Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 48516-NP

PROJECT PAPER

PROPOSED ADDITIONAL FINANCING CREDIT

IN THE AMOUNT O F SDR 49.6 MILLION (UW73.7 MILLION EQUIVALENT)

AND A

PROPOSED ADDITIONAL FINANCING GRANT

IN THE AMOUNT O F SDR 10.5 MILLION (US$15.5 MILLION EQUIVALENT)

T O NEPAL

FOR THE

POWER DEVELOPMENT PROJECT

May 18,2009

Sustainable Development Department Energy Unit South Asia Region

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

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CURRENCY EQUIVALENTS

(Exchange Rate Effective April 30,2009)

AEPC ARCS CDO DDCs DEF EIA EIRR ESMAP ESSD FM FY G M P GON IAS IBRD ICB IDA IPPs M&E MHFGs MHVEC MIS NCB NEA NPC OAG PAP PDF PDO PDP PMAS REDP

Currency Unit = Nepalese Rupees NPRs 1 = US$0.0123

US$1 = NPRs 80.92

FISCAL YEAR July 16 - July 15

ABBREVIATIONS AND ACRONYMS

Alternative Energy Promotion Center Audit Report Compliance System Chief District Officer District Development Committees District Energy Fund Environmental Impact Assessment Economic Internal Rate of Return Energy Sector Management Assistance Program Environment and Social Studies Department Financial Management Fiscal Year Governance and Accountability Action Plan Government of Nepal International Accounting Standards International Bank for Reconstruction and Development International Competitive Bidding International Development Association Independent Power Producers Monitoring and Evaluation Microhydro Functional Groups Microhydro Village Electrification Component Management Information System National Competitive Bidding Nepal Electricity Authority National Planning Commission Office of the Auditor General Project-Affected People Power Development Fund Project Development Objective Power Development Project Poverty Monitoring and Analysis System Rural Energy Development Program

FOR OFFlClAL USE ONLY

RFP SDR SIA SOE S S TL UNDB VDC

Request for Proposal Special Drawing Rights Social Impact Assessment Statement of Expenditures Substations Transmission Lines United Nations Development Business Village Development Committee

Vice President: Isabel M. Guerrero Country Director: Susan G. Goldmark

Sector Director/Manager: John H. SteidSalman Zaheer Task Team Leader: Michael Haney

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

Table of Contents

A . Introduction .................................................................................................................... 1

. .................................................... B Background and Rationale for Additional Financing 1

C . Project Implementation Experience .............................................................................. 4

....................................................... . D Proposed Changes under the Additional Financing 6

. ......................................................................... E Consistency with Interim Strategy Note 7

. . . F . Appraisal of Project Activities ........................................................................................ 7

...................................................................................................... . G Expected Outcomes 12

........................................................................................................ H . Benefits and Risks 12

I . Financial Terms and Conditions for the Additional Financing ..................................... 14

................................................ Annex 1 : Combined Results Framework and Monitoring 15 ..................................................................................... Annex 2 . Financial Management 19

............................................................................... Annex 3 : Procurement Arrangements 34 Annex 4 . Governance and Accountability Framework .................................................... 39 Annex 5 . Withdrawal of the Proceeds of the Additional Financing ................................. 47

Project Paper Data Sheet

I Current closing date: December 3 1,20 10

Date: May 18,2009 Country: Nepal Project Name: Power Development Project Project ID: PI16190

Annual Cumulative

Team Leader: Michael Haney Sector DirectorIManager: John Stein1 Salman Zaheer Country Director: Susan Goldmark Environmental Category: B

Is approval for any policy exception sought from the Board? 1 o ~ e s oP Revised project development objectives1outcomes [If applicable]

Borrower: Government of Nepal Responsible agencies: Nepal Electricity Authority; Alternative Energy Promotion Cer Revised estimated disbursements (Bank FY/US$m)

9.4 9.4

- Revised closing date: December 3 1,2012

The project development objective has been changed and is: "To increase access to electricity in rural areas; and improve the quantum and efficiency of electricity supply

Does the restructured or scaled-up project require any exceptions from Bank policies? Have these been approved by Bank management?

Before the revision, the PDO was: "Build capacity to manage the development of Ner hydro power potential in a prudent and sustainable manner; increase access to electric services in rural areas; and improve the supply and accountability of electricity."

30.0 39.4

o Yes X I o Yes o P

I The Results Framework has been improved for clarity and measurability, and revised

35.7 75.1

Borrower IDA Credit IDA Grant Total

14.1 89.2

reflect the additional investments and extension of the project implementation period. Does the scaled-up or restructured project trigger any new safeguard policies? If so, click here to indicate which one(s) No.

For Additional Financing [ ] Loan [XI Credit [XI Grant For Loans/Credits/Grants:

Total Bank financing (US$m.): 89.2 Proposed terms: IDA Grant terms for SDR 10.5 million (US$ 15.5 million equivalent) and Standard IDA Credit terms for SDR 49.6 million (US$ 73.7 million equivalenl

Financing Plan (US$m.)

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Source Total Amounl

A. Introduction

1. This Project Paper seeks the approval of the Executive Directors to.provide an additional credit in the amount of SDR 49.6 million (USD 73.7 million equivalent) and additional grant in the amount of SDR 10.5 million (USD 15.5 million equivalent) to Nepal for the Power Development Project (PO433 1 I), Credit No. 3766-NEP & IDA Grant No. H039-NEP.

2. The project development objective has been revised to better reflect the focus and scale of project activities following the restructuring of the project in 2008 and in light of the proposed project scale-up, and is, "to increase access to electricity in rural areas; and improve the quantum and efficiency of electricity supply." The proposed additional funding would help finance the costs associated with: (i) rehabilitation of existing assets and new investments required to support the response of the Government of Nepal to the energy crisis in the country; (ii) scaling- up of the Government's successful off-grid rural electrification program; and (iii) additional technical assistance to benefit the Nepal Electricity Authority and the Alternative Energy Promotion Center, two implementing agencies. The Closing Date of the proposed Additional Financing is December 3 1,20 12.

B. Background and Rationale for Additional Financing

3. Nepal is experiencing an energy crisis of unprecedented severity. In January 2009, as a result of generation shortages and transmission bottlenecks, the national power grid moved to a regime of 16 hours of scheduled "load-shedding" (or rotating outages), meaning consumers were supplied with electricity for only 8 hours per day.' This has had a highly negative impact on all aspects of the economy and has imposed a heavy burden on Nepal's people. Back-up systems which had been established over the years to help industry, commerce and households cope with the poor power supply are being pushed to their limits or, in some cases, rendered useless.

4. Load-shedding has long been a facet of the hydro-dependent power system in Nepal, where protracted conflict, and weak institutions and finances have hampered efforts to increase power generation capacity (Nepal's total grid-connected generation capacity amounts to a meager 683 MW, and the actual available capacity at any point in time is generally considerably lower). Electricity supply is worst in the dry season (October to May) when river flows are lower. This past winter, the fragile power system was further weakened by two events that led to the current crisis: drought in many parts of the country (resulting in reduced water levels for hydropower generation) and the breaching of the Kosi embankment which wiped out portions of a transmission line used to import power from India.

5. In December 2008, the Government declared a "national energy crisis" and approved an Energy Crisis Management Action Plan. The Action Plan includes demand- and supply-side investments aimed at alleviating load-shedding; the estimated cost of the short and medium term measures in the Action Plan is around Rs. 15 billion (about USD 195 million). However, despite

' By May 2009 load-shedding was reduced to 12 hours daily, but there is concern that the water levels in rivers and precipitation are considerably below the historic norms for this time of year.

these recent efforts to address the energy crisis, it is clear that chronic power shortages will continue to be a defining feature of life in Nepal for several years to come, constraining the country's economic and human development. In the absence of a concerted scale-up of grid- supplied power, Nepal will continue to be burdened by a heavy reliance on costly, and often polluting, alternative means for meeting the demand for electricity, or to do without electricity, at a high cost to its people and its economy.

6. The Government of Nepal (GON) has requested Bank support for implementation of the Energy Crisis Management Action Plan. The Government's immediate priority is to identify and implement quick investments to help prevent the eruption in coming winters of a crisis of the severity currently being experienced, while implementing medium-to-long term development plans on a parallel basis. The Government would also like to ensure the continued expansion of its successful microhydro rural electrification program.

7. Key policy issues in the sector include: reform of the sector institutional and policy framework; establishing a positive investment climate and enabling environment; finances, tariffs and investment requirements; expanding access to electricity; and demand-side management.

8. Sector institutional andpolicy@amework. Between the different agencies that comprise the power sector institutional framework there are some overlapping areas of responsibility, which causes confusion and is a deterrent to attracting investment. And while the legislative and policy framework governing the power sector is generally clear and comprehensive, the practical application of this framework by the ministries and agencies involved in the power sector is not always consistent. Weak coordination between these agencies and limited capacity within agencies make it difficult for investors to advance projects; the "single-window" policy identified in the Electricity Act is in effect not operational.

9. Investment climate and enabling environment. Successive governments have consistently expressed a commitment to attracting the private sector to develop hydropower projects; however, much remains to be done to create an investment climate conducive to attracting the levels of investment required by this capital-intensive sector. Financial and implementation constraints have not allowed the Government to play the leading role in building the common infi-astructure (roads and transmission corridors) needed to stimulate hydropower development in remote locations. The rationale for Government development of such projects is compelling, as they usually bring high economic returns, and it is not feasible to burden individual projects with the high costs of this common infrastructure. For larger projects that are designed for export of power to India, Government has the leading role in negotiating cross-border infrastructure with India; slow progress in this area is holding back development of larger projects.

10. Finances, tariffs and investment requirements. NEA is loss-making and heavily indebted. A large portion of the utility's debt service is to the Government to pay back on-lent funds. Consumer tariffs, while among the highest in the region2, have been frozen for several years and do not cover the utility's costs. This combination of circumstances has pushed NEA

* Households -the largest consumer group - are charged an average of around 9 USc/kWh, with higher rates for industrial and commercial consumers.

into a vicious downward cycle: the liquidity in the sector is insufficient to maintain existing capacity, much less develop the new generation capacity which is urgently needed to improve the power supply and to help grow the economy. An increase in the consumer tariff is not feasible under the current circumstances of poor supply; however, without adequate financing for maintenance and expansion, the sector's performance is likely to deteriorate until corrective measures are taken to restore the health of the utility's finances.

11. Irrespective of the state of the national utility's finances, it is clear that Nepal's capital markets could provide only the smaller part of the sector's total investment requirements. International development partners and multilateral agencies can make up some of the difference. But without a significant increase of private capital flows into the sector, the expansion of generation supply capacity in Nepal will continue to be slow and inadequate to the growth in demand. The difficult financial situation of the sector and the poor prognosis of the availability of funds underscore the imperative to improve the investment climate and to bring down the high costs of developing hydropower in Nepal.

12. Expanding access to electricity. While most (> 90%) urban Nepalis have access to electricity (even if the supply of it is limited), only about 15% of rural Nepalis, who constitute the bulk of the population, are thought to have access to reliable sources of electricity. Increasing access to electricity is thus one of the major human and economic development challenges facing Nepal. The difficult topography of the country and the remoteness of many of its population points add to the high per-unit costs of off-grid electrification programs, exacerbating this enormous challenge.

