Report and Recommendation of the President to the Board of Directors

Project Number: 49214-001 March 2016

Proposed Loan Power Grid Corporation of India Limited Solar Power Transmission Sector Project Guaranteed by India

Distribution of the attached 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 Public Communications Policy 2011 after excluding information that is subject to exceptions to disclosure set forth in the policy, as identified during negotiations between ADB and the borrower.

CURRENCY EQUIVALENTS (as of 05 February 2016)

Currency unit – Indian rupee/s (Re/Rs)

Re1.00 = $0.0148036956

$1.00 = Rs67.5507

ABBREVIATIONS

ADB – Asian Development Bank GW – gigawatt km – kilometer kV – kilovolt MNRE – Ministry of New and Renewable Energy POWERGRID – Power Grid Corporation of India Limited

NOTES

(i) The fiscal year (FY) of the Government of India ends on 31 March. “FY” before a calendar year denotes the year in which the fiscal year ends, e.g., FY2015 begins 1 April 2014 and ends on 31 March 2015.

(ii) In this report, “$” refers to US dollars.

Vice-President W. Zhang, Operations 1 Director General H. Kim, South Asia Department (SARD) Director A. Jude, Energy Division, SARD Team leader K. Ogino, Principal Energy Specialist, SARD Co-Team Leader S. Cowlin, Energy Specialist, SERD Team members J. Acharya, Senior Energy Specialist, SARD K. Enomoto, Energy Specialist, SARD L. George, Energy Specialist, SARD Y. Jang, Social Development Specialist, SARD A. Jeffries, Principal Energy Specialist, SARD V.S. Rekha, Principal Counsel, Office of the General Counsel Y. Zhou, Environment Specialist, SARD Peer reviewer P. Perera, Principal Energy Specialist, East Asia 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.

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CONTENTS

Page

PROJECT AT A GLANCE

I. THE PROPOSAL 2

II. The Project 2

A. Rationale 2 B. Impact and Outcome 6 C. Outputs 6 D. Investment and Financing Plans 6 E. Implementation Arrangements 7

III. Due diligence 8

A. Technical 8 B. Economic and Financial 8 C. Governance 9 D. Poverty and Social 10 E. Safeguards 10 F. Risks and Mitigating Measures 11

IV. RECOMMENDATION 12

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I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on (i) a proposed loan, and (ii) the proposed administration of a loan to be provided from the ADB Clean Technology Fund (CTF)1 , to Power Grid Corporation of India Limited (POWERGRID), with a sovereign guarantee from India, for the Solar Park Transmission Sector Project.2 2. The project will finance high voltage transmission systems to help evacuate solar power generated from new solar parks to the national grid that will make available additional clean energy to beneficiaries in India. Subprojects will connect mega solar parks to the interstate transmission system.3

II. THE PROJECT

A. Rationale

3. Economic and Sector Context: Lack of high-quality and reliable electricity supply continues to constrain India’s economic growth. In FY2014–2015 India experienced total energy and peak power deficits of 2.1% and 2.6%, respectively.4 These figures do not consider the more than 300 million people who remain without access to the electricity grid.5 India ranked 105th globally in terms of per capita electricity consumption in 2012; with continued industrialization, projected population growth, increased grid access, and increased wealth, required power generating capacity is projected to more than double from its present 276 Gigawatts (GW) in July 2015 by FY2031–2032.6 India’s power system is dominated by thermal generation from fossil fuels, which have suffered from domestic fuel shortages and high imported fuel prices. The Government has prioritized energy security in planning for the future additional generating capacity, and has increased its target for installed renewable energy capacity to reach 175 GW by 2022. 4. Sector Development Plan: The revised solar target of 100 GW installed capacity by 2022 is a substantial increase from the current installed capacity of 5 GW. The Government is targeting 40 GW of installed capacity to come from rooftop solar projects and 60 GW to be from medium and large utility-scale projects. In support of rooftop solar deployment, the Ministry of New and Renewable Energy (MNRE) has drafted model net-metering regulations and is working with distribution utilities to enact such regulations and with commercial banks to facilitate growth in this segment7. The Government has also supported development of utility-scale solar projects through provision of various incentives, including capital subsidies, customs concessions, and accelerated

1 Financed by the Clean Technology Fund (CTF). The CTF is a $5.3 billion fund providing middle-income countries

with resources to scale up demonstration, deployment and transfer of low-carbon clean technologies. India’s revised CTF investment plan was endorsed in August 2015 by the CTF trust fund committee. CTF financing approvals for the investment program were received on xx-Month-2016.

