Nepal - Economic situation and prospects (Vol. 1 of 2) : Main report

FILE COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIA-T-InV- Not For Public Use 125 Vol. 1 Report No125-NEP ECONOMIC SITUATION AND PROSPECTS OF NEPAL April 13, 1973 Asia Region South Asia Department This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS Currency Unit Nepalese Rupee (NR) Effective February 20, 1973 US$1 Nrs 10.56 NR 1 US$0.095 NRs 1,000 US$94.70 NRs 1,000,000 US$94,697 Prior to February 20, 1973 ,US$1 NRs 10.125 NR 1 US$0.099 NRs 1,000 US$98.77 NRs 1,000,000 US$98,765 NOTE: All calculations in this Report are made on the basis of the rates of exchange in force prior to February 20, 1973. On that date the Nepalese rupee was devalued in terms of the US$ by 4.12 percent. Nepal Fiscal Year - July 16 to July 15 Nepal Calendar Year - April 16 to April 15 This report is based upon the findings of a mission which visited Nepal between May 1 and May 25, 1972. The mission consisted of: Messrs. A. Cleveland (Chief of Mission), N. Reynolds (General Economist), Z. Samad (Agricultural Economist, FAO), W. Wyatt (Irrigation Specialist, FAO), A.- Tarnawiecki (Industry Specialist), M. Heitner (Industry Specialist), K. Clare (Transportation Economist), B. Newbry (Education Specialist), E. Erkmen (Electric Power Specialist), H. Jones (Population Specialist), C,. Xenos (Population Specialist, consultant), H. Granados (Fiscal Specialist, JM1F), and Miss M. Hill (Secretary).  ECONOMIC SITUATION AND PROSPECTS OF NEPAL Table of Contents Page No. COUNTRY DATA SUMMARY AND CONCLUSIONS i -v I. Development Problems 1 Introduction 1 Relations with India and Development Constraints 2 Recent Economic Performance 3 Development Priorities: The Hills and the Terai 3 II. Human Resources and Education 7 Population 7 Health and Nutrition 9 Education 10 Conclusions 15 III. Agriculture 16 Recent Agricultural Growth 16 Elements of Agricultural Policy 18 IV. Industry and Tourism 22 Introduction 22 Factors Restricting Industrial Development 22 Development Opportunities 23 Tourism 25 V. Transport and Power 28 The Road System 28 Investment in Roads 29 Air Transport 30 Telecommunications 31 Power 32 Problems in Power Development 33  Page No. VI. Public Investment and Finance 35 Public Investment and Development Planning 35 Government Finance 36 VII. The External Sector: Problems and Prospects 40 STATISTICAL APPENDIX 43 MAPS -oOo-  Page I of 2 pages COUNTRY DATA - NEPAL - AREA POPULATION (est.) DENSITY l141,000 sq. km. 11-7Wmillion (mid-1971) 80 persq. km. Rate of Growth: 2.2 percent (mid-1971) 615 per sq. km. of arable lmad POPULATION CHARACTERISTICS (1970) HEALTH (1971) Crude Birth Rate (per 1,000) 42 (est) Population per physician 37,000 Crude Death Rate (per 1,000) 20 (est) Population per hospital bed Infant Mortality (per 1,000 live births) between 200 & 300 (est) INCOME DISTRIBUTION DISTRIBUTION OF LAND OWNERSHIP % of national income, lowest quintile .. eL owned by top 10% of owners highest quintile .. % owned by smallest 10% of owners ACCESS TO PIPED WATER ACCESS TO ELECTRICITY (1971) % of population - urban % of population - urban 2.2 - rural - rural NUTRITION EDUCATION (1971) Calorie intake as % of requirements Adult literacy rate % 10 Per capita protein intake Primary school enrollment 7, 32 GNP PER CAPITA in 197: US $ 70-80 GROSS NATIONAL PRODUCT IN 1971/72 ANNUAL RATE OF GROWTH (%. constant prices) US $ Mln. % Approximately 2.14 (1964/65 - 1 %69/70) GNP at current market prices 1,000 (approx) 100 Gross Domestic Investment Gross National Saving Current Account Balance Exports of Goods, NFS Imports of Goods, NFS GDP BY INDJSTRIAL ORIGIN IN 1970 Value Added Labor Forced V. A. Per Worker US $ Mln. % Mln. % US 7. Agriculture 634.0 69.0 . 90.0 (est.) Industry 83.0 9.0 Services 92.0 10.0 Unallocated 110.0 12.0 .. .. Total/Average 919.0 100.0 100.0 GOVERNMENT FINANCE Central Government (NR Mln.) % of GDP 1971/72 1971/72 Current Receipts 518.1 5.2 Current Expenditure 358.2 3.6 Current Surplus 159.9 1.6 Capital Expenditures 520.5 5.7 External Assistance (net) 299.6 3.0 Intemal Borrowing & Use of Cash Balances 110.0 1.1 a/ These figures shculd be treated with extreme caution. Estimates of agricultural production are highly tentative and as a consequence, the growth and level of GDP is subject to wide margins of error. b/ Includes Mining and Cottage Ine-iustrv. not available not applicable NOTE: In this table, figures in US dollars are calculated on the basis of the rate of exchange prevailing before February 20, 1973.  Page 2 of 2 pages COUNTRY DATA - NEPAL July July July July December MONEY, CREDIT and PRICES 1965 1969 1970 1971 1971 (Million NR outstanding end period) Money and Quasi Money 554A.0 993.10 963.3 1115.9 1149.4 Bank Credit to Public Sector 149.10 129.8 167.6 258.8 218.3 Bank Credit to Private Sector 136.5 207.2 25o.9 321.0 3I43.3 (Percentages or Index Numbers) Money and Quasi Money as % of GDP 8.0 9.9 9.9 11.1 11.5 General Price Index (1963 = 100) Annual percentage changes in: General Price Index Bank credit to Public Sector 29 54 32 Bank credit to Private Sector .. 20 25 21, 25 TRANSACTIONS IN ODNVERTIBLE CURRBNCIESSa 1969/70 1970/71 1971/72 (9 mos.) (Million US$) Receipts Exports 10.8 8.6 10.9 Invisibles 10.8 11.5 13.1 Miscellaneous 6.2 5.0 6.2 Total 27. 25.1 30.2 EXTERNAL DEBT. OUTSTANDING AND DISBURSED Payments (12 1/71) Imports 12.9 7.8 13.3 US $ Mln Miscellaneous 5.8 9.1 6.9 Total 177 lo. 20.2 Public Debt, incl. guaranteed 8.4 Non-Guaranteed Private Debt Surplus 9.1 8.2 10.0 Total outstanding & Disbursed 8.4 DEBT SERVICE RATIO for 1971 and 1972 GFGSS OFFICIAL RESERVES Less than 1% % July July July June Sept Public Debt, incl. guaranteed 1969 1970 1971 1972 1972 Non-Guaranteed P rivate Debt. (Million 03$) Total outstanding & Disbursed 79.6 91.3 102.1 112.0 117.0 IBRD/IDA LENDING,(Javuary 31, 1973) (millics- US$) RATE OF EXCb'ANGE Up to Februarv 20, 1973 IBRD IDA US $ 1.00 = NR 10.125 NR 1.00 = US $ 0.099 Outstanding & Disbursed 0.*41414 Undisbursed .. 7.982 Since February 20. 1973 Outstanding incl. Undisbursed .. 8 US $ 1.00 = NR 10.56 NR 1.00 = US $ 0.095 /a Since substantial parts of Nepal's foreign trade are unrecorded, there is no overall balance of payment available. This table is a balance of paymentawith countries other than India and represents about 10% of Nepal's foreign trade. not available not applicable NOTE: In this table, figures in US dollars are calculated on the basis of the rate of exchange prevailing before February 20, 1973. South Asia Department February 22, 1973  SUMMARY AND CONCLUSIONS i. There are few countries in the world where the gap between popular image and the reality are as wide as in Nepal. The image is that of an Asian Switzerland. One thinks of the Kathmandu Valley with its neat wooden homes, green fields, population in their pointed caps, a skyline of pagodas and palaces and a background provided by the Himalayan peaks. In this image, the country has a "once upon a time" quality, which seems to render economic development not merely distant but irrelevant. The reality behind this facade is quite different. Most of the 11 million population live in dire poverty. Per capita income is well below $100 annually and probably does not exceed $75. Health standards are extremely poor and it is estimated that infant mortality may be as much as 200 to 300 per thousand. ii. Nepal's concern with economic development dates only from the late 1950's and the process of growth is still at a very early stage. Seen against this background, development efforts over the last 10 to 15 years have not been inconsiderable. Substantial investment has taken place as Nepal, with considerable foreign assistance, both in the form of capital and technical assistance, has begun to grapple with its massive development problems. Much of the investment that has taken place has been concentrated in economic infrastructure, especially road transport and power. However, it is unlikely that much improvement in per capita output has taken place as the modest increase in aggregate output has been more or less offset by population increase. Foodgrain productivity has declined, as agricultural investments have failed to compensate for declining fertility due to exploi- tation of marginal land and to soil exhaustion. Slow growth of foodgrain output along with rapid demographic growth have led to a sharp decline in the rice surpluses produced in the Terai and exported to India, which financed a large part of Nepal's substantial import requirements. Nepal's serious long run development problems are masked by her generally stable current economic situation: she presently enjoys a relatively high level of foreign exchange reserves, there is no problem of external debt and she is comparatively free of the problems of price and monetary instability. iii. The constraints to Nepal's development are many and severe and their effective solutions will require years if not decades of resolute effort. The country's topography is a major developmental handicap. The Hills, which contain about 60 percent of the population, consist of pockets of population physically separated by the rugged mountains. Communication among the many separate valleys is poor. The Hills contain only about one-third of the country's arable land and population density is not only extremely high but forced to cope with soil of low fertility. Migration from the Hills to the Terai or to India alleviates this problem only to a very minor degree. A great part of the population suffers from  ii nutritional deficiencies and disease. As a result of absence of educational opportunities in a country in which traditionally, education was restricted to a small ruling elite, there is a general and widespread shortage of manpower skills at all levels in both private and public sectors of the economy. Even though there has been marked improvement in the past, Government institutions are still weak and public administration backward in many respects. A tradition of prompt and effective decision-making within the Government is only now beginning to appear. One of the conse- quences of these shortcomings, inevitable in a country newly arrived on the development scene, is a limited capacity effectively to prepare as well as implement investment plans and programs. The Government has found it difficult to utilize even the relatively low level of savings it has been able to generate out of the country's extremely low income levels. Elements of a Development Strategy iv. Without attempting to be comprehensive, the principal elements of a development strategy for Nepal stand out clearly. These include an appropriate plan for the development of the Hills; a comprehensive plan for the development of the Terai; provision of additional road transport, and especially feeder roads, to tie together the separate parts of the economy; providing the proper balance in this process between essential economic infrastructure and more quick-yielding commodity production so as to take advantage as quickly as possible of the numerous import substitution and export promotion opportunities; a concerted effort to improve health through providing both necessary care and nutritional advice and food, especially to the age group below 18 months; improvement of the capability of the public sector's principal institutions and entities concerned with development so as to increase as rapidly as possible Nepal's presently limited absorptive capacity; implementing an educational reform which will both eliminate progressively present widespread illiteracy and provide at the same time for those skills which are now in extremely short supply. The pace at which Nepal will succeed in implementing her development programs will depend in large measure on her success in developing effec- tive institutions and the extent to which she can mobilize domestic resources. v. Migration to both the Terai and to India has been one of' the principal means whereby tens of thousands of people in the Hills have sought to escape the problem of extreme population density, poverty and food shortages. Their earnings have helped to alleviate, and continue to alle- viate today the economic problems of the Hills. Continuous migration, however, has limits. Part of the solution to the problem lies in organized migration and resettlement in the Terai. Reclamation of forest land in the Terai would allow the productive resettlement of hundreds of thousands of residents of the Hills. Such a resettlement and reclamation policy would need careful development and application, so as to avoid erosion of the valuable land resources of the Terai. Migration by itself will not, however, provide the answer to developing the economy of the Hills and providing an  iii adequate living to the inhabitants who remair.. A key requisite for develop- ment of the Hills is the building of a transportation network including feeder roads into the valleys, which will raise returns on past road investments, and improvement of trails and suspension bridges. Along with the development of the transport system, in many cases agricultural produc- tion can be increased by the introduction of agricultural credit, a number of simple production techniques and a gradual shift in emphasis towards such crops as potatoes and other vegetables. In the longer run, the Hills would appear to offer substantial export potential through the development of a horticulture-based agriculture. vi. As part of a plan for development of the Hills, the Government is considering the integrated development of north-south growth axes or corridors, each with its own growth center and each to be linked to the Terai by road. The concept merits serious consideration but it should be borne in mind that success requires a considerable degree of coordination among the concerned Government agencies and the development of effective regional administrative organizations now lacking. vii. The economic problems facing the Terai are of a different nature. As part of the program of controlled migration from the Hills described above, it is necessary to introduce effective land use planning, forest management, provision of credit and management personnel as part of the settlement process, as well as necessary infrastructure. A second neces- sary thrust in development policy for the Terai should be programs to increase the productivity of land already under cultivation. The success of this program will require besides irrigation, an effective agricultural extension service program along with improved seeds, fertilizers, pesticides and institutional credit. This program deserves very high national priority not only for its contribution to alleviating the problem of poverty in thy Hills but also to take advantage of the considerable agricultural potential of the Terai for developing agricultural exports and assuring that Nepal isv not forced to become a net foodgrain importer in the late 1970's. viii. Predominantly agricultural, and with limited possibilities for diversification, Nepal's development will, for a long time to come, be largely dependent on its ability to increase agricultural production. With rapid population growth,high priority must be attached to expanding the supply of foodstuffs. Moreover, Nepal's development will depend heavily on its ability to create surpluses in agriculture to pay for its large and growing import requirements. Most of Nepal's exports are generated in agriculture, mainly rice, jute and forest products; the possibilities for diversification of exports are either limited (e.g., tourism) or remote (e.g., the export of large amounts of hydroelectric energy to India. A number of policy changes are required if the necessary increase in agriculture production is to be achieved. These include more sophisticated irrigation projects designed for optimum water management and double cropping. The existing system of land tenure acts as a disincentive to increased production. The present high rentals which are charged to tenants  iv leave little margin for investment and improvement. Regulation of rents throughout the country is needed. Such a program will require setting up of an agency which can effectively administer such a program. While institutional credit is now available in Nepal, the program suffers from serious deficiencies in the distribution of credit between income groups and regions. Cooperative credit institutions need to be introduced in particular in the Hills. Moreover, at present, it is the large farmers who have ready access to cooperative credit while smaller farmers suffer from the unwillingness of the cooperatives to take undue risk. Nepal needs an accelerated program of adaptive agricultural research. While improved varieties of wheat have been successfully introduced, rice and maize programs have not been successful. Adaptive research programs in livestock and horticulture are required. Finally, expanded and improved agricultural extension services are needed in order to make available to farmers improved techniques. ix. Industry is. a minor activity in Nepal with manufacturing account- ing for only 2 to 3 percent of GDP. Much of the industry is agro-based and much of it is devoted to producing exports for the Indian market, especially rice milling and wood products. While trade in manufactures with India is facilitated by the comparatively free movement of goods and people between the two countries, Nepalese industries have difficulty in competing with Indian manufactures which are backed by superior marketing and financial facilities. Other problems are a lack of entrepreneurship, narrowness of the internal market and procedural delays in obtaining licenses and loans. It would seem desirable to concentrate at this stage of Nepal's development on the promotion of small scale industry, some of which in the past has been comparatively successful in competing with Indian manufactures. Among the advantages of small scale industry in Nepal are the fact that they require less capital per unit of output, they are labor intensive and they require less management skill. Small enter- prises, moreover, make sense in the case of Nepal, split up as it is into many small markets. By locating close to these