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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank IMPLEMENTATION COMPLETION REPORT (SCL PPFB-P3340) ON A LOAN IN THE AMOUNT OF US$ 210 MILLION TO THE GOVERNMENT OF INDIA FOR ANDHRA PRADESH POWER SECTOR RESTRUCTURING PROJECT (APL I) February 20, 2004 Report No: Energy and Infrastructure Unit South Asia Region

2 CURRENCY EQUIVALENTS (Exchange Rate Effective : February 2004) Currency Unit = Indian Rupee (Rs.) Rs = US$ 2.18 US$ 1.00 = Rs FISCAL YEAR April 1 March 31 ABBREVIATIONS AND ACRONYMS APERC APERL APGENCO APL APSEB APTRANSCO ARR CIDA CPDCL CRISIL DEA DFID Discoms ERR EPDCL FRR FY GOAP GOI GSDP GWh HT KV kwh LT MOU MTFF MU NPDCL PMU QAG SPDCL T&D Andhra Pradesh Electricity Regulatory Commission Andhra Pradesh Economic Reform Loan Generation Corporation of Andhra Pradesh Ltd. Adaptable Program Lending Andhra Pradesh State Electricity Board Transmission Corporation of Andhra Pradesh Ltd. Annual Revenue Requirement Canadian International Development Agency Central Power Distribution Compnay Ltd. Crisil Advisory Services Department of Economic Affairs Department for International Development Distribution Companies Economic Rate of Return Eastern Power Distribution Compnay Ltd. Financial Rate of Return Fiscal Year (Indian) Government of Andhra Pradesh Government of India Gross State Domestic Product Gigawatt hour High Tension Kilo volt Kilowatt hour Low tension Memorandum of Understanding Medium Term Fiscal Framework Million Unit (Unit=1kWh) Northern Power Distribution Compnay Ltd. Project Management Unit Quality Assurance Group Southern Power Distribution Compnay Ltd. Transmission & Distribution Vice President: Country Director Sector Director Task Team Leader/Task Manager: Praful C. Patel Michael F. Carter John A. Roome Bhavna Bhatia

3 INDIA AP POWER SECTOR RESTRUCTURING PROJECT (APL I) CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 4 5. Major Factors Affecting Implementation and Outcome Sustainability Bank and Borrower Performance Lessons Learned Partner Comments Additional Information 25 Annex 1. Key Performance Indicators/Log Frame Matrix 27 Annex 2. Project Costs and Financing 31 Annex 3. Economic Costs and Benefits 33 Annex 4. Bank Inputs 36 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 40 Annex 6. Ratings of Bank and Borrower Performance 41 Annex 7. List of Supporting Documents 42 Annex 8. Key Achievements of APERC 43 Annex 9. Financial Performance of the Power Sector 46 Annex 10. Distribution Companies - Efficiency Improvement Initiatives 49 Annex 11. Technical Assistance Support provided to Andhra Pradesh Power Sector 51 Annex 12. Transition Arrangements to Regular Operation 52 Annex 13. Andhra Pradesh's Assessment of the Implementation of APL1 53

4 Project ID: P Team Leader: Bhavna Bhatia Project Name: AP POWER APL I TL Unit: SASEI ICR Type: Core ICR Report Date: February 20, Project Data Name: AP POWER APL I L/C/TF Number: SCL-44410; PPFB-P3340 Country/Department: INDIA Region: South Asia Regional Office Sector/subsector: Power (100%) Theme: Public expenditure, financial management and procurement (P); Infrastructure services for private sector development (P); Regulation and competition policy (P); Legal institutions for a market economy (P); State enterprise/bank restructuring and privatization (S) KEY DATES Original Revised/Actual PCD: 06/30/1998 Effective: 06/04/ /22/1999 Appraisal: 10/05/1998 MTR: Approval: 02/18/1999 Closing: 08/31/ /31/2003 Borrower/Implementing Agency: Other Partners: Government of India/Government of Andhra Pradesh; Government of India/Transmission Corporation of Andhra Pradesh (APTRANSCO) and power distribution companies Department for International Development (DfID); Canadian International Development Agency (CIDA) STAFF Current At Appraisal Vice President: Praful C. Patel Meiko Nishimizu Country Director: Michael F. Carter Edwin R. Lim Sector Director: John A. Roome Alastair J. McKechnie Team Leader at ICR: Bhavna Bhatia Mohinder P. Gulati ICR Primary Author: Bhavna Bhatia 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: Sustainability: Institutional Development Impact: Bank Performance: Borrower Performance: S L SU S S QAG (if available) Quality at Entry: HS Project at Risk at Any Time: Yes ICR S

