Nepal - Review of the economic situation

Report No. 1180-NEP 3 Review of the Economic_ Situation of Nepal July 22, 1976 South Asia Region Country Programs Department FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equlvalents Before October 9, 1975: US$1 - Nepalese Rupees (Rs) 10.56 Rs 1 = US$0.094 = Indian Rupees (IR) 0.726 After October 9, 1975: US$1 = Rs 12.50 Rs 1 = US$0.08 Fiscal Year Nepal Fiscal Year - July 16 to July 15 This report is based on the findings of a mission composed of Messrs. C.J. Jansen (mission chief), C.P. Cacho and D. Kumar. The mission visited Nepal from January 18 to February 7, 1976.  FOR OFFICUIL USE ONLY SPECIAL REPORT: REVIEW OF THE ECONOMIC SITUATION OF NEPAL TABLE OF CONTENTS Page No. Basic Data Summary and Conclusions . .......... ............ ............... i - viii I. The Scope for Development . .. A. Background .....1 .......0......0 B. Development Objectives .......................... 3 C. Planning and Development Management ............. 6 1. Planning Organization .............. 6 2. Development Management at the Local Level 7 3. Public Sector Management.. 8 II. The Fifth Plan .......... ..... 9 A. Introduction .. ... . . . . .. .. .. ........... 9 B. Agriculture ................... 11 1. General ............ 0 . 11 2. Past Growth Record 12 3. The Agricultural Development Strategy 14 4. Institutional Aspects. 16 5. Prospects for Agricultural Growth 18 C. Industry . . .19 D. Transport ... ..... .. ................. 21 E. Tourism .,........ ,, , . .......... 22 F. Power .24 G. Education .. ......... I..,... . ............. . , 25 H. Health .. . . . . . . . . . . . . . . . . . . . .26 I. Water Supply and Sewerage. .. .. 27 J. Conclusions ..... ........ a .................. 28 III. The Financing of Development . . . 30 A. Domestic Resources . ... .. .30 1. Prospects for Revenue .. . . 30 2. Prospects for Current Expenditures . 31 3. Prospects for Public Savings 33 4. Prospects for the Overall Deficit . 33 This document has a mtricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -2- Page No. B. Balance of Payments .... ....................... 34 C. External Assistance ........ . . . . . . . . . . . . . . . ........ . 36 1. Priority of Foreign Aided Projects .......... 37 2. Design of Foreign Aided Projects ... ....... 37 3. Local Currency Requirements of Foreign Aided Projects ..... ....................... 37 4. Co-financing Arrangements ................... 38 5. Terms and Conditions of Aid ................. 38 Annex I Summary of Industrial Projects under Consideration by HMG or Nepal Statistical Appendix Maps List of Tables in the Text Table No. 1 Sectoral Allocation of Public Investments 10 2 Targets and Achievements of Major Agricultural Programs during the Fourth Plan 13 3 Growth of Agriculture: A Tentative Mission Projection 19 4 Growth during the Fifth Plan: A Tentative Mission Projection 29 5 Public Finance during the Fifth Plan: A Tentati-ve Misson Forecast 32 6 Balance of Payments 34  Page 1 of 2 pages COUNTRY DATA - NEPAL AREA 2/ POPULATION DENSITY 140,797 kwr- 12.6 million (mid-1975) 90 per =2/ Rate of Growth: 2.2% (from 1965 to 1975) 452 per 2m- of arable land POPULATION CHARACTERISTICS 19Q75) HEALTH (1975) Crude Birth Rate (per 1,000) 4O Population per physician 36,000 Crude Death Rate (per 1,000) 20 Population per hospital bed 5,800 Infant Mortality (per 1,000 live births) 200 INCOME DISTRIBUTION (year) DISTRIBUTION OF LAND OWNERSHIP (year) % of national income, nignsst quintile .. % owned by top 10% of owners lowest quintile .* % owned by smallest 10% of owners ACCESS TO PIPED WATER (1974) ACCESS TO ELECTRICITY (1975) % of population - urban .% of population - urban - rural - rural 7.00 3.0 NUTRITION (year) EDUCATION (year) Calorie intake as % of requirements .. Adult literacy rate % (1971-72) 14 Per capita protein intake Primary school enrollment % (1974-75) 43 1/ GNP PER CAPITA in L975 : US $111 GROSS NATIONAL PRODUCT IN 1974-75 ANNUAL RATE OF GROWTH (M. constant prices) US $ Mln. % 1965-75 GNP at Market Prices 1,42.1h-- 1ioo - 2.2 Gross Domestic Investment 150 1D.5 Gross National Saving 100 7. o Current Account Balance - 2 5 -1.8 Exports of Goods, NFS 104 7.3 Imports of Goods, NFS 154 10.8 OUTPUT, LABOR FORCE AND PRODUCTIVITY IN 1971-72 Value Added Labor Force V. A. Per Worker US7 $ n. % Mln. % US $ 7 Agriculture 698 68 4.6 14.4 15e 6 Industry 92 9 0.1 2.8 667 26 Services 237 23 0.1 2.8 1, 743 68 Unallocated Total/Average 179T 100.0 4.o ioo.o 2,56Z 100.0 GOVERNMENT FINANCE Central Government (NRa Mln.) . of GDP 1974- 75 1,048 7.1 Current Receipts 576 3.9 Current Expenditure Current Surplus 484 3.3 Capital Expenditures 926 6.3 External Assistance (net) 483 3.3 1/ The Per Capita GNP estimate is calculated by the same conversion technique as the 1975 World Atlas. All other conversions to dollars in this table are it the average exchange rate prevailing during the period covered. not available not applicable  Page 2 of 2 pages COUNTRY DATA - NEFAL MONEY, CREDIT and PRICES 1965 1971 1972 1973 197L -975 (Million NRs outstanding mid-July) Money and Quasi Money 554 1,055 1,240 1,493 1,850 2,027 Bank Credit to Public Sector -149 -103 -39 138 238 795 Bank Credit to Private Sector 136 320 400 459 732 843 (Percentages or Index Numbers) Money and Quasi Money as % of GDP 9.9 -11.6 11.9 13.3 1L.41 13.7 General Price Index ( 1962/3 a 100) 2/ 167 169 188 218 Z55 Annual percentage changes in: General Price Index 1.2 11.2 16.0 17.0 Bank credit to Public Sector 6e4 164.1 v 72.5 234.0 Bank credit to Private Sector 15.0 25.0 14.8 59.5 15.2 BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1965/66 to 1969/70) 1973/4 1974/5 US $Mln % (Millions US $) Exports of Goods, NFS 100 104 Food grains & livr animals 25o9 54.0 Imports of Goods, NFS 116 154 Inedible crude materials 13.4 27.9 Resource Gap (deficit = -) Consumer goods 8.2 17.1 Interest Payments (net) 11 9 All other commodities 0,5 1.0 Workers' Remittances 11 16 Total 1o0.0 Other Factor Payments (net) Net Transfers EXTERNAL DEBT. DECEMBER 31. 1973 Balance on Current Account 6 75 US $ Mln Direct Foreign Investment Net MLT Borrowing 8 10 Public Debt, incl. guaranteed 19.6 Disbursements -2 Non-Guaranteed Private Debt Amortization Total outstanding & Disbursed 1Y.0 Subtotal 8 1/ Capital Grants 21 25 DEBT SERVICE RATIO for 1973- Other Capital (net) Less thanl% Other items n.e.i -28 J49 Increase in Reserves (+) - 7 41 Public Debt, incl. guaranteed Non-Guaranteed Private Debt Gross Reserves (end year) 130.5 113.3 Total outstanding & Disbursed Net Reserves (end year) 123.5 154.3 RATE OF EXCHANGE IBRD/IDA LENDING.(End of Feb. 1976) (Million US $): Through Feb. 1973 Feb. 1973 - Oct. 1975 IBRD IDA US $ 1.00 = NXs 10.125 USR 1IDA - NRs 10.56 NR 1.00 = us $ 0.099 NR 1.00 - US$ 0.095 Outstanding & Disbursed -- 6.1 Undisbursed -- 52.7 Since Oct. 1975 Outstanding incl. Undisbursed -- 50@ US $ 1.00 = NRs 12.'5 1.00 = us $ 0.08 1/ Ratio of Debt Service to Exports of Goods and Non-Factor Services. 2/ Consumer's Price Index (Kathmandu). , not available not applicable April 9, 1976 EPD/PRD  SUMMARY AND CONCLUSIONS Introduction 1. This is a review of the investment program of Nepal in the context of development priorities and an assessment of the role of foreign aid in the development process. Nepal's development task is unusually difficult. The country has few natural resources, is landlocked and far removed from sources of essential supplies and from export markets and has a difficult topography which hampers internal transport and communications. The population density is high and still increasing. 2. It is only since the beginning of the 1950's that economic and social development have been adopted as main government objectives. Achieve- ments, viewed within this brief perspective, have been impressive. Development efforts have broken Nepal's virtual isolation and set the country on the path towards modernization. Transport, power, communications, and water supply facilities serving the main centers of population have been established. By a large education effort, literacy has been raised from 1 to 14% of the population. Almost half of the nation's children are attending primary schools while secondary and higher education are expanding rapidly. Malaria has been brought under control and campaigns are being waged against a number of other endemic diseases. His Majesty's Government (HMG) has established supporting services for agriculture and industry including trading and banking enterprises and industrial estates and has also set up factories in promising fields where private enterprise has lagged. HMG moreover has made attempts to modernize the government administration and for this purpose has sent many students abroad for advanced training. As a result, many important posts in the administration are occupied by well educated officers who understand the development problems of the country and are rapidly becoming more experienced in dealing with them. Their number, however, is still small and shortages of middle and higher echelon professionals continue to hamper development efforts. 3. In spite of these efforts to lay the groundwork for a modern eco- nomy, economic growth has remained sluggish. Over the past ten years, GDP growth has hardly exceeded the 2.1-2.2% growth rate of the population. Throughout Nepal, people have remained extremely poor as expressed in a per capita GNP of just over $100 in 1975. Particularly in the overcrowded valleys in the Hills where cultivation is being pushed onto steep hillsides, population has been growing faster than food production. The diet of many people has dropped below subsistence needs and'many are undernourished. The increase in farm households has been faster than the increase in cultivated area. As a result, holdings have become increasingly fragmented and since yields have remained stagnant, marketable surpluses have dropped. Grain exports have declined from 500,000 tons a year in the early 1960's to about 200,000 tons in recent years. Unless the declining trend is reversed soon, grain exports may cease entirely within a decade. Development Priorities 4. The pressure of population on resources is bound to increase further as population grows from 12.6 million in 1975 to 20-22 million by  - ii - the turn of the century. Even a successful birth control program cannot prevent population from reaching at least the lower limit of this range. An adequate livelihood for such a greatly increased population must lie chiefly in more productive use of known resources and efficient resource allocation to maximize production. The emphasis on production growth does not neces- sarily conflict, however, with the official development objectives of balanced regional development, equality and popular participation in development. Development in Nepal is unthinkable without the active involvement of the millions of small farmers who make up almost all of the work force and who account for the major part of production. But the choice between alternative development possibilities will have to be determined in the first place by efficiency considerations. 5. For the development strategy in the medium term, on which this report is concentrating, this means that the emphasis should shift from the expansion of infrastructure to the expansion of directly productive activi- ties. Most of past development efforts were devoted to road construction and other infrastructure. This shift in emphasis is the leading principle of the Fifth Five-Year Plan (1976-80) which rightly states that the time has come for Nepal to derive increased production benefits from its past efforts to establish and expand the infrastructure. 6. A shift in the investment allocation in favor of quick-yielding activities is indeed highly desirable. As yet, past investments have paid off very poorly in terms of production growth. Total gross capital formation in Nepal is estimated at 8.5-10.5% of GDP, while the real GDP growth rate has only been just over 2%. In view of the scarcity of resources in Nepal, the planners are right in looking for opportunities for more rapid growth, without neglecting the need for completion of the basic infrastructure. 7. It would be a mistake, however, to expect that such a shift in in- vestment emphasis could lead to a sharp acceleration of GDP growth. The remaining years of the decade should be viewed primarily as a period in which the development strategy is being reoriented towards new goals and the basis is being laid for more rapid growth in the 1980's. The following are the main reasons why it will take time before the recommended shift in investment emphasis can be expected to pay off in terms of output acceleration. 8. First, Nepal does not possess major untapped natural resources such as extensive virgin lands or easily exploitable mineral. rem,Irces which would permit substantial production gains at low lnvr-.Liii'nt 'w;I in the immediate future. Significant long-term development possibilities exist in agriculture, forestry, water resources and tourism. Exploitation of these possibilities, however, requires a lengthy period of project preparation and institution building before development can gather momentum. 9. Secondly, Nepal's development is hampered by low absorptive capacity. The country is short of technical and administrative skills at all levels; development institutions are still being built up and as yet unable to provide support for sustained rapid production growth.  10. Thirdly, the room for adjustment of the investment program is bound to be small in the short run. Investment decisions taken in preceding years determine most of the content of the investment program in the next two, three years and infrastructure investments still have a large place in this program. A new deyelopment strategy will require the elaboration of new development schemes in each of the new areas of emphasis and this will require time. 11. To achieve the desired acceleration of GDP growth as soon as pos- sible, official development efforts should be concentrated on a limited number of areas which carry the promise of relatively quick production gains. The following is a tentative list of such areas. 1. Agriculture 12. (i) The most important opportunities for raising production lie in the Terai where grain production averages only 1-1.3 tons per hectare. These yields can be raised substantially by improvements in agricultural ex- tension of the type now being applied in the IDA-financed Birganj Irrigation project, by increased application of inputs, which by now are well identified and technically proven, and by minor irrigation including increased tapping of the groundwater underlying the Terai plains. Achievement of production increases in the Terai along these lines will require further improvements in marketing, credit, and extension services. To ensure that sufficient financial resources will be available for future development schemes, HMG should further- more attempt to recover from farmers the cost of operation and maintenance of agricultural projects and at least part of the investment cost of agricultural projects. 13. (ii) A further possibility for significant production gains lies in stepping up the conversion of about 300,000 ha of level forest lands in the Terai into farm land wherever this can be done without serious ecological damage. Besides contributing to foodgrain production, this would allow for resettlement of some 200,000 families, a significant proportion of the surplus population of the Hills. Although settlement of level forest land does not fully solve Nepal's agricultural problems, it would buy time to work out more lasting solutions. Further progress is needed in the formulation of land settlement policies including decisions regarding farm size and the price which settlers will have to pay for the land allotted to them. 14. (iii) In the Hills, productivity of small farmers can be raised through use of improved seeds and cultivation practices, including increased use of green and farm yard manure. The main constraints are transport dif- ficulties and shortcomings in extension and marketing. Experience during the preparation of the Nuwakot and Rasuwa rural development projects suggests that the new district administration plan could help in bringing about major improvements in rural institutions. To achieve these improvements, HMG will have to give priority to the training of district development officers. Even if all is done that is possible prgress in rural development will be slowed down in the next several years by shortages of suitable manpower.  - iv - 15. (iv) The Hills present significant scope for specialization on fruits, vegetables, spices and livestock products for sale in Terai and export markets. On a limited scale these products are already being produced in the Hills. The scope for specialization will however remain limited until the food situation in the Hills has improved and until better transport links have been established between the Hills and the Terai. The latter may take many years for the more remote areas. Meanwhile, however, there is scope for planting fruit trees on a cooperative scale on degraded forest lands on hillsides. Livestock production could moreover be expanded by planting of fodder trees in degraded forests. 2. Industry 16. The manufacturing sector is still small, but there is scope for increased processing of agricultural products - sugar, starch, glucose, leather and footwear, flour, lumber and wood based products and for increased substitution of imported cement and cotton textiles. Only a few projects in this sector are ready for completion. The main constraints have been the lack of project preparation ability and the shortage of domestic entrepreneurs and of skilled personnel. 3. Transport 17. Emphasis in this sector should shift from trunk roads to feeder roads to link the East-West highway with the more populous valleys in Hills districts. Such roads should be integrated with rural development projects in the command areas of these roads. Thus far there has been almost no complemen- tarity between transport and agriculture investments; hence, transport invest- ments have had little effect on production. Suspension bridges can bring savings in time and energy to Hills farmers and increase their access to markets. 4. Tourism 18. Priority should be given to organizational improvements in this sector - improved and expanded international air services, participation in international travel circuits, improved access and management of tourist sites. Tourism is one of the few possibilities to increase foreign exchange earnings and therefore deserves serious attention. 5. Human resources 19. (i) One of Nepal's most pressing problems is the rapid increase of the population. HMG has officially endorsed family planning activities. The spread of family planning practices however is hampered by shortages of suit- ably trained personnel and the lack of access to health facilities. In view of the shortage of staff, family planning efforts should be concentrated in those areas in which rural development projects are being undertaken. Closely  related to the success of family planning, is the reduction of the still high infant mortality; for this and other reasons family planning efforts should be integrated with the country's health services. 