Philippines - Manila Power Distribution Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 16145-PH IMPLEMENTATION COMPLETION REPORT PHILIPPINES MANILA POWER DISTRIBUTION PROJECT (Loan 3084-PH) NOVEMBER 22, 1996 Infrastructure Operations Division Country Department I East Asia and Pacific Region 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 EOUIVALENTS (As of December, 1988) Currency Unit = Philippines Peso (P) P1.00= 100 Centavos (ctv.) US$1.00 = P 21.4 P1000=US$46.73 (As of June, 1996) US$1.0= P 26.2 P1000=US$ 38,2 WEIGHTS AND MEASURES kV= kilovolt (1,000 volts) MW= Megawatt (1000 kW) kWh= Kilowatt hour (1,000 watt-hours) Gwh= Gigawatt hours (one million kWh) REPUBLIC OF THE PHILIPPINES FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS DBP = Development Bank of the Philippines DOE = Department of Energy ERR = Economic Rate of Return ICC - Investment Coordinating Committee ICR= Implementation Completion Reporting IPPs = Independent power producers KfW = Kreditanstalt fur Wiederaufbau MERALCO = Manila Electnrc Company NEDA = National Economic Development Authority NPC = National Power Corporation OECF = Overseas Economic Cooperation Fund Acting Vice President Hope, Nicholas C. Director Khalilzadeh-Shirazi. Javad Acting Division Chief Farhandi, Mohammad TIask Manager Irving, John  FOR OFFICIAL USE ONLY Table of Contents PREFACE ..........................................:.i EVALUATION SUMMARY. ii PART I PROJECT IMPLEMENTATION ASSESSMENT A. STATEMENT/EVALUATION OF OBJECTIVES .I B. ACHIEVEMENT OF OBJECTIVES ...3 C. MAJOR FACTORS AFFECTING THE PROJECT .4 D. PROJECT SUSTAINABILITY ....5 E. BANK PERFORMANCE .5 F. BORROWER PERFORMANCE .6 G. ASSESSMENT OF OUTCOE .7 H. FUTURE OPERATION .7 I. KEY LESSONS LEARNED .8 PART II STATISTICAL ANNEXES ANNEX A: STATISTICAL TABLES . . . 9 TABLE 1: SUMMARY OF ASSESSMENT .............................................9 TABLE 2: RELATED BANK LOANS .............................................. 10 TABLE 3: PROJECT TIMETABLE .............................................. 1 TABLE 4: CREDIT DISBURSEMENTS: CUMULATIVE ESTIMATED AND ACTUAL ..1................ I TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION ............................................. 12 TABLE 6: KEY INDICATORS FOR PROJECT OPERATION (A TO E) ............................................ 1 6 TABLE 7: STuDiES INCLUDED IN PROJECT ............................................. 20 TABLE 8A: PROJECT COSTS ..21 TABLE 8B: PROJECT FINANCNG ..21 TABLE 9: ECONOMIC COSTS AND BENEFrrS ....................................... 22 TABLE 10: STATuS OF LEGAL COVENANTS ................. .. .................... 23 TABLE 11: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS ................................... 24 TABLE 12: BANK RESOURCES: STAFF INPUTS . ........................................ 24 TABLE 13: BANKRESOURCES: MISSIONS ........................................ 25 APPENDIXES: A. FOLLOW-UP LETrER TO ICR MISSION .26 B. BORROWER CONTRIBUTION TO THE ICR .27 C. BORROWER COMMENTS TO THE ICR .34 D. MAP(IBRD21390) .38 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 wiLhout World Bank authorization.   IMPLEMENTATION COMPLETION REPORT PHILIPPINES MANILA POWER DISTRIBUTION PROJECT Preface This is the Implementation Completion Report (ICR) for the Manila Power Distribution Project in the Republic of the Philippines, for which Loan 3084-PH in the amount of US$65.5 million equivalent was approved on June 8, 1989 and made effective on November 17, 1989. Loan 3084-PH closed on June 30, 1996 compared with the original closing date of June 30, 1995. Final disbursement is expected to take place by December 30, 1996, at which time a balance of US$ 5.673,769.92 will be canceled. The ICR was prepared by Ephrem Asebe, Consultant, EA1IN, under the supervision of John Irving, Senior Power Engineer, Infrastructure Operations Division of the East Asia & Pacific Region, Country Department I. It was reviewed by Mr. J. Shivakumar, Chief, Infrastructure Operations Division, and Mr. Walter Schwermer, Project Adviser. The borrower provided its comments that are included as appendices to the ICR. Preparation of this ICR began during the Bank's supervision mnission in February 1996 followed by an ICR mission in October, 1996. It is based on material in the project file. The Borrower contributed to the preparation of the ICR by preparing its own evaluation of the project's execution and commenting on the draft ICR.   ii MANILA POWER DISTRIBUTION PROJECT (Loan No. 3084-PH) PHILIPPINES Evaluation Summary Background & Project Objectives: i. Manila Electric Company (MERALCO) is the major private distribution firm which serves Metro Manila and the surrounding area. Much of the present project was initially appraised in August 1987 as a component of the Bacon-Manito Geothermal Power Project. However, the loan negotiations were delayed until an arrangement for channeling the proceeds of the Bank loan to MERALCO was worked out. With the