Progress Report on the Second Tranche Release. Program Number: Loan Number: 2038 November Bangladesh: Power Sector Development Program

Transcription

1 Progress Report on the Second Tranche Release Program Number: Loan Number: 2038 November 2005 Bangladesh: Power Sector Development Program

2 CURRENCY EQUIVALENTS (as of 2 November 2005) Currency Unit taka (Tk) Tk1.00 = $ $1.00 = Tk ABBREVIATIONS ADB Asian Development Bank BERC BOO Bangladesh Energy Regulatory Commission build-own-operate BPDB Bangladesh Power Development Board DESA DESCO Dhaka Electric Supply Authority Dhaka Electric Supply Company Limited EGCB Electricity Generation Company of Bangladesh Limited ERD Economic Relations Division of the Government of Bangladesh MOF Ministry of Finance MPEMR Ministry of Power, Energy, and Mineral Resources NLDC national load dispatch center RPC Rural Power Company Limited PGCB Power Grid Company of Bangladesh Limited PSDP Power Sector Development Program PSOD Private Sector Operations Department of ADB PSRB Power Sector Reforms in Bangladesh REB Rural Electrification Board RPCL Rural Power Company Limited USAID United States Agency for International Development WEIGHTS AND MEASURES kwh (kilowatt-hour) 1,000 watt-hours MW (megawatt) 1,000,000 watts NOTES (i) (ii) The fiscal year (FY) of the Government ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends. For example, FY2005 begins on 1 July 2005 and ends on 30 June In this report, "$" refers to US dollars.

3 CONTENTS Page I. INTRODUCTION 1 II. POWER SECTOR REFORMS IN BANGLADESH 1 III. PROGRESS OF PROGRAM IMPLEMENTATION A. Enhancing the Financial Health of Sector Entities 3 B. Launching and Making Operational the Energy Regulatory Commission 5 C. Optimizing Generation Costs 5 D. Institutional Reorganization of Sector Entities 6 IV. STATUS OF SECOND TRANCHE CONDITIONS A. Status of Tranche Conditions 7 B. Status of Nontranche Conditions 10 V. CONCLUSION 11 V. THE PRESIDENT S DECISION 11 APPENDIES 1. Policy Matrix for Release of Tranches Status of Compliance with Loan Covenants 15

4 I. INTRODUCTION 1. On 10 December 2003, the Asian Development Bank (ADB) approved two loans to the People s Republic of Bangladesh for the Power Sector Development Program (PSDP), one a program loan (the Program) of $100 million, and the other a project loan of $186 million, both to be financed from ADB s ordinary capital resources. 1 The loan agreements were signed on 18 December 2003, and the loans became effective on 2 August The Program was to provide support and incentives to the Government of Bangladesh (the Government) for power sector reform activities mainly through financial stabilization of sector entities and their improved governance. These reform activities include (i) enhancing the financial health of two major transmission and distribution companies, namely Power Grid Company of Bangladesh Limited (PGCB) and Dhaka Electric Supply Company Limited (DESCO), and to some extent the Bangladesh Power Development Board (BPDB), Dhaka Electric Supply Authority (DESA), and Rural Electrification Board; (ii) launching and making operational the Bangladesh Energy Regulatory Commission (BERC); (iii) optimizing generation costs on a national basis; and (iv) restructuring of power sector entities. 3. The project loan is linked to the ongoing power sector reforms and will (i) expand peak load generation capacity at Siddhirganj to reduce load shedding, (ii) introduce competition in generation by investing in a new National Load Dispatch Center, (iii) enhance network reliability, and (iv) increase access to electricity services in urban and rural areas of northwestern Bangladesh. 4. The entire exercise of the PSDP will support economic growth of the country and gradually relieve the Government of financially supporting the sector. The combination of higher economic growth and the shift in public expenditure to social sectors will contribute to reducing poverty. 5. Under the Program, two tranches of $50 million each have been linked to sequenced policy reform targets. The first tranche was released on 11 August 2004 upon compliance by the Government and the sector entities with the conditions for its release. The first tranche conditions involved the (i) restoration of financial health of sector entities, (ii) launch of BERC, (iii) adoption and notification of a grid code, (iv) establishment of a competitive regime for electricity dispatch and transmission billing, and (v) issuance of a tax-free bond by PGCB. The release of the second tranche was expected by December The loan, originally scheduled to close on 30 June 2005, has been extended to 31 December II. POWER SECTOR REFORMS IN BANGLADESH 6. The power sector in Bangladesh performed poorly through the late 1980s and early 1990s. The major constraints in the sector were (i) the lack of institutional capability, (ii) the unavailability of long-term domestic capital for financing investments, (iii) limited foreign 1 ADB Report and Recommendation of the President to the Board of Directors on Proposed Loans to the People s Republic of Bangladesh for the Power Sector Development Program. Manila.