20. (ii) Due to the shortage of food in many parts of the country, there is widespread undernourishment and malnutrition, particularly among mothers with infants and school children, half of whom are significantly below normal height and/or weight. In the long run, the problem must be solved by increased food production and a sharply reduced growth rate of the population. Meanwhile, however, there is need for nutrition support with foreign assistance to the vulnerable groups. 21. (iii) Urgent attention must be given to manpower needs. Particularly at the intermediate level there are serious shortages of technicians such as extension agents, agricultural credit officers, cooperative guidance officers, junior health workers, land surveyors, construction foremen and supervisors, etc. These shortages seriously hamper the implementation of development schemes. Priority should therefore be given to the expansion of appropriate training facilities. Needed Adjustments in the Development Program 22. The above mentioned development areas are well recognized by Nepal's planners. The Fifth Plan proposes development projects related to each of them. The weakness of the Plan appears to be that it recommends action over a too wide front. To avoid dissipation of limited resources, priorities must be established and strictly adhered to. For instance, in transport and agriculture, efforts should be concentrated on the implementation of a few of the proposed North-South penetration roads with complementary rural development projects in the command area. Such concentration of rural development activi- ties is to be preferred over an effort to make an equal amount of resources available for rural development in all 75 districts of the country. Another instance would be the concentration of irrigation efforts on the proper im- plementation of schemes underway, on on-farm development and proper maintenance of existing schemes. Instances where concentration of effort would be benefi- cial exist for each of the priority development areas. The problem is to concentrate development efforts on those programs which yield rapid and high returns and which interlink with development activities in other sectors. Projects should also be designed in such a way that beneficiaries pay for current costs (operation and maintenance) as well as at least part of the investment cost of projects. 23. The authorities should moreover review to what extent projects already under implementation can be redesigned or postponed, if they have a long gestation period and limited importance for direct production increases. The question whether such rescheduling is desirable should not be judged merely on narrow considerations of project finance. Even when finance with a high grant element is available, the project may entail substantial financing from domestic resources and require current expenditures which in some cases (certain highways) appear well below expected benefits.  - vi - 24. To achieve the desirable reshaping of the public investment it would furthermore be necessary to build up the domestic project preparation ability. Most of the investment still tends to be directed to larger projects with a high foreign exchange component. The development strategy which seems appro- priate for Nepal, however, requires generally smaller projects with a high component of local labor. To carry out an increasing number of such projects, with or without foreign aid, will require more project preparation units in the technical ministries of HMG. The most urgent need for such units is in agriculture, irrigation, and transport but there are other areas such as industry, tourism and human resources development in which improved project preparation is also desirable. The establishment of strong project units will require technical assistance from abroad to fill gaps in local expertise and training on the job and abroad. Domestic Resource Mobilization 25. Implementation of a high-priority investment program should be ac- companied by increased efforts to raise domestic resources. In spite of satisfactory revenue efforts, the share of domestic resources for development financing is smaller than in most countries at Nepal's development stage. The low proportion of Government revenue to GDP (about 6%) is explained by the difficulty of levying taxes in remote Hills districts and exercising control over the movement of goods over the long border with India. It is also explained by the failure of the authorities to levy land and water charges in agricultural projects and to charge a proper sale price for crown land in the Terai. Roughly estimated, direct Government revenue from agriculture amounts to only 1% of value added although the sector accounts for 68% of GDP. Cur- rent government expenditures have also been small and thus there has remained a surplus averaging about 2% of GDP for the financing of development expendi- tures. Current expenditures, however, have been rising more rapidly than revenue and this trend is likely to continue because of urgent claims to raise government salaries, and increase maintenance outlays. As a result government savings are declining. 26. In view of the vital importance of domestic savings for development, a resource mobilization program is needed for the next two or three. years. The program should take account of current revenue potentials and current expenditure needs and should also attempt to put public enterprises on a sound footing. All instruments of government policy, including external and monetary instruments, should be used in support of resource mobilization. Subsidies should be abolished wherever they are not justified on strong efficiency or equity grounds. Consultations regarding Foreign Aid 27. Even with successful efforts, domestic resources will continue to cover only a small portion of development expenditures. If Nepal's economy is to develop, it will need substantial assistance from abroad. Such assist- ance has been forthcoming from many donor countries, mostly on very soft terms and conditions. Recently, disbursements have amounted to $30 - 35 million on  - vii - an annual basis. Since commitments have been increasing rapidly and an early acceleration of disbursements seems likely, aid flows will probably remain large during the Fifth Plan period, averaging perhaps $50 million per year in constant 1974-75 prices. 1. Priority of foreign aided projects 28. The volume of aid disbursements during the Plan is likely to rise to about 60% of total public investment. Such a large involvement of for- eign donors unavoidably influences the composition of public investment. On the basis of preliminary data it appears that disbursements on infrastr'ucture will constitute a large proportion of aid during the Fifth Plan. Most of the Fifth Plan development projects have been under preparation for several, in some instances for many, years. Priorities for actual spending in the second half of the 1970's were to a large extent determined in the early years of the decade and do not yet reflect the shift in Nepal's development strategy towards directly productive activities. 29. Some of the projects which are now being studied by foreign aid agencies reflect to a much larger extent the priorities of the Plan. Included among those are development projects for the Far Western region, feeder roads connected with rural development programs, suspension bridges to shorten distances in hilly areas, assistance to agricultural training, etc. Since foreign aid obviously will have to play a significant role in Nepal's economic development for many more years, it is important that HMG make efforts to keep donors and foreign aid missions well informed about its development objectives and priorities. 2. Design of foreign-aided projects 30. Insufficient guidance from Nepalese side in the identification phase of projects frequently has led donors to follow a type of project design reflecting the factor endowment of the donor country rather than that of Nepal. As a result, most of the highways designed for Nepal by foreign donors appear too costly in terms of capital and maintenance cost, particularly since some traffic densities are very low. The long-term solution of Nepal's transport problems will require more imaginative, low-cost solutions geared to Nepal's particular situation. Another example is in certain factories which are equipped with labor saving machinery more appropriate for advanced economies than for Nepal where the opportunity cost of labor is low. 3. Local currency requirements of foreign-aided projects 31. Certain of Nepal's donors have been financing the full investment cost of projects including all local currency expenditures. On the average, foreign financing accounts for a high proportion of project cost. Prelim- inary information indicates that disbursements of foreign aid during the Fifth Plan will cover 70% of total spending on the respective projects during the Plan. This still will leave about Rs 1,350 million to be covered from domestic  - viii - financial resources, leaving less than Rs 1,000 million for all those develop- ment activities with high local currency components which in the past received little foreign aid such as minor roads, minor irrigation works, rural develop- ment activities, administrative improvements, a large part of the outlay on education and health and finally repair and maintenance of the transport network. 32. Action by donors to meet this local currency problem might include two steps. First, donors might attempt to redirect their assistance to the above-mentioned development projects which according to the reordering of development priorities of Nepal should play an increasingly important role in the development programs. Secondly, donors should be encouraged to finance part of the local currency requirements of projects. Furthermore, in many cases (technical education, agricultural extension, rural development schemes), current expenditures are also large and essential. In view of the scarcity of domestic financial resources, it is highly desirable that donors in such cases finance also part of these current expenditures. 4. Co-financing arrangements 33. Completion of Nepal's basic infrastructure including power projects for domestic electricity consumption will require a number of investments which each individually may prove too large to be financed by one donor alone. The Kulekhani hydroelectric project was the first major project which was fi- nanced by several donors. Despite the increased emphasis on smaller projects in all sectors, there are expected to be other large ventures which will require cooperation among interested parties during project design and co- financing arrangements during execution. 5. Terms and conditions of aid 34. Most of the aid to Nepal has been in the form of grants and as a result Nepal's external debt is very low. In view of its weak financial position and the long time it will take before it will become independent from outside resources, aid to Nepal should be preferably in the form of grants or highly concessionary loans.  SPECIAL REPORT: REVIEW OF THE ECONOMIC SITUATION OF NEPAL I. The Scope for Development A. Background 1. With many of the other least developed countries Nepal shares the problem of having a rapidly growing population and few readily exploitable resources. In Nepal's case the problem is exacerbated by its landlocked location in Central Asia and the difficult topography of the Himalayan hills and mountains where 60% of the people live. Large parts of the country can only be reached by foot trails; in such areas transport volume and thus the size of the market is limited to what people can carry on their backs. 2. Until about forty years ago, Nepal's population was stationary. People lived in a precarious balance with the meager agricultural resources of the Hills, at or near the subsistence level. The fertile plains south of the Hills, the Terai, were sparsely inhabited because of malaria. Since then population has been growing by over 2% a year. Forests on steep hillsides were felled to allow expansion of the cultivated area and mountain pastures became overgrazed because of the growing number of livestock. In spite of the more intense cultivation, the availability of foodgrains and livestock pro- ducts increased slower than the number of people. Meanwhile, however, malaria was being brought under control allowing increased cultivation of the Terai and food deficits of the Hills could be to some extent supplemented by sur- pluses from the Terai. The Hills population has been trying to acquire part of these surpluses with the proceeds of its own surplus of livestock products, spices and handicrafts and by the earnings from temporary migration. Each winter, one-third of the economically active population roams southward in search of work and food. People move to the Terai and further south, to India. Incomes in the Hills are moreover supplemented by the remittances from the Gurkha regiments in the British and Indian armies. Inspite of these earnings, the economic situation in the Hills is getting worse. Lack of land and of fuel in the higher valleys is forcing people to give up their life in the Hills and to settle permanently, often illegally, in the Terai or to move to the cities. As a result, population in the Terai has been growing by 2.6% a year, in the Kathmandu valley, the most advanced part of the country, by 7% a year, and in the Hills by only 1.4% a year. 3. Throughout Nepal, people are poor. Per capita income is estimated at $111 per year. Regional differences in income are, however, important. According to the 1968/69 farm management study, average farm incomes were Rs 1,000 on an average holding of 0.4 ha. in the Hills and Rs 1,900 on an average holding of 3.0 ha. in the Terai. But income distribution among farm- ers was more equal in the Hills, where most of the farmers own their land, than in the Terai where there are many tenant farmers. On the basis of the farm management study, the mission calculates that the Gini coefficient of  farm income distribution was 41% in the Hills and 49% in the Terai. 1/ Since there are more landless laborers in the Terai than in the Hills, the difference in inequality is probably larger than expressed by these figures. Moreover, migration earnings which play a large role in the economy of the Hills are probably larger on average for farmers who have small holdings and this would further reduce income inequality in the Hills. 4. With so many of the people living close to the subsistence level it has been difficult to mobilize resources for development. The few people with larger incomes such as real estate and landowners and businessmen have in various ways been able to minimize their tax payments. An additional diffi- culty in raising government revenue is that much of the country's foreign trade passes unchecked and untaxed over the long (1,300 km.) border with India. 5. At the same time, the capacity of His Majesty's Government (HMG) to deliver services to the population is rendered very difficult by the inaccess- ibility of many parts of the country. Until recently, government activity in such areas was very limited with most of the social and economic services concentrated in the Kathmandu valley and parts of the Terai. The inhabitants of the Hill valleys relied on their traditional system of mutual help to establish whatever modest infrastructure they needed: minor irrigation works, village roads, mountain trails, and village schools. 6. A further constraint on development is the shortage of basic mate- rials for development. Imports of cement, iron and steel, POL and industrial equipment, are limited not only by the lack of foreign exchange resources but also by the remote location of the country. India has been frequently short of these materials and this forced Nepal to cover part of her needs by import- ing from overseas. These imports have been extremely expensive, particularly in the case of heavy materials such as cement, because of the high transport cost. Moreover, transshipment in Calcutta, the designated port for Nepal's overseas trade, and again at the Nepalese border, has caused delays high de- murrage charges, deterioration of goods and losses through pilfering. 7. Nepal's achievements in economic development have to be viewed in the light of these constraints and also of the short period during which HMG has systematically directed its efforts to the country's economic development. Until 1951, Nepal was under a feudalistic, exploitative regime that kept the country isolated from external influences. Efforts to modernize the country started only after the expulsion of the Rana regime by King Tribhuvan. Practically all investments in infrastructure and social and economic services took place after that year. Achievements should be viewed within this time perspective. The East-West highway spanning the length of the country through the Terai will be completed within the next decade, a number of other all= 1/ The Gini coefficient is a measure for the equality of income distribu- tion. It varies from 0 when everybody has the same income to 1 when there is perfect inequality (virtually one person draws the entire national income and nobody else has any income at all). The above - figures suggest moderate to high inequality.  weather roads have been built, and there is a network of airports and power, telephone and water supply in Kathmandu and most other towns. Primary schools have been built for almost half of the nation's children and a growing number of health posts are in operation. Malaria has largely been brought under control and other endemic diseases are being attacked. Supporting services have been established for agriculture and industry. HMG has taken the lead in setting up trading corporations, a construction corporation, financial institutions, industrial estates and a number of industrial enterprises in fields where private initiative seemed to lag. Helped by foreign technical assistance, the authorities have systematically encouraged the professional training abroad of young people. Several of the important posts in the administration are occupied by well-trained officials who are rapidly gaining experience and insight in the development problems of their country. The number of such officials is still small however and critical manpower shortages persist at the middle and higher echelon. 