Report and Recommendation of the President to the Board of Directors

Project Number: 39916 June 2006

Proposed Loan India: NTPC Capacity Expansion Financing Facility

In accordance with ADB’s public communications policy (PCP, 2005), this abbreviated version of the RRP excludes confidential information and ADB’s assessment of project or transaction risk as well as other information referred to in paragraph 126 of the PCP.

CURRENCY EQUIVALENTS (as of 15 May 2006)

Currency Unit – Indian rupee/s (Rs)

Rs1.00 = $0.022 $1.00 = Rs45.00

ABBREVIATIONS

ADB – Asian Development Bank APDRP – Accelerated Power Development Reform Program

C&AG – Comptroller and Auditor General of India CEA – Central Electricity Authority

CERC – Central Electricity Regulatory Commission CFS – complementary financing scheme CMD – chairman and managing director CPSU – central power sector utilities

EBITDA – earnings before interest, taxes, depreciation, and amortization

EMG – Environment Management Group EMS – environmental management system EMP – environmental management plan

EPEMS – environmental policy and environmental management system IPO – initial public offering ISO – International Organization for Standardization LIBOR – London interbank offered rate mmscmd – million metric standard cubic meters per day MOP – Ministry of Power NEP – National Electricity Policy Nm3 – normal cubic meters

NTPC – National Thermal Power Corporation Limited or NTPC Limited PLF – plant load factor PPA – power purchase agreement RBI – Reserve Bank of India SEB – state electricity board SERC – state electricity regulatory commission STPP – super thermal power project T&D – transmission and distribution TPA – tripartite agreement

WEIGHTS AND MEASURES

GW (gigawatt) – 1,000,000 kilowatt GWh (gigawatt-hour) – 1,000,000 kilowatt-hours km (kilometer) – 1,000 meters kWh (kilowatt-hour) – 1,000 watt-hours kV (kilovolt) – 1,000 volts MW (megawatt) – 1,000,000 watts

NOTES

(i) The fiscal year (FY) of NTPC and the Government of India ends on 31 March. FY before a calendar year denotes the year in which the fiscal year ends.

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

Vice President L. Jin, Operations Group 1 Director General B. Bestani, Private Sector Operations Department (PSOD) Director S. Chander, Infrastructure Finance Division, PSOD Team leader D. Purka, Structure Finance Specialist, PSOD Team members H. Brooke, Senior Counsel, Office of the General Counsel A. Sagar, Head, Private Sector and Financial Services Group, India

Resident Mission, PSOD

CONTENTS

Page LOAN SUMMARY iii

MAPS vii

I. THE PROPOSAL 1

II. INTRODUCTION 1

III. RATIONALE: SECTOR PERFORMANCE, CHALLENGES, AND OPPORTUNITIES 2 A. Power Sector in India 2 B. Challenges and Opportunities 5 C. Asian Development Bank Operations 6

IV. THE BORROWER 7 A. Background 7 B. Navratna Status 8 C. Corporate Governance 9 D. Financial Performance 10 E. Capital Expenditure and Financing Plan 10 F. Special Features 11

V. THE PROPOSED LOAN 13 A. ADB Loan 13 B. Main Terms and Conditions 13

VI. BENEFITS, IMPACTS, AND RISKS 14 A. Justification for ADB Assistance 14 B. Environmental and Social Safeguards 15 C. Anticorruption Policy, and Combating Money Laundering and the Financing of

Terrorism 17 D. Main Risks and Mitigation Measures 17

VII. EXPOSURE LIMITS 19

VIII. ASSURANCES 20

IX. RECOMMENDATION 20

APPENDIXES 1. Overview of the Power Sector in India 21 2. Description of NTPC Limited 28 3. Financial Performance of NTPC Limited 35 4. Installed Generation Capacity and Expansion Plan of NTPC Limited 40 5. Description of Projects 41 6. Assessing Development Effectiveness 44 7. Summary Assessment of Environmental Management Systems of NTPC Limited 46

SUPPLEMENTARY APPENDIXES (available on request) A. Full Assessment of Environmental Management System B. Summary of Environmental Impact Assessment

LOAN SUMMARY Borrower NTPC Limited (formerly known as the National Thermal Power

Corporation Limited) (NTPC)

Classification Targeting Classification: General intervention Sector: Energy Subsector: Conventional power generation (other than hydropower) Theme: Sustainable economic growth Subthemes: Promoting economic efficiency and enabling markets, fostering physical infrastructure development

Environment and Social Assessment

The loan is to be made on a corporate basis to partially fund NTPC’s capital expansion program. Therefore, this intervention is classified as equivalent to environmental category FI. NTPC's corporate environment policy and environmental management system was reviewed. It provides the overall framework for environmental management in accordance with the requirements of the Asian Development Bank (ADB). ADB identified some areas for improvement, and NTPC indicated its intent to implement such recommendations. Notwithstanding the corporate loan classification, the two projects to be funded by the loan are each classified as environmental category A. The environmental impact assessment for each project was prepared and reviewed, site visits undertaken, and a summary environmental impact assessment of both projects circulated to ADB’s Board of Directors and posted on ADB’s website on 29 March 2006. Compliance with ADB’s policies on involuntary resettlement and indigenous peoples was also assessed, and in view of the fact that resettlement and land acquisition has already been satisfactorily completed in each location, a category C was assigned for both projects. NTPC and the relevant district authorities verified the satisfactory completion of land acquisition and compensatory payments.

Proposed Loan A direct loan comprising (i) a tranche of $75 million to be loaned directly to NTPC, and (ii) a tranche of $225 million to be participated in by commercial banks under ADB’s Complementary Finance Scheme. The loan will finance a portion of NTPC’s planned power generation capacity expansion, including a portion of the foreign exchange requirements of (i) the Sipat Super Thermal Power Plant Project (stages I and II) located in Bilaspur, Chattisgarh; and (ii) the Kahalgaon Thermal Power Plant Project (Stage II) in Bhagalpur, Bihar.

Expansion Costs and Financing Plan

NTPC plans to commission a total of nearly 9,160 megawatts (MW) by the end of the 10th Plan (FY2007), including 3,710 MW in 2006.

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NTPC intends to double capacity to 46,461 MW at an estimated cost of Rs700 billion ($15.5 billion) by the end of FY2012 (i.e., end of the 11th Plan). This equates to annual average expenditures of Rs117 billion ($2.6 billion). NTPC has developed its financing strategy based in large part on the tariff norms laid out by the Central Electricity Regulatory Commission. These norms require that all projects must be financed by a debt to equity ratio of not less than 70:30. NTPC’s internal cash generation from operations is sufficient to fund the equity requirement, which earns a fixed rate of return of 14% through the tariff. With annual average expenditures of $2.6 billion equivalent per annum, NTPC must raise approximately $1.8 billion in debt each year from a combination of secured and unsecured sources, both in local and foreign currency. NTPC is not permitted under the external commercial borrowing provisions of the Reserve Bank of India to borrow more than $500 million equivalent each year from foreign sources. Accordingly, $1.3 billion on average must be sourced each year from Indian banks, financial institutions, and domestic capital market.

Financial Performance NTPC retains a BB+ long-term issuer default credit rating by Fitch and Standard and Poor’s (S&P)—the rating is equivalent to the sovereign rating of India (i.e., as a majority Government-owned company, NTPC is constrained by the sovereign rating). S&P recently upgraded its outlook for the sovereign and NTPC to “positive” based on overall fiscal improvements in India. Based on audited results from FY2005, NTPC generated Rs232 billion ($5.2 billion) in revenues, Rs66 billon ($1.5 billion) in operating profit, and Rs58 billion ($1.3 billion) in net profit after tax. Revenue growth is principally driven by capacity additions and tariffs. Revenue surged 16.9% in FY2005 with the commissioning of 2,000 MW of new capacity. Despite an ambitious capital expansion plan, NTPC has strong coverage ratios—net debt/operating income, debt service coverage, and interest coverage ratios were 3.1, 4.8, and 9.5 respectively for the estimated financial statements ending March 2006, supported by regular strong cash flows. Its total liabilities to net worth ratio of 0.73 (i.e., 42:58), indicates that the company is not significantly leveraged, and has sufficient headroom for additional borrowings to match capital expansion plans. While 28% of its debt is denominated in foreign currencies, foreign exchange risk is minimal as any related losses can be passed through in the tariffs. While budgeted expenditures will exert some pressure on NTPC’s credit ratios, cash flows from new facilities should keep coverage ratios at acceptable levels.

Benefits The benefits of the proposed loan include (i) addition of 4,480 MW of power generating capacity to help reduce the supply deficit in India; (ii) introduction of new thermal power plant technology in

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India, which will improve operational efficiency, reduce fuel consumption, and hence reduce the emissions of greenhouse gases and other pollutants; (iii) improvement of environmental standards for power plants owned and operated by the largest supplier of electricity in India; and (iv) facilitation of commercial cofinancing of $225 million.

Risks The main risks and mitigation measures are (i) NTPC credit risk; (ii) state electricity board counterparty/credit risk; (iii) tariff and regulatory risk; (iv) sector reform risk; (v) fuel supply risk; (vi) subordination risk (in the event of default or non-payment). These risks were addressed in the course of due diligence and are explained in detail in this document.

Justification As the largest power generator in India, NTPC’s operations and expansion plans are critical to reducing peak power demand and energy deficits that are forecast to persist for at least several more years. NTPC is a financially sound enterprise with a strong balance sheet, an effective governance structure, and experienced management. Although a state-owned enterprise, NTPC is operated as an independent commercial entity. The proposed intervention is line with recent country strategy and program updates for India, the Pilot Financing Instruments and Modalities (2005) approved by the Board, and the Private Sector Operations Department’s focus on infrastructure financing in India.

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I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed loan to NTPC Limited (formerly known as the National Thermal Power Corporation Limited), a Government of India majority state-owned enterprise (SOE), to be made available under (i) a direct loan tranche of up to $75 million, and (ii) a loan tranche of up to $225 million to be advanced by the Asian Development Bank (ADB) as lender of record under ADB’s Complementary Financing Scheme (CFS). If approved, the loan will be ADB’s first financing of an SOE pursuant to the issuance of the Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities paper.1

II. INTRODUCTION 2. Although India’s power sector has expanded rapidly in the past few years, power shortages, and poor quality and reliability of supply constrain economic growth. Despite moderate growth in power generation capacity, India has a large supply deficit that will persist for at least several years. In 2005, the national peak power deficit was 12% and energy deficit 7%. As the current 10th Plan targets (if met) would fulfill only 75% of needed capacity additions by 2007, peak power and energy shortfalls will persist over the short to medium term. The Government has set an ambitious target of providing Power for All by 2012 during the 10th and 11th plans. Based on the 16th Electricity Power Survey, prepared by the Central Electricity Authority (CEA),2 India will require additional capacity of nearly 100,000 megawatts (MW)3 by 2012 to achieve this goal. As the largest power generator in India, NTPC’s ability to increase supply plays a fundamental role in the economic development targets. 3. To finance these expansion plans, NTPC has developed certain capital raising strategies. These strategies have in large part been influenced by a regulatory tariff order issued in 2004.4 In order to optimize its returns in line with this tariff order, NTPC is seeking to ensure that its debt component is not less than 70% of its overall capital employed, and of this amount, 30% needs to be sourced in foreign currency. Bank of America, a leading international commercial bank, approached ADB’s Private Sector Operations Department with a goal of arranging commercial, nonsovereign US dollar lending for NTPC. The loan would finance a portion of the foreign exchange requirement of its fiscal 2007 capital expenditures. Bank of America identified ADB as a finance partner with the strengths needed to create a loan package that would assist NTPC in its capital raising plan. Due to commercial bank credit limits on cross-border (i.e., offshore) lending, tenors of syndicated bank loans of this magnitude are limited to 5 years, with a few exceptional cases of 7 years. The financing of power generation plants typically require tenors of 10–12 years (including grace periods) to amortize the debt to be recovered from end-user tariffs. Accordingly, ADB’s ability and development role to provide longer term financing was seen as a significant strength. Therefore, Bank of America as the proposed lead arranger approached ADB in June 2005 to express their interest in participating 1 ADB. 2005. Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities. Manila. 2 Central Electricity Authority. 2000. Sixteenth Electric Power Survey of India. New Delhi. 3 This figure was determined by CEA based on actual demand growth for the previous 5 years and based on

average GDP growth of 7.4% per annum and gradual reductions in transmission and distribution losses to 18.5% in 2011–2012. Based on recent GDP growth, these figures could possibly be understated. To date, no update of the Electric Power Survey has been finalized.

4 Under the Electricity Act, 2003, the Central Electricity Regulatory Commission (CERC) issued a national tariff order establishing the post-tax rate of return on equity at 14%, not on total capital employed, for both public and private generators. As CERC prescribes the debt-equity ratio for new projects at 70:30, any equity financing in excess of the stipulated 30% benchmark will not attract the 14% rate of return, but, instead, only the stipulated cost of interest for that project.

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in ADB’s CFS or lender of record facility. This would be coupled with an ADB direct loan. The concept clearance for this transaction was approved in July 2005, environmental and social site visits conducted in November 2005, and due diligence mission completed in April 2006.

III. RATIONALE: SECTOR PERFORMANCE, CHALLENGES, AND OPPORTUNITIES A. Power Sector in India

1. Structure of the Power Sector 4. The Indian power sector is broadly divided into utilities owned by the central Government, state governments, and private sector. The central power sector utilities5 (CPSUs), including NTPC and Power Grid Corporation of India (Powergrid),6 participate in the wholesale power supply and interstate bulk transmission. The state sector is operated by state electricity boards (SEBs) or unbundled state utilities. SEBs were established as integrated state monopolies by the Electricity Supply Act of 1948 to engage in generation and intrastate transmission and distribution. In recent years, some states (e.g., Andhra Pradesh, Gujarat, and Orissa) have unbundled their SEBs into separate generation, transmission, and distribution companies. The private sector comprises relatively small independent power producers, operating roughly 10% of India’s total capacity. Some private companies have also established a presence in unbundled distribution companies. 5. The central and state governments share responsibility for development of the power industry. The Ministry of Power (MOP) governs the central power sector in the country and oversees CPSU operation. CEA advises MOP on electricity policy and technical matters. The Central Electricity Regulatory Commission (CERC), created in 1998 under the Electricity Regulatory Commission Act, regulates tariffs for the CPSUs and other entities with interstate generation or transmission operations. This act, which has since been replaced by the Electricity Act (2003), also provided for the formation of state electricity regulatory commissions to rationalize energy tariffs and formulate policy within each state. As of 31 March 2005, 24 states had established state electricity regulatory commissions. Additional background on the power sector is given in Appendix 1.

2. Supply and Demand 6. India is the third largest electricity consumer in Asia behind the People’s Republic of China and Japan. As of 30 September 2005, India’s installed power generation capacity was 123,014 MW, of which 57% is owned and operated by state entities, 32% by central public sector undertakings (such as NTPC), and 11% by independent power producers. Thermal plants, mostly coal-fired, provide 66% of the installed capacity. Hydropower comprises 26% of the capacity, and the remaining 8% is provided by gas and oil-fired thermal plants, renewable energy plants, and nuclear plants. However, despite its ever-growing population and economy, India’s consumption remains relatively low at 606 kilowatt-hours per capita per annum. 7. Power demand in India has grown rapidly since the 1980s as the economic growth has accelerated at an annual average of 5.6% since 1980. Under MOP’s Power for All by 2012

5 Other CPSUs include the National Hydroelectric Power Corporation, Nuclear Power Corporation, Power Finance

Corporation, and Rural Electrification Corporation. 6 In 1992, the central entity known today as Power Grid Corporation of India Limited (Powergrid) was established to

construct, operate, and maintain interstate and interregional transmission systems.

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initiative, target capacity is being expanded to maintain India’s current 8% economic growth rate. Of total electricity sold in India, industry accounts for approximately 33%, agriculture and households for 25% each, and businesses and others for the remaining 17%. Power demand growth has slowed in recent years to approximately 2–3%, not due to a lack of demand, but due to inadequate capacity and poor transmission and distribution infrastructure. Power quality remains poor, marked by high voltage fluctuations and recurring load shedding. India continues to suffer from chronic electricity shortage, where peak demand exceeds supply by over 12%; the energy deficit between April and September 2005 was 7%.7 As the current 10th Plan fulfills only 75% of needed capacity additions to 2007, energy shortfalls will persist over the short to medium term. The Government of India seeks to eliminate this deficit by 2012, which marks the end of the next 5-year plan (the 11th Plan, 2008–2012).

3. Generation Expansion under the 10th and 11th Plans 8. As of 30 September 2005, India's power system had an installed generation capacity of approximately 123,014 MW. The Government’s successive 5-year plans set out targets for economic development in various sectors, including the power sector. Each successive 5-year plan has increased power generation capacity addition targets. The 9th Plan (1998–2002) targeted a capacity addition of 40,245 MW, of which 24% was to come from hydro capacity, 73% from thermal capacity, and the remainder from nuclear capacity. However, only about 19,251 MW or 48% of the planned capacity addition was actually added. The target for capacity addition is set at 41,110 MW under the 10th Plan (2003–2007). Exactly how much will be commissioned before the end of this fiscal year is not yet clear, although general agreement is that the target will not be met. With the Government’s ambitious target of providing Power for All by 2012 during the 10th and 11th plans, India will require additional capacity of nearly 100,000 MW by 2012 to achieve the goal. As the largest generator in India, NTPC’s ability to expand power generation capacity plays a fundamental role in the country meeting its economic development targets.

4. Power Sector and Regulatory Reform

9. NTPC sells its generation capacity to all SEBs in India (except for a few in the northeast region). In the past, NTPC was perennially exposed to the problem of large accounts receivable from the weaker SEBs. The SEBs have been plagued by poor metering, low collections, high receivables, and high theft/losses, and were unable to recover those losses through tariff increases. As with most of ADB’s developing member countries, tariffs in India are politically sensitive and are held at artificially low levels for political and social reasons. Many states provide subsidized electricity to farmers and disadvantaged households, which results in tariffs that are significantly below the cost of supply. 10. During the early 1990s, the SEB-dominated power industry became a drain on the Indian economy and changes were needed in the context of the Government’s economic reform program. The Government initially focused on increasing investment in power generation by opening up participation to private power providers and offering to fast-track projects. However it made little progress with this effort, as only a handful of projects reached financial close, and the reforms did not address the underlying fundamental weaknesses of the SEBs, which lost ever larger sums with each kilowatt-hour bought from new suppliers.

