Nepal - Rasuwa - Nuwakot Rural Development (Phase Two) Project

Dcuzmu of The World Bank FOR OMCIAL USE ONLY CA .\4l&rP Report No. P-4355-NEP REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 16.6 MILLION TO THE KINGDOM OF NEPAL FOR A RASUWA-NUWAKOT RURAL DEVELOPMENT PROJECT--PHASE II June 26, 1986 This document has a restricted distribution and may be used by recipients only in the performance of tfieir official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Nepalese Rupees (NRs) US$1.00 = NRs 20.5 WEIGHTS AND MEASURES Metric System FISCAL YEAR July 16 - July 15 ABBREVIATIONS AND ACRONYMS ADBN - Agricultural Development Bank, Nepal AIC - Agricultural Input Corporation APROSC - Agricultural Projects Services Center CSI - Cottage and Small Industries W A - Department of Agriculture DP - District Panchayat DTO - District Technical Office HMC/N - His Majesty's Government of Nepal IDA - International Development Association ICB - International Competitive Bidding IRDB - Integrated Rural Development Board LCB - Local Competitive Bidding LDO - Local Development Officer MPLD - Ministry of Panchayat & Local Development O&M - Operation and Maintenance PC - Project Coordinator PCC - Project Coordination Committee PCO - Project Coordinator's Office RDI - Rural Development Project I SFDP - Small Farmers Development Programme SOE - Statement of Expenditure TA - Technical Assistance TOR - Terms of Reference UG - Users Group UNDP - United Nations Development Programme VP - Village Panchayat  FOR OFFMCAL USE ONLY NEPAL RASUWA-NUWAKOT RURAL DEVELOPMENT PROJECT-PHASE II Credit and Project Summary Borrower: His Majesty's Government of Nepal (HMG/N) Executing Agency: Ministry of Panchayat and Local Development (MPLD) Amount: SDR 16.6 M (US$19.1 K Equivalent) Terms: Standard Project The proposed project is the second phase of the Description: IDA-financed Rural Development Project (Credit 617-NEP), covering the Rasuwa and Nuwakot districts in the Central Development Region of Nepal, which was completed in June 1984. The proposed project would aim: (a) to consolidate the investments made during the earlier phase of develop- ment by making all physical facilities fully operational, and by improving the qualities and coverage of agricul- tural support services and the services of the institu- tions responsible for rural infrastructure development and maintenance; (b) to further improve the agricultural production base and the socio-economic infrastructure (roads, bridges, drinking water); (c) to expand forestry plantation and soil conservation programs; and (d) to promote development of effective local level planning and implementation of rural development projects. The project would be implemented over an eight-year period and at full development would benefit some 20,000 farm families and generate incremental annual production of 22,000 Mt of foodgrains, 0.8 M litres of milk, 0.6 M3 of fuelwood, and some 250 tons of tropical and sub-tropical fruits, apart from additional sustained employment equivalent to about 5000 manyears annually. Unquantified benefits would also accrue from the development of rural infrastructure, forestry and soil conservation works, and human resource and institutional development. The project does not face any unusual technical or engineering risks. It would be implemented under a more stable administrative environment as a result of EfMG/N's coumitment to the implementation of new administrative arrangements for decentralized rural development planning and implementation. Nevertheless, organizational, staffing and local funding problems could conceivably affect timely implementation. These risks, however, would This document has a restricted distribution and may be used by recipients only in the performance of their official dutiem Its contents may not otherwise be disclosed without World Dank authorization.  -ii- be partly offset by the strong implementation support, technical assistance, and staff development provided under the project, and by the fact that the project is focussed on selected activities for which experience was gained under a first phase. Estimated Cost: 1/ (USs Million) Local Foreign Total Extension, Training and Research, Farms and ATU 2.1 0.6 2.7 Irrigation 2.4 1.2 3.6 Agricultural Credit 0.6 0.0 0.6 Agricultural Inputs 0.2 1.0 1.2 Livestock Development 0.7 0.2 0.9 Rural Infrastructure 1.5 0.9 2.4 Forestry 1.7 0.1 1.8 Soil Conservation 0.5 0.2 0.7 Implementation Support & Institutional Development 1.5 0.7 2.2 Technical Assistance, Overseas training and studies 0.2 1.6 1.8 Total Base Costs 11.4 6.5 17.9 Physical Contingencies 0.5 0.4 0.9 Price Contingencies 2.9 1.8 4.7 Total Project Costs 14.8 8.7 23.5 Financing Plan: US$ Million IDA UNDP HMG/N TOTAL Local Costs 11.0 0.5 3.3 14.8 Foreign Costs 8.1 0.6 - 8.7 TOTAL 19.1 1.1 3.3 1/ 23.5 Z 81.0 5.0 14.0 100.0 1/ Including taxes and duties of US$0.2 M (approximately).  -lll- Estimated Dibursements: 1/ (USs Million) FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 Annual 1.0 1.8 2.0 2.5 3.0 3.7 3.5 1.7 Cumulative 1.0 2.8 4.8 7.3 10.3 14.0 17.4 19.1 Z 5.0 15.0 25.0 38.0 54.0 73.0 91.0 100.0 Economic Rate of Return: 21Z (On 851 of investments for which benefits can be quantified) Appraisal Report: Nepal-Rasuwa Nuwakot Rural Development Project Phase II, Report No. 5834a-NEP, dated June 20, 1986 Map: IBRD 18881 1/ According to IDA Fiscal Year. Credit closing date is December 31, 1993.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A RASUWA-NUWAKOT RURAL DEVELOPMENT PROJECT--PHASE II 1. I submit the following report and recommendation for a proposed Development Credit to the Kingdom of Nepal for Special Drawing Rights (SDRs) 16.6 million (US$19.1 million equivalent) on standard IDA terms to help finance a Rasuwa-Nuwakot Rural Development Project-Phase II in the Rasuwa and Nuwakot districts. UNDP proposes to provide US$1.1 million equivalent to assist with the financing of the technical assistance component. PART I - THE ECONOMY 1/ 2. The most recent economic report, Nepal: Prospects for Economic Adjustment and Growth (Report No. 5867-NEP), was distributed to the Executive Directors on December 17, 1985. The principal features and recent performance of the economy are described below. Country data are shown in Annex I. 3. Nepal is one of the least-developed countries in the world. Per capita income is estimated at US$170 (1983) and health and education standards are well below the average for South Asia. Life expectancy at birth is about 46 years, infant mortality is about 145 per 1,000 and adult literacy is only 19 percent. The population, estimated to be 16.3 million (mid-1984), grew at a rate of about 2.7 percent per year between 1971 and 1984. About 95 percent of the population lives in rural areas. 4. Population density with respect to arable land (394 persons per sq km) has reached very high levels, and cultivation has been extended to marginal lands and forests. Forests have been denuded further to meet the growing demand for fuelwood, on which Nepal depends for more than 90 percent of its energy consumption, mostly for household cooking and heating. Because of deforestation and excessive grazing on hills and mountains, when rainfall is abundant, accelerated soil erosion occurs causing rivers to silt and flood with consequent loss of agricultural productivity. 5. Agriculture, largely rainfed, accounts for nearly 60 percent of Nepal's GDP and merchandise exports and provides the main source of livelihood to more than 90 percent of the population. Crop production accounts for about 60 percent of agricultural output, livestock for 30 percent, and forestry for 10 percent. Apart from agricultural land, Nepal's only other important exploitable resources are hydropower and tourism. 1/ Substantially unchanged from Narayani III Irrigation Project, Report No. 4332-NEP, dated June 2, 1986.  -2- Exploitation of its vast hydropower resources will depend upon the Government's ability to enter into complex agreements with neighboring countries regarding the use and development of water resources and the exchange of water-related benefits. The tourism sector, based primarily on Nepal's Himalayan environment provides about 20 percent of the country's foreign exchange earnings, but accounts for only about 1 percent of GDP. 6. Following centuries of self-imposed isolation, efforts to develop the economy of Nepal began in the mid-1950s-a time when the country had virtually no physical infrastructure, an ancient administrative system, and very limited educational and health services. Between 1955 and 1975, the country's primary development goal was to build basic infrastructure and provide a basis for future economic growth. Reasonably good progress has been made. A basic road network now exists. Schools accommodating almost half of the children of primary school age have been built, as have a number of secondary schools and a national university. A rudimentary hospital system, including rural health posts, has also been established. Then, in the Fifth Five-Year Plan the Government shifted its development objectives to stress accelerating economic growth and creating employment, as well as raising living standards. These objectives were reiterated in the Sixth Plan (FY8B-FY85) and in the Seventh Plan (FY86-FY90), which also appropriately assigned high priority to developing agriculture, small-scale industries and Nepal's abundant water resources. Additionally, both Sixth and Seventh Plans stressed the need to conserve soil, control population growth, make better use of existing infrastructure, expand absorptive capacity and develop human resources. But despite rapid expansion of development expenditures, sup- ported by growing foreign assistance, from US$103 million (7 percent of GDP) in FY75 to US$421 million (18 percent of GDP) in FY85, per capita real income grew at only 0.5 percent arnually during this period. 