Nepal - Mahakali Irrigation Project

Document of The World Bank Lt copt FOR OFFICIAL USE ONLY Report No. P-2847-NEP REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR THE MAHAKALI IRRIGATION PROJECT (STAGE I) June 5, 1980 This document bhs a restricted distribution and may be used by recipients only in the perfornnce of their official duties. Its contents may not otherwise be disclosed without World Bank a-uthorintion.  CURRENCY EQUIVALENTS Currency Unit - Nepalese Rupee (NR) Since March 20, 1978 US$1.00 NR* 12.00 NR 1.00 - Us$0.08 NRs 100 - US$8.33 FINANCIAL YEAR July 16 - July 15 ABBREVIATIONS AND ACRONYMS ADBN - Agricultural Development Bank of Nepal AIC - Agricultural Inputs Corporation DA - Department of Agriculture DCA - Development Credit Agreement DIHM - Department of Irrigation, Hydrology and Meteorology HMGN - His Majesty's Government of Nepal MFA - Ministry of Food and Agriculture MIDB - Mahakali Irrigation Development Board MWPI - Ministry of Water, Power and Irrigation NFC - Nepal Food Corporation O&M - Operation and Maintenance PM - Project Manager REC - Rice Export Company WUG - Water Users' Group  NEPAL FOR OFFICIAL USE ONLY MAHAKALI IRRIGATION PROJECT (STAGE I) Credit and Project Summary Borrower: Kingdom of Nepal Amount: US$16.0 million Terms: Standard Project Description: The proposed project would improve an existing irriga- tion system (3,400 ha) and extend it to 6,600 ha with the objective of (a) improving the reliability of water deliveries to the farmers within the existing system and in the quantities required; (b) extending irrigation facilities by an additional 3,200 ha; (c) improving comr munications and operating efficiencies by providing all weather access throughout the existing and extended irri- gated areas; and (d) accelerating agricultural development and thus increasing farm incomes. The proposed project would also strengthen the agricultural extension services under the ongoing Bhairawa-Lumbini Groundwater Project (Cr. 654-NEP). The proposed project would consist of: (i) improvements to the existing irrigation and drainage system in about 3,400 ha and its extension by another 3,200 ha; (ii) con- struction of a connected network of all weather access and canal service roads; (iii) construction of buildings for engineering and agricultural activities and staff quarters; (iv) strengthening agricultural extension, research and training activities, including construction of a pilot demonstration farm cum training center; (v) procurement of equipment for construction, survey and laboratory activities and project operation and mainte- nance; (vi) provision of technical services; (vii) fellow- ships for Nepali students to study civil and mechanical engineering and agriculture; and (viii) strengthening agricultural development activities in the Bhairawa-Lumbini Groundwater Project (Cr. 654-NEP). The project faces no special risks. Thb document has a reticted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Estimated Cost US$ Million Equivalent of Project: Component Local Foreign Total Civil Works Irrigation & Drainage Systems 1.6 0.7 3.3 Tracks 2.3 0.6 2.9 Buildings 0.6 0.1 0.7 Sub-Total 5.5 1.4 6.9 Equipment and Materials - 2.5 2.5 Technical Services 0.2 1.2 1.4 Fellowships - 1.0 1.0 Project Overheads 0.6 0.2 0.8 Land Acquisition 0.3 - 0.3 Incremental Cost of Agricultural Extension for Bhairawa-Lumbini Project 0.1 - 0.1 Base Cost 6.7 6.3 13.0 Contingencies Physical 1.0 1.1 2.1 Price 2.1 2.1 4.2 Sub-Total 9.8 9.5 19.3 Duties and Taxes 0.2 - 0.2 TOTAL PROJECT COST 10.0 9.5 19.5 Financing Plan: US$ Million Equivalent Local Foreign Total IDA 6.5 9.5 16.0 Government 3.3 - 3.3 Farmers 0.2 - 0.2 Total 10.0 9.5 19.5 Estimated IDA US$ Million Equivalent Disbursements: IDA FY 1981 1982 1983 1984 1985 1986 Annual 0.3 3.5 3.9 3.4 3.5 1.4 Cumulative 0.3 3.8 7.7 11.1 14.6 16.0 Rate of Return: 14% Staff Appraisal Report: No. 2931-NEP dated June 2, 1980.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR THE MAHAKALI IRRIGATION PROJECT (STAGE I) 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal for the equivalent of US$16.0 million on standard IDA terms to help finance the Mahakali Irrigation Project (Stage I). PART I - THE ECONOMY 1/ 2. The most recent economic report entitled "Nepal-Development Perform- ance and Prospects" (Report No. 2692-NEP) was distributed to the Executive Directors on December 14, 1979. The principal findings of the Report are described below. Country data are shown in Annex I. 3. Nepal is one of the least developed countries in the world. Per capita income is estimated at $110 (1977), and health and education standards are well below the average of South Asia: life expectancy at birth is about 45 years, infant mortality 150 per thousand, and adult literacy 19%. The population, growing at the rate of 2.6% a year, is estimated to be 13.3 million (1978). Over 90% of the population live in rural areas. 4. The economy of Nepal centers around agriculture. It accounts for more than 60% of GDP and 75% of merchandise exports, and provides a livelihood to over 90% of the population. In addition, most of the industrial sector, which comprises about 9% of GDP, processes agricultural raw materials. About 25% of total rural incomes are estimated to arise from non-agricultural activities. Cottage industries are one of the most important of these, engaging over I million people and comprising about 6% of GDP. They provide basic consumer goods in the many small, isolated markets where such goods would otherwise not be available. 5. As a small open economy, Nepal is highly susceptible to develop- ments in India. The Terai, which lies along the Indian border, has close and virtually free trading links with India, and accounts for about 60% of the country's GDP, and about 40% of the population. The Kathmandu Valley, the administrative and commercial center, is closely linked with the Terai, but at significant transportation costs. The rest of the country, the Hills and Mountains, is almost inaccessible and consists of a large number of fragmented markets. 1/ Part I of this Report is substantially the same as Part I of the Report and Recommendation of the President to the Executive Directors on a proposed credit to the Kingdom of Nepal for a Community Forestry Develop- ment and Training Project (Report No. P-2763-NEP of April 2, 1980).  6. When Nepal adopted economic and social development as major govern- ment objectives in the early 1950s, there was virtually no economic or administrative infrastructure. Initial development efforts were necessarily concentrated on establishing a foundation for future development. During these early stages, it was inevitable that growth would remain slow and that there would be little if any increase in per capita income. However, the Fifth Development Plan (1975/76 - 1979/80) was to be a turning point; it was believed that the country was poised for more rapid growth on the order of 4 - 5% annually. The level of investment was to increase substantially and its focus to shift towards the more directly productive sectors and the social services. 7. Public investment performance has been excellent; development expenditures have grown at over 15% annually in real terms and the Government has been relatively successful in reorienting investment away from the trans- port sector towards agriculture and the social services. However, few of the other Fifth Plan objectives have been achieved. The GDP growth rate is likely to average only 2.4% per year, mainly because of poor agricultural performance. Little progress has been made in increasing agricultural productivity and agricultural production increased at an annual rate of only 0.7% during the first four years of the Fifth Plan. Growth in other sectors has been mixed, with the poor agricultural performance limiting the growth of agro-related industries. Production in several large industries including jute goods, sugar, leather goods, and cement have increased but most Fifth Plan targets will go unmet. In the services sector, tourism has been dynamic, but it still only contributes about 1% of GDP. 8. The economic situation deteriorated markedly in 1979/80 and is now worse than it has been in many years. The poor monsoon in South Asia in 1979 has had a severe impact on Nepal's foodgrain production in 1979/80. Both the maize and rice crops suffered major losses, and as a result, agricultural production is likely to decline by 4%. The non-agricultural sector continues to