Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 7713-IN

STAFF APPRAISAL REPORT

INDIA

MAHARASHTRA POWER PROJECT

MAY 26, 1989

Asia Country Department IV (India)Transport and Energy Operations Division

Tirs document has a restidcted distribution and may be used by recipients ody In the performance oftheir officld duies. Its contents may not othenvwis. be disclosed without Wodld BDk authorization.

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CURRENCY EQUIVALENTS

Currency Unit - Rupees (Rs)Rs 1.00 - Paise 100US$1.00 - Rs 15.00Rs 1,000,000 - US$66,667

MEASURES AND EQUIVALENTS

1 Kilometer (km) 1,000 meters (m) - 0.6214 miles (mi)1 Meter (m) - 39.37 inches (in)1 Cubic Meter (m3 ) - 1.31 cubic yard (cu yd) - 35.35 cu.ft.1 Thousand Cubic M-ter (MCM) - 1,000 cubic meters1 Barrel (Bbl) - 0.159 cubic meter1 Normal Cubic Meter

of Natural Gas (Nm3) - 37.32 Standard Cubic Feet (SCF)1 Ton (t) 1,000 kilograms (kg) = 2,200 lbs1 Metric Ton of Oil (390 API) = 7.60 barrels1 Kilocalorie (kcal) = 3.97 British Thermal Units (BTU)1 Kilovolt CkV) = 1,000 volts (V)1 Kilovolt ampere (kVA) 1,000 volt-amperes (VA)1 Megawatt (MW) = 1,000 kilowatts (kW) = 1 million watts1 Kilowatt-hour (kWh) = 1,000 watt-hours1 Megawatt-hour (MWh) = 1,000 kilowatt-hours1 Gigawatt-hour (GWh) 1,000,000 kilowatt-hours1 Ton of Oil Equivalent (toe) 10 million kilocalories

ABBREVIATIONS AND ACRONYMS

BSES - Bombay Suburban Electricity SupplyCEA - Central Electricity AuthorityCIL - Coal India LimitedCWC - Central Water CommissionGOI - Government of IndiaGOM - Government of MaharashtraGOMED - Government of Maharashtra Energy DepartmentGOMID - Government of Maharashtra Irrigation DepartmentIBRD - International Bank for Reconstruction and DevelopmentIDA - International Development AssociationICB - International Competitive BiddingLCB - Local Competitive BiddingMSEB - Maharashtra State Electricity BoardMIS - Management Information SystemsNHPC - National Hydroelectric Power CorporationNTPC - National Thermal Power CorporationPFC - Power Finance CorporationREC - Rural Electrification CorporationREB - Regional Electricity BoardROR - Rate of ReturnSEB - State Electricity BoardTEC - Tata Electric CompaniesWREB - Western Region Electricity Board

Fiscal Year

April 1 - March 31

FOR OFmFCIAL USE ONLYINDIA

HAHARASHTRA POWER PROJECT

STAFF APPRAISAL REPORT

Table of Contents

Page No.

Loan and Project Summary .................................. i-iii

I. SECTORAL CONTEXT .......................................... 1Overview ............................................. 1India's Commercial Energy Resources .............. . . ... 2Electricity Supply and Demand ........................ 3Organization of the Power Sector ..................... 4Financial Performance and Tariffs .................... 6Power Sector Planning ................................ 8Entities' Management and Operations .... .............. 9GOI's Strategy in the Power Sector ................... 10Bank Group Strategy in the Power Sector .... .......... 12Bank Group Participationi ............................. 14

II. THE BENEFICIARIES .......................................... 16Introduction .......................................... 16A. Government of Maharashtra Irrigation Department .... 16

Organization and Technical Capabilities ........ 16Project Accounts and Audit ..................... 17

B. Maharashtra State Electricity Board ................ 17Introduction ................................... 17Organization ................................... 19Operation and Maintenance ...................... 19Tariffs ...... . ......................... 20Personnel and Staffing ......................... 21Training ....................................... 21Corporate Planning ............................. 22Financial Planning ............................. 22Financial Organization and Accounting .......... 22External Audit ................................. 23Int2rnal Audit ................................. 23Consumers Billing .............................. 24Management Information System andData Processing .............................. 24

Tax Regime .................................... 25Insurance ...................................... 25

This report is based on the findings of an appraisal mission. to India inJanuary/February 1989. Mission members were Messrs. A. Covindassamy(Senior Financial Analyst), A. Sanchez (Principal Engineer),M. Tomlinson (Economist), B. Trembath (Power Engineer), B. Partridge(Environment Specialist), G. Dunnion (Consultant), and J. Niessen(Consultant Economist).

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 Bank authorization.

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Page No.

III. THE PROJEC'...25III~~~. TEPRJ ........................... I ............................2

Project Satting ... 25Project bjectivee .... 27Project Description. .... ... .... . .27Project Engineering . ......................... ...... 28Project Implementation and Construction Schedule .3Water Rights .. . ....................................... 31Resettlement and Land Acquisition ... 31Environmental Aspects . . . 32Project Costs ... 34Project Financing. . . 35On-Lending Arrangements ..... . .. ...... . . 36Procurement ... 36Disbursements ... 37Project Operation ..... 38Project Monitoring .... .. . .38Project Risks... 39

IV. FINANCE .40A. Introduction .40B. Historical Performance .41C. Future Financial Situation & Performance Targets 43

Profitability and Crediworthiness: . 44Indebtedness and Capital Structure .46Capital Investment Plan .47Working Capital ........... . ................... 47Investment Financing Policy .48State Government Transfers .49

V. ECONOMIC ANALYSIS.. .......................... 50Electricity Demand In The Western Region . .50Lease-Cost Analysis. ............... . .50Progtwa and Project Analyses . .51

Program and Project Costs .. 51Program and Project Benefits .. 52

Economic Rate of Retur . .53Program .. 53Project ....... 53

VI. AGREEMENTS AND RECOMENDATION . . 54Agreements Reached During Negotiations . .54Rcommendation... 56

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Page No.ANNEXES

1.1 All-India: Electricity Supply and Demand .................. 571.2 Maharashtra: Electricity Supply and Deman .591.3 Previous Loar.s and Credits to

Indian Power Sector (January 31, 1989) .61

2.1 Performance Indicators, India and SelectedAsian Countries. 1981 .62

2.2 A Comparison of the Performance of MSEB andOther SEBs, 1987 .63

2.3 Action Plan tor Managerial Development .642.4 MSEB's Head Office Staff Set-up as on March 31, 1988 .872.5 Summary of MSEB's Tariff .882.6 MSEB's Workforce (as of March 31, 1988) .912.7 MSEB's Training Program 1986187 and 1987/88 .92

3.1 Detailed Project Description ....... . ..................... 933.2 Construction Schedule for Koyna IV Power Plant ............ 1053.3 Project Detailed Cost Table .1063.4 PrGcurement Arrangements .1133.5 Procurement Schedule for Major Contracts .1153.6 ;chedule of Estimated Disbursements .1173.7 Terms of Referenr.e for Panel of Experts

for the Koyna TV Hydroelectric Power Plant .1183.8 Suggested Terms of Reference for Engineering

Consultancy Services for Koyna IV .1203.9 Suggested Terms of Reference for Consultancy

Services for Dam Repair Work ............................ 1233.10 Proposed Terms of Reference for Studies of Load Dispatch

a:xd Interstate Power Trading in the Western Region . 1253.31 Details to be Included in Annual Resettlement and

Rehabilitation Plans . .. 1273.12 Organization for Design and Construction ................. 1283.13 Layout of Koyna Complex .129

4.1 MSEB - General Parameters .. 1304.2 Actual and Forecast Balance Sheets .1324.3 Actual and Forecast Sources and Applications of

Funds Statements .1334.4 Financial Action Plan .1344.5 Assumptions Followed fe Financial Projections .1364.6 Financial Indicators .1404.7 MSEB's Investment Plan .1414.8 Financing of Investment... . 1434.9 Working Capital Schedule .1444.10 Transfers from and to the Government .1454.11 Unit Costs of Sales and Productivity.. 146

5.1 Economic Analysisn a l y s is.... 147

6.1 Related Documer,ts in the Project File.. 169

MAPS: IBRD 21492 and 21493

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INDIA

MAHARASHTRA POWER PROJ!CT

Loan and Pro1ect Sumary

Borrower s India, acting by its President

Beneficiaries a 1) Maharashtra State Electricity Board (MSEB), and2) Government of Maharashtra Irrigation Department (GOMID)

Amount s US$400 million equivalent

Terms s Twenty years, including e 5-year grace period, at theBank's standard variable interest rate.

Onlending Terms s Government of India (GOI) to Government of Maharashtra(GOM): about US$400 million equivalent as part of CentralGovernment assistance to Maharashtra for developmentprojects on terms and conditions applicable at the time,of which US$230 million equivalent will be retained by GOMfor the Koyna IV project omponent, and US$170 milliononlent to Maharashtra State Electricity Board for theproject transmission and distribution component.

GOM to Maharashtra State Electricity Board: US$170 millionequivalent for the project transmissior and distributioncomponent, with repayment over 20 year including 5 yearsgrace period at GOM's interest rate applicable at the timeof its lending to MSEB (but not less than 9X per annum).

GOI would bear the foreign exchange and interest raterisk.