successful restructuring of the Development Bank of the Philippines (DBP), the project was re-appraised and a financing mechanism agreed whereby DBP would borrow from the Bank and relend the funds to MERALCO to finance a component of its five year program (1989-93). ii. The objectives of the project were to improve MERALCO's subtransmission and distribution systems, facilitate better communications between substations, and revitalize the organization's maintenance. In so doing, the project was expected to enable the company to meet increasing load demands in the coming years, reduce losses and ensure more effective distribution of electricity within its franchise area and support improvement of MERALCO's technical and commercial operations. iii. The main components of the project were: a) construction and upgrading of the subtransmnission lines, and addition of substation capacity; b) construction and upgrading of distribution systems; c) improvement and expansion of the radio-multiplex facilities for system monitoring and control; d) provision of equipment and vehicles to improve maintenance; and e) action programs designed to reduce system losses, enhance system reliability and improve management of accounts receivable and payable. iv. The project objectives as defined in the SAR were clear. They were important for the overall achievement of the Government's energy sector strategy plan. The design of the project was appropriate with clearly set targets to be achieved. The main anticipated challenges: a) occasional liquidity constraints which are normal to public utility companies; b) procurement delays; and c) delays in acquisition of right of ways were not foreseen to be beyond the capability of the organization. However, the real challenge came from another source, delays in decisions being taken by MERALCO on the appropriate primary distribution system voltage level. Implementation Experience and Results. v. The project appears to have made a greater contribution to the overall fulfillment of the energy sector strategy objectives than to the specific project targets of the Manila Power Distribution Project. With respect to the former, the project was successful in advancing the overarching objectives of the energy sector i.e., implementing a least-cost energy sector strategy; achieving a break-through in private sector participation in the Philippines' energy sector; mobilizing adequate financial resources; implementing  iii regionalization, decentralization and separation of generation, transrmission, distribution activities into separate companies or profit centers. vi. More specifically, the project's most significant achievement is the demonstration of a key tenet of the Bank's Country Assistance Strategy: providing assistance to enable the private sector increase its involvement in the development of a key infrastructure sector without further resort to official assistance. In the case of MERALCO, which was precluded from borrowing from the market since 1986, the mere fact that the Bank was willing to participate in such an arrangement in 1987 opened the door for more development funding from KfW, OECF between 1988 and 1990, as well as funding from [FC in 1988. MERALCO resumed borrowing from the market in 1990, and since then it has made a highly successful public offering of its common stock with 65 percent being traded internationally and 35 percent domestically. Its stock price has doubled compared to initial offerings and has remained at about that level. Today, MERALCO no longer needs official development finance. It now meets its financial needs from the international commercial markets. vii. With respect to the specific objectives of the Bank financed component of the five-year development program, an initial significant system loss reduction, from 22 percent to 14.8 percent, was achieved during the preparation phase of the project. By the end of 1995, subsequent improvement in loss reduction reached 13.0 percent. The technical loss portion alone has declined from 11 percent in 1986 to 8.6 percent in 1995. Further loss reduction is expected when the additional investments in the distribution system are in full service. Reliability of the system was also much improved. The system interruption frequency rate which rose from 48.8 in 1985 to 278.8 in 1993, during the period of energy brownout, has declined back to 48.8 in 1995. Better coordination and control between substations were realized. The organization's maintenance was revitalized. Some improvement in the management of accounts receivable and payable have been achieved. Overall, the re-estimated ERR for the 1998- 1993 program was 59 percent compared to the 32 percent estimated at appraisal. viii. However, project completion was delayed relative to the original schedule. The most significant delay resulted from management's desire to have a second opinion on the appropriate long-term distribution system voltage level, causing