Nepal - Second Water Supply and Sewerage Project

FILE COPYf Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2041-NEP REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A SECOND WATER SUPPLY AND SEWERAGE PROJECT April 11, 1977 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 autborzation.  CURRENCY EQUIVALENTS US$1 - NRs 12.50 NR 1 = US$0.08 NRB 100,000 = US$8,000 NRs 1,000,000 US$80,000 FISCAL YEAR Nepal Fiscal Year - July 16 to July 15 PRINCIPAL ABBREVIATIONS AND ACRONYMS MWP - Ministry of Water and Power UNDP - United Nations Development Programme WHO - World Health Organization WSSB - Water Supply and Sewerage Board WSSD - Water Supply and Sewerage Department  FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A SECOND WATER SUPPLY AND SEWERAGE PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal for the equivalent of US$8.0 million on standard IDA terms to help finance a project for improving and extending water supply and sewerage facilities in Kathmandu, Kathmandu Valley, Pokhara, Biratnagar, and Birganj. The proceeds of the credit would be relent to the Water Supply and Sewerage Board (WSSB) with interest at 9% per annum for a term of 25 years, including a five-year grace period on the payment of principal and interest. PART I - THE ECONOMY 2. The most recent economic report entitled "Review of the Economic Situation of Nepal" (Report No. 1180-NEP) was distributed to the Executive Directors on July 30, 1976. The principal findings of the report and the developments since then are described below. Country data are shown in Annex I. 3. Nepal has been classified by the United Nations as one of the least-developed countries in the world. Its per capita income in 1975 was estimated at $110. It has a population of 12.6 million, estimated to be growing at around 2% per year. A large proportion, nearly 96% of the popula- tion, live in rural areas. Health and education facilities are below the standards achieved in the rest of South Asia. Nepal has an infant mortality rate of 200 per thousand live births, an adult literacy rate of 14%, and a life expectancy at birth under 45 years. 4. The country has a difficult topography which severely limits the area of arable land. Yet population density is now 450 per square kilometer of land for all of Nepal and 930 persons in the Hill areas where 59% of the people live. Already the results of pushing the area of cultivated land beyond economically feasible and ecologically safe limits are being felt in the Hill areas. Agricultural yields have declined, and soil erosion and landslides have resulted in these areas. In the Terai plains where foodgrains, sugar and jute are cultivated, little room is left for extending the cultivated areas. The traditional grain surpluses produced in the Terai are declining as population has grown. 5. The landlocked position of the country imposes an additional con- straint. Far removed from sources of supplies of development goods and access to export markets, development is more costly in Nepal than in many other countries. Moreover, uncertainties of trade and transit over the sub- continent complicates all economic decision-making, necessitates the holding of relatively large foreign exchange reserves, and reduces the country's attraction to private investors. This document has a restricted distribution and may be used by recipients only in the performance of their ofMcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - 2 - 6. The economy is predominantly agricultural. About 67% of total value added originates in agriculture, and over 90% of the labor force is engaged in this activity. Agricultural products constitute more than 80% of Nepal's exports. Ninety percent of these exports go to India. Rice, the main export, accounts for about 60% of the total export value, while jute is the second most important. Industrial value added amounts to only 4% of GDP and Nepal, therefore, has to import almost all of its capital goods and a large part of manufactured consumer goods. 7. In the past decade, Nepal's GDP growth rate averaged 2.4% per year, marginally above the rate of population growth. Thus far, development efforts have been mostly directed towards building an economic and administrative in- frastructure. This was necessary since it was only in the early fifties that the Government adopted economic and social development as major objectives. The investments in infrastructure made since then were the country's first steps toward modernization. They have not yet paid off, however, in terms of accelerated economic growth. 8. There have been no significant changes in the trend of economic growth in 1975/76. The weather continues to be the main factor which deter- mines yearly fluctuations in growth. Last year, weather conditions were very favorable, the grain crop was large, and GDP grew by about 4%, well above the average 2.4% of the past decade. The balance of payments benefited from temporarily larger rice exports, improved administrative control of rice exports, increased incomes from tourism and increased inflow of remittances. At the same time, imports of petroleum products, fertilizer, cement, and iron and steel declined, because these items had been overstocked in the previous year. Foreign exchange reserves rose by 6% to $119.7 million, the equivalent of about nine months of imports. Last year's higher GDP growth rate and the improvement in the balance of payments were chiefly due to fortuitous factors rather than to an improvement in the longer term growth trend of the economy. 