5 The Project was rated at risk during the period January-July 2003 on account of unsatisfactory performance in the areas of financial management, procurement and non-compliance with the financial covenants. The financial management rating was upgraded after submission of entity audit reports for FY2002 by all the six power utilities. There were some delays in the procurement decisions by the executing agency during this period. A close monitoring by the project team facilitated satisfactory resolution and the procurement rating was accordingly upgraded. The companies, at the loan closure, were in partial compliance of the financial covenants. 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: Background Andhra Pradesh is one of India s leading reforming states which has, since 1999 implemented several measures towards fiscal, governance and sectoral reforms. Power sector reforms are at the center-stage of the Government of Andhra Pradesh's (GOAP) overall reform program, and are a key complement to the fiscal reform program because of the sector s large demand on the budget resources. Power sector reforms are critical to remove infrastructure constraints for accelerating economic growth as well as to bring a shift in the public expenditure from power sector to social sectors and other priority areas for public expenditure. By the late nineties the state was facing both energy and peak shortages and the quality of power supply had deteriorated; the power utility s financial losses had grown to Rs 39 billion and new investments were not financible. The power subsidies had increased to 1.6 percent of the Gross State Domestic Product (GSDP) while on the other hand the combined public expenditure on health and education had declined from 4.7 percent of GSDP in FY1987 to 3.6 percent of GSDP in FY1998. In the absence of power sector reforms the need for investment support and subsidies from the government s budget would continue to grow and crowd out social sector investments A comprehensive program of power sector reforms was initiated by the GOAP in The GOAP requested the Bank for a multi-phased adaptable program lending with an indicative financing of US $ 1 billion over a period of eight to ten years to support the implementation of reforms. This project ( the Project or APL1 ) is the first in a series of the Bank s Adaptable Program Lending operations aimed at providing programmatic support ( the Program ) to Andhra Pradesh for reforming the power sector The development objectives of the Program are (i) to ensure that by FY2007 the energy requirements of the state are met and that consumers are provided with reliable, high-quality and cost effective electricity supply, by creditworthy and commercially operated utilities functioning in a competitive and appropriately regulated power market, with significant private ownership and participation; and (ii) to bring about a permanent shift in the public expenditure in the power sector from a major drain on the budget to a contributor of funds for social sectors and other priority areas for public investment. The program was designed to be implemented in a phased manner : Phase I ( ) establishment of legal, regulatory and institutional framework, and removal of critical bottlenecks of the power system; Phase II ( ) fully functional regulatory commission and corporate entities, privatization of a part of the distribution business, partial restoration of the sector's creditworthiness and improvement in system efficiency; Phase III ( ) completion of distribution privatization, consolidation of the functioning and financial performance of new power utilities; and Phase IV ( ) deepening of reforms to increase competition and private participation, attainment of high customer satisfaction through reduction of power deficit, and improvement in quality and efficiency of electricity services. Implementation of Phase I and part of the Phase II (fully functional regulatory commission and corporate entitiess) has been completed; - 2 -

6 several initiatives for improving operational efficiency and customer service are underway; and the government now plans to deepen the reforms through introduction of competition An important component of the Bank's Country Assistance Strategy (CAS) in India has been to focus on states that demonstrate a commitment to reforms, particularly in financial management, power sector administration and governance. Andhra Pradesh is one of the focus states for the Bank s lending in India. The Bank is supporting Andhra Pradesh s program of fiscal and governance reforms through the structural adjustment support under the Andhra Pradesh Economic Reform Loan 1, and has also financed investment projects in the areas of health, child nutrition, forestry irrigation and rural roads. Project Objectives The development objectives of the first Project (APL1) were (i) to initiate the reform process by establishing the new legal, regulatory, institutional framework and industry structure (including establishment of an independent Regulatory Commission, creation of the new power companies and initiation of preparatory work for privatization of the distribution business) and (ii) to remove some of the critical bottlenecks of the power system. The project objectives were consistent with the Government s priorities and the Bank s Country Assistance Strategy. The power sector reforms were aimed to reduce pressures on the state s public finances and remove sectoral constraints to the state s economic growth, thereby facilitating sustainable poverty reduction The Project design was relevant for achieving the project objectives. A two-pronged approach of parallel implementation of policy reforms and investments to remove critical bottlenecks in the power system was an appropriate design. A High Level Committee set up by the GOAP under the chairmanship of Mr. Hiten Bhaya submitted its report on the medium term reform program in April The committee recommended unbundling of vertically integrated State Electricity Board, the establishment of an regulatory independent agency, and enactment of Electricity Reforms Act in the state to provide legal basis for the implementation of reforms. The design supported the GOAP s plan for reforms laid out in its detailed Power Sector Policy Statement (October 1998) and thus had the required ownership The project was built upon the four decade long experience of operations and management of the power sector under the public ownership, while specifically recognizing that (i) the government s multiple, but often conflicting roles as a policy maker, regulator and the owner of power utilities constrained the commercialization of the sector, (ii) government's interference in the operations, management and important decision making (investment, tariffs and personnel issues) of the state owned vertically integrated power utility had led to substantial deterioration in its operational efficiency and financial viability, and (iii) the prevailing system did not promote accountability or provide incentives to the managers and staff for improving performance. The project design also incorporated the limited experience available at that time from the two Indian states where the reforms had been initiated The project objectives were important but complex and demanding for the government and the implementing agency. The pervasive politicization of the power sector, opposition to reforms from strong and powerful groups with entrenched vested interests in the business as usual and the likely resistance from the employees posed significant risk to the project outcome. Also, the reform experience in Orissa and Haryana had generated considerable opposition and had not yet shown any tangible results. In the environment of unbundling and establishment of the new companies, which could create uncertainty and unrest among the employees, implementation of investment program was quite demanding for the executing agency. The expected outcome of the financial turnaround of the sector in FY2004 and the expectations of the pace of tariff rationalization and reduction in subsidy were ambitious

