ASIAN DEVELOPMENT BANK RRP: IND 29473

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON PROPOSED LOANS

TO

INDIA

FOR THE

MADHYA PRADESH POWER SECTOR DEVELOPMENT PROGRAM

November 2001

CURRENCY EQUIVALENTS(as of 1 November 2001)

Currency Unit − Indian Rupee (Re/Rs) Re1.00 = $0.0208

$1.00 = Rs47.98

In this report, an exchange rate of $1.00 = Rs0.47 was used forcalculation purposes. This was the prevailing rate during appraisal.

ABBREVIATIONS

ADB – Asian Development BankBMU – benefit monitoring unitCSEB – Chhattisgarh State Electricity BoardCIDA – Canadian International Development AgencyDFID – Department for International DevelopmentEISP – Energy Infrastructure Services ProjectERC – Electricity Regulatory CommissionHP – horsepowerHT – high tensionIEE – initial environmental examinationLIBOR – London interbank offered rateLT – low tensionMOU – memorandum of understandingMP – Madhya PradeshMPEB – Madhya Pradesh Electricity BoardMPG – Madhya Pradesh governmentMPPGCL – Madhya Pradesh Power Generation Company

LimitedMPPTCL – Madhya Pradesh Power Transmission Company

LimitedMPSEB – Madhya Pradesh State Electricity BoardMPSERC – Madhya Pradesh State Electricity Regulatory

CommissionNHPC – National Hydroelectric Power CorporationNTPC – National Thermal Power CorporationPFC – Power Finance CorporationPMU – project management unitPRA – participatory rapid appraisalSC/ST – scheduled caste/scheduled tribeSEB – State Electricity BoardSPU – strategic policy unitTA – technical assistanceT&D – transmission and distribution

NOTES

(i) The fiscal year (FY) of the Government ends on 31 March. FY before a calendaryear denotes the year in which the FY ends. Thus, FY2003 will start on 1 April2002 and end on 31 March 2003.

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

WEIGHTS AND MEASURES

GWh – gigawatt-hour (1,000 megawatt-hours)kV – kilovolt (1,000 watts)kWh – kilowatt-hour (1,000 watt-hours)MW – megawatt (1,000 kilowatts)W – watt (unit of active power)

CONTENTS Page

LOAN AND PROGRAM SUMMARY ii

MAP viii

I. THE PROPOSAL 1

II. INTRODUCTION 1

III. THE SECTOR 2A. Macroeconomic Context 2B. Sector Description and Recent Performance 4C. Constraints and Issues 7D. State Government Objectives and Strategy 9E. External Assistance to the Sector 10F. ADB’s Operations and Strategy in the Sector 11

IV. THE SECTOR DEVELOPMENT PROGRAM 12A. Rationale 12B. Objectives and Scope 13C. Policy Framework and Actions 14D. The Investment Project 18E. Social and Environmental Measures 20

V. THE LOANS 22A. The Policy Loan 22B. The Investment Loan 25

VI. BENEFITS AND RISKS 32A. Expected Impacts 32B. Risks and Safeguards 35

VII. ASSURANCES 36A. Specific Assurances 36B. Conditions for Loan Effectiveness 38

VIII. RECOMMENDATION 39

APPENDIXES 40

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LOAN AND PROGRAM SUMMARY

Borrower India

The Proposal A sector development program (SDP) comprising a policy loan of$150 million and an investment loan of $200 million, for a total of$350 million from ordinary capital resources of the AsianDevelopment Bank (ADB) to support restructuring of the MadhyaPradesh Power Sector.

Rationale The SDP is designed to support the creation of an efficient, self-sustaining, and competitive power sector to provide sufficientquantity and quality of power to support the economic and socialdevelopment of Madhya Pradesh (MP). Given the complexity ofsector reforms, implementation will follow a phased approach overa period of time. The SDP supports the first stage of reforms thatlay the foundation for change and create an enabling environmentfor future private sector involvement through independent sectorregulation; institutional and organizational actions for improvedsector governance; establishment and gradual operationalizationof new sector companies; decisions about reconfigurating thedistribution segment, and managerial, financial, and operationalefficiency improvements in ongoing operations. These policyinitiatives will be supported by targeted physical investments toreduce system losses, improve operational and financialperformance, and increase the delivery capacity of the powersector to reap the benefits offered by sector restructuring.

The SDP seeks to assist in improving public and private resourceallocation in MP by increasing the operational efficiencies anddelivery capacity, and progressively reducing the demands on thestate budget for the power sector that have resulted in suboptimalallocation of public funds at the expense of other stateresponsibilities like education and health. This requiressimultaneous intervention at the policy level to provide thenecessary legal and institutional framework, and at the projectlevel to support critical investment components to ensure thesuccess of the reforms. Therefore, a mixed-modality SDP seekingto establish appropriate policies as well as supporting projectinvestments is considered the best instrument for supportingpower sector restructuring initiatives.

Classification Thematic: Economic GrowthGood Governance

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The Sector Development Program

Objectives and Scope The immediate objectives of the policy component (the Program)of the SDP are to (i) improve the policy environment andgovernance of the sector; (ii) initiate the establishment of acommercial and competitive business environment to promoteefficiency gains and loss reduction; (iii) improve the financialviability of the Madhya Pradesh State Electricity Board (MPSEB)through financial restructuring; and (iv) introduce a computerizedinformation and revenue management system.

Policy Frameworkand Actions The policy framework includes support for several actions.

The MP Vidyut Sudhar Adhiniyam, 2000 (the Reform Act), broughtinto force on 3 July 2001, is the most progressive in India to dateand includes provision for (i) restructuring MPSEB, (ii) mandatorymetering of all consumers; (iii) rationalizing tariffs so that allclasses of consumers will pay at least 75 percent of cost of supply(progressively phased over 5 years); (iv) allocating subsidies fromthe MP government (MPG) budget before subsidizing anycategory of consumers; (v) creating the MP State ElectricityRegulatory Commission (MPSERC); and (vi) referring disputeresolution between MPG and the MPSERC to the CentralElectricity Regulatory Commission rather than to the courts.

The existing MP Electricity Regulatory Commission was convertedinto the first MPSERC following the coming into force of theReform Act.

The generation, transmission, and distribution functions of MPSEBwill be corporatized and commercialized.

The MPSEB tariff structure will be rationalized and free powersupply in the state will be restricted.

The sector will undergo financial restructuring.

The Investment Project The investment component (the Project) of the SDP comprises sixcomponents:

A: 33 kilovolt (kV) and 11kV system improvements in Bhopal,Gwalior, Indore, Jabalpur, Khargone, Mandsaur, and Ujjain areas;

B: Conversion of selected low-voltage feeders supplyingagricultural pumps in selected divisions in Mandsaur andUjjain districts to 11kV operation;

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C: Reinforcement and augmentation of the transmission systemfacilities in selected priority areas of MP;

D: Setting up of a computerized information and revenuemanagement system;

E: Provision of three-phase meters; and

F: Consulting services for the initial phase of projectimplementation.

Cost Estimates The Project is estimated to cost $318.9 million equivalent,comprising $200.0 million in foreign exchange and $118.9 millionequivalent in local currency costs.

($ million)Financing Plan Source Foreign

Exchan geLocal

CurrencyTotalCost

Percent

ADB 200.0 0.0 200.0 62.7

MPSEB/MPG

0.0 118.9 118.9 37.3

Total 200.0 118.9 318.9 100.0

ADB = Asian Development Bank; MPG = Madhya Pradesh government,MPSEB = Madhya Pradesh State Electricity Board.

Environmental and Social Measures The Project is classified as Category B. An initial environmental

examination was undertaken and the summary is attached as acore appendix.

The poverty impact assessment for the SDP indicates that themandatory metering under the Reform Act is more beneficial forlow-income and poor households than the flat rate currentlycharged, since the per-unit charge is higher on a flat rate basis.Under the SDP, access to power connections by consumers livingbelow the poverty line will be facilitated through a scheme ofamortizing the upfront connection charges and associated feesover 12 months. Improved technical and nontechnical efficiencywill benefit all categories of consumers by improving supplyquality.

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The Policy Loan

Loan Amountand Terms A loan of $150 million from ADB’s ordinary capital resources will

be provided under ADB’s LIBOR-based lending facility. The loanwill have a 15-year term, including a grace period of 3 years, aninterest rate to be determined in accordance with ADB’s LIBOR-based lending facility, including commitment charges and front-end fee. The Government will bear the foreign exchange risk onthe loan in accordance with its policy.

Program Periodand Tranching The period of the policy loan is December 2001 to June 2003. The

loan will be released in three tranches:

Tranche 1 of $65 million when (i) the Reform Act is in force;(ii) MPSERC awards the first tariff order; (iii) MP PowerGeneration Company Ltd. (MPPGCL), MP Power TransmissionCompany Ltd. (MPPTCL), and MP Power Distribution CompanyLtd. (MPPDCL) are incorporated and registered under the IndianCompanies Act, 1956; (iv) MPG and MPSEB agree on all thearrangements, with all outstanding dues paid, in accordance withthe memorandum of understanding; and (v) MPG issues an orderallowing MPSEB to disconnect all defaulting municipalities.

Tranche 2 of $40 million when (i) not less than 7,500 energy auditmeters are installed and operationalized; (ii) boards of directors forthe MPPGCL and MPPTCL are established with the majority ofmembers recruited in an open and transparent basis from outsidegovernment services; (iii) distribution reconfiguration is decided byMPG; (iv) MPG pays Rs2,000 million of total outstanding dues asof 31 March 2001 owed by municipalities to MPSEB; (v) asatisfactory debt restructuring plan of MPSEB is submitted; and(vi) second tariff filing is done by MPSEB before MPSERC.

Tranche 3 of $45 million when (i) all new distribution companiesare incorporated and registered under the Indian Companies Act;(ii) transfer scheme(s) are finalized; (iii) MPSEB assets aretransferred to MPPGCL, MPPTCL, and at least one of the newlyincorporated distribution companies, in accordance with thetransfer scheme(s); (iv) MPG pays Rs2,423 million of totaloutstanding dues as of 31 March 2001 owed by municipalities toMPSEB; and (v) third tariff filing is done by MPSEB beforeMPSERC.

Executing Agencies The Executing Agencies will be the Finance Department and theEnergy Department of MPG.

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Procurement The proceeds of the policy loan will finance the foreign exchangecosts (excluding local taxes and duties) of eligible items producedin and procured from ADB’s member countries.

Counterpart Funds Counterpart funds to be generated by the policy loan will betransferred from the Government to MPG under the normalarrangements for the transfer of external assistance and will betreated as an additionality to the Government’s transfers allocatedannually to MPG. Counterpart funds will be used by MPG, inaccordance with arrangements satisfactory to ADB, to support thefinancial restructuring of MPSEB and adjustment costs associatedwith the SDP, including (i) payment of outstanding municipalitiesand other local bodies dues, (ii) rationalization of electricity duty,(iii) set-off on dues of market borrowing of MPSEB to MPG,(iv) set-off of cross-liabilities between MPG and MPSEB, and(v) payment of debt obligations of MPSEB.

The Investment Loan

Loan Amountand Terms A loan of $200 million from ADB’s ordinary capital resources will

be provided under ADB’s LIBOR-based lending facility. Theinvestment loan will have a 20-year term, including a grace periodof 5 years, an interest rate determined in accordance with ADB’sLIBOR-based lending facility, a commitment charge of 0.75percent per annum, and a front-end fee of 1.0 percent. The loanproceeds will be transferred by the Government to MPG under itsnormal transfer arrangements. MPG will relend the loan proceedsto MPSEB at an interest rate of 12 percent with a term of 20years, including a grace period of 5 years. The Government willbear the foreign exchange risk on the loan in accordance with itspolicy.

ImplementationArrangements andExecuting Agency The Project will be executed by MPSEB (or its successor entities

with the prior approval of ADB). MPSEB, a statutory organizationcreated under the Government’s Electricity (Supply) Act 1948, ismanaged by a board appointed by MPG. Its successor entities willbe companies registered under the Companies’ Act, 1956 of theBorrower.

Procurement and Consulting Services Procurement of goods and services will be carried out in

accordance with ADB’s Guidelines for Procurement. Internationalconsultants will provide support for Project implementation and berecruited in accordance with ADB’s Guidelines on the Use ofConsultants. For implementation of component D, as also for

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benefit monitoring of the SDP, MPSEB will engage consultantsusing its own funds and procedures.

Time Frame Project implementation will commence in January 2002 and becompleted in December 2005. Disbursement under the projectloan will continue until June 2006.

Risks and Safeguards The major risks of the SDP are (i) regulatory risk, (ii) financialsituation of MPSEB, (iii) lack of adequate technical assistancesupport for outstanding analytical work, and (iv) operationalineffectiveness. These will be mitigated by (i) providingcomprehensive institutional strengthening and training forMPSERC, (ii) initiating comprehensive financial restructuring ofMPSEB with support from all stakeholders, (iii) solicitingcofinancing from bilateral assistance agencies and ADB providingadditional technical assistance funds, and (iv) changing andstrengthening organizational and management structures andpractices and effective follow-up mechanisms.

I. THE PROPOSAL

1. I submit for your approval the following Report and Recommendation on proposedassistance to India for the Madhya Pradesh Power Sector Development Program, that includes(i) a policy loan, and (ii) an investment loan.

II. INTRODUCTION

2. India’s economy has been growing by about 6 percent annually over the last six years.1

The country’s economic performance, however, does not necessarily imply that the economy isfully utilizing its growth potential. The slowing of economic reforms since the mid-1990shighlighted the major problems affecting the economy including severe infrastructurebottlenecks, widening fiscal deficits, poverty, and illiteracy. In particular, the deteriorating fiscalhealth of the central and state governments is significantly undermining the long-term growthpotential of the economy. Insufficient investments in physical infrastructure, both public andprivate, prevent the economy from reaping the benefits that are offered by market reforms andliberalization. This is particularly worrisome as empirical evidence on India strongly suggeststhat economic growth is the most effective path to sustained poverty reduction.

3. Under the Indian federal structure the states are responsible for a large number of vitalactivities, including infrastructure facilities, education, health, and law enforcement.Consequently, the fiscal health of the states is crucial for delivering these public services. Whilea large part of the states’ fiscal deficit is due to financial mismanagement and the priorityservicing of political interests, the inability of the states to recover the costs of their services is afurther reason for their poor fiscal health. For example, in the power sector, the inadequateaverage tariff base necessitates high budgetary subsidies to power utilities. As one result of thefiscal crunch, the electricity generation expansion target set for the Eighth Five-Year Plan(1992/97) fell short by 50 percent due primarily to inadequate investment at the state level. If notremedied, the unavailability of sufficient power will be the single most important constraint toeconomic development in the coming years and will thwart efforts to attract domestic andforeign investment.

4. Recognizing the importance of improving policymaking at the state level to enhancestructural reforms in India, in 1996 the Asian Development Bank (ADB) adopted a new strategyfor its operations in India directly targeting a portion of its assistance to selected states that havedemonstrated the political will to (i) undertake structural reforms in their macrofinances;(ii) improve their public resources management, (iii) restructure public sector enterprises; and(iv) undertake sectoral reforms. Gujarat was the first state chosen for this type of holistic support.ADB approved the first loan in December 1996.2 Based on the willingness and commitment ofthe Madhya Pradesh government (MPG) to reforms, the state of Madhya Pradesh (MP) wasincluded as the second focal state. Kerala was included as the third focal state and policydialogue has been initiated. The MPG and ADB agreed on a program to enhance resourceallocation to social sectors, improve fiscal capabilities, reform the public enterprise sector, andpromote an enabling environment for private sector participation in supporting infrastructure.The reform program was supported by the approval of the MP Public Resource ManagementProgram loan,3 which initiated power sector reform with ADB agreeing, in principal, to provide

1 CER: IND 200019: Country Economic Review , India, December 2000.2 Loan 1506-IND: Gujarat Public Sector Resource Management Program, for $250 million, approved on

18 December 1996.3 Loan 1717-IND: Madhya Pradesh Public Resource Management Program, for $250 million, approved on

14 December 1999.

2

targeted assistance for power sector development. The Power Sector Development Program(SDP) is included in the 2001 country program for India. The Fact-Finding Mission andAppraisal Mission were fielded during March-April 2001 and August-September 2001.4 Thisreport is based on the agreements reached during the missions.

III. THE SECTOR

A. Macroeconomic Context

1. Recent Macroeconomic Performance

5. In terms of area, MP was the largest state in India and fourth in population until it wasbifurcated into two states, MP and Chhattisgarh, on 1 November 2000, on the basis of the MPReorganization Act, 2000. Its rich deposits of coal, iron ore, limestone, and forest resourceswere the prime sources of industrial growth in the prebifurcated state. The major resource-tiedindustries were steel, cement, and newsprint. During the 1980’s, the state had three primaryattractions for many industrial units not based on local resources, such as chemical, electricalappliances, yarns, and garments: abundant land, no labor problems, and uninterrupted powersupply. Thus the state economy has shown robust growth averaging 4.4 percent since 1980/81,accelerating to 5 percent during 1990/96. The contribution of the primary sector in statedomestic product declined gradually over time and the contribution of services and industry roseconsistently. For example, the share of the primary sector declined from 43.4 percent in 1993/94to 39.6 percent in 1998/99. Similarly, the share of manufacturing and construction rose from21.4 percent to 23.0 percent during the same period.

6. However, the industrial growth situation has changed noticeably since 1995/96.Countrywide industrial recession and acute power shortages (almost 14 percent of the peakdemand in 1995/96) led to a sharp decline in industrial growth in MP.5 The growth rate of realnet state domestic product of registered manufacturing declined sharply from 7.1 percent in1994/95 to 4.4 percent in 1995/96, and 1.1 percent in 1996/97. Many industrial units wereforced to shutdown leading to large-scale unemployment. For example, the ferro alloys industrymade its debut in the state in 1989. The number of units rose to 22 by 1995. Power shortagescoupled with steep hikes in the power tariff after 1995 and strong market pressure due to thenew open import policy led to the closure of almost all of the 22 units as of 1999;6 and theirpower consumption reduced from 424 million units in 1995/96 to 17.34 in 1999/2000. Totalinvestment in these plants was about Rs2 billion and 20,000 workers were involved directly orindirectly. Similarly many designated economic growth centers in MP failed to promoteindustrialization due to the lack of proper infrastructure, such as roads, water, and street lightsetc. A recent small survey of constraints faced by small-and medium-sized enterprises in MP7

identifies lack of infrastructure, in particular shortage of electricity and its quality, followed by thepoor state of the roads.

4 The project team consisted of D. Graczyk, Senior Energy Sector Specialist and Mission Leader; IWEN; B. M.Karunaratne, Senior Project Engineer, IWEN; P. Ghosh, Senior Environment Specialist, ENVD; K. GerhaeusserSenior Programs Officer, PW2; S. Chander, Senior Project Engineer, IWEN; Y. L. Feng, Senior EnvironmentSpecialist, ENVD; M. Mitra, Senior Social Specialist, SOCD; T. Kimura, Energy Sector Specialist, IWEN; C. Litwin,Poverty Reduction Specialist, IWEN; V. S. Rekha, Counsel, OGC; and H. Mukhopadhyay, Macroeconomist, INRM.

5 The reasons for postreform industrial recession in India are still being debated. However, high lending rates, creditsqueeze, and political uncertainties are some of the important factors.

6 National Institute of Public Finance and Policy. 1999. Fiscal Industrial Incentives of the Government of MadhyaPradesh: Costs and Benefits. New Delhi.

7 TA 3338-IND: Capacity Building for Public Enterprises Reform and Social Safety Net in Madhya Pradesh, for$750,000, approved on 14 December 1999.

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7. MP is one of the poorest states in India. In 1998/99, the per capita annual income wasRs7,350 (in constant prices) as compared with Rs9,739 at the all-India level. The percentage ofthe population living below the poverty line was 37.4 in 1999/2000, much higher than the all-India figure of 26.1 percent.

8. The new MP comprises roughly two thirds of the state before bifurcation, in terms of landarea and population, is industrially more diversified with a higher proportion of light andmanufacturing industries, and will have a higher per-capita income than the undivided state.However, the new MP has lost most of its natural and mineral resources to Chhattisgarh, andwill need to adopt a new strategy for stimulating industrial growth. Therefore, future plans forindustrialization in the new MP should primarily focus on promoting industries that are notresource-tied. States in India are competing to attract these industries. As decided by thecouncil of state finance ministers, all fiscal incentives for industrialization were ended byApril 2001. Thus, future industrialization will critically depend on adequate infrastructure facilitiesincluding power and good roads, as well as adequate education and health facilities to attractgrowth industries and their employees.

2. Macroeconomic Linkages of Power Sector Reform

9. Delays in reforms and the MPG policy of free power supply to a large proportion of itsagricultural and domestic consumers (para. 62) has brought the MP Electricity Board (MPEB)(para. 20) into a severe financial crisis. As a result, MPEB is unable to provide adequate power,which is the most important ingredient of growth in the state. Also, the state exchequer is losingpotential revenues that could have been mobilized from a financially strong electricity board. Forexample, in fiscal year (FY) 2001 MPEB’s dues from interest on MPG loans (Rs3.33 billion) andfor electricity duty (Rs3.31 billion), which MPEB collects on behalf of MPG, is estimated to beequivalent to almost 8 percent of the state’s own revenue (both tax and nontax), and 0.8 percentof the net state domestic product. However, as a result of misdirected power policies and anoncommercial tariff structure, MPG provides annual budgetary support for MPEB such as therural electrification subsidy, subsidy for free power supply, and fresh loans. And althoughMPEB’s dues are adjusted entirely against budgetary support, MPG’s unpaid subsidy to MPEBamounted to Rs23.3 billion as of March 2001. In 1996, MPG adjusted Rs7.9 billion by writing offits loans to MPEB, and in FY 1998 converted another Rs7 billion of its loans to equity to clearthe backlog of subsidy payment from the state budget to MPEB.

10. Although funds are not fully fungible, fiscal imbalances, budgetary allocations, and thefinancial deterioration of MPSEB are clearly linked, as state budget support to the power sectorcrowds out public expenditure and investments in alternative sectors more productive forpoverty reduction. The cash shortfall of MPSEB under a no-reform scenario is estimated atRs16.7 billion for FY2002. In terms of evaluating the opportunity cost of MPSEB’s cashrequirements, the cash shortfall translates into 32 percent of total social sector spending,including capital investments. In view of the state fiscal imbalances, the Government has beencompelled to finance budgetary support for the power sector through the banking sector. Thecash requirement of MPSEB would amount to 43 percent of the gross fiscal deficit. Furtherdeterioration of MPSEB would increase resource requirements from the banking sector andaffect the ability of the sector to lend for private sector investments, which are more productivefor economic growth. The macroeconomic linkages of the power sector reform are summarizedin Figure 1.

11. MPG support for the power sector is targeted primarily at operational subsidies insteadof supporting investments in system expansion to improve quantity, quality, and reliability of

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supply or at least for adequate maintenance of existing assets. The electrification ratio forhouseholds in MP is about 42 percent, with less than 29 percent electrified in rural areas. Effortsby the state to increase private sector investment in power generation were undermined by theMPEB’s low credit rating. Recognizing its inability to fund the additional investments required inthe power sector, MPG has decided to reorganize the power sector to increase the self-financing capability with the objective of increasing the ability to allocate budget resources tosocial sectors.

Figure 1: Macroeconomic Linkages of Power Sector Reform

B. Sector Description and Recent Performance

1. Organization

12. India consists of 28 states8 and 7 union territories with a total population of over 1 billion.The organization of the power sector is determined by the country’s federal structure. All majorissues affecting the power sector require concurrent action by the central and stategovernments.

13. The central Government’s Ministry of Power provides overall guidance to the sectorthrough the Central Electricity Authority (CEA). The Government owns central power utilitiessuch as the National Thermal Power Corporation (NTPC), National Hydroelectric Power

8 Three new states, Chhattisgarh, Jharkhand, and Uttaranchal, were created in November 2000 through thebifurcation of Madhya Pradesh, Bihar, and Uttar Pradesh states, respectively.

Fiscal reliefto the stategovernment

Benefits to thereal sector

Higherrevenuegrowth

Higheremployment

Reduction inPoverty

Stabledemand for

mass-consumption

items

Higherexpenditure

on socialsectors

Highercapital

expenditure

Power Sector Reform

Increasedcredit available

for privatesector

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Corporation (NHPC), Nuclear Power Corporation and the Powergrid Corporation of India(Powergrid), which are engaged in generation and interstate power transmission. The RuralElectrification Corporation and the Power Finance Corporation (PFC) are Government-ownedand dedicated to financing power sector activities. The Power Trading Corporation was recentlyestablished to be responsible for power trading for large independent power producers targetedto multistate purchases.

14. State governments control the rest of the sector through 17 state electricity boards(SEBs) and 12 electricity departments, which provide distribution facilities and set retail tariffswithin a state, and share responsibility with the central power sector agencies for powergeneration and transmission. The central agencies own and operate 32 percent of the country’stotal generation, while the SEBs and electricity departments have 64 percent of the total. Inaddition, five private utilities in urban agglomerations have a 4 percent share in powergeneration.

15. In 1998, the Electricity Regulatory Commission (ERC) Act was passed by the IndianParliament and in the same year the Central Electricity Regulatory Commission (CERC) wasestablished. The ERC Act gives CERC full autonomy to regulate central power utilities and toset bulk tariffs. The ERC Act also encourages the states to establish state electricity regulatorycommissions with full authority for state-level power utilities.

2. State Electricity Boards

16. The Indian Electricity Act of 1910 and the Electricity (Supply) Act of 1948 provide thelegal basis for the establishment and operation of SEBs. SEBs are typically vertically integratedentities owned by their respective state governments. While they are nominally independentfrom the state governments, their commercial and financial operations are subject to substantialintervention by these governments, in particular for tariff setting, metering policies, andelectrification targets. Most SEBs are ordered to provide free or highly subsidized power to theagriculture sector and to a substantial portion of domestic consumers. Continuous politicizationof the sector combined with a lack of commercial culture and accountability have resulted innegative internal cash generation by SEBs, impeded expansion of the power system, andrestrained adequate maintenance and rehabilitation of existing assets. As a result, the demand-supply gap has widened, and the quality of power supply has deteriorated in almost all parts ofthe country.

17. Recognizing the need to separate social obligations from commercial imperatives, somestates initiated power sector reforms in the mid-1990s and passed their own power sectorreform bills to provide a legal basis for SEB reorganization. The states that have reorganized, orare in the process of reorganizing, their power sectors are Orissa (1996), Haryana (1998),Andhra Pradesh (1999), Karnataka (1999), MP (2000), Rajasthan (2000), Uttar Pradesh (2000),Delhi (2001), and Gujarat (2001). The major objective of the state power sector reform is toincrease the sector’s self-generation of funds and to reduce its reliance on budget transfers fromthe state’s budget. Although each state has adopted a unique model of power reform, all modelsreflect in one way or the other the desire to distance the government from power sectoroperations.

3. Central Power Utilities

18. Until 1972, the SEBs were almost solely responsible for developing power generationand transmission within their states, but were unable to meet the rapidly increasing demand forelectricity. To improve the efficiency of generation, three central sector agencies — NTPC,

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NHPC, and Nuclear Power Corporation — were established in 1975 to generate bulk power forsale to SEBs. In 1989, Powergrid was established as a transmission and dispatch company byamalgamating the transmission and dispatch assets of all central power sector agencies. Inaddition to these wholly owned companies, the Government also has shares in special-purposegenerating companies.

