Power Policies Funding Scheme

8/6/2019 Power Policies Funding Scheme

1/110

Report and Recommendation of the Presidentto the Board of Directors

Project Number: 32298February 2007

Proposed Multitranche Financing Facility

India: Madhya Pradesh Power Sector Investment

Program


2/110

CURRENCY EQUIVALENTS(as of 28 February 2007)

Currency Unit Indian rupees/s (Re/Rs)

Rs1.00 = $0.0226

$1.00 = Rs44.22

ABBREVIATIONS

ADB Asian Development BankCDM clean development mechanismCEA Central Electricity AuthorityCMD chairman and managing directorCO2 carbon dioxideCSP Country Strategy ProgrammeDFID Department for International Development of the United KingdomDISCOM distribution company

DISCOM-C Madhya Pradesh Madhya Kshetra Vidyut Vitaran Company LimitedDISCOM-E Madhya Pradesh Poorv Kshetra Vidyut Vitaran Company LimitedDISCOM-W Madhya Pradesh Paschim Kshetra Vidyut Vitaran Company LimitedEA executing agencyEARF environmental assessment and review frameworkECF Energy Conservation FundEIRR economic internal rate of returnEMP environmental management planEPA Environmental Protection AgencyCERC Central Electricity Regulatory CommissionFFA Framework Financing AgreementFIRR financial internal rate of return

FMA Financial Management AssessmentFRP Financial Restructuring PlanFY fiscal yearGDP gross domestic productGENCO Madhya Pradesh Power Generating Company LimitedGOMP Government of Madhya PradeshGRC grievance redress committeeHVDS high-voltage distribution systemICB International Competitive BiddingIEE initial environmental examinationIPDF indigenous peoples development frameworkIPP independent power producer

LIBOR London interbank offered rateMFF multitranche financing facilityMOP Minister of PowerMP Madhya PradeshMPPSDP Madhya Pradesh Power Sector Development Program

MPSEB Madhya Pradesh State Electricity BoardMPERC Madhya Pradesh Electricity Regulatory Commission


3/110

MIS Management Information SystemsMYT Multi Year TariffNEP National Electricity PolicyO&M operation and maintenanceOCR ordinary capital resourcesPFR periodic financing request

PMU Project Management UnitPPA power purchase agreementPPP Private Public PartnershipRF Resettlement FrameworkRP Resettlement PlanSCADA Supervisory Control and Data AcquisitionTRADECO Madhya Pradesh Power Trading Company LimitedTRANSCO Madhya Pradesh Power Transmission Company LimitedWACC Weighted Average Cost of Capital

WEIGHTS AND MEASURES

GWh gigawatt-hour (1,000 megawatt-hours)ha (hectare) Unit of areakm (kilometer) 1,000 meterskV kilovolt (1,000 volts)kW kilowatt (1,000 watts)kWh kilowatt-hourMVA megavolt-ampere(1,000,000 volt-amperes)MW megawatt (1,000 kilowatts)MWh megawatt-hourVA Volt-ampere

NOTES

(i) The fiscal year (FY) of India and its agencies runs from 1 April to 31 March of thefollowing year. FY before a calendar year denotes the year in which the fiscalyear ends, e.g., FY2006 ends on 31 March 2006.

(ii) In this report, "$" refers to US dollars.

Vice President L. Jin, Operations Group 1Director General K. Senga, South Asia Department (SARD)Director T. Kandiah, Energy Division, SARD

Team leader N. T. Anvaripour, Senior Energy Specialist (Finance), SARDTeam members M. Canonica, Energy Specialist, SARD

I. Caetani, Social Development Specialist, SARDA. Djusupbekova , Senior Counsel, Office of the General CounselV. Karbar, Project Implementation Specialist, India Resident MissionD. Millison, Senior Energy Specialist, SARDN. Sakai, Energy Specialist (Private Participation), SARDL. B. Sondjaja, Energy Specialist, SARD


4/110


5/110


6/110

12. Economic Analysis of Tranche 1 and Tranche 2 6813. Summary Initial Environmental Examination 7314. Summary Poverty Reduction and Social Strategy 8115. Summary Resettlement Plan 84

SUPPLEMENTARY APPENDIXES (available on request)A. Tariff StructureB. Energy Efficiency and System Loss ReductionC. Private Sector ParticipationD. Review of MP Program and Project LoanE. Financial AssessmentF. Financial Management AssessmentG. Past and Projected Financial Performance of Executing AgenciesH. Economic AnalysisI. Environmental Assessment Review FrameworkJ. Short Resettlement Plans by Project ComponentsK. Environmental Management Plan


7/110

FACILITY INVESTMENT PROGRAM SUMMARY

Borrower India

Classification Targeting classification: General interventionSector: Energy

Subsector: Transmission, distribution, energy efficiency, and energtradingThemes: Sustainable economic growth, governance, sector-widecapacity development, institutional and financial restructuring, andprivate sector developmentSubthemes: Fostering physical infrastructure development

EnvironmentAssessment

Tranche 1 Category BTranche 2 Category B

Overview Indias goal to establish universal power supply at an affordableprice by 2012 will require an estimated 100,000 megawatts (MW)

of new generating capacity, as well as downstream networks toevacuate, transmit, and distribute the power. The main policyinstrument in the power sector is the National Electricity Policy,which calls for power for all by 2012 (including ruralelectrification), reduced aggregate technical and commerciallosses, better cost recovery, greater private sector participation,full development of hydropower, use of information technology forgreater operational efficiencies, and protection of consumersinterests.

The Electricity Act, 2003 (the Act) is the cornerstone legislation forthe power sector, providing the legal framework for the efficient

development of the sector. The act is concerned primarily withunbundling of state electricity boards, open access, andcompetition. The act also mandates full metering for all consumerclasses, multiyear tariff determinations, and tariffs set within 20%of the deemed cost of supply, as well as availability-based tariffsand 100% rural electrification.

Reform of the Madhya Pradesh (MP) power sector hasprogressed within the policy and legislative framework of India.The Government of Madhya Pradesh (GOMP) has demonstratedits commitment to reforms and has made encouraging progress.In December 2001, the Asian Development Bank (ADB) approved

the Madhya Pradesh Power Sector Development Program thatcombined program lending with physical investment financing thataddressed key reform areas. It also increased delivery capacity ofthe power sector, including substantial reduction in transmissionlosses.

With substantial support from ADBs program loan, restructuringof the power sector was completed. Five companies wereestablished for generation, transmission, and distribution. GOMP


8/110

ii

achieved a comprehensive financial restructuring that includedinjecting equity and taking over loan arrears in lieu of ruralelectrification loans and subsidies. Transmission losses, targetedthrough physical investments, were reduced to an internationallyacceptable level. Throughout the reform process, the MPElectricity Regulatory Commission (MPERC)an independent,

state-level regulatory agencyadopted a realistic and supportiveposition through its regulatory mechanisms.

To facilitate economic growth by increasing electricity supply to itsurban and rural population, GOMP conducted a diagnosticassessment of earlier reforms and physical investments. Basedon the diagnostic work, the challenges in the power sector can besummarized as follows:

Generation. MP has suffered from chronic peak capacity andenergy shortages in recent years. The peak deficit has exceeded20% and the energy deficit consistently has been about 13% for

the past 3 years. Installed capacity in or available to MP is about6,300 MW, with about 3,000 MW owned and operated by thegenerating company. Generating capacity available to meet peakdemand is significantly less than required to eliminate the energydeficit. Therefore, new physical investments, as well as renovationand modernization of existing generating facilities, are essential.

Transmission. Since 2002, transmission circuit length hasincreased almost 14%, while transformation capacity has risen41%. Transmission losses have been reduced to an acceptablelevel of about 5%, and availability of the transmission network hasexceeded 98% for the past year. However, due to continued

growth in demand, the transmission capacity is inadequate toserve peak demand. During 2006, the transmission system servedthe highest ever maximum demand of 5,780 MW. Peak demand isexpected to grow on average at about 9% to 2012. Thetransmission network will require significant investment if capacityis to be increased to match this forecast demand growth.

Distribution. GOMP policy targets 100% village electrification by2008 and 100% household electrification by 2012. The distributionnetwork needs significant investment to reach these targets. Lossreduction and reliability improvement are also sector policyimperatives for the distribution subsector. Losses for distribution

companies exceed 35%, and power quality is poor due toundersized conductors, long low-voltage circuits, and overloadingof distribution transformers.