7. The country's difficult terrain, landlocked position, and poor natural resource base have contributed to its disappointing economic performance. Other important factors are the Government's severely limited capacity to manage the economy and to administer rapidly expanding develop- ment programs. 8. Over the past ten years, public expenditures have continued to grow faster than revenues, with increasing shares of the growing budget deficits financed by aid flows. The situation deteriorated sharply, starting in FY83 when large unanticipated emergency expenditures due to a drought necessitated recourse to significant domestic bank borrowings. The budget position has remained unstable since then, and the continued reliance on domestic bank financing has created inflationary pressures. Serious balance of payments problems have also emerged in the past three years as the cumulative result of a decade of poor economic management, as characterized by low real GDP growth, and dwindling agricultural surpluses for export. The external payments position remained precarious in FY84 and FY85, with the country continuing to lose foreign exchange reserves. By June 1985, gross official international reserves had declined to the equivalent of 1.6 months of imports compared with the peak of 6.2 months at the end of FY82. 9. To restore financial stability, the Government needs urgently to step up domestic resource mobilization while stringently controlling the growth of expenditures in order to reduce domestic bank borrowings. As a result of efforts to improve income tax assessment and collection and to apply indirect  -3- taxes, revenues have steadily increased, but the tax structure remains inelastic and narrowly based. Immediate reform should be geared to rationalizing the structure of taxation and widening the tax base, for example, by reducing income tax exemptions and deductions and eliminating sales tax rate differentials between imported and domestically-produced goods. 10. To control expenditure, the Government must contain the growth of wages and salaries, now the largest component in the regular budget. A freeze on further civil service hiring is required over the next few years. Implicitly, selective redeployment of positions is also required in order to achieve priority objectives in some sectors. Also, in the wake of a hefty 35 percent general salary increase introduced in FY85, no increases should be allowed in the Seventh Plan period. Additionally, public enterprise reform must be pursued in order to reduce subsidy and transfer payments to public corporations, some of which are causing a serious drain on the budget. Development expenditures should be directed toward activities that will produce economic results efficiently and quickly. To this end, existing productive capacity and infrastructure need to be strengthened to increase their usage, for example, through measures to improve operations and maintain roads and irrigation canals. Resources for new investments should be directed to activities that will earn additional foreign exchange for the economy within short gestation periods. To lessen the burden of counterpart funding, the Government should take a critical look at the pipeline of ongo- ing operations and re-evaluate the returns to the economy of completing each project. Tough decisions will likely be required to postpone, re-design or cancel any ongoing project that does not measure up to the criteria applied. 11. Concurrently, additional foreign exchange needs to be generated through export promotion and efficient import substitution in order to stabi- lize the country's precarious external payments position and to accelerate real GDP growth in the medium to longer term. To improve its agricultural trade position, the Government's immediate priority should be to secure an adequate supply of foodgrains (rice, maize, wheat) and principal food crops (sugar, oil seeds) to eliminate the sporadic requirement for food imports in years when the monsoon fails. An effort should also be made over the longer term to promote the export of minor cash crops such as ginger and cardamom. The key elements to improve agricultural production over the medium term include: improvements in the supply and distribution of agricultural inputs; increased access by farmers to credit; investments in transport, storage and other basic infrastructure to facilitate marketing; and a more effective and flexible agricultural pricing policy. The development of cottage and small industries (CSI) should also receive high priority over the next few years because of their potential for earning foreign exchange. Currently, the output from CSI, such as carpets, ready-made garments, and handicrafts, accounts for 30 percent of Nepal's total merchandise exports. In recent years, the Government has legislated a wide range of fiscal and administra- tive incentives to stimulate private investment in CSI as well as the export of CSI products. Implementation of these measures, together with the alleviation of severe transport and transit constraints, constitute essential elements of an export trade promotion strategy for Nepal. 12. In late 1985, the Government took major first steps toward stabilizing, and stimulating growth of, the economy. Effective November 30, 1985, the Nepalese Rupee was devalued by about 14 percent. Subsequently, the  -4- Government introduced a financial stabilization program as part of a 13-month standby arrangement with the International Monetary Fund. Major features of the program are: (a) maintenance of a flexible exchange rate policy; (b) restraints on public regular and development expenditures; (c) strengthened tax administration to help reduce the budget deficit; (d) restraint on the creation of domestic credit, especially bank credit to the public sector; (e) maintenance of key bank deposit rates at positive real levels; (f) increases in the prices charged by public enterprises and a reduction in the subsidies received by them; (g) restraint on external com- mercial borrowing; (h) increased numbers of licenses for commercial imports; (i) abolition of a 10 percent cash subsidy on exports; and (j) a number of procedural and institutional reforms liberalizing and rationalizing the trade and exchange regime. 13. The tasks that Nepal must undertake to address its multiple long-term development problems are challenging. While it attempts to mobilize domestic resources to finance about 40-50 percent of development expenditures, exter- nal assistance at concessional terms will continue to play an important role in financing investment and achieving economic growth. In the last three years, aid commitments to Nepal have averaged US$250 million per year, and have almost entirely been in the form of grants or concessional credits with grant elements exceeding 70 percent. Gross disbursements grew from about US$130 million in FY81 to US$165 million in FY85. Nearly 70 percent of total aid disbursements have come from members of the Nepal Aid Group, formed in 1976 and now comprising eight Developing Assistance Committee (DAC) countries and four multilateral agencies. 14. By December 1985, Nepal's official foreign debt outstanding and disbursed amounted to about US$530 million. As virtually all loans have been concessional, debt-service payments, including payments to the International Monetary Fund (IMF), have remained small in relation to exports of goods and services: in FY85, debt-service payments amounted to about US$17 million, equivalent to 5 percent of experts of goods and services. These payments over the medium term, are anticipated to remain ac about 7 percent of Nepal's exports of goods and services. PART II - BANK GROUP OPERATIONS 15. Bank Group operations in Nepal began in 1969 with an IDA credit of US$1.7 million equivalent for a telecommunications project. Since then, 42 additional credits have been approved, bringing total IDA assistance to Nepal to US$622.6 million equivalent, net of cancellations. In view of Nepal's many development needs, this assistance has been for projects in a wide variety of sectors. Five of these sectors account for about 90% of IDA credits by amount: irrigation/agriculture (US$192.0 million for 16 projects); water supply and sewerage (US$46.8 million for three projects); power and energy (US$168.0 million for four projects); telecommunications (US$41.7 million for four projects); and highways (US$67.0 million for three projects). The proposed credit of US$19.1 million would be the second to be approved in FY86. No Bank loans have been made to Nepal. IFC has made three investments in Nepal, the first in FY75 (US$3.1 million) for the expansion of the Soaltee Hotel project in Kathmandu, the second in FY82 (DM 14.5 million) to Nepal Orind Magnesite Company for the mining and production of dead burnt  -5- magnesite, and a third approved by FY84, but not yet signed to Nepal Metal Company (DM 7.8 million), a zinc/lead mining and concentrates project. Annex II contains a summary statement of IDA credits and IFC operations as of March 31, 1986. 