Nepal - Third Telecommunications Project

Document of FILE COPY The World Bank FOR OFFICIAL USE ONLI-' Report No. P-2306-NEP REPORT AND RECONMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A THIRD TELECOMMUNICATIONS PROJECT April 25, 1978 This doeDent has a restricted diltrlbon mand my be used by recipients only In the performasce of their ofclal duties. Its contents my not otherwise be disclosed wIthout World Bank authoriation.  CURRENCY EQUIVALENTS Currency Unit - Nepalese Rupee (NR) US$1.00 - NRs 12.00 NR 1.00 - US$0.08 NRa 1,000,000 - US$83,333 Until March 20, 1978 US$1.00 - NRs 12.50 FISCAL YEAR July 16 to July 15 ABBREVLATIONS AND ACRONYMS CDP - Gross Domestic Product ITU - International Telecommunications Union NTB - Nepal Telecommunications Board NTC - Nepal Telecommunications Corporation ODM Ministry of Overseas Development of the United Kingdom STD - Subscriber Trunk Dialing UHF - Ultra High Frequency VHF - Very High Frequency  FOR OFFICIAL USE ONLY NEPAL THIRD TELECOMMUNICATIONS PROJECT Credit and Project Summary Borrower: Government of Nepal Beneficiary: Nepal Telecommunications Corporation (NTC) Amount: US$14.5 million Terms: Standard Relending Terms: The Government of Nepal to NTC with repayment over 20 years, including five years' grace at an interest rate of 9% per annum. Project Description: The project is designed to extend existing facilities so as to enable about 70% of the demand for local telephone service to be met; it will extend the long distance network to areas presently without service, provide long distance dialing and open up exchange service at 21 new locations; it also provides for sub- scribers radio facilities at 100 isolated loca- tions (mainly community centers), will expand telex facilities to meet demand for most of the country and provide a small satellite earth station to improve and expand international telecommunication facilities. Provision has been made for technical assistance in project implementation and training. The project faces no special risks beyond those commonly asso- ciated with telecommunications projects. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii Estimated Cost of Project: US$ Million Equivalent Local Foreign Total Local facilities 2.9 9.4 12.3 Long distance 0.5 2.7 3.2 International 0.2 1.4 1.6 Telex 0.2 1.2 1.4 Consultants - 0.1 0.1 Miscellaneous 0.1 0.9 1.0 Buildings 2.9 - 2.9 Basic Cost 6.8 15.7 22.5 Customs Duties 0.2 - 0.2 Price Contingencies 1.1 1.8 2.9 Total Cost 8.1 17.5 25.6 Financing Plan: Local Foreign Total IDA - 14.5 14.5 Bilateral (ODM) - 3.0 3.0 NTC 8.1 - 8.1 Total Project Cost 8.1 17.5 25.6 Est imated Disbursements US$ Millions from Credit: Annual Cumulative FY 1979 0.75 0.75 1980 2.86 3.61 1981 2.94 6.55 1982 5.15 11.70 1983 2.70 14.40 1984 0.10 14.50 Rate of Return: At least 18%. Appraisal Report: No. 1897-NEP dated April 14, 1978,  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A THIRD TELECOMMUNICATIONS PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal for the equivalent of US$14.5 mil- lion on standard IDA terms to help finance a third telecommunications project. The proceeds of the credit would be relent to the Nepal Telecommunications Corporation for a term of 20 years, including a five-year grace period, with interest at 9% per annum. The Ministry of Overseas Development of the United Kingdom would provide US$3.0 million equivalent as a grant towards financing the foreign exchange cost of the proposed project. PART I - THE ECONOMY 2. The most recent economic report entitled "Nepal-Country Economic Memorandum" (Report No. 1873a-NEP) was distributed to the Executive Directors on March 21, 1978. The principal findings of the Memorandum are described below. Country data are shown in Annex I. 3. Nepal is one of the least developed countries in the world. Per capita income in 1976 was estimated at $120, and health and education standards are well below the average of South Asia: life expectancy at birth of less than 44 years, infant mortality exceeds 200 per thousand, and adult literacy is only 19%. Population in mid-1976 was 12.9 million, of which over 90% lived in rural areas. Both birth and death rates are high, keeping popu- lation growth at 2.1% a year. 4. The economy of Nepal centers around agriculture. It accounts for 65% of GDP and almost 75% of merchandise exports, and provides a livelihood to over 90% of the population. In addition, most of the small industrial sector, which comprises about 4% of GDP, processes agricultural raw materials. However, about 25% of total rural incomes are estimated to arise from non- agricultural activities. Cottage industries are one of the most important of these, estimated to engage over 1 million people and comprise about 7% of GDP. They provide basic consumer goods in the many small, isolated markets where they would otherwise not be available. 5. The landlocked, isolated location of Nepal and its extremely rugged topography have severely constrained the country's development. Nepal is far removed from sources of supply of many development goods and access to export markets, which makes development more costly and uncertain than in most countries. The inaccessability of much of the country compounds these prob- lems and limits the rate at which development activities and the expansion of social services can be undertaken.  - 2 - 6. When Nepal adopted economic and social development as major govern- ment objectives in the early 1950s, there was virtually no economic and administrative infrastructure. Under these circumstances. initial development efforts necessarily concentrated on establishing a foundation for future devel- opment. It was inevitable that during these early stages growth would remain slow and that as a result, there would be little if any increase in per capita income. However, four successive development plans passed with little shift in emphasis, or improvement in per capita incomes and living standards. The Fifth Plan (1975/76 - 1979/80) was to become the turning point; emphasis was to shift away from heavy infrastructure towards quicker-yielding investments in directly productive activities, and the provision of social services. Investment in primary infrastructure would be highly selective, and kept in line with the country's near-term ability to exploit it. Infrastructure directly supporting other development activities would continue to receive priority. 7. To some extent the objectives of the Fifth Plan are being achieved. Overall public investment has been close to targets, and investment is begin- ning to be reoriented. However, GDP growth is well below the 4-5% annual growth rate envisioned in the Plan, mainly because of poor agricultural per- formance. Favorable weather in 1975/76 led to a record cereals crop, and GDP was estimated to have grown by 4-5%. However, a poor monsoon resulted in a 5.5% drop in cereals production in 1976/77, and overall economic growth of only about 1% resulted. In 1977/78, it again appears that adverse weather will limit growth in GDP to no more than 2%. 8. In the external sector, overall performance continues to be good. Foreign exchange reserves in September 1977 stood at US$144 million, 16% higher than a year earlier, and at the equivalent of about 10 months of imports. But the rise in reserves has occurred in conjunction with a large and increasing trade deficit. Imports have been growing under the impetus of the Government's development programs, while exports, principally rice (almost 50% of total exports) and jute (about 15%), declined. However, increased tourism earnings and Gurkha remittances brought about a sig- nificant improvement in current account. Tourism earnings accounted for 22% of total convertible foreign exchange earnings in 1976/77 and have displaced Gurkha remittances as the largest single source of convertible foreign exchange. 9. Despite increasing receipts from tourism and remittances from abroad, improvement in the trade balance remains critically important. Imports, particularly development goods and raw materials, are bound to rise steadily; however, prospects for exports are not promising. Prospects for rice, the largest export, are not favorable due to declining surpluses at home, and a rice glut on the Indian markets. Tourism is likely to continue growing although probably not as rapidly as in the past (para 15). 10. The Government has recently reformed the trade and payments system by eliminating the broken cross-exchange rate vis-a-vis the U.S. dollar and Indian rupee (by revaluing the Nepalese rupee against the  dollar by 4.3% and devaluing against the Indian rupee by 4.3%) and by abolish- ing the Export Exchange Entitlement scheme. In its place, a dual exchange rate has been established that offers premium exchange rates and hence incentive, for trade with overseas countries. Certain development goods can be imported at subsidized rates. 11. The recent signing of new trade and transit treaties with India should help improve conditions for foreign trade. The transit treaty allows the transit of goods to and from Bangladesh, and the expansion of existing port facilities for Nepal in Calcutta. The new trade treaty provides for improved access of Nepalese goods to the Indian market. 12. The poor long-run performance of the economy is chiefly due to the poor growth of agricultural production which is failing to keep pace with population growth. Over the period 1967/77, cereals production grew at an average annual rate of only 1.8% against an annual increase in population of 2.1%. Increases in the area under cultivation account for almost all of this increase; average yields rose by only 0.1% annually. Malnutrition is acute in the Hills, which contain only one-third of the country's agricultural land, yet close to two-thirds of the population. Population density on agricultural land in these areas is higher than in Bangladesh, under even less favorable natural conditions. Cultivation has been pushed up steep hillsides and onto marginal land, and average yields have actually declined. Food availability for the average family has dropped to less than the equivalent of 225 days minimum subsistence needs a year. Because they have little to trade except their labor, one-third of the inhabitants of these areas migrates seasonally to the Terai plains and northern India for food and work. Since the mid- sixties, an estimated 400,000 have migrated permanently; there are signs this exodus is accelerating. Family planning services which could help mitigate this crisis are weak. Although they are available in most of the larger towns, they are only just beginning to be extended into outlying rural areas. These efforts are being hampered by the inaccessibility of most of the popu- lation; mounting a program on the scale needed will require much more manpower and funds. 