Pakistan: Second Power Transmission Enhancement Investment Program (Tranche 2)

Periodic Financing Request Report Project Number: 48078-004 MFF Number: 0092 September 2017 Pakistan: Second Power Transmission Enhancement Investment Program (Tranche 2) Distribution of this document is restricted until it has been approved by Management. Following such approval, ADB will disclose the document to the public in accordance with ADB's Public Communications Policy 2011.

CURRENCY EQUIVALENTS (as of 15 September 2017) Currency unit Pakistan rupee (PRe/PRs) PRe1.00 = $0.0095 $1.00 = PRs 104.65 ABBREVIATIONS ADB ADF AFS AGP Asian Development Bank Asian Development Fund Audited Financial Statement Auditor General of Pakistan CPEC China-Pakistan Economic Corridor CPPA-G DMD DMF EAD EMP FAM FMA FMC -- Central Power Purchasing Agency (Guarantee) Limited Deputy Managing Director design and monitoring framework Economic Affairs Division environmental management plan facility administration manual financial management assessment facility management consultant GDP gross domestic product MFF MOE MOF multitranche financing facility Ministry of Energy Ministry of Finance NEPRA National Electric Power Regulatory Authority NTDC National Transmission and Despatch Company Limited PAM project administration manual PMU project management unit RMS revenue metering system RRP SCADA STL short-circuit testing liaison report and recommendation of the President supervisory control and data acquisition WEIGHTS AND MEASURES GWh gigawatt-hour (1,000 megawatt-hours) km kilometer kv kilovolt MVA megavolt-ampere MW megawatt (1,000 kilowatts) NOTE (i) The fiscal year (FY) of the Government of Pakistan and its agencies ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2016 ends on 30 June 2016. (ii) In this report, $ refers to United States dollars.

Vice-President W. Zhang, Operations 1 Director General S. O Sullivan, Central and West Asia Department (CWRD) Officer-in-Charge J. Hwang, Energy Division, CWRD Team leader Team members Peer reviewers Z. Lei, Senior Energy Specialist, CWRD N. Djenchuraev, Senior Environment Specialist, CWRD D. Garcia, Project Officer, CWRD Y. Inoue, Finance Specialist (Energy), CWRD E. Khattak, Senior Project Officer (Energy), CWRD A. Khokhar, Senior Safeguards Officer, CWRD E. Macalintal, Senior Operations Assistant, CWRD L. Mtchedlishvili, Principal Energy Specialist, CWRD D. Pham, Senior Financial Management Specialist, CWRD P. Rhee, Senior Counsel, Office of the General Counsel A. Sakai, Energy Specialist, CWRD S. Yoneoka, Energy Specialist (Smart Grids), Sustainable Development and Climate Change Department In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

TRANCHE AT A GLANCE CONTENTS Page I. BACKGROUND 1 II. ASSESSMENT OF IMPLEMENTATION 3 III. PERIODIC FINANCING REQUEST 4 A. Impact and Outcome 4 B. Outputs 4 C. Investment and Financing Plans 5 D. Implementation Arrangements 6 E. Project Readiness 6 F. Advance Contracting and Retroactive Financing 7 IV. DUE DILIGENCE 7 A. Technical 7 B. Economic and Financial 7 C. Governance 8 D. Poverty, Social, and Gender Dimensions 8 E. Safeguards 8 F. Climate Change Impact 9 G. Risks and Mitigating Measures 9 H. Risk Categorization 10 V. ASSURANCES 10 VI. RECOMMENDATION 10 APPENDIXES 1. Periodic Financing Request from the Government of Pakistan 2. Design and Monitoring Framework (Tranche 2) 3. Loan Agreement 4. Project Agreement 5. Updated Contribution to the ADB Results Framework 6. Project Administration Manual (Tranche 2) 7. Economic Analysis (Tranche Investments) 8. Financial Analysis (Tranche Investments) 9. Updated Summary of Poverty Reduction and Social Strategy 10. Initial Environmental Examinations 11. Land Acquisition and Resettlement Plans 12. Updated Risk Assessment and Risk Management Plan Supplementary Appendixes A. Project Climate Risk Assessment and Management Report