13. Demand-side management. In addition to efforts to improve power supply, demand-side measures are needed to help close the gap between supply and demand. Demand will continue to grow and will impose increasingly unaffordable capacity requirements on the power system (i.e. the demand "peak" will become more pronounced) unless properly managed. In view of the expected continued high growth of demand for electricity, demand-side management is an essential part of the management of the energy sector.

14. The Government's response to the energy crisis and sector development challenges has been multi-faceted. As noted, the Energy Crisis Management Action Plan that was adopted by the Government in December 2008, consists of short-, medium- and long-term activities, all of which will be implemented in parallel. At the same time, the Government recognizes that the scope for emergency measures as the first level response is relatively limited for the power sector. The utility has moved to stabilize power supply to industry through dedicated feeders. The Nepal Electricity Authority raised the tariff that it pays to Independent Power Producers (IPPs) in order to stimulate more investment in generation projects that, while relatively small- scale, in the aggregate have the potential to make a significant contribution to Nepal's installed capacity. And load-shedding, while stressful for people and the economy, has been carried out according to a reliable schedule, allowing consumers to plan their consumption.

15. Several medium-to-large generation projects are under construction, and efforts continue to develop new projects. The Government has sponsored several international hydropower investment conferences over the last year, and efforts continue to prepare large-scale storage

projects for development, possibly with private sector involvement. The Government of Nepal has been in discussion with the Government of India over cross-border transmission lines which will be used for both import and export of electricity.

C. Project Implementation Experience

16. The Power Development Project was approved by the Board of Executive Directors on May 22, 2003, and made effective on March 25, 2004. At the time of approval, the Project consisted of three components: (i) the Power Development Fund (PDF), to promote the development of Nepal's hydropower potential through private sector participation in projects up to 50 MW (47% of project costs); (ii) Microhydro Village Electrification, through a community- based program managed by the Alternative Energy Promotion Center (AEPC) (6% of project costs); and (iii) transmission and distribution investments, managed by the Nepal Electricity Authority (NEA) (38% of project costs). Unallocated funds accounted for the balance.

17. Implementation of the components managed by AEPC and the NEA proceeded well after project start-up. However, the PDF was unable to attract private interest in hydropower investments, largely due to the uncertain political environment and unrest throughout the country. As a result, the component rating and the overall project ratings were unsatisfactory for the first few years of project implementation. Recognizing that this uncertainty and the political transition would continue for the life of the project, the Government requested the restructuring of the Project in November 2007, and the Board of Executive Directors approved this restructuring on February 15,2008.

18. The changes introduced by the February 2008 restructuring were to modify the project development objectives, to reallocate funds from the non-performing PDF component to the two performing components (AEPC and NEA), and to revise the NEA financial covenants to make them more realistic. Project implementation arrangements remained unchanged as a result of the restructuring.

o The Project Development Objective was revised to: Build capacity to manage the development of Nepal3 hydropower potential in a prudent and sustainable manner; increase access to electricity services in rural areas; and improve the supply and accountability of e~ectricity.~

o The PDF component allocation was reduced from USD 35.5 mln to USD 9.2 mln (a reduction of 74%), while the allocation of the NEA component was increased from USD 28.4 mln to USD 64.5 (an increase of 127%), and for the AEPC component from USD 4.9 mln to USD 9.3 mln (an increase of 90%).~

o The NEA financial covenants were revised to focus on two operational targets related to accounts receivable and accounts payable.

The original Project Development Objective was: to develop Nepal's hydropower potential in an environmentally and socially sustainable manner to help meet electricity demand; improve access of rural areas in electricity services; and promote private participation in the power sector to improve efficiency and to mobilize financing in the sector's investments.

Appreciation of the SDR accounts for the net increase in the USD amount.

19. Implementation progress has been good since restructuring: the Project DO and IP ratings have been consistently Satisfactory. NEA has initiated procurement for all goods and services in its component and expects to complete these activities before the current project closing date of December 31, 2010. Most significantly this will entail completion of two 220 kV transmission lines and some transmission lines of lower voltages; strengthening distribution networks; supply and delivery of emergency restoration towers; and execution of technical assistance initiatives aimed at strengthening capacity within NEA.

20. AEPC expects to use its current allocation by end-2009, at which time the funds will have financed village-level microhydro schemes that are fully operational, accounting for an aggregate capacity of 2,500 kW and serving 75 villages and 25,000 households. In addition, another 75 schemes will be at various stages of preparation and, when completed, will account for an aggregate capacity of approximately 1,500 kW and benefit an additional 13,000 household^.^

21. The PDF component (which at project restructuring in 2008 was reduced in scope to focus on technical assistance) has not been utilized. In view of the poor utilization of the TA funds under the PDF component, the Government of Nepal requested and IDA agreed (in May 2009) to reallocate USD $3.0 million from the PDF component to the NEA component to support additional technical assistance activities, including the introduction of a new financial management information system and associated training. The residual allocation for the PDF component is about USD $3.3 million. In view of the significant reduction of resources for the PDF component, project development outcomes related to building capacity to manage the development of Nepal's hydropower potential can no longer be achieved and it is therefore proposed to revise the project development objective to reflect more accurately the revised scope and focus of project activities.

22. Performance on the financial management side has been less successful. While the NEA is in compliance with the revised loan covenant pertaining to accounts receivable (less than three months since FY2005/06), it is not in compliance with the covenant for accounts payable (the accounts payable are currently estimated at slightly above four months against the target of three months). NEA's inability to meet this loan covenant is largely due to factors beyond NEA7s control: the political and social unrest in the country (bandhs, strikes, disturbance in the Terai region etc.); lack of security for meter readers; absence of retail tariff increases for the last eight years; and the absence of other sources of revenue to compensate for losses incurred. IDA funds are on-lent by the Government to NEA at 8.00 % per annurn, which adds to NEA7s financial liabilities. To a lesser extent, NEA7s financial management weakness is a result of its technical and managerial operating inefficiency (which is in turn sensitive to the challenging socio- political environment in which the utility operates). In order to mitigate the risks associated with NEA's weak financial performance, an Action Plan for Financial Management Improvement was agreed in April 2009 and is now under implementation (see para. 52 and Annex 2, Attachment 1, for a fuller description).

AEPC estimates that its current allocation under the PDP will be fully disbursed by the end of calendar 2009 as a result of both good implementation experience and increases in the world prices for inputs such as steel and cement over 2003-2008. However, these prices are now on a downward trend as a result of the recent global contraction of demand.

D. Proposed Changes under the Additional Financing

23. Project Development Objective and Results Framework. The project development objective has been revised to, "increase access to electricity in rural areas; and improve the quantum and efficiency of electricity supply." This revision was undertaken to (i) reflect the significant downsizing of the PDF component, and (ii) to improve the clarity and measurability of the PDO. The Results Framework has been revised to improve the outcome and intermediate results indicators that will be used to measure project success, and to incorporate new indicators and targets associated with the additional investments and extension of the project implementation period (Annex 1).

24. Supported activities. The Additional Financing would support additional investments under the NEA component and scaled-up activities under the Microhydro Village Electrification Component. The additional investments under the NEA component would include rehabilitation of generation assets, transmission and distribution strengthening, and technical assistance funds for continued institutional strengthening, training, and execution of technical studies and other documentation associated with power sector development. The Microhydro Village Electrification Component would receive financing for additional village-level microhydro schemes.

25. Implementation arrangements. Implementation arrangements, including disbursements, financial management, procurement and safeguards, remain as under the on-going Power Development Project. The project coordination unit at NEA will continue to be responsible for the implementation of the NEA component, with support from NEA's Environment and Social Studies Department on safeguards-related activities. The Microhydro Village Electrification Component will be implemented by the Alternative Energy Promotion Center under the existing arrangements.

26. Implementation period. The project closing date for the Additional Financing will be December 3 1,20 12.

27. Service Costs. For the NEA component (Part C of the Project), the service costs of field investigations carried out by NEA's Soil, Rock and Concrete Laboratory as inputs to feasibility studies for new hydropower projects will be financed at loo%, based on the SRC Laboratory's standard rates for such work.

28. Procurement. Procurement for sub-projects under the proposed Additional Financing will be carried out in accordance with the Bank's 2006 Anti-Corruption Guidelines, and the "Guidelines: Procurement under IBRD Loans and IDA Credits" published by the Bank in May 2004 and revised in October 2006, and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" published in May 2004 and revised in October 2006. Annex 3 details the procurement arrangements that will apply to the proposed Additional Financing.

29. Subsidiary Agreement between Government of Nepal and the Nepal Electricity Authority. The interest rate charged by GON to NEA will be 6.0% per annurn for the funds made available to NEA.

E. Consistency with Interim Strategy Note

30. The proposed Additional Financing is fully supportive of the Interim Strategy Note (ISN) FY2010-11 for Nepal that is scheduled for Board presentation on June 4, 2009. ISN Pillar 2 - Laying the foundation for sustainable economic growth - identifies the need to alleviate bottlenecks and constraints in key sectors, such as power, as a priority for the Bank's program in Nepal. ISN Pillar 3 - Enhancing equitable access to services and social inclusion - emphasizes the importance of continuing programs in sectors where the Bank is already engaged, including microhydro development in rural Nepal. The proposed Additional Financing for the Power Development Project is included in the Indicative IDA Lending Program, and the scaled up project will contribute to achieving the ISN goal of increasing the availability of power generation capacity in Nepal by 100 MW.

F. Appraisal of Project Activities

General

3 1. The proposed additional investments entail no exceptions to Bank policies.

Technical and Economic

32. The NEA sub-projects proposed under the Additional Financing were identified on the basis of: (i) their relevance in responding to the energy crisis, (ii) ease of implementation, (iii) minimal adverse impact, and (iv) the feasibility of completing major sub-projects one year before the revised closing date. The appraisal of the proposed investments was carried out on the basis of consultations, review and analysis in Kathmandu, and site visits to the Duhabi Multifuel Plant; the Hetauda Diesel Centre; the Kali Gandaki 'A' Hydroelectric Plant; and the proposed Bharatpur-Bardghat 220kV transmission line. The appraisal confirmed the feasibility and importance to the Nepal power system of the proposed investments.

33. Economic analysis of the sub-projects proposed under the Additional Financing show the following economic rates of return. In addition to the quantifiable benefits, several of the projects are expected to bring significant non-quantifiable benefits, for example, the transmission line will provide a strong incentive to holders of licenses in the Marsyangdi corridor to develop their projects; whereas the absence of transmission capacity would lead to further delays in development.

34. The proposed rehabilitation of the two thermal generation plants entails low-cost replacement of parts and upgrading of obsolete parts that are needed to return the plants to near- maximum operating capacity, and to help ensure their smooth operation. As a result of these small investments, an additional 22 MW of generation capacity will be made available.

Subproject

Kali Gandaki 'A' HEP rehabilitation

Hetauda Diesel Center rehabilitation

Duhabi Multifuel Plant rehabilitation

Bharatpur - Bardghat 220kV transmission line

Pathlaiya 132 kV substation

Kathmandu Valley distribution network strengthening

35. At the Kali Gandaki 'A' HEP, the rehabilitation required is more complex in nature given certain deficiencies in the design of the plant and the destructive effect of silt in the Kali Gandaki River on the turbines and other parts of the plant infrastructure. These investments are urgently required, as Kali Gandaki HEP is the largest generation plant in the Nepal power system, with a nameplate capacity of 144 MW.

