al/tf. -J;c. DumeNnt of The World Bank FOR OFFICIAL USE ONLY

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized DumeNnt of The World Bank FOR OFFICIAL USE ONLY al/tf. -J;c. REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE Report INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO USt226.O TO THE REPUBLIC OF INDONESIA FOR A POWER TRANSMISSION AND DISTRIBUTION December 18, 1986 MILLION PROJECT No. P-4427-IND - - Tis document has a restricted distribution and may be used by recipients oniy in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS Currency Unit - Indonesia Rupiah (Rp) (As of September 1986) US$1 a Rp 1,650 Rp 100 = US$ Rp 1 million = US$ GOVERNMENT OF INDONESIA AND PLN FISCAL YEAR (BY) April I-March 31 WEIGHTS AND MEASURES 1 metric ton = 1,000 kilograms (kg) 1 liter (1) = barrels (bbl) 1 kilometer (km) = miles (mi) 1 kilovolt (kv) = 1,000 volts (v) 1 megavolt-ampere (MVA) = 1,000 kilovolt-amperes (kva) 1 megawatt (MW) = 1,000 kilowatts (kw) 1 gigawatt hour (GWh) 1 million kilowatt hours (kwh) ABBREVIATIONS BAKOREN - National Energy Board BAPPENAS - National Development Planning Board DCEP - Directorate-General of Electric Power, Hinistry of Mines and Energy JABOTABEK - Jakarta, Bogor, Tangerang and Bekasi area LNG - Liquified Natural Gas LPG - Liquified Petroleum Gas LRMC - Long-Run Marginal Cost MME - Ministry of Mines and Energy PERTAMINA - National Oil and Gas Company PLN - National Electricity Authority ROR - Financial Rate of Return SFR - Self-Financing Ratio

3 FOR OFFICIAL USE ONLY INDONESIA POWER TRANSMISSION AND DISTRIBUTION PROJECT Loan and Project Summary Borrower: Beneficiary: Amount: Terms: Onlending Terms: Project Description: Risks: Republic of Indonesia National Electricity Authority (PLN) $226.0 million equivalent. Repayable in 20 years, including 5 years of grace, at the standard variable interest rate. The proceeds of the loan would be onlent from the Government of Indonesia (GOI) to PLN for 20 years including a grace period of 5 years; the onlending rate would be equal to the Bank's standard variable interest rate plus no less than a quarter percent for administration charges. The Government vould bear the foreign exchange risk. The proposed project would support government objectives to promote productive activities and to improve the welfare of the population through the provision of electric power, and also to improve the economic and technical efficiency of energy supply and use. In particular, the proposed project would: (a) expand transmission and substation facilities in Java to efficiently utilize the planned addition to generating capacity during the period from to 1990/91; (b) extend distribution facilities in the Jakarta, Tangerang, Bogor and Bekasi areas to supply electricity to industries, commercial consumers and about 250,000 new residential consumers in urban and rural areas; (c) expand PLN's center for testing and certifying indigenous products and for researching utility-oriented problems; and (d) provide consulting services to (i) assist PLN's Engineering Services Center; (ii) continue the detailed engineering of a coal fired thermal power plant at Paiton in East Java; and (iii) define and implement measures to improve PLN's operating efficiency. The principal risk relates to possible delays in implementing the transmission and substations component of the project because of difficulties in land acquisition. Advance action has been initiated by PLN to help prevent such delays. This document has a restricted distribution and may be usod by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 Estimated Costs: Local Foreign Total (US; million) ---- Transmission lines and substations Distribution Testing and Research Center Consulting Services for: Paiton Engineering Services Center Efficiency improvement Total Base Cost Physical contingencies Price contingencies Total Project Cost /a Interest during construction Total Financing Required Financing Plan: Local Foreign Total Federal Republic of Germany IERD COI/PLN Total Estimated Disbursements: Bank FY Annual Cumulative Economic Rate of Return: 17Z for PLN's investment program for Java for the period 1987 to Staff Appraisal Report: No IND dated December 17, 1986 Maps: IBRD 12453R6 IBRD 17207R2 /a Identifiable taxes and duties are about US$9.7 million equivalent, and the total project cost, net of tazes, is US$356.5 million equivalent.

5 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF INDONESIA FOR THE POWER TRANSMISSION AND DISTRIBUTION PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Indonesia for the equivalent of US$226.0 million to help finance the Power Transmission and Distribution Project. The loan would have a term of 20 years, including 5 years of grace, at the standard variable interest rate. PART I - THE ECONOMY 2. An economic report entitled "Indonesia: Adjusting to Lower Oil Revenues" (No IND, dated May 20, 1986) was distributed to the Executive Directors on May 27, Annex I gives selected economic data for the country. Background 3. The Republic of Indonesia is a highly diverse country spread across an archipelago of more than 13,000 islands with a land area of about 2 million km. It has a population of over 158 million, growing at about 2.11 p.a., and is the world's fifth most populous nation. The country has a diversified resource base, with plentiful primary energy resources, significant mineral deposits, large timber potential and a developed system of agricultural commodity production and export. A high proportion of these primary resources are located on the less populated islands of Sumatra and Kalimantan, while two thirds of the population lives on Java, which has areas with some of the highest rural population densities in the world. About a quarter of the population lives in urban areas, and the current rate of urban population growth is about 4% p.a. The 1984 estimate of GNP per capita is UJ2540, which places Indonesia at the lower end of the middle-income countries.- Macroeconomic DeveLopments and Resource Management 4. During the 19709, the Indonesian economy grew at almost 8% p.a. This growth was associated with rapid increases in public expenditures, total investment and savings. Following the turbulence of the mid-1960s, the Government of Indonesia (GOI) took effective action to restore macroeconomic stability, liberalize the economy, rehabilitate infrastructure, and provide incentives for domestic and foreign private investment. However, the dominant external influence was the huge expansion, and significant variability, in foreign exchange earnings from oil. Net earnings from oil and LNG exports rose from US$0.6 billion in 1973/74 to US$10.6 billion in 1980/81, when the 1/ On the basis of the WorLd Bank's system of country classification and Atlas methodology for calculation of GNP.

6 -2- current account enjoyed a surplus of US$2.1 billion. Oil and LNG also prbvided about 602 of budget revenues by 1980/81 and helped finance a sustained increase in demand. The pattern of expenditures helped foster diversified growth. Of particular note has been the support for agriculture through investment in infrastructure and support services. This supported an agricultural growth rate of almost 4% p.a. and led to the recent achievement of self-sufficiency in rice. Manufacturing also enjoyed a high growth rate during the 1970s (of about 14% p.a.), although this was from a very low base and predominantly oriented towards the protected domestic market. 5. Over the past five years, the economy has been buffeted by unfavorable external developments, especially for oil. Accordingly, the external terms of trade deteriorated by more than 15% from 1981/82 to 1985/86. In response, the Government acted decisively to stabilize the economy and provide a basis for longer-term structural adjustment. Related measures included: (a) restraints on public investment and reductions in budget subsidies; (b) maintenance of a flexible exchange rate policy (following a major devaluation in March 1983); (c) wide-ranging structural reforms in the taxation and financial systems; and (d) a major reorganization of customs, ports and shipping operations. These measures had a positive impact on the balance of payments, with the current account deficit reduced from US$7.2 billion (8.5% of GNP) in 1982/83 to an estimated US$1.7 billion (2.2% of CNP) in 1985/86. Domestic inflation was also reduced to less than 5% in However, this stabilization process has involved a heavy cost in terms of lower investment and growth. Since 1981, GDP growth has averaged only 2.6% p.a.; adjusting for population growth and the terms of trade loss, per capita incomes have fallen. The industrial sector has been particularly hard hit, with low rates of capacity utilization and emerging financial problems in many enterprises. 6. The economic outlook for Indonesia is dominated by the recent collapse and uncertain prospects for world oil markets. Preliminary indicators are that Indonesia's net oil/lng export earnings could fall by more than 60% during 1986/87. Because of the cautious management strategy adopted by the Government in recent years, Indonesia is better placed than most oil exporters to cushion the short-term impact of lower oil revenues. External reserves stand at over US$10 billion (equivalent to nine months of imports) and another US$2 billion is available in undrawn commercial credits. However, the Government is still legitimately concerned about the impact of a prolonged shortfall in oil revenues. Despite tight controls over public external borrowing in recent years, the debt service ratio had reached 25% by 1985 and will rise further (even without new borrowing) over the next few years. The scope, therefore, for additional borrowing to cover the resource gap is limited. Instead, the Government has opted for further measures, to restrain aggregate demand and promote structural change in the economy. Already, an austerity budget has been announced for 1986/87, with total expenditure budgeted to decline by 9% (24% for development expenditure). By itself, the austere budget for 1986/87 would not have been sufficient to bring the current account deficit down to manageable levels, nor to promote the necessary structural adjustment in the economy. Therefore, faced with the prospect of lower oil prices over the medium term, the Covernment decided to devalue the Rupiah by 31% (IMF method) on September 12. This adjustment is considered appropriate in light of the projected loss of oil revenues and helped to pre-