I. BACKGROUND 1. The Asian Development Bank (ADB) approved a multitranche financing facility (MFF II) to Pakistan on 23 August 2016 for an aggregate amount of up to $810 million comprising $800 million from ADB s ordinary capital resources (OCR) and $10 million equivalent from Special Funds resources (Asian Development Fund [ADF]) for the Second Power Transmission Enhancement Investment Program. 1 ADB and the Government of Pakistan signed a framework financing agreement (FFA) for the investment program on 15 July 2016. The investment program supports (i) the evacuation of new power generation; and (ii) improvement of system reliability and power supply quality. It also helps improve the financial management, regulatory relations, planning, project management, and procurement capacities of the transmission system owner and operator, the National Transmission and Despatch Company Limited (NTDC), and the sector s newly established commercial operator, the Central Power Purchasing Agency (Guarantee) Limited (CPPA-G). 2. Pakistan faces power shortages. About 34% of the population lacks access to grid electricity, one of the main constraints to inclusive sustainable growth. The average daily shortfall of 4,5006,000 megawatts (MW) caused frequent load shedding, which led to civil strife and factory closures in 2013 and 2014. Aging, overloaded, and unreliable transmission and distribution systems exacerbate the problem. Three major contributing factors are (i) the gap between end-user and cost recovery tariffs, 2 (ii) limited private sector participation, and (iii) lack of transparency and low institutional efficiency. 3. The government s development vision is reflected in Pakistan s Vision 2025, 3 which aims to create, by 2025, a globally competitive and prosperous country providing a high quality of life for all its citizens. To address the persistent energy crisis, the government announced the National Power Policy 2013. 4 The three guiding principles of the policy are efficiency, competition, and sustainability. It focuses on five targets, one of which is to decrease aggregate technical and commercial transmission and distribution losses from 23%25% in 2013 to 16% in 2017. 5 In line with the government s 2013 National Power Policy, ADB s sector strategy is to promote a reliable and affordable energy system by rationalizing tariffs, reducing transmission and distribution losses, and increasing reliable energy supply and access. 4. ADB, together with other development partners, supports sector reforms through the $2.4 billion Sustainable Energy Reform Program (comprising three subprograms). 6 The National Electric Power Regulatory Authority (NEPRA) Act is being amended to improve the regulatory framework, allowing (i) full cost-recovery tariffs, (ii) improved efficiency and accountability of the government as a policy maker and NEPRA as a sector regulator, and (iii) future competitive electricity market development. The Alternative Energy Development Board and the Private 1 ADB. 2016. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility to the Islamic Republic of Pakistan for the Second Power Transmission Enhancement Investment Program. Manila. 2 The gap between the end-user and cost-recovery tariff consists of two factors: (i) the difference between costrecovery and National Electric Power Regulatory Authority (NEPRA)-determined tariffs; and (ii) the difference between NEPRA-determined and government-notified tariffs, which are balanced through subsidies. 3 Government of Pakistan. 2014. Pakistan Vision 2025: One Nation One Vision. Islamabad. 4 Government of Pakistan, Ministry of Water and Power. 2013. National Power Policy 2013. Islamabad. 5 Other targets include decreasing the supplydemand gap from 4,5005,000 MW to 0 MW by 2017; decreasing the cost of generation from $0.12/unit to $0.10/unit by 2017, increasing collection from 85% to 95% by 2017; and decreasing the decision-making processing time at the Ministry of Water and Power, related departments, and regulators from long to short durations. 6 Subprograms 1 ($400 million) and 2 ($400 million) were approved in 2014 and 2015, with cofinancing from the World Bank ($1.1 billion) and Japan International Cooperation Agency ( 10 billion). Subprogram 3 was approved in June 2017, with cofinancing from the Agençe Française de Développement ( 100 million).