ProjectDescriDtion s The main objective of the Project is to improve power

supply and operating efficiency in MSEB and in the WesternRegion power system through: (a) expanding regionalpeaking capacity at least cost; (b) improving utilizationof existing generating capacity; (c) strengthening andupgrading MSEB's transmission and distribution system; (d)recommending ways to improve load dispatch in the WesternRegion and rationalize bulk power regional trading; (e)improving MSEBs retail tariff structure; (f)strengthenin' MSEB's finances; and (g) introducinginstitutional improvements to MSEB. The Project wouldinclude: (i) construction of a 1000 MV fourth-stage of theKoyna hydroelectric power plant; (ii) inspection andrepairs, as needed, of the existing Koyna dam; (iii)supply and erection of equipment and material for MSEB'sfive-year transmission and distribution investmentprogram, and strengthening of MSEB capabilities forplanning of distribution systems; (iv) implementation ofplans to strengthen MSEB finances, management and

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operations; and (v) consultancy and training services, aswell as computer hardware and software required toimplement the project.

Benefitsand Risks: Through the Project, the Bank will be supporting GOI's

effort to: (a) alleviate power shortages in the WesternRegion and to meet future demand in Maharashtra byexploiting indigenous hydro resources; (b) improve thereliability of supply and reduce system losses inMaharashtra and in the Western Region; (c) improve theplanning capability of MSEB; and (d) strengthen MSEB'sfinances and management. The proposed Koyna IV schemepresents the usual risks associated with major uidergroundworks, such as unexpected geological conditions that mayadversely affect project cost and construction schedule.However, the geological exploration orogram carried outthus far, and the excavation works carried out for theneighboring stages I to III, which are also underground,indicate that the geological setting is adequate for theproposed works, and that risks are acceptably low. Inaddition, external consultancy expertise is being providedunder the proposed Project to assist GOIaD during pro4ictconstruction. The Transmission and Distributioncomponents do not present any extraordinary risks.

Project Costs: Local Foreign Total--- (US$ Million)--------

A. Koyna IV Power Station 156.3 166.0 32z.3

B. MSEB's InvestmentProgram 248.7 243.7 492.4

Total Base Costs 405.0 409.7 814.7

Physical Contingencies 47.1 45.0 92.1Price Contingencies 86.1 85.9 172.0

Total Project Costs 538.2 540.6 1,078.8

Interest DuringConstruction 197.2 67.8 265.0

Total Financing Required 735.4 608.4 1,343.8_____~~~~~~~~- =- XD _

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Financing Plan: Local Foreign Total------- (US$ Million)------

IBRD 400 400Cofinanciers 150 150GOI/GOM/MSEB 736 58 794

Total 736 608 1,344

Estimated Disbursements:

Bank FY 1989 1990 1991 1992 1993 1994 1995 1996 1997

Annual 1.1 38.5 71.4 75.0 75.6 82.4 34.8 15.1 6.1

Cumulative 1.1 39.6 111.0 186.0 261.6 344.0 378.8 393.9 400.0

Economic Rate of Return: 14.0! (for the Western Region development program)

INDIA

MAHARASHTRA POWER PROJECT

STAFF APPRAISAL REPORT

I. Sectoral Context

Overview

1.01 India's power systems presently have an installed capacity ofnearly 54,000 MW and provided about 189,000 G'Wh of energy in FY 1987/88,making them comparable in size to the power sectors of France and the U.K.and to the combined power sectors of all the countries of Sub-SaharanAfrica. However, despite impressive progress in expand.ng supply over thelast few years (installed capacity has increased from 32,000 MW in 1981/82and energy availability from 114,000 GWh) shortages persist equivalent tcabout 202 of maximum power demand and 102 of total energy demand. Thequality of electricity supplies also remains mostly unsatisfactory. Tomeet a higher proportion of demand, improve the quality of sipplies andfurther extend rural electrification, GOI plans to install .-n additional80,000 MW of capacity by the turn of the century. This wou-d cost aboutUS$150 billion at present prices and claim between 25? and 30? of totalallocations under the Eighth and Ninth Plans (compared with about 20? underthe Seventh Plan). Implementing such a large program of investments wouldadd sharp pressures to government finances and pose considerable managerialand technical challenges for sector entities. Currently, the Bank financesabout 5? of the sector's investments.

1.02 In addition to substantially expanding supply, the sector is nowmaking encouraging efficiency gains through improving the utilization ofexisting assets. For example, plant load factor averaged 52Z in 1987/88compared with only 42? in 1980/81. Each 1 kW of generating capacitytherefore aow provides 880 kWh more electricity annually than in 1980/81.Similarly, the rate of fuel consumption by thermal stations has been cutabout 102 since 1979/80. ITt row requizes only 720 tons of coal to generate1 GWh, whereas in 1979/80 802 tons of coal (of equivalent quality) wererequired. For the sector as a who_c, this improvement represents an annualsaving of approximately 12 million tons of coal, viz. 8? of annual coalconsumption in power plants. The improvements in power stations' loadfactors and fuel consumption reflect healthy improvements in maintenanceand operations management. The improvements are all the more commendablein view of the deteriorating quality of coal the sector has had to contendwith. A significant institutional development has been that the number ofemployees per thousand consumers has been cut 34? from 28.7 per thousand in1980/81 to 19.0 per thousand at present. Sector efficiency has also beenimproved, though more modestly, through improvements in tariff levelsrelative to economic supply costs (para 1.20). Since 1981/82, tariffs haveincreased in real terms by an average 5? per annum. Tariffs to industrialand commercial consumers (over 60? of total consumption) now areapproximately 802 of marginal cost and continue to improve. The weakesaelement of retail power tariffs are charges to agriculture, which continueto be heavily subsidized.

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1.03 Despite these gains, India's power utilities for the most partremain relatively inefficient. Key constraints are the dividedresponsibility (between GOI and the States) for power development,political interference in the operations of the State Electricity Boards(SEBs) and weaknesses in the financial structure of the sector, whichundermine financial performance and hold down resource mobilization. Theeffects of these constraints are that India's power systems deliver toconsumers less power and of a poorer quality than they should be able to,and at a higher cost. The costs to the econimy of shortages and poorquality supplies are magnified by remaining inefficiencies in end-use ofelectricity - the result mostly of insufficient comsercial incentives inmany markets and bsidized power prices to low voltage consumers,particularly agriculture. The National Thermal Power Corporation (NTPC) isthe one notable exception in this picture. NTPC, which now provides about12Z of SEBs' bulk electricity supplies, has emerged from its first tenyears as a utility which is efficient by international standards. In1987/88, NTPC earned a return on assets (most less than five years old) of16.8Z.

1.04 GOI is aware of present inefficiencies, their causes and thelikely repercussions on future sector development. Under the Seventh Plan,there have been encouraging signs of a strengthening resolve to addressconstraints in a substantive way. GOI has mounted initiatives to bringfinancial discipline to the SEBs (para 1.17) and has accelerateddevelopnent of the relatively efficient central utilities, particularlyNTPC. GOI also has formed the Power Finance Corporation (PFC) to mobilizeadditional resources for SEBs willing to make needed institutional reforms.In addition, GOI is reviewing its policy on private sector involvement inpower supply and aims to ease regulatory and financial disincentives toprivate sector participation (para 1.17). Finally, GOI is also reviewingits fuel supply policy for the sector. As well as considering several fuelimport options, GOI has deci, 'd to sanction more domestic natural gas forpower generations 8,000 K. gas-fired plant will be added under theEighth Plan. The principa,. Ahallenge facing GOI under the Eighth Plan isto improve the balance in sector development between expansion andefficiency improvement. Central to achieving this will be to ensure thatutilities' institutional development keeps pace with their physicalexpansion. To help meet the sector's enormous investment requirements, GOImust also realize more of the sector's potential to mobilize resources.

India's Commercial Energy Resources

1.05 India's commercial energy resources comprise coal, oil, gas,hydroelectricity and nuclear energy. Of the non-renewable resources, coalis the most abundant. Reserves of thermal coal have been estimated at over125 billion tons and 60 billion tons are considered economicallyrecoverable. However, coal quality generally is poor and is getting worse.Ash contents are up to 50, which increases power station capital andoperating costs and exacerbates problems of coal transport. GOI's emphasison development of pithead statians eases transport problems, but does notreduce the other costs associated with poor coal quality. Further pitheaddevelopment will be increasingly constrained by pollution concerns andwater availability. These difficulties, together with high production

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costs and high transportation costs have raised questions concerning thecontinued competitiveness of India's coal industry. Recently, GOI hasbegun to give consideration to imports of coal, which probably would beeconomic at coastal and some inland locations.

1.06 India's proven and probable oil and gas reserves are estimated at580 million tons oil equivalent (mtoe), sufficieit for only 20 years supplyat present rates of consumption. Domestic oil production, which currentlyprovides about two-thirds of India's requirements, is peaking. Oil importsconsequently are expected to rise over the next few years, even thoughnatural gas may be able to substitute for a part of future oil consumption.In the past, GOI limited natural gas to premium markets, such as petro-chemicals and fertilizer. However, with growing estimates of reserves(currently 360 mtoe) and the recent completion of a large gas pipeline, gasis now becoming an important fuel for power generation. Oil productscontinue to have limited use in thermal power generation, being confinedprimarily to stabilizing combustion in coal-fired power stations and tofuelling captive generating plant.