2 The design and monitoring framework is in Appendix 1. 3 The Asian Development Bank (ADB) is providing project preparatory technical assistance for Preparing the Solar

Park Development and Transmission Sector Project (TA8979-IND). 4 Central Electricity Authority (CEA). 2015. Load Generation Balance Report 2015–2016. Available:

http://www.cea.nic.in/reports/yearly/lgbr_report.pdf 5 World Bank; International Energy Agency (IEA). 2014. Sustainable Energy for All 2013–2014: Global Tracking

Framework. Available: https://openknowledge.worldbank.org/handle/10986/16537 6 IEA. 2012. Understanding Energy Challenges in India. Available: https://www.iea.org/publications/

free publications/publication/India_study_FINAL_WEB.pdf 7 ADB has also been requested to provide a $625 million financial intermediation loan, including $125 million of ADB

CTF, to support rooftop solar. Project development is in process and an application is being made to CTF.

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depreciation. As many distribution utilities in India are financially distressed, central level entities, such as the Solar Energy Corporation of India (SECI), are entering into long term power-purchase agreements (PPAs) with the project developers and selling the power on to utilities. The Government also recently introduced reforms to encourage purchase of solar power by the distribution companies as well as to improve their financial position. The Ujwal Discom Assurance Yojana program targets at improving the financial position of the distribution utilities through improved efficiency, reduced losses, and tariff reform, which should reduce the perceived offtake risk and increase the PPAs directly between utilities and solar developers. Recent amendments to India’s tariff policy require that 8% of power purchased by utilities be from solar energy by 2022 (an increased from the previous target of 3%), prohibits inter-state transmission charges for renewable energy, and promotes the development of ancillary services to facilitate high penetrations of renewable energy on the grid. 5. Solar Park Initiative: Approximately 20 GW of the targeted 100 GW of installed solar capacity is expected to be realized from utility-scale projects being developed in 25 solar parks supported by the Government. The solar parks initiative seeks to address the time and expense involved in obtaining suitable land and required clearances for solar projects, which have been identified as key barriers to solar expansion in India. Solar parks provide solar project developers with access to a site and necessary infrastructure for a lease fee. In addition to increasing the speed with which projects can be deployed, lower tariffs are also anticipated from these projects due to economies of scale being realized by developing a plot of land that will host several projects8. The Government is also providing capital subsidies for solar park development with an aim to further bring down costs to developers and ultimately the solar power purchase prices. States with sufficient institutional capacity are developing parks through their state utilities, while others are forming joint ventures with SECI or the private sector for park development. 6. Solar Park Transmission: In 2012, India’s central transmission utility, Power Grid Corporation of India Limited (POWERGRID), published a Green Energy Corridors 9 plan to connect renewable resource rich areas to the existing grid. This plan detailed the transmission expansion projects required to achieve the renewable energy targets at that time. The Government’s recently revised renewable energy targets will require additional transmission expansion, including to areas where solar parks are being developed. The transmission line expansion associated with solar parks is being built through the state transmission companies or POWERGRID. In cases where at least 50% of the power produced at a park will be consumed within the host state, the state transmission company may choose to build the transmission network. POWERGRID may be requested to undertake the transmission line expansion for the remainder of parks. To date, the Ministry of Power has assigned POWERGRID to connect 9 solar parks in 7 states10 to the existing grid and declared that the relevant transmission infrastructure to connect these solar parks will be classified as inter-state transmission system assets, thereby socializing the costs across the power network.

8 Solar project auctions for the solar parks at Gani-Sakunala in Andhra Pradesh and Bhadla Phase II in Rajasthan

yielded successful low bids of 4.63 Rs/kWh and 4.34 Rs/kWh, respectively. 9 POWERGRID. 2012. Report on Green Energy Corridors–Transmission Plan for Envisaged Renewable Capacity.

Gurgaon. 10 States allocated to POWERGRID by the Ministry of Power in January 2015 include Andhra Pradesh, Gujarat,

Karnataka, Madhya Pradesh, Meghalaya, Rajasthan, and Uttar Pradesh; additional states may be allocated to POWERGRID in the future.