7 Ministry of Power monthly statistics.

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11. To address state and national difficulties, a reform program was initiated in the mid 1990s based on the recommendations of a high-profile Government commission on power sector reform. The program included (i) organizational state reforms, including commercialization and unbundling of generation, transmission, and distribution; (ii) regional and national organizational reforms to strengthen the role of CPSUs; (iii) large-scale involvement of the private sector in generation and distribution, through transparent and competitive selection processes; (iv) creation of a central regulator to regulate bulk tariffs and state regulator for small generation and end-user tariffs and thus to depoliticize electricity tariff setting; and (v) a progressive phase out of subsidies to agricultural consumers and increase of tariffs to be more reflective of the cost of supply. While the suggested reforms emanated from the central Government, states were given flexibility to choose their own reform path, which had very mixed results.8 The lack of competitive standards in the power sector, an emphasis on privatization for its own sake rather than for effecting improvements in quality of supply and consumer satisfaction, the seeking of higher returns on investment without corresponding improvements in supply, and improper sequencing undermined the gains made in nonpolitical and transparent tariff setting and private sector participation in the sector. The well-publicized failures of reform in certain states stalled any progress or political will in the others. 12. A much stronger central government role was required to accelerate the reform process. In 1998, the Government enacted the Electricity Regulatory Commission Act, which led to the establishment of an independent central regulatory commission (CERC) and state-level equivalents (state electricity regulatory commissions). In 2003, the more comprehensive Electricity Act was promulgated, which consolidated existing legislation in the sector under a single act and includes provisions to improve competition and efficient use of resources. It includes initiatives to (i) liberalize generation, transmission, and distribution; (ii) remove the causes of the SEB crisis; (iii) upgrade the central and state regulatory infrastructure; and (iv) improve coordination between the central and state governments in planning and developing the power sector. The Government formulated a national tariff policy and national electricity policy in consultation with CEA, CERC, and the state governments. While progress of sector reform continues to be slow, these recent legislative changes, new financial penalties to enforce grid discipline by the SEBs, and the settlement of past dues (para. 13) seem to have put the sector on the road to recovery and curtailed the financial problems of the SEBs, which had infected the sector as a whole.

5. One-Time Settlement of SEB Debts 13. The growing SEB losses eventually triggered Government intervention in April 2002, when MOP announced a plan aimed at settling the SEBs’ overdue debts, including those to NTPC, through tripartite agreements signed by MOP, Reserve Bank of India, and each of the states. Under the terms of the agreements, the states settled Rs320.3 billion ($7.1 billion) of the SEBs’ debt by issuing 8.5% tax-free bonds (via the Reserve Bank of India) to the CPSUs (e.g., NTPC, Powergrid), effectively swapping poor receivables for quasi-sovereign, interest-bearing instruments. The state governments issued bonds worth Rs164.1 billion ($3.6 billion) to NTPC in lieu of past SEB debts. If a SEB falls more than 90 days behind on current dues, several penalties are in place including reduction of power supply from the CPSUs, Government suspension of funds under the Accelerated Power Development Reform Program, or

8 The failures of the unbundling and privatization-driven efforts in Orissa were well-publicized. However, the

experience in Gujarat and Madhya Pradesh, which focused on restructuring through corporatization, was more positive. The reform efforts in the National Capital Region of Delhi provided some positive results by introducing private distribution concessions, but no final conclusion can be drawn as yet.

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adjustments against release of central Government assistance and share of federal tax revenue to the states. The SEBs are also required to open letters of credit with commercial banks in favor of NTPC, covering 105% of the average monthly billing for the preceding 12 months of sales to secure current electricity sales. Additional incentives are in place for timely settlement by the SEBs on current dues, including a small reduction in bond face value and rebates on current dues. NTPC’s cash collections against current billings have shown substantial improvement as a result—from about 76% in fiscal 2002 to over 100%9 since fiscal 2004. Once the immediate pressures of its overdue receivables were alleviated through the settlement, the resulting improvement in the cash resources of the SEBs strengthened their capacity to pay on time, improved metering and collections in the interim, and permitted them to focus on institutional reform efforts. Additional details of this settlement scheme are contained in Appendix 1. B. Challenges and Opportunities 14. Considering the existing supply-demand gap and the expected increase in per capita consumption (in view of the overall GDP growth targets for the economy), the 16th Electricity Power Survey has projected a peak load demand of 157,107 MW and energy demand of 975 billion kilowatt-hours by the end of March 2012 (i.e., end of the 11th Plan). To meet this projected growth in peak demand and account for transmission and distribution system losses, India will require 212,000 MW of generating capacity by 2012. To accomplish this ambitious goal, both the public and private sector will be needed to substantially contribute to generation and high-voltage transmission capacity. Given the limited SEB resources and limited success of independent power producers in achieving financial closure of projects,10 the onus of adding to the country’s generation capacity rests largely with NTPC. NTPC’s ability to develop and construct large projects reasonably within budget and on time is fundamental to India’s economic growth targets. 15. The focus of power sector reforms in the past decade has been on reforming the state regulatory framework and improving the state transmission and distribution networks. On these accounts, moderate progress has been made. However, in the process, power generation capacity and interstate transmission investment programs have continued to suffer from relatively inadequate attention. Capacity additions have been made, but not enough to meet demand. Private sector investment in generation to complement public expenditures has been very limited. Recent announcements by the Government to promote the ultra-mega power projects (a series of 4,000 MW power generation complexes to be awarded through competitive bidding by the end of 2006) recognize this ongoing challenge. The Government is also undertaking plans through Powergrid to develop a national grid by 2012, which will involve construction of 60,000 kilometers of high voltage lines to evacuate 100,000 MW of power from new generating stations. 16. Implementation of the 2003 Electricity Act could result in the development of a more competitive market for power in India, but the challenge will be to sustain the pace of national and state reform and the relative financial recovery of the sector. The Electricity Act has opened up several opportunities for existing power sector players such as NTPC, including direct supply to large customers, retail supply, distribution, power trading, etc. In such a competitive environment, NTPC will continue to benefit from its extremely competitive tariffs, multilocation

9 More than 100% were collected in the last fiscal year due to the incentive schemes under the tripartite agreement

and voluntary incentives provided by NTPC before the end of the fiscal year. 10 Only 70 MW of private generation capacity was added in FY2005, and 600 MW added in 2006.

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facilities (and diverse customer base, reducing the credit risk of any one particular off taker), and the ability to sell directly to creditworthy bulk consumers who are allowed open access. However, the Electricity Act also consolidates existing reform programs and laws under the single act, requiring SEBs to lay out a transitional period to unbundle and segregate their businesses and upgrade their transmission and distribution systems under an investment and incentive scheme from the central Government.11 Whether state regulators and governments can sustain the political will to continue the pace of reform, including retail tariff restructuring, to ensure the long-term financial viability of the state utilities remains to be seen. 17. As demonstrated by India’s 15-year history of sector reforms, the economic benefits generated by the sector are not sustainable unless the investments in central power generation and transmission infrastructure are accompanied by structural reforms of the state electricity units. ADB’s sovereign operations have been actively supporting reform and restructuring efforts through technical assistance, policy dialogue, and loan operations in the states of Assam,12 Gujarat,13 and Madhya Pradesh.14 Support for SEB reforms in other states (West Bengal, Maharashtra, and Tamil Nadu) was also provided through an onlending facility to Power Finance Corporation.15 ADB is currently supporting unbundling, corporatization, and other reform efforts in Uttaranchal.16 International funding agencies, such as the World Bank and the United Kingdom’s Department for International Development, have been active in power sector reform in other states such as Andhra Pradesh, Haryana, Karnataka, Orissa, Rajasthan, and Uttar Pradesh. Progress made at the state level improves the financial viability of the state’s electric utilities so it has the resources to improve the quality and reliability of power supply and expand distribution of electricity to those not yet connected. Improvements also reduce the burden of the power sector on the state’s fiscal position, so it can allocate resources more productively to poverty reduction and socioeconomic development activities. C. Asian Development Bank Operations

6. ADB’s Country Strategy for India 18. As cited in the most recent country strategy and program (CSP),17 the Government’s 10th Plan observes the growing impatience in the country that “a large number of our people continue to live in abject poverty and there are alarming gaps in social attainments even after five decades of planning.” The 10th Plan emphasizes that development must be defined not just in terms of increased GDP but more broadly in terms of human well-being. Thus, the strategy of

11 Known as the Accelerated Power Development and Reform Program, the Government provides incentives to the

states for undertaking renovation and modernization programs for thermal and hydropower stations and to strengthen and improve the subtransmission and distribution network. The Government earmarked a total of Rs400 billion ($8.9 billion) for the program under the 10th Plan. For the investment component, the Government will provide concessional loans for 50% of the program. Under the incentive component, MOP will make a grant to the states of 50% of the SEBs’ actual cash-loss reductions year-to-year. This component was introduced to motivate the SEBs and utilities to reduce their financial losses.

12 ADB. 2003. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India for Assam Power Sector Development Program. Manila (Loan 2036/2037-IND).

13 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India for the Gujarat Power Sector Development Program. Manila (Loan 1803/1804-IND).

14 ADB. 2001. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India for Madhya Pradesh Power Sector Development Program. Manila (Loan 1868/1869-IND)..

15 ADB. 2002. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India for State Power Sector Reform Project. Manila (Loan 1968-IND).

16 ADB. 2006. Report and Recommendation of the President to the Board of Directors on a Proposed Multitranche Financing Facility to India for the Uttaranchal Power Sector Investment Program. Manila (Project Number 37139).

17 ADB. 2003. Country Strategy and Program (2003–2006) India. Manila.

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the 10th Plan consists of the themes of high growth, equitable growth, and human development. Political and economic developments since finalizing the CSP indicate that its assistance strategy remains valid, especially the core strategy of poverty reduction through infrastructure-led growth, supported by social development and good governance. The 2006–2008 CSP18 update indicates that the objective of accelerating India’s GDP growth to 8% depends critically on upgrading infrastructure facilities and improving efficiency of such public services. ADB’s proposed assistance program reflects this priority with infrastructure accounting for nearly 77% of the 3-year pipeline (not including private sector and nonsovereign operations, such as the proposed loan). Support of strong governance programs and introduction of international best practices are essential to leverage and maximize the development impact of ADB’s relatively modest assistance to the Government.

7. ADB’s Power Sector Strategy for India 19. ADB’s assistance for the power sector as outlined in the 2006–2008 CSP update has six main priorities: (i) reforming the sector; (ii) promoting higher efficiency and low-carbon power sources; (iii) expanding and optimizing transmission and distribution systems; (iv) supporting institutional strengthening to implement reforms required by the Electricity Act of 2003, including development of more flexible power delivery and trading systems; (v) promoting private sector participation; and (vi) encouraging energy conservation, and ensuring environmental and social sustainability. To support the Government’s mission of Power for All by 2012, ADB’s strategy for the power sector will be in synergy with the 10th and 11th plans. This includes national and state interventions and specifically references supporting power generation through NTPC.

8. ADB's Nonsovereign Operations in India 20. ADB’s nonsovereign operations should support the main themes reflected in the CSP/CSP updates, specifically the core strategy of poverty reduction through infrastructure-led growth. As documented in the 2006–2008 CSP update, ADB’s nonsovereign operations will continue to focus on the infrastructure and financial sectors. The proposed transaction is in line with the power sector objectives contained in the CSP update, specifically improving thermal efficiency in power generation leading to reduced coal use and strengthening the country’s environmental protection by getting the dominant utility (27% of energy supply) to upgrade its environmental standards for air emissions and effluent discharge. Under the Innovation and Efficiency Initiative modalities (footnote 1), ADB will be able to deliver flexible financing solutions (such as the proposed loan) in support of interventions with subsovereign entities.

IV. THE BORROWER A. Background 21. NTPC is a Government of India majority-owned company engaged in the development, construction, and operation of mainly thermal power plants in India. As of 31 December 2005, the total installed capacity of NTPC was 24,249 MW, through 13 coal-fired power stations (19,980 MW), seven gas-fired power stations (3,955 MW), and three joint venture projects (314 MW), making it India’s largest generating company. NTPC also manages the operation of Badarpur power station (705 MW) on behalf of the Government. As of 31 December 2005, NTPC's share of the total installed capacity of India was 19.6% and it contributed 27.1% of the

18 ADB. 2005. Country Strategy and Program Update (2006–2008): India. Manila.

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total power generation in India during fiscal year (FY) 2005. Appendix 2 provides additional information on NTPC. 22. Most NTPC plants are base-load facilities by design and are among the lowest cost thermal facilities, with average costs 10–50% lower than other thermal generators. The average selling price of NTPC's power during FY 2005 was Rs1.52 ($0.035) per kilowatt-hour. This makes NTPC one of the cheapest sources of power for most SEBs, and secures a favorable position in the merit dispatch order in the states in which it is dispatched. NTPC’s operations are also efficient. Its plant load factor19 improved in FY2005 to 87.5% from 84.4% the previous year, and the availability factor of NTPC plants increased to 91.2% from 88.8%. B. Navratna Status

23. NTPC does not rely on Government funds and is not subject to any Government budgetary approvals. Based on its financial and operational performance, in July 1997 the Government named NTPC one of the nine initial Navratna (or nine jewels) companies and granted it enhanced autonomy in making financial and other decisions, including the freedom to engage in investment, capital expenditures, and raising of funds at home and internationally without Government approval or interference. NTPC is permitted to form joint ventures and subsidiaries up to specified limits, subscribe equity in these entities, purchase, and receive new technology and knowledge transfer. It is permitted to decide the locations for its plants (a matter previously determined by the Planning Commission) and has the freedom to independently negotiate power purchase agreements with its customers. This status has helped NTPC to increase the speed of implementing new projects, absorbing new technologies, and formatting joint ventures in the core generation as well as support service businesses. 24. Like other state-owned enterprises, NTPC enters into an annual memorandum of understanding with the Government on performance monitoring. The agreement sets annual performance targets for the physical, financial, and dynamic parameters of NTPC. These parameters include total electricity generated, plant availability factor, financial gross margin, and the ratio of net profit to net worth. At the end of each fiscal year, MOP evaluates NTPC’s actual performance against the targets. NTPC has been ranked in the excellent category (the best category) for the 15th consecutive year since the memorandum of understanding system became operative in FY1988. 25. NTPC was 100% Government owned prior to its initial public offering (IPO) in October 2004. The IPO raised Rs54 billion ($1.2 billion) through the issuance of new shares plus divesting a portion of the Government’s shares. The Government now owns 89.5% of NTPC, while institutional, foreign, and individual investors own the remaining 10.5% of the publicly listed shares.20 The current value of NTPC’s share price has nearly doubled since the IPO.21 The proceeds from the new shares are being applied to funding NTPC’s capital expansion program. The IPO’s success reflects positive sentiments from both domestic and foreign investors toward NTPC’s financial strength, its position in the market, and its growth prospects. 19 The plant load factor is typically a good indicator of a power utility’s efficiency in use of its assets. 20 After its IPO, only one foreign institutional investor, Capital Research Management Company A/C Capital World

Growth & Income Fund, holds more than 1% of outstanding shares. The remainder of the shareholders hold less than 1%. Total foreign institutional ownership is approximately 6%.

21 The IPO price was Rs62/share in November 2004. As of 10 May 2006, NTPC’s stock closed at Rs129.60/share.

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C. Corporate Governance 26. NTPC’s 11-member board currently comprises five full-time executive directors, and two part-time and four independent directors.22 The Government appoints the chairperson and managing director for a 5-year tenure, and appoints the directors in consultation with the chairperson and managing director. The current chairperson and managing director was appointed on 1 April 2006. Full time directors are appointed for 5-year terms, whereas independent directors are appointed for 3 years. The two part-time directors are MOP representatives and remain directors as long as they concurrently serve in MOP. Although the Government has the power to direct NTPC activities, it has allowed the company to operate as an independent, commercial entity. 27. NTPC’s board of directors has established several board committees including, for example, an audit committee, a shareholders/investors grievance committee, investment committee, and committee on management controls. The audit committee, established with two independent directors and the two part-time directors (i.e., from MOP), is chaired by an independent director. All members of the audit committee are qualified to interpret and understand financial statements. No remuneration committee has been established because the Board does not determine the salaries and tenure of its directors. Like other public enterprises, salaries, directors’ sitting fees, and tenures are determined by the Government. However, NTPC does disclose the salary, benefits, performance-based incentives, and independent sitting fees for its directors in its annual report. 28. While privatization of SOEs in India remains a sensitive and politically difficult task for any coalition government, strong corporate governance reform can often provide significant results toward improving performance and efficiency of the enterprise. NTPC is often cited as a model for SOE reform. Based on a World Bank study on corporate governance reform in SOEs,23 the following reforms were included and have already been implemented by NTPC:

(i) subject the utility to company law and other laws that apply to private sector companies;

(ii) appoint independent directors to the board and ensure that independent directors constitute at least 50% of directors;

(iii) require NTPC to borrow from commercial lenders without the benefit of a government guarantee, bringing to bear the benefits of scrutiny by commercial lenders and international credit-rating agencies;

(iv) list a minority of the company’s shares on public stock exchanges, to create market information on commercial performance and create performance monitoring by shareholders other than the Government (because shareholders have a residual rather than priority claim on the firm’s assets, the value of minority shareholders’ investments in the utility depends more strongly on performance of the utility compared with the lenders); and

22 Clause 49 issued by the Securities Exchange Board of India stipulates that companies listed on the domestic

bourses must have at least 50% independent directors on their board. If the chairperson is nonexecutive, the independent directors should comprise only one third of the board's strength. Based on the recommendation of the chairperson and managing director, the President of India has appointed four independent directors to the Board effective 30 January 2006, for 3 years.

23 The World Bank Group. 2004. Some Options for Improving the Governance of State-Owned Electric Utilities. Washington, DC.