13. While the average-sized farm in the Terai is only 2.4 ha, it is still almost six times as large as that in the Hills. The small surpluses produced by the Terai farmers have been the basis for Nepal's rice exports. However, these exports have been steadily declining, from about half a million tons in the early sixties to only about 100,000 tons in 1977/78. This has been the result of production lagging behind population growth (para 12) and, more recently, the relative decline in export prices resulting from good crops in India in combination with poor harvests at home. 14. Agriculture thus has the highest development priority in Nepal, not only because of its central economic role, but also because of the pressing need for food in the Hills. However, only the Terai presents opportunities for establishing market-oriented farming in the near future; agricultural development in the Hills will have to concentrate on meeting subsistence needs. With the exception of the Kathmandu Valley, farmers in the Hills are extremely poor; hence, low-cost means of raising production will have to predominate initially -- improved agricultural practices, better crop selection, the use  - 4 - of improved local varieties and, wherever possible, increased use of organic fertilizers. The focus of agricultural development efforts in the Terai has been on major surface irrigation schemes to increase cropping intensity. But lack of adequate attention in the past to bringing development down to the farm level has resulted in the full benefits not being realized. The general lack of support services -- inputs, credit, extension and research, and farm- to-market roads -- compounded this problem. However, recent major irrigation projects financed by IDA and ADB are addressing these problems by taking more comprehensive and integrated approaches. Nevertheless, research and extension activities need to be strengthened further. Research activities must concen- trate on adapting promising crop varieties to the many different micro-climates, while organization of extension activities and training of extension agents must be improved to ensure the delivery of extension advice to farmers. 15. Although agriculture must occupy a predominant position in Nepal's immediate development strategy, important opportunities exist in other directly productive sectors, notably industry and tourism. Investment opportunities in large-scale industry are limited by the extremely low purchasing power of the population, the inaccessibility of much of the country, the country's remote- ness from sources of supply and markets abroad, and its poor endowment with mineral resources. Under these circumstances, most private capital is invested in small agroindustries, trade, tourism and real estate, where profits are more assured. Effective promotion of agro-industrial investments would help promote crop diversification by farmers and maximize domestic value added. Similarly, improved marketing arrangements both within Nepal and abroad, inputs supply and credit availability could help expand production by cottage industries. Tourism is one of the most rapidly growing sectors of the economy. Tourist arrivals have risen from fewer than 50,000 in 1971 to over 125,000 in 1977. But unless tourist services, particularly air transport, are expanded apace, this growth must necessarily come to a halt. There is also potential in forest-based industries, based on controlled exploitation of forest resources. But at present, fuelwood needs are causing the rapid depletion of forest resources in the Hills, contributing to the already massive erosion arising from natural causes and forage depletion. Immediate efforts in this sector must, therefore, concentrate on reforestation and watershed management. In the longer run, fuller exploitation of Nepal's vast water resources could provide a basis for accelerated economic growth. 16. Nepal has made significant progress in mobilizing domestic resources to undertake its development programs, considering the extreme poverty, low degree of monetization, and fragmented nature of the economy. Revenues have grown at 16% a year since 1969/70, and revenues as a percentage of GDP have increased from 5.0% in 1969/70 to about 7.5% in 1976/77. Over the same period, the Government was able to maintain savings on current expenditures in excess of 2% of GDP, a good achievement for a country in Nepal's economic position. 1/ It will be difficult, however, to maintain the public savings rate because 1/ Average budgetary savings for the least developed countries as a whole is about -0.7%.  - 5 - current expenditures will have to start growing more rapidly than in the past to allow for proper maintenance of roads and major irrigation schemes, and the operating expenses of expanding social services. 17. The narrow tax base limits the potential for generating increased revenues through tax rate adjustments, but there is still considerable scope for increasing the contribution of agriculture and improving tax administra- tion. Effective implementation of the recent agreement with India to improve control of unauthorized trade along the long common border would constitute an important step in this direction. 