Nepal - Power Development Project

Page 1 Document of The World Bank Report No: 2363 1-NP PROJECT APPRAISAL DOCUMENT ON A PROPOSED IDA CREDIT SDR 36.80 MILLION IN THE AMOUNT OF (US$50.40 MILLION EQUIVALENT) AND PROPOSED IDA GRANT OF SDR 18.40 MILLION IN THE AMOUNT OF (US $25.20 MILLION EQUIVALENT) TO KINGDOM of NEPAL FOR A NEPAL POWER DEVELOPMENT PROJECT April 25, 2003 Energy and Infrastructure Sector South Asia Regional Office Page 2 CURRENCY EQUIVALENTS (Exchange Rate Effective February 2002) ACRP ADB AEPC BME CAS CEF DANIDA DDC DOED EIA EMP ESAP FMR GTZ HMGM KoN IAS IDC IDA JBIC KfW MHFG MOPE MOST MOWR NEA NORAD OM PCI PDF Board PDF RAP REDP REDS SEA S IA SFR S&R TA UNDP USAID VDC VCDP Currency Unit = Nepalese Rupees NPRs. 1 = US$0.0133 US$1 = NRs.78.3 FISCAL YEAR July 16 -- July 15 ABBREVIATIONS AND ACRONYMS Acquisition Compensation Rehabilitation Plan Asian Development Bank Altemative Energy Promotion Centre Benefit Monitoring and Evaluation Country Assistance Strategy Community Energy Funds Danish Intemational Development Agency District Development Committee Department of Electricity Development Environmental Impact Assessment Environmental Management Plan Energy Sector Assistance Program Financial Monitoring Reports Deutsche Gesellschaft fur Technische Zusammenarbeit GmbH His Majesty's Govemment of Nepal Kingdom of Nepal Intemational Accounting Standards Interest During Construction Intemational Development Association Japan Bank for Intemational Cooperation Kreditanstalt fur Wiederaufbau Micro-hydro Functional Group Ministry of Population and Environment Ministry of Science and Technology Ministry of Water Resources Nepal Electricity Authority Norwegian Agency for Development Cooperation Operational Manual Participating Credit Institution Power Development Fund Board Power Development Fund Resettlement Action Plan Rural Energy Development Program Rural Energy Development Section Sectoral Environmental Assessment Social Impact Assessment Self-financing Ratio Screening and Ranking Technical Assistance United Nations Development Programme United States Agency for Intemational Development Village Development Committee Vulnerable Community Development Plan Vice President: Mieko Nishimizu Country Director: Kenichi Ohashi Task Team Leader: Mudassar Imran Sector DirectorManager: Vincent GouamePenelope Brook Page 3 NEPAL POWER DEVELOPMENT PROJECT CONTENTS Page .. A . Project Development Objective .......................................................................................................... 1 1 . Project development objective ........................................................................................................ 1 2 . Key performance indicators ............................................................................................................ 1 B . Strategic Context ................................................................................................................................ 1 1 . Sector-related Country Assistance Strategy (CAS) goal supported by the project ......................... 1 2 . Main sector issues and Government strategy .................................................................................. 2 3 . Sector issues to be addressed by the project and strategic choices ................................................. 3 C . Project Description Summary ............................................................................................................. 5 1 . Project components ......................................................................................................................... 5 2 . Key policy and institutional reforms supported by the project ....................................................... 7 3 . Benefits and target population ........................................................................................................ 8 4 . Institutional and implementation arrangements .............................................................................. 8 D . Project Rationale .............................................................................................................................. 13 2 . Major related projects financed by the Bank andor other development agencies ........................ 15 3 . Lessons learned and reflected in the project design ...................................................................... 16 5 . Value added of Bank support in this project ................................................................................. 17 E . Summary Project Analysis ................................................................................................................ 19 1 . Economic ...................................................................................................................................... 19 2 . Financial ........................................................................................................................................ 19 3 . Technical ....................................................................................................................................... 21 4 . Institutional ................................................................................................................................... 22 5 . Environmental ......................................................................................................................... 