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(v) structure the audit committee so it consists of a minimum of three members, a majority of nonexecutive independent directors, and the committee chairperson cannot be the chairperson of the board.

29. NTPC’s corporate governance reforms have also been recognized by international bodies. In 2005, NTPC was awarded the Golden Peacock Global Award for Excellence in Corporate Governance in the Public Sector Units category by the World Council for Corporate Governance.24 NTPC was declared the winner of this award by a jury headed by Ola Ullsten, former prime minister of Sweden, in addition to other luminaries. D. Financial Performance 30. NTPC maintains a BB+ long-term issuer default credit rating by Fitch and S&P; a rating equivalent to the sovereign rating of India. Despite the AAA local credit rating, NTPC is constrained by the sovereign rating of BB+ as a majority Government-owned company. S&P recently upgraded its outlook for the sovereign and NTPC to “positive” based on overall fiscal improvements in India. In FY2005, NTPC generated Rs232 billion ($5.2 billion) in revenues, Rs66 billon ($1.5 billion) in operating profit, and Rs58 billion ($1.3 billion) in net profit after tax. Revenue growth is principally driven by capacity additions and tariffs. Revenue surged 16.9% in FY2005 with the commissioning of 2,000 MW of new capacity. Despite an ambitious capital expansion plan, NTPC has strong coverage ratios—net debt/earnings before interest, taxes, depreciation, and amortization; debt service coverage; and interest coverage ratios were 3.1; 4.8; and 9.5 respectively for the estimated accounts ending March 2006,25 supported by strong cash flows. Its total liabilities to net worth of 0.73 (i.e., 42:58), indicates that the company is not significantly leveraged, and headroom for long-term borrowings to match capital expansion plans is sufficient. While 28% of its debt is denominated in foreign currencies, foreign exchange risk is minimal as any related losses on debt service payments can be passed through in the tariffs as permitted by the regulator. While budgeted capital expenditures will exert some pressure on NTPC’s credit ratios, cash flows from new facilities should keep coverage ratios at sufficient levels. Appendix 3 provides more detailed financial information. E. Capital Expenditure and Financing Plan 31. The NTPC generation capacity expansion program currently appears to be on schedule with 2,000 MW being commissioned in FY2005 and an additional 500 MW in FY2006. NTPC is forecasting to commission a total of 3,710 MW in the current fiscal year. Based on these projections, nearly 9,160 MW will be added by NTPC by the end of the 10th Plan. NTPC intends to double capacity to 46,461 MW at an estimated cost of Rs700 billion ($15.5 billion) by the end of FY2012 (i.e., end of the 11th Plan). This equates to annual average expenditures of Rs117 billion ($2.6 billion). A schedule of existing and planned expansion projects is attached as Appendix 4. 32. NTPC has developed a financing strategy based in part on CERC’s tariff order. The tariff order dictates the extent to which the cost of financing NTPC’s ongoing projects can be recovered from the bulk tariffs. As indicated in the 2004 order,26 all projects should be financed by a debt to equity ratio of 70:30.27 NTPC’s internal cash generation from operations is sufficient 24 Information available at http://www.wcfcg.net 25 As of 30 May 2006, NTPC’s audited financial results for FY2006, ending 31 March 2006, are not yet available. 26 CERC. 2004. Terms and Conditions for Tariff Period 2004–2009. New Delhi. 27 This specified ratio indicates that the equity component should not be greater than 30% of total capital, as this

would increase the weighted average cost of capital to be recovered from the tariff.

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to fund such equity requirements for its proposed new projects. Under the tariff norms, equity earns a maximum rate of return ceiling of 14%, paid through the tariff. With annual average proposed expenditures of $2.6 billion equivalent per annum, NTPC must raise approximately $1.8 billion in debt each year. NTPC is not permitted under the external commercial borrowing guidelines of the Reserve Bank of India to borrow more than $500 million equivalent each year from foreign sources. This means that to optimize NTPC’s project financing program, nearly $1.3 billion equivalent of debt must be raised in rupees through local financial institutions, banks, and the bond market. As Indian financial institutions have single borrower limits of 15% of net own funds, NTPC has determined that limited headroom is available in the next several years to continue borrowing from these banks and financial institutions. By process of elimination, this leaves rupee bond issues and external commercial borrowings as the key sources of financing for future projects. Based on this analysis, NTPC’s long-term corporate debt strategy is to borrow external bank-sourced debt on an unsecured basis, and to complement such borrowings to the maximum practical extent with rupee bond issues, which must, as required by the Companies Act, be secured against NTPC’s assets.28 F. Special Features

1. SOE Lending under Innovation and Efficiency Initiative Pilot Financing Instruments

33. As outlined in Innovation and Efficiency Initiative: Pilot Financing Instruments and Modalities (footnote 1), numerous SOEs are creditworthy and have the long-term financial viability to borrow without government guarantees. They constitute a “third generation”29 of potential borrowers, and are increasingly important as SOEs operate rather independently from the sovereign. These entities play an important role in creating employment and providing infrastructure and basic public services. Giving them access to affordable long-term credit is critical to promoting economic growth. Since 1997, NTPC has been borrowing without Government assistance from external commercial financial sources. ADB’s objective in processing this transaction is to lend and to facilitate cofinancing, in each case without government guarantee to NTPC so as to ensure that power generation can be expanded at a least cost to the economy and the recovery of the power sector can be sustained.

2. Supporting NTPC’s Reform Program 34. ADB lending to a state-owned enterprise should be accompanied by corporate and/or sector reforms (footnote 1). As described in para. 26, NTPC has in the past voluntarily undertaken numerous corporate governance reforms to improve performance, transparency, and efficiency; and is currently seen as a governance model for other SOEs in India. 35. In support of its corporate governance reforms, NTPC passed a formal antifraud policy on 29 March 2006. Over the years, NTPC has put in place various policies and procedures to guide its employees to ensure that officials dealing with and undertaking transactions conduct themselves in a transparent and uniform manner. These procedures include delegation of financial and administrative powers; project and contracts management systems; finance and human resources; code of conduct for directors and senior management; and conduct, discipline, and appeal rules for employees. NTPC was one of the first SOEs to appoint a chief

28 Under Section 125 of the Companies Act, bonds must be secured by 125% of their value against issuer’s assets. 29 The first generation of clients is the sovereign states and the second generation comprises private sector

companies. SOEs lie somewhere in between the two, forming a distinct group or third generation.

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vigilance officer. This officer reports directly to the board chair and maintains a full fledged investigation unit at headquarters and at each project site. This group has been operational in NTPC since 1985. In addition, a more explicit policy was formulated to formalize and consolidate these policies. This will include a whistle blower policy, under which employees (confidentially, if so desired) can report to management unethical behavior, actual or suspected fraud, or violation of conduct or ethics policy. This policy will also apply to NTPC’s suppliers, contractors, consultants, and service providers doing any type of business with NTPC. The responsibility for fraud prevention will rest with the individual to ensure that no fraudulent activity is being committed in their areas of responsibility/control. NTPC has been instituting these corporate reforms on a continuing basis. The reforms are considered by ADB to constitute valuable steps toward good governance that should be emulated by others. 36. In addition, NTPC is voluntarily undertaking other reforms in its operations with respect to operational efficiency and environmental improvements. One of the loan’s two eligible projects, the Sipat Super Thermal Power Project (Stage I), will utilize supercritical boiler technology to improve the plant’s thermal efficiency and reduce greenhouse gas emissions compared with standard boiler equipment. These supercritical boilers operate at higher temperatures and pressure than traditional technology.30 Supercritical coal-fired power plants can achieve thermal efficiencies of up to 40%, compared with the standard 37% level. A 1% increase in efficiency can reduce specific emissions (such as carbon dioxide, nitrogen oxides, sulfur oxides, and suspended particulates) by approximately 2.6%.31 Sipat Stage I is the first implementation of supercritical technology in India, demonstrating how thermal projects can convert energy resources into electricity more efficiently and more cleanly, while utilizing coal for baseload power plants. NTPC intends to implement supercritical technology throughout its future coal-fired projects to improve efficiency, reduce coal consumption, and reduce emissions. 37. As it diversifies its business outside of thermal power generation and considers developing and operating power projects outside of India, NTPC is voluntarily raising its effluent control standards and environmental performance standards despite the fact that its generation plants already comply with India government standards. Specifically through the dialogue on this proposed loan, NTPC has committed to raise its effluent discharge quality standards to meet ADB environmental mitigation levels on all new projects.32 In addition, improvements are being made to environmental performance standards. For example, the suspended particulate matter air emissions limit set by the Central Pollution Control Board of India is 150 micrograms per cubic meter. For its operations, NTPC has set its internal limits to a lower level, 100 micrograms per cubic meter. However, for its new plants (including the two projects to be financed under this loan), it is currently ordering electrostatic precipitators33 with a design parameter well below the ADB emission requirement of 50 micrograms per cubic meter. NTPC has also carried out a performance enhancement package for electrostatic precipitators at its existing plants, whereby the control system was upgraded and the collection surface area increased. As a result of these efforts, particulate emissions have been reduced by approximately 50%. These examples demonstrate NTPC’s appreciation of environmental mitigation efforts and its voluntary reform program above and beyond what is required by Indian

30 Due to higher thermal efficiency, supercritical plants have lower heat rates, lower specific fuel consumption, and

reduced emissions. Further, supercritical units have other efficiency advantages such as faster startup times, load changes, and higher adaptability for sliding pressure operations and fuel quality variation.

31 NTPC data. 32 Regarding environmental performance and emissions, ADB follows the standards and approaches laid out in

World Bank. 1999. Pollution Prevention and Abatement Handbook. Washington, DC. 33 Electrostatic precipitators use electronic charges to collect and remove fly ash from the fuel gases before they are

emitted through the stack.

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law. Further details on plant environmental performance standards are provided in Supplementary Appendix A.

V. THE PROPOSED LOAN A. ADB Loan 38. The proposed ADB loan to NTPC is for up to $300 million to be provided in two tranches: (i) tranche A of up to $75 million with a maturity of up to 11 years, including an availability period of up to 4 years, and semiannual repayments starting at the end of year 7; and (ii) tranche B of up to $225 million with a maturity of up to 7 years, including an availability period of up to 18 months and semiannual repayments starting at the end of year 4. Tranche A from ADB’s ordinary capital resources will carry an interest rate to be determined in accordance with the London interbank offered rate (LIBOR) plus a margin determined by ADB's Interest Rate Committee. Similarly, ADB’s Interest Rate Committee will determine the up-front and commitment fees. Tranche B, loaned by ADB as lender of record under its CFS program, will be syndicated to commercial banks by the lead CFS arranger, with an interest rate of LIBOR plus a margin to be determined by the commercial market during syndication. 39. NTPC, as the borrower of the loan, is responsible for the development, construction, and operation of its power generation projects. Proceeds of the proposed loan will be applied to eligible capital expenditures and civil works for its power generation projects, including (i) the 2,980 MW Sipat Super Thermal Power Plant Project (Stages I and II) located in Bilaspur, Chhattisgarh state; and (ii) the 1,500 MW Kahalgaon Thermal Power Plant Project (Stage II) in Bhagalpur, Bihar state. A summary description of these two projects is provided in Appendix 5. B. Main Terms and Conditions 40. The loan proceeds will finance eligible goods and services procured from ADB’s member countries for NTPC’s generation expansion projects, including the two projects cited (para 39). The loan documentation will include financial covenants as well as covenants relating to ADB’s policies. ADB will also enter into a participation agreement with Bank of America, which will arrange the CFS tranche on an underwritten basis. Bank of America intends to syndicate this tranche after Board approval. Based on market analysis, commercial banks are sufficiently interested in participating in this transaction at the terms initially discussed. ADB will take no risk, financing, repayment, or otherwise, on tranche B. 41. Typical infrastructure projects processed under nonsovereign operations policies seek to obtain project financing on a limited or nonrecourse financing basis by providing lenders with the benefit of security over all financial and physical assets of the proposed project. Such a financing arrangement is the established means by which a start-up company or a special purpose company established by equity investors34 obtains project financing for which a suitable financial return has been projected. In contrast to such a project financing structure, the repayment and other obligations under the proposed loan will not be borne by a special purpose vehicle, but instead, by NTPC, being a creditworthy borrower. The loan will not be secured against specific assets of NTPC. In the event of a default, ADB will have the right to accelerate the loan and seek repayment from NTPC’s internal cash generation rather than enforcing

34 Private sector projects typically are structured around a loan to a special purpose vehicle with few assets other

than a concession or a license. The loan is secured by collateral comprising the physical assets of the project and the contractual entitlements of the borrower.

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security over specific assets. As an unsecured indebtedness, ADB’s loan would (i) be subordinated to all secured debt (as of 31 March 2005, Rs44,407 million or $986.8 million), and (ii) rank pari passu with NTPC’s existing unsecured debt (Rs126,471 million or $2,810 million) and its future unsecured debt. While the loan would also be subordinate to all future secured debt, ADB will limit the extent of such secured liabilities to an acceptable level by means of obtaining from NTPC the benefit of a negative pledge covenant in the loan agreement. 42. NTPC has requested a loan structure in which the blended terms of the two tranches provide long-term funding (para 38). Whereas the syndicated commercial bank market is constrained to offering maximum 5 year tenors (exception to 7 years), the ADB-funded tranche A is proposed to have a longer average life than tranche B (i.e., tranche A will mature after tranche B). This difference in repayment maturities has been appropriately priced based on market norms and creates no seniority of one tranche to the other. ADB will ensure that its rights to accelerate and enforce its debt will be triggered under cross-default provisions. Alternative loan structures (e.g., structures under which NTPC would benefit from some form of ADB credit enhancement) have been considered. However, NTPC has indicated its strong preference for the proposed loan structure since it provides the lowest all-in cost of borrowing. At the same time, it enables ADB to facilitate through its CFS program a substantial tranche of the syndicated bank market debt at optimal market terms.

VI. BENEFITS, IMPACTS, AND RISKS A. Justification for Asian Development Bank Assistance 43. A proposed framework for assessing the development effectiveness of the loan is attached as Appendix 6. The loan merits ADB’s support for the following reasons:

(i) To reduce current peak demand and energy deficits and sustain economic growth of approximately 8% per annum, India needs to add substantial amounts of power generation capacity. India also needs to diversify its mix of energy resources for power generation to reduce its dependence on coal. The Government has committed to add nearly 100,000 MW of thermal, hydro, and renewable power generation capacity before the end of the 11th Plan. NTPC’s ability to develop, finance, construct, and commission new plants is integral to the Government’s economic development plans. The proposed loan will partially finance foreign exchange expenditures for two large generation projects, adding 4,480 MW to the regional grids between 2006 and 2008.

(ii) The proposed loan will help NTPC finance a project that is introducing

supercritical steam technology (footnote 30) into power generation plants in India; this technology improves thermal efficiency by up to 5% and reduces air emissions such as carbon dioxide, nitrogen oxides, and sulfur oxides by 2.6% for each percentage increase in thermal efficiency. ADB’s financing will be applied to the first supercritical project being implemented in India.

(iii) The proposed loan helps improve the country’s environmental standards by

supporting the dominant electric utility (27% of total energy produced in FY2005) in upgrading and improving its own environmental standards. For the two eligible power generation projects under the loan, NTPC has agreed to adhere to ADB’s air emissions standards. In addition, during the course of loan processing and

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due diligence, NTPC has committed to improve its effluent discharge standards for all new power generation projects to be in line with ADB standards.

(iv) Through the use of its CFS facility, ADB’s loan will catalyze $225 million of

commercial cofinancing, which both strengthens NTPC’s relationship with international commercial banks, and through a 3-to-1 leveraging of ADB funds, reduces ADB’s overall exposure in the transaction.

(v) The proposed loan helps NTPC more closely match its liabilities to the cost-

recovery formula dictated by CERC’s tariff order. NTPC is the largest electricity generator in India; any financial mismatch (e.g., shorter tenors that would typically be offered via standard corporate borrowings), could put pressure on bulk power and ultimately retail tariffs, which could undermine the sector's financial recovery and stall further reforms. The syndicated commercial bank market does not provide offshore US dollar financing beyond 5-year tenors (and on an exceptional basis, up to 7 years) in India. However, ADB has the ability to lend long-term funds where, as in the present case, it can have a development impact.

(vi) ADB’s CSP update for India (2006–2008) confirms ADB’s support for the power

sector in India, specifically through national interventions and development of more efficient, low-carbon power generation through agencies such as NTPC. The financing supports the focus on strengthening good governance in public sector organizations to optimize the development impact of physical investments. The CSP update currently being prepared for 2007–2009 underscores the need for ADB to focus its assistance on Navratna companies such as NTPC.

(vii) The proposed loan is consistent with the Innovation and Efficiency Initiative to

provide nonsovereign financing to creditworthy state-owned enterprises (footnote 1). NTPC is one of the Navratna companies in India that operate with managerial, operational, and financial autonomy from the Government; and has implemented corporate and operational reforms to improve its transparency, performance, and efficiency.

