Project Number: 47037-005 MFF Number: 0084 November 2016

Democratic Socialist Republic of Sri Lanka: Green Power Development and Energy Efficiency Improvement Investment Program (Tranche 2) and Minor Change to the Facility Distribution of this document is restricted until it has been approved by Management. Following such approval, ADB will disclose the document to the public in accordance with ADB's Public Communications Policy 2011.

Periodic Financing Request Report

CURRENCY EQUIVALENTS (as of 8 November 2016)

Currency Unit – Sri Lanka rupee/s (SLRe/SLRs)

SLRe1.00 = $0.00675

$1.00 = SLRs147.93

ABBREVIATIONS ADB – Asian Development Bank ADF – Asian Development Fund AFD – Agence Française de Développement CEB – Ceylon Electricity Board EIA – environmental impact assessment EMP – environmental management plan FBU – functional business unit FFA – framework financing agreement IEE – initial environmental examination km – kilometer kV – kilovolt MFF – multitranche financing facility MPRE – Ministry of Power and Renewable Energy MW – megawatt OCR – ordinary capital resources PAM – project administration manual SDR – special drawing rights SPS – Safeguard Policy Statement

NOTE

In this report, "$" refers to US dollars.

Vice-President W. Zhang, Operations 1 Director General H. Kim, South Asia Department (SARD) Director M. Khamudkhanov, Officer-in-Charge, Energy Division, SARD Team leader M. Khamudkhanov, Principal Energy Specialist, SARD Team members A. Bernaldo, Associate Project Officer, SARD Y. Jang, Social Development Specialist, SARD A. Syed, Senior Counsel, Office of the General Counsel R. Wimalasena, Senior Project Officer (Energy), SARD A. Zhou, Senior Energy Specialist, SARD Y. Zhou, Environment Specialist, SARD Peer reviewer P. Wijayatunga, Principal Energy Specialist, Sustainable Development

and Climate Change Department In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page

TRANCHE AT A GLANCE

MAP

I. BACKGROUND 1

II. ASSESSMENT OF IMPLEMENTATION 2

III. PERIODIC FINANCING REQUEST 3

A. Impact and Outcome 3

B. Outputs 3

C. Investment and Financing Plans 4

D. Implementation Arrangements 5

E. Project Readiness 6

F. Advance Contracting and Retroactive Financing 6

IV. DUE DILIGENCE 7

A. Technical 7

B. Economic and Financial 7

C. Governance 7

D. Poverty, Social, and Gender Dimensions 8

E. Safeguards 8

F. Risks and Mitigating Measures 9

G. Risk Categorization 10

V. ASSURANCES 10

VI. MINOR CHANGE OF MULTITRANCHE FINANCING FACILITY: EXTENSION OF THE MULTITRANCHE FINANCING FACILITY AVAILABILITY PERIOD 10

VII. RECOMMENDATION 10

APPENDIXES 1. Design and Monitoring Framework for Project 2 2. Guarantee Agreement 3. Loan Agreement: Special Funds Resources 4. Loan Agreement: Ordinary Capital Resources 5. Updated Contribution to the ADB Results Framework 6. Project Administration Manual for Project 2 7. Economic Analysis for Project 2 8. Financial Analysis for Project 2 9. Updated Summary of Poverty Reduction and Social Strategy 10. Environmental Impact Assessment: 220-kilovolt Mannar–Nadukuda Transmission Line 11. Initial Environmental Examination: Transmission Infrastructure Enhancement 12. Initial Environmental Examination: Medium-Voltage Network Efficiency Improvement 13. Resettlement Plan 14. Project Climate Risk Assessment and Management Report 15. Updated Risk Assessment and Risk Management Plan

Project Classification Information Status: Complete

TRANCHE AT A GLANCE

Source: Asian Development Bank 09112016162801278242This document must only be generated in eOps. Generated Date: 09-Nov-2016 16:28:07 PM

1. Basic Data Project Number: 47037-005Project Name Green Power Development and Energy Efficiency

Improvement Investment Program - Tranche 2Department/Division

SARD/SAEN

Country Sri Lanka Executing Agency Ceylon Electricity BoardBorrower Ceylon Electricity Board.

2. Sector Subsector(s) ADB Financing ($ million)Energy Electricity transmission and distribution 141.00

Energy efficiency and conservation 9.00Total 150.00

3. Strategic Agenda Subcomponents Climate Change Information Inclusive economic growth (IEG)

Pillar 2: Access to economic opportunities, including jobs, made more inclusive

Environmentally sustainable growth (ESG)

Global and regional transboundary environmental concerns

Adaptation ($ million) 10.00Mitigation ($ million) 30.00CO2 reduction (tons per annum) 114,663Climate Change impact on the Project

Medium

.

4. Drivers of Change Components Gender Equity and MainstreamingGovernance and capacity development (GCD)

Institutional development

Knowledge solutions (KNS)

Pilot-testing innovation and learning

Partnerships (PAR) Bilateral institutions (not client government)Official cofinancing

No gender elements (NGE)

.