18. In view of the limited prospects for additional resource mobiliza- tion, foreign aid remains a decisive factor in Nepal's development. Foreign aid has increased rapidly during the 1970s. In the next two years, disburse- ment of aid already committed will provide about $200 million. Present pro- jections indicate, however, that there will be a residual financing gap of $75 million. This will prove difficult to fill through projects assistance. Donors need to consider financing a larger portion of the local costs of pro- jects, increasing commodity assistance, and providing sector aid. 19. As important as the need for additional financial assistance is the need further to boost absorptive capacity. Donors have responded through project-related technical assistance, and more recently, through efforts to strengthen the development administration capacity in certain key sectors. To assist in the overall coordination of financial and technical assistance efforts, the Nepal Aid Group was formed in 1976; the Group has met twice at plenary meetings to discuss overall external assistance needs as well as to discuss and coordinate strategy at the local level in Kathmandu. 20. As of December 31, 1976, official foreign debt amounted to $236 M. Although utilization has been slow in the past, disbursements are beginning to accelerate rapidly. Debt service was about $2.2 M in 1977 or equivalent to about 2% of exports of goods and services. In view of the accelerated development efforts, external public debt is expected to rise and, based on the trend in recent years, may reach about $450 million by 1980, of which approximately 50% could be in IDA credits. The total debt service ratio by 1980 is, however, projected to remain below 5%. Debt service to the Bank Group alone would be less than 2% of exports of goods and services. PART II - BANK GROUP OPERATIONS IN NEPAL 21. The first IDA credit to Nepal in the amount of $1.7 M equivalent was made in FY70 for a telecommunications project. This was followed by credits for highways ($2.2 M), tourism ($3.2 M), irrigation ($6.0 M), a second telecom- munications project ($5.5 M), a water supply and sewerage project ($11.8 M), a settlement project ($6.0 M), a power project ($26.0 M), a rural development project ($8.0 M), a groundwater project ($9.0 M), a technical assistance project ($3.0 M), a second water supply and sewerage project ($8.0 M), and a Nepal Industrial Development Corporation Project ($4.0 M). In FY78, to date,  - 6 - two credits have been approved; for a second highway project (US$17.0 M) and a technical education project (US$5.7M). The proposed credit would bring the total amount of IDA assistance to Nepal to US$131.6 M equivalent, net of can- cellations. No Bank loans have been made to Nepal. IFC made its first invest- ment in Nepal ($3.1 M) in a hotel project in Kathmandu in FY75. Annex II contains a summary statement of Bank Group operations as of March 31, 1978, and notes on the execution of ongoing IDA projects. It shows certain delays in the implementation of these projects, 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 con- straint, considerable technical assistance is being given by Bank Group staff, including our Resident Mission in Kathmandu. As a result, improvement in the rate of disbursements is being realized. During the first six months of FY78, $8.4 M were disbursed compared to $12.8 M disbursed during the entire previous seven years. There is, however, substantial scope for further improvement. 22. 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 constraint on the utilization of increased aid has been Nepal's limited absorptive capacity, affecting the pace of project preparation and implementation; The Bank has agreed to assist the Government in project preparation 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 also addressed the problem of absorptive capacity through its role in organizing the Aid Group for Nepal (para 19). 23. The 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 con- necting the Hills to the Terai), communications and hydroelectric power. Preparation of projects in irrigation, forestry, power and rural develop- ment is under way. PART III - THE TELECOMMUNICATIONS SECTOR Background and Country Considerations 24. Nepal's topography and difficult terrain have hampered the develop- ment of road and rail facilities and created problems in providing safe all- weather airstrips. Many areas are isolated, creating numerous "mini" econo- mies with historically little interconnection. The lack of adequate surface and air communication underscores the need for a reliable telecommunication network for efficient government administration, effective provision of serv- ices and economic development in general. 25. The telecommunications sector in Nepal is still at a very early stage of development. Until the early 1960s, telecommunications facilities  7- consisted of a 300-line manual telephone exchange in the Kathmandu area and a telegraph line to India supplemented by an HF radio station. Under a USAID- assisted project, completed in 1964, a 1,000-line automatic exchange was installed in Kathmandu and low power HF radio links for telegraph service were provided between Kathmandu and 57 other locations mainly in Central Nepal and in the Terai. The first IDA Credit (US$1.7 million, Credit No. 166-NEP of November 10, 1969), together with Indian Aid, helped finance a project for the expansion of local and long-distance facilities as well as the interconnection of the system with the Indian network. The second Credit (US$5.5 million, Credit No. 397-NEP of June 20, 1973) is helping finance Nepal's second tele- communications development program consisting of the further expansion of domestic and international telecommunications facilities. At present there are less than 13,000 telephones in the country, or 0.10 telephone per 100 people. This compares with 0.30 telephones per hundred inhabitants in India, 0.33 in Pakistan, 0.53 in Sri Lanka, and 0.83 in Thailand. North America has 67.9 telephones per 100 people, Europe 19.5, Asia 2.6, and Africa 1.1. The ongoing project would