1.07 India's hydroelectric potential is equivalent to about 100,000 MW.At present only 16,000 MW have been developed and 4,700 14W are underconstruction. Schemes to add a further 23,000 MW are at various stages ofplanning. The pace of India's hydroelectric development has slowed overthe past decade. Under the Sixth Plan, hydro stations provided 342 of newcapacity, whereas under the Seventh Plan hydro will provide only 30? of newcapacity. GOI is striving to reverse this decline in view of the prominentrole of hydro schemes in regional least-cost power development. Progressto date, however, has been comparatively slow. Key difficulties have beeninadequate financial resources in states with the greatest hydro potential,lengthy disputes over water rights and environmental issues, and thelimited technical rescarces available for the preparation of large hydroprojects.

1.M1 India's uranium reserves could support a modest nuclear program(8,000 - 10,000 MW). Currently, India's nuclear power generating capacityis 1,230 MW.

Electricity SuPpiy and Demand

1.09 In 1987/88, utilities' power generation 1/ was 189,000 GWh from aninstalled capacity of 54,000 MW (Annex 1.1). Almost 602 of generation wasfrom coal, 352 was hydroelectricity and the balance was generation fromoil, nuclear energy, and natural gas. Deteriorating coal quality hasincreased the sector's own power consumption to about 102 of grossgeneration. Also, rapid expansion of rural electrification and inadequateinvestment in transmission and distribution have increased system losses tomore than 22Z of gross generation. The Bank has stressed the importance ofproper balance in system development between system expansion andreinforcement of existing facilities and will continue to supporttransmission and distribution investments designed to reduce system lossesand improve service quality.

1/ Net of consumption by power stations.

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1.10 Electricity consumption has been growing at approximately twice asfast as total commercial energy consumption and electricity now accountsfor more than 30Z of India's total commercial energy consumption. Between1981/82 and 1987/88, electricity consumption increased at 8.92 per annum interms of energy consumed and 7.62 per annum in terms of the maximum loadmet (Annex 1.1). Principal consumption shares in 1987/88 were: industrial,551; agricultural, 181; domestic, 14Z; and commercial, 82. As energyconsumption and the maximum load met have both been constrained by supplycapacity, energy and power demands probably have been increasing morequickly than reflected through consumption data. CEA estimates thatpresent shortages are about 21,000 GWh (about 102 of energy demand) and8,400 MW (about 21Z of the maximum load met). CEA projects that bothenerg7 demand and maximum power demand will grow at approximately 92 perannum through 1999/2000 and that demand will continue to be supply-constrained (Annex 1.1), although to a lesser extent than at present.Increases in demand are expected to bp led by domestic and agriculturalconsumers; the shares of consumption by industry and commercial consumersare both expected to fall slightly (Annex 1.1). Continued increases inreal retail electricity tariffs (which averaged 51 per annum between1980/81 and 1987/88) may slow the pace of demand growth and ease pressureon supplies. However, this relief will be mitigated by the relative easewith which industrial and commercial consumers can pass tariff increasesthrough to customers. Agriculture's consumption share is expected tocontinue to grow steadily through continued subsidization and further ruralelectrification.

1.11 Between 1981/82 and 1987/88, electricity consumption inMaharashtra increased at 8.8Z per annum in terms of energy consumed and7.72 per annum in terms of the maximum load met (Annex 1.2). Principalconsumption shares in Maharashtra in 1987/88 were: industrial 522,agricultural 19Z, domestic 16Z, and commercial 72. As in the case ofnational consumption, energy consumption in Maharashtra and the maximumload met have both been constrained by inadequate supply capacity: CEAestimates that at present, unserved demand is equivalent to approximately14Z of the maximum load met and 2Z of energy consumption. However, CEAprojects that through 1999/2000, maximum load in Maharashtra will increasemore slowly than in the past (6.92 per annum), while maximum generatingcapability will increase relatively more quickly. Together, CZA expectsthat by 1999/2000, these effects will close Maharashtra's power deficit tothe equivalent of about 61 of the maximum load met. Increases inMaharashtra's energy generating capability are projected to keep pace withincreases in energy demand. Demand increases in Maharashtra are expectedto follow the national pattern, with strongest growth in domestic andagricultural consumption (both expected to average about 10.7Z per annum)and declining shares of industrial and commercial consumption (Annex 1.2).

Organization of the Power Sector

1.12 Responsibility for electricity supply is shared between GOT andthe States. GOl controls CEA, NTPC, NHPC, the Rural ElectrificationCorporation (REC), and (through CEA) the Regional Electricity Boards(REBs). The States control the SEBs and the day-to-day oNerations of theREBs CEA is part of the Department of Power within the Ministry ofEnergy. NTPC, NHPC and REC are public corporations reporting to the

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Department of Power. SEBs were instituted under the Electricity (Supply)Act, 1948, to promote power development and to regulate private licensees,such as the Tata Electric Companies. Although SEBs are supposed to beautonomous, in practice they are under the control of state governments insuch matters as capital investment, tariffs, borrowings, and salary andpersonnel policies. As a first step towards integrating power supplynationally, SEBs have been grouped into five regional systems, eachcoordinated by an REB. Activities coordinated regionally include states'generation schedules and overhaul and maintenance programs, power transfersand concomitant tariffs.

1.13 Public Utilities. CEA was created in 1950 to develop a nationalpower policy and to coordinate power utilities. It is responsible forvetting investment proposals, providing consulting support to SEBs,promoting integration of regional power systems, training sector personnel,and research and development. Unfortunately, CEA's effectiveness has beenlimited severely by shortages of skilled staff and other resources.Recently, GOI formed the Power Finance Corporation (PFC). PFC's functionsare to mobilize additional resources for sector development and to pursueinstitutional reform of sector entities, particularly the SEBs. TheCorporation's lending operations are focussing on completing priorityrehabilitation and distribution projects being implemented by SEBs.

1.14 NTPC and NHPC were formed in 1975 to construct and operate largepower stations and transmission facilities and to sell bulk power to theSEBs. NTPC has grown rapidly and now provides about 122 of India's totalpower supplies. In the process it has established a proven track recordfor implementing major projects and has gained a reputation for beingefficient. NTPC also enjoys a strong financial position (para 1.18).NHPC, ostensibly established to promote the development of India's hydropotential, has not yet enjoyed the same success and is developingrelatively slowly. Principally this is because States control water rightsand are reluctant to relinquish hydro projects to NHPC. REC was formed in1969 to coordinate rural electrification and provide financial andtechnical expertise for SEB schemes. REC finances more than 70Z of ruralelectrification investments, but has proved a relatively weak institutionin its technical and financial operations. At present, there is noorganization with responaibility for developing a natioral transmissiongrid, although GOI is contemplating the formation of such a utility.

1.15 Private Utilities. Private utilities at present make only amatrginal contribution to public electricity supply, though private captivegeneration is extensive (equivalent to about 152 of public supply).However, GOI is attempting to increase private participation in powersupply to mobilize additional resources for the sector and to secure thepotential efficiency gains. To this end, GOI has a White Paper on privateutilities under final review which aims to ease regulatory and financialdisincentives to private investment in the sector.

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1.16 In Maharashtra, already home to twe of India's four privateutilities, 21 a significant expansion of private involvement in powersupply is likely over the next few years. TEC is seeking to installadditional gas-fired capacity and to improve the utilization of an existinghydro station through its conversion to a pumped-storage scheme. BSES,hitherto an efficiently-run distribution utility, has proposed expandingits involvement in the sector through a thermal generation project. Inaddition, the Government of Maharashtra (GOM) is actively seeking proposalsfrom the private sector regarding projects to be constructed during theEighth Plan. As well as seeking to mobilize additional resources for thesector, GOM is considering innovative project implementation arrangements,such as build-operate-turnover (BOT) schemes to ease pressure on technicalresources available in MSEB and GOM.

Financial Performance and Tariffs

1.17 In 1986/87, only 2 SEBs made a profit (MSEB and Orissa SEB). SEbsas a whole incurred a combined loss before subsidies of approximatelyRs 15,800 million (US$ 1,190 million). This corresponds to a return on netfixed assets at historic cost of 3.52 before interest, and -9.32 afterinterest. SEBs' investment self-financing rate, which was equivalent toonly 2.02 of capital expenditure, was correspondingly low. Partly, thepoor results reflect that almost all SEBs' capital expenditures arefinanced by debt. As a first step in improving SEBs' finances, GOT hasamended the Electricity (Supply) Act to require SEBs to earn a minimum rateof return of 32 on net assets at historic cost after meeting operatingexpenses, taxes. depreciation and interest. 3/ The Bank supports GOI'sinitiative and has changed the form of its financial covenants accordingly.In terms of the Bank's conventional method of calculation, the 3Y minimumreturn corresponds to a return on assets valued at historic cost ofapproximately 6 to 8 and a return on revalued assets of 42 to 6Z.Although modest, this target nevertheless represents a substantialimprovement on existing performance. Many SEBs, particularly those of thepoorer states, are experiencing considerable difficulty achieving even thislevel of performance. To stimulate private sector interest in powersupply, a second initiative under consideration by GOI is to increase from121 to 152 returns on paid-in capit'l that private power utilities arepermitted to earn.

