Zambia - Kariba North Hydroelectric Project

o0MA) O/-ZA FuIIJ COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Repor No. P-1380a-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS PROPOSING AN INCREASE IN THE AMOUNT OF THE LOAN TO THE KARIBA NORTH BANK COMPANY LIMITED WITH THE GUARANTEE OF THE REPUBLIC OF ZAMBIA FOR THE KARIBA NORTH PROJECT (LOAN 701-ZA OF JULY 7,1970.) June 14, 1974 | This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank.Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENT EQUIVALENTS Zambian Kwacha (K) 1 US$1.555 US$ 1 = KO.643 Prior to February 13, 1973: K 1 = US$1.40 US$ 1 = KOo714 GOVERNMNENT OF REPU BLIC OF ZAITBIA (GRZ) Fiscal Year: January 1 - December 31 KARIBA NORTH BANK COMPANY LIMITED (KNBC) Fiscal Year: July 1 - June 30 CENTRAL AFRICAN POWER CORPORATION (CAPC) Fiscal Year: July 1 - June 30  REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS PROPOSING AN INCREASE IN THE AMOUNT OF THE LOAN TO THE KARIBA NORTH BANK COMPANY LIMITED WITH THE GUARAUNTEE OF THE REPUBLIC OF ZAMBIA FOR THE KARIBA NORTH PROJECT (Loan 701-ZA of July 7, 1970) 1. I submit the following report and recommendation for a supplemental loan to the Kariba North Bank Company Limited for the Kariba North Project, in an amount of $42.1 million equivalent, to finance cost increases. The proposed supplemental loan would be in the form of a second7trEache of Loan No. 701 ZA (Kariba North Project), increasing the original amount of Loan No. 701 ZA from $40 million equivalent to $82.1 million equivalent. The grace period under the original loan (the first tranche) would be extended by eighteen months (from July 31, 1975 to January 31, 1977); the rate of interest on the second tranche would be 7-1/4 percent per annum; and amortization of both tranches would be over a peri,)d of twenty years, commencing February 1, 1977. PART I: THE ECONOMY 2. The last Economic Report on Zambia (Report No. 4-ZA) was issued on December 26, 1972. An updating mission visited Zambia in October-November 1973. The most recent economic data are summarized in Annex I. 3. The economy is characterized by a distinct dualism between the large modern sector and the rural subsistence erconomy. Almost half the population of 4.5 million is involved in the modern sector; the remainder depend for their livelihood on small-scale traditional agriculture. The average per capita national income in 1971 was estimated at $100 in the traditional sector while the figure for the modern sector is over $650. There are approximately 400,000 in wage employment, which has been growing at about 3 percent per annum in recent years. Population growth is estimated at 2.5 percent per annum. 4. The shortage of trained citizens to man the economy has been a critical constraint to development. At Independence (1964) there were only about 100 citizens who were university graduates and 1,000 possessing secondary school level certificates. Since then remarkable progress has been made in expanding education at all levels. At present there are over 800 Zambian university graduates and the annual output from the secondary schools has risen to over 6,000. In recent years the Government has placed special emphasis on expanding vocational and technical training. 5. The modern sector is dominated by the copper industry, which con- tributes nearly 40 percent of GDP and 95 percent of exports. Thus the world copper price has a large and pervasive effect on the economy. Unfortunately,  the copper price is notoriously unstable and the Government has inadequate means of insulating the economy from the fluctuations of the copper market. In recent months, Zambia has benefitted from the record copper prices result- ing in a dramatic improvement in the country's financial and foreign exchange position. However, it is essential to view the present exceptional situation in a longer term perspective. Economic trends between 1970-73 were in sharp contrast with those in the preceeding years, as well as current trends. 6. Between 1964 and 1969, gross national income at constant prices grew on the average by almost 17 percent a year. More than half of this increase, however, resulted from the improvement in terms of trade. Then, as now, the sharp increase in the world copper price had placed Zambia in a strong financial position. The Government's budget and the balance of payments produced growing surpluses. In the course of 1970, however, the period of rapidly rising incomes ended owing to a combination of unfavorable factors. The two most important factors were the sharp deciine in the copper price in the second half of 1970 from US$1680 to US$1090 a toA and the flood- ing of the Mufulira mine in September 1970 which accounted for 25 percent of Zambia's copper output. The combined result of lower copper prices and production losses was a fall in the value of copper output of 40 percent between 1969 and 1971 and a fall in gross national income per capita from US$425 to about US$355 over the same period, with little recovery in 1972 and 1973. Although the price of copper improved markedly in the second half of 1973, sales fell below the projected level due to a combination of produc- tion problems and transport bottlenecks. 