9. After substantial efforts in the last two decades to build up the country's infrastructure, Nepal's planners believe that the time has come for a shift in the development strategy. The leading principle of the current five-year plan (1976-80) is that Nepal should aim its development efforts at deriving increased production benefits from its past efforts to establish and expand the infrastructure. The allocation of investment funds under the plan shows a drop in the share of transport and communications (from 41% to 23% of the total) and corresponding increases in the share of agriculture, industry and the social sectors. Attention is to be concentrated on quick-yielding projects, mostly in agriculture but with an appropriate component of viable import substitution in industry. 10. The most important opportunity to reap production gains lies in agriculture. Present yields in the Terai, where most of the foodgrains are cultivated, average only 1-1.3 tons per hectare. These yieldscan be increased substantially by improvements in agricultural extension, by increased appli- cation of inputs, and by minor irrigation. Similar improvements could also be extended to sugar and jute cultivation which also have very low yields. The wide difference between growing conditions in the Hills and in the Terai  - 3 - offers scope for increased specialization and exchange of products. For the time being, the Hills must continue to emphasize food production in view of the serious food deficits in the area. Hlowever, in the long run, the Hills area is comparatively well suited to produce cash crops -- fruits, spices, vegetables, potatoes, natural silk, etc. On a limited scale these items are already being produced. Achievement of production gains will also require the strengthening of marketing and credit institutions. Some progress in institution-building has already been made in recent years, as evidenced by the establishment of the Agricultural Development Bank and the Agricultural Productivity and Service Center. 11. Although agriculture must occupy a predominant position in Nepal's development strategy, opportunities also exist in other directly productive sectors, mainly industry and tourism, and these should be vigorously pursued. The contribution of modern industry to GDP is still small, about 4%, but it has been growing. Most of the sector consists of the processing of agricul- tural products such as rice, wheat, vegetable oil, sugar and jute. The re- mainder is made up of factories producing simple consumer goods, wood pro- ducts, bricks, tiles and cement. The small size of the market, lack of raw materials, competition from Indian products, and the shortage of domestic entrepreneurs and trained workers will continue to be limiting factors for some time. Modern industry, nevertheless, has its role in Nepal's future development. The scope for processing of agricultural products for domestic use and export should increase with the intended diversification of agricul- ture. Further growth of the economy will also present scope for more import substitution. 12. Tourism has grown at 11.5% per year over the last five years; tourist arrivals at present are estimated to be above 85,000. Foreign ex- change earnings from this source are equivalent to those from merchandise exports. In line with a master plan for the sector, prepared with German assistance, a number of projects are to be undertaken to develop hill sta- tions, observation points, and national parks as well as to restore ancient temples and to strengthen the hotel school. While small in size, these projects are important for the long-term development of tourism. 13. On the basis of these and other considerations, it appears that there is sufficient scope for development of the directly productive sectors to allow a modest acceleration of GDP growth to perhaps 3.5% a year during the last years of the decade and 4-5% in the 1980s. The proposed develop- ment strategy appears to be appropriate to Nepal's circumstances. The past ratio of investment (8.5-10.5% of GDP) to growth (2% of GDP) appears to be very high and, 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. 14. Nepal has made commendable efforts to mobilize domestic resources for development. In the last five years, real revenue growth has averaged over 7% a year, much higher than the growth rate of GDP, and budgetary savings were maintained at 40% of revenue, slightly over 2% of GDP. This result was obtained in the face of serious difficulties. On the revenue side,  - 4 - Nepal suffers from the constraints of extreme poverty and low degree of mone- tization of the economy. The open border with India moreover makes it diffi- cult to control foreign trade and to levy the trade taxes which play such a large role in the tax system of most developing countries. On the current expenditures side, the Government has to cope with rising claims for main- tenance of infrastructure and the need to raise government salaries from levels which are low even by the standards of a poor country. 