Country Economic Memorandum

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Report No. 1873a-NEP Nepal Country Economic Memorandum March 16, 1978 South Asia Programs Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 Currency Equivalents Before October 9, 1975: US$1 = Nepalese Rupees (Rs) Rs 1 = US$0.094 = Indian Rupees (IR) After October 9, 1975: US$1 = Rs Rs 1 = US$0.08 Fiscal Year Nepal Fiscal Year - July 16 to July 15 This report is based on the findings of a mission composed of Messrs. C.J. Jansen (mission chief), C.L. Robless and J. Borthwick. The mission visited Nepal from October 30 to November 16, 1977.

3 FOR OFFICIAL USE ONLY NEPAL COUNTRY ECONOMIC MEMORANDUM TABLE OF CONTENTS Page No. List of Tables in the Text... Country Data... Summary and Conclusions... I. The First Half of the Fifth Plan A. Background B. Highlights of Recent Economic Developments... 3 Production Resource Mobilization Balance of Payments and Foreign Aid... 6 II. Sector Development Programs A. Raising Output and Productivity B. Social Services C. Physical Infrastructure III. Development Administration A. Introduction B. Sector Planning and Project Preparation C. Implementation Problems D. Shortages of Skilled Manpower IV. Issues and Prospects A. Development Strategy B. Price and Trade Policies C. Fiscal Policy D. Foreign Aid E. Policy Study Priorities Statistical Appendix Maps This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 Tables In text: Page Nc 1 Government Finance Balance of Payments, 1974/ / Sectoral Allocation of Public Investment ADBN Lending Operations, 1974/ / External Assistance Needs: A Tentative Mission Projection

5 Page 1 of 2 pagas COUNTRY DATA - NEPAL AREA POPULATION DENSITY 140,797 sq. km million (mid-1976) 92 per sq. km. Rate of Growth: 2.1% (from 1965 to 1975) per sq. km. arable land POPUlATION CHARACTERISTICS (1975) HEALTH Crude birth rate (per 1,000) 46.3 Population per physician 36,000 Crude birth rate (per 1,000) 27.8 Population per hospital bed 5,800 Infant mortality (per 1,000 live births) INCOME DISTRIBUTION DISTRIBUTION OF LAND OWNERSIIP X of national income, highest quintile.. 1 owned by top 10% of owners lowest quintile.. % owned by smallest 10% of owners ACCESS TO PIPED WATER (1975) ACCESS TO ELECTRICITY (1975) X of population - urban 86% 7 of population - urban )3 0 - rural 2% - rural ) - NUTRITION ( ) EDUCATION ( ) Calorie intake as % of requirements 86.0% Adult litcracy rate X 19.2% Per capita protein intake.. Primary school enrollment % 59.0% GNP PER CAPITA IN 1976: US$120 /a GROSS NATIONAL PRODUCT IN ANNUAL RATE OF GROWTH (Y., constant prices) US$ Mln. Z GNP at Market Prices 1, Gross Domestic Investment Gross National Saving Current Account Balance Exports of Goods, NFS Imports of Goods, NFS OUTPUT. LABOR FORCE AND PRODUCTIVITY IN Value Added Labor Force /b V. A. Per Worker us$ Mln. 7 Mln. Z US $ Agriculture Industry v Services Total/Average 1, GOVERNMENr FINANCE CENTRAL GOVERNMENT Rs. Mln. Rs. Mln. Rs. Mln. 1974/75 % of GDP 1975/ /77 Current Receipts 1,008.2 (6.8) 1, ,321.3 Current Expenditure (3.5) Current Surplus Capital Espenditure , ,510.5 External Assistance (net) Note: All conversions to US dollars in this table are at the average exchange rate prevailing during the period covered. /a GNP per capita data based on World Bank Atlas Methodology ( basis). d Total labor force; unemployed are allocated to sector of their normal occupation... not available

6 Page 2 of 2 pages COUNTRY DATA - NEPAL MONEY, CREDIT AND PRICES (Million Rs outstanding mid-july) Money and Quasi Money 1,493 1,850 2,027 2,458 3,144 Bank Credit to Public Sector Bank Credit to Privace Sector (Percentages or Index Numbers) Money and Quasi Money as 7. of GDP General Price Index ( ) Annual Percentage changes in: General Price Index Bank Credit to Public Sector (net) Bank Credit to Private Sector BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1974/ /77) a/ 1974/75 L975/ /77 USS Mln. 7. (Millions US$) Exports, f.o.b. b/ Foodstuff & raw materials Imports, c.i.e. b/ Manufactures All, other cocmmodities 4., Trade Balance Total Services, net of which: Tourism EXTERNAL DEBT, DECElf8ER 31, 1976 Transfers, net US$ Min. of which: Private Remittances Indian Excise Refund Public Debt, incl. guaranteed Non-Guaranteed Private Debt Current Account Balance Total outstanding & Disbursed official Grants OfficLal Capital, net DEBT SERVICE RATIO for 1977 less than 2.5% c/ Private Capital, net Public Debt, inc. guaranteed Change in Reserves (- Increase) " Non-Guaranteed Private Debt Gross Reserves (mid July) Total outstanding & Disbursed Net Reserves Fuel and Related Materials tbrd/ida LENDING, (December 1977) (Million US$): _ Imports of which: Petroleum IBRD IDA Exports of which: Petroleum Outstanding & Disbursed 21.3 Undisbursed RATE OF EXCHANGE Through October 1975 Since October 1975 US$ 1.00 = NRs US$ NRs 12.5 NR US$ NR 1.00 = US$ 0.08 Gutstanding incl. Undisbursed a/ Cuscoms basis. b/ Paymests ba3is. c/ Ratio of Debt Service to Exports of Goods and Non-Factor Services. not available not applicable South Asia Programs Department February 23, 1978

7 STATISTICAL APPENDIX Table No. Table of Contents POPULATION 1.1 Population Estimates and Projections 1.2 Implications of Population Projections 1.3 Regional Distribution of Population 1.4 Age Composition of Population 1.5 Growth of Labor Force 1.6 Economically Active Population Classified by Industry, Occupation, and Employment Status NATIONAL ACCOUNTS 2.1 Gross Domestic Product of Nepal at Current Market Prices 2.2 Total Agricultural and Non-Agriculture GDP at Current and Constant Prices 2.3 Regional Distribution of GDP 2.4 Saving, Investment, Outlay, and Production During the Fifth Plan EXTERNAL SECTOR 3.1 Receipts and Payments of Convertible Foreign Exchange 3.2 Composition of Total Exports 3.3 Composition of Total Imports 3.4 Composition of Trade with Countries other than India 3.5 International Reserves 3.6 Foreign Grants Received EXTERNAL DEBT r 4.1 External Public Debt Outstanding Including Undisbursed as of December 31, Service Payments, Commitments, Disbursements and Outstanding Amounts of External Public Debt Projections Based on Debt Outstanding Including Undisbursed as of December 31, 1976 PUBLIC FINANCE 5.1 Central Government Budgetary Performance 5.2 Budgetary Expenditure of the Central Government 5.3 Budgetary Revenue of the Central Government

8 Statistical Appendix Table of Contents (Continued) Table No. PLAN 5.4 Total Allocation of the Fifth Plan Outlay 5.5 Public Sector Allocation of the Fifth Plan Outlay MONETARY STATISTICS 6.1 Monetary Authorities' Account 6.2 Assets and Liabilities of Commercial Banks 6.3 Agricultural Development Bank--Resources and Utilization of Funds 6.4 Nepal Industrial Development Corporation--Resources and Utilization of Funds AGRICULTURAL STATISTICS 7.1 Area, Production, and Yields of Major Crops 7.2 Annual Consumption of Agricultural Inputs STATISTICS OF OTHER SECTORS 8.1 Production of Principal Industries 8.2 Manufacturing Establishments--Structure and Economic Activities 8.3 Highway Network 8.4 Tourist Arrivals and Expenditures 8.5 Number of Pupils, Teachers and Pupil/Teacher Ratio by Level of Education 8.6 Number of Schools and Enrollment Ratio by Level of Education and Region 8.7 Government Expenditure on Education by Level 8.8 Projection of Demand and Supply of Technical Manpower in the Fifth Plan 8.9 Nepal Nutrition Status Survey 8.10 Family Planning Program Achievement PRICES 9.1 Kathmandu Consumer Price Index PUBLIC CORPORATIONS 10.1 Outcome of Operations of Certain Public Enterprises

9 NEPAL: COUNTRY ECONOMIC MEMORANDUM SUMMARY AND CONCLUSIONS i. This report presents an overview of achievements in the first half of Nepal's Fifth Plan (1975/ /80). The macro-economic objective of the Fifth Plan was to lift the GDP growth rate from its low level of about 2% a year to 4-5% by shifting the emphasis in investment from large-scale infrastructure to quicker-yielding investments in directly productive activities. However, the Plan also sought to distribute the benefits of development to more people by spreading investment resources more evenly over the country's regions and increasing investment in the social services. ii. The major conclusion that can be drawn from the first three years of the Plan is that the Government has indeed been able to reorient its investment. The volume of public investment has also been growing rapidly - in real terms, growth has exceeded the predictions of the Bank's last economic report, and is very close to Plan projections. iii. Despite these favorable developments, there has been little economic growth. Stagnant agricultural production has been the principal reason. In part this has been due to poor weather which has led to two successive years of decline in agricultural production. The more fundamental reason is the failure to achieve a breakthrough in raising the level of agricultural productivity. For several decades Nepal has been able to feed its growing population by extending agricultural cultivation over larger areas. The methods of cultivation used have been traditional and yields have remained low. In the Hills, cultivation has already been pushed into marginal areas where it has caused a serious increase in soil erosion. In the Terai, a relatively small area of level forest land could be brought under cultivation, but much of it is of poor quality. Unless a breakthrough is achieved soon in raising agricultural productivity and identifying new opportunities in industry, per capita income will start to fall. Nepal will then cease to be a net food exporter and become dependent on the outside world for satisfying its subsistence needs. Outside agriculture there are as yet few alternatives for income earning. Import substituting industry has made some progress in a highly protected environment and tourism has boomed, but the contributions of both to GDP and employment are still small. iv. Achievements in the first half of the Fifth Plan must be measured against this background of urgency. In agriculture, the principal developments have been in irrigation, mainly in the Terai. On the basis of recent progress, the Government expects 100, ,000 hectares to be brought under cultivation in 1979/80, compared with 55,000 under the Fourth Plan. Agricultural credit has also expanded rapidly through the operations of the Agricultural Development Bank. However, much less progress has been made in improving agricultural practices and technology, the two biggest constraints to increased agricultural production. Agricultural research has not yet been adapted to local conditions, little coordination exists between research and extension activities, and while the Plan's targets for

