Report No. 29382-NP Nepal Development Policy Review Restarting Growth and Poverty Reduction March 24, 2005 Poverty Reduction and Economic Management South Asia Region Document of the World Bank FOROFFICIAL USE ONLY NEA Nepal ElectricityAuthority RSF Rural Self-Reliant Fund NPC National PlanningCommission RUPP Rural Urban PartnershipProgram Nepal SIMI Nepal Small Irrigation Management Initiatives SAARC South Asian Association for Regional Cooperation SARIJE SouthAsian Regional Initiative for Energy NGOs Non-Govemmental Organizations Cooperationand Development NLSS Nepal Living StandardsSurvey SASEC SouthAsian Sub-regional EconomicCooperation NPDP Nepal Power DevelopmentProject SEB StateElectricity Boards (India) NRB Nepal RastraBank SFCL Small Farmers' Cooperative Limited NRs Nepali Rupees SFDB Small Farmers' Development Bank NTFP Non Timber ForestProducts SFDP Small Fanners' Development Program NTSC Nepal Trade and CompetitivenessStudy SIDA Swedish Intemational DevelopmentAgency OAP Old Age Pension SME Small and Medium Sized Enterprises OWC One Window Committee SPS Sanitary andPhytosanitaryMeasures OECD Organization for Economic Cooperation and Development SNV NetherlandsDevelopment Organization PAF Poverty Alleviation Fund SPO Sub Project Ofices PDF Power DevelopmentFund TA Technical Assistance PPI Private Participation in Infrastructure UN UnitedNations PRSP Poverty ReductionStrategy Paper UNCTAD UnitedNations Conference ai: Tra& and Development PSLP Priority Sector Lending Program UNDP United Nations Development Program PTC Power Trading Corporation (India) w UttarPradesh RCIW Rural Community Infrastructure Works Program VAM Vulnerability Analysis Mapping Approach REDP Rural EnergyDevelopmentProgram VDC Village Development Committee RMDC Rural Micro-Finance Development Centre WB World Bank RMDP Road Maintenance and Development Project WFP World Food Program RMRP RoadMaintenanceand Rehabilitation Project WTO World Trade Organization RNAC Royal Nepal Airlines Corporation WUA Water Users' Association Vice President: Praful C. Patel, SARVP Country Director: Kenichi Ohashi, SACNP Sector Director: Sadiq Ahmed, SASPR Sector Manager: Kapil Kapoor, SASPR Task Managers: Ahmad Ahsan, SASPR & Sarath Rajapatirana, Consultant Team Members. LynnBennet, Giovanna Prennushi (Poverty, MDGs and Exclusion); Roshan Darshan Bajracharya, Bigyan Pradhan, Sailesh Tiwari, (Fiscal and Financial Management); Christopher J. Costain, Sabin R. Shrestha (Finance and Private Sector), Mudassar Imran, Tenzin Dolma Norbhu, BinyamReja (Infrastructure); Sakwa J. Bunyasi, Gloria Kessler (Agriculture); Robert P. Beschel, Vlkram Menon, Geeta Sethi, (Governance, Decentralization); Rajendra Joshi, Qaiser Khan, Tirtha Rana, Robert J. Palacios, Tashi Tenzing (Service Delivery, and Social Protection); Bala Bhaskar NaiduKalimili, (Data and Statistics); Shahnaz Sultana Ahmed, and Neena Shrestha (document production and logistics). Dr. Deva B. Shakya and staff o f the Agro-Enterprise Center o f the FNCCI provided a background paper on the "Agriculture Development Programme for Hills of the Mid-Westem and Far-WestemRegions o f Nepal, A Concept Paper", M a y 2004. The team thanks peer reviewers Meena Acharya (Institute for IntegratedDevelopment Studies, Kathmandu), Brian Pinto (The World Bank), and John Williamson (Institute for International Economics) for very helpful comments. The team also thanks Dina Umalili-Deininger, Mark Dutz, Elena Glinskaya, Nick Manning, Daniel Sellen, Isabel G. Lavadenz Paccieri, Donna Thompson, and Salman Zaidi for comments and suggestions at various phases. The team thanks Honorable Vice Chairman o f the National Planning Commission, Dr. Shankar Sharma, Dr. Yuba Raj Khatiwada, Member, National Planning Commission and other members o f the DPR Advisory Committee o f H i s Majesty's Government o f Nepal, Dr. Tilak Rawal, Govemor, Nepal Rastra Bank, Dr. Bimal Koirala, Chief Secretary, Mr. Bhanu Acharya, Secretary, Finance, and the staff of the various Government, private, research, and civil society organizations, the D D C members from Parbat and other districts, and former members o f the VDC (Chua) for their guidance during the DPR mission in January-February 2004. The team also thanks all Government officials and other participants in three workshops, chaired by Dr. Sharma and Dr. Khatiwada, held as part of the DPR draft consultations from October 10to 12, 2004 inKathmandu, Nepal. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed /withoutW o r l d Bank authorization. TABLE OF CONTENTS EXECUTIVE SUMMARY ......................................................................................................................................... I CHAPTER 1: ASSESSING DEVELOPMENT OUTCOMES GROWTH, POVERTY REDUCTIONAND A. Difficult Initial Conditions and Challenges... ................................................................................................................................................ - SOCIAL INCLUSION 1 .............................................................. 1 B. Reforms andResponse................ C. Development Under Threat- D. Policy Lessons??om the Sour .......................................................... 7 E. Poverty Reduction andMille F. Accounting for PovertyTrends .............................. G. Social Exclusion...................... H. Progresstowardsthe MDGs I.Summingup............................................................ ........................................................ 14 CHAPTER 2: IMPROVINGMACROECONOMICPOLICIES FOR GROWTHAND POVERTY REDUCTION ............................................................................................................................................................ 17 A. Introduction: The Challengeof Restoring Growth .............................................................. 17 B. The Government'sStrategyandPolicyIssues..................................... .............................................. 17 C. Fiscal andFiduciary ManagementIssues............... ............................................ 18 D. External Sector Issues....................... ...................................................................................................... 21 .24 F. SummingUp........................................................ E. StrengtheningEconomicManagement........................................................................................................ ......................................................... 25 CHAPTER 3: IMPROVINGTHE INVESTMENT CLIMATE ........................................................................... A. Introduction -Restoringthe InvestmentClimate ................................................ 27 ................................. 27 B. The Regulatory Environment........... ........................................................ 27 C. Financial Sector............................................................................................................................................ 29 D. Infrastructure (Transport, PowerandTelecommunications)................ .......................... 30 E. Summingup .......................................................... ......................................................... 34 CHAPTER 4: FOSTERINGGROWTHINAGRICULTURE AND LAGGINGREGIONS ............................ 35 A. The Central Role of Agriculture and Emerging Dynamism............................. ....................................... 35 B. GovernmentStrategyandPolicies................... ........................................................ 36 C. Output Markets and Marketing ........................................................................................... .37 D. FactorMarkets...................................................... ........................................................ 39 E. Developmentofthe WesternLagging Regions- Challenge andPotential....................................... 42 F. Summingup.......................................................................................... ........................... 46 CHAPTER 5: IMPROVINGINSTITUTIONSAND GOVERNANCE FOR PUBLIC SERVICE DELIVERY ..................................................................................................................................................................................... 47 A. Challengesto Good Govemance......................................................... .......................................... 47 B. StrengtheningCentral GovernmentInstitutions ...................................................................................... 48 C. Making GovernmentMore Responsive:Restarting Decentralization andEmpowering Communities .......52 D. Addressing Social Inclusion........................................ ....................................................... 56 E. Summingup .............................. ...................................................................................... 59 CHAPTER 6: SOCIAL SECTORPOLICIESAND SOCIAL PROTECTION .................................................. 61 A. Introduction......................................................................................... ........................................... 61 B. Education.............................................. ......................................................... 61 C. Health....... .............................................................. 63 ................................ 65 F. SummingUp... ............................... ........................................................................................... ...........67 71 CHAPTER 7. - ACHIEVING PEACEAND RESTORINGPROGRESS. ........................................................ 73 A. MediumTermDevelopment Prospects..................................................................... B. The PovertyReduction Strategy and Growth Scenarios ........................................... C. Risks............................................................................ ......... .......................................................................................................................................... 77 REFERENCES .......................................................................................................................................................... 79 STATISTICAL ANNEX Figures Figure 1.1 Logarithmic Level o f Per Capita Income..................................................................................................... 3 Figure 1.2 Volatility inIncomes......................................................................... ..3 Figure 1.3 Nepal and Regional Governance Indicators...................................... ............................. 4 Figure 1.4Conflict Affected Districts inNepal............................................................................................................. 5 Figure 1.5 Trends and Projections o f MillenniumDevelopment Goals ......................................................... Figure 2.1 Actual and EquilibriumReal Exchange Rate................................................................................ Figure 3.1 Exit and Entry Policies... ....................................... Figure 3.2 Flexibility o f Labor Markets ...................................................................................................................... 29 Figure 4.1 Ecological Zones o fNepal ......... 37 al, 2004 ...................................... ........................................................................................................ Figure 5.1 The Structure o f Local B 53 Figure 7.1 Nepal: Real Per Capita Incomes - Peace and Conflict Scenarios............................................................... 74 Tables Table 1.1Economic Performance Indicators inPre-and ReformPeriods, andRecent Years ....................................... 2 Table 1.2 Nepal: GDP composition (% o f GDP, Average o f Period) ........................................................................... 3 Table 1.3 Disparity inIncomes and Human Development........................................................................................... .4 Table 1.4 Income and Human Development Indicators by Intensity o f Conflict .................................. Table 1.5 Growth o f Factors and Their Contribution............................................................................ Table 1.6 Comparative Human Development Indicators inFour South Asian Countries........................................... 10 Table 1.7 Gender Disparities inKey Human Development Indicators, 1996 and 2000.............................................. 11 Table 1.8 HumanDevelopment by Caste and Ethnicity............................................................................ Table 1.9 MDG/PRSP Selected Indicators................................................................................................ Table 2.1 Nepal: Fiscal Indicators, 1991-2003 ............................................................ ...................... Table 2.2 Correlation o f Prices inNepal and India ................................................................................... Table 3.1 Comparative Investment Climate Indicators ............................................................................................... 28 Table 3.2 Comparative Infrastructure Indicators............................................................................... 30 Table 3.3 Comparative Telecommunications Indicators ............................................................................................. 33 Table 4.1 Growth o f Agriculture Sector and Composition....................... ............ 37 Table 4.2. L o w Agricultural Productivity ................................................ ................................................ 38 Table 4.3 Percentage of Households Producing and Selling Different Products, Nepal............................................. 38 Table 4.4 IrrigationManagement Systems ............................................................................. Table 4.5 Fertilizer Use, Nepal.............................................................................................. Table 4.6 Potential Pocket Areas for Production and Non-FarmActivities inThree Highway Corridors o f MWDR & FWDR...................................................................................................................................... 45 Table 5.1 Comparative Corruption Scorecard for the Sectors..................................................................................... 49 Table 5.2 Functional and Revenue Assignments o f Local Bodies .............................................................................. 54 Table 6.1 Comparison of "Deaths by Cause" and DALYsLost by Cause .............................. ............................. 64 Table 6.2 Coverage of Major Social Protection Programs inNepal [need to indicate source] ................................... 67 Table 6.3 Key indicators o f public sector pension schemes in 2003 ........................................................................... 69 EXECUTIVESUMMARY A. Overview 1. Nepal - with a d@cult geography, afeudal history and a late start in development - made good progress in overcoming these constraints within the short span of afew decades; but now this progress is under serious threatfrom conflict at home and a more competitive environment abroad. Policy reforms starting inthe mid 1980s significantly increasedper capita income growth and there is emerging evidence o f a significant decline in poverty in the second half o f the 1990s that i s corroborated by improving human development indicators. Still, as the intense conflict and political instability in Nepal indicate, progress was neither fast enough and nor were its benefits well distributed to meet the tide o f rising expectations that accompanied the advent o f democracy in 1990. Due to its extreme initial poverty, even after 15 years o f reasonable growth ending in 2001, Nepal remained a very poor country with the lowest per capita income inSouth Asia. 2. Further, inequality in income and human development left the mid- andfar- Western hill regions and the Janajati (indigenous) and Dalit ("oppressed'? groups lagging behind andfeeling excluded. This exclusion has helped to fuel an eight-year long Maoist insurgency and social conflict that has sharply escalated since 2001. A constitutional crisis following the suspension o f parliament in 2002 has created further uncertainty. This conflict combined with a more competitive external environment has led growth to falter in the last three years and now threatens to reverse Nepal's progress. The extent o f this threat cannot be over-estimated. If the threat posed by this conflict i s not addressed throughpeace or mitigation, Nepal could join the few countries that achieved considerable progress but then went on to lose a decade or more o f development duringwhen poverty reduction and human development were markedly reversed. 3. This report, the Nepal Development Policy Review (DPR) of 2004 provides an assessment of Nepal S progress in development and discusses the development policy agenda and priorities to accelerate development. The aim of the review i s to inform both Government policies and further refinement o f its poverty reduction strategy as well as World Bank assistance and policy dialogue. It takes as its point o f departure the lo*Five Year Plan (2002-2007) and its Summary/the Poverty Reduction Strategy Paper (PRSP) and presents a menu o f policies that address three related development themes. The first i s the need to restart and accelerate growth mainly through commercializing agnculture and increasing trade and competitiveness. The second i s making growth more inclusive through focusing on developing agriculture and the lagging Western regions. The third i s improving governance and public service delivery by strengthening institutions at both the national and local government levels. In discussing these issues, the DPR presents recommendations, at the end o f this executive summary, to help Nepal achieve its development goals. But implementing many o f these policies will require a political consensus and mitigating, ifnot ending, the adverse effects o f the insurgency and political discord among the principal actors. It i s important to note that it i s outside the purview o f this Review to discuss the political process o f reaching such a consensus. However, following the lofi PladPRSP's approach, this review highlights the risks of an alternative scenario if a consensus is not reached and majority o f the policies recommended are not implemented. B. Constraints and Challenges 4. Lack of Connectivity:Because o f Nepal's geography, transport costs are very high, hindering the growth o f commerce and markets, and contributing to regional disparities in economic and human development. Given that many disadvantaged groups live in relatively remote regions, the lack o f physical connectivity mirrors to some extent the lack o f social connectivity. The high level o f ethno- linguistic fractionalization and the isolation o f mountain and hill population made it very difficult to achieve better distribution o f even the modest gains from growth that took place after 1985. This together with social exclusion may have contributed to the present crisis over time. 5. Deficient policy regimes: Until the mid-1980s, the policy regimes were interventionist, protectionist and public sector led. The exchange rate was overvalued. The policy environment resulted in limited private sector activity and depressed investment and foreign trade. GDP did not grow fast enough or have a broadbase, beingmainly confined to construction, trade and hospitality sectors, missing the benefits of the Green Revolution in agriculture that was taking place in neighboring countries. The policy regime created rents for some segments o f the society, while others did not have access to opportunities to earn higher incomes or to public services. 6. Limited governance and institutional development: Good governance i s hindered by a legacy o f gender, ethnic and caste-based social stratification coupled with high ethno-linguistic diversity. The centralization o f power in the Government and in the Kathmandu area has not helped to extend development to the mid-Western and Far Western regions. While there have been good efforts inrecent years to address this issue through decentralization and devolution strategies, much remains to be done. Over-centralization o f government in an ethnically and culturally diverse country also meant that economic opportunities and service delivery were poor in the remote regions. Consequently, the insurgency has planted its base firmly inthose remote Western regions, further hamperingthe delivery o f public services to those areas. Deepening the vicious cycle o f lack o f representation and poor service delivery, conflict has also ledto the dismantling o f local Governments inthe past two years. 7. External conditions have become more challenging. An increasingly competitive external environment caused by the winding down o f the Multi-fibre Arrangement, the loss o f market share inkey exports such as carpets, and a more restrictive trade treaty with India suggest that the rapid growth o f exports and the non-agricultural sector in the 1990s cannot be sustained without implementing further policy reforms and improving infrastructure. Exports have sharply fallen since 2001. The progress in integrating with the world economy in the 1990s i s likely to be reversed unless Nepal implements measures to raise competitiveness. Meanwhile, Nepal's competitors in its major exports have undertaken stronger reform measures making them more competitive compared to their past and inrelation to Nepal. Thus, Nepal has a formidable reformagenda ahead to keep pace with its competitors. C. Policy Reforms and Response 8. A fiscal and external payment crisis led to reforms starting in the mid-1980s. The reforms progressed in four phases. The first phase liberalized the import regime, investment and licensing regulations, the financial sector, and improved fiscal and financial management. Inthe second phase, in the early 1990s, entry o f firms, trade and current account transactions, and financial sector policies were liberalized and important governance reforms such as an independent auditor general and parliamentary oversight were introduced. In the third phase, in the second half o f the 1990s, the agriculture sector was liberalized, a VAT was introduced, and local government laws were passed. In the last three years, the fourth phase, the Government has implemented further tax reforms, improved public expenditure management, strengthened anti-corruption institutions, and infrastructure and financial sector regulatory frameworks. The Government i s gradually devolving service delivery management to local communities to increase their power to monitor and discipline service providers and to increase accountability. 9. Nepal's economy responded well to these reforms. Per-capita income growth accelerated since the mid-1980s, the economy became more diversified, and income volatility decreased markedly. Per capita growth rate rose to 2.5% p.a. between 1986 and 2001. The economy became more open and diversified as the share o f trade inGDP and inworld exports almost doubled. The share o f agriculture dropped from 70% to 40%. The pattern o f growth also changed in the second half o f the 1990s as agricultural growth 11 rates accelerated and its contribution to growth increased. Growth in incomes inthis period also appear to have been pro-poor in the sense o f leading to a proportionately greater increases in consumption by the lower two deciles. 10. A preliminary analysis of the Rural Household Consumption survey (2001), the Demographic and Health surveys, and the Nepal Living Standards survey of 2003/2004 suggests that there has been a signijicant decline in poverty since the mid 1990s, though inequality across regions has persisted and poverty may have increased in the last threeyears given the lower GDP growth rate. Initialresults o fthe latest household survey suggest that poverty declined from 42% in 1996 to about 3 1% in2003104. Higher agricultural incomes combined with a swift increase inremittances were associated with these first signs o f falling poverty. Consistent with the decrease in consumption poverty, surveys also show a perceptible improvement inrelated human development indicators, higher consumption o f durables, and significantly greater access to services. Despite this progress, Nepal remains very poor given that it started its development from a very low base and late. Nepal i s also unlikely to achieve key millennium development goals such as universalprimary education, childmalnutrition, matemal mortality, and access to safe drinkmg water. More importantly, the differences in poverty and human development indicators across different regions, ethnic groups and castes have persisted, which gives rise to social stress and conflict. Reduced GDP growth in recent years may have reversed gains in poverty reduction made until 2001. 11. Further, Nepal's good progress over 1985 to 2001 could not be sustained in theface of conflict and a sharp slump in exports since 2001. Nepal's GDP growth declined inFY 2002 and while a modest recovery is underway, per-capita GDP in 2004 will not have recovered to their 2001 level. The recovery i s fi-agile as it i s mainly based on a good monsoonand foreign remittances. Private investment - currently at around 12% o f GDP compared to the average o f 15% in the mid 1990s -- remains shy and key non- apculture sectors, whose growth accounted for three-fourth o f the growth in the 1990s, are performing significantly below trend. Sectors which enjoyed substantial export led growth (e.g. manufactures such as garments and carpets) in the 1990s are now facing low demand and adverse medium term prospects. Except for tourism (4% o f GDP), most o f the service sector i s also similarly afflicted. Buttourism itself i s threatenedby the insurgency and street demonstrations. 12. Afer nearly two decades of betterpe$ormance, three issues stand out as medium term challenges. First, growth has to be restarted and accelerated to reduce poverty and cope with Nepal's population increase. Even with 2.5% per-capita economic growth between 1985 and 2001, large incidence and pockets of poverty persisted. And even if Nepal's fertility rate declines to the average level o f selected Asian countries, Nepal will add 40 million to its population in the next 50 years.' Without faster growth of income and employment, Nepal will be unable to provide employment for the 2.8% growth p.a. in labor force that i s currently talung place. Second, economic growth has to be more pro-poor, inclusive and spatially even. Of particular importance i s the need to accelerate apcultural growth rates. Further, more attention has to be paid to the lagging regions. Despite plans to the contrary, investment in infrastructure in the poor and excluded Western regions lagged considerably behind, resulting in lower economic opportunities. Third, governance and public service delivery has to be improved by strengthening institutions at boththe national and local government levels. D. Development Agendafor Restarting Growth and making it Inclusive 13. The Government is aware of the challenges and has included goals to address them in its strategy. Achieving the goals of the 1Othplan and PRSP will require restarting inclusive growth while maintaining I Thapa, Shyam, "Population Growth inNepal: The Challenges Ahead", Perspective, 2001. Dr.Thapa cites a UNStudy's estimate o f 21 Asian countries. ... 111 macroeconomic stability and undertaking reforms to increase competitiveness. The goals or the four pillars o f the Government's poverty strategy are: (i)broad based growth, with special emphasis on agriculture; (ii)accelerating human development through renewed emphasis on effective delivery o f basic social services and economic infrastructure; (iii)ensuring social and economic inclusion o f the poor, marginalized groups and backward regions; and (iv) vigorously pursuing good governance as a means o f delivering better development results and to ensure social and economic justice. In addition, public investmentwill be appropriately focused on developing social andphysical infrastructure. 14. Meeting the PRSP'sfirst aim of reducingpoverty through broad based income growth will depend critically on raising growth of agriculture to the PRSP target of 4% and above and through accelerating the growth of aggregate productivity from its current low rates. Agriculture growth particularly in the lagging regions will also support the objective o f social inclusion. Excessive reliance on raising investment rates significantly may neither be feasible nor advisable ina poor country where resources are highly constrained. The main thrust should be to raise overall productivity in the medium term by commercializing agriculture and increasing Nepal's trade and competitiveness. Achieving this will depend, in turn, on a sound macroeconomic fiamework and improving the investment climate and the incentive regime. Macroeconomic Policy 15. A sound fiscal policy, complemented by prudent monetaly and exchange rate policies, underpinned Nepal's better economic performance in the 1990s; but, there are three impending fiscal challenges that have to be addressed to achieve steady and stable growth. First, the most significant danger i s contingent and off-budget liabilities arising from the financial sector related to two large, wholly or partly owned, Government banks that have a negative net worth o f around 7% o f GDP. Further, with the present liabilities of the Agricultural Development Bank o f Nepal (ADBN), total financial sector liabilities can increase the fiscal burdenby as much as 10% o f GDP - or roughly o f the same order as tax revenue collection. The second challenge to fiscal stability and sustainability i s posed by the rapid growth inpensionliabilities inthe next decade that will further crowd out pro-poor spending. The thirdcause of fiscal vulnerability i s low tax revenue collection (9 to 10% o f GDP), causing Nepal to be excessively dependent on external assistance and constraining public services, growth, and future revenues in a vicious circle. 16. Given the scarcity of resources, Government needs to make public spending more effective through four measures. First, budget envelopes need to be made more realistic. The medium-term expenditure framework (MTEF) introduced in 2002 has been a good start for prioritizing development expenditures, but it only partly addresses the issue o f unrealistically large development budget envelopes. A second measure would be to base the MTEF on program budgets that integrate and prioritize regular (current) and capital expenditures. This will also help the Government to improve donor harmonization. Third, regular tracking o f expenditures and development outcomes along with publicly disseminating the findings will help to achieve development targets. A fourth way to increase the effectiveness o f public expenditures would be to leverage private provision o f services and infrastructure investment. External Sector 17. The external sector is crucial for the growth of a small-open economy such as Nepal and opportunities exist in several areas to increase competitiveness. However, external sector adjustment i s needed to avail these opportunities and restore growth o f exports and the manufacturing sector. Export growth has fallen to 8% in the current year compared to 15% growth p.a. inthe 1990s. The medium term outlook i s clouded by the rescinding o f the Multi-fibre Arrangement in 2005 that will put Nepal at a disadvantage vis-A-vis the duty free access o f African garments exporters to the U S market under the 1v African Growth and Opportunities Act. Yet, Nepal has opportunities to exploit to increase its competitiveness: its comparative advantage in a number o f agriculture and manufacturing niche markets, its proximity to the large and fast growing Indian and Chinese economies, the availability o f preferential access to Europe and to India, hydroelectric resources for power exports to the supply constrained Indian markets; its natural beauty and important religions and cultural sites that draw tourists; a growing pool o f educated labor, and "catch up opportunities" to raise productivity. 18. But Nepal has to undertake signijicant tradepolicy and behind- the-border reforms to improve the investment climate and to take advantage of these assets. First, the remaining anti-export bias has to be reduced by adjusting tariffs away from their present cascading structure. Second, improvements in customs, duty drawback, trade facilitation, standards and quality, infrastructure and transport, and business support services will be crucial. Third, regulatory reforms in labor markets and in specific sectors such as garments, carpets, agriculture to remove price or entry restrictions have to be addressed.' These measures are neededto make the country more competitive both within and outside the region. 19. Nepal can also take measures to benefitfrom the large and swiftly growing Indian market and the trade preferences its exports to India and EU enjoy. First, Nepal needs to broaden its agreement with India to include and attract Indian investment. The aim should be to forge Indian capital, technology and market access to Nepalese capital, labor, and resources. To this end, Nepal has to pursue the proposed Bilateral InvestmentPromotion and Protection Agreement to provide further assurance on investment and trade rights to investors (including Indians). Efforts to forge formal agreement should be further complemented by advertising efforts to attract investment from India. Thus, Nepal should make a special effort to advertise its preferentialaccess to Europe through the "Everything But Arms'' initiative. Second, economic diplomacy with the Indian central government needs to be extended to the neighboring Indian states, for ensuring market access and easing transit rights. This i s important as state governments wield discretionary powers that sometimes disrupt trade. Third, Nepal needs to harmonize border procedures, documentation, special economic zones (SEZ) rules, product standards and Customs software with India such that Indo-Nepal trade and transit i s easily facilitated and third country oriented exports can also proceed with minimal transactions costs. Fourth, Nepal could facilitate Indian interests in Nepal by proceeding with building the Tibet-India transit routes and in return request more transit routes and shipping facilities at a variety o f Indianports including the efficient Mumbaiport. 20. A crucial challengefor Nepal now is to sustain the level of the current remittance earnings, which now accountfor about 12%of GDP.Government i s now preparinga new ActPolicy guideline relating to Migration and Foreign Employment. A formal memorandum o f understanding has been signed with Malaysia and ratified. Talks are proceeding with Qatar, UAE, Hong Kong and Korea. Nepal could take three other measures to sustain foreign employment. First, the most important, for the long runi s the need for continued investments in education, with special emphasis on the English language, to increase the demand for Nepalese labor abroad. Second, employment-seelang talks also need to be extended to countries such as Japan, where aging o f its population will require the import o f more foreign labor. Third, if the private sector i s not forthcoming, Nepal needs to provide attractive financial instruments for Nepalese labor to transfer their salaries via formal channels. Ingeneral, service standards inthe transfer o f remittances that allow a quick and secure transfer o f funds i s important. Finally, Government also needs to ensure a joint public and private sector oversight body to ensure that Nepal's business reputation as a reliable source of educated and disciplined labor is maintained. Conversely, this oversight should also ensure that unscrupulous private sector operators do not defraud the hard-eamed remittances by workers. See Ministry of Industry,Commerceand Supplies, HMGN, Nepal Trade and Competiliveness Study, 2004 for more details. V Improving the Investment Climate 21. Aside from restoring peace, or at least signlficantly mitigating the conflict, improving the investment climate will be essential for restarting growth. It will depend on three broad factors i.e. strengthening business environment regulatory framework to promote competition and efficiency, undertaking financial sector reforms to ensure access to credit, and improving infrastructure. 22. Reform of the regulatolyfiamework would include thefollowing. First, to reduce the costs o f entry, there i s need to clarify and simplify the implementation o f the rules o f entry. For this Govemment could reduce the number o f institutions involved and adopt automatic clearances (e.g. company registration could be linked to the tax system). Second, the bankruptcy law needs to be modemized through the new Company and Insolvency Acts to allow easier and less time-consuming exit policies. Third, consensus needs to be built around an appropriate competition law for Nepal, emphasizing both traditional law enforcement (control o f cartels, abuse o f dominance and mergers) as well as enhanced competition advocacy - influencing the regulatory process to spur grass-roots entrepreneurship as well as influencing public awareness o f all stakeholders regarding the benefits o f competition. Finally, labor market rigidities need to be addressed. Legislative reforms are needed to allow flexible labor contracts under which employers could retrench workers with reasonable compensation (in fact, rigid labor laws encourage extra-legal contracts and hiring many foreign nationals because they are easy to get rid of). Due to the rigidity o f the labor laws, formal-sector wage differentials between India and Nepal are becoming narrower than what differences inlabor productivity would warrant. As labor reforms may take time due to political opposition, Govemment could proceed, as announced inthe last budget speech, to set up Special Economic Zones and Export Processing Zones where more flexible labor market conditions could prevail. 23. In the case of infrastructure, transport remains a key constraint. Nepal has one o f the lowest road densities for a landlocked country. In a terrain where roads are the main arteries o f the economy, their lack means connectivity becomes a costly constraint. An estimated 3.5 million people (15% o f the population) do not have road access inNepal; some villages can be up to 13 days walk to the nearest road. To increase connectivity five issues need to be addressed. These are: (i) ensuring adequate funding for road maintenance (only 50% o f the needed funds are available) and making expenditure more effective through institutional arrangements such as the Roads Board; (ii) expanding the domestic road network and increasing public funding for it through completing key North-South corridors, the fast track Kathmandu-Terai link, and expanding and upgradingrural roads; (iii) better coordinatingpublic spending on roads to meet demands for private sector development and public services; (iv) creating room for greater private sector participation through improving the legal environment and institutional reform; and (v) ensuring that rural roads program supports local economic needs by transferring authority and providing technical assistance to District Development Committees (DDCs). 24. Nepal has vast hydroelectric resources, which present a source of wealth and exports to India. But,accessto power is highlylimited inrural areas andpower costs are among the highest inSouth Asia. Despite this potential and a large increase o f capacity in the last five years, only 522 MW has been developed so far. Only 40% o f Nepalese households have access to electricity. The agenda o f reform would include the following: (i) cut system losses that are still highat about 24% to gain efficiency and revenue and reduce business costs; (ii) examine alternative restructuring options to lower costs o f the power sector through negotiating good contracts with private providers and usingthe growing prospect o f power trading; (iii), explore the power export potential to India (since at present it exports only 10% o f generation); (iv) promote more commercial and private sector led power exchanges and ratify the Power Trading Agreement between India; and (v) perhaps, most important, set up a competent and effective independent regulatory body for attracting efficient private investment. vi 25. Developing telecommunications is a key to increasing connectivity and external competitiveness. Despite strong growth, there i s still considerable unmet demand and costs for firms are among the highest inthe region. A reform agenda would involve increasing competitioninthe sector, rebalancing tariffs to reduce cross subsidization, expanding access to the rural areas, reforming institutions to clarify regulatory authority between the N T C and FMD and commercializing the NTC perhaps with a view to privatization of the services. There i s also the need to clearly separate the govemment's policy-makmg and operational roles in the sector. The Government has started to implement these policies by creating Nepal Telecoms and proceedingto divest its stake. 26. I n addition to sector-spec$c regulatory agencies, Nepal would benefit from an improved legal and enabling environment for private sector participation and strengthened capabilities for contract design, bidding and monitoring across infrastructure sectors. The lack o f sufficient protection o f investor rights inthe existing Build Operate Transfer (BOT) Ordinance (2003) and Rules (2004), coupled with a potential exclusive emphasis on unconstrained sole source contracting, creates an undesirable environment that i s not in the interest o f the country as a whole. There i s a need to professionallyreview the existing Ordinance and Rules within the context o f the broader legal enabling environment for private sector participation, together with a decision on appropriate measures to strengthen the existing BOT cell within the Ministry of Physical Planning and Works. Such a review will help to ensure that all projects benefit from sufficient policy development, information sharing and implementationcapacity. Fostering Growth in Agriculture and the Lagging Regions 27. Agriculture is central topoverty reduction and growth in Nepal. It contributes about 40% o f GDP; it employs more than two-thirds of the labor force. It i s especially important to the poor, as it is the main source o f income of the poorest households (90% o f the bottom consumption quintile). Unsurprisingly, stagnant per-capita agricultural incomes over the last few decades were associated with Nepal's persistently high poverty rates until the mid-1990s. Conversely, accelerating agricultural growth has helpedreduce poverty since the mid-1990s. 28. Sustaining and improving the agricultural sector's growth performance over the longer term, will require emphasis on increasing farm productivity and agricultural marketing eficiency to strengthen farmer capacity to respond to growing domestic and international market opportunities.This will involve policy and regulatory reforms to reduce the barriers to increased private sector participation and investments in the agncultural sector, including reforms o f land and credit policies and regulations governing agricultural trade. It will require fostering increased public and private investments in rural infrastructure (roads, markets, electrification) and rural services (credit, agncultural research and extension, land administration, market information, export promotion, phyto-sanitary services, grading and quality control). Integral to the revival of the government's investment program will be institutional reforms o f government agencies to ensure the improved delivery o f rural-related public goods and services, including through greater participation o f users and communities. 29. Developing agriculture in lagging regions is a principalfactor in poverty reduction and conflict resolution. Developing agriculture inthe mid-Western development region (MWDR) and the far-Westem development region (FWDR)i s a crucial issue for Nepal both for prosperity and peace. These regions lag significantly behind the rest of Nepal by most development indicators and poverty i s more acute. Yet, these regions have considerable growth potential. The strategy for developing the lagging regions could include the following elements: (i) strengthening rural connectivity and access to markets and market services; (ii) regulatory and legal reforms to promote contract farming and producer marketing groups; (iii)developing innovative approaches to irrigation, such as drip irrigation; (iv) improving research and extension services, including through private sector and NGO participation, to improve access by farmers vii to better technologies and farming practices, including support for diversificationto highvalue crops such as horticulture; and (v) formulating market promotion strategies. Addressing Social Exclusion and Improving Institutions and Governance 30. Improving governance is constrained by a legacy of gender, ethnic and caste-based social stratijkation coupled with high ethno-linguistic diversity. Against this backdrop, there are four main challenges to improving governance. These are (i)strengtheningthe accountability and representative institutions that Nepal has built up at the local government and national level; (ii)improving government effectiveness by makmg the civil service more accountable, disciplined and professional; (iii) restarting decentralization so that the government i s more responsive to the heterogeneous needs and preferences o f a diverse people, and (iv) encouraging government and public service providers to be more inclusive to reduce large gender, ethnic and caste based disparities. To implement these Nepal can draw on an unusually active community involvement - that is, the presence o f active local social capital -- in development witnessed inmany areas such as forest, education, roads, irrigation, water and sanitation. 31. At the civil service level, the Government has several priorities. First, the civil service has to be made more effective and professional through improving its slull mix, increasing incentives by raising the salaries o f senior managers and professional staff, enforcing tighter discipline, better performance evaluation, and more diversity. A related issue i s clarifying accountability between the civil service and politicians by changing civil service rules. As part o f the effort to improve the effectiveness o f the civil service, a second important priority will be to implement measures already outlined in the govemment's "roadmap" to promote greater gender, caste and ethnic diversity at all levels inthe civil service. 32. After having achieved a strong start, decentralization has now stalled as the tenure of the last local governments expired in 2002 and Government now needs to resolve key pending issues. One indication o f the recent slowdown i s that although the Government has set up a high level Decentralization Implementation and Monitoring Committee (DIMC) this body has not met for the last two years. One way to restart the process i s by making the D I M C resolve key pending issues such as the following: consolidating the size and number o f Local Bodies to ensure that they have adequate revenue bases; implementing administrative decentralization through forming a local Government civil service clearly accountable to them; clarifying ambiguity between various political and administrative entities at the local level, including DDCs, VDCs, School Management Committees and line departments. This would require amending the provisions in 21 Acts that contradict the Local Self Governance Act. Alongside administrative decentralization, fiscal decentralization needs to be strengthened through clarifying overlapping and limited expenditure assignments and improving revenue decentralization and collection incentives, and bringingmore clarity to the fiscal transfer system. 