Private Sector Participation. GOMP recognizes the need forfurther private sector participation to meet the sectors overallfinancing requirements and to enhance operational efficiencies.Through implementation of power sector reforms under the ADB-financed Madhya Pradesh Power Sector Development Program


9/110

iii

(2001), GOMP has created the enabling environment for privatesector participation and public-private partnerships (PPP).However, private sector contributions have been slow to develop.The financial fragility of the sector is perceived to be the keyimpediment to private investment. Opportunities for private sectorinvolvement include (i) electricity generation from renewable and

nonrenewable resources, (ii) transmission network ownership andleasing, (iii) further distribution network franchising and leasing,(iv) bilateral electricity trading, and (v) maintenance contracting.Pilot distribution system franchising schemes have beenimplemented, and some minor maintenance functions have beenoutsourced. In generation, GOMP has proposals for independentpower producer thermal projects in the next 5 years with acombined capacity of 12,000 MW, although the number ofprojects implemented is expected to be a small subset of thistotal.

Capacity Constraints. ADBs 2001 program loan included a

capacity development component to address the policyenvironment. This assistance was successful, and GOMP hasdemonstrated the capacity to formulate and execute sector policysince 2001. However, the diagnostic assessment by GOMPdemonstrated technical, commercial, financial, and managementconstraints in the new power sector companies. Key areasidentified include design and implementation of a backboneenterprise resource planning system covering (i) billing andcollection; (ii) finance and accounting; (iii) metering datamanagement, (iv) management information systems; (v)maintenance management; (vi) materials management; (vii)project systems; (viii) human resources and e-mail solutions,

together with the appropriate network infrastructure and support.Capacity development also is required to improve the companiesinternal audit and control capability.

The constraint being addressed through a comprehensivefunctional support and capacity-building program. ADB and theDepartment for International Development of the United Kingdom(DFID) are partnering in capacity development. ADB and DFID

jointly have supported the MP power sector since the initial stageof reforms. DFID is providing 18.5 million $35.2 million as of 21September 2006) in technical assistance (14.5 million) andfinancial assistance (4million) covering 20062010. The DFID

program under implementation across the sector emphasizes (i)mapping further reforms by supporting GOMP, (ii) capacitybuilding in MPERC, and (iii) financial management and humanresources development in all companies. In addition to theseprincipal areas of work, socioeconomic impact studies also arebeing conducted.

ADB has included an additional $10 million under the investmentprogram for a selective capacity development program. This


10/110

iv

program focuses on implementation support of SupervisoryControl and Data Acquisition (SCADA) systems in the distributioncompanies; and development of a trading and settlements supportsystem, metering, and communications for the new tradingcompany, whose future role is pivotal in the effective commercialoperation of the reformed sector. In addition, ADBs capacity

development program will support energy efficiency activities andstrategic PPP.

Sector Road Map andInvestment ProgramDescription

Key constraints, challenges, and opportunities identified throughdiagnostic work paved the way for defining a strategic framework,a new sector strategy, and action plans over the short to mediumterm. The action plans are sequenced and complementtransactions involving the private and public sectors. These areencapsulated in a medium-term sector road map (20072012).The sector road map is linked to a comprehensive investmentprogram covering physical investments and nonphysicalinterventions in further sector reforms, capacity development,

fiduciary oversight and governance, knowledge management,safeguards, procurement, disbursements, project implementation,evaluation, supervision, monitoring, and reporting.

Physical Investments. Reserve Bank of India forecasts asignificant improvement in MPs economic performance from 2007to 2012, which is expected to drive strong growth in demand forelectricity. The objective of full household electrification by 2012 isexpected to generate further growth in electricity demand. Basedon consistent growth in the national and state economy, andmoderate increases in tariffs to bring them in line with the truecost of supply, unrestricted consumer demand for electricity in MP

is forecast to increase by 7% from 2007 to 2012. With energylosses currently at about 41%, more than 6,000 MW of peakgeneration and network capacity will have to be added over thenext 5 years to serve this demand.

A coherent and realistic state and regional plan for expansion ofgeneration capacity is in place with contributions from public andprivate financial resources. The need to transmit an additional6,000 MW of peak power is the main driver of the investmentprogram for the transmission and distribution systems. Theinvestment program is predicated on building sufficient capacity toevacuate power from existing and planned power stations and

substations, and delivering power reliability and efficiency toconsumers. It also targets significant reductions in technical andcommercial losses, reducing the requirement for additionalcapacity by more than 1,000 MW and returning to a capacity andenergy surplus by 2011.

The total investment program for the power sector is estimated tobe $5.3 billion (20072012), with $3.0 billion needed fortransmission and distribution. The financing plan involves the


11/110

v

state government budget, as well as the private sector andinstitutions such as ADB.

In this context, India requested ADB support for the investmentprogram in the form of a multitranche financing facility (MFF).Such support provides a platform for financial and expert

assistance, blending reform and capacity development withinvestments. ADB support will be extended for the transmissionand distribution segments of the sector since a joint venturebetween state and central power utilities, private sectorinvestments, and central-level generating projects (e.g., ultramega power projects) are planned to eliminate the generationdeficit. The impact of the transmission component will be furtherreductions in losses and increased capacity for electricitytransmission to meet forecast demand growth. The impact of thedistribution component will be reduced technical and nontechnicallosses, improved voltage profiles, power quality and reliability, andmore efficient revenue collection.

The project component of the earlier ADB loan covered thetransmission and distribution subsectors. The program componentassisted GOMP in (i) implementing key policy reforms andestablishing a policy framework, including a fully operational,independent state regulatory commission; (ii) unbundling theMPSEB into five companies; (iii) improving sector governancethrough more functional independence; and (iv) restructuringtariffs and issuing new tariff orders that allow revenue realization.Remaining policy issues are currently being addressed.

The Investment Program will be a logical replication of the project

component of the previous ADB loan, covering transmission anddistribution subsectors by taking into account the interrelatednature of the subsectors. Subprojects are designed in a repeaternature in the transmission and distribution subsectors, and oneset of project from each subsector is presented in the Report andRecommendation of the President. The executing agencies (EAs)have gained substantial experience from implementing theprevious ADB project.

The MFF is particularly well suited for the Investment Programbecause (i) the aim of the Investment Program is to supportGOMPs long-term objectives, as stated in the sector road map;

(ii) the performance of the previous loan can guide the provision ofsubsequent loans, thereby offering proper incentives forimplementation; and (iii) the MFF can offer the flexibility requiredfor the Investment Program to support the participation of fourcompanies with different levels of readiness.

Nonphysical Investments. ADB is providing $10 million forcapacity development in various areas to maximize the synergywith the DFID-funded capacity development program. ADBs


12/110

vi

capacity development program will focus on implementationsupport of SCADA systems in the distribution companies; anddeveloping a trading and settlements support system, metering,and communications for the new trading company, whose futurerole is pivotal in the effective commercial operation of thereformed sector. In addition, nonphysical investments will provide

substantial support for the establishment of (i) an energyconservation fund and other energy efficiency initiatives (e.g.,Clean Development Mechanism); and (ii) strategic PPP with theintention of achieving the requisite reduction in distribution lossesand improving the quality of service to consumers.

Sector Investment andFinancing Plan

Table 1: Power Sector Financing Plan, 20072012

Investment Program 20072012 $ Million %Investments

Generation 2,300 43.1

Transmission 1,400 26.2

Distribution 1,600 30.0

Nonphysical Investments 40 0.7Total Investments 5,340 100.0

Financing SourcesDomestic Financial Institutions 2,585 48.8

Asian Development Bank 620 11.6

Department for International Development , UK 35 0.7

Private Investors 700 13.1

Internal Funds 800 15.0

Government of Madhya Pradesh 600 11.2

Total Funding 5,340 100.0

Sources: Asian Development Bank estimates.

Table 2: Transmission and Distribution Financing Plan, 20072012Financing Sources $ Million %Domestic Financial Institutions 1,345 44.8

Asian Development Bank 620 20.7

Department for International Development, UK 25 1.2

Private Investors 100 3.3

Internal Funds 610 20.0

Government of Madhya Pradesh 300 10.0

Total Funding 3,000 100.0

Sources: Asian Development Bank estimates

Multitranche Financing

Facility

India has asked ADB to extend financing of $620 million (included

in the Country Operations Business Plan 2007-2009) over 8 yearsthrough an MFF for its power sector investment program. Thisfinancing represents 11.6% of the total financing plan and 20.7%of the financing plan for the transmission and distributionsegment. The MFF will allow financing of individual subprojects,as projects and conditions warrant, by linking financing to projectreadiness, reforms, capacity, and work on various themes. Thetentative implementation schedule of the MFF envisages fivetranches covering transmission, distribution, and nonphysical


13/110

vii

investments. Due diligence in key areas, such as technical,economic, financial, and safeguards, has been completed forTranche 1 and Tranche 2. It is underway for further tranches.

Framework FinancingAgreement

India has entered into a financing framework agreement (FFA)with ADB. The FFA satisfies the requirements established in

Appendix 4 of the Pilot Financing Instruments and Modalities.