25 6 . Social ............................................................................................................................................ 31 7 . Safeguard Policies ......................................................................................................................... 36 2 . Critical Risks ................................................................................................................................. 40 3 . Possible Controversial Aspects ..................................................................................................... 41 1 . Effectiveness Condition ................................................................................................................ 42 2 . Other ............................................................................................................................................. 42 . ............................................................. 1 Project alternatives considered and reasons for rejection 13 4 . Indications of borrower commitment and ownership ................................................................... 16 F . Sustainability and Risks .................................................................................................................... 39 1 . Sustainability ................................................................................................................................. 39 G . Main Credit Conditions .................................................................................................................... 42 H . Readiness for Implementation .......................................................................................................... 44 I . Compliance with Bank Policies ......................................................................................................... 44 Page 4 Annexes Annex 1: Annex 2: Annex 3: Annex 4: Annex 5: Annex 6: Annex 7: Annex 8: Annex 9: Annex 10: Annex 11: Annex 12: Project Design Summary ........................................................................................... 46 Detailed Project Description ...................................................................................... 49 Estimated Project Costs ............................................................................................. 58 Cost Benefit Analysis Summary ................................................................................ 61 Financial Summary .................................................................................................... 68 Procurement and Disbursement Arrangements .......................................................... 75 Project Processing Schedule ...................................................................................... 95 Documents in the Project File* .................................................................................. 96 Statement of Loans and Credits ................................................................................. 98 Country at a Glance .................................................................................................... 99 Environmental Assessment and Management ......................................................... 101 Eligibility Criteria for Project Components ............................................................. 109 MAP(S) IBRD NEP28875 ... . 111 . Page 5 NEPAL POWER DEVELOPMENT PROJECT IDA CREDIT IDA GRANT FOR POOREST COUNTRY LOCAL COMMUNITIES LOCAL. SOURCES OF BORROWING COUNTRY SUB-BORROWER( S) UN DEVELOPMENT PROGRAMME Total: Project Appraisal Document South Asia Regional Office SASE1 11.70 38.70 50.40 5.50 19.70 25.20 1.10 0.00 1.10 2.80 0.00 2.80 38.00 0.00 38.00 0.80 0.00 0.80 75.00 58.40 133.40 Date: April 25, 2003 Team Leader: Mudassar Imran Sector Managermirector: Penelope Brook, Vincent Gouarne Sector(s): Power (SO%), Other industry (lo%), Sub-national government administration (10%) Country Managermirector: Kenichi Ohashi Theme(s): Other environment and natural resources Project ID: PO433 11 management (P), Other public sector governance (P), Lending Instrument: Specific Investment Loan (SIL) Other financial and private sector development (P) [ ]Loan [XI Credit [XI Grant [ ]Guarantee [ ]Other: For Loans/Credits/Others: Amount (US$m): IDA 75.6 [Credit US$50.4 m; Grant US$25.2 m] Proposed Terms (IDA): Standard Credit Grace period (years): 10 Commitment fee: 0.50 Years to maturity: 40 Service charge: 0.75% - iv - Page 6 3orrower: KINGDOM OF NEPAL IDA Grant Annual Cumulative Responsible agency: MINISTRY OF WATER RESOURCES Address: Singh Durbar, Katmandu Contact Person: Secretary Tel: 977-1-4228046 Fax 977-1-4227536 4.00 4.00 Department of Electricity Development (DOED) Address: Thapa Gaun, Anamnagar, Katmandu Contact Person: Director General Tel: 977-1-4480218 Fax: 977-1-4480257 Email: Other Agency(ies): Nepal Electricity Authority ("EA) Address: Durbar Marg, Katmandu Contact Person: Managing Director Tel: 977-1-4227725 Fax: 977-1-4227035 Email: neamd@mos.com.np 7.00 11.00 Alternative Energy Promotion Centre (AEPC) Address: Krishna Galli, Lalitpur Contact Person: Executive Director rel: 977-1-5539237 Fax: 977-1-5542397 Email: energy @aepc.wlink.com.np 6.00 17.00 5.00 22.00 3 .OO 25.00 0.20 25.20 I I I I I I Project implementation