B. Environmental and Social Safeguards 44. This intervention is classified as equivalent to environmental category FI. Further to this classification, NTPC’s corporate environment policy and environmental management systems, along with the plant-specific environmental management system, was reviewed. A summary of ADB’s assessment is attached as Appendix 7 and the full assessment is in Supplementary Appendix B. In November 1995, NTPC became the first Indian public utility to bring out a comprehensive environmental management document: NTPC Environment Policy and Environment Management System. Among the guiding principles adopted in the document are the company's proactive approach to the environment, optimum utilization of equipment, adoption of latest technologies, and continual environmental improvement. The policy also envisages efficient utilization of resources, thereby minimizing waste, maximizing ash utilization, and providing a greenbelt (i.e., afforestation program) around the plant perimeter for maintaining ecological balance. NTPC has established an environmental management system as per ISO-14001 certification at each power generation plant. As a result of pursuing sound environmental

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management practices, all NTPC power stations,35 as well as the corporate environment management and ash utilization division, are already certified as ISO-14001 compliant by certifying agencies. ADB identified some minor areas for further improvement in the environment policy and environmental management systems, and NTPC has indicated its intent to implement such recommendations. 45. In view of the proceeds of the financing being applied to two specific projects (each classified as environmental category A), the environmental impact assessment for each project was prepared and reviewed, site visits undertaken, and a summary environmental impact assessment (Supplementary Appendix A) of both projects circulated to ADB’s Board and posted on ADB’s website on 29 March 2006. 46. The main adverse environmental impacts of the projects will be a marginal decline in air quality and ash and effluent production. The decline in ambient air quality is minor due to (i) the use of coal with a sulfur content of around 0.36% for Sipat and 0.40% for Kahalgaon; (ii) use of a two-stage combustion process that reduces the formation of thermal nitrogen oxides in the furnace; (iii) trapping more than 99.9% of fly ash in high-efficiency electrostatic precipitators to limit particulate emissions to less than 50 mg/Nm3, in line with ADB limits; and (iv) installing 275 meter high stacks that promote higher mixing.36 About 40% of the ash produced as a by-product of combustion over the initial 9 years of plant operation will be utilized, with 100% of ash to be utilized beyond this period. The main uses will be fly-ash-based Portland Pozzolana cement manufacturing, clay fly-ash brick manufacturing, road and embankment construction, agriculture and wasteland development, and mine filling. Effluent from plant processes will be reused or treated to ADB standards before discharge. Other major impact mitigation measures include a coal dust suppression system and an extensive greenbelt program. 47. NTPC and relevant local authorities will regularly monitor environmental features that relate to the main project impacts to check their compliance with project approval conditions and pollution standards. NTPC will submit periodic monitoring reports to ADB on environmental performance. The principal parameters to be monitored will be local meteorology, flue gas emissions, local ambient air quality, surface water and groundwater quality, discharge effluent quality, soils, aquatic ecology, and noise levels. 48. Resettlement and indigenous people’s aspects in relation to the projects have also been assessed, and in view of the fact that resettlement and land acquisition has already been satisfactorily completed in each location, a category C was assigned to both projects. The review was inclusive of the associated components such as access roads, water pipelines, reservoirs, coal transport system, ash dykes, and transmission lines for evacuation of power. The land for the physical construction work involved in the Kahalgaon Project was acquired in 198537 and Sipat in 2000 as per the Land Acquisition Act, 1984. As the land was acquired over 20 years ago, the compensation and resettlement activities at Kahalgaon have been completed. All affected households were compensated as per the Land Acquisition Act. A comprehensive resettlement 35 Excluding Simhadri, which was recently commissioned and currently seeking certification. 36 The Sipat and Kahalgaon ambient air quality is classified under World Bank guidelines as poor due mainly to

vehicle movements on unsealed roads, agricultural disturbance of soil, and domestic activities. As such, emissions from the two plants will have a negligible impact on overall ambient air quality. While the suspended particulate matter and nitrous oxide limits will be met for both plants, there are minor deviations with regard to sulfur oxide emissions (5% for Sipat, 14% for Kahalgaon). Mitigation measures to reduce total daily weight of sulfur oxide emissions to meet the guidelines were considered but determined to be cost ineffective for the small reduction sought. Additional information is contained in the summary environmental impact assessment.

37 As the Kahalgaon stage II Project is an extension of an existing site, all land was acquired in 1985 when the first plant was constructed.

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and rehabilitation plan for Sipat was prepared as per the NTPC policy on resettlement and rehabilitation and is presently under implementation.38 During the due diligence, ADB met with the district magistrates to confirm the status of compensation payments. 49. NTPC’s policy provides for adequate rehabilitation and resettlement options and facilities to those affected; those affected by the Land Acquisition Act proceedings were provided with compensation and assistance along with rehabilitation programs, which are still ongoing in many of the villages around Sipat. NTPC has institutionalized the resettlement agenda by having its own corporate policy, with full time staff exclusively responsible for implementation of resettlement and rehabilitation plans. C. Anticorruption Policy, and Combating Money Laundering and the Financing of

Terrorism 50. NTPC was advised of ADB’s policies on anticorruption39 and the combating of money laundering and financing of terrorism.40 Consistent with its commitment to good governance, accountability, and transparency, ADB will require NTPC to institute, maintain, and comply with internal procedures and controls following international best practice standards for the purpose of preventing corruption or money laundering activities or the financing of terrorism, and covenant with ADB to refrain from engaging in such activities. Further information on NTPC’s own anticorruption efforts is described in para. 35. D. Main Risks and Mitigation Measures 51. The main risks of the transaction and its mitigation measures are as follows:

(i) NTPC credit risk. NTPC’s current financial position is quite strong, with sustained operating margins and cash flow, low levels of debt, and strong coverage ratios to adequately service and repay the proposed loan. Given NTPC’s large capital expansion program, cash outflows should continue to grow and debt levels will rise over the medium term. As new capacity comes online, revenues will strengthen to offset some of the additional pressures of capital investments and rising debt service. NTPC’s coverage ratios will gradually decline as more debt is borrowed, but the projected ratios maintain sufficient levels throughout the loan period. Stress tests of key variables (including foreign exchange exposure, delays in project commissioning, fuel prices, interest rates, etc.) have been carried out, and indicate no significant threats to NTPC’s ability to service its existing and future debt. To the extent cash flows do come under some pressure, NTPC will most likely defer certain projects or raise additional resources through sale of its short-term securities and investments.

(ii) SEB counterparty/credit risk. Retail distribution of electricity in India is

essentially handled by the state electricity units, and all generators are exposed to this credit risk. While the tripartite agreement settlement has resolved the past due receivables and provided incentives for the improvement of current dues of

38 Land acquisition of 1,510 hectares was completed between 1997 and 1999, 55% of which was barren

Government-owned land. The land required (243 hectares) for the coal transport system was acquired in 2003 and 2004.

39 ADB. 1998. Anticorruption. Manila. 40 ADB. 2003. Enhancing the Asian Development Bank’s Role in Combating Money Laundering and the Financing of

Terrorism. Manila.

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the SEBs, residual risk remains as many SEBs are still loss-making although to a lesser extent. However, relative to other utilities, these risks are lower for NTPC because of its dominant position in electricity supply (being the lowest cost producer, it is a preferred supplier by distributors) and the ability to cut off power supply for nonpayment (as empowered in the tripartite agreement) has helped secure payments. Further, NTPC’s ownership of generation stations across all regions of India helps it diversify its customer base and exposure to all the regional power markets, blending the risks of poor SEBs with the stronger ones.

(iii) Tariff and regulatory risk. CERC, which sets tariffs for NTPC’s plants, issued

the most recent tariff order in 2004. India follows a cost-plus-tariff structure, with all debt servicing, foreign exchange losses, operation, and maintenance (including fuel costs) passed through in the tariffs. In addition, NTPC is allowed to earn a maximum 14% return on its equity funding (capped at 30% of total project costs). The recovery of NTPC’s operating costs is tied to it meeting minimum availability requirements set by CERC, with incentives for exceeding these levels. NTPC regularly meets and exceeds these operational targets. While the 2004 tariff order presents an amortization challenge for NTPC, the tariffs for each plant are set to ensure the costs of production and financing are fully covered. ADB’s loan to NTPC will be made in US dollars and any foreign exchange risk can be passed through in the tariffs.

(iv) Sector reform risk. The Electricity Act put in place a framework for reforms in

the sector, but in several areas the details and timing are yet to be finalized by the relevant authorities. Under the Electricity Act, the SEBs are required to unbundle their operations into separate generation, transmission, and distribution companies. A transition period is likely required to allow these changes to be put into effect. As India is likely to be a power deficient country in the intermediate term, development of a more competitive spot or pool market is unlikely. Once unbundled, NTPC’s power purchase agreements with the SEBs will be reallocated to the new entities, which may or may not have credit standing equivalent to their predecessors. This could affect their ability to make timely payments to NTPC. At the same time, these companies are unlikely to be unbundled without the accompanying reforms to the fundamental tariff structure to allow recovery of costs by the individual units. Furthermore the tariff policy issued by CEA in early 2006 indicates that all power purchase agreements must be backed by adequate and bankable payment security mechanisms. In of the event that such arrangements prove unacceptable to NTPC, it has the option to sell the power to other buyers with better credit. NTPC is the dominant supplier of inexpensive base-load power to the SEBs, so this will mitigate the risk that power is either not purchased by the new entities or that payment risk will increase as a result of sector reform.

(v) Fuel supply risk. As coal dominates NTPC’s fuel mix, it also represents a risk to

NTPC’s operations in terms of supply and price. NTPC’s fuel risks are essentially mitigated by India’s substantial coal reserves (230 times production levels in 2003), which limit its dependence on imported coal. The Government continues to manage domestic fuel supply and delink domestic and international energy prices. Coal from state-owned coal companies met 97% of NTPC demand in FY2005 and imports helped fill the gap. NTPC is currently investing directly into the coal mine business to reduce supply risk and to put competitive pressure on

19

price negotiations with existing suppliers. Even if fuel prices rise by a small percentage each year, margins should not be affected as any price increases are passed through in the tariffs. While NTPC’s gas plants have worked below full capacity due to receiving only 80% of the gas supply required, the same has been true for all of NTPC’s competitors. NTPC is in the process of negotiating with new gas suppliers to bridge the gap. As gas-fired plants only comprise 17% of NTPC’s existing capacity, gas supply and price risks will not have a substantial impact on operations.

(vi) Subordination risk. As the proposed loan is unsecured, ADB will be

subordinated to NTPC’s secured creditors. However, as of 31 March 2005, only 26% of NTPC’s total long-term liabilities were secured and comprised solely of rupee bonds and one loan from the World Bank.41 This totals Rs44,407 million ($986.8 million) in secured liabilities against NTPC’s net fixed assets of Rs322,433 ($7.2 billion).42 Per its corporate debt financing strategy, NTPC does not secure its external and domestic borrowings other than required by law for rupee bond issues. All external commercial borrowings have been made from the international bank market on a negative pledge basis, except for a loan extended by the World Bank in 1993. Approximately $4.4 billion has been raised without creating a charge on fixed assets. Further, all rupee loan agreements executed with Indian lenders are unsecured. Therefore, ADB’s loan will rank pari passu with NTPC’s existing and future unsecured creditors. In the event of such nonpayment, ADB may have somewhat restricted rights of recovery through legal or arbitral processes. ADB believes however that its existing relationship with NTPC43 and ADB’s lending program to the power sector will assist it in ensuring that it is not deprived of its pari passu ranking shared with other unsecured creditors.

VII. EXPOSURE LIMITS

52. The proposed ADB loan exposure of $75 million to NTPC will be ADB’s 19th nonsovereign investment in India, and the first loan to a state-owned enterprise in India without sovereign guarantee under the Pilot Financing Instruments and Modalities (footnote 1). It will, once approved, represent 4.2% of ADB’s aggregate nonsovereign exposure and increase its nonsovereign investment in the thermal power sector from 27.6% of its total exposure to 30.6%.44

41 A loan of $400 million made by the World Bank in December 1993 to specifically finance construction of the

Rihand Super Thermal Power Plant is secured against these fixed assets. This loan is guaranteed by the Government of India.

42 This is the book value of net fixed assets, not necessarily the market and/or salvage value of these assets. In addition, it excludes the value of NTPC investments and other current assets, which are liquid assets. Therefore, this is a very conservative estimate of NTPC’s available assets should security need to be enforced in the event of nonliquidity.

43 ADB. 1988. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to India for the Unchahar Thermal Power Extension Project. Manila (Loan 0907-IND, for 160 million) was amended and relent in 1995 to NTPC. As of 30 April 2006, approximately $80.0 million remains outstanding.

44 Exposure is defined as the total outstanding plus undisbursed commitments (with signed legal agreements) and is based on data as of 31 March 2006.

20

VIII. ASSURANCES 53. In line with the ADB Charter, the Government of India will be asked to confirm that it has no objection to the proposed assistance to NTPC. No funding will be disbursed until ADB receives such confirmation.

IX. RECOMMENDATION

54. I am satisfied that the proposed loan would comply with the Articles of Agreement of ADB and recommend that the Board approve a loan to NTPC Limited comprising (i) a direct loan tranche of up to $75 million from ADB’s ordinary capital resources with a

term of up to 11 years, including a grace period of up to 7 years, with interest to be determined in accordance with ADB’s LIBOR-based lending facility; and

(ii) a loan tranche processed under ADB’s CFS of up to $225 million with a term up to 7

years, including a grace period of up to 4 years, and bearing interest as mutually agreed between NTPC and the participating banks with the concurrence of ADB,

and such other terms and conditions as are substantially in accordance with those set forth in this report, and as may be reported to the Board.

Haruhiko Kuroda President

30 June 2006

Appendix 1 21

OVERVIEW OF THE POWER SECTOR IN INDIA

A. Introduction 1. In fiscal year (FY) 2005, demand for electricity in India exceeded supply by an estimated 7.3% in terms of total requirements and 11.7% in terms of peak demand requirements. Although power generation capacity increased substantially in recent years, it has not kept pace with the growth in demand or the growth of the economy generally. According to the United Nations, India has one of the lowest electricity consumption levels in the world, at 569 kilowatt-hours (kWh) per capita in 2002, due in part to unreliable supply and inadequate distribution networks. This contrasts with 1,484 kWh per capita in the People’s Republic of China, 2,183 kWh per capita in Brazil, and 13,456 kWh per capita in the United States in 2002. 2. Historically, state and central government entities played the dominant roles in the development of the Indian power industry. However, capacity growth did not keep pace with demand due to inadequate investment and the poor financial health of the state electricity boards (SEBs). However, in light of persistent shortages in recent years, the Government has taken significant action to restructure the industry and attract both public and private sector investment. This included measures to restructure the SEBs and improve their financial health. In addition, the Government has liberalized policies relating to the generation and distribution sectors. B. Background 3. At the time of independence in 1947, India had power generating capacity of a meager 1,362 megawatts (MW). Power was only available in a few urban centers, not in villages or rural areas. Generation and distribution of power was carried out primarily by private utility companies. By statute, the central and state governments have jurisdiction over the power sector. Hence, the state legislatures have full power to legislate regarding the power sector, subject to the power provision that the state enactment does not conflict with any central enactment in the sector. The Electricity (Supply) Act, 1948, of India (the Supply Act) created the institutional framework under which the industry was developed; this framework was not substantially modified until the recent passage of the Electricity Act. The Supply Act led to the creation of the SEBs, state government agencies with the sole responsibility for generation, transmission, and distribution of electricity within each state. Most states established SEBs to manage and operate power systems; the smaller states and Union territories established electricity departments. As of 31 March 2005, the SEBs owned or controlled approximately 56% of India's total generating capacity and had substantial control of most of the distribution assets. 4. The Ministry of Power (MOP) and the Ministry of Non Conventional Energy Sources of the Government are primarily responsible for the development of the power industry in the country. MOP is responsible for overseeing India's power industry. Its duties include sector planning; policy and legislation formulation; monitoring of power project implementation; training and human resource development; and administration of legislation in regard to thermal and hydropower generation, transmission, and distribution. In the mid 1970s, the Government recognized that relying solely on the SEBs for power development was leading to power shortages and large interstate imbalances, particularly in light of the uneven distribution of coal and hydroelectric resources throughout the country. To facilitate a more active central role, in 1975 the Government created National Thermal Power Corporation Limited (NTPC) and National Hydro Power Corporation Limited to establish thermal and hydro generating plants and to install associated interregional transmission systems. In the same year, it established the

22 Appendix 1

Central Electricity Authority (CEA) in its present form to develop a uniform national power policy. Additional power generating companies were established later. These entities are collectively referred to as the central power sector utilities (CPSUs) and are directly accountable to MOP. In 1992, the central entity known today as Power Grid Corporation of India Limited (Powergrid) was established to construct, operate, and maintain interstate and interregional transmission systems. The Power Trading Corporation India Limited was formed in 1999 to allow surplus power supplies to be efficiently traded to utilities with deficit power supplies. This corporation is promoted by NTPC, Powergrid, National Hydro Power Corporation Limited, and Power Finance Corporation. 5. Through successive 5-year development plans, the Government implemented a major expansion of generating assets. From 1982, when NTPC's first project was commissioned, to the end of FY2005, India's total installed capacity increased from 35,781 MW to 118,419 MW, representing a compound annual growth rate of 5.3%. In addition, captive generation capacity at the end of FY2004 was approximately 19,061 MW. The transmission and distribution network has been expanded to cover nearly 80% of the country. However, this expansion has not kept pace with the growing demand for electricity. C. Summary of Recent Developments 6. To supplement public sector investment, the Government took steps in 1991 to attract private investment into the power industry. The Government permitted 100% foreign ownership of power generating assets and provided assured returns; a 5-year tax holiday; low equity requirements; and for some private generators, counterguarantees against nonpayment of dues by the SEBs. However, these reforms still did not address the poor financial health of the SEBs, and power shortages persisted. Transmission and distribution (T&D) losses were especially high, due to inadequate metering, obsolete equipment, and theft. T&D losses were estimated to be 32.9% on average for the country in FY2001. The commercial losses of the SEBs were Rs206 billion ($4.7 billion) in FY2004. By March 2004, overdue payments by the SEBs to the CPSUs, including interest and surcharges, amounted to Rs53 billion ($1.2 billion). 7. To provide incentives for the states to take concrete measures to restructure their power operations, the Government introduced the Accelerated Power Development Program in FY2001 (later renamed the Accelerated Power Development and Reform Program or APDRP) as the incentive was linked to the reform process. The APDRP aims to bring down T&D losses to 10% through various central, state, and local initiatives, and to improve the performance of generating stations through renovation and modernization. To improve the financial health of the SEBs, the Government implemented the scheme for one-time settlement of outstanding dues, which settled the outstanding dues of the SEBs payable to the CPSUs, and set up a system to facilitate the full payment of subsequent billings. The recently adopted Electricity Act consolidates all existing laws governing the industry, creates a program for restructuring the SEBs, and introduces greater competition and access into certain segments of the industry (paras. 15–16). D. Supply and Demand 8. Power demand in India has grown rapidly since the 1980s as the country’s economic growth accelerated to an annual average of 5.6% since 1980. Under MOP’s Power for All by 2012, target capacity is being expanded to maintain India’s current 8% economic growth rate. Of total electricity sold in India, industry accounts for approximately 33%; agriculture and households for 25% each; and businesses, commercial, and other small categories the

