China - Shuikou Hydroelectric Project

Docment of The World Bank FOR OFFICIAL USE ONLY Report No. P-4420-CUIA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL HANK FOR RECONSTRUCTION AND DEVELOPMENT TO rHE EXECUTIVE nIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIIVALENT TO t140 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE SHUIKOU HYDROELECTRIC PROJECT December 3, 1986 I 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 authorization.  CURRENCY EQUIVALENTS Currency Name - Renminbi CRMB) Currency Unit - Yuan (Y) = 100 Fen Calendar 1985 November 1986 $1.00 = Y 2.96 $1.00 = Y 3.70 Y 1.00 = $0.34 Y 1.00 = $0.27 Fiscal Year January 1 to December 31 Weights and Measures km - Kilometer (= 0.62 miles) kWh - Kilowatt hour (= 860.42 kcaLs) CWh - Cigawatt hour (1,000,000 kiLowatt hours) TWh - Terawatt hour (1,000,000,000 kilowatt hours) kW - Kilowatt (1,000 watts) MW - Megawatt (1,000 kilowatts) kV - Kilovolt (1,000 volts) kVA - Kilovolt-ampere (1,000 volt-amperes M1VA - Megavolt-ampere (1,000 kilovolt-amperes) TPD - Ton per day PRINCIPAL ABBREVIATIONS AND ACRONYMS USED ECEPA - East China Electric Power Administration ECHIDI - East China Hydroelectric Power Investigation and Design Institute ECC - East China Grid FPEPB - Fujian Provincial Electric Power Bureau FPC - Fujian Provincial Grid FTPS - Fuzhou Thermal Power Station CPF - Government of the Province of Fujian GVIAO - Gross Value of Industrial and Agricultural Output HIPDC - Huaneng International Power Development Corporation ICB - International Competitive Bidding LIB - Limited International Bidding LCB - Local Competitive Bidding MOF - Ministry of Finance MWREP - Ministry of Water Resources and Electric Power SAA - State Audit Administration SBC - Special Board of Consultants SHPC - Shuikou Hydroelectric Project Corporation SPC - State Planning Commission WREPERI - Water Resources and Electric Power Economic Research Institute  FOR OFFICIL U.SE ONLY CHINA SHUIKOU HYDROELECTRIC PROJECT Loan and Project Summary Borrower: The People's Republic of China Beneficiary: Fujian Provincial Electric Power Bureau (FPEPB) Amount: $140 million equivalent Terms: 20 years, including five years grace, at standard variable interest rate Onlending Terms: The proceeds of the loan would be onlent from the Government to FPEPB under a subsidiary loan agree- ment with a 20 year term, including five years of grace and at an interest rate of 8.5Z p.a. The foreign exchange risk (between the dollar and RMB) and commitment fees would be borne by FPEPB. Project Objectives The project seeks to support economic growth in East and Descriptions: China and Fujian province through development of a major hydroelectric site on the Min river. The project would be the Bank's first involvement in the power subsector in Fujian province and the fifth Bank loan for development of the power subsector in China. The project would help to: (a) develop a major hydro site to serve primarily as a peaking station in the East China Grid; (b) introduce modern technology for speedy construction of a large dam and power station; (c) link the East China and Fujian systems and promote more effective integrated operation of a major regional grid; and (d) provide training in management of international contracts for large civil works and in financial management. The project comprises the construction of a 101 m high concrete gravity dam, spillway, powerhouse and navigation lock; provision and installation of seven generating units of 200 MW each; construction of a single-circuit 500 kV transmission line and instal- lation of equipment at an associated substation; provision of consulting services for design and construction management; resettlement of the reservoir area population and a program for its economic and social reestablishment; and carrying out of studies and a training program. 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 authorization.  - ii - Benefits: The project will provide a dependable capacity of 1,000 MW to meet the peak demand for the combined East China and Fujian provincial grids and generate an average of 4,950 CWh annually. Indirect benefits include the improvement of navigational conditiona on the Min river, and the expansion of the capacity of the Waiyang-Fuzhou railway. Risks: The geological conditions are very good; investi- gations have been thorough and engineering competent. There is an inherent risk of delay because of the size of the project and its long gestation period but arrangements made for construction have reduced it to a minimum. Estimated Costs: /a Local Foreign Total /b ---------- ($ million) -- Preparatory works 19.9 2.9 22.8 Resettlement compensation 100.5 - 100.5 Civil and associated works 59.7 139.4 199.1 Metal works 9.8 3.8 13.6 Electrical and mechanical works 71.8 80.9 152.8 Transmission lines 30.4 25.0 55.4 Engineering and construction supervision 7.8 10.9 18.7 Administration 10.5 - 10.5 Technical assistance and training 0.5 1.0 1.5 Total Base Cost: 310.8 264.0 574.8 Contingencies Physical 27.7 23.1 50.8 Price 118.8 111.4 230.2 Total Project Cost: 457.3 398.5 855.8 Interest During Construction IBRD loan - 72.7 72.7 Other loans 83.2 76.1 159.3 Total Financing Required: 540.5 547.3 1,087.8 /a The project will be exempt from import duties and taxes. 7i Figures may not total exactly due to rounding.  Financing Plan: Local Foreign Total ---------- (US$ million) ------- IBRD loan - 140.0 140.0 Foreign exchange loan(s) to be arranged - 260.0 260.0 Local bank loan(s) 540.5 147.3 687.8 Total 540.5 547.3 1,087.8 Estimated Disbursements: Bank FY 1987 1988 1989 1990 1991 -------------- (US$ million) --------------- Annual 4.0 24.0 28.0 36.0 48.0 Cumulative 4.0 28.0 56.0 92.0 140.0 Economic Rate of Return: 15% Staff Appraisal Report: No. 6189-CHA dated November 24, 1986. Map: IBRD 19561  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE SHUIKOU HYDROELECTRIC PROJECT 1. I submit the following report and recommendation on a proposed Loan to the People's Republic of China to help finance a Shuikou Hydroelectric Project. The loan for $140 million would have a term of 20 years, including five years of grace, at the standard variable interest rate. The proceeds of the loan would be onlent from the Government to FPEPB under a subsidiary loan agreement for a term of 20 years, including five years of grace, and at an interest rate of 8.5% p.a. FPEPB would bear the foreign exchange risk (between the dollar and the Borrower's currency) and commitment fee on the subsidiary loan. PART I - THE ECONOMY 2. A country economic report, entitled "China: Long-Term Issues and Options" (No. 5206-CHA), was distributed to the Executive Directors on May 22, 1985. Basic data on the economy are given in Annex II. Background 3. Since 1978, China has initiated economic reforms in both rural and urban areas and in the external sector. Reforms have thus far progressed the farthest in the rural economy. Following some experiments with the abolition of collective farming in impoverished areas, the Government implemented a com- prehensive restructuring of rural institutions based on various forms of the "production responsibility system". By 1983 the farm household had become the fundamental unit of management and production in agriculture, within a frame- work of collective or state ownership of land and major fixed assets. Reforms are now proceeding in the urban economy, and there have been significant changes in enterprise management and finance. The scope for collective and individual economic activities has been enlarged, and state enterprises have been allowed greater freedom in production, pricing and marketing above their mandatory plan targets. State enterprises have also been allowed to retain some profits, and investment projects are increasingly being financed on a loan rather than a grant basis. 4. In international trade and investment, China has been progressively opening up to the rest of the world. Between 1978 and 1985, the share of exports to GDP nearly doubled to about 10%, a ratio similar to other large economies such as the U.S. and Brazil. Foreign investment has been encour- aged, first through the establishment of four Special Economic Zones and the signing of joint venture contracts for off-shore oil exploration, and more recently through the opening of 14 coastal cities to foreign investment.  -2- Growth and Stabilization 5. Reforms have helped to stimulate more rapid development of the economy. Real GDP growth averaged 5% p.a. between 1978 and 1981 and 1OZ p.a. between 1981 and 1985. More recently, in 1985, growth accelerated to 12.3% as a result of further reforms emphasizing decentralized decisionmaking, and the expansionary macroeconomic policies of 1984. During 1978-1985, per capita incomes in real terms more than doubled in rural areas and increased by more than 50% in urban areas. Agriculture has continued its remarkably strong performance, with gross agricultural output value (excluding rural industry and commerce) rising at nearly 11% p.a. between 1981 and 1985 and grain output at 8% p.a. (reaching as high as 407 million tons in 1984). Cash crops and animal husbandry, stimulated by rising demand and attractive prices, have also grown rapidly. Gross industrial output value grew at over 10% p.a. over the same period, with heavy industry growing somewhat faster than light industry (12% p.a. vs. 9% p.a.). If rural industrial output is included, gross indus- trial output value grew at close to 12% p.a. in real terms between 1981 and 1984. The energy constraint on industrial growth was eased by rising coal output (8Z p.a. between 1981 and 1985), renewed increases in crude oil produc- tion (4% p.a. between 1981 and 1985) and improvements in the efficiency of energy utilization (primary commercial energy consumption grew only 60% as fast as CDP between 1981 and 1985). Manufactured exports growth, at 8% p.a. in real terms between 1981 and 1985, was slower than during the 1978-81 period in the face of worsening world market conditions. 6. The Government continues to face difficulties in combining system reform and rapid overall growth with maintenance of economic stability. During 1979 and 1980, China experienced large budget and current account deficits, combined with excessive investment and inflationary pressures. In response, a strict stabilize or program was introduced in 1981 relying mainly on administrative controls r investment spending. The program slowed growth but also helped lower the buuget deficit from about 5% of GDP in 1979 to less than 1% in 1981, reduce inflation to around 2% p.a., and change China's exter- nal position to one of current account surpluses averaging nearly $4 billion during 1982-84. As a result, foreign debt and debt service ratios were still at low levels ($13.1 billion and 6.8%, respectively, in 1984), and China's foreign currency reserves rose to $17.8 billion (over 9 monthst imports) by mid-1984. 