5 2 exchange debt service capability in the economy, (iv) poor management systems and procedures, (v) low employee commitment, and (vi) institutional weaknesses in governance. 7. Recognizing the need to improve the performance of the power sector, the Government adopted a policy paper titled Power Sector Reforms in Bangladesh (PSRB) in 1994 in consultation with the major development partners 2 in the power sector. PSRB envisions, in the long term, a structure of the power sector based on (i) the separation of sector regulation and operation; (ii) the autonomy and commercial orientation of the sector entities; (iii) unbundling generation, transmission, and distribution; and (iv) increased private sector participation. Under such a structure, transmission assets would remain in the public sector, while generation and distribution assets would have both public and private ownership. The objective of these initiatives is to eliminate monopolies and foster competition. Commercial discipline and good customer service are expected to be achieved through competition among entities in the power sector. 8. Under PSRB, the Government has made several achievements since 1994, including the (i) creation of a competitive, diverse market of independent public and private generation companies; (ii) restructuring of the sector by transferring all transmission assets and operations to a new transmission company, PGCB; and (iii) creation of competitive environment through the establishment of several sector entities including DESCO, Ashuganj Power Company Limited, Electricity Generation Company of Bangladesh Limited (EGCB), and West Zone Power Distribution Company Limited. 9. Despite some progress in reforming the power sector, Bangladesh s electrification ratio is still very low, providing access to electricity to only about a third of the population. Per capita generation is also very low, only about 155 kilowatt-hours (kwh) per capita per year, which is among the lowest rates in the world. The inadequate supply of electricity is a major constraint to economic growth in the country. Consumption of electricity in Bangladesh grew at an average annual rate of 8.2% from fiscal year (FY) 1994 to FY2004 and is forecast to grow at an annual rate of about 8% for the following 10 years. The current dependable generating capacity of the country is about 3,950 megawatts (MW). During FY2005, load shedding in the range of MW was resorted to on 287 days for a total duration of 1,433 hours. Bangladesh is facing an anticipated shortfall of about 2,500 MW of generating capacity over the next 5 years, which confirms the need to attract more domestic and foreign investment to meet demand. The Government envisions that this would be possible through implementing various sector reforms including those included in the Program. The passage in Parliament of the new Energy Regulatory Commission Act 2003 is a landmark event that is set to accelerate and consolidate the process of power sector reform. 2 ADB, World Bank, Department for International Development of the United Kingdom, Japan Bank for International Cooperation, Kreditanstalt für Wiederaufbau of Germany, and the United States Agency for International Development.

6 3 III. PROGRESS OF PROGRAM IMPLEMENTATION A. Enhancing the Financial Health of Sector Entities 10. Since the approval of the Program, the Government and power sector entities in Bangladesh have taken evident steps to enhance the financial health of the sector entities. The two major companies of the power sector, PGCB and DESCO, in particular have undertaken a number of reform measures to improve their financial position, such as (i) a change in billing procedures for wheeling charge from asset-based billing to energy-based billing, (ii) load balancing among different transformers, (iii) the expansion of computerized billing systems, and (iv) upgrading their power supply systems. PGCB and DESCO have now become financially sustainable companies and yielded a net profit before tax of Tk117 million and Tk338 million, respectively, in FY2004. In addition, through changes in the business environment and organizational set up under PSRB, the power sector entities achieved major improvements in their operational and financial performance. The overall system losses of the power sector entities were substantially reduced from 34.9% in FY1998 to 26.4% in FY2005. In the same period, average revenue collections against billings were also much improved from 85.6% to 95.8%. 11. The financial sustainability of the power sector entities was seriously jeopardized by an enormous amount of outstanding dues owed by the Government and its agencies. As of 30 June 2002, arrears owed by Government ministries were estimated to be about Tk3.30 billion, and those owed by the Government s autonomous and semi-autonomous bodies about Tk6.80 billion. 12. Aside from the establishment of special budgets and release of several tranches to settle the bills owed by Government agencies, a senior interministerial meeting held on 23 March 2005 concluded that (i) the Ministry of Finance (MOF) would arrange the allocation of additional funds for the Government ministries and divisions whose dues have been reconciled for settlement through a combination of cash payments and accounting adjustments against debt service liabilities; (ii) the power utilities, under the supervision of the Ministry of Power, Energy, and Mineral Resources (MPEMR), would continue to reconcile the outstanding dues and inform MOF of the results for settlement; (iii) in the future, outstanding dues should not exceed 3 months consumption, and all the Government ministries and divisions should ensure regular payments; and (iv) following settlement of all past dues, MPEMR would develop and implement a work plan to avoid accumulation of dues. 13. The Government also directed the power utilities to write off all surcharges billed to the Government agencies including those billed to its autonomous and semi-autonomous bodies. Consequent to implementation of the above decisions, the amount of outstanding dues owed by the Government ministries and divisions was substantially reduced to from about Tk3.3 billion in June 2002 to about Tk1.2 billion in June With regard to the arrears owed by the Government s autonomous and semiautonomous bodies, the Government achieved a major breakthrough by establishing a culture of accountability for electricity used by the Government s autonomous and semi-autonomous bodies. While most of these bodies pay current electricity bills, more than 80% of the outstanding dues are attributable to only four kinds of organizations, namely city corporations,