8. Ever since the country ended its self-imposed isolation, Nepal has been receiving generous assistance from abroad. India and China have helped with road construction as did the USSR, the United Kingdom, the United States and Switzerland. India and China are moreover helping to estab- lish industrial undertakings. Other donors involved in power development are Japan, the Asian Development Bank and IDA. Support for education, health, family planning, nutrition and other social services has been received from the United States and a number of U.N. agencies. Almost all earlier mentioned donors have been assisting Nepal in a large range of agricultural development activities - schemes for irrigation, rural development, land settlement, agri- cultural credit, etc. UNDP has been financing a varied program of preinvest- ment studies and technical assistance activities. Several bilateral donors have also been providing technical assistance as well as training of Nepalese nationals abroad. Altogether the international community has shown great and continuing interest in Nepal's development. At times, the multiple activities of foreign donors have overwhelmed the limited capacity of the small govern- ment administration to absorb advice and assistance. As a result, several foreign-assisted projects have been selected, designed and executed according to preferences and factor endowments of the donors rather than of Nepal. There is still a danger that development is guided by the availability of aid rather than by the priorities set by the administration. B. Development Objectives 9. Since the mid-1950's, HMG has adopted successive five-year develop- ment plans. The year 1975-76 is the first year of the Fifth Plan. The of- ficially stated development objectives underlying the plan are balanced regional development, the establishment of an egalitarian society and par- ticipation of all citizens in the country's development. 10. The importance attached to balanced regional development is under- standable in a country such as Nepal which is badly fragmented in all respects - geographically, ethnically, culturally and economically. Earlier invest- ments in infrastructure have laid the foundation for attempts to increase  - 4 - unity. Thus far, however, these investments have hardly affected social and economic ties among regions and the effect on production has been minimal. The plan, therefore, emphasizes investments aimed at deriving economic bene- fits from the earlier infrastructure investments. Examples are the North- South roads penetrating densely populated valleys in the Hills and connecting these with the Terai and the East-West highway. Construction of these pene- tration roads will be accompanied by rural development programs in the Hills areas served by them. Other examples are the programs to promote on-farm development on irrigated lands, and the dispersion of social services into remote areas. 11. Such investments should not only lead to production growth but also further the objective of balanced regional development. Since the Hills and the Terai have different comparative advantages, specialization could lead to increased prosperity in both areas. The Hills are better suited than the Terai to the production of vegetables, fruits, spices and dairy and livestock products. The Terai could absorb greater quantities of these products in re- turn for grains which are short in supply in the Hills. The Terai, which has a labor deficit as well as some undeveloped land, can moreover continue to absorb seasonal and permanent migration from the Hills. Implementation of this strategy requires that the rural development schemes associated with the penetration routes first increase the security of the Hills farmer by in- creasing his grain output and then gradually bring him to greater specializa- tion on high value cash crops. 12. The objective of balanced regional development can only be achieved in stages however. The effort to bring development to all parts of the country at the same time would almost certainly lead to serious disappointments, be- cause of the lack of the required manpower and even of sufficient insight in the type of action needed to bring about development. As a long run objective however it is a worthwhile goal which eventually should lead to increased pro- duction and incomes of the country's small farmers. This would help meet a further objective of the plan, the establishment of a "dynamic and egalitarian society". In fact it is difficult to envisage a growth path for Nepal which would not be based on higher productivity of the millions of small farmers which, together, account for most of the country's production. The objective of equality is furthermore to be served by increased spending on education and health and greater emphasis within these sectors on programs which will reach large masses of people such as adult education, mass inoculation and rural health posts. A further government policy aimed at regional balance and equality is the sale of fertilizer, seeds and other inputs at the same prices throughout Nepal. In view of the high transport cost of these goods to remote areas the implied subsidy to farmers in such areas could be considerable. 13. Implementation of agricultural development schemes will require that the future beneficiaries actively cooperate in the execution of the schemes and to a large degree even participate in the decision making. To obtain this local involvement the Government is building on the cooperation of the rural population in district and village Panchayats (councils). Traditionally these have accounted for most of local decision making and for the construction and  -5- maintenance of rural public works through voluntary contribution of labor. In view of the limited trained manpower and the weak organization of many Panchayats, the expectations built on their contribution to local de- velopment does not appear fully realistic. A critical assessment is needed of the strengths and weaknesses of the Panchayats leading to a training pro- gram to upgrade the technical competence of their core staff. 14. In the long term, Nepal's development problems will be increasingly dominated by the pressure of population on available resources. Already, population density is extremely high. In the Hills, where 59% of the people live, population density has reached 930 persons per cultivated square kilo- meter and the average farm has shrunk to less than 0.4 hectares. Density in the Terai is lower at 340 persons, but in that area the growth of population is faster. Current population growth is estimated at 2.16%. With a young population (average age 24 years, 51% of the population below 20 years of age), continued rapid or even accelerating population growth is likely. Demographers forecast an acceleration of population growth to 2.30% by 1986; part of this acceleration will be caused by declining death rates, particular- ly declining infant mortality. In view of widespread illiteracy, lack of communications with many parts of the country, and still weak health services, there is little prospect for early reduction of the growth rate. The unavoid- able conclusion is, therefore, that population will continue to grow rapidly, rising from 12.6 million in 1975 to 20-22 million by the turn of the century. The implied annual growth rates are 1.85% (minimum) and 2.25% (maximum). 15. Nepal has only very limited possibilities to provide an adequate livelihood to these rapidly increasing numbers. As will be discussed more extensively, yields in agriculture can be raised through irrigation, use of better inputs, better cultivation methods and production of higher value crops. The cultivated area can be modestly expanded. Livestock and forestry production can be improved and expanded. Domestic value added from agri- culture can be raised through increased industrial processing. Some of the big hydropotential can be harnessed for electricity sales to India. Tourism can be better organized and expanded. There are limited emigration pbssibilities to neighboring countries. Taken together these possibilities do not add up to a substantial growth potential. There is, therefore, an urgent need for innovative thinking to discover new growth possibilities, particularly in the field of labor intensive industrial production. Almost regardless of the results of such new growth areas, however, Nepal clearly faces an extremely difficult development task and the development strategy must, therefore, strive for the utmost efficiency in resource allocation. 16. The present report reviews the prospects in the limited time span of the Fifth Five-Year Plan (1976-80). Against the longer term perspective of increasing population pressure it should be clear however that the over- riding concern during the Plan period should be to identify and execute projects leading to rapid production growth. In Nepal's difficult circum- stances, other considerations will have to take second place. At the same time, it should be recognized that emphasis on production growth does not  - 6 - necessarily conflict with the Plan's objectives of regional development, equality and popular participation. Development in Nepal is unthinkable with- out the active involvement of the millions of small farmers who make up almost all of the work force and who account for the major part of the country's production. But the choice between alternative possibilities will have to be determined in the first instance by efficiency considerations. C. Planning and Development Management 1. Planning Organization 17. Immediate responsibility for planning rests with the National Planning Commission (NPC), which is assisted by a secretariat of 65 pro- fessionals. All economic ministries furthermore have planning cells, but most of these are not fully staffed. The main functions of the NPC are to prepare the five-year plan and to watch over its execution through annual programs and regular follow-up. 18. Implementation of the annual programs is reviewed quarterly within each ministry and half yearly in a series of meetings chaired by the Prime Minister and covering the development efforts of the entire public sector. The NPC, which provides the secretariat for these reviews, follows up on the decisions taken during the reviews. NPC staff make on-site visits to verify reports made to the meetings and investigate the cause of delays. 19. The planning machinery is well articulated and on the whole staffed with competent officials, particularly at the NPC level. A major weakness of the entire planning process, however, is the lack of project preparation ability throughout the government administration. Project preparation units are insufficiently staffed in practically all technical ministries. As men- tioned, this weakness has caused foreign aid agencies to take the lead in identifying, preparing and executing most projects themselves. On many proj- ects, the involvement of Nepalese staff has been small at all stages of the project cycle. In areas where no foreign aid was forthcoming such as minor irrigation, the lack of preparation ability has led to delays and costly mis- takes in designs. The need to strengthen local project preparation units exists in all fields. There are, however, three fields in which the need to do so appears particularly urgent: agriculture, irrigation and transport. An effort to build strong project preparation units in these and other fields will require such as industry, tourism and human resources technical assistance from abroad of the required caliber to fill gaps in local expertise, and training programs for junior professionals to assure a sufficient supply of Nepalese professionals in the longer run. 20. A second weakness exists in the field of general economic management. Several developments over the past few years suggest that there is a need for a central body which can provide the analysis necessary for macro-economic decision making. Such developments include the sudden expan- sion in 1974/75 of credit to the public sector particularly to National Trad- ing Limited, and the related overstocking on cement and fertilizer; seeming  -7- indecision about pricing policies; the length of time it took to adjust interest and exchange rates to realistic levels; the lack of attention to the deterioration in the last two years of the balance of payments; and the con- sequent loss of reserves. As yet there appears to be no central unit charged with carrying out the macro-economic analysis to advise on such developments. However, the Ministry of Finance, the Central Bank and the National Planning Commission all seem to have staff qualified to carry out this task. 2. Development Management at the Local Level 21. In an essentially agricultural country with inadequate and diffi- cult transport and communication facilities and meager financial resources much is to be gained from locating development management as closely as pos- sible to the scene of activity and involving the beneficiaries themselves in' the planning and implementation process. Recognizing this, HMG has decided on a new district administration plan intended to shift emphasis from the maintenance of law and order to the promotion of development as the primary purpose of district adminstration. To this end, a specially trained district development officer (DDO) is to be appointed to each district who will be next in line to the chief district officer (CDO) and will have immediate responsibi- lity for promoting development in the district. As such, he brings together as a team the technicians of various government ministries stationed in the district and makes this team cooperate with the district panchayat. As part of local development efforts, each district has received in 1975/76 a central government grant of Rs 200,000 as seed money for local development projects to be executed according to the wishes and with the voluntary help of panchayat members. The cooperation with the team of technicians of various government ministries under the guidance of the DDO is expected to guarantee the com- petent technical execution of these local activities. 22. Experience in the preparation of the IDA-financed Rural Development Project in Nuwakot and Rasuwa districts indicates that the district adminis- tration plan has indeed all the ingredients for successful development coope- ration of the people and of the relevant government officials. The main limiting factor will, however, be the lack of development insight and expe- rience of the CDO and the DDO. At present, these officers will generally be unable to draw up and implement realistic district development plans. In view of the high priority of rural development, HMG should consider setting up a training scheme for these senior officials as well as a central or regional 1/ service which would provide continuing guidance in the formula- tion of district plans. In view of the large size of this task, the training scheme and the guidance service should initially concentrate on a limited 1/ Nepal is divided into four regions: the Eastern, Central, Western and Far Western regions. Each region contains mountains, hills and Terai districts. Kathmandu is in the Central region. A regional administra- tion plan which would move part of the decision making to the regions is in the making.  -8- number of districts, instead of trying to provide the same level of services immediately to the entire country. While knowledge of Nepalese conditions will necessarily be of decisive importance in the proposed training scheme and guidance service, this is nevertheless an area in which appropriate foreign technical assistance could also be useful. 3. Public Sector Management 23. Over the past 19 years, 72 public enterprises were established, of which 13 are public utilities, 10 social utilities, and 5 industrial estates. This leaves 44 public enterprises in industry, trade, commerce, and banking, fields which are chiefly left to the private sector in many other mixed econo- mies, but where private entrepreneurship appeared to be lagging. 24. According to their statute, these enterprises are to be run as auto- nomous bodies, who would be free from red tape. Many of them, however, are less independent than might be expected. The boards of these enterprises frequently include top civil servants of related technical ministries, while at the same time HMG awards many contracts to these enterprises, often by direct negotiations. Also, public enterprises tend to be managed on civil service rather than on business lines and the frequent changes of senior staff, for example a new manager about every 18 months in some firms, adverse- ly affect the quality of management. Because accounting tends to be weak, it is not possible to give a composite picture of the operations of public enter- prises. Incomplete information indicates that most of them are yielding returns of under 3% on assets and some are incurring losses. Statistical Appendix Table X.I. only partly illustrates the situation since the figures of assets are not available and the enterprises listed are not necessarily representative. Steps to improve this situation have been taken with as yet uncertain results.  -9- II. The Fifth Plan A. Introduction 25. The achievements of the Fourth Plan (1970/71-1974/75) remained below target in most sectors of the economy. The overall growth rate of GDP was 2.2% a year in real terms over the preceding plan compared with a target growth rate of 4%. Growth in agriculture amounted to 1.8% a year and growth in all other sectors, which in Nepal account for only a third of GDP, averaged 3%. In the main sectors, the Plan had set growth targets of 3.0% and 11.6% a year for the growth of foodgrain and cash crops respectively. But actual achievements averaged 1.9% for foodgrains and 3.9% for cash crops. By the end of the plan some 65% of the target of 1,830 km of roads was completed, only 54,400 hectares out of a planned total of 183,600 hectares of land had been brought under irrigation, 31,300 kw of the planned increase of 40,300 kw in power capacity had been installed, achievements in education lagged behind targets, and some 4.2 million additional gallons of drinking water had been provided compared with the five-year target of 7.4 million gallons. 26. The reasons for the shortfalls in the implementation of the Fourth Plan have been several. First, shortages of basic raw materials and building materials led to interruptions in the execution of projects. Second, the respective ministries have seriously overestimated the state of preparation of many projects. This was most patently the case with the irrigation pro- jects, but there are similar examples in other sectors. Third, many delays occurred because the administration delayed giving the required approvals, sometimes in the most obvious matters. This weakness is recognized in the Fifth Plan 1/ which states that the major reasons why programs were not executed to schedule were of an administrative nature and which speaks of a state of administrative indecision. 27. The low growth rate under the Fourth Plan was a continuation of the 2-2.5% annual growth rate which has prevailed since national accounts were first established in the early 1960's. The Fifth Plan (1975/76 - 1979/80) is meant to bring about an increase in the GDP growth rate to 4-5% a year (minimum and maximum plan). This growth expectation is based on an expected increase in the growth rate of agriculture from 2.3% to 3.6% and in the combined growth rate of all other sectors from 3.0 to 7.5% a year. In the following sections of this chapter we will attempt to review the likelihood of such an accelera- tion for the major sectors. 28. The public investment program amounts to a total of Rs 6.2-7.5 bil- lion ($580-700 million). These amounts compare with actual investments in the Fourth Plan of Rs 3.9 billion ($370 million). According to a rough cal- culation, public ihvestments rose over 7% a year in real terms during the 1/ The Fifth Plan in Brief, National Planning Commission, 1975.  - 10 - Fourth Plan. If a 7% growth rate were sustained over the entire period of the Fifth Plan, total investments would still fall about 10% short of the minimum investment program. At first glance it would seem, therefore, that implement- ation of the public investment program may be difficult to achieve. As the table below shows, the Plan is expected to bring about a big shift in the sectoral allocation of investment resources. Tab-e-1-- SECTORAL ALLOCATION OF PUBLIC INVESTMENT (in % of total) Fourth Plan Fifth Plan Minimum Maximum 1. Agriculture 25.8 29.8 30.2 of which irrigation 10.1 11.4 12.1 2. Industry 18.3 22.4 20.0 of which power 8.8 11.9 10.6 3. Transport and Communication 40.9 23.2 26.4 4. Social Services 15.1 24.6 21.4 of which education 4.7 10.5 8.9 of which health 5.9 6.9 6.0 TOTAL 100.0 100.0 100.0 Source: Fifth Plan. 29. The most striking feature in the proposed allocation for the Fifth Plan is the drop of the share of transport and communications in the total public investment outlay. The allocation of each of the other sectors would, however, rise.. This shift reflects HMG's broad view that more attention must be paid to the social sectors and that the time has come to reap greater benefits from past investments in infrastructure through increased attention to directly productive activities. In agriculture, most of the increase in investment funds would go to schemes directly promoting agricultural produc- tion rather than to irrigation investment. 30. The shift in the investment allocation in favor of quick-yielding activities is indeed highly desirable. As yet past investments have paid off very poorly in terms of production growth. Total gross capital formation in Nepal is estimated at 8.5-10.5% of GDP (see Statistical Appendix Table II-3), while the real GDP growth rate has been just over 2%. This suggests a capital output ratio of the order of 4 or higher. Moreover, since investment has been growing much more rapidly than GDP, the capital output ratio has  - 11 - tended to deteriorate further. In view of the scarcity of resources in Nepal the planners are right in attempting to move towards opportunities for more rapid growth. 31. The room for such a shift during the next four years may however be much smaller than indicated in the Plan, because the composition of the new investment program is strongly determined by investment projects which were undertaken but not fully completed during the last plan. Particularly in transport and irrigation but also in other sectors, a large number of projects lagged behind schedule. As will be discussed later, many of these projects are likely to be completed during the Fifth Plan. As a result, there will be a large addition to productive capacity in some sectors, which by itself of course should have a favorable effect on the growth rate of the economy. The large volume of projects underway has however diminished the scope for the authorities to reshape the public investment program according to the earlier discussed change in development objectives. B. Agriculture 1. General 32. Even more than in most developing countries, agriculture dominates the economy and there can be no doubt that this sector holds the key to Nepal's development. Agriculture and related activities account for 93% of the acti- vities of the labor force, 68% of the contributions to GDP and 80% of merchan- dise exports. Alternative development possibilities in resource-poor Nepal are few. The rate of the country's development, therefore, depends on the speed with which change can be introduced in agriculture. And since there is little idle land, progress will depend mostly on increasing yield on the area presently under cultivation. 33. Technically speaking, the scope for yield increases is considerable. As in many other LDC's, crop results per hectare are well below the potential and the technology for raising productivity is available. Research and experi- mentation on seeds, inputs, water management, erosion control and breeding stock have established feasible means to raise yields. Continued research will of course be required to expand knowledge on production possibilities. Certain types of production and many areas of the country have been insufficiently explored as yet. Nevertheless, if the means could be found to apply already existing technology, production could rise substantially within a relatively short time span. 34. The question is what factors constrain the transfer of seeds, inputs, advice, etc., to the farmer and what difficulties arise in implementing fully prepared irrigation and other supportive investments in agriculture. As in other developing countries, the constraints are numerous. The most important of these are weaknesses in institutions and policies regarding extension, marketing, credit, local administration and land ownership. An additional factor, particular to Nepal, is the isolation of much of the Hills population and the still sparse transportation network in the rest of the country.  - 12 - 2. Past Growth Record 35. Past performance of agriculture has to be viewed against these powerful constraints. As mentioned earlier, growth of agriculture during the Fourth Plan was slow and well below the targets of 3.0% a year for food- grain production and 11.6% for cash crop production. Grain production in- creased even slightly slower than population confirming earlier analyses of Nepal's agricultural situation 1/ which have pointed out that on present trends Nepal's grain exports will be declining, turning the country into a net grain importer in the early 1980's. This is still a real danger. 36. An unfavorable element in the growth record is that production growth was almost entirely due to the increase in cultivated area. For most products, yields per hectare have stagnated during the plan periods. Productivity trends were slightly more favorable in the Kathmandu Valley and in the Terai than in the Hills, where extension of cultivation over marginal lands and increasing erosion have led to actual declines of productivity. 37. On examination it appears that almost all agricultural programs have indeed been far behind schedule. The major exception is the use of im- proved seeds which is spreading rapidly; by 1973/74 such seeds were sown on almost a quarter of the area under major foodgrains. On almost all other programs the actual achievement has remained far below the target. The question is whether some of these targets have been too high to begin with. Obviously this was the case with the irrigation program, where the state of preparation of projects and the usual delays in implementation should have made it clear from the start that the target of 184,000 hectares was too high. During the fourth plan, irrigation facilities were completed over only 54,400 hectares. Serious shortfalls in other programs (fertilizer, insecticides, land reclamation, credit) also raise doubts whether plan targets had been set after sufficient allowance for probable difficulties in implementation. 38. The shortfalls in actual achievements tend to hide, however, that some progress has been made in building up institutions, in the training of development personnel, and the preparation of programs and projects. The number of extension officers under training is increasing rapidly, the organization of the Agricultural Development Bank is rapidly improving, an increasing number of cooperatives and Panchayats is receiving guidance, the capacity to produce improved seeds has been stepped up, and a large number of irrigation projects is under construction. While essential for future suc- cess in agriculture, all these developments have not yet led to actual in- creases in production. It is with this proviso that the following table should be read in which targets and achievements during the first four years of the plan are compared for the major agricultural programs. 1/ Agriculture Sector Survey of Nepal, December 20, 1974, IBRD Report No. 519a-NEP.  - 13 - Table 2: TARGETS AND ACHIEVEMENTS OF MAJOR AGRICULTURAL PROGRAMS DURING THE FOURTH PLAN Plan Achive- Unit target ment Progress 1. Area under improved seeds Heeteres - 47-2,000- 548,592 - 116% (a) Paddy Hectares 197,000 222,618 113% (b) Wheat Hectares 200,000 246,877 122% (c) Maize Hectares 75,000 79,097 105% 2. Use of chemical fertilizer (in nutrient) Metric Tons 91,031 51,016 56% 3. Sale and distribution of seeds through institu- tions Metric Tons 11,118 8,270 74% 4. Sale and distribution of insecticides and fungicides Rupees 3,930,000 1,863,562 47% 5. Additional irrigation facilities Hectares 183,632 54,424 30% 6. Additional land reclamation Hectares 25,000 14,100 56% 7. Number of families to be resettled Number 8,000 5,235 65% 8. Agriculture credit Rs. (in 10 million) 47. 39.56 84% Source: National Planning Commission 39. The record appears slightly more favorable in the case of the modest programs to distribute improved breeding stock of cows, buffaloes and pigs through government farms. However, the feeding situation of livestock is steadily worsening through overgrazing. This is particularly true for the Hills. Thus it remains uncertain whether the livestock program, as it is currently beinA undertaken, will lead to durable production increases.  - 14 - 3. The agricultural development strategy 40. A key objective of the Fifth Plan is to raise agricultural output by 3.6% a year, almost double the rate of growth achieved during the Fourth Plan. The strategy outlined in the Plan to achieve this objective corresponds well with the recommendation on this subject in the Bank's 1974 Agricultural Sector Survey. Particularly noteworthy are the Plan's emphasis on the import- ance of increasing the productivity of small farmers. The major features of the agricultural plan are discussed in the following paragraphs. 41. The Plan aims at a shift in the overall allocation of resources in favor of agriculture. The planners' point of depar!ture was that the pre- ceding twenty years of infrastructure building shouwd be followed by in- creased stress on expansion of directly productive activities, primarily agriculture and related activities. Accordingly, public investments in agriculture are to rise from 26% of the total in the previous plan to 30%. The plan also aims at increasing drastically the allocation of current ex- penditures for agriculture indicating the government's determination to strengthen agricultural services. 42. Specialization of agricultural production according to agroclimatic zones. The wide difference in growing conditions in the Hills and the Terai offers scope for increased specialization and exchange of products. In view of the serious food deficit of the Hills population, most of the emphasis for agricultural development of the Hills must remain, for the time being, on increasing food production through the increased use of farm yard manure and green manure and better cultivation practices. In the long run however, the Hills have a comparative advantage for producing a large range of valuable fruits, spices, vegetables, and perhaps, natural silk. On a limited scale, many of these items are already produced. Further development of the poten- tial of the Hills for cash crops depends on improved organization of produc- tion, including provision of required inputs and above all on the size and accessibility of the market. The Terai and the Indian market can absorb in- creasing amounts of potatoes and vegetables from the Hills. Organization of the marketing circuit, however, could prove to be the bottleneck certainly for more remote areas. For such areas the accent in the plan remains rightly on increasing foodgrain production. This necessity is also recognized in the February 1976 IDA credit for rural development in the Nuwakot and Rasuwa districts. Most of the benefits of this project are to be derived from increased grain production to meet the subsistence needs of these remote districts. 43. The scope for agricultural development is much more favorable in the Terai which has more plentiful land and good possibilities for irriga- tion. The agricultural surpluses of the Terai, mostly rice and jute, have been the source of most of the country's export earnings and of some food supplies to the Hills.  - 15 - 44. Development programs and projects in the Terai aim at strengthening its role as a source of food surpluses, agricultural exports and addi- tional employment opportunities. As Terai incomes go up, demand for Hills vegetables and other cash crops would moreover rise, thus increasing the scope for specialization. 45. Linking the Hills with the Terai. The complementary development strategies for th- Hills and the Terai can only be carried out if there are improvements in transport and communications between the two areas. The plan aims at following the construction of the country's East-West Highway with North-South roads which would penetrate some of the more densely populated valleys. 46. Expansion of irrigation facilities. Water is one of the country's few abundant resources. Apart from their significance for power development which will be discussed later, water resources can be used for a considerable expansion of the irrigated area. The irrigable area has been estimated, at 1.3 million hectares, about 50% of the total cultivated area. At present, 260,000 hectares are provided with some type of irrigation facility. 47. The Government is now re-orienting its irrigation policy. A large number of schemes, severely delayed from the last Plan, are now underway and progress on a number of them is satisfactory. As far as new schemes are concerned, more emphasis is being given to small schemes with quicker returns, and to mobilization of the considerable artesian potential of the aquifers under the Janakpur and Lumbini zones. Development of groundwater is proving to be costly and requires good organization. It should lead however to faster returns than the surface irrigation schemes which in most cases require storage reservoirs to ensure reliable year-round irrigation and which suffer from the heavy sedimentation in Nepal's rivers. The potential for private sector involvement in the development of shallow tubewells should be stressed, especially through institutional credit. 48h Next to devoting its energies to the completion of schemes from the last plan, Government is increasing its attention to complementary on-farm development of schemes that have been carried out or that are in their final stage of construction. The capability in this respect has been far below requirements on previous schemes. Encouraging progress however, is for instance, being made with on-farm development in the IDA-financed Narayani Zone scheme (Birganj project). 49. A bottleneck in the design and implementation of smaller irrigation schemes, is the lack of highly-qualified manpower. The unstable geological conditions in the Hills lead to very difficult construction problems. The staff of the Irrigation Department needs to be strengthened as soon as pos- sible with high-level technical manpower. Since such manpower may be un- available in the required number in Nepal during the next several years, the Department should investigate what possibilities exist for obtaining suitable technical assistance from abroad for this purpose.  - 16 - 50. Improvement of the relation of the tiller to the land. The results of the 1965 Land Reform Act have been below expectations. Actual reallotment of land amounted to only some 10% of the target of 250,000 hectares, itself only 10% of the cultivated area. Put in this way, progress appears minimal. The 1971 Land Reform study confirms the persistence of inequalities in land- holdings, although these are perhaps smaller in Nepal than in other countries of the sub-continent. Given the role of land ownership in the social struc- ture of a rural country such as Nepal it should not be surprising that change is coming about slowly. The fact that little land was re-allotted should, however, not obscure the progress made in the registration of land ownership. This improved registration has created the basis for enforcing land ownership and tenancy laws and increasing Government revenues from land taxes. A gradual, persistent effort as is presently undertaken should steadily reduce evasion of the Land Reform Act and also strengthen the basis for land taxation. 51. Better utilization of forest resources. Delays in the issue of licenses and lack of transportation has led to a very low degree of commer- cial exploitation until a change in policy last year permitted a substantial increase in logging. In the Hills, however, there has been uncontrolled use of forests for firewood and livestock fodder. The result has been degrada- tion of forests, denudation of hillsides and loss of land through landslides. Some of the degraded forests in the Hills could be planted with fruit trees on a scale which would be large enough to permit sufficient spraying. Other Hills forests could be brought under better management to permit increased lopping off of foliage for livestock fodder. Meanwhile, settlers from the Hills have illegally occupied large areas of forest land in the Terai; in some forests the authorities have subsequently forced these squatters to leave. During the Plan, the authorities intend to increase demarcation and protection of forests which should be reserved for commercial exploitation or for water- shed protection and to settle farmers on marginal, level forest lands in the Terai in an orderly manner. Improvements in the organization of resettlement is highly important. Roughly estimated 1/ the Terai still contains about 300,000 hectares of level forest land which is suitable for cultivation. Full utilization of the total potential settlement area for cultivation by former Hills farmers would allow the complete absorption of some 6-7 years of natural growth of the Hills population. 4. Institutional Aspects 52. The units for planning and project analysis of the Ministry of Agriculture and Irrigation are insufficiently staffed to guide project prepar- ation and implementation although they may be strengthened somewhat by the return of staff presently studying abroad. Additional technical assistance from abroad for these units seems however very desirable. The launching of the Agricultural Projects Services Centre (APROSC) was motivated by the dearth of bankable projects in the private sector available for financing by the internal banking system, but its list of functions includes projects work for government agencies in the fields of agriculture and rural development. It may be desirable to delineate more clearly the responsibilities of the Ministry 1/ Agricultural Sector Survey, Vol. I, para. 3.37.  - 17 - and APROSC in the preparation of projects. In its first year of operation APROSC has prepared three projects accepted for financing and completed the evaluation of a rural development project and of the arrangements for procur- ing and exporting rice. Although APROSC has a well-trained nucleus staff, its management rightly believes that technical assistance from abroad is needed to build up the Centre. 