period: 6 years Expected effectiveness date: 07/01/2003 Expected closing date: 06/30/2009 -v- Page 7 A. Project Development Objective 1. Project development objective: (see Annex 1) The project objectives are to: (a) develop Nepal's hydropower potential in an environmentally and socially sustainable manner so as to help meet electricity demand; (b) improve access of rural areas to electricity services; and (c) promote private participation in the power sector as a way to improve sector efficiency and to mobilize financing for the sector's investment requirements. The KoN has identified the development of its hydro-recourse potential as a key priority to serve the energy needs of a vast majority of its population who have little or no access to electricity, and to reduce poverty. The objectives of this project are therefore consistent with the developmental and poverty reduction objectives of the KoN. 2. Key performance indicators: (see Annex 1) The key specific project performance indicators are outlined as follows and further detailed in Annex 1: (a) Service coverage in rural areas will be improved and number of villages served with electricity will increase. About 30,000 new households will be electrified involving 125 to 150 new systems. There would be sustained build-up of pipeline of schemes emerging from village development committees. (b) A pipeline of bankable projects will be developed through PDF. At least 12 private power projects are expected to come on stream by 2008. (c) Transparent and objective processes for inviting investment offers for medium sized hydro projects will be adopted, thus achieving more competitive terms and conditions for private power purchases by the grid. (d) One 220kV transmission line and other smaller transmission lines and sub-transmission lines will be constructed, and the associated substations, and distribution schemes will be expanded. About 34,000 consumers, including 17,000 new consumers, will benefit through the distribution scheme. (e) Financial efficiency of NEA would be improved. This would be evidenced by a DSCR of at least 1.2,6% ROR; and 90-day levels of accounts receivables and payables. (f) Operational efficiency of NEA would be improved by reduction of losses from 23.4% to no more than 17% by 2007. (g) The capacity of MOPE and DOED to assess and monitor environmental and social impacts of hydro projects would be improved. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 18578-NP The project supports the CAS goal of developing basic infrastructure to promote broad-based economic growth and improve resource utilization. In particular, the CAS sector strategy calls for increasing domestic power supply and facilitating private sector investments in power. The micro- hydro village electrification component of this project fits well with the CAS strategy of bringing resources closer to the beneficiaries and supporting decentralization and community-based projects. Date of latest CAS discussion: 12/13/98 -1- Page 8 2. Main sector issues and Government strategy: Nepal has vast hydro resources, which represent a source of potential wealth. Commercially exploitable hydropower generating potential is estimated to be about 43,000 MW. However, despite the hydropower generation potential, only 522 MW has so far been developed with another 119 MW under construction. Based on the 2001 census, 40 percent of Nepal's households have access to electricity. Disparity in access is stark with over 90 percent of the urban population connected, in contrast to an estimated 30 percent in rural areas. Main Sector Issues: Nepal's power sector performs well in comparison to other public sector institutions operating in power development in South Asia, especially, in terms of cost recovery and financial viability. However, the sector is beset with a series of institutional problems that constrain its efficient development and mobilization of private capital. These problems are identified in the Bank-financed sector work (Nepal Proposed Power Sector Development Strategy Report No. 21912-NP, dated March 19,2001). The most prominent are the following: (i) overlaps in the policy, regulatory, and operational functions of public institutions operating in the electricity sector; (ii) inadequacies of the existing institutional structure of the Nepal Electricity Authority (NEA) to meet future needs of the power sector; (iii) insufficient institutional arrangements for the promotion of power trade; and (iv) weak institutional support for improving electricity access to rural areas. The consequences of these constraints are reflected in poor quantity and quality of supply, high systems losses, minimal power exchanges with India, and high cost of power. The retail price electricity in Nepal is one of the highest in South Asia and has now reached the limits of affordability for a vast majority of the population. Government Strategy: Recognizing the need to address these issues and to develop its water resource potential, the Government has made the development of Nepal's hydro-electric potential to serve the energy needs of its people and for export, one of its key developmental objectives. The Government's Ninth Plan (1998-2002) for the sector called for: (i) production of sufficient and reliable hydroelectricity at cheaper cost to meet domestic demand, and for export; (ii) reduction of