7 3.2 Revised Objective: The objectives were not revised during the life of the project. 3.3 Original Components: The project had following four main components: (i) Transmission system augmentation. This component provided support for capacity augmentation of overloaded transmission lines and sub-stations, construction of new sub-stations and transmission lines to meet the load growth, establishment of switching sub-stations to provide operational flexibility to the system and installation of capacitors to improve voltage and reduce system losses. (ii) Sub-transmission and distribution system strengthening. The support was envisaged for (i) installation of three phase distribution transformers to provide relief where the transformer overloading was more than 150 percent (both in urban and rural areas), and single phase distribution transformers to improve voltages at the tail end of the distribution lines, (ii) augmentation of power transformation capacity at the existing 33/11 kv sub-stations to reduce overloading, improve supply reliability and meet load growth, (iii) construction of new 33 kv lines, and (iv) installation of breakers and battery system at the existing 33/11 kv substations for better transformer protection and feeder control. (iii) Metering system improvement. This component included support for installation of better quality and high accuracy consumer meters for improving billing accuracy, feeder meters for energy accounting, boundary meters for measurement of energy exchange between the unbundled power companies, and computer systems to process data at the distribution system level. (iv) Technical assistance for reform program management, institutional development of the Regulatory Commission, corporatization, commercialization, institutional development of the new power utilities, investment planning and other technical issues In addition, US $ 11 million were retained as unallocated amount to be utilized among the above mentioned four project components. At appraisal investment schemes costing US$ 125 million were finalized (referred as APL1 main schemes) and the remaining schemes were finalized during the project implementation (referred as APL1 supplemental schemes). The bi-lateral donors DFID and CIDA through provision of grant support for technical assistance have extensively supported the project. 3.4 Revised Components: The project components were not revised. 3.5 Quality at Entry: QAG rated the project highly satisfactory for quality at entry. The ICR rating for the quality at entry is in agreement with the QAG s rating. QAG assessment stated, well articulated development objectives appear ambitious but not unreasonable in the light of developments in Andhra Pradesh so far". Further initial actions taken suggest strong Borrower s commitment to reforming its power sector". QAG endorsed APL to be an appropriate instrument for supporting comprehensive reform program and well suited for the Bank's dealing with reform program risks. For the appropriateness and realism of project/conditionality the QAG stated that sequencing of conditions, specially on subsequent APLs, appear well suited, leaving the Bank room for necessary flexibility while providing a clear framework. Readiness for implementation was rated as highly satisfactory by the QAG. 4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: The Project has been successful in meeting its development objectives to a large extent. The outcome and impact resulting from the project implementation have been significant. The financial - 4 -

8 performance of the power sector is improving but continues to remain highly vulnerable. This section presents the assessment of the outcomes against the objectives set for the APL1 project. Objective 1: Establishment of the new legal, regulatory, and institutional framework and preparation for distribution privatization Functional unbundling of APSEB and corporatization. Andhra Pradesh was the third state in India to enact the state Power Sector Reform Legislation (February 1999) that sets the legal foundation for reforms, regulation, industry and market structure. The vertically integrated power utility has been restructured into six corporatized entities a power generation company (APGENCO), a transmission and bulk supply company (APTRANSCO) and four distribution companies (Discoms) for retail power supply. The assets and liabilities of the SEB were apportioned to the six new companies and the final transfer of employees completed in March Andhra Pradesh has a total generation capacity of 10,600 MWs (December 2003) comprising state-owned generation (68 percent), central generating stations (20 percent) and IPPs (12 percent). The share of hydro, though declining, accounts for about one third of the total available capacity. The APTRANSCO is responsible for transmission, trading and system operations. It purchases power from all the generators for bulk sale to the Discoms who in turn supply power to the consumers in their respective geographical area designated under the license issued by the Regulator. Discoms purchase power solely from the APTRANSCO (single buyer model) based on a bulk supply agreement. Over the years, several industries in the state have set up self-generation (captive) plants which can sell their surplus power to APTRANSCO. The unbundling was implemented as per the planned schedule under the Project. The Board of Directors of the companies and some senior managers with skills and experience appropriate for new business and regulatory environment have been appointed through a competitive selection process. Unbundling has spurred the utilities to focus on their specific functions and initial signs of commercial tension and performance improvements are evident Power Sector Regulation. Andhra Pradesh Electricity Regulatory Commission (APERC) set up in April 1999 is now well established with over 50 staff. The GOAP has ensured timely appointment of the Commission members following a transparent process laid out in the Reform Act, provided adequate budget to the Commission which is charged to the consolidated fund of the state, and supported the Commission s functional independence. The APERC has set a good track record of operating through transparent regulatory processes, with the involvement of stakeholders and public, and has demonstrated its ability to take independent decisions. It has issued important regulatory orders (including licenses, tariffs, consumer performance standards, technical codes, guidelines for planning etc.) and has set precedent in defining several regulatory approaches in the country. In the important area of tariff reforms a transparent process with a distinct role of regulator and the government has been established where (i) the regulator establishes full-cost tariffs for each consumer category that is necessary for the utility to cover its prudent costs and earn a return on capital (ii) the regulator determines the extent of cross subsidy (iii) the government makes an upfront explicit subsidy commitment for specific consumer categories and (iv) finally based on the subsidy commitment the regulator announces the tariffs. The APERC has maintained that in the absence of timely payment of subsidy the full cost tariffs would be charged to ensure financial viability of the utilities. Some tariff related orders of the Commission have been appealed in the courts, most of which have been dispensed in favor of the Commission instilling its role in tariff setting. In an independent review of the power sector carried out by a credit rating agency (CRISIL) in 2003, the APERC ranked first among all the states for its performance and achievements (refer Annex 8 for details on APERC) Governance Reforms in the Power Sector. The utilities have implemented impressive measures to control electricity theft and improve operational efficiency. Andhra Pradesh is the first state to enact anti-theft legislation (in July 2000) which, stipulates penalties that includes mandatory imprisonment for - 5 -

