Dscument of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 8523-BD

STAFF APPRAISAL REPORT

BANGTADESH

THIRD RURAL ELECTRIFICATION PROJECT

APRIL 9, 1990

Industry and Energy DivisionCountry Department IAsia Region

This document bas a restricted distribution and may be used by recipient only in the performanee oftbeir offiWial duties. Its contents may not otherwise be disclosed without World Bank authorization.

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BANGLADESH

THIRD RURAL ELECTRIFItVTION PROJECT

CURRENCY EQUIVALENTS

Currency Unit - Taka (Tk)Taka 1.00 - US$0.0295Taka 33.9 - US$1.00Taka 1.00 - Paisa 100

WEIGHTS AND MEASURES

kV - Kilowatt (- 1.341 horsepower)mW Megawatt (thousand kilowatts)MVA - Megavolt-Ampere (thousand kilovolt amperes)kWh - Kilowatt hour (- 860.42 kcals)GWh . Gigswatt hour (million kilowatt hours)kV - Kilovolt (thousand volts)TOE - Ton of oil equivalent (thousand kilograms oil equivalent)kcal = Kilocalorie (- 3.968 British thermal units (Btu))km = Kilometer (0.6214 mile)MCFD - Thousand cubic feet per dayMMCFD - Million cubic feet per dayTCF = Trillion cubic feet

ABBREVIATIONS AND ACRONYMS

ADB - Asian Development BankACRE - Area Coverage Rural ElectrificationBPC - Bangladesh Petroleum CorporationBPDB = Bangladesh Power Development BoardCIDA - Canadian International Development AgencyDCA = Development Credit AgreementlIRR - Economic Internal Rate of ReturnERL - Eastern Refinery LimitedESAC = Energy Sector Adjustment CreditpY - Fiscal YearGOB - Government of BangladeshICB - International Competitive BiddingKFAED - Kuwait Fund for Arab Economic DevelopmentKfW - Kreditanstalt fuer ViederaufbauLCB - Local Competitive BiddingLIB = Limited International BiddingLPG - Liquified Petroleum GasLRMC v Long Run Marginal CostKMEM - Ministry of Energy and Mineral ResourcesNRECAIGC - National Rural Electric Cooperatives Association/Gilbert CommonwealthODA - Overseas Development Administation (UK)OECF - Overseas Economic Cooperation Fund (Japan)OPEC = Organization of Petroleum Exporting CountriesPBS - Palli Bidyut Samity (Rural Electrification Cooperative)REB - Rural Electrification BoardSFD = Saudi Fund for DevelopmentTOR - Terms of ReferenceTFYP = Third Five Year PlanUNDP - United Nations Development ProgrammeUSAID = United States Agency for International Development

REB's Fiscal Year X July 1 to June 30

FOR OFFICIAL USE ONLY

BANGLADESH

THIRD RURAL ELECTRIFICATION PROJECT

CREDIT AND PROJECT SUMMARY

Borrower s People's Rep.blic of Bangladesh

Beneficiary s Rural Electrification Board (REB)

Amount t SDR 79.6 million (US$105 million)

Terms s Standard, with 40 years maturity

Cofinancing s USAID, under an existing commitment until July 199:,and thereafter under an extension to be confirmed byDecember 31, 1990, of the ongoing technical assistancegrant.

Onlendins Terms : The Government of Bangladesh (GOB) would relend theproceeds of the credit to REB for a period of 33 yearsincluding a grace period of 8 years, at a rate of0.752 per annum (capitalized) during the grace periodand 22 during the repayment period. The assets of thecompleted schemes would be transferred by REB to therespective Rural Electrification Cooperatives (PalliBidyut Samities--PBSs) on the basis of sub loans. Thesub loans would be for a period of 30 years. includinga grace period of 5 years, at a rate of 0.75? perannum (capitalized) during the grace period and 32 perannum during the repayment period. GOB would bear theforeign exchange risk.

Project Description t The project would include: (a) installation ofdistribution networks in four new PBSs (Comilla,Dinaipur, Manikganj and Cox's Bazar), all of whichshow good prospects for financial viability;(b) expansion of five existing PBS networks andintensification of existing PBS networks financed byIDA under the First Rural Electrification Project(Cr.1262-BD); (c) rehabilitation of distribution linesand substations to be taken over from BPDB; (d) tech-nical assistance to strengthen REB and PBSs;managerial, financial and institutional performance,and training; and (e) construction of REB centralfacilities (offices, training center and workshop/warehouse).

Risks s No major technical risks are foreseen. The majorimplementation risk concerns possible constraints onGOB's local funds to support the program. This riskhas been mitigated by reducing the program's overallsize, by improved planning and construction super-vision by REB and by extending the implementationperiod from five to seven years.

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World BakQauthorization.

Local Foreign Total

-------(US$ Million)------Estimated Costs

New PBSs 20.2 42.8 63.0PBS Extension/Intensification 11.3 25.8 37.1RiB Central Facilities 8.8 0.5 9.3Technical Assistance and Training 2.0 10.1 12.1

Base Cost 42.4 79.1 121.5

Physical Contingencies 2.1 4.0 6.1Price Contingencies 14.5 18.1 32.6

Total Project Cost al 59.0 101.2 160.2

Interest during Construction 3.3 - 3.3

Total Financing Required 62.3 101.2 163.5

Financing Plans

IDA 19.1 85.9 105.0Cofinancing 2.4 15.3 17.7GOB 40.8 - 40.8

Total 62.3 101.2 163.5

a/ The total project cost net of taxes and duties (US$15.4 million) isUS$144.8 million.

Estimated Disbursements

IDA FY 91 92 93 94 95 96 97 9s

Annual 2.3 10.9 18.8 22.6 22.3 16.1 9.0 3.0

Cumulative 2.3 13.2 32.0 54.6 76.9 93.0 102.0 105.0

Economic Rate of Returns 172

Maps IBRD 22134

BANGLADESH

THIRD RURAL ELECTRIFICATION PROJECT

STAFF APPRAISAL REPORT

Table of Contents

Pase No.1 ENERGY SECTOR

A. Sectoral Importance . ... . . . . . .......... . 1B. Energy Resources and Supply . 1.... . ..... 1C. nergy Consumption ... . * ... .............. 2D. Organization of the Energy Sector .3...... . 3S. Energy Pricing . . . . . . . . . . . . . . . . . . .4F. GOB's Energy Sector Strategy .S........ 5G. Bank Group Involvement in the Energy Sector SH Cofinancing and Donor Coordination ......... 7

II. THE BENEFICIARIESA. Rural Electrification 7

Baclkground . . . . . . . . . . . . . . . .. 7

Future Developments .... . . . . . .... . 8B Rural Electrification Board g...4.. .9

Organisation of RlB .... . . . . . . . . . . . 9Lending Operations to PBSs 9Subsidies . .4. . . . . . .4.4 44 * . . . *.* . *.. 10Scheme Selection and Implementation . . . . . . . 10RIB Supervision and Honitoring of the PBSs . . . 11Impact Evaluation of the RE Program .. 11Coordination between BPDB and REB. 12Transfer of BPDB Lines to PBSs 12Training.. 1* . ... .*. . *. . . * . . .. . **... 13

C. Palli Bidyut Samlties-PBSs (Rural ElectrificationCooperatives) ..*. . .*. . . . . . . . . . .. . . 13Organization Structure .. 13PBS Responsibilities ...... 4... 13Losses in PBSa System. 14Advisory Consulting Services 14

III. THE PROJECTProject Setting .... . . . . . . . . . . 14Project Objectives ........ .... . ..... 15Project Description .... . . .... . . . . . . . 15System Design . .. . . . . . . . . . . . . . . . 16Project Cost . . . . . . . *. . .... .16Project Financing .... . ............. . 18Project Implementation and Consulting Services . . 16Procurement . . . . . *. .. .. . . . . . . . .. . . 19Disbursement ; . * . . . . . . . . . . . . . . . . . 20Developmental Impact . .............. . 21Project Monitoring ... 22Risks . . . . . . . .............. ... . * * .4..... 22

This report is based on the findings of an IDA appraisal mission In December1989 comprising Messrs./Mnes. S. Oushes (Senior Power Engineer), MG. Webb(Principal Energy Economist), S. Mukherji (Financial Analyst), L. Haistre(Consultant, Power Economist) and B. Wu (Consultant, Financial Analyst).Mrs. A. Thornton supervised the production of the report.

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IV. FINANCESA. Rural Electrification Board . . . . . . . . . . . . . 22

Financial Objectives .e................ . 22Past Results and Present Position . . . . . . . . . 22Future Performance ......................... ... 25Accounting Systems and Organization . . . . . . . . 26External Auditing .... . . . ............... . 26Insurance Arrangement . . . . . . . . .. . . . . . 26

B. PBSs . . ........ ;t......................... 27Past Operation lesults ........ .... .. 27Auditing . . . . . . . . . . . . . . ..... . . 28

V. PROJECT JUSTIFICATIONA. Electricity Demand Forecast . . . . . . . . . . . . . 29

Demand Forecast for Rural Electrification Program . 29Demand Forecast for the Project PB$s . . . . . . . 30

B. Least Cost Analysis . ............... . 30C. Economic Internal Rate of Return . . . . . .. ... 31D. Sensitivity and Risk Analysis . . . . . . . . . . . . 32E. Justification of Bank Group Involvement . . . . . . . 33

VI. SUMMARY OF AGREEMENTS REACHED AND RECOMMENDATIONS . . . . 34

ANNEXES

2.1 Bangladesh Historical Growth in Demand Energy Generation and Sales.2.2 Bangladesh Generating Capacity and Energy Forecast.2.3 Bangladesh Maximum Demand and Generation Forecast.2.4 RED Organization Chart.2.5 REB Staffing.2.6 Timing, Cost and Financing of the RE Program.2.7 Selection Criteria for Areas to be Electrified.2.8 Status of Transfer of BPDB Lines to PBSs in Operation.2.9 REB Training Program.2.10 PBS9 Organization Charts.2.11 PBSs Characteristics.