2 Power Infrastructure Board are being merged to improve the operational efficiency and mainstream development of renewable energy through the private sector. An electricity market operation unit was established in NEPRA, enabling timely approval of the market operator s fee for the CPPA-G, thus improving its financial independence. The CPPA-G is evolving into a competitive wholesale electricity market operator, 7 which is essential for an efficient and transparent power sector. Transmission tariff guidelines 8 were adopted, establishing a transparent methodology for the determination of transmission revenue and use of the service charge, a prerequisite for the approval of privately financed transmission projects. 5. Joint efforts by the government and development partners contributed to a reduction in the duration of load shedding in urban areas and the industrial sector from 12 hours per day in 2013 to 6 hours and 4 hours in 2016, and a drop in the transmission and distribution loss from 25.0% to 20.6% during the same period. 9 Significant private sector investments have been attracted. Under the ChinaPakistan Economic Corridor (CPEC) initiative, $22 billion in power generation investments by 2022 have been planned, primarily from the private sector. This will bring an additional 10,100 MW of generation capacity before the end of 2019. 10 Along with generation projects outside the CPEC, a total additional 14,000 MW of generation capacity will be added by the end of 2019, which will achieve a 224 MW power surplus during peak hours in 2019 if the transmission and distribution system does not pose constraints. The NTDC prepared an investment and power procurement program outlining an $11 billion investment in the transmission system during 20162026. In 2016, a $1 billion investment was approved to enhance the NTDC s network. In addition, under the CPEC initiative, a $3 billion investment from the private sector was secured to develop two 660 kilovolt (kv) high-voltage direct current transmission lines totaling 4,000 MW of capacity. 11 Removing the bottlenecks in transmission and distribution is vital for providing reliable energy for all. 6. The MFF II will address the constraints of the power transmission system and help improve the organizational efficiency and effectiveness of the NTDC and CPPA-G. Tranche 1 was approved on 31 August 2016, in the amount of $115 million from OCR (Loan 3419) and $10 million equivalent from the ADF (Loan 3420-SF). The loan and project agreements were signed on 29 November 2016 and the loans became effective on 24 February 2017. The OCR loan will close on 31 December 2020 and the ADF loan on 31 December 2026. The OCR loan supports the construction of new transmission lines in Punjab and Sindh provinces, the extension and augmentation of the existing four substations in Punjab Province, and the installation of shunt reactors and the replacement of protection equipment in 11 grid stations in the South area. The ADF loan will finance a facility management consultant to implement and monitor the MFF II; and provide capacity development to support the NTDC s organizational restructuring, and its capacity in planning, design, operation, and assets management, throughout the MFF II. 7. Proposed Tranche 2. On 5 July 2017, ADB received the government s periodic financing request for tranche 2, totaling $260 million, from OCR (Appendix 1). The government s counterpart financing is $85 million for tranche 2. The proposed tranche 2 meets the selection criteria set forth in schedule 4 of the FFA. It will expand the 220 kv transmission system in Sindh 7 This is supported by ADB. 2014. Technical Assistance to the Islamic Republic of Pakistan for Strengthening the Central Power Purchasing Agency. Manila. 8 NEPRA. 2017. NEPRA Determination of Use of System Charges (Methodology & Process) Guidelines 2016. Islamabad. 9 NEPRA. 2017. State of Industry Report 2016. Islamabad. In addition, the supplydemand gap during peak time was 5,298 MW, the generation cost was about 0.07 USD/kWh, and the collection rate was 94.5% by FY2016. 10 CPEC. CPEC Energy Priority Projects. http://cpec.gov.pk/energy. 11 The two high-voltage direct current transmission lines will evacuate electricity from the power hub in Sindh to the load center in Punjab, with commercial operation in 2019.

3 and Balochistan provinces to remove transmission network bottlenecks and enable the network to handle expected future loads. It will also upgrade the supervisory control and data acquisition (SCADA) system across the national grid to enable the transmission system operator, NTDC, to monitor and control the grid in real time, and prevent or reduce the duration of network outages increasing the grid stability, reliability, and resilience to accommodate more intermittent renewable energy. It will also feed computerized metering data complying with the grid code into the system for settlement of the market operator, CPPA-G, to streamline revenue collection, billing and payment processes, and create the foundation for an energy trading platform. II. ASSESSMENT OF IMPLEMENTATION 8. Physical and nonphysical progress. The NTDC is the executing agency under tranche 1. As of 31 August 2017, one of eight procurement packages had been awarded. The awarded contracts total $6.7 million, of which $0.12 million has been disbursed. The request for proposal for a facility management consultant was issued on 10 April 2017, and the contract award is expected by the fourth quarter (Q4) of 2017. Construction has not commenced. Tranche 1 was rated actual problem mainly because of a procurement start-up delay caused by institutional restructuring of the NTDC and finalizing major equipment pre-type test requirements of the tender. 12 As the MFF and Tranche 1 were approved in August 2016, no substantial physical progress has been achieved yet. During the same period, around 150 new junior engineers have been engaged, among which 17% are female. 