India - Andhra Pradesh Power Sector Restructuring Project

Report No. PID6603 Project Name India-Andhra Pradesh Power Sector (@+) ... Restructuring Project Region South Asia Sector Energy Project ID INPE49537 Borrower Government of India Loan Amount US $ 210 million Implementing agency 1. Transmission Corporation of Andhra Pradesh (APTRANSCO) 2. Andhra Pradesh Generation Company (APGENCO) Date this PID prepared January 31, 1999 Project Appraisal date October 1998 Project Board date February 18, 1999 Background 1. With a population of 72 million, Andhra Pradesh (AP) is one of India's largest states. Despite a rich resource base, the state's economic and social development has been substantially below its potential. In the last ten years its annual growth rate of 4.6 percent in gross state domestic product has been lower than the national average of 5.6 percent. Most social development indicators in Andhra Pradesh are below the national average. Infant mortality rate is 73 per thousand of births. Population below the poverty line is almost 30 percent. Malnutrition among children aged 0-6 years is estimated at about 30 percent. The literacy rate is only 44 percent, significantly lower than the national average. At 33 percent, the female literacy rate is one of the country's lowest. The poor health and educational status of the population is largely explained by declining budgetary allocations for these services. From FY1987 to FY1998, total combined public expenditure on health and education declined from 4.7 percent of state's gross domestic product to 3.6 percent. 2. Development expenditure in Andhra Pradesh has been crowded out in the last 15 years by costly and poorly targeted subsidies, by a rapidly expanding civil service and by interest payments. As a result, critical public spending on social development and on the maintenance of the essential irrigation and road networks has fallen far short of the state's needs. Power sector development has not kept up with demand and constrains economic activity and burdens the state finances. These are some of the major reasons for the low level of social development in the state, the high incidence of poverty and the relatively slow rate of economic growth. Due to low tariffs and consequential need for subsidizing it, Andhra's power sector has imposed a heavy burden on the State's finances; in 1997 power subsidies amounted to 1.6w of GSDP and 46t of the fiscal deficit of the state. 3. The Government of Andhra Pradesh is aware of these issues and has launched a comprehensive program of economic and structural reforms to address  them, to accelerate economic growth in the state and to increase the capacity to finance much-needed human development in the longer term. Power sector reform is the focus of the proposed Andhra Pradesh Power Sector Restructuring Program. A parallel operation, the Andhra Pradesh Economic Restructuring Project (APERP, for which Ln. 4360 and Cr. 3103-IN were approved on June 25, 1998) provides resources to meet immediate priority needs in human development (nutrition, primary health and primary education) and in the maintenance of economic assets affecting the rural poor (irrigation, rural roads and core access roads). These investments are linked to a program of fiscal reforms aimed at bringing about a permanent shift in public expenditure and debt. 4. Andhra's power sector has deteriorated in the last few years and is now in a critical physical and financial situation, which affects the economic growth of the state and the welfare of its people. Though operational efficiency of the generation plants of Andhra Pradesh State Electricity Board (APSEB) compares well with the international standards, the energy deficit of about 13t and peak demand deficit of about 23t in the state, is one of the worst in India. Electricity sales to agriculture sector is heavily subsidized. Due to un-remunerative tariffs, high level of technical and non-technical losses (estimated at a minimum of 33%), relative neglect of investment in transmission and distribution systems, and inadequate maintenance of system, a comparatively well performing utility has become near bankrupt and is unable to provide quality supply and efficient service to its customers. 5. The Andhra Pradesh is convinced that the State's power requirements cannot be met without a massive mobilization of private financing; restoration of creditworthiness of the power utilities; and establishment of a proper enabling environment, including a legal and regulatory framework. To meet this goal the Government of Andhra Pradesh intends to reform and restructure its power sector, have commercially operated and privately owned utilities functioning in a competitive environment and withdraw itself from the sector as an owner, operator, and regulator of the utilities. The Bank plans to support Andhra in implementing its power sector reform program, and a long term investment program through an adaptable program lending (APL) comprising a series of loans, to an extent of US$1 billion. Each of these loans shall be linked to achievement of agreed milestones, and shall finance successive investment projects in transmission and distribution. Program and Project Objectives 6. The proposed Andhra Pradesh Power Sector Restructuring Program has two directly inter-linked development objectives: ni The reform of the power sector is the single most important element of structural and fiscal reform in Andhra Pradesh. The underlying broader development objective of the Andhra Pradesh Power Sector Restructuring Program is to bring about a permanent shift in public expenditure in the power sector, from a major drain on the budget to a contributor of funds for social sectors and other priority areas for public investment. This fiscal dimension links the Program to the broader APERP. Taken together, APERP and the proposed Andhra Pradesh Power Sector Restructuring Program would make a major contribution to modernizing the state's infrastructure and social sectors, and they would be fundamental to the restructuring of the state's finances and for the acceleration of economic growth and longer term human development. - 2 -  ni Andhra Pradesh's power sector has deteriorated in the past several years and is now in a critical physical and financial situation, which constrains the economic growth of the state and affects the welfare of its population. The power sector-specific development objective of the Andhra Pradesh Power Sector Restructuring Program is to ensure that, by FY2007 the energy requirements of the state are met, and that consumers are provided with reliable, high-quality and cost-effective electricity supply by creditworthy and commercially-operated power utilities, functioning in a competitive and appropriately regulated power market, with significant private ownership and participation. 