19. The central agencies, including NTPC, NHPC, and Powergrid, are seriously affected bythe poor financial health of most SEBs, as was evidenced several times in the past whenexcessive accounts receivable from SEBs seriously impaired the central agencies’ financialliquidity. To resolve this problem, NTPC has, in addition to restricting supply and obtainingGovernment appropriation to settle SEB debts, even resorted to taking over the SEB generationfacilities in settlement of accounts receivable.9 ADB’s two loans to Powergrid,10 restrictinvestments to SEBs that have a satisfactory payment record with Powergrid and makeprovisions for Powergrid to suspend power supply to delinquent SEBs.

4. Madhya Pradesh Power Sector

20. The MP power sector was operated by a vertically integrated monopoly, MPEB.Following the bifurcation of the state into MP and Chhattisgarh, in pursuance of subsection (4)of section 58 of the MP Reorganization Act, 2000, MPEB was succeeded by the MP StateElectricity Board (MPSEB) and the Chhattisgarh State Electricity Board (CSEB), both verticallyintegrated monopolies. As of 1 November 2000, the total installed capacity in the undividedstate of MP was 4,261 megawatt (MW). The division of generating capacity following thebifurcation is given in Table 1.

Table 1: Generation Plant Details (1999-2000)State Type Total

(megawatts)A. Madhya Pradesh (new) Thermal

HydroTotal (A)

2,148 7532,901

B. Chhattisgarh ThermalHydro

Total (B)

1,240 1201,360

C. Total (Old MP) ThermalHydro

Total (C)

3,388 8734,261

Central Allocation 1,521 Source: MPSEB.

21. Based on a provisional Government order, generation capacity was allocated betweenthe two states on the basis of asset location. Similarly, transmission assets, distribution regions,and project/asset-specific liabilities, including employees, would be split along geographic stateborders. However, non-project/asset-specific liabilities (including employees) would beapportioned on the basis of population leaving MPSEB to assume approximately 79 percent oftotal long-term debt of MPEB. Both states have requested the Government to reconsider its

9 As part of the agreement to change the executing agency for Loan 907-IND: Unchahar Thermal Power Project, for$160.0 million approved on 29 September 1988 to NTPC, ADB, the Government, the Uttar Pradesh government,and NTPC agreed to transfer title to the 420-MW Stage-I to NTPC. NTPC has since taken over the TalcherThermal Power Station from Orissa SEB, and the Tanda Thermal Power Station from Uttar Pradesh SEB in lieu ofdues owned by these states.

10 Loan 1405-IND: Power Transmission (Sector) Project, for $275 million, approved on 16 November 1995 andLoan 1764-IND: Power Transmission Improvement (Sector) Project, for $250 million, approved on 6 October 2000.

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order. Nonetheless, MPSEB was already granted the right of first refusal for purchasing surpluspower from CSEB’s own production. The key indicators for the new MP’s power sector aregiven in Supplementary Appendix A.

22. From 1993 to 2000, power demand grew by a compounded 7.3 percent annually.However, annual growth rates fluctuated strongly due to the severe power shortagesexperienced from 1996 to 1998. Growth was also uneven between the different customercategories over the same period with high tension (HT) industrial consumers showing zerogrowth compared with a compounded 16 percent growth rate for agricultural consumers.

23. The size of load served, as well as the load mix, in the two new states differssignificantly from that of the undivided MP state (Table 2). As a result, the new MPSEB isexpected to be in a financially weaker position than erstwhile MPEB because (i) many high-profile industrial consumers reside in Chhattisgarh, (ii) 94 percent of agricultural consumersremain in the new MP, and (iii) allocation of 32 percent of generation capacity to Chhattisgarhwill leave the new MP with a more serious power shortage.

Table 2: Load Mix for MPSEB and MPEB in 1999-2000State Unit Domestic LT Agriculture HT Industry All Other TotalMadhya Pradesh MU 2,622.2 8,994.6 2,984.2 3,721.6 18,322.6(MPSEB) 14% 49% 16% 21% 100%Chhattisgarh MU 929.8 624.3 2,916.8 942.3 5,413.2

% 17% 12% 54% 17% 100%Total (MPEB) MU 3,552.0 9,618.9 5,901.0 4,663.9 23,735.8

% 15% 41% 25% 19% 100%HT = high tension, LT = low tension, MPEB = Madhya Pradesh Electricity Board, MU = million units.Source: MPSEB.

C. Constraints and Issues

24. Load Restrictions. Power demand grew by 6.4 percent in 1999/2000 and the peakdemand-supply gap in the same year is estimated at about 1,500 MW. This unserved, orsuppressed demand, results from planned (load relief) and unplanned (load shedding) cuts. Inresponse to the shortage, MPEB resorted to load restrictions for HT, low tension (LT), and ruralconsumers. Energy shortfall reached 1,060 gigawatt-hours in 1998/99 and is estimated to haveincreased to 1,552 gigawatt-hours for the year 1999/2000. Quality of supply has also sufferedas a result of overloaded transmission and distribution facilities; the system has been operatingat lower than normal frequency and voltage approximately 55 percent of the time. Transmission,distribution, and generation limitations are thus preventing the system from meeting demand.

25. Independent Power Producer Policy. In response to the growing supply gap, MPGinitiated a policy to invite private power producers and entered into power purchase agreementswith a total of 17 sponsors. However, none of the independent power producers has achievedfinancial closure yet due to MPEB’s insufficient escrow capacity11. In December 1999, theescrow capacity was reviewed and revised to 900 MW, which is only 35 percent of the capacityestimated 18 months earlier, pointing to the sector’s severe financial problems.

11 The term escrow used here refers to the deposition of the revenue stream from a specific revenue collectioncenter, e.g., a distribution unit, into a separate account in an identified bank, an escrow agent. In the power sectorthis mechanism is mostly used to guarantee payment of an independent power producer, to whom the primaryclaim on a revenue stream from a distribution zone is transferred or escrowed.

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26. Tariff Structure and Subsidies. The financial problems of MPEB and its successorMPSEB are in large part due to an MPG policy (para. 62) to provide free power to single-pointconnections12 in urban and rural areas and for agricultural pump connections up to5 horsepower. Moreover, MPG instructed MPEB to supply almost free electricity to ruralelectricity cooperative committees (Rs0.07 per kWh) and to pursue a vigorous ruralelectrification program. This resulted in lopsided growth rates in the domestic and primarily theagriculture sectors at the expense of the industrial and commercial consumer categories.Industrial consumption was 82.7 percent of total energy consumption in 1970/71, but dropped toonly 20 percent of consumption in 1999/2000. During the same period, the percentage ofagricultural consumption went up from 3.4 percent to 41 percent.

27. With its high energy consumption, the agriculture sector contributed barely 6 percent oftotal MPEB revenue in 1999/2000, while the industry sector’s contribution was 43 percentcompared with 20 percent of consumption. In terms of average realization per kilowatt-hour(kWh), the agriculture sector accounted for Rs0.27 and the domestic sector for Rs0.93 ascompared with an average cost of supply of Rs3.03 per kWh (Table 3).

Table 3: Average Realization from Energy SoldFY1996 FY2000

Item %TotalConsumption

Average TariffRs/kWh

%TotalRevenue

%TotalConsumption

Average TariffRs/kWh

%TotalRevenue

Domestica 15 0.65 7 15 0.93 8

Irrigation/Agriculture

35 0.18 4 41 0.27 6

HT Industriesb 33 2.66 62 20 3.82 43

Ave.OverallSupply Cost

1.74 3.03

HT= high tension, kWh= kilowatt-hour, Rs= Indian Rupee.aIncludes single point consumers.bIncludes steel plants.Source: MPSEB.

28. This situation has resulted in (i) MPSEB not having resources to finance its systemexpansion to meet unserved demand; (ii) industrial consumers paying high tariffs that impairtheir competitiveness and consequently establishing their own generation facilities, erodingMPSEB’s consumer mix; and (iii) MPSEB being unable, without subsidies from the stategovernment, to earn a return on its investments as prescribed by law.

29. Captive Power. In direct response to the deficient quantity and quality of power supplycoupled with high tariffs, major industrial consumers have set up their own captive powergeneration plants. From 1995/96 to 1999/2000, growth of captive generation averaged 8.7percent per year, with the last two years being above 9.3 percent for a total of 1,390 MW ofinstalled captive capacity for MPEB. Of this, 671 MW or 48 percent is located in the territorysupplied by the new MPSEB. This represents considerable loss of revenues for MPSEB.

30. System Losses. From 1994/95 to 1998/99, transmission and distribution (T&D) losseshave varied within a range of 19.6 percent to 20.9 percent. Precise loss estimation is hamperedby the fact that currently only about 38 percent of energy input into the distribution system ismeasured due to the policy of free supply for designated agricultural and domestic consumers,

12 These are unmetered connections intended for operation of a single power outlet point only.

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and the charging of a flat rate for several other consumer groups. In addition, a significantnumber of meters are defective and consumption of those customers also needs to beestimated.

31. Losses consist of two major types: technical and commercial. Estimation of technicallosses can be made rather precisely through load-flow analysis. Commercial losses aregenerally a function of the operation of the system; and can include theft, metering problems,and billing and collection inefficiencies. Given the current absence of energy audit and full end-user metering of agricultural customers, reestimation of consumption by MPSEB consultantsbased on connected load, supply restrictions, etc., provides strong evidence that agriculturalconsumption is gravely overstated and that losses are understated. This revised estimate showslosses of around 47 percent, of which 22 percent are considered technical and 25 percentcommercial. Reduction in technical losses generally requires significant investment; because ofthe financial constraint of MPSEB, the improvement in technical losses is expected to be slow.On the other hand, major improvement in nontechnical losses can be quickly achieved withconcerted management effort at much lower levels of investment.

D. State Government Objectives and Strategy

1. The Policy Framework

32. As a result of efforts made by the National Development Council13 the high-levelCommittee on Power was constituted in June 1993. In its report submitted in October 1994,the committee recommended (i) organizational reforms at the state level, consisting ofcommercialization and vertical and horizontal unbundling; (ii) large-scale involvement of theprivate sector in generation and distribution; (iii) depoliticizing electricity-tariff setting by creatingnational and regional tariff boards; and (iv) progressive phasing out of subsidies to agriculturalconsumers. These recommendations were renewed in the council meeting with Power ministersin October and December 1996, and are outlined in the Common Minimum National Action Planfor Power.

33. In response to the National Development Council’s recommendation, MPG appointed ahigh-level committee in 1996 to review the existing power sector situation and to suggestmeasures for its restructuring in the context of economic liberalization and introduction of privatecapital into the sector. Named after its chairman, the Tata Rao Committee issued Guidelines onRestructuring and Privatization of Power Sector and Power Tariff in January 1997. The majorrecommendations of the report were to (i) divide MPEB along functional lines, (ii) maintainMPEB as a holding company, (iii) establish a regulatory authority, (iv) allow private sectorinvestment in all functional areas, and (v) improve the financial and operational efficiency of thedistribution segment before inviting private sector investment. The report recommendedfundamental changes in the free supply of power to certain consumer segments, and that anysubsidies must be transparent and reimbursed to the utility on a timely basis. The Tata RaoCommittee advised against separating and privatizing urban area distribution from semiurbanand rural distribution, as this would leave the remaining public sector distribution segment highlynonviable. It also recommended maintaining uniform tariffs for each category of consumers, aslong as the areas continue to be MPEB subsidiaries.

13 India's highest political body, the council is chaired by the Prime Minister and comprises the chief ministers of all thestates in India.

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E. External Assistance to the Sector

34. The power sector has received a major portion of India's external assistance. Of ADB’stotal Government-guaranteed lending to India amounting to $9.898 billion as of 31 October2001, 9 loans for $1.865 billion (18.8 percent) were approved for the power sector. The first fourprojects were for power generation; three were sector loans to support improvements in SEBefficiency and development of the national transmission grid; and the two most recent were forsector development to support the restructuring of a state’s power sector. In addition, under itsprivate sector operations, ADB has approved three loans and investments totaling $79.8 millionfor one captive transmission and two generation projects.14 Power subprojects have also beenconsidered for financing under ADB's private sector infrastructure facility15 and the InfrastructureDevelopment Finance Company.16 ADB also has approved $12.9 million for 21 technicalassistance (TA), mainly advisory, at both the national and state levels. The TAs have focusedon environmental and pollution control issues related to power generation, bulk transmissiontariffs, improved least-cost system planning, tariff studies at the retail level, improved technicaland commercial operations, power sector restructuring, and establishment of an independentregulatory authority. Previous ADB assistance to India’s power sector is listed in SupplementaryAppendix B.

35. The major funding source to the sector is the World Bank Group. The World Bank hassupported power generation, transmission, and distribution projects, including assistancedirected to SEBs. The World Bank is supporting power sector reforms in the states of AndhraPradesh, Haryana, Orissa, Rajasthan, and Uttar Pradesh. In Andhra Pradesh and UttarPradesh, power sector reform is viewed as part of overall reform of the state finances. ADBcoordinates with the World Bank on the geographical demarcation of state-level operations, aswell as to ensure overall complementarity of actions at both the central and state levels. ADBand the World Bank have concurrent ongoing operations for different projects with threeorganizations: PFC, Powergrid, and NTPC. Other major agencies funding the sector are theJapan Bank for International Cooperation, Kreditanstalt für Wiederaufbau for the Government ofGermany, Department for International Development of the United Kingdom (DFID), CanadianInternational Development Agency (CIDA), and United States Agency for InternationalDevelopment. Although the combined assistance of all aid agencies constitutes only about 8-10percent of the total investments in the sector, several key policy initiatives have been catalyzedas a result. Major external assistance provided to the power sector by other aid agencies is alsolisted in Supplementary Appendix B.

36. The Japan Bank for International Cooperation is supporting the expansion of publicsector generation, transmission, and distribution including rural electrification. It has nogeographic preferences.

37. DFID’s exclusive objective in providing assistance is poverty reduction. It is financingstudies for power sector restructuring in Andhra Pradesh, Haryana, and Orissa; and has noplans to participate in the financing of hardware other than in renewable energy systems. It is

14 Loan 7058/1036-IND: CESC Limited, for $17.8 million, approved on 4 October 1990; Loan 7082/1142-IND: CESCLimited II, for $32.0 million, approved on 13 December 1991; and Loan 7130/1499-IND: Balagarh Power CompanyLimited, for $15 million in equity and a loan for $25 million, approved on 5 December 1996.

15 Loans 1480/1481/1482-IND: Private Sector Infrastructure Facility, for a total of $300 million, approved on7 November 1996.

16 Investment 7138-IND: Infrastructure Development Finance Company, for $30 million equity investment, approvedon 14 October 1997. The loan amount was subsequently reduced to $15.463 million due to greater than expectedsubscription from the investors.

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considering (i) cooperating with ADB to fund studies on power sector restructuring in MP andWest Bengal states; and (ii) assisting these states in other areas also, preferably in the "soft"sectors, like health and education.

38. The United States Agency for International Development has extensively supported andcontinues to support policy aspects of private sector participation. It has supported studies forstate sector reforms through PFC, and by providing grant assistance for energy management,conservation, and training.

39. CIDA assisted Kerala in conducting extensive studies for restructuring its power sector.ADB is following up on CIDA’s work through policy dialogue and preparation for a possible loanintervention. Together with the World Bank, CIDA is providing similar TA for power sectorreforms in Andhra Pradesh. In Madhya Pradesh, CIDA and ADB are cooperating andcoordinating closely in providing assistance to MPSEB and MPG for power sector reform. CIDAprovides the most bilateral assistance and is providing an umbrella TA to MPSEB through theEnergy Infrastructure Services Project (EISP). The EISP’s components include (i) rationalizingthe tariff structure; (ii) developing a power system master plan; (iii) supporting distributionreconfiguration and preparation of a grid code; (iv) restructuring MPSEB debt and preparingopening balance sheets for the new sector entities; (v) supporting capacity building for cross-cutting themes in environment, gender equality, socioeconomic analysis, and governance; and(vi) developing a poverty reduction strategy as it relates to energy availability for the poor(para. 50).

F. ADB’s Operations and Strategy in the Sector

1. Lessons Learned

40. ADB operations in India’s power sector have generally been successful from a projectpoint of view, i.e., the projects concerned have achieved their physical objectives. However,except for the ongoing loans to Powergrid and Gujarat (footnote 10),17 these projects were notdesigned to change the business environment, and sector performance continues to deteriorate.This was primarily on account of (i) political interference in tariff setting; (ii) rapid growth of thedemand for electricity, making conventional investment strategies unworkable; (iii) governmentrules and regulations and control of the SEBs that inhibited speedy decision making; and (iv) thenoncommercial setup of the sector, which did not generate the market for alternative players tostep in to bridge the gap between supply and demand.

41. Although the past strategy enabled ADB to support many projects, it spread ADB'sresources too thinly, with the result that it could not achieve its desired goal of policy reformswith its power sector borrowers. In most states, the power sector has been the largest recipientof state resources, in terms of subsidies as well as in terms of capital investments. Thus, macromanagement of the state's finances needs to be improved if the power sector is to besuccessfully turned around. Therefore, ADB is now assisting selected states with power sectorreforms, only in the context of a holistic change in their macroeconomic management.

2. Operational Strategy

42. ADB’s current operational strategy in India is to support efforts to achieve highersustainable economic growth to promote employment and reduce poverty. Its contribution to

17 Loans 1803/1804-IND: Gujarat Power Sector Development Program, for $350 million, approved on 13 December2000.

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higher growth focuses on improving the supply-side efficiency of the economy, especially byreducing bottlenecks in key infrastructure sectors. Emphasis is on improving the policy,institutional, and regulatory framework to enhance the efficiency of public sector operations andto encourage private investment. Improving resource mobilization to finance the necessaryinvestments is a key component of ADB’s assistance, and includes support for the developmentof financial and capital markets, as well as for improving internal resource mobilization in thesector agencies and enhancing their creditworthiness. High priority is also given to assistingprojects that contribute to environmental improvement.

43. ADB's strategy for India was revised in 1996 to accommodate an urgent need for aportion of its assistance to be provided in a systematic and comprehensive way at thesubnational or state level. This need reflects the facts that (i) a geographic focus, together withthe ongoing selective sector focus, enables ADB to maximize its developmental impact both inthe states concerned and, through the demonstrational impact of its operations on other statesas well; (ii) state-level economic reforms, which have been lagging behind initiatives takenby the Government, need support and incentives; and (iii) the states have considerableautonomy and have major legislative, administrative, and fiscal responsibilities in manyeconomic and social sectors. Key elements of the subnational assistance include (i) improvingthe states' public resources management, (ii) reforming and restructuring public sectorenterprises to improve operating efficiencies, and (iii) supporting reforms in key infrastructuresectors with a view to increasing private investment (para. 4).

44. Reflecting ADB’s overall country strategy for India and in recognition of the dualisticstructure of India's power sector, ADB's strategy for the power sector, which has been pursuedin coordination with the World Bank, intends to operate at two levels. At the central level,assistance is provided to central power sector companies such as Powergrid (para. 18,footnote 10) and PFC18 with a view to supporting their commercialization and using them asagents to leverage reform in their client SEBs. Through its support to PFC, ADB seeks topromote power sector reforms in states that would currently not qualify for direct lendingoperations. At the state level, by considering assistance only for states that demonstrate thepolitical will to substantially restructure and commercialize their power sectors, and by assistingthem to actualize the reforms, ADB is building up the reform process from the grassroots.Improvements in the power sector will increase the fiscal space of the state governments andincrease their ability to allocate more resources for poverty reduction and socioeconomicdevelopment.

IV. THE SECTOR DEVELOPMENT PROGRAM

A. Rationale

45. The power sector has become one of the major budget items for MPG due to politicizedsector management. Despite receiving high annual subsidies, the sector has not been in aposition to meet the growing demand for power, and quality and reliability of power supply havedeteriorated. Political interference in tariff setting and sector operations had adverse impacts onthe operational and financial performance of the MPSEB, which finds itself in a severe financialcrisis. The lack of sufficient and reliable power is eroding MP’s competitiveness, and prevents itfrom attracting the same level of industrial investments as some of its neighboring states. At thesame time, the demands on the state budget for the power sector have resulted in suboptimalallocation of public funds at the expense of other state responsibilities like education and health,

18 Loan 1161-IND: Power Efficiency (Sector) Project, for $250 million, approved on 26 March 1992. The loan accountwas closed on 18 December 1998.

13

further undermining the state’s attractiveness as a location for new industrial developments,especially information technology and biotechnology, which are India’s future growth sectors.Restoring the sector’s financial viability and sustainability is a declared objective of MPG andthe SDP provides the basis for MPG to reform and restructure the power sector.

46. MPG adopted the recommendations of the Tata Rao Report as the base model forsector reform, namely, (i) functional unbundling of MPSEB, (ii) retention of MPSEB as a holdingcompany, (iii) establishment of a regulatory authority, and (iv) improvement of operational andfinancial efficiency of the distribution segment before inviting private sector investment.However, MPG found that given the complexity of the sector reforms to be undertaken,implementation should be phased. Stage I of the reforms will lay the foundation for change andcreate the conducive environment for future private sector involvement in the power sector19

(Appendix 1 provides a vision for the long-term sector model). In close dialogue with ADB, MPGdeveloped a detailed plan for stage I of the reform process that aims at creating an enablingenvironment and independent sector regulation; establishing new sector companies and theirgradual operationalization; deciding on reconfiguring the distribution segment; and improvingmanagerial, financial, and operational efficiency of its ongoing operations. Those policyinitiatives would be supported by targeted physical investments to reduce system losses andincrease the delivery capacity of the power sector to reap the benefits offered by sectorrestructuring. On the basis of the policy dialogue associated with the SDP, MPG submitted itsdevelopment policy letter (Appendix 2), which includes a policy matrix and memorandum ofunderstanding (MOU) between MPB and MPSEB. A detailed plan for stage I of the reformprocess is provided in Appendix 3.

47. The SDP is designed to support MPG’s long-term goal to ensure an efficient, self-sustaining, and competitive power sector to provide sufficient quantity and quality of power tosupport the state’s economic and social development. The SDP provides incentives forinstitutional and organizational actions for improved sector governance and the functionalunbundling of MPSEB, and in parallel supports physical investments to strengthen the capacityof the power system and to reduce technical and nontechnical losses to improve operationaland financial sector performance. The SDP seeks to improve public and private resourceallocation in MP by increasing MPSEB’s operational efficiencies and delivery capacity, andprogressively reducing the need for transfers from the state government budget. This requiressimultaneous intervention at the policy level to provide the necessary legal and institutionalframework, and at the project level, to support critical investment components to ensuresuccess of the reform. Therefore, a mixed-modality sector development program is consideredthe best instrument for supporting an initiative to restructure the power sector. The SDPconstitutes the first stage of the reform process, and will be followed by a second loanintervention upon successful implementation of the first stage of reforms.

B. Objectives and Scope

48. The immediate objectives of the SDP are to assist MPG and MPSEB to (i) improve thepolicy environment and governance of the sector; (ii) initiate the establishment of a commercialand competitive business environment to promote efficiency gains and loss reduction;(iii) improve the financial viability of the MPSEB through financial restructuring; (iv) improve thequality and quantity of supply by reinforcing, modernizing, and rehabilitating the T&D systems to

19 The India Country Strategy Program for 2003 includes TA for Increasing Private Sector Participation in ElectricityDistribution.

14

promote economic growth; (v) introduce a computerized information and revenue managementsystem; and (vi) pursue installation of meters.

49. Given the lack of creditworthiness of MPSEB to attract private capital and the parallelneed to meet the growing demand for energy, the sector reform and restructuring strategy mustfocus on enhancing the cash flow at the distribution end. In addition to rationalizing the tariffstructure, the SDP will (i) reduce T&D losses, (ii) pursue 100 percent metering, (iii) improvebilling and collection efficiency, and (iv) install efficient operational management of power sectorcompanies. To achieve these changes, autonomous functioning of the power sector alongcommercial lines, especially of the distribution functions, and independent sector regulation andcorporatization of the generation, transmission, and distribution functions of MPSEB, arerequired. The SDP is designed to assist MPG and MPSEB in achieving these objectives. TheSDP frameworks are provided in Appendix 4.

C. Policy Framework and Actions

50. During its deliberation of the Tata Rao Report, MPG recognized that irrespective of thechoice of the long-term sector model, a set of preparatory studies would be needed to optimizesector expansion, ensure its commercial viability, attract and optimize private capital investment,and establish benchmark performance for introducing competition. Consequently, MPGrequested ADB assistance for preparing and financing the MP Power Sector DevelopmentProject.20 The TA was designed as a cluster TA to include six studies, two financed by ADB andfour by CIDA.21 In addition, CIDA recently expanded the EISP scope to include funding ofactivities related to implementing stage I and preparing stage II of the power sector reforms(para. 39). ADB will coordinate the overall MP power sector reform program and CIDA isworking closely with ADB to implement the studies. The first TA subproject to be implementedreviewed electricity legislation and regulation, and included drafting of the MP Power SectorReform Bill and support for the selection of a base model for the restructured power sector.

51. In May 2000, an MOU was signed between the Union Ministry of Power and MPG. In theMOU both parties affirm their joint commitment to the reform of the power sector, and set outtime-bound reform measures to be implemented by MP and the implementation support to beprovided by the Government. The MOU outlines the objectives of the reform program: topromote the development of an efficient, commercially viable and competitive power supplyindustry, which will provide reliable and quality power at competitive prices to all consumers inthe state and which will support the industrial development in the State. The Governmentcommits to support the reforms by allocating additional power from central power stations; andproviding financial support for investment projects through Powergrid and PFC, and technicalconsulting assistance.

1. Governance

52. ADB had extensive policy dialogue with MPG and MPEB about the legislative frameworkand the need to constitute the regulatory authority under a separate state power sector bill and

20 TA 2980-IND: Technical Assistance to India for the Madhya Pradesh Power Sector Development Project, for$1,000,000, approved on 7 January 1998. The six studies include (i) preparation of a power system master plan(CIDA); (ii) preparation of a framework for rationalization of tariffs (CIDA); (iii) review of electricity legislation andregulation (ADB); (iv) solicitation for private sector implementation of a generation project (ADB); (v) technical andmanagerial upgrading of distribution profit centers (CIDA); and (vi) demandside management (CIDA).

21 Implementation of CIDA’s TA components was delayed due to then prevailing external environment. CIDA iscurrently implementing TA components (i) and (ii).

15

not under the ERC Act to ensure independence of the regulator. As a result of the policydialogue, the MP Vidyut Sudhar Adhiniyam, 2000 (the Reform Act) was brought into force on3 July 2001. The Reform Act is the most progressive in India to date and includes provision for(i) restructuring MPSEB, (ii) mandatory metering of all consumers, (iii) tariff rationalization sothat all classes of consumers will pay at least 75 percent of the cost of supply (progressivelyphased over 5 years), (iv) allocation of MPG budget subsidies before subsidizing any categoryof consumers, (v) creation of the MP State Electricity Regulatory Commission (MPSERC), and(vi) dispute resolution between MPG and MPSERC by reference to the CERC as againstreference to the courts. The Reform Act is primarily an enabling provision for reform and leavessufficient flexibility for the power sector structure to evolve with future policy decisions andoperational requirements. Its prescriptive elements, like mandatory metering and minimum tarifflevels, are aimed at reducing political interference and ensuring the commercial management ofpower sector operations.

53. The MP Electricity Regulatory Commission was established in June 1999 under the ERCAct and was recognized as the first MPSERC upon bringing the Reform Act into force.MPSERC is gradually increasing its role as a proactive sector stakeholder. It formed an advisorycommittee consisting of representatives of different consumer groups, labor unions,nongovernment organizations, academic and research bodies, and various governmentdepartments, and issued a tariff philosophy paper for discussion. Its first tariff award was madeafter holding extensive public hearings throughout MP involving questions and answer sessionswith MPSEB officials. Also, in response to MPG’s recent proposals for a state-wide, load-shedding schedule, MPSERC held several public consultations before issuing an order.