33, With the IOth Plan/PRSP there has been explicit recognition of caste and ethnicity as factors affecting income and human development outcome, and the importance of social inclusion. Besides grassroots development programs, there has been some recent advancement at the policy level. Although it still leaves some issues un-addressed, the passage o f the 11' Amendment (known as the Women's Inheritance Bill) in 2002 was a step towards greater legal equality for women. Progress has been slower on caste and ethnic groups. Although there are laws setting punishments for discrimination against Dalits, many forms o f discriminationare commonly practiced throughout the country. A further challenge to inclusion i s to help non-Nepali speaking children from ethic and linguistic minorities to transition successfully into the Nepali-medium schools by providing bilingual teachers - preferably females from disadvantaged groups. On a broader front, the government has shown its concern for increasing the representation o f excluded groups not only to the civil service, but also in elected government (at all levels) and inhealth, education and employment. This effort will need strong political backing and expert technical advice to look at a range o f strategies adopted by other countries that have tried to redress ... V l l l historical discrimination without undermining meritocracy or creating rigid and divisive entitlement systems. Human Development Policies and Social Protection 34. Nepal has achieved considerableprogress in improving human development indicators in thepast decade but signijkant disparities persist. Initial results from a sub-sample o f a recent household survey shows that the people perceive much improved access to education and health services compared to 8 years ago. Still, Nepal could fall below MDG targets and the goals o f the Tenth plan in areas such as matemal mortality, child malnutrition, and sanitation. Further, large regional and social group based disparities persist. 35. Education funding, quality, management by local communities and secondary and tertiary education are issues to be addressed. After achieving 80% net enrollment rates in primary education Nepal faces many challenges in meeting the goal o f universal primary education (UPE) along with ensuring quality. The first i s to provide adequate funding, supplies and teachers for public schools so that the poor are not deterred by highcosts of fees that schools feel compelled to charge to meet these needs. Second, faced with school bureaucracy or teachers that are not accountable to local communities, Nepal now has embarked on a program to empower communities to manage their own schools. This measure will have to be implemented with proper legal basis to resolve ambiguity o f roles. Resistance from government officials will need to be countered by transferring the authority for hiring teachers to these communities. As this i s a new initiative, there i s need to monitor and evaluate its impact. Third, while major gains have been made in prioritizing primary education, more resources will.be needed for secondary and tertiary education. This would require greater private sector participation and cost recovery. 36. Health strategy needs to prioritize public spending and promote greater private sector participation. Nepal witnessed many health status improvements inthe 1990s. But, given the poor initial conditions and deficiencies in delivery systems, several health indicators (such as matemal mortality, child malnutrition) are among lowest in South Asia. There are also considerable differences in access to heath services based on income group, locality, caste, ethnic group and gender. Communicable diseases, maternal mortality, and poor nutrition cause most o f the burden o f disease. Although the Government's 10th Plan the Health Sector Strategy puts forward an Essential Health Care Program o f four priority interventions, the allocations o f public funds - mostly more tertiary care --do not reflect these priorities. Alongside ensuring adequate resources, the other challenge for Government i s ensuring that the priority interventions are well implemented. This will require the Government to follow through on its program to devolve public health posts to Local Health Management committees. Government will have to formulate a more systematic strategy to mobilize the private sector, which accounts for 70% o f all health spending, for providing services for the poor. 37. Water supply and sanitation coverage has grown but quality has emerged as an issue. In the 1990s, the sector saw reforms that shifted from the supply driven approach to service delivery o f the 1980s to a demand driven approach. It also adoptedparticipatory decision malung in delivering rural water and sanitation services. In addition, community participation has shifted from voluntary labor contribution to community empowerment and management. Though this approach had much success and officially 80% o f Nepal's population has access to safe water, in practice poor maintenance has led to poor quality o f water supply and doubts whether MDG targets can be reached. A host o f issues need to be addressed for further progress in this sector. These include little coverage inthe Eastem regions, poor coordination by overlapping sector institutions, unreliability o f supply and water quality, lack o f a adequate framework for community participation, thinly spread public expenditures, politicization o f tariff adjustments for cost recovery and lack o f good monitoring and evaluation systems. ix 38. that accelerating economic growth i s not sufficient for poverty reduction, the lothPlan includes several Socialprotection require better coordination and avoiding large potential liabilities: Recognizing targeted programs intended to protect the most vulnerable as part o f its social protectionpillar. But there are questions about the effectiveness of a patchwork o f Government programs many with small numbers o f actual beneficiaries and relatively high administrative overheads. The origin o f many o f these programs i s ad hoc: either when Nepal signs international conventions (e.g. children, disabled etc.) or sometimes when they are leftover from donor fundedprograms that have lost external support. The main issue about social protection schemes inNepal i s that they need coordinating and better evaluation o f their effectiveness to focus on a few effective programs such as the Old Age Pension scheme. The second issue i s the potential financial liability as well as the labor market rigidities that Nepal's back-loaded formal pension systems create. E. Medium Term Prospects 39. Nepal is at cross roads today between the prospect of sustaining and accelerating appreciable gains in human development and poverty reduction and the dangers of serious reversals of these gains. The PRSP presents two medium term scenarios - the normal case and the alternative case - to take into account the downside risks arising from the present conflict and constitutional crisis. Underpinned by a prudent fiscal framework that lowers public sector borrowing requirements to less than 1% o f GDP inthe final year, the "normal" scenario inthe PRSP projects growth rate o f 6.2% p.a. over the next five years - with growth rates reaching a maximum o f 7.5% at the end of the plan. The alternative low-case scenario projects a 4.3% growth rate per annum. It i s more likely that the alternative scenario i s the relevant one given recent developments. Much depends on a return to peace. Otherwise, even the alternative scenario may not be feasible. Raising productivity will likely be the main driver in accelerating growth rather than raising savings and investments. 40. There are considerable risks in the medium term arising out of the conflict, implementation capacity, and external conditions. The risks are the following. The first and most important risk comes from conflict and the constitutional crisis that have created instability and uncertainty about institutions, rules and laws. The second risk arises from the tension between the substantial reform agenda and the Government's capacity to implement it. A more competitive external environment brought about by the forthcoming phasing out of the MFA and Nepal losing market share in other exports poses the third risk. The fourth risk i s a long term risk, which requires interventionnow. At current fertility rates, there will be more than a tripling of population in the next 50 years with tremendous pressure on land and other resources. The fifth risk i s posed by the contingent liabilities o f the non-performing assets o f the two large banks whose negative net worth are estimated to be about 7% o f GDP. 41. The Development Policy Review has highlighted technical aspects of implementing of three key themes of the IOthPlan/PRSP - accelerating growth, making growth more inclusive, and strengthening institutionsfor good governance. Implementingthe specific recommendations will require willingness on the part o fall parties to discuss, evaluate and come to an agreement on these specific measures. It is only thenthat the PRSP/lO* Plan's normal casecanbe achieved. X Key Recommendations EconomicManagement Improve economic management through better high level monitoring o f economic, trade, transport, and agricultural performance and hold regular consultations with private sector groups to identify critical areas for policy formulation. Address emerging actual and contingent fiscal liabilities. Restructure the two main commercial banks and undertake pension reforms to maintain fiscal soundness and introduce an explicit reporting system on the financial operations, guarantees issued and balance sheets o f public enterprises to monitor actual and contingent liabilities. Raise revenues by devolvingmore administrative power and budgetsto the DGs of Inland RevenueDepartmentand Customs. Implement a Custom's modernization plan, computerize tax processing to reduce discretionary power and transactions costs. Improve public expenditure managementby: (i)preparing programbudgets that integrate all expenditures in the MTEF; (ii) allocationandimplementationofexpendituresonkeyeconomicactivitiesinroads; (iii) expendituresof raising raising non-salary current expenditures; (iv) tracking expenditure; and (v) increasing fiscal decentralization through transferring more functions and budgets for service delivery to local Govemments. Agriculture,Trade, andInvestmentClimate Promote the commercialization of agriculture through the development of infrastructure, and improved delivery of agricultural services and legislation to make contracts, commercial farming and farmer marketing groups more legally secure; ensure supply o f credit through MFIs as ADBN is restructured, and introduce matching grants; and secure land rights through better land records to remove all remaining ambiguity on the dual tenure system. Adopt a comprehensivelagging regions strategy to develop the mid- and far- Westem hills and mountain areas through providing roads, infrastructure, and policies to facilitate private sector and farmer group based commercial agriculture. Set up an Apex Trade organizationto implement proposals of the Government's Nepal Trade and Competitiveness Study to improve trade policy coordination, reduce customs and transport costs, improve facilities for standards andmarket access, improve conditions for FDI by reducing SME reservations, and address the specific supply side constraints in garments, carpets, tea, and other sectors. Use Nepal' access to the EU's EBA facility to attract capital and expertise from India and other countries to locate production inNepal. Amend the labor act to make the labor market more flexible by enabling contracts between employers and employees that allow flexible hiringand retrenchment arrangementson agreed terms. Provide exemptions from labor market constraints within export processing and special economic zones. Attract PPI in transport, power and telecommunications sectors with revisions to existing laws such as the Build Operate Transfer Ordinance (2003) and Rules (2004) to protect investor rights while ensuring sufficient transparency and competition, strengthening capabilities for contract design, bidding and monitoring, and setting up independent regulators. Corporatize Nepal Electricity Authority and proceed with unbundling of operations. Set up a formula approach tc tariffs to avoid politicizing tariff setting. Ratify the Power Trading Act and the Power Trade Committee. Increasetransport connectivityby (i) improving road maintenance through increasing allocations to be spent through the Roads Board; (ii)extending the road network by completing the three North-South corridors in the Westem regions complete the Kathmandu-Terai fast track link and upgrading rural roads; and (iii)reducing transport costs througk harmonizing border procedures and documentation with India and other neighboring countries for groups to identify anc resolve key policy and implementation issues. xi Key Recommendations ImprovingPublicServices, EmpoweringCommunitiesandPromotingInclusion Strengthen institutions for accountability and transparency by restoring representative local Governments, financial management rules (such as making the Auditor General's Report accessible to the public) and introducing a Freedom o f Information act missing inNepal Improve civil service performance and professionalism through salary decompression and increase in executive ranks, tighter enforcement of discipline, making transfers transparent and counter signed, and making civil service more inclusive through measures suggested in the report. Clarify accountability o f political and civil service levels through sharper delineation of roles. Restart decentralization and strengthen devolution by empowering local governments and communities by making service providers responsible to them. Create local Govemment civil service recruited on a centralized merit basis, but employed by local Governments. Transfer greater resources to local Govemments through the DDC formula and make the formula more comprehensive; clarify all ambiguity with respect to functional authority o f local Governments vs. central agencies. Take advantage of Nepal's effective community group organizations and local social capital through devolving authority, responsibility and resources for service delivery to water user, road user, water and sanitation, and women's savings associations, school and health management committees. Clarify ambiguities concerning roles between local Government and community groups. Transfer recruitment authority o f teachers to school management committees and stop centralized recruitment. Transfer all water and sanitation project maintenance to user groups after their rehabilitation i s complete. Introduce better performance evaluation of local Government and senice groups through regular public expenditure tracking and core welfare and service delivery surveys to be carried out by independent parties and make this informationavailable to all user groups. Address the main diseases that contribute to the burden of disease by extending Essential Health Care package, in phases, with special focus on improving coverage of nursemidwife attended births. Reform regulatory framework to encourage greater private and NGO participation inthe delivery o fbasic health services. Enforce new laws to increase representation of Janajati, Dalit and women in civil service and other public institutions. Set up a bilingual education program at the primary level for transition o f children from non-Nepali to Nepali. Rationalizesocial protection programs through evaluating their impact and cost-benefits. Expand small but good base of micro credit organizations to include savings and other micro-life insurance. xii CHAPTER1:ASSESSING DEVELOPMENTOUTCOMES - GROWTH, POVERTYREDUCTIONAND SOCIAL INCLUSION A. DifficultInitialConditionsand Challenges 1. Nepal had a late start in development in the 1960s andfaced formidable challenges, including a difJicult geography and a history that left it extremely poor in terms of physical and human capital endowments. In terms of geography, Nepal is a landlocked country with a difficult terrain that rises steeply from the plains of Terai in the South to the middle hills and to the Himalayan range in the North. Transport costs are very high, hindering the development o f commerce and markets, and contributing to regional disparities in economic and human development. For more than a century after 1846, Nepal was ruled by the dynastic Prime Ministerial Rana family, whose principal objective was the extraction of resources from the land and the people to support a lavish lifestyle and repress any political or economic threat to its continuity. Thus, as late as forty years ago, Nepal had strilungly low levels of human and physical capital and infrastructure compared to its neighbors. Today Nepal i s the poorest country in South Asia with a per-capita income o f about $250. 2. The problem of Nepal's difficult initial conditions was compounded by the policies that Nepal followed in the next two decades until 1985. These policies, based on development thinking o f those times, were interventionist, protectionist, state-led, and resulted, until recently, in a large public sector, dominance o f state corporations, and a closed economy leading to low levels o f investment and productivity. 3. Thus between 1965 and 1985, the first two decades for which data are available, per-capita economic growth was stagnant at round 0.6% (see Table 1.1next page) but with the additional burden of Nepal's rising population growth rate and without thefruits of the Green Revolution then takingplace in the countries to the South. With a significantly appreciatedreal effective exchange rate inthe first half o f the 1980s, economic growth was heavily concentrated in the non-tradable activities, mainly in construction and restaurants and hotel^.^ Further, suppressed interest rates and the overvalued exchange rates led to capital-intensive production and employment growth was too slow to match the growth of people entering the labor force. 4. Private sector investment rates were low during this period (at 9% of GDP, see Table 1.1) and the economy remained closed and undiversiJiedwith agriculture accountingfor close to 60% of GDP and more than 90% of employment at the end of thisperiod - the mid 1980s.Infrastructure was very limited at the end o f the period. As recently as in 1985, 78% of the worlung age population o f above 15 years had no schooling compared to 61% and 63% in India and Bangladesh respectively. Finally, excessive Government expenditures and burgeoning deficits pushed Nepal into a fiscal and external crisis in the early 1980s. The real effective exchange rate i s defined as the relative price ofnon-tradables to tradables. Table 1.1 Economic Performance Indicators in Pre-and Reform Periods, and RecentYears Pre- Entire Reform Reform Period 1971- 1981- 1991- 2001 2002 2003 2004 1965-85 1985-2001 1965-2001 1980 1990 2000 est Growth (%) Real GDP Per capita Income 0.8 2.2 2.4 3.1 -2.8 0.7 1.4 0.6 2.5 1.6 Real GDP 2.8 4.5 4.7 5.5 -0.6 3.0 3.7 2.6 4.8 3.8 Population 2.1 2.3 2.4 2.3 2.3 2.3 2.3 2.1 2.4 2.2 Investmentand Savings (YOof GDP) Investment(Including Stocks) 16.3 19.9 23.3 24.1 25.6 26.9 27.2 17.6 22.6 20.5 Public Fixed Investment 3.9 7.7 7.0 7.6 7.6 6.9 7.2 5.0 7.2 6.1 Private Fixed Investment 9.2 10.8 13.7 11.4 11.7 12.3 12.8 9.4 12.6 11.0 Gross Domestic Savings 9.0 10.5 12.8 15.0 12.0 11.4 11.3 7.5 12.3 9.6 Fiscal Indicators (% of GDP) Revenue 6.5 8.5 9.8 11.4 9.3 12.4 12.2 6.3 9.4 7.8 Expenditure 11.0 17.6 16.5 17.5 17.6 16.1 17.4 11.3 17.0 13.8 Deficit 2.2 6.5 5.3 6.1 8.3 3.7 5.2 2.5 6.0 4.0 olw Domestic Financing 1.1 2.8 1.5 2.7 4.8 0.9 0.9 1.3 2.0 1.6 Public Debt ,, 64.4 63.8 69.7 66.6 64.0 58.3 Public Savings 0.2 0.2 0.8 0.1 External Sector (% of GDP) Export to GDP 11.4 11.7 21.0 24.1 19.3 16.9 15.7 11.5 17.9 15.8 Import to GDP 16.1 21.1 32.2 35.6 30.6 31.5 31.8 18.5 28.6 25.2 CAB to GDP -0.4 -4.7 -4.8 4.8 4.5 1.8 1.0 -2.0 -4.0 -3.2 Gross Official Reserves in Months of Imports 6.7 3.6 5.4 6.1 Money and Credit (YOof GDP) M2 16.2 27.2 37.5 52.2 53.0 54.2 56.1 16.6 36.3 25.6 Domestic Credit (net) 9.6 24.9 32.6 44.7 47.4 49.4 51.1 10.5 32.4 20.4 Domestic Credit to Private Sector (net) 6.1 11.3 21.433.2 33.6 35.9 .. 6.1 19.6 12.4 Prices and Interest Rates (%) Inflation 7.5 10.6 9.3 2.2 2.9 4.5 5.3 7.5 8.8 8.2 Lending Rates 13.5 15.6 12.4 7.7 ,, .. .I 14.7 13.5 13.9 Source. World Bank estimates from various sources. B. ReformsandResponse 5. Responding to balance ofpayments andfiscal crisis, Nepal started implementing economicpolicy reforms around 1985 that progressed over four different phases in the next twenty years. In the first reform episode (1985-1986), public savings rose due to improvements in expenditure and tax policies. Importantly, a 15% step devaluation was undertaken to correct external imbalances that helpedto offset a significant overvaluation of the exchange rate. Structural reforms made the first attempts to liberalize the import regime, introduced duty drawback and bonded warehouse schemes, and eased industrial licensing. 6. In the second reform episode, in the early 1990s, the tax base was broadened, revenue administration improved and trade and industrial policies werefurther liberalized. A steady reduction in tariffs was launched and quantitative restrictions virtually dismantled. In addition, the foreign exchange system was unified and Nepal attained current account convertibility. Interest rates were liberalized and banking sector entry was facilitated. The private sector expanded due to liberalization o f entry through the new investment act and privatization. After stalling in the middle 1990s, the third reform episode around 1997 liberalizedthe agncultural sector, introduced a neutral VAT and strengthened local governments. In 2 the most recent reform episode since 2000, the 1 Figure 1.1 LogarithmicLevelof Per CapitaIncome4 Government has improved tax policy and administration, I 6.3 introduced a medium-term expenditure framework, I restructured the management o f Nepal's troubled two main commercial banks and strengthened financial sector regulations and anti-corruption efforts. 7. As evident from Table 1.I on theprevious page, the economy responded well to these reforms. First per- capita income growth accelerated markedly after reforms were launched inthe mid-1980s (see also Figure 1.1)and the economy diversified (See Table 1.2) as the growth was led by industry and services. Second, the share o f 1965 1970 1975 1980 1965 1990 1995 2000 agriculture fell from 64% of the economy in the mid- -Log -Log of Per Capita Income of Trend Per Capita lncom 1970s to less than 40% at the beginning o f the 20' century. The share of industry increased from 12% to Source: WorldBankestimatesfrom CBS data 21% thirty years later. 8. Third, this diversification led to significantly Figure 1.2 Volatility in Incomes lower volatility in incomes as evident in Figures 1.1and 1.2 As the sources of growth moved away from agriculture to industrial and services sectors (finance and construction), and irrigation expanded, the dependence o f the economy on rainfall declined. The standard deviation of per-capita GDP incomes fell from nearly 4 in the 1965 to 1985 period to around 1.5 in the second period. It i s evident that achieving successful stabilization and better fiscal, financial and extemal sector policies helped to -0.02i I -004 improve economic performance. Nevertheless, a 65 considerable agenda remains pending. II " " '70' '75' '"80' " " " 85 ' 9 0 ' 95 ' "00 I-GDPGrowthRates 1 Source: WorldBankestimatesfromCBS data 9. Notwithstanding these achievements, three signijkant development failures made the Table 1.2 Nepal: GDP composition (% of GDP, Average of Period) foundations of Nepal's development fragile, and 1975-1977 1999-2001 sowed the seeds of the faltering economic Agriculture,fisheries,forestry 64.2 39.0 performance and the violent insurgency in Nepal's Industry 10.6 20.4 countryside since 2001. Foremost among the policy Manufacturing 4.8 9.0 failures in the 1990s was the exclusion o f certain Electricity,Gas, Water 0.3 0.8 regions and ethnic groups and castes from the benefits o f growth and human development. In Construction 5.4 10.1 particular, the Western to Far Western hills region Services 25.2 40.7 accounting for around 22% o f the population and Trade, restaurants,hotels 4.1 11.2 some specific ethnic and caste groups (the Dalits Transport, communications,storage 5.4 8.5 and indigenous Janajatis that account for 46% o f the Financialand real estate 8.5 10.1 population') were left lagging behind. A 1999 Community and social services 7.2 10.9 estimate suggests that incomes in the mid- and far- Source: Estimatedfrom CBS Data. The trend of actual andlogarithmicper capita GDP i s derived from applyingHedrick-Prescottfilters. This trend can also be seen as representingpotentialoutput suggestingthat Nepal's economyachieved at or abovepotentialinthe 199Os, while less than so beforethat. Accordingto the 2001 Census. Western hill regions were only one half o f that in Kathmandu valley and Eastern Terai (Table 1.3). Similarly, these areas and excluded ethnic groups have lower education and literacy levels, and higher infant and maternal mortality rates.6 Set against the highexpectations broughtby the advent o f democracy in 1991, this exclusion led to disenchantment among the lagging groups and regions, which became the base o f a violent "Maoist" insurgency. Table 1.3 Disparityin Incomesand Human Development Population (%I IlliteracyAdult Human Per Capita Lifeexpectancy Human PovertyIndex Income (Yea4 developmentindex - Rural 8% 52 41 1094 58.7 446 East 23 43 42 1073 62.0 Central 35 52 41 1713 61.3 West 20 40 1022 67.3 Mid-West 13 45 43 861 53.2 Far West 9 5 45 899 52 1 ,385 Source. CBS and httDl l w UndD or4 nd~ublications/nhdr2OOl/cha~ter2 Ddf 10. The second policy failure was the inability to provide a policy environment to generate and sustain rapid growth to combat poverty. Nepal's long-term per-capita growth rate o f 1.7% p.a. between 1965 and 2001 meant that per-capita income grew from US$130 in 1965 to US$240 ($1350 inPPP terms) in today's dollars and exchange rates. Given that at the current trend of fertility decline Nepal's population i s expected to grow to 77 million in the next four decades, it i s clear that the population growth will be putting enormous demand on the country's resources and require a much faster growth in the demand for jobs. Inthe past slow growth also meant that growth o fjobs was limited and didnot keep pace with the growth of the labor force dampening the growth o f wages. Of particular importance has been the lack o f agriculture sector growth until the second half o f the 1990s. On a per-capita basis, per- capita agricultural output remained largely stagnant over the thirty-five year period ending in 2001. As 85% of the population remains inrural areas and 80% o f the labor force worked inthe agriculture sector even as late as 1990, the stagnancy of the agricultural incomes largely explains the persistence of poverty into the mid-1990s. Conversely, the marked increase in agnculture growth, along with remittances, i s likely the key factor behindpoverty declining since 1996. 11. The thirdpolicyfailure lay in low Government effectiveness - i.e. the ability Figure 1.3 Nepal and Regional Governance Indicators NEPFIL (2002) to implement its ownpolicies -- combined I with political instability. The insurgency Voice and RccountabiJitg I and the political conflict are undermining I Political Stability I the credibility o f public institutions. I Comparison o f measures o f governance Governnent Effectiveness I with neighboring countries (Figure 1.3) shows Nepal to rank poorly in several Regulatory Quality I governance indicators but particularly so I Rule of Lau in political stability and government 1 I effectiveness. Moreover, in the last two Control of Corruption I years these indicators may have got ! I worse. EI 25 58 75 IEE Conparison uith regional average (South Asia) (louer bar) Country's Percentile Rank (O-lBB) Iourcs: D.KauW"r 0. Knxls md R.Ihislruni, 2003: Gouemmce R ~ l l e r s111: G o u r n m c r Indicators #am 1936-2002 Ihltp://uwu.urrldb~nh.~rsnibi~r~u~m~nc~nub~~~~unrltnl5.hiolI See Table 1.8 on page 12. 4 C. DevelopmentUnder Threat -Recent Developmentsand Conflict 12. Due to these policy failures, the achievements of the 1990sare now under Figure1.4 ConflictAffectedDistrictsinNepal threat of reversal from several directions FAR .- and pose a considerable challenge to the Government. An eight-year long insurgency that has claimed more than 10,000 lives - most o f it since 2002 - has disrupted development and governance in big parts o f Nepal, inflicting large costs o f war (See Fig. 1.4 and Box 1.1). A more competitive external environment brought about by the rescinding o f the MFA and steady loss inthe market share o f exports such as carpets suggests that the rapid growth in exports and the non- agricultural sector inthe 1990s cannot be sustained. Source: IJNNotification. Januarv 2004 13. Indeed, in an early indication of Nepal 's difficult medium term prospect growth hasfaltered from 2002 when Nepal was confronted by the conjluence of adverse economic shocks -- excessive rainfall, a global slowdown that led to a collapse in exports, and a sharply escalated Maoist insurgency. Nepal's GDP declined in FY 2002 and a modest and fragile recovery i s underway with GDP growing by around 2.3 percent inFY 2003 and is expected to be close to 4% inFY 2004. Yet, the recovery i s fragile as it is wholly based on a good monsoon and foreign remittances. Private investment - currently at around 12% of GDP compared to around 15% in the mid 1990s -- remains shy and key non-agriculture sectors, whose growth accounted for three-fourth o f the growth in the 1990s, are performing significantly below trend. Sectors which enjoyed substantial export led growth (e.g. manufactures such as garments and carpets) in the 1990s are now facing low demand and adverse medium term prospects. Except for tourism (4% o f GDP), most o f the'service sector i s also similarly afflicted. But tourism itself i s threatened by the insurgency and street demonstrations. Regenerating growth will require foremost the restoration o f peace or at least a significant mitigation o f conflict. But this requires an understanding o f the origins o f the conflict and its costs. Box 1.1The "Maoist" InsurgencyinNepal-Origins and Costs The origins of the "Maoist" insurgenq, which began in 1996 but became intense after 2001, lie in both ideological issues as well as regional, caste and ethnicity related exclusion issues. The ideological aspect is more related to Marxist-Maoist class conflict against "feudalism", whose main political demand i s to hold a constitutional convention that would also consider the option o f creating a republic as an altemative to the current system o f constitutional monarchy. The caste and ethnicity based aspect is rooted in the exclusion o f different caste and ethnic groups based on a specific hierarchy. The regional aspect concems the mid and far westem Hill regions that lag behind most development indicators where the Maoists' conflict originated (see Figure 1.4). Resolvingthe conflict will depend very much on the commitment o f the different parties to agree to a common set o f rules of the game with respect to politics as well as making economic growth more inclusive b y different means discussed in the review. The cost of the Conflict on the economy and the people are enormous. Currently the conflict is imposing high costs in terms o f foregone growth and poverty reduction, through several channels: -- dampenedprivate sector investment and confidence due to insecurity and uncertainty; -- extortion o frents and informal taxes by Maoists from large and small businesses; (Continued innext page). 5 Box 1.1The "Maoist" Insurgency inNepal-Origins and Costs (Continued) --lower public investment as development spending is curtailed; --lower sales o fprivate fmby20 to 25% to rural markets due to transport disruptions; -- increase in transportation costs and time. For instance the transit time between Kathmandu to BirguanjRaxaul, a key economic link,has been doubled due to the conflict; -- direct costs to infrastructure, which i s estimated at about $250 million; -- human and capital flight away from conflict affected areas. Household survey data shows as many as 20% o f male working age populationhave l e f l some o f the affected districts; and -- disruptions inservice delivery due to the dismantling of elected local Governments, and disruption of specific services. For example, compared to a national average o f 75% o f children being vaccinated, less than 37% o f children had been done so in two conflict-affected districts surveyed recently. Education sector has suffered in particular due to attacks on teachers. Overall, if one conservatively estimates that Nepal's GDP level and growth rates have fallen by 2% points p.a., this implies that in the next 5 years then per-capita-GDP will be more than 10% (ifpeace had been restored in2002) to 14%lower (ifpeace is restored inthe next few months) than it would be otherwise (See Chapter 7). H o w could Nepal have grown reasonably rapidly, with significant decline inpoverty, since 1996, inthe midst of this conflict? The answer to this i s the conflict has become truly intense since early 2002. Before that year, the conflict was a low-grade insurgency less disruptive than the typical political instability and frequent changes inGovernment that takes place inmany developing countries. 14. Khat can the Government do to mitigate the costs of conflict? In addition to seeking political resolution to the conflict, one clear answer lies in much greater attention to economic opportunities and public services in lagging regions. One insight comes fi-om loolung at income and human development indicators indistricts grouped according to the intensity o f conflict (Table 1.4). Table 1.4 Income and Human DevelopmentIndicatorsby Intensityof Conflict Human Securitystatus Numberof PopulationGrowth Population Population Expectancy Literacy Life Districts Rate 2001 Share Index Years % Phase I 24 3.8 8626156 27.4 1555 0.38 63.3 39.4 Phase II (moderately 15 3.8 16028936 50.9 1806 0.38 62.1 43.9 affected) Phase 111 (highly 36 1.6 6836412 21.7 83613 0.27 56.4 35.6 affected) Source: World Bank estimates from various sources and UNDP circular, March 2004. 15. According to the UN Security class$cation, signijkant conflict is now raging in 36 out of 75 districts (i.e. Phase 111districts). All together 51 districts (Phase I1and I11 districts) are affected (see Figure 1.4). As table 1.4 shows the most conflict affected areas o f Phase 111, lag significantly behind in human development indicators such as life expectancy and literacy. Improving conditions in these districts in the Western and Far Eastern areas will require a focused agnculture strategy for these primarily hill regions, improvements in infrastructure and access, as well as improvement in public services and empowerment through effective decentralization. Since agriculture i s at the heart o f these 6 issues, a strategy for lagging regions i s discussed in more detail in Chapter 4. More broadly though, the mitigation o f the conflict will depend on Nepal's ability to restart growth o f incomes and employment. D. Policy Lessonsfromthe Sources of Growth 16. Seenfrom a long term perspective what are the policy lessons that can be drawn from Nepal's growth experience? The stylized facts o f Nepal's growth experience are its low average growth rate for the past 35 years (1.7% growth p.a. in per capita incomes, the lowest in S. Asia); the sharp acceleration that took place between 1985 and 2001 (2.5%) compared to the previous twenty years (0.6%); and the muted impact o f growth on poverty reduction untilthe mid-1990s. The two proximate explanatory factors are l o w growth o f the large agriculture sector and productivity. Growth in both cases improved and accelerated after 1985, and especially after 1995 in the case o f agriculture. The underlying factor behind this acceleration was policy reforms that took place, starting in 1985, and then deepened, albeit haltingly, inthe 1990s. 17. Improvement in Agricultural Performance and Diversification. I n sectoral terms, the most notablefeature has been that per-capita agricultural value added has beenflat over the thirty-jhe year span of 1965-2OOZ.During this period, aggregate GDP grew at just over 4%, the non-agriculture sector grew by 5.9%, while agriculture sector grew by 2.5%, i.e. roughly the same as population growth rate. Given that the importance o f agnculture in Nepal's economy - accounting for more than two-thirds o f value added in the beginning of the period and more than half o f value added on average - its slower rate of growth dragged down overall per-capita growth rates. Further, given that 86% o f the labor force was employed inagriculture on average during this period, this also helps to explain the persistence o f poverty until well into the mid-1990s. Conversely, when annual agriculture growth accelerated to 3.7% in the second half o f the 1990s, or about 1.5% p.a. in per-capita terms, this combined with remittances by Nepalese labor abroad, i s associated with an appreciable drop inrural consumptionpoverty according to preliminary estimates.' 18. The reasons for low agriculture growth are the following. First, inadequate infrastructure development - the lack o f roads and access to markets and irrigation - raises input and technology costs, lowers output prices and dampens commercializationand incentives for growth. The lack o f infrastructure particularly lowers incentives for hills agnculture. Second, the consistent under-funding o f public investment in agriculture and related infrastructure.8 Third, the policy environment with restrictions on private supply o f agncultural inputs due to the monopoly position o f the Agricultural Inputs Corporation until 1997 hindered the supply o f affordable high-yielding inputs. Finally, agriculture sector terms o f trade fell for most o fthis period, excepting towards the end o fthe 1980s and the second halfo f 1 9 9 0 ~ . ~ 19. Trends in Productivity. Another factor behind low growth in Nepal has been the low growth of productivity. Aggregate productivity actually declined in the first two decades since 1965 as investments on less competitive non-tradable sectors such as construction dominated economic activity. After liberalization and stabilization reforms started in 1985 productivity increased significantly by more than 1.3% point p.a. i.e. from -0.8% in the previous period to 0.5% (see Table 1.5, below). lo Thus, the growth inproductivity can explainall ofthe acceleration ofGDPgrowth. '* See discussion below in Section E o f this chapter. Sharma, Shiva and Sonali Deraniyagala, "Agricultural Reforms and the Performance o f Agriculture", Chapter 5, in Macroeconomics ofPoverty Reduction: The Case Study ofNepal, UNDP, UNHouse. Terms oftrade movements have beenmeasured via the changes inthe ratio of agriculture to non-agriculture deflator. Note other studies also support this picture o f the movement inthe terms o f trade. lo The acceleration o f growth intotal factor productivitysince the 1990s or the second half o f the 1980s and onwards is found by a number o f papers using different methodologies: e.g. Khatiwada, Y.R., Suman K. Sharma, Vikash R. Satyal, Ram S. Kharel, "Nepal Sources o f Economic Growth", Institutefor Integrated Development Studies, Nepal, 2002, Table 4.2. , Bajracharya, P. and Bajracharya, S. "Total Factor ProductivityGrowth in Nepal: An Estimate, Economic Journal of 7 Table 1.5 Growth of Factors and Their Contribution Growth Rate Contribution of Growth Rates GDP TFP Capital Human Capital Human Capital Labor Capital 1972-1985 4.2 -0.8 3.3 1.7 6.8 3.3 2.5 1985-2001 4.9 0.5 2.7 1.7 5.7 3.3 2.5 1972-2001 4.6 -0.1 3.0 1.7 6.2 3.3 2.5 Source: Estimates by A. Ahsan, and B. Karmacharya, "Explaining Nepal's Growth", 2004, mimeo. 20. Why did productivity growth accelerate in the 1990s? Empirical analysis o f the determinants o f growth and productivity suggests the following: the adjustment o f real effective exchange rates, current account liberalization, stabilization as indicated by higher foreign exchange reserves for needed imports, and an improvement inthe terms of trade, all contributed to higher productivity. Trade policy reforms that took place steadily over the decade opened the economy to greater competition and exports, while at the same time facilitated the imports o f raw materials and capital goods. While difficult to capture quantitatively, productivity inthe 1990s should have also increased inresponse to regulatory and banlung sector reforms that increased factor mobility inboth real and financial capital. Agriculture sector reforms liberalized private sector trade inboth agriculturalinputsand outputs. 21. Policy and Institutional Factors. A third insight to the sources of Nepal's growth comesfrom the policy and institutional variables, drawing on the results of more than a decade of research on determinants of growth across countries. A good summary of the results o f this research lists the major variables that have affected growth across time and across countries as presented in a variety o f papers." Usingthis framework, the acceleration o f per capita growth rates inNepal from 1.1 % during 1972-1985 to 2.5% during 1985-2001i s explainedby good fiscal management, financial deepening, and openness o f the economy. Conversely, inadequate investments in transport and communications and exchange rate overvaluation lowered growth. Chapter 3 discusses developments inthese areas. E. PovertyReductionandMillenniumDevelopmentGoals 22. There was reduction in poverty but progress was delayed and uneven. During the mid 1990s to 2001, there has been a significant reduction in poverty indicated by an increase in consumption, in the ownership o f household durables and improvements inhuman development indicators.'* Rural per capita consumption growth appears to have been "pro-poor" in the sense that it increased more for those in the lower de~iles'~.The sources o f growth in this period, agricultural incomes and remittances from labor, could account for the relatively equitable pattern o f growth. Yet, it i s noteworthy that inequality between the regions has persisted with the mid- and far- Western regions continuing to lag behind. (see Box 1.2). The prevailing social structure, which excludes certain ethnic communities and "low caste" dalits has adverse impacts on both poverty reduction and empowerment. A mixed picture emerging with respect to Development Issues, 2002, and Ahsan, A. and B. Karmacharya, ExplainingNepal's Growth Performance, Mimeo, World Bank, 2004. Sources: FromWorld Bank Growth website, downloadedin2003. The evidence comes from the Rural Household Consumption Survey of 2001, the Demographic household survey of 2001, and the preliminary analysis of thepartial sample from the Nepal Living Standard Survey of 2003104.A cross-check on the robustness of these results is provided by a detailed analysis offood consumption, ownership of durables, and household amenities. InFYOl rural households consumed 30% more eggs, 17%more milk,twice as much oil, more vegetables, fruit, meat (40%), and fish (60%) than inFY96.Consumptionof foodgrains, which can be seen as "inferior goods", declined slightly. Encouragingly,consumptionof higher-qualityfood items increasedequally or more for people inthe bottom four deciles of the consumption distribution than for the better-off. Similarly ahigher percentage of households owns radios, televisions, telephones, andbicycles Note: The figure refers to per capita consumptionadjusted for temporalprice changes and spatial price differences, with the EasternTerai regionbeingthe numeraire. For details, see Lanjouw, Prennushi, and Zaidi (1998) and Prennushi(2004). Data sources: 1995196NLSS Iand 2000101 NRHCS. 8 the likelihood of Nepal achieving MDGs and underscores that growth must be maintained and service delivery must improve to raise achievements. 23. Significant improvements appear to have taken place in all agro-climatic belts and regions, but the regional ranking does not seem to have changed. The Western part of the country and the mountains remain poorer than the Eastern part.I4 The rural eastern Terai (which comprises the Terai belt of the Eastern and Central Development Regions) i s the area where improvements in consumption levels seem most significant. Increasein Real Consumptionin Rural Nepal Subjective Perceptionsof Poverty 1995-96 2000-01 (% of respondents) 199596 2003-04 Real per capita Real per capita To the questionduringthe last month,did your family have consumption consumption less than adequateconsumptionof : By Area FY96 prices FY96 prices % increase p.a. 'All rural 5938 6934 3.1% Food 51 32 Western Hills 5316 6214 3.2% Housing 64 41 'EasternHills 6771 7217 1.3% Clothing 58 36 Western Terai 5444 6245 2.8% Health Care 59 28 ~ EasternTerai 6111 7746 4.9% Children's Schooling 45 21 During the last month,did your family have Mountains 5564 6498 3.1% lessthan adequatetotal income : Hills 6095 6734 2.0% 73 67 Terai 5867 7182 4.1% Using survey-based food prices (cumulativeincrease: 50% over five years) ,Source: RHCS2001 Source: NLSS I& II l4 For an analysis ofregional differences based on the 1995/96Nepal Living Standards Survey (NLSS I)see the 1998Poverty Assessment (World Bank, 1998) and Prennushi(1999), as well as CBS (1996, 1997). 9 24. These improvements in Table 1.6 Comparative Human Development Indicators in Four South Asian Countries economic well-being are mirrored by improvements in Nepal Bangladesh Pakistan India some social indicators." Data GDP Per Capita PPP 1350 1720 1940 2570 from the Nepal Demographic Child malnutrition (%) 48.3 47.7 38.2 46.7 and Health Surveys o f 1996 Under-5 mortality rate 83.0 73.0 101.0 90.0 and 2001 indicate a decline in Access to safe water (% pop.) 88.0 97.0 90.0 84.0 all three malnutrition indicators Access to sanitation (% pop.) 28.0 48.0 62.0 28.0 in rural areas: height-for-age, Net primary enrollment ratio 82.2 86.6 66.9 83.3 weight-for-height, and weight- % of cohort reaching grade 5 -male 57.2 63.4 59.2 for-age. Infant mortality % of cohort reaching grade 5 -female 69.2 67.8 58.7 declined from 78.5 to 64.4 and Total fertility rate 4.2 3.0 4.5 2.9 child mortality fkom 118.3 to Maternal mortality ratio 539.0 380.0 500.0 540.0 91.2 per thousand. The total %of births attended by skilled health staff 10.9 11.6 20.0 42.5 fertility rate went down from Net primary enroll. ratio gap (M-F) 8.7 -1.8 19.8 15.0 41.O 49.7 39.5 39.6 4.6 children per woman to 4.1. Secondary school pupils - % females Life expectancy at birth,female 59.6 62.7 65.1 64.2 School attendance increased as well, encouragingly more for Source: World Bank, PREM DEC Indicators Data Base. Nepal data has been updated for primary enrollment and maternal mortality. girls than for boys. Some I human development indicators have improved to a point where they are now comparable to those in other richer South Asian countries (see Table 1.6 above). But there i s no assurance at all that these gains can be sustainedwithout restarting growth. F. Accountingfor PovertyTrends 25. A full confirmation and explanation of these trends will need to wait for the analysis of the nationally representative sample of the NLSS I.which is now ongoing. Nevertheless, three factors can help to explain a large part o f the reduction o f poverty. The agriculture sector grew at a much faster pace between FY96 and FYOl than before, remittances from Nepalese abroad grew by 30% p.a. and the 2001 Census showed slower-than-forecast populationgrowth over the previous decade.16 26. The last two-and-a-halfyears have been difJicultfor Nepal. The worldwide recession in2002 and 2003 and a more restrictive trade treaty with India weakened demand for Nepal's exports and domestic policy uncertainty have contributed to a reduction in income growth. The domestic security situation worsened considerably, diverting scarce human, financial, and managerial resources to defense. As a result, growth has declined sharply and per capita income level in 2004 i s less than what it was in 2001. The increase in consumption by the poor could have been reversed. Above all the worsened security situation has been the dominant factor for the poor performance and its resolution i s a must to restore growth and address poverty reduction. l5 This i s noted also in the Tenth P l d o v e r t y Reduction StrategyPaper 2002-2007 (HMG, 2003) for the NinthPlan, which covers FY98-02. l6 The populationgrowth rate between 1991and 2001 was 2.27%, based on the 2001 PopulationCensus, lower than the 2.4% that hadbeenprojected on the basis of earlier trends (CBS, 1994). 10 G. Social Exclusion 27. Poverty reduction and human development in Nepal in the 1990s is marred by continuing social exclusion of women and ethnic and caste groups. There i s considerable evidence that in Nepal social exclusion has a major influence on poverty outcomes. Inaddition to location, social identity in terms o f caste, ethnicity and gender also continues to influence access to assets, opportunity and representation. Women and people from "low caste" and disadvantaged indigenous groups have a significantly higher riskof having lower human development indicators and of falling below the poverty line than other social groups. 