EIRR

224%

95%

96%

14%

19%

23%

36. The effectiveness of the desanding basin at the plant's water intake is poor. The plant management has recorded silt concentrations in the water entering the turbines that are higher than the silt concentrations in the water entering the desanding basin, which indicates problems with the design or operation of the desanding basin. Normally, when the measured water silt loads become excessive, a hydropower plant may be operated at reduced output or even shut down altogether until the incoming water silt level reduces. This avoids subjecting the plant to excessively high silt levels, and so prolongs the life of susceptible plant components. Unfortunately, due to Nepal's power shortage, Kali Gandaki 'A' HEP does not have this flexibility and must continue operating regardless of the incoming silt concentration, further increasing the damage to the turbines and the risk of a serious accident.

37. Urgent rehabilitation of the main inlet valve and repair of the turbines are required to maintain the plant's short-term peak power capability and its longer term energy output capability. Investments will also cover other repairs and spare parts which will be required in the course of time, and technical assistance to consider the scope for improvements to the design of the desanding basin. The proposed investments will bring a large benefit through reduction of the loss of electricity generation and plant down time.

38. The proposed Bharatpur-Bardghat 220 kV transmission line is the continuation of the Hetauda-Bharatpur 220 kV transmission that is currently under construction with funding fiom

the Power Development Project. When completed, the Hetauda-Bardghat transmission line will help relieve line overloading and congestion and enhance system reliability and stability. It will also make possible the transmission of large volumes of power from generation projects under development in the western part of the country to load centers in central and eastern Nepal. In the initial years the line loading capacity will be 60-70 MW from the power flows of Kali Gandaki (144 MW), Marsyangdi (69 MW), and Middle ~ a r s ~ a n ~ d i (70 MW). After the commissioning of Upper Karnali (300 MW), Upper Seti (127 MW) and Upper Marsyangdi (51 MW), the line will be loaded at full capacity. It is expected that the transmission line will provide a strong incentive to holders of licenses in the Marsyangdi corridor to develop their projects.

39. The Pathlaiya 13211 1 kV sub-station will help meet the increasing load demand and improve system security. At present, all 66 kV substations in the Birgunj corridor, one of the largest industrial areas of Nepal, are overloaded. Lines trip frequently, causing supply interruptions and outages. The load will be transferred from the overloaded 66 kV line to the existing 132 kV double circuit transmission line, which will loop in and out at the Pathlaiya 132111 kV substation. The sub-station will improve system reliability by minimizing the interruptions; improving the voltage profile; and reducing system losses by about 6 MW.

40. The distribution network in Kathmandu Valley is old and severely overloaded as a result of the tremendous growth in demand in recent years. The network is currently in a fragile state, experiencing overloading of lines, frequent failure of transformers, etc. The proposed investments are necessary to help maintain the system in working order while NEA works on plans for an eventual distribution system rehabilitation, and will help reduce losses.

Governance and Accountability

41. The power sector exhibits both strengths and weaknesses with respect to governance and accountability. The crisis in the formal (grid-based) power sector has developed over the long term and is the result of inadequate maintenance and investments in physical infrastructure, exacerbated by specific weak points of accountability, notably in financial management. As a highly centralized and technical sector, the power sector does not lend itself to public scrutiny. Formal and informal institutions that could exercise some degree of oversight over the sector, such a regulatory commission or consumer advocacy groups, are not strong in Nepal.

42. At the same time, the power sector exhibits important strengths that will benefit the implementation of both components of the proposed Additional Financing. The technical capacity of the Nepal Electricity Authority remains good, particularly on the professional level, despite the difficulties of recent years which have led many to look for work outside the country. In contrast to other sectors, the power sector does not suffer from high turn-over or lack of continuity in its management. The sector's system losses (reported at about 25%) are not high compared to those of other countries in the region, particularly taking into account the civil conflict that lasted a decade in Nepal. Other positive factors include the existence of a pool of domestic investors interested in contributing to sector development (who effectively exercise some degree of technically competent oversight); and a good payment culture, which indicates that consumers are not broadly disaffected with the utility but rather, more concerned with the fundamental supply problem.

43. With respect to off-grid electrification, transparency, accountability and social participation are the defining principles of the Microhydro Village Electrification Program, and are incorporated at the central, district and community levels. The potential accountability risks of this component derive from the fact that demand for rural electrification far outstrips supply; hence, even with well-defined procedures for the identification of candidate villages, there is still a high degree of discretion involved in the ultimate selection of beneficiary villages. This gives rise to the risk of abuse of discretion or politicization - or at least the risk of the perception of same. To address this possible risk, it is proposed to task a group of social scientists with investigating, through field research, the actual, on-the-ground practices followed in the implementation of the component, and to propose recommendations to address any identified shortcomings which can be incorporated into the operating guidelines for the component.

44. Given the myriad challenges of the overall environment in Nepal, a fundamental part of the strategy to mitigate governance and accountability risks in the proposed Additional Financing has been the selection of the sub-projects themselves. These were identified and appraised on the basis of (i) their relevance in responding to the energy crisis, (ii) appropriateness to implementation capacity at NEA and AEPC, and (iii) minimal adverse impact. The bulk of the Additional Financing will be used for a small number of sub-projects under the NEA component, and procurement and implementation of these larger investments is well within the capacity of NEA, as demonstrated by the experience of the on-going PDP.

45. In addition, and to complement these basic design strengths, the implementing agencies have developed a Governance and Accountability Action Plan ( G M P ) which aims to strengthen governance performance and increase the use of social accountability mechanisms. More information on the governance diagnostic and the G M P is given in Annex 4.

46. In parallel with the implementation of the Power Development Project and the GAAP, the Bank's South Asia Region is spearheading an initiative to strengthen governance in key sectors of the economy, including the power sector, through provision of technical assistance and training. This initiative, which will be funded by trust funds under the administration of the Bank, will work with the established sector entities as well as credible representatives of consumer groups who have not to date had a strong voice in the public discourse on the power sector.

Procurement

47. To date, the power sector has not experienced the negative procurement practices that have been seen in other sectors in Nepal (collusion, intimidation of bidders, etc.). This is likely the result of the highly technical nature of the sector, the large-value contracts that are almost invariably procured through ICB, and the existence of a relatively large market of regionallforeign contractors that are interested in these large contracts, which are thus relatively immune to collusion and intimidation that may be organized locally.

48. Procurement capacity at NEA7s project coordination unit is good. As a result of the restructuring of the project in early 2008, the NEA allocation was more than doubled. In little more than a year, NEA has launched all of the new procurement corresponding to this significant increase of funds. Recognizing that the proposed Additional Financing will place an additional

burden on the project coordination unit, NEA management has agreed to strengthen the project coordination unit in terms of staff as well as structure. A detailed procurement plan has been prepared for the proposed additional investments in consultation with the Bank procurement and technical staff.

49. For the microhydro component, procurement of the electro-mechanical equipment required for these systems is handled on the basis of pre-qualification of contractors and consultants, which significantly increases the likelihood of high-quality work and accountability to communities, as the contractors and consultants have an interest in maintaining their AEPC status as pre-qualified contractors in this growth industry. It is expected that an additional benefit of this mechanism is that it contributes to a reduction of tensions in the post-conflict environment, as contractors are based throughout the country.

50. Annex 3 provides details on the procurement arrangements for the proposed Additional Financing.

Financial Management and Disbursement

51. Financial management and disbursement arrangements will be identical to those under the current Power Development Project. Retroactive financing will be available for both components effective from June 1, 2009, not exceeding SDR 5.38 million (equivalent to US$8.0 million) under the IDA Credit and SDR 1.34 million (equivalent to US$2.0 million) under the IDA Grant for eligible expenditures under Categories (1) and (2). Withdrawal of proceeds and disbursement categories for the Additional Financing are detailed in Annex 5.

52. NEA has begun implementing the Action Plan for Financial Management Improvement (Annex 2, Attachment 1). The institutional strengthening program will: (i) introduce reforms in the accounting framework of NEA, (ii) develop and implement a new Financial Accounting System, (iii) revise the Accounting Policy and Manual based on International Accounting Standards (IAS), (iv) support training of NEA staff, and (v) assist in clearing the backlog of audit irregularities. In order to support NEA in carrying out these actions, a consulting firm will be engaged in 2009 to provide technical assistance in strengthening financial management.

Safeguards

53. The Power Development Project was classified as Environmental Category "A", largely because of the Power Development Fund component, which was expected to finance new investments in medium-sized hydropower plants. As described in paragraph 21, as a result of project restructuring, the PDF component was converted from an investment fund to a fund for technical assistance. In view of this significant revision, and taking into account the nature of the proposed new investments, the Additional Financing operation has been classified as Environmental Category "B".

54. The safeguards policies triggered by the additional investments are Involuntary Resettlement, Environmental Assessment and Forests. The safeguards procedures established for the on-going Power Development Project have been updated to reflect the inclusion of rehabilitation of existing generation assets as a category of investment covered by the project. NEA has prepared a revision of the "Operational Manual of Environmental/Social Impact

Assessment (EIAISIA) for Sub-projects Financed under the Additional Financing of the Power Development Project (April 2009)". The draft revised framework has been conveyed to the Bank and disclosed on the NEA Website. For the Microhydro component, AEPC will continue to follow the "Environment Assessment Guidelines for Community-owned and Managed Micro Hydro Schemes" that apply to the on-going Power Development Project and to prepare Vulnerable Community Development Plans for each village in which microhydro schemes are installed. .

Monitoring and Evaluation

55. Monitoring and evaluation will be carried out under the existing arrangements for the Power Development Project. For the NEA component, the project coordination unit at NEA will be responsible for collecting and collating data on project outcomes and physical implementation progress for the individual sub-projects, with inputs from the functional teams in the field that oversee sub-project implementation. In addition, as reflected in the Governance and Accountability Action Plan, NEA will strengthen its environmental monitoring capacity through: (i) introducing a system of periodic compliance checks, and (ii) annual independent monitoring of recommendations made in EIAs.

56. For the Microhydro component, AEPC will continue to submit quarterly reports on implementation progress. In addition, as reflected in the Governance and Accountability Action Plan, AEPC will enhance its M&E framework and establish a new Management Information System (MIS) following completion of an ESMAP-funded study on socio-economic impacts of micro-hydro development.

G. Expected Outcomes

57. The proposed investments will seek to strengthen the Nepal power system and to improve available power capacity and energy generated to help address the severe energy crisis. An important outcome of the project will be to help prevent continued deterioration of the availability of the Kali Gandaki 'A' HEP, which is the largest generation plant in Nepal and at risk of prolonged shut-down and possibly irreparable turbine damage under present operating conditions. The scaling-up of the Microhydro component will allow AEPC to install an additional 4.25 MW in generation capacity in rural Nepal. The new transmission line will add 500 MW of new transmission capacity, which will be needed to evacuate power from projects in the Marsyangdi corridor and to relieve transmission congestion. The outcome and intermediate results indicators have been revised to reflect the new and scaled-up investments, and targets have likewise been updated.

