Nepal - Recent developments and selected issues in trade promotion

Report No. 4663-NEP Fi LE OPY Nepal Recent Developments and Selected Issues in Trade Promotion October 14, 1983 South Asia Programs Department FOR OFFICIAL USE ONLY Document of the World Bank 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 /a Nepalese Rs per Nepalese Rs per End of Period US$ Indian Rs Period Average US$ Indian Rs 1974/75 10.56 1.39 1974/75 10.56 1.39 1975/76 12.50 1.39 1975/76 12.02 1.39 1976/77 12.50 1.39 1976/77 12.50 1.39 1977/78 12.00 1.45 1977/78 12.36 1.41 1978/79 12.00 1.45 1978/79 12.00 1.45 1979/80 12.00 1.45 1979/80 12.00 1.45 1980/81 12.00 1.45 1980/81 12.00 1.45 1981/82 13.20 1.45 1981/82 12.96 1.45 1982/83 14.50 1.45 1982/83 13.86 1.45 FISCAL YEAR Nepal Fiscal Year - July 16 to July 15 /a Until the end of May 1983, the Nepalese Rupee was pegged simultaneously to the U.S. Dollar and the Indian Rupee, at fixed exchange rates. On June 1, 1983, Nepal introduced a trade-weighted basket peg arrangement, with the U.S. Dollar as the intervention currency. An Exporters' Exchange Entitlement (EEE) Scheme was operated between 1961 and March 1978 to increase and diversify trade with third countries (i.e., countries other than India). Under that scheme, exporters to third countries could retain specified proportions of foreign exchange earnings, depending on items exported, and spend them on imports (at least 10% on development goods; and up to 70% and 20%, respectively, on basic consumer goods and luxury goods), or trade the entitlements on the open market. On March 30, 1978, the EEE Scheme was replaced with a dual exchange rate against the U.S. Dollar and a separate single rate against the Indian Rupee. In September 1981, the dual rate against the Dollar was unified. The dual peg (against the U.S. Dollar and the Indian log Rupee) was continued until the June 1983 change in pegging arrangement. This report is based on the findings of an economic mission which visited Nepal in April/May 1983; the mission members were Hassan Fazel (Chief of Mission), Inai Bradfield, M'hamed Cherif and Austin Fernando (Consultant). Mr. E. Peter Wright contributed Chapter 3, based on the findings of a separate mission which he led. Ms. Michele De Nevers and Mr. J. A. Simmons, respectively, contributed the Industry and Tourism sections of Chapter 4. Ms. Geri Wise provided secretarial support and coordinated production of the report.  FOR OFFICIAL USE ONLY TITLE : NEPAL: RECENT DEVELOPMENTS AND SELECTED ISSUES IN TRADE PROMOTION COUNTRY : NEPAL REGION : SOUTH ASIA SECTOR : COUNTRY ECONOMIC REPORT TYPE CLASSIF MM/YY LAGUAGES 4663-NEP CEM Restricted 10 83 English PUBDATE : 8310 ABSTRACT : Nepal's production, government revenues and exports, which had suffered as a result of drought in 1979/80, recovered substantially during 1980/81 and 1981/82. At the same time, however, largely owing to an expansionary fiscal policy, aggregate demand rose at a faster rate, resulting in increased inflation and wider trade deficits. With yet another severe drought in 1982/83, agricultural and total output declined, and the budget, inflation and balance of payments situations deteriorated further. To restore economic stability, the Government has now pared the 1983/84 budget, and is emphasizing intensification of commodity production and export development, particularly by the private sector. Part I of this Report reviews Nepal's recent economic policies and performance, including measures and issues in development administration. In addition, the role of external assistance is discussed, providing estimates and suggesting priorities for external aid. In view of the longer-term need for raising Nepal's very low income and consumption levels, and for strengthening its foreign trade sector, Part II-of the Report focusses on priority policies and measures for increasing production as well as exports. In the context of trade development, this part of the Report also reviews Nepal's new scheme of export incentives, and suggests measures for alleviating the critical transport and transit constraints facing the trade sector. 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.   GLOSSARY ADB - Asian Development Bank ADBN - Agricultural Development Bank of Nepal APROSC - Agricultural Projects Services Centre CEDA - Centre for Economic Development and Administration CSP - Cropping Systems Programme EPZ - Export Promotion Zone FITA - Foreign Investment and Technology Act ICP - Integrated Cereals Project TEA - Industrial Enterprises Act IRRI - International Rice Research Institute M.B.C.R. - Marginal Benefit Cost Ratio MT - Metric ton NASC - National Administrative Staff College NFC - Nepal Food Corporation NIDC - Nepal Industrial Development Corporation RNAC - Royal Nepal Airline Corporation Sajha - Cooperative society TCU - Transit Coordination Unit TPC - Trade Promotion Centre SYMBOLS Not available - Nil or negligible  1-  NEPAL - RECENT DEVELOPMENTS AND SELECTED ISSUES IN TRADE PROMOTION Table of Contents Page No. Abstract Glossary List of Tables and Diagram in the Text Country Data SUMMARY AND CONCLUSIONS ................................. i PART I: RECENT DEVELOPMENTS AND AID REQUIREMENTS 1............. Chapter 1: INTRODUCTION AND RECENT ECONOMIC PERFORMANCE .... 