3.1 Project Details.3.2 Project Cost Estimate.3.3 Project Implementation Sc.edule.3.4 Disbursement Profile.

4.1 Past Financial Performance and Financial Projections for REB.4.2 Assumptions used for REB Financial Projections.4.3 Financial Projections for the Project PBSs.4.4 Assumptions used for the PBS Financial Projections.4.5 Key Performance Indicators for Selected PBSs.

5.1 Detailed Analysis of PBS Past Demand.5.2 Economic Internal Rate of Return.

6.1 Data and Documents available in Project File

TABLES

3.1 Project Cost S"uiary.3.2 Project Financing Plan.3.3 Procurement Arrangements.

4.1 REB Operating Performance: FY85-894.2 REB's Projected Operating Performance FY90-954.3 Key Performance Indicators for Selected PBSs--19881894.4 Project PBSs--Projected Operating Performance FY94-2003

5.1 FY82-89 Development of PBSs' Electricity Sales5.2 Demand Forecasts for PY90-2000

TD RURAL IICTRIFiCAMION PROJEOT

STAFF APPRAISAL RIIPOR

1. ENERGY SECTOR

A. Sectoral Importance

1.01 The energy sector plays a key role In Bangladesh's development.Given its severe resource limitations and persistent balance of paymentsconstraints, the country needs an efficient energy sector to promoteeconomic growth, mobilize resources for sector entities and the Governmentbudget, and reduce foreign exchange outlays on energy Imports. However,shortages of local resources, caused lrimarily by the under-pricing ofenergy and inadequate cost recovery actions, and the absence of a coordin-ated plan for channeling foreign assistance to priority investments, haveimpeded the achievement of energy targets. Further, in the past, unreli-able power supply has constrained overall economic growth, and only 82 ofthe population has access to electricity. The Government's Third Five-YearPlan (TFYP) (FY86-90) recognized the need for the energy sector'saccelerated development and earmarked about 162 of total public allocationsfor the sector (para. 1.13).

B. Energy Resources and SUDplY

1.0, Bangladesh's principal commercially exploitable energy resourcesconsist of substant'al reserves of relatively low-cost natural gas andlimited hydropower potential. There are also potential oil, coal and peatresources for which the economic feasibility has yet to be determined,although this is the subject of ongoing studies for coal and oil. Atpresent, substantial quantities of oil are still imported. About 402 oftotal energy supply is from commercial resources, and the remainder is fromtraditional fuels in the form of crop residues, animal dung and wood. InFY87, domestic sources (natural gas and hydropower) accounted for about 602and imported sources (oil and coal) for about 402 of commercial energysupplies.

1.03 Natural Gas and Oil. Natural gas output increased from 45 billioncubic feet (bcf) in FY80 to about 147 bcf in FY89 (14Z annual growth rate).It is now the main source of commercial energy, accounting for about 592 ofsupply compared to 36Z in FY80. Estimated recoverable reserves, all locatedin the east zone, are about 10 trillion cubic feet (tcf), sufficient to meetincremental demand for another 15 years and to supply all existing gas-using projects and those to be commissioned in the 19909 throughout theirdesigned lives. Further, prospects are good for increasing the reserves toat least 15 tcf. The Government of Bangladesh (GOB) has accorded highpriority to these reserves' development: the gas exploration and developmentprogram is reviewed annually with IDA in accord with an agreement under theEnergy Sector Adjustment Credit (ESAC) (Cr.1999-BD). Oil was discovered inthe Sylhet gas field area in 1989; however, it is too early to estimate thefind's full significance. Under the Petroleum Exploration Promotion Project(Cr.1402-BD) GOB prepared promotional packages aimed at attracting

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international oil companies to undertake petroleum exploration. Tnepromotions, which were carried out in London, Houston and Dhaka in June/July1989, were well attended and more than 20 companies purchased explorationdata packages. By January 15, 1990, the closing date for submission of theoffers, however, GOB has received only one offer and is consideringextending the closing date. With these efforts petroleum imports are beingreduced. In FY88 they claimed about 13Z of the country's limited foreignexchange earnings, compared to 242 in FY86.

1.04 Coal and Peat. Several thick coal seams at depths of less than 200meters have recently been located in the Barapukaria area of DinajpurDistrict in the vest zone. With the assistance of consultants funded by theOverseas Development Administration (ODA), UK, GOB is assessing the tech-nical and economic feasibility of mining this coal. The consultants' mid-1988 report estimated total potentially mineable resources of 265 milliontons, with an average he-t value of 11,400 British Thermal Unitsllb.Following the report's review by GOB, ODA and IDA, a full feasibility study,to be completed by December 1990, was initiated. Good peat deposits areknown to exist in the Faridpur and Khulna districts in the vest zone. TheBangladesh Power Development Board(BPDB) is assessing the potential formining and processing peat and installing a small experimental generationplant.

1.05 HYdropower. Bangladesh's hydropower potential is estimated to beabout 1,500 GVh/year, of which 1,050 GWh/year has been developed with theinstallation of 330 MS capacity on the Karnafuli river at Kaptai (nearChittagong). Two other prospective hydro sites have been investigated inthe same area; however, since their development would require the relocationof about 30,000 people, no detailed engineering studies have beenundertaken.

1.06 Traditional Fuels. Per capita biomass supplies are continuouslydiminishing, and Increases in forest-based fuelwood or a major shift tocovmercial fuels are not viable options to meet the supply gap due to thehigh population density and low income levels. However, the substitution ofcommercial fuels for traditional fuels is occurring slowly. It is thereforeimportant for GOB to improve biomass recovery and conversion efficiency,e.g., in cooking stoves, charcoal kilns and other wood-burning equipment.GOB has agreed, under the joint World Bank/UNDP Energy Sector ManagementAssistance Programme, to undertake an inter-fuel substitution study toassess the micro and macroeconomic impacts of substitution and formulate aleast-cost strategy for meeting commercial energy needs. Funding for thestudy is presently beig sought.

C. Energy Consumption

1.07 Bangladesh's per capita commercial energy consumption of about 42kilograms of oil equivalent per annum is among the lowest in the world(about one-ninth of the average for low-income countries). In FY87, grosscommercial energy consumption was about 4.6 million tons of oil equivalent,of which natural gas accounted for 54?, petroleum 38S, hydropower 52, andcoal 3S. However, with the accelerated development of gas supplies, theconsumption of coamercial energy increased rapidly at 10.8? a year duringFY83-87, compared with annual real GDP growth rate of about 4.1?. The GDP/

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commercial energy elasticity was thus rather high at about 2.6, compared tothe average of about 1.1 for all developing countries. The bulk of gasconsumption in FY88 was in power generation (442) and fertilizer production(362); however, other industrial, commercial and domestic uses are expandingsteadily. There is considerable inefficiency in commercial energy use andhence substantial scope for improvement, particularly in industry, petroleumrefining and electric power transmission and distribution. This issue isbeing addressed through the Industrial Energy Efficiency Project(Cr.2942-BD), the Pover Distribution (16 Towns) Project (Cr.2016-BD), andthe proposed Power Distribution and Rehabilitation Project (FY9lS). Totalconsumption of traditional fuels (biomass etc.) declined by 52 during FY83-87, principally because of a sharp fall in the use of rice hulls.Consequently, total energy consumption increased by only 2.4Z a year duringFY83-87, aru t.he overall GDP/energy elasticity was about 0.6, comparable tothat for all developing countries.

1.08 With increased gas availability and GO8's policy of substituting gasfor imported petroleum products, the country's dependence on imported energywas significantly reduced during FY8O-87 from about 60? to 402 of the totalcommercial energy needs. Further, the share of crude oil and petroleumproducts in commercial energy supply declined from 552 in FY80 to 38Z inFY87. However, petroleum products are still a dominant source of energy inthe transportation sector. Despite this decline in the relative importanceof petroleum products and the global decline in petroleum prices, petroleumimports continue to be substantial and claimed about 132 of the country'sforeign exchange earnings in FY88 (para. 1.03).

D. Organization of the Energy Sector

1.09 The principal institutions responsible for energy sector policy are:(a) the Planning Commission, which is responsible for macroeconomicplanning, including the Five-Year Plans and the Annual Development Plans(ADPs), and for approving all capital investments costing more than Tk 5.0million (US$152,000); and (b) the Ministry of Energy and *U;neral Resources(MEMR), which is responsible for overseeing the operations of the fourprincipal publicly-owned energy sector entities which produce, transport anddeliver most of Bangladesh's commercial energy. The entities are BPDB, theRural Electrification Board (REB), Petrobangla, and the Bangladesh PetroleumCorporation (BPC). BPDB is responsible for electricity generation, trans-mission and distribution, except in areas served by REB. REB is responsiblefor the construction of rural electrification schemes and organizing pros-pective consumers into semi-autonomous cooperatives called Palli BidyutSamities (PBSs) which buy electricity from BPDB and distribute it to theirconsumers. Petrobangla is responsible for the exploration, production anddelivery of natural gas and the exploration and development of oil and solidminerals, including coal. Under the ESAC, GOB reorganized Petrobangla as aholding company, holding equi.y in a new set of operationally independentoperating companies established along functional lines for exploration anddrilling, production, transmission and distribution of gas. BPC is respon-sible for purchasing and refining crude oil and marketing petroleumproducts. The refining operation is carried out at Bangladesh's onlyrefinery by Eastern Refinery Limited (ERL), a BPC subsidiary. Liquefiedpetroleum gas (LPG) is bottled and sold to private marketing companies byLPG Limited, another BPC subsidiary. Three other BPC subsidiaries marketpetroleum products and LPG.

