Peru - Second Power Engineering Project

Document of The World Bank FOR OmCIAL USE ONLY Rev t No. P-4009-PE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN OF USg13.5 MILLION EQUIVALENT TO ELECTROPERU WITH THE GUARANTEE OF THE REPUBLIC OF PERU FOR THE POWER ENGINEERING II PROJECT June 13, 1985 This doneiagi I= a reus&lMt. dIuilautloin su may be a.ed by recipient emy In the petfonuunce of ir eal dude.. 1s eamleb may a gtirw be diswisedl wi thot World Bk otl  Currency Unit (SI.) CURRENCY EQUIVALENTS The exchange rate is being adjusted daily roughly in line with the differential between domestic and international inflation. The exchange rate and currency equivalents as of May 15, 1985 were as follows: US$1 - S/.9,056 S/.1 - US$0.000110 S/.1,000 - US$0.11 FISCAL YEAR January 1 - December 31 ABBREVIATIONS COFIDE - State Development Finance Corporation ELECTROLIMA - Electrolima, S.A. (Lima Power Company) ELECTROPERU - Empresa Electricidad del Peru, S.A. (National Power Company) GWh - Gigawatt hour (1,000,000 KWh) kWh - Kilowatt hour IDB - Inter-American Development Bank kgoe - Kilogram of oil equivalent MW - Megawatt (1,000 Kw) MEM - Ministry of Energy and Mines NEC - National Energy Council toe - tons of oil equivalent tpy - ton per year USAID - United States Agency for International Development  FOR OMCIAL USE ONLY iuu - PDSUETS nrozr PGrz zNuosmuxu& II PROJECr TABLE OF CONTENTS Page No. SUNMARY AND CONCLUSIONS. . . . . . . . . . . . . . . . . . . . . I. The Economy . . . . . . . . . . . . . . . . . . . . . . . . . II. Bank Group Operations in Peru . . . . . . . . . . . . . . . . 5 III. The Energy Sector . . . . . . . . . . . . . . . . . . . . . . 7 IV. The Project . . . . . . *. *. *. *. .*. ...*. . . . . . . . . 15 V. Legal Instruments and Authority . . . . . . . . . . . . . . . 20 VI. Recommendation . . . . . . . . . . . . . . . . . . . . .. 20 Annex I - Social and Economic Indicators . . . . . . . . . 21 Annex II - The Status of Bank Group Operations in Peru . . 27 Annex III - Supplementary Data Sheet . . . . . . . . . . . . 29 Annex IV - Consolidated Financial Statements . . . . . . . 31 Annex v - List of Goods and Studies . . . . . . . . . . . 33 Annex VI - Statistical Information for Regional Utilities . 34 Annex VII - Implementation Schedule . . . . . . . . . . . . 35 Map . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 This document has a restricted distribution and may be used by recpients only in the performance of | I th offici duties. Its contents may not otherwise be discosed without World Bank authorization.  PERU ?OWER ENGINEERING II PROJECT LOAN AND PROJECT SUMMARY Borrower: Empresa Electricidad del Peru, S.A. (ELECTROPERU). In accordance with Peruvian law, the Corporacion Financiera de Desarrollo (COFIDE) would act as ELECTROPERU ' and the Guarantor's financial agent. Guarantor: Republic of Peru. Beneficiaries: Electro-Norte S.A., Electro-Sur-Medio S.A., Electro- Sur-Oeste S.A., Electro-Oriente S.A., Electro-Centro S.A., Electro-Sur-Este S.A., Electro-Norte-Medio Ridrandina S.A., and Electro-Sur S.A. Amount: US$13.5 million equivalent. Terms: Repayable in 17 years, including four years of grace, at the standard variable interest rate. Relending Terms: ELECTROPERU would onlend $13.1 million of the proceeds of the loan to the beneficiaries (Electro-Norte US$1.95 -aillion, Electro-Sur-Medio US$1.4 million, Electro-Sur-Oeste US$0.6 million, Electro-Oriente US$1.2 million, Electro-Centro US$2.2 million, Electro-Sur-Este US$1.95 million, Electro-Norte-Medio Ridrandina US$2.95 million and Electro-Sur US$0.85 million) all on the same terms and conditions as the Bank loan, and would retain US$0.4 million for its own use. The beneficiaries would bear the foreign exchange and interest rate risks. Project Description: The proposed project is designed to support the process of regionalization by which nine regional utilities have been established to be in charge of all local electricity services. This process will improve the efficiency of the electricity services by making them more responsive to local needs. The project consists of: (i) studies to improve the organization, performance and operations of the regional utilities; (ii) studies to identify the causes of high system losses and poor reliability and to propose measures for system rehabilitation; (iii) distri- bution planning studies; (iv) a study to develop performance indicators and performance targets and to identify the measures needed to achieve such targets; (v) consultant services to review the current tariff structure and make recommendations for the implementation of the necessary adjustments; (vi) studies to bring  - il - regional generation projects to feasibility level: and (vii) purchase, and--where applicable--iustallation of microcomputers and accessories, equipment for communications, high-prlority system components and parts, and maintenance and laboratory equipment. Risks: The principal risks facing the Project arise from the relative lack of experience and, in some cases, weak management of the beneficiaries. To reduce these risks, ELECTROPERU would set up a coordinating unit (to assist the management of the regional companies until the regionalization process is well-established and to supervise the project) and the beneficiaries would set up *-ordinating groups to facilitate procurement and the undertaking of transmission and distribution studies. The Bank will also provide assistance drafting terms-of-reference for some of the studies included In the project. The project poses no environmental risks. Estimated Project Cost (US$000): Local Foreign TOTAL Studies 4,170 4,835 9,005 Maintenance equipment 1,610 2,010 3,620 Communications, computing equipment, system components and parts 2,130 2,375 4,505 Laboratory equipment 790 1,130 1,920 Total Base Cost 8,700 10,350 19,050 Physical contingencies 870 1,035 1,905 Price contingencies 1,730 2,115 3,845 Total 11,300 13,500 24,800 Financing Plan: Beneficiaries and ELECTROPERU 11,300 - 11,300 Bank - 13,500 13,500 11,300 13,500 24,800 Estimated (US$ million by Bank FY) Disbursements: 1986 1987 1988 1989 1990 Annual 1.5 4.9 3.9 2.6 0.6 Cumulative 1.5 6.4 10.3 12.9 13.5 Rate of Return: Not applicable Staff Appraisal Report: None  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ELECTROPERU FOR THE POWER ENGINEERING II PROJECT 1. I submit the following report and recommendation on a proposed loan to ELECTROPERU for the equivalent of US$13.5 million to help finance a project supporting the Peruvian power sector regionalization process. The proposed loan would have a term of 17 years, includirg four years of grace, at the standard variable interest rate. PART I - THE ECONOKY1/ 2. A Peru Country Economic Memorandum (Report No. 5267) was distributed to the Executive Directors on November 6, 1984. The following is based on the findings of that report and the findings of an economic mission to Peru in November 1984. Country data sheets are attached as Annex I. Natural and Human Resources 3. Peru, the fourth largest c.untry in Latin America, is divided by the Andes mountains into three distinct regions: the coastal region with 46 percent of the population and most of the country's modern economic activity; the mountain region with 44 percent of the couitry's population; and the sparsely populated tropical rain forests east of the Andes. 4. Peru's natural resources include large deposits of minerals- particularly copper, iron, silver, and zinc--located mainly in the mountains and the southern coast. There are also large phosphate deposits and substantial petroleum resources in the rain forest and off-shore, but their full extent has not yet been ascertained. Another major natural resource is the large fishing potential in coastal waters, although the catch is subject to sharp fluctuations. Only a small portion of Peru's total land area is arable, and most of the soils suitable for intensive agriculture are already being farmed. Peru's energy resources are discussed further in Part III, The Energy Sector. 5. After accelerating during 1930-1960, birth rates have fallen gradually, mainly caused by the urbanization process and improved education. But with declining death rates, population has continued to grow at about 2.5 percent p.a. between 1972 and 1981 to 17 million. Preliminary 1981 census information indicates that fertility declined by 20 percent during the past decade and the current rate of population growth has dropped to 2.2 percent p.a. The census also indicates that the reduction in population growth is most marked among the 65 percent of the population living in the urban areas. The Government is quite population-conscious and is now supporting a family planning program. 