54. In relation to the selection of a model for the postreform power sector, two largestakeholder meetings were organized during 1999. Representatives from unions, the MPFederation of Industries, academia, MPG officials, Madhya Pradesh Electricity RegulatoryCommission, and MPEB staff attended the meetings. The workshops contributed significantly toan understanding of the objectives, strategies, challenges, and benefits of power sectorrestructuring, and increased the transparency of the reform process.

55. Both the MOU and the Reform Act define MPG’s long-term vision for the sector and setthe legal framework for restructuring. However, in the short-term, visible improvements in thepower sector can only be achieved by combining internal efficiency enhancements of the utilityand MPG actions to boost MPSEB’s financial viability.

56. To depoliticize sector management, open and transparent recruitment processes mustbe used to fill boards of directors and senior management positions of the new sectorcompanies. MPG has agreed to recruit experts from outside government services for functionalareas including finance, commercial, corporate planning, and information technology. Inrecognition of the importance of installing and maintaining commercial discipline in the sector,MPG has taken the leadership role and issued an order to appropriate at source outstandingdues of municipalities and other government bodies. MPG also committed to make futuresubsidy payments to MPSEB in cash on a monthly basis.

2. Reform Model and Institutional Arrangements

57. Details of the power sector model for stage I of reforms were decided upon by MPGthrough continuous policy dialogue with ADB. As recommended by the Tata Rao Report, MPGdecided to functionally segregate MPSEB into separate generation, transmission, and distributioncompanies incorporated under the Indian Companies’ Act, 1956, to conduct business on acommercial basis. MPSEB will remain as the holding company of the newly incorporated

16

companies, and will also act as the single buyer and system operator during the first stage ofpower sector reform. All generation assets of MPSEB will be transferred to the newly incorporatedgenerating company, and each of the plants will be operated as an independent profit center. Alltransmission assets will be transferred to the newly established transmission company and it willact as the wheeling agent for intrastate transmission activities.

58. Stage I of the reforms also has to contend with the continuous uncertainty overapportionment of liabilities and employees between the two states as a result of bifurcation. Thefinal apportionment will impact on MPG’s decision on transfer schemes (proposed to beprepared under ADB TA) that are a prerequisite for full operationalization of the new sectorcompanies. Further, MPG recognizes the importance of identifying and assessing any costsresulting from the transfer schemes early to be able to mitigate their impacts.

59. Detailed analytical work needs to be carried out before the final number of distributioncompanies can be decided upon. Moreover, the final decision on the number of distributioncompanies includes an element of political decision making about the extent of supportablecross-subsidization within and between the new distribution entities and the treatment ofpredominantly rural distribution areas. Therefore, MPG decided to retain the existing distributionregions under MPSEB as the holding company until a final decision has been reached ondistribution reconfiguration. ADB also initiated policy dialogue with MPG and MPSEB that someof the existing distribution circles should already start operating as independent profit centers toprovide practical experience and best practices before operationalization of the new distributioncompanies becomes effective. The most suitable candidates for the profit center approach arethose distribution circles whose facilities are proposed for upgrading and strengthening. MPSEBshould give priority to installing of meters for energy audit and for end-consumers in these circles;and fully delegate managerial powers to those circles as part of the overall internal efficiencyenhancement measures currently being implemented.

60. While principally open to divestment and private sector involvement in all three functionalareas, MPG wishes to make its decision based on full and detailed information about the currentoperational and financial situation and the business prospects of the power sector in themedium term. Learning from experiences made elsewhere, MPG will first establish the legal andregulatory framework and an enabling business environment to create certainty for investorsbefore soliciting private sector investments.

61. MPG recognizes the benefits of creating a formal coordination mechanism for the reformprocess since effective reform management will require that a strategic and program overviewbe maintained at the highest level throughout the reform process to ensure effective use ofresources and to establish priorities. MPG has set up an institutional framework for managingpower sector reform under the apex of the Steering Committee for Power Sector Reformchaired by the chief secretary. The members of the committee include the principal secretariesfor power, finance, law, and planning; secretary, finance; and chairman, MPSEB. In addition, thejoint secretary reforms, Union Ministry of Power, and director, ADB, Department of EconomicAffairs, have been included to ensure close coordination on power sector reforms. Reporting tothe committee is the Strategic Policy Unit (SPU) headed by the principal secretary, power. TheSPU is responsible for defining the critical path for reform and for preparing a time-boundimplementation plan and review mechanisms, keeping in mind the institutional, financial, andregulatory imperatives. The SPU includes representatives from MPSEB and the Power andFinance ministries of MPG, and coordinates with ADB and other assistance agencies in thesector. Power sector experts from outside the state and representatives of consumer groups areinvited to provide feedback and input to the SPU on an intermittent basis. The SPU shouldideally be supported by a professional implementation task force to analyze best practices and

17

present alternative scenarios considering local conditions. With the assistance of ADB, MPG iscurrently identifying external funding for the implementation task force and the SPU. DFID hasexpressed general interest in supporting both.

3. Restriction of Free Power Supply

62. With effect from 1 January 2001, a new MPG policy became effective reducing freesupply of power to agriculture consumers and single-point consumers. Under the new policyonly scheduled castes and scheduled tribes (SC/ST) consumers who are living below thepoverty line and with a monthly consumption of not more than 20 kWh will receive free powersupply under the single-point scheme. SC/ST agricultural consumers are now only eligible forfree electricity supply for pumps up to 5 horsepower if they have less than 1 hectare of irrigatedland. As a consequence of this policy, about 95 percent of agriculture consumers and75 percent of single-point consumers are now required to pay their electricity bills fully. MPSEBexpects annual revenues from the agriculture sector to increase by Rs1,610 million, and fromsingle-point connections up to Rs1,440 million once the new policy is fully implemented. Theprojected increase is equivalent to 19 percent of total revenues from LT consumers in FY2000.

4. Energy Audit and Metering

63. The MP Urja Vidheyak, 2001, or the MP Energy Act for the prohibition of unauthorizeduse of electricity; and the assessment, compounding, and recovery of arrears and dues toreduce losses caused by illegal abstraction, use, consumption, and pilferage of electricity wasenacted on 17 April 2001. A comprehensive energy audit comprising the installation of 7,500meters is being implemented on all feeders up to the 11 kilovolt (kV) level; electronic meters willbe provided to all HT consumers. This will allow MPSEB to record and compare the energyinput into a specific distribution feeder with the realized revenues coming from the same feeder.Grouping and accounting of consumers according to distribution feeder will be implemented aspart of the energy audit. In addition to allowing specific targeting of high loss zones for efficiencyimprovements, the energy audit is a fundamental ingredient for distribution reconfiguration andcorporatization/divestment to be carried out as part of sector reform.

64. While preparing for supplying and installing meters to all endusers, MPSEB haslaunched a campaign to regularize unmetered connections using self-assessment of electricityconsumption. Under the scheme, administrative requirements for official connections arerelaxed, and consumers are encouraged to self-assess their monthly electricity consumptionand make payments based on this assessment. Once meters have been installed theconnections will be billed based on the meter reading. The self-assessment campaign fulfillsthree objectives: (i) immediately increase MPSEB’s revenues, (ii) lower resistance to meterinstallation, and (iii) assist in detecting tampering of meters if metered consumption issubstantially lower than that self-assessed. It also benefits poorer consumers who until nowcould not obtain legal connections due to lack of titles to their land/housing. Under the newpolicy, proof of property titles is no longer a requirement for obtaining a connection fromMPSEB. After an interim period, all nonregistered connections will be levied with heavy finesand ultimately disconnected.

5. Internal Reforms

65. The self-assessment scheme is part of the comprehensive measures implemented byMPSEB to increase the internal operational efficiencies. Simplifying procedural hurdles to obtainofficial connections will reduce nonmonetary access barriers to the network, whilesimultaneously reducing illegal connections and thus system losses.

18

66. Introduction of grievance procedures to better respond to customer needs and toincrease public participation is another step toward a commercial and competitive power sector.MPSEB has formed grievance redress committees at district and subdivision levels headed byrepresentatives of MPSEB and the local community. In anticipation of the new businessenvironment, MPSEB has implemented measures to decentralize powers and to increaseMPSEB officers’ responsibility for incidents of theft in their jurisdiction. As part of the internalrestructuring, MPSEB banned all new recruitment and revised the retirement age from 60 to 58years starting in January 2001, which immediately reduced the number of employees by about1,200 (of a total of 67,000).

67. MPSEB recently delegated more operational responsibilities. Administrative,commercial, and financial responsibilities created on a graduated scale by MPSEB weredelegated to individual generating plants and distribution circles. For example, in an effort toincrease the number of high-profile customers, line extensions for HT consumers can now beapproved by superintending engineers, and for industrial consumers up to 5 MW by regionalchief engineers instead of requiring approval of MPSEB board members.

68. In response to the changes resulting from the sector reforms, MPSEB is adjusting itsorganizational set-up. MPSEB’s reform coordination structure mirrors MPG’s, in the sense thatMPSEB’s High-Level Reform Coordination Committee is supported by a coordinationcommittee, which in turn collaborates closely with the Corporate Planning Group, (thecounterparts for CIDA’s EISP), which acts as MPSEB’s resource center for coordination with thereform process and is equivalent to MPG’s implementation task force.

69. A tariff and regulatory affairs cell is being created by MPSEB to concentrate andcultivate specialist expertise for the annual tariff filings and to act as the focal point for any datarequest by MPSERC. The expertise of senior officers assigned to the social and environmentalmanagement cell was obtained during their work with the Corporate Planning Group on powersystem planning, and financial and socioeconomic analysis. Officers assigned to the projectmanagement unit (PMU) were involved in preparing project reports for submission to ADB underthe project loan and have been associated with reform-related activities carried out by corporateplanning group. All new organizational units are staffed with officers representing generation,transmission, and distribution functions with a view to the unbundling of MPSEB, and theexpertise and functional requirements of the new companies.

70. The successful implementation of the reform initiatives requires a combination offinancial support for reform adjustment costs and system improvements, and technical adviceon properly integrating the reforms into operational procedures and their implementation in day-to-day management of MPSEB.

D. The Investment Project

1. Project Description

71. An outline description of the investment components (the Project) is given inSupplementary Appendix C. The components include the following:

A — 33kV and 11kV system improvements in Bhopal, Gwalior, Indore,Jabalpur, Khargone, Mandsaur, and Ujjain areas;

B — Conversion of selected low-voltage feeders supplying agricultural pumps

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in selected divisions in Mandsaur and Ujjain districts to 11kV operation.

C — Reinforcement and augmentation of the transmission system facilities inselected priority areas.

D — Setting up of a computerized information and revenue managementsystem.

E — Provision of three-phase meters.

F — Consulting services for the initial phase of Project implementation.

2. Cost Estimates

72. The summary cost estimates of the Project are in Table 4 (details are in Appendix 5).

Table 4: Cost Estimates($ million)

Item Foreign Exchange Local Currency Total CostI. Project Components

A. 33kV and 11kV System ImprovementsB. 11kV ConversionC. Transmission System ReinforcementsD. Computerized Information and Revenue

Management SystemE. MeteringF. Consulting Services

Subtotal (I)

55.85.3

89.17.8

1.11.8

160.9

27.1 1.8

29.6 2.0

0.0 0.0

60.5

82.97.1

118.79.8

1.11.8

221.4

II. ContingenciesPhysicalPrice

Subtotal (II)

15.95.0

20.9

6.0 8.7

14.7

21.913.735.6

Front-End FeeTaxes and DutiesInterest /Commitment Charges duringConstruction

2.00.0

16.2

0.030.513.2

2.030.529.4

Total 200.0 118.9 318.9 KV = kiloVolt. Source: MPSEB, Staff Estimates.

3. Financing Plan

73. The proposed financing plan for the Project is summarized in Table 5.

Table 5: Financing Plan for the Project($ million)

Source Foreign Exchange Local Currency Total Cost PercentADB 200.0 0.0 200.0 62.7MPSEB and MPG 0.0 118.9 118.9 37.3TOTAL 200.0 118.9 318.9 100.0ADB = Asian Development Bank, MPSEB = Madhya Pradesh State Electricity Board, MPG = Government ofMadhya Pradesh.Source: MPSEB, Staff estimates.

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E. Social and Environmental Measures

1. Social Dimensions

74. Participatory rapid appraisal (PRA) and extensive public consultations were undertakenthroughout MP during appraisal of the SDP (Supplementary Appendix D). The PRA objectivewas to investigate the impacts of the reform process on consumers, especially the poor. ThePRA also examined barriers for the poor to access electricity connections. In addition,consultations were held with three MPSEB labor unions and associations representing differentclasses of employees to discuss the concerns of the employees with regard to the current statusof MPSEB and the reform process. The unions expressed concern in three major areas:(i) political interference in MPSEB operations, including tariff setting; noting that field staff wereoften put in a situation of implementing policies with little support for enforcement; (ii) MPSEB’sfinancial status and allocation of resources for maintenance; and (iii) lack of generation capacity.Ultimately, the current situation in the areas where the unions expressed concern affects themorale, dedication, and incentives to enforce policies.

75. MP has a high percentage of scheduled tribes and scheduled castes (SC/ST). They areoverrepresented among households living below the poverty line. The tribal populationconstitutes approximately 23.3 percent of the total population, is mainly rural, and ischaracterized by small and marginal landholdings; forest-based occupations; and limited accessto water resources, and infrastructure and agricultural technology including electrical irrigationpumps. Under the new MPSEB policy on free power supply, SC/ST consumers living below thepoverty line are eligible for the single-point scheme; the connection charge is amortized overfour monthly installments. This policy does not apply to other consumers living below thepoverty line.

76. The new mandatory metering policy of MPSEB was found to be more beneficial for low-income and poor households as opposed to the flat rate tariff currently charged; the per-unitcharge is higher on a flat rate basis. The current schedule of load shedding combined withbilling on a flat rate basis is regressive in the sense that consumers experiencing more loadshedding will be paying a higher unit rate than consumers experiencing less.

77. The PRA findings indicate a consistent demand and willingness to pay for improvedsupply of power services, even in remote areas, for irrigation and domestic use. This finding isalso confirmed by the poverty impact assessment (Appendix 6). However, the seasonality ofagriculture results in a mismatch of rural farm incomes and MPSEB billing practices.Furthermore, small and marginal SC/ST farmers who have been exempted from power chargesand who now have to pay unless they are classified as living below the poverty line are finding itdifficult to pay as their access to water resources and alternative income sources have declined.The PRA found that while MPSEB informally implements installment-based payments of bills,such installments need to be systematized and poverty-related policies and guidelines for thepower sector more effectively communicated to MPSEB field staff.

78. The PRA found a substantial number of illegal connections among low-incomehouseholds, which MPSEB finds difficult to legalize. These connections are partially a result ofthe recent policy changes requiring certificates to prove “below-poverty” status, which can bedifficult to obtain for poorer households. While MPSEB and MPG are attempting to mitigate thisproblem by authorizing village heads to issue the certificates, not all village heads have yetbeen made aware of this new scheme. However, the PRA found that the major reason for illegalconnections appears to be the inability of poorer consumers to pay up-front connection chargesand associated fees in one payment, and found that 12 monthly installments would facilitate the

21

ability of these consumers to afford the initial charges. The findings where discussed withMPSEB, which agreed to introduce a 12 month installment facility applicable to all consumersliving below the poverty line. A detailed analysis of the barriers for poor households to accesselectricity is also provided in Appendix 6.

2. Environment

79. The potential environmental impacts of the policy and institutional changes under theSDP as per the Reform Act were evaluated (Appendix 7). Most potential impacts are consideredbeneficial from an environmental point of view. Policy dialogue is ongoing with MPSERC toenhance benefits by institutionalizing environmental management in sector regulation and toalso increase public participation during conceptualization of new investment projects. On theoperational side, MPSEB has agreed to establish a fully functional social and environmentalmanagement cell; selection of officers is ongoing. The new cell will include an environmentalmanagement and monitoring section to ensure that the Project is undertaken, and all projectfacilities operated and maintained in compliance with all applicable laws, rules, and regulations,including ADB’s Environmental Assessment Requirements. A proposed organizational setup forthe cell is in Supplementary Appendix E.

80. The Project is classified as Environment Category B as it will have limited environmentalimpacts during construction and operational stages. Based on the environmental assessmentsand surveys conducted for components A and C, the associated potential adverseenvironmental impacts can be mitigated to an acceptable level by adequate implementation ofthe measures outlined in the initial environmental examination (IEE); a summary is given inAppendix 7. Although 1.4 kilometers of the alignment of the transmission lines is forested, it iseither degraded Grade IV forest or no tree is standing on the affected area. No endangered,rare, or threatened species of flora or fauna have been reported in the project sites.Nevertheless, compensatory forestry will be strictly implemented in coordination with the StateForest Department. Adequate provisions have been made in the Project to cover theenvironmental mitigation and monitoring requirements, and their associated costs.

81. MPSEB’s current technical specification for transformer oil and practices of reclamationof used transformer oil shows its capability of handling process-generated wastes to minimizeadverse environmental effects of the components. MPSEB will comply with India’sEnvironmental Protection Act and other applicable regulations for the handling of usedtransformer oil. All new transformer and capacitors purchased under the project loan by MPSEBmust be polychlorinated biphenyl (PCB)-free and specifications in the bidding documents will bemade accordingly.

82. No significant rehabilitation, land acquisition, or compensation is required for the Project.For the Jabalpur, Khargone, and Mandsaur areas under component A, site selection forsubstations and routing of transmission lines has been completed, and a land acquisition andcompensation plan (Supplementary Appendix F) prepared in line with ADB’s policy oninvoluntary resettlement.22 The social assessment shows that 49 of the 62 proposed sites forsubstations are government owned, and will be transferred to MPSEB for nominal payments.These sites are free of encroachments. The remaining 13 sites are privately owned and aremostly agricultural lands belonging to small-and medium-sized landholders. Field visits revealedthat the owners of these sites were willing to donate their land to MPSEB with the expectationthat their power supply will improve. However, MPSEB decided to compensate the owners in

22 ADB. 1998. The Bank’s Policy on Involuntary Resettlement. Handbook on Resettlement. Manila.

22

accordance with market rates for comparable land. Crop compensation as per market rates andproduction levels will be paid for any crop losses that might occur during construction. Rs40million is included is included in the project cost for these purposes.

83. For the remaining components, pending final site selection for construction ofsubstations and routing of transmission lines, land acquisition and resettlement frameworkswere prepared in keeping with ADB’s policy on involuntary resettlement. The resettlementframework for the Project is based on the principles that involuntary resettlement will be avoidedor minimized where possible by exploring other alternative project designs, and where landacquisition is unavoidable, people losing assets, livelihoods, or other resources will be assistedin restoring or preferably improving their former standard of living. All those affected are entitledto be compensated for their lost assets, incomes, and businesses at replacement cost, andprovided with rehabilitation measures in keeping with the ADB policy. Lack of legal rights will notbe a bar to rehabilitation assistance for people affected by the Project. Compensation for ethnicminorities, households headed by women, and families with disabled and other vulnerablefamilies will be carried out with respect for their particular cultural and specific needs. The finalland acquisition and resettlement plan will be prepared in keeping with ADB policy, and bereviewed and approved by ADB prior to construction activities. Implementation of the plans willbe monitored by the PMU, which will submit regular reports to ADB.

V. THE LOANS

A. The Policy Loan

1. Amount of Loan, Terms, and Sources of Funds

84. The Government of India has requested a policy loan of $150 million from ADB’sordinary capital resources to help finance the policy component of the SDP. The loan will have a15-year term, including a grace period of 3 years; an interest rate determined in accordancewith ADB’s LIBOR-based lending facility; a commitment charge of 0.75 percent per annum; afront-end fee of 1.0 percent, (the fee will be capitalized in the loan), conversion options that maybe exercised in accordance with terms of the draft Loan Agreement, the Loan Regulations, andADB’s Conversion Guidelines; and other terms and conditions set forth in the draft LoanAgreement. The Government has provided ADB with (i) the reasons for its decision to borrowunder ADB’s LIBOR-based lending facility on the basis of these terms and conditions, and (ii) anundertaking that these choices were the Government’s own independent decision and not madein reliance on any communication or advice from ADB. The counterpart funds to be generatedfrom the loan proceeds will be transferred from the Government to MPG under normalarrangements for the transfer of external assistance. The funds transferred to MPG will betreated as “additional” to the Government’s transfers allocated annually to MPG. TheGovernment will bear the foreign exchange risk in accordance with its policy.

85. MPG is expected to incur the following costs of adjustments over the reform period:

(i) Payments of outstanding dues of municipalities and other local and state bodiesoutstanding as of 31 March 2001 will cost approximately Rs7,423 million ($164million) after deducting 26 percent on account of bifurcation.

(ii) Rationalization of electricity duty is expected to cause a revenue loss of aboutRs350 million ($7.5 million) each year in the next five years for a total of$37 million.

23

(iii) Set-off of dues of market borrowing of MPSEB to MPG will result in costs ofRs6,750 million ($144 million) over a five years period.

(iv) Set-off of cross-liabilities23 between MPG and MPSEB will result in a one-timepayment of Rs620 million ($13.2 million).

(v) Reduction of debt obligations of MPSEB.

2. Executing Agencies

86. The Executing Agencies will be the Finance Department and the Energy Department ofMPG.

3. Procurement and Disbursement

87. The proceeds of the policy loan will be utilized to finance the full foreign exchange costs(excluding the local duties and taxes) of imports produced in and procured from ADB’s membercountries, other than those specified in the list of ineligible items (Supplementary Appendix G)and imports financed by other bilateral and multilateral sources. All procurement will be throughnormal commercial practices in case of procurement by the private sector, or prescribedprocedures acceptable to ADB in the case of procurement by the public sector, having dueregard for the principles of economy and efficiency. The Government will certify that (i) if theproceeds of the loan will finance imports already made, the value of eligible imports in theperiod concerned exceeds the amount of the requested withdrawal, or (ii) if the loan proceedsare to finance goods to be imported, the value of eligible imports in the immediately preceding12 months period is equal to or greater than the amount of the requested disbursement plus allother amounts expected to be withdrawn from the loan during the succeeding one year.

4. Counterpart Funds

88. Counterpart funds generated by the policy loan will be transferred by the Government toMPG and be used by MPG under arrangements satisfactory to ADB, to support the financialrestructuring of MPSEB and adjustment costs associated with the SDP, including (i) payment ofoutstanding municipalities’ and other local and state bodies’ dues owed to MPSEB,(ii) rationalization of electricity duty, (iii) set-off of dues of market borrowings of MPSEB to MPG,(iv) set-off of cross liabilities between MPG and MPSEB, and (v) reduction of debt obligations ofMPSEB.

5. Monitoring and Tranching

a. Tranche 1

89. Release of the first tranche of $65 million (anticipated in December 2001) is dependenton fulfillment of the following actions:

(i) The Reform Act is brought in force.

(ii) MPSERC has announced the first tariff award.

23 MPG’s subsidy-related liabilities owed to MPSEB (approximately Rs18.5 billion as of 31 March 2001) wereadjusted against MPSEB’s loans owed to MPG (approximately Rs17.9 billion as of 31 March 2001) and net amountof Rs620 million was in cash from MPG to MPSEB.

24

(iii) MP Power Generation Company Limited (MPPGCL), MP Power TransmissionCompany Limited (MPPTCL), and MP Power Distribution Company Limited(MPPDCL) are incorporated and registered under the Indian Companies Act,1956.

(iv) MPG and MPSEB agree on all the arrangements, with all outstanding dues paid,in accordance with the MOU24 between MPG and MPSEB.

(v) MPG issues orders allowing MPSEB to disconnect with immediate effect, alldefaulting municipalities and other MPG bodies exceeding payables for morethan the immediately preceding one month equivalent of sales.25

b. Tranche 2

90. Release of the second tranche of $40 million (anticipated in September 2002) isdependent on fulfillment of the following actions:

(i) MPSEB has installed and operationalized not less than 7,500 meters as requiredfor the energy audit.

(ii) Establishment of boards of directors of MPPGCL and MPPTCL that shall includemajority of experts recruited in an open and transparent basis from outsidegovernment services, represented by the disciplines of finance, commerce,human resources, corporate planning, and information technology expertise.

(iii) MPG has taken a decision on distribution reconfiguration based on, inter alia, theEISP study findings, as mutually agreed between ADB and MPG.

(iv) MPG has paid MPSEB in cash Rs2,000 million out of total outstanding dues as of31 March 2001 (approximately Rs7,423 million after deducting 26.62 percent onaccount of bifurcation) owed by municipalities and other local and MPG bodies toMPSEB.

(v) MPG has submitted an approved debt restructuring plan for MPSEB to ADB,based on, inter alia, the EISP study, as mutually agreed between ADB and MPG,(the plan will also include a proposal of MPSEB through MPG to the Governmenton settlement of dues owed by it to central sector undertakings).

(vi) MPSEB has made its second tariff filing before MPSERC.

c. Tranche 3

91. Release of the third tranche of $45 million (anticipated in June 2003) is dependent onfulfillment of the following actions:

(i) New distribution companies are incorporated and registered under the IndianCompanies Act, 1956 as per decision on distribution reconfiguration.

24 The MOU is attached to the Development Policy Letter.25 The date of billing by MPSEB will be taken as the basis to calculate outstanding dues.

25

(ii) The transfer scheme(s)26 are finalized as mutually agreed between ADB andMPG.

(iii) MPSEB assets are transferred to MPPGCL, MPPTCL, and at least one of thenewly incorporated distribution companies, in accordance with the transferscheme(s).

(iv) MPSEB has made a third tariff filing before MPSERC.

(v) MPG has paid MPSEB in cash Rs2,423 million out of total outstanding dues as of31 March 2001 (approximately Rs7,423 million after deducting 26.62 percent onaccount of bifurcation) owed by municipalities and other local and MPG bodies.

B. The Investment Loan

1. Amount of Loan, Terms, and Sources of Funds

92. The Government of India has requested an investment loan of $200 million from ADB’sordinary capital resources to help finance the investment component of the SDP. The loan willhave a 20-year term, including a grace period of 5 years; an interest rate determined inaccordance with ADB’s LIBOR-based lending facility; a commitment charge of 0.75 percent perannum; a front-end fee of 1.0 percent, (the fee will be capitalized in the loan), conversionoptions that may be exercised in accordance with the terms of the draft Loan Agreement, theLoan Regulations, and ADB’s Conversion Guidelines; and other terms and conditions set forthin the draft Loan Agreement. The Government has provided ADB with (i) the reasons for itsdecision to borrow under ADB’s LIBOR-based lending facility on the basis of these terms andconditions, and (ii) an undertaking that these choices were the Government’s own independentdecision and not made in reliance on any communication or advice from ADB. The loanproceeds will be transferred by the Government to MPG under its normal arrangements oftransfers to MPG. MPG will relend the loan proceeds to MPSEB, at an interest rate of12 percent with a term of 20 years, including a grace period of 5 years. The Government willbear the foreign exchange risk in accordance with its policy.

2. The Executing Agency

93. The Executing Agency for the Project will be MPSEB (or its successor entities to beestablished as a result of the reform program, with prior ADB agreement).

94. MPSEB is a statutory body created under the Indian Electricity (Supply) Act of 1948. Itsobjectives are to generate, transmit, and distribute electricity in the state of Madhya Pradesh.