the completion dates of various subprojects to slide from the original schedule. As the Bank assumed that the decision on system design standard had been made by MERALCO, the implementation schedule in the appraisal report did not reflect the time needed to reach a consensus on that standard. Also, the 1991-93 brownouts in NPC power generation were a major distraction for MERALCO's management. Other contributing factors to the delays include MERALCO's lack of experience with the Bank's procurement guidelines and the major expansion and reorganization of the company since 1988; and further, the company has also reported that it encountered problems in securing available land for substations and right of ways during implementation. ix. The Bank's role in project identification was highly satisfactory. It was carried out on the basis of the Energy Sector Study (Report 7269-PH), over an extended period in the context of the Philippine economic recovery. The Bank's assistance to the borrower in the preparation phase was satisfactory. How-ever, while Bank support for preparation with respect to financial and procurement matters was strong, initial support for the engineering aspect of the work was weak. The Bank only learned in early 1992 that a firm decision on the distribution system design standard had not been made; this was well into  iv the implementation phase of the project. This issue had been left hanging mainly because of lack of continuity of supervising engineers. Thus, although the Bank team did not foresee the consequence of the delay in the system design decision, in other respects, both appraisal and supervision were satisfactory. x. The Borrower's preparation and implementation of the project can also be considered to have been satisfactory. As noted above (para. viii), delayed choices in primary distribution system affected all subsequent phases of the implementation work: preparation of detail design, specifications and evaluations of bids, etc. Early in the project preparation phase, administrative, legal and technical measures were taken to reduce the system losses from 22 percent to 14.8 percent within eighteen months. System reliability also significantly improved over the course of the project implementation. MERALCO has proved that it has mastered the bid evaluation process in the course of implementation as evidenced from the Bank's note of appreciation for the high quality of its bid evaluation. ix. The benefits of the project are likely to be sustained. In fact, the fill benefits will be realized when the ongoing subtransmission and substation are put into service by 1998. The official develop-ment finance MERALCO secured has opened up opportunities for the company to access loans from domestic and international sources, which further enhance the sustainability of the project benefits. xii. Overall, the project outcome is satisfactory. The recalculated ERR of 59 percent for NIERALCO's 1989-93 program is high despite some lag in putting into service some of the Bank-financed subprojects at the closing of the loan. Implementation is progressing, and the project will achieve well- integrated transmission and distribution systems which are likely to result in further reductions in system losses, higher system reliability of supply to existing customers, provision of additional distribution capacity to satisfy demand, and overall operational efficiency. Summary of Findings, Future Operations, and Lessons Learned xiii. The most important finding of the implementation experience is that the Bank should develop a keen sense of understanding of the concerns of the private sector to be able to help its development. Much of the delays could have been foreseen and a realistic implementation plan prepared if the Bank had detected the delays in the company's decisions on the design standards either during preparation or at appraisal. xiv. MERALCO's main indicators of the success of its future operations remain the same as its current ones: minimization of system losses, achieving high level of system reliability, and more efficient management of its accounts receivable and payable. xv. In designing future Bank projects with on-lending to private borrowers, the Bank may need to study the behavior of the private sector's decision making process towards official development finance. A proper understanding of the private sector may be vital, to find out the level of private sector commitment and how it is expressed. For example, in MERALCO's case, the time lost in seeking Investment Coordinating Committee (ICC) and National Economic Development Authority (NEDA) approval could have been read as a signal that MERALCO was not as prepared as it should have been to implement the project as anticipated at appraisal.  