Nepal - Prospects for economic adjustment and growth

andy>> Q;<. vW-: December 12, 1985) S OL f ~ IAml 1'Pri )tl V I ) I I t I r1 FOR OFFICIAL USE C)NLY 4 , Docunei . n ;e World Bank 1 bi ; ,ime;l ha -i sa restricte(I disitrihiutiotn and may he used by reO ipients * iy in the pei: t' na-ce of tLheir official dJutieS. Its cooit(ets tay not otherwise be discl osecl ".itno,aL Worid Bank aLUthoriz7ation.  CURRENCY EQUIVALENTS a/ (Annual Averages) NRs per US$1.00 US$ per NRs 1.00 1980/81 12.000 0.0833 1981/82 12.936 0.0773 1982/83 13.796 0.0725 1983/84 15.260 0.0655 1984/85 17.800 0.0560 PRINCIPAL ABBREVIATIONS AND ACRONYMS AIC - Agricultural Imports Corporation FCG - Financial Comptroller General FP/MCH - Family Planning and Maternal and Child Health HA - Hectare IMF - International Monetary Fund MT - Metric Ton MW - Megawatt NCCN - National Construction Company of Nepal NFC - Nepal Food Corporation O&M - Operations and Maintenance RNAC - Royal Nepal Airline Corporation SCR - Special Commodity Rates UNDP - United Nations Development Programme HIS MAJESTY'S GOVERNMENT OF NEPAL FISCAL YEAR July 16 - JuLy 15 a/ Until the end of May 1983, the Nepalese Rupee was pegged simultaneously to the US Dollar and the Indian Rupee at fixed exchange rates. On June 1, 1983, Nepal introduced a trade-weighted basket peg arrangement with the US Dollar as the intervention currency. This report was prepared by an economic mission which visited Nepal in June 1985. The mission consisted of Kazuko Uchimura (mission leader), Neil McMullen and Vidya Shetty. Reinold van Til (IMF Resident Representative in Nepal) also contributed to the report.  FOR OMCuL USE ONLY FOR OFFICIAL USE ONLY TITLE NEPAL: PROSPECTS FOR ECONOMIC ADJUSTMENT AND GROWTH COUNTRY : NEPAL REGION : SOUTH ASIA SECTOR : COUNTRY ECONOMIC REPORT TYPE CLASSIF MM/YY LANGUAGES 5867-NEP CEM Restricted 12 85 English PUBDATE : 8512 ABSTRACT : Nepal faces serious financial imbalances both in the balance of payments and the budget that require immediate action. The Government needs urgently to step up domestic resource mobilization measures whLle stringently controlling the growth of expenditures to reduce domestic bank borrowings. To achieve even modest per capita GDP growth over the medium term, the Government's economic adjustment program must include measures to expand agricultural output primarily for import substitution and to foster growth in export-oriented cottage and small-scale industries and in tourism. These measures are discussed in Part I. Part II of the report-identifies key issues in project implementation and in maintenance of existing assets, and offers recommendations on policies and actions for removing the bottlenecks. I b domeot has a reutricted disttion and may be wed by recipients only in the perfonuance of r d| fk offTal duties. Its contents may not otherwis be disclosed without World mank authorization.  NEPAL - PROSPECTS FOR ECONOMIC ADJUSTMENT AND GROWTH Table of Contents Pare No. SUMMARY AND CONCLUSIONS ................. .. .. . .. . ................................ . i PART I: MANAGING ECONOMIC ADJUSTMENT IN TRE SHORT TO MEDIUM TERM 1.... Chanter I: RECENT ECONOMIC DEVELOPMENTS ............ ................ 1 A. INTRODUCTION ................................................................ I B. GDP C-ROWTH AND SECTORAL DEVELOPMENTS .......................... 1 GDP Growth .................................................. 1 Developments in Selected Sectors ............................. 3 C. FISCAL AND MONETARY DEVELOPMENTS ...................... .......... . 6 Budgetary Trends ....... ... ................................... 6 Inflation, Domestic Credit and Monetary Expansion . ........... 12 D. MANAGEMENT OF EXTERNAL PAYMENTS ....................... .......... 13 BaLance of Payments ........... 13 Debt Service Burden ........ o................................. 16 Chapter II: AN ACTION PROGRAM FOR STABILIZATION AND ADJUSTMENT ...... 19 A. MAIN ELEMENTS OF AN ECONOMIC ADJUSTMENT PROGRAM .... o ...... o.... 19 Action to be taken in the Short Term ........................ 19 Action to be taken over the Medium Term ...................... 20 B. SHORT-TERM POLICY REQUIREMENTS ...................... ........ . 20 Management of Public Expenditure .. . ... 20 Development Outlays .... .... ..60-6 ............. 19 Improving Resource Mobilization in the Public Sector . 22 Policies for Export Promotion ............ o ...... o ............ 31 C. NEDIUM-TERM POLICY REQUIREMENTS ........ o ....................... 32 Priorities in Agriculture ...... ....................... ..... . 32 Expanding Cottage and Small Industry Production .......... o ... 33 Reviving Tourism Growth ... ................. 34 Improving O&M and Accelerating Project Implementation ........ 35 D. ROLE OF DONORS ............ o............ o ...... . 36 Re-evaluation of Ongoing Projects ............ .. .............. 37 Design of New Projects ... ... ................... 37 Assistance Directed at 0M ........ . . . . . . ................. ........ ...... 38 Budget and Balance of Payments Support .......... .. ........... 38  Pase No. Chapter III: NEDIUM-TERM PROSPECTS AND EXTERNAL FINANCING REQUIRENENTS ........................................... 40 A. OVERVIEW OF GROWTH PROSPECTS . . ......... . 40 GDP Growth Prospects ....... ................................... 40 Fiscal Strategies ........ .................................... 42 Prospects for Exports and Imports ..... ....................... 45 Exports .................................................... 45 Imports ................................................................ 47 Consequences of a Failure to Implement an Adjustment Program ......................................... 49 B. EXTERNAL FINANCING REQUIREMENTS AND STRATEGY ................ ... 51 External Financing Requirements ..... ....................... 51 Fiuancing Strategy ........................................... 51 Foreign Reserve and Debt Service Management ................ .. 56 PART II: ACCELERATING PROJECT IMPLEMENTATION AND IMPROVING MAINTENANCE ......... ................... .................... 58 Chapter IV: ISSUES IN PROJECT IMPLEMENTATION AND MAINTENANCE ........ 58 A. PROJECT MANAGEMENT AND STAFFING CONSTRAINTS .................... 59 Project Staffing Constraints ................................. 59 Centralized Decision Making ............... .. ................. 60 Past Efforts at Reforming Public Administration .............. 60 Suggested Areas for Change ................................ .. 61 B. FINANCIAL MANAGEMENT CONSTRAINTS .............. .. ............... 62 Inadequate Allocation of Local Funds ......................... 63 Delays in Fund Release .................... ................... 63 Suggested Areas for Change ................................... 64 C. PROBLEMS OF THE LOCAL CONSTRUCTION INDUSTRY .......... .......... 65 State-of-the Art of the Local Construction Industry .... ...... 66 Public Policy Environment for the Construction Industry ...... 67 Goverrment Action Required for Developing the Construction Industry ................. .. ................... 67 D. MAINTENANCE OF EXISTING FACILITIES ............................. 69 Categories of O&M Shortfalls ............... .. ................ 70 Estimating Incremental O&M Requirements ...................... 72 Proposals to Improve Provisions for O&M ...................... 74 ANNEXES ..... .................... A. ESTIMATING OPERATIONS AND MAINTENANCE REQUIREMENTS IN NEPAL .... 78 B. PROPOSED POLICIES FOR THE SEVENTH PLAN ........................ 84 C. LOGISTICS FOR DEVELOPMENT ..................................... 86 D. MILESTONES IN ADMINISTRATIVE DEVELOPMENT ...................... 92  LIST OF TABLES AND CHARTS IN THE TEXT Pate No. STATISTICAL APPENDIX ..................................................... 96 Table I-1 : Historical GDP Growth ...................... .... 2 Table I-2 : Agricultural Production ............................... 4 Table I-3 : Central Government Budgetary Performance ............. 7 Table I-4 : Factors Affecting Money Supply ............ ............ 12 Table I-5 : Balance of Payments Summary .... ........ .......... 14 Table I-6 : Movements in Exchange Rates ............. o ............. 16 Table I-7 : Foreign Borrowings and Debt Service Ratio ............. 17 Table II-l : Estimated Revenue Impact of Selected Tax Reform Measures ........ 0........ 27 Table II-2 : Cost Recovery Performance by Sectors ................ 29 Table III-1: Historical and Projected Growth Rates ............... . 41 Table III-2: Medium Term Government Finance Assuming Implementation of Adjustment Measures ........ .** 43 Table III-3: Budgetary Operations - Historical and Projected ....... 44 Table III-4: Real Export Growth Rate Projections ....o .............. 47 Table III-5: Balance of Payments Projections ....o .................. 48 Table I}I-6: Assumptions of Alternative Growth Scenarios .... ....... 50 Table I}I-7: Summary of Foreign Exchange Requirements and Sources .. 52 Table III-8: Foreign Capital Commitments and Disbursements ......... 53 Table III-9: Nepal Aid Pipeline ................ ........ 55 Table III-10: Debt Service Projections .............................. 57 Table IV-1: Estimates of Incremental Expenditure Requirements for Operations and Maintenance .73 Table Al: Recommended O&K Costs for Irrigation .81 Table A2: Irrigation Projects: Seventh Five Year Plan 0&M Expenditure Targets ...82 Table A3: Nepal - Roads by Region, Classification and Type 83 Chart 1: Factors Influencing Domestic Price Movements. 11 Chart 2: O&M Requirements and Actuals .71  Page I of 2 COUNTRY DATA - NEPAL AREA PGirULATION DENSITY 140,797 sq. km. 16.3 million (mid-1984) 115 per sq. km. Rate of Growth: 2.72 (from 1971 to 1984) 394 per sq. km agricultural land POPULATION CRCTERISTICS (1979) HEALTH (1980) Crude Birth Rate (per '000): 41.6 Population per Physician : 30,060 Crude Birth 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 Z of National Income, highest quintile: 59.2 Z Owned by Top 101 of Owners lowest quintile : 4.6 2 Owned by Smallest 10% of Owners ACCESS TO PIPED WATER (1976) ACCESS TO ELECTRICITY (1975) Z of Population - urban : 81S Z of Population 3.0 rural : 5Z NUTRITION (1980) EDUCATION (1980) Calorie Intake as Z of Requirements 86 Adult Literacy Rate : 19 Per Capita Protein Intake (grams Primary School Enrollment : 91 per day) 45 GRP PER CAPITA IN 1983: USS170 GROSS DOMESTIC PRODUCT IN 1984/85 ANNUAL RATE OF GROWTH, 1974/75-1984/85 (1, constant prices) USS Mln. CDP at Narket Prices 2,344 100.0 3.2 Gross Domestic Investment 446 19.0 Gross Domestic Saving 247 10.5 Current Account Balance (exc. official grants) -168 -7.2 Exports of Goods, NFS 288 12.3 Imports of Goods, NFS 487 20.8 OUTPUT. LABOR FORCE AND PRODUCTIVITY IN 1982/83 Value Added _ Value Addet___ Labor Force iJ Per Worker USS Mln. 2 Mln. Z USS Agriculture 1,286 56 6.3 91.0 204 Industryb/ 277 12 0.2 3.0 1,385 Services 725 32 0.4 6.0 1.813 Total/Average 2,282 l00 6.9 100 331 GOVERNMENT FINANCE CENTRAL GOVERNMENT Rs. lIn. 2 of CDP 1981182 1982/83 1983/84 1984/85 1984/85 Current Receipts 2,668 2,808 3,342 3,961 9.5 Regular Expenditures 1,627 1,994 2.274 2,984 7.1 Current Surplus 1,041 814 1,068 977 2.3 Development Expenditure 3,7 27 4,982 5,164 5,528 13.2 External Assistance (Net) 1,688 2,028 2,861 2,663 6.4 Note: All conversions to US dollars in this table are at the average exchange rate prevailing during the period covered. Fiscal year data are for Nepalese fiscal year, July 16 - July 15. PY Total labor force; unemployed are allocated to sector of their normal occupation. hf Includes mining, manufacturing, construction and utilities.  Page 2 of 2 MONZV. CRIDIT AID PRIClS 198 ML8 19e2 193 18X 18 (Nillion Rs outstanding mid-July) Money and Quasi Money 5.285 6,308 7.459 9.222 10.456 12,213 lank Credit to Government 1.258 1.263 2.062 4.090 5.029 6.433 Dank Credit to Public Enterprises 702 946 840 1.137 953 1.151 Dank Credit to Private Sector 2.346 2.952 3,142 3.264 3.842 4.689 Money and Quasi Money as s of CDP 22.6 21.7 Z229 27.4 27.4 29.3 General Price lndex (1974/75 - 100) 128.7 145.9 161.2 184.1 195.6 198.6 Annual Percentage Changes in: General Price Index 9.6 13.4 10.4 14.2 6.2 1.5 Dank Credit to Governmet 15.8 -0.4 57.1 93.8 24.2 27.9 Bank Credit to Public Enterprises 14.9 33.3 1.0 44.0 -18.9 20.8 lank Credit to Private Sector 26.9 26.9 2.4 3.7 16.9 22.1 1981/82 1982/83 1983/84 1984/85 NERCHAUDISE EXPORTS 1984/85 (US$ Million) USS KIn. .z ALAIICE OF PAIMKS Agricultural products 91.7 59 Exports 277.6 250.4 303.5 306.0 Manufactures 617 41 Hercbandise f.ob 115.6 82.3 123.9 155.4 lon-iactor Services 162.0 168.1 179.5 150.6 Total 155.4 100 Imports 450. 5 521.6 551.3 515.3 Merchandise c. i.f 382.5 459.0 473.6 445.7 EXAL DEST, DECEMBER 31- 1984 Non-factor Services 68.0 62.6 77.7 69.6 es$ mi. Reasurce Cap 172.8 271.2 247.8 209.3 Public Debt. inc. guaranteed 426.5 Net factor Income 12.5 13.0 0.1 0 Non-Cuaranteed Private Debt Net Current Transfers 40.6 41.7 50.2 41.7 Total Outstanding 8 Disbursed 426. 5 Current Account Deficit 119.8 216.5 197.5 167.6 Official Grant Aid 89.4 95.3 100.1 87.1 DEBT SERVICE RATIO for 1984/85 2 Net. MOLT Loans 59.8 67.0 87.2 73.8 Public Debt. ine. guaranteed 3.9 Disbursenients 62.3 69.9 92.4 '8. 7 Repayments 2. 5 2.9 5.1 4.9 Capital Flows I.E.I. 9.3 5. 2 1.0 -40.0 IRED/IDA LENDING, Sent. 30. 1985 (Millions US$) Overall lalance 38.8 -'9.0 -9.1 -46 7 US$ iln. Change in Net Reserves -38.8 49.0 9.0 46.7 1RBp IDA (-increase) Ourstandirg 4 Dimhb.rsrd - 19S 0 Gross Officisl Reserves 322.6 163.1 123.1 93.6 Undisb.rsed - 394 8 (Mid July) Outsrtading. incl. oand2sbursed - 499.H RATE OF EXCHtANE From March 20. 1978 From September 19. 1961 From December 17, 1982 to Seutember 186 1981 to December 16. 1982 to May 31 _1983 __ June 30. i84 al Dp9enerL 9S'. USS1.00 - NRa 12.00 USS1.00 - NRa 13.2 USS1.00 - NRs 14.3 USS1.00 - MRs 16.4 USSl.00 - *RRs 1 .0 NR 1.00 - USS 0.083 NR 1.00 - USS 0.076 NR 1.00 - USS 0.070 N11.00 - USS 0.061 no 1.0l - USS .O0E6 March 31. 1985 June 30. 1985 USS1.00 - MRs 18.1 USS1.00 * MRs 18.1 NR 1.00 - USS 0.055 HR 1.00 - USS 0.055 W Since June 1. 1983. the Nepal Rastra Rank announces the exchange rate daily. based on a trade-weighted basket. with the US dollar as the intervention currency. The rate shown here is the mid-rate on the date indicated. Soutb Arnia Prosgrams Department NM.vvmher l;! rM  SUMMARY AND CONCLUSIONS Overview i. Today, after nearly three decades of development efforts, Nepal is still one of the poorest countries in the world with a per capita income of only US$170 (1983). Successive development plans, supported by steadily growing foreign assistance, have faiLed to Lift the country out of its condi- tion of abject poverty. Over the past 15 years, real GDP growth has barely kept pace with population growth. Most importantly, per capita agricultural output has declined steadily which, among other adverse repercussions, has resulted in dwindling agricultural export surpluses. The growing need for food and fuel has led to rapid environmental degradation, including deforestation, soil erosion and destruction of watersheds. Social indicators for life expectancy, infant mortality and adult literacy have remained well below the average for South Asian countries. ii. While the country's difficult terrain and landlocked position and its poor natural resource base have certainly all contributed to the poor economic performance, an equally important factor has been the limited capacity of the Government to manage the economy and to administer the grow- ing number of externally supported development programs. The country's system of production incentives has been inadequate and budgetary management has had many shortcomings. The weaknesses of Nepal's public administration are perhaps most vividly reflected in the slow implementation of projects. Currently, some 1,300 projects are being executed and, much more often than not, actual performance, both in terms of physical progress and rate of fund utilization, falls far short of budgetary targets. The slow disbursement of funds for aid-financed projects has resulted in a large undisbursed balance amounting to nearly US$900 million by the end of 1984/85. iii. The emergence during the past three years of unsustainable budget and balance of payments deficits is in fact the cumulative result of many years of weak economic management. Until 1982/83 steadily growing budget deficits had been largely financed by aid flows; likewise, the worsening trade balance, a result of declining export surpluses and growing imports fueled by large public expenditures, had been offset by private transfers and concessional aid. Since 1982/83, however, heavy reliance on domestic bank financing has put strong pressures on the balance of payments, and the country has continued to lose foreign exchange reserves to the point where reserves have currently reached an unacceptably low level. iv. The need for corrective policy action is now critical. The Government recognizes this and over the past few months has begun to take some initial corrective steps. Thus for instance, in order to contain the growth of regular expenditures, it has been decided to grant no further salary increases to civil servants in 1985/86, and to reduce hiring. With respect to deveLopment expenditures, the Government intends to reduce budgetary allocations in 1985/86 by 10 percent across the board, and to make specific cuts for projects with 100 percent local financing by deferring the implementation of small locally-administered projects and cancelling others  -ii- having low priority, as well as cutting deveLopment grants to districts. Nevertheless, a much more comprehensive program to address both the short- term emergency and the medium-term stagnation must be adopted urgently.l/ In view of the low level of reserves, it is clear that the imbalances in the budget and in the balance of payments simply cannot be allowed to continue. Corrective action will require the implementation of a strict program to restrain demand and reduce excess Liquidity in the economy. However, in order to prevent an actual decline in Nepal's precariously low living levels as a result of a short-term stabilization program, as well as to Lay the basis for rekindling some growth over the medium term, it is equally impor- tant that measures to boost production, accelerate the implementation of aid-financed priority investments and increase the efficiency of government spending be adopted at the same time. The purpose of this report is to sketch the broad outlines of a possible approach, aithough it is recognized that more work is needed on the details of such a program. Economic Management Issues v. Economic management in Nepal suffers from many deficiencies, includ- ing poor budgetary policies, an inadequate system of production incentives and a variety of impediments to timely project implementation and utilization of foreign aid funds. Budgetary policies have been characterized by inade- quate revenue efforts in the face of rapidly growing spending, much of which has had limited economic benefits. The tax base is narrow primarily because of the tax-exempt status of major sectors of the economy. For all practical purposes the agricultural sector goes untaxed. The transport sector also is exempt from income taxes while industry receives wide exemptions under the Industrial Enterprise Act. In addition, personal income tax exemptions and deductions are very high. Imports and narrowly based sales taxes and excises provide the bulk of revenues. While the elasticity of the tax system is thus low, the fact is that frequent rate adjustments have led to a buoyancy of the system with respect to GDP of around 1.4. Even so the revenue effort has been far from sufficient given expenditure trends. The most important factor in the recent surge in current spending has been the rapid growth of civil service employment coupled with substantial wage and salary increases. Subsidies to often inefficient public enterprises have also grown quickly, while development spending has been spread too thinly over too many projects. Moreover, while spending for operations and maintenance has been much below needs, cost recovery has been very poor partly because of low service charges which have remained unchanged over the years and partly because of weak collection efforts. 