Nepal - Second Highway Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLY Report No. P-2117-NEP REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A SECOND HIGHWAY PROJECT June 24, 1977 This document has a restricted distribution and may be used by recipients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Nepalese Rupee (NR) US$1.00 = NR 12.45 (January 1977) NR 1.00 = US$0.08 NR I million = US$80,321 WEIGHTS AND MEASURES Metric System Metric British/US Equivalent 1 meter (m) 3.28 feet (ft) 1 kilometer (km) 0.62 miles (mi) 1 metric ton (m ton) 2,204.6 pounds (lb) 1 hectare (ha) 2.47 acres (ac) ABBREVIATIONS AND ACRONYMS CIDA = Canadian International Development Agency GDP = Gross Domestic Product ILO = International Labor Organization M = Million MWT = Ministry of Works and Transport USAID = United States Agency for International Development UNDP = United Nations Development Program GOVERNMENT OF NEPAL FISCAL YEAR July 16 to July 15  FOR OFCILh USE ONLY NEPAL - THE SECOND HIGHWAY PROJECT Credit and Project Summary Borrower: Kingdom of Nepal Amount: US$17.0 million equivalent Terms: Standard ProJect Description: The project provides for construction of a feeder road connecting the Dang Valley to the East-West Highway in the Par-Western Region of the country, upgrading of a mountainous section of the main road between Kathmandu and the Indian border, support for the Government's Five-Year Road Maintenance Program, consultants' services, and training of mechanics. The details of the project are given below: Project Components: (a) construction, generally on an existing alignment, of a 50-km feeder road, together with improve- ments to connecting local roads; (b) procurement of construction equipment for use by the feeder.road construction contractors; (c) upgrading, on the existing alignment, of a 17.5 km mountainous section of the main Kathmandu-Indian border road; (d) Provision of road maintenance equipment, spares, two workshops and facilities in support of a nationwide Five-Year Road Maintenance Program; (e) consulting services for: (i) feasibility studies, detailed engineering and assistance in construction supervision for the feeder road; (ii) feasibility studies of the remaining 190 km section of the East- West Highway; and (iii) technical investigation assistance; (f) training of construction and maintenance equipment mechanics. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Cost US$ (millions) Estimates I/ Item Local Foreign Total A. Feeder Road Construction 1. Feeder road construction and equipment (with residual value) 1.58 2.01 3.59 2. Local road improvements 0.20 0.20 0.40 Subtotal 1.78 2.21 3.99 B. Main Road Upgrading 0.60 0.90 1.50 C. Road Maintenance Program 1. Equipment and spares 0.30 6.16 6.46 2. Workshops and tools 0.22 0.45 0.67 Subtotal 0.52 6.61 7.13 D. Consulting Services 1. Feeder road feasibility studies, detailed engineering, and con- struction supervision 0.23 0.59 0.82 2. East-West Highway feasi- bility studies 0.20 0.40 0.60 3. Technical Investigation Assistance 0.00 0.02 0.02 Subtotal 0.43 1.01 1.44 E. Mechanics' Training 0.40 0.40 0.80 Subtotal (A, B, C, D & E) 3.73 11.13 14.86 F. Contingencies 1. Physical 0.54 1.35 1.89 2. Price 1.40 1.85 3.25 Subtotal 1.94 3.20 5.14 TOTAL PROJECT COSTS 5.67 14.33 20.00 1/ Including Taxes and Duties (US$0.40 M equivalent).  Financing US$ Millions Equivalent Plan: Local Foreign Total IDA Credit 2.7 14.3 17.0 The Government 1/ 3.0 - 3.0 TOTAL 5.7 14.3 20.0 Estimated Disbursements: IDA Fiscal Year US$ Millions Annual Cumulative 1978 4.3 4.3 1979 7.1 11.4 1980 4.0 15.4 1981 1.2 16.6 1982 0.4 17.0 TOTAL 17.0 Technical Assistance: Consultants' services for: (i) preparation of feasi- bility studies and detailed engineering and construction supervision for feeder road; (ii) preparation of a pre- feasibility study, and possibly further feasibility studies and detailed engineering, for the East-West Highway in the Far-Western Region (190 km); and (iii) preparation of pavement and slope stability investiga- tions for possible improvement of mountainous section of the Kathmandu-Indian border road. The ILO will assist the Government in preparing and executing a program for training mechanics. Rate of Return: The weighted-average economic rate of return for the entire project is estimated at 28%. Appraisal Report: No. 1439a-NEP dated June 9, 1977. 1/ Including Taxes and Duties (US$0.40 M equivalent).  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A SECOND HIGHWAY PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal for the equivalent of US$17.0 M on standard IDA terms to help finance a Second Highway Project. PART I - THE ECONOMY 1/ 2. The most recent economic report entitled "Review of the Economic Situation of Nepal" (Report No. 1180-NEP) was distributed to the Executive Directors on July 30, 1976. The principal findings of the report and the developments since then are described below. Country data are shown in Annex I. 3. Nepal has been classified by the United Nations as one of the least-developed countries in the world. Its per capita income in 1975 was estimated at $110. It has a population of 12.6 M, estimated to be growing at around 2% per year. A large proportion, nearly 96% of the population, live in rural areas. Health and education facilities are below the standards achieved in the rest of South Asia. Nepal has an infant mortality rate of 200-300 per thousand live births, an adult literacy rate of 14%, and a life expectancy at birth of less than 44 years. 4. The country has a difficult topography which severely limits the area of arable land. Yet population density is now 450 per square kilometer of arable land for all of Nepal and 930 persons in the Hill areas where 59% of the people live. Already the results of pushing the area of cultivated land beyond economically feasible and ecologically safe limits are being felt in the Hill areas. Agricultural yields have declined, and soil erosion and landslides have resulted in these areas. In the Terai plains where food- grains, sugar and jute are grown, little room is left for extending the cul- tivated areas. The traditional grain surpluses produced in the Terai are declining as population has grown. 5. The landlocked position of the country imposes an additional con- straint. Far removed from sources of supplies of development goods and ac- cess to export markets, development is more costly in Nepal than in many other countries. Moreover, uncertainties of trade and transit over the sub- continent complicates all economic decision-making, necessitates the holding of relatively large foreign exchange reserves, and reduces the country's attraction to private investors. 