Tanzania - Second Kidatu Hydroelectric Power Project

FILE COPY Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-1 879-TA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE UNITED REPUBLIC OF TANZANIA FOR THE KIDATU HYDROELECTRIC PROJECT - SECOND STAGE June 18, 1976 This document bas a restricted distibution and may be used by recipients only In the performance of their official duties. Its contents imy not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (as at November 1, 1975) Tanzania SH = US$0.12 US$1.00 = TSh8.05 (The Tanzania Shilling is officially valued at a fixed rate of 9.66 TSh to the SDR. The US Dollar/Tanzania Shilling exchange rate is therefore subject to change. Conversions in this report were made at US$1.00 to TSh8.05, which is close to the short-term average exchange rate.) ABBREVIATIONS KfW - KreuitailStalt fur WiLederaufbau KWh - Kilowatt hour MW - Megawatt SIDA - Swedish International Development Agency SWECO - Swedish Consultlng Croup TANESCO - Tanzania Electric Supply Company Ltd. TANU - Tanganyika African National Union TANZANIA FISCAL YEAR July 1st - June 30th  FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE UNITED REPUBLIC OF TANZANIA FOR THE KIDATU HYDROELECTRIC PROJECT - SECOND STAGE 1. I submit the following report and recommendation on a proposed loan to the United Republic of Tanzania for the equivalent of US$30 million to help finance construction of the Second Stage development of the Kidatu Hydroelectric Project on the Great Ruaha River. The proposed loan will be on standard Third Window terms of 25 years, including seven years of grace, with interest at 4.85 percent. These funds will be relent to the Tanzania Electric Supply Company, Limited (TANESCO) at an interest rate of 8.85 percent per annum for 25 years, including five years of grace. In addition, the Swedish International Development Authority (SIDA) has committed SKr8O million (US$18.6 million equivalent) on a grant basis and Kreditanstalk fur Wiederaufbau (KfW) of the Federal Republic of Germany has committed DM60 million (US$24 million equivalent) at 2 percent for 30 years (including 10 years of grace) to the Government of Tanzania for this project. PART I - THE ECONOMY General 2. Although it has been sometime since the last full economic and updating reports on Tanzania were finalized in May and December 1972, respectively, considerable staff economic work has been accomplished on the country since that time. An agricultural sector report was issued in December 1974. The report of an industry and mining mission was distributed in April 1975 and a study of the fiscal aspects of Tanzania's recent decentralization was completed in April 1975. In March 1976, at the request of the Government, the Bank mounted a special mission which analyzed the fiscal implications of the Government's programs for Universal Primary Education and Univer- sal Rural Water Supply. The work of this mission will provide a substantial input to the work of the basic economic mission which is scheduled to visit Tanzania in mid-1976. Throughout the last two years 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.  -2- or so, Bank staff have engaged in a continuous economic dialogue with the Government on the serious balance of payments difficulties which have been encountered by the country and the Government's policies and programs designed to close the external gap. These policies and programs were reviewed in the Program Loan President's Report No. P-1517a-TA, dated November 25, 1974 and in a memorandum (M75-687) from the Secretary dated September 25, 1975. The Consul- tative Group for East Africa met in April 1975 to discuss the progress and prospects of the Tanzania economy and the need for additional resources to support the Government's development program. 3. The TANU Party, under the leadership of President Nyerere, has been the guiding force in Tanzania's political evolution since the 1950's. Over the years following independence the political leadership has developed a philosophy of egalitarian socialism which has been articulated in many documents, most central of which is the Arusha Declaration of 1967. In restructuring the political, economic and social life of the country the leadership has introduced an impressive series of far-reaching institutional reforms. For the past decade Tanzania's social and economic policy has been guided by three fundamental objectives: (a) the achievement of a participatory, decentralized socialist economic order; (b) the eradication of absolute poverty and progress toward greater income equality; and (c) more rapid long-term economic growth with full participation of all regions and population groups in the development process. Reflecting this philosophy some of the Government's most significant decisions have been in the area of income policy. The tax structure is highly progressive and middle and upper incomes have been restrained while lower income wages have been increased. In the provision of social infrastructure services, poorer areas have been favored. As a result of these and related policies, differentials in living standards between upper and lower urban dwellers have been narrowed and some impact has been made on urban/rural differentials and regional disparities of in- come. 4. The overriding goal is to develop a socialist economic system and the consequence has been a series of industry nationalization measures and proliferation of government parastatal enterprises. The state has increasingly intervened in the price mechanism; prices of domestic factors and products and imports are controlled directly or by such indirect methods as import licensing. These structural changes have resulted in some implementation problems. In addition, scarce managerial manpower has been spread very thinly, exacerbating already serious shortages of top and middle-level staff. Some of these conflicts should be seen, however, as the inevitable consequence of a "frontal" attack on poverty and underdevelopment.  -3- 5. With a per capita income of only $130, Tanzania is classi- fied as one of the 25 least developed countries as defined by the United Nations (Country Data are provided in Annex I). Between 1968 and 1973 Tanzania's GDP grew at 4.6 percent per annum. Domestic savings averaged 17 percent of GDP, while gross investment averaged 21 percent -- extremely high rates for a country at Tanzania's low level of per capita income. The growth rate of GDP was not commensu- rate with the magnitude of the investment effort, however, in part because of the high proportion of investment which was directed into infrastructure and social services projects such as the transportation links with Zambia, because of sluggish growth in the agricultural sector, and because of stagnant or declining productivity in parastatal enterprises. During this period the balance of payments position of Tanzania was generally satisfactory, despite the disappointingly slow growth of exports (overall export volume grew at only three percent per year from 1968 to 1972 and in 1973 export volume fell back to the 1968 level). Nevertheless, because of a sharp increase in capital inflows, the overall balance of payments was in surplus from 1971 to 1973, and there was a modest build-up in foreign exchange reserves. As a result of prudent financial management, net reserves were increased to approximately $145 million by the end of 1973, the equivalent of four months' imports. 