Nepal - Grain Storage Project

Document of The World Bank FILE COPY FOR OFmICIAL USE ONLY 3qggtNe. P-2867-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 GRAIN STORAGE PROJECT August 6, 1980 This domet bas a rstrlcted distributio and may be _ed by recipients oly in the pufmance of thor kii dties. ts coteuts may not oterwise be dseloed witbout Wodd Bank admthizatIon.  CURRENCY EQUIVALENTS Currency Unit - Nepalese Rupee (NR) Since March 20, 1978 US$1.00 = NRs 12.00 NR 1.00 = US$0.08 NRs 100 = US$8.33 FINANCIAL YEAR July 16 - July 15 ABBREVIATIONS AND ACRONYMS ADBN - Agricultural Development Bank of Nepal AMC - Agricultural Marketing Corporation APROSC - Agricultural Projects Services Center DCA - Development Credit Agreement FAMSD - Food and Agricultural Marketing Services Department FPCC - Food Policy Coordination Committee HMG - His Majesty's Government of Nepal MFA - Ministry of Food and Agriculture MSU - Management Support Unit MT - metric ton NFC - Nepal Food Corporation PA - Project Agreement PMCC - Project Management and Coordination Committee PEU - Project Engineering Unit REC - Rice Export Company SDRs - Special Drawing Rights  FOR OFFICIAL USE ONLY NEPAL GRAIN STORAGE PROJECT Credit and Project Summary Borrower: Kingdom of Nepal Beneficiary: Nepal Food Corporation (NFC) Amount: Special Drawing Rights 4.8 million (US$6.2 million equivalent as of date of negotiations). Terms: Standard Terms to NFC: The Government would pass on US$5.9 million equivalent of the proceeds of the credit to NFC as equity contri- bution. Project Description: The proposed project would assist the Government in imple- menting its foodgrain policies by providing good storage facilities and strengthening NFC and the Rice Export Companies (RECs), so that they may be able to meet food- grain procurement, distribution and export requirements and reduce quantitative and qualitative storage losses. The project would also provide necessary information for further development of the storage, processing and dis- tribution sub-sector and for future Government foodgrain marketing and price policy formulation. The project would consist of: (i) construction of 40,000 MT of bagged grain storage warehouses comprising 37,000 MT storage capacity at eight procurement centers in the Terai and a 3,000 MT transshipment storage facility at Hetauda; (ii) technical assistance for NFC in management and organization, and in finance and accounting, and for NFC and RECs in grain quality control and godown maintenance; (iii) training and study tours for NFC and RECs managers; and (iv) studies on future needs for foodgrain storage and processing facilities and on foodgrain marketing and price policy. The project faces no special risks. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Estimated Cost US$ Million Equivalent of Project: Component Local Foreign Total I. Storage Facilities Land 0.04 - 0.04 Civil Works 1.79 1.47 3.26 Equipment 0.16 0.46 0.62 Subtotal 1.99 1.93 3.92 II. Project Engineering Unit Vehicles 0.01 0.03 0.04 Operation 0.09 0.21 0.30 Subtotal 0.10 0.24 0.34 III. Technical Assistance and Training 0.11 0.63 0.74 IV. Studies 0.18 0.08 0.26 Base Cost 2.38 2.88 5.26 V. Contingencies Physical 0.28 0.29 0.57 Price 0.64 0.78 1.42 Subtotal Project Cost 3.30 3.95 7.25 VI. Duties and Taxes 0.79 - 0.79 TOTAL PROJECT COST 4.09 3.95 8.04 Financing Plan: US$ Million Equivalent Local Foreign Total IDA 2.25 3.95 6.20 Government 1.80 - 1.80 NFC 0.04 - 0.04 Total 4.09 3.95 8.04 Estimated IDA US$ Million Equivalent Disbursements: IDA FY 1981 1982 1983 1984 Annual 0.10 1.91 2.67 1.52 Cumulative 0.10 2.01 4.68 6.20 Rate of Return: 18% Staff Appraisal Report: No. 2862-NEP dated July 24, 1980.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A GRAIN STORAGE PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal for Special Drawing Rights (SDRs) 4.8 million (US$6.2 million equivalent as of the date of negotiations) on standard IDA terms to help finance a Grain Storage Project. The Government would pass on US$5.9 million equivalent of the proceeds of the credit to the Nepal Food Corporation as an equity contribution. PART I - THE ECONOMY 1/ 2. The most recent economic report entitled "Nepal-Development Perform- ance and Prospects" (Report No. 2692-NEP) was distributed to the Executive Directors on December 14, 1979. The principal findings of the Report are described below. Country data are shown in Annex I. 3. Nepal is one of the least developed countries in the world. Per capita income is estimated at $110 (1977), and health and education standards are well below the average of South Asia: life expectancy at birth is about 45 years, infant mortality 150 per thousand, and adult literacy 19%. The population, growing at the rate of 2.6% a year, is estimated to be 13.3 million (1978). Over 90% of the population live in rural areas. 4. The economy of Nepal centers around agriculture. It accounts for more than 60% of GDP and 75% of merchandise exports, and provides a livelihood to over 90% of the population. In addition, most of the industrial sector, which comprises about 9% of GDP, processes agricultural raw materials. About 25% of total rural incomes are estimated to arise from non-agricultural activities. Cottage industries are one of the most important of these, engaging over 1 million people and comprising about 6% of GDP. They provide basic consumer goods in the many small isolated markets where such goods would otherwise not be available. 