53. Agricultural research is essentially adaptive and is focused on raising productivity to satisfy domestic food demand through providing found- ation seeds, plants and stock. Research is hampered by the shortage of senior personnel. Arrangements are in progress with USAID to help develop crop research. Similar arrangements for assistance on livestock research also appear desirable. 54. Agricultural extension services are still weak particularly at the level of the agent who has immediate contact with the farmer. Those engaged at this level are Junior Technician (JT) and Junior Technical Assistant (JTA). Their numbers are inadequate but staunch efforts are being made to fill all vacancies by the end of the Fifth Plan. It has also been decided to train and engage some 4,000 so-called Agricultural Assistants (AAs) to ensure that every village is covered by a village level worker during the Fifth Plan. 55. A past criticism of extension workers is that they did not always have a package of conveniently available inputs to present to the farmer. Insofar as transport is available, this criticism is losing validity. There were significant increases in the use of key inputs up to 1973/74 through supplies provided mainly by the Inputs Corporation. Sinc.e then the growth in the consumption of some inputs, notably chemical fertilizer, wheat seeds and tools, has tended to weaken. This should signal the need for special promo- tional efforts by all the concerned agencies. 56. Meanwhile it should be pointed out that improved inputs have only limited significance for small farmers below the subsistence level. Despite production increases arising from the use of improved technology, these far- mers are bound to get in financial trouble, because they will frequently be unable to increase their marketable surplus, because of the hunger gap before the harvest. For these farmers, and this includes a large part of the Hills farmers, the best way to increase production will be use of manure, improved varieties and better cultivation practices, as recommended under the IDA- financed Rural Development project, rather than the use of fertilizer. 57. The Agricultural Development Bank (ADB) works closely with the Inputs Corporation. The main purposes for which the credit is extended are given in Appendix Table VI-6 which shows a remarkable increase in credit for cereal and cash crop production. 58. ADB is more than a bank as it has responsibility for the promotion and management of guided cooperatives so essential to agricultural development in conditions of small, scattered small-scale farming communities. The early failure of cooperatives organized along conventional lines led to the institu- tion of a system of guided cooperatives fully staffed by employees of ADB.  - 18 - The Fifth Plan envisages a fourfold increase in credit delivery to be ac- complished by raising the number of units serviced from 720 to 1,026 and roughly doubling the staff to about 1,428. The emphasis is to be on increas- ing the number of farmers per cooperative unit rather than proliferating the number of societies. The question is whether the lending target can be reached without unduly enlarging overdue debts. Much will depend on the effectiveness of the extension services, more particularly agricultural extension. As stated earlier, these are likely to remain weak for some time. 59. A start has been made with the organization of markets for wheat and milk in as yet very limited areas and for rice. In rice, however, these have not yet ended the situation in which the small farmer is at the virtual mercy of the miller. As this situation may adversely affect output and surplus for export, it may be worth exploring the feasibility of having the companies buy paddy directly from farmers even in competition with the millers. Improved and expanded marketing is likely to require expansion of storage capacity and some technical assistance in marketing management. 5. Prospects for agricultural growth 60. In spite of the above-mentioned, and other government, programs to overcome the constraints on agricultural development, progress in agriculture during the next several years is bound to remain modest. Even if the targets for irrigation, use of improved seeds, use of fertilizer, and implementation of other programs are fully met, the impact on the growth rate will still be limited, since the improved cultivation practices under these programs would still cover only a sall part of the cultivated area. Thus, attainment of the irrigation targ2 might, by a rough calculation, lift the growth rate of foodgrains production by at most 0.8% a year. The implied optimistic assump- tion is that completion of irrigation schemes would be followed immediately by the introduction of the improved practices needed to reap the benefits from irrigation. Since on past experience, it is neither likely that the irrigation target can be fully met nor that optimum benefits can be attained immediately after competition, the actual effect of irrigation and foodgrains production is bound to be much more modest than the 0.8% indicated above. 61. Similarly, attainment of the Plan's target for fertilizer use might by itself raise the growth rate of foodgrain production by 1.2-1.4%. However, since the distribution and credit system may not have the capacity to handle the tripling of fertilizer consumption required by the target, the effect of fertilizer use on the growth rate is likely to be more modest, per- haps only 0.4-0.6%. 62. Through further rough estimates of the probable effects of major agricultural programs the mission has tentatively projected the growth of total value added in agriculture at 3.1% a year. These projections are summed up in the following table.  - 19 - Table 3: GROWTH OF AGRICULTURE: A TENTATIVE MISSION PROJECTION (in percent per year) Weight in Fifth Plan Total Agri. Fourth Tentative Production /L Plan Target /2 Mission Proj. Foodgrains and potatoes 63.8 1.9 3.1 2.7 Cash crops 14.6 2.0 10.9 3.0 Meat production 3.6 2.8 2.0 Milk production 13.5 9.3 5.6 Other products 4.5 5.2 /3 3.1 /3 Total agriculture 100.0 5.2 /4 3.1 /1 Based on the composition of value added in agriculture in 1968/69. /2 Although the Fifth Plan has minimum and maximum targets for investment and overall GDP growth, the Plan document shows only one growth rate for sectors and sub-sectors. /3 Arbitrarily estimated to grow at the same rate as the rest of agriculture. /4 Actually the Fifth Plan gives a growth target for all of agriculture of only 3.6%. Apparently, the planners have themselvesu iscounted the targets for the individual sub-sectors. These tentative projections indicate that agricultural growth during the Plan period would remain at a fairly low level. The 3.1% growth rate would never- theless be a worthwhile achievement. It would represent an advance over the sluggish 2% growth rate of the last several years. Most important, growth would have started to inch ahead of population growth, thus staving off the spectre of overall food deficits within the next decade and opening the prospect of a way out of the present situation of below subsistence levels of production for large parts of the rural population. C. Industry 63. Modern industrial production makes as yet only a tiny, although rapidly growing, contribution to GDP. Over the last ten years, value added in manufacturing has more than doubled in real terms and the contribution of GDP increased from 1.6 to 3.0%. Most of the sector consists of the pro- cessing of Nepal's agricultural products such as rice, wheat, vegetable oil, sugar, and jute. These processing units account for 35% of value added in industry. The remainder is made up by factories producing consumption articles such as soap, matches, beer, cigarettes, footwear; forest-based factories such as saw mills and wooden furniture factories; bricks and tile factories; an agricultural implements factory; and the most important recent addition, a  - 20 - cement factory. Altogether, the manufacturing sector consisted, in 1972-73, of 2,400 establishments employing 48,000 people who produced a value added which is 2.6 times the national average for the total work force 1/. 64. In addition to this more or less modern industrial sector, there is a larger traditional cottage and small scale industries sector consisting of some 400,000 units which provides full or part-time employment to about 1 mil- lion people. Value added contributed by this sector amounted to 6.8% of GDP; value added per worker was only one-third the average for the total work force. This traditional sector produces most of the daily needs of the rural population for clothing, furniture, pottery, utensils, implements, etc. 65. Believing that the introduction of modern technology could lead to rapid gains in output and to considerable foreign exchange savings (both in increased value added from agricultural exports and import substitution), the authorities concentrated their attention on the modern manufacturing sec- tor rather than on the traditional cottage industries. 66. The large role of foreign sponsors in the establishment of industries strengthened the bias towards capital intensity. Several industries has been producing below capacity and incurred financial losses, in spite of generous fiscal incentives and financial assistance. The reasons have been overestim- ations of the market, shortages of essential imported raw materials and competition from Indian final products which enter Nepal over a virtually uncontrolled border. 67. The allocation of public resources to industrial development during the Fifth Plan amounts to Rs 580 million, 8.8% of public investment 2/. This amount includes the Government's contribution to private industrial ventures. Achievement of these investment targets will hinge first on further progress on project preparation and secondly on satisfactory agreements with foreign donors and private sponsors. As yet, much remains to be done on both counts and consequently realization of the industrial plan remains uncertain. It is clear that progress in industrialization will be hampered for some more time by the lack of fully prepared projects. It is also clear that HMG is as yet providing too little attention to the cottage and small scale industries sector. This last sector is far more important in terms of employment and 1/ The 1972-73 industrial census from which these data are taken further- more reported that 12,000 workers were non-Nepalese; that out of 2,400 establishments, 1,900 employed less than 10 workers and 65 establish- ments 100 or more; that cereals and vegetable oil mills contributed 49.4% of industrial value added, sugar refineries 3.8%, jute mills 1.5%, saw mills 1.4%, wooden furniture factories 4.6%, bricks and tile factories 11.4% and yarn and textile factories only 0.7%. 2/ Annex I contains a summary of industrial projects currently under consideration.  - 21 - value added than the modern industrial sector. Innovative solutions in the organization and choice of products of the cottage industries sector should be able to make a substantial contribution to Nepal's development. D. Transport 68. Sustained efforts during the last twenty years have provided Nepal with a modest transport network. Over the entire country, there were in 1974 3,200 km of roads. The most important road links are 518 km of East-West highway, which will have a length of 1,040 km when fully completed, the road from Raxaul on the Indian border to Kathmandu, and roads from Kathmandu to the Chinese border, to Pokhara and to Trisuli. Apart from the roads radiating from Kathmandu, the Hills have almost no motorable roads. Connections in the Hills are by a 10,000 km network of mule tracks and foot trails. Increased emphasis is being given to shortening distances on the most important trails by the construction of suspension bridges over deep gorges. Such bridges will will be of importance in stimulating production for the market by Hills farmers. 69. Road and bridge construction is extraordinarily difficult and costly because of the rugged topography and also because the unstable geo- logical conditions of the Himalayan mountains lead to frequent landslides. To these problems should be added the difficulties of obtaining timely sup- plies, from India or overseas, of road construction materials and road build- ing equipment. There are moreover manpower difficulties. Road engineers and skilled construction workers are in extremely short supply. A reliable pool of unskilled construction workers is hard to mobilize since Nepal's work force, although poor and seasonally underemployed, is tied to agriculture as its chief means of existence. Paradoxically in view of Nepal's poverty, it has been necessary to rely to some extent on Indian workers to help carry out highway construction. 70. Due to all these factors, the cost of road and bridge construction is extremely high and public investment outlays on transportation have been far higher than those on any other sector. 71. Meanwhile economic effects have been small. Passenger traffic on most roads, particularly in the Hills, is modest and the movement of goods insignificant. It appears that highways have been useful to rural people by lowering the prices of inputs and consumer goods in retail points along the road but that production in the command areas has not yet responded 1/. While immediate benefits have thus been small, maintenance and repairs have been inadequate and costs are extremely high, particularly in landslide prone areas. 1/ Cf. M. Schroeder and D. Sisler, "Impact of the Sonauli-Pokhara Highway on the Regional Income and Agricultural Production of Pokhara Valley", Cornell International Agricultural Development Bulletin, August 1971, as quoted in the Agricultural Sector Survey report. It is unlikely that this conclusion will have to be modified because of developments since the study.  - 22 - 72. The costliness of transport investment, the tardiness of economic benefits, and the forbidding maintenance and repair costs indicate the need for a different approach to Nepal's transport problems. The authorities have recognized this need. First, as has been mentioned, the Fifth Plan is based on the recognition that the time has come to reap more benefits from the available infrastructure. Accordingly the total allocation to transport was reduced from 40 (actually 44%) in the previous plan to 23-26% in the Fifth Plan. 73. Second, within the transport allocation, there is increased em- phasis on finding more cost effective ways to satisfy transport needs, such as feeder roads, suspension bridges, improvements of trails and construction of less important roads to gravel or fair weather standards. The feeder roads program is aimed at meeting the requirements of agriculture. A number of the feeder roads included in the Plan had been recommended by the Bank's Agricultural Sector Survey. Altogether, the Plan aims at the construction of 17 feeder roads with a total length of 670 km at a cost of Rs 313 million ($30 million) in 1974/75 prices. In view of the high level of construction costs this would probably represent an underestimation of the total cost of such a program. In view of the stage of preparation of the feeder roads pro- gram it is unlikely that more than about half of it can be completed by the end of the Plan period. It is important to stress that an ambitious feeder road program cannot be viable economically, unless construction standards are kept at a minimum level. This is so because of high construction and mainten- ance costs and low traffic density. 74. The Plan furthermore aims at improving transportation possibilities in the Hills by the construction of a large program of suspension bridges. These relatively small actions appear very important for improvement of the conditions in rural areas and may, in fact, be more effective than the conven- tional construction of highways and bridges or the improvement of aviation. After the establishment of 51 airports and airstrips the Government is intend- ing to slow down the expansion of the aviation network and to direct most of its attention to the maintenance and equipment of existing fields. 75. In spite of the intention to reorient transport investment, about 60% of the funds available for this sector will continue to be spent on high- way construction. The reason is that more than half of transport investment in the Fifth Plan will be needed for the completion of highway projects which were fully prepared and financed by foreign donors and partly already under construction before the beginning of the Plan. Some of these may turn out to be extremely costly with benefits that may be very disappointing. E. Tourism 76. Nepal's magnificent landscape, and rich cultural heritage have been discovered by a growing number of visitors over the past ten years and tourism has become a growing source of income and employment and a major source of foreign exchange earnings. During the years 1965-1975, the number of tourists  - 23 - increased at an average rate of 33% a year, slackening somewhat towards the end of the period in line with the recent stagnation of tourism worldwide. During the same period the contribution of tourism to convertible currency earnings increased from 5 to over 40% of the total. The contribution in- creased sharply after 1972 when it was decided that payments for hotels and other facilities had to be made in convertible currency rather than in Indian Rupees. Employment in t-he tourist industry is estimated at 7,500 persons. This estimate includes the employment of mountain guides and porters. The contribution of tourism to GDP is estimated at just over 1%. 77. Domestic value added in tourism has been estimated 1/ at 65-75% of gross tourist expenditures. This is much higher than value added in many other foreign exchange earning or saving activities. In view of the scarcity of opportunities to expand Nepal's foreign exchange earnings, the industry therefore deserves high priority in Nepal's overall development. 78. Tourism development is guided by a tourism development plan for- mulated in 1972 with German technical assistance. The Fifth Plan incor- porated, wherever possible, the set of programs contained in the seconid phase of this plan. Important features of the second phase of the tourism plan are development of various resort centers and tourist attractions in the Kathmandu Valley; development of hill stati6ns, observation points, and recreational areas; promotion of handicrafts and cottage industry; develop- ment of national parks (at Langtang, Chitwan, Mount Everest, Annapurna, and Dhanlargiri); development and restoration of pilgrimage centers (at Lumbini, Muktinath, Janakpur, and Bharchestra); extension of supportive services and facilities at several country resort areas (including Tansen, Gorkha, and Trisuli). 79. Most of these projects are modest in size but could be very im- portant for the long-term development of the industry; for some of these, foreign financial and technical assistance would be very useful. Areas for possible additional external assistance for tourism in Nepal include develop- ment of site and access roads to resort areas and tourist attractions; de- velopment of hill stations; development of cottage industries and handicrafts; restoration and preservation of monuments and shrines. IDA is currently help- ing to finance the construction of one hotel in Kathmandu. 