v xvi. The critical issue facing the distribution utilities is to become sufficiently credit-worthy to secure loans and equity capital on their own in the capital market. As in the case of MERALCO, available official development finance can help them begin that process. The problem is one of devising legally appropriate transitional financing mechanisms for channeling development finance. To the extent that some of the remaining 145 distribution companies in the Philippines, representing some 40 percent of the distribution capacity, become credible borrowers through consolidation program, DBP could serve as a channel for development finance to recast their operations and finances to be able to meet their future development finance from the market.  MANILA POWER DISTRIBUTION PROJECT (Loan No. 3084-PH) PHILIPPINES PART I: IMPLEMENTATION ASSESSMENT A. STATEMENT/EVALUATION OF OBJECTIVES 1. Background. The Philippines' electric power industry is now divided into three segments: a) generation, b) transmission, and c) distribution. While National Power Corporation ( NPC) was dominant in generation, it is likely to reduce its role in the future as Independent Power Producers' (IPPs) take over new generation. NPC is expected to be responsible for transmission through a number of grids that serve virtually the entire country except for remote rural areas and small outlying islands. MERALCO is the major private distribution firm which serves Metro Manila and its surroundings, and accounts for about 70% of NPC's sales in Luzon and about 59% of NPC's sales Nation-wide. Today, MIERALCO is the biggest of 146 electricity distribution companies in the Philippines and rates as the fourth largest industry in terms of gross revenue in the country. 2. The Manila Power Distribution Project loan was the third in a series of Bank Group-financed projects to MERALCO, the first two of which were made by the International Finance Corporation (EFC). IFC's first loan to MERALCO was for US$12.0 million equivalent in 1967. The second was for US$32 million equivalent in 1988 intended to finance a time slice of MERALCO's investment program between 1989 and 1991. Much of what is Manila Power Distribution Project was initially appraised in August 1987 as a component of the Bacon-Manito Geothermal Power Project (Loan 2969-0-PH and 2969-1-PH). However, the MERALCO's component of the Project was dropped from the loan because, under the Foreign Borrowing Act of the Philippines, the government is precluded from guaranteeing directly the indebtedness of private institutions. The loan was delayed until an arrangement for channeling the proceeds of the Bank loan to MERALCO, acceptable to the Government, MERALCO, and the Bank, was worked out. 3. With the successful restructuring of Development Bank of the Philippines (DBP) and subsequent designation of DBP as the nation's wholesale bank, the parties agreed that DBP was in a position to serve as a conduit for official foreign loans to private sector companies, with a waver of the single borrower lirnit by the Monetary Board. Accordingly, the project was reappraised under the new condition whereby, DBP would borrow from the World Bank and relent the funds to MERALCO to finance its five year development program (1989-93) under terms that include a twenty year maturity and a five year grace period, and a fixed spread not to exceed 3.65% over the Bank's interest rates. 4. Project Objectives. As stated in the Bank Staff Appraisal Report, the objectives of Manila Power Distribution Project were to: improve MERALCO's subtransmission and distribution systems, facilitate better communications between substations, and revitalize the organization's maintenance capabilities. In so doing, the project would enable the company to meet increasing load demands in the coming years, reduce losses, and ensure more efficient distribution of electricity within its franchise  2 area. The proposed project would also support improvement of NERALCO's technical and commercial operations. 5. Project Components. The main components of the Project were: a) construction and upgrading of the subtransmission lines, and addition of substation capacity; b) construction and upgrading of distribution systems; c) improvement and expansion of the radio-multiplex facilities for system monitoring and control; and d) provision of equipment and vehicles to improve maintenance. In addition, the project incorporated action programs for reducing system losses and, improving system reliability, accounts receivable and payable 6. Evaluation of Objectives. The project objectives, as defined in the SAR, were clear. Identified project components were clearly tied with each of the project objectives. The expected benefits from achievement of the objectives had measurable qualitative and quantitative targets. For example, system losses were targeted to be reduced to 9 percent by 1993 from 22 percent in 1987, which was on the high side. The capacity to meet increasing load demand was also quantitatively defined. System reliability was to improve through relieving line over-loading, reinforcing existing lines, improving operational flexibility and providing alternative sources of power and capacity for growth. 