rural-urban and regional disparities in electricity supply; and (iii) linkage of rural electrification with rural economic activities. Similar goals are envisaged under the Tenth Plan with the aim of increasing generation capacity to 800 MW by 2008. This emphasis on power development follows the adoption of the Hydropower Development Policy in the early 1990s which, combined with changes in electricity legislation and the opening up of the power sector to local and foreign private investments, was intended to make institutions operating in the power sector efficient and creditworthy, as well as increase the participation of the private sector in the provision of electricity services of the people. While under this policy and regulatory framework KoN has been able to attract some private (foreign) investments in power generation, there was recognition that more needed to be done to attract private capital in the sector, and to improve the efficiency and creditworthiness of NEA. The revised Hydropower Development Policy, of 2001, addresses many of the sector's issues. Accordingly, it envisages an increased involvement of private investors in the production, distribution, and management of electricity, while recognizing the need for institutional and structural changes in the power industry to meet the sector's development objectives. The revised Policy calls for the creation of a more competitive environment for private sector participation, including introduction of more transparent and investment friendly procedures. Development of small hydro projects as well as of district level projects under decentralized schemes in hilly and remote areas are also highlighted. Finally, special attention is required to be paid to the social and environmental aspects of hydroelectric development to ensure that adverse effects on the environment and communities are reduced to the minimum. Page 9 While progress has been made on several fronts, further actions are needed. For example, while unbundling has been done to the extent that there are several private generation facilities in place as well as some internal unbundling in distribution, additional work may be needed to examine alternative restructuring options, in the longer term, for NEA and implementation of the most suitable one in the context of Nepal. While the NEA, the Government owned grid operator, generator and distributor added some 132,000 new connections in 2001/2 and various transmission and distribution links were extended including those in 42 hilly districts, increasing access to remote areas though decentralized schemes remains a challenge. The Tariff Fixation Commission has been put in place, but it presently falls short of a fully fledged regulator. Furthermore, implementation of some elements of the hydropower policy, such as private sector participation, are hampered by country economic and security risk, and the lack of adequate domestic capital market, issues which are beyond the control of the power sector. 3. Sector issues to be addressed by the project and strategic choices: To a large extent the sectoral issues identified above, such as those related to improvements in the efficiency of the NEA system, creation of a framework for mobilizing private capital into the sector, increasing access to power in rural areas and generally those related to improvements in the quality and quantity of power supplies and the high cost of power are addressed in the project though the assistance it provides with the implementation of the Hydropower Policy (detailed above). The capital needs of the power sector vastly exceed the availability of resources from the traditional multi-lateral and bi-lateral agencies. The need for raising financing has now become even more important given the declining trend in the availability of concessional resources for power sector development, and the recognition that scarce public resources are needed for the development of social sectors. Increasingly, therefore, investment resources for power development will need to be mobilized through the private sector. The proposed project would help attract private financing in hydro electric generation by establishing the Power Development Fund (PDF) to support small and medium hydro investments. The project further supports the implementation of the Government's Hydropower Development Policy by promoting private development by establishing a transparent process for inviting offers for medium-sized hydropower, on an international competitive basis, and thus is expected to lower the average cost of private power sold to the grid. The project gives importance to development of hydro resources in a socially and environmentally sustainable manner to ensure that investments are supported by the communities, and are thus successfully carried out while also protecting the Country's resources. A Screening and Ranking (S&R) study, financed under Power Sector Efficiency Project (Cra2347-NEP), was aimed at reducing project implementation risks by selecting hydro-electric schemes through a transparent and public process, in addition to application of techno-economic criteria. The medium-sized hydro schemes to be supported under the project come from the set of schemes recommended as appropriate for meeting Nepal's domestic electricity needs. The project provides opportunities to the local private