India - Third Rural Electrification Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-3316-IN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR THE THIRD RURAL ELECTRIFICATION PROJECT May 12, 1982 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank suthorization.  CURRENCY EQUIVALENTS (as of April 30, 1982) US$1 = Rs 9.365 Rs 1 = US$0.1068 Rs 1 million US$106,800 The US Dollar/Rupee exchange rate is subject to change. Conversions in the Staff Appraisal Report were made at US$1.00 to Rs 8.0, which represents the projected average exchange rate over the disbursement period. FISCAL YEAR April 1 - March 31 ABBREVIATIONS AND ACRONYMS USED IN THIS REPORT ARDC - Agricultural Refinance and Development Corporation CEA - Central Electricity Authority GOI - Government of India NHPC - National Hydro Power Corporation NTPC - National Thermal Power Corporation REB - Regional Electricity Board REC - Rural Electrification Corporation SEB - State Electricity Board SI - System Improvement kV - kilovolt = 1,000 volts kWh - kilowatt-hour = 1,000 watt-hours MW - megawatt = 1,000 kilowatts Gwh - gigawatt-hour = 1,000,000 kilowatt-hours HP - horse-power  FOR OFFICIAL USE ONLY INDIA THIRD RURAL ELECTRIFICATION PROJECT LOAN AND PROJECT SUMMARY Borrower: India, acting by its President. Beneficiary: Rural Electrification Corporation (REC). Amount: US$304.5 million, including capitalized front end fee. Terms: Repayment over 20 years, including five years' grace, at 11.6% interest per annum; front end fee of 1.5% of base loan amount. On-Lending Government of India (GOI) to REC (US$275 million): Terms: An interest rate of 7.75% per annum, with repayment over 20 years, including 5 years' grace. REC to State Electricity Boards (SEBs): Interest rates from 7.5% to 10% per annum, with repayments over 15-20 years, including grace periods of 2-5 years. GOI to SEBs, through State Government fund allocations (US$25 million): As part of Central assistance to States for financing development projects, under terms and conditions applicable at the time. Project The project is designed primarily to assist the Govern- Description: ment of India in the expansion and improvement of rural electrification in about 14 States, in accordance with its Sixth Five-Year Plan (1980/81 - 1984/85). The project would help finance equipment and materials for about 3,500 rural electrification schemes meeting specific eligibility criteria in the participating States, about 100 distribution system improvement schemes, and additional buildings and equipment for a rural electrification training institute. The risks involved are no greater than can normally be expected with operations of this type. Thi document has a restricted distribution and may be used by recipints only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii- Estimated Cost: (US$ millions) Item Local Foreign Total Rural Electrification Schemes 508.8 86.8 595.6 System Improvement Schemes 43.1 6.9 50.0 Training Facility 1.5 - 1.5 553.4 93.7 647.1 Physical Contingencies 0.2 - 0.2 Price Contingencies 122.7 20.8 143.5 Total Project Cost 676.3 114.5 790.8 Front-End Fee on Bank Loan - 4.5 4.5 Total Financing Required 676.3 1/ 119.0 795.3 1/ 1/ Including about US$32 million in taxes and duties. Financing Plan: (US$ millions) Local Foreign Total Bank 185.5 119.0 304.5 GOI loans and equity 490.8 - 490.8 Total 676.3 119.0 795.3 Estimated (US$ millions) Disbursements: Bank FY FY83 FY84 FY85 FY86 Annual 11.5 1/ 134.0 126.0 33.0 Cumulative 11.5 145.5 271.5 304.5 1/ Including payment of front end fee of US$4.5 million. Rate of Return: About 53%. Appraisal Report: No. 3612b-IN, dated May 7, 1982.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR A THIRD RURAL ELECTRIFICATION PROJECT 1. I submit the following report and recommendation on a proposed loan to India in an amount equivalent to US$304.5 million (including a capitalized front end fee of US$4.5 million) to help finance a Third Rural Electrifica- tion Project, designed primarily to assist the Government of India (GOI) in the expansion and improvement of rural electrification in about 14 States, in accordance with its Sixth Five-Year Plan (1980/81-1984/85). Amortization would be over 20 years, including five years' grace, at an interest rate of 11.6% per annum. About US$275 million of the loan proceeds would be onlent by the Government to the Rural Electrification Corporation (REC) for 20 years, including five years' grace, at an interest rate of 7.75% per annum. REC would in turn onlend the major part of these funds to State Electricity Boards (SEBs) to finance rural electrification schemes included in the project. The balance of US$25 million of the loan would be made available by the Government to participating SEBs through State Governments in accordance with its standard terms and arrangements for financing develop- ment projects, to finance distribution system improvement schemes under the project. The exchange risk for the proposed loan would be borne by the Government of India. PART I - THE ECONOMY 2. An economic report, "Economic Situation and Prospects of India" (3872-IN, dated April 7, 1982), was distributed to the Executive Directors on April 19, 1982. Country data sheets are attached as Annex I. Background 3. India is a large and diverse country with a population of about 701 million (in mid-1982) and an annual per capita income of US$240. Economic growth has been slow in the past, averaging about 3.6% per annum over the past 30 years. The economy is dominated by agriculture which employs more than two-thirds of the labor force. However, the land base is not sufficient to provide an adequate livelihood to everyone engaged in agricultural activities, especially those with little or no land. Conse- quently the latter have only an insecure grasp on the means of existence. Growth of value-added in agriculture -- 2.3% per annum over the past 30 years -- has been slower than growth of industrial value-added (5.0% per annum). As a result, there has been a gradual decline in the share of agriculture in GDP (at factor cost measured in 1970/71 prices) from 60% to about 40%, while the share of industry rose from 15% to around 24%. But industrialization has not been rapid enough to absorb the growing labor force, or to bring about a rapid economic transformation, with significantly higher productivity and income levels. 4. Nevertheless, there has been steady progress on several fronts. In the face of a large and rapidly growing population, India has been able to increase agricultural output faster than total population while eliminating  -2- persistent dependence on foodgrain imports. Savings and investment have increased markedly since 1950/51: gross domestic savings more than doubled from 10.8% of GDP (at factor cost) to 24.8%, while gross domestic investment rose from 12.5% of GDP to 26.2%. Foreign savings (balance of payments deficit on current account) have never financed a major portion of domestic investment: a peak of about 20% was reached during the early 1960s; for a few years in the late 1970s, surpluses arose, and at the present time, for- eign savings are about 10% of investment. External assistance has been low both as a percentage of GDP and in per capita terms. Net external assistance has never risen above 3% of GDP, and was less than 1% at the end of the 1970s. 5. Before the 1970s, India placed relatively less emphasis on export promotion and more on import substitution. The volume growth of exports between 1950/51 and 1979/80 averaged only 3.5% per annum, only marginally higher than the volume growth of imports over the same period. In the early to mid-1970s, however, India's terms of trade, which had remained roughly constant during the 1960s, deteriorated sharply. In response, the Government introduced various policy measures designed to stimulate exports. As a result, the volume of India's exports grew on average about 7.6% per annum for the 1970s as a whole, a performance which demonstrates that sustained rapid growth is possible. While expanding world markets, particularly in the nearby Middle East, contributed to this growth, liberalized access to imported inputs and more effective export incentives played a major role. 6. Moving into the second half of the 1970s, the Indian economy was buoyed by relatively rapid export growth and an expanding level of foodgrain output, which culminated in a record 132 million tons of foodgrain production in 1978/79. As a result, growth in real GDP, agricultural and industrial value-added, substantially exceeded the historical 30-year trends (paragraph 3). In 1979/80, however, this momentum was broken when the worst drought in recent years, combined with a doubling of international oil prices and domestic supply shortages, led to a sharp fall in foodgrain production, a decline in GDP, and the opening up of a large trade deficit. Severe infla- tionary pressures also emerged after several years of virtual price stability. The impact of these setbacks is still being felt in the Indian economy, particularly in the balance of payments, and adjustments will be needed for some years to come. However, the short-term recovery process is almost completed and the economy has regained its growth momentum. Recent Trends 7. In 1980/81, the economy substantially recovered with real GDP growing by 7.5%. While industrial output expanded by 4%, recovery was particularly robust in agriculture where normal weather helped output to rise by more than 15%. Increased foodgrain production, along with judicious use of Government buffer stocks built up in earlier years, also helped moderate price rises. Inflation remained a serious problem with the annual average wholesale price index rising 18%, although the second half of the year provided clear evidence of a deceleration in inflation. 8. 1981/82 was a year of solid growth after the rebound in 1980/81 and GDP grew by 5.5%. While foodgrain production rose only modestly over its 1980/81 level, other crops including oilseeds and sugarcane performed well and total agricultural output grew by 4%. The availability of power, coal  -3- and rail transport, already improved in 1980/81, was even better in 1981/82, recording growth rates of about 10%, 9.4% and 15% respectively. As con- straints on the supply of infrastructure and basic commodities continued to ease, industrial output responded with an 8% increase. The downward trend in inflation continued. Wholesale prices rose by about 9% on an average annual basis, while the increase on a March 1981 to March 1982 basis was less than 2%, showing a continued deceleration. Easier supply conditions, combined with a more restrictive monetary policy, contributed to the sharp decline in the rate of inflation. 