6. Events then occurred which resulted in a drastic change in the overall balance of payments of Tanzania. The 1973 and 1974 rains failed in many parts of the country necessitating substantial increases in imports of basic food items beginning in mid-1974. The drought also affected cash crops, leading to a further decline in the export volumes of coffee, cotton and sisal. Although world prices for Tanzania's exports jumped 52 percent in 1974, total export receipts rose only 18 percent due to drought-affected crop yields. At this same time as a result of higher prices for imports the total import bill for 1974 rose by 60 percent over 1973. The outcome of these forces was a rapid depletion of net reserves to only $50 million at the end of 1974, equivalent to only three weeks of imports. Industrial production also stagnated in 1974, due in part to shortages of imported raw materials and spare parts stemming from the growing foreign exchange constraint. As a result, overall GDP may have actually declined slightly during the year although official statistics indicate an increase of 2 percent. While production declined, domestic demand increased rapidly, due to expansionary fiscal, monetary and wage policies, causing severe pressure on the domestic price level. The retail price index for low income workers rose by 57 percent in 1974 while that for middle-grade civil servants jumped 35 percent.  -4- 7. During 1975, while the food production shortfall was substantially reversed and inflation was reduced to around 30 percent, grain imports were still required and the balance of payments situa- tion remained critical. In addition, export performance was extremely disappointing with total value of exports declining by over 11 percent. The overall balance of payments gap for 1975 was about $140-$145 million, equal to the deficit for 1974. Tanzania was able to cover the 1975 foreign exchange gap by curtailing imports to the bare minimum and by securing substantial program type assistance, including a $30 million Program Loan (No. 1063-TA) from the Bank and a $24.3 mil- lion drawing on the IMF special oil facility approved in August 1975. Tanzania's present economic crisis cannot be attributed exclusively to drought-related crop failures and import price escalation. The most distur- bing aspect of Tanzania's economic situation has been the declining growth rate of output from the agricultural, industrial and mining sectors. The growth rate of agricultural output had been running slightly behind the rate of growth of population for six years prior to the harvest failure of 1974. Inadequate producer price incentives, inefficiencies in the transport and distribution systems for inputs and marketed production contributed to this disappointing performance. The problem was also compounded by the Government's early 1974 decision to rapidly increase the pace of villagization which it views as the only effective way to deliver essential economic and social services to a widely scattered population. (It is now estimated that about 70 percent of the rural population, almost 9 million people, are living in villages). The Government is aware that the inadequately planned and poorly coordinated villagization has had a negative impact on agricultural production but the 1974 decision was made to complete the process in as short a time as possible and the resettlement is now largely an accomplished fact. On the other hand, in the modern sector many enterprises have experienced declining labor productivity which has been attributed to lack of incentives, poor discipline and ineffective management. Furthermore, while the ratio of domestic savings to GDP rose during the 1960's, it began to decline by 1973 and fall drastically to 7.5 percent in 1974 as a direct outcome of the balance of payments crisis. In addition to the above- mentioned factors, the high level of investment which has gone into slow-gestation social and economic infrastructure rather than into the directly productive sectors has prevented more rapid growth of output. 8. The Tanzanian Government in late 1974 formulated a compre- hensive program of policy actions to bring the balance of payments under control in the medium run and to restore the growth rate of output. The principal elements of the program included a reallocation of investment in favor of directly productive sectors, measures to raise agricultural output, steps to improve incentives in industry and mining  -5- and to increase the export orientation of these sectors, and constraints on public and private consumption demand. Imports were cut through direct controls and measures were introduced to slow down the rate of growth of private consumption. Indirect taxes were raised and further increased in the 1975/76 budget. User charges for water and electri- city were also raised and an extremely restrictive wage and salary policy has been followed. Further, the Government is making a serious effort to bring the rate of growth-of-public consumption expenditures under control. The 1975/76 budget called for a level of current expenditures below the revised estimate for 1974/75 and while this target may not be realistic the intentions of the Government are never- theless clear. In addition cuts of about 7 percent in the civil service were made in March 1976. 9. On the production side, several steps have been taken to increase output. The Government has raised agricultural producer prices to levels approaching world parity and certain progressive export taxes have been reduced or eliminated. The overall planning capability of the Ministry of Agriculture is being strengthened and a project coordiantion unit to improve implementation has been established in the Ministry. Furthermore, as a major component of its efforts to expand material production the Government has made signi- ficant progress in reallocating public investment in favor of the directly productive sectors of agriculture, industry and mining. Another problem area in which action has been undertaken is that of export development. In October 1975, Tanzania, in conjunction with Kenya and Uganda, devalued the shilling by approximately 14 percent. Given the heavy reliance of the East African Community on export markets in the U.K. and the substantial recent decline in the value of sterling, this devaluation can be construed as an attempt at restoration of competitiveness of exports to the U.K. and also an incentive to exporters to non-sterling markets. The Government's progress in implementing policies and programs designed to close the balance of payments gap in accordance with understandings relating to the program loan was the subject of a memorandum (M75-687) from the Secretary to the Executive Directors dated September 25, 1975 (paragraph 2 above). The most ecouraging aspect of the Government's response to the balance of payments crisis was the demonstration that Tanzania retains the ability to push through necessary and unpopular measures over a wide front. It is this characteristic of a "hard state," together with the basically sound program of economic restructuring, which holds the promise for the future. 