28. Gender disparities are wide in Nepal. Govemment efforts have been focused on empowering women, but gender-based social exclusion remains strong. In terms o f consumption poverty, since consumption i s measured at the household rather than at the individual level, it i s difficult to establish directly that women as a group are poorer than men. However, household survey data show that women receive lower wages in comparable jobs with males, spend less on self-consumption and have little or no access to credit. The majority still does not eam an identifiable individual income; women's basic needs are generally met from pooled family income, but married women are conditioned to eat last. By social circumstances, women consume less of any available "luxury" foods, such as meat. 29. Human development indicators continue to show gender disparities even though Nepal has made rapid progress in reducing maternal mortality rates and increasing female life expectancy as well as improvingfemale literacy levels and years of schooling. At the aggregate level, female life expectancy surpassed that o f males and Nepal i s no longer among those few countries inthe world where men outlive women; but in rural areas (especially in the hills and mountains) women still die earlier than men. And despite the improvement in female educational indicators the large gender gaps in literacy and years o f schooling remain (Table 1.7). Table 1.7 Gender Disparitiesin Key Human Development Indicators,1996 and 2000 Life Expectancy(years) Adult Literacy (Yo) Average School Going Years 1996 2000 1996 2000 1996 2000 Male Female Male Female Male Female Male Female Male Female Male Female Mountain 52.7 50.4 48.6 51.1 44.2 11.8 61.9 26.6 2.27 0.71 3.71 1.33 Hill 58.0 55.5 65.4 64.7 58.4 24.3 72.3 39.5 3.42 1.61 3:97 2.18 Terai 59.5 57.0 61.7 63.2 52.3 19.9 60.2 32.5 3.10 1.25 3.71 1.93 Urban 63.2 60.3 71.4 70.8 76.7 51.5 81.2 56.9 5.63 3.88 6.01 3.80 Rural 53.7 51.3 58.2 59.3 52.0 19.5 63.6 32.3 2.93 1.15 3.40 1.66 Nepal 55.0 52.4 59.3 59.8 54.3 21.3 65.8 35.4 2.55 1.13 4.45 2.25 ~ ~ - Source: Nepal Human Development Reports, 1996and 2001, 30. In terms of empowerment, Nepali women are still largely without voice and influence in the public domain. Their representation in Nepal's influential civil service and in all three levels o f elected government lags far behind men's: women make up somewhat less than 8 percent o f the overall staff o f the civil service and only 4 percent o f the officer level staff, lower than other South Asian countries. Women are also under-represented in Nepal's elected government. After the last elections they made up only about 6 percent of the lower house and 15 percent o f the upper house (where some o f the seats can benominatedby the King).Inthe lower District and Village levelbodies, women have even less voice. 3 1. Caste and ethnicity-based disparities are widely prevalent. At the top o f the social hierarchy are the priestly Bahuns or Brahmins, the warrior or ruler Chetris or Kshatriya, closely followed by the Newars or the people from the Kathmandu valley. The indigenous peoples o f Nepal, many o f whom live 11 in the middle or high hills were assigned the middlerung. The indigenous groups who call themselves Janajati are at the middle group. Below them are ranked the occupational castes called the Dalit, meaning literally "the oppressed". Janajatis and Dalits make up a considerable proportion o f Nepal's population: some 31 and 16 percent respectively." Table 1.8 reports Human Development Indicators for these different groups and shows that, on every indicator, Janajati groups fall below the national average and well below the Brahmins, Chetris andthe Newars, and the situation o fthe HillDalits i s even worse. Table 1.8 Human Developmentby Caste and Ethnicity Human Dev. Average Chhetri Newar ~ Bahunl Hill Hill Indicators Nepal Brahmin Janajatis - Dalit Life expectancy (yrs) 55.0 60.8 53.0 50.3 Adult literacy (%) 36.7 58.0 35.2 23.8 Mean yrs schooling 2.3 4.7 2.0 1.2 Per capita income (NR) 7,673 9,921 6,607 4,940 Per capita PPP (US$) 1,186 1,533 1,021 764 1, Life expectancy index 0.500 0.597 0.467 0.422 2, Educational attainment index 0.295 0.490 0.280 0.186 3. Income index 0.179 0.237 0.181 0.289 0.152 0.110 Human Dev. Index 0.325 0.441 0.299 0.239 Ratioof national HDI -- - 100 135.9 92.2 73.6 I Source: ESP, "A Strategy to Empower Nepal's DisadvantagedGroups", Document page 7 (based on data from the Nepal HumanDevelopmentReport,NESAC, 1999. 32. Even relatively well off ethnic groups lack access to power. Some Janajati groups like the Gurungs, Magars and Rais who traditionally went for army service in the Indian or British army have higher educational and income indicators as do groups like the Thakali and Sherpas who have done well intrading, tourism and other businesses. But interms of empowerment, neither Janajati nor Dalits have beenvery successful injoining the civil service. H. Progress towardstheMDGs 33. The Millennium Development Goals (MDGs) are a set of goals on poverty reduction, education, health, and the environment, that the international community agreed to try to achieve by theyear 201.5." For each goal, indicators have been selected and numerical targets to be achieved by 2015 have been set. The Nepal Tenth Plafloverty Reduction Strategy 2002-2007 also contains a set o f targets for 2007 for some o f these indicators. Table 1.9presents selected indicators with baseline data and targets. " Not surprisingly there i s considerablecontroversy about these figures and differentdata sources- as well as different interest groups- give different figures. We have used the 2001 Census figures. It may be better to think of the Janajatis as making up 31to 37 percent of the populationandthe Dalits accounting for between 12 and 16 percent-though certain Dalit organizations claim20 percent ofthe population. The MDGs come from the MillenniumDeclaration, which was signed by 150heads of state at the MillenniumSummit in New York in September2000. The MDGs draw on the agreement reached at the UNglobal conferences ofthe 1990s. 12 Table 1.9 MDGlPRSPSelected Indicators 1990 mid-1990s 2ooo PRSP' lothtarget MDG Poverty and malnutrition Population below national poverty line - 42' - 30 20 Prevalence of child malnutrition (% of children under 3 years of age whose weight-for-age is low) 57 46.92 43.62 - 28.5 Universal primary education Net primary enrollment ratio (% of relevant age group) (survey data) - 57' 65.83 90 100 Net primary enrollment ratio (% of relevant age group) (MOES data) 644 82.4 90 100 Gender equality Ratio of girls to boys in primary and secondary education (%) 863 - 100 Ratio of girls to boys in primary education (GER %) (MOES data) 564 864 - 100 Ratio of girls to boys in lower sec. education (GER YO)(MOES data) 414 814 - 100 Ratio of girls to boys in higher sec. education (GER %) (MOES data) X4 __ 100 Life expectancy (note: PRSP, not MDG indicator) 65 Adult literacy (15+) (note: PRSP, not MDG indicator) 63 -- Average years of schooling (note: PRSP, not MDG indicator) - - Infantand child mortality Infant mortality rate (per 1,000 live births) 78.52 64.42 45 Under 5 mortality rate (per 1,000) 161.1 118.32 91.22 72 54 Share of I-yr-old children immunized against measles 452 63.62 100 Maternalmortality Maternal mortality ratio (per 100,000live births) 53Ci2 300 _- Births attended by skilled health staff (% of total) 7.42 132 __ - Reproductive health Contraceptive prevalence rate (% or women ages 15-49) 24.12 28A2 38.g2 47 - Environment Access to an improved water source (% of population) 462 802 85 100 Source: Source 1 is NLSS I,; 2. Nepal Family Health Survey and DHSs, 3. BCHIMES, 4. MOES data are for 2002. Cells where the source is not given (and are not targets) are from the UNDP MDG country report. See: CBS (1996); HMGIMOH, New ERA and ORC Macro (2002); CBS and UNICEF (2001); HMGlMOES (2002); and UNDP (2002). 34. As discussed earlier, sufficiently fast progress has been made with some indicators to achieve the MDG target on current trends in those areas. Figure 1.5, at the end o f this chapter, presents projections based on extrapolating linearly the trends o f the second half of the 1990s while its implications are summarized inthe next paragraph. But these trends may not be sustained if growth were to falter, service delivery remained disrupted due to conflict, and social exclusion continued. Further, in general, it becomes progressively more difficult to raise human development indicators as the poorer groups are harder to reach. 35. With these qualifications, the prospects for achieving the MDG targets can be summarized as follows: 0 The poverty target may be achieved, while the target o f halving malnutrition would not, despite recent progress. 0 The education targets may or may not be achieved, as current trends vary by data source. According to the Ministry o f Education and Sports data, the target o f universal net primary enrollment would be reached on current trends; according to household survey data, it would not. Further, given that many o f the out-of-school children are from socially excluded groups, reaching themwill require extra efforts. 13 0 The gender education equality indicators would be met, according to MOES data. 0 The infant and childmortality targets may be achievable, but projecting current trends out to 2015 i s not very reliable inthis case because improvements become more difficult as rates decline. The vaccination targets could be achieved; the percentage o f children aged 12-23 months who are fully immunized by 12 months o f age (which is an intermediate indicator for infant and child health) has increased, according to the NDHSs, from 36 percent in 1996 to 60 percent in2001.'' 0 Data on maternalmortality are not sufficient to assess likelihood o f achievement. e The PRSP target o f contraceptive prevalence (47%) may be achieved (there i s no set MDG target for this indicator). Note that there was an acceleration in the diffusion o f modem contraceptive methods in the second half o f the 1990s compared to the first half (based on NDHS data), as evidenced inthe greater slope o f the second segment o f the line in chart 6. 0 The target for access to drinking water (100%) may be achieved given the current definition o f access to water. But water quality has declined due to lack o f maintenance of drinlung water facilities, so the data would need to be revised. Universal access to safe water i s unlikely to be attained unless measures are taken to improve maintenance alongside coverage. I.Summingup 36. At the end of thisperiod of nearly two decades of betterpe$ormance, four outcomes stand out as policy issues. First, overall growth rates were neither fast enough to make a significant dent on poverty untilthe second halfo fthe 1990s, nor couldthey be sustained as per capita income fell over the past three years. Growth has to be restarted and accelerated. Even a respectable 2.5% per-capita economic growth between 1985 and 2001 has not been able to increase per-capita incomes significantly or reduce poverty measurably. The improvement in poverty reduction indicated by the N L S S I1data would have reversed after 2003. Second, economic growth was uneven across different regions and for a long while excluded agriculture. Growth has to be more pro-poor and spatially even by focusing on agriculture and lagging regions. Despite plans to the contrary, investment in infrastructure in the poorer and lagging Western regions fell considerably short o f targets resultinginlower economic opportunities. Over-centralization o f government in an ethnically and culturally diverse country also meant that service delivery was poor in the remote regions. A violent insurgency, which spread across Nepal, has planted its base firmly inthose remote Western regions. It provides a substantial threat to further progress in policy reform, service delivery and effective govemance in general. On the other hand, deepening economic reforms, providing greater opportunities to the socially excluded and improved service delivery to all groups and parts o f the country are the essential ingredients for a return to economic, political and social progress and stability. 37. Third, unless appropriate policies and adjustments are made, as discussed in other chapters in this review, to increase Nepal's competitiveness and restore the investment climate, Nepal is unlikely to repeat even the modest achievements of the 1990s. A reversal o f both income growth and human development i s more likely. But most important, the current conflict and political uncertainty have to be resolved or at least significantly mitigated as it i s severely taxing economic activity, development, and threatening the gains o f the last two decades. 38. Fourth, social exclusion had a major, adverse, influence on poverty outcomes and empowerment. Inaddition to location, social identity in terms o f caste, ethnicity and gender also continues to influence access to assets, opportunity and representation. Women and people from "low caste" and disadvantaged indigenous groups have a significantly higher risk o f having lower human development indicators and o f l 9 Note that the MDGindicator i s vaccination against measles, but separate data on this vaccination are not consistently available. 14 falling below the poverty line than other social groups. Even relatively well off ethnic groups lack access to power. Neither the Janajati nor Dalits have been notably successful in joining the civil service or gaining elected office. With respect to the attainment of MDG, progress has beenmade in some areas but not in others. Thus while halving of poverty could be achieved (by restarting growth) but not halving of malnutrition; while the education target may be achieved but not the coverage o f children from disadvantaged groups; the target for drinkingwater could be achieved but water quality will remain poor. But even these achievements may not be sustained if growth were to falter, service delivery remained disrupted due to conflict, and social exclusioncontinued. 15 Figure 1.5 Trends and Projections of Millennium Development Goals Chart 1:Percentage livlngbelowthe poverty line I Chart2: Percentageof malnourished children (weight-for-age) 501 42 v lo 0 1990 1995 2000 2005 2010 2015 2020 1985 1990 1995 2000 2005 2010 2015 2020 Year Year -+-Target -F- NLSS-NRHCSRural -+-PRSP I +-Target +NDHS 1 ~ chart 3: Netprimary enrollmentrate Chart 4: Gender equality ineducation 1201 1985 1990 1995 2000 2005 2010 2015 2020 1985 1990 1995 2000 2005 2010 2015 2020 Year Year 1 +Primary -+- secondary Lower A Target1 +MOE x - Target -+-NLSS VBCHIMES +PRSP target 4 Chart 5: Infantand child mortalii rates (perthousandllve births). Chart 6: Use of moderncontraceptionmethods NDHS 1183 - 40 100 I 5 4 !?20 40 10 0 1985 1990 1995 2000 2005 2010 2015 2020 1990 1995 2000 2005 2010 Year Year tInfantMortality Child Mortality -=--Target Child Mortality tNDHS-I--PRSPtarget Chart7:AcceSStoen Improvedwater source I 120 1001 100 2o 0 1 1985 1990 1995 2000 2005 2010 2015 2020 Year & -a- NDHS PRSP target MDG target 16 CHAPTER 2: IMPROVINGMACROECONOMICPOLICIES FOR GROWTHAND POVERTY REDUCTION A. Introduction:The Challengeof RestoringGrowth 1. Afer attaining aper capita income growth rate of 2.6% in the 1990s,Nepal's per-capitafell by - 0.5% between 2001 and 2003. While a modest recovery i s underway, per-capita income in2004 will still not be restored to its 2001 level. The medium term outlook i s cloudy. A violent insurgency covers large parts o f the country and imposes steep costs on economic activity. Alongside the forthcoming rescinding o f the MFA, Nepal's significant loss in the global market share o f carpets and garments in recent years indicates Nepal's slipping position in an increasingly competitive global economy. It is clear from the discussion o f the sources of growth in Chapter 1, Nepal - a small open economy, highly dependent on trade and exports -- will need important policy adjustments to increase trade and competitiveness to restore growth. Restoring economic growth rates to the trend o f the 1990s, let alone achieving the 10" Plan/PRSP's target per-capita growth rate o f 4% and its human development goals, will be a formidable challenge. 2. Sustained poverty reduction and human development, however, will require going one step further thanjust raising mean incomes: it will require apro-poor pattern of growth, i.e. one, which raises incomes of poorer deciles, through higher agricultural incomes, job creation, and wages. It will mean providing opportunities and better public services in Nepal's Western regions where the poor are disproportionately located. It will also require a special focus on Dalit ("the oppressed") and Janajati (indigenous) groups who lag systematically behind in human development (See Chapter 1). Finally, the experience of the 1990s also suggests that a pro-poor growth strategy will need to reduce income volatility as these have asymmetrically adverse effects on the poor. Towards these ends government strategy has to focus on fiscal, trade, and economic management issues B. The Government's Strategy and PolicyIssues 3 . The Government's IOth Five Year Plan, whose summary is Nepal's Poverty Reduction Strategy, makes the achievement of broad-based growth, especially in the rural economy, one of the key pillarsfor achieving its targets. Nepal's development policy agenda is well articulated in Nepal's Poverty Reduction Strategy (PRSP). It lays out a coherent four-pillar strategy consisting of: "i)broad based growth with special emphasis on agriculture; ii)accelerating human development through renewed emphasis on effective delivery o f basic social services and economic infrastructure; iii)ensuring social and economic inclusion of the poor, marginalized groups and backward regions; and iv) vigorously pursuing good governance both as a means of delivering better development results and to ensure social and economic justice." The strategy i s well anchored in a medium term fiscal framework that focuses resources on human development and physical infrastructure. 4. In sectoral terms, the strategy envisages that more than 3/4`h of growth will comefrom the non- agriculture sector, but also a robust agriculture sector growth of 4%p.a. A "quick rebound" of economic activity following peace and especially o f non-agriculture sectors such as manufacturing, exports, construction and tourism will account for the growth of the private sector. The recovery o f private sector investment (rising to 19% of GDP by 2007, compared to 12% currently) and trade and exports will lead the way to growth. Public investments in power, roads, and telecommunications are the instruments for encouraging private sector investment. In the rural sector, the implementation of the Agricultural Perspective Plan (APP), including ensuring the supply o f fertilizer, irrigation, and the development o f livestock, horticulture and highvalue crops in the hill regions will dnve agriculture growth. Expansion of 17 rural roads, electricity and marketing networks, expansion and rehabilitation o f irrigation networks and small-scale surface irrigation schemes inthe hillregions will be the driversbehind agricultural growth. 5. But the PRSP depicts this picture somewhat broadly. First, the strategies for accelerating growth needmore specificity. Second, policiesneedto be better prioritized. Another challenge will be to improve the institutions o f economic management for better policy coordination along with improving monitoring so that mid-course corrections inpolicies could be made. Based on this, this review focuses on three key policy issues: (i)the strategy for restarting and accelerating growth, with especial emphasis on trade and agriculture as two key policy levers; (ii) improving public service delivery and governance; and (iii) strengthening social protection and inclusion policies. The rest o f this chapter focuses on three strategic issues: fiscal management to raise resources and use them effectively for development, external sector policies to increase competitiveness and trade, and strengthening institutions for improving economic management, including aid coordination. C. FiscalandFiduciary ManagementIssues 6. Nepal's fiscal management has been prudent in the 1990s (Table 2.1). Aggregate public sector debt has been relatively stable at around the 66% of GDP, though mainly because o f negative growth in 1991- 1997- GDP in 2002 it increased to 69% in 1996 2001 2000 2001 2002 2003 recent years. The share o f short-term (% of GDP) debt inpublic debt i s less than 1% and ,Deficit(-) or Surplus (incl. Grants) -5.4 -4.0 -3.5 4.5 -6.2 -1.6 debt servicing i s about 1.5% o f GDP. Deficit (-) or Surplus (excl. Grants) -7.0 -5.7 -5.0 -6.1 -8.3 -3.7 Analysis o f public debt dynamics Revenue 9.3 10.2 10.7 11.4 9.3 12.4 shows public debt to GDP ratios to Grants Received 1.7 1.7 1.5 1.6 2.1 2.1 fall rapidly inthe next four years from Expenditure 16.7 16.4 15.7 17.5 17.2 16.1 68% o f GDP to around 54% o f GDP by 2007, under relatively modest Financing growth assumptions, low interest rates Domestic borrowing(net) 1.9 1.4 0.9 2.7 4.8 0.9 (negative real interest rates for public Foreign borrowing (net) 3.5 2.7 2.6 1.8 1.4 0.7 borrowing on top o f large volume o f grant financing) and a declining share Debt 64.7 64.0 64.6 63.7 69.6 66. o f gross external financing need. A Domesticdebt 15.0 13.8 14.3 14.6 17.4 variety of stress tests suggest that, Foreigndebt 49.7 50.2 50.2 49.1 52.1 48. short o f a major depreciation, public debt to GDP ratios will be contained PublicSavings (From NAS) 0.7 1.0 1.1 0.2 0.2 0,81 to 60% o f GDP or less.20 Source:IFSand IMF. 7. But three major challenges tofiscal stability have emerged. These are contingent liabilities inthe financial sector and possibly hidden ones in the public enterprise sector, the growing pension obligation, and the low tax collection. First, the most significant contingent liability threat comes from the financial sector. The two large wholly or partly owned Govemment banks have a negative net worth o f around 7% o f GDP. Additional liabilities also arise from the need to restructure the Agricultural Development Bank of Nepal. Thus a clear fiscal priority i s that these Banks be restructured and privatized in an orderly manner and with external help, as otherwise these liabilities can increase the fiscal burdenby as much as 10% o f GDP - or roughly of the same order as tax revenue collection. A related issue here is the need to improve management of public enterprises. Currently, public enterprises (PES)in Nepal, unlike in other 2oIMF,Nepal - StaffReport for the 2003 Article IV Consultations, August, 2003, Table 5. 18 South Asian countries, have limited borrowing requirements o f less than 1% o f GDP. While there are known contingent liabilities inthe form o f overdue wages, pensioncontributions, severance pay and other benefits that amount to $300 million or 4.5 % o f GDP, they are more than offset by assets estimated to be worth more than $1.2 billion. However, the poor quality o f auditing o f these enterprises and delays in producing financial reports suggests that dangers may be lurking. 8. The second challenge tofiscal sustainability is posed by the rapid growth in pension liabilities. The pension bill in 2003-04 i s close to Rs. 3.3 billion, rising from 3.1 billion in 2002-03 excluding teachers' pensions.21 This i s financed directly from the budget and i s now more than 20 percent o f salaries and allowances. This fiscal burdenwill grow in the next decade due to the internal demographics of the different groups covered, the rapid turnover o f military and police personnel and the maturation o f the teachers' scheme. Preliminary estimates o f the unfundedpension liability for core civil servants only i s close to 6 percent o f GDP suggesting that the net-present value o f the total liability lies inthe range o f 10-15 percent o f GDP, effectively implying that public debt i s higher by this margin. As Chapter 6 discusses, the Government has started formulating a reform plan that would introduce a contributory pension scheme and accumulated funds towards offsettingthis liability. 9. The third cause offiscal vulnerability is low revenue collection, which makes Nepal's dependence on external assistance acute and constrains public services, growth and future revenues in a vicious circle. With a tax to GDP ratio o f around 9% o f GDP, Nepal's tax effort is, (alongside Bangladesh), the lowest in the region. An indicative analysis o f resource requirements for MDG goals show there i s a considerable resource shortfall in terms o f requirements to meet the MDG (3 to 5% o f GDP), which cannot be fully met by foreign assistance. Hence, raisingrevenues i s a major priority. 10. Nepal has made considerable progress with tax policy and administrative reforms in recent years. Overall revenue collection remains low and two issues have to be addressed. First, improving tax administration to further strengthen the revenue effort and make the tax department more private sector friendly. The second i s removing loopholes and price distortions arising from exemptions o f some products and services and taxes and duties on others that create a bias against foreign trade. Some o f these "other duties and charges" have to be removed over the medium term as part o f Nepal's entry agreement into the World Trade Organization. Concerning administrative reforms, strengthening the administrative authority o f the Director Generals o f the IRD and the C D over their staff are important next steps. Currently they have no authority over appointments and transfers at the officer levels and their operational budget (e.g. 0.8% o f collection inthe case o f the Inland Revenue Department) i s significantly lower incomparison to internationalnorms (3 to 4% for developing countries) and needto be increased. 11. Several expenditure issues remain to be addressed. First, on the allocation side there i s an overemphasis on the development budget to the detriment o f operations and maintenance expenditures. Non-salary regular budget expenditures on road maintenance and education are much lower in comparison to needs (See Chapters 3 and 6 for more details). Within the development budget, the shift away from economic expenditures such as agnculture, irrigation, and transportation to social sectors and security and its possible adverse impact on growth prospects needs a critical scrutiny. Second, budget implementation i s affected by unrealistically large development budgets that regularly fall short in actual expenditures. 12. The introduction of the Medium Term Expenditure Framework (MTEF) has also helped to better implement the development budget in a clear, prioritized expenditure framework in harmony with the PRSP, but there are severalpending issues. First,the MTEFneedsto be extended to cover regular as well as development expenditures to make it a truly program budget, which for now can be loosely tied to a '' Tnis excludes spending on teachers' pensions, which are not available immediately 19 parsimonious set o f performance indicators. Second, a related issue is to improve the classification o f expenditures by reclassifying the regular and development expenditures into current and capital expenditures and present these together as integrated program budgets. Third, performance indicators need to gauge actual progress rather than just spending. Strengthening the MTEF through program budgets will also help to improve donor coordination, a high priority for Nepal. Fortunately, important progress has been made by the Government inthis respect as presented inBox 2.1 below. Box 2.1 Donor and Aid HarmonizationEfforts Donor coordination is particularlyimportantfor Nepalgiventhe large role aid playsinfinancingdevelopment. Accountingfor 5% of GDP andmorethan athird of Govemmentexpenditures, aid affectsbudgetrealism, its executionand public expenditure effectiveness. Budget Implementation: The availability of this funding canmakeor breakabudget inany givenyear. Becauseaid decisions are oftenmadewithout cooridinatingit with the nationalbudget, aidprojectionsare necessarilybased on indicativeaid commitmentsand activities inthepipeline. This results inbudgetunrealism. Theseprojectionsconsistently overestimate availability of aid moneyand inabsence of domestic sources(domestic revenueandborrowing)to close the fundinggap; budget underperformanceaverages 10percent each year. This delaysinvestmentprojectsfrom beingcompleted, resultingnot only in lowerbenefitsbut also weakenedaccountabilityof ministries. Aggregatebudget implementationis also adversely affected. Inan environment where there is little or no revenuesurplus, any shortfallinaid flow results into either more domesticborrowing or failure to implementbudget activities,bothhavingeconomic costs. Public ExpenditureEffectiveness: A second issue is lack of aid coordination lowers public expenditure efectiveness. The aid that Nepalreceives finances alarge number of projectsandprograms, widely dispersedacross sectors, and, again, with inadequate coordinationwith the budget. As NepaleseGovemmentagenciesandinstitutionsby themselveshave little incentivesto refuse aid, donor suggestedprojectsget ad-hoc scrutiny, oftentakenplaceoutsidethe budget, andwithout adequate accounting. This leadsto averyhighdegree of aid fragmentation, estimatedto be amongthe highest inthe world, and aloweringof public expenditureeffectiveness. What canthe Governmentdo about it? The Govemmentcanuse sector programbudgetsandthe MediumTermExpenditure Frameworkto integrate donor support more effectivelyinto thebudgetcycle. Very recently, the Govemmenthas undertakenan importantinitiative to harmonizedonor activities at programlevelsas well as on financial managementaspects. Ontheir side, donorsneedto committo the disciplineof financingprogramsonly after the MTEF providesthese priorities. The three tier Aid HarmonizationProgram: This processof improving aid coordinationgot agoodboost duringthe the NationalDevelopmentForum2004, where developmentpartnerscommittedto align aidwith the PovertyReductionStrategy throughthe MediumTerm ExpenditureFramework inathree-tier harmonizationprogram. The mainpurposeofharmonizationis to improve aid effectiveness,reducetransaction costs of aid delivery, andbetteralign aidwith nationalstrategies. The threebroad levelsofharmonizationare: a. harmonizationat the overallprogramlevel -aligningdonor support with govemment's own strategyandpriorities underpinnedby MTEF; b. harmonizationat the individual programlevel-programmaticapproachon a well thought out sectoralimplementationplananduse ofgovemment's own financialprocedures andreportingsystem; c. harmonizationat the financialmodality level-movementaway from the activity basedbudgetsto programbudgetsthat not only reduces transaction costs significantlybut also gives the govemmentgreater flexibility to adjust budgetto priorities. This strategy i s beingimplementedthrough presentingfive sectoralbusinessplans inthe first ever donor harmonizationmeetingto be held in early2005 as part of FY 2006 budgetpreparation. ImplementationChallenges: Implementationchallengesremainhowever. Fiduciaryconcems, weak accountabilityand monitoring system, aid agencies' needto identify their contributionsduringbudget execution, low absorption capacity, and absence of sector strategywith prioritization of activities will be importantchallengesto implementingthe harmonizationplan. Donorshavegenuine concemabout these issues and areluctanceto completelytransfer to Government systems. Nevertheless, there is no clear evidencethat directinvolvementof developmentpartnersinprojectimplementationhave either enhanced sustainabilityor strengthenedimplementationcapacityto better outcomeresults. The answer to donors' concemslies in strengtheningcountry's existinginstitutionsimplementationcapacity andexpenditure managementand service deliveryreforms-- - ownedandleadbythe country. A patientimplementationof the three tier approachwill catalyzeprocesseswithin the govemment to producesound strategies(businessplan), rationalspendingprograms (MTEF) andeffectiveservices as highlighted inthe World DevelopmentReport, 2004, ImprovingPublic Sewices,for thePoor. 20 13. Fiduciary Management: Nepal`s legal and regulatory framework for ensuring public financial management is good for a country at its level of economic development, but unsatisfactory implementation in the past as well as the current suspension of many of its provisions appears to be increasing irregularities. The Constitution and financialrules requires the Ministryo f Finance to submit a detailed comparison o f the financial results and budgets; it also accords the Auditor General (AG) complete legal and professional independence. The Public Accounts Committee (PAC) headed by a member o f the main opposition party in Parliament used to be proactive, meeting year round, discussing public accounts and the Auditor General's (AG) annual report and recommendations as well as all aspects of public sector financial management. But more recently, the AG's annual report, which used to receive a wide public coverage both through the PAC and the media, has not been released in the last two years. Annual reports for 2002 and 2003 were prepared in a timely fashion by the Auditor General, and were forwarded to His Majesty the King, as requiredby the Constitution. But these reports now remain shelved perhaps due to the absence o f parliament without any public disclosure and reports are that the volume o f irregularities had increased. Inaddition to the suspension o f financial rules, weak compliance o f financial management rules due to low penalties, the lack o f financial management trained personnel, and inadequate monitoring o f actual implementation undermines financial management. Another pending issue i s for the government to reform procurement laws to increase efficiency and transparency in procurement. D. External Sector Issues 14. With a trade to GDP ratio of about 50% and external remittances now accountingfor 12% of GDP the role of the external sector is, after agriculture, the most important for growth and poverty reduction in Nepal. While trade policy reforms led to the reduction in tariff rates from 32% in the early 1990s to around 14%in200022new duties and charges were added inthe last three years to raise nominal protection to around 18%. However, it i s noteworthy that there has been a nearly complete dismantling o f quantitative restrictions. These reforms combined with achieving current account convertibility, easing entry, and the benefits o f pegging o f the Nepalese rupee to the Indian rupee led to rapid export growth at 15% per annum in the 1990s. Consequently, Nepal doubled its share in global exports while exports became more diversified as the share o f manufactures increased to 66% from 30%. The growth o f remittances inrecent years and the rise intourism earnings helpedto increase the current account position and reserves. The growth o f foreign exchange earnings enabled steady increase in the imports o f capital goods at a steady annual rate o f 10%per annum. 15. Some tradepolicy reforms remain pending. First, one feature o f Nepal's tariff structure i s that it has cascading rates. That is, tariff rates are higher, the higher the level o f processing. This creates a bias against high value added activities, which means that in a labor abundant economy, a cascading tariff structure discriminates against employment. It i s also true that raising domestic value added through opposite means (i.e. having lower tariffs on low levels o f value added and hightariffs on highvalue added activities) can be equally distortionary and go against the country's comparative advantage. Second, exports continue to be disadvantaged due to the bias inherent in import tariffs not adequately off-set through duty drawback and easier customs procedures. The passbook scheme for duty drawbacks i s not working well. In fact some exporters do not even claim duty drawback on their imported inputs because of the hightransactions costs involved inclaiming duty drawbacks. Similarly, export clearance processes 22 Note that in the last three years Nepal has added 5 to 10% points o f other duties and charges as agricultural and security levy, etc and raisenominalprotection to around 18%. These include a local development fee o f 1.5%, special fee o f 1.O% when customs duties are equal or below 5% and 3% when customs duties exceed 5%. Inaddition, there i s a 10%tax on cars and bicycles and a fee o f 5% on some processed agricultural products such as rice o f 10%. These taxes and duties (referred to as para-tariffs in WTO parlance) discriminate against foreign trade similar to general tariffs since they are not levied on domestic production. They raise protection o f domestic production and act as a tax on exports. 21 are cumbersome. N o r i s customs clearance o f imports satisfactory, which raises transaction costs and curtails competition. 16. Addressing trade and exchange rate issues have become important because the positive developments of the 1990s are now being reversed and even show signs of decline. A combination o f domestic conflict, increasing transport costsz3and uncertainty, the appreciation o f the Nepali rupee over the past year, persistent regulatory and infi-astructural weakness and general lack o f confidence inplacing orders inNepal have hit exports hard. Inthe current more competitive environment Nepal's exchange rate pegging arrangement to the Indian Rupee and - its level will reauire continuous review (see Figure 2.1 Actual and Equilibrium Real Exchange Rate 8% in 2003 compared to 15% growth in the 15G 1990s. A particular issue i s that export 140 performance o f the last few months and current 130 policy inertia makes it all but certain that the 120 garments exports - with its 50,000 jobs - could 110 collapse after the MFA's phase out in January 1w 2005 unless emergency actions are taken to 90 increase competitiveness. These would include 80 lowering transport costs sharply through 70 1979 activating the container-train running from Birgunj, providing export processing zone - facilities at border points such as Birgunj, Source: De Soto, R. "Estimating the Misalignment of the Real Exchan e Rate in Ne al", mimeo, 2003 do-& port handling time in Kolkata with support from Indian authorities, speeding up Customs transactions and inviting foreign collaborationto improve market access inEurope and the West. 17. Despite short term problems discussed above, in the medium term Nepal has several assets, which would make Nepal potentially more competitive. These include: (i) having comparative advantage in a number of apculture and manufacturing products (garments, carpets, pashmina, food products, being the mainproducts); (ii) proximity to the large and fast growing Indian and Chinese economies; (iii) the availability of preferential access to Europe and India; (iv) its hydroelectric resources that provide the potential for power exports to the supply constrained Indian markets; (v) its natural beauty and important religions and cultural sites that draw tourists (4% o f GDP); (vi) its growing pool o f educated labor, and (vii) "catch up opportunities" to raise productivity. Inparticular, preferentialtreatment for duty free entry to Europe under the EBA initiative and to India, combined with lower wages and better investment climate than some neighboring states, can attract foreign and Indian investment with their know-how and market access for export oriented activities. There has already been joint investment or advanced proposals for large scale Indian and foreign investment in sectors such as garments and power. Given these factors, Nepal, with its small share in the world market, should be able to enter major markets without muchresistance. 18. As the Nepal Trade and Competitiveness Study identi9es in detail, important policy and institutional reforms are neededfor Nepal to exploit these opportunities. 25 Its recommendations adopted by the Government, are grouped under six areas: strengthening trade policy and implementation institutions, trade facilitation in Customs and transport, improving labor market flexibility especially in 23 Trucks from Kathmanduto the Birgunj container port andborder now take two days due to the inabilityto travel at night. 24 The real exchangerate i s defined as the ratio of prices of tradable to non-tradable goods. The equilibrium real effective exchangerate is one which, for given sustainable values of other relevant variables suchas taxes, terms for trade, capital and aid flows, results in thejoint attainment of intemal and extemal equilibrium. 25 HisMajesty's Government ofNepal, Nepal Tradeand CompetitivenessStudy, MOICS, 2004. 22 employment policies, improving the investment climate especially in FDI, and sector specific policies. Beyond these policies there are two other key variables in the external sector - Nepal's economic relationship with India and the employment o f Nepalese labor abroad - that have significant bearing on Nepal's development. 19. The nature of Nepal's economic relationship Table 2.2 Correlationof Prices in Nepal and India with India is a key factor in Nepal's development. India i s the destination of more than 50% o f its exports Nepal Log(CP1)with AR(1) 1 and the source o f half of its imports.26About 70% o f Agricultural RSq Coefficient T-st Laborers Nepal's labor force abroad works in India. The 1750 India 0.997 0.477 2.9 kilometers o f porous borders means that in addition to I Bihar 0.998 0.399 formal trade, there is a considerable volume o f Uttar Pradesh 0.994 1.022 unrecorded trade in goods, exchange o f labor and, West Bengal 0.998 0.501 accordingly, a close correlation o f prices in Nepal, India - CPI 0.996 1.094 India and the neighboring states o f Bihar, UP, and India -WPI 0.996 0.514 West Bengal (see Table 2.2). By some estimates, the Source:World Bank estimatesfrom various sources. 265 joint ventures with India accounts for more than a third o f all FDIinNepal. 20. Nepal has attempted to maintain close relationship with India and cement it in bilateral treaties on trade and transit and an agreement to control unauthorized trade. The first trade treaty and transit with India was signed in 1950 and subsequently renewed in 1960, 1971, 1978 (when trade was de-linked from transit), 1991, 1996, and 2002. These treaties provided duty free access o f primary exports, for selected Nepalese manufactured exports, preferences to Indian manufacturing exports, and agreements on transit and transshipment. The most recent Indo-Nepal Trade Treaty renewed in March 2002, however, introduced several new restrictions intighter rules o f origin requirements and documentation, and the use of trade related quotas that will be triggered by export volume. 27 21. Given the importance of the Indian economyfor Nepal, a key question is what are somepolicies that Nepal can adopt to benefit from its proximity to the large and fast growing Indian economy. First, Nepal needs to broaden its agreement with India to include and attract Indian investment. The aim should be to forge Indian capital, technology and market access to Nepalese capital, labor, and resources. To this end, Nepal could pursue the proposed Bilateral Investment Promotion and Protection Agreement to provide further assurance on investment and trade rights to investors (including Indians). Efforts to forge formal agreement should be further complemented by advertising efforts to attract investment from India. Thus, Nepal should make a special effort to advertise its preferential access to Europe through the EBA. Second, economic diplomacy with the central Government needs to be extended to the neighboring Indian states, for ensuring market access and easing transit rights.This i s important as State Governments wield discretionary powers that often disrupt trade. Third, Nepal needs to harmonize border procedures, documentation, special economic zones (SEZ) rules, product standards and Customs software with India such that Indo-Nepal trade and transit i s easily facilitated and third country oriented exports can also proceed with minimal transactions costs. Fourth, Nepal could facilitate Indian interests in Nepal by proceeding to build the Tibet-India transit routes and in return request more transit routes and shipping facilities at a variety o f Indianports including the efficient Mumbai port.28 26 Nepalese exports to India includes edible oil, toiletries and cosmetics,jute goods, polyester yam, and a variety of agricultural goods such as pulses, hides and skins, herbs, cardamom, rice bran oil, ginger. Imports from India include mechanical equipment and spare parts, cottontextile, camber, cotton thread, chemicals, electrical equipment, agricultural equipment, etc. (source:www.south-asia.comiEmbassy-India/indeprel.htm). 27 See, HMGN, Nepal Trade and Competitiveness Study, MOICS, 2004, Box 2.1 28 A study has shownthat inthe case ofhigh value products such as carpets andthe greater efficiency of the Mumbai port can more than off-set the higher costs of land transport. 23 22. A major economic development in the 1990s has been the growth of foreign employment of Nepalese labor abroad and private transfers. Currently about 800,000 Nepalese are employed abroad who together remit to Nepal approximately $800 million (12% o f GDP) compared to $ 633 million in merchandise exports and $155 million in tourism receipts. Given that these remittance earnings have grown at a rate o f 30% p.a., this implies that GNP growth has been significantly faster than GDP growth, with its concomitant effects on consumption and demand side effects on GDPgrowth. Increasing demand for labor abroad both due to higher incomes inthe Far East, Middle East, and India, a tendency to switch demand to Nepalese labor instead o f labor from traditional sources o f labor supply, and the rising education o f Nepalese labor have increased demand abroad. On the supply side, the lack o f opportunities at home, and, perversely, the "push" factor due to the war, and the switch from informal to formal sources o f transferring money home have all ledto this higher recorded increase. 23. A crucial challenge for Nepal now is to sustain the level of the current remittance eamings, which now account for about 12% of GDP. Government is now preparing a new ActPolicy guideline relating to Migration and Foreign Employment. A formal memorandumo f understanding has been signed with Malaysia and ratified. Talks are under process with Qatar, UAE, HongKongandKorea. Nepal could take three other measures to sustain foreign employment and remittances. First, most important, for the long run i s the need for continued investments in education, with special emphasis on the English language, to increase the demand for Nepalese labor abroad. Second, employment-seeking talks also need to be extended to countries such as Japan, where aging o f its population will require the import o f more foreign labor. Third, ifthe private sector i s not forthcoming, Nepal needs to provide attractive financial instruments for Nepalese labor to transfer their salaries via formal channels. Ingeneral, service standards in the transfer of remittances that allow a quick and fast transfer of funds is important. Finally, Government also needs to ensure a joint public and private sector oversight body to ensure that Nepal's business reputation as a reliable source o f educated and disciplined labor i s maintained. Conversely, this oversight should also ensure that unscrupulous private sector operators do not defraud the hard-earned remittances by workers. E. StrengtheningEconomicManagement 24. Strengthening Economic Management Institutions. While many of the modern institutions and policies for economic management exist in Nepal, implementation is undermined by lack of adequate coordination and inadequate attention to monitoring and evaluation. 29 Lines o f responsibility between multiple organizations are often very unclear, adversely affecting implementation. Policy coordination at the Cabinet level appears to be weak partly due to the lack o f substantive policy discussions (see Chapter 5) resulting in overall coordination problems. While the National Planning Commission (NPC) has a wider view of economic issues, its role i s focused on development planning and it does not have executive powers. Recently the use of results oriented instruments such as the Immediate Action Plan and the Medium Term Expenditure Framework to prioritize policies and budgets show improvements in policy coordination. But, as widely recognized two areas, coordination and monitoring need further strengthening. The failure to implement the Agricultural Perspective Plan's (APP) Hills strategy, as it depended on the inter-sectoral coordinationbetween agriculture, transport, commerce, finance and several other agencies i s one example o f this. A second i s the inability to resolve the laws, the 21 Acts that inconsistently impinge on decentralization. 25. Weak coordination is also the result of inadequate attention to monitoring of results andprogress and need addressing at several levels. Critical priorities are improving the weak national income accounts 29 These includeinstitutionsandlawsconcerningpropertyrights, contract enforcement,regulatorybodies, monetaryandfiscal institutions,prudentialregulationsand supervision. 24 through support for the national statistical capacity buildingplan. Second, monitoring and evaluation o f service delivery indicators such as immunization, enrollment, the provision o f medicine, school supplies, absenteeism, also need to be implemented as part o f the government's newmonitoring plans. Lastly, more attention i s needed for conducting periodic household surveys, and equally important, developing the capacity to use these surveys to inform policy making and poverty reducing interventions. F. Summingup 26. With respect to the government's strategy for restarting growth, this chapter has analyzed and made recommendations on thefollowing strategic areas:Jiscal management, external sector reforms and economic management. In the first case, measures recommended included policies to increase revenue collection, monitor and manage contingent liabilities, and improve the effectiveness o f public expenditures. Opportunities to increase revenues through interim but significant improvements in tax administration were, highlighted. The threat to fiscal sustainability o f liabilities posed by the insolvent banking sector and the growing pension obligations and their remedies were highlighted. 