1 INTRODUCTION .............................................. 1 RECENT ECONOMIC PERFORMANCE ............................... 3 Economic Growth ......................................... 3 Public Finance and Money ................................ 6 Prices .................................................. 11 Balance of Payments ..................................... 12 Chapter 2: EXTERNAL ASSISTANCE ............................. 15 INTRODUCTION .............................................. 15 BALANCE OF PAYMENTS PROSPECTS, 1983/84-1984/85 ............ 15 THE ROLE OF EXTERNAL ASSISTANCE ........................... 18 Aid Commitments and Disbursements, 1980/81-1982/83 ...... 18 Aid Requirements and Priorities, 1983/84-1984/85 ........ 19 Chapter 3: DEVELOPMENT ADMINISTRATION ...................... 24 INTRODUCTION .............................................. 24 THE ADMINISTRATIVE ENVIRONMENT ............................ 24 NATIONAL ECONOMIC MANAGEMENT .............................. 26 PUBLIC ENTERPRISES ........................................ 28 DECENTRALIZATION .......................................... 29 AN AGENDA FOR FURTHER ACTION .............................. 30 PART II: TRADE DEVELOPMENT ................................... 32 Chapter 4: SELECTED ISSUES IN PRODUCTION AND EXPORTS ....... 32 BACKGROUND ................................................ 32 ISSUES AND PROSPECTS FOR PRODUCTION ....................... 34  Page No. AGRICULTURE .......................... ..................... 34 Improved Technologies ...... ............ .. ............... 34 Incentives and Prices ........ ........................... 38 INDUSTRY ........................... ....................... 42 Exports to India ........................................ 43 Exports to Third Countries ............... .. ............. 44 Import Substitution ........................... 45 Using Local and Indian Materials ............ .. .......... 45 Using Local and Third Country Materials ......... ........ 46 TOURISM ............................ ....................... 47 Promotion and Marketing ...... ............ .. .............. 47 Air Access .............................................. 48 Review of Tourist Taxation ............... .. ............. 49 Preservation of Tourist Assets .. 49 Chapter 5: EXPORT INCENTIVES AND INSTITUTIONS .... .......... 52 INTRODUCTION ........ ............... .. ..................... 52 FISCAL AND MONETARY INCENTIVES .............. .. ............ 52 SUPPORTING SERVICES ...... .............. .. ................. 58 Inspection and Quality Control ............. .. ........... 58 Licensing and Documentation ............... .. ............ 59 INSTITUTIONAL SUPPORT ...... ............. .. ................ 59 Annex to Chapter 5: FISCAL INCENTIVES UNDER THE INDUSTRIAL ENTERPRISES ACT, AND THE FOREIGN INVESTMENT AND TECHNOLOGY ACT ...................................... 61 Chapter 6: TRANSPORT AND TRANSIT OF EXTERNAL TRADE .... ..... 66 INTRODUCTION .............................................. 66 INFRASTRUCTURE ........................ .................... 67 Haulage ........................... ...................... 67 Handling and Storage .................. .. ................ 70 SECURITY OF FREIGPT ...... .............. .. ................. 71 PROCEDURES ......... 72 MANPOWER SUPPLY AND FACILITIES .............. .. ............ 72 A SUGGESTED STRATEGY ................... .. ................. 73 STATISTICAL APPENDIX .......................................... 75 MAP  Page No. LIST OF TABLES AND DIAGRAM IN THE TEXT Table 1: GDP Growth During Fifth and Part of Sixth Plan ..... 3 Table 2: Budgetary Performance During the Fifth and Part of Sixth Plan ................................... 7 Table 3: Factors Affecting Changes in Broad Money, 1979/80-1982/83 .................................. 8 Table 4: Changes in National Urban Consumer Price Index, 1978/79-1982/83 .................................. 12 Table 5: Summary Balance of Payments ........................ 13 Table 6: Balance of Payments, 1980/81-1984/85 .... ........... 17 Table 7: Foreign Aid Pipeline, 1983/84-1984/85 .... .......... 21 Table 8: Current Receipts and Expenditures of Foreign Exchange ......................................... 33 Table 9: Economic Analysis of Some Cropping Patterns at CSP Sites, 1981/82 ............................... 36 Table 10: Net Producer Margins, Selected Crops and Locations ........................................ 