10 - ii - expanding the supply of extension and research personnel are likely to be achieved, their effectiveness will continue to be hampered by inadequate training, lack of relevant advice for farmers, and poor organization. For these reasons, results in terms of increased production on completed irrigation projects have been disappointing. In areas where concerted efforts were made at on-farm development and providing advice and inputs to farmers, results, however, have been more satisfactory. One example is the Narayani Zone project, where yields, in spite of the bad monsoons, have risen from tons per hectare to tons. v. Reforestation and erosion-control programs have been small compared to the country's enormous needs and have been concentrated principally in the Terai. Unless far larger and more comprehensive programs are initiated, the remaining accessible forests in the Hills will be depleted within 12 years; those in the Terai within 20 years. The environmental destruction would doom agricultural prospects of large parts of the country and reduce the hydropower potential. vi. In industry, some progress has been made in establishing agro-based and import-substituting ventures. Some of the large, capital intensive import substituting industries presently under consideration are of questionable economic merit. Expansion potential is likely to be limited to light consumer goods industries, a few large agro-industries, medium and small scale "repeater" projects (e.g., food mills, construction materials), and cottage industries in selected subsectors. The Government is strengthening institutional support; however, there is need to develop a coherent industrial strategy, and to further improve project preparation and promotion in areas with potential. At present, cottage industries constitute the majority of industrial production and employment, providing goods and incremental earnings to farm families and contributing to exports. However, productivity and earnings are low and remoteness works against cottage industries in certain subsectors. While Government is improving institutional support to small and cottage industries, innovative approaches are needed to select promising product lines for promotion, reach rural craft families with low cost but effective support, and mobilize private as well as public marketing agents. vii. Together with the promotion of directly productive economic activity, the Plan calls for accelerated development of basic social services. This emphasis seems warranted not only because of the immediate welfare effects of such services, but also their potential contribution to labor productivity. Achievements to date have been mixed, however. In education, the Government made further progress in reorienting curricula towards the practical needs of the mostly rural population. Primary school enrollments have soared, and programs are under way to expand the supply and improve the training of middle level skilled and technical manpower. Nonetheless, shortages of technical manpower and other graduate level skills for which Nepal currently depends on training facilities abroad will persist for some time. Shortages of medical and paramedical staff will be the principal factor constraining implementation of the Government's integrated rural health services program. In the first two years of the Plan, 75 new posts were added bringing the total to about 410. The target of 810 by the end of the Plan is unlikely

11 - iii - to be met mostly because of staff constraints. The access of the rural population to piped water is also improving but at a slower pace than needs would indicate. Over 90% of the rural people still drink polluted water. Urban water supplies have, however, been expanding rapidly. The family planning program, too, urgently needs more attention. While the number of accepters has risen (from less than 2,000 in 1966/67 to over 138,000 in 1975/76), followup surveys on past accepters indicate that fewer than 2% of reproductive age couples are currently protected. The pace of progress is too slow to bring population growth under control. A far larger program will be needed to expand the reach of effective family planning services to the rural people. In view of Nepal's poverty and lack of trained manpower, extremely inexpensive and simple solutions must be found to make a large-scale program feasible. viii. In transportation, the Plan indicated that greater priority would be given to the construction of North-South feeder roads, suspension bridges, and ropeways, to link the Hills with the East-West roads in the Terai. Although steps have been taken towards realizing the new road development strategy, priority is still being given to the completion of ongoing highway projects, particularly the East-West Highway, which are to account for some 60% of Fifth Plan outlays for highway construction. Meanwhile, road construction is extremely costly in most of Nepal, and with the exception of a very few connections, prospective transport volumes are small. A modification of the strategy, therefore, appears needed in favor of much less expensive solutions such as improvement of trails, construction of gravel roads with villagers' participation, and perhaps construction of ropeways. The need for further major additions to the trunk network deserves critical examination. ix. In the Hills, where power transmission facilities are unavailable yet hydroelectric potential is large, microplants are planned as one means of improving the national distribution of power. At the present state of technology these are costly projects, however, and unless less expensive solutions can be found and the micro-plants also serve irrigation purposes, they may be hard to justify, even in terms of their social benefits. Two micro-plants have been constructed during the first two years of the Plan, with seven more to be initiated over the next few year. x. In spite of progress in many areas, achievements in the different sectors have failed to accelerate economic growth. A critical shortcoming underlying this poor record is the lack of attention being devoted to the strengthening of development institutions and the improvement of sector planning and project preparation. Some steps have been taken to this end: planning cells were established in key development ministries during the Fourth Plan, specialized project preparation centers have been set up for agriculture and industry, and technical assistance has been sought on a limited scale to help in project planning. These are all steps in the right direction, but more are needed. xi. The following seem to be the main problems with planning in Nepal: (a) the planning cells are in most cases understaffed. Although their focus has been on sectoral strategy, they have been insufficiently equipped

12 - iv - to prepare workable sector plans which provide practical guidelines for the entire complex of measures that is needed to accelerate the development of a given sector. Particularly in agriculture and industry, the planning cells have been unable to examine adequately the need for improvements in development institutions and, by and large, they have been unable to direct the resources of the sector towards the task of project preparation. A review of the planning cells appears needed; it should depart from the principle that planning is the task of all managers (i.e. all middle and high level officials) in the public sector and not of a separate unit alone. The planning cells should encourage managers to exercise their planning responsibilities; (b) the design of development projects has almost invariably focused on the physical aspects of the project and neglected the complementary measures, particularly the institutional improvements and manpower requirements needed to enable the project to generate its full benefits; (c) there is an urgent need for an indepth review of the professional staff needs of the technical ministries in the areas of sector planning and project preparation. The objective of such a review would be to identify immediate shortages and technical assistance requirements; (d) the unsatisfactory amount of resources devoted to sector planning and project identification and preparation is to a certain extent due to insufficient guidance from the central agencies that are responsible for overall resource allocation. It is unlikely that the operating ministries will assign more of their best resources to sector planning and project preparation unless they know that this would be required for their proposals to pass the muster of the National Planning Commission for inclusion in the Plan, and of the Ministry of Finance for annual allocations under the budget. And this in turn will happen only if both agencies assert their leadership and devote more of their own resources to guidance and review. xii. Other measures are also needed. One of them would be simply to increase the rewards (salaries) and facilities (housing, transportation) of those doing vital work on development projects, particularly projects in rural areas. Others relate to the streamlining of Government's organizational machinery. In this respect, the Government is considering far greater delegation of responsibility to regional and local units, and greater involvement of the Panchayats in the execution and supervision of district-level development projects; reduction in the current number of ministries and public corporations; and greater flexibility in personnel policy throughout the public service. Such a program of action could help in establishing a more efficient government, especially in view of recent measures to strengthen the district administration. Decentralized administration does not, however, guarantee that delegated authority will in fact be exercised. This will require a more modern management style in the civil service and well-defined rules of conduct, permitting civil servants to feel secure in exercising initiative and accepting responsibility. xiii. Provided the Government makes adequate efforts to remove administrative obstacles to development and improve project preparation and implementation capacity, public investment could grow by 12% per year in real terms (21% in current prices). This will, in turn, require that resource mobilization be intensified. Although tax rates are already high, there is scope for additional revenue from sales taxes, rationalization of income and land taxes, and improved tax administration and collection.

13 xiv. But even if appropriate revenue action is taken, the budgetary gap will remain wide. While some recourse to domestic borrowing will be possible, foreign aid will remain of paramount importance in supplementing domestic resources in the financing of the Government's investment efforts. Disbursements from aid already negotiated will cover a major portion of development expenditures during the remaining period of the present Plan, but about Rs 0.9 billion for the period 1977/ /80 remain for which financing is still to be found. xv. A major difficulty which donors will encounter in financing this gap is the scarcity of development projects suitable for external financing. To some extent this difficulty can be overcome by financing a higher proportion of total project costs, including part of local expenditures and current expenditures in cases such as agricultural research or education schemes. Donors should in addition consider providing sector or program assistance for the large number of smaller development activities, which in the past have not been considered suitable for foreign project assistance and have been wholly financed from domestic resources. These include rural development activities like rural schools, health posts, and village water supplies, reforestation programs, minor irrigation and on-farm development, feeder road construction, and trails improvement. xvi. While foreign assistance in the execution of these activities is very desirable, successful sector or program assistance faces many difficulties. Slow progress in the above areas finds its roots in the weakness of the relevant development institutions, failure to adapt project design to local conditions, and shortages of trained manpower. Program assistance will be ineffective unless it tackles these constraints by simultaneously extending technical assistance, and, if necessary, proceeding first on a pilot basis. In the process of implementation, it may also be necessary to include commodity aid in the form of construction materials, inputs and payments in kind to workers. xvii. There can be few countries in which the need for accelerated growth and satisfaction of elementary human needs is more pressing than in Nepal. Apart from the need to deal with immediate priorities, the Government will want to devote more of its resources to study the issues which will determine the development perspective for the 1980s. Some of the issues meriting increased attention are; the economic, social and technical constraints on an increase in agricultural productivity in the Hills and the Terai, the study of economic factors to be taken into account in poverty alleviation and their effects on economic growth as well as welfare, the development prospects of Nepal as part of the South Asian sub-continent, the improvement of basic statistics for macro-economic decision-making, the improvement of the efficiency of public enterprises, and the design of a training program to raise the competence and development insight of middle and high level personnel.

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15 CHAPTER I THE FIRST HALF OF THE FIFTH PLAN A. Background 1.01 Nepal is reaching a critical stage in its development. For several decades, the country has been able to maintain the per capita income level of its rapidly growing population by extending agriculture at constant yields over larger areas and by modest progress in import-substituting industries and tourism. Had it not been for the reserve of idle land in the Terai 1/, per capita incomes would have dropped. By now, however, almost all suitable land has been brought under cultivation, and only a breakthrough in agricultural productivity can prevent a decline in living standards In the Terai, there is still a relatively small area of level forest land which could be converted into farm land without serious ecological damage, but much of it is of poor quality. In the Hills, no such reserve is left; cultivation has been pushed up steep hillsides causing increasingly serious erosion and bringing very meager agricultural output in exchange. Food availability for the average farm family in the Hills has declined to the equivalent of 225 days of minimum subsistence needs, and in the Mountain districts the situation is even worse. One-third of the population of these areas migrates to the Terai and Northern India in the lean season to find temporary work and food, and an estimated 400,000 have moved permanently during the last decade. There are signs this exodus is accelerating The average Terai farm family produces enough food for subsistence and a small surplus for trade. These surpluses have been the basis for Nepal's rice exports, traditionally the country's chief source of foreign exchange. But under the pressure of increasing numbers and shrinking farm size, rice exports have been dropping steadily from half a million tons in the early 1960's to scarcely one hundred thousand tons in the current year. With the relentless increase in population, the food position will continue to worsen and threatens before long to turn Nepal into a net food importer Given the limited opportunities for further acreage expansion, food self-sufficiency can only be assured through increased agricultural productivity. Throughout Nepal, yields have remained very low -- two tons of paddy per hectare and one ton of wheat. Efforts to raise productivity -- irrigation projects, agricultural training and extension services, subsidized sales of inputs -- have had only limited success. Nor have many realistic alternatives to agriculture appeared. Manufacturing production has increased fairly rapidly, to about 4% of GDP, but probably at considerable resource cost. Tourism has also expanded to become an important source of foreign exchange, 1/ The Terai is the extension of the Indo-Gangetic plain into southern Nepal.