H. Benefits and Risks

58. The anticipated benefits of the investments proposed under the Additional Financing operation include: increased energy production from reducing down-time at the Kali Gandaki 'A' HEP, the largest plant in the Nepal power system; availability of an additional estimated 22 MW of capacity through rehabilitation of existing thermal generation assets; additional 500 MW

in new transmission capacity to relay power from existing and expected future projects; increased system stability and reliability; increased reliability of the Kathmandu Valley distribution network; and the extension of access to electricity to an additional 36,000 households in rural Nepal.

59. Overall, country risk in Nepal remains substantial due to the fluid political situation and social and economic stresses - including those emanating from the energy crisis that the proposed operation seeks to help alleviate - that strain the Government's capacity for quick decision-making and effective action. Parts of the country are experiencing civil disturbances of various kinds, including frequent disruption of traffic on highways and in cities, and labor and other types of public protest. These factors pose an implementation risk for the project which is largely beyond mitigation on the project level.

60. The NEA component is vulnerable to implementation risks emanating from the above- noted external factors, and also moderate procurement risk. Financial management risk, while substantial, has been explicitly addressed in the preparation of the proposed Additional Financing. The measures to mitigate these risks include: provision of technical assistance for institutional strengthening in financial management; support to the implementation of the Action Plan to Improve Financial Management that was recently prepared by NEA; and intensive project supervision, made possible by the fact that the task team leader and financial management specialist are both stationed in Kathmandu, to be joined soon by the procurement specialist.

61. The limited number of the proposed new sub-projects and the structure of procurement packaging will also help mitigate procurement risks. Experience with the on-going PDP has shown strong market interest in contracts for erection of transmission lines and other relatively routine power sector works, and there is no evidence of undesirable practices seen in other sectors in Nepal (e.g. collusion and intimidation of bidders). The proposed new closing date of December 2012 will also help mitigate the risk of delays in procurement and implementation; the new investments proposed under the Additional Financing have been selected because, among other factors, they can be implemented by the end of 201 1. While the primary rationale for the closing date of December 2012 is to allow sufficient time for implementation of the Microhydro component, the additional time available for completion of the larger infi-astructure works in the event of significant unforeseen delays is an important measure for mitigating the implementation risk faced by the NEA component.

62. The Microhydro Village Electrification Component faces a risk of price increases which could impact the implementing agency's ability to deliver the agreed targets. While the prices of key inputs (steel, cement) that saw increases in recent years have been on a downward trend, it is not clear that this trend will continue. It is proposed to address the longer term risk to sustainability of these village-level schemes through an independent review by an international microhydro expert of schemes that have been in operation for more than five years. The proposed review would consider technical and institutional aspects of the design of the Microhydro Village Electrification Program, and explore the scope for cost control. The Bank team has applied for trust funds to carry out the proposed study.

I. Financial Terms and Conditions for the Additional Financing

63. The Additional Financing will be provided on standard IDA terms for credits and grants.

Annex 1: Combined Results Framework and Monitoring Power Development Project and Power Development Project Additional Financing

PDO

To increase access to electricity in rural areas; and improve the quantum and efficiency of electricity supply.

Intermediate Results Increase in service coverage.

Progress towards loss reduction

Outputs from each component Increase in service coverage in rural areas through micro-hydro schemes.

Increase in coverage through grid extensions Increase in grid connection access by upgrading and construction of transmission and distribution infrastructure increase in total available capacity energy production by rehabilitating generation plants

Project Outcome Indicators

Number of additional rural households with access to electricity generated by micro-hydro schemes.

Number of additional rural households with access to grid-connected electricity.

Increased transmission capacity (MW)

Increased generation capacity (MW)

Increased energy generation (GWh)

Reduced transmission and distribution losses in project-supported distribution centers outside Kathmandu Valley.

Reduced distribution losses in distribution centers in Kathmandu Valley

Intermediate Result Indicators Total kW capacity of new micro-hydro village schemes (off-grid)

Km of distribution lines built (grid extension) Number of distribution centers under rehabilitation

Output Indicators Number of micro-hydro schemes installed and operating.

Number of rural grid extension rehabilitation sub-projects completed

Number of new transmission lines constructed

Number of distribution substations rehabilitated or newly constructed

Contracts awarded for rehabilitation work

Use of Project Outcome Information

To track progress towards achievement of and contribution to national sector goals.

Use of Intermediate Results Indicative of progress towards PDO outcome target of increased access and improved electricity supply

Indicative of progress towards PDO outcome target of reduced T&T losses

Use of Output Monitoring To determine if component implementation is on track.

TO determine if component implementation is on track.

TO determine if component implementation is on track.

TO determine if component implementation is on track.

Results Monitoring

YRO

Data Collections and Reporting Baseline

Target Values

AEPC

NEA

NEA

AEPC

NE A

in distribution centers in Kathmandu Valley

Intermediate Results Indicators

Total kW capacity of new micro-hydro village schemes (off-grid)

Km of distribution lines built (grid extension)

Number of distribution centers under rehabilitation

Output indicators

Rural Access to Electricity

Number of new micro-hydro schemes installed.

Number of rural grid extension rehabilitation sub- projects completed.

YRl 2004/2007

aggregate distribution losses (2008)

0

(2003)

0 (2003)

0 (2007)

0 (2003)

0 (2003)

Responsibility for Data

Collection

Frequency and Reports

YR2 2008

Data Collection

Instruments

1,638

--

--

42

--

YR3 2009

YR4 2010

399

(2,037 cum.)

--

--

3 3 (75 cum.)

--

reported by NEA

Annually reported By AEPC.

Annually by

NE A

Annually reported by NEA

Annually reported By AEPC,

Annually reported by NEA.

YR5 2011

Reports

Progress Reports issued by AEPC.

Supervision Rep0rts

Supervision Reports

Progress Reports issued by AEPC.

Progress Reports issued by NE A

1,372

(3,409 cum.)

--

--

75 (1 50 cum.)

--

YR6 2012

1,900

(5,309 cum.)

700

--

50 (200 cum.)

5

1,400

(6,709 cum.)

500

(1,200 cum.)

9

50 (250 cum.)

10 (15 cum.)

losses in 9 distribution centers in Kathmandu Valley by 6% points

1,400

(8,109 cum.)

1,000

(2,200 cum.)

9

c u m , 1 )

50 (300 cum.)

1 (16 cum.)

Results Monitoring

Increased Quantum and Efficiency of Electricity supply

Number of new transmission lines (TL) I substations (SS) constructed

Number of distribution sub- stations rehabilitated or newly constructed

Major contracts awarded for generation rehabilitation work

Baseline

YRO

Data Collections and Reporting

0 (2003)

0 (2007)

0 (2008)

Target Values

Responsibility for Data

Collection

Frequency and Reports

YR1 200412007

Data Collection

Instruments

NEA

NEA

NEA

0

--

--

YR2 2008

YR3 2009

1 (one SS)

--

--

Annually reported By NEA.

Annually reported By NEA.

Annually reported By NEA.

YR4 2010

Supervision Reports.

Supervision Reports.

Supervision Reports.

1 (one TL) (1 SS, 1 TL cum.)

--

5

YR5 2011

--

4

--

YR6 2012

3 (one TL, two SS) (3 SS, 2 TL cum.)

10 (14 cum.)

--

2 (one TL, 1 s s ) (4 SS, 3 TL cum.)

--

--

Annex 2. Financial Management

Adequacy of FM Arrangements

1. The overall project Financial Management (FM) rating of the ongoing Power Development Project is less than satisfactory due to non-compliance of finance related covenants and also due to concerns related to FM primarily at the NEA entity level. In order to mitigate the risks associated with FM at the NEA entity level, the Action Plan for Financial Management Improvement has been discussed and agreed upon (Attachment I). Implementation of the Action Plan will be closely monitored during the implementation of the ongoing project and Additional Financing. NEA will recruit a consulting firm by the beginning of FY2009110 to assist in the completion of these actions. The institutional strengthening program envisages to: (i) introduce reform in accounting framework of NEA, (ii) develop and implement new Financial Accounting System, (iii) revise the Accounting Policy and Manual based on International Accounting Standards (IAS), (iv) provide training to NEA staff, and (v) assist in clearing backlog of audit irregularities. At the project level, both NEA and AEPC have established good systems and sound practices are in place. There were few deficiencies observed at the AEPC during recent supervision that relate to internal control system and maintaining of books of accounts, and these have now been gradually addressed through the Action Plan agreed during supervision mission. Project level staff at both NEA and AEPC are committed and well versed with their FM systems. No additional funds will be allocated to Part A (PDF component) as part of this Additional Financing.

2. The NEA financial covenants were revised at restructuring. According to the revised Project Agreement, there are two financial covenants as follows:

Under Section 4.03, NEA is required to take appropriate measures to maintain its net accounts receivables at no more than 3 months of sales equivalent, and accountable payable at no more than 3 months of cost of sales equivalent.

Under Section 4.05, NEA is required to submit to the Association no less than 3 months prior to the commencement of each Fiscal Year financial projections for the next seven years.

3. Both of these covenants are currently in default. Under the Action Plan referred to above, efforts are being taken to address the capacity constraints that have contributed to the weak performance with respect to these covenants.

4. At project restructuring, Section 4.03 of the Project Agreement was amended. According to this, NEA now has to comply with the following financial covenants and targets:

5. The actual financial performance (original and revised assumptions) based on the information provided by NEA and the provisional financial statements of FY2007108 are as follows:

6. The Accounts Receivables (average collection period) as per the original covenants conditions was calculated for the above fiscal years excluding provision for doubtful debts and revised assumption of excluding street lighting. Based on these assumptions, NEA has met the revised covenant of accounts receivable of less than 3 months since FY2005106.

Financial Indicators

Rate of return on historical net fixed assets Debt Service Coverage Ratio Accounts Receivable - months of sales (Including street lighting) Covenant (Section 4.03) Accounts Receivable -months of sales (Excluding street lighting) Covenant (Section 4.03) Accounts Payable - months of cost of sales Covenant (Re - Section 4.03) Accounts Payable - months of cost of sales (without considering interest expenses and interest and Royalty payable to Government)

7. As per the original covenants in the Project Agreement, the Accounts Payable (average payment period) was calculated based on all cash operating expenses excluding customer deposits but including interest and Royalty payable to Government. After the revision to the covenant, this calculation took into account all cash operating expenses and excluded customer deposits and interest payable to Government. However, under both assumptions, NEA does not meet the covenant requirements on accounts payable. NEA has cited disturbances caused by political unrest such as, bandhs, strikes, disturbance in the Terai etc., lack of security during the meter reading, tariff remaining

Original Loan Covenant 6%

1.20 <3 months

<3 months

<3 months

<3 months

Actual for FY2003104

3.65%

0.96

3.75

8.37

4.18

Actual for FY2004105

3.84%

0.91 3.46

3.46

8.46

4.36

Actual for FY 2005106

2.86%

0.83 3.50

2.91

9.39

3.56

Actual for FY 2006/07

5.12%

1.17 3.84

2.44

10.76

3.31

Estimated for FY 2007108

3.21%

1.19 4.37

2.79

12.13

3.63

static for several years and subsidy for losses not provided to NEA by the Government, commitment of waiver of dues by the political parties, loss incurred by NEA and NEA management inefficiency as the reasons for not being able to meet this covenant.