5. As a small open economy, Nepal is highly susceptible to develop- ments in India. The Terai, which lies along the Indian border, has close and virtually free trading links with India, and accounts for about 60% of the country's GDP, and about 40% of the population. The Kathmandu Valley, the administrative and commercial center, is closely linked with the Terai, but at significant transportation costs. The rest of the country, the Hills and Mountains, is almost inaccessible and consists of a large number of fragmented markets. 1/ Part I of this Report is substantially the same as 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 Third Water Supply and Sewerage Project (Report No. P-2862-NEP of July 8, 1980).  -2 - 6. When Nepal adopted economic and social development as major govern- ment objectives in the early 1950s, there was virtually no economic or administrative infrastructure. Initial development efforts were necessarily concentrated on establishing a foundation for future development. During these early stages, it was inevitable that growth would remain slow and that there would be little if any increase in per capita income. However, the Fifth Development Plan (1975/76 - 1979/80) was to be a turning point; it was believed that the country was poised for more rapid growth on the order of 4 - 5% annually. The level of investment was to increase substantially and its focus to shift towards the more directly productive sectors and the social services. 7. Public investment performance has been excellent; development expenditures have grown at over 15% annually in real terms and the Government has been relatively successful in reorienting investment away from the trans- port sector towards agriculture and the social services. However, few of the other Fifth Plan objectives have been achieved. The GDP growth rate is likely to average only 2.4% per year, mainly because of poor agricultural performance. Little progress has been made in increasing agricultural productivity and agricultural production increased at an annual rate of only 0.7% during the first four years of the Fifth Plan. Growth in other sectors has been mixed, with the poor agricultural performance limiting the growth of agro-related industries. Production in several large industries including jute goods, sugar, leather goods, and cement have increased but most Fifth Plan targets will go unmet. In the services sector, tourism has been dynamic, but it still only contributes about 1% of GDP. 8. The economic situation deteriorated markedly in 1979/80 and is now worse than it has been in many years. The poor monsoon in South Asia in 1979 has had a severe impact on Nepal's foodgrain production in 1979/80. Both the maize and rice crops suffered major losses, and as a result, agricultural production is likely to decline by 4%. The non-agricultural sector continues to be constrained by supply bottleneck problems and delays in the preparation of new development projects in the public sector. This sector's growth is expected to be only about 4% in 1979/80, which when combined with the decline in agriculture, gives a 1% decline in GDP. 9. The disappointing overall performance of the domestic economy during the Fifth Plan period has been accompanied by a widening trade deficit. Imports have grown under the impetus of the Government's development program while the trend in export earnings has been sluggish due to declining rice exports. The deterioration on the trade account has been partly covered by increased tourism receipts and remittances from Gurkhas (soldiers from Nepal serving in the British or Indian armies). Foreign assistance in the form of grants and concessionary financing have generally ensured that the overall balance remained in surplus. Foreign exchange reserves in July 1979 were equivalent to nearly nine months of imports. However, the shortfall in food- grain production in 1979/80 could have a serious impact on Nepal's external position, since not only will rice exports further decline, but foodgrains will have to be imported, this all coming at a time when Nepal's oil bill is rising steeply. The Government has therefore appealed to the international community for emergency assistance in obtaining foodgrains and for help in  distributing food to the shortfall areas; by the end of January 1980 donors had committed 33,000 tons of foodgrains. 10. On March 31, 1978, the authorities replaced a complex system of multiple exchange rates and exchange and trade restrictions with a dual exchange system. Transactions with India, which were virtually free from restrictions, were unaffected by these changes. New treaties on trade and transit with India were also concluded in March 1978. Under the dual exchange rate system, Nepal maintains a basic rate of NRs 12.00 per dollar, with a second, premium rate applying for all merchandise trade with third countries except for imports of certain development goods. On February 21, 1980, the premium rate was changed from NRs 16.00 per dollar to NRs 14.00 per dollar, but the exemption was restricted to only imports of petrol and petroleum products, cement and chemical fertilizers. These exchange rate adjustments involved an appreciation of about 14% for exports to third countries and an overall appreciation of about 2% for imports from third countries. But this was partly offset by (i) withdrawing the 12% duty on exports of raw jute; and (ii) raising import duties on a wide range of imports from third countries. However, with the exception of raw jute exports, earnings in domestic currency from exports to third countries will decline, leading to a possible shift of some exports to India. The overall trade balance is likely to be adversely affected by the recent measures. 