15. In view of the pressures to increase current expenditures, all that can be realistically expected in the next few years is that government main- tains its savings rate at 2% of GDP. Only when economic growth starts to accelerate significantly in the 1980s will there be prospects for an increase in this rate. Given the constraints on mobilizing domestic resources, which will prevail even with continued satisfactory fiscal management, foreign aid will remain a decisive factor in Nepal's economic development. In fact, since public savings are likely to increase less rapidly than public investment during the period of the current five-year plan, aid will become, at least temporarily, more important. In view of this scarcity of public savings, aid will have to cover not only the foreign exchange cost of projects, but, as a rule, also at least part of local cost. Total aid disbursements during 1971- 75 (the previous five-year plan) averaged $33 million a year in constant (1974/75) prices and covered 45% of public investment. During 1976-80 (the present five-year plan), this proportion would have to rise to 57% if public investment is not to be held back by lack of financial resources. Under these circumstances, disbursements in real terms would have to rise by around 12.5% per year to average about $60 million in constant 1974/75 prices and about $90 million in current prices. 16. The international community has thus far been very responsive to these aid needs of Nepal. Shortage of finance has not yet been a bottleneck and prospects are that aid flows of the required magnitude will continue to be available. The real factor determining Nepal's development pace will remain the growth of absorptive capacity, and it is this factor which will determine the actual level of aid disbursements. The essential questions regarding aid to Nepal are, therefore, what donors should do to attune their aid programs to Nepal's development priorities and what they can do to raise absorptive capacity. 17. These questions, obviously requiring consultations between the Nepal Government and the donors, provide the focus for the Nepal aid group which had its first meeting in Tokyo last December. On the basis of sector and project documentation prepared by the Government, the meeting reviewed the type of projects needed to support the Government's development strategy and the type of technical assistance programs needed to build up absorptive capacity. Sustained attention to these matters in the framework of the aid group is expected to lead to improvements in the composition of aid and to speed up the still very slow rate of disbursement of aid funds. 18. As of December 31, 1975, official foreign debt amounted to only $120 million, of which 28% was to IDA. Of the $120 million, $86 million remained undisbursed. This low utilization is largely due to the fact that 80% of foreign loans has been contracted since 1970. Debt service was about  - 5 - $1.5 million in 1975 or equivalent to about 2% of exports of goods and ser- vices. However, future assistance may increasingly take the form of loans. Most of them will probably be on concessionary terms, which is highly desir- able in view of Nepal's poverty and limited export prospects. In view of tlle accelerated development efforts, external public debt is expected to rise and, based on the trend in recent years, may reach about $350 million by 1980, of which approxirnately 50% could be in IDA credits. The total debt service ratio by 1980 is, however, projected to remain below 10%. I)ebt service to the Bank Group alone would be less than 2% of exports of goods and services. PART II - BANK GROUP OPERATIONS IN NEPAL 19. The first IDA credit to Nepal in the amount of $1.7 million equiva- lent was made in FY70 for a telecommunications project. This was followed by credits for highways ($2.5 million), tourism ($3.2 million), irrigation ($6.0 million), a second telecommunications project ($5.5 million), a water sup- ply and sewerage project ($7.8 million), a settlement project ($6.0 million), a power project ($26.0 million) and a rural development project ($8.0 million). Already approved in FY77 are a groundwater project ($9.0 million) and a techni- cal assistance project ($3.0 million). Additional financing ($4.0 million) is presently under consideration by the Executive Directors to assist in meeting an anticipated cost overrun in the first Water Supply and Sewerage project. The proposed credit would bring the total amount of IDA assistance to Nepal to $90.7 million equivalent, net of cancellations. No Bank loans have been made to Nepal. IFC made its first investment in Nepal ($3.2 million) in a hotel project in Kathmandu in FY75. Annex II contains a summary statement of Baak Group operations as of February 28, 1977, and notes on the execution of ongoing IDA projects. It shows that delays in the implementation of these projects are common, particularly during the initial periods. These delays have been largely due to Nepal's limited technical and managerial capabilities. In order to assist Nepal in coping with this constraint, considerable technical assistance is being given by Bank Group staff, including our Resident Mission in Kathmandu. As a result, improvement in the rate oE disbursements is being realized. During the first nine months of FY77, $4.2 million were disbursed compare,l to $6.9 million disbursed during the entire previous six years. There is, however, substantial scope for further improvement. 