16. Bank Group lending to Nepal so far has been modest compared to the country's need for external assistance. The international community has shown considerable interest in Nepal's economic development and, to date, a shortage of funds has not been a major bottleneck. The main constraint on the utilization of increased aid has been Nepal's limited absorptive capacity, affecting the pace of project preparation and implementation. The Bank Group has provided assistance to the Government in project preparation through two Technical Assistance Credits (Cr. 659-NEP and 1379-NEP) and by acting as Executing Agency for a number of technical assistance projects financed by UNDP. Project completion reports have been prepared for six projects: First Telecommunications (Cr. 166-NEP), First Highways (Cr. 223-NEP), Tourism (Cr. 291-NEP), Birganj Irrigation (Cr. 373-NEP) and Settlement Project (Cr. 505-NEP) and Bhairawa-Lumbini Irrigation (Cr. 654-NEP), and the First Rural Development Project (Cr. 617-NEP). 17. In recent years the Bank introduced a greater focus to its lending, attaching particular importance to agriculture, rural development, forestry, and human resource development. Agriculture, a main source of livelihood tro over 90% of the population, accounts for about 60% of GDP and 70% of exports. The primary objective of our lending in this sector is to increase production vith a view to maintaining self-sufficiency in foodgrains, particularly in the hills, and achieving larger surpluses for exports. To that end, we will be emphasizing actions and investment aimed at improving the supply of inputs and strengthening support services to maximize benefits from existing infrastructure and equipment. In forestry, our principal concern will be to support reforestation efforts at the community level. These investments in agriculture and forestry would need to be supplemented by effective programs to control population growth particularly in the hill areas where a rapidly growilag need for food, fuelwood and fodder is causing serious environmental degradation. In education and training, our objectives will be to improve the quality of primary education as well as increase the supply of trained technical manpower for greater efficiency in public administration. Outside these three areas of primary emphasis, our involvement will be more selective and would concentrate in areas where our investments would complement growth in production capacity. Accordingly, we envisage maintaining some support in the power sector which previousLy absorbed a significant portion of our lending, but we envisage our future role more as a provider of technical assistance and a catalyst for mobilizing additional external resources. In transport and communications, we plan to combine technical assistance througn sector work with selected interventions designed to facilitate regional integration and improved rural ._.cess to markets and input supplies. We also propose to continue our support to Cottage Industries where our previous investment has made a notable contribution to export promotion, import substitution and rural employment generation. 18. In allocating our resources, our basic approach will be to attempt to strike a proper balance between the necessary emphasis on quick-and high yielding investments (such as in agriculture), which is dictated by Nepal's precarious budgetary and balan'_ of payments position, and an equally important commitment to those sectors where impact cannot be felt immediately  -6- but which nevertheless are critical to the country's long-term development (e.g., population and human resource development). We will also deliberately target some of our operations to the poorest and least developed parts of the country, for example, the hill areas. 19. The proposed project is essentially consistent with an aspect of our longer term strategy to address the problems of environmental decay and institution building in the food deficit hill areas while further extending greater regional balance in development activities. In part, however, the focus on promoting agricultural production responds also to our concern to enhance the productive capacity of all sectors in order to offset possible negative consequences following the necessary demand management measures which HMG needs to implement in light of the immediate economic problems. 20. In terms of design and approach the proposed project would benefit from our experience with two previous IDA-supported projects (Mahakali Hill Cr. 939-NEP and Rasuwa Nuwakot I Cr. 617-NEP). The most important lesson learnt from these two previous projects is the extent to which Nepal's institutional and administrative system is constrained in terms of project implementation capacity. Consequently, unlike the previous projects which had components being implemented simultaneously in a number of sectors, the scope of the proposed project would be scaled down to focus on those areas which would enhance agricultural production. More importantly the project would consolidate and extend initiatives which have shown promising results but require further attention and persistence. The new project would also provide a basis to broaden our dialogue with the Government on important policy issues such as cost recovery and subsidy reduction which bear on the effectiveness and efficiency of tural development efforts in Nepal overall. PART III - SECTORAL BACKGROUND General 21. Agriculture is the mainstay of the economy. However, decades of exhaustive land use and over exploitation of natural resources have resulted in increasing ecological imbalance, particularly in the Hills, leading to a progressively deteriorating food, fodder and fuelwood balance. While HMG/N's strategy and investment plans for agriculture and rural development generally reflected a sense of priority appropriate to the importance of solving these problems, achievements have fallen short of target. Production of basic agricultural commodities is well below potential, correction of the agro- ecological imbalances has not progressed adequately, and improvement of the socio-economic conditions in rural areas, lags. Some of the investment programs were not well designed and many were not effectively implemented due to inadequate deployment of skilled manpower, shortages of local funds and weaknesses in the relevant institutions, administrative structure and opera- tional procedures. In many cases, there were too many poorly related programs and projects creating conflicting demands on scarce public resources. 22. The resource base for agricultural production is restricted due to the rugged terrain. Only about a sixth of the land area is suitable for cultivation, of which some 15 percent is irrigated. The land/man ratio for  -7- the whole country is estimated at about 5 persons per ha of arable land, compared to 9 persons per ha for the Hills. Further, the distribution of land ownership is skewed despite past efforts of HMC/N to promote land reform. Traditional methods of farming in the Hills involve continuous and ezhaustive cultivation of limited areas of terraced hillside. The topography and sparse road network isolate many agricultural areas and restrict the supply and use of chemical fertilizers; as a result, the availability of livestock manure is often a key factor in determining whether productivity is reasonably maintained. 23. Agricultural production during the last decade increased only by about 0.7 percent per annum, while population grew annuaLly by about 2.7 percent, thus leading to a progressively deteriorating food balance. It is estimated that 39 out of the 75 districts are currently deficit in food production, and unless production trends are improved, domestic production of cereals would meet only about 65 percent of Nepal's consumption requirements by year 2000. By that time, the Hills will be in deficit by 60 percent and the Terai--which is now in surplus--by 10 percent. 24. The present forest area in Nepal covers some 4.3M ha (3.9M ha in the mountains and Hills and 0.4M ha in the Terai). These figures reflect a 33 percent reduction in forest areas between 1964 and 1980. Destruction is accelerating because of tree felling for fuelwood and additional cultivable lands, and through reduction of regeneration and seedling growth by uncon- trolled grazing. As the forests are destroyed and fuelwood sources become remote and relatively inaccessible, use of dried dung and crop residues for fuel is increasing, thereby removing what are often the only sources of replacement of soil nutrients. This in turn is accelerating the decline in crop yields. Furthermore, the disappearance of forests is also resulting in increased damage to agricultural lands in the lower catchments of the watersheds, and in general degradation of the environment. If demand con- tinues to increase at present rates and there are no major reinforcements of reforestation efforts, accessible forests in the Hills face the grim prospect of almost complete disappearance within the next 15 years, and those in the Terai within 25 years. Policies and Priorities for Agriculture/Rural Development 25. Prior to the launching of the Fifth Five-Year Development Plan (1975-1980), the development strategy of HMG/N was to promote regional agricultural specialization (foodgrains in the Terai, and horticulture, tea, spices, and livestock in the Hills) developed through implementation of individual sub-sectoral promotion and support programs. The Fifth Plan, however, marked the beginning of a shift in the above strategy whereby: (a) increased resources were allocated to the developmpnt, exploitation and conservation of the natural resources; (b) priority was given to self- sufficiency in food production in the Hills and intensification of agricul- tural production in the Terai for the purpose of generating an exportable surplus; and (c) multisectoral projects became the primary vehicle for supporting agricultural growth and rural development in the Hills.  -8- IDA Assistance Strategy for Operations and Institution Building in the Sector 26. In support of the overall priorities and objectives of the Fifth and Sixth Five-Year Development Plans, past IDA lending strategy for agriculture/ rural development had the following underlying objectives: (a) to accelerate the production of essential foodgrains, fuelwood, and fodder; (b) to help prevent the deterioration of the agro-ecological conditions in the Hills; (c) to improve the socio-economic conditions and physical infrastructure in the rural areas; (d) to improve the technological base and institutional framework for agricultural/rural development; (e) to promote development of local and national level institutions foe planning, programming and implementing development programs; and (f) to assist HMG/N in instituting more effective national cost recovery mecharnis.ia and improving provisions for operation and maintenance of assets. 27. To date IDA assistance has been in: implementing multisectoral area development programs in the Hills; developing irrigation facilities both in the Terai as well as in the Hills; improving agricultural extension; improv- ing marketing infrastructure; providing agricultural credit; and promoting extensive reforestation throughout the country. The proposed project would continue support in several of these areas and would translate lessons learned from previous operations into a more focussed and modest project design for rural development in Nepal, and would assist HMG/N in developing and implementing more effective cost recovery as well as operation and maintenance arrangements. 28. Rural Development Programme Design in Nepal. Nepal has followed an integraced multi-sector approach to rural development. This approach combined all the aspects of agricultural development (irrigatior., extension, credit, forestry, marketing, etc.) with efforts to address constraints in other areas, including education, health, transport/communications and cottage industry. The IDA-supported first Rural Development Project (Cr. 617-NEP) was completed in December 1983. It was the first large-scale development program to address the problems in the mid-Hills of Nepal. The project was also among the early rural development (RD) projects to be assisted by the Bank Group. Given the lack of development in the Hills and the fact that rural development needs cut across sectoral lines, the project turned out to be complex, encompassing a large number of components. The project was to be implemented through a coordination mechanism, which was novel to the existing institutions and operational procEdures. Nevertheless, certain key activities, such as the appointment of the Project Coordinator (PC), the establishment of the Project Coordination Committee (PCC) and the basic project planning exercise were carried out prior to credit effectiveness, allowing the project to commence on time. By and large, the project made considerable progress in most of its components up to 1979. At that time, 1MG/N introduced new edministrative arrangements for implementa- tion of RD projects (most important of which was the creation of a new Ministry of Panchayat and Local Development (MPLD) and a heirarchy of commit- tees for project coordination). This, together with the then prevailing political and administrative uncertainties and the problems of staff shortages, frequent staff transfers and shortage of local funds, severely a'fected project implementation. As a result, the project had to be extended by two years. The revised project was completed in December 1983 and the credit was fully disbursed by March 1984. A Project Completion Report has been prepared and a Project Performance Audit is under preparation.  -9- 29. Despite the implementation constraints, most of which were of an organizational nature, the project achieved most of its broad objectives, particularly with respect to expanding agricultural production and developing rural infrastructure. The project also introduced an extension organization in an area which hitherto had no such services. Through the project, important technological changes affecting cropping patterns and husbandry practices were introduced, along with increased use of improved seeds and chemical fertilizers. Additionally, over 3,000 ha of afforestation was carried out ard 105 drinking water schemes, 8 suspension and 39 wooden bridges were constructed. An evaluation study done in 1982 estimated that, compared to the base year of the project, paddy production in the area had increased by 34 percent, wheat by 17 percent, maize by 15 percent, millet by 14 percent and potato by 66 percent. However, production improvements are believed to have taken place mainly on the more accessible and irrigated areas, with minor changes on the more remote and rainfed areas. The effects of the infrastructure and social components have been mixed. Evidently, the bridges constructed under the project have had a positive impact in the project areas, enabling year round communication between villages. Benefits have also been generated from the drinking water supply component and from improved trails and tracks. However, the potential benefits from these are not being fully realized because most of these schemes are facing repair and maintenance problems. The impact of other components, such as cottage industry, health, and education has been minimal, primarily because the development of these sectors is faced with major sectoral (organizational, managerial and some policy) constraints, the remedies for which proved to be beyond the scope of a rural development project. 30. The Second Rural Development Project (Mahakali Hills Cr. 939-NEP) was prepared and appraised at a time (1978-79) when the implementation of RD I wa3 proceeding satisfactorily. It was therefore designed and structured along the same lines of RD I, and consequently, it too turned out tc be a complex project with a large number of components involving some 18 implementing agencies. The project area included three very remote districts with poor accessibility, particularly during the rainy season, and with minimal physical facilities such as buildings for staff housing, project offices, etc. Implementation during the initial years was negligible because of (a) the problems created by a severe earthquake in the area in the first year of the project; (b) delays in staffing of the Project Coordinator's office (PCO); (c) lack of physical facilities at the project headquarters; (d) shortage of contractors for civil work; (e) problems of transporting construction materials to the remote sites; and (f) delays in the release of local funds for project works. Consequently, during the first five years of the project, only about 25 percent of the credit was disbursed, and the credit closing date had to be extended by two years to February 28, 1987, to enable completion of on-going civil works and other programs. However, the past two years have witnessed considerable improvements in implementation as a result of improvements in the staff situation, project management and administration and partial relief of the funding problem. A recent review of project implementation (March 1986) has shown that although achievements in respect of all components are not upto SAR targets, the projc_t has (a) established the physical and institutional arrangements required for providing crop and livestock extension services in the three project districts; (b) increased substantially the supply of agricultural credit and farm inputs in the project area; and (c) initiated a program for improvement  -10- in the rural infrastructure, i.e., drinking water supply, mule trails, offices and housing for district and sub-district level staff, and for soil conservation activities. However, as in the case of RD I, the developmental impact of the social services components have generally not been encouraging except for the health sector in which case nearly 70 percent of SAR targets for delivery of services and development of physical facilities have been achieved. By the end of current Government financial year, total project expenditure will have reached about 65 percent of SAR estimates of project costs and some 40 percent of the IDA credit will have been disbursed. 1/ The present credit closing date a.li allow completion of the remaining civil works program, consolidation of project activities already initiated, institution of a program for systematic operation and maintenance of all project buildings and other physical facilities, full operationalization of the irrigation schemes, and improvement of the scope and quality of agricul- tural support services instituted under the project. 31. The two rural development projects were executed under difficult and uncertain institutional and political circumstances, when HMG/N was struggling to establish an institutional base for effective execution of such projects. The organizational and institutional difficulties were further aggravated by the large number of complex multisectoral projects that were initiated during this period. The enactment of the Decentralization Act of 1982, and the Decentralization Rules and Regulations of 1984, which went into effect in July 1985, are expected to help overcome many of the organizational weaknesses impeding effective planning and implementation of RD projects. The proposed project, therefore, would have the benefit of being implemented under a more stable and predictable institutional framework. 