11. The poor long-run performance of the economy is chiefly due to the failure of agricultural production to keep pace with population growth. Over the period 1967-77, foodgrain production grew at an average annual rate of only 1.5%. Increases in the area under cultivation account for almost all of this, since average yields rose by only 0.1% annually. Although poor monsoons have adversely affected agricultural production, the more fundamental reason is the failure to more fully exploit the irrigation infrastructure. In the past, insufficient attention has been paid to bringing water down to the farm level and this has been compounded by inadequate support services such as extension and research, timely supplies of improved seed and fertilizer and other inputs, credit and farm-to-market roads. However, recent major irriga- tion projects financed by IDA and the Asian Development Bank are addressing these problems by taking more comprehensive and integrated approaches. 12. In the Hills and Mountains, which contain only one-third of the country's agricultural land and yet have nearly two-thirds of the population, population pressures have pushed cultivation up steep hillsides and onto marginal land; average yields have actually declined. Population density on agricultural land in these areas is higher than in Bangladesh. Malnutrition is acute; food production meets only two-thirds of minimum subsistence needs. Because they have little to trade except their labor, one-third of the inhab- itants of these Hill areas migrate seasonally to the Terai plains and northern India for food and work. Since the early sixties, an estimated 400,000 have migrated permanently, and there are signs that this exodus is accelerating. 13. The seriousness of the economic and social problems confronting Nepal calls for a well focused development strategy that directly addresses the difficult choices to be made. The revised Fundamental Principles of the  Sixth Plan recently adopted by the Government and endorsed by members of the Nepal Aid Group at its January 31, 1980 meeting, is an important milestone in the Government's efforts to evolve a program that meets Nepal's needs. The highest priority is placed on developing agriculture, including revitalization of Hill food nroduction to meet local requirements since significant agro- climatic specialization between the Hills and Terai is feasible only in the longer run. At the same time, since land holdings in the Hills are too small to generate much more than subsistence needs, programs will be started to encourage diversification into other activities such as small-scale and cottage industries to supplement Hill incomes. For the Terai, the strategy is to continue efforts to realize the Terai's considerable potential for increasing production of foodgrains and cash crops. The irrigation infrastructure is to be more fully utilized and improvements to extension services and associated inputs concentrated on those areas with irrigation facilities. Rural electri- fication is seen as an important element in providing for increased production in rural areas. Reafforestation programs are given priority in order to provide fuelwood and fodder as well as to reduce soil erosion. 14. While these efforts in the directly productive sectors merit urgent attention, Nepal faces similar challenges in developing its human resources. Although curbing population growth requires major actions, selective programs in education and health can greatly assist population planning as well as alleviate human suffering and lay the basis for future increases in productiv- ity. The Government's strategy recognises that the approach must be selective since programs for meeting basic needs generally have only a long-term impact on manpower development but divert resources away from activities more directly and immediately related to production. Increasing foodgrains production will meet the major need of improved nutrition. Better and more readily available supplies of drinking water and fuelwood will meet other needs, while also freeing labor currently spent in their collection. Basic health facilities are to be expanded through integrated community health posts, while in educa- tion, stress is placed on improving the quality of primary and adult vocational education. Family planning programs are to be stepped up. The other basic need to be met in rural areas is improved transport, and the Sixth Plan will include programs to improve trails, tracks, and suspension bridges. 