Nepal - Second Telecommunications Project

CIRCULATING COPY TO BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Report No. P-1227-NEP REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A SECOND TELECOMMUNICATIONS PROJECT April 12, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  Currency Unit Nepalese Rupee (NR) US$1 = NR 10.56 NR1 US$0.095 NR 1,000 - US$94.70 NR 1,000,000 US$94,697 Nepal Fiscal Year - July 16 to July 15 Nepal Calendar Year = April 16 to April 15  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A SECOND TELECOMMUNICATIONS PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal for the equivalent of US$5.5 million on standard IDA terms to help finance a project for the expansion of domestic and international telecommunication facilities of the Nepal Telecommunications Board (NTD). The proceeds of the credit would be relent to the NTB for a term of 20 years, including a five-year grace period, with interest at 7-1/4 percent per annum. PART I - THE ECONOMY 2. The most recent economic report entitled "Economic Situation and Prospects of Nepal" (125-NEP) is being distributed separately to the Executive Directors. The principal findings and conclusions of that report are summarized below. 3. Nepal has been classified by the United Nations as one of the least-developed countries in the world. Its per capita income is estimated at $70-80 per year; the literacy rate is only about 10 percent. Lack of dependable statistical data makes difficult a precise assessment of the recent economic performance. Available statistics should therefore be considered as indicating no more than orders of magnitude and broad trends. There is, however, evidence that since 1965 Nepal's real economic growth per capita has been almost entirely neutralized by population growth, estimated at 2.2 percent a year. Agriculture accounts for about 70 percent of GDP and provides employment for about 90 percent of the labor force of which the great majority are subsistence farmers. The industrial sector is very small and its contribution to GDP has been marginal. 4. Serious efforts toward development have been underway only since the late 1950's. Development expenditures have increased rapidly -- from NRs 232 million in 1964/65 to NRs 570 million in 1971/72. The great bulk of the resources available for development have been invested in infrastructure, particularly roads, power and irrigation facilities. About half of expen- ditures for development during this period have been financed with external assistance, notably from India, the United States and China. About 80 percent has been in the form of grants. Nepal's external debt service has thus remained very low. Gross external reserves have been increasing and as of September 1972 stood at $117 million, of which about $90 million were convertible. 5. In its efforts to formulate and implement development programs and projects, the Government is faced with unusually severe constraints.  - 2 - The country is landlocked and the physical resource base is very narrow, consisting mainly of agricultural land, hardwood forests and abundant water resources available for both power generation and irrigation. No minerals in commercial quantities have been discovered. Nepal's internal market is small and production costs tend to be high. About 60 percent of the popu- lation live in the Hills 1/ at or near subsistence levels. For lack of trans- portation facilities, large numbers of communities are virtually isolated from each other. This lack of transportation underscores the need for extending and improving the country's telecommunications system (see para- graph 32). 6. One of the important constraints on Nepal's economic development has been the limited capacity of the Government to plan, appraise and imple- ment development programs and projects. The problem is apparent in most sectors and its principal elements include poor coordination of closely related programs; lack of progress reporting and evaluation; defective project formulation and implementation; and general difficulty in taking decisions within the Government. Given Nepal's late awakening to the process of economic development, these problems are not unexpected. While note- worthy attempts at improvements have been undertaken in the past few years, much remains to be done and substantial technical assistance will be required to supplement the limited Nepalese staff that possesses requisite skills. 7. Inspite of these constraints, the prospects for increasing agricultural output, without which little growth is possible, are reasonably good. Within the agricultural sector, the best possibility over the short and medium term is increasing the production of foodgrains, particularly rice, wheat and maize. Preliminary analysis of Nepal's future foodgrain position indicates that unless timely and effective measures are taken, the current export surplus (about 300,000 tons of rice per year mainly to India) may soon turn into a deficit. In the Hills, where no additional land is available and yields are low, the principal requirement is to increase produc- tivity by means of improved technology and to restructure agriculture away from foodgrains toward more suitable horticulture and livestock production. In the Terai 1/ to the south, foodgrain production can be substantially increased not only from improved technology but also by expanding the area under cultivation and making use of the potential for extending irrigation and for controlled resettlement in cleared forest areas and waste land. Cultivated land in Nepal amounts to about 1.8 million ha or about 13 percent of the total area of the country. However, only about 120,000 ha are irrigated and all of the systems in operation are designed primarily 1/ The Hills in the central region consist of cluster of rugged mountains ranging from 1,000-4,00() meters in elevation and cut by the valleys and gorges of Nepal's major north-south river systems. The Terai is a narrow plain along the Indian border with elevations up to 1,000 meters (see attached map).  -3- to provide supplemental water to the wet season rice crop. Few of them have significant supplies of water during the dry season and double cropping is therefore very limited. Expansion of irrigated agriculture in areas where double cropping can be practiced offers the best possibility of expanding foodgrain production over the medium term. In the longer term, the output of foodgrain and also cash crops can be increased further by bringing new land under cultivation in the forested areas of the Terai. 