5. Poverty and SDG Targeting Location ImpactGeographic TargetingHousehold TargetingSDG Targeting

NoNoYes

Rural HighUrban Medium

SDG Goals SDG7, SDG13.

6. Risk Categorization: Complex.

7. Safeguard Categorization Environment: A Involuntary Resettlement: B Indigenous Peoples: C.

8. Financing

Modality and Sources Amount ($ million)

ADB 150.00

Sovereign MFF-Tranche (Loan): Asian Development Fund 55.00

Sovereign MFF-Tranche (Loan): Ordinary capital resources 95.00

Cofinancing 30.00

Agence Francaise de Developpement - Loan 30.00

Counterpart 80.00

Government

80.00

Total 260.00.

9. Effective Development CooperationUse of country procurement systems NoUse of country public financial management systems Yes

TRANCHE AT A GLANCE

Source: Asian Development Bank 09112016162801278242This document must only be generated in eOps. Generated Date: 09-Nov-2016 16:28:07 PM

Date of Receipt by ADB of PFR: 19 August 2016 Tranche Number: 2.

10. Country Operations Business PlanCPS http://www.adb.org/documents/sri-lanka-interim-country-partnership-strateg

y-2015-2016COBP http://www.adb.org/documents/sri-lanka-country-operations-business-plan-2

016-2018.

11. Tranche SummaryTranche 2 will finance investments in (i) transmission infrastructure enhancement; (ii) efficiency improvement of medium voltagenetwork; and (iii) demand-side management improvement for energy efficiency including development of an innovative smart gridand metering pilot subproject..

Impact: The impact will be increased access to clean and reliable power supply. Outcome: The outcome will be enhanced system efficiency and reliability. .

Outputs: (i) Transmission infrastructure enhanced, (ii) efficiency of medium-voltage network improved, and (iii) demand-sidemanagement for energy efficiency improved..

Implementation Arrangements: Ceylon Electricity Board will be the executing agency..

Project Readiness: CEB appointed a project director and established project implementation units with full-time project managersand engineers for each output. CEB submitted draft bidding documents for major transmission procurement packages to ADBduring March-September 2016. Evaluation is ongoing for two procurement contracts. CEB will issue the remaining biddingdocuments for the transmission and distribution procurement packages in the fourth quarter of 2016, and for the smart grid andmetering pilot subproject in the second quarter of 2017 after consultant recruitment.

.

12. Significant Developments in the MFF and Previous TranchesTranche 1 (Loans 3146/3147 and Loan 8290 [administered by ADB]) approved in July 2014 for $180 million financed (i)construction of the 30-MW Moragolla hydropower plant and an associated 132 kV transmission line in Central Province; (ii)construction of four new grid substations and augmentation of existing three grid substations, construction of 10 km 132 kVassociated transmission lines, and upgrading of Pannipitiya - Panadura 12.3 km 132 kV transmission line in Western, Eastern, andNorth Central provinces; (iii) erection of 87 km 33 kV lines and gantries around Vavunativu and Madampe in Eastern and NorthWestern provinces; (iv) demand-side management pilot subprojects in Colombo; and (v) capacity building and project managementfor preparing future MFF investments and supervising implementation of capital investments of the first tranche. As of 8 November2016, the cumulative contract awards and disbursements were $56.975 million (31.65%) and $4.679 million (2.60%), respectively.Of the 20 loan covenants, 5 have been met, 13 are being met, and 2 are not yet due.

.

13. MilestonesEstimated Approval Estimated Completiona

29 November 2016 30 June 2022

14. Linked Documents-

Required Document Disclosure Date(i) Environment IEE - Initial Environment Examination Weblink:

http://www.adb.org/projects/documents/sri-gpdeeiip-t2-medium-voltage-network-efficiency-improvement-jul-2016-iee

19-AUG-2016

IEE - Initial Environment Examination

http://www.adb.org/projects/documents/sri-gpdeeiip-t2-transmission-infrastructure-enhancement-jul-2016-iee

19-AUG-2016

EIA - Environmental Impact Assessment

http://www.adb.org/projects/documents/sri-gpdeeiip-mannar-nadukuda-tl-jul-2016-eia

07-JUL-2016

(ii) Involuntary resettlement RP - Resettlement Plan Weblink:

http://www.adb.org/projects/documents/sri-gpdeeiip-t2-jul-2016-rp 19-AUG-2016

-

. .

a For Tranches, this refers to the financial closing date.

I. BACKGROUND

1. A framework financing agreement (FFA) for the Green Power Development and Energy Efficiency Improvement Investment Program was signed between the Asian Development Bank (ADB) and Sri Lanka on 19 May 2014. On 15 July 2014, ADB’s Board of Directors approved the provision of a multitranche financing facility (MFF) to Sri Lanka, with an aggregate facility amount of up to $360 million.1 The MFF aims to support the Government of Sri Lanka in advancing sustainable power sector development and universal access to electricity services.