15. For Nepal to establish a basis for more rapid and sustained growth, the structure of its economy will need to change since its present dependence on agriculture limits the economy's overall growth potential to about 4% per year. Tourism offers perhaps the best near-term potential for increased foreign exchange earnings; however, efforts are needed to reduce its capital intensity, strengthen linkages with other local industries and extend its benefits beyond the Kathmandu Valley. Hydropower also offers some possibil- ities, but neither it nor tourism will ever be substantial generators of employment. In the long run, Nepal must diversify and develop its industrial sector. Obviously, efforts in this sector must be on a highly selective basis. The multiplicity and complexity of the constraints to industrial development, including the lack of natural resources and a skilled labor force, as well as Nepal's small domestic market and landlocked position will nullify any general- ized approach. Public enterprises need to operate more efficiently, village and cottage industries should be promoted. Beyond this, joint ventures with  -5- India, for example, as in cement production, may be attractive. The precon- ditions for industrialization must be established in the near future or there is a danger that Nepal will always be struggling to move its economy beyond subsistence. These include providing financial incentives, research and extension services on the technical, financial and marketing aspects of enter- prise, and the upgrading of manpower skills in the areas where Nepal may have a comparative advantage. 16. Nepal has made significant progress in mobilizing domestic resources to support its development efforts, considering the extreme poverty, low degree of monetization, and fragmented nature of the economy. Revenue grew at 16% a year in current terms between 1969/70 and 1978/79, while as a percentage of GDP it increased from 5% in 1969/70 to about 9% in 1978/79. Over the same period, the Government was able to maintain savings on current account in excess of 2% of GDP, a good achievement for a country in Nepal's economic position. However, this excellent record is now in jeopardy. Revenues from income and land taxes declined in 1978/79 and although total revenues grew by 14%, the bulk of the increase came from taxes on international trade as a result of higher imports. No real growth in total revenues is expected during 1979/80, after allowing for inflation. This slowdown reflects not only the weak economy in 1979/80, but also the impact on the tax system of the political difficulties facing Nepal. While only limited scope exists for discretionary tax measures, there is a potential for increased tax revenues from agriculture, particularly in the Terai. Revenues could be increased through improving the tax machinery, and the government has approved, in principle, various admin- istrative reforms in this direction, including the formation of a Special Revenue Service. 17. Foreign assistance has been a decisive factor in Nepal's development. During the Fifth Plan, foreign financing equalled about 45% of development expenditures. In view of the limited prospects for increased domestic resource mobilization, foreign financing requirements may be about 60% of planned Sixth Plan development expenditures, which amount to about NRs 10 billion or over $800 million at 1979/80 prices. Aid commitments need to average about $225 million annually during 1980-82 compared with $160 million during 1977-79. However, even this level of foreign assistance would not provide the Government with sufficient resources to meet increasing consumption demands. Additional aid, either through financing a higher proportion of total project costs or in the form of commodity assistance, could provide budgetary support to meet pressing recurrent expenditure requirements, particularly in the social sectors. The Nepal Aid Group was formed in 1976 to assist in the overall coordination of financial and technical assistance efforts. The Group has met three times at plenary meetings under the Chairmanship of the Bank to discuss overall external assistance needs as well as at the local level in Kathmandu to discuss and coordinate strategy. At the latest plenary meeting, which was held in Paris on January 31, 1980, and was attended by representatives from eight countries and six international organizations, Nepal received aid indications exceeding US$200 million equivalent. 18. Although foreign aid commitments and disbursements grew by over 25% annually during the Fifth Plan period, only 40% of disbursements included in the Government's budget were from foreign borrowing, the remainder being grants. As of December 31, 1978, official foreign debt outstanding was only  -6- $88 million, of which $i5 million was due to multilateral agencies. These loans were obtained on a highly concessional basis and the grant element of total aid remains in excess of 90%. As a result, debt service payments were only US$3.1 million during 1978/79, equivalent to less than 2% of exports of goods and services. Medium-term prospects are also good; by 1981/82 total service on existing debt is expected to amount to only US$5.1 million, still less than 2% of projected goods and services exports. PART II - BANK GROUP OPERATIONS IN NEPAL 19. Bank Group operations in Nepal began in FY70 with an IDA credit of US$1.7 million equivalent for a telecommunications project. Since then, 20 additional credits have been