be constrained by supply bottleneck problems and delays in the preparation of new development projects in the public sector. This sector's growth is expected to be only about 4% in 1979/80, which when combined with the decline in agriculture, gives a 1% decline in GDP. 9. The disappointing overall performance of the domestic economy during the Fifth Plan period has been accompanied by a widening trade deficit. Imports have grown under the impetus of the Government's development program while the trend in export earnings has been sluggish due to declining rice exports. The deterioration on the trade account has been partly covered by increased tourism receipts and remittances from Gurkhas (soldiers from Nepal serving in the British or Indian armies). Foreign assistance in the form of grants and concessionary financing have generally ensured that the overall balance remained in surplus. Foreign exchange reserves in July 1979 were equivalent to nearly nine months of imports. However, the shortfall in food- grain production in 1979/80 could have a serious impact on Nepal's external position, since not only will rice exports further decline, but foodgrains will have to be imported, this all coming at a time when Nepal's oil bill is rising steeply. The Government has therefore appealed to the international community for emergency assistance in obtaining foodgrains and for help in  -3- distributing food to the shortfall areas; by the end of January 1980 donors had committed 33,000 tons of foodgrains. 10. On March 31, 1978, the authorities replaced a complex svstem of multiple exchange rates and exchange and trade restrictions with a dual exchange system. Transactions with India, which were virtually free from restrictions, were unaffected by these changes. New treaties on trade and transit with India were also concluded in March 1978. Under the dual exchange rate system, Nepal maintains a basic rate of Rs 12.00 per dollar, with a second, premium rate applying for all merchandise trade with third countries except for imports of certain development goods. On February 21, 1980, the premium rate was changed from Rs 16.00 per dollar to Rs 14.00 per dollar, but the exemption was restricted to only imports of petrol and petroleum products, cement and chemical fertilizers. These exchange rate adjustments involved an appreciation of about 14% for exports to third coun- tries and an overall appreciation of about 2% for imports from third countries. But this was partly offset by (i) withdrawing the 12% duty on exports of raw jute; and (ii) raising import duties on a wide range of imports from third countries. However, with the exception of raw jute exports, earnings in domestic currency from exports to third countries will decline, leading to a possible shift of some exports to India. The overall trade balance is likely to be adversely affected by the recent measures. 11. The poor long-run performance of the economy is chiefly due to the failure of agricultural production to keep pace with population growth. Over the period 1967-77, foodgrain production grew at an average annual rate of only 1.5%. Increases in the area under cultivation account for almost all of this, since average yields rose by only 0.1% annually. Although poor monsoons have adversely affected agricultural production, the more fundamental reason is the failure to more fully exploit the irrigation infrastructure. In the past, insufficient attention has been paid to bringing water down to the farm level and this has been compounded by inadequate support services such as extension and research, timely supplies of improved seed and fertilizer and other inputs, credit and farm-to-market roads. However, recent major irriga- tion projects financed by IDA and the Asian Development Bank are addressing these problems by taking more comprehensive and integrated approaches. 12. In the Hills and Mountains, which contain only one-third of the country's agricultural land and yet have nearly two-thirds of the population, population pressures have pushed cultivation up steep hillsides and onto marginal land; average yields have actually declined. Population density on agricultural land in these areas is higher than in Bangladesh. Malnutrition is acute; food production meets only two-thirds of minimum subsistence needs. Because they have little to trade except their labor, one-third of the inhab- itants of these Hill areas migrate seasonally to the Terai plains and northern India for food and work. Since the early sixties, an estimated 400,000 have migrated permanently, and there are signs that this exodus is accelerating. 13. The seriousness of the economic and social problems confronting Nepal calls for a well focused development strategy that directly addresses the difficult choices to be made. The revised Fundamental Principles of the  -4- Sixth Plan recently adopted by the GovernmenL and endorsed by members of the Nepal Aid Group at its January 31, 1980 meeting, is an important milestone irf the Government's efforts to evolve a program that meets Nepal's needs. T,he highest priority is placed on developing agriculture, including revitalizatior of Hill food production to meet local requirements since significant agro- climatic specialization between the Hills and Terai is feasible only in the longer run. At the same time, since land holdings in the Hills are too small to generate much more than subsistence needs, programs will be started to encourage diversification into other activities such as small-scale and cottage industries to supplement Hill incomes. For the Terai, the strategy is to continue efforts to realize the Terai's considerable potential for increasing production of foodgrains and cash crops. The irrigation infrastructure is to be more fully utilized and improvements to extension services and associated inputs concentrated on those areas with irrigation facilities. Rural electri- fication is seen as an important element in providing for increased production in rural areas. Reafforestation programs are given priority in order to provide fuelwood and fodder as well as to reduce soil erosion. 14. While these efforts in the directly productive sectors merit urgent attention, Nepal faces similar challenges in developing its human resources. Although curbing population growth requires major actions, selective programs in education and health can greatly assist population planning as well as alleviate human suffering and lay the basis for future increases in productiv- ity. The Government's strategy recognises that the approach must be selective since programs for meeting basic needs generally have only a long-term impact on manpower development but divert resources away from activities more directly and immediately related to production. Increasing foodgrains production will meet the major need of improved nutrition. Better and more readily available supplies of drinking water and fuelwood will meet other needs, while also freeing labor currently spent in their collection. Basic health facilities are to be expanded through integrated community health posts, while in educa- tion, stress is placed on improving the quality of primary and adult vocational education. Family planning programs are to be stepped up. The other basic need to be met in rural areas is improved transport, and the Sixth Plan will include programs to improve trails, tracks, and suspension bridges. 15. For Nepal to establish a basis for more rapid and sustained growth, the structure of its economy will need to change since its present dependence on agriculture limits the economy's overall growth potential to about 4% per year. Tourism offers perhaps the best near-term potential for increased foreign exchange earnings; however, efforts are needed to reduce its capital intensity, strengthen linkages with other local industries and extend its benefits beyond the Kathmandu Valley. Hydropower also offers some possibil- ities, but neither it nor tourism will ever be substantial generators of employment. In the long run, Nepal must diversify and develop its industrial sector. Obviously, efforts in this sector must be on a highly selective basis. The multiplicity and complexity of the constraints to industrial development, including the lack of natural resources and a skilled labor force, as well as Nepal's small domestic market and landlocked position will nullify any general- ized approach. Public enterprises need to operate more efficiently, village and cottage industries should be promoted. Beyond this, joint ventures with  - 5 - India, for example, as in cement production, may be attractive. The precon- ditions for industrialization must be established in the near future or there is a danger that Nepal will always be struggling to move its economy beyond subsistence. These include providing financial incentives, research and extension services on the technical, financial and marketing aspects of enter- prise, and the upgrading of manpower skills in the areas where Nepal may have a comparative advantage. 