7. This comfortable balance of payments position disappeared rapidly during the course of 1984 and early 1985. Partly as a result of decentraliza- tion of decisionmaking and the lack of effective indirect policy instruments, there was a rapid acceleration of investment and consumption during late 1984 and the Sirst half of 1985, causing the economy to overheat. Real GDP grew by 12% dur4 1985, while average wages in state-owned enterprises rose by 201, and domestic credit grew by 22%. The retail price index rose by B.8% in 1985. There was also a rapid expansion in consumer goods imports. As a result, foreign exchange reserves had fallen to $13.2 billion by the end of 1985 (equivalent to 4.2 months of imports), and the current account deficit for the year was $12 billion, much of which was financed by an increase in foreign borrowing. China's external debt by end 1985 reached $20 billion, up from $13.1 billion in 1984 and the debt service ratio (including short-term debt)  - 3 - rose to 8%. The Government responded by launching a strict stabilization program that aims to control imports and borrowing and includes further increases in interest rates as well as a series of administrative directives governing bank credit and project approval. Most recently, in July 1986, the Renminbi was devalued from Y 3.2 to the US dollar to Y 3.7, and a program to improve controls over external borrowing was introduced. As a result, aggre- gate credit and investment as well as new import orders have begun to slow. The balance of payments in 1986 is likely to show an improvement, albeit small from 1985. Recent Reforms 8. The Central Committee of the Chinese Communist Party issued a major document on "reform of the economic structure" in October 1984. According to that decision, confirmed by the recently approved Seventh Five-Year Plan: (a) state enterprises should be made fully independent units which pursue profits and are responsible for losses; (b) the scope of mandatory planning should be reduced and replaced by indicative planning, while the focus of planning should shift from annual to medium- and long-term guidance planning; (c) a more rational price system should be introduced, reducing the role of state-controlled prices and increasing the role of "floating" and free market prices; and (d) the tat system should be improved, finance and banking should be reformed, and a larger role should be given to indirect macroeconomic regu- lation through indirect instruments such as tax, credit and pricing policy. 9. Rural reforms have continued to progress more rapidly than reforms elsewhere in the economy. There has been a remarkable spread of nonagricul- tural activities like processing, transport, and commerce. "Specialized households" (which concentrate on cash crops, animal husbandry, or nonagri- cultural activities) and pooling of capital by small groups oi households in various types of ventures are becoming increasingly common forms of economiL organization in China's rural areas. Wholesale markets for some agricultural product-, have emerged. To encourage investment in land improvement and devel- opment, farming contracts between collective and peasant households for the use of land (which typically had been fixed for no more than 3-5 years) can now be extended to as long as 15-20 years. In early 19S5, the system of agricultural procurement was changed. Previously the Government purchased quota output of grain and other crops at relatively low prices and stood ready to purchase all above-quota output at a higher price. Under the new system, procurement up to a certain amount (below former quota procurement) is based on contracts concluded voluntarily between peasants and procurement agen- cies. Prices for these purchases are based on the relatively high average price of past years. Output above the contracted amount must be sold by peasants directly on the free market, but the Government will intervene to purchase grain if the price falls to the original quota procurement price. Thus, a considerably larger portion of basic crop production will be produced for and traded on markets with flexible prices. 10. The momentum of urban reforms has continued with significant progress on several fronts. In enterprise management, the focus has been on broadening and delineating the decisionmaking authority of urban enterprises. Profit retention now extends to virtually all state-owned industrial enter-  -4- prises and to nonindustrial mactori like transport, commerce, construction, and other services. Urban collectives and individual enterprises, as well as A variety of joint ventures between them and state enterprises, have grown rapidly (the number employed in urban individual enterprises rose from 150,000 in 1978 to 3.4 million in 1984). 11. In financial reforms, the most important new development has been the implementation of a profit taz system to replace profit remittances by state enterprises to the government budget. Though most enterprises have switched to this system, the benefits have been limited because financial discipline at the enterprise level remains weak. Efforts have been made to strengthen accounting and auditing systems and more strictly enforce existing financial regulations, but the expectation remains strong that the Government will subsidize losses. 12. Progress has also been made with price reform. The majority of agriculture commodity prices were decontrolled even before the recent change in pricing and procurement of grain. Prices of many consumer goods are also set by negotiations between producers and commercial units. "Floating prices" (up to 20% above or below official prices) are now allowed for many industrial producer goods (either for all output or for output above the mandatory plan target). Price adjustments for key energy products and raw materials (which in many cases are severely underpriced) and for subsidized basic consumer goods like grain and edible oil have proven more difficult to implement, hindered by the potential impact of price changes on urban living standards and on the finances of energy-using enterprises. Nevertheless, some price rises have occurred (e.g., for coal and petroleum), and, moreover, the share of free-market transactions, at largely uncontrolled prices, has increased in recent years. Gradually over time, a two-tier system is emerging; a large but shrinking share of the total supply of most important goods is subject to mandatory plan allocation and administratively set prices, while at the margin a substantial and growing share is allocated by the market mechanism, largely at flexible prices. This pattern may permit China to "grow out of the plan" in a relatively smooth transition, though there are obvious threats to this strategy arising from the strong incentive for arbitrage between planned and unplanned realms. 13. The Government recognizes the need to develop new tools of indirect macroeconomic management and has taken some steps to do so. The People's Bank of China was established as a separate central bank at the beginning of 1984, with its commercial banking functions taken on by the newly created Industrial and Commercial Bank of China. In 1985, new methods of credit planning and control were introduced and redeposit requirements were introduced for the specialized banks. Interest rates (including deposit rates) were also raised in 1985, with some move toward unification of rates and development of a term structure resembling that in other countries. Technical transformation loans with a maturity less than one year and loans for working capital now carry the same 7.9% interest rate while loans of longer maturity carry higher rates, up to 10.8% for 10-year loans. However, interest rates on budgetary capital construction loans (formerly grants) remain low, and there is a variety of directed credit schemes. On the external side, greater use is now being made of the exchange rate. The old internal settlement rate was abolished at the  - 5 - begh'.aing of 1985, and between January 1985 and the present, the Renminbi ha. been devalued three times, most recently in JuLy, by 16% against the US dollar. Despite these changes, progress in perfecting new indirect levers of control has been slow. Recent difficulties in securing macroeconomic balance highlight the need to strengthen institutions and macroeconomic management tools (including monetary, fiscal, and exchange rate instruments) for a decentralized and more market-oriented economy. Long-Term Issues and Prospects 14. In April 1986, a national Party conference adopted the new Seventh Five-Year Plan covering the period 1986-90. The Plan reaffirms the commitment to economic r'.form and provides guidelines for future reform and development. Target growtn rates (7% p.a. for industry, 6% for agriculture, 7.5% for GNP) are below rates of growth achieved with the Sixth Five-Year Plan, investment is to be restrained in the next few years, and emphasis is to be placed upon quality rather than quantity of output. It is thought that slower growth will facilitate reform and help maintain macroeconomic balance. 15. The Plan identifies three main areas of reform. First, enterprise management and incentives are to be improved by: giving enLerprises greater autonomy in production, pricing, and employment decisions; lowering and equalizing taxes; increasing competition; increasing accountability for performance; and reforming personnel procedures. In addition, more small state enterprises will be turned over to collective or individual management through centracts or leases. Second, the role of the market is to be further extended, and market networks strengthened. The scope of mandatory planning will be further reduced, and markets for capital, technology, and labor will gradually be developed. Third, the emphasis of planning will shift from detailed administrative control to indirect macroeconomic control through economic policy. To this end a series of mutually reinforcing reforms in the planning, pricing, fiscal, banking, and labor and wage systems will be intro- duced during the plan period. 16. Specific policy measures will take time to design and implement, however. Many of the reforms required will be difficult. Since reforms in different areas are closely interrelated, appropriate sequencing and coordina- tion are essential. For example, price reform in the absence of improvements in enterprise financial discipline will have limited benefits, yet the more profit-oriented behavior that would result from tighter financial discipline would exacerbate the adverse impact of distorted prices. Similarly, reform of the labor allocation system will be incomplete without eliminating many of the "social responsibilities" of enterDrises (which Itow provide housing, medical care, and pensions for their workers and in many cases education and jobs for workers' children) and replacing them with Government-supported social service programs. 