40 Diagram 1: Nepal Transit Transport Network (Schematic) 74  I  Page 1 of 2 pages COUNTRY DATA - NEPAL AREA POPULATION DENSITY 140,797Tsq. km. 15.0 million (mid-1981) 104 per sq km Rate of Growth: 2.6% (from 1970 to 1981) a/ 356 per sq. km. agricultural land POPULATION CHARACTERISTICS (1979) HEALTH Crude Birth Rate (per 000): - 43.6 - Population per Physician 30,060 Crude Death Rate (per 000): 19.8 Population per Hospital Bed: 6,390 Infant Mortality (per 000 live births): 147.7 INCOME DISTRIBUTION DISTRIBUTION OF LAND OWNERSHIP % of National Income, highest quintile: 59% % Owned by Top 10% of Owners lowest quintile : 5% % Owned by Smallest 10% of Owners: ACCESS TO PIPED WATER (1976) ACCESS TO ELECTRICITY (1975) % of Population - urban : 81% % of population 3.0 rural : 5% NUTRITION EDUCATION (1975-1976) Calorie Intake as % of Requirements: 86 Adult Literacy Rate : 19% a/ Per Capita Protein Intake (grams Primary School Enrollment: 91% per day): 45 GNP PER CAPITA IN 1981: US$150 GROSS DOMESTIC PRODUCT IN 1981/82 ANNUAL RATE OF GROWTH, 1970-1981 a/ (%, constant prices) US$ Mln. % GDP at Market Prices 2,514 100.0 2.1 Gross Domestic Investment 389 15.5 Gross Domestic Saving 216 8.6 Current Account Balance (exc. official grants) -120 -4.8 Exports of Goods, NFS 277 11.0 Imports of Goods, NFS 450 17.9 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1979/80 Value Added Value Added Labor Force b/ Per Worker US$ Mnln. _ Mn. %_ USS Agriculture 1,065 57 6.9 93 155 Industry c/ 251 14 0.1 2 1,696 Services 543 29 0.4 5 1,468 Total/Average 1,859 100 7.4 ice 251 GOVERNMENT FINANCE CENTRAL COVERNMENT Rs. Mln. % of CDP 1979/80 1980/81 1981/82 1982/83 1982/83 Current Receipts 1,853 2,403 2,866 3,001 8.3 Regular Expenditures 1,055 1,264 1,589 2,025 5.6 Current Surplus 798 1,139 1,277 976 2.7 Development Expenditure 2,309 2,731 4,034 4,808 13.2 External Assistance (Net) 1,318 1,374 1,953 2,607 7.8 Note: All conversions to US dollars in this table are at the average exchange rate prevailing during the period covered. a/ World Development Report 1983. b/ Total labor force; unemployed are allocated to sector of their normal occupation. c/ Includes mining, manufacturing, construction and utilities. .. not available  Page 2 of 2 pages MONEY, CREDIT AND PRICES 1979 1980 1982 1982 1983 a/ (Million Rs outstanding mid-July) Money and Quasi Money 4,512 5,285 6,308 7,459 8,780 Bank Credit to Government 1,176 1,362 1,357 2,132 3,185 Bank Credit to Public Enterprises 436 501 668 618 981 Bank Credit to Private Sector 1,976 2,547 3,231 3,363 3,717 Money and Ouasi Money as % of CDP 20.3 22.6 21.7 22.9 24.2 General Price Index (1974/75 = 100) 116.6 125.5 148.0 159.7 180.5 Annual Percentage Changes in: General Price Index 10.0 7.6 17.9 7.9 13.0 Bank Credit to Government 21.8 15.8 -0.4 57.1 49.4 Bank Credit to Public Enterprises 24.3 14.9 33.3 -7.5 58.7 Bank Credit to Private Sector 24.3 28.9 26.9 4.1 10.5 TRADE PAYMENTS AND CAPITAL FLOWS BALANCE OF PAYMENTS MERCPANDISE EXPORTS 1981/82 b/ US$ Mln. Z 1980/81 1981/82 1982/83 (Millions USS) Exports, f.o.b. c/ 134.4 115.4 67.3 Agricultural products 92.0 80.0 Imports, f.o.b. ci 352.6 363.6 408.3 Manufactures 23.0 20.0 Trade Balance -218.2 -248.2 -341.0 Total 115.0 100.0 Services, net 75.4 87.3 78.1 of which: Tourism 64.5 51.4 61.4 EXTERNAL DEBT, DECEMBER 31, 1982 US$ Mln. Transfers, net 46.4 40.5 37.6 of which: Private Remit. 38.9 34.5 .. Public Debt, inc. guaranteed 296.6 Indian Excise Refund 4.7 3.1 2.5 Non-Guaranteed Private Debt - Current Account Balance -96.4 -120.4 -225.3 Total Outstanding & Disbursed 296.6 (exc. grants) Official Grants 71.7 89.3 102.5 Official Capital, net 52.8 59.3 72.1 Private Capital, net -12.0 10.8 14.6 DEBT SERVICE RATIO for 1982/83 d/ Z Change in Reserves -16.1 -39.0 36.1 Public Debt, inc. guaranteed 7.0 (- = Increase) Gross Official Reserves (mid-July) 195.8 232.6 159.7 IBRD/IDA LENDING, JULY 31, 1983 US$ Mln. IBRD IDA Outstanding & Disbursed - 160.8 Undisbursed - 199.9 Outstanding, incl. undisbursed - 360.7 RATE OF EXCHANGE From October 1975 From March 20, 1978 From September 19, 1981 From december 17, 1982 Through October 1975 to March 20, 1978 to September 18, 1981 to December 16, 1982 to May 31, 1983 US$1.00 - NRs 10.56 US$1.00 = NRs 12.5 US$1.00 = NRs 12.00 US$1.00 - NRs 13.2 US$1.00 - NRs 14.3 NR 1.00 = US$ 0.095 NR 1.00 = US$ 0.08 NR 1.00 - US$ 0.083 NR 1.00 - US$ 0.076 NR 1.00 - US$ 0.070 a/ Estimate b/ Customs basis. c/ Payments basis. d/ Ratio of Debt Service to Exports of Goods and Services. not applicable not available South Asia Programs Department October 1983  SUJMMARY AND CONCLUSIONS i. Nepal's economy, largely based on rainfed traditional agriculture, has continued to stagnate over time relative to population growth, while showing large yearly fluctuations in function of the weather. The ini- tially low levels of average income and consumption have been sustained by extending the cultivated area through forest clearance. Due to rapid population growth, forests have been further denuded to meet the growing demand for fuelwood, on which Nepal depends for over 90% of its energy consumption, mostly for household cooking and heating. Deforestation is estimated at the equivalent of clearcutting more than 100,000 ha per annum. On account of deforestation and excessive grazing on the hills and mountains, with high rainfall, there is accelerated soil erosion leading to silting of rivers, downstream flooding and loss of agricultural produc- tivity all along. ii. The Hills have long been afflicted by chronic food deficits, forc- ing increasing numbers of people to migrate to the Terai. The proportion of Nepal's population living in the hills and mountains has declined from 63% in 1971 to 58% in 1981. The traditional grain surpluses of the Terai, which met some of the Hill deficits and provided the bulk