20. Bank Group lending to Nepal has so far been at a modest level com- pared to the country's need for, and total receipts of, external assistance. The international community has persistently shown considerable interest in Nepal's economic development and, to date, shortage of funds has not been a bottleneck. The main constraLnt on the utilization of aid has been Nepal's limited absorptive capacity, affecting the pace of project preparationi and implementation. The Bank has agreed to assist the Government in project pre- paration through the technical assistance credit and by acting as Executing Agency for a number of technical assistance projects in the current UNDP Five- Year Program. The Bank Group has addressed the problem of absorptive capacity also through its role in organizing an aid group for Nepal (para 17).  - 6 - 21. Tne Bank Group's current strategy places major emphasis upon the directly productive sectors (particularly agriculture) and the development of complementary infrastructure, including feeder roads (particularly roads connecting the Hills to the Terai), communications and hydroelectric power. A Nepal Industrial Development Corporation project is scheduled for presentation to the Board in May 1977. A feeder road project has been appraised and is expected to be negotiated before the end of the current fiscal year. Prepara- tion of projects in irrigation, telecommunications, rural development and horticulture is underway. PART III - VWATER SUPPLY AND SEWERAGE IN NEPAL 22. The water supply and sewerage sector in Nepal is still in a very early stage of development. Only about 750,000 inhabitants (6% of the popula- tion) living mostly in urban areas have access to water supply systems. About 20,000 house connections, including 5,000 metered connections, serve a popula- tion of about 160,000. The balance of the population served uses standpipes. The population that is not served (nearly 12 million) use the traditional sources of water (private tubewells, dugwells, rivers, and other sources), which are often of doubtful quality, with the threat of health hazards. As for sewerage, only the center of Kathmandu is served by a small system. In other towns and in the villages water borne sewerage is restricted to hos- pitals, government buildings, and new houses with septic tanks. Drainage systems, much needed in view of heavy rain during the monsoon, exist only in a few towns. 23. Due to insufficient sources, inadequate storage and distribution capacity, and extensive leakage and wastage, the piped systems are only able to provide water intermittently and service is generally restricted to a few hours a day (4-6 hours in Kathmandu). Approximately 50% of the water produced is lost through leakage and wastage. Quality control is generally inadequate. Only the Kathmandu water supply system is subject to chemical quality testing and occasionally to bacteriological tests. In addition, the Department of Health carries out some surveillance when cholera or typhoid cases are reported or suspected. 24. There are three main Government agencies operating in the sector: (a) The Water Supply and Sewerage Board (WSSB), which was formed in 1973 under the Ministry of Water and Power (MWP) as the Government's executing agency for the first IDA financed Water Supply and Sewerage Project (Credit No. 470-NEP of May 8, 1974), is responsible for the construction and operation of the facilities in Kathmandu, Kathmandu Valley and Pokhara. WSSB's present service area has about 470,000 inhabitants. (b) The Water Supply and Sewerage Department (WSSD), also under MWP, is responsible for the construction and ope- ration of water supply and sewerage schemes in all urban  -7- areas not served by WSSB, regional and district head- quarters, rural communities with more than 3,000 in- habitants and certain urban and rural water supply schemes not taken over by the panchayats (town coun- cils). It is charged with the responsibility of ser- ving a population of about 6.4 million. (c) The Local Development Department was created in 1971 under the Ministry of Panchayat to serve communities of less than 3,000. It has responsibility for public works, including water supply and sewerage. Its service area has a population of about 5.7 million. Among these agencies, WSSB is the best organized and operates on a commercial basis. It is the Government's intention that, ultimately, WSSB will take responsibility for the whole sector throughout Nepal. A sector report being prepared under the IBRD/WHO Cooperative Program will, inter alia, focus on the long-term organizational aspects of the sector. It is scheduled for com- pletion in mid-1977. 