10. Tanzania's prospects for bringing the balance of payments deficit under control in the medium term clearly depend upon the effectiveness of the program of policy actions outlined above. It is not possible to determine the time period over which all the policy  -6- measures introduced by the Tanzanian Government will take effect. The austerity measures introduced in 1974 and 1975 have already had an impact on imports and on domestic consumption, and the recovery of food production in 1975 has clearly helped to alleviate the food deficit. However, the basic program of economic restructuring will require more time before its full effects can be realized. For example, some new investments in agriculture, industry and mining that will directly benefit the balance of payments will take several years to come to fruition. Thus the balance of payments will remain weak in the short run. However, Tanzania should have a stronger economy at the end of the restructuring process. The central focus of the assistance efforts should be, therefore, to ensure that the balance of payments gaps arising over the next few years do not prevent Tanzania from implementing a development program designed to incorporate the required policy changes. In this connection, negotia- tions for a proposed second program credit were directly held in Dar es Salaam. In addition, and despite Tanzania's impressive domestic savings performance, a continued capital inflow in excess of the foreign exchange component of high priority projects will also be required if Tanzania is to achieve its development targets. Financing of some local expenditures will, therefore, be justified. 11. In terms of debt outstanding and disbursed, the Bank Group is Tanzania's second largest creditor after the People's Republic of China. Other major lenders are Sweden, Canada, Denmark, the Netherlands and the Federal Republic of Germany. The current low overall debt service ratio of about 7 percent is expected to rise to about 11 percent by 1980 and remain at about that level throughout the 1980's. Includ- ing a notional one-third share of the debt of the East African Communi- ty Corporations, the IBRD is presently holding 13 percent of Tanzania's outstanding external debt and IDA 10 percent; the IBRD share is expected to rise about 23 percent in the next five years, and the IDA share to rise about 13 percent. Debt service payments to the Bank are about 13 percent of total debt service payments; the corresponding share of IDA is about 3 percent. These two figures are projected to rise to about 25 percent and 3 percent, respectively, by 1980. The debt service ratio of Bank loans to exports is expected to rise to about 2 percent by 1980. The Bank's exposure is high because several major donors are now making their aid available either on grant basis or very concessional terms and because as a result of prudent debt management suppliers' credit have been kept to a minimum. The average interest rate on loans to Tanzania outstanding at December 31, 1974 amounted to only 2.4 percent and the average term was 22 years.  -7- 12. Tanzania is considered eligible for Bank lending on Third Window terms on the basis of the following criteria: (a) Per capita income In 1972 - $120 (b) Performance The Government's strong commitment to development is evident from the recent high rates of domestic savings and gross investments which averaged 17 percent and 21 percent, respect- ively, of the GDP between 1968 and 1973 (paragraph 5 above). Its program for economic restructuring is basically sound and, in order to achieve this restructuring, Tanzania has shown itself willing to push through necessary but unpopular measures over a wide front. (c) Ability to repay In view of the Government's encouraging response to the serious balance of payments crisis, its prudent management of the foreign debt (paragraph 5 above) and good medium term develop- ment prospects, Tanzania is creditworthy for limited amounts of Bank lending on intermediate terms as proposed herein. (d) Access to alternative sources of capital Tanzania's ability to implement its development program depends to a large extent on the continued availability of external capital. While it has received additional external assistance in recent years, this has not been commensurate with its need and it cannot prudently borrow substantial additional sums on commercial terms.  -8- East African Community 13. The East African Community Corporations have experienced difficulties in recent years. While the 1967 Treaty for East African Cooperation is one of the most far-reaching and comprehen- sive economic cooperation agreements in existence among sovereign states in the developing world, in practice, the degree of economic integration and cooperation among the Partner States is much less than what was envisaged in the Treaty. Political developments in the Partner States have created tension within the Community and impaired the growth of inter-state trade. These difficulties have been compounded by the balance of payments constraints which all three Partner States experienced. 14. Of the Community Corporations, the East African Railways Corporation (EARC) has been the most severely affected. As a result of long delays by the Partner States in approving increases in tariffs and restrictions on the interstate transfer of corporate funds, EARC was unable to order essential spare parts and supplies with the result that its operational capacity has deteriorated considerably. In July 1974, the Partner States agreed, with Bank assistance, on a package of financial measures to rehabilitate the EARC including interstate transfer of funds and injection of additional capital. However, this agreement was never fully implemented and as a result disbursements under Loan No. 674-EA (East African Railways III) were suspended in February 1975. A further meeting was held in July 1975 at which an agreement was again reached on formula for sharing of debt service payment by the Partner States, and suspension of the loan was lifted. 