9. Lessons learned. ADB has supported the NTDC through four tranches of the Power Transmission Enhancement Investment Program (MFF I) 13 and tranche 1 of the MFF II. Lessons from previous loans have been incorporated in the design of tranche 2. In the MFF I, the NTDC requested bidders to conduct fresh type tests after contract award if the proposed equipment were not type tested by a short-circuit testing liaison (STL) laboratory, which significantly delayed implementation because of lack of time slots at the STL laboratory for type testing. This situation is compounded by the lack of manufacturers active in Pakistan with equipment that is type tested by STL laboratory. To improve contract execution efficiency without compromising quality, NTDC decided to rationalize type test requirements. After full consultation with stakeholders, the NTDC approved the final clause on type testing in May 2017, which will apply to all future bidding documents. This will accelerate procurement under tranche 1. 10. Restructuring of the National Transmission and Despatch Company. To cope with the challenge to at least double transmission capacity by 2020, the NTDC started to restructure its organization in August 2016 to improve institutional efficiency. The restructuring, expected to be completed in Q4 2017, focuses on strengthening its core functions: planning, design, project development, system management and operations, and improving regulatory compliance, such as timely submission of tariff petitions, investment plans, and loan forecasts, in accordance with NEPRA rules and regulations. These functions will be strengthened by creating two groups: (i) planning, design, and engineering (group 1), and (ii) asset development and management (group 2). Two deputy managing directors (DMDs) the DMD for planning, design and engineering and the DMD for asset development and management have been selected based on merit to lead the groups. A Corporate Affairs Department, headed by a general manager, has been established to improve regulatory compliance and strategic planning. 12 Two bid evaluation reports, totaling estimated $14 million, were submitted and under ADB s review. The project rating is expected to improve to potential problem when these contracts are awarded in Q4 2017. 13 ADB. 2006. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility to the Islamic Republic of Pakistan for the Power Transmission Enhancement Investment Program. Manila

4 11. ADB s project management unit (PMU) is under group 2. Project managers are being assigned, and will report to a program manager (chief engineer level) who is responsible for each tranche or loan. The project managers will be fully responsible at the subproject level for procurement and execution until commissioning, under the guidance of the program manager. The project managers will select staff for design and engineering, procurement and contract management, construction execution, and safeguard compliance. These staff will report to project managers and coordinate with their line departments. A project coordinator funded by the ADB loan will assist the DMD (asset development and management) in overall ADB project management. 12. The strengthened PMU is expected to address the former PMU s lack of ownership, responsibility, and authority. The facility management consultant, funded by tranche 1, will support the PMU in design, project management, and environmental and social safeguards monitoring throughout the MFF II. The consultant will enhance the PMU s technical capacity in the state-ofthe-art design of 500 kv substations, and introduce international good practice. 13. Compliance. The government and NTDC are in compliance with most of the FFA undertakings and the loan covenants, including safeguards in the loan agreement for tranche 1. Tranche 1 is classified category B for environment, B for involuntary resettlement, and C for indigenous peoples. No permanent land will be acquired and no affected people will be displaced. The initial environmental examinations (IEEs) and resettlement plans have been disclosed, and related safeguard requirements have been incorporated in the bidding documents. Construction has not commenced, and certain undertakings and covenants are not yet due. Before construction begins, (i) NTDC will update draft resettlement plans based on the detailed design to be conducted by turnkey contractors, and implement the plans after ADB s approval; and (ii) turnkey contractors will prepare site-specific environmental management plans (EMPs). The covenants on timely submission of the NTDC s annual audited financial statement (AFS) for fiscal year (FY) 2016 14 and the investment plan/report and load growth forecasts 15 have not been fully complied with. The status of compliance with the FFA undertakings and loan covenants is in Appendix 1. III. PERIODIC FINANCING REQUEST A. Impact and Outcome 14. The project will be aligned with the following impacts: (i) improved transmission infrastructure (footnote 4), and (ii) improved energy market transparency and efficiency (footnote 3). The outcome will be improved coverage, reliability, transparency, and quality of the power transmission service in Pakistan. The design and monitoring framework is in Appendix 2. B. Outputs 15. Tranche 2 will support the NTDC in meeting growing electricity demand efficiently and reliably, and extending service to underserved areas and poorer segments of the population. It has two outputs: (i) Output 1: 220 kv transmission network augmented and expanded: 14 The submission of the NTDC s AFS was delayed because of the separation of the CPPA-G from the NTDC in 2015. The NTDC submitted the AFS for FY2015 in June 2017, and will submit its FY2016 AFS in Q4 2017. 15 The NTDC submitted its investment plan and load forecast during the fact-finding mission in May, but it has not yet submitted a full-fledged plan and report. The NTDC is restructuring its organization, and a Corporative Affairs Department has been set up to take charge of regulatory compliance, including the provision of the requested plan/report and forecasts. The plan/report and forecast for 2017 are expected to be received in Q4 2017. Future plans/reports and forecasts will be received as requested in the loan covenant of tranche 1.