7 - 3 - empt speculative capital outflows. With continued prudence and some recovery in oil prices, the current account deficit could be brought back to less than 3X of GNP over the next three years. However, economic performance would remain highly constrained, with CDP growth close to 2% p.a. and declining per capita incomes. Policies for Growth and Adjustment 7. Indonesia's ability to achieve its goals of sustainable growth with equity will depend crucially on the skill with which it manages the transition from oil dependency toward a more diversified, semi-industrial economy. Some of the elements of this strategy, including structural reforms in the taxation and financial systems, are already in place. The recent devaluation will also help to improve Indonesia's competitiveness and promote non-oil export development. However, successful adjustment will require continued action in three key policy areas: management of the public investment program (and improvements in the regulatory/policy environment for private investment), rationalization of the external trade regime and development of the financial sector. 8. The projected import constraint imposes serious limitations on the rate at which Indonesia can undertake new investments over the next few years. At the same time, some reallocation of resources towards regional development and the social sectors might be justified, in order to reduce the import content of investment while still meeting the Covernment's equity and employment objectives. It is therefore important that mechanisms are established to facilitate orderly and rational adjustments to the public investment program. Possible options include preparation of multiyear expenditure plans (at least for the larger projects), identification of a core program of high priority projects and strengthening of project appraisal/selection procedures. The Government is also considering ways to improve project implementation, so that investment returns can be realized more promptly. Given the budgetary constraints, it is expected that the private sector will be called upon to play an increasingly important role in capital formation. To encourage this process, the Government recently announced simplifications in investment approval procedures and a major internal reorganization of the Investment Coordinating Board. These measures were followed, in May 1986, by a package of regulatory refdrms to make Indonesia more attractive to foreign investors. 9. The recent decline in the price of oil has clearly demonstrated the importance of reducing the economy's heavy dependence on a single source of foreign exchange and, more generally, the need to rationalize the external trade regime. The Government has set a target of doubling non-oil exports in nominal terms over the next five years. This target should be attainable provided that economic recovery in the industrial economies is sustained, Indonesia's access to those markets is not constrained by protectionist measures and, most importantly, Indonesia follows appropriate trade and exchange rate policies. In this context, the Government has introduced two important policy reforms in 1986, aimed at reducing trade-related distortions. The first package of trade ref' ;is, designed to provide internationally priced inputs to exporters, was announced on May 6. Under the

8 - 4 - scheme, "producer exporters" were given the option of importing their inputs free from licensing restrictions and exempt from import duties. Preliminary results suggest that the scheme is being implemented efficiently and is highly effective in supporting exporters. The second package of trade reforms, designed to reduce import restrictions, improve industrial efficiency and promote non-oil exports, was announced on October 25. As a result of the October 25 measures, import license restrictions have been removed on 166 items and relaxed on 105 items for actual users and licensed agents. Together, these items account for 27% of all items and 44Z of total import value previously restricted to approved importers. Although agricultural products and some important manufactured goods (e.g., steel, textiles and plastics) are excluded, the reform signals the Government's intention to shift to tariffs as the primary instrument of import policy. 10. The Government's decision to move towards a more liberal financial environment raises a number of issues relating to resource mobilization, financial intermediation and credit allocation. Over the longer term, as the scope for subsidized credit is reduced, the banking system will have to play an increasingly important role in mobilizing domestic resources. However, during the transition period, some potential conflicts between the resource mobilization and credit allocation objectives could arise. For example, the increase in deposit rates following the recent financial reforms, while encouraging resource mobilization, has also led to high real lending rates which have tended to dampen investment and credit demand. This in turn may restrain economic activity. It is therefore important to find ways to reduce the high intermediation costs of banks. Consideration should also be given to other ways of mobilizing financial resources, including development of a capital market, expansion of the banking network (especially in rural areas) and selective relaxation of restrictions on private banks (combined with inciaased bank supervision). Incomes, Employment and Human Development 11. Indonesia's physical, human and economic resources are very unevenly distributed among its main regions. Java, for example, accounts for almost 50% of Indonesia's GDP and 62% of its population, but only 7% of its land area. Although all five of the country's main regions experienced rapid per capita growth in the 1970s, regional differences in output tended to widen. To a large extent, differences in performance are associated with the importance of the mineral sector, particularly petroleum. However, there are two important processes at work in Indonesia which enable the benefits of growth to be more evenly spread than indicated by output trends. The first of these is migration. Between 1971 and 1980, 4.3 million people (or 16% of the natural increase in population) resettled permanently in provinces outside those of their birth. Approximately 1.7 million people moved from Java to the Other Islands, of whom one million were resettled through the official transmigration program. There has also been substantial rural-urban migration both between and within provinces. The second process is the redistribution of income through the government budget. Regional variations in per capita consumption are much less pronounced than differences in per capita output. This is largely due to the impact of taxation on the oil sector.

9 12. An analysis of household expenditures indicates that Indonesia's rapid economic development has been accompanied by significant progress in reducing poverty. Between 1970 and 1980, the proportion of the population living in poverty declined from 57% to 40X; the decline was particularly rapid in the Other Islands and in urban areas. The core of the poverty problem continues to be in rural Java, where landless laborers form a large, and possibly rising, proportion of the population and where, for most of the 1970s, there is little evidence of any rise in real agricultural wages. However, there was a significant rise in real agricultural wages around associated with the sharp increase in rice output and booming overall economic growth. Increases in rural nonagricultural and urban wages also occurred at the beginning of the 1980s. Despite the slowdown in economic growth and stabilization measures since 1982, the limited available evidence suggests that wages and incomes have held up, partly as a consequence of continued agricultural growth. 13. In the future, the availability of productive employment will be a key determinant of income distribution. The labor force is expected to grow at about 2.3% p.a. over the next decade, while economic growth will be lower than in the 1970s. The resultant squeeze in the labor market could lead to stagnant or declining labor income, especially in rural areas and the urban informal sector. Given the balance of payments constraint facing the country, Indonesia's employment outlook depends crucially on the pattern of economic growth, and in particular the extent of labor absorption in the commodityproducing sectors. Although over the long term the structural shift in employment away from agriculture should continue, this sector will still account for half or more of total employment and the growth in agricultural incomes will be an important determinant of job opportunities elsewhere in nonfarm activities. This will require continued priority to agriculture in the form of supportive pricing and investment policy, with some shift in emphasis toward the Other Islands. On Java, attention will need to be paid to issues of agricultural diversification and the pace of mechanization. With respect to the industrial sector, the development of an efficient, relatively export-oriented pattern of production can also contribute to significant labor absorption in the medium to long term, especially in Java; this will involve a continuing major role for small-scale firms. If a favorable evolution of the employment situation is to occur, there will also need to be an appropriate pattern of public expenditure and supportive policies for the urban informal sector; finally, the transmigration program can make a substantial contribution, provided it is closely coordinated with complementary agricultural investment programs, in tree crops, water resources and livestock development. 14. There has been substantial progress in extending the provision of social services throughout the population. Universal enrollment in primary education has been virtually achieved and the enrollment rate in secondary schools is now about 35%. However, the weak educational base of the population continues to be a major obstacle to rapid economic development and a substantial further expansion of secondary and tertiary education will be necessary as well as a major effort to raise the quality of the whole system. In the health sector, there has been a large expansion in facilities, notably at the subdistrict level, but continued investment and an improvement in quality will be necessary to increase effectiveness. This will have to be