1/ Part I of this Report is substantially identical to Part I of the Report and Recommendation of the President to the Executive Directors on a proposed credit to the Kingdom of Nepal for a Nepal Industrial Develop- ment Corporation Project (Report No. P-2050-NEP of April 19, 1977).  - 2 - 6. The economy is predominantly agricultural. About 68% of total value added originates in agriculture, and over 90% of the labor force is engaged in this activity. Agricultural products constitute more than 80% of Nepal's exports. Ninety percent of these exports go to India. Rice, the main export, accounts for about 60% of the total export value, while jute is the second most important. Industrial value added amounts to only 4% of GDP and Nepal, therefore, has to import almost all of its capital goods and a large part of manufactured consumer goods. 7. Between 1965 and 1975, Nepal's GDP growth rate averaged 2.4% per year, marginally above the rate of population growth. Thus far, development efforts have been mostly directed towards building an economic and adminis- trative infrastructure. This was necessary since it was only in the early fifties that the Government adopted economic and social development as major objectives. The investments in infrastructure made since then were the country's first steps toward modernization. They have not yet paid off, however, in terms of accelerated economic growth. 8. There have been no significant changes in the trend of economic growth in 1975/76. The weather continues to be the main factor which deter- mines yearly fluctuations in growth. Last year, weather conditions were very favorable, the grain crop was large, and GDP grew by about 6%, well above the average of 2.4% of the past decade. The balance of payments benefited from temporarily larger rice exports, improved administrative control of rice exports, increased incomes from tourism and increased inflows of remittances. At the same time, imports of petroleum products,. fertilizer, cement, and iron and steel declined, because these items had been overstocked in the previous year. Foreign exchange reserves rose by 6% to $119.7 M, the equivalent of about nine months of imports. Last year's higher GDP growth rate and the improvement in the balance of payments were chiefly due to fortuitous factors rather than to an improvement in the longer term growth trend of the economy. 9. After substantial efforts in the last two decades to build up the country's infrastructure, Nepal's planners believe that the time has come for a shift in the development strategy. The leading principle of the current five-year plan (1976-80) is that Nepal should aim its development efforts at deriving increased production benefits from its past efforts to establish and expand the infrastructure. The allocation of investment funds under the plan shows a drop in the share of transport and communications (from 41% to 23% of the total) and corresponding increases in the share of agriculture, industry and the social sectors. Attention is to be concentrated on quick-yielding projects, mostly in agriculture but with an appropriate component of viable import substitution in industry. 10. The most important opportunity to reap production gains lies in agriculture. Present yields in the Terai, where most of the foodgrains are cultivated, average only 1-1.3 tons per hectare. These yields can be increased substantially by improvements in agricultural extension, by in- creased application of inputs, and by minor irrigation. Similar improve- ments could also be extended to sugar and jute cultivation which also have  - 3 - very low yields. The wide difference between growing conditions in the Hills and in the Terai offers scope for increased specialization and ex- change of products. For the time being, the Hills must continue to empha- size food production in view of the serious food deficits in the area. However, in the long run, the Hills area is comparatively well-suited to produce cash crops -- fruits, spices, vegetables, potatoes and natural silk, etc. On a limited scale these items are already being produced. Achieve- ment of production gains will also require the strengthening of marketing and credit institutions. Some progress in institution-building has already been made in recent years, as evidenced by the establishment of the Agricul- tural Development Bank and the Agricultural Projects Services Center. 11. Although agriculture must occupy a predominant position in Nepal's development strategy, opportunities also exist in other directly productive sectors, mainly industry and tourism, and these should be vigorously pursued. The contribution of modern industry to GDP is still small, about 4%, but it has been growing. Most of the sector consists of the processing of agricul- tural products such as rice, wheat, vegetable oil, sugar and jute. The re- mainder is made up of factories producing simple consumer goods, wood products, bricks, tiles and cement. The small size of the market, lack of raw materials, competition from Indian products, and the shortage of domestic entrepreneurs and trained workers will continue to be limiting factors for some time. Modern industry, nevertheless, has its role in Nepal's future development. The scope for processing of agricultural products for domestic use and export should increase with the intended diversification of agriculture. Further growth of the economy will also present scope for more import substitution. 12. Tourism has grown at 11.5% per year over the last five years; tourist arrivals at present are estimated to be above 85,000. Foreign ex- change earnings from this source are equivalent to those from merchandise exports. In line with a master plan for the sector, prepared with German assistance, a number of projects are to be undertaken to develop hill stations, observation points, and national parks as well as to restore ancient temples, and to strengthen the hotel school. While small in size, these projects are important for the long-term development of tourism. 13. On the basis of these and other considerations, it appears that there is sufficient scope for development of the directly-productive sectors to allow a modest acceleration of GDP growth to perhaps 3.5% a year during the last years of the decade and 4-5% in the 1980s. The proposed develop- ment strategy appears to be appropriate to Nepal's circumstances. The past ratio of investment (8.5-10.5% of GDP) to growth (2% of GDP) appears to be very high and, in view of the scarcity of resources in Nepal, the planners are right in looking for opportunities for more rapid growth without neglect- ing the need for completion of the basic infrastructure. 