1/ Substantially the same as Part I in Report No. P-3955-PE of April 18, 1985.  - 2 - Past Development Policies and Performance (1968-78) 6. Two successive military Governments, in office from October 1968 until July 1980, aimed at promoting economic growth and improving the distribution of 5s1ome and wealth. They nationalized many production and distribution activities, and conducted a sweeping land reform. However, many of their policies had an excessive cost, and implementation was often inefficient. In particular, expansionary fiscal and credit policies between 1968 and 1977 produced strong inflationary pressures and expanded external borrowing, raising Peru's external debt to almost US$8.4 billion (including short-term indebtedness); about two-third's of GDP. By mid-1978, the country was in the midst of a severe financial crisis; inflation had accelerated to an annual rate of about 100 percent and the banking system's net international reserves dropped to a negative level of US$1 billion. Peru was no longer able to service its foreign obligations. 7. Beginning in May 1978, the Government adopted a number of important measures aimed at strengthening public finances, improving the balance of payments and curbing inflation. It negotiated a stand-by-arrangement with the IMF and carried out major debt-relief operations, postponing repayment of about US$1 billion due in 1979/80 to the 1982-1986 period. The Government also adopted a complementary Economic Recovery Program, including measures to open up the economy, supported by a US$115 million Bank Program Loan in May 1979. 8. The Government's program resulted in reducing the overall public sector deficit from 5.7 percent of GDP in 1978 to 1.7 percent in 1979, and the more careful management of public finances had a positive impact on the balance of payments. At the same time, an increase in petroleum exports and a substantial improvement in Peru's terms of trade generated a surplus in the current account of the balance of payments in 1979 and equilibrium in 1980, as well as strengthening Peru's net reserves position. GDP growth recovered, but the public sector deficit increased again to six percent of GDP in 1980, and inflation exceeded 60 percent. 9. After a new constitution was written by a popularly elected constituent assembly, elections were held in May 1980, and the winner, President Fernando Belaunde, was inaugurated on July 28, 1980. His Gove.nment confronted severe structural weaknesses only temporarily obscured by the improvements in the terms of trade and the resumption of growth. The Government initially accelerated import liberalization and streamlined export incentives. At the same time, new legislation offered greater incentives to investors. Substantial changes were made in the financial sector, through upward adjustments of the interest rate, and the reduction of legal reserve requirements. The Government also made progress in correcting major price distortions by reducing food subsidies, eliminating some price controls and periodically adjusting public utility and petroleum product prices. Finally, the Government endeavored to strengthen public management and rationalize public investment and its financing, an effort that was supported by a Bank-sponsored Consultative Group meeting in May 1981.  -3- Recent Developments and Outlook 10. The 1981-83 world recession radically changed Peru's economic situation. In 1981, the first full year of the new Government, the world demand for Peru's main exports declined, interest rates on the country's external debt increased, and the terms of trade fell by 10 percent as a result of lower export prices. The overall negative impact of these external events on Peru's balance of payments was estimated at US$740 million. A substantial recovery of agricultural output (with a growth rate of almost 12 percent) and an even faster growth of construction (mostly public) allowed GDP growth of near four percent. However, industrial output stagnated, mining fell by four percent, the public sector deficit increased to about eight percent of GDP and the current account of the balance of payments closed with a deficit of US$1.7 billion. 11. By 1982, economic activity was slowing down, world commodity prices continued to fall, and the public sector deficit had also increased. The Government then adopted an austerity program and in June 1982, the IMF approved an SDR 850 million compensatory-cum-EFF arrangement to support Peru's stabilization efforts. The current account deficit in the balance of payments was reduced slightly (to US$1.6 billion) in 1982, despite lower export prices, but GDP growth slowed to less than one percent, industrial output fell more than two percent, the public sector deficit rose to 8.8 percent of GDP, and inflation continued at more than 70 percent. 12. The still sizeable public sector and current account deficits, combined with the reduced availability of external loans from international commercial banks, encouraged the Government to try to accelerate the adjustment process in 1983. The new measures included a large cut in public investment, acceleration of price adjustments of publicly supplied goods and services, and faster reduction of food subsidies. Also, the Government followed a restrictive monetary policy, and mini-devaluations from January to August 1983 again exceeded domestic inflation, as they had during 1982. 13. Peru's economic difficulties, however, were compounded by natural disasters suffered during the first half of 1983. Heavy rains flooded the northern part of the country; Liiere was also a severe drought in the south, massive landslides in the central area, and a reduction in the fish catch.Most of these were linked to a change in El Nino, a current in the Pacific Ocean off the Peruvian coast. These disasters were costly; replacing the damaged infrastructure could require over US$500 million. Output losses were also substantial. Agricultural production was particularly hard hit in the north of Peru where cotton crops were destroyed. Flooding of the Talara oil fields and damage to the trans-Andean pipeline caused a 12 percent drop in oil production (to an average of 172,000 bpd), and a ten percent fall in petroleum exports. 14. In addition to the natural disasters, the private sector suffered from a severe credit squeeze when the Central Bank protected Peru's foreign exchange reserves as foreign interest payments rose and previous inflows of short-term capital reversed. The squeeze in the private sector was intensified by the dominant claim of the public sector on available credit. Despite the credit squeeze, inflation accelerated to 125 percent, in part a result of the natural disasters, but also of inflationary exnectations  - 4 - fueled by the mini-devaluations. The 10.9 percent GDP decline was dominated by output drops in manufacturing, services and agriculture, although output in some smaller sectors, such as fishing and construction, fell more sharply. The current account deficit in the balance of payments was reduced to about US$900 million as imports declined with output. The fi-;ancing of even this reduced deficit required a renegotiation of commercial bank debt (in March 1983) and of debt to member countries of the Paris Club (in July 1983). The rescheduling agreement with the commercial banks allowed for the phased release of US$450 million in "new money", subject to the Government's receiving continuing IMF support under the EFF agreement. Unfortunately, public sector revenues declined substantially during the recession, and the public sector deficit, at nearly 11 percent of GDP, substantially exceeded the Government's target under the EFF. 15. By the end of 1983, it was clear to the Government that it could not meet the terms of the EFF arrangement; it therefore negotiated with the IMF an 18-month Standby to replace the final period of the EFF. The Standby was approved in April 1984. As part of its new program, the Government increased interest payments in bank denosits, raised electricity and water rates in real terns and confirmed its tight money program. On the strength of the Standby, Peru's commercial creditor banks agreed to a rescheduling of US$1.5 billion in amortization payments due to them between January 1984 and July 1985, and released US$100 million in new money. Bilateral lenders agreed under the Paris Club in June 1984 to reschedule over US$800 million of 1984/85 principal and interest payments. No drawings have been made against the Standby since June 19B4, since the Government found itself unable to meet the program targets. 