17. China's objective of quadrupling the gross output value of industry and agriculture between 1980 and 200D (which means CDP growth of well over 6% p.a.) will require significant improvements in efficiency as well as continued high saving and investment rates. The Plan recognizes there must be major structural changes in the economy over the next two decades, including a  -6- reduction in the share of agriculture, a rise in the share of industry and services (which at present is unusually low), and substantial urbanization. There will also be a shift within agriculture, away from grain and basic crops and into cash crops and animal husbandry. The new plan will emphasiza development of the service sector, mainly through removing restrictions on collective and individual activity. Urban development will focus on small and medium-sized cities and towns, while restrictions on growth of large urban areas will continue. 18. Certain physical/technical constraints will hinder the attempt to achieve China's targets for the year 2000 and its longer-term goal of catching up with developed countries. Despite rapid growth and substantial improve- ments in efficiency in recent years, agriculture may again become a constraint on overall growth, since land in China is severcly limited. In energy, short- ages of fuel (primarily coal) and electricity may continue to constrain growth of transport and commercial infrastructure. Without large new investments and improved efficiency, economic growth will lag. In mobilizing resources in all these areas, China could profitably make use of foreign borrowing. Finally, the rising share of the elderly in China's population (related to the slowdown in population growth) means ciat more resources will have to be devoted to maintaining thLeir consumption levels, especially in the decades after 2000. 19. Poor motivation and inefficient utilization of labor in the state sector of the economy are major problems which can be solved only by coordi- nated reforms in labor allocation, the wage system, enterprise management, and social services, among other things. Peforms in the system of education and training to develop China's "human capital" potential aLso are crucial. Back- ward technology and inefficient use of existing technology must be addressed by a combination of reforms, appropriately directed investment, and transfer of advanced foreign technology. Irrational location of factories, suboptimal scale of many plants, and poor utilization of physical capital in general are related problems. 20. If reforms successfully transform the economic system, with a bene- ficial impact on growth and efficiency, a new set of issues will come to the fore. Management of a reformed economy with indirect fiscal, monetary, and other instruments is a major issue (see para. 15 above). In this context, maintaining an adequate saving rate (since the Government no longer accounts for the bulk of aggregate saving) and avoiding i'sflation (as well as deep cyclical downturns) will be major goals. Assurinig an adequate minimum standard of living for the population and an appropriate level of sociaL services will become a major challenge, as enterprise and rural communal responsibilities in these areas are reduced. The problem of poor, backward rural areas in various parts of the country will continue to require atten- tion. Redistributing financial resources to these areas through the fiscal system, easing restrictions on migration out of the poorest areas, and lower- ing nonagricultural wages to make investment in them more attractive are some options for alleviating poverty. 21. In order to mobilize the external resources needed for rapid, sustained growth the Plan calls for export growth of 40-50% over the next five years to reach $38 billion; g-eater efforts to attract foreign investment; and  -7- increased but cautious commercial borrowing. Imports are expected to reach $45 billion by 1990, implying a fairly ilow growth race of 4% per annum buL on a very high base volume of imports in 1984-86. By implication, the Plan calls for continued borrowing on the world capital markets through the end of the decade. Under this scenario China's current account deficit would average around $7-8 billion p.a. during the remainder of this decade, equivalent to about 1-2% of CNP. This implies that the present debt service ratio would increase by 1990, although it would remain below the 15% ceiling given in the Plan. If China's exports grew more slowly, imports would probably have to be cut back, because a higher borrowing target although feasible, might not be comfortable in terms of debt service indicators. This highlights the need for continued export growth in order to meet other Plan objectives and to service present and future commercial borrowing. The Plan recognizes that flexible use of exchange rate and pricing policies wiLl be needed to encourage export growth. 22. Even with continued good export performance, China will have substantial external capitaL requirements during the remainder of the decade, and access to concessionary capital will continue to play an important role in sustaining Chins's growth. China is still one ot the poorer countries of the worLd, but its access to concessionary capital for financing development and modernization is limited. Apart from Bank Croup hinds, a significant amount of concessionary capital is likely to come only from Japan and a few other bilateral donors and will probably average no more than $500-600 million p.a. during the rest of the 1980s. PART II - BANK CROUP OPERATIONS 23. To achieve the target growth rates envisioned in the Seventh Five- Year Plan, to increase efficiency, and to maintain equity in distribution, China will need continuing economic reforms. China will need to import more technology, increase trade, and expand investment. In the next few years, therefore, the Bank can best assist China by increasing its access to foreign technology and capital and supporting the implementation of reforms that will help to increase the efEiciency of resource use and reduce poverty. 24. To address China's objective of updating technology, the Bank will play the role of an intermediary. In transportation, energy, industry, agri- culture and social sectors, the Bank will contribute to technology transfer by bringing the Bank's experience to bear on project design and implementation and by helping China to seek appropriate technical solutions through interna- tional competitive bidding, training, and foreign technical assistance. 25. Bank assistance will be closely linked with the Covernment's reform ettorts. There are five major elements common to both rural and urban reform in China that will be the focus of the Bank's involvement. First, institu- tional change, involving both the separation of economic and administrative functions and further decentralization of decisionmaking, will extend to every sector in which the Bank is involved. Second, financial sector reform, primarily development of financial institutions, has become a focus of Bank  - 8 - assistance. Third, improving planning and project analysis will be critical to reform in sectors such as agriculture and industry, where decisions are now being made by households and independent enterprises, as well as in infra- structure where direct government involvement will be required. The Bank will therefore continue its emphasis on introducing appraisal methods and financial planning as well as analysis of intersectoral issues. Fourth, the Bank will be involved in the Government's major program of price reform and development of indirect levers such as control via money, credit and fiscal policies. And finally, the Bank will support reforms in health, education and other social services and measures, in particular, to address the problems of poor regions. Economic and Sector Work 26. The Bank's economic and sector work in China aims at expanding the understanding of the structure and direction of the Chinese economy and of the tools of economic management. This work provides a foundation for Bank Group lending and for the dialogue with the Government on development options and policies. The Bank's program of economic and sector work in China is in four main areas. The first consists of studies ained at providing timely advice on the macrosystemic elements of economic reform. Past w,rk has included two major economic reports, and a third will be produced this year based or the findings of an FY86 mission which studied the evolving processes of mobiliza- tion, intermediation and allocation of investment resources in China. .A study on reform of China's foreign trade and investment regimes will be undertaken in FY87. 27. A secord area of the program is concerned with maLcroeconomic manage- ment. Working iir close cooperation with the IMF, the Bank will Assist China in examining medium-term macroeconomic prospects, with particular attention to fiscal, balance of payments and external debt trends and related policy issues. The Bank will also continue to organize seminars on macrneconomic issues. 28. The third area is sector analysis to provide support to the reform process at the sectoral and micro levels, to strengthen sector planning and to underpin the development of the Bank's lending program. Emphasis will be given to sector work in industry, energy and transport, reflecting priorities identified for the Seventh Five-Year Plan. 29. The fourth area of economic and sector work is continued collabora- tive economic study with the Chinese Academy of Social Sciences and other Chinese zesearch institutions. This type of collaboration has proven to be an effective means of introducing Chinese academics and technicians to modern research concepts and techniques. A study of state enterprise management has been completed, and work is now underway on a similar study of township and village collective enterprises, which are expected to become increasingly important industrial organizations in the reformed system. Lending Operations 30. Since China's change of representation in the Bank Group in May 1980, 42 projects involving lending of $4,126.1 million to China have been  - 9 - approved. Of the projects, thirteen have been in the agriculture sector, ten in energy, six in transport, four in industry, four in education, two each in health and technical cooperation and one in water supply. In FY85, IFC made its first investment in China of $17.02 million for automobile manufacturing. 31. In addition to the already approved Red Soils Area Development Project and the proposed project, we expect to present to the Board this year projects in port development, machine tools, agriculture, coal, urban sanita- tion and highway development. For FY87 and beyond, we expect the lending program for China to continue to grow from current levels. Infrastructure projects in energy and transport will remain priorities. Technical renovation of enterprises, particularly in industry, will be given greater attention and support as will the regional approach to project development, which is the basis of a proposed project to meet the needs of Gansu province. 