8. With respect to Section 4.05, NEA plans to submit to IDA the financial projections by end-May 2009.

9. From the fiduciary perspective, based on current assessment, the FM risk rating is substantial.

External Audit

10. The Office of the Auditor General is responsible for auditing the accounts of each component of the Project - Part A (PDF component), Part B (Micro-hydro component) and Part C (NEA component) of the Power Development Fund Project. As per the provisions of the Financing Agreement, a separate Project Account for each component has to be submitted within six months after the end of the fiscal year. In addition, as required by the Project Agreement with the entity (NEA), an entity Financial Statements for NEA has to be submitted within six months of the end of the fiscal year. Audit of the NEA will be carried out by a qualified and experienced auditing firm appointed by the Office of the Auditor General. Altogether four sets of audit reports for each fiscal year are required under the Project.

11. NEA financial statements have always been qualified reports with serious observations from the Auditors. Some of the observations made by the Auditors in FY2006107 and FY2007108 audit included (i) un-reconciled inter-unit control accounts which may impact on the profit, loss, assets and liabilities, (ii) continuing delay in updating the fixed assets register and incomplete physical verification of fixed assets, (iii) lack of reconciliation of main books of accounts with the subsidiary records and ledgers, (iv) lack of action to recover receivable outstanding amounts for more than three years, (v) lack of effective action plan to reduce transmission and distribution loss, (vi) lack of management attention to utilize the spill-over energy during rainy season, (vii) inadequate internal control system and ineffective internal audit function in NEA, and (viii) lack of confirmation of adequacy of provision of slow moving, non-moving, damaged and obsolete inventory items, receivables, advances, deposits, and claims. In order to response to these observations, NEA has agreed upon an Action Plan with IDA for Financial Management Improvement (Attachment 1). In addition, an institutional strengthening component will address many of these issues and the consultant is expected to be on board by the beginning of FY2009110.

12. Furthermore, to address the issue of delays in the submission of audit reports, it is recommended that all implementing agencies proactively plan the audit process closely with the auditors to reduce the time lag from the existing levels of delay. The following audit reports will be monitored in the Audit Report Compliance System (ARCS):

Implementation Progress Reports

Implementing Agency

DOED

AEPC

NEA

NEA

13. As with the arrangements with the audit reports, separate progress reports are required from each component - Part A, Part B and Part C - which need to be submitted on a trimester basis. There are no outstanding reports.

Disclosure of Information and Corporate Governance

14. As required by the Right to Information Act, 2007, information on the Power Development Project, including the Additional Financing, will be made available for public disclosure (refer to Annex 4, Governance and Accountability Framework). Implementing agencies will post on their Websites all available guidelines, procedures, and other key information related to the project. AEPC has already established a mechanism for publicly disseminating the information on community grants for microhydro plants through display boards in the communities. NEA and AEPC have agreed to disclose the following through their Websites: Procurement Plan; Procurement Complaints Mechanism; Trimester Implementation Progress Reports (approved versions); Invitation for Expression of Interest, Bid Documents, Request for Proposals, Minutes of Pre-bid Conferences, Contract Awards; and Annual Audited Financial Statements.

Audit Due Date

6 months after the end of each fiscal year (January 1 5'h)

6 months after the end of each fiscal year 6 months after the end of each fiscal year

6 months after the end of each fiscal year

Audit

Part A Financial Statements

Part B Financial Statements

Part C Financial Statements

Entity (NEA) Financial Statements

Supervision

Auditors

Office of the Auditor General (OAG)

Office of the Auditor General

Office of the Auditor General

Qualified and Experienced Audit Finn appointed by the

15. Intensive supervision of financial management will be undertaken by the Bank which will include follow-up on the implementation of the agreed Action Plan for financial management improvement at NEA and AEPC among other things. The FM rating will be reviewed periodically and assess the progress. The Bank team will also work closely with the consulting firm to be recruited by NEA under the TA component. A detailed FM review will be carried out on a trimesterly basis to ensure that agreed actions are on track.

Allocation of financing proceeds

16. Disbursement under proposed financing will be made as indicated in the following table, which indicates the percentage of financing for different categories of

expenditures of the project. Total financing is at the proportion of 83% credit and 17% grant proceeds. It is expected that IDA funds will be disbursed over a period of two years. The Closing Date of the financing is December 3 1,2012.

Allocation of Financing Proceeds

Concrete Laborato

Disbursement Arrangements

17. Disbursements fi-om IDA will be made based on full documentation for contracts above the Prior Review threshold or SOEs. The Designated Accounts currently being used by NEA and AEPC will be used for the Additional Financing.

Disbursement Condition

18. Disbursements for Category 2 (NEA Component) will happen only after NEA has updated the revised Operational Manual of Environmental-Social Impact Assessment for subprojects in form and substance acceptable to IDA.

Retroactive Financing

19. Retroactive financing will be provided for both components effective from June 1, 2009, not exceeding SDR 6.72 million (equivalent to US$lO.O million) for eligible

expenditures under Categories (1) and (2). The limit under the IDA Credit will be SDR 5.38 million (equivalent to US$ 8.0 million) and the limit under the IDA Grant will be SDR 1.34 million (equivalent to US$2.0 million).

Use of Statements of Expenditures (SOEs)

20. SOEs will be used for following expenditures: (i) contracts for works and goods costing less than US$ 100,000 equivalent per contract; (ii) contracts for services of consulting firms costing less than US$ 100,000 equivalent per contract; (iii) contracts for services of individual consultants costing less than US$25,000 equivalent per contract; (iv) service costs for soil, rock and concrete laboratory; (v) all sub-project grants; (vi) all training and promotional activities; and (vi) all incremental operating costs. During the supervision, the mission will closely review SOE claims to ensure that funds are utilized for the intended purposes. Any ineligible expenditure identified during such reviews will need to be refunded to IDA.

Designated Accounts

21. The Designated Accounts in US Dollars currently being used under the parent project will be used on terms and conditions satisfactory to IDA to be used for the purpose of payments of goods, services and reimbursing pre-financed expenditures of operating costs and training. The authorized allocations for the Designated Account of the AEPC will further be increased by US$ 750,000. Similarly, the authorized allocations for the Designated Account of the NEA will further be increased by US$1,500,000.

Risk Rating Summary

INHERENT RISKS I=== I Country level

- Quality of PFM institutions (see PEFA-PFM,CFAA, CPAR, CPIA & other diagnostics), standard of financial accounting, reporting and auditing, quality of FM profession.

Entity level

- Reform in accounting framework of NEA, Development and implementation of new Financial Accounting System, revision of the Accounting Policy and Manual based on International Accounting Standards (IAS), training to NEA staff, and clearing backlog of audit irregularities.

Project level

- Relative size of the Bank loan, type of lending instrument, complexity of the project (e.g. sectors involved, number of implementing and sub- implementing entities, multi-donor etc.)

OVERALL INHERENT RISK

Risk Assessment

X

Residual Risk

S

Previous Risk Assessment

H

H S M L Risk Mitigating Measures

Implementation of Action Plan

CONTROL, RISKS

Budget

Accounting

Internal Controls

Funds flow

Financial Reporting

Auditing

OVERAL,I, CONTROL RISK

RESIDUAL RISK RATrNG

H - High S-Su

Risk Assessment / I'revious Risk Risk M~tigating Measures

tantial M -Modest

Residual Risk

Attachment 1 to Annex 2

Action Plan for Financial Management Improvement in NEA

Expected Results

8

Reconciliation of current transaction as well as old transactions.

Adjustment of all outstanding amounts.

• 100% reconciliation/ adjustment of old unrecognized accounts.

The system shall automatically generate reconciliation statement.

Reconciliation & update of fixed assets ledger.

Full reconciliation of physical balance with fixed assets register.

Issue

1 Deficiencies in NEA's control environment Un-reconciled Inter-unit accounts which may impact on Profit, Loss, Assets and Liabilities

Continuing delay in updating Fixed Assets Register and incomplete physical verification of fixed assets.

Monitori ng

Indicator S

7

100%

100%

20% 20% 60% 100%

100%

90%

100%

Initiatives and Status

2

Current Year's inter unit transactions are reconciled more than 99%. However, preceding year's old transactions could not be reconciled significantly due to unavailability of details of the account. Different tasks forces are formed in all budget Centers as well as at corporate level.

More than 90% budget centers have updated fixed assets register.

Physical verification of fixed assets is completed by the majority of the budget centers.

Proposed Actions

3

Reconciliation of inter-unit Accounts.

Recruitment of the consultants by ISP I1 for strengthening house keeping.

Adjustment of all outstanding items in the inter-unit reconciliation statement on the recommendations submitted by the Task Force & Consultants.

Development of reconciliation system by the consultants.

Implementation of Computerized Fixed Assets Registers prepared by the physical verification project.

Formation of team for physical Verifications of Fixed Assets.

Carry out physical

Responsible Unit

4

All Budget Centers.

Project Manager ISP 11.

Consultants of ISP 11.

A/C Chief of respective budget centers.

All Budget Centers.

All GM Offices.

Modality

5

ICB Process.

Write off of outstanding items.

Add back of outstanding items to income if they are not payable.

Adjustment of outstanding items.

Implementation of reconciliation system.

Update Fixed Assets Registers.

Conduct physical verification of fixed assets by team.

Take appropriate

Time Frame (Tentative date of completion)

6

July 2009.

Current year's Transactions within July 15, 2009.

Old transactions reconciliations as under:

- 15 July 2009 - 15July2010 - 2010 Dec. - 201 1 Feb

Develop reconciliation system by December 2009.

December 2009.

December 2009.

January 2010.

Issue

1

Lack of reconciliation of main books of accounts with subsidiary records and ledgers (stock ledgers)

Non settlement of pending items of bank reconciliation.

Lack of action to recover receivable outstanding amounts for more than three years.

Lack of effective action plan to reduce transmission and distribution loss.

Monitori ng

Indicator S

7

100%

100%

100%

100%

100%

* Formatio n of committ ee.

Expected Results

8 rn Adjustment of all

damaged, lost fixed assets.

Main accounts are tallied with the subsidiary records and ledgers.

No pending items in bank reconciliation statements.

Formation of joint Committee.

rn Settlement and Recovery of receivables amounts for more than three years.

rn Committee in place.

Achievement in loss reduction target.

Initiatives and Status

2

Most of the budget centers have reconciled Stock ledgers with main ledgers

A few pending items in bank reconciliation are in the stage of settlement.

Out of the total outstanding of Rs. 130 million for more than 3 years, Rs. 25 million was settled by Seventh power project (old Project) during the fiscal year 2007108. Rs. 47.8 million is relating to claim against GoN.

A theft control task force has been formed in each branchidistribution centers for prevention and control of electricity leakages.

Responsible Unit

4

All Budget Centers.

GM OfficesBudget Centers.

Corporate Finance Department & Central A/C Department.

G M R O & Branch offices.

GM offices DistributioniRE.

Proposed Actions

3 verification of fixed assets and compare it with FA register.

Adjustment shall be made as required

Reconciliation of subsidiaries accounts with main ledgers (except consumer ledger i, e separately explained in this short term action plan).

Settlement of old items pending in bank reconciliation statements.

Recovery of old receivables.

rn Account adjustment of old unreserved receivables.

As per the recent decision of GoN, a committee for electricity theft control is formed in each district under the

Modality

5 decision for damaged, lost andor assets not in NEA's possession

Reconciliation of accounts.

rn Adjustment of assets, liabilities, income and expense.