markets, such enterprises can enjoy a competitive edge over Indian products which bear heavy trans- portation costs to reach the same market. Among the products with export potential to countries other than India are jute and other products based on raw materials in which Nepal has a comparative advantage (such as decorative plywood and veneer), or which are labor intensive or bring high prices per unit volume (e.g., carpets, curios, jewelry). x. There is no doubt that for many years to come, economic develop- ment in Nepal will be heavily dependent on the magnitude and on the direction of public investment. The mobilization of resources by the public sector, therefore, acquires special importance. Until quite recently, it is true that the public investment prqblem has been less one of mobilizing additional resources than in being able effectively to carry out budgeted development expenditures. Looking to the future, however, it may be expected that Nepal's absorptive capacity will increase and with it her ability to utilize considerably larger volumes of savings  v in new investment. The outlook for a continued flow of bilateral grant aid on a scale as large as the past is uncertain. It is, therefore, unlike- ly that the present comfortable foreign exchange reserve position will remain a permanent feature. Prudence dictates that the Government should make a determined effort to develop an increasing level of resources to finance public investment. xi. There are two directions which the Government should follow simultaneously in order to insure that domestic resources are effectively mobilized and channelled to support the higher levels of public investment expenditure required by an economy as primitive as Nepal's, with heavy requirements for investment in virtually all sectors. The first problem is the need to raise more public revenues. Nepal's tax effort is one of the lowest among developing countries, although given the limited monetization of the country, it is not negligible. Improved fiscal performance can be secured in a number of ways: Many large property owners escape taxation and evasion is believed to cost the Treasury a third of its potential import revenue. The very poor saving performance of a majority of public corpora- tions also needs careful review. Proceeds from income and profits taxation appear to be unduly modest. Land taxes, although among the highest in the developing world, may need to be reassessed in those areas which benefit from public irrigation facilities. There would appear to be scope for an improvement in taxes on international trade and internal transactions, the ratio of these to GNP in Nepal is among the lowest in the developing world. xii. A second aspect of the problem of effective domestic resource mobilization is the need for creating new channels and strengthening exist- ing channels to facilitate the effective employment of financial savings. The extension of the commercial banking network will help to meet the credit and other banking needs of a growing economy. The mobilization of funds through these institutions will facilitate investment in the private sector. xiii. While principal reliance has to be placed on generating savings internally, these efforts will have to be supplemented in generous measure by foreign savings. Moreover, while export earnings will necessarily have to be the principal source of the foreign exchange needed to support the growing level of Nepal's imports in the future, the country will continue to require substantial foreign assistance. In the past, much of this foreign assistance has been channelled to comparatively few sectors, much of it basic economic infrastructure and particularly road transport and irrigation. In the next phase of Nepal's development, it will be necessary for foreign donors to assist Nepal in a broader range of investment activities, not only in further development of basic infrastructure, but in a broadening variety of directly productive investment as well. As in the past, because of Nepal's limited growth and export prospects, foreign assistance should be made available on highly concessional terms.   I. DEVELoPMEN'I'T i;M:1 1. It is banal to say that each developing country has its own unique problems. It is no less banal to say that each developing "land- locked" country has perhaps more unique problems than others and Nepal is no exception. Topographically, Nepal is divided into three natural regions lying parallel to each other. To the south is the Terai which includes a narrow extension of India's Gangetic Plain and the lower slopes of the hilly area to the north. The central region, the Hills, consists of a cluster of rugged mountains ranging from 1,200 to 3,600 meters in elevation and cut by the valleys and gorges of Nepal's major north-south river systems. The northern region includes the main Himalayan range with peaks rising from 3,000 to 8,800 meters. 2. The natural direction of communication follows the main rivers which flow south; for centuries, movement of goods and people followed these routes. Most trade routes, neither easy nor rapid, thus led either to Tibet or to India. They rarely linked adjoining valleys, because of the difficulty of communication, the lack of goods to exchange (most valleys produced the same things), and the political fragmentation of the country divided into a multiplicity of independent kingdoms. By and large, Nepal remained largely isolated, with the exception of the Terai. 3. Nepal's economic isolation was not only the result of geography, but also of deliberate policy when the Ranas took over from the Gurkha dynasty. Their policy of isolation undoubtedly preserved Nepal's sovereignty, but was later used as a means of ensuring the survival of an outdated feudal regime. Isolation was extended also to the intellectual sphere. During the 104 years of their rule, the Ranas remained opposed to any form of public schooling for the people. When King Tribhuvan took over from the Ranas in 1951, less than one percent of children of school age was enrolled in primary schools and there were only 49 students taking higher education courses. This policy of isolation was mostly directed against the Europeans, first against their colonialism and, thereafter, against their ideas and techniques. It did not, however, interfere with the movement of people, and many Nepalese, mostly Gurkhas, migrated to India or joined the Indian and British armies. This relieved population pressure in the Hills, gained the goodwill of the British and brought significant revenues. 4. Evolving a development policy immediately after medieval Nepal's formal opening to the modern world in 1951 would have proved premature - as well as traumatic. A transition period was needed for Nepalese society to find ways to adjust itself to a completely new set of situations after a century of static political and economic life. It is not, therefore, sur- prising that a decade passed before the Government was able to devote part of its energy to problems of development.  Relations with India and Development Constraints 5. Situated between two powerful nations, China and India, Nepal's viability is dependent partly on the relationships developed with both India and China. Economic relations with China are likely to remain limited. On the other hand, Nepal's economy is largely dependent on India. This dependence includes both transit -- given the country's landlocked position -- and trade: Nepal's imports, mostly from India, amount to 10 percent of its GNP. Moreover, it is estimated that perhaps over half a million Nepalese are at present working in India. Much of Nepal is part of the Gangetic economic complex. The contiguous States of Uttar Pradesh and Bihar account for most of trade with India; and it is Nepal's misfor- tune that these two states are among the poorest and slowest growing Indian states, a factor which will, to some extent, inhibit Nepal's growth. 6. India provides substantial foreign aid, largely in grant form. In 1971/1972, for instance, India contributed 44 percent of total foreign assistance or about 20 percent of total Nepalese development expenditures for that year. India provides not only funds, but also human resources to Nepal in the form of a large technical assistance program. 7. While Nepalese industry benefits from the proximity to the Indian market, it is not easy for Nepal to compete either in India or the domestic market with the large and more efficient Indian industry. Nepal's economic freedom of action is restricted in other ways. The rate of inflation, for example, is strongly influenced by price developments across the frontier. Pricing policies must take into account Indian prices. For instance, when the Government tried to encourage the use of fertilizers, it reduced their prices. The result, however, was re-export to India, where prices were much higher. In many respects, therefore, Nepal's economy is highly dependent on the Indian economy. This does not mean, however, that the Government cannot take independent initiatives in formulating development policy. It does mean, particularly in parts of Nepal such as the Terai and Kathtnandu Valley, that to be effective Government policy must take into account the closeness to and complementaries with neighboring Indian states. 8. Nepalese concern with economic development is very recent, and the process of growth still at a very early stage. Investment levels are low and the ability to use investment effectively is still quite limited. Given Nepal's late awakening to the process of economic development, this problem of limited absorptive capacity is not surprising. It is in part a legacy of the country's educational backwardness; Government agencies are in many instances staffed by inadequately trained people. Intra-governmental coor- dination is not highly developed and the process of making decisions there- fore tends to be time consuming. Moreover, the education system set up after 1951 has not been geared to producing the skills the country needs. Tech- nical skills and particularly planning and management capacity are in very short supply. In the private sector, Nepalese entrepreneural talent is also  scarce. There is, in short, a general lack of decision-making ability, a serious obstacle to development. 9. In its efforts to formulate and implement development programs and projects, the Government is faced with other severe constraints. The physical resource base is narrow, consisting mainly of agricultural land, hardwood forests and abundant water resources available for both power generation and irrigation. No minerals in commercial quantities have been discovered. The country is landlocked and all trade with overseas countries must be transported through India at relatively high cost. Nepal's internal market is small and production costs tend to be high. For lack of transpor- tation facilities,alarge number of communities are virtually isolated from each other. The data needed to plan and carry out development is either lacking or extremely weak. Recent Economic Performance 10. Nepal is a very poor country, whose per capita income probably does not exceed US$70 to 80 a year. Ninety percent of the labor force is employed in agriculture, which produces about 70 percent of the gross product.Manufacturing is a minor economic activity, producing no more than 3 percent of GDP. Cottage industry may amount to about 7 percent of gross product. Consumption of energy is very limited in spite of a substantial hydroelectric potential, and is largely restricted to consumption by households. Despite substantial investments, the transportation network is still in its infancy. 11. Over the past decade, growth in aggregrate output has been more or less neutralized by the population increases; moreover the rate of population growth appears to be accelerating. This poses a particularly difficult problem in the Hills, which have a limited resource base and which have long suffered from overpopulation. The Blow pace of economic growth has taken place despite increasing public investment in agriculture and infrastruc- ture. Slow growth of foodgrain production and rapid demographic growth have resulted in a rapid decline of the rice surpluses produced in the Terai and exported to India, which finance a large part of Nepal's substantial import requirements. Foodgrain production in FY1972 has been far short of normal levels and the situation is critical in certain Hill areas. So far, the Government has procured about 150,000 tons of which 6,000 tons had to be airlifted. Development Priorities: The Hills and the Terai 12. At first glance, Nepal is still very much the country that the picture postcards and coffee-table books depict. The Kathmandu Valley with its neat wooden homes, green fields, its population in their pointed caps, a skyline of pagodas and palaces and a background provided by the peaks of the Himalayas has a "once upon a time" quality which makes economic develop- ment seem not merely distant but irrelevant. Yet, behind this facade, a  -4- tragedy is taking place in the Hills. Sixty percent of the population are concentrated in the Hills which contain only about one-third of the country's arable land. Population density per sq. km. of arable land is probably as high as 1,100, a concentration similar to that found in certain Asiatic deltas, but where, in contrast, the soil is more fertile and the climate allows two to three crops a year. 13. If old censuses are to be believed, population, previously stable, more than doubled in the last 40 years and much additional land was brought under cultivation. Consequently, it is not only the valleys which are cultivated but much of the hillsides too. These are terraced in strips which are often only a few yards wide, and the extension of cultivation tip and down the Hills has probably meant the taking up of continuously less productive land. However careful the terracing, the extension of cultivation has led to erosion, thus compounding the pressure on land. Cultivated holdings are tiny. A recent survey revealed that 17 percent of households cultivated holdings of less than 0.1 hectare, while another 21 percent of households cultivated between 0.1 and 0.2 hectares. Only 8 percent of house- holds cultivated holdings of more than one hectare. To make matters worse, average holdings are reported to be fragmented into 3 to 5 parcels. 14. The Hill people thus eke out a bare subsistence from the land. In part because of inadequate medical care, but mainly because of nutritional deficiencies, infant mortality is estimated at 300 per 1,000. The National Health Survey of 1965/66 revealed that 56 percent of all deaths involved children under 5, the critical age for survival being about 18 months when the child is weaned and immediately put on largely indigestible grain foods. 15. In response to the problems of extreme poverty and food supply, millions of Hill people have migrated to the Terai and India in search of subsistence while tens of thousand of Gurkhas have joined the British and Indian armies. The substantial pensions and remittances of these migrants have alleviated the problems of the Hills. Continuous migration to India is, of course, only a partial answer, for most Nepalese have few skills to offer. Part of the solution to the problem of the Hills is organized migration and resettlement in the Terai. There are 1.3 million hectares of forest in the Eastern and Western Terai. Not all this forest can or should, of course, be turned into cropland. Yet, even if, say, only 20 percent of forest were reclaimed, this would provide an additional 250,000 hectares of arable land, equivalent to 14 percent of the present arable land, and allow the resettlement of about one million persons. The implementation of a proper reclamation and resettlement plan, carefully conceived and controlled so as to avoid erosion, is urgently required. 16. Properly organized migration would for a time alleviate the Hills' most pressing problems, but ultimately the economy of the Hills will have to be developed, so that it can offer a decent living to those of its inhabitants  who remain. A key prerequisite for development of the Hills is the building of a road network, wlhich would open many of the up-to-now isolated and fragmented small economic entities to monetized exchange. The recent substantial efforts in road development have benefited Nepal, but it is also clear that the economy is not going to be knit together by main roads only. Building feeder roads from the main "roadhead" to collection and distribution centers in nearby valleys would probably raise the returns on past road investment, while providing the basic requirements for uplifting the economic conditions of the area. Such roads need not be connected to every farm, nor link every valley, since it should be possible to carry even heavy goods over the re- maining short distances in the small amounts that are likely to be traded. At the beginning, cheap dirt roads can be built, passable only by bullock carts and tractors. At the same time, cooperative credit should be provided. Simple production techniques can also be introduced (for instance, water mills using nearby waterfalls to produce electricity and lift water from the local stream for irrigation), allowing the manufacturing of some agri- cultural implements in small workshops, the powering of some textile looms, etc. Hillsides could gradually turn to crops which require few inputs, such as potatoes and other vegetables, which would be traded for food- grains, other simple consumer goods and some productive inputs. 17. The Hills are capable of producing large quantities of fruits for markets in the sub-continent; but the magnitude of investments required, their long gestation period and the lack of substantial outlets in the near future for such costly products preclude, for the time being, such a development approach. At the present level of development, the potato stage comes probably before the fruit stage. Although the development of the Hills will be an arduous task, the development of the Kathmandu Valley offers encouragement. It is a small valley of no more than 560 sq. km. with about half a million people. Despite this density (1,000 persons per sq. km.) the Valley has recently become self-sufficient in wheat and potatoes, in addition to producing enough quantities of vegetables for the relatively affluent and growing local market. The success has been due in part to the availability of fertilizer, water and improved seeds. 