16. Nepal has made significant progress in mobilizing domestic resources to support its development efforts, considering the extreme poverty, low degree of monetization, and fragmented nature of the economy. Revenue grew at 16% a year in current terms between 1969/70 and 1978/79, while as a percentage of GDP it increased from 5% in 1969/70 to about 9% in 1978/79. Over the same period, the Government was able to maintain savings on current account in excess of 2% of GDP, a good achievement for a country in Nepal's economic position. However, this excellent record is now in jeopardy. Revenues from income and land taxes declined in 1978/79 and although total revenues grew by 14%, the bulk of the increase came from taxes on international trade as a result of higher imports. No real growth in total revenues is expected during 1979/80, after allowing for inflation. This slowdown reflects not only the weak economy in 1979/80, but also the impact on the tax system of the political difficulties facing Nepal. While only limited scope exists for discretionary tax measures, there is a potential for increased tax revenues from agriculture, particularly in the Terai. Revenues could be increased through improving the tax machinery, and the government has approved, in principle, various admin- istrative reforms in this direction, including the formation of a Special Revenue Service. 17. Foreign assistance has been a decisive factor in Nepal's development. During the Fifth Plan, foreign financing equalled about 45% of development expenditures. In view of the limited prospects for increased domestic resource mobilization, foreign financing requirements may be about 60% of planned Sixth Plan development expenditures, which amount to about NRs 10 billion or over $800 million at 1979/80 prices. Aid commitments need to average about $225 million annually during 1980-82 compared with $160 million during 1977-79. However, even this level of foreign assistance would not provide the Government with sufficient resources to meet increasing consumption demands. Additional aid, either through financing a higher proportion of total project costs or in the form of commodity assistance, could provide budgetary support to meet pressing recurrent expenditure requirements, particularly in the social sectors. To assist with overall coordination of financial and technical assistance efforts, the Nepal Aid Group was formed in 1976. The Group has met three times at plenary meetings under the chairmanship of the Bank to discuss overall external assistance needs as well as at the local level in Kathmandu to discuss and coordinate the strategy. At the latest plenary meeting, which was held in Paris in January 31, 1980, and was attended by representatives from eight countries and six international organizations, Nepal received aid indications exceeding US$200 million equivalent. 18. Although foreign aid commitments and disbursements grew by over 25% annually during the Fifth Plan period, only 40% of disbursements included in the Government's budget were from foreign borrowing, the remainder being  - 6 - grants. As of December 31, 1978, official foreign debt outstanding was only $88 million, of which $75 million was due to multilateral agencies. These loans were obtained on a highly concessional basis and the grant element of total aid remains in excess of 90%. As a result, debt service payments were only US$3.1 million during 1978/79, equivalent to less than 2% of exports of goods and services. Medium-term prospects are also good; by 1981/82 total service on existing debt is expected to amount to only US$5.1 million, still less than 2% of projected goods and services exports. PART II - BANK GROUP OPERATIONS IN NEPAL 19. Bank Group operations in Nepal began in FY70 with an IDA credit of US$1.7 million equivalent for a telecommunications project. Since then, 19 additional credits have been approved, bringing total IDA assistance to Nepal to US$218.4 million equivalent, net of cancellations. In view of Nepal's many development needs, this assistance has been for projects in a wide variety of sectors. Six of these sectors account for 82% of IDA credits by amount: irrigation ($59.0 million for 4 projects); power ($40.8 million for 1 project); telecommunications ($21.7 million for 3 projects); highways ($19.5 million for 2 projects); water supply and sewerage ($19.8 million for 2 projects), and rural development ($19.0 million for 2 projects). The remaining $39.0 million of IDA assistance has been for one project in each of the areas of settlement, technical education, tourism, technical assistance, forestry and industrial development financing. The proposed credit would be the second in FY80, bringing the total amount of IDA assistance to Nepal to US$234.4 million equivalent, net of cancellations. No Bank loans have been made to Nepal. IFC made its first investment in Nepal ($3.1 million) in a hotel project in Kathmandu in FY75. Annex II contains a summary statement of Bank Group operations as of April 30, 1980, and notes on the execution of ongoing IDA projects. It shows certain delays in the implementation of these projects, particularly during the initial periods. These delays have been largely due to Nepal's limited technical and managerial capabilities. In order to assist Nepal in coping with this constraint, considerable technical assistance is being given by Bank Group staff, including our Resident Mission in Kathmandu. As a result, improvement in the rate of disbursements is being realized. During FY78, US$11.8 million equivalent were disbursed compared to US$12.8 million equivalent disbursed during the entire previous seven years; disbursements during FY79 indicate a further improvement, disbursing a further $18.2 million equivalent. Disbursements in the first ten months of FY80 reached US$17.2 million equivalent. 20. Bank Group lending to Nepal has so far been at a modest level compared to the country's need for external assistance. The international community has shown considerable interest in Nepal's economic development and, to date, shortage of funds has not been a bottleneck. The main constraint on the utilization of increased aid has been Nepal's limited absorptive capacity, affecting the pace of project preparation and implementation. The Bank is  affecting the pace of project preparation and implementation. The Bank is assisting the Government in project preparation through the Technical Assis- tance Credit and by acting as Executing Agency for a number of technical assistance projects in the current UNDP Five-Year Program. The Bank Group has also addressed the problem of absorptive capacity through its role in organizing the Aid Group for Nepal (para 17). 21. The Bank Group's current strategy places major emphasis upon the directly-productive sectors (particularly agriculture) and the development of complementary infrastructure, including feeder roads (particularly con- necting the Hills to the Terai), communications and hydroelectric power. Preparation of projects in irrigation, Hill food production, agricultural extension, cottage/small scale industry, water supply and power is under way. PART III - THE AGRICULTURAL SECTOR 22. Agriculture is the key sector for Nepal's economic development: farm production and related activities contribute more than 60% of GDP, pro- vide almost 90% of employment and about 75% of merchandise exports, mostly foodgrains2 jute and oilseed. Only about one sixth of Nepal's gross area of 141,000 km is cultivable. Foodgrains account for about 90% of cropped area, rice being the most important (50%), followed by maize, wheat, other cereals and pulses. The rest of the cropped area is under oilseeds, jute, potato, tobacco, sugarcane and horticultural crops. Growth of agricultural production (average 1.1% per year 1970-77), which is largely determined by foodgrain performance, has not kept up with population growth. Growth has primarily come from area expansion since yields have largely stagnated (para 11). 