of OFAP is also put up and considered by the loan sanctioning authority while consideration of the proposal for further financial assistance to the respective utility. Consideration of proposal/sanction of the loan have been used as leverage depending upon the gravity of the outstanding issues, for ensuring SEB/State Government actions. 6. OFAP mechanism has helped in bringing about qualitative as well as quantitative improvements in the SEBs performance. The OFAP has brought about increased awareness at all levels of SEBs problems and has led to a qualitative change of perception leading to action on the part of SEBs/State Governments on many critical issues. 7. PFC at its level has been making earnest efforts in bringing about improvement in the performance of the SEBs. This, being a monumental task, required a pragmatic and long-term perspective with flexible and positive approach. The focus has been on enduring improvements rather than on certain financial parameters through motivating and securing willingness/commitment of the State Governments.