32. In the energy sector, future Bank lending will be aimed at improving efficiency of energy consumption and expanding energy production. For example, in the coal subsector, we will assist in upgrading the facilities and operations of existing mines and in transferring improved technology for mines under construction or in operation. In power, we will assist China in tech- nology transfer, system planning, staff training and institution building. In the petroleum subsector, the rationale for project involvement will lie in the identification, packaging and transfer of specialized technologies as well as in the strengthening of investment planning and management capabilities. 33. Future transport projects will be aimed at contributing to China's efforts to efficiently meet the transport requirements of its growing economy. In roads, major changes in organization and financing will be required as a result of administrative decentralization and introduction of the production responsibility system in rural areas. In railways, we will focus on technologies to improve domestic production of railway equipment and materials in addition to our work on line construction and electrification. We also intend to broaden our involvement in ports to include coastal shipping and inland water transport. For all transport subsectors, we will support efforts to improve financial analysis and investment planning. 34. Bank Lending in industry will continue to support financial interme- diaries which provide credit to state and collective enterprises. In addi- tion, we will expand lending through direct and subsector operations to upgrade technology, conserve energy, and improve overall organization and management, particularly in fertilizer, cement, machine tools and other capital goods industries. 35. Agriculture lending will focus on developing institutions to provide services to individual farmers and to monitor and stimulate change in the pace and pattern of agricultural development. The shift from grant to loan finance and the increased autonomy of the rural banking system will continue to be supported through rural credit projects. We will also assist with the train- ing, research, extension, and other service activities of the ministries concerned with agriculture. In addition, we expect to finance programs for specialized agricultural development such as livestock and for irrigation and area development.  - 10 - 36. Bank lending in education will suppport China's efforts to expand and improve the quality of higher education, develop technical and vocational education and strengthen basic education by improving training of teachers and administrators, increasing domestic capacity to produce teaching materials and educational equipment, and raising the quality of schools administration at the provincial level. 37. Project preparation in the urban sector is currently concentraLed in Shanghai on efforts to improve services, especially in environmental upgrading and housing, and development of municipal institutions. Future lending is expected to include support for development of medium-size and small urban areas in specific provinces. In addition, we expect to continue lending for rural water supply. Bank lending in health will provide access to new medical technologies for more efficient health care in both the lingering problems of communicable disease, particularly in poor rural areas, and the emerging problems of chronic disease. This will involve further support for medical training and planning and management of service delivery systems. Projects will also support the reform of systems for supplying and financing health services. 38. Cofinancing with multilateral and bilateral agencies has been arranged for projects in coal, power, transport, agriculture and rural water supply and will remain a feature of our assistance program. We will explore further options for cofinancing with export credit agencies. Commercial bank cofinancing and the use of B-loans also appear viable, particularly as China increases the overall volume of its foreign borrowing. In technical assist- ance, we will continue to incorporate into projects components for training, overseas study, and access to foreign expertise. In addition, we will be the executing agency for a second UNDP umbrella project in China. EDI activities remain an important element of the Bank's program and in coming years will provide an extensive program of policy seminars for senior Chinese officials, and economic and financial management courses and sector-specific training for officials from core and line agencies. Implementation 39. Project implementation is generaLly proceeding well. Most project agencies, as well as the Ministry of Finance and the State Planning Commission, have established and staffed offices to handle Bank projects. Disbursement performance has also been satisfactory. Special accounts have been established for a majority of the approved projects and have heLped to speed disbursements. In October 1985, the Bank opened a resident office in Beijing to support further expansion of the lending program, accelerate project preparation, improve project implementation and further economic and sector work.  - 11 - PART III - THE ENERGY SECTOR AND THE POWER SUBSECTOR Overview 40. China is the fourth largest producer and third largest consumer of commercial energy in the world. Coal is China's most important source of energy, accounting for some 75% of commercial consumption. Oil production has increased rapidly since the 1950s to become an important source of both commercial energy and export earnings, representing about 181 and 22% of the respective totals. Some 25% of oil production and 1% of coal production are exported. Natural gas (2%), hydroelectric power (5%) and limited quantities of shale oil and geothe mal power make up the balance of commercial energy. Non-commercial energy resources supply energy equivalent to about one third of commercial production. 41. China has made remarkable progress in developing energy resources over the last three decades. Annual coal production has increased from about 60 million tons in 1952 to 850 million tons in 1985. During the same period, annual oil production increased from 0.1 million tons to 125 million tons, and annual electricity generation increased from about 7.3 TWh to 407 TWh. Nevertheless, the rate of growth of energy supplies could constrain the Government's efforts to quadruple the gross value of industrial and agricul- tural output during the period from 1980 to 2000. To avoid an energy bottle- neck to economic development, China will need to increase coal production beyond current targets for the year 2000 and meet at least the official output targets set for other types of energy resources as well as greatly improve the efficiency of energy use. Achievement of these targets will require the modernization of technology and management throughout the energy sector, increased commitment of financial resources, and a strengthening of planning and coordination among the diverse components of both the energy and transpor- tation sectors. In its Sixth Five-Year Plan (1981-85), the Government accorded high priority to the development of these sectors and they are continuing to receive emphasis in the Seventh Five-Year Plan (1986-90). Resource Endowment 42. China is well endowed with primary energy. Coal and lignite reserves are concentrated in the north and northeast, which have about 70% of the total recoverable reserves (700 billion tons). Future.plans call for increasing coal production significantly, but this will pose difficult transport problems (primarily due to a shortage of railroad capacity). Biomass fuels account for more than 25% of final consumption. Recoverable reserves of oil onshore have been variously estimated between 6-15 billion tons, and estimates for offshore oil reserves range from 3-10 billion tons. Recoverable reserves of non-associated gas have so far been estimated at about 3 trillion cubic feet (TCF), about 90% of which are located in Sichuan prov- ince. In addition, recoverable reserves of associated gas are estimated at about 1.8 TCF. Unofficial estimates of oil shale in China place reserves at 400 billion tons. China's hydropower potential, among the largest in the world, is estimated at 1900 TWh p.a., of which 87 TWh p.a. have so far been developed. A major constraint has been that the bulk of the undeveloped potential is located in four major basins in the southwest and northwest of  - 12 - China, 1,200-1,500 km away from major industrial load centers. The known uranium reserves in China are sufficient to sustain 15,000 MW of nuclear power plant for 30 years. Although potential sources of geothermal energy are abundant in the mountainous southwestern part of the country, their role is likely to remain limited due to their distance from major load centers. Efficiency of Energy Use 43. China's consumption of energy per unit of GDP is well above that of any major developed or developing country. The underlying reasons for the high intensity and relative inefficiency of fuel use in China are the struc- ture of industrial production, the scale of industrial units, the raw materials used, and the technology employed. In the late 1970s, the Govern- ment began to address these inefficiencies by instituting regulations on energy use, establishing conservation centers to provide technical assistance, and allocating a larger share of investment funds for industrial moderniza- tion, particularly those projects which contributed to energy conservation. As a result, energy consumption per unit of GVIAD declined by 7% p.a. during 1979-81, 3% p.a. during 1982-83 and 7% in 1984. Technical and operational improvements are estimated to have accounted for about 40% of these energy savings. The other 60% came from a decline in the relative importance of heavy industry, the closure of some inefficient small-scale plants and other structural changes within industrial subsectors. There is now an urgent need to complement and gradually replace the current system of administrative controls with a system that would provide more autonomy to individual entities and rely on an energy price structure that reflects the cost and relative scarcity of each source of energy. The Power Subsector 44. Since the 1950s, China has grown to become the fifth largest producer of electricity in the world. Annual per capita generation of electrical energy grew from 8 kWh in 1949 to 389 kWh in 1985. Oi the total installed capacity of 86,290 MW in 1985, 30% was hydro and 70% was thermal. Power is distributed through 30 grids, of which 13 (representing over 80% of the total capacity) exceed 1,000 HW each. Energy sales in 1985 reached 327 TWh, having grown at an average of 13.8% p.a. since 1949 and 7.9% since 1974. Of these sales, 80% represented industrial consumption, 10% agricul- tural, 1% transportation and 9% residential and urban commercial usage. About 60% of the population has access to electricity. The rate of growth of installed capacity has fallen in recent years; during the Sixth Five Year Plan it was only about 5.6% on the average, and the total increase was about 20,000 MW. At present, customer requests exceed available supplies by between 45 and 50 TWh per year, and this shortage is likely to continue in the medium term. Electricity is allocated