10 -6 - complemented by a major expansion in water supply and sanitation if the improvement in indices of mortality and morbidity during the 1970u is to be maintained. By 1981, only 182 of the rural and 40% of the urban population had access to safe water, compared with government targets of 60% and 75%, respectively, for External Capital FLows 15. The ongoing program of economic reforms should help to hold the current account deficit to sustainable levels over the medium term, despite the impact of lower oil revenues. Even so, continued resource transfers from abroad will be cssential to sustain modest GDP growth (2% p.a.) over the next three years. Staff projections indicate that new public medium- and long-term (llt) borrowing will have to average about US$4.8 billion p.a. from 1986/87 to 1988/89, including about US$2.4 billion p.a. of official development assistance and the balance from import-related credits and untied borrowing. Indonesia is well placed to arrange the necessary financing on reasonable terms; the Government's record of economic management is good and a comfortable cushion of external reserves has been rebuilt over the past three years. 16. Total public debt outstanding at the end of 1985 is estimated at US$28 billion, with an additional US$15 billion of undisbursed commitments. Of the total debt disbursed and outstanding, official assistance (including nonconcessional multilateral aid) accounts for 48% and obligations at variable interest rates for only 21%; there is no short-term public debt. The average maturity of public MLT debt at the end of 1985 is estimated at 16 years. The Covernment continues to manage its external debt quite prudently. Until 1981, Indonesia had succeeded in maintaining its public debt service ratio, based on gross exports, at below 10%. However, because of the sharp drop in oil export receipts over the past three years, the ratio rose to about 20% in With the projected levels and composition of borrowings and export earnings, Indonesia t s public debt service ratio would rise to about 31% in 1986 and then gradually decline in later years. With private MLT debt included, the total debt service ratio would rise from 25% in 1985 to around 37% in 1986 and then decline again. PART II - BANK GROUP OPERATIONS IN INDONESIA 17. As of September 30, 1986, Indonesia had received 48 IDA credits totalling US$ million (less cancellations) and 113 Bank loans amounting to US$8, million (less cancellations). IFC commitments totalled US$163.2 million. Annex II contains a summary of IDA credits, Bank loans and IFC investments as of September 30, The share of the Bank Group in Indonesia's public (disbursed) external debt outstanding at the end of 1985 was 14.8%, and the share of debt service, 9.7%, compared with 14.5% and 8.8%, respectively, in From 1968 until 1974, all lending to Indonesia was made through IDA. Due to the country's improved creditworthiness following the commodity and oil-price boom in 1973/74, the bulk of the Bank Group's lending in the remainder of the 1970s was through IBRD loans, with a modest amount of IDA lending being justified primarily an poverty grounds, as the per capita GNP was well below the IDA cutoff level. IDA lending was discontinued in FY80. Given the critical importance of agriculture (including transmigra-

11 tion) for employment, food security and exports, over one third of Bank Groupassisted projects have bean in this sector. In addition, loans and credits have been extended to virtually alt ocher sectors of the economy, including transportation, education, urban development, water supply, rural development, industrial development financing (including small-scale industry), power, telecommunications, population and nutrition, and technical assistance. 18. During Repelitas I ( ) and II ( ), and in line with the objectives of these first two Five-Year Plans, a high proportion of Bank Group lending was directed initially toward the rehabilitation and then the expansion of infrastrtucture and production facilities. Special attention was also given to meeting the shortage of skilled manpower and technical assistance needed for preinvestmenc studies and project execution. Repelica III ( ), published in early 1979, stressed the need for continued high growth and stability, but departed from previous plans by placing special emphasis on more equitable income distribution and poverty alleviation. This focus, which was fully in line with the conclusions of the basic economic report, required greater attention to employment generation (particularly in the industrial sector) and to improvements in basic public services. While Bank lending was already consistent with these objectives, increased emphasis has been given to these priorities. However, the adverse economic developments that occurred in the latter half of the plan period and the measures taken to address them, led to a reshaping of development objectives for Repelita IV ( ). These emphasize restoring growth of incomes and employment while continuing financial prudence, promoting structural change toward a more diversified economy, and maintaining efforts to improve income distribution and alleviate poverty. This shift in focus has underscored the need to follow through on reforms that have already been initialed, seek increased efficiencies in the economy, mobilize domestic resources to finance needed investments and recurrent expenditures, and foster a policy environment conducive to the achievement of required changes. 19. The Bank has geared its tending and economic work program to address these needs and to maintain a high level of resource transfer. The approach is to continue to emphasize the ongoing dialogue on economic policy that has been a cornerstone of the Bank's relationship with the Government for many years, and to coordinate discussion of macroeconomic issues with advice on institutional and policy reform in important sectors and subsectors, coupled with lending operations and technical assistance that meet priority needs and support institutional improvements in specific areas. Emphasis in economic work is being given to trade and industrial issues, development of the financial system, and public resource management. In the lending program, agriculture continues to receive the most attention. However, the program is broadly based, and includes increasing emphasis on efficiency improvements in the infrastructure sectors and on education and human resource development. Continued attention is being given to power and energy, where the Bank is concentrating on policies to diversify Indonesia's energy base, rationalize pricing and improve sector planning. In transportation, the Bank is focussing on efficiency improvements in the maricime sector and on improving the national network of highways and rural roads. In urban development and water supply, lending is being directed toward establishment of appropriate sector policies and institutional development aimed at strengthening local government

12 and regional enterprises, in order to minimize demands on the government budget and decentralize the responsibility for addromuing basic needs. In all, the Bank'u landing program is intended to contribute about 20% of Indonesia's capital requirements during the next three years and is expedted to be an important catalyst in attracting other funds. Whore possible, we are seeking also to widen the impact of Bank lending through technical nssistanco, am well am complementary investments and coordinated policy dialogue with other donors. 20. Implementation, as rflected by disbursements, hai,been steadily improvig over the past three years. The disbursement ratio I has risen from 15% 2' in FY84 to about 18.5% in FY86. Although this is not yot a satisfactory level, this improvement reflects the results of efforts which the Government and the Bank have been making to address key implementation problem areas. These include budgeting and budget release procedures, procurement procedures, managerial capacity, limited capacity in the local consulting and contracting industries and land acquisition. Several special Bank missions have addressed various aspects of these problems and made recommendations, many of which have been adopted by the Government. Seminars on procurement and disbursement procedures am well as others which have addressed more broadly implementation problems of specific sectors have been held, in addition to regular formal meetings between the Bank and the Government to review implementation and disbursement performance and project and sector-specific problems. As a consequence of these joint initiatives, the Government has acted to streamline some complex budgetary and financial procedures, improved its information system, and instituted training programs in procedures and project management. In addition, a ministerial level committee responsible to the President has been established to monitor implementation performance, as well as a ministerial committee on land acquisition. To continue to assist in alleviating the problems which persist, the Bank has been, and will be in future, working with the implementation monitoring committee as well as on specific problem areas agreed with the Government. Activities are already underway include: developing the consulting and contracting industries, improving budgeting and financial procedures, simplifying reimbursement procedures, and strengthening management information systems for procurement and post-contract implementation monitoring. Energy Resources PART III - THE ENERGY SECTOR AND ELECTRICITY SUBSECTOR The Energy Sector 21. Oil. Indonesia is richly endowed with energy resources including oil, natural gas, coal, hydropower and geothermal energy. Oil and natural gas 2/ The ratio of actual disbursements during the fiscal year to the cumulative undisbursed amount at the beginning of the fiscal year. 3/ Excluding the Special Assistance Program (SAP) - related disbursements which added 2.8%.