7. The development objective of the Project i.e. First Andhra Pradesh Power Sector Restructuring Project (APL1), is to initiate (i) the reform process by establishing the new legal, regulatory, institutional framework, and industry structure (including the creation of an independent Regulatory Commission, unbundling of APSEB into new generation, transmission and distribution companies), (ii) the preparatory work for privatization of the distribution business, and (iii) removal of the most critical bottlenecks of the power system with a view to demonstrate the benefits - though on a limited scale initially - which could be expected from the power sector reforms. Program and Project Description 8. The Reform Program consists of (a) functional separation by unbundling the vertically integrated APSEB into generation, transmission, and distribution companies, (b) independent regulation by creating an independent and autonomous Regulatory Commission following the effectiveness of the new Andhra Pradesh Electricity Reform Act (notified on October 29, 1998), (c) corporatization and commercialization of the new entities in the power sector, and (d) privatization of distribution business and private sector participation in new generation, leveraging its generation assets through joint ventures, and dis-investment in other business. Andhra Pradesh's long term Investment Program will focus on rehabilitation and expansion of transmission, sub-transmission and distribution system, implementation of demand side management measures and technical assistance to support Andhra's power sector entities in implementing reform program, 9. The Project will help initiate the reform process and is expected to part finance critically needed transmission system augmentation, sub- transmission and distribution system rehabilitation and strengthening, improvement of metering system, implementation of demand side management measures, and technical assistance to the new companies. Project Cost and Financing 10. Total estimated cost of the project is about US $ 576 million. The proposed Bank loan is expected to finance about US$ 210 million; Andhra government about US$ 128 million, co-financing to an amount of about US$ 73 million by DFID and CIDA and financing by other financial institutions to an amount of US$ 165 million. Project Implementation 11. The project will be implemented over a four year time period (1999-2003). However the reform program and the related long-term investment program would -3 -  be implemented over a period of about ten years. The project would be implemented by APSEB's successor entities -- APTRANSCO, APGENCO and distribution companies. A Steering Committee, for policy direction, chaired by the Chief Secretary, a Task Force chaired by Secretary (Energy) for operationalizing the policy decisions, and a Reform Project Management Group headed by a Chief Engineer, for preparation, co-ordination and management of the reform program have been put in place for the program and project implementation. Project Sustainability 12. By implementing the proposed reform agenda, Andhra Pradesh can make its utilities commercially viable and mobilize resources to finance the rehabilitation and expansion of its power system. Investments will not only contribute to reducing the power gap, but will also create the basis for sustainable future growth of the system. This will benefit all electricity consumers. Andhra Pradesh expects that the State's improved power supply position would contribute to attracting additional investment and encourage existing industries to expand their production facilities. The proposed project will facilitate the execution of the reform program. Even if the next phases of the program were not to take place the project would lead, under reasonable assumptions, to durable reduction in physical system bottlenecks and therefore efficiency improvements, albeit limited to a small part of the power system. 13. The reform in the power sector is critical to structural and fiscal reform in the state. In the absence of power sector reform, the power sector would continue to burden public finances, in fact the need for investment support and subsidies would continue to grow. During the transition period, the Government will try to keep the impact of its financial support on the budget to the minimum, moderate the impact on the social sector and raise the bulk of funds through commercial approaches and market-based instruments. The Government recognizes the possibility of its adverse effect on the socially more desirable expenditure in the short term. However, in the long term a reformed power sector shall become a net contributor to the state's resources and help create more fiscal space in the budget to support higher levels of social sector investment. Participation 14. To ensure the sustainability of the reform program, Andhra has developed the reform program with the involvement and participation of various stakeholders. A comprehensive communication program has been launched by GoAP and APSEB to address the concerns of various stakeholders and build public support for the reform process. A large number of booklets, leaflets, and documents have been published and widely disseminated; both print and electronic media has been used extensively to communicate. The strategy and the reform program has been discussed with the labor unions and employee associations, who went on strike twice during 1997 but have finally reached an agreement with the government. A well attended meeting