18. The economic problems facing the Terai are of a different nature. The Terai produces most of Nepal's exportable surpluses (riceand wood products to India; jute and jute goods to third countries), but of late, foodgrain surpluses have declined rapidly, because of population growth and the slow gains in output. On the other hand, the per capita land resource base is about three times that of the Hills; moreover, this resource base can be extended substantially. Development of the Terai calls for two concerted actions. One is the strictly controlled settlement of migrants from the Hills in the forests of the Terai. This requires land-use planning, forest management, the provision of credit and management for settlement, and infrastructure. Two pilot settlement projects carried out with foreign technical assistance have had excellent results and the average income per householder in the settlements is believed to be over three times  - 6 - the general average for Nepal. Given the special importance of the Terai in Nepal's economy as a producer of export surpluses, the size of holdings should be designed so as to make possible production above the subsistence level. 19. The second thrust of development policy for the Terai should be to increase the productivity of land already under cultivation. Perhaps 20 percent of the land in the Terai is irrigated by public schemes, the main purpose of which has been the provision of supplementary water for the staple wet season rice crops. While this approach has met with some success, it did not provide for intensive cultivation which can only be achieved by irrigation facilities allowing for double-cropping. A good start has already been made in this direction and three projects, covering nearly 50,000 ha., are going to be implemented soon with the assistance of the Asian Development Bank and the World Bank Group. This new irrigation policy,which should be extended. will allow the Terai to increase its agricultural output and to remain a net exporter of foodgrains to other parts of Nepal and to India. The success of this program will require, besides the irrigation, adequate agricultural extension services, along with the improved seeds, fertilizers, pesticides and institutional credit.  -7- II. HUMAN RESOURCES AND EDUCATION Population 20. Ethnically, Nepal's population falls into two groups: Indo- Nepalese (about 80 percent of the population) and Tibeto-Nepalese (about 20 percent). They speak some 30 languages and dialects. Nepali, the main language, is the mother tongue of over 50 percent of the population. In most of the Terai, Indian languages are prevalent. In the Kathmandu Valley, slightly less than half of the population speaks Nepali. The other half, the Newars, who have lived in the Valley for perhaps more than 15 centuries, retain a language belonging to the Tibeto-Burman family. Hinduism is the main religion in Nepal. In 1961, 88 percent of the popula- tion were Hindus; 9 percent were Buddhists and 3 percent, Muslems. Hinduism, influenced by Tantrism, is the major religion. There is however, much intermingling of Hindu and Buddhist beliefs. Many Nepalese regard the country as being about equally divided between Hindus and Buddhists. 21. Both Hinduism and Buddhism have assimilated many elements of Shamanism, an indigenous folk religion based on a belief in supernatural beings and on the ability of certain persons called shamans to communicate with them. Both religions live in harmony with each other. The caste system, upon which traditional Indo-Nepalese society was based, is closely associated with Hinduism, which spread to many communities of the Buddhist Tibeto-Nepalese ethnic groups. The extreme ethnic diversity, large number of languages, proximity of two powerful neighboring cultures (Tibet and India) created different family structures, eating habits, living styles and religious beliefs which, coupled with the country's extreme topography, has resulted in major communication problems that complicate the task of Nepal's development. 22. The population of Nepal is officially estimated at about 11.2 million, increasing at about 2.2 percent per annum; however, neither the population size nor its rate of growth are really known. The margin of error between the official estimate and the true numbers may well be very substantial. Nepal has a young population. Both the 1952/54 and 1961 censuses show a young age distribution with almost 40 percent aged under 15 and another 10 percent 15 to 19. Nepal is also a country of very early and almost universal marriage. Less than 1 percent of the population remains single through life and, in 1961, only 5 percent of women aged 20-24 had not married. In the same year, 25 percent of women aged 10-14 were reported as already married. 23. A very young population, early marriages, high fertility and some improvement in public health facilities together would suggest a rapid population growth in future. Assuming that the crude death rate would gradually decline from about 20 now to about 13 per 1,000, Nepal's population would be nearly 23 million inhabitants by 1995, if fertility remains unchanged. This would mean that, by that year, the annual rate of population growth would be 3.1 percent.  -8- 24. These demographic prospects are rather alarming when it is realized that even now the Hill areas are over-populated, resulting in continuing migration to other parts of the country or abroad. The average population density in Nepal in 1971 was probably about 80 per sq. km. However, about 13 percent of the total land area is cultivated so that average density per cultivated square kilometer is 615. But again, this figure is a national average; the Hills contain about 60 percent of the population, but only one-third of the cultivated area. Extraordinarily high concentrations are therefore crowded onto the slopes of many of the narrow, fertile valleys. 25. As a result, except in the Terai, the limits to land cultivation imposed by climate and topography have more or less been reached. Over- grazing and the expansion of the cultivated area at the expense of the forest cover have accelerated the natural erosion, which is constant, severe and widespread. 26. Rapid population growth, especially in the Hills, has met with two types of response: a high rate of migration, and the adoption of a family planning program. A deteriorating land/man ratio has compelled a growing number of Hill people to try to find their subsistence elsewhere. The Nepalese are a very mobile population and Nepal has, since the middle of the 19th century, been a net exporter of population. Thousands of men emigrated to join the Gurkha regiments in the British and Indian armies, otherswent to seek work in the tea plantations in northern India, whilst many were employed in security posts in major Indian cities. According to the 1961 Indian census, there were almost 500,000 Nepalese-born persons living in India, coming mostly from the Hill regions. It is estimated that about 80,000 Nepalese emigrate to india annually and, of these, 60,000 return one to five years later. 27. With Lhe greater control of malaria now being exercised in the Terai,this region has become the focus of migration from the Hills. None- theless, population in the Hills is believed to have increased by over half a million between 1961 and 1971. During the same period there was also immigration into Nepal. Firstly, an increasing number of Indians from adjacent UtLar Pradesh and persons of Nepalese origin from Assam migrated to the Terai and competed with Nepalese for land reclaimed ille- gally and in an economically wasteful manner from former jungle areas. Secondly, Nepalese who served as soldiers in Burma during World War II returned because of the political situation in Burma and, thirdly, with the Chinese occupation of Tibet, many Tibetan refugees fled to Northern Nepal. 28. Family planning was started in 1958 by a voluntary organization which still exists. Subsequently, the Government officially assumed responsi- bility for a program and handed it over in 1968 to a semi-autonomous board, the Family Planning and Maternity and Child Health Project (FPMCI-). by 1971, 87 project centers were in operation with the expectation that the number would increase to 150 by 1974. The centers are essentially clinics which serve the surrounding population. The key workers in the program are health aides who are young women with about 8 years of schooling, followed by 6 weeks of paramedical training. They are usually local residents and know the  local customs, leaders and dialects. However, they lack social stature because,among other things, of their youth. 29. The achievements of the program have so far not been too impress- ive. According to available statistics, the cumulative number of new acceptors up to the end of 1971 was 95,000 but, after a very promising start in 1968/69, the number of new acceptors is decreasing. But much more significant than the number of new acceptors are the poor continuation rates. Funds provided for FPMCHs are modest: NR 7.5 million for 1971/72 (0.7 percent of the national budget) and NR 5.8 million for FY 1972/73. The Family Planning network is still very thin. 30. Although there is increasing awareness and appreciation of Nepal's population problem in Government circles, there is little evidence of serious commitment. Moreover, as in many developing countries, the "ideal" size of a family in Nepal is still large. The first priority should be to determine the reasons behind the present low continuation rates of new acceptors - rather than to expand the present family planning network. Health and Nutrition 31. The main health problem in Nepal is high infant and children mortali- ty. Empirical observation suggests an infant mortility rate as high as 200 to 300 per 1,000 live births. In addition, mortality of children belonging to the 2 to 5 age group is very high: the National Health Survey found that 56 percent of all deaths involved children aged under 5. Life expectancy at birth is probably between 40 and 45 years. 32. The very high infant and children mortality is partly a problem of nutritional and children care education, which can only be solved with an adequate extension of the health and family planning network and the training of an adequate number of medical and paramedical personnel. But by and large, the present health education points less to a medical, than to an economic problem. Health aides are expected to provide some nutrition- al education to the most vulnerable groups of the community, pregnant mothers and pre-school children; but the health infrastructure in Nepal is inadequate and covers only a small proportion of the population. Health aides have little equipment for demonstration programs. Since the critical age for child survival is at about 18 months when the child is weaned and immediately put on largely indigestable grain foods, the World Food Program proposes to distribute skimmed milk and corn-soya-milk to pregnant mothers and babies through FPMCHs, mission hospitals and the Red Cross. Although only a small percentage of these two groups of population will be reached, some useful demonstration effect is expected. 33- Until recently, large areas of the Terai had few people because of endemic malaria. Under a program financed largely by the U.S. malaria has been eliminated in many areas. However, serious problems are still posed by the fact that Indians and Nepalese have been migrating to the malaria- free areas in increasing numbers, while the malaria program has not yet covered  - 10 - these uncontrolled settlers. The incidence of tuberculosis is high throughout the country, especially in urban areas. Other diseases of major importance are smallpox and cholera - which occur in epidemic pro- portions - typhoid,venereal disease, leprosy, filariasis, trachoma and, in the mountain regions, goiter. Dysentery and other intestinal diseases are commonplace. The planned health program includes increasing health posts from 33 to 258, preventive programs for malaria, leprosy, tuberculosis and smallpox and construction of a number of 10 to 100 bed hospitals. 34. Health services in Nepal are both inadequate and very unevenly distributed. In 1971, the Kingdom had only around 310 doctors (one per 37,000 people), of whom more than 80 percent are in Government service. About a third of these practice in the Kathmandu Valley, which has about 5 percent of the total population. The health problems of most of the people are, therefore, treated by traditional methods (ayurvedic, shaman). In its efforts to extend and improve medical services, the Government is relying increasingly upon a still embryonic paramedical corps. In 1971, there were only 158 graduate nurses, 223 auxiliary nurse midwives and 405 auxiliary health workers. 35. Government expenditures for health services have approximately tripled since 1964/65. This is roughly the same rate at which total Government expenditures have increased. In the Fourth Plar, (1970-75), about NR 100 million of public expenditures are allocated for health services, excluding family planning, compared to total estimated Government expenditures during the Plan period of nearly NR 5,000 million. This is a very modest amount, in part reflecting the inadequate training facilities and the geographic constraint on establishment and support of rural programs. Education The Education System in Transition 36. Basic to an understanding of the shortcomings of the present educa- tional system in Nepalis aa appreciation of the fact that during the 104 years of their rule, which ended in 1951, the Ranas remained opposed to any form of universal public schooling. Only they and other members of the ruling elite provided formal instruction for their own children to prepare them to take their place in the governmental structure. In 1951, less than one percent of the children of school age was enrolled in primary schools. Only about 10 percent of the adult population is believed to be literate. This lack of educational base partly explains the limited absorptive capacity of the country and the difficulty in implementing development programs. In the last two decades, progress has, been rapid: primary enrollment increased to about 500,000, secondary to 103,000 and higher education to about 21,500. Impressive as these gains may be, only 32 percent of the primary age group are enrolled.  37. About 500,000 children in the 6-10 age group are now enrolled in about 7,250 schools; one-sixth are in private schools. Only about 15 percent are girls. The dropout rate is high because many children still enter the labor force at an early age in the countryside. Of 100 children registered in the first grade in 1965, 14 entered grade 6 in 1970. Shortage of qualified teachers has been a severe problem. Out of 18,250 teachers, 20-25 percent are reported as trained, i.e., have 6-10 years of schooling plus some professional training. There is a marked disparity of educational opportunity and quality between Kathmandu and the rest of the country. Facilities in the Valley are good; teachers are generally qualified and students have access to text books. Adequacy of schooling appears to be a function of distance from Kathmandu with rapid deterioration in facilities, teacher quality and text book supplies as the distance increases. 38. Enrollment in the 1,065 secondary schools increased from 1,680 in 1951 to over 100,000 in 1970, of whom 20 percent are in private schools. Enrollment is about 5 percent of the age group. Retention rates have been relatively good. Of 100 students in grade 6 in 1965, 70 were in grade 10 in 1969. However, the wastage through failure at the School Leaving Certificate (SLC) level is very high, the pass rate being about 30 percent. 39. The development of vocational and technical education has been haphazard. Twelve specialized centers, responsible to a variety of Ministries, offer skill training, each having its own entrance requirements and curriculum. Very small enrollments, ranging from 16 to 160, and unnecessary duplication make them expensive. Total enrollment in 1971 was about 850 and output about 460. Twenty-nine multi-purpose secondary schools offered vocational programs. In 1969, 275 students had taken one of the vocational programs and 169 passed the SLC. A follow-up study showed that less than 5 percent of these students were gainfully employed and only 3 percent in jobs related to their training. 40. The unstructured growth of higher education in Nepal is also a major point of dissatisfaction with education in Nepal. From 250 students in 1951, higher education grew to 21,500 in 1972, mostly in 49 colleges. Almost half of the students were majors with very poor prospects of finding suitable employment. Less than one-fifth enrolled in science and technology. As In many other developing countries, higher education has, therefore, grown in an uncontrolled way. The Nepal Education Planning Commission had recommended in 1954 that higher education should be limited to 5 percent of secondary enrollment. Today, higher education enrollment has reached over 20 percent of secondary enrollment. As a result, over 25 percent of total education expenditures have been spent on higher education. At the same time, government grants-in-aid provided 70 percent of higher education costs, against about 50 percent in primary schools, and 25 percent in secondary schools. While fees are comparatively high for primary and secondary education, there are virtually no tuition fees for higher education.  - 12 - 41. The rapid growth of the education system in Nepal has resulted in generally poor standards. This growth was also largely unplanned. As a result, administration is disorganized and Government and non-Government schools uncoordinated. Education at all levels is largely academic and unrelated to development needs. Education is concentrated in the Kathmandu Valley and, although the economy is largely agricultural, practically no agricultural subjects are taught; higher education mushroomed in an uncoordinated fashion and unemployment of graduates grew, while manpower needs remained unfilled. 