13 -9- now account for almost all of total commercial energy consumption. While undiscovered oil reserves are estimated at billion barrels, proven resources are about 9.5 billion barrels. Production capability is about 1.9 million barrels per day but the current production level is about 1.3 million barrels per day, due to OPEC production quotas. 22. Natural Gas. The estimated pr 3 ven remp.ning natural gas reserve as of January 1984 was about 80 trillion ft (TTC),- of which 901 is non-associ- * ated and can be developed independently of oil. However, major reserves are generally located away from population and industrial centers. The Arun field in North Sumatra has 14 TCF and Natuma in the South China Sea has 41 TCF. About 5.0 TCF of reserves are proven in offshore Java of which about 2.6 TCF are in the East and 2.3 3CF are in the West. Production of natural gas reached 1,580 billion ft in Half of this was exported as liquified natural gas (LUG) to Japg 7 from Arun and Badak. LNC production was about 15 million tons in Gas pipelines have been Laid to domestic steel and fertilizer factories and domestic consumption is expected to increase by about 8.01 per year. 23. Coal. Indonesia's coal reserves are believed to be as high as 20 billion tons, mostly located in West and South Sumatra and Kalimantan. While production is currently about 530,000 tons per year, the Government has planned for major increases. Work started early in 1982 on a 3.0 million ton per year mine at Bukit Asam and on a 0.6 million ton per year mine at the nearby Muara Tiga coal field. Proven reserves in this area are over 400 million tons. The Government is also implementing a program to raise the coal production at n;fbilin in West Sumatra to 1.3 million tons per year, mainly for export. In addition, in 1981, the Government entered into a number of production-sharing agreements with private foreign and Indonesian joint-venture companies for the exploration and exploitation of Kalimantan coal reserves. Coal reserves defined by these contractors and expected to be economically recoverable, amount to about 1.0 billion tons. The South Sumatra and Kalimantan coal has a potential for sustaining a large program of coal-fired power generation in the country. 24. Hydropower. Indonesia's total hydroelectric resources are large but development is limited by their geographic distribution relative to demand. The largest hydroelectric resource potential (over 35% of the total) lies in Irian Jaya, where the demand is less than one percent of total domestic demand, while Java, which accounts for 80Z of current consumption, has less than 10% of the total potential. Existing hydroelectric installations aggregate to 2,028 MW; they are located in Java (1,235 MW), Sumatra (612 MW), and Sulawesi (181 NW). Schemes with an aggregate capacity of about 1,000 NW are currently under construction. The National Electricity Authority (PLN), assisted by Nippon Koei of Japan, has carried out a systematic countrywide resource survey, using funds from IBRD Loan 1365-IND, that has produced an 4/ 1 TCF of gas = 24.7 million tons of oil equivalent. 5/ 1 ton of LNG = 1.2 tons of oil equivalent.

14 inventory of hydroelectric site,s. The survey is being followed up with various prefeasibility and feasibility studies of the promising hydroelectric sites. Prefeasibility studies o;7 21 such hydro schemes were financed under Loan 1365-IND. In addition, prefeasibility studies for 20 sites and feasibility studies for 6 sites are being financed under Loan 2300-IND. 25. Geothermal. Surface manifestations of geothermal energy are found on all islands except Kalimantan, but only a few sites have been investigated and only one, Kamojang in West Java, has been developed. It is believed that potential reserves may approach 10,000 MW, distributed as follows: Java, 5,500 MW; Sulawesi, 1,400 KW; Sumatra, 1,100 MW; and other islands, 2,000 MW. The Government, in collaboration with the Government of New Zealand, initiated development of the Kamojang field in The first 30 MW generating set was commissioned for commercial operation in January 1983 and the station will be expanded by 110 MW under the Twelfth Power Project (Loan 2214-IND). Further development potential exists in Kamojang. In 1982, PERTAMINA (The National Oil and Gas Company) entered into a joint operation contract with Union Geothermal, a subsidiary of Union Oil of California, for development of the Salak Field in West Java. A potential of MW has been proven by explorations. Also, PERTAMINA has explored geothermal fields at Dierng and Drajat in Java. The economic viability of developing these fields is under study. Institutions in the Energy Sector 26. The principal agency responsible for implementing government policies in the energy sector is the Ministry of Mines and Energy (MME). MME was established in 1978 to coordinate all activities in the energy sector and to control the three state enterprises responsible for the carrying out of government policies in the energy subsectors: PERTAMINA for oil and gas, P.N. BATUBARA for coal and PLN for electricity. Other ministries and agencies are also involved in the sector; for example, the Ministry of Public Works is responsible for hydropower resource surveys, the Ministry of Agriculture oversees forestry products, and the National Atomic Energy Commission is responsible for nuclear development. To help facilitate appropriate coordination of energy policy, the Government has established an interministerial National Energy Board (BAKOREN) to oversee sectoral development. BAKOREN is supported by a technical committee (PTE) consisting of senior officials in different departments, chaired by the Director General of Electric Power and New Energy (DCEP). The Electricity Subsector 27. The electricity subsector is regulated by ME through the Director General of Electric Power and New Energy. The subsector comprises: (a) PLN, the National Electricity Authority; (b) captive plants installed by private parties for their own use; (c) some small municipal franchises; and (d) a small number of cooperatives which were set up to provide electricity in certain rural areas remote from PLN supply systems. An electricity act was passed in 1985 (Law No. 15), consolidating earlier decrees, which permits private and cooperative franchise participation in the electricity subsector. The DCEP is the chairman of the supervisory board which oversees PLN's operations and reviews PLN's investment plans, budgets and tariffs.

15 PLN's Organization 28. PLN was established as a public corporation (Perum) under Presidential Decree No. 18 of 1972, with responsibility for the generation, transmission and distribution of electricity and the planning, construction and operation of electricity supply facilities. PLN is managed by a board of directors headed by a President Director, who is appointed by the President and is accountable to the Ministry of Mines and Energy. The President Director has authority for all day-to-day operations of PLN. The board currently includes five other directors with functional responsibility, respectively, for planning, construction, operations, finance and administration. Operational responsibility devolves to 17 regions, and responsibility for major construction to 14 project managers. Also reporting to the board are several staff units responsible for power research, education and training, and management services as well as an audit unit, called the Corporation Inspectorate, and a Java system operation and control unit. An engineering services unit was added in PLN's Facilities 29. PLN is the dominant entity in the electricity subsector. In 1985/86, it had 5,240 MW of installed generation capacity--1,680 MW of steam (oil-fired), 800 MW of steam (coal-fired), 930 MW of gas turbines, 740 MW of diesel, 1,060 MW of hydroelectric and 30 MW of geothermal. PLN also operates over 11,600 km of transmission lines at 70, 150 and 500 kv and about 86,000 km of distribution lines. Sector Development issues, Objectives and Strategy 30. Since oil has been Indonesia's major export commodity, the major thrust of the Government's energy policy has been to maintain the level of export earnings by diversifying domestic consumption away from oil to alternative and more economic energy resources such as coal, hydropower, geothermal and gas. The Government's strategy is to use the electricity sector as the principal agent for implementing this policy. The Government's other major objectives are to increase the welfare of the population by increasing the proportion of electrified households from the current low level of about 14X to about 40Z over the next 10 years, and to support economic development through the supply of electricity to productive users in urban and rural areas. Extending the supply of electricity will also help to reduce oil consumption by substituting electricity for kerosene and diesel oil in applications where electricity is more economical. Currently, in support of these objectives, PLN has formulated a 10-year investment program amounting to about US$15 billion equivalent. Captive Generation 31. Due to nonavailability of electricity supply from the grid, a large number of industrial and commercial establishments produce electricity for their own use. The growth of this "captive" power was very rapid in the 1970s, and their installed capacity is comparable to the generating capacity of PLN. Since the captive power generation is largely diesel-based and gener-