add about 8,000 telephones, raising the telephone density to 0.16 telephones per 100 people. Existing Telecommunications Facilities 26. Local telephone exchange facilities and long-distance service are now only available at Kathmandu, Patan, Biratnagar, Pokhara, Birganj and eight smaller towns. The number of main subscriber lines at these centers is 8,800 with a waiting list of 9,000. The quality of service is reasonably satisfac- tory. Nine more towns are being provided with exchange and long-distance service under the second IDA project and as a result, by 1979, 18 of the country's 75 administrative districts will be connected to the telephone net- work. HF radio links operating on a part-time basis provide a basic telegraph service to 79 other towns and villages. Telegraph facilities operating via teleprinter links exist in three of the 75 government district headquarters towns. International telephone, telex and telegraph facilities operate to India, Pakistan, Bangladesh, Hong Kong and Tokyo via land line or HF radio. The quality and realiability of these services are in many instances poor and they have only limited capacity for extension. Sector Organization 27. Until 1969, the telecommunications system was operated by the Telecommunications Department of the Ministry of Works, Transport and Com- munications. The Nepal Telecommunications Board (NTB) was created in October 1969, as a semi-autonomous agency, to carry out the first Telecommunications Development Program, towards the financing of which Credit No. 166-NEP was made (para 35). In consultation with the Association, the Government on June 15, 1975, passed legislation converting NTB into a government-owned statutory corporation (NTC) which has increased operational and financial autonomy. 28. NTC, the proposed beneficiary of this credit, is responsible for the provision and operation of all public telecommunications services in Nepal. The Board of Directors is appointed by Government and consists of six members  - 8 - under the Chairmanship of the Secretary of Communications. Other members of the Board are NTC's General Manager, the Joint Secretary of the Ministry of Finance, a senior officer of the Ministry of Public Works and Transport, the President of the Kathmandu District Panchayat and the Regional Manager of NTC for Kathmandu. NTC's present manager and senior staff are satisfactory. 29. NTC's internal organization is based on three headquarters depart- ments dealing with engineering, business/personnel and accounting matters. Day-to-day operations are handled by three Regional Headquarters. Although a satisfactory organizational framework has been created, much remains to be done in developing tools for effective management particularly in completing the introduction of commercial accounts. Technical assistance in management is being provided by ODM. 30. Financial results have been poor in the past because of inefficien- cies, the small size and type of the network operated and low tariff levels. However, with the network's expansion and structural changes, improved pro- ductivity of NTC's staff and tariff increases, major improvments have taken place (para 46). In FY1975, for the first time, NTC had a positive rate of return. Results in FY1976 and FY1977 have shown further progressive improve- ment to an 8% rate of return. It is expected that NTC will generate the local funds required for its development programs and maintain a rate of return in excess of 10% as from fiscal year 1981. Sector Constraints 31. The primary constraint in the sector is the shortage of intermediate and lower level skilled technical manpower. In 1971, the Government applied for UNDP assistance in setting up a Telecommunications Training Center. This project ran into initial difficulties because of dispute over control of the training school. The project was subsequently delayed when in 1976, UNDP was short of funds. A new project agreement has since been signed, and the Project Manager and three experts are now operating in Nepal. Two more experts are arriving shortly and satisfactory progress is now expected in easing this constraint. Sector Objectives 32. The telecommunications development strategy in Nepal has been to establish communications in and between the towns with the largest popula- tions and demand for services; establish an institutional framework for sector development; and develop a financial basis for future expansion. These objec- tives are being gradually achieved and currently emphasis is being placed on expanding service to more remote areas and on sector expansion related to national development needs. Demand and Market Aspects 33. The demand for telephone service as measured by connections installed and waiting list in these areas having service, has grown at a rate of about 20 percent per annum since 1969. However, because of the embryonic nature of telecommunications in Nepal, the lack of penetration  - 9 - into many regions of the country, and the extensive waiting lists in those areas with access to service, this figure cannot be taken as an accurate reflection of potential demand. At this stage of development, it is essentially the pace at which new areas gain access and the quality of service improves that will determine the rate at which telephone services grow. 34. Using the experience in similar countries, long distance traffic is expected to increase at 23% per annum over the next five years. In addition an increase of 60% is expected in 1981 when subscriber trunk dialing (STD) is provided. International