42. Dissatisfaction with education and the government's determination to gain control of the system led to the appointment of a Palace Task Force in 1970 which was charged with drafting a new plan for education in harmony with national aspirations and consistent with future manpower requirements. Its report, adopted in mid-1971, marks a significant turning point in Nepal education. The principal focus of the reform is on change from the 5-5 structure of primary and secondary education to a 3-4-3 structure of primary, lower secondary and upper secondary, respectively, with introduction of vocational education beginning at the 12-15 age group of the upper secondary level. Another interesting feature of the reform plan is the creation of the National Development Service. Under this scheme, a student passing the first year of the diploma course (bachelor's degree) or the first year of the degree course (master's degree) will be required to serve for a year in a place where he is assigned either in education, health, agriculture or construction service corps. Holders of foreign diplomas or degrees will be barred from continuing further studies or taking up employment in Nepal until they have fulfilled this service requirement. The plan establishes a National Education Committee, which will oversee the implementation of the Plan and have authority for estab- lishing policies and goals. School administration is delegated to the Ministry of Education. To that end, the country has been divided into three regions, each headed by a Regional Director with overall supervision of the implementation of education policies, although direct supervision will be the responsibility of 75 District Education Officers. These officers, and the staff working with a district education committee, will be responsible for organizing education services, school staffing and supervising the pro- vision of materials and equipment. 43. Higher education, which is now fragmented into 49 largely autonomous colleges, will be the responsibility of Tribhuvan University which will function as an autonomous institution within the policies enunciated by the National Education Committee. The University will have its own budget as well as responsibility for curriculum, personnel and facilities.  - 13 - 44. During the Plan implementation period a dual system of education will operate, but the old system is to be phased out. The complete shift is expected to be accomplished by 1976. Unlike the education chapter in the Fourth Plan, which emphasized expansion in numbers, the new Plan. emphasizes quality of education related to Nepal's needs, training of more skilled workers and a change in the attitude toward work at all levels. Problems in Implementation 45. Success in implementation of the Plan will partly depend on the ability of the central government to commit the necessary funds and of local governments to meet their financial obligations. For the new Plan, total budgetary requirements have been projected at NR 576 million, or 10 percent of the Central budget as compared with 6-8 percent between 1965 and 1972. Government expenditures will mostly cover teachers' salaries, with land, buildings and furniture being largely a local responsibility. There is no provision for capital requirement for normal schools. At this stage, it is impossible to assess the adequacy of the projected availability of resources, given the lack of precise teacher enrollment projections. It is essential that the cost of the Plan should be more carefully projected and both source and the availability of funds be determined. 46. Administrative problems are of several kinds. The most obvious one is the result of the topography of the country, the total lack of tele- communications in rural areas and the lack of a comprehensive transportation network, which considerably limits the movement of persons and goods. Physical constraints alone are a major obstacle for effective administration. The staffing of the administrative infrastructure by competent people is a serious problem. The pool of competent professionals on which to draw is very limited indeed. A key element in the success of the system lies in the ability of the 75 district education officers and their supervisory staff to perform their duties effectively. Teacher and Manpower Training 47. By 1976, about 18,000 teachers will be needed. Present output is about 850 "regular" teachers annually and there are plans to double training capacity within the next five years. The situation is more difficult in reaching the target of 1,700 vocational teachers. There is no pool of vocational teachers on which to draw except the small number of poorly trained teachers in the multi-purpose schools. Training of vocational teachers has virtually to be started ab initio. Lack of trained teachers appears therefore the most serious threat to Plan implementation and educational reform. 48. The anomaly of high unemployment with concurrent shortages of skilled workers, common in developing countries, is generally true in Nepal. Although the problem of unemployed educated in Kathmandu is becoming acute, there are 500 junior technical assistants' posts unfilled in the Ministry of Agriculture and the need for about 250 operators and maintenance  - 14 - personnel for the airport expansion cannot be met. Essentially because many educated people resist appointment outside Kathmandu, except in a few cities and towns, the more educated person and his family are bound to feel isola- ted. This problem is of major importance to Nepal, for the most isolated districts are generally the poorest and therefore in need of the best administrators and skilled personnel. Moreover, in the case of junior technical assistants, the pay is low and career prospects are poor. Estab- lishment of the National Development Service might offer a partial answer to this problem. The principal requirement for training in Nepal is for middle-level technicians, apart from those in teaching positions. The need includes overseers (particularly for road construction and irrigation projects), paramedical personnel (especially for the Family Planning and Health Program), and agricultural technicians (for the extension service and service agencies). There is a dearth of accountants and a shortage of trained managers. The Human Research Division of the National Planning Commission has estimated future manpower requirements, but these estimates require further work prior to their use as a basis for planning vocational training. 1/ 49. The problem of teacher shortage is aggravated by the resistance of teachers to assignsment cutside the towns and cities. The more competent educators concentrate in a few areas, producing more educated Nepalis who wish to remain in the same areas. Training of educators is also made difficult by Nepal's topography. Recruitment of students for teacher preparation is handicapped by the lack of easy travel between villages and the normal schools. 50. Sociological factors interfere with achievement of Nepal's goal of educational reforms. Most teachers come from castes which have traditionally looked down on physical manual activities. Moreover, the socio-econcoic class structure of Nepal, combined withi tL-e school fee system, keeps most members of lower classes from acquiring enough education to become teachers. Therefore, the approaches used by teachers will reflect, in curriculum and methods, a bias towards the upper-clasE/caste values, which frustrates the objective of emphasis on vocational subjects. At present, therefore, Nepal is drawing on the potentialities of only a tiny portion of its population. Most of the peasants are barred from reaching positions of educational leadership, although the population is preponder- antly peasant. A vicious circle has developed: rural areas are likely to attract second-rate teachers, which in turn limits the possibility for peasant children to advance to teaching positions. 1/ A reservoir of manpower, with a variety of skills which is little used, is theGurkhas whO have left the British Army. An obstacle to the employment of Gurkhas in government jobs is the fact that they have no f&rvmia] :ac:.idenm qulifications; however, as roads are built into the Wk':;ft*^I a1tld CI.-;tVrnI hllt.11 areas, tiheir practical skills and experience nuty t itid eitmplouiient 1iear the villages to which they have returned.  - 15 - Conclusions 51. The spirit of the reform deserves warm endorsement but its success will depend on its effective implementation. The introduction of agricul- tural subjects in all secondary schools in rural areas is sound, but pressure to expand this and other vocational programs beyond the Ministry's capacity to plan and provide for teachers should be resisted. A sound teacher train- ing program is vital for healthy development of the system. To carry out the reforms efficiently, priority shbuld also be given to strengthening of: the administrative and planning capacity in the Ministry of Education. While it would undoubtedly be politically difficult, strict controls should be exerted on costly and sometimes wasteful development of higher education. Finally, a thorough assessment of manpower requirements should be completed before defining education programs; manpower projections should be related to development goals. 52. Emphasis should be given to developing the skills needed for develop- ment. Too rapid an expansion of education could result in poor staffing of the system, managed by a weak administrative structure. The goal of increased literacy needs to be balanced with providing for needed skills. What is called for is a rephasing of the implementation schedule of the reform which is consistent with both the administrative capacity and educational priorities of the Kingdom.  16 - III. AGRICULTURE 53. Agriculture (including forestry) directly accounts for about 70 percent of GDP, 80 percent of Nepal's export earnings, and provides employ- ment for about 90 percent of the labor force. Land and forest revenues account for about 20 percent of total domestic Government revenues. Accord- ing to the most recent available data, based on no more than informed guesses, agricultural GDP grew at a compound rate of about 1.8 percent per year in real terms between 1962-70, which is a little more than half that of the non-agricultural sectors and was less than the average growth of population of about 2 percent. Predominantly agricultural, and with limited possibi- lities for diversification, Nepal's economic development will, for a long time to come, be largely dependent on its ability to increase agricultural production. With rapid population growth and high infant mortality due, in part, to nutritional deficiencies, high priority must be attached to expanded supply of foodstuffs. Moreover, Nepal's development will depend heavily on its ability to create surpluses in agriculture to pay for its large and growing import requirements. Most of Nepal's exports are genera- ted in agriculture -- mainly rice, jute and forest products; the possibi- lities for diversification of exports are either limited (e.g., tourism) or remote (the export of large amounts of energy to India). Recent Agricultural Growth 54. Statistical information on the agricultural sector in Nepal is particularly weak and the available data should be regarded as indicating only general orders of magnitude. Any assessment of agricultural per- formance is therefore necessarily tentative. GROWTH OF CROP AREA AND OUTPUT 1961/62-1970/71 AND OUTPUT IN 1970/71 Average Annual Growth (%) Area Production Production 1970/71 (in thousand tons) Cereals 1.9 0.9 3,486 Rice 0.9 0.7 2,305 Wheat 13.9 9.3 193 Maize -0.1 -0.9 833 Jute 9.7 4.8 53 Oilseeds 0.3 1.6 55 Sugarcane 6.8 11.9 236 Source: Ministry of Food and Agriculture: Economic Analysis and Planning Division. By far the most disturbing development is that for cereals as a group there has been a downward trend in per capita production. Moreover, there  - 17 - has been a falling trend in yields, suggesting that the use of inputs and improved cultivation practices have been insufficient to compensate for declining fertility, due probably to soil exhaustion and reclamation of marginal lands. Wheat, a minor crop, has been the only dynamic foodgrain, due mainly to the introduction of high yielding varieties. 55. Although of only minor importance in the sector as a whole, cash crops are the major source of income for many farmers. Jute, however, is of major importance to the economy, providing 70 percent of convertible foreign currency earnings (i.e., from exports to countries outside India). Jute yields are poor and the quality rather low, but its weak competitive position has been improved through the Exporters' Exchange Entitlement Scheme 1/, which provides a strong incentive for jute cultivation. As a result, the area under jute has more than doubled during the sixties. Rape- seed is an important export to India; oilseeds output, however, has risen slowly in recent years. Sugarcane production has increased rapidly and there has been some apparent improvement in yields, which are, however, still low. Tobacco production has stagnated and the bulk of leaf utilized in domestic cigarette factories has to be imported. 56. Nepal's production of fruits and vegetables other than potatoes is not reported. Potatoes are an important crop and its production has expanded very rapidly from 186,000 tons in 1964/65 to 273,000 tons in 1970/71, largely on account of the introduction of a new seed. Selected subregions have demonstrated comparative advantage in this line of pro- duction. However, most of these favorable regions lack road transporta- tion for movement of the produce to possible markets both within Nepal and to India. 57. According to the 1961/62 Census of Agriculture for Livestock, Nepal farmers maintained an estimated 7.3 million cattle (an average of 4.9 head of cattle per holding against 2.9 in India), 1.8 million sheep, 2 million goats, 200,000 yak, 150,000 swine and 14 million poultry. It is probable that the number of poultry has been increasing very rapidly. Buffalo are concentrated in the Western and Far Western Hill districts and in some districts of the Eastern Hills where the production and marketing of ghee is a major source of income. Bovines predominate in all other districts where the production of bullocks for draft power is of higher priority than the production of milk and ghee. The management of the cattle herd is generally very poor, its genetic quality and productivity very low and religious beliefs prevent rapid improvement. Poor management of the cattle herd places a heavy burden on the nation's 1/ See Chapter IV.  - 18 - deteriorating pasture resources. On the other hand, sheep and yaks are the mainstay of economic life in the Himalayan region and offer reasonable prospects for development. 58. Most of Nepal's 86,000 sq. km. of forest and alpine pasture lands are under the control of the Forestry Ministry. Of this total, forests proper are believed to consist of 13,000 sq km in the Eastern and Western Terai on land that is or could be made accessible to bullock- cart transport; 8,000 sq. km. in the Inner Terai which is more difficult to reach; 25,000 sq. km. scattered through the Hills are considered non- accessible except for porter transport to supply local consumption. Harvest rates for forest products are not available. A previous Bank report estimated that the value of timber harvested could have exceeded NR 500 million in 1966/67. There is little doubt that government revenues (only NR 20 million annually since 1963/64 from forestry production) are far below their potential as a result of theft and illegal clearing. Forestry resources in Nepal are thus extensive, but their use is far from being optimal. Development of forest roads and effective controls on theft and unauthorized land clearing are two problem areas which deserve high priority attention. Elements of Agricultural Policy 59. The disappointing performance of the agricultural sector in the recent past ernphasises the need for a clear and urgent definition of agricultural development policy for the Hills and the Terai were outlined in Chapter I. The development of the Hills entails the building of a road network which would open the isolated and fragmented small economic entities to exchange; changes in the cropping pattern along with improvement in production techniques and the provision of credit, fertilizer, seeds and irrigation water; in addition, controlled migration from the Hills for resettlement in the Terai forests included within a comprehensive land use plan designed to avoid erosion. The resource base (cultivated land and capital investments) should be expanded. In addition, however, an important element in developing the foodgrain potential of the Terai is the provision of irrigation to make possible double cropping. 60. By 1972, the Government had provided irrigation for a command area cf about 120,000 ha. through about 100 projects. About 20 percent of the irrigated area produces a second crop. Although there has been little coordinated planning in Nepal, successive governments have accorded irriga- tion high priority in their development programs, but the Department of Irrigation has been voted much more money than it has managed to spend. The principal causes of under-spending in the past appear to have been problems of communication and transport, and difflculties In the mobilization of materials and work force.  - 19 - 61. Local irrigation works, such as tanks, wells and small drains and channels constructed by the farmers themselves also play an important role. They are estimated to supply water to about 400,000 hectares, but in many places such works are not dependable and frequently fail to ensure an adequate and regular supply of water. In 1967/68, about 12 percent of the 1.8 million hectares of cultivated land were irrigated (including public and private facilities) with more or less dependable water. With the new schemes completed since then, the percentage may now be about 15 percent. 