32. In general, implementation experience of the first two IDA-financed, and other donor financed, RD projects in Nepal has contributed to the following lessons: (a) in the Nepalese context RD projects need to be kept simple and focussed on a few key sectors/subsectors, such as agriculture, forestry, soil conservation, and rural infrastructure development; (b) com- plex and centralized inter-ministerial coordination requirements should be kept to the minimum; emphasis should instead be given to program coordination at the district level with the help of effective central support; (c) proper financial and personnel management, including timely flow of funds to implementing agencies and timely posting and retention of qualified staff, is crucial to proper implementation; (d) line ministries must view projects as an integral part of their own work program and demonstrate full commitment to implementation; (e) local level institutions, e.g., Users' Groups (UG), have to be fostered for assisting in the planning and construction of physical infrastructure and for taking over their operation and maintenance responsibilities; (f) design of civil works should be kept simple and to standards that can be easily built and maintained with available local skills and materials; (g) recommended agricultural production technologies should be consistent with the logistic situation of the respective areas and, more importantly, such recommendations need to be based on technologies which are already available and not dependent on the outcome of future applied research activities; (h) considerable attention needs to be given to effective manage- I/ Disbursements have lagged partly because of substantial depreciation of the Nepalese currency since appraisal.  -11- ment of the extension service effort to transmit these technologies; and (i) more effective cost recovery mechanisms need to be put in place to ensure that funds at the local level are available for at least operation and main- tenance purposes. 33. Cost Recovery. Cost recovery measures to help ensure the effective operation and maintenance of assets and services have been less than satisfactory. Moreover, in view of serious budgetary problems which Nepal faces, the Bank has been urging HMG/N to find ways of improving its domestic resource mobilization efforts (see also IBRD Report No. 5867-NEP dated December 12, 1985, "Nepal-Prospects for Economic Growth and Adjustment"). In the context of the agricultural sector there are two areas of immediate concern: pricing of irrigation services and of input supplies such as fertilizer and chemicals. Inputs are currently provided through the Agricultural Input Corporation (AIC) with large subsidies. Water charges are inadequate and collections are poor as discussed below. 34. In the case of irrigation, which is divided into large schemes (above 200 ha), medium (between 50-200 ha), and small (below 50 ha) there is no countrywide and consistently applied cost-recovery mechanism. The Irrigation Department is responsible for the large schemes which are generally located in the Terai and administered by appointed Irrigation Boards. These Boards levy 'scheme-specific' water charges. Experience has been poor, with collec- tions amounting to only a fraction of the assessed charges which are about NUs. 100 per ha, per crop. The Ministry of Panchayat and Local Development (MPLD) and the Department of Agriculture (DOA) oversee the operation and maintenance of small and medium irrigation schemes, which are largely located in Hill areas. The District Panchayats (DP), which come under the jurisdic- tion of MPLD, are empowered to collect irrigation charges. Notwithstanding, cost recovery measures are not diligently enforced. Furthermore, the under- lying principles and guidelines for the levy and collection of relevant charges are ambiguous and often conflicting. More importantly, water supplies are not always reliable. Consequently, there is often little justification for authorities to collect water charges. 35. Our strategy for assisting HMG/N in improving cost recovery has several elements. First, for large-scale irrigation schemes, national cost recovery policies and methods are being developed and will begin to be imple- mented in the context of the Narayani III Irrigation Project, to be proposed for Bank consideration shortly. Second, under the proposed project, steps are being taken by the Government to review and agree with IDA on a set of actions necessary (a) to formulate and implement policies and methods for cost recovery in small and medium irrigation schemes in the project area and more broadly on a national basis, and (b) to reduce input subsidies, and revitalize the financial and operational capacity of AIC and begin to stimu- late a broader development of input supply channels, including the private sector. Rationale for the Proposed Project 36. Experience in Nepal and elsewhere has shown that the problems of rural development are far too complex and deep rooted to expect isolated or relatively short-term intervention to make a fully significant and sustainable impact. This is even more applicable in respect of the Hills of Nepal in which basic infrastructure is only poorly developed and decades of  -12- land misuse and the resulting agro-ecological imbalances need correction. Despite this impediment, it is important for the government to continue with its program to augment food production, correct regional imbalances and improve the economic and social conditions in rural areas. The first RD project--though it suffered delays and administrative problems and was, in retrospect, too ambitious and complex--did meet its broad objectives. More importantly, it helped generate some fundamental institutional, technological and attitudinal pre-conditions for accelerated gains in agricultural production, forestry development, introduction of more rational land use, and further institutional and infrastructure development in the two project districts. Further investments are, however, needed to complete or rehabilitate some of the physical infrastructure, and special attention is needed to help achieve appropriate staffing, operation and maintenance, in order to reinforce and consolidate first phase investments and thereby optimize long run benefits from them. The proposed follow-up project is developed from lessons learned from the first two rural development projects and focuses primarily an directly productive activities. PART IV - THE PROJECT 37. The proposed project, prepared by a Nepalese consultancy group--the Agriculture Projects Services Centre (APROSC)--was appraised in January/February, 1985. Negotiations were held in Washington, D.C., from March 5 - March 11, 1986, with the Nepalese delegation lead by the Additional Secretary, Ministry of Panchayat and Local Development. The Staff Appraisal Report (No. 5834a-NEP) dated June 20, 1986, is being circulated separately. A supplementary data sheet is attached as Annex III. Project Objectives and Strategy 38. The proposed project would: (a) intensify agricultural and forestry development and further the impetus created by RD I in increasing production, employment and rural incomes in the two project districts; (b) ensure that investments made under RD I, as a first phase development, continue to yield the expected benefits; (c) expand and improve the quality and coverage of support services and improve the operations of institutions responsible for rural infrastructure; and (d) strengthen regional, district, panchayat and village level capabilities for preparation and implementation of development programs and for the maintenance of rural infrastructure. The proposed project would focus on activities that are directly production oriented and would help promote changes in existing land use and farming systems. It would strengthen physical infrastructure and institutions that would directly support investments in agriculture. Special emphasis would be given to small farmers as primary beneficiaries of the project. Finally, the project would promote farmers' participation, individually or in groups, in the production of inputs (seeds, planting materials, root stocks, etc.), dis- tribution of other farm inputs and the construction and maintenance of rural infrastructure. 39. In designing the proposed project and determining its scope, full cognizance has been taken of the lessons learned from the first two projects (paras 29-33) and of key Government development priorities and constraints (paras 10-12). More specifically, the proposed project would have fewer  -13- components than the previous ones, and each of the four major components would include activities successfully initiated during the first phase. This sharper focus is also highly consistent with current efforts to rationalize and consolidate Government initiatives, to ensure that highest priority activities receive the needed attention when overall financial and human resources are so severely constrained. The project has been processed after detailed consultation with and agreement of the participating line ministries and agencies, all of which have gained substantial experience through the implementation of the first project. Following the Decentralization Act, coordination of project activities would be at the district level with tech- nical support and implementation assistance provided by a well staffed (local and expatriate) Project Coordinator's Office (PCO), whose role and functions have been clearly defined. Reflecting in part the current fiscal constraints facing the country, the project would also support efforts to review and improve cost recovery performance with a view to generating revenues for local operation and maintenance purposes as well as for investment in other complementary rural development services (paras 36, 58-59). Project Description 40. The proposed project, following the relevant implementation experience and IDA disbursement profile, has been designed for implementation over an eight-year period. 