27. I n the case of the external sector, the need for increasing competitiveness through higher productivity was stressed. The priority i s for the Government to implement the recommendations o f the Nepal Trade and Competitiveness Study, which it has adopted. Two related areas were stressed: forging closer economic ties with India, and especially, inviting Indian investment to avail o f Nepal's EBA preferences in Europe. Second, the importance of short term regulatory policies and long term education investment policies to sustain the foreign employment o f labor was also highlighted. Inaddition, there i s a trade agenda to be addressed including reducing tariffs to bring them closer to competitors' levels and reducing the tariff escalation. 25 26 CHAPTER 3: IMPROVING THE INVESTMENT CLIMATE A. Introduction-Restoringthe InvestmentClimate 1. growth. In keeping with the trend o f the 1990s, the loth Plan projects close to three-fourth o f future Poverty reduction in Nepal depends primarily on accelerating broad-based, labor intensive growth in Nepal to come from the non-agricultural sector. This sector i s assumed to grow at the rate o f 6 to 7% p. a., with the private sector beingthe source o f most o f this growth. But as the developments inthe last three years --when non-agriculture sector growth, exports and private investment rates have dropped significantly - show Nepal's investment climate has worsened with the conflict in the near term. Inthe medium term not only will Nepal need to restore its investment climate, it has to go the extra mile to improve it significantly to offset its inherent geographical disadvantages o f being landlocked, having relatively less developed human capital, and a perception o f being investor unfnendly. 2. Aside from restoring peace, or at least signijkantly mitigating the conflict, improving the investment climate will depend on threefactors. First, the regulatory framework governing private sector activity needs to be addressed in areas that lead to bureaucratic delays and high transactions costs, especially those concerning tax administration, inadequate bankruptcy laws, highly restrictive labor market regulations, and enforcing contracts. Second, Government will need to sustain the financial deepening that has been closely associated with economic growth in Nepal; here the biggest challenge will be to prevent an incipient banking crisis. Third, infrastructure will need to be improved. While there has been considerable progress in developing infrastructure in the 1990s, including through private participation, Nepal remains an infrastructure-constrained country, with considerable unmet demand, poor reliability and high costs. As infrastructure requirements and demands on scarce public resources are large, a key task will be to prioritize public expenditures. A particular challenge will be to improve connectivity and rural infrastructure. A closely related challenge will be to set up regulatory frameworks that can attract private participation ininfrastructure. B. The RegulatoryEnvironment 3. The investment climate of Nepal was improving until the escalation of the insurgency in 2002, but serious problems remain. The liberalization o f the trade regime since the early 1990s, the easing o f entry regulations, the opening up o f infrastructure investment to the private sector, relatively low tax rates and a robust growth in credit all helped to improve the investment climate (see Table 3.1 next page). Domestic private investment rates increased to 15% o f GDP in the mid-1990s compared to 9% in the 1980s. But private sector perception o f the investment climate continues to view it as unfriendly and Government policies to be the most important obstacle to business. A 1999/00 survey showed many o f the firms (36%) specifically identifiedred tape, time delay and corruption as key obstacles. Beyond that, cumbersome and discretionary tax administration, lack o f clarity and predictability o f Government policies and labor regulations were cited as other key issues. 30 30 The BusinessEnvironment andManufacturingPerformancesurvey inNepal, World Bank, Biggs (2000), for instance reportedthat 36% of firms viewed Govemmentto be the biggest obstacle. 27 Year Nepal Bangladesh India Pakistan Sri Lanka 4. Entry and Exit Policies: I n terms of the law, it is not too difficult Figure 3.1 Exit and Entry Policies to invest and to enter an industry in Costto Starta Business(%of incomepercapita Nepal but in practice, multiple agencies that are responsible for investment approval do not coordinate and raise the costs of *7I 2aJ Leastcost-Global 1 191.0 entry. Together, the Amended Industrial Act o f 1992 and the I Foreign Investment and Technology n Act of 1992 provide an adequate 50 legal framework as well as incentives 0 for investment. However, Denmtk China sri Vietnam Pakistan India BangladeshSouthAsia Nepal implementation has been bnka Average problematical since responsibilities for implementation are diffused Source: Estimated from DoingBusinessReport 2004, The WorldBank among a number o f entities. They include the Ministry of Industry, One Window Committee, the Industrial Promotion Board and the Board of Investment and Fast Track Committees. Some of the important elements o fthese acts that created these institutions have been over ridden by other acts such as the Income Tax Act o f May 2002. Industrial licensing, tax authorities and local authorities do not work together with the result the "one stop" entry process i s stretched over many steps. This may explain Nepal's unusually highcosts of starting a business and the country having the lowest amount of foreign direct investment in the sub-continent (see Figure 3.1). 28 5. Conduct Policies. Frequent and unexpected changes in the policy regime such as import tariff schedules, customs valuation and classijication processes create an uncertain business environment. 31 Industrial licensing, tax authorities and local authorities do not work together. Examples o f inadequate consultations and poor coordination are plenty. Many firms find it difficult to operate in the present environment given the economic uncertainty that adds to the already uncertain security environment. Many of them remain inlimbo with no plans to expand operations or simply exit. 6. A reform agendafor the regulatory environment needs to comprise thefollowing. First, improve the regulatory framework through the rationalization o f institutions (to allow less conflict and duplication), clarify and simplify implementation by reducing the number o f institutions involved and by adopting automatic clearances (e.g. company registration could be linked to the Figure 3.2 Flexibility of Labor Markets tax system). There i s also scope to improve I business and HMGNrelations throughjoint committee approaches where the business Flexibility of Firing Index community participates in the design o f policies. Second, the bankruptcy law must I:] be modernized through the new Company and Insolvency Acts to allow easier and less time-consuming exit policies. Finally, labor 50 40 market rigidities need to be addressed. 30 Legislative reforms are needed to make 20 I O labor law consistent with labor contracts 0 (see Figure 3.2). And, Government should I Hong Kong. Bangladesh Pakistan SouthAsia Sn Lanka India Nepal allow dismissal with reasonable compensation. In fact rigid labor laws encourage extra-legal contracts and hiring Source: Estimatedfrom DoingBusiness Report2004, The World Bank many foreign nationals because they are easy to get rid of. Giventhat some o f these reforms may be time consuming due to political opposition, Government should proceed to implement the setting up o f Special Economic Zones and the Export Processing Zones where the current restrictive labor regulations can be relaxed. C. Financial Sector 7. The first task for the Government is to prevent a potential banking crisis by prudently restructuring the two Banks that accountfor SO% of banking sector assets. Gross non-performing loans make up 60% o f the assets o f the RBB and the NBL, while together their negative net worth i s estimated to be in the range o f 7% o f GDP. Thus, their insolvency endangers the banking sector as a whole, and with it future growth prospects. Government has set inprocess strong loanrecovery mechanisms through the Debt Recovery Tribunal and the recent appointment of a Judge for the Appellate Court (redress mechanism). While efforts by the RBB and the NBLhad some success inrecovering loans and improving portfolios, they are currently runninginto strong "political" resistance as large willful defaulters continue to take refuge behind the weak judiciary system (in the form o f stay orders by the courts) precluding the banks from taking further legal action for an indefinite period. Immediate priority i s to stay the course in implementingbanking sector reforms. This entails, first, amending the law concerning the Debt Recovery Tribunal to limit the scope o f the courts in issuing stay orders. Second, encouraging the NRl3 to enforce the Blacklisting Directive more rigorously as there are instances o f banks failing to carry out their duties as required under the Directive, and third, complete the restructuring o f the assets o f the two banks through settingup an Asset Management company. 31 However, this aspect couldbe remediedwith the WTO entryprocessunderway. 29 8. The second task ahead is to implement the banking supervision and regulatory reforms, including, most crucially, strengthening the role of Nepal Rastra Bank by providing it with autonomy in the conduct of monetary policy, banking system regulation and supervision, and the licensing of banks and non-bank. Alongside amending Article 86 o f the NRB Act to this end, the Government needs to increase the capacity o f the NRB.For this it has to persist with the implementation o f human resource management changes including rationalizing the staff through the VRS program to make it a more professional body. A second requirement would be to upgrade the N R B ' s archaic management and information system by introducing an automated clearing-house system, among other measures. 9. The two major development banks need restructuring or liquidation. Agricultural Development Bank o f Nepal (ADB/N) i s facing a number o f challenges from its past performance and from the Maoist insurgency that has led to the closure o f some 45 offices inthe last five years. Similarly, Nepal Industrial Development Corporation has to be liquidated or privatized. ADB/N i s one of the largest financial institutions in the country and has some 38%-48% o f loans in the non-performance category. The bank has been a conduit for cheap credit in the past with long maturity periods involving huge subsidies for relatively large borrowers. It followed the past policy o f meeting credit targets irrespective o f financial viability and had little incentive to mobilize saving deposits or recover funds. It also lacked risk evaluation and monitoring capability. HMGN should also be mindful of the need to improve the profitability o f the ADB/N and the very real limitations on the ability to operate branchnetworks outside the Kathmandu Valley due to the deteriorated security situation. The Nepal Industrial Development Corporation (NIDC), on the other hand, i s a candidate for liquidation. Detailed analysis o f the portfolio and the availability o ftrained staff suggest that it i s unviable. D. Infrastructure(Transport,Power andTelecommunications) 10. Along with improving the policy environment in trade, regulation andfinancial sector policies, further efforts are necessary to use the current and limited infrastructure better and to create infrastructure that supports private sector development. Given the country's geography and difficult terrain, access to infrastructure i s the worst in South Asia by most indicators (Table 3.2). Transport, which i s a key to private sector activities as well as the delivery o f public services, remains limited. Of particular importance i s inadequate road connectivity inNepal. Table 3.2 Comparative InfrastructureIndicators Year Nepal Bangladesh India Pakistan Sri Lanka Paved Roads, % of Total (1999) 30.8 9.5 45.7 43.0 95.0 Internet Users (thousands) (2000) 50.0 100.0 5000.0 133.9 121.5 Electricity Consumption per Capita (Kwh) (1999) 47.1 89.0 379.2 321.2 255.3 Telephones Mainlines per Employee (1997) 37.2 14.7 33.7 48.3 30.4 Road Density (Kml sq. km of land) (1999) 0.1 1.4 1.o 0.3 1.5 GDP per unii energy use (PPP $ per kg oil (1999) 3.5 10.8 4.7 4.2 8.1 An, cquivaici it) ,;,Fin"+\ Note (I): Data for telephone mainlines per employee for Bangladesh is for the year 1995, and for India is for the year 1996. Source (I): World Development Indicators for paved roads, internet users, electricity consumption per capita, road density and GDP per unit energy use. Source (ii) Social Indicators and Fixed Factors,for telephone mainlines per employee and radios per 1000 people Transport-Mainly Roads 11. Transport remains a defining constraint to growth, public services, and poverty reduction in Nepal as recognized in the IOth Plan/Poverty Reduction Strategy. Nepal has one o f the lowest road 30 densities for a landlocked country. As roads are the main arteries o f the economy in Nepal's terrain, the lack o f roads makes connectivity a significant constraint. An estimated 3.5 million people (15% o f the population) do not have road access inNepal; some villages can be up to 13 days walk to the nearest road head. The Government's strategy for the transport sector i s outlined inthe Tenth Plan, which includes: (a) maintaining the road network in serviceable condition; (b) expanding the road network to link 10 district headquarters with a motorable road; (c) improving rural access and decentralizing the management and financing o f rural roads to local bodies; (d) improving sector management; (e) encouraging private sector participation inroad construction and operation; and (f) facilitating trade and transit. However, achieving the targets i s likely to be difficult in the current security environment and if the Government cannot address the issues inthe following paragraph. 12. The Government currently funds only half of road maintenance requirements endangering the maintenance of this key asset. The proportion o f the strategic road network ingood and fair condition had increased from less than 50% in 1992 to 90% in 2001 but that has deteriorated again to 69% in recent years due to lack o f maintenance. Reversing this trend i s an urgent priority. HMGN has recently established an autonomous Roads Board and Road Fund to provide stable funding for road maintenance from user fees. The Roads Board has this year generated about NRs500 million from fuel levies and other user charges, but this i s only about half o f what i s required to fully fundNepal's Strategic RoadNetwork (SRN). 32 The maintenance gap could be met by increasing the fuel levy on At the current consumption level this could raise about NRs1.8 billion (US$25 million), with the small shortfall met by counterpart funds from districts and municipalities. 13. Increasing andprioritizing investment through revamping thepriority investmentplan is needed. Nepal currently invests far less on roads program in comparison to its needs. In order to facilitate the 6.3% GDP growth anticipated in the Tenth Plan, Nepal needs to invest about 2.5% o f its GDP (about US$145 million a year) in expanding and maintaining its road assets34.These estimates are substantially higher than the current $ 55 million expenditure inthe road sector. Another way to look at the shortage o f investment i s at its current resource allocation o f about US$30 million investment on new construction, it will take HMGN 19 years to complete the Tenth Plan targets and recent initiatives in the road sector. Three actions are implicit: increasing road expenditure allocation, prioritizing these more carefully, and, when possible, setting up regulatory frameworks for private sector participation. 14. Expanding the road network and completing the North-South corridors are a high priority. The road network inNepal has increased from 7000 km in 1990 to 16000km in 2003 (of which 4627 km are black top roads). But there are three priority areas for hrther road expansion, North South Corridors, a fast track Kathmandu-Terai link, and expanding and upgrading village roads. Perhaps most important, the North South Corridors and roads to several Westem districts remain incomplete. The hill districts in Nepal are accessed through major North-South Corridors that link them to the East West Highway, which would inturn connect them to the Terai, India and to the rest o f the country35.The total length requiredto complete road links in western Nepal is about 1184 km, o f which only 581 km has already been opened into a track or i s under construction for initial opening. Hence, completing these roads i s a highpriority. 32 S R N includesthe mainhighway andfeeder roads, 33 The current fuel levy transferred to the RoadsBoard is NRsl.5 on petrol and NRs 1on diesel. to NRs5.5 (or 7 cents) per liter of petrol andto NRs5 per liter of diesel. 34 The estimatesare only for the road sub-sector;air transport is not included. For comparisonwith other countries, China currentlyinvests about4 to 5% of its GDP on expandingandmaintainingits transport system, while Korea, duringits development stage, usedto spend about 5.2%of its GDP. Brazil spends about 2.4% of its GDP, and Bangladeshspends about 2.5% ofits GDP. Most OECD countries, with maturetransport network, invest about 3% of their GDP on maintaining their transport assets. 35 Ofthe 17 district headquartersnot servedby road, 12are inwesternNepal, while the five are inthe east. Roadconnection for easternNepal is progressingwith assistancefrom DFID, RAP and own HMGN funding. 31 15. Transferring rural road network development to decentralized management but with appropriate technical support will be key for rural development. There are currently about 14,000 km o f rural roads. Most o f these are under the management o f the respective DDCs; an estimated 4000 km o f district roads, now under the Department o f Roads management, will be transferred to district government management. But technical support to local Governments are needed to ensure that road planning is economically viable and avoid the mistakes of the past. Many unsustainable and environmentally damaging roads have been built or many lulometers of roads have been built for which there i s little vehicular demand as the road may not be connected to the remainder o f the network. 16. Government needs to attach much more urgency to transport and trade transit issues. Ninety percent o f Nepal's foreign trade route depends on access to India's transportation system, where the nearest seaport, Kolkata, i s located 1056 kilometers away in India. While the Government has built three Inland Container Depots (ICDs) in the border towns with India and focused on improving and harmonizing transit and customs procedures, the pace o f implementation has been slow. Although, the road-based ICDs are operating effectively under a lease hold contract with a private Terminal Management Company, the rail-linked I C D has just commenced operations three years after all physical work, including rail spur line from Raxaul, has been completed. Aside from the direct financial costs, delays like this raises costs for firms, and more critically, creates policy uncertainty for firms preventing them from investing to increase their competitiveness. Power Sector 17. Nepal has vast hydro resources, whichpresent a source ofpotential wealth and exports to India, but currently access to power is very limited in rural areas and power costs are among the highest in South Asia. Despite this potential (estimated at 43,000 MW), and a doubling o f capacity in the last five years, only 522 MW of generation capacity has been developed so far. Based on the 2001 census, 40% o f Nepalese households have access to electricity. Recognizing the critical importance o f energy access to poverty reduction, HMGN has made environmentally and socially sustainable development o f Nepal's hydroelectric potential one of its key developmental objectives. The emphasis on power development follows the adoption of the Hydro Power Policy in the early 1990s and the revisions to this policy in 2001/02. This policy envisages increased and competitive involvement o f private investors in the production, distribution, and management o f electricity, while recognizing the need for institutional and structural changes in the power industry to meet the sector's development objectives. Development o f small hydro projects and district level projects under decentralized schemes inhilly and remote areas has also been highlighted. In the meantime, private sector generation has increased in some areas while in other parts o f the country Maoists activities have ledto the closure o f some plants. 18. But while considerable progress has been made on many fronts, many issues and challenges remain that constrain thepower sector's ability to support poverty reduction efforts to its full potential. First, despite the efforts o f NEA, the systems losses are still high at about 24%, considerable efficiency and revenue gains can be made in this area. More work i s needed to examine alternative restructuring options to lower costs of the power sector in the context o f greater private sector participation and growing prospect o f power trading. 19. Second, Government needs to have a more focused policy in attracting private sector participation in thepower sector, including in rural areas. On the financing side, the longterm financing facility, which the Government aims to create under the Power Development Fund (PDF) can play a critical role in mobilizing private investments inNepal's power sector and should be implemented on an urgentbasis. Butat least equally important will be the needfor institutional and regulatory reforms. Here Government needs to remove overlaps in the power sector further in policy, regulatory, and operational 32 functions o f public sector institutions operating inthe power sector that create conflict o f interest and send confusing signals to the private sector. 20. Setting up a competent and effective independent regulatory body is perhaps the highest priority for attracting efficientprivate investment as there is no such body at present. The Electricity Tariff Fixing Committee (ETFC) that has been established falls well short o f a full fledged regulator. Partially because o f the lack of a competent regulatory agency, the IPP costs inNepal are very high, and the IPP's generate power inthe low value wet season when already there i s surplus energy. Although the prevailing political environment inNepal i s delaying the passage o f the regulatory act, there are several actions that HMGN can take in the transition period. These include: widen the role o f the EFTC in areas where the existing order can be used as a base; improve the quality o f staff o f the ETFC by attracting with suitable compensation packages the best available technically competent candidates; and draft the regulatory act based on best practice experience from other countries with similar country and sector situations. When Parliament i s restored, these transition efforts would facilitate the establishment o f a competent and independent regulatory authority, which can perform the functions o f setting and enforcing rules under which the sector operates, including the importantrole o f setting power tariffs. 21. Third, to ensure demandfor new capacity, more needs to be done to promote power trade with India, which is very limited at present. In 2002, Nepal exported only 10% o f its output to India. At present there i s little or no commercial orientation to power exchanges and the Power Trading Agreement between India and Nepal has not been ratified by the Parliament. While recent developments include formation o f a joint technical committee between India's Power Trading Corporation and HMGNNEA; and preparation o f term sheets on the volume o f power and energy to be traded between Nepal and India, agreements and decisions on power trading transmission link with India needto be expedited. Telecommunications 22. I n the last seven years, the telecommunications sector in Nepal grew at a rapid pace, but there is still considerable unmet demand and the need to increase competition. The number o f fixed line customers increased from about 84,000 in 1995 to about 350,000 in 2003, bringingfixed line penetration to over 1.8% (see Table 3.3 below). The introduction o f prepaid mobile services by NTC and the start o f services by the second fixed line operator, UTL also increased teledensity. The liberalization o f the ISP and VSAT market has led to a rapid diffusion of internet services in Nepal, although mainly in Kathmandu and other bigger urban areas. There are approximately 1500 Internethosts and about 35,000 Table 3.3 Comparative TelecommunicationsIndicators Cellular Fixedteledensity Totalteledensity Estimated internet Telephone Costof a 3 MinuteCallto teledensity(%) (%) (Yo) users (thousands) Mainlinesper the US (In US$) and utility Employee providingthe service. Bangladesh 0.81 0.46 1.27 204 55 1.24 BTTB India 1.22 3.98 5.20 16,580 108 0.6 BSNL Nepal 0.09 1.77 2.77 175 92 3.0411.27 NTC1Budget Calls Pakistan 0.85 2.50 3.35 1,500 73 1.35 PTCL Sri Lanka 4.92 4.65 9.57 200 131 0.7 SLT Source, World Telecommunications Development Report 2003. ITU, Nepal's numbers were updated by HMGN in October 2004. Intemet subscribers, with the number of users estimated to be two or three times higher. Despite the growth o f telecommunications, there i s considerable unmet demand and costs are high.Inparticular, there is a waiting list for fixed services estimated at 200,000 subscribers (February 2004). Also, unlike 33 neighboring countries, the cellular market did not witness higher growth despite the entry o f few private operators owing mainly to the lack o f competition in the mobile market and the delayed introduction o f prepaidmobile services inmid-2003. 23. Developing telecommunications is a key to increasing connectivity and external competitiveness. A reform agenda wouldinvolve increasing competitioninthe sector, rebalancing o ftariffs to reduce cross subsidization, expanding access to the rural areas, reforming institutions inthe sector to clarify regulatory authority between the N T C and FMD and commercializingthe N T C perhaps with a view to privatization o f the services. There i s also the needto clearly separate the government's policy-making and operational roles inthe sector, with the restructuring and increased private ownership o f NTC. E. Summingup 24. Nepal has to act on a number offronts to raise its investment rate, particularly private investment to restart growth. Towards this end, it has to improve the regulatory environment and adopt investment regime that i s more friendly to private investment than perceived by the private sector at present. Restructuring and reforming the financial sector would be necessary to increase access to credit and also to increase efficiency in the financial sector. Infrastructure, particularly the lack o f connectivity, has been a factor in l o w private sector participation as well as HMGN's ability to provide public services to the different parts of the country. It has retarded growth as well as skewed development to the detriment of welfare o f different parts o f the country. Roads will play a crucial role to increase connectivity and to facilitate trade both internally and with the rest o f the world. Nepal has large power potential and this needs to be exploited with power exports to India. Similarly there i s a policy agenda to be addressed in the telecommunications sector to allow the private sector to play a larger role by improving the regulatory environment for that purpose. 34 CHAPTER 4: FOSTERINGGROWTHINAGRICULTURE AND LAGGINGREGIONS A. The CentralRole of Agriculture and EmergingDynamism 1. Agriculture and rural development are central to poverty reduction and growth in Nepal. Although the sector's contribution to GDP has declined to about 40% in 2001, it employs more than two- thirds ofthe labor force and is the main source o fincome for 83% ofthe population. Agriculture inNepal i s to a large extent subsistence and smallholder-based. About 96% of land owned by agricultural households and 83% o f the operational landholdings are less than 3 hectares. Agriculture i s especially important for the poor, as it i s the main source o f income for the poorest households (90% o f the bottom consumption quartile). Hence, agriculture's performance has widespread implications for the overall welfare o f Nepal. Unsurprisingly, stagnant per-capita agncultural incomes o f the last few decades were associated with Nepal's persistently stubborn high poverty rates until the mid-1990s. Conversely, acceleration inthe growth o f agricultural incomes from 1.5% in 1991-95 to 3.7% in 1996-2001, alongside the rapid growth o f remittances, i s associated with significant poverty reduction and demonstrates the sector's potential contribution to poverty reduction. 2. Increasing productivity, cropping intensity and diversification to higher value products (i.e. crops, livestock), stimulated by a number of demand- and supply-side developments, contributed to agriculture's improved pe$ormance in the second half of the 1990s.Risingincomes increasing domestic demand and improved export opportunities expanded markets for agricultural products. Indeed, the share of agricultural exports in total production value increased fkom 20% to 35% from the first to the second half o f the 1990s. The agncultural sector's supply response was in turn facilitated by the Government Agricultural Perspective Plan (APP) led expansion o f infrastructure - in particular, roads, which facilitatedmarketing and irrigation, which facilitated increasedproductivity - and credit, which facilitated farm investments. In addition important policy reforms contributed to improving the incentive environment for agricultural commodity and input markets. These included trade policy reform, which enabled increased agricultural exports, increased internal commodity market deregulation that encouraged greater private sector participation and investments, and input market deregulation particularly for fertilizer, which enabled improved farmer access and use. These policy reforms and investments contributed to improving the competitiveness o f Nepal's agnculture and improved production incentives by farmers. The agricultural sector grew despite the lowering o f import tariffs36and the removal o f subsidies on fertilizer and on shallow tube wells.37 3. Despite substantial constraints such as a difJicult terrain and poor connectivity, there are opportunities on which to build. Nepal i s blessed with a broad range o f ago-ecological zones and proximity to vast markets in India, Bangladesh, and China. The mountains have a natural advantage in animal production and livestock products, while the hills have comparative advantage in a variety of crops, such as off-season vegetables, tea, citrus, seed production, and spices. Despite the Terai's similarity to growing conditions in northern India (and the fact that Indian farmers are subsidised), this area i s considered to have growth potential in vegetables, fruits, oilseeds, betel nuts, and some cereals. Another important asset i s a culture of active community groups in Nepal's hills - in forest management, water and roaduser groups -- indicating the presence o f significant social capital at the community level, 36 Nepal's agriculturaltariff ratesof around 14%are the lowest inthe SouthAsiaregion. 37 Budgetary subsidiestotallingabout 0.2% of GDP exist ina few areas such as transport subsidieson fertilizer,a transport subsidy on food supply inthe remote districts o fthe country, an irrigationsubsidyfor some surface schemes, interest subsidieson small loans extendedby the AgriculturalDevelopmentBank, and a capitalsubsidy onbio-gas and small irrigationprojects. 35 4. Sustaining and improving on the agricultural sector's performance over the longer term, to maximize its contribution to rural growth and poverty reduction in Nepal would need government commitment tofoster an enabling environmentfor the development of a highproductivity, diversified, and commercialized agricultural sector. This would be in line with the Government's 10' Five Year Plan (2002-2007), which assigns a central role to the development o f agnculture and the rural economy in poverty reduction. This i s also in line with the Agricultural Perspective Plan's (APP) broad thrust, but differing in its greater emphasis on policy and institutional issues and a broader approach in its hills strategy. Achieving these goals would require measures to increase farm productivity and agricultural marketing efficiency by strengthening farmer capacity to take advantage o f growing domestic and international market opportunities. These will require actions in two major areas. First, policy and regulatory reforms are needed to reduce the barriers to private sector participation and investments inthe agricultural sector. These would include reforms o f land and credit policies and o f the multiple laws, rules and executive orders governing agricultural trade. Second, fostering increased public and private investments in rural infrastructure (roads, markets, electrification) and rural services (credit, agncultural research and extension, land administration, market information, export promotion, phyto-sanitary services, grading and quality control) will be critical. Integral to the revival o f the govemment's investment program will be institutional reforms o f government agencies to ensure the improved delivery of rural-related public goods and services, including through greater participation o f users and communities. 5. Recognizing the diverse agro-ecological conditions in Nepal (Terai, hills and mountains), regionally differentiated rural development strategies would be critical. For example, the mid and far Western regions o f Nepal lag significantly behindininfrastructure, incomes and human development than other parts o f Nepal. Their characteristics and endowments offer unique potentials, opportunities and challenges, and will need special focus. B. Government Strategy and Policies 6. The Agricultural Perspective Plan (APP), launched in 1995, is the government's key policy on agricultural and rural development. This Plan was launched during the 9th Plan Period but was only partially implemented. The APP strategy was expected to lead to a technology-based green revolution in agriculture, which would raise outputs, and incomes through increased use o f yield increasing inputs (fertilizer, improved seed, reliable irrigation) and promotion o f off-farm activities. The strategy was regionally differentiated between the Terai, which would focus on high yielding input based food grain production, and the hills and mountains, which would focus on horticulture and livestock production in prioritized pocket programs. The APP envisaged significant increases in public and private investments and an integrated package approach to exploit complementarities between public and private investments and with other sectors such as transport and energy. The APP included explicit investment targets focused on four priority inputs:fertilizer, irrigation, technology, and infrastructure. 7. The IOthPlan's growth strategies for agriculture sector are to modernize, diversify and commercialize crop and livestock production by expanding the use of technology, and increasing the access of farmers to modern agricultural inputs and credit. Similarly, promoting the participation o f the private sector and NGOs/INGOs in service delivery, market promotion and infrastructure development are other major strategies. To diversify and commercialize agriculture, the Plan intends to mobilize private and non-government service providers in partnership and on a contract basis; promoting cooperative and contract farming; devolving local agncultural programs to local bodies; strengthening agriculture stations as resource centers to ensure the supply o f quality seeds, saplings, and breeds for subsequent multiplication for local needs; and providing technical backstopping. 36 8. Going by the experience of the 9thPlan (FY 1997 to ZOOZ), the key challengefor Government will be implementation. In the past the promise of the APP was impeded, first, by actual investments which fell short o f targets: on average only two-thirds o f the planned development expenditures were realized. Second, inter-departmental coordination to implement the APP was weak. Beyond implementation, the APP suffered from the inadequate attention to incentives, marketing and demand issues, and the commercialization of agriculture. While the 10* Plan touches on these issues, it needs more specificity on the commercialization strategy as well as on addressing the continuing problems o f coordination o f the different agencies concerned with agriculture. The issues in output and factor markets that impede the growth of agnculture are describednext. C. OutputMarkets and Marketing 9. Output Trends: The agricultural sector's growth pe$ormance improved Table 4.1 Growth of AgricultureSector and Composition markedly between theJirst and second half of Growth Rates Growth Rates Share of the 1990s. This improved performance was Value Added mainly led by a much faster growth o f food 1990191to 1995196to 1995196to grains (Table 4.1) as irrigation expanded which 199495 1999100 1999100 made output less volatile, fertilizer used Agriculture, Fishery, 1.75 2.97 100.00 increased, and new roads and markets improved and Forestry incentives and facilitated private sector entry. Food grains 0.88 2.32 34.70 Growth o f livestock, a significant part o f Cash Crops 3.44 5.55 7.56 agnculture, also accelerated. Other Crops 5.41 3.02 18.73 Livestock 1.62 3.57 28.97 10. Regional variation: There is Forestry 3.33 9.66 1.35 considerable variation in Nepal's agriculture Fishery 2.51 0.26 8.70 t among the dierent ecological zones and physiographic regions of the country: i.e. between theplains of the Terai, the central Hills Figure 4.1 Ecological Zones of Nepal (called the Shivaliks and middle mountains in Figure 4.1). Terai plains, accounting for only 17% of total land area accounts for nearly 50% o f total crop land. The most striking characteristic o f the Hills and Mountains is their diversity o f agro-ecological zones and their potential as a source o f high-value crops. Livestock i s more important than cereals. All these drive home the need to take a differentiated approach to agriculture in Nepal and to take into account the special features of its hills and mountains. 37 11. Low Agricultural ProductiviQ. Table 4.2. Low Agricultural Productivity Because Nepal missed the Green Revolution that tookplace in most of South Asia in the Crop Yields in Nepaland its Neighbors ~ 1970s and 1980s, productivity remains low Wheat Rice paddy Sugarcane Pulses Maite for a number of crops compared to mffha mffha mffha Mt/ha W h a neighboring Indian states and Bangladesh Nepal 1.8 2.7 37.2 0.77 1.8 (Table 4.2). Limited availability and use o f India irrigation and inputs, such as improved seeds, Uttar Pradesh 2.7 2.0 54.8 0.8 1.6 fertilizer and technical advice contributed to Bihar 2.1 1.5 42.4 0.8 2.3 low agncultural productivity. Only about two- West Bengal 2.5 2.3 67.9 0.7 2.5 fifths o f the cropped land is irrigated and less Bangladesh 2.2 3.5 40 0.83 1.5 than half o f the irrigated land benefits from Source: FA0 year round irrigation. Until recently, input monopolies raised prices o f modern inputs. In addition, difficult terrain - a large share o f Nepal's agnculture i s in terraced hills, also makes agricultural production more complex. These factors limited yield growth. Between the early 1960s and the late 1990s, paddy yields inNepal only grew at 0.6% per year, while neighboring countries achieved growth rates between 1.4% and 2% per year. demand potentially % of households % of households % of output exists, scarcity o f market producing selling sold infrastructure such as wet dry collection centres, season season Padd 75 22 7.4 storage facilities and Cerells, includingpaddy 98 84 24 8.8 organised market places Other crops 75 79 29 12.9 limit opportunities for 'Any crop 100 100 46 13 13. Recent indications are marketing and commercialization are increasing even in the hills regions as evident from the growth of production of off-season vegetables, vegetable seeds, lentil, honey, spices, milk, and livestock. In particular, agncultural exports have been increasing rapidly with their share increasing from an average o f 14% in the first half o f the 1990sto 19% in the second half o f the 1990s. Duringthe same period, growth of export of agncultural products increased dramatically from 20% to 35%. Much o f the growth in agncultural exports was the result o f increased trade with India, which i s the destination for 90% o f Nepal's agricultural exports. Four constraints have to be addressed, however, to buildonthis potential for commercializing agnculture. 38 See the discussion onTransport in Chapter 3. 38 14. First, the lack of connectivity and especially roads is probably the single-most important constraint to agricultural growth, especially in the mid and far western regions. Even though nearly 1,000 local haat bazaars and Government built up urban markets are operational in different parts o f the country, particularly in the eastem, central and western regions, distance to markets remains a major issue. This exerts a strong impact on crop choice and diversification, use o f inputs and the balance between farm and non-farm activity. Thus, the 1995-96 survey finds that vegetable production tends to occur within 3 hours' distance from an urban market. Cereals and pulses dominate production in areas within 8 hours' from markets. Beyond 8 hours travel time, the local economy is self-contained (subsistence based), showing little interaction with the market. Chemical and fertilizer inputstend not be used beyond a distance o f 5 hours. These distances raise transport costs, increase products losses during transit and create thin and segmented markets. Thus, transport and village to market roads will play a pivotal role inthe move away from subsistence faming to high-value crops. 15. Second, market facilities - markets, storage, processing and drying centres - are grossly inadequate in the mid- and far-western regions compared to the other regions. All these contribute to limited markets, l o w prices and low productivity. Priority needs to be given to developing market infrastructures in these regions, especially in commodities, which have revealed their potential for commercialisation. 16. Third, regulatory and legal reforms are needed to promote private sector and community organizationparticipation in commercial activities, the developments of markets, and the introduction of standards. Thus, there i s a need to extensively streamline 66 laws, 38 rules and regulations, 39 executive orders and 39 by-laws that impinge on commercial and contract farming into a more manageable set. Fourth, experienced NGO or private sector based assistance in the formation and operation o f a group approach to production, processing, and marketing o f high value commodities will be useful given the small scale o fNepal's agnculture. D. FactorMarkets 17. There is signiJicant scope and need to improve policies and eficiency in land, waterhrigation, and credit markets. Although there was significant expansion o f irrigation and credit inthe 1990s, which helped to boost agriculture, market rigidities (land), inefficient pricing and weak institutional incentives (water), and inadequate and unsustainable coverage (credit) pose major constraints at present. 18. Labor. Currently, more than two-thirds of the labor force in Nepal is employed in agriculture. This is significantly higher than other South Asia neighbors such as India (58%), Bangladesh (55%) and Pakistan (47%). This share of the labor force in agriculture, however, declined rapidly inthe 1990s from more than 80% to 66%, with significant growth in the share o f industrial employment (currently 13%) and employment abroad (approximately 9% of the labor force). Within the agriculture sector, self- employment dominates. There were only 180,000 permanent agriculture laborers - or less than 3% o f the labor force in agnculture. Overall, less than 3% o f households employed both permanent and casual workers. In the absence of employment opportunities and lacking assets, a good proportion o f the farm labor pledge their services to land owners for long periods - effectively working as bonded labor. In Western Nepal, this practice becomes more formal with labor being tied to the land as Kamaiya (indentured) labor. While this practice was declared illegal and abolished in2000, it continues inreality in the absence o f other opportunities or programs to provide them with other assets. Wage data inNepal i s extremely weak. However, field visits and the household survey data suggests that the tightening o f labor market has resulted inan increase inagriculture wage rates. Despite this, real wages in agriculture remain low relative to neighboring countries. This suggests employment intensive growth that would foster more rapid wage increases inrural areas will be critical to ruralpoverty reduction. 39 19. Land. The agrarian structure in Nepal is dominated by small-land holdings. The average size o f land owned i s about 0.8 ha, which i s frequently fragmented, averaging 3.3 parcels. This i s inpart due to Nepal's Land Act of 1962, which imposes a stringent limit on land holdings. It allows for a maximum o f 17ha per holding inTerai, and 4 ha inthe hills and mountains. Inaddition, cropping intensity i s relatively low, and increases only slightly as farm size decreases. The small landholdings and their low productivity pose difficulties for many agriculture-based households in generating an adequate income and livelihood and are important determinants o f poverty. 20. Land rental and sales markets are constrained by land policy relating to land leasing and weak land administration systems. Nepal's dual tenure system allowed both tenant and owners to lay claim on the same land. Lack of clear ownership rights thus discourages investments or renting o f land to more productive users and can pose limits on the use o f land as collateral. Only 9% o f the land area was rented in1994, butthere is also considerable hiddentenancy. Ina muchwelcomed move that would improvethe functioning of land rental markets, this provision was repealed through an amendment o f the Land Act in 1998. But its implementation and positive impact will take time. Land ownership records are very rudimentary. Measures to improve land administration systems, particularly cadastral and land title records, to provide greater security of ownership and reduce transactions costs will also be needed. irrigation, Nepal irrigation Strategy needs to be Irrigated Area Surface Ground Total regionally differentiated (Table 4.4). In Terai, the (ha) bysystem Water Water strategy for expanding irrigation should include a and Source combination o f surface and groundwater irrigation ~Ov~rnment 290,000 30,000 320,000 development. Large irrigation schemes (greater than operated 10,000 ha) can be developed with surface water sources. Farmer operated 690~000 190800 880,000 Groundwater development could be focused on crop Total 980,000 220,000 1,200,000 22. Many surface irrigation systems are plagued by low eflciency. Inmany cases, only about two- thirds of the irrigation command area actually receives irrigation. Moreover, many surface irrigation systems suffer from inadequate maintenance leading to their rapid deterioration. Poor irrigation maintenance arises from inadequate budget allocation exacerbated by poor cost recovery, and lack o f incentives and accountability for maintenance by irrigation agencies. At one level, the average cost recovery for operations and maintenance in the Government Agency Managed schemes i s estimated at only 1.3%, and the pricing i s seriously distorted by makmg it tied to the size o f landholding rather than actual use o f water. The cycle of deferred-maintenance and consequent costly rehabilitation undermines the quality o f irrigation service delivery. Institutionally, participatory water user's associations have done muchbetter than government agency managed systems at cost recovery and maintenance. But some large size surface irrigation facilities, which have a strong public good component, will continue to need Government management. 