80. Further actions which could help the development of the sector relate to the organization of travel to and within Nepal. At present tourism is to some extent hampered by the unreliability of air service, both domestic and international, and the scarcity of local transportation outside Kathmandu. Most tourists arrive in Nepal on a larger international 1/ ARTEP: The Challenge for Nepal, 1974.  - 24 - trip devoting only a part of their total travel time and money to their stay in Nepal and cannot afford delays arising from flight cancellations and unconfirmed reservations. Improvement of the reliability and expansion of air services is therefore important. Tourism could furthermore benefit from joint promotion efforts with Thailand, Singapore, Hong Kong, and India. F. Power 81. One of Nepal's greatest assets is the abundance of water and the potential it offers for the development of hydroelectric power and irriga- tion. Thus far, power development has been geared to the requirements of the small Nepalese market. Eventually, however, Nepal will want to produce hydropower for use by neighboring countries. The potential is estimated at 83,000 MW. Thus far, only one of the possible giant projects is under study, the Karnali project, which would have an installed capacity of 1,500-1,800 MW and require investments in excess of $1 billion. Feasibility studies on this project are being reviewed under UNDP aegis with participation of Indian experts. The obstacles in executing the technical studies and making the financial arrangements for this project are formidable. Even if they could be finalized however in the next few years, which appears quite unlikely, it would take at least until the 1990's for this project to be completed. 82. Actual investments in the power sector, as well as most of the ongoing feasibility studies are in the context of the domestic market, with provision for sale of peak supplies to Northern India. Present installed capacity is 54 MW, half of which was completed during the Fourth Plan. Power consumption is still only 10 kwh per capita, as compared to 20 kwh in Bangladesh and 120 kwh in India. Actually only 3% of households have access to electricity and the availability of electricty for industry and commerce is limited to a few areas. Demand is thus suppressed by lack of supplies. 83. Satisfaction of the needs of industry, including agricultural processing, and commerce will require considerable expansion of power sup- plies. Major projects to be undertaken during the Plan are the Kulekhani (60 MW), Devighat (14 MW), Kankai (33 MW), and perhaps Sharvababai (49 MW) projects. Since none of these projects is likely to be completed before 1979-80, the Government is also undertaking a number of minor hydel and thermal projects to satisfy rising power needs of other sectors and of households in the next few years. 84. Meanwhile the Government is also commissioning studies, with for- eign technical assistance, of a number of projects to be undertaken in the 1980's. Apart from the studies on the Karnali project, studies are to be made of the Gandaki river basin, of the Bagmati project, and of possible schemes on the Seti, Sarda and Rapti rivers. 85. The resources required for power development - finance, equipment and qualified manpower - cannot be furnished by Nepal acting alone. More- over, financial requirements of power development are probably being under- estimated. International assistance will therefore have to play a major role  - 25 - in power development. Currently, there is ample evidence of donor interest in this field. The Kulekhani project is being financed with assistance from Japan's Overseas Economic Cooperation Fund ($10.0 million), the Kuwait Fund ($17.5 million), IDA ($26.0 million) and UNDP (engineering studies, $3.0 million). HMG is financing the balance. No definite arrangements have as yet been made for the financing of other projects. G. Education 86. Perhaps even more than in other sectors achievements in education should be viewed in the appropriate historical perspective. At the end of the Rana regime which opposed schooling of the general population, only 10,000 children were in school, less than 1% of the school age population. Less than 2% of the people were literate. From the early 1950's on, educa- tion has been expanding at an enormous rate. At the time of the 1971 census, the literate population had risen to 1.3 million, 14% of the population over 6 years. Primary school enrolment amounted to 43% of the relevant age group. In addition, Tribhuvan University had a total of 20,000 students, at the undergraduate level. The participation of women in education was lagging. The literacy rate of females was 4% as compared to 24% for males; the primary enrolment ratio for girls was 17% as compared to 67% for boys. 87. By the early 1970's it became clear that this rapidly expanded education system had a number of serious shortcomings and in 1971, HMG began to remove the deficiencies of the system. It adopted an education reform (National Education System Plan) which was to make education more responsive to the needs of a developing country. The content of education was revised, the new curricula emphasizing practical instruction. At the secondary level, vocational training was included as part of the normal curriculum. Under the reform, more resources are made available for teacher training (only one-third of primary teachers are qualified) and salaries of teachers, which were very low, were raised. An important feature of the reform is the shortening of primary education from 5 to 3 years. The Government's eventual goal is that all children will attend primary school but only half of them would go on to the 4-year lower secondary level and only half of those again would proceed to the 3-year higher secondary level. The shortening of primary education would lead to important reductions in the cost of primary education and should, therefore, make the achievement of universal primary education less costly. There is however some doubt that basic numeracy and literacy can be permanently retained by the average pupil in an environment largely condition- ed to illiteracy. Unless literacy skills obtained in primary education are reinforced by use they are easily lost. To the extent the environment in remote parts of rural Nepal is unlikely to offer such reinforcement, it may be premature to strive for universal primary education. 88. Inspite of substantial aid from abroad, the projected expansion of education will be a heavy burden on Nepal's domestic resources. Under the Plan's allocation, 9-11% of a greatly increased public investment program is to be devoted to education as compared to 5% in the previous plan. After completion of school buildings, etc., these increased development expenditures  - 26 - will be followed by even sharper rises in current expenditures. Education's claim on public resources is still modest, only 10% of public resources and 1% of GDP. These are low proportions, even for a country at Nepal's develop- ment stage. Partly, they are explained by the low salaries of teachers, the still low enrollment proportions and also to some extent by the amount of self-help in rural school construction and the modest standards of equipment. It is easy to predict, however, that education expenditures will soon present a much larger claim on public resources, perhaps 15-18%, by the end of the Plan period. 89. The Government may wish to consider whether in particular the higher education program justifies such an increase. There seems to be a need for a reassessment of the potentially very expensive higher education program in the light of expected absorptive capacity. 90. More attention however seems to be needed for the training of middle-level manpower. Particularly at the intermediate level there are serious shortages of technicians such as extension agents, agricultural credit officers, cooperative guidance officers, junior health workers, land surve- yors, construction foremen and supervisors, etc. Shortages in these fields seriously hamper the implementation of development schemes and are perhaps the most serious bottleneck in economic development.---In the education field, priority should, therefore, be given to the expansion of training facilities on the intermediate technical level. H. Health 91. The Fifth Plan provides for a substantial increase in funds alloc- ated to the health sector. The population's general health is still unsatis- factory. Infant mortality is high, malnutrition and under-nourishment of children common, and communicable diseases such as tuberculosis, typhoid fever and cholera widespread. The death rate is high, about 20 per 1,000 inhabitants and life expectancy at birth is only 45 years. 92. To combat these ills, the country has a small system of hospitals and health posts which corer only part of the population and which is inade- quately staffed with nurses, auxiliary health workers and doctors. There is one doctor for every 36,000 inhabitants in the country as compared to 1:10,000 in India and 1:6,000 in Sri Lanka. The Kathmandu valley has 1 doctor per 6,500 people and half of the country's hospital beds. 93. Perhaps the most serious problem is the poor health of children. Lack of hygiene and improper feeding habits lead to high infant mortality (200 per 1,000). The resulting uncertainty about family size in turn hampers efforts to convince couples to have fewer children. The development of chil- dren over one year of age is hampered by lack of food. A recent survey finds that 58% of the children in the Hills and 49% in the Terai are below normal height or weight or both as a result of undernourishment and malnutrition. More details about the survey are provided in Appendix VIII-15. Many of these  - 27 - children risk never attaining full development. Related to the child health problem and very serious in view of Nepal's limited capacity to carry people is the high birth rate (40 per thousand). Nepal's population has no reli- gious prejudice against birth control and women who have borne children are generally favorably disposed to birth control when it has been explained to them. Present habits and living conditions however preclude rapid spread of birth control practices, unless an effective campaign is undertaken to change attitudes. Particularly in the Hills, communications, however, are so poor that it is difficult to reach most of the child'-bearing couples and to supply them regularly with temporary birth control devices. To be successful, family planning must therefore rely on vasectomy and sterilization as permanent methods of birth control. 94. The main objective of the Fifth Plan in the health sector is to provide minimum basic health services to the maximum number of people in every region. The emphasis is on preventive medicine. The chief vehicle for delivering health services at the grass-root level are the rural Health Posts. The ultimate goal is to gradually upgrade these posts into Integrated Health Posts which will incorporate all of the public health services includ- ing health education, family planning, and campaigns against communicable diseases. Other elements of the health policy include strengthening of in- stitutions and research in the field of traditional (Ayurvedic) medicine, reorientation of the Institute of Medicineto sufpplying low and middle personnel and allowing non-governmental agencies to establish health institu- tions and facilities. In addition to the establishment of Integrated Health Posts, activities under the Fifth Plan include a countrywide family planning (FP) and maternity child health care program, and expansion of programs to eradicate communicable diseases as part of its efforts to improve external health. 95. The main difficulties of the health program are the pronounced shortage of trained manpower and adequate supplies and equipment for the health centers. In view of these constraints, health targets are probably too optimistic. In view of these difficulties external assistance will continue to be very desirable. The main sources of external assistance in the health sector have been the United States, UNICEF, WHO, and India. Assistance has also been available from Japan, Canada, and the Netherlands. 96. The most important area which seems as yet insufficiently covered in the national health program or in foreign assistance program relates to child nutrition. In view of the lack of foodstuffs in the Hills there is no obvious domestic solution for this problem. A certain amount of foreign assistance could however be devoted to school feeding program and other nutrition projects. I. Water Supply and Sewerage 97. Standards of water supply and sewerage are still very low. Only the small urban population has access to public water supplies, mostly from standpipes. Of the rural population, less than 2% benefit from public water  - 28 - supplies. Altogether, an estimated 735,000 people or 6% of the total pop- ulation have access to public water supplies. Sewerage is available in small parts of Kathmandu (to about 20% of its population); in the remainder of the country there are almost no public facilities for waste disposal. In view of the abundance of water including groundwater throughout Nepal, improvement of water supplies may be one of the most cost effective ways to improve public health, perhaps even more so than in other countries where water is more scarce. 98. During the Fourth Plan additional water supplies were created for 250,000 people, about one-fifth of the increase in total population during the Plan period, at a cost corresponding to about 1.5% of public develop- ment expenditures. Almost no improvements were made in the availability of sewerage facilities and solid waste removal. 99. The current Plan proposes a substantial increase in outlays to 3.5% of development expenditure (about $17 million). The proposal is to extend public water supplies to an additional 800,000 people and improve and expand urban water and sewerage facilities. An important part of the financing of this program will be contributed by the IDA Water Supply and Sewerage Project ($7.8 million) which aims at water supply and sewerage improvements in the Kathmandu Valley and Pokhara. 100. The main problems of the sector seem to be at present in the insti- tutional and manpower field. There has been sufficient indication of donor interest in carrying out new projects in this sector, both in urban and rural areas. The main need seems to be to tie in aid for such projects with a coordinated approach to technical assistance to help overcome institutional and manpower constraints. A sector survey by the WHO/IBRD Cooperative Program has recommended a redefinitin of institutional responsibilities over the next few years, byu a process of evaluation of exisitng agencies. J. Conclusions 101. The foregoing review of major sectors shows that many useful devel- opment projects and programs are underway, that some policies are being im- proved, that useful institutions are being created or strengthened and that acceptance and understanding of improved technology is growing. There have certainly been widespread and well conceived efforts to set development going. These efforts have not yet been paying off in terms of accelerating production growth which should not be surprising in view of the intractable nature of many of Nepal's development problems. 102. A rough picture emerges regarding the prospects for production and investment. Growth of agriculture is likely to become slightly more rapid than in the past. Our rough calculations indicate a growth rate of production of about 3% a year, significantly higher than past growth, although lower than the rate expected by the planners. Growth of industry will be helped by the output of recently completed projects and of a few projects such as the  - 29 - textile factory, the expansion of the brewery and sugar mill now underway. There is a lack of sufficiently prepared new projects, however. It seems therefore unlikely that the past growth rate of manufacturing of 8% can be exceeded. Owing to a fairly high investment level and the completion of new facilities, the output of the construction, power and transport sectors is likely to continue growing at about the same rate as during the Fourth Plan. Since these sectors make only small contributions to GDP, the impact of their growth rate on overall GDP growth is correspondingly small. The outlook for cottage industries, a more substantial sector in terms of GDP contribut- tion, does not look favorable. Inspite of some useful schemes and measures, the Government has not yet developed an approach which will put cottage industries in a strong competitive position. Assuming finally that the services sectors will grow at about the same rate as the rest of the economy, the mission has arrived at some very tentative GDP projections. They are presented to illustrate the mission's view, that overall growth during the Fifth Plan will probably be ahead of population growth and significantly higher than in the past, although well below plan targets. Table 4: GROWTH DURING THE FIFTH PLAN: A TENTATIVE MISSION PROJECTION (in % per year) Fourth Plan (Rough mission Tentative Mission Estimates) Plan (max.) Projection Agriculture 1.8 3.6 3 Manufacturing 8 ) 6-8 Construction, Transport, Power 7 8 7-9 Cottage Industries 1.2 ) 2-4 Services 2.2 ) 3-4 GDP 2.2 5 3.2-3.7 103. The total volume of investment during the Fifth Plan will be in- fluenced by the fact that half of the proposed investment consists of proj- ects that were already underway at the beginning of the Plan period. Roughly another 25-30% of proposed projects are fully prepared and financed and are ready for implementation. This leaves 20-25% of proposed investments which will still require further preparation; outlays on these projects will pro- bably be small. A countervailing influence is that real costs of investments are frequently, and in many cases seriously, underestimated. Altogether it seems possible that total investments will grow by 7% a year reaching Rs 5.5 billion (US$515 million) in 1974/75 prices during the Five-Year period. The Plan's minimum estimate was for an amount of Rs 6.2 billion. A large part of this investment will consist of a continuation of investment projects started under the previous plan. As will be discussed in the next chapter which reviews the prospects for development financing, the composition of these investment outlays is likely to be considerably at variance with the invest- ment priorities of the Plan.  - 30 - III. The Financing of Development A. Domestic Resources 104. Nepal's government budget is unusually small. Revenue amounts to less than 6% of GDP and current expenditure to 3.5%. These proportions are significantly smaller than they are in most countries at Nepal's development level 1/. Apart from the factors of poverty and low degree of monetization which Nepal shares with these other countries, the low proportion of revenue is explained by-the country's geography. Lack of communications has made it difficult to collect sales and excise taxes and taxes on incomes and property in the Hills districts. The authorities have furthermore found it difficult to control movements of goods across the long border with India with the result that customs revenue is very small. Given these constraints, HMG's overall revenue efforts have certainly been satisfactory. The real growth of revenue has been computed by the mission at 7.3% a year during the Fourth Plan, as compared to a real GDP growth rate of 2.2% a year. Revenue growth thus was more rapid than the growth of the economy as a whole. 