The FFA records the full set of warranties and representations ofADB operating policies and procedures on all crosscuttingthemes, covering safeguards, governance, anticorruption,financial management, procurement, and disbursement andsubproject selection criteria.

Before ADB accepts a Periodic Financing Request (PFR), India,MP, and sector companies will ensure full compliance with theterms and conditions of the FFA. The capacity developmentcomponent will provide support if necessary. ADB teams will

evaluate all funding requests, and will ensure that they adhere torepresentations made and will continue to do so. ADB teams willprovide ongoing guidance to the authorities, and make availableadditional experts under the capacity development component, ifneeded. ADB staff will inform the Government of India (theGovernment), and report to Management, and the Board on thestatus of individual loans, including the performance on warrantiesand representations. Failure to comply with any of theseautomatically will hold back additional financing under the MFF.

Periodic FinancingRequests

The MFF transaction is accompanied by two PFRs, one forTranche 1 for transmission components and another for Tranche2 for distribution components that are ready for implementation.

PFR 1, Transmission Capacity Expansion. This componentincludes construction of (i) 2 circuit kilometers (cct-km) of 400kilovolt (kV) and about 1,500 cct-km of 220 kV transmission linesacross the state of MP; (ii) eight new 220/132 kV substations, withtransformer capacity of 160 megavolt-ampere (MVA) each; and(iii) one new 400/220/132 kV substation with 315 MVA transformercapacity.

PFR 2, Distribution Efficiency Enhancement. The distributioncomponent will undertake (i) construction of high-voltagedistribution systems in six distribution circles in the easterndistribution zone of MP, including conversion of about 7,400 km oflow-voltage lines to high-voltage lines; (ii) remote metering ofabout 2,000 industrial consumers; (iii) metering of about 250,000consumers; and (iv) renovation of the protection system at about100 substations.


14/110

viii

Amount and Terms The MFF will provide up to $620 million, secured from the ordinarycapital resources of ADB, with final terms and conditions to beestablished under individual loan agreements based on prevailingADB policies.

Pursuant to the FFA, the Government has submitted two PFRs to

ADB totaling $151 million for Tranche 1 and Tranche 2 to financetransmission and distribution subprojects. Both PFRs arepresented to the Board with the MFF and the FFA. Tranche 1 andTranche 2 loans will have a principal repayment period of 20years, not including a grace period of 5 years. However, eachfuture tranche may be financed under terms different from thefinancing terms of previous or subsequent tranches. Financing willbe made available under ADBs London interbank offered rate(LIBOR)-based lending facility. The Government can choose fromeligible currencies and interest rate regimes, which can changewith each loan. Currency and interest rate swaps will be madeavailable during the financing period. Repayment schedules can

be structured to satisfy the needs of individual loans.

Each tranche under the MFF would be at least $40 million, exceptfor the nonphysical investments component, which would have aminimum loan amount of $5 million.

Allocation and RelendingTerms

The Government will make loans available to GOMP on the sameterms and conditions as the ones applicable to the Government.GOMP will onlend to sector companies, as the EA, with a 1percentage point spread, through respective onlendingagreements.

Retroactive Financing Retroactive financing may be possible under individual loans forexpenditures incurred 12 months before the signing of thecorresponding loan agreement, with a ceiling of up to 20% of theloan amount, in accordance with the Board paper on Cost Sharingand Eligibility of Expenditures for Asian Development BankFinancing: A New Approach. The Government, GOMP, and EAshave been informed that approval of advance procurement actionand retroactive financing does not commit ADB to financing any ofthe proposed subprojects. Each PFR will specify the nature ofexpenditure if retroactive financing is requested.

Period of Utilization Until 30 June 2015, with the last PFR submission by 31 December

2010.

Estimated ProjectCompletion Date

31 December 2014.

Executing Agencies andImplementationArrangements

The EAs will be Madhya Pradesh Power Transmission CompanyLimited (TRANSCO), Madhya Pradesh Madhya Kshetra VidyutVitaran Company Limited (DISCOM-C), Madhya Pradesh PoorvKshetra Vidyut Vitaran Company Limited (DISCOM-E), Madhya


15/110

ix

Pradesh Paschim Kshetra Vidyut Vitaran Company Limited(DISCOM-W), and the Madhya Pradesh Power Trading CompanyLimited (TRADECO).

The EAs will be guided by a coordinating committee chaired bythe chairman and managing director of TRANSCO, who has

extensive experience at major project delivery and loandisbursement through an earlier ADB loan. This approach willensure the sharing of best practices within the state. The EA forthe energy efficiency component will be identified in the future.

The Government will be responsible for the implementation of theMFF and loans in accordance with the FFA and individual loanagreements.

The Energy Department (ED) of GOMP handles overallinvestment program management in MP. Based on nationalpolicies, the Energy Department formulates state power sector

policies, road map, and long-term investment plan. It also isresponsible for creating an enabling environment for private sectorinvestment in the state. The ED will monitor and evaluate theimplementation of the approved investment program and report itto Ministry of Power.

MPERC will take part in monitoring since it conducts due diligencefor all investment proposals and reviews detailed project reportsfrom the state power companies or private sector before warrantapproval.

Once an investment program is approved, the companies will

implement and be responsible for it. They also will overseeprofessionally and efficiently the investment operations plannedover the next few years. The staff of all power sector companieshas acquired substantial experience, including management skillsand systems in the previous ADB-financed project. Teams havebeen set up to conduct best practices in technical, financial,project management, procurement, and environmental and socialsafeguards. Evaluation, monitoring, and reporting systems will bepart of the work.

Procurement Procurement to be financed under the MFF will be undertaken inaccordance with ADBs Procurement Guidelines, (2006, as

amended from time to time), and will be in line with ADBsEnvironmental Assessment Guidelines (e.g., environmentallyresponsible procurement). International competitive bidding (ICB)will be used for supply and construction of the facilities beingfunded under the investment program (substations, transmissionlines, equipment, and transformers, etc.). ICB will be utilized forsupply contracts estimated to cost the equivalent of or more than$1 million. Limited international bidding or national competitivebidding will be used for supply contracts estimated at $250,000


16/110

x

$1 million, and shopping for contracts estimated at less than$250,000. Contract packages will be prepared to ensuremaximum competition under ICB.

Consulting Services Consultants will be selected and engaged in accordance withADBs Guidelines on the Use of Consultants (2006, as amended

from time to time). Consulting firms will be chosen throughinternational competition using the quality- and cost-basedselection method. Individual experts may be recruited followingADBs procedures for engagement of individual consultants basedon resume submitted in response to specific terms of reference forthe assignment.

Project Benefits andBeneficiaries of theFacility

The MFF is designed to benefit all grid-connected consumerswithadequate and reliable supply of electricity. This would support theGovernments projections for growth in energy demand, as well asits plan to make affordable grid-based electricity supplies availableto the entire population by 2012. Substantial investments in

rehabilitation, augmentation, and expansion of the powertransmission system will increase reliability of supply to theresidential, agricultural, commercial, and industrial consumerswithin the state of MP. A secure and predictable electricity supplywill enable social and economic benefits to materialize, and willensure improved conditions for schools, hospitals, and othersocial services. At the state level, the economic and financial costof supplying electricity will be reduced by directly addressinginherent inefficiencies.

The investment program will enable urban and rural domesticconsumers to receive a supply of electricity at an acceptable

voltage level, and with minimal scheduled and unscheduledoutages. Rural consumers in particular will see a significantlyimproved electricity supply, unaffected by the lengthy scheduledoutages that are currently experienced. This will have positiveoutcomes for educational and social activities, and will open upopportunities for energy-dependent rural enterprises. Industrialand commercial consumers also will benefit from improved supplyreliability and quality, thereby enhancing production and outputand reducing equipment failures. In addition, the investmentprogram will create short-term and long-term employmentopportunities and tax revenues.

Risks and Assumptions The MFF is accompanied by some risks, particularly costoverruns, commissioning delays, investment timing mismatches,and stalled sector reforms. Given the cost-plus tariff settingmechanism employed in MP and in other Indian states, costoverruns can be passed through to consumers. If tariff increasesare substantial, the demand growth upon which the investmentprogram is predicated could be constrained, undermining the


17/110

xi

economic and financial viability of investments. This risk isdeemed to be small. Cost projections are thorough andconservative, and have been based on a basket of tender pricessubmitted over the past 12 months. Moreover, turnkey contractingwill be used where appropriate, thereby transferring a large part ofprice and implementation risk to turnkey contractors. Investmentcomponents are interrelated to some extent. Benefits expected to

flow from one component might be reduced if commission delaysare experienced in other components. Such risk will be containedand managed through contractual mechanisms that includeprovisions for liquidated damages when commissioning delays arethe fault of contractors. Sufficient slippage provision will be builtinto the implementation program to minimize the risk ofcommissioning delays outside the control of contractors.TRANSCOs experience in managing and disbursing major loansand capital programs provides further comfort.Capacity building and public policy reform are essential to thelong-term growth and sustainability of the sector. The risk of aslowdown or reversal in the reform process is very unlikely. The

Government and GOMP remain committed to the reform processas a secure and reliable power supply is viewed as a key enablerfor economic growth and poverty reduction.