1/ Since this report was finalized, the Government took some important stabilization measures which are described in a postscript to these Summary and Conclusions (see para. xxx).  -iii- vi. Foremost among the inadequacy in production incentives has been the lack of an active exchange rate policy. In spite of the slow growth of merchandise exports and import substitution activities over the years, coupled with rapid import growth the authorities did not make appropriate adjustments in the exchange rate. One sector which appears to have been especially hurt by declining price competitiveness is tourism. Also, while Indian rupee reserves were virtually depleted by June 1985, the Government continued to maintain a constant exchange rate between the Nepali and Indian rupees. In the agricultural sector, the Government's low crop support prices, particularly for foodgrains. set to assure low and stable consumer prices in food deficit and urban areas, have adversely affected producers and caused leakages of crops grown in the terai across the border to India. In addition, a lack of operation and maintenance activities has limited the potential returns on existing irrigation facilities. A general neglect of spending for operations and maintenance has, in fact, constrained the con- tribution to economic growth of a number of sectors such as the transport sector or tourism, the latter especially because of the run-down state of the national airline. Government services to promote production and exports are also seriously deficient; these range from basic support services for agriculture to storage, grading and marketing facilities for a number of export commodities. In the case of the latter, administrative procedures, such as licensing or documentation, in fact act as bottlenecks to exporting. vii. Delays in project implementation represent an enormous cost to the Nepalese economy not only because of cost overruns and delayed and reduced benefits, but also because almost 50 percent of aid flows cover local costs and thus provide free foreign exchange. The poor project implementation record in Nepal above all is a direct manifestation of the more fundamental and pervasive problem of inefficiency in the civil service. The efficiency of the public administration is constrained by the sense of insecurity sur- rounding managers in Government, whose real authority is severely circumscribed; assuming responsibility even for minor decisions, is widely perceived as more likely to entail risks than rewards. In addition, project implementation units are chronically understaffed because of a slow and cumbersome process of staff appointment/recruitment. Project managers do not control the appointment and transfer of staff, making it very difficult to extract good performance. Reform efforts in these areas have been defined in the past but have mostly not been acted upon. Additional obstacles to effec- tive project implementation are shortfalls in annual budgetary allocations, both because of inappropriate accounting practices and delays in the release of funds as well as because of the general shortage of budgetary resources, and because of the rudimentary state of the local construction industry. viii. The result of this ineffective economic management in Nepal is a stagnant economy which has failed to adjust to a changing internal and exter- nal environment; the failure to adjust has come to reveal itself in the current economic and financial difficulties. As a percentage of GDP the 1984/85 budget deficit exceeded 10 percent, domestic bank borrowing was close to four percent, the current account deficit in the balance of payments was  -iv- more than seven percent and gross official reserves had dwindled to less than two months of imports. A continuation of current trends would not only lead to a decline in living levels for what is already one of the pooresc countries in the world but would furthermore jeopardize prospects for a recovery in the medium term. Nepal simply cannot sustain its current level of per capita income and support a minimum level of essential and raw material imports without resorting to increased external borrowing or conces- sional aid flows. However, the country cannot afford to borrow on commercial terms and in order to lay claim to additional concessional foreign assistance above current levels, a significant change in the policy environment is necessary. To avoid the consequences of falling income levels and the risk of adverse poLitical and social repercussions, an economic stabilization and adjustment program must be put in place immediately. An Action Program ix. A program to restore financial stability in the short term through demand management complemented by a policy package to stimulate increased output responses over the medium term will have to comprise a wide range of macro-economic and sectoral measures; some can be taken almost immediately and are expected to yield quick results while others, though initiated now, will inevitably take time to exert their impact fully. Briefly, the required policy agenda for the short term includes the following: (a) public expendi- ture restraint measures focused primarily on the wage and salary bill and hiring practices; (b) concentration of development spending on the comple- tion of a "core program" of high priority ongoing projects and increased allocations for operations and maintenance (O&M); (c) adoption of a package of tax measures; (d) measures to promote both exports and efficient import substitution, including not only institutional arrangements to boost exports, but maintaining a real effective exchange rate which make Nepalese producers competitive; and (e) measures to speed up disbursements from the existing aid pipeline. The policy agenda over the medium term will have to focus on actions to stimulate supply and improve project implementation performance. They include: (a) agricultural programs concentrated on the terai and those select areas of the hills with high potential; (b) promotion of export- oriented cottage and small-scale industries and tourism; (c) creation of a planning and budgeting framework for operations and maintenance expenditures; (d) changes in personnel practices that directly affect project implementation; and (e) strengthening the local construction industry includ- ing training programs for artisans and mechanics. If the Government imple- ments a policy agenda along these lines and the donor community supports this by limiting the number of new projects, by efforts to accelerate the implementation of projects in the "core" program, and by the provision of quick-disbursing assistance, there is a good chance that the Nepalese economy can extricate itself from the current financial predicament and begin to make some progress towards the goal of raising the living levels of its people. x. More specifically, the main elements of an action program on the part of the Government in the areas of budgetary policies, production incentives,  v 1 and project implementation can be spelled out as follows. A reduction in the budget deficit and in turn, the need for bank borrowing is essential to restore financial stability in the short term and lay the conditions for uninterrupted growth thereafter. The first requirement is for a reform or the taxation structure to increase revenues and improve the elasticity of the system. There is a variety of measures which can be introduced relatively quickly since they do not require extensive administrative changes and foct's on those taxes where assessment and collection procedures are well in plate. The main 2mphasis of any reform must be on widening the tax base and rationalizing the structure. Foremost among the required tax reforms arP (a) a reduction in the levels of personal income tax exemptions and deductions; (b) elimination of differences in sales tax rates for domestic and imported goods, including differentials among imported goods by country of origin; (c) fuller coverage of sales taxes to include services such as eLectricity, telephone and telecommunication charges which are presently untaxed; (d) extension of excise taxes to imported goods; (e) reducing exemp- tion levels, updating valuations and increasing the coverage of property taxes to include hotels and industrial properties; and (f) rs sing agricul- tural land taxes. These measures would add an estimated seven percent to total tax revenues, Public revenue mobilization can be enhanced further by improvring cost recovery performance ir Gov.ernment-run services. Service charges, such as university tuition fees, which have remained unchanged for many years should be raised and revised at regular intervals. Special efforts must be made to improve collections especially of water charges in the irrigation sector which has shown the lowest cost recovery rates amoiag public services. xi. On the expenditure side the first priority is to bring regular expen- ditures and in particular its largest component, wages and salaries, under effective control. To do this, the Government must first severely restrict recruitment during the remainder of the decade. Vacancies in key positions should be filled by transfers of existing s:aff. Less important positions coild be abolished as they become vacant. Secondly, real increases in the civil service wage bill, including wage drift, should be kept under two percent during the next five years. In view of the large salary increases granted to civil servants in 1984/85, no further upward adjustments should be allowed over the next three years. Promotion policies should aLso be imple- mented within the framework of the two percent ceiling. xii. If the Government implements the tax proposals discussed above, public revenues should reach the equivalent of 10.2 percent of GDP on average during the next five years. Restraint in regular spending along the lines suggested would keep these outlays at around 7.3 percent of GDP, yielding a surplus available for financing development expenditures amounting to 2.9 percent of GDP. Given possible aid inflows as discussed below equivalent to around nine percent of GDP and in view of the need to limit domestic bank borrowing to pre-1982/83 levels of around 1 percent of GDP, this implies that development spending will have to be limited to around 12.5 percent of GDP on average during the next five years, down from 13.8 percent in the recent  -vi- past. The key consideration here is to strike an appropriate balance between completing ongoing projects, starting up new projects and intensifying opera- tions and maintenance activities. The Government has recently initiated a review process whereby some 60 high priority projects were selected fo. close monitoring. This process should be extended to cover all ongoing operations. The review should re-evaluate the returns to the economy of completing each project or program and decide which should be postponed, dropped, rephased or reduced in scope. This exercise will need to be conducted in consultation with donors in the case of aid-financed projects. The desirabLe avoroach would be to concentrate resources in accelerating the implementation ot investments that are reasonably close to completion and where the costs to the economy of delays would be serious, and on projects with high and early economic returns, particularly those supporting directly productive activities in the private sector. For projects in an initial phase of implementation, the Government should be prepared to defer or redesign all those where activities rely heavily on irfported inputs or incur a substantial increase in operations and maintenance coots without good prospects for cost. recovery. Having identified the "core projects", the Government should direct an all-out effort towards their early completion addressing bot- tlenecks that threaten to delay their implementation. If shortages in coun- terpart funding become a problem, the Government must quickly approach the concerned donor and work out different disbursement shares over the life of the project that would allow Nepal to put up lower shares during the adjust- ment period. Furthermore, in order to minimize procedural delays in the release of funds for donor-funded projects, the Government should make a more extensive use of special accounts or revolving accounts. Xiii. In the area of operations and maintenance expenditures, the incremen- tal funding needed for activities that are seriously underfunded and can realistically be carried out, is estimated at NRs. 3.1 billion over the period or close to 1i percent of total development spending. As additional projects are completed, the O&K requirements will increase proportionately. On the other hand savings can be achieved by a reduction in subsidies to public corporations. While waire studies a.- -eeded before necessary restruc- turing programs can be put into effect to increase the efficiency of these corporations, further action is possible in the short term in the area of pricing policies. Thus, for instance, public utilities can become self- reliant by implementing tariff revisions at regular intervals whiLe several trading corporations would generate profits if proper pricing policies are followed. xiv. Given all of the above only about five percent of the estimated total of development expenditures would be available for spending on new projects. This is all to the good, since the current capacity to prepare and implement new projecrt is severely limited. xv. Foremost among measures to boost uroduction is to maintain an appropriate exchange rate to foster exports as well as efficient import substitution. Among the industrial products with the greatest potential for  -vii- expansion are ready-made garments, carpets and handicrafts. In agriculture, foodgrains (wheat, rice and maize) and foodcrops such as sugar and oilseeds offer good prospects for increased output and substitution tnr imports. To realize the output potential of these products the Government will have to strengthen support services to small private producers, especially credit and marketing assistance. rn respect of exports there are several additional actions which must be taken. "Special Commodity Rate" air freight rates are available for exports of readv-made garments to the U.S. and of carpets to Europe, but the country has thus far taiLed to take advantage os these. Warehouse facilities at Kathmandu airport. where customs clearance takes place, can be expanded at very Little cost thereby avoiding damage to goods and consequent Loss of customers. In addition, some administrative bot- tlenecks to exporting can be alleviated quickLy: export licensing and documentation procedures can be streamlined to allow exporters to respond quickly to markets. Also, the export of minor agricultural products would be greatly facilitated by the introduction of quality control measures, and better storage and grading facilities. xvi. Under the present circumstances, the focus of the Government's economic adjustment program in agriculture should be on expanding output in the terai where a large part of the irrigation infrastructure is Located and other supporting services are more readily available. This does not mean that development of hill agriculture should not continue as a national priority. However, as a practical matter the best prospects for obtaining larger marketable surpluses of crops that can be exported profitably or can replace imports lie in the terai. Additional operations and maintenance work would lead to substantialLy higher returns from existing irrigation facilities. A key to expanding agricultural production is to ensure that crop prices in the terai are set at the same level as those in neighboring Indian states. In the tourism sector, the primary requirement, apart from maintaining an appropriate exchange rate, is to facilitate air access to Nepal. Improved air safety for the national airline, by obtaining a new servicing agreement with a major international airline, and allowing more international carriers through Kathmandu are essential. In addition, earn- ings per tourist can be increased by devising tour packages which entail a much wider coverage of cities and sites. xvii. An acceleration in the implementation of projects in Nepal is of major importance both to boost economic growth and to provide additional balance of payments support since almost half of aid flows cover local costs. While the growth benefits would only accrue in the medium term, it is impor- tant that remedial action be initiated now as many of the measures involve basic structural changes and will take time to bear fruit. Foremost among these changes is a reform of public administration practices and personnel policies that directly affect project implementation. It is crucial that implementation authority be decentralized and that the responsibilities of project managers be widened. At present, project managers are obliged to refer decisions on every aspect of project implementation to headquarters. Managers should, in particular, have more control over the appointment and  -viii- transfer of their staff and deputized staff should be made responsible to the project manager rather than to their previous departments; only in these conditions can staff performance be expected to improve. Staff turnover should be reduced to ensure greater continuity at the project site: key staff should remain at one post for at least three years. Project managers should have a major input in determining wage incentives for field staff and disciplinary action must be taken against those who faiL to report to their posts in the field. The Government might also seriously consider hiring qualified private sector individuals on a contract basis to be funded bv donors, especially tor remote pusts where it is ditficult to retain civil servants. xviii. To the extent that a generalized shortage of local counterpart funds delays project implementation, only an improvement in the Government's over- all budgetary position can resolve the issue. While, as was mentioned before, in the case of foreign-assisted projects, it is possible for the Government to approach a donor and work out a new disbursement schedule to reduce Nepal's share of the costs during the earLy years, this is clearly only a temporary solution. On the other hand, there are often delays in the provision of funds to projects for procedural reasons and these must be remedied separately. For instance, the problem of inadequate budgetary allocations to individual projects must be solved by instituting a system of budgets on a project-by-project basis, which as a first step will require better accounting practices. The Government should also seriously consider dropping the requirement that funds be released only upon reimbursement by foreign donor agencies; the resulting cash flow problems can be much reduced through the use of special accounts. On the other hand, it would not be appropriate to relax the second condition for the release of such funds, i.e., timely submission of up-to-date expenditure accounts; here, in fact, better accounting practices are needed. xix. Since the Government is the principal source of demand for construction, itself executes much of the work and also regulates the industry, it can play a critical role in strengthening the local construction industry. Policy measures that can have a significant impact include the following. (a) To supplement the formal training at the Institute of Engineering, which is the major supplier of engineers and artisans, the Government should organize (informal) training programs to upgrade skills of existing construction manpower. (b) In order to assess the "real" competence of contractors and their suitability for a particular contract, the Government will need to replace the present system of registration and categorization by one which requires periodic registration renewal and re-categorization on the basis of an individual contractor's demonstrated performance.  -ix- (c) Prompt decisions should be made in awarding contracts; also they should provide for full adjustments for price increases due to delay in decision of awards as well as for general price escalation. (d) Given the shortcomings of domestic contractors. the Government should continue its approach of slicing and packaging civil works, but shouLd ensure that the work is confined to one season for completion so as to avoid interrupticns by monsoon and labor shortage during harvest time. (e) In order to improve the timely availability of equipment in the Government pool, and upgrade the level of maintenance, top priority must be given to preparing an inventory of all con- struction equipment in the country; assessing the demand for such equipment over the medium term; preparing an inventory of spare parts and project future needs for their steady supply; and undertake on-the-job training of mechanics in basic main- tenance skills. (f) To improve the liquidity position of the contractors, the Covernment needs to reduce the bureaucratic layers of clearance so that contractors' bills are promptly paid. (g) Recognizing the limitations of creditworthiness of the Nepalese contractor and the poor credibility of his collateral, the Government will need to relax the current credit conditions. One approach is to aLlow commercial banks to lend to contractors upon fulfillment of conditions similar to those used in pre-qualifying contractors for awarding contracts, and the loan can be secured by 100 percent of the payment for the work. (b) In t.;. short to medium term. Nepal will continue to rely on imports for essential building materials. The only approach to the current problem of erratic supplies is to institute better planning for importing materials, phasing it over peak and low periods of demand and to improve the timeliness of distribution. The Government must also allow the private sector a larger role in the procurement and distribution of raw materials. XX. The responsibility for designing and implementing the various ele- ments of the action program discussed above rests squarely with the Government. Even so, a program of this nature is unlikely to succeed without substantial cooperation and financial support from the donor community. The current difficult economic situation calls for a re-definition of the role of foreign assistance with a view to enhancing its effectiveness, in particular for a re-orientation in the approach of donor agencies from emphasis on  project financing to non-project lending. This includes a re-evaluation together with Government of ongoing projects, larger provisions for balance of payments support, increased funding of operations and maintenance activities and realism in the design of new projects. xxi. The bulk of development expenditures during the next five years are expected to cover ongoing projects. Under the circumstances, donor efforts should be directed at helping the Government complete these activities. Yet, given the enormous backloe of foreign-financed projects and the burden of counterpart funding, it is vital that each donor agency, in cooperation with Government, take a critical look at its ongoing projects. re-evaluate the returns to tne economy of completing each project and decide which should be postponed, dropped, rephased or reduced in scope. Having decided on which projects should be continued, every donor should then make an all-out effort towards their early completion, increasing the frequency of supervision missions, increasing the number of (donor-financed) field staff and hiring local staff on contract to accelerate implementation. xxii. If the Goverrment genuinely commits itself and implements a stabi- lization and adjustment program, donors should be prepared to support the action program by providing a higher proportion of their current level of assistance in tile form of quick-disbursing aid. Government efforts at increasing agricultural production will give rise to increased demands for imported agricultural inputs, such as fertilizer and chemicals; improved maintenance of roads, buildings and irrigation canals will require more imported machinery, equipment and spare parts and a variety of construction materials; expansion of cottage and small industry production of garments and carpets will generate an increased demand for imported wool and fabrics. Vital to the success of these efforts is increased commodity assistance, to be seen not merely as a resource transfer but as the donor community's sup- port for the economic reforms. xxiii. Several donors finance O&M expenditures of completed projects financed by them under subsequent phases of their assistance programs and undertake rehabilitation of facilities which had deteriorated in the absence of adequate maintenance. The practice of funding O&M expenditures under project assistance should continue, at least as long as the present budget crisis persists. At the same time, it is important that donors and Government work out in advance an orderly schedule for phasing out this type of assistance. To ensure that foreign assistance will not continue to finance O&M expenditures indefinitely, donors should help the Government formulate cost recovery measures in those sectors where they provide O&M funding and insist on their strict implementation. At the same time, donors may consider financing free standing maintenance projects in sectors such as roads or irrigation. Furthermore, in sectors such as health and education, donors may wish to consider financing onLy recurrent expenditures, i.e., medical supplies, text books and even staff salaries, in order to improve the capacity utilization of existing facilities.  -xi- xxiv. Even though short-term concerns for budget and balance of payments support are likely to preoccupy poLicy makers for the next few years, both the Government and donors must not lose sight of the longer-term objective of accelerated economic growth. While financial resources for starting new activities during the Seventh Plan period will be severely, but justifiably, constrained, the Government will need to continue to undertake a selected number of new development projects designed to broaden the export base of the economy and to expand productive capacity. The donor community will continue to play a major role in this effort. in designing new projeccs, however. there are two important consideracions to be kept in mind: first, the cech- nical design of projects should be kept as simple as possible for ease of implementation, and second, projects must be designed so as to minimize future O&M requirements. xxv. If the action program, supported by the donors, takes hold, we can expect a modest upward shift in Nepal's growth path and a distinct improve- ment in the budget and the balance of payments. Specifically, we envisage GDP growth to rise to 3.8 percent per year, thus allowing for some growth in real per capita incomes. As compared with the past, total investment would grow at a much slower rate, reflecting the underlying assumption that growth over the next few years must come primarily from increased efficiency in the use of existing capacity. With the revenue and expenditure policies dis- cussed above in place, the overall budget deficit as a share of GDP would decline from almost 11 percent currently to nine percent by 1989/90. Ezports are expected to grow at 5.2 percent per annum in real terms versus a 4.2 percent per annum real growth in imports. The recent deterioration in the balance of paynents reflected in growing current account deficits and declin- ing reserves would be halted and reversed; as a share of GDP the current account deficit over the next five years would decline gradually from about eight percent during the next couple of years to less than seven percent by 1989/90. At the same time the country would be able to raise its gross official foreign reserves from one-and-a-half months' imports in August 1985 to a more comfortable level of three months in about two years. xxvi. If such an action program cannot be implemented, Nepal's growth rate is likely to fall below the present already unsatisfactory levels. The combination of growing budget deficits and insufficient growth in output cannot continue for much longer as the country is rapidly depleting its international reserves. xxvii. The donor community has a vital role to play if the success of the Government's program is to be ensured. Two key considerations underlie an external financing strategy for Nepal. First, the current budgetary and balance of payments difficulties are expected to persist beyond the short term. Second, with the undisbursed aid balance estimated at around US$900 million Government and donors should embark on new projects selectively. In 1984/85 new aid commitments totaled about US$300 million. It is envisaged that during 1985/86 about US$300 million worth of new aid will again be committed, about US$250 million in project aid and US$50 million in quick-  -xii- disbursing assistance. It is estimated that a yearly level of new commit- ments of about $300 million is appropriate during the next few years. New commitments of project aid should r3t exceed about $200 million per year, given the country's absorptive capacity constraints. On the other hand, if Nepal begins to implement an action program along the lines discussed above, but not before, the country would merit an infusion of quick-disbursing commodity assistance to help defray the transitional costs of the adjustment program. It is estimated that a LeveL of about $100 million per vear in program assistance (whicn disburses tullv in one to three years) wouid be needed beginning in FY1986/87. x=viii. An integral part of the Government action program would be initia- tives aimed at accelerating the reLease of funds which would lead to a 10-15 percent improvement in aid disbursements over the past. In these conditions including the availability of quick-disbursing assistance, aid disbursements would increase from $230 million in 1985/86 to $325 million in 1989/90, wiith the result that the undisbursed balance would increase only marginally in nominal terms during the next five years and decline in real terms. The grant element of new aid commitments should be increased over that of the past two to three years, with grants accounting for about 45 percent of totaL commitments and concessional loans for the remaining 55 percent. The debt service ratio is expected to remain around seven percent over the five-year period and rise to about nine percent by the middle of the next decade. xxix. The most crucial aspect of the action program and growth scenario presented above is that Government begins to implement the necessary struc- tural changes. Once this process is started donors must respond appropriately. Failure of the donors to provide increasing levels of com- modity assistance in support of a well prepared and seriously implemented Government program would mean a further deterioration in the internal and external accounts and a further impoverishment of the Nepalese people. Postscript xxx. At the end of November 1985 the Nepalese Government took several economic policy measures designed to stabilize the economy. Effective November 30, 1985, the exchange rate of the Nepal Rupee was devalued from 1.45 to 1.70 per Indian Rupee and from NRs. 17.50 to NRs. 20.50 per US$. At the same time, the Government announced its decision to put in place a finan- cial stabilization program as part of a proposed 13 month standby arrangement with the International Monetary Fund. Major features of the program are: (a) the maintenance of a flexible exchange rate policy; (b) restraints on public regular and development expenditures; (c) strengthened tax administra- tion so as to help reduce the budget deficit; (d) restraint on domestic credit creation, especially bank credit to the public sector; (e) maintenance of key bank deposit rates at positive real levels; (f) increases in public enterprise prices and a reductiun in their subsidies; (g) restraint on com- mercial external borrowing; (h) increased licenses for commercial imports;  -xiii- (i) abolition of the 10 percent cash subsidy on exports; and (j) a number of procedural and institutional reforms liberalizing and rationalizing the trade and exchange system. While it would be premature to attempt to assess the impact of these measures at this point, they clearly constitute a major first step towards stabilization and eventual revitalization of the Nepalese economy.  PART I: MANAGING ECONOMIC ADJUSTMENT IN THE SHORT TO MEDIUM TERM Chapter I: RECENT ECONOMIC DEVELOPMENTS A. Introduction 1.01 Three decades of development efforts, supported by growing foreign assistance, have brought little improvement in the lives of most Nepalese people. Today, Nepal is still one of the poorest countries in the world with per capita income estimated at only US$170 (1983). Since the early seventies, rapid increases in population have virtually offset real GDP growth. Agricultural production has continued to stagnate, and the pressure of population has resulted in a serious degredation of the fragile hill environment. A low adult literacy rate (19 percent), low average life expec- tancy (46 years) and high infant mortality (about 150 per thousand) indicate the extent of deprivation of basic needs. 1.02 While part of the explanation for past stagnation lies in factors beyond Nepal's Lontrol, such as the country's difficult terrain and landlocked position and its poor natural resource base, weaknesses in public administration and poor economic management are also equally relevant. The Government's limited capacity to administer its expanding deveLopment programs is most clearly reflected in slow implementation of projects. The country's system of productive incentives has been inadequate, and the budgetary management has had many shortcomings. The emergence of serious budget and balance of payments problems in the past three years is also the cumulative result of at least a decade of poor economic management. In the remainder of this chapter, we will briefly describe major developments in the Nepalese economy in recent years, focussing primarily on the deteriorating balance of payments and budgetary situation. B. GDP Growth and Sectoral Developments GDP Growth 1.03 Nepal's economy is dominated by developments in the agricultural sector which contributes about 60 percent of GDP, 75 percent cf exports and 90 percent of employment; industrial activity accounts for about 10 percent of GDP, and services make up the remaining 30 percent. During the 1982/83-1984/85 period, Nepal achieved an annual real GDP growth rate of 2.9 percent (against an annual average population growth of 2.7 percent), with the agriculturaL sector growing at 2.5 percent and the non-agricultural sectors at 3.4 percent. Closer inspection reveals large year-to-year fluc- tuations in growth resulting from the strong influence of the weather on the country's predominantly rainfed agriculture. A severe drought in 1982/83 caused a 2.5 percent drop in agricultural output, a virtual stagnation in non-agricultural activities and a 1.4 percent decline in real GDP. The economy rebounded in 1983/84 thanks to a strong recovery in agricultural production, but the return of poor monsoons once again dampened growth of agricultural output and real GDP in 1984/85. Over the 1970/171-1984/85  -2- period, real GOP growth averaged 2.8 percent per annum and barely kept pace with the population growth of 2.7 percent. Agricultural output increased at 1.5 percent annually (see Table I-1). This relatively poor long-term agricultural performance is explained by a virtual stagnation in output during 1970/71-1979180. However, agricultural growth accelerated thereafter, improving to 3.2 percent p.a. during the Sixth Plan period.l/ Table I-1: HISTORICAL CDP GROWTH (Percent Per Annum in 1974175 Prices) Averate Annual &rowth __ 1970/71-1984/85 1980181-1984185 al 1982183-1984/85 1982/83 1983/84 1984/85 (Sixth Plan Period) Agriculture 1.5 3.2 2.5 -2.5 8.7 2.5 Non-Agriculture 4.9 3.7 3.4 0.4 5.5 3.4 CDP 2.8 3.4 2.9 -1.4 7.4 2.8 -Percent Per Annum Population Growth 2.7 2.6 2.6 2.6 2.6 2.6 Estimates */ 1979/80 was a particularly poor year, agriculturally. Hence the base year figures for the Sixth Plan period were normalized by caking thi' average values for 1978/79, 1979/80 and 1980/81. Source: Ministry of Finance, Economic Survey, nany years. 