105. Current expenditures have remained small, first because there has been little to spend, and second because the lack of communications with many parts of the country has physically limited the Government's ability to provide services to its citizens. A further factor is the low level of government salaries. These range from Rs 110 per month for the lowest paid worker to Rs 1700 per month for top civil servants. The median government salary is Rs 165 and the average Rs 230 ($18) per month. 106. At this low level of revenue and expenditures the authorities have been able to achieve budgetary savings of about 2% of GDP. These have helped the financing of the government's development expenditures which have aver- aged 5.5% of GDP during the Fourth Plan. Most of the remaining deficit has been financed with foreign grants and, more recently, loans on concessionary terms. Development expenditures have, however, been growing much faster than GDP and they are expected to continue to do so during the Fifth Plan. The question is what contribution domestic resources will be able to make to the financing of development expenditures and how much foreign sources of finance should contribute to this purpose. The mission has made tentative projections of the prospects for public finance which are summed up in Table 6 and summarily discussed in the following paragraphs. 107. 1. Prospects for revenue. The fastest growing elements have been indirect taxes, particularly excise duties, the sales tax, and to a lesser extent import duties. These taxes account for almost two-thirds of the rev- enue increase during the Fourth Plan. Dividends of government enterprises increased rapidly. Taxes on income and property contributed very little to revenue. 1/ Comparison with other developing countries of the same size and income level would suggest a share of both revenue and current expenditures of about 12% (see Patterns of Development, 1950-70, Chenery and Syrquin).  - 31 - 108. The favorable rate of revenue growth is not so much due to built-in elasticity of the system as to improvements in collection and frequent ad- justments of specific tax rates. Most of the excise and sales taxes and im- port duties are still levied at specific rather than ad valorem rates. In the inflationary condition of recent years this necessitated frequent tax rate adjustments; HMG has been diligent in making these adjustments, raising the rates generally more than would have been required to maintain revenue at the same level in constant prices. HMG is gradually switching from specific to ad valorem rates, thus guaranteeing more automatic response to price changes. 109. For the future, the major potential for revenue increase lies in improving the application of existing laws rather than in rate increases (except for inflation correction on specific indirect tax rates). In spite of the limitations of Nepal's tax potential it would seem that there is room for significant revenue growth in several areas. In line with official think- ing appropriate measures could lead to increased revenue from land taxes, water rates on irrigated land, forest fees, urban property taxes, import and export duties and profits from government enterprises. 110. Improved revenue collection from these taxes could go hand in hand with the HMG goal of reducing the regressive impact of the tax system. Increased taxation of rural and urban property would be designed to tax the relatively better off rather than small farmers. The institutionalization of the rice trade and the ensuing increase in returns from export duties is affecting the financial position of middlemen rather than that of the farmers. Improvement of border control would permit the Government to diminish tax rates on essential imports and increase tax incidence on goods consumed by the middle and higher income groups. Changes in import duties introduced with the 1975/76 budget have indeed included reductions in duties on some basic consumption items such as salt, sugar and charcoal. The favorable growth record of revenue in the past combined with the prospect of a modest accel- eration of GDP growth and the fact that there are possibilities to improve tax yields suggest that there should be some increase in the growth rate of total revenue. The planners have forecast a growth rate of revenue during the Fifth Plan of 8% a year in real terms as compared to 7.3% during the previous plan. This growth rate should be feasible. 111. 2. Prospects for current expenditures. Current expenditures have been growing much faster than revenue. In real terms they have been increas- ing by about 10% a year. The fastest growing elements have been general administration and education expenses. Inspite of this rapid growth, the overall level of Government services is still at a modest level and in a few areas an acceleration of expenditure growth seems to be in store. 112. The most important of these are maintenance expenditures. Since most of the existing transport infrastructure, and irrigation works are of relatively recent date, the need for maintenance has been small in the past.  Table 5: Public Finance during the Fifth Plan: A Tentative Mission Forecast (in Rs million) Third Plan (1965/6-1969/70 Fourth Plan (1970/1-1974/5) Fifth Plan (1975/6-1979/80) Current 1974/75 % of Current 1974/75 % of Real Growth 1974/75 % of Real Growth Prices Prices GDP Prices Prices GDP Rate p.a. Prices GDP Rate p.a. Revenue 1,677 2,793 4.49 3,380 3,978 5.76 7.3 5,980 7.3 8.5 Tax 1,471 2,450 3.95 2,842 3,345 4.85 6.4 Non-Tax 206 343 .55 538 633 .92 13.0 Regular expenditure 911 1,517 2.44 2,054 2,418 3.50 9.8 4,260 5.2 12 Budgetary savings 766 1,276 2.06 1,326 1,561 2.26 4.2 1,720 2.1 2 Development expenditure 1,639 2,729 4.40 3,316 3,903 5.65 7.4 5,470 6.7 7.0 Budget deficit 873 1,454 2.34 1,990 2,342 3.39 10.0 3,750 4.6 9.9 Financed by: Domestic credit 855 1,424 2.29 491 578 .84 600 .7 Use of reserves -902 -1,502 -2.42 12 14 .02 ) Foreign grants 905 1,507 2.43 1,186 1,396 2.02 3 150 3.8 12.5 Foreign loans 15 25 .04 301 354 .51 ) GDP 37,280 62,080 100.00 58,640 69,021 100.00 2.2 81,980 100.0 3.5  - 33 - Meanwhile it has become clear that under the geological and climatic condi- tions prevailing in Nepal maintenance cannot be neglected for long. A fast rise in maintenance outlays appears necessary to forestall rapid deterioration of infrastructure. 113. A further factor of expenditure increase is the need to raise govern- ment salaries to more realistic levels. HMG has partly compensated the lowest paid government servants by providing them with subsidized basic necessities such as rice. To maintain morale it may be necessary, however, to raise salaries within the next few years. 114. In addition to the level of Government salaries there is the in- crease in the number of government officials. In the past five years their number has been rising by about 8% a year. While it is difficult to judge the extent to which this increase is proportionate to a real increase in tasks performed by HMG there can be no doubt that the proposed expansion of education and health services and the growing requirements of general administration are likely to lead to continued expansion of the number of government servants. 115. In the light of these considerations the 8% rate of annual increase in current expenditures projected by the planners may well prove to be on the low side. For the purpose of our projections we tentatively assume a 12% increase in regular expenditures. 116. 3. Prospects for public savings. The authorities have been able to maintain government savings during the last ten years at an average level slightly over 2% of GDP. As current expenditures are likely to continue to grow faster than revenue, budgetary savings should be expected to decline gradually. 117. Meanwhile HMG has also been able to muster some further financial resources through borrowings from the banking system. There should be some scope for continued use of this source. There is some evidence, however, that the private sector has had insufficient access to banking funds which may have had an adverse influence on the development of private industry. About two-thirds of the expansion of domestic credit since 1972 has been to HMG, to public enterprises and to the rice export companies established by the Government. Little was left to help finance the private sector of the economy. Believing that the public sector should not preempt a too large share of the resources of financial intermediaries, we have tentatively assumed that HMG will not increase its borrowing from the banking system. 118. 4. Prospects for the overall deficit. The earlier mentioned esti- mate of development outlays during the Fifth Plan of Rs 5.5 billion would lead to a deficit of about Rs 3.2 billion in 1974/75 prices ($300 million) which cannot be c6vered from domestic resources. Unless sufficient foreign aid on concessional terms is available, investment outlays will have to be cut. The prospects for the balance of payments and for foreign aid are re- viewed in the final sections of this chapter.  - 34 - B. Balance of Payments 119. The difficult domestic resource position discussed in the preceding section is likely to be matched by a tightening of the external financial position. Although balance of payments estimates are only available for 1973/74 and 1974/75, it is clear from the steady increase in foreign exchange reserves that the overall balance of payments must have been in overall surplus since the mid-1960s. At the end of 1974, reserves amounted to $133 million, the equivalent of almost one year's imports. Since then, however, the balance of payments has deteriorated as shown by the following table: Table 6: BALANCE OF PAYMENTS (in US$ million) 1973/74 1974/75 $ million % of GDP $ million % of GDP Exports, f.o.b. 79 6.3 82 5.9 Imports, c.i.f. -116 -9.3 -154 -11.0 Tourism 18 1.4 21 1.5 Other non-factor services 3 .2 1 .1 Resource balance - 16 -1.3 - 50 - 3.5 Investment income 11 .9 9 .6 Private remittances (Gorkha's) 11 .9 16 1.1 Current accounts 6 .5 - 25 - 1.8 Official grants 21 1.7 25 1.8 Official loans 8 .6 10 .7 less amortization - 2 - .1 Errors and omissions* - 28 -2.3 - 49 - 3.5 Use of reserves - 7 - .6 41 2.9 * Includes private capital flows. Source: Based on IMF estimates. 120. The structure of the balance of payments is simple. Export of rice to India and jute to the world market account for two-thirds of export earn- ings. Imports are more heterogeneous, covering a large range of manufactured goods and raw materials. Increasing receipts from tourism have come to supple- ment the country's foreign exchange earnings but still left a resource gap equivalent to 3.5% of GDP in 1974/75. Imports in that year were unusually high due to a crash import program of cement, fertilizer, steel and other basic necessities, and to the sharp increase in the prices of petroleum and fertilizer in India at that time. On the basis of some recovery of this sharp terms-of-trade deterioration, a 2.5% resource gap might be a more typical figure. This resource gap is financed by remittances and pensions  - 35 - of Gurkha soldiers, interest on the now declining foreign exchange holdings, disbursements of foreign aid and, recently, a drawdown of exchange holdings. There remains then a large unexplained negative item which may be due to underestimation of imports, private capital flight, or both. The April 1975 increase in interest rates should have reduced the tendency for capital flight. 121. Inspite of the increase in interest rates, balance of payments pros- pects do not look favorable. On the export side there is little hope for a rapid increase of traditional exports. Jute exports have suffered under the recent depression of the world market for jute. Although a moderate improve- ment of market conditions is expected, Nepal's jute is likely to remain in a weak competitive position compared with producers downstream in India and Bangladesh. Rice production is likely to grow somewhat faster than in the past. The expected growth rate of 2.7% is, however, only marginally higher than the population growth rate and there seems, therefore, little reason to hope that Nepal can do more than maintain rice exports at the present level of 200,000 MT per year. The recent establishment of rice exporting companies is likely to lead to reduced smuggling and perhaps increased fiscal revenue but not to an increase in the real volume of rice exports. 122. The only traditional item which offers scope for rapid export in- crease is timber and perhaps wood-based products. In order to achieve this increase, the management of the forestry sector needs to be tightened. As earlier noted, there is ample scope for such an improvement. Increased utilization of this important natural resource should be relatively easy to achieve. 123. In the section on industry (Chapter II, C) mention has been made of a few possibilities for developing new export products. None of these is likely to add much to export earnings in the near future. They neverthe- less deserve very serious consideration since these and similar ventures will have to make an increasingly important contribution to the long-run solution of the balance of payments problem. 124. Exports of hydro-electricity also offer little prospect for the medium-term. Depending on the development of domestic demand, minor and temporary electricity exports may occur by the early 1980's when the projects now under preparation will be completed. The outlook for substantial earnings from major projects, such as the Karnali project, however, is quite uncertain and in any case could not be counted on until several years after the project would have been completed in the 1990's. 125. In the services field there is still considerable potential for increased earnings from tourism. These earnings have rapidly increased and now account for 20% of gross foreign exchange earnings. As pointed out, improvements in the organization and management of the sector are needed to increase the stream of visitors and the benefits derived from tourism. 126. Imports have been rising more rapidly than exports and will probably continue to do so in the future. They have risen from an average level of 8.5%  - 36 - of GDP in the late 1960's to 9.3% in 1973/74, and 11% in 1974/75. Even with- out the temporary upsurge in last year's imports caused by the crash import program of basic necessities, imports would have been growing rapidly. Al- though nothing precise is known about the commodity composition of foreign trade, there can be little doubt that the import increase is closely related to the increase in investment outlays. Nepal produces few of the capital goods needed for development projects and the rapid growth of investment has been by far the most dynamic factor in an otherwise mostly stagnant economy. Further but probably less important elements in import growth have been the raw materials requirements of industrial production and the imports needed for the tourist industry. 127. With the expected increase in development outlays, tentatively estimated by the mission at 10% a year in real terms, imports will probably continue to grow at a rapid rate. Since there are no comparable pros- pects for near-term export growth the external resource gap is likely to widen during the Plan period. The available information does not provide a proper basis for estimating the future size of the resource gap; a sub- stantfal increase in the gap from its present level of 2.5-3% of GDP to 4.5-6% over the course of the Fifth Plan seems, however, quite likely. 128. For the financing of the resource gap, Nepal should be able to count on continued remittances from Gurkha soldiers and on interest earned on whatever foreign exchange holdings can be maintained. Of course there is no reason for Nepal to maintain resources at an excessive level. In its landlocked position the country is, however, extremely vulnerable to trade and transport developments beyond its control. To prevent sudden shortages, that would interrupt development activities, foreign reserves should be maintained at a relatively high level. In view of this consideration, there is probably little room for financing of the resource gap through a drawdown of reserves. If meanwhile an outflow of private capital were to occur at the level which it appears to have attained in recent years, the foreign exchange problem might easily become unmanageable. The authorities should therefore be prepared to take adequate measures in case of a re-emergence of capital outflows. 129. On certain rough assumptions the various financing items would leave about Rs 3,200-3,800 million (in 1974/75 prices) for the Fifth Plan period to be covered by foreign aid disbursements. C. External Assistance 130. Foreign aid commitments increased rapidly in the past few years. Since much of the aid is connected with projects already under execution or in advanced stage of preparation, it is likely that this increase in commit- ments is already being followed by an acceleration in disbursements. Of course delays may occur in aid negotiation or project execution. Nevertheless at the beginning of the Fifth Plan it appears likely that aid disbursements will rise sufficiently to cover the earlier discussed gap in the financing of the public investment program.  - 37 - 131. This does not mean, however, that the composition of prospective aid matches the requirements of the investment program. While the increase in foreign aid commitments is of course a favorable development, it is de- sirable that IDIG and donors remain in close contact concerning the priority, the design, the local currency requirements, the co-financing arrangements and the financing conditions of foreign-aided projects. 1. Priority of foreign-aided projects 132. The volume of aid disbursements during the Plan is likely to rise to about 60% of total public investment. Such a large involvement of foreign donors is almost unavoidably influencing the composition of public investment. In the past, most of the aid was devoted to infrastructure (power and trans- port and communications) partly because projects in these sectors are more amenable to foreign financing. Meanwhile the development strategy has shifted in favor of directly productive activities. Due to the long lead time required for the preparation of development projects, disbursements on infrastructure projects are expected to remain disproportionately large during the Fifth Plan period. Priorities for actual spending in the second half of the 1970's were to a large extent determined in the early years of the decade. 