of merchandise exports, have dwindled steadily to very little now. If all of the above inter-related trends continue, the low incomes and consumption levels in the country would quite simply decline intolerably. At the same time, falling exports, coupled with the necessity to import foodgrains--even fuel, as a result of the deforestation--would make Nepal's balance of payments position untenable. iii. Thus far, in a normal rainfall year, Nepal has not had to import foodgrains. Even so, its balance of payments has been weakening over time, revealing a high propensity to import for consumption and intermediate use without, as yet, generating a corresponding growth of output and tradables. Between 1974/75 and 1981/82--both "normal" years--the ratio of Nepal's foreign exchange receipts to payments, on current account, declined from 85% to 73%. This ratio dropped to 55% in 1982/83 when agricultural exports fell and foodgrains had to be imported owing to a bad drought. But as hinted in the preceding paragraph, such a payments position could become a regular feature. iv. Efforts to deal with the symptoms outlined above are severely circumscribed by Nepal's difficult physical geography, and by its limited financial and institutional capabilities. All the same, Nepal's Sixth Five-Year Plan (1980/81-1984/85) had intended to begin addressing most of the symptoms. The Plan intention was appropriate, as was its strategy, which (a) accorded high priority to developing agriculture, small-scale industries and Nepal's abundant water resources; (b) stressed soil conser- vation and population control; (c) emphasized full utilization of existing infrastructure; and (d) underscored needed improvements in development administration. The sector programs, and the investment and production targets, however, did not conform to the Plan strategy. For instance, large new projects--in irrigation, industry and road construction--were  -ii- proposed, while concrete programs to intensify agricultural production through complementing past irrigation investments were lacking, as were programs to strengthen erosion or population control. Moreover, although the Plan expenditure and output targets were far beyond the country's financial and implementation capacity, fiscal policy during 1980/8l-1982/83 set out to achieve the expenditure targets. In the event, during the first three years of the Plan, the budget deficit rose from 6% to 10% of CDP. Foreign aid disbursements, which grew from $125 million (5% of CDP) in 1980/81 to $175 million (7% of CDP) in 1982/83, financed part of the deficits; the remainder was largely financed by domestic bank borrowing. The resulting expansion of domestic liquidity put pressure on the price level. During the period, the rate of inflation in Nepal averaged 12%, while the rate in Nepal's trading partner countries averaged 8%. Correspondingly, the balance of payments deteriorated, due to domestic demand pressure and to loss of export competitiveness. The current account deficit more than doubled, from $96 million (4% of CDP) to over $200 mil- lion (over 8% of GDP), even after adjusting for emergency foodgrain imports last year. v. Since even minimum basic needs are still largely unmet in Nepal, desirable increases in consumption and investment are quite high. Yet, as illustrated above, mere increases in aggregate expenditures run an immediate risk of macroeconomic instability and mtust be limited, as the revised 1983/84 budget has attempted to do through a realistic reassessment of resources and expenditure requirements. Furthermore, public expendi- tures need to be refocused and emphasize fuller utilization of existing investments and to address the country's pressing longer-term development problems, specifically rapid population growth; deforestation, and atten- dant soil erosion and fuelwood shortages; long-term agricultural stagnation; and limited institutional capability for development management. And, all of this will need to be done in the context of severe financial and foreign exchange constraints. vi. Recent studies dealing with most of Nepal's deep-rooted problems are available, including the World Bank's report on population strategy; the World Bank/UNDP report on energy issues and options, and the Asian Development Bank's agricultural sector study. Also, the World Bank's October 1981 economic report (Nepal: Policies and Prospects for Accelerated Crowth) examined the principal issues in, and recommended measures to lessen, administrative and domestic financial constraints. The present economic report reviews progress in both these areas, and also addresses the subject of trade development, aimed at strengthening Nepal's balance of payments. vii. Some progress has occurred in recent years in the area of family planning. Nepal has introduced wage compensation for sterilization, and is starting incentive programs for families who limit their offspring. Incentives are also being introduced to promote formal, non-formal and technical education for women. The preliminary count of the 1982/83 sterilization program shows a 40-50% increase over 1981/82--from 30,000 to between 43,000 and 45,000.  -iii- viii. The population report (Kingdom of Nepal: Report on Population Strategy) has recommended a target of raising prevalence of contraception from an estimated 7% in 1981 to 15% in 1986, a level of use consistent with a significant fertility decline. Achievement of this target requires action on a number of fronts: consolidation of the overstretched family planning program; improved continuation rates for acceptors of temporary methods; extension of vasectomy and sterilization services; greater emphasis on promotional activities; coordination of demand creation with service delivery; and greater community participation in family planning. Major efforts are required to improve the quality and management of support services. Improvement in family planning programs will also require addi- tional investments in training and retraining field staff. A most impor- tant condition for success is for the National Commission on Population to assume the task of coordinating and monitoring all population programs in the country. ix. The energy sector report (Nepal: Issues and Options in the Energy Sector) offers options for meeting future demand in the medium- and long- term based on afforestation, dissemination of improved cooking stoves, development of micro-hydro schemes in the Hills and biogas plants in the Terai, and development of large- and medium-size hydropower projects, which offer scope for export of power to India. The report includes recommenda- tions for a variety of technical assistance for institutional strengthening and training. x. A key factor in determining the energy strategy is the economic cost of alternative fuels. Comparisons based on end-use efficiency indi- cate that, for meeting household cooking and heating needs, fuelwood from planned forestry programs is much cheaper than kerosene or electricity. Therefore, a long-term energy strategy has to focus on providing adequate fuelwood supplies to meet projected demand. In the short to medium term, the economic cost of fuelwood is much higher because the overexploitation and erosion resulting from forest shrinkage imposes very high costs on fuelwood use. Thus in the medium term, before forestry programs can be sufficiently expanded, there is justification for introducing other fuels to alleviate pressure on the forests. In the area of energy pricing policy, key recommendations include the removal of subsidies on fuelwood in urban areas supplied by the Fuelwood Corporation, and increases in elec- tricity tariffs to reflect seasonal variations in energy production cost and peak loads. xi. Though admittedly limited, prospective pockets of improvable agricultural production do exist in Nepal, both in the Terai and in the Hills. In the latter particularly there is, above all, a need for a more cohesive agricultural strategy, combining crops, livestock and forestry, to reinforce ongoing rural development and cottage industry programs. Complementing the Asian Development Bank study on agriculture (Nepal: Agriculture Sector Strategy Study), this economic report furthermore sug- gests that policies and measures for raising agricultural productivity in Nepal need to emphasize: (a) the design and efficient delivery of modern technological packages, and (b) adequate producer incentives. Several economically viable methods for improving yields have been developed  -iv- through the Integrated Cereals Proiect, which emphasizes Hill agriculture, and through the irrigation, and research and extension projects in the Terai. These packages now have to be delivered economically on a large scale and, equally important, renewed biologically. To ensure successful delivery of the improved technologies, the institutions which handle agricultural inputs in Nepal--the Agricultural Inputs Corporation and the Sajhas--need to be reviewed and strengthened thoroughly and immediately. Renewal of the improved technologies needs to be ensured with an adequately staffed and funded network of research and extension services. As a case in point, the production programs organized by the Integrated Cereals Project need to be implemented through the institutional base being created under the research and extension projects. xii. Agricultural producer margins in Nepal have been seriously eroded over the years since agricultural pricing policy has generally favored consumer interests. For producers, the existing fertilizer subsidy program has been largely ineffective because of insufficient supplies, and an uneven distribution of the little that has been available, with 50% dis- tributed in the Terai and another 40% in the Kathmandu Valley. Prices of some cash crops (notably sugarcane) have been unduly high relative to food crops. Cenerally this has meant greater relative returns and incentives to growers in the Terai, where these cash crops are grown. For foodgrains (paddy and wheat), output support prices are also announced too late in the crop year to influence producer decisions; and then these prices are set at levels below the expected market prices. The grain market, furthermore, is characterized by a few buyers facing many small farmers, also resulting in unfavorable prices to producers. xiii. To