25. Government expenditures for new construction in the sector have risen from approximately $150,000 in FY1971 to approximately $1.0 million in FY1976 (including the first Water Supply and Sewerage Project), and are pro- jected to reach an average of close to $8.0 million in the following five years. More than two thirds of these investments would be carried out by WSSB. 26. The concept of paying adequate rates for water service was, until recently, unknown in Nepal. This has contributed to substantial wastage of water. Though st*ill at inadequate levels, water charges are being increasingly introduced. As WSSB extends its area of activities and improves its service, water charges will have to be increased if the supply of water is to remain self supporting financially. 27. In recent years a number of donors have been assisting Nepal in the development of the sector and its agencies. Germany is providing assistance to WSSD for the construction of a water supply system in central Bhaktapur, an attractive tourist center in the Kathmandu Valley, while India has provided similar assistance to WSSD and the Local Development Department. The UN Inter- national Children's Emergency Fund has assisted the latter with the construc- tion of small schemes in rural areas. The United Kingdom is providing WSSB with a team of experts for technical assistance in engineering and financial administration. UNDP provided financing for a Master Plan for the development of water supply and sewerage facilities in Kathmandu Valley which was completed in 1973. Despite this support, a considerable amount of work remains to be done. 28. IDA's first Water Supply and Sewerage Project (largely based on the Master Plan referred to in the previous paragraph) provides for the improvement and extension of water supply facilities in Kathmandu Valley and in Pokhara, a  - 8 - major center for tourism, and sewerage facilities in Kathmandu and Lalitpur, a suburb of Kathmandu. Implementation of the project is about a year behind schedule mainly due to WSSB's inexperience at the beginning in dealing with relatively complex contracts. However, major contracts (amounting to a total of US$10.8 million equivalent) have been let. All remaining contracts are expected to be let by June 1977, and construction to be completed by end-1978. Due to worldwide inflation since the 1973 appraisal of the project, a cost overrun of approximately US$6.0 million is expected. Additional financing (US$4.0) to assist in meeting this cost overrun is currently under consider- ation by the Executive Directors. In implementing the first project, the Government has obtained technical assistance from the United Kingdom in the fields of engineering, finance, leak detection, metering and quality control. There has been substantial improvement as a result and arrangements are being made for such assistance to continue. WSSB's need for technical assistance will continue for the next few years in view of the shortage of qualified Nepalese personnel and the planned extension of its service area. PART IV - THE PROJECT 29. The proposed project is based on the Master Plan studies for Kath- mandu Valley financed by UNDP, and studies for Pokhara, Biratnagar and Birganj financed by the Government, all carried out by UK consultants. The studies, completed in 1973, were reviewed in 1976 by WSSB assisted by U.S. consultants, and the cost estimates were updated during project preparation. The project was appraised in October, 1976. The appraisal report entitled "Nepal - Appraisal of the Second Water Supply and Sewerage Project" (No. 1420b-NEP) dated April 11, 1977 is being circulated separately. Negotiations were held in Washington during March 9-17, 1977. The Government was represented by Mr. K.D. Adhikari, Secretary, Miinistry of Water and Power. A Credit and Project Summary is attached as Annex III. Description of the Project 30. The project is largely a continuation of the first IDA-financed Water Supply and Sewerage Project. It consists of additional works in Kath- mandu, Kathmandu Valley and Pokhara. It also includes works in the towns of Biratnagar, and Birganj. Biratnagar is a regional center in the Eastern Terai and Birganj, a town astride the main access route from India to Kathmandu, is an important regional center for trade in agricultural products. The works in Biratnagar and Birganj were originally proposed as components in the first project, but had to be excluded because the requisite funds could not be found. 