16 ally more expensive than P1N's supply, government policy supports the replacemeat of uneconomic captive generation sources by PLN's supply as rapidly as PLN's grid can be extended to these sources, and to license new captive plants only when they are economically efficient or where PLN cannot supply. Pricing 32. Following the increases in international oil prices in the 1970s, petroleum products in Indonesia were highly subsidized. However, the Covernment has moved rapidly to remove the subsidies in the past four years. After a total increase of about 225X since December 1981, the weighted average of domestic prices of petroleum fuels in September 1986 was slightly above the average international price, although the kerosene price remained at about 75% of the international level. Electricity prices have been increased by about 130% since 1981, resulting in the current average price of about 96.0 Rp/kWh, which was equivalent to about USC8.5/kWh prior to the devaluation in September 1986 and which now amounts to about USC5.8/kWh. Mainly because of the devaluation, adjustments are needed to fully reflect the long-run marginal cost of supply both in the level and structure of PLN's tariffs. The proposed project would address this need (para. 73). Institutions and Manpower 33. Weak institutions and scarcity of trained manpower continue to constrain rapid and efficient implementation of the energy strategy in spite of the progress that has been achieved. In the electricity subsector, PLN has made considerable progress not only in achieving a rapid expansion (its sales grew by over 300% in the 10-year period 1974/75 to 1984/85), but also in preparing for an even larger program in the future. The Fourth Five-Year plan (1984/85 to 1988/89) had set a target of increasing PLN's sales by 15OX, from about 10,000 GWh in 1983/84 to about 25,000 GWh in 1988/89. These targets have since been scaled down in view of the deteriorating economic environment and financial constraints. The sales target for 1988/89 is now about 19,000 GCh. To meet even this reduced goal, PLN needs to implement and operate projects and systems of growing size and increasing technical and managerial complexity. PLN also needs to continuously enhance and improve its capabilities in all areas of management to manage such rapid growth. Special emphasis on project management, engineering, finance and accounts, and manpower development are needed. Also, PLN needs to strengthen its capacity to efficiently operate and maintain the increasingly complex facilities currently being constructed as well as those planned for the future. Import Substitution 34. The electricity industry is capital intensive with high import requirements. About 60% of PLN's total proposed investment in the 10-year period from 1984/85 to 1993/94 is expected to be in foreign exchange and to amount to over US$10 billion equivalent. To help reduce the import content of the program, the Government has been promoting, inter alia, increased use of local consultants for engineering, and increased domestic manufacturing of selected equipment. The implications of this policy for PLN are twofold. First, it needs to strengthen its engineering capability to supervise and

17 guide the work of consultants, and secondly, it needs to develop its Testing and Research Center to undertake a program of product testing, quality control and guidance to local manufacturers, for the products for which it is a dominant purchaser. Bank Role and Strategy 35. The Bank has been actively involved in developing and implementing most of the sectoral objectives described above. In 1981, the Bank carried out a study of energy sector issues and prepared a report entitled "Indonesia: Issues and Options in the Energy Sector". The report confirmed that alternatives for oil must be developed quickly for electricity generation and recommended that this strategy should be extended to other sectors such as industry, transportation and households. It emphasized the need for efficient pricing, stronger institutions and manpower development as major objectives. In support of its ongoing dialogue with the Government on the pricing of energy products, the Bank prepared a report entitled "Indonesia: Selected Issues of Energy Pricing Policy" in Actions of the Government on the pricing of petroleum products and electricity in the past three years have now eliminated net subsidies. In October 1984, the Bank carried out a detailed review of PLN's investment program for the ten-year period from 1984/85 to 1993/94. The findings supported the general direction of the plans but suggested a scaling down of the programs and some measures for improving investment efficiency. These findings, which were accepted by the Government, were presented in the Bank report "Indonesia Power Sector Investment Review" in Also, a Bank mission studied the possible measures to improve the operational efficiency of thermal and hydra plants and the maintenance of diesel plants, and presented its findings in a report entitled "Indonesia: Power Generation Efficiency Study" in The Government and PLN have accepted the recommendations of these reports. In addition, the Bank reviewed the rural electrification program in Indonesia and presented its findings in a report in November 1986, entitled "Indonesia: Rural Electrification Review." An Energy Options Study is currently being carried out which will assist the Government in formulating a strategy for the development and use of primary fuels. 36. The Bank is also financing considerable technical assistance for institutional development in the energy sector, including support to PLN in such important areas as project management, planning, power market survey, hydro survey, accounting, manpower development and training. Furthermore, in the coal subsector, various steps are being initiated for institutional and manpower development under two Bank-assisted projects: the Bukit Asam Coal Mining Development and Transportation Project (Loan 2079-IND) and the Coal ExpLoration Engineering Project (Loan 2153-IND). In the gas subsector, a study on liquified petroleum gas (LPC) was financed under Credit 898-IND and an energy pricing study is being financed under a Bank loan for the Gas Distribution Project (Loan 2690-IND). 37. The Bank's involvement with the electricity subsector in Indonesia has gone through two distinct phases and has now entered the third and most crucial phase. In the first phase ( ), the Bank's work was directed towards creating an autonomous national entity to deal with the sectoral

18 problams and, after PLN's creation in 1972, to heln put in place procedures and systems to manage and improve its then small-scale operations. In the second phase ( ), the primary thrust of the Bank's work has been to assist PLN to rapidly expand its supply facilities (sales increased 122Z in the period) and, coupled with efforts to evolve integrated grids (particularly in Java), to take full advantage of advanced technologies to reduce supply costs. The fruits of this effort are expected to be reaped in the period with the commissioning of large power plants at Suralaya (1,600 MW), Saguling (700 MW), and Cirata (500 MW), with an overlay of a 500-kV transmission grid. The costs of electricity supply are expected to drop significantly in real terms during this period. The current phase of the Bank's involvement is focused partly on contributing to the financing of Indonesia's massive power programs to meet its development needs, and more so, to build on the foundations laid in the second phase to transform PLN into a modern and mature utility like others in the region through a major emphasis on institutional objectives. These include greater financial autonomy, better operating efficiencies, and improved engineering and research capabilities. The proposed project addresses these concerns and would provide technical assistance, inter alia, for the efficiency improvement measures. Suitable efficiency improvement measures have been agreed with PLN. Action plans have been formulated and their implementation would be monitored (paras. 53 and 70). Earlier Bank Group Operations and PLN's Performance 38. Since 1969, the Bank Group has provided US$2,083 million for power generation, transmission and distribution facilities through 14 separate projects. Four distribution projects (Credits 165-IND and 334-IND, and Loans 1259-IND and 2056-IND) rehabilitated and expanded distribution facilities in the greater Jakarta area. Ten power projects (Credit 399-IND and Loans 1127-IND, 1365-IND, 1513-IND, 1708-IND, 1872-IND, 1950-IND, 2214-IND, 2300-IND and 2443-IND) assisted PLN to expand electricity generation capacity in Java, to provide a strong all-java 500-kV grid, to extend distribution facilities in Java, to reduce system transmission and distribution losses, and to introduce a program of mini hydro development in Sumatra. Project Performance Audit Reports (PPARs) on the first six projects (Credits 165-IND, 334-IND, 399-IND and Loans ll27-ind, 1259-IND, and 1365-IND) have been issued and the lessons learned from these operations are being applied to subsequent operations. They relate mainly to the need for timely appointment of consultants, and delays in procurement and constiuction. 39. PLN's implementation capacity has grown substantially since the Bank's early association with it. All Bank-financed projects have been or are being implemented as desigrned and generally within the estimated cost. However, delays of the order of six months to two years in implementation have been experienced compared to the appraisal estimates. The growing size and complexity of the projects, coupled with cumbersome procedures for the appointment of consultants, award of contracts, opening of letters of credit, and budget approvals, have been responsible for most of the delays. Implementation schedules for Bank-financed projects, however, have generally been optimized to international standards with little slack to accommodate the delays which can occur in a still-maturing utility like PLN. Moreover, steps