62. Until recently, the underlying philosophy behind public irrigation development has not been double-cropping, but provision of supplementary water to ensure the staple wet season rice crops. All of the completed projects and almost all of the on-going ones were based on this "protective irrigation" concept. This approach was understandable considering the shortage of readily available water in the dry season. 63. If the land and water resources are to be fully exploited, more sophisticated irrigation projects designed for optimum water management and double cropping are required. This type of irrigation is much more complex than the traditional one and demands new skills and techniques which require many years of experience by both Government officials and farmers before the full benefits can be attained. The sooner this "learning by doing" process is begun, the better. A start has already been made to introduce improved irrigation and double cropping. Recently ihe Government has signed loan agreements with the Asian Development Bank for two projects, one in the Kankai Area (5,000 ha.) and the other in the Chitwan Valley (11,000 ha.). A third one, the Birganj Irrigation Project (about 30,000 ha.), is to be financed by the World Bank Group. 64. Policy for irrigation development should be formulated in the context of national planning. Irrigation will, and should, be given considerable priority, but there is a danger that too much may be attempted and too little completed. For example, the Government has undertaken the Mahakali (25,000 ha.) and the Chatra Projects (67,000 ha.), both of which could absorb a significant proportion of the trained manpower resources of the country, although the ultimate benefits appear doubtful. As part of the new policy these two projects should be thoroughly reviewed to determine whether the resources to be devoted to them are commensurate with the probable benefits. 65. Irrigation is a necessary input.to achieve increased production but not a sufficient one. Successful irrigated agriculture requires the use of other inputs (fertilizers, pesticides, improved seeds, etc.) which in turn require the availability of cooperative credit. And finally, even if the package of modern inputs is available, it is necessary to ensure that other obstacles do not prevent their optimal use. Among the major problems are the need for land reform and improved availability of agricultural inputs, including credit, fertilizer and seeds.  - 20 - 66. The land structure inherited from the recent feudal past acts as a disincentive to increased production. It impairs the productive capacity of the tenants, because rent is generally fixed so high that a large portion of output accrues to the landholders, leaving the tenant with no margin for investment. Moreover, the present system also affects adversely the incentive of tenants to undertake permanent improvements, because of the fear of his being ejected at any moment. The government has not been inactive in the field of land reform. It has provided ceilings on both individual and family land holdings. While some holders were able to by-pass the law, 123,000 ha. of land above these ceilings have been identified, of which 75,000 ha. have been acquired and 54,000 ha. actually distributed. MIaximum legal rent, fixed at 50 percent of the main crop, is undoubtedly too high and acts as a major disincentive to intensified farming; the rapid increase in production in the Kathmandu Valley, due in part to the introduction of a fixed rent, is an index of the benefits of such a policy. This fixed rent system has been recently extended to districts in the eastern Terai. The land teform program has not basically changed the land structure of the whole country but the results, so far, have been encouraging. It has focussed principally on tenurial reforms. Regulation of rents throughout the country is needed, but at present hampered by the lack of an agency which can administer this program, and by the need for change in the power structure in the villages. 67. Institutional creclit was non-existent 10 years ago. Today it provides 21 percent of credit needs, a percentage roughly comparable to that in India. There are, however, large disparities in credit distri- bution between income groups and regions. Large farmers obtained (1971) 49 percent of their loans from credit institutions, compared to 16 percent and 9 percent for medium and small farmers, respectively. In the Hills, less than 10 percent of credit needs were obtained from cooperatives, while in the Terai over 51 percent of the loans took tihe form of institutional credit. Interest rates ranged betweern 25 and 50 percent annually for private credit (mostly money lenders) compared to 9 to 10 percent for institutional credit. In the Hills (except in the Kathmandu valley) this inequity of distribution of credit reflects the lack of sufficient cooperatives. A key prerequisite for development of the valleysin the Hills is the introduction of cooperative credit institutions. In the Terai, although the cooperative network is reasonably well developed, the small farmers suffer from the fact that cooperatives are not inclined to take undue risks. They insist on written proof that the borrower cultivates a particular piece of land, which most owners refuse to furnish to their tenants. India recently introduced the Small Farmers Development Agency, designed as an answer to this problem. A similar scheme might warrant introduction in Nepal. 68. Consumption of fertilizer is growing but is still very low (12.5 kg. per ha.). Apparent consumption of fertilizer has increased from about 3,000 tons in 1965/66 to over 30,000 tons in 1970/71. Fertilizer supply is uncertain because of irregular transit through India; high  - 21 - transportation costs or lack of transportation had discouraged use of fertilizer in the Hills (prices in early 1972 were on average 25 to 30 percent higher in the hlills than in the Terai), and fertilizer price in India was much higher than in the Terai area of Nepal, which has resulted in re-export of fertilizer to India. To overcome, at least partly, these problems the Agricultural Marketing Corporation has formulated a new price policy which became effective in July, 1972: prices have been unified for the whole country, which involves substantial subsidies, more or less equal to internal transportation costs, while price differential with Indian prices has been reduced in the hope that the small difference re- .!; ining (about 10 percent) would not be enough of an incentive for smuggling. The extent to which these pricing policies have produced the desired effect is not as yet apparent. 69. Negligible five years ago, the total area under improved seeds is reported to have increased from about 4 percent in 1968/69 to 7 percent in 1970/71; wheat area under improved seeds has expanded substantially and now covers about one-third of the planted area. The research station of the Agricultural Education and Research Department near Kathmandu has successfully adapted improved varieties of wheat. Adaptive work in rice has not yet produced a variety suitable for monsoon sowing. The maize varieties identified abroad are difficult to adapt to the Hills because they are too long maturing under the prevailing climatic and light condit:ions to fit into the traditional cropping patterns. The pressing problemn is to identify high yielding varieties with the maturation periods of local varieties. 70. The slow response of farmers to improved seeds and fertilizers is in large part the result of inadequacy in marketing and distribution facilities, which is also one of the reasons for the imbalance in foodgrain distribution in the country. Part of the problem stems from the inadequate transport system generally, but the difficulty also stems from lack of storage space as well as poor management generally in the physical dis- tribution of foodstuffs. 71. Over the long run increase in agricultural production will require the transformation of present traditional agriculture on the basis of an applied agricultural research program. To date the only notable success has been the adoption of improved varieties of wheat. Research on rice and maize has not yet produced useful results. Although the government plans to induce farmers to switch production in the Hills away from foodgrains and into horticultural products (a number of which are produced at present for local markets) present horticultural research stations are few in number and relatively ineffective. There is also need for applied research in livestock development. 72. While an accelerated program of agriculture research is thus essential to the sector's long run growth, there is no doubt that product- tivity improvements are possible today on the basis of applying existing knowledge of improved practices. Present extension services are inadequate for the job required. Most of the extension service staff consist of inexperienced and inadequately trained "junior technical assistants". Steps should be taken to increase the number of extension service workers and to provide necessary training.  - 22 - IV. INDUSTRY AND TOURISM 73. Industry is a minor activity in Nepal: manufacturing today accounts for 2 to 3 percent of the GDP, against 1 to 2 percent in 1964/65. Cottage industries may represent about 7 percent of the GDP. It is estimated that there are 200,000 people employed in the industrial sector (excluding those engaged in cottage industries), mostly in factories having less than 30 employees. There are very few "medium size" enterprises in Nepal and their combined employment is below 5,000. 1/ Most Nepalese industries are agro-based: rice, sugar and saw milling, cigarettes, tex- tiles (jute and cotton), shoes, ghee and vegetable oils. Apart from rice milling, jute is the most important industry and in 1970/71, jute goods accounted for 27 percent of exports to countries other than India with raw jute exports accounting for another 43 percent. 74. This slow development of the industrial sector occurred despite the very ambitious objectives of the Second and Third Five Year Plans and the grant of substantial incentives: tariff protection, tax holidays, duty exemptions on imported equipment and materials and availability of foreign exchange for imports. Industrial plans have been little more than a list of industries to be established. There are, as shown below, many factors restricting Nepal's freedom in devising industrial development plans. 75. As a result of the largely unguarded 1,100 km. border between India and Nepal, people and goods move freely from and to Nepal. There exists, therefore, a de facto common market. This explains the concentra- tion of the existing embryonic industrial sector along the border and along the north-south axis from Kathmandu to the border. Even at this early stage of development, a large part of industry is export-oriented towards India: rice milling and wood products. In the longer term, there is no doubt that a substantial part of industrial investment, based on local resources (e.g. energy and forestry products), will continue to be directed towards the Indian market. Factors Restricting Industrial Development 76. While goods and people move between India and Nepal with a minimum of interference from authorities, Nepalese industries have difficulty in competing with Indian manufactures. The latter enjoy a market large enough to allow economies of scale and generally have reasonably good marketing organizations, backed with adequate finance, while their Nepalese counter- parts have tiny markets and little knowledge of modern marketing practice. 1/ Industrial units employing more than 100 persons.  - 23 - 77. A second major handicap to industrialization is the lack of entrepreneurship. The feudal or quasi-feudal social system based on agri- culture which existed in Nepal until a few years ago did not favor entre- preneurship, nor the development of managerial capacity. Knowledge of finance, of marketing, even of simple management procedures and accounting practices is inadequate. Moreover, the existence of alternative fields for investment, such as real estate, trade, and the 8 1/2 percent tax-free development bonds, deter potential investors from directing their funds to the unknown and more risky fields of industry. 78. The narrowness of the internal market is another problem. With a per capita annual income in the range of US$70 to 80, purchasing power of the majority of the population for manufactured goods is very small. More- over, the urban middle class, which in other developing countries has of- fered a market for consumer goods, is extremely thin in Nepal. A substantial proportion of the urban population lives in towns near the Indian border which have ready access to several Indian producing centers. Indian-made goods are therefore likely to be cheaper than Nepalese goods. A large majority of the population are tenant farmers living outside the monetary economy in largely inaccessible rural areas. They make most of the products they need domestically. The mountainous topography results in physical barriers which segment an already small market into many parts that are not linked together effectively by proper transport systems. This results in a serious problem of efficient scale of production. Based on transport costs one large production unit at one particular place may be less economical than a number of small production units in different localities. This works in favor of decentralized small production units, but at the same time precludes certain fields of industrial activities, where scale is essential to efficient production. 79. Procedural delays have been the rule in the past and there is no doubt that Nepal would gain much by streamlining licensing procedures, by granting incentives automatically according to clearly defined rules, instead of relying on ad hoc decisions and by shortening the time required for the Nepal Industrial Development Corporation to process a loan application. Investment by foreign capital and by the local minority who at present seem to have a large share of the available entrepreneurship and liquid capital should be encouraged, but under clearly and strictly defined conditions or limitations. Excessive control of the Nepalese economy by foreign nationals can be avoided through substantial Nepalese participation in joint ventures and arrangements for the eventual transfer of control to Nepalese nationals. Development Opportunities 80. The Nepalese industries in the embryonic "industrial belt" concentra- ted along the Indian border are agro-based and largely export-oriented in items which enjoy an easy market in India such as rice milling and  - 24 - wood products. Hydroelectric energy potential is great, but has still to be developed. Although certain minerals such as iron ore, copper, nickel, cobalt, graphite and gypsum are reported to have been discovered, it has not yet been determined that any of these deposits can be commercially developed. Forestry-based industrial activities (e.g. plywood and paper) call for careful marketing studies and probably marketing arrangements with India. 81. Industrial development based on import substitution, while not negligible, is nonetheless limited. There is at any rate little scope for import substitution by large-scale industries at present, except in cement and cotton textiles, although the past performance of existing weaving mills has been discouraging. Other import substitution opportunities lie in soft drinks, some food products, filter cigerettes, glass, plastic articles and furniture. 82. The promotion of small-scale industry,is at this stage, probably one of the best avenues along which to proceed efficiently with the import- substitution process and with industrial development. In the past, small- scale industries have been reasonably successful and have been able to com- pete with Indian manufacturers in many product lines. There are at present three industrial estates: Patan, built with Indian assistance, Hetaura and Balaju created by Nepal Industrial Development Corporation (NIDC). Their success has prompted the Indian authorities to assist Nepal in building two more industrial estates (Dharan and Nepalganj). These small industries (some of which could be better defined as medium-sized in Nepal's context) cover a wide range of products: textiles, wool, cotton, silk, furniture, footwear, carpets, blankets, animal feed, biscuit and confectionary, razor blades and curios. In the Hetaura industrial estate, several industries big by Nepalese standards have been established (e.g. oil mills, cigarettesand brewery), and several others are planned (e.g. plywood, cotton and bottles). 83. The economic advantages of small-scale industries are well known. They require less capital per unit of output and lower input of advanced technologies, and they are labor-intensive; more importantly in the case of Nepal, they require less management skills. In addition, small business- men do have considerable experience in marketing on a small scale. Given the fragmentation of the Nepal market into many small markets, small-scale industries can be set up near these markets, giving them a competitive edge over Indian products, which haveto bear heavy transportation costs. Given the poor customs enforcement at the Indian border, protective tariffs cannot be effective for long; import-substitution projects which, in order to be viable, need to have their products priced considerably above Indian prices, cannot and should not be promoted. 