2. Sri Lanka has improved its energy sector performance and achieved a national electrification ratio of 98% in 2014 compared with 29% in 1990.2 However, high dependence on expensive fossil fuel energy continues. Sector challenges include meeting growing demand for electricity at a low cost and acceptable reliability, and attaining long-term sustainability. The increase in the share of thermal oil-fired energy in power generation, from 6% in 1995 to 35% in 2014, creates a high cost base and is not a viable and sustainable solution for energy security and environment protection in the long term. Diversification of the generation mix primarily to renewable energy sources, improved network efficiency, reduced technical losses, and supply- and demand-side management are required. The transmission network needs to be expanded and modernized. Improvement of the 33-kilovolt (kV) network is required to improve system reliability and expand power supply into the rural areas to serve poor households.

3. Sri Lanka has a national investment program including sector investments that are based on the National Energy Policy and Strategies, which includes a sector road map, a long-term investment plan, and appropriate policy and reform measures.3 By 2020, the government objectives are to (i) increase power supply capacity to about 6,400 megawatts (MW) and reduce generation cost by adding aggregate base load capacity of about 2,000 MW from three coal-fired plants,4 (ii) increase the share of energy supply from nonconventional renewable energy sources to 20%,5 and (iii) reduce total network losses to 10%. While the government aims to increase supply capacity and replace expensive and inefficient oil-fired power plants by constructing low-cost coal-fired plants, the remaining supply capacity will come from renewable sources. The 20% increase in power generation from nonconventional renewable sources will add to 29% (2014) of conventional hydropower generation and will ensure that in the future a substantial portion of electricity is produced by clean energy sources.

4. The MFF is based on a development framework including a long-term energy sector investment program linked to the National Energy Policy and Strategies. The MFF was designed to support the green power development and energy efficiency improvement portion of the government’s energy sector investment program by (i) financing hydropower development; (ii) expanding transmission and medium-voltage infrastructure to improve network efficiency and enable power evacuation of renewable energy in the system; (iii) piloting innovative demand-side management technologies for energy efficiency; and (iv) supporting institutional capacity building for power system development, and project management and supervision.

5. The MFF is financing part of the government’s energy sector investment program that was originally estimated at $4.8 billion for 2014–2020. It has separate financing plans for the overall facility and for individual tranches. The MFF supports green power development,

1 ADB. 2014. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche

Financing Facility to the Democratic Socialist Republic of Sri Lanka for the Green Power Development and Energy Efficiency Improvement Investment Program. Manila.

2 Ceylon Electricity Board. 2015. Statistical Digest 2014. Colombo.

3 Government of Sri Lanka. 2008. National Energy Policy and Strategies of Sri Lanka. Colombo.

4 The 900 MW Puttalam coal-fired power plant that was completed in 2014 is already operational.

5 Nonconventional renewable energy sources include mini hydropower (up to 10 MW capacity), wind, solar, and

biomass.

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including hydropower generation, and the proposed 375 MW wind power parks through the financing of relevant power evacuation transmission infrastructure.6 It helps to encourage and facilitate private sector investment in renewable power generation by improving transmission infrastructure. The MFF aids an ongoing and essential dialogue with the government on pursuing power sector reforms in coordination with other development partners. The MFF is consistent with ADB’s interim country partnership strategy for Sri Lanka.7

6. ADB received the periodic financing request for tranche 2 (for $180 million) on 19 August 2016. The government and Ceylon Electricity Board (CEB) propose counterpart financing of $80 million. The investments under tranche 2 will cover part of the government’s investment plan. The proposed tranche subprojects are consistent with the overall MFF outcome and outputs. The tranche will focus on investments in transmission infrastructure enhancement, medium-voltage network efficiency improvement, and development of a smart grid and metering pilot subproject for demand-side management.

II. ASSESSMENT OF IMPLEMENTATION

7. On 29 July 2014, ADB management approved tranche 1 of the MFF in the amount of $180 million to finance the following: (i) construction of the 30 MW run-of-river hydropower plant at Moragolla and 0.5 kilometers (km) of a dedicated 132 kV transmission line in Central Province; (ii) construction of four new grid substations at Kerewalapitiya, Kappalturai, Kalutara, and Kesbewa and augmentation of the existing Katunayake, Trincomalee, and Anuradhapura grid substations; construction of 10 km of 132 kV associated transmission lines; and upgrading of the Pannipitiya–Panadura 12.3 km 132 kV transmission line in Western Province, Eastern Province, and North Central Province; (iii) erection of 87 km of 33 kV lines and gantries around Vavunativu and Madampe in Eastern Province and North Western Province; and (iv) demand-side management pilot subprojects in Colombo. Nonphysical outputs included capacity building and project management for preparing future MFF investments and supervising implementation of capital investments of project 1. The relevant ADB ordinary capital resources (OCR) and Asian Development Fund (ADF) loan agreements and a project agreement were signed on 20 November 2014, and the loans became effective on 2 February 2015. The Agence Française de Développement (AFD) loan agreement was signed on 2 October 2015. Project 1 is envisaged to be completed by 30 September 2019. The loan closing date is 30 March 2020. The Ministry of Power and Renewable Energy (MPRE)8 is the executing agency, and CEB is the implementing agency for the project. Project 1 is currently on track. As of 8 November 2016, the total awarded contract amount was $56.975 million (31.65% of the approved amount), and $4.679 million (2.60% of the approved amount) had been disbursed.