23. The Government has had to moderate its earlier approach to regional specialization according to comparative advantage (foodgrains in Terai vs. horticulture, tea and livestock in Hills) in view of the need for a proper foodbase in the Hills. The role of the Terai will continue to be the genera- tion of domestic and exportable foodgrain surpluses as a resource for further development. Since area expansion is limited in the Terai, emphasis will be given to increasing yields, mainly by an expansion and upgrading of existing irrigation infrastructure and inputs. Initial results from the IDA-assisted Narayani Zone Irrigation Project (Stage I) indicate that substantial yield improvements can be expected from improved irrigation water supply combined with increased agricultural inputs and effective extension services. 24. Agricultural Institutions. Apart from the Ministry of Forest, the Government has three major Ministries dealing with agriculture: the Ministry of Food and Agriculture (MFA); the Ministry of Land Reform; and the Ministry of Water, Power and Irrigation. Irrigation projects are the responsibility of the MWPI which includes the Department of Irrigation, Hydrology and Meteorology (DIHM). MFA includes the Department of Agriculture (DA), and the Department of Food and Agriculture Marketing Services. MFA also has  - 8 - overall responsibility for a number of public sector corporations which include the Agricultural Inputs Corporation (AIC), Agricultural Development Bank of Nepal (ADBN) and Nepal Food Corporation. In general, like rmany other government agencies, agricultural institutions suffer from lack of trained staff. 25. Agricultural Extension, Research and Training. The DA's Division of Agricultural Extension and Training is responsible for operation of agri- cultural extension services through offices located at the regional and district levels. Effectiveness of extension services is hampered by inade- quate staff training and lack of communication, transportation, and housing facilities at the village level. 26. The DA carries out research, mainly in food crop production, in a research complex near Kathmandu and in 12 smaller stations dispersed through- out Nepal. Some agricultural research stations are also national crop devel- opment headquarters. 1/ The United States Agency for International Develop- ment (USAID) has supported research in cereal improvement based on high yielding varieties of wheat from India and rice from the Philippines. The United Nations Development Programme, in conjunction with the International Maize and Wheat Improvement Center, Is assisting with a high protein maize program. The linkage between research and extension activities is poor, however, and the products of research are not always directly well dissemi- nated to farmers. With technical assistance from USAID, the Institute of Agriculture and Animal Science of Tribhuvan University is responsible for formal agricultural training of extension workers. The Institute also provides vocational training for agricultural teachers and in-service train- ing for leading farmers. Recently, research stations have also been involved in training activities for extension workers and farmers. However, this training suffers from shortage of experienced instructors and training facilities. IDA's financing of intensified and reorganized extension serv- ices in six Terai districts under ongoing irrigation projects (para 33) promises to yield favorable results, as already noticeable in the Parsa district where the Training and Visit system is being implemented. A project for agricultural research and extension for eight more districts in the Terai is being prepared. 27. Agricultural Inputs Supply. AIC is mainly responsible for the marketing of fertilizers, seed, pesticides, and agricultural equipment. AIC distributes these inputs to cooperative societies (Sajhas), village committees, other public organizations, and private traders, fixes retail prices for all inputs, and is responsible for input storage. Provision of inputs is coordinated with District Agricultural Officers, ADBN and cooperatives. The activities of AIC have been rapidly expanding and are fairly satisfactory. 28. Agricultural Credit. ADBN is the main source of institutional credit in agriculture; two commercial banks play only a minor role in this 1/ The national development programs for paddy, maize, jute and wheat have their headquarters in Parwanipur (Birganj Irrigation Project, Naryani Zone), Rampur, and Tarahara Agriculture Stations, and Bahirawa Agricul- ture Farm (in Bhairawa-Lumbini Groundwater Project), respectively.  - 9 - sector. ADBN extends short, medium and long-term loans to individual farmers, groups of farmers, cooperative societies and village committees. Overall lending has increased considerably over recent years, and now covers about 25% of total agricultural credit needs. ADBN's financial position is reason- ably sound, although overdues run at about 24% of loans outstanding. Repayment performance of cooperative societies has even been poorer. Loans are extended for a wide variety of purposes, including irrigation, mechanization, warehous- ing and marketing. Interest rates vary between 6 and 16% according to borrower and purpose. Application procedures for institutional credit are lengthy and cumbersome. Consequently, many farmers avoid this source in favor of easier credit from private lenders at higher cost. With the assistance of the Asian Development Bank, ADBN is making efforts to improve its procedures in order to reach a larger number of small farmers. 29. Cooperative Movement. Since 1976, the cooperative movement has been reorganized under the name Sajha. In order to reach more farmers and mobilize local savings, the Government converted existing "guided" societies (under ADBN management) and village committees into village cooperative societies, under the direction of village panchayats. They are to provide credit, inputs, marketing services and some basic consumer goods. They function as collective borrowers towards ADBN and as agents of national trad- ing organizations. So far, 723 Sajha cooperatives have been established in 30 districts, covering all Terai districts and three Hill districts. They employ paid managers and are directed by the heads of constituting village panchayats. Membership is compulsory for all participants in a previous compulsory saving scheme. These savings, deposited with ADBN, constitute the share capital of village societies and are the main collateral for collective loans. Sajhas suffer from lack of trained management, high default rates and local political interference. Only a few societies are engaged in marketing of crops, where they face serious competition from private traders. Suitable warehouse and transportation facilities are scarce, reducing Sajhas' capacity to distribute inputs to farmers and to market their produce. The Cooperative Department of the Ministry of Land Reform is currently making efforts to improve management of Sajhas through training and consolidation of smaller units. 30. Marketing and Transportation. Domestic marketing services in Nepal are not well developed, due to the lack of roads, telecommunications systems, and warehouses. Since the late 1960s, several public sector organizations have been established for marketing major farm products. These include the Nepal Food Corporation (NFC), Rice Export Companies (RECs), National Trading Ltd., and Jute Development and Trade Corporation. Officially, export of rice was exclusively the responsibility of RECs, which are joint ventures with the private sector traditionally involved in rice trading, with the majority of shares held by the Government. In practice, however, since the Indian border is open, extensive free trading occurs, for which no reliable data is avail- able. The Government has recently liberalized export trading for foodgrains, and plans to place control of public sector domestic and export trading in NFC and strengthen it so that it may be better able to promote government foodgrain policies.  - 10 - The Irrigation Sub-Sector 31. Water Resources Utilization. Nepal has abundant water resources, including3major rivers with annual average discharges totaling about 150 billion m and capable of irrigating 6 to 8 million ha. However, there are only about 1.3 million ha of land suitable for surface irrigation in the country. Exploitable groundwater resources, largely concentrated in the Terai, could provide tubewell irrigation for about 0.4 to 0.6 million ha. Total irrigation potential is, therefore, less than 2 million ha. Utilization of water resources for irrigation is limited by several factors: (i) there are few reliable sources of perennial surface water for year-round irrigation except for the eight major rivers 1/; (ii) these large rivers are costly to develop particularly for relatively small command areas typical in the Terai; (iii) heavy sedimentation in riverbeds creates considerable problems in construction, operation and maintenance of irrigation systems; and (iv) power supplies to energize tubewells are severely restricted in extent and amount. At present, only about 300,000 ha (about 23% of the potential surface irri- gable area) are provided with some form of irrigation, of which about 150,000 ha are under public schemes. 32. Irrigation Development. Before the launching of Nepal's first Development Plan in 1957, few substantial irrigation works had been under- taken by the Government. The main reasons were limited financial resources and shortage of trained manpower. Nevertheless, with schemes such as the 11,000 ha Chandra Project (1922), farmers' stream diversions, bucket-lift, and other traditional methods, irrigation had been provided to an area of some 154,000 ha, mainly in the Hills. During the First and Second Develop- ment Plans (1957-62 and 1962-65 respectively), the Government's irrigation programs were concentrated on building medium sized systems (15-16,000 ha) in the Terai. In the Third Plan (1965-70), however, a program was launched for construction of minor irrigation projects, mostly in the Terai, to encourage greater farmer participation and to expand irrigated areas rapidly. Due to poor investigations and construction, many of these projects fell short of expectations, which resulted in discouraging response from farmers. The Government switched back in the Fourth Plan (1970-75) to a policy of con- structing medium-sized irrigation projects. In keeping with the priority given to quick yielding investments, the emphasis shifted in the Fifth Plan (1975-80) towards the completion of ongoing schemes and new investment in projects with short gestation periods and high returns, including groundwater development for irrigation by tubewells. The target was to bring 146,000 ha under irrigation in addition to the present 300,000 ha. However, it is esti- mated that by the end of the Fifth Plan, only about 100,000 ha will have been completed. The main reasons for the shortfall are (i) the shortage of tech- nical personnel for design, construction, supervision and project management; (ii) chronic shortages in cement and steel; (iii) weak local civil works con- tractors; and (iv) slow procurement due to the country being landlocked and to administrative bottlenecks. Bank Group strategy is to assist the Government in resolving these constraints through financial and technical assistance, including components of the proposed project. Preliminary targets set for the 1/ The Mahakali (Sarda), Karnali, Babai, Rapti, Narayani (Gandak), Bagmati, Kosi and Kankai Rivers.  - 11 - Sixth Plan (1980-85) call for the irrigation of 40% of agricultural land in the Terai and 12% in the Hills by 1990 (presently 12% in the Terai and much less in the Hills). The irrigation infrastructure is to be more fully utilized and extension services and associated inputs to irrigated areas to be enhanced (para 13). 33. Bank Group's Participation in Irrigation Development. The Bank Group is presently involved in four ongoing irrigation projects and two rural development projects with irrigation components. The Bank has also acted as Executing Agency for UNDP in the preparation of feasibility studies, prepared by Tahal Consulting Engineers (Israel), under the Major Irrigation (Far West Region) Project. The Birganj Irrigation Project (Narayani Zone) (Cr. 373-NEP, US$6.0 M, 1973), under construction since 1974, was originally designed to improve and upgrade 28,700 ha of its command area. In November 1977, the Government and the Association agreed to reduce the scope of the project and limit the works to 16,000 ha of the command area so as to accommodate a 50% cost overrun during 1974-77. After a slow start due to procurement and staffing difficulties, project implementation has steadily improved. All civil works and equipment contracts have been awarded, and construction is about 95% complete. The executing agency, the Narayani Zone Irrigation Development Board, is operating effectively. Crop yields achieved under irrigated conditions are promising. Water charges are being levied in areas reached by irrigation, and farmers' acceptance is satisfactory. The project if expected to be completed by mid-1980. The Narayani Zone Irrigation Devel- opment (Stage II) Project (Cr. 856-NEP, US$14.0 M, 1978) is also proceeding satisfactorily. Construction works are ongoing in three of the six irrigation blocks and contracts for two additional blocks were awarded in February 1980. The Bhairawa-Lumbini Groundwater Project (Cr. 654-NEP, US$9.0 M, 1976), the first full scale tubewell project in Nepal provides for construction of 63 deep wells, detailed development of the 7,500 ha command area and agricultural supporting services. Actual work on the project started in July 1977. Twenty seven tubewells have been constructed. Thirty-three wells are scheduled to be fully equipped by June 1980. All drilling is to be completed by July 1980, and all 63 wells are to be fully equipped by June 1981. Un- fortunately, progress in irrigation works is about 18 months behind original schedule due mainly to shortage and poor performance of local contractors. This problem is being overcome through Bank staff and consultants' assistance to the project authority in procurement matters and supervision. The project is scheduled for completion by June 1982. The Sunsari-Morang Irrigation and Development Project (Cr. 812-NEP, US$30.0 M, 1978) provides for the substantial upgrading of the existing Chatra Canal irrigation system in Eastern Nepal by almost doubling the irrigated area from 35,000 ha, at present, to about 66,000 ha. Studies for major canal structural repairs, sediment control and river training are well advanced. Contracts for priority works have been awarded and procurement action for equipment and civil works for Chatra Main Canal is underway. An EEC Special Action Credit of about US$4.0 million equivalent was approved in June 1979 to help finance part of the Government's share of the local cost. A component in the First Rural Development Project (Cr. 617-NEP, US$8.0 M, 1976) is providing for improvement of small scale Hill irrigation schemes and development of a high lift scheme on the Batar plateau in Nuwakot District. This consists of the improved irrigation for approximately 1,900 ha.  - 12 - Construction of the major works for the Batar plateau (approximately 200 ha) has been completed, and satisfactory progress has been achieved for the development of the small scale schemes. The Second Rural Development Project (Cr. 939-NEP, US$11.0 M, 1979) also includes a component for providing assist- ance for improvement of small scale Hill irrigation schemes in the Mahakali Zone. Implementation of this project is just starting. 34. Manpower Situation. One of the main constraints in the implemen- tation of irrigation projects in Nepal is the shortage of technical personnel in DIHM for design and construction supervision. Available staff is very thinly spread over the various regions, divisions, and projects, and is hardly sufficient to meet present needs. The shortage of engineers will be a major constraint in implementing the irrigation projects under the Sixth Five Year Plan. For the Sunsari-Morang Irrigation and Drainage Development Project, DIHM was unable to provide the necessary design staff. Local consulting firms were called upon to work together with a small project staff and project con- sultants in order to meet manpower requirements. Only a limited number of local consulting firms is available. Any completed project would require about as much staff for operation and maintenance as is now available for construction. Hence, the number of irrigation engineers in the country has to be increased drastically if irrigation development is to be accelerated. PART IV - THE PROJECT 35. The proposed project would implement part of a comprehensive master- plan for the development of the Kanchanpur District in the Far West Region of Nepal. The Plan was approved by the Government in December 1979. The Plan delineates areas to be maintained as commercial forest and wildlife reserves, areas to be reforested and areas in the Terai to be developed for rainfed and irrigated agriculture, including resettlement and settlement of landless farm families. The proposed project would implement a first phase of the irrigation development under this Plan. The proposed project was identified by a Bank mission in 1976 and a feasibility study was prepared by Tahal Consulting Engineers (Israel). The study was financed by UNDP, with the Bank as Executing Agency, and the Project was appraised in January 1980. 