9. The performance of the agriculture sector in 1981/82 ensured that supply conditions in the country remained quite favorable. It also provided 4 continuing evidence of the positive effects of large investments and appropriate policies in past years. Foodgrain production reached between 132 and 134 million tons, thus matching or perhaps surpassing the previous record. Irrigated area expanded by 2.5 million hectares, while fertilizer consumption improved over its 1980/81 level by more than 7%, despite substan- tial price increases. Recent performance and probable future trends suggest that on average foodgrain supplies will exceed demand. However, the balance remains delicate with some imports likely to be required from time to time. Indeed, the effects of the severe 1979/80 drought were still being felt in 1981/82 when 2.25 million tons of wheat were imported to rebuild depleted stocks. Nevertheless, the relatively low import requirement, the ability of the Government to delay imports for as long as two years after the production shortfall, and the decline in foodgrain prices in real terms demonstrate the flexibility and resilience provided by the public foodgrain system. 10. Shortages of basic commodities and infrastructural services were major contributors to industrial stagnation and the onset of high inflation in 1979/80. This was the culmination of several years of declining capacity utilization in important, interrelated sectors such as power, coal, and rail transport. A major cause of the improved economic climate over the last two years has been a much improved level of output in these sectors, due mainly to greater efficiency and utilization of installed capacity. Expansion of coal output by about 10 million tons for the second successive year and of rail freight traffic to a record level were particularly noteworthy features of the 1981/82 economic performance. The shortfalls in domestic energy production which contributed so heavily to the poor 1979/80 performance have also been reduced. However, even though there remains large scope for improving efficiency, further improvements in capacity utilization will become increasingly difficult, and increases in capacity are needed to meet increasing demand. 11. Despite a brief phase in the late 1970s, when savings rates exceeded investment rates and foreign exchange reserves actually increased, recent experience shows that the needs of the Indian economy continue to outstrip the availability of resources, both internal and external. Investment exceeds domestic savings. The latter, at 26% of GDP, are already high and further increases, particularly from the household sector, will be increas- ingly difficult to obtain. However, over the last two years, the Government has taken a number of measures to generate higher savings in the public sector. Principal among these were price and tax increases, and subsidy reductions, on a range of commodities produced mainly in the public sector.  -4- 12. The shortage of resources is even more apparent in the foreign sec- tor. Problems became serious after 1979/80 when the cost of India's POL imports rose sharply and the terms of trade deteriorated. Coupled with domestic supply shortages and a slowing down in export growth, these factors caused India's current account deficit to rise from only 0.6% of GDP in 1979/80 to 2% of GDP in 1980/81. In 1981/82, the current account deficit rose to US$4.3 billion, representing 2.7% of GDP. Unfavorable movements in export prices and the terms of trade threatened a worse outcome. However, the much improved performance of basic import-substituting industries and a resumption of healthy export volume growth (8.3%) prevented this. To finance this gap in the face of inadequate concessional aid flows, the Government drew down a record US$2.36 billion in foreign exchange reserves, withdrew almost US$700 million under the recently negotiated IMF Extended Fund Facility, and turned increasingly to other non-concessional sources of finance. In 1980/81 and 1981/82 for example, new commitments for commercial borrowing totalling over US$1.3 billion were contracted for major projects. 13. The trends in the volume and terms of India's trade indicate that significant adjustments will need to be made in the economy to bring India's external accounts into reasonable balance at an acceptable level of growth. In particular, there is a need to increase the growth of exports, to increase production of commodities such as fertilizer, cement and steel which India can produce efficiently, in order to reduce imports of these items, to moderate the rise in oil imports through greater domestic production and slower demand growth, and to further reduce the constraints in transportation and other infrastructural facilities which are retarding growth in a wide range of activities, including exports. It is encouraging that, in response to the present balance of payments difficulties, the Government has not reacted by placing more stringent controls on imports, but rather has main- tained and extended the more liberal policies evolved in the past several years. Recent improvements in the availability of power, a major constraint facing exporters, and the adoption of several new export and industrial policy measures have improved the prospects for accelerating export growth. Development Prospects 14. The experience of recent years illustrates that India does have the capacity to grow and develop at a more rapid pace. Although the industrial sector is small compared to the size of the economy, it nevertheless is large in absolute terms and has a highly diversified structure, capable of manufac- turing a wide variety of consumer and capital goods. Basic infrastructure -- irrigation, railways, telecommunications, power, roads and ports -- is exten- sive compared to many countries, although there is considerable need for additional capacity as well as improvement in the utilization of existing capacity. India is also well-endowed with human resources and with institu- tional infrastructure for development. Finally, India has an extensive natural resource base in terms of land, water, and minerals (primarily coal and ferrous ores, but also gas and oil). With good economic policies and reasonable access to foreign savings, India has the capability for managing these considerable resources to accelerate its long-term growth. 15. The medium-term framework for advancing India's development objec- tives is the Sixth Five Year Plan (1980/81-1984/85), which is now about halfway completed. The Plan assigns priority to agriculture, energy develop- ment, the growth of exports and domestic import substitutes where  -5- appropriate, and the removal of infrastructural bottlenecks. Overall perfor- mance has so far been encouraging, although the likelihood of continued bottlenecks in key sectors such as power and transport is growing. Moreover, fulfillment of the Plan targets will require an acceleration of domestic savings rates. The efforts of the Central Government to raise resources have so far been impressive and are likely to be broadly sufficient to meet the financing requirements of the Central Government's share in plan investment, if inflation can be kept in check. However, a significant shortfall in savings is likely to occur in some states unless further measures are intro- duced. There will be a need also for continuous efforts to maintain and raise further the already high level of private savings. Recent increases in interest rates and tax concessions on time deposits should stimulate such savings. The further dampening of inflationary expectations, the prospects for which look bright, will be an important part of this effort. 16. The higher capital formation rates of the past few years augur well for future income growth. Thus far, however, output growth has not matched the size of India's investment programs. Much of this phenomenon relates to India's stage of development, in which a large and growing proportion of investment has been needed to build up basic infrastructure. These services, such as power, transport and irrigation, have inherently high capital output ratios. However, at least some of the rise in the sectoral capital output ratios has been due to a deterioration in efficiency and is avoidable through better management. Bottlenecks in these basic sectors clearly can prejudice growth in other sectors where large investments have been made. As demon- strated in the last two years, performance in the basic service sectors can be improved through better planning and management, thus leading to higher productivity and capacity utilization, throughout the economy. At the same time, programs to expand domestic capacity are vital. In the case of trade- able commodities like coal, steel and cement, this is justified on the grounds of comparative advantage. For sectors such as power and transporta- tion, expansion of planned capacity in accordance with the requirements of the rest of the economy will be vital to overall medium- and long-term prospects. At present rates of development, however, an adequate balance between supply and demand in these sectors will be difficult to sustain. Performance in the power sector to date suggests that India's power deficit will continue into the early 1990s, although more rapid project implementa- tion and efficiency could narrow the size of the gap. For railways, real investment levels may be inadequate to meet demand projections and will need to be monitored closely and adjusted upward as necessary if serious bottlenecks are to be avoided in the next few years. 17. Under the Sixth Plan, India has an ambitious energy production program backed by substantial financial commitment. While the gap between domestic consumption of petroleum and production remains large, the prospects for progressive substitution of domestic petroleum for imports are quite bright. In 1981, resources for exploration were raised by successive price increases for petroleum products. On the production side, scheduled expan- sion is expected to raise domestic production of crude from the current 46% to about 64% of demand by 1984/85. The rapidly expanding level of exploratory activity, combined with the possibilities for accelerated offtake from known fields offer much encouragement for India's longer term energy prospects.  -6- 18. The continuation of India's balance of payments difficulties has been marked by the progressive use of foreign exchange reserves and non-concessional borrowing to finance the deficit. Use of reserves reached a record level in 1981/82, leaving less than four months of import coverage by the end of the year. At the same time, India also made use of the IMF Extended Fund Facility. Entering this period with a favorable debt service profile, India has so far also been able to tap commercial capital markets at favorable spreads (over, of course, relatively high underlying rates) and in the last two years commercial borrowing has been stepped up. These sources will be important in the future since India's current account deficits, though not large relative to the size of the economy, will nevertheless be large in absolute terms and will necessitate external borrowing beyond levels expected to be available from normal concessional sources. 