Warranties andRepresentations

MP has a well-defined power sector road map, a clear investmentand capacity development program, and the people andinstitutions to deliver on the objectives and targets. The provisionof ADB finance through an MFF requires an agreement on keywarranties and representations, which are intended to ensureprogram success. The FFA captures critical provisions for ADBfinancing, including (i) subproject eligibility criteria; (ii) selection,and implementation, capacity building, safeguards framework; (iii)procurement and disbursement procedures; (iv) financialmanagement and fiduciary oversight; (v) monitoring,administration, and reporting.

ADB will provide direct support to the EAs responsible for programimplementation, from headquarters and through the India ResidentMission. A program support office has been established that willcoordinate specific implementation tasks, including procurement,subproject management, monitoring, and supervision. The officewill comprise professional, experienced staff, especially in theareas of safeguards, financial management, administration, andreporting. Although an MFF can be a flexible instrument for theauthorities, its viability requires a strong local presence and qualityresources allocated to implementation.

Each new financing request to be converted into a new loan willrequire an evaluation of the performance of the previous one. ADBwill conduct periodic review missions, which will include duediligence on warranties and representations made to ADB. Inaddition, staff will report on any issues or problems faced by theauthorities and the EAs under the program, and the remedialactions suggested to overcome them.


18/110


19/110

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposedmultitranche financing facility (MFF) to India for the Madhya Pradesh Power Sector InvestmentProgram (Investment Program). Design and Monitoring Framework is in Appendix 1.

II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Background, Performance Indicators, and Analysis

2. India faces formidable challenges in achieving balanced infrastructure development,where the provision of adequate energy plays an essential role in reducing poverty throughsustainable economic growth. The Government of India (the Government) has confirmed itsPower for All initiative to provide universal power supply by 2012, which will require 100,000megawatt (MW) of new generation capacity and related transmission and distribution facilities.Cognizant of the vast impact on the global environment and energy security, the Governmentdeveloped the Integrated Energy Policy1 . The policy encapsulates the vision to meet thedemand for energy services of all sectors reliably with safe, clean, and convenient energy in a

technically efficient, economically viable, and environmentally sustainable manner. TheIntegrated Energy Policy provides for specific measures, including (i) optimizing the powersupply mix through greater use of indigenous hydropower resources and renewable energy; (ii)pursuing technologies that maximize energy efficiency, demand-side management, andconservation; and (iii) continuing related power sector reforms to control technical andcommercial losses of the state transmission and distribution utilities, with the restructuringsupported by the Accelerated Power Development and Reform Program.

3. The past poor performance of state electricity boards was a roadblock to private sectorinvestment. In 2001, the Government adopted a program of unbundling, open access, tariffrestructuring, and rationalization. An independent central regulatory body was established, andthe formation of state-level regulatory bodies was made mandatory. The Electricity Act, 2003

was intended to improve governance in the power sector through continued institutionalrestructuring and improved management of sector entities to ensure long-term sustainability.Compulsory metering, open access to transmission systems, facilitation of power trading, lifelinetariff for the poor and rural consumers and rationalization of tariffs have been initiated.Separation of generation, transmission, and distribution has been made obligatory. The CentralElectricity Regulatory Commission has prescribed detailed rules for cost accounting andallowable tariffs. Further, the Electricity Act, 2003 mandated full metering for all consumerclasses, multiyear tariffs (MYT), tariffs to be within 20% of the deemed cost of supply by 2012,availability-based tariffs, and 100% rural electrification.

4. Power sector reforms (Appendix 2) in Madhya Pradesh (MP), which began in 2001,received additional impetus from the Electricity Act, 2003, and have accelerated in the past two

years. The government of Madhya Pradesh (GOMP) has demonstrated its commitment toreforms and has made encouraging progress. In December 2001, the Asian Development Bank(ADB) approved the Madhya Pradesh Power Sector Development Program (MPPSDP), whichhad a $150 million program component and a $200 million project component. The objectives ofthe program component were to (i) establish independent regulation, (ii) improve sectorgovernance through institutional and organizational actions, (iii) establish and begin operationsof new sector companies, (iv) reduce system losses, and (v) increase the delivery capacity ofthe power system. With substantial support from ADBs program loan, unbundling has been

1Planning Commission, Government of India, 2006. Integrated Energy Policy. India


20/110

2

completed, all sector companies have been given cost-reflective tariffs that will gradually moveto full cost recovery, and capacity is being developed in all companies to operate in the evolvingcommercial and competitive sector.

5. Following the unbundling of the Madhya Pradesh State Electricity Board (MPSEB), fivepower sector companies have been incorporated: MP Power Generating Company Limited

(GENCO), MP Power Transmission Company Limited (TRANSCO), and three distributioncompanies (DISCOMs2). GENCO has been vested with MPs electricity generation assets andhas taken over their operation. TRANSCO has become the sole transmission company in thestate. The three DISCOMs have taken over the distribution and supply activities in threegeographic areas (east, central, and west). In June 2005, the companies started to operateindependently. The formation of the MP Power Trading Company Limited (TRADECO) wasannounced in June 2006 for the bulk procurement of electricity from generators in order to sellto DISCOMs. All power purchase agreements for which MPSEB was the purchasingcounterparty have been transferred to TRADECO. To provide an avenue for sector companiesto reach financial sustainability, GOMP undertook sector financial restructuring that includedinjecting equity and taking over loan arrears in lieu of rural electrification loans and subsidyarrears in 20052006. MPSEB will remain in place until the successor entities have built enough

capacity to handle their own corporate affairs and financial management.

6. Throughout the reform process, the MP Electricity Regulatory Authority (MPERC), anindependent, state-level regulatory agency formed in 1999, has adopted a realistic andsupportive position through its regulatory mechanisms. In 2001, it issued its first tariff orders(Supplementary Appendix A) for all sector companiesofftake tariffs for GENCO, allowablecosts and returns for TRANSCO, and uniform retail tariffs for DISCOMs. In September 2002,MPERC introduced a time-of-day tariff applicable to some classes of consumers. Between 2001and 2004, a single 1-year tariff was ordered. In the revised tariff philosophy of December 2003,MPERC proposed to determine a full-cost tariff for all consumer categories with the objective ofensuring that the sector companies receive enough income to cover expenditures and provide areasonable return on assets. In March 2006, MPERC passed the first MYT orders for generation

and transmission covering 20072009. However, the distribution retail tariff order still covered asingle year, 2007. The first multiyear retail tariff will cover 20082010. DISCOMs filed MYTapplications on 31 October 2006 to be effective as on 1 April 2007.

B. Analysis of Key Problems and Opportunities

7. The Governments and GOMPs main objective for the power sector is increasingelectricity supply to its urban and rural population to facilitate economic growth. Based ondiagnostic work undertaken by GOMP, achieving this objective in MP faces the followingchallenges (Appendix 3):

1. Sector Constraints

8. Generation. Installed capacity in or available to MP is about 6,300 MW, with about3,000 MW owned and operated by GENCO. Less than 100 MW of net installed generatingcapacity has been added in MP in the past 5 years. However, plant utilization has increasedfrom 63% in 2002 to more than 70% in 2006, which has helped in meeting the growth in energydemand during this period. Electricity demand is estimated to have grown at an average of 5%

2Madhya Pradesh Madhya Kshetra Vidyut Vitaran Company Limited (DISCOM-C), Madhya Pradesh Poorv KshetraVidyut Vitaran Company Limited (DISCOM-E), Madhya Pradesh Paschim Kshetra Vidyut Vitaran Company Limited(DISCOM-W).


21/110

3

over the same period, whereas actual sales have increased by more than 7% on average. Thesupply-demand balance is now critical. MP has suffered from chronic peak capacity and energyshortages in recent years. The peak deficit has exceeded 20% and the energy deficitconsistently has been about 13% for the past 3 years. Annual energy demand is estimated toexceed supply by more than 13% in 2007, and is forecast to grow by approximately 7% through2012.