36. Negotiations were held in Washington, D.C. in May 1980. The Nepalese delegation was led by Mr. P.P. Shah, Secretary, Ministry of Water, Power and Irrigation. A report entitled "Nepal - Staff Appraisal Report - Mahakali Irrigation Project (Stage I)," Report No. 2931, dated June 2, 1980 is being distributed separately. A supplementary data sheet is attached as Annex III. 37. The proposed project would rehabilitate and upgrade the existing irrigation system on the left bank of the Mahakali River in the Far Western Region of Nepal. The 1920 Agreement between the Governments of India and Nepal regulates the use of the Mahakali (Sarda) River waters. Following this agreemeit, India built a barrage on the river inside India and a 1,000 cusecs (28.3 m /s) capacity conveyance canal into Nepalese territory. This system diverts water from the Mahakali River at the Sarda Barrage into Nepal through the conveyance canal. Construction was completed in 1928. The agreement stipulates the following water rights for nepal: (a) from May 15 to October 15, a supply of 460 cusecs (13.0 m Is) and, provided a surplus  - 13 - is available, a supply of up to 1,000 cusecs (28.3 m3Is); and (b) from October 15 to May 15, a supply of 150 cusecs (4.25 m Is). So far, Nepal uses substantially less than half the waters it is entitled to use and the water requirements for the proposed project are well within its agreed water alloca- tion. 38. The present irrigation system is commanded by a 13 km long main canal. The canal lacks adequate water level control and the inflow of sedi- ments poses serious maintenance and operational problems. Irrigation water is released from the main canal into 11 distributary canals and several minor canals. From these canals the water is released into tertiary units, where tertiary canals have been constructed. The existing irrigation system has several defects: the capacities of the distributaries are generally insuffi- cient to meet the peak water requirements; the number of tertiary outlets and length of tertiary canals constructed is insufficient for proper water distri- bution; water flow in the tertiary canals and outlets cannot be controlled, and field irrigation and drainage channels serving individual farms are lack- ing. Overall water management in the project area is poor. A completed section of the East-West Highway passes through the project area but otherwise the area is served only by a haphazard road network of cart tracks intercon- necting villages and service tracks along the main canal and the upper reaches of most distributaries. The entire track system becomes impassable during the monsoon season. Project Objectives 39. The proposed project would improve the existing irrigation system (3,400 ha) and extend it to 6,600 ha (net) with the objective of: (a) improv- ing the reliability of water deliveries in the quantities required to the farmers within the existing system; (b) extending irrigation facilities to an additional 3,200 ha; (c) improving communications and operating efficiency by providing all weather access throughout the existing and extended irrigated areas; and (d) accelerating agricultural development and thus increasing farm incomes. To achieve the above objectives, the project is designed to: (a) increase the capacity of the existing distribution system and extend it to new areas; (b) improve the handling of sediment in the main canal; (c) improve water control through additional control structures and through the extension of the distribution system to outlets serving 7-8 ha of land; (d) improve drainage conditions; (e) provide a complete public access road network and all weather service roads along canals; (f) intensify agricultural extension, research and training; (g) develop technical staff by providing fellowships for Nepali students to study engineering and agriculture abroad. Project Description 40. The main components of the project would be: (a) improvements to the existing irrigation and drainage system in about 3,400 ha; (b) extension of irrigation and drainage systems by 3,200 ha to a total of 6,600 ha; (c) construction of an interconnected network of all weather access and canal service roads;  - 14 - (d) construction of buildings for engineering and agricultural activities and staff quarters; (e) strengthening agricultural extension, research and training activities, including construction of a pilot demonstration farm-cum-training center; (f) procurement of materials, equipment and vehicles for con- struction, survey and laboratory activities and project operation and maintenance; (g) provision of technical services, including foreign and local consultants for project implementation and aerial photography and mapping; (h) fellowships for Nepali students to study civil and mechanical engineering and agriculture; and (i) strengthening agricultural development activities in the on-going Bhairawa-Lumbini Groundwater Project (Cr. 654-NEP) over a three-year period. Organization and Implementation 41. In accordance with the Government's established practice, implemen- tation of the project would be carried out by a board to be established under the Development Board Act of 1956. The Mahakali Irrigation Development Board (MIDB) would be chaired by the Secretary of the Ministry of Water, Power and Irrigation. It would include representatives from the Ministries of Finance, Food and Agriculture, Forest, and Land Reform, and the National Planning Commission, and the Directors General of the Departments of Agriculture and of Irrigation, Hydrology and Meteorology. In addition, the Project Manager (PM) would be a member of MIDB, would be stationed at Mahendranagar and would be responsible for day-to-day management of project implementation. MIDB would be staffed during implementation of the project in accordance with a plan satisfactory to the Association (Section 3.03(a) of the draft Development Credit Agreement (DCA)). Formation of MIDB and the appointment of the PM with qualifications and experience satisfactory to IDA would be conditions of effectiveness of the proposed Credit (Section 6.01(a) and (b) of the draft DCA). Under the PM, five divisions would be established for: Irrigation, Roads, Agriculture, Administration and Finance, and Farm Group Development. An Equipment Maintenance Unit would be established under the Irrigation Division of MIDB. The Irrigation Division would be responsible for carrying out the irrigation and drainage works of the project and for maintaining the canal network down to tertiary outlets. The Road Division, headed by a senior roads engineer, would construct and maintain the roads component. As local contractors lack construction equipment, equipment procured under the project would be leased to contractors together with operators. The Government plans to provide incentives to enable the PM to recruit equipment operators and mechanics. Views would be exchanged with the Association on a yearly basis on the amount of funds required for operation and maintenance (O&M) and the O&M budget would be submitted to the Association not later than July 31 in each year (Section 4.03(a) of the draft DCA). The Irrigation Division would also  - 15 - prepare a comprehensive operation and maintenance manual to be transmitted to IDA in draft by October 1, 1982 and in final form by October 1, 1983 (Section 4.03(b) of the draft DCA). The Agricultural Division, headed by an agricul- tural development officer would be responsible for extension and the operation of the pilot farm and training center. The Administration and Finance Division would be responsible for general administration, accounting, finance, procure- ment and inventory control, and collection of water charges. The Farm Group Development Division, headed by a Cooperative Officer, would be responsible for organizing water users' groups (para 43). In view of the urgent need for good communications and effective extension activities, the appointment of the senior roads engineer and the agricultural development officer, with qualifications and experience satisfactory to IDA, would be conditions of credit effectiveness (Section 6.01(c) of the draft DCA). 