7 4 municipalities, the Dhaka Water and Sewage Authority, and Bangladesh Jute Mills Corporation. Especially city corporations and municipalities never paid electricity bills in the past, particularly for public use such as street lighting, traffic lights, and public markets. It is impractical for the power utilities to disconnect electricity supply for public use on account of nonpayment of bills. At the intervention of the Government, city corporations and the Dhaka Water and Sewage Authority have begun to pay the electricity bills in recent months. 15. To settle the outstanding bills, the power sector entities have first to reconcile the amount of outstanding dues with consumers, which is extremely difficult given that the outstanding dues have been accumulating for years, during which time records have been lost and organizations have changed. Therefore, a large portion of the outstanding dues claimed by the power utilities are in dispute, particularly those for the Government s autonomous and semiautonomous bodies. The senior interministerial meeting of 23 March 2005 concluded that (i) power utilities should make their best effort to reconcile outstanding dues with consumers; (ii) BPDB, DESA, and DESCO should reach a saddle point (that is, a fair compromise) regarding the old pending bills through writing them off and/or rescheduling them wherever practical; (iii) MPEMR should take action urgently to resolve the pending bills associated with city corporations for street lighting and traffic lights; and (iv) MPEMR should rigorously implement a work plan for the next 6 months to reduce the pending bills to within 3 months consumption. 16. The outstanding dues owed by the Government s autonomous and semi-autonomous bodies as of 30 June 2005 were reduced from about Tk6.8 billion in June 2002 to about Tk4.8 billion. They are expected to be further reduced upon implementation of the above decisions. 17. During the preparation of the Program, PGCB received a positive response from commercial banks regarding the possibility of raising funds through the issuance of bonds. If the bonds are successfully raised, they would mark the first direct commercial borrowing by the public part of the power sector in Bangladesh. As power utilities cannot be financially selfsustaining without a long-term bond market, and as raising capital through bonds reduces the Government s need to finance the sector, the Government desired that such a market be developed. On 30 March 2004, the Government gave its approval for PGCB to issue, in one or more tranches, 7 10 year tax-free bonds worth up to Tk2 billion to finance the local currency costs of constructing NLDC. This construction is to be carried out by PGCB under the project component of the PSDP. Following appointment of an issue manager in February 2004, PGCB decided to issue the bonds in four tranches of Tk500 million each, and the necessary steps for issuance are being taken. As the bidding process for NLDC is ongoing, the first tranche of bonds is expected to be issued in December 2005, in time for making an advance payment to the contractor. 18. Since DESA had incurred significant unrecovered losses, it was considered important to investigate the nature, causes, and extent of these losses due to nonpayment of electricity bills particularly by nonpublic consumers. For this purpose, DESA engaged an independent auditor on 30 June The independent auditor will carry out its tasks in accordance with the terms of reference endorsed by ADB and report in detail on, among other things, (i) policies and practices that have in the past resulted in the failure of power sector entities to collect payments for the provision of electricity; (ii) recommended mechanisms through which the Government may launch efforts to recover all or at least part of recovered past dues for electricity supply, and

8 5 (iii) recommended strategies for mitigating future losses, including ways of improving and preserving records on defaulters, and the extent of default amounts, which may expedite any required recovery in the future. 19. DESA engaged another independent auditor on 23 March 2005 to identify uncollected balance of accounts receivable in the Mirpur area prior to 1 September 1998, when the area was transferred from DESA to DESCO. If any are identified, they will be paid by MOF pursuant to the Government s letter to ADB dated 12 July B. Launching and Making Operational the Energy Regulator Commission 20. Under PSRB, a new regulatory authority was to be established for (i) setting electricity tariffs and determining the corresponding performance norms; (ii) collecting, verifying, and disseminating sector statistics; (iii) reviewing and approving long-term power planning; (iv) creating and maintaining a nondiscriminatory and commercial business environment in the sector; and (v) adjudicating disputes between sector entities. Following the passage in Parliament of the Energy Regulatory Commission Act 2003, the Government established BERC in March 2004 as an independent energy sector regulator. The Government appointed two members of BERC in April 2004, one of whom was the concurrent acting chairman pending the appointment of a full time chairman. As the Government appointed a full time chairman of BERC on 4 June 2005, BERC now meets the minimum quorum to meet and hold discussions. Appointment of the remaining two members is being undertaken after failures to find suitable candidates in earlier attempts. BERC moved to a new office building in February 2005 with financial assistance from the United States Agency for International Development (USAID). While BERC has yet to become fully functional, it has started its business as an independent regulator by issuing licenses to captive power generators and finalizing various rules and regulations with support from the consultants funded by USAID and the Government s budget allocations. USAID has been providing assistance for capacity building in BERC and is expected to provide continued assistance. C. Optimizing Generation Costs 21. The Government has endeavored to promote private sector participation in generation activities to optimize generation costs. As part of this effort, Rural Power Company Limited (RPCL) was incorporated in December 1994 as an independent power producer to construct a power plant at Mymensingh. ADB supported RPCL in the construction of a 70 MW power plant. RPCL successfully completed this plant and expanded its generating capacity to 140 MW by building another 70 MW power plant using domestic resources it mobilized. RPCL is now expanding its capacity to 210 MW. In 1996, BPDB awarded contracts for three barge-mounted power plants with a combined capacity of about 300 MW. In 1998, BPDB awarded a contract under a competitive bidding process to build on a build-own-operate-transfer basis Meghnaghat 1 Power Station with a generating capacity of 450 MW. BPDB awarded another contract in 1997 for the construction of a 360 MW power plant at Haripur. Successful completion of the Meghnaghat 1 and Haripur power stations reduced the cost of private power from Tk3.85/kWh in FY2000 to Tk2.87/kWh in FY2002 and further to Tk2.12/kWh in FY2003. Currently, independent power producers account for about 40% of total generation. 22. To further optimize generation costs, the Government planned to award a build-ownoperate-transfer contract to an independent power producer for the development and operation of the Meghnaghat 2 Power Plant with a generating capacity of 450 MW or more, subject to receipt of credible bids. Following the opening of financial proposals of the two technically