19 are being taken at the entity and national level to streamline budgeting and procurement procedures. PART IV - THE PROJECT 40. Feasibility studies for the transmission expansion in Java were funded under the Sixth Power Project (Loan 1365-IND) and were completed in The feasibility studies for the expansion of distribution facilities in the Jakarta, Bogor, Tangerang and Bekasi (Jabotabek) area were completed in 1980, for the period up to PLN updated both these studies and presented them to the Bank in October Bank missions appraised the project in December 1984 and updated the appraisal in September l9b6. Negotiations were held in Washington from November 20 to November 24, The Indonesian delegation was led by Dr. Arismunander, Director General of Electric Power and New Energy, Ministry of Mines and Energy. A Staff Appraisal Report (No IND) is being distributed separately. Supplementary project data are given in Annex III. Project Objectives and Scope 41. The proposed project would support the Government's objectives to promote productive activities and to improve the welfare of the population through the provision of electric power, and also to improve the economic and technical efficiency of energy supply and use. The extension of the network would enable PLN to supply electricity to currently unelectrified areas to serve residential, commercial and industrial consumers. In Java, the waiting lists of industrial consumers alone amount to over 500 MW. Extension of PLN's supply would also reduce the growth of uneconomic captive generation and help to reduce oil consumption. In addition, by ensuring that the investments in transmission and distribution during the next three to four years proceed at the desired level, the project would help to reduce the cost of electricity by optimizing the productivity of ongoing investments in generation projects. 42. The project would also help to further strengthen PLN. The project would improve PLN's engineering capability by providing technical assistance for strengthening the new Engineering Services Center, and thereby promote more efficient use of scarce engineering talent. PLN's Testing and Research Center would also be equipped for an expanded role in the testing and certifying of indigenously produced equipment. In addition, the project would help to strengthen PLN's financial position by ensuring continued attention to measures necessary to achieve this objective, including tariff adjustments and technical assistance for efficiency improvements. Finally, the project would support detailed engineering of the proposed coal-fired power plant at Paiton in East Java, which is the next important step in the Governmentts energy diversification strategy. Rationale for Bank Involvement 43. The Bank strongly supports the Government's objectives in the power sector and has played a major role through 14 projects since 1969 in helping to build PLN into an autonomous power utility capable of meeting the demands imposed by a large and sustained investment program. At this juncture, given Indonesia's tight resource constraints, the Bank considers it of particular

20 importance to work with PLN to further improve its capacity to manage the expanded system efficiently and to draw the greatest benefits possible from both the proposed expansion and PLN's existing assets. Project Description 44. The proposed project would comprise: (a) construction of 150-kV and 70-kV transmission lines in Java; and substations (b) construction of 20-kV and 220/380-V distribution facilities in the Jakarta, Bogor, Tangerang and Bekasi areas (Jabotabek); (c) equipment for PLN's Testing and Research Center; and (d) consulting services for: Ci) efficiency improvement measures; (ii) engineering of the Paiton steam power plant in East Java; and iii) development of PLN's Engineering Services Center. 45. Transmission and Distribution. In 1981, using funds from the Sixth Power Project (Loan 1365-IND), Beca Worley International of New Zealand reviewed the development requirements for the transmission and distribution program for the period up to Their report, dated April 1982, identified additional requirements which have resulted in several projects financed by the Overseas Economic Cooperation Fund (Japan), the Federal Republic of Germany, the Asian Development Bank, and export credits. PLN has carried out further studies to define the total required program of transmission and substation development in Java up to 1990, to match the ongoing program of generating capacity additions in the same period, which amount to over 1,800 MW. A review of the ongoing transmission projects with respect to the required program has identified the balance of requirements for Java, which are proposed for financing in this project. 46. The distribution component of the project covers the requirements for the expansion of distribution facilities in the Jakarta, Bogor, Tangerang and Bekasi (Jabotabek) areas up to the middle of The studies for identifying these requirements were carried out by PLN, following up on the studies carried out by SOFRELEC of France in 1979/80, to identify requirements up to The scope of the transmission lines component of the project, in terms of physical construction, involves about 174 km of 150-kV lines, 229 km of 70-kV lines and 49 km of 150-kV underground cables. The quantities of substation equipment covered by the project include about 1,410 MVA of stepdown transformers, materials [or 136 switching bays at 150 kv and 70 kv, 393 units of 20-kV switchgear and 25 new substations. The distribution component includes construction of about 1,406 km of 20-kV lines, 2,417 km of

21 V lines, 1,505 stepdown substations and 254,000 service entrances. To improve the utilization of stepdown transformers at 150-kV and 70-kV substa'tions included in the project, PLN would carry out a comprehensive transformer relocation program to suit the project impleir.etation schedule. 48. In view of the difficulties experienced in the past with the acquisition of land for substations and rights-of-way for the ctransmission lines, advance action has been initiated in this project. Out of chea 25 new substations proposed to be constructed, Land has already bee! plirchllsed for 10 locations. Acquisition of land for the remaining lcatiolns would be completed by June Surveys and inventories for tran.mins.lou lines in East and Central Java have been completed, while the remainit. slucetys and inventories would be completed by October Compensaa:ion For a;ll rightsof-way is scheduled to be completed by March Due to long Lead times for procurement of transmls; itol tines and substation equipment, PLN has encountered difficulties in respoatding quickly to requests from industrial consumers for supply of power in arena requiring installation of new 150-kV or 70-kV substations. As a result, irndulstries sometimes find it necessary to purchase their own generating, equipnn.-nt, mostly diesel plants, even though it may be uneconomic to do so. In order to respond to such situations, the project allows flexibility for PLN to meet urgent needs for power supply to consumers at locations which may not be covered by the currently envisaged list of substations. Moreover, the proposed transmission Lines and substations in the project have been derived on the basis of the current expectation of demand growth in different areas in Java, which could change, requiring alteration to the physical plans for lines and substations. PLN has already standardized the transmission lines and substation designs, which will permit changes in the program to be made without difficulty. The project cost estimate therefore provides physical contingencies of 10% to permit variations in the required quantities of materials. PLN has agreed to review annually, beginning December 31, 1987, the plan for substations and transmission lines included in the project in order to identify any necessary changes. PLN would subsequently reflect these changes in the plan in a manner satisfactory to the Bank. 50. Testing and Research Center. PLN's Testing and Research Center is responsible for the testing of electrical power equipment, including certification of Local products and assistance to the power equipment industry, as well as applied research on problems relevant to PLN's operations. Studies have been carried out with French assistance to prepare a master plan for the development of the Center for the next 15 years. The project provides for a part of the funds needed for the first five-year period, primarily for the purchase of additional equipment for existing laboratories, to enable them to augment and modernize the test facilities. 51. Consulting Services. Funds for commencing the design and detailed engineering for a thermal power plant in East Java (at Paiton) were provided in the Eleventh and Thirteenth Power Projects (Loans 2056-iND and 2300-IND). Consultants have been appointed following Bank guidelines. They have now completed the design work and specifications for turbine generators and steam generators, and other major components. The project would finance an exten-