9 electricity theft. There has been a quantum jump in the registration of theft cases 150,000 cases during FY as against 9200 cases during the period FY About 4100 consumers and 50 employees have been arrested. In a statewide program launched in FY2001 the utilities regularized about 2 million residential and 200,000 agriculture connections of which about 60 percent were illegal connections. The utilities have also completed 100 percent census of agricultural pumpsets in the state Preparation for distribution privatization. Distribution privatization has been delayed from the schedule planned under the reform program (>30 percent by FY2002) due to lack of adequate preparation, declining international investor interest and very limited domestic investor interests in the power distribution. Another consideration for the delay has been to gain from the experience of privatization in Orissa and Delhi. The international investment bankers have advised a minimum set of preconditions that should be met before launching the transaction, to minimize the high risks perceived by the potential private investors. Learning from the privatization experience in Orissa (i) efforts are underway to improve the availability and reliability of information, (ii) long term tariff principles have been finalized to mitigate the regulatory risks, and (iii) the state government has set a track record of providing full subsidy during the transition and providing the governance/law and order support for controlling theft and improving collections. However, an important issue that remains to be addressed is mitigating risk of subsidized power supply to the agriculture consumers (estimated to be about 40 percent of total electricity sales). As per the revised schedule the GOAP plans to finalize its privatization strategy by March 2005 and address the remaining measures required to get the transaction ready. It has also signed a Memorandum of Understanding with the Government of India to continue reforms, specifically to reduce the cost-revenue gap, achieve 100 percent consumer metering and privatize distribution. The government will need to flexibly adapt its privatization strategy in the context of new market and industry structure envisaged under the Electricity Act 2003, and in view of the investor interest prevailing at the time of transaction launch. Objective 2: Removal of critical bottlenecks in the power system Implementation of reforms by the GOAP and the Bank s support has catalyzed Andhra Pradesh to attract investment and technical assistance support from several financial institutions, bilateral donors and private investors. During FY about Rs 65 billion has been invested in Andhra Pradesh s power sector (public companies) of which two-third has been in the transmission and distribution (T&D) system. New generation capacity of about 3000 MWs has been added during this period improving the availability of power supply. Electricity access rate has increased from 50 percent in FY1999 to 67 percent in FY2003 (urban 90 percent and rural 60 percent) Successful implementation of the APL1 project (accounting for one third of total investment in T&D during FY ) has yielded several positive outcomes with regard to improvements in the availability, reliability and quality of power supply. In FY2003 the transmission system handled 16 percent (about 6000 Million kwh) more energy compared to FY1999. Monitoring at select areas in the distribution system where investment support has been provided under the APL1 project reveals improvements in the voltages, reduction in outages and reduction in distribution transformer failures. Estimated T&D losses have reduced from 38 percent in FY1999 to 26 percent in FY2003, which is indeed a commendable achievement compared to other power utilities in the country, including those managed by the private sector (refer section 4.2 and Annex 1 for details on the outcomes) Good efforts have been made to improve the quality of customer service which was highlighted as a main concern by the customers (report on Socio-economic impact assessment of power sector reforms 2001). The utilities in response to this feedback have prioritized efforts to pro-actively address these concerns, and some specific measures include (i) introduction of spot billing system which facilitates meter reading in the presence of the customers and thereby minimizes billing complaints, (ii) establishment of - 6 -

