Nepal - Grain Storage Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 2862-NEP NEPAL GRAIN STORAGE PROJECT STAFF APPRAISAL REPORT July 24, 1980 Agriculture D Division South Asia Projects Department 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 (NRs) US$1.00 = NRs 12.00 NRs 1.00 = US$0.083 NRs 1,000,000 = US$83,333 WEIGHTS AND MEASURES 1 kilogram (kg) = 2.20 pounds 1 metric ton (MT) 1,000 kg = 0.98 long tons 1 millimeter (mm) = 0.039 inches 1 meter (m) 2 = 3.29 feet = 1.09 yards 1 square meter (m ) = 1.19 square yards 1 kilometer (km) 2 = 0.62 miles 1 square kilometer (km ) 2 = 0.386 square miles 1 hectare (ha) - 10,000 m = 2.47 acres 1 cubic meter (m ) = 35.31 cubic feet ABBREVIATIONS AND ACRONYMS AMC - Agricultural Marketing Corporation APROSC - Agricultural Projects Services Center DGM - Deputy General Manager 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 NFC - Nepal Food Corporation PEU - Project Engineering Unit PMCC - Project Management and Coordination Committee REC - Rice Export Company FINANCIAL YEAR July 16 - July 15  FOR OFFICIAL USE ONLY NEPAL GRAIN STORAGE PROJECT STAFF APPRAISAL REPORT Table of Contents Page No. I. PROJECT BACKGROUND ................................... 1 II. THE AGRICULTURAL AND FOODGRAIN SECTORS .... ........... 1 A. The Agricultural Sector .......................... 1 B. The Foodgrain Sector ............................. 2 Production .......... 2 Consumption and Exports ...................... 3 Marketing .................................... 4 Transport .................................... 4 Post Harvest Operations ...................... 5 Storage Practices and Losses .... ............. 6 Grain Storage Resources ...................... 7 C. Government Foodgrain Policies and Practices ...... 8 Policy Objectives and Formulation .... ........ 8 Foodgrain Distribution Policy .... ............ 8 Foodgrain Export Policy ...................... 9 Price Support Policy ......................... 10 III. PROJECT INSTITUTIONS ................................. 11 A. Nepal Food Corporation ........................... 11 General ...................................... 11 Organization and Management .... .............. 11 Operations ................................... 11 B. Rice Export Companies ............................ 14 Management and Organization .... .............. 14 Operations ................................... 14 IV. THE PROJECT .......................................... 15 Project Concept and Objectives ....................... 15 Major Features ....................................... 16 Project Area ......................................... 16 Detailed Features .................................... 17 Project Cost Estimates ............................... 22 Financing ............................................ 24 Procurement .......................................... 24 Disbursement ......................................... 25 This report is based on the findings of an IDA appraisal mission comprising Messrs. W. Schwermer, K. Ohashi and Ms. A. Duersten (IDA), and Messrs. Y. Takata and M. Yamada (Consultants), which visited Nepal in October/ November 1979. 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 - Page No. V. ORGANIZATION AND MANAGEMENT ........................... 25 General ............................................... 25 Reorganization of Nepal Food Corporation and Rice Export Companies ........................... 26 Project Management and Coordination .... ............... 27 Project Implementation ................................ 27 Accounts and Audit .................................... 30 Project Monitoring and Evaluation .... ................. 30 VI. BENEFITS AND JUSTIFICATION ............................ 30 Benefits .............................................. 30 Beneficiaries ......................................... 31 Economic Rate of Return .............................. 32 Sensitivity Analysis and Project Risks .... ........... 32 VII. RECOMMENDATIONS .33 ANNEXES 1. Foodgrain Production Characteristics 2. Project Institutions 3. Storage Resources, Requirements and Storage Gap in Project Area 4. Specifications and Cost of Storage Modules 5. Project Cost 6. Draft Terms of Reference for Project Consultants 7. Draft Terms of Reference for Project Studies 8. Disbursement Schedule 9. Draft Terms of Reference for PEU Engineering Personnel 10. Economic Analysis 11. Selected Documents and Data Available in Project File CHARTS Implementation Schedule 21265 Nepal Food Corporation Organization Chart 21253 Proposed Organization Chart for Nepal Food Corporation 21266 Far Western Rice Export Company Organization Chart 21267 Model Design for 1,000 Metric Ton Godown 21165 Model Design for 2,000 Metric Ton Godown 21166 MAP Location and Capacity of NFC/RECs Grain Storage Facilities (IBRD 14831R)  NEPAL GRAIN STORAGE PROJECT STAFF APPRAISAL REPORT I. PROJECT BACKGROUND 1.01 At the request of HMG, an IDA project identification mission visited Nepal in October/November 1978 and prepared a detailed outline of the project and terms of reference for project preparation. For this task HMG engaged Agricultural Projects Services Center (APROSC) which began its assignment in January 1979. Financing for project preparation was provided under the NEPAL - Technical Assistance Project (IDA Credit 659-NEP). A second IDA mission visited Nepal in May 1979 to assist APROSC in its project preparation work. The consultants submitted their preparation report in October, 1979. 1.02 This report is based on the findings of an IDA appraisal mission comprising Messrs. W. Schwermer, K. Ohashi and Ms. A. Duersten (IDA), and Messrs. Y. Takata, and M. Yamada (Consultants), which visited Nepal in October/ November 1979. II. THE AGRICULTURAL AND FOODGRAIN SECTORS A. The Agricultural Sector 2.01 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. Agricultural potential and practices vary widely among the country's three distinct regions, which are running parallel from east to west. Ihe northern belt accounts for 16% of the country's total area of 141,000 km and comprises the Mountains, rising above 2,700 meters. Crop cultivation in this area is extremely limited and livestock is the main source of livelihood. The Hills, lying between 800 and 2,700 meters, amount to some 61% of total land area. While accounting for only about one-third of arable land, the Hills must support nearly two-thirds of Nepal's population of about 13 million. Cultivation is confined to the valleys, plateaus and steep terraced slopes. Yields are low, and serious soil erosion problems exist. The Terai region lies to the extreme south, and com- prises 23% of surface area; it consists of a narrow strip of alluvial plain and has traditionally produced a surplus which has been the basis for Nepalese agricultural trade and exports. 2.02 Agriculture's performance in the 1970s has been disappointing. The sector grew at only about 2.2% annually, barely keeping pace with population growth, and below targets set out in the Fourth and Fifth Plans of 2.8% and 3.5% per year, respectively. This unsatisfactory record is, in part, the result of exogenous factors (see para 2.05), but the problems of the sector  -2 - also reflect budgetary and institutional constraints in the Nepalese economy. While overall public investment in the agricultural sector has greatly increased, difficulties have been experienced, in providing sufficient institutional support, especially trained staff and extension and credit services, and in establishing an adequate level of recurrent cost financing. B. The Foodgrain Sector Production 2.03 Foodgrain production is by far the most important activity in the agricultural sector, accounting for 90% of total cropped area and 80% of the sector's value added. Cereals, particularly rice, constitite the major portion of the Nepalese diet, and rice exports have averaged about 30% of Nepal's merchandise exports over the last three years. The major foodgrains are paddy, maize and wheat followed by millet and barley. Details of pro- duction, cropped area, yields, and regional importance of the major foodgrains are presented in Annex 1, Tables 1, 2 and 3. Paddy is Nepal's main crop cultivated on about 57% of the total area under foodgrains. Production is concentrated in the Terai, but cultivation also takes place in the Hill areas. Use of modern inputs has remained low (fertilizer use was 5 kg nutrients/ha in Nepal as compared to 24 kg nutrients/ha in India in 1976/77), and only about 10% of cropped area under paddy is irrigated. Production growth of paddy averaged 1.8% per year over the period since 1966/67, reaching an average level of 2.5 million MT annually in the last three years. This modest growth was achieved mainly through extending the area under paddy cultivation, from 1.1 million ha to 1.26 million ha; average paddy yields increased by only about 0.7% annually from 1.81 MT/ha during 1966/67 through 1968/69 to 1.92 MT/ha during 1975/76 through 1977/78. 2.04 Maize accounts for some 20% of total cropped area. Some 61% of maize production takes place in the Hills. The area under maize cultivation has stagnated in recent years, and average yields declined from 1.81 MT/ha to 1.70 MT/ha resulting in a reduction of output from 824,000 MT in 1966/67 to 740,000 MT in 1977/78. Wheat is grown on 16% of total cultivated area. A relatively new crop in Nepal, wheat 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. Grown mainly in the Terai as a winter crop, on land traditionally left fallow, it has become an additional source of income. But, as with paddy, increased production has been mainly due to extending the area under cultivation. Average yields have remained stagnant. Millet and barley are minor grains in terms of overall production, but they make a significant contribution to the diet in the Hill and Mountain areas, where cultivation of these crops is concentrated. Production records for both crops have been poor, with yields declining for millet and stagnating for barley. 2.05 Overall, the performance of the foodgrain sector has not been encouraging, and per capita foodgrain production has declined since 1973. Considerable agricultural investments have been made in the Terai, but food- grain production gains in this region have not reached anticipated levels; they have also not been sufficient to compensate for lagging production in  - 3 - the Hills, where a growing human and animal population has entailed falling agricultural productivity as cultivation is pushed to increasingly marginal areas. Dependence on the monsoon remains high, and unfavorable weather con- ditions have resulted in four poor harvests in the 1970s. The rapid increases in fertilizer and transportation costs caused by the sharp increases in oil prices have seriously hampered the expansion of supportive serviceb and the use of modern inputs. The problems of modern inputs, particularly of fertil- izer, have been exacerbated by transportation constraints, administrative and organizational bottlenecks in the distribution network and weaknesses in the extension system. In addition, a considerable part of the grain produced is lost due to insufficient and poor storage facilities and practices. Farm- gate foodgrain prices may not have been high enough to provide adequate incentive to increase production (para 2.28). Consumption and Exports 2.06 Cereal consumption is currently estimated to constitute some 80% and 85% of the Hill and the Terai diet, respectively. With Nepal's population having grown annually by about 2.2% during the 1970s, the increase in demand for foodgrains has outstripped incremental production and created a growing number of food deficit districts in the Hills. Eleven out of 18 Hill districts in the east and 15 out of 35 Hill districts in the west are now reported to have chronic foodgrain deficits. As a result, public sector distribution of foodgrains has been increasing steadily from 21,900 MT in 1974/75 to an estimated 40,000 MT in 1978/79, and grain exports, especially of rice, have been on the decline. Rice exports which had reached 221,000 MT in 1975/76 fell to 39,200 MT in 1977/78 before recovering somewhat in 1978/79 to an estimated 70,000 MT. Rice exports declined not only because of the dwindling exportable surplus but also because of the reduced demand from the traditional Indian market (para 3.11). Nepal has been actively seeking new export markets, but the poor quality of Nepalese rice resulting in part from substandard stor- age conditions, has severely hampered entry into new markets. For upgrading Nepalese rice to improve its acceptability in international markets, construc- tion of better storage facilities would be an important first step. 2.07 The poor agricultural record has led to doubts about whether Nepal can still be regarded as a food surplus country. Cereal production in 1976 and 1977 appears to have been insufficient to meet national caloric require- ments for normal subsistence 1/, and various forecasts indicate that Nepal's internal food supply situation may continue to worsen 2/. Due to the important role of rice as foreign exchange earner and because of balance of payment needs, however, it appears unlikely that Nepal will discontinue rice exports altogether in the foreseeable future. A reduction in the present, extensive storage losses (para 2.19) would contribute to foodgrain availability for 1/ World Bank, Nepal-Agricultural Sector Review, April 1979, pp. 20-21. 2/ World Bank, Nepal-Development Performance and Prospects, December 1979, p. 67; FAO, A Policy and Action Plan for Strengthening National Food Security in Nepal (draft report), July 1978.  - 4 - exports; but efforts in this respect are being severely hampered by a lack of suitable storage facilities (paras 2.18 and 2.21). Marketing 2.08 About 86% of paddy is marketed during the post-harvest months from November to April. The large majority of farmers, due to a lack of storage facilities and because of need for cash, sell their produce immediately after harvest, when prices are usually lowest. Nepalese foodgrain markets can be divided into primary, secondary and terminal markets. Most farmers sell their produce in the primary or village markets which are dominated by private traders who often are also money lenders, advancing famers cash against future grain. Some farmers take their grain to secondary makets which consist of small market centers where wholesalers, commission agents, rice millers and Rice Export Companies (RECs) are the principal buyers. Only very few farmers take their produce directly to terminal markets where millers, Nepal Food Corporation (NFC), and RECs operate and from where surplus foodgrain is sent either for internal distribution or for export. 2.09 Cooperatives, which are called Sajha in Nepal, are required under present policies to procure any surplus grain, but play only a minor role in foodgrain marketing. RECs have used Sajha as purchasing agents paying a 3.0% to 3.5% commission on the foodgrain procured for RECs, and NFC on several occasions purchased wheat through Sajha. These arrangements have been working with a varying degree of success, largely depending on capability of the indiv- idual Sajha and on coordination between Sajha and NFC/RECs. There is con- siderable potential for additional involvement of Sajha in the procurement for NFC and RECs; but coordination between these institutions would have to be improved, and NFC/RECs would have to assist Sajha in developing necessary procurement and storage management expertise. Transport 2.10 Farmers transport their foodgrain, using mainly bullock carts in the Terai and pack animals and porters in the Hills. Millers, merchants and RECs in the eastern Terai transport the bagged grain by truck. In the western Terai, all-weather roads are rare and transport depends on the weather con- ditions. Tractors and bullock carts are used in addition to trucks. For exports as well as east-west and west-east movement of grain, NFC and RECs rely heavily on the Indian Railways. The grain is moved by truck across the border to an Indian railhead from where it is transported either to export markets via Calcutta or to another Indian railhead and back into Nepal. NFC transports grain to Kathmandu in hired trucks of 10 MT carrying capacity which can go as far as Hetauda where the Corporation owns and rents some trans- shipment storage facilities. Onward transport from Hetauda is restricted to trucks carrying a maximum weight of 7.5 MT. For grain transport to Hill distribution areas other than Kathmandu Valley, NFC, because of the lack of roads, depends mostly on porters and animals. Some Hill and Mountain areas, especially in the Far-Western Region, are so inaccessible by traditional means that foodgrain has to be flown in by small aircraft on a regular basis.  -5- Post Harvest Operations 2.11 Threshing. Traditional floor threshing with bullock teams is prac- ticed in most of the Terai and in parts of the Hills. Manual threshing with sticks or beater bars is also common especially for wheat, barley and millet. For paddy th.sshing in the Terai and in Kathmandu Valley, mechanized threshers are now widely used which are either foot pedal-operated or power-driven. Maize is stripped from the cob mostly by hand, but hand-operated cob-strippers are on the increase. 2.12 Drying. Sun-drying on woven mats, earth floors or road surfaces is the only form of pre-storage drying carried out at the farm level. Most of the paddy is harvested in the dry season and can be sun-dryed to moisture levels which permit safe storage (13% to 14% moisture content). Wheat, maize and early paddy on the other hand are often harvested under wet conditions, so that, by and large, sun-drying is not possible for many weeks, resulting in serious deterioration in grain quality and quantitative losses. At the commercial level, sun-drying is the predominant practice. Only four rice mills in the country are provided with mechanized drying facilities. The lack of mechanized drying equipment is a serious problem in storage of wheat and maize which rapidly deteriorate unless the generally high moisture content of these crops at harvest is properly reduced before storage. 2.13 Milling. At farm level, paddy is hulled in the traditional wooden pestle either by hand pounding with a wooden peg or by the use of a foot- operated pivoting pole. Wheat, maize, millet and barley are handground between two stones. There are about 1,800 commercial rice mills, which are heavily concentrated in the Terai, especially in the eastern Zones. Most rice mills are Engleberg type disc hullers; only about 50 mills are of the modern rubber-roller sheller type. With the exception of one rice mill operated by the Seti & Mahakali Rice Export Company, all rice mills are operated by private owners. 2.14 The rice mills rely almost exclusively on husk-fired boilers as their power source. The husk, obtained as a byproduct from the milling operation, is sufficient to meet the mills' energy needs. A survey carried out by the Food Research Laboratory of the Food and Agricultural Marketing Services Department (FAMSD) determined that much of the rice milling equipment is dilapidated and various equipment items used in the same mill are often not compatible. The average recovery rate in the mills surveyed has been 60% for white rice and 66.5% for parboiled rice. It appears that recovery rates and the quality of the rice could be significantly improved with the use of modern equipment and with the introduction of better management practices. However, more research needs to be done before a program to strengthen the rice milling sector can be developed. Commercial milling of wheat is currently on the increase with some 10 new flour mills under construction or planned. Fifteen large mills with a total capacity of 260 MT/day have been licensed, but only five are operational.  -6- Storage Practices and Losses 2.15 On-farm storage is usually limited to grain for family consumption and for seed. Grain to be sold is generally marketed shortly after harvest. Following sun-drying, farmers in the Terai commonly store paddy in traditional outdoor or indoor bamboo and mud bins which are built on raised platforms. 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. There is a paucity of quantified information on on-farm storage losses, but losses appear to be significant and have been quoted as high as 20% over a storage season. Inadequate drying and poor storage facilities seem to 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. 2.16 Off-farm foodgrain storage is maintained by Sajha cooperatives, foodgrain merchants and millers, Nepal Food Corporation (NFC) and Rice Export Companies (RECs). Grain is invariably stored in bags. Sajha's involvement in foodgrain is mainly for procurement and storage of paddy on behalf of RECs, and has been concentrated in the Far Western Region, where market infrastruc- ture is lacking. Sajha storage facilities have been inadequate for this purpose, particularly in the Far Western Region, and are being replaced by new well-designed multi-purpose facilities, which are financed by the Agricultural Development Bank. However, no serious attempt has yet been made to introduce sound foodgrain storage practices. Quality is largely ignored in procuring the grain from the farmer and pest control is limited to ineffective usage of fumigants and the occasional dusting of infested stocks with malathion. 2.17 Grain merchants generally store foodgrains for short periods and pay little attention to the quality of storage facilities or to good quality control practices. Rice mill storage is usually of poor quality with in- adequate protection against moisture and rodents. Fumigation is attempted only in extreme cases, usually by sealing off the entire godown. Rice husk is commonly used as dunnage to absorb moisture and this causes the rice in the bottom layers of bags to discolor badly. Storage losses at Sajha and trader/miller levels have not been studied, but are thought to be signi- ficant. 2.18 NFC owns most of its storage facilities at procurement and trans- shipment centers, but RECs rely almost exclusively on rented godowns which rarely meet acceptable quality standards. Some of the NFC godowns, and most of the godowns hired by RECs have damp mud floors and offer no protection against rodents and birds; fumigation is often impracticable or ineffective because of internal structures obstructing the use of fumigation sheets, or is hampered by the proximity of many rented storage facilities to private residences; protection against weather is frequently inadequate because of leaking roofs and poor ventilation; and narrow doorways and insufficient lighting prevent efficient grain movement. The poor quality of many godowns  - 7 - coupled with the lack of essential quality control equipment such as fumiga- tion sheets and spraying gear, has contributed to NFC/RECs' longtime neglect of proper storage practices. NFC/RECs management is now giving increased attention to this and has recently employed a number of quality control staff. While some improvements in grain grading and storage practices appear to have been made, the overall effect of this staff addition has been iimited by the lack of equipment and good quality godowns and by inadequate experience of the quality control personnel. 2.19 Information on NFC/RECs storage losses is scarce. Storage losses vary with the kind of grain, moisture content, duration of storage and quality control management. Grain lots investigated at NFC revealed weight losses of 20% over 18 months in a 400 ton lot of white rice; a 15% loss for maize over one year; and even a case of 100% loss in wheat after 8 months storage. Considerable storage losses are also evidenced by large rice quantities earmarked for export having been rejected and by substantial rice sales at reduced prices following infestation and deterioration of the grain. The mission conducted a sample survey of losses, by weighing the grain and analyz- ing its quality at eight procurement centers of RECs and NFC, and evaluating the experience of these institutions. The analysis suggests that losses over a six-month period under substandard storage conditions, with present manage- ment practices, are 4.0% for parboiled rice, 5.0% for white rice, 7.5% for wheat and 8.0% for maize. The principal reasons for the high loss in wheat and maize are the poor quality of godown, the high moisture content of these crops (15% to 18%) at the time of procurement and the absence of proper grain drying equipment. In the Far Western Region, due to a lack of storage facil- ities, paddy has to be stored frequently outdoors without any protection. Paddy losses in open storage are estimated at 5% and 11% after 3 and 6 months respectively. Grain Storage Resources 2.20 Grain storage facilities are maintained by the private sector, Sajha cooperatives and NFC/RECs. Information on private sector grain storage is sketchy and unreliable. 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 HMG programs. NFC at present owns conventional bag storage warehouses at 98 locations with a total capacity of 28,500 MT, of which 11,200 MT are located in the Terai and 17,300 MT at trans-shipment and distribution centers in the Hills and Mountains. By April 1979, NFC had rented an additional capacity of 16,200 MT from private and institutional sources, bringing NFC's total available storage capacity to 44,700 MT. Stor- age under construction totals 23,300 MT including 10,000 MT and 12,750 MT funded by UNDP and UK/ODA respectively. The construction programs will pri- marily replace some of NFC's own dilapidated warehouses and rented facilities which are not suitable for long-term grain storage. 2.21 The eight RECs own storage of 4,500 MT, all of which is located in the Terai, and are presently constructing 3,000 MT, and, as of April 1979, they hired 104 facilities with a capacity of 44,700 MT. The warehouses owned by NFC and RECs have been built for grain storage and are mostly suitable for this purpose, but most of the hired godowns are small (between 200 and 500 MT) and not intended for long-term grain storage; some are rooms in residential  - 8 - buildings. A large number of these rented godowns are widely scattered, badly located and without easy access by truck. The distribution of the storage facilities owned or being constructed by NFC/RECs in various districts is shown in IBRD Map 14831R. C. Government Foodgrain Policies and Practices Policy Objectives and Formulation 2.22 The government foodgrain policy in Nepal has four stated objectives: (i) to make foodgrains available to the poor in food deficit areas at reasonable prices; (ii) to stabilize foodgrain prices; (iii) to promote foodgrain exports; and (iv) to increase agricultural production by providing incen- tive prices to producers. The key institutions in implementing foodgrain policy are the Nepal Food Cor- poration (NFC) and the eight Rice Export Companies (RECs). 2.23 Responsibility for policy decisions in the sector rests with the Ministry of Food and Agriculture (MFA), although policy directives often originate at more senior levels in HMG. On matters of policy formulation, the Food and Agricultural Marketing Services Department (FAMSD) of the Ministry plays a crucial role. It collects price information, analyzes trade patterns, and prepares an annual Food Balance Sheet which presents the overall foodgrain situation in the country, and assesses food surplus and deficit status by district. On the basis of this analysis FAMSD prepares recommendations for public sector grain procurement in the different Zones, for public distribu- tion programs in the deficit 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 of the Committee. Foodgrain Distribution Policy 2.24 HMG's program for subsidized foodgrain distribution is implemented by NFC. The volume of public sector distribution has been increasing steadily to an estimated 40,000 MT in 1978/79 (para 3.06). 