23. With these considerations, Government can unbundle the maintenance strategy in thefollowing manner: (a) maintenance of the head-works and big structures should remain under government 40 responsibility. The Govemment can fund these works through an adequate budget appropriation for operations and maintenance; (b) maintenance o f the secondary level (main canals) depending on their size, complexity and capacity o f user groups could be taken over by federations o f W A S(as they do in the Hills), co-financed by the Government and W A S .Collection o f fees will o f course require a clear link to quality o f services delivered. The tertiary level (minor canals and watercourses) should be wholly transferred to water users. Adequate capacity will need to be built at the WUA level to ensure a smooth transfer and sustainability. WUAs would collect fees for the O&M o f their scheme from their members and put inplace the organizational structure and incentives for water distribution and management at their level. They would contract any services themselves. 24. Fertilizer. Although increasing, fertilizer use remains low in Nepal. During the 1965-1990 period, fertilizer consumption increased by over 22%. Usage dropped in the early 1990s but increased significantly in the second half of the 1990s.Data from a 2001/02 household survey indicate fertilizer consumptiono f 56 kg per hectare o f cultivated land; the Amculture Sector Performance Review found similar results at 58 kgha. Nevertheless, fertilizer consumption per unit o f arable land i s four to six times lower than Pakistan, which similarly does not provide fertilizer price subsidies (Table 4.5). 25. I n 1997,the government removed thefertilizer distribution and import monopoly of the Agricultural Inputs Corporation. The entry o f the private sector in Fertilizer Application Rate both imports and distribution improved the domestic Formal source Informal Source Total availability o f fertilizers considerably. At the same (kg nutrientslha) (kg nutrientslha) (kg nutrientslha) time, the government also phased out fertilizer Before subsidies, and the prices o f fertilizers were deregulation decontrolled at the wholesale and retail level. Notably, 1992193- 1996197 25 3 28 despite the elimination o f fertilizer subsidies, fertilizer 1996/97 22 4 26 consumption still increased. Improved market After incentives and expanding use o f irrigation and access deregulation to credit also likely contributed to enhance the 1997198 15 5 20 incentives for increased fertilizer use. 1998199 38 6 44 I999100 35 7 42 Source: Shrestha (2000) 26. Credit. The growth of agriculture in the second half of the 1990s was underpinned by a significant growth in agricultural credit from formal sources though its coverage is still limited and its sustainability is in question. After being stagnant in the first half, the share o f credit in agricultural GDP grew from 6% in 1994 to more than 10% by 2001, implying a doubling in real terms. But its coverage remains limited, especially for the poor. Only 8% o f the households at the bottom income quartile had loans from formal sources, compared to 26% in each o f the wealthier quartiles. On average, only 14% o f households had access to formal credit (including provision by other banks and Grameen-type institutions. One major source o f formal credit i s the ADBN. The recent financial audit o f the ADBN, the source o f more than 85% o f formal credit, has revealed that the ADBN's assets have sharply deteriorated inquality, placingfuture lendinginjeopardy. 39 Note: 1. It i s conservatively assumed that 10 percent and 15 percent of the total fertilizer importedand distributed from formal source may additionally have been illegally brought into Nepal from India before deregulation for the period of 1992193 - 1996197 and FY 1996197. 2. The differences inthe proportion o f informal source o f fertilizer are guided by the pricing structure adopted inNepal. The higher the price o f third country imported fertilizer i s greater the tendency o f farmers to purchase illegal cross border fertilizer. For instance, there was relatively a smaller contribution (10-15 percent) o f informal source to total fertilizer application before fertilizer deregulation since the price differentiation between the imported fertilizer and illegal cross border fertilizer was small (10-12 percent). 41 27. n e challengefor thefuture is expanding access to credit especially to thepoorerfarmers. There are three approaches for addressing the issue on ensuring adequate credit. First, Government, with the technical assistance from the Asian Development Bank, has begun the restructuring o f the ADBN with the goal o f separating its development lending from commercial banking and refocusing the development lendingto medium and larger borrowers. This is being accompanied by a rationalization o f the branch network and o f the business processes and expansion o f financial products. The restructuring o f ADBN should have a beneficial fiscal impact and may indeed succeed in supporting the target group of commercially viable medium and larger borrowers. Second, the Government will need to provide more focus on expanding and ensuring a sound business environment for micro finance intermediaries (MFIs) and other rural finance intermediaries (trade credit providers and other informal sources). Third, Government has to consider addressing the issue o f credit market failures - i.e. the less than optimal supply o f credit for viable capital project and investments and maintenance - with the use o f matching grants. Under these schemes, farmers can be partly reimbursed for capital costs they incur for a variety o f agricultural implements - tubewells, to surface water canal maintenance, implements etc. This approach has the merit of being economically sound and better targeted for productive use. Nepal can draw on the considerable experience o f usingmatching grants inthe South Asian Region and elsewhere (see Box 4.1). Box 4.1: Suggested guidelinesfor providingmatchinggrants for income-generatingactivities Target matching grant assistance to very poor communities or groups that are beyondthe current reach of micro-finance institutions. One way to do this is to make the grant amount large enough to be useful to the poorest, but too small to be worthwhile for better off groups. The income generating activities financed must be cost-effective ways of reducing poverty. This can be demonstratedby impactand cost-effectivenessindicators. The investmentsshouldnot compete directlywith privateinvestment(existingor likely). Beneficiaries should always contribute at least partly in cash (no less than 5% of the total project cost), which will demonstratecommitmentandcan serve towardthe initialworking capitalto operatethe activity. Over generoussubsidiesmay create false positivedemand (evenwhere beneficiariescontributeinthe form of labor or cash). This mayjeopardize future maintenance of the investment by beneficiaries.Subsidies used without tied commitments for repayment, user fees, or maintenance,may create perverseincentivesfor greater rent-seekingby beneficiaries. Grants should be combined with training and support to establish local savings and credit associationsto capture increased incomeflows andfinance future economic activities(group or individual) on a sustainablebasis. Subsidies based on percentagecost-sharing of subprojects create an unknown contingent liability for govemment. This can be avoidedby basingthese on per capita amounts, or fixing a ceiling for govemment contributionswith excessbeingmet by beneficiaries. Source World Bank,AgriculturalSourcebook, 2004. E. Developmentofthe Western LaggingRegions-ChallengeandPotential 28. The Challenge. The challenge of promoting more rapid rural growth and development and reducing poverty remains large in Nepal. The mid-Western development region (MWDR) and the far- Western development region (FWDR) provide an important illustrative example. They lag significantly behind the rest of Nepal in terms of most development indicators. Poverty i s much more acute in these regions with about 48% o f the population below poverty line in the Terai and over 70% in the hills and mountains. Nine o f the 10 hill districts produce less than required for minimumself-sufficiency and all 8 mountain districts have chronic food deficits. Interms o f various development indicators, the bottom 13 districts o f Nepal's 75 districts4' lie in these two regions.41Further, the people of these regions have a 40 ICIMODISNV, studyof 1997. 41 Agro-Enterprises Center, "Agriculture DevelopmentProgrammefor Hillsof Mid-WestemandFar-WestemDevelopment Regions ofNepal:A ConceptPaper", BackgroundPaper, May, 2004. 42 distinct sense o f being marginal and excluded from a Kathmandu driven development process. Unsurprisingly, these regions now constitute the heartland o f the Maoist insurgency. As the lothFive Year Plan recognizes, a special effort i s needed to develop these regions. This section sketches an outline o f such a development strategy. 29. The Potential. While the MWDR and the FWDR are backward, these regions have considerable economic potential -and in particular two assets -- waiting to be tapped. Ifutilized properly, these assets and regions can become not only a driver o f poverty reduction for the people inthese regions, but an asset for Nepal's growth in general. The first asset comes from the ago-ecological diversity o f these regions with its astonishingly large range o f height. This leads to comparative advantage in high value horticulture and crops at different seasons. These include high quality fruits and vegetables, both seasonal and off-season, ginger (drylfresh), lentil, vegetable seed, products such as vegetable ghee, medicinal and aromatic plant products, non-forest timber products such as rosin turpentine and some agricultural by- products, honey production, as well as livestock and forestry products. Several success stories have already emerged: e.g. bee keeping and the production o f lentil inDang, off-season vegetable inDhankuta and Makwanpur; sunflower in the FWDR; tea and coffee, in many parts o f Nepal from East to Far-West Development Regions. Another interesting feature i s that in many o f these cases, farmer organizations (groups, cooperatives, associations) consisting mostly o f smallholder farmers have been active and are among the most productive farmers. 30. This brings up the second asset of the hills: the traditionally strong community spirit - i.e. social capital -- that one witnesses in this area, the drivingforce behind an unusual success of community and user groups inforestly, irrigation, roads, and water and sanitation sectors. Perhaps, the most acclaimed example on this comes from the one million hectares o f previously degraded forestland (about 18% o f the total forest area o f Nepal) that was brought under successful community forestry program. More than 13000 user groups have been formed to manage forest areas where 1.45 million households or 35% o f the population o f Nepal are involved. This activity has been particularly intense in the MWDR and the FWDRbyreportedlymore than 3200 Community Forest groups who covered an area o fabout 278,750 ha of forestland and benefited almost 320000 household^.^^ Elements of a Strategy 31, As these two areas are predominantly rural and agriculture dominates economic activity, agricultural and rural growth built primarily on connectivity and commercialization is the key to development. The poor development outcomes in the MWDR and FWDR can be largely attributed to subsistence farming and poor access to infrastructure. Despite the growth o f the road network in and a general increase in rural mobility, the extreme northwest (the Karnali Zone) and much o f the MWDRandFWDRstill remains extremely isolated. 32. While the Government has already identiJied the key strategic thrusts required for economic development of Hills and mountain regions in its IOth Plan and the Agricultural Perspective Plan", it is not yet clear to commercial stakeholders in the MWDR and FWDR what strategies are currently in place to intens@ agricultural production and its commercialization. Two issues lower expectations in particular. First, as most dramatically illustratedby the lack o f investment inrural roads inChapter 2, the strategy o f the APP has yet to be properly implemented in these regions. Second, more emphasis i s needed on marketing and generating demand. One example o f the lack thereof i s the Crop Diversification 42 Baral, S.R.andB.Karki, (2002), "A BaselineStudy onNon-timberforest productsinFar Westem DevelopmentRegion, Neapl.Agro-EnterprisesCenter, Kathmandu. 43 See Chapter 3. 44 The identificationof pocket areas for leading commodities, development o f infrastructure, technology development and institutionalupliftment 43 Project4' -- one o f the main projects particularly designed for MWDR and FWDR -- has no component on development o f off-farm value adding programs and product marketing. 33. Given these considerations, a morefocused and comprehensivestrategy is needed to speed up the development and commercializing agriculture in MWDR and FWDR by combining some elements of the APP with commercialization. Such a strategy would consist o f the following elements: (a) regulatory and policy reforms that facilitate private sector entry and the development o f cooperative marketing; (b) improvement ininfrastructure-roads, rural electrification and micro-irrigation; inparticular development o f north-southhighway corridors that can link areas o f products o f identifiedpotential to markets; and (c) developingmarket promotion strategies. 34. Regulatoly and legal reforms to promote private sector participation will be key. Global experience with regional developmentprograms clearly indicate that successful programs are those that are private investment led, with the role of the Government being to provide confidence and policy credibility, and public goods such as infrastructure and research, and some risk mitigation measures such as providing credit and seed capital.46But the first requirement for this i s that the approximately 66 laws, 38 rules and regulations, 39 executive orders and 39 by-laws4' that impinge on agncultural activities and trade and private sector investment be reformed. Inparticular laws to support contract, commercial and cooperating farming, and removing domestic barriers to trading will be particularly im~ortant.~'The first i s the Draft Bill for Commercial Agriculture Contract Act-2060 with the provisions for private sector or farmers to take government or local body owned land and other privately owned land into lease for a certain period for commercial agncultural production and also for legal validity o f agreements for contract farming. The second i s reforms in the Cooperative Act-2048 for the purpose o f registration and management o f cooperatives inthe country. The cooperative approach in input marketing and easy access to credit has also been possible through different forms o f saving and credit cooperatives. But, there have been few cooperatives, which are directly geared towards collective production and product marketing, partly because the existing Cooperative Act i s silent on the legality o f Marketing Cooperatives and nor does it allow cooperatives to function as a commercial entity. Finally, private sector participation will be boosted if standards can be fostered. Thus another priority i s the Plant Protection Act-2060 under which plant quarantine offices across the country will be enforcing quarantine rules in compatible to SPS Agreement under WTO. Currently, both capacity and capability o f Plant and Livestock Quarantine offices and Department of Food Technology and Quality Control for inspectiodtesting and issuing phyto- sanitary/quality certificates are limited. 35. Improving connectivity and infrastructure in the MWDR and the FWDR by completing afew key road networks under construction will be necessary for connecting high value crop areas and markets and inviting moreprivate sector participation. The connectivity potential from these roads i s sketched out in Table 4.6. Community projects would help, given the high social capital potential o f region. But a particular issue here i s the institutional vacuum created by the absence o f local Governments. Inthe past This i s aproject of the Ministry of Agriculture and Cooperatives(MOAC) and fundedby the ADB. Anwar Shah, "Bridging the Economic Divide Within Countries: A Scorecard on the Performance of Regional Policies in ReducingRegionalIncomeDisparities", WorldDevelopment, Vol. 31,2003. PesticidesAct-2048, PesticidesRules-2050, Plant ProtectionAct-2029, Plant ProtectionRule-2031, Seeds Act-2045, Seeds Rule-2054, Food Act-2023, Food Rules-2027, Nepal Standards (Certification Mark) Act-2036 and Rules-2039, Contract Act-2056, Local Self-Govemance Act-2055, Local Self-GovemanceRule-2056,Animal Health andLivestockServices Act- 2055, Animal Health and Livestock Services Rule-2056,Cooperative Act-2048, Cooperatives Rule-2049 are some of the Acts andRulespromulgatedby the govemment o fNepalthat havebeenplaying vital role inthe agricultural development of Nepal. Contract farming is a forward agreement between farmers and processing and/or marketing firms for the supply of agricultural products, frequently at predetermined prices. The purchaser provides a number of support measures to the farmers such as supply of inputs, and provision of technical advice, loan and transportation.The farmer provides a specific commodity, quantityand quality standards ofwhich is determinedby the purchaser(FA0 2001). 44 the Division o f Local Infrastructure Development and Rural Roads and Agricultural Roads (DoLDAR) o f MOLDand its regional and district level units - which have the technical responsibility for the development o f rural transport network - has worked with DDCsNDCs. But now given their absence progress has slowed down. 36. Irrigation. The lack of Table 4.6 PotentialPocketAreas for Productionand Non-Farm Activities in Three dry season irrigation is the HighwayCorridorsof MWDR & FWDR greatest constraint faced by majority of the smallholder farmers engaged in upland farming in the hills of Nepal, particularly in the Westernparts District of Nepal where annual average rainfall is halfthat of the eastern parts of Nepal. Here, the seasonaVperennia1 springs and Pockets Numbers streams or rainwater are the 36\411181131141 1 1 4 1 1 0 1 3 114(12(0 1121 1 potential sources o f irrigationand a wide variety of innovative irrigation schemes that are already in use, needs to be disseminated for efficient irrigation sources. Without such to develop 10,000 ha irrigation through the adoption o f these modem technology for the production o f high-value crops will not be met. Among these practices are the drip and sprinkler technology promoted have proven to have water application efficiency in an order o f 75% or more compared to 20 to 50% in other conventional surface irrigation (DE, 2002). 37. Extension and Research Services.Agronomic and horticultural development in the Hill regions will depend on high quality extension and research activities to deliver improved seedshaplings, farming technology, management practices etc. Agriculture extension system will also have to address the needs o f a wide range of clients from small farmers to large-scale commercial enterprises. There i s also need to broaden the concept of extension to include support for development o f input and output marketing, social mobilization, H V C farming, fadorchard managements, business planning, natural resource management, post harvest handling and primary value addition. There i s also growing concern with pesticide residues in agncultural products. Most o f the WTO member countries, including recently the GOI, introduce stringent SPS measures to control the use o f chemical pesticides infarming. Lately, even the GO1 has adopted a SPS Measure to control the import o f fruits and vegetables, tea etc. Hence, successful exports to India, and potentially, the Middle East and the Far East will require that farmers be thoroughly trained to use the pesticides judiciously by introducing PM techniques. Given these varied and sophisticated demands a key need here i s to improve the quality o f extension and research services and it i s clear that the incentive structure will be key. 38. One important implication of this is that public sector institutions like DADO and NARC cannot be the sole or predominant extension service provider and there is a need to bring theprivate sector and NGOs in these activities. Analysis o f lessons o f many projects and programs show widespread farmer dissatisfaction with the weakness o f the research and extension system to provide effective services to commercial agnculture stakeholders. Experienced local and internationalprivate extension companies can be contracted to set up and run farmers' schools as well as providing improved training for extension workers (i.e. for junior technicians or junior technical assistants). Such training has to be purely 45 performance based. Inaddition, public agencies, private companies and NGOs can be give performance based contracts with farmer groups and local government to provide extension services to the farmers. 39. Developing Market Promotion Activities. The commercialization of agriculture is occurring but there is considerablepotential to expand this. As commercialization o f agnculture i s relatively recent in the MWDR and the FWDR, programs for market promotion will be needed. The support activities will need to include activities such as: (i)strengthening o f government quality testing/certifying units and quarantine inspection/certification units in MWDR and FWDR; (ii)facilitating the export o f products through organizing agriculture trade fairs organization and participation in similar fairs inother countries; (iii)introduction of temporary support measures in the form o f schemedmatching grant to assist value addition activities consistent with the export requirements (grading, packaging, quality certification, and sample exports); (iv) export counseling and international market information services; (v) training on agriculture product export practices, packaginglpost-harvest handling, quality requirements; and (vi) organizing periodic interactions programs between importers and exporters for establishing marketing linkages, particularly bringinginimporters from India. F. Summingup 40. The review of Governmentpolicies and strategy suggests that a wide range of policy reforms are needed to improve the eficiency of output andfactor markets in order to sustain agricultural growth. Key among these i s the reforms o f laws and regulations that restrain private sector investment and trade, contract farming and the development o f cooperative farming inthe sector. The importance o f improving road connections o f various hnds and marketing facilities i s clear. On factor markets, the need to further strengthen land property rights by improving land records and removing the harm caused by dual tenure system and facilitating land exchange was emphasized. A need to link water charges more carefully to actual use and improving maintenance arrangements by increasing the role o f farmer managed systems in all but large scale irrigation systems has emerged. The issue o f sustaining and increasing access to credit became clear. A recommendation to use matching grants scheme to meet capital costs and investment requirements by farmers also becomes clear. 41. Elements offocused strategy on the lagging mid- andfar- Western regions that have considerable potential. A common theme across all recommendations i s the need to use Nepal's proven effectiveness o f community and user groups to manage agricultural growth and the need to promote more private sector participation. Beyond this the importance o f reviving and strengthening local governments to promote agncultural development becomes paramount. Thus, for instance, even the design o f any Western regions development strategy, let alone its implementation, will need to be done by the local and regional governments. This issue o f decentralization i s addressed inthe discussion on Governance inChapter 5. 46 CHAPTER5: IMPROVING INSTITUTIONSAND GOVERNANCEFORPUBLIC SERVICE DELIVERY A. Challengesto Good Governance 1. Nepal succeeded in building up a wide range of good government institutions -- a system of laws and organizations, checks and balances -- in a short span of time, though their relative lack of history and tradition has inevitably also made thesefragile. Policies, infrastructure and economic and human development outcomes have steadily improved under these institutions, though clearly not fast enough to meet the tide o f rising expectations that accompanied the advent o f democracy in 1991. But Nepal can draw upon a number o f important strengths in advancing its governance and public management reform agenda. The administrative and accountability framework i s in place; a lively press and nascent but growing civil society are creating additional pressures for change. Inthis setting, HMGN should be able to take forward radical reform. However, set against these dynamics are the tremendous challenges confronting HMGNat the present time, whose severity cannot be over-estimated. 2. n e Challenge of History and Geography. Nepal's history and geography contributes significantly to contemporary governance challenges. The high degree o f ethno-linguistic fractionalization and the isolation o f mountain and hill communities make it hard to consolidate services and realize the gains from economies o f scale.49It has also complicated efforts to form a unified state in which all citizens are able to participate to their fullest potential. Historically, political and economic power has rested in the Kathmandu valley and has been concentrated in a small group o f upper caste elites. Consistent with this tradition, the civil service has historically been heavily dominated by high- caste Nepalese from the Kathmanduvalley. 3. A Compressed History of Development. From its background as an isolated, feudal state locked between India and China in the 1950s, with extremely low human development indicators, Nepal has made considerable progress in establishing the elements o f a modemparliamentary democracy and public administration. Unlike most o f South Asia, where the legal and administrative roots o f Public Administration were established in the middle o f the 19th Century, it was only in 1951 that the civil service was established. The Constitution o f 1990 accorded the Auditor General complete legal and professional independence and created a Commission for the Investigation o f Abuse o f Authority, the only independent anti-corruption agency in South Asia. The Nepali Parliament's Public Accounts Committee, headed by an opposition member and with open public access, has served as a vocal institution o f acco~ntability.~~Government financial management systems functions relatively well and i s more computerizedthan many neighboring countries. 4. Political Instability throughout the 1990s. Nepal's twelve year experience with parliamentary democracy has been characterized by chronic political instability, including no fewer than twelve prime ministers throughout this period. Ministerial positions have been utilized as a key reward for potential coalition partners, resulting in frequent changes at the top and corresponding changes in the bureaucracy. One study o f Nepali politics from 1994 to 1998 revealed that, out o f 265 members in Parliament, 121 were able to become ministers. This constant turnover has fundamentally affected implementation and made public administration hostage to electoral and political interests. 49 It would, for example, take awitness, litigant or victim inthe remote regions ofNepal's Dolpadistrict seventeendays to reachthe nearest district court. 50 Although the PAC, thoughproactiveinthe past, has lacked authorityto take actions against non-complianceor to enforce its directives.One assessment in 1998, for example, revealedthat the majority of ministriescompliedwith less than 30 percent of PAC's directives. See, PAC Ninth AnuualReport, June 1998, cited from SuryaPrakash Shrestha 47 5. A State in Conflict. Political flux and the inability o f the state to solve the violent insurgency that has claimed over 10,000 lives have also led to a growing disappointment with the political and developmental processes. Government i s widely viewed as having failed to meet the aspirations o f the people, which could lead to a crisis o f legitimacy. The Maoist insurgency has gained strength from the failure o f institutionsto deliverbasic public services, to include the poor in accessing growth and services and to prevent corruption and instability. The insurgency has compounded the problems o f reach and has meant that the remit of the government has shrunk largely to urban and semi-urban areas. Weak legitimacy can reduce the willingness o f the public to comply with government directives or support political initiatives. It will also raise the risk that some of the administrative gains inrecent years could be weakened or reversed by broader political developments. At worst, it could lead to regime collapse and the problem o f a "failed state." 6. Against this backdrop, this chapter discussesfour main issuesfor good governance. The first i s restoring and strengthening the accountability and representative institutions that Nepal had built up at both national and local government levels under which Nepal has achieved good progress. Their absence and that o f alternative institutions have created a vacuum that i s underminingthe legitimacy o f the State. The second issue i s improving the government effectiveness - i.e. the ability to implement its own policies. The key task here i s to make the civil service more accountable, disciplined, and professional. The third issue concerns restarting decentralization to make Government more responsive to the heterogeneous needs and preferences o f a diverse people. Decentralization o f power and devolution o f public services to local Governments and community groups i s vital for bringing the Government closer to Nepal's widely dispersed people. This shortens the "long route o f accountability" and enables service users and communities to monitor their governments, discipline their service providers, and have their voices heard. The fourth issue to make government and public services more inclusive to reduce the large gender, ethnic and caste based disparities now prevalent inNepal. B. Strengthening CentralGovernment Institutions 7. Parliamentary Oversight and Transparency: For all its shortcomings and instability, the dissolution o f Parliament in October 2002 has meant that a fundamental pillar o f accountability and policy making has been weakened. This i s most evident inthe long queue o f bills that lie pending, and the current lack o f a functioning Public Accounts Committee. The Auditor General's annual report i s now sent to the King, as per the Constitution, but it i s not laid before Parliament-reducing the benefits o f transparency and diminishing scrutiny. Nepal will need to re-establish this mechanism and ensure Parliamentary oversight ofpublic expenditure. 8. Judiciary: Nepal has an independent Judiciary with three tiers including the Supreme Court, 16 Appellate Courts and District Courts in each o f Nepal's 75 districts. Incomparison with other countries in South Asia, Nepal's judiciary does not fare badly. According to a recent study by Transparency International, 42 percent of citizens who had regular interaction with the judiciary reported encountering corruption, as opposed to 100 percent in India and Sri Lanka; 96 percent in Pakistan; and 75 percent in Bangladesh.s' A number o f leading scholars have argued that Nepal's problems with legal and judicial reform are in fact much less intractable than those confronting its neighbors.s2Dysfunctional practices are not so deeply entrenched and the number o f cases pending i s a fraction o f what it i s inIndia and Palustan. There is stronger supervision o f lower courts and data i s better maintained and more accessible. The language o f Justice is Nepali, which makes justice more accessible. While these findings provide reason for hope, much can be done to improve the functioning o f the legal system. A detailed assessment of 51 NepalLaw Society, pp. 11-12. Other survey datahas placedthe incidenceof corruptioneven lower, at around30 percent. 52 Erik Jensen, Robert Moog and ShahidKardar, Understanding and Reforming the NepaleseLegal System, Asia Foundation, 2001, pp. 5-6. 48 gender issues, for example, found consistent patterns o f discrimination on the part o f the judiciary - over 98% o f whom are,maleS3indicating the need for substantive training and professional development. The Supreme Court has recently approved a five-year plan formulated for the comprehensive development o f thejudiciary. An important priority is the amendment o f inconsistent legislation. 9. Anti-Corruption: Although comparative survey data by Transparency International indicates that, in comparison with other South Asian countries, the actual day-to-day experience of citizens with corruption is lower in Nepal (Table 5.1),54the data still paints a disturbing picture of a public sector corruption. For instance, the average cost o fbribes paid to the police was N R s 1,637 (around $US 22), or just under 10percent of annualper capita GDP." Table 5.1 ComparativeCorruption Scorecardfor the Sectors (Percentage of respondents reporting corruption in their interaction with the agenq) Country School Health Power landAdmin Tax Police Judiciary Bangladesh 40 58 32 73 19 84 75 India 34 15 30 47 15 100 100 Pakistan 92 96 96 100 99 100 96 Srilanka 61 92 NA 98 NA 100 100 Source:Transparency International Report, 2003. 10. During the last two years, HMGN has taken a number of impressive initiatives to combat corruption. A National Vigilance Centre was set up located inthe Prime Minister's office in 2002 to co- ordinate the anti-corruption function within the executive branch. Important pieces o f legislation were passed in 2002, including the Commission for Investigation o f Abuse o f Authority (CIAA) Second Amendment Bill. Collectively, these laws clarified the procedures surrounding the impeachment o f high- rankingpoliticians, government officials and the heads o f constitutional bodies. 11. The CIAA is the only constitutionally independent anticorruption body in South Asia and has the power to initiate cases against all top oficials, including the Prime Minister and his Cabinet. There has been a quantumleap inthe number o f complaints coming to the CIAA as well as inthe disposal o f cases. Action i s being taken against over 600 public officials. This initiative i s an important effort to attack corruption through the vehicle o f disproportionate assets.56The anticorruption agenda has been one o f the bright spots in Nepal's governance reforms. Considerable work remains in improving the capacity and professionalism o f these units o f both the CIAA and the NVC; in expanding the CIAA's presence into the districts; in expeditiously processing anticorruption cases and departmental disciplinary proceedings; and in strengthening the NVC and ensuring that it plays an appropriate role inhelping to prevent corruption and facilitating public outreach. 12. The National Human Rights Commission: There is a broad consensus among many human rights groups that the situation within the country improved markedly after the establishment o f multi- 53 A Study of Gender and Judges, Kathmandu: Pro Public, 1999.Innearly 60% o f rape cases reviewed by researchers, the court declared a verdict o fnot guilty. 54 Transparency Intemational, Corruption in South Asia: Insights and Benchmarksfor Citizen Feedback Surveys in Five Countries 2003. It should be noted that, as a region, South Asia does not fare particularly well inglobal anticorruption surveys conductedby Transparency Intemational and other organizations. 55 TransparencyIntemational, 2002, pp. 33-34. 56 See KeshabPoudel, "A Political Gimmick," Spotlight, Vol. 22, No. 8 (16 August, 2002). See also Transparency IntemationalNepal, Newsletter Vol. 5, No. 1(April, 2003). 49 party democracy in 1990. Nepal has ratified major international human rights agreements, passed the 1997 National Human Rights Commission Act, and set up commissions to address the rights o f historically disadvantaged groups such as women, Janajatis and Dalits. The National Human Rights Commission (NHRC) was established as an autonomous and statutory body in 2000 and has the authority to probe incidents o f human rightsviolations, present recommendations and guidelines. The Commission wields considerable power and authority and its status report o f 2003 presents a comprehensive and balanced attempt to catalogue the status o f human rights issues in Nepal. Still, there continue to be a number o f legal contradictions between the Constitution, domestic legislation, and several o f the international agreements to which Nepal i s a signatory. Many human rights groups allege that efforts to achieve rights-based governance have been hampered by entrenched discriminatory practices and an administrative culture in which legal rights are often ignored or only weakly enforced." These weaknesses in institutions are particularly highlighted in times o f conflict and both the police and the Maoists are alleged to engage inhumanrights violations. 13. Information and Transparency. Since the restoration o f a multiparty system in 1990, Nepal has enjoyed a major expansion inthe circulation and dissemination o f information, but there are i s no Rightto Information legislation. There has been a rapid growth in the number of newspapers, radio stations and television operators and email service providers." Some concerns remain though. After the proclamation of emergency in 2002, apprehension has multiplied regarding censorship and attacks upon journalists. Both the Army and the Maoists have been accused o f harassing and even murdering journalists, prohibiting the gathering o f news in areas under their control, and imposing cens~rship.'~N o Right to Information legislation currently exists within Nepal, although some discussion about the need for such a legal framework has recently taken place within government. A second concern centers on the state's lingering role inthe media and the nascent capacity o f many private sector news organizations. Key Executive Branch Institutions and Functions. 14. Cabinet: Nepal's cabinet is relatively small and the distribution of functions is reasonable. Its 21 Cabinet ministries i s significantly less than that in India and Bangladesh and less than half the number in Sri Lanka. Nepal i s noteworthy in that it has largely resisted to temptation to fragment administrative unitsto accommodate the requirements o fcoalitionpolitics. 15. Policy Coordination: Although Nepal has procedures in place for a formal Cabinet system, policy coordination, monitoring and implementation are weak. Policy coordination has improved in the last few years through the efforts of the Government to prioritize its policies and expenditures in a consistent manner. The Immediate Action Plan, the Medium Term Expenditure Framework and the PRSP's preparation and implementation have helped to improve coordination and responsiveness. The merger o f the Prime Minister's Office with the Cabinet Secretariat has created clearer functional responsibilities including tracking how directives are being implemented and coordinating HMGN's "good governance" agenda. Nevertheless, policy coordination in some key areas such as trade policy, implementing the APP, and monitoring and evaluation remains weak and needs addressing. 16. Civil Service: Relatively small, Nepal's civil service effectiveness is hampered by inappropriate skill mix, poor incentives both in terms of pay and lax discipline, and its exclusiveness. The core civil 57 A variety of humanrights organizationshavecriticized the "culture of impunity" within government,includingthe National HumanRights Commission, Amnesty Intemational, the Asian HumanRights Commission, the DamoclesNetwork and ReportersWithout Borders. 58 See U.S. Departmentof States, Background Note: Nepal, 2001. 59 For example, see the National HumanRights Commission, Human Rights in Nepal: A Status Report 2003 (Kathmandu: The Asia Foundation, 2003), pp. 18-24; U.S.Department of State, Nepal: Country Reports on Human Rights Practices, 2002), pp 10-11. 50 service in Nepal comprises 99,264 (of which 87,000 are filled) positions, or roughly 0.43 civil servants per hundred population, which in per capita terms is one o f the smallest in both South Asia and the developing world. Total public employment including teachers, police, and employees o f municipal, district and local government i s approximately 271,000 or 1.17 employees per 100 population. By way o f contrast, Sri Lanka's total civilian government employment i s nearly three and a half times larger than Nepal's on a per capita basis. But while public employment i s not overly large, it suffers from problems o f inappropriate skills mix, heavy wage compression, and low productivity. The composition o f Nepal's civil service i s particularly skewed towards the lower unskilled tiers.60The vast majority of employees (approximately 55 percent) are in the Administrative Service, followed by Health (18 percent), Engineering (9.6 percent) and Agriculture (5.5 percent). 17. Recognizing the need to improve the skill mix of the civil service, the Government has made substantial improvements in human resource management in recent years. A Personnel Information System (PIS) has been developed that, for the first time, i s capable o f providing accurate, real-time information on the size and composition o f the civil service. The PIS will shortly be linked to the payroll system to create a comprehensive human resource database (essential for traclung posts, vacancies, transfers, and forecasting future salary and pensionliabilities). 18. The civil service's performance incentives are undermined by a heavily compressed wage structure, the worst in both South Asia and the developing world, and relatively very low salaries at professional and managerial levels in comparison to the private sector though this is not true at other levels. The compression ratio (defined as the ratio o f highest to lowest paid) in the Nepalese core civil service i s 3.6 (for salary) and 3.3 (for total net compensation), which means that a ministry secretary i s paid only three and a half times more than a peon in the same ministry.6' In contrast, the compression ratio in Sri Lanka i s around 7; inBangladesh it i s 10; and among various Indian states it varies from 5.6 to 11.7. Similarly, salary remuneration at senior levels (between US$160 to $225 for Joint Secretaries and Secretaries) can be less than a fifth of that in the private sector. These pay structures do not motivate employees or help to attract the best talent and increase the risks o f corruption. 19. Problems with performance evaluation also hinder performance and incentives for service delivery. The current system i s cumbersome and lacks transparency; it does not allow for intermediate feedback to enable corrective action. Clear job descriptions do not exist against which performance can be measured. Increasing the capacity and role o f performance assessment i s low and there i s little understanding o f its value as a managerial tool for performance improvement and staff development.62 20. A relatedproblem is the ineffective disciplinary procedures that make it difficult to expeditiously sanction staff for malfeasance or poor performance. Only about 581 staff was subject to formal disciplinary procedures during the twenty-seven year period from 1976 through 2003. Only 6 civil servants were suspended and one dismissed from service throughout the entire twenty-seven year period.63Simplification of punitive measures and streamlining o f the appeals processes i s an important agenda for reform. 21. Recent Administrative Reforms: Over the past Jive years, HMGN has implemented a number of important administrative reforms. An Administrative reform Monitoring and Coordination Committee headed by the Prime Minister has been established to lead the govemance reformprogram and take major policy decisions. A number of government organizations in areas such as aviation, telecommunication 6o Source: IMF `The Civil Service Sector: Key Issues and Reform Plans ' Nepal Selected Issues Paper, 2002. 61 See IMF The Civil ServiceSector: Key Issues and Reform Plans,p.4. For an analysis of the issues around Performance Evaluation InNepal see Dr. Surya Prakash Shrestha, GovernanceStudy: Nepal (Manila: Asian Development Bank, 1999), p. 42. 63 This data is derived from HMGN's computerized Personnel Information System. 51 and tourism have been transformed into autonomous bodies. Within the civil service, vacant positions have been frozen since 2001 and about 7500 of the 17,000 vacancies in the civil service have been abolished. Efforts are underway to standardize job descriptions, and clarify codes o f conduct and punishmentprovisions for civil servants. 22. The Government has recently put together an excellent road map of reforms to be implemented under the Governance Reform Program that cover a range of issues linked with ethics, capacity, efJiciency and transparency. The program contains 67 proposed reforms to be implemented under a variety o f headings. Three of the most prominent recommendations include a draft Governance Act that seeks to clarify the division of responsibility between ministers and civil servants with regard to civil service transfers (among other initiatives); proposed amendments to the 1993 Civil Service Act; and the creation o f a Local Civil Service, recruited into a nationalpool from which Local Governments would be free to hire staff. The latter represents an innovative approach to empower the DDCs and VDCs to employ their own staff while trying to ensure some quality control. To operate smoothly the program will need to ensure that information flows smoothly between the local governments and the new Local Civil Service Commission. The Commission would have to take up the challenge o f having a pool of credible staff and improving career progression and salary incentives. 23. Within this context, Nepal will require to focus reform on a number of critical areas to move forward and implement its designfor public administration reform. This could be done by: (i) Implementing selected Civil Service reforms in Personnel Management and Administration to increase accountability and incentives. Procedures for monitoring staff performance need to be revised and updated to introduce greater transparency, feedback mechanisms and a stronger focus upon results. Disciplinary procedures need to be streamlined and made more effective. The salary structure needs to be overhauled and its heavily compressed structure rectified to increase incentives for its professional and executive ranks. (ii) Making the Civil Service more representative. Information derived from the Public Service Commissionfrom 1999-2001 underscores the non-representative nature of Nepal's civil service. Around 97 percent o f those accepted for the senior civil service ranks were Brahmins, Chettris and Newars, even though these groups constitute only about 35 percent o f the population. At the same time only 5 percent of those recommended for recruitment were women. A variety o f initiatives should be implemented to make the civil service more representative o f Nepali society as a whole. Barriers that have traditionally made it difficult for various caste andor ethnic groups to enter the civil service need to be assessed and eliminated. This could include reforming the civil service examinationto use a more vernacular version o f Nepali or even some local languages; expanding the number o f locations where the civil service examinations i s offered; and tracking and malung available public data on the ethnic caste and gender composition o fnew recruits. (iii)Defining ClearBoundaries betweenthePoliticalandAdministrative Spheres: Civil service rules need to clarify responsibility and accountability between civil servants and the political level. At present one of the most dysfunctional features o f Nepal's administration has been the politically motivated frequent transfers and lack o f stable tenure within the bureaucracy. This had led to politicization o f the civil service. C. Making Government MoreResponsive: RestartingDecentralization and Empowering Communities 24. Strengthening central institutions like the Parliament, the Judiciary and the Civil Service are critical to improving the accountability and service delivery. However, ifNepal i s to address the needs o f heterogeneous and widely distributed population, it will also have to address demands for 52 decentralization, equality and inclusion. With 70 languages and dialects and more than a hundred caste and ethnic groups, Nepal has a very diverse population and one o f the highest ethno-linguistic fractionalization comparable to many Sub-Saharan African countries. By bringing government closer to the people, decentralization allows better reflection of local preferences, needs and constraints inpublic decision-making. Administrative and political decentralization i s also a necessary condition for making the civil service more inclusive and for bringingissues o f "voice" into planning and monitoring o f service delivery. Given this, the Government considers decentralization as key to improving service delivery. 