8. While all transmission and medium-voltage procurement contracts have been awarded and designs for the demand-side management pilot subprojects have been finalized for bidding within 2016, there were delays in implementing the 30 MW Moragolla hydropower plant relating to the recruitment of project supervision consultants. The new management of MPRE and CEB appointed in 2015 wanted to (i) review the original arrangement of engaging an international firm through quality- and cost-based selection, and (ii) explore the option for CEB to handle construction management and supervision with the support of national consultants. After several rounds of discussions with ADB that focused on ensuring the hydropower plant’s construction quality and safety, MPRE and CEB reconfirmed that the original arrangement could continue. In

6 This includes 300 MW on Mannar Island and 75 MW in Mannar District on the main island in Northern Province.

The first 100 MW wind park is expected to be established on Mannar Island in 2018, followed by additional wind power developments.

7 ADB. 2015. Interim Country Partnership Strategy: Sri Lanka, 2015–2016. Manila.

8 Formerly Ministry of Power and Energy.

3

October 2016, CEB signed a contract with the first-ranked consulting firm; the bidding for civil works and electromechanical facilities for the hydropower plant will commence soon.

9. The government and the executing and implementing agencies for tranche 1 are currently in compliance with most of the FFA undertakings and loan covenants set forth in the respective loan agreements. 9 Fulfillment of certain undertakings and covenants has been delayed and is currently ongoing. Although CEB’s board of directors has not yet made a decision on the financial separation of its functionally unbundled licensed business units (para. 26), the government is committed to complete this process with an implementation plan for such financial separation expected to be finalized by the end of 2016. To facilitate on-time invoicing and payments by licensees, CEB will set up an actual cash-based bulk supply transaction account by the end of 2016. In addition to the operational Distribution Code and Supply Services Code, the Public Utilities Commission of Sri Lanka will approve a new Grid Code by the end of 2016 to update the 2014 version.

III. PERIODIC FINANCING REQUEST

A. Impact and Outcome

10. The impact of project 2 of the investment program will be increased access to clean and reliable power supply aligned with the National Energy Policy and Strategies of Sri Lanka (footnote 3). The outcome will be enhanced system efficiency and reliability. The project’s design and monitoring framework is in Appendix 1.

B. Outputs

11. The project includes the following three outputs:

(i) Transmission infrastructure enhanced. This includes (a) construction of the 144 km 220 kV New Polpitiya–Hambantota, 29.1 km 220 kV Mannar–Nadukuda, and 23.7 km 132 kV Padukka–Horana transmission lines, and the single in-and-out 0.5 km 132 kV underground cable connection from the Colombo C grid substation to Kolonnawa grid substation; and stringing of the second circuit of the existing 100 km 132 kV Habarana–Valaichchenai transmission line; (b) augmentation of the existing 220/132/33 kV Biyagama and Kotugoda; 220/33 kV Mannar, Colombo C, and Kolonnawa Stanley; and 132/33 kV Kolonnawa, Padukka, Horana, Dehiwala, and Madampe grid substations; and (c) construction of 220/132/33 kV Hambantota, 220/33 kV Nadukuda and Biyagama, and 132/11 kV Colombo B grid substations in the Central, Eastern, Northern, North Central, Western, Sabaragamuwa and Southern provinces to absorb the increased power demand and ensure stable system operation with intermittent wind generation.

(ii) Efficiency of medium-voltage network improved. This includes (a) construction of 60 km of 33 kV lines in Mahailluppallama, Ethgala, Chinabay, Sooriyawewa, and Bentota areas, and gantries in Mahailuppallama, Ethgala, Chinabay, and Weniwelara areas; and (b) augmentation of 33/11 kV Ethulkotte and Beligaha primary substations, and construction of a 33/11 kV Rattanapitiya primary substation in the Central, Eastern, North Central, Southern, and Western provinces to address overloading of conductors and voltage drop in medium-voltage lines.

(iii) Demand-side management for energy efficiency improved. This includes development of a smart grid and metering pilot subproject, including installation of

9 CEB’s compliance with paragraph 6 of Schedule 5 to the Loan Agreement (Ordinary Operations) dated 20

November 2014 was delayed, as CEB initiated the fisheries surveys in April 2016 and water flow measurement in June 2016 (against the target date of December 2015). Prior to installation of water flow measurement equipment, CEB was collecting water flow data on the Mahaweli River from the Mahaweli Authority.

4

10,000 smart meters, with the smart metering infrastructure and meter management system in the Katunayake Consumer Service Center Area in Western Province.

12. Outputs 1 and 2 involve turnkey contracts for transmission and medium-voltage distribution subprojects. Output 3 involves one turnkey contract and a consulting services contract to help CEB implement the smart grid and metering pilot subproject. The updated contribution to the ADB results framework is in Appendix 5.