1/ It would cover the two hill districts of Rasuwa and Nuwakot, located in the Bagmati zone of the Central Development Region of Nepal. The project area has a total population of some 230,000 people located in some 80 village panchayats. 41. The project would consist of four major components: 2/ (a) agricul- tural developmt (total outlay of US$9.0 M; 50 percent of base costs)whic would focus on i) strengthening extension, research, credit and other support services; construction of new irrigation schemes and rehabilitation/ maintenance of existing ones; (ii) establishing private fruit orchards; and (iii) improving preventive and curative animal health services and the genetic potentials of large and small ruminants; (b) forestry and soil con- servation (total outlay of US$2.5 M; 14 percent of ba costs which would include (i) afforestation, protection, enrichment, and management of existing forests through community participation; and (ii) preventive and curative measures for the protection of upper catchments, minor watersheds, and agricultural lands, infrastructure and settlements on the lower catchments; (c) rural infrastructure development (total outlay of US$2.4 M; 14 percent of base costs), which would emphasize construction of new drinking water schemes, suspension bridges and motorable tracks, as well as rehabilitation and maintenance of old and existing ones and strengthening district level capabilities for operation and maintenance of physical infrastructure; and 1/ The implementation period would be two years shorter than what is indicated by the relevant disbursement profile because (i) it is a repeater project; and (ii) no new implementing agency would need to be established and implementation would be by existing line departments which have gained considerable experience through implementing the earlier project. 2/ All costs quoted in this section are base costs.  -14- (d) institutional development and implementation assistance (total outlay of US$2.2 M; 12 percent of base costs), which would include (i) maintenance of a Project Coordinator's office; the strengthening of planning, monitoring and implementation capabilities and accounting/financial support services of the district offices; and (ii) strengthening of regional offices of the Agriculture, Livestock and Irrigation Departments. In addition to these four major components, the project would include a technical assistance, overseas training and studies program (total outlay of US$1.8 M; 10 percent of base costs), with provision of 8 man years of senior 1/ and 38 man-years of mid- level professionals, 2/ including international volunteers, and short-term overseas training of key management and technical staff. Funds would also be provided for undertaking studies designed to identify key project/sector related issues (socio-economic, organizational, technical, financial), as well as to generate information on the impact of the various components. This component would include, among other things, a review of HMG/N's cost recovery policies and relevant experiences to-date. Findings of this study would be used to formulate and implement more broadly appropriate national policies and methods for cost recovery and reduction of subsidies (para 58). Salient Features of the Irrigation Sub-Component 42. Irrigation development would include Hill Terrace irrigation and Medium Irrigation Schemes. In the case of Hill Terrace irrigation, the proposed project would complete/rehabilitate 18 small schemes (net incremen- tal command area of 300 ha) that were undertaken during the RD I project period. The extent and nature of work required would vary from scheme to scheme, generally including reconstruction of canaLs/headworks/crossings damaged by land slides, improving/protecting canals/headworks and other structures and, in some instances, extending/deepening the distribution system. Under the proposed project 28 new hill terrace irrigation schemes (total command area 900 ha) and four medium size irrigation schemes (net incremental area of about 750 ha) would be constructed. The hill terrace schemes would draw water from small perennial water sources. Most of these schemes would be essentially development/expansion of existing rudimentary systems and would not result in any significant withdrawal of additional water. 43. The four medium size schemes would be located on the small tributaries (streams) of the Trishuli River - the Phalangukhola, Tadi Khola and Likhu Khola. The Trishuli River originates in Tibet, joins the Gandaki River below the project area which then flows into the Narayani River down into the Indo-Cangetic Plain. The insignificant volume of water that would be withdrawn by the proposed new schemes would not impact in any meaningful way on the quality and quantity of the flows in the Trishuli, the Gandaki or the Narayani Rivers. We are therefore satisfied that the proposed irrigation component of the project will not have any adverse effects on the lower riparian countries, India and Bangladesh. 1/ One Planning, Monitoring and Evaluation Advisor and one Engineering Services Advisor. 2/ Areas of specialization: adaptive research, water management, pasture development, field engineering, vocational training.  -15- Project Organization and Management 44. The proposed project would be implemented by the relevant line departments and agencies at the district and sub-district levels under the overall guidance and supervision of the District Panchayats (DP) of the Rasuwa and Nuwakot districts, as provided under the Decentralization Act of 1982 and the Decentralization Rules of 1984, which became effective as of July 1985. The central and regional offices of the respective line minis- tries would provide technical supervision (for programming, budgeting and implementation) and exercise control on release of funds. Within the two project districts, the Local Development Officer (LDO), as the secretary of the DP, would have responsibility for coordinating planning and implementation. The overall coordination, monitoring of project implementa- tion and implementation support, as required, to the district level agencies would be provided by a Project Coordinator's Office (PCO, para 45), acting as the field arm of the Ministry of Panchayat and Local Development (MPLD) and the Integrated Rural Development Board (IRDB). 45. The Project Coordinator's Office (PCO). The PCO would be headed by a Project Coordinator (PC) who would be a confirmed class I gazetted officer with qualifications and experience satisfactory to IDA. Although not a member of the District Plan Formulation and the District Supervision Committees (established under the Decentralization Act and Rules) of Rasuwa and Nuwakot, the PC would attend and participate actively in the deliberation of these committees. An assurance to this effect was obtained during negotiations. The PCO would be reorganized into seven operational sections, namely, Coordinator's Secretariat, Financial Management and Planning, Monitoring and Evaluation, Training and Communication, Administration, Engineering Services and Kathmandu Liaison Office. All except the latter two would be headed by a gazetted class III Officer (non-technical), while the Engineering Services Section would be headed by a Divisional Engineer (gazetted class II/Technical), and the Liaison Office by a non-gazetted class I/non-technical officer. 46. The District Technical Offices (DTO). The DTOs of Nuwakot and Rasuwa districts would be reorganized into three functionally separate sections: (a) civil works (bridges, tracks, buildings); (b) minor irrigation and drinking water supply; and (c) operation and maintenance. These technical sections would each be headed by an engineer and the Divisional Engineer of the PCO would provide technical supervision and guidance to both the DTOs. 47. Village Panchayats (VP) and User Groups (UG). In line with the provisions of the Decentralization Act and Rules, greater use of these entities would be made for planning, supervision and implementation of project activities at the local level, as well as for operation and main- tenance of physical infrastructure. The VPs would be responsible for identifying and prioritizing development schemes in their respective areas, estimating total resource requirements and mobilizing local resources. Wherever possible, UGs would be formed and would assist the VPs in the above activities. An assurance to this effect was obtained during negotiations. 