Report and Recommendation of the President to the Board of Directors

Project Number: 50059-003 June 2020

Proposed Loan, Administration of Grant, and Administration of Technical Assistance Grant : South Asia Subregional Economic Cooperation Power Transmission and Distribution System Strengthening Project

Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB's Access to Information Policy.

CURRENCY EQUIVALENTS (as of 20 May 2020) Currency unit – Nepalese rupee/s (NRe/NRs) NRe1.00 = $0.00823 $1.00 = NRs121.46

ABBREVIATIONS ADB – Asian Development Bank ERC – Electricity Regulatory Commission GAP – gender action plan IEE – initial environmental examination MW – megawatt NEA – Nepal Electricity Authority PAM – project administration manual PMD – Project Management Directorate SASEC – South Asia Subregional Economic Cooperation TA – technical assistance

NOTES (i) The fiscal year (FY) of the Government of Nepal and its agencies ends on 15 July. “FY” before a calendar year denotes the year in which the fiscal year ends, e.g., FY2020 ends on 15 July 2020. (ii) In this report, "$" refers to United States dollars.

Vice-President Shixin Chen, Operations 1 Director General Kenichi Yokoyama, South Asia Department (SARD) Director Priyantha Wijayatunga, Energy Division (SAEN), SARD

Team leader Jiwan Acharya, Principal Energy Specialist, SAEN, SARD Team members Aaron Dennis, Social Development Specialist, SAEN, SARD Len George, Senior Energy Specialist, SAEN, SARD Sajid Raza Zaffar Khan, Financial Management Specialist, Portfolio, Results, and Quality Control Unit, Office of the Director General, SARD Rosanna Mae Labitag, Operations Assistant, SAEN, SARD Pushkar Manandhar, Senior Project Officer (Energy), Nepal Resident Mission (NRM), SARD Emma Marsden, Senior Environment Specialist, SAEN, SARD Lyailya Nazarbekova, Principal Counsel, Office of the General Counsel Karen Grace Ochavo, Associate Environment Officer, SAEN, SARD Arun Rana, Senior Project Officer, NRM, SARD Grishma Shah, Project Officer (Energy), NRM, SARD Deepak Singh, Senior Environment Officer, NRM, SARD Suman Subba, Senior Social Development Officer (Gender), NRM, SARD Laxmi Subedi, Senior Social Development Officer (Safeguards), NRM, SARD Peer reviewer Dae Kyeong Kim, Senior Energy Specialist (Smart Grids), Energy Sector Group, Sustainable Development and Climate Change Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page PROJECT AT A GLANCE I. THE PROPOSAL 1 II. THE PROJECT 1 A. Rationale 1 B. Project Description 4 C. Value Added by ADB 5 D. Summary Cost Estimates and Financing Plan 6 E. Implementation Arrangements 7 III. ATTACHED TECHNICAL ASSISTANCE 8 IV. DUE DILIGENCE 8 A. Technical 8 B. Economic and Financial Viability 9 C. Sustainability 9 D. Governance 9 E. Poverty, Social, and Gender 10 F. Safeguards 11 G. Summary of Risk Assessment and Risk Management Plan 12 V. ASSURANCES 12 VI. RECOMMENDATION 12

APPENDIXES 1. Design and Monitoring Framework 13 2. List of Linked Documents 16 Project Classification Information Status: Complete

PROJECT AT A GLANCE

1. Basic Data Project Number: 50059-003 Project Name South Asia Subregional Economic Department/Division SARD/SAEN Cooperation Power Transmission and Distribution System Strengthening Project Country Nepal Executing Agency Nepal Electricity Authority Borrower Government of Nepal (NEA)

Country Economic https://www.adb.org/Documents/LinkedDocs/ Indicators ?id=50059-003-CEI Portfolio at a Glance https://www.adb.org/Documents/LinkedDocs/ ?id=50059-003-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million) Energy Electricity transmission and distribution 200.00 Total 200.00 3. Operational Priorities Climate Change Information Addressing remaining poverty and reducing inequalities GHG reductions (tons per annum) 78,724 Accelerating progress in gender equality Climate Change impact on the Low Tackling climate change, building climate and disaster resilience, and Project enhancing environmental sustainability Making cities more livable ADB Financing Strengthening governance and institutional capacity Adaptation ($ million) 1.00 Fostering regional cooperation and integration Mitigation ($ million) 118.90

Cofinancing Adaptation ($ million) 0.00 Mitigation ($ million) 18.20 Sustainable Development Goals Gender Equity and Mainstreaming SDG 5.b Effective gender mainstreaming (EGM) SDG 7.a SDG 13.a Poverty Targeting General Intervention on Poverty 4. Risk Categorization: Low . 5. Safeguard Categorization Environment: B Involuntary Resettlement: B Indigenous Peoples: C

. 6. Financing Modality and Sources Amount ($ million) ADB 200.00 Sovereign Project (Concessional Loan): Ordinary capital resources 200.00 Cofinancing 35.00 Government of Norway - Project grant (Full ADB Administration) 35.00 Counterpart 87.00 Government 87.00 Total 322.00 Note: An attached technical assistance will be financed on a grant basis by the ATF - Norway TA Grant in the amount of $5,000,000.

Currency of ADB Financing: US Dollar

Source: Asian Development Bank This document must only be generated in eOps. 17022020082540472556 Generated Date: 05-Jun-2020 14:02:40 PM

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed loan to Nepal for the South Asia Subregional Economic Cooperation Power Transmission and Distribution System Strengthening Project. The report also describes the proposed (i) administration of a grant, and (ii) administration of technical assistance (TA), both to be provided by the Government of Norway, for the South Asia Subregional Economic Cooperation Power Transmission and Distribution System Strengthening Project, and if the Board approves the proposed loan, I, acting under the authority delegated to me by the Board, approve the administration of the grant and the administration of the TA.