Appendix 1 23

remaining 17%. Power demand growth has slowed in recent years to approximately 2–3%, not due to a lack of demand, but due to inadequate capacity and poor T&D infrastructure. Power quality remains poor, marked by high voltage fluctuations and recurring load shedding. India continues to suffer from chronic electricity shortage, where peak demand exceeds supply by over 12% and an energy deficit of 7% was recorded between April and September 2005.1 As the current 10th Plan fulfills only 75% of needed capacity additions to 2007, energy shortfalls will persist over the short to medium term. The Government seeks to eliminate this deficit by 2012, which marks the end of the next 5-year plan (the 11th Plan, 2008–2012). E. Power Generation 9. As of 31 March 2005, India's power system had an installed generating capacity of approximately 118,419 MW. Thermal power plants powered by coal, gas, naphtha, or oil accounted for approximately 68% of total power capacity; hydroelectric stations for approximately 26%; and others (including nuclear stations, wind power, and other renewable energy sources such as biomass) accounted for approximately 6%. The CPSUs accounted for approximately 33% of total power generation capacity, state electricity utilities for 56%, and private sector companies for 11%. 10. The Government adopts a system of successive 5-year plans that set out targets for economic development in various sectors, including the power sector. Each successive 5-year plan has increased power generation capacity addition targets. The 9th Plan (1998–2002) targeted a capacity addition of 40,245 MW, of which 24% was to come from hydro capacity, 73% from thermal capacity, and the remainder from nuclear capacity. MOP estimates that only around 19,251 MW or 48% of the planned capacity addition was added in the aggregate during the 9th Plan. The target for capacity addition has been set at 41,110 MW under the 10th Plan as shown in Appendix 4. The Government has set an ambitious target of providing Power for All 2012 during the 10th and 11th plans. Based on CEA’s 16th Electricity Power Survey, India will require additional capacity creation of nearly 100,000 MW by 2012 to achieve this goal. 11. Capacity utilization in the Indian power sector, as best measured by the plant load factor (PLF) of generating plants, is low. However, the PLF for coal-fired plants increased from 63% in FY1996 to 75% in FY2005. The PLF varies significantly across ownership segments. Coal-fired generating plants owned by SEBs operated at an average PLF of around 70% in FY2005, while those owned by private utilities and CPSUs operated at a PLF of 85% and 82%, respectively, during the same period. F. Transmission and Distribution 12. In India, the T&D system is a three-tier structure comprising regional grids, state grids, and distribution networks. The distribution network and the state grids are owned and operated by SEBs or state governments through SEBs. Powergrid owns and operates most interstate transmission links. To facilitate the transfer of power between neighboring states, state grids are interconnected to form regional grids. Because peak demand does not occur simultaneously in all states, situations may arise when one state has a surplus of power, while another faces a deficit. The regional grids facilitate transfers of power from a power surplus state to a power deficit state. The grids also facilitate the optimal scheduling of maintenance outages and better coordination between the power plants. The regional grids are to be eventually integrated to form a national grid, whereby surplus power from a region could be transferred to a region 1 Ministry of Power monthly statistics.

24 Appendix 1

facing power deficits, thereby facilitating a more optimal utilization of the national generating capacity. 13. At present, the national grid has a capacity of 8,500 MW and Powergrid expects to achieve grid capacity of 30,000 MW by FY2010. The T&D system in India is characterized by high losses, ranging from 24–33% during FY1997 to FY2001, which includes theft as well as commercial losses. This compares with T&D losses of 10–15% in developed countries. T&D losses for the 19 SEBs and eight electricity departments increased from 22% in FY1993 to 30% in FY2001. However, in the absence of adequate metering, loss figures have an implicit element of inaccuracy. T&D losses were reduced from 34% in FY2002 to 32% in FY2003. 14. The country’s transmission perspective plan for the 10th and 11th plans focuses on the creation of a national grid in a phased manner by adding over 60,000 kilometers of transmission network by 2012. Such an integrated grid will evacuate an additional 100,000 MW by 2012 and carry 60% of the power generated in the country. The existing interregional power transfer capacity is 9,000 MW, which is to be enhanced to 30,000 MW by 2012 through system upgrading. For creation of such a grid, an investment of Rs710,000 million ($15.7 billion) is envisaged. Of this, Rs500,000 million is planned to be mobilized by Powergrid and the remaining Rs210,000 million through private sector participation. G. Power Sector Reform

1. The Electricity Act (2003) 15. In 2003, to enhance the scope of power sector reforms, promote competition, and eliminate the multiple legislation governing the electricity supply industry, the Government enacted the Electricity Act. The Electricity Act calls for the eventual unbundling of the SEBs so that the generation, transmission, and distribution functions are established as separate corporations. In addition, the Electricity Act provides for open access, whereby any generator has nondiscriminatory access to transmission lines or distribution systems, and permits the creation of alternative or parallel distribution networks. However, these reforms are likely to require time to have full effect. Private sector investments are allowed in the transmission sector and foreign direct investment in this sector is being encouraged by the Government. In addition, decentralized distributed generation using nonconventional sources of energy, such as solar power and biomass, are being encouraged in the country. 16. The Electricity Act includes wide ranging initiatives to (i) liberalize generation and T&D, (ii) identify the causes of and solve the SEB crisis, (iii) upgrade infrastructure, and (iv) improve coordination between the central and state governments in planning and development. Some of the key provisions of the Electricity Act include

(i) eliminates the licensing requirement for generating stations (excluding hydro) that comply with the grid standards as set by CEA;

(ii) specifies technical standards, grid standards, and safety requirements; (iii) exempts captive power plants from obtaining licenses and other approvals; (iv) provides state governments with the flexibility to decide the sequencing and

phasing of SEB restructuring, hence retaining the integrated SEB structure for a transition period;

(v) requires transmission and distribution line operators to provide nonpreferential open access to any generator or buyer of electricity, subject only to technical considerations;

Appendix 1 25

(vi) introduces power trading as a distinct industry activity; (vii) specifies the regulatory functions of the Central Electricity Regulatory

Commission (CERC); (viii) requires states to establish their own regulatory commissions; (ix) creates separate licensees for transmission, distribution, and supply; (x) requires the metering of all consumers to improve accountability; (xi) requires the formulation of a national electricity policy; and (xii) requires the formulation of a national tariff policy. 2. National Electricity Policy

17. Under the Electricity Act, the central Government is required to prepare a national electricity policy (NEP) in consultation with CEA and the state governments. On 12 February 2005, the Government issued the NEP to (i) provide guidelines to accelerate the development of the power sector, (ii) supply electricity to all areas; and (iii) protect customers' interests. The NEP aims to provide access to electricity to all villages and households within 5 years. In addition, the NEP seeks to meet power demand and ensure the availability of electricity is increased to over 1,000 kWh per capita by 2012. The NEP recommends easier procedures for setting up power plants that are close to hydro and thermal power sources, and recommends alternative long-term fuel sources such as liquid fuel and nuclear power. The NEP focuses on renovation and modernization techniques to achieve higher efficiency levels. Development of captive generation is encouraged, and the NEP recommends the use of spare energy in captive generation plants with larger requirements.

3. SEB Reform

a. Accelerated Power Development Reform Program 18. To improve the condition of the SEBs, the Government launched a combination of regulatory and development initiatives. In 2001, the Government initiated the Accelerated Power Development Plan to provide financial assistance to the states for undertaking renovation and modernization programs for thermal and hydropower stations, and to strengthen and improve the subtransmission and distribution network. The program was renamed the APDRP in 2003. The Government earmarked a total of Rs400 billion for the program during the 10th Plan. The program includes investment components and incentive components. 19. Under the investment component of the APDRP, the Government provides financial assistance to the states to strengthen and upgrade their subtransmission and distribution networks. Half of the cost of such projects (estimated at Rs200,000 million or $4.4 billion equivalent in the 10th Plan) is met by the Government through concessional loans, with the balance arranged by the states as counterpart funding from financial institutions. Nearly 500 subtransmission and distribution SEB projects have been approved for funding under this program.2 For states in the northeastern region, Himachal Pradesh, Jammu and Kashmir, Sikkim, and Uttaranchal, the Government provides financial assistance for up to 100% of the project cost. Under the incentive component, MOP makes a grant to the states of 50% of the SEB's actual cash-loss reductions year over year. This component was introduced to motivate the SEBs and utilities to reduce their financial losses.

2 Additional investment details on a state by state basis are available at http://www.powermin.nic.in or

http://www.apdrp.com.

26 Appendix 1

b. Scheme for One-Time Settlement of Outstanding Dues

20. The growing SEB losses eventually triggered Government intervention in April 2002, when MOP announced a scheme for one-time settlement of outstanding dues aimed at settling debts, including those to NTPC, through tripartite agreements (TPAs) between MOP, the Reserve Bank of India (RBI), and the states. It provides for

(i) securitization of dues outstanding and 40% of surcharge/interest as of 30 September 2001 through tax-free bonds (bearing a coupon of 8.5% and maturing in various stages, starting from 1 October 2006 until 1 April 2016) to be issued by RBI on behalf of each of the state governments to the CPSUs;

(ii) waiver of the remaining 60% of surcharge and interest due by the SEBs; and

(iii) conversion of any previously issued bonds by SEBs into new TPA bonds.

It also provides for the full payment of all dues after 30 September 2001 through a mechanism

(i) requiring SEBs to open and maintain letters of credit to CPSUs equivalent to 105% of the average monthly billing for the preceding 12 months;

(ii) offering SEBs a one-time cash incentive equal to 2% of the bond amounts for opening and maintaining letters of credit securing their payment obligations;

(iii) for regular serving of the bonds between FY2003 and FY2007, offering SEBs cash incentives on the principal amount, equal to 6% rebate in FY2003, 5% in FY2004, and 4% in each of FY2005 and FY2006; and

(iv) allowing CPSUs to take action in the case of failure to make payment of current dues within the stipulated 60-day period or failing to maintain the letters of credit. Allowable actions include (i) graded reductions in power supply; and (ii) if payment defaults continue for more than 90 days, recovery of payments from RBI directly. Any payments made by RBI would then be debited from the applicable state’s allocation from the central Government (accounts maintained at RBI).

21. The March 2003 settlement was documented by individual TPAs between MOP, RBI, and each state to effectively settle overdue payments owed by the SEBs and to put in place incentives for future timely payment. The TPAs also contain a series of obligations on the part of each state government and its SEB in relation to ongoing power industry reforms, including the establishment of state electricity regulatory commissions, the metering of distribution feeders, and the completion of tariff petitions in accordance with performance milestones reviewed by MOP. The SEBs have opened letters of credit as envisaged in the scheme, which has enabled full realization of the current billings in most cases. In FY2004 and FY2005, NTPC realized 100% of the amounts for power sold to SEBs as a result of this arrangement. The state governments have ensured timely servicing of the bonds to date. While progress of sector reform continues to be slow, these recent legislative changes and the TPA settlement seem to have put the sector on the road to recovery and curtailed the SEBs financial problems, which had infected the sector as a whole. Once the immediate pressures of its debt service were alleviated through the TPAs, the resulting improvement in the cash resources of the SEBs strengthened their capacity to pay on time and improve metering and collection in the interim.

Appendix 1 27

H. Regulatory Framework 22. The central and state governments share responsibility for the development of the power industry. MOP is the ministry governing the power sector in the country and oversees the operational performance of all CPSUs. CEA advises MOP on electricity policy and technical matters, among others. CERC was constituted under the Electricity Regulatory Commission Act, 1998, to regulate the tariffs for the CPSUs and other entities with interstate generation or transmission operations. The act, which has since been replaced by the Electricity Act, also provided for the formation of state electricity regulatory commissions (SERCs) to rationalize energy tariffs and formulate policy within each state. As of 31 March 2005, 24 states had set up their SERCs. A joint electricity regulatory commission has been established for two more states. Geographically, the SEBs are grouped into five regional electricity boards, which coordinate system operations in the respective regional grids including generation schedule, overhaul, and intergrid maintenance programs, power transfers, and tariffs.

1. Tariff Setting for Generators

23. Tariffs for state sector generators are regulated by the SERCs or the respective state governments, and those for independent power producers are not regulated. The Electricity Act empowers CERC to set the tariff of generating companies owned or controlled by the Government and other entities with interstate generation or transmission operations. CERC advises the Government on the formulation of the national tariff policy. The tariff policy is intended to serve as a guide in the actual tariff setting. CERC issued tariff regulations for 5 years effective from 1 April 2004. These regulations provide for tariffs consisting of a capacity charge, a variable charge, and an unscheduled interchange charge.

2. Tariff Setting for Consumers 24. Under the Electricity Act, the SERCs regulate the tariffs for customers of the SEBs and electricity departments. The act allows state governments to price power for certain customers at subsidized rates, but requires them to fund the subsidy transparently from their respective state government budgets. While setting the consumer tariffs, some states have attempted to cross-subsidize agricultural and domestic tariffs by charging higher rates for industrial and commercial consumers. Even with cross-subsidization, tariffs have not kept pace with the cost of supply. The cost of supply for distribution licensees averaged Rs3.49 ($0.079) per kWh in FY2002, up from Rs1.09 ($0.025) per kWh in FY1989. The increase in the total cost of supply is mainly due to the increase in power purchase costs and continued theft and losses. The average tariff has not increased proportionately with the increase of the cost of supply. The average revenue per unit was Rs2.40 ($0.055) per kWh in FY2002, leaving a gap of Rs1.10 ($0.025) for every kWh of power supplied. This has adversely affected most of the SEBs and their commercial losses totaled approximately Rs330 billion ($7.5 billion) in FY2002. However, the Government has taken many reforms, including setting up of SERCs under the Electricity Act to set tariffs. The Government also issued a national tariff policy recommending methods in which subsidies can be reduced.

28 Appendix 2

DESCRIPTION OF NTPC LIMITED A. Overview 1. NTPC Limited (formerly known as National Thermal Power Generation Limited) is a Government-owned entity with 89.5% of its paid-up capital contributed by the Government and the balance of 10.5% being held with foreign institutional investors, financial institutions, banks, and the general public. NTPC is primarily involved in constructing and operating power stations. According to the annual report of the Ministry of Power (MOP) for fiscal year (FY) 2005, NTPC is the largest thermal generating company in India. As of 31 December 2005, the NTPC’s total installed capacity was 24,249 megawatts (MW), through 13 coal-fired power stations (19,980 MW), seven gas-fired power stations (3,955 MW), and three joint venture projects (314 MW). NTPC also manages the operations of Badarpur power station (705 MW) on behalf of the Government. As of 31 December 2005, NTPC's share of the total installed capacity of India was 19.6%, and it contributed 27.1% of the total power generation during FY2005. The average selling price of NTPC's power during FY2005 was Rs1.52 ($0.035) per kilowatt hour (kWh), which is cheaper than many thermal tariffs in India. NTPC supplies power to the state electricity boards (SEBs), the electricity departments, unbundled entities of SEBs (together with SEBs and electricity departments, the state electricity utilities), and Indian Railways; with the majority of the generation output being purchased by the state electricity utilities under separate long-term power purchase agreements (PPAs). 2. NTPC is pursuing expansion of its business activities into hydroelectric generation, coal mining, gas exploration, and participation in the liquefied natural gas value chain, which supplements and supports its core power generation activities. In addition to its core business, NTPC provides consultancy services to power utilities in both India and internationally. Through its wholly owned subsidiaries, NTPC proposes to implement and operate small- to medium-sized hydroelectric power plants and engage in power trading and power distribution. It is also involved in a number of joint ventures, including a joint venture with Alstom, Germany, for the renovation and modernization of third party power plants in India and other member countries of the South Asian Association for Regional Cooperation. B. History 3. Prior to the establishment of NTPC, power generation and capacity augmentation in India was largely the responsibility of SEBs. The gap between the demand for electricity and the ability of SEBs to supply it was perceived by the Government as a significant factor affecting the economic development of India. To address this undersupply, the Government established hydroelectric and thermal generation companies in the central sector, which comprises central Government-owned power utilities (the central sector). NTPC was incorporated as a Government Company under the Companies Act, 1956 of India on 7 November 1975 as the National Thermal Power Corporation Limited. 4. In December 1976, the Government gave approval for NTPC to construct its first "super thermal" (greater than 1,000 MW) power project at Singrauli. The first unit at Singrauli was successfully commissioned on 13 February 1982. Since 1982, through expansion of existing plants, construction of new plants, and takeover of plants from state electricity units, NTPC has grown to become the largest thermal generation utility in India with a total installed capacity as of 31 December 2005 of 23,935 MW (excluding joint ventures).

Appendix 2 29

5. On 28 October 2005, in order to give NTPC a new corporate identity, the name of NTPC was changed from National Thermal Power Corporation Limited to NTPC Limited. The new name of NTPC signifies the substantial ground covered by NTPC and its subsidiaries in the areas of hydropower, coal mining, oil and gas value chain, power trading, and also the substantial efforts in the area of power distribution. All the initiatives of backward, forward, and lateral integration are primarily aimed at strengthening NTPC's core business of power generation. C. NTPC's Relationship with the Government 6. NTPC is currently 89.5% owned by the Government; the remaining 10.5% is vested with foreign institutional investors, financial institutions, banks, and the general public. The President of India is the beneficial owner of the Government shareholding. Under NTPC's Articles of Association, the chairman and managing director (the CMD) is appointed by the Government of India. The remainder of NTPC's board of directors is appointed by the Government of India in consultation with the CMD, except for the Government's nominee directors and independent directors. Independent directors as well as Government-nominated directors are appointed by the President of India. At present, the Board is comprised of five full-time directors, including the CMD, two part-time directors nominated by the Government, and four independent directors who are nonofficial part-time directors. NTPC's Articles of Association vest management power of NTPC in the Board. 7. Based on NTPC's performance, the Government in July 1997 named NTPC one of the nine initial Navratna companies (nine jewels) and granted it enhanced autonomy in making financial and other decisions, including the freedom to engage in investment, capital expenditures, and raising of funds at home and internationally without Government approval or interference. It is generally permitted to form joint ventures and subsidiaries up to specified limits, subscribe equity in these entities, and purchase and receive new technology and knowledge transfer. It is permitted to decide the locations for its plants (a matter previously determined by the Planning Commission) and has the freedom to independently negotiate power purchase agreements with its customers. In addition, NTPC can generally borrow from both the domestic and international markets. However, in the case of borrowing from the international market, NTPC is subject to guidelines issued by the Ministry of Finance and/or the Reserve Bank of India. Under the existing guidelines, NTPC can borrow up to $500 million per annum from the international market without seeking any Government approvals. 8. NTPC pays dividends annually to the Government and its other shareholders. The dividend paid for FY2005 was Rs19,790 million ($439.8 million), or 34.1% of profits after tax, which is almost double the dividend paid for the previous fiscal year of Rs10,823 million ($240.5 million). NTPC's dividend target is 30% of profit after tax, but the policy allows NTPC to take into account its requirements for internal resources to fund its capacity expansion program. The declaration and payment of a dividend is recommended prudently by the Board and approved by the NTPC shareholders. 9. NTPC enters into an annual memorandum of understanding with the Government, which sets annual performance targets for the physical, financial, and dynamic parameters of NTPC. These parameters include total electricity generated, availability factor, financial gross margin, and the ratio of net profit to net worth. An evaluation of the actual performance of NTPC against the targets is conducted at the end of each fiscal year. NTPC has been placed in the excellent category (the best category) for the 15th consecutive year since the memorandum of understanding system became operative in FY1988.