9. Investments in capacity are planned to remove the peak deficit by 2012. The bulk ofplanned generation capacity expansion will be coal-fired thermal plants, reflecting the availabilityof coal to MP, relatively short project development cycle, and low development risk of coal-firedplants. Approximately 800 MW of additional hydropower capacity is planned, primarily aspeaking plants. Development of planned generation expansion will be shared equally by thestate, central, and private sectors. The current portfolio of MP state projects, which are underconstruction or in the planning phase, are all thermal-based. These are expected to increase theinstalled capacity by approximately 700 MW by the end of 2007. Private sector contributions willcome through competitively bid and greenfield projects. Private sector projects are expected tobe predominantly coal-fired thermal plants. MP will receive an allocation from the central sectorand joint venture hydropower and thermal projects that are in development, including the 500

MW Omkareshwar hydropower project. MP also will receive an allocation of approximately 400MW of new capacity from the Kawas and Gandhar gas-based projects. In addition, theGovernment is developing ultra mega power projects under tariff-based competitive bidding.These projects will meet the power needs of some states, including MP, through thetransmission of power regionally and nationally. MP has consented to take 12,000 MW basedon the power securing agreement with the Ministry of Power.

10. Transmission. Since 2002, transmission circuit length has increased almost 14%, whiletransformation capacity has risen 41%. Consequently, transmission losses have been reducedto an acceptable level of about 5%, and availability of the transmission network has exceeded98% for the past year. However, transmission capacity within MP is inadequate to serve peakdemand due to continued growth in demand. An (n-1) security level is used for transmission

planning.3

Investment in the transmission network has not matched the consistently highdemand growth in recent years, which means that supply security is significantly less than (n-1)for parts of the transmission networkin other words failure of a major network componentmight necessitate load shedding.

11. Distribution. In broad terms, the distribution system is the primary bottleneck inelectricity delivery in MP. It is characterized by high ratios of Low Voltage (LV) circuit length toMedium Voltage (MV) circuit length (about 64% in central and east zones, and 47% in westzone), overloaded power transformers (20% of all power transformers were overloaded at somestage in 2005), and overloaded distribution transformers (10% of all distribution transformerswere overloaded at some stage in 2005). By most measures, the MP distribution system suffersfrom such a severe capacity shortage that it is incapable of providing adequate quality and

reliability of supply to all customers. Safety is compromised on the networks of the threeDISCOMs due to shoddy installation of equipment and inadequate maintenance practices.Losses arising from poorly executed connections at distribution transformers exceed standards.

2. System Losses

12. The high network losses (Supplementary Appendix B ) are a pressing energy efficiencyissue for MP. Previous investments have successfully targeted transmission losses, which are

3Supply can be maintained to all customers with the outage of one major item of equipment.


22/110

4

now about 5%. As this is a reasonable level for a transmission network, only minor furtherimprovements are anticipated. Distribution network losses in many areas are 40%45%, whichis unacceptably high. Comparing the DISCOMs with a notional international benchmarkdistribution network indicates thatafter correction for different system characteristics, loadfactor, and energy supplieda reasonable target for technical distribution losses in MP is about19%. DISCOMs and MPERC have agreed on loss reduction targets, which form part of

distribution tariff determinations. DISCOMs will be penalized financially if they fail to achievethese targets, and will be rewarded if they exceed the targets. The distribution component of theMFF will address losses, among other things. The high-voltage distribution system (HVDS)subproject in particular will impact directly technical and nontechnical losses. Other measures,such as consumer and distribution transformer metering, will help in identifying and isolatinglosses. As a result, MPERC will be able to more accurately measure and report on the technicalperformance of DISCOMs. Incorrect and manipulated meter reading for high-value customers issuspected of causing significant commercial losses, and remote metering of these customerswill address the issue.

3. Private Participation

13. Through its National Electricity Policy (NEP)4, and in keeping with open access andother provisions in the Electricity Act, 2003, the Central Electricity Authority (CEA) has statedthat private participation in the sector is desirable and is to be encouraged. GOMP has beencognizant of the need for further private sector participation to meet the sectors financingrequirements and to enhance operational efficiencies. ADB and GOMP has continued policydialogue since processing the MPPSDP in 2001, and agreed that further private sectorparticipation would be a critical medium-term objective. Through implementation of power sectorreforms under MPPSDP, GOMP has created enabling environments for private sectorparticipation and public-private partnerships (PPP). In 2005, MPERC defined the terms andconditions for intrastate open access in MPwith the intention of further enabling private sectorparticipation in the generation and retail subsectors (Supplementary Appendix C). Despite theseinitiatives, the private sector is not yet playing a major role in the MP power sector. The financial

fragility of the sector is perceived to be the main impediment to private investments. ADBsintervention has the potential improve the sectors financial viability, so that the private sectorincreasingly will see investment reward as commensurate with risk and will begin to participateas intended under federal and state policy.

14. In generation, GOMP has proposals for independent power producer thermal projects inthe next 5 years with a combined capacity of 12,000 MW, although the number of projectsimplemented is expected to be a small subset of this total. The first project is in the biddingphase, and 15 private investors have been short-listed. In addition, further opportunities inrenewable energy generationsmall to medium hydroelectric, wind, and biomassabound. Intransmission, opportunities for PPP include outsourcing operation and maintenance. Indistribution, DISCOMs are piloting franchising schemes for rural distribution systems. They also

are exploring a strategic partnership schemes in urban distribution systems for achieving therequisite reduction in distribution losses, as well as improving the quality of service toconsumers. To this end, GOMP has started a scoping exercise with ADB involving potentialinvestors and other stakeholders.

15. Energy efficiency initiatives are another area where PPPs might play a key role(Supplementary Appendix C). The private sector is expected to participate in the establishmentof an Energy Conservation Fund (ECF) as financier, fund operator, and financing recipient. The

4Ministry of Power. Government of India, 2005. National Electricity Policy. India.


23/110

5

ECF could provide technical assistance for project development, as necessary. The fund alsocould help finance revenue-generating energy efficiency projects implemented mainly by theprivate sector and through PPP schemes, Energy Service Company (ESCOs), powerdevelopers, and other entities, including community-owned energy service providers. ADBsdirect participation would open the opportunity for additional credit enhancements in the form ofpartial credit guarantees, and cofinancing from new carbon and energy efficiency funds

expected to be operational by 2007 and 2008. ADB participation in the fund also would addsubstantial value to the MFF proposal as it presents innovative financing, mobilizes privateparticipation, and could capitalize on carbon credit opportunities. Design and operationalprocedures of the ECF, which are mandated under the Energy Conservation Act 2001, will bedetailed following due diligence for Tranche 4 of the MFF.

4. Financial Sustainability of the Sector

16. Achieving financial sustainability of the sector is a key objective of GOMP power sectorreforms. Sustainability currently is undermined by energy inefficiency, specifically the level oftechnical and nontechnical losses in the distribution subsector. In addition to reducing theselosses, systematic billing and collection by distribution companies, payments of intercompany

obligations, and timely remittance of subsidies by the Government are essential for the financialsustainability of the sector.

17. Before the sector reforms, MPSEBs financial position was critical due to inadequatetariffs, nonremunerative investments in rural electrification schemes to meet social obligations,delays in tariff subsidy from GOMP, and high commercial and technical losses in thetransmission and distribution networks. To meet cash flow requirements, MPSEB has beendefaulting on payment obligations to its suppliers and lenders by reducing capital investmentsand pursuing suboptimal repair and maintenance practices. Following the unbundling of MPSEBin 2002, GOMP prepared a financial restructuring plan (FRP) with the objective of restoring thesectors financial sustainability. Sector companies began operating independently in June 2005.In line with this, GOMP undertook financial restructuring of the sector, which included injecting

equity and taking over loan arrears and rural electrification loans in lieu of subsidy arrears in20052006. GOMP is updating the FRP to reflect the results of the financial restructuring and tomap further reforms in the sector. However, shortfalls in sector revenues are likely to continuefor next 3 to 5 years as a result of high distribution losses. In this context, targeted loss-reduction investments are critical to bring the cost of supply in line with average retail tariffs bythe end of the Eleventh Plan (20082012), and to achieve sector profitability and eventuallyfinancial sustainability.

18. GOMP continues to extend subsidies to various customer groups, such as domesticconsumers and small farmers (for irrigation). However, GOMP is reducing progressively thenumber of categories and the level of subsidies to be paid. Currently, power sector subsidiesare reflected as a line item in the state budget. Sector companies collect development cess of

10 paisa per kilowatt-hour (kWh) and electricity dues on behalf of GOMP. Rather than passthese through to GOMP, they are set off against electricity tariff subsidies. In this way, subsidiesare not paid upfront. Instead, the companies deduct subsidy payments before they remit thecash to the MPSEB.