16 - 2 - but it is still only about 1% of GDP. Cottage industries, 7% of GDP and an important source of rural employment, still, for the most part operate at very low levels of productivity Past development efforts have not yet resulted in an improvement in the quality of life of Nepal's population. When Nepal opened its borders to the outside world in the early 1950's, it had an extremely weak administration, and practically no transportation, electricity, or telecommunications facilities. Under the circumstances, initial development efforts necessarily concentrated on establishing a foundation for future development. It was inevitable that during these stages growth would remain slow, and as a result, there has beem little or no increase in per capita income By almost every standard, Nepal has remained exceedingly poor. The per capita annual income of $120 is one of the lowest in the world, but of all the measures of poverty in Nepal this is perhaps the least revealing. Many basic needs of life go unmet. For instance, in the Hills where over 60% of the population lives, food is scarce and average annual per capita incomes have been estimated as low as $25. Daily hikes of many hours are needed to fetch drinking water, fuelwood, and fodder for livestock. Many children have to walk hours to reach school. Throughout Nepal, few people have access to unpolluted water, or even elementary health care. Life expectancy at birth is only 42 years, and the rate of infant mortality at over 200 per thousand is among the highest in the world. About 80% of the adult population is illiterate. Addressing these basic human needs is the highest development priority in Nepal today, not only on welfare grounds, but also as a necessary condition for accelerating economic growth The Fifth Plan was to become the turning point 1/. The necessary primary infrastructure was largely in place, and the major thrust of public investment was to be reoriented towards smaller, quicker-yielding investments that exploited that infrastructure, and to the social services. The Plan would also attempt to spread growth outside the narrow and privileged confines of the Kathmandu Valley, and to mobilize the energies of the rural people for local development schemes. The planners believed that Nepal was poised for more rapid growth and that during the period of the Plan, GDP growth would accelerate from its historic rate of 2% a year to 4-5% The Bank's last economic report 2/ broadly endorsed this strategy, but indicated that many institutional shortcomings were likely to delay any significant acceleration of the growth rate during the Fifth Plan, or even a substantial shift in the composition of investment. The main constraints would continue to be serious shortages of administrative and technical manpower in all economic sectors; lack of adaptive research, particularly in agriculture; lack of coordination between Government agencies; poor and dilatory decision 1/ The Fifth Plan covers the period July 16, July 15, / "Review of the Economic Situation of Nepal," Report No NEP, dated July 22, 1976.

17 - 3 - procedures; lack of incentives for farmers and entrepreneurs to strive for higher productivity; and finally, in all sectors, a lack of well prepared projects. Only if these shortages were alleviated would there be reasonable prospects for more rapid economic growth The principal aims of this report are to provide an analysis of progress in the main economic sectors in the last three years (Ch. II), a review of the steps taken to expand absorptive capacity (Ch. III), and some suggestions for future action (Ch. IV). In so doing, a perspective of the macroeconomic conditions within which the country had to operate is necessary. The remainder of this chapter briefly examines those conditions. B. Highlights of Recent Economic Developments Production 1.10 Growth in the Plan's first three years (1975/ /78) has not been encouraging. In 1975/76, the grain crop was relatively large owing to favorable weather. According to rough estimates by the mission 1/, GDP grew by almost 4% as compared with the average of just over 2% in the preceding decade. The balance of payments benefited from temporarily larger rice exports and increased incomes from tourism. At the same time, imports of petroleum products, fertilizer, cement and iron and steel declined because these items were overstocked in the previous year. Foreign exchange reserves rose to the equivalent of 10 months of imports, probably more than needed as a reasonable precaution for export shortfalls and unexpected import needs. The higher GDP growth rate and improved balance of payments and reserves situation were, however, due to fortuitous circumstances and did not represent an improvement in the long term growth trend of the economy Results in 1976/77 were less favorable, mainly because of a 8.5% drop in paddy output. Rice exports fell, and since the output decline coincided with a plentiful supply of grain on Indian markets, export prices were similarly low. Because of the low price across the border, domestic prices were also low, and as a result farm incomes in the Terai dropped severely. Production of other foodgrains remained unchanged. In the Terai, however, the low rice price may have accounted for some shift in resources in favor of sugarcane and jute, the output of which expanded significantly. The output of the small industrial sector rose with the opening of new cement and soap plants (production increases of 70% and 160%) and better utilization of capacity in sugar (+53%) and jute mills (+15%). The opening of new hotels led to a resumption of the growth in tourist arrivals by 14%. It is roughly estimated that the overall growth of GDP has been only 1% in real terms and that per capita incomes declined by about 1%. The income of surplus-producing 1/ National Accounts statistics are available only up to 1974/75.

18 - 4 - rice farms in the Terai must have dropped much more, but urban and other consumers experienced equivalent gains. The nation as a whole, however, lost considerably because of the implied terms-of-trade deterioration From the very limited data available, it appears that the growth record for 1977/78 will also be unsatisfactory. Due to a late monsoon, Nepal had a poor rice harvest for the second year in succession. The harvest is provisionally estimated at 2.4 million tons of paddy, approximately the same as last year's, and no higher than production achieved at the beginning of the 1970's. Rice exports will probably not exceed 100,000 tons and prices are likely to remain low. The purchasing power of Terai farmers will remain depressed, despite significant further growth in the production of jute, sugarcane and oilseeds. Private sector investment, mainly in industry and tourism, appears to be rising, as is industrial output. The increase, however, is limited by a shortage of electricity. Roughly estimated, GDP growth in 1977/78 is likely to amount to 2%. Resource Mobilization 1.13 Despite a low degree of monetization, sluggish economic growth and the problems of revenue collection in a country where many areas are inaccessible, and the movement of people and goods over a long border difficult to control, the Government has made progress in mobilizing domestic resources. Revenue increased from 5% of GDP in 1970/71 to 7.5% in 1975/76. Although this level is still extremely low, even for a country with Nepal's per capita income, the revenue increase has nevertheless been significant. The implied rate of revenue growth over the period was over 7% a year in real terms, three times the corresponding rate of GDP growth. Current expenditures also increased rapidly, but the Government nevertheless managed to save about 2% of GDP on its current budget. This savings record compares well with the average budgetary savings of -0.7% of GDP realized by the group of least developed countries. 1/ 1.14 Low money incomes in the agricultural sector and low export earnings in the last two years are having adverse effects on revenue collection. Usually, actual revenue is close to the original budget but in 1976/77 it showed a considerable shortfall. A number of ambitious revenue measures had been introduced in the original budget. But by the middle of the fiscal year, as the effects of the agricultural shortfall as well as the effect of credit restrictions on private investment were beginning to be felt throughout the economy, the Government decided to reverse some of these measures to provide encouragement to the business community The revenue budget for the current year was drawn up with more modest expectations. Another shortfall, however, is likely. After discovery of widespread over-invoicing, the authorities have suspended the issue of 1/ Source: World Tables 1976, World Bank, data for 1973.

19 - 5 - import licenses against export bonus vouchers earned before August 6, 1977 under the Export Exchange Entitlement (EEE) scheme 1/, which covers Nepal's exports to countries other than India. Since August 6, entitlements against exports have been determined according to standard prices set by the Government itself. Trade with third countries dropped off drastically. At the same time, exports, declined by 40.5% during the first two months of 1977/78 as compared to 1976/77. Imports also fell but only by 1.8%. However, the full impact on imports is not expected to be felt for several more months. As imports under the scheme include all the items with high import duty (on average, 50% of CIF value), the decline is having a marked effect on customs revenue and also on sales tax revenue. Although revenue from other taxes is developing well, the overall outcome will depend on a speedy recovery of traderelated taxes. The authorities are optimistic, expecting a shortfall of only 5%; a larger shortfall, however, seems entirely possible. 2/ 1.16 Low civil service salaries, shortages of trained manpower, and physical difficulties in expanding public services have combined to keep current expenditures lower than Nepal's needs would warrant. In the last few years, however, growth of current expenditures has absorbed all of the revenue growth and the relative contribution of the current surplus in financing development expenditures has been declining, from 47% in 1974/75 to 35% in 1976/77 and probably less again in 1977/78. The contribution of aid disbursements increased from 39% to 43%, and the contribution of internal borrowing from 10% to 21%. The latter consisted chiefly of loans from the banking system. Developments in government finance are summarized below: 1/ Under the EEE scheme, exporters are entitled to retain 45% of the foreign exchange earnings on raw materials (60% for processed goods) which could be spent on imports provided at least' 10% was spent on development goods, and no more than 70% and 20% on basic consumer goods and luxury goods respectively. The premium fetched by these entitlements on the open market led to an effective exchange rate on export earnings which was about 60% above the official rate. 2/ Authorities have already been forced to sell Rs 22 million of convertible currency, which was sold at the equivalent of Rs 19.5 per US dollar (a premium of 56%), to bolster declining revenues.

20 - 6 - Table 1: GOVERNMENT FINANCE (Rs billion) 1974/ / / /78 Budget Actual Budget Actual Budget Actual Budget Total Revenue Current Expenditure Current Surplus Development Exp Deficit (-) Financed by: /a Foreign Grants Foreign Loans Domestic Borrowing Use of Cash Balance /a 1976/77 figures from provisional actual budget. Source: Ministry of Finance, Budget Speeches The use of bank financing to cover the Government's overall deficits has become cause for increasing concern, due to emerging inflationary pressure. The other inflationary factor is the continuing rise in foreign assets. Following a 32% rise during the energy crisis, the inflation rate declined to only 3.7% in 1975/76 and 0.9% in 1976/77. Since early 1977, however, there have been signs of increasing inflation. Month-to-month annual inflation has risen steadily and amounted to 13% for the 12-month period ending mid-september With a 27% increase in the money supply during the same period, the potential for further inflation is great, particularly since imports from third countries are stagnating. The authorities are aware of this danger, but have not yet acted forcefully, perhaps fearing that austere measures may dampen business activity. The recently introduced 0.75% tax on bank loans seems a weak deterrent to would-be borrowers, while the new tax on interest earnings (maximum 20% of interest earnings over Rs 13,000) would actually discourage savings. Balance of Payments and Foreign Aid 1.18 Nepal's foreign exchange reserves in September 1977 stood at US$144 million, 16% higher than in September 1976, and at the equivalent of about 10 months of imports. The rise in reserves occurred despite a large and increasing trade deficit, as the following table shows.

21 - 7 - Table 2: BALANCE OF PAYMENTS, 1974/ /77 (in millions of US$) 1974/ / /77 Export, f.o.b Imports, c.i.f Trade balance Services (net) of which: tourism (15.7) (17.1) (23.0) Transfers (net) Of which: Private remittances (18.9) (18.7) (21.5) Indian excise refunds ( 9.6) ( 7.9) ( 9.3) Current account balance Official grants Official capital (net) Private capital (net) Overall balance Source: IMF on the basis of data provided by Nepal Rastra Bank The trade deficit increased substantially in 1976/77. Imports grew under the impetus of the Government's development programs, while exports, principally rice and jute, declined. Jute exports benefited from production and price increases, but account for only 15% of exports in comparison with 50% from rice Increased tourism earnings and remittances from Gurkha's and workers abroad, however, brought about marked declines in Nepal's current account deficit. Earnings from tourism accounted for over 22% of total covertible foreign exchange earnings in 1976/77 and have displaced Gurkha remittances as the largest single source of convertible foreign exchange. At current growth rates, tourism could soon displace rice exports as the largest single source of total foreign exchange Despite increasing receipts from tourism and manpower abroad, improvement of the trade balance remains critically important. Imports, particularly development goods and raw materials, are bound to rise steadily, and although a few import substituting industries (e.g., textiles, cement) are under construction, some, like the cotton textile industry, will depend largely upon imported raw materials. Generally, there will be increasing need for imports of raw materials and maintenance goods as development projects are completed. As against this, the prospects for rice exports in 1977/78 and beyond are not promising, because of the decline in the exportable surplus and the abundance of grain in Indian markets. Prospects for jute exports are fair in the current year and the near-term, and there have been some increases in the exports of cottage industries products, partly as a result of the EEE scheme. As yet, however, there has been no concerted export drive on the scale that is needed.

22 Foreign aid has been the principal means for financing the current account deficit. Private capital inflows have been negligible except for possibly quite large short-term inflows from India to take advantage of higher interest rates in Nepal. Although no precise data are available, it is likely that these inflows have contributed significantly to the high liquidity of the banking system. Most foreign assistance continues to be in the form of grants, although loan assistance has been increasing rapidly. Official loans net of amortization increased from US$12.1 million in 1975/76 to US$16.3 million in 1976/77, an increase of 35%. In 1977, total debt service amounted to 2.4% of merchandise exports.