5 (ii) (a) subproject 1: 220 kv 500 megavolt-ampere (MVA) Mirpur Khas substation with associated 80 kilometer (km) transmission lines in Sindh; (b) subproject 2: 220 km Dera Ismail KhanZhob 220 kv transmission line with 220 kv 320 MVA Zhob substation in Balochistan; and (c) subproject 3: 360 km 220 kv GudduShikarpurUchSibbi transmission line in Sindh and Balochistan provinces. Output 2: SCADA and revenue metering system (RMS) upgraded. This adopts high-level technology and includes subproject 4: the procurement, installation, and commissioning of the next phase of the NTDC s SCADA and RMS system. 16. A SCADA supervision consulting firm will be recruited under output 2 to help the NTDC implement the SCADA and RMS system upgrade. A SCADA expert has also been helping the NTDC select a turnkey contractor to construct the component and recruit the SCADA supervision consulting firm. 17. The facility management consultant funded by the support component of tranche 1 will help the NTDC manage the implementation of output 1. The support component of tranche 1 will provide capacity building to the NTDC throughout the MFF II. C. Investment and Financing Plans 18. Tranche 2 is estimated to cost $345 million (Table 1). Detailed cost estimates by expenditure category and by financier are in the project administration manual (PAM) for tranche 2 (Appendix 6). Table 1: Tranche Investment Plan ($ million) Item Amount a A. Base Cost b 1. Expansion of the 220 kv transmission network 163.35 2. Upgrade of NTDC s SCADA and RMS 98.06 Subtotal (A) 261.41 B. Contingencies c 37.92 C. Financing Charges During Implementation d 45.67 Total (A+B+C) 345.00 kv = kilovolt, NTDC = National Transmission and Despatch Company Limited, RMS = revenue metering system, SCADA = supervisory control and data acquisition. a Includes taxes and duties of $32.13 million to be financed from the NTDC s cash resources. b In mid-2017 prices. c Physical contingencies are computed at 5% and 9% for Taxes and Duties. Price contingencies computed at 1.5% in 2017, 1.4% in 2018, 1.5% in 2019 and onward on foreign exchange costs; and 4.7% in 2017, 5.0% in 2018, 5.2% in 2019, 5.5% in 2020 and onward on local currency costs; includes provision for potential exchange rate fluctuation under the assumption of a purchasing power parity exchange rate. d Includes interest and commitment charges. Interest during construction for the ADB loan has been computed at the 5-year fixed swap rate plus a contractual spread of 0.50% and 0.10% of maturity premium. The ADB loan will be onlent at 12.00% per annum and carry the same repayment and grace periods. Commitment charges are calculated at 0.15% on the average undisbursed amount. Source: Asian Development Bank assessment. 19. The government has requested a loan of $260 million from ADB s ordinary capital resources to help finance the project. The loan will have a 25-year term, including a grace period of 5 years, and an annual interest rate determined in accordance with ADB s London interbank offered rate (LIBOR)based lending facility, a commitment charge of 0.15% per year, and such other terms and conditions set forth in the draft loan and project agreements (Appendixes 3 and

6 4). Based on the custom-tailored method, the average loan maturity is 15.98 years and the maturity premium payable to ADB is 0.10% per year. 20. The financing plan is in Table 2. Table 2: Financing Plan Amount ($ million) Share of Total (%) Source Asian Development Bank 260.00 75.36 National Transmission Despatch Company Limited 85.00 24.64 Total 345.00 100.00 Source: Asian Development Bank assessment. D. Implementation Arrangements 21. The executing agency is the NTDC. The Ministry of Energy (Power Division) provides overall sector coordination, and liaises with ADB on policy and reforms and overall ADB projectrelated issues. The NTDC has established a PMU to implement Tranche 1 and 2. The PMU s day-to-day project management includes procurement, construction supervision, inspection and testing of equipment, financial management, and monitoring of and reporting on progress. 22. The Tranche will be implemented over 5 years, including procurement and construction activities. Physical completion is expected by 30 June 2022. Loan closing will be on 31 December 2022, or on a date agreed between the government and ADB. The implementation arrangements are summarized in Table 3 and described in detail in the PAM (Appendix 6). Table 3: Implementation Arrangements Aspects Arrangements Implementation period January 2018December 2022 Estimated completion date 30 June 2022 (loan closing on 31 December 2022) Management (i) Oversight body MOE (Power Division) (ii) Executing agency NTDC (iii) Key implementation agency NTDC (iv) Implementation units Project management unit in NTDC Procurement International 3 packages $238 million competitive bidding Consulting services QCBS (90:10) 384 person-months $3.7 million