9 6 responsive bidders for the Meghnaghat 2 Project, the financial bid evaluation report was submitted to the Cabinet Committee on Government Purchases in January While reviewing the report, the committee noted a deviation regarding the qualifications of the lowest evaluated bidder and returned the report to MPEMR for clarification. The case was subsequently referred to the Cabinet Committee on Economic Affairs, which, on 26 June 2005, accepted the deviation in question. Pursuant to the approval of the Cabinet Committee on Government Purchases on 15 August 2005, BPDB issued the notice of award to the lowest bidder on 29 August The Program also seeks to optimize generation costs through establishing a competitive regime for electricity dispatch and improved efficiencies in grid operation by the adoption of a grid code. MPEMR issued a notification in the Bangladesh Gazette on 24 April 2004, adopting the principles of (i) a competitive dispatch regime for electricity generation through a competitive cooperative pool operated by PGCB, in which the capital cost of generation will be recovered upon the availability of electricity generation capacity, and (ii) the dispatch being based on the unit incremental cost of electricity generation. To ensure safety, discipline, reliability, and efficiency in the operation and maintenance of national grid, MPEMR, with the technical assistance of ADB, formulated a grid code setting out the requirements for connection to the national grid and issued an office order notifying the adoption of the grid code. In addition, MPEMR issued a notification on 24 March 2004 adopting a new regime for transmission billing. Under the new billing regime, the billable amounts distinguish energy purchases from BPDB and charges for transmission services rendered by PGCB. The result is distribution entities paying two separate bills, one to BPDB for the cost of energy purchased, and the other to PGCB for the cost of transmission services rendered. D. Institutional Reorganization of Sector Entities 24. The process of separating generation, transmission, and distribution functions, known as unbundling, is essential to introducing commercial practices and fostering competitiveness in the sector. To enable competition with greater functional focus and better accountability, the Government initiated reforms in 1994 that reorganized the power sector into several different companies based on functional responsibilities. Before the 1994 reforms, all generation and transmission was with BPDB, and distribution was with a few institutions such as BPDB, DESA and the rural electric cooperatives. Today there are several entities operating in the power sector. In addition to a number of independent power producers, six new companies have been established since The Government s commitment to restructuring of the power sector entities culminated in 2004 in the approval by the Cabinet Committee on Economic Affairs of the proposals for the corporatization of BPDB on 12 June, DESA on 8 July, and BPDB s northwest zone distribution network on 3 March. As for BPDB s northwest zone distribution network, the Memorandum and Articles of Association was approved by the Government in October 2004 and submitted to the Registrar of Joint Stock Companies and Firms of Bangladesh (the Registrar) on 26 June 2005 for registration. BPDB s northwest zone distribution network has now been incorporated as Northwest Zone Power Distribution Company Limited, as certified by the Registrar on 3 August Advertisement for recruitment of management began on 29 August 2004, and the applications received were reviewed by the Scrutiny Committee of BPDB. A selection committee has been formed by MPEMR for the selection of the candidates for the management posts. The constitution of the Board and appointment of management is being undertaken. For corporatization of DESA, the Memorandum and Articles of Association was submitted to the Registrar on 5 July 2005 for registration of the company, after endorsement of the minister-in-