48. Project Staffing. HMG/N, prior to negotiations, filled key vacancies in the relevant line departments at the district and sub-district levels. Assurances were obtained during negotiations that (a) project staff would be  -16- appointed, deployed and maintained in a manner that would ensure timely implementation of project and achievement of its objectives; (b) the LDOs in the two project districts would be at least confirmed class II gazetted officers with other qualifications and experience satisfactory to IDA; and (c) incremental posts created under the project and determined, during the mid-term review (para 50), to be essential for continued development during the post-project years, would be absorbed in the regular budget of ERG begin- ning in its 1990-91 fiscal year. 49. Agricultural Credit. Under the proposed project, incremental seasonal credit requirements for farm inputs would be provided by ADBN out of its own resources. The IDA credit, however, would provide MRs 4.3 million covering ADBN medium term credit needs for (i) orchard development; (ii) establishment of fruit preservation units by producers; (iii) purchase of milch animals, small ruminants and dairy equipment by farmers; and (v) setting up operations of a cadre of Animal Health Workers. Additionally, NRs 7.3 million would be provided to ADBN for establishing and operating ten Small Farmers Development sub-projects under its ongoing Small Farmer Development Program (SFDP), which is designed to channel credit to small farmer/landless farmer groups for improving crop, livestock and horticultural production and for supporting other income generating activities. Rates for rural credit are fixed by the Nepal Rastra Bank which provides refinancing to ADBN at rates ranging from 6-8 percent, depending on the purpose of the loan. Interest rates charged by ADBN to individuals for short and medium term loans range from 10 percent to 15 percent, depending on the purpose of the loan. Longer term loans (tree crop development) normally carry interest rates of 10 percent, medium term loans (livestock and irrigation development) 12 percent and short term loans 15 percent. Loans from ADBN to Sajha Cooperatives are 4 percent less than those made direct to individuals. Interest on loans from cooperatives to individuals bear the same interest rates as those made direct by ADBN to individuals. With the rate of inflation currently estimated at 7 percent, these interest rates are positive. 50. Mid-term Review. A mid-term review of the project would be completed no later than December 31, 1989, to assess project progress in relation to appraisal objectives and targets, and to identify major implementation constraints, particularly those related to project staffing, organization and flow of funds. As necessary, the mid-term review would determine ways to resolve key issues and recommend measures to facilitate timely and effective project implementation. The terms of reference and scope of the review would be agreed with IDA by January 31, 1989. Project Costs and Financing 51. Total project costs are estimated at US$23.5 M, including price and physical contingencies (US$5.7 M) and a small amount of local taxes and duties (US$0.2 H). The foreign expenditure component is estimated at US$8.7 M equivalent, or about 37 percent of total cost. Price contingencies (US$4.8 M) are about 25 percent of base costs plus physical contingencies  -17- and were estimated according to current estimates of inflation rates. 1/ Physical contingencies (US$0.9 M) were estimated at 7 percent for civiL, works and 5 percent for other expenditures. 52. The proposed IDA credit of US$19.1 H would be to HMG/N on standard terms and conditions and would cover 81 percent of total project costs (93 percent of foreign and 74 percent of local costs). UNDP is expected to finance part of the technical assistance, overseas training and project related studies component amounting to US$1.1 M, equivalent to about 5 percent of total project costs. The IDA credit and UNDP grant together would finance about 86 percent of total project costs. The HMG/N contribution would be US$3.3 M (NRs. 59 M), about 14 percent of total project costs. Since most of the project beneficiaries would be small farmers producing for subsistence, no cash contribution from them other than the amounts they would borrow from ADBN for crop input, improved animals for milk, meat, wool and draught power, and for agricultural tool/equipment purchase, would be expected. However, they would make substantial contribution in kind (in the form of family labor or local materials) for on-farm development works and development and OEM of irrigation and physical infrastructure. IDA and UNDP funds would be channelled through the Ministry of Finance to the participat- ing line ministries. Funds to ADBN covering the agricultural credit provi- sion would be onlent to ADBN by HMG/N under a Subsidiary Loan Agreement, the terms and conditions of which would be satisfactory to IDA and which, among other things, would provide for a repayment period not exceeding 7 years, and an interest rate that would be equivalent to the prevailing discount rate of the Nepal Rastra Bank. Funds to AIC would be provided by HMG under an agreement between HMG and AIC, the terms and conditions of which would also be satisfactory to IDA. Execution of the Subsidiary Loan Agreement with ADBN and the Financial Agreement with AIC would be conditions of disbursement of IDA funds in respect of expenditures for the provision of credit to farmers and funds to AIC for importation and distribution of farm inputs. Signing of the UNDP TA agreement, appointment of an executing agency for the UNDP TA project and satisfactory reorganization of the PCO would be conditions of IDA credit effectiveness. Procurement and Disbursement 53. All civil works (US$10.0 M) would be simple structures of standard- ized designs, widely dispersed geographically and over time, thus rendering them unsuitable for International Competitive Bidding (ICB). Construction of buildings, roads, bridges, drinking water supplies, soil conservation struc- tures and irrigation works would therefore be awarded to local contractors following Local Competitive Bidding (LCB) procedures, which were found at appraisa. to be satisfactory. Vehicles, equipment and furniture (US$1.7 M) would be grouped in appropriate bidding packages to facilitate competitive bidding. Procurement would be by ICB in accordance with Bank guidelines, except where individual items are valued at less than US$30,000 and the total order does not exceed US$150,000, in which case procurement would be by LCB procedures satisfactory to IDA. Fertilizers and agrochemicals (US$1.7) would be procured by AIC through ICB. Nearly 50 percent of the total expenditures 1/ 1986/87, 7 percent; 1987/88, 7.3 percent; 1988/89-1989/90, 7.6 percent; 1990/91, 6.0 percent; 1991/92 and onwards, 4.5 percent.  -18- for forestry and soil conservation (US$2.4 M) would be for hired labor, 35 percent for planting materials, and 15 percent would be transportation costs. None of these would be suitable for competitive bidding, and hence these would be performed through contract labor and/or under force account. Breeding stock (US$0.15 M) would be purchased from local and Indian markets at prevailing market rates and would not be suitable for usual bidding procedures. The balance of project costs (US$7.6 M) would be for staff salaries, vehicle operating and maintenance costs, miscellaneous adaptive research costs, in-country training, agricultural credit, technical assistance, and overseas training which would not be suitable for competitive bidding. 34. Disbursements. Disbursements under the proposed IDA credit are expected to be completed by December 31, 1993. Disbursements would be made for civil works, equipment, vehicles, construction materials, agricultural materials (partly through credit) and inputs, in-country training as well as for incremental salaries and operating costs, on a declining basis. 55. Accounts and Audit. Under EKG/N rules, it is the responsibility of the Ministry of Finance to maintain, through the offices of the Financial Comptroller General, all government accounts while the Auditor General is responsible for auditing of all such accounts. HMG/N seeks to ensure that all accounts are maintained following sound accounting principles, and the scope of the audit is sufficient to evaluate the regularity, propriety, economy, efficiency and effectiveness of public expenditure. However, performance of HMG/N to date in respect of the IDA audit and accounting requirements has been unsatisfactory, and in most projects the audited accounts have frequently been substantially in arrears. This is partly because expenditures related to IDA-financed projects have been audited by the Auditor General as part of the implementing government department's overall financial records and the Auditor General does not release the full audit report until it is cleared through several steps, including presenta- tion of the main report to the National Panchayat. In order to ensure that covenants related to audit in IDA assisted projects are complied with on time, IDA has been assisting project accounting staff in preparing separate project accounts in such detail as required for audit, soon after the end of each fiscal year, and presenting these to the Auditor General. IDA has also proposed the format and content of the auditors report on such accounts which can be completed and forwarded to IDA without waiting for the full audit report of the concerned department's overall annual financial accounts. Similar procedures are being instituted for timely audit of all withdrawal applications based on Statements of Expenditure (SOEs). The project would also provide additional accounting staff and in-service training to existing accounting staff in the two project districts to improve financial management. Assurances were obtained during negotiations that EMC would cause the participating line departments, the AIC and ADBN: (i) to maintain separate records and accounts for all project expenditures in accordance with sound accounting principles; (ii) to have such accounts audited by an independent auditor acceptable to IDA, in accordance with sound auditing principles; (iii) to forward to IDA, such accounts together with the Auditor's reports and certification within nine months after the end of each fiscal year; and (iv) to include in the annual audit reports submitted to IDA, a separate opinion from the Auditor as to whether the disbursements made on the basis of SOEs were in respect of goods and services received and incurred for the purposes of the project. During negotiations it was also  -19- agreed that, to facilitate disbursement flows, a Special Account in the Nepal Rashtra Bank would be opened and maintained by the borrower on terms and conditions satisfactory to the Association, and with an authorized allocation of an amount equivalent to US$350,000. 