7. The project objectives were also important for the overall achievement of the Government's energy sector strategy, which the Bank supported through a number of generation and transmission projects. At the time, the overarching concerns of the Bank were mobilizing sufficient resources through private participation to remove the energy constraints on the growth of the Philippines' economy. The Bank sought to revitalize economic growth, improve the efficiency of the public corporations and accelerate privatization in the energy sector. MERALCO's investment in distribution system was designed to supplement the government least-cost strategy in transmission, generation projects, and sector coordination. The government was persuaded to guarantee the loan to support substransmission and distribution system extensions and improvements to help ensure that MERALCO maintained investment at the appropriate level. The channeling of the loan through DBP was also an important objective of the Bank, as it would enhance DBP's role as a new wholesale bank for the private sector. 8. The project was well designed with clearly set targets to be achieved. First, the load forecast for Luzon and for MERALCO were assessed. Second, estimated system loss reductions were targeted. Third, the expected operational and commercial targets were forecasted. Accordingly, retail power tariffs in the Manila area were indexed with NPC tariffs, and the exchange rate to provide MERALCO a rate of return higher than 8% based on agreed levels of losses, expected to decline over the subsequent five years. Finally, these targets were to be made part of the loan covenants and subject to regular review of Bank supervision. 9. The project was neither complex nor demanding for the implementing agency. There were few special institutional changes foreseen which the beneficiary had to undertake as part of Bank conditionality i.e. reduction of system losses, improving reliability and efficiency of management of accounts receivable and payable. The main anticipated challenges: a) occasional liquidity constraints  normal to public utility companies, b) procurement delays, and c) delays in acquisition of right of ways, were foreseen to be not beyond the capability of the organization. However, the real challenge came from another source; delays in the decision being taken on the appropriate long-term primary distribution system voltage level. B. Achievement of Project Objectives 10. Overall, the project appears to have yielded a greater contribution to the fulfillment of the energy sector strategy objectives than to the specific project targets. With respect to the former, the project was successful in advancing the overarching objectives of the energy sector. i.e., implementing a least-cost energy sector strategy. This was achieved through: major investments in generation and transmission (Bacon-Manito and the Energy Sector Loans, see table 2 Related Bank Loans) with appropriate complementary investment; achieving a break through in the private sector participation in the Philippines energy sector; mobilizing adequate financial resources for financing of the private sector including developing DBP as a wholesale Bank; and moving towards decentralization and separation of generation, transmission, distribution activities, into separate companies or profit centers. 11. More specificaUly, the most significant achievement of the project is the demonstration of a key tenet of the Bank's Country Assistance Strategy: providing assistance to enable the private sector increase its involvement in the development of a key infrastructure sector without further resort to official assistance. In the case of MERALCO, which was precluded from borrowing from the capital market since 1986, the mere fact that the Bank was willing to participate in such an arrangement in 1987 opened the door for more development funding from KfW, OECF between 1988 to 1990, as well as funding from IFC in 1988. MERALCO resumed borroving from the market in 1990, and since then it has made a highly successful public offering of its common stock with 65 percent being traded internationally and 35 percent domestically. Its stock price has doubled compared to initial offerings and has remained at about that level. The financial restructuring of MERALCO resulted in raising of new equity capital and retained earnings. Today, MERALCO no longer needs official development finance. The Bank's inter-mediation has helped catalyze MERALCO's access into international markets for financing its investments. 