19. MPERC is determining tariffs in compliance with the NEP of CEA. The tariff orderssupport the rationalization of operating costs and the commercialization of overall systemoperations. Most importantly, the tariff orders reflect the official viewpoint that electric power willbe provided on a cost-of-supply basis, and that all consumers will pay for electric service. Tariffsinclude consideration of good governance, financial sustainability, distributive justice, economic


24/110

6

efficiency, and fair pricing. They also are consistent with ADB guidance. In 2006, MPERCpassed a distribution and retail tariff order for 2007, as well as the first MYT order for generationand transmission covering 20072009. MPERC allowed TRANSCO to base its tariff on full costrecovery of loan capital, depreciation, return on equity, operation and maintenance expenses,administrative and general expenses, repairs and maintenance expenses, interest on workingcapital, MPERC fee, and income taxes. With the proper implementation of the tariff policy,

TRANSCO is projected to maintain profitability, while DISCOM-E is expected to achieveprofitability by 2008.

5. Capacity Development

20. The early stages of reform led to the creation of successor companies that haveassumed operating responsibilities for generation, transmission, distribution, and recentlytrading. They have inherited assets, liabilities, procedures, systems, and the work regime fromMPSEB. Staff have been allocated to the new companies on an as is where is basis. Boardshave been appointed. Below this level, organization structures in the new companies have beenevolving. Concerns have been raised that earlier efforts to contain costs in the loss-incurringMPSEB have led to shortages of skills in strategically significant disciplines and work areas. In

addition, sector companies in the transition phase face resource constraints for financialmanagement and reporting, as well as for enhancing their internal audit and control capability.

21. Recognizing these constraints, GOMP included a $45 million nonphysical investmentcomponent for capacity development to support physical investments. Department forInternational Development of the United Kingdom (DFID) is providing assistance 5 for furthercapacity development, specifically in financial management, technical planning, and humanresources development, as well as in commercial areas. DFID assistance, which will cover20062010, will complement ADBs physical investments included under the MFF. ADB alsoincluded an additional $10 million under the MFF for capacity development to support energyefficiency activities, such as the establishment of ECF and other energy efficiency initiatives,e.g., Clean Development Mechanism (CDM). The funds also will support information technology

and management information systems (MIS)6

for TRADECO that are not covered under theDFID program. Since the initial stage of reforms, ADB and DFID have supported jointly the MPpower sector.

22. From 2002 to 2006, ADB (Supplementary Appendix D) helped GOMP (i) improve thepolicy environment and governance of the sector, (ii) initiate the establishment of a commercialand competitive business environment to promote efficiency gains and loss reduction, and (iii)introduce a computerized information and revenue management system. The CanadianInternational Development Agency worked with ADB from 2002 to 2004, providing extensivesupport for the development of financial restructuring plans, as well as the assessment ofpension fund liabilities. From 2002 to 2005, DFID provided complementary support to the reformprocess through detailed needs assessments for accounting and information and technology

systems for the successor companies. DFIDs capacity development assistance covers (i)defining the commercial relation ships between sector companies, including market operationsupport during the transition to the new market mechanisms, energy billing arrangements, andpreparation of PPAs; (ii) financial management through setting financial policies, cost andrevenue centers, planning, modeling, controls, and reporting; (iii) accounting systems, including

5DFID is providing 18.5 million in technical assistance (14.5 million) and financial assistance (4.0 million) from2006 to 2010.

6A needs assessment will be conducted to design the capacity building component for TRADECO. Therefore, thiscomponent will be included in the third tranche that is scheduled for April 2008.


25/110

7

specification of long-term accounting requirements and preparation of chart of accounts; (iv)human resource strategies, needs assessment, organizational structure, and development ofrecruitment procedures and supporting mechanisms (e.g., job descriptions); (v) development,procurement, and implementation of integrated MIS solutions, including components such asbilling, accounting, materials management, project management, asset maintenancemanagement, and technical applications; and (vi) regulatory support, including filing tariff

applications and interaction with MPERC. DFID assistance also supports technical areas, suchas distribution investment planning, facilitation of decentralization and standardization, loadforecasting, power quality and reliability, benchmarking, and equipment standards for allDISCOMs and transmission investment planning studies to meet demand growth and openaccess requirements for TRANSCO.

6. Sector Road Map

23. To overcome these challenges, GOMP has developed a sector road map linked to acomprehensive investment program. The sector road maps objective is to establish the route toachieving the sustainable growth of the power sector in MP. The road map aims to deliver thefollowing outcomes: (i) strengthening power supply capacity to improve access to reliable and

affordable electricity, (ii) enhancing efficiency and quality of power supply, and (iii) ensuringfinancial health of the power sector through continued power sector reform at the sector andcorporate levels. Based on the sector road map, the MP power sector needs an estimated $5.3billion in investments through to 2012. The largest component is generation, accounting for $2.3billion of planned investment (43%). This is followed by $1.6 billion for distribution, includingrural electrification (30%), and $1.4 billion for transmission (26%). The investment programincludes $40 million for a comprehensive capacity building program to meet the sectorsincreasing management capacity requirements. The physical investments will address currentunserved energy demand and provide additional capacity to meet forecast demand growth. Theinstalled generating capacity of thermal and hydropower plants will be increased, while technicaland nontechnical losses will be reduced through enhanced transmission capacity and theadoption of more appropriate voltage levels for distribution. The need for load shedding also will

be reduced during peak demand periods (A matrix that summarizes the sector road map is inAppendix 1).

7. Asian Development Banks Strategy

24. Cognizant of the strong nexus between infrastructure and poverty reduction, ADBsoverall assistance has taken a balanced infrastructure development approach, comprising roadsystems, water transport, railways, hydrocarbons, and energy. Within the energy sector, thecountry strategy and program 20032006 (CSP) focused investment programs on clean energydevelopment, including run-of-the-river hydropower projects, other forms of renewable energy,rural electrification, and energy efficiency improvements. Guided by the CSP, the 2004 and2005 CSP updates7 outlined six priorities of ADBs power sector assistance: (i) reforming the

power sector, (ii) promoting higher efficiency and low-carbon power sources, (iii) expanding andoptimizing transmission and distribution systems, (iv) strengthening institutions to implementreforms required by the 2003 Electricity Act, (v) promoting private sector participation, and (vi)encouraging energy conservation and ensuring environmental and social sustainability.

25. Under its energy efficiency and carbon market initiatives, ADB is providing acomprehensive technical assistance program that began in 2005. The program includes: (i)

7ADB. 2004. Country Strategy and Program Update (20042006): India. Manila; ADB. 2005. Country Strategy andProgram Update (20052007): India. Manila.


26/110

8

CDM8, which provides capacity building for financial and municipal sectors, with an ultimategoal of reducing greenhouse gasses through CDM projects; (ii) support the inception of theenergy efficiency initiative in developing member countries 9 for country-level assessment ofnear-term energy efficiency opportunities focusing on conservation and demand-sidemanagement; and (iii) assistance for renewable energy in rural areas through the ADBRenewable Energy and Climate Change Program.

26. ADB will continue to expand its promotion of and support for power sector reforms inother states. ADB also will intensify its efforts in the states where it is already active, such asAssam, Gujarat, MP, and Uttaranchal. The interventions will promote knowledge transfer inrelation to best practices in the international power sector, improve corporate governance instate-owned utilities, and ensure that appropriate environmental and social safeguards areincorporated into new power sector investments. The proposed intervention in MP is consistentwith the strategy of supporting state-level sector reforms, in this case with the emphasis on thetransmission and distribution subsectors.

8. Lessons

27. In the past, ADB extended assistance to discrete power projects in various states, aswell as to the central power sector agencies. Although this policy enabled ADB to support manyprojects, it spread ADBs resources too thinly. As a result, ADB could not achieve fully itsdesired goal of policy reforms with its power sector borrowers. In most states, the power sectorwas the largest recipient of state resources in terms of subsidies and capital investments. Indiarecognized that macro management of the states finances needed to be improved to turnaround the power sector.

28. Since 2000, ADB has focused its lending on states committed to reforming andrestructuring their power sectors on the premise that improving the power sector towardfinancial sustainability will increase the ability of state governments to allocate resources forpoverty reduction. In 2003, ADB conducted project performance audits of energy projects in

India, which identified the following lessons: (i) ADB needs to be flexible and adaptable tochanging conditions in India, (ii) land acquisition should be carried out expeditiously to minimizeimplementation delays, (iii) construction contracts should be properly packaged to facilitateimplementation and coordination, and (iv) loan covenants should be appropriate. These issueswere taken into consideration when selecting the subprojects, finalizing procurement packages,and implementing subprojects under the ongoing loan. The experience is reflected in thepreparation of the proposed MFF, and ensured that these lessons are incorporated into MFFdesign and project preparedness criteria agreed between India and ADB.