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 NFC's procurement and overhead expenses. For price determination the country has been divided into three sectors: Sector A - Mountains and remote Hills;  - 9 - Sector B - lower Hills and Terai; Sector C - Kathmandu Valley. Distribution prices are heavily subsidized with the biggest subsidy being provided in Sector A. For example, in the Eastern Development Region, the average cost of transporting one kilogram of rice from the Terai to the Hills is NRs 1.65, the average rice procurement price is NRs 2.40/kg, but NFC's average selling price is only NRs 2.Q4/kg. Part of the subsidy is financed by the Rice Export Companies (RECs) which have to sell under an export levy scheme 20% equivalent of the quantity of rice exports to NFC at a concessionary price fixed annually by MFA, which has been as low as 52% of RECs' procurement price. However, with the decline in rice exports, the levy, which has been fluctuating between 20% and 30% of exports, has diminished, and, as a consequence, NFC has been compelled to procure a growing amount of foodgrain directly at open market prices (mostly from RECs). This development has led to widening financial deficits at NFC (para 3.07) which have been compounded by losses resulting from poor storage conditions and unsatisfactory storage practices (para 2.18). 2.25 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 a lack of storage facilities. Foodgrain Export Policy 2.26 In 1974 HMG established eight quasi-Government Rice Export Companies (RECs) and granted a rice export monopoly to these institutions. Earlier, rice exports had been in the hands of private traders, and went almost exclusively to India where Nepal enjoyed an easily accessible captive rice market. Due to Nepal's long open border with India, a large portion of this trade was transacted through informal channels, giving rise to substantial H1MG revenue losses. In addition, foreign exchange earnings from this informal trade were not made fully available to Nepal. The main objective of insti- tutionalizing rice exports was to improve the rice market structure, which before 1974 was characterized by the dominance of a few private traders, and thereby (i) provide incentive prices to paddy farmers, (ii) increase HMG revenue by preventing customs and income tax evasion, and (iii) increase foreign exchange earnings. Another important objective was to provide food- grains to NFC at low prices, through the levy system, to meet food requirements in deficit areas. 2.27 During their first two years of operation, RECs were successful in meeting the stated objectives, with rice exports reaching a high of 221,000 MT in 1975/76. But, as India's steadily increasing foodgrain harvests sharply reduced the demand of the Indian market for Nepalese rice and the rising domestic foodgrain requirements greatly reduced the exportable surplus, RECs became less able to meet expectations and in some instances incurred financial losses. Part of RECs problems have been the result of the relatively low quality of Nepalese rice. Substandard godown conditions and inadequate quality control have led to discoloration and to difficulties in meeting with "free of  - 10 - insects" specifications. To improve rice quality, RECs have increased their quality control efforts, but due to the lack of proper storage facilities and quality control equipment their endeavors have had little success so far. In July 1979, HMG removed RECs export monopoly, permitting private traders to resume rice exports, except government-to-government rice export which is reserved for RECs. The private sector is expected to capture some of the export market. The extent to which rice exports will be shifted from the public to the private sector remains, however, to be seen. The policy change is not expected to affect the informal trade across the border to India, nor much of the trade with third countries which has been on a government-to- government basis. Should internal food requirements continue to expand faster than production, supply, not marketing constraints, would increasingly determine Nepal's ability to export rice. Price Support Policy 2.28 HMG price policy for foodgrains is dictated by the twin objectives of assuring low and stable consumer prices while providing adequate incentives to producers. The Government fixes each year a support price for paddy and wheat. The objective of the support price is to provide the farmer with a minimum incentive price, and public sector institutions are instructed not to purchase foodgrain below this price. However, a number of factors have caused the support price to be of questionable effectiveness in meeting the objective. The price is not fixed until after planting, but only shortly before harvesting, thereby reducing the potential impact on producer decisions. Secondly, while the price is fixed, taking into account the Nepalese cost of production, the proximity to India and the long open border limit independent price decisions as any large differential would 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 and below what is justified when export prices for rice are considered, even after allowing for trade and transport margins. Fourthly, the support price for paddy has remained constant for three years, and public sector procurement at the primary level has been limited; only in the western Regions have NFC/RECs procured substantial quantities of paddy and wheat in primary markets, from farmers or Sajha. Generally, public sector agencies have not been geared to "defend" the Government support price. While complete data do not exist on farmgate prices actually received by farmers, it appears that millers and private traders are purchasing grain at below the support price in the west, and above the support price in the east. NFC/RECs primary procurement in the west, particularly for wheat, has helped to counteract such a trend and ensure farmers a better price, but in the east, the RECs have been purchasing rice mainly from millers and traders, thereby limiting any direct effect of their operations on farmgate prices. Finally, for the price mechanism to be used as a more effective instrument of production policy will require a better data base on the costs and returns to agricultural crops, supplemented by a further strengthening of public sector capability to implement Government price policy objectives. 2.29 In recognition of the need for a better data base for determining Government price policy, HMG is planning to engage consultants to carry out a study to provide the basis for future policy decisions. Furthermore, to make  - 11 - the support price system work more effectively, NFC and RECs are being instruc- ted to increase their direct procurement from farmers and through Sajha. By the end of the Sixth Plan in 1984/85, direct procurement by NFC/RECs is to reach 50% of the foodgrain marketed annually by farmers. This may be difficult to achieve, but the decision appears to be basically in the right direction. Additional storage capacity for NFC/RECs would be crucial for meeting this objective. III. PROJECT INSTITUTIONS A. Nepal Food Corporation (NFC) General 3.01 Until mid-1972, HMG foodgrain distribution policy was mainly con- cerned with the Kathmandu Valley, as most other Hill districts were able to provide for themselves. In 1972, widespread food shortages compelled HMG to expand distribution operations nationwide. To that end, the Agricultural Marketing Corporation (AMC) was formed through the merger of the Food Manage- ment Corporation, which had been responsible for food distribution in the Kathmandu Valley, and the Agriculture Supply Corporation, which had been in charge of input supply. It soon became clear that AMC was not able to handle both foodgrains and inputs, and consequently, in 1974, AMC was divided into the Nepal Food Corporation (NFC) responsible for implementing HMG food dis- tribution policy, and the Agricultural Inputs Corporation for supplying inputs. At the same time HMG established eight Rice Export Companies (RECs), and a rice levy system was introduced under which RECs are required to provide NFC with a source of low-priced rice for internal distribution. NFC also has been making use of RECs to procure wheat and maize for internal distribution. In recent years, NFC in addition to its foodgrain distribution responsibilities, has taken up trading in mustard seed, pulses, sugar, and sheep and goats. Organization and Management 1/ 3.02 NFC has been incorporated under the Corporations Act of 1964 and is governed by a seven member Board of Directors appointed by HMG. The Board comprises representatives of the Ministries of Finance, Industry and Commerce, and Works and Transport, and of the Nepal Rastra Bank and FAMSD. Chief Exec- utive is the General Manager who is assisted by two Deputy General Managers (DGMs), directing operations and administrative functions of six headquarter divisions, four regional and 58 branch offices. Total staff strength is about 810. An organization plan is presented in Chart 21253. 3.03 NFC's organizational structure and management are in need of strength- ening. The present organization does not adequately serve NFC's operational requirements, and management is constrained by a lack of trained staff, inade- quate management information systems, and weak financial and internal control systems. Details are in paras 4.14 through 4.20. 1/ See also FAO Report: Organizational and Management Review - Nepal Food Corporation, 1979.  - 12 - Operations 3.04 Procurement. Until recently, the major portion of NFC's procurement took place in the form of levy purchases from RECs. In 1975/76, NFC procured 49,900 MT of grains through levy purchases as compared to 16,300 MT in 1974/75. However, after 1975/76 levy procurement declined to 29,900 MT in 1976/77, and to 17,800 MT in 1977/78. While levy purchases decreased, 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, generally by calling tenders, and also commenced purchasing wheat and maize, both as levy and in the open market, with part of the wheat being sup- plied by Sajba. In 1977/78 wheat and maize procurement were 9,600 MT, almost 20% of NFC's total foodgrain procurement. 3.05 Quality Control. NFC introduced quality standards in its procurement operations, specifying limits for such characteristics as moisture content, foreign matter, broken and damaged kernel (Annex 2, Table 1). The standards are in part based on the voluntary "Paddy and Rice Grading Standards" prom- ulgated by FAMSD in 1974 (Annex 2, Table 2) and have been designed to improve grain quality at the procurement stage. NFC has also strengthened storage quality control procedures under a project for which UK/ODA has provided financial and technical assistance. A nucleus staff of Food Technologists and Food Technology Assistants has been recruited and given some basic training. Responsibility of this staff is to take and analyze grain samples at the procurement stage, routinely inspect stocks and godowns, and organize and supervise pest control measures. While introduction of grading standards and recruitment of some quality control staff have been encouraging steps in developing sound quality control practices, considerable improvements are still required in this field. Due largely to the shortage of quality control staff and their lack of practical experience, performance has not yet reached desired levels. 3.06 Distribution. NFC uses a national network of Sajha and private dealers for distributing foodgrains. In remote Hill and Mountain areas, NFC sells directly to the public through its own field offices. Although NFC sells at subsidized prices, no formal rationing is in effect. It appears that such factors as limits on quantities available and the lower quality of the publicly distributed grain act as a form of rationing, with higher income consumers going to open-market shops. Foodgrain distribution by NFC has increased considerably over the recent years, from 21,900 MT in 1974/75 to 35,400 MT in 1977/78 and an estimated 40,000 MT in 1978/79. Forecasts for NFC's future distribution requirements vary considerably. NFC's latest fore- cast projects NFC distribution to reach 64,700 MT in 1984/85. A somewhat older forecast estimates that by 1984/85 NFC will have to supply about 120,000 MT. District-wise distribution quantities are agreed upon between MFA and NFC on the basis of the Food Balance Sheet which presents distribution needs as reported separately by the Chief District Officer, District Panchayat and NFC depot officials. Most NFC grain is distributed in Kathmandu Valley, but the share of the Mountain and Hill regions has been growing (see Annex 2, Table 3) and is anticipated to expand further as food deficits increase in these regions. Since transportation costs, especially to Hill and Mountain  - 13 - districts, are very high (exceeding 500% of the grain procurement price in case of some villages), proper inventory management and transportation plan- ning will become increasingly important. 