Adjustment of old pending items appearing in the bank reconciliation statement.

A Joint committee (including the officials of NEA & GOV Nepal) is formed to settle loan, interest & receivables.

rn Settle receivables from GoN.

Recover receivables from others and write off irrecoverable receivables.

Time Frame (Tentative date of completion)

6

July 15, 2009.

15 July 2009.

rn Formation of joint committee by July 15, 2009.

Settlement with GoN within July 15, 2010.

Recovery from others within Dec, 2010.

Immediately by July 15, 2009.

Issue Initiatives and Status I Proposed Actions

Aggregate Transmission, co-ordination of I Distribution and I Chief District Officer

Various interaction and awareness program will be carried out in different places.

commercial losses was 25.15% in 2007/08.

NEA will seek co- operation of political parties, civil society and police administration for electricity theft control program in the major affected areas.

(CDO) which includes representatives of major political parties.

Load shedding hours will be increased at peak load time in the major leakages areaslfeeders.

Government has encouraged installing capacitor bank in the factories.

Power factor of the substation will be improved.

I ~echnica l losses will

Responsible Unit

BranchDistribution centers.

Modality

4 Regional offices.

GM office Distributions.

5

Conduct open interaction program to local people and political parties.

Interaction with local people & political parties.

Holding interaction program through media.

By disconnecting lines.

Increasing Load shedding hours.

Encouraging to install capacitor Bank.

Renovation of Substations & replacement of new spare parts to improve power factor.

I Installation and

Regular basis.

Regular basis.

Regular basis.

Expected Results

8

Time Frame (Tentative date of completion)

6

July 15,2009.

July 16, 2010.

July 16,2010.

Monitori ng

Indicator S

7

July 15, 2009.

July 15,2009.

Reductio n o f 1% loss in areas where theft is rampant

Do

Do

*LOSS reductio n by 30%

.LOSS reductio n by 40%

Loss reductio n by 30%

Loss

Increased awareness in theft issues.

Loss reduction

Reliable & qualitative power supply.

Power factor improvement

Loss reduction.

Issue

1

Lack of management attention to utilize the spill-over energy during rainy season.

Inadequate internal control system and ineffective internal audit function in NEA.

Lack of confirmation of the adequacy of provision of slow moving, non-moving, damaged and obsolete inventory items, receivables, advances, deposits, and claims. Additional Comments in FY2006/07 Audit Non-reconciliation of Share capital Account (para 3.1)

Non-reconciliation of Loan Account (para 3.3)

Expected Results

8

Optimum utilization of energy.

Effective internal control.

Reduction of audit queries.

Effective founding of internal Audit as per Nepal Standards on Auditing.

Adequate provision in financial statement.

Reconciliation of Share Capital AIC.

Reconciliation of Long term Loan

Initiatives and Status

2

Management has acknowledged this issue & find out solutions/alternatives to utilize the spill over energy during rainy seasons. Various Internal control measures have been enforced by utilizing the available resources to make them effective. The positional head of the Internal audit was upgraded from director to deputy managing director and the offices of internal audit were also decentralized in the regional level. Audit is carried out by competent and qualified staffs available in NE A.

NEA intends to provide adequate amount for inventories obsolesces and doubtful advances. NEA has recognized and disclosed all valid claims.

Recently, Ministry of Finance has formed a Task Force on the request of NEA for reconciliation and confirmation of GoN investment in NEA. Recently, Ministry of Finance has formed a Task

Monitori ng

Indicator S

7 reductio n by 3 0%

Increase in Sales & revenue

25%

75%

100%

100%

100%

Proposed Actions

3 be minimized by using Low Voltage Capacitor.

Proper utilization of spill- over energy

Appointment of qualified engineers & Accountants .

Provide training to staff

Enhancement in motivation,

. preparation of regional audit manuals, guidelines & procedures,

Assessment of additional provision

Reconciliation of Share capital account with GoN.

Reconciliation of Long Term Loan account

Responsible Unit

4

Power stations and LDC.

DMD Administrations and DMD Internal Audit.

GM officesFinance & Accounts Department.

Finance & Accounts Division. Corporate Finance '

Department.

Finance & Accounts Division.

Modality

5 use of Low Voltage Capacitor.

By strengthening transmission lines & substations

Strengthening and implementation of internal control systems.

Planning of internal audit & implementation of audit manuals, guidelines and procedures.

Timely reporting & monitoring of audit queries.

Examination and verification of property, assets.

Verification of accounts & adjustment of differences.

Verification of accounts.

Time Frame (Tentative date of completion)

6

Partially up to July 15, 2009 & balance up to 2011.

July 15, 2009.

July 15, 2009.

December 2010.

July 15, 2009.

July 30, 2009.

July 30, 2009.

Issue

1

Non reconciliation of Customer ledgers etc. (para3.10)

Claim not accepted by NEA (para 3.13)

No adequate provision for pension, gratuity accumulated leave and medical facilities. (para 3.14)

Payment variation of Kali Gandaki A (para 3.17)

Initiatives and Status

2 out by all budget centers in 2007108. The condition of inventories was identified and appropriate provision was made. Out of 142 collection centers under DCS and RE, 89 collection centers have completed reconciliation and remaining are in progress. Dues from municipalities' up to the Year 2007/08 are fully recovered and adjusted Amount pending in suspense account is settled now. NEA Board has decided to collect the electricity bill allowing maximum in twelve installment with exception of penalty NEA has disclosed all valid claims. NEA is going to make actuary valuation by a competent professional. Data collection and updating work is substantially completed. Valuation will complete within three months. Short/excess provision in earlier years in respect of employees liabilities will be adjusted accordingly.

Payment amount of variation order is under consideration of NEA Board.

Monitori ng

Indicator S

7

80%

20%

100%

100%

100%

100%

90%

100%

Expected Results

8

Achievement in reconciliation of customer ledgers.

Disclosure of all valid claims

Recruitment completed.

Known liability with regards to retirement staff.

Adequate provision for retirement benefits to employees.

Settlement of Disputes

Proposed Actions

3 inventories obsolesces.

Balancing of Subsidiary ledgers. Confirming differences between sub-ledgers and main ledgers. Reconciliation of customer ledgers. Recommendation for appropriate adjustment /disposal o fun reconciled items,

Assessment of all claims

Estimation of liabilities on provisional basis till completion of actuary valuation. Acquiring consultancy service of ~ c t u a r y Valuation. Submission of Final report by consultants.

Finalize the amount of variation order.

Time Frame (Tentative date of completion)

6

Current ledgers- on or before: - Oct.30,

2009. - July 15,

2010.

Old ledgers- July 15, 2010.

July 15, 2009.

April 2009.

September 2009.

December 2009.

August 2009.

Responsible Unit

4 Department.

A11 Collection centers. Regional office. GM office(DCS/RE). . Head office, NEA Board.

Finance & Accounts Department.

Consultant of actuary valuation. Finance & Accounts Department. Head office. NEA Board.

GM Generation. NEA Board.

Modality

5 Adjustment.

Group formation working in revenue section. Implementation of incentive plan for consumer account reconciliation.

Assessment of claims

Recruitment of consultants by negotiation.

Getting all the information of all permanent & retired staffs.

Actuary Valuation.

Finalize and present the variation proposal before Board. Approval of amount of variation

Annex 3: Procurement Arrangements Nepal Power Development Project - Additional Financing

A. Nepal Electricity Authority component

Section I. Procurement of Goods and Works

Part A: General

Goods, works and supply and installation contracts shall be procured in accordance with the provisions of Section I of the Guidelines for Procurement under IBRD Loans and IDA Credits published in May 2004, and revised in October 2006 (the Guidelines) and the following provisions of this Section I.

Part B: International Competitive Bidding

1. Except as otherwise provided in Part C of this Section, goods and works shall be procured under contracts awarded in accordance with the provisions of Section I1 of the Guidelines and paragraph 4 of Appendix 1 thereto.

2. The following provisions shall apply to goods and works to be procured under contracts awarded in accordance with the provisions of paragraph 1 of this Part B:

(a) Preference for domestically manufactured goods and domestic contractors: The provisions of paragraphs 2.55 and 2.56 of the Guidelines and Appendix 2 thereto shall apply to goods manufactured in the territory of the Borrower and works to be carried out by domestic contractors.

(b) Notification and Advertising: The invitation to bid for each contract estimated to cost $500,000 equivalent or more shall be advertised in accordance with the procedures described under paragraph 2.8 of the Guidelines.

Part C: Other Procurement Procedures

1. National Competitive Bidding

(a) Works estimated to cost less than $100,000 equivalent per contract may be procured under contracts awarded in accordance with the provisions of paragraphs 3.3 and 3.4 of the Guidelines.

(b) For the purpose of the procurement referred to in (a) above, the following shall be observed:

(i) only the model bidding documents for NCB agreed with the Bank (as amended from time to time) shall be used;

(ii) invitations to bid shall be advertised in at least one national newspaper with a wide circulation, at least 30 days prior to the deadline for submission of bids; (iii) bid documents shall be made available, by mail or in person, to all who pay the required fee; (iv) there shall not be any restrictions such as registrationllicensing requirements etc. for purchase of bid documents and bidding by foreign bidders, and no preference of any kind shall be given to any bidders in the bidding process when competing with the foreign bidders, state owned enterprises, or small scale enterprises; (v) qualification criteria shall be stated in bidding documents, and, if registration process is required, a foreign bidder declared as the lowest evaluated responsive bidder shall be given a reasonable opportunity of registering, without let or hindrance; (vi) bids shall be opened in public in one location, immediately after the deadline of the submission of bids; (vii) contracts shall be awarded to the lowest evaluated responsive bidder; (viii) rebidding shall not be carried out without the prior concurrence of the Association; (ix) evaluation of bids shall be made in strict adherence to the criteria stipulated in the bidding documents; (x) except in cases of force majeure andlor situations beyond the control of the Project, extension of bid validity shall not be allowed without the prior concurrence of the Association: (a) for the first request of extension if it is longer than four weeks; and (b) for all subsequent requests for extension irrespective of the period.

3. Limited International Bidding

Items such as turbine parts, valves and electromechanical equipment which are available only from a limited number of fabricators and suppliers may be procured in accordance with the provisions of Section 111, paragraph 3.2 of the Guidelines.

4. Shopping

Goods estimated to cost less than $50,000 equivalent per contract may be procured under contracts awarded on the basis of shopping procedures in accordance with the provisions of paragraphs 3.5 of the Guidelines.

5. Direct Contracting

Proprietary items such as spares or parts required for the repair and rehabilitation of diesel and multi-fuel plants, hydropower and electromechanical systems which meet the conditions described in Section I11 paragraph 3.6 of the Guidelines may be procured through direct contracts with concerned manufacturers/firms in accordance with the procedures described in Section 111, paragraphs 3.6 and 3.7 of the Guidelines.

Part D: Review by the Association of Procurement Decisions

1. Procurement Planning

Prior to the issuance of any invitations to bid for contracts, the proposed procurement plan for the first 18 months of the Project implementation shall be furnished to and agreed with the Association in accordance with the provisions of paragraph 1 of Appendix 1 to the Guidelines. Procurement of all goods and works shall be undertaken in accordance with such procurement plan as shall have been approved by the Association, and with the provisions of said paragraph 1. The Borrower shall update the plan on an annual basis or as needed, always covering the next 18 months period of project implementation and each such updating shall be furnished to the Association for its review and approval.