19. India's development prospects over the next few years will hinge on the extent to which the economy can be brought into both internal and exter- nal balance, while at the same time maintaining reasonably high growth. In the longer term, income growth represents the best strategy for achieving these needed adjustments, both by generating higher savings, for further investment, and by fostering the development of export and import- substituting industry to realign the balance of payments. In the short-term, significant external borrowing, including an increased emphasis on commercial borrowing, will be necessary to cope with the balance of payments consequen- ces of such a growth strategy. However, an important element in providing India with the capacity to adjust flexibly will be adequate flows of conces- sional assistance. Although India is currently in a position to increase borrowing on commercial terms from the very low levels of the past, there are limits to India's creditworthiness in world markets. Maintaining an adequate rate of growth while adjusting the structure of the Indian economy to a more open and efficient environment as intended by the Government requires foreign resources in addition to the level of commercial borrowing available to India. Indeed, along with increasing exports, higher levels of investment to support an adequate rate of growth is a key element in maintaining India's recently improved creditworthiness. India is still a very poor country with a large rural sector and enormous investment requirements for human develop- ment and basic infrastructure. The fact that India has been able to maintain over the past seven years a rate of growth above the long term trend, despite the severe setbacks of 1979/80, lends substance to the hope that a more open trade policy and concerted efforts to remove constraints on the growth of productive capacity, supported by adequate mobilization of savings both foreign and domestic, can sustain a rate of growth closer to 50% per annum than the long run trend of 3.60% per annum. Combined with a reduction in the rate of population increase to below 20% per annum, a 50% growth rate would mean a doubling of the trend rate of growth of per capita income of less than 1.40% per annum. Success in these efforts could make difference to the prospects of easing poverty in India. 20. A large and growing population and severe poverty underline the need for India's development efforts to be protected and accelerated if possible. The 1981 Census placed India's population at 683.4 million, or about 12 million higher than official projections. The fact that there was no decline in inter-census rates of population growth, equivalent to about 2.2% per annum, is a cause for concern. While further analysis may suggest this rate of growth to be slightly overestimated, the expectation of a measurable decline in the population growth rate has not materialized. Until full  -7- details of the Census are released, firm judgements about the reasons for this outcome are not possible. However, the results re-emphasize the need for continuing efforts to strengthen the family planning program in a broad range of activities and services. These efforts are given high priority in the Sixth Plan which aims at a rise in the proportion of protected couples in the reproductive age group from its estimated 1979/80 level of about 23% to over 35% by 1984/85. 21. Reduction of poverty remains the central goal of Indian economic growth. More than one-third of the world's poor live in India, and more than 80% of the Indian poor belong to the rural households of landless laborers and small farmers. About 51% of the rural population and 38% of the urban population subsist below the poverty line. Improvements in the living stand- ards of the poor will depend to a large extent on the overall growth of the economy, particularly on increases in agricultural production and employment, in non-farm rural employment, and also in employment opportunities in urban areas. These developments will have to stem in large part from market forces which, however, must be encouraged and reinforced by appropriate Government policies and the strengthening of basic services and infrastructure. The declining trend in real foodgrain prices between 1970 and 1981 resulting from India's sustained effort to raise agricultural production, reflects such developments. There is also a role for direct Government action in faster implementation of land reform (though the scope for significant reduction in poverty through land redistribution is quite limited in India), in increasing the supply of credit available to small farmers and rural artisans, and finally in broadening the provision of those services which enhance the human capital of the poor and improve living standards. Many of the latter are elements of the Minimum Needs Program, which has been an integral part of Indian planning for the past decade. Progress has been slow but steady in the expansion of primary education, the extension of rural health facilities and the provision of secure village water supplies. Operations such as the community health volunteer program and the national adult literacy campaign provide encouraging evidence that well-targetted, relatively low-cost programs can lead to enhanced prospects for India's poor. PART II - BANK GROUP OPERATIONS IN INDIA 22. Since 1949, the Bank Group has made 65 loans and 148 development credits to India totalling US$3,571 million and US$10,633 million (both net of cancellation), respectively. Of these amounts, US$1,232 million has been repaid, and US$5,254 million was still undisbursed as of March 31, 1982. Bank Group disbursements to India in the current fiscal year through March 31, 1982 totalled US$858 million, representing an increase of about 28 percent over the same period last year. Annex II contains a summary statement of disbursements as of March 31, 1982, and notes on the execution of ongoing projects. 23. Since 1959, IFC has made 25 commitments in India totalling US$176.5 million, of which US$24.5 million has been repaid, US$42.6 million sold and US$7.5 million cancelled. Of the balance of US$101.9 million, US$94.0 million represents loans and US$7.9 million equity. A summary state- ment of IFC operations as of March 31, 1982, is also included in Annex II (page 5).  -8- 24. In recent years, Bank Group lending has emphasized agriculture. The Bank Group has been particularly active in supporting minor irrigation and other on-farm investments through agricultural credit operations and in providing direct support to major and medium irrigation. Marketing, seed development, agricultural extension, dairying, and forestry are other agricultural activities supported by the Bank Group. Also, the Bank Group has been active in financing the expansion of output in the fertilizer sector and, through its sizeable assistance to development finance institutions, in a wide range of geographically scattered medium- and small-scale industrial enterprises. The Bank Group has also been active in supporting infrastruc- ture development for power, telecommunications, and railways. Family plan- ning, water supply development, urban investments and the development of oil and natural gas have also received Bank Group support in recent years. 25. The direction of assistance under the Bank/IDA program has been consistent with India's needs and the Government's priorities. The emphasis of the program on agriculture, power, water supply and other infrastructure sectors remains highly relevant. Projects designed to foster agricultural production through the provision of essential inputs, particularly water and credit for on-farm investments, will continue to receive emphasis. Improved water management and intensification and streamlining of extension systems form an important institution-building aspect of the Bank Group's program for the next several years. Special emphasis will be given to projects benefitting small farmers. The Bank Group's continuing role in the fer- tilizer sector assists India in the more efficient provision of another key input in the agricultural growth process. Projects supporting water supply, sewerage, urban development and investments in the petroleum sector also form an integral part of the Bank's lending strategy to India for the next several years. Lending in support of infrastructure and industrial investments will focus on those subsectors which have recently emerged as key constraints on India's overall growth, primarily power and transportation. 26. The need for a substantial net transfer of external resources in support of the development of India's economy has been a recurrent theme of Bank economic reports and of the discussions within the India Consortium. Thanks in part to the response of the aid community, India successfully adjusted to the changed world price situation of the mid-1970s. However, there is now a need for increased foreign assistance to adjust to an even greater deterioration in balance of payments anticipated during the 1980s by augmenting domestic resources and stimulating investment. As in the past, Bank Group assistance for projects in India should aim to include the financ- ing of local expenditures. India imports relatively few capital goods because of the capacity and competitiveness of the domestic capital goods industry. Consequently, the foreign exchange component tends to be small in most projects. This is particularly the case in such high-priority sec- tors as agriculture, irrigation, and water supply. 27. India's poverty and needs are such that whenever possible, external capital requirements should be provided on concessionary terms. Accordingly, the bulk of the Bank Group assistance to India has been, and should continue to be, provided from IDA. However, the amount of IDA funds that can reasonably be allocated to India remains small in relation to India's needs for external support. Therefore, India should be eligible and regarded as creditworthy for some supplemental Bank lending. The ratio of India's debt service to the level of exports was about 11% in 1981/82 and is projected to  -9- remain below 20% through 1995/96. As of March 31, 1982, outstanding loans to India held by the Bank totalled US$2,433 million, of which US$1,062 million remain to be disbursed, leaving a net amount outstanding of US$1,371 million. 