C. Investment and Financing Plans

13. The tranche is estimated to cost $260 million (Table 1).

Table 1: Tranche Investment Plan ($ million)

Item Amounta

A. Base Costb

1. Transmission infrastructure enhancement 201.1 2. Medium-voltage network efficiency improvement 29.2 3. Smart grid and metering pilot subproject 11.1 Subtotal (A) 241.4 B. Contingencies

c 13.0

C. Financing Charges During Implementationd 5.6

Total (A+B+C) 260.0 a In Q1 2016 prices.

b Includes an incremental (land acquisition, environmental and social mitigation, and counterpart support) cost of

$10.4 million to be financed by Ceylon Electricity Board. Also includes taxes and duties of $51.0 million to be financed from government and Ceylon Electricity Board resources.

c Physical contingencies computed at 2.8% of base cost for the transmission infrastructure enhancement output,

4.0% of base cost for the medium-voltage network efficiency improvement output, and 5.0% of base cost for the smart grid and metering pilot subproject. Price contingencies were computed using the Asian Development Bank’s forecasts of international and domestic inflation. Includes provision for potential exchange rate fluctuation under the assumption of a purchasing power parity exchange rate.

d Financing charges during implementation include interest from all financing sources. For the ordinary capital

resources funded subprojects, interest during implementation is computed using a base rate at the 5-year swap rate for the London interbank offered rate for United States dollars (1.19%) plus an effective contractual spread of 50 basis points and a maturity premium of 10 basis points. Commitment charges for an ordinary capital resources loan are computed at 0.15% per year to be charged on the undisbursed loan amount. For the Asian Development Fund financed subprojects, interest during construction has been computed at 2.00%. For the Agence Française de Développement financed subprojects, interest during construction has been computed at 1.23%.

Sources: Asian Development Bank and Ceylon Electricity Board estimates.

14. To finance project 2, the government requested the following loans to be provided to CEB with a sovereign guarantee from Sri Lanka:10 (i) a $95 million loan from ADB’s OCR; (ii) a loan in various currencies equivalent to SDR 40.041 million from ADB’s Special Funds resources (ADF);11 and (iii) a $30 million equivalent loan from AFD to be partially administered by ADB.12 The financing plan is in Table 2.

10

ADB approved a major change in the facility to enable a direct loan to CEB (ADB. 2016. Major Change in Facility. MFF 0084: Green Power Development and Energy Efficiency Improvement Investment Program (Sri Lanka). Manila).

11 Any ADF allocation will be subject to (i) the general availability of ADF resources from time to time; (ii) Sri Lanka’s access to such resources pursuant to ADB’s graduation policy, as amended from time to time, and the requirements of the ADF donors; and (iii) the availability of such resources to Sri Lanka pursuant to ADB’s policy on performance-based allocation of ADF resources, as amended from time to time. The requested loan is equivalent to $55 million (as of 27 October 2016, the date of the loan negotiations).

12 AFD will provide contractual parallel cofinancing where ADB may cover procurement and disbursement supervision through partial administration of cofinancing.

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Table 2: Financing Plan Source

Amount ($ million)

Share of Total (%)

A. Asian Development Bank

Ordinary capital resources loan 95.0 36.5

Special Funds resources loan 55.0 21.2

Subtotal (A) 150.0 57.7

B. Cofinanciers

Agence Française de Développement loana 30.0 11.5

Subtotal (B) 30.0 11.5

C. Government and Ceylon Electricity Board 80.0 30.8

Total (A+B+C) 260.0 100.0 a

Agence Française de Développement confirmed that it will cofinance project 2. Sources: Asian Development Bank and Ceylon Electricity Board estimates.

15. The OCR loan will have a 25-year term, including a grace period of 5 years; a straight-line repayment method; an annual interest rate determined in accordance with ADB’s London interbank offered rate-based lending facility;13 a commitment charge of 0.15% per year; and such other terms and conditions set forth in the draft OCR loan agreement. The ADF loan will have a 25-year term, including a grace period of 5 years; an interest rate of 2% per annum during the grace period and thereafter; and such other terms and conditions set forth in the draft ADF loan agreement. The ADF loan will finance (i) the transmission infrastructure for evacuation of power from the future wind parks, (ii) the medium-voltage network efficiency improvement to enhance quality and reliability of the electricity supply to customers, and (iii) the smart grid and metering pilot subproject. 16. The government and CEB will finance the interest during implementation, taxes and duties, contingencies, and incremental costs (land acquisition, environmental and social mitigation, and counterpart support).14 Financing charges during implementation of $5.6 million include interest during construction to be paid by CEB to ADB and AFD for the provided loans. D. Implementation Arrangements

17. CEB will be the executing and implementing agency. A steering committee, chaired by the MPRE secretary as originally envisaged under the MFF, will guide CEB and review progress and results. CEB will set up project implementation units for each output, which will oversee procurement, disbursement, financial management and accounting, quality assurance, and social and environmental issues. Full-time managers will supervise each project output. 18. The government and CEB asked ADB to approve advance contracting for procurement of goods and civil works, including preparing bidding documents, inviting and receiving bids for project contracts, and retroactive financing under the project. Retroactive financing will be allowed for up to 20% of the individual loan amount for expenditures incurred prior to loan effectiveness. The government and CEB were advised that ADB's approval of advance contracting and retroactive financing does not commit ADB to finance any part of the project. Given that the project will be jointly financed by ADB and AFD, universal procurement will apply to works, goods, and consulting services to be financed under the project.15

13

The interest includes a maturity premium of 10 basis points payable to ADB since the OCR loan has an average loan maturity of 15.25 years based on the above loan terms and CEB’s choice of repayment option and dates.