7. The decline in the value of copper sales between 1970 and 1972 had a strong adverse affect on the budgetary situation, national savings and the balance of payments. The deterioration in the budgetary situation was compounded by two additional factors: first, recurrent expenditures had been allowed to increase sharply aid second, government revenue from the mining sector declined because of new capital depreciation allowances granted as an incentive to boost further investment. Consequently, the Government's recurrent budget which in 1970 still had a surplus of US$246 million - more than enough to finance all development expenditure -- showed deficits of US$25 million in 1971 and US$76 million in 1972. At the same time private savings were also adversely affected and their domestic availability further reduced by the mounting problem of capital flight since 1969. In 1973, partly as a result of improved copper prices and partly owing to severe aus- terity measures, the recurrent budget showed a small surplus of approximately US$37 million. 8. Net foreign reserves declined from a peak of US$605 million in August 1970, to US$131 million by December 1973 (equal to two months imports). This sharp decline cannot entirely be explained by the unfavorable develop- ment in the prices and output of copper and by government's deficit financing alone. Part of the decline was due to legal and illegal capital exports. 9. The Government has over the past two years taken steps to restore the financial balance. To improve the balance of payments, imports of certain  luxury goods and consumer goods that are also produced locally were prohibited, and a surtax on dutiable imports was introduced. Exchange control regulations were tightened, including measures to curb capital flight. To improve the budgetary situation, new tax measures were introduced in the 1972 and 1973 budgets. Austere spending policies kept the increase in recurrent expenditure down to 4 percent in 1972 and 6 pe:-cent in 1973. The underlying positive trend in the balance of payments o;curing over the past twelve months has been obscured by the Government's cecision to repay bonds that had been con- tracted in 1969 in payment for the acquisition of a majority shareholding in the two major mining groups. The repayment (US$239 million) was financed, in part, from two Eurodollar loans totaling US$150 million. 10. The closure of the Rhodesian border created a serious crisis, caus- ing severe restrictions on imports and necessitating major expenditures on expanding the capacity of alternative routes. Shortage of imports held back investment and interfered with copper production. The value of total imports fell slightly in 1973, and gross fixed capital formation is estimated to have declined from US$525 million in 1972 to US$367 million in 1973. It is expected that, as a result of the emergency measures taken over the past twelve months, imports will rise substantially in 1974-75. The Tanzania-Zambia Railway which is now being used to transport goods to the Zambian border should be- come fully operational in 1975 and, provided the Lobito and Malawi routes remain open, Zambia should have no problem obtaining all her essential im- port requirements. 11. Zambia's Second National Development Plan, 1972-76 (SNDP) envisaged a total investment of US$3,000 million, of wh:Lch approximately one-half was to be undertaken by Central Government, one-eighth by public sector enter- prises and the remainder by the private sector. The core of the SNDP was the proposed investment of US$560 million in the expansion of copper production. The targets set in the SNDP are now largely of historical interest. The unanticipated fall in the price of copper and the emergency situation arising from the closure of th'! Rhodesian border led to a reduction and distortion in planned capital expenditure. The Government has commenced the preparation of the Third National Development Plan (1977-81) which is scheduled for pub- lication in 1976. 12. In brief, Zambia's primary objective is to sustain growth while: (i) correcting the rural-urban imbalance; (ii) redistributing income; and (iii) providing new employment opportunities. Zambia hopes to achieve this objective by investments in (a) mining and the related power sector to yield income for strengthening other sectors, (b) manu- facturing industries to become less dependent on imports and to expand employment opportunities, (c) agricultural production and processing industries to make Zambia self-sufficient in most foodstuffs, and (d) rural development projects to benefit large nurbers of rural poor. The most difficult challenge is to raise the productivity of the large tradi- tional agriculture sector. Recognizing the need for a concentrated effort to improve traditional agriculture, the Government has decided on a strategy of integrated rural development, which has been successfully introduced in some other African countries. The Government plans to start "Intensive  - 4 - Development Zones" (IDZs) in two or three areas with suf'icient potential, and, if successful, subsequently increase their number. Attempts to increase agricultural productivity will be accompanied by investments to improve the quality of life in rural areas by providing, for example, community centers, rural electrification, improved roads and water supplies, health facilities and village industries. 