traffic is expected to grow at a level similar to long distance traffic but, until such time as satellite communication is introduced, international traffic will be artificially restricted. Telex demand is presently suppressed by the capacity of the Kathmandu exchange and the absence of facilities outside Kathmandu. Demand in similar countries is increasing at between 25 percent and 40 percent per annum. The lower figure has been used in NTC's projections. NTC intends to undertake a study to assist in planning the further development of the sector (para 41). The Association's Role 35. IDA has been closely associated with the development of the tele- communications sector in Nepal since 1967, when the Government requested IDA's assistance in financing its first Telecommunications Development Program (July 1969 - July 1973). This Program constituted the first Tele- communications Project financed under Credit No. 166-NEP in association with Indian Aid. There were initial delays in procurement and in obtaining expert assistance. These were followed by managerial problems and completion was delayed by approximately two years. A Project Performance Audit Report was distributed to the Executive Directors on January 3, 1978 (Sec M78-2). The Report notes the progress made in establishing an institutional framework for the development of the sector and the role the project has played in facilitating the development of the country's economy. 36. The second Credit (No. 397-NEP) was designed to finance the foreign exchange cost of Nepal's Second Telecommunications Development Program (July 1973 - July 1979) for the expansion of domestic and international telecom- munications facilities, and to build up NTC technically and financially as an institution. There have again been initial delays in obtaining expert assistance for the preparation of specifications, accompanied by lack of continuity of NTC's management. Although project implementation is now proceeding satisfactorily, completion is expected.to be about twelve months behind schedule. Due to major increases in the number of calls made by sub- scribers in Kathmandu, resulting from increased economic activity, it was necessary to provide additional switching equipment in the Kathmandu ex- change and reduce provision for connection of additional subscribers in other exchanges by 18%. As of March 31, 1978, US$0.8 million was disbursed. In addition, US$2.0 million equivalent is expected to be committed by June 1978, and another US$2.0 million by December 1978.  - 10 - PART IV - THE PROJECT 37. The proposed project, which is Nepal's Third Telecommunications Development Program, to be executed in fiscal years 1979-1983, was prepared by NTC and appraised by a mission which visited Nepal in November 1977. The mission's report "Nepal Telecommunications Corporation - Appraisal of the Third Telecommunications Project" (No. 1897-NEP) is being distributed sepa- rately to the Executive Directors. Negotiations were held in Washington during March/April 1978. The Government delegation was led by Mr. Basudev Pradhan, Joint Secretary, Ministry of Finance, and NTC was represented by its General Manager Mr. R.P. Sharma. A timetable of key events relating to the project, special implementation actions to be taken by the Association, and special conditions of the credit are given in Annex III. Project Description 38. The project provides for the improvement and expansion of telecom- munication facilities in Nepal and includes: (a) an increase in telephone exchange network capacity to provide for 20,600 additional subscriber lines, including provision of 21 new exchanges (10 automatic and 11 manual), and conversion of 6 existing manual exchanges to automatic operation; (b) extension of microwave and UHF/VHF radio systems and land lines to serve 14 new centers; (c) provision of subscriber radio facilities to 100 isolated locations (mainly community centers); (d) introduction of Subscriber Trunk Dialing (STD) at 19 automatic exchanges;. (e) provision of automatic telex exchange facilities for the country as a whole serving up to 400 subscribers; and (f) provision of a small satellite earth station to improve and expand international telephone facilities. 39. At its completion the project is designed to meet about 70% of total projected demand in areas with existing telephone service and extend service to 21 additional areas of administrative, economic and social importance. Subscribers' radio telephone facilities which would be provided to about 100 other locations would facilitate the provision of social services and economic development in presently isolated areas. STD at all automatic exchanges would provide, at least cost, an efficient high quality 24-hour service. Telex facilities would be available to all centers connected to the backbone long distance system and are essential to meeting the needs of Government,  - 11 - industry, business and tourism. A satellite ground station would improve and expand Nepal's international telecommunication facilities and would give sub- stantial savings in foreign exchange costs because it would increase Nepal's share in total revenues from international services. NTC is also negotiating with India to improve facilities on the Indian route by replacing the existing land line by higher quality and capacity microwave and coaxial cable facilities. Project Cost and Financing 40. Total project cost is estimated at US$25.6 million equivalent in- cluding US$0.2 million equivalent of customs duties. The foreign exchange