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7. Borrower: POWERGRID is responsible for planning, developing, and operating the high-voltage interstate and interregional power transmission network.11 POWERGRID operates about 90% of the country’s interstate and interregional transmission networks—consisting of 126,965 circuit kilometers (km) of transmission lines and 205 transmission substations with a transformer capacity of about 246,004 megavolt-amperes (MVA) as of 31 December 2015—and provides nondiscriminatory open access to its transmission system for any licensed utility or generating company.12 POWERGRID has a sound implementation record in upgrading and strengthening the national high-voltage transmission network, with consistent good operational performance evidenced by transmission network availability of above 99% for the past 5 years. 8. Project Design: POWERGRID’s immediate investment plans consist of expanding the 765 kV transmission network to connect the Bhadla Phase III solar park in Rajasthan. Subsequent subprojects under this investment will further expand the 765 kV transmission network to connect one or more additional solar parks to the interstate transmission network13. The transmission subprojects will include pooling substations, reactors, transmission lines, and associated equipment, as required, to connect solar parks to the existing interstate transmission system. 9. Subproject Selection. Criteria for subprojects that will be financed under the loan:

(i) The subproject should be technically feasible. (ii) The subproject will be required transmission expansion, including to areas where

new solar parks are being developed. (iii) The subproject will be designated as part of the interstate transmission system. (iv) Any subproject classified as category A in accordance with ADB’s Safeguards

Policy Statement (2009) will not be eligible. 10. Core Subproject: Based on the data available and the eligibility criteria, ADB and POWERGRID will jointly appraise the following core subproject connecting the 1,000 MW Bhadla Phase III Solar Park in Rajasthan to the national grid. The subproject comprises construction of about 100 km of 765 kV double circuit transmission lines, additional 400 kV double circuit transmission lines connecting the existing Bhadla substation with a new Bhadla Phase III pooling station, and construction of a new 765/400/220 kV pooling station at Bhadla Phase III with 3x1,500 MVA and 3x500 MVA transformers and four 220 kV line bays.

11. Subproject Selection After Board Approval: The subsequent subprojects are expected to expand the 765 kV transmission network to connect new solar parks with capacity of at least 1,000 MW with specific subprojects to be determined based on readiness and need. Selection of additional subprojects after loan approval will satisfy the eligibility criteria (para. 9), and POWERGRID will follow procedures that include (i) carrying out a technical feasibility study for each subproject; (ii) preparing a resettlement plan (RP); (iii) conducting an initial environmental examination (IEE); and (iv) if indigenous people are impacted, preparing an indigenous peoples plan (IPP) as per the Safeguard Policy Statement (2009). The technical feasibility study will include a detailed engineering design of the subproject, cost estimates, contract packages, and implementation schedule. The RP and IEE must meet the requirements of the resettlement framework and environmental assessment and review framework, respectively. If indigenous people are affected, an IPP will be prepared in accordance with the indigenous peoples planning

11 As of 30 June 2015, the Government of India owned 57.9% of POWERGRID, which makes the company majority

state-owned and therefore a public sector undertaking. 12 POWERGRID. Our Network.

http://www.powergridindia.com/_layouts/PowerGrid/User/ContentPage.aspx?PId=80&LangID=English. 13 The proposed subprojects in Western Rajasthan may be replaced or supplemented by other subprojects to expand

the transmission network to connect solar parks.

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framework. POWERGRID will submit an appraisal report to ADB for consideration and approval of each additional subproject. ADB will not consider any subproject that does not satisfy all of the eligibility criteria or where the above procedures have not been followed (paras. 9 and 11). 12. Alignment with ADB strategy and operations: Supporting the Solar Park Transmission Sector Project is consistent with the Strategy 2020 and Energy Policy, 2009 of the Asian Development Bank (ADB) that advocate the promotion of renewable energy, improved energy security, and facilitation of the country’s transition to a low-carbon economy.14 It is also consistent with the India country partnership strategy, 2013–2017 that supports (i) clean and renewable energy expansion, particularly solar; (ii) transmission expansion at the state and central levels; and (iii) grid integration of renewable energy.15 13. Institutional Capacity: Since 1995, ADB has provided POWERGRID eight sovereign-guaranteed loans and two nonsovereign loans to strengthen its transmission system nationally. The projects have a good implementation history and high ratings. Among these, ADB provided two loan facilities in 2011 consisting of a nonsovereign loan and a sovereign-guaranteed loan in a single financing package. 16 The nonsovereign loan represented POWERGRID’s first transaction without sovereign support, and helped POWERGRID diversify its financing sources. ADB provided two additional loan facilities in 2015 consisting of sovereign and nonsovereign loans for the Green Energy Corridor and Grid Strengthening Project17. 14. Rationale for Sector Lending: The Government seeks to scale up installed solar capacity to 20 times the current levels and is planning for this growth in a phased manner. Solar parks will be identified and developed on an ongoing basis in the coming years, but land availability, site preparation, and the provision of access to the grid will all vary based on the specific site’s current land usage, existing infrastructure, and distance from the existing transmission network. Sector lending will allow POWERGRID to undertake transmission line expansion to individual solar park sites according to planned commissioning of solar parks based on their readiness. The phased approach will also allow a more gradual introduction of increasing grid-penetration of variable renewable energy. This will allow time for improved institutional capacity to manage the power grid under the targeted power generator scenario, which expects a total of 160 GW of installed generation capacity in 2022 to be from wind and solar technologies, whose power output profiles differ greatly from India’s current generation mix that is dominated by thermal plants. 15. Development Coordination: POWERGRID’s current mandate to expand the transmission network to connect 9 of the planned 25 solar parks is estimated to require $1.3 billion, which is additional to the estimated $6 billion investment requirement for Green Energy Corridors projects. As such, the Government is seeking support from several development finance