15. The Partner States recognized that because of their fundamen- tal, political and economic differences, a review of the 1967 Treaty was called for. For this purpose a Commission has been established consisting of three Cabinet level officials from each country, with Mr. Demas, President of the Caribbean Development Bank, as Chairman. This Commission is expected to submit its reports by the end of 1976. While there is hope that the Commission may deal with the structural differences in the long run, the Corporations are still facing a difficult period. 16. Since February 1976 the relationship between the Partner States has further deteriorated. Arrangements for debt service payments  -9- were again disrupted resulting in long delay in making debt service payments to the Bank. Disbursements to the East African Railways Corporation, the East African Harbours Corporation, the East African Posts and Telecommunications Corporation and the East African Development Bank were suspended by the Bank on April 28, 1976. As the Executive Directors were informed on May 25, 1976, (SecM76-383), a mission visited East Africa in May to discuss with the Presidents and Finance Ministers the debt service problems which endangered both the Bank's opera- tions in East Africa and the credit standing of the Community and the Partner States (being jointly and severally responsi- ble). An agreement was reached to ensure remittances from the Regional Offices of the Corporations to complete all over- due payments and these were made by June 1, 1976. Disburse- ments on the Community loans were, therefore, resumed with effect from June 1. Regarding future debt service payments, the Agreement specifies (i) fixed contributions by each Partner State to meet external debt obligations, (ii) commits the Governmentsto ensure remittances from the Regional Offices of the Corporation, (iii) establishes a mechanism and procedure for timely payments, and (iv) provides automatic foreign exchange cover for debt service remittances. PART II - BANK GROUP OPERATIONS IN TANZANIA 16. Tanzania joined the Bank, IDA and IFC in 1962. Beginning with an IDA credit for education in 1963, 23 IDA credits and nine  - 10- Bank loans amounting to $349.8 million have so far been approved for Tanzania. In addition, Tanzania has been a beneficiary of 10 loans totalling $244.8 million, which have been extended for the develop- ment of the common services and development bank operated regionally by Tanzania, Kenya and Uganda through their association in the East African Community. The only IFC investments in Tanzania to date, totalling $4.7 million, were made in the Kilombero Sugar Company in 1969 and 1964. This Company encountered financial difficulties and in 1969 IFC and other investors sold their interest in the Company to the Government. Annex II contains summary statements of Bank loans and IDA credits to Tanzania and the East African Community organizations as of May 31, 1976 and notes on the execution of ongoing projects. 18. In keeping with Tanzania's overall development strategy our lending operations are increasingly focusing on the rural sector and directly productive projects. Up to the end of FY72 10 out of 14 loans and credits made directly to Tanzania had been for infrastruc- ture. Of the 18 Tanzania operations approved since then all but four: Urban Sites and Services (Credit No. 495-TA), Highway Maintenance (Credit No. 507-TA) and Educations IV and V (Credits No. 371-TA and 607-TA), were for directly productive projects. These directly productive projects are supporting both the agricultural and industrial sectors, including the Kigoma Integrated Rural Development Project (Credit No. 508-TA) and our first direct lending for an industrial project (Mwanza Textiles, Loan No. 1123-TA). In addition, a tobacco processing project and a project to support selected industries at Morogoro are expected to be ready for considera- tion by the Executive Directors in the near future. A proposed second rural development project and a water supply project have recently been appraised in the field and negotiations for a second program loan were recently held in Dar es Salaam (see paragraph 10 above). 19. While it should be borne in mind that over one-half of total Bank Group lending to Tanzania has been approved in the last two fiscal years and that initial start-up difficulties are perhaps inevitable, the project implementation difficulties referred to in Annex II of this report have been greater than anticipated. Some of these problems stem from the scarcity of suitably trained and qualified manpower, some reflect the understandable reluctance and apprehension of an essentially conservative traditional sector to adopt  -11- new "technology" and others are undoubtedly a reflection of the strains created in a society which is attempting a unique traverse from one set of economic, institutional and political rules to another. The Government has become extremely conscious of these implementation issues and is taking steps to resolve these problems. An earlier reluctance to recruit technical assistance for planning and implementation has been replaced by a willingness to utilize such assistance whenever it is demonstrably necessary. A technical assistance project designed to strengthen project preparation and implementation was recently approved by the Executive Directors. At the request of the Government about 10 technical staff have been applied by the Agriculture Development Services (ADS) and a Bank staff member has recently been seconded to the Project Implementation Unit in the Ministry of Agriculture. In a longer term attempt to alleviate the human resource constraints our lending is expected to increasingly emphasize formal and non-formal training. Furthermore, a conscious attempt is being made to develop less complex projects. 20. The difficulties facing the EAC and the common services corporations (paragraph 13 above) have affected the Bank's lending program to the Community. Yet while the exact form of the reorganized Community services remains to be determined, the development of the transport and communications infrastructure to facilitate national programs of the Partner States will continue to be an important aspect of the development of the three countries. We therefore anti- cipate a continuing role for the Bank in these sectors. Field appraisal of a fourth Posts and Telecommunications project has been completed and a Railways project and a Harbours project will be ready for appraisal in fiscal year 1977. In each instance all organizational and guarantee questions will be resolved before conclusion of lending arrangements. PART III - THE POWER SECTOR Background 21. The main indigenous energy resource in Tanzania is hydro power. Most of the potential is in the basins of eight rivers draining into the Indian Ocean, although there is also scope for hydro development on three of the rivers of the Nile system within Tanzania. A small quantity of coal is mined in the-Songwe-Kiwiri area