1.18 The financial performance of NTPC and NHPC is considerablystronger than that of the SEBs, though not wholly satisfactory. In1987/88, NTPC earned a return on net assets (most less than five years old)before interest of 16.8Z. NHPC earned a return before interest of 12.52.However, NTPC's cash flow after debt service and working capital financingin 1987/88 was equivalent to only 82 of investment expenditures and that ofNHPC to only 12 of investment expenditures. These modest contributionsreflect both the size of the Corporations' revenue bases relative to their

2/ Tata Electric Companies (TEC), a private generatiun and bulk supplyutility, is based in Bombay. Bombay Suburban Electricity Supply(BSES), a private distribution utility, provides supply to finalconsumers in the Bombay metro area. The other private utilitiesoperate in Ahmedabad and Calcutta.

3/ GOI does not accept the principle of revaluation of assets.

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investment programs (which have increased substantially) and their supplycontracts with SEBs, which include a fixed price for five years. Cash flowwill improve significantly over the next few years as many projectscurrently under construction are brought into service. Unfertunately, bothCorporations are presently also carrying high accounts receivables: NTPChas the equivalent of 3.8 months billings outstanding and NEPC has11 months billings outstanding. GOI is in the process of devising anaction plan to reduce NTPC's receivables to the equivalent of 2 monthsbillings, as covenanted uider existing Bank loans. The forthcomingNorthern Region Transmission Project will include a similar plan to reduceNHPC's receivables, and the proposed project includes a reduction in MSEB'spayables (para 4.18).

1.19 In lending to individual SEBs, the Bank will continue to press forstate-specific programs '.o improve resource mobilization, for example,through agreed financial programs capable, as a minimum, of achieving the3Z rate of return specified in the Act. Where higher returns are required,as was the case in the recent Nathpa Jhakri Power Project and in theproposed project (para 4.15), the Bank will press state governments to usetheir discretion under the Act to require a higher rate of return.

1.20 In general, SEBs' tariffs do not cover the long run marginal costof supply (LRMC). Moreover, there are sharp differences in the structureof electricity tariffs with industrial tariffs at or above LRMC, andagricultural tariffs heavily subsidized. The average level of SEBs'tariffs is estimated at approximately 60-70% of long run marginal costwhich represents an improvement from about 50% of LRHC in 1981 followingreal tariff increases which have averaged 5Z per annum. In Maharashtra,the average level of retail tariffs is one of the highest in India and isestimated to be 74Z of marginal cost (para 2.15). The level of SEBs'tariffs relative to LRMC will continue to improve as rates are increased tomeet at least GOI's minimum rate of return target. However, the structureof tariffs remains unsatisfactory. Tariffs do not distinguish between thecosts of supplying peak as opposed to off-peak energy, frequently areexcessively complex and invariably heavily cross-subsidize low voltageconsumers. Despite GOI accepting the principle in both its Sixth andSeventh Plans that energy prices should "reflect true costs', social andagricultural objectives have sharply limited progress towards thisobjective. Moreover, very little has so far been done to improve tariffstructures through tapping the considerable potential for consumer loadmanagement. To impress an GOI, the States and SEBs the full costs ofcross-subsidization, the Bank will continue to require tariff studies inparallel with lending operations. One such study currently is beingundertaken by MSEB (para 2.17), and others are underway in Kerala andKarnataka. These studies will be used to design tariff reform programs forimpl6mentation in parallel with the project concerned. The proposedMaharashtra Power Project includes a component which will help MSEBimplement tariff reforms in Maharashtra. Most probably, these will includethe introduction of peak and off-peak retail tariffs and the launching ofadditional load management initiatives (para 2.17). Notwithstanding theseefforts, resistance to economic power pricing in India, at least for somecategories of consumers, is such that progress in pricing reform with theSEBs is likely to be slow.

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1.21 The tariffs of NTPC and NHPC have several shortcomings, notablythat they are based on average generation costs and do not distinguishbetween supply costs in peak and off-peak periods. Recently. GOI hasestablished a committee to recommend the principles on which both NTPC andNHPC should set their tariffs. It is widely expected that the committeewill recommend a tariff structure more closely aligned to the structure ofthe Corporati3ns' fixed and variable costs. This would be an importantstep towards ensuring that NTPC's and NHPC's stations are utilised asefficiently as possible, and towards more closely integrating operations ofthe regional grids (para 1.25). The forthcoming Bank operations with NTPCand NHPC will include components to assist each Corporation to restructuret',eir tariffs.

Power Sector Planning

1.22 The Bank has consistently encouraged GOI to pursue integratedpower system planning and to operate India's regional grids in anintegrated way. In response, GOI has prepared regional least-costgeneration development plans and recently has prepared a NationalTransmission Plan. Although these plans are important steps towardsintegrated planning, they need further refinement and regular updating.

1.23 Disparities between regional generation development plans,national Five-Year Plans and SEBs' capital budgets have been substantial.Fewer projects have been included in Five-Year Plans than in regionaldevelopment plans owing to a lack of resources. In addition, inadequateprovisions for cost escalation and inadequate implementation planning haveled to still fewer projects being executed. The resulting power deficitshave undermined long-term least-cost planning by necessitating rapidexpansion of short gestation generating capacity. The deficits have alsostimulated investment in captive generating plant. Usually, this iseconomically less efficient than public electricity supply, in part becauseof the dependence of captive plant upon high value petroleum products.

1.24 The Bank is continuing to stress the importance of furtherstrengthening sector investment planning. For Bank project appraisals,analyses undertaken by CEA (in collaboration with the Bank) go well beyondCEA's traditional,appraisals (Annex 5.1, para 5). These analyses areexposing CEA to the more rigorous planning techniques employed by powerutilities outside India. For both generation and transmission planning.the results have been a gradual improvement in the quality of CEA's projectappraisals and (often substantial) economies in the technical design ofparticular projects. Scope remains for further improvement, but the Bank'sinvolvement with CEA is helping India to improve the economic efficiency ofpower sector planning. In parallel with this, the Bank is continuing tostress to GOI the importance of integrating pricing with planning and ofeasing pressure on supplies through extending load management. Economicsector work being und2rtaken in FY 1989/90 4/ will include comprehensivereviews of sector planning, power pricing and load management potential,and environmental aspects of power development to identify practical waysthe efficiency of sector planning can be enhanced.

4/ A study entitled 'Long Term Issues Facing The Power Sector' is expectedto completed in December, 1989.

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1.25 To complement CEA's regional planning, the Bank is emphasizing theneed to operate each regional power system in an integrated way. Atpresent, only the Northern Region is approaching this. In the otherRegions, SEBs operate largely independently and most of the economiesavailable through diversity in the timing of states' peak demands are notyet being realised. To facilitate regional operations, GOI is encouragingstates to reach the necessary agreements on technical operating parameters.However, progress is likely to be slow so long as severe power shortagesexist. To improve the coordination of operations in the Western Region,the Bank and CEA have agreed upon a program of work to be undertaken inparallel with the proposed project that will identify opportunities foreconomic load dispatch in the Region and rationalize interstate powertradinj (para 3.02). Similar initiatives are planned in the Northern andEastern Regions in parallel with the forthcoming operations with NHPC andNTPC. Even if generation operations become coordinated within Regions,national coordination will be very difficult without extensive directcurrent transmission facilities to overcome problems of frequency control.The first such facility, a link between Northern and Western Regions, is acomponent rf the Central Power Transmission Project.

Entities' Mlanagement and Operations

1.26 Institutional and financial evolution of the sector has not keptpace with the tremendous physical growth of India's power systems. Thestructure and capabilities of sector entities require strengthening and theroles of some entities and the services they provide (principally CEA andCWC) need refocutsing. Compared with the relatively efficient managementand operations of NTPC, the capabilities of central agencies and most SEBsare extremely weak. However, even the institutional and financialcapabilities of NTPC are straining under the pressures of managing theCorporation's rapid growth. Most SEBs have adequately qualifiedengineering staff but lack experienced persounel for financial planning andcontrol. Unfortunately, significant pay differentials between the publicand private sectors make it difficult for SEBs to recruit and retain thenecessary staff. Overstaffing also remains a problem, though SEBs havemade significant progress on this over the last few years: since 1980/81,the number of staff per thousand consumers has been cut 34Z (para 1.02).(MSEB's ratio of 17.5 staff per thousand consumers compares favourably withthe national average of 19.0). SEBs' management practices also are oftenoutmoded and inadequate. For example, the accounts of some SEBs are stillmaintained principally to track cash receipts and expenditures. (Theuniform system of commercial accounting mandated through the 1985 amendmentof the Electricity (Supply) Act is being implemented, but only slowly).And in SEBs which have implemented commercial accounting (such as MSEB),there is still too little use of accounting information for managerialpurposes.

1.27 Institutional reform is a principal objective of the Bank'sstrategy in India's power sector (para 1.34). Consequently, the Bank islimiting its direct operations with SEBs to those Boards which, togetherwith their state governments, are committed to institutional reform. Underthe proposed project, MSEB would launch initiatives to streamlinemanagement through reorganizations in key areas and strengthen its

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management information systems (para 2.12). In addition to specificproject components aimed at institutional strengthening, the Bank willcontinue to support ad-hoc initiatives which aim to improve understandingof the factors underlying SEBs' poor financial performance and to identifyways constraints can be eased. One such recent initiative has been theworkshop on SEBs' finances, run in conjunction with PFC in February, 1989.