25. The Local Self Government Act and Raising Voice: While different forms o f local governments have existed in Nepal for more than four decades, the enactment o f the Local Self Government Act (LSGA) in 1999 was, by far, the strongest attempt to establish roles and functions for service delivery and local decision making at the sub-national level o f government. The LSGA defines three types o f local bodies, municipalities for urban areas, Village Development Committees (VDCs) for rural areas and District Development Committees (DDCs) at the district level. The Act further defines functions and sectoral assignments for these bodies and endows them with revenue powers. InJanuary 2004 there were 3913 VDCs, 58 municipalities and 75 DDCs inNepal (See Figure5.1). That this political structure was Figure 5.1 The Structure of Local Bodies in Nepal, 2004 75 District Development Committees DDC Divided in: 1)Municipal Corporation-1; 2)Sub-municipal corporation-4; L 3913 Village Development 58 Municipalities 3)Municipality-53 Committees: VDC Wards:VDCs-9 equal inpopulation Municipalities at least 9(maximum i s 35) equal inpopulation put inplace after consultations by nine different governments (including six coalitions between 1994 and 2000), with near unanimous support, demonstrates the national consensus behind it. Unfortunately, after having achieved a strong start, decentralization has now stalled as the tenure o f the last local Governments expired in2002. One indication of this i s although the Governmenthas set up a highpower Decentralization Implementation and Monitoring Committee (DIMC) this body has not met for the last two years. One way to restart the process i s by malung the D I M C focus on resolving key pendingissues note below. 53 Issues and Next Steps for Restarting Decentralization 26. Consolidate size and number of local bodies. Some VDCs and DDCs, particularly those inmore remote areas, have very small populations or revenue base 64raising the issue o f whether they can be effective centers for provision o f services. Thus, there i s a need to reduce the number of VDCs and DDCsby consolidatingthem into functionally viable units. 27. Implement administrative decentralization through resolving administrative ambiguity and forming a Local Government Civil Service. The second and related issue i s the ongoing division o f responsibilities between various political and administrative entities at the local level, including DDCs, VDCs, School Management Committees, line departments, etc (see Table 5.2). This would require Table 5.2 Functionaland RevenueAssignmentsof Local Bodies Villagesand Wards Districtsand Municipalities. Agriculture Provide marketslveterinary services/ pasture. Ensure supply of seeds and fertilizers. Drinking Water Implementwater projects, clean ponds, wells. Multi VDCs project, Operate Projects. Transport Buildlmaintain trails, roads, bridges, culverts. Build/ maintain district roads l suspension bridges. Education Establish pre-primary schools; superviselmanage Prioritize schools; superviselmonitor schools; formulate schools; offer adulffinformal education, sports and policies for adult education and sports; Pre-primary libraries. Schools Waterllrrigation Buildloperate irrigation, soil erosion and electricity Multi VDCs projects. Buildloperate irrigationlsolid waste projects, canals and dams. disposallelectricity facilities. Control waterlairlnoise pollution. Physicaldevelopment Build community buildings, prepare land use plan/ Protect unregistered land; issue building permits plan; provide solid waste planslhousing . Buildloperate small hydro projects. Prepare land use sanitation. Health Services Operatelmanage health postslsub-post(HP/SHP); Operatelmanage district HPISHP, hospitals Help with Assist in Management. vaccinationslfamily planning; arrange medication supply. 1 Forest Plant trees protect forest and environment. Language and Culture Preserve religious placeslrest houses;preserve Preserve archeological objects; promotel languages, cultures, religions, inventory languageslreligionsl cultures. Tourism and Cottage Preserve /develop tourism areas cottage industries. Develop industrial zone; Protect naturallculturallhistorical industries tourism sites cottage industries. Varia Encourage employment; assist cooperativeness; keep Determine the district wage rates ;fight child labor birthldeath registry; help helplessldisabled; women Approve cinemas; Open libraries. /disadvantaged groups; encourage industry; prevent 1 natural calamities. House /Land Tax/ IPT 1 Yes-75% 25% of VDC collected revenues. 100% in the case of land/ land revenuetax Municipalities Marketfees Yes No for districts, Yes for Municipalities Businesslcommerciallrent Yes No for districts, Yes for Municipalities tax ~ Natural resourcetax 35% of revenue collected to VDC of origin Yes 65%, No for Municipalities Roadtolls Yes on district roads, None for municipalities I, yes Entertainmenttax II1Cinemas Rafting, boating, fishing, and cinemas Source: LSGA. Ward: article 25;VDC: article 28; Municipality: article 96; DDC: article 18: The least populated district, Manang, has a population of 9,587 while the largest, Katmandu has 1,081,845 residents. The average population per VDC inManang i s 737 while inNepal as a whole, it is almost 5 100. Yet Manang with an area o f 2,246 is not muchlarger than the average district inNepal at 1,962 square Km. 54 amending the provisions invarious acts, which contradict the Local Self Governance 28. ClarifL overlapping and limited expenditure assignments. Past legislationhas made a reasonable job in defining the functions and roles o f local bodies (Table 5.2). However, the roles o f VDCs, municipalities, and DDCs remain somewhat confusing without clear separation o f powers between the local bodies and line ministries, even for functions that have been devolved.66 This i s because key legislations have not been amended and are in conflict with the LGSA. This results in overlaps, excuses not to devolve resources and staff and undermined accountability to the public. Further local bodies expenditure i s limited. For fiscal year 2003-2004, the share o f local bodies inpublic spending was around 5%, largely financed by transfers from the central government. International best practice indicates that for a country with characteristics o fNepal, it should be at least twice the amount. 29. Improve revenue decentralization and collection incentives: With local government revenue constituting only 3% o f all revenues, tax assignments and revenue efforts seem inadequate. For instance, the design of revenue sources for DDCs, based substantially on revenue sharing in other LGs taxes and central government taxes limits fiscal autonomy and accountability, since DDCs do not decide the corresponding tax rates. Currently DDCs inNepal seem dependent on external sources with at least 60% of their financial resources coming from non-own-sources. Both VDCs and municipalities have been given independent revenue raising powers, but inneither case has it been effectively 30. Improve thefiscal transfer system: The distribution arrangement o f Central Government transfers to local bodies are improving but need to be improved further and made more predictable (see Box 5.1) to enable local bodies carry out their assignments effectively. Among these transfers, block grants constitute more than 65% o f the income o f local bodies (LBs) in 2000-2001, however the released amounts to local bodies were substantially lower in part due to the fiscal situation, and in part because o f the conflict. There i s need to increase transparency in transfers. At present transfers are based on import levy funded octroi replacement for districts, LDF grants for municipalities determined by posts, VDC's municipalities-salary grants and an amount set by HMGN districts and VDCs and municipalities development grants all allocated using different set o f rules or formula. Lack o f predictability and transparency reduces the incentive for a realistic budget, hampers implementation, and reduces accountability o f the local bodies to their constituents. Further, the current design o f the fiscal transfer system does not create incentives for local revenue mobilization, in part because o f the lack o f hard budget constraints. The transparency o f transfers can be increased by replacing the historical octroi replacement by a formula that integrates all transfers (LDF, salaries, development) to municipalities and takes into account population and tax base (see Box 5.1). 31. Create incentives for local capacity development: It is generally claimed by the central government (MOF and line ministries) that local governments' institutional capacity i s weak and constitutes one o f the main constraints to fiscal decentralization. However, the assignment o f both expenditure and revenue raising authority does not generate a real need for developing this capacity. Decentralization policy would include putting in place the following: a capacity window for funding capacity building for Local Bodies; a system to monitor fiscal decentralization and service delivery to facilitate redesign; a plan to increase central government capacity to manage and support decentralization; and a policy to ensure that donor funds flow according to the fiscal rules rather than through parallel mechanisms. Otherwise, donor financing for local governments will increase the dependency of local At present 23 Acts create conflicts or ambiguity with the LSGA. Fourteen acts have been redrafted but not enacted. For example, in2000-2001 for functions devolved to local bodies (agriculture extension, livestock, education and health), only half of the total expenditures were through the local bodies (total expenditure was Rs. 10.5 billion). 67 These include house and land taxes, property taxes (municipalities), vehicle and other local fees and taxes. 55 governments on donors replacing dependency on the central government and will relax local hard budget constraints. I Box 5.1 The New DistrictFiscalTransfer Formula, Possible ImprovementsandExtendingit to VDCs A fiscal transfer formula has been put in place in 2003-2004 for the general block grant to DDC. This grant is allocated according to the following criterion; (i) according to the inverse of the1996 Human Development 50% Index produced by UNDP; (ii) 20% according to the official population (2001 Census); (iii) according to a 20% transport cost factor using food transportation cost data; and (iv) 10% according to the area of the district. This formula i s a good first step, except it does not take into account fiscal effort. Further improvementscanbe made by combining salaries and development transfers into one formula based transfer. Inthe case of the VDCs the salaries transfers couldremain unchangedbut the equal-per-VDC developmentgrants should be replacedby grants that take into account population size and density (implicitly district size) and the tax potential of the district (using the classification provision allowed under article 20 of the LSGA and thus modifying the criteria currently used in LSGA). Transfers reflect horizontal disparities inneeds and revenue potential help enforce hard budget constraints and not provide disincentives for local revenue mobilization. For public services of a national nature, such as educationand health, block grants with some additional amount conditional on performance (e.g. girl attendance at schools) couldbe considered. 32. Develop a comprehensive plan for decentralization: Finally, a decentralization plan needs to be developed with all the necessary components, including both administrative and fiscal decentralization arrangements, and based on the objectives that the Government has set. The plan can be implemented in an asymmetrical manner, proceed faster inareas where more capacity exists. To this end, HMGNneeds to begin upgrading the shlls o f the Central Fiscal Commissionto lead and monitor the reformprogram. 33. Empower communities and user groups: Despite being wracked by political strife for the past eight years, Nepal has been able to achieve MDG targets comparable to other South Asian countries which have been less conflict-affected. Although, service delivery by the central Government has been severely affected by the conflict, this has been mitigated in part by the large pool of community-based organizations andor user groups that assure that community based services still function. Representing member interests, these local groups are well placedto assure the accountability relationshipbetween the member and the service provider. These groups have been successful at extracting better services out o f poorly managed Government provided public services. One nascent example i s the performance o f the publicly funded but locally managed community schools. These user groups are active in every sector from natural resource management to schools to micro-credit to governance and civil rights. They have been able to compensate for the administrative and financial weakness o f the centrally managed and provided services despite the conflict. They have also managed to draw in external funds by providing successful development models to donors who are looking to get the best results from their resources. Though support to the Poverty Alleviation Fund (PAF) HMGN can further harness the strengths o f Nepal's vibrant community groups D. AddressingSocial Inclusion 34. ?$%le the government has been concerned about gender disparities since the 15'~Five-Year Plan in 1982, it is only with the IOfh Plan/PRSP that there has been explicit recognition of caste and ethnicity asfactors affecting income and human development outcomes. Although the government does not as yet have a coherent "strategy" for overcoming it, the identification o f social exclusion as a development problem and the accompanying commitment to social inclusion as one o f the four pillars o f the PRSP i s a significant step. 35. Recent programs and policy developments in gender rights: In terms o f development efforts, women's issues have been popular with the donors and over the last 20 years there have been many 56 donor-supported government projects and programs for women. These have to a large extent reflectedthe shifts in development community perspectives, moving from the view o f women as child bearers and providers of health care in the `60s and OS, to a slow realization o f women's critical productive role in Nepal's rural economy in the %Os, to the recognition o f women as citizens in need o f equal legal and political rights in the `90s.Many o f these programs use a group-based approach, first developed inNepal through the government-sponsored Production Credit for Rural Women Program (PCRW) in the early `80s. From the beginning this approach had a strong focus on empowerment through awareness as well as through access to self-earned income. The program created the first cadre o f Women Development Officers, many o f whom continue to serve in rural areas and constitute an important presence at the district level. Women have also been increasingly incorporated into the user group approaches that have been successful in many sectors in Nepal including forestry, drinking water, agricultural innovation, literacy and sometimes health, though there are inconsistencies in the attention devoted to empowerment and social inclusion inthe formation and operation o fthese groups. 36. I n addition to grassroots development programs, there has been some progress recently on inclusion at the policy level. Although it still leaves many issues unaddressed, the passage o f the 11' Amendment (known as the Women's Inheritance Bill) in 2002 was at least a move towards greater legal equality for women. The PRSP has also committed to "affirmative action to increase women's role in public office" and to monitoring progress on its gender mainstreaming agenda. The creation of a National Women's Commission in 2002 i s another step, although the Commission has not been able to get the bill for its formal establishment as a constitutional body passed by cabinet and the majority o f its members are nominated by the party in power, without adequate representation o f the NGO and academic communities. 37. With respect to caste and ethnic groups progress has been slow. Although there are now laws setting punishments for discrimination against Dalits, different forms o f discrimination are commonly practiced throughout the country and particularly in the rural areas o f the Far Western Hills and the Eastern Terai. Indeed, the Constitution's protection o f "traditional practices" actually calls into question whether the practices associated with "untouchability" as a part o f the religion and traditional based caste system can actually be outlawed. 38. I n terms ofprograms, the PRSP has highlightedthe need for affirmative action to "increase their representatiodparticipation at various levels o f public office and political process". In 1997 the government created the Dalit Committee within the Ministry o f Local Development. The Committee has a budget to implement programs such as scholarships and training programs but the allocation o f funds i s controlled centrally from Kathmandu and accountability for expenditures i s weak. In early 2002 the National Dalit Commission was set up by the government, but again the bill for its formal establishment as a semi-autonomous body has not yet been approved and the Commission suffers from the fact that (like the National Women's Commission) its members were all appointed from the various Dalit wings o f the different political parties with no representation on behalf o f Dalit civil society organizations. Both the national women's commission and the national Dalits commission are inactive at present, since the terms of their members expired inMarch 2004 andno new members have been appointed. 39. The Janajati or indigenous peoples have so far received the least attention in terms of government or donor supported grass-roots programs. Many in government have felt that since the Janajati category includes powerful groups like the Newars, the Gurungs and the Thakalis, it should not be treated as a single group for government support and welfare programs. Indeed, though some Janajati groups are concerned about the low socio-economic status of some o f their member groups, others are concerned primarily with their low level of representation in the political and administrative governance of the country. The National Janajati Foundation, created in 2002, succeeded (unlike the National 57 Women's Commission and the National Dalit Commission) in getting the bill for its formal establishment as a constitutional body established. 40. Innovative steps towards inclusive education and civil service representation: In addition to the central place that the PRSP has given to governance and social inclusion there are a few important concrete actions that the government i s beginning to take, most notably inthe areas o f education and civil service reform. These actions, if implemented with commitment and persistence, could be an important signal that the government i s committed to dismantling the old social and political institutions that have blockedpro-poor growth inthis country and ledto the current crisis o f governance. 41. In education, the government's program for primary education, the Nepal Education For All (NEFA) program, contains specific measures to reach out to lagging ethnic groups. This program, supported by multiple donors, focuses on the transfer o f responsibility and funding for primary schools to community School Management Committees (SMCs) (see Chapter 6 also). Hiring and firing o f teachers would also be transferred to the SMC to make teachers more accountable to the community they serve. To address specific threats such as elite capture or politicization o f the SMC, a possible solution i s being sought by malung the planned block grants to SMCs conditional on the involvement o f women's and children's groups or other strong local organizations to work in partnership with the SMC. The NEFA has also addressed the problems faced by children who do not speak Nepali as their mother tongue (52% o f the population). A bilingual home to school transition module for teachers i s being developed and communities are given incentives to hire teachers (preferably women) who are able to speak the local language as well as Nepali in the classroom. Success inthis area i s critical for meeting MDG target. This may also help find a solution to the difficult issue of the use o f mother tongues in primary education, where it is necessary to find a middle path between ignoring the problem o f non-Nepali speakmg children on the one hand and burdening the already strained education system with creating separate curricula in many different languages on the other. Inany case, to make inclusive education a reality, some way must be found to ensure that non-Nepali speakers get the extra assistance they need to become successful students. 42. In the area of civil service reform, the Ministry of General Administration (MOGA) has recently developed a draft "roadmap "for Civil Service Reform which contains clear steps towards afirmative action, including a proposal to targetheserve 40 percent of all new posts and vacancies for excluded groups (20 percent for women, and 10 percent each for Dalits and Janajatis). One o f the keys to introducing greater equity while maintaining the tradition o f meritocracy seems to be establishing link between the move towards greater diversity and improvements in the quality o f client service, which had not yet been done in the MOGA proposal. Only as part o f the broader effort to improve public administration can affirmative action in Nepal escape from being seen as "patronage for special interest groups" and gain the broad public support it needs. 43. Remaining Challenges to Inclusion: These two concrete moves, discussed above, to operationalize the PRSP commitment to social inclusion and good governance are encouraging. Nevertheless, it i s necessary to temper the optimism generated by the efforts o f reform-minded leaders in certainparts o f government with implementation challenges at the middle levels o f the bureaucracy and at the district level and below. There, formal institutions and the progressive reform policies interact with the dense network of informal systems o f behaviors and values based on relations o f kinship, party affiliation, business interests, caste, ethnicity and gender. 44. When it comes to changingpatterns of exclusion based on social identity, the influence of these informal institutions or the informal "rules of the game" can be especially strong, because these institutions are actually systems of value through which individuals and groups deJine their very 58 identity.68Policy changes here challenge very fundamental relations o f power and the self-identity and ways o f interacting with others that follow from those relations. Though it i s more comfortable to think o f the "implementation gap" as due to "lack o f capacity" and therefore something that can be addressed through painless donor-funded training, the major causes o f poor implementation probably lie deeper; powerful informal systems, behaviors and norms are still very much at work. The "implementation gap" can be seen as a manifestation of informal social and political institutions that continue to be able to block the actual realization of government's stated intentions to get resources and decision-making power flowing more equitably to the excluded groups and remote regions. Overcoming this gap requires strong commitment and greater effort. But it must be done in such way as not to create special regimes based on ethnic and caste origin of persons. Otherwise, there i s risk that affirmative action policies may end up recreating systems of patronage similar to those o f feudal times. What can be done best i s to create equality o f opportunity and not guarantee equality o f outcomes. 45. Closing the gap: Reducing the "implementation gap" is critical to get the country back on a strong growth path and to achieve lasting peace. Two possible ways to close this gap involve increasing the diversity among those who make the critical decisions about implementation and using social accountability tools to increase civic involvement and instill greater transparency inthe allocation and use o f public resources. Some important foundations o f democratic governance have been laid in the past 13 years and the major strength o f the PRSP i s that it seeks to build on these. Tools like the Medium Term Expenditure Framework and the effort to develop a strong Poverty Monitoring and Analysis System may seem rather technocratic and uninspiring, and citizen's report cards and social audit may sound like the latest civil society fad. But such approaches may in the end be essential to both poverty reduction and sustainable peace inNepal because they are on the critical path to a govemment that i s accountable, that delivers on its commitments and ensures that all citizens are treated e q ~ i t a b l y . ~ ~ E. Summingup 46. Governance: Nepalfaces four challenges with respect to governance. These are to strengthen the accountability o f representative institutions both at the national and local levels, civil service reforms to make it more accountable, professional and disciplined; restarting decentralization and expanding community managed service delivery programs; and encouraging the government and public service to be more inclusive by reducing large gender, ethnic and caste based disparities. 47. In the case of the central Government, this chapter has noted the importance of strengthening accountability and representative policy-making institutions so that stability is restored. The need to make the civil service - the Government's main instrument for implementing its policies - more professional, merit-based, and inclusive has been highlighted. Decompressing salaries to raise incentives for the managerial and professional ranks, enforcing discipline, ensuring security o f tenure through carefully delineating the roles o f the civil service and political levels have also been identified as important. Some suggestions have been made to make the civil service more inclusive. A recent survey in8 districts indifferent geographical regions ofNepal found 205 different practices o f caste-based discrimination. Fifty-four were related to denial of entry, to services, to common resources to kinshiprelations and to participation.; 81 were related to discrimination of different fields o f occupation, to educational institutions, political rights, govemment or NGO programs or offices or religious or cultural activities. O f the 106 Dalit respondents to the survey 92 percent reported experienced it intheir lifetime and even after democracy. Krishna Bhattachan, Kamala Hemchuri, Yogendra Gurung, Chakraman Biswakarma, 2003, Existing Practices o f Caste-Based Untouchability inNepal and Strategy for a Campaign for its Elimination, Action Aid, Nepal. 69 Drawn fromLynnBennett, "Gender, Caste and Ethnic Exclusion in Nepal", Background note for the Nepal Development Policy Review, 2004. 59 48. Given the wide heterogeneity, service delivery improvements will lie in strengthening local Governments and devolution of management and financing to communities. This would entail consolidating the size of local bodies, implementing administrative decentralization, removing the ambiguities and overlapping expenditure and revenue raising assignments and providing stable fiscal transfers in line with agreed priorities and empowering local bodies such as school management committees and local user groups. The role o f caste and ethnicity as factors affecting income and human development outcomes have been highlighted.Although the government has identified social inclusion as a development goal and while there has been some progress with gender exclusion giving greater legal equality to women, progress in including disadvantaged caste and ethnic groups has been slower. There i s still discrimination against Dalit children and, in general, non-Nepali speaking children are put at disadvantage. While Government has passed legislation to address such unacceptable practices, more effort that will go beyond formal rules would be needed to address this issue. This would include political support, technical expertise to design systems that do not undermine meritocracy and avoid negative effects o frigid reservation policies. 60 CHAPTER 6: SOCIAL SECTORPOLICIES AND SOCIAL PROTECTION A. Introduction 1. Starting much later in development, Nepal has made considerable progress in improving social indicators in the past decade, though it still remains a very poor country interms o f human development. Nepal i s now comparable in indicators such as under-5 mortality, primary school enrollment, female enrollment, and access to safe water to its much richer South Asian neighbors (see Chapter 1). Initial results from a partial sample o f the most recent household survey shows that the people perceive much improved access to education and health services. Still, its maternal mortality ratio, child malnutrition and sanitation indicators are among the worst in the world. Nepal could fall below Tenth Plan as well as MDGtargets. Given widespreadpoverty and slow growth of income, greater effort has to be made inthe delivery o f social services in education, health and water supply and sanitation to serve especially those who do not adequately benefit from growth o f income or those in areas where social service delivery hitherto has been deficient. This i s an aspect o f social inclusion. Moreover, the government should consider providing social protection to the poor and the vulnerable when they cannot benefit from growth alone. B. Education 2. Enrollment in primary education grew rapidly during the 1990s, as net enrolment ratio (NER) rose to about go%, according to the MoES. The Tenth P l a f l R S P aims at increasing the NER to 90% by 2007 and the Education for All (EFA) Program to 96% by 2009. Since the NER has been increasing approximately 1% per annum since 1995, these targets are not likely to be met. Moreover, enrollment data from household surveys are lower, as discussed inChapter 2. 3. Behind this improvement is a significant increase inpublic expenditures. Inthe last five years, the share of public expenditure on education rose from 12% to 15%, and the share o f primary education has risen significantly from 48% to 59% o f education expenditures, driven by national and international commitments to make primary education universal. Although part o f the increased allocation for the primary sub-sector came from the increased share o f education inpublic spending a substantial part came from reduction o f public spending on higher education. Spending on primary education has been equitable and the lowest income decile uses public schools as much as higher deciles. 4. I n spite of considerable investments in the basic andprimary education sub-sector, the quality of education remainspoor. The grade 5 completion rate rose from 44% to 54% between 1998 and 2001, but this still means that almost half the children do not complete primary school. The EFA program aims at increasing the Grade 5 completion rate to 60% by 2009. Previous experience indicates that this aim will be hard to achieve without significant improvements in the way public schools operate. Public schools also perform poorly interms of success rates in School Leaving Certificate (SLC) Examinations: the pass rate i s 85% for private schools and 15% for public schools. 5. The Government is preparing a sector wide program to support basic and primary education. Among the innovative features o f this approach i s a move towards decentralized planning and the loth PlaflRSP on improving delivery of school services by transferring management o f public implementation, based on school management at the local level. This i s line with the emphasis placed by schools to communities. This also partly responds to escalating conflict and political uncertainty due to which normal functioning of schools i s threatened as the central agencies can no longer reach communities in many parts of the country. The new strategy includes a focus on results and improving monitoring and evaluation by using a common and simplified framework. Finally, the Government i s 61 setting up a joint financing arrangement with aligned donor and government procedures for financial management, disbursement and reporting. Issues 6. Quality is hampered by lack of funds for supplies, textbooks, and teacher training, as well as by a freeze in hiring. The non-salary recurrent budget o f Rs. 300 per teacher per year for primary schools i s grossly inadequate. Given a teacher-student ratio o f 1:40, non-salary expenditure per student i s only Rs 10 or less than US$ 0.05 per year. A closely related issue i s that textbooks are not delivered in time. The Government has recently decided to gradually open textbook production and distribution to private sector to help ensure timely delivery of textbooks. The Government has also been freezing the number o f teacher positions during the last few years while enrollment continues to rise. This, coupled with persisting uneven deployment o f teachers, has led to a large variance in teacher student ratio. Female teachers from disadvantaged communities -- instrumental to ensure access for girls and children from socially excluded groups - are in short supply. In spite o f Government policy to appoint at least one female teacher per school, more than halfo f primary schools still do not have a single female teacher. 7. Access to education by thepoorest is hampered by hidden costs. Even though they are forbidden by the Education Act to levy any kind o f fee, many primary schools impose admission andor examination fees in response to dire financial needs. This makes access difficult for children from poor households. It also raises the quality gap between private and public schools, effectively denying poor children (who cannot afford private schooling) access to quality education. The Government has established various scholarships and fee waivers to help children from poor households access primary, secondary and tertiary education, but these interventions are poorly targeted and have not been evaluated. The need to helpwith work at home or on the family farm also discourages school attendance. 8. The insurgency has affected the delivery of education. The education sector continues to employ the same strategy for delivery o f education throughout the country as if the insurgency had little or no impact. Block grants do help to address some o f the issues arising from the insurgency, but they too need to be monitored. Block grants help to get funds allocated at the local level when the machinery o f traditional delivery has been disrupteddue to the insurgency. Similarly, technical support being provided by the government cannot reach many areas o f the country. Alternative mechanisms o f delivery and monitoring of resources and services needto be developed. 9. Strengthening School Management Committees and the role of communities in managing schools can bring about improvements in school governance, but the legal framework supporting this policy needs more clarity. The 7thAmendment o f the Education Act provided the legal basis for transferring school management to communities, but its application has been slow until recently. As a part of its policy o f decentralizing responsibility for service delivery, HMGN seeks to bring education services at the primary and secondary level under community school management. On the other hand, the Local Self Governance Act (LGSA) mandates the Village Development Committee (VDC) to monitor and manage schools within its territory. Likewise, it mandates the Municipality to assist inoperation and management of schools within its territory. But the role o f these local government authorities vis-a-vis School Management Committees needs to be clarified. Ongoing experience with transfer o f management o f schools to communities indicates that transferred schools are yet to gain meaningful autonomy, due in part to the confusion inthe existing legal framework. 10. Secondary and higher education needs more budgetary and institutional support. Increased expenditures on primary education have crowded out investments in higher education. The share o f higher education inpublic expenditures on education decreased from 20% to 10% during the last decade. Considering that around 40% o f university enrolment i s actually at the higher secondary level, the actual 62 share o f expenditures for higher education i s no more than 7%. This figure i s considerably below the level o f 15 to 20% recommended by the "Constructing Knowledge Societies: New Challenges for Tertiary Education" by a committee appointed to look into secondary and tertiary education. The existing legal framework fragments secondary education into lower secondary, secondary and higher secondary education. Inspite of the Government's policy of integrating higher secondary education with the rest o f secondary education, this agenda has remainedunfulfilled for a long time. Lack o f institutional autonomy inhighereducation undermines goodmanagement. 11. The second most important issue in higher education i s developing a sound framework for formula based funding. Other critical issues in higher education are accreditation, support to disadvantaged students, funding for research and development o f a credible action plan for phasing out proficiency certificate level intandem with upgrading public secondary schools to higher secondary level. While the increasing expenditures on primary education to raise enrollment i s important, the country will need to find the right balance as it cannot afford to neglect secondary and tertiary education because the success achieved in primary education will create demand for secondary and tertiary education, and also inthe interestsoflongterm growth. Recommendations 12. The Government needs toprovide adequate grants to schools to meet expenditures on teachers as well as non-salary recurrent costs. Particularly, central recruitment needs to be stopped for vacancies and be replaced by local level recruitment. But care needs to be taken that this does not lead to low and inadequate teachedstudent ratios. 13. Clearer legislationfor transferring power to communities is needed, together with a more careful monitoring of the devolution of schools to communities. Otherwise, the vested-interests opposing devolution will not allow its successful implementation. 14. Inter- and intra- sectoral allocations will need to be reassessed to ensure appropriate level of funding for higher education, while maintaining the level o f funding for primary education compatible with commitments towards universalprimary education. C. Health 15. Nepal also witnessed many health status improvements in the 1990, but given the poor initial conditions and dejciencies in delivery systems, health indicators remain poor. Infant mortality rate (IMR) declined to 64per 1000 live births and totalfertilip rate (TFR) fell from 5.6 to 4.1 live births per woman of child bearing age. Public expenditure on health as a proportion o f GDP (0.9%) i s comparable to other South Asian countries. There are also considerable differences in access to heath services based on income group, locality, caste, ethnic group and gender. These rates are still unacceptably high, and important challenges remain, including (i) a maternal mortality rate o f 539 per 100,000 live births (ii) malnutrition affecting half o f all children under five; and (iii)the emerging threat o f HIV/AIDS. Infectious diseases, nutritional disorders, and maternal and prenatal diseases dominate the overall pattern of morbidity and mortality in Nepal, accounting for half o f all deaths and two thirds o f lost disability adjusted life years (DALYs) (Table 6.1). Non-communicable diseases, including tobacco and alcohol related, are beginningto increase inrelative importance, though not to the same extent yet as they have in many low-income countries. Beyond the issues concerning burden o f disease, another key challenge for Nepal i s to hasten the decline in fertility and lower population growth rates. 63 16. The highest risk groups are children under Jive, particularly girls, who account for 52.5 percent Causesof Death Cause-Specific DALYs Lost as Deaths as percent percentof All 1 of all female deaths, and women of of All Deaths DALYsLost reproductive age. Although children represent only 16 percent o f the Group I: Infectious diseases and 49.7 68.5 maternal, pre-natal and nutritional population, they account for over 50 problems. percent of the total DALYs lost Group II: Non-communicable and 42.1 22.8 from all causes, and 80 percent o f congenital problems. their deaths are due to Group I Group 111:Injuries and accidents. 6.9 8.7 I causes. Women 15-49 years old Unclassified. 1.o 0.0 experience a 26 percent higher loss o f DALYs than men inthe same age group. Much o f this excess loss i s related to pregnancy related problems. 17. Decentralization Challenge: The Government's main strategy is to promote the devolution of powerfor health service deliveryfrom the center to local governments andpromote community oversight. Since there are n o elected bodies at present, the devolution o f sub-health posts has been limited to handing them over to Local Health Management Committees (LHMC) indistrict and village councils that have adequate representation of females and lower caste people. This arrangement has increased community oversight. MOH has begun training o f L H M C officials and Government officials at the local level to promote effective decentralization o f services. However, technical support from sector agencies based at district and central levels remains below what would be needed. 18. Public Private Partnership: Recognizing the important health services that theprivate sector and NGOs already provide, Government has sought to build partnerships with these groups. Agreements and operating mechanisms now exist between the MOH and NGOs andprivate providers. 19. Implementation Capacity and Management: Although the Government has a well-articulated vision and strategy for health in Nepal, the capacity to implement is weak. Some important functions are under-staffed with no organizational homes specified for activities such as environmental health, gender and social issues and public-private partnership. The shortage o f physical facilities and technical capacity at the district level lowers motivation and productivity. Recommendations toAddress Unfinished Agenda 20. Dealing with health of the poor through more focus on priority diseases: It will be crucial to target the interventions to the groups not served adequately. Although Nepal spends 5.1 percent o f its GDP on health, private-out-pocket spending finances more than 70 percent o f this expenditure. In the medium term improving public provision o f health services through more focus on preventive care and public services such as communicable diseases, maternal mortality, and nutrition i s needed. 21. Improving management of health service systems and moving towards a stewardship role: While 85 percent of the nation's population lives in rural areas, only 51 percent o f total public health expenditures serve rural areas. Aside from increasing resources, decentralization and devolution of services to community oversight and local Governments will be essential to increase the accountability of service providers. 22. Developing the framework for public-private partnership. Private delivery of health services, already important in Nepal, will become even more so in the future. There i s scope and need for the 64 Government to make greater use o f public-private partnerships to expand services for the poor. A transparent and supportive policy framework for private services, more government use o f private bodies to deliver health services, transferring resources to local Governments and communities to increase their discretionto choose among competing suppliers are all needed. 23. Strengthening Government monitoring and oversight capacity. As the Government turns to local governments, communities, and the private sector for managing the delivery o f services, it will need to increase its capacity to monitor the service delivery performance o f different agents, make monitoring results available to the public, and take corrective actions as needed. 24. A key challengefor Nepal is to hasten the decline in itsfertility rate, which according to the 2001 census, is half of that of 21 other Asian countries. While Nepal's current population policy targets well some of the key factors driving fertility -- early marriage and child bearing, son preference and uncertainty o f child survival due to high child morality rates, alongside lack o f education and poverty -- the policy i s undermined by lack o f a multi-sectoral approach and inadequate attention to supply side factors. Current family planningprograms have sought to mobilize NGOs,private sector and community groups to raise awareness and provide contraceptives. Similarly mass media i s used to promote family planning practices and surveys suggest a general awareness o f these. But these efforts need to be made more effective by ensuring that supply side factors are also adequately addressed. These factors would include skilled and female service providers being available at health facilities, privacy and confidentiality, appropriate counseling, information material, and, most important, adequate supply o f contraceptives at regional and district levels constrain service users. Also critical will be to ensure the availability o f family planning services. Available data (NDHS 2001) suggest that contraceptive prevalence rate i s only 39% despite the demand by 67% o f married women o f reproductive age for such services. D. Water Supply and Sanitation 25. Sector Developments. I n the 1990s, the water supply and sanitation sector saw reforms that shifted from the supply driven approach to service delivery of the 1980s (the Water and Sanitation Decade) to a demand driven approach. It also adopted participatory decision malung in rural water and sanitation service delivery. Inaddition, community participation shifted from voluntary labor contribution to community empowerment and management. HMGN has defined sector objectives clearly: (i)to provide and ensure safe, convenient and adequate water supply to all Nepalese people with sanitation as an integral component, with a specific focus on disadvantaged groups; (ii) to reduce the incidence o f water-related diseases; (iii) to lessen the burden o f women and children who are traditionally involved in collecting water; and (iv) taking care o f domestic sanitation and hygiene. 26. The Government's policies in the sector are sound; the main issue lies with implementing them. The National Water Supply and Sanitation Policy (1998) and the 10th PladPRSP define the role and responsibilities o f the institutions clearly. The strategy emphasizes decentralization, seeks support and partnerships from NGOs, private sectors organizations, and involves user groups. It also determines tariff rates for urban water supply to move towards cost recovery and prescribes lower rates for low-income households, but with penalties to discourage waste. As the issues discussed below indicates the main challenge ahead lies in implementing these policies well. Sector Issues and Recommendations 27. Limited sector coverage: The IOth PladPRSP has set a target for water supply and sanitation coverage at the end of the Plan period o f 85% and 50% respectively compared to 71% and 25% in the 9th Plan. Given the need for rehabilitation o f 10% o f the Government built schemes and major repair o f some 65 9,500 o f these schemes, the MDG targets may not be achieved without adequate investments and institutional arrangements to make these investments effective and sustainable. 28. Multitude of sector institution and coordination challenges: The present institutional arrangement in the sector involves a multitude of organizations. The principal public sector institutions are the Department o f Water Supply and Sewerage (DWSS), the Nepal Water Supply Corporation (NWSC) and the Rural Water Supply and Sanitation Fund Development Board (the Fund Board) reporting to the Ministry of Physical Planning and Works (MPPW). This has lead to various approaches to service delivery as well as various interpretations o f the sector policy and some confusion. This makes coordination among the different actors challenging. A related issue i s donor coordination. In order to bringabout efficiency inthe sector and prevent duplication o f efforts, the government would need to take responsibility in coordinating donors. While the Government could ask donors to assist in providing technical inputdadvice, it needs to coordinate donor agencies and assume full ownership o f its decisions. This would ensure effective use of donor resources. 