23 - 9 - CHAPTER II SECTOR DEVELOPMENT PROGRAMS 2.01 Four successive Five-Year Plans geared to the development of major infrastructure brought little improvement in incomes and living standards in Nepal. Reflecting Government's concern over this, the Fifth Plan contained increased allocations to agriculture and social services, and a major cutback in transportation allocations. In some ways, this reorientation is being realized; as Table II-1 shows, relative sector outlays during the first two years of the Plan are close to targets. There are also indications of accelerating progress in certain key sectors. Table 3: SECTORAL ALLOCATION OF PUBLIC INVESTMENT (in % of total) Fourth Plan Fifth Plan Expenditures Minimum Maximum for 1975/ /77 Agriculture of which Irrigation Industry Power Transport and Communication Social Services of which Education of which Health TOTAL /a /a About 3.9% was for general public services and miscellaneous expenditures. Source: Fifth Plan and Budget Speeches. But more important than the achievement of sectoral allocations or aggregate growth targets is whether sector development programs themselves are beginning to emphasize directly productive investments, and services aimed at meeting basic needs. The purpose of this chapter is therefore to investigate the degree to which sector development strategies are changing to reflect the country's three highest priorities: (a) raising employment, productivity, and

24 output through quick-yielding investments; (b) meeting basic health and education needs; and (c) improving infrastructure, although more selectively than in the past. A. Raising Output and Productivity 2.02 Growing sufficient food and promoting equitable, sustained overall economic growth in Nepal requires concentrating development efforts on agriculture. The economy of Nepal centers around agriculture; it contributes over 65% of GDP, accounts for almost 75% of merchandise exports, and provides a livelihood to over 90% of the population. Nevertheless, industry is growing fairly rapidly, and over 25% of rural income derives from non-agricultural sources. The potential for income from these sources, cottage industries and porterage for tourists in particular, is significant and cannot be overlooked in promoting rural economic growth Agricultural conditions in Nepal are not uniform; in fact, agriculture is practiced in two entirely different economic and ecological settings. About 60% of the population lives in the Hills, which contain only one-third of the agricultural land. Population density there is even higher than in neighboring Bangladesh, and natural conditions even less favorable. Mountainous terrain limits irrigation and restricts transport. A shortage of land forces the cultivation of steep, landlide-prone hillsides, the over-grazing of pasturelands, and the defoliation (for livestock fodder) and destruction of forests. 1/ All this has seriously contributed to the already massive erosion caused by natural forces. Topsoil is washed down to the Terai where it causes siltation and flooding that destroys agricultural land. The Hills have a large food deficit (see para. 1.02) which it cannot overcome by trade, mainly because there are few goods to trade. As a result, labor itself has had to migrate to the Terai Agricultural conditions in the Terai are much more favorable -- population density is only one-third that of the Hills, and the average farm is almost six times as large (2.4 ha). The Terai presents the only opportunity in the foreseeable future for establishing farms producing substantial surpluses for trade. The region has always exported surplus rice to India (see para. 1.03) and cash crops are already an important part of agriculture there. It also presents the only opportunity for developing Nepal's substantial forest resources, which cover about one-third of the country. The bestsuited land could be set aside for providing material for forest-based industries, while much of the remaining land could be cleared to allow the settlement of some of the excess population of the Hills. Although the Government has sponsored settlement programs since the 1960's, it is estimated that only 8% of the 400,000 migrants from the Hills since the mid-1960's were settled officially. Poor administration and inter-ministerial coordination in forest 1/ The destruction of forests is also the result of a shortage of fuelwood (see para. 2.46).

25 demarcation and land allocation hamper official programs while illegal settlers continue encroachment at a rapid rate, and perpetuate subsistence farming in the Terai. Most important, no adequate basis has been developed for selecting the areas with higher potential, and insufficient progress has been made in establishing cadres for promoting productive agriculture. However, the potential for settlement is limited; even if the goal of 60,000 ha is achieved, it would allow the settlement of only 250,000 people from the Hills. 1/ 2.05 During the Fifth Plan, expenditure on agriculture was to increase from 26% to 29% of total outlays, and in line with Plan strategy, emphasize quick-yielding investments. Production was to grow at 3.6% annually, twice as fast as during the Fourth Plan. Long-term strategy called for specialization along lines of comparative advantage -- the Terai was to specialize in foodgrains, jute, sugarcane, and other minor cash crops for which the Terai was best suited, while the Hills would concentrate on cash crops like fruits, vegetables and spices. The agronomic basis for this specialization requires, however, much further study. Moreover, as pointed out in the Bank's last economic report, the lack of transportation facilities between the Hills and the Terai, but particularly the desperate and worsening food shortage in the Hills, severely limit the possibilities for implementing such a strategy The worsening food position in the Hills is the most urgent problem in Nepal today. The highest priority is raising foodgrains production there to subsistence levels. Failure to do so neglects the basic need of perhaps half the population. The extreme poverty of the Hills necessitates reliance on low-cost measures to increase yields, including improved cultivation practices, better crop selection (e.g., potatoes instead of millet), improved local varieties, better livestock management, and where possible, increased use of organic fertilizers (see also para. 2.46) All agricultural infrastructure in Nepal - farm to market roads, agricultural storage, irrigation facilities - is underdeveloped and must be expanded. In the Fifth Plan, however, the Government recognized that the success of any program designed to raise agricultural production in Nepal depended even more critically upon the ability of agricultural institutions and support services to reach the farmer. Nevertheless, development expenditures still focus on infrastructure, particularly large-scale irrigation systems Although irrigation expenditures in the first three years of the Plan fell short of the target (see Table 3), they rose in the 1977/78 budget to account for about 12% of the total outlays, and now exceed those for the rest of agriculture combined. During the first two years of the current plan, an additional 23,000 ha of land have been brought under irrigation, and the Government envisages that ,000 ha of the Plan target of 146,000 ha will 1/ A World Bank Agricultural Sector Mission in 1973 estimated about 250,000 ha of currently protected forest could be better utilized as agricultural land. This would still allow settlement of at most I million people.

26 be completed. However, the construction of major irrigation structures has not always resulted in effective utilization of the water, because it failed to reach the farmers' fields. To realize more fully potential benefits, the Government is starting to undertake smaller schemes (Command Area Development projects) that bring water down to the farmers' fields Almost all agricultural infrastructure is located in the Terai, despite similar needs in the Hills. In part this is inevitable, as construction in the Hills is extremely difficult and expensive. However, in some cases these extra costs would be more than offset by higher social benefits. Irrigation in particular has considerable technical potential, yet thorough economic and social feasibility studies have yet to be carried out As there is limited scope for expanding the area under cultivation, the principal means of raising production and farm incomes must be through increasing the extremely low yields, and increasing the cropping ratio. Lack of irrigation is one constraint, but the fundamental bottlenecks are poor agricultural practices and unimproved technologies. This will require increased work on basic technology as well as its adaptation to local conditions, and getting it to the farmers, particularly those in the Hills who need it most The research and extension programs of the Ministry of Agriculture have key roles to play in agricultural development, yet they remain largely ineffective. Not only are they weakly staffed; they also concentrate almost exclusively on the Terai. Extension agents especially, are hampered by inadequate agricultural training, a lack of relevant advice for farmers, and poor organization. Research focuses on basic research and seed multiplication, and not on adapting promising varieties to the different micro-climates. Extension agents are consequently confined to carrying out production tests on farmer's fields with seeds often ill-suited to local conditions, and to distributing "minikits" of seed and fertilizer. They have little advice to offer on improved cultivation and irrigation practices or crop selection, the advice most needed, especially in the Hills. Pilot projects of the Training and Visit (Benor) System in Nepal have been successful and suggest extension activities can be made more effective if organization, supervision and linkages to research are tightened Agricultural credit has proven one of the key factors in moving farmers out of subsistence into the market economy. In most countries where the breakthrough has been achieved, the farmers' subsistence had been more or less assured, and they had relatively convenient access to markets, inputs, credit and extension advice. The Terai meets most such criteria and is already undergoing this transition; however, in the Hills, the scope for agricultural credit is much less certain. There, increased production is likely to result in little marketable surplus. Thus, if production is raised by capitalintensive means, many farmers will be unable to repay loans. Lower-cost, more labor-intensive means of raising yields (see para. 2.06) will have to be followed at first. Hence, lending activities of the Agricultural Development Bank of Nepal (ADBN) will initially concentrate more heavily on the Terai, expanding to the Hills as subsistence becomes assured.

27 ADBN operations continue to expand rapidly. Thirty-three new branches have been added since 1974/75, bringing the total number of branches to 140. The volume of loans also grows rapidly as Table II-2 shows. Shortterm production loans (comprising about 30% of total loans in 1976/77) have been the fastest growing component, increasing at an annual rate of 20%. Table 4: ADBN LENDING OPERATIONS, 1974/ /78 (Rs million) (Projected) 1974/ / / /78 Cereal and Cash Crop Production Farm Mechanization and Irrigation Animal Husbandry Agro-industry Horticulture Tea Loan to Agricultural Inputs Corporation Total Note: Source: 1974/75 lending abnormally large because of lending to establish rice exporting companies. Agricultural Development Bank of Nepal. But despite this acceleration, total agricultural credit is still extremely low - in 1976/77, production loans averaged only Rs 27/ha, the equivalent of only 12 kg of fertilizer. 1/ 2.14 In the past, the bulk of ADBN lending has been directly to farmers, with the consequence that most small farmers were unable to obtain credit, either because they did not own enough land to be considered creditworthy, or were far away from the nearest ADBN branch. An innovation currently being tried is group credit on a joint liability basis. But since 1973/74 lending to cooperatives has become the predominant channel. In 1976/77, 40% of total lending was to cooperatives; in 1977/78 it is expected to reach almost 60% Most of the cooperatives are of the Sajha variety (multi-purpose); the remainder are credit cooperatives from an earlier credit co-op movement now being absorbed into the Sajha movement. The sudden creation in 1976 of 1,000 Sajha cooperatives necessarily posed a considerable administrative burden on ADBN, which is responsible for their management, and obviously meant that several years of consolidation would be needed before the cooperatives could begin effective operations. There are signs that the Sajha 1/ Includes both Terai and Hills.

28 are now assuming a larger role in promoting agricultural development. Lending through Sajha increases, and the Government has recently decided that twothirds of the co-op leadership will be small farmers (including tenant farmers) to make the co-ops more responsive to small farmers' needs. However, much of the Sajha administrative efforts currently concentrate on non-agricultural activities like the sales of consumer goods. Sales of farm implements, fertilizers, and improved seeds must assume top priority in future Fertilizer use, after several years of stagnation, appears to be increasing again. The Agricultural Inputs Corporation, responsible for the importation and distribution of all agricultural inputs, reports fertilizer consumption of 31,000 tons in 1975/76 and expects consumption to continue increasing at 10-15% per annum during the remainder of the Fifth Plan Integrated rural development projects have become a major vehicle of improving life in the Hills. Most projects are district level agricultural development projects. 1/ This is based on the recognition that any improvement in rural life must start with increased agricultural production if it is to be sustained. However, they also include improvements in health, education, and water supply service. There is strong interest on the part of the Nepal Aid Group in assisting in these projects; about eight such projects are currently being undertaken. The Government's framework for rural development projects is the district administration, which since its 1976 reform is organized to carry out all local development activities. In addition, the Government attaches importance to the role of Sajha cooperatives as instruments to mobilize the participation of rural people. For the most part donors have been adjusting their rural development assistance to these realities of Nepal's development administration. Donors are also giving more attention to the large scope for food aid in the Hills, which could be used to improve infrastructure and at the same time help to meet the food shortage Any development strategy that focuses on meeting basis needs through raising income over a broad base must take a particularly demanding view of industrial investment. Agro-based industries are an integral part of economic development in a predominantly agricultural economy; however, many industrial projects, because of their capital-intensive nature, tie up large amounts of resources that might much more effectively be used in helping raise income on a broad base. The exceptions are those industries that produce low-cost, basic consumer goods like textiles, footwear, matches, and soap - products that themselves satisfy basic needs Industry, cottage industries included, is the largest nonagricultural source of income in Nepal. It is estimated to comprise about 11% of GDP - cottage and small-scale industries, about 7%; medium and largescale, about 4%. 2/ The formal industrial sector is small; according to the 1/ Some (e.g., Rapti) are being considered on a zonal basis. 2/ In Nepal, small industries are defined as those with fixed assets of less than Rs 200,000; within this group, cottage industries are those with fewer than 10 employees.