84. Another avenue of possible development of Nepal's industries is the establishment of industries for export to countries other than India. Transit problems (delays and pilferage) are undoubtedly a major obstable to promotion of such exports. Extension of jute processing facilities  - 25 - should be c;irefully explored. World market prospects are uncertain. The recent agreement between the nmain jute producing countries (India, Bangla- desh, Thailand and Nepal) to participate in the International Jute Center should provide the opportunity for a comprehensive review of investment opportunities in jute manufacturing. The jute industry possibly may require special incentive treatment because of its importance in creating employment and in providing hard currency earnings. Nevertheless, the economic and financial cost of supporting it should be carefully examined. In the case of exports other than jute, the emphasis should be placed on i.anufactures based on raw materials in which Nepal has a comparative advantage (such as decorative plywood and veneer), or which are labor- intensive, and on products with high prices per unit volume (e.g., carpets, curios, jewelry). 85. One feature of the incentive scheme which needs to be reviewed is the Exporter's Exchange Entitlement. Under this scheme, a Nepali exporter of manufactured goods and of raw jute receives an import entitle- ment in convertible currency he can use more or less freely. In the recent past, this had led to substantial investments in activities of dubious value, to which institutional financing has been associated. These activities werce based on imports of materials, such as stainless steel and synthetic fibers, for re-export, after nominal processing, to India where the imports of such commodities were strictly controlled and restricted. This line of business proved so profitable to Nepalese exporters and reached such a magnitude that India had to put an end to it. As a result the new India - Nepal Treaty of 1971 specifies that (i) the Government of India will provide access to the Indian market free of customs duties and quantitative restrictions for all manufactured articles which contain not less than 90 percent of the Nepalese materials or Nepalese and Indian materials; and (ii) in the case of other manufactured articles in which the value of Nepalese material and labor added in Nepal is at least 50 percent of the ex-factory price, the Government of India will decide in each case the nature and extent of access. The terms of the Treaty are still favorable to Nepal, but include restrictive changes which did not exist previously. The entitlement encouraged imports of non-essential consumer goods, many of which were later smuggled into India. Moreover, this scheme denies protect- tion to the infant Nepali industry. Tourism 86. Starting from an alxittedly low base, the number of foreign tourists, excluding Indians - , increased rapidly from about 6,000 in 1962 to nearly 50,000 in 1971; had it not been for the events in the sub-continent l/ There are no immigration formalities for Indian citizens wishing to visit Nepal.  - 26 - that year, it is probable that the number of tourists would have been much higher. About three quarters, the more affluent visitors, mostly sojourn in Kathmandu and their average stay is about five nights. Trekking and climbing also attract some visitors. An important group of visitors (about 20 percent) consists of young people mostly travelling by road. They spend little but stay longer (about 3-4 weeks). The tourist sector is expected to continue to develop rapidly. Improved air connections and increased availability of hotel facilities will attract part of the substantial number of foreign tourists visiting India. Kathmandu is the main center for foreign tourists and the only site where hotels meet international standards. At present, Kathmandu has 1,075 hotel beds, of which 570 are in the three-star category and above. However, there is a large construction program underway. In Kathmandu, 480 hotel beds are planned to be added at the beginning of 1973, and 240 and 800 more in 1973 and 1974 respectively. Pokhara at present has 42 hotel beds and over 200 are to be added in 1974. 87. A 10-year "master plan" for the development of tourism was adopted in September 1972. The plan, involving an expenditure of NR 174 million, includes the restoration and preservation of cultural, historical and religious monuments; the creation of infrastructure (ground and air transportation) in centers of tourist attraction, particularly outside the Valley of Kathmandu; and the upgrading of tourist facilities such as accommodation, sightseeing, shopping and entertainment. This plan is a list of numerous, apparently sound projects, but the evaluation of the administrative capacity to carry them out effectively and the de inition of a clear sense of priorities is needed. 88. Except for young travellers, most tourists come by air, Three foreign airlines operate to Kathmandu - Thai International, Burma Airlines, and Indian Airlines from Calcutta and New Delhi. Since its creation in 1959, the Royal Nepal Airlines Corporation (RNAC) has enjoyed a steady growth and now carries over 200,000 passengers on domestic routes, as against 75,000 five years ago; the air network is reasonably well developed. During the same period, international passenger traffic rose from 41,000 to 101,000. RNAC covers international routes also and is expected to extend them further. Other international airlines have shown interest in negotiating traffic rights in Nepal. 89. According to the Nepal Rastra Bank, recorded convertible foreign exchange earnings from tourism for 1971/72 were US$2.0 million as compared with US$200,000 in 1965. Per capita spending appears, therefore, to have been less than US$12 per day for the high income tourist groups. Probably an important part of tourist spending is being financed through transactions in the unauthorized market where the rates can be 40 to 60 percent higher than the official rate. Against the US$2.0 million gross earnings, the outflow of convertible currency to service the foreign debt, to pay foreign personnel,  - 27 - royalties, imports of goods and services, is not known, but is probably substantial. Thus the net convertible foreign exchange earnings from tourism are unknown. Fiscal revenues directly attributed to tourism during FY 1970/71 are estimated at NR 1,000,000 in sales taxes. Many new hotels enjoy tax holidays for a number of years after they start functioning; this contributes to the low level of fiscal revenues derived from tourism. 90. Little is known about the employment created by the tourist industry. It has been estimated that 950 people are directly employed in classified hotels in Kathmandu and some 1,100 in Nepal as a whole. Including non-classi- fied accommodations, the total may amount to 1,500. Indirect employment in several activities related to tourism (manufacture of hotel furniture, handicrafts and curios, food supply to hotels, taxi drivers, guides and porters) is probably as important as direct employment. Except for the requirements of younger travellers, the import content of tourism is high, including capital and current expenditures. This is normal at an early stage of tourism development. RNAC's new non-stop route -- Bangkok/Kathmandu/ Delhi -- so far has been successful. The ultimate goal is to develop destina- tional traffic by opening the Teheran/Kabul/Kathmandu/Bangkok route, which will increase transit traffic to and from India. Tourism is a sound development activity provided growth is reasonable and diversified centers of interest are provided.  - 28 - V. TRANSPORT AND POWER 91. There are few countries whose development is as vitally dependent on provision of new transport and communication facilities as Nepal. As has been pointed out earlier, much of the population is located in "mini- economies", physically compartmentalized and isolated from one another because of Nepal's extremely mountainous terrain. The embryonic road, telecommunications, and internal air-transport systems, together play a unique and indispensable role in linking Nepal's regions into a viable economy. The Road System 92. The extraordinary sight of 2,000 persons carrying a steam-roller wheel over a bridle path in Nepal has been compared with that of "ants on a wall pulling a huge crumb". Even in this latter half of the 20th century, most goods are carried from one part of the country to another on human backs. For millions of persons scattered over far-flung and isolated villages, the only available means of transportation are steep, narrow foot- trails and narrow planks or loose tree-trunk bridges over turbulent rivers, which are difficult and unsuitable even for pack animals. 93. This network of porter trails, developed over centuries, is esti- mated at about 10,000 kilometers. But, except for the building of some modern suspension bridges which not only reduce the length of certain trails significantly, but also permit porters to operate during the rainy season on trails that are otherwise impassable, very little improvement has been brought to the network. The requirement for trail improvement (widening of existing trails, more suspension bridges, etc.) is recognized in the Fourth Plan, but since trails are a local responsibility, little investment bv the central Government is earmarked for this purpose. 94. The first road of real importance in Nepal was the 123 kilometer highway from Kathmandu to Bhainse, completed in 1956; it was subsequently extended to the Indian border at Birgani. This road continues as the key link between Kathmandu and the Terai and India. A highway from Kathmandu to Kodari connects the Nepal capital with Tibet; this route has so far not been of much economic significance for either domestic or international trade. Work is nearing completion on a road extending westward from Kathmandu to Pokhara (176 km), the country's second largest city in the Hills. Another road, already completed, connects Pokhara to Bhairawa near the Indian border, thus providing a second north-south route linking the Hills and the Terai. 95. Much of the road construction effort of the past few years has been concentrated on the so-called East-West Highway which, according to government plans, will span the entire country with a main artery through the Terai; less than half the planned route has been completed, mainly in the eastern area. Finally, in eastern Nepal a road from Biratnagar, near the Indian border, to Dharan now provides a significant north-south route linked with the East-West Highway. The pace of all-weather road  - 29 - construction has increased during recent years. Construction of All-Weather Roads Total Average Annual Kilometers Number of Kilometers "55 to 1965 446 44.6 -.65 to 1972 1,045 150.0 In mid-1972, the network of all-weather roads totalled 1,491 kilometers, of which 863 kilometers were paved and 628 gravel. 96. Of the 12,300 motor vehicles in the country in 1972, automobiles and jeeps represented 57 percent, trucks 37 percent and buses 6 percent. The size of the fleet is adequate for the country's present needs. Freight on all-weather roads carried in 1970 was about 212,000 tons, over two-thirds of which was carried on the Kathmandu-Birganj road. The average cost of truck transport is high due to the substantial imbalance in traffic on this route; most southbound vehicles are empty because of the lack of traffic demand in that direction. Investment in Roads 97. Under the Third Plan (1966-69) about NR 570 million (out of which 85 percent was for roads), or 35 percent of public sector expenditures were devoted to transport investment. During the Fourth Plan(1972-76), over NRl billion, or 40 percent of public sector expenditures, is to be invested in transport, 80 percent of which being allocated to roads. Primary objec- tives of the Fourth Plan are to complete the East-West Highway and to build North-South roads connecting the Terai and the Hills. Investment in the East-West Highway is planned at NR438.6 million or 54 percent of the total investment envisaged for all road development. While this route is undoub- tedly a basic long-term requirement for promoting the unity of the country, it is not certain that such a major allocation is warranted: perhaps a more gradual approach would be better. The investment does not appear to have been based on detailed feasibility studies. The 18 feeder roads being studied by the UNDP offer the possibility of opening up the monetized portion of the economy to large numbers of people. The UNDP proposals merit serious consideration and may provide the framework for road develop- ment during the present decade. Development of roads in the Hills should not be based exclusively on economic rates of return but should also take into account external factors that are difficult to quantify. 98. There are several principal problems associated with the roads. One is that they may be built to excessively high standards for the potential traffic. For example, the eastern part of the East--West High-  - 30 - way has been built to Asian highway standards; the extent to which this is justified is uncertain. Moreover, maintenance of roads in Nepal has been neglected. Because of rugged terrain and heavy seasonal rainfall, roads tend to deteriorate rapidly and therefore a policy of properly maintaining roads is of particular importance. Firm action is needed to fix and enforce load limits carried by trucks to reduce damage to roads and to the vehicles. 99. The economy is not going to be knit together by main roads only. In Nepal, feeder roads do not imply short roads from farms to market or from farm to main roads, since it should be possible to carry even heavy goods over short distances. What is required is somewhat longer roads over relatively difficult terrain from the "roadhead" to a collection and distri- bution center in a nearby valley. 100. The choice of feeder roads is not easy. The informaticn base could and should be improved, but selection should not be delayed. Once a road has been completed, however, an effort should be made to study the changes that occur in order to gain experience and, secondly, to take whatever steps are feasible to influence and stimulate desirable change. Communication is, indeed, a necessary condition to uplift the economy of isolated areas, but not a sufficient one. What scattered information there is suggests that the initial result of building a road in the Hills is a substantial fall in the prices of consumer goods, such as salt. Bus traffic also develops, because consumers visit the nearest major market (e.g., Kathmandu in the case of the Kodari-Kathmandu road) where goods are cheaper and in greater variety. But rapid development of exchange between the main markets and the area newly opened to the road network does not follow necessarily. Each small region has its own balance of payments and, if there are to be imports, tlere must be exports to pay for them. At the cost of stating the obvious, investment in roads cannot be taken in isolation and should be combined with other investments (e.g. in agriculture) which will raise the productivity in the area thus creating surpluses and allowing imports of productive inputs and consumer goods. There is a real danger that investment in feeder roads to the Hills without related investment would lead to increased migration to the Terai. Air Transport 101. Internal air transport in Nepal has developed rapidly, -/ from 25,000 persons in 1966 to nearly 210,000 in 1970. There are at present 15 airports and eight STOL strips. The STOL strips are located in mountain areas where population centers are small and traffic density is low. Since extensive areas of Nepal are not served by the road network, air transport provides the only means of passenger transport between many widely scattered population centers. Movement of administrative personnel, as well as 1/ International air transport is examined in Chapter IV.  - 31 - emergency services and some small amounts of urgently needed supplies are made possible by this service. Unfortunately, domestic air operations are curtailed for periods up to four months during the rainy season. Since porter transport is also very restricted during the monsoon, access to remotely located commu- nities is very poor indeed. 102. Royal Nepal Airlines, which benefits from technical collaboration with Air France, is a reasonably well managed company. Maintenance standards are good. The company's operations suffer, however, from two factors beyond its control: lack of telecommunication and the existence of grass runways, which cannot be utilized in rainy weather. These constraints should ease considerably when the on-going Asian Development Bank project of airport improvements and on-going and proposed World Bank Group telecommunication projects are completed. Telecommunications 103. The telecommunications sector in Nepal is still in its infant stage of development. Until a general program of expansion was initiated in 1968, local telephone services were available in the Kathmandu area and Biratnagar in the southeastern part of the country, and there existed no long-distance network for normal telephone communication. As of July 1972, the telephone density of .06 per 100 people in Nepal was one of the lowest in the world and well below the average for developing countries. Minimum communications -- mainly used for telegraph purposes -- between some 78 centers throughout the country, are provided by means of high frequency (HF) radio stations which operate on a part-time basis. These stations are overloaded at the main centers and the use of voice transmission leads to considerable distortion of messages. International telecommunications services are inadequate since the land line to India via Birganj is subject to disruption due to landslides and flooding during the monsoon season. The first phase of the expansion program, which is currently under implementation, provides for installation of a number of local exchange systems and establishment of long distance services linking Kathmandu with principal cities in eastern and central Nepal, and for improve- ment of international services. The cost of this phase amounts to a little over $4 million, of which $1.7 million is being financed by the Bank Group. A second phase, to start in 1974, would provide additional capacity to meet growth in the areas already provided with service. It would also extend telephone communications to the major towns in western Nepal at a total cost of approximately $8 million for which Bank Group financing of $5.5 million is being proposed. Until 1969, the telecommunications system was operated by the Nepal Telecommunications Department of the Ministry of Works, Transport and Communications. As part of the expansion program, the Government estab- lished in 1969 the Nepal Telecommunications Board (NTB), which is responsible for the provision and operation of all public domestic and international telecommunications services within Nepal. NTB operates within an annual budget appropriation; tariff adjustments are subject ta Government approval; and recruitment and dismissal of high-level staff is handled by the Public Service Commission. NTB's financial results have been poor in the past,  - 32 - largely due to the fact that the telecommunications network is still very small and does not allow significant economies of scale. However, with expansion of the network accompanied by a proposed tariff increase, the situa- tion is expected to improve rapidly and become satisfactory toward the end of the second phase of the expansion program. Power 104. Nepal is one of the few countries in the world with a very large under-developed hydroelectrical potential. According to a very rough estimate, this potential is about 83,000 MW, which is equal to the combined total installed hydroelectric capacity of Canada, the United States, and Mexico. In spite of this, the per capita consumption of electric power is among the lowest in the world, presently amounting to less than 6 KWh compared to the 1964 average of 867 KWh and 116 KWh for the world and for developing countries, respectively. Total installed generating capacity is only about 55 MW, of which 33 MW is hydroelectric. The balance is produced with diesel and steam equipment. 