10 special cells in all operation circles for new connection release and complaint redressal and (iii) establishment of computerized customer care centers which are one-stop windows for complaint handling, bill payment and any follow up on supply related issues. These initiatives have received encouraging feedback from the consumers and the utilities plan to extend these measures in other towns throughout the state. The utilities have adopted the performance standards for customer service issued by the APERC. Financial performance outcome and fiscal impact of the power sector The power sector's financial performance has improved since the initiation of the reforms, however it is short of the expectations set out in the business plans prepared by the GOAP. As a part of the implementation of the reform program the GOAP had prepared a business plan in January 1999, and under the APL1 project committed to support sector s financial restructuring, improve cost recovery, reduce the financial losses and provide subsidy support to the utilities. The business plan was updated in January 2002 and integrated in the GOAP s medium term fiscal framework (MTFF), and an action plan to reduce power sector losses and government s subsidy support to the sector was agreed under the Bank s first Structural Adjustment Loan in January During FY the sector incurred an annual loss of about Rs 30 billion causing enormous burden on the state s finances (nearly 2 percent of GSDP). The higher than projected financial losses in FY2000 and FY2001 were mainly due to adverse sales mix resulting from the decline in the sales to the subsidizing HT-industrial consumers and increased sales to the subsidized agriculture consumers 3. The financial performance in FY2002 was particularly poor and losses exceeded the expectations reflected in the government's MTFF by 28 percent. Severe country-wide drought during this year resulting in low hydro-power generation and increased demand for irrigation 4 had an adverse impact on the financial performance of the utilities (the impact of hydro failure is estimated to be about Rs 5 billion). In FY2003, the financial performance has improved significantly and the deficit reduced to Rs 19.1 billion (provisional estimates) despite a difficult drought (27 percent lower than the previous year and 5 percent higher than Rs 17.9 billion projected under the MTFF) (refer Annex 9 for details). The financial performance of the sector, however, continues to remain fragile. Actual (Rs. billion) (% of GSDP) (-2.11) (-2.55) (-2.22) APL1 targets (Rs billion) APERL 1 targets (Rs billion) (% of GSDP) Note: (P): Provisional. Source : Business Plan, September 2004 Table 1: Power Sector Finances (Net Profit / (-) Loss) (P) (-1.95) (-1.62) (-1.16) (-1.09) There are several areas where Andhra Pradesh s power sector has performed well with a positive impact on its finances, supported by the efforts of the government, regulator, and utilities. These include (i) reduction in cross subsidy among consumer categories, introduction of multi-year tariff incentive scheme and improvement of quality of supply for HT-industrial consumers; these measures have resulted in reversal of the five year trend of declining sales to HT-industries to 26 percent growth in sales in FY2003; (ii) reduction in T&D losses from 38 percent in FY1999 to 26 percent in FY2003 through increased investments for augmentation and rehabilitation of the T&D network, control of theft, and better consumer metering (the progress has marginally exceeded 10.5 percentage point loss reduction target set under the business plan in 1999); (iii) further improvements in the collection efficiency from 92 percent in FY2000 to 98 percent in FY2003; and (iv) reduction in the costs through financial restructuring and efficient power - 7 -

11 procurement. The financial restructuring involved a cleanup of APSEB's balance sheet and restructuring of outstanding liabilities to bring down cashflow in the initial years while postponing the servicing of these liabilities to the later years. The GOAP wrote off its Rs 9 billion debt to APSEB against the accumulated losses of APSEB; Rs 28 billion dues for coal and power purchases were converted into medium to long term liabilities by issue of bonds (7-10 years with 5-8 years moratorium); and Rs 8.3 billion outstanding dues to a financial institution were rescheduled with a repayment relief in the first two years. The impact of reduction in distribution losses and improvements in metering and collection efficiency is evident from the fact that during the period FY while the power purchased by the Discoms increased by an average annual compounded growth rate of 2.3 percent, the sales increased at a higher rate of about 7 percent and the revenue by 16 percent On the other hand inadequate progress in tariff reforms has had an adverse impact on the sector s financial performance and resultant fiscal implications. After the APERC s first tariff order (in July 2000) increasing average tariffs by 15 percent, agriculture by 50 percent and residential by percent (across various consumption blocks), almost no further tariff increases have been affected. While the APERC has made sustained progress in reducing cross subsidies 5 the progress on improving cost recovery through tariffs for the subsidized consumer categories has been very slow primarily due to socio-political considerations. Power sector subsidies are unsustainable and have significant opportunity cost - in FY2002 the subsidy support to the power sector (Rs.28.3 billion) was higher than the spending in some social sectors (Rs.21.2 billion for primary education and Rs.7.7 billion for primary health) Like other states in India, Andhra Pradesh has adopted a policy of providing subsidy for agricultural production through low electricity tariff. Tariffs for agriculture consumers in Andhra Pradesh are lowest among all the states in the country and have not been revised during the last three years 6. Agriculture consumers are estimated to account for 40 percent of the total utility sales, but contribute only 5 percent to the utility s revenue. With the progressive reduction in cross-subsidies, the fiscal impact of power supply to agriculture is likely to grow if the present trend of growing sales to agriculture consumers and mere 10 percent cost recovery continues. Metering of agriculture consumers is another area where progress is lagging, in spite of the APERC s directives for full metering. In FY2003 the utilities agreed to provide new electricity connections on metered basis and have submitted a plan to achieve full metering (by FY2007) to the APERC for approval. The subsidies delivered under the present flat-rate tariff system are regressive and benefit large farmers much more than the small and marginal farmers (Report on Power Supply to Agriculture, World Bank, 2001). Externalities like overuse of water and uneconomic crop choices are some of the negative outcomes of the tariff subsidy policy. Improving the service, enhancing cost recovery, and agriculture consumer metering constitute key challenges in commercialization and privatization of the distribution business. The GOAP has set up a Task Force on Power Supply to Agriculture to assess and develop alternate mechanism to provide subsidy to the consumers Overall, an independent rating agency (CRISIL) in its all-india assessment of progress of power sector reforms (2003) has rated Andhra Pradesh as a leader. The state has qualified to receive cash incentive under the Accelerated Power Development and Reforms program (APDRP) of the GOI for reducing its revenue-cost gap in FY