1.28 The operations of many SEBs continue to be hampered by the poorcondition of their plant and equipment. Nevertheless, there have beensignificant improvements in plant utilization. Despite deteriorating coalquality, plant load factors have increased ten percentage points since1980/81 and the rate of fuel consumption has been cut by 102 since 1979180(para 1.02). The poor condition of plant can principally be attributed topersistent capacity shortages, which have obliged SEBs to operate plantthrough normal maintenance periods. However, poor plant condition alsoreflects manufacturing deficiencies and the difficulties of obtaining spareparts in a timely manner. In general, these problems have been recognizedby the relevant authorities and corrective steps are being taken. Underthe proposed project, MSEB will take actions to strengthen its maintenanceof installations and will establish an operation and maintenance unit(para 2.14). Also, through its program of sector work, 5/ the Bank isseeking to identify generic causes of recurring technical problems and torecommend solutions that could be implemented in parallel with futurelending operations. Distribution systems also mostly are in poorcondition, reflecting inadequate maintenance, overloading owing toinadequate investment and equipment deficiencies. Rehabilitation,particularly of thermal plant and distribution systems, is a most cost-effective way to improve efficiency and augment system capacity. Recently,GOI has initiated a program to rehabilitate 30 thermal power stations.However, because of the divided responsibility for sector development (para1.12), GOI is less able to effect improvements in distribution. Whereverappropriate, the Bank will continue to include rehabilitation componentsunder its loans. The proposed project includes a time-slice of MSEB'sinvestments in transmission and distribution, the balance of which, asbetween rehabilitation and extension, has been agreed with. the Bank(paras 3.09 and 3.11).

GOI's Strategy in the Power Sector

1.29 The Five-Year Plan constitutes the only formal statement ofIndia's energy and power policies. Separate formalization of India's powerpolicy is made difficult by the constitutional arrangement wherebyresponsibility for the sector is shared between GOI and the States. Whilethe Eighth Plan has yet to be finalized, preliminary indications suggestthere will be little change in energy and power objectives from thosereflected in the Seventh Plan. PrincipaL objectives are likely to remainto: (a) develop energy supplies at a rate commensurate with economic growthand social needs; (b) substitute indigenous energy resources for importedfuels wherever this is economically feasible; and (c) encourage rationaland efficient energy use. India's power policies are governed byessentially the same objectives, although alleviation of India's acute

5/ Specifically, the Power System Efficiency Study, which will becompleted in June, 1989.

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power shortages most probably will continue to dominate GOI's short-termstrategy. Over the longer term, achievement of least-cost developmentassumes greater importance.

1.30 Recent GOI initiatives (its establishment of PFC and attempts atimproving SEBs' financial performance and at stimulating private sectorparticipation in power supply) are encouraging signs that the Eighth Planwill focus more sharply on tackling root causes of sector inefficiencies.Specific power policy objectives for the Eighth Plan will likely be to:

(a) rehabilitate thermal plant (para 1.28);

(b) accelerate implementation of ongoing projects - GOI hascreated a ministry to improve implementation of public sectorprojects; also, lending by PFC will aim to acceleraterehabilitation and distribution projects (para 1.13);

(c) be more supportive of private sector participation in powersupply (para 1.15);

(d) permit the construction of shorter gestation gas or oil-firedplants (para 1.04); and

'e) improve the quality and reliability of coal supplies to powerstations (para 1.05).

1.31 GOI's long-term strategy for power sector development comprises ablend of policies to address investment, organizational, institutional andfinancial issues. Regarding investment, the Eighth Plan objectives willlikely be to:

(a) accelerate hydro development (para 1.07);

(b) increase investment in transmission and distribution relativeto investment in generation (para 1.09);

(c) extend coal beneficiation to improve both quality andhomogeneity of supplies to power stations (para 1.05);

(d) diversify coal transport, for example, through theintroduction of coastal shipping (para 1.05);

(e) diversify the fuels used for power generation; GOI recognizesthat gas has an economic role to play; also that importedcoal may be economic at some locations (paras 1.04 and 1.06);and

(f) continue steady development of nuclear power (para 1.08).

1.32 Long-term organizational, institutional and financial issues aremore controversial and GOI still needs clearly defined strategies in theseareas. GOI recognizes the institutional and financial weakness of theSEBs, but is heavily constrained in its ability to effect improvements

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unilaterally (para 1.12). Initiatives GOI is likely to pursue urder theEighth Plan vill be tot

(a) increase the role of efficient central sector inst'tution3,particularly NTPC (para 1.14);

(b) accelerate implementation of the uniform system of commercialaccounting for all SEBs (para 1.26); and

(c) give more favorable consideration to specific proposals forprivate sector participation in power supply, particularlywhen such developments would mobilize additional resourcesfor the sector (para 1.15).

1.33 GOI's initiative in forming PFC will also begin to yield resultsunder the Eighth Plan. Funds lent by PFC will be attractive to SEBsbecause, at least in part, they will be additional to Plan allocations.GOI expects that PFC will pursue institutional reform of SEBs throughsubjecting loan beneficiaries to conditionality designed to improveefficiency and financial performance. In addition, GOI will also press forimprovements in SEBs' financial performance through requiring SEBs to meetor exceed the minimum rate of return target specified in the 1985 amendmentto the Electricity Supply Act (para 1.17).. Finally, GOI is giving closeconsideration to formation of an entity to oversee development andoperation of a national transmission grid. GOI recognizes that this wouldbe difficult within the present organization of the sector (para 1.12).

Bank Group Strategy in the Power Sector

1.34 The Bank supports the elements of GOI's strategy outlined above.However, while each element is desirable, the strategy does not address allthe sector's deficiencies in a sufficiently determined way. Additionalefforts are needed to address constraints in the areas of planning,pricing, load management, institutional development and finance. Theprevalent nature of these constraints suggests that a sector-wide approachshould be sought. However, the comparative autonomy of the States and SEBsfrom GOI makes it difficult to achieve progress through involvementexclusively with central agencies. With the exception of the introductionof uniform commercial accounting in SEBs, few improvements at the statelevel have been realized through umbrella projects coordinated by a centralagency. The experience of the Bank ln its earlier transmission projects,and more recently in rural electrification, has been particularlydisappointing. As a result, the Bank is pursuing a more direct involvementwith selected SEBs which, together with their state government, arecommitted to reform and where state-specific programs can be designed toaddress areas of deficiency. Initial experience with individual SEBs (inKarnataka and Uttar Pradesh) has been encouraging. Under the Uttar Pradeshand Karnataka Power Projects, Uttar Pradesh State Electricity Board andKarnataka Electricity Board each agreed to comprehensive programs ofinstitutional and financicl reform. Under the proposed project, MSEB willalso implement a program of institutional and financial reforms. The mainobjectives of the program will be to strengthen MSEB's managementorganization and management information systems and to adjust MSEB's tariffto reflect more closely the level and structure of economic supply costs.

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Tariffs and financial performance will continue to be the areas in whichprogress is most difficult to make as States have limited incentives toimprove SEBsB financial performance.

1.35 In parallel with lending to selected SEBs, the Bank plans tocontinue to support central sector entities. Increased reliance by theSEBs on generation from NTPC and NHPC appears to be the best way toencourage decisions at the state level consistent with the nationalinterest. Difficulties GOI has experienced in bringing hydro projects intothe central sector mean that NTPC will continue to be the main recipient ofBank support. NTPC's record to date is impressive, though the Corporationcontinues to face strains emanating from its rapid growth and will benefitfrom continued Bank support (paras 1.18 and 1.26). In the wider context,the Bank feels that a review is needed of the organization and technicalservices provided by sector entities. This review should encompass theorganization and functions of CEA and consider the desirability ofestablishing a utility specifically to develop and operate a national powergrid. Such an institutional review is included in the Bank's program ofeconomic sector work (para 1.24).

1.36 In addition to addressing areas in which GOI's strategy appearsdeficient, it is appropriate also for the Bank to focus on aspects of thestrategy already adopted, where the Bank can catalyse progress. In thisregard, specific objectives the Bank has adopted are to assist:

(a) integration of power systems operations, including throughthe formation of a national grid. Work that will beundertaken by CEA and the Bank in parallel with the proposedproject will improve coordination of SEBs' operations in theWestern Region and facilitate efficient dispatch of new andexisting power stations (para 3.02);

(b) acceleration of hydro development. The proposed projectwould assist facilitate more efficient utilization of theexisting Koyna reservoir and thereby avoid the need for moreexpensive peaking thermal plant (para 5.04);

(c) development of international projects that could result inlow-cost sources of power for India, such as the Karnalihydro project in Nepal and the Pancheshwar hydro projectlying on the border between India and Nepal;

(d) strategy developments that require coordinated actions byorganizations within and outside the power sector. The Bankcan tailor its own lending operations to improve inter-sectoral cooperation. Priority areas concern improvements incoal quality and transportation, and the use of natural gasfor power generation;

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(e) development of private sector power generation. Possibleoperations with BSES and TEC will aim to complement GOI'sinitiatives to stimulcte private sector participation inpower supply (para 1.1Z). Specific project objectives willbe to mobilize funds not available to public power utilitiesand to improve commercial arrangements between privateutilities and SEBs; and

(f) development of a comprehensive strategy regardingenvironmental and sociological aspects of power sectordevelopment. Economic sector work being undertaken this year(para 1.24) will recommend uniform eni'ironmental,sociological and anthropological safeguards for powerprojects in India and improved procedures within GOI and theStates for reviewing proposed projects.