133. Projects which are now being studied by foreign aid agencies reflect to a much larger extent the priorities of the Plan. Included among those are development attempts for the Far Western region, feeder roads connected with rural development programs, suspension bridges to shorten distances in hilly areas, assistance to agricultural training, etc. Since foreign aid obviously will have to play a significant role in Nepal's economic develop- ment for many more years, it is important that HMG make efforts to keep donors well informed about its development objectives and priorities and that it keep in close contact with foreign aid missions visiting Nepal to identify future assistance programs. 2. Design of foreign-aided projects 134. Insufficient guidance from Nepalese side and at times insistence by HMG on unnecessarily high standards of execution has led donors to follow a type of project design reflecting the factor endowment of the donor country rather than that of Nepal. Much of the transport facilities designed for Nepal by foreign donors appear too costly in terms of capital and maintenance cost, particularly since the traffic density on some of the transport connec- tions is extremely low and unlikely to rise significantly in the future. The long-term solution of Nepal's transport problems will require more imaginative, low-cost solutions geared to Nepal's particular situation. Another example is that certain factories are equipped with labor saving machinery more ap- propriate for advanced economies with high wage costs than for Nepal where the opportunity cost of labor is low. 3. Local currency requirements of foreign-aided projects 135. Certain of Nepal's donors have been financing the full investment cost of projects including all local currency expenditures. On the average,  - 38 - the proportion of foreign financing of aided projects is very high. Prelim- inary information indicates that the disbursements of foreign aid funds during the Fifth Plan will cover 70% of total spending on the respective projects during the Plan. This still will leave about Rs. 1,350 million to be covered from domestic financial resources. As the mission's tentative projections for public finance indicate this sum would absorb close to 60% of all the domestic resources available for development. 136. With such a large part of development resources pre-empted by the local currency requirements of foreign aided projects, only Rs 970 million would be left for all development activities which are usually less suitable for foreign aid financing. This includes a large part of the expenditures for minor roads, minor irrigation works, a variety of rural development activities, improvement in the administrative infrastructure, a large part of the outlay on education and health, and finally repair and major maintenance of the transport network. These items, which taken together are of vital importance for the economic and social development of the country, are bound to suffer severely from lack of funds during the Fifth Plan period, unless donors can further increase the proportion of their project financing. Al- though other considerations also play a role in this matter, financing by foreign donors of a very high proportion of investment costs of foreign-aided projects including as much as possible of local currency expenditures would be desirable in view of Nepal's extremely difficult financial situation. 137. Donors also should be encouraged to finance certain current ex- penditures of development projects. In many cases (technical education, agricultural extension, rural development schemes) the usual distinction between current and capital expenditures is artificial. In view of the extreme scarcity of domestic financial resources it is highly desirable that donors also finance part of such current expenditures. 4. Co-financing arrangements 138. Completion of Nepal's basic infrastructure including hydel proj- ects for domestic electricity consumption will require a number of invest- ments- which each individually may-prove too large to be-financed by one donor alone. The Kulekhani hydroelectric project was the first major project which was financed by several donors. Despite the increased emphasis on smaller projects in all sectors, there are expected to be other large ventures which will require cooperation among interested parties during the project design stages and co-financing arrangements for the execution of the projects. 5. Terms and conditions of aid 139. In view of its weak financial position and the long time it will take for the country to become independent of outside resources, aid to Nepal should be preferably in the form of grants or to the extent lenders' policies preclude this on concessionary lending conditions including long maturity periods. Most of the aid to Nepal has indeed been in the form of grants. -As-a result, Nepal's external debt is very low.  - 39 - 140. As of December 31, 1974 official foreign debt amounted to only $106.2 million of which $71.0 million remained undisbursed. This low utili- zation is due to the fact that most foreign loans have been contracted only recently. Consequently, debt service was about $1.5 million in 1974 or equivalent to about 1.9% of exports of goods and services. However, future assistance may increasingly take the form of loans, most of them on soft conditions. In view of the accelerated development efforts, external public debt is expected to rise and, based on the trend in recent years, may well reach $250 million by 1980. The debt service ratio by 1980 is, however, forecast to remain below 10%.   ANNEX 1 Page 1 SUMMARY OF INDUSTRIAL PROJECTS UNDER CONSIDERATION BY HMC OF NEPAL Agro-based Industries Sugar Mills. At present there are 3 mills which, after expansion now being undertaken, will produce 23,000 tons of sugar a year. This will still leave a need to import 14,000-16,000 tons per year. Since sugar cane production is well established in Nepal and could provide increased returns on areas now under other crops, there may be room for an additional sugar mill. A brief feasibility study by NIDC discusses establishment of 2 mills each producing 11,000-12,000 tons of sugar at an investment cost of $5 million each, of which 75% in foreign exchange. Further investigation appears needed (i) of the measures to be taken to expand cane production and increase yields, which are now among the lowest in the world; and (ii) whether the existing mills could be further expanded to handle all foreseeable increases in cane production. Two flour mills, to be established at Biratnagar and Janakpur. Wheat production has been expanding rapidly especially as a winter crop creating a demand for increased milling capacity. NIDC has approved finan- cing of both projects which would have a capacity of 40 tons per day and the Government has issued the required licenses. Investment cost would amount to $0.7 million each. Jute weaving mill. This was one of the largest projects of the original plan, with a capacity of 12,000 tons per year and an investment cost of $24 million. Mainly due to unfavorable market conditions, the project seems unattractive and has been dropped for the time being. Starch and glucose. A joint Indian-Nepalese feasibility study concludes that there would be scope for a $1.3 million plant to produce, on the basis of domestically grown maize, 5,000 tons of starch, 2,250 tons of glucose and smaller quantities of by-products such as gluten and maize oil. Most of the starch would be used in the domestic textile industry and the glucose in the food industry. The study asserts that there should be no difficulty in exporting surpluses, if any, to India. The raw materials position seems assured since Nepal currently has a maize surplus of 40,000 tons a year, which is sold on the Indian market. Potable and industrial alcohol. A $1 million extension of the recently modernized sugar refinery at Birganj, mostly to satisfy the needs of the domestic market. The project has been approved and will soon be undertaken. A vegetable ghee factory ($2.4 million) and a vegetable oil factory ($1.4 million) were already under construction when the plan period started. The ghee project has run into administrative and procurement problems.  ANNEX 1 Page 2 Forest-based Industries Although one-third of Nepal's territory is covered by forests, forestry and forest-based industries are still making only a small contri- bution to the national economy. The plant aims at rehabilitation of the existing 35 saw mills which should be able to provide more timber for ex- ports, for domestic production and for use in forest-based industries. Pulp and paper. The $4.7 million plant originally in the plan which would produce 33,000 tons of paper a year does not seem viable and has been dropped for the time being. The main difficulty is the lack of long fiber raw material. The problem could be overcome through mixing with imported materials and eventually afforestation with fast growing long fiber species. Since large parts of Nepal should permanently remain covered by forests, exploration of the potential for pulp and paper production should certainly continue. The domestic market (6,000 tons) will for a long time remain too small to sustain an economically sized plant. However, India is likely to remain permanently short of raw materials for paper production and should therefore present a potential export market. Rosin and turpentine. According to a joint Nepalese-Indian feas- ibility study, Nepal's forests contain sufficient chirpine stands to permit commercial resin tapping. The plan proposes a $1.3 million plant to produce rosin and turpentine oil, mostly for export. Parqueting. The plan proposes a very small project ($0.1 million). In view of availability of good hardwood trees, the project could serve as a model for further utilization of this resource. Basic Materials Cement plant. Nepal has been, and still is, critically short of cement. Since India is also short of cement, Nepal recently has had to im- port most of its cement from overseas. The cement plant near Kathmandu, which started production in 1975, produces 30-40,000 tons per year, some 60% of capacity. Once raw material problems have been overcome, production could rise to about 50,000 tons. Nepal's cement consumption amounts to 120,000 tons. A recent consultant study reviewed by UNIDO indicates that a second plant could be established near Hetaura in Central Nepal. The limestone deposits, on which the plant would be based, occurs in irregularly shaped bands necessitating selective mining by labor intensive methods. Earlier Chinese and Russian studies had concluded that the plant was unfeasible because of the poor quality of the deposits. However, considering the generally mediocre quality of other deposits in Nepal or elsewhere on the subcontinent, the low cost of labor for selective mining, and the extremely high cost of imports from overseas, the proposition may prove to be the least expensive way to foresee in Nepal's cement demand, particularly if labor (direct employment  ANNEX 1 Page 3 1,000 persons) is costed at its economic rather than its financial value. The proposed plant would have a capacity of 260,000 tons. According to rough UNIDO calculations which take account of expected inflation during construction the plant would cost $55 million. A recent review by the Bank seems to indicate that a smaller capacity of about 200,000 tons a year would be preferable. Production of such a plant might rise from 100,000 tons in 1981 to 180,000- 200,000 tons by the mid-1980s. Basic consumption goods The main project in this field is a $9.4 million cotton textile mill, currently under construction in Hetaura with Chinese financial and technical assistance. The plant will have a capacity of 10 million meters of various medium grades of cotton cloth, satisfying some 10-12% of total domestic requirements. It will employ 2,000 workers. Since cotton produc- tion in Nepal is still in the experimental stage, cotton will have to be imported. Leather and footwear. In spite of Nepal's large livestock popula- tion, leather production is small. Most of the tanning is done in traditional cottage industries. The plan provides for the establishment of a few small modern tanneries (about $0.25 million each) and the expansion of the existing shoe factory (from 250 to 600 pairs per day). As modern abattoirs are set up, there should be room for establishment of more modern tanneries producing good quality leather for domestic and foreign markets. Further projects in this category concern the production of soap, carbonated beverages, biscuits, and malt. Mining projects Exploration has thus far turned up little evidence of substantial mineral resources. The limestone deposits have been mentioned above in con- nection with the cement plant. In addition, the plan foresees the explora- tion of magnesite deposits at Kharidunga in the hills N.E. from Kathmandu. According to a feasibility study in 1973 by German consultants, beneficiation could reduce the silica content of these low grade deposits to an acceptable level and selective mining could avoid ore with high iron content. The study recommends annual production of dead burnt beneficiated magnesite for export to India (25,000 tons of sinter) and overseas (20,000 tons of refractory brick). The study estimated investment cost at $11.5 million; this estimate requires correction for price increases since the completion of the study. The Govern- ment would like to implement the project in cooperation with foreign mining concerns, but thus far there have been no definite expressions of interest. Among the problems that require further study are those of transport and of the marketing of the output.  ANNEX 1 Page 4 Another, probably more ambitious scheme, concerning the exploita- tion of the Kharidunga magnesite deposits is the establishment of a plant producing 30,000 tons fused magnesium phosphate for mixing with urea fer- tilizer. The project would use low grade magnesite ore without beneficia- tion and imported rock phosphate. The Bureau of Mines believes that demand in India which is short of magnesite would be sufficient to provide a market for the output. The German consultants recommended more detailed study of this project on the basis of a pilot plant. Lead and zinc deposits in Rasuwa district could, according to a Bureau of Mines survey, produce 25,000 MT of concentrated ore at an invest- ment cost of $4 million. Foreign mining interests apparently have expressed interest in this project. The transport problems of this project are ob- viously extremely difficult since implementation of the project would require construction of a 73 km road to the project site up in the hills.  SPECIAL REPORT: REVIEW OF THE ECONOMIC SITUATION OF NEPAL ***I***I*** ********* STATISTICAL APPENDIX   STATISTICAL APPENDIX I. POPULATION I-I Population Estimates and Projections I-2 Implications of Population Projections I-3 Regional Distribution of Populations I-4 Age and Sex Composition I-5 Growth of Labor Force 1-6 Economically Active Population Classified by Industry, Occupation, and Employment Status II. NATIONAL ACCOUNTS II-l Gross Domestic Product of Nepal at Current Market Prices II-2 Total Agriculture and Non-Agriculture GDP at Current and Constant Prices II-3 Expenditures on GDP at Current Market Prices II-4 Regional Distribution of GDP PLAN II-5 Saving, Investment, Outlay, and Production During the Fifth Plan III. EXTERNAL SECTOR III-1 Summary Balance of Payments III-2 Receipts and Payments of Convertible Foreign Exchange III-3 Composition of Total Exports III-4 Composition of Total Imports III-5 Composition of Trade with Countries Other Than India III-6 International Reserves III-7 Foreign Grants Received IV. EXTERNAL DEBT IV-i External Public Debt Outstandina including Undisbursed as of December 31, 1975 IV-2 Service Payments, Commitments, Disbursements and Outstanding Amounts of External Public Debt Projections Based on Debt Outstanding Including Undisbursed as of December 31, 1975  STATISTICAL APPENDIX (Continued) V. PUBLIC FINANCE V-1 Central Government Budgetary Performance V-2 Budgetary Expenditure of the Central Government V-3 Budgetary Revenue of the Central Government PLAN V-4 Public Sector Allocations and Actuals During Third and Fourths Plans V-5 Total Allocation of the Fifth Plan Outlay V-6 Public Sector Allocation of the Fifth Plan Outlay VI. MONETARY STATISTICS VI-1 Monetary Authorities' Account VI-2 Assets and Liabilities of Commercial Banks VI-3 Agricultural Development Bank--Resources and Utilization of Funds VI-4 Nepal Industrial Development Corporation--Resources and Utilization of Funds VI-5 Agricultural Development Bank - Annual Disbursements VI-6 Agricultural Development Bank - Proposed Lending Program VII. AGRICULTURAL STATISTICS VII-1 Area, Production, and Yields of Major Crops VII-2 Annual Consumption of Inputs IIII. STATISTICS OF OTHER SECTORS VIII-1 Production of Principal Industries VIII-2 Manufacturing Establishments--Structure and Economic Activities VIII-3 Highway Network VIII-4 Road Construction Program of the Fifth Plan VIII-5 Number of Motor Vehicles in Service VIII-6 Tourist Arrivals and Expenditures VIII-7 Tourist Arrivals by Nationalities VIII-8 Tourist Arrivals by Purpose of Visit VIII-9 Number of Pupils, Teachers and Pupil/Teacher Ratio by Level of Education VIII-10 Number of Schools and Enrollment Ratio by Region and Level of Education VIII-11 Teachers' Salary and Recurrent Cost per School VIII-12 Government Expenditure on Education by Level VIII-13 Projection of Demand and Supply of Technical Manpower in the Fifth Plan  STATISTICAL APPENDIX (Continued) VIII-14 Nepal Nutrition Status Survey VIII-15 Family Planning Performance in Selected Districts VIII-16 Existing and Planned Achievement by Region VIII-17 Existing and Planned Health Posts IX. PRICES IX-1 Changes in Kathmandu Consumers' Price Index X. PUBLIC CORPORATIONS X-1 Public Sector Corporations: Rate of Return on Assets X-2 Outcome of Operations of Certain Public Enterprises   Tabl-e I-1: POPUATION ;TIAATB-n AND P.ROJ'jiCTIONS Population . rerag3 Annuyual ear (thousand) Grotdth () 1911 >, 9 2'9 5, 5?' 4o* 13 ) 533 192' 6, 28,4 2. 1953 8 257 2., 162 9,2413 1.6 1971 1',556 2.07 1976 11 , 357 7. - 195' 14, 315 ;2 . I 5 196 '.6,051 . .30 Source: Central Bhreau of St-^atistics, ?opDu''nico Provections for Nepal, 1971-198t May 1974.  Table 1-2: IMlPLIC!ATIONS 0F POPULATION PROJECTIONS 1971 1976 1981 1986 Density per Km 82 91 1,2 ,lL Alales per tholisand females l,O'L 1,013 1,013 1,012 Life expectancy at birth (years) 42.5 45.0 47.5 50.0 Crude birth rate 42.87 400.0 38.59 38.64 Crude death rate 22.30 19.84 18.14 18.34 Source: Centrra1 Bureau of Statistics, Population Projectiorns for Nepal, 1971-1936, August 1974.  Table I-3: REGTONAL DISTRIBUTION OF POPULMTIONT (Percentrage) 1971 1976 1981 1986 'astern Region 24.21 23.94 23.70 23.44 iHills and mcuntains 12.20 11.84 11.51 11.17 Terai 12.01 12.10 12.19 12.27 Central Region 33-45 33.66 33.88 34.10 Hills and mountains 18.13 13.09 13.04 17.99 Terai 15.32 15.57 15.84 16.11 Vestern Reg-ion 21.33 21.24 21.07 20.90 Hills and mountains 16.l9 15.99 15.79 15.59 Trai 5 .14 5.26 5.28 5.31 Far Wqesterr Region 21.01 21.16 21.35 21.56 Hill.s andr mountains 15.88 15.68 15.49 15.30 Terai 5.13 5.48 5.86 6.26 Lotal. hills and mountains 62.40 61.59 60.83 60.05 of whichi Kathmandu District (3.00) Total Teral 37.60 38.41 39-17 39-95 100.00 100.00 100.00 100.00 Source: Central Bureau of Statistics, Population Projections for Nepal, 1971-1986, August 1974.