2. Prior Review

With respect to all ICB contracts for goods, works and supply and installation works, and the first of each contract for goods, works and supply and installation works regardless of value, the procedures set forth in paragraphs 2 and 3 of Appendix 1 to the Guidelines shall apply.

3. Post Review

With respect to each contract not governed by paragraph 2 of this Part, the procedures set forth in paragraph 4 of Appendix 1 to the Guidelines shall apply.

Section 11. Employment of Consultants

Part A: General

Consultants' services shall be procured in accordance with the provisions of Sections I and IV of the "Guidelines: Selection and Employment of Consultants by World Bank Borrowers", published in May 2004 and revised in October 2006 (the Consultant Guidelines), paragraph 1 of Appendix 1 thereto, Appendix 2 thereto and the following provisions of this Section 11.

Part B: Particular Methods of Procurement of Consultants' Services

1. Except as otherwise provided in paragraph 2 below, consultants' services shall be procured under contracts awarded on the basis of Quality and Cost-based Selection using only the Request for Proposal (RFP) documents approved by the Association. 2. Other Methods of Procurement of Consultants' Services. The following list specifies methods of procurement, other than Quality and Cost-based Selection, which may be used for consultants' services. The Procurement Plan shall specify the circumstances under which such methods may be used.

Procurement Method (a) Quality-Based Selection (b) Selection under a Fixed Budget (c) Least-Cost Selection (d) Selection Based on Consultants' Qualifications (e) Single-Source Selection (f) Procedures set forth in paragraphs 5.2 and 5.3 of the Consultant Guidelines for the Selection of Individual Consultants (g) Sole Source Procedures for the Selection of Individual Consultants

Part C: Review by the Association of the Selection of Consultants

1. Selection Planning

A plan for the selection of consultants required for the first 18 months of project implementation, which shall include contract cost estimates, contract packaging, and procedures, shall be furnished to and agreed with the Association for its review and approval prior to the issuance to consultants of any requests for proposals. The Borrower shall update the plan on an annual basis or as needed, always covering the next 18 months period of project implementation and each such updating shall be furnished to the Association for its review and approval. Selection of all consultants' services shall be undertaken in accordance with such selection plan (as updated from time to time) as shall have been approved by the Association.

2. Prior Review (a) With respect to each contract for the employment of consulting firms estimated to cost the equivalent of $100,000 or more, the procedures set forth in paragraphs 2, 3 and 4 of Appendix 1 to the Consultant Guidelines shall apply.

(b) With respect to each contract for the employment of individual consultants or firms to be selected on a sole source basis regardless of value, or contracts with individual consultants to be selected competitively whose estimated cost is equivalent to $25,000 or more, the report on the comparison of the qualifications and experience of candidates, the qualifications, experience terms of reference and terms of employment of the consultants shall be furnished to the Association for its prior review and approval. The contract shall be awarded only after the said approval shall have been given. The provisions of paragraph 3 of Appendix 1 to the Consultant Guidelines shall also apply to such contracts.

3. Post Review With respect to each contract not governed by paragraph 2 of this Part, the procedures set forth in paragraph5 of Appendix 1 to the Consultant Guidelines shall apply.

Section 111. Other

NEA shall appoint a senior procurement consultant with demonstrated experience in international procurement, with the terms of reference acceptable to the Association, to assist NEA in the management of procurement under Part C of the Project.

B. Microhydro Village Electrification Component

The proposed Additional Financing would be providing funds to scale-up the MHVEC. This is a demand-led component and the contracts cannot be identified at the outset. Hence, procurement activities related to this component do not appear in the procurement plan. The procurement arrangements under this component shall be identical to those in use for the parent project.

C. Procurement Risk

Most of the new contracts to be funded under the NEA component, because of their high value, will be procured through ICB and be subject to prior review by the Bank. NEA has good procurement capacity and this is evidenced by the fact that despite the NEA allocation being increased by 127% after project restructuring in April 2008, in little over a year NEA has initiated the procurement for all the new contracts corresponding to this increase. However, NEA may not have adequate resources to effectively undertake, in a timely manner, the additional procurement actions that this Additional Financing entails, and there is a risk that there would be delays in the critical procurement activities. To address this, NEA has agreed to augment the resources available in the project coordination office to enable it to handle the increased procurement load. Lastly, the power sector has not to date been affected by the increasing cases of negative practices (such as collusion, intimidation of bidders etc.) occurring in public procurement under other sectors in Nepal. This is likely the result of the highly technical nature of the sector, the large value of the contracts that are almost invariably procured through ICB and the existence of a relatively large market of foreignlregional contractors who are relatively immune to possible collusion, intimidation etc. that may be organized by local elements.

Based on the above, the overall risk or procurement under the Additional Financing is rated as Moderate, as for the parent project.

Annex 4. Governance and Accountability Framework Nepal Power Development Project - Additional Financing

A. Governance Structure

1. The proposed Additional Financing operation would support additional investments in two components of the on-going Power Development Project: (i) the Nepal Electricity Authority component, consisting of investments in the national grid (generation, transmission and distribution), and (ii) the Microhydro Village Electrification Component (MHVEC), consisting of small-scale off-grid, cornrnunity- managed projects. Governance and accountability actions that respond to the divergent risk profiles and potential governance issues of each component are embedded in the project design and implementation arrangements.

2. One of the most important attributes of the proposed Additional Financing operation with respect to managing the governance and accountability risks in the sector has been the selection of the sub-projects themselves. These were selected on the basis of the following criteria: (i) their relevance in responding to the energy crisis; (ii) ease of implementation; and (iii) for the sub-projects in the NEA component, feasibility of completion one year before the revised closing date (the last year is intended for the MHVEC). The bulk of the Additional Financing will be used for a small number of sub- projects under the NEA component, and procurement and implementation of these larger investments is well within the capacity of NEA, as demonstrated by the experience of the on-going PDP.

3. Project Oversight. NEA Component. A project coordination office in NEA has been responsible for implementing the on-going Power Development Project since 2004 and will be responsible for the implementation of the new investments. The project coordinating office is led by a Project Coordinator and includes in addition managers for the individual sub-projects; accounts chief and accounting staff; and support staff. In addition to its own resources, the project coordinating office is supported by other functional units at NEA, e.g. the Environmental and Social Studies Department, as required. Individual sub-projects under the NEA component, while coordinated through the project coordinating office, also report to their respective functional units at NEA's corporate office.

4. Strengthening NEA project coordination ofJice. In view of the increased scope of work resulting from the Additional Financing, NEA has agreed to carry out a workload analysis for the project coordination office, and to implement the recommendations of the workload analysis.

5. Microhydro Village ElectrzJication Component: Oversight of the MHVEC is carried out on the central, district and community levels. On the central level, project oversight is provided for by (i) the Project Advisory Committee, consisting of representatives of several ministries and funding agencies, (ii) the Rural Energy Development Program Project Execution Board under the leadership of the Executive

Director of the Alternative Energy Promotion Center (AEPC; the national agency for renewable energy promotion) and including representatives of the Association of the District Development Committees of Nepal, Village Development Committees of Nepal and the Ministry of Finance; and (iii) a REDP program management unit headed by a National Program Director and a National Program Manager.

6. On the district level, village-level microhydro systems are implemented through the District Development Committees (DDCs), as per the Local Self-Governance Act (2000). In the 40 districts in which the MHVEP operates, District Energy and Environment Sections have been established as part of the DDCs, with the mandate to support local-level capacity-building, planning and M&E, creation of District Energy Funds (DEF), and to undertake resource mobilization through supporting organizations, financial institutions and the private sector.

B. Social Oversight and Participation

7 . NEA component: The sub-projects currently supported under the Power Development Project and those proposed under the Additional Financing operation are technical investments in the development of the national grid and, as such, are relatively small in number and large in value (e.g. construction of a high-voltage transmission line, or repair of a hydropower turbine). The implementation of these investments is centralized, and the scope for social oversight and participation as such is limited given the nature of the investments. However, for those sub-projects that have social impacts, consultations in the context of the impact assessment have been carried out and design revisions made where necessary and possible (e.g. re-alignment of the route of the transmission line to avoid populated areas).

8. Microhydro component: The potential accountability risks of this component derive from the fact that demand for rural electrification far outstrips supply; hence, even with well-defined, progressive procedures for the identification of candidate villages and for the implementation of projects on the community level, there is still a high degree of discretion involved in the ultimate selection of beneficiary villages, and possibly on the level of determining local benefits (such as who receives employment opportunities connected with the operation of the power house). This gives rise to the risk of abuse of discretion or politicization - or at least the risk of the perception of same. To address this possible risk, it is proposed to task a group of social scientists to investigate, through field research, the actual, on-the-ground practices followed in the implementation of the component, and to propose recommendations to address any identified shortcomings which can be incorporated into the operating guidelines for the component.

9. Once villages are selected, social accountability mechanisms are embedded in component design, as community ownership and accountability are at the heart of the microhydro component and community mobilization is the main tool for project implementation. In each community, Microhydro Functional Groups (MHFGs) are constituted from existing community organizations (which themselves are formed with the help of a competitively selected local NGO as the Support Organization) and include one man and one woman from each household, and 100% of households, ensuring

proportional representation of Dalits, vulnerable and other marginalized groups. The MHFG is the key body at the village level for establishment, operation and management of microhydro plants. With support from the REDP central office, DEES and the facilitating SOs, the MHFG work through preparation of detailed action plans; enter into the various agreements required for the construction of MHs; mobilize local resources and make payments to companies selected for providing various goods and services. For local level resource mobilization, and to establish community energy funds for the poor, MHFG collaborate with DDCs, VDCs, banks and other partners as required.

C. Transparency, Disclosure and Communication Strategy

10. As required by the Right to Information Act, 2007, disclosure requirements under the Additional Financing are expected to be even more transparent and all information readily available for public disclosure. Implementing agencies are to post on their Websites all available guidelines, procedures, and other key information related to the Power Development Project. NEA and AEPC have agreed to disclose the following through their Websites: Procurement Plan; Procurement Complaints Mechanism; Trimester Implementation Progress Reports (approved versions); Invitation for Expression of Interest, Bid Documents, Request for Proposals, Minutes of Pre-bid Conferences, Contract Awards; and Annual Audited Financial Statements.

11. NEA component: NEA maintains a Web site that provides general information on the power sector and the utility, including legislative acts of relevance to the power sector; NEA's Annual Reports from the last two years; a detailed, accurate load-shedding schedule (which is widely used by consumers); and tender notices. NEA will have a separate page in its website for the Power Development Project. The NEA will disclose through its Website the frameworks for environmental and social impact assessment that are being revised in connection with the new sub-projects proposed under the Additional Finance.

12. Disclosure on the sub-project level: for sub-projects with significant social and environmental impacts, full Environmental and Social Impact Assessments are carried out. In such cases (which are limited to the transmission lines funded under PDP and proposed under the Additional Financing), the key stakeholders include: (i) project- affected households, (ii) local government, (iii) the implementing agency, and (iv) NGOs and other social organizations active in the project area. Public consultation is an integral part of the process throughout the planning and execution of the sub-projects. NEA's Environment and Social Studies Department (ESSD) interacts with PAPs/communities, project personnel, government departments, and NGOs from the early stages of sub- project preparation on a regular basis for preparation and implementation of the Resettlement Action Plan. Even though these sub-projects do not entail significant social impacts, the project will ensure that affected communities are made aware of the possible adverse social impacts. Public contact drives are organized by the ESSD, and public awareness is spread through NGOs and other social organizations active in the affected areas. The suggestions made by the community and project-affected groups were incorporated in the Resettlement Action Plan during the selection of the route of the transmission line and substation and tower locations.