3.07 Deficit Financing. When NFC and RECs were established, it was anti- cipated thac the rice export levy and the low levy prices would enable NFC to distribute foodgrains in food deficit areas at subsidized prices without impairing NFC's financial viability. As rice exports dwindled and the level of levy as a percentage of the export was lowered, the supply of levy rice to NFC sharply declined in the face of increasing food distribution require- ments, so that NFC has had to procure more and more of its foodgrains at market prices. As HMG permitted NFC to increase its distribution prices only by a fraction of the increased costs, NFC's financial position has seriously deter- iorated. (Details about levy prices, distribution prices, and subsidies are provided in Annex 2, Tables 4 and 5). With the exception of the first finan- cial year, NFC's profit and loss statements indicate steadily increasing annual deficits (Annex 2, Table 6). The unaudited balance sheet for Financial Year 1977/78 (Annex 2, Table 7) shows an accumulated loss of NRs 24.3 million, including an operating loss for 1977/78 of NRs 16.1 million (about US$1.3 mil- lion equivalent). The accumulated loss is projected to have grown to about NRs 65 million at the end of FY 1978/79. A five-year financial forecast (Annex 2, Table 8) based on NFC's most recent conservative projections for distribution requirements (46,400 MT in 1980/81 increasing to 64,700 MT in 1984/85) projects continuously growing annual deficits, reaching an estimated NRs 71.2 million by 1984/85. 3.08 While NFC's financial deficits are partly due to inefficiencies, such as poor financial management (paras 4.19 and 4.20) and excessive storage losses (para 2.19), their main cause is HMG's subsidized foodgrain distribu- tion policy which requires NFC to sell foodgrains at prices which do not permit the Corporation to recover all costs incurred in its procurement and distribution operations. HMG assistance in NFC deficit financing has been negligible. HMG has made modest equity contributions to help NFC meet its increasing working capital requirements, but NFC deficits so far have been funded almost exclusively through bank borrowings. These borrowings together with large loans for working capital financing in turn have aggravated NFC's financial problems. Given HMG's distribution pricing policies, NFC cannot be expected to operate profitably and needs HMG support for deficit financing. Without such support NFC cannot be expected to become financially viable. At negotiations an assurance was obtained from HMG that, beginning fiscal year 1982 and under arrangements satisfactory to IDA, HMG would provide NFC annually with grant funds from budgetary sources sufficient to cover costs which are necessarily incurred by NFC in carrying out HMG foodgrain distribution poli- cies but are not recovered in the distribution prices fixed by HMG. Such cost would include parts of transportation and interest cost and portions of procurement cost where procurement prices exceed distribution prices. For proper recording of these costs, NFC, with the assistance of a financial specialist (para 4.21), would establish appropriate accounts and accounting procedures. In addition, NFC would prepare and present to HMG annually five year projections for distribution and HMG financing requirements. Copies of such projections would be made available to IDA. Annual direct fiscal cost to HMG are estimated to amount to less than 2% of HMG's annual expenditures.  - 14 - B. Rice Export Companies (RECs) Management and Organization 3.09 In 1974 HMG established eight RECs as joint ventures with the pri- vate sector traditionally involved in rice trading and milling, and granted a rice export monopoly to these institutions. RECs are located in the Terai where they procure foodgrains in nine Zones: Mechi, Koshi, Sagarmatha, Janakpur, Narayani, Lumbini, Bheri, Seti and Mahakali. Foodgrain procurement of each REC is limited to one Zone, except for the Seti and Mahakali Rice Ex- port Company which covers two Zones. RECs are incorporated under the Company Act of 1964, with the majority of the shares being held by HMG and most of the remainder owned by private traders and millers. Each REC is governed by a Board of Directors consisting of nine members. The Board gernerally comprises the General Manager, who is appointed by HMG; three traders and millers; a farmers' representative; the Chief Customs and Chief Excise Officers; and representatives of NFC and the Agricultural Development Bank. The Board is chaired by one of the traders or millers. While the Board sets the policies for RECs operations and determines procurement and export prices, the General Manager is responsible for day-to-day activities. He is generally assisted by a Deputy General Manager who supervises both line and staff functions. The organization of the Far-Western REC is presented as an example in Chart 21267. Operations 3.10 Procurement. Procurement prices set by RECs' Boards vary with the quality of the grain procured and differ from region to region. RECs procure paddy, and small amounts of wheat and maize through Sajha and through their own depots. Rice is procured from millers and traders. In 1978/79, RECs operated 57 depots and made procurement arrangements with 44 Sajha (Details are in Annex 2, Table 9). Total rice and paddy procurement has decreased from 236,800 MT in 1975/76 to 119,100 MT in 1977/78, with paddy amounting to less than 15% of the total (Annex 2, Table 10). RECs in the past were not very keen on paddy procurement since purchasing of rice was more convenient, and since the lack of storage facilities in some Zones and cash flow problems at indivi- dual RECs constrained purchasing of large quantities of paddy. With the elimination of the rice export monopoly, rice exports are open to the private sector, and RECs can no longer rely on millers and traders for their supply. The Companies will therefore have to expand their paddy procurement program. Additional storage facilities will be required for this purpose together with training of procurement staff. It will also be necessary to develop a detailed procurement program including staffing and location of procurement depots, and procurement coordination with Sajha (para 5.12). 3.11 Exports. Export targets are set annually for each REC by the Food Policy Coordination Committee (FPCC). As the pattern of rice exports has changed from the traditional dependence on the Indian market, FPCC has also functioned as an important link with third country buyers, often negotiating sales contracts on behalf of RECs. However, rice export to third countries has not been very successful because of the low quality of Nepalese rice.  - 15 - Insect infestation and discoloration have made it difficult to sell Nepalese rice in third country markets. Nepal has had also to accept high price dis- counts for its rice. Such discounts have ranged from 23% to 36% of the fob Bangkok price for Thai rice (5% brokens) with the average amounting to 28%. When there was Indian demand for Nepalese rice, RECs exports reached a high of 221,000 MT, but then declined to 39,200 MT in 1977/78. For 1978/79, rice exports are estimated at 70,000 MT. Along with exports, levy sales to NFC dropped from 49,900 MT in 1975/76 to 17,800 MT in 1977/78. On the other hand, sales to NFC at prices covering RECs cost increased over the same period from zero to 15,100 MT. (Details are in Annex 2, Table 11.) 3.12 The problems encountered in penetrating third country markets have forced RECs to give increased attention to quality control. The Companies have therefore adopted the same grading standards as NFC (Annex 2, Table 1) and engaged quality control personnel called Graders, who are responsible for inspecting grain at the time of procurement and during storage, and for super- vising pest control operations. Efforts in improving quality control have, however, been seriously hampered by the poor quality of most RECs godowns, the lack of essential equipment such as fumigation sheets and spraying gear, and by inadequate experience and training of the quality control staff. Construc- tion of new godowns designed for long-term grain storage, and equipping RECs with necessary quality control equipment would be essential prerequisites for upgrading the quality of Nepalese rice. Furthermore, RECs quality control procedures would need to be further strengthened, and additional training would have to be given to procurement staff and Graders. IV. THE PROJECT Project Concept and Objectives 4.01 Under HMG's program of providing minimum support prices to foodgrain producers, NFC and RECs are being instructed to increase direct procurement from farmers and through Sajha. Increased foodgrain procurement by NFC will also be necessary to meet growing distribution needs in the Hills and Moun- tains. To support a growing procurement program in the Terai, additional storage facilities would be needed. Additional storage in the Terai would also be required for the implementation of HMG's food security program under which NFC would manage a 10,000 MT foodgrain reserve at strategic locations in the Terai and at trans-shipment points such as Hetauda. Furthermore, addi- tional and improved storage warehouses would be necessary for meeting HMG's policy objective of promoting foodgrain exports. The new export markets, which RECs are trying to penetrate, entail long storage periods in Nepal and demand higher quality rice than Nepal had previously been able to ship to India. RECs now have to store most of their rice in substandard godowns where the grain suffers high quantitative losses and considerable quality deter- ioration. As a result, the rice finds little acceptability in international markets and has to be sold at low prices. 4.02 The major objective of the project would be to assist HMG in the implementation of its foodgrain policy by providing good storage facilities  - 16 - and strengthening the management and technical capabilities of NFC and RECs, so that these institutions can meet foodgrain procurement, distribution and export requirements and reduce quantitative and qualitative storage losses. In addition, the project would be aimed at providing necessary information for further development of the post-harvest sub-sector and for future HMG foodgrain policy formulation. Major Features 4.03 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 trans-shipment 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 foodgrain marketing and price policy and on future needs for foodgrain storage and processing facilities. Project Area 4.04 The project area would comprise the nine Zones where the eight RECs are located: Mechi, Koshi, Sagarmatha, Janakpur, Narayani, Lumbini, Bheri, Seti and Mahakali, and Hetauda. NFC/RECs foodgrain procurement in the project area decreased from 236,800 MT in 1975/76 to 116,800 MT in 1976/77 before recovering slightly to 134,000 MT in 1977/78. Average annual procurement over the three year period was 162,600 MT or 13.2% of net foodgrain production. NFC/RECs procurement varies considerably among the different project area Zones. As a percentage of net foodgrain production, procurement is lowest in Lumbini (3.3%) and highest in Mechi (39.5%). (Details are in Annex 3, Tables 1 and 2.) Hetauda is important as trans-shipment center. During the years 1977/78 and 1978/79 about 22,000 MT have been transported annually from the Terai via Hetauda to Kathmandu Valley and other Hill areas. Grain is trans- ported by trucks which carry 10 MT each up to Hetauda; but then, due to poor road conditions, the load needs to be lightened to 7.5 MT before continuing onward transport to Kathmandu Valley. From Hetauda to other Hill areas, grain is transported mostly by porters or by animals. 4.05 Storage facilities owned or rented by NFC/RECs in the Terai, together with warehouses under construction or already planned, are summarized below. (Details by Zone are in Annex 3, Table 7.) NFC's AND RECs' STORAGE CAPACITY IN THE TERAI (in '000 MT) Suitable NFC RECs Total for Grain Storage /a Owned 11.2 4.5 15.7 10.7 Rented 12.9 44.7 57.6 8.8 Under Construction 8.0 3.0 11.0 11.0 Total 32 .1 52.2 84.3 30.5 /a Storage facilities suitable for medium and long-term storage are characterized by damp-proof concrete floors, and they permit proper fumigation and adequate ventilation. They also provide effective protection against birds and rodents.  - 1 7 - At Hetauda, NFC owns and rents storage capacity of 1,300 MT and 400 MT respec- tively. Of the total, 500 MT are suitable for grain storage. 4.06 Storage requirements of NFC/RECs have been estimated on the basis of projected foodgrain production (Annex 3, Tables 3 and 4) and the assumption that the NFC,AECs procurement as a percentage of foodgrain production in the Terai will decline as a result of the recent HMG decision to eliminate RECs' rice export monopoly. Given the strength of the private sector in the various project area Zones, reductions in the procurement percentage are estimated to range from 40% in eastern Nepal to 10% in the west. (Details by Zone are in Annex 3, Table 2.) NFC/RECs storage needs by 1985/86 have been projected separately for each Zone and are estimated to total 104,900 MT (Annex 3, Table 7). Taking into account existing storage facilities suitable for storing grain, the total storage gap of NFC/RECs in the Terai is projected to reach 74,400 MT by 1985/86 (Annex 3, Table 7). For Hetauda, the storage gap by 1985/86 is estimated at 5,100 MT including 2,500 MT for reserve stocks which HMG intends to keep at Hetauda under its food security program. Thus, project storage of 37,000 MT in the Terai and 3,000 MT in Hetauda would be only about 50% of total additional storage requirements in the project area and appear to be justified for the immediate future. In view of local construction sector constraints and land acquisition problems as have been encountered under the UNDP and UK/ODA assisted storage projects, a larger construction program under the project would not be prudent at this time. Assuming satisfactory imple- mentation of this project, a repeater project could be initiated to meet the balance of projected 1984/85 storage requirements. 