ICS TBD person-months $1.3 million Retroactive financing and/or advance contracting Advance contracting, including the preparation of bidding documents, inviting and receiving bids for contracts, and retroactive financing of up to 20% of the loan amount for expenditures incurred 12 months Disbursement before loan signing. The loan proceeds will be disbursed in accordance with ADB s Loan Disbursement Handbook (2017, as amended from time to time) and detailed arrangements agreed on between the government and ADB. ADB = Asian Development Bank, ICS = individual consultant selection, MOE = Ministry of Energy, NTDC = National Transmission and Despatch Company Limited, QCBS = quality- and cost-based selection, TBD = To be decided Source: Asian Development Bank. E. Project Readiness 23. The proposed subprojects were included in the NTDC s investment plan, which NEPRA approved. The Executive Committee of the National Economic Council approved the Planning

7 Commission Form-1 (PC-1) of subprojects 1 and 2 in November 2016, and the Central Development Working Party approved subprojects 3 and 4 in July and September 2017. The PC- 1 comprises the project scope and design; and demonstrates the project s technical, financial, and economic viability. 24. The NTDC advertised for implementation support consultants for the SCADA system on 10 May 2017, and submitted the draft bidding documents of SCADA to ADB on 20 June 2017. The consultants will be mobilized in Q1 2018, and the turnkey contractor will be selected in Q2 2018. Bidding documents of substations and transmission lines will be issued in October 2017. The master bidding documents approved in tranche 1 will be adopted, given the similarity of technical specifications and qualification requirements. The request for proposal for the facility management consultant was issued in April 2017. The facility management consultant will help the NTDC manage the implementation of substation and transmission subprojects, and is expected to be mobilized in Q4 2017. 25. The PMU has been established and is functional. The land acquisition and resettlement plans (LARPs) and IEEs were disclosed on 15 June and 21 June 2017, respectively. F. Advance Contracting and Retroactive Financing 26. In line with FFA provisions, ADB will apply (i) advance contracting of turnkey contracts, and consultants; and (ii) retroactive financing of eligible expenditures for turnkey contracts and consultants up to 20% of the amount of the proposed loan incurred before loan effectiveness but not earlier than 12 months before the date of signing of the related loan agreement. IV. DUE DILIGENCE A. Technical 27. Tranche 2 will continue the effort of tranche 1 in addressing constraints in the transmission system and enhancing the network s capacity to absorb expected future loads. The 820 MVA of substation capacity and 660 km of transmission lines will be added to the system. All the grid stations will connect with SCADA, which will enable more stable and reliable power supply. The SCADA component, deploying high-level technology, will support the transformation of the country s electricity sector to meet country s growing economy demand and the changing environment, such as increasing renewable energy power generation. Detailed due diligence, including load flow analysis, cost verification, and technology selection analysis, was conducted to confirm the project as the most optimal design to address the issues. B. Economic and Financial 28. The main benefits derived from tranche 2 are (i) improved service reliability, (ii) reduced transmission loss, (iii) increased flow of power from increased substation capacity, and (iv) expanded network capacity. The analyses compare the incremental costs and benefits of with- and without-project scenarios. 29. The economic evaluation was completed in accordance with ADB s Guidelines for the Economic Analysis of Projects 16 (Appendix 7). An economic internal rate of return of 20.4% justifies the viability of tranche 2. A sensitivity analysis found that the project s economic viability remained robust in the cases of (i) a 10% increase in capital costs; (ii) a 10% decrease in benefits; 16 https://www.adb.org/documents/guidelines-economic-analysis-projects

