Nepal - Cash Crop Development Project

Document of The World Bank FOR OFFICIAL USE CINLY Report No. P-3467-NEP REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN AN AMOUNT EQUIVALENT TO US$6.0 MILLION (SDRs 5.6 MILLION TO THE KINGDOM OF NEPAL FOR A CASH CROP DEVELOPMENT PROJECT March 3, 1983 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit - Nepalese Rupee (NR) Since December 17, 1982 US$1.00 = NRs 14.3 ABBREVIATIONS AND ACRONYMS ADBN - Agricultural Development Bank of Nepal AIC - Agricultural Inputs Corporation BSF - Birganj Sugar Factory DOA - Department of Agriculture FAMSD - Food and Marketing Services Division FCV - Flue Cured Virginia HMGN - His Majesty's Government of Nepal JCF - Janakpur Cigarette Factory MOA - Ministry of Agriculture NVGI - Nepal Vanaspati Ghee Industries PCC - Project Coordinating Committee SMS - Subject Matter Specialist TDC - Tobacco Development Corporation T&V - Training and Visit NEPAL FINANCIAL YEAR July 16 - July 15  FOR OFFICIAL USE ONLY KINGDOM OF NEI'AL CASH CROP DEVELOPMENT PROJECT Credit and Project Summary Borrower: Kingdom of Nepal Beneficiary: Agricultural Development Bank of Nepal Amount: Special Drawing Rights (SDRs) 5.6 million (US$6.0 million equivalent) Terms: Standard Reiending Terms: An amount of US$214 million would be on-lent to ADkiX oni terms equivalent to present rediscount facilities of the Central Bank which allow ADBN to have a 4% interest margin. In line with present policy, ADBN would lend to cooperatives at 11% and 8%. who in turn would on-lend to farmers at 15% and 12% for short and medium-term loans, respectively. ADBN would also lend directly to farmers at 15% and 12% for short and medium-term loans respectiv&-ILy. Project Objectives and Description: The project -h-ould pro-o_e cash crop production. Specifically it aims to inlcrease produ^tion of sugarcane, tobacco and oilseeds (mustard and rapeseed). Pilot development of sericulture and groundnuts would also be initiated and existing ginger research facilities strengthened. The project would improve support services for these crops and would build on existing efforts to upgrade agricultural extension and research in Nepal. The project would also provide for credit to match the increased input requirements. In addition, to facilitate the movement of cane to the sugar factory, the project would provide for upgrading of about 59 kms of feeder roads, construc- tion of about 5 kms of new roads, and construction of two small bridges. The major benefits from the project would be (a) incraased agr cultural production (cash crops); (b'l savings 1n r ofeigrn eKchange, primarily through im.port substitution; and (c) increased net farm income. The project faces no special risks. The sugar and cigarette factories that will process the increased production are performirng well and the Government has taken action to deal with the Tobacco Development Company's financial problems. No marketing problems are expected for the other crops. This document has sa restrictd distribution and may be used by recipients only in the performance of their ofBiaW duties. Its contents may not otherwise be disclosed, without World Bank authorization.  Estimated Cost: US$ Million Local Foreign Total Civil Works 1.28 0.93 2.21 Vehicles - 0.08 0.08 Equipment and Furniture 0.03 0.15 0.18 Credit 2.43 - 2.43 Monitoring and Evaluation 0.09 - 0.09 Incremental Staff Costs 0.18 - 0.18 Incremental Operating Costs 0.18 0.07 0.25 Training and Technical Services 0.05 0.09 0.14 Base Costs 4.24 1.32 5.56 Physical Contingencies 0.25 0.18 0.43 Price Contingencies 1.04 0.33 1.37 Total Project Costs 5.53 1/ 1.83 7.36 Financing Plan: IDA 4.17 1.83 6.00 HMG 1.36 - 1.36 Total 5.53 1.83 7.36 Estimated IDA FY FY84 FY85 FY86 FY87 FY88 FY89 Disbursements: Annual 0.2 0.8 1.5 1.6 1.2 0.7 Cumulative 0.2 1.0 2.5 4.1 5.3 6.0 Economic Rate of Return: 62% Staff Appraisal Report: No. 4073-NEP, dated January 28, 1983 Map: IBRD 16603 IBRD 16604 1/ Inc:ludes US$0.03 of duties and taxes.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE KINGDOM OF NEPAL FOR A CASH CROP DEVELOPMENT PROJECT 1. I submit the following report and recommendation on a proposed development credit to the Kingdom of Nepal in an amount of Special Drawing Rights (SDRs) 5.6 million (US$6.0 million equivalent) on standard IDA terms to help finance a Cash Crop Development Project. Of the proceeds of the credit, about US$2.4 million would be onlent to the Agricultural Development Bank of Nepal (ADBN) to provide short and medium-term credit under the * project. PART I - THE ECONOMY 1/ 2. The most recent economic report, "Nepal - Policies and Prospects for Accelerated Growth" (Report No. 3577-NEP) was distributed to the Executive Directors on October 15, 1981. The principal findings of the report and recent developments are described below. Country data are shown in Annex I, 3. Nepal is one of the least developed countries in the world. Per capita income is estimar-ed at US$156 (1981) and health and education stand- ards are well below the average for South Asia: life expectancy at birth is only about 44 years, infant mortality is 150 per thousand, and adult literacy is only about 20%, The population, estimated to be 15.0 million (1981), grew at a rate of about 2.6% per year during 11)71 to 1981. About 95% of the population live in rural areas. 