4.07 Storage would be provided in each of the nine project Zones in the Terai except in Narayani and Lumbini where existing capacity appears to be adequate. A storage depot would be constructed at eight locations in the Terai and in Hetauda. The locations in the Terai have been selected on the basis of present and projected grain procurement, availability of transporta- tion facilities, proximity to road and rail network, and existing milling capacity. Project storage locations and capacities would be as follows: ZONE LOCATION CAPACITY (in MT) Mechi Birtamod 9,000 Koshi Biratnagar 7,000 Sagarmatha Lahan 5,000 Janakpur Janakpur 3,000 Bheri Nepalgunj 4,000 Bheri Rajapur 3,000 Seti Dhangarhi 4,000 Mahakali Mahendranagar 2,000 Narayani Hetauda 3,000 TOTAL 40,000 Detailed Features 4.08 Storage Warehouse Complexes. Since grain would be handled in bags in the foreseeable future, project storage facilities would be conventional  - 18 - bag storage warehouses. The design would be simple, provide for easy con- struction with locally available construction material and equipment, permit easy operation without sophisticated grain handling machinery, and would allow for proper stock inspection and effective quality control measures. The basic warehouse module would have a capacity of 1,000 MT of milled rice in 100 kg bags or of 750 MT, 900 MT and 950 MT of paddy, maize and wheat respectively. A second warehouse module of 2,000 MT (rice weight) would consist essentially of two 1,000 MT modules joined together gable to gable but separated by a permanent cross partition wall. Designs for the two modules are presented in Charts 21165 and 21166. The basic 1,000 MT module would be a rectangular building with dimensions 63 ft. x 100 ft (19.2 m x 30.5 m) by 14 ft., 10 in. (4.5 m) high; and with a gable roof sloped 20 degrees. Wall footings would be of plain concrete. Solid brick piers would be raised on the footings to support a prefabricated steel tubular roof truss system. Walls between the piers would be brick, and roof covering would be corrugated galvanized iron sheets. The reinforced 5oncrete floor would be designed to support a distri- buted load of 2,700 kg/m . Each warehouse would be provided with roof and wall ventilators, double leaf metal sliding doors and a continuous, roofed loading deck on one side of the building. Specifications for the 1,000 MT module and cost estimates for both storage modules are in Annex 4. Detailed designs of the two modules would be prepared by the Project Engineering Unit (paras 4.11 and 5.06). 4.09 At each of the nine storage locations, ancillary facilities would be constructed comprising an office building, a laboratory, and housing for essential resident staff, together with a drying shed, a garage and a store for gunny bags and materials. Storage sites would need to be improved. Site improvements would be financed under the project and include an access road and all weather roads inside the godown complex, a parking lot and boundary walls. Other improvements would be land filling, land levelling, sanitation, water and power supply, and drainage. Cost estimates for godown construction, ancillary facilities and site improvements at each of the nine storage loca- tions are detailed in Annex 5, Table 1. 4.10 Warehousing and Quality Control Equipment. The project would provide at each site a weighbridge and a simple husk fired batch dryer. Installation, initial operator training and preparation of operating instruc- tions would be the responsibility of the supplier. Other warehousing equipment would consist of grain cleaners, platform scales, pallets and sack barrows and would vary in number with the size of each godown complex. Quality control equipment would include dust applicators, fumigation sheets, spraying gear, moisture meters, and miscellaneous other equipment items, detailed in Annex 5, Table 3. Cost details and estimated equipment cost at each storage site are presented in Annex 5, Tables 1 and 2. 4.11 Project Engineering Unit (PEU). A Project Engineering Unit would be established in NFC. PEU's main responsibilities would be the design of storage modules and ancillary facilities, preparation of site layout, tender- ing for civil works construction and equipment, and construction supervision  - 19 - (para 5.06). The project would provide funds for PEU operations, and, since mobility of PEU staff would be essential for effective supervision, it would also finance vehicles for PEU engineers and construction supervisors. (Cost details are in Annex 5, Table 4.) 4.12 Mobile Fumigation Units. Present pest control practices of NFC/RECs are limited mainly to application of malathion at the time of intake into storage and to usage of aluminum phosphide. For fumigation with aluminum phosphide, NFC/RECs generally attempt to seal the entire godown, a practice which given the types and poor quality of most existing godowns is usually not effective. Treatment of infested grain with methyl bromide under gas proof sheets is considerably more effective but requires trained personnel and specialized equipment both of which are presently not available in Nepal. The project would finance equipment for two fumigation squads which would be operated by NFC and comprise one operator and two spraymen. Each squad would be provided with fully protective clothing and a vehicle which would carry methyl bromide cylinders, necessary piping with power sprayers, tanks and pesticide concentrates. A quality control specialist who would train the squad personnel would also be engaged under the project (para 4.22). One of the units would cover all NFC/RECs storage facilities west of Butwal. The other unit would be responsible for the remaining NFC/RECs warehouses in the Terai and at Hetauda. Cost of the fumigation squads are in Annex 5, Table 5. 4.13 Technical Assistance. Technical assistance would be provided to (i) strengthen NFC's organization and management capabilities (paras 4.14 through 4.18), (ii) improve financial management and internal audit systems at NFC (paras 4.19 through 4.21), and (iii) assist NFC and RECs in the imple- mentation of proper quality control procedures; improve godown maintenance; train quality control staff, storekeepers and procurement personnel; and help PEU in tender preparation for quality control and drying equipment (para 4.22). 4.14 NFC's organization is in need of strengthening. The organizational structure (Chart 21253) is basically line-staff with some unusual variations: (i) The Finance Division is reporting to the Deputy General Manager (DGM) Operations; (ii) the Construction and Maintenance Division is reporting to the DGM Administration; and (iii) the unity of command principle is not being followed between headquarters, regional offices and branch offices. The absence of a clear chain of command between headquarters and field offices coupled with inadequate delegation of responsibilities and authority to regional and branch offices is causing long delays in decision making, and overburdening of headquarters staff with trivial matters which could be solved more effec- tively at lower levels. 4.15 To strengthen its operational effectiveness, NFC needs to revise its organizational structure. All staff functions should be assumed by the DGM for Administration who would provide the necessary line support for financial  - 20 - management, personnel management, general services and planning. Support should not be limited to irregular assistance on the basis of explicit manage- ment requests, but include a structured management information system to pro- vide necessary operational, financial and statistical data for planning and decision making at the operational level, and a strong personnel management system for recruiting qualified personnel and for planned in-service training. The DGM Operations should be responsible for all line functions including Trade which is now combined with Planning. Most importantly, the DGM Opera- tions should have the direct authority over and responsibility for all field offices which need to be structured along single lines of command. In addi- tion, a program for decentralization of authority and responsibility at the various field office levels needs to be developed together with a system of control over field office operations. A revised organizational structure is presented in Chart 21266. 4.16 NFC's management also is in need of strengthening. Planning, organi- zing, direction, control and coordination appear to be ad hoc managerial functions rather than primary management responsibilities. There are several apparent reasons for this, including shortage of trained, experienced staff, especially at the professional level; temporary appointment of personnel for long periods; a rather recent top management; frequent transfer of key division heads; inadequate delegation of responsibility and authority; lack of manage- ment information systems; and inadequate communication between field offices and headquarters. 4.17 Improvement in management effectiveness will to some degree depend on the availability of highly competent staff in key positions. However, recruitment of new and additional staff is a factor which can be regulated by NFC only to a limited degree because many important factors such as pay scale and creation of positions are subject to ministerial decisions. On the other hand, there are a number of steps that NFC can take to strengthen its manage- ment capabilities: (i) reorganization and delegation of responsibility and authority, as outlined above, would provide for a more manageable organization; (ii) additional emphasis on training through appointment of a training officer and development of training programs including in-service and foreign training would permit valuable staff development within the existing personnel struc- ture; (ii) establishment of a management information system including monthly and quarterly reports on matters such as financial operations, cash flows, inventory status and grain movements, personnel management and training requirements, and comparisons of actual with budgeted results would consider- ably improve day-to-day management by the General Manager and DGMs and make quarterly Board meetings more meaningful; and (iv) monthly staff meetings of the General Manager, DGMs and division heads, in addition to more frequent visits by headquarters staff to field offices, would assist in alleviating communication problems. 4.18 In view of the shortage of trained and experienced staff and the unlikelihood of such staff becoming available in the near future, technical assistance in the form of organization and management expertise would be re- quired for approximately two years to strengthen NFC's organization and man- agement capabilities. The project would finance such expertise (para 4.23). In addition, for staff development, NFC would engage a training manager who would, with the assistance of the organization and management expert, design a staff training program. (Draft Terms of Reference for the consultant are in Annex 6.)  - 21 - 4.19 NFC's accounting, financial reporting and auditing systems require considerable improvements in systems design, operating procedures and staff capability. Only then would the Finance and Internal Audit Divisions be able to provide management and other concerned agencies with accurate and timely financial information. At present, reconciliation of payment registers, sub- sidiary ledg-.s and bank statements is not an established monthly procedure; a general ledger is not maintained for final entry control and for the prep- aration of financial statements; account titles are not sufficiently descrip- tive; and accounts are not adequately segregated. As a result, financial statements are late (for FY 1977/78 a tentative balance sheet and income statement were only completed by October 1979) and not reliable. The audit of accounting records and financial statements of FY 1976/77 indicated several qualifications regarding the balance sheet and income statement, including the auditors' inability to verify bank balances, accounts payable and receivable, and ending inventories; and the tentative income statement for FY 1977/78 does not balance. 4.20 NFC's internal controls are weak. There are no pre-audit procedures, expenditures are sometimes difficult to verify, field offices are irregular in submitting financial reports, and comparisons of actual with budgeted expendi- tures are not prepared on a regular basis. Cash management is also poor; an audit program does not exist; and the Internal Audit Division as well as the Finance Division lack trained and experienced staff. Actions required to improve NFC's financial and internal control procedures include (i) updating and effective implementation of NFC's accounting manual, (ii) in-service training of finance and internal audit personnel in the principles and funda- mentals of accounting, (iii) pre-auditing, (iv) daily recording of all trans- actions, (v) preparation of annual budgets and monthly interim income state- ments, (vi) monthly comparison of actual and budgeted expenditures, (vii) monthly cash flow projections, (viii) introduction of accounting on an accrual basis, (ix) development of an audit program, and (x) maintenance of inventory control records at regional offices. 4.21 To strengthen NFC's financial management capabilities, and consider- ing the scope of improvement required as well as the lack of expertise within NFC, technical assistance in the form of expertise in the fields of financial management and auditing would be necessary. The project would provide for a specialist who would be engaged for about 30 months and work closely with NFC's present external audit firm. (Draft Terms of Reference for the project financed consultant are in Annex 6.) 4.22 Establishment of proper procurement and storage quality control pro- cedures at NFC and RECs is in its infancy. Godown maintenance is poor. Given the high storage losses (para 2.19), and quality problems experienced in rice exporting (para 3.11), NFC and RECs are now giving increased attention to this area. By engaging some quality control staff and by adopting grading standards and a standard for quality control procedures, these institutions have taken the first important steps in strengthening quality control practices. But staffing is not yet adequate; existing staff have little experience and require additional training; quality control practices and procedures need to be further developed; and expertise for operating mechanical drying and fumigation equipment is not available with NFC/RECs. To assist NFC/RECs in strengthening quality control  - 22 - practices and godown maintenance, to train quality control and procurement staff, and to help PEU in the preparation of specifications for quality con- trol and drying equipment, the project would provide for a two-year engagement of a quality control specialist. (Draft Terms of Reference are in Annex 6.) 