29 /73 Industrial Census, total employment was only 52,000, less than 1% of the labor force. Thus far, the sector as a whole has been strongly geared to agricultural processing; almost 80% of the over 2000 establishments employed fewer than 10 workers, and 75% of the establishments were rice and oilseed mills. These agro-industrial establishments also accounted for 50% of net output Cottage industry engages over I million persons in about 400,000 households, mostly rural. Over 90% of the establishments employ fewer than 5 workers, and have fixed assets of less than Rs 500, excluding buildings. For the most part, they process local raw materials like wool, fibers, wood and foods for.small local markets. As such, they supplement the extremely low rural incomes, and provide basic consumer goods in small isolated markets where they would otherwise not be available. Some 15% of cottage industry production is now exported, mainly in metal handicrafts, woolen products, and readymade garments Investment opportunities in large scale industry are limited by the extremely low purchasing power of the population, the inaccessibility of much of the country, the country's remoteness, and poor endowment of mineral resources. Under such circumstances, except for small agro-industries and a few industries in which entrepreneurs perceive definite export potential (e.g., jute and sugar), most private capital is invested in trade, tourism and real estate, where risks are lower and profits more assured. But as some enterprises can operate at a financial loss that can be more than offset by profits made under the Export Exchange Entitlement Scheme (see para 1.15) on exports to countries other than India, there is no guarantee that private industry is economically efficient though. Private entrepreneurs have also tried to limit their financial exposure; almost all private industry has low equity participation and a heavy debt component There is need for the Ministries of Industry, Finance and Planning to develop a coherent industrial strategy and plan. The industrial investment program for the Fifth Plan is merely an assortment of project ideas with tentative cost and output estimates. For the most part they reflect a lack of proper feasibility and market studies, consideration of alternative technologies or capacities, and consultation between concerned ministries. However, almost all project proposals reflect the Government's determination to reduce dependence upon imports of basic consumer and industrial goods, and boost exports. And although the Industrial Policy Statement of 1974 reserved basic industries for the public sector, emerging ownership patterns indicate there are as yet no standard criteria, and that ultimate ownership depends mainly upon who initiates the proposal Current public sector projects and proposals center around heavy industries and include a cement factory, a structural iron and steel mill, and a textile plant. The cement plant, with 260,000 tons annual capacity, is under construction with ADB assistance, and is scheduled to commence production in The proposed iron and steel mill is of extremely dubious viability - no provision has been made for the 35 MW annual power requirement, it would be based upon low grade local iron ore, it has unassured charcoal

30 supplies, and serious transportation problems. Other heavy industries under consideration for public investment include a silica-lime brick factory, a fertilizer production and blending plant, and an iron foundry. A textile plant of 10 million meters annual capacity has been constructed with Chinese assistance. This project would substitute for part of Nepal's annual imports of about 100 million meters, but faces problems of raw cotton supplies and difficulties in competing with larger Indian mills. The Chinese Government has also agreed to provide assistance for an additional sugar mill, pulp and paper factory and ceramics plant Major private sector projects in relatively advanced stage of preparation include additional sugar mills and factories for producing leather goods, starch and glucose, and electrical accessories. All projects would be import-substituting, except the sugar mills, which would be export-oriented. Several of these project proposals face severe raw material problems and marketing constraints Industrial investment opportunities appear limited to a narrow range of "one of a kind" import-substituting industries, a few large agroprocessing industries, and the continuation of medium-scale repeater projects, e.g., rice and oil mills, construction material factories, and leather tanning plants. Potential for expansion in organized medium and large industry probably lies mainly in (a) light consumer goods industries, e.g., garments, footwear, (b) selected primary and secondary agroprocessing industries for local and export markets, and (c) small and medium scale "repeater" projects. In these industries, improved promotion by NIDC and project preparation by ISC are required. Small and medium scale projects mobilize local capital, take advantage of dispersed markets and raw materials, and are usually relatively labor intensive. The growth of agroprocessing industries will depend largely upon increased domestic availability of raw materials, largely through increased yields in e.g., sugarcane and cotton There appears to be potential for expanding the already significant role of cottage industries as sources of incremental rural incomes, basic goods and services, and export earnings. However, problems related to transportation, limited and dispersed purchasing power, and economies of scale in certain product lines necessitate a selective approach. Cottage industries in certain lines will face increased competition from modern locally manufactured and imported goods, but will have continued advantages in meeting certain basic needs, e.g., garments, footwear, agricultural implement manufacture and repair. In exports, the already significant contribution of cottage industries could be increased (probably in woolen products, garments and handloom textiles, and metal handicrafts) if problems of design and production and marketing organization could be addressed. At present, the Department of Cottage and Village Industries (DCVI) provides training, the Handicrafts and Cottage Industries Sales Emporium markets some cottage industry products, and commercial banks are responsible for credit. However, innovative approaches to cottage industry development are needed which select promising product lines and geographical areas, reach rural craft families with low cost but effective support, and mobilize private as well as public marketing agents for exports and local sales. DCVI and ISC are conducting a cottage industry

31 study to examine prospects in five subsectors in Gandaki and Bagmati Zones, and to prepare a project for promising products and areas Tourism is the exception to the general state of economic stagnation. It is also one of the few areas in which Nepal has genuine, unique potential for development. Arrivals have risen from fewer than 50,000 in 1971 to over 105,000 in / Moreover, the average convertible currency expenditure per tourist (US$173 in 1976) has doubled since Tourism clearly deserves to be encouraged, but unless the ability to provide for tourists increases concomitantly, doing so could prove counter productive in the short-run. Some tourist services, most notably air transport, are strained to the limit, and there is some evidence of environmental destruction and pollution in the most popular trekking regions. Excursions to Pokhara are being encouraged to relieve pressure on the Kathmandu Valley, and new trekking areas are being opened up to relieve pressure on the Mt. Everest area. Nevertheless, these are at best stopgap measures, and longer term strategy will have to focus on two areas in particular: expanding infrastructure, and preserving the natural environment, through, inter alia, the establishment and sound management of national parks Despite its rapid growth, the overall impact of tourism has been limited: most of the benefits of tourism have been concentrated regionally, there has been little direct employment generation, and domestic value-added has been unnecessarily low. The decision to open up new trekking regions and otherwise encourage tourism outside the Kathmandu Valley should improve regional distribution of benefits, and the rising percentage of trekkers among tourists will increase the incomes of the rural poor in the Hills. Reducing the high foreign exchange content of tourism services (at least 40%) by diverting demand to the domestic market (most food, for instance) will not only increase net foreign benefits to Nepal, but should help improve incomes and employment. B. Social Services 2.30 Many basic needs of life go unmet for millions of Nepalese - food and fuelwood are scarce in the Hills, water is highly polluted and often far away, over 80% of the population is illiterate, and there are health problems of every description. These conditions do not only imply a low level of welfare for the majority of the Nepalese, they also have deleterious economic effects. Illiteracy is associated with slow progress in agricultural productivity; high infant mortality and ignorance are associated with high fertility, which in turn reduces the effect of a given growth rate on per capita income and investment; undernourishment and energy spent in fetching water, fuelwood and fodder reduce the scope for productive activity and lower the enrollment of children in schools. Not until education and health standards are drastically raised will it be possible for the average Nepalese to make 1/ Excluding Indian tourists arriving by land.

32 his full contribution to economic growth. Recognizing the magnitude of these needs, the Government drastically increased allocations on these social services from 15% of outlays during the Fourth Plan to 21-25% in the Fifth Plan. However, individual sector programs have yet to be fully geared to delivering these services, in terms of both strategy and efficiency The standard of health in Nepal is poor. Malnutrition is common, water is polluted, and infectious disease is widespread. As such, the solution to the health problem ultimately rests in sectors other than medical services themselves, agriculture and water supply in particular. Nevertheless, public health programs to educate in health care and deliver simple preventive and curative care are the foundation of any effective public health program The health care delivery system being developed has two serious shortcomings. First, the preventive health program places insufficient emphasis on the importance of proper nutrition, unpolluted water, and education in hygiene and sanitation. The system thus fails to tackle the underlying causes of illness, which results in an inefficient use of scarce health resources. Secondly, much of the health budget is consumed in providing hospital services that serve only the urban population, only 5% of the total. Over 50% of the country's 1,500 beds are located in Kathmandu, and the majority of the hospitals are small 15-bed units that are relatively expensive to equip and staff, yet which are unable to provide comprehensive hospital services The rural health effort focuses on health posts, small centers staffed by paramedical personnel who provide basic health services. About 410 health posts are in operation; however, the total of 810 by the end of the Fifth Plan is unlikely to be met, due to a shortage of staff. Current training permits the addition of only about 50 health posts a year. Not only are most undermanned; they also receive supplies for only about 6 months operation a year. The proposed doctor training facility at Tribhuvan University should eventually improve the availability of doctors, and steps are also being taken to increase the output of nurses and other paramedical personnel. It will be several years however before manpower constraints can be expected to diminish; in the meantime the scope for increasing health care will remain severely limited Nepal needs an effective family planning program. The dense and rapidly growing population increases the pressure on Nepal's very limited natural resources, and erodes what little improvements in incomes that are being achieved. Fewer births can also greatly improve mother and child health. Nepal's family planning program is over ten years old, and the number of accepters has risen from fewer than 2,000 in 1966/67 to over 138,000 in 1975/76. There was a decline in 1976/77 due to adverse publicity associated with family planning programs in India, but the Government believes the decline will only be temporary. Nevertheless, the results of follow-up surveys indicate fewer than 2% of the couples of reproductive age are protected. 1/ Much heavier emphasis on family planning is needed if the program is to have 1/ The survey showed that within one year only about 22% of accepters were continuing users; within 5 years, only 2%.