D. Financial Management

13. NEA Component. Financial management has been adequate on the project level but sub-optimal on the entity level, and is inextricably linked with sector finances. The reasons for this performance are complex and have deep roots, and include: (i) the fact that sector finances are beyond the control of NEA; (ii) the impossibility of raising retail tariffs given the current very poor state of service quality; and (iii) the high interest rate that GON charges for externally borrowed funds that it on-lends to NEA, making debt service a significant burden on the utility.

14. As part of the preparation for the proposed Additional Finance, NEA prepared and committed to the implementation of an Action Plan for Financial Management Improvement (Annex 2, Attachment I), which is incorporated by reference into the GAAP.

15. Microhydro component. AEPC has established a good financial management system, and sound practices are in place. Project level staff are committed to improving some areas of weaknesses as suggested by the Bank, such as maintaining sub-accounts and improving internal control.

E. Procurement

16. NEA component: as under the parent project, procurement for the proposed AF will be carried out according to a detailed procurement plan agreed with the Bank prior to the launching of the procurement process. Most of the new contracts to be funded under the NEA component, because of their high value, will be procured through ICB and will be subject to prior review by the Bank. Some specialized goods for which there are only limited international suppliers/manufacturers shall be procured through limited international bidding. When justified (e.g. when spare parts are needed and the original equipment manufacturer is the only appropriate source), goods and services may be procured through direct contracting. Information on contract opportunities shall be provided through publication of a GPN in the UNDB as well as on the NEA Website and in print publications. Subsequent information on contract awards shall also be disclosed publicly.

17. NEA has demonstrated good procurement capacity in its administration of the Power Development Project to date. Even though the allocation to the NEA component was increased by 127% at the time of project restructuring, in little over a year NEA initiated procurement for all of the new contracts corresponding to this large increase. The tenders carried out under the PDP show a good record of competition for the contracts. The power sector has not to date witnessed the negative procurement practices that have been seen in other sectors in Nepal (collusion, intimidation of bidders, etc.) This is likely the result of the highly technical nature of the sector, the large value contracts that are almost invariably procured through ICB, and the existence of a relatively large market of regionallforeign contractors that are interested in these large contracts and thus are relatively immune to possible collusion and intimidation that may be organized by local elements.

18. Microhydro component. Procurement of the electro-mechanical equipment required for microhydro systems is handled by respective MHFGs following guidelines prepared by REDP and endorsed by GON and the World Bank. Only pre-qualified contractors and consultants are eligible to participate in tenders, which significantly increases the likelihood of high-quality work and accountability to communities, as the contractors and consultants have an interest in maintaining their status as pre-qualified contractors in this growth industry, and in being certified by AEPC as qualified contractors and service providers. AEPC sets a normative price per kW as well as a fixed subsidy/community grant amount per kW irrespective of the actual cost. Competition in procurement of goods/works contracts by MHFGs is carried out on the basis of national shopping through request for quotations from at least three of the certified contractors. Guidance from AEPC significantly eases the burden of negotiating and contract management on beneficiary communities. Currently, seventeen contractors throughout the country have been pre-qualified by AEPC for manufacturing and installing microhydro systems up to 500 kW capacity (the maximum for a village-level scheme). Similarly, twenty-one consultants have been pre-qualified as for carrying out feasibility study of Micro / Mini- Hydropower Projects up to 500 kW capacity. The AEPC Website provides a complete list of these pre-qualified contractors and consultants with contact information.

F. Monitoring and Evaluation

19. NEA component. The day-to-day responsibility for sub-projects that are under implementation in the field lies with the respective NEA project team that collects data on physical implementation progress, and turns this information into the project coordination unit which collates data on physical progress and tracks payments to contractors in the overall context of context of contract management. Monitoring of compliance with recommendations made in environmental assessments needs strengthening and the proposed Additional Financing will aim to strengthen ESSD's capacity for environmental compliance monitoring and auditing activities.

20. Microhydro component. REDPIAEPC collect data -From communities and districts on the various renewable energy projects (microhydro, solar, toilet attached biogas and improved stoves) under implementation, and on key outputs produced through community mobilization and program activities (e.g. the number of COs, FGs, weekly saving and credit amounts, community infrastructure such as drinking water supply/ponds, rural roadsltrails, schools buildings, etc.). M&E as practiced to date has focused on quantitative targets rather than socio-economic impacts or even productive uses of electricity in off-grid applications. These have been based on the National Planning Commission's (NPC) Poverty Monitoring and Analysis System (PMAS), which includes two energy-related indicators: (i) the percent of population with access to electricity, and (ii) average per capita electricity consumption.

21. AEPC would like to improve its systems for collecting and analyzing data on the impact of rural electrification and to introduce a Management Information System that will provide information of a deeper nature than the two NPC indicators described above. With this objective, AEPC requested Bank for technical assistance to analyze the socio-

economic impacts of off-grid electrification and to design a Monitoring & Evaluation framework for its rural electrification programs; this study is currently under implementation with ESMAP funding; results are expected by September 2009. Operationalization of the M&E framework will be supported by the project and monitored in the context of the Governance and Accountability Action Plan (section H.)

G. Grievance Redress Mechanism

22. NEA component. NEA'S social impact assessment framework that applies to the Additional Financing operation calls for the establishment of effective mechanisms for resolving grievances during the implementation of sub-projects, with particular reference to complaints and issues related to payment of compensation and resettlement programs in connection with land acquisition, resettlement and loss of livelihood caused by the sub- project. Project-Affected People (PAP) will have access to both locally formed grievance redress committees and regular courts. The local committees will consist of sub-project officialslstaff and representatives of local bodies and affected people. As a first step, complaints will be filed with the local committees for resolution at the sub-project level. If resolution is not possible at the sub-project level, then cases will be referred to regular courts in accordance with the laws of Nepal. The structure and roles and responsibilities of each member of GRC will be detailed in Resettlement Action Plan of each sub-project.

23. Microhydro component. AEPC has established a system for grievance redress on the community, district and central levels. Each community in which a microhydro scheme is implemented appoints a Vulnerable Community focal person who ensures that the project benefits are distributed in accordance with the agreed plan and who is also responsible for maintaining a log of grievances. The Vulnerable Community focal person regularly informs the Microhydro Functional Group of recorded grievances. At the district level, a VC focal person is appointed in the District Energy and Environment Section which is part of the District Development Committee. A representative of AEPCJREDP serves as the VC focal person on the central level. AEPC would like to improve the effectiveness of its grievance redress mechanism and the Governance and Accountability Action Plan includes support for a diagnostic of the grievance redress mechanism and implementation of recommendations.

H. Governance and Accountability Action Plan

24. A Governance and Accountability Action Plan (GMP) has been agreed with the Government based on the risks identified for the proposed operation. The GAAP indicates agreed critical actions that Government and implementing agencies believe will reduce governance risks and that the Bank will monitor during the course of project implementation. As implementation progresses, the GAAP will be updated in consultation with the NEA and AEPC project teams. The Action Plan for Improving Financial Management will be monitored in conjunction with the GAAP.

Governance and Accountability Action Plan (GAAP)

Issues Identified For Monitoring

NEA Component Financial management capacity

Project Implementation Capacity

Environmental management

Disclosure and Communications

Microhydro Village Grievance redress mechanism

Monitoring & Evaluation

Cost-control of MH systems

Long-term sustainability of MH systems

Disclosure

Indicative Timeline

1. As indicated in the Action Plan

1. May 2009 2. June 2009 3. Over2010

1. June 2009 2. As needed

July 2009

1. August 2009.

2. August 2009.

1. September 2009

2. Dec 2009

1.1. Oct 2009

1.2. Oct 2009 - June 2010

2.1 January 20 10

1. June 2009 2. July 2009 3. Sept 2009 4. Jan 2010 5. Over 2010

1. June 2009 2. July 2009 3. Sept 2009 4. Jan 2010 5. Over 2010 August 2009

Proposed Mitigation Measures

(implemented by the Nepal Electricity 1. Implement Action Plan for Improving Financial Management.

2. Implement TA contract, Institutional Strengthening, Financial Management.

On basis of analysis of work load, assign additional professional staff to project coordination unit as required. Introduce system of periodic compliance checks and annual independent monitoring of recommendations made in EIAs. 1. Upgrade NEA Website to improve user-friendliness with respect to disclosure and public communication. 2. Create Website for Power Development Project. Electrification Component Preparation of analysis of existing mechanism with recommendations for improvement.

1. Establish new M&E framework and establish new MIS system.

2. Introduce 31d party monitoring with use of social accountability mechanisms (e.g. "report cards") Carry out review of cost dynamics of MH systems to identify cost-control measures (e.g. design modifications, procurement innovations, changes to institutional/financial arrangements). Carry out a study of the long-term sustainability of MH systems that have been in operation for 5+ years.

Upgrade AEPC Website to include disclosure of key project documents

Milestones

Authority) 1. As indicated in the Action Plan.

2.1. Submission of draft RFP to Bank 2.2. Launching of tender 2.3. Execution of contract 1. Work load analysis 2. Appointment of additional project coordination unit staff as required Preparation of protocol for system of monitoring by ESSD

1. Improved Website.

2. Creation of new Website.

(implemented by AEPC/REDP) 1. Completion of analysis and formulation of recommendations.

2. Implementation of recommendations. 1.1 Facilitate completion of on- going study with development of M&E fiamework and MIS system 1.2. Implement recommendations of study.

2.1 Initiation of 31d party monitoring system

1. Preparation of TOR 2. Launch tender 3. Award study 4. Complete study 5. Implement recommendations

1. Preparation of TOR 2. Launch tender 3. Award contract 4. Complete study 5 . Implement recommendations Improved Website

Issues Identified I Proposed Mitigation Measures I Milestones For Monitoring I -

Review of Project I In conjunction with Bank, carry I 1. Preparation of TOR

Indicative

2. August 2009 3. Sept - Oct 2009

Governance Risks out study of core governance risks of MHVEP using field-based social science techniques, and recommend im~rovements

2. Contract consultants 3. Implement study

Annex 5. Withdrawal of the Proceeds of the Additional Financing Nepal Power Development Project - Additional Financing

Category

Part B of the Project (AEPC) (a) Community Subproject Grants (b) Goods (c) Consultants' Services (d) Training and Promotional Activities (e) Incremental Operating Costs

Part C of the Project (NEA) (a) Goods and Works (b) Consultants' Services (c) Services Costs (for NEA's Soil, Rock and Concrete Laboratory) (d) Unallocated TOTAL

Amount of the Credit Allocated

(Expressed in USD)

0

0 0 0

0

71,830,000

500,000

1,370,000 73,700,000

Amount of the Grant Allocated

(Expressed in USD)

10,860,000

200,000 300,000 320,000

320,000

3,500,000

15,500,000

% of Expenditures to be Financed

100%

100% 100% 100%

45%

100% 100% 100%

89,200,000