14 The government financing will be limited to any exemptions on taxes and duties.

15 Universal procurement was approved under the MFF (footnote 1).

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19. The implementation arrangements are summarized in Table 3 and described in detail in the project administration manual (PAM) in Appendix 6.

Table 3: Implementation Arrangements Aspects Arrangements

Implementation period January 2017–December 2021 Estimated completion date 31 December 2021 Estimated loan closing date 30 June 2022 Management

(i) Oversight body Steering committee consisting the secretary, MPRE (chair) and representatives of MNPEA, MOF, MPRE, DWC, and CEB (members)

(ii) Executing agency CEB (iii) Key implementing agencies CEB (iv) Project management unit Established in CEB

Procurement International competitive bidding

6 procurement packages

$179.25 million

Consulting services Quality- and cost-based selection

34 person-months $0.75 million

Retroactive financing and/or advance contracting

Advance contracting, including preparation of bidding documents, inviting and receiving bids for contracts, and retroactive financing of up to 20% of the loan amount for expenditures incurred prior to loan effectiveness, but no earlier than 12 months before the signing of the loan agreement.

Disbursement The loan proceeds will be disbursed in accordance with ADB’s Loan Disbursement Handbook (2015, as amended from time to time) and detailed arrangements agreed with the government and CEB.

ADB = Asian Development Bank, CEB = Ceylon Electricity Board, DWC = Department of Wildlife Conservation, MOF = Ministry of Finance, MNPEA = Ministry of National Policies and Economic Affairs, MPRE = Ministry of Power and Renewable Energy. Source: Asian Development Bank estimates.

E. Project Readiness

20. CEB appointed a project director and established project implementation units with full-time project managers and engineers for each output. CEB submitted draft bidding documents for major transmission procurement packages to ADB during March–September 2016. Evaluation is ongoing for two procurement contracts. CEB will issue the remaining bidding documents for the transmission and distribution procurement packages in the fourth quarter of 2016, and for the smart grid and metering pilot subproject in the second quarter of 2017 after consultant recruitment.

21. The draft environmental impact assessment (EIA) for the 220 kV Mannar–Nadukuda transmission line was disclosed on ADB’s website on 7 July 2016. The draft initial environmental examination (IEE) reports for other environmental category B subprojects were disclosed on 19 August 2016. Given the minimum environmental footprint of output 3, which involves installation of smart meters, it is categorized as environmental category C. CEB received necessary clearances from the Central Environmental Authority and Department of Coastal Conservation. The draft resettlement plan for project 2 was disclosed on 19 August 2016.

F. Advance Contracting and Retroactive Financing

22. ADB approved advance contracting for procurement of goods and turnkey contracts (including preparation of bidding documents; and inviting, receiving, and evaluating bids for

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project contracts) under the MFF on 7 April 2014 that covers both tranches. The advance contracting for project 2 was advertised on ADB’s website on 2 June 2016.

IV. DUE DILIGENCE

A. Technical

23. CEB prepared technical studies on the transmission and distribution subprojects. The due diligence focused on technology, nature and characteristics of investment plans, and the most appropriate electricity evacuation arrangements from the proposed wind power park. ADB assessed the technical studies as acceptable. Cost estimates are reasonable and unit costs compare favorably with similar recent projects in Sri Lanka.

B. Economic and Financial

24. The project will benefit electricity consumers and the overall economy through improved supply reliability, reduced network losses, and incremental consumption. The economic viability of the project has been examined through a cost–benefit analysis, by comparing with- and without-project scenarios, conducted using ADB guidelines for the economic analysis of projects (Appendix 7). All project outputs have been confirmed as least-cost, with sound economic rationale for investment. The aggregate economic internal rate of return is estimated at 22.3%, above the assumed hurdle rate of 12.0% and, on this basis, the overall project is economically viable. A sensitivity and risk analysis demonstrates adequate economic performance for the project.

25. Financial viability was examined by comparing the incremental costs and benefits on a with- and without-investment basis using ADB guidelines for financial analysis of projects (Appendix 8). The real weighted average cost of capital was calculated for each output and resulted in a 2.5% average cost for the overall project. Financial viability was assessed by comparing the weighted average cost of capital with the financial internal rate of return for each output and for the overall project. The aggregate financial internal rate of return is 4.4%, which is higher than the weighted average cost of capital of 2.5%, suggesting that the overall project is financially viable. Sensitivity analysis shows that the estimated financial returns of output 3 are sensitive to variations to capital and operation costs and implementation delays. However, considering the potential of smart metering to reduce future network and generation investment requirements, undertaking the pilot subproject appears to be a sound strategic investment.