33 perceptible impact. Coverage of rural areas in particular must increase. Although the FP/MCH 1/ program has offices in 62 of 75 district headquarters, very little of the surrounding areas is covered. In an attempt to improve this, workers have been assigned to outlying panchayats, but to date they cover_only 330 panchayats of over 4,000 total. Given the seriousness of the population problem and the lack of financial and medical resources, solution of the population problem will require enormous determination and initiative to devise low-cost solutions and obtain mass participation Polluted water is a major source of disease in Nepal. Water systems are very few; by 1977 only 24 urban areas comprising about 5% of the population had piped water systems. Although these systems provided water to about 85% of the pqpulation of these centers, supply is only intermittent, and almost without exception, polluted. Less than 2% of the rural population are served by water supply systems. There is currently only one sewerage system in the country, a small one located in central Kathmandu Highest priority is being given to major urban centers, where the problem is considered most severe. Towns of over 10,000 population will receive comprehensive water supply and sewerage systems via private, metered connections. Smaller towns will initially be limited to water supply systems only, which will concentrate on delivery by public standposts. Towns of less than 3,000 population will receive water supply systems only if self-help is assured. In contrast with the big improvements being made in the Kathmandu Valley and the largest towns of the Terai, only 40 rural water projects have been completed since In view of the high cost of the proposed urban systems and the relatively few people they will serve, the strategy to be followed in this sector appears to require serious re-examination. The main question is the scope, for designing less expensive water systems operating at lower standards of service which would permit reaching larger numbers of people at the same investment amount Nepal has made tremendous progress in education, considering that in 1951 less than 1% of the school age population was enrolled in school, and literacy stood at less than 2%. By 1976 literacy had risen to 19%, and the primary school enrollment rate to 59%. The education strategy for the Fifth Plan emphasizes two areas: primary education and the training of middlelevel manpower. The goals are to raise the primary enrollment rate to 64% by the end of the Plan and to train 15,000 technicians to help meet development needs Official statistics indicate impressive progress in primary education during the first two years of the Fifth Plan. Enrollments in 1976 increased 61% over 1974 and the primary school enrollment rate rose from 43% to 59%. Lower and upper secondary enrollments increased by 20% and 18% respectively, over the same period. However, this achievement obscures serious equity, efficiency and quality problems in the system that must be tackled. There are still less than one-fifth as many girls enrolled as boys, about half 1/ Family Planning and Mother and Child Health.

34 the pupils in any one grade are repeaters 1/, and only about 40% of the primary and lower secondary, and 50% of the upper secondary school teachers are trained. C. Physical Infrastructure 2.39 Under the Fifth Plan, investment in primary infrastructure would be highly selective, and kept in line with the country's near-term ability to exploit it. It would be limited to investments necessary to supplement existing infrastructure (e.g. farm-level irrigation, and feeder roads), priority needs like electric power for industry, and the completion of certain priority projects like the East-West highway Transport development strategy during the first four plans had concentrated on ending Nepal's isolation, and integrating the major regions of the country. Highways were constructed from Kathmandu to India and China, and an East-West highway was started in the Terai. Despite tremendous physical constraints, the road network has grown rapidly - from only a few kilometers in the early 1950's to over 4,200 km (1,750 km paved) by Nevertheless, the road density remains one of the lowest in the world, and alternative modes of transport have to play an important role. In 1977, there were 26 regular airfields in the country, and 35 STOL 2/ airfields in the Hills. The main means of transport in the Hills remains, however, the 10,000 km of foot-trails In line with the Fifth Plan, road construction was to shift towards North-South feeder roads linked to the East-West highway. These roads would help integrate the Hills and Terai by facilitating the movement of goods and people and would improve access to the Hills. However, recognizing that road construction in the past had often been unnecessarily costly due to construction standards higher than conditions or traffic warranted, most of these roads would initially be single lane, and unpaved. Road maintenance was also to assume more importance since overemphasis of construction in the past at the expense of maintenance had led to serious deterioration of the existing road network Although progress has been made towards realizing the strategy four North-South roads are currently under construction, and two more are expected to be started later in the Plan this progress must be seen in perspective. Construction of the East-West Highway into the Western and Far Western region still absorbs about 60% of transportation outlays, and the initiative for the construction of feeder roads seems to come mostly from foreign donors and local self-help. Moreover, if completed, the new feeder roads program would still total less than 400 km, far short of the Plan target of 670 km. 1/ Consequently, primary school enrollment rates are inflated, as many pupils enrolled in primary grades exceed primary school age. 2/ Short Takeoff and Landing.

35 Contrary to the declared emphasis on North-South feeder roads, the Government intends to construct a second East-West Highway in the Hills. This project seems of questionable economic viability considering the high construction costs, proneness to landslide damage, and the low traffic density on existing roads But the Government also realizes that road construction in general is neither technically nor economically feasible on a large scale, and that improving access to Hills on a broad front requires additional, less costly approaches. Such low-cost alternatives include trails improvement, suspension bridges over rivers and widening trails. But the volume and speed at which goods can be transported by foot-trails is necessarily limited, and ropeways are a possible alternative in some areas. A recently completed UNDP study found that two proposed ropeways, one in the Far West and one in the East, would be economically viable (both IRR estimated about 8%). But before further consideration is given to undertaking these projects, several important aspects must be considered: the availability of electric power, the operation and maintenance of these systems in remote areas, their economic viability vis-a-vis low-cost roads, the desirability of being able to transport people as well as goods, and the unfavorable effect of replacing the labor of porters The sparse road network means telecommunications and radio service assume added importance as means of national integration, and development administration. Radio programs in agriculture, health, and education have proven effective channels for development in many countries, but in Nepal only the Kathmandu Valley currently has service. To remedy this, the Government intends to establish medium-wave stations in each of the four development regions. However, such a network would require many relay stations in the Hills, and depend upon the regional availability of electricity (see para. 2.48). The telecommunications system expands rapidly, and although still small, now provides services within and between major urban centers and has established international communications links. The next steps are to incorporate additional districts (only 18 of 75 have service currently), expand into western Nepal, and provide for growing needs in the urban centers. International links will also be expanded and improved to cope with increased trade and tourism Because of its location on the water shed of the Himalayas, Nepal has an enormous hydro-electric potential. However, that potential is only just beginning to be developed - the per capita consumption of electric power is one of the lowest in the world. Installed hydro-capacity in 1977 was only 33.4 MW, with about 21 MW of diesel generation in addition. Hydro-power is being developed to meet the needs of domestic industry (and to some extent agriculture) and for export to neighboring countries. However, the full extent of domestic energy needs is only just becoming apparent. Over 85% of total energy consumption in Nepal is in the form of fuelwood (in rural areas 95%) and unless alternative sources of energy are developed, it has been estimated that at current rates remaining accessible forest reserves in the Hills will be depleted within 12 years; those in the Terai, within 20 years. In some areas in the Hills farmers are now being forced to use manure for fuel, rather than as fertilizer. Failure to resolve this impending energy

36 crisis will not only leave millions of Nepalese without a basic means for survival, but also exacerbate the already massive erosion problem. Forestry and power development are thus inextricably linked Electric power delivery cannot expand as rapidly as needs would warrant, so concurrent action is needed in the forestry sector to develop additional fuelwood and control erosion. Much responsibility rests with the Forest Department. To begin with forest policy must be reoriented. It currently emphasizes forest protection and is heavily oriented towards the Terai, where over 80% of the budget and 75% of Forest Department staff are concentrated. Reforestation targets and erosion control efforts are only a fraction of what is required. However, for such programs to be successful on the national level, they will have to enlist the support of the people. Pilot projects in erosion control suggest that a strategy which relies heavily upon local administration would have the best chance of success. One precondition for such approach to be effective would be met in the new Forestry Act - jurisdiction over local forests would be turned over to the Panchayats, who would assume responsibility for their protection, control, and exploitation. However, such a program could not be successful without proper technical support from the Forest Department, which would have to shift its activities towards extension and seedlings production In the short run, the production and consumption of electric power will continue to focus on the more highly developed Central region. The region faces power shortages until 1981 when the Kulekhani scheme (60 MW) begins operations. The Gandaki project (14 MW) scheduled for operation in 1978/79 will provide only temporary relief. By the mid-1980's, the Devighat (15 MW), and Kankai (48 1W) or Kulekhani II (30 MW) projects would be needed to avert major power shortages Special regional and international cooperation would be required if the huge Karnali project (3,600 MW) were to be carried out. On the basis of the already completed survey, the project site has been finalized and the necessary structure determined. Power produced would be exported to neighboring countries. Preliminary negotiation with India on financing and power sales are starting. However, considerable additional external assistance would be required, and important technical and organizational problems will have to be solved before construction can start. Project costs have been estimated at $1.5 billion In the Hills, where transmission facilities are unavailable yet needs and potential are large, micro-hydro plants of less than 0.5 MW are regarded as one means of improving the overall distribution of electric power. By late 1977, two had been constructed, and studies had been made for 19 more. Experience with micro-plants so far has shown them to be relatively expensive, and although the provision of electric power could reduce destruction of the environment in the Hills, it appears that these projects will not be economically viable unless technological improvements permit a reduction in construction cost, and a substantial amount of power generated can be used for directly productive activities like agriculture and cottage industries.

37 CHAPTER III DEVELOPMENT ADMINISTRATION A. Introduction 3.01 Nepal has great difficulty absorbing new investment. The rugged topography of the country and consequent inaccessibility of many areas renders project preparation and implementation complex, time-consuming, and costly. The country's-landlocked position adds to these internal physical problems. Transhipment problems in Calcutta for development goods from overseas, and again at the Indo-Nepalese border add to the cost and complexity of development activities. They lead to delays and uncertainties in the delivery of basic development materials and frequently cause shortfalls in project implementation. On the institutional front, the establishment of agencies necessary for promoting economic growth has only recently begun. In the early fifties, when Nepal emerged from centuries of tradition and isolation, practically no schools and no economic development services existed, and public administration hardly extended beyond the Kathmandu Valley. Since then substantial progress has been made in establishing a cadre of developmentoriented administrators, technicians and institutions. However, it will still take considerable time before the shortage of skilled manpower is overcome The Government has made significant progress in overcoming these formidable constraints and raising the level of public investment. During the period 1970/ /77, development expenditures in the public sector increased by 9% a year in real terms. During the same years, the shortfall in actual expenditures from budgeted provisions declined gradually from 30% to less than 20%. Simultaneously, aid disbursements increased from $29 million to $47 million. Partial data suggest, moreover, that disbursements are now at least keeping pace with commitments. In 1976/77, Aid Group members' commitments increased by 67%, from $210 million to $350 million; disbursements by these donors rose slightly faster, raising the ratio of disbursements to commitments from 30% to 32% Despite this encouraging advance, investment remains at an extremely low 9-10% of GDP. Due to limited attention to project identification and preparation, long delays in implementation and poor follow-up after completion, many investments (irrigation projects, highways) have turned out to be less beneficial than expected. To some extent, a lowering of capital-output ratios should result from the shift of investments from infrastructure to directly productive activities. But aside from the earlier mentioned constraints on this shift (para 1.08), changes in development administration appear equally necessary. To achieve the urgently needed acceleration of economic growth, the Government will have to concentrate much more of its resources (including foreign assistance, as appropriate) to three tasks:

38 (a) preparing workable sector plans and identifying and preparing projects; (b) lifting institutional and administrative constraints on project implementation; (c) preparing a manpower strategy The object of this chapter is to examine briefly the progress in these areas since the Bank's last economic report and to consider what further actions are necessary. B. Sector Planning and Project Preparation 3.05 Nepal's experience with development planning dates back to the 1950's. However, to increase the operational content of its plans, the Government established special planning cells in key development ministries during the period of the Fourth Plan, as well as specialized project preparation centers for agriculture and industry: the Agricultural Projects Service Center (APROSC) and the Industrial Services Center (ISC). The Government also sought financial assistance for project planning in a number of agencies, including APROSC, ISC, the Irrigation and Roads Departments, and the Water Supply and Sewerage Board These steps are in the right direction, but they have not yet had much effect. The planning cells are almost uniformly understaffed, partly because positions in them are felt to be of little operational consequence and, therefore, unattractive from a career point of view. Although their focus has been on sector strategy, they have been insufficiently equipped to prepare workable sector plans. The industrial investment program of the Fifth Plan, for example, reflects some of the problems involved (para. 2.22) In agriculture and industry, in particular, the planning cells have been unable to examine adequately the need for improvements in development institutions and by and large they have been unable to direct the resources of the sector to the task of project preparation. APROSC and ISC, which were originally established for preparing projects for the private sector, have been used to make up for this shortfall. They have been required to involve themselves increasingly in preparing projects for public investment. Both institutions, however, are still relatively new and appear already overloaded with work. A review and perhaps an overhaul of the planning cells appears to be in order. It should depart from the principle that planning is an essential responsibility of all managers (i.e. all middle and high-level officials) in the public sector. It is not the responsibility of a separate unit alone. The function of the planning cells is to guide managers at all levels to perceive and exercise their planning responsibilities.