30 Appendix 2

D. Power Generation Operations 10. The engineering, construction, and operation of power plants for the thermal generation of power is the core business of NTPC. Sales of energy accounted for 90% of NTPC’s operating income in FY2005. As of 31 December 2005, NTPC owned and operated 23 power plants located throughout India (including those owned by joint ventures), which generated 27.1% of India's total power generation and constituted 19.6% of India's total installed capacity. A list of NTPC's power projects that are commissioned, under implementation, and/or planned during the 10th and 11th plan periods is contained in Appendix 4. NTPC sells power to most of the state electricity utilities and Indian Railways. In FY2005, NTPC generated 159.1 billion kWh (excluding joint ventures), an increase of 6.7% over the same period in the previous year. The majority of generation was through NTPC's coal-fired plants (136.1 billion kWh) as against its gas-fired plants (23.0 billion kWh). NTPC’s facilities are located throughout India, but mostly concentrated in the central and eastern states. 11. Historically, the operating performance of NTPC in its core business has been above the national average. The availability factor1 for coal-fired stations increased from 85.9% in FY1995 to 91.2% in FY2005, which compares favorably against international standards. The plant load factor2 (PLF) at coal-fired stations increased from 76.6% in FY1995 to 87.5% during FY2005, which is the highest since the date of incorporation of NTPC (the Indian average during FY2005 being 74.8% according to CEA). Although the availability factor at gas-fired stations is high (82.4% in FY2005) due to constraints on the availability of gas, the PLF is significantly lower than at coal-fired stations (65.4% in FY2005). NTPC is adopting a number of strategies to address this. From FY1995 to FY2005, employee productivity nearly doubled as measured by the ratio of revenue to number of employees. While installed capacity of NTPC increased by 50.0% between FY1995 and FY2005, employee numbers increased by only 8.6%. E. Capacity Expansion 12. NTPC has a current installed capacity of 24,249 MW. NTPC plans to become a generation company with power generation of 30,000 MW plus by the end of the 10th Plan (end 2007), 46,000 MW plus by the end of the 11th Plan (end 2012), and 66,000 MW plus by the end of the 12th Plan (end 2017). NTPC plans to add a capacity of 9,160 MW during the 10th Plan and 17,052 MW during the 11th Plan. NTPC is adopting a multipronged growth strategy for capacity addition through greenfield projects, expansion of existing stations, acquisitions and takeovers, and establishment of joint ventures and subsidiaries. In addition to the 4,000 MW already commissioned during the 10th Plan and 8,970 MW under implementation during the 10th and 11th plans, the basket of new generation projects identified for implementation in the 10th and 11th plans includes both greenfield projects and the expansion of existing power plants. Appendix 4 provides a detailed list of expansion projects. F. Subsidiaries 13. NTPC has four wholly owned subsidiaries. Although the current level of activity of the subsidiaries is relatively small in comparison with the main power generation operations of NTPC, they form part of NTPC's diversification business strategy. NTPC's wholly owned subsidiary, NTPC Vidyut Vyapar Nigam Limited, was incorporated on 1 November 2002 to

1 The availability factor is a measure of how often a plant is available for being dispatched by the grid operator, 2 The plant load factor is a measure of how much capacity is actually dispatched.

Appendix 2 31

undertake power trading. In FY2005, it made a profit after tax of Rs57 million on gross income of Rs5,992 million. NTPC incorporated a wholly owned subsidiary company, NTPC Electric Supply Company Limited, in August 2002 to pursue investments in electricity distribution businesses. In FY2005, it made a profit after tax of Rs0.40 million on gross income of Rs75 million. Pipavav Power Development Company was formed as a wholly owned subsidiary company of NTPC with the objective of acquiring land for the Pipavav Mega Power project (2,000 MW) and to perform activity related to site development. NTPC incorporated a wholly owned subsidiary company, NTPC Hydro Limited, on 12 December 2002 to develop small- and medium-sized3 hydroelectric power projects of up to 250 MW and to boost its capacity addition program in the hydroelectric sector. Its first hydroelectric project is Lata Tapovan hydroelectric power project (162 MW) in the state of Uttaranchal. As of March 2006, NTPC Hydro Limited had not commenced operations of any hydroelectric power plants. G. Power Purchase Agreements 14. The capacity of each unit at each power station owned by NTPC is contracted to various customers under the PPAs. For coal-fired stations, the term of the PPA for each unit is 25 years. For gas-fired stations, the term of the PPA for each unit is 15 years. As part of its investment approval procedure, NTPC requires PPAs to be in place for all new plants before approval is given for investment. All existing facilities have contracted 100% of their capacity. As of 31 December 2005, NTPC's top 10 customers and their respective percentage share in NTPC's revenue are Uttar Pradesh (16.2%), Maharashtra (9.5%), Andhra Pradesh (8.6%), Madhya Pradesh (8.0%), Delhi (7.8%), Tamil Nadu (5.4%), Gujarat (4.9%), Orissa (4.4%), Haryana (4.2%), and Bihar (3.9%). H. Tariffs 15. Different tariffs apply to each of NTPC's plants. The tariffs are notified by CERC and are performance based, mainly comprising the following components:

(i) Capacity charges are fixed monthly payments made by each of the plant beneficiaries for making the plant capacity available. The fixed charges are made up of components such as operation and maintenance costs, debt servicing cost, depreciation, and a fixed return on equity at 14% (post tax). Recovery of full fixed charge is dependent on achieving target availability of 80% as prescribed in the relevant regulations.

(ii) Energy charges primarily comprise a pass through of actual fuel cost as per prescribed operational norms in accordance with the precommitted daily schedule of dispatch, which is a schedule of power supply as agreed between NTPC and its customers on a daily basis.

(iii) An unscheduled interchange charge is made for any supply and consumption of energy that differs from the precommitted daily schedule at the rates based on grid frequency.

(iv) An incentive at the rate of Rs0.25 per kWh is provided for scheduled energy above a target PLF of 80%.

3 Larger hydroelectric projects are undertaken by NTPC directly.

32 Appendix 2

(v) Foreign exchange rate variation and tax on the generation income of NTPC are treated as passed through.

16. In March 2004, CERC notified NTPC of the terms and conditions for determining tariff applicable with effect from 1 April 2004 for 5 years. NTPC has made a tariff petition for each power station in accordance with the said terms and conditions. CERC has yet to notify NTPC of the tariff for each power station for 1 April 2004 to 31 March 2009. Pending final determination of the tariff for this period, CERC has directed NTPC by notification that on a provisional basis the annual fixed charges as applied on 31 March 2004 will be billed at target availability and variable charges based on norms of operation notified in regulation 2004. I. Fuel Supply 17. Fuel is NTPC's single largest expense accounting for 55.1% of revenue distribution in FY2005. NTPC uses two primary fuel sources: coal and natural gas. Long-term fuel supply agreements tied to plant life (25 years for coal and 15 years for natural gas) are arranged before any new plant receives investment approval. To further support its power generation activities, NTPC implements hydroelectric power projects and is assessing the viability of entering into the field of nuclear power generation. An increase in fuel prices would have an effect on the dispatch of NTPC's power stations as units are dispatched in merit order (units with the cheapest cost of generation dispatched first). NTPC is pursuing a number of strategies to control increases in prices.

1. Coal 18. NTPC procures coal from subsidiaries of Coal India Limited, a Government-owned enterprise, and Singareni Collieries Company Limited, also a Government-owned company. Coal supply for each of NTPC's plants is allocated by the Standing Linkage Committee, which is a Government committee led by a representative of the Ministry of Coal along with members from the Ministry of Railways, Ministry of Shipping, and Ministry of Surface Transport; and one member each from the ministries representing the various utility sectors, including MOP. The coal requirements of projects in the utility sector are reviewed by the Standing Linkage Committee on a quarterly basis. Most of NTPC coal-fired stations are located within 25 kilometers of the coal mines that supply the stations. These stations are serviced by dedicated transportation systems owned and operated by NTPC, which reduce supply interruptions and transportation costs. 19. For each plant, NTPC enters into a long-term coal supply agreement with the relevant company that runs the mine that services the plant. Each plant is supplied coal by specific coal mines identified by the Standing Linkage Committee and the supplying company. Each coal supply agreement addresses the quality and quantity of coal supply required for sustained generation, provides for quantity flexibility on both a short- and long-term basis, and allows for alternative sources of supply as backup. The specifications of the coal are agreed up front, and NTPC has the right to reject coal that does not meet certain specified parameters. 20. The contracts provide that NTPC will purchase the quantity of coal necessary to run the plant at a PLF of 80%. NTPC is required to pay a penalty if it fails to purchase at least 90% of that quantity. The price of the coal varies depending on its calorific value. Prior to 1996, the Government determined coal prices. Since 1996, the Government has deregulated coal prices in a phased manner. Today, coal prices are determined by the supplying coal companies. Each of NTPC's coal supply agreements includes a pricing formula that sets the ceiling on the price

Appendix 2 33

NTPC can be charged, and also includes an equitable treatment clause so that if the coal supplier is selling coal at a lower price to other customers, NTPC has the right to purchase coal at that lower price. 21. At present, the overall demand for steam/noncoking coal in India exceeds production. The power sector currently accounts for 77% of demand and the sector's demand for steam coal is expected to increase substantially in connection with its planned increases in capacity. NTPC's current coal supplies are sufficient to generate power to meet targets set by CEA. To address any additional demand for coal, NTPC has decided to begin importing coal. In addition, to reduce the cost of coal, fill gaps in fuel availability, and as a fuel security measure, NTPC intends to commence coal mining operations in the near future.

2. Natural Gas 22. India's domestic natural gas supply is insufficient to satisfy demand. Natural gas is allocated to each of NTPC's plants by the Gas Linkage Committee, comprising a representative from the Ministry of Petroleum and National Gas, MOP, Ministry of Steel, Ministry of Fertilizers, Ministry of Chemical and Petrochemicals, Planning Commission, Ministry of Finance, GAIL India Limited, Oil and Natural Gas Corporation, and Oil India Limited. Following allocation, NTPC enters into a long-term gas supply agreement with GAIL India Limited to purchase the allocated gas. Gas prices are fixed by the Ministry of Petroleum and National Gas using the administered pricing mechanism. This mechanism is used by the Government to fix gas prices based on market determined pricing. A proposal to dismantle the administered pricing mechanism for natural gas and institute an independent petroleum regulatory board to regulate prices and supply is under consideration by the Government. 23. While most of NTPC's gas-fired stations are located along major gas pipelines, NTPC has experienced gas supply constraints, where less than the allocated amount of gas has been made available. Due to the nonavailability of gas and the high prices of liquid fuel, NTPC added only 2,700 MW of capacity during the 9th Plan as against a proposal for adding 5,300 MW. NTPC requires 16 million cubic meters per day (mmcmd) of gas to run its gas-fired stations at a PLF of 80%. In FY2005, NTPC received 10.4 mmcmd of gas, which represented 79.8% of its allocation of 13 mmcmd. To increase its existing gas supplies, NTPC has received additional gas supplies from Parma Mukta Tapti gas fields, Gujarat State Petroleum Corporation Limited, and other gas sources increasing the gas supply level to 10.9 mmcmd on average for FY2006. NTPC also addresses gas shortages by using alternate fuels such as naphtha and high speed diesel. However, these fuels are more expensive than gas and therefore their use increases the cost of supply and the cost of power generated by the issuer. As a result, the PLF at its gas-fired stations was only 65.4% compared with 87.5% for its coal-fired stations in FY2005. 24. To have the affordability of gas prices for power generation, compatible with other fuel options, such as coal, NTPC is considering participating in different elements of the liquefied natural gas value chain through equity participation or strategic investments with prospective partners in both India and internationally. This includes participation in oil/gas exploration, liquification plants, shipping ventures, and regasification plants. The NTPC-led consortium of Canaro Resources Ltd. and Geo Petrol International has been allotted an oil and gas exploration block in Arunachal Pradesh under the fifth round of the New Exploration and Licensing Policy by the Government.

34 Appendix 2

J. Work Force 25. As of 31 March 2005, NTPC had approximately 21,420 employees, comprising 8,566 executives and 12,854 nonexecutives; the turnover rate for its executive workforce was low at 0.4% in FY2005. NTPC has never had any major strike or work stoppage, and currently has no unresolved strike proceedings. NTPC considers its relations with its employees to be good. In a survey conducted by Business Today and Hewitt Associates in 2003, NTPC was ranked the third best employer in India. It retained this status during a survey held by Hewitt Associates and CNBC TV 18 in 2004. In addition, NTPC has been ranked the 5th best company to work for in India in a survey conducted by Business Today and Mercer Consulting in 2005. K. Management and the Board 26. In accordance with its Articles of Association, NTPC is managed by a board. Although the CMD controls NTPC's day-to-day management, NTPC's management is by the board and does not depend on any key individuals. As of 1 April 2006, the Board comprised 11 directors. Of these, 5 are full-time functional directors of NTPC including the CMD, 2 are part-time directors nominated by the Government, and 4 are nonofficial part-time directors (independent directors). Per Article 49 of the Listing Agreement, 50% of NTPC’s board are independent, nonexecutive directors. 27. The functional directors, including the CMD, are appointed for 5 years, until the incumbent reaches retirement age, or until further instructions from the Government, whichever event occurs earlier. Government nominees representing the Government retire from the board on ceasing to be officials of MOP. Part-time nonofficial directors are appointed by the Government for a 3-year tenure. Currently, four part-time nonofficial directors are on the board. The age limit of full-time functional directors, including the CMD, is 60 years. The current board of directors includes

(i) T. Sankaralingam, CMD of NTPC; (ii) Chandan Roy, director (operations) of NTPC; (iii) R.S. Sharma, director (commercial) of NTPC; (iv) R.K. Jain, director (technical) of NTPC; (v) A.K. Singhal, director (finance) of NTPC; (vi) M. Sahoo, an Indian administrative services officer, part-time director nominated by

the Government with effect from July 2002; (vii) Harish Chandra, an Indian administrative services officer, the Government's

nominee director with effect from July 2005; (viii) Ashok Misra, currently a director of the Indian Institute of Technology, Mumbai, an

independent director since February 2002; (ix) R.K. Pachauri, former head of Tata Energy Research Institute, New Delhi, joined

the Board in 2002 as an independent director; (x) Mirza Ishtiaq Beg, former chairman of CEA and ex officio secretary of the

Government of India, joined the Board in 2006 as an independent director; and (xii) Gian Prakash Gupta, former chairman and managing director of Industrial

Development Bank of India and chairman of UTI Bank, joined the Board in 2006 as an independent director.

Appendix 3 35

FINANCIAL PERFORMANCE OF NTPC LIMITED A. Introduction 1. NTPC maintains a BB+ long-term issuer default credit rating by Fitch and Standard and Poor’s (S&P), which is equivalent to the sovereign rating of India. In March 2006, Fitch and S&P also assigned a BB+ rating to the $1 billion medium-term note program closed by NTPC. These ratings reflect its dominant market share, diversified asset portfolio, and strong financial profile. NTPC maintains a AAA issuer local rating by the Investment Information and Credit Rating Agency and its rupee bonds are similarly rated. S&P recently upgraded its outlook for the sovereign and NTPC to positive from stable based on overall fiscal improvements in India. Despite such strong financial indicators and AAA local credit ratings, NTPC’s foreign currency ratings are constrained by being majority owned by the Government, so that its rating cannot surpass the sovereign’s own rating of BB+. B. Historical Financial Performance 2. A summary of historical financial performance is included in Table A3.1. The most recent financial results were analyzed and some of the reasons for its performance and year-on-year changes indicated in this appendix. The information was gathered from audited financial statements prepared by NTPC in accordance with its accounting policies, which conform to Indian generally accepted accounting principles (GAAP), and have been audited by its statutory auditors in accordance with Indian auditing standards.