8. Over-population in the Hills and uncontrolled migration to the Terai pose serious threats to future development. A greatly expanded land clearance and resettlement program in the Terai would help to absorb part of the excess population and, if carefully planned and controlled, could substantially reduce wasteful destruction of forests and severe erosion of arable land. Intensive farming of new irrigated land would also provide a livelihood for migrant farmers as would a program for systematic and efficient utilization of Nepal's forest resources. 9. Exploitation of Nepal's forest resources with a view toward developing exports of timber offers one of the most promising opportunities for export diversification. The tourism sector, for which the Association has granted a credit of $4.2 million in March 1972, has expanded very rapid- ly in recent years and continued growth is quite possible, provided a program for increasing hotel accommodations and other facilities is implemented. Most of Nepal's recorded foreign trade (75 percent of exports and 90 percent of imports) is with India. In addition, because of the relatively open border, there is substantial unrecorded trade between the two countries. Total recorded merchandise exports to all countries have averaged about $40 million over the past several years. Of exports to India, about 50 percent has been rice. Jute and jute products account for about 70 percent of exports to third countries. 10. With a quickening of the pace of the development effort, a major constraint on further development is Nepal's ability to mobilize resources, both domestic and foreign. Over the past seven years (1964/65-1971/72), domestic revenue and total expenditures grew by about 15 percent per year -- substantially faster than the growth of GDP. Development expenditures alone more than doubled and increased their share of GDP from 3.9 percent to 5.7 percent. However, with domestic revenue currently only about 5.2 percent of GDP, Nepal's tax effort remains low. Substantial improvement will be necessary if development expenditures are to continue growing at a satisfactory rate. 11. Although Nepal's absorptive capacity is today limited, her own efforts, supplemented by technical assistance, will progressively enable her effectively to utilize an increasing volume of new investment. With domestic savings at a low level, the need for external resources may be expected to expand substantially. The outlook for a continued flow of bilateral grant aid on the scale of the past is uncertain. Nepal's currently comfortable foreign exchange reserve position is, therefore, unlikely to be a permanent feature. With limited prospects for earning convertible currency and, in view of its extreme poverty, Nepal's requirements for foreign assistance on soft terms could rise rapidly in the future.  -4- PART II - BANK GROUP OPERATTONS IN NEPAL 12. The first IDA credit to Nepal in the amount of $1.7 million equivalent was made in FY 1970 for a telecommuncations project. This was followed by credits for highways ($2.5 million), tourism ($4.2 million) and irrigation ($6 million). The proposed credit would bring the total amount of IDA assistance to Nepal to $19.9 million equivalent. No Bank loan has been made to Nepal and there are no IFC operations in the country. Annex 2 con- tains a summary statement of IDA credits as of Mfarch 31, 1973 and notes on the execution of ongoing projects. It shows that there have been delays in the implementation of the ongoing projects, which were largely due to Nepal's limited technical and management capabilities. 13. Bank Group lending to Nepal has so far been at a modest level compared to the country's needs for, and total receipts of external assistance. This is due to the relatively large amounts of assistance given to Nepal by other donors and the country's limited absorptive capacity, affecting the rate of project identification, preparation and implementation. Prospective Bank Group operations in Nepal reflect the country's needs (a) to place major emphasis upon directly productive sectors, particularly agriculture and forestry; (b) to give special attention to integrated schemes within the agricultural sector upon which economic development in Nepal basically depends; and (c) to continue assistance for the development of infrastructure, including water supply, feeder roads and other forms of communications, par- ticularly between the Hills and the Terai. 14. A mission to appraise a water supply and sewerage project will visit Nepal during the cu1rrent fiscal year; further missions are scheduled in the coming months for a number of prospective projects including a forestry/settlement project, a rural development project and a second high- way project. In view of the institutional constraints and shortage of trained personnel in Nepal, the identification, preparation and implementation of these projects are likely to require more time and effort on the part of the Bank Group as well as greater inputs of technical assistance, than is common in other countries. For this reason, technical assistance will be an important element in many future projects. PART III - TELECOMMUNICATIONS IN NE]PAL 15. The telecommunications sector in Nepal is still in its infant stage. Until the first IDA telecommunications credit (166-NEP) was made to Nepal in November 1969, local telephone services were available only in the Kathmandu area and Biratnagar in the southeastern part of the country, and there existed no long-distance network for normal telephone conversation. In July 1972, the total number of subscribers was still a mere 4,563. The telephone density at that time was .06 per 100 people, a substantial increase from .025 per 100 people in 1969. Nonetheless, the density is one of the  lowest in the world and well below the average for developing countries. The quality of the local telephone service has been showing steady improvement even though it is still far from being adequate. 16. Minimum communications -- mainly used for telegraph purposes -- between some 78 centers throughout the country are provided by means of high frequency (HF) radio stations which operate on a part-time basis. These stations are overloaded at the main centers and the use of voice transmission leads to considerable distortion of messages. Even though international telecommunications services are gradually improving, they are still inadequate since the land line to India via Birganj is subject to disruption due to landslides and flooding during the monsoon season and the alternative HF radio services to India, Pakistan and Bangladesh do not provide adequate transmission standards for telephone service. 