9. External Assistance

29. The power sector in India has received assistance from various international

development partners (Appendix 4). The World Bank has been the major source of externalfunding to the sector, focusing on reforms in generation, rehabilitation and improvement, anddevelopment of renewable energy resources. The United States Agency for InternationalDevelopment has supported policy aspects of private sector participation, with studies on statesector reforms, and has provided assistance for energy management. Kreditanstalt fr

8ADB. 2004. Technical Assistance to India for Capacity Development for Clean Development Mechanism. Manila(TA 4496)

9ADB. 2006. Technical Assistance to India forSupport the Inception of the Energy Efficiency Initiative in DevelopingMember Countries. Manila (TA 6346-REG)


27/110

9

Wiederaufbau of the Government of Germany has focused on improving the energy efficiency ofthermal power plants and clean electricity production in various states. Japan Bank forInternational Corporation has supported the expansion of public sector generation,transmission, and distribution, including rural electrification.

30. ADB has been coordinating with other development partners to maximize the value of

sector reforms and physical investments10. The Canadian International Development Agencyworked with ADB from 2002 to 2004 on MP power sector reform, and has provided extensivesupport for development of financial restructuring plans, reconfiguration of distributionoperations, and assessment of pension fund liabilities. DFID has provided technical andfinancial assistance for power sector restructuring in Andhra Pradesh, Haryana, Orissa, andWest Bengal, as well as in MP in cooperation with ADB.

10. Policy Dialogue

31. Energy Efficiency. GOMP is aware that energy efficiency and renewable energypotential to bridge supply gaps, specifically in distributed and decentralized generationapplication, is substantially unrealized. Total potential of energy efficiency, renewable energy,

and distributed and decentralized generation is roughly equivalent to current state-wide powerimports. The main sources of this potential are conservation and demand-side management,solar water heating and photovoltaic systems, wind power, small hydropower, biomass-biogas,and biofuels. Cofinancing of energy efficiency projects is possible through the Kyoto Protocol,second-tier carbon markets, commercial clean energy investment funds, and the globalenvironment facility. The Energy Conservation Act 2001 mandates the creation of state-levelECF. GOMP approved on 26 September 2006 a new policy for unconventional resourcedevelopment, including directing 5% of the Rs0.10 per kWh cess on power sales into a state-level ECF to be created. MP will be among the first few states in India to create the ECF. 11

32. Cash Management. Sector cash management, in terms of revenues and payments, iscentralized under MPSEB. Although the five companies are operated separately and

independently, the revenues from their businesses are consolidated and utilized by MPSEB inaccordance with a prescriptive cash flow mechanism. Priority is given to payment of salariesand wages, coal and oil supplies, power purchases, debt service, essential operation &management expenses, and administrative and capital expenditures. The cash flow mechanismis expected to be retained until the sector is returned to profitability in 2011, according toprojections in the FRP. However, TRANSCOs projections show that it will make a profit, andwill be capable of meeting its own operating costs and debt repayments, in 2007. Similarly,DISCOMs financial projections indicate that DISCOM-E will achieve profitability in 2009, whileDISCOM-C and DISCOM-W are expected to reach that milestone in 2010 with only smalloperating losses in 2009. Accordingly, the cash flow mechanism could be discontinuedbeginning 1 April 2008.

33. Governance Measures. Companies are introducing an enterprise resource planning-based procurement system, which will increase transparency, accountability, and efficiency inprocurement. Use of ADB guidelines on procurement and consulting services and standardbidding documents will provide an opportunity for better monitoring. Bid specifications andpackaging will ensure maximum competition under international competitive bidding procedures.

10Appendix 4 provides further details.

11Further details are discussed in para. 44.


28/110

10

34. Recruitment of financial management experts and establishment of internal controlsystems supported with advanced information and communication technology-based financialmanagement systems will ensure efficiency and accountability. External auditors will audit thefinancial statements, which will be published regularly and reported to the shareholders andMPERC. Measurable financial performance indicators for each company will be set, evaluated,and benchmarked by MPERC. ADB review missions will have regular access to the executing

agencies (EA) accounting and control systems to monitor expenditures and other financialtransactions, and ensure safe custody of project-financed assets.

35. The appointment of independent board members in the sector companies will clarify andenhance their role as custodians of stakeholder interests. Revisions to board recruitmentprocedures and establishment of board-level committees will encourage diversity and facilitatethe introduction of additional private sector expertise. The development of a formal code ofconduct for board members, as well as public disclosure of operational and financialperformance of the sector entities on the MPERC web site, will ensure transparency in thepower sector in MP. A summary of governance measures is in Table 1.

Table 1: Governance Measures

Area MeasureProcurement Use of the Asian Development Bank (ADB) guidelines on procurement and

consulting services. Use of ADBs standard bidding documents and standard request for proposal

documents for procurement and recruitment of consultants. Bid specifications and packaging to be prepared to ensure maximum

competition under international competitive bidding procedures. Capacity development of sector entities on e-procurement to increase

transparency, accountability, and efficiency in procurement.FinancialManagementand Audit

Regular access to the Executing Agencys accounting and control systems tomonitor expenditures and other financial transactions and safe custody ofproject-financed assets.

Capacity development of the sector companies in accounting and internal

control systems, financial management, and audit capabilities. Expanded use of advanced information and communication technology-based

financial management systems will ensure efficient and accountability. External auditors acceptable to ADB to audit financial statements, which will

be published regularly and reported to the shareholders. Measurable financial performance indicators for each company to be

established, evaluated, and benchmarked. Introduction of an appropriate internal audit system through the capacity

building program. Implementation of an operational risk mitigation action plan and undertaking a

joint operational risk assessment with development partners.Institutionaland/or

CorporateGovernance

Public disclosure of operational and financial performance of the sectorcompanies to improve transparency.

Fully functional sector regulator to ensure equal opportunities for all sectorentities and to improve sector governance. Continued introduction of a new corporate culture through further

commercialization. Appointment of independent board of directors. Revision of board recruitment procedures. Development of formal code of conduct for board of directors. Delegation of powers to companies management. Promotion of private sector participation and public-private partnership. Expansion of computerized billing system.

Source: ADB assessment.


29/110

11

III. INVESTMENT PROPOSAL

36. The Investment Program will address directly sector issues and provide a solidfoundation for the sustainable growth of the reformed power sector in MP. Consequently, qualityand reliability of supply to consumers will improve, productive uses of electricity will escalate

economically, and quality of life will improve. Additionally, the direct benefit to electricityconsumers will underpin the expected economic value of the reforms. A secure and predictableelectricity supply will enable social and economic benefits to materialize, and will ensureimproved conditions for schools, hospitals, and other social services. The targeted loss-reduction investments will bring the cost of supply in line with average retail tariffs by the end ofthe Eleventh Plan (20082012), and will achieve sector profitability and eventually financialsustainability. The proposed Investment Program to be supported by ADB will require 8 yearsfor full implementation, and will require flexibility in subproject selection to achieve overallobjectives and to mitigate risk.

37. The EAs have gained substantial experience from implementing the previous ADBproject. The project component of the earlier ADB loan covered the transmission and

distribution subsectors. The program component assisted GOMP in (i) implementing key policyreforms and establishing a policy framework, including a fully operational, independent stateregulatory commission; (ii) unbundling the MPSEB into five companies; (iii) improving sectorgovernance through more functional independence; and (iv) restructuring tariffs and issuing newtariff orders that allow revenue realization. Remaining policy issues are currently beingaddressed. The Investment Program will be a logical replication of the project component of theprevious ADB loan, covering transmission and distribution subsectors12 by taking into accountthe interrelated nature of the subsectors. The transmission component will complete theestablishment of a backbone for transmission, while the distribution component will extendpower to end connections and target physical and nonphysical system losses. Subprojects aredesigned in a repeater nature in the transmission and distribution subsectors, and one set ofproject from each subsector is presented in the Report and Recommendation of the President

(RRP). The MFF is particularly well suited for the Investment Program because (i) the aim of theInvestment Program is to support GOMPs long-term objectives, as stated in the sector roadmap; (ii) the performance of the previous loan can guide the provision of subsequent loans,thereby offering proper incentives for implementation; and (iii) the MFF can offer the flexibilityrequired for the Investment Program to support the participation of four companies with differentlevels of readiness.

A. Impact and Outcome

38. The transmission and distribution component of MPs investment program from 2007through 2012 is predicated on building sufficient capacity for evacuation of power from existingand planned power stations and substations, and delivering power reliability and efficiently to

consumers. ADB will finance key components of the transmission investment program from2007 through to 2012 ($250 million of an estimated total investment requirement of $1.4 billion),as well as part of the distribution investment program ($360 million of a total estimatedinvestment requirement of $1.6 billion). The construction of new transmission lines will removeconstraints to power flow, and will provide additional operational flexibility to TRANSCO in itsrole as an independent system operator in MP. Supply reliability will be improved further, andwill promote open access and development of intrastate and interstate power trading by

12The generation expansion will be shared equally by the state, central, and private sectors. See para. 9. for details.