but commercially exploitable bulk deposits have yet to be proven. While sizeable deposits of bituminous coal have been discovered north of Lake Nyasa, the remoteness of this field makes it unlikely that this coal would be  -12- economic in electricity generation for the coastal region in the foresee- able future. Firewood is the main fuel in the subsistence sector and its potential in this respect is being examined in the context of a number of the Bank's regional rural development projects. Firewood is also in limited use by industry for generating processing steam. The main commercial form of energy, oil, is imported both in crude form and as refined products. A refinery with a one million ton per year capacity in Dar es Salaam processes the crude imports for domestic consumption and re-export. The existing diesel power stations and gas turbine use oil fuel from this refinery as well as imported gas oil. Oil prospecting, which has been carried on for many years without success, is continuing in the several areas by AGIP (an Italian oil company which has exclusive prospecting rights in the coastal sedimentary belt and the continental shelf). 22. Since independence in 1961, the power sector has been growing much more rapidly than the economy as a whole. Sales by the Tanzania Electric Supply Company, Ltd. (TANESCO) rose at an average rate of 10 per- cent per annum between 1964-1975. Total investment by TANESCO during 1964-1969 amounted to T Sh 276 million (US$39 million*) or about 5.7 percent of total national investment. Power investment in the Goverrment's 1969- 1974 plan was projected at about 6.0 percent of the total planned national investment during that period. This allocation of resources to power is viewed as appropriate for a country in Tanzania's stage of develop- ment. 23. The industrial sector accounts for the bulk of electricity con- sumption. During 1970-1975, industrial users accounted for about 69 percent of total sales followed by domestic users with about 18 percent and the commercial sector with about 13 percent. Only 950,000 persons (less than 7 percent of total population) have access to electricity through 71,570 connections, although about 12 percent of the population live in the towns and villages where electricity is available. Present overall per connection consumption of about 5,500 kWh per annum and annual per capita consumption of about 70 kWh for domestic users are low. Connection density is about .25 per 1,000 population in rural areas and about 65 per 1,000 population in urban areas. Existing Facilities and Development Program 24. The Government and TANESCO have attempted to exploit available domestic energy resources through the development of hydro power. Reflecting this, Tanzania's current total installed generating capacity of about 266 MW includes 151 MW of hydro. The remaining capacity consits of 100 MW of diesel At the then prevailing exchange rate.  -13- and steam and 15 MW of gas-turbine. Recent oil price increases have provided additional Lncentives for hydro development and as a result, a 10 MW hydro electric project was financed by the U.S.S.R. Other investments have included extensions of existing disbribution facilities and construction of about twenty small diesel stations in various townships. Plants already under construction and scheduled for commissioning in the period of 1975-1980 (which would exclude the project presently under considera- tion) will bring TANESCO's installed capacity to about 355 MW and the country's total to about 375 MW. TANESCO 25. Taaizania E:Lectric Supply iompany, Ltd. was founded as a private company in 1931. In 1964 it was acquired totally by the Government of Tanzania through purchase from the East African Power and Lighting Company Limited (EAP&L) of Kenya of all the issued shares not already held by the Government. Payments for these shares were made over a twelve-year period and com-pleted by the end of 1975. A parastatal under the sponsorship of the Ministry of Water, Energy and Minerals, TANESCO has been made responsible for the development of the country's power industry. It has functioned as the sole organization for the public generation and distribution of elec- tricity throughout mainland Tanzania and operates in accordance with com- mercial principles. 26. In 1973, TANESCO was reorganized along functinnal lines based on the recommendations of a study carried out by Scandiaconsult, a Swedish firm. This reorganization was aimed at giving more operational and cons- truction responsibilities to regional levels. Day-to-day operations are under the direction of the General Manager, who is assisted by a Deputy General Manager and six Division Managers. The management is responsible to a Board of Directors consisting of a chairman, who is the Minister of Water, Energy and Minerals, and ten other members: representatives of various other ministries, the industrial and banking sectors, the Tanganyika African National Union (TANU) and the Parliament; a university professor; and the General Manager of TANESCO. The Board meets about every two months. 27. The present General Manager, who has served since early 1973, is the first Tanzanian appointed to this position. Assurances have been obtained that from time to time the Government and Bank would discuss the qualifications and experience appropriate in considering General Manager appointments (Section 4.01 of the Joint Financing Agreement). TANESCO is well-managed and has been very successful in filling most of its senior managerial positions with qualified Tanzanian staff. In accordance  -14- with the Government's general Tanzanization policy, the percentage of Tanzanian citizens in senior staff posts increased from 20 percent in 1964 to about 80 percent today. This has been brought about by a well- planned training and sponsorship program which has been initiated, admi- nistered and partly funded by TANESCO and SIDA during the past ten years. TANESCO currently has about a 3,000 man-work force. Reflecting TANESCO's management capacity, this figure has been stable over the past five years even with the rapid growth in services provided. 