13. Although copper will remain for many years Zambia's most important economic asset, sustained long-term economic development depends on the creation of a more diversified econorm4C structure. To encourage d-1ve siF-ca- tion, a number of important policy changes, particularly relating to pzices and incomes are required. 14. The Government has recently boosted agricultural producer prlces but has yet to raise consumer prices so as to reduce the large subsidies enjoyed by residents in the urban areas. It has put into effect the first elements of a new incomes policy, which is designed not only to reduce the great disparity between urban and rural incomes but also to obtain a greater share of incomes generated by the mining industry for the developmenit of the rest of the economy. One of these elements is the measures, announced in August 1973, designed to give the Government a firmer control of the mining industry. As the new arrangements are still being negotiated, it is too early to say to what extent they will enable the Government to increase the contribution of mining to general economic development without affecting detrimentally the production and efficiency of the mines. Another element of the new incomes policy relates to wages and salaries paid to Zambfan workers. The manifesto which was recently adopted by the Central Committee of the ruling party announced the introduction of a "Zambian wage structure". This would separate the wages paid to Zambians from those paid to expatriates so that the wage basic levels in the economy could reflect more truly the economic conditions in Zambia rather than the conditions on the international labor market for the supply and demand of highly skilled expatriates. 15. Zambia's financial position over the past year has improved sub- stantially with the marked upswing in copper prices. Average copper prices in 1973 were about 50 percent higher than in 1972, and prices in 1974 are forecast to increase further. The high copper price has increased the Government's scope for noninflationary domestic borrowing by tapping part of the excess liquidity created by the external surplus. For 1974, the budgetary position should improve further and domestic revenues may once again be used to finance a substantial part of government investment. In view of this prospect, Bank lending would be mainly related to foreign costs of projects but some local cost financing may be justified for projects in the social and agriculture sectors where the foreign exchange component is very small. Budgetary savings, together with disbursements from foreign loans, should cover the financial needs of the Government.and there would be no need for deficit financing. 16. Over the past year, the Government has actively sought foreign assist- ance for the public sector investment program. At the same time, it stepped up borrowing from commercial sources. Because of its limited borrowing in  - 5 - the past, Zambia's debt service obligations are low. Thus, there is consider- able scope for further borro7wing abroad on conven'tional terms. To achieve a 5% growth rate Zambia's foreign borrowing will have to increase gradually from US$120 million in 1974 to US$250 million p.a. in 1980 and to US$300 million p.a. in l985. The debt service ratio would grow from 3.9% in 197L to .5% in 1985, assuming that exports grow at 5% p.a. in real terms, that copper prices will increase at the same rate as international prices generally, and that approxi- mately two-thirds of the borrowing is on commercial terms (10% p.a. repayable over 10 years), and the remainder on IBRD terms. The Government recognizes the need to plan external borrowing to reduce as far as possible the effect of short-term fluctuations in the copper price on the balance of payments and the development budget. PART II: BANK GROUP OPERATIONS 17. The Bank has made sixteen loans to Zambia and the IFC has two investments there. Four loans were made for railways and electric nower before Zambia became independent and are guaranteed by the UK as well as Zambia. Since Independence, four loans have been made for agri- cultu-al development, three for education, two for highways, and two for power. Total lending to date has been US$339.1 million (net of cancellations), of which US$198.9 million is for electric power, US$47.2 million for transportation, US$55.7 million for education, and US$24.8 million for agriculture. Six loans are fully disbursed and the first loan made in 1953 (No. 74-RN), was repaid in full in February 1972. The IFC made its first investment in Zambia in February 1972, providing US$1.1 million for expansion of a shoe manufacturing company. A second IFC investment in the same company, totalling US$1.2 million, was made in June 1973. As of December 31, 1972, the Bank's share in Zambia's total debt (disbursed and undisbursed) was 16 percent, while the Bank's share in Zambia's total debt service payments in 1973 was 12 percent. Present projections indicate that the Bank's share in Zambia's debt would increase to about 29 percent in 1980, while the Bank's share in Zambia's debt service would increase to about 38 percent in 1980. Annex II contains a summary statement of Bank loans and IFC investnents as of May 31, 197!1, and rotes on the execution of ongoing projects. 