14 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank, 2008–2020.

Manila; and ADB. 2009. Energy Policy. Manila. 15 ADB. 2013. Country Partnership Strategy: India, 2013–2017. Manila. 16 ADB. 2011. Report and Recommendation of the President to the Board of Directors: Proposed Loans for the National

Grid Improvement Project in India. Manila. 17 ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Loan Power Grid

Corporation of India, Limited Green Energy Corridor and Grid Strengthening Project (Guaranteed by India). Manila. ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Loan Power Grid Corporation of India, (non-sovereign loan).

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institutions in addition to ADB. The World Bank is proposing a loan of $300 million (including $30 million from the Clean Technology Fund) for solar park transmission in Karnataka, Madhya Pradesh, and Telangana. KfW has committed up to 1 billion Euro for Green Energy Corridors. ADB is coordinating with these and other development partners to harmonize contributions and ensure leveraging of respective technical assistance activities, including the United States Agency for International Development’s planned $30 million technical assistance program to support grid integration of variable renewable energy. B. Impact and Outcome

16. The impact will be increased supply of renewable energy to the Indian power system and reduced greenhouse gas emissions intensity of the Indian economy. The outcome will be an increased contribution of solar energy to India’s power mix. C. Outputs

17. The project’s output will be 2,000 MW of solar parks connected to the interstate transmission network. The first 1,000 MW will be achieved through the core subproject to help the Bhadla Phase III solar park connect to the interstate transmission system. This will include establishment of a 765/400/220kV Pooling Station at Bhadla, a 400 kV line to connect this pooling station to an existing substation at Bhadla, and a 765 kV interconnection from the pooling station to the Bikaner substation. Additional subprojects will connect solar parks with of least 1,000 MW additional solar capacity to the interstate transmission system, and will include pooling stations, transmission lines, and associated equipment.

D. Investment and Financing Plans 18. The project is estimated to cost $640 million (Table 1).

Table 1: Project Investment Plan ($ million)

Item Amounta

A. Base Costb 1. Towers 189.1 2. Conductors (including Insulators) 75.7 3. Substations 155.3 2. Transformers and reactors 104.7 Subtotal (A) 524.8 B. Contingenciesc 51.2 C. Financing Charges During Implementationd 64.0 Total (A+B+C) 640.0 a Includes taxes and duties to be financed from ADB loan resources.

b In end-2015 prices. Note estimated base cost for Bhadla Phase III subprojects is $171.4 million. c Includes both physical and price contingencies and foreign exchange variation. d Includes interest and commitment charges. Interest during construction for ADB sovereign loan is computed at

the 5-year forward London interbank offered rate plus a spread of 0.5%, and a sovereign guarantee fee (payable by Power Grid Corporation of India Limited to the Government of India) of 1.2%. Commitment charges for an ADB loan are 0.15% per year to be charged on the undisbursed loan amount. Interest during construction for ADB CTF loan has been computed at an interest rate of 0.25%, a management fee of 0.18%, and a sovereign guarantee fee (payable by Power Grid Corporation of India Limited to the Government of India) of 1.2%. Applicable rates for additional debt funds are included.

Source: Power Grid Corporation of India Limited and Asian Development Bank estimates.