2. The proposed project will complete the reinforcement and modernization of the power supply system in in .1 This project will also begin strengthening distribution systems outside of Kathmandu in a systematic and phased manner starting with the Bharatpur metropolitan area of Chitwan district in Bagmati Province and Pokhara of Kaski district in Gandaki Province, where supply interruptions are frequent and prolonged. The project will also support Province 2, where the quality of electricity supply is poor and about 20% of households are still without access to the national grid. Further, the project will strengthen transmission lines for evacuation of hydropower to the main load center in Kathmandu and other load centers, while excess power is traded with neighboring countries.

II. THE PROJECT

A. Rationale

3. Nepal is a landlocked, mountainous country located between the large and fast-growing economies of the People’s Republic of China to the north and India to the east, west, and south. Nepal’s gross domestic product (GDP) growth averaged 7.3% during fiscal year (FY) 2017– FY2019. With deepening economic uncertainties due to the coronavirus disease (COVID-19) pandemic, compounded by social and health emergencies, the preliminary estimates from the Central Bureau of Statistics in Nepal show that GDP growth will significantly decline to 2.3% in FY2020.2 The need to stimulate post-COVID-19 economic recovery by developing Nepal’s infrastructure has become more relevant.

4. Sector challenges. Following years of facing chronic electricity shortages, especially during dry winter months (October to March), Nepal made significant improvements in electricity supply during FY2017 and FY2018. These improvements were achieved through a combination of (i) increased electricity imports from India of about 400 megawatts (MW); (ii) improved transmission capacity and operational flexibility by commissioning new transmission facilities; and (iii) better load management involving major industrial customers. While there is currently no significant gap between electricity demand and supply, the power transmission and distribution systems need further strengthening to increase network capacity and redundancy and eliminate bottlenecks between generation hubs and load centers. Also, although 78% of Nepal’s population has access to grid-supplied electricity, the distribution systems require immediate upgrading and expansion to improve the reliability and quality of supply, and to facilitate expected future demand growth. The poor financial position of Nepal Electricity Authority (NEA), due to poor billing and collection practices, and inadequate tariffs, impinge on its capacity to invest in distribution system

1 Nepal is composed of seven provinces as defined by Schedule 4 of the Constitution of Nepal. Some of the provinces have names in place while others are recognized by numbers. 2 GDP estimates for FY2020 of the Central Bureau of Statistics, Government of Nepal, published on 29 April 2020. 2

expansion, and address high technical and commercial losses arising from deteriorated and under-capacity assets and electricity theft. These investment requirements over the next 10 years until 2030 are beyond the budgetary resources of the government. At the same time, the investment environment in the sector, including regulation, is not sufficiently mature to attract private sector capital and participation at the level required, particularly in the transmission and distribution subsectors.

5. Government priorities and reform initiatives. The government recognizes the continued need for physical investment in electricity supply infrastructure. Government issued the White Paper on Energy, Water Resources and Irrigation Sector’s Current Status and Roadmap for Future on 8 May 2018 outlining priorities and reform initiatives for 2018−2028 including hydropower development, and modernizing transmission and distribution subsectors. The Government of Nepal initiated plans to install an additional 15,000 MW of generation capacity by 2028 to meet domestic demand, and to export surplus electricity to India and Bangladesh. In this regard, the government will support the construction of selected storage-type hydropower plants while encouraging the private sector to invest in run-of-river hydropower projects and other renewable energy sources. As indicated in the White Paper, the focus of Nepal’s power system investment program is now gearing toward delivering a reliable and high-quality supply of electricity to domestic consumers through enhanced transmission and distribution systems, and positioning the country to become a net energy exporter. These investments are critical to satisfy the country’s power supply needs in the longer-term and to provide universal access to reliable electricity supply by 2030. These investments will also contribute to promoting sustainable energy for all (Sustainable Development Goal 7) and achieving Nepal’s Nationally Determined Contributions to the United Nations Framework Convention on Climate Change to reduce the country’s dependency on fossil fuel by 50%.3

6. Nepal Electricity Authority. The executing agency of the project, NEA, was established on 16 August 1985 under the Nepal Electricity Authority Act, 1984 as the main national utility responsible for generation, transmission, and distribution of electricity in the country. NEA has historically been under-resourced and hampered by inadequate end-use tariffs, leading to poorly maintained assets, unserved demand for electricity, and crippling financial losses. At the same time, it has been compelled to extend its network into rural areas without adequate returns and to provide grid connections to independent power producers at power purchase rates that it cannot afford. NEA has been governed in a manner that has hampered performance improvement. Investment priorities and tariff-setting have regularly been politicized, resulting in an unsustainable debt burden on NEA. Significant improvements have become evident in 2017 to 2019, however, driven by a significant tariff increase, NEA’s commitment to reduce distribution losses and load-shedding, more effective and decisive management of the power system, and a government-backed financial restructuring plan for NEA.4 These measures have helped NEA deliver continuous electricity supply to its consumers in Kathmandu and to make operating profits. The government and NEA have demonstrated genuine commitment to maintaining this reform momentum.

3 Government of Nepal, Ministry of Population and Environment. 2016. Nationally Determined Contributions. Kathmandu. 4 Key features of financial restructuring plan approved and executed in FY2017 include conversion of foreign loans & certain power import costs payable to government into equity, reduction of interest rate on government funded loans from 8% to 5% and reversal of share capital previously reimbursed for import losses into income. Implementation of financial restructuring plan resulted in increase of share capital by NRs12.4 billion, conversion of long-term borrowing into equity amounting to NRs14.6 billion and decrease in accumulated loss of NRs5.2 billion. The managing director has also signed performance contracts with the chiefs of the regional offices and project managers with a target to reduce its loss, control leakage, reduce administrative expenses, settle outstanding dues, and increase the number of consumers. 3

7. The Asian Development Bank (ADB) and other development partners have been continuing their support for the government’s power system reform efforts; the promulgation of the Nepal Electricity Regulatory Commission Act, 2017 is an important milestone in that regard. Through this legislation, the government has effectively removed itself from direct electricity regulation, particularly with respect to tariff-setting and consumer protection, which have been brought under the Electricity Regulatory Commission (ERC). The ERC has been operational since mid-May 2019 and is preparing to assume increased responsibility as the principal independent regulatory body for electricity. The government and NEA are proceeding with structural unbundling and creation of separate entities for generation, transmission, distribution, and power trading, and the complex task of devolution of responsibility for electricity distribution to provincial authorities is underway.5 The overall improvements in the energy sector have facilitated commercial investment in the 216 MW Upper Trishuli-1 Hydropower Project, which is the largest private sector hydropower project under development with international investment participation, including ADB’s nonsovereign financing. At the same time, the government has recognized that improving NEA’s technical and commercial viability is a prerequisite for attracting significant private investment. In particular, improving NEA’s network to deliver reliable electricity to and around the country’s existing and planned commercial and industrial hubs will increase and diversify NEA’s revenue base away from Kathmandu. This investment, along with NEA’s ongoing efforts to modernize its asset register and revalue its generation and network assets, will facilitate devolution of NEA’s distribution assets to provincial authorities and promote transparency.