12 Revenue deficit/surplus per kwh Consumer category-wise average tariffs FY2000 FY2001 FY2002 FY2003 FY FY2000 FY2001 FY2002 FY2003 Projected Actual Residential HT-indy Agri. Avg cost Performance of Power Companies (FY2003) (Provisional estimates) (Rs. Billion) GENCO TRANSCO CPDCL EPDCL NPDCL SPDCL Revenue Operating expenditure EBITDA Operating profit/(loss) Cost recovery (%) 83% 87% 67% 74% Electricity purchased (MU) Electricity Sales (MUs) Residential (%) Commercial (%) HT Industry (%) Agriculture (%) Others (%) Metered sales (%) 45% 63% 41% 49% Distribution loss (%) 23% 17% 21% 22% Further implementation of power sector reform and Bank s support The GOAP is committed to continue the implementation of the reform program. The next structural and market reforms envisaged, as mandated in the national Electricity Act 2003, include segregation of transmission wires and trading function by June 2004, introduction of open access and move from the present single buyer industry structure to multi-buyer structure whereby allowing the Discoms to purchase power from the generators. Move to the multi-buyer model is expected to bring in efficiency gains from competitive and commercial procurement of power by the Discoms. On the regulatory front, implementation of multi-year tariffs and preparation of strategy for introduction of open access and increased competition in retail power supply will be important areas of focus As mentioned earlier in the report, to achieve sustained improvement in the financial performance of the power utilities and reducing fiscal pressures caused by the sector the ultimate objective of the reform program - it is critical to address the issues of power supply to subsidized consumer categories. In the next stage of reform implementation the GOAP and power utilities need to (i) progressively move the tariffs of various consumer categories to the cost of supply (ii) complete metering of all consumers as per the plan approved by the Regulatory Commission and (iii) design subsidy delivery mechanisms which - 9 -

13 would facilitate targeting and enable the utilities to operate commercially. These measures are necessary for privatization as well as commercialization of the distribution business Based on the GOAP s commitment to continue power sector reforms, the Bank remains willing to continue to engage in the sector. The Bank has had extensive dialogue with the GoAP under the second Structural Adjustment Loan (APERL 2) on deepening the reforms in the power sector. The progress in implementing power sector reforms, including subsidy reforms for power supply to agriculture, will be an integral part of the Bank s programmatic structural adjustment support to Andhra Pradesh. Further support under the "APL program" would be provided based on the demonstrated sustained improvements in the financial performance of the power sector. The Bank s support would be provided in accordance with the "rules of engagement in the state power sector" finalized in consultation with the GOI and the states. The support could be through a range of instruments including technical assistance, investment lending, budgetary support (sector adjustment lending) and guarantees. Some areas where the Bank may consider support include distribution privatization, improvement in and expansion of rural access, and initiatives to introduce competition and open access to transmission and distribution wires. 4.2 Outputs by components: Overall outcome of the investment project is satisfactory. Prioritized investments in transmission and distribution have resulted in improvements in the availability, reliability and quality of power supply. This is substantiated by monitoring of key indicators including voltage levels, T&D losses, feeder outages and transformer burnout rates. Improvements in billing and reduction in nontechnical losses have been realized with the implementation of metering system improvement program. An independent study carried out by the consultants at the project mid term reported improvements in voltages, reduction in pump burnouts, and perceived increase in consumer satisfaction regarding power supply conditions. (i) Transmission system augmentation. Implementation of this sub-component is highly satisfactory as almost all the schemes under the project have been successfully completed and put into operation. Under the project 23 new 220 & 132 kv sub-stations have been commissioned and transformer capacity augmented at 16 sub-stations adding about 1900 MVA transformation capacity. About 2300 kms of 220/132 kv transmission lines and 350 MVA capacitor banks have been installed. These investments have resulted in evacuation of additional power, increase in voltage stability, reduction in transmission losses. Maximum energy handled by the transmission system has increased from GWh/day in FY1999 to GWh/day in FY2003. Voltage levels in 220 kv Feeders Voltage levels in 132 kv Feeders No. of Feeders Less than 210 kv kv kv Above 230 kv 0 5 No. of Feeders Less than 120 kv kv kv Before APL1 After APL1 Before APL1 After APL1-10 -