revive producer incentives, the overall objective of keeping food prices consistently low for consumers should be reassessed. Recent measures to reduce subsidies on grain sold by the Nepal Food Corporation should be continued, with sales of subsidized grain confined to the most needy. In areas where returns to fertilizer use are high, farmers in the country have been willing, and should be expected to, pay higher prices for fertilizers. Savings thus obtained by reduction of subsidies would enable importation and distribution of more fertilizers. Furthermore, fertilizer distribution could be improved by encouraging the private sector to under- take more retail sales of agricultural inputs. At the same time, institu- tional credit supply to farmers should be augmented to enable farmers to meet the higher costs of modern input packages, and to make a dent in rural indebtedness. This implies not only expanding the network of credit institutions, but also simplifying the procedures and conditions of estab- lishing collateral for loans. xiv. Producer prices need to be raised, properly timed and enforced to the maximum extent possible, with prices in the Terai closely aligned to adjoining Indian border market prices. Relative prices of cash and food crops need to be carefully set to provide adequate incentives to both crops, consistent with the comparative advantage of growing each type of crop. While the foodgrain market in Nepal requires intervention in favor of producers, indiscriminate public procurement would be a costly and counterproductive solution. Public intervention would be better directed  towards provision and improvement of basic infrastructure, such as rural roads, to give farmers as well as prospective buyers better access to each other and to alternative markets. Better storage and preservation facilities would also increase the bargaining power of producers. Lacking such facilities at present, farmers are often forced to sell their products at distress prices for fear of spoilage. Wherever possible, the private sector and producer cooperatives could be given incentives to invest in storage and preservation facilities. xv. Over the past two years, several positive steps have been taken to strengthen Nepal's development administration. Civil service salaries have been increased. The Nepal Administrative Staff College (NASC), established in 1982, has been given broad responsibilities for public service training and has already held a number of courses for senior officials and public enterprise managers. The procedure for the release of budgetary funds has been simplified, accompanied by stricter enforcement of expenditure accounting. Planning and policy analysis is being built up in line minis- tries for agriculture, industry, water resources and education. Financial targets have been set for public enterprises and enterprises have been given more autonomy in personnel and pricing policies. xvi. The implementation of these administrative reforms now has to be pursued vigorously, and a number of additional steps must be taken aimed primarily at minimizing overlapping functions and constraining the growth of government. Otherwise it will prove difficult if not impossible to implement "incentive salary" policies in view of Nepal's straitened finan- cial circumstances. The administrative environment could be improved further by a high-level monitoring of important administrative issues such as appointment of competent staff, job security and decision-making authority. To perform such a function, there is a case for a small unit in the Prime Minister's Office, staffed by two or three high-level aides with long experience in government. Also, focusing NASC training on a narrower range of subjects would enable the College to devote more staff time to field research and to perform an advisory role to government. While the financial results of public enterprises may be improved by raising product prices, the basic problem is to find ways of reducing costs and increasing efficiency. The Corporation Coordination Division of the Ministry of Finance is thinking along these lines, but it needs the necessary authority and technical assistance to carry out a major program of enterprise reform. xvii. One major additional task is the strengthening of the Foreign Aid Division of the Ministry of Finance, particularly in managing the foreign aid data base and in coordinating donor activities. Jointly, the Ministry of Finance and the Planning Commission need to establish firm procedures and functions for screening major investment proposals. Also, the process of building up planning and policy analysis capabilities in the line minis- tries needs to be continued. xviii. Currently, much attention is being given in Nepal to proposals for the decentralization of development administration. According to one proposal, an elaborate bureaucratic apparatus may be created at the dis- trict level with responsibilities for plan preparation, monitoring and  -vi- evaluation. Nepal's approach to decentralization needs to be carefully reviewed, however, to ensure that the bureaucracy does not expand and that the private sector plays an important