14. Nepal has made commendable efforts to mobilize domestic resources for development. In the last five years, real revenue growth has averaged over 7% per year, much higher than the growth rate of GDP, and budgetary savings  -4- were maintained at 40% of revenue, slightly over 2% of GDP. This result was obtained in the face of serious difficulties. On the revenue side, Nepal suffers from the constraints of extreme poverty and low degree of monetiza- tion of the economy. The open border with India, moreover, makes it difficult to control foreign trade and to levy the trade taxes which play such a large role in the tax system of most developing countries. On the current expendi- tures side, the Government has to cope with rising claims for maintenance of infrastructure and the need to raise government salaries from levels which are low even by the standards of a poor country. 15. In view of the pressures to increase current expenditures, all that can be realistically expected in the next few years is that the Government maintains its savings rate at 2% of GDP. Only when economic growth starts to accelerate significantly in the 1980s will there be prospects for an in- crease in this rate. Given the constraints on mobilizing domestic resources, which will prevail even with continued satisfactory fiscal management, foreign aid will remain a decisive factor in Nepal's economic develop- ment. In fact, since public savings are likely to increase less rapidly than public investment during the period of the current five-year plan, aid will become, at least temporarily, more important. In view of this scarcity of public savings, aid will have to cover not only the foreign exchange cost of projects, but, as a rule, also at least part of local cost. Total aid dis- bursements during 1971-75 (the previous five-year plan) averaged $33 M a year in constant (1974/75) prices and covered 45% of public investment. During 1976-80 (the present five-year plan), this proportion would have to rise to 57% if public investment is not to be held back by lack of financial resources. Under these circumstances, disbursements in real terms would have to rise by around 12.5% per year to average about $60 M in constant (1974/75) prices and about $90 M in current prices. 16. The international community has thus far been very responsive to these aid needs of Nepal. Shortage of finance has not yet been a bottleneck and prospects are that aid flows of the required magnitude will continue to be available. The real factor determining Nepal's development pace will remain the growth of absorptive capacity, and it is this factor which will determine the actual level of aid disbursements. The essential questions regarding aid to Nepal are, therefore, what donors should do to attune their aid programs to Nepal's development priorities and what they can do to help raise absorptive capacity. 17. These questions, obviously requiring consultations between the Nepal Government and the donors, provide the focus for the Nepal Aid Coordination Group which had its first meeting in Tokyo last December. On the basis of sector and project documentation prepared by the Government, the meeting reviewed the type of projects needed to support the Government's development strategy and the type of technical assistance programs needed to build up absorptive capacity. Sustained attention to these matters in the framework of  the Group is expected to lead to improvements in the composition of aid and to speed up the still very slow rate of disbursement of aid funds. 18. As of December 31, 1976, official foreign debt amounted to $236 M, of which 33% was to IDA. Of the $236 M, $192 M remained undisbursed. This low utilization is largely due to the fact that the bulk of foreign loans has been contracted since 1970. Debt service was about $1.5 M in 1975 or equiva- lent to about 2% of exports of goods and services. Most external loans will probably continue to be on concessionary terms, which is highly desirable in view of Nepal's poverty and limited export prospects. In view of the accele- rated development efforts, external public debt is expected to rise and, based on the trend in recent years, may reach about $350 M by 1980, of which approxi- mately 50% could be in IDA credits. The total debt service ratio by 1980 is, however, projected to remain below 10%. Debt service to the Bank Group alone would be less than 2% of exports of goods and services. PART II - BANK GROUP OPERATIONS IN NEPAL 19. The first IDA credit to Nepal in the amount of $1.7 M equivalent was made in FY70 for a telecommunications project. This was followed by credits for highways ($2.5 M), tourism ($3.2 M), irrigation ($6.0 M), a second telecom- munications project ($5.5 M), a water supply and sewerage project ($11.8 M), a settlement project ($6.0 M), a power project ($26.0 M) and a rural develop- ment project ($8.0 M). Approved in FY77 were a groundwater project ($9.0 M), a technical assistance project ($3.0 M), a second water supply and sewerage project ($8.0 M), and a Nepal Industrial Development Corporation Project ($4.0 M). The proposed credit would bring the total amount of IDA assistance to Nepal to $111.7 M equivalent, net of cancellations. No Bank loans have been made to Nepal. IFC made its first investment in Nepal ($3.2 M) in a hotel project in Kathmandu in FY75. Annex II contains a summary statement of Bank Group operations as of May 31, 1977, and notes on the execution of ongoing IDA projects. It shows certain delays in the implementation of these projects, particularly during the initial periods. These delays have been largely due to Nepal's limited technical and managerial capabilities. In order to assist Nepal in coping with this constraint, considerable technical assist- ance is being given by Bank Group staff, including our Resident Mission in Kathmandu. As a result, improvement in the rate of disbursements is being realized. During the first ten months of FY77, $4.9 M were disbursed compared to $6.9 M disbursed during the entire previous six years. There is, however, substantial scope for further improvement. 