16. In 1984, the economy experienced a modest recovery, with GDP increasing by about 4 percent as fishing rebounded strongly, agriculture began a slow recovery, and moderate growth resumed in most other sectors except Government services and manufacturing. The recovery in manufacturing was weak because real domestic demand remained depressed, reflecting continuing tight credit conditions. Since exports rose slightly, while imports again fell in response to continuing slack in domestic demand and rising protection, the current account balance of payments deficit contracted to about US$770 million. Continuing substantial public medium and long-term loan disbursements and diminished short-term capital outflows were the main factors contributing to a net capital inflow more than adequate to cover the current account deficit. However, the current account deficit had been substantially reduced by Government non-payment of interest due to commercial banks making the increase of US$75 million in Peru's reserves illusory. The inflation rate slowed perceptibly in the latter part of 1984, reflecting both tight money and renewed output growth. Inflation for the year dropped to about 112 percent, compared with 125 percent the previous year. In the last half of the year, the sol was devalued faster than domestic inflation considerably improving Peru's international competitive position. With an improvement in public sector revenues and a drop in expenditures, the public sector deficit declined to a little over 8 percent of GDP. 17. As of May, 1985, arrears on Peru's external debt service payments were approximately US$500 million, of which interest accounted for US$350 million and principal US$150 million. Some of the interest payments were  -5- more than 180 days overdue, although none of the loans Involved has been clasified as "value impaired" by the U.S. banking authorities. Peru confronts a very serious problem in servicing its outstanding debt, estimated at US$13.3 billion at end-1984 (roughly 71 percent of GDP), of which total medium and long-term debt was US$12.1 billion (public, on estimated US$9.8 billion in 1984 (US$7.9 billion in 1984)). The bulk of the overall debt will mature over the next four years, posing acute short-run difficulties. The 1984 level of public sector debt service obligations (principal and interest) represented 72.3 percent of exports of goods and non-factor services and transfers, while interest obligations alone represented 27.5 percent. In view of Peru's difficulties in meeting even its interest payment obligations in 1984/5, it will probably be necessary for the Government to raise public sector revenues and export receipts, gain access to new commercial money, and seek further debt rescheduling if it is to service its debt obligations over the next several years. The new Government assuming power at the end of July will need to focus at an early stage on the conditions for obtaining such debt relief. 18. The Central Bank continues to exert strict control over credit and the Government has implemented a number of tax measures, including raising gasoline prices, designed to raise revenues and reduce the public sector deficit to 7.1 percent of GDP from 8.1 percent in 1984. If satisfactory new arrangements regarding debt service can be made with the commercial banks, which hold more than half of Peru's external debt, and the new Government is committed to initiating a viable economic recovery program to raise the country's longer-term economic growth rate, Peru could remain creditworthy for Bank lending. Pending the resolution of present uncertainties, Bank lending will continue only at a substantially reduced rate. PART II - BANK GROUP OPERATIONS IN PERU2/ 19. The Bank has approved 59 loans to Peru for a total amount of US$1,671.9 million, net of cancellations. About 22 percent of the Bank's lending to Peru has been for transportation (mainly highways and ports), 25 percent for agriculture, 19 percent for the energy sector, 11 percent for mining and industry, about 15 percent for education, health and urban development, 7 percent for a program loan in support of the Economic Recovery Program in 1979, and one percent for technical assistance. 20. Annex II contains a summary statement of Bank loans and their disbursement status as of March 31, 1985. As of this date, US$746." million was undisbursed. Disbursements on Bank-financed projects moved slowly in the late 1970s, primarily because of weak project execution capacity and a shortage of counterpart funds that worsened as the economy deteriorated during this period. Disbursements improved until FY83, however, with vigorous efforts by the Bank and Government to correct the situation by: inter alia, (i) opening a Bank resident mission in Peru; (ii) restructuring a number of slow-moving projects; (iii) Government provision of adequate counterpart funds; and (iv) Government creation of a special comission to monitor loan execution and resolve administrative problems. Disbursement 2/ Substantially the same as Part II of Report No. P-3955-PE of April 18, 1985.  - 6 - rates (the rate of disbursements to undisbursed funds) in FY8O-82 averaged 33 percent, well above comparable countries and above pre-1980 rates for Peru. Although actual disbursements continued to rise in FY83 (US$86.9 million) and FY84 (US$104.2 million), the rate decreased to around 20 percent because the large number of loans approved in 1982-83 increased the undisbursed balance and because only Limited counterpart funds were available. To some extent, the counterpart problem has been ameliorated by the Special Action Program which the Bank initiated in Peru in 1983. The Program increased the percentage of costs which the Bank would finance in seven projects and established revolving funds in five projects. 21. The main objectives of Bank lending to Peru have been to assist in: (i) the expansion of productive capacity in crucial sectors, i.e., petroleum, agriculture and mining; (ii) the strengthening, through techaical assistance 'Loans and regular operations, of public sector management, including more effective economic policies; (iii) the creation of the physical infrastructure needed to sustain and foster economic development; and (iv) the improvement of living conditions for the urban and rural poor. In the years prior to 1980, Bank lending concentrated on infrastructure in the transportation and power sectors. More recently, the Bank's emphasis has shifted to more directly productive fields-petroleum, agriculture, mining, and industry--to help Peru to strengthen its balance of payments and to lending for socially oriented projects in the areas of health, education and urban development. The recently reduced program will focus on priority social projects or technical assistance projects that will provide a foundation for the resumption, if and when circumstances warrant, of a rnormal lending program. 22. Earlier this fiscal year, the Bank approved a US$27 million primary education project and a US$4 million project which will establish institutions to assist the industrial sector in Peru in reducing energy costs through conservation by means of conducting energy audits and through other means. Another project is tinder preparation which would continue and expand the work begun under the first Public Sector Management Project (Loan 2204-PE) which was approved in September 1982. Bank lending beyond these projects will depend very much on the economic program and development priorities that the new Government scheduled to take office in July 1985 adopts. Possible areas of lending could be in industry, petroleum development, water and electric power. Some project preparation work has been undertaken in all of these areas. 23. Bank loans conctituted an estimated 6.0 percent of Peru's total public external debt outstanding and disbursed at the end of 1983, and absorbed about nine percent of the country's public external debt service in 1983 (taking into account the effects of rescheduling of 1983 principal and interest payments). 