36 Appendix 3

Table A3.1: Historical Financial Performance (Rs billion, unless otherwise stated)

Item

9 Months Ending 31/12/05

Fiscal 2005

Fiscal 2004

Fiscal 2003

Fiscal 2002

Income StatementRevenues 188.5 231.9 198.4 194.5 178.3 Revenue Growth (%) 8.4 16.9 20.0 9.1 (7.9) EBITDAa 46.4 66.4 49.2 57.1 50.7 Interest Incurred 7.2 11.4 10.9 9.5 7.8 Non-Operational Income 19.9 29.8 61.3 4.0 6.7 Net Income 42.5 58.1 52.6 36.1 35.4

Balance SheetCash and Equivalents 94.9 87.9 66.4 23.9 13.7 Total Net Fixed Assets n/a 322.4 287.5 262.3 238.1 Senior Long-Term Debt 179.5 170.3 153.5 130.7 93.9 Total Debt 180.8 172.6 156.2 133.8 117.6 Common Equity 460.3 417.8 355.5 315.1 286.5 Total Capital 641.1 590.4 511.7 448.9 404.1

Cash FlowCash Flow from Operations 51.7 77.4 60.5 74.9 62.7 Capital Expenditure (35.5) (53.7) (46.7) (32.9) (30.8) Financing Cost (7.8) (11.7) (10.0) (9.2) (8.9) Equity Raised 0 26.8 0 0 0Dividends (11.3) (23.4) (3.5) (11.1) (8.2) Net Debt Decrease/(Increase) (1.2) 5.1 20.0 (5.9) (16.2) Net Free Cash Flow (15.2) (28.6) (16.2) (15.2) (24.6)

Credit RatiosInterest Cover 6.4 5.8 4.5 6.0 6.5 Debt Service Cover n/a 5.0 3.8 1.3 2.7 Total Debt / EBITDA 3.9 2.6 3.2 3.3 2.3 Debt to Equity 39:61 41:59 44:56 42:58 41:59Return on Net Worth (%) 9.2 13.9 14.8 11.5 12.4( ) = negative, EBITDA = earnings before interest, taxes, depreciation and amortization.a For these purposes, EBITDA excludes non-operational income.Source: NTPC financial statements.

Appendix 3 37

1. Sales, Revenue, and Operating Profit

3. Based on the cost-plus nature of the tariff setting process and its superior operating efficiency, NTPC has consistently increased its sales and operating profit. In FY2005, sales revenue accounted for Rs231.9 billion ($5.1 billion) resulting in operating profit of Rs60.7 billion ($1.4 billion). This compares favorably with FY2004 results of sales turnover of Rs198.4 billion ($4.4 billion) and operating profit of Rs59.0 billion ($1.3 billion), indicating sales growth of 16.9% and operating profit growth of 3.0%. In the 9 months ending 31 December 2005,1 NTPC generated Rs188.5 billion in net sales and operating profit of Rs44.5 billion. This revenue is enhanced by nonoperational interest income earned on the 8.5% tripartite agreement (TPA) bonds issued by the state governments as well as nonoperational income from other long-term investments.2 NTPC produced profits after tax of Rs58.1 billion ($1.3 billion) for FY2005 and Rs52.6 billion ($1.2 billion) for FY2004. 4. Revenues are principally driven by capacity and tariffs. Tariffs are based on a cost-plus formula under which all operating costs and a 14% return on equity can be recovered. Prior to the 2004 tariff order, the rate of return on equity was 16%; this reduction will moderately reduce NTPC’s earnings in the future. While tariffs have been steadily reduced since the mid 1990s, NTPC’s aggressive capital expenditure program should boost revenues over the medium term as new capacity is commissioned. As an indication, revenue increased 16.9% in FY2005 with the commissioning of 2,000 megawatts (MW) and is expected to increase by 8.4% in FY2006. Operating margins have historically been in the mid to high 30% range, but the tightening of minimum plant operating standards (ironically as a result of NTPC’s excellent performance record) has partially reduced NTPC’s ability to earn incentive payments for plant load factors above the target threshold.

2. Liquidity and Cash Flow 5. NTPC has stable cash flow from its existing power generation operations at 23 different plants throughout India. Net cash from operations in FY2005 was Rs50.5 billion, as against Rs57.4 billion in the previous year. This reduction is due to an increase in debtors following the write back of provisions, while liabilities decreased following adjustment of advances received from customers, resulting in increased use of cash in working capital. Liquidity risks are reduced by NTPC’s significant balances of cash and cash equivalents (Rs95 billion or $2.1 billion as of 31 December 2005), and strong and stable cash flows from operations. As indicated earlier, NTPC’s cash inflow has been enhanced by interest income from the TPA bonds. This income will continue to modestly improve cash flows over the medium term. NTPC could also raise more cash, if necessary, by liquidating a portion of the bonds each year as provided for in the TPA agreements. Until now, it has elected not to sell any of the bonds. 6. Cash flow has been generally pressured by high capital expenditures, dividends, and financing costs. Capital expenditures have increased consistently from Rs25 billion in FY2001 to Rs53.7 billion in FY2005. For 9 months ending 31 December 2005, capital expenditures were Rs35.5 billion. Capital expenditures are expected to grow substantially, to be financed mostly by debt and internal cash generation per the tariff guidelines on financing.

1 Audited results for FY2006, which ended on 31 March 2006, are not yet available. 2 Interest on the TPA bonds added Rs34,854 million to operational earnings in FY2004 and Rs13,949 million in

FY2005. Because this interest is essentially recovery of the principal and surcharges on past electricity sales, it is considered here as operational income.

38 Appendix 3

7. Historically, dividends paid have been approximately 25–30% of profit after tax and have been adjusted annually based on the profit earned, future capital expenditures, cash flow situation, and financing needs. NTPC paid a Rs20.7 billion dividend (net of dividend tax) in FY2005, up from Rs3.1 billion in FY2004. The Board has taken prudent decisions with regard to recommending dividend levels to shareholders for their approval. Return on net worth was 13.9% and 14.9% in FY2005 and 2004 respectively. Finance charges have been consistent between Rs9 billion and Rs11 billion per year, but interest coverage ratios have been 5.8 times EBITDA3 (5.8x), 4.5x and 6.0x for the last 3 years. These three items—capital expenditures, dividends, and financing costs—have generally been responsible for the net cash flows in recent years. However, these outflows have not resulted in significant additional net debt in recent years having been offset by revenue growth, nonoperational income from bonds and other investments, and the proceeds in FY2005 from its public offering (a net cash inflow of Rs26.8 billion or $595.6 million).

3. Existing Capital Structure 8. NTPC's funding operations are designed to ensure the necessary financial resources are available to fund the current and proposed expansion of its generation capacity at the lowest possible funding cost. NTPC's primary source of funding traditionally has been foreign currency loans from multilateral or bilateral financial agencies. These loans were guaranteed by the Government. More recently, NTPC has undertaken foreign-currency-denominated external commercial borrowings in the form of export credits for imported equipment; issuance of Eurobonds and syndicated loans; and domestic borrowings denominated in rupees, including term loans and bonds. In the past, NTPC's debt funding has been either secured or unsecured depending on the availability of funds and the cost of borrowing. 9. NTPC has maintained low debt levels and robust interest coverage ratios since the late 1990s despite rising capital expenditures and modest cash outflows. Total debt to EBITDA was 2.6x in FY2005 and 3.2x in FY2004. For the 9 months ending 31 December 2005, the annualized rate is 2.9x. NTPC’s long-term liabilities in FY2005 were Rs170.3 billion ($3.8 billion); 28% of this debt is denominated in foreign currency. Under the current tariff order, fluctuations in exchange rates for offshore debt repayments are recoverable through the tariff. As of 31 March 2005, NTPC has secured liabilities of Rs44.4 billion ($986.8 million), and unsecured debt of Rs126.4 billion ($2.8 billion). Only 26% of its total long-term liabilities is secured and is comprised solely of rupee bonds and one loan from the World Bank.4 Unsecured debt is comprised of bank loans denominated in local currency (60%); bank loans in foreign currency, some of which are guaranteed by the Government (26%); bonds denominated in foreign currency, namely Eurobonds (7%); fixed deposits (3%); and one bond issuance denominated in local currency5 (4%). Table A3.2 demonstrates the relative magnitude between the two classes of debt:

3 EBITDA means earnings before interest, taxes, depreciation and amortization. 4 A loan of $400 million made by the World Bank in December 1993 to specifically finance construction of the Rihand

Super Thermal Power Plant is secured against these fixed assets. This loan is guaranteed by the Government of India.

5 Has since been secured as required by law.

Appendix 3 39

Table A3.2: NTPC Debt Structure (Rs million)

Item FY 2005 FY 2004 FY 2003 FY 2002 Secured debt 44,407 45,844 41,226 16,455 Unsecured debt 126,421 108,684 90,931 99,357

Source: NTPC financial statements. 10. As disclosed in the annual financial statements, contingent liabilities as of 31 March 2005 are Rs19.7 billion ($440 million) as against Rs19.5 billion in FY2004. These comprise mainly claims relating to capital works, local court cases in which residents are petitioning for enhanced land compensation payments,6 and other minor claims. External audit reports indicate that the contingent liabilities disclosed by NTPC are sufficient to cover the pending cases. C. Auditing Arrangements and Financial Management 11. NTPC’s independent auditors are appointed each year by the Comptroller and Auditor General of India (C&AG), the authority for appointment of auditors of state-owned companies per Section 619 of the Companies Act. International accounting firms are not currently permitted to practice in India. Therefore, local firms of chartered accountants undertake the audit of NTPC’s financial statements. More than one firm is required to complete the audit (five, in the case of NTPC), with each firm undertaking a specific region’s accounts to audit. This is not uncommon for large state-owned companies in India with widespread operations. Financial statements are prepared in accordance with Indian GAAP audited on an annual and semiannual basis. The draft reports are first reviewed by and discussed with the audit committee before then being submitted to the board of directors for its review and approval. 12. As a state-owned enterprise, NTPC is required to undergo an audit review by the C&AG in addition to the statutory audit conducted. As part of this review, the C&AG is required to review the company’s financial management and control system. This includes functional reviews of its corporate governance and audit committee, business risks, system of accounts and financial control, fraud risk, asset management, award and execution of contracts, internal audit, human resources, legal cases, and review of its electronic data processing and management information systems. No serious concerns were raised in the C&AG report for FY2005 that would indicate any internal control or audit risk to NTPC’s ability to properly manage its financial accounts and systems.

6 Enhanced compensation is above and beyond what has been paid under the Land Acquisition Act. As assessed by

ADB, this has no implication on compliance with ADB safeguard policies.

40 Appendix 4

INSTALLED GENERATION CAPACITY AND EXPANSION PLAN OF NTPC LIMITED (as of 31 December 2005)

Power Project Location

Installed Capacity

(MW) Fuel

10th Plan 2003–2007

(MW)

11th Plan 2008–2012

(MW) A. Northern Region1. Singrauli Uttar Pradesh 2,000 Coal2. Rihand Uttar Pradesh 2,000 Coal 1,000 3.Tanda Ambedekar Nagar 440 Coal4. Unchahar Uttar Pradesh 840 Coal 210 5. Koldam Himachal Pradesh Hydro 800 6. Loharinagpala Uttranchal Hydro 600 7. Tapovan Vishnugad Uttranchal Hydro 520 8. Lata Tapovan Uttranchal Hydro 162 Subtotal (A) 5,280 1,210 2,082

B. Western Region1. Korba Chhattisgarh 2,100 Coal2. Vindhyachal Madhya Pradesh 2,260 Coal 1,000 3. Kawas Gujarat 645 Gas 725 575 4. Jhanor Gandhar Gujarat 648 Gas 725 575 5. Sipat, Stage I and II Chattisgarh Coal 1,000 1,980 6. Bhilai (Joint Venture) Chattisgarh Coal 500 7. Integrated project Chattisgarh Coal 800 Subtotal (B) 5,653 3,450 4,430

Southern Region1. Ramagundam Andhra Pradesh 2,600 Coal 500 2. Simhadri Andhra Pradesh 1,000 Coal 500 3. Rajiv Gandhi Combined Cycle Kerala 350 Naphtha 1,950 4. Ennore (Joint Venture) Tamilnadu Coal 1,000 Subtotal (C) 3,950 1,000 2,950

Eastern Region1. Farakka West Bengal 1,600 Coal 500 2. Kahalgaon Bihar 840 Coal 1,500 3. Talcher Super Thermal Orissa 3,460 Coal 2,000 4. Barh Bihar Coal 1,980 5. Nabinagar (Joint Venture) Bihar Coal 1,000 6. North Karanpura Jharkhand Coal 1,980 7. Ramam, Stage III West Bangal Hydro 90 8. Hutung, Stage II Arunachal Pradesh Hydro 1,000 9. Kalai, Stage I and II Arunachal Pradesh Hydro 1,040 Subtotal (D) 5,900 3,500 7,590

National Capital Region1. Dadri Thermal Uttar Pradesh 1,657 Coal/Gas2. Anta Rajasthan 413 Gas3. Auraiya Uttar Pradesh 652 Gas4. Faridabad Haryana 430 Gas Subtotal (E) 3,152 Total 23,935 9,160 17,052 MW = megawatt.Source: NTPC Limited.

Appendix 5 41

DESCRIPTION OF THE PROJECTS 1. The proceeds from the proposed loan will be applied to partially finance foreign exchange expenditures for the coal-fired Kahalgaon Super Thermal Power Plant (STPP) stage II and the Sipat STPP stages I and II, both of which are currently under construction. Brief descriptions of these projects are contained here. Further information is contained in Supplementary Appendix B. A. Kahalgaon Super Thermal Power Plant, Stage II

1. Project Description 2. The Kahalgaon Stage II STPP is 1,500 megawatts (MW) in capacity, consisting of two phases being constructed concurrently: phase I for 1,000 MW (2 x 500 MW units); and phase II for 500 MW (1 x 500 MW unit). The three 500 MW steam generators are all traditional units. Total annual electricity generation from the Stage II STPP will be 10,500 gigawatts (GWh), with generated electricity supplying the northern, eastern, and western regions of India. Construction of Kahalgaon Stage II commenced in July 2003. Commissioning of Stage II units will occur over 6 months, with the first unit scheduled to come on line in November 2006. 3. The project site is located 3–4 kilometers (km) south of Kahalgaon township and 4 km west of the Ganges River in Bhagalpur district, Bihar state. The Stage II plant and all associated facilities except the water supply pipeline are being constructed within the existing Kahalgaon STPP Stage I site. The Stage II site covers 400 hectares (ha), consisting of the main plant and switchyard (96 ha), an ash dyke (296 ha), and township extension (8 ha). 4. Coal to power the Stage II plant will be mined from the Rajmahal Expansion coalfields. The total annual coal consumption of Stage II is estimated to be 9.99 million tons. Water will be sourced from the Ganges River via new pumps fitted into the Stage I pump house. Water extraction for Stage II will average 5,845 cubic meters (m3) per hour (1.62 m3/second) to meet all plant and facility requirements once the ash water recirculation system is operational. 5. An annual production of 4.1 million tons of ash is expected. High efficiency electrostatic precipitators (99.9% efficient) will trap fly ash in dry form. Ash will then be taken in buffer hoppers for onward transportation in dry form or slurrified in wetting units for pumping to ash ponds for disposal. Bottom ash will be extracted and disposed of in wet form. Different forms of liquid effluent from the plant will be collected and recycled, or treated in the central monitoring basin and discharged from the site. Treated effluent discharge will total 1,020 m3/hour when ash water recirculation occurs. Power from the plant will be evacuated via a new 400 kilovolt (kV) high voltage transmission line from Kahalgaon to Biharsharif being installed by Power Grid of India Ltd.

2. Project Economics 6. The need for the additional power generation has been identified by the Central Electricity Authority (CEA), Ministry of Power.1 CEA identified a 9.7% shortage in terms of anticipated peak and a 4.8% deficit in energy availability in the year beginning April 1998. During the same period the western region had a 21.4% shortage in terms of anticipated peak and a 5.1% deficit in energy availability. Accordingly, for the Government to fully meet electricity 1 Central Electricity Authority, Ministry of Power. 1998. 15th Electric Power Survey of India. New Delhi.

42 Appendix 5

demand by 2012 the without project scenario is not a viable option. Without the Project, industry expansion would be stifled and residential consumption of electricity limited. 7. In conducting a least-cost generation analysis for the country, CEA considered the economics of generation and transmission, losses in the system, load center requirements, grid stability, security of supply, quality of power including voltage profile, and environmental considerations including rehabilitation and resettlement (footnote 1). The most cost-effective option was determined to be coal-fired thermal power generation located near the fuel source (i.e., mine mouth). This form of generation delivers a lower cost per kWh than either gas-fired thermal or hydroelectric plants, because of the transportation cost of imported natural gas or the transmission cost of electricity produced by hydroelectric plants. 8. The Kahalgaon Stage 1 STPP site was selected as the optimum site for the additional Stage II generating units as NTPC had sufficient land to accommodate the plant without the need for land acquisition and resettlement. Other favorable site features include adequate available coal nearby (32 km away), a very reliable water source nearby, and the ability to use some Stage 1 infrastructure to service the additional units (e.g., merry-go-round, pump house, site roads, and accommodation). The site is also remote from other large-scale industrial developments. 9. In its comprehensive feasibility study, NTPC carried out an economic analysis of the expansion of the Kahalgaon Project, and has indicated an internal rate of return of 12%. The main quantifiable economic benefit of the Project will be the value of 10,500 GWh of incremental electricity generated and added to the grid. The economic unit cost of generation for each unit is Rs1.72 per kWh ($0.038 per kWh). B. Sipat Super Thermal Power Plant, Stages I and II

1. Description 10. The Sipat STPP consists of two stages that are being constructed concurrently: Stage I—1,980 MW (3 x 660 MW units); and Stage II—1,000 MW (2 x 500 MW units). Total annual electricity generation from STPP will be 20,883 GWh, with generated electricity supplying the western region of India via Seoni. Construction of Sipat stages I & II commenced simultaneously in late 2003. Stage II (2 x 500 MW) will be completed prior to Stage I, with the first and second units scheduled to be commissioned in June and December 2007. Commissioning of Stage I (3 x 660 MW) will occur over 20 months, with the first unit scheduled to come on line in April 2008. 11. The project site is located near Sipat village, Bilaspur district, Chhattisgarh state. The site covers 1,753 ha, consisting of: the main plant and switchyard (621 ha), ash dykes (632 ha), reservoir and township (257 ha), and merry-go-round rail coal transport system (243 ha). 12. Coal to power the plant will be mined from the Dipika (extension) mine block of Korba coalfield. The total coal consumption of the plant will be 2,122 tons/hour (18.59 million tons/annum). The Stage I steam generators are 660 MW “super-critical water tube, direct pulverized coal-fired, balanced draft furnace, single reheat, radiant, dry bottom type,” the first supercritical plant to be installed in India. The Stage II generators are 500 MW traditional steam technology. 13. Water will be pumped from the right bank canal that is fed by the Hasdeo Barrage, located approximately 65 km from the site. The maximum water requirement for the plant is

Appendix 5 43

estimated to be 13,400 m3/hour (3.72) with once-through ash water recirculation operating for Stage I. 14. Around 6.4 million tons of ash will be produced annually. High efficiency electrostatic precipitators (99.9% efficient) will trap fly ash in dry form. Ash will then be taken in buffer hoppers for onward transportation in dry form or slurrified in wetting units for pumping to ash ponds for disposal. Bottom ash will be extracted and disposed of in wet form. Liquid effluent from the plant will be collected and recycled, or treated in the central monitoring basin and discharged from the site. Treated effluent discharge will total 1,265 m3/hour of industrial waste and 529 m3/hour of domestic waste. Power from the plant will be evacuated via new 765 kV high voltage transmission lines to Seoni and associated 400 kV lines, being installed by Power Grid Corporation of India Ltd.