20. Bank Group lending to Nepal has so far been at a modest level com- pared to the country's need for, and total receipts of, external assistance. The international community has persistently shown considerable interest in Nepal's economic development and, to date, shortage of funds has not been a bottleneck. The main constraint on the utilization of increased aid has been  - 6 - Nepal's limited absorptive capacity, affecting the pace of project preparation and implementation. The Bank has agreed to assist the Government in project preparation through the technical assistance credit and by acting as Executing Agency for a number of technical assistance projects in the current UNDP Five-Year Program. The Bank Group has also addressed the problem of absorptive capacity through its role in organizing the Aid Coordination Group for Nepal (para 17). 21. The Bank Group's current strategy places major emphasis upon the directly-productive sectors (particularly agriculture) and the development of complementary infrastructure, including feeder roads (particularly connecting the Hills to the Terai), communications and hydroelectric power. Preparation of projects in irrigation, telecommunications, rural development and horti- culture is underway. PART III - THE TRANSPORT SECTOR A. Overview 22. Historically, transport in Nepal has been over trails by means of porters and, to a smaller extent, by pack animals. These means are still of great importance, especially in the Hills. However, with the Government's emphasis on infrastructure since the 1950's, a road network has begun to emerge, and numerous airports and landing fields have been built. Railroads, ropeways and waterways play a minor role in Nepal's transport system. 23. In the past, transport demand has been local in nature, between nearby villages and rural areas in the Hills. Since the 1950's, with the eradication of malaria in the Terai and increased trade with India, transport demand has been largely concentrated in a north-south direction. Grains and manufactured goods move in a northern direction into the Hills, while herbs and spices come south. More recently, with the development of the East-West highway system, lateral transport demand has started to develop along the Terai. 24. All modern modes of transport are regulated and/or operated by the Ministry of Public Works and Transport (MWT). While there is no separate entity within the MWT which specifically coordinates the various modes, problems of inter-modal competition are minimal. Some assistance is provided in trans- port planning by a transport economist financed by the United Nations Develop- ment Program (UNDP). Also, the Center for Economic Development and Adminis- tration is now carrying out a study to evaluate the relative merits of invest- ment in various modes of transport, particularly in the Hills. Investment plans are reviewed by the National Planning Commission and final approval for implementation rests with the Ministry of Finance.  - 7 - 25. Nepal's investment strategy in transport has been generally based on a 1965 survey organized and financed by IDA which concluded that roads should be the prime mode. Most development expenditures have been financed by exter- nal agencies, primarily by Mainland China, India, U.S.S.R., U.K., U.S., and, more recently, Switzerland and the Asian Development Bank. Although external assistance has been essential for the development of infrastructure, the preference by donors for major self-contained projects, usually designed and supervised by them, has sometimes made it difficult to plan and execute investment plans in optimal fashion. B. Highways 26. Although road transport is the dominant modern mode of transpor- tation, Nepal still has one of the smallest road networks, either in relation to surface area or to population, of any country in the world. Road construction outside the Kathmandu Valley was only started in 1953. At present, the total road network is about 4,200 km of which about 1,600 km are paved. The two main national roads are: (i) the north-south road from the Indian border at Birganj to Kathmandu and then to the Mainland Chinese (Tibet) border; and (ii) the East-West Highway in the Terai which, when completed (about 1985), will traverse the length of the country. By 1982, the total road network is ex- pected to be about 5,800 km (about a 40% increase over the present system). 27. Over the last five years, the vehicle fleet has grown at an average rate of 9% per annum, and, in 1976, there were 15,500 registered vehicles (about 35% were trucks and buses). However, with no information on scrapping, only about two-thirds of these vehicles are estimated to be in operation. Traffic over the road system is light, with the exception of the Kathmandu Valley. In general, traffic seems to be growing at about 5% per annum, al- though the growth rates vary considerably throughout the system, especially in the rural areas. 28. Extremes in topographic and climatic conditions are the major obsta- cle to reliable and inexpensive road transport in Nepal. The rugged, moun- tainous terrain and the large number of rivers and streams, together with heavy monsoon rains, create great difficulty in the construction of roads, and make Nepal's road network one of the most difficult in the world to maintain. Land- slides are a constant threat within the mountainous regions, while in the Terai, flooding and washouts are a major problem. 29. During the current Five-Year Plan (1976-80), the Government is aiming at the completion of about 1,200 km of roads, including continued construction of the East-West Highway. The Government recognizes that these roads are being constructed in advance of heavy traffic, but regards the network currently planned as the minimum required for integrating the country, improving access to the Hills, and stimulating overall economic development. At the same time, the Government realizes that, as the network increases,  - 8 - greater emphasis will have to be given to road maintenance. In addition to construction of road and trail suspension bridges, the IDA Highway I project (Cr. 223-NEP) included support for a four-year road maintenance program com- prised of equipment, workshops, spare parts, and a commitment by the Govern- ment to provide adequate funding for recurrent costs and further purchases of equipment and spare parts. Although there were delays in initiating the project implementation, followed by further delays due to shortages of materials (notably cement), transportation difficulties in the Hills, and contractual difficulties due to price increases, the general objectives of the project have been realized. Some improvements in road maintenance took place, but these were not sufficient largely because funds were not adequate. In 1976, only about NRs 22.0 M (US$1.8 M equivalent), or about 11% of the Roads Department's total expenditure (NRs 196 M including NRs 121 M from external sources), was spent on road maintenance. The Government is now taking steps to overcome this situation, including a near doubling of road maintenance funds budgeted for 1977 and the reintroduction of an equipment rental system with updated charges reflecting the full cost of purchasing and maintaining road maintenance equipment. 