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1.10 The exceptions to public sector domination of the energy sector arein traditional energy and in the distribution of petroleum products handledby BPC subsidiaries, which rely primarily on privately-owned road and rivertankers for transport and on private dealers for local retailing. Althoughthe petroleum distribution system is operating satisfactorily, the expectedfuture growth in demand for cometc±al energy may stretch the system'scapability to meet demand efficiently. Consequently, there may be scope forincreasing private sector participation. Private sector participation isalso being encouraged in other areas of the energy sector. Private sectorinvolvement in the distribution of LPG in Ehulna is being promoted under theRefinery Modification and LPG Recovery and Distribution Project (Cr.1749-BD);this private asector role will be enhanced under the proposed Bakhrabad LPGRecovery and Distribution Project (PY91). Further, GOB is seeking toincrease private oil exploration through promotional packages under thePetroleum Exploration Promotion Project (Cr.1402-BD) (para. 1.03).

E. Energy Pricing

1.11 GOB's key energy pricing policy objectives include economicefficiency, resource mobilization and equity. Accordingly, it has beenIncreasing energy prices to reflect the costs to Bangladesh of meetingconsumers' energy requirements, while minimizing the adverse effects on low-income consumers. In accordance with this policy, gas prices were increasedby an average of 18? annually during FY86-90. In FY90, the average gasprice is about Tk 43.5/MCF, which is slightly abov- the estimat.. long-runmarginal cost (LRMC) of supply (Tk 40.0/MCI). In accordance with itsefficiency and resource mobilization objectives, GOB agreed under the ESACto ensure that the weighted average domestic price (net of distribution,marketing and other handling costs) is always at least 115? of the borderprice. In December i989 this ratio was 111, marginally below the agreedlevel.

1.12 Turning to electricity prices, BPDB's tariff rates for each consumerclass are unifom throughout Bangladesh, while each PBS sets its own tariffrates with the approval of REB. Electricity tariffs have been raisedfrequently in recent years. During FY80-90, BPDB's average tariff rateswere increased at an annual average rate of about 12.52 in nominal terms andabout 2.52 in real terms, with a total increase of about 28? in real terms,while rates for energized PlSs were increased at average annual rates of 13?in nominal terms (4? in real terms) during FY84-90. BPDB's average tariffis now Tk 2.16/kWh and that for PBSs is Tk 2.60/kWh.

1.13 Under the Second Rural Electrification Project (Cr.1633-BD) and thePower Transmission and Distribution Project (Cr.1648-BD), GOB, BPDB, and REBagreed to carry out a tariff study based on LRMC and to Implement agreedrecommaendations. Coopers and Lybrand Associates Ltd. (UK), completed thestudy In August 1986 and highlighted various deficiencies, including anexcessive number of tariff categories, tariff rates lower than the economiccosts of supply, significant cross-subsidization, an-d little incentive toreduce consumption during the system's peak period. Based on the tariffstudy, GOB reformed power tariffs in early FY88. For BPDB, a new simplifiedtariff was introduced In August 1987. The number of tariff categories wasreduced from 19 to 10; new two-rate time-of-day tariffs for 33 kV and 11 kVconsumers and an optional time-of-day tariff for large low-voltage consumers

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were i 'tced; and the sizes of the subsidized blocks of energy forresidenti. consumers were greatly reduced. In the PBSs, tariffs forresidential consumers were changed from a constant rate to three blockIncreasing rates to limit electricity consumption at heavily subsidizedrates. The new tariff structures greatly improved the signals whichelectricity prices give to consumers &bout the costs to Bangladesh ofmeeting their consumption requirements. In addition to the restructuring,PBSs' average tariff rates were increased by about 251 on July 1, 1987, andon August 1, 1987 BPDB's tariffs were increased by about 17X. Subsequently,electricity tariffs for all consumers were increased by about 32 on July 1,1988 as a result of the FY89 gas price increase. Further, effective July 1,1989, PBS tariffs were increased by about 11?, and BPDB's tariffs wereincreased by about 7.51. The FY90 tariff increase was accompanied by adoubling of the kWh excise tax rate to Tk 0.10 to mobilize resources for theBudget. Following these tariff Increases, BPDB's overall average tariffrate is about 70? of LRHC, and that for PBSs is about 562 of LRMC. BPDB'stariff rates for supplies to industrial, commercial and large (above 200kVhlmonth) residential consumers esceed LRNC while the tariff rates forsmall residential consumers and bulk rates to PBSs are below LRMC. Despitethe series of tariff increases, neither BPDB nor most PBSs have been able tomeet their financial covenants (paras. 4.01 and 4.11).

F. GOB's Energv Sector Strategy

1.14 Recognizing the importance of improving energy supplies to meetforecast demand, GOB accorded high priority to the energy sector in the TFYP(para. 1.01). The TPYP's principal energy objectives are to: (a) acceleratethe development of domestic natural gas resources to reduce the country'sdependence on imported oil; (b) improve the reliability and quality of powersupply and reduce power system losses; (c) improve energy use and efficiencythrough conservation measures and appropriate pricing policies; (d) meetenergy demands at least cost to the economy; (e) improve the energy sectorentities' performance; and (f) encourage the private sector's participationIn the energy sector, particularly in gas and oil exploration. Followingdonor-funded studies, GOB has implemented, with some measure of success,agreed recommendations regarding policy changes, capital investments,pricing decisions and resource mobilization (paras. 1.09 to 1.12). However,due to over ambitious and uncoordinated investment plans and local currencyconstraints, implementation of capital investment programs have notproceeded as planned. To underscore its commitment to the sector's develop-ment, GOB allocated Tk 61 billion (US$2.0 billion equivalent) at FY85 pricesfor energy investments under the TFYP. Energy accounts for 162 of the totalplan allocation, compared with about 12? under the Second Five-Year Plan,and is exceeded only by the allocation to the agricultural sector.

G. Bank Group Involvement in the Energy Sector

1.15 Lending in the power and gap subsectors has been designed to:(a) strengthen investment planning to meet forecast demand for gas andelectricity at least cost, (b) improve sectoral institutions' performanceand provide training, (c) optimize the use of available energy resourcesthrough appropriate energy pricing and conservation measures, (d) appraisediscovered gas fields and optimize their development, and (e) attractprivate capital to intensify oil exploration.

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1.16 Since 1973 IDA has supported GOB's energy strategy through 13credits, amounting to US$858 million equivalent, representing about 152 ofIDA resources committed to Bangladesh. Seven of the credits were for powerprojects aggregating to US$390 million, while the remaining six credits,totalling US$305 million, were for other energy projects. The credit forthe Greater Khulna Power Distribution Project (Cr.934-BD) was closed onJune 30, 1986. The project completion report, which will be issued in mid1990, shows that changes in design and procurement delays occurred due toinadequate system studies and detailed design. Based on that experience.BPDB has strengthened its planning and design organizations to ensure thatall major system studies and bid documents are prepared in a timely manner.Except for the procurement problems in the Project's initial stages, BPDB'sproject implementation was satisfactory. Implementation of the AshuganjPower Project (Cr.1254-BD) was very good; the project was completed ahead ofschedule and below the estimated cost. Both projects generated the expectedbenefits and contributed to the power subsector's more efficient develop-ment. Implementation of the Rural Electrification Project (Cr.1262-BD) isnearly complete and all the seven rural electrification cooperatives (PBSs)financed under the project are in operation. The Second RuralElectrification Project (Cr.1633-BD) is under implementation with ascheduled completion by 1991/92. Both projects are about 12 to 18 monthsbehind the schedule envisaged at appraisal. REB and PBSs' financialperformance have been unsatisfactory mainly because of improper financialpolicies, non transfer of BPDB lines and customers to PBSs in rural areas,and lack of coordination between BPDB and REB. These issues will beaddressed under the proposed Project (paras. 2.14, 2.15 and 4.03).

1.17 Although considerable progress was achieved through the aboveprojects, they did not provide an effective means to rationalize the entireenergy investment program and address issues affecting the overall organiza-tion of Bangladesh's power and petroleum subsectors. Thus during FY87, GOBand IDA developed a comprehensive energy sector program, including invest-ment planning, institutional development, and energy pricing and resourcemobilization, to be implemented under the ESAC. The ESAC was made effectivein June 1989 and all of the first tranche was released by December 31, 1989.A second tranche review mission visited Bangladesh in that month. AlthoughGOB had made substantial progress in meeting the release conditions,especially concerning energy pricing and the reduction of power systemlosses, IDA decided to delay the second tranche release pending satisfactionof other agreements. Based on recent progress, the release could occur byJune 30, 1990. Since the ESAC provides a policy framework for investmentprojects, they need relatively few, mainly project-specific, conditions toensure their effective implementation.

1.18 Under the ESAC, it has been agreed that new capital investmentswould be focused on priority projects under an agreed three-year rollingPriority Investment Program (PIP). GOB has included this Project in the PIPfor FY90-92 since GOB accords high priority to improving the econouicconditions of the rural population and to furthering the substitution ofindigenous energy (basically electricity generated using natural gas) forImported petroleum products.

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H. Cofinancing and Donor Coordination

1.19 Under Cr.934-BD, Cr.1254-BD, and Cr.1586-BD, there has been sig-nicant cofinancing between IDA and the Asian Development Bank (ADB),Ireditanstanlt fuer Wiederaufbau WKfV), Canadian International DevelopmentAgency (CIDA), Kuwait Fund for Arab Economic Development (KFAED),Organization of Petroleum Exporting Countries (OPEC), and the United NationsDevelopment Programme (UNDP). Furthermore, during the preparation of theESAC, donors representing twelve major bilateral and multilateral agenciesattended several coordination meetings. This coordination resulted in KfWcofinancing the ESAC. There was no cofinancing under Cr.1262-BD andCr.1633-BD since the various donors involved in the RE program providedfinancing under parallel operations (para. 2.03). However, despite the factthat the schemes were carried out in parallel, coordination among the donorswas good and led to adopting uniform onlending terms and consistentfinancial covenants for all the RE projects.