28. Of the external assistance received by India, the proportion con- tributed by the Bank Group has grown significantly. In 1969/70, the Bank Group accounted for 34% of total commitments, 13% of gross disbursements, and 12% of net disbursements as compared with 54%, 42% and 52%, respectively, in 1981/82. On December 31, 1981, India's outstanding and disbursed external public debt was about US$17.4 billion, of which the Bank Group's share was US$6.6 billion or 38% (IDA's US$5.6 billion and IBRD's US$1.0 billion). Because Bank Group assistance to India is predominantly in the form of IDA credits, debt service to the Bank Group will rise slowly. In 1981/82, about 16.0% of India's total debt service payments were to the Bank Group. PART III - THE POWER SECTOR Background 29. The performance of the Indian power supply industry and the economy as a whole are closely related, and economic growth and improvement of the standard of living depend to a large degree on the development of the power sector. Since alternative sources of energy are not readily available in the amounts needed, shortage of power has an immediate impact on virtually all activities of the economy. Indeed, the direct loss of value added to the economy attributed to power shortages has been estimated at about 3% of GDP. 1/ In recent years, energy matters have been receiving top priority consideration in Central and State Government policy planning, and the power sector now takes the largest share of India's public investment resources (12% of the Sixth Five-Year Plan outlay). In spite of this emphasis, demand for power has continued to outstrip supply. Power Supply and Demand - India-Wide 30. In the 1950s and 1960s, installed capacity and power generation managed to keep pace with the nation's demand for power, both growing at an average annual rate of 10%-12%. Since 1970, the situation has deteriorated: delays in commissioning new power projects, operating and maintenance problems, and insufficient investment under severe budget constraints have led to a critical situation in which demand for power consistently outstrips supply. This situation was exacerbated by below-average monsoon rains (particularly in the early 1970s and in 1979) which affected hydro-electric power generation, and an unstable coal supply caused by disruptions in coal mining and transport, as well as the poor quality of the coal itself. Between 1970/71 and 1974/75, growth in power generation averaged only 5% annually. The situation improved considerably over the period 1975/76 through 1979/80, with growth in both generation and capacity averaging 7%-9% annually. This improvement was brought about as the result of successive good monsoons in 1975/76 and 1976/77, improved coal supply, and a concerted 1/ India: Economic Issues in the Power Sector (World Bank Report No. 2335-IN, April 1979).  -10- effort to improve project implementation, thermal capacity utilization and overall power system management. In 1979/80, however, generation increased by only about 2% in spite of a 7% increase in capacity, due mainly to lower hydro plant availability than normal and longer periods required for commissioning new plants. Data for 1980/81 indicate an increase of about 6.5% over the previous year for both power generation and capacity. Power shortages have persisted in many parts of the country, particularly in the Eastern Region. Total installed generating capacity as of March 1981 was about 33,000 MW, including non-utility plant. Of this total generating capacity, about 62% was conventional thermal, 36% hydro, and the 2% balance nuclear. Although additional new utility generating capacity of about 3,212 MW is expected to have been commissioned in 1981/82, power shortages will continue. 31. Industry consumes about 60% of all electricity sold, while agriculture (mainly irrigation) accounts for another 17%, and domestic use for only about 11%. As a result of accelerated agricultural development programs, there has been a marked growth of power consumption in the rural areas where more than 80% of India's population live. The number of electrified villages, for example, grew from just over 3,000 in 1950/51 to some 279,000, or about 48% of all the villages in India, by October 1981. CEA projections indicate that during the ten-year period 1980/81-1989/90, new utility generating capacity will grow at an annual rate of just under 11% to total some 79,000 MW, of which about 46,000 MW (58%) would be thermal, 31,000 MW (40%) hydro and 1,800 MW (2%) nuclear. The construction of an additional 15,000 km of 400 kV transmission is planned for this period to distribute the power output through integrated grid transmission systems. Sector Institutions 32. The institutional structure of the Indian power sector is complex. Under the Indian Constitution, the responsibility for supplying power is shared between the Central Government and the State Governments, and full agreement between the Center and the States is required for the implementation of most actions. With the rapid expansion of the power sector, there has been an increasing need to coordinate the activities in the power industry beyond State boundaries, and various agencies have been established with a view to promoting integrated power development in the country. The principal agencies in the sector are: (i) the State Electricity Boards (SEBs); (ii) the Regional Electricity Boards (REBs); (iii) the Central Electricity Authority (CEA); (iv) the two Central power corporations - the National Thermal Power Corporation (NTPC) and the National Hydro Power Corporation (NHPC); and (v) the Rural Electrification Corporation (REC). 33. State and Regional Electricity Boards (SEBs and REBs). The SEBs were established by the State Governments under the Electricity (Supply) Act, 1948. Their major task at the time of establishment was to bring together the small, privately-owned power plants and facilities within their respective States. The SEBs continue to promote the coordinated development of the generation, supply and distribution of power within their respective States and to control and regulate other power supply undertakings which are private licensees. At the present time, the States own or control over 90% of India's electricity supply facilities. While the SEBs are corporate entities in their own right and enjoy basic autonomy in the management of their day-to-day operations, they are under the effective control of their  -1 1- State Governments in such policy matters as capital investment, finance, tariff changes and personnel. As a means of improving collaboration between the SEBs and establishing power systems on a broader regional basis, four Regional Electricity Boards were established between 1964 and 1966 to help develop integrated power systems in their respective regions, and thus prepare for the transition from separate power systems at State level to regional systems and finally to an interconnected national grid. The chairmanship of each REB is assumed in rotation by the Chairman of the SEBs in the region, and the REBs are staffed by engineers seconded from the constituent SEBs. At present, the REBs function in an advisory capacity for coordination of maintenance programs, generation schedules, interstate power transfer and pricing. The potential role of the REBs in the light of the progressive integration of Indian power sector operations is being reviewed by the Government of India. 34. Central Electricity Authority (CEA). The CEA was set up in 1950 to be responsible for developing a national policy for power development, and to coordinate the activities of the various planning agencies involved in electricity supply. As a result of the amendments to the general provisions of the Electricity (Supply) Act, which became effective in November 1976, the scope of the CEA's functions was expanded. In addition to the general responsibility outlined above, CEA was made responsible for the formation of power development plans, optimization of investments in the power sector, training of personnel, interconnected system operations, and research and development. The SEBs are required to submit their investment proposals to the CEA for technical and economic appraisal. With the rapid growth of the power sector, greater emphasis is now being placed on regional planning, with the ultimate objective of developing an integrated national planning system. 35. National Thermal Power Corporation (NTPC) and National Hydro Power Corporation (NHPC). In order to cope with the persistent inadequacy of power supply to meet the growing demand, GOI has undertaken to supplement the efforts of the States by constructing large-scale, Centrally-owned thermal power stations at coal fields and hydro stations in four regions, as well as associated high-voltage transmission lines - a step to interconnect the systems beyond State boundaries. This would lead ultimately to an integrated national power grid. Accordingly, the National Thermal Power Corporation and the National Hydro Power Corporation were established in November 1975 under the Companies Act, 1956, as public corporations wholly owned by GOI, with authority to design, construct, own and operate generating and associated transmission facilities and supply power in bulk to the States. The Centrally-owned generating stations are designed to supplement the States' activities and add new power generation capacity effectively within the shortest period of time. These stations will be integrated in the national power system and will initially supply bulk power to the States within the regions in which they are located. 36. Rural Electrification Corporation (REC). To help SEBs undertake the task of rural electrification, the REC was established in 1969 under the Companies Act, 1956, as a public corporation wholly owned by GOI. Its main institutional objective is to finance rural electrification schemes prepared by SEBs throughout India, functioning as a financial intermediary with technical expertise, and ensuring the efficient on-lending of funds drawn primarily from GOI. In undertaking the task, REC is directed to coordinate its lending operations with the activities of other agencies, such as the  -12- Agricultural Refinance and Development Corporation (ARDC), which provide financing for rural development. Although the amount of REC financial support is small in relation to total SEB operations in the power sector, REC today finances more than half of the total rural electrification expenditures, and supervises schemes accounting for about 70% of the total expenditures (para 47). Bank Group Operations in the Power Sector 37. Since 1954, the Bank has made eleven loans to India for power projects amounting to US$658.5 million and IDA fifteen credits totalling US$2,096 million. Of these amounts, US$2,120 million is for generating plant; US$23 million for construction equipment for the Beas hydro-electric project; US$380 million for the provision of high voltage transmission; and US$232 million for the support of rural electrification schemes. Fourteen loans and credits have been completed: nine for generating plant, the Beas Project, the first three Power Transmission Projects, and the First Rural Electrification Project. The Fourth Power Transmission (Credit 604-IN of January 1976), First Singrauli (Credit 685-IN of