29. Institutional de$ciencies: Institutional deficiencies, particularly, in the urban sub-sector, have led to unreliable, intermittent, inequitable and poor quality supply. Consumers thus make expensive investments on alternative sources like boreholes and tanker services and on installingpumps and storage devices. The leaks inthe distribution system not only result inwastage o f water but also expose the water supplied to contamination and forces households to spend considerable sums o f money to boil and filter the water. There i s also need to monitor effectiveness and further clarify the roles and responsibilities o f sector agencies inthe context o f decentralization, to ensure that the best institutional set up to implement sector policies and achieve sector objectives i s put inplace. 30. Over-programming of sector financing: The sectoral budget as a percentage o f the development budget has remained fairly constant around 6 to 7% in the last five years. Inthe past, there has been a consistent tendency to over program the budget, so actual expenditures tend to be lower than budgeted. In this context, a clear priority is ensuring efficient use of resources through performance based budget allocations through regular reviews and a well established framework to allocate resources among the different groups and users. 31. Lack of consistent framework for community contributions/empowerment: In the rural water supply and sanitation sector, decentralized participatory approaches with communities malung contributions in cash and/or kind are an accepted general norm. However, the amount that communities are required to contribute ranges from 10% to over 30% depending on the implementindfunding agency. The level o f community involvement/empowerment,in actual practice, also varies. There i s a need to have a consistent policy framework. 32. Resource mobilization/politicization of tariff increases: The challenge i s to ensure that resources are mobilized on a regular basis to improve the availability o f resources for operation and maintenance. Furtherthis needs to be done without burdeningthe people, as has often beenthe case, with costly lumpy, politicized ad hoc tariff increases required because o f deferred maintenance leading, in a vicious cycle, to costly rehabilitatiodreplacements. 33. A key mechanism to make investments more effective and achieve coordination would be to promote greater customer responsiveness and involvement and use monitoring and evaluation: The different service delivery mechanisms, such as service delivery through the public sector - central government, local government - NGOs, community based organizations need to be more responsive to customer needs. Customer satisfaction surveys could be used for monitoring. The central government would need to concentrate its efforts on monitoring and evaluation both o f service delivery and o f water quality. Efficiency in monitoring would help to eliminate mismanagement o f resources such as 66 personnel, vehicles etc. This would also provide an effective tool for the Government to weed out inefficient and costly service delivery approaches. E. SocialProtection 34. In the IOth Plan, HMGN follows a two-part strategy: foster broad based growth to beneft principally the moderately poor (who are some 60% of the poor), and combine targeted programs with social mobilization to reach the very poor. Social protection programs in Nepal also go beyond poverty reduction to pension and provident funds for the formal sector. Social Safety Netsfor thePoor and Vulnerable 35. There are several uncoordinated government programs, many with small numbers of actual beneficiaries and relatively high administrative overheads, covering diferent benefciaries, from children to the disabled to war victims (see Table 6.2). That more than 400 budget lines exist to finance these programs, indicate the fragmented and uncoordinated nature o f social safety net programs inNepal. Many o f these programs originated from the signing o f international conventions (e.g. children, disabled etc.) or from donor-funded programs, which have lost external support. The Poverty Alleviation Fund (PAF) i s emerging as a major instrument to consolidate these programs and thus reduce overhead and improve monitoring of costs and impact. Table 6.2 Coverageof MajorSocial Protection Programsin Nepal [need to indicatesource] Program Numberof Beneficiaries Cost in Rupees 1000s Non-ContributorySchemes Old Age IncomeSecurity 192,000 348,264, HelplessWidows Assistance 228,000 226,760, DisabledPensions 3,700 4,400, Pensionsfor Civil Servants, Teachers, Military and Police 318,000 3,260,000, Foodfor Work 300,000 350,000, Foodfor Education 292,000 290,000, Other Schemesfor children, elderly etc. Few Thousands Few millions mostly in overhead Source: World Bank team estimates. Coverageand Assessment of Main Programs 36. A number of programs appear to be of a short-term nature, beingfunded for one or two years and then terminated. This may again be a response to changes in donor support, but may also reflect political pressures. Whatever the reasons, the inconsistent funding o f programs leads to inefficiency and reduces effectiveness, with chronic under-funding o f programs and termination after the initial investments. In addition, special projects may create parallel local administrative structures that undermine existing mechanisms. Monitoring and evaluation remains a problem for all programs and this i s necessary as a first step to assess whether programs are cost-effective or needto be redesigned. 37. Food Based Assistance: There is one major public works program, heavily supported by WFP until 2006. The Rural Community Infrastructure Works (RCIW) program i s a food-for-work intervention that involves poor households in the creation and maintenance o f critical physical assets such as rural roads, irrigation, agro-forestry assets and river control. RCIW operates in 30 o f Nepal's 75 districts, including some o f the country's most remote and food-insecure areas. The program relies on a decentralized approach in which communities help select project activities. Nearly 300,000 beneficiaries are estimated to benefit from the program annually, with an annual cost o f US$4.6 million. RCIW 67 operates through the Ministry of Local Development and receives extensive support from WFP, with technical support from GTZ, DANIDA and DfID. 38. The Food-for-Education (Ffi) program was started in 1996 with WFP assistance. It currently provides food to public primary and lower secondary children in schools within 16 districts. Children receive a hot midday meal of blended food (haluwa). In addition, a de-worming program operates within the FfE in coordination with the WHO and Ministry o f Health. The program i s implemented by District Education Offices under the Ministryo f Education and Sports. WFP estimates that FfE can serve 292,000 children annually at a cost o f US$3.8 million. 39. Safety Net Programsfor the Elderly: The universalflat old agepension (OAP) of Rupees 100 to all people above 7.5 years was first announced on 26 December 1994. Five districts from the five development regions of Nepal were selected on a pilot basis and the implementation of the pilot was carried out by the Ministry of Education and Sports and at the grass-roots level by the Village Development Committees. During the financial year 1995-96, OAP was extended to the entire country and was implemented by the Home Ministry. Since 1996-97, the Ministry o f Local Development has administered the OAF', and the allowances have been distributed by the ward offices in the urban areas and Village Development Committees in the rural areas. Two additional transfers were introduced in 1996, namely the Helpless Widows Allowance for widows above 60 years o f age" and a disabled pension71, each paying Rupees 100 per month. During the International Year o f Elderly Persons (1999), the ruling Nepali Congress raised the old age allowance from Rupees 100 to Rupees 150. All Nepalese men and women who are 75 years and older are eligible for the pension. According to the directives issued by the Ministry of Local Development, eligibility for old age allowance i s strictly based on the age mentioned inthe Nepalese Citizenship certificate. A Social Security Program Identity Card will be issued to those eligible. The combined number o f beneficiaries exceeded 400,000 individuals or about 1.8 percent o fthe total population. 40. In principle, this program overlaps with those covering formal sector employees. On the other hand, coverage o f the contributory schemes i s likely to remain very low for decades to come, making the Old Age Pension Program the sole alternative to family support systems for the vast majority o f the population. So its role i s to filla gap that i s created by low coverage inthe formal sector schemes. 41. A preliminary analysis suggests that this program, along with the means-tested widows benefit, reaches a high proportion of the eligible population, but that there are sharp geographic diflerences. There i s also a tradeoff between administrative simplicity and inclusion on the one hand and budgetary limitations on the other handthat needs to be better understood. Pensions and Provident Fundfor the Formal Sector 42. Public Sector Pensions. Approximately 320,000 civil servants, military, police and teachers belong to dejked benefit schemes that pay pensions with provisions for survivors. Currently, it i s estimated that there are around 103,000 pensioners. The pension bill in 2003-04 was close to Rs3.3 billion rupees, rising from Rs3.06 billion in 2002-03, excluding teachers' pensions. This i s financed directly from the budget and i s now equivalent to 5.4 percent o f regular expenditures. While an estimate o f the ' O All Nepalese widows who havecrossedthe age of 60 anddo not have any economic source of income, those who don't get any care from family members, andthose who don't get thepension of their late husbands are entitled. " DisabledNepalesecitizens havingthe following physical infirmities andbeingat least sixteen years of age: blind, who do not have bothhands or who havehands that don't work, who do not havebothlegs or who have legs that don't work. 68 present value o f future spending has not yet been produced, based on international experience, the figure i s likely to be o f the order o f 15-20 percent o f GDP.72 43. Hidden within these aggregates are important differences betweensub-schemes. Specifically, it i s necessary to distinguish civil servants and teachers from military and police because eligibility requirements differ substantially. While civil servants typically retire at age 58 or above and are required to have at least 20 years o f service in order to receive a pension, military and police personnel are not subject to an age requirement and may receive a pension after only 16 years o f service. 44. In order to accurately assess thefinancial status of the defined benefit system, it is important to disaggregate the key indicators, as shown in Table 6.3. It i s important to note that the ratio o f pensioners to contributors would have been much higher ifit were not for the recent doubling o f the size o f the army. Also important i s the fact that teachers were only granted pension rightsin 1996 so that the relatively high ratio o f active employees to pensioners reflects the immaturity o f this scheme. This ratio will rise rapidly as evidenced by the growth inthe number o f pensioners in this category from four to ten thousand in the last five years. Table 6.3 Key indicatorsof publicsector pensionschemesin 2003 Category Active employees Pensioners Ratio: activeto Spending2003-4 Shareof pensioners (Rs millions) spending Civil servants' 87016 30000 2.9 Army2 80000 38000 2.2 Police2 55000 25000 2.2 Teachers2 96000 10000 9.6 n.a. n.a Total 318016 103000 3.1 3260 Note: ITThere are 99,398 positions but 12,000 are not currently filled. 2IEstimates by DPR team. 45. Employees' Provident Fund: Public sector employees and private firms with at least 10 employees are required to either contribute to the EPF or set up provident funds meeting the same conditions. The tax-exempt contributions mandated are set at 20 percent o f basic salary, split evenly between employer and employee. Currently, there are an estimated 380,000 contributors to the EPF and an unknown number of employees covered by employer-administered provident finds. This represents an estimated 20 percent o f employees in Nepal and 6 percent o f the entire economically active population. Despite the highcontribution rate, several factors limit the effective amount o f forced savings. destined to generate income at retirement. While withdrawals have always been allowed upon termination o f employment, other types o f withdrawals were allowed prior to retirement until this practice was ended in 2001. However, loans to members are permitted and this represented 32% o fprogram assets in2003. 46. The long-run rate of return on EPF accounts in real terms has barely exceeded inflation until recently. Although data on average covered wage growth are not available, the differential between EPF returns and wage growth i s likely to be small or even negative. For example, income per capita has grown at about 1.5 percent per annum since 1970 while real returns on EPF balances have averaged about 1 percent during this period. Real wage growth for lower level civil servants appears to be much higher over the same three decades. Finally, since allowances are not included in the earnings base subject to provident fund contributions, the effective replacement rate that can be generated i s reduced. Inprivate '' See Holzmann, Palacios andZvinniene (2001). "On the Economicsand Scope of Implicit PensionDebt: An Intemational Perspective", Empirica 28 (2001)/1, 97-129. 69 sector firms inparticular, allowances can make up a significant share o f total compensation. Overall, EPF plays a minimal role in old age income security even for the limited share o f the labor force that it covers. 47. Next Steps in Reforming Pension Funds and the EPF: The main impetusfor pension reform in Nepal today is the growth in expenditures on civil service pensions. This phenomenon poses a fiscal threat that has broader negative impact on the population through larger deficits or the crowding out of other programs. The fact that pensions are indexed to civil service salaries at present also complicates broader efforts to reform the public sector. Untilrecently, little attention has been given to the long term financial viability of this scheme so that recent growth trends have causedjustifiable concern. 48. Aside from thefiscal impact, the civil service pension scheme exhibits many designflaws at the microeconomic level with implications for labor markets and equity. For example, labor mobility i s hindered by the back-loaded benefit formula and vesting rules that create a substantial loss for a civil servant that shifts from public to private sector employment. The use o f a benefit formula and position- specific indexation also introduce inequities within and across generations. 49. nese are commonfeatures of civil servicepension schemes in SouthAsia and elsewhere and are now in the process of being reformed in many countries including neighboring India. One set o f reform options involves a range of parametric changes to rationalize within the current structure such as increasing the retirement age, lengthening o f the earnings base used in the benefit calculation, reduction inaccrual rates and a shift from wage to price indexation. Another approachwould be to move towards a contributory pension system that resulted in an accumulation o f assets that would be used to offset pension liabilities. These approaches are not mutually exclusive. 50. Employee Provident Fund. A thorough review o f the overall pension system covering the entire formal sector would consider the merits of integration o f public and private sector pensions to achieve better labor mobility, lower costs and common social policy objectives. Microfinance 51. Nepal has a fairly sophisticated group of micro-finance practitioners and donors who are well aware of global best practice that discourages mixing financial service delivery (where loans must be paid back promptly) with the delivery of grant money (which does not need to be paid back). There i s a great deal o f successful experience inthe country o f savings-led micro-finance service delivery which has proved to be both operationally and financially self-sustaining after initial investments to build group capacity and social capital. 52. Micro-credit is one of the principal methods of encouraging income generation and small business development in Nepal. There are several targeted micro-credit programs operated through different ministries with different donors supporting them. The major credit initiatives include the Small Farmers Development Program (SFDP), the Production Credit for Rural Women (PCRW) and the Micro- CreditProject for Women (MCPW). 53. In recent years, two trends have been evident in microfinance. First, some organizations are increasingly turning to lending without collateral requirements to reach the poorest segments o f the population. Second, formal financial institutions have become less directly involved in lending operations, relying instead on intermediary organizations such as NGOs and cooperatives to reduce operating costs. There has also been an emphasis on generating local funds either through revolving credit funds such as PCRW and MCPW or enforced group savings (Grameen clones). 70 54. Issues and Future Potential in Microfinance: Despite Nepal's vibrant micro-finance sector, outreach topoor rural borrowers is still very low with something like 6.5percent of poor men and women estimated to have access to micro-credit through formal public and private sector institutions. Why has coverage remained so low? There i s broad agreement inthe micro-finance community that the constraints to scaling up include: o Weak mainstreamformal sector intermediaries -characterizedby a cautious andrather bureaucratic banlung culture and increasing politicization; Shortcomings inthe policy and regulatory framework for micro-finance. Despite the fact that Nepal has adopted forward-looking policies which allow development banks with lower levels o f capitalization, permit NGOs to register as financial intermediaries and grant limited banlung licenses to cooperatives approved by the central bank, many flaws remain inthe legislationand the central bank i s overstretched initsregulatoryrole; General lack ofrural infi-astructureand markets which, inturn, limit the potential for highretumrural farm and non-farm enterprises and the demand for money to finance these enterprises; Inadequate investmentin social intermediation, capacity buildingo f Micro-Finance Intermediaries (MFIs) and Business Support Services; and The security situation which has increased the general risluness attached to all economic activities in therural areas-andhas particularly threatenedthe operation o fmicro-finance organizations and programs identified with the government. 55. The security situation appears to have hampered the development of new approaches in micro- finance such as life and health insurance which can contribute to risk reduction and social protection. Micro-finance organizations in Bangladesh and India are offering these types o f products and even pensions but these have yet to reach Nepal despite its vibrant and large micro-finance sector. Technical support and possible partnerships with micro-finance NGOs in Bangladesh and India could help in the development o f these new micro-finance products which could have significant impact on social protection. F. Summingup 56. First, there are many socialprotection schemes in Nepal. Their effectiveness i s however reduced by not being coordinated; in some cases their impact is not clear. Some are assured funding only in the short term and their continuing funding i s an issue. Assistance programs, which encourage good practices such as food for education, are dependent on food surpluses in World Food Program (WFP) donor countries that are beyond the control o f the Government. The pension and provident funds in the formal sector unless reformed could create fiscal problems in the future and they have to be monitored carefully and reformedto be fiscally and financially sustainable. 57. Second, apart from thefiscal implications, there are labor market implications for the pension andprovidentfunds. They tend to reduce the flexibility of the labor market as well as raise real wages for those involved in the schemes, unrelated to productivity gains. Labor mobility i s hindered by the back loaded benefit formula used. There i s a need to develop a new contributory pension scheme which allows labor mobility and where the benefits are not back-loaded. 58. Finally, microfinance schemes can be seen as social protection even if the loans are market priced and savings are accumulated at rates that allow the funds to continue to the future. Global experience as well as regional experience shows that the issue for poor has always been more about access to credit and less about the cost of credit. Microfinance in Nepal needs to develop and offer 71 financial products beyond credit to include savings73and micro-life insurance, which has been tried in Bangladesh and other countries. 73 Again global experience shows that the poorest are better reachedthrough micro-savingsschemes which helpprovidea cushionagainst vulnerability. 72 CHAPTER7. - ACHIEVING PEACEAND RESTORINGPROGRESS A. MediumTermDevelopmentProspects 1. Nepal is at a crossroad today between the prospect of sustaining and accelerating gains in human development and poverty reduction and the danger of serious reversals of these gains. Despite a late start indevelopment and a difficult geography, Nepal succeeded inbuildingup a wide range of good government institutions - a system o f laws and organizations, checks and balances - in a short span o f time since the 1950s, though their newness and compressed history have also made them fragile. Policies, infrastructure, incomes, and human development outcomes steadily improved under these institutions. Economic growth accelerated in the 1990s, became more inclusive and less volatile in the second half of the 1990s. Evidence from several household surveys corroborate that poverty has declined appreciably since the mid 1990s. But now this progress i s under threat o f reversal from political instability and a domestic conflict that has sharply escalated inthe past two years. Meanwhile conflict and an increasingly competitive extemal environment could prevent the country from reaching the highrates of export growth that it reached inthe 1990s. 2. Nepal's medium term prospects largely hinge on its ability to tackle these immediate threats by restoring a minimum degree of stability under which development can proceed and the country can undertake structural reforms to increase competitiveness. While the immediate need i s to reduce the severity of the conflict if not negotiate a complete settlement, Nepal's development strategy will need to confront the issues o f the lagging regions, disadvantaged ethnic and caste groups, who feel excluded and disempowered. Focusing development efforts on these groups and regions through investing in better connectivity, agricultural development, public services and institutions to empower them will be key elements o f the medium term strategy. Second, policy measures have to be taken to increase competitiveness and productivity, rather than rely exclusively on raising investment and saving (at present levels of productivity) to raise GDP. The latter is neither advisable nor feasible. Productivity gains canbe achieved through improvements intransport and customs procedures and through policy reforms to make the labor market flexible and also by removing minimum support prices and SME reservations. Third, a more concerted effort to commercialize agriculture can all help to raise its growth prospects. All such measures will help Nepal to exploit its comparative advantage in agriculture, labor intensive manufacturing and tourism. In turn these measures can improve the country's medium term growth and poverty reductionprospects. B. The PovertyReductionStrategy and GrowthScenarios 3. Nepal's 1Oih Five Year Plan, whose summary is the poverty reduction strategy has four pillars: (1) broad based growth with special emphasis on agriculture; (ii)accelerating human development through renewed emphasis on effective delivery o f basic social services and economic infrastructure; (iii) ensuring social and economic inclusion of the poor, marginalized groups and backward regions; and (iv) vigorouslypursuhg good governance as a means o f delivering better development results and to ensure social and economic justice. Planned public investment has been, appropriately, focused on developing social and physicalinfrastructure. 4. The PRSPpresents two medium term scenarios - the normal case and the alternative case - to take into account the downside risks arisingfrom the present conflict. Underpinned by a prudent fiscal frame work that lowers public sector borrowing requirements to less than 1% of GDP inthe final year, the "normal" scenario in the PRSP projects a growth rate o f 6.2% p.a. over the next five years -with growth rates reaching a maximum of 7.5% at the end of the plan. The low-case scenario projects a 4.3% growth 73 rate per annum. In sectoral terms, the normal scenario envisages that more than 3/4tho f GDP growth will come from the non-agriculture sector inkeeping with past trends. 5. The normal case is contingent on a "quick rebound" of economic activity following peace, especially in the non-agriculture sectors such as manufacturing, exports, construction and tourism -- all based on private sector led growth. The PRSP envisages a strong recovery o f private sector investment (rising to 19% o f GDP by 2007, compared to 12% currently) that would lead to strong trade and export growth. Public investments in power, roads and telecommunications are the instruments for encouraging private sector investment. In the rural sector, the implementation o f the APP, including ensuring the supply o f fertilizer, irrigation, and the development o f livestock, horticulture and highvalue crops inthe hillregions would drive agriculture growth. Expansion ofruralroads, electricityandmarketingnetworks, expansion and rehabilitation o f irrigation networks and small-scale surface irrigation schemes in the hill regions will be the drivers behindagricultural growth inthose areas. 6. Unfortunately, the Jirst two years of the IOth plan has made it clear that assumptions of the normal case are not holding and it has become evident that even attaining the "alternative case" scenario will be challenging. Nepal's growth rate in the past three years has only averaged at around 2.0%. While growth inthe last two years has been in line with the alternative case scenario, it has been possible only because o f the resilient growth o f the agricultural sector and not the non-agricultural sector. Except for tourism, growth in other sectors such as manufacturing, transport and communications has been considerably below the trend o f the 1990s. This means that even attaining the "alternative case target" o f 4.3% ina scenario o f continuing insurgency would depend largely on good weather. 7. The reason for poor performance of the non-agriculture sector is the cost imposed on the sector by the conflict. These costs have tumed out to be steep and consequently Nepal's export growth i s much slower in the last three years compared to 1990s. A conservative estimate i s that GDP growth rates have fallen by 2% points p.a. (i.e. to around 4%) due to falling investment (by more than 3% Doints o f GDP), due to disruptions in economic activity and associated rising costs. This implies that in the next 5 years, per-capita-GDP would be 10% to I I 14% lower than what it would have been if peace had been restored in source;World Bankestimate 74 past trends and If Government can make the needed adjustments. The economy showed considerable 8, Overall, ifpeace is restored, the "normal case scenario does not look too unrealistic going by responsiveness to good policies in the past, achieving a trend growth rate o f about 5% in the 1990s and attained a growth rate of 6% in FY 2001. Considering that both human and capital stock have increased substantially over the 1990s, infrastructure has improved markedly and currently a steady stream o f remittances stimulates demand, medium-term growth prospects would seem favorable. But Government would need to focus more on two areas than it does inthe 10* plan. These are to provide an environment to increase productivity and efficiency instead o f depending on higher investment and savings as well as encourage the commercializationof agriculture. 9. Some growth arithmetic highlights thepoint on the excessive reliance of the PRSP on investment and savings instead of productivity. The 10" Plan envisages investment and private investment rates to more than double in real terms compared to the rates o f investment during 1996 to 2001, a period o f relative normalcy. Similarly, the consumption rate i s expected to fall by 5 percentage points o f GDP to provide a part of the savings for investment. But as may be expected from a low-income country such as Nepal, the recent household consumption surveys show that consumption has increased appreciably in regions and across income levels. Hence, clearly the premise o f achieving significantly higher investment and savings rates i s not tenable and more focus on growth o f productivity i s needed. As discussed earlier in Chapter 2, the empirical evidence from both aggregate analysis and firm level analysis suggests that productivity levels and growth are very low in Nepal. Aggregate productivity growth even after considerable improvement inthe 1990swas still at 0.3% p.a. compared to say 2.5% growth inIndia. 10. Nepal has the basis to increase its productivity by primarily focusing onfour areas. The first is commercializing agriculture to take advantage o f its diverse agro-ecological zones and the variety of high value crops, horticulture, and livestock, some at off-season, that it can produce will raise agricultural incomes and productivity inthe hills.The prospects for commercial agriculture are already evident inthe faster growth o f commercial crops, livestock and exports in the second half o f the 1990s. Second, by focusing on trade competitiveness. Nepal has revealed comparative advantage in agriculture and manufacturing products (garments, carpets, pashmina, and edible oils, light manufacturing goods). The proximity to the large and fast growing Indian and Chinese economies and the availability o f preferential access to Europe and to India, which many o f its neighbors don't enjoy, lower wages and an arguably better investment climate than neighboring Uttar Pradesh and Bihar - in terms o f infrastructure and governance --could help to draw foreign and Indian investment with their know-how and market access for export oriented activities. 11. This leads to the third prospect of growth and productivity, i.e. by attracting foreign direct investment. At present, FDIi s by far the lowest in South Asia. Incomparisonto Sri Lanka where 70% o f ready-made garments exports come from foreign investors, in Nepal FDI share in that sector i s virtually nil. A combination of conflict, political instability and unfriendly Govemment policies such as reservations on carpet manufacturing, restrictions on foreign supply o f services, and high transactions costs have kept FDIshy away from the country. Butwith Nepal's accession to the WTO, its commitment to modernize Customs and liberalize a wide range o f services that investors need, and its preferential access to India and Europe can make the country attractive to FDI. Starting from a low base, this could be a significant factor to spur productivity. 12. The fourth source of future growth and productivity comes with its changing demographic composition with more and better education. This raises the prospects o f increasing productivity o f both capital and labor. As more o f Nepal's population enters the labor force and the dependency ratio declines, that would add to growth. For a long time, labor force growth rate and schooling growth rates have remained persistently low, but that changed in the 1990s as Nepal underwent a demographic transition. The share of working age population after increasing from 53.4% in 1996to 54.8% in2006 i s expected to 75 increase at a faster rate to 57.8% by 2016 increasing the growth o f productive labor even if participation rates remain the same. Alongside, the significant increase in schooling in the 1990s offers the scope for raising productivity. Although, it i s worth emphasizing that these increases in productivity can only happen if there i s investment in raising productivity and labor market flexibility provides greater incentives for both firms and labor to invest inincreasing their productivity. 13. Another asset, especially important for human capital development and growth, is the strong presence and vibrancy of Nepal's communities - i.e. local or community level social capital. This i s witnessed in the dynamism of its many user groups in various sectors such as forestry, irrigation, water and sanitation, micro-finance and women's savings. It i s also witnessed in the good start o f local Governments inNepal, where even though development i s inthe early phases and at present it i s arrested. Local governments have displayed considerable activism in development and organizing the delivery o f public, specifically "club," goods that benefit the communities. This asset has enabled Nepal to achieve significant improvements in human development indicators despite weak public services and the disruptions due to political instability and conflict. It also offers Nepal a route to improve public service term growth and development strategy spelled out inthe lothFive Year Plan and the PRSP. delivery through devolution. To some extent these assets are highlighted in the Government medium C. Risks 14. It is self-evident that risks in Nepal are very high, but the resilience of its economy and institutions are also high. Despite significant instability and turmoil over the last decade, the economy grew at a respectable rate and considerable human development took place. Still, the escalating conflict o f the last three years and growing street agitation shows that the main risk i s political. The other downside risks arise from the changing foreign trade environment (such as the rescinding o f the MFA) and Nepal's excessive dependence on remittances to maintain its current account balance. Other risks include the constraints on Government capacity to implement an inclusive growth strategy, address contingent liabilities, and tackle Nepal's population growth. 15. Thefirst and most signijkant risk comesfrom political instability and conflict that has created instability and uncertainty about institutions, rules and laws. The roots o f this instability lie in the relative exclusion of lagging regions primarily in the hills o f the mid- and far-Westem regions and the dalits and indigenous groups from having access to income and other benefits o f public services. An eight-year long insurgency originating from these regions has claimed more than 9,500 lives - most o f them since 2001 has disrupted development, local governments, and public services in large parts o f - Nepal. The war has inflicted large costs to the tune o f more than 2% o f GDP each year and has large cumulative adverse effect on future growth. More recently, political unrest, transport blockades and street demonstrations every month have eroded business confidence. The suspension o f laws and representative institutions have also led to greater uncertainty. It i s unclear that Nepal will be able to attain its low altemative case growth scenario inthis climate. 16. The second risk comes from a more competitive external environment brought about by the forthcoming phasing out of the MFA, the loss of its market share o f carpets to cheaper machine made carpets, and a more stringent trade treaty with India. These factors suggest that the rapid growth in exports and the non-agricultural sector inthe 1990s- that accounted for 3/4' o f all growth inthe 1990s -- cannot be sustained without implementing further policy reforms and serving better access to Indian and foreign markets. Per capita income has fallen since 2001 as the shock o f falling exports and escalating conflict combined with excessive rainfall in 2002. As the inexorable pressure o f population grows and the share o f working age population increases - as demographic trends predict - the challenge will be to stimulate growth and investment at a faster pace to create the jobs needed to employ the new entrants to the labor force. 76 17. The third risk is posed by substantial reform agenda that the Government needs to implement to restart growth and to have more inclusive growth. The insurgency and the social conflict make implementation o f the various agenda items identified in this review and programs already identified by the Government difficult. In one sense the reform are the antidote to the conflict (such as policies to increase inclusion, increase transparency and provide better service delivery). But the implementation itselfi s constrained by the on going conflict. This calls for careful prioritization and phasing o f the reform agenda. 18. Thefourth risk is posed by the contingent liability of the non-performing assets of the two large banks whose negative net worth is estimated to be about 7% of GDP. The inability to restructure these assets inan orderly manner could lead to a significant fiscal burden and a sharp reduction in the access to credit. Ineither case, there would be crowding out o f private investment. 19. The$$h risk of losing the race against population growth is more long term risk, though it requires intervention now. While Nepal's demographic transition into lower fertility rates has started it i s very recent and slow. At its current rate of fertility decline, Nepal's population will grow to 77 million in the next 50 years. This will lead to overwhelming and unbearable pressure on its limited land resources and overwhelm growth and poverty reduction prospects. Alternatively, if Nepal i s able to intervene through both supply and demand side of family planning practices leading to a decline in fertility similar to the average o f 21 selected Asian c~untries'~,then population growth rate would slow down and grow to about 50 millioninthe next 50 years, leading to a much more manageable situation. D. Summingup 20. Starting from a low base, Nepal has made good progress in developing a wide range of institutions - laws and organizations and checks and balances. But their newness also made these institutions fragile and unable to deal with the foremost challenge o f the exclusion o f lagging regions and ethnic groups and castes. Their inability to cope with the tide o f rising expectations that came with democracy in 1990 has led to widespread resentment particularly among the lagging regions and groups. This has fueled an eight-year long insurgency that has violently escalated inthe last three years leading to the unraveling o f key representative and accountability institutions. This now threatens to stall and roll back the progress that Nepal has achieved and more fundamentally the legitimacy o f the state. 21. This review has attempted to offer a menu of technical options that Nepal needs to pursue in order to restart growth, increase social inclusion and improve service delivery. 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World Bank, (2003), Doing Business in 2004 World Bank (2004), Agricultural Sourcebook,Washington, D.C. 81 82 STATISTICAL ANNEX 84 StatisticalAnnex :Contents Section 1: National Accounts and Social Indicators Table 1.1: Nepal: Nominal Gross Domestic Product by Sector, 1994/95-2002/2003 Table 1.2: Nepal: Real Gross Domestic Product by Sector, 1994/95-2002/03 Table 1.3: Nepal: Gross Domestic Product Deflators, 1994/95-2001/02 Table 1.4: Nepal: Gross Domestic Product by Expenditure Components, 1994/95-2001/02 Table 1.5: Nepal: Savings and Investment, 1994/95-2000/01 Table 1.6: Nepal: Social Indicators Section 2: Balance of Payments: Currnet Account Table 2.l(a): Nepal: Balance o f Payments, 1995/96-2002/03 Table 2.l(b): Nepal: Balance of Paymentswith India, 1995/96-2001/02 Table 2.l(c): Nepal: Balance of Paymentswith ThirdWorld, 1995/96-2001/02 Table 2.2(a): Nepal: Foreign Trade, 1995/96-2001/02 Table 2.2(b): Nepal: ForeignTrade with India, 1995/96-1999/00 Table 2.2(c): Nepal: Foreign Trade with Third World, 1995/96-2001/02 Table 2.3: Nepal: Exports of Major Commodities, 1994/95 - 2001/02 Table 2.4(a): Nepal: Services and Current Transfers, 1995/96-2001/02 Table 2.4(b): Nepal: Services and Current Transfers with India, 1995/96-2001/02 Table 2.4(c): Nepal: Services and Current Transfers with Third World, 1995/96-2001/02 Table 2.5: Nepal: Tourism Indicators, 1994-2002 Table 2.6: Nepal: Average Customs Dutyby Main Category of Goods, 1999/2000 - 2001-02 1/ Section 3: Balance of Payments :Capital Account Table 3.1. Nepal: Extemal Debt and Debt Service, 1994/95-2001/02 Table 3.2: Nepal: Gross InternationalReserves, 1994/95-2001/02 1/ Section 4: Public Finance Table 4.1:Nepal: Summary of Central Government Operations, 1994/95-2002/03 1/ Table 4.2: Nepal: Central Government Revenue, 1995/96-2002/03 Table 4.3: Nepal: Central Government Expenditure by Economic Classification, 1995/96-2001/02 Table 4.4: Nepal: Central Government Expenditure by Functional Classification, 1995196-2001/02 Section 5: Monetary Survey Table 5.1:Nepal: Monetary Survey, 1994/95-2002103 Table 5.2: Nepal: Structure of Interest Rates, 1994/95-2001/02 Table 5.3: Nepal: Non-Performing Loans of Public Enterprises, 1996/97-2001/02 Section 6: Agriculture, Energy, Industry, Prices and Wages Table 6.1:Nepal: Agricutural Production and Yield, 1995/96-2001/02 Table 6.2: Nepal: Manufacturing Production Indices, 1997/98-2001/02 Table 6.3: Nepal: Energy Consumption, 1994/95-2001/02 Table 6.4: Nepal: Changes inthe Consumer Price Index, 1994/95-2001/02 Table 6.5: Nepal: Monthly Wages inMajor Sectors, 1994/95-2001/02 Table 1.1: Nepal: N o m i n a l Gross Domestic Product by Sector, 1994/95-2002/2003 Est. 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 2002103 (Inbillionso fNepalese rupees, at currentprices) Agriculture, Fisheries, and forestry 85.6 96.9 108.8 112.5 132.4 145.1 151.1 160.1 169.7 Industry 46.6 53.5 60.0 63.4 69.9 78.7 84.0 84.5 88.9 Mining and quarrying 1.1 1.3 1.5 1.6 1.7 1.8 1.9 2.1 2.2 Manufacturing 19.6 22.5 24.8 27.0 30.3 33.6 35.5 32.8 33.7 Electricity and water 2.9 3.6 4.5 4.4 4.6 5.9 7.0 7.4 8.5 Construction 23.1 26.1 29.3 30.5 33.3 37.4 39.6 42.2 44.5 Services 77.8 89.0 100.8 113.9 127.7 142.4 158.5 159.9 169.9 Trade, restaurants, and hotels 24.3 28.3 30.6 33.7 39.3 42.9 44.6 40.5 42.6 Transport and communications 14.0 15.9 19.3 22.6 24.6 29.3 33.3 34.7 37.1 Financial and real estate 20.5 23.5 27.2 29.8 33.2 36.9 41.6 43.9 46.9 Community and social services 18.9 21.3 23.7 27.8 30.6 33.3 39.0 40.8 43.4 GDP at factor cost 210.0 239.4 269.6 289.8 330.0 366.3 393.6 404.5 428.5 Agricultural GDP 85.6 96.9 108.8 112.5 132.4 145.1 151.1 160.1 169.7 Non-agricultural GDP 124.4 142.5 160.8 177.3 197.6 221.1 242.5 244.3 258.8 Value of imputed bankingservices 5.1 5.9 7.0 7.9 9.4 10.7 11.9 12.4 13.3 Net indirect taxes 14.3 15.5 18.0 18.9 21.5 23.9 28.6 29.2 31.0 GDP at market prices 219.2 248.9 280.5 300.8 342.0 319.5 410.3 421.3 446.2 (Percentage share in nominal GDP) Agriculture, Fisheries, and forestry 40.8 40.5 40.4 38.8 40.1 39.6 38.4 39.6 39.6 Industry 22.2 22.3 22.3 21.9 21.2 21.5 21.3 20.9 20.7 Miningand quarrying 0.5 0.6 0.6 0.5 0.5 0.5 0.5 0.5 0.5 Manufacturing 9.3 9.4 9.2 9.3 9.2 9.2 9.0 8.1 7.9 Electricity and water 1.4 1.5 1.7 1.5 1.4 1.6 1.8 1.8 2.0 Construction 11.0 10.9 10.9 10.5 10.1 10.2 10.1 10.4 10.4 Services 37.0 37.2 37.4 39.3 38.7 38.9 40.3 39.5 39.7 Trade, restaurants, and hotels 11.6 11.8 11.3 11.6 11.9 11.7 11.3 10.0 9.9 Transport and communications 6.7 6.6 7.2 7.8 7.5 8.0 8.5 8.6 8.7 Financial and real estate 9.8 9.8 10.1 10.3 10.1 10.1 10.6 10.8 10.9 Community and social services 9.0 8.9 8.8 9.6 9.3 9.1 9.9 10.1 10.1 GDP at factor cost 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agricultural GDP 40.8 40.5 40.4 38.8 40.1 39.6 38.4 39.6 39.6 Non-agricultural GDP 59.2 59.5 59.6 61.2 59.9 60.4 61.6 60.4 60.4 Source: LMF. Table 1.2: Nepal: Real Gross Domestic Product by Sector, 1994/95-2002/03 Est. 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 2002103 (Inbillions ofNeualese ruuees. at 1994195urices) Agriculture, Fisheries,and forestry 85.6 88.8 92.7 93.5 96.2 100.9 106.4 108.8 111.1 Industry 46.6 50.7 54.0 55.3 58.6 63.7 65.4 63.3 64.7 Mining and quarrying 1.1 1.3 1.3 1.4 1.4 1.5 1.5 1.6 1.6 Manufacturing 19.6 21.3 22.8 23.6 24.9 26.6 27.6 24.9 25.0 Electricity and water 2.9 3.4 3.5 3.3 3.5 4.0 4.4 4.5 5.0 Construction 23.1 24.7 26.4 27.0 28.8 31.6 31.8 32.4 33.1 Services 77.8 82.4 86.3 92.1 97.0 102.5 107.9 106.4 109.2 Trade, restaurants, and hotels 24.3 25.4 26.5 28.0 29.1 31.0 31.5 28.2 28.6 Transport and communications 14.0 14.8 15.9 17.2 18.4 19.6 20.9 21.2 22.0 Financial and real estate 20.5 22.1 23.1 24.5 25.7 27.0 27.5 28.4 29.5 Community and social services 18.9 20.1 20.8 22.4 23.9 24.8 28.1 28.5 29.2 GDP at factor cost 210.0 221.9 233.0 240.8 251.8 267.1 279.8 278.5 285.1 Agricultural GDP 85.6 88.8 92.7 93.5 96.2 100.9 106.4 108.8 111.1 Non-agricultural GDP 124.4 133.1 140.3 147.3 155.6 166.2 173.4 169.7 174.0 Value of imputed banking servioes 5.1 5.6 5.7 6.2 6.6 7.2 7.8 7.8 8.2 Net indirect taxes 14.3 14.6 15.7 15.5 16.2 17.5 18.6 18.5 19.0 GDP at market prices 219.2 230.9 243.0 250.2 261.4 277.4 290.6 289.2 295.8 (Annual percentage change) Agriculture, Fisheries,and forestry -0.3 3.8 4.4 0.9 2.8 4.9 5.5 2.2 2.1 Industry 4.0 8.8 6.5 2 3 6.0 8.7 2.7 -3.3 2.3 Miningand quarrying 3.5 13.0 6.8 1.3 3.7 4.5 4.5 1.o 2.9 Manufacturing 2.0 9.0 7.1 3.4 5.3 7.2 3.8 -10.0 0.4 Electricity and water 12.0 19.3 1.8 -4.1 5.7 14.3 9.6 1.7 11.5 Construction 5.2 7.1 6.6 2.2 6.8 9.6 0.9 1.7 2.4 Services 6.0 5.9 4.8 6.7 5.4 5.7 5.3 -1.4 2.7 Transport and communications 10.6 5.5 7.7 8.1 6.8 7.0 6.2 1.9 3.5 Trade, restaurants, and hotels 5.5 4.5 4.1 5.8 3.9 6.8 1.5 -10.4 1.4 Financial and real estate 4.3 7.6 4.7 5.9 5.0 5.1 1.7 3.3 3.7 Community and social services 4.8 6.2 3.6 7.6 6.6 4.0 13.1 1.7 2.2 GDP at factor cost 2.9 5.7 5.0 3.3 4.5 6.1 4.7 -0.5 2.4 Agricultural GDP -0.3 3.8 4.4 0.9 2.8 4.9 5.5 2.2 2.1 Non-agricultural GDP 5.3 7.0 5.4 5.0 5.6 6.8 4.3 -2.1 2.5 Value of imputed banking servioes 12.0 11.0 1.5 8.4 6.9 9.4 8.3 0.1 5.1 Net indirect taxes 16.1 2.1 7.7 -0.9 4.5 7.8 6.4 -0.6 2.5 CDP at market prices 3.5 5.3 5.3 2.9 4.5 6.1 4.8 -0.5 2.3 Source: MF. Table 1.3: Nepal: Gross Domestic Product Deflators, 1994/9S-2001/02 Est. 1994195 1995196 1996197 1997198 1998199 1999100 2000/01 2001102 2002103 (1994-95=100) Agriculture, Fisheries, and forestry 100.0 109.1 117.3 120.3 137.7 143.9 142.0 147.3 152.8 Industry 100.0 105.5 111.1 114.7 119.4 123.5 128.4 133.4 137.2 Miningand quarrying 100.0 106.3 110.9 113.8 119.0 122.6 124.4 131.4 136.2 Manufacturing 100.0 105.4 108.7 114.3 122.1 125.9 128.4 131.8 134.9 Electricity and water 100.0 105.4 128.3 131.6 131.6 147.6 158.7 164.0 169.5 Construction 100.0 105.5 111.0 113.1 115.5 118.5 124.4 130.6 134.2 Services 100.0 108.0 116.7 123.7 131.6 138.9 146.8 150.2 155.5 Trade, restaurants, and hotels 100.0 111.4 115.5 120.4 135.2 138.2 141.5 143.5 148.8 Transport and communications 100.0 107.7 121.5 131.5 134.2 149.3 159.6 163.4 168.8 Financial and real estate 100.0 106.4 117.4 121.6 129.1 136.6 151.4 154.5 159.1 Community and social services 100.0 105.8 114.0 124.2 128.0 134.0 138.9 142.8 148.6 GDP at factor cost 100.0 107.9 115.7 120.3 131.1 137.1 140.7 145.3 150.3 Agricultural GDP 100.0 109.1 117.3 120.3 137.7 143.9 142.0 147.3 152.8 Non-agricultural GDP 100.0 107.1 114.6 120.4 127.0 133.0 139.9 144.0 148.7 Value of imputed banking servioes 100.0 105.6 122.9 127.7 142.8 148.1 152.1 158.0 161.4 Net indirect taxes 100.0 106.2 114.5 121.9 132.1 136.8 153.7 157.9 163.2 GDP at market prices 100.0 107.8 115.4 120.3 130.9 136.8 141.2 145.7 150.8 (Annual percentage change) Agriculture, Fisheries, and forestry 8.5 7.8 2.5 14.4 4.5 -1.3 3.7 3.8 Industry 4.7 6.7 3.3 4.0 3.5 3.9 3.9 2.9 Miningand quarrying -11.4 15.4 2.6 4.6 3.1 1.4 5.7 3.7 Manufacturing 4.4 3.9 5.2 6.8 3.2 2.0 2.7 2.4 Electricity and water 3.4 25.0 2.6 0.0 12.2 7.5 3.4 3.3 Construction 5.5 6.6 1.9 2.2 2.5 5.0 5.0 2.8 Services 8.5 6.2 6.0 6.4 5.5 5.7 2.3 3.5 Transport and communications 7.7 11.8 8.3 2.1 11.3 6.9 2.4 3.3 Trade, restaurants, and hotels 16.3 -0.3 4.3 12.3 2.2 2.4 1.5 3.7 Financial and real estate 7.0 9.9 3.6 6.2 5.8 10.9 2.0 3.0 Community and social services 1.5 7.1 9.0 3.1 4.7 3.6 2.8 4.0 GDP at factor cost 7.8 7.0 4.0 8.9 4.6 2.6 3.2 3.5 Agricultural GDP 7.8 8.5 7.9 2.5 14.4 4.5 -1.3 3.7 3.8 Non-agricultural GDP 8.4 7.2 6.4 5.0 5.5 4.7 5.2 2.9 3.3 Value o f imputed banking servioes 4.1 13.0 3.9 11.8 3.7 2.7 3.9 2.1 Net indirect taxes 6.3 7.8 6.5 8.4 3.5 12.4 2.7 3.4 GDP at market prices 7.4 7.8 6.9 4.2 8.8 4.6 3.2 3.2 3.5 Source: IMF. Table 1.4: Nepal: Gross Domestic Product by Expenditure Components, 1994/95-2001/02 Est. 