II. THE BENEFICIARIES

A. Rural Electrification

Background

2.01 Although in 1976 over 902 of Bangladesh's population lived in ruralareas, and agriculture accounted for nearly 601 of its gross domesticproduct and employed over 751 of the labor force, less than 31 of the ruralpopulation had access to electricity. At that time, GOB decided to extendthe public supply ef electricity to rural areas to improve the quality oflife of the rural population and stimulate economic growth through thedevelopment of agriculture and small-scale agro-industries. Following thatdecision, GOB created REB in 1977 to carry out a national program of ruralelectrification (para. 2.06). In 1978, a comprehensive rural electrifi-cation master plan was developed by RED, with assistance of USAID-financedconsultants, National Rural Electrification Cooperative Association andGilbert Commonwealth (NRECAIGC). The plan envisaged the country-wide ruralelectrification in five phases by year 2000. Because of resourceconstraints the target date for program completion is now 2005 and may bedelayed further.

2.02 Rural electrification under the plan is based on the concept of'Area Coverage Rural Electrification' (ACRE), involving the design of abasic distribution system to provide a backbone system that can cater forrapid increases in the number of consumer connections. The ACRE conceptinvolves the development of autonomous member-owned rural electric coopera-tives (PBSs), each of which covers an area of 900-1,300 square km. and hasbetween 20,000 and 30,000 members. Each PBS includes three to fiveupazilas, which are administrative districts. The formation of PBSs hasbeen progressing smoothly under REB guidance and its consultants, althoughit involves a lengthy and laborious process at the local level in insti-tution building and training. The PBSs are subject to supervision andcontrol by REB, which is the lending and construction institution.

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2.03 The rural electrification master plan envisages the creation of 62PBSs by FY200S. Phase I was completed in 1986, Phase II is expected to becompleted in 1989, and Phase III is now underway with scheduled completionin 1992193. These three phases cover about 402 of the geographical ruralarea with a population of 31 million. Phase I was financed by USAID(US$69.3 million for 13 PBSs), IFARD (US$30.0 million for 8 PBSs), and ADB(US$7.2 million for the expansion of 2 PBSs). Phase II is being financed byIDA (US$48.0 million for 7 PBSs under Cr.1262-BD and Cr.l504-3-BD), USAID(US$50.0 million for 4 PBSs), and Finland (US$5.7 million for 1 PBS).Phase III, comprising the formation of 7 new PBSs and the extension andintensification of the Phase I and 1I PBSs, is under construction withfinancial assistance from IDA (US$79.0 million for 7 new PBSs and extensionof 5 existing PISs under Cr.1633-BD), USAID (US$60.0 million for theintensification of the 17 PBSs financed under their previous projects), CIDAand Saudi Fund for Development (SFD) (US$28.0 million and US$15.0 millionrespectively, for the extension of 8 Phase I PBSs financed by KFAED), andFinland (US$4.4 million for the augmentation of 22 existing substations).

2.04 By June 1989, 33 PBSs under Phases I and II had been connected tothe grid and were supplying over 396,000 consumers, of which 315,000 weredomestic, 56,000 commercial, 14,400 irrigation, 7,600 industrial and 3,000others (including public lighting). In FY89, total electricity sales were372 GWh (about 10 of BPDB sales) and were divided as follows: domestic/others 25S, industrial/commercial 502, and irrigation 252. Annex 2.1 giveshistorical growth in demand, energy generation and sales for Bangladesh, andshows the relative contribution of PBSs' consumption. While the sales havebeen significantly lower than that projected under the Second RuralElectrification Project, the average annual growth rate was 43Z during FY83-89. A major reason for the lower than forecast sales has been BPDB's delaysin providing power supply to newly constructed PBSs substations and inhanding over BPDB lines with associated customers to PBSs (para. 2.15). Theseven new PBS6 under Phase III have been organized and most of them areexpected to commence operation in 1990/91.

Future Developments

2.05 GOB is now considering the implementation of Phase IV of theprogram. In June 1988, REB completed the prefeasibility study for thisphase to cover an area of about 60,000 sq km. in 206 upazilas, includingabout 800,000 new connections. It identified 19 areas for the formation ofnew PBSs and 22 areas for annexation to existing PBSs. However, consideringthe economy's absorptive capacity and the ongoing program's scale, inFebruary 1989 MEHR reduced the program to 110 upazilas with 11 areas wherenew PBSs would be formed and 19 areas which would be annexed to existingPBSs. The Phase IV program is now planned to cover about 32.000 sq km. ofrural areas and provide service to about 435,000 consumers. Its estimatedcost is about US$350 million, including about US$250 million in foreigncurrency. It is planned to start in FY91 and to be completed by 2000. Inaddition to IDA financing for Phase IV-A, GOB is seeking additionalfinancing for Phase IV-B from ADB, IFAED, Japan, SFD and Finland. Annexes2.2 and 2.3 show forecast to year 2000 of BPDB generation capacity as wellas the impact of future sales to REB.

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B. Rural Electrification Board

Organization of REB

2.06 REB and PBSo are the proposed Project's prospective beneficiaries.RED is a government entity which was formed in 1977 with dual respon-sibilities as the implementing agency for constructing RE schemes and thefinancial intermediary and supervising agency after completed scheues arehanded over to the P8Ss (para. 2.11). It is responsible for the initiation,planning and implementation of rural electrification schemes within theframework of the rural electrification master plan. Its specific responsi-bilities include: (a) arranging finance for rural electrification schemes;(b) constructing new distribution systems and rehabilitating existingschemes; (c) organizing prospective consumers into PBSs and prescribingtheir by-laws; (d) establishing PBSs' technical and administrativestandards; and (e) approving their tariffs. Although RED's Ordinance alsoallows it to generate electricity to supply rural areas, it has not done soand has no firm plans to construct power stations. RnE's managementconsists of a chairman, three full-time members and four part-time members.GOB determines the chairman and members' period, terms and conditions ofappointment. REB's organization and staffing charts are shown inAnnexes 2.4 and 2.5. IDA considers its structure appropriate for REB'sactivities and objectives. Since the rural electrification program'sinception, NRECA, under financial assistance from USAID, has been supportingREB's development as a viable and effective organization. MRECA's contractwill expire on July 31, 1991; however, GOB has requested USAID to finance afive-year extension of NRECA's contract (para. 2.21).

2.07 The fragmentation of REB's headquarters in Dhaka in 16 rentalbuildings impedes effective management coordination and high productivity.Further, REB is considering computerizing some of its activities andrationalizing its working environment. The availability of suitable centraloffice facilities would greatly improve REB's productivity and effective-ness. Also, PBSs' increasing demands for maintenance repair services couldbe met at least cost by establishing a central, fully equipped REB workshop.To address these issues the proposed Project includes new headquartersoffices for REB, together with a new training center and workshop/warehousefacilities (para. 3.04(g)).

Lending Operations to PBSs

2.08 As of June 30, 1989, REB's investment in the rural electrificationschemes was Tk 7.8 billion (Annex 2.6). About 72S ox the financing require-ments were provided by external sources (para. 2.03), with the balance of28X covered by GOB contributions. To mobilize resources within thesubsector for the RE program's future phases, REB acted as a financialintermediary, administering funds allocated to the RE program. Uponcompletion and transfer of a scheme to a PBS, REB onlends the constructioncost of the scheme to the PBS. In the early years, onlending terms weredifferent for the various sources of financing. However, since 1983 allonlending arrangements have followed onlending terms first introduced underIDA Cr.1262-BD. Under these terms, Government contributions to the REprogram are passed on to REB as equity, while external financing obtained bythe Government is ='Aent to REB with a maturity of 30 years, including a

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grace period of 5 years, at an interest rate of 0.752 p.a. during the graceperiod and 21 p.a. thereafter. When a completed RE scheme is transferred toa particular PBS, the entire construction costs of the scheme are passed tothe PBS as a loan with a maturity of 30 years, Including a grace period of 5years starting from the date of PBS registration, at an interest rate of0.75Z p.a. during the grace period and 32 p.a. during the repayment period.In both cases, interest during the grace period is capitalized and added tothe loan principal. As of June 1989, REB had made loans of Tk 7.2 billionto PBSs.

Subsidies

2.09 The rural electrification program is subsidized in three ways:(a) through an operating subsidy during the first five years of a PBS'slife; (b) through the bulk supply tariff (BST) since the rate is below LRHC;and (c) through grants and soft onlending terms on loans to financeinvestment. Two of these subsidies, (a) and (b), are of limited duration.The operating subsidy only supports PBSs during their infancy, and the BSTsubsidy is being eliminated gradually through the phased increase of the BSTrate to LRMC. The subsidy inherent in the onlending terms is justified bythe fact that rural electrification program is of national interest and hasa high economic internal rate of return, although it requires a subsidizedinterest rate to be financiallv viable. However, in future such subsidieswould be limited and the PBSs Lhould be able to generate part of the fundsneeded for the RE program's expansion. GOB/REB agreed under the proposedProject that the individual performance agreements (para. 2.11) wouldinclude shorter repayment periods for those P8Ss whose cash position, aftermeeting operating expenses, debt service liability and payments into thereplacement reserve fund, would enable advance payments to be made againstthe debt service liability.