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19. POWERGRID has requested a sovereign-guaranteed loan of $320 million to finance the project. The financing plan (table 2) includes a $270 million loan from ADB ordinary capital resources (OCR) and a $50 million loan from the ADB Clean Technology Fund, to be administered by ADB. The loans will be made directly to POWERGRID, with a separate guarantee agreement with the government. Financing from ADB’s OCR will have a 20-year term, including a 5-year grace period, straight line amortization, an annual interest rate determined following ADB’s London interbank offered rate-based lending facility, a commitment charge of 0.15% per year, and other terms and conditions set forth in the draft loan and guarantee agreements. Based on this, the average loan maturity is 12.75 years. The ADB CTF loan financing comes with a 40-year term, including a grace period of 10 years, an annual interest rate of 0.25%, a management fee of 0.18% per year, and such other terms and conditions set forth in the draft loan and project agreements. POWERGRID will bear the foreign exchange risk under these loans. The loan will include taxes and duties for the investment components. 18 The remaining financing will be mobilized by POWERGRID, including debt from other lenders and equity contributions. The financing plan is in Table 2.

Table 2: Financing Plan

Source Amount ($ million) Share of Total (%)

Asian Development Bank Ordinary capital resources (loan) 270.0 42.2 ADB Clean technology fund (loan) 50.0 7.8

POWERGRID (other sources) a 128.0 20.0 POWERGRID equity (internal sources) 192.0 30.0

Total 640.0 100.0 Note: Numbers may not sum precisely due to rounding. POWERGRID = Power Grid Corporation of India Limited. a Expected to be POWERGRID's domestic bond issuance and other corporate loan financing. Source: Asian Development Bank estimates.

E. Implementation Arrangements

20. The implementation arrangements are summarized in Table 3.

Table 3: Implementation Arrangements

Aspects Arrangements

Implementation period January 2017–June 2022

Estimated completion date 30 June 2022 (loan closing date of 31 December 2022)

Management

(i) Oversight body Coordination committee, POWERGRID

(ii) Executing agency POWERGRID

(iii) Key implementing agencies POWERGRID

(iv) Implementation unit POWERGRID’s Northern Regional Office

Procurementa International competitive bidding

15 contracts $444 million

18 This includes taxes and duties to be financed from government resources by cash contribution and ADB. The amount

of taxes and duties to be financed by ADB (i) is within the reasonable threshold identified in the India country partnership strategy, (ii) does not represent an excessive share of the investment plan, (iii) applies only to ADB-financed expenditures, and (iv) is considered material and relevant to the project’s success.

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Aspects Arrangements

Retroactive financing and/or advance contracting

All eligible contract packages and eligible expenditures agreed between ADB and the borrower have been approved for retroactive financing and advance contracting.

Disbursementb The loan proceeds will be disbursed following ADB's Loan Disbursement Handbook (2015, as amended from time to time) and detailed arrangements agreed upon between POWERGRID and ADB.

ADB = Asian Development Bank, POWERGRID = Power Grid Corporation of India Limited. a Number of contracts and total contract value to be confirmed. b CTF will be disbursed on a priority basis of POWERGRID’s requirements. Sources: Asian Development Bank and POWERGRID estimates.

III. DUE DILIGENCE

A. Technical

21. POWERGRID has in-house planning capabilities, including computer-aided facilities for transmission system planning, design, operation, and maintenance. POWERGRID’s solar park expansion analysis identified the required investments and estimated capital expenditure to connect the planned solar parks to the existing transmission network. B. Economic and Financial

22. The project-level model takes detailed cost estimates for the specific project-funded assets, including the funding sources, and projects financial revenues generated from, and costs incurred related to, these assets. The project’s required capital investment is estimated in Indian rupees using mid-2015 price levels. Capital costs were estimated based on recent procurement data and market sources. Costs include civil works, equipment, land development, environment and social mitigation costs, project management cost, and taxes. Incremental operation and maintenance (O&M) costs are computed based on regulatory norms. The project’s financial viability was examined by comparing the incremental costs and benefits. A preliminary financial assessment the transmission expansion to have a financial internal rate of return (FIRR) is calculated at 4.49% in real terms (8.87% on a nominal basis), which compares favorably with the estimated weighted average of cost of capital (WACC) value of 3.94% in real terms (7.66% on a nominal basis), thus substantiating the project’s financial viability19. POWERGRID’s project-level returns are based on the return on equity (ROE) and capital cost allowed by CERC regulations, therefore a reduction of the ROE in the CERC tariff guidelines or disallowance of any project cost component could negatively affect returns. However, the risk is considered limited due to National Tariff Policy provisions that specify a full cost pass-through, as well as the regulator’s past record in implementing this policy.20 23. The private sector is responding aggressively to opportunities to develop solar projects in India in light of the Government’s ambitious targets under the Jawarharlal Nehru National Solar Mission (2010, updated 2015) and the conducive policy environment created by complementary legislation and initiatives that recognize the environmental benefits of solar energy, including India’s Electricity Act, 2003 and the National Action Plan on Climate Change (2008). However, the transmission infrastructure required to enable increased penetration of solar energy remains