1/ Since 1979/80 was an exceptionally poor year for agricultural output, the base year figure for the Sixth Plan period was "normalized" by taking the three-year average agricultural value added for 1978/79, 1979/80 and 1980/81.  -3- Developments in Selected Sectors 1.04 Agricultural output, as noted above, rebounded strongLy in 1983/84 from the drought induced decline of the previous year, and some of the momen- tum carried over into 1984/85 despite the return of poor monsoons. However, production gains in food crops, which account for as much as 70 percent of cultivated land, were realized largely by extending the area under cultivation: average yields have remained stagnant or declined over time. and foodgrain output has grown at onLy one percent annuallv during 1974/75-1984/85. Herein lies the fundamental problem facing NepaL's agricul- ture today; the low productivity of foodgrain producing areas has meant that the needs of the country's rapidly growing populacion for food had to be met by clearing forests and extending cultivation to marginal lands, and this has, in turn, led to even lower average yields. (See Table I-2). These average yield figures, of course, give no indication of the wide differences in the population density and agricultural productivity that exist between the hills and the terai. Over the years, per capita production in the hill areas has declined in absolute terms, reducing the real incomes of the two- thirds of the country's population that live there, and speeding up migration to the terai which offers better opportunities and potential for increased crop production. On the other hand, cash crop production has expended at 3.3 percent p.a. over the past ten years. Two factors have been responsible for the relatively favorable performance of cash crops. First, cash crops are grown largely in the terai, where farmers have better access to credit, agricultural support services and markets. Second, the prevailing price relationships have favored the production of cash crops relative to foodgrains. The long-term stagnation of the agricultural sector as a whole (1.5 percent p.a. during 1970171-1984/85) relative to higher population growth (2.7 percent) has resulted in a decline in per capita food availabilities and exportable food surpluses.  -4- Table I-2: AGRICULTURAL PRODUCTION Percentage Changes --- Annual Percentage Changes ---- 1974/75- 1974/75 1984/85 1981/82 1982/83 1983/84 1984/85 (Base Year) Foodgrain a/ Area (ha) 2,141,332 1.4 2.0 0.6 3.7 4.3 Index Production (mt) 3.775,208 1.0 3.8 -23.0 39.4 -1.5 YieLd (mt/ha) 1.8 0.9 1.9 -24.0 34.4 -5.6 Cash Crops b/ Area (ha) 221,876 1.4 18.7 -17.0 -2.6 8.9 Index Production (mt) 670,901 3.3 13.6 10.4 -1.9 7.4 Yield (mt/ha) 3.0 1.9 -4.3 32.9 0.7 -1.3 a/ Includes paddy, wheat, maize, barley and millet. bi Includes sugarcane, oilseeds, tobacco, jute and potato. Source: Ministry of Finance, Economic Survey, 1985 1.05 Progress has also remained slow in the forestry sector. Under its many afforestation programs, the Government has achieved annual planting rates estimated between 2,500 to 5,000 ha. over the last few years, but this is grossly inadequate relative to the scale of current environmental degrada- tion and the country's longer-term requirements. A forecast of future fuel demand in the 1983 UNDP-World Bank energy sector report 1/ calls for the annual planting rate to reach 50,000 ha. by 1990 and an average of 100,000 ha. during the 1990s. The Government also recognizes the magnitude of this environmental crisis and the groundwork is being laid gradually for more extensive and effective resources management and afforestation, includ- ing a greater emphasis on more community involvement in planning and implementation. The problem is one of phasing and scale: Nepal just does not now have the infrastructure and institutional capacity to support large scale resource management and development programs, and institution building is a lengthy process. 1.06 Nepal's industrial sector is small. Its output comprises consumer goods (footwear, textiles, processed foods), construction materials and simple assembly items. Within the formal sector, larger-scale manufacturing is undertaken by public enterprises in or near Kathmandu Valley. Private 1/ Nepal: Issues and Options in the Energy Sector (Report of the Joint UNDP/World Bank Energy Sector Assessment Program), August 1983.  -5- investment is concentrated in small and cottage industries. Outside Kathmandu, industrial production occurs almost exclusively in cottage industries which service the rural subsistence economy, providing woolen and cotton handloom textiles, food products, forest-based and simple metal products. Progress in import substitution of manufactured goods has been hampered by Nepal's proximity to India; the long, porous border with India makes it difficult for Nepal to procect its "infant industries" from competi- tion with goods from India's more developed industrial sector. Similarly, India's relatively develuped industrial base Limits India as a potential market for Nepal's industrial exports. However, in recent years, the country has had considerabLe success promoting the export of ready-made garments and carpets, the output of cottage and small industries, to third country markets. The share of cottage and small industry products in total merchan- dise exports has grown from less than one percent in 1981/82 to 27 percent in 1984/85. 1.07 Total installed electricity generating capacity expanded from 138 MW at the end of 1982 to 172 MW in mid-1985, and consumption grew at an average rate of 12 percent per annum. The reliability of electricity suppLy has vastly improved since the 60 MW Kulekhani hydroelectric generating station was commissioned in December 1982: extensive load shedding which occurred prior to the commissioning of the station has virtually ceased. Despite the ongoing programs to extend and improve the metering system, electricity losses, estimated at 30 to 35 percent of total generation, still remain a serious problen that adversely affects the financial position of the Nepal Electricity Authority. The rapidly growing system calls for greatly improved maintenance (particularly preventive maintenance) and more intensive training of operations and maintenance (OEM) personnel. In road transport, the groundwork for a basic road network has been established with the completion, during the past year, of arrangements for the construction of the last por- tion of the East-West Highway. Ac the same time, there continues to be a lack of proper maintenance of the existing road network. In civil aviation, Royal Nepal Airline Corporation (RNAC) has extended its services to 38 points in the country and ten major cities in nine Asian countries during the past five years. However, maintenance is also a major bottleneck here. The growth of air traffic has been slowed by the frequent grounding of older aircrafts in the company's fleet; in 1985, RNAC is reported to have discontinued its aircraft servicing agreement with a major international airline. 1.08 Inadequate funding of O&M requirements has also been hampering progress in the social sectors. To cite an example in the education sector, the rapid expansion in enrollment in primary and secondary schools 1/ has had little impact to date on improving the literacy rate which remains among the 1/ By 1984/85, Nepal has achieved a total primary school enrollment rate of about 80 percent and secondary school enrollment rate of about 20 percent.  -6- lowest in south Asia. The reason is that while the Government established many new schools and enrolled a great number of new students, it has failed to meet the rapidly growing demand for properly trained teachers, appropriate teaching materials, relevant and well thought out curricula and proper school buildings. This has resuLted in the poor quality of instruction and high dropout rate. Furthermore, despite the recognition by the Government of the need to contain population growth, its famiLy planning programs have not yet significantly affected the country's fertility rate. The Government's efforts to improve the utilization of its existing family planning and mater- nal and child health (FP/MCH) service facilities have been hampered by the lack of recurrent funding (e.g.. shortages of drugs) and poor management (e.g., frequent absences of appointed staff). Further extension of the FP/MCH service delivery is rendered difficuLt by absorptive capacity problems in the sector, as evidenced by the limited availability of trained personnel and organizational weaknesses in the concerned agencies. C. Fiscal and Monetary Developments Budgetary Trends 1.09 The rapid increases in public outlays during the Sixth Plan period (1980/81-1984/85) far outstxipped the growth of revenues, progressively reducing revenue surpluses and widening overall deficits. This was essen- tially a continuation of a fiscal trend that started in the mid seventies. The result has been an increased recourse to domestic bank financing which proved to be highly expansionary: i. led to 3trong demand pressures reflected in rising domestic prices and a deterioration in the balance of payments position.  -7- Table I-3: CENTRAL GOVERNMENT BUDGETARY PERFORMANCE (In NRs. Million) Revised Budget Estimate Estimate 1980/81 1981/8: 1982/83 1983/84 1984/85 1985/86 Revenue 2402.0 2667.6 2807.6 3342.3 3960.5 5385.2 Tax Revenue 2042.0 2218.3 2430.2 2751.6 3273.0 4284.1 Non-Tax Revenue 360.0 449.3 377.4 590.7 687.5 1101.1 Regular Expenditure a/ 1349.8 1626.3 1993.7 2273.6 2984.1 3989.7 Revenue Surplus b/ 1052.2 1041.3 813.9 1068.7 976.4 1395.5 Development Expenditure and Net Lending 2726.0 3723.2 4951.3 5096.6 5443.6 7356.6 Development 2731.2 3726.8 4982.0 5163.7 5527.6 7486.4 Net Lending -5.2 -3.6 -30.7 -67.1 -84.0 -129.8 Overall Balance (Gross) c/ -1673.8 -2681.9 -4137.4 -4027.9 -4467.2 -5961.1 Overall Balance (Net) d/ -1587.5 -2578.1 -4043.8 -3861.4 -4298.8 -5653.1 Financed by: Foreign Financing (Net) official Grants 868.9 993. 1090.2 876.6 1097.5 1924.7 Met Loan Disbursements 662.2 697.5 946.2 1600.1 1603.9 2452.5 Gross Loan Disbursements 693.3 729.9 985.7 1670.9 1701.9 2617.5 Repayments e/ 31.1 32.4 39.5 70.8 98.0 165.0 Domestic Borrowings (Net) ;6v4 887.3 2007.4 1384.7 1597.4 1298.9 Memo Items OveralL Deficit as X of GDP f/ 5.8 8.5 12.0 10.1 10.3 13.0 Revenue Surplus as Z of GDP 3.9 3.4 2.4 2.8 2.3 3.2 Domestic Borrowings as Z of GDP 0.) 2.9 6.0 3.6 3.8 3.0 a/ Loan repayments are included under regular expenditures. b/ Revenues minus regular expenditures. c/ Includes repayment of loan principal. d/ Excludes repayment of loan principal. e/ From Ministry of Finance: Budget Speech, several years. f/ Net deficit, i.e. excluding repayment of loan principal. Source: Ministry of Finance, Economic Survey, 1985  -8- 1.10 During 1980/81-1981/82, regular expenditures grew at 22 percent and development expenditures at 35 percent. In 1982/83, government relief measures necessitated by the drought (i.e., distribution of foodgrains to deficit areas, distribution of improved seeds and fertilizers as well as installation of shallow tubewelLs for the crash winter wheat program) sus- tained this spending momentum. With revenues increasing by only five percent that year, the budgetary deficit soared from six percent of GDP in 1980/81 to 12 percent in 1982/83. (See Table 1-3.) The economy rebounded the following year, and the recovery in revenue growth coupled with expenditure restraint helped secure higher revenue surDluses for the Central Government budeet in 1983/84 and 1984/85. 1.11 It should be noted that the expenditure restraint during the past couple of years was concentrated on development outlays which increased by only 3.4 percent in 1983/84 and seven percent in 1984/85; the slow growth has largely been the result of cutbacks or postponements in Government financed development projects, but delays in the implementation of aid-financed projects and reduced funding for O&M 1/ also contributed to lower development spending during these years. 1.12 On the other hand, regular expenditures continued to rise, growing by 14 percent in 1983/84 and 31 percent in 1984/85. Critical to the surge in regular expenditures has been the steady three percent annual growth in civil service employment since 1980/81 coupled with a 35 percent general civil service salary increase and an additional 30 percent salary increase for teachers, both of which became effective during 1984/85. An added category of regular expenditures that has shown significant growth during this period is subsidy payments to public enterprises. The Government provides a direct transport subsidy to the Agricultural Inputs Corporation (AIC) for distribut- ing fertilizers and improved seeds to remote parts of the country. In addi- tion to this directly budgeted subsidy, the Government provides two forms of indirect subsidies to public enterprises, i.e., interest-free loans for covering operating losses mostly to trading corporations, the bulk of which are not repaid, and additional equity investment in some of the more finan- cially troubled enterprises to help stem decapitalization. 2/ Also con- tributing to the rapi:i growth of regular expenditures are interest payments on foreign and domestic debt which have soared from 10 percent of regular expenditures in 1980/81 to 17 percent in 1984/85. This rising share of interest payments reflects the progressively higher levels of budgetary deficits in recent years. Left unchecked, this process will feed upon itself and eventually necessitate a draconian cutback in total expenditures. 1/ Operations and maintenance activities are included in development expenditures. 2/ The Government's equity investments in public enterprises are generally classified under development expenditures.  -9- 1.13 Overall budgetary deficits widened from the equivalent of six percent of GDP in 1980/81 to 12 percent in 1982/83, and remained thereafter at around 11 percent. Gross disbursements of foreign grants and loans have on the average accounted for 50 percent of development expenditures during this period; as a share of CDP, gross aid disbursements increased just slightly from six percent in 1980/81 to seven percent in 1984/85. SimultaneousLy, net domestic borrowings 1/ have grown dramatically! rising as a share of GDP from 0.2 percent in 1980/81 to three percent in 1984/85. 1.14 The 1985/86 budget estimates, presented to the Rastriya Panchayat on July 9, 1985, are shown in Table 1-3. The budget calls for 34 percent growth in regular and 35 percent growth in development expenditures. The budget also estimates a 35 percent increase in revenues, an unrealistic target when judged against the limited new tax measures introduced in 1985/86. (See para. 1.15 below). The overall budgetary deficit, according to budget estimates, would widen further from 11 percent of GDP in 1984/85 to 14 per- cent of the official 1985/86 GDP estimate. 1.15 Essentially, the budget estimates represent an untenable fiscal scenario. While recognizing the need to step up domestic resource mobi- lization over the medium term, the Government nevertheless failed to put together a package of measures for the 1985/86 budget that would sig- nificantly broaden the tax base. The discretionary tax measures adopted in 1985/86 consist mainly of minor adjustments in existing tax rates and the introduction of revenue stamp duties; 2/ their contribution to revenue mobi- lization is expected to be rather limited and fall significantly below budget estimates. The Government also hopes to raise additional revenues through improvements in tax administration such as the introduction of a dual point 1/ Since loan repayments are included as expenditure items under regular expenditures under Nepal's budget classification, financing items are shown in terms of gross disbursements. 2/ New tax measures introduced in 1985/86 include the following: -- a new revenue stamp tax on sales receipts of selected commodities and services; -- revision of import duties, e.g., lowering of duties on kerosene, an increase in duties on cement and coal; -- increases in vehicle tax; -- revision in excises, e.g., introduction of new excises on wine and cider, increases in rates on cement and liquor, and a shift from specific to ad valorem rates for some products; -- introduction of a new system of tax credits with respect to sales tax paid by industrial enterprises. The Government also announced the sale of government equity in public enterprises as an additional "incidental" measure.  -10- sales tax collection system, 1/ and sales of government held shares in public enterprises. 1.16 In order to contain the growth of regular expenditures, the Government has decided to grant no further salary increases to civil servants in 1985/86, and to reduce hiring. In addition, it has deferred purchases of some real property and suspended the voluntary retirement program under which civil servants were provided financial incentives to retire. With respect to development expenditures. the Government incends to reduce budgetary alloca- tions by 10 percent across the board. and to make specific cuts for projects with 100 percent local financing by deferring the implementation of small locally-administered projects and cancelling others having low priority, as well as cutting development grants to districts. The Bank staff estimates that, if the Government is successful in enforcing these measures, the nominal rate of growth of regular expenditures can be contained at 10 percent in 1985/86, and that of development expenditures at around 15 percent. This would reduce the overall budget deficit to 10 percent GDP from the budget estimate of 14 percent. 1/ In mid-July 1985, the sales tax became payable at customs points on imported raw materials and intermediate goods, and payments could be credited against sales taxes payable at production points.  -ll- Chart 1: FACTORS INFLUENCING DOMESTIC PRICE MOVEMENTS * 40- 30 Change" In Money Supply c 20 -- FoDmrnMl PrkModuct Indc U 0-30 S * 2 0 3 Doomestin Pridc Indemen 0 3 1981/82 1982/83 1983/84 1984/85 Fical Year  -12- Inflation, Domestic Credit and Monetary Expansion 1.17 The annual rate of inflation (as measured by the GDP deflator) rose from seven percent in 1981/82 to 13 percent in 1982/83 primarily as a result of the drought induced decline in foodgrain supplies which also necessitated emergency expenditures, a rapid increase in credit to the Government and an acceleration in the growth of money supply. As the economy recovered in 1983/84, the budgetary situation improved, thus reducing the growth of bank credit to the Government. The turnaround in agriculture eased the foodgrain supply situation. This Led to a decline in the domestic inflation rate to six percent that year. For 1984/85 as a whole, the economy exhibited a moderate trend in prices, with the average annual rate of inflation estimated to have remained around six percent. Table I-4: FACTORS AFFECTING CHANGES IN MONEY SUPPLY (Annual Percentage Changes) Mid-July 1980/81 1981/82 1982/83 1983/84 1984/85 a/ Broad Money 19.3 18.2 23.7 13.4 16.8 Money 13.3 12.6 20.4 13.4 li.9 Quasi Money 26.3 24.1 26.7 13.3 21.1 Net Foreign Assets 8.2 28.3 -15.7 -2.7 -29.4 Domestic Credit 19.9 17.1 40.5 15.7 24.9 Claims on Public Sector 12.7 31.3 80.1 14.5 26.8 Claims on Government 0.3 63.3 98.4 23.0 27.9 Claims on Public Enterprises 34.9 -11.3 35.4 -16.1 20.7 Claims on Private Sector 25.8 6.4 3.9 17.7 22.0 a/ Preliminary. Source: Ministry of Finance, Economic Survey, 1985 1.18 Particularly starting in 1982/83, the public sector's extensive recourse to the banking system not only led to inflation but also resulced in a substantial reduction in net foreign assets. The growth of total domestic credit more than doubled to 40 percent in 1982/83. Credit to the Government and public enterprises increased by 98 percent and 35 percent, respectively. The heavy borrowings by the public sector led to the crowding out of credit to the private sector. Net foreign assets of the banking system declined by 16 percent. In 1983/84, the recovery of the economy and some relaxation of credit controls on non-essential imports caused claims on the private sector to grow by 18 percent. On the other hand, the growth of net credit to the  -13- public sector slowed, thanks to improvements in the budgetary situation. As a result, total domestic credit growth was more or less in line with the demand for broad money and net foreign assets declined marginally. In 1984/85, the Government further relaxed credit controls, causing a rapid expansion in domestic credit and money supply. Domestic credit growth rose to 25 percent. Buoyed by credit demand from both the Government and public enterprise, the rate of growth of credit to the public sector nearly doubled to 27 percent: private sector credit growth also increased to 22 percent. This expansion in net domestic credit resulted in a 17 percent growth in broad money, and while not reflected in accelerating inflation, led to a substantial deterioration in the balance of payments and a large 29 percent decline in net foreign assets. 1.19 On the policy front, the Government took a number of measures during 1984/85 to promote savings through the financial system and to increase competition among commercial banks. Firstly, the Government introduced a more flexible interest rate policy by allowing commercial banks to raise savings deposit rates by up to 1.5 percentage points and term deposit rates by up to one percentage point above the minimum deposit rates. Secondly, to facilitate the channeling of resources to the rural sector, the Agricultural Development Bank of Nepal, the most important source of institutional finan.e for agriculture, was authorized to accept deposits in urban areas on the same basis as commercial banks, and to float agricultural savings certificates with maturities of six and nine months and with a tax-free yield of 10 percent. Thirdly, the first commercial bank founded jointly by foreign and domestic entrepreneurs commenced operaticns in 1984/85 and negotiations are underway for the establishment of two other such banks. D. Management of External Payments Balance of Payments 1.20 Nepal's balance of payments deteriorated sharply during the last three years resulting in substantial losses in foreign reserves: US$49 million in 1982/83, US$9 million in 1983/84, and an estimated US$47 million in 1984/85. This deteriorating external payments position is a reflection of the steady worsening of the country's trade balance which had started a number of years earlier. During 1975/76 - 1984/85, merchandise exports, constrained by the declining supply of agricultural surpluses, grew at only five percent per annum (in current US dollars), while merchandise imports, fueled by rapidly rising public investment expanded twice as fast, at 11 percent per annum. This led to the progressive widening of the deficits on the trade account. Notwithstanding the steady increases in non-factor serv- ice receipts (primarily tourism incomes), the current account deficit rose rapidly from one percent of GDP in 1975/76 to 7.2 percent in 1984/85. Nevertheless, until 1982/83, foreign aid flows had been more than adequate to offset the growth in the trade and current account deficits, and the country had built up total gross international reserves equal to seven to eight months of import coverage.  -14- Table I-5: BALANCE OF PAYMENTS SUMMARY (USs Million in Current Prices) Preliminary 1980/81 1981/82 1982/83 1983/84 1984/85 Exports (GNFS) 293.6 277.6 250.4 303.5 306.0 Merchandise f.o.b 134.4 115.6 82.3 123.9 155.4 N.n-factor Services 159.2 162.0 168.1 179.5 150.6 Imports (CNFS) 446.4 450.5 521.6 551.3 515.3 Merchandise c.i.f 370.2 382.5 459.0 473.6 445.7 Non-factor Services 76.2 68.0 62.6 77.7 69.6 Resource Gap 152.8 172.8 271.2 247.8 209.3 Net Factor Income 10.1 12.5 13.0 0.1 0.0 Factor Receipts 13.3 15.2 14.7 7.1 11.5 Factor Payments 3.3 2.7 1.7 7.0 11.5 Net Current Transfers 46.4 40.6 41.7 50.2 41.7 Transfer Receipts 47.9 42.4 44.1 52.9 43.2 Transfer Payments 1.5 1.8 2.4 2.7 1.5 Current Account Deficit 96.4 119.8 216.5 197.5 167.6 Official Grant Aid 71.7 89.4 95.3 100.1 87.1 Net M&LT Loans 52.8 59.8 67.0 87.2 73.8 Disbursements 55.4 62.3 69.9 92.0 78.7 Repayments 2.6 2.5 2.9 4.8 4.9 Capital Flows N.E.I. -11.9 9.4 5.3 1.0 -40.0 Overall Balance 16.2 38.8 -48.9 -9.1 -46.7 Change in Net Reserves -16.2 -38.8 48.9 9.1 46.7 (-increase) Official Gross Reserves a/ 195.8 232.6 163.1 123.1 68.4 b/ (End Period) Memo Items Exchange Rate (NR/US$) Period Average 12.000 12.936 13.796 15.260 17.800 Current Account Deficit 4.2 5.1 8.9 7.1 7.2 as Z of GDP Official Gross Reserves in 5.2 6.2 3.7 2.6 1.6 Months of Import Coverage a/ Official Reserves. b/ Provisional. Source: Nepal Rastra Bank and staff estimates.  -15- 1.21 The balance of payments situation, however, worsened sharply in 1982/83; the immediate cause was the drought-induced decline in agricultural production. The current account deficit rose from five percent of GDP in 1981/82 to nine percent in 1982/83. Despite the recovery of agricultural production and merchandise exports in 1983/84 and 1984/85, sustained import demand kept the current account deficit above seven percent of GDP. Underlying the strong import demand pressures were the Government's expan- sionary fiscal management policies and the weak revenue performance discussed above (paras. 1.09-1.13). The external payments position was turtner weakened during the period by a decline in tourism earnings which had grown steadily through the early eighties. and compensated for the stagnation of merchandise export incomes at that time. The strengthening of the US dollar against European currencies since 1982 has hurt Nepal's tourism trade by increasing the cost of tour packages, denominated in US dollars, for the Europeans who comprise the bulk of tourists to Nepal. 1.22 In an attempt to contain the growth of merchandise imports, the Government in July 1983 took a number of steps to control imports from con- vertible currency countries, including licensing, selective quotas, and license fees ranging from one to 25 percent of c.i.f. values. These measures diverted import trade from convertible currency countries to India: India's share in Nepal's merchandise imports increased from 40 percent in 1982/83 to an estimated 51 percent in 1984/85. The result was a dramatic decline in Indian rupee reserves which in turn led the Government to reverse its policy and relax the import licensing for third countries in January 1985. Nevertheless, the Nepal Rastra Bank's holdings of Indian rupees continued to shrink during the last few months of 1984/85 until these reserves were vir- tually depleted in June 1985. 1/ The deterioration in the overaLl external balance in 1984/85 can be traced to a net outflow of US$40 million recorded under "icapital, n.e.i." (See Table I-5). The Government attributss about one half of this net capital outflow to leads and lags associated with the export-import transactions of the ready-made garment manufacturers. 2/ The rema nder of the outflow is believed to consist of capital flight and valua- tion adjustments in exports and imports. Despite the present external pay- ments crisis with India, the Government continued the policy of maintaining free convertibility between the two currencies at a more or less constant rate of 1.45 Nepalese rupees to one Indian rupee. 1/ The Government had to sell convertible currencies to the Reserve Bank of India in June 1985 in order to replenish the Indian rupee reserves. 2/ These firms, while prepaying for inputs imported from India, tend to repatriate export earnings with some lag since Government regulations permit delays in the surrender of export receipts, or up to Six months from the date of exportation.  -16- Table 1-6: MOVEMENTS IN EXCHANGE RATES (1980/81=100) Nominal Effective Real Effective Exchange Rate Exchange Rate 1980/81 100.0 100.0 1981/82 103.9 113.3 1982/83 103.6 112.2 1983/84 97.5 105.8 1984/85 93.8 101.0 Source: International Monetary Fund. 1.23 The trade-weighted real effective exchange rate index 1/ indicates virtually no change in the external competitiveness of the tradable sector over the position of five years ago, with the significant depreciation in the last two years offsetting the appreciation observed in 1981/82 and 1982/83 (See Table I-6). On the other hand, movements in indices of the ratio of export unit values to nontradable prices indicate substantial deterioration of export competitiveness during 1980/81-1984/85, e.g., rice (21 percent); ghee (five percent); jute goods (11 percent); hides and skins (46 percent); and carpets (eight percent). These developments appear to have contributed to the slow growth of overall export volumes. 1.24 Since 1982/83, official grant flows and disbursements of concessional loans have not been sufficient to offset the widening deficits on the current account; the overall deficits have been financed by a drawdown in interna- tional reserves. By June 1985, gross official reserves had declined to 1.6 months of imports compared with the peak of 6.2 months at the end of 1981/82. Total gross reserves dwindled from eight months to 2.7 months of import coverage during the same period. Debt Service Burden 1.25 The bulk of Nepal's long- and medium-term foreign borrowings have been on highly concessional terms though the Government contracted commercial loans totaling US$46.7 million between 1980/81 and 1984/85. These non- concessional loans were mostly suppliers credits tied to specific projects. 1/ The use of Nepal's consumer price index in the computation of the real effective exchange rate makes the latter highly sensitive to movements in foodgrain prices (or foodgrain output and weather). For this reason, the real effective exchange rate index should be used as only one of severaL indicators of external competitiveness.  -17- The debt service burden is still small; nevertheless, the ratio of total debt service payments to exports of goods and services has been increasing steadily from 1.4 percent in 1980/81 to 3.8 percent in 1983/84, and to an estimated 5.3 percent in 1984/85. Table I-7: FOREIGN BORROWINGS AND DEBT SERVICE RATIO a/ (In USS Million) 1980/81 1981/82 1982/83 1983/84 1984/85 Total M & LT Foreign Loan Commitments 103.2 108.2 157.9 185.7 230.0 b/ Concessionary Loans 99.5 108.2 145.8 170.1 214.7 b/ Non-Concessionary Loans 3.7 0.0 12.1 bI 15.6 b/ 15.3 b/ Total Debt Service on M & LT Loans 4.4 5.5 7.0 11.9 16.5 Repayment of Principal 2.2 2.5 3.4 4.8 5.0 Interest Payment 2.2 3.0 3.6 7.1 11.5 Export of Goods and Services c/ 306.9 292.8 265.1 310.9 311.1 Debt Service Ratio 1.4 1.9 2.7 3.8 5.3 a/ There are small discrepancies between these loan repayment and interest payments figures and the official estimates that appear in the balance of payments summary. b/ Ministry of Finance estimates. c/ From balance of payments summary. Source: Ministry of Finance and Bank Debt Reporting System. 1.26 As reviewed in the preceding paragraphs, Nepal faces serious finan- cial imbalances both in the balance of payments and the budget that require immediate Government action. In recent years, rapid increases in public expenditures combined with an inadequate revenue performance have caused a progressive wideninS of budgetary deficits and heavy recourse to domestic bank financing. The strong and sustained import demand pressures resulting from the Government's expansionary fiscal policies, combined with the weak long-term export performance, have been largely responsible for the sharp deterioration of the country's balance of payments position since 1982/83. The increases in the balance of payments deficits were not fully financed by rising inflows of concessional capital. The Government had to draw down on foreign reserved to cover the balance. During the past three years, the country continued to lose foreign reserves, its gross official international reserves declining from seven months of imports at the end of 1981/82 to a  -18- little over two months at the end of 1984/85. These trends cannot be alLowed to continue much longer, and the Government must, without further delay, adopt a package of adjustment measures to halt any further deterioration in the budgetary and external positions. Without such a program, Nepal's development prospects and the living standard of its peopLe are in jeopardy. Chapter II will examine the options available to the Government to deal with the situation.  -19- Chapter II: AN ACTION PROGRAM FOR STABILIZATION AND ADJUSTMENT A. Main Elements of an Economic Adjustment Program 2.01 If Nepal is to extricate itself from the condition of economic stag- nation and pervasive poverty, the Government will first have to take quick and effective action to restore financial stability. This will entail, essentially, a program of demand management in the short term, and especially stringent controls over expenditure growth so as to reduce the need for domestic borrowing. To attain real per capita income growth in the medium term, the short-run measures will have to be complemented by policies aimed at increasing domestic resource mobiLization, expanding agricultural output and fostering growth in industry and in tourism to boost export earnings. The limited financial resources available for development expenditures must be directed at activities that permit increased utilization of existing productive capacity, such as operations and maintenance (O&W), and to quick- yielding investments. It will also be crucial for the Government to maintain an exchange rate which will stem further foreign reserve losses in the short term by dampening the demand for non-essential imports and improve the com- petitiveness of the country's exports over the longer term. Action to be taken in the Short term 2.02 In summary form, the Government's stabilization and adjustment program over the coming years should comprise as a minimum the following actions: (a) expenditure restraint measures focused on containing the salaries and wages component of regular expenditures and curtailing hiring of civil servants (para. 2.06'- (b) reordering of priorities in develpment outlays, including increased budgetary allocations to O&M activities starting in FY86/87, identification of a "core program" of high- priority ongoing projects for accelerated imple,rintation or postponement or rephasing of other activities (paras. 2.08-2.09); (c) adoption of a package of measures to mobilize resources in the public sector starting in FY86/87 (paras. 2.18-2.21); and (d) adoption of a package of measures for export promotion, including a flexible exchange rate policy (para. 2.22), the establishment of customs bonding and -warehousing arrangements (para. 2.24), obtaining IATA special commodity rates for air freighted export commodities (para. 2.22), and streamlining of  -20- export licensing and documentation procedures (para. 2.23); and (e) implementing a package of measures to speed up disbursement from the aid pipeline, including use of revolving funds and hiring private accountants on contract basis (para. 2.08). Action to be taken over the Medium Term 2.03 Over the next three years, the Government should adopt a series of measures that aim to stimulate supply responses and to improve project implementation performance. They include: (f) agricultural programs focused on the terai designed to promote the production of food crops for import substitution purposes (para. 2.27); (g) promotion of export-oriented cottage and small-scale industries (para. 2.29) and tourism (para. 2.31) with emphasis on provision of Government services aimed at helping private entrepreneurs and exporters improve product development and marketing practices; (h) establishment of a planning and budgeting framework for O&N expenditures, starting with work on the data base and economic classification of the budget (para. 2.33); Ci) changes in personnel practices that impact most directly on project implementation, including decentralization of authority and accountability to the project manager level, reduction in staff turnover and better job matching (para. 2.34); and Cj) adoption of a package of measures aimed at fostering the development of the fledgling local construction industry which has become an obstacle to efficient project implementation (para. 2.35). B. Short-Term Policy Requirements Management of Public Expenditure 2.04 The Government's most immediate concern in the short term should be to restore stability to the country's deteriorating government finances and the external position. A careful examination of past public expenditure patterns is called for in order to identify areas where a cutback is possible or restraint is necessary. 2.05 Regular expenditure. As discussed earlier, the most important factor in the recent surge in regular expenditures has been the rapid growth of  -21- civil service employment combined with substantial increases in wages and salaries. During 1979/80-1983/84, the period for which data are available, the number of civil servants grew at an annual average rate of three percent. While the increases varied from one year to the next, the growth was generally concentrated in the higher grades in non-gazetted posts. indicating upward adjustments in the grade structure of non-gazetted officers and a tendency towards increasing wage drift. However, such changes were not as crucial as the overall increases in wages and salaries. The total wage and salary biLl increased by 17 percent in 1982/83 and 48 percent in 1983/84 in current prices; the per capita wage and salary cost in the civil service increased by 11 percent and 42 percent, respectively, as compared with domes- tic inflation rates of 12 percent in 1982/83 and six percent in 1983/84. While information on pubLic sector employment is not available for 1984/85, the 30 percent general civil service salary increase that became effective during that year added further momentum to the growth in expenditures on wages and salaries. 