30. The Government also realizes that, as the basic network nears completion, increased emphasis and expenditures will be required for the construction of feeder roads in support of the directly-productive sectors, primarily agriculture. However, past investment decisions will limit the Government's flexibility in budget allocations for some years. The recently- formed Aid Coordination Group is prepared to assist the Government in the planning and programming of such investment decisions. 31. The Roads Department (headed by a Chief Engineer) is responsible for the design, construction, maintenance, and administration for all national roads. The extension of the road system in recent years, and the associated maintenance workload, has taxed the Department's operational capacity and highlighted deficiencies in institutional arrangements, maintenance and repair of road equipment, and professional and technical skills. In recognition of these limitations, and as a result of the UNDP-financed institutional improve- ment study included under IDA's Highways I project, the Department is being decentralized in accordance with a phased expansion plan over the next five years. Four regional offices are being set up which will eventually be self-contained with respect to maintenance and all but major construction projects. At headquarters in Kathmandu, the Department will continue to administer major works and maintain technical and administrative backup services. 32. To assist in carrying out the Roads Department's program, the Government is keen to promote the development of the local contracting industry. At present, there are about 300 contractors in Nepal, but only 5-10 are medium-sized firms with the largest being the Government-owned National Construction Corporation of Nepal. Several foreign contractors are active on externally-financed projects. Small contractor's operations are labor-intensive, while the larger contractors use a blend of labor and equipment. Constraints to the development of the industry are the lack of access to credit, shortage of skilled labor, lack of equipment, and, until recently, one-sided contract conditions favoring the Government. A study  of the industry is being carried out by Nepal's Center for Economic Develop- ment and Administration, but it is concentrating only on specific road proj- ects. At the Government's request, an IDA-financed specialist will shortly begin to assist the Center in broadening the scope of the study to take into account all types of construction and to address the full range of constraints. Also, the U.K. is financing a construction unit to train staff in feeder road construction techniques, with emphasis on on-the-job training and self-help projects. PART IV - THE PROJECT 33. The feeder road component of the proposed project was identified in late 1973 on the basis of a UNDP-financed road feasibility study carried out during 1971-1973 by COALMA (Italian consultants). After delays in engaging consultants for further feasibility studies and detailed engineering, the project preparation work, undertaken by N.D. Lea and Associates (Canadian consultants), began in January 1976. The Thankot-Naubise Road upgrading component was identified by the Government in March 1976. The project prep- aration work was carried out by the Government's Roads Department with IDA assistance in early 1977, and the detailed engineering is well underway (com- pletion expected in late 1977). The road maintenance component was first discussed in 1973 and was prepared by the Roads Department, with IDA assist- ance. At the request of the Government, the project was appraised in November 1976. A report entitled "Nepal - Appraisal of a Second Highway Project (No. 1439a-NEP)" is being distributed separately to the Executive Directors. Negotiations were held in Washington, D.C., during May 3-4, 1977. The Gov- ernment was represented by a team led by Dr. D.R. Panday, Additional Secretary, Ministry of Finance. A. Project Description 34. The proposed project would provide equipment for the construction of a 50-km feeder road, together with improvements to connecting local roads. It would also provide for the upgrading, on the existing alignment, of the mountainous Thankot-Naubise section (17.5 km) of the main Kathmandu-Indian border road. In addition, it would provide equipment, spare parts, and workshop facilities and equipment in support of a nationwide Five-Year Road Maintenance Program (FY1978-1982). Consultants' services would be included for: (i) the feasibility studies and detailed engineering for the feeder road, as well as assistance in construction supervision; (ii) feasibility studies for the remaining 190 km of the East-West Highway; and (iii) assistance in technical investigations. Finally, the project would provide for the training of construction and maintenance equipment mechanics. Feeder Road Construction 35. The feeder road (50 km), to be constructed in the Far-Western Re- gion, would improve the link from the East-West Highway in the Terai to the  - 10 - Dang Valley. Within the Valley, the proposed road would link the main trading town of Ghorai to the new government administrative (Zonal) headquarters at Tulsipur. The project would also include culverting and other minor improve- ments to numerous local roads and tracks. While construction would be pri- marily labor-intensive, some construction equipment would be provided under the project for heavy work. The equipment would be rented (at commercial rates) or sold to contractors working on the feeder road either outright or on a hire/purchase basis. The Government would maintain its equipment in good operating condition (Section 3.07(i) of the Development Credit Agreement). On completion of the construction, the rented equipment may be sold to con- tractors, and the workshop would be used to house a maintenance unit for the feeder and other roads in the area. For equipment not sold, the Government would arrange for the equipment to be made available to contractors on other road works or included in the Department's road maintenance fleet (Section 3.07(ii) of the Development Credit Agreement). To avoid difficulties for the contractors, the