42. About 2,200 ha of over-mature and unproductive Terai Plain forest would be cleared within the project area, as part of the development plan for the Kanchanpur District (para 35), prior to project implementation on the corresponding area. Clearing is already being undertaken by the Forest Products Development Board, and would be completed by May 31, 1982 (Section 3.05(b) of the draft DCA). In order to unite two sections of a wildlife reserve and reduce river bank erosion, the Government intends to move farm families now living along the Mahakali and Chaudar Rivers to the project area. Responsibility for moving these farmers rests with the Resettlement Department of the Ministry of Forest. The existing committee for forest, resettlement and irrigation development in Kanchanpur District would coor- dinate matters concerning forest clearing, settlement and project construction (Section 3.05(a) of the draft DCA). This Committee is chaired by the Mahakali Zonal Commissioner. Members of the Committee include the PM of MIDB, the Conservator of the Seti and Mahakali Circles, the President of the District Panchayat, the Resettlement Officer, the Chief District Officer, the Land Revenue Officer, and the District Forest Officer. 43. Throughout the project area, tertiary turnouts would be constructed to provide water control to units of a maximum of 40 ha. The distribution beyond the tertiary outlets would be extended to outlets serving groups of farms of 7-8 ha. Within the 40 ha tertiary units, Water Users' Groups (WUGs) would be established to regulate water distribution based on rotational deliveries proportional to individual holdings. Each WUG would be represented by a leader, and sub-leaders for the 7-8 ha sub-groups, all elected by the farmers. Water would be made available on a regular basis to a tertiary canal unit improved or completed under the project only after a WUG has been formed, field channels constructed and satisfactory distribution routines formulated (Section 4.04 of the draft DCA). Technical Assistance 44. Because of a sharp increase in the number of development projects in Nepal in recent years, the availability of suitably trained engineering and agricultural staff is a major constraint in the implementation of addi- tional irrigation projects. To develop additional manpower, IDA is assisting  - 16 - Nepal with the Technical Education Project (Credit No. 772-NEP, US$5.7 M, 1978) which would build up the capacity of the Institute of Engineering and establish teaching programs in civil engineering. A component of this Projecr assists in the preparation of a project for the establishment of a polytech- nical school in Pokhara. IDA is also assisting in the preparation of a manpower study for the agricultural sector. However, graduates of the Institute of Engineering will only be of the diploma level and too few to meet the expected demand. In order to assist in meeting the need for trained manpower at the B.Sc. level, financing is provided under the proposed credit for fellowships for about 80 Nepali students to study civil engineering, mechanical engineer- ing and agriculture in accordance with a plan satisfactory to the Association (Section 3.04 of the draft DCA). Students would be sent for training within the next two years. This represents a substantial increase in the civil engi- neering staff of the Irrigation Department. Prior to going for training in other Asian countries, the trainee would enter into a contract with the con- cerned Government Department committing himself to work on development projects for five years following completion of these studies. The Government would sanction the necessary number of positions and make adequate budgetary alloca- tions for this purpose, sufficiently in advance of the return of the graduates from abroad. 45. The staff of the Board would be assisted and trained by consultants in project planning and scheduling, design of project works, preparation of bid documents and bid evaluation, modern construction techniques, construc- tion quality control, monitoring of progress and costs, and operation and maintenance. About 110 man-months of engineering services would be provided over a five year period. Technical assistance costs, at US$8,500 per man month (including salaries, fees, international travel, subsistence and ancillary costs), are estimated at US$0.9 million equivalent. Selection of these consultants with qualifications and experience satisfactory to the Association would be a condition of effectiveness of the proposed credit (Section 6.01(d) of the draft DCA). 46. Since most of the farmers have inadequate knowledge of water man- agement and cultivation of relatively new crops like cotton, soybean, and groundnuts, a 20-ha pilot farm with training center would be established under the project. By May 31, 1982, two agricultural consultants (a field crop agronomist and a cotton agronomist) with qualifications, experience and terms and conditions of employment satisfactory to IDA would be engaged to assist with the operation of the pilot farm, in particular to develop suitable cropping patterns, assist in water management and provide in-service training for extension workers and farmers (Section 3.02(b) of the draft DCA). The cost of this technical assistance component is estimated at US$150,000 equiv- alent. 47. The IDA-assisted Bhairawa-Lumbini Groundwater Project (Credit No. 654-NEP, US$9.0 million) was approved in 1976 for the development of ground- water irrigation in the Lumbini Zone. Agriculture extension for the Project is carried out by DA. Little progress has been achieved in the extension services due to shortage of qualified DA staff, which is more severe than anticipated at the time of appraisal. As construction of about half of the 63 tubewells under this Project will be completed by June 1980, the strengthening of ongoing agricultural extension work for the project becomes essential.  - 17 - Therefore, the proposed credit would finance a local consultant for about 36 months, and related operational costs. Total cost of this component is approx- imately US$0.1 million equivalent. The consultant would assist project staff in preparation and implementation of rotational irrigation schedules and assist in establishing field demonstration plots for recommended cropping patterns, with special regard to wheat cultivation under different soil and drainage conditions. The consultant would also assist project staff in carrying out routine in-service training for extension workers and farmers. Monitoring and Evaluation 48. In order to obtain a reliable data base MIDB would carry out a benchmark survey during the first two years of project implementation. The survey would be furnished to the Association by June 30, 1982. A similar survey would be conducted when project works are completed, and a report prepared and furnished to the Association by December 31, 1986 (Section 3.07(c) of the draft DCA). MIDB would also prepare a project completion report within six months after final disbursements of the Credit and would submit the report to the Association (Section 3.07(d) of the draft DCA). Cost and Financing 49. The total project cost is estimated at US$19.5 M equivalent includ- ing about US$0.15 M in duties and taxes and US$0.35 M in land acquisition. The foreign exchange component is estimated at US$9.5 M equivalent, about 48% of the total project cost. The proposed credit of US$16.0 M would finance the entire foreign exchange cost of the project plus US$6.5 M equivalent of local cost, amounting to about 83% of total project costs net of taxes and duties. Local cost financing is recommended in view of the country's very limited capacity to generate resources (para 17 above). The Government would finance US$3.3 M equivalent of the local cost and the farmers would contribute in labor the balance of US$0.2 M equivalent. Procurement and Disbursement 50. Procurement of materials, equipment, vehicles and spare parts would be on the basis of international competitive bidding following IDA guidelines. Items costing less than US$75,000 equivalent each, up to US$500,000 equivalent in the aggregate, would be procured in accordance with Government procurement procedures, which are satisfactory to IDA. Civil works construction would be limited to the dry season and generally carried out through labor inten- sive methods. In addition, works would be small and scattered throughout the project area. These works, totalling US$6.9 million equivalent over three and a half years, would not attract large foreign contractors and would, therefore, be let on the basis of local competitive bidding in accordance with Government procedures, which are satisfactory. It is expected that contractors from neighboring districts of India would participate in the tendering. This would supplement the few Nepalese contractors for this type of civil works near the project area. Small repair works in the existing system totaling about US$1.4 million equivalent would be carried out through force account.  - 18 - 51. Disbursement would be made against: (a) 100% of foreign expendi- tures and 80% of local expenditures for civil works (by contract or by force account); (b) 100% of foreign expenditures of directly imported materials, equipment, vehicles, and spare parts; (c) 100% of the ex-factory price for such materials and equipment manufactured locally; (d) 75% of total cost for equipment and materials procured locally under off-the-shelf procedures; (e) 100% of total expenditures for technical services and fellowships; and (f) 75% of expenditures for agricultural extension and training staff. Cost Recovery 52. The investment cost related to irrigation would amount to about NRs 17,000 (US$1,416) per ha of the 6,600 ha net project area. This is equivalent to an annual capital cost of about NRs 1,730 (US$144) per ha, over 50 years at a 10% interest rate. Annual O&M cost is estimated at about NRs 280 (US$23) per ha. Thus, a watercharge of about NRs 2,000 (US$167) per ha would be necessary for full cost recovery. Water charges in the project area have increased from NRs 6 to NRs 60 per ha per crop since 1975. Under the present cropping intensity of about 130%, this amounts to about NRs 80 per ha per year. With a projected cropping intensity of 165% at full development, the total charge would be about NRs 100 per ha per year. Indirectly, increases in land tax revenues, from cleared land and in duties on milling and export of rice, would contribute a further NRs 75 per ha per year. However, since it is the Government's policy to cover O&M cost and as much as feasible of capital cost from benefitting farmers, water rates would have to be raised substan- tially. 53. Full recovery of the irrigation investment cost (NRs 2,000 per ha per year) would imply a twenty-fold increase of present rates and would tax away more than 85% of the estimated average project rent per ha (65% of average incremental farm income). The vast majority of the benefitting farm households are living under subsistence conditions, with an average per capita income of about NRs 780 (US$65) per year, approximately half the national average. Even after full development many would not exceed the projected average income of about NRs 1,420 ((US$118) after payment of water charges covering O&M costs. Imposing a full recovery charge at full development would keep average incomes well below the national average and would reduce or even eliminate the incentive of farmers to participate in the scheme and to take the risks associated with it. Since fixing charges according to size of holding is not administratively practical, water charges would have to be set at a level that takes into account the ability to pay of farmers with incomes below the average. However, there is scope for partial capital cost recovery, since water rates set to recover O&M costs would only amount to about 12% of the average project rent, equivalent to an increase of about 180% over present levels. 54. Not later than one year after completion of the works in an area commanded by a distributary, the Government would establish and collect water charges sufficient to: (a) cover O&M costs; and (b) recover, in progressive steps over a reasonable period of time, the investment cost of irrigation works to the fullest extent possible, having due regard to the farmers' ability to pay, the necessary incentives for their participation in the pro- ject, and the need for public savings to finance other development activities  - 19 - (Section 4.02(a) of the draft DCA). The Government intends, on an experi- mental basis, to introduce on a limited area a charging system that takes into account the number of irrigations received by farmers instead of the present flat rate system. This is intended as a step towards a volumetric water charge and to encourage more efficient water use by farmers. Benefits and Risk 55. The project would improve irrigation and drainage in the existing irrigated area as well as expand the area under irrigation. It would provide farmers with a more reliable supply of water, reduce dependence on erratic monsoon rainfall and thus increase the incentives for higher input use and adoption of more advanced farming practices. Project benefits would be generated through: (a) structural improvements and rehabilitation of the existing irrigation system (3,400 ha), allowing regulated and more reliable water supply down to 7-8 ha farm group outlets; (b) introduction of full scale irrigation to an area coming under cultivation for the first time (3,200 ha); (c) improving farm and water management practices by organizing farmers in Water Users Groups and providing them with appropriate training; and (d) improving the quality of advice given to farmers through strengthening and stream-lining of the local agricultural extension system. 56. The principal benefits of the project would be increases in the annual production of foodgrains (7,600 tons), cash crops (1,600 tons) and vegetables (2,000 tons) in the project area valued at a little over US$2.0 million equivalent. Increased employment opportunities would also be brought about by the project. Increased farm labor requirements are estimated at about 360,000 mandays a year at full development. Construction activities and forest clearing also would create employment in the order of 4 million mandays during the five years of project implementation. 57. Other benefits of the project weoid include improved future avail- ability of trained engineers and agriculturisI.s as a consequence of the project's training component. 58. Poverty in the project area weiiid ;e reduced bv the project siace the number of farm families presently with NRs 780 per capita per year cr less would be reduced roughly from about 65% to about 40%. Average pFr capita income at full development would almost double to abouit NRs 1,420, close to the national average. 59. The economic rate of return of the project is estimated at 14%. Analysis indicates that the project's viability would not be seriously affected by longer implementation and benefit build-up periods. Sensitivity to cost overruns is also moderate. The rate of return is, however, sensitive to deviations from the assumed level of gross returns at full development. It is not likely that shortfalls in benefits would exceed the critical limit, since market prospects for crops to be produced are good and since a strengthened extension service, tailored to the needs of farmers, would be an important component of the project.  - 20 - 60. There are no risks attached to this project beyond those that are typically present in agriculture and irrigation development schemes in Nepal. The project would have no adverse environmental impact. PART V - LEGAL INSTRUMENTS AND AUTHORITY 61. The draft Development Credit Agreement between the Kingdom of Nepal and the Association and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement, are being distributed to the Executive Directors separately. 62. Special conditions of the project are listed in Section III of Annex III. Special conditions of effectiveness are: (a) selection of engineering consultants; (b) establishment of MIDB; and (c) appointment of a Project Manager, senior roads engineer and an agricultural development officer with qualifica- tions and experience satisfactory to the Association. 63. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 64. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President Attachments June 5, 1980  - 21 - WADL! 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