31. The project includes construction of reservoirs and secondary water supply distribution mains in Kathmandu Valley and Pokhara, and extensions to the sewage collection systems in Kathmandu and Lalitpur. In Biratnagar and Birganj, the project would be a first step towards improving and extending  - 9 - the existing water supply systems. The project also includes studies for the preparation of water supply schemes for six other towns; updating of water supply and sewerage master plans; and a tariff study. The appointment of consultants to assist WSSB in engineering and project implementation would be a condition of effectiveness of the proposed credit (Section 7.01(a) of the Development Credit Agreement). WSSB staff would continue to be trained by the UK technical assistance team in the fields of engineering, adminis- tration, finance, metering and laboratory work. Adequate facilities, equipment and vehicles are included in the project for this purpose. The project is expected to be completed by mid-1981. Project Cost and Financing 32. The total cost of the project is estimated at US$11.0 million equi- valent (excluding duties and taxes of approximately US$0.3 million equivalent). This consists of US$5.1 million equivalent for water supply, US$0.8 million equivalent for sewerage, US$1.5 million equivalent for engineering, technical assistance in project implementation and studies, US$0.1 million equivalent for project administration, and US$3.5 million equivalent for physical and price contingencies. Details of project cost are included in Annex III. The foreign exchange component is estimated at US$5.6 million equivalent. The proposed credit of US$8.0 million equivalent would cover the foreign exchange cost and US$2.4 million equivalent of the local cost (see para 15 above). The Government would finance the remaining US$3.3 million equivalent (includ- ing duties and taxes) as equity contribution to WSSB. The proceeds of the credit would be relent to WSSB with interest at 9 percent per annum, for a term of 25 years, including a five year grace period on the payment of prin- cipal; interest during the grace period would be waived. The execution of a subsidiary loan agreement between the Government and WSSB would be a condi- tion of effectiveness (Section 7.01(b) of the Development Credit Agreement). Project Organization 33. The proposed project would be carried out by WSSB. WSSB's Board of Directors consists of seven members under the chairmanship of the Secretary, MWP. The other six members are the chief executive (the Project-in-Charge) of WSSB, who serves as the Board's Secretary, the Chief Engineer of WSSD, and representatives of the National Planning Commission and of the Mtinistries of Finance, Health, and Panchayat. The present Project-in-Charge is well quali- fied and experienced. The Government has agreed that at all times it would fill the position of the Project-in-Charge with a person with qualifications and experience acceptable to the Association (Section 4.02 (b)(i) of the Development Credit Agreement). 34. Whereas the consultants who prepared the first project had recom- mended the creation of a water supply and sewerage corporation to operate as a completely independent agency, the Government elected, with IDA's concurrence, to establish WSSB within MWP as an interim agency until sufficient experience had been gained. The creation of a Corporation will be considered in the light of the recommendations of the sector report being prepared under the IBRD/WHO Cooperative Program (para 24). WSSB's performance has improved  - 10 - appreciably in recent months and it is considered capable of carrying out the proposed project. The Government has agreed to extend the responsibilities of WSSB to include Biratnagar and Birganj Water Supply systems (Section 4.05(ii) of the Development Credit Agreement). In addition to technical assistance from the UK, the Government would institute a program of training acceptable to the Association (Sections 4.02(b)(ii) and 3.08 of Development Credit Agreement). Financial Aspects 35. Under the Development Credit Agreement for the first Project, WSSB is required to achieve a rate of return of at least 1% on average net fixed assets in operation for the fiscal years 1976-78. A water tariff increase of 60% in FY1975 enabled WSSB to realize a revenue surplus and almost fulfill this requirement in FY1976. Credit 470-NEP also requires WSSB to achieve rates of return in subsequent fiscal years rising gradually to 8% in FY1987 and thereafter. It is proposed, however, that the rate covenant be modified to require WSSB to achieve a rate of return in FY1979 of at least 2% rising gradually to at least 6% in FY1987 and thereafter (Section 4.06 of the Devel- opment Credit Agreement). In order to fulfill these rates of return, it is estimated that WSSB will have to increase its tariffs by approximately 100% in FY1979, with further substantial increases in following years, and a new charge for sewerage. While the 6% rate of return is modest, it is considered realistic in view of the substantial tariff increase required. Moreover, it would be sufficient to enable WSSB to contribute increasingly to the financing of its investment plans. This contribution is estimated to reach 20% in FY1984. A study covering all aspects of demand and tariffs was to be carried out by consultants under Credit 470-NEP in FY1977. Because of the delay in implementation of the first project this study is now included in the proposed project and to be carried out in 1978. 