approved, bringing total IDA assistance to Nepal to US$261.4 million equivalent, net of cancellations. In view of Nepal's many development needs, this assistance has been for projects in a wide variety of sectors. Six of these sectors account for 85% of IDA credits by amount: irrigation ($75.0 million for 5 projects); water supply and sewerage ($46.8 million for 3 projects), power ($40.8 million for 1 project); telecommunica- tions ($21.7 million for 3 projects); highways ($19.2 million for 2 projects); and rural development ($19.0 million for 2 projects). The remaining $38.9 million of IDA assistance has been for one project in each of the areas of settlement, technical education, tourism, technical assistance, forestry and industrial development financing. The proposed credit would be the second in FY81, bringing the total amount of IDA assistance to Nepal to US$267.6 million equivalent, net of cancellations. No Bank loans have been made to Nepal. IFC made its first investment in Nepal ($3.1 million) in a hotel project in Kathmandu in FY75. Annex II contains a summary statement of Bank Group operations as of June 30, 1980, 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 assistance 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 FY78, US$11.8 million equivalent were disbursed compared to US$12.8 million equivalent disbursed during the entire previous seven years; disburse- ments during FY79 and FY80 indicate a further improvement, disbursing a further US$18.2 million and US$22.6 million equivalent, respectively. 20. Bank Group lending to Nepal has so far been at a modest level compared to the country's need for external assistance. The international community has 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 Nepal's limited absorptive capacity, affecting the pace of project preparation and implementation. The Bank is assisting the Government in project preparation through the Technical Assis- tance 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 organ- izing the Aid Group for Nepal (para 17). 21. The Bank Group's current strategy places major emphasis upon the directly-productive sectors (particularly agriculture) and the e-Telopment of complementary infrastructure, including feeder roads (particularly con- necting the Hills to the Terai), communications and hydroelectric power. Preparation of projects in irrigation, Hill food production, agricultural extension, cottage/small scale industry, technical education and power is under way. PART III - THE AGRICULTURAL AND FOODGRAIN SECTORS A. The Agricultural Sector 22. The agricultural sector dominates the Nepalese economy, accounting for more than 60% of GDP, providing employment to about 90% of the labor force, and constituting about 75% of merchandise exports, mostly foodgrains. Agri- cultural potential and practices vary widely among the country's three distinct geographic regions, which run parallel to each other from east to west. T e northern region accounts for 16% of the country's total area of 141,000 km and comprises the Mountains. Crop cultivation in this area is extremely limited and livestock is the main source of livelihood. The Hills amount to some 61% of total land area. With only about one-third of arable land, the Hills must support nearly two-thirds of Nepal's population. Cultivation is confined to the narrow valleys, plateaus and steep terraced slopes. Yields are low, and soil erosion is serious. The Terai lies to the south, and comprises 23% of the area; it consists of a narrow strip of alluvial plain and has traditionally produced an agricultural surplus which is the basis for Nepalese agricultural trade and exports. 23. In the 1970s agricultural production grew at only about 2.2% annually, below targets set in the Fourth and Fifth Plans of 2.8% and 3.5% per year, respectively. Growth has primarily come from area expansion, but further scope for this is limited. Inadequate institutional support, especially trained manpower, extension and credit services, provision of inputs and recurrent cost financing, are severe constraints on agricultural development. In the Hills the high cost of transportation exacerbates these constraints. B. The Foodgrain Sector Production 24. Foodgrain production accounts for 90% of total cropped area and 80% of the agricultural sector's value added. The major foodgrains are paddy, maize and wheat followed by millet and barley. Cereals, particularly rice, constitute the major portion of the Nepalese diet, and rice, the main crop, has accounted for about 30% of Nepal's merchandise exports. Paddy  - 8 - production, about 2.5 million MT a year, is mainly concentrated in the Terai, with less cultivation in the Hill areas. Use of modern inputs has remained low, and only about 10% of cropped area under paddy is irrigated. Maize, the second crop, is mainly produced in the Hills. Yields have declined in recent years. Production reached 740,000 MT in 1977/78. Wheat, a relatively new crop grown mainly in the Terai, has had the best production record of all foodgrains, having increased by more than 150% from 159,000 MT in 1966/67 to 411,000 MT in 1977/78, mainly due to the extension of the area under cul- tivation. Millet and barley, minor grains in terms of overall production, make a significant contribution to the diet in the Hill and Mountain