April 1977), First Korba (Credit 793-IN of May 1978), Third Trombay (Loan 1549-IN of June 1978), and First Ramagundam (Credit 874-IN and Loan 1648-IN of February 1979) Thermal Power Projects, and the Second Rural Electrification Project (Credit 911-IN of June 1979), are in an advanced stage of implementation. The first unit of the Singrauli project was commissioned on schedule in February, 1982. The credit for the Second Singrauli Thermal Power Project (Credit 1027-IN) and the credit/loan for the first stage of the Farakka Thermal Power Project (Credit 1053-IN and Loan 1887-IN) were approved in May and June 1980, respectively. The credit for the second stage of the Korba Thermal Power Project (Credit 1172-IN), and the loan for the second stage of the Ramagundam Thermal Power Project (Loan 2076-IN) were approved in July and December 1981, respectively. The First and Second Singrauli, First Korba, and Trombay projects are on schedule. The Farakka and Ramagundam projects and the Fourth Power Transmission Project are proceeding satisfactorily after initial delays. The First Rural Electrification Corporation Project was closed in December 1980, and a completion report was submitted to the Bank in December 1981. Thirteen SEBs participated in the project. Although some delays in disbursement were incurred as a result of shortages in 1978/79 and 1979/80 of aluminum for conductors, a slower than anticipated introduction of ICB procurement procedures, and the timing of the SEBs' participation in the project, the project has been successfully implemented. Under the Second Rural Electrification Project, safeguards were introduced to streamline the procurement process and provide for priority allocations of conductor-grade aluminum. Implementation of the project to date has been smooth, with disbursements running ahead of schedule: US$115 million had been disbursed by March 31, 1982, compared to the appraisal estimate of about US$110 million. 38. A project performance audit was conducted in 1980 for the Second Power Transmission Project (Credit 242-IN). The project was considered to have been successful in assisting the nine beneficiary SEBs in extending their transmission systems to help meet their growing power requirements. Utilization of generating capacity in these SEBs exceeded the appraisal forecast. Institutional objectives mainly concerned the rehabilitation of the finances of the SEBs, and this improvement effort is continuing under subsequent projects. In 1979/80, seven of the nine SEBs reached their target rate of return of 9.5%. The audit also highlighted the difficulties of  -13- adequately supervising a project of this nature which consisted of many wide-scattered sub-projects, and the absence of a close working relationship between the Bank Group and the beneficiary SEBs, which complicated the process of effecting institutional improvements. With the assumption of increased responsibilities by the CEA in the power sector, a considerably more effective relationship with the SEBs is envisaged. Bank Group Strategy in the Power Sector 39. The Bank Group has had a continuing dialogue with the Government in seeking solutions to a number of complex and politically sensitive problems which have confronted the Indian electricity supply industry since Independence. The sensitivity of Center-State relations and the political constraints arising from the fact that electricity supply is within the concurrent jurisdiction of the Central and State Governments have dictated a policy of seeking progress through cooperation. Specific aspects of this dialogue, including some of the results achieved and particular areas of concern, are discussed in the following paragraphs. 40. Some noteworthy results already achieved include: (a) the establishment of the REBs and later of the Centrally-owned power companies, which mark the first important steps towards nationwide power operation; (b) amendment of the Electricity (Supply) Act in 1976, to strengthen the role of the CEA; (c) amendments to the financial provisions of the Electricity (Supply) Act, 1948, which provide for the development of SEBs on a more commercial basis, with the objective of financing from internal sources a reasonable proportion of their investments; (d) implementation of action plans by the weaker SEBs, which were designed to improve their financial performance through tariff increases, rationalization of manpower requirements, improved maintenance management, and the introduction of other cost-effective measures; (e) tariff studies by thirteen SEBs with a view to reassessing tariff policies; and (f) satisfactory progress of NTPC's generation/transmission construction program with Bank Group assistance. 41. In 1978 the Indian authorities recognized that all aspects of the sector nee-ded to be reviewed in depth and that satisfactory solutions had to be found for outstanding sector development problems. Consequently, GOI established in November 1978 a Committee on Power whose purpose was to examine all aspects of the power industry and make recommendations for improvements. The Committee completed its task and submitted its conclusions to GOI in September 1980. These conclusions refer to all major aspects of the power sector - power planning, project formulation and implementation, operation and maintenance, organization and management, finance, financial management and tariffs, rural electrification, and research and development. Implementation of some of the Committee's recommendations is already underway: for example, better planning procedures and improved operations and maintenance management, such as plant breakdown procedure and spare parts procurement. However, other important measures require due deliberation by GOI and the State Governments and their joint agreement before they can be implemented. These measures include sector development, organizational structure, and sector finances, an aspect on which some results have recently begun to emerge. 42. Two areas of specific concern to the Bank Group in the past have been the lack of a nationwide long-range plan for power development, and the weak  -14- financial position of some SEBs. With regard to the first of these, first chapters of the long-range national power development study have been submitted for Bank review, in compliance with an undertaking given during negotiations for the Second Korba Thermal Power Project. The full report will be submitted within three months. The study assesses the future power demand in India based on the country's expected economic development and develops a least-cost sequence of generation and transmission plant installation which will assure most economic power supply. After the Bank has reviewed the plan and discussed it with GOI, the Indian authorities will finalize the plan in detail and will draft a power development strategy on the basis of the plan, as revised from time to time. With regard to the financial performance of the SEBs, there has been considerable improvement in the overall performance during 1978/79 and 1979/80: ten out of fourteen major SEBs reached or exceeded the target rate of return of 9.5% on net fixed assets in these two years, compared to seven in 1977/78. Average payments for electricity by consumers are rising appreciably (para 66). GOI is keen to improve performance through the introduction of financial policies that would enable the SEBs to operate more along commercial lines and enhance their self-financing capability (para 62). 43. During negotiations for the Second Korba Thermal Power Project in May 1981, GOI agreed to prepare by April 1982 an action plan for improvements in five major areas 1/ within the power sector that continue to be of particular concern. The plan was provided to the Bank during negotiations for the proposed project, in compliance with the agreed delivery date, and is presently under review by Bank staff. Rural Electrification 44. The primary objective of GOI in its drive for rural electrification is to ensure increased agricultural output by providing reliable and economic power for irrigation pumps. Secondary objectives are the provision of electricity for domestic, commercial and small industrial consumers in the villages, and to improve employment possibilities and the quality of life in rural areas. 45. The demand for electricity for agricultural pumping accounts for about 17% of India's total demand, up from about 9% ten years ago. Consumption for agricultural pumping has been growing at a rate of about 13% per year, reflecting the rapid increase in the connection of irrigation pumps to the grid. By October 1981, almost 4.5 million irrigation pumps had been electrified, most of these in the States of Tamil Nadu, Maharashtra, Uttar Pradesh, Madhya Pradesh, and Andhra Pradesh. A continuing high growth rate in the numbers of irrigation pump connections, amounting to about 10% per year, is projected by GOI for the coming decade; the emphasis on rural electrification as a vehicle for increasing agricultural production is to be maintained and intensified, a desirable development. 1/ Improvement in performance of thermal power plants; coordination of power development with other sectors of the economy; intensification of hydro-electric power development; strengthening of role of the Central sector in power generation and transmission; and establishment of appropriate financial objectives and policies.  -15- 46. By October 1981, about 279,000 (48%) of the 576,000 villages in India had been electrified, the percentages of villages electrified in each State ranging from about 15% to 100%. The number of villages connected to the grid has grown at a rate of about 10% per year since 1970. The Sixth Five-Year Plan, 1980/81-1984/85, provides for the connection of about 100,000 new villages to the grid. 47. The Plan also provides for a continuing high growth rate (10% per annum) for pump connections. About 2.5 million additional pumps are expected to be energized by 1984/85. Of this total, 90% of villages and 63% of pumps are to be connected with REC finance or supervision. All rural electrification investments and operations in each State are carried out by the SEBs. The SEBs finance their rural electrification expenditures from a number of sources, the major sources being ARDC and REC, both of which utilize GOI funds. ARDC's contribution is used primarily to refinance commercial bank lending to SEBs for irrigation pump connections. Commercial banks themselves also provide funds. Total expenditure on rural electrification under the Sixth Plan is expected to amount to about Rs 23,000 million (US$2,900 million), of which REC's direct financing share is about 51%. PART IV - THE PROJECT 48. The project was prepared by REC and appraised by a mission which visited India in May/June 1981. A Staff Appraisal Report is being distributed separately to the Executive Directors. Negotiations were held in Washington in April 1982. GOI and REC were represented by a delegation with Mr. S. C. Jain as coordinator. A Supplementary Project Data Sheet is attached as Annex III. Project Description 49. The proposed project would assist GOI, during 1983/84 and 1984/85, in the expansion and improvement of rural electrification in a number of States in accordance with GOI's Sixth Five-Year Plan (1980/81-1984/85). It would also contribute to the expansion of training facilities for rural electrification. Specifically, the project comprises the following components: (i) financing of about 1,800 rural electrification schemes approved by REC between April 1, 1978 and January 31, 1982, and for about 1,700 new schemes approved or to be approved by REC in the period February 1, 1982 to March 31, 1984; (ii) financing of about 100 distribution system improvement schemes; (iii) buildings, furniture and equipment for REC's Central Training Institute for Rural Electrification. 