19 The WACC is computed based on a pretax cost of capital of the ADB sovereign loan of 3.5%, the ADB CTF at 1.45%,

applicable rates for other corporate loans, local bonds at 8.5%, and a cost of equity at 15.5%. 20 National Tariff Policy provision 5.3 (a) to (h) stipulates performance-based cost of service regulation that assures

adequate return on investment and complete pass-through of costs.

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a public sector responsibility. Solar power is still more expensive than conventional power in India and imposes an additional cost burden for integrating the associated variable power generation to the grid. The Government has approved transmission expansion to connect solar parks be declared as part of the inter-state transmission system, with costs socialized across the entire network, ensuring these connection costs do not further increase solar tariffs. Use of ADB CTF and OCR resources to finance this transmission expansion reduces the cost of connecting the solar parks to the existing network, ultimately reducing the transmission charges paid by consumers. 24. The Solar Park Transmission Sector Project provides a means to export excess solar energy from regions of excess supply to power-deficit regions and those seeking to meet RPO requirements. As such, the project will directly support India’s continued solar energy expansion and will also contribute to the integrated interstate and interregional grid, allowing for power trading across larger geographical areas, which is considered a prerequisite to effectively deploying high penetrations of variable renewable energy. Electricity from the solar parks would displace coal-fired generation from existing plants (a resource cost saving) in states with renewable energy shortfalls. In light of these benefits, and consistent with other ADB economic analysis of renewable energy transmission, the subprojects’ economic internal rates of return are expected to be greater than 16%. The projects are thus preliminarily assessed as financially viable and economically sustainable. 25. POWERGRID’s financial management capacity has been thoroughly evaluated by ADB and determined to be strong. The government has awarded POWERGRID “Navratna” status, which gives public sector undertakings a degree of managerial and financial autonomy despite their majority-government ownership.21 POWERGRID maintains an international long-term issue credit rating of BBB– (Outlook: Stable) from both Standard & Poor’s and Fitch, and enjoys the highest domestic credit rating of AAA.22 Based on the cost-plus nature of the tariff-setting process coupled with its operating efficiency, POWERGRID has increased revenues and net profits consistently, maintaining a robust financial position with stable cash flows to cover its costs, capital investment, and debt payments. Over the last three years, it achieved a post-tax return on net worth of over 10.0% and an average debt service coverage ratio of 1.5 times. In FY2015, the return on net worth rose to 13.1%23 and the debt service coverage ratio improved to 2.0 times.24 POWERGRID’s debt–to–equity ratio has remained at approximately 70:30. Although POWERGRID has an aggressive investment plan and a large need for additional borrowings, financial projections show it has a sound financial position even under stress scenarios.

C. Governance

26. As a publicly listed company, POWERGRID is subject to several strong governance measures imposed by India’s Securities and Exchange Board, which enhance accountability, transparency, and predictability of its financial governance through information disclosure to

21 Navratna-status public sector undertakings may invest up to less than (i) Rs10 billion or (ii) 15% of net worth on a

single project or 30% of net worth in a single year, without having to seek the government’s permission. 22 Since 2001, POWERGRID’s domestic bonds have been rated AAA by the Credit Rating Information Services of India

Limited and AAA by the Investment Information and Credit Rating Agency of India Limited. Since 2008, the Credit Analysis and Research has also given these bonds an AAA rating.

23 POWERGRID. 2015. FY2014–2015 Press and Analysts Meet Announcement. Mumbai. 24 POWERGRID. 2015. Audited Annual Financial Results for the year ended 31March 2015. Gurgaon.

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shareholders, investment professionals, and the general public. POWERGRID has an advanced accounting system using computerization with confidentiality and integrity at various levels. The financial management risk is thus low. 27. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and POWERGRID. The specific policy requirements and supplementary measures will be described in the project administration manual. D. Poverty and Social

28. The power sector is a key driver of India’s economic growth and development. Access to reliable, stable, and adequate electricity supply increases agricultural, industrial, and commercial productivity, and enhances economic growth. Economic growth helps reduce poverty and improve quality of life, particularly for the most vulnerable segments of society. The project will avoid or minimize negative impacts on affected people. Social design features include (i) compensation for loss of crops and trees at market value, (ii) additional assistance for affected vulnerable households, and (iii) equal opportunities to access employment and equal pay for men and women under civil works contracts.