39 The unsatisfactory amount of resources devoted to sector planning, and project identification and preparation appears partly due to insufficient guidance from the central agencies responsible for overall resource allocation, the National Planning Commission (NPC) and the Ministry of Finance. By virtue of its central role in the decision-making process, and the experience and size of its staff, NPC should be in a strong position to ensure that sectoral investment programs tie in solidly with the overall plan. It has, however, devoted too little of its resources to this task. The Fifth Plan contains many projects which have been inadequately scrutinized for their economic and technical feasibility. In contrast, the bulk of NPC's resources appear to have been devoted to overall strategy formulation and the monitoring of plan execution. Project design, the specification of adaptive research targets, the strengthening and guidance of development institutions, and the coordination of development action between sectors have all suffered as a result. Of course, it is primarily the ministries' rather than NPC's function to carry out the more detailed planning tasks at the sectoral level, but it is unlikely that operating ministries and agencies will devote more of their best resources to these functions unless they see that this is required for their proposals to pass the muster of the NPC for inclusion in the Plan, and of the Ministry of Finance for annual allocations under the budget. This will happen only if both central agencies assert their leadership, devote more of their own resources to the scrutiny of development proposals and thus increase the general awareness of the need for planning work In the preparation of the annual budget, the Ministry of Finance does require that all requests for development expenditure be supported by justification of the feasibility of projects. The Ministry's guidelines, issued jointly with the NPC, explain in general terms the major activities to be emphasized in the investment program for the following year and specify the information required from operating agencies to support their requests for expenditure: the objectives, expected benefits, and costs of the project; their manpower and material requirements; and their state of preparation. Returns from the operating agencies, however, have generally been of poor quality, and incomplete. The annual development budgets contain many projects for which feasibility studies and total costs estimates were never prepared. Projects cutting across sectors have been advanced without evidence of coordination among the operating,agencies concerned. For example, there is little evidence of interministerial consultation on projects in hydropower and irrigation, although both use the same water resources, or on projects in transport and agriculture although agriculture is the main source of trade and transport activity. In the field of water resources, however, an encouraging development has been the recent establishment of a national water resources and energy commission. This commission is to ensure coordinated policy formulation and to provide guidance in the design and implementation of projects. In the Forest Department's programs for agricultural settlement in the Terai, the slow progress made has been largely the result of poor interministerial coordination in obtaining agreement on the release of forest land. Instances have also arisen of projects being approved without adequate specification of manpower requirements. As a result of these shortcomings, budget requests from the operating agencies have been generally of poor quality and incomplete. This has hampered the efficient use of development resources.

40 C. Implementation Problems 3.10 While the lack of adequately prepared projects has lowered the growth of investment, administrative bottlenecks have contributed to significant delays once implementation began. The history of a number of externallyaided projects indicate that the following are the main problems Budgetary allocations are released only by quarter. This makes it necessary for line management to seek special approval from budget authorities if faster disbursement proves possible. Combined with the limited authority given to line management to switch funds between items in the budget no matter how small or for what purpose, these restrictive procedures have contributed to much inflexibility in the execution of programs Implementation has also been held up in many cases by long delays in awarding contracts and effecting purchases. The inexperience of line management in many cases with international competitive bidding procedures and their limited exercise of delegated authority have been significant contributing factors. Transshipment problems at Calcutta, Nepal's only transit port at present, have exacerbated the situation Most important of all, provision for the current expenditure requirements of development projects has often been too low. As a result, many projects are inadequately staffed. Further, even this limited staff is subject to high turnover, with key personnel seeking transfers to more lucrative openings as they gain experience. In the Hill areas, in particular, rigorous living conditions and an absence of adequate housing facilities have made it difficult to place and retain personnel with the requisite expertise and experience. The Government may wish to consider whether special salary allowances, housing facilities, and promotion opportunities should be provided to development personnel in such areas The need to improve coordination among government agencies in the implementation process is most apparent in the poor follow-through.of infrastructure projects. In the irrigation and roads sectors, for example, the record of the departments concerned in bringing to completion their major civil works targets is markedly improving. However, the lack of attention to the agricultural development of the areas served by irrigation or road projects is seriously reducing the benefits they were intended to produce in the first place The problems cited above are by no means characteristics of all operating agencies and projects. Nonetheless, the frequency with which they occur makes it necessary for Government to pay much more attention than in the past to improvements in development administration At the beginning of the Fifth Plan, the Government had strengthened the autonomy of the district administrations regarding local development. The representatives of different ministries (agriculture, roads, education, etc.) were to perform their functions under the guidance of the district development

41 officer. This measure has already contributed to greater activity in many districts and has led to better cooperation in the implementation of integrated rural development projects. Nevertheless, more delegation down to the district level will be needed to achieve more flexible use of technical personnel and equipment. Central control of these resources has led to bottlenecks in planning and implementation, which could be avoided if there were greater delegation of authority to the regional and district level In an effort to streamline Government's organizational machinery, the Government established a ministerial-level Administrative Reforms Commission. The Commission's report, issued in August 1976, recommended giving more responsibility to regional and local units, and involving the Panchayats in the execution and supervision of district development projects. It also recommended a reddction in the number of ministries, single boards of directors for corporations having similar functions, and greater flexibility in personnel policy throughout the public service. These recommendations are still being studied by the Government; their implementation could clearly contribute to greater coordination and speed in development matters and is therefore very desirable It is, however, less clear that the range of measures envisaged will be sufficient to induce civil servants to indeed exercise the authority delegated to them. At present, civil servants at all levels seem preoccupied with the fear of being accused of impropriety whenever financial decisions have to be made. Such matters are almost always referred to higher levels or submitted to committees under which personal responsibility can be avoided. The propriety rather than the purpose of expenditure continues to be the main concern throughout the civil service, and the result has been very slow action even on seemingly trivial matters. These bureaucratic realities suggest that it is very important for the Government to develop strict but clear rules of conduct which make it possible for the civil servant to feel secure when exercising the authority delegated to him At the same time the Government will also want to increase the understanding by middle and high level staff of the country's development objectives. This is an essential requirement for more efficient action. An appropriate training program will need to be devised to raise the competence and development insight of civil servants, managers of public corporations and leaders of the private sector. Such a training program might include both courses in Nepal and attendance at economic development institutes abroad. Technical and financial assistance from abroad should be readily available for the design and execution of such a training program. D. Shortages of Skilled Manpower 3.20 A third factor constraining the absorptive capacity of the economy is the shortage of qualified administrative, supervisory and technical manpower. Partial information indicates that the problem is most acute in technical fields, particularly in engineering, agriculture and health services. Based on incremental needs by operating agencies for technical personnel and

42 the expected supplies of trained manpower from local education and training institutions, and overseas graduates, a deficit of 4,230 technical personnel was estimated for the Fifth Plan. No estimates are available of the requirements of public corporations and the private sector In an endeavor to expand the availability of qualified manpower, the Fifth Plan placed high priority on the implementation of the New Education System Plan initiated in 1971 which, among other aims, calls for increasing the enrollment capacity of local vocational and technical schools and improving the quality of their instruction, reorienting higher education to ensure the relevance of training to employment needs, and expanding and reorienting the curricula primary and secondary education. It will, however, take several years before these measures lead to meaningful increases in the stock of qualified manpower Comprehensive information is not available on the degree to which the Government will be able to meet is supply targets under the Fifth Plan. Information on a few key sectors, however, indicates that many positions are, and will remain, unfilled. There is a shortage of nearly 100 senior civil engineering technicians in the ministries responsible for construction projects. In agricultural extension and research work, there are some vacancies in the establishment for Junior Technicians (JT) and Junior Technical Assistants (JTA) who now number about 1,500. An additional 2,700 JTs and JTAs are required for the Fifth Plan, but only 900 have been recruited so far There are serious manpower shortages in project preparation and implementation, and overall management at all levels. To identify the most critical needs, an in-depth review of the requirements of key technical ministries is warranted. The object of such a review would be to prepare an action program for bridging current shortages and utilizing external technical assistance to alleviate them. External technical assistance could concentrate on supplementiang domestic efforts at project preparation while available domestic manpower could be used to strengthen project implementation. The proposed exercise itself could benefit greatly from input by experts in project planning and government administration; technical assistance is therefore recommended This exercise in turn should lead to more comprehensive manpower planning. The technical basis of the work currently undertaken needs to be improved. As reflected in the documentation on the Fifth Plan, it is limited in depth, coverage, and the length of the period for which requirements are determined. Requirements have been specified in occupational and educational categories which are too broad for educational planning and the identification of technical assistance needs. Estimates of manpower shortages have been made only for the public sector and do not include requirements of the private sector or public corporations. Moreover, these estimates have been limited to the period of the Fifth Plan, too short a time horizon. Because of the long lead time required for human resource development, it is necessary for a body like the NPC to devote more resources to manpower planning on an ongoing basis, coordinate the preparation and review of estimates of manpower demand and supply, and encourage and support forward planning by individual agencies.

43 CHAPTER IV ISSUES AND PROSPECTS A. Development Strategy 4.01 As the Government completes its present Plan and prepares for the next (starting July 1980), it will want to focus more sharply on the satisfaction of the basic needs of its people for food and other goods and services needed for productive survival. In such a strategy, the needs of the people in the Hills and Mountains should be given much more attention than in the past. The most important opportunities for raising food production lie in the Terai. The steps being taken to utilize this potential were reviewed in Chapter II. Projected increases in the near-term will, however, not be sufficient to cover food deficits in the Hills and restore the Terai's rice export earnings - the country's most important commodity foreign exchange earner. Efforts to raise production in the Hills have been extremely limited and although the potential of the Hills is relatively small, much more can and must be done to raise grain production. This is the only way to meet the minimum food needs of these heavily populated areas Alongside the implementation of projects to expand foodgrain production in both the Terai and the Hills, more emphasis needs to be given to developing transport and communications links between the two areas and among communities in the Hills and Mountains. These links would make it possible to deliver essential administrative, social and technical services to presently isolated settlements and help develop the basis for greater interregional trade. While progress on the East-West Highway is already improving intra- Terai transportation and communications, the limited number of north-south links which have been established so far continue to make it necessary for most Hills people to transport their needs by backpack over foot-trails from Terai markets to their homes Underscoring the precarious nature of economic livelihood in the Hills is the rapidly increasing permanent and seasonal migration to the Terai. Further labor transfers will no doubt occur and in the process mitigate the increasing population pressure on agricultural resources in the Hills. But the absorptive capacity of the Terai for productive employment is already under strain, and will be enlarged only marginally when agricultural settlements programs, now subject to long delay, begin to show progress. Altogether, the Terai will offer little additional employment opportunity to the inhabitants of the Hills unless agriculture there can be intensified and demand for labor increased. The immediate priority for Hills development must, therefore, continue to lie in agricultural production focused on foodgrain supplies in conjunction with livestock and fodder development. Additionally, as the Government addresses itself to the task of building up the physical and social infrastructure in these areas, the implementation of labor-intensive