18. Progress on Bank operations in Zambia has been adversely affected by the difficulties Zambia has faced over the past decade. The Unilateral Declaration of Independence in Southern Rhodesia in 1965 led Zambia to sever her close economic ties with Southern Rhodesia at a considerable cost, disrupting the development program. Shortage of skilled manpower has inter- fered with progress on some projects, while recent cost escalations have caused difficulties on others, especially the Kariba North project. Finally, the sharp fall in copper prices in 1971 and 1972 forced the Government to rephase capital expenditures on several programs; this affected the Bank's first education project. The Zambia-Rhodesia border closure created an addi- tional financial burden, but has not, however, caused significant delays to Bank-financed projects. Substantial assistance was provided by various bila- teral sources to help Zambia meet this emergency. To help maintain Zambia's development effort in the face of these financial problems, the Bank made  available in June 1973 a US$30 million program loan. However, the recent improvement in Zambia's financial position, caused primarily by the increase in copper prices over the past year, diminished the need for part of this loan. In March 1974, after discussions initiated by the Bank, the Govern- ment requested the cancellation of US$17.5 million of the loan. 19. We propose to continue assisting Zambia in achieving her develop- ment objectives. A mixed farming project is presently being prepared and the Bank is also assisting in formulating proposals for Intensive Develop- ment Zones (IDZ). While still at the early planning stage, the Bank expects to assist in the financing of these and other projects (e.g., forestry) in the agricultural sector. Rapid drift of population to the towns has given rise to serious urban problems which cannot be ignored; the Bank is respond- ing to this need with a project scheduled for Board consideration at the same time as the proposed operation,for the provision of serviced sites for self-help housing in Lusaka and for the upgrading of squatter settlements. A oroject for telecommunications development is also being prepared. The supplementary loan presently under consideration for the Kariba North Project will help meet cost over-runs experienced during construction of the project. PART III - THE ELECTRIC POWER SECTOR 20. The major wholesale supplier of electric power to Zambia and Southern Rhodesia is the Central African Power Corporation (CAPC), which owns the Kariba dam and the South Bank power station, and transmits power from this and other sources over its extensive 330 kv grid in both countries. CAPC was established, following the dissolution of the Federation of Rhodesia and Nyasaland in 1963, to be responsible for power production and bulk trans- mission, and is jointly owned and operated by Zambia and Southern Rhodesia. The Corporation is controlled by a Higher Authority for Power (HAP) comprising members from Zambia and Southern Rhodesia - the latter being appointed under an Order-in-Council of the United Kingdom Government following Southern Rhodesia's Unilateral Declaration of Independence (UDI) in 1965. In spite of UDI, the interconnected system is continuing to operate with the support of all parties. CAPC has remained a viable institution, operating efficiently and providing substantial benefits and economies to both countries. 21. CAPC sells power to five companies: two in Zambia and three in Southern Rhodesia. In Zambia, CAPC sells power to the Copperbelt Power Company (CPC), owned 51 percent by Government and 49 percent by the Government controlled mining companies, and to the Zambia Electricity Supply Corporation Limited (ZESCO), which was set up in 1969 as an entity wholly owned by the Government to be responsible for all power production in Zambia, except from the Kariba North Bank power station. ZESCO operates the 600 MW Kafue (Stage I) hydroelectric station, the 108 14W Victoria Falls hydroelectric power stations and a few other small thermal, diesel and hydroelectric stations. The Kafue and Victoria Falls power stations are interconnected to CAPC's power system  - 7 - and ZESCO sells its entire power production, in bulk, to CAP>. ZESCO purchases its power from CAPC, in turn, for its consumers throughout Zambia. The copper mines, which account for 75 percent of the total consumption in Zambia, obtain their requirements directly from the CAPC system, through CPC. 22. The growth of demand, generatirng capacity and ernergy production capability of the interconnected system is depicted in Annexes IV and V. Presently, 1,884 NW of installed capacity is available to the CAPC intercon- nected system, but the energy resources are already insufficient to meet the demand and a period of energy shortages is forecast until the Kariba North Bank power station is commissiored. 23. The construction of the Kariba North station is the most economic source of additional power to meet the existing shortages and growth in de- mand and, upon completion in 1976, will add 600 MW capacity to the inter- connected system. Further generating capacity would be required by 1977, which would be met by the Kafue II Hydroelectric Project in Zambia (600 MW), for which the Bank made a loan (919 ZA) to ZESCO in July 1973. 