30/110

12

providing sufficient excess substation and line capacity to handle unplanned power transfers.From the perspective of consumers, the impact of the distribution component will be morepronounced and apparent. Improvements in voltage profiles will be evident through betterlighting and fewer equipment failures. Supply will be more consistent and momentary outageswill be reduced significantly. The distribution component also will impact directly technical andnontechnical losses, and eventually sector profitability and financial sustainability.

B. Outputs

39. The ADB supported subset of the investment program will cover three areas:

(i) Transmission capacity expansion. Time-critical transmission lines,substations, and auxiliary equipment will be constructed to evacuate and transmitpower from new power stations and substations to consumers. The scope oftransmission work will comprise the construction of (a) 2 cct-km of 400 kV 13 and1,435 cct-km of 220 kV transmission lines across the state; (b) eight new220/132 kV substations with transformer capacity of 160 MVA14 each; and (c)one new 400/220/132 kV substation with 315 MVA transformer capacity.

(ii) Distribution efficiency enhancement. Targeted capital works will be designedto improve efficiency through loss reduction and to enhance supply reliability inall DISCOMs. Subprojects will include (a) rollout of an HVDS; (b) remotemetering of high-value customers (metering of unmetered consumers anddistribution transformers metering); (c) renovation of substation protection, andmodernization of substations and substation Supervisory Control and DataAcquisition (SCADA); and (d) expansion of the village lighting scheme (feederseparation scheme).

(iii) Nonphysical investments. A number of nonphysical investments willcomplement physical investments, including implementation of SCADA systems

in DISCOM-E, development of a trading and settlements support system forTRADECO, facilitation of strategic PPP, and establishment of ECF and otherenergy efficiency initiatives such as CDM.

C. Technical Justification and Selection Criteria

40. Transmission components form part of the least-cost expansion plan of the Government,MP, and TRANSCO. TRANSCOs planning process uses investment signals provided throughthe national and regional demand forecast produced by the CEA, and from state energy anddemand forecasts produced with the assistance of DISCOMs. TRANSCOs transmissionnetwork was modeled using power system analysis framework software, and this model was theprimary transmission planning tool for assessing the technical benefits of the transmission

components. Distribution components were modeled and analyzed using power systemsanalysis software, and are focused on network augmentation and reinforcement rather thanexpansion. The expansion program is technically, financially, and economically viable. It can beimplemented with minimal environmental and social impact. Best practice design standards andconstruction techniques will be applied to all investments.

41. The following are the criteria for selecting each subproject:

13Kilovolt (kV)

14Megavolt-ampere 1,000,000 volt-amperes (MVA).


31/110

13

(i) Subproject designs will be consistent with overall least-cost expansion plansdesigned on a least cost basis and reflect best practice design, construction,and operations and maintenance features.

(ii) Subprojects will display performance-based design consistent with international

benchmarks for system efficiency and operational risk. Subprojects should havequantifiable energy efficiency improvements.

(i) Subproject designs will be consistent with the environmental management plan(EMP), the resettlement framework (RF), and the indigenous peopledevelopment framework (IPDF). Land acquisition and resettlement plans (RP)and indigenous people development plans (IPDP) based on the agreed IPDF andthe RF will be prepared as necessary for additional subprojects before ADBapproves funding.

(ii) All subprojects require environmental assessments in accordance with ADBsEnvironment Policy (2002). Category A subprojects will require a summary

environmental impact assessment (SEIA), category B subprojects will require asummary initial environmental examination (SIEE). SEIA and SIEE for category Aand B-sensitive subprojects respectively must be prepared and made available tothe public 120 days before a Periodic Financing Request (PFR) is submitted toADB. EMPs with budgets will be prepared for each subproject.

D. Special Features

42. High-Voltage Distribution System. The objective of HVDS is a virtual elimination oftheft-related commercial losses, as well as significant reduction in technical losses. This will beachieved by replacing the overhead open wire low-voltage (0.4 kV) distribution system with ahigh-voltage (11 kV) distribution system, and placing additional, lower-rated transformers close

to consumers premises. By extending the 11 kV network closer to consumers serviceconnections, illegal connections from lengthy low-voltage lines will become difficult. In theabsence of LV voltage drop, voltage profiles also will improve and interference betweenneighboring customers loads will be decreased. Further, unscheduled supply interruptions areexpected to be reduced from fewer overloaded transformers and circuits. A pilot studyundertaken by DISCOM-W confirmed the viability of the HVDS scheme, with distribution loss inthe study area reduced from 26.7% to 8.4%.

43. Strategic Public-Private Partnership Scheme. Under the Investment Program, astrategic partnership with the private sector will be developed in selected urban areas under thefranchising modality with the intention of achieving the requisite reduction in distribution lossesand improving the quality of service to consumers. If successful, this scheme will be extended

into other semi-urban and urban areas in MP. Under the modality, the strategic partnershipswith the private sector, selected through competitive bidding process, would buy power from theincumbents distribution licensee at bulk import points. The PPP would be responsible for alldownstream distribution-related activities, including long-term capital investment and operationand maintenance. These franchises will be at least long enough to recover the investments innetwork augmentation and expansion. Gwalior city under DISCOM-C has been selected for pilottesting the scheme.

44. Energy Conservation Fund. ADB funds will partly capitalize a new special purposevehicle created for the ECF. Operations of the ECF will be outsourced through competitive


32/110

14

bidding to a consortium of an ESCO with experience in project implementation and a financialinstitution with professional experience in fund management. Additional equity contributions bypower sector companies and private financiers will be possible. ADBs direct participation willcreate the opportunity for additional credit enhancements in the form of partial creditguarantees, cofinancing from the new CDM and energy efficiency funds expected to beoperational by 2007 and 2008. The ECF investments will be repaid from revenue generated

directly by the projects. ADB participation in the ECF offers innovative financing, mobilizesprivate participation, and capitalizes on carbon credit opportunities. Various parties will need tobe consulted during the development of the ECF. For this reason, it will be included in one ofthe further tranches of the MFF, tentatively scheduled for April 2008.

45. Carbon Emissions Trading. Cofinancing of alternative energy projects is possiblethrough the Kyoto Protocol CDM, second-tier carbon markets, commercial clean energyinvestment funds, and the Global Environment Facility. CDM and second-tier carbon marketsmight be the best options for carbon credit transactions. ADB will provide indirect supportthrough an ongoing technical assistance project executed by the Ministry of Environment andForests, the designated national authority for CDM. The HVDS is the only component confirmedfor ADB funding that appears to be a promising CDM candidate based on expected emissions

reductions. ADB will assist in preparing a project concept note for submission to the ministry toestimate the relative prospects for CDM. ADB will assist in further development accordinglythrough a technical assistance.15

E. Investment Program and Financing Plan

46. The total power sector investment program and indicative financing for 20072012 isshown in Table 2. Indicative cost estimates for appraised subprojects are in Appendix 5.

Table 2: Madhya Pradesh Power Sector Investment Program, 20072012

Investment Program 20072012 $ (million) %Investments

Generation 2,300 43.1Transmission 1,400 26.2Distribution 1,600 30.0Nonphysical Investments 40 0.7

Total Investments 5,340 100.0

FinancingDomestic Financial Institutions 2,585 48.4Asian Development Bank 620 11.6Department for International Development , UnitedKingdom

35 0.7

Private Investors 700 13.1Internal Funds 800 15.0Government of Madhya Pradesh 600 11.2

Total Funding 5,340 100.0Sources: Asian Development Bank estimates.

47. The Government has requested financing up to the equivalent of $620 million (includedin the Country Operations Business Plan 2007-2009) from ADBs ordinary capital resources tohelp finance part of the Investment Program covering transmission, distribution, capacitybuilding, and energy efficiency. ADBs participation as a partner (i) reduces the cost of funds, (ii)

15ADB. 2006. Technical Assistance for Supporting the Inception of the Energy Efficiency Initiative in Developing

Member Countries. Manila (TA 6346-REG).


33/110

15

establishes standards in various thematic areas, and (iii) helps to attract other long-termfinanciers to the sector. The Government and GOMP have asked ADB to extend this finance inthe form of an MFF.

48. The financing will be provided under an MFF in accordance with ADB policy.16 The StaffInstructions on the Use of MFF17 was followed in processing the MFF. The MFF will extend

multiple loans to finance a range of projects under the Investment Program, subject to thesubmission of a related periodic financing request (PFR)

Pilot Financing Instruments andModalities

by the Government and execution ofthe related loan and project agreements. Each PFR will be accompanied by a detailed costestimate, as well as an implementation schedule. The Fra

Documents

Power Policies Funding Scheme