8. ADB assistance to the sector. ADB is a major development partner supporting Nepal’s energy sector in the generation, transmission, and distribution subsectors with an active sovereign portfolio of about $630 million as of December 2019. ADB and other development partners are actively engaged in policy and institutional reforms, policy dialogues, knowledge products and services, and essential capacity building. To reflect lessons from earlier projects, particularly with respect to land acquisition and advanced procurement action, project readiness criteria have been developed for the overall project portfolio. The most recent energy sector project approved by ADB for Nepal in 2017 focuses on construction of new grid substations, reinforcement and modernization of electricity distribution infrastructure within the , and a smart metering rollout; implementation performance of this project has been satisfactory.6 Also, ADB’s Private Sector Operations Department is supporting the Upper Trishuli-1 Hydropower Project, which was approved in April 2019.7 ADB will continue to explore opportunities for public–private partnerships and nonsovereign investments across the energy sector.

9. South Asia Subregional Economic Cooperation Program. The project is closely aligned with the South Asia Subregional Economic Cooperation (SASEC) Program to help Nepal improve its energy security by developing infrastructure and promoting intraregional power trade. The project is aligned with the SASEC Operational Plan, 2016–2025 Update’s priorities for energy which include (i) improving interconnections to access large-scale electricity and natural gas resources; (ii) harnessing unutilized regional indigenous hydropower potential; (iii) developing low-carbon energy (wind and solar); and (iv) facilitating bilateral and regional coordination mechanisms, including knowledge sharing.8 The project will support upgrading of substations in Khimti, Barhabise, and to enable full operation of the transmission line passing

5 NEA has already realigned its regional offices to harmonize with the provincial geographical coverage and has started keeping separate financial and performance records. 6 ADB. 2017. Report and Recommendation of the President to the Board of Directors: Proposed Loan to Nepal for the Power Transmission and Distribution Efficiency Enhancement Project. Manila. 7 ADB. 2019. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Nepal Water and Energy Development company Private Limited for Upper Trishuli- 1 Hydropower Project in Nepal. Manila. 8 ADB. 2020. South Asia Subregional Economic Cooperation Operational Plan 2016-2025 Update. Manila.

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through these substations at 400 kilovolts (kV), and to facilitate cross-border power exchange with India. The upgrading of these substations will facilitate export of excess electricity to neighboring countries and import of electricity to meet domestic demand during the winter periods (October to March) using energy banking.9

10. Alignment with ADB priorities. ADB’s country partnership strategy for Nepal, 2020–2024 supports the government's development objective of accelerated and inclusive economic growth.10 This project is fully aligned with the strategy to focus on energy sector reform and financial sustainability, and to strengthen transmission and distribution systems to support regional cooperation and integration. The project is aligned with six operational priorities under ADB’s Strategy 2030.11 It will contribute to addressing remaining poverty and reducing inequalities by strengthening the distribution network in Province 2, where 35% of the population is poor (compared with the national average of 29%). The project will contribute to accelerating progress in gender equality by targeting women and poor households headed by women for awareness-raising on efficient and safe use of electricity, energy-based livelihood activities, and new electricity connections in Province 2. It will help address climate change by upgrading transmission and distribution system to reduce systems losses and evacuate hydropower and improve the urban environment in the Kathmandu Valley and environs. Regional cooperation and integration will be supported by strengthening transmission infrastructure for cross-border power exchange with India. Similarly, the project will help address strengthening governance and institutional capacity through the investment and TA.

11. National emergency resilience and post-pandemic recovery. The project has become even more relevant as a result of the COVID-19 pandemic. Reinforcing electricity networks in urban centers and commercial hubs is essential to underpin and sustain post-pandemic economic recovery. These interventions are also needed to provide resilience to shocks (such as the COVID-19 pandemic). In response to the pandemic, the government has temporarily closed businesses and schools and confined people to their homes for extended periods of time. This, in turn, has highlighted the importance of providing reliable electricity supply to all so that vulnerable communities are not disproportionately penalized and can recover quickly in times of crisis now and in the future. Further, the project’s support to NEA’s initiatives to automate its network operations will reduce the need for human intervention, thereby improving NEA’s ability to maintain electricity supply during national emergencies such as pandemics and natural disasters.

B. Project Description

12. The project is aligned with the following impacts: (i) reliable and efficient electricity for all achieved by 2028,12 and (ii) energy trade infrastructure in SASEC countries improved.13 The project will have the following outcome: access, reliability, and efficiency of power supply in Nepal improved.14

9 The power secretaries of India and Nepal are currently engaged in high-level discussions on energy banking arrangements. 10 ADB. 2019. Country Partnership Strategy: Nepal, 2020–2024—Promoting Connectivity, Developed Services, and Resilience. Manila. 11 ADB. 2018. Strategy 2030 Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific. Manila. 12 Government of Nepal, Ministry of Energy, Water and Irrigation. 2018. White Paper—Current Situation and Future Road Map of Energy, Water Resources and Irrigation Development in Nepal. Kathmandu. 13 ADB. 2016. South Asia Subregional Economic Cooperation Operational Plan, 2016–2025. Manila. 14 The design and monitoring framework is in Appendix 1. 5

13. Output 1: Power system transmission capacity increased. The project will finance (i) upgrading of three substations by 1,265 megavolt amperes (MVA), 400 kV from 220 kV in Khimti 1, Barhabise, and Lapsiphedi in Bagmati Province to enhance capacity for evacuation of electricity from hydropower stations for domestic consumption, and for exportation of excess electricity; and (ii) upgrading of existing 15-kilometer (km) 132 kV double-circuit transmission lines from the Pathlaiya substation to the Parwanipur substation using advanced high-capacity conductors, and construction of new 2x65 MVA 132/33 kV and 1x45 MVA 132/11 kV substation and associated facilities at Pokhariya in Province 2. The latter will especially help cater to unserved demand and support industrial corridor development located in Province 2, which is a priority of the government.