E. Safeguards

29. The project is expected to be classified as category B for environment, category B for involuntary resettlement, and category C for indigenous people. In accordance with ADB’s Safeguard Policy Statement (2009), the project’s potential environmental and social impacts and risks will be identified. Measures to avoid, mitigate, and compensate for adverse environmental impacts will be incorporated in the initial environmental examination, which will include the environmental management plan. Environmental impacts of transmission lines can be minimized by careful route selection. Any lines and substations that require compensatory afforestation due to impacts on forest land will be budgeted to offset this impact. Any private land required is expected to be acquired on a willing-buyer, willing-seller basis and through negotiated settlement.25 For subprojects requiring use of government or POWERGRID-owned land, due diligence will confirm there are no encroachers or informal settlers and that the land is free of claims and disputes or will ensure appropriate actions are undertaken to compensate project-affected people. For the transmission towers and lines, impacts are temporary and will occur during construction in loss of crops and trees, which will be compensated. Measures to avoid, mitigate, and compensate for adverse impacts will be incorporated in a compensation plan for temporary damages, analogous to ADB’s resettlement plan. This contains basic elements of a resettlement plan, as required by ADB's Safeguard Policy Statement for category B projects, and is based on the principles of the Safeguard Policy Statement; the Indian Telegraph Act, 1885; and the Electricity Act, 2003. POWERGRID has the commitment and ability to manage the social and environmental risks.26

Information disclosure to and consultations with affected people will be conducted following ADB requirements.

25 The private land is expected to be acquired through negotiated settlement between willing buyer and willing seller,

such that there is no expropriation required. The negotiation is expected to be done through meaningful consultation with affected persons and POWERGRID's committee dealing with the land purchase, and will aim to offer a fair price. POWERGRID will ensure any negotiations with affected persons are transparent, and an appropriate expert will validate the transaction. POWERGRID will document the processes of negotiation, such as the consultation processes, policies, and laws applicable to such transactions and third-party validation, and will submit to ADB after the completion of negotiations and payment.

26 POWERGRID developed a comprehensive environmental and social management system in 1998 and revised it in 2009. This integrated guidance and best practices from the World Bank through a multi-stakeholder and participatory consultation process.

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F. Risks and Mitigating Measures

30. Major risks and mitigating measures are shown in Table 4. The risks are manageable, and appropriate mitigation measures are incorporated. Integrated benefits are expected to outweigh the costs.

Table 4: Summary of Risks and Mitigating Measures

Risks Mitigating Measures Delayed commissioning of solar parks Central government agencies, including MNRE and CEA, and the state

regulators are periodically reviewing plans. Periodic coordination between state and central transmission agencies and the solar park developers will support synchronized commissioning of parks and lines.

Project completion delayed Completion delays largely result from issues related to land acquisition and right-of-way approvals. Land for the project is being identified, and the risk of delays is expected to be low. POWERGRID has a strong in-house technical, legal, and management team that monitors implementation and their project implementation has historically been good. In the case of delays and ensuing cost overruns, tariff regulations allow the regulator to approve an increase in cost, based on which the transmission tariff is calculated, such that POWERGRID can recover cost increases outside its control through the standard tariff methodology.

Lower revenue

Due to its business profile, regulated nature of capital expenditure, predictable tariff-based revenues, and full cost recovery from a supportive regulatory environment, POWERGRID revenue risk is considered to be low. The essential nature of power transmission has resulted in a good collection record with customers and low overdue receivables. Tariff regulations allow cost recovery of regulator-approved cost overruns.

Regulatory changes The regulator has historically avoided making sudden or significantly adverse regulatory changes. Major regulatory decisions have been made on the basis of objective criteria and input from stakeholders via a public and transparent process. The regulator provides detailed explanation in support of new or amended regulations. The tariff structure and components have remained largely unchanged in past regulatory periods.

Foreign exchange variations A majority of POWERGRID’s long-term debt is denominated in Indian rupees, and there is no foreign exchange risk with this. For foreign currency debt, POWERGRID has not undertaken any foreign exchange hedging, since foreign exchange-related costs or losses are permitted as a pass-through in the POWERGRID tariff, without further regulatory approval.

POWERGRID = Power Grid Corporation of India Limited. Source: Asian Development Bank estimates.