sector to develop generation projects that will help to further develop indigenous skills and resources. While the project does not directly support export-oriented projects, it will help build experience in developing hydropower projects with the private sector, paving the way for private power export initiatives in the future. At present, only about 200,000 rural households are electrified leaving about 3.5 million households without access to electricity. The current rate of electrification is not sufficient to keep pace with growth in the rural population. The Hydropower Development Policy's objectives of -3- Page 10 reducing rural-urban disparities in electric supply and linkage of electrification with rural economic activities are being supported by the project through financing of grid and off-grid rural electrification activities. In particular, the community-based village electrification component which involves social mobilization and training, will nurture development of indigenous skills and local resources, and improve access of communities to other rural development programs. Further, the project supports the Government's decentralization efforts inasmuch as the micro-hydro component involves active participation of district development committees and village development committees The project also promotes improved functioning of the grid, and fosters commercialization and reform of the electricity industry. An efficient and financially viable NEA is key to the successful implementation of the Government's policies in the power sector. The project supports institutional strengthening of NEA in the areas of financial management, including implementation of a more rigorous accounting and internal control systems, which meet international accounting standards. NEA's corporate financial performance will be monitored to ensure that NEA remains creditworthy and can stand by its power purchase agreements with private power developers. Finally, the project supports ongoing adoption by NEA of organizational reforms in order to achieve efficiency improvements and more competitive service. The Nepal Power Sector Development Strategy report identified a number of institutional reform options for NEA ranging from internal reforms of the NEA system (in which NEA's functions are internally separated through profit centers) to unbundling generation, transmission, and distribution (and subsequently privatization of the unbundled utilities). As a first step, NEA have already taken actions to implement the internal reforms. The project provides an opportunity to evaluate alternative options in more detail and pave the way for supporting, in the future, the option that is most suitable for Nepal. -4- Page 11 C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for cost breakdown): The Project consists of three components, namely: (a) establishment of a Power Development Fund (PDF) to finance private development of small and medium-sized hydro schemes; (b) community-based village electrification through construction of micro-hydro systems (sizes of up to 100 kW); and (c) grid transmission and distribution improvements. Total project cost including interest during construction (IDC) is estimated at US$ 133.4 million, equivalent, of which IDA financing is US$75.6 million comprising an IDA credit of US$50.4 million and an IDA Grant of US25.2 million. Part A. The PDF Component The Power Development Fund will be a financing facility to be established by the Government under this project. The Fund will provide long-term financing for private-sector small and medium-sized hydropower developments in Nepal to overcome: (a) the lack of sufficient debt financing for private-sector hydropower projects; (b) inadequate maturity of available debt financing; and (c) the need to provide comfort to private investors wishing to become involved in "first time" projects. The fund will be wholly owned and operated by the Government, but with administrative management contracted out to a commercial bank. Initial financing of sub-loans for investment projects through the PDF will be provided by IDA. Over time, it is envisaged that resources from other international and domestic financial institutions will be mobilized, which together with reflows of debt service payments from the sub-borrowers, will augment the corpus of investment funds accessible through the PDF. Under this credit operation, the PDF will finance small hydro schemes with an aggregate capacity of about 25 MW and one medium-sized scheme of about 30 MW. The US$35 million from IDA Credit is expected to leverage financing from other sources, i.e., developers' equity and commercial banks, of about US$40 million. There has been significant interest in participation in the fund already expressed by developers and bankers. The PDF will be managed by a Fund Administrator, which will be a private commercial bank operating in Nepal and selected by the Government through a competitive bidding process agreed with the Bank. Following an evaluation process satisfactory to the Bank the Government has approved selection of a local well established commercial bank, and the Bank has provided its no- objection to this selection. An PDF Board formed by the Government will be responsible for approving sub-loans in accordance with the recommendations of the Fund Administrator. Technical