with the state and national level NGOs was held by Andhra in October 1997 and then in October 1998. For greater participation of staff, Andhra has recently launched a newsletter, held workshops for enhancing awareness and established a mechanism of regular feedback. -4-  Lessons learned from the past Operations 15. During the 1980s and early 1990s, the Bank Group's strategy in power focused on: (a) extensive support to Central Government owned agencies; (b) financing SEBs; and (c) financing existing private power utilities and encouraging the Government to lower entry barriers for new investors. The success of this strategy was uneven. The lessons learnt suggest that the strategy of state led sectoral expansion was no longer appropriate, in the Indian context. The experience indicates that autonomy of the management of government owned enterprises is constrained because of ownership by the government rather than the legal impediments. The management processes are affected by political interference in day to day operations of the state utilities. These lessons led to: (a) the design of the current state power sector reform program, including the promotion of privatization of distribution; and (b) the development of NTPC's and POWERGRID's investment and commercial policies. In Andhra Pradesh, ADB through its financing for Rayalaseema thermal project in 1989 and PFC (financed by both the World Bank and ADB) through its Operational and Financial Action Plan (OFAP) between 1989 and 1997 attempted revitalization of APSEB but could not stop its rapid decline into insolvency. Thus, for a sustainable solution to the sector's problems implementation of a comprehensive reform and restructuring program is critical. In the last five years power sector reforms were launched by Orissa and Haryana. In Orissa the Regulatory Commission has been in operation for about three years, has issued licenses, decided two tariff revisions through a process of public hearings and wide consultations, which have been accepted by the stakeholders as just and fair. The Government of Orissa has sold 49t of equity in its thermal generation company and is in the advanced stages of bid evaluation for privatization of entire distribution system in the state. Similarly in Haryana the Regulatory Commission, though established recently, is in the process of setting its regulation, tariff procedures, and is conducting hearings for license applications. These developments have encouraged other states to consider launching power sector reforms. Environmental and Social Aspects 16. As the project supports investments in strengthening and expansion of and transmission and distribution systems, no major environmental issues are perceived. Power generation is not a part of the project and most of the new generation will be by private sector, which will also follow the GoI environmental standards. The project is expected to have an overall positive environmental impact through improved efficiency in supply and demand side management. The design of lines and substations will incorporate safety features, and their route/location will be defined to minimize any adverse environmental impact. APSEB has prepared an environmental policy as apart of "Environmental Framework and Safeguards for Transmission Projects" which will govern all the APLs. APSEB has also prepared an Environmental Mitigation Plan (EMP), in conformity with the Bank standards, for mitigation of adverse environmental impacts of investments under APL1. EMPs will also be prepared for investment projects under subsequent APLs. 17. There are no major displacement and resettlement issues and the impact of investments under the project on land acquisition is minimal. GoAP has approved a Social Policy and Procedures (SP&P) including an entitlement framework to address the adverse impacts associated with land acquisition and loss of other assets in implementing investment projects in the power sector - 5 -  (irrespective of the source of financing). A detailed Resettlement Action Plan (RAP) has been prepared by APSEB for schemes under the first Project, which has been reviewed by the Bank and found to be satisfactory. Impact on the Poor 18. The reform program would help the poor by freeing up state funding for higher priority use in the social sectors - the reform in the power sector is the single most important aspect of structural and fiscal reform in the state. Most importantly, by improving the power supply, the program will eliminate one of the most serious constraints to higher economic growth. Andhra Pradesh is a poor state even in the Indian context and poverty is widespread. In the long term, its eradication is fundamentally dependent on growth and employment, the state's direct poverty alleviation interventions notwithstanding. These indirect impacts are regarded to be more important in Andhra Pradesh, where connection rates are still low, in rural areas well below 20 percent of households, and the poor typically do not have a power connection. It must be recognized that as a consequence of restoration of creditworthiness of the entities the investments that would actually get implemented on the ground are likely to far exceed what APSEB would have been able to execute without reforms. The key contribution of power reform to the poor is to lift the burden the power sector has placed on the state government finances (which mostly these poor indirectly have to bear) and simultaneously remove the power supply bottleneck to economic activity and growth. 19. The main direct poverty consideration of the Program and the proposed project is related to electricity pricing. While Andhra's electricity pricing policy emphasizes cost recovery, the utilities would continue to provide low- cost (lifeline) rates for poor electricity consumers to ensure that service for basic household uses of electricity remains affordable. Contact Point: The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone No. (202)458 5454 Fax No. (202) 522 1500 J. Parthasarthy Chairman, APSEB Vidyud Soudha Hyderabad, India Tel. 91 11 339 1174 Fax. 91 11 331 7663 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending February 26, 1999. - 6 -