cost is estimated at US$17.5 million equivalent and local cost at US$8.1 mil- lion equivalent. The proposed credit of US$14.5 million equivalent would finance 83% of the foreign exchange cost. ODM has agreed in principle to financing the balance of the foreign exchange cost, US$3.0 million equivalent, on a parallel basis. NTC would finance 100% of local costs. Proceeds of the proposed credit would be relent to NTC for a term of 20 years, including a five-year grace period, with interest at 9 percent per annum. The ODM grant would be applied to the telex exchange/apparatus and the satellite earth station together with related engineering. The estimated cost of these two components is US$1.3 million equivalent and US$1.7 million equivalent, respectively. This proposed financing plan has the advantage over possible alternatives that it avoids the need to split orders and preserves the bene- fits of standardization in the expansion of the existing system. Project Implementation 41. The project would be carried out by NTC's own staff assisted by suppliers' installers. This is a common practice in telecommunications pro- jects. Technical assistance would be required in the preparation of speci- fications and tender documents, and the supervision of installation of the earth station and automatic telephone exchanges; NTC is arranging for obtain- ing this assistance. In view of past experience (para 36), satisfactory arrangements for obtaining this technical assistance would be a condition of effectiveness (Section 5.01(d) of the Development Credit Agreement). An eco- nomic study to assist in further development of the sector would be carried out by NTC, with assistance from Bank staff, and would be completed by December 31, 1980 (Section 2.08 of the Project Agreement). 42. In order to avoid further delay in provision of essential services and to allow steady and continuous expansion development, the project would overlap the ongoing project and a possible future development program. In doing so there are likely to be some economies of scale through association of similar project components in procurement and installation. Building works are being undertaken and allowing for the necessary lead times, NTC should be in a position to place orders as early as 1978. However, installation has been scheduled to take place over a period of four years, July 1979 to July 1983. 43. The targets established for installation of new exchanges, addi- tional capacity, connection of subscribers and provision of STD facilities are based on NTC's ability to train its technical work force and carry out  - 12 - the program with the assistance of consultants and suppliers. Microwave and UHF system expansion will be phased to parallel local network expansion. The earth station and new telex exchange, which would largely be installed by the suppliers, are expected to be brought into service by 1981. Procurement and Disbursements 44. All procurement would be through international competitive bidding, except for 3,800 lines of exchange equipment and 500 channels of multiplex equipment for expansion of existing facilities which are estimated to cost US$1.2 million. These should, on grounds of standardization and economy, be procured from the original suppliers previously selected after ICB. Technical assistance for preparation of specifications and evaluation of bids for automatic telephone exchanges would be obtained through bilateral sources. 45, The proposed credit would be disbursed against 100% of foreign expenditures for imported equipment and materials including installation services and training. Financial Aspects 46. Under the Development Credit Agreement for the Second Project, NTC is required to achieve a rate of return of at least 5% on average net fixed assets in operation in fiscal years 1975 - 1979, and thereafter of at least 10%. International and long distance tariffs were increased in 1975/76, contributing to the improvement in the rate of return, which reached 8% in fiscal years 1976 and 1977 and, because of the effect of inflation on costs, is estimated at 7% for FY1978. Local tariffs, however, have basically remained unchanged since 1973. In order for NTC to generate enough funds to finance the local cost of its development program and in view of the comparatively low present local tariffs, it was agreed during negotiations that by July 1978 NTC would increase its local tariffs to produce an increase in total revenues of 30%. This would require present local tariffs, including subscribers deposit and connection fees, to be increased by 50-100% The level of tariffs would still be lower than it is in India. It would enable NTC to achieve a rate of return of 8% or more for fiscal years 1979 and 1980. During negotia- tions it was agreed that NTC would be required to achieve a rate of return on average net fixed assets in operation, as revalued from time to time, of at least 8% in fiscal years 1979 and 1980 and 10% thereafter. NTC would review the value of its assets annually. Whenever a change of more than 10% in the value of these assets is determined, NTC would revalue the assets for the rate of return calculation. The first such review would be made by July 1979 (Section 4.03 (c) of the Project Agreement). In order to offset the effects of inflation on operating costs and asset values, it is expected that another tariff increase would be needed in 1984. The tariff increase in July 1978 would be a condition of effectiveness of the Development Credit Agreement (Section 5.01(c) of the Development Credit Agreement). 