Government would not charge a road cess on the feeder road during the construction period (Section 4.05(i) of the Development Credit Agreement). Main Road Upgrading (Thankot-Naubise) 36. The 17.5 km section of the main road between Kathmandu and the Indian border is located between Thankot in the Kathmandu Valley and Naubise, the junction with the main road to Pokhara. This is the most heavily-used road in Nepal, presently serving about 300 vehicles per day (about 80% trucks and buses). Upon completion of the upgrading in 1980, the traffic is expected to increase to about 375 vehicles per day. The present alignment is tortuous, traversing a mountain pass subject to landslides which, during the rainy season, often block the road for several days. The road surface is in poor condition with frequent undulations and jagged edges, and many sections have failed completely. Also, side drainage is poor and several bridges need to be replaced. Upgrading work would comprise pavement widening (from 3.5 to 6.5 meters), minor realignments, drainage improvements, and landslide pro- tection. No disbursements would be made until the Association approves the detailed engineering, contract drawings, specifications, construction program and arrangements for construction supervision (Schedule 1, para 4(ii) of the Development Credit Agreement). Five-Year Road Maintenance Program (1978-1982) 37. The Five-Year Road Maintenance Program, prepared by the Roads De- partment in late 1976, is aimed at achieving adequate road maintenance on the 2,700 km of main roads within the country's existing network (4,200 km) and the expected network increase of 1,600 km during the period. While the Program is under continuous review by the Department, a technical assistance team would provide a detailed review and make recommendations for improve- ments and assist in its implementation. The services would include, inter alia, technical assistance in planning, programming and budgeting during the initial critical stages of the Department's decentralization program, project preparation procedures. reevaluation of rcad maintenance equipment and materials, spare parts and tools, facilities, and man-power requirements and other recurrent costs, training of road overseer-s aad other technical  - 11 - staff, and assessing additional staffing and training needs. The Government would employ such a technical assistance team on terms and conditions satis- factory to the Association (Section 3.02(b) of the Development Credit Agree- ment), and arrangements are nearly completed for the Canadian International Development Agency (CIDA) to finance the team (four specialists for an initial period of 18 months each beginning September 1977). For mechanics' training, the International Labor Organization (ILO) has agreed, at the Government's request, to assist in the preparation and execution of a program which the Association considers suitable. 38. As presently conceived, the Program covers the Department's esti- mated needs for equipment and materials, spare parts and tools, workshops (in the Eastern and Western Regions), including recurrent costs, to maintain the country's main roads. The total expenditure is estimated at NRs 330 M, in- cluding NRs 130 M in capital costs and NRs 200 M in recurrent costs. The pro- posed credit would finance about 67% of the capital expenditures (NRs 89 M). The Government would require the technical assistance team to review the Program in detail and make its recommendations by March 31, 1978 (Section 3.03(i) of the Development Credit Agreement). Also, the Government would, with respect to the Program, review and exchange views with the Association regarding the team's findings and major recommendations (Section 3.03(ii) and Section 3.03 (iii) of the Development Credit Agreement) and carry out recom- mendations mutually-agreed with the Association (Section 3.03(iv) of the De- velopment Credit Agreement). In addition, the Government would release funds required for the Program in a timely fashion, including adequate funds for the procurement and maintenance of road maintenance equipment (Section 3.03(v) of the Development Credit Agreement). The funds required are in keeping with the amounts the Government is presently allocating for this purpose. Consultants' Services 39. The Road Department's consultants (N.D. Lea and Associates, Canada) prepared the feasibility studies and detailed engineering for the feeder road during 1976 (about 44 actual man-months). Prior to the award of any construc- tion contracts, the Government would engage an engineer to assist with con- struction supervision having qualifications and experience acceptable to the Association, and on terms and conditions acceptable to the Association (Section 3.02(a) of the Development Credit Agreement). The Government has requested that N.D. Lea and Associates provide an engineer to perform this function, as well as to train on-site Department staff and local contractors in road construction techniques (estimated at 38 man-months). 40. The consultants' services also include the preparation of a four- month pre-feasibility study for the remaining unbuilt section of the East-West Highway (190 km) in the Far-Western Region (estimated at 18 man-months). If the study (expected to be completed by January 1978) indicates that further project preparation work is justified, funds provided under the project would be used for this purpose (about 32 man-months). These studies are intended to provide the basis for the Government to request external financing for con- struction. To carry out the studies, the Government would engage consultants with qualifications and experience acceptable to the Association, and on terms and conditions acceptable to the Association (Section 3.02(a) of the Develop- ment Credit Agreement).  - 12 - 41. In addition, the consultants' services to be financed under the proposed credit include investigations of pavement and slope stability related to the improvement of a mountainous Thankot-Naubise section of the main Kathmandu-Indian border road, that were carried out during 1976 (4 actual man-months). Mechanics' Training 42. The mechanics' training program, to be prepared and executed by the Government with ILO assistance, would (i) upgrade the Road Department's staff of mechanics and recruits, and (ii) train school-leavers over a three- year period. Two trainers would be provided for an initial period of three years to assist the Engineering Institute of Nepal in conducting the program. The Government would submit the proposed program to the Association for approval by December 31, 1977 (Section 3.09(i) of the Development Credit Agreement). B. Prolect Execution 43. The Roads Department would be responsible for the overall execution of the project. With the equipment, other capital inputs, technical assist- ance, and training to be provided under the project, the Department is capable of carrying out this responsibility. The Government would improve the col- lection of vehicle registration data so that a more accurate estimate of the running fleet is available (Section 4.02(b) of the Development Credit Agree- ment). The Government would also strengthen the Planning Branch of the Roads Department, in order to upgrade its capability to undertake appropriate economic and technical analyses for all major investments in the highway sector (Section 4.06 of the Development Credit Agreement). Recognizing the inefficiencies in levying a road cess (i.e. high administrative costs and disruption in traffic flow), the Government would arrange for a study to investigate, by June 30, 1978, under terms of reference approved by the Association, practical methods of raising revenues in the transport sector alternative to the road cess, and implement recommendations mutually-agreed with the Association (Sections 4.05(ii) and 4.05 (iii) of the Development Credit Agreement). 44. For the feeder road construction, technical assistance would be provided by the Canadian consultants, N.D. Lea and Associates. For the Thankot-Naubise road upgrading, the Government agrees that a consultant for construction supervision is required and arrangements for securing financing for the consultant are underway. For the Five-Year Road Maintenance Program, the Department would be assisted by the CIDA-financed team (para 37). 45. In addition to the ILO-assisted mechanics' training program (para 42), the Department would undertake training of its other staff, and the Government would, by July 31, 1978, submit a Departmental training program to the Association for approval (Section 3.09(ii) of the Development Credit Agreement).  - 13 - C. Project Costs and Financing 46. The total project costs are estimated at US$20.0 M equivalent, in- cluding about US$5.1 M equivalent in physical and price contingencies. The proposed credit of US$17.0 M equivalent would finance about 87% of the proj- ect costs (net of taxes), including foreign exchange costs of US$14.3 M equiv- alent and local costs of US$2.7 M equivalent. Local cost financing is justi- fied for the reasons discussed in para 15. Retroactive financing up to US$0.4 M is included for feeder road construction equipment. In addition, retro- active financing up to US$0.5 M is included for expenditures already incurred for consultants' services (paras 39 and 41). The Government's contribution to the financing would amount to US$2.6 M equivalent (net of about US$0.4 M equivalent in taxes and duties), or about 13% of net project cost. The cost estimates for equipment for road construction, maintenance and workshops are based on recent preliminary quotations by manufacturers. The cost estimates for the feeder road contruction are based upon the consultants' detailed engineering and the costs of recent similar works in the area. Actual costs are included for the feeder road feasibility studies and detailed engineering, whereas the costs for construction supervision are based on detailed time schedules and expected foreign and local staffing rates. For the Thankot- Naubise road upgrading, the cost estimates are based upon the Roads Depart- ment's preliminary engineering (to be updated upon completion of the detailed engineering) and the costs of recent similar works nearby. The cost of the East-West Highway studies are based on costs under similar conditions else- where in Nepal. The major elements included in the cost estimate are feeder road construction including equipment (US$4.0 M); main road upgrading (US$1.5 M); road maintenance equipment, spare parts and workshops and tools (US$7.1 M); consultants' services, at an average cost of US$75,000 per expatriate man-year, including a billing rate of US$4,900 per man-month (US$1.5 M); and mechanics' training (US$0.8 M). Physical contingencies are estimated at US$1.9 M (20% for upgrading the Thankot-Naubise road and 10% for other civil works, road construction and maintenance equipment and consulting services). Price con- tingencies are estimated at US$3.2 M (12% and 8% annually, respectively, for civil works and for road construction and maintenance equipment and consulting services). D. Procurement and Disbursement 47. The road construction and maintenance equipment, spare parts, and workshop machinery and tools would be procured under international competitive bidding (ICB), while contracts for the construction of the workshops would be awarded on the basis of local competitive bidding (LCB). Feeder road con- struction would be divided into about ten contracts, ranging between US$100,000- US$300,000 equivalent, with prequalified contractors able to bid on one con- tract or any combination. The contracts for the Thankot-Naubise road upgrad- ing would be divided and awarded in a similar manner. Prequalification would be open to local and foreign contractors. All procurement would be in accordance with the Association's "Guidelines".  - 14 - 48. The Department's conditions of contract have been recently revised to put contractors and construction agencies of the Government on an equitable footing, including the introduction of procedures for arbitration and provi- sions for inflation adjustments. Under the project, the Government would take additional steps to assist the local contracting industry, e.g. (i) contractors awarded contracts would receive a 15% cash advance against a suitable guarantee; (ii) contractors would have options concerning the use of equipment, including providing their own equipment, hiring it from the Department, or using the cash advance to purchase equipment with import assistance from the Government; and (iii) technical assistance in road construction techniques would be made available to contractors by N.D. Lea and Associates' construction supervision advisor. 