17. The ongoing project provides for the connection of an additional 4,000 subscribers on automatic and 1,000 subscribers on manual telephone exchanges. Long distance telephone services will be provided for the first time in Nepal linking Kathmandu with the main cities including Pokhara, Birganj, Nepalganj, Bhairawa, and Biratnagar (via Malangwa, Janakpur, Siraha, Rajbiraj, Dharan). International services will be improved by the intercon- nection of the Kathmandu-Birganj microwave system with the microwave routes to Calcutta and Delhi. After initial delays in making the credit effective, delay in signing an agreement with India for some of the aid provisions and delays in taking procurement action, this project is now proceedineg satis- factoril) and completion is expected by December 1974, some 18 monthls behind schedule. 18. Until 1969, the telecommunications system was operated by the Nepal Telecommunications Department of the Ministry of Works, Transport and Communications. In view of the expansion of services as provided under the first telecommunications credit, the Government, with the support of the Association, established in 1969 the Nepal Telecommunications Board (NTB) which since then has been responsible for the provision and operation of all public domestic and international telecommunications services within Nepal. NTB operates within an annual budget appropriation; tariff adjustments are subject to government approval; and recruitment and dismissal of higlh- level staff are banded by tlie Puiblic Serrvice Commi;ssinT1. 19. Government is now considering legislation providing for the conversion of NTB into a corporation. While this proposed conversion is unlikely to necessitate major changes in the existing organization, it should result in a greater degree of autonomy in the overall operations of the entity. Majority ownership would continue to be vested in Government, but there would be provision for public and employee participation in the ownership of the Corporation and participation on the Board of Directors. The operation of the Nepal Telecommunications Corporation (NTC), when created, will be s-',ject to rules to be issued eby Government and arlicles adopted 'y the Cornoration. The GIovernrnent has atreec,' that any proposed rules or articles will fie made available to thle Qs-noclation for COmmnent hbFc7rc being bro-ught into force.  -8- rapidly to becoine quite satisfactory towards the end of this decade. Accord- ingly, it was agreed in negotiating the proposed credit that a 5 percent rate of return on average net fixed assets in operation would be required in FY1975-79, and 10 percent from FY1980 onward. The debt service covenant of the present agreement, which required NTB to obtain IDA agreement before contracting new debt unless the debt service coverage exceeds 1.5, has been repeated under the new credit. 29. The financing plan assumes an increase in telecommunications tariffs to provide an increase in total revenues of about 15 percent on existing revenues effective July 1973. During negotiations, the Government agreed to a tariff increase scheme which would yield the required revenue increase. T-e -Coverrment has also agreed that, during the project period, telecommunications tariffs may be reduced only with the agreement of the Association; that funds will not be transferred from NTB during the construction period without submitting a satisfactory financing plan acceptable to the Association; and that it will provide short-term financing to NTB as and w1hen the need arises. Procurement and Disbursenent 30. All procurement would be by international c:ompetitive bidding in accordance with the Bank Group's "Guidelines for Procurement" except for additions to the microwave system and extensions to existing telephone exchanges and those now ieinz insraLiled under the first project. These items will cost an estimated US$500,000 ancd should, on the grounds of compatibility and the economies resulting from the use of existing common equipment and ancillary facilities, be contracted for with the original suppliers. There is a 5 percent customs duty preference for goods from Commonwealth countries, but NTB intends to evaluate all tenders on the basis of C. I. F. pri rces. 31. The proposed credit would be disbursed against the C. I. F. cost of imported equipment and materials and the foreign exchange costs of services and training. Estimated disbursements from the proposed credit are shown in AMnnex 3. As the pro-ject is part of a continuing investment program, it is proposed that any savings be made available, after consultation with the Association, for the purchase of additional items of the same type. Benefits 32. The basic justification for the proposed project is that it would help provide an essential part of the infrastructure required to facilitate communications, which in turn should contribute importantly towards economic development of the country. The present inadequate communication system seriously hinders production, distribution and marketing. There is also a need for improved and expanded telecommunication facilities in order to meet the requirements of administration, health and other social services. The rate of return on the project based upon expected revenues is 20 percent. A sensitivity analysis has been carried out, showing that, even with a combination of unfavorable developments of the main parameters, the rate of return would not be less than 14 percent.  -9- PART V - LEGAL INSTRUMENTS AND AUTHORITY 33. The draft Development Credit Agreement between the Kingdom of Nepal and the Association, the Recommendation of the Committee provided for in Article V, Section 1(d) of the Articles of Agreement and the text of a resolution approving the proposed credit are being distributed to the Executive Directors separately. The draft agreement conforms to the normal pattern of credits for telecommunications projects. 34. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 35. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President Attachments April 12, 1973   ANNEX 1 Page 1 of 2 pages COUNTRY DATA - NEPAL- AREA POPULATION (est.) DENSITY 14l,000 sq. km. 1l.2million (mid-197l) 8o persq. km. Rate of Growth: 2.2 percent (mid-1