22 sion of their services for procurement, post contract engineering and contracts coordination work involving about 250 man-months of effort over about a one-year period starting in early As agreed under the Fourteenth Power Project (Loan 2443-IND), PLN has established an Engineering Services Center to integrate expertise and optimize use of scarce manpower in project formulation, engineering and implementation. PLN has now proposed to employ the services of a consulting engineering firm to help in the development of the center. The proposed project provides for such services, amounting to about 500 man-months spread over a period of about three years. Terms of reference for the services and shortlist of consultants were agreed with the Bank and proposals from the consultants have been received and are being evaluated. The appointment of consultants is expected to be completed by March 31, The project also provides for technical assistance to enable PLN to formulate in detail and carry out certain efficiency improvement measures (para. 70) including: (a) renovation of hydro-plants at Plengan, Ketenger, Lamajan and Jelok in Java; (b) improvement in the availability factor of the Suralaya coal-fired thermal plant; (c) improvement of the data base for distribution systems, including detailed mapping; and (d) training. The assistance may be in the form of individual experts or consulting firms to be selected in accordance with the Bank's guidelines. These would be carried out in 1987 and 1988 and would amount to about [50 man-months of consultant services. Project Cost and Financing Plan 54. The total cost of the project including the physical and price contingencies is estimated at about US$366.2 million equivalent, of which about US$240.2 million (66%) is in foreign exchange. Costs are inclusive of taxes and duties estimated to be about $9.7 million. All costs are based on December 1986 prices and physical contingencies average about 7.7% of the base cost. The price contingencies, which amount to about 10.8% of the base cost plus physical contingencies, are based on: (i) domestic inflation rates of 10% in 1987, 5% in 1988, and 3.5% in 1989 and thereafter; and (ii) international inflation rates of 3.0% in 1987, 1.0% p.a. in , and 3.5% in 1991 and thereafter. Total financing required for the project is estimaled at US$386.2 million (including interest during construction of about US$20.0 million), of which about US$260.2 million (67%) is in foreign exchange. 55. The proposed Bank loan of US$226.0 million would cover about 59% of the total financing requirements of the project, including 87% of the foreign exchange component. The Government and PLN are in the process of finalizing arrangements for financial assistance from the Government of the Federal Republic of Germany to cover the foreign exchange cost, estimated at about $14.2 million, of goods and services required for the construction of transmission lines and substations in Central Java. The Bank Loan would be extended to the Government for 20 years, including five years of grace, at the Bank's standard variable interest rate. The Government would onlend the proceeds of the loan to PLN with the same amortization and grace periods at an interest rate equal to the Bank's standard variable interest rate plus no less

23 than a quarter percent for administration charges. The Government would bear the foreign exchange risk. The onlending to PLN would be made under a subsidiary loan agreement, satisfactory to the Bank. The signing of the subsidiary loan agreement would be a condition of loan effectiveness. The Government and PLN would finance the local costs, including taxes and duties, and interest during construction. Procurement and Disbursement 56. Except for concrete poles which would be procured by local competitive bidding, all equipment financed under the Bank loan would be procured by International Competitive Bidding (ICB) procedures in accordance with the Bank's procurement guidelines. Qualifying domestic manufacturers would receive a preference in bid evaluation of 15% of the CIF price or the applicable import duty, whichever is lower. The Bank-financed items will include: (a) transmission towers, conductors, insulators, and accessories; (b) transformers; (c) 150 kv cables; (d) 150 kw, 70 kv and 20 kv switchgear, control cables and accessories; (e) substation equipment; (f) distribution materials; (g) concrete poles; and Ch) consulting services. Consultants would he engaged in accordance with Bank guidelines. All bidding packages for goods financed by the Bank and estimated to cost over US$1.0 million equivalent would be subject to the Bank's prior review of procurement documents, which is expected to cover all Bank-financed contracts. 57. The Bank loan would be disbursed against: (a) 100% of foreign expenditures for directly imported equipment and materials; (b) 100% of ex-factory expenditures for locally manufactured items; (c) 70% of local expenditures for other items procured locally (ex-shelf);(d) 80% of local expenditures (ex-factory cost) for concrete poles; and (e) 80% of local expenditures for the services of local consultants and 100% of foreign expenditures for the services of other consultants. All disbursements would be on the basis of full documentation. No disbursements would be made for expenditures prior to loan signing. Loan disbursement is expected to be completed by June 30, The disbursement period has been estimated taking into account the advanced state of preparation of the project and the Bank's past experience with similar projects. Project Implementation 58. PLN would have overall responsibility for implementing the project. PLN has car.ied out the feasibility studies for the transmission lines and substations, completed most of the preliminary survey and design work, and prepared tender documents. Consultants have been selected for assisting PLN in tender evaluation, contract negotiations, post-contract engineering work and construction management of the project. The total work is divided between three local consulting firms, each assisted by a foreign consultant. These arrangements have been accepted by the Bank and the work is being financed under the Fourteenth Power Project (Loan 2h43-IND). The engineering and construction of the distribution component of the project would be carried out by PLN's own distribution staff. The staff in the Jabotabek area is already implementing the ongoing program for the expansion of the distribution network (under the Eleventh Power Project, Loan 2056-IND) and is sufficiently

24 experienced for the proposed program. ALL procurement would be carried out by PLN's staff at its head office. Since there were considerable delays in the procurement cycle in the Eleventh Power Project (Loan 2056-IND) and in the Fourteenth Power Project (Loan 2443-IND), which resulted in delays in implementation and disbursements, both the Government and PLN plan to implement an action program to complete all contract awards by October The construction of the transmission lines and substations is expected to be completed by the end of 1991 and the distribution equipment is planned to be installed by the middle of Project implementation is expected to be completed in all respects by December 31, Institutional Aspects 60. Over the past ten years, PLY has grown impressively to become the largest utility in the country. Inevitably, such a rate of growth has been attained at the cost of considerable strain on PLN's management. Key areas in which a need for strengthening has been recognized as a condition of maintaining the growth are planning, project management, management information systems, efficiency improvement, manpower development, and accounting and budgeting. 61. In all of these areas appropriate technical assistance has been devised in consultation with the Bank, and in most cases supported with Bank funds. For its overall planning activities, PLN established a corporate planning unit in 1981 and a market survey unit in The Government has recently set up a new planning directorate in MME which would establish procedures to ensure coordination of the relevant agencies in providing policy guidance and in reviewing and approving the demand forecasts prepared by PLN's power market survey group. PLN has also, as agreed in the context of past projects, begun to prepare a rolling ten-year financial forecast and financing plan based on its long-term investment program (para. 67). Both operational and financial objectives were elaborated in PLN's five-year corporate plan, approved by its Board in November PLN's manpower development and planning needs have been addressed under a number of Bank-supported projects. Of particular note is the Twelfth Power Project (Loan 2214-IND), which includes a major training component focussed on reorganizing and enlarging PLN's manpower planning, training and personnel management functions for middle- and lower-level staff. Special attention is also being given to the training needs of PLN's accounting and auditing staff. 62. In the project management area, the Eighth Power Project (Loan IND) included technical assistance which specifically addressed all aspects of project management. The recommended project cost and progress reporting system has been implemented. The Bank has also assisted PLN in developing an integrated management information system, including improved accounting and financial management information systems. In all of these efforts, the assignment of local counterpart staff has been emphasized in order to ensure the transfer of know-how and effective maintenance of the systems by local staff once the systems are installed for operation. Finally, to strengthen PLN's engineering capabilities, as agreed under the Fourteenth Power Project (Loan 2443-IND), PLN has established an Engineering Services Center (para. 52)