role. The overriding concern in administrative reform should be to achieve greater efficiency in the use of the country's very limited resources. xix. Since 1980/81, Nepal's efforts at domestic resource mobilization have focused on tightening income tax assessment and collection; on discre- tionary measures largely in the area of indirect taxes; and on reducing subsidies to public enterprises. While there has, as a result, been a steady increase in revenues, the tax structure remains inelastic, so that future efforts must be geared towards increasing the elasticity of the system. xx. Some scope exists for increasing tax elasticity by shifting items on the indirect tax schedules from specific to ad valorem bases. In addition, there may be scope for increasing yields from the land tax, urban property taxes and income taxes. In this case, the design of suitable measures is constrained by the absence of complete or up-to-date data on land ownership, urban property values and income distribution. Therefore, as a means to strengthening resource mobilization, the Government needs to arrange for timely completion of cadastral surveys, which have been going on for many years; for compilation of data on property ownership and market values; and for an update of data on earnings and income distribution. xxi. To sustain and further develop its economy, Nepal must mobilize additional free foreign exchange resources through export promotion and efficient import substitution. Improving agricultural production, rural incomes and food distribution within the country is a major way of doing so, if only to avoid the need to import and distribute large quantities of foodgrains. Agricultural development also remains the key to a gradual expansion of Nepal's traditional merchandise exports. In addition, development of energy resources is a mtajor means to strengthening the balance of payments by reducing the need to import fuel and opening up a large export potential. xxii. Prospects for industrial exports and import substitution are con- strained by the generally undeveloped state of industry in the country and by Nepal's geographical location. Nonetheless, there is some scope for increasing the exports of light consumer goods to India, but this will require renegotiating the relevant sections of the Trade Treaty with India. Existing joint ventures with Indian firms producing import substitutes could be strengthened to undertake additional production of low value-to- weight items, notably construction materials, agricultural tools and some consumer non-durables. xxiii. The best potential for industrial exports to third countries (countries other than India) is in leather goods and in labor-intensive, high value-to-weight handicraft items, such as woolen carpets, metal sculptures, specialized garments, Jewelry, and some wood and paper products. These items rely on Nepal's artisanal skills, which are largely based in rural households in the Hills. Hence, an additional benefit of  -vii- promoting such products would be the provision of extra incomes to the Hill population. Potential also exists for import substitution of items used by hotels, restaurants and services catering to tourism (e.g., food, furniture, textiles). In all cases, it will be essential to establish and maintain appropriate product standards and quality, and to adhere to delivery schedules. xxiv. Nepal's mountain environment and its rich cultural heritage attract many tourists. Receipts from tourism have grown steadily, now providing about 20% of the country's total foreign exchange earnings. About 60% of earnings from tourism are retained in Nepal. Given the underutilization of present hotel capacity in the country, the first priority in raising earn- ings from tourism is a strengthened promotion and marketing program and improved air access. To support these efforts, a review of taxation on the sector is required, in the context of Nepal's competitiveness in the market. Attention also needs to be given to further improving the pas- senger terminal facilities at Kathmandu airport and to preserving tourist assets. For the latter, important measures include continued work on the preservation and restoration of historic sites, opening up of new trekking routes and the environmental protection of existing routes. xxv. Nepal's Industrial Enterprises Act, and the Foreign Investment and Technology Act, both passed in 1981, have legislated a wide range of fiscal and administrative incentives for investors and exporters, particularly in the private sector. The Acts provide for tax holidays and concessions, preferential access to institutional investment capital, protection of private investment, repatriation of profits and dividends by foreign investors, and simplification of licensing and documentation procedures. xxvi. The package of incentives needs to be refined with a view to increasing the net benefits to Nepal, and a selective and phased implemen- tation would be appropriate. Nepal also needs to increase pre-shipment and post-shipment credit facilities for manufacturers and exporters. And while implementing the package of incentives, it would also be important to maintain