areas, where their cultivation is concentrated. Overall performance of the foodgrain sector has not been encouraging, and per capita foodgrain production has actually declined since 1973. In addition to the effect of unfavorable weather conditions, inadequate inputs and organizational constraints, farmgate prices in the last years may have not been high enough to provide adequate incentive to increase production. Consumption and Exports 25. Cereal consumption is estimated to constitute some 80% and 85% of the Hill and the Terai diet, respectively. Due to a growing population and stagnating production, 26 out of 53 Hill districts are reported to have chronic foodgrain deficits. Therefore, the Government subsidizes distribution of foodgrains to the poor in deficit areas. Subsidized distribution has been increasing steadily from 21,900 MT in 1974/75 to an estimated 40,000 MT in 1978/79. On the other hand, rice exports have declined from 221,000 MT in 1975/76 to 39,200 MT in 1977/78,. before recovering somewhat in 1978/79 to an estimated 70,000 MT. With reduced demand from the traditional Indian market, Nepal has been actively seeking new export markets, but the poor quality of Nepalese rice, resulting in part from substandard storage conditions, has severely hampered this effort. Construction of better storage facilities would be an important step for upgrading Nepalese rice to improve its accept- ability in international markets, while the reduction in the present extensive storage losses would contribute to foodgrain availability. Marketing 26. It is reported that 30-40% of produced grains are traded. However, there are no reliable data on this trade. Due to shortage of storage facil- ities and need for cash, the large majority of farmers sell their produce shortly after harvest, when prices are usually lowest. They sell mainly to private traders, who often are also money lenders advancing farmers cash against future grain. Present policies require Sajhas (cooperatives) to procure any surplus grain from farmers. However, due to capacity constraints, they play only a minor role in foodgrain marketing. They sell procured paddy to Rice Export Companies (RECs), and the Nepal Food Corporation (NFC) has, from time to time, purchased wheat through them. There is considerable potential for additional involvement of Sajhas in the procurement for NFC and RECs; but coordination between these institutions would have to be improved, and NFC/RECs would have to assist Sajhas in developing necessary procurement and storage management expertise. RECs buy most of their needs from private traders and millers, while NFC depends on RECs for most of its rice purchases.  -9- Milling 27. There are only 50 modern mills in Nepal. Otherwise milling is carried out by traditional means, or using old equipment. The recovery rate in milling ar' the quality of milled rice would be greatly improved by the use of modern milling practices. Storage 28. On-farm storage is usually limited to grain for family consumption and for seed. Farmers in the Terai commonly store paddy in traditional outdoor or indoor bamboo and mud bins. In the Hills, the standard storage container for paddy is a woven bamboo cylinder. For maize, rack storage of cobs is practiced in all parts of Nepal and wheat is generally stored in earthenware pots, woven baskets and wooden boxes. Inadequate drying and poor storage facilities cause considerable losses from insect attack especially in the case of wheat and maize, which often suffer initial infestation in the field. For late paddy, harvested in October-December and dried to safe storage levels, insect infestation is a lesser problem, but rodent damage appears to be high. 29. Off-farm foodgrain storage is maintained by Sajhas, private traders, millers, NFC and RECs. Grain is invariably stored in bags. Sajhas procure and store paddy on behalf of RECs mainly in the Far Western Region, where market infrastructure is lacking. Sajha storage facilities have been in- adequate and some of them are being replaced by new well-designed multi-purpose facilities, financed by the Agricultural Development Bank of Nepal (ADBN). However no serious attempt has yet been made to introduce sound foodgrain storage practices, and pest control is largely ineffective. Rice mill storage is usually also of poor quality with inadequate protection against moisture and rodents. 30. Some of the godowns used by NFC and most of RECs' godowns have damp mud floors and are without protection against rodents and birds; fum- igation is often impracticable or ineffective because of internal structures obstructing the use of fumigation sheets, or is hampered by the proximity of many storage facilities to private residences. Protection against weather is frequently inadequate because of leaking roofs and poor ventilation; and unsuitable design prevents efficient grain movement. NFC and RECs manage- ments are now giving increased attention to proper storage practices and have recently begun to employ quality control staff. However, only limited progress has been made due to shortage of equipment and suitable godowns and inadequate experience. Although data on storage losses are scarce, NFC and RECs losses are estimated to reach about 7.5% per annum. 