95. MPSEB is governed by a board appointed by MPG comprising a full-time chair and fourfull-time members for financial, generation, transmission, and distribution functions. SeeSupplementary Appendix H for the organization chart for MPSEB.

26 Scheme(s) concerning transfer of properties, rights, liabilities, and employees from MPSEB to its successor entitiesunder the Reform Act.

26

a. Financial Performance

i. Financial Performance of MPEB

96. Income statements, balance sheets, and cash flow statements, both historical andprojected are given in Supplementary Appendix I. Financial performance for FY1998–FY2001 issummarized in Table 6 and cost of supply and tariffs are shown in Table 7.

Table 6: Summary of Historical Financial Performance of MPEB and MPSEB(Rs Million)

MPEB MPSEBItems FY1998 FY1999 FY2000 FY2000 FY2001

Actual Actual Actual Pro Forma Provisional

Power Generation & Purchase (GWh) 30,486 33,059 34434 27,754 26,662T&D Losses (%) 19.1 19.4 31.6 34.0 49.0Power Sales (GWh) 24,652 26,659 23,547 18,323 13,598

Sales Revenue (excl. subsidies andsubventions)

47,333 48,217 54,507 36,373 34,508

EBITDA (excl. subsidies andsubventions)

3,426 (1,432) 388 (10,465) (14,070)

Net Income before Subsidies andSubventions

(7,530) (16,067) (16,844) (23,504) (27,302)

Net Income after Subsidies andSubventions

1,225 1,169 (13,713) (21,206) (25,362)

Net Fixed Assets 40,835 38,978 39,488 32,097 42,237Long-Term Debts 43,585 52,466 61,147 48,289 48,926Loans and Equity from the StateGovernment

23,251 25,434 21,621 15,865 15,865

Return on Net Fixed Assets 3.0% 3.0% -34.7% -66.1% -60.9%EBITDA = earnings before interest, taxes, depreciation, and amortization, GWh = gigawatt-hour, MPEB = Madhya PradeshElectricity Board, T&D = Transmission and Distribution, MPSEB = Madhya Pradesh State Electricity Board.Note: T&D Losses and Power Sales for FY2001 reflect reassessment of agricultural consumption.Source: MPSEB.

Table 7: Average Cost of Power and Tariff (Rs/kWh) by Category andConsumption Share (%)

MPEB MPSEBFY 2000 FY2001 Oct 2001

Consumer Category Share Avg. Tariff Share Avg. Tariff New tariff % increase

Low Tension Consumers Domestic 12.4% 1.05 17.2% 1.86 2.22 19.5%

Single Point 2.7% 0.38 2.0% 1.45 4.11 183.4%

Commercial 3.3% 3.62 4.7% 4.32 4.82 11.6%

Water Works 0.8% 0.85 1.1% 1.72 2.26 31.1%

Industrial 3.5% 2.89 4.5% 3.82 4.20 9.9%

Agricultural 41.0% 0.27 31.2% 0.58 0.65 13.2%

Public Lighting 0.6% 1.08 0.9% 1.74 2.76 58.2%

Total LT 64.4% 0.76 61.7% 1.52 1.77 16.0%

High Tension Consumers Railway 6.2% 5.32 8.2% 4.95 5.20 5.0%

Coal Mines 3.9% 4.31 3.8% 4.32 4.73 9.7%

Steel Plants 0.8% 4.79 0.6% 4.37 4.54 3.9%

27

Water Works 1.3% 1.54 2.2% 2.38 2.76 15.9%

Irrigation 0.1% 4.78 0.1% 5.36 5.63 5.0%

Licensee 4.0% 0.07 7.2% 0.80 1.50 88.4%

Border Village 0.1% 0.10 0.2% 0.31 0.31 0.0%

Industry 19.2% 3.79 16.0% 4.49 4.72 5.1%

Total HT 35.6% 3.63 38.3% 3.60 4.07 13.0%

Average Tariff 100.0% 1.78 100.0% 2.32 2.58 11.0%

Average Cost of Supply 3.03 4.61MPEB = Madhya Pradesh Electricity Board, MPSEB = Madhya Pradesh State Electricity Board.a. Tariff is exclusive of electricity duties and cess.b. Average cost of supply = (fuel cost + power purchase cost + administration cost + depreciation + financial charges) / salesvolume.c. Share and average tariff of agricultural consumers for MPSEB reflect reassessment of consumption volumed. New tariff for single-point consumers reflects the recent change of policy described in para 62.Source: MPSEB.

97. While sales revenue of MPEB has consistently increased from Rs47.3 billion in FY1998to Rs54.5 billion in FY2000, cash flow position has deteriorated as shown in earnings beforeinterest, taxes, depreciation, and amortization, and in FY2000 revenue narrowly coveredoperating cost, leaving no cash available for debt service. One of the major reasons for this wasthe high cost structure due to the high level of T&D losses, estimated at 31.6 percent in FY2000as compared with an estimated 19.3 percent in FY1999. This sharp increase resulted fromreassessment of consumption of agricultural consumers. As most of agricultural consumers arenot metered, their consumption tended to be overestimated and they are overbilled; thiscontributes to an underestimation of losses. A recent study by MPSEB in collaboration withEISP on actual consumption by unmetered consumers has revealed that the actual systemlosses for MPSEB could be as high as 47.1 percent in FY2000.

98. Another reason for the cash flow problems is low cost recovery as shown in Table 7. InFY2000, the tariff covered only 60 percent of cost of supply due to the highly subsidized tariff forLT consumers, particularly agricultural and domestic consumers. In addition, fuel and powerpurchase cost continually increased well above revenue increases. The lack of an automaticfuel or power purchase cost adjustment mechanism, which passes cost fluctuations on toconsumers, has also contributed to squeezing profit margins of MPEB. MPEB started to have aserious cash flow problem in FY1999. In response to this, tariffs were raised in March 1999.However, the increase was only sufficient to cover increasing operating costs, and MPEBcontinued to post substantial net losses.

99. Until FY1999, MPEB continued to achieve 3 percent statutory rate of return on net fixedassets after subsidy and subvention from MPG. However, MPG was unable to budget for therequired subsidy and subvention amounts, and was not even able to pay budgeted amounts incash. Adjusting subsidy and subvention payments at the end of each fiscal year against MPEB’spayments of liabilities to MPG has been common practice. In FY2000, MPEB stoppedrecognizing unbudgeted subsidies in its accounts and was thus not able to achieve a 3 percentrate of return. Even after this change of accounting policy, subsidy and subvention receivable ofMPEB stood at Rs23.3 billion as of 31 March 2001.

ii. Financial Position of MPSEB

100. In April 2001 the Government issued a provisional order whereby assets and project-related liabilities of MPEB would be apportioned on a geographical location basis betweenMPSEB and CSEB while non project-related liabilities would be apportioned based on a

28

population basis (MP: Chhattisgarh = 73.38:26.62). The pro forma financial figures in Table 6were prepared as per this order. Accordingly, MPSEB would assume approximately 79 percentof the total long-term debt of MPEB. On the other hand, MPSEB would retain onlyapproximately 67 percent of the total revenue base of MPEB, losing a substantial proportion ofthe high-profile industrial customers while keeping 94 percent of MPEB’s agriculturalconsumers. Therefore, the Government’s order further undermines MPSEB’s capacity to serviceits debt obligations. Both MPSEB and CSEB have requested the Government to reconsider theorder.

101. Independent from the final apportionment of assets and liabilities, the new MPSEB facesmore serious financial problem than its predecessor. In addition to the shift in its customer base,T&D losses are estimated at about 49 percent in FY2001; this coupled with accumulatingenergy dues from public sector consumers (Rs8.75 billion as of 31 March 2001), continues tosqueeze MPSEB’s cash flow. MPG had no fiscal space to provide sufficient budgetary supportin cash and has accumulated unpaid subsidy of Rs18.5 billion as of March 2001 (estimate afterdeducting 26.62 percent on account of bifurcation). Consequently, with the current tariff level,MPSEB has been unable to fully pay its dues to power and fuel suppliers, and defaulted on itspayment obligations to creditors.

102. To break the vicious spiral of this circular debt, MPG agreed under the SDP to offset itssubsidy-related and other liabilities owed to MPSEB (Rs18.5 billion) against its loans owed toMPG (Rs17.9 billion). The net balance of Rs0.6 billion was paid in cash by MPG to MPSEB.Furthermore, MPG agreed to pay all outstanding energy dues of municipalities and other MPGbodies and to ensure that they will remain current with their bills. MPG will use the entire policyloan under the SDP to settle, in cash, municipality and other MPG arrears outstanding as of31 March 2001 (Rs7.4 billion). As regards dues after March 2001, MPG has committed that ifmunicipalities and state government bodies do not make full payments of their energy dues,appropriations at source will be made by MPG so that the balance of receivables do not exceedone-month equivalent of sales. These measures will help MPSEB overcome its immediateliquidity problem, clean up its balance sheet, repay some of its creditors, and improve itsborrowing capacity for future investments.

103. As of 31 March 2001, MPSEB owed approximately Rs16 billion to central power sectorundertakings, mainly NTPC, Nuclear Power Corporation, and Coal India. Since accumulatedliabilities to central power sector undertaking is a common problem of SEBs throughout India, acommittee was set up by the Government to look into strategies for a one-time settlement ofdebts. The committee proposed that the state governments take over the SEBs’ liabilities andissue a 15-year tax-free bond to the central power sector creditors bearing 8.5 percent interestper annum with a 5-year grace period for repayment. In this securitization scheme, payment ofcurrent dues by SEBs would need to be guaranteed by the state governments. To becomeeffective, the scheme requires consent from a majority of state governments. However, someuncertainty exists as to whether the scheme would be workable given substantial liabilities to beassumed by state governments, many of which have little fiscal space. NTPC, one of thebiggest nonfinancial creditors to MPSEB, has indicated that regardless of this one-timesettlement issue it would continue to supply power unless MPSEB defaults on current dues.

b. Projected Financial Performance

104. MPSEB’s projected financial performance is summarized in Table 8 and the majorassumptions used in the financial evaluation of the Project and detailed calculation are providedin Appendix 8. The opening balance sheet of MPSEB is based on the Government’s order ofApril 2001 regarding apportionment of assets and liabilities of MPEB.

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Table 8: Summary of MPSEB’s Projected Financial Performance(Rs Million)

Item FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010

Power Generation 26,662 25,944 24,545 24,378 25,554 25,673 25,904 26,592 27,707 28,887

& Purchase (GWh)

T&D Losses 49.0% 43.2% 38.0% 35.0% 32.0% 29.0% 26.0% 24.0% 23.0% 22.0%

Power Sales (GWh) 13,598 14,297 14,808 15,451 17,377 18,228 19,169 20,210 21,335 22,532

Sales Revenuea 34,508 36,218 42,908 47,411 55,642 61,964 68,507 75,410 83,853 93,765

EBITDAa (14,070) (11,453) (3,186) (283) 3,299 7,058 10,623 13,071 15,517 18,613

Net Income beforeSubsidy and Subvention

(27,302) (20,720) (12,681) (11,777) (14,195) (12,337) (10,680) (9,191) (9,160) (6,263)

Net Income afterSubsidy and Subvention

(25,362) (14,892) (5,580) (4,324) (6,049) (3,724) (1,572) 433 1,064 4,656

Net Fixed Assets 42,237 43,180 49,890 51,467 52,377 50,875 49,651 48,405 46,663 44,424

Long-Term Debt 48,926 63,162 82,800 89,062 97,806 104,807 107,607 106,506 103,383 95,148

Loans and Equity fromState Government

15,865 17,627 1,696 1,696 1,696 1,696 1,696 1,696 1,696 1,696

Return on Net FixedAssets

–60.9% –38.0% –14.0% –9.4% –12.8% –7.8% –3.4% 1.0% 2.5% 11.8%

Debt Service CoverageRatio

(0.91) (1.78) (1.75) (1.94) (6.72) 0.67 0.76 0.99 1.20 1.26

Gwh = gigawatt-hour, T&D = transmission and distribution.aExcluding subsidies and subventionsSource: Staff Estimate.

105. MPSERC issued a tariff award in September 2001. As shown in Table 7, average tariffsfor LT and HT consumers were raised by 16 percent and 13 percent respectively, resulting in anoverall tariff increase of 11 percent due to expected change in the consumer mix from FY2001to FY2002. Although the new agricultural tariff is still far below the cost of supply, new tariffs areexpected to boost FY2002 revenue by 17 percent27 on an annual basis. Further tariff increasesare projected to enable MPSEB to achieve at least 75 percent cost recovery by FY2007 asrequired by the Reform Act except for agricultural consumers and a minor bulk purchaser. Theprojected average retail tariff per kWh for each consumer category is provided in Appendix 8,Table A8.2. The projection envisages that (i) a modest tariff increase will continue to be given tothe consumer categories being already charged higher-than-cost tariff, and (ii) tariff increaseabove inflation rate for consumers paying tariff below cost of service until achieving 100 percentcost of recovery. For commercial and industrial consumers in HT and LT categories, no furthertariff increase is assumed once the tariffs reach the breakeven point of cost of captive power(approximately Rs5.00/kwh). Also in September 2001, the MPG raised cess on electricity fromRs0.01 to Rs0.10 per unit. This is expected to generate additional tax revenue of Rs1.5 billion toRs1.6 billion per year.

c. Impact of the SDP on MPSEB’s Financial Projections

106. The projected financial results also depend on substantial reduction of losses,particularly nontechnical losses. In the projection, the current T&D losses are assumed to be49.0 percent in FY2001 based on the recent MPSEB estimate. The losses are projected to bereduced by 5 percent in FY2002, 3 percent annually up to FY 2007, and diminishing marginsthereafter. The projected reduction of T&D losses is in line with MPSEB’s comprehensive loss

27 Since new tariffs became effective on 26 September 2001, net increase of revenue in FY 2002 will be about 6.6percent.

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reduction plan partly financed under the Project. The projection also envisages improvement ofcollection efficiency due to computerization of the revenue management system financed underthe Project and the MPG’s assurance under the SDP of full recovery of dues from municipalitiesand other state government bodies.

107. Based on the MOU between MPG and MPSEB (agreed upon under the SDP), theprojection envisages (i) any future subsidy and subvention to be paid in cash, (ii) free powersupply bills to be fully reimbursed monthly, (iii) cash grant equal to electricity duties and cess tobe provided monthly, and (iv) additional cash injection in the form of subvention and/or capitalgrant to be provided to the extent necessary for MPSEB to remain solvent. As MPSEB hasdefaulted on all creditors and cannot afford to fully service its debt obligations for the next fewyears, it needs to agree with lenders and bondholders on debt restructuring as soon aspossible. Under EISP, CIDA is financing TA to prepare a debt restructuring plan for MPSEB.Initiation of negotiations with creditors based on the plan is a second tranche release conditionunder the Program. In the projection, debt service obligations, which have become due andunpaid, as well as ones that will become due over the next three years, are assumed to berescheduled in a manner reasonably acceptable to creditors.

108. The financial projections in Table 8 and in Appendix 8 present a base case scenarioduring SDP implementation. The projection indicates that MPSEB would be able to overcomeimmediate liquidity shortage through additional cash in-flow from tariff increase, partial recoveryof arrears from municipalities and state government bodies, and cash injection from MPG in theform of subsidies and subventions. In the medium to long term, efficiency improvement,particularly T&D loss reduction, will be a key driver for recovery of financial soundness.Reduction of losses by 3 – 5 percent annually, together with an average annual tariff increase ofabout 6 percent28 and continued government support, is expected to bring MPSEB back to abreak-even position in FY2008 and 3 percent rate of return in FY2010 on an after-subsidy andsubvention basis. This means that from FY2010 onward, MPG would start to phase out theannual subsidies and subventions. An upside scenario would be feasible if MPSERC increasesthe agricultural tariff to achieve 75 percent cost recovery by FY2007 and MPSEB accelerates itsloss reduction program to achieve target 22 percent by FY2007. In this scenario, MPSEB wouldachieve positive net income without subsidies and subventions by FY2006.

3. Implementation Arrangements

a. Management

109. The MPSEB Chairman will be in overall charge of the Project. Day-to-day projectimplementation will be undertaken and supervised by the PMU, which was established in May2001 specifically for the Project, headed by a senior MPSEB officer. The PMU will be assistedby a team of consultants to refine project details, procurement activities, and projectmanagement in general. MPSEB is in the process of expanding the staff strength of the PMU tocorrespond with the increased workload. Except for exceptional organizational requirements,the staff assigned to the PMU will be retained for the entire duration of project implementation inthe PMU and any vacancy in the PMU will be filled before such vacancy is made effective. ThePMU will be delegated decision-making powers.

28 Annual tariff increase is projected at 10 percent for LT consumers and 4 percent for HT consumers until FY2007.

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b. Implementation Schedule and Performance Review

110. Project implementation will commence in January 2002 and be completed in December2005 (Supplementary Appendix J). Direct supervision of implementation and monitoring theoperational performance of the components will be the responsibility of MPSEB. The PMU willprepare progress reports for the respective project components and submit them to MPG andADB on a quarterly basis within 20 days of the end of each quarter. The reports will contain anarrative description of progress made during the period. ADB will monitor the overall financialand technical performance of the state’s power sector, and the MPG’s fiscal position. MPSEBwill set up a benefit monitoring unit (BMU) within and reporting to the PMU, to monitor andevaluate the scope, implementation arrangements, and progress of SDP achievement. Thequarterly reporting will include socioeconomic and poverty indicators reflecting the impacts ofthe policy and the project components on end-consumers, particularly those living below thepoverty line. Using consulting services, the BMU will undertake an in-depth qualitative andquantitative assessment of the impacts of the reform on end-consumers. Outline terms ofreference for the consulting services are in Supplementary Appendix K.

c. Disbursement Procedures

111. Since the disbursements under the Project will be mainly for supply of goods, ADB'scommitment and direct payment procedures will be used for disbursement purposes.

d. Reports, Accounts, and Audits

112. MPSEB and the PMU will prepare separate progress reports for their respectivecomponents and submit them to ADB on a quarterly basis within 20 days from the end of eachquarter. The reports will include narrative descriptions of progress made during the period;changes to the implementation schedule, if any; problems or difficulties encountered and theremedial actions taken; the performance of the project implementation consultants whereapplicable; and the work to be carried out in the upcoming period. The reports will also includesummary financial accounts for the Project consisting of project expenditures during the period,year to date, and total expenditure to date. ADB will review the implementation and operation ofthe Project based on these reports and meet with MPSEB and the MPG officials at leastsemiannually to discuss project progress. Completion reports will be submitted to ADB withinthree months from completion of each of the components. A project completion report will besubmitted to ADB within three months of physical completion of the Project.

113. MPSEB will have its annual financial statements, including the income statement, balancesheet, and sources and applications of funds statements, audited by a professional auditing firmacceptable to ADB. Unaudited statements will be submitted to ADB within six months and auditedstatements within nine months from the close of the financial year. MPSEB will also submit toADB audited project accounts and the auditors’ observations with respect to compliance with theloan covenants.

4. Procurement and Consulting Services

114. ADB-financed goods and services will be procured in accordance with ADB's Guidelinesfor Procurement. For such procurement, bidding documents will be prepared in a manner toensure maximum competition under international competitive bidding. Each supply contract,estimated to cost the equivalent of $500,000 or more, will be awarded on the basis of internationalcompetitive bidding. Each contract estimated to cost less than the equivalent of $500,000 will beawarded on the basis of international shopping. For transmission lines and grid substations in

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general, separate contracts will be let on the basis of supply of materials. The contract for erectionof transmission lines will, however, include supply of tower steel. For facilities at 33kV and below,materials and equipment will be procured under supply only contracts. Erection will be done eitherby MPSEB’s own staff or under separate erection contracts to be let on the basis of localcompetitive bidding. A list of the major contract packages under the Project with their estimatedcosts is attached in Appendix 9. To expedite the procurement process, advance procurementaction was approved and MPSEB has been advised that approval of such advance procurementaction by ADB does not commit ADB to finance any ensuing Project. The Project does not includeretroactive financing.

115. To assist with timely project implementation, an international consulting firm with expertisein transmission line and substation construction, and project management will be engaged,following ADB’s Guidelines on the Use of Consultants. About 72 person-months of consultingservices are expected to be required for this purpose during the first two years of projectimplementation. A broad outline of the terms of reference for consulting services is given inSupplementary Appendix L.

116. For implementation of component D: Computerization of Information and RevenueManagement System, as also to carry out benefit monitoring of the SDP, MPSEB will engageexternal consultants, using its own funds and procedures. If however, ADB financing is requiredfor consulting services, then ADB’s Guidelines on the Use of Consultants will be followed.

VI. BENEFITS AND RISKS

A. Expected Impacts

1. Financial Analysis

117. Financial evaluation was undertaken for components A, B, and C. The financial rate ofreturn of each component is satisfactory compared with MPSEB’s weighted average real cost ofcapital of 7.81 percent. The financial internal rate of return for each component and itssensitivity analysis are summarized in Table 9. The sensitivity analysis for components A, B,and C confirmed that they would be expected to produce reasonable financial returns undervarious downside scenarios. The major assumptions used in the financial evaluation of theProject and detailed calculations are in Appendix 10.

Table 9: Sensitivity Analysis of the Financial Internal Rate of ReturnScenario A B C

Base Case 9.8% 10.0% 16.3%

a. 10% Increase in Capital Cost 8.5% 8.9% 14.7%

b. One Year Delay 8.7% 9.0% 14.1%

c. 10% Decrease in Tariffs 8.4% 8.7% 14.5%

d. a+b 7.7% 8.0% 12.8%

2. Economic Analysis

118. The SDP has as one of its immediate objectives establishing a commercial andcompetitive business environment in the power sector to promote efficiency gains and lossreductions. With overall T&D losses estimated at 47 percent, comprehensive reduction of lossesis one of MPSEB’s priorities. MPSEB’s loss reduction strategy targets three levels: (i) energyaudit and end-user metering, (ii) internal efficiency improvement through computerized billingand revenue system, and (iii) physical investments directly targeting loss reduction.

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119. Benefits from loss reduction are threefold. First, they will generate additional revenue forMPSEB. Second, commercial loss reduction in particular will reduce power demand for differentcustomer categories, and will thus indirectly contribute to reduced power shortages. Third,technical loss reduction in particular will result in economic resource cost savings as less unitsneed to be generated, transmitted, and distributed to supply the same amount of energy to end-consumers.

120. Project components A and B are for investment in the five distribution regions of MP withthe highest losses, namely, Bhopal, Gwalior, Indore, Jabalpur, and Ujjain. Component C isdirected at transmission system improvements throughout MP to reduce technical losses. Themethodology applied for the three components is similar.

121. The economic analysis was carried out at border price level using FY2001 prices. Toconvert financial cost into economic cost, taxes and duties were deducted. No pricecontingencies are included in the base capital cost, but the economic capital costs include10 percent physical contingencies. The costs were separated into foreign exchange, indirectforeign exchange, and local currency costs. Local costs were further separated and specificconversion factors used for unskilled labor. The remaining local costs were converted to borderprices by applying a standard conversion factor. Annual operation and maintenance cost werealso calculated in economic prices.

122. The economic benefits of loss reduction were calculated separately for technical andcommercial loss reduction. Technical loss reduction under component A was valued at theaverage cost of supply at LT level for FY2002, and for component C at the average cost ofsupply at extra high tension level for FY2000, the latest year for which the breakdown isavailable. Commercial loss reduction was valued at the increasing tariff levels up to FY2010,reflecting the changing relationship between average cost of supply and average tariff, whichresults in reduction of economic subsidies over the lifetime of the Project. Benefits are expectedto build up gradually over three years.

123. The base case economic internal rates of return are estimated at 17.1 percent forcomponent A, 16.8 percent for component B, and at 16.4 percent for Project component C.They were calculated for 25 years, including the construction period. No residual values wereconsidered. Comprehensive sensitivity analysis, including calculation of switching values,indicated that the economic internal rate of return values for all components are above the 12percent threshold for all adverse circumstances tested. Details of the economic analysis and thesensitivity analysis are in Appendix 11.

3. Poverty and Environmental Dimensions

124. The current state of electricity supply and operations has serious adverse impacts onincome earning activities for the poor. They are affected both indirectly, through reduced wageemployment opportunities,29 and directly, through reduced farm profitability and householdwelfare. The restructuring process provides an opportunity for MPSEB to review its operationsand the impacts on consumers. For MPG, it provides an opportunity to review the impacts of thetariff and subsidy policy and other interventions in the power sector. An in-depth povertyassessment was carried out to assess the impacts of the reforms and of the investmentcomponent on the poor under the SDP (Appendix 6).

29 This is particularly affecting the landless and the poorest of the poor.

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125. The poverty assessment revealed that the poor face significant barriers to accesselectricity. The new policy of MPSEB includes applying connection charges retroactively. Thepoverty assessment revealed that the introduction of connection charges constituted a barrierfor the poor to access electricity. Under the current policy SC/ST consumers below the povertyline are eligible for a single-point scheme for which the connection charge is amortized in fourmonthly installments. However, a majority of the poor do not fall into the SC/ST category andare as such not eligible for the scheme. On the basis of an affordability assessment and inconsultations with the poor MPSEB will introduce an interest-free 12 month installment facilityfor all consumers below the poverty line.

126. The current tariff and subsidy structure has hampered economic growth through itsburden on the fiscal budget, crowding out alternative public investments, and through its burdenon the banking sector, with consequent credit squeeze for private investments. Most of the poordo not have electricity connections and as such they are not beneficiaries of subsidizedelectricity tariffs. However, they are indirectly paying in terms of forgone investments and aredirectly affected by the lack of ability of MPSEB to provide good quality of services and toexpand the network into poorer areas. Thus, the current subsidy and tariff structure cannot bedefended on the basis of providing cheap services to the poor. Although the agricultural tariffssubsidize input costs for the agricultural sector, this has severely hampered the ability ofMPSEB to provide good quality of services. Tariffs set below the cost of supply, withoutadequate compensation from MPG, has made load shedding financially beneficial for MPSEBwhereas it has adverse impacts on consumers and economic growth.

127. Most of the poor are not connected, and those who are, experience poor quality ofservices. Farm profitability has been especially affected by voltage fluctuations since in additionto reducing farm output, it has led to increased costs. The findings show that the impact ofvoltage fluctuations has been especially costly for the poor. Load-shedding has led to reducedfarm output and forced consumers to diversify their energy sources, with consequent reductionin benefits of electricity use. The prevalence of unscheduled load-shedding, which representsabout 62 percent of the total number of power cuts, has especially been devastating byincreasing uncertainty in production and consumption activities.

128. The new mandatory metering policy was found to be beneficial for poor consumers andwill act to reduce the impacts of tariff increases. Metered consumers pay a lower per unit tariffthan unmetered consumers. In addition, it benefits consumers who consume more electricity.Since the majority of the poor are unmetered and consume small amounts the effect isregressive. These regressive effects of the tariff structure are further reinforced by theoccurrence of load shedding. Consumers experiencing less load shedding are paying a lowerper unit charge. Metering will reduce the impacts of tariff increases on the poor. Operationalefficiency gains from the SPD will further reduce the need for and the impact of tariff increases.

129. The SDP is designed to improve the policy and institutional environment of the sector asoutlined in the Reform Act with the long-term aim of improving the quality and quantity of thepower supply. The Reform Act has positive impacts from an environmental point of view as itoffers the opportunity to institutionalize environmental management in sector regulation beyondthe existing all-India statutory environmental requirements. Also, the decentralization of powersfor metering, revenue realization, disconnection, prosecution for theft, meter tampering, anddiversion of electricity to new power sector companies will facilitate adoption of measures toprevent energy wastage. This will contribute positively to more economic use of resources thatwill enhance environmental conservation.