2. Project Economics 15. The need for the additional power generation was identified by CEA, Ministry of Power, in an electricity supply and demand analysis for the western region of India. The analysis projected a 4.9% deficit in power supply in 1996 and a 1% deficit in 1997. By 2003, the power supply position in the western region was a 20.3% deficit at peak periods and a 12.6% deficit in energy availability versus demand. The “without project” scenario would mean that this significant energy deficit in the western region would continue, stifling the expansion of industry and curbing residential consumption of electricity. The Project will generate 2,980 MW of power in the region. 16. In preparing its least-cost analysis for India, CEA considered the economics of generation and transmission; losses in the system; load center requirements; grid stability; security of supply; quality of power, including voltage profile; and environmental considerations, including rehabilitation and resettlement (footnote 2). The most cost-effective option was found to be coal-fired thermal power generation located near the fuel source (i.e., the mine mouth). Because of the significant transport cost savings over imported natural gas or transmission of electricity from hydropower sites in other grid regions (i.e., the northern and eastern regions), this form of power generation delivers a lower cost per kWh than either gas-fired thermal or hydroelectric plants. 17. CEA identified the general locality for the plant primarily on the basis of its proximity to the Korba coalfield. The government of Madhya Pradesh and the Madhya Pradesh State Electricity Board then suggested four alternative sites for the 3,000 MW plant (Bishrampur, Birsinghpur, Ratanpur, and Sipat). NTPC conducted a detailed analysis of these sites, based on the availability of suitable land (800 ha of barren land), distance from coal source (40 km), availability and distance from a reliable water source (65 km), road and rail access, availability of infrastructure, and environmental impact. 18. In its comprehensive feasibility study, NTPC has carried out an economic analysis of the Sipat Project and has indicated an internal rate of return of 14%. The main quantifiable economic benefit will be the value of 20,883 GWh of incremental electricity generation added to the western region grid. The economic cost of generation from STPP is about Rs1.49 per kWh ($0.033 per kWh).

44 Appendix 6

ASSESSING DEVELOPMENT EFFECTIVENESS

Concept Impact Performance Measure A. Business Performance (NTPC loan)

Financial objectives NTPC operates as a financial viable power generator during and after ADB’s loan is repaid

• Corporate business plan objectives

• ADB financial covenants (i.e., debt service cover ratio, leverage ratio, and accounts receivable) on an annual basis

• Regular annual dividends issued to all shareholders of approximately 30% of net profit after tax

Operational objectives NTPC complies with CERC

regulatory requirements • No adverse reports or

financial penalties levied by CERC

NTPC complies with

memorandum of understanding performance targets as set by the Ministry of Power (for the Government of India)a

• 4,480 MW of power capacity added to the respective regional grids from the Sipat and Kahalgaon power projects

• Gross power generation target

• Plant availability factor of a minimum of 87%

• Ratio of net profit to net worth of 10%

B. Economic Sustainability (NTPC operations)

Efficient allocation of capital to economically viable power generation projects

Within a reasonable time frame, NTPC is able to develop, construct, finance, commission, and operate new power generation facilities in India.

• Remain the lowest average cost supplier of thermal power in India

• Projects commissioned in line with Government 10th and 11th plan targets

• Projects are in compliance with federal and state regulatory requirements

• Projects create long employment opportunities (during and after construction) for local population.

Appendix 6 45

Concept Impact Performance Measure Demonstrate the implementation of more efficient methods and technology for thermal power generation

Improve the efficient use of indigenous fuel sources in power generation while reducing air emissions and greenhouse gases

• Greater use of supercritical boilers in thermal power projects in India

• Increased thermal efficiency rates

C. Private Sector Development (Impact Beyond NTPC)

Provide adequate infrastructure (e.g., power supply) for private sector enterprises to grow

Sufficient and reliable electricity required by small- and medium-sized businesses to generate growth and productive use of resources

• Sustained 6–8% per annum GDP growth rates (in line with Government targets)

• Job creation in private enterprises

Contribute to the sustainable growth and development of the power sector in India.

Catalyze other domestic and international investors to provide long-term funding to both public and private sector power generators.

• Increased future commercial funding provided to power generation companies and projects.b

Demonstrate replicable standards for corporate governance and anticorruption (beyond what is required by the Indian Companies Act)

Improved corporate governance leads to greater access to capital markets, reduced risk perception from investors

• Indian companies implementing similar governance policies as NTPCa

D. Compliance with Environmental and Social Policies

Comply with ADB’s policies on the environment (2002), involuntary resettlement (2005), and indigenous peoples (2003).

NTPC’s Sipat and Kahalgaon power projects meet ADB’s environmental and social safeguard requirements.

• NTPC’s semi-annual project construction and monitoring reports demonstrating compliance with ADB’s and the Government’s requirements.

ADB = Asian Development Bank, CERC = Central Electricity Regulatory Commission, GDP = gross domestic product, MW = megawatt, OM = Operations Manual. a May vary year to year, depending on Government decision. b A causal link will be difficult to establish and isolate. Analysis will have to rely on anecdotal evidence and market commentary.

Source: ADB estimates.

Appendix 7 46

SUMMARY ASSESSMENT OF ENVIRONMENTAL MANAGEMENT SYSTEMS OF NTPC LIMITED

A. Introduction 1. This summary assessment by ADB of NTPC Limited of India’s environmental management was conducted to measure the comprehensiveness and effectiveness of the organization’s environmental management in accordance with the internal requirements of the Asian Development Bank (ADB) for the assessment of financial intermediation loans.1 As the proposed loan is a corporate loan, it has been classified as if it was equivalent to a loan to a financial intermediary despite no financial intermediation for the projects, with NTPC ownership of the projects during construction and operation. 2. This assessment is based on NTPC’s Environment Policy and Environmental Management System (EMS)2 and the Kahalgaon Environmental Management Systems Manual3 for Stage I of the Kahalgaon Super Thermal Power Plant (STPP). B. Description of NTPC 3. NTPC Limited was incorporated as a wholly owned Government of India company in 1975 with the aim of accelerating power generation in the country. It is the largest thermal power generator in India with 23,749 megawatts (MW) of installed capacity. Current company ownership is split between the Government (89.5%) and foreign institutional investors, domestic banks, the public, and others (10.5%). C. Description of the Proposed Projects 4. The proceeds from the proposed loan are to be applied to the coal-fired Kahalgaon STPP Stage II and Sipat STPP stages I and II, both of which are currently under construction. 5. The Kahalgaon Stage II STPP is 1,500 MW in capacity, consisting of two phases being constructed concurrently: Phase I—1,000 MW (2 x 500 MW units); and Phase II—500 MW (1 x 500 MW unit). The three 500 MW steam generators are all traditional technology (i.e., not supercritical). Total annual electricity generation from the Stage II STPP will be 10,500 gigawatt-hours (GWh), with generated electricity supplying the northern, eastern and western regions of India. The project site is located 3–4 kilometers south of Kahalgaon township and 4 kilometers west of the Ganges River in Bhagalpur district, Bihar. The Stage II plant and all associated facilities, except the water supply pipeline, are being constructed on 400 hectares of the existing Kahalgaon STPP Stage I site. 6. The Sipat STPP consists of two stages being constructed concurrently: Stage I–1,980 MW (3 x 660 MW units); and Stage II–1,000 MW (2 x 500 MW units). Total annual electricity generation from the STPP will be 20,883 GWh, with generated electricity supplying the western region of India. The project site is located near Sipat village, Bilaspur district, Chhattisgarh, and covers 1,753 hectares.

1 ADB. 2003. Environmental Assessment Guidelines. Manila. 2 NTPC. 1995. NTPC’s Environment Policy and Environmental Management System. New Delhi. 3 NTPC. 2005. Kahalgaon Environmental Management Systems Manual: Issue No. 2. Kahalgaon.

Appendix 7 47

D. Overview of the Environmental Management System 7. NTPC established an EMS in 1995 at the corporate center. The corporate center was subsequently accredited under ISO 14001 and similar accreditation has been progressively obtained for each operational plant based on a separate EMS manual for each plant, prepared in accordance with ISO 14001. E. Assessment of Environmental Management Staff Capabilities 8. NTPC’s organizational structure for environmental management consists of different groups at corporate, regional, and station levels that are responsible for initiating measures to mitigate the environmental impact of power projects. The environmental groups and their relevant directorates at the corporate center are

(i) Environment Management Group (EMG), Operations Division; (ii) Environment Science Group, Research and Development Center, Operations

Division; (iii) Ash Utilization Group, Operations Division; (iv) Environmental Engineering Group, Engineering Division; (v) Resettlement and Rehabilitation Group, Personnel Division; (vi) Safety, Welfare, Horticulture, and Public Health; Personnel Division; and (vii) Center for Power Efficiency and Environment Protection.

9. The environmental groups at each station that are either directly or indirectly responsible for environmental management activities are

(i) EMG, (ii) Environment Chemistry Group, (iii) Electrostatic Precipitator, Management Group, (iv) Ash Utilization Group, (v) Resettlement and Rehabilitation Group, (vi) Occupational Health and Safety, and (vii) Horticulture.

10. Project environmental clearances prior to commencement are managed by the Environmental Engineering Group, Engineering Division, led by M.H. Rao, additional general manager, who reports to K. Prakasa Rao, executive director, under the management of Shri R.K. Jain, director (Technical). Environmental monitoring activities conducted by the corporate center are managed by the EMG, led by Ram Gopal, general manager. He reports to Chandan Roy, director (Operations) through the Engineering Division (Commercial and Resettlement and Rehabilitation). In addition to the corporate center EMG, each station has an EMG that reports to the general manager of that station. F. Overview of Environmental Policy

1. Corporate EMS 11. NTPC established the corporate center Environment Policy and Environmental Management System (EPEMS) in 1995 for the systematic management of environmental risks. This document sets out NTPC’s environment policy, institutional arrangements, corporate

Appendix 7 48

environmental concerns, relative environmental standards, and monitoring procedures. The corporate center was ISO 14001 accredited in 2001. 12. NTPC’s environment policy objectives are to

(i) achieve and maintain a leader’s role in environmental management in the power sector in India,

(ii) keep in view the various environmental requirements in all its business decisions, (iii) continuously adopt ways and means for environment protection and environment

improvement around its business units, (iv) adopt sound environment management practices, and (v) aim at full compliance with the statutory norms/requirements.

13. The main environmental concerns identified in the EPEMS relate to the production of emissions, effluents, and solid wastes. The EPEMS also gives a brief overview of NTPC’s approach to environmental management throughout the project cycle and upgrading and retrofitting initiatives. The corporate EPEMS summarizes Government requirements for thermal power plant stack heights, emission standards, and national ambient air quality standards.

2. Corporate Environmental Management and Ash Utilization Group Environmental Policy

14. The environment policy of the Corporate Environment Management and Ash Utilization Division, as adopted in March 2003 under the EMS, includes

(i) continually improving environmental performance of all NTPC power stations in pursuance of powering India’s growth;

(ii) continually monitoring all stations for pollution prevention and environmental protection;

(iii) conserving natural resources including land by utilizing more ash generated by plants;

(iv) assisting stations to comply with relevant environmental legislation and regulations;

(v) promoting environmental awareness among NTPC employees; and (vi) creating awareness of ash utilization and its environmental benefits among

engineers, builders, architects, potential entrepreneurs, NTPC personnel and the public.

3. Plant EMS

15. Each power station has a plant-specific EMS manual and is certified under ISO 14001. The EMS manual for the operating 840 MW Kahalgaon Stage I STPP was reviewed as an indicative system. This manual, dated 1 May 2005, addresses all essential components of an EMS, including the plant-specific environment policy, planning procedures, implementation and operation, checking, corrective action, and management review.

4. Description of Environmental Performance Monitoring and Reporting System

16. Environmental performance monitoring is undertaken weekly at each plant, with monthly reports sent to each relevant state pollution control board. The corporate center and each plant

Appendix 7 49

is regularly audited under the requirements of ISO 14001 certification. Internal audits are conducted every quarter to verify performance, with external surveillance audits conducted every year to monitor EMS compliance and every 3 years for ISO 14001 reaccreditation. 17. Ongoing monitoring of parameters relating to the main project environmental impacts at each plant is conducted to verify compliance with environmental clearance conditions, with meteorological conditions also monitored to assess the dispersion of plant emissions. The main parameters monitored are ambient air quality and emissions (suspended particulate matter, sulfur dioxide and nitrogen oxides); and effluents (pH, total suspended solids, biochemical oxygen demand, chemical oxygen demand, total dissolved solids, chlorides, sulphates, total dissolved phosphates, oil and grease, heavy metals). Monitoring procedures are in accordance with the standards published by the Bureau of India Standards, Central Pollution Control Board and other relevant authorities, with the parameters required by statutory bodies generally analyzed as per methods of the Bureau of India Standards. 18. NTPC operates laboratories at the station level and at the corporate research and development center to conduct routine measurements and advanced testing and research, with some environmental laboratories approved by state pollution control boards. 19. Quarterly environmental auditing is undertaken at each station to ensure compliance with consent conditions and relevant laws and regulations. Auditing consists of the following:

(i) Preparatory activities. Pre visit information is obtained from the power station and reviewed by the audit team consisting of 4–5 team members. The main areas for consideration are identified and specific tasks are allocated to team members.

(ii) On-site visit. The audit team conducts an on-site inspection of activities and

facilities, visits the surrounding neighborhood, and discusses issues with staff. Discussions are usually conducted as per a protocol that incorporates a flexible checklist. A draft audit report describing findings and recommendations is prepared during the visit and presented to senior management at the conclusion of the audit.

(iii) Post visit activities. The full audit report is prepared within 3–4 weeks of the on-

site visit and presented to site management. Site management then develops a plan of action as soon as possible to address the audit findings and recommendations.

(iv) Management reporting. Each plant monitors emissions, ambient air quality,

effluent discharge, and ash pond effluents; and reports this data to the general manager of the station and the corporate center EMG. Monthly exception reports are submitted to management detailing any nonconformance. Decisions are then taken to rectify nonconformance with corrective actions, whose implementation are periodically monitored.

G. Environmental Assessment and Review Procedures for Projects 20. As it owns and operates its projects, NTPC will not onlend loan funds for subprojects as in a traditional FI project. The Kahalgaon Stage II and Sipat stages I & II STPPs have been

Appendix 7 50

assessed and approved in accordance with Government and relevant state government requirements. 21. The Government and ADB pollution prevention standards for new coal-fired thermal power plants differ in a number of aspects. The ADB standards for plant emissions, ambient air quality, and effluent, as set out in the World Bank’s Pollution Prevention and Abatement Handbook,4 are generally more stringent than the Government standards. ADB has reviewed the project environmental impact assessments and approvals, and where the ADB pollution standard is more stringent, NTPC has revised the proposed mitigation measures to achieve the ADB standard for the Kahalgaon Stage II and Sipat STPPs. In the event that NTPC requests ADB funds to be applied to other NTPC projects, NTPC’s environmental assessment and review procedures will be followed and supplemented as necessary to comply with ADB safeguard policies. H. Recommendations on Environmental Management Systems

1. Environmental Management System 22. The International Organization for Standardization (ISO) released the ISO 14001 standard in 1997 to provide a best practice specification for the implementation of an EMS. The 1995 corporate center EPEMS was not written in accordance with ISO 14001 requirements, although the corporate center was accredited under ISO 14001 in 2001. The EPEMS provides the overall framework for environmental management, but it does not contain the essential components of an EMS. In addition, ISO 14001 requires “continual improvement,” with an EMS being a living document; but the EPEMS has not been updated since 1995, therefore some sections are well out of date. 23. In comparison, the Kahalgaon EMS Manual is a comprehensive plan prepared in accordance with ISO 14001 requirements. It provides a clear and coordinated system for environmental management during plant operation; defining environment policy, responsibilities, and procedures. The NTPC corporate center EPEMS should be updated in line with ISO 14001 requirements, and coordinated with the ISO 14001-compliant plant EMS manuals.

2. Environmental Assessment 24. NTPC’s environmental assessment and review procedures are in accordance with central and state government requirements as evidenced by the granting of development approval for the Kahalgaon Stage II and Sipat STPPs. Despite this, documented assessment and review procedures were not available from NTPC, indicating that they have yet to be formalized as part of the NTPC EMS. NTPC’s environmental assessment and review procedures should be formalized as a supporting guideline for the EPEMS.

3. Plant Environmental Management Plans 25. It is recommended that NTPC prepares a comprehensive template environmental management plan (EMP) for future coal-fired thermal power plants to provide consistent construction and operation management measures for all new plants. The EMP should describe the main plant environmental management measures, management responsibilities, and

4 World Bank. 1998. Pollution Prevention and Abatement Handbook. Washington, DC.

Appendix 7 51

implementation schedule common to most projects, from which plant-specific EMPs would be developed. I. Summary 26. None of the recommended actions to improve NTPC’s EMS and related procedures are essential prior to ADB providing financing for NTPC to be applied to the Kahalgaon Stage II and Sipat STPPs. Revision of the EPEMS will improve NTPC’s environmental management, but the key component of the overall EMS is the ISO 14001-compliant plant EMS manual for each plant. These manuals establish a comprehensive EMS for plant operation, effectively dealing with the main project impacts. Formalization of NTPC’s environmental assessment and review procedures, and drafting of a template EMP for coal-fired thermal plants, will mainly assist in the formulation and management of new projects to be constructed, therefore they should be presented to NTPC as recommendations, not precursors to loan processing.