Scheme Selection and Implementation

2.10 To determine priorities under Phase IV-A, BEB selected 11 areasaccording to a rating system that -mphasiz-s existing infrastructure,availability of power supply and roads, ?Ad potential number of customers.The ranking approach, which was also us.,d in Phases I-III, is discussed inAnnex 2.7. For the proposed Project, GOB agreed to carry out ten-yearfinancial projections of the 11 candidate PBSs and to select only thoseshowing good prospects for financial viability. Following IDA appraisal ofthe proposed Project, a Project Proforma containing details or projecttargets, physical facilities, proposed financing and cost benefit analysisis prepared by REB. GOB's procedures require the Project Proforma to bereviewed by the Project Evaluation Committee (PEC) of the PlanningComuission and to be approved by the Executive Committee of the NationalEconomic Council (ECNEC). To ensure that project implementation would notbe delayed while obtaining necessary GOB approval and clearances, draftProject Proforma for the proposed Project were prepared by REB and approvedby PEC as a condition of negotiations. A condition of Credit effectivenesswould be GOB's approval of the final Project Proforma.

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REB Supervision and Monitoring of the PBSs

2.11 REB is responsible for the initial promotion of PBSs and exercisesstatutory control over them. This includes the supervision of their opera-tions, assiating with the implementation of technical and administrativecontrol systems which RUB has developed for the PBSs, and training PBSs'staff. Pollowing REB's implementation of a project, schemes are handed overto the newly created PBSs. REB lends the initial cost of the scheme,secured by a mortgage, to the PBS, provides loans to cover their workingcapital requirements, and arranges finance for PBSs' expansion. During thefirst five years of operation, an operating subsidy is provided by GOB.Under the uniform onlending agreement, all the PBSs, after the first fiveyears, are expected to earn sufficient revenue to cover operating expenses,including depreciation, and generate, after debt service and provision ofincrease in working capital, a surplus equivalent to at least 202 of annualcapital expenditure after the sixth year of operation. PBSs' actualfinancial results as well as projections made by Coopers and LybrandAssociates (C&LA) (para. 2.12) indicate that PBSs' financial performancewill vary widely, and that it would be more appropriate to set specifictargets in the form of Performance Agreements. During negotiations it wasagreed that REB will introduce procedures for the annual determination ofPerformance Agreements with individual PBSs, that it vould satisfactorilyenforce such Agreements and would each year monitor, to the Association'ssatisfaction, PBSs' performance against the targets. The financial targetswould include the year in which revenue should cover operating costs, debtservice, the level of self-financing to be achieved each year, accountsreceivable, accounts payable and system losses. It is anticipated that sometargets, such as those for operations and maintenance costs would be set atcommon levls for all PBSs. REB has established a Financial Planning Cellto prepare financial projections for existing and proposed PBSs using amodel developed by C&LA. For REB, the Financial Planning Cell would be incharge of preparing, negotiating and monitoring the Performance Agreementswith the PBSs. The Performance Agreements would include a target onaccounts pavable for power purchases, namely that such purchases would notexceed the total billed consumption of the preceding two months. Further,the agreement would include a target for accounts receivable which shouldnot exceed 3 months' average billing of the twelve preceding months (theseasonal effect of irrigation being taken into account). The introductionof Performance Agreements for all energized PBSs would be a condition ofeffectiveness of the proposed credit.

Impact Evaluation of the RE Program

2.12 REB has set up an Evaluation Cell in its Program PlanningDirectorate to assess the impact of completed rural electrification schemeson rural communities. A study of the 12 Phase I PBSs financed by USAID wascarried out in 1983 by REB's Evaluation Cell, USAID and Dhaka University'sInstitute of Statistical Research and Training. Further, an exploratorystudy of small scale industrial and commercial development in four PBSs wascarried out by the Bangladesh Center for Advanced Studies in 1988. Thestudy assessed the socio-economic changes which have occurred in ruralcommunities as a result of electrification. A comprehensive assessment ofthe RE program's overall developmental impact, including the strengtheningof REB's evaluation cell, is being carried out with USAID assistance. The

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results of the various studies indicate that ACRE program's major objectivesare being realized. However, many erergized PBSs are not financiallyviable. To address this issus, in 1988 USAID appointed consultants (C&LA),to study i.3s' financial policies and performance. The study concluded thatalthough the RE program as a whole could be financially viable, individualPBSs' financial performance would vary widely depending on consumer mix anddensity. The study made several recommendations to improve REB/PBSs'financial viability, which are being implemented by GOB/REB under thisProject.

2.13 NRECA prepares annual evaluation reports on the RE program'simplementation. The most recent report, covering 1988, identified a numberof problems* including the need to improve power supplies to PBSs, delays inhanding over BPDB's lines to PBSs, shortage of local currency for projectimplementation, and the need for a new headquarters complex for REB toimprove staff productivity and efficiency. These problems are beingaddressed under the proposed Project (paras. 2.07 and 2.15).

Coordination between BPDB and REB

2.14 Although BPDB's member (Distribution) is a part-time ex-officiomember of REB's Board, coordination between REB and BPDB has been ineffec-tive. Because BPDB has not supplied power to some substations constructedby REB under Phase II and III for long periods of time, newly constructedPBSs' distribution networks could not be energized. Although these problemswere anticipated under the Second Rural Electrification Project, BPDB failedto expand its transmission and distribution capacity in a timely manner toprovide reliable power supply to PBSs. Coordination between REB and BPDB atthe operation level needs to be improved to ensure that REB's expansionprogram ic consistent with BPDB's plans,and that PBSs participating in theproposed Project receive adequate power on time. As a condition ofnegotiations for the proposed Proiect. a joint MEMRtREB/BPDB engineering andplanning group has been created and is operational. A list of BkDBsubstations which need to be upgraded to provide timely supply to the PBSshas been prepared jointly by BPDB and REB.

Transfer of BPDB Lines to PBSs

2.15 In the planning of PBS distribution networks, REB assumes, inaccordance with the 1977 RED Ordinance, that existing BPDB 11 kV lines andcustomers within the PBSs areas would be handed over to the PBSs. AlthoughBPDB has handed over about 3,750 km of lines, there is a backlog of about1,700 km to be handed over (Annex 2.9). Further, several PBS villagesalready equipped with distribution networks cannot be energized because theBPDB lines, which are part of the supply system, have not been transferred.During negotiations a dated action plan for the transfer of BPDB lines toPBSs was agreed with GOB and about 500 km of BPDB lines have already beentransferred to PBSs. The actual handing over of the remaining 1,200 km ofthe backlog would be a condition of Credit effectiveness. To avoid thisproblem in the project PBSs, during negotiations it was agreed that theproiect areas would be surveyed and a dated program prepared for BPDBhandover of lines and customers before the start of project implementation.

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Training

2.16 REB's training program is designed to meet its own requirements.together with those of PBSs and local construction and consulting firmswhich are implementing the rural electrification program. Between July 1980and June 1989 it trained about 14,700 persons in courses designed andsupervised by NRECA (Annex 2.10). Its training programs have enabled REB toovercome a shortage of linesmen in PBSs which had earlier hindered consumerconnections. By June 1989, about 725 PBS employees had participated intraining courses for linesmen. REB, with assistance by NRECA, has alsoinitiated training in Rot Line Maintenance. A comprehensive trainingprogram and the teaching of working procedures has enabled the PBSs tomanage their technical operations efficiently. Wbile REB's training programis challenging when judged in terms of the number of persons to be trainedand skills to be developed, to date it has been successful in meeting itsobjectives. However, the lack of a centrally located training center withadequate physical facilities for conducting technical training programs,continues to hamper the Training Directorate efficient functioning. Thisissue vould be addressed through the construction of training facilitiesunder the proposed Project (para. 2.07).

C. Palli Bidyut Samities (PB88 (Rural Electrification Cooperatives)

Organization Structure

2.17 The PBS system consists of member-owned autonomous cooperatives forelectricity distribution in rural areas. A PBS's initial Board of Directorsis selected from local citizens, subject to the approval of REB's Board ofDirectors. After their appointment the directors register the PBS with REB,which then proceeds to promote PBS membership among potential consumers.The Board of Directors consists of 10-15 members elected by an annualmembers' meeting. Eligibility to become or remain a director includes beinga bona fide member of a PBS and a resident of its area. Any person ororganization in a PBS area may become a member of the PBS followingacceptance by the Board of Directors and payment of the membershipapplication fee of Tk 10.

2.18 The typical organizational structure for PBSs was developed by REB,with NRECA's assistance. Two sample organizational charts have beenprepared as flexible models to meet different levels of activity(Annex 2.11). The chief executive, the General Manager, is accountable tothe Board of Directors. Four main departments, each headed by an AssistantGeneral Manager, are responsible for extension and member services, finance,construction and maintenance, and general services. In each PBS fivepositions are reserved for female advisors to the PBS Board, who serve aschannels for expression of women's development needs in PBS areas. Theorganization structure has been reviewed by IDA and found satisfactory.

PBS Responsibilities

2.19 A PBS's responsibilities begin when a scheme is handed over afterconstruction and energisation. A PBS's principal objective is to supply itsmembers and other consumers with electricity. Its functions includes(a) distribution of electricity and making consumer connections; (b) meterreading, billing and collection; (c) purchase of electricity from BPDB;(d) planning and implementing the expansion of local distribution systems

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with REB's financial and technical assistance; and (e) technical andfinancial aosistance to consumers for wiring their premises, acquiring andinstalling electrical appliances, and improving their power factors throughthe installation of capacitors.

Losses in PBSs Systems

2.20 System losses are a problem for most PBSs. In June 1989, systemlosses in 5 out of the 17 PBSs which had been energized for at least fouryears were about ten percentage points higher than the anticipated levels,namely that losses would not exceed 252 in a PBS's first year of operations,202 in the second year, 152 in the third year, and lOZ in subsequent years(Annex 2.12). To identify the causes of losses and introduce appropriateremedial measures, in 1988189 R8B with NRECA's assistance, carried out astudy to determine the causes of high PBS losses. The study determined thatfrom year five, a typical PBSs' technical losses should generally be about71 to 10X. The remaining losses are non-technical in nature, resulting fromillegal connections, improper meter reading or outright corruption. Duringnegotiations, dated loss reduction targets to be incorporated in thePerformance Agreements were agreed with GOB/R8B (para. 2.11).