12. With respect to the non-financial objectives of the project, an initial significant reduction, from 22 percent to 14.8 percent, was achieved during the preparation phase of the project. By year-end 1995, subsequent improvement in loss reduction reached 13.0 percent. The technical loss portion alone has declined from 11 percent in 1986 to 8.6 percent in 1995. Further loss reduction is expected when the additional investments in the distribution system are in full service. Reliability of the system was also much improved. System interruption frequency rate which was 48.8 in 1985 rose to 278.8 in 1993 during the period of energy brownout but has declined back to 48.8 in 1995. Better coordination and control between substations were realized with the implementation of the telecommunication component of the project. The provision of equipment and vehicles helped revitalize the organization's maintenance capabilities. Some improvement in the management of accounts receivable and payable has been achieved.  4 13. The re-estimated econornic rate of return for the project is 59 percent, significantly higher than the SAR estimate of 32 percent not withstanding the delays in the implementation of some of the subproject components. C. Major Factors Affecting the Project 14. There were several internal and external factors which contributed to the delays in implementation. The most important factor affecting the timely realization of the project's objectives, was the delay experienced in making the decisions on the appropriate long-term system voltage level of the primary distribution system of MERALCO. Progress from design to the procurement phase was rather slow as the company management tried to search for a design standard to optimize its distribution system operation. MERALCO was initially enthusiastic to get a Bank loan to finance the project. Preparation of designs of the project did not, however, progress after the Bank and the govemment agreed to drop the project after failing to find an appropnrate mechanism to channel the loan. The false start created skepticism that the project would come through. When a financing mechanism was finally found with DBP serving as a conduit for channeling the Bank loan to MERALCO, MERALCO was still skeptical that the project would get the loan. As a result, MIERALCO did not follow through nor made the critical system choice decisions to get ICC and NEDA clearance. 15. On the other hand, the Bank being at the early stage of its dealings with the private sector, appeared not to have understood correctly the significance of the delays MERALCO was experiencing in getting clearance from ICC and NEDA. In retrospect, the lack of clearance by ICC and NEDA should have served as a signal that MERALCO's management was not committed to the project's time table. In fact, MNERALCO's management was awaiting the results of the Voltage System Study to get a second opinion on the choice of primary distribution system, six months after the project had been declared effective. MERALCO's management was also uncertain about the progress on the generation and transmission expansion being executed by NPC. 16. MERALCO's lack of experience with the Bank's procurement procedures also led to some delays at different stages of the process (e.g. preparation of specifications, bid opening, contract signature). The fact that since 1988, MERALCO has been undergoing major reorganization and expansion, including operationalization of the three regions, introduction of total quality management and re-engineering, had detracted management's attention from the project. The company has also reported that it encountered problems in securing available land for substations and right of ways during project implementation. The Govemment's reluctance to approve necessary tariff increases too soon after the 1989 December Coup d'etat, also caused MERALCO to fail to comply the 8% rate of return on its re-valued assets requiring Bank's agreement to waive the 8% rate of return covenant for 1990.  5 D. Project Sustainability 17. The project is likely to sustain the benefits generated by its components. In fact, the full benefit of the project will be realized when most of the ongoing subtransmission and substation works are completed and put into service by 1998. The official development finance MIERALCO secured has opened up opportunities for the company to get access to loans from domestic and international sources. Despite the limit on the level of its borrowings because of country risks, MERALCO is left in a better position to mobilize resources than it was before the loan. MERALCO has also substantially improved its maintenance capabilities. For example, when Typhoon Katring hit its franchise area on October 21, 1994, causing a total system blackout, MERALCO was able to restore service in 79% of its 529 circuits within 24 hours and in 97% in six days. E. Bank Performance 18. Identification. Project identification was highly satisfactory being carried out over an extended period in the context of the Philippine economic recovery. The Energy Sector Study (Report No. 7269-PH) provided the framework for the identification of MERALCO's five year (1989-93) investment program. Optimization of the company's five year program was conceived within the long- term development framework of the Philippines energy sector. The integration of MERALCO's primary distribution system with NPC's transmission was a significant step in the optimization of the overall power system efficiency. 