31. Sajha cooperatives own multi-purpose warehouses with a combined capacity of 37,290 MT, with additional 5,600 MT being constructed or proposed under ongoing Government programs. NFC and RECs warehouses, which directly serve the distribution and export activities, have a total capacity of 33,000 MT, of which 15,700 MT are located in the Terai. By April 1979, they had rented an additional capacity of 60,900 MT, bringing their combined total available storage capacity to approximately 100,000 MT. Most of the hired godowns are small (between 200 and 500 MT) and not suitable for long-term  - 10 - grain storage; some are rooms in residential buildings. These rented godowns are mostly widely scattered, badly located and not easily accessible by trucks. Storage under construction totals 26,300 MT, including 10,000 MT funded by UNDP and 12,750 MT by UK/ODA. These will replace some of the dilapidated warehouses. ODA is also providing technical assistance and training in quality control together with its financial assistance. C. Government Foodgrain Policies and Practices Policy Objectives and Formulation 32. The government foodgrain policy aims at making foodgrains available to the poor in food deficit areas at reasonable prices; stabilizing foodgrain prices; promoting foodgrain exports; and increasing foodgrain production by providing incentive prices to producers. The Government implements its policy through NFC and RECs. Responsibility for policy decisions in the sector rests with the Ministry of Food and Agriculture (MFA), with the Food and Agricultural Marketing Services Department (FAMSD) playing a crucial role. FAMSD collects price information, analyzes trade patterns, and prepares an annual Food Balance Sheet which presents the overall foodgrain situation in the country, assesses food surplus and deficit status by district and prepares recommendations for public sector grain procurement for public distribution programs in the defi- cit districts, and for the amount of rice exports. Subsequently, distribution quantities are agreed between MFA and NFC, and the overall export target as well as quotas for individual RECs are set by the Food Policy Coordination Committee (FPCC), which comprises the Ministers of Food and Agriculture, Finance, and Industry and Commerce as members; the Secretary, MFA as an observer; and the General Manager of NFC as ex-officio Executive Secretary. Foodgrain Distribution Policy 33. The Government program for subsidized foodgrain distribution is implemented by NFC. NFC distribution prices are determined by MFA which takes into account the remoteness of the deficit areas and concomitant transportation cost, in addition to local market prices and overhead expenses. Distribution prices are heavily subsidized with the biggest subsidy being provided in the Mountains and remote Hills. Total cost of the subsidy is estimated to have reached approximately the equivalent of US$4 million in 1977/78. Part of the subsidy is carried by RECs which have to sell to NFC, under an export levy scheme, tne equivalent of 20% of their rice exports at a concessionary price fixed annually by MFA. Such prices have in some cases been as low as 52% of RECs' procurement price. However, as rice exports declined, levy procurement has diminished, and NFC has been compelled to procure a growing amount of foodgrain directly at open market prices (mostly from RECs). 34. To ensure adequate food supplies for the Hills, especially in emergencies, and to stabilize prices during times of food shortages, HMG has recently adopted a food security program under the auspices of the World Food Program. Under this scheme, NFC is to maintain a foodgrain reserve stock of 5,000 MT at strategic locations in the Hills and 10,000 MT in the Terai and at trans-shipment centers such as Hetauda. Implementation of the program and effective price stabilization through maintenance of adequate buffer stocks are, however, constrained by inadequate storage facilities.  -11 - Foodgrain Export Policy 35. Until 1974, rice exports were in the hands of a few private traders, and went almost exclusively to India, where Nepal enjoyed an easily accessible market. Due to Nepal's long open border with India, a large p(tion of this trade was through informal channels, resulting in substantial foreign exchange and revenue losses to the Government. Since 1974, the Government has estab- lished eight RECs as joint ventures with the private sector traditionally involved in rice trading and milling, with the majority of the shares being held by the Government, and granted them a rice export monopoly. The main objectives of institutionalizing rice exports were to (i) provide incentive prices to paddy farmers; (ii) increase Government revenue by preventing customs and income tax evasion; (iii) increase Government foreign exchange earnings; and (iv) provide foodgrains to NFC at low prices, through the levy system, to meet food requirements in deficit areas. 