14. Output 2: Distribution systems in the Kathmandu Valley, Bharatpur, and Pokhara, and consumers’ awareness on energy efficiency and safety improved. This output will include (i) construction of a 12-kilometer underground 132 kV double-circuit transmission line from Bhaktapur substation to ; (ii) construction of a 2-kilometer 66 kV transmission line from Koteshwor to Baneswor, and a new 132/11 kV substation with automation in Koteshwor in the Kathmandu Valley in Bagmati Province; (iii) modernization and reinforcement of the Kathmandu Valley and Bharatpur distribution center in Chitwan district in Bagmati Province; and Pokhara distribution center in Kaski district in Gandaki Province benefiting about 450,000 customers in total. Awareness on efficient use of electricity will be promoted especially among women and disadvantaged groups.

15. Output 3: Distribution network and capacity of women to use electricity for energy- based enterprises development in Province 2 improved. The project will support network extension and reinforcement by constructing 350 circuit-km (ckm) of 33 kV, 1,000 ckm of 11 kV, and 960 circuit-km of 0.4 kV distribution lines and substations to provide quality and reliable electricity supply to 850,000 new and existing customers in Province 2.15 The project will also support (i) energy-based development of women-led enterprises through awareness raising and training, and (ii) pilot demonstration on improved distribution center management in Province 2.

C. Value Added by ADB

16. ADB’s support for development coordination and energy sector reforms is critical in mobilizing cofinancing from other sources, including from the Government of Norway, and leveraging its own resources to help the government meet the substantial financial and skills resource requirement in the energy sector. ADB has a long history of partnership with NEA and a record of providing financial assistance with progressive loan and grant covenants and conditions aimed at ensuring NEA’s institutional and financial recovery and improved governance. ADB’s continued involvement provides a valuable signal to investors and to other development partners that the government is committed to reforms, and that NEA is on a path to sustainability. The project will build on the experience from other ADB projects, particularly on procurement packaging, implementation schedules, and stronger monitoring and supervision. ADB is also drawing on its experience in promoting new technologies such as more efficient high temperature low sag conductors as well as regional cooperation and integration to help Nepal quickly harness its indigenous renewable energy potential and deliver it into the subregional power trading market in SASEC countries.

15 Providing reliable power supply will complement a mechanized irrigation project in Province 2, which is being processed by the Environment, Natural Resources and Agriculture Division of ADB’s South Asia Department.

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D. Summary Cost Estimates and Financing Plan

17. The project is estimated to cost $322 million (Table 1).

18. Detailed cost estimates by expenditure category and by financier are included in the project administration manual (PAM).16

Table 1: Summary Cost Estimates ($ million) Item Amounta A. Base Costa 1. Transmission reinforcement 70.2 2. Distribution modernization 159.5 3. Energy access 67.3 Subtotal (A) 297.0 B. Contingenciesb 20.2 C. Financial Charges During Implementationc 4.8 Total (A+B+C) 322.0 a In second quarter 2019 prices. Includes taxes and duties of $9.1 million. b Physical contingencies computed at 3% for transmission components, 1% for the distribution component, and 5% for the energy access component. Price contingencies computed using the Asian Development Bank's forecasts of international and domestic inflation. Includes provision for potential exchange rate fluctuation under the assumption of a purchasing power parity exchange rate. c For the concessional ordinary capital resources-funded component, interest during implementation has been computed using a base rate of 1%. Sources: Nepal Electricity Authority and Asian Development Bank estimates.

19. The government has requested a concessional loan of $200 million from ADB’s ordinary capital resources to help finance the project. The loan will have a 32-year term, including a grace period of 8 years, an interest rate of 1.0% per year during the grace period and 1.5% per year thereafter; and such other terms and conditions set forth in the draft loan and project agreements.

20. The summary financing plan is in Table 2. ADB will finance expenditures in relation to key turnkey contracts under all three outputs. The Government of Norway will provide grant cofinancing equivalent to $35 million,17 to be administered by ADB. This grant will be used to finance expenditures in relation to key turnkey contracts under outputs 1 and 3. The government will utilize its counterpart funds to meet the remaining costs of the project, including land acquisition and other social and environmental mitigation, contingencies, and taxes and duties.

Table 2: Summary Financing Plan Amount Share of Total Source ($ million) (%) Asian Development Bank Ordinary capital resources (concessional loan) 200.0 62.1 Government of Norway (grant)a 35.0 10.9 Government of Nepal 87.0 27.0 Total 322.0 100.0 a Includes administration fees and other charges as may be deducted pursuant to the cofinancing agreement. Sources: Nepal Electricity Authority and Asian Development Bank estimates.

16 Project Administration Manual (accessible from the list of linked documents in Appendix 2). 17 The actual amount is NKr315 million. ADB entered into a cofinancing agreement with Norway for the project and TA on 4 November 2019. 7

21. Climate mitigation is estimated to cost $137.1 million and climate adaptation is estimated to cost $1 million. ADB will finance 86.7% of mitigation costs and 100% of adaptation costs. The Government of Norway will finance 13.3% of mitigation costs. Details are in the Climate Change Assessment.18

E. Implementation Arrangements

22. The Ministry of Finance will relend the loan to NEA on the same terms as ADB, and provide the grant supported by Norway to NEA as grant. NEA will serve as the executing agency and will implement all activities under the ADB loan through its Project Management Directorate (PMD). NEA will assign a dedicated team for this project headed by a project director. The establishment of a dedicated PMD for ADB projects and streamlined internal NEA management practices (such as having a managing director to make all procurement decisions) has improved NEA’s performance in project implementation. Project supervision consultants will be recruited to support NEA in implementing the project. All procurement, including consulting services, will follow the ADB Procurement Policy (2017, as amended from time to time) and Procurement Regulations for ADB Borrowers (2017, as amended from time to time) and its associated staff instructions and/or project administration instructions. Universal procurement will also be applied to this project given the cofinancing arrangement with the Government of Norway.