C. Governance

26. CEB is a vertically integrated utility comprising six functional business units (FBUs). The Sri Lanka Electricity Act, 2009 encourages efficiency improvements of CEB by regulating each FBU. The act empowers the Public Utilities Commission of Sri Lanka, an independent regulator, to regulate the electricity supply industry. The Public Utilities Commission of Sri Lanka issued individual licenses to FBUs in 2009. It established a tariff methodology and a road map for tariff reforms and rebalancing in 2011. Financial accounts are segregated to allow each FBU to operate as a profit center, and a transfer-pricing scheme between FBUs was developed. However, the process of delegating day-to-day management and financial decision-making to FBU heads is not complete, and the transfer-pricing scheme is not fully functioning.

27. CEB has the necessary capacity to undertake the project and has implemented ADB-financed projects in the past. The financial management assessment of CEB concludes that it can fulfill ADB’s fiduciary requirements for the project. CEB regularly faces cash shortfalls

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because of low tariffs, expensive power generation, and expensive short-term loans. These shortcomings have to be corrected. Under the Sri Lanka Electricity Act, 2009, all tariffs must reflect costs, and the treasury will bear the cost of any government-approved subsidy. In March 2008, the government introduced a new tariff structure that increased average retail tariffs by 30%. Further tariff increases followed in January 2011, February 2012, and April 2013. The government also converted CEB’s long-term debt into equity. The financial management capacity of CEB is assessed as acceptable for the project. The overall risk is assessed as moderate and several risk mitigation measures will be implemented. Details of the financial management assessment of CEB are in the PAM and in the assessment of CEB’s financial performance and projections.16 CEB’s financial performance improved to some extent during 2013–2015. However, its ongoing financial sustainability will depend on the extent to which it is allowed to (i) charge its customers fully cost-reflective tariffs to service debt, and (ii) undertake a prudent capital and operating expenditure program.

28. All procurement will be carried out in accordance with ADB’s Procurement Guidelines (2015, as amended from time to time). Recruitment of consultants will follow ADB’s Guidelines on the Use of Consultants (2013, as amended from time to time). CEB will maintain and regularly update a project website including procurement information. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and CEB. The specific policy requirements and supplementary measures are described in the PAM. D. Poverty, Social, and Gender Dimensions

29. The project will contribute to sustainable economic development, poverty reduction, and social well-being through improvement in the reliability and quality of power supply (Appendix 9). Stable supply of electricity will promote business expansion and increase jobs, which will help reduce poverty. The project is expected to generate jobs for skilled and unskilled laborers during construction. Reliability improvement of the 33 kV network will enhance the quality and reliability of the electricity supply to 246,100 consumers and the living standards of rural households.

E. Safeguards

30. Environment. Tranche 2 is classified as environmental category A. Following the environmental assessment and review framework of the investment program,17 a full EIA for the 220 kV Mannar–Nadukuda transmission line, including an environmental management plan (EMP), was prepared and disclosed on ADB’s website on 7 July 2016 (Appendix 10). The IEE reports for other transmission and distribution lines and substations were prepared (Appendix 11 and Appendix 12). Any update in the EIA and IEE reports resulting from a change in project scope will be disclosed. Mitigation measures are proposed in the EIA and EMP to minimize habitat and species disturbance as a result of construction, and potential bird collision with the overhead transmission line during operation. Implementation of a biodiversity management plan will ensure no net loss of biodiversity. Potential environmental impacts of other subprojects are site-specific; mostly temporary during construction; and readily mitigated by adherence to national and international environmental standards, design criteria, and management practices as set out in the EMP. The project’s environmental safeguards documents have been prepared in compliance with ADB’s Safeguard Policy Statement (SPS) (2009), the environmental assessment and review framework for the MFF, and Sri Lankan environmental regulations. Public consultations were conducted with local communities, government authorities and nongovernment organizations, including ornithological societies, and their feedback was taken

16

The summary of CEB’s historical financial performance and projections is in the Financial Analysis (Appendix 8). 17

The environmental assessment and review framework were updated to include the second tranche subprojects.

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into account during project design. Public concerns were identified in the EIA, and mitigation measures were incorporated into the EMP. PMU has dedicated staff for monitoring environmental issues and implementing the EMP.

31. CEB has implemented several ADB projects and has adequate institutional capacity and experience to manage environmental risks during pre-construction, construction, and operation. The EMP will be incorporated into civil works contracts, giving contractors the primary responsibility for implementation during construction. CEB will retain qualified and experienced external experts or qualified nongovernment organizations to verify monitoring information on the Mannar–Nadukuda transmission line that will cross the Vankalai sanctuary. 18 CEB will supervise construction and EMP implementation. CEB will provide environmental monitoring reports to ADB quarterly while works are ongoing within the Vankalai sanctuary and semiannually thereafter. Environmental monitoring reports on other subprojects will be submitted to ADB semiannually during construction and annually during operation. A corrective action plan will be prepared and implemented for any non-compliance issues. The contractors and CEB will adhere to the SPS and national environmental regulations. In the event of any unanticipated environmental impacts during project implementation, CEB will update the EIA and IEE reports and revise the EMP, which will be disclosed on the ADB website.