49. To take advantage of the earliest construction season and overcome prolonged delivery schedules, bids for the feeder road construction equipment were invited in January 1977 in accordance with IDA guidelines, and are now being awarded for delivery from about end-1977. Bids for the feeder road construction were called in May 1977 and are expected to be awarded shortly after credit effectiveness in time for construction to begin at the end of the monsoon (November 1977). Disbursements are based on a 4-1/2-year construction period. Bids for the Thankot-Naubise road upgrading would be invited in late 1977 with a construction period of 24 months. Bids for the first of two groups of road maintenance equipment and spare parts would be invited in August 1977 in accordance with IDA guidelines, with delivery expected about one year later. Bids for workshop construction would be invited about November 1977, after the layouts have been reviewed by the CIDA-financed team. The CIDA-financed team would begin work in September 1977 for an initial period of 18 months. The team's services are expected to be extended to cover satisfac- tory implementation of the Five-Year Road Maintenance Program. The Government and the Association have reached an understanding on the project implementation schedule and reporting requirements. 50. Disbursements from the proposed credit would be made for: (i) 100% of the foreign expenditures for imported road construction and maintenance equipment; (ii) 75% of the civil works for the feeder road construction (ex- cluding the purchase of contractor rental equipment), Thankot-Naubise road upgrading, and the road maintenance workshops; (iii) 100% of the costs for consulting services; and (iv) 100% of the foreign expenditures for mechanics' training. E. Project Benefits and Risks 51. The main purpose of the project is to assist the Government in de- veloping the institutional capability within the Roads Department for expand- ing and maintaining the road network so as to provide the basis for economic development to take place. Specifically, feeder road construction and im- provements provide the reliable access required for stimulating agricultural production and other directly-productive activities. Main road upgrading provides more dependable traffic flow on the only road connection between  - 15 - Kathmandu and the Indian border, as well as the eastern and western parts of the country. Improved road maintenance helps to preserve the substantial investments Nepal has recently put into the network, as well as to lower user costs. The weighted-average economic rate of return (ER) for the entire proj- ect is estimated at 28%. Based upon experiences with IDA's Highway I project, the risks include administrative delays in procurement and extended construc- tion time due to inclement weather and inefficiencies caused by remoteness of area. The possible effect of these risks on construction and maintenance costs, as well as lower growth in traffic have been taken into account in the preparation of this second project and are considered to be within reasonable limits. 52. The feeder road component will provide nearly all-weather and year- round access to and within the Dang Valley. Wet season access (June-October) is not possible at present because the numerous river crossings become flooded and the soils become soft and slippery, particularly in the mountain sections. About 85% of the benefits from the component would result from increased agri- cultural production, while the remainder would result from lower user cost savings. With the improved access, agricultural production is forecast to increase due to reduced transport costs for farm inputs and the marketing of farm products, and the availability of increased agricultural extension ser- vices. Recently, in anticipation of the construction of the feeder road component, the Government and USAID agreed to include the Dang Valley in the ongoing USAID-sponsored Basic Cereals Program which promotes agricultural research, development and extension of rice and other foodgrains. Even with this minimum package of farm inputs and agricultural services, the ER for the component is estimated at 30%. If construction costs (about 25% of project cost) were to be 20% higher and benefits from agricultural production 20% lower than assumed in these calculations, the ER would be about 24%. In addition to the Basic Cereals Program, the Government and USAID are presently preparing a comprehensive regional development project which would include the Dang Valley, as well as surrounding districts. Based on these efforts, the Government will endeavor to prepare a development program for the Dang Valley before 1979, and begin implementation of the program before 1980 to coincide with the completion of the project road. 53. The main benefits from upgrading the Thankot-Naubise road would arise from reductions in user costs and avoidance of emergency maintenance and reconstruction costs and time losses due to landslides. With the improvement, the average annual expenditure for emergency maintenance and reconstruction costs is expected to be reduced from about NRs 1.2 M to about NRs 0.2 M. Other benefits would arise from the improvement of the pavement since the structural strength of the existing pavement is inadequate and resurfacing is needed about every two to three years rather than the normal six-year cycle. Assuming an annual traffic growth of 5% for the first 10 years following the upgrading, the ER is estimated at 14%. If the construction costs (about 10% of project cost) were to be 20% higher and the benefits 20% lower, the ER would be about 8%. 54. Benefits from the road maintenance component would constitute savings from (i) deferment of future reconstruction costs; (ii) reduced future mainte- nance costs; and (iii) lower user costs (vehicle operating and time costs).  - 16 - Using only the savings in user costs as a convenient and conservative proxy of the benefits, and projecting a 9% growth rate in total annual vehicle-km, the ER over an eight-year period is estimated at 30%. Even if maintenance costs (about 40% of project cost) were 20% higher and benefits 20% lower than assumed in these calculations, the ER is estimated at 12%, and the component would merit high priority. PART V - LEGAL INSTRUMENTS AND AUTHORITY 55. The draft Development Credit Agreement between the Kingdom of Nepal and the Association, the recommendation of the Committee provided for in Article V, Section 1 (d) of the Articles of Agreement, and the text of a draft resolution approving the proposed credit are being distributed to the Executive Directors separately. 56. Special conditions of the project are listed in Section III of Annex III. 57. I am satisfied that the proposed development credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 58. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President by J. Burke Knapp Attachments June 24, 1977  * S~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ W S 0