8 and (iii) a 1-year delay in completion, with the results comparing favorably with the economic opportunity cost of capital of 9.0% in all cases. 30. A financial evaluation was carried out in accordance with ADB s Guidelines for the Financial Management and Analysis of Projects 17 (Appendix 8). Tranche 2 is financially viable, with a financial internal rate of return of 7.60%, which is greater than the weighted average cost of capital at 3.37%. A sensitivity analysis found that the project s financial viability remained robust in the cases of (i) a 10% increase in capital costs, (ii) a 10% increase in operation and maintenance costs, (iii) a 10% decrease in revenues, and (iv) a 1-year delay in completion. 31. The NTDC s operating performance has improved from PRs6.0 billion profit before tax in 2012 to PRs11.0 billion in 2015. Its liquidity has also improved since the activities of the CPPA, which held large outstanding receivables from distribution companies, were transferred to the CPPA-G in May 2015. As a regulated entity, with a regulated rate of return on equity of 15%, the NTDC s financial operation is expected to remain stable throughout the MFF II. C. Governance 32. The financial management assessment for tranche 2 was conducted in May 2017 and the NTDC s pre-mitigation risks are substantial. An action plan was agreed to assist the NTDC in strengthening its financial management. 18 Although the NTDC has significant experience with ADB projects and Procurement Guidelines (2015, as amended from time to time), capacity development and support are required to prevent the delays experienced in previous projects. This will be provided through a strengthened, dedicated PMU, a facility management consultant, and capacity development support. 33. ADB s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and the NTDC. The specific policy requirements and supplementary measures are described in the PAM. D. Poverty, Social, and Gender Dimensions 34. The updated summary of poverty reduction and social strategy is in Appendix 9. Reliable and adequate electricity supply promotes business expansion, increases employment, and improves living conditions, which contribute to poverty reduction. Reliable and good-quality electricity supply is necessary to meet the basic human needs of health and education. Poor and vulnerable consumers, as well as public institutions such as hospitals and schools, are often particularly disadvantaged by inadequate power supply, load shedding, and poor product quality. Tranche 2 will help solve these issues by enabling more reliable and better quality electricity supply. Given the nature of the outputs, tranche 2 is classified as having no gender elements. However, the project will undertake follow-up the actions to meet the government quota of 10% employment of women, which is being supported under supporting component of tranche 1 (Loan 3420-SF). The loan agreement includes standard assurances by contractors on core labor standards (including equal pay for equal types of work) and awareness programs on HIV/AIDS and sexually transmitted infections. E. Safeguards 17 https://www.adb.org/documents/financial-management-and-analysis-projects 18 The World Bank is supporting the implementation of an enterprise resources planning system for the NTDC.

9 35. Environment. The project is classified category B for environment. The environmental assessment and review framework of the MFF II was reviewed and confirmed to remain valid. The NTDC has prepared IEEs for four subprojects in accordance with ADB s Safeguard Policy Statement (2009) and the environmental assessment and review framework. Major anticipated negative environmental impacts of the project relate to soil erosion, noise and dust generation, tree cutting, and occupational health and safety during construction; and electromagnetic fields during operation. The starting towers of the GudduShikarpur section of the GudduShikarpur UchSibbi subproject are located 2 km from the Indus Dolphin Game Reserve, which the subproject will not impact. Adequate mitigation measures are incorporated in the project design and will be implemented through EMPs. The EMPs include capacity building for contractors before construction, during construction, and throughout operation. The project complies with public disclosure and consultation requirements. Public consultations on the subprojects were conducted from July 2016 to April 2017. IEEs were disclosed on the ADB website on 21 June 2017, and will be disclosed locally during public hearings in accordance with national legislation. A project grievance redress mechanism will be established before project implementation. 36. Social. The project is categorized B for involuntary resettlement and C for indigenous peoples. About 40 hectares of private land (20 of which are barren) owned by 16 individual landowners (affected persons) will be permanently acquired for substations. The installation of transmission lines will temporarily impact about 2,830 hectares of cropped area, owned by 923 individual land or crop owners. No tenants, leaseholders, or farm works are involved. The cropped area will be temporarily affected during transmission line construction in three phases: (i) construction of the tower foundation and footing, (ii) erection of towers, and (iii) stringing of wires. No physical displacement will occur under any subproject of tranche 2, but eight of the 16 landowners will lose 10% or more of their productive land. None of the subprojects will impact communities of indigenous populations or ethnic minorities, or interfere with their territories, livelihoods, customary properties, or natural or cultural resources. 