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B. Risks and Safeguards

130. The SDP has several perceived risks:

131. Regulatory Risk . A central aspect of power sector reform is the establishment of anindependent regulatory authority to ensure the commercial operation of the sector, including arationalization for the tariff structure. A comprehensive program for institutional strengthening ofMPSERC, in particular for tariff setting principles and other financial aspects is required. In thepast, ADB supported participation of the three commissioners at an external training course andis currently preparing assistance to MPSERC for the drafting of rules, regulations, and licenses.DFID has prepared terms of reference for long-term consulting support for MPSERC and hasalready given approval in principal; the final decision by DFID is expected before the end of2001.

132. Financial Situation of MPSEB . To bring the sector to a sound commercial footing andto promote private investment, MPSEB will have to overcome the short-term liquidity crisis andimprove its financial viability in the long run. Given uncertainty of future tariff increase andoperational efficiency improvements, MPSEB will need to substantially reduce its financialburden through comprehensive financial restructuring with support from its stakeholdersincluding creditors, MPG, and the Government. Mitigation measures include the following:

(i) Settlement of unpaid revenue subsidy by MPG through a set-off againstoutstanding state government loans to MPSEB is a first tranche releasecondition. This will leave MPSEB less leveraged and will facilitate raising newfunds in the market at lower cost.

(ii) CIDA included analysis of debt and liabilities and preparation of an outlinefinancial restructuring plan under their EISP assistance to MPSEB.

(iii) MPG and MPSEB to agree on a future payment modality for subsidies andsubventions over the reform period.

133. Support for Outstanding Analytical Work . The model for the postreform sector hasbeen agreed upon in principle. However, in addition to the financial and accounting work requiredfor the functional segregation and the distribution reconfiguration (provided by CIDA under theEISP), substantial work is needed to develop schemes to transfer assets, liabilities, and personnelto the new power sector companies and to introduce the computerized information and revenuemanagement system. The India country strategy program for 2001 includes three small-scaleTAs30 and the 2002 program includes a TA for MP Power Sector Reform. The proposed scope ofthis TA is expected to focus on developing transfer schemes concerning MPSEB, under theReform Act. If cofinancing for the outstanding work cannot be mobilized, ADB will make further TAfunds available to support the reform activities.

134. Operational Effectiveness . The operational effectiveness of MPSEB and other powersector entities that will be created during the reform period will be critical in determining successor failure. To improve effectiveness, processes are being built into the system to strengthen theentities capacity to deliver over time. These include the following:

30 The TAs are for (i) corporate restructuring of MPSEB, (ii) business plan development, and (iii) capacity building forimproved customer responsiveness.

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(i) The composition of board of directors and senior management of new sectorcompanies will be changed to include professional expertise from outsidegovernment services. The operational performance is expected to improve as aresult of these measures.

(ii) Delegation of authorities to management of distribution circles benefiting fromADB assistance is being promoted. This will increase the accountability andprepare employees and customers for the creation of new distribution companieswith a more efficient and responsive management style.

135. Bifurcation of the Undivided State of Madhya Pradesh . Following the bifurcation ofthe undivided state of MP, the Government issued a provisional order on the bifurcation of theassets and liabilities (including employees) of MPEB between MPSEB and CSEB. MPG and theChhattisgarh government are requesting reconsideration of the order. Further, MPSEB haspending litigation with the CSEB on the revenues collected and retained by the latter between 1December 2000 and 15 April 2001. Since these two issues could impact on the agreement onthe transfer scheme(s), it has been made a third tranche condition and an assurance has beenincluded in the loan documentation that the Government will take timely steps to resolve theseissues (para. 149).

VII. ASSURANCES

A. Specific Assurances

136. In addition to the standard assurances, the Government, MPG and MPSEB, have giventhe following assurances, which have been incorporated in the legal documents.

1. General

137. The policies adopted and actions taken prior to the loan, as described in thedevelopment policy letter and policy matrix, will continue to be in effect for at least the durationof the SDP.

138. The Government will transfer the counterpart funds generated under the policy loan, andthe loan proceeds under the investment loan, under normal arrangements for transfer ofexternal assistance to MPG and shall treat such counterpart funds as an additionality totransfers allocated annually to MPG.

139. The Government will cause MPG to ensure that sufficient budgetary allocations aremade to MPSEB in a timely manner for efficient and timely implementation of the Project andthe SDP.

2. Administrative

140. MPG will, at all times, continue to emphasize, respect, and support the autonomy ofMPSEB with respect to commercial, administrative, and operational activities.

141. The Government and MPG will assist in expediting, issue of due permits and licenses forthe effective functioning of MPSEB’s successor entities as may be required by law.

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142. MPG and MPSEB will review with ADB the recommendations of the EISP study and othertechnical assistance, towards the restructuring of the power sector for its long-term administrative,financial, and economic viability, for implementation thereof in a manner satisfactory to ADB.

143. Within 15 months from the loan effectiveness, MPG will ensure that the majority of theofficers in the senior management of MPPGCL, MPPTCL, and one of the established distributioncompanies, are recruited through open and competitive selection process by the board ofdirectors of the respective companies.

3. Financial

144. MPG will make timely and adequate budgetary appropriations to meet its subsidy andsubvention payments to ensure that all dues are paid in cash to MPSEB (or its successor entities)within no more than six months of the raising of the claim by MPSEB or such entities.

145. MPG will make timely and adequate budgetary appropriations to meet its ruralelectrification subsidy/subvention payments based on the MOU between MPG and MPSEB; andwill continue to make timely and appropriate budgetary appropriations to meet MPSEB’sbalance of receivables (excluding past dues until 31 August 2001) from municipalities and otherlocal and state bodies so as not to exceed the immediately preceding one month’s equivalent ofsales at any time with effect from 1 January 2002.

4. Sector Reforms

146. MPG will ensure that MPSEB or its successor entities carry out proper metering of allend consumers in MP, in a phased manner for completion within four years from the date ofloan effectiveness of the SDP.

147. MPG will ensure that the power sector reforms under the SDP and the preparation of thetransfer scheme(s) are undertaken with full information and participation of all stakeholdersincluding, but not limited to, consumers, utilities, employees, and unions of MPSEB, andnongovernment organizations. In doing so, MPG will also ensure that such participation includesinformation to the stakeholders, procuring feedback on the same.

148. Recommendations of any employee transfer under the transfer scheme(s) will be in fullparticipation and consultation of all affected, in accordance with the applicable laws andregulations of the Government and MPG.

149. The Government will take timely steps in resolution of issues relating to (i) the finalallocation of assets and liabilities of MPSEB and the CSEB, (ii) the revenue collected by theCSEB from 1 December 2000 to 15 April 2001, and (iii) allocation of surplus power from CSEBand central sector utilities to MPSEB.

5. SDP Implementation and Benefit Monitoring

150. The MPG and MPSEB will undertake together with ADB, periodic reviews during SDPimplementation, to evaluate the scope, implementation arrangements, progress, andachievement of the SDP objectives in accordance with ADB’s Project PerformanceManagement System guidelines. For this purpose, MPSEB will set up the BMU within threemonths of loan effectiveness.

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6. Social Issues

151. MPG and MPSEB will allow all consumers living below the poverty line to make theirpayment for electricity connection charges, including all up-front charges associated withelectricity connections, in 12 monthly installments.

7. Successor Entities

152. Owing to the functional segregation of MPSEB under the SDP, if at any time in theinterest of proper implementation of the Project, ADB, MPG, and MPSEB find it necessary,MPSEB will transfer its rights and obligations under the related loan documents to its successorentity(ies) as required, with prior approval of and on such terms, conditions, and arrangementsas acceptable to ADB, wherefore such successor entity(ies) as the case may be, will bedeemed to be substituted for MPSEB.

8. Consulting Services

153. Within four months of the loan effectiveness and under its own financing, MPSEB willengage the domestic consultant required to implement component D of the Project.

9. Environmental Compliance and Resettlement Issues

154. MPSEB will establish a fully functional social and environmental management cell withinfour months of loan effectiveness to the satisfaction of ADB.

155. MPG and MPSEB will ensure that the Project is undertaken and all project facilitiesoperated and maintained in compliance with all applicable laws, rules, and regulations of theGovernment and MPG, the initial environmental examinations, and ADB’s environmentalguidelines and the Environmental Assessment Requirements.

156. MPSEB will provide ADB with annual reports on the monitoring results, permits,licenses, and clearances obtained for the Project. In case of any violation of laws and standardscited, the report will include certification from the relevant authority that such violation has beenrectified or an acceptable plan for correction approved.

157. MPG and MPSEB will ensure that in case of any specific land acquisition andresettlement under the Project, the Land Acquisition and Compensation Plan (where there is noresettlement) and the Land Acquisition and Resettlement Framework (where there isresettlement) for the various subprojects as agreed upon with ADB are implemented and duecompensation is paid to those affected in accordance with ADB’s involuntary resettlement policyand ADB’s Handbook on Resettlement (1998) as amended from time to time.

B. Conditions for Loan Effectiveness

158. In addition to the conditions set forth in the ADB’s ordinary operations loan regulations,following are conditions for effectiveness for the SDP loans:

(i) Legal opinions satisfactory to ADB will have been provided for the Loan andProgram Agreements for the policy loan; and the Loan and Project Agreements forthe investment loan.

39

(ii) The MP state legislature will have passed supplementary budget and MPG willhave paid MPSEB not less than (a) Rs3,000 million out of total outstanding duesas of 31 March 2001 (approximately Rs7,423 million after deducting 26.62percent on account of bifurcation) and (b) total dues between 1 April to 31 August2001, owed by municipalities and other local and MPG bodies to MPSEB.

VIII. RECOMMENDATION

159. I am satisfied that the proposed loans would comply with the Articles of Agreement of ADBand recommend that the Board approve:

(i) the loan of $150,000,000 to India for the Madhya Pradesh Power SectorDevelopment Program from ADB’s ordinary capital resources, with interest to bedetermined in accordance with ADB’s LIBOR-based loan facility; an amortizationperiod of 15 years, including a grace period of 3 years, and such other terms andconditions as are substantially in accordance with those set forth in the draftLoan and Program Agreements presented to the Board; and

(ii) the loan of $200,000,000 to India for the Madhya Pradesh Power SectorDevelopment Project from ADB’s ordinary capital resources, with interest to bedetermined in accordance with ADB’s LIBOR-based loan facility; an amortizationperiod of 20 years, including a grace period of 5 years, and such other terms andconditions as are substantially in accordance with those set forth in the draftLoan and Project Agreements presented to the Board.

TADAO CHINOPresident

14 November 2001

APPENDIXES

CORE

Number Title Page Cited On(page, para.)

1 Long-Term Sector Model 41 13, 46

2 Development Policy Letter 42 13, 46

3 Implementation Plan for Stage I 53 13, 46

4 Sector Development Program Frameworks 56 14, 49

5 Project Cost Estimates 60 19, 72

6 Poverty Impact Assessment 61 20, 77

7 Summary Initial Environmental Examination 70 21, 79

8 Financial Performance and Projections for MPSEB 77 30, 108

9 Contract Packages and Cost Estimates 81 31, 114

10 Financial Evaluation of the Project 83 32, 117

11 Economic Evaluation 87 33, 123

SUPPLEMENTARY APPENDIXES(Available on request)

A. Key Sector IndicatorsB. External Assistance to the Power Sector in IndiaC. Project DescriptionD. Participatory Rapid Appraisal and Social DimensionsE. Proposed Organization of Environmental Management Cell of Madhya

Pradesh State Electricity BoardF. Summary Land Acquisition and Compensation PlanG. List of Ineligible ItemsH. Organizational Chart of the MPSEBI. Financial Statements of MPSEBJ. Project Implementation ScheduleK. Terms of Reference for Benefit Monitoring and Impact AssessmentL. Terms of Reference for Project Implementation Consultants

40

Appendix 1

LONG-TERM SECTOR MODEL for MADHYA PRADESH POWER SECTOR

Component Status Quo Stage I Stage II

Gov. Role Owner Owner Part owner

PrivateInvestors

None, IPPs permitted None, IPPs permitted Private shares,partial divestment

IndependentRegulator

Established underCentral Act

Established under State Act Fully operationalcontrol

GenerationCompanies

Multiple GenCos

TransmissionCompanies

Single TransCo

DistributionCompanies

Multiple DistCos

EnergyBrokers /MPSEB

Single buyer ormultiple buyer

SystemManager

Parastatal, verticallyintegrated utility,possible IPPgeneration

Corporatized generation,transmission and distributionfunctions, IPP generation withMPG guarantee

By TransCo

FinancialPerformance

Weak, not meetingcurrent operating costs

Strengthened, meetingoperational costs

Stable, raisescommercial capital,meets commercialperformancecovenants

Subsidies Subsidies from statebudget and heavycross-subsidies

Cross-subsidies reduced inaccordance with Reform Actand direct poverty reductionsubsidies from MPG budget

Direct povertyreduction subsidiesfrom MPG budget

Tariff Design Nonoptimal Tariff structure rationalized Wires rates forTransCo andDistCos

DevelopmentBank Role

Important fundingsource, highinvolvement

Limited new investment, workwith MPG and Regulator

Selectiveinvestment, non-economic funding(e.g., ruralelectrification)

DistCo = distribution company, GenCo = generation company, IPP = Independent Power Producer,MPG = Madhya Pradesh Government, MPSEB = Madhya Pradesh State Electricity Board,TransCo = transmission company.

41

42 A,ppendix 2, page 1

Tel Oft: ;551370

551848

Res :552298

'tit. $. ~

1:1 &:r ~

Chief Secretary

"tt~ ~

-q"ffi't ~. ~--462004

Government of Madhya PradeshVaflabh Bhavan, Bhopal-462004 .

D.o. N~. 5:!. 3 /C.S./2001

Bhopal, Dated 9 November, 2()O )

Subject: Madhya Pradesh Power Sector Development

Programme -ADB Assistance.

The Government of Madhya Pradeh has developed a

Power Sector Development Policy Frame Work in conectioll \\it 11

am enclosing a copy of the same along \viththe above ADB loan.

EncI.:as above !\ .'"'~,I lI v ---2:" 1\ "'-

(P.K. Mehrotra)

Shri C.M. Vasudeva,

Secretary.Govt. of India,

Deptt. Of Economics Affairs,

New Delhi.

thc associatcd Policy Matrix for your kind infonnation.

p ~ l- } U\i --c:. ;.--C:-.Vc..- ...~~\ I Yours sincerely,

43 Appendix 2, page 2

Dr. Adarsh KishoreAdditional Secretary (FB, ADB & EF)Tel. No.301 3183

~ ~/NewDelhi.

New Delhi, the ~ November, 2001

Dear Mr. Chino,

This is regarding the Madhya Pradesh Power Sector DevelopmentProgramme Loan.

I enclose a copy of the letter dated 1 st November 2001 of theGovernment of Madhya Pradesh to this Department, expressing the unequivocalcommitment of the State to implement the Madhya Pradesh Power SectorDevelopment Program, for which negotiations for a total loan of US$ 350 millionare scheduled to take place from 71h November, 2001 in Manila. A Policy Matrixoutlining the proposed actions by the Government of Madhya Pradesh and acopy of draft MoU is also enclosed.

I am pleased to convey the full support of the Government of India to theGovernment of Madhya Pradesh in implementing the Programme, and requestAD8 to lend US $ 350 million from its ordinary capital resources so as to enablethe Government of India to re-Iend these funds to the Government of MadhyaPradesh.

I take this opportunity to convey my good wishes to you.

With warm regards,

Yours sincerely,

~~

(Dt. Adarsh Kishore)

EncJ: As above

Mr. Tadao Chino

President

Asian Development Bank

Manila, Philippines.

~ ~ Ministry of Finance

~ -cr;m ~ Department (Jf Economic Affairs

Appendix 2, page 344

K. Shankar-Narayanan.I.A.S

Principal SecretaryEnergy

~ Off. : (0755) 551147, 597562

Fax :(0755)559642Resi. : (0755) 557308

Email- kshankarnarayanan@hotmail.com

GOVT. OF MADHYA PRADESH

MANTRALAYA VALLABHBHAWAN

BHOPAL -462 004

D.~. Letter No.7"4~;1:;:;J~(

! °\-I.I-~Dat~ l

Dear Shri k-~~ /

1. The Government of India, at the request of the Government of ilJ1adhya Pradesh. hasaoprcached the Asian Deveiopment Bank (ADS) for financiaj assistance of $350 miilion tosupport implementaticn of the Madhya Pradesh Power Sector Development Program{MPPSDP) by the State of Madhya Pradesh, The Government of \~adhya Praqesh, togetrer..vith ACB. has carried out a rcvjevv of the power sector and have finalized the str~tegjes for theshort ,and medium term for restructuring of the sector based on (!) the state's High L~ve!

Committee Report on PoY'/er SE-ctor Reforms (th8 Tc.ta Rao Com~ittee Report) off 1997; anj (ii)the preparatory studies conducted under technical asslstance projects funded by:AOB and theCanaaian internationai Development Agency (CIOA); and (iii) the Nleli1oranc;um ofUnder?tanding dated May 2COO signed betvveen the Government of India 3nd tht Governmentc'f ~laphya Pradesh, The power sector has deteriorated in the past several years to su,::;h ane;<tent that its critical physical and financial situaticn is becoming a severe constraint toeconomic gruv\/t1 and has affected the \Melfare of the people in general, With thi$ backgrolJn(Jthe Government of Madhya Pr3desh has resci'Jed to urdertake pcwar sector ,ef:)rms and makeadequar? an(j erilcier:t pol;ver avaiiacie to aii secto(s of tne econorr;y and SCCiely',

A. Objectives of Power S~ctor Reforms

2 'he objectives of tr1e ;.;c\;.l/er sector reforms are'

(a) To achieve ccmmerciat =fficienc:1 and financia! viabilit-/ so that the sector jcesnot absorb "'1adhya Pradesh's financial resources that are needed for socio-economic development;

(b) To improve delivery of services and acr.ieve cost effecti'.jeness throl,lgh t=chn:cal,managerial and administrative restructuring of the utilities.

(c\, j To increa~e the operating efficiency of all power sector utilities thtough greater

competition, managerial autonomy ar.d higher accountability.

(d) To create an environment which will attract private capita!, both domestic andforeign to supplement public sector investment;

B. P.,pproach to the Reforms

3. The legislative basis for restructuring and regulating the State's power sector is tne

~l1adhya Pradesh Vidyllt Sudhar Adhin!yam 2000 (No.4 of 2001) (the Reform Act)

Appendix 2, page 445

4. The key provisions of the Act are

(i) Independent tariff setting and regulation. through the establishment of theMadhya Pradesh Electricity Regulatory Commission;

(ii) Compulsory metering of all consumers;

(iii) Recovery of at least 75 percent of the cost to serve each consumer category,through the tariffs of that consumer category. progressively over a period of 5

years;

(iv) Functional segregation of the sector into generation,distribution;

transmission and

(v) Reorganization of the Madhya Pradesh State Electricity Board into severalsuccessor companies, to enable competition; and

(vi) Commercialization of all activities in the sector, including promotion of prNatesector participation wherever feasible and desirable.

5. Under the Act referred in paragraph 3, the Madhya Pradesh Electricity RegulatoryCommission (MPERC) a ne',v statutory, independent regulatory authority has been establishedwhich is responsible for:

(a) setting electricity tariffs and determining the corresponding performance norms;

(b) collecting, verifying and disseminating sector statistics;

(0) coordinating long term PQlNer planning;

(d) creating and maintaining a non-discriminatory and commercial businessenvironment in this sector;

(e) adjudicating disputes betvveen sector entities; and

(f) licensing.

6. In the power generation segment of the sector, it is expectea that in the long-term, therewould be several generating companies, both public and private. The latter could be of varioustypes including:

(a) independent power producers;

(b) cooperative generators;

(c) captive generating units selling their surplus energy to the grid; and

(d) private generating and distribution companies.

7. At present Madhya Pradesh's pOller grid is being maintained by the MPSEB. Afterrestructuring, in order to facilitate povJer pooling and wheeling between suppliers andconsumers, the State's power grid will be maintained by the transmission subsidiary of MPSEB,

46 Appendix 2, page 5

which will re responsible for operation, system expansion and maintenance of properparameters in the grid under the supervision of the regulator. This entity will aJso be responsiblefor the interconnections with other power systems of the country.

8. To have a sustainable power sector development and to provide quality power ondemand to all consumers, GOMP would undertake segregation of the generation, transmissionand distribution functions and will corporatize the utilities. GOMP will review the working of thereorganized utilities/companies and will take measures to restructure them to achievecommercial viability and reduction and elimination of power theft within a spe~ified time frame.If the achievement of those objectives required sufficient disinvestments for professionalisingmanagement and fully distancing it from Government, the same wouJd be undertaken.

c. Private Sector Participation

9. The Government of Madhya Pradesh reaffirms its commitmen~ to encourc.geinvoivement of private sector participation in generation and distribution in a i phased mannerthrough a transparent and competitive bidding process. In support of this, the State's approechwill be to foster a business environment, which will provide a level playing fieid both for theprivate and public sectors and also by separating sector regulation from operations. It isrecognized, however, that to provide incentives for better technical performanCl:1, there has to becompetition and an appropriate enabling commercial business environmEtnt. As alreadymentioned earlier, Madhya Pradesh has established the Madhya Pradesh jState ElectricltyRegulatory Commission to make tariff setting and regulation, transparent and apolitical, arId hasmade metering compulsorf. Further, in order to create an enabling environment' GOMP has alsoenacted a lay, prohibiting unauthorized use of electrical energy and to brihg into effect atransparent, effective and speedy mechanism for assessment and compounding of cases ofillegal abstraction, use. consumption and pilferage of energy, and recovery of electricity chargesin a manner \Nhich series public interest and ensures fair play and justice.

D. Tariffs

10. The Government of Madhya Pradesh recognizes the fact that there has to be a tariffrationalization if private and foreign investments are to be forthcoming in the power sector.Utilities should operate on commercial principles and earn adequate rates of return on capitalinvestments. On the other hand, grant of unrestrained freedom to fix the tariff ~y power utilities...vill lead to consumer interest being adversely affected. Looking to this Madhya Pradesh has setup an independent regulatory commission. While the Government of Madhya Pradeshrecognizes, on the one hand, the need for the continuance of subsidized tariff for agriculturaland socially obligatory activities like drinking water and street lighting and lighting for urban andrural poor, on the other hand, it also recognizes that these subsidies will have to be explicit,quantified, reasonable and targeted and that, while cross-subsidization cannot be fullyeliminated, it has to be kept within reasonable limits. Thus, the Reform Act provides a minimumrecovery of 75 percent of the cost to seNe a category of consumers has been mandated. As ameasure to demonstrate its will to rationalize electricity tariffs and reverse the trand ofincreasing cross-subsidization of agriculture consumers, rv1 PERC has raised the effective tarifffor electricity, supply to the agriculture sector from Rs 1.00 per kWh to Rs. 1.20 ~er kVvh witheffect from 5'h Oct. 2001. This trend is expected to continue in the years ahead. In addition, theGovernment of f'v1adhya Pradesh has restricted the provision of free power supply to single-Jightpoint urban and rural consumers and to agricultural consumers 'Nith purr,ps up to 5 HP effectiveJanuary 2001.

Appendix 21 page 647

E. Public Consultations

11. The Government believes that pO'Ner sector reform requires concerted interventions atdifferent levels of the sector to make the reforms a success. A phased approach taking intoaccount the ground realities and the available financial and managerial resources of theGovernment and the sector has been drafted. The Government of Madhya Pradesh held publicconsultations about domestic and international experiences 't.Jith power sector reform and themerits of different sector structures before it commenced the preparation of the MadhyaPradesh Reform Act. The Reform Act was brought into force on 3 July 2001 and is the mostprogressive in India todate. Similarly, many of reports generated by the ADS and CIDA-fundedstudies were prepared after consultations vvith various stakeholders and their viewsincorporated. This makes the Madhya Pradesh reform program one of the most transparent inIndia.

F. Conclusion

12. Only a reliable and efficient electricity infrastructure will pave the V Jay for the contir,uedexpansion of the state's economy and the welfare of its people. The Government of MadhyaPradesh once again reaffirms its commitment to restructure the pQ\Ner isector along commerciallines. Given its vast experience in the reform process in the pO'\.'ier sectors of its developingmember countries. ADS can playa majOr role in assisting Madhya Pradesh in restructuring thesector. On behalf of the Government of Madhya Pradesh, I wish to convey our unequivocalcommitment to the ~J1ac!hy.a Pradesh Power Sector Development Prc~ram and request you tokindly for.;vard this letter to the President of ADB for the purpose of seel{ing ADS's assistance forits implementation.

13. A Policy Matrix outlining the proposed actions by the G0'11'ernr11ent of 1'v1adhya Pradeshand a copy of draft M aU is enclosed.

V'/ith regards,

\( ~urs sincerely,

d~~~} (K. ShaRkat: !'161==.~/Q~~1)~

Shri Ashok Lavasa,Joint Secretary ,Government of India,Ministry of Finance,Department of Economic Affairs,i'4EW DELHI.

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ppendix 2, page

9

Appendix 2, page 1051

Memorandum of Understandinq (MOU) between the Government of

.Madhva Pr:adesh and Madhva Pradesh State Electricitv Board

1. The aide-memoire of the ADB fact-finding mission visiting MP in March/April, 2001included a covenant for GoMP and MPSEB to agree on a memorandum of understandingto settle the outstanding RE-subvention as of 31 st March 2001, acceptable to ADB (seepage 12,para 40,point j of the said aide-memoire).

The Status as of 14th April 2001 is as under:

Pavables bv MPSEB(Rs.in Crore)

Particulars MPEB 'MPSEB !% Share

310.86 : : 228.11 I 73.38%

4.04.2001 918.92 I 674.30 ! 73.38%

as on 14.04.2001 1 203.67 I i 883.25 I 73.38%2.433.45 , 11.785.66 i 73.38%

2. The above net amount of payable by the GoMP to MPSEB of Rs. 61.98 Crore has

been paid in cash.

GoMP has paid in cash to MPSEB energy bills for free supply of power from2001 to August, 2001. Thereafter, GoMP will continue to pay in cash to MPSEB

energy bills in full for free supply of power and also supply of power on account of

subsidized tariff as directed by the GoMP on a monthly b~.sis.

3.

~v4. GoMP will release grant to MPSEB every month, for an amount equal to the monthly

energy duty and cess received from MPSEB.

5. GoMP has budgeted for the FY 2001-2002, an amount of Rs. 325 Crore forsubsidies/subventions due to MPSEB, including for those mentioned under paras. 3 and 4above. However, a re-assessment of the sufficiency of such budgeted amount will beundertaken promptly by GOMP, after announcement of tariff award by MPSERC forFY 2001-2002, and its impact on the financial position of MPSEB. Such re-assessment will

~ also take into account impact of such budgetary subsidies/subventions on the targets

- ~ ...:.-'..

Appendix 2, page 1152

agreed under the ADB-financed Madhya Pradesh Public Resource Management ProgramLoan, approved by ADB as on 14 December 1999. If such re-assessment indicatesadditional budgeting, GOMP will include such requirements under the immediately

subsequent supplementary budget.

~

ONZ-

FINANCE DEPARTMENT

GOVT. OF M.P.

ON BEHALF OFENERGY DEPARTMENT

GOVT. OF M.P.