44 rural work programs could generate short-run employment while serving as a basis for developing the productive capacity of the Hills. B. Price and Trade Policies 4.04 The costs of an early acceleration of economic growth will clearly be heavy. It will put much pressure on the investible resources that will need to be generated, and the improvements in organization and administration that must be brought about. Nepal has further to contend with the increased development costs which its rugged topography and land-locked position entail (para. 3.01). With such heavy demands, Nepal should be cautious to avoid any inefficiency in resource allocation. Current policies, however, do not always reflect this caution; on the contrary, several of them are apt to lead to serious inefficiencies To a large extent, these are the result of trade and exchange policies which have been implemented since the early sixties to reduce Nepal's economic dependence on India, with whom it shares a 500-mile border. Given the cultural, religious and family ties which have existed between the people of the Terai and India, the trading and transport networks which flow from the villages and towns of the Terai to the principal cities of India, and the long-standing dependence of the country on India for much of its needs for essential commodities and capital, more than 90% of Nepal's trade in the early 1960s was with this country To promote trade with third countries, the Export Exchange Entitlement (EEE) scheme was introduced, resulting in flexible exchange rates for exports to and imports from third countries. The EEE scheme has opened new export channels and improved the balance of trade with third countries. In the process, however, the multiple exchange rates created have made it easier for distortions to occur in resource allocation away from comparative advantage, and together with the high effective taxation of major commodity exports to India, have contributed to a weakening in the balance of trade with that country. In particular, the fixed and relatively low exchange rate with India may have given undue encouragement to imports from that country and put possible exports to it at a disadvantage. Given the deteriorating trade position with India, and as the prospects for expanding rice exports - Nepal's major export item to India - in the intermediate term are not strong, a reexamination of the EEE scheme as a means of achieving the Government's overall external trade objectives is warranted. Discussions with the IMF on this matter have been under way for sometime Other trade and price policies have had equally adverse effects on economic performance. Grain sales are subject to levies and export taxes which are acting as a disincentive to production. Local authorities have restricted the movement of agricultural products within their districts, distorting prices and production and hence, incentives to produce according to comparative advantage. Other inefficiencies have arisen from poor management of some public enterprises, and too low pricing of the output of

45 certain enterprises. Further factors contributing to the inefficiency have been the complex procedures for investment licensing, although it appears that recently more flexible procedures have been introduced. These and other policies have taxed the limited administrative capability of the public sector and contributed to inefficient resource use and a low growth rate of the economy. C. Fiscal Policy 4.08 The required pace of expansion of the Government's development programs will lead to substantial increases in both development and current expenditures., With respect to the latter, adequate provision must be made not only for staff expansion in key development sectors, as discussed in Chapter II, but also the maintenance costs of newly created infrastructure and the much needed adjustment of government salaries to enhance incentives in the wake of increases in the cost of living Resource mobilization will have to be intensified. Although tax rates are already high, there is nonetheless scope for additional revenue from sales taxes and through rationalization of the income tax and land revenue systems. Detailed recommendations on these and other measures have been made in a report by the IMF; these are now being considered by the Government. There also appears to be substantial scope for enlarging the financial contributions to the budget of the rapidly growing public enterprise sector through improvements in pricing policies, operational performance, and tax collection - matters which are now receiving the active attention of the Public Corporation Coordination Council. A further contribution to revenue mobilization could be made by higher charges on irrigation waters and other agricultural inputs; here the Government will wish to weigh the trade-off between the cost of input subsidies and the corresponding benefit of higher outputs But even if appropriate revenue action is taken, the budgetary gap will remain wide. Some recourse to domestic borrowing will of course be possible. However, in view of the need to ensure that public corporations and the private sector have adequate recourse to bank credit, and given recent pressures on the price level, further substantial increases in the use of these funds to finance public investment in the remaining two years of the Plan appears inadvisable The contribution of government savings to the financing of investment during 1975/ /78 has risen: from about Rs 0.45 billion to about Rs 0.65 billion. With current expenditures growing by over 17% per year, it will not be possible to prevent a decline in the relative contribution of government savings to the development effort unless revenues grow by about 15% per year in current prices. In recent years, about 40% of tax revenue growth appears to have been due to built-in responses to economic growth and improved tax administration. Maintaining a 15% rate of annual growth in public revenue will require continued strengthening of administration and enforcement, as well as the implementation of new revenue measures such as those proposed by the IMF.

46 As against the prospect of stagnation in public savings, a significant acceleration of development expenditures is likely to take place. In agriculture, where irrigation investment accounts for one-half of total development expenditure, new irrigated acreage is to be doubled from an average of 12,000 hectares in the first two years to about 25,000 in the remaining three. The targets appear feasible in the light of progress on a number of ongoing projects. In forestry, sizeable provisions have been made for resettlement projects but large shortfalls are likely, while allocation for reforestation are far too low. In industry, the prospects for expansion of investment remain uncertain. In road construction, the volume of work to be undertaken is planned to double. While construction capacity shows signs of marked improvement, expansion may fall short of this target. In power, the major project will be the construction of the Kulekhani hydroelectric scheme; disbursements are expected to increase rapidly in the next three years. Work on the initiation of a large number of new mini-hydro plants is also planned for 1977/ A shortfall in development expenditure of about 20% from budgeted provisions for 1977/78 is expected. Assuming further that the implementation capacity of the public sector continues to grow in line with most recent performance, development expenditure growth of some 21% per year appears likely for the period 1977/ /80. At this pace, total public investment would grow from Rs 1.0 billion in 1974/75 to Rs 2.6 billion by 1979/80. This would amount to Rs 9.0 billion for the five-year period in current prices, which compares with Rs 7.0 billion as forecast in the Bank's last economic report and Rs 7.7 billion and Rs 9.3 billion, respectively, under the Plan's minimum and maximum programs Assuming appropriate revenue measures are taken, the overall budget deficit, as shown in the table below, will increase from Rs 1.0 billion in 1976/77 to Rs 2.1 billion in 1979/80. Some Rs 0.25 billion can be expected annually from domestic borrowing, leaving the large remainder to come from foreign financing.

47 Table 5: EXTERNAL ASSISTANCE NEEDS: A TENTATIVE MISSION PROJECTION (Rs billion) 1976/ / / /80 Revenue Current expenditure Current surplus Development expenditure Overall deficit Financed from: Domestic borrowing.46 /a External aid already negotiated Gap /a Including Rs 16 billion of cash balances. D. Foreign Aid 4.15 Preliminary Government estimates suggest that disbursements from already negotiated projects will rise from Rs 0.6 billion in 1976/77 to Rs 0.9 billion in 1977/78, Rs 1.2 billion in 1978/79 and Rs 1.1 billion in 1979/80. Under these circumstances, additional disbursements of external assistance of Rs 0.9 billion would be required for the period 1977/ /80. Although new commitments in 1977/78 and 1978/79 could lead to greater disbursements than currently projected for 1979/80, present project-aid targets already appear to be ambitious. A substantial shortfall from the above amounts of aid disbursements thus seems more likely As there is no reasonable expectation that the required additional funds can be raised locally, other means for bridging the resource gap need to be considered. One means would be an increase in the proportion of total project cost financed by foreign donors including part or all of local capital costs, and current costs in sectors such as education or agricultural extension. The scope for doing so is largest in agricultural and social services projects in which domestic investment costs and associated current expenditures typically account for a large proportion of total cost. The Government already faces difficulties in ensuring adequate provision of local resources in a number of foreign-aided projects in the above fields. Greater external financing of the local costs involved could expedite the implementation of these projects.

48 Non-project assistance must also be considered as a means of bridging the gap. Such assistance could be directed at the many programs being undertaken by the Government whose individual project components do not land themselves to project assistance in terms of their size and foreign exchange requirements, but are nevertheless highly important to economic development - agricultural improvement schemes, reforestation schemes, minor irrigation and drainage works, foot-trails in the Hills areas, agricultural extension, processing and marketing projects, small-scale indigenous industry development and rural schools in remote areas, health posts and community development schemes. There are, in addition, a miscellany of other activities supported by the Government which are not suitable for project lending - particularly, local development activities supported by seed money from the Government, and executed according to the wishes and with the voluntary help of local Panchayat members. Finally, there are the import programs of the Government to help bridge the pervasive shortage of basic materials for development - cement, iron and steel, fertilizer, POL, and agricultural, industrial and transport equipment During the first two years of the Plan, the above activities accounted for some 40% of the Government's total development expenditures. But given the slow growth of GDP and resources, they will become increasingly difficult to finance, particularly since general purpose grants are declining while project aid grows and preempts an increasing portion of domestic funds in the form of local counterpart costs. Yet, such activities are crucial to development insofar as they advance the efficacy of the entire investment effort, help meet basic needs, and encourage popular participation in the development process. Special changes appear needed in present official development assistance policies for Nepal, incorporating a greater share of program-type support to accompany project lending More foreign aid directed towards sectoral development on a program basis is advocated. Such program aid could be built around the investment requirements of a number of small investments, and be combined with technical assist-ance--which-eitends beyond proiect fqxruulation and i into institut-ion-buitrd-ii-.t' 'could also include commodity assistance-for'the wage goods--needed'to reward employment To some extent this approach is already being followed in the Government's integrated rural development projects; although disbursements on these projects have not been fast, they are contributing to the financing of a number of smaller but vital activities which otherwise would not attract foreign aid. It should also be possible, moreover, to design other, more rapidly disbursing programs such as construction of replicable facilities in large areas of the country, e.g., the building of village schools, trails improvement programs, building programs for rural health posts according to standard designs, and large-scale tree planting programs. Such activities could be largely carried out by local labor who would be paid food for work. Experience with rural development programs in Nepal has shown an overwhelming willingness on the " part of rural people to join in such efforts. To be sure, such rural works programs could result in cases of infrastructure being built ahead of the concomitant requirements particularly personnel to operate them. Initially, the

49 improved schools or health posts for example might stand empty. As has occurred in other LDCs, however, political pressure on the Government to follow through with the remaining complementary measures such as the training of teachers and nurses can be expected to follow Program assistance promises a high pay-off in terms of the integrated attention which is necessary for key sectors in Nepal's development endeavors. Administrative complexities exist but it should be possible to overcome them. Candidates for such a sectoral approach would be rural works, reforestation programs, programs for minor irrigation and on-farm development and feeder road construction. Insofar as such programs would require the clear identification of the aims of foreign assistance, they should obviate the danger of dissipation associated with program aid. E. Policy Study Priorities 4.22 In few other LDCs is the case for economic growth and change more pressing than in Nepal. As the Government equips itself to deal with immediate priorities, it is also important that the foundations for sound decision-making be laid for longer-run action in the eighties. A nonexhaustive list of six issues stands out for attention A first priority is the need to refine and improve the Government's programs for raising agricultural prouct.ii.ty -- ky req'iemgent for accelerating economic growth and laying the haesi for overty alleviation. For h-is, it is essential to strengthen adaptive research to enable higheryielding crop varieties to be adapted to the many widely different sets of agricultural conditions that exist in Nepal. This research should also give a better insight in the eventual scope for the specialization of agriculture between the Hills and the Terai. Alongside such research for identifying technical options, a better understanding of the economic and social conditions is necessary, including land tenure conditions which impinge upon farm household behavior, and the ability and willingness of small farmers to improve farm practices and adopt new technology The second priority is poverty alleviation which will require better designed programs for improving the access of the poor to basic services. A prerequisite here is a systematic evaluation of existing delivery systems for extending essential administrative, social and technical services to the poor. The constraints standing in the way of a vastly,increased family planning effort appropriately linked to other basic health services, for example, need urgent examination A third priority relates to Nepal as part of the South Asia subcontinent with whose economy it is intertwined. This second area for study must be an elucidation of Nepal's development prospects as it seeks faster economic growth while striving at the same time to reduce its economic dependence on India. A host of issues needs to be carefully considered - the investment strategy in agriculture and industry, the appropriateness of the