23. For project implementation, turnkey contracts will be tendered. Construction activities will require 60 months to complete. The total time for project implementation after loan effectiveness is estimated at 5 years and 6 months for detailed design, bidding, construction, and commissioning. The government has set up a high-level coordination committee comprising representatives of key government agencies and other stakeholders to ensure coordination among different agencies (dealing with roads, water supply, sewage, and telecommunications and cable television operators), and provide necessary support and guidance to NEA.

24. The implementation arrangements are summarized in Table 3 and described in detail in the PAM (footnote 16).

Table 3: Implementation Arrangements Aspects Arrangements Implementation period June 2020–December 2025 Estimated completion date 31 December 2025 Estimated loan and grant closing date 30 June 2026 Management (i) Oversight body Steering committee chaired by secretary, Ministry of Energy, Water Resources and Irrigation (ii) Executing agency Nepal Electricity Authority (iii) Key implementing agency Nepal Electricity Authority (iv) Implementation unit Nepal Electricity Authority Project Management Directorate, Matatirtha Procurement Open competitive bidding 7 contracts $232.5 million (internationally advertised) Consulting services QCBS 245 person-months $3.0 million Retroactive financing and/or advance Advance contracting for goods, works, and consulting services; and contracting retroactive financing for works up to a maximum of 20% of loan amount. Disbursement The loan and grant proceeds will be disbursed following ADB's Loan Disbursement Handbook (2017, as amended from time to time) and detailed arrangements agreed between the government and ADB. ADB = Asian Development Bank, QCBS = quality- and cost-based selection. Sources: ADB; and Nepal Electricity Authority.

18 Climate Change Assessment (accessible from the list of linked documents in Appendix 2).

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III. ATTACHED TECHNICAL ASSISTANCE

25. The TA will support NEA in implementing the project. It will help NEA in implementing the gender action plan (GAP) and fill the gaps in NEA’s capacity for mainstreaming gender in its operations, building on previous support. The TA will provide much-needed capacity development support to ensure that, under NEA’s operations, the energy needs of poor and disadvantaged communities are addressed; social safeguard risks minimized; and results and impacts maximized, documented, and reported. The TA will provide consultancy services to assist NEA staff in implementing the project and introducing new models of managing distribution centers. The TA will also support the Ministry of Energy, Water Resources and Irrigation; the Department of Electricity Development; NEA; and the newly established ERC to implement sector reforms, including the new regulatory requirements of ERC. The TA will also support identification of poor and disadvantaged people targeted for electricity connection, and develop viable modality to support them, including energy-based enterprise development. The TA will be implemented over 5 years and will be administered by ADB in close coordination with NEA and the ERC. An international consultancy firm, in partnership with a national nongovernment organization or firm, will provide technical support for TA implementation. ADB will engage the consultants following the ADB Procurement Policy and the Procurement Regulations for ADB Borrowers, and its associated staff instructions and/or project administration instructions. Necessary consultations were held with NEA and ERC officials, and the TA concept and its implementation modality were agreed upon. Details of the TA are included in the Attached Technical Assistance Report.19

26. The TA is estimated to cost $5.1 million, of which $5.0 million20 will be financed on a grant basis by the Government of Norway and administered by ADB. The government and NEA will provide counterpart support in the form of staff, office space and supplies, and other in-kind contributions. All disbursements under the TA will be made in accordance with ADB’s Technical Assistance Disbursement Handbook (2010, as amended from time to time).

IV. DUE DILIGENCE

A. Technical

27. The project aims to enhance the quantity and quality of power supplied to NEA’s customers in and outside of the Kathmandu Valley. This will require (i) augmentation of transmission substations; (ii) reconstruction and upgrading of medium-voltage and low-voltage distribution networks; and (iii) introduction of smart grid elements. Due diligence was undertaken to confirm that the cost estimates are reasonable and unit costs compare favorably with similar recent ADB projects in India and Nepal.

28. The proposed transmission and distribution facilities follow planning and design practices already being implemented by NEA in other projects. Additional scrutiny will be imposed to ensure that construction standards are high and reflect international best practice in terms of works supervision. Overall, the proposed works follow international good practice and are considered technically acceptable. The project design also incorporates climate change-related aspects and will contribute to reduction of 78,724 tCO2 per year by reducing losses and providing new connection with clean source of energy, and the project is categorized low risk in the climate change assessment.21

19 Attached Technical Assistance Report (accessible from the list of linked documents in Appendix 2). 20 The actual amount is NKr45 million. 21 Climate Change Assessment (accessible from the list of linked documents in Appendix 2). 9

B. Economic and Financial Viability

29. Economic viability. The project was analyzed for economic viability in accordance with ADB’s guidelines for economic analysis.22 A with-project and without-project framework was adopted, and subprojects were grouped by outcome (subproject “clusters”), rather than by component. The economic internal rate of return of the overall project is 13.9%. Sensitivity analysis demonstrates that the project’s expected economic performance is robust under a range of downside scenarios.

30. Financial viability. Financial analysis of the project was carried out in accordance with ADB’s Guidelines on Financial Management and Analysis of Projects.23 All financial costs and benefits were expressed in constant 2019 prices. The project’s weighted average cost of capital was estimated at 4.8% (in pretax real terms). Even assuming gradually declining tariffs in real terms, the project is forecast to deliver an overall financial internal rate of return of 7.4%.24

C. Sustainability

31. NEA has historically been plagued by poor financial performance and low debt-repaying capacity on account of suboptimal operational performance, substantial and expensive power procurement from independent power producers within Nepal and from India, and stagnant tariffs. It posted an annual loss of NRs9 billion during FY2016 and its accumulated losses had risen to NRs35 billon by the end of FY2016. However, a strong commitment to reduce distribution losses and load-shedding, and a government-backed financial restructuring plan allowed NEA to post a net profit of NRs1.5 billion in FY2017 (its first profit in more than a decade), with profit increasing to NRs2.9 billion in FY2018. With the commissioning of a number of new private- and state-owned power generation plants and the establishment of the ERC in 2018, the short- to medium-term financial outlook for NEA is increasingly favorable. While high volume of outstanding debts and NEA’s capacity to repay due to limited profits are of some concern, continued profitability, strong financial support by the government, and likely improvements in tariffs following the establishment of the ERC are likely to adequately address the issue.