Bank Group Participation

1.37 The Bank has made 28 loans (US$5,339 million) and 18 IDA Credits(US$2,306 million) for Indian power projects (Annex 1.3). Twenty-twoprojects have been completed: 15 generation; 4 transmission; and 3 ruralelectrification. Projects currently under implementation include: 12generation, 3 of which are hydro; 2 transmission; and 5 which include a mixof generation, transmission and distribution. With respect to NTPCprojects, the first-phase projects at Singrauli, Korba, and Ramagundam werecommissioned on or ahead of schedule and the plants have been operating athigh efficiency. The second-phase extensions at these sites, the Farakka,the Rihand Power Transmission, and the Combined Cycle Projects areproceeding satisfactorily.

1a38 Through its participation in the sector in recent years, the Bankhas contributed to the creation and development of NTPC which, with2,500 MW commissioned in the last five years and around 3,000 MW underconstruction, is becoming a large and efficient generating company byinternational standards. The Bank also has assisted one of the few privateutilities ir. the country - the Tata Electric Companies - in supporting theconstruction of the first 500 MW thermal unit in India and the Bank isplanning further operations to support development of private utilities.Similarly, the Bank promoted - through two transmission projects. theCentral and Rihand Power Transmission Projects - the introduction of highvoltage, direct current technology. In addition to contributing in asubstantive way to the supply of power, projects financed by the Bank alsohave promoted the development in India of a large public and privatemanufacturing sector for the construction of the required equipment (e.g.steam generators, turbo-generators, auxiliary and transmission equipment).While these industries still lack the quality and efficiency of theirinternational counterparts, the competition resulting from internationalcompetitive bidding will encourage further improvements in the quality ofdomestically manufactured equipment.

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1.39 The Bank has had a direct involvement in Maharashtra's powersector through the First, Second, Third and Fourth Trombay Power Projectswith Tata Electric Companies 6/ and through the Chandrapur Thermal PowerProject (Loan 2544-IN in 1985) with MSEB. Implementation of the firstthree Trombay projects was completed successfully. The Project CompletionReport for the Third Trombay Project (February, 1986) notes that theproject fully achieved its objectives and is likely to yield an economicrate of return in excess of 302. Implementation of the Fourth Project isproceeding satisfactorily and all Bank funds are now committed. Afterinitial delays related to necessary environmental clearances,implementation of the Chandrapur Power Project is also now proceedingsatisfactorily. The Bank has also had indirect involvements inMaharashtra's power aector through the First, Second and Third RuralElectrification Projects, 7/ and through the First, Second and ThirdTransmission Projects. 81 While the physical objectives of these projectsmostly have been achieved, implementation frequently was problematic andinstitutional gains proved very disappointing relative to expectations.

1.40 A performance audit conducted in 1980 for the Second PoweiLTransmission Project (Credit 242-IN) concluded that the project succeededin helping the nine beneficiary SEBs extend their transmission systems tomeet their growing power requirements. Utilization of generating capacityin these SEBs exceeded the appraisal forecast. However, the audithighlighted the difficulties of effecting institutional improvements in theabsence of a close working relationship between the Bank and beneficiarySEBs. Project Completion Reports for the Third and Fourth TransmissionProjects (Credits 377-IN and 604-IN) highlight that Bank expectations toimprove the financial practices and viability of the SEBs through centrallymanaged projects have not been fulfilled; despite some progress, SEBs ingeneral did not respond to initiatives mounted by GOI. These PCRs alsoemphasize that direct Bank involvement with SEBs is desirable and theattempts to reach SEBs through the Center probably will be successful onlywhen the Center is more directly involved in the sector in the region, foralleviating power shortages and assisting in system expansion andoperation. Another performance audit, conducted in 1985 for the First andSecond Rural Electrification Projects (Credits 572-IN and 911-IN),concluded that India's rural electrification program, of which the projectswere a part, has helped the country achieve food self-sufficiency,alleviate poverty, and strengthen the rural economy; however, littleprogress was made in bringing about institutional improvements. In commonwith the previous audit, this also emphasized that the Bank should devoteresources to deal with the SEBs directly.

6/ Respectively, Loans 106-IN, 164-IN (in 1957), 1549-IN (in 1978) and2452-IN (in 1984).

7/ Respectively, Credits 572-IN and 977-IN and Loan 2165-IN (in 1982).

8/ Respectively, Loan 416-IN and Credits 242-IN and 377-IN.

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II. THE BENEFICIARIES

Introduction

2.01 The two principal beneficiaries of the project are the Governmentof Maharashtra Irrigation Department (GOMID), which vill implement theKoyna IV hydroelectric component, and the Maharashtra State ElectricityBoard (MSEB). MSEB vill have responsibility for implementation of theTransmission and Distribution component, as well as for the operation andmaintenance of Koyna IV hydro component (under a 30-year leasingarrangement with GOM) once construction completed. A brief account of thetwo Action Plans, aimed respectively at trengthening the operationalmanagement as well as consolidating the longer run financial soundness ofMSEB, is given in paras 2.12 and 4.01.

A. Government of Maharashtra Irrigation Department

2.02 GOMID is an operational unit of the Government of Maharashtra,responsible for implementing all irrigation and hydropower schemes inMaharashtra. The Bank au.d GOMID have been associated in a number ofirrigation and hydroelectric projects dating back to the earlier Koynadevelopments. The most recent project financed by the Bank and implementedby GOMID is the Maharashtra Composite Irrigation Project (Loan 1621-IN),approved in 1986. GOMID is therefore thoroughly familiar with the Bank'sprocedures for project implementation.

Organization and Technical Capabilities

2.03 Civil engineering design is carried out under the chief engineer(projects). He is responsible for the Central Design Office (CDO) whichcarries out major civil design work; he is also responsible for theMaharashtra Engineering Research Institute (a well reputed organizationcarrying out basic and applied research in the civil engineering field),the Dam Safety Organization, and the Engineering Staff College. The chiefengineer (electrical) is responsible for the design of permanent equipmentfor each installation, and the chief engineer (mechanical) is responsiblefor provision and maintenance of construction plant by force account units.Coordination of the various inputs is the responsibility of the regionalsuperintending engineer in charge of the project. Improvement to theexisting organization will be implemented under the proposed project(para 3.10).

2.04 At the operating level, responsibility is divided among a numberof functional divisions and six regional divisions, each headed by a chiefengineer. Regional chief engineers are responsible for investigation andconstruction of new projects and operation and maintenance of existingirrigation projects.

2.05 GOMID's design and construction organization is well establishedand experienced. GOID and its predecessor (Maharashtra Izrigation andPower Department) have been responsible for the construction of some 600large and medium-sized dams throughout the state. GOMID also hasconsiderable experience in hydropower, having installed some 1,200 MW over

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the last 30 years. Most of their hydro developments are small to mediumsized plants associated with irrigation dams. However, they have also beenresponsible for a number of large developments, including the first threestages of the Koyna scheme, which are directly relevant to the currentlyproposed development. Stages I and II, which were completed in 1967, havean installed capacity of 560 MW in eight units, and a very similarconfiguration to Stage TV. The Stage III development, completed in 1976,also inclu.des a major dam, an underground powerhouse, long tunnels, and afurther 500 MW of capacity in four units. In the construction area, thepractice of GOMID carrying out a large proportion of its work by forceaccount has resulted in the desirable situation of supervising engineershaving direct construction experience. Specific GOMID arrangements toimplement Koyna IV are discussed in Chapter III.

2.06 Hydropower plants in Maharashtra belong to GOM; they are leasedfor 30 years to MSEB, which is fully responsible for their operation £. imaintenance. For each plant, the lease rent payment is calculated so thatGOM recoup all investment costs for power generation, at an 8Z interestrate, over a 30-year period. After 30 years, the facility will return toGOM and a new lease contract would be negotiated. All hydro plants inMaharishtra are less than 30 years old, but the lease for the older oneswill be eligible for renegotiation within two years. MsEB bears alloperation and maintenance costs.

2.07 The 8Z interest rate used for calculation of the lease-rentpayments is substantially below the ongoing interest rate for long-termloans to MSEB (1lZ to 14Z), and the rate charged by GOM for loans to itsagencies and corporations (9Z). Hence, it arguably includes an element ofsubsidization. Moreover, the 30-year period used in the calculation isless than the economic life of most hydro plants. This situation should becorrected in the future for new hydro plants; hence under the FinancialAction Plan (Annex 4.4, para 2(c)), GOM and MSEB will revise the terms ofthe lease agreements to be signed later than December 31, 1989.

Project Accounts and Audit

2.08 External audit of project accounts will be carried out by theComptroller and Auditor General of India, through his localrepresentatives, the Auditor General of Maharashtra. Agreement was reachedwith GOM during negotiations that GOMID will set up separate accounts forthe proposed project, to be audited annually by an independent auditoracceptable to the Bank, and that it will provide the Bank with auditedfinancial statements of said project accounts within nine months of the endof each fiscal year, together with a certified report by the Auditor.