2.06 If regular expenditure growth is to be brought under effective control, wages and salaries, now the largest component in the regular budget, must be contained. To do this, Lhe Government must severely restrict recruitment during the remainder of the Seventh Plan period. Vacancies in key positions should be filled by transfers of existing staff. Less impor- tant positions could be abolished as they become vacant. Secondly, real increases in the civil service wage bill, including wage drift, should be kept under t'ao percent during the next five years. In view of the large salary increases granted to civil servants in 1984/85, no further upward adjustments should be allowed over the next three years. Promotion policies should also be implemented within the framework of the two percent ceiling. 2.07 Reordering priorities in development outlays. Given the anticipated constraints in financial resources, development outlays would also need to be contained over the next five years. The key consideration here should be to try to achieve the best possible use of available resources by focusing on the composition of expenditures and striking an appropriate balance between completing ongoing projects and programs, starting up new projects and inten- sifying O&M activities. 2.08 In view of the enormous number of ongoing operations, it is crucial that the Government undertake a review of the ongoing projects, reevaluate the returns to the economy of completing each project or program and decide which should be postponed, dropped, rephased or reduced in scope. The Government has recently initiated this process by identifying 60 national priority projects; it should continue to monitor these priority projects closeLy while extending the review process to other ongoing projects and programs. This exercise would need to be conducted in consultation with donors who finance a large share of the ongoing projects. The desirable approach would be to concentrate resources in accelerating the implementation of investments that are reasonably close to completion and where the costs to the economy of delays would be serious, and on projects with high and early  -22- economic returnq. Having identified the "core projects", the Government should direct an .11-out effort towards their early completion addressing bottlenecks that tiireaten to delay their implementation. If shortages in counterpart funding becomes a problem, the Government must quickly approach the concerned donor and work out different disbursement shares over the life of the project that would allow Nepal to put up lower shares during the adjustment period. Furthermore, an acceleration in disbursement from the existing aid pipeline is of major impLrtance. In order to minimize proce- dural delays in the release of funds for donor-funded projects. the Government should make more extensive use of special or revolving accounts. With these accounts. advances can be made by the donor for a portion of reimbursable project expenditures and replenishment approved upon receipt of withdrawal application and evidence of legitimate use of funds previously released. The Government might also seriously consider hiring qualified accountants from the private sector on a contract basis to be funded by donors to help facilitate disbursement. 2.09 Provision of adequate budgetary resources for O&M is a matter of growing concern in Nepal. Inadequate provisions for O&M in the past has resulted in the underutilization of productive assets and the need to rehabilitate facilities and equipment that have been allowed to deteriorate prematurely. The Government will need to make provisions for O&M expenditure requirements over and above the amounts already budgeted; such incremental O&M funding requirements are estimated to increase from NRs. 415 million in 1985/86 to NRs. 830 million in 1989/90 in constant 1984/85 prices. (See paras. 4.27-4.32 and Annex A for a more detailed analysis of the issue and an account of how these estimates were derived.) The additional funding must be met by reallocating resources from other expenditure categories, such as postponement or cancellation of ongoing projects, cutting back on transfer and subsidy payments to public enterprises and reducing expenditures on wages and salaries. 2.10 Over the medium term, financial resources for starting new activities are going to be severely constrained, though the Government is expected to continue to undertake a small number of new projects. These investments should be directed at short-gestation high-return projects, preferably those with good foreign exchange earning potential. In designing new projects, there are two important considerations that Lhe Government (and donors) need to keep in mind: first, the technical design of projects should be as simple as possible for ease of implementation, and second, projects should be designed so as to minimize the O&M burden on the Government and the beneficiaries in the long run. Improving Resource Mobilization in the Public Sector 2.11 The Government's financial stabilization and economic adjustment program will need to include both a package of new tax proposals to increase revenues as well as measures to improve the cost recovery rates from depart- mental services. Furthermore, the Government should consider a cutback on  -23- subsidies and transfer payments to inefficient public enterprises which are becoming enormous drains on the budget. In this section, each of these topics will be discussed with some suggestions for action. 2.12 Deficiencies in the Tax System.l/ Nepal's present tax system 2/ suffers from three major deficiencies: (a) a narrow tax base, (b) low elas- ticity of tax revenues with respect co GDP, and (c) multiple and often mutually conflicting objectives of the tax system that reduce its effectiveness. 2.13 The narrowness of the tax base derives primarily from the tax-exempt status of major sectors of the economy. The agricultural sector goes vir- tually untaxed; all agricultural incomes are exempt from income tax, and the land tax, the only tax on agriculture, makes a minimal contribution because its specific rates have remained unchanged for more than 15 years. The transportation sector is also exempt from income taxes and, furthermore, receives a partial rebate of motor vehicle taxes, while industry receives wide exemptions under the Industrial Enterprise Act of 1982. 2.14 The income tax base, narrow to start with, has been further eroded over time by increases in exemptions and deductions. As a result of high personal exemptions and deductions,3/ a taxpayer is unlikely to incur any tax liability until his gross income reaches NRs. 30,000--10 times the country's per capita income. An examination of the civil service salary structure shows that despite the recent salary increases, less than one percent of the civil service is liable to income tax. Property taxes likewise yield limited revenues because of high exemption levels and infre- quent adjustment of property values. 2.15 In addition, the bases of domestic sales taxes and excises are also narrow, with about 70 percent of revenues from both these taxes being derived 1/ Discussions in this section are based largely on the findings of IMF's recent study. (See IMF: Government Finance During the Seventh Plan, 1985.) 2/ By international standards, Nepal's tax effort is low. According to a recent study of 21 developing countries with a per capita income of below US$300, Nepal had the lowest tax/GDP ratio of 7 percent compared with the average for this group of countries of 13.2 percent. (See Vito Tanzi, "Quantitative Characteristics of the Tax System in Developing Countries", in Newberry and Stern: Modern Tax Theory for Developing Countries [The World Bank, forthcomingJ). 3/ In Nepal, personal exemptions amount to 6.3 times the per capita income, more than double the level in other countries in Asia, e.g., India, Malaysia and Thailand.  -24- from alcohol and tobacco products. Conversely imports provide about 50 percent of tax revenues. 2.16 The elasticity of the tax system is low--estimated at between 0.7 and 0.9 with wide variations among different types of taxes--even though the buoyancy of the tax system with respect to GDP, reflecting frequent tax rate adjustments over the years, is significantly higher at around 1.4. A low elasticity of the tax system ordinarily indicates the prevalence of one or more of the following factors: (a) specific rather than ad valorem tax rates; (b) gaps in the tax system, notably, the absence of taxation on agricultural incomes and capital gains; and (c) administrative problems. In Nepal, all of these factors exist and will need to be addressed. 2.17 An examination of Nepal's tax system also shows that each tax instru- ment has been assigned multiple objectives that are mutually incompatible, i.e., raising revenues, ensuring equity, influencing the direction of foreign trade, protecting and promoting domestic industries, irrespective of whether the tax is suited to the particular role or not. For example, the sales tax, the primary function of which is to raise revenues, is also being used to protect domestic industries and influence the direction of traue. This results in a complex structure of highly differentiated rates which makes it difficult for the policymakers to ascertain the impact of a rate change on any one of its objectives. The many trade-offs that result from multiple objectives, among others, reduce the revenue impact of any one tax instrument. 2.18 Proposals for new tax measures. As suggested above there is con- siderable scope for tax reform, especially with the objective of raising more revenues. Given the need to introduce new measures as early as possible to maximize returns during the next few years, the reform measures proposed below are such that they do not require extensive administrative changes and focus on those taxes whose assessment and collection procedures are well in place. The main emphasis of any immediate reform should be on widening the tax base and rationalizing the structure of taxation. To the extent possible, each tax instrument should be assigned a single, unequivocal role, e.g., the sales tax should be used primarily for raising revenues, excise duties for discouraging consumption of certain non-essential items, and import duties for the protection of a select number of domestic industries with potential comparative advantage. The impact of the proposed measures is quantified and summarized in Table II-1 below. Our proposals cover income tax, import duties, sales tax and excises, urban house and land tax and agricultural land tax; if all the proposed measures were to be adopted together, the Government would be able to mobilize an additional NRs. 315 million, or about eight percent of the current total public revenue, in the first year of implementation. Out of that total, it is estimated that the adjustment of specific rates for the agricultural land tax would yield as much as NRs. 110 million, the rationalization and selective increases in the sales tax would raise about NRs. 60 million, the rationalization and exten- sion of the excises would mobilize another NRs. 55 million, and reducing  -25- personal deductions and exemptions and restructuring income tax incentives would also allow the Government to collect about NRs.' 55 million. Proposed measures for import duties and urban house and land tax are expected to yield nearly NRs. 20 million each. (a) Income Tax -- A reform of the income tax should start with a reduction in the levels of personal tax exemptions and deductions. It is proposed that the exemption level for both married and individual taxpayers be reduced by NRs. 5,000. and personal deductions be lowered to one-half of the present level. -- The method of computing personal deductions needs to be changed to ensure greater equity. It is recommended that deductions be expressed in fixed rupee amounts, rather than as a percentage of gross income. -- The company income tax should be standardized at the current maximum rate of 55 percent. Since the objective of the company tax is to tax the owners of companies on their share of the companies' net income, rather than to tax the companies as separate entities, there is no rationale for the existing progressive rate structure. (b) Import Duties 1/ - It is recommended that the one percent duty provision for raw materials, machinery and equipment be reviewed. Tariffs should be determined on the basis of the effective rate of protection; the rate structure should be rationalized under an overall industrial protection policy and applied only to a selected number of enterprises chosen on grounds of potential comparative advantage. Cc) Sales Tax - In oLder to rationalize the structure of the sales tax, it is recom- mended that the Government eliminate the rate differentials between domestic and imported goods, as well as the rate differentials among imported goods by country of origin. This would imply increasing the 1/ To encourage import replacement and export industries, the Industrial Enterprises Act has a provision of a one percent duty on all machinery, equipment and raw material imports. On the other hand, the rates of import duty on final consumer items are relatively high. This policy provides no protection for raw materials production in the country, while actively encouraging the production of consumer items and industries assembling imported raw materials which involve little domestic value added.  -26- rates on domestic goods to match those on imported goods, and equalizing rates between Indian and third country imports. -- While exempting basic foodstuffs from the sales tax on welfare grounds, higher rates shouLd be imposed on luxury consumer goods, whether domestically produced or imported; consideration should also be given to removing the one percent rate category because the primary objective of this tax should be to raise as much revenues as possible, and applying the one percent rate dGes not serve that purpose. Currently, there are five sales tax rates, viz., one percent, five percent, 10 percent, 15 percent and 20 percent. -- The coverage of this tax should be extended to those services that are not presently taxed. It is proposed that a five percent sales tax rate be applied to electricity charges, telephone and telecommunication charges, non-life insurance premiums and tourist packages.  -27- Table II-1: ESTIMATED REVENUE IMPACT OF SELECTED TAX REFORM MEASURES (In NRs. Million - 1984/85 Constant Prices) Year 1 Year 2 Year 3 Year 4 Year 5 Income Tax Reduction of personal exemption by NRs. 5000 7.4 7.5 7.9 8.1 8.2 Reduction of personal deductions by one half of present leveL 28.7 29.2 30.2 30.9 32.0 Rationalization of income tax incentives 18.5 18.6 19.8 19.9 20.4 Import Duties Rationalization and restructuring of rates 18.5 19.7 2G.6 21.3 22.5 Sales Tax Increase of tax rates on domestic goods to 25Z to equalize those on imports 41.7 45.5 50.0 54.4 59.2 Taxation of selective services at 5Z rate 12.0 12.9 14.3 15.4 17.0 Rationalization of sales tax incentives 4.6 5.1 5.6 5.9 6.8 Excise Taxes Extension of excise taxes to imported goods 46.3 50.6 55.6 60.3 66.0 Rationalization of excise tax incentives 9.3 10.3 11.1 11.8 12.9 Urban House and Land Tax Removal of exemption for hotels and industriaL property 0.9 0.9 0.8 0.7 0.7 Update of urban property values and reduction of exemption levels 18.5 18.9 18.3 18.4 18.4 Land Revenue Adjustment of specific rates 109.3 101.2 93.7 86.8 80.3 TOTAL 315.7 320.4 327.9 333.9 344.4 Source: Staff Estimates.  -28- (d) Excises -- The Government would be able to cut administrative costs by reducing the List of excisable goods to cover only those items requiring taxation for social reasons, such as alcohol and cigarettes. Other goods, which are now subject to excises for revenue reasons should simply lie brought under the sales tax. The excise tax should be applied uniformly, whether the goods are domestically produced or imported. (e) Urban House and Land Tax -- Property valuation (unchanged since 1974) must be brought up to date and maintained at regular intervals. -- All hotels and industrial properties, now exempt, should be subject to the urban house and land tax. -- The Government should consider reducing the current exemption level for this tax. At present, any property valued under NRs. 100,000 is exempt (NRs. 200,000 if owner-occupied). (f) Agricultural Land Tax -- This tax represents the only means of revenue mobilization from the agricultural sector.l/ It is recommended that the Government raise the specific rates of the agricultural land tax which have remained unchanged since 1967/68. The target should be to achieve an average effective tax rate of 1.5 percent of agricultural output. It is further suggested that after the initial revision the rate should be adjusted at periodic intervals, say every five years. 2.19 Cost recovery in departmental services. Improving the cost recovery performance in Government-run services is equally crucial from the standpoint of public revenue mobilization. A review of service charges, or revenues from the Government sale of goods and services, over the past several years reveals that the receipts have either stagnated or declined relative to costs. This holds true for all categories shown in Table II-2 with the exception of the education sector where revenue is estimated to have increased substantially in 1983/84. In the forestry sector, which has shown the highest cost recovery rates to date, receipts have fallen sharply in the 1/ Ideally, agricultural incomes should be subject to the general income tax rate structure like any other taxable income. However, in the light of administrative weaknesses, the introduction of a general income tax on agricultural income is expected to require a number of years of prepara- tion under the circumstances. An increase in the land tax is seen as the only feasible alternative.  -29- last three years because of a cutback in production for conservation purposes. Generally speaking, however, the poor cost recovery performance has been attributed to the low service charges that have remained unchanged over many years (e.g., university tuition fees) and to the poor collection effort (e.g., irrigation water charges). Furthermore, there are sectors, such as health, where no charges appear to be levied despite rapid growth in the cost of providing the services. As overall public expenditures grow, the Government needs to explore and utilize all possible avenues for cost recovery. Service charges will need to be reviewed and revised at regular intervals. A special effort should be made to improve colLection ot water charges in the irrigation sector which has shown the lowest cost recovery rates among pubLic services and where substantiaL funds need to be mobiLized to meet the growing operations and maintenance requirements of the existing facilities. Table 11-2: COST RECOVERY PERFORMANCE BY SECTORS, 1978/79 - 1984/85 (Rs. Million) 1978179 1979/80 1980181 1981/82 1982183 !983/84 1984/85 Irrw iftaiou Receiptcs a/ 0.7 1.3 0.5 0.6 0.9 1.0 1.0 Costs b/ 230.0 235.1 291.4 363.2 492.1 550.3 667.9 Receipts/Cos.c Ratio 0.3 0. 5 0.1 0.1 0. 2 0. 2 0.1 Drinkine Water Receipts a/ 0.6 0.6 0.6 0.5 0.6 0.8 1.0 Costs b/ 65.9 61.3 76.3 111.4 248.3 226.9 211.0 Receipts/Costs Ratio 0.9 0.9 0.8 0.4 0.2 0.3 0.4 Educat ion Receipts a) 0.1 2.9 3.2 3.3 3.6 6.3 7.5 Costs b/ 315.3 330.6 384.2 519.0 734.0 815.8 838.7 Receipts/Costs Ratio - 0.8 0.8 0.6 0.5 0.7 0.9 Forests Receipts a/ 82.7 86.5 90.5 113.6 53.9 60.6 80.0 Costs bl 70.8 98.5 93.9 190.8 235.4 242.5 274.3 Receipts/Costs Ratio 116.8 87.9 96.4 59.5 22.9 25.0 29.2 Transoort Receipts a/ 6.0 10.9 25.3 19.2 35.2 41.2 42.5 Costs b/ 520.1 682.5 637.9 784.1 853.0 801.4 757.0 Receipts/Costs Ratio 1.2 1.6 4.0 2.4 4.1 5.1 5.6 a/ Revenues from departmental enterprises under non-tsx revenues. bl Development and regular expenditures combined. Source: Ministry of Finance. Budiet Speech, several years.  -30- 2.20 Reducing subsidies and transfers to public enterprises. There are 53 puLlic sector enterprises in Nepal which taken together comprise a sig- nificant share of economic activity in the country. In general, their per- formance has been deteriorating steadily since the early 1980s. While no attempt has been made to estimate shortfalls in spending for O&M as such by public corporations, a review of their operations suggests not only that their O&M spending is seriously deficient but furthermore that many of these corporations are becoming a serious drain on fiscal resources. The trading companies, in particular, have required increasing subsidies, loans and infusions of equity capital from the budget to prop up their failing finances. Between 1979/80 and 1982/83, losses of the four trading companies totaled NRs. 640 million; given the negative net worth and poor cash posi- tions of these companies, their future losses are likely to be reflected directly and immediately in the Central Government budget. While the trading companies are running the largest losses, they are not the only public enterprises to have become a drain on fiscal resources. Many other corporations, most notably the public utilities, have come to rely on Government Loans and equity payments. 2.21 The financial difficulties of the public enterprises stem from a wide variety of causes including weak management, overstaffing, infLexible pricing policies, and poor inventory practices to cite just a few. Further studies are needed before the Government can prepare and put into effect the neces- sary financial restructuring programs for all those enterprises that have become a drain on the budget. Early in 1985/86, the Government made a start toward the difficult task of streamlining the finances of public corporations by broadly classifying these enterprises into (a) those that now make con- tributions to the Treasury; (b) those that can be made self reliant; and (c) those that would need to continue to depend on transfers from the budget. Birganj Sugar Factory and Janakpur Cigarette Factory are examples of the first category of profitable enterprises. Public utilities enterprises belong to the second category, and it is Government policy that they become self reliant by some combination of measures to reduce costs and increase tariffs at regular intervals. Among trading corporations, the Oil Corporation and National Trading, Ltd. should also seek to be self reliant; the Oil Corporation, in particular, should be able to generate significant profits with proper pricing policies and greater attention to cost reduction. On the other hand, the Nepal Food Corporation (NFC), the agency in charge of foodgrain procurement, and the Agricultural Inputs Corporation (AIC) respon- sible for input distribution, will probably need to continue to rely on Government subsidies over the short to medium term. However, it is essential, even in the case of these two corporations, that subsidies be specified in advance both as to magnitude and purpose and preferably be limited to transport subsidies; their pricing policies should be designed to enable the Government to contain subsidies at specified levels in the short term and to progressively reduce subsidies in the longer run.  -31- Policies for Export Promotion 2.22 In respect of export promotion, there are several actions which can yield quick results. Firstly, maintenance of a flexible exchange rate policy will be crucial for improving the international competitiveness of Nepal's exports, and over the longer term, increasing the supply of export commodities. The Government should also help improve the price competitive- ness of tiepalese exports by obtaining Special Commodity Rate (SCR) air freight rates for ready-made garments to the United States and carpets to Europe.l/ In the longer run, sealed containerization from Kathmandu to port by surface transportation would allow cottage industries to offer their customers the option of cheaper though sLower transportation. The dialogue with the Government of India should be continued to permit the early realiza- tion of this option. 2.23 The Government will also need to continue to focus on the administra- tive bottlenecks to export promotion; some can be alleviated quickly. The cumbersome and time-consuming export licensing and documentation procedures are known to delay export shipment by as much a3 severaL months. The con- straint imposed by such a system can severely limit the potential growth of export industries by inhibiting the ability of exporters to meet deadlines or to take orders which require a quick turnaround time. The recent p-roposal within the Government to streamline this process and to centralize the paper- work and the licensing responsibility within concerned departments or agen- cies is a well considered move. To make the new system effective, the government agencies concerned should establish and abide by a maximum response time that is acceptable to exporters and overseas buyers. 2.24 Regarding customs clearance, warehouse facilities at Kathmandu have not expanded in line with the dramatic increases in airfreighted exports from Kathmandu. Consequently, customs inspection of export consignments has to take place in the open air and this causes serious problems during the mon- soon season. Recently, one of Nepal's major importers suffered a 60 percent loss from a large shipment of carpets that had been left out in the rain during clearance. Urgent Government action is needed to put custom clearance 1/ It is standard practice for airlines to offer discount rates to par- ticular industries that have prospects as air cargo customers. Thus, IATA SCRs exist for garments to the United States from Bombay or Dhaka, offering discounts of around 40 percent below the best general cargo rates. While old SCRs are still available between Kathmandu and Europe for mica and pig bristles whose export volumes are now negligible, no SCR exists for Nepalese garments and carpets to the United States in spite of the huge growth potential. Notwithstanding pressure from the industry on RNAC and other carriers, no progress has been made to date. The Government should be more aggressive in pushing for SCRs from Kathmandu to all major destinations in the United States a.id Europe.  -32- facilities under cover, or to allow clearance and sealing of goods to take place at the exporters' premises. 2.25 To improve the marketing of agricultural commodities, investments in basic infrastructure, such as storage and grading facilities and assembly points, will need to be undertaken in various parts of the country. Furthermore, while exporters must ultimately ensure acceptable quality for their products. the Government can help significantlv bv escablishing offi- cial quality control services that incLude (a) the prescription of standards and grades tor exports, (b) setting up of adequate laboracory facilities to check samples, and (c) preshipment inspection for qualitv, and certification. C. Medium-term Policy Requirements 2.26 The foregoing sections contained a discussion on Government actions that would have an impact on the budget and the balance of payments in the near term. However, a more permanent 3olution to the country's current financial difficulties must be found in programs to accelerate production growth. The Government would need to make more vigorous efforts, supported by appropriate policies, to expand production for export and to promote economically viable import-replacement programs. It is recognized that much more work is needed to spell out details of specific action programs in these areas. The following discussion is therefore intended only to provide a broad guide to possible approaches. Priorities in Agriculture 2.2' Over the next few years, the main thrust of the Government's strategy in agriculture should be to secure an adequate supply of foodgrains (rice, maize, wheat) and other food crops (sugar, oil seeds) to eliminate the need for food imports which now amount to US$50 to US$100 million every year. It is unLikely that traditional exports of foodgrains (rice and maize) to India would grow significantly owing to the rapidly rising domestic demand within Nepal and greater food self-sufficiency in India. With respect to the production of cereals the primary emphasis should be on import substitution. Similarly, the production of tobacco, oil seeds and sugar in the terai should receive high priority because the prospects for import replacement in these crops are considered good. It is anticipated that the terai areas would continue to produce exportable surpluses of jute, pulses, ginger and herbs and vigorous efforts should be made to increase their output. The hill areas are expected to record modest increases in the production of the remaining traditional export items such as hides and skins, cardamon and ghee. 2.28 The primary focus of the Government's economic adjustment program in this sector should be on expanding production in the terai where a large part of the country's irrigation infrastructure is located and other supporting services are more readily available. This should not be interpreted to mean that development of hill agriculture should be given a lower priority. The concern for developing the hill regions must continue as a national priority,  -33- but as a practical matter, the best prospects for obtaining larger marketable surpluses of crops that can be exported profitabLy or replace imports are in the terai. There, improvements in the utilization of existing irrigation facilities (through additional operations and maintenance work), in combina- tion with other complementary inputs and support services and appropriate pricing policies, should lead farmers to raise cropping intensity and increase yields relatively quickly. The Government owned NFC intervenes in the procurement of major food grains, but to date, it has been able to pur- chase only a small fraction of the marketable surplus. rhe Government's low crop support prices, particularly for foodgrains. set to assure low and stable consumer prices in food deficit areas and in urban areas, have adver- sely affected producer incentives and caused leakages of crops grown in the terai across the border to India. At the minimum, official pricing policy sh.ould ensure that the crop prices in the terai are maintained at the same level as in neighboring Indian states. Maintaining an appropriate exchange rate between Nepalese and Indian currencies would be crucial for boosting production in the terai and promoting an orderly trade in agricultural com- modities between the two countries. More timely distribution of inputs by AIC and adequate provision of support services including credit, extension and research are also vital to improving farmer incentives and achieving better agricultural performances. While the policy of subsidizing inputs will probably need to be continued over the short-to medium-term to encourage intensification of agricultural production, the Government's goal over the longer run should be to progressively reduce these subsidies. (See also para. 2.21). Expanding Cottage and Small Industry Production 2.29 As mentioned earlier (para. 1.06), the prospects for promoting import substitution manufacturing activities in Nepal are constrained by the proximity to India and the stiff competition offered by India's more advanced industrial base. Under these circumstances, successful industrial develop- ment in Nepal is predicated on an export-oriented development strategy utilizing local labor and traditional skills. For that reason, the promotion of cottage and small-scale industries should be an integral part of the Government's medium-term adjustment program. Their export potential is substantial: although cottage industries account for only about 30 percent of industrial production in Nepal, their output constituted about US$40 million or 30 percent of total merchandise exports in 1984/85. We anticipate that ready-made garments, carpets and handicrafts, will together provide the largest source of growth for merchandise exports; this group of exports is projected to grow at about seven percent per annum in real terms and account for about half of the projected increase in export receipts during 1984/85-1989/90. To realize the output potential of these commodities, the Government will need to strengthen support services to small private producers, especially credit and market development. The Government credit policy for cottage and small industries has emphasized offering special subsidized interest rates. However, limited availability of credit rather than its cost has been the bottleneck for cottage and small industries.  -34- While liberalizing credit allocations to the private sector (by limiting borrowings by the public sector), the Government must also help strengthen the capacity of banks to identify Lid evaluate projects. Given that cottage and small industries comprise very small private producers with no access to marketing channels, the Government-run trade offices wiLl need to continue to improve their marketing services, including provision of overseas market information and contacts with clients to ensure a steady supply of goods and the development uf products that meet the requirements of buyers abroad. Furthermore, to secure producers a steadv supply of the necessary raw materials at competitive prices. more private traders should be licensed to import rather than rely on inefficient public trading corporations. 2.30 Of the three commodities, the export of ready-made garments has shown the most phenomenal growth in recent years, its share of total me-rchandise exports jumping from less than one percent in 1980/81 to 17 percent in 1984/85. This industry was started by Indian garment manufacturers who brought in Indian machines, labor and fabric to manufacture garments which were supplied to Indian importers in the United States. However, the industry has now evolved to the point where Nepalese owned and managed fac- tories have been established, and some 30 percent of the labor is now indigenous. The Government's objective for the ready-made garments industry should be to build on this initial growth, and to consolidate the industry by further increasing the Nepalese value added content. The most serious risk to the country continuing to achieve high growth of ready-made garment exports is the possibility of quota imposition by the United States. The Government should consider special representation to industrial countries against quotas in view of Nepal's extreme poverty and very limited options for increasing expert incomes. In any event, the strategy of Nepalese gar- ment manufacturers should be to diversify into new product lines and to increase the domestic value added content in the quota restrained categories. The carpet industry is well-established in Nepal, dating back to the 1960s when a Swiss-assisted development project started a weaving operation in one of the Tibetan refugee camps in the Kathmandu valley. The industry has developed substantially since then, and carpets now represent the second largest export to third countries. The strategy in carpets should be to defend the key German and Swiss markets, which presently absorb 70 to 80 percent of Itpal's carpet exports, against low cost copies from China and to open up new markets in the United States. In handicrafts, there should be greater emphasis on product development beyond traditional export items like religious paintings and sculptures to achieve innovative, marketable products utilizing craft skills. Reviving Tourism Growth 2.31 Traditionally, tourism has been an important source of foreign exchange earnings for Nepal that supplemented the steadily declining incomes from merchandise exports. Since 1978, however, the rate of growth of tourist arrivals has slowed. Whereas the number of non-Indian tourists had increased dramatically from 12,567 in 1966 to 125,636 in 1978, there has been a gradual  -35- decline thereafter; in 1984, there were only 112,694 visitors from the third countries. This reflects the impact of the world recession and the rising cost of a visit to Nepal. The factors that have contributed to the higher costs include the strengthening of the US Dollar--the currency quoted by tour operators--against the currencies of Europe, where the majority of tourists originate, and rising air transport costs. Limited air access to Nepal has posed additional constraints. In view of its great potential for earning foreign exchange, reviving tourism growth should be an important objective and the Covernment should take a much more dynamic approac!. to marketing the country's tourism potential. 