10 7 charge for MPEMR. DESA has been incorporated as the Dhaka Power Distribution Company Limited 3 as certified by the Registrar on 25 October For the corporatization of BPDB, a draft memorandum and articles of association have been prepared for review by the Government. In view of the substantive and irreversible progress made by the Government regarding corporatization of these power sector entities, corporatization of DESA is being assisted by ADB TA3978-BAN, 4 and ADB approved TA4626-BAN 5 on 2 August 2005 to assist in the corporatization process of BPDB. IV. STATUS OF SECOND TRANCHE CONDITIONS A. Status of Tranche Conditions 26. The first tranche of the Program was released when the loan became effective. The second tranche release requires compliance with eight conditions: (i) settlement of accumulated and outstanding dues owed by the Borrower s Government and its closed state-owned enterprises to the power utilities for the period up to and including 31 December 2003; (ii) settlement of outstanding dues owed by the Borrower s currently operating autonomous and semi-autonomous bodies for the supply of electricity up to and including 31 December 2003 (in case of any such entity failing to fully settle its dues to the relevant power sector entity or entities, the Borrower shall settle all such dues); (iii) MOF and DESA provision of additional cash support to DESCO to cover any shortfall in the first year of DESCO s operations of the Gulshan Circle; (iv) appointment of an independent auditor acceptable to ADB to investigate past unrecovered losses due to nonpayment of electricity bills by nonpublic customers, and the Government s written agreement to present the auditor s report to ADB and the public within 6 months of the release of the second tranche; (v) unconditional loss contribution to DESA for the uncollected accounts receivable in the Mirpur Area for the period prior to 1 September 1998, if any; (vi) the Government s causing the reorganization of BPDB, DESA, BPDB s northwest zone distribution network, and Siddhirganj Power Station into independent corporate bodies incorporated under the Companies Act 1994, and its further ensuring that the Board of each such entity is constituted in accordance with principles and procedures acceptable to ADB; (vii) submission of first tariff applications by DESCO and PGCB to BERC and the Borrower s written agreement to cause BERC to process such applications within 3 months of receipt; and (viii) the award of contract for Meghnaghat 2 Project being subject to receipt of credible bids (the status of each tranche conditions for the release of the first and second tranche are summarized in Appendix 1). 27. Settlement of dues up to 31 December 2003 owed by the Borrower s Government. This condition has been complied with. In July 2003, MOF released Tk1.853 billion to partly settle the outstanding dues owed by the Government ministries and divisions to the power 3 The name DESA will be used in the report for convenience. 4 ADB Technical Assistance to the People s Republic of Bangladesh for the Corporatization of the Dhaka Electric Supply Authority. Manila. 5 ADB Technical Assistance to the People s Republic of Bangladesh for the Corporatization of the Bangladesh Power Development Board. Manila.

11 8 utilities. In May 2004, MOF released additional Tk1.679 billion and allocated Tk2.069 billion in FY2005 for settlement of all outstanding dues up to 31 March In 2005, MOF released Tk476 million on 11 April, Tk295 million on 3 May, and Tk161 million on 25 June to settle the dues up to 30 December 2004, which had been reconciled by the power utilities and the Government ministries and divisions. The amount of outstanding dues owed by the Government ministries and divisions was substantially reduced from about Tk3.30 billion in June 2002 to about Tk1.14 billion in June 2005, or 3.75 times the average monthly bill. 28. Settlement of dues up to 31 December 2003 owed by the Borrower s autonomous and semi-autonomous bodies. This condition has been complied with. At the direction of the Government in March 2005, all surcharges billed by the power utilities to the Government s autonomous and semi-autonomous bodies were written off. While most of the Government s autonomous and semi-autonomous bodies are paying current electricity bills, more than 80% of the outstanding dues are attributable to four kinds of organizations, namely city corporations, municipalities, the Dhaka Water and Sewage Authority, and the Bangladesh Jute Mills Corporation. The reconciliation process is being undertaken by the power utilities with the Government s autonomous and semi-autonomous bodies. The outstanding dues owed by the Government s autonomous and semi-autonomous bodies as of 30 June 2005 were significantly reduced from about Tk6.80 billion in June 2002 to about Tk4.84 billion, including those bills not yet reconciled, or times the average monthly bill. The outstanding dues are expected to have been further reduced by now in view of a number of measures that have been implemented by the Government (para. 15). In any case, the Government s autonomous and semi-autonomous bodies have paid all the reconciled bills at least up to 31 December Given that the condition is settlement of dues up to that date, and the accounts receivable as of 30 June 2005 are about 18 times the average monthly bill, this condition is considered to have been complied with. 29. MOF and DESA to provide cash support to DESCO in case of any shortfall in the first year of DESCO s operations in the Gulshan Circle. This condition has been complied with. DESCO took over the loss-incurring Mirpur area from DESA in September At that time, the collection-to-import ratio of Mirpur area was around 35%. Although DESCO improved its collection-to-import ratio in Mirpur area to over 69% by the time the Program was processed, there remained large accumulated losses in DESCO that were incurred during the transition period. In view of the accumulated losses and DESCO having recently taken over the Gulshan Circle from DESA in April 2003, the Government agreed under the Program to compensate DESCO for any shortfall in the first year of DESCO s operation of the Gulshan Circle. DESCO, however, earned a net profit of Tk338 million in FY2004, and thus no compensation is required. 30. Appointment of an independent auditor and the Borrower s written agreement to release the full Report within 6 months of the release of the second tranche. This condition has been complied with. Since DESA had incurred a significant amount of unrecovered losses, it was considered important to investigate the nature, causes, and extent of such unrecovered losses due to nonpayment of electricity bills, particularly by nonpublic consumers. For this purpose, the Government is required under the Program to appoint an independent auditor and agree in writing to present the auditor s report to ADB and to release the full report to the public within 6 months of the release of the second tranche. DESA engaged an independent auditor on 30 June 2005 pursuant to this condition. The independent auditor will carry out its tasks in accordance with the terms of reference endorsed by ADB and report in detail on, among other things, (i) policies and practices that have in the past resulted in failure of power sector entities to collect payments for provision of electricity;