assistance from IDA grant of about $2.5 million (in addition to the credit noted above) will finance the Administrator's fees, as well as the operating expenses associated with the PDF Board during initial years of operation of the PDF. Once this capacity is developed the fund is expected to become self-sustaining. In parallel with the PDF project there are several technical assistance activities which were not all designed solely to support the PDF initiative but which will facilitate the implementation: (a) technical assistance is being provided by GTZ, under its Small Hydro Promotion Project to assist local entrepreneurs in ensuring that their investment proposals are bankable; (b) the Government of Norway is extending technical assistance to the Ministry of Population and Environment (MOPE) for institutional building, with special emphasis on strengthening MOPES functional capabilities, in the exercise of its regulatory mandate of monitoring environmental conditionalities of the license for development of hydropower schemes to be financed under the PDF; (c) technical assistance to the Department of Electricity Development (DOED) is being provided by USAID through consultants under its Private Sector Hydropower Development Project, to develop DOED's capability in managing the private power solicitation and award processes for medium- and larger- -5- Page 12 sized hydro schemes; and (d) USAID is also supporting the strengthening of DOED's capacity to review the environmental and social impact assessments of the investment schemes. Technical assistance provided by USAID is in its second phase. It was renewed in 2001, for an additional period of five years to 2006, after which the need for further assistance will be reviewed. Part B. Micro-Hydro Village Electrification This component will support the scaling-up of community-based micro-hydro village electrification by developing about 2.5 to 3.0 MW of new micro hydropower systems to serve some 30,000 new consumers. The project will be build on the successes achieved under the UNDP- financed Rural Energy Development Program (REDP) and will extend electrification activities from the 15 districts currently served to another ten more districts. Program implementation will be decentralized through local government, Le., District Development Committees (DDC) and the Village Development Committees (VDC), and involves formation of a micro-hydro functional group (MHFG) at each participating community. The Alternative Energy Promotion Centre (AEPC), which is the agency responsible for promotion and development of alternative and renewable energy technologies in Nepal, will assume overall management of this project component. Further, through UNDP co-financing, the existing REDP project support unit will be strengthened to support the increased level of micro hydro system development envisaged. The total cost of this project component is estimated at US$ 8.9 million. Of this, the Bank would provide IDA grant of about US$5.5 million to finance the Government subsidies for the construction of micro hydro schemes, and support the administration of community mobilization, trainingkapacity building, and associated activities. The remainder of the costs will be financed by UNDP (US$O.8 million for program suppodmanagement), community contributions (US$ 1.1 million) DDCNDC investments (US$0.7 million), and the balance from loans to the community from local banks, e.g., the Agricultural Development Bank of Nepal. Part C. NEA Component This component involves investment support for the construction of a 220 kV double circuit transmission line (with one circuit strung initially) from Khimti Power station to the existing 132 kV Dhalkebar substation. Further transmission and sub-transmission investments would be selected based on NEAs priority least cost investment plan and the project eligibility criteria set out in Annex 12, part C. This may include the financing of a 132 kV transmission line from Dhalkebar substation to Bhittamod on the Nepalese side of the border with India (joining the Indian grid at Sitamarhi substation in Bihar about 40 km from the Nepalese border) to facilitate cross border power trade, and the extension of 132 kV line bays at the associated substations. But financing of the Dhalkebar to Bittamod transmission line, and the associated sub-station is contingent on the appropriate institutional, administrative, legal, social and environmental arrangements being in place and satisfactory to IDA. The IDA financing will likewise finance supply and installation of equipment and materials, and civil works for the extension of NEA's sub-transmission and distribution systems to rural areas and towns not electrified, and rehabilitation and reinforcement of NEAs existing distribution systems in urban and semi-industrial centers. The transmission lines will enhance grid reliability and stability reduce system losses. Sub- transmission and distribution schemes will improve access, quality, reliability and operational efficiency of power supply to consumers. Acquisition of spare parts and protection equipment is also included. IDA financing for these investments is estimated at US$ 3 1 .O million, comprising an IDA credit of US$ 15.4 million and an IDA grant of US$ 15.6 million. -6- Page 13 Technical assistance (TA) activities will involve several institutional building