28. A review of TANESCO's financial performance clearly indicates that TANESCO enjoyed a period of adequate earnings until 1974 when fuel prices sharply increased (diesel oil by 140 percent and furnace oil by 200 percent). A dry spell which limited hydro generation and repeated failures of the diesel units and the gas turbine at the Ubungo station also contributed to the deterioration of TANESCO's profitability in that year. As a result, the rate of return on average net operating assets dropped from 13.4 percent in 1973 to 6.3 percent in 1974, inspite of the 30 percent across-the-board tariff surcharge effective April 1, 1974. An analysis of TANESCO's cash flow for 1970-1974 indicates that its net internally generated cash accounted for about 16.5 percent of the total financing required during this five-year period. This is satisfactory, particularly in view of the fact that its total assets more than doubled in real terms during these five years. TANESCO's debt-equity ratio of 50/50 as of December 31, 1974 reflected a satisfactory capital structure. Rural Electrification 29. The Government's program for the electrification of rural areas basically covers the electrification of "ujamaa villages" with bilateral assistance. Since this operation is expected to be unprofitable, it is expected that a new organization (the Rural Electrification Corporation) will be established for this purpose. According to a draft study on the duties and responsibilities for this organization (prepared by TANESCO and approved in principle by the Ministry of Water, Energy and Minerals) this corporation would be involved in the planning of village electrification in connection with the general power planning of the country carried out by TANESCO. It is intended that TANESCO would assist in the construction and operation of these village power systems, but that these facilities would be owned by this new organization and that all expenditures in excess of revenues would be covered by Government subsidies. It is also intended that these installations would be turned over to TANESCO when they become commercially viable. This arrangement is satisfactory as it would not impair TANESCO's principle of commercial viability but would also make the technical and cost-conscious expertise of the management of TANESCO avail- able to the rural electrification operations.  -15- PART IV - THE PROJECT 30. A report entitled "Tanzania - Appraisal of the Kidatu Hydroelectric Project - Second Stage Development" is being circulated to the Executive Directors separately. This project is essentially a continuation of the First Stage Kidatu Rydroelectric Project which was appraised in 1970 and cofinanced by SIDA, the Canadian International Development Authority (CIDA) and the Bank {Loan No. 715 TA). The First Stage was completed according to the original schedule, although with substantial cost overruns, and has operated satisfactorily since May 1975. The water intake, headrace tunnel, powerhouse, control room, tailrace tunnel, switchyard, and all related civil works of the accessories and auxiliaries at Kidatu had been excavated and constructed during the First Stage according to an ultimate design which includes provision for this Second Stage. 31. The Project has been prepared following reconnaissance and pre- appraisal missions in May 1974 and December 1974, a report on the geological situation and design by a Bank consultant, and a feasibility study dated February 1975 by the consultants (SWECO). The Project was appraised in April 1975 by a Bank mission joined by SIDA representatives. A loan and pro- ject summary is given in Annex III. Negotiations were held in Washington in January 1976. The Tanzanian delegation was led by Mr. Kasambala, General Manager, TANESCO. Project Description 32. This proposed Second Stage of the Kidatu Hydroelectric Development includes the construction of a concrete dam located 6 km downstream of the Mtera bridge on the Dodoma-Iringa highway, with a maximum height above the river bed of about 45 m and a total crest length of 350 m. The selection of the site was based on favorable ground conditions and reservoir capacity. The dam would ensure the provision of a regulated river flow during dry seasons sufficient for the requirements of the entire Kidatu Scheme. 33. At the existing Kidatu station the water is being conveyed from the Kidatu reservoir to the turbines through a concrete intake structure, a headrace tunnel, and four vertical penstocks. Only two of the penstocks have been provided with steel lining and cylindrical gates during the First Stage construction and the other two shafts would be provided in this Project. The two existing Francis type turbines have been coupled to two generators, each of 50 MW rating. Two additional turbine-generator units similar to the existing ones would be provided for under this Project.  -16- 34. In the Kidatu powerhouse, two additional sets of transformers, one set for each generating unit, would also be placed underground in separate rooms adjacent to the main machinery hall. Power from the new transformers would be transmitted to the existing outdoor switchyard by a set of cables which would be financed by this Project. The existing trans- mission line, would then transmit the additional power supplied by this Project to a step-down substation to be constructed at Ubungo on the outskirts of Dar es Salaam. Although the capacity of the above-mentioned Kidatu-Ubungo line is sufficient to carry additional power, studies have shown that a 220/130 KV, 90 MVA transformer at the existing Morogoro substation would be necessary for better reactive load distribution and system voltage regulation to obtain better stability for higher load tansportation and to reduce system losses. Such a transformer station has, therefore, been included in the Project for financing. 35. Finally, the Project would finance consulting services necessary for project design and construction and a training program for TANESCO's middle management and professional staff. With regard to training it was agreed that TANESCO would submit a training program to the Bank for review and comment by June 30, 1976 (Section 3.04 of the Joint Financing Agreement). 36. Although there are no competing claims for the waters of-the Great Ruaha River upstream of the Kidatu and Mtera dam site, continued availability of water in sufficient quantities for the Project would be essential. Assurances were therefore obtained that the Government will not permit significant abstraction of water from the Great Ruaha River or its tributaries upstream of Kidatu that would reduce the potential generating output of the Kidatu station (Section 5.03 of the Joint Financing Agreement). Estimated Costs and Financing 37. The estimated total cost of the Project is US$91.0 million equivalent net of customs duties but including interest and commitment charges during construction. Approximately US$63.6 million or 70 percent of this would be foreign exchange. These costs are presented in more detail in Annex III. As a result of construction experience from the completion of the First Staae, physical contingencies of 25 percent on civil works and 15 percent on equipment have been included in project costs. Based on the experience of rapid price increases both in Tanzania in general but particularly under Loan 715-TA, relatively high price contingency allowances of 42 percent on civil works and 29 percent on equipment have also been provided.  -17- 38. The proposed loan of US$30 million equivalent, together with the SIDA grant of US$18.6 million equivalent, will be made available on a joint financing basis. Together with the KfW parallel financing of US$24 million equivalent, the total contribution of external funds to this project, amount- ing to about 79 percent of the total project costs, would cover foreign exchange component as well as about US$9.0 million equivalent of local costs. The proposed loan would finance US$25.5 million of the foreign costs and contribute US$4.5 million towards the local costs. Financing of some local costs is considered justified (paragraph 10 above). TANESCO will finance internally the remaining 21 percent of project costs. The funds made available under the Third Window loan would be on-lent by the Government to TANESCO for 25 years including five years grace at 8.85 percent per annum. Also, the proceeds of the SIDA grant and KfW loan would be on-lent by the Government to TANESCO on the same terms. TANESCO would bear the foreign exchange risk (Section 5.06 of the Joint Financing Agreement). Procurement and Disbursements 39. All contracts in excess of $120,000 equivalent to be financed from the proposed loan and SIDA grant would be awarded on the basis of international competitive bidding consistent with the Bank/IDA Guidelines for Procurement. As some of the contracts to be let under this Project, both for manufactured goods and for civil works, could attract local bidding, domestic manufacturer's would be allowed a preference of 15 percent or the existing rate of duties (whichever is lower) over the c.i.f. price of competing foreign suppliers and domestic civil works contractors would be allowed a preferential margin of 7-1/2 percent over the bid prices of foreign contractors. Contracts to be financed from the KfW loan are also expected to be awarded on the basis of international competitive bidding. 40. The loan will finance the training program and the interest and other charges related to the loan during the project construction period (estimated at about US$3.5 million equivalent). The loan will also be jointly disbursed with SIDA on the basis of 10:7 ratio, against: (a) 100 percent of the foreign expenditure on mechanical and electrical equipment at Mtera and consulting services and training; and (b) 75 percent of the costs of civil works. The loan and SIDA grant would include a total of about US$1.1 million for retroactive financing of services of consultants and experts. KfW, as a parallel cofinancier, has agreed to finance costs for supply and installation of the turbines, generators and electrical and mechanical equipment at Kidatu and the 90 MVA transformer at Morogoro. The Project is expected to be completed by the end of 1980; the closing date would be December 31, 1981.  -18- Project Supervision 41. The Swedish Consulting Group (SWECO) has been involved in the Kidatu Scheme since its participation in the 1968 comparative study which identified Kidatu as the most economic location for power develop- ment in Tanzania. SWECO was engaged by TANESCO for the design, prepara- tion of bidding documents, bid evaluation and supervision of the First Stage Kidatu Development and will serve in an identical capacity during the Second Stage. SWECO's performance under the First Stage gave rise to some difficulties and differences with TANESCO, but corrective measures have been instituted and TANESCO has requested SWECO to continue. 42. TANESCO has agreed to strengthen its own construction manage- ment and supervisory capacity with the appointment of two full-time experts, one to work at the site and the other to advise the head of TANESCO's Planning Division at TANESCO's headquarters (Section 3.05 of the Joint Financing Agreement). In addition, TANESCO will have available on a part-time basis an adviser on contractor's claims to protect TANESCO from unreasonable claims and a panel of experts to advise it on project design and on project implementation (Section 3.05 of the Joint Financing Agreement). Financial Aspects 43. As noted above (paragraph 28), TANESCO's financial position deteriorated considerably after the oil price increases. In spite of Government's approval of a 30 percent surcharge effective April 1974 to compensate for cost increases, TANESCO had to request a further 12  -19- percent tariff increase in 1975 in order to meet the minimum 7 percent rate of return required under Loan 715-TA. However, this second increase was not acted upon by the Government. In any case the appraisal team's financial projections indicated that an even more substantial tariff increase would be required beyond 1975. If appropriate increases were not forthcoming TANESCO's ability to mobilize funds to support its ongoing operations and to finance its future investment program would be endangered. The only alternative to this internal financing, a Government allocation to TANESCO, would imply a subsidy to the users of power which certainly cannot be justified in the Tanzanian context. 44. Therefore, in order to begin to re-establish the financial viability of TANESCO and to provide sufficient funds for its needs (as measured by a 7 percent return on revalued assets), the Government approved a further tariff increase of 40 percent effective June 1976. Furthermore, assurances have been received from the Government that in the future, tariffs would continue to be adjusted to maintain a rate of return on average revalued net fixed assets in operation of at least 7 percent in 1977 and thereafter (Section 5.09 of the Joint Financing Agreement). 45. In addition, with the assistance of the Bank, a study is being undertaken to develop a cost reflecting tariff structure to replace the present system. While the average level of tariffs under the restructured system would be adequate to ensure the minimum rate of return, the new tariffs would reflect as much as possible costs of supply and provide in- centives to consume electricity during the off peak hours and to restrict peak demand. It is anticipated that a well designed tariff structure will cut into peak demand and by reducing the growth in the load curve over time lead to a rephasing of future power investments. Given the high investments required in the power sector, this will allow a substantial increase in the allocation of resources to directly productive projects and make an important contribution to Tanzania's development. Assurances were obtained during negotiations that TANESCO would review the study with the Government and the Bank and then introduce a cost reflecting tariff structure by December 1, 1976 or such other date as shall be agreed (Section 5.10 of the Joint Financing Agreement). 