36. During their first two years of operation, RECs were successful in meeting the stated objectives, with rice exports reaching a high of 221,000 Mi in 1975/76. But, rising local requirements and India's steadily increasing foodgrain harvests sharply reduced exports and RECs in some instances incurred financial losses. Part of RECs problems has been the result of the relatively low quality of Nepalese rice, partly due to the lack of proper storage facili- ties and quality control equipment. In July 1979, the Government removed RECs export monopoly, permitting private traders to resume rice exports, except government-to-government rice export which is reserved for RECs. Should internal food requirements continue to expand faster than production, Nepal's ability to export rice would be increasingly constrained by the dwindling surplus. Price Support Policy 37. The Government's price policy for foodgrains aims at assuring low and stable consumer prices while providing adequate incentives to producers. Each year the Government fixes a support price for the purchase of paddy and wheat by public sector institutions. However, a number of factors have reduced the effectiveness of the support price. Firstly, the price is fixed only after planting, thereby reducing the potential impact on producer deci- sions. Secondly, the long open border with India limits independent price decisions as differentials result in considerable grain movements across the border. Thirdly, although market prices have tended to be above support prices, profit margins for foodgrains have been below those for cash crops. Fourthly, the support price for paddy has remained constant for three years, and public sector direct procurement from farmers has been limited (para 26). In the east, the RECs have been purchasing rice mainly from millers and traders, thereby limiting direct effect of their operations on farmgate prices. Finally, for the price mechanism to be a more effective instrument of produc- tion policy better data would be required on the costs and returns of agri- cultural crops, supplemented by a further strengthening of public sector capability to implement Government price policy objectives. Therefore, NFC and RECs are being instructed to increase their direct procurement from farmers and through Sajhas. By the end of the Sixth Plan in 1984/85, such direct procurement is to reach 50% of the foodgrain marketed annually by  - 12 - farmers. Additional storage capacity for NFC/RECs would be crucial for meeting this objective. Nepal Food Corporation (NFC) 38. Until mid-1972, Government's foodgrain distribution policy was mainly concerned with the Kathmandu Valley. In 1972, widespread food short- ages compelled the Government to expand distribution operations nationwide and to that end, the Agricultural Marketing Corporation was established, to be succeeded by NFC in 1974. NFC's seven member Board of Directors, appointed by the Government, comprises representatives of the Ministries of Finance, Industry and Commerce, and Works and Transport, and of the Nepal Rastra Bank and FAMSD. Shortage of trained staff, inadequate management information systems, and weak financial and internal control systems constrain NFC's operations. 39. Until recently, the major portion of NFC's procurement took place in the form of the levy purchases from RECs (para 33). Due to declining exports levy purchases fell from 49,900 MT in 1975/76 to 17,800 MT in 1977/78. On the other hand, NFC procurement from RECs at prices covering RECs' cost rose from zero in 1975/76 to 15,100 MT in 1977/78. At the same time, NFC started to procure rice from traders and millers, and also commenced purchas- ing wheat and maize. In 1977/78, wheat and maize procurement were 9,600 MT, almost 20% of NFC's total foodgrain procurement. 40. NFC uses a national network of Sajhas and private dealers for distributing foodgrains. In remote Hill and Mountain areas, NFC sells directly to the public through its own field offices. Foodgrain distribution by NFC has increased from 21,900 MT in 1974/75 to 35,400 MT in 1977/78 and an esti- mated 40,000 MT in 1978/79. NFC estimates that distribution will reach 65,000 MT in 1984/85. Most NFC grain is distributed in Kathmandu Valley, but the share of the Mountain and Hill regions has been growing and will expand further as food deficits increase in these regions. Since transportation costs, especially to Hill and Mountain districts, are very high (exceeding 500% of the grain procurement price in some cases), proper inventory management and transportation planning will become increasingly important. 41. Decreased levy procurement of rice and increased market purchases to meet growing distribution needs at strictly controlled prices have caused NFC's financial position to deteriorate seriously. Accumulated losses are estimated at about NRs 65 million at the end of FY1978/79. Due to increasing distribution requirements, annual deficits are rising steadily and are pro- jected to reach about NRs 71 million by 1984/85. These deficits have so far been funded almost exclusively through bank borrowings, aggravating NFC's financial problems. Rice Export Companies (RECs) 42. Foodgrain procurement of each of the eight RECs established by the Government (para 35) is limited to one Zone, except for the Seti and Mahakali Rice Export Company which covers two. Each REC is governed by a Board of Directors consisting of nine members. The Board generally comprises the  - 13 - General Manager, who is appointed by the Government; three traders and millers (one of whom chairs the Board); a farmers' representative; the Chief Customs and Chief Excise Officers; and representatives of NFC and ADBN. 43. REC