47. During negotiations it was also agreed that NTC would not incur any debt without the Association's approval unless internal cash generation  - 13 - during the preceeding 12 months covers maximum future debt service at least 1.5 times. It was also agreed that NTC would not undertake works in addition to the established program involving a capital expenditure exceeding US$1.0 million equivalent during the project implementation period, without the prior agreement of the Association (Sections 4.04 and 4.05 of the Project Agreement). These are the same as agreed under Credit 397-NEP. Accounting and Auditing 48. As required under the first Credit (166-NEP), NTB retained con- sultants to outline the basis for a new commercial accounting system, which was partly implemented. In August 1977, NTC contracted a local consulting firm which, in collaboration with NTC's financial staff, will complete and fully introduce the new system as from fiscal year 1979. Necessary training of staff and supervision of the working of the system for one year after implementation is also included in the consultants' contract. During nego- tiations assurances were obtained that the new accounting system will be fully introduced in fiscal year 1979, that necessary adjustments of fixed assets, inventories and receivables will be made and that the financial statements for fiscal year 1979 will be based on the new system (Section 4.01(b) of the Project Agreement). 49. The present audit is carried out under the official Audit Act for state entities and, since the commercial accounting system had not been intro- duced no auditor's opinion on the commercial financial results had been re- quired. Submission of the report within five months after the end of the fiscal year (as required under existing covenants) has not been possible. During negotiations, assurances were obtained that commercial audits will be carried out in parallel with the Government audit and that as from fiscal year 1979, a commercial audit report will be sent to the Association within six months of the end of the fiscal year (Section 4.02 of the Project Agreement). Benefits and Risks 50. The present telephone density of one telephone per thousand people gives Nepal one of the lowest telephone densities in the world. The inade- quate communications systems is a serious constraint on the development of agricultural and industrial production, trade and tourism. The improvement and expansion of telecommunication facilities is also required for effective administration and health and other social services. Improved and expanded facilities under the proposed project would raise the telephone density to 2.5 per thousand people by 1983 and contribute importantly towards economic and social development of the country. The proposed project would be the least cost solution for the proposed development. The internal financial rate of return of the project, based upon expected incremental revenues from increased traffic attributable to the project and the stipulated tariff levels, is 18 percent. The economic rate of return would be considerably higher, reflecting consumer benefits, saved travel time, increased Govern- ment and business efficiency, and the strengthening of NTC as an institution responsible for the sector. A sensitivity analysis has been carried out, showing that, even with a combination of unfavorable developments, the  - 14 - financial rate of return would not be less than 13 percent. It is also estimated that as from 1984 NTC will contribute to Government over US$2.0 million net per year. 51. The main project risk relates to delays in equipment procurement and installation. Technical assistance in procurement is being arranged and the earth station would be installed by the suppliers and NTC staff specially trained in its operation. Assistance would also be sought from the con- tractors for the installation of the microwave and UHF systems and the automatic telephone exchange and in the training of staff for these instal- lations. Training of technical staff is being provided under a UNDP project with ITU as Executing Agency (para 31). Given these arrangements, the risk involved is reasonable. PART V - LEGAL INSTRUMENTS AND AUTHORITY 52. The draft Development Credit Agreement between the Kingdom of Nepal and the Association, the draft Project Agreement between the Association and NTC and the recommendation of the Committee provided for in Article V, Section 1 (d) of the Articles of Agreement, are being distributed to the Executive Directors separately. 53. Special conditions of the project are listed in Section III of Annex III. Special conditions of effectiveness are: (a) execution of the Project Agreement; (b) execution of the subsidiary loan agreement between the Government and NTC; (c) increase of NTC's local tariffs and connection fees to levels satisfactory to the Association with effect on July 16, 1978; (d) satisfactory arrangements for obtaining technical assistance for detailed engineering, preparation of specifications and evaluation of bids; and (e) satisfactory arrangements for financing the telex equipment and earth satel- lite station (Article V of Development Credit Agreement). 54. I am satisfied that the proposed development credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 55. I recommend that the Executive Directors approve the proposed credit. Robert S. McNamara President Attachments April 25, 1978  ANNEX. I Page 1 of 4 pages NEPAL - SOCIAL INDICATORS DATA SHEET LAND AREA (THOU KM2) -