4. Population density with respect to arable land has reached alarming levels and is threatening to overwhelm the resource base of the economy. Cultivation has been extended beyond economically feasible and ecologically safe limits in the Hills, and together wilh denudation of forests to meet housing and fuel needs, soil erosion has become a critical problem. Firewood and water have become more difficult to obtain as the forests are reduced and springs and streams dry up. This deg:-adation of the agricultural base has made even the present low level of living standards difficult to main- tain. 5. AgricuiLure accounts for nearly 60% of Nepal's GDP and 75% of merchandise exports, and provides the main source of livelihood to over 90% l/ Parts I arnd II of this report are substantially the same as in the President's Report (Report No. P-3437--NEP) dated December 29, 1982 for the Bhairawa-Lumbini Groundwater Stage II Project in Nepal, distributecd to the Executive Directors under cover of the Secretary's Memorandum IDA/R83-1.  -2- of the population. Crop production accounts for about 60% of agricultural output, livestock for 30%, and forestry for 10%. Paddy is the predominant food cIrop (planted on about half of the total cropped area), followed by maize, wheat, millet, and barley; cash crops (oilseeds, jute, sugar and tobacco) are grown on about 10% of the cropped area. About 25% of total rural incomes arise from nonagricultural activities, of which cottage industries are one of the more important and engages over one million people on a part time basis. 6. Apart from agricultural land, Nepal's only other important exploitable resources are hydropower and tourism. The exploitation of the vast hydropower resources, however, beyond that required to satisfy the country's own power demand, will depend crucially on Nepal's ability to enter complex: financial, exploitation and export agreements with neighbouring countries. The tourism sector, based on Nepal's magnificent landscape and rich cultural heritage, has been dynamic though it still accounts for only about 1% of GDP. 7. When modernization efforts started in the early 1950s, there was virtually no economic or administrative infrastructure, and initial develop- ment efforts were necessarily concentrated on establishing a foundation for future development. The Fifth Development Plan (1975/76-1979/80) marked a shift in development objectives; acceleration of economic growth, employment creation and raising living standards of the population became major plan objectives. Development expenditures rose during this period and there were substantial shifts in the composition of spending away from transport to agriculture, power and social services. But given the lead time required for investments to start yielding returns, GDP growth barely kept up with that of population. 8. Part of the reason for this stagnation lies in factors beyond Nepal's control. The difficult topography and poor resource base are obviously important in retarding growth. Nepal's landlocked position, long open border with India and the dependence of its overseas trade on transit through India create additional disadvantages. While Nepal benefits from the proximity of a vast potential market for Nepalese goods, the ability to pursue independent economic policy measures is circumscribed. Furthermore, industrial develop- ment faces the competition of a far larger and more efficient industrial sector in India. 9. But factors within Nepal's control have also contributed to the stagnation. Problems with the implementation of projects in most sectors of the economy have constrained the growth of public sector capital formation which grew at an average of only 5.5% per annum in real terms during the 1970s. In addition, the returns on investments were often lower than expected because necessary complementary investments or current spending were lacking, and because of managerial deficiencies. A good example is the agriculture sector, where output stagnated despite considerable investments  -3- in irrigation, a virtual doublirig of the irrigated area and a 40% increase in fertilizer use between 1974/75 and 1979/80. tn the past, insufficient atten- t-ion was paid to bringing water down to the farm level and this was com- pounded by inadequate support services such as extension and research, by the lack of timely supplies of improved seed, fertilizer and other inputs such as credit, and by the lack of farm-to-market roads. Recent major irrigation projects financed by IDA and the Asian Development Bank are now addressing some of these problems by taking more comprehensive and integrated approaches. 10. Over the past decade, the Government lhas made continuous efforts to rincrease tax revenues. But, despite the improving long-term trends, the revenue effort (about 9% of GDP) remains small by comparable international standards. With limited domestic resources, current expenditures have been squeezed in order to generate savings for investment spending, with the result that the efficiency of total spending was lowered. Furthermore, while about one quarter of total budgetary expenditures (regular and development) was being financed by the rest of the world in 1974/75, this proportion was 36% in 1981/82. Ii. The slow economic growth has been accompanied by a widening trade deficit. Import payments have grown while the trend in export earnings has been sluggish due to declining rice exports. Increased tourism receipts and remittances, together with foreign assistance in the form of grants and concessionary financing have, however, genera:ly ensured that the overall balance remained in surplus. But even so, for-oign exchange reserves have declined from being equivalent to abou, one year of imports in .-he ea.ly 1970s to six months in 1981. 