14 (ii) Sub-transmission and distribution system strengthening. Overall 90 percent of the schemes financed under this sub-component have been satisfactorily completed and the balance are expected to be completed by July The completion of some schemes has been delayed due to delays in finalization of the schemes by the Discoms. About 6000 new distribution transformers have been installed along with the capacity augmentation at 188 numbers 33/11 kv substations. About 2000 MVA new capacity and 33 & 11 kv lines (1600 kms) have been added under APL1. Other measures taken up for rehabilitation of the dilapidated distribution network includ replacement of 33 and 11 kv circuit breakers, re-conductoring with large capacity conductors, separation of bunched 11 kv feeders and bifurcation of over loaded 11 kv feeders. All these investments have contributed to reduction in distribution losses, improvement in power supply quality in terms of better voltages and reduction of outages (refer Annex 1). The distribution transformer failure has reduced from 35 percent in FY1999 to 19 percent in FY2003. Box 1: Extracts from ASCI Report Improvement in LT Voltages: The improvement in LT voltages are generally in the range of 5 to 20 percent. The voltages are generally in the order of 400 to 445 volts. In some cases it is based on records maintained by the distribution staff and in some cases the voltages were actually measured. The inspecting engineers have also enquired the agricultural consumers particularly those who have pumpsets at the tail end of LT lines, where these transformers are installed. The consumers have informed that voltages have improved on installation of new transformers and they are able to run pumpsets. Burning of motors has become much less frequent. There is a perceivable increase in level of satisfaction among consumers. Reduction in Distribution transformer failures: The loading on the existing transformers is reduced and also the LT line lengths from each transformer and this has resulted in reduction in failure rate of distribution transformers, particularly in the feeders/areas where the additional transformers are installed. This reduction in transformer failure rate has resulted in savings of Rs. 126 million and Rs. 189 million for the years FY2001 and FY2002. Improvement in reliability of supply: It is acknowledged by the distribution staff and the consumers that reliability of supply has improved on installation of additional transformers. The inspection team has inspected 586 transformers and at each of these locations they have interacted with 8 to 10 consumers to get their reaction on the quality of supply etc. The team has interacted with over 5000 consumers. The level of consumer satisfaction is good. Source: Review design criteria, quality assurance, certification of works and quantification of benefits of APL1 project, by Administrative Staff College of India (ASCI), February 2002 (iii) Metering System improvement. The Bank has supported a large program to provide good quality consumer and energy audit meters. About 433,000 electronic consumer meters, 34,000 energy audit meters for 11 kv feeders and for distribution transformers supplying power to predominantly agriculture consumers have been financed under the project. Further, the utilities have procured a large number of meters to regularize illegal consumers and provide better quality meters to the existing consumers. These efforts have resulted in substantial increase in revenue and reduction of nontechnical losses in the distribution system. Metered sales as a proportion of total power purchased by the Discoms has increased from 41.4 percent to 47.6 percent during the same period. (iv) Technical Assistance. The GOAP, power utilities, and APERC have benefited extensively from the technical assistance support provided by the DFID, CIDA and Bank. Several international and national consultants/experts have assisted on strategic issues of regulation, distribution privatization, utility management, commercialization, business planning, human resource development, power system planning and operations (refer Annex 11). The grant support provided by the bi-lateral donors has been very timely and has yielded good institutional development impact (refer section 4.5 below)