D. Governance

32. Financial management. The financial management assessment of NEA, conducted in September 2016 for the Power Transmission and Distribution Efficiency Enhancement Project, was updated in accordance with ADB guidelines.25 Based on the assessment, the key financial management risks remain because of (i) NEA’s current spreadsheet-based accounting system, which is inflexible, prone to errors, and inadequate for an entity of NEA’s size and complexity; (ii) inflated assets and liabilities requiring write-down; (iii) inadequate resolution of audit issues; (iv) delays in the implementation of the enterprise resource planning-based integrated financial management information systems; and (v) weak internal controls. A further concern arises from the government’s preference that for all future loans, NEA will borrow directly from development partners in foreign currency with a sovereign guarantee. Additionally, NEA had difficulty in complying with financial covenants under previous ADB loans, in particular the current ratio, although recent improvements in NEA’s financial results are encouraging. Based on the above, NEA’s overall pre-mitigation financial management risk is substantial. A number of initiatives are

22 ADB. 2017. Guidelines for the Economic Analysis of Projects. Manila; and ADB. 2013. Cost–Benefit Analysis for Development: A Practical Guide. Manila. 23 ADB. 2005. Financial Management and Analysis of Projects. Manila. 24 Economic Analysis and Financial Analysis (accessible from the list of linked documents in Appendix 2). 25 ADB. 2015. Financial Management Technical Guidance Note: Financial Management Assessment. Manila.

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underway to address financial management weaknesses. These are part of the time-bound financial management action plan agreed with NEA and are reflected in the loan agreement. These measures include the deployment of enterprise resource planning implementation, completion of fixed assets verification, conversion of financial statements to Nepal Financial Reporting Standards, introduction of internal audit and financial management manuals, and implementation of a risk management policy.

33. Procurement. A procurement capacity assessment of NEA was conducted as part of due diligence. NEA has sufficient capacity and experience in local and foreign procurement, including ADB’s standard bidding procedures, through domestic projects and external assistance from development partners. Through strategic procurement planning, NEA is able to achieve value for money by using strategic contract packaging with combination of large and small packages, some packages with smaller lots, and lowest evaluated cost in the evaluation criteria.

34. Coronavirus disease 2019’s impact on project implementation. The impact of the COVID-19 pandemic on the project has been reviewed by ADB and NEA. Because the project has an implementation period of 5.5 years with physical work not expected to commence at least until June 2021, COVID-19 is not expected to cause any significant delays or cost increases. No changes to implementation arrangements are considered necessary at this stage; NEA’s PMD continues to work effectively and efficiently within the constraints imposed by the government’s response to the pandemic. However, given the evolving trend and severity of the COVID-19 emergency, its potential impact will be regularly reviewed by NEA’s PMD and ADB.

35. Anticorruption. Integrity due diligence was conducted.26 No significant integrity risks were identified. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and NEA. The specific policy requirements and supplementary measures are described in the PAM.

E. Poverty, Social, and Gender

36. Nepal’s per capita gross domestic product is one of the lowest in the world at about $993.9 in 2018. About 80% of the country’s population lives in rural areas where poverty is more prevalent and severe. The Government of Nepal, in pursuit of Sustainable Development Goal 1 (end poverty in all its forms everywhere), aims to further reduce poverty significantly by the end of 2030. However, limited access to modern energy resources and inefficient grid connectivity have been hindering development. The COVID-19 pandemic has disproportionate impacts on the poor, informal sector workers, migrant workers, households depending on remittances, and women. With the economic disruption caused by the pandemic, vulnerable individuals, including those who are just above the poverty line, are likely to be pushed below the poverty line. Nepal’s estimated poverty headcount ratios of 3.9% at $1.90 per day, 27.6% at $3.20 a day, and 65.1% at $5.50 a day for FY2020 are projected to increase to 4.8% at $1.90 a day, 30.5% at $3.20 a day, and 68.1% at $5.50 day from FY2020 to FY2021.27 The project aims to enhance the distribution capacity, improve the reliability and quality of electricity, and help reduce technical losses in the project areas. The project will create employment opportunities for skilled and unskilled labor during the construction phase, and in the medium to long-term by promoting energy-based enterprises in poor communities. Moreover, using cleaner energy will improve urban and rural air quality, people’s health, living conditions, and overall quality of life. The project

26 ADB. 2003. Enhancing the Asian Development Bank’s Role in Combating Money Laundering and the Financing of Terrorism. Manila. 27 ADB. 2020. Asian Development Outlook 2020: What Drives Innovation in Asia? Manila. Updated in April 2020. 11 is classified effective gender mainstreaming to maximize gains where appropriate. Through the attached TA, the project will include strengthening the capacity of NEA to (i) institutionalize gender equality and social inclusion (GESI);28 (ii) implement a gender action plan (GAP) to support the participation of women, the poor and excluded groups in project activities; and (iii) support women and disadvantaged groups to productively use energy with safety and efficiency. The social safeguards unit and GESI team will monitor and supervise implementation of the GAP.