50. The project will be implemented over four years, from 1982/83 through 1985/86. For the first two components, the project will finance those expenditures incurred in the two years 1983/84 and 1984/85. Rural  -16- electrification schemes financed under the project would be those in REC's standard scheme classification categories determined as eligible for Bank financing, l/ in States eligible to participate in the project. The eligible categories are those in which schemes are likely to have economic rates of return well above the opportunity cost of capital. States eligible to participate in the project are those which have (a) endorsed undertakings given by their SEBs to meet certain financial performance criteria; (b) endorsed undertakings given by their SEBs to introduce systems of commercial accounting; and (c) agreed to provide limited subsidies for their SEB's rural electrification operations (paras 62, 64, 65). Fourteen States are expected to be eligible to benefit under the proposed project. States proposing to participate in the project have indicated to GOI their agreement in principle to accept these financial requirements on behalf of their SEBs. 51. System Improvement (SI) schemes are concerned with rural distribution system improvement and reinforcement. This component of the project provides for a number of separate distribution system improvement schemes which would be designed to upgrade the grid, rather than provide new connections. 52. GOI has decided that the activities of the REC-operated Central Training Institute for Rural Electrification, located in Hyderabad in Andhra Pradesh, should be expanded to include workshops and seminars for the SEBs' upper- and middle-level officers in non-engineering disciplines. Funds have been provided under the project to construct, furnish and equip buildings for the Institute, including a hostel which would replace existing rented accommodation. Project Implementation 53. The project will be implemented primarily by the SEBs under the supervision of REC. REC is headed by a Board of Directors, presently consisting of eight members, appointed by the President of India. The Chairman and Managing Director, who is assisted by several Directors, is REC's chief executive. REC's staff strength at the time of project appraisal was 798, of which about 260 were employed in eleven regional offices. A planned increase in staff of about 2%-3% per year over the next few years will be adequate to handle increased loan commitments and greater involvement in scheme appraisal and monitoring. Strengthening of regional office staff in States such as Uttar Pradesh, Bihar, and West Bengal, with weak implementation performance, will be emphasized. The overall quality of management and staff is satisfactory, and the staff structure is appropriate for REC's function. REC's connection with the SEBs is maintained through staff secondment, involving mainly senior-level staff, to REC. Special importance is placed by REC on the training of SEB staff who will be involved in rural electrification schemes. 1/ Eligible categories of rural electrification schemes are as follows: Ordinary Advanced (OA): Electrification of groups of villages in economi- cally advanced areas; Ordinary Backward (OB): Electrification of groups of villages in somewhat less advanced areas; Special Project - Agricul- ture (SPA): connection of irrigation pumps in groups of villages, co-financed by other institutions; Special Project - Industry (SPI): connection of small and medium industry in rural industrial estates.  -17- 54. The rural electrification component of the project will be implemented as part of REC's ongoing rural electrification lending program. REC will appraise, approve, and monitor all rural electrification schemes in the eligible categories and will onlend the required funds to the SEBs for their implementation. System improvement schemes will be appraised and monitored by REC (Section 2.09 of the Project Agreement), although funds for these schemes will not be lent by REC but will be provided to the participating SEBs by GOI through State fund allocations under the Sixth Five-Year Plan. This arrangement is in accordance with a recent GOI decision to limit the financial involvement of REC in system improvements to those directly associated with electrification schemes. 55. SEBs will design rural electrification scheme proposals for the new schemes according to well-established REC requirements. REC has prepared pro forma procedures and manuals to assist SEB staff in this endeavor. Schemes will then be appraised by REC for technical, financial and economic feasibility, and, provided they meet the necessary criteria, will be formally approved by REC's Board of Directors. REC recently introduced discounted cash flow methods and economic rate of return criteria into its scheme feasibility analysis, replacing the previously used measure of financial return on investment. The new methodology has been in use since June 1981, and will be applied in the analysis of all schemes submitted to REC for approval in the future. Project Cost and Financing 56. The total cost of the project, including contingencies and about US$32 million in taxes and duties, is estimated at about US$791 million equivalent, of which about US$115 million represents the estimated foreign exchange costs. A capitalized front end fee on the proposed IBRD loan adds a further US$4.5 million to the financing required. The project cost estimates are based on early 1982 prices and include price contingencies of 8.5% for 1982/83, 8.0% for 1983/84, 7.5% for 1984/85 and 7.0% for 1985/86, for both local and foreign costs. A physical contingency of about 10% has been included in the cost of the training institute. No physical contingencies have been provided for the other project components; purchases for these will be limited to the funds available. The proposed IBRD loan of US$304.5 million (including the capitalized front end fee of US$4.5 million) would finance all of the foreign exchange costs of about US$115 million and about US$185 million of the local costs, and would cover about 40% of the total project cost net of taxes and duties. The remainder of the cost of the project would be provided by GOI from its own resources. 57. About US$275 million of the proceeds of the proposed loan would be onlent by GOI to REC at an interest rate of 7.75% per annum with repayment over 20 years, including five years' grace, under a subsidiary loan agreement between GOI and REC. The balance of about US$25 million of the loan would be made available by GOI to participating SEBs through its allocation to State funds as part of its normal assistance to the States for development projects, under terms and conditions applicable at the time. Execution of the subsidiary loan agreement between GOI and REC will be a condition of effectiveness for the loan (Section 6.01 of the Loan Agreement). REC will in turn onlend funds to the SEBs for financing the rural electrification schemes at its current rates of interest of 7.5%-10% per annum (depending on  -18- the type of scheme), with maturities of 15-20 years, including grace periods from two to five years. Loan repayments to REC are used to retire REC's obligations to GOI. In the light of GOI policy favoring the rural sector in general, these onlending arrangements are satisfactory. State Governments will onlend funds to the SEBs for financing the system improvement schemes under their normal terms of lending to such State institutions. Current rates of interest are 6%-11% per annum. The exchange risk will be borne by the Government of India. Inflation in India over the past five years has averaged about 9.5% per annum, although this reflects the unusual conditions prevailing after the 1979 drought (para 6). The rate of inflation has fallen sharply during 1981/82 so that the average annual inflation rate over the next five years is not expected to exceed 8%. The interest rate of 7.75% per annum for onlending by GOI to REC is comparable to this rate; the interest rate of 7.5% to 10% for onlending by REC to the SEBs will be positive, on the average, in real terms. Procurement and Disbursement 58. All items financed under the proposed loan, with the exception of the construction, equipping and furnishing of the training institute, would be procured though international competitive bidding procedures in accordance with Bank guidelines. As in the case of the two previous Rural Electrification projects (Credits 572-IN and 911-IN), SEBs will be responsible for procuring their own project materials according to REC's standard specifications and standard conditions of contract. REC will provide assistance to the SEBs in the preparation of bid documents and will ensure that quantities of materials specified are consistent with scheme requirements. SEBs will invite bids for their material requirements for rural electrification and system improvement schemes for the two-year period 1983/84-1984/85. These materials would include, for rural electrification schemes, items such as conductors, distribution transformers, high-voltage insulators and galvanized iron wire, and for system improvement schemes, items such as conductors, power transformers and switchgear. Indian manufacturers competing under international competitive bidding procedures will receive a margin of preference of 15%, or the current rate of customs duty, whichever is less, and are expected to win most of the contract awards. Contracts of US$500,000 equivalent or more for equipment and materials and for civil works for the training institute will be subject to prior review by the Bank. Civil works and equipment associated with the construction of the training institute would be procured locally by REC using procedures acceptable to the Bank. The proceeds of the loan will be disbursed during a four-year period against normal documentation, and will cover 100% of the c.i.f. cost of imported goods or of the ex-factory cost of goods manufactured in India, 70% of expenditures for equipment procured locally for the Central Training Institute, and 70% of expenditures on civil works for its construction. REC Finances 59. REC's financial position is satisfactory. As of March 31, 1981, its loan portfolio had reached about US$1,173 million, having grown by about 20% per annum over the previous two years. Outstanding loans to SEBs accounted for about 94% of REC's assets; the SEBs' repayment record continued to be good, and no recovery problems are foreseen at present. The debt/equity ratio at March 31, 1981 was 76/24, reflecting REC's increasing reliance in  -19- recent years on' loan capital from GOI and market sources. For the 1981/82 fiscal year, an operating ratio of 79% and debt service coverage of 1.6 are forecast, compared with ratios of 77% and 1.7 respectively in 1980/81. The forecast returns on average total capitalization and on average equity are 5.6% and 3.6%, as against 5.1% and 3.2% in 1980/81. 