15 Based on the above assessment of progress on reforms (section 4.1) and implementation of the investment project (section 4.2) the APL1 project outcome is rated Satisfactory. 4.3 Net Present Value/Economic rate of return: Economic Rate of Return (ERR) of the APL1 project estimated at 41.8 percent is in line with the appraisal estimate of 37.6 percent (refer Annex 3). The economic costs are estimated before taxes and duties and the benefits are estimated at the willingness to pay, which is consistent with the methodology adopted at the appraisal. The ERR for the transmission component (43.4 percent) is estimated based on the reduction in transmission losses resulting from the investments in the transmission system under APL1. The loss reduction established by the load flow study carried out by APTRANSCO is higher than the benefits envisaged at the appraisal The utilities have realized significant benefits of reduction in technical and non-techincal losses, and improvements in the quality of supply from the investments in distribution and metering system. Extensive governance efforts, including reduction in electricity theft have substantially contributed to reduction in non-technical losses. However, in the absence of full consumer metering it is difficult to segregate technical and non-technical losses. Limited survey of consumers before and after the installation of high quality meters shows 5-20 percent increase in the metered energy, which validates ten percent increase in metered sales assumed at the appraisal. Improvements in voltages and reduction in transformer overloading have resulted in reduction in transformer failure rates, thereby improving the availability and reliability of power supply for the consumers and reduction in maintenance costs for the utilities. The net present value of savings from reduced distribution transformers failures is estimated to be Rs 2 billion. The ERR of distribution component is 40 percent and that of the metering component is 42.5 percent. The ERR is robust despite some delays in implementation of distribution and metering schemes under the project. Since in addition to the APL1 investments the utilities implemented a large program of investments in T&D, a cost benefit analysis of the aggregate investment program shows a robust ERR of 51.5 percent The additional benefits (not included in the analysis as these are difficult to quantify) accrue to the consumers on account of improved voltage conditions, and reduction in interruptions. These improvements would generally translate in reduction of motor burnouts for the farmers, reduction in equipment damage for industries and create an attractive environment for the new industries. Consumers have also benefited from the improvements in customer service quality, specifically in complaint handling, reduction in metering and billing discrepancies, and improved facilities for bill collection The economic benefits of the reform program are high. At appraisal, the baseline estimate was Rs 221 billion (NPV at 12 percent over 20 years) with a worst-case based on a sensitivity analysis to be Rs.141 billion. At project completion the benefits of the reform program is estimated at Rs.189 billion. The economic benefits are considered to arise from reduction in T&D losses, reduction in consumption by pilferers, reduced cost of captive generation and lower repair costs of distribution transformers. 4.4 Financial rate of return: Financial rate of return (FRR) of the project is estimated to be 38 percent. The component-wise FRRs are : transmission 36.9 percent, distribution 29 percent and metering 41.6 percent. Despite some adverse factors such as slow pace of tariff rationalization and lower than projected growth in the electricity sales the financial returns are robust on account of higher than envisaged reduction in the technical and non-technical losses (theft) in the T&D system. When considering the capital financing structure for APL1-12 -

16 investments, the returns estimated at the ICR are much higher compared to the appraisal estimates due to decrease in the interest rate and greater leverage obtained by the equity investments by virtue of loan from the financial institutions (refer Annex 3). The utility's equity contribution has been about Rs 1020 million as against the estimated equity contribution of Rs 1735 million at appraisal. High financial return confirms that the prioritized investments supported by the APL1 project were useful to reduce losses and infrastructure constraints in the T&D system. 4.5 Institutional development impact: The institutional development impact of the project has been substantial. The new power companies and the Regulatory Commission established under the project are functioning satisfactorily under the new legal, structural and regulatory framework The APERC has set a good track record of regulating the sector as per the legal framework, and has in a short span of four years developed significant capacity on sector regulation. The Commission has received advise from the international and national consultants in developing its rules and guidelines of functioning, as well as on the strategic issues of sector regulation. The Commission members and staff have undergone extensive training and have undertaken study tours to U.K, Argentina, and Brazil to understand the regulatory reforms implemented by these countries. The APERC has an ongoing exchange program with the Pennsylvania Public Utility Commission and the members/staff actively participate in seminars/workshops to disseminate the knowledge and share experiences. The APERC has set precedent in addressing important regulatory issues in the sector. On the important issue of tariffs setting the Commission has established a transparent review process, has made efforts to link tariffs to cost of supply and reduce the cross subsidy among consumer categories. However, the progress on reducing subsidy provided to the agriculture and residential consumers and metering of agriculture consumers (inspite of regulatory directives) has been constrained due to socio-political considerations The power companies have developed their institutional capacity during the course of implementation of the project. The management of the companies has been strengthened with the induction of a few key managers with appropriate skills and experience in the area of finance, corporate planning, information technology and human resources development. The companies are streamlining their business processes and performance review practices to enhance their commercial orientation and operate in the new regulated environment. Some specific areas of institutional development include (i) sector regulation - a Regulatory Affairs Cell has been set up in APTRANSCO (and more recently in the discoms as well) which provides support for interface with the Regulatory Commission, tariff filing and compliance with the regulatory directives; the staff have been trained on the key regulatory principles; (ii) power procurement and merit order dispatch thereby reducing the cost of power procurement; (iii) use of specifically designed information technology interventions for establishment of database and management tools to analyze, review and monitor performance e.g. customer analysis tool to target customers for improving billing and collection efficiency; and (iv) streamlining financial management function in the Discoms (refer Annex 10) Human resource development has been an important part of the reforms with a special emphasis on the staff and management training. The Power Training Institute has been strengthened and offers training on regular basis. A large number of staff have been involved in the implementation of reforms, operation and management of the power utilities under the new legal, and regulatory framework. Working along with the international and national consultants the staff have gained knowledge in the areas of sector regulation, planning, information management, and operational efficiency improvement. While implementing the APL1 project the staff have gained experience in investment planning, procurement, and integrating social and environmental aspects in project planning and execution