56. Retroactive financing of up to US$300,000 would be provided to cover the following project expenditures incurred after July 16, 1985; (i) salaries, allowances and other operational costs of the PCO; (ii) pur- chase of vehicles, equipment and furniture; (iii) feasibility studies and detailed design of irrigation schemes and other civil works; and (iv) staff training. Fiscal Impact and Cost Recovery 57. Fiscal Impact. Since the beginning of the 80's, Nepal has been experiencing an unfavorable budgetary situation with deficits running up to 12 percent of GDP. Consequently, Nepal is faced with the problem of main- taining a reasonable level of development expenditure while reducing the growth of regular expenditures and, at the same time, increasing the mobi- lization of public resources. During project implementation, HHG/N would be required to provide, on an average, about NRs. 8.0 (US$0.44 M) annually as local funds, equivalent to less than one-tenth of one percent of current levels of public expenditure and revenue, respectively. During the post- project phase, after eight years of project implementation, the average annual recurrent cost for maintaining project related services and O&M costs for the physical infrastructure would amount to about N&s. 7 M (US$0.39 M). This level of incremental public expenditure would be justified in view of the project's expected contribution to improving agricultural productivity, employment and rural incomes and in preventing further deterioration of the environment in the project areas. However, it is expected that during implementation, efforts would be made by the Government to keep overall incremental salary and wage costs at a minimum by giving priority to redeployment/reallocation of existing personnel in meeting the project's incremental staff requirements. Secondly, steps for mobilization of resources at the panchayat/village levels would be intensified in order to reduce the O&M burden on the public sector, and a program by HMG/N for the necessary studies and mechanisms to rationalize and reduce overall subsidies and improve cost recovery would be initiated as discussed below. 58. Cost Recovery. A stated objective of HMG/N is to generate increased amounts of resources at the local level with a view to ploughing these back into the local economies, either for new investments or for operation and maintenance of physical infrastructure. In keeping with this policy, provi- sion exists for levying irrigation water charges (currently fixed at about NRs. 62 per ha per crop for hill and small irrigation schemes, and NRs. 100 per ha per crop in larger command areas). The District Panchayats are also empowered, under the Decentralization Act, to collect tolls on roads and bridges. Notwithstanding the above, cost recovery measures are not diligently enforced; the underlying principles, policies and guidelines for the levy and collection of relevant charges are ambiguous and often conflicting. The current levels of irrigation water charges were established in 1975 and the published rates do not recover present operation and main- tenance costs. Moreover, only small amounts are collected, and the system is not flexible enough to take into account unforeseen circumstances such as land slides, drought, power failure, etc.  -23- .^L&.LLh hZH I - SOULW C^tJ S I Page I of 6 on cn icnn ln m. U AL 140.5 140o. 140.6 MKICUILTUlL 35.3 36.5 41.2 w m :ia COOU) tw * - 1o0 275.3 1011.1 umm Ouuwm URn cAnfa thILOUL Of OIL iUVaLUIT) 3.0 10.0 10.0 235.7 566.6 POsUATON.INg" CT(foUh ) 90.0 11)50.0 1573*.0 mi Mor4n0U cz or ToTAL) 2.1 3.9 4.9 22.3 35.9 P01FJITI0E WOICTII0N P8UTUU I0 TIM 2000 (lULL) 24.5 SIAf1MM P0PUaTT Cm") 74.0 iOe"UMsu msiNMs 1.6. sxom"z Dsm P11 me. M. A.5 50.6 111.5 173.5 36.9 7U sq. IN. aGR. ID 2".2 305.4 374.5 353.3 1591.2 PWUTION AN STUCTU (2) 0-14 US 39.0 42.0 42.5 36.3 3s.2 154 s 57.4 55.0 54.2 "A 57.7 63 muIDnn 3.4 2.9 2.9 '.3 3.5 POP1ULATU 3oWMW RMAS (2) TOTAL 1.4 1.9 2.5 2.u 2.3 URA 4.5 4.2 5.0 4.1 4.1 CUD S KUllo SAT (PE TN0S) 45.9 46.3 41.6 27.5 10.1 MM3 DUATR RATE (PER TWU0S) 25.6 23.0 16.1 10.2 9.4 :OSS RWD1DUCTzIO RATE 2.7 3.1 3.0 1.7 1.W A.MILY PLIIIC ACETORS. ANNUAL (TO) .. 29.7 223.2 UStS Of oIrWD Ktl)WC .. .. 7.0 49A 56.5 FOOD MDf II TIISSS iHUER or FOOD LOD. PER CAITTA (1969-71-100) 106.0 101.0 U5.0 116.b 124.4 PER CAPITA SUPPLY Or CALORIES (a OF 1EIIUIINTS) 57.0 94.0 B9.0 1U6.3 115.7 PROTEINS (GAUMS P1 DAY) 50.0 50.0 47.0 60.1 60.3 0O 1AGCII ANDIAL AD PULSE 10.0 9.0 L.0 /c 14.4 14.1 CiInD (ACES 1-4) DVETR RATE 32.5 27.5 21.0 7.3 7.2 LIF CEPECT. AT llirrH (C1A*S) 33.4 41.4 66.1 60.5 b0.6 DIANT IOCT. KM (PU THOUS) 194.5 172.5 143.0 19.2 b4.V ACCZSS TO SAFE WATER (%POP) TOL .. 8.5 14.0 id 14.2 *6.0 URBAN 47.7 71.0 83.0 o7i 77.2 N7.b RUMRL .. 6.0 7.o 7;- 34.6 37.1 ACCESS TO KICRITA DISPOSAL Cs or POruuATION) TOTAL .. 1.5 2.C t/ 7.8 501.1 URBAN .. 13.0 16.0o7 21.8 52.9 RURAL .. 1.0 I.D7-i S.5 44.7 PO9UlATIO PER PRISICJa 73470.0 51360.0 Is 30060.0 I4 3315.0 7751.7 POP. PcI NS1U PlESSOR .. 7c00.0 1. 334z0.0 /d 4690.7 Zb54.8 20P. PCIE OSPITAL ED TOTAL U260.0 6930.0 5720.0 It 1039.2 11lZ.2 URBAN 290.0 330.0 450.0 77 299.1 651.4 RURAL .. .. .. 6028.2 259i0.9 ADUSSIONS PER HOSPlTAL SBE .. .. .. 52.3 41.1 AVERAGE SUZE OF SEHOLD TOTAL 5.5 URA 5 ...... RURAL .. .. AVERAGE NO. OP PERSONS/ROOM TOTAL ;. .. URAN 2.0 .. IRIAL .. .. RCENTAGE O Do U GLLICS 1r1T ELECT. TOTAL .. .. URDO 3n.2 .. RURAL .. ..  -24- ANNEX I T A I L It Page 2 of 6 NAL SOCIAL INOCATORS D NEPAL aEEEC VRUS (IdIGOTI AVIRAESJ /a lOUT (clST RICIIIT 6TIMATO) lb RCCIIT LOW I cow KIDDL INCOM ;i,.L 1970L. KSTIATUL& AStA & PACIcnC ASIA & PACIIc ADJUS D ENOLIIINT RATIOS PrEDAus TOTAL 10.0 26.0 73.0 gp.. 100.7 mmIR 19.0 43.0 102.0 105.5 104.4 TtmuLS 1.0 6.0 42.0 79.3 97.2 SECoNDY: TOTAL -.0 10.0 21.0 31.3 47.8 UALZ 11.0 14.0 32.0 40.5 50.b OtWS 2.0 3.0 9.0 21.9 ".8 TOCATIOWAl. (2 or SEWt1DA ) 0.2 5.5 6.8 C 3.2 113.4 PUPIL-uKAmKI RATIO PRDLM 33.0 22.0 46.0 35.0 30.4 SUNOIIDU 32.0 .. 22.0 17.4 22.2 PASSEGRI CAZSITIMID to 0.1 0.4 .. 0.9 10.1 RAI RICKIMIS/IOUSADUD MP 3.0 4.8 22.7 129.4 172.9 TV RCIUR/TIUISJD PO .. .. .. 19.5 58.5 NISPAPRE ("ALTY GmIZL INTEUSTR) CIRlUATION PM TiIOUND POU TON 0.7 2.4 7.1 25.7 65.3 CUDV ANNUAL ASTlNDlCiI TA .. .. .. 6.0 3.4 LABORCI TOTAL LABK VOIE (TROS) 4853.0 5534.0 7413.0 DLUZ (PZUNCT) 40.5 39.2 39.0 33.2 33.6 AGCULTJLURE (PEET) V5.0 94.0 93.0 Id 69.6 52.2 INDSSTRY CPERCENT) 2.0 2.0 2.0 71 15.6 17.9 PARTICIPATION RAT (CPERCENT) TOTAL 51.6 4.68 47.1 41.9 38.9 KALE 41.5 58.8 56.9 53.6 50.13 FEIALE 41.8 38.6 36.9 29.1 2b.8 ECONONIC DEPEDNCY RATIO. 0.6 0.9 1.0 1.0 1.1 INCON DIS SZINTI PERCENT OF PRIVATE INCOME RECEIVED UT MICHEST 520 orHUSEWLDS .. .. 35.3 NICHEST 202 OF SOUSEOLWS .. .. 59.2 _ .. 48.U LOWEST 202 OF hOUSEROLDS .. .. 4.6 c .. o.4 LOWEST 402 OF HOUSEOLDS .. .. 12.64 .. 15.5 PoPUCE SIE QAuPs ESTMATED ABSOLUT POVERTY INC0ME LEVEL (USS PER CAPITA) UN .. .. 95.0 133.9 RMtAL .. .. 45.0 111.6 151.9 ESTmATEO RELATlVE POVERTY I!COHE LEVEL (USS PER CAPrrk) URAN .. .. .. .. 17 7.9 RURAL .. .. 41.0 LL. 61.7 164.7 ESTMEATED POP. BELCU ABSOLUTE POVElRY INCOME LEVEL (2) URIAN .. .. 55.0 Ic 43.8 23.5 PIIRAL .. .. 61.0 Ic 51.7 37.1 Nar AVAILALE .NOT APPLICAN.E N O T E S /a The group avrages for each Indicator cre population-ielghted artcletc _sana. Coverage of countriem among the indicators depends on avaloabilcty of data and a" not uniform. /b Unless otberwis* noted. "Data for 1960" refer to any year b.tveen 1959 and 19b1: "Data for 197U" between 1969 and 1971; nd data for '"ost Recent tscute" between 1981 aod 1983. Ic 1977; Id 1980; /. Personnl Ln governmt wervices only; If 1978; .X 1979. JUNE. 1945  ANNX I -25- lage 3 of 6 *DMMN1OY FSOCAL DIATO NaeuAtiinomte dMam e dMiaa riia%au mom mrilIy Jfd hemeaauouihdlaheandrelkiabet sod alebe mmd tha uy may natbe aurmatiamay CMr b1mm d tlibik of Kadudimd ddlWor ad cmu mid by dim coanUl. in coa bte date TMe da am nonet1ele1, miW to TMe r oma a () th s comfy pomp ddsu bju comnry and (2) aouo _au p withs m bat hlheramp incxmtha corry promp ofthe ubjm mmi a(ampiror 'Hblsm uau ONEspone pmopwintr MiddslEIcomeNorth Afrim md Middloe lM' .cam beamosofuraup o4dtl alhe). th as I p omp data tlb e ama.. popmlaon wI uWark_hmeemu for ea odicaor adsbowolywh0 mody oftheom_nbuapompw dator aldicator. Sba dh esmtp courtri gtheindodon_I don te avalability odBdta anb is not uiom cutio muM be ed b I nein f eam nofam indctor tanodir. Tlae . ae eamiy mimscopinhe whmBof nc iedictrt a imamong the amunu ad 6mn poUP. ARE (thousand sq.kn) Cr " Rat (pm' ieaud)-Nunber ofive births in the year Tau-Tol srfae nita ompriing lndW area and idnd wte; per thousad of mid-yar population; 1960, 1970, and 1983 data. 1960.1970 and 1963 dataL Chd Dath Roe (pw eahend)-Number of deaths in the year 4gniinbwul-Estmate of agricultural area ed temporarl or per thousanod of mid-yer population