12 9 (ii) (iii) recommended mechanisms through which the Government may launch efforts to recover all or at least part of such unrecovered past dues for electricity supply, and recommended strategies for mitigating future losses, including ways of improving and preserving records on defaulters and the extend of default amounts, which may expedite any required recovery in the future. 31. The Government has, through a letter to ADB from the Economic Relations Division of MOF dated 12 July 2005, confirmed that it shall release the auditor s report to ADB and to the public within 6 months of the release of the second tranche. 32. Loss contribution to DESA for any uncollected accounts receivable in the Mirpur Area prior to 1 September This condition has been complied with. Under this condition, if there remains an uncollected balance of accounts receivable for the period prior to 1 September 1998 as of the date of the second tranche, MOF shall cause a loss contribution to DESA in an amount equal to such unrecovered accounts receivable. DESA engaged an independent auditor on 23 March 2005 to identify uncollected balance of accounts receivable in the Mirpur area prior to 1 September 1998, when the area was transferred from DESA to DESCO. Although the auditor has worked since March 2005, it has not identified any uncollected accounts receivable so far, and therefore no loss contribution is required at present. MOF nevertheless confirmed in its letter to ADB dated 3 July 2005 that it would make an unconditional loss contribution to DESA for the unrecovered accounts receivable, if any, owed by Government ministries or divisions. 33. Institutional reorganization of power sector entities. The Government is covenanted under the Program to cause the reorganization of BPDB, DESA, BPDB s northwest zone distribution network, and Siddhirganj Power Station into independent corporate bodies incorporated under the Companies Act 1994, as amended. The Government shall further ensure that the board of each such entity is constituted in accordance with principles and procedures acceptable to ADB, including that at least 50% of the membership of boards of directors shall be persons who are neither current employees, nor past employees in the preceding 3 years, of the Government or any of its public or semi-public organizations. In addition, at least 25% of all board members of each of the companies should be representatives of independent consumer or professional interests. In 2004, the Cabinet Committee on Economic Affairs approved the proposals for corporatization of BPDB in June, DESA in July, and BPDB s northwest zone distribution network in March. Following the Cabinet Committee on Economic Affairs approval, corporatization of these institutions is being undertaken (para. 25). With respect to Siddhirganj Power Station, EGCB has been assigned to take over its assets, as per the BPDB Board s resolution dated 12 September Given that EGCB is an institution incorporated under the Companies Act 1994, this decision is considered acceptable to ADB. Based on the provisional valuation of assets undertaken by BPDB, the transfer of assets and liabilities of Siddhirganj Power Station to EGCB is being undertaken. Besides, the Government has, through its letter to ADB from the Economic Relations Division of MOF dated 12 July 2005, confirmed that the board of each corporatized body will be constituted in accordance with the agreed principles described in the loan agreement. In view of this confirmation and the substantive progress made by the Government as elaborated above and in para. 25, this condition is considered to have been substantially complied with. 34. Submission of first tariff applications by DESCO and PGCB, and the Borrower s written agreement to cause BERC to process the applications. Under this condition for release of the second tranche, DESCO and PGCB should file their first tariff applications to

13 10 BERC, established under the Energy Regulatory Commission Act 2003, and the Borrower should make a written agreement to cause BERC to process all such applications within 3 months of receipt of the subject applications. PGCB filed its first tariff application to BERC in October 2004, but processing of the application was affected due to delays in BERC becoming functional. DESCO submitted its first tariff application only in June BERC, as an independent regulatory body, wrote a letter to ADB on 6 July 2005 confirming that BERC will process the tariff applications received from PGCB and DESCO within 3 months, in line with and subject to the fulfillment of the provisions of the Energy Regulatory Commission Act The letter also states that three members of BERC, including its chairman, have already been appointed, and the remaining two members are expected to be appointed soon. The letter further states that, with limited staff and the support of external consultants, BERC has begun its services. Tariff applications of PGCB and DESCO are being processed by BERC. In the Government s view, BERC is an independent body whose autonomy is secured under the Act that created it, and therefore the Government is not in a position to enter into a written agreement with ADB regarding anything related to BERC s scope of work. The written confirmation from BERC is considered acceptable and as such this condition is considered to be complied with. 35. Award of contract for Meghhaghat 2 Project. Subject to receipt of credible bids on the basis of agreed evaluation criteria, the Government is covenanted under the Program to award a contact to an independent power producer on a build-own-operate basis for the development and operation of Meghnaghat 2 Power Plant with a generating capacity of 450 MW or more. This condition was included in the Program as part of public private partnership, and ADB s Private Sector Operations Department (PSOD) intended to participate in this project. Subsequent to the opening of the financial proposals of the two technically qualified bidders for the Meghnaghat 2 Project on 16 May 2004, the financial proposal evaluation report was submitted to the Cabinet Committee on Government Purchases in January The committee noted that the lower bidder had changed the name of the lead sponsor between prequalification and submission of the bid. The case was therefore returned to MPEMR for clarification and subsequently referred to the Cabinet Committee on Economic Affairs, which accepted the deviation on 25 June However, PSOD wrote a letter to the Government on 8 August 2005 to inform it that ADB will not consider financing the Meghanghat 2 Project from its private sector window as the proposed sponsor of the lower bid does not have the stipulated technical qualifications and changed composition after its submission of the final bid. Meanwhile, the price for electricity offered by the higher bid is too high. Despite this, BPDB issued the notice of award to the lowest bidder on 29 August 2005 after obtaining approval of the Cabinet Committee on Government Purchases on 15 August As BPDB issued the notice of award, this condition is deemed to have been technically complied with. B. Status of Nontranche Conditions 36. The loan covenants covered a number of actions associated with the policy conditionalities for the Program covering the (i) implementation arrangement, (ii) use of counterpart funds, (iii) implementation of the policy letter, and (iv) program reviews. There has been a concerted effort to ensure that the loan covenants were complied with as an integral part of the policy reform process. The status of compliance with loan covenants is presented in Appendix 2.