24. IFC commitments as of March 31, 1985 were US$42.6 million of which US$Z2.9 million is held by the Corporation. A summary statement of IFC investments as of March 31, 1985 is presented in Annex II. The other principal lending agencies active in Peru are the Inter-American Development Bank (IDB) and the United States Agency for International Development  - 7 - (USAID). Their total commitments as of December 31, 1984 were US$1.6 billion and US$438 million, respectively. In its future operations,IDB is expected to empnaslze lending for agriculture, industry, mining, roads and small-scale irrigation. USAID is expected to stress rural, urban and private sector development. PART III - TEE ENERGY SECTOR 25. Energy Resource Base and Balance. Peru has diverse and as yet largely untapped energy resources, consisting of hydroelectric power, oil, natural gas, coal, geothermal power, and renewable resources such as firewood and bagasse. Hydroelectric potential, of which less than 4 percent (2,000 MW) is presently exploited, is estimated at about 58,000 MW. Proven and probable oil reserves are estimated at about 1.4 billion barrels, natural gas at about 54 billion cubic meters and coal at about 1 billion tons. Although hot water springs exist in many parts of the country, the Government is only now beginning to study these geothermal resources. Peru also has abundant forests covering almost 60 percent of its total land area. More than 95 percent of these forests, however, are located in the sparsely populated Selva region, with fuelwood scarce in most of the densely-populated areas. 26. Peru consumes annually about 11.3 million tons of oil equivalent (toe) of energy, resulting in a per capita consumption of about 690 kilograms of oil equivalent (kgoe), compared with a world average of 1,500 kgoe, and a Latin American average of 1,000 kgoe. Petroleum products accounted for the largest share of energy consumption (about 60%), followed by firewood (24%), electricity (6%), natural gas (5%), bagasse and other biomass (4.5%), and coal (0.5%). 27. Ccmmercial energy consumption is about 8.3 million toe, accounting for 73 percent of total consumption; traditional sources accounted for the remaining 27 percent. The transport sector is the largest consumer of commercial energy (30%), followed by industry (22Z), household (20%), and mining and metallurgical sectors (15%). Petroleum is the main energy source for industry, mining and transport sectors, accounting for 49 percent, 46 percent, and 100 percent, respectively, of consumption in those sectors. 28. During the last decade, the petroleum subsector in Peru has changed considerably. Successful commercial exploitation of its petroleum deposits transformed Peru from a net importer of petroleum to a net exporter by 1978. This was accompanied by an increased growth in domestic consumption of petroleum energy, partly due to a shift in consumption from iron-petroleum to petroleum energy. Peru's petroleum production during 1985-88 is forecast to average about 9.8 million tons per year (tpy), beyond which it is expected to decline unless new wells are discovered. As a result, crude exports are likely to decrease sharply from the present level of about 2 million tons, further aggravating Peru's trade balance. As domestic consumption rises, Peru is likely to become a net petroleum importer by the late 1980s. In this context, energy conservation and inter-fuel substitution, especially in the industrial and mining sectors are of crucial importance for Peru. PETROPERU, the national petroleum company, therefore, is keen on energy conservation and rationalization as a means to maintain surplus petroleum for exports.  -8- Energy Sector Organization and Planning 29. The Ministry of Energy and Mines (MEM) is responsible for formulating energy policy and coordinating all energy planning activities in the country. It regulates the exploration and exploitation of all energy resources except forests, which is the responsibility of the Ministry of Agriculture. MEM also initiates fuel pricinig actions but these must be approved by the Minister of Finance and Economy. Operational responsibility of the sector is delegated to various public sector corporations which report to HEM. PETROPERU is responsible for the petroleum sub-sector; ELECTROPERU and associated electric utility companies for the electric power sub-sector. 30. The Government of Peru gives high priority to developing its energy sector. In 1981, it established a National Energy Council (NEC) to provide energy policy advice to the Minister of Energy and Mines; following approval of its statutes in June 1983, the Council was officially inaugurated in November 1983. The Council is comprised of a Directing Committee and a Technical Secretariat. The Directing Committee consists of energy specialists and representatives from various public-sector companies in the energy sector. The Technical Secretariat is the Council's permanent working body and is divided into three divisions: (i) energy policy, (ii) energy conservation, and (iii) new and renewable energy sources. One of the tasks of the Council is to promote the creation of a National Center for Energy Conservation along with appropriate energy conservation legislation. The Council's other tasks include preparing energy balances, recommending financial policies for hydrocarbon and electricity development, coordinating training programs for the energy sector, and carrying out energy planning for the country. The Electric-Power Subsector 31. Prior to 1972, the public utility portion of the subsector was composed of private, municipal and State entities serving concession zones or regions; no national sector planning or coordination existed. Captive plants serving large mining and industrial installations, which accounted for about 40 percent of total electricity generation, were generally not interconnected with public-service systems. The Electricity Law of 1972 made the State the principal authority in the sector. Under this Law, MEM was given responsibility for power sector policy formulation, for the authorization of investments, and for regulation and tariff setting. The 1972 Electricity Law also created ELECTROPERU, provided for State participation in existing private utilities (by far the largest of which was the predecessor company to ELECTROLIMA') and provided for interconnection of power systems. The law gave ELECTROPERU responsibility for planning, engineering, construction and operation of all new generating facilities larger than 10 MW and for the development and construction of the transmission network. 32. This structure proved to be ineffective. ELECTROPERU was poorly managed and overstaffed, quality of service was poor and planning was inadequate. To address these problems, organization studies were carried out in 1979 and 1980, financed by the Bank under Loan 1215-PE, and by the Inter-American Development Bank (IDB). With input from these studies, a general electricity law was drafted and enacted in 1982.  33. The 1982 Electricity Law called for the decentralization of distribution and of local generation. Pursuant to the law, eight new regional companies (in addition to ELECTROLIMA, which already existed) have been created. ELECTROPERU, however, still maintains its planning role (which is being strengthened under loans 2018-PE and 2179-PE) and continues to be responsible for large generation projects and for interregional transmission. 34. The following is a listing of the principal institutions in the sector and their functions: a) The eirectorate General of Electricity within the Ministry of Energy and Mines, is the agency responsible for policy formulation; b) ELECTROPERU iB the holding company for the regional utility companies and has been given the responsibility for supervising and coordinating their activities, carrying out investment planning at the national level, executing multi-regional projects and operating large generation projects and the national transmission system; c) the Tariff Comission is a rate setting body which has representatives from the Government, municipalities, private industry, the College of Engineers and the regional utilities, and d) the regional utilities provide electricity service within their areas. 