B. Maharashtra State Electricity Board

Introduction

2.09 The proposed project would be the second Bank operation with MSEB.The first project (Chandrapur Thermal Power Project, Loan 2544-IN) focussedon training, reduction of transmission and distribution losses, financialaccounting, and tariff structure improvement. The project is proceeding

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satisfactorily, except with regard to commercial receivables (paras 4.06and 4.17), and delay in preparation of a tariff structure study nowunderway (para 2.17).

2.10 MSEB was constituted in 1954 under the Electricity (Supply) Act of1948; it is responsible for generation, transmission, and distribution ofelectricity throughout the State of Maharashtra. It constitutes thelargest state power network in India, with an installed capacity of about6,000 MW as of end-1987 (13Z of all-India); 256,000 km of distributionlines, and 150,000 km of above 11 kV transmission lines. It has about97,000 employees (10Z of the sector). MSEB seives about 6.5 millionconnections comprising 4.3 million domestic, 0.7 million commercial, 0.2million industrial, 1.2 million agric__tura)., and less than 0.1 millionmiscellaneous. Industrial consumption represents 38Z of the total, whilecommercial represents 2Z; agriculture 17Z; domestic consumption 8Z; andother consumers and bulk power trading 35X. The Board constructs andoperates generating stations and transmission and distribution networks tosupply final consumers, and also issues licenses to private power utilitiesin Maharashtra 9/ and for private captive generation. MSEB is not fullyautonomous in executing its responsibilities, since the Government ofMaharashtra Energy Department (GOMED) exercises considerable infl-ence overthe Board's activities, especially in matters of staffing, borrowing, andtariff-setting. Furthermore, MSEB's capital investment program is anintegral part of Mahareshtra's capital budget formulated by GOI ntd GOM ona five-year basis.

2.11 Although there is scope for improvement in management efficiencyand productivity by international standards (Annex 2.1) as well as forimproved financial performance, MSEB raiks favourably in comparison withother SEBs in Ii.dia (Annex 2.2) in terms of efficiency and financialperformance; it is the seventh SEB in terms of number of employees per1,000 consumers (17.5 employees/l,000 consumers), and the second for thenumber of employees per GWh (4.6 employees per GWh); it was one of the twoSEBs in the country with a positive net income in FY 1986/87, and a rate ofreturn (on historically valued net fixed assets, after depreciation,interest and taxes) close to the 32 minimum stipulated in the Electricity(Supply) Act (equivalent to a 9.3Z ROR on historical assets according toBank definition).

2.12 During preparation of the proposed project, the management,operations and finances of MSEB have been reviewed in the context of anAction Plan for Managerial Development (.nnex 2.3), and a Financial ActionPlan (A ,ex 4.4), aimed at strengthening the overall operational,managerial and financial performance of this utility. The main areas thatwould need improvement are organization, management information systems,and finances. MSEB's present organization was found to be generallysatisfactory. However, in order to improve the quality of electricityservice and enhance productivity, the organization of MSEB will need to bestrengthened in the following areas: (a) corporate planning; (b)distribution planning; (c) operations performance monitoring; (d)management accounting; (e) environment protection; and (f) management

9/ The Tata Electric Companies (TEC) and Bombay Suburban ElectricitySupply (BSES), both operating in Bombay.

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information systems. The necessary actions needed to achieve thisimprovement have been discussed with MSEB's management, and are included inan Action Plan for Manager'al Development (Annex 2.3), including specifictargets, proposed actions to achieve them, and an implementation timetable.The different aspects of the Action Plan are discussed below in the ensuingparagraphs. During negotiations, agreement was reached with MSEB on thecontent of the Action Plan as well as on its implementation in accordancewith an agreed timetable (para 6.02(a)). Regarding electricity tariffs,specific actions to improve cost recovery from consumers and inter-statepower trading have already been identified and are discussed in para 2.17.Measures necessary to improve the financial situation of MSEB andstrengthen its financial autonomy are discussed in Chapter IV.

Organization

2.13 MSEB is a corporate body managed by a Board consisting of a full-time Chairman, and three full-time Members (for Accounts, Technical, andAdministration). Board Members are appointed by GOM, and define MSEB'sgeneral policies, as well as managing their respective sectors. The Boardmeets about twice every month. MSEB's field organization for distribution(Annex 2.4) is generally satisfactory. It is set up around seven RegionalDistribution Zones, under a Technical Director (Distribution). Each Zone,headed by a Regional Chief Engineer, comprises about five Circles, each offi-re Divisions. An average Division serves about 60,000 consumers, with aworkforce of about 700. The Division is a fairly autonomous entity, incharge of distribution system maintenance, commercial relations withconsumers, billing and collection, consumers connection and disconnection,local accounting, and personnel management. Generation (Operations &Haintenance) is organized in the field in eight zones corresponding to themain power plants and transmission substations. MSEB directly executes asubstantial part of its development program, espertally transmission linesand substations, with its departmental organization.

Operation and Maintenance

2.14 MSEB's operation and plant maintenance standards and practices aresatisfactory. This is confirmed by the relative low load shedding takingplace in a system with little or no spare capacity. Overall plantperformance is acceptable. Major maintenance is done by contractors orsuppliers and routine maintenance is done by MSEB staff. Major equipmentis maintained in accordance with routines and schedules prescribed bymanufacturers. Transmiscion lines are inspected at least once a month, andmajor components of distribution systems are also inspected periodically inaccordance with pre-established schedules. Reporting of performance forgeneration and analysis of field reports are systematically done at MSEB'sheadquarters. Reporting of performance for Transmission and most of all,for Distribution is less satisfactory, where the management is not providedwith a consistent set of operational performance indicators. As part ofthe Action Plan for Managerial Development (Annex 2.3, para 2.3), aperformance monitoring system will be implemented, and present monitoringindicators will be reviewed and revised, if needed. Moreover, a centralOperation and Maintenance (O&M) unit will be established to monitortechnical performance indicators and maintenance standards (terms ofreference are given in Annex 2.3, Attachment 4). Training as well as

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technical visits to selected public utilities to acquaint MSEB's staff withon-going practices in this respect will be financed under the proposedproject (para 3.06). Maintenance of installations such as buildings,auxiliary services (i.e. water treatment plants, repair shops, storagearea, etc.) is corrective rather than preventive. Standards are generallybelow those for a utility of the size and importance of MSEB. The generalcondition and cleanliness of some installation poses risks to safe plantoperation and to safety and health of staff. Under the Action Plan forManagerial Development (Annex 2.3. para 2.3), MSEB will establish byMarch 31, 1990, an O&M unit, and prepare, before December 31, 1990,maintenance manuals and preventive maintenance routines.

Tariffs

2.15 MSEB's existing tariff is summarized in Annex 2.5, together withthe relationship of the main elements of the tariff in comparison withestimated economic supply costs. The principal features of the tariff areits complexity, the cross-subsidy of low voltage consumers (andagricultural consumers in particular) by industry and the absence of anydistinction between the co'sts of providing energy during peak and off-peakperiods. MSEB's average tariff level of 75 paise per kWh in 1987188 isestimated to have been equivalent to approximately 74Z of the marginal costof supplies and is one of the highest in India. However, the structure ofMSEB's tariff shows sharp divergences from the structure of marginal costestimates. For example, while the tariff to large industrial consumers isequivalent to approximately 1152 of the marginal cost of supplying theseconsumers, agricultural consumers are charged only 82 of the marginal costof their supplies. Similarly, the tariff to commercial consumers isapproximately 602 of marginal cost, while that to domestic consumers isabout only 24Z of marginal cost.

2.16 Under the 1985 revision to the Electricity (Supply) Act, SEBs havethe authority to adjust the level and structure of their tariffs. Inpractice, however, SEBs do not adjust tariffs without the concurrence oftheir state government; power tariffs (particularly to low voltageconsumers) have become a highly charged political issue. Nevertheless, thepace of reform of MSEB's tariff has been impressive. Since 1984/85, theaverage level of MSEB's tariff has increased 25.02 in real terms, anaverage real increase of 7.7Z per annum (Annex 2.5), page 2). Prices toindustry increased over 30? in real terms during this period as did pricesto bulk purchasers of power. 10/

2.17 The proposed project includes actions which aim to continueimproving the level and structure of MSEB's tariff in relation to economicsupply costs through a series of load management initiatives and selectivetariff increases. This project component will be based upon the findingsand recommendations of a study of MSEB-s tariff presently being undertakenby consultants. During negotiations, MSEB agreed that, prior toDecember 31, 1989, it would furnish to the Bank a copy of the finsl reportof the tariff study (para 6.02(b)). It was understood during negotiationsthat the Bank will provide MSEB with comments on the findings andrecommendations of the study, and that MSEB will take the Bank's comments

10/ MSEB also provides bulk power supplies to TEC, BSES and States in theWestern and Southern Regions.

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into account when formulating its proposals for tariff adjustments and loadmanagement initiatives. MSEB also agreed that, prior to June 30, 1990, itwill afford the Bank an opportunity to comment on the tariff adjustmentsand load management initiatives it lntends to implement based, inter alia,on the recommendation of the tariff study (para 6.02(b)).