60. REC's financial position is expected to remain satisfactory during the implementation of the project. Its loan portfolio is expected to reach about US$2,440 million by March 31, 1986, representing a total increase of about 108% over the five-year period from March 31, 1981. The return on average total capitalization is expected to rise to about 6%. The debt/equity ratio will increase to 82/18, and debt service coverage will fall to 1.3 times, slightly above the 1.2 times required by IDA under previous rural electrification agreements. REC's operating ratio will remain at about 79%, well within the required 90% limit. In this regard, REC will ensure that in any fiscal year, its internally generated funds will cover at least 1.2 times its debt service requirement, and its administrative expenses and interest payments will not exceed 90% of its interest receipts (Section 4.03 of the Project Agreement). Financial Aspects of the State Electricity Boards 61. One of the areas identified in the recently-completed power sector improvement plan (para 43) concerns the establishment of revised sector financial objectives and policies and improved information and accounting systems. These financial matters were discussed in some detail with GOI during appraisal of the proposed project and understandings were reached which should accelerate progress in implementing improvements in this area. These understandings were concerned primarily with (a) financial objectives and policies, and (b) accounting practices. 62. With regard to financial objectives and policies, a major concern of the Bank Group in the past has been the financial performance of the SEBs. Under previous projects in the power sector in India, the principal measure of financial performance of the SEBs has been the rate of return on net fixed assets. This measure was first recommended by a GOI committee in 1964, and a rate of return of 9.5% was adopted as the criterion for satisfactory financial performance in all Bank Group-financed projects in the sector. However, the appropriateness of the 9.5% rate of return requirement has been undergoing review recently in light of the need for the SEBs to meet their obligations under the amended Electricity (Supply) Act to provide a reasonable contribution to the financing of their investment programs. The amendments to the Act were designed to reorganize the financial structures of the SEBs along commercial lines by introducing (a) financial policies and accounting practices that would require the SEBs to adjust tariffs to produce annual revenues sufficient to cover all operating costs, meet debt service obligations, and provide a reasonable contribution to their investment programs; and (b) a capital structure which is less debt-oriented, through the conversion of State Government loans into equity share capital and the financing of future expansion in part by way of State Government equity, rather than debt. Many SEBs have been unable to meet their debt service obligations to their State Governments; in some instances, the interest payments have not been made to the State Government and have accumulated over many years as a contingent liability. Progress made to date by the States to make the amendments to the Act effective has been slow, since many of the  -20- SEBs were awaiting the recommendations of the Committee on Power (para 41) before introducing changes. During appraisal of the proposed project, the introduction of a measure of financial performance of the SEBs based on an adequate level of self-financing, rather than a rate of return concept, was discussed and accepted by GOI. It was subsequently agreed during negotiations that the SEBs should provide, beginning in 1982/83 (see para 63), a contribution to investment of not less than 20% of theif average annual capital expenditures, instead of a 9.5% rate of return on net fixed assets. Further, in order to participate in the project, SEBs would be required to provide undertakings, endorsed by their respective State Governments, to this effect. (Section 3.04(a) of the Loan Agreement, and Section 2.03(a) and Schedule 2 para 1(a) of the Project Agreement.) The new provisions concerning SEBs' self-financing will also apply to previous Agreements involving SEBs; these will be amended accordingly. 63. Most of the SEBs will be required to attain the 20% level of contribution from the current financial year, 1982/83. However, there are four States (Bihar, Haryana, Uttar Pradesh and West Bengal), those with primarily agriculturally intensive electricity needs, for which the immediate attainment by the SEBs of the required contributions to investment would be almost impossible. Electricity demand within these States is greatly influenced by extremes of climate such as drought, which affect both the quantity and mix of electricity consumption. Moreover, the SEBs in these States are those which in the past have suffered from a number of problems of a managerial and operational nature which cannot readily be solved in the short term. In recognition of the conditions prevailing in these, and in order to encourage the SEBs to take actions to improve their financial performance, the SEBs of Bihar, Haryana, Uttar Pradesh and West Bengal would attain the 20% contribution to investment progressively over the next four years (three years in the case of the Uttar Pradesh SEB), in accordance with a schedule of interim levels established and agreed during negotiations. In addition, these SEBs will submit to the Bank, by December 31, 1982, an action plan outlining the steps to be taken and the improvements to be made in order to ensure that the required contributions to investment are achieved. (Section 3.04(a) of the Loan Agreement, and Section 2.03(a) and Schedule 2 para l(a) of the Project Agreement.) 64. An area of much concern to the Bank is the growth in the amounts of subsidy 1/ paid by State Governments to their SEBs in respect of their rural electrification operations, which have increased from Rs 466 million in 1975/76 to an estimated Rs 5,886 million in 1980/81, or from 4% to 24% of SEB sales revenues. The size of these amounts and their increasing trend has made it desirable to introduce measures to progressively contain the amounts of rural electrification subsidy paid by the States, both to encourage movements towards economic pricing in the power sector as well as to conserve scarce resources that could be utilized in other parts of the economy. GOI and the State Governments recognize the problem and agree in principle to a subsidy reduction. Consequently, the State Governments, in conjunction with 1/ Under ongoing projects in the Indian power sector, subsidies are paid by the State Governments to the SEBs in amounts sufficient to cover the lesser of the SEBs' rural electrification losses or to enable the SEBs to achieve a 9.5% rate of return on net fixed assets.  -21- their SEBs, will each prepare by December 31, 1982 a plan for a phased reduction in rural electrification subsidies over the next 3-5 years with the objective of containing them to a reasonable proportion of the SEB's gross revenues from its sales of electricity. The Bank considers that this would be about 10% of electricity sales revenues; however, interim annual subsidy limits will be specified in the plan, which is to be agreed upon by GOI and the Bank. The 10% of revenues from electricity sales would be the upper limit of the subsidies; if lower, the amount of losses from rural electrification activities would constitute the maximum subsidization. State Governments will be required to provide to GOI and the Bank undertakings to limit annual rural electrification subsidies on the basis of the subsidy reduction plan, as a condition of participation in the project (Section 3.04(a) of the Loan Agreement, and Section 2.03(a) and Schedule 2 para l(c) of the Project Agreement). 65. Improvement to the standard of accounting practices among SEBs has been the subject of a continuous dialogue with GOI, and is a key element for the effective monitoring of the financial performance of the SEBs. The introduction of a uniform commercial system of accounting based upon generally accepted accounting principles has been proposed by the Bank and is presently under preparation in CEA. A plan and schedule for the development and implementation of the system, including the necessary legislative amendments to the Electricity (Supply) Act, has already been provided to the Bank. The development and implementation of the commercial accounting system will be under the supervision of a special unit which will be established within the Ministry of Energy (Section 3.06 of the Loan Agreement). The Government has indicated that consultants will be retained to assist the special unit in this effort. The system is expected to be fully operational in all SEBs, with audited accounts being produced within six months after the close of the fiscal year, by March 1985. Accordingly, SEBs would be required to provide to GOI and the Bank undertakings, endorsed by their respective State Governments, to introduce a uniform commercial system of accounting from April 1, 1984 as a condition of participation in the project (Section 3.04(a) of the Loan Agreement, and Section 2.03(a) and Schedule 2 para 1(b) of the Project Agreement). 