Advisory Consulting Services

2.21 The first agreement with NRECA, financed by USAID, to providegeneral institution building and technical consulting services to REB andPBSs, was signed in February 1978. Among other things, NRECA assisted insetting up PBSs' accounting and operating systems, which IDA considersappropriate. The initial const?lting services agreement with NRECA expiredIn July 1984 but was extended initially to July 1987 and subsequently toJuly 1991 under USAID financing. However, in 1991 RIB and PBSs will stillrequire institutional strengthening and technical consulting services(para. 3.08). During negotiations REB agreed to continue to employ, underterms and conditions acceptable to IDA. consultants to review technicalspecifications, supervise construction, and assist REB and PBSs indeveloping their technical and institutional capabilities (para. 3.08).

III. THE PROJECT

Project Setting

3.01 GOB attaches great importance to the scheduled completion of theongoing rural electrification program by FY2005 (para. 2.01). However,because of resource constraints, GOB is focusing on the intensification ofservice connections within existing PBS areas to improve existing PBSs'financial viability, and expansion of the backbone system to new areas. Theproposed Project consists of the first part of Phase IV (Phase IV-A), whichwould start in 1991, when major works under Phase III have been completed.It comprises the installation of new electricity distribution networks infour proposed PBS areas; rehabilitation of existing distribution networks inthose areas; expansion of five PBSs and intensification of the networks inseven existing PBSs; and technical assistance to strengthen REB and PBSs'financial and institutional performance. GOB is approaching other donors tofinance Phase IV-B of the program (para. 2.05).

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Proiect Objectives

3.02 The Project's main objectives would be to substitute power at leastcost for imported petroleum products and to strengthen REB and PBSs'performance byt (a) expanding existing distribution networks to unservedareas; (b) rehabilitating systems which REB would take over from BPDB;(c) reducing system losses; and (d) improving PBSs' financial viability andinstitutional performance by increasing the density of connections andmodifying accounting practices. It is anticipated that the Project, by itscompletion date, vill extend the public electricity supply to about 122,000domestic consumers, 20,000 commercial consumers, 2,900 industrial consumers,and 5,600 irrigation pumps.

Project Description

3.03 The proposed Project would consist of the supply and installation ofthe necessary equipment and material and the associated engineering servicesfor the implementation of Phase IV-A of the Rural Electrification program.It would include: (a) the installation of new distribution networks in fournew PBSs (Manikganj, Comilla, Dinajpur and Cox's Bazar); (b) expansion offive existing PESs' networks to include seven new upaxilas (Rangpur PBS-1,Rangpur PBS-2, Pabna PBS-1, Meherpur PES and Kushtia PBS); (c) intensifica-tion of seven PBSs financed by IDA under the First RE Project (Cr.1262-BD);(d) rehabilitation of existing BPDB lines and substations to be taken overby PBSs; (e) construction of central facilities for REB (offices, trainingcenter and workshop/warehouse); (f) consultant services to assist REB inproject engineering and construction supervision; and (g) technical assis-tance and training to strengthen the managerial, financial and institutionalaspects of both REB and the PBSs.

3.04 The proposed Project (details of which are given in Annex 3.1) wouldconsist of the following components:

(a) construction of about 6,035 km of 33 kV and 11 kV three phase andsingle phase primary lines, and about 3,015 km of 4001230 voltssecondary lines;

(b) construction of 18 substations 33111 kV of 10 MVA each and upgradingof 6 substations;

(c) service materials for consumer connections including serviceconnections, meters and LT capacitors;

(d) support commodities consisting of vehicles, motor cycles, tools,communications equipment, boats, etc.;

(e) rehabilitation of about 850 km of existing 33 kV, 11 kV and lowvoltage lines and distribution substations now operated by BPDB butto be taken over by PBSs in the areas included in the proposedProject;

(f) general plant for the PBSs consisting of local transport, office andresidential buildings, including cost of land and office equipment;

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(g) infrastructure and support faciliti.. for REB consisting ofheadquarter offices (10,000 square me-ers), training center,workshop and warehouse facilities (12,700 square meters); and

(h) consulting services to assist REB and the PBSs in project executionand management, including upgrading of technical and financialskills.

System Design

3.05 The system design was selected in 1978 for the program as a wholeafter evaluating alternatives for the primary voltage (11 kV vs. 33 kV),types of poles, types of conductors, and three phase vs. single phaseexpansion. It was found that 11 kV was the least cost primary voltage forboth three phase and single phase lines, together with both three phase andsingle phase transformers. ACSR conductors mounted on wooden poles wereselected as the least cost design for the lines. The basic design willcontinue to be used for the proposed Project following its successful use todate. Although some modifications have been introdsiced to take account ofexperience learned from specific site conditions in Bangladesh, Includingthe need for further actions to be taken--both through design and operation--to reduce system losses. A priority action is to raise the system powerfactor to the level of 0.90 and the proposed Project includes procurement ofLV capacitors of various size and pole-mounted 11 kV capacitors. Duringnegotiations REB agreed to submit no later than December 31, 1990 a datedprogram, satisfactory to IDA, to install capacitors on both the 11 kV and LVsystems to ensure that the power factor does not fall below 0.90.

Pro]ect Cost

3.06 The Project's estimated cost, including physical and pricecontingencies, duties and taxes, is US$160.2 million based on mid-1989prices. It comprises US$101.2 million on foreign exchange, and US$59.0million in loca)l costs, including US$15.4 million in taxes and duties.Physical contingencies of 5S are assumed for equipment, materials andservices on the basis of previous experience with rural electrificationprojects. Price contingencies for foreign costs are assumed at 4.9S eachyear from 1990 to 1995 and 3.7S each year thereafter. Price contingenciesfor local costs are assumed at 10 for FY90, 91 for PY91, 8S for FY92 and 72each year thereafter. The cost estimates are summarized below and presentedin detail in Annex 3.2.

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Table 3.1: PROJECT COST SUIOARY

Local Forelgn Total LocaI Foreign Total Foreign Exchange Cost(r*io htillon)(USS Million) (U)

A. Now PBSn

Line Material ^/ 296.1 1202.? 1497.3 6.7 1C.4 44.1 s0Substation Matorial & a4.5 140.4 174.9 1.0 4.1 5.1 s0Support Comoditie 10.2 05.9 02.1 0.5 1.9 2.4 s0Line Construction 100.0 100.0 2.9 2.9Substation Construction 10.5 10.6 0.8 0.8Consulting services 58.4 41.7 97.1 1.6 1.8 2.9 45General Plant 68.7 56.7 1.7 1.7REB Overheads and 119.2 119.2 8.5 8.5other *xpeem / - - - - - -Sub-Total A 087.6 1462.8 2140.8 20.2 42.6 08.0 66

B. P65 extens./intenaif.

Line Material I/ 186.9 757.2 "44.1 5.5 22.8 27.6 80Substation Material 2 18.5 74.6 98.8 0.5 2.2 2.7 s0Support Comrodities 4.6 16.7 28.8 0.1 0.6 0.7 s0Line Constructlon 68.0 68.0 1.9 1.9Substation Construction 7.5 7.5 0.2 0.2Consulting servics 29.9 24.5 54.4 0.9 0.7 1.0 45RIB Overhead and 76.1 75.1 2.2 2.2other expenses -

Sub-Total B 165.5 675.2 1260.7 11.8 26.6 87.1 69

C. REB central facilities

Subtotal C 288.5 16.4 816.9 6.0 0.5 9.8 6

0. TA and TraininA

SubtotaI 0 69.1 842.2 411.5 2.0 10.1 12.1 ea

Total aBse Costa 1440.6 2088.6 4129.4 42.4 79.1 121.5 65

Physical Contingencies 72.0 184.4 206.4 2.1 4.0 6.1 e6Price Continencies 492.1 615.0 1107.1 14.5 16.1 82.0 5s

Total Project Costs 2004.9 8488.0 5442.9 59.0 101.2 100.2 esInterest during Constr. 112.1 112.1 8.8 8.8

Total Finance Required 2117.0 8416.0 5655.0 02.8 101.1 168.5

/ The Ites lnclud the cost of materials required to construct new lim and torehabiIltato old Itnes, secure matrtal for consumer connections and LT capaectors.

V Thsese ita Include th cost of mterial to construct n substations and to rehabilItatethe old substations.

0 Thee it.o. lnclud costa lncurrd on REB adeinlotration, doevlopmnt, operation (fromdate of registration to date of mrgiMtion), and staff training costa of P*Ss; andcompensation charge to im for system taken over by PUS.

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Prolect Financing

3.07 The financing requirements, including interest during construction(IDC) at a rate of 0.752 p.a., are US$163.5 million, including US$62.3million in local costs and US$101.2 million in foreign exchange. A proposedIDA credit of US$lO million equivalent would finance 852 of the foreigncost and 442 of the local cost excluding taxes and duties and IDC, whichwould represent 732 of the total project cost (excluding lr.al taxes andduties and IDC). USAID has been requested to finance the technical assis-tance component, representing 152 of the foreign cost and 62 of the localcost. The remaining 502 of the local cost, together with local taxes andduties and IDC, would be covered by grants from GOB to RED. The proposedfinancing plan is summarized in Table 3.2. Cost overrun and foreignexchange risk would be covered by GOB. During negotiations GOB agreed tocontinue to provide to REB, as a grant contribution, all the local fundsthat may be required for the proposed Project.

Table 3.2s PROJECT FINANCING PLAN

Local Foreign Total(US$ Million Equivalent)

IDA 19.1 85.9 105.0Cofinancing 2.4 15.3 17.7GOB 40.8 a/ - 40.8Total 62.3 101.2 163.5

aI Of which US$15.4 million is taxes and duties.