24. Future development of the interconnected system until 1980 would consist of (a) the expansion of CAPC's 330 kv transmission system; and (b) the provision of additional generating capacity. After ZESCO's Kafue Stage II hydroelectric project is completed, further generating capacity would most economically and conveniently be met by the third stage of Kafue River development (450 MW). Planning for the Kafue Stage III project, however, is only at a preliminary stage. For reasons of national self-sufficiency, Southern Rhodesia has recently announced a program to construct the Wankie thermal power station for operation in 1977, although this would not be the most economic source of power for t.he CAPC system after the Kafue II project. 25. Bank lending has been a major factor in developing the intercon- nected system in Zambia and Southern Rhodesia and, in particular, the Kariba power scheme. The first Bank loan (145 RN) was made in 1956 for the Kariba dam, the adjacent South Bank power station (600 MW) in Southern Rhodesia, and the interconnected 330 kv transmission system; a second Bank loan (392 RNS) was made in 1964 for extending the transmission system; a third (701 ZA) was made in 1970 for the Kariba North Bank power station, and the proposed second tranche of this loan would assist in meeting cost overruns encountered in construction of this station. 26. The Kariba North Bank Company (KNBC), owned entirely by the Govern- ment of Zambia, was created to implement the Kariba North Bank station as relations with Southern Rhodesia. made it infeasible for CAPC to construct the power station as its owner, which it would normally have done. KNBC is the Borrow- er for Loan 701 ZA and the owner of the power station. KNBC has appointed CAPC as its agent to oversee all matters relating to construction of the proj- ect. After completion of the project, KNBC has also agreed to lease the Kariba  North power station to CAPC, which would operate it as part of the intercon- necr.ed system. CAPC has, in turn, agreed to pay rent sufficient to cover .IBC's entire debt service and reasonable administrative costs. These arrange- ments would enable the interconnected system to continue to operate as an effective integrated power system. PART IV - THE PROJECT Description and Purpose 27. A full description of the project was given in my Report (P-843) of June 24, 1970, recommending the loan to the Kariba North Bank Company (KNIBC) for a hydroelectric power project. An updated loan and project sum- mary is attached as Annex III. 28. The project forms part of the s-heme to utilize the hydroelectric power potential available at Kariba, estimated at 8,500 GWh annually. This scheme began in 1956 with the construction of a dam on the Zambesi River, a power station (600 MW) on the South Bank in Southern Rhodesia which generates about 5,250 GWh annually, and a transmission system, which has subsequently been extended, connecting the South Bank power station with load centers in Zambia and Southern Rhodesia. The project consists of the construction of an underground power station on the North Bank of the Zambesi River, with an installed capacity Qf 600 MW, provided by four 150 MW turbo- generators. The station will match the generating capacity of the South Bank station, but has been designed so that its capacity could ultimately be increased to 900 MW. Construction of the Project 29. Sir Alexander Gibb & Partners (Gibb), who were the civil. engineering consultants on the Kariba dam, have been retained as consultants on the civil works for Kariba North. Merz & McLellan have been engaged as the electrical and nmechanical consultants. The main civil works contract for the project was awarded in January 1971 to the Mitchell Construction Kinnear Moodie Group (Mitchell) of the United Kingdom, who was the lowest bidder at K20.5 million. All bids were substantially higher than the estimate of about KTh.0 million, inclusive of contingencies, made by the consultants, Gibb, in 1968, and used as the appraisal estimate in 1970. 30. Mitchell started construction of the main civil works in April 1971, and initially made satisfactory progress. However, the rate of progress slowed down considerably from March 1972, with implications for serious delays in the erection and commissioning of the generating units, the first of which  - 9 - was scheduled for operatior. in July 1974. Differences arose between Mitchell, Gibb and KNBC on the causes of the slow down, on claims for increased cost, and on contract performance. Efforts to resolve these differences vere unsuccessful. 