12. Whereas 1980/81 was a year of recovery from the previous year's severe drought, 1981/82 was a more modest yea-:; agricultural production is estimated to have grown by 3.5% and GDP by about 4%. Budgetary developments were quite encouraging. Development expenditures increased sharply, and revenue collections increased substantially for the second successive year. Ne.vertheless, the budget deficit increased from about 5.5% of GDP in 1980/81 to about 8.5% in 1981/82, and while foreign assistance also increased, domes- tic borrowing rose sharply. Also, the underlying economic trends have not picked up yet, and the economy remains dependent upon the weather. Early reports indicate that the 1982 monsoon has been less than satisfactory and thi will adversely affect economic performance in 1982/83. : c aOn Seprember 19, 1981 Nepal unified it:s exchange rate with the US *.:llar a; 3Ro 1',2 = US$1; the exchange rate with the Indian rupee was -..Langed N.' 145 = 100. Th-s completed a series of steps to refora i:.al's eAchan- w-cate system which .gan when a complex system of multiple exchange rates and trade restrictions for overseas trade was replaced with a dual exchange system on March 31, 1978.  -4- 14. During 1979-81 economic policy making had been delayed by political developments. Following disturbances in 1979, a referendum was held in May 1980, which reaffirmed the existing partyless system, with suitable reforms. The constitution was amended in December 1980 to provide, among other things, for direct election of members of parliament. General elections were held in May 1981, and the political situation appears to have since stabilized. During the past year, the Government has focussed its attention on economic problems and on implementing the Sixth Plan (1980/81-1984/85). 15. The Sixth Plan reflects Nepal's determination to search for ways to overcome stagnation and, as a set of objectives, it was endorsed by members of the Nepal Aid group at its December 1981 meeting. The strategy to shift investment into more productive sectors is continued and emphasis is given to alleviating some of the factors that limited past growth. The Plan's prin- cipal objectives are to increase production at a faster rate, to increase employment, and to meet basic minimum needs in food, fuel (firewood), drink- ing water, health services, primary education and rural transportation. The strategy: (i) accords high priority to developing agriculture, small-scale industries and Nepal's abundant water resources; (ii) stresses soil conserva- tion and population control; and (iii) emphasizes full utilization of exist- ing infrastructure and alleviation of absorptive capacity constraints. The development strategy also calls for full involvement of the private sector in agriculture, manufacturing, trade, tourism, construction and transport opera- tions. 16. Achieving the Plan's objectives will require quick-yielding sector programs to generate growth in the short to medium-term as well as human resource development programs to lay the foundation for sustained growth in the longer term. Program targets must also be made consistent with overall financial and implementation capacity. But at the same time, vigorous measures are needed to remove administrative and domestic financial con- straints, and the Government has begun to respond to these problems. Reforms in development administration include the establishment of an Administrative Staff College; appointment of a Permanent Pay Commission to review civil service salaries and schemes of service; creation of a Central Monitoring Unit within the Foreign Aid Division of the Ministry of Finance; and estab- lishment of treasury offices in each of Nepal's 75 districts to expedite the release and audit of budgetary funds. The record 49% increase in development expenditures during 1981/82 may indicate that these efforts have resulted in a speed up in disbursements. To strengthen domestic resource mobilization, the Government has set up a revenue training center; formed a Tariff Board which recommended increases in indirect taxes for the 1982/83 budget; made preparations for close monitoring of all public enterprises and also liqui- dated certain of these enterprises; and decided to phase out rice and fer- tilizer subsidies in the relatively higher-income Kathmandu Valley. 17. Nepal has received substantial external assistance,. Aid commitments have averaged US$165 million per year since 1976, and, according to current  -5- indications, could reachl an average of about US$300 million per year during 1981/82-1983/84. Foreign assistance is expected to account for about 53% of total development spending during the Sixth Plan period. The Nepal Aid Group was formed in 1976 to assist in the overall coordination of financial and technical assistance efforts and the Group ncw accounts for some 70% of all aid disbursements. The Group has met four times at plenary meetings under the chairmanship of the Bank to discuss overall external assistance needs; local Aid Group meetings in Kathmandu are also held to discuss and coordinate sectoral development strategies. 18. Foreign aid disbursements grew rapidly in current prices during the past five years and were estimated to be US$156 million in 1981/82, but only about 42% of disburseme-ats were from foreign borrowings, the remainder being grants. As of December 31, 1981, official fcreign debt outstanding was US$234 million, of which. US$192 million was cue to multilateral agencies. These loans were obtained on a highly concessional basis and the grant ele- ment of total loans remains in excess of 70%. As a result, debt service payments were only US$4.0 million during 1981, equivalent to less than 2% of exports of goods and services. PART II - BANK GROUP OPERA"IONS IN NEPAL 9. Bank Group operations in Nepal began in FY70 with an IDA credit of US$1.