19. Preparation. Bank assistance to the borrower in the preparation phase can be considered satisfactory. During the preparation phase, the Bank focused on assisting the Government to establish an acceptable financing mechanism for channeling official development finance to the private sector, and at the same time finding a less complicated and inexpensive syndication scheme for MERALCO. The Bank's financial analyst played a prominent role in finalizing the financial aspects of the loan. Although the Bank's preference was a direct loan to MERALCO, the Govemrnment was not prepared to guarantee direct loans to private companies. In the end, the Bank and the Govemment agreed to channel the loan through DBP, and avoided the syndication scheme through a waver of single borrower limit. Unfortunately, MERALCO did not continue making progress in the critical design phase of the work, after the project was dropped from the Bacon-Manito Project, while the Bank assumed that the design was progressing well. This misreading of the company's readiness for implementation had unintended consequences on the Bank's design of loan conditionality, implementation schedule, and resource allocation for supervision. 20. Appraisal. The Bank's performance in the project appraisal phase can be considered satisfactory. To be sure, the financial packaging and lending instruments were adequate and appropriate. MERALCO's operational problems of system losses, system reliability and efficiency in the management of accounts receivable and payable were diagnosed early when the project was first appraised as part of the Bacon Manito project. Remedial measures required to reduce system losses were undertaken before project appraisal. A significant reduction of system losses from 22 percent to 14.8 percent was attained between August 1987 and December 1987. Measures were being  6 undertaken to improve perfornance of system reliability, accounts receivable and payable. Bank staff, being in the early phase of lending to the private sector, appeared to have overestimated MERALCO's readiness with the design of the distribution system, its technical capacity to deal rapidly with the changing conditions of demand growth, and its technical capacity to adopt the specification to coordinate its subtransmission plans into the new generation and transmission capacities of NPC. Moreover, because of this misperception by Bank staff during the appraisal phase of the project, MERALCO's problem of implementation was wrongly identified to be a procurement problem, when, all along, it was lack of progress in the design phase. 21. Supervision. Overall, Bank supervision was satisfactory. The first supervision mission was undertaken between November 19 and December 12, 1990. Earlier, in March 1990, the reporting system to be used was agreed upon. Subsequent supervision visits were of limited scope and focused on the procurement and financial aspect of implementation. Since at appraisal the Bank saw no technical risks in the implementation of the project, both the transmission and distribution components were considered to be within the technical and managerial capabilities of MERALCO. As a result, while enough attention was paid to the supervision of the procurement and financial aspects of project implementation, supervision of the engineering aspect was negligible. The Bank only learned in early 1992 that a firm decision on the distribution system design standard had not been made; this was well into the implementation phase of the project. This issue had been left hanging mainly because of the lack of continuity of supervising engineers. In retrospect, this was unfortunate. The Bank should have carefully scrutinized the design and implementation of the technical aspects of the project, just as it would supervise a public enterprise. A more careful follow up of the engineering phase would have helped to uncover the reason behind the lack of progress in project implementation. F. The Borrower Performance 22. Preparation. The Borrower's preparation of the project can be considered satisfactory. As noted above, the delay in selecting a primary distribution system affected all subsequent phases of the implementation works including preparations of detail design specifications and evaluations of bids. Because of the uncertainties over the availability of Bank loan, MERALCO had not made enough progress in performing appropriate design studies. Consequently, these delays had cascading effects on completion dates of the sub-components of the project. 