25 to unify project formulation, engineering, design, procurement and construction monitoring. Thus, while much remains to be done in terms of institutional development, considerable programs is being made through a wide range of initiatives. Long-Term Development Plan 63. PLN follows a practice of preparing a long-term development plan to cover the projected requirements of generation, transmission, distribution and other facilities. The latest plan, covering the development period 1985/86 to 1993/94, shows generating capacity increasing from about 5,240 KW in 1985/86 to over 10,000 MW in 1993/94. The major growth would be achieved by the construction of coal-fired thermal, hydro and geothermal plants, reducing the share of oil-based electricity generation from the current level of about 66% to about 40% in 1993/94. It is a balanced program which support. a vital part of the Government's objective of reducing the domestic usage of oil. While PLN appears capable of implementing such a program, a major constraint may develop in mobilizing the required finances if the Indonesian economy does not improve within the next two or three years. 64. In order to ensure soundness of the overall development program, the Bank has made the following agreements with the Government and PLN, which would be continued under the proposed project: (i) the Covernment would review annually with the Bank and PLN, PLN's development plan and associated financial forecast and financing plan, and would take appropriate measures to facilitate PLN's access to required finance; (ii) the Government would, through PLN, review annually with the Bank, in particular, potential changes in the load growth for electric power on Java and any adjustment which may be required in PLN's development plan to accommodate these changes; (iii) the Government and PLN would review annually with the Bank, PLN's proposed investment budget for the following year in order to enable the Bank to express its views on the priorities reflected in the budget and on the balance among the generation, transmission and distribution investment; and (iv) PLN would prepare and furnish to the Bank annually for review its proposed customer connection program, and thereafter implement the program. Financial Performance 65. Concurrent with PLN's incorporatlon in 1972, measures were taken with the support of the Bank Croup to establish a sound financial basis for the organization, and to eliminate the operating losses which were then being incurred. This was achieved by During the period 1982/83 through 1986/87. PLN is expected to have self-financed about 19X of its capital investment program, mainly from depreciation and consumers' contributions. The government equity contribution accounts for about 35% of the program, and the major source of funding has been borrowing, which corresponds to about 46% of the program. As a result of this mix of funding, PLN's debt/equity ratio is still low at about 40/60 estimated for 1986/87, and its debt service coverage ratio exceeds the required 1.5. Its latest balance sheet ( unaudited) shows a healthy current ratio of 2.1 and substantial liquidity.

26 Since May 1980, tariff. have been adjusted upwards four times, with the last much adjustment being in March The magnitudes of these tariff adjustments have been inadequate to cover cost increases other than the oil price impact on PLU's fuel bills, and they have also lagged behind the fuel price.ncreaseu. PLN's not income, therefore, declined steadily after 1980/81 and remained negative (on a revalued asuets basis) through 1985/86, and this trend is expected to continue in 1986/87. Howeverp with depreciation, consumers' contributions, and lower than expected capital expenditures, PLN was able to meet until 1985/86, the indicative targets of a solf-financing ratio (SFR) required or projected under previous Bank inns. The Government, in the past, provided PLN with substantial funding, mainly in the form of equity. Although PLN is authorized by its charter to borrow from local and foreign lenders and to issue its own obligations, the Covernment in practice secures all foreign borrowings on behalf of PLN and bears all foreign exchange risks. Due to growing budgetary constraints facing the Government, foreign borrowings through onlending arrangements have become increasingly important. In addition, the Covernment is allowing PLY to borrow from governmentowned banks at subsidized interest rates to finance its local cost investment expenditures. 67. Given the size of PLN's planned capital expenditures and the resource constraints faced by the country in the near term, PLN's long-term objective is to minimize government equity funding, increase the level of self-financing, and fill financin gaps by substantially increasing both foreign and local borrowings. As agreed under earlier Bank loans, PLN has begun to prepare a rolling ten-year financial forecast based on its proposed development program and also a financing plan for the first five years, as part of its corforate planning procedures. The financial forecast and financing plan ate adopted by PLN's Board and discissed with the Government and the Bank. These practices would be continued under the proposed project. 68. During the past three years, PLN has initiated various measures to improve its operational efficiency and reduce costs. These measures, along with a 10% rrduction in July 1986 of the prices of industrial fuel oils (the impact of which was offset partially by a simultaneous reduction of about 6% in the electricity tariff for industrial consumers), have helped to improve PLN's operating ratio. Its financial rate of return (ROR) is estimated to be about 0.5Z in 1986/87, compared to -0.2% in 1985/86 and -0.9% in 1983/84. The SFR for 1986/87 would, however, be at a level of about 15%, compared to 20% in 1985/86 and 22% in 1983/84. This decline is mainly because debt service payments would absorb a larger share of the internally generated funds, as repayments on some of the onlent foreign loans have now started. The improvement in PLN's operating ratio during the last 2-3 years, however, is marginal. PLN is not able to satisfy the revenue covenant adopted under the Fourteenth Power Project (Loan 2443-IND) in 1984, which requires it to achieve a ROR of not less than 6% in 1985/86, and annual RORs of not less than 8% in the fiscal years thereafter. For PLN to have achieved the covenanted RORs for 1985/86 and 1986/87, tariffs would have to have been increased by about 13% at the beginning of 1985/86, and by about 52 in 1986/87. The Government, however, did not permit any tariff increase, as it considered a tariff increase would have reduced the pressure on PLN to improve its efficiency. The Government also considered that PLN's financial performance needed to be evaluated in a

27 broader context because of the inherent differences among its regional operations. Financial Performance Monitoring 69. The Government, PLN and the Hank have reviewed jointly whether the revenue covenant currently applicable to PLM, is appropriate for PLN's operations as a whole and whether PLN realistically can be expected to achieve the * financial o',jectives underlying the covenant. PLN's operations in Java, which account fvr about 801 of its total energy sales, are profitable. These operations, vnich include Large central power stations which supply electricity through an interconnected grid system, are at a scale which is reaching a level comparable to, and have conditions which are similar to, those prevailing in other large utilities in the region. By most standards, PLN's operations in Java are considered well established and sufficiently commercially oriented to warrant their performance to be measured by normal utility yardsticks. PLN's operations outside Java, however, differ substantially from those in Java, and are highly unprofitable. These are small-scale operations based largely on diesel which are dispersed over a large number of islands, and encompass over 600 separate power generation and supply networks. These networks have a high cost of energy generation. This, coupled with isolated load centers, limited demand and high transmission and distribution losses, results in high overall energy supply costs. Moreover, PLN carries out at the Government's direction, both inside and outside Java, a variety of socially oriented operations, such as its rural electrification programs which are not of a coumercial nature. These noncommercial activities comprise a major portion of PLN's operations outside Java and have a significant adverse impact on PLN's overall finances. PLN is not able to set a tariff outside Java which is higher than in Java because the Government considers a countrywide uniform tariff to be desirable to meet social and regional development objectives. The Government and PLN, however, recognize that over a period of time these operations should become self-sustaining and eventually profitable. 70. As a means for improving its overall operating performance, PLN has agreed to carry out, in consultation with the Bank, action plans: (a) for controlling and reducing system losses in its 1986/87 and thereafter; and (b) for efficiency improvements for all its operations, including detailed, monitorable targets for its operations outside Java. These improvements are, however, not expected to alter significantly in the medium term the operational differences between PLN's operations in Java and those outside Java. The Government, PLN and the Bank have therefore agreed that PLN should adopt separate financial nerformance targets for the two types of operations, where the operations in Java would be expected to earn annual RORs commensurate with the nature of these operations, and the operations outside Java would progressively achieve a break-even situation within the next five years. Agreements have been reached that: (a) PLN would take all measures required to realize for its Java operations, no later than in 1988/89 and in each fiscal year thereafter, an annual ROR of not less than 8%; and (b) PLN would take all measures required with respect to its non-java operations to produce for each fiscal year after 1989/90 total revenues equivalent to not Less than the sum of: (i) total operating expenses for non-java operations; and (ii) the amount by which debt service requirements for non-java operations exceed the