35. The law allows the establishment of private electric power generation companies, as well as joint public/private sector companies. The Bank has been requested to participate, together with IDB, in financing a hydroelectric project for a joint company. The project is under consideration for possible Bank financing. 36. As of December 31, 1984 the Peruvian power sector had an installed generating capacity of 2,300 MW, of which 73% is hydro. In addition, about 1,100 MW are owned by autoproducers (78% thermal). The power sector serves about 1.4 million customers, and this implies that about 42% of the population has access to electricity. Sector Issues 37. The regionalization of electricity services has uncovered important issues that the sector should address to achieve satisfactory levels of efficiency. ELECTROPERU is still overstaffed and the ongoing efforts to reduce personnel should be maintained. At present, there is a freeze on new staff hirings; the Bank is monitoring progress in this matter through Loan 2179-PE. Parallel to this, the power sector should use the autonomy which it was given in 1981 to untie its pay scales from the public sector salary structure to increase the relative salaries of professional and skilled staff, particularly outside Lima. Finally, training efforts should be intensified, particularly for the staff of the regional utiliti-q, some of which are having to handle new responsibilities. Through Loan 2179-PE the Bank is already providing assistance in this area. 38. Human resource management is but one of the problems that the sector has. System planning is still poor, the inventory of alternative  - 10 - generation projects for future system expansion is inadequate (the Bank is assisting in this regard through studies financed under loan 2018-PE), sector finances are in a poor shape (paras. 40-46), and the operations of the system still leave room for improvement. Technical losses and the frequency of outages are high, particularly in some regions, and in many areas maintenance nas been poor an. rehabilitation of networks and installatins will be required. 39. To assist the Government and ELECTROPERU in monitoring the performance of the regional utilities and to help the Tariff Comission in estal-lishing efficiency standards for the disallowance of costs for rate setting purposes ELECTROPERU would engage consultants, whose qualifications and terms of reference should be satisfactory to the Bank, to carry-out a atudy to develop performance indicators and performance targets, and to identify the measures needed to achieve these targets. IT is expected that the consultants will be engaged by March 30, 1986 and ttiat the study would be completed by December 31, 1986. The resulting recommendations would be implemented after consultation with the Bank. Sector Finances3/ 40. Until 1970 power companies in Peru maintained steady profitability and a strong financial situation. Rate levels were set to allow them to earn a return on equity close to 11.5 percent and this allowed them to tap the capital markets when necessary. In the early seventies this stopped working well. High inflation and political pressures not to increase the rates charged by the utilities, several of which had been recently nationalized,caused real tariff levels to erode and sector finances to deteriorate. 41. After 1975 efforts were made to improve rate levels; however, inflation often offset the increases approved and the achievements were modest and insufficient to allow the financial recuperation of the sector. The failure of sector authorities to follow a consistent tariff policy has resulted in financial seesaws for the sector, which in the past few years has been forced to cut down on investments and to seek financial assistance from the Government. The evolution of electricity rates is shown in the table below. Average Electricity Rates Current Constant USS cents/ Year Soles/kWh Soles/kWh kWh 1979 6.90 6.90 3.07 1980 10.16 6.38 3.52 1981 18.78 6.73 4.45 1982 33.43 7.28 4.79 1983 62.94 6.49 3.87 1984 153.01 7.51 4.23 December 1984 253.27 9.07 4.44 3/ Since the regionalization process is so recent most of the beneficiaries do not yet have audited financial statements for their first year of operation. Thus a consolidated analysis of sector finances is more meaningful than an analysis of each beneficiary. ELECTROPERU's financial situation mirrors that of the sector.  - 11 - As may be seen, some improvement in rate levels was achieved by 1982 but this was lost in 1983. At their present level of about US$cents 4.4/kWh average rates represent about 65 percent of long-run marginal cost. 42. In 1983 the sector had a rate of return on revalued assets of -1.2 percent. ELECTROPERU's rate of return was -1.7 percent. These results, in the context of a recession and serious fiscal problems faced by the Government, caused ELECTROPERU to stop or slow-down construction of some large projects. Problems were compounded as access to external financing was no longer available, and the sector had to increase its reliance on short-term borrowings. 43. Between December 1983 and December 1984 electricity rates were increased nearly 40 percent above inflation, but this was insufficient to meet the sector's financial requirements. The investment program was reduced significantly relative to the sector's original expectations, to accommodate the public sector investment targets agreed with the IMF and also reflecting lack of access to external financing. By year-end, the debt equity ratio had increased to 50:50, which is still sound. Nearly one-third of the sector's indebtedness was short-term, which reflects both relatively short average debt maturities (nine years) for the long-term debt of the sector, and a significant use of short-term financing as source of funding. 44. Prospects for 1985 are not too different from what took place in 1984. Electricity rate increases approved before the beginning of the year were 8, 7.5 and 7 percent for January, February and March, respectively. At the time these figures were decided upon, it had been expected that inflation would be running below 6 percent per month, so that the increases approved evidenced the intention to improve real tariff levels. The actual inflation rate for January, however, was 14 percent, a significant jump from the trend of the previous twelve months, when it had averaged about 6 percent. To offset this, it was decided to change the amount of the March increase, from 7 percent to 9.4 percent, and to have higher increases (12, 11 and 10 percent) in April, May, and June 1985. 45. The financial projections shown in Annex IV reflect no increase in 1985 average rates over their 1984 level, to take into account the real drop that took place in January. This assumes no further real tariff erosion through June (which under the present tariff increase plans seem reasonable), and tariff increases of two percent over inflation in each of the following months. ELECTROPERU and the regional companies have agreed to request monthly increases of at least 2 percent from the tariff commission until the en; of 1986 (Sections 4.02 and 5.02 of respectively the draft Project and Loan Agreements) and the Government has agreed to take the actions necessary to enable the companies to make such requests and the Tariff Commission to favorably consider them (Section 3.01 of the draft Cuarantee Agreement). On this basis, it is anticipated that by December 1985 electricity rates would average US$cents 4.67/kWh, which represents an increase of five percent over their level in December 1984.  - 12 - 46. The financial projections (Annex IV) assume that from 1986 and until 1989 electricity rates will be increased 10 percent per year, in real terms. This would result in rates of return of 4 percent in 1986 and 1987, 5 percent in 1988 and 6 percent in 1989. Under this assumption, by 1988.'89 average tariffs would be close to the long-run marginal cost level, sector finances would have improved to a reasonable level and the need for equity contributions from the Government would have then been substantially reduced or eliminated, provided that sector investments are kept relatively low. The Bank intends to continue its dialogue with the Government that will take office in July 1985 to encourage a faster pace of financial improvement for the sector. Tariff Legislation 47. Through sector legislation approved in 1982, the Government has set as a policy objective the reestablishment of the financial soundness that the sector once had. This legislation provides that, on average, the sector shall earn a rate of return on net fixed assets in operation of 12 percent. An addition to the electricity tariff consumers also pay a tax (which amounts to 25 percent of the electricity bill for consumers that buy more than 150 kWh per month, and to 10 percent for those that buy less). Of the tax proceeds 80 percent is earmarked for system expansion, and the 20 percent balance goes to the Federal Government to help fund its budget. 