Personnel and Staffing

2.18 At the end of FY1988, HSEB had about 97,000 regular employees, andabout 8,000 skilled workers employed in non-permanent positions(Annex 2.6). About 6,000 of the regular workforce and all the daily wageworkers were engaged in construction activities. Distribution andOperation & Maintenance staff represent 85,000 employees, of which morethan 50? were unskilled workers. Although significant labor productivitygains were achieved over the last few years (from 21 employees per thousandconsumers in FY83 to 15 employees per thousand consumers in FY1987/88), andMSEB's labour productivity is one of the highest amongst India's StateElectricity Boards, MSEB is still over-staffed compared to public utilitiesin cceparable developing countries (Annex 2.1) (for example, in Indonesia,there are 81 consumers per employee). MSEB's management has placed, in FY1986/87, a freeze on recruitment of all staff below junior enginseer level(levels III and IV). Future expansion (7.7? per annum in terms of powergeneration, and 6.2? per annum in terms of number of consumers) over theFY 1987188 to FY 1994/95 period is expected to be met with an averagelabour force increase of 2X per annum. To achieve this target, MSEB'sAction Plan for Managerial Development includes the preparation of a humanresources development plan, including monitorable annual staff productivitytargets, and a manpower plan (Annex 2.3, para 3.3, and Attachment 7).

Training

2.19 MSEB has an active Training Department located at Nasik,supervising eight training centers (four for generation, and four for T&D),mainly for technicians and engineers. In addition, MSEB has in-housetraining programs in accounting and administration, and external trainingprograms in finance, management of human resources for higher level staff,computer skills and science, and in specialized technical fields. InFY1987/88, training courses were delivered to 1,329 employees in differentfields, of which 1,273 within MSEB (Annex 2.7). MSEB has also developedhuman resources management and staff motivation programs, and isexperimenting--with some success--with Quality Circles and "protege"(mentor) arrangements for junior staff. However, there is a deficiency inspecific training for higher level staff in public utilities management,particularly in management accounting, corporate planning, operationperformance monitoring systems, and MIS computerization for publicutilities. The proposed project will finance specific training programs inpublic utilities management and MIS (operation and maintenance, para 2.14;financial planning, para 2.21; and management accounting, para 2.23). TheAction Plan for Managerial Developmeit also includes specific targets forcomputer training (Annex 2.3, para 3.2).

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Corporate Planning

2.20 To date MSEB has no Investment Planning or Corporate Planning unitto ptepare medium and long-term development plans and to integrate theplans of the different organizational units. Investment Planning isnominally under the Chief Engineer (Transmission Planning); OperationPlanning is coordinated by the Director Generation (Operations &Maintenance); Sales Planning is under the Chief Engineer (Commercial);Personnel Planning under the Member (Administration); and FinancialPlanning is under the Director (Finance). The planning cycle in MSEB islimited to the preparation every five years of the State and NationalPlans. With the considerable developments planned to occur in the future,coordination between generation, T&D, commercial, and finance functions isbecoming increasingly important. The planning function needs to bereorganized and strengthened, to become a centralized, coordinating, andforwarding-looking function. The need for a planning unit is recognized byMSEB management, and the establishment of a centralized planning unit isincluded in the Action Plan for Managerial Development (Annex 2.3, para 2.2and Attachment 2). This unit will prepare and maintain a detailed,revolving five-year plan, as well as long-term indicative 10 and 20-yearplans; it will also coordinate the preparation of disaggregated powerdemand forecasts, and detailed plans for generation and T&D, investment,finance, and manpower.

Financial Planning

2.21 Financial planning is carried out mainly for the annualcalculation and negotiation of GOM loans to MSEB, and the preparation ofthe National and State Plans, but not for management purpose. The Boardprepares every five years, as part of the National and State planningprocess, reports on its investment program and investment financingrequirements. These documents are of little practical use for financialplanning purpose, as they are prepared in constant prices, and do notprovide a complete investment and working capital financing plan includingall sources available. Moreover, the five-year plan is not updatedannually, and therefore rapidly becomes obsolete. An experimentalFinancial Planning Unit has been established in relation with thepreparation of the proposed project, but its present staffing isinsufficient, and the scope for strengthening it is limited by the acuteshortage in MSEB of suitably trained staff. The unit also needs dataprocessing support, but the introduction of micro-computers andcomputerized financial planning models is being delayed by the necessarylead-time to train staff in their operation. The strengthening of theFinancial Planning Unit, and the satisfaction of its logistic needs isincluded in the Action Plan for Managerial Development (Annex 2.3,para 2.2). The proposed project will provide support for purchase of dataprocessing hardware and software, and for training abroad, as necessary(para 3.06, and Annex 3.1).

Financial Organization and Accounting

2.22 Financial operations in MSEB are regulated by the Electricity(Supply) Act, 1948, amended in 1978 and 1985 to reorganize finances of SEBsalong commercial lines. MSEB successfully introduced new commercial

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accounting system in 1985. The organization of MSEB's financial complex issatisfactory. It is is headed by a full-time Board Member (Accounts), whois a senior member of the Indian Administrative Service. He is assisted bya Director (Accounts) for financial accounting; a Director (Finance) forrevenue collection, financial operations, treasury, and the budget; aDirector (Management Accounts) for consumer billing, computer centermanagement, and management accounting; and a Director (Internal Audit) forfield office inspection, internal financial audit, and relations with theExternal Auditor. In addition, the Accounting Department has field officesin every zone and division, under the administrative authority of the localChief Engineer, but with permanent functional relations with theDirectorate of Finance and the Directorate of Management Accounts.Accounts Department staff are competent and well-trained.

2.23 Management Accounting needs to be strengthened. Reasonablyreliable cost data are available only for thermal generation, but not forT&D. Data availability is insufficient for tariff setting, performancemonitoring, or economic analysis. MSEB is aware of this weakness and hasrequested Bank support under the proposed project to modernize itsmanagement accounting system. The proposed project includes provision fororganizing a training programlworkshop for upper level managementaccounting staff (para 3.06 and Annex 3.1). The implementation of a newmanagement accounting system is included in the Action Plan for ManagerialDevelopment (Annex 2.3, para 3.1), under terms of reference given inAttachment 6 to Annex 2.3.

External Audit

2.24 The audit of MSEB's accounts is carried out annually by theComptroller and Auditor General of India through his local representative,the Auditor General of Maharashtra. The FY1987/88 audit report wascompleted recently and found satisfactory. Accounting procedures in MSEBhave been found satisfactory in general jy the Auditor. According to theAct, the accounts and the Auditor's report must be submitted to the StateGovernment within six months of the close of the year. In the past, MSEBhas submitted the financial statements to the Auditor within the six-monthlimit, but the Auditor's report was finalized after the six-month period,although within the nine-month period stipulated in the Chandrapur ThermalPower Project. The existing audit arrangements under the on-goingChandrapur Thermal Power Project are satisfactory, and should be continued.During negotiations, MSEB agreed to continue to furnish to the Bank, by nolater than nine months after the end of each fiscal year, its auditedaccounts together with the Auditor's certificate and report.

Internal Audit

2.25 MSEB's internal control is limited at present to financial andmonetary transactions, including capital expenditures, store purchases,billing and collection. Controls are carried out by the Chief Auditor, whoreports to the Member (Accounts). This unit has proved to be efficient inestablishment of sound financial procedures. However, its role is limitedto financial transactions, and does not extend to all managerial practicesand internal procedures, which are also covered in modern internal auditunits. MSoreover, the placement of this unit under the Member (Accounts)

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may limit its autonomy and independence. The extension of the role of theInternal Audit Unit, and suitable arrangements to guarantee itsindependence and autonomy are included in the Action Plan for ManagerialDevelopment (Annex 2.3, para 2.3), and terms of reference are given inAttachment 5 to Annex 2.3.

Consumers Billing

2.26 All electricity consumption is metered, except for low voltageagriculture. Meter reading and billing is done on a monthly basis forindustrial and agricultural high voltage consumers. For other consumers,meter reading is carried out every two months (every four months in ruralareas). Although consumeL billing is still mostly manual, it is reasonablyefficient and is not responsible for collection delays. MSEB has initiatedin 1974 a billing computerization program, with one computer center in eachzone. To date four out of seven zones have been successfully computerized(Pune, Bombay, Nagpur, and Aurangabad). Computerization of the remainingthree zones is delayed by the shortage of staff with computer skills(despite MSEB's computer training program), the considerable work requiredfor the initial data input (each region represent about one millionconsumers), and telecommunication deficiencies between regions. Theseissues will be addressed under MSEB's Data Processing Plan (para 2.28).

Management Information System and Data Processing

2.27 MSEB has embarked on the development of its management informationsystem (MIS), and encouraging results have been achieved in the areas offinancial accounting, consumer billing, investment project monitoring,inventory management and fixed assets management; the MIS is still underdevelopment for personnel management. At present, each of the maindepartments has its own MIS and data processing systems which have beendeveloped independently. With the growth ! the number of consumers, theincreased generation capacity, and the expansion of the transmission anddistribution network, an increasing volume of data must be collected andprocessed to provide timely information to the decision centers. MISdevelopment has not kept up to the Board's expansion, hence some systemsneed to be modernized and integrated to become an effective m