initiatives at NEA. These include strengthening of NEA's financial management, audit and accounting systems. The TA will also support the conduct of marketing studies to review opportunities for productive use of surplus energy, extension of service to rural areas, power wheeling, and associated pricing studies that would enhance opportunities for private sector participation in the power sector. Also to be financed is the engagement of engineering consultants to assist NEA in undertaking the 220 kV transmission scheme. IDA Grant financing for TA is estimated at US$ 1.6 million. Component Part Al. PDF Investment Funds Part A2. Technical Assistance for PDF Administration Part B 1. Micro-hydro Village Electrification Investments Part B2.1 UNDP-financed TA Part C1. NEA Transmission and Distribution Investments Part C2. TA for NEA institutional strengthening Part C3. NEA Project Administration and Engineering 75.00 2.90 8.10 0.80 33.7 1.80 2.00 % of Bank- Total financing Credit Grant Total 56.2 35.00 35.00 2.2 2.50 2.50 6.1 5.50 5.50 0.6 25.2 15.4 15.6 3 1 .OO 1.4 1.60 1.60 1.5 Total Project Costs 124.3 93.2 50.40 25.20 75.6 Interest during construction 9.10 6.80 Total Financing Required 133.40 100.0 50.40 25.20 75.6 It is envisaged that separate financing from the Global Environmental Facility (GEF), under its Climate Change Operational Program, would be availed by KoN during the course of project implementation. GEF financing would be explored for activities on removal of market entry barriers to micro and small hydro development in Nepal, capacity building and policy support. 2. Key policy and institutional reforms supported by the project: See Section B.3. 46.3 3.3 7.3 0.0 41.0 2.1 0.0 100.0 0.0 The project supports implementation of policy and institutional reforms outlined in the Hydro Power Policy especially policies related to improving the enabling environment for private sector participation. This involves (a) establishment of a transparent and objective process for inviting offers, on an internationally competitive basis, for private power development of power facilities; (b) formulation of appropriate policy and pricing incentives to attract investments for smaller-sized hydropower; and (c) establishment of a long-term funding facility, the Power Development Fund (PDF), to support private initiatives. To improve electricity access to rural areas, the project also supports supplementing existing institutional methods of delivering electricity services to rural areas with innovative approaches, such as by developing community based systems. The importance of approaches involving local communities is also highlighted in the Nepal, Power Development Strategy Report. 100.0 An efficient and financially viable grid operator is key to the implementation of the Hydro Power Policy. Although in the South Asia Regional context NEA as an integrated utility has been performing better than many other public utilities in terms of project efficiency and cost recovery, -7- Page 14 further changes are required to improve operational efficiency. Some restructuring has recently been carried out and studies are underway on a new grid code and schedule of wheeling charges. The project supports such further improvements in the efficiency of the NEA system and also improvements in financial management. Substantial institutional reform is not within the objectives of this project, but the project will, nonetheless, provide an opportunity for opening up dialogue with NEA to identify and implement in the long-term the most suitable institutional design for NEA that improves efficiency and meets the future need of the sector. These discussions will take as their starting point the recent institutional changes and also consider the proposals outlined in the Nepal, Power Development Strategy report. 3. Benefits and target population: Mobilization of private sector investments in hydropower would result in additional power supply to meet the growing demand for electricity in Nepal. This will support the country's socio- economic development, help reduce reliance on imported petroleum products, as well as develop indigenous skills and entrepreneurship. About 30,000 consumers in remote rural communities would have better access to electricity supply from micro-hydro systems in their localities. Grid- connected electricity consumers would benefit from the project in terms of extension of new connections, as well as improvements in quality and reliability of service as a result of the strengthening of NEA's transmission and distribution network. About 37,000 new consumers will be added to the NEA grid through the distribution scheme. The Nepal, Power Sector Development Strategy report outlines the positive impacts access to electricity has on the lives of the people. Improved access is beneficial for education and health services; improved communications and household and industry productivity. 