46. During a period of rapidly increasing prices (as Tanzania is still undergoing), calculation of TANESCO's rate of return on the basis of the historical costs of its assets may result in a serious shortfall in the company's ability to finance replacement parts and undertake new investments. As a result, the legal documents call for the calculation of TANESCO's rate of return on the basis of revalued assets (see paragraph4 4). To facilitate this TANESCO, with Bank assistance, completed a study which revalued its  -20- fixed assets in 1975. This revaluation resulted in an increase in TANESCO's net fixed assets from $32.3 million to $55.6 million as of December 31, 1974 and it was agreed during negotiations that in the future TANESCO's fixed assets would be revalued every two years on the basis of a procedure agreed to by the Bank (Section 5.08 of the Joint Financing Agreement). Project Justification 47. The Project would supply additinnal energy to TANESCO's inter- connected system which accounted for about 90 percent of total TANESCO sales in 1974. The average rate of growth of electricity sales in the system since 1966 has been 10.5 percent per annum with industrial sales growing at 14 percent per annum, commercial sales at 9 percent per annum and domestic sales at 8 percent per annum. Taking into account the 40 percent tariff increase as well as a number of recent marketing developments, the Bank appraisal mission prepared a load forecast which indicates that the kwh sales growth from the interconnected system would increase fron an abnor- mally low level of 5.6 percent in 1974 to 7.7 percent in 1975 and 8.3 Dercent in 1976, and would reach an average of about 10 percent per annum from 1977 through 1985. This projected maximum demand together with installed and firm capacity indicate that the existing interconnected system will be capable of meeting capacity requirements until 1980. This Project has therefore been designed and phased to provide the capacity required to meet the growth in power demand after 1980. 48. Alternatives to the proposed Project would include another hydro scheme or a thermal station. A number of hydro alternatives have been studied in the last decade by consultants and most were eliminated as too remote, small or geologically unsatisfactory. When the remaining choices were examined in detail, the Second Stage development of Kidatu was estab- lised as the preferred hydro alternative. Its lower cost reflected, among other things, the fact that all major civil works except for the Mtera dam, had already been constructed during the First Stage. The Second Stage of Kidatu was then compared with alternative thermal developments and with thermo/hydro blends. Analyses of these indicated that the proposed Project would be preferred over the thermal-hydro blend at discount rates up to 14 percent and that a thermal alternative would only be economic at discount rates higher than 23 percent. Since the opportunity cost of capital in Tanzania is estimated at below both these fitures, the Kidatu development is the recommended alternative. 49. The rate of return on the Project is expected to be 23 percent. If the foreign exchange cost is shadow-priced at 1.35 (US$1 = TShlO.87) the rate of return would still be 19 percent.  -21- 50. An in-depth study in relation with Mtera Reservoir is underway. The study will make recommendations with regard to development including game preservation and fishing. An agreement has been reached that the recommendations resulting from this study will be discussed with Sweden and the Bank and implemented accordingly (Section 5.02 of the Joint Financing Agreement). PART V - LEGAL INSTRUMENTS AND AUTHORITY 51. The draft Loan Agreement between the United Republic of Tanzania and the Bank, the draft Joint Financing Agreement between the United Repub- lic of Tanzania, the Kingdom of Sweden, TANESCO and the Bank, the draft Lenders Agreement between KfW and the Bank, the Report of the Committee provided for in Article III (Section 4(iii) of the Articles of Agreement of the Bank and the text of a draft Resolution approving the proposed Loan are being distributed to the Executive Directors separately. The draft agreements conform to those previously used for this type of project and financing arrangements (Section 6.01 of the draft Loan Agreement). 52. Special features of the legal documents are referred to in paragraphs 27, 35, 36, 39, 42, 44, 45, 46 and 50. Special conditions of effectiveness of the proposed Loan would be the execution of the Swedish Development Cooperation Agreement and KfW Loan Agreement with Tanzania. 53. I am satisfied that the proposed Loan would comply with the Articles of Agreement of the Bank and with the established criteria for Third Window Loans. PART VI - RECOMMENDATION 54. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments Washington, D. C. June 18, 1976   Page I of ij pages TANZANIA -SOCIAL INDICAINSR DATA SUffT LAND AREA (TNOU MM2) . ... ------- ~~~~~~~TANZANtA REfERENCE COUNTRIES (1910) TOTA;L 945.1 MOST RECENT ARABLE ..1960 1970 ESTINATE KENYA KOREA, REP. OF MALAVSIA~ G4P PER CAPITA (USS) 60.0 110.0 130.0 140.0 270.0 440.0 POPULATION AND VITAL STATISTICS POPULATION (MIOYR. MILLION) 9.6 i. 1.9 La 14.0La. 11.2 31.4 10.9 POPULATION DENSITY PER SQUARE KM. 10.0 14.0 15.0 19.0 119.0 33.0 PER SQUARE KM. ARABLE LANE) I 47.0 ..* 49.0 VITAL STATISIICS 3. CRUDE BIRTH RATE PER THOUSAND 46.0 A.b 41. TO4. 8. 40a C"RUDE DEOATH MATE PN HUSN 25.0 7a 22.0o. 18. 8.0 z. IFANT MORTALITY RATE ( THOU) 190.0 160.0 S. . 5.0/, . 4 1. 0 LIFE EXPECTANCT AT BIRTH CTRS) 38.0 42.0 44.0 48.0 65.0 64.0a~ GROSS REPRODUCTION RATE .. 3.2 3.2 1.4 2.6 2. 8 POPULATION GROWTH RATE CZ) T3TAL 2.3 3.0 2.9 3.1 2.4 3.1 URA .. 5.0 /a 4.5 r.0 A 4.0 URBAN P,OPULATION (I OF TOTAL) 4.0 6.0 7.0 10.0 41.0 29.0 /a AGE STRUCTURE (PERCENT) a TOa14 TEARS 42.Lok 4.4 / . 48.4 42.1 45. . 15 To 64 YLARS s4. il 53.0 . 48.0 54.4 S2.0 0 65 TEARS AND OVER 2.0 2.6 . 3.6 3.3 3. 0 4. AGE DEPENDENCY RATIO 0.61 ab 0.9 I. 1. 0. /a ECONOMNIC DEPENDENCY RATIO0.9 c 1.2 ..1.1 A 1.4 9 FAMILT PLANNING- ACCEPTORS (CUMULATIVE. THOU) ... .. . 220.0 / 0 USERS (I OF MARRIEDW OEN) . .. 80 E MPLO(ME NT TOTL LAO OC TOSN) 4900.0 5600.0 /ab . 5100. ~ 0400.0 2 900. 0 LABOR FORCE IN AGRICULTURE (I) .. 91.0 4 .. 90:.0 50.5 41.0 ~ UNEMPLOYED (Z IF LABOR FORCE) . .. 5.0 /a 6.0ab INCOME DISTRIBUTION I-" OF RIVTE INCOME REC*D BY- HIGHEST 5I OF POPULATION .. 3. .20.2 z3 2.1 28.31 HIGHEST 201 IFPPLTO . 6. .52.6 a. 47.1 5. LOEST 2 01 If POPULATION .. 2.34 c 3.9 ~ 6.1 3 5k LOgWEST 401 OF POPULATION r. .a I. 1:. t 14. 11.2 a DISTRIBUTION OF LAND OWNERSHIP IOWNED BY SMALLEST 10% OWNERS ... . .2. HEALTH AND NUTRITION POPU;LATO E PTIIN20000.0 /sA215?0.0Da 21430.0 /a 7800.0 2210. L.3860.0 /i.d POPULATION PER NURSIN PESNI.Zj49.a 4100 ~ 1T. ~16. 100. ~o. POPULATION PER HOSPIAL BE 530.0 T. 10O~j 810.00 1920.00 210.0 /a PER CAPITA SUPPLY OF CRALORIES( (I Of REQJIREMENTS) 69.0 73.0 96 . 10to1.0 1033 9.0 9 4 PROTEIN (GRAMSPER DAY) 420.0 43. 63.0 71.0 65.0 409.0 -0F WHICH ALMRAL AND PULSE 22 0a 2 3.00. 29.0 1 9.0 20.0a DEATH RATE (/THOU) AGES 1-4 ... .. .4.0 EDUCATION AJUSTE ENROLLMENT RATIO PRIMARY SCHOOL 25.0 37.0 . 67.0 104.0 a89. 0 SECONDARY SCHOOL 2.0 3.0 ..0 41.0 3 4 .0 YEA1RS OF SC HOOLING PROVIDED (FIRST AND SECOND LEVEL) 1 3.0 1 3. 0 1 3. 0 13.0 12.0 IS. 0 VOCATIONAL