9 November 2001

ON BEHALF OFMADHYA PRADBSH STATE

ELECTRICITY' BOARD

Appendix 3, page 1

IMPLEMENTATION PLAN FOR STAGE I

SectorRestructuring

Tasks to be Completed Responsibility Time Frame

A. Sector Model andRegulatory Reform

State’s decision to reform the powersector

MPG Done

Establish the MPERC under Central Act MPG Done –June 1999

File tariff petition beforeMPERC/MPSERC

MPSEB Done –April 2001

Bring MP Power Sector Reform Bill intoforce(MPSERC takes over from MPERC)

MPG Done –July 2001

Issue tariff order MPSERC Done –September 2001

Draft regulatory framework MPG, MPSERC,ADB, otherassistanceagencies

Ongoing activity

Capacity building of MPSERC MPG, MPSERC,ADB, otherassistanceagencies

Ongoing activity

Incorporate and register generation,transmission, and distributioncompanies under the Companies Act

MPG, ADB First trancherelease condition

Decide on distribution reconfiguration MPG, MPSEB,ADB

Work ongoingunder CIDAassistance, secondtranche releasecondition

Constitute independent boards andmanagement for new companies

MPG, MPSEB,ADB

Second trancherelease condition,administrativeassurance

Incorporate and register distributioncompanies

MPG, MPSEB,ADB

Third trancherelease condition

Transfer MPSEB assets to generation,transmission, and at least onedistribution company

MPG, MPSEB,ADB

Third trancherelease condition

53

Appendix 3, page 2

B. FinancialDiagnostic ofMPSEB

Conduct detailed accounting work –financial analysis of MPSEB

MPSEB, ADB,CIDA, otherassistanceagencies

Ongoing activity

Analyze debt and liabilities, and preparefinancial restructuring plan

MPSEB, ADB,CIDA, assistanceagencies

Ongoing activity,second trancherelease condition

Create opening balance sheets for newsector companies

MPG, MPSEB,ADB, CIDA, otherassistanceagencies

Ongoing activity

Undertake corporate financial planning MPSEB, ADB,CIDA

Ongoing activity

C. Framework forRationalization ofTariffs

Estimate long-run marginal cost andcost of service

MPSEB, CIDA Final report byMarch 2002

Estimate ability and willingness to pay MPSEB, CIDA Final report byDecember 2001

Provide support for future tariff filings ofMPSEB

MPSEB, CIDA Ongoing activity

D. Transfer Scheme(Assets, Liabilitiesand Employees)

Finalize transfer scheme(s) MPG, MPSEB,ADB

Third trancherelease condition

Notify granting of provisional license toMPSEB’s successor entities

MPSERC, MPG Before third tranche

Notify bringing the transfer schemerules into force

MPSERC, MPG Before third tranche

TechnicalImprovement

Tasks to be completed Responsibility Time Frame

A. Long-TermSystemMaster Plan

Complete load forecast MPSEB, CIDA Ongoing, finalreport byDecember 2001

Develop generation, transmission anddistribution investment plan

MPSEB, CIDA Ongoing, report byDecember 2001

B. Initiate Measuresfor Reducing T&DLosses

Operationalize energy audit meters MPSEB Second trancherelease condition

Meter all consumers MPSEB End of 2004

Bring into force a bill against theft MPG Done –May 2001

Undertake internal efficiencyimprovement measures

MPSEB Ongoing

4354

Appendix 3, page 3

Computerize information and revenuemanagement system

MPSEB, ADB,other donors

Pilot ongoing,hardware providedunder ADB ProjectLoan

C. PerformanceParameters

Grid code MPSEB, ADB,CIDA,

All tasks to becompleted beforenotification of assettransfer (thirdtranche release)

Distribution code MPSEB, ADB,CIDA

Benchmarking indicators MPSEB, ADB,CIDA

D. ADB LoanPreparation

Technical components MPSEB, CIDA,ADB

Environmental assessment MPSEB, ADB,CIDA

First four taskscompleted

Social, poverty, and impact analysis MPSEB, ADB,CIDA

Land acquisition and resettlement plan MPSEB, ADB

Bidding documents MPSEB, ADB Advancedprocurement actionapproved, ADBprocurementseminar held inNovember 2001

ADB = Asian Development Bank, CIDA = Canadian International Development Agency, MP = Madhya Pradesh,MPERC = Madhya Pradesh Electricity Regulatory Commission, MPG = Madhya Pradesh Government, MPSEB =Madhya Pradesh State Electricity Board, MPSERC = Madhya Pradesh State Electricity Regulatory Commission.

55

SECTOR DEVELOPMENT PROGRAM FRAMEWORKS

Table A4.1: PROGRAM FRAMEWORK FOR POLICY LOAN

Design Summary Program Targets Program MonitoringMechanisms Risks / Assumptions

1. GoalTo improve state budget ofMadhya Pradesh

• Budget outlay for powersector reduced

• Annual budget • External environment

2. PurposeSupport establishment ofcompetitive, commerciallymanaged, financially viable,and efficient power sector

• Sector unbundled

• Independent and transparentsector regulation

• Depoliticized tariff setting

• MPG official notification ofregistration of new sectorentities

• Bringing into force of ReformAct

• Regulatory Commissionestablished under ReformAct

• Political will

• Political will

• Political will

3. OutputsEstablishment of new sectorentities

MPSERC operationalized

• Nomination of board ofdirectors

• Opening balance sheetsprepared

• Transfer of assets

• Regulatory frameworkestablished

• Business procedures andinternal regulations finalized

• Official notification ofnomination

• Balance sheets approved

• Transfer scheme(s)approved

• Regulation and proceduresapproved

• First tariff ruling issued

• Political appointments

• Bifurcation of MPEB notfinalized

• Bifurcation of MPEB notfinalized, labor unions

• Regulatory risk –independence of regulator

• Regulatory risk –independence of regulator

Appendix 4, page 1

56

Design Summary Program Targets Program MonitoringMechanisms Risks / Assumptions

Distribution reconfigurationfinalized

• Distribution companiesincorporated

• Decision on reconfiguration • TA report delayed• Political disagreement over

reconfiguration model

• Bifurcation of MPEB notfinalized

4. Inputs ADB policy loan of$150 million

TA – IND 2980: MadhyaPradesh Power SectorDevelopment Program

Small-scale TAs for(i) Corporate Restructuring ofMPSEB, (ii) Capacity Buildingfor Improved CustomerResponsiveness, and(iii) Business PlanDevelopment for Power SectorCompanies.

TA (2002) for Madhya PradeshPower Sector

ADB = Asian Development Bank, MPEB = Madhya Pradesh Electricity Board, MPG = Madhya Pradesh Government, MPSERC = Madhya Pradesh StateElectricity Regulatory Commission, TA = technical assistance.

Appendix 4, page 2

57

Table A4.2: PROJECT FRAMEWORK FOR INVESTMENT LOAN

Design Summary Performance Targets Project MonitoringMechanisms

Risks/ Assumptions

1. GoalTo improve state budget ofMadhya Pradesh

• Budget outlay for power sectorreduced – spending for povertyreduction increased

• Annual budget • External environment

2. PurposeTo enhance quantity and qualityof power delivery

• Network to be able to evacuatepeak load by 2006

• System operated at optimalfrequency and voltage levels

• System operations report • Availability of funds

• Sufficient generatingcapacity and powerpurchases

• Regional grid discipline

3. OutputsEnergy Audit implemented andoperationalized

100% metering

Transmission, subtransmission,and distribution networkstrengthened

• Meters installed at all feedersdown to 11 kV level by June 2002

• All consumers metered by end2004

Construction of:• 170 33/11 kV substations and

7,600 11/0.4 kV substations

• 1,800 km of 33 kV and 2,095 km of11 kV lines

• Monthly reports oninstallation and operation

• Monthly reports oninstallation and operation

• Project reports andmissions

• Manufactures delivermeter on time

• Availability of funds

• Meter manufacturing

• Delays in procurement

• Sufficient delegation ofoperationalresponsibilities to fieldstaff

Appendix 4, page 3

58

Design Summary Performance Targets Project MonitoringMechanisms

Risks/ Assumptions

Introduction of LT-less systemin high theft areas

Overall system loss reduced

Effective billing and collectionprocedures installed

• 71 132/33 kV substationsaugmented and 35 newsubstations at 132/33 kV level built

• 220 km of 220kV and 634 km of132kV

• Commercial losses reduced from25% to 8% in pilot areas

• System loss reduced from 49% inFY2001 to 32% in FY2005

• Collection efficiency improved to92% in FY2005.

• Division and districtstatistics

• Annual loss reductionstatistics

• Monthly billing andrevenue statistics

• Political will

• Political will

4. Inputs

ADB project loan of $200million

CIDA TAs for (i) Power SystemMaster Plan and (ii) TariffRationalization Study

CIDA – Canadian International Development Agency, km = kilometer, kV = kilovolt, TA = technical assistance.

Appendix 4, page 4

59

60

PROJECT COST ESTIMATESExchange Rate: $1.0 = Rs 47.00

Project Component Foreign Exchange Local Cost Total Cost($ million) Rs million $ million equiv. $ million equiv.

A: 33kV and 11kV System Improvements in Bhopal, Gwalior, Indore, Jabalpur, Khargone Mandsaur, and Ujjain Areas

1. 33kV subtransmission 28.0 601.6 12.8 40.8 2. 11kV and low voltage distribution 27.8 633.0 13.5 41.3 3. Land Acquisition and Compensation 0.0 40.0 0.9 0.9

Subtotal (A) 55.8 1,274.6 27.1 82.9

B: Conversion of Low Voltage Lines to 11kV in Mandsaur and Ujjain Districts 1. Mandsaur 3.1 51.5 1.1 4.2 2. Ujjain 2.2 34.6 0.7 3.0

Subtotal (B) 5.3 86.1 1.8 7.1

C: Transmission System Reinforcements 1. 400/220kV Additional Transformers 8.5 79.9 1.7 10.2 2. 220/132kV Additional Transformers 4.1 36.4 0.8 4.9 3. 220kV Lines 6.3 83.5 1.8 8.1 4. New 220 kV substations 11.6 179.3 3.8 15.4 5. 220kV Feeder Bays 1.1 12.8 0.3 1.4 6. 132kV Lines 16.9 347.4 7.4 24.3 7. New 132/33kV Substations 20.5 433.5 9.2 29.7 8. 132kV Feeder Bays 4.3 55.5 1.2 5.5 9. 132/33kV Substation Augmentation 15.8 162.0 3.4 19.2

Subtotal (C) 89.1 1,390.2 29.6 118.7

D: Computerized Information and Revenue Management System Computer Hardware 7.8 92.0 2.0 9.8

Subtotal (D) 7.8 92.0 2.0 9.8

E: Metering Metering 1.1 0.0 0.0 1.1

Subtotal (E) 1.1 0.0 0.0 1.1

F: Consulting Services for Project Implementation Consulting Services for Project 1.8 0.0 0.0 1.8 Implementation

Subtotal (F) 1.8 0.0 0.0 1.8 Subtotal Base Cost 160.9 2,842.9 60.5 221.4

G: Contingencies Physical 15.9 281.4 6.0 21.9 Price 5.0 410.9 8.7 13.7

Subtotal (G) 20.9 692.3 14.7 35.6

Front-end Fee 2.0 0.0 0.0 2.0 Taxes and Duties 0.0 1,435.3 30.5 30.5 Interest/Commitment Char ges

During Construction 16.2 620.4 13.2 29.4

Total 200.0 5,590.9 118.9 318.9

Appendix 5

Appendix 6, page 1

POVERTY IMPACT ASSESSMENT

A. Poverty Profile

1. The domestic electrification ratio in the new state of Madhya Pradesh is estimated at42 percent with 80 percent of the households electrified in urban areas and 29 percent in rural.Poverty is fairly equally distributed between rural (37.1 percent) and urban areas (38.4 percent).Thus, the urban bias in electrification favors the nonpoor. Due to the lack of poverty statistics inconsumer data of the Madhya Pradesh State Electricity Board (MPSEB), the poverty profile(Tables A6.1 and A6.2) of electricity and nonelectricity users is based on primary household andfarm data from a socioeconomic survey carried out by Canadian International DevelopmentAgency (CIDA)-funded consultants during the first half of 2001. The definition of poverty usedfor households is based on the poverty line applied for provision of food subsidies (“Blue Cards”issued by the Madhya Pradesh government [MPG]). Landholding criteria of less than 1 hectarehas been used to set the poverty line for farmers. Given the overall poverty profile of MadhyaPradesh and rural/urban electrification ratios the survey sample appears to be biased in favor ofusers and nonpoor. Some caution should therefore be used in interpreting connection ratios forconsumer categories. In addition to the quantitative analysis, qualitative assessments weremade to complement and assess the survey findings. These are based on participatory andindividual stakeholder consultations in the field carried out during appraisal of the SectorDevelopment Program (SDP).

1. Domestic Users and Non-users

2. Econometric analysis indicates that income is a major determinant of households’access to electricity. Income levels are substantially more important for the poor than for thenonpoor. The location (rural/urban) of the households is also an important determinant ofaccess for households below the poverty line. The average income of the poor with access is 46percent higher than the income of the poor with no access (Table A6.1). Over 36 percent of thepoor households lack access to electricity while the corresponding figure is less than 17 percentfor nonpoor. Thus, when income is a barrier to access the current subsidy structure onelectricity consumption is inequitable, and would be difficult to defend on the basis of providingcheap and affordable services to the poor. Barriers to access for the poor will be discussed inparas. 4 to 7.

Table A6.1: Poverty Profile – Domestic ConsumersPoor Households Nonpoor Households Total Households

AccessShare

Mean Income(Rs/month) Share

Mean Income(Rs/month) Share

Mean Income(Rs/month)

Electricity 63.5% 1,379 87.3% 5,860 83.3% 5,289

No Electricity 36.5% 942 12.7% 1,690 16.7% 1,426

Total Sample 16.7% 1,219 83.3% 5,332 100.0% 4,644Poverty line: Expenditure< Rs 12,000/household/Year.Source: Calculations based on the socioeconomic survey.

2. Agricultural Users and Non-users

3. About 6.6 million farmers live in the new state of Madhya Pradesh. Over 4 million, or61 percent, are marginal farmer with landholdings of less than 1 hectare. Although landholdingsare on average similar for poor electric pump users and nonusers,1 difference in income earning

1 Evidently, since the upward landholding boundary is set at < 1 ha for the poor farmers.

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is significant. A majority of the poor nonusers do not own land but engage in share cropping2

and supplement farm income by temporary wage employment. Poor users own one 3 or 5horsepower (HP) electric pump. About 30 percent of the poor farmers share capital costs, initialconnection charges, and electricity bills with other farmers. Sharing was not found to becommon among nonpoor farmers who tend to own more than one pump above 5 HP. Allnonusers own diesel pumps irrespective of whether they are poor or not. However, the type ofpump is a significant determinant of farm income and profitability. About 80 percent of thenonpoor farmers reported that groundwater levels had dropped in the last two years. For poorfarmers the corresponding figure is 87 percent. While nonpoor farmers reported thatgroundwater levels are on average 36 feet, poor farmers are exposed to about 20 percent lowerwater levels (43 feet). The low capacity irrigation pumps owned by the poor farmers make themmore vulnerable to the low water levels.

Table A6.2: Poverty Profile – Agricultural ConsumersPoor Farmers Nonpoor Farmers Total Farmers

AccessShare

MeanIncome

(Rs/month)

MeanLandholding

(ha)Share

MeanIncome

(Rs/month)

MeanLandholding

(ha)Share

MeanIncome

(Rs/month)

MeanLandholding

(ha)Electricity 80.3% 1,468 0.68 91.7% 5,028 5.43 90.0% 4,556 4.81

No Electricity 19.7% 1,263 0.67 8.3% 2,937 4.14 10.0% 2478 3.13

Total Sample 14.9% 1,447 0.68 85.1% 4,854 5.33 100% 4,348 4.64ha = hectare.Poverty line: Marginal farmers with less than 1 hectare in landholdings.Source: Calculations based on the socioeconomic survey.

B. Barriers to Access

4. Four main barriers for the poor to access electricity services were identified during theparticipatory stakeholder consultations with the poor. First, insufficient new investments toextend grid-connections to poor rural areas. Second, in areas where the grid exists, connectioncosts, associated transaction costs (including waiting time and number of applications) and up-front charges are major barriers for the poor to connect. Third, business practices of propertyrights have excluded a large share of urban and rural poor since they could not produce thenecessary land titles required to obtain official connections. However, this policy has recentlybeen changed. The fourth is related to the poor quality of electricity supply and load-shedding,which acts to deter connections since cost savings and other benefits will be limited. Load-shedding will further be discussed in paras. 8 to 10

5. The socioeconomic survey included questions to examine issues related to access toelectricity. Table A6.3 presents the responses from nonusers. Forty-six percent stated theywould not be able to afford electricity. Affordability is consistently perceived to be higher for thepoor than the nonpoor. Nearly 60 percent of the poor stated that they would be able to pay whilethis was only 48 percent for the nonpoor. The perception of affordability is related to thewillingness to pay, which also is higher for the poor than for the nonpoor (Table A6.9). Quality ofhousing is perceived to be a problem for both poor and nonpoor. Econometric analysis confirmsthis conclusion and results indicate that a house made of thatch is 13 percent less likely to haveelectricity.

6. A substantial number of nonusers reported that they have applied for but not receivedconnections. This may indicate the presence of transaction costs associated with connections.

2 The landowner will share input costs in exchange for a share in crop output.

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Some respondents stated that they did not need electricity. Surprisingly, this response washigher among the rural nonpoor than among the poor.

Table A6.3: Perceived Reasons for Not Having Electricity (Domestic)Rural Urban

ReasonPoor Nonpoor Poor Nonpoor

Total

No connections nearby 44.7% 37.8% 32.1% 27.5% 36.1%Applied but waiting 31.6% 18.9% 50.0% 47.5% 32.8%Cannot afford 39.5% 53.7% 38.9% 40.0% 45.6%House not appropriate for wiring 26.3% 29.7% 21.4% 15.0% 24.4%Do not need/want it 5.3% 16.2% 14.3% 12.5% 12.8%Poverty line: Expenditure< Rs 12,000/household/Year.Source: Calculations based on the socioeconomic survey.

7. On average, users spend 5 percent of their income on electricity. As expected theexpenditure share is higher for the poor (8 percent) than for the nonpoor (3 percent)3.Consultations with nonusers show that kerosene expenditure shares vary between 7 and 15percent of household income. Since kerosene is mainly used for lighting purposes expendituresavings from electricity are quite substantial.4

C. Load-Shedding and Quality of Supply

8. The prevalence of load-shedding causes consumers to diversify their energy sources,where kerosene is the main substitute for electricity. Over 90 percent of electricity users in ruralareas reported that they also use kerosene for lighting. In urban areas, load-shedding is lessfrequent, and thus, the use of kerosene by electricity users is less common (Table A6.4). Forceddiversification of energy sources incurs additional costs and reduces benefits of electricity.Ultimately, load-shedding affects the willingness to pay for electricity. Where consumers arecharged on a flat rate basis, load-shedding leads to a higher per unit cost and reduces the netbenefits per unit consumed. This reinforces the adverse effects of load-shedding on consumer’swillingness to pay for electricity.

9. Load-shedding in rural areas is nearly six times more frequent than in urban areas(Table A6.4). Scheduled load-shedding is announced to consumers in advance of the seasonto allow consumers to adjust and plan for it. Still, scheduled load-shedding disrupts activities,increases loss of income, and increases costs. However, the unscheduled load-sheddingcauses the most serious problems for consumers as it increases uncertainty in production andconsumption activities and does not allow consumer to adjust activities in advance. Between 10to 15 percent of total load-shedding and 62 percent of the number of power cuts in rural areasare unscheduled (Table A6.4).

Table A6.4: Distribution of Load-shedding by AreaRural Semi-urban Urban

ItemScheduled Unscheduled Total Scheduled Unscheduled Total Scheduled Unscheduled Total

Min. Hrs 270 30.45 300.5 120 30 150 45 3 48Max Hrs 270 50.4 320.4 120 35 155 45 7 52No. ofPower Cuts 30 48 78 30 4 34 30 4 34

Source: Madhya Pradesh State Electricity Board, April 2001.

3 Survey data on expenditure on kerosene was not available.4 Expenditure savings includes the direct financial cash savings for the household but does not account for efficiencygains or improved quality of light.

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10. Eighty-seven percent of the agricultural consumers reported that the quality of supplyhad deteriorated during the last year. The poor quality of supply appears to affect poor andnonpoor equally (Table A6.5). However, the consequences of power cuts and voltagefluctuations tend to be more serious for the poor. Over 60 percent of the farmers reported pumpburnouts as a result of voltage fluctuations (Table A6.6). Nearly 20 percent experience morethan one burnout during Rabbi season. Poor farmers are more vulnerable to pump burnoutsbecause they do not have the same adjustment and coping capabilities as nonpoor farmers.They seldom own more than one pump and the loss in crop production can be devastating.Voltage fluctuations in power supply also have a bearing on the maintenance cost of pumps.

Table A6.5: Quality of SupplyPoor Nonpoor Total

ItemDomestic Farmer Domestic Farmer Domestic Farmer

Power Cutsa 67.8% 82.5% 56.1% 84.0% 57.6% 83.8%Voltage Variations 47.8% 65.7% 44.1% 71.2% 44.6% 70.5%Voltage Drop 55.7% 52.5% 52.9%Mean hrs of PowerSupply / Day

6.3 7.0

a Unscheduled power cuts for farmers.Source: Calculations based on the socioeconomic survey.

Table A6.6: Effects of Voltage FluctuationsPoor Nonpoor Total

No. of Pump Burn OutsShare Share Share

1 39.6% 44.5% 43.0%2 8.2% 14.8% 14.3%More than 2 7.0% 3.4% 4.1%Total 54.8% 62.7% 61.4%

Source: Calculations based on the socioeconomic survey.

D. Impacts of Reforms

1. Connections for the Poor

11. The new MPSEB policy includes applying connection charges retroactively. The MPSEBconsumer base data indicate that the introduction of connection charges has resulted in areduction of single point consumers. This can partially be explained by an increase in otherconsumer groups. However, consultations with the poor and MPSEB staff show that poorconsumers have been disconnected as a result of inability to pay up-front connection charges.This may have resulted in an increase of illegal connections and thus, a consequent reduction inrevenue for MPSEB. Under the current policy, scheduled caste and tribe consumers livingbelow the poverty line are eligible for the single point scheme for which the connection charge isamortized (interest-free) in four monthly installments. However, this policy does not apply toother consumers living below the poverty line. Consultations with poor ‘illegal’ consumersshowed that these consumers are not eligible for the single point scheme and up-front costsassociated with various charges, such as meter charges, service connection charges, etc, aretoo high for them to afford in one monthly installment. On the basis of the consumers self-assessment and on their level of income, MPSEB will introduce an interest-free 12 monthinstallment facility to address the ability of the poor to pay up-front charges.

2. Metering of the Poor

12. As part of the loss reduction program, MPSEB has introduced mandatory metering ofconsumers. The metering policy has been found to be beneficial for poor and low-incomeconsumers as opposed to the flat rate tariff currently charged. A poor urban consumer who has

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two light bulbs and a fan is billed Rs115 per month on a flat rate basis. With metering, thecorresponding bill on a per unit basis would amount to Rs87 per month, or 24 percent less.5

13. Load-shedding combined with flat rate tariffs is regressive in the sense that consumersexperiencing more load-shedding are paying a higher unit rate than consumers experiencingless. Over 50 percent of domestic poor consumers and 84 percent of the poor farmers are notmetered (Tables A6.7 and A6.8). In addition, of the ones who do have meters, few receiveregular readings. Thus, when load-shedding increases, bills are not adjusted.

Table A6.7: Metering of Domestic ConsumersRural Urban

ItemPoor Nonpoor Poor Nonpoor

Total

Metered 43.5% 65.0 56.5% 82.7% 80.6%Meter is Working 94.2% 87% 99.7% 96.1% 96.4%Meter is Read on a RegularBasis

7.2% 21.4% 43.5% 58.2% 57.0%

Billed According to Meter 13.0% 18.1% 45.7% 54.7% 54.0% Source: Calculations based on the socioeconomic survey.

Table A6.8: Metering of Agricultural ConsumersRural Total

ItemPoor Nonpoor

Metered 16.2% 13.0% 13.4%Meter is Read on a Regular Basis 54.2% 34.7% 37.8%

Source: Calculations based on the socioeconomic survey.

3. Willingness to Pay

14. Over 60 percent of agricultural consumers are willing to pay more for better qualitysupply. Poor farmers are particularly willing to pay more if services improve (65.4 percent). Thewillingness to pay more is also higher for the poor than for the nonpoor. Similar results arefound for domestic consumers. Sixty-seven percent of domestic consumers are willing to paymore, as are nearly 75 percent of the poor, and 66 percent of the nonpoor. The poor are onaverage willing to pay 27 percent more than their current bill for better quality supply, while thecorresponding figure is 23 percent for the nonpoor (Table A6.9).

Table A6.9: Willingness to Pay MoreDomestic Agriculture

VariablePoor Nonpoor All Poor Nonpoor All

Mean WTPM 27.3% 22.7% 23.2% 23.8% 22.9% 23.0% Source: Calculations based on the socioeconomic survey

15. The willingness to pay for better quality service is governed by a number of factors, suchas the costs and loss in income that occurs as a result of voltage fluctuations and load-shedding. Econometric simulations (Table A6.10) show that metering followed by income arethe most important factors influencing the willingness to pay for domestic consumers. Urbanconsumers are willing to pay more than rural consumers, even when controlling for incomedifferences. For agricultural consumers groundwater levels and voltage variations are the mostimportant factors while metering is not significant. For poor farmers, these factors are ofparticular importance. Groundwater levels are directly related to electricity consumption forirrigation purposes. Low capacity pumps in combination with low groundwater levels affect theability to irrigate. In addition, flat rate charges induce inefficient utilization of both electricity andwater. While nonpoor farmers invest in higher HP pumps, this option is not economically viable 5 The light bulbs are assumed each to be used for 8 hours a day and the fan for 15 hours.

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Appendix 6, page 6

for poor farmers and thus the distribution of water resources is directly effected by the ability toeffectively utilize electricity for irrigation purposes. Thus, flat rate charges cause inefficientutilization and unequitable distribution of both electricity and water resources. The latter effect isreinforced by the fact that poor farmers tend to live in more drought-prone areas.

Table A6.10: Willingness to Pay (dependent variable)Domestic Agriculture

VariablePoor Nonpoor Poor Nonpoor

Income 0.142(4.11)

0.390(11.59)

0.132(1.98)

0.068(2.83)

Metering 0.498(2.43)

0.372(5.66)

0.03(1.23)

0.03(1.46)

Frequency of MeterReading

0.079(1.99)

0.04(1.22)

0.143(1.73)

0.112(1.92)

Frequency of Power Cutsa -0.110(-2.73)

-0.035(2.62)

-0.069(2.23)

-0.074(-2.76)

Frequency of VoltageFluctuations

-0.082(-2.67)

-0.107(-2.069)

-0.19(-2.00)

-0.123(-2.60)

Groundwater (feet) 0.30(1.98)

0.23(4.24)

Rural/Urban -0.154(-2.69)

-0.197(-4.28)

*t - statistics in parenthesisa Power cuts for farmers include unscheduled only.Source: Estimations are based on the socioeconomic survey data.

16. The results show that load-shedding is an important factor but less so than voltagefluctuations. This is because voltage fluctuations reduce farm profitability by reducing cropyields and by increasing pump maintenance costs. The econometric simulations indicate thatthe reduction in farm profitability due to voltage fluctuations is likely to be higher than the loss ofincome that occurs as a result of load-shedding. The results show that the effects of the poorquality of supply and services affect poor farmers more than the nonpoor. Overall, eighty-eightpercent of the farmers expect increased yields as a result of improved quality of supply; 50percent expect at least a 20 percent increase in yields.