4.23 Total cost for 78 man-months of technical assistance (paras 4.13 through 4.22) estimated at about US$600,000 have been calculated on the basis of a man-month cost of US$7,500 including subsistence and allowances. (Details are in Annex 5, Table 6.) An assurance was obtained from NFC at negotiations that all technical assistance services would be engaged by December 31, 1980 on terms and conditions satisfactory to IDA. 4.24. Training. Training would be required tc develop the skills necessary for effective management and storage quality control at NFC and RECs. Much of this would be on-the-job training provided by project consultants. However, some formal management training would have to be given outside Nepal. NFC's four regional and five of its branch managers would participate in storage management courses which are, for example, offered at the Indian Grain Storage Institute and last for about four weeks. Similar storage management training would be made available to managers of RECs. In addition, the project would finance training courses of about three months each for NFC's division heads. These courses also could be arranged in India or other South Asian countries and would cover specialized subjects related to the division heads' responsi- bilities. Furthermore, the project would provide short-term study tours for NFC's top management to become familiar with management practices and operat- ing procedures of institutions similar to NFC in the region. Development of a suitable training program for NFC and RECs managers would be the responsi- bility of the training manager who would be engaged locally by NFC. An assurance was obtained from NFC at negotiations that foreign training and study tours satisfactory to IDA would be arranged by June 30, 1981. (Cost details on training are in Annex 5, Table 6.) 4.25 Studies. The project would provide funds for a foodgrain marketing and price policy study and a foodgrain storage and processing study. The former would be designed to assist HMG in the formulation of suitable market- ing policies including procurement and distribution pricing to provide ade- quate incentives to foodgrain producers for increasing production and improv- ing grain quality, and to minimize the drain on the Government budget. The latter would concentrate on further development needs in the post-harvest foodgrain sector and (i) establish a comprehensive picture of storage and processing facilities available in Nepal, (ii) project requirements in the storage and processing sub-sectors, and (iii) prepare recommendations for sub-sector development. On the basis of the latter study's findings further programs and projects could be prepared. An assurance was obtained from HMG at negotiations that engagement of consultants for the studies would be com- pleted by December 31, 1980 on terms and conditions acceptable to IDA. (Draft Terms of Reference for the two studies are in Annex 7. Cost estimates are in Annex 5, Table 7.) Project Cost Estimates 4.26 Total project costs including taxes and duties, over the four year development period, are estimated at NRs 96.39M (US$8.04M equivalent), of  - 23 - which about US$3.95M is foreign exchange. Details of project costs, summarized below, are in Annex 5. 4.27 Cost estimates are based on findings during appraisal updated to December 1979. Physical contingencies have been added at 15% on all civil works and equipment cost for storage warehouses. Price contlagencies amount- ing to 24.5% of the sum of base cost and physical contingencies are also included and represent expected price increases compounded annually on all cost components. Inflation rates have been estimated at 10.5%, 9% and 8% for 1980, 1981 and 1982 respectively and at 7% for 1983 and 1984. Duties and taxes included in the cost estimates total NRs 9.37M (US$0.78M). SUMMARY OF PROJECT COST Foreign Local Foreign Total Local Foreign Total Exchange ----- NRs million --- ----- US$ million --- % 1. Storage Facilities Land 0.49 - 0.49 0.04 - 0.04 0 Civil Works 26.30 17.64 43.94 2.19 1.47 3.66 40 Equipment 3.01 5.29 8.30 0.26 0.44 0.70 64 Sub-total 29.80 22.93 52.73 2.49 1.91 4.40 43 2. PEU Vehicles 0.29 0.38 0.67 0.03 0.03 0.06 57 Operations 1.21 2.45 3.66 0.09 0.21 0.30 67 Sub-total 1.50 2.83 4.33 0.12 0.24 0.36 65 3. Fumigation Units 0.35 0.28 0.63 0.03 0.02 0.05 44 4. Training and Technical Assistance 1.41 7.50 8.91 0.11 0.63 0.74 84 5. Studies 2.14 1.00 3.14 0.18 0.08 0.26 32 BASE COST ESTIMATE 35.20 34.54 69.74 2.93 2.88 5.81 50 6. Contingencies Physical 4.40 3.44 7.84 0.36 0.29 0.65 44 Price 9.41 9.40 18.81 0.80 0.78 1.58 50 Sub-total 13.81 12.84 26.65 1.16 1.07 2.23 48 TOTAL PROJECT COST 49.01 47.38 96.39 4.09 3.95 8.04 49 Project Cost Ex- cluding Duties and Taxes 39.64 47.38 87.02 3.30 3.95 7.25 54  - 24 - Financing 4.28 The project financing plan would be: -US----------- US$ M -------------- IDA Total HMG NFC Amount % Storage Complexes 6.36 1.71 0.04 4.61 75 Project Engineering Unit 0.44 0.06 - 0.38 86 Mobile Fumigation Units 0.06 0.03 - 0.03 50 Technical Assistance and Training 0.88 - - 0.88 100 Studies 0.30 - - 0.30 100 TOTAL 8.04 1.80 0.04 6.20 77 Percent of Total 100% 22% 1% 77% 4.29 The proposed IDA Credit of SDRs 4.8M (equivalent to US$6.2M as of the date of negotiations) would meet about 85% of project cost net of duties and taxes. The Credit would cover all foreign exchange costs and about 55% of local costs. The Ministry of Finance would pass on US$5.9M of the proceeds of the Credit to NFC as HMG equity contribution for financing con- struction and equipping storage complexes (US$4.6M); procurement of vehicles for the Project Engineering Unit (PEU) and of specially equipped vehicles for the fumigation squads (US$0.1M); technical assistance and training (US$0.9M); and PEU's staff cost (US$0.3M). The balance of IDA funds (US$0.3M) would be passed on to the Ministry of Food and Agriculture (MFA) to finance con- sultancy services which would be engaged by MFA for carrying out the project studies. In order to permit early commencement of the foodgrain marketing and price policy study, retroactive financing up to US$100,000 is proposed for cost appropriately incurred for the study after November 1, 1979. 4.30 HMG's contribution of NRs 21.6M (US$1.8M) would finance about 22% of project cost. It would cover the government's contribution to new godown construction, equipment and vehicles procurement and PEU operations. NFC's contribution of NRs 0.48M (US$0.04M) would finance the purchase of land for new godowns. Procurement 4.31 Civil works contracts for the construction of godowns and ancillary facilities and for site improvements (US$5.29M) would be let on the basis of international competitive bidding (ICB) in accordance with IDA guidelines. Since contracts are small, only Indian contractors near the Nepalese border would be expected to bid on the contracts, in addition to local construction companies. Domestic contractors would be awarded a margin of preference of 7.5%. The Project Engineering Unit would pre-qualify all domestic and foreign bidders for civil works. Prequalification criteria are in Annex 4, Appendix 1. Construction would take place in three phases. To the extent practical, the contracts of one phase would be bulked. A contract would in- clude all civil works at one site. Contractors would be able to bid for one contract or for a combination of contracts or for the entire phase.  - 25 - 4.32 Equipment items and vehicles (US$1.14M) would be mostly imported and would be procured under ICB contracts. Items which cannot be bulked into contracts exceeding US$100,000 may be procured under NFC's local competitive bidding procedures which are satisfactory to IDA. Minor items costing less than US$10,000 each, for which bulking into contracts of at least US$10,000 is not prac.-Lcal, may be procured by prudent shopping with due regard to efficiency and economy, up to a total of US$100,000. The procurement of weighbridges and mechanical dryers would include initial operator training and preparation of detailed operating procedures by the supplier (para 4.10). Technical assistance services engaged, staffing of the Project Engineering Unit (PEU), and arrangements for foreign training and for the studies (US$1.52M) would be on terms and conditions satisfactory to IDA. The balance of project costs (US$0.09M) would cover PEU operating costs not involving procurement, and land purchases. An assurance was obtained from NFC at nego- tiations that for all contracts in excess of US$100,000 draft tender documents and bid evaluation would be submitted for IDA review prior to contract award. Disbursement 4.33 Disbursements under the proposed credit would cover: (i) 100% of foreign expenditures or 75% of local expenditure for civil works contracts awarded under ICB - SDRs 2.98M (US$3.85M); (ii) 100% of foreign expenditures for directly imported equipment and vehicles or 75% of local expenditure for locally procured items - SDRs 0.64M (US$0.83M); (iii) 100% of PEU staff cost - SDRs 0.26M (US$0.34M); and (iv) 100% of expenditures for technical assistance, training and the two studies - SDRs 0.92M (US$1.18M). Disbursement for items (i), (ii) and (iv) would be made against full document- ation submitted to IDA. Claims against civil works would be substantiated by a copy of interim payment certificates or work completion certificates approved by NFC's general manager and co-signed by the chief engineer heading PEU. For expenditures in (iii), disbursements would be made against certified statements of expenditure. Documents supporting the latter type of disburse- ments would not be submitted to IDA for review but retained by NFC and made available for inspection by IDA during supervision mission visits. A schedule of estimated disbursements is given in Annex 8. V. ORGANIZATION AND MANAGEMENT General 5.01 Successful development of the post-harvest foodgrain sector depends heavily on the organizational and managerial strength of the constituent institutions. The existing organizational structure was developed during a  - 26 - period when food deficits in the Hills and Mountains were small, Nepal's overall foodgrain surplus was substantial, and India was absorbing any excess rice production which was not required for Nepal's internal needs. The present structure has not been able to adjust adequately to changes which have occurred in recent years, namely the increasing disparity between foodgrain production and consumption requirements in Hill and Mountain districts, the disappearance of the Indian demand for Nepalese rice, and higher quality standards in other export markets, and, as a consequence, inefficiencies, duplication of functions, cash flow problems, and weaknesses in coordination have increasingly reduced the ability of public sector institutions to meet effectively demands on the post-harvest sector. To take account of the new environment in which public sector procurement, distribution and exports are taking place, considerable restructuring of the organizational arrangements would be necessary. Reorganization of Nepal Food Corporation and Rice Export Companies 5.02 Since RECs entire rice purchases come from private traders and millers, and because paddy procured by RECs is milled almost exclusively by privately owned mills, RECs' Board members from the private sector have been in a serious conflict of interest, especially with regard to the Board's price decisions. This conflict of interest has been considerably aggravated by the recent Government decision to eliminate RECs rice export monopoly and to permit private traders to resume rice exports. In recognizing this problem, HMG has now decided to appoint NFC in accordance with the Company Act as RECs' Manag- ing Agent. In this role, NFC would assume the responsibility of RECs Boards, including the establishment of procurement and export programs and of prices, and the development of strategies for effective competition with the private sector in paddy procurement and rice exports. Completion of necessary arrange- ments would be a condition of Credit effectiveness. NFC's responsibilities as RECs' Managing Agent have been agreed upon during negotiations. 