14 11 V. CONCLUSION 37. The Government has made substantive progress in meeting the objectives of the Program and in complying with loan covenants. The most notable achievements are the Cabinet Committee on Economic Affair s approval for corporatization of the major power sector entities, settlement of the long-lasting outstanding dues owed by the Government and its agencies, and establishment of an independent energy sector regulator. Such wide-ranging reforms, requiring consensus building among various stakeholders, were not easy to accomplish. Vested interests that stood to gain from the current organizational structure provided considerable resistance to any change. Under the Program, seven of the eight conditions for the second tranche release have been fully complied with, and one condition has been substantially complied with. Release of the second tranche has been discussed with other development partners in Bangladesh including the International Monetary Fund and the World Bank. VI. THE PRESIDENT S DECISION 38. In view of the progress made in the implementation of the overall program and the full compliance with seven conditions and the substantial compliance with the remaining one condition for the release of the second tranche, the President has authorized the release of the second tranche of $50,000,000 for the Power Sector Development Program loan. In accordance with established procedure, the tranche release will be effected not less than 10 working days after the circulation of this progress report to the Board.

15 POLICY MATRI FOR RELEASE OF TRANCHES Conditions Status/Remarks First Tranche A. Reform of the Power Sector through Financial Restructuring of Sector Entities. Settlement of at least $90 million for recovery and/or adjustment of all dues for suppliers of MOF released the required funds in a several tranches for electricity to Government, and its closed stateowned settlement of arrears owed by the Government up to March enterprises, up to 30 June 2002 Second Tranche 12 Appendix 1 Causing DESA to pursue more systematically and actively collect all of its unrecovered accounts receivable through its erstwhile Mirpur Division Government approval for PGCB to issue 7 10 year tax-free bonds of up to Tk2 billion in one or more tranches to finance the local currency costs of PGCB s National Load Dispatch Center MPEMR issued notification to DESA on 16 March 2004 Bangladesh Gazette notification was issued on 15 March 2004 allowing PGCB to issue 7 10 year tax-free bonds of up to Tk2 billion. Payment of all outstanding dues for the supply of electricity in the period up to 31 December 2003 to the Government and its closed state-owned enterprises. Payment of all dues for supplies of electricity to the Government and its autonomous and semiautonomous bodies up to 31 December Cash support by the Government and DESA to DESCO to cover shortfalls, if any, in the first year of DESCO s operation of the Gulshan Circle. MOF released the required funds in several tranches for settlement of arrears owed by the Government up to March As of 30 June 2005, accounts receivable from Government ministries are 3.75 times the average monthly bill. The amount of outstanding dues was substantially reduced from Tk6.80 billion in June 2002 to about Tk4.84 billion in June As of 30 June 2005, accounts receivable from the Government s autonomous and semi-autonomous bodies were times the average monthly bill including those bills not yet reconciled. While the process of reconciliation of electricity bills is ongoing, all the Government s autonomous and semi-autonomous bodies have paid the reconciled bills at least up to 31 December No shortfalls were incurred in the first year of DESCO s operation of the Gulshan Circle.

16 Conditions Status/Remarks First Tranche Appointment of an independent auditor for undertaking an investigation of past unrecovered DESA appointed an independent auditor on 30 June On 12 losses in DESA due to nonpayment of electricity July 2005, ERD sent written agreement to ADB on releasing the supply bills by nonpublic customers, and written report to ADB and the public within 6 months of release of the agreement to present the report of such an second tranche. independent auditor to ADB and to release the full report to the public within 6 months of the release of the second tranche In spite of the renewed efforts by DESA, if there remains an uncollected balance of accounts receivables for the period prior to 1 September 1998 in its erstwhile Mirpur area, MOF shall make an unconditional loss contribution to DESA for the uncollected balance of accounts receivable. B. Establishment of BERC and Improved Quality of Supply Appointment of at least three commissioners to the BERC and BERC made operational under the Energy Act Notification of a grid code for the sector by the Government to be adopted on a pilot basis. DESCO and PGCB to file first tariff applications to BERC, and the Government s written agreement to review the tariff applications within 3 months of receipt. C. Optimizing Generation Costs on a National Basis Competitive dispatch for generation to be started. PGCB will operate a cooperative pool wherein the capital cost of the generation plant will be recovered based on availability, but usage will be based on the unit incremental cost of generation. Subject to receipt of credible bids, award of a BOO contract for the Meghnaghat 2 Project. An independent auditor has been working since March 2005, and no unrecovered accounts receivable have been identified so far. Hence, no loss contribution is required at present. Nevertheless, MOF sent a letter to ADB on 3 July 2005 confirming its commitment to make an unconditional loss contribution to DESA if any unrecovered accounts receivable owed by Government ministries or divisions are identified. Two commissioners were appointed on 28 April 2004, and the chairman was appointed on 4 June MPEMR issued an office order on 1 September 2004 notifying adoption of a grid code. DESCO filed its first tariff application to BERC in June and PGCB filed its first application in October BERC, in its letter to ADB dated 6 July 2005, confirmed that it would review the tariff applications within 3 months. Bangladesh Gazette notification was issued by MPEMR on 24 April 2004 adopting the principles of competitive dispatch. BPDB issued the notice of award to the lowest bidder on 29 August Second Tranche Appendix 1 13