Project Implementation and Consulting Services

3.08 The Project would be implemented during 1991-97 after major worksunder ACRE Phase III would have been completed. The implementation scheduleis shown in Annex 3.3. As the main implementing agency, REB would beresponsible for the overall project management, including% (a) projectengineering, design, construction and system operation; (b) procurement andlogistics; (c) financial system, record and accounts; (d) development of newPBSs; and (e) training. Engineering design and layout of the backbonedistribution systems would be done by REB, which also oversees design andconstruction. Detailed design and layouts of the village distributionsystems would be done by local consultants, and construction of the distri-bution systems, including substations, by local contractors under contractswith REB. Under Phases l-III of the rural electrification program, REB hasassisted in developing an adequate number of competent firms to meet theproposed Project's consultancy and construction requirements. REB wouldprocure project equipment using technical specifications prepared on thebasis of the design criteria adopted for the RE program. While involvementof REB staff and local consultants would be much greater than in previousprojects in engineering, design and construction supervision, the develop-ment and organization of Phase IV PBSs, together with the continuousmonitoring of the 40 PBSs under Phases I-I1l, would require further manage-ment and technical support from the expatriate consultants NRECA/GC. GOBhas requosted USAID to continue financing NRECAIGC beyond July 1991 for

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another five years. If USAID does not provide this financing GOB would findan alternative financing source. During negotiations agreement was reachedon the scope of the technical assistance and training to be provided byconsultants during project implementation. The financing of the additionaltechnical assistance component after July 1991 should be determined beforeDecember 31, 1990.

Procurement

3.09 The various components would be procured as follows:

Table 3.3: PROCUREMENT ARRANGEMENTS

Procurement arrangements(US$ Million)

ICB LCB Other NA Total

Line Material I/ 73.5 0.5 0.5 18.6 93.1(73.5) (0.5) (0.5) (74.5)

Substation Material 21 8.0 0.2 0.2 1.8 10.2(8.0) (0.2) (0.2) (8.4)

Support Commodities 2/ 2.9 0.- 0.2 0.5 3.8(2.9) (0.2) (0.2) (3.3)

Line Construction 7.4 7.4(6.0) (6.0)

Substation Construction 0 8 0.8(0.5) (0.5)

Consulting Services 4.2 4.2(4.2) (4.2)

General Plant 2.7 2.7

RED Overheads andother expenses 8

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3.10 Procurement of most material and equipment needed for the projectwould be on the basis of ICB according to IDA guidelines. Local suppliersand manufacturers competing for the supply of goods under ICB would have apreference of 152 or the applicable customs duty, whichever is less.Contracts for minor quantities of materials, tools, spares and equipment notexceeding US$100,000 each and in aggregate not exceeding US$1,000,000 wouldbe procured according to LIB procedures. In addition, contracts for minorquantities of materials not exceeding US$50,000 each and in aggregate notexceeding US$1,000,000 would he procured using LCB procedures satisfactoryto IDA. All the construction work financed by IDA, including the civilworks related to lines and substations, would be carried out using localcontractors selected according to LCB procedures satisfactory to IDA. Civilworks related to buildings and REB'; central facilities to be financed inpart by IDA and in part through GCn s contribution to the project, would beconstructed by local contractors also selected through LCB procedures.Except for REB's Headquarter complex, all the buildings are scatteredgeographically and would cost less tha.. US$200,000 each. Since the localconstruction industry can provide competitive prices, IDA has agreed thatthese buildings, like the construction works, can be procured under LCBprocedures. However, as per Bank Group's Procurement Guidelines, para 3.3,any foreign firms wishing to participate will be allowed to do so.Consultants for project engineering and supervision would be selected andemployed in accordance with the Bank Group Guidelines for the use ofconsultants.

3.11 To suit the implementation schedule procurement of the equipment,materials and support commodities would be split in four tranches over 1991to 1995. Further each tranche would include separate packages to beprocured under ICB as shown in Annex 3.3. All bidding packages andcontracts over US$100,000 would be subject to IDA's prior review and willapply to about 90o of the estimated cost of IDA-financed items.

3.12 Under GOB's current policy, single phase meters cannot be importedand, further, all single LV customers are required to purchase their ownmeters in the local market. The application of this policy to rural areaswould cause a significant drop in new connections and it would be contraryto the RE program's objectives. Prior to negotiations, GOB waived theimport ban for all IDA-financed proiects including the proposed Project, andagreed that meters would be purchased by REB under ICB and not by individualconsumers.

Disbursement

3.13 Disbursements under the proposed credit would be in respect ofmaterials and equipment, erection and commissioning expenditure, andconsulting fees, as shown belows

(a) 1001 of the CIF expenditure of imported material for lines, sub-stations and support commodities; in the case of locallymanufactured goods, 10OZ of ex-factory expenditure, and in the caseof goods procured locally, 70? of the expenditure;

(b) 1001 of total expenditure of consulting services, includinginspection of equipment and materials; and

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(c) 852 of civil vorks related to the expenditure of erection andcommissioning, including civil works related to lines, substationsand infrastructure facilities.

These disbursements would be fully documented except for small civil workscosting less than US$20,000. In such cases, disbursement will be madeag'Rinst Statemeat of Expenses (SOE), the documentation of which will not besubmitted to IDA but retained for inspection by supervision missions. Thestandard procedures for auditing SOEs would apply. To facilitate disburse-ment, a Special Account would be established in the Bangladesh Bank (CentralBank) on terms and conditions satisfactory to IDA. The amount of theSpecial Account is proposed to be set at US$2.5 million. The disbursementschedule is indicated in Annex 3.4.

Developmental Impact

3.14 Environment. The Project's direct environmental impact would belimited to the construction of distribution lines and substations and PBSheadquarters facilities. There would also be an indirect, but very limited,impact caused by increased irrigation schemes and expansion of small scaleindustries. The Project would have a positive environmental impact byproviding a higher quality of life since lighting by electricity is cleanerand less of a fire hazard than kerosene lamps. The replacement of dieseland gasoline engines would reduce local air pollution and lead to a netimprovement in air quality since the grid generating plants are moreefficient and generally burn natural gas. Tree cutting requirements wouldbe minimal since much of the area requiring pole setting is on farmlandunder cultivation. With each PBS headquarters limited to 3 acres and eachpole requiring only about 2.25 square feet of clearance space, total lostagricultural land would be negligible. Overall, the Project would be inCategory B in terms of environmental impact, although many components wouldbe in Category C. The engineering and construction codes and practices usedare largely derived from those used by NRECA in the US which provide for themitigation of the minor environmental impacts. The scheduling of lineconstruction would be such as to minimize damage to agricultural crops.

3.15 Poverty Alleviation. Much of the labor force in rural areas iscomprised of poor and landless persons. Income distribution would beachieved through increased economic activity and creation of employmentopportunities mainly in agriculture and small scale industry. The REprogram would provide employment to the local labor force for erecting thedistribution works and through the economic activities set in motion as aresult of backward and forward linkages of the program. An assessment ofthe RE program's overall developmental impact will be carried out during1990 under USAID financing.

3.1E Women in Development. The extension of electricity supply to ruralhouseholds would have a positive impact on women but mainly in the higherincome groups. Female advisors have been officially made a part of the PBSBoards and serve as channels for the expression of demands by women in thePBS areas. Further, PBSs employ many women in their headquarter officesespecially for the revenue function. At the community level, electrifica-tion of public facilities such as dispensaries, schools, offices and placesof worship will result in better services to the residents and in particularto women attending these facilities.

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Project Monitoring

3.17 During implementation the proposed Project would be monitored byREB with the assistance of consultants. After completion (within six monthsafter the closing date or a later date agreed with IDA) REB would furnish toIDA a Project Completion Report on the Project's execution and initialoperation, its cost and benefits, REB's performance and the accomplishmentof the Credit's objectives.

Risks

3.18 The Project presents no major technical or environmental risks andinvolves no complexities as it is a continuation of the ongoing program ofrural electrification. The principal risk concerns possible delays inproject implementation because of shortage of local funds from GOB. Thisrisk has been mitigated by reducing the program's overall size, by Improvedplanning and construction supervision by REB, and by extending theimplementation period from five to seven years.

IV. FINANCES

A. Rural Electrification Board

Financial Obiectives

4.01 REB's financial objectives originate from the financial covenantsagreed under Cr.1262-BD and Cr.1633-BD which require REB to achieve anoperating ratio 1/ not exceeding 751 in any fiscal year beginning FY86 and aminimum long-term debt service coverage of 1.5. Other donors have adoptedthe same covenants. As explained in paras. 4.03 and 4.04, REB so far hasbeen unable to meet its financial objectives. To improve the financialposition of REBI/PBSs, the consultants, Coopers and Lybrand Associates (UK),recommended that the existing onlending terms should be modified. Thisissue will be addressed under the proposed credit (para. 4.03).

Past Results and Present Position

4.02 EEB's FY85-89 operating performance is summarized below and givenin greater detail in Annex 4.1

11 Operating ratio in context of this analysis has been defined as theratio between all operating expenses, excluding depreciation butincluding interest charges and operating revenues.