export competitiveness by constant monitoring of the exchange rate and price developments in Nepal relative to export competitor and trading partner countries. xxvii. Trade promotion in Nepal is severely constrained by major proflems in moving goods to and from the country. Almost all of Nepal's merchandise trade moves over land to or through India, using the Port of Calcutta for overseas trade. The potential for air cargo is underutilized. The main problems of the transport and transit system include a highly inadequate physical infrastructure for hauling, handling and storing goods; frequent damage and loss of goods; cumbersome procedures for rationing capacity, ensuring security and satisfying administrative requirements (for revenue and information); and limited operational and managerial capability all along the system. The direct and indirect costs of such constraints to the economy of Nepal have been estimated at some $200 million per year, equiv- alent to 8% of Nepal's GDP in 1981/82.  -viii- xxviii. Transit transport conditions have been studied extensively by the resident UNCTAD/ESCAP Advisory Team in Nepal. The findings of those studies need to be translated into a plan of action, involving Nepal and the transit countries--India and Bangladesh. Urgent action is required on many fronts to relieve the critical bottlenecks in this sector. Rail traffic, which requires transhipment enroute between the broad- and meter- gauge services of Indian Railways, could be improved by using less con- gested alternative transhipment points. There are possibilities for using Indian and Bangladesh railways to gain access to the ports of Chittagong and Chalna. More use could be made of the faster road transport, employing inter-modal containers, if bridges and pavements along the transit corridor were improved. Further improvement of physical infrastructure calls for identifying, and quickly procuring, cargo handling equipment, and for substantially increasing warehousing capacity for Nepalese goods at Calcutta, Birganj and Tribbuvan Airport. Nepal's Transit Coordination Unit needs to take a lead in the formulation of transport and transit policy, analysis and dissemination of information on tariffs and procedures, and simplification of transit entry and exit procedures. In addition, training should be organized for equipment operation and maintenance; warehouse management; materials handling and supervision; cargo clearance procedures; freight forwarding and insurance. At the same time, the working and living conditions of customs staff at border points need to be improved with adequate provision of at least basic office, godown and housing facilities. xxix. Nepal and the donor community quite clearly face an almost unprece- dented challenge in addressing the country's multiple long-term development problems. There are critical and essential expenditure and institution- building needs in many basic areas and sectors of the economy. Continued donor support for these development activities will be vital in complementing, and ensuring the success of, Nepal's own efforts at mobi- lizing domestic and foreign exchange resources to finance investment and economic growth. A review of requirements and realistically feasible levels of total aid disbursements over the next two years, taking into account expected disbursements from past commitments, suggests a need for new aid commitments of $245 million in 1983/84 and $250 million in 1984/85. This estimate of new commitments excludes the financing requirements of the large Marsyangdi hydroelectric project. xxx. At present, Nepal is facing a difficult external payments position because the balance of payments in 1982/83 deteriorated sharply on account of the severe drought. The Government has assigned top priority to agricultural recovery, particularly food production. An intensive winter wheat program was launched successfully last year after the drought-induced failure of the main paddy and maize crops. Similar arrangements were made for the 1983/84 paddy crop, and the Government intends to continue these programs. The success of such programs, however, depends vitally on the importation and distribution of adequate amounts of fertilizers. In sup- port of these efforts to intensify food production, ar.d given that the aid pipeline contains relatively little aid for fertilizers, donors need to consider providing some quick-disbursLng commodity assistance. Commodity aid commitments of about $30 million Ln 1983/84 (out of the proposed total of $245 million) would provide the essential support to increasing food production.  PART I: RECENT DEVELOPMENTS AND AID REQUIREMENTS Chapter 1: INTRODUCTION AND RECENT ECONOMIC PERFORMANCE INTRODUCTION 1.01 Efforts to develop the economy of Nepal take place against the background of severe physical, institutional and economic obstacles. The severity of these constraints is quite evident from the slow progress in almost all sectors during the 30 years since the country began to modernize its economy. Meanwhile, rapid population growth has made it increasingly difficult for the country to break out of a low-level economic trap. The majority of Nepal