17 Conditions Status/Remarks First Tranche Transfer transmission billing from generation to distribution entities. Thus distribution entities will MPEMR issued a notification on 24 March The new billing pay two bills one to BPDB for the energy system is in operation. purchased, and the second to PGCB for the transmission service rendered. D. Institutional Reorganization Government to cause the reorganization of BPDB, DESA, BPDB s northwest zone distribution network, and Siddhirganj Power Station into independent corporate bodies incorporated under the Companies Act 1994, as amended. Government to further ensure that the Board of each such entity is constituted in accordance with the principles and procedures acceptable to ADB. Substantially complied with. In 2004, the Cabinet Committee on Economic Affairs approved the proposals for corporatization of BPDB in June, DESA in July, and BPDB s northwest zone distribution network in March. EGCB, which has been incorporated under the Companies Act 2004, is assigned to take over the assets of Siddhirganj Power Station as per the BPDB Board resolution dated 12 September BPDB s northwest zone distribution network has been corporatized as the Northwest Zone Power Distribution Company Limited, as certified by the Registrar on 3 August DESA has been corporatized, as certified by the Registrar on 25 October The assets and liabilities of Siddhirganj are being handed over to EGCB. In view of the substantive and irreversible progress made by the Government, corporatization of DESA is being assisted by ADB TA3978-BAN, and ADB has approved TA4626-BAN in August 2005 to assist in corporatization of BPDB. Second Tranche ADB = Asian Development Bank, BERC = Bangladesh Energy Regulatory Commission, BOO = build-own-operate, BPDB = Bangladesh Power Development Board, DESA = Dhaka Electric Supply Authority, DESCO = Dhaka Electric Supply Company Limited, EGCB = Electricity Generation Company of Bangladesh Limited, ERD = Economic Relations Division of the Ministry of Finance, Registrar = Registrar of Joint Stock Companies and Firms of Bangladesh, MOF = Ministry of Finance, MPEMR = Ministry of Power, Energy and Mineral Resources, PGCB = Power Grid Company of Bangladesh Limited. 14 Appendix 1

18 STATUS OF COMPLIANCE WITH LOAN COVENANTS (Schedule 5 of the Loan Agreement) Program Implementation and Other Matters A. Implementation Arrangements 1. The Finance Division of the Ministry of Finance and the Power Division of the Ministry of Power, Energy, and Mineral Resources shall be the program Executing Agencies. As such, each of these ministries will be responsible for the overall supervision of program implementation and for ensuring that the proceeds of the Loan are disbursed and utilized in accordance with the Loan Agreement. B. Use of Counterpart Funds 1. The Borrower shall ensure that the Counterpart Funds are used to (i) finance the program expenditures and associated costs of reform, including settlement of outstanding arrears of BPDB, DESA, DESCO, and REB due from the Borrower and its autonomous and semi-autonomous bodies and (ii) provide necessary financial support to write-off DESA s uncovered accounts receivable in its erstwhile Mirpur Division to the extent of covering an amount equal to sales of electricity by DESA prior to 1 September 1998 that have not been paid for, and to the extent that there is a shortfall (as calculated by determining profit after depreciation) in the first year of DESCO s operations of the Gulshan Circle. MOF and DESA will provide additional cash support to DESCO to cover such shortfalls in DESCO s finances by way of enabling it to effect a complete financial turnaround of the Gulshan Circle. C. Implementation of the Policy Letter. 1. The Borrower shall ensure that the policies adopted and actions taken as described in the policy letter and the policy matrix continue in effect for the duration of the program period. D. Program Reviews Status/Remarks The Finance Division of the Ministry of Finance and the Power Division of the Ministry of Power, Energy, and Mineral Resources have been implementing the Program. ADB released $50 million to the Government under the first tranche release of the program loan. MOF released the required funds in several tranches to settle the outstanding dues owed by the Government agencies up to 31 March All policies have been adopted and actions have been taken as described in the policy letter and policy matrix. 1. The Borrower and ADB shall jointly monitor the implementation of the Program and shall assess the impact of all relevant sector reforms through semiannual reviews. To assist ADB with the reviews, the Borrower shall provide relevant information through regular reporting on the progress and impact of policy reforms. The Borrower and ADB jointly monitored the implementation of the Program and assessed the impact of key relevant sector reforms during review missions. ADB = Asian Development Bank, BPDB = Bangladesh Power Development Board, DESA = Dhaka Electric Supply Authority, DESCO = Dhaka Electric Supply Company Limited, MOF = Ministry of Finance, REB = Rural Electrification Board. Appendix Appendix 2 15