5.03 Further restructuring of the institutional setup would have to follow to take account of the other fundamental changes in the sector. RECs, due to reduced exports, have become increasingly dependent on NFC for selling excess grain. However, since profit margins on such sales are slim, RECs are not keen on selling to NFC, and NFC cannot fully rely on RECs to meet its food- grain requirements. With the reduction in levy procurement, NFC had to make separate procurement arrangements, and may have to develop its own procurement r. twork further to ensure supplies. As a result, procurement efforts are being duplicai_ed. There is also considerable duplication of quality control and accounting functions at RECs and at NFC's regional and branch offices. This has led to wastage of scarce resources, especially since there is a serious short- age of experienced and well trained accounting and quality control personnel. Also, the decline in exports has resulted in excessive overhead cost at several RECs; cash flow problems have emerged; and deficits at some RECs have impaired their financial viability. In addition to the problem of keeping each REC as a viable legally and financially independent organization in the context of rising overhead costs, the task of coordinating transport, exports, and domestic sales to NFC has become a complex one. To help NFC to carry out more effectively the foodgrain price support program by procuring grains directly from the farmers and to develop assured sources of supply for foodgrains  - 27 - required for domestic distribution and to help reduce the overhead costs of the public sector foodgrain operations, it appears highly desirable to combine the functions of NFC and RECs and have NFC assume full control over public sector foodgrain procurement, domestic distribution and export. This would make it possible to take major decisions governing these activities in a more purposive manner geared to supporting the government policies for the development of the foodgrain sector. Added benefits of merging the respon- sibilities of NFC and RECs would include a more rational organization of grain procurement staff, reduced overhead costs, and higher technical standards of grain procurement, quality control and export/distribution operations. HMG has therefore decided that NFC should take over full control of ownership and functions of RECs. An assurance was obtained from HMG at negotiations that necessary actions, including acquisition by NFC of the outstanding shares required for NFC to exercise such control, would be completed by June 30, 1982. NFC would prepare a program detailing the required actions, and a plan for reorganizing NFC and RECs (para 5.09). Project Management and Coordination 5.04 Overall responsibility for project implementation would rest with the Ministry of Food and Agriculture (MFA). A Project Management and Coor- dination Committee (PMCC) would be established under the chairmanship of the Secretary, MFA, and would comprise the Joint Secretaries of MFA, the Ministry of Finance, and the National Planning Commission; the Director General of FAMSD; the General Manager of NFC; the chief engineer of the Project Engi- neering Unit (PEU); and a member of the Agricultural Development Bank. A Deputy General Manager of NFC would serve as the secretary of the Committee. Administrative support to PMCC would be provided by NFC. 5.05 PMCC would meet as necessary, but at least quarterly, to review project progress, formulate policies, and give directives for project imple- mentation. In particular, PMCC would (i) ensure timely flow of funds to NFC and MFA; (ii) monitor physical implementation; (iii) review NFC and RECs performance regarding quality control and storage loss reduction; (iv) monitor implementation of the programs for NFC to take over full control of ownership and functions of RECs and for reorganizing NFC and RECs, and of the plan to expand direct foodgrain procurement by NFC/RECs from farmers and through Sajha (paras 5.09 and 5.10); (v) ensure timely land acquisition for the project; and (vi) guide preparation of the two studies financed under the project and upon completion of the studies make appropriate recommendations for further sector development and for foodgrain marketing and price policy formulation. Com- position and functions of PMCC were agreed upon during negotiations. Estab- lishment of PMCC would be a condition of Credit effectiveness. Project Implementation 5.06 Project Engineering Unit. For executing the project construc- tion program and procuring the equipment provided under the project, NFC would establish a Project Engineering Unit (PEU) (para 4.11). Detailed functions of PEU would include: (i) preparation of storage module designs including structural drawnings, specifications and cost estimates; (ii)  - 28 - designing ancillary facilities; (iii) preselection of construction sites, arranging soil surveys at storage sites, and preparing site layouts; (iv) prequalification of contractors; (v) preparing tender documents for civil works, vehicles and equipment; (vi) evaluating bids, preparing bid evaluation reports for NFC Board and IDA consideration; (vii) preparation of documentation for civil works contracts and for equipment and vehicles procurement, and award of contracts; (viii) supervising construction; (ix) managing project funds for civil works construction, equipment and vehicles procurement, and PEU operations; (x) maintaining project accounts; (xi) submitting disbursement requests to IDA; and (xii) preparing quarterly progress reports for PMCC discussion and IDA review. For design specification of grain drying and quality control equipment, including specialized vehicles for fumigation squads, PEU would consult with the quality control specialist who would be engaged under the project (para 4.22). 5.07 To avoid overburdening NFC which presently finds it difficult to carry out its routine responsibilities, PEU would be administratively self- contained and provided with well qualified staff able to perform PEU's functions with minimal demands on NFC managment. The Unit would be headed by an internationally-recruited chief engineer reporting directly to NFC's general manager, and include locally-recruited engineering consultants, com- prising two senior engineers responsible for different construction phases, construction supervisors responsible for individual construction sites, and two draftsmen; and support staff. PEU's staffing plan and repsonsibilities were agreed upon at negotiations. Engagement of the chief engineer and the two senior engineers would be in accordance with terms of reference satis- factory to IDA. Draft Terms of Reference for PEU's engineering personnel are in Annex 9. Appointment of the chief engineer would be a condition of Credit effectiveness. 5.08 Management Support Unit. A Management Support Unit would be estab- lished within NFC, reporting directly to the General Manager and headed by one of NFC's Deputy General Managers. Responsibilities of the Unit would include (i) identification of consultants for organization and management, finance and internal audit, and quality control; (ii) preparation of recom- mendations on consultants engagement for NFC Board consideration and IDA review; (iii) submission of disbursement requests for consultants expenses; (iv) development of a time-bound action plan for taking over full control by NFC over RECs (para 5.09); (v) preparation of a program for increasing primary market procurement by NFC/RECs from farmers and through Sajha (para 5.10); and (vi) preparation of quarterly progress reports for PMCC and IDA. An assurance was obtained from NFC during negotiations that it would establish the Manage- ment Support Unit with composition and responsibilities satisfactory to IDA, by October 31, 1980. 5.09 A time-bound action program for NFC to assume full control of ownership and functions of RECs would detail (i) administrative steps to be taken; (ii) legal measures to be carried out; (iii) financial arrangements to be made; and (iv) changes in responsibilities and in the organizational structure to be implemented for smooth integration of RECs into NFC. A plan providing details on administrative, legal and financial actions, including timing of such actions, would be completed and presented for PMCC review and IDA comments not later than October 31, 1980. The program, specifying changes  - 29 - in organization, responsibilities and staff structure, would be prepared with the assistance of the management and organization consultant provided under the project (para 4.18), and would be examined by PMCC. Together with the program a study would be prepared to determine whether RECs should retain their legal identity as autonomous companies. Copies of the reorganization program and 'he study would be made available to IDA for comments by June 30, 1981. Appropriate assurances were obtained from NFC and HMG during negotia- tions. 5.10 The plan for expanding NFC/RECs' primary market procurement would be prepared in close cooperation with FAMSD, the Department of Cooperatives and the consultants preparing the foodgrain marketing and price policy study (para 4.25). The plan would provide a phased program for establishing neces- sary infrastructure and institutional arrangements in the various Terai dis- tricts in which procurement would be concentrated. It would specify the Sajha cooperatives to be included in the program and present in detail procurement, credit and transportation arrangements to be set up. In addition, Sajha staff- ing requirements and training needs in procurement and quality control would be determined. Training would be carried out by NFC/RECs, with the assistance of the quality control specialist provided under the project (para 4.22). Where Sajha are not able to organize procurement for NFC/RECs, the program would outline alternative arrangements, including the establishment by NFC/RECs of additional temporary and permanent procurement centers, staffing of the centers and training to be provided. It would also detail the system of payments to farmers and grading standards to be followed by Sajha and NFC/RECs procurement personnel. The plan would be under continuous review by NFC and PMCC and would be modified as necessary to reflect the experience gained during implementa- tion. A first draft of the plan, which would be detailed for the initial phase and provide a broad outline for later phases, would be presented to IDA by June 30, 1981. An assurance to this effect was obtained from NFC during negotiations. 5.11 Implementation Schedule. The project would be implemented over a period of about four years. The construction program would be divided into three phases with a construction time of approximately twelve months for each phase. Phase I would include the storage centers in Birtamod and Biratnagar in the east (16,000 MT); phase II construction would cover three facilities in Lahan, Janakpur and Hetauda in the central region (11,000 MT); and phase III would comprise four sites in western Nepal: Nepalgunj, Rajapur, Dhangarhi and Mahendranagar (13,000 MT). Construction would start in the east so that PEU may gain initial experience in a region where construction and construc- tion supervision are anticipated to be least difficult taking into considera- tion the existing transportation network and the capacity of the local con- struction industry. As the construction program would reach the Terai Zones in the west, PEU would be expected to have gained sufficient experience to cope effectively with the less developed infrastructure in this area. Land has been acquired at five sites in the nine locations, but is adequate only at three sites. Early land acquisition would be crucial for timely project implementation. As is evidenced by the storage projects financed with UK/ODA and UNDP assistance, slow land acquisition would result in considerable imple- mentation delays. It would, therefore, be a condition of Credit effectiveness that phase I storage sites had been acquired. For phases II and III, an assurance has been obtained from NFC during negotiations that land aquisition  - 30 - be completed by August 31, 1981. Sites to be acquired would be selected in accordance with criteria detailed in Annex 9, Appendix 1. An assurance was obtained from NFC during negotiations that all construction sites would be agreed with IDA. Details on the status of site selection and land acquisition are in Annex 9, Table 1. A project implementation schedule, which has been agreed upon during negotiations, is presented in Chart 21265. Accounts and Audit 5.12 NFC and MFA would establish and maintain separate accounts for the project in accordance with sound accounting practices and ensure that these accounts would be audited annually by independent auditors acceptable to IDA. Certified copies of the audited accounts and auditors' reports would be sent to IDA within twelve months after the close of each financial year. The audit report would be required to include a statement that funds disbursed against statements of expenditures had been used for the purpose for which they were provided. Assurances were obtained from NFC and HMG at negotiations that these accounting, audit and reporting procedures would be adopted. Project Monitoring and Evaluation 5.13 PMCC would monitor project implementation on the basis of detailed implementation plans which would be prepared by NFC and MFA for their respective sub-projects. PMCC would also review major implementation and coordination problems and assist in solving them to avoid uncessary cost or slippage. Day-to-day monitoring would be conducted by the heads of PEU and of the Management Support Unit. 5.14 Evaluation of the project would concentrate on NFC/RECs' operat- ing efficiency, including storage utilization; storage losses; turnover of stocks; age of stocks; procurement arrangements; quality control at procure- ment, during storage and at distribution; cost of godown operations; and transportation cost. Evaluation would also address organizational, managerial, financial, and staff development aspects of the project. In addition, evalu- ation would focus on changes in NFC/RECs procurement pattern, especially with regard to primary market procurement directly from farmers or through Sajha. The Evaluation and Project Analysis Division of MFA would be responsible for project evaluation and would prepare written evaluation reports, at least annually, evaluating (i) developments in the above areas and (ii) deviations from appraisal estimates regarding benefits, cost and implementation schedul- ing. Copies of the evaluation reports would be made available to IDA for information. The Division would also prepare a Project Completion Report and furnish the report to IDA not later than six months after the Credit Closing Date. An appropriate assurance was obtained from HMG during negotiations. VI. BENEFITS AND JUSTIFICATION Benefits 6.01 The project would strengthen NFC/RECs' organization, management and technical capabilities, and assist in implementing HMG foodgrain policy more effectively. The principal economic benefits would be the reduction  - 31 - in grain storage losses and savings in operating cost. At full development, safe storage provided by new project godowns and improvements in NFC/RECs quality control practices would reduce the present storage loss rate estimated at 7.5% per annum (weighted average loss of grains actually stored by NFC/RECs in recent years) to about 1.6% (the level to which storage losses are estimated feasible to be reduced at the storage of quality the project is providing), reducing annual storage losses from an estimated 3,600 MT of foodgrain at present to about 800 MT. 2,800 MT of grain which would thus be saved annually are valued at US$850,000. Of this, about 2,400 MT would be saved in new godowns. About 400 MT would be saved through improved pest control in existing storage facilities. Assuming that Nepal would continue to produce an overall grain surplus, the reduction in storage losses would result in increased annual foreign exchange earnings of about US$880,000. In addition, project storage would be more economic to operate than the large number of scattered small-size facilities now rented by NFC/RECs. Annual savings in operating cost are estimated at about US$140,000 at full development (Annex 10, Table 4). Total annual cost savings thus would be almost US$1 million. Details are in Annex 10, Table 5. 