17. The econometric results in Table A6.10 show that the impacts of the variousinterventions of improving the quality of services vary between different consumer categories.While the number of poor connected to the grid might be relatively small, the results show thatthe magnitude of the direct impacts of reduced voltage fluctuations are especially pro-poor. Fordomestic consumers, a meter-based tariff, followed by reduced load-shedding, was found to bethe most pro-poor intervention. The importance of voltage fluctuations was less for poordomestic consumers due to the limited ownership of appliances.

5. Conclusions

18. The current state of electricity supply and operations has serious adverse impacts onincome earning activities for the poor. They are affected both indirectly, through reduced wageemployment opportunities6 and directly, through reduced farm profitability and householdwelfare. The restructuring process provides an opportunity for MPSEB to review its operationsand the impacts on consumers. For the state government, it provides an opportunity to assessthe impacts of its subsidy policy and other interventions in the electricity sector. Given thesignificant barriers for the poor to access electricity, it is difficult to defend the current subsidystructure on the basis of providing cheap services to the poor. Most of the poor do not haveelectricity connections and are not benefiting from subsidized electricity tariffs. However, they

6 This particularly affects the landless and the poorest of the poor.

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Appendix 6, page 7

are indirectly paying in terms of forgone investments and are directly affected by the lack offinancial ability of MPSEB to expand the network into poorer areas.

19. The lack of reforms would have a disastrous effect on farmers’ ability to cope with thepoor quality of supply in combination with low groundwater levels. This would particularly affectthe poor who are less able to cope with the uncertainty that unscheduled load-shedding brings.Absence of tariff reform would be expected to continue draining the state government budget,and thus, increase the opportunity costs in terms of investing in other sectors more beneficial forpoverty reduction.

20. While tariff restructuring is necessary to improve the quality of supply, the impacts ofsuch increases on the poor are significantly reduced by introducing meter-based tariffs. Inaddition, the improved quality of supply would lead to decreased expenditure on kerosene. Thewillingness to pay higher tariffs, especially by the poor, reflects high adjustment and opportunitycosts of the poor quality of electricity supply. Further reducing the ability of MPSEB to maintainnetwork systems would result in increased unscheduled load-shedding and uncertainty forconsumers and reduced benefits of electrification. Tariffs set below the cost of supply, withoutcompensation from the state government, reduces the ability of MPSEB to purchase bulkpower. Every sold unit is a loss and thus, load-shedding under the current tariff regime isfinancially beneficial for MPSEB while adversely affecting consumers.

67

POVERTY IMPACT ASSESSMENTMatrix 1: Structural Reform in Operations

Type of EffectChannel

Direct Indirect Macro NonPoorLabor Market Reduced labor requirements Increased demand for unskilled

labor as a result of improvedquality of supply through(i) economic growth, and(ii) improved resource allocationand utilization

Increased demand for unskilledlabor as a result of (i) increasedinvestor confidence inmacroeconomic stability andimproved governance, and(ii) reduced crowding-out effectsof alternative private investments

Increased demand for skilledlabor

Producer andConsumer Prices

Increased efficiency in operationsand metering will act to reducethe need for tariff increases

The reduction in the need for tariffincreases spills over to othersectors

Increased efficiency will act toreduce necessary tariff increases

Net PublicTransfers

Reduced implicit and explicitsubsidies to the power sector

Increased transfers to socialsectors

Reduced budget deficit

Access to PublicGoods andServices

• Increased ability to financerural electrification inunserved areas

• Improved quality of serviceswill reduce costs of appliancepurchases and maintenancecosts

• Enhanced governancereduces transaction costs foraccess

• Increased fiscal space forinvestments in alternativepublic services

• Reduced crowding-outeffects on privateinvestments

↓Increased access to alternativepublic and private sector services

• Increased ability to financerural electrification inunserved areas

• Improved quality of serviceswill reduce costs of appliancepurchases and maintenancecosts

• Enhanced governancereduces transaction costs foraccess

Total Net Effects The direct effects:• Enhanced ability to pursue electrification to increase investments and productivity in rural areas, where the majority of the poor reside• Improved quality of supply → cost reduction of replacement and maintenance of appliances• Reduced need for and impact on the poor of tariff increases• Reduced load-shedding → increased farm profitability and welfareThe indirect and macroeconomic effects:• Fiscal space essential for investments in alternative public services for the poor• Reduced crowding-out effects in the banking sector will reduce cost of public and private sector investments and increase labor demand• Economic growth will generate income-generating opportunities

Assumptions • Fiscal discipline• Amortization of up-front connection charges for the poor

Appendix 6, page 8

68

Matrix 2: Tariff RationalizationType of Effect

Channel Direct Indirect Macro Non-PoorLabor Market Energy intensive sectors may

reduce production and demandfor unskilled labor during theadjustment period

Reduced crowding-out effects onprivate investments → increaseddemand for labor

Energy intensive sectors mayreduce production and demandfor skilled labor during a transitionperiod

Producer andConsumer Prices

Increased tariffs to endconsumers is partially offset bymetering

Prices of energy input intensivegoods will increase

Enhanced economic growth as aresult of improved allocativeefficiency

Increased tariffs to endconsumers

Net PublicTransfers

Reduction of explicit and implicitsubsidies to the power sector

Increased transfers to socialsectors

Access to PublicGoods andServices

Enhanced financial ability andincentives to invest in ruralelectrification, maintenance, andsystem enhancements →increased quantity and improvedquality of supply

Increased access to alternativepublic goods and services throughincreased fiscal space

• Increased fiscal space forinvestments in alternativepublic services

• Reduced crowding-outeffects on public investments

↓Increased access to alternativepublic services

• Increased ability to financeaccess to electricity inunserved areas

• Improved quality of serviceswill reduce costs of appliancepurchases

Total Net Effects The direct effects:• Tariff increases• Improved quality of supply → cost reduction of replacement and maintenance of appliances• Enhanced incentives to pursue rural electrification to previously unserved areas → enhancement of income-generating activities and

productivity• Reduced load-shedding → increased farm profitability and welfareThe indirect and macroeconomic effects:• Increased fiscal space and improved economic environment will enhance growth and income-generating opportunities• Economic growth will enhance income-generating activities

Assumptions • Fiscal discipline• Amortization of up-front connection charges for the poor

Appendix 6, page 9

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Appendix 7, page 1

SUMMARY INITIAL ENVIRONMENTAL EXAMINATION

A. Introduction

1. The Sector Development Program (SDP) includes a policy loan (the Program) and aninvestment loan (the Project). The SDP seeks to establish appropriate policy and institutionalenvironment to improve the governance of the power sector in Madhya Pradesh (MP) . TheProject consists of (i) subtransmission and distribution system strengthening (component A); (ii)conversion of low voltage lines to 110 kilovolt (kV) (component B), (iii) transmission systemstrengthening (component C), and (vi) setting up of a computerized information and revenuemanagement system (component D). A description of the Project is given in para. 71 andSupplementary Appendix C.

2. The SDP is classified as Category B due to the limited impacts of the Program andcomponents A, B, and C of the Project. The Program’s potential environmental impact, and inparticular of the MP Reform Act, was evaluated and an impact analysis prepared, showing thatmost potential environmental impacts are considered beneficial (Table A7.1). Initialenvironmental examinations (IEEs) were conducted by MPSEB for components A and C.Consultations were held with related agencies, and interviews were carried out with farmers andother stakeholders. This summary IEE presents the major findings of the IEEs and discussionswith concerned government officials. Based on the findings of the summary IEE, anenvironmental impact assessment is not required for the components.

3. This report describes the existing environment in the area where the components are tobe implemented; the likely environmental impacts of the components; and the various measuresthat will be undertaken by the Madhya Pradesh State Electricity Board (MPSEB) during thedesign, construction, and maintenance stages to mitigate any potential significant adverseenvironmental impacts. Some of the measures such as the selection and survey of thealignment for the transmission lines have already been started by MPSEB.

B. Description of the Environment

4. The proposed transmission system of component C will pass through the whole state ofMP. Component A will upgrade and expand the existing substation capacity and distributionlines in Bhopal, Gwalior, Indore, Jabalpur, Khargone, Mandsaur, and Ujjain.

5. MP is located in the center of India and is one of the biggest state in the country. Exceptfor the valley of the Narmada and Tapti, MP consists of a plateau with mean elevation of about500 meters above sea level, interspersed with mountains of the Vindhya and the Satpuraranges. The main river systems are the Betwa, Chambal, Indravati, Mahanadi, Narmada, Sindh,and Tapti. The area is part of a peninsular plateau consisting of sedimentary and metamorphicrocks, and is structurally part of the peninsular block. The area is geologically stable and notprone to earthquakes.

6. The MP climate is extreme in the north, temperate and breezy in the plateau, andgenerally hot and humid in the eastern and southern plains. Summer is hot, with temperaturesranging from 22oC to 48oC, while winter is mild, with temperatures ranging from 4oC to 23oC.The low-lying area of Baghelkhand and Gwalior plains have lighter soil; and the Narmada valleyis formed by deep rich alluvial deposits.

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Appendix 7, page 2

7. About 35 percent (154,497 square kilometer [km2]) of the total geographical area(443,496 km2) is under forest cover. The forest cover consists of 82,700 km2 (54 percent) ofreserve forest and 66,678 km2 (43 percent) of protected forest, with the rest, about 5,119 km2 (3percent), classified as other forest.1 There are 9 national parks and 22 wildlife sanctuaries inMadhya Pradesh. In the subproject areas, the notable wildlife species are jackal, fox, andmonkey. No endangered or rare species of flora or fauna are reported in the subproject areas.

C. Screening of Potential Environmental Impacts and Mitigation Measures

1. Environmental Impacts Due to Project Location and Design

8. Potential adverse environmental impacts associated with transmission lines andsubstations can be avoided or minimized through careful route and site selection. Preliminarysite selection was done based on the topographic sheets of the Survey of India and ForestAtlas2. For the selection of the optimum route or substation site, consideration was given toensure that the route: (i) minimizes human resettlements; (ii) does not affect monuments ofcultural or historical importance; (iii) does not create a threat to the survival of any communitywith special reference to tribal communities; (iv) does not affect any public utility services likeplaygrounds or schools; (v) does not pass through any sanctuaries, national park, etc; and,(vi) minimizes damage to existing forest resources.

9. As a rule, alignments are sited 10-15 km away from major towns, whenever possible, toaccount for future urban expansion. Similarly, forests are avoided whenever possible. When notpossible, a route that will minimize damage to the existing forest resources is selected inconsultation with the local divisional forest officer. Alignments in the subprojects avoidedwetlands and unstable areas. MPSEB undertook the route selection for individual transmissionlines in close consultation with representatives from the State Forest Department. Alternativealignments were considered to ensure that disruptions to environmentally sensitive areas wouldbe minimal. Clearances from the Ministry of Environment and Forests (MOEF) are beingprocessed for the use of 3.78 hectares of forestland for the right-of-way (ROW) of transmissionlines. Land values are not expected to be affected, as the selected line route generally passesthrough uninhabited areas, cultivated lands, and forests.

2. Environmental Effects Related to Construction

10. Under component C, only two transmission lines will pass through forested areas inMandsaur (1.0 km, 2.7 hectares in Gunjaliya Protected Forest,) and Indore (0.4 km, 1.08hectares in Main Vindhya Reserved Forest). This could not be avoided due the presence oftowns and villages and vast area of forestland in the two districts. However, no endangered,threatened, or rare species of fauna and flora are recorded in the forest affected by thetransmission line route. Divisional forest officers of the State Forest Department and executiveengineer Extra High Tension (Construction and Maintenance) of MPSEB have prepared a joint

1 The Indian Forest Act, 1927 regulates the classification and declaration of different categories of forests. The state

government may constitute any forestland or wasteland, which is the property of Government or over which theGovernment has proprietary rights, or to the whole or any part of the forest-produce of which the Government isentitled, a reserved forest or protected forest in the manner provided in the act. A reserved forest usually has goodquality of woods, and the right of people in it is very limited until a clearance is obtained. A protected forest isusually near villages or human settlement where people are entitled to the existing forest activities, such asfuelwood collection and grazing. Clearance procedures for development activities in both forests are the same.

2 Government of India. Survey of India, Forest Atlas. Delhi.

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Appendix 7, page 3

investigation report for each of the two forest areas where the two transmission line will pass.The two reports conclude that the forest that will be affected is either degraded Grade IV forestas in the case of Gunjaliya Protected Forest, or without trees standing on the ground as in thatof Main Vindhya Reserve Forest. MPSEB has obtained the first stage clearance from MOEF forusing the land of Gunjaliya Protected Forest for ROW. Clearance for Main Vindhya ReservedForest is being processed. With provision for compensatory forestry, the overall forest conditionwill improve.

11. To mitigate losses to existing forests, clearing of the transmission line ROW will be doneunder the supervision of the Forest Department, and low canopy seed trees and shrubs will bekept intact if they do not interfere with tower erection and line installation. The wood will be soldby the Forest Department, which will retain the proceeds from the sale. MPSEB will provideconstruction crews with fuelwood or alternative fuels as a precaution against collection offuelwood from the nearby forest. Local forest department personnel will assess the risk ofpoaching during construction and take appropriate action. Guard stations will be established, asneeded, at the entrance to forested areas. Since the affected forest is mostly revenue forest andis currently accessible, this impact may not be significant. Nonetheless, MPSEB staff will reportto the Forest Department any noticeable encroachment resulting from the Project.

12. Most of the route will pass through agricultural lands or wasteland. According to theElectricity (Supply) Act, 1948, no land acquisition is required for placing transmission towers onprivate land. However, any damage will be duly compensated. Associated impacts onagricultural land will be restricted to the construction phase and will be temporary in nature.Agricultural land will be lost permanently at the base of the transmission tower, estimated at0.2–1.0 square meters per average farm holding. After construction, agricultural land within thetransmission line corridors can be used again for farming purposes.

3. Environmental Effects During Operation

13. Three-meter wide strips of land under each conductor will be cleared and maintained asmaintenance ROWs. Lopping of trees will be carried out with the assistance of the ForestDepartment to ensure that the required clearances are maintained throughout the stretch of thetransmission lines. This will reduce the chances of forest fires due to electric sparks.

14. To minimize the risk of accidents and exposure to electric fields, houses will not beallowed within the ROW and under the 220 kV and 132 kV double circuit lines. Disturbed areasduring the construction of transmission towers will be rehabilitated to minimize soil erosion.

15. MPSEB has discontinued procurement of poly-chlorinated biphenyls (PCBs) transformeroil since 1974. Pure hydrocarbon mineral oil has been used since then. New transformers andcapacitors to be purchased under the Project will not have any adverse environmental impacts.None of the transformers to be replaced will be disposed of. Instead, they will be used in othersubstations where loads are less. Used transformer oil will be collected and reclaimed bycontractors through the Office of Stores and Purchase. Scrap will be collected and disposed ofin compliance with the Environmental Protection Act, 1986, and applicable regulations andrules.

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Appendix 7, page 4

D. Institutional Requirements and Environmental Monitoring Program

16. For component C, the EHT construction circles and divisions are responsible forimplementation and supervision of the construction of new transmission lines and substations.These divisions will ensure that the Project will comply with best environmental and engineeringpractices during the construction phase. The EHT line maintenance and substationmaintenance circle and divisions are responsible for operation and maintenance of newtransmission lines and substations.

17. Monitoring activities include patrolling and thermo vision scanning. Monthly preventivemaintenance will be carried out to identify and resolve problems related to cooling oil, gaskets,circuit breakers, vibration measurements, and other activities. Monitoring results will bepublished monthly, including a report on the corrective actions taken.

18. As part of the normal duties of the concerned divisional forest officer and staff,monitoring of impacts on ecological resources will be carried out. Monitoring of compensatoryforests will be established in coordination with the Forest Department, and MPSEB willundertake environmental monitoring in accordance with the Government’s environmental andsocial regulations and rules.

19. For component A, a field level monitoring committee will be looking after the constructionwork, operation, and maintenance of the subtransmission and distribution system; and ensurethat the management of any scrap will comply with the Environmental Protection Act, 1986, andother applicable regulations and rules.

20. In addition, MPSEB will establish a fully functional social and environmentalmanagement cell within four months of loan effectiveness. The new cell will include anenvironmental management and monitoring section to ensure that the Project is undertaken andall project facilities operated and maintained in compliance with all applicable laws, rules, andregulations.

E. Conclusions

21. Based on the environmental assessment and surveys conducted for the subprojects,associated potential adverse environmental impacts can be mitigated to an acceptable level byadequate implementation of the measures as stated in the IEEs. Although part of the affectedarea for the alignment of the transmission lines is forested, it is mainly lower grade forest, andno endangered, rare, or threatened species of flora or fauna are recorded. Nevertheless,compensatory forestry will be strictly implemented in coordination with the Forest Department.Adequate provisions have been made in the Project to cover the environmental mitigation andmonitoring requirements, and their associated costs.

22. The Project will strengthen the establishment of the State Power Transmission Systemof the MP. Overall, the social and environmental impacts associated with the two subprojectsare limited to the construction period and can be mitigated to an acceptable level byimplementation of recommended measures and by best engineering and environmentalpractices.

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Appendix 7, page 5

Table 7.1: Evaluation of the Madhya Pradesh Power Reform Act, 2001 for Potential Environmental Impacts

Policy/Institutional change PotentialEnvironmental

Impact a

Remarks

Set up regulatory authority (MPSERC) withindependence ensured by specifyingprofessional qualifications of members,prohibition of members from concurrently orsubsequently holding government office, andsafeguards against conflict of interest

+ An independent regulatory authority is assumedto be able to withstand political pressure ontariff setting and other regulatory functions,thereby enabling cost recovery, which in turnwould give appropriate price signals for energyconservation.

Functions of MPSERC include tariff setting,ensuring quality of service, efficiency, safety,perspective planning, promoting competition,adjudicating or facilitating dispute resolution,coordination with environmental regulatoryauthorities and evolve policies/procedures forenvironmental regulation of the electricityindustry, standard setting, ensuring data andinformation collection, and others.

+ The functions of MPSERC encompass thosenecessary for setting up a competitive supplyside for the electricity industry, planning toensure least-cost supply over the long-run, costrecovery through tariff policies, safety, andstrengthened environmental regulation. Thesewill contribute to energy efficiency on supplyand demand sides, appropriate fuel mix, andproper environmental management.

MPSERC to function as a quasi-judicialauthority, following the civil procedure code.

+ Quasi-judicial procedures, including the passingof appellable speaking orders (findings) willenhance transparency, thereby strengtheningindependence of the authority from politicalpressures.

State government’s powers restricted toproviding policy directions in writing confinedto overall planning/coordination fordevelopment of the electricity industry, butnot in relation to tariff setting or licensing.Disputes between state government andMPSERC to be subject to binding, timebound adjudication by the Central ElectricityRegulatory Commission (CERC).

+ Clear demarcation of roles of state governmentand MPSERC is conducive to independent tariffsetting and licensing, the latter facilitatingcompetitive supply. The requirement of stategovernment’s policy advice to be in writingsafeguards against the introduction of personalor partisan agendas. The state government’spolicy advisory role may facilitate policycoordination across sectors. The disputeresolution mechanism further secures MPSERCagainst unwarranted interference by the stategovernment on political considerations.

Licensing of transmission and supply:public participation (PP) requirement beforeissue of license for each “project.”

+ PP will ensure that potential environmentalimpacts are identified and addressed.

Requirement of economical power purchase,including least-cost dispatch principle.

? Should be strengthened by a requirement thatelectricity sellers must be environmentallycompliant to be eligible, and the least-costprinciple to be supplemented by considerationof integrated resource planning to ensure alevel playing field between energy supply andenergy conservation options to meet a givendemand.

This provision may permit/facilitatedecentralized supply by renewable energytechnology options.

No exclusivity in grant of license. + Decentralization of such powers to licenseeswill facilitate adoption of measures forpreventing energy wastage.

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Appendix 7, page 6

Policy/Institutional change PotentialEnvironmental

Impact a

Remarks

Licensees to have powers of metering,revenue realization, disconnection,prosecution for theft, meter tampering, anddiversion of electricity.

+ The key to ensuring that licensees keep to theconditions of their license is enforcementthrough the penalty of revoking the license.

MPSERC is empowered to enquire intocomplaints against breach of license +conditions and revoke license throughspeaking orders.

+

Reorganization of the MPSEB may beeffected by the state government throughtransfers of assets, liabilities, personnel, andfunctions of the Board to other agencies.

+ Provided such reorganization is effected toensure separation of transmission, distribution,and generation, and facilitate privatization, thiswill be conducive to the emergence of acompetitive electricity supply market by profit-oriented suppliers. This will help ensureefficiency in generation, besides providingappropriate price signals to consumers forenergy conservation.

a + = positive, - = negative, 0 = neutral or negligible, ? = uncertain.

Table A7.2: Tariff Setting PrinciplesItems Potential

EnvironmentalImpact a

Remarks

Cost of supply at an adequate andimproving level of efficiency.

+ Increase in efficiency is generally conduciveto environmental conservation provided thatsuppliers remain compliant withenvironmental regulations.

Factors that encourage efficiency,economical use of resources, goodperformance, optimum investments.

+ In particular, economy in use of (natural)resources enhances environmentalconservation.

Commercial principles. + Profit orientation is generally conducive toefficiency.

Interest of consumers but they must payreasonable charges.

? Lower tariffs are not conducive to energyconservation.

If state government wishes to subsidize anyconsumer category over the tariff for thatcategory, it must directly compensate thesupplier.

– Subsidies weaken incentives for energyconservation; however, the requirement thatthe state government must compensatesupplier would normally act as deterrent toprovision of such subsidy.

No undue preference to any consumercategory, but distinctions may be made onthe basis of load factor, power factor, totalconsumption of electricity, time of supply,geographical location, nature of supply,purpose, paying capacity, need for cross-subsidization.

+ This provision will help eliminate politicallyinspired (cross) subsidies to particularconsumer categories.

Life-line rates may be given to poorconsumers for basic needs; for all otherssubsidy to be progressively reduced over 5

+ Assuming that such life-line supply would bea small part of the total, progressiveelimination/reduction of all other subsidies

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Appendix 7, page 7

Items PotentialEnvironmental

Impact a

Remarks

years so that each consumer category paysat least 75% of average cost of supply tothat consumer category.

would be conducive to energy efficiency.

Public hearings to be conducted beforedeciding tariffs.

+ Public hearings will improve transparency intariff setting and reduce possibilities forundue (cross) subsidy to any consumercategory, or windfall profits to suppliers,thereby enhancing both demand-and supply-side efficiency.

MPSERC will follow specified quasi-judicialprocesses with respect to enforcement oflicensing conditions.

+ A predictable, transparent enforcementprocess is important for the success ofprivatization of generation, and transmissionand distribution units.

A state advisory board with representationof supply, transmission, and generationlicensees, and other stakeholders to adviseMPSERC on major policy issues andquality, continuity, extent of service, andcompliance by licensees.

+ This measure will enhance monitoring oflicensees’ performance. Improvedcompliance is conducive to generation,transmission, and supply efficiency.

By such consultation, MPSERC is todetermine standards of performance,power system operator codes, safetyregulations, charter for consumers, publicrights to information about working oflicenses; circumstances in which licenseesare to inform consumers about their right tocompensation.

+ These measures will also enhancecompliance by licensees.

Arbitration and appeals procedures arecodified.

+ Clearly laid down arbitration and appealsprocedures are conducive to private sectorparticipation, which may enhance energyefficiency.

MPSERC to prepare accounts that are tobe audited by the independent comptrollerand auditor general.

+ Formal requirements of preparation ofMPSERC’s accounts and their independentaudit will enhance the accountability of theinstitution to its mandate.

Penalties for licensees for acts of omissionand commission in relation to the reform actinclude imprisonment, in addition to(modest) monetary fines.

– Penalties by way of imprisonment willdiscourage private sector participation, andwill also raise evidentiary standards for proofof violation of the reform act, makingenforcement more difficult. Modest monetarypenalties will have little deterrent effect.

a + = positive, - = negative, 0 = neutral or negligible, ? = uncertain

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Appendix 8, page 1

FINANCIAL PERFORMANCE AND PROJECTIONS FORMADHYA PRADESH STATE ELECTRICITY BOARD

A. General

1. The projected financial statements are in current terms. The domestic and internationalinflation rates in the projections are presented in Table A8.1. The rupee is assumed todepreciate against the dollar at the end of every fiscal year by the difference between the twoinflation rates according to “purchasing power parity theory.” Forecasted foreign exchange ratesare also given in Table A8.1.

Table A8.1: Inflation and Foreign Exchange RatesItem FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010

Inflation Rate

Domestic(%) 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5% 6.5%

International(%) 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4%

Foreign Exchange Rate(Rs/$)

47.0 48.9 50.8 52.9 55.0 57.2 59.5 61.9 64.3

B. Income Statements

1. Sales Revenues

2. The Madhya Pradesh State Electricity Regulatory Commission (MPSERC) issued a tariffaward in September 2001 whereby the overall average tariff will be increased by 11percentcompared with the average tariff of Rs2.32/kilowatt-hour (kWh) in FY2001. Based on this,revenue in FY2002 is projected to be approximately 6.6 percent higher than the revenue withthe previous tariffs. Thereafter, it is assumed that tariff will be revised at the beginning of eachyear. Among low tension (LT) consumers, domestic, waterworks, agriculture, and street lightconsumers are currently charged below the cost of supply. A tariff increase above inflation rateis assumed for these consumers until full cost recovery is ensured. However, for agriculturalconsumers, 75 percent cost recovery would be achieved in FY2010 under the base case and inFY2007 for the upside scenario. Since most of high tension (HT) consumers are alreadycharged more than the cost of supply, a modest increase is projected except for waterworks andtwo minor bulk consumers (rural electrification cooperatives and border villages). Particularly forindustrial and commercial consumers that have the option to switch to captive generation, notariff increase is envisaged once the tariffs reach a breakeven point with cost of captive power(approximately Rs5.00/kWh). Under the base case scenario, full recovery of cost will beachieved by FY2009. Projected electricity tariffs net of electricity duty and sales tax arepresented in Table A8.2.