105. Nepal Electricity Corporation (NEC), a totally Government-owned utility, provides service in the capital town of Kathmandu and the surround- ing townships. The Electricity Department of the Ministry of Water and Power (ED) is responsible for the Hetaura-Birganj corridor. These two areas, which form the Central System, are inter-connected. The rate of growth of peak demand and generation of this Central System has been 21-22 percent per year since the early 1960's. Sales have increased somewhat faster due to an appreciable decrease in system losses (from 51.5 percent in 1963/64 to 30 percent in 1971/72). This high rate of growth is likely to continue for a number of years, since only a quarter of the total number of domestic dwell- ings are now supplied. The remaining three-quarters depend for lighting and cooking on kerosene, woodfuel and other types of energy whose supplies are not dependable due to costly and difficult transportation conditions. 106. Generating capacity of 13.5 MW, mostly diesel, is scattered around the remainder of the country among five other public plants (Operated by ED and three private companies) and a multiplicity of individual industrial and service plants. In these centers the growth of consumption has been very slow. The high cost of electricity due to the small size of the operation and the high cost of transporting diesel fuel are the main reasons for this stagnation. Only Biratnagar has any possibility of growth in the near future. Ample supplies at reasonable costs are now available to this area from the recently commissioned Sunkosi irrigation and power project on the Indian side of the border. 107. In the long run, due to the lack of other indigenous energy reserves, growth in the power sector will be based on development of the country's hydroelectric resources. However, in the newly developing areas where the expected demand is too small to permit the economic use of hydroelectric  - 33 - schemes or transmission lines, the Government is aiming at developing the load with diesel installations or, along the Indian border, by means of imports from India. The existing generating capacity in the Kathmandu area is expected to meet the demand up to 1975-76 and two projects which are under consideration are expected to meet the demand in this area up to around 1980. The Electricity Department also has a program for introduc- ing electricity to 10 separate centers, all located close to the Indian border in the Terai. The program involves importing electricity fror India at all ten locations and exporting electricity from one point in the Central .; 3tem to the Indian grid. This scheme for exchanging up to 5,000 KW of power between the two countries was agreed upon in November 1971. Problems in Power Development 108. Planning power development outside the Kathmandu area is a complex problem. On the demand side, it involves consideration of: (a) the domestic energy demand, expecially in the densely populated areas; (b) the possible growth in the use of tubewell and lift irrigation; aud (c) the additional energy demand that may be created by the development of planned regional centers. On the supply side, it involves the consideration of all possible resources including: (a) the non-commercial indigenous resources such as woodfuel and dungcake; (b) the import of different types of energy, such as coal, kerosene and electricity; and (c) the indigenous commercial resources consisting of hydroelectric potential. The problem of determining the optimum resource mix to meet these demands has not been dealt with systematic- ally. To date the approach to power needs has taken place on an ad hoc basis. This has resulted in individual unit sizes too small to permit the economic development of local hydroelectric potential. 109. The problem of planning for specific power projects also deserves very close attention. The only organization authorized to undertake power development planning in the country is the Electricity Department. Its personnel is also responsible for power operations (in part of the Central System), construction activities and planning development of the vast hydroelectric resources of the country for the purpose of exporting power to India. With all these tasks to perform, the Department's limited personnel is overburdened and, as a result, great difficulty is experienced in properly fulfilling some of these responsibilities. 110. The Electricity Department, by virtue of its being a Government department, lacks the degree of autonomy which is required for a public power utility company to manage successfully a commercial business where day-to-day operations, as well as planning, communications, control, accounting, procurement, labor relations and incentive systems differ greatly from the activities of Government departments. It would be, there- fore, advisable that the power operating branches of the Electricity Department be separated from the Government administration and incorporated in an autonomous body. Thus relieved of its operational responsibilities, it could better concentrate on planning, regulation and other problems such as developing large scale projects for export purposes.  - 34 - 111. The waste of scarce human resources and the consequent loss of operational efficiency resulting from extreme fragmentation of the power industry should be rectified. Integration of all utilities would bring: (a) better expertise to even the smallest installations; (b) standardiza- tion throughout the country; (c) reduction in the needed quantity of spare parts; and (d) fast replacement in case of serious damage to equipment. The existence of regular commercial flights to most regions where present utilities are located facilitates such integration. It is, therefore, advisable that existing public power operations be integrated under one autonomous body responsible for all future power public supplies. 112. Initially, the price of electricity contained an element of sub- sidy because NEC, which supplies the Kathmandu area, made little or no profit and the price of electricity did not include provision for repay- ment of interest. By the beginning of 1971, when NEC had begun to earn substantial profits, a tariff reduction of 43 percent was given to domestic consumers in the hope that this would stimulate demand sufficiently to absorb the excess generating capacity. However, experience since the rate reduction indicates clearly that household demand is not responsive to even a large decrease in price. Therefore, and because the purpose was not served, this subsidy should be withdrawn and the financial strength of NEC restored. It is essential to ensure, in future projects, that proper pricing policies are followed, so as to guarantee the long-term financial viability of public power enterprises. 113. Since the hydroelectric potential of Nepal is one of its most important assets, no effort should be spared in achieving development at some later stage of the potential for exporting energy to India and eventually to Bangladesh. However, to be competitive with alternate sources of energy in India, Nepal's energy must be produced in large scale projects, requiring heavy capital costs. This problem of financing has yet to be solved. However, informal talks have already taken place between India and Nepal about the possible development of the Karnali project in Nepal.  - 35 - VI. PUBLIC INVESTMENT AND FINANCE Public Investment and Development Planning 1i4. Nepal's current development plan is a considerable improvement over earlier plans. The basic objectives given in the development plan are sound, but it suffers from the absence of a clear development strategy and policies for its implementation. In the Fourth Plan (1970-75), like its predecessor, plan targets are very ambitious in relation to the administrative and managerial resources available, resulting in large spending shortfalls. The gap between planned and actual expenditures amounted to 17 percent of the development budget in 1968/69, 24 percent in 1969/70 and 45 percent in 1970/71. 115. The link between plan objectives and actual investments has not been always apparent; in some cases planned investments did not materialize, while unplanned investments did. Regardless of formal statements of economic objectives,there have been two main thrusts to Nepal's development strategy. Firstly, there has been very heavy concentration of development expenditures on long-gestation infrastructure projects, particularly roads and power facilities, while insufficient ancillary investments and inputs have been planned or implemented. For the first two years of the Fourth Plan, for instance, 70 percent of total investment has been allocated to long-gestation projects. And because of this overemphasis on long-gestation projects, public investments have had little effect on economic growth. The second major thrust of development strategy has been concentration of investments in the Kathmandu Valley and the Terai which, contrary to expectations, have had little secondary effect on the economies of the Hills. 116. The failure of this approach to generate much growth strongly suggests that Nepal's development strategy over the balance of the Fourth Plan and during the Fifth Plan period should be reoriented towards increasing the output of commodities that can be produced and marketed efficiently. This would mean larger investment programs designed to increase the output of foodgrains and cash crops and greater emphasis on the development of the Hills through a better utilization of the existing road network by means of new feeder roads. Additional investments in main roads and power will, of course, be required but these investments should be selected primarily because they are essential to expansion of the commodity producing sectors. 117. Nepal is becoming increasingly aware of the deficiencies of its planning process. Planning units are now being set up in the various ministries. The central planning agency was reorganized in July 1972 when a broadly based National Development Council was created under the chairmanship of the King. The Council is expected to oversee the work of the Planning Commission, which has been strengthened in terms of both staff and functions. The effectiveness of this reorganization would be adversely affected if coordination is not considerably improved between ministries and between individual departments within ministries which, in the past, has been unsatisfactory.  - 36 - Government Finance 118. The strategic importance of public sector investment derives from the fact that private productive investment appears to be very small. This does not necessarily mean that resources in private hands are not substantial. However, considerable private savings are kept in the form of stocks in the countryside and invested in financial assets in the urban areas. While it is essential to channel these private savings into productive investment, it is clear that for some time to come, economic development in Nepal will continue to be heavily dependent on the magnitude and the direction of public investment. It is for this reason that the mobilization of resources by the public sector is of particular importance in Nepal. 119. Between 1964/65 and 1971/72, development expenditures increased by 14 percent per year in current prices or about 8 percent per year in real terms. Foreign grants have accounted for a large, but declining part of development expenditures: 61 percent in 1964/65 and 45 percent in 1971/72. The increase in the ratio of development expenditures to GDP (from 3.9 percent to 5.7 percent) has therefore been due in growing measure to Nepal's own efforts. Government Budget, 1968/69-1972/73-/ (millions of Nepalese Rupees) 1971/72 1972/73 Actual 2 Revised Original 1968/69 1969/70 1970/71- Estimates Estimates Total receipts 599 708 730 778 892 Revenue 413 464 460 518 601 Foreign grants 186 244 271 260 291 Total expenditure 537 684 770 929 1,268 Regular expenditures 193 219 305 358 410 Development expenditures 344 465 465 571 858 (Original estimates of development expenditures) (458) (608) (633) (770) (858) Overall balance, surplus or deficit (-) 62 24 -39 -151 -376 Financing Domestic (net) 7 13 30 50 171 External ... 8 33 40 120 Use of Treasury cash balances (increase -) -69 -45 -23 61 84 Source: IMF, based on data supplied by the Nepalese authorities. 1/ Because of rounding, figures do not necessarily add up. 2/ During 1970/71, significant changes were made in the budget classification of expenditures.  - 37 - 120. Regular and development expenditures rose at approximately the same rate (about 16 percent annually) in the past five years (1966/67- 1971/72), development expenditures accounting for about three-fifths of total expenditures. Of the various functional categories of expenditures, expenditures for agriculture increased most rapidly, but represented only 15 percent of total expenditures in 1971/72. The second largest increase was registered by expenditures for infrastructure, and especially roads and bridges. In contrast, expenditure for education and health and for general services such as administration, justice and police increased more slowly than total budgetary expenditures. Current expenditures as a whole have so far been more or less in line with the growth of current revenues. Defense expenditures are minimal, representing about 0.6 percent of GDP. Public debt is negligible, as is its servicing. 121. Until quite recently, Nepal's public investment problem has been less one of mobilizing additional resources than carrying out budgeted development expenditures. Thus, in recent years, actual development expenditures have averaged 25 percent below planned spending. It appears that the 1972/73 expenditure will follow this pattern. The result, until fairly recently, had been budget surpluses and the building up of Treasury cash balances. Symptomatic of the same problem, the level of foreign exchange reserves is very high, equivalent to over 12 months imports and over 11 percent of GDP. 122. Looking beyond the present, however, it may be expected that Nepal's absorptive capacity will increase and with it her ability to utilize considerably larger volumes of savings in new investment. The outlook for a continued flow of bilateral grant aid on the scale of the past is uncertain. It is, therefore, unlikely that the present comfortable resource position of the country will continue to be a permanent feature. Accordingly, prudence dictates that the Government should make a concentrated effort to develop an increasing level of domestic resources. Fiscal revenues will, inevitably, comprise a principal component of such resources. 123. Tax revenues account for nearly 90 percent of total domestic revenues. Taxes on foreign trade (i.e. import and export duties and the refund by India of excise duties levied on Indian manufactures imported into Nepal) are the most important single source although their share of tax revenues has decreased from 55 percent in 1964/65 to 42 percent in 1971/72. The second most important source of revenue is taxes on domestic production and consumption, the proceeds which increased 10 times between 1964/65 and 1971/72, when it reached NR 135 million, or about 30 percent of tax revenues. Sales taxes have been increased several times since 1965/66. Excise taxes on cigarettes and rakshi (a local liquor) are by far the most important, accounting for nearly one half of total excise tax proceeds. Excise taxes on sugar and matches are also of considerable importance. An excise duty on rice of 1 rupee per 100 kg. was introduced in 1968/619. 124. The third most important source of revenue is the tax on property, especially on land (18 percent of total tax revenues). Between 1962 and 1967, the rate of land taxes was increased several times. It is estimated that land revenue collection in 1969/70 was about 1.5 percent of the value of the  - 38 - total agricultural production in that year. 125. Urban property tax proceeds have remained unchanged during the last four years at NR 15 million per annum. Tax rates have been raised in the 1972/73 budget. This was a sound decision, since the rate structure was rather nominal and the ownership of urban property is thought to be heavily concentrated. 