2.32 Given the underutilization of existing hotel capacity in Kathmandu, high priority should be given to promotional and marketing campaigns. Per tourist earnings can be increased by devising tour packages that cover many more cities and sites, hence entailing a longer average stay in the country. Efforts should continue on the preservation and restoration of historic sites, opening up of new trekking routes, and providing environmental protec- tion on existing routes. The Government should also take measures to improve air access to Nepal. In view of RNAC's relatively weak financial position and the unsatisfactory standard of maintenance for the fleet, the Government should resist further expansion of its air services to other cities, and seriously consider, instead, the alternative of allowing more foreign air- lines to include Kathmandu on their scheduled international flights. In its strategy vis-a-vis RNAC, the Government should focus first on air safety by obtaining a new fLeet serv4cing agreement with a major international carrier. Improving O&M and Accelerating Project Implementation 2.33 In the area of O&M expenditures , a topic discussed at greater length in Chapter IV, the incremental funding needed for activities that are seriously underfunded and can realistically be carricd oct is estimated at NRs. 3.1 billion over the Seventh Plan period, or close to 11 percent of total development spending. As additional projects are completed, the O&M requirements will increase proportionately. in terms of meeting the rising O&M needs, improving the cost recovery performance in the public sector will be critical to raising the necessary resources. At the same time, the estimation of O&M expenditure requirements for past and ongoing projects should becomve an integral part of the Government's annual budgeting and multi-year planning exercises. Currently, budgetary allocations for O&M activities are made rather haphazardly without the necessary detailed project-by-project analysis of exact requirements; neither data nor analyti- cal tools now exist for making accurate estimates of the O&M expenditure needs. To facilitate the analysis of O&M requirements, the Minister of Finance will need to first build up a data base for O&M expenditures by sector and project and then introduce an economic classification of expendi- tures into the budget process. (See para. 4.31-4.32.) 2.34 While the impact of any remedial measures to a, '-ratine project implementation is likely to be felt only in the medium L= , .s important  -36- that corrective action be initiated now as many of the measures involve basic structural changes that would take time to bear fruit. Foremost among these changes is a reform of public administration practices and personnel policies that affect project implementation. It is crucial that implementation authority be decentralized and that the responsibilities of project managers be widened, particularly in reference to staff appointment and transfer, and the release of funds. Staff turnover should be reduced to ensure greater continuity at the project site. Moreover, there should be better matching of jobs and q!ialifications. The Government might also consider hiring qualitied privaXe !.:..tor individuals on a contract basis. to be tunded by donors, especially for remote posts where it is difficult co retain civiL servants. (See also paras. 4.03-4.17.) 2.35 The weakness of Nepal's construction industry has been a major cause of project implementation delays and a serious constraint to the Government's carrying out O&M activities. Since the Government is the principal source of demand for construction itself and executes much of the work and also regu- lates the industry, it can play a critical role in strengthening the local construction industry. Policy measures that can have significant impact include the following: (a) replacing the present system of contractor registration by one that requires periodic registration renewal and recategorization on the basis of an individual contractor's demonstrated performance; (b) prompt decisions in awarding contracts and full adjustments for price increases due to delay in decision of awards as well as general price escalation; (c) prompt payment of contractor's bills by Government agencies; (d) relaxing commercial bank credit conditions for contractors; (e) allowing private traders a larger role in the procurement and distribu- tion of construction materials; and (f) preparing an inventory of all con- struction equipment and spare parts in the Government pool in order to improve the availability of equipment leased to contractors and to upgrade the level of equipment maintenance. (See also paras. 4.19-4.23.) D. Role of Donors 2.36 The responsibility for designing and implementing the various ele- ments of the action program rests squarely with the Government. Even so, a program of this nature is unlikely to succeed without substantial coopera- tion and support from the donor community. As illustrated further below, Nepal's balance of payments difficulties are likely to persist beyond the near term. The situation clearly calls for a re-definition of the role of foreign assistance, a re-orientation in the approach of donor agencies from heavy emphasis on financing projects that take many years to implement to shorter-gestation projects, and even to non-project lending to permit a quick transfer of resources. The questions which arise are: in what ways can the donors help the Government design projects that minimize implementation delays and yield high returns? What does non-project lending imply in the context of the needs of Nepal's economy and its institutions? And can the  -37- country and the donors strike an appropriate balance between the needs for external payments and budget support and the obvious requirements for capital investment to sustain longer-term growth? The following discussions will touch on four areas where a new approach by donors can enhance the effective- ness of foreign assistance, viz., re-evaluation of ongoing projects, funding of O&M activities and provision of balance of payments support. Re-evaluation of Ongoing Projects 2.37 The bulk of development expenditures under the Seventh Plan are expected to be activities carried over from the previous Plan. Under the circumstances, the donors' efforts should be directed at helping the Government complete ongoing projects. At the same time, given the enormous backlog of foreign financed projects and the burden to the Government of counterpart funding, it would be necessary for each donor agency to actively collaborate with the Government in taking a critical look at its existing portfolio of projects, re-evaluate the returns to the economy of completing each project and decide if any ongoing project should be postponed, dropped (cancelled), rephased or reduced in scope. Having decided on which projects in the pipeline should be continued, each donor agency should expend an all-out effort towards their early completion, increasing the frequency of supervision missions where appropriate, increasing the number of (donor- financed) field staff and hiring local staff on contract to accelerate implementation. Design of New Projects 2.38 Even though the short-term concerns for budget and balance of pay- ments support are likely to preoccupy policy makers for the next few years, both the Government and the donors should not lose sight of the longer term objective of accelerated economic growth. While financial resources for starting new activities during the Seventh Plan period are going to be severely constrained, the Government will need to continue to undertake a selected number of new development projects designed to broaden the export base of the economy and to expand its productive capacity in the medium to longer term. Needless to say, donors will be expected to continue to play a major role in project financing. In designing new projects, there are two important considerations that donors and Government need to keep in mind: first, the technical design of projects should be kept as simple as possible for ease of implementation, and second, projects should be designed so as to minimize the OM burden on the Government and the beneficiaries. 2.39 In Chapter IV, there is a brief discussion of the problems of the fledgling construction industry in Nepal and the resultant difficulties in undertaking civil works. While it is not always possible to tailor project designs to the capaci:y of Nepal's local contractors, enough care should be taken by donor agencies to make the designs simple, to employ technologies suited to local conditions and skill levels, and to apply realistic construc- tion standards. This would not only help facilitate project implementation  -38- but also enable the Government to hand over the maintenance responsibilities to local communities upon project completion. Furthermore, donors must give adequate attention to the O&M requirements of the project upon completion. In designing projects that incur large recurring costs for the Central Government budget in terms of increased staff and services, such as, agricul- tural extension or health and education, donors will need to adjust the size and scope of the project to the anticipated ability of the Government to finance these services. Where maintenance is likely to become a problem, e.g., roads and irrigation, the Government and donors should make sure to involve the local beneficiaries in decision making in the early phase of project design on matters such as the location of feeder roads and tertiary canals and the appropriate maintenance standards, so that the local coumunity wilL get a better understanding of their O&M responsibilities and the need to impose user charges in order to pay for O&M. Assistance Directed at O&M 2.40 Some donors fund the recurring O&U expenditures of completed projects financed by them under subsequent phases of their assistance programs and undertake rehabilitation of facilities which had deteriorated in the absence of adequate maintenance. The practice of funding O&M expenditures under project assistance should continue, at least as long as the present budget crisis persists. At the same time, it is important that the donors and the Government work out in advance an orderly schedule for phasing out this type of assistance. To ensure that foreign assistance will not continue to finance O&M expenditures indefinitely, donors should help the Government formulate cost recovery measures in those sectors where they provide O&M funding and insist on their strict implementation. 2.41 Donors may also consider financing free standing maintenance projects in sectors such as roads or irrigation. These projects wouLd ordinarily include a large component of technical assistance for institution building, e.g., training in inventory planning and management, accounting and in basic mechanical skills, and have provisions for financing machinery, equipment and spare parts. In service sectors like health and education, the donors may wish to consider financing only recurrent expenditures, e.g., medical supplies, text books, even staff salaries, in order to improve the capacity utilization of existing facilities. Budget and Balance of Payments Support 2.42 The Government's firm commitment to adopting stabilization measures over the next couple of years is essential if the country is to achieve even modest growth rates during the Seventh Plan period. Moreover, it is a pre- requisite if donors are to support the country through the difficult adjust- ment period by providing a higher share of their aid in the form of quick- disbursing assistance. For instance, the Government's effort at increasing agricultural production will give rise to increased demands for impGrted agricultural inputs, such as fertilizer and chemicals; improved maintenance  -39- of roads, buildings and irrigation canals will require more imported machinery, equipment and spare parts and a variety of construction materials; expansion of cottage and small industry production of garments and carpets will generate an increased demand for imported wool and fabrics. It would be helpful if a large part of these import requirements could be financed by donors through commodity assistance. However, it is important that this type of assistance should be seen not merely as a resource transfer to cLose the financing gap in the balance of payments but also as the donor community's support for economic reforms that would support sustained growth for the economy over the medium to longer term.  -40- Chapter nII: MEDIUM-TERM PROSPECTS AND EXTERNAL FINANCING REQUIREMENTS A. Overview of Growth Prospects 3.01 If the action program outlined in Chapter II takes hold, we can expect a modest upward shift in Nepal's growth path and a distinct improve- ment in the budget and the balance of payments. The GDP, fiscal and balance of payments scenarios for the Seventh Plan period, as outlined in Tables III-1, III-2 and III-5 aLso rest upon continuing strong, but reoriented, donor support of the Government's adjustment program, averaging about US$300 million in commitments per annum, including some US$100 million in quick-disbursing assistance. GDP Growth Prospects 3.02 Past and projected growth rates by major expenditure categories are set out alongside the Government's Seventh Plan targets in Table III-1. The Seventh Plan aims at achieving an annual average GDP growth rate of 4.5 percent during the 1985/86-1989/90 period. This is probably the minimum acceptable growth target that the Government can set, given the dire poverty in the country and the rapidly growing population. Nevertheless, a 4.5 percent growth rate appears somewhat ambitious when judged against past performance, the anticipated implementation of an austerity program under the proposed IMF standby arrangement, and the expected scarcity in the next couple of years of foreign exchange for financing the import of essential capital and intermediate goods. In fact, the Government targets an average investment growth rate for the Plan period of only 3.3 percent which repre- sents a significant reduction from historical trends. Barring dramatic improvements in the ICOR, it would be difficult to achieve an average annual GDP growth of 4.5 percent. 3.03 In the Bank staff's base case scenario, GDP is projected to grow at an average rate of 3.8 percent per annum with annual growth substantially reduced to 2.5 percent in the first two years of the Plan period due to the austerity program but increasing to 4.5 percent in the later years on the assumption that the Government implements an adjustment program along the lines discussed in this report and that it is then supported by the donor community. Agriculture and the non-agricultural sectors growth rates are expected to average three percent and 4.5 percent, respectively over the Plan period. The projected average annual agricu.tural growth rate of three percent reflects a continuation of the gradual upward trend that started during the Sixth Plan period. The base case scenario has total investment growing on the average at 3.2 percent per annum, much below the average growth rate achieved over the past decade; the implicit assumption here is that the projected GDP growth over the next few years will and must come from increased efficiency in the use of existing capacity and less from new  -41- investments. Exports are projected to grow at 5.2 percent per annum (merchan- dise exports at 3.7 percent and non-factor service receipts at 6.4 percent), at a slightly higher rate than recorded historically. This assumes a con- certed export promotion drive, entailing an active exchange rate policy and izistitutional support. The projected rate of growth of imports of 4.2 per- cent per annum is to a large extent a function of aid flows. It is below the historical rate, reflecting the more efficient use of imported raw materials and intermediate goods, and increased import replacement for food and other products. The future course of the balance of payments and external capital flows is analyzed in detail below. S blIII-: HISTOIICAL AND PROJECTED GRUOM1 RATES, 1975176 - 1989190 (Percet) 1970/71-1984185 1960/81-19U185 1985811989/90 1985/16-9891990 (Actual) (Actual) bl Staff Projections National Plassing Camaueson (Sao& Came) Tartest a/ Real -aywth Rate. FP (at factor cost) 2.J 3.4 3.8 4.5 Agriculturo 1.5 3.2 3.0 3.5 Non-rAriculure 4.9 3.7 '.J 5-J Exports (g.nfa) 4.9 3.6 5.2 4.3 Imorca (g.nfs) 5.0 6.1 4.2 5.5 conamption 2.3 3.4 3.8 4.7 Invesment 7.6 5.3 3.2 3.3 Shares of GD7 1970/71 1984/85 1989190 19J9/90 Actual evised Staff IPC Eat. _at. Tmato a/ bxport. (5g4fe) 9.1 13.1 13.9 12.1 Imports (g3nfu) 15.4 22.0 22.4 21.6 Resource Cap 6.3 8.9 8.3 9.5 Conaimption 96.7 69.9 90.2 91.7 Investmnt 9.5 19.0 18.3 17.8 Do_estic Savings 3.3 10.0 10.0 8.3 a,/ same year (1984185) figures used by N1C were preliminmry .sti_tes. ki Base yar (1979110) was normalized by taking average values for 1978/79, 1979/10 and 1980/81 bocas it waa not a typical yer. Sourc: latioal Planing Coiission and Staff Estimtes.  -42- Fiscal Strategies 3.04 A reduction in the budget deficit and in turn, the need for bank borrowing is essential to restore financial stability in the short term and lay the conditions for uninterrupted growth thereafter. Revenues would need to rise by about 5.5 percent per annum in real terms during the next five years in large part based on the implementation of the tax proposals dis- cussed in Chapter II. On the expenditure side, regular expenditure growth should be held to about 4.4 percent per annum while development expenditures should not grow at more than about two percent per annum with most of this increase attributable to increased spending for O&M. Details of a scenario for government finances for the 1985/86-1989/90 period based on implementa- tion of the action program discussed in Chapter II are presented below and in Tables III-2 and III-3.  -43- rlrn-2kIzJ: MEUDIUM TOE COVUNRNT PrmNCE ASSMNG INFIJWNTATION Olr ADJiURl NUSURIS (Ill. eillion i. Conatant 19S4185 Prices) Official Rewised Projected Aasul Five Seventb CutiLate Average YTer Pln Target. 19U/65 ltl5186 196117 1497/86 1988169 19J9/90 growtt.h _7A_l live Yeer Total Revenues 3,960.5 4,290.0 4,615.0 4,780.0 4,945.0 5,145.0 5.42 23,775.0 23,990.0 Normal Growth 3,960.5 4,105.0 4,250.0 4,405.0 4,560.0 4,750.0 3.n 22,070.0 22,060.0 Use measured - 185.0 365.0 375.0 385.0 395.0 - 1,705.0 1,930.0 1985186 Budget Mehaures 1 - 45.0 50.0 55.0 55.0 60.0 - 265.0 Mimaion Tax Proposals V - 0.0 315.0 320.0 325.0. 335.0 - 1,295.0 Incidental Neasurea 3/ - 140.0 0.0 0.0 0.0 0.0 - 140.0 - Expediture. 8,427.7 8,150.0 9,095.0 9,370.0 9,590.0 9.680.0 2.% 46,615.0 47,970.0 Regular 2,984.1 3,045.0 3,195.0 3,420.0 2,620.0 3,700.0 4.43 16,980.0 18,970.0 Interest Paymets 502.0 670.0 740.0 790.0 830.0 860.0 11.42 3,890.0 - Repayment of Loans 169.0 235.0 245.0 285.0 285.0 285.0 11.02 1,385.0 - Other Itema 2,313.1 2,090.0 2,210.0 2,345.0 2,505.0 2,555.0 2.02 11,705.0 - Deelopment 5,443.6 5,835.0 5,900.0 5,950.0 5,970.0 5,980.0 1.9S 29,635.0 29,000.0 Ongoing Projects V/ - 3,250.0 3,250.0 3,200.0 3,080.0 3,000.0 - 15,780.0 18,900.0 Transfers g - 400.0 425.0