31. During the period from October 1972 to January 1973, intensive efforts were made by the Government, in consuLtation with the Bank and other parties con- cerned, to settle the issues arising out of the main civil works contract, but no agreement was reached. On Januatry 25, 1973, Mitchell informed KNEC that work at the site, which by then was moving at a very slow pace, would be suspended on January 31. On that date, Mitchell went into receivership and the Govern- ment immediately took over the site. 32. Claims and counterclaims under the Mitchell contract have been asserted by the parties involved. KNBC is taking steps in respect of its claims which involve possible recoaery under a performance bond. It is expected that, in due course, the courts will establish responsibilities and liabilities in the case. 1/ Selection of New Civil Works Contractor 33. After Mitchell went into receivership, the Government, in consulta- tion with the Bank, initiated discussions on the alternative courses of action and their respective costs and implications to determine the most appropriate course of action for completing the project. A new round of competitive bidding was not tried in view of the high cost of delays, estimated at K 1.2 million per month. Negotiation with a single contractor, selected from among those who originally bid for the civil works contract, was agreed to be the most economic course of action. The Government selected Energoprojekt, a Yugoslav contractor who had satisfactorily completed the Kafue Stage I Proj- ect in 1971 and had thus attracted the confidence of the Government. Moreover, this firm was willing to mobilize immediately and complete the Kariba North project to specific targets. The Bank concurred with this selection. 34. Energoprojekt undertook to complete the civil works according to new targets determined by Gibb. The targets called for entry to be granted to the electrical works contractor by December 15, 1973 and commissioning of the first generating unit in October 1975. 35. Energoprojekt also agreed to negotiate a new contract based on its original unsuccessful tender in 1970 but appropriately adjusted to account for changes in economic circumstances since the awarding of the original contract. Mobilization began in May 1973 and work was restarted on the basis of an interim arrangement. A new unit price contract was signed in November 1973. 1/ Additional details are given in Annex VI (para. 5).  - 10 - Per:hormance of the New Contractor 36. Energoprojekt has brought in adequate construction equipment and sufficient expatriate personnel for operation on a three shift basis. Its methods of construction and maintenance of constructon equipment are effizient and there is now confidence in achieving the target of comms8iioning the f:Erst generating unit by October 15, 1975, sixteen months later than tne originai. target date. 37. Initially, Energoprojekt concentrated its work on the two critical sections of the project - viz., (a) the machine hall and (b) the tailrace outfal1. Good progress has been achieved in these two areas. The power house cavern has been excavated to the loading bay level. Excavation to the turbine pits is in brisk progress. Access was provided to the generating plant contractor according to schedule on December 15, 1973, earning Energo- projekt its first bonus. Work is now proceeding well in all areas. Administration 38. CAPC has felt hampered in the fulfillment of its role as agent because of the restrictions the border closure has placed on the movement of its staff. However, CAPC and the Government are presently discussing possible arrangements that should permit specified CAPC personnel access over the Kariba dam to the site. To expedite decisions, the Government has appointed its Permanent Secretary, Ministry of Transport, Power & Works as Chairman Qf the KNBC, and has provided KNBC with a fulU time Secretary who has been familiar with the project from inception. Effect of Closure of the Zambian-Southern Rhodesian Border 39. In 1971, suppliers of the permanent plant and equipment for the project chose the Beira-Southern Rhodesia rail and road route for transport to the Kariba dam. The closure of the Zambian-Southern Rhodesiar. border in February 1973 necessitated rerouting of this equipment. Initially the Bank was informed that heavy equipment required for the Kariba North project would be exempt from the Zambian embargo on the use of the Beira-Southern Rhodesia route, but the Government decided in March 1974 that only equipment which had al- ready reached Southern Rhodesia would be allowed to continue using that route. The project consultant, in consultation with the suppliers of equipment, transporta- tion authorities, and agencies concerned, then prepared a program for rerouting the heavy equipment, via either the Dar-es-Salaam (Tanzania) road route or the Lobito Bay (Angola) rail and road route, that would ensure deliveries at site without further delays and in accordance with construction requirements. The cost of this rerouting has been estimated at US$5.4 million, of which US$5.0 million represents the foreign cost. Project Costs 40. The Bank's original $40.0 million loan (701-ZA), which became ef- fective on January 11, 1971, represented the estimated foreign exchange costs  of the project in 1970 when the total cost, including interest during con- struction, was estimated at K40.7 million (US$57.1 million equivalent). The total project cost is now estimated at K90.4 million (US$1h0.6 million equivalent). Of the total, foreign exchange costs represent K56.0 million (US$87.1 million) and local costs K34.4 million (US$53.5 million). To meet the cost increase, supplementary financing of US$47.1 million equivalent in foreign exchange and K21.4 million in local currency is required (in addition to a Government grant of KO.9 million). 