through quotas based on priorities set by central, provincial and county authorities. X 45. The Seventh Five-Year Plan envisages increasing the generating capacity by as much as 35,000 MW to generate 550 TWh by 1990. Several thermal power ,tations will be constructed along the coast and near major coal mines in Shanxi, Heilongjiang, Henan, Shaanxi, Shandong, Anhui, Guizhou, Nei Monggol and Ningxia. Large hydroelectric stations will be built in the middle and  - 13 - upper reaches of the Yellow river, and the Hongshui river valleys. Construc- tion of a nuclear plant in Guangdong province will start during this period. In the next five years, a 500 kV grid, supplying electricity to the northeastern, eastern, southern and central China, will be comnissioned. If successfully implemented, this should alleviate shortages in the long-term. 46. Market Conditions. Electricity consumption increased at an average rate of 10.6% p.a. between 1965 and 1979, but this rate slowed down during 1979-85 when it averaged only 6.0% p.a. On a countrywide basis, the power shortage is about 15% of industrial electricity requirements. It is estimated that by the year 2000, generation requirements could be in the 960-1,290 TWh range, requiring an additional 109,000-178,000 MW in generating capacity. The share of electricity in total energy consumption has been rising from about 132 of final comercial energy use in 1970 to about 15% in 1975 and 18% in 1980. The share is expected to reach 26-27% in the year 2000. The manufact- uring sector will ccntinue to account for at least three quarters of final electricity consumption, although electricity per unit of value added may fall slightly. Electricity use is expected to grow at 11-13% p.a. in residential and commercial sectors, reflecting household income and service sector growth. Use will also increase in transportation, reflecting the increase in the share of electric locomotives in total railway haulage. 47. Institutions. Since 1982, the Ministry of Water Resources and Electric Power (MWREP) has been responsible for overseeing all aspects of electric power development and water resource management, including policy making and system planning as well as the design, construction and operation of power and water resource projects of regional importance. Under MWREP, there are six regional power administrations which coordinate operations and load dispatching for the regional grids and formulate long-term development plans for approval by MWREP and the State Planning Commission. Below the regional administrations are 22 provincial and municipal power bureaus operating as parts of the regional grids, while eight other power bureaus still operate in isolation. In addition, the Government established in 1985 the Huaneng International Power Development Corporation (HIPDC) as a joint venture company to attract foreign and domestic investment to establish and operate power plants mainly in the coastal open cities. 48. MWREP has about 2.5 million employees of whom about 51% are directly under the Ministry and about 49% are under the provincial institutions. Of the total, less than 30% have completed formal education beyond junior secondary school level, indicating a shortage of trained manpower, particu- larly for well-trained administrative and technical staff. In the late 1970s, MWREP initiated a long-term training program to upgrade the quality of its existing staff at all levels. MWREP is also strengthening its capacity for full-time training of potential employees through its Education Department which sponsors four universities, 39 technical colleges, television and cor- respondence universities and 27 secondary-level vocational schools. About 30,000 students were enrolled in these schools in 1985. About 15,300 new staff are assigned to MWREP annually. An estimated 7,000 come from four-year colleges and 8,300 are junior college graduates. These programs, supplemented by periodic in-service short courses for managerial and technical staff and on-the-job worker training, are expected to lead gradually to improvements in  - 14 - the productivity of the workers in the sector. The proposed project would include a training component in support of these activities. 49. Planning. Overall system planning is the responsibility of the Planning Department of MWREP which reviews the proposals of the regional administrations and provincial bureaus for the short-term (annual), medium term (5-year) and long-term (10-15 year). For major hydro projects, the investigation, planning and design are carried out by the regional hydro- electric investigation and design institutes. For system expansion, trans- mission lines and substations above 110kV and for major thermal projectsp the studies, planning and design are carried out by the regional electric power design institutes. As the planning of China's power subsector development becomes increasingly complex, up-to-date system planning techniques will need to be adopted, particularly to evaluate large-scale projects with long lead times and to make decisions about the appropriate generating plant mix, power plant location, and grid configuration. Arrangements were made under the Second Power Project for introducing least cost investment programming techniques through the technical assistance of the International Atomic Energy Agency and for staff training of the Planning Department of MWREP and the Water Resources and Electric Power Economic Research Institute (WREPRI) in Beijing. They are working satisfactorily. During 1986-86 WREPERI assisted the Cuangxi and Fujian Provincial Electric Power Bureaus to formulate their least cost development programs. 50. Tariffs. Electricity tariffs have in general remained constant since 1953, although recently the average revenue per unit has been increasing due to the growing share of consumption by light industries, and commercial and residential users which pay higher rates. The national average was about 7.0 fen/kWh (USc2.3/kWh) in 1985, well below the marginal cost of supply. To support the Government's recent policy to move towards increased reliance on prices rather than administrated quotas, the electricity allocation system will need to be revised and more appropriate tariff structures introduced. To assist the Government in developing appropriate electricity tariffs, the Bank's Third Power Project includes an important tariff study that will commence with a case study of the East China Grid (ECC) which will provide a sound analytical basis both for tariffs for final consumers and for inter- system transfers to promote integrated operation. 51. Financing. Inadequate financing has contributed to the shortage of generating capacity and low standard of transmission and distribution facili- ties. In the past, limited allocations from the central budget have caused considerable slow-down of power projects. Now, as a result of recent reforms, the power bureaus can cover about 10-15% of their investment requirements through internal cash generation. Further changes in the funding mechanism and the financial discipline applicable to the power bureaus may need to be considered in order to increase the amount of resources available for invest- X ment in the subsector and the levels of self-financing by the power bureaus. Tnis may also require higher tariff increases in the future than now foreseen. 52. Technology Transfer. The transfer and development of modern tech- nologies will be crucial if China is to achieve its ambitious goals of increasing energy production and efficiency sufficiently to achieve its  - 15 - broader economic gcals. Technology transfer is critical for thermal power plants, where increases in pressure and size of units and greater development of cogeneration (combined heat and power generation) could reduce net fuel consumption by some 20Z by the year 2000, thus greatly alleviating pressures on coal supplies and transport. Coal based thermal generation is expected to provide about three quarters of the total generation until the end of the century. Technical transfer needed for hydroelectric projects includes inter- pretation of geological data, judgment of foundation excavation, design for sophisticated structures and construction management and adoption of the largest possible generating unit !izes. The slow pace of construction of hydro-power projects has contributed to the low level of hydro resources in the past. Timely progress in construction will be an important focus of the proposed project. 53. Subsector Strategy. The Government's basic strategy for the power subsector is to modernize, increase efficiency, and expand at a rate suffi- cient to meet the requirements of industrial development and improve the living conditions of the population. The strategy includes the following specific objectives: (a) establishing new enterprises to expand generating capacity as rapidly as possible; (b) increasing the financial autonomy of power sector enterprises; (c) introducing a more rational pricing system; Cd) adopting modern techniques in project design and system planning; (e) accelerating the pace of hydroelectric development; (f) developing mine- mouth, coal-fired thermal stations which are supplemented, where necessary, by stations located near ports and load centers; (g) constructing extra high voltage transmission lines for interconnection between regions; (h) replacing low pressure medium size (50-100 MW) thermal units with higher pressure 300- 600 MW units and conversion of oil-fired units to coal-firing; and (i) devel- oping nuclear power in areas where other forms of energy are scarce. Role of the Bank 54. Past Bank lending operations have assisted the Government in addressing subsector problems and rationalizing subsector investment deci- sions. The major thrust of Bank assistance has been to introduce modern concepts of utility management and pover system technology. Each operation has focussed on specific aspects of the Government's sectoral objectives. 55. The first power project in FY84 (the 600 MW Lubuge hydra project) successfully promoted cofinancing arrangements in export tredits for the major electrical and mechanical equipment and bilateral grants for engineering services; introduced international competitive bidding for civil works and modern construction techniques for a rockfill dam, power tunnel and under- ground powerhouse; and enhanced the financial autonomy of the Yunnan Provincial Electric Power Bureau. The training component under the project included training of staff design, construction management, quality control, accounting and cost control through technical assistance. 56. A second power project in FY85 provided for the transmission of power from a 1300 MW mine-mouth, coal-fired thermal power station at Xuzhou to the East China grid, promoted a bilateral loan for the Yangtze river crossing works, and assisted with the transfer of technology in 500 kV transmission  - 16 - line and substation design, construction, operation and maintenance. The training component under the project included the establishment of a training center and equipping of two other technical schools in Nanjing and Shanghai for the operation and maintenance of 500 kV transmission lines and substa- tions. The project also introduced least cost programming techniques to several provincial power bureaus. 