31. The government and POWERGRID have assured ADB that implementation of the project shall conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the project administration manual and loan documents. 32. The government and POWERGRID have agreed with ADB on certain covenants for the project, which are set forth in the loan agreement and guarantee agreement.

12

IV. RECOMMENDATION

33. 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

(i) the loan of $270,000,000 to the Power Grid Corporation of India Limited, to be Guaranteed by India, for the Solar Park Transmission Sector Project, from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; for a term of 20 years, including a grace period of 5 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan and guarantee agreements presented to the Board; and

(ii) the administration by ADB of the loan not exceeding the equivalent of $50,000,000 to Power Grid Corporation of India Limited for the additional financing of the Solar Park Transmission Sector Project, to be provided by the ADB Clean Technology Fund, and such other terms and conditions as are substantially in accordance with those set forth in the draft loan and guarantee agreements presented to the Board.

Takehiko Nakao President

{Date TBD}

Appendix-1

DESIGN AND MONITORING FRAMEWORK

Impacts the Project is aligned with:

Supply of renewable energy increased (Jawaharlal Nehru National Solar Mission)a Energy intensity of economy reduced (India Nationally Determined Contribution to the United Nations Framework Convention on Climate Change)b

Results Chain Performance Indicators

with Targets and Baselines Data Sources and

Reporting Risks

Outcome By 2022: Contribution of solar energy to India’s power mix increased

a. 2.0 GW of installed capacity from solar energy added (2016 baseline: 5 GW)

a. Annual reports of the MNRE

Policy support for private solar power projects is weakened due to changing priorities within the Government.

Full investor capacity within each park is not realized due to changes in market conditions.

b. Additional 3,153 GWh of renewable electricity generated from Bhadla III and other supported solar parks fed to grid (2016 baseline: 0 GWh)

b. Monthly and annual reports of CEA

Outputs By 2021: 1. Electricity from solar parks delivered to interstate transmission system

1a. Expansion of 765 kV double circuit transmission lines to connect 2,000 MW of solar parks to interstate transmission system (2016 baseline: 0)

1a-c. POWERGRID annual reports

Rights-of-way issues cause delays.

Completion of associated transmission lines (external to the project) is delayed.

Increases in the prices of equipment and materials exceed contingency and inflation forecasts.

1b.Expansion of 400 kV double circuit transmission lines (2016 baseline: 0)

1c. Additional 765/400/220 kV pooling stations transfomers and reactors. (2016 baseline: 0)

Key Activities with Milestones

1. 2,000 MW of solar parks connected to the interstate transmission system 1.1 Identify and technically appraise subprojects (Q1-Q4 2016) 1.2 Prepare engineering designs (Q1–Q4 2016) 1.3 Conduct financial and economic assessment (Q2-Q4 2016) 1.4 Prepare bid documents (Q1–Q4 2016) 1.5 Award contracts for goods, works, and services (Q3 2016–Q1 2017) 1.6 Construct assets (Q3 2016–Q4 2019) 1.7 Make assets operational (Q1–Q2 2020)

Appendix-1

Key Activities with Milestones

Inputs

ADB OCR (loan): $270 million ADB CTF (loan): $50 million POWERGRID (other sources):d $128 million POWERGRID equity (internal sources): $192 million

Assumptions for Partner Financing

None.

a Ministry of New and Renewable Energy, Government of India. 2009. Jawaharlal Nehru National Solar Mission. Available: http://pib.nic.in/archieve/others/2009/Nov/mission-JNNSM.pdf Targets recently increased as reported in Government of India Press Release. Jawaharlal Nehru National Solar Mission. 23 July 2015. Available: http://pib.nic.in/newsite/pmreleases.aspx?mincode=28 b Ministry of Environment and Forests, Government of India. 2015. India Intended Nationally Determined Contribution

to the United Nations Framework Convention on Climate Change. Available: http://www4.unfccc.int/submissions/INDC/Published%20Documents/India/1/INDIA%20INDC%20TO%20UNFCCC.pdf c These outputs will be confirmed during project processing and implementation. d Expected to be POWERGRID’s domestic bond issuance and/or parallel financing from the commercial banking sector and/or other financial institutions. ADB = Asian Development Bank, G/CD = governance and capacity development, km = kilometer, kV = kilovolt, MNRE = Ministry of New and Renewable Energy, MVA = megavolt-ampere, MW = megawatt, POWERGRID = Power Grid Corporation of India Limited. Source: Asian Development Bank.