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 2002103 (InbillionsofNepaleserupees, at currentprices) GDP at market prices 219.2 248.9 280.5 300.8 342.0 379.5 410.3 421.3 446.2 Consumption 184.9 212.8 241.4 259.4 295.5 321.9 349.3 371.5 395.6 Public 20.3 23.0 25.0 28.0 30.5 34.0 40.2 42.3 46.8 Private 164.6 189.8 216.4 231.4 264.9 287.9 309.1 329.2 348.8 Gross domesticinvestment 55.2 68.0 71.1 74.1 70.1 92.3 98.3 103.6 116.3 Gross fixed Investment 48.4 56.1 60.8 65.4 65.3 73.3 78.0 81.3 85.5 Public 15.1 17.6 19.4 22.6 23.9 26.4 31.3 32.0 31.5 Private 33.3 38.5 41.4 42.8 41.4 46.9 46.8 49.2 54.1 Change in stocks 6.9 11.9 10.3 9.4 4.8 18.9 20.3 22.4 30.8 ResourceBalance -20.9 -31.9 -31.9 -33.3 -23.5 -34.7 -37.3 -53.8 -65.1 Exports 54.7 56.8 73.9 68.7 78.2 88.4 91.8 67.7 65.2 Imports 75.7 88.7 105.8 101.9 101.6 123.1 129.1 121.5 130.9 (Percentage share in nominalGDP) Consumption 84.3 85.5 86.0 86.2 86.4 84.8 85.1 88.2 88.7 Public 9.2 9.2 8.9 9.3 8.9 8.9 9.8 10.0 10.5 Private 75.1 76.2 17.1 76.9 77.5 15.9 15.3 78.1 78.2 GrossDomesticInvestment 25.2 27.3 25.3 24.8 20.5 24.3 24.0 24.6 26.1 Gross fixed investment 22.1 22.5 21.7 21.7 19.1 19.3 19.0 19.3 19.2 Public 6.9 7.1 6.9 7.5 7.0 7.0 7.6 1.6 7.0 private 15.2 15.4 14.8 14.2 12.1 12.4 11.4 11.7 12.1 Change in stocks 3.1 4.8 3.7 3.1 1.4 5.0 4.9 5.3 6.9 ResourceBalance -9.5 -12.8 -11.4 -11.1 -6.9 -9.1 -9.1 -12.8 -14.7 Exports 25.0 22.8 26.3 22.8 22.8 23.3 22.4 16.1 14.6 Imports 34.5 35.6 37.7 33.9 29.7 32.4 31.5 28.8 29.3 Note: Exports and imports of goods and services reflectthe revisedcoverage of the balanceof payments Source:IMF. Table 1.5: Nepal: Savings and Investment, 1994/95-2000/01 Est. 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 2002103 (In billions of Nepaleserupees, at current prices) Gross nationalsavings 44.9 47.1 60.8 65.4 65.3 73.3 78.0 103.6 116.3 Public sector 1/ 3.1 3.8 3.8 3.9 3.1 4.3 1.o 0.9 2.6 Private sector 41.8 43.3 48.8 52.9 64.0 71.0 81.8 55.2 45.9 Foreign Savings 0.0 0.0 7.9 8.5 -1.7 -1.9 4 . 7 47.6 67.8 Gross domestic Investment 55.2 68.0 71.1 74.7 70.1 92.3 98.3 103.6 116.3 Gross fixed investment 48.4 56.1 60.8 65.4 65.3 73.3 78.0 81.3 85.5 Public sector 15.1 17.6 19.4 22.6 23.9 26.4 31.3 32.0 31.5 Privatesector 33.3 38.5 41.4 42.8 41.4 46.9 46.8 49.2 54.1 Change in stocks 6.9 11.9 10.3 9.4 4.8 18.9 20.3 22.4 30.8 Saving-investmentgap -10.3 -20.9 -10.3 -9.4 -4.8 -18.9 -20.3 0.0 0.0 Public sector -1 1.9 -13.8 -15.6 -18.7 -20.8 -22.1 -30.3 -31.1 -28.9 Privatesector 8.5 4.8 7.4 10.1 22.6 24.1 35.0 5.9 -8.2 (InpercentofnominalGDP) Gross nationalsavings 20.5 18.9 21.7 21.7 19.1 19.3 19.0 24.6 26.1 Public sector I/ I .4 1.5 1.4 1.3 0.9 1.1 0.2 0.2 0.6 Privatesector 19.1 17.4 17.4 17.6 18.7 18.7 19.9 13.1 10.3 ForeignSavings 0.0 0.0 2.8 2.8 -0.5 -0.5 -1.2 11.3 15.2 Gross domestic investment 25.2 27.3 25.3 24.8 20.5 24.3 24.0 24.6 26.1 Gross fixed investment 22.1 22.5 21.7 21.7 19.1 19.3 19.0 19.3 19.2 Public sector 6.9 7.1 6.9 7.5 7.0 7.0 7.6 7.6 7.0 Privatesector 15.2 15.4 14.8 14.2 12.1 12.4 11.4 11.7 12.1 Change in stocks 3.1 4.8 3.7 3.1 1.4 5.0 4.9 5.3 6.9 Saving-investmentgap -4.7 -8.4 -3.7 -3.1 -1.4 -5.0 -4.9 0.0 0.0 Public sector -5.4 -5.6 -5.6 -6.2 -6.1 -5.8 -7.4 -7.4 -6.5 Privatesector 3.9 1.9 2.6 3.3 6.6 6.4 8.5 1.4 -1.8 Note: Defined as revenue less regular expenditure and estimatedrecurrent costs of developmentexpenditure. Source: IMF Table 1.6: Nepal: Social Indicators Latestsinalevear Same reaionlincomearouo 1970-75 1980-85 1994-00 India South Low Total populationmid-year (millions) 13.1 16.2 23 1016 1,355 2,460 Growthrate (percentannual average) 2.0 2.1 2.4 1.8 1.9 2.0 Urban population(percentof population) 5.0 7.8 11.9 28.4 28.4 31.9 Total fertility rate (births per woman) 6.2 5.9 4.3 3.1 3.3 3.6 Total labor force (millions) 7 11 439 585 1,085 Femalesin laborforce (percent) 39 40 32 33 38 Laborforce participationrate 48 48 43 43 50 Poverty National headcountindex 42 35 Urban headcountindex 23 30.5 Rural Headcountindex 44 36.7 Income GNP percapita (US. dollars) 120 170 240 450 440 410 Consumerprice index (1995=100) 17 35 137 144 142 140 Food price index (1995-100) 33 144 137 Incomeiconsumptiondistribution Gini index 36.7 37.8 Lowestquintile (percentof income or consumption) 7.6 8.1 Highestquintile (percentof income or consumption) 44.8 46.1 Publicexpenditure Health (percentof GDP) 1.3 0.8 0.9 1.2 Education(percentof GNP) 1.5 2.6 2.5 2.9 3.0 3.4 Social securityand welfare (percentof GDP) 0.1 0.1 0.4 Net primaryschoolenrollment rate (percentof age group) Total 60 78 77 77 86 Male ... 80 93 83 83 89 Female 37 63 71 70 82 Gross secondary school enrollment Total 12 27 32 49 Male 19 39 45 59 Female 4 14 18 39 Adult literacy(percent) 22 58 68 66 71 Femaleliteracy 33 45 42 52 Access to safe water (percentof population) Total 8 24 81 88 67 76 Urban 85 79 85 92 92 88 Rural 5 20 80 86 85 70 Access to electricity(percent) 15 54 Populationper physician 30,221 13,617 2,459 2,500 Populationper hospital bed 5,719 4,308 1,503 1,429 1,152 Immunizationrate (Percentunder 12 months) Measles 34 73 50 53 57 DPT 32 76 55 57 57 Child malnutrition(percentunder 5 years) 69 47 47 49 Life expectancy at birth(in years) Total 45 51 59 63 62 59 Male 46 52 59 62 62 58 Female 44 50 59 63 63 60 Mortality Infant (perthousand live births) 160 115 74 69 73 76 Under 5 (perthousand live births) 234 180 105 88 96 115 Adult(l5-59) Male [per 1,000population) 482 376 260 222 227 294 Female(per 1,000population) 476 395 265 209 212 261 Maternal(per 100,000 live births) 830 440 Table 2.l(a): Nepal: Balanceof Payments,1995/96-2002/03 (inMillionsof U.S.dollars) Est. 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001/02 2002103 Exports,f.0.b. 659 602 1160 856 763 971 942 754 633 Merchandiseexports 353 360 398 445 525 722 755 618 633 Re-exports 0 0 0 0 238 250 187 136 0 Imports, c.i.f. 1277 1350 1750 1551 1390 1713 1773 1496 1630 Tradebalance -617 -748 -589 -695 -627 -742 -831 -742 -997 Services (net) 203 177 141 203 314 273 216 108 120 Receipts 48 1 46 1 381 435 545 513 477 362 372 Payments 279 285 240 232 23 1 240 262 254 252 Privatetransfers (net) 207 192 309 355 338 497 680 777 825 Receipts 218 202 330 383 354 524 699 803 855 Recordedprivatetransfers, 118 78 117 138 188 224 290 316 318 Estimatedremittances 100 125 213 245 166 300 409 487 537 Payments 10 10 21 28 16 28 19 26 31 Currentaccount balance(excludinggrants) -207 -380 -139 -137 25 28 64 143 -53 Officialgrants 107 137 102 88 137 133 108 143 161 Current accountbalance(Includinggrants) -100 -243 -38 -49 162 161 172 287 107 Officialcapital grantsand loans(net) 283 144 170 430 248 237 181 236 78 Officialcapitalgrants. 107 0 21 286 143 114 84 74 78 Official,capital(net) 176 144 149 144 105 123 97 162 Loans 228 186 197 229 174 198 164 105 123 Amortization 52 52 48 44 47 53 61 66 73 Private(net) 0 0 0 22 29 4 -7 -1 -5 FDI 0 7 29 11 9 3 6 -4 -2 Privatecapital and errorsand omissions -182 62 -95 -277 -315 -208 -320 -420 -137 Overallbalance 1 -40 66 179 155 220 38 -25 92 Memorandum items: Current account (excl. official transfers; percentof GDP) -4.7 -8.4 -2.8 -2.8 0.5 0.5 1.2 2.6 -0.9 Current account (excluding gold) -6 -9.1 -4.4 -3.6 0.1 0.2 2.2 2.6 -1 Current account (incl. official transfers; percentof GDP) -2 -5.4 -0.8 -1.0 3.2 2.9 3.1 5.2 2 Gross foreign assets (eop; at period averagerates) 869 805 870 973 1133 1347 1423 1371 1490 o/w: Central Bank 702 609 650 712 791 947 1020 1048 1177 (inmonths of imports of g&s) 5.4 3.7 4.4 5.3 4.9 5.6 7.0 6.7 6.9 Short-term debt as percent of gross foreign assets of NRE 7.4 16.0 27.2 28.0 28.1 26.1 21.8 18.9 18.3 Total extemal debt as a percent of GDP n.a. n.a. 50.5 52.7 53.7 51.8 49.9 52.9 52.2 Gross foreign assets ofbanking system as percentof rese 132.5 125.2 121.0 131.1 147.5 153.8 152.4 Debt service (inpercent of exports of goods and services 6.3 6.8 4.8 4.7 5.1 4.8 6.1 7.5 7.4 and private transfer receipts) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 NRKJSdollar (period average) 50 55 57 62 68 69 74 76 78 NW$ exchange rate (eop) 50 56 57 68 68 70 75 78 75 GDP at market prices (US$) 4401 4522 4919 4856 5034 5494 5582 5549 5738 Table 2.l(b): Nepal: Balance of Payments with India, 1995/96-2001/02 (inMillions ofUS.dollars) 1995196 1996197 1997198 1998199 1999100 2000101 2001102 Exports,f.0.b. 309 553 855 423 557 540 512 Merchandise exports 67 142 92 185 307 353 376 Re-exports 242 411 763 238 250 187 136 Imports,c.i.f. 444 587 341 596 693 141 159 Trade balance -135 -34 508 -113 -136 -207 -241 Services(net) 68 18 33 39 46 45 21 Receipts 163 108 118 140 142 133 111 Payments 95 90 85 101 96 88 84 Privatetransfers(net) 59 89 69 108 135 158 165 Receipts 67 113 78 122 153 175 189 Recorded private transfers. 36 49 32 66 74 73 83 Estimatedremittances 31 64 46 56 79 102 106 Payments 8 24 9 14 18 17 24 Current account balance(excludinggrants) -9 73 411 -26 45 -4 -55 Official grants 16 23 20 19 24 7 22 Current account balance(Includinggrants) 7 96 431 -7 69 3 -33 Official capital grantsand loans(net) 0 1 0 2 3 1 2 Official capital grants. 0 1 0 2 3 1 2 Official, capital (net) 0 0 0 0 0 0 0 Loans 0 0 0 0 0 0 0 Amortization 0 0 0 0 0 0 0 Private capital Grants 0 0 0 0 0 0 0 Privatecapital and errors andomissions -15 -51 -369 -66 13 80 38 Overallbalance -8 40 62 -11 85 84 1 Memorandumitem: Current account balance (percent of GDP) -0.2 1.5 8.3 -0.5 0.8 -0.1 -1.o Source: IMF Table 2.l(c):Nepal: Balance of Payments with Third World, 1995/96-2001/02 (in Millions 0fU.S. dollars) 1995196 1996197 1997198 1998199 1999100 2000101 2001/02 Exports, f.0.b. 293 303 305 340 414 402 242 Merchandiseexports 293 303 305 340 414 402 242 Re-exports 0 0 0 0 0 0 0 Imports, c.i.f. 906 964 1203 794 1020 1026 737 Trade balance -613 -661 -898 -454 -606 -624 -495 Services (net) 99 187 107 274 227 171 80 Receipts 298 328 263 405 371 344 250 Payments 199 141 156 131 144 173 170 Private transfers (net) 134 266 241 230 362 522 613 Receipts 136 270 253 232 371 524 614 Recordedprivate transfers, 42 89 85 122 1so 217 233 Estimated remittances 94 181 168 110 221 307 381 Payments 2 4 12 2 9 2 1 Current account balance (excluding grants) -380 -208 -550 50 -17 69 198 Official grants 121 96 73 118 12s 87 121 Current account balance (Including grants) -259 -112 -471 168 108 156 319 Official capital grants and loans (net) 134 360 296 214 196 120 85 Official capital grants. 0 215 147 109 73 17 46 Official, capital (net) 134 145 149 105 123 103 39 Loans 186 195 197 I S 8 182 164 105 Amortization 52 S I 48 53 59 61 66 Private capital Grants 0 39 0 32 26 65 22 Private capital and errors and omissions 94 -151 179 -198 -206 -386 -465 Overall balance -31 136 -2 216 124 -45 -39 Memorandum item: Current account balance (percent o f GDP) -9.4 4.3 -11.2 1.o -0.3 1.2 3.6 Source: IMF. Table 2.2(a): Nepal: Foreign Trade, 1995/96-2001/02 (inMillions o fUS.dollars) 1995196 1996/97 1997198 1998199 1999100 2000/01 2001/02 Exports, f.0.b. 601 856 1160 763 971 942 754 Merchandise exports 359 445 397 525 721 755 618 Food and live animals 35 51 41 55 61 65 70 Tobacco and beverages 0 0 0 I 1 1 2 Crude materials and edibles 14 8 12 7 8 10 13 Animal and vegetable oil and fats 4 35 6 53 46 56 98 Chemicals and drugs 11 31 23 41 57 55 42 Manufactured goods, classified 189 188 194 199 230 257 224 Machinery and transport equipment 0 1 1 1 6 5 5 Miscellaneous manufactured articles 105 130 114 168 312 307 164 Commodities and transactions n.i.e. I1 1 1 0 0 0 0 0 Re-exports 242 411 763 238 250 187 136 Imports, c.i.f. 1351 1551 1750 1390 1713 1773 1496 Food and live animals 87 79 95 112 157 81 92 Tobacco and beverages 9 13 10 13 13 12 11 Crude materials and edibles 88 112 96 92 101 102 89 Animal and vegetable oil and fats 101 267 126 227 273 357 305 Chemicals and drugs 51 33 41 49 64 76 102 Manufactured goods, classified 157 179 149 184 210 175 163 Machinery and transport equipment 510 526 784 377 498 558 424 Miscellaneous manufactured articles 277 270 242 266 297 312 245 Commodities and transactions n.i.e. I/ 69 64 70 63 97 98 63 2 8 137 7 3 2 2 Memorandum items: Trade Balance (percent of GDP) -16.6 -14.3 -12.0 -12.4 -13.5 -14.9 -13.4 Exports 13.3 17.6 23.6 15.2 17.6 16.9 13.6 Imports 29.9 32.0 35.6 27.6 31.2 31.8 27.0 Note: Includes classified exports and imports, and adjustments to reconcile figures with summary balance o f payments data. Source: IMF. Table 2.20): Nepal: Foreign Trade with India, 1995/96-1999/00 (inMillions o fUS.dollars) 1995196 1996197 1997198 1998199 1999100 2000101 2001102 Exports, f.0.b. 308 855 553 423 557 540 512 Merchandiseexports 66 92 142 185 307 353 376 Food and live animals 23 31 28 30 54 54 63 Tobacco and beverages 0 0 0 1 1 1 2 Crude materials and edibles 6 7 5 5 7 10 12 Animal and vegetable oil and fats 2 3 32 so 42 53 95 Chemicals and drugs 11 23 31 41 56 54 42 Manufactured goods, classified 22 27 41 48 81 121 131 Machinery and transport equipment 0 0 0 0 3 3 4 Miscellaneous manufactured articles 1 1 4 10 63 57 27 Commodities and transactions n.i.e. I/ 1 0 1 0 0 0 0 Re-exports 242 763 411 238 250 187 136 Imports, c.i.f. 444 547 587 596 693 747 759 Food and live animals 59 64 54 81 101 60 75 Tobacco and beverages 8 9 11 I O 9 9 10 Crude materials and edibles 16 12 16 20 22 32 38 Animal and vegetable oil and fats 8 9 153 128 129 151 197 Chemicals and drugs 1 2 0 1 1 6 0 Manufactured goods, classified 64 71 85 81 91 90 69 Machinery and transport equipment 172 157 160 154 203 245 244 Miscellaneous manufactured articles 96 89 83 98 101 118 100 Commodities and transactions n.i.e. 11 18 22 22 20 34 3s 24 2 112 3 3 2 2 2 Memorandum items: Trade Balance (percentof GDP) -3.0 6.3 -0.7 -3.4 -2.5 -3.7 -4.5 Exports 6.8 17.4 11.4 8.4 10.1 9.7 9.2 Imports 9.8 11.1 12.1 11.8 12.6 13.4 13.7 Note: Includes classified exports and imports, and adjustments to reconcile figures with summary balance o f payments data. Source: IMF. Table 2.2(c): Nepal: Foreign Trade with Third World, 1995/96-2001/02 (inMillionso fUS.dollars) 1995196 1996197 1997198 1998199 1999100 2000101 2001102 Exports,f.0.b. 293 305 303 340 414 402 242 Merchandise exports 293 305 303 340 414 402 242 Food and live animals 12 16 23 2s 7 11 7 Tobacco and beverages 0 0 0 0 0 0 0 Crude materials and edibles 8 5 3 2 1 0 1 Animal and vegetable oil and fats 2 3 3 3 4 3 3 Chemicals and drugs 0 0 0 0 1 1 0 Manufactured goods, classified 167 167 147 151 149 136 93 Machinery and transport equipment 0 1 1 1 3 2 1 Miscellaneous manufactured articles 104 113 126 158 249 250 137 Commodities and transactions n.1.e. I1 0 0 0 0 0 0 0 Re-exports 0 0 0 0 0 0 0 Imports, c.i.f. 907 1203 964 794 1020 1026 731 Food and live animals 28 31 2s 31 56 21 17 Tobacco and beverages 1 1 2 3 4 3 1 Crude materials and edibles 72 84 96 72 79 70 51 Animal and vegetable oil and fats 93 1I 7 1I 4 99 144 206 108 Chemicals and drugs so 39 33 48 63 70 102 Manufactured goods, classified 93 78 94 103 1 I 9 85 94 Machinery and transport equipment 338 627 366 223 295 313 180 Miscellaneous manufactured articles 181 153 187 168 196 194 145 Commodities and transactions n.i.e. 11 51 48 42 43 63 63 39 0 25 5 4 1 0 0 Memorandum items: Trade Balance (percent of GDP) -13.6 -18.3 -13.6 -9.0 -11.0 -11.2 -8.9 Exports 6.5 6.2 6.2 6.8 7.5 7.2 4.4 Imports 20.0 24.5 19.9 15.8 18.6 18.4 13.3 Note: Includes classified exports and imports, and adjustments to reconcile figures with summary balance o f payments data. Source: EMF. Table 2.3: Nepal: Exports of Major Commodities, 1994/95 2001/02 - 1994195 1995196 1996197 1997198 1998199 1999/00 2000/01 2001/02 (Inthousands ofU.S.dollars) Carpets 154.5 147.9 155.7 137.0 144.3 142.5 116.4 80.8 Pashmina n.a. n.a. n.a. n.a. n.a. 90.0 92.8 24.5 Ready-made garments 102.9 97.3 104.4 113.2 142.8 201.9 177.8 101.8 Hides and Skins 11.5 10.7 8.1 9.9 6.6 4.9 9.6 8.0 Jute goods 4.6 8.2 9.9 11.6 12.8 16.0 17.5 21.2 Pulses 9.2 12.0 19.2 17.1 17.6 15.3 16.5 15.8 Handicrafts 2.9 1.5 2.5 2.6 3.2 3.7 3.6 3.2 Cardamon 2.8 3.5 3.7 3.7 3.4 3.2 4.0 4.7 Catechu 0.1 0.5 1.o 1.1 1.7 2.9 2.0 2.3 Ghee 1.o 0.6 1.6 2.7 5.8 5.4 6.4 0.2 Mustard and linseed 1.3 1.o 0.6 0.2 0.3 0.4 0.5 0.1 Rawjute 1.7 0.6 0.1 0.1 0.0 0.0 1.5 0.1 Dried ginger 1.5 0.9 0.8 0.7 0.6 0.9 0.8 0.9 Herbs 1.o 0.9 1.2 1.1 0.6 1.1 1.3 1.2 Other Exports 58.1 74.5 89.2 119.4 185.5 238.4 304.1 264.7 o f which: Vegitable Ghee n.a. n.a. n.a. 25.5 46.3 39.7 48.2 91.6 Total Merchandise exports 353.2 360.0 396.9 444.6 525.3 721.7 754.8 618.4 (Annual percentage change) Carpets -4.3 5.2 -12.0 5.3 -1.2 -18.3 -30.6 Pashmina n.a. ma. n.a. n.a. n.a. 3.1 -73.6 Ready-made garments -5.4 7.3 8.5 26.1 41.4 -11.9 -42.7 Hides and Skins -6.9 -24.9 22.9 -33.1 -25.7 94.6 -16.4 Jute goods 77.4 20.7 17.5 10.0 24.7 9.7 21.0 Pulses 31.3 60.0 -11.2 3.2 -13.1 7.5 -3.9 Handicrafts -49.0 68.3 3.3 25.8 13.2 -2.8 -11.6 Cardamon 28.1 3.4 0.5 -6.6 -6.0 25.1 15.1 Catechu 250.7 97.8 15.9 53.4 67.1 -29.6 12.5 Ghee and vegetable ghee -36.0 146.2 70.8 114.0 -5.7 17.2 -97.4 Mustardand linseed -25.6 -36.3 -75.2 85.0 49.8 21.0 -74.1 Rawjute -65.3 -90.6 44.6 -100.0 -93.3 Dried ginger -44.6 -4.7 -17.8 -9.7 42.3 -4.1 7.4 Herbs -10.3 40.7 -15.0 -42.7 83.3 19.4 -6.2 Other Exports 28.3 19.6 33.9 55.3 28.5 27.6 -13.0 o f which: Vegitable Ghee n.a. n.a. n.a. 81.6 -14.2 21.4 90.0 Total Merchandise exports 1.9 10.2 12.0 18.2 37.4 4.6 -18.1 (Share of total exports) Carpets 43.8 41.1 39.2 30.8 27.5 19.7 15.4 13.1 Pashmina n.a. n.a. n.a. n.a. n.a. 12.5 12.3 4.0 Ready-made garments 29.1 27.0 26.3 25.5 27.2 28.0 23.6 16.5 Hides and Skins 3.3 3.0 2.0 2.2 1.3 0.7 1.3 1.3 Jute goods 1.3 2.3 2.5 2.6 2.4 2.2 2.3 3.4 Pulses 2.6 3.3 4.8 3.8 3.4 2.1 2.2 2.6 Handicrafts 0.8 0.4 0.6 0.6 0.6 0.5 0.5 0.5 Cardamon 0.8 1.o 0.9 0.8 0.7 0.4 0.5 0.8 Catechu 0.0 0.1 0.2 0.3 0.3 0.4 0.3 0.4 Ghee and vegetable ghee 0.3 0.2 0.4 0.6 1.1 0.8 0.8 0.0 Mustard and linseed 0.4 0.3 0.2 0.0 0.1 0.1 0.1 0.0 Rawjute 0.5 0.2 0.0 0.0 0.0 0.0 0.2 0.0 Dried ginger 0.4 0.2 0.2 0.2 0.1 0.1 0.1 0.1 Herbs 0.3 0.2 0.3 0.2 0.1 0.2 0.2 0.2 Other Exports 16.4 20.7 22.5 26.9 35.3 33.0 40.3 42.8 o f which: Vegitable Ghee n.a. n.a. n.a. 5.7 8.8 5.5 6.4 14.8 Source: IMF. Table 2.4(a): Nepal: Services and Current Transfers, 1995/96-2001/02 (in Millions ofUS.dollars) 1995/96 1996197 1997/98 1998/99 1999100 2000101 2001102 Services and current transfers (net) 496 619 541 788 903 990 1028 Services (net) 167 205 140 313 273 216 108 Receipts 461 436 381 545 513 477 362 Freightandinsurance 0 0 0 0 0 0 0 Transportation 64 67 60 56 64 56 33 Travel 172 160 1so 179 175 159 113 Investment income 31 30 35 38 51 60 39 Compensationofemployee 0 8 0 13 16 14 16 Govemment,n i e 88 99 70 191 128 102 116 Other 106 72 66 68 79 86 45 Payments 294 231 241 232 240 262 254 Freight andinsurance 2s 2s 2s 29 29 27 18 Transportation 34 34 27 36 43 45 45 Travel 146 85 105 77 69 7s 7s Investment income 33 23 29 27 31 51 63 Compensationof employee 0 1 0 1 0 0 1 Govemment,n.i.e. 7 8 8 9 9 9 7 Other 49 55 47 53 59 54 45 Private current transfers (net) 192 355 309 338 497 680 778 Receipts 202 383 331 354 524 699 803 Privafiremittances 78 138 127 188 224 290 316 Indianexciserefund n.a. n.a. n.a. 19 19 19 22 Otherestimatedremittances 125 245 214 166 300 409 487 Payments I O 28 21 16 27 19 2s Official Current transfers (net) 137 119 93 137 133 94 143 Receipts 137 119 93 137 133 94 143 Payments 0 0 0 0 0 0 0 Source: IMF. Table 2.4@): Nepal: Services and Current Transfers with India, 1995/96-2001/02 (inMillions of US.dollars) 1995196 1996197 1997198 1998199 1999100 2000101 2001102 Services and current transfers (net) 143 121 130 166 205 210 214 Services(net) 68 33 18 39 46 45 21 Receipts 163 118 108 140 142 133 111 Freightand insurance 0 0 0 0 0 0 0 Transportation 12 11 I O 11 16 10 6 Travel 98 62 56 53 55 47 37 Investmentincome 3 3 1 2 2 9 13 Compensationofemployee 0 0 3 2 2 2 1 Govemment, n.i.e 1 1 0 47 35 36 30 Other 49 42 38 25 32 29 24 Payments 95 85 90 101 96 88 84 Freight and insurance 22 23 23 26 21 24 16 Transportation 3 3 2 2 5 4 7 Travel 43 35 31 43 33 32 34 Investmentincome 2 1 0 1 0 0 0 Compensationof employee 0 0 0 1 0 0 1 Govemment,n.i.e. 0 0 0 0 0 3 0 Other 25 23 28 28 31 25 26 Private current transfers (net) 59 69 89 108 135 158 165 Receipts 67 79 1I3 122 153 175 189 Privaftremittances 36 32 49 66 74 13 83 Indianexcise refund n.a. n.a. n.a. 19 19 19 22 Other estimatedremittances 31 46 64 56 79 102 106 Payments 8 9 24 14 18 17 24 Official Current transfers (net) 16 20 23 19 24 I 22 Receipts 16 20 23 19 24 7 22 Payments 0 0 0 0 0 0 0 Source: IMF Table 2.4(c):Nepal: Services and Current Transfers with Third World, 1995/96-2001/02 (inMillions ofU.S. dollars) 1995196 1996197 1997198 1998199 1999100 2000101 2001102 Servicesand currenttransfers (net) 353 420 549 622 698 780 814 Services(net) 99 107 187 274 227 171 81 Receipts 298 263 328 405 371 344 251 Freight andinsurance 0 0 0 0 0 0 0 Transportation 52 49 57 45 48 46 27 Travel 74 88 1.04 126 120 112 76 Investmentincome 28 32 29 36 49 51 26 Compensationof employee 0 0 S 11 14 12 15 Govemment,n.i.e 87 69 99 144 93 66 86 Other 57 25 34 43 47 57 21 Payments 199 IS6 141 131 144 174 170 Freightand insurance 3 2 2 3 2 3 2 Transportation 31 24 32 34 38 41 38 Travel 103 70 48 34 36 43 41 Investment income 31 28 23 26 31 51 63 Compensationof employee 0 0 1 0 0 0 0 Govemment,n.i.e. 7 8 8 9 9 6 7 Other 2s 25 27 25 28 29 19 Privatecurrenttransfers(net) 133 240 266 230 362 522 613 Receipts 135 252 270 232 371 524 614 Privaftremittances 42 95 89 122 150 217 233 Indianexcise refund Other estimatedremittances 94 168 181 110 221 307 381 Payments 2 12 4 2 9 2 1 Official Currenttransfers (net) 121 73 96 118 109 81 121 Receipts 121 73 96 118 109 87 121 Payments 0 0 0 0 0 0 0 Source:IMF. Table 2.5: Nepal: Tourism Indicators, 1994-2002 1994 1995 1996 1997 1998 1999 2000 2001 2002 Tourist arrivals (in thousands) 325.6 363.4 393.6 421.9 463.7 491.5 463.0 362 216 (PercentageChange) 11.2 11.3 8.3 7.2 9.9 6.0 -5.8 -21.8 -26.7 Ofwhich :Europe 135.2 137.7 139.8 143.4 157.8 171.6 166.3 137.8 India21 102.5 117.3 122.5 133.4 143.2 140.7 95.9 64.3 Japan 19.6 25.4 29.9 35.0 37.3 38.8 41.0 28.9 United States and Canada 26.1 29.7 30.6 36.3 43.0 46.9 49.0 39.1 Average days of stay 10.0 11.3 13.5 10.5 10.8 12.8 12.0 12 12 Per capita expenditure (InNrs) 21 14,400 24,6 17 24,344 23,226 31,282 32,550 32163.0 34345 (InUS.dollars) 31 394 474 430 402 476 479 454.0 467.3 (Percentage Change) 16.9 20.5 -9.3 -6.6 18.4 0.6 -5.9 2.9 Hotel-bed capacity 17,730 21,807 25,638 27,612 28,878 32,214 34958.0 36163 (Percentage Change) 41.3 23.0 17.6 7.7 4.6 11.6 8.5 3.5 Notes: I/Estimated. 21By air only. 31Excluding Indian tourists Source: IMF. Table 2.6: Nepal: Average Customs Duty by Main Category of Goods, 1999/2000 2001-02 1/ - Chapter Numbers Main Category o f Goods 1999100 2001102 1-10 Live animals 5.0 10.5 11-20 Grains, vegetable extracts, sugars 15.6 16.7 21-30 Beverage, tobacco, mineral fuels, pharmaceuticals 11.7 13.6 31-40 Fertilizers, cosmetics, soaps, chemicals, plastics 15.3 20.6 41-50 Raw hides, skins, wood, paper, silk 10.9 11.7 51-w wool, cotton, man-made fibres, carpets 13.2 11.2 61-70 Clothing. footwear, ceramics, glassware, stoneware 21.1 20.1 71-80 Iron, steel copper, nickel, aluminum, lead, zinc, tin 12.9 12.9 81-90 Tools, machinery, vehicles, aircrafts 11.9 11.9 91-97 Clocks, musical instruments, arms, fumiture, art 20.6 21.1 Total number o f items 5,198 5,321 Sum o f duties 68,3 10 76,441 Average customs duty 13.1 14.4 Notes: I/HarmonizedSystemClassification; Averageofcustomsdutiesforallitemineachchapter. Source: IMF. Table 3.1. Nepal: ExternalDebt and Debt Service, 199495-2001/02 1994/95 1995/96 1996197 1997/98 1998/99 1999100 2000/01 2001102 (Inmillions ofUS.dollars) Debt outstandingI/ 2,295 2,370 2,482 2,561 2,702 2,848 2,786 2,933 TotalMedium and Long-term 2,295 2,320 2,361 2,414 2,532 2,662 2,630 2,808 Multilateral 1,842 1,940 1,983 2,090 2,169 2,244 2,251 2,394 AsDB 698 757 802 910 948 1012 1043 1132 EEC 10 9 8 8 7 6 6 6 IDA 1002 1052 1059 1080 1107 1123 1102 1156 IFAD 58 57 57 44 58 57 55 57 IMF 21 55 43 34 25 21 15 10 7 NDF 8 11 16 18 20 20 19 20 OPEC 12 10 7 6 9 11 16 16 Bilateral2/ 453 380 378 324 363 418 379 414 Austria 0 6 5 5 4 6 5 5 Belgium 9 8 7 6 6 5 4 8 Finland 0 0 6 6 6 7 6 6 France 51 53 51 52 48 45 40 44 Korea 0 0 0 2 10 10 9 10 Kuwait 16 15 13 12 11 10 8 8 OECF 370 291 286 229 264 309 291 317 Saudi Fund 8 7 10 13 14 26 16 16 Short-term debt 3/ ... 50 121 147 170 186 156 125 Total debt service 82 84 84 86 84 83 98 132 Amortization 4/ 59 60 55 62 59 57 69 81 Of which :To IMF 51 7 8 7 7 7 6 5 4 Interest41 23 24 28 24 25 26 29 51 Ofwhich :To IMF 0.2 0.2 0.7 0.7 0.7 0.4 0.4 0.4 (inpercent) Debt service ratio 6/ 6.3 6.8 4.8 4.7 5.0 4.7 6.1 7.5 Of which : To IMF 0.6 0.7 0.5 0.5 0.3 0.2 0.2 0.4 Outstanding debtlGDP 52.1 52.4 50.5 52.8 53.7 51.8 49.9 52.9 O f which: To IMF 1.3 1.o 0.7 0.5 0.4 0.3 0.2 0.1 l / Consists primarily of medium- and long-tempublic and publicly guaranteeddebt excluding foreign liabilities of the banking systemother than liabilities to the IMF. 2/ Amounts less than U S 1 millionwere owed to Russia, United States and Australia invarious years. 3/ Includes outstandingtrade credits and amortization due in the following year. 4/ Includesprincipal and interest repaymentsof public enterprises and someprivate entities, as well as the centralgolvemment. 51Excluding IMFtrust fund. 6/ Inpercentof exports of goods and services (excluding re-exports)andprivatetransfers. Source: IMF. Table 3.2: Nepal: Gross International Reserves, 1994/95-2001/02 1/ 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 FOREIGNEXCHANGERESERVES (Inmillions o fUS.dollars, endo fperiod) Nepal Rastra Bank(NRB) 694 594 636 702 781 932 1007 1035 Convertible 568 488 475 533 709 772 710 727 Nonconvertible 126 106 161 169 72 160 297 308 Commercialbanks 169 197 219 262 345 401 402 323 Convertible 156 187 203 246 304 369 364 303 Nonconvertible 13 10 16 16 41 32 38 20 Total 863 791 855 964 1126 1333 1409 1358 Convertible 724 675 678 779 1013 1141 1074 1030 Nonconvertible 139 116 177 185 113 192 335 328 Other gross foreign assets of NRB 15 15 15 14 14 14 14 14 SDR holdings 0 0 0 0 0 0 0 0 Gold 21 6 6 6 6 6 6 6 6 Reservetranche position 9 9 9 8 8 8 7 8 Total gross foreign assets of NRB 709 609 651 716 795 946 1021 1049 Nepal Rastra Bank (Inmonths ofimports ofgoodsand services) Gross foreign assets 5.2 3.7 4.4 5.3 4.9 5.6 7.0 6.7 Notes: 11Totals differ from monetary sector figures owing to valuation effects. 21Valued at historical prices. Source: IMF. Table 4.1: Nepal: Summary of Central Government Operations, 1994195-2002/03 1/ Est. 1994195 1995196 I996197 1997198 1998199 1999100 2000101 2001102 2002103 (InbillionsofNepaleserupees) Total revenue and grants 26.9 31.6 35.5 37.1 39.3 46.4 53.6 54.4 64.3 Total revenue 22.9 26.9 29.5 31.7 35.0 40.7 46.8 48.6 54.7 Tax revenue 19.2 21.7 24.4 25.9 28.8 33.2 38.9 39.3 42.0 Nontax revenue 3.7 5.1 5.1 5.8 6.5 7.6 8.0 9.2 12.7 Grants 3.9 4.8 6.0 5.4 4.3 5.7 6.8 5.8 9.6 Total expenditure 35.0 43.7 46.4 50.5 52.8 59.8 72.1 12.6 72.7 Regularexpenditure 15.2 18.7 20.7 27.7 31.9 36.5 45.8 48.7 51.6 Developmentexpenditure 19.8 25.0 25.7 22.9 20.8 23.3 26.3 23.9 21.1 Overall balance before grants -12.1 -16.9 -16.9 -18.8 -17.7 -19.0 -25.3 -24.0 -18.0 Overall balance after grants -8.2 -12.0 -10.9 -13.4 -13.4 -13.3 -18.5 -18.2 -8.4 Financing 8.2 12.0 10.9 13.4 13.4 13.3 18.5 18.2 8.4 Net foreign loans 5.4 7.1 6.9 11.5 8.7 10.0 7.5 6.0 3.1 Gross disbursements 7.3 9.5 9.0 14.2 11.9 13.7 12.0 10.8 8.6 Amortization 1.9 2.4 2.1 2.7 3.2 3.7 4.5 4.8 5.5 Net domestic financing 2.8 5.0 4.0 1.9 4.7 3.4 11.0 12.2 5.3 Bank financing 1.3 2.2 2.0 2.7 2.4 5.5 7.2 4.0 10.1 Nonbank financing 1.5 2.9 2.0 -0.8 2.4 -2.2 3.7 8.2 -4.8 (InpercentofGDP) Total revenue and grants 12.3 12.7 12.7 12.3 11.5 12.2 13.1 12.9 14.4 Total revenue 10.4 10.8 10.5 10.5 10.2 10.7 11.4 11.5 12.3 Tax revenue 8.8 8.7 8.7 8.6 8.4 8.7 9.5 9.3 9.4 Nontax revenue 1.7 2.0 1.8 1.9 1.9 2.0 1.9 2.2 2.8 Grants 1.8 1.9 2.1 1.8 1.3 1.5 1.6 1.4 2.2 Total expenditure 16.0 17.6 16.5 16.8 15.4 15.7 17.6 17.2 16.3 Regularexpenditure 6.9 7.5 7.4 9.2 9.3 9.6 11.2 11.6 11.6 Developmentexpenditure 9.0 10.0 9.2 7.6 6.1 6.1 6.4 5.7 4.7 Overall balance before grants -5.5 -6.8 -6.0 -6.2 -5.2 -5.0 -6.2 -5.1 -4.0 Overall balanceafter grants -3.7 -4.8 -3.9 -4.5 -3.9 -3.5 -4.5 -4.3 -1.9 Financing 3.7 4.8 3.9 4.5 3.9 3.5 4.5 4.3 1.9 Net foreign loans 2.5 2.9 2.5 3.8 2.5 2.6 1.8 1.4 0.7 Gross disbursements 3.3 3.8 3.2 4.7 3.5 3.6 2.9 2.6 1.9 Amortization 0.9 1.o 0.7 0.9 0.9 1.o 1.1 1.1 1.2 Net domestic financing 1.3 2.0 1.4 0.6 1.4 0.9 2.7 2.9 1.2 Bank financing 0.6 0.9 0.7 0.9 0.7 1.5 1.8 0.9 2.3 Nonbank financing 0.7 1.2 0.7 -0.3 0.7 -0.6 0.9 1.9 -1.1 Memorandum item: NominalGDP (Billions Nrs) 219.2 248.9 280.5 300.8 342.0 379.5 410.3 421.3 446.2 I/FiscalyearsstartonJuly 16. Source: IMF. Table 4.2: Nepal: Central Government Revenue, 1995/96-2002103 Est. 1995196 1996197 1997198 1998199 1999100 2000101 2001102 2002103 (InbillionsofNepaleserupees) Total revenue 1/ 26.8 29.5 31.7 35.0 40.7 ' 46.8 48.6 54.7 Tax revenue 21.7 24.4 25.9 28.8 33.2 38.9 39.3 42.0 Taxes on income andprofits 3.3 4.1 4.9 6.2 7.4 9.1 8.9 7.8 Taxes on property 1.3 1.1 1.1 1.1 1.1 0.6 1.1 1.4 Registrationand landrevenue 1.1 1.o 1.o 1.o 1.o 0.6 1.1 1.4 Otherpropertytaxes 0.2 0.1 0.1 0.1 0.1 0.0 0.0 0.0 Taxes on goods andservices 9.8 10.9 11.4 11.9 13.8 16.6 16.6 18.7 VATlSalestax 21 6.4 7.1 7.1 7.9 9.9 12.0 11.9 13.4 Excisetaxes 1.9 2.3 2.9 3.0 3.1 3.8 3.8 4.7 Other 31 1.4 1.5 1.4 1.1 0.8 0.8 0.9 0.6 Taxeson intemationaltrade 7.3 8.3 8.5 9.5 10.8 12.6 12.7 14.3 Import taxes 6.3 7.1 7.2 7.9 9.0 10.6 10.0 10.6 Indianexciserefund 0.9 1.o 1.1 1.2 1.3 1.5 1.7 2.4 Export taxes 0.2 0.2 0.2 0.4 0.4 0.5 0.9 0.9 Other 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.4 Nontax revenue I / 5.1 5.1 5.8 6.3 7.6 8.0 9.2 12.7 Charges, fees, fines, etc. 0.9 1.1 1.2 1.4 1.7 1.9 2.0 2.3 Sales o f goods and services 0.0 1.o 1.3 1.o 1.1 1.2 1.1 1.3 Dividends 1.4 1.1 1.3 1.8 2.5 2.3 2.5 3.O Royaltyand,fixed asset sales 0.1 0.4 0.6 0.2 0.6 0.9 0.7 1.9 Interestreceipts 1.7 1.4 1.2 1.7 1.6 1.4 1.2 0.9 Miscellaneous 0.0 0.1 0.1 0.1 0.1 0.1 1.6 3.2 (InpercentofGDP) Total revenue I / 10.8 10.5 10.5 10.2 10.7 11.4 11.5 12.3 Tax revenue 8.7 8.7 8.6 8.4 8.7 9.5 9.3 9.4 Taxes on income andprofits 1.3 1.5 1.6 1.8 2.0 2.2 2.1 1.7 Taxes onproperty 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Taxes on goods and services 0.5 0.4 0.4 0.3 0.3 0.2 0.3 0.3 VAT1Sales tax 21 0.4 0.4 0.3 0.3 0.3 0.1 0.3 0.3 Excise taxes 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other 31 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Taxes on intemationaltrade 3.9 3.9 3.8 3.5 3.6 4.0 3.9 4.2 Importtaxes 2.6 2.5 2.4 2.3 2.6 2.9 2.8 3.O Indianexciserefund 0.8 0.8 1.o 0.9 0.8 0.9 0.9 1.1 Export taxes 0.6 0.5 0.5 0.3 0.2 0.2 0.2 0.1 Nontax revenue 1/ 2.9 3.0 2.8 2.8 2.8 3.1 3.0 3.2 Charges, fees, fines, etc. 2.5 2.5 2.4 2.3 2.4 2.6 2.4 2.4 Sales o f goods and services 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.5 Dividends 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 Royalty and,fixed asset sales 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.1 Interestreceipts 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Miscellaneous 2.1 1.8 1.9 1.8 2.0 1.9 2.2 2.8 MemorandumItem: NominalGDP (Billions ofNrs.) 248.9 280.5 300.8 342.0 379.5 410.3 421.3 446.2 11Adjustedbytakingout of non-taxrevenuethe principalrepaymentsfrom corporations (classifiedas negativecapital spending). 21Sales tax prior to 1997198. 31Includestaxes on entertainmenthotel, contracts, and air flight. Air flight revenues are nowmostlyretainedby the CivilAviation Authority. Source: IMF Table 4.3: Nepal: CentralGovernmentExpenditureby Economic Classification,1995/96-2001/02 1995196 1996/97 1997/98 1998/99 1999100 2000/01 2001/02 (inbillions o fNepalese rupees) Total expenditure 43.7 46.4 49.9 52.8 59.8 72.1 72.3 Currentexpenditure1/ 18.7 20.7 27.8 31.9 36.5 45.8 48.7 Goods and Services 20.8 23.7 26.5 35.4 37.9 Wages, salaries and benefits 16.5 18.1 19.8 28.5 29.9 Core civil service 6.9 7.1 7.7 11.3 10.0 Police salaries 2.3 2.6 2.8 4.1 5.0 Defense salaries 2.1 2.5 2.9 3.6 4.5 Teacher salaries 5.2 6.0 6.4 9.5 10.4 Retirement facilities 1.o 1.2 1.3 2.1 2.8 Other Goods and Services 3.4 4.4 5.5 4.9 5.2 Interest payments 3.9 4.1 3.8 4.1 4.8 4.7 5.8 Domestic debt 2.6 2.9 2.4 2.5 3.2 3.0 4.0 Foreigndebt 1.3 0.0 1.3 1.5 1.6 1.7 1.8 Subsidies and transfers 1.7 1.8 3.2 4.1 5.1 5.7 5.0 Capital Expenditure2/ 25.0 25.7 19.0 19.0 19.4 21.2 20.9 Acquisition o f fixed assets 12.5 13.3 13.1 14.4 13.8 Purchase o f stocks 1.9 1.6 1.3 1.1 1.5 Capital transfers (grants) 4.6 4.2 4.9 5.6 5.6 Net Lending 3.2 1.8 3.9 5.1 2.9 Investment inloans 4.4 4.0 6.1 7.1 4.8 Less repayment o f loans 1.2 2.2 2.2 2.1 1.9 Total expenditure 17.5 16.5 16.6 15.4 15.7 17.6 17.2 Currentexpenditure1/ 7.5 7.4 9.2 9.3 9.6 11.2 11.6 Goods and Services 6.9 6.9 7.0 8.6 9.0 Wages, salaries and benefits 5.5 5.3 5.2 6.9 7.1 Core civil service 2.3 2.1 2.0 2.8 2.4 Police salaries 0.8 0.8 0.7 1.o 1.2 Defense salaries 0.7 0.7 0.8 0.9 1.1 Teacher salaries 1.7 1.7 1.7 2.3 2.5 Retirement facilities 0.3 0.3 0.3 0.5 0.7 Other Goods and Services 1.1 1.3 1.4 1.2 1.2 Interest payments 1.5 1.5 1.2 1.2 1.3 1.1 1.4 Domestic debt 1.o 1.o 0.8 0.7 0.8 0.7 0.9 Foreign debt 0.5 0.0 0.4 0.5 0.4 0.4 0.4 Subsidies and transfers 0.7 0.7 1.o 1.2 1.3 1.4 1.2 Capital Expenditure 2/ 10.0 9.1 6.3 5.6 5.1 5.2 5.0 Acquisition o f fixed assets 4.2 3.9 3.5 3.5 3.3 Purchase o f stocks 0.6 0.5 0.3 0.3 0.4 Capital transfers (grants) 1.5 1.2 1.3 1.4 1.3 Net Lending 1.1 0.5 1.o 1.2 0.7 Investment inloans 1.5 1.2 1.6 1.7 1.1 Less repaymento f loans 0.4 0.7 0.6 0.5 0.4 Memorandum Item: Nominal GDP (Billions o fNrs.) 248.9 280.5 300.8 342.0 379.5 410.3 421.3 Notes: 1/ Current Expenditure adjusted by subtracting payment o f amortization on domestic and foreign loans. 2/ Capital expenditure adjustedby adding net lending. Source: IMF. Table 4.4: Nepal: Central Government Expenditure by Functional Classification, 1995/96-2001/02 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 (Inbillions ofNepalese rupees) Total expenditure 43.7 46.4 49.9 52.8 59.8 72.1 72.6 Current expenditure 18.7 20.7 23.2 26.5 29.3 37.1 44.1 Social services 5.3 5.9 7.1 7.9 8.9 10.7 13.5 Education 4.3 4.8 5.7 6.0 6.7 8.2 10.4 Health 0.8 1.0 1.o 1.1 1.3 1.5 2.1 Other 0.2 0.2 0.3 0.7 0.8 0.9 0.9 Economic services 1.7 1.9 2.0 2.3 2.4 2.5 3.0 Agriculture related 0.4 0.4 0.4 0.4 0.5 0.5 0.6 Forestry 0.5 0.5 0.5 0.7 0.8 0.8 1.o Infrastructure 0.6 0.7 0.8 0.9 0.9 0.9 1.1 Other 0.2 0.3 0.3 0.3 0.3 2.6 3.7 Defense 2.1 2.4 2.6 3.0 3.5 3.8 5.8 Interest payments 3.9 4.1 3.8 4.1 4.8 4.7 5.8 General administration 3.1 3.5 3.9 4.5 5.5 8.0 11.0 Other 2.5 3.0 3.9 4.7 4.3 7.3 5.1 Development expenditure 25.0 25.7 26.7 26.4 30.4 35.0 28.5 Social services 7.6 8.3 10.7 9.7 12.2 12.9 10.5 Education 1.7 2.4 2.4 1.6 2.6 2.8 2.3 Health 0.9 1.6 2.7 1.7 2.1 2.0 1.6 Drinking water 1.1 1.3 1.7 1.9 2.4 2.4 2.0 Other 3.9 3.0 4.0 4.5 5.1 5.7 4.6 Economic services 17.4 17.4 15.9 16.7 18.2 22.1 18.0 Agriculture related 5.4 5.0 4.8 4.9 5.6 6.6 5.4 Infrastructure 10.4 10.9 10.8 11.4 11.4 12.8 10.4 Other 1.6 1.5 0.3 0.4 1.2 2.7 2.2 (InpercentofGDP) Total expenditure 17.6 16.5 16.6 15.4 15.7 17.6 17.2 Current Expenditure 7.5 7.4 7.7 7.7 7.7 9.0 10.5 Development Expenditure 10.0 9.2 8.9 7.7 8.0 8.5 6.8 Social services 5.2 5.1 5.9 5.1 5.6 5.7 5.7 Ofwhrch: Education 2.4 2.6 2.7 2.2 2.4 2.7 3.O Health 0.7 0.9 1.3 0.8 0.9 0.9 0.9 Drinking water 0.4 0.5 0.6 0.6 0.6 0.6 0.5 Economic services 7.7 6.9 6.0 5.6 5.4 6.0 5 .o Ofwhrch :Agriculture related 2.3 1.9 1.7 1.6 1.6 1.7 1.4 Infrastructure 4.4 4.1 3.9 3.6 3.2 3.3 2.7 Defense 0.9 0.8 0.9 0.9 0.9 0.9 1.4 Interest payments 1.6 1.5 1.2 1.2 1.3 1.1 1.4 General administration 1.3 1.3 1.3 1.3 1.4 2.0 2.6 Other 1.o 1.1 1.3 1.4 1.1 1.8 1.2 (Inpercent o ftotal expenditure) Total expenditure 100.0 100.0 100.0 100.0 lOO.0 100.0 100.0 Current Expenditure 42.8 44.7 46.6 50.1 49.1 51.4 60.7 Development Expenditure 57.2 55.3 53.4 49.9 50.9 48.6 39.3 Social services 29.5 30.6 35.6 33.2 35.3 32.7 33.0 Ofwhich: Education 13.7 15.4 16.2 14.5 15.5 15.3 17.5 Health 3.9 5.6 7.5 5.3 5.8 4.9 5.1 Drinkingwater 2.5 2.9 3.4 3.6 4.1 3.3 2.7 Economic services 43.8 41.5 36.0 36.0 34.6 34.2 28.9 Ofwhich :Agriculture related 13.2 11.5 10.5 10.1 10.1 9.9 8.2 Infrastructure 25.2 25.0 23.3 23.2 20.5 19.0 15.8 Defense 4.9 5.1 5.2 5.7 5.8 5.3 8.0 Interest payments 8.9 8.8 7.5 7.7 8.1 6.5 8.0 General administration 7.2 7.6 7.9 8.6 9.1 11.1 15.1 Other 5.8 6.4 7.8 8.8 7.1 10.1 7.1 Memo Item Nominal GDP (Billions Nrs) # 248.9 280.5 300.8 342.0 379.5 410.3 421.3 Source: IMF. Table 5.1: Nepal: Monetary Survey, 1994/95-2002/03 Est. 1994/95 1995/96 1996197 1997198 1998/99 1999100 2000101 2001/02 2002103 (In billionsof NeDaleseruDees. end of Deriod) Net foreign assets 37.09 37.70 40.19 55.57 65.03 ' 80.4; 87.80 88.42 92.05 Assets 43.86 45.27 49.37 66.11 77.61 94.86 106.19 107.00 111.47 Liabilities 6.78 7.57 9.18 10.54 12.58 14.39 18.39 18.58 19.42 Net domestic assets 43.90 54.95 63.53 70.89 87.77 105.65 126.66 135.57 150.15 Domestic credit 69.60 86.62 98.27 112.82 130.97 154.35 183.43 200.31 222.76 Public sector 23.83 26.85 28.18 29.82 32.62 36.40 46.99 58.60 61.57 Government(net) 22.60 24.89 26.58 28.76 31.06 34.59 44.77 55.52 58.67 Nonfinancialpublic enterprises 1.23 1.96 1.60 1.06 1.57 1.81 2.22 3.08 2.90 Privatesector 1/ 45.77 59.78 70.09 83.00 98.35 117.95 136.44 141.71 161.19 Other item (net) -25.70 -31.67 -34.74 -41.93 -43.20 -48.70 -56.78 -64.74 -72.61 Broad money 80.98 92.66 103.72 126.46 152.80 186.12 214.45 223.99 242.20 Narrow money 32.99 36.50 38.46 45.16 51.06 60.98 70.58 77.16 81.42 Quasi-money 48.00 56.16 65.26 81.30 101.74 125.14 143.88 146.83 160.78 (Annual percentagechange) Net foreign assets, 1.7 6.6 38.3 17.0 23.7 9.8 4.0 4.1 Net domestic assets 30.8 25.2 15.6 11.6 23.8 20.4 18.9 16.9 10.8 Domestic credit 25.1 24.5 13.4 14.8 16.1 17.8 19.3 13.5 11.2 Public sector 4.5 12.6 5.0 5.8 9.4 11.6 28.0 12.7 5.1 Private sector I / 39.4 30.6 17.3 18.4 18.5 19.9 16.5 13.8 13.7 Broad money 16.1 14.4 11.9 21.9 20.8 21.8 15.2 4.4 8.1 Narrow money 15.7 10.6 5.4 17.4 13.1 19.4 15.7 9.3 5.5 Quasi-money 16.3 17 16.2 24.6 25.1 23.0 15.0 2.1 9.5 I / Include credit to financial public enterprises. Source: IMF. Table 5.2: Nepal: Structure of Interest Rates, 1994/95-2001/02 1994195 1995196 1996197 1997198 1998199 1999100 2000101 2001102 Refinancing Facilities of Nepal Rastra Bank to commercial banks Export bills 11.o 11.0 11.0 9.0 9.0 6.5 6.5 2.0-4.5 Industrial Sector 11.o 11.0 11.0 9.0 9.0 7.5 7.5 3.0-5.5 Agricultural sector 11.0 11.0 11.0 9.0 9.0 6.5 6.7 4.5-5.5 Service sector 11.0 11.o 11.0 9.0 9.0 7.5 7.5 3.0-5.5 Commercial banks Savings deposits 7.0-8.0 7.5-8.0 7.340 6.5-8.0 5.75-8.0 4.0-6.5 3.0-6.5 2.5-6.25 Time deposits 3 months 5.0-7.5 6.75-8.0 6.75-9.0 5.0-8.0 4.0-7.5 4.0-6.0 2.5-6.0 2.0-5.25 6 Months 6.0-8.0 7.25-9.0 7.25-9.0 6.0-8.5 6.0-8.0 5.0-6.75 3.5-6.76 2.5-6.0 1 year 8.0-9.25 9.5-11.O 9.5-11.0 9.0-10.5 7.25-9.5 6.0-7.75 4.5-7.75 3.5-7.0 2 years negotiable negotiable negotiable 9.5-12.0 7.25-10.25 5.75-8.5 4.25-8.5 3.25-8.0 Loans Industry 14.0-18.0 15.0-17.5 15.0-17.5 13.5-17.0 11.5-17.0 10.5-15.5 9.5-15.0 7.0-14.5 Agriculture 13.0-15.5 14.5-16.0 14.5-16.0 14.5-15.5 14.0-15.5 12.0-14.5 12.5-14.5 12.0-14.0 Services 17.0-18.0 18.0 18.0 18.0 18.0 7.5-17.0 7.5-16.0 7.0-15.5 Export bills 12.0-16.0 13.0-16.0 14.5-16.5 12.5-16.0 7.5-15.0 7.5-15.0 7.5-12.5 6.5-12.5 Commercial loans and overdrafts 12.0-19.0 14.5-20.0 14.5-20.0 13.5-20.0 10.0-19.0 9.0-18.0 9.0-18.0 2.0-4.26 Agricultural Development Bank of Nepal To cooperatives 12.0-15.0 12.0-15.0 12.0-15.0 13.0-16.0 13.0-16.0 11.0-12.0 11.0-12.0 10.0-12.0 To others 14.0-17.0 14.0-17.0 14.0-17.0 15.0-18.0 15.0-18.0 12.0-16.0 12.0-16.0 10.0-16.0 Nepal Industrial Development Corporation 15.0-16.0 15.0-16.0 15.0-18.0 15.5-18.0 15.5-18.0 15.5-18.0 15.5-18.0 13.5-14.5 Government securities National savings certificates 9.0-15.5 9.0-15.5 9.0-13.25 9.0-13.25 9.0-13.25 8.5-13.25 8.5-13.25 8.5-13.25 Treasury bills (3 month) 1/ 7.4 10.9 10.2 3.5 2.3 5.3 4.3 3.8 Treasury bills (1 year) ... ... 9.0-12.0 5.9-7.3 4.7-7.0 5.5-7.3 5.1 5.2 Development bonds 3.0-10.5 3.0-12.0 3.0-12.0 3.0-12.0 3.0-12.0 3.0-10.5 3.0-10.5 3.0-8.0 25-year special bonds 3.0 3.0 3.0 3.0 3.0 20-year special bonds 3.0 5.0 5.0 5.0 5.0 5.0 5.0 5.1 Special loan 1.O-14.0 1.0-13.0 1.0-13.0 1.0-13.0 1.0-9.5 1.0-9.5 1.0-9.5 1.0-9.0 1/ Annual weighted average. Source: IMF. Table 5.3: Nepal: Non-Performing Loans of Public Enterprises, 1996197-2001102 (In millions of Nepaleserupees,end of period) 1996197 1999/00 2000/01 2001/02 Principal Interest Total Principal Interest Total Principal Interest Total Principal Interest Total Nepal FoodCorporation 0 0 0 7 5 12 0 0 0 0 0 0 NepalTransportationCorporation 19 13 32 19 27 46 0 0 0 19 69 00 Himal CementCompany 2 0 2 0 0 0 0 0 0 29 61 90 BhaktapurTile and Brick Corporation 3 2 4 2 3 5 3 4 7 16 21 37 RaghupatiJute Mill 10 137 147 0 0 0 0 0 0 0 0 0 Rice ExportingCompanies 13 100 112 3 32 35 3 32 35 3 0 11 Cottage Industrialand HandicraffEmporium 93 07 179 0 136 136 0 136 136 3 136 139 NationalTrading Ltd. 0 0 0 1 0 1 0 0 0 0 0 0 AgriculturalTools Factory 0 31 31 137 8 145 0 0 0 0 0 0 HetaduaLeatherFactory 2 18 19 2 20 30 2 33 35 2 34 36 HetaduaClothes Factory 0 0 0 37 0 45 37 15 52 0 0 0 Total 140 387 527 207 247 455 45 220 265 72 329 401 Source: IMF. Table 6.1: Nepal: Agricutural Productionand Yield, 1995196-2001102 1995196 1996197 I997198 1998199 1999/00 2000101 2001102 1995196 1996197 1997198 1998199 1999100 2000101 2001102 (In thousands of metrictons) (Percentage Change) Production of Major Crops Foodgrains 6,256 6,395 6,331 6.465 6,985 7,172 7,247 156 2 2 -10 2 1 8 0 2 7 1 0 Paddy 3,579 3,699 3,641 3,710 4,030 4,216 4,165 22 2 3 4 -16 1 9 8 6 4 6 -1 2 Wheat 1,013 1,056 1,001 1.086 1,184 1,158 1,258 10 8 4 2 -52 8 5 9 0 -2 2 8 6 Maize 1,331 1,312 1,367 1,346 1,445 1.484 1,511 4 6 -1 4 4 2 -15 7 4 2 7 1 8 Miilet 292 289 285 291 295 283 283 9 0 -1 0 -14 2 1 1 4 -4 1 0 0 Bariey 41 39 37 32 31 30 31 36 7 -4 9 -5 1 -135 -3 1 -3 2 3 3 Cash Crops 2,604 2,722 2.782 3.203 3,428 3.678 3,877 5 8 4 5 2 2 151 7 0 7 3 5 4 Sugarcane 1,569 1,622 1,718 1,972 2.103 2,212 2,248 4 5 3 4 5 9 148 6 8 5 2 1 6 Jute 15 14 15 16 15 16 17 36 4 -6 7 7 1 6 7 -63 6 7 6 3 Oilseeds 116 119 109 120 123 132 135 13 7 2 6 -84 101 2 5 7 3 2 3 Potato 898 962 935 1,091 1.183 1,314 1,473 6 9 7 1 -28 167 8 4 11 1 12 1 Tobacco 6 5 5 4 4 4 4 -14 3 -16 7 0 0 -200 0 0 0 0 00 Distrlbutlon of FertiHzerI/ 133 122 109 157 148 146 141 -24 4 -8 3 -107 670 236 -1 4 -3 4 (in thousands of hectares) (Percentage change) Area under cultivatlon. 2/ Fwdgrains 3,242 3,267 3,243 3.253 3,321 3,314 3,296 4 3 0 8 -07 0 3 2 1 -0 2 -0 5 Paddy 1,497 1511 1,506 1,514 1,551 1,560 1,517 5 3 0 9 -03 0 5 2 4 0 6 -2 8 Wheat 654 667 640 641 660 641 667 3 2 2 0 -40 0 2 3 0 -2 9 4 1 Maize 792 794 799 802 819 825 826 2 7 0 3 0 6 0 4 2 1 0 7 0 1 Millet 260 260 262 264 263 260 258 4 0 0 0 0 8 0 8 -04 -1 1 -0 8 Barley 39 35 36 32 28 28 28 25 8 -10 3 2 9 -11 1 -125 0 0 0 0 Cash Crops 353 356 361 379 390 391 398 8 8 0 8 1 4 5 0 2 9 0 3 1 8 Sugarcane 45 46 49 54 58 59 59 7 1 2 2 6 5 102 7 4 1 7 0 0 Jute 11 11 12 12 15 11 12 22 2 0 0 9 1 0 0 250 -26 7 9 1 Oilseeds 185 182 179 190 190 168 188 8 8 -1 6 -16 6 1 0 0 -1 1 0 0 potato 106 111 118 118 123 129 135 9 3 4 7 4 5 1 7 4 2 4 9 4 7 Tobacco 6 6 5 5 4 4 4 -14 3 0 0 -167 0 0 -200 0 0 0 0 (In metric lonslhectares) (Percentage change) Yields Foodgrains 1 9 2 0 2 0 2 0 2 1 2 2 2 2 13 5 1 4 -03 1 8 5 8 4 6 0 0 Paddy 2 4 2 4 2 4 2 5 2 6 2 7 2 7 138 2 4 -12 1 4 6 0 3 9 0 0 Wheat 1 5 1 6 1 6 1 7 1 8 1.8 1 9 10 6 2 2 -12 8 3 5 9 0 3 5 6 Maize 1 7 1 7 1.7 1.7 1 8 1.8 1.8 -1 1 -1 7 3 5 -19 5 1 2 0 0 0 Miilet 1 1 1 1 1.1 1 1 1.1 1.1 1.1 2 1 -1 0 -21 1 3 1 8 -1 9 0 0 Barley 1 1 1 1 1.0 1 0 1 1 1 1 1.1 5 1 6 0 -78 -27 107 -0 6 0 0 Cash crops 7 4 7 6 7 7 8 5 8 8 9 4 9 7 -2 9 3 7 0 8 9 7 4 0 6 9 3 2 Sugarcane 34 9 35 3 351 365 363 375 381 -2 3 1 1 -06 4 2 -07 3 4 1 6 Jute 1 4 1 3 1 3 1 3 1 0 1 5 1 4 4 9 -6 7 -1 8 6 7 -250 50 0 -6 7 Oilseed 0 6 0 7 0 6 0 6 0 6 0 7 0 7 4 5 4 3 -69 3 7 2 5 8 1 0 0 potato 8 5 8 7 8 1 9 2 9 6 102 109 -2 6 2 3 -70 147 4 0 6 1 6 9 Tobacco 1 0 0 8 1 0 0 8 1 0 1 0 0 9 0 0 -16 7 200 -200 250 0 0 -10 0 Notes' 11Private sector has participated in fertilizer trading activity since November 1997 21Areas cuitivated with m r e than one crop are incuded under each crop. Source IMP. Table 6.2: Nepal: Manufacturing Production Indices, 1997/98-2001/02 Weights I / 1997/98 1998/99 1999/00 2000/01 2001102 1997/98 1998/99 1999/00 (Indices 1996/97 = 100) (percentage chi Overall production 100.0 103.4 108.9 116.1 120.1 112.2 3.4 5.3 6.6 Food 26.2 111.6 118.1 127.3 134.5 127.3 11.6 5.8 7.8 Of which: Sugar 3.5 104 110.2 142.7 119.4 95.6 4 6.0 29.5 Vegetable ghee 1.5 115.6 111.5 118.9 153.1 188.5 15.6 -3.5 6.6 Rice 2.0 124 131.4 125.7 131 148.3 24 6.0 -4.3 Soybean oil 0.8 115 131.1 133.5 146.3 165.3 15 14.0 1.8 Processed milk 3.0 108 111.2 114.5 124.1 135.8 8 3.0 3.0 Beverage 10.5 111.4 120.2 131.1 139.8 117.5 11.4 7.9 9.1 Tobacco 13.8 92.2 98.8 108 113.9 112.1 -7.8 7.2 9.3 Textile 22.4 103.3 107 107.1 99.1 71.5 3.3 3.6 0.1 of which: Cotton cloth 1.5 94 79.9 70.6 65.9 59 -6 -15.0 -11.6 Synthetic cloth 3.0 106 93.3 99.6 101.5 103.8 6 -12.0 6.8 Woolen carpet 16.7 102.9 111.2 109.7 99.3 61.9 2.9 8.1 -1.3 Jute Goods 1.2 114 116.3 135.1 130.9 139.6 14 2.0 16.2 Readymadegarments 7.2 96 103.7 123.5 122.1 88.7 -4 8.0 19.1 Processed leather 1.o 109 111.2 108.1 134.6 121.8 9 2.0 -2.8 Wood products 1.2 99 95.6 93.3 91.4 99 -1 -3.4 -2.4 Paper 1.9 101 103 111.3 125.5 123.6 1 2.0 8.1 Other chemical products 6.8 98.6 105.5 114.5 130.7 148.6 -1.4 7.0 8.5 Rubber products 1.5 96 98 96.5 96.6 101.2 -4 2.1 -1.5 Plastic Products 1.9 105 111.3 110.6 148.6 178.6 5 6.0 -0.6 Nonmetallic mineral products 13.3 104.7 114.5 120.6 117.9 124.5 4.7 9.4 5.3 of which: Bricks 3.9 83 96.5 96.3 96.5 100.9 -17 16.3 -0.2 Cement 4.3 124.1 130.6 142.4 137.1 145.8 24.1 5.2 9.0 Iron and Steel Basic Industries 5.1 107.9 107.4 120.4 134.1 139.7 7.9 -0.5 12.1 Electrical Industrial Machinery Apparatus, appliances, etc. 1.8 113 116.4 121.0 146.4 151.5 13 3.0 4.0 Othei's 0.5 93.1 89.3 98.9 92.6 101.7 -6.9 -4..1. 10.8 I / Weights are based on the Census of Manufacturing Establishments (1996/97). Source: IMF. Table 6.3: Nepal: Energy Consumption, 1994195-2001102 1996197 1997198 1998199 I999100 2000101 2001102 Traditional 6,268 6,403 6,540 6,681 6,824 6,997 Of which : Fuelwood 5,574 5,694 5,816 5,941 6,068 6,217 Commercial 691 768 811 1,044 1,088 1,169 Petroleum 554 625 661 709 734 758 Coal 60 61 61 236 253 290 Hydropower 77 83 89 99 108 121 Total 6,959 7,192 7,376 7,754 7,954 8,205 (Annual percentagechange) Traditional 1.3 2.2 2.1 2.2 2.1 2.5 Of which : Fuelwood 0.9 2.2 2.1 2.1 2.1 2.5 Commercial 6.1 11.1 5.6 28.7 4.2 7.4 Petroleum 9.3 12.8 5.8 7.3 3.5 3.3 Coal -16.7 1.7 0.0 286.9 7.2 14.6 Hydropower 6.9 7.8 7.2 11.2 9.1 12.0 Total 1.8 3.3 2.6 5.1 2.6 3.2 Source: IMF. Table 6.4: Nepal: Changes in the Consumer Price Index, 1994/95-2001/02 (Annualpercentagechange) 1994/95 1995/96 1996/97 1997/98 1998/99 1999/00 2000/01 2001/02 Overall National Index 7.6 8.1 8.1 8.3 11.4 3.4 2.4 2.9 By commodity Food and beverage 7.3 8.9 8.2 7.8 16.2 0.4 -2.4 3.7 Foodgrains 7.9 8.5 9.1 3.2 18.6 8.6 -13.7 2.1 Milk and Milk products 1.3 10.9 12.0 7.7 9.5 3.7 5.7 1.2 Oil and Fats 11.1 13.2 2.5 8.3 29.0 -22.6 -4.7 8.3 Beverages 3.9 6.9 9.2 14.8 8.7 3.7 2.0 5.0 Vegetables and Fruits 5.0 3.7 3.7 16.6 19.9 -16.9 4.1 7.5 Other goods and semces 8.1 6.7 8.0 9.0 5.8 7.1 8.1 2.1 Cloth, clothing, and sewing services 10.1 7.2 7.8 6.9 6.0 4.7 2.2 2.5 Fuel, light and water 3.2 3.9 11.2 7.5 2.8 13.3 22.3 -0.9 Regional Indices Kathmandu 8.0 6.0 7.8 7.3 8.2 3.7 3.2 2.0 Terai 7.4 9.5 8.1 9.0 13.3 3.1 1.1 3.4 Hills 7.8 9.5 8.6 8.0 11.6 3.7 5.2 2.5 Source: IMF. Table 6.5: Nepal: Monthly Wages inMajor Sectors, 1994/95-2001102 1994/95 1995/96 1996/97 1997198 1998/99 1999/00 2000/01 2001/02 Agriculture (In Nepalese rupees) Kathmandu 2,550 2,800 3,000 3,000 3,000 3,000 3,000 3,000 Birgunj 1,350 1,500 1,500 1,500 1,500 1,625 2,425 2,550 Biratnagar 1,350 1,350 1,350 1,350 1,487 1,500 1,500 1,500 Industry I/ Skilled 1,610 1,610 1,610 1,960 1,960 2,276 2,276 2,276 Unskilled 1,450 1,450 1,450 1,800 1,800 2,116 2,116 2,116 Construction 21 Skilled Kathmandu 5,100 5,350 5,550 5,700 5,700 5,700 6,000 6,300 Birgunj 2,820 3,300 3,300 3,375 3,913 4,050 4,313 4,500 Biratnagar 3,600 3,600 3,600 3,950 4,473 4,500 4,575 4,800 Semi-skilled Kathmandu 4,500 4,625 4,675 4,950 4,950 4,950 5,050 5,550 Biratnagar 3,000 3,000 3,000 3,250 3,875 3,900 3,975 4,200 Unskilled Kathmandu 2,700 2,950 3,000 3,000 3,000 3,000 3,112 3,450 Biratnagar 1,800 1,800 1,800 1,925 2,375 2,400 2,400 2,400 Agriculture (In US. dollars) Kathmandu 51.2 50.7 52.6 48.5 43.8 42.2 40.6 39.0 Birgunj 27.1 27.2 26.3 24.3 21.9 22.8 32.8 33.2 Biratnagar 27.1 24.4 23.7 21.8 21.9 21,I 20.3 19.5 Industry I/ Skilled 32.3 29.2 29.2 31.7 28.6 32.0 30.8 29.6 Unskilled 29.1 26.3 25.4 29.1 26.3 29.8 28.7 27.5 Construction 21 Skilled Kathmandu 102.4 96.9 97.3 92.2 83.2 80.2 81.3 81.9 Birgunj 56.6 59.8 57.9 54.6 56.9 57.0 58.4 58.5 Biratnagar 72.3 65.2 63.1 62.3 65.3 63.3 62.0 62.4 Semi-skilled Kathmandu 90.4 83.8 82 80.1 72.3 69.6 68.4 72.2 Biratnagar 60.2 54.3 52.6 52.6 56.5 54.9 53.8 54.6 Unskilled Kathmandu 54.2 53.4 52.6 48.5 43.8 42.2 42.2 44.9 Biratnagar 36.1 32.6 31.6 31.I 34.7 33.8 32.5 31.2 Notes: I / Minimum monthlywage, includingallowances, which are the same in Kathmandu, Birgunj and Biratnagar. 21Carpenters and masons. Source: IMF.