48. The law also established a system to equalize generation and transmission costs. The utilities are required to sell all energy they generate to a Fund, which pays them for their actual cost. The Fund, in turn, pro zeeds to sell to the utilities the energy they require at the average cost of all its energy purchases. This mechanism results in fairly uniform rates for the sale of electricity to the final consumers throughout the country. 49. This framework, which also provides for quarterly asset revaluation, is sound. A noteworthy feature has been the establishment of a Tariff Commission in which the Government, the utilities and the private sector are represented (para.34). During 1984 this Commission evidenced a high degree of professionalism and ability to resist political pressures against tariff increases. Agreement has been reached that any change to the Electricity Law which would materially and adversely affect the ability of the Commission to carry out its duties under the Laww would be considered an event of default under the loan. (Section 6.01 (c) of the draft Loan Agreement).  - 13 - Tariff Structure 50. Under Loan 1215-PE, in 1982 the Ministry of Energy and Mines completed, with assistance from consultants, a study of electricity tariffs to assist them in developing tariff structures based on marginal costs. The results of the study show that the residential sector, small industry, and irrigation are paying tariffs substantially below marginal costs, while large industry's tariffs are substantially in line with marginal costs and tariffs to the commercial sector are higher than marginal costs. Cross subsidization between regions is taking place through equalization of generation and transmission costs as described above, however the tariff structures do recognize differences in distribution costs, and these result in regional spreads of up to ten percent over the average national tariffs. 51. The Tariff Commission (para. 49) now intends to update the 1982 Tariff Study and has budgeted training in marginal cost pricing for its staff. They plan to progressively adapt the existing tariff structures to reflect marginal costs, and the Bank would assist them through the proposed loan, by financing consultant services. The consultants would be engaged for the Tariff Commission by ELECTROPERU. The Bank will monitor the Commission's efforts on this subject. Power Demand and Sector Investment 52. Electricity consumption in Peru is expected to grow at a four percent average annual rate during the next decade. Generation requirements in the interconnected North Central Region, which accounts for about 85 percent of the country's electricity use, are expected to increase from a level of 7,100 GWh in 1985 to about 12,200 GWh in 1994, which also reflects incorporation of existing loads (including those served by important autoproducers, such as mining companies) to the interconnected grid. Generation requirements in the two main interconnected southern systems, are expected to increase (also reflecting connection of existing loads to main grids) from 600 GWh in 1985 to 2200 GWh in 1994. In addition to the incorporation of the autoproducers' generation facilities to the grid, it is necessary that new generation facilities be commissioned in order to meet the market requirements. At present the following projects are being considered: (i) in the North-Central System: Carhuaquero (78 MW, 1988), Yuracmayo dam (88 GWB of firm energy, 1988), Yuncan (126 NW, 1992), Mayush (100 MW, 1994); (ii) in the southern systems: Charcani V (135 MW, 1987), Machu-Picchu extension (70 MW, 1987), Puente Ciel (1988) and Aricota (1990) regulating storages. The Carhuaqueto, Charcani and Machu-Picchu projects are already under construction and Yuracmayo is being financed under Loan 2179-PE. A decision on the timing of Yuncan and Mayush is expected once system optimization studies are updated. Alternatives utilizing gas are presently also being considered and, if proven economic, could allow delaying one of these two projects. The Bank is following up the study of these  - 14 - alternatives. The investment program also includes the transmission lines Chiclayo-Piura-Trujillo (1987/1988), Arequipa-Toquepala (1987) and Tintayo-Azangaro-Juliana-Puno (1988/1992), which are needed to enhance system interconnection and allow the replacement of thermal generation. 53. Minimum investment needs during the period 1985-1990 are estimated to amount to US$1.8 billion, an average of US$300 million per year. Approximately half of this investment is required for completion of works under execution. The investment level of US$300 million per year is well below what Electroperu has considered as desirable (around US$450 million). It is unrealistic to assume, under the present difficult financial situation faced by the sector, an upgrading of system reliability beyond the reasonable level provided by the US$300 million annual investment benchmark. Experience with Past Lending 54. The Bank has made seven loans amounting to US$208.7 million for power development in Peru. Three loans, totalling US$56.5 million, were for hydroelectric projects for the Lima area and three assigned US$111.3 million for expansion of the Lima distribution networks. The most recent loan, US$81.2 million, was made to ELECTROLIMA in 1982; it financed distribution works, studies and training and also included funding for ELECTROPERU (US$12.3 million) for studies and training and for RIDRANDINA (US$3.6 million) for the preparation of a hydroelectric project. 55. Execution of the five projects that have been completed was generally satisfactory. A Project Performance Audit Report has only been done for the Fourth Project (Ln. 511-PE of 1967). This report (Sec. M75-682 of September 23, 1975) indicates that the project was completed about a year late and with a small cost overrun. The delay arose from Empresas Electricas Asociadas'(ELECTROLIMA's privately-owned predecessor) initial financial problems; these were resolved during project execution. Performance during project execution was good. The project's economic rate of return was above the 12 percent expected, primarily because of the increase in oil prices in 1973. The report also noted that the project did not sufficieutly address sectoral weaknesses. Bank Strategy 56. The Bank's present strategy for the sector focuses on (i) strengthening the management and organization of the sector; (ii) supporting the process of regionalization; (iii) promoting the improvement of sector finances and the introduction of rational tariff policies; and (iv) supporting the preparation and execution of hydroelectric projects which are economically justified and will result in oil savings. The proposed project would promote the first three of the above listed objectives.  - 15 - PART IV - THE PROJECT Background 57. The proposed project was identified by Bank staff in October 1984 during the supervision of Loans 2018-PE and 2179-PE. Field appraisal took place in late January/early February 1985, preceded by a preparation mission by an individual consultant in early January. Negotiations were held in Washington from May 20 to May 24, 1985; the Peruvian delegation was led by Mr. Javier Abugattas Fatule, Director of Public Credit. Special Conditions of the project are included in Annex III. Project Objectives 58. The proposed project is designed to support the process of regionalization, which the Bank and the Inter-American Development Bank (IDB) both support. The main objective of the project is to improve the efficiency of the sector by providing assistance to the regional utilities to address those areas where they are facing the most pressing problems: distribution losses, high frequency of outages, inadequate collection procedures, an inadequate inventory of generation alternatives to meet regional market needs, and needs to purchase equipment critical to adequate system operation. 