41. The cost estimates, at the time of appraisal (April 1970) and at preseni:, are summarised in Annex VI, together with notes on the basis of the present cost estimate and causes of the :ost increases. The cost estimates are now based entirely on contracts awarded or decided. Costs have increased on preliminary works by 131 percent, engineering by 99 percent, electrical and mechanical equipment by 44 percent and civil works by 219 percent - those on the civil works being the most significant. The chief reasons for the cost increases are: (a) bids received for civil works and electrical and mechanical plant were higher than the appraisal estimates;l/ (b) Mitchell's failure, the subsequent change of contractor, and consequent construction delays; and (c) world-wide price inflation after bids were received. In our best judgement, the increases in costs can be attributed as follows: 1/ In my memorandum R71-5 of January 11, 1971, I informed the Executive Directors that bids received for the project had resulted in substantially higher estimates of project costs than those which had been used to deter- mine the amount of the loan and that I intended to propose a supplementary loan of some $11.0 million for the Kariba North project in order to fi- nance the full foreign exchange requirements.  - 12 - (in million Kwacha) (a) Underestimation at appraisal of the costs of civil works .......... o.. ..*.o. 12.9 (b) Underestimation at appraisal of the costs of electrical and mechanical equipment . 3.9 Total 16.8 16.8 (c) Additional cost due to change of contractor Additional cost of civil works . . 8.8 Net loss of equipment advance . 1.7 Mobilization of new contractor (about) .. 1.0 Total- 11.5 11.5 (d) Post-bidding inflation and exchange variations.. 8.6 (e) Payments to Mitchell Construction Co. for alleged bad rock ....... ........................ 1.0 (f) Costs due to non-provision of housing facilities 0.9 (g) Cost of rerouting heavy equipment .............. 3.5 (h) Additional interest during construction due to delay . ......................................... 7.L Total 49.7 Justification L2. The project cost, excluding interest during construction, now stands at K123 per kW installed. Considering that the capital cost of a new thermal station in Zambia would be about K220 per kilowatt installed, the Kariba North B?nk hydroelectric station still represents the least cost alternative for expansion of generating capacity of the CAPC interconnected system. The cost of ene-rgy production from Kariba North would also continue to represent the lowest of all available alternatives. 1t3. The rate of return on the project, calculated on the basis of revised project costs and expected revenues of CAPC, is 1 percent. This is only slightly lower than the rate of return originally calculated for the project since revenues are now expected to be substantially larger than originally forecast.  - 13 44. The Government has agreed to provide Kj.2 (MS$5.0) million, on. terms satisfactory to the Bank, to cover the foreign cost of the rerouting of heavy equipment (para. 39). The proposed second tranche of loan 701 ZA would finance the balance of the additional foreign exchange costs of $42.1 million. 45. With respect to the local costs, the original Loan Agreement between CAPC and KNBC,signed in December 1970, called for a loan by CAPC of K13.0 million at an interest rate of 7 percent per annum to cover all local costs, including interest during construction. When it first became apparent that there would be substantial cost overruns, CAPC agreed in principle to increase its loan to K20 million, subject to the condition that the Bank would make a supplementary loan to cover the additional foreign costs. Il accordance with this earlier agreement, CAPC has reaffirmed its intention to increase its loan to K20.0 million. 46. The Government has also agreed to lend KNBC an amount of K13.5 million, at an interest rate of 7-3/4 percent, to cover the gap in local cost financing; this is in addition to approximately KO.9 million the Government has already made available to KNBC in the form of grants. The Government loan to KNBC would be substantially refinanced by a proposed loan to the Government of about K13.0 million from the Commonwealth Development Corporation (CDC) that would be made specifically for the purpose of constructing the Kariba North project. 47. The revised financing plan for the project, in summary, would be as follows :l/ 1/ Annex VIII gives financial statements for KNBC.  -4- 1970/7 1977/78 k__2i ons4 US kuival-ent (~Mil1ions) Financial Requirements Construction Expenditure Foreign Currency 48.1 74.8 Local Currency 29.2 L5.L Interest during Construction Foreign CurrencY I-BR. - 701- -Di-A ~ 5.6 8.7 Proposed IBRD Supplementary Loan 2.3 3.6 Local Currency CAPC Loan 3.6 5.6 Proposed CAPC Supplementary loan 0.h 0.6 Proposed GRZ Loan 2 1.2 1.9 Total Requirements 90.I 140..6 Sources Foreign Currency IBRD - 701-ZA 25.7 40 .0 Proposed IBRD Supplementary loan 27.1 42.1 Proposed GRZ Loan 1 3.2 5.0 Local Currency CAPC Loan 13.0 20.2 Proposed CAPC Supplementary Loan 7.0 10.9 Proposed GRZ Loan 2 13.5 21.0 (RZ Grants 0.9 1.4 Total Sources 90.o4 lo.6  - 15 - 49. CAPC's financial position is sound. Its balance sheet is summarized in Annex VII. In FY73, the rate of return on average net fixed assets in operation (before interest but after depreciation) was 8.7 percent, This return has permitted CAPC to develop the transmission network defined in its loan covenants to the Bank and to generate a substantial portion of the cost of the Kariba North Bank station. CAPC cannot transfer funds freely between Zambia and Southern Rdodesia, as only overhead adjustments are authorized. As a result, on a cash basis, the operations in Zambia and Southern Rhodesia are distinct. So far, CAPC has been able to balance its revenues and expendi- tures separately in the two countries, but it will not be able to do this after 1977. 