66. Until recently, the average level of tariffs charged by most SEBs has been below reasonable economic measures of cost of supply. Since 1978, however, base tariffs, duties and taxes, and fuel surcharges (all items charged to the consumer) have risen significantly, particularly for industrial and commercial consumers. For example, total payments per kWh by industrial consumers have risen at an average rate of about 17% per year between 1977/78 and 1981/82, well beyond the rate of inflation. In some instances, these tariff increases have reached a rate of 20%-30% per year. Tariffs for industrial and commercial consumers are approaching long-run marginal cost levels in most major States, and may be exceeding them in some cases. For example, the long-run marginal cost estimates for 1980/81 indicate that industrial tariffs for that year approximated the long-run marginal costs in nine of 13 States for which data were available, and possibly exceeded them in the case of four. However, while industrial and commercial cost recovery has improved, cross-subsidization of domestic and agricultural consumers has increased. This is a result of socio-political considerations of the State Governments and SEBs and their desire to keep tariff levels low for economically weaker consumers: residential tariff levels have increased by only about 5% per year, and irrigation pump tariffs  -22- have remained constant. Nevertheless, industrial and commercial tariff increases have carried total average revenue per kWh closer to an economically satisfactory level. The share of these two consumer groups in total electricity consumption in India amounts to about 65%, and significantly more in such major States as West Bengal and Maharashtra. The emerging trend is encouraging and constitutes a significant improvement. The measures proposed under the project in connection with the financial performance of the SEBs should also encourage increases in tariffs in the long term. Most of the SEBs have now completed tariff studies based on marginal cost pricing principles. Revisions and improvements to these tariff studies based on reviews by Bank Group staff are under way, and the study for the one remaining major SEB is being finalized. Project Justification and Risks 67. The project would benefit about 500,000 households and about 100,000 commercial consumers. About 543,000 pumps will be electrified, about 25,000 small industrial enterprises will be connected to the distribution network, and about 18,000 villages will obtain access to the grid. The main economic benefits would be cost savings accruing to the economy by using electricity rather than alternative conventional energy sources such as kerosene for home lighting and diesel oil for irrigation pumps and motors. In the economic analysis, electric power was found to yield a clear cost advantage when compared with these non-electric energy sources in such rural applications as irrigation pumping, domestic and street lighting, and small village industries. For example, the economic cost advantage for a typical 5 HP electric irrigation pump over a similar diesel pump amounts to about Rs 2,700 (US$340) per year. In the case of domestic lighting, the advantage of using electricity is about Rs 390 (US$49) per connection per year, and in the case of small industry, about Rs 5,100 (US$640) per year. For pumping and small industry, the diesel alternative only becomes attractive if the marginal cost of power more than doubles from the assumed all-India average at the rural retail level, which takes into account the characteristics of the dominant pumping load. The proposed project also offers a number of socio-economic benefits which cannot be readily quantified and are therefore not taken into account in the computation of the economic rate of return. These include increased agricultural output in the villages and improvement in the quality of life in the rural areas newly connected to the electrification grid, which may help to reduce urban migration. As rural electrification progresses, the benefits also accrue to smaller farmers and small-scale rural industries. Landless laborers would benefit through an increase in employment opportunities generated by irrigation-induced multiple cropping. While there will be substantial variations depending upon the types of schemes and the conditions prevailing in different States, the weighted average economic rate of return is about 53%, with about 70% for advanced area electrification schemes, 27% for less-advanced area electrification schemes, 60% for pump connection schemes, and 43% for distribution system reinforcement schemes. 68. There are no special risks involved in project implementation as REC has had considerable experience in financing and supervising new rural electrification and distribution system improvement schemes.  -23- PART V - LEGAL INSTRUMENTS AND AUTHORITY 69. The draft Loan Agreement between India and the Bank, the draft Project Agreement between the Bank and REC, and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank are being distributed to the Executive Directors separately. 70. Special conditions of the project are listed in Section III of Annex III. Execution of the Subsidiary Loan Agreement between India and REC has been made an additional condition of loan effectiveness (Section 6.01 of the Loan Agreement). 71. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 72. I recommend that the Executive Directors approve the proposed loan. A. W. Clausen President by Ernest Stern May 12, 1982   ANNEX I Page 1 of 5 TABLE 3A INDIA - SOCIAL INDICATORS DATA SHEET INDIA REFERENCE GROUPS (WEIGHTED A_jRAGES LAKD AREA (THOUSAND SQ. MK.) NDMST RECENT ESTINATIa TOTAL 3287.6 HOST RECENT Low INC4E MIDL INu0 AGRICULTURAL 1809.5 1960 /b 1970 /b ESTIMATE /b ASIA & PACIFIC ASIA & PACIFIC GNP PER CAPITA (US4) 640.0 100.0 190.0 232.3 1136.1 ENERGY CONSUMPTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) 111.1 152.5 241.8 499.4 1150.6 POPULATION AND VITAL STATISTICS POPULATION, MID-YEAR (THOUS.) 434850.0 547569.0 659217.0 URaAN POPULATION (PERCENT OF TOTAL) 17.9 19.7 22.0 17.3 40.8 POPULATION PROJECTIONS POPULATION IN YEAR 2000 (MILLIONS) 974.7 STATIONARY POPULATION (MILLIONS) 1621.0 YEAR STATIONARY POPULATION IS REACHED 2115 POPULATION DENSITY PER SQ. KM. 132.3 166.6 200.5 153.6 373.1 PER SQ. KM. AGRICULTURAL LAND 246.7 308.0 355.8 360.3 2382.8 POPULATION AGE STRUCTURE (PERCENT) 0-14 YRS. 40.1 42.4 41.1 37.4 39.8 15-64 YRS. 56.8 54.7 56.0 59.2 56.7 65 YRS. AND ABOVE 3.1 2.9 2.9 3.5 3.5 POPULATION GROWTH RATE (PERCENT) TOTAL 1.8 2.3 2.1 2.1 2.3 URBAN 2.5 3.3 3.3 3.4 3.8 CRUDE BIRTH RATE (PER THOUSAND) 44.2 40.3 34.0 27.7 29.7 CRUDE DEATH RATE (PER THOUSAND) 22.7 17.4 13.5 10.2 7.5 GROSS REPRODUCTION RATE 3.1 2.8 2.3 2.5 1.9 FAMILY PLANNING ACCEPTORS, ANNUAL (THOUSANDS) 64.0 3782.0 5619.0 USERS (PERCENT OF MARRIED WOMEN) .. 12.0 22.6 20.4 44.1 FOOD AND NUTRITION INDEX OF FOOD PRODUCTION PER CAPITA (1969-71-100) 98.0 102.0 93.0 107.1 123.7 PER CAPITA SUPPLY OF CALORIES (PERCENT OF REQUIREMENTS) 93.0 92.0 91.0 98.6 112.6 PROTEINS (GRAMS PER DAY) 52.0 51.0 50.0 56.9 62.5 OF WHICH ANIMAL AND PULSE 17.0 15.0 13.0 14.2 19.7 CHILD (AGES 1-4) MORTALITY RATE 27.1 20.4 14.8 14.6 4.8 HEALTH LIFE EXPECTANCY AT BIRTH (YEARS) 42.2 47.5 51.9 57.7 64.0 INFANT MORTALITY RATE (PER THOUSAND) .. 134.0 125.0 89.1 50.2 ACCESS TO SAFE WATER (PERCENT OF POPULATION) TOTAL 17.0 33.0 30.1 45.9 URBAN .. 60.0 83.0 65.8 68.0 RURAL .. 6.0 20.0 20.1 34.4 ACCESS TO EXCRETA DISPOSAL (PERCENT OF POPULATION) TOTAL '' 18.0 20.0 17.6 53.4 URBAN .. 85.0 87.0 71.0 71.0 RURAL .. 1.0 2.0 4.8 42.4 POPULATION PER PHYSICIAN 4850.4/c 4889.0 3617.4 3857.7 4428.7 POPULATION PER NURSING PERSON 9630.07- 8296.5 6429.4 6411.8 2229.7 POPULATION PER HOSPITAL BED TOTAL 2149.0/d 1612.9 1311.1 1132.8 588.5 URHAN .. .. 363.5 322.3 579.6 RURAL .. .. 10429.1 5600.5 1138.5 ADMISSIONS PER HOSPITAL BED .. HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL 5.2 5.6 5.2 URBAN 5.2 5.6 4.8 RURAL 5.2 5.6 5.3 AVERAGE NUMBER OF PERSONS PER ROOM TOTAL 2.6 2.8 URbAN 2.6 2.8 RURAL 2.6 2.8 ACCESS TO ELECTRICITY (PERCENT OF DWELLINGS) TOTAL .. URSAN .. RURAL ..  ANNEX I Page 2 of 5 TABLE 3A INDIA - SOCIAL INDICATORS DATA SHEET INDIA REFERENCE GOUPS (WEIGITED AVE ES - MOST RECENT ESTIMATE)X MOST RECENT LOW INCOME MIDDLE INCOME 1960 /b 1970 /b ESTIMATE /b ASIA & PACIFIC ASIA 4 PACIFIC EDUCATION MJUUMD ENROLLMENT RATIOS PRIMARY: TOTAL 61.0 73.0 79.0 85.9 99.8 MALE 80.0 90.0 94.0 94.4 100.6 FEMALE 40.0 56.0 63.0 64.5 98.8 SECONDARY: TOTAL 20.0 26.0 28.0 38.0laa 53.5 MALE 30.0 36.0 37.0 34.6la 58.4 FEMALE 10.0 15.0 18.0 18.O7aa 48.6 VOCATIONAL ENROL. (T OF SECONDARY) 8.0 1.0 1.0 3.8 21.1 PUPIL-TEACHER RATIO PRIMARY 29.0 41.0 41.0 32.8 34.2 SECONDARY 16.0 21.0 .. 19.9 31.7 ADULT LITERACY RATE (PERCENT) 28.0 33.4 36.0 52.8 86.5 CONSUMPTION PASSENGER CARS PER THOUSAND POPULATION 0.7 1.1 1.3 1.7 12.7 RADIO REC?JRS PER THOUSAND PUPULA ION 4.9 21.5 32.5 35.3 174.1 TV RECEIVERS PER THOUSAND POPULATION 0.0 0.0 1.0 3.7 50.6 NEWSPAPER ("DAILY GENERAL INTEREST") CIRCULATION PER THOUSAND POPULATION 11.0 16.0 16.9 14.6 106.8 CINEMA ANNUAL ATTENDANCE PER CAPITA 4.0 6.3 3.8 3.4 4.3 LABOR FORCE TOTAL LABOR FORCE (THOUSANDS) 189761.4 220670.5 256699.4 FEMALE (PERCENT) 31.2 32.4 31.9 29.3 37.4 AGRICULTURE (PERCENT) 74.0 74.0 71.0 69.8 50.2 INDUSTRY (PERCENT) 11.0 11.0 11.0 14.1 21.9 PARTICIPATION RATE (PERCENT) TOTAL 43.6 40.3 38.9 39.7 40.2 MALE 58.0 52.6 51.3 51.5 49.8 FEMALE 28.2 27.1 25.7 23.3 31.1 ECONOMIC DEPENDENCY ilATIO 1.0 1.1 1.1 1.1 1.1 INCOME DISTRIBUTION PERCENT OF PRIVATE INCOME RECEIVED BY HIGHEST 5 PERCENT OF HOUSEHOLDS 26.7 26.3/e 22.2 HIGHEST 20 PERCENT OF HOUSEHOLDS 51.7 48.9/e 49.4 LOWEST 20 PERCENT OF hOUSEHOLDS 4.1 6.77; 7.0 LOWEST 40 PERCENT OF HOUSEhOLDS 13.6 17.27; 16.2 POVERTY TARGET GROUPS ESTIMATED ABSOLUTE POVERTY INCOME LEVEL (US$ PER CAPITA) URBAN .. .. 132.0 134.1 248.6 RURAL *- '- 114.0 111.6 193.7 LSTIMATED RELATIVE POVERTY INCOME LEVEL (US5 PER CAPITA) URBAN .. .. .. .. 249.8 RURAL .. .. .. .. 234.3 ESTIMATED POPULLATION BELOW ABSOLUTE POVERTY INCOME LEVEL (PERCENT) URBAN .. .. 40.3 41.7 21.2 RURAL .. .. 50.7 51.7 32.2 Not available Not applicable. NOTES /a The group averages for each indicator are population-weighted arithmetic means. Coverage of countries among the iodicators depends on availability of data and is not uniform. /aa China included in total only. /b Unless atherwise noted, data for 1960 refer to any year between 1959 and 1961; for 1970, between 1969 and 1971; and for Most Recent Estimate, between 1976 and 1979. /c 1962; /d 1958; /e 1964-65. May, 1981  ANNU I Page 3 of 5 Ittee: Alohogh the data re drean fro eonerea genrally lodge the -ot ohalatvbad fai, ft ehowl sha be -otd that they say tee he le-- catoalyoeathl ncns f helakofetoarled eonntt ed oteteocdby diffaca esnm Ia teltlgthe date. The data are,oe theece .. eefol. to d-ecihe ordeta of sagolnuda, il-dtoa tred., and che..acrerlee ceral sae-J.. aoebesesratfe The refenc soneor he eas o, oc dtrygr- of oe eohject cotrr cad >2) a -oetry jtte wIsh enseeat higher a-erag ieo thee the oceetry gnaop of the.ujetcoty(cetfor'aIa upu l Eporteta' group there 'hdleIambth Aftia sad Kuddle taef" te. heahaeaof et-sg enclotoitraafoellee) . I the refernc grup data ohe aneraeear, ppoaIo fegedertsgn ee n each istaeeed 'hw ptat. ceoft f h citre f geoup h.e data o holdctr lc tdhe....rae. o tef ecee gthe fndtcaore dapedortetalhlyetaa and enorolfoe, cutIo sta he oaI lea:d it-lnlgseae f n nleo oeohar Thae.. ..ea.e are onl.y uefuenopate he Iaoeo LAJID AREA >thoue..d eq.ks.> ooulcpe teta td -5L