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Table 4.1: REB OPERATING PERPORMANCE--FY85-39(In Tk Million)

FY85 PY86 FY87 FY88 FY89

Revenues 4.1 6.4 63.5 72.9 99.7Expenses 23.1 29.2 32.4 37.2 43.9Repayment of Loans from PBS 0.0 0.0 0.0 0.0 50.1Internally Generated Funds (16.2) (20.0) 56.7 39.8 111.3

Debt ServicesInterest 29.4 38.8 34.1 61.4 93.5Amortization 0.0 0.0 0.0 0.0 77.3

Operating Ratio 12.0 10.2 1.0 1.3 1.3

Debt Service Coverage Ratio (0.6) (0.5) 1.7 0.6 0.7

4.03 Since the RE program's inception, REB has been acting both as theimplementing agency responsible for the construction of rural electrifi-cation schemes and as the financial intermediary and supervising agencyafter the completed schemes are handed over to PBSs. REB's performance asan implementing agency is impressive. As of June 1989, 33 PBSs withcombined assets of Tk 7.1 billion have been energized. This, together withconstruction work in progress of Tk 0.3 billion, represents an averageannual investment level of Tk 0.7 billion during the ten-year period ofFY80-89. However, a review of REB's past financial performance reveals adisturbing trend which, if not addressed, could undermine REB's long-termfinancial health as a financial intermediary. It relates to REB's seriousliquidity problem, as reflected by its continuing dependence on GOBbudgetary allocations to cover its operating expenses and REB's inability toservice its debt to GOB from internally generated funds. The basic causesof REB's insolvency are: (a) the tandem relationship between the graceperiod on GOB loans to REB and the grace period on corresponding REB loansto PBSs; (b) PBSs' default on debt service to REB; and (c) the inordinatedelays in the scheme closing process. These are discussed in more detailbelow.

4.04 Onlending Terms. Given the two to three year time lag between thesignature of REB loans with GOB and the date of a PBS's registration, the 5-year grace period on each GOB loan to REB expires before the end of the 5-year grace period on the corresponding REB loan to a PBS, which starts fromthe date of PBS registration. This tandem relationship has two adverseimplications for RIB's cash flow. First, during the grace period of REBloans to PBSs, REB cannot use interest revenues from PBSs to cover itsoperating expenses (administrative expenses and interest on GOB loans) sinceinterest charges on REB loans to PBSs are capitalized. Second, REB has toservice its debt to GOB before PBSs start repaying the onlent funds to REB.In recent years, GOB has been deducting REB's debt service obligations fromits annual allocation to REB. While this practice has allowed REB, unlikeother public institutions, to be current on its debt service obligationsunder the SLA, on the IDA credits, it has diminished local funds for newschemes. Similarly, the five-year grace period on REB's loans to PBS starts

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at the date of PBS registration instead of at the date of energization,which is typically one year later. Consequently, debt service for a PBSbecomes due before it has been operating for five years to build up itssales and generate an operating surplus for meeting debt service to REB. Toensure REB's and PBSs' solvency and to provide a rational basis formonitoring REB's future financial position, during negotiations GOB/REBaareed thats (a) the grace period on GOB loans to RB should be extended to8 years while keeping the repayment period of 25 years and other onlendingconditions similar to those already agreed under Cr.1633-BD: and (b) the 5-year grace period on REB loans to PBSs should start from the date ofcommercial energization, which is the end of the month when bills are firstsent to consumers. The conclusion for the proposed Credit of a SubsidiaryLoan Agreement between GOB and REB satisfactory to IDA is a condition forcredit effectiveness. Further, during nesotiations it was agreed that oncompletion of each scheme under the proposed Prolect REB will enter into aSubloan Agreement with the PBSs under terms and conditions satisfactory toIDA.

4.05 Depreciation Fund. By June 1986, debt service to REB from thefirst 4 PBSs became due, and by June 1989, 12 PBSs were liable for debtservicing. Although 7 of them had operating surpluses after interestcharges and depreciation, only a partial payment of Tk 50 million was madein FY89. One of the factors explaining the PBSs' poor debt serviceperformance was the depreciation fund policy prescribed by REB. Accordingto this policy, each PBS should maintain a depreciation fund in a bankaccount and deposit the full amount of its annual depreciation charge intothe said account. Compliance with this policy took precedence over debtservice payments to REB. This resulted in some PBSs accumulating largebalances in the depreciation fund account while, at the same time, owingsubstantial arrears to REB. In view of the serious shortages of local fundsand the crowding-out impact that GOB's contributions to the RE program wouldhave on other development programs in the country, the efficient use of theresources mobilized in the subsector is critical to the long termsustainability of the RE program. The recent report submitted by Coopersand Lybrand Associates (UK) (para. 2.12) noted that there is nojustification to continue the current practice. This conclusion has beenendorsed by the major donors of the RE program. In 1989 REB agreed tosuspend the depreciation fund and to introduce a replacement reserve fundlimited to a maximum of 5 of gross fixed assets. This policy was fullyimplemented effective July 1, 1989.

4.06 Scheme Closing Process. REB's liquidity problem is furthercompounded by the inordinate delays in the scheme closing process. In manycases, capital investments that have been completed and handed over to EBSshave remained in REB's accounts as current assets for several years. Thus,REB has been deprived of interest revenues which would have accrued. This,together with the inappropriate treatment of interest accrued during thegrace period on REB loans to PBSs in the income statement explains very highoperating ratio during FY85-89. To avoid the future reoccurrence of thissituation, during negotiations, REB agreed that the process of schemeclosing out would be completed within six months from the date of a PBS'scommercial energization (para. 4.09).

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Future Performance

4.07 REB proforma financial statements vere prepared for FY90-95(Annex 4.1) on the basis of the investment plan of the Phase IV ruralelectrification program and the revised onlending terms discussed Inparas. 2.05 and 4.04 and other assumptions set out in Annex 4.2. Due to thedeficiencies in the management of the accounting systems for capital work-in-progress, assets transfer and loan sales to PB8s, accurate Information ona PBS by PBS basis is not available at this stage (para. 4.09). Sincereconciliation between assets transfer and loan sales for the existing 33PBSs just began recently and will be completed only by end-1990 financialprojections were prepared on the ACRE basis (group of PBSs financed underthe same operation). REB's projected financial performance is consideredconservative in view of the assumption used. For instance, the finalcompletion date of Phase III RE program in 1992/93 ie taken as the assettransfer date for all the PBSs involved, and interest revenues are assumedto flow in thereafter. In reality, however, REB will collect interestrevenues and repayment of principal from some PBSs much earlier than that.Key financial indicators based on the proforms statements in Annex 4.1 areshown in Table 4.2.

Table 4.2: REB'S PROJECTED OPERATING PERFORMANCE FY90-95(In Tk Million)

FY90 FY91 FY92 93 FY94 FY95

Revenues 225.2 221.0 249.5 261.4 257.1 252.8Expenses 54.0 62.5 72.6 84.2 107.2 120.4Repayment of Loans from PBSs 297.0 297.0 297.0 297.0 297.0 297.0Internally Generated Fund 477.5 466.2 486.6 488.9 473.3 455.8

Debt Service:Interest 49.7 93.6 90.6 111.2 119.2 115.8Ammortization 102.2 194.0 194.0 194.0 194.0 194.0

Operating Ratio 0.4 0.7 0.6 0.7 0.8 0.8Debt Service Coverage Ratio 3.1 1.6 1.7 1.6 1.5 1.5

4.08 During the forecast period FY90-95, total investment on the REprogram is estimated at Tk 16 billion of which Tk 10.5 billion (652) is inforeign exchange. It is expected that external donors would providefinancing for the investment program's entire foreign cost (para. 2.05) andthe local cost would be covered by GOB equity contributions. Clearly, REB'sfinancial position as a financial intermediary depends on the PBS's futureperformance. Assuming an 8-year grace period on GOB loans to REB and thatthe system of annual performance agreements described in para. 4.10 issuccessfully implemented, REB's financial position would improve substan-tially. Its operating ratio would not exceed the covenanted level of 752and debt service coverage would be maintained at or above 1.5 throughout theperiod. To ensure resource mobilization within the limit of affordabilityand to enhance REB's long-term financial viability, it was agreed duringnegotiations that REB shall ensure that: (a) its administrative expenses and

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interest payments in any fiscal year beginning FY91 shall not exceed amaximun of 752 of the aggregate interest and other revenues received fromall sources during that fiscal year: and (b) its internal sources of funds,including PBS loan repayments in any fiscal year, shall cover at least 1.5times the debt service requirement.

Accounting Systems and Organization

4.09 REB's accounting systems were designed by NRECA based on soundaccounting principles. Subsequently, REB has implemented and operated thesystem under NRECA's supervision. REB's financial functions are managed bythe Board Member of Finance, who is assisted by four directors overseeingmatters relating to finance, accounts, PBS loans and auldit and procurement,and one deputy director for internal audit. In recent years, severalfinancial management deficiencies have been identified. These includeproblems associated with the operation of the material accounting system andin the management of accounting systems for capital work-in-progress, assetstransfer and loan sales to PBSs. As a result, information on asset transferand loan sales on a PBS by PBS basis is difficult to obtain. This hascaused inordinate delays in the scheme closing process and seriouslyaffected REB's capacity to generate revenue. REB is aware of this situationand reconciliation work is now under way. To ensure timely and long-lastingimprovements in the identified areas, during negotiations REB agreed that itwould prepare and furnish to IDA by December 31, 1990 an action plan toimplement the required reforms to its accountin8 systems and procedures andthereafter implement the said plan as agreed with IDA.

External Auditing

4.10 REB's accounts are audited by private auditing firms. Underprevious Credits (Cr.1262-BD and Cr.1633-BD) REB is required to furnish toIDA, not later than nine months after the end of each fiscal year, certifiedcopies of its financial statements accompanied by the auditor's report. Thequality of the audits for the recent years has shown some improvement,although some deficiencies remain to be addressed. To ensure accountabilityfor resources used by REB, during negotiations it was agreed that REB shouldhave its accounts audited by independent auditors acceptable to IDA andfurnish to IDA no later than nine months after the end of each fiscal yearcertified copies of its financial statements, accompanied by the auditor'sreport which would cover the Special Account and include a separate opinionas to whether 80E submitted can be relied upon to support the relatedwithdrawal applications.

Insurance Arrangement

4.11 All REB loans to PBSs are secured by mortgages on the assetstransferred to PBSs. To provide coverage for PBSs' assets, REB hasestablished an insurance pool fund, requiring each PBS to maintain areplacement reserve fund equal to 52 of its gross fixed assets. The fund isadministered by RIB. This arrangement is considered adequate.