57. Under the third and fourth power projects in FY86 the Bank is financing an integrated 600 NW coal-fired unit (Beilungang Thermal), which will set performance standards for a series of same size thermal units, and the 1100 MW Yantan hydroelectric project. Both projects were selected on the basis of least-cost studies. The third project aLso includes a tariff study (see para. 50). ThLese projects will help alleviate severe power shortages in east and south China. 58. The proposed project will help reduce the shortage of generating capacity and energy in the East China and Fujian provincial grids (FPG), assist in developing techniques to speed up construction of large hydro- electric projects, and promote integrated operation of an emerging large regional power system. Discussions between the Government and the Bank are in progress on building up a strong pipeline of project. which will continue to support the subsector objectives. PART IV - THE PROJECT 59. The project was identified in July 1980 and appraised in February 1986. Negotiations were held in Washington in November 1986, with a delega- tion headed by Mr. Luo Qing, Deputy Director, External Finance Department, Ministry of Finance. A Staff Appraisal Report (No. 6189-CHA, dated November 24, 1986) is being distributed separately to the Executive Directors. A map (IBRD No. 19561) showing the project location is attached. Supplemen- tary project data are provided in Annex III. Project Objectives 60. The project aim is to assist China to alleviate the acute shortage of energy and peaking capacity in the East China Grid (ECC), which now has a predominantly thermal capacity. The project is also intended to meet the growing energy requirements of Fujian province, where this would be the first Bank involvement in power development. The specific objectives of the project are to: ti) develop a major hydro site to serve primarily as a peaking station for ECG; Cii) introduce the most modern technology available for speedy construction of a large dam ard power station; (iii) promote more effective integrated operation of a major regional grid; and (iv) provide training in management of international contracts for large civil works and in financial management.  - 17 - Project Description 61. The project comprises the following: (a) preparatory works comprising access roads, construction colony, relocation of a main highway, a bridge across the river, con- struction power lines, etc.; (b) construction of a 101 m high concrete gravity dom, a spillway, a powerhouse, a three-stage navigation lock and appurtenant works; (c) provision and installation of seven 200 MW generating sets and associated electrical systems including a 500 kV step-up substation; (d) construction of a 500 kV single-circuit transmission line, including necessary equipment in an associated substation; (e) resettlement of about 63,000 people, comprising identification of substitute land and a diversified agriculturaL package designed to help reconstruct the production systems and social communities of the relocated population; (f) consulting services for engineering and construction management; (g) studies of Ci) coordinated operation of hydroelectric plants in the Fujian and East China grids and related system improvements; and (ii) power system controls and dispatching systems in Fujian and East China; and (h) training. Project Management and Implementation 62. The beneficiary of the proposed project will be FPEPB, a state-owned enterprise under the direction of MWREP. FPEFB is assigned responsibility by the Government for the local execution of the government program for power generation, capital investment, power sales and tariffs, employment and payroll, materials consumption and tax and profit remittances to the central government. A charter of FPEPB has been issued and is acceptable to the Bank. 63. FPEPB is headed by a director who is appointed by MWREP. As of the end of 1985 FPEPB had about 16,500 employees of whom only about 22% have received technical training equivalent or above college level. Technical staff with formal education are now being centrally trained and assigned to FPEPB at the rate of 120 per year. FPEPB also administers three schools for training of technicians, skilled workers and administrative personnel. The bureau expects to fully meet its staff requirements from 1988 onwards. 64. FPEPB is capable of formulating its expansion program, designing and building medium size (up to 200 KW) hydroelectric and thermal pLants, and 110- 220 kV transmission lines. The construction of the large Shuikou hydroelec- tric project would be organized by FPEPB through the Shuikou Hydroelectric  - 18 - Power Corporation (SHPC), which was set up in 1985. FPEPB and SHPC have entered into contractual arrangements. Outside assistance will be used for engineering designs under the proposed loan. 65. The preliminary design for the project was carried out by the East China Hydroelectric Power Investigation and Design Institute (ECHIDI) in 1980. It was reviewed during 1982/83 by the International Engineering Company of USA, now named Morrison Kundsen Engineering Co. Detailed designs of the project will be carried out by ECHIDI, with assistance of Morrison Knudsen Co. 66. Construction of preparatory works on the project and land acquisi- tion commenced in 1985 and are proceeding well. Procurement on the main civil works contract, which will be awarded through ICB, is also well advanced. Bidding has been completed. The implementation program is to start construc- tion of the main civil works in January 1987 and complete the main dam struc- ture in 1993 so that the first two 200 MW generating units can be in commer- cial operation by mid-1993. The remaining five units will be commissioned at intervals by mid-1995. The project completion date will be June 30, 1995 and the closing date of the Bank loan will be December 31, 1991 since the Bank will be only providing funds to cover the foreign exchange needs during the initial four years of project implementation (see para. 71). 67. Concurrently with the construction of the project, but outside its scope, a 66 km section of the Waiyang-Fuzhou railway, which would be flooded by the proposed Shuikou reservoir, is being relocated to a higher level as a special project (costing about $114 million) in the Seventh Plan. Work on this project started in January 1986 and is scheduled to be completed by October 1989. Construction of the Shuikou dam is controlled to a large extent by the progress of this railway relocation project, as the critical river diversion into a channel is scheduled for November 1989. So far the reloca- tion work is proceeding satisfactorily. However, during negotiations, assurances were obtained from the Government that it will take all steps necessary to ensure that the permanent railway relocation shall be carried out in accordance with appropriate engineering practices and completed in a timely manner, and that the Bank will be furnished from time to time with information related thereto. 68. A Special Board of Consultants (SBC) has been established to review the designs of the project and, in particular, the safety aspects of the dam. SBC held its first meeting in December 1985 and confirmed that the choice of site is optimum and that the layout and designs take full advantage of topography and geology. During negotiations, assurances were obtained that FPEPB wilL prepare, at least one year ahead of completion of the dam, a program of annual maintenance of the works, which is satisfactory to the Bank, and undertake periodic inspections of the dam and associated works using independent experts whose qualifications and experience will be reviewed with the Bank. Assurances were also obtained that FPEPB will continue to employ: (a) consultants for design and supervision of construction; and (b) a Special Board of Consultants for review of designs and construction during the period of construction.  - 19 - Studies and Training 69. Consulting services will be used to assist in the studies included in the project. Financing will be provided under the Bank loan. An amount of $1.0 million has been provisionally included in the loan for studies and training. Training will comprise two subcomponents. Utility managers and financial planners will be trained through short-term study tours to provide an opportunity for senior officials to gain exposure to modern utility manage- ment techniques. The study tours will be designed to compLement similar training programs included in two earlier Bank-financed power projects (Beilungang Thermal and Yantan Hydroelectric). The second subcomponent of the training program will be carried out in China. Contractual arrangements with foreign consultants will provide for training of Chinese engineers and managers in contract management and efficient control and reporting of con- struction to achieve the earliest possible civil works completion and plant commissioning dates. At negotiations, assurances were obtained that FPEPB will carry out studies in accordance with terms of reference and timing agreed with the Bank and will implement the training component in accordance with the -greed program. Cost Estimates 70. The cost estimates are based on mid-1986 price levels. Physical contingencies include 10% for preparatory works, main civil works and engineering/administration, and 7% for metal works and electro-mechanical equipment. Price escalations for both foreign and local costs are calculated on the basis of the projected international inflation rates of 7.2% for 1986, 6.8% for 1987-88, 7% for 1989, 7.1% for 1990 and 4.0% for 1991 and there- after. The total financing required is $1,087.8 million equivalent, including interest during construction. The project would be exempted from customs duties and taxes. Financing PLan 71. Because this monolithic project will have a lengthy construction period of about nine years, the Government decided to phase the project financing rather than secure financing for the entire project at the outset. The Government did not wish to secure all financing up front because it felt it would unnecessarily tie up resources which could be used for other projects with requirements for more immediate funding. The proposed loan would help to finance only the initial four years of project implementation (1987-90). At the Government's request, however, the Bank has agreed to consider a request for a second loan for the remaining period of the project. Nevertheless, the Government is committed to and envisions no difficulty in providing for completion of the project even if the Bank does not provide additional financing at a later stage. At negotiations, the Government's commitment to provide funding for the entire project was reconfirmed. 