32. Involuntary resettlement. The project is classified as category B for involuntary resettlement. No physical displacement is envisaged. Private land acquisition is required only for one substation and several gantries, involves 2.87 hectares with three affected people, and will be procured through negotiated settlement. Transmission and distribution lines will mostly have temporary impacts in terms of loss of crops and trees. The land affected due to the tower footing of the project is 14.47 hectares. No significant resettlement impact is expected due to the land acquisition and tower erection along the right-of-way. Construction will be carried out avoiding intensive cropping seasons. The project’s social impacts have been adequately assessed, and compensation will be paid to the affected people commensurate to the impacts. Budgetary provisions are in place to compensate affected people in a timely manner for the losses if and when they occur. A resettlement plan was prepared for project 2 that is adequate to address the assessed risks (Appendix 13). CEB has implemented several ADB projects and is capable of conducting resettlement in accordance with the SPS. Additional assistance will be given to vulnerable households, including those headed by women. Social surveys and consultations were undertaken in accordance with the SPS and the resettlement framework. CEB will monitor the implementation of the resettlement plan and submit monitoring reports to ADB semiannually. Since no indigenous peoples will be affected by the project, it is classified as category C for indigenous peoples.

33. Climate change impact. The project’s outputs will further reduce technical losses and improve network efficiency, resulting in 154 gigawatt-hours of energy savings per year, equivalent to avoiding about 114,663 tons of carbon dioxide emissions per year. The climate change risk screening confirms that the project has medium climate change risks (Appendix 14).

F. Risks and Mitigating Measures

34. Major risks and mitigating measures are summarized in Table 4 and described in detail in the updated risk assessment and risk management plan (Appendix 15). The risks appear to be moderate and may be adequately mitigated. Overall, the integrated benefits and impacts are expected to outweigh the mitigation costs.

18

The proposed transmission line will pass through the wetland sanctuary area following the route of the old damaged 33 kV line that runs parallel to the existing operational railway that also crosses that area.

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Table 4: Summary of Risks and Mitigating Measures Risks Mitigating Measures

Insufficient cash generation by Ceylon Electricity Board to fund its operations

Progress on energy sector reforms, including (i) an independent energy sector regulatory framework, tariff structure rationalization, and internal structural reforms in Ceylon Electricity Board; (ii) improvement of Ceylon Electricity Board’s financial management; and (iii) commissioning low-cost generation, including from hydropower and other renewable energy

Potential difficulties in managing the grid due to instability as a result of integrating renewable wind generation

Addressing of wind integration requirements under the renewable energy master plan and system stability studies prepared under Asian Development Bank technical assistance, investment for renewable energy integration proposed under the tranche, and changes proposed in regulatory codes and commercial arrangements

Delays in generation and transmission investments

Timely implementation of Ceylon Electricity Board’s long-term generation and transmission investment plans

Cost escalation including unexpected increase in prices of commodities and raw materials

Close supervision by the steering committee and the Asian Development Bank, open and transparent competitive bidding, proactive project implementation, advance contracting, and inclusion of physical and price contingencies in the cost estimates

Source: Asian Development Bank.

G. Risk Categorization

35. Tranche 2 is categorized as complex due to its environmental category A.

V. ASSURANCES

36. The government and CEB have assured ADB that implementation of the project shall conform to all applicable ADB policies, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the PAM and loan documents. The government and CEB have agreed with ADB on certain covenants, including on financial management, for the project, which are set forth in the legal agreements.

VI. MINOR CHANGE OF MULTITRANCHE FINANCING FACILITY: EXTENSION OF THE MULTITRANCHE FINANCING FACILITY AVAILABILITY PERIOD

37. Under the FFA, the current MFF availability period is until 31 March 2021, whereas the estimated loan closing date for tranche 2 is 30 June 2022. Accordingly, an extension of the MFF availability period is required to fully and properly implement tranche 2. An extension of the MFF availability period from 31 March 2021 to 13 July 2024 (which is within the permissible 10-year availability period for the MFF) is therefore requested.

VII. RECOMMENDATION

38. On the basis of the approval by ADB’s Board of Directors for the provision of loans under the multitranche financing facility in an aggregate principal amount not exceeding $360,000,000 to the Democratic Socialist Republic of Sri Lanka for the Green Power Development and Energy Efficiency Improvement Investment Program, it is recommended that the President approve the proposed tranche as described in para. 14 and such other terms and conditions as are substantially in accordance with those set forth in the draft guarantee and loan agreements for the proposed tranche.

39. It is further recommended that the President approve the minor change of the multitranche financing facility as described in para. 37 to extend the availability period of the Green Power Development and Energy Efficiency Improvement Investment Program from 31 March 2021 to 13 July 2024.