126. Large inflows of foreign savings, underestimation of revenue collections and underspending of budgeted development expenditures led to a very comfortable budgetary resource position up to 1969/70. No public borrowing was required and some cash balances were accumulated. The first substantial deficit (NR 150 million) appeared in 1971/72 and the 1972/73 planned deficit is NR 375 million. It is not unlikely that the actual deficit will be smaller. These deficits are largely the consequence of the decision of Nepalese authorities to step up development expenditures. The budgetary deficits have been financed in part by borrowing from the commercial banks. This financing has not been inflation- ary in its effects.. 127. There are two main approaches which the Government should follow simultaneously in order to ensure that domestic resources are effectively mobilized and channeled to support the higher levels of public expenditure required by an economy such as Nepal's, with heavy requirements for new investments in virtually all sectors. The first problem is the need to raise more public revenue. Nepal's taxation levels is one of the lowest among the developing countries, and low even in relation to other very poor countries. Improvement in fiscal performance requires a number of measures. Enforcement should be improved: many large urban property owners escape taxation and evasion is believed to cost the Treasury a third of its potential import revenues. The very poor saving performance of the majority of public corporations also needs careful review. Proceeds from income and profits taxation appear to be very modest. Land taxes, although among the highest in the developing world, may need to be reassessed in areas which benefit from public irrigation. From an equity viewpoint, it is important to evaluate carefully the extent to which any additional taxes are ultimately paid, directly or indirectly, by the poorest productive agents, i.e., the tillers of the soil. This is a complex problem, and the solution is related to the problem of enforcement of rent controls. Altnough, as pointed out earlier, there is heavy reliance on indirect taxes, the ratio to GINP of taxes on international trade and internal trans- actions in Nepal is stili one of Che iowest in tne deveioping world. The present apparent "undertaxation' and the very commendable tax effort of the government in recent years suggest that resource availabilities should not constrain public development expenditures in the near future, if there is no drastic reversalof foreign saving flows, and if currenL expenditure growth is kept under control.  - 39 - 128. A second aspect of the problem of efficient domestic resource utilization is the need for the creation of new channels and the strengthening of existing channels which would facilitate the effective employment of financial savings. The reactivation of the Compulsory Savings Scheme will be a step in the right direction. The extension of the commercial banking network would help to meet the credit and other banking needs of a growing economy. The mobilization of funds through these institutions will facilitate investment in the private sector as well as the borrowing requirements of government.  - 40 - VII. THE EXTERNAL SECTOR: PROBLEMS AND PROSPECTS 129. Important as is Nepal's own ability to generate savings internally, these efforts will have to be supplemented in generous measure by foreign savings. Moreover, in order to sustain and accelerate the development process which is gradually gaining momentum, Nepal will require a growing volume and a widening range of imports, especially of investment goods and raw materials. Previous chapters have emphasized the multiplicity of the country's needs for substantial investments both for basic economic and social infrastructure as well as for directly productive activities in such areas as agriculture, industry and tourism. 130. The present import content of the economy amounts to over 10 percent of GDP. Since only the Terai and the Kathmandu Valley have significant foreign trade sectors, the import content of these two geographical and eco- nomic entities is perhaps as high as 15 to 20 percent. Total recorded and unrecorded imports in 1971/72 might have been about NR 1 billion (approxi- mately US$100 million) of which NR 865 million came from India. 1/ Over 50 percent of imports. were manufactured consumer goods, followed by food products (19 percent), petroleum products (10 percent), machinery and transport equip- ment, and building materials and chemicals (about 7 percent each). Imports have probably increased in recent years. Imports from third countries have increased considerably in recent years, from $7.4 million in 1968/69 to $13.3 million in 1971/72. A further sharp increase is indicated for 1972/73, financed by a planned liberal utilization of foreign exchange reserves. 131. Nepal's foreign exchange proceeds depend mainly on transactions with India (85 percent of total trade is with India). At present, merchandise exports account for about one-third of convertible exchange receipts which totalled around US$30 million in 1971/72, while earnings from invisibles (mainly Gurkha earnings, interest on foreign exchange reserves and tourist receipts) account for about two-fifths of the total. Foreign grants and loans currently contribute about one-tenth of convertible foreign exchange receipts (see Table 3.1). Despite an unfavorable balance of trade, foreign exchange reserves have continued to rise steadily and substantially, from about $50 million in July 1967 to $117 million (12 months' imports) in September 1972. This has been due largely to increasing receipts of invisi- bles and foreign aid. Between 1966/67 and 1971/72, Gurkha pensions and allowances increased from $3.0 to $5.7 million, tourist expenditures from $0.8 to $2.0 million and interest on investment of foreign exchange holdings from $1.6 to $4.0 million. Foodstuffsmake up the largest category of exports. Manufactured consumer goods exports increased in importance through the late 1960's but declined sharply in 1972 following the closing of several facto- ries producing synthetic textiles and steel utensils exported to India. - 1/ Statistics on recorded foreign trade have been compiled only through 1968/69 and do not include all transactions with India. Statistics:are available for later years for trade with countries other than India, but not for trade with India which can only be estimated on the basis of informed guesses.  -- 41 - 132. Trade with India has been facilitated by a treaty signed in 1971 and valid for 5 years. The treaty allows custom-free and unlimited entry to India of Nepal's primary products, as well as manufactured goods which contain at least 90 percent Nepalese materials or Nepalese and Indian mate- rials. This limit is designed to prevent the re-export to India of commodi- ties imported from third countries, which are scarce in India because of regulations prohibiting the import of non-essential goods. Exports to third countries must transit through India, where transportation and storage facilities are inadequate and pilferage incidence high. These factors have added to costs. In the 1971 treaty, inidia agreed to provide adequate ware- house facilities in Calcutta for Nepalese goods and the treaty further provides that goods moving to and from Calcutta will be shipped in either sealed railway wagons or truck containers. This should reduce the cost of Nepal's exports. Nepal has been seeking to broaden the deviation of its foreign trade and in recent years have seen a steady, if slow, decline in the share of trade with India. Increased domestic production has reduced the need for imports from India of items such as cigarettes and beverages. A major effort has been launched, through the Trade Promotion Center established in 1970, to increase exports to overseas cotntries. The Center is concentrating on commodity surveys, and studies of training, marketing information, transport and export incentive needs. 133. Among the principal products with export promise are foodgrains, forest products and jute and jute products. Food products account for the bulk of exports to India; the remainder is mostly wood and wood products. During the last decade, poor growth of foodgrain output coupled with population growth has resulted in a sharp decline in the exportable surplus of the main export item, rice from the Terai. The new emphasis on irrigation projects which would allow for double cropping is, therefore3 to be welcomed. The resource base of the Terai can be substantially increased by turning part of the forest into cropland, but this calls for careful implementation. Resulting increases in productivity and area cropped could reverse the present trend which, if continued, might well turn the present foodgrain surplus into a deficit around the end of the present decade. Nepal's development problem would be seriously aggravated, if she were to lose her main export item. 134. Forestry resources in Nepal are rather extensive, but as pointed out earlier, their present use is far from being optimal. If properly exploited, they could offer promising export opportunities. A study of forestry-based industrial activities (plywood, paper, etc.) should include detailed marketing analyses and probable marketing arrangements with India. 135. A third major export item is jute and jute products, mostly exported to countries other than India. Nepal is a relatively small producer; against a world import demand of about 2 million tons annually, Nepal's exports of jute and jute goods are around 30,000 tons. Nepal's raw jute fiber is of indifferent quality and her processing facilities are outdated. A $4 million project (financed by the Asian Development Bank)  - 42 - for modernizing both jute cultivation and processing facilities should allow Nepal to increase both the value and the quantum of its exports, because of improvement in the quality of the fiber and better utilization of processing facilities. Extension of jute processing facilities should be carefully explored in the context of a comprehensive review of investment opportunities in jute manufacturing. 136. As noted elsewhere in this report, other promising possibilities for earning foreign exchange include tourism, sale of hydroelectric energy to India (paragraph 113) and industrial products. At this stage of develop- ment, however, industry's direct contribution to exports is likely to remain limited, except perhaps in forestry-based industry (see Chapter IV above). 137. While export earnings will necessarily have to be the principal source of her foreign exchange availabilities, Nepal will continue to require substantial foreign assistance on favorable terms. Most of the foreign assistance received by Nepal has indeed been in the form of grant aid. On a commitment basis, foreign aid increased from NR 128.5 million to NR 283.7 million during the Third Plan period and continued to increase to over NR 335 million for the first two years of the Fourth Plan period, 1970/71 and 1971/72. India has consistently been the major donor, with mainland China and the U.S. alternating between second and third places. In 1971/72, India contributed 44 percent, mainland China 17 percent, and the U.S. 15 percent. As a result of the receipt of aid on very concessional terms, Nepal's exter- nal debt situation is very favorable. In January 1972, the public external debt amounted to only $8.4 million, debt service in 1971/72 only $0.3 million, and the debt service ratio less than 1 percent. 138. In the past, much foreign assistance has been channelled to very few sectors, largely basic economic infrastructure and especially road trans- port and power. In the next phase of Nepal's development, it will be neces- sary for foreign donors to assist Nepal in a broader range of investment activities, not only infrastructure, but a variety of directly productive investments as well. As in the past, because of Nepal's limited growth and export prospects, future assistance will have to be on very concessional terms. -oOo-  - 43 - STATISTICAL APPENDIX TABLE NO. TITLE 2.1 Gross Domestic Product by Industrial Origin, 1964/65 - 1969/70 3.1 Receipts and Payments of Convertible Foreign Exchange, 1966/67 - 1971/72 3.2 Recorded Foreign Merchandise Trade, 1967/68 3.3 Commodity Composition of Trade with Overseas Countries, 1967/68 - 1971/72 3.4 Foreign Aid Received, 1962/63 - 1971/72 4.1 External Public Debt Outstanding as of December 31, 1971 5.1 Central Government Budgetary Performance, 1964/65 - 1972/73 5.2 Central Government Expenditure, 1964/65 - 1972/73 6.1 Consolidated Operations of the Central Bank and the Commercial Banks, 1967-73 6.2 Assets and Liabilities of Commercial Banks, 1967-72 6.3 Gross Reserves, 1964-72 7.1 Agricultural Production, 1965/66 - 1971/72 7.2 Supply and Use of Selected Agricultural Inputs 1965/66 - 1971/72 8.1 Production of Principal Industries, 1965/66 - 1971/72 8.2 NIDC, Outstanding Financial Assistance 8.3 Education Development 1951 - 1970 8.4 The Highway Network, 1965-72 8.5 Air Passenger Traffic, 1966-70 8.6 Tourist Trade, 1962-71   Table 2.1: NRPALL: GRQSS DOMTNTIC PRODUCT BY INDUSTRIAL ORIGIN, 1964/65-1969/70 (millior of Nepalese rupees at current market prices) Sector 196L/65 1965/66 1966/67 1967/68 1968/69 1969/701/ Agriculture 3,915 4,694 4,218 5,217 5,890 6,563 Mining 1 2 1 1 1 1 Manufacturing 83 98 104 137 212 278 Construction 123 108 118 134 144 192 Transport Conmunication 91 93 102 120 141 158 Cottage Industries 392 46 422 522 589 656 Financial Institutions 69 80 82 87 1o6 128 Owmership of Dwellings 654 669 683 698 714 729 Public Administration and Defence 82 101 143 154 166 199 Public Utilities 4 5 8 10 11 15 Wholesale and Retail Trade 309 299 248 247 358 274 Services 170 177 204 219 235 256 Total 5,893 6,795 6,333 7,546 8,567 9,1445 Source: Central Bureau of Statistics, Kathmandu. 1/ Provisional.   iable 3.1: NEPAL: RECEIPTS AflD PAYMENTS OF CONVERTIBLE FOREIGN EXCHANGE, 1966/67-1971/72 (miillions of U.S. dollars) ,, Pro;ections -19606.67 1 7,/68 ._968 /69 196r/7C 7 Q7c/T7 l971/72' 1972/7 ?eceipts- Exports. :erchandiso 7.5 3.8 13.6 I0. 8.6 1C.9 12.8 Invisibles ,.6 I.6 8.1 10. I' ' 1.1 15.Q (Durk1.. PCr.Sicnsi ,-s allo 7ences) (3.0) (3.8) (4.4) (!.6) (4.8) (5.7) (5.5) (TouristI expenditures) (0.8) (0.8) (0.9) (1.3) (1-.) (2.0) (4.) (Inter_st) (1.6) (1.6) (2.-') (40) (4. (4-C) (Diplomatic :n4ssicrs) (0.2) (0.1) (c.6) (0.9) (1.1) (1-4) (1.4) sCeelianec us / 3. -C 4.1 6.2 5.0 6.2 6.o (Clearing account iith mi.jnl nri China) (0.3) (C.1, (Q.6) (0.6) (C.2) (O.4) ( - ) Total 16.2 20.S 26.1 27.8 25 .1 30.2 34.6 Payments Imports, rnerchandise-2/ o.7 7.3 7.4 12.9 7.8 13.3 31.7 (Imports un(ler EE) (_) (5.7) (j-6) (5.9) (4-7) (5-4) (4.9) 3ebt Repa;vrent and Int2test Payment .1 0.1 0.1 0.2 0.6 -0. 1.0 Other lnvisibles C. 0.1 1.C 1.0 0.7 0.9 2.7 Diplomatic ! issions 1.1 1.0 1.2 1.4 1.); 1.2 1 Hiscellaneous 1.4 2.2 1.9 3.2 6.4 4.1. TotF.l 9 11.2 11.6 18.7 ] 6.9 20.2 38 .4 Surplus cI' Deficit (-) 6.7, 9.6 14.5 9.1 8.2 10.0 -3.8 Sourc-: : epKl Rastra Btnk 1/ The Nepalese rupee ,ras devalued on December 11, 1967; conversion was made at mNR7.6 U.S. $1 for trans-ctions in fisccl e-r 1966/67 ar.,r at N-10.12--' U.S. $1 for transacticns in the fclo:.Ting -eriocis. 2/ Includes Foreign grants and loans. 3/ Including imports r,- irler the .E.xrort2r's Flxch.- lge ntitlement Scheme (F. .E.). IT/ Base' on ri-,e rOtr ct'e7-a1.  Table 3.2: NEPAL: RECORDED FOREIGN MERCHANDISE TRADE, 1967/68/1 (Thousand Nepalese rupees) amports Exports Third Third Co.-modity India/2 Countries Total India-/2 Countries Total Food Products 83,500 1,360 84,860 205,662 532 206,194 Beverage and Tobacco 7,140 331 7,471 1,603 8 1,611 .rude Materials 40,481 3,975 44,456 10,083 94,940 105,023 Mineral Fuels 42,204 - 42,204 12 1 13 Oil (anLimal and veg.) 9,906 4 9,910 959 33 992 Ch emicals 31,882 594 32,476 438 143 581 IManufactured Goods 166,630 12,081 178,711 76,764 1,293 78,057 Machinerv and Transpcrt Equip. 28,557 8,959 37,516 435 - 435 Misc. Manufactures 29,104 9,577 38,681 5,148 546 5,694 Miscellaneous 873 172 1,045 363 - 363 TOTAL 440,277 37,053 477,330 301,467 97,496 398,963 /1 The latest full fiscal year for which data is available. /2 Because of the relative open border a large but unknown part of trade between Nepal and India is unrecorded. Source: Nepal Rastra Bank and NIDC Statistical Abstract.  Table 3.3: NEPAL: COMMODITY COMPOSITION OF TRADE WITH OVEFO-AS COUNTRIES, 1967/68-1971/72 l/ (Thousands of U.S. dollars) Percent 1971/72 1967/68 1968/69 1969/70 1970/71 of Total 1st 9 Months Exports Raw Jute 4,914 7,794 4,209 3,558 42.4 3,271 Jute Goods 3 211 9 602 2 266 2 274 27.1 1 915 Sub Total .1 3 W 7 Bristles 680 1,408 1,651 787 9.4 202 Carpets 80 60 115 75 0.9 32 Curios 145 188 395 184 2.2 S9 Mica 140 920 920 89 1.1 - Musk 20 409 282 287 3.4 63 Miscellaneous./ 178 1,039 1,494 1,145 13.6 519 Total 9,368 14,420 11,331 8,396 100.0 60,695/ Imports Raw Materials 1,478 2,008 2,869 490 5.9 752 Machinery and Spare Parts 841 539 1,206 460 5.5 903 Readymade Garments, Carpets, etc. 1,005 473 1,152 2,568 30.8 2,001 Building Materials3/ 583 502 575 587 7.1 1,009 Agricultural Tools and Fertilizers 298 842 451 146 1.8 629 Food Products 654 822 245 82 1.0 lie Radios, etc. 216 78 223 84 4 1.0 72 Miscellaneous 707 3,604 5,332 3,909 < 47.0 3,357 Total 5,782 8,868 12,054 8,327 100.0 8,841 Balance 3,586 5,552 -710 69 - -2,772 Source: Nepal Rastra Bank. 1/ Calculated on cash basis and includes EEE plus government trade; excludes trade under bilateral payments agreements. Totals may not add due to rounding a.nd co0nversion. / Includes feathers, oil seeds, candy, monkeys, goat skins, etc. 3/ Includes construction and electrical materials as well as household furnishings. 4/ Of the total, 8 percent is laboratory and medicinal goods, 19 percent vehicles, and 60 percent unclassified. Customs records indicate exports of about $16 million during 1971/72. This should appear in trade data for the last three months of 1971/72 and 1972/73.  Table 3.4: NEPAL: FOREIGN AID RECEIVED, 196a/63-1971/72 (Million Nepalese rupees) Second Three-Year Third Plan Period Fourth Plan Source Plan Period 1965/66 1966/67 1967/68 1965/69 1969/70 1970/71 1971/72 1962/63-1964/65 (Pev. Budget Total Est.) (Est.) United States 194.5 57,9 34.9 32.2 36.9 43.7 59.0 67.2 India 104.3 93.0 77.6 95,9 126.2 139.5 126.0 150.0 Mainland China 46.2 16.2 24,6 26.2 46.9 4.5 6o.o 69.1 U.S.SoRo 87.5 5.0 4.9 3.1 3.8 4.5 3.5 6.o Others 36.5 6.5 / 0O1 0.7 5*5 7