50. In view of the restriction on transfer of funds, separate cash flow projections were prepared for CAPC's operations in Zambia and Southern Rhodesia up to FY1976/77. 1/ They indicate that CAPC's cash position in each country would be sound in that period and that CAPC would be able to generate suf- ficient funds in Zambia to disburse fully its K7.0 million supplementary loan to KNBC by June 30, 1976. In FY1976/77, CAPC would be able to meet the first rent payment for the Kariba North power station. 51. It is not possible to make firm forecasts beyond 1977 as agreements have not been reached on the amounts to be paid for purchases of power by CAPC from either KAFUE II or the projected Wankie thermal plant in Southern Rhodesia (para. 2b). Indeed, some uncertainty enshrouds the CAPC system after 1977. The two main alternatives are: (1) the CAPC system could remain fully interconnected between the two countries and operated on sound economic principles, taking its supplies from the cheapest available sources; or (2) the CAPC system could effectively cease, requiring each country to operate on a national basis only. The former alternative would require free transfers of funds betweer. the two countries to meet cash deficits in Zambia, since hydro- electric generation in Zambia would, if interconnections of new power sources based on sound economic principles continued, constitute the preferred and main source of energy for CAPC. However, even if these problems should not be resolved and the CAPC system should split, sufficient revenues would be generated by the Zambian market alone at prevailing tariffs to meet all debt service obligations of the Kafue and Kariba projects. Release of Additional Guarantees 52. The original arrangements contemplated for financing the second stage of the Kariba scheme envisaged a Bank loan to CAPC, with Zambia guaranteeing half the loan and Southern Rhodesia the other half, but relations with Southern 1/ ANNEX VII gives cash flow projections for CAPC in Zambia and Southerr Rhodesia.  - 16 - Rhodesia made this course impossible. All concerned agreed, however, that Zambia should not be required to incur a greater liability for this project Uhan it would have incurred under the original arrangements. The United Kingdom, which continues to be the ultimate guarantor for the earlier Bank loans for the Kariba scheme, accordingly agreed that the Bank should release Zambia from a part of its obligations as guarantor of loans 185-RN and 392-RNS. A release of guarantees arrangement was therefore devised for loan 701 ZA in order that Zambia's guarantee responsibility would be limited to 50 percent of the total of Bank loans for the Kariba scheme. 53. Additional releases of Zambian guarantees in respect of the two earlier loans need to be made in view of the necessity for a large supple- mentary Bank loan. Arrangements have been made to relieve Zambia of all pay- ments under the earlier loans beginning with the December 1, 1972 payment in respect of loan 145-RN. However, even with the additional releases, the portions of the loans available to be released will not be sufficient to maintain the 50% guarantee sharing arrangement, and Zambia will be re- quired to carry about 53% of the burden of guarantees for the full Kariba scheme. PART V - LEGAL INSTRUMENTS AND AUTHORITY .-IJ. The draft Amending Loan Agreement between the Bank, KNBC and the Republic of Zambia, the draft Amending Release Agreement between the United Kingdom, the Republic of Zambia and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement, the text of a resolution approving the proposed supplemental loan and the text of a resolution approving the proposed amended guarantee release arrangements are being distributed to the Executive Directors separately. Zambia's guarantee X under loan 701-ZA would extend to the proposed supplemental loan. 55. A draft Loar, Amendirg Agreement between CAPC and KNBC, d a draft Loan Agreement between the Republic of Zambia and KNBC have bee agreed. The signing of these documents would be a condition of effectivene s for the proposed supplemental loan. 56. I am satisfied that the proposed supplemental loan would comply with the Articles of Agreement of the Bank. U~~~  - 17 - PART VI - RECOMMENDATION 57. I recommend that the Executive Directors approve the proposed supplemental loan and the proposed additional release of Zambian guarantees on the two earlier Bank loans related to the KaribaVscheme. Robert S. McNamara President Attachments June 14, 1974   <1 s1 t 83 m1 u a i Xt . 2 aMo@v .z X i~~~~~~~~~~~~~~~~~~~~~~~~~~~~'3 A 9z! ~OG;8