23. Implementation/Operation. The Borrower's implementation of the project has been satisfactory. Early in the project preparation phase, administrative, legal and technical measures were taken to reduce the system losses from 22 percent to 14.8 percent within eighteen months, although subsequent improvements were marginal. System reliability also significantly improved over the course of project implementation. initially, MERALCO had its attention deflected from implementation due to the critical supply situation when NPC was experiencing brownouts. The construction of the three bulk delivery 230 kV- I 15 kV substations namely Calauan, Sta. Rosa and Duhat were delayed; but these are expected to be completed by December 1996. Six other substations are expected to commence in 1997. With respect to the transmission line projects, the Balintawak leg of Marikina- Novaliches-Balintawak line and Gardner-Pamplona line were completed after delays of two years and  7 one year respectively. Dolores-Marikina 115 kV line is expected to be completed in June 1996. Other 115 kV line subprojects delayed included: Sta. Rosa-Balibago line expected to be in service in December 1996, Gardner-MCCRRPI in September 1996, and Araneta-Sta. Mesa in October 1988. 24. Under the project, MERALCO has demonstrated increasing intuitional capacity in managing procurement, accounting and other project activities. In particular, its demonstrated capability with Bank bid evaluation process was exemplary. This was evident from a letter the Bank wrote appreciating the high quality of its bid evaluation performnance, and requesting MERALCO if it would object to the Bank sharing MERALCO's high quality works with the Bank's clients as a model for good practice. Moreover, by diligently practicing ICB, MERALCO was able to get savings of more than 10 % in the prices of goods procured under the loan. Also when the borrower, the Development Bank of the Philippines, was delinquent with regard to reporting of its June 30, 1990 audited annual accounts and the reporting of activities in Special Account established for the project, MERALCO assumed the responsibility for the Special Account successfully. G. Assessment of Outcome 25. Taking into account the earlier delays, overall, the project outcome can be considered satisfactory. The recalculated ERR of 59 percent is high although some of the subprojects of the five- year program financed under the loan are still ongoing at the closing of the loan. Implementation is progressing, and it appears likely that the project will achieve a well integrated transmission and distribution system which is more reliable and with reduction of system losses, increased system reliability and operational efficiency. H. Future Operation 26. MERALCO's main indicators of success of its future operations remain the same as its current ones, minimization of system losses, achieving high level of system reliability, and more efficient management of its accounts receivable and payable. MERALCO, as a private public company, is keen on sustaining higher than the 8 percent rate of return on re-valued assets. With respect to the timing for OED evaluation of the project, early 1999 may be appropriate. This will be the most probable date to find out if the full targets for the system losses and efficiency of services are attained. I. Key Lessons Learned 27. NMERALCO's experience has two significant lessons for designing and implementation of future projects in the infrastructure sector: (i) In designing future Bank projects with on-lending to private borrowers, the Bank may need to study the private sector's decision making process towards  8 official development finance. A proper understanding of the private sector to find out the level of commitment and how it is expressed may be vital. For example, in MERALCO's case the time lost in seeking ICC's and NEDA's approval could have been read as a signal that MERALCO was not as prepared as it should have been to implement the project as anticipated at appraisal. (ii) The critical issue facing the distribution utilities is to become sufficiently credit-worthy to secure loans and equity capital on their own in the capital market. As in the case of NERALCO, available official development finance can help them begin that process. The problem is one of devising legally appropriate transitional financing mechanism for channeling the development finance. To the extent that some of the remaining 145 distribution companies in the Philippines, representing some 40 percent of the distribution capacity, become credible borrowers through a consolidation program, DBP could serve as a channel for development finance to recast their operations and finances to be able to meet their future development finance from the market.  9 Anncx A IMPLEMENTATION COMPLETION REl'ORT i'lllLIPi'lIN'ES .MIERALCO POWER DISTRIBUTION COMPANY I'ART II: STATISTICAL ANNEXES ANNEX A: STATISTICAL TA1LES (Loan 3084-1I11) Tahilc 1: Siimmary of,Assesimcit A. AVchievrmcnt folltirc ctiv SunbstnlniAl Pairfi;il NcyliONbc ! Macroeconomic policies a oo Sector policies o o o Financial objectives 00