4. Institutional and implementation arrangements: Implementation period: six years Project Coordination and oversight Part A: The Power Development Fund (PDF) will be administered on behalf of the Government by a competitively selected commercial bank in Nepal (called the Administrator), pursuant to the terms of a PDF Administration Agreement. As the administering agency for the PDF, the PDF Administrator, will: (a) review proposals for PDF financing according to the criteria laid down in the operations manual and make recommendations to the PDF Board; (b) negotiate the terms of loans approved by the PDF Board and prepare the loan documentation; (c) operate the PDF account; (d) monitor sub-borrower performance under loans from the PDF; (e) handle debt service collections; (f) maintain the books of account of the PDF, which will be audited annually by auditors acceptable to IDA; and (g) provide trimestral financial monitoring reports to the Ministry of Finance, Ministry of Water Resources, the PDF Board and IDA on the pipeline of pending projects and the status of outstanding loans. An PDF Board will be established and will be responsible for the overall policy direction and supervision of the PDF. The functions of the PDF Board will be to: (a) approve proposals for loans in accordance with a recommendation of the PDF Administrator and with the concurrence of IDA; (b) certify financial institutions as Participating Credit Institutions (PCI); (c) provide the Government with advice, as required, concerning the management reports to be provided by the PDF Administrator; and (d) monitor the performance of the PDF Administrator and to make recommendations to the Government concerning the termination or renewal of the Administration Agreement. Recommendations for sub-project funding would be proposed by the Administrator to the PDF Board. Funding decisions would be based on financial and commercial grounds in -8- Page 15 accordance with the policy and operating guidelines of the PDF. The PDF's lending policies, terms and conditions, sub-project eligibility criteria, and approval process are summarized in Annex 12. The Department of Electricity Development (DOED) in the Ministry of Water Resources (MOWR) is responsible for conducting competitive solicitations for development of hydro generation schemes. Technical assistance is being provided by USAID to select qualified private developers for identified medium-sized projects. Prospective private developers for Kabeli-A (30 MW) and Rahughat (27 MW) have been pre-qualified, and the Request for Proposals (RFP) is expected to be issued as soon as funding is secure. At the same time, DOED, with the assistance of GTZ-financed consultants, will take measures to strengthen the pipeline of hydroelectric schemes sized below 10 MWs. At present, there is an indicative pipeline of small hydro schemes at mature stages of preparation. Part B: The Alternate Energy Promotion Centre (AEPC), will be responsible for implementation of the community-based micro-hydro development component. The AEPC, is an autonomous body under the Ministry of Science and Technology (MOST). It was established in late 1996, with the main objective of promoting and developing alternative and renewable energy technologies through local organizations, to raise living standards of rural people. The project will be guided by the decisions of the Project Management Committee which will have the following membership: AEPC's Executive Director as Chairperson, representatives from the National Planning Commission and the Ministry of Local Development (MOLD), a representative of the Association of District Development Committees of Nepal (ADDCN), District Energy Network, Association of Village Development Committees of Nepal, and REDP's Manager. (See Annex 2). UNDP will provide technical assistance to AEPC for implementation of this component. Part C: The Nepal Electricity Authority (NEA) will be the executing agency for Part C of the project. NEA has the capacity to implement these transmission and distribution investments using its own project management resources, as demonstrated in previous credits, but to ensure continued capacity building, NEA will contract consultants for a limited amount of technical assistance in the area of project implementation and for financial management improvements. During the course of the project there will be further discussion of the organizational development of NEA, outlined in the Nepal, Power Sector Development Strategy report, on which NEA has already embarked. This support will be aimed at shaping NEA in the appropriate form, in the longer-term, to support the ongoing development of the power sector in Nepal in the future. Policy guidance MOWR is responsible for the overall policy guidance in the power sector. The Ministry is responsible for the licensing of generation, transmission and distribution projects through DOED. DOED also functions as a one-stop window for private investors in the power sector. MOWR will ensure that close coordination between NEA and DOED would be maintained, particularly with respect to sub-projects involving private power sales to or through NEA-operated facilities. The Ministry of Population and Environment (MOPE) provides overall policy guidance in the context of the 1997 Environmental Protection Act, and is responsible for providing environmental clearances. Policy guidance for the micro-hydro component would be provided by MOST through AEPC. The project will be pursued in accordance with the Government's policy on Subsidy for Renewable Energy (2000) and Renewable Energy Subsidy Delivery Mechanism (2000). -9- Page 16 On-lending terms The IDA credit and IDA grant will be provided to KoN on standard IDA terms, with the applicable service charge in the legal agreements there is also a