59. The process of regionalization will improve the efficiency of the electricity services by providing a local structure to deal with problems of a local nature and by making management more responsive to local needs. Were ELECTROPERU to continue being responsible for local operations a radical transformation of its cumbersome structure would have to take place. It is unlikely that this could be achieved in a few years. 60. The proposed project can help improve the very poor image of the public electricity service at the outset of the regionalization process. The newly-formed regional companies need to improve their external image through better quality of service. Improved service could help ease the political tensions which may result from the tariff increases that the sector requires. Project Description 61. The project consists of the following components: (i) studies to improve the administrative systems and commercial operations of the regional utilities, including customer service; (ii) studies to identify the causes of high transmission and distribution losses, poor system reliability and inadequate safety standards, and to propose measures for system rehabilitation; (iii) distribution planning studies; (iv) a study to develop performance indicators and performance targets, and to identify the measures needed to achieve such targets; (v) consultant services to review the current tariff structure and make recommendations for the implementation of the necessary adjustments.  - 16 - (vi) studies to identify and/or bring to a feasibility level generation projects to meet regional market requirements or replace oil-based generation; 4/ (vii) studies for regional load-dispatch centers; (viii) studies of communications systems; (ix) the purchase of maintenance equipment, including vehicles; (x) the purchase and installation of microcomputers and accessories; (xi) the purchase and installation of equipment for communications; (xii) the purchase of high-priority system components and parts; (xiii) the purchase and installation of laboratory equipment. 62. Annex V presents the goods to be procured and studies to be undert.ken, with an estimate of price. They were selected to be included in the project on the basis of a joint evaluation by the Bank and the regional utilities management of the most urgent needs of the utilities. It was agreed that equipment that would have a high return in terms of revenues and service quality was that associated with loss reduction, improvement of billing and collection, increase of generation capacity and reduction of service restoration time. On the basis of these objectives, the following classes of equipment would be first priorities: (i) Instruments necessary to carry-out the diagnostic phase of a loss reduction program and to provide a laboratory with high standard calibration means; (ii) computer systems for billing and general use (administrative and technical); (iii) parts for diesel group rehabilitation in areas with insufficient generation capacity; (iv) vehicles for operation and maintenance personnel and trucks especially equipped for discribution network maintenance/ repair; and (v) communication system equipment. 63. The training needs of the regional utilities are not part of this project; they have been taken into account by ELECTROPERU in designing a sector training program which is being financed through loan 2179-PE. Implementation of this program is now starting. Project Cost and Financing 64. The cost estimate for the project is as follows: 4/ The studies would complement those being carried out under Loan 2018-PE, which are mostly for larger projects.  - 17 - Project Cost (in US$ thousands) Local Cost Foreign Cost Total Studies 4,170 4,835 9,005 Maintenance equipment 1,610 2,010 3,620 Communication and computing equipment, system components and parts 2,130 2,375 4,505 Laboratory equipment 790 1,130 1,920 Sub-total 8,700 10,350 19,050 Physical contingencies 870 1,035 1,905 Price Contingencies 1,730 2,115 3,845 Total 11,300 13,500 24,800 65. Base costs are as of December 1984. The base cost estimates are considered to be conservative, consequently a ten percent allowance for physical contingencies seems adequate. Price contingencies assume the following inflation rates: 1985 5.0 percent; 1986 7.5 percent; 1987-90 8 percent. The proposed US$13.5 million Bank loan would finance the full foreign cost. The regional utilities would finance the local cost component, which includes some US$3.2 million in taxes and customs duties, and interest during project implementation. The Borrower and the Beneficiaries 66. The Borrower of the proposed loan would be Empresa Electricidad del Peru S.A. (ELECTROPERU), an autonomous agency of the Peruvian Government which owns the Government's shares in the regional power utilities. As a holding company, it appoints the Boards of Directors and supervises the operations of the regional utilities, approves their annual budgets, and channels to them external funds. In addition, ELECTROPERU is responsible for sector planning at the national level, establishes standards for electricity service, carries out research, operates multiregional hydroelectric projects and transmission lines, and is responsible for construction of large multiregional generation projects. It would on-lend the proceeds of the loan to the participating regional companies on the same terms and conditions as the Bank loan (Sections 3.01 (b) of the draft Loan Agreement and 2.04 of the draft Project Agreement). The foreign exchange and interest risks will be borne by the beneficiaries. The execution of satisfactory subsidiary agreements between ELECTROPERU and each of the regional companies would be a condition of loan effectiveness (Section 7.01 (a) of the draft Loan Agreement). 67. The project would be implemented by the following regional companies: Electro-Sur-Oeste, Electro-Norte, Electro-Sur-Medio, Electro-Centro, Electro-Oriente, Electro Sur-Este, Electro-Norte-Medio Hidrandina, and Electro-Sur. They were all established between late 198 and early 1985. Electro-Sur's corporate registration is pending and is expected to be completed in the very near future. Formal creation of the company will be required beiore loan signing. However, if this is not done by November 20, 1985, the loan amount would be reduced by US$850,000 and Electro-Sur removed from the project. The areas served by each of the regional companies are shown in the map included in this report. Additional information on the services provided by each company is found in Annex VI and the specific goods  - 18 - to be procured and studies to be undertaken by each company are detailed in Annex V (para. 62). The studies referred to in para. 61(iv and v) would be implemented by ELECTROPERU (Section 3.01 (a) of the draft Loan Agreement). To assist the regional companies in the preparation of terms of reference, and to supervise project execution, ELECTROPERU would establish a project coordinating unit. A condition of loan effectiveness is that the coordinating unit has been established in a manner satisfactory to the Bank (Section 7.01 (c) of the draft Loan Agreement). 68. The allocation of the proposed loan proceeds to the beneficiaries would be as follows: Electro-Sur-Oeste US$600,000; Electro-Norte US$1,950,000; Electro-Sur-Media US$1,400,000; Electro-Centro US$2,200,000; Electro-Oriente US$1,200,000; Electro-Sur-Este US$1,950,000; Hidrandina US$2,950,000 and Electro-Sur US$850,000. About US$400,000 would be used by ELECTROPERU to finance the studies described in para. 61(iv and v) and the purchase of microcomputer and laboratory equipment. 69. The beneficiaries are organized as corporations, and are governed by Peru's Corporation Law and by the 1982 Electricity Law and its regulations. At least 90 percent of their shares are to be always owned by the Government, through ELECTROPERU. They are responsible for providing electricity service and for constructing generation projects of local interest. 70. In general, it may be said that the regional utilities face the following common problems: (a) generation difficulties, which are in large part due to past poor maintenance; (b) inadequate stocks of spare parts, due to financial constraints; (c) slow project execution, due too to financial constraints; (d) weak transmission networks; (e) old and poorly-maintained distribution systems; (f) generally poor quality of supply, poor customer service and inefficient administration. 