72. The proposed Bank loan of $140.0 million will meet about 43% of total project cost incurred during the period 1987-90. It wiLl be used to finance the estimated foreign costs of the following components: (a) the main civil and penstock works contracts; (b) the first two generating units; and  - 20 - (c) consulting services, studies and oversearn training. The foreign exchange requirement of $547.3 million is expected to be met by the proposed Bank loin ($140.0 million), foreign exchange loans ($260.0 million) to be arranged by the Government, and local bank loans ($147.3 million). The local cost ($540.5 million equivalent) will be financed through loans from local banks. 73. The proposed Bank loan will be made to the Covernment of China at the standard variable interest rate for a 20-year term, including five years of grace. Assurances were obtained that the Government will onlend the proceeds of the Bank loan to FPEPB under a subsidiary loan agreement with a 20-year term, including five years of grace, at an interest rate of 8.5% p.a., and that FPEPB will bear the commitment charges and foreign exchange risk (between the dollar and the Borrower's currency). A Project Agreement will be concluded between the Bank and FPEPB. Execution of an acceptable subsidiary loan agreement between the Government and FPEPB and approval of the Loan Agreement by the State Council will be conditions of loan effectiveness. Procurement and Disbursement 74. The main items to be procured are (a) preparatory works; (b) the main civil works; (c) electrical and mechanical equipment; and (d) engineering and consultancy services. A number of contracts for preparatory civil and electrical works, totalling about $27 million, were awarded in 1985, following local competitive bidding procedures acceptable to the Bank. These contracts will not be financed by the Bank. The proposed Hank loan will partly finance the main civil works contract, the supply and erection of the first two 200 MW turbogenerators and associated equipment, including 500 kV equipment, and the 500 kV transmission line which will be procured through ICB in accordance with the Bank's Procurement Guidelines. The total value of these contracts is estimated at about $465.5 million. In bid evaluation, qualified domestic manufacturers would be eligible for a preference of 15% or the import duty, whichever is lower. Supply and erection of the remaining five generating sets and associated equipment will be procured locally by LCB. The procurement arrangements for the project are summarized in a table below. All bidding packages for goods financed by the Bank and estimated to cost over US$1.0 million equivalent would be subject to the Bank's prior review of procurement documents, which cover most of the Bank-financed contracts. Items or groups of items estimated to cost less than the equivalent of $150,000 per contract, up to an aggregate amount of $2,000,000 could be procured on the basis of at least three bids from qualified suppliers eligible under the guidelines in accordance with limited international bidding procedures (LIB).  - 21 - PROCUREMENT ARRANGEMENTS (US$ inillion equivalent) I. Procurement method Project element LCB ICB Other NA Total Preparatory works 26.9 - - 26.9 Resettlement - - 138.3 138.3 Civil and associated works - 294.6 - 294.6 (103.1) (103.1) Cates, hoist., and cranes lb 15.3 5.8 - 21.1 (1.5) (1.5) Turbines Ic 55.6 39.5 - 95.1 (6.9) (5.9) Cenerators /c 48.7 35.9 - 84.6 (4.1) (4.1) Transformers, switchgear Id 13.5 46.2 - 59.7 (5.8) (5.8) Controls 5.0 - 5.0 (0.7) (0.7) Transmission line, etc. /b 46.8 38.5 - 85.3 (7.3) (7.3) Engineering - 27.4 27.4 (9.2) (9.2) Administration, scudies & training - - - 17.8 17.8 (1.4) (1.4) Total 206.8 465.5 165.7 17.8 855.8 Trr- (129.4) -(9.2) (I.4) (140.0) /a Figures in parentheses are the respective amounts financed by the proposed Bank loan. /b Materials (steet) to be imported by ICB; fabrication and supply by LCB. 7i The first two units will be imported under ICB. The remaining five units will be procured through LCB but will not be financed by the Bank loan. /d 500 kV equipment imported under ICB; rest through LCB. 75. The Bank loan will be disbursed against: (a) 100% of the foreign expenditures of directly imporLed equipment and materials; (b) 100I of local expenditures ex-iactory of locally manufactured items; (c) 75% of the cost of other items procured locally; (d) 70% of total cost of main civil works pro- cured through ICB; and (e) 100% of the cost of consulting services and over- seas training. For expenditures relating to training and contracts for goods and services each valued less than $200,000 equivalent, reimbursements will be made on the basis of statements of expenditures. Documentation supporting such expenditures need not be submitted to the Bank but should be retained in the FPEPB project office in Fuzhou and made available for review by the Bank's supervision missions. To facilitate disbursement, a special account with an  - 22 - authorized allocation of $490 million (representing four months average project expenditure.) wiLl be established in a bank on terms and conditions acceptable to the Bank. Applications for replenishmenta wiLl be rntde quarterly or when the Special Account is drawn down to 50Z of the initial deposit, whichever occurs first. Retroactive financing will be permitted for up to $10 million in expenditures incurred for the main civil works contract prior to the date of loan signing but after December 1. 1986. Planning, Accounting and Audit 76. FPEPB works closely with H4WREP and the planning departments of the Government of the Province of Fujian to develop its an.m;al r4d five-year plans. The plans are integrated with the national plans chrough MWREP and approved by SPC. The present system of planning does not inciude long-term financial planning at the provincial power bureau level. In order to deal with financial issues emerging with the ongoing reforms, FPEPB needs t; 4dopt a systematic approach to planning its financial affairs. The Bank has I furnished a financial forecasting model to FPEPB to enablo it to study thc- impact of expansion plans and price variations on its future financial positions. At negotiations, assurances were obtained ftom FPEPB that by December 31 of each year commencing December 31, 1987, VPEB will furnish to the Bank a financial plan containing forecast income statenents, sources and uses of funds, and balance sheets for the next five years.' An understanding was reached at negotiations that FPEPB will furnish to the Bank financial projections for an additional five years subsequent to the period of the financial plans. 77. FPEPB is a self-accounting entity reporting directly to MWREP. The bureau maintains its accounts on an accrual basis uaing A double entry system and follows accournting procedures e3tablished by MOF. FPEPB's subordinate units prepare accounting information monthly; the headquarters ctnsolidates accounts monthly, quarterly and annually. All these are done tn a timely manner. 78. As with almost all Bank-financed projects in China, the Foreign Investment Audit Bureau of the State Audit Administration (SMA) will be responsible for auditing FPEPB's accounts. Actual audit work will be conducted by the Fujian Provincial Audit Bureau, a subordinate organization of SAA which was established in 1984. Assurances were obtained at negotiatiors that FPEPB will furnish annual financial statements, certified by an accep- table auditor, to the Bank within six months of the end of each financial year. Financial Position 79. During the five-year period from 1981 through 1985, FPEPB's energy sales increased by about 40% while revenues increased by about 48%. The ope- rating ratio, which has previously remained reasonably constant at about 57% increased to about 70% in 1984 and 1985. During the period, FPEPB realized an average rate of return of about 13% based on historically valued average net fixed assets in operation. Debt service coverage ratio has remained satisfac- tory.  - 23 - 80. During the period 1986-1995, the Fujian power system is projected to maintain a high rate of growth. Up to 1988, FPEPB'u sales are projected to grow at an annual rate of about 11.4%, and net fixed assets in operations are expected to increase by 23% p.s. over the current level. However, during the 1989-1993 period, the bulk of projected increases in demand is expected to be met by the Fuzhou Thermal Power Station (FTPS), a plant being built and operated outside the jurisdiction of FPEPB. As a result, FPEPB is projected to experience very little growth over the 1988 level. From 1994 on, FPEPB's performance is expected to improve dramatically as the Shuikou project becomes operational. Sales increase is expected to average at about 25% for 1994 and 1995. While financial indicators for the period 19B6-1995 continue to be satisfactory, with rate of return and operating ratio averaging 9.4% and 69Z respectively, and average revenue increasing from the 1986 level of 7.4 fen/kWh to 12 fen/kWh in 1995, FPEPB faces many uncertainties which might prevent it from achieving these results. These include: (a) lack of experi- ence and clear procedures for implementing power rate increases; (b) institu- tional changes introduced through economic reform; and (c) arrangements yet to be made for sales of Shuikou power to East China and for the operation of FTPS. 81. At negotiations, assurances were obtained from FPEPB that it will take measures, including but not limited to tariff adjustments, to ensure that operating revenues are sufficient to meet the aggregate of its total operating expenses and the amount by which its financial obligations exceed depreciation and non-cash operating expenses. Assurances were also obtained that FPEPB will incur additional debt only if a reasonable forecast of its revenues and expenditures indicates that its internal cash generation will provide a debt service coverage of at least 1.3 times. 82. Because the basis for FPEPB's purchase of FTPS vutput has not yet been fully agreed and, sinilarly, a basis for the planned sales of Shuikou power to the East China Electric Power Administration (ECEPA) - 86% of its dependable capacity and 50% of the firm energy - has yet to be established, assurances were obtained during negotiations that FPEPB wilt enter into and implement power purchase and sales contracts with HIPDC and ECEPA satisfactory to the Bank, and the Government will take all efforts necessary to enable FPF?B, ECEPA, and HIPDC to enter into and to implement those contracts. An un.erstanding was reached during negotiations on the principles of such agreements. Benefits and Risks 83. The Shuikou Hydroelectric Project is intended to supply peaking powex to the combined FCC and FPC, which serve the provinces of Fujian, Zhejiang, Jiangsu and Anhui, and Shanghai Municipality. These areas consti- tute one of the most important economic regions in China, acounting for about 29% of the country's industrial output. While these areas have experienced rapid growth in recent years, the rate of growth has been increasingly limited by a shortage of electricity. 