6.02 An important additional but unquantifiable benefit stemming from the project would be HMG's ability to implement its support price and price stabil- ization policies more effectively. Project storage would permit NFC/RECs to expand primary market procurement directly from farmers and through Sajha. Especially in the west, where farmgate prices appear to have been sometimes lower than support prices, such increased public sector procurement would ensure that farmers receive at least the support price and thereby encourage them to increase foodgrain production. Benefits from training and technical assistance in management, organization and finance are difficult to quantify. However, these components are expected to produce appreciable savings through improved inventory and financial management and reductions in transportation cost. Benefits from merging the functions of NFC and RECs also have not been quantified. In the present situation, characterized by high overhead cost, duplication of functions and weak coordination among NFC and RECs, scarce resources are wasted. The take over by NFC of full control over ownership and functions of RECs would permit considerable rationalization of operations and thus reduce costs. Beneficiaries 6.03 Benefits would accrue primarily to the Government in the form of reduced grain storage losses, resulting in additional foreign exchange earn- ings, higher income from public sector export operations and/or reduced defi- cits in subsidized foodgrain distribution. The project would also benefit farmers and low income consumers. Additional storage and strengthened public sector institutions would enable NFC/RECs to increase primary market procure- ment in accordance with HMG policy. Expanded primary market procurement by the public sector would provide greater assurance to farmers that they receive at least minimum support prices and would increase competition for their produce. As a result, farmgate prices would be expected to rise. Reduced storage losses and improvements in NFC management and organization would result also in less costly and more efficient public food distribution and would therefore contri- bute to greater availability of foodgrains to low income consumers at reason- able prices.  - 32 - Economic Rate of Return (ERR) 6.04 Economic cost and benefit values have been calculated at estimated border prices. Prices of internationally traded goods have been converted at the official exchange rate (US$1.00 = NRs 12.00). For calculating the econo- mic value of non-traded goods including unskilled labor the Standard Conver- sion Factor (0.9) has been applied. All costs and benefits are expressed in 1979 constant Nepalese Rupees. Economic rates of return (ERR) have been calculated separately for new godowns, improved pest control in existing godowns, and for the entire project. Economic costs for the new godown compo- nent include cost of land, civil works, storage equipment, PEU, a prorated share of the cost of mobile fumigation units and of technical assistance per- taining to pest control, and operating costs. Economic costs of the component concerning improved pest control in existing godowns consist of the prorated share of the costs of fumigation units and technical assistance. ERR for the entire project is estimated at about 18%, with individual ERR of 16% for new godowns and over 100% for improved pest control in existing godowns. Details on assumptions used in ERR calculations are presented in Annex 10. ERR for the project component involving improved pest control in existing storage is high because the use of relatively low cost pesticide treatment would permit the better utilization of substantial sunk costs in NFC/RECs' existing godowns. Sensitivity Analysis and Project Risks 6.05 ERR is not very sensitive to a delay in benefits. Even if benefit streams are lagged by two full years, ERR is reduced only to 11% for the new godown component and to 13% for the entire project. Switching values have been calculated to determine the sensitivity of major cost and benefit compo- nents. The following percentage changes in cost or benefits would have to occur before ERR is reduced to 10%, which would still be satisfactory: % Increase (Decrease) Required to Reduce ERR to 10% Pest Control New Component in Godown Existing Entire Cost or Benefit Component Component Godowns Project Cost Civil Works Cost 54 N.A. 81 Equipment Cost 179 N.A. 267 Total Cost 35 221 48 Benefits Savings in Storage Losses (31) N.A. (233) Savings in Operating Cost (157) (69) (38) Total Benefits (26) (69) (33)  - 33 - The analysis shows that ERR is not very sensitive to changes in costs and in savings in operating cost. Cost overruns by 35% for the entire project are very unlikely. Costs have been estimated on fairly detailed storage designs (see Charts 21165 and 21166), and a physical contingency of 15% has already been added to all major cost components. Economic viability of the project is most sensicive to benefits from reduced storage losses. There are three potential reasons why savings from loss reductions could be lower than antici- pated: (i) project storage may create excess capacity, due to low NFC/RECs procurement; (ii) anticipated loss reductions from present levels may not materialize because of poor construction of project godowns or inadequate improvements in quality control; and (iii) ineffective management and organi- zational weaknesses may prevent NFC/RECs to make effective use of project storage facilities. As the project provides for only about 50% of total anti- cipated NFC/RECs storage requirements in the project area, the chances of under-utilizing project godowns are minimal. Moreover, in projecting storage requirements, the intention expressed by MFA to increase substantially direct procurement from farmers and Sajha has not been taken into consideration because the feasibility of this needs to be further analyzed (para 5.12). Furthermore, the estimated loading factor of 67% for project godowns has been calculated on the assumption that all existing godowns of comparable quality would first be loaded to 90% before any of the new godowns would be used; and new capacity has been assumed to be utilized only to a maximum of 90%. Even if the loading factor should turn out to be lower than projected, it would have to fall to 46% before ERR is reduced to 10%. Regarding the risk of poor godown construction and insufficient quality control improvements, safeguards have been taken in the project by (i) limiting godown design to two simple modules which would be easy to construct with locally available material and equipment and (ii) providing a Project Engineering Unit which would be staffed with well qualified engineers who would supervise all cri- tical steps of construction. Adequate improvements in quality control would be ensured by project provisions for technical assistance and training in this field. Concerning management and organizational weaknesses of NFC/RECs, appropriate technical assistance and training components have been included in the project for strengthening NFC's management capabilities and organiza- tional structure. In addition, a training manager would be engaged by NFC to identify training needs and prepare suitable programs for staff develop- ment. Moreover, care would be taken of a number of prevailing problems in organization and coordination by NFC taking over full control of REC's owner- ship and functions. Operations would be rationalized; quality control, storage management and procurement procedures would be standardized; and transportation would be arranged in a coordinated manner. In view of these precautions taken in project design, the risks have been reduced to acceptable levels and would not jeopardize project success. VII. RECOMMENDATIONS 7.01 During negotiations, assurances were obtained from HMG and/or NFC on the following:  - 34 - (i) annual NFC deficits resulting from HMG distribution policy to be financed annually by HMG with the begin- ning of the fiscal year 1982 (HMG) (para 3.08); (ii) consultants to be engaged by December 31, 1980 on terms and conditions satisfactory to IDA (HMG and NFC) (paras 4.23 and 4.25); (iii) foreign training (including study tours) to be arranged by June 30, 1981 on terms and conditions satisfactory to IDA (NFC) (para 4.24); (iv) necessary actions for NFC to take over full control of ownership and functions of RECs to be completed by June 30, 1982, and a plan detailing such actions to be presented to IDA by October 31, 1980 (HMG) (paras 5.06 and 5.09); (v) PEU's internationally-recruited chief engineer and two locally recruited senior engineers to be engaged on terms and conditions satisfactory to IDA (NFC) (para 5.07); (vi) establishment of a Management Support Unit, with composition and responsibilities satisfactory to IDA, to be completed by October 31, 1980 (NFC) (para 5.08); (vii) a reorganization plan for NFC and RECs and a draft plan detailing arrangements for increased primary market pro- curement by NFC/RECs to be furnished to IDA by June 30, 1981 (NFC) (paras 5.09 and 5.10); (viii) acquisition of all construction sites satisfactory to IDA to be completed by August 31, 1981 (NFC) (para 5.11); and (ix) certified copies of audited accounts and auditors' reports to be sent to IDA within twelve months after the close of each financial year (HMG and NFC) (para 5.12); 7.02 Agreement has also been reached on the following conditions of Credit effectiveness: (i) appointment of NFC as RECs' Managing Agent (para 5.02); (ii) establishment of PMCC (para 5.05); (iii) engagement of a chief engineer to head PEU (para 5.07); and (iv) acquisition by NFC of land for phase I construction sites (para 5.11).  - 35 - 7.03 It is recommended that retroactive financing up to a total of US$100,000 be made available for expenditures after November 1, 1979, appro- priately incurred on the foodgrain marketing and price policy study included in the project (paras 4.25 and 4.29). 7.04 With the above conditions and assurances, the project would be suitable for an IDA Credit of SDRs 4.8M (US$6.2M) to HMG on standard IDA terms.  - 36 - ANNEX 1 Table 1 NEPAL GRAIN STORAGE PROJECT Gross Production of Foodgrains ('000 MT) l/ Other2/ Total % Change Year Paddy Maize Wheat Foodgrains Foodgrains From Past Year 1966/67 2,007 824 159 148 3,138 1967/68 2,027 735 204 136 3,102 -1.1 1968/69 2,178 765 233 143 3,319 7.0 1969/70 2,241 795 265 149 3,450 3.9 1970/71 2,304 833 193 150 3,480 0.9 1971/72 2,358 730 225 155 3,468 -0.3 1972/73 2,010 822 312 159 3,303 -4.8 1973/74 2,416 814 308 168 3,706 12.2 1974/75 2,452 827 331 169 3,779 2.0 1975/76 2,605 748 387 168 3,908 3.4 1976/77 2,386 797 362 159 3,704 -5.2 1977/78 2,282 740 411 152 3,585 -3.2 Average Annual Growth Rate (%) 3/ 1966/67 to 1977/78 1.8 -0.2 7.9 1.3 1.8 l/ Source: Economic Survey, Ministry of Finance, various issues. 2/ Barley and millet. 3/ The average of 1966/67, 1967/68, and 1968/69 is compared with the average of 1975/76, 1976/77, and 1977/78.  ANNEX 1 - 37 - Table 2 NEPAL GRAIN STORAGE PROJECT Cultivated Area ('000 ha) and Yield (MT/ha) for Major Foodgrainsl/ Year Paddy Maize Wheat Total Foodgrains Area Yield Area Yield Area Yield Area 1966/67 1,100 1.82 450 1.83 126 1.26 1,803 1967/68 1,154 1.75 412 1.78 192 1.07 1,883 1968/69 1,172 1.86 421 1.81 208 1.13 1,936 1969/70 1,173 1.91 433 1.83 226 1.17 1,970 1970/71 1,122 2.05 445 1.86 228 0.84 1,937 1971/72 1,204 1.95 435 1.67 247 0.91 2,029 1972/73 1,142 1.76 446 1.84 259 1.20 1,995 1973/74 1,227 1.97 453 1.80 274 1.24 2,107 1974/75 1,240 1.97 458 1.80 291 1.13 2,142 1975/76 1,256 2.07 452 1.66 329 1.17 2,189 1976/77 1,262 1.89 455 1.79 348 1.04 2,203 1977/78 1,264 1.81 445 1.66 366 1.12 2,222 Average Annual 2/ Growth Rate (%)- 1966/67 to 1977/78 1.1 0.7 0.6 -0.7 7.9 -0.4 1.8 1/ Source: Economic Survey, Ministry of Finance, various issues. 2/ The average of 1966/67, 1967/68, and 1968/69 is compared with the average of 1975/76, 1976/77, and 1977/78.  NEPAL GRAIN STORAGE PR&SECT Gross Production of Major Foodgrains by Reglon 1969/79-1977/78 ('000 MT) Terai Hil3. Mountains Year Paddy Maize Wheat Paddy Maize Wheat Paddy Maize Wheat 1969/70 1,804 248 121 305 473 106 42 74 38 1970/71 1,842 260 83 418 495 81 44 78 29 1971/72 1,905 157 103 409 497 92 44 76 30 1972/73 1,564 271 194 402 475 93 44 76 25 1973/74 1,927 257 207 444 478 96 45 79 25 X 1974/75 1,966 267 211 444 482 98 42 78 22 1975/76 2,088 217 264 463 454 105 54 77 18 1976/77 1,873 240 241 455 470 110 57 77 11 1977/78 1,753 219 265 473 45? 134 56 69 12 Source: Ministry of Food and Agriculture.