71. ELECTROLIMA was excluded from the proposed project because its needs are being addressed by current loans 2018-PE and 2179-PE. Procurement and Disbursements 72. The services and goods to be procured under this project comprise studies and a large number of equipment purchases, each of which is of relatively small-value. The regional utilities would carry-out the procurement by themselves. However, since there may be cases where due to the similar nature of the goods to be procured advantage could be derived from packaging, the regional companies would establish a gi up to coordinate procurement and arrange purchase-pooling (Section 2.06(b) of the draft Project Agreement).  - 19 - 73. It is estimated that about half of the cost of the studies would be related to transmission and-distribution system rehabilitation and expansion. It is important that the recommendations arising from these studies are consistent and do not jeopardize the achievement of standardization. At negotiations, understanding was reached that a single consultant should be utilized to carry-out these studies to assure meeting that objective. As a condition of loan effectiveness, the regional companies would establish a coordinating group to prepare terms of reference for, select and subsequently supervise the consultant (Sections 2.06 (a) of the draft Project Agreement and 7.01 (c) of the draft Loan Agreement). 74. The procurement of goods will be mainly through limited international bidding (LIB). LIB is appropriate because of the diverse nature of the items to be procured and the relatively small amounts to be purchased of each item. In the event that the utilities decide to combine their procurement for items such as vehicles and communication equipment, a few lots could exceed US$400,000. If this is the case, ICB will be used. International and local shopping as well as direct contracting would be also used for the procurement of off-the-shelf items of small value (less than US$20,000); the total amount of purchases under these procedures would not exceed US$700,000 and direct contracting would be limited to US$400,000 of that total. (Schedule to the draft Project Agreement). 75. The proposed loan would be disbursed as follows: (a) 100% of expenditures for consultant's services; (b) 100% of foreign expenditures for goods and 70% of local expenditures, in case of purchase of locally manufactured goods. Disbursements would be fully documented. Disbursements for local expenditures may be based on statements of expenditure. Such statements would be subject to review and audit by the Bank. A disbursement period of four years has been estimated based upon the project implementation schedule (Annex VII) and the Bank's experience in projects with Peru. It is expected that the project will be completed by December 31, 1989 and the closing date would be set at June 30, 1990. To assist ELECTROPERU and the beneficiaries the Bank would prepare a first draft of the terms-of-reference for the transmission and distribution studies included in the project. 76. To speed-up disbursements, a special account would be established of tip to an amount of US$1.0 million. This would reduce the exposure to inflation of suppliers, and consequently is expected to result in lower project costs. Benefits and Risks 77. The proposed loan would make a contribution to the power sector by assisting the Government in its strategy of regionalization to improve sector efficiency. The regional utilities would incorporate equipment and parts which are critical to viable system operation and maintenance. They would also develop an adequate planning framework for the distribution system and  - 20 - establish design criteria to upgrade it, reducing losses and improving operations safety, reliability and efficiency. The improvement of the billing and collection procedures should be reflected in a better cash position. 78. The principal risks facing the project arise from the relative lack of experience and, in some cases, weak management of the beneficiaries. To reduce these risks, ELECTROPERU's managerial coordinating unit, formed by a few senior staff, would assist the regional utilities to overcome the problems arising from their new responsibilities (para. 67). Besides this general role, the unit would assist in the preparation and review of terms-of-reference for the studies in the project and would supervise project implementation. The Bank will facilitate project implementation by providing assistance in drafting terms-of-reference for some of the studies included in the project. The project poses no environmental risks; on the contrary, by improving the safety of some transmission and distribution installations, it will reduce environmental risks. PART V - LEGAL INSTRUMENTS AND AUTHORITY 79. The draft Loan Agreement between the Bank and ELECTROPERU, the draft Project Agreement between the Bank and the Beneficiaries, the draft Guarantee Agreement between the Republic of Peru and the Bank and the Report and Recommendations of the Committee provided for in Article III, Section 4(iii) of the Bank's Articles of Agreement are being distributed separately to the Executive Directors. 80. The main features of the draft Loan, Project and Guarantee Agreements are referred to in the text and listed in Annex III. Special conditions of effectiveness would be that the subsidiary loan agreements have been executed, that the Coordinating Group and Unit have been established and that the Loan Agreement has been registered with the Government's Office of Public Credit (Section 7.01 of the draft Loan Agreement). A condition of loan signing would be the formal legal creation of Electro-Sur, but if that company is not created by November 20, 1985, the loan amount would be reduced by US$850,000 and Electro-Sur removed from the project. 81. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 82. I recommend that the Executive Directors approve the proposed loan. A.W. Clausen President by Ernest Stern Washington, D.C. June 13, 1985  _ 21._ AM1 tScLL lag 2. o et ~~~"T norw XS&" Rom; iu m* c au. TOIL 12035.2 1285.S 1283.2 Acem9CULTLC 3020.1 39p.3 305.2 US CNIS (US) 230.0 S4.O 1170.0 2066.2 2451.0 cmaSAN9 OF COIL * U BYREIT 423.0 707.0 337.0 1407.6 Ismt ,nTt S SKI sUSmi reOLruaION.NI-fa(I Raw) 9605.0 12833.0 17031.0 r3M NOLATION CI OP TOTLS) *.3 39.35 63.9 65.9 47.8 FOPILATlO M WOMCTIUI3 POFULIAftO IN WEaR 2000 (ILL) 26.3 STATZONIR POPULAtION (WIL) 30.0 WEAR 5TAYIOtS POP. 7rucm 2110 FOFULATZOU OrESITT PE S. a. 7.3 10.0 12.9 33.6 1.0, FER SQ. B. ACE?. LW 321.6 4.9 3*.2 92.*2 157.2 POPLtATIOM . mTucn.n (S) 0-14 ES 42.6 LA.3 42.4 40.1 21.4 11-" Yf1i s3.0 31.7 34.1 33.8 30.9 *5 AIM ASOVE 1.4 3.9 2.5 4.1 7.2 POPULATION QCO' RATEn (1) TOrAL 2.1 2.S 2.6 2.3 1.1 URBAN 1.2 1.2 2.3 3.7 3.4 CUDE ltrIT RATE CFEt TS) rs5.35 41.5 36.3 21.3 23.0 CRUDE ThEA1N RATE 1PER TrO2) 13.] 14. tl.1 6.1 9.1 CR005 EEPRIJCTON RATE 3.2 3.0 2D. 2.0 1.1 raILT FLAItNC ACCePTorS. ANNUAL rYTOUS) 251tS (C OF PARRIS OMOS) . - ... mm AMInm 1lD03 or mm0 PRIOO. ER CAPITA (1969-71-100) 9n.0 102.0 37.0 113.0 100 E CWTA SUP.Y OF CALORZES CI Ofr aQUIRUEENTS3 103.0 102.0 99.0 ii:.) 13.0 PROTINCS (G1AE PIR 0AY) 7.0 63.0 60.0 67.9 9.2 or NCN AAL 4U PuSE 29.0 26.0 23.O/c 24.1 34.1 auLD CAmS 1-43 01*T5 SATE 37.9 2'0.2 3.9 5.3 10.0 ,a' LW! EICT. AT UtRTS (TEAS) 47.3 13.4 37.9 64.6 67.2 tWIAXT NOT. RATE (FIR TWUOS) L2.1 119.7 63.4 62.4 71.4 ACCESS TO SAP! WATER CMFO) rotAL t.6 33.0 46. 3/1 64.5 CREAM 30.2 36.0 GO.fd7l- 77.8 RURAL 0.6 8.0 23.07 "4.3. ACCESS O IXCETA D157FOSAL Ci or voPILAT?ON) TOTAL .. 36.0 34.0/d 14.6 RIAN.. 22.0 st.O71 69.8 RuL .. 1_..0 .. 29.3 FOPUATION FEB PtSCIAX 1910.0 LS10.0 1290.0 1170.0 10t4.6 FO. PER MSING PERSON 2210.0/f 720.0 6n0.0/d 1012.2 762.s FOP. Fr MosPTAL IC TOTAL 400.0 430.0 520.0/c 477.0 334. guJm 210.0/r 320.0 &00.07- 667. s 216.0 RURAL . 2500.0 got@.d7 1321.6L. AlSIISSIO FIR HOSPITAL ED .. 19. 23.0/c 27.2 20.0 1=c AVERUA StZE OS M1ME05Q ToraL 4.9 4.of una 0-3 *9 RULtA 4.9 4Ij * AVEtJZ No. OF ersONrO TrtAL 2. U1na 2.0 1.7.. 1135L 2.7 2.& a5s TO 'LCC. CZ OS 05C.LZSM) MAL 26.0 32.0 an" so3. 7 3. .. RUAM. 4.2 32.7  - 22.- r * A > Page 2 of 6 mm - juv w tw aasi p SW? (tS SM? U?3SAI n 974 9 1- uuuTa ta. unCa a cam mm ,DN551 IOaLUCET tATIOS niaRY: WaL 111.0 WM 112.0 ilL0 'U2.2 .ILE Vs10 113 17.0 S 107.2 TILE 7t.0 97.0 106.0 103.5 97.9 SCCONDART- TrTA. 15.0 30.0 54.0 40.0 56.5 NILE 13.0 15.0 60.0 33.1 us.4 1ULE 13.0 216.0 53.0