84. In the area to be served by the project, peak demand has grown at an average rate of 8.0% p.a. between 1970 and 1985, and electric energy demand  - 24 - rose by 9.0% p.a., over the same period, even though demand was suppressed due to a shortage of generating capacity. Based on a reasonable load projection, the peak demand and energy generation of ECG and FPC combined would increase from 10,963 KW and 77,889 CWh in 1985 to 26,818 KW and 172,960 GWh in 1995, which represents average annual growth rates of 9.4% and 8.3% respectively. 85. ECG's long-term expansion strategy, developed through a comprehen- sive program of studies over many years, is based on continued reliance on coal shipped from northern China as the primary source of energy, and the continuing development of the remaining hydropower sites in the region for meeting peak loads. Shuikou is the only sizable hydro project with a geo- graphically convenient location. A recent least ccst expansion study of the ECG system, carried out by WREPERI, confirmed the optimality of ECG's develop- ment strategy, and concluded that the commissioning of the Shuikou hydropower project, with seven units of 200 MW each, would be justified at the earliest practicable date in 1993/94. A supplementary study undertaken by ECHIDI indicated that the next best alternative, which involves the development of a pumped storage hydroelectric scheme, would only become competitive with the Shuikou project at discount rates above 14.2%. 86. The economic rate of return of the project was calculated using the economic prices of inputs (shadow priced capital cost of generating plant, associated transmission lines and resettlement, operation and maintenance cost, and distribution cost) and valuing the output at the cost of providing peak energy using the next best project -- the pumped storage scheme. On this basis, the economic rate of return of the project is 15Z. 87. The risks associated with most hydroelectric projects are uncertain- ties in geological, hydrological and related aspects; they are minimal in this case and further reduced by very extensive investigations and competent engineering. The risk of delay in construction is inherent in a large project such as Shuikou, but the concentration of main civil works into a single ICB contract, facilitation of imports of all construction equipment and materials in short supply in China, and arrangements made for effective construction and contract supervision should keep them to a minimum. The progress of the parallel railway relocation project requires careful observation and control during the early years. If this work is executed on schedule, and financing of the second phase of construction (from 1990 onwards) is ensured, the project should not encounter any major difficulties during construction. Environmental and Sociological Considerations 88. There are no mineral resources, archaeological sites or artifacts of significance in the reservoir area. No downstream degradation or serious sedimentation problems are expected to result from the project. 89. About 2,100 ha of farm land, 1,300 ha of forest land, and 700 ha of reclaimed land will be inundated and 63,000 people will have to be resettled due to the construction of the project. The project contains a resettlement component that will provide for the full economic and social reestablishment of the affected population; this resettlement pLan was prepared by the Government and has been appraised and found to be satisfactory to the Bank.  - 25 - Under this component, financial resources are provided to compensate both village entities and family units, so as to enable them to reconstruct their settlements, productive assets and individual dwellings. The compensation package is differentiated to meet the situations of various socio-economic population subgroups, and takes into account land tenure patterns, types of land use and soil quality. Sites have been identified and selected for all the new villages, with due regard to availability of water, health conditions, and proximity to agricultural fields. Connecting roads will be built wherever necessary. Dwelling plots are allocated to each family. Dwelling designs are open to choice and ne-; dwellings are usually planned to exceed the floor area and amenities of prior dwellings. 90. Agricultural redevelopment is the core of the resettlement compo- nent. A diversified agricultural package was designed to restore the produc- tive base of the relocated population. Availability of substitute lands was ensured through systematic identification of large tracts of land currently uncultivated but which have agricultural potential or are suitable for refor- estation, and of suitable sites for implanting the new villages. The alterna- tive agricultural packages envisaged under the project consist of different mires of grain crops, vegetables, fruit trees, animal husbandry, fish ponds and managed forests. In addition, a substantiaL development will be achieved in fruit and tree planting, economic trees and in reforestation for timber. 91. The timetable for population relocation out of the reservoir site is synchronized with the dam construction schedule, the elevations of the flood level behind the cofferdams and the main dam, the vertical distribution of villages and the various infrastructural items in the reservoir area. The timetable is designed to ensure a safe lead time over these deadlines, so as not to impede construction progress. 92. The implementation of the resettlement program will be the responsi- bility of a recently established Resettlement Office under the provincial government. This organization will cooperate closely with but will be independent from SHPC. The Resettlement Office will also arrange for reporting and monitoring of resettlement progress and of the restoration of the productive base and welfare of the dislocated population. To assist in the successful implementation of the resettlement program, assurances were obtained from the Government during negotiations that it will carry out or cause to be carried out the resettlement program in a manner satisfactory to the Bank. PART V - RECOKMENDATION 93. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President December 3, 1986 Washington, D.C.  -26 - ANNEX I Page I of 3 Population I 13,19 million (mid-1983) CNP per capita: $300 (1983) CHINA - ECONOMIC INDICATORS Amount - 1985 Annual growth rates (I) (militen USS at Actual Projacted Indicator current priees)/b 1980 1981 1982 1983 198 1985 198T 1987 1981 19B9 1990 NATIONAL ACCOUNTS /s Gross domestic product 265,300 6.6 4.9 7.8 9.6 14.0 12.3 6.8 6.8 6.8 6.8 6.8 Agriculture 81,710 -1.7 6.4 11.2 9.0 13.9 14.2 4.9 4.9 4.9 4.9 4.9 Industry 133.985 12.3 2.3 7.3 11.4 16.6 15.0 7.7 7.7 7.7 7.7 7.7 Services 49,010 8.2 8.9 3.3 6.5 7.7 10.0 7.9 7.9 7.9 7.9 7.9 Consumption 175,780 9.1 5.2 5.9 9.0 12.5 12.5 8.9 7.4 7.4 7.4 7.1 Cross investment 102,100 1.3 -3.1 10.9 15.2 20.7 40.0 2.3 4.8 4.8 5.1 5.7 Exports of GNFS /s 27,582 17.8 16.7 0.6 9.5 13.0 5.0 8.9 8.8 5.8 8.8 8.8 imports of CNFS 7T; 40,158 16.1 -6.7 -5.7 28.1 25.9 60.1 0.0 5.8 5.9 6.0 6.2 Creos national savinga 90.110 -0.2 3.6 17.0 12.D 17.0 21.0 2.4 5.1 5.1 5.6 6.2 PRICES GOP deflator (1980 - 100) 100.0 101.8 101.7 102.9 107.6 313.1 110.7 124.7 131.0 137.5 144.4 Exchange rate (Yuan/US$) 1.5O 1.70 1.89 1.98 2.32 2.95 3.45 3.70 3.70 3.70 3.70 Shsre of COP at mrket price. (Z) Average annuml increase (Z) (at current prices) (at constant 1981 prices 1Y60 1970 1975 1980 1985 1990 1960-70 1970-75 97-8 1980-8 1986-89 198996 Cross domescic produc. /a 100.0 100.0 100.0 100.0 100.0 100.0 6.1 5.2 6.5 9.0 7.3 6.6 Agriculture 23.0 35.0 32.8 32.0 30.8 31.3 6.7 3.4 3.3 10.1 5.0 4.8 Industry 48.D 41.0 45.8 4B.0 47.1 49.9 7.8 7.5 9.9 9.4 8.6 7.4 Services 29.0 24.0 21.4 20.0 21.1 18.8 3.4 4.5 5.4 6.6 8.2 7.5 Consumption 62.4 70.8 69.1 71.3 66.1 69.3 6.1 4.7 6.4 8.1 8.4 6.8 Gross Investment 37.8 29.2 31.1 30.0 38.4 30.9 9.5 6.9 9.7 11.3 5.1 6.1 Exports of GNFS 4.8 2.8 5.3 7.1 10.4 10.0 -1.5 10.8 5.7 12.3 8.0 7.7 Imports of GNFS 5.0 2.7 5.5 0.4 15.1 10.2 1.2 13.9 13.0 12.2 8.4 7.4 Gross national savings 37.7 29.2 30.9 28.9 33.9 30.7 9.1 6.7 7.2 14.0 4.8 6.2 As 2 of GDP 1957 1970 1980 1983 1985 PUBLIC FINANCE Current revenues 28.7 29.6 30.6 27.8 29.3 Current eKpenditures 15.1 15.7 23.1 21.6 21.5 Surplus (+) or deficit C-) +13.6 +13.9 +7.5 +6.2 +7.8 Capital expenditure 13.7 13.3 11.0 7.8 8.2 Foreign financing 0.7 n.a. 0.5 0.2 0.4 1960-70 1970-75 1975-80 1980-84 1984-89 1989-94 oTmER INDICATORS GNP growth rate (Z) 6.3 5.1 6.4 9.2 7.2 6.6 GCP per capits growth rate (2) 3.5 2.9 5.2 7.9 6.1 5.5 Energy consumption growth rate (2) -0.3 9.2 5.8 4.1 5.3 4.8 ICDR 3.3 4.7 5.1 3.8 4.0 4.6 Marginal savings rate 0.4 0.4 0.3 0.3 0.2 0.3 Import elasticity 0.2 2.7 2.0 1.4 1.1 1.2 /a Date for 1981 and 1982 are from different sources: data for 1982 exclude re-exports. East Aaia and Paciftc Regional Office August 15, 1986  - 27 - ANNEX I Page 21 of' 3 Population : 1,019 million (mid-1983) CNP per captta: 5300 (1983) CHINA - EXTERNAL T'RADF Amount - 1985 Annutli growtlh rates (CE (Ct conntaint prlcem) lb (ml llion IJS9 at Actuln Pra current prices) 1980 1981 1982 1983 19114 1985 TiT EXTERNAL TRADE /a Merchandlse eitportoi 25,108 14.8 17.3 5.5 10.1 In.4 0.4 8.7 Primary 13,7h2 1.5 -1.4 3.9 14.6 9.6 22.3 6.8 Manufactiures 1,346 32.2 16.2 6.6 7.0 11.1 -I3.n 10.4 Murchandine imports 38,231 6.8 7.2 0.2 29.7 22.3 44.9 h.2 Food 3,174 9.1 hH.3 42.9 -30.9 -24.9 -46.5 7.1 PetrolaLmM 152 52.6 -65.5 130.0 -43.5 30.8 20.4 35.5 Machinery and rquipment 14,790 16.4 19.0 -41.7 34.7 H2.1 73.4 S., Others 21,915 0.9 -13.5 7.1 71.7 16.8 36.4 6.3 PRICES Export price tndex (1980"100) 100.0 1112.7 98.7 88.8 90.5 83.b 126.0 Import price Index (1980-100) 100.0 3tl4.5 89.2 76.? 18.4 75.1 112.0 Termn of trade index (i980-100) 100.0 9e.3 130.7 115.8 115.4 111.3 112.5 Composition of merchandise trade (2) Averiage ainnUnI increase (Z) (at current pricen) (at constant prices) 1978 L981 1985 1990 1980-84 198_8-9 1989-94 Exports 100.0 100.0 100.0 100.0 30.8 7.9 7.6 Primary 53.4 46.6 54.8 42.1 6.7 6.4 h.1 Manufactures 46.6 53.4 45.2 57.9 15.2 9.4 8.2 Imports 100.0 100.0 100.0 100.0 14.9 8.5 7.5 Food 12.8 17.4 3.6 9.7 13.9 8.9 8.5 Petroleum 0.5 0.4 0.4 0.9 13.0 17.2 16.1 Machinery and equipment 18.9 29.2 38.7 33.3 23.6 12.0 6.8 Others 67.9 53.0 57.3 56.1 20.5 6.7 7.5 Share of trade with Share of trade with Share of trade with industrial developing the USSR and cotintries (2) countrtes (2) Eastern Europa (Z) 1977 1980 1983 1977 1980 1983 1977 3980 19H3 DIRECTION OF TRADE Exports 36.4 44.7 42.1 46.8 48.7 53.2 16.8 6.6 4.7 Imports 63.1 73.6 69.0 20.7 19.7 24.5 16.2 6.7 6.5 In Based on cuscosm statistics. Exports, f.o.h.. imports. f.o.b. lb Growths In 1985 of itemized exports and imports are prelitmnary estimates. East A.st and Pacific Regional Of fice August 15, 1986  - 2S - ANNEX I Page 3 of 3 Population :1,019 million (mid-1913) CNP per capita: $300 (1983) CHINA - HALANCF OF PAYMENTS, EXTERNAL CAPITAL AND PENT (Nillions of US$ at cirrent prices) Actual Prolected tudicator 197R 1979 1980 19R1 1982 19R3 19i6 I985 19