Table A8.2: Projected Average Cost of power and Consumer-wise Tariff(Rs/kWh, excluding electricity duties and sales taxes)

Item FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010

A. LT ConsumersDomestic Light & Fan 1.86 2.22 2.67 2.93 3.23 3.55 3.66 3.77 3.88 3.99

Single-Point Consumers 1.45 4.11 4.11 4.11 4.11 4.11 4.11 4.11 4.11 4.11

NonDomestic Consumers 4.32 4.82 4.92 5.02 5.02 5.02 5.02 5.02 5.02 5.02

Waterworks Schemes 1.72 2.26 2.71 2.98 3.28 3.60 3.71 3.82 3.94 4.06

LT Industrial Consumers 3.82 4.20 4.36 4.54 4.77 5.00 5.00 5.00 5.00 5.00

Agriculture Consumers 0.58 0.65 0.81 1.02 1.27 1.53 1.83 2.20 2.64 3.17

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Appendix 8, page 2

Street Light Consumers 1.74 2.76 3.31 3.64 3.75 3.86 3.98 3.98 3.98 3.98

Subtotal (A) 1.52 1.77 1.99 2.19 2.39 2.63 2.83 3.07 3.34 3.67B. HT Consumers

Railway Traction 4.95 5.20 5.46 5.73 6.02 6.02 6.02 6.02 6.02 6.02

Coal Mines 4.32 4.73 4.97 5.22 5.48 5.75 6.04 6.04 6.04 6.04

Mini Steel Plants 4.37 4.54 4.63 4.73 4.82 4.92 5.02 5.02 5.02 5.02

HT WaterworksSchemes

2.38 2.76 2.98 3.22 3.48 3.76 3.95 4.07 4.19 4.31

HT Irrigation Schemes 5.36 5.63 5.74 5.85 5.85 5.85 5.85 5.85 5.85 5.85

Licensees 0.08 1.50 1.88 2.34 2.81 3.38 3.98 4.10 4.23 4.35

Border Villages 0.31 0.31 0.38 0.45 0.54 0.65 0.78 0.94 1.13 1.35

Other HT Consumers 4.49 4.72 4.91 5.01 5.01 5.01 5.01 5.01 5.01 5.01

Subtotal (B) 3.60 4.07 4.29 4.52 4.69 4.85 5.03 5.07 5.10 5.14

Overall Average 2.32 2.58 2.78 2.99 3.15 3.36 3.56 3.72 3.92 4.15

Increase 11.0% 8.0% 7.3% 5.5% 6.8% 5.7% 4.7% 5.3% 5.9%

Increase - LT 16.0% 12.7% 9.9% 9.3% 10.0% 7.6% 8.3% 9.0% 9.7%

Increase - HT 13.0% 5.4% 5.4% 3.7% 3.6% 3.7% 0.6% 0.7% 0.7%

Average Cost of Supply 4.61 4.32 4.07 4.05 3.67 3.63 3.63 3.75 3.84 3.87

Cost Recovery - LT 33% 41% 49% 54% 65% 72% 78% 82% 87% 95%

Cost Recovery - HT 78% 94% 105% 112% 128% 134% 139% 135% 133% 133%

Cost Recovery - Total 50% 60% 68% 74% 86% 93% 98% 99% 102% 107%HT = high tension, LT = low tension.

Source: MPSEB, Staff estimates.

3. Table A8.3 provides forecasted consumption growth on an unrestricted basis. Due to thesluggish local economy, only marginal demand growth is expected for HT consumers. Thesharp decrease in FY2001 for LT consumers is due to reassessment of agriculturalconsumption. Consumption by LT consumers is expected to show a big increase in FY2002because of legalization of illegally connected agricultural consumers. Otherwise, demandgrowth corresponding to overall economic growth of the state is envisaged for LT consumers. Inthe projection, due to limited power purchase capability, power cuts between 5 to 20 percent areenvisaged for the first three years except for railways, coal mines, and waterworks.

Table A8.3: Unrestricted Consumption Growth (%)Item FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010LT Consumers -36.0% 20.3% 4.7% 4.7% 5.1% 5.1% 5.2% 5.5% 5.6% 5.6%HT Consumers 0.1% 0.6% 1.5% 3.6% 4.3% 4.5% 5.2% 5.3% 5.6% 5.6% Total -25.8% 12.8% 3.6% 4.4% 4.8% 4.9% 5.2% 5.4% 5.6% 5.6%Source: MPSEB, Staff estimates.

4. Efficiency gains are to be realized by reducing of transmission and distribution lossesand improving collection efficiency. Substantial reduction of transmission and distribution lossesfor the first five years is to be mainly driven by nontechnical loss reduction through full metering,energy audit, and tariff rationalization. Modest but continuous reduction of losses is expected tofollow as benefit of technical loss reduction program financed partly under the Project willmaterialize. Improvement of collection efficiency will result from computerizing the informationand revenue management system and full recovery of dues from municipalities and stategovernment bodies.

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Appendix 8, page 3

Table A8.4: Efficiency ImprovementItem FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010T&DLosses

49.0% 43.2% 38.0% 35.0% 32.0% 29.0% 26.0% 24.0% 23.0% 22.0%

CollectionEfficiency

86% 86% 88% 90% 92% 94% 95% 96% 97% 98%

T&D = transmission and distribution.Source: MPSEB, Staff estimates.

2. Operating Expenses

4. MPSEB’s own power generation, power purchase, and their unit costs are presented inTable A8.5. Since no investment in new power plant is expected, the gap between supplythrough self-generation and demand is assumed to be be filled by power purchase mainly fromcentral sector utilities.

Table A8.5: Self-Generation and Power PurchaseItem FY2001 Fy2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010Gross ThermalGeneration(GWh)

12,489 12,781 13,616 13,767 13,955 14,143 14,370 14,519 14,682 14,755

Gross HydelGeneration(GWh)

1,576 2,102 2,102 2,102 2,102 2,102 2,102 2,102 2,102 2,102

Auxiliary Consumption-Thermal (%)

9.52% 9.53% 9.57% 9.57% 9.57% 9.57% 9.57% 9.57% 9.57% 9.57%

Auxiliary Consumption-Hydel (%)

0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5% 0.5%

Unit Fuel Cost (Rs/kWh) 0.89 0.93 0.98 1.04 1.10 1.17 1.24 1.31 1.39 1.48

Power Purchased(GWh)

13,794 13,325 11,218 10,204 10,113 10,088 10,136 11,025 11,983 13,087

Unit Purchase Cost(Rs/kWh)

1.88 1.94 2.02 2.11 2.21 2.32 2.43 2.57 2.71 2.87

GWh = gigawatt-hour, kWh = kilowatt-hour.Source: MPSEB, Staff estimates.

5. The administrative costs are projected as follows:

(i) Operation and maintenance: Cost is estimated to grow at 5.0 percent annually.(ii) Employee costs: 2500 employees are estimated to retire every year. Salary per

head is assumed to grow at domestic inflation rate (6.5 percent) annually.(iii) Depreciation: Fixed assets are depreciated, on average, at the rate of

7.2 percent with straight-line method.(iv) Others: Other expenses are escalated by domestic inflation rates.

3. Subsidy, Subvention, and Grant

6. Based on the memorandum of understanding between Madhya Pradesh government(MPG) and MPSEB, the following subsidies, subventions, and grants, are projected:

(i) Cash grant equivalent to electricity duties and cess will be provided.(ii) Free power supply bills will be fully reimbursed in cash (approximately Rs500

million per year).(iii) Revenue subsidies will be provided in cash up to Rs2,750 million.(iv) A capital grant will be provided to cover up to 50 percent of capital investment

excluding ADB project.

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Appendix 8, page 4

In FY2002, the MPG budgeted Rs3,250 million for items (ii) and (iii). MPG indicates thatRs3,250 million will continue to be the maximum cash subsidy and subvention.

4. Debt Service, New Borrowing and Financial Charges

7. Interest and principal payments on the outstanding loans, which have become due andunpaid and will become due by FY2003, are assumed to be rescheduled and rescheduled loansbe fully repaid over 7 years. Other loans that will become due after FY2003 will be repaid as peroriginal amortization schedule. All outstanding loans from MPG will be written off againstsubsidy receivables from MPG in FY2002, resulting in net payment of Rs620 million fromGOMP to MPSEB. The financial charges are calculated based on the actual borrowing rates.Interest rates for the Project are assumed to be 12 percent per annum for the AsianDevelopment Bank (ADB) loan and 11 percent for the counterpart funding. Net cash shortfall isassumed to be financed by new loans at interest rates of 11 to 14 percent per annum.

C. Balance Sheet

8. Working capital items are projected as follows:

(i) cash and bank balances: 2 percent of annual sales revenue;(ii) receivables from municipalities and state government bodies: receivables

outstanding as of March 2001 (Rs7,423 million) will be fully recovered in cash byFY2004 as per tranche release conditionalities;

(iii) other receivables against supply of power: calculated based on projectedcollection efficiency;

(iv) subsidy receivables: receivables outstanding as of March 2001 will be written offagainst outstanding loans from MPG;

(v) fuel-related liabilities: gradually reduced to one month of purchase;(vi) power purchase liabilities: MPSEB is assumed to remain current on power

purchase bills after March 2001; and(vii) of unpaid liabilities of Rs16 billion to central power sector as of March 2001,

Rs10 billion will be converted into a 15-year loan with 5-year grace period.

9. The projected annual capital investments are given in Table A8.6. No investment in newgeneration plant is envisaged. For loss reduction, priority will be given to transmission anddistribution.

Table A8.6: Capital Investment Plan(Rs million)

Item FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 FY2009 FY2010Generation 801 821 2,921 1,906 390 1,055 2,088 1,500 1,500 1,500Transmission 128 648 3,360 2,870 848 1,000 1,000 1,500 1,500 1,500Distribution and others 1,873 3,395 4,605 960 3,194 2,000 2,000 2,500 2,500 2,500 Total 2,802 4,864 10,886 5,736 4,432 4,055 5,088 5,500 5,500 5,500Source: MPSEB, Staff estimates.

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Appendix 9, page 1

CONTRACT PACKAGES AND COST ESTIMATES

Table A9.1: List of Contract PackagesContract Item Procurement Estimated Value

No. Mode ($ million)Part A: Distribution System Improvements andPart B: Conversion of Low Voltage Lines to 11kV1. Transformers and Voltage Boosters ICB 26.12. Capacitors ICB 0.73. Circuit Breakers ICB 8.94. Isolators and Sectionalizers ICB 1.35. Lightning Arrestors and Fuses ICB 1.46. Insulators ICB 1.57. Conductors and Sleeves ICB 11.88. Cross Arms, Stays, and Earthing ICB 8.09. Cables and Clamps ICB 0.710. Energy Meters ICB 0.711. Switch Fuse Units ICB 0.1

Part C-1: Transmission Lines1. Towers (including erection) ICB 17.22. Conductor and Groundwire ICB 9.73. Insulators ICB 1.34. Line Hardware and Accessories ICB 0.8

Part C-2: Substations1. Transformers ICB 30.92. Circuit Breakers ICB 7.03. CTs and PTs ICB 3.04. Isolators and Earth Switches ICB 1.35. Lightning Arrestors ICB 0.76. Insulators ICB 2.27. Control and Protection Equipment ICB 2.68. Carrier Communication Equipment ICB 6.19. AC and DC Equipment ICB 0.410. Busbar Structures and Earthing ICB 5.011. 33kV Equipment ICB/IS 4.412. Cables and Miscellaneous Items ICB/IS 2.1

Part D: Computer System1. Computer Hardware ICB 7.8

Part E: Metering1. Three-phase Meters ICB 1.1ICB = international competitive bidding, KV = kilovolt, IS = international shopping.Note: In Part C-1, the cost of Package 1 includes erection charges which will be financed by MPSEB.Source: MPSEB and Staff estimates.

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Appendix 9, page 2

Table A9.2: Cost Estimates for Consulting Services($ ‘000)

Foreign Local TotalItem Exchange Currency Cost

1. Remuneration 1,368.0 0.0 1,368.02. Per Diem 194.4 0.0 194.43. International/Local Travel 60.0 3.3 63.3

4. Computers and Associated Equipment 15.0 0.0 15.05. Contingencies 162.6 0.3 162.9

Total 1,800.0 3.6 1,803.6Source: Staff estimates.

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Appendix 10, page 1

FINANCIAL EVALUATION OF THE PROJECT

1. The major assumptions used in the financial evaluation of the investment Project arediscussed in this appendix.

A. General

2. The financial evaluation of the Project was carried out on an incremental basis and alsoon a subproject basis due to its discreet nature. Impact of tax payment is not considered forcalculation of benefit and weighted average cost of capital since the Madhya Pradesh StateElectricity Board (MPSEB) will not be in a position to pay income taxes. All prices are inconstant September 2001 value. Foreign exchange rate is assumed at Rs47.00 to $1.00.

3. The capital cost of each subproject and its disbursement schedule were reviewed duringthe Appraisal mission. Physical contingency is assumed at 10 percent of the base cost.

4. MPSEB’s cost of capital is calculated for the Project as a whole. The Project will befinanced by foreign debt (60 percent) and local debt. The cost of debt for the Project in rupees is12 percent and 11 percent, respectively, for the ADB loan and domestic commercial loans. Theweighed average cost of capital is estimated in real terms and shown in Table A10.1.

Table A10.1: Weighted Average Cost of CapitalSource Amount

(Rs million)Cost(%)

Weighted(%)

ADB Loan 9,400 9.38 6.51

Domestic CommercialLoan

4,151 4.23 1.30

Weighted AverageCost of Capital

7.81

Source: MPSEB, Staff estimates.

B. Components A, B, and C

1. Capital Cost

5. The Project is assumed to commence operation in 2 years and reach full capacity in 4years after the start of construction. The operating life of the Project is 20 years with no salvagevalue. Total cost of Rs10,742 million is scheduled to be disbursed as presented in Table A10.2.

Table A10.2: Disbursement Schedule(Rs million)

Item FY2002 FY2003 FY2004 FY2005 TotalComponent A 288 2,656 989 350 4,283Component B 27 243 75 24 369Component C 0 3,143 2,604 382 6,129Source: Staff estimates.

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Appendix 10, page 2

2. Sales Revenue

a. Tariff

6. Revenues corresponding to incremental power sales are assumed to be at thedistribution level with overall weighted average retail tariff in FY2002.

b. Sales Volume

7. Due to technical and commercial loss reduction components A, B, and C are assumed torealize incremental power sales of 222 gigawatt-hour (GWh), 18 GWh and 472 GWhrespectively.

3. Operating Cost

8. Annual operating cost is expected to be 1.0 percent of total capital costs for componentA and C. No incremental operational cost is required for component B.

Table A10.3: Financial Internal Rate of Return for Project Component A(Rs million)

RevenueFiscal Year Volume Tariff Total Operatin g Profit Capital Net Cash

MkWh Rs/kWh Revenue Cost BeforeTax

Investment Flow

2002 (288) (288)2003 (2,656) (2,656)2004 55 2.58 143 29 114 (989) (875)2005 111 2.58 286 39 247 (350) (103)2006 222 2.58 572 43 529 5292007 222 2.58 572 43 529 5292008 222 2.58 572 43 529 5292009 222 2.58 572 43 529 5292010 222 2.58 572 43 529 5292011 222 2.58 572 43 529 5292012 222 2.58 572 43 529 5292013 222 2.58 572 43 529 5292014 222 2.58 572 43 529 5292015 222 2.58 572 43 529 5292016 222 2.58 572 43 529 5292017 222 2.58 572 43 529 5292018 222 2.58 572 43 529 5292019 222 2.58 572 43 529 5292020 222 2.58 572 43 529 5292021 222 2.58 572 43 529 5292022 222 2.58 572 43 529 5292023 222 2.58 572 43 529 5292024 222 2.58 572 43 529 5292025 222 2.58 572 43 529 5292026 222 2.58 572 43 529 529

Financial Internal Rate of Return = 9.8%kWh = kilowatt-hour, MkWh = million kilowatt-hour.Source: Staff estimates.

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Appendix 10, page 3

Table A10.4: Financial Internal Rate of Return for Project Component B(Rs million)

RevenueFiscal Year Volume Tariff Total Profit Capital Net Cash

MkWh Rs/kWh Revenue Before Tax Investment Flow2002 (27) (27)2003 (243) (243)2004 4 2.58 11 11 (75) (63)2005 13 2.58 34 34 (24) 102006 18 2.58 45 45 452007 18 2.58 45 45 452008 18 2.58 45 45 452009 18 2.58 45 45 452010 18 2.58 45 45 452011 18 2.58 45 45 452012 18 2.58 45 45 452013 18 2.58 45 45 452014 18 2.58 45 45 452015 18 2.58 45 45 452016 18 2.58 45 45 452017 18 2.58 45 45 452018 18 2.58 45 45 452019 18 2.58 45 45 452020 18 2.58 45 45 452021 18 2.58 45 45 452022 18 2.58 45 45 452023 18 2.58 45 45 452024 18 2.58 45 45 452025 18 2.58 45 45 452026 18 2.58 45 45 45

Financial Internal Rate of Return = 10.0%kWh = kilowatt-hour, MkWh = million kilowatt-hour.Source: Staff estimates.

85

Appendix 10, page 4

Table A10.5: Financial Internal Rate of Return for Project Component C(Rs million)

RevenueFiscal Year Volume Tariff Total Operatin g Profit Capital Net Cash

MkWh Rs/kWh Revenue Cost Before Tax Investment Flow2003 (3,143) (3,143)2004 118 2.58 304 31 273 (2,604) (2,331)2005 236 2.58 609 57 551 (382) 1692006 472 2.58 1,217 61 1,156 1,1562007 472 2.58 1,217 61 1,156 1,1562008 472 2.58 1,217 61 1,156 1,1562009 472 2.58 1,217 61 1,156 1,1562010 472 2.58 1,217 61 1,156 1,1562011 472 2.58 1,217 61 1,156 1,1562012 472 2.58 1,217 61 1,156 1,1562013 472 2.58 1,217 61 1,156 1,1562014 472 2.58 1,217 61 1,156 1,1562015 472 2.58 1,217 61 1,156 1,1562016 472 2.58 1,217 61 1,156 1,1562017 472 2.58 1,217 61 1,156 1,1562018 472 2.58 1,217 61 1,156 1,1562019 472 2.58 1,217 61 1,156 1,1562020 472 2.58 1,217 61 1,156 1,1562021 472 2.58 1,217 61 1,156 1,1562022 472 2.58 1,217 61 1,156 1,1562023 472 2.58 1,217 61 1,156 1,1562024 472 2.58 1,217 61 1,156 1,1562025 472 2.58 1,217 61 1,156 1,1562026 472 2.58 1,217 61 1,156 1,156

Financial Internal Rate of Return = 16.3%kWh = kilowatt-hour, MkWh = million kilowatt-hour.Source: Staff estimates.

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Appendix 11, page 1

ECONOMIC EVALUATION

1. The Sector Development Program has as one of its immediate objectives to establish acommercial and competitive business environment in the power sector to promote efficiencygains and loss reductions. Overall system losses in Madhya Pradesh are estimated at 47percent, comprising 22 percent technical and 25 commercial losses for a total estimated loss of16,857 million units. However, regional data of losses show high discrepancies between thedifferent distribution areas. Gwalior (64 percent) and Ujjain (60 percent) districts have thehighest distribution system losses, with Indore following close behind with an estimated 52percent loss and Bhopal and Jabalpur at 48 percent and 46 percent. Project components A andB support physical investments for technical and commercial loss reduction in those regions.These physical investments are an integral part of the comprehensive loss reduction strategycurrently being implemented by the Madhya Pradesh State Electricity Board (MPSEB). The lossreduction strategy of MPSEB is targeting three levels, (i) energy audit and end-user metering togain more accurate loss estimation data to identify the distribution circles with the highestlosses, (ii) internal efficiency improvement through computerized billing and revenue systemand increased staff responsibilities for reducing theft and meter tampering, and (iii) physicalinvestments directly targeting loss reduction.

2. Component C supports upgrading and rehabilitation of state transmission systemcomponents to reduce technical losses throughout the state. Load-flow analysis for 9 of theproposed 132 33 kilovolt (kV) substations found an average loss reduction value of11 megawatt (MW) per substation with the lowest value at 4.6 MW and the highest at 16 MW. Inthe economic analysis a value of 3 MW of loss reduction for the 25 substations was used, whichestimates benefits conservatively. In addition, a reduction of 57 MW peak-load transmission losshas also been included in the analysis.

3. Benefits from loss reduction are threefold. First, they will generate additional revenue forMPSEB and contribute to an improvement in the financial situation, which will ultimately result inan improved power supply situation. Second, commercial loss reduction in particular will reducepower demand for different customer categories according to their respective price elasticity ofdemand, and will thus indirectly contribute to a reduction of power shortages. No analysis ofprice elasticity has been carried out for Madhya Pradesh and the currently available dataappears insufficient to calculate appropriate values. Third, technical loss reduction in particularwill result in economic resource cost savings as less units need to be generated, transmitted,and distributed to supply the same amount of energy to end-consumers.

4. The methodology of economic evaluation for all subprojects is similar. The economicanalysis was carried out at border price level using FY2001 prices. To convert financial cost intoeconomic cost, taxes and duties were deducted. No price contingencies are included in thebase capital cost but the economic capital costs include 10 percent physical contingencies. Thecosts were separated into foreign exchange, indirect foreign exchange, and local currencycosts. Local costs were further separated and a specific conversion factor of 0.85 was used forunskilled labor. The remaining local costs were converted to border price level by applying astandard conversion factor of 0.9. Annual operation and maintenance costs were alsocalculated in economic prices as a percentage of the total capital investment cost. However, nooperational and maintenance cost were included for component B since the conversion ofexisting low tension (LT) lines into 11 kV does not create any incremental cost.

5. The economic benefits of loss reduction were calculated separately for technical andcommercial loss reduction. Technical loss reduction under component A was valued at theaverage cost of supply at LT level for FY2000, and for component C at the average cost ofsupply at extra high tension level for FY2000, the latest year for which the breakdown is

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Appendix 11, page 2

available. Commercial loss reduction was valued at the increasing tariff levels up to FY2010,reflecting the changing relationship between average cost of supply and average tariff, whichresults in reduction of economic subsidies over the lifetime of the Project. Benefits are assumedto build up gradually over three years.

6. The base case economic internal rate of return (EIRR) for component A is estimated at17.1 percent, for component B at 16.8 percent, and for component C at 16.4 percent. TheEIRRs were calculated for 25 years, including the construction period. No residual value wasconsidered. Comprehensive sensitivity analysis and calculation of switching values indicatesthat the EIRR values for all three project components are above the 12 percent threshold for alladverse circumstances tested. Implementation delay was tested by assuming that the buildup ofbenefits over a three-year period will only commence after finalization of construction. Details ofthe economic analysis and the sensitivity analysis are provided in Tables A11.1 – A11.6.

Table A11.1: Economic Internal Rate of Return for Project Components A(Rs million)

Economic BenefitsFiscal Year Technical Loss

Reduction(MkWh)

Cost Savings CapitalInvestment

Operating Cost Net Cash Flow

2002 (288) (288)2003 (2,622) (2,622)2004 55 223 (919) (29) (725)2005 111 447 (316) (38) 932006 222 894 (41) 8522007 222 894 (41) 8522008 222 894 (41) 8522009 222 894 (41) 8522010 222 894 (41) 8522011 222 894 (41) 8522012 222 894 (41) 8522013 222 894 (41) 8522014 222 894 (41) 8522015 222 894 (41) 8522016 222 894 (41) 8522017 222 894 (41) 8522018 222 894 (41) 8522019 222 894 (41) 8522020 222 894 (41) 8522021 222 894 (41) 8522022 222 894 (41) 8522023 222 894 (41) 8522024 222 894 (41) 8522025 222 894 (41) 8522026 222 894 (41) 852

Economic Internal Rate of Return = 17.1%Net Present Value = 1,240

MkWh = million kilowatt-hour.Source: Staff estimates.

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Appendix 11, page 3

Table A11.2: Economic Internal Rate of Return for Project Component B(Rs million)

Economic BenefitsFiscalYear

Technical LossReduction

(MkWh)

Ave. Tariff(Rs/kWh)

CostSavings

Ave. Cost ofSupplyRs/kWh

Change inrelation

tariff: cost ofsupply

in %

CapitalInvestment

Net CashFlow

2002 2.53 4.03 63 (27) (27)2003 2.67 3.80 70 (242) (242)2004 4 2.85 12 3.77 76 (71) (58)2005 13 3.02 40 3.67 83 (22) 182006 18 3.22 56 3.63 89 562007 18 3.42 60 3.63 94 602008 18 3.65 64 3.75 97 642009 18 3.83 67 3.84 100 672010 18 4.04 71 3.87 104 712011 18 4.04 71 3.87 104 712012 18 4.04 71 3.87 104 712013 18 4.04 71 3.87 104 712014 18 4.04 71 3.87 104 712015 18 4.04 71 3.87 104 712016 18 4.04 71 3.87 104 712017 18 4.04 71 3.87 104 712018 18 4.04 71 3.87 104 712019 18 4.04 71 3.87 104 712020 18 4.04 71 3.87 104 712021 18 4.04 71 3.87 104 712022 18 4.04 71 3.87 104 712023 18 4.04 71 3.87 104 712024 18 4.04 71 3.87 104 712025 18 4.04 71 3.87 104 712026 18 4.04 71 3.87 104 71

Economic Internal Rate of Return = 16.8%Net Present Value = 75

kWh = kilowatt-hour, MkWh = million kilowatt-hour.Source: Staff estimates.

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Appendix 11, page 4

Table A11.3: Economic Internal Rate of Return for Project Component C(Rs million)

Economic BenefitsFiscalYear

Technical LossReduction

MkWh

Ave. Cost ofSupply atEHT levelRs/kWh

CostSavings

CapitalInvestment

Operating Cost Net CashFlow

2003 (3,087) (3,087)2004 118 2.5 295 (2,493) (31) (2,228)2005 236 2.5 591 (326) (56) 2092006 472 2.5 1,182 (59) 1,1232007 472 2.5 1,182 (59) 1,1232008 472 2.5 1,182 (59) 1,1232009 472 2.5 1,182 (59) 1,1232010 472 2.5 1,182 (59) 1,1232011 472 2.5 1,182 (59) 1,1232012 472 2.5 1,182 (59) 1,1232013 472 2.5 1,182 (59) 1,1232014 472 2.5 1,182 (59) 1,1232015 472 2.5 1,182 (59) 1,1232016 472 2.5 1,182 (59) 1,1232017 472 2.5 1,182 (59) 1,1232018 472 2.5 1,182 (59) 1,1232019 472 2.5 1,182 (59) 1,1232020 472 2.5 1,182 (59) 1,1232021 472 2.5 1,182 (59) 1,1232022 472 2.5 1,182 (59) 1,1232023 472 2.5 1,182 (59) 1,1232024 472 2.5 1,182 (59) 1,1232025 472 2.5 1,182 (59) 1,1232026 472 2.5 1,182 (59) 1,123

Economic Internal Rate of Return = 16.4%Net Present Value = 1,585

EHT = extra high tension, kWh = kilowatt-hour, MkWh = million kilowatt-hour.Source: Staff estimates.

Table A11.4: Sensitivity Testing for Project Component AVariable Test EIRR Switching Value NPV

Base Case 17.1 1,240Capital Cost +10 % 15.4 38% 895

+20% 14.0 551

Benefits -10% 15.3 28% 771-20% 13.4 303

Value of -10% 15.3 37% 771Technical Losses -20% 15.4 303

Units of -10% 15.1 27% 731Technical Losses -20% 13.1 232

Implementation Delay 1 year 14.6 6852 years 12.8 190

EIRR = economic internal rate of return, NPV = net present value.Source: Staff estimates.

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Appendix 11, page 5

Table A11.5: Sensitivity Testing for Project Component BVariable Test EIRR Switching

ValueNPV

Base Case 16.8 75

Capital Cost +10% 15.3 39% 47+20% 14.0 19

Benefits -10% 15.1 28% 39-20% 13.4 4

Units of -10% 15.1 30% 39Technical Losses -20% 13.4 4

Value of -10% 13.6 7Technical Losses -20% 10.4 -54

Implementation Delay 1 year 15.0 242 years 12.9 4

EIRR = economic internal rate of return, NPV = net present value.Source: Staff estimates.

Table A11.6: Sensitivity Testing for Project Component CVariable Test EIRR Switching

ValueNPV

Base Case 16.4 1,585

Capital Cost +10% 14.83 31% 1,050+20% 13.3 514

Benefits -10% 14.6 24% 891-20% 12.71 197

Units of -10% 14.6 24% 891Technical Losses -20% 12.7 197

Value of -10% 14.6 24% 891Technical Losses -20% 12.7 197

Implementation Delay 1 year 15.0 242 years 12.9 4

EIRR = economic internal rate of return, NPV = net present value.Source: Staff estimates.

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