37. The MFF II s land acquisition and resettlement framework prepared under tranche 1 was reviewed and confirmed to remain valid for tranche 2. Two draft LARPs for new grid stations that involve the permanent acquisition of private land, one draft resettlement plan for transmission lines that involves only temporary impacts to crops, and one due diligence report for the SCADA and RMS that involves no involuntary resettlement impacts, consistent with the approved land acquisition and resettlement framework and ADB s Safeguard Policy Statement, have been prepared for tranche 2. The NTDC endorsed the draft LARPs and resettlement plan, and they were disclosed on the ADB website on 15 June 2017. The NTDC will update the draft LARPs and resettlement plan when the turnkey contractors finalize the design, and will obtain ADB s approval of the updated or final LARPs and resettlement plan and supervise its implementation. F. Climate Change Impact 38. A climate change risk assessment was conducted with a rating of medium. The main risks to the project are a potential increase in flood levels, landslides, and a rise in temperatures. The risks will be mitigated through a best-practice engineering design, including a $10 million cost in strengthening flood-proof foundations. A summary of the climate change risk assessment and management measures is in Supplementary Appendix A. G. Risks and Mitigating Measures 39. Major risks and mitigating measures are described in detail in the risk assessment and risk management plan (Appendix 12). Adequate mitigation measures were incorporated in the

10 project design. The major risks and mitigation measures for tranche 2 are summarized in Table 4. Overall, the benefits and impacts are expected to outweigh the costs. Risks Regulatory environment: Delayed progress on policy, regulatory, and institutional reforms Procurement: Delays caused by capacity constraints and NTDC s internal bureaucratic procedures Financial reporting and monitoring: incomplete and delayed reports, and manual accounting processes Security uncertainties at some project sites delay implementation Table 4: Summary of Risks and Mitigating Measures Mitigating Measures ADB and other development partners approved the Sustainable Energy Sector Reform Program. Augment PMU staff, simplify internal processes, and use master bidding documents. Supplement with consulting services. Provide capacity building support from the resident mission. Implementation of an enterprise resource management system, being supported by the World Bank a. Continue to engage reputable audit firms to audit financial statements. The NTDC allocates sufficient resources and adopts an effective security management plan based on experience from ongoing projects in Balochistan. Implementation: Delayed NTDC s ADB, along with other major development partners, provides restructuring hampers implementation advice and capacity building to the NTDC. ADB = Asian Development Bank, NTDC = National Transmission and Despatch Company Limited, PMU = project management unit. a World Bank. 2016. National Transmission Modernization I Project (P154987). Washington, DC. Source: Asian Development Bank. H. Risk Categorization 40. Tranche 2 is categorized complex since the loan amount exceeds $200 million. The NTDC is familiar with the proposed investments, and has significant experience in executing ADB-funded projects. V. ASSURANCES 41. The government and NTDC have assured ADB that implementation of the project shall conform to all applicable ADB policies, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the PAM and loan documents. 42. The government and the NTDC have agreed with ADB on certain covenants for the project, which are set forth in the loan agreement and project agreement. No withdrawal shall be made under the loan agreement for goods, works, or consulting services until (i) ADB has received a certified copy of the duly executed and effective relending letter of agreement between the borrower and NTDC; (ii) ADB has received a copy of the audited annual financial statements of NTDC for the fiscal year ending 30 June 2016; and (iii) the PMU has been established and staffed in accordance with the specifications set out in the PAM. VI. RECOMMENDATION 43. On the basis of the approval by ADB s Board of Directors for the provision of loans under the multitranche financing facility in an aggregate principal amount not exceeding $810,000,000 to the Islamic Republic of Pakistan for the Second Power Transmission Enhancement Investment Program, it is recommended that the President approve the proposed tranche as described in para. 19 and such other terms and conditions as are substantially in accordance with those set forth in the draft loan and project agreements for the proposed tranche.