36. During negotiations, it was also agreed that WSSB would not incur any debt which would result in a revenue/debt service ratio below 1.5 with- out the Association's approval (Section 4.07 of the Development Credit Agree- ment). This is the same ratio as agreed under Credit 470-NEP. Procurement and Disbursement 37. Contracts would be awarded on the basis of international competi- tive bidding in accordance with IDA guidelines, except for minor contracts for equipment (each item below US$50,000) and civil works (each contract below US$100,000), which would be let under local procurement procedures which are satisfactory to IDA. The total of these minor contracts would not exceed US$500,000 equivalent, including minor works done by force account. Although there is no manufacturer of pipes in Nepal at present, such a factory could be established within the project implementation period. A margin of prefer- ence up to 15%, or customs duties if lower, is proposed for local manufac- turers. A margin of preference of 7.5% would also be granted to local civil works contractors.  - 11 - 38. Disbursements would be made against: (i) 100% of foreign expen- ditures for directly imported equipment; (ii) 100% of local expenditures (ex- factory) for locally manufactured equipment; (iii) 60% of local expenditures for other goods procured locally; (iv) 100% of foreign expenditures and 30% of local expenditures for civil works (including force account); and (v) 100% of total expenditures for consulting services. A disbursement schedule is in- cluded in Annex III. Benefits and Risks 39. Water supply of doubtful quality and inadequate quantity reached only about 400,000 inhabitants in the present WSSB service area in July 1976 and sewerage facilities served only about 27,000 people. Upon its completion in 1981, the proposed project would provide an adequate supply of safe water to about 590,000 people (over 80% of the inhabitants of the project area) and sewerage facilities for over 85,000. By 1985 the beneficiaries of the water supply systems would be approximately 710,000 people, representing 96% of the total population of the project area. The population thus served would include a large majority of the urban poor in these areas. Further extension of the services would require increased capital outlays. The health benefits to the inhabitants of the project area and the reduction of pollution in the Bagmati River would be the main benefits of the proposed project. Improvement of sanitary conditions in Kathmandu Valley and in Pokhara would also benefit the tourist industry which is an important foreign exchange earner for Nepal. Another important benefit is the strengthening of WSSB as an institution capable of improving and extending its services in the project area and ul- timately over the whole country. The proposed project is the least cost solution for providing these services, and future water charges would exceed the average incremental cost of water by FY1981. While this would maintain charges at levels affordable to the great majority, WSSB would continue to be self supporting and financially viable. 40. Project risks may arise from delays in project implementation and from political and social pressure to avoid tariff increases as needed in future to achieve the rates of return required for the financial viability of WSSB. Technical assistance and increased supervision effort would help meet the former, while the proposed tariff study would recommend tariffs which maximize revenues within the consumers' ability to pay and ensure that the urban poor can afford to obtain the minimum amount of water required by an average family to maintain a healthy and productive life. PART V - LEGAL INSTRUMENTS AND AUTHORITY 41. The draft Development Credit Agreement between the Kingdom of lNepal and the Association, the recommendation of the Committee provided for in Article V, Section 1(d) of the Articles of Agreement and the text of a draft resolution approving the proposed credit are being distributed to the Execu- tive Directors separately.  - 12 - 42. Special conditions of the project are listed in Section III of Annex IV. Additional conditions of effectiveness would be (i) effectiveness of the agreement amending Development Credit Agreement 470-NEP to finance the cost overrun on the first project; (ii) the appointment of consultants to assist WSSB in engineering design and project supervision; and (iii) the execution of the subsidiary loan agreement between the Government and WSSB for relending the proceeds of the proposed credit. 43. I am satisfied that the proposed development credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 44. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President Attachments April 11, 1977  ANNEX I Nireof 4~ pages NEPAL - SOCIAL INDICATORS DATA SHEEt LANID AREA (THOU RN?)------------------------- --------------- ~~~~~NEPAL REFERENCE COUNTRIES (1970) TOTAL 140.8 MOST RECENT AGRIC. 4 2.3 t1 6 0 1970 ESTIMATE AFGHANISTAN BOLIVI A TUMRKEY"