F. Safeguards

37. In compliance with ADB’s Safeguard Policy Statement (2009), the project’s safeguard categories are as follows.29

38. Environment (category B). An initial environmental examination (IEE) was prepared per ADB's Safeguard Policy Statement (2009) and disclosed on the ADB website on 24 February 2020. Public consultations were held as part of the IEE, and more consultations with a special focus on women and vulnerable groups will take place during implementation. In addition, as the project involves existing facilities (substations), environmental audits were conducted, and results are summarized in the IEE. The project is not expected to cause significant environmental impacts. Potential impacts are mostly temporary, predictable, and generally reversible, although risks related to bird collisions, pollution, health, and safety will remain during operation. Impacts can be mitigated through implementation of the environmental management plan included in the IEE. NEA has assured ADB that works within Parsa National Park will be confined to the existing right-of-way from Pathlaiya substation, works within the Lake Cluster of the Pokhara Valley Ramsar site will be confined to the existing road, and works in the Koshi Tappu Wildlife Reserve buffer zone will not encroach into this site; site-specific biodiversity management plans are to be cleared by ADB before any works in the respective areas can take place. No other works will take place within the boundaries or buffer zones of internationally important biodiversity or cultural heritage areas. NEA has experience in implementing ADB projects and sufficient capacity to implement the environmental safeguards. In addition, environment consultants will support NEA and provide trainings to develop NEA staff capacity on environmental safeguards implementation.

39. Involuntary resettlement (category B) and indigenous peoples (category C). Ten substations require the acquisition of private land (5.69 hectares in total), which will affect an estimated 17 households with 92 people. No permanent or temporary structures need to be relocated. Among the affected households, three are losing more than 10% of their land. Surface disturbance during the construction of underground distribution lines and overhead line restringing will have temporary impacts. Social surveys and consultations were undertaken in accordance with ADB’s Safeguard Policy Statement (2009). The project’s social impacts were adequately assessed, and compensation will be paid to the affected people commensurate with the replacement costs. A resettlement plan covering all components has been prepared and disclosed on the ADB website on 24 February 2020. Budgetary provisions are in place to compensate affected people, including non-title holders, for their losses in a timely manner. The loan agreement includes a standard assurance related to the resettlement impacts and social matters. NEA has its own environment division, which also covers social aspects, and it has previous experience with land acquisition. Implementation consultants will be engaged to assist the PMD and strengthen its capacity. The implementation of the resettlement plan will be

28 Gender equality and social inclusion (GESI) is a concept that addresses unequal power relations between women and men and between different social groups. It focuses on the need for action to rebalance these power relations and ensure equal rights, opportunities, and respect for all individuals regardless of their social identity. 29 ADB. Safeguard Categories.

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monitored and supervised by NEA, and monitoring reports will be submitted to ADB semiannually. The resettlement plan covers due diligence for indigenous peoples, and the project does not have any impacts on their dignity, human rights, livelihood system, culture, or natural resources.

G. Summary of Risk Assessment and Risk Management Plan

40. Significant risks and mitigating measures are summarized in Table 4 and described in detail in the risk assessment and risk management plan.30

Table 4: Summary of Risks and Mitigating Measures Risks Mitigation Measures Financial NEA will be supported by ADB and other development partners to ensure the preparation and sustainability of submission of comprehensive and timely tariff petitions to the ERC. NEA’s financial position will NEA improve after promulgation of a tariff-setting framework by the ERC, which is expected to allow recovery of reasonable costs of supply. Further, financial restructuring and balance sheet rationalization in the form of NEA’s Financial Restructuring Plan III has been proposed by NEA to the government. ADB’s attached technical assistance will provide further support to NEA. Weak overall With the support of ADB and other development partners, NEA is in the process of implementing financial various reforms for improvements in overall governance and financial management, including (i) management, enterprise resource planning implementation and physical verification of assets and inventories financial supported under World Bank-financed projects, (ii) conversion of NEA financial statements to reporting, and Nepal Financial Reporting Standards by fiscal year 2020, (iii) introduction of a risk-based internal internal audit audit manual, (iv) training provision for 20–25 staff members on an annual basis from the Institute arrangements of Chartered Accountants of India in risk-based auditing, and (v) increased staff levels in the internal audit department, among others. ADB’s attached technical assistance will support NEA. ADB = Asian Development Bank, ERC = Electricity Regulatory Commission, NEA = Nepal Electricity Authority. Source: ADB.

V. ASSURANCES

41. The government and NEA have assured ADB that implementation of the project shall conform to all applicable ADB requirements, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, financial management, and disbursement as described in detail in the PAM and loan documents.

42. The government and NEA have agreed with ADB on certain covenants for the project, which are set forth in the draft loan agreement, project agreement, and grant agreement.

VI. RECOMMENDATION

43. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the loan of $200,000,000 to Nepal for the South Asia Subregional Economic Cooperation Power Transmission and Distribution System Strengthening Project, from ADB’s ordinary capital resources, in concessional terms, with an interest charge at the rate of 1.0% per year during the grace period and 1.5% per year thereafter; for a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan and project agreements presented to the Board. Masatsugu Asakawa President

2 June 2020

30 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2). Appendix 1 13

DESIGN AND MONITORING FRAMEWORK Impacts the Project is Aligned with (i) Reliable and efficient electricity for all achieved by 2028 (White Paper on Energy, Water Resources and Irrigation’s Current Status and Roadmap for Future)a (ii) Energy trade infrastructure in SASEC countries improved (SASEC Operational Plan Update, 2016– 2025)b

Data Sources Results Performance Indicators with and Risks Chain Targets and Baselines Reporting Mechanisms Outcome By 2026: Access, a. Electrification rate in Province a–c. NEA Delays in the completion of reliability, 2 increased to 95% reports planned energy generation and (2018 baseline: 80%) (RFI 1.3) projects may underutilize the efficiency of transmission and distribution power supply b. System losses reduced to networks. in Nepal 25% in Province 2 improved (2017 baseline: 31.3%) (TI 1.3.1)

c. Annual per capita electricity consumption in Nepal increased to 700 kWh by 2026 (2018 baseline: 198 kWh) Outputs By 2025: 1. Power 1a. 1,265 MVA of 400/220 kV 1a–c. NEA Exponential growth in COVID-19 system transformer capacity installed in reports cases prolongs impact on global transmission three substations in New Khimti value chains beyond projections, capacity 1, Barhabise, and Lapsiphedi which could delay procurement of increased (2019 baseline: 0) (TI 4.1.2) goods and services, and slow down project implementation. 1b. Existing 15 km 132 kV double-circuit transmission lines from Pathlaiya substation to the Parwanipur substation in Province 2 upgraded (2019 baseline: 0) (TI 4.1.2)

1c. New 132/33 kV, 2x65 MVA and 132/11 kV 1x45 MVA substation and associated facilities at Pokhariya in Province 2 commissioned (2019 baseline: 0) (TI 4.1.2) 2. By 2025: Distribution 2a. 12 km 132 kV double-circuit 2a–c. NEA system in the transmission line from reports Kathmandu Bhaktapur to Koteshwor, and 2 Valley, km 66 kV transmission line from Bharatpur, Koteshwor to Banewsor and Pokhara, commissioned and (2019 baseline: 0) (TI 4.1.2) consumers’ awareness on energy

14 Appendix 1

Data Sources Results Performance Indicators with and Risks Chain Targets and Baselines Reporting Mechanisms efficiency 2b. 1 new 132/66/11 kV and safety automated substation in improved Koteshwor commissioned (2019 baseline: 0) (TI 4.1.2)

2c. 9 distribution centers in the Kathmandu Valley, the Bharatpur distribution center in Chitwan district, and the Pokhara distribution center in Kaski district reinforced and 2d. Pre- and modernizedc post- training (2019 baseline: 0) (TI 4.1.2) assessments

2d. At least 500 electricity users (30% women) at the electricity distribution centers in the Kathmandu Valley, Bharatpur, and Pokhara reported knowledge on safe and efficient energy used (2019 baseline: 0) (TI 4.3.1) 3. By 2025: Distribution 3a. 10 new 33/11 kV 3a–d. NEA network and substations, 350 circuit-km of 33 reports capacity of kV lines, 1,000 circuit-km of 11 women to kV lines, and 960 circuit-km of use electricity low-voltage lines commissioned for energy- in Province 2 based (2019 baseline: 0) (TI 4.1.2) enterprises development 3b. 15,000 poor households in Province 2 newly connected or improved improved connection in Province 2d (2019 baseline: 0) (RFI 1.3, 4.1)

3c. At least 100 new and/or existing women-led energy- based enterprises in Province 2 reported increased knowledge on business developmentd (2019 baseline: 0) (TI 2.1.4)

3d. At least 2 model distribution centers for planning, information collection and dissemination, and customer care developed in Province 2 (2019 baseline: 0)d Key Activities with Milestones 1. Power system transmission capacity increased 1.1 Prepare detailed design (Q3 2019) 1.2 Complete bidding process (Q2 2020)

Appendix 1 15

Data Sources Results Performance Indicators with and Risks Chain Targets and Baselines Reporting Mechanisms 1.3 Install 400/220 kV transformer capacity in three substations (Q1 2025)

2. Distribution system in the Kathmandu Valley, Bharatpur, and Pokhara, and consumers’ awareness on energy efficiency and safety improved 2.1 Prepare detailed design for the Kathmandu Valley, Bharatpur, and Pokhara (Q4 2019) 2.2 Conduct procurement (Q1 2020) 2.3 Carry out installation of substations (Q4 2025) 2.4 Carry out reinforcement and modernization (Q4 2025) 2.5 Conduct awareness-raising activities (Q4 2025)

3. Distribution network and capacity of women to use electricity for energy-based enterprises development in Province 2 improved 3.1 Prepare detailed design (Q4 2019) 3.2 Conduct procurement (Q3 2020) 3.3 Construct substations, 33 kV lines, 11 kV lines, and low-voltage lines, model distribution centers (Q4 2025) 3.4 Prepare and implement energy-based enterprise development program led by women (Q4 2025) Project Management and Capacity-Building Activities Set up project implementation unit. Set up project performance monitoring system. Select consultants. Conduct review missions and prepare progress reports and project completion report. Orientation of NEA staff on new technologies, gender mainstreaming, safeguards, and financial management. Inputs Asian Development Bank: $200 million (loan) Government of Norway: $35 million (grant) Government of Nepal: $87 million Assumptions for Partner Financing Not applicable km = kilometer, kV = kilovolt, kWh = kilowatt-hour, MVA = megavolt-ampere, NEA = Nepal Electricity Authority, Q = quarter, RFI = results framework indicator, SASEC = South Asia Subregional Economic Cooperation, TI = Tracking Indicator. a Government of Nepal; Ministry of Energy, Water Resources and Irrigation. 2018. White Paper on Energy, Water Resources and Irrigation’s Current Status and Roadmap for Future. Kathmandu. b Asian Development Bank. 2016. South Asia Subregional Economic Cooperation: Operational Plan 2016–2025. Manila. c Reinforcement and modernization constitute strengthening of the existing system and use of new technology or materials. d To be financed by the attached technical assistance and government counterpart funds. Contributions to the Asian Development Bank Results Framework: RFI 1.3: Poor and vulnerable people with improved standards of living (number). Target: 850,000 (households in Province 2 with new or improved connections to electricity). TI 2.1.4: Women and girls benefiting from new or improved infrastructure (number). Target: 100 (approximate number of women members of energy-based enterprises). RFI 4.1: People benefiting from improved services in urban areas (number). Target: 450,000 households. TI 4.1.2: Urban infrastructure assets established or improved. Target: 1 (12 km of 132 kV double-circuit line from Bhaktapur to Koteshwor, and 2 km 66 kV from Koteshwor to Baneswor constructed) (2019 baseline: 0). TI 4.3.1: Solutions to enhance urban environment implemented (number). Target: 3 (Kathmandu Valley, Pokhara, and Bharatpur). Source: Asian Development Bank.

16 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=50059-003-3

1. Loan Agreement 2. Grant Agreement 3. Project Agreement 4. Sector Assessment (Summary): Energy 5. Project Administration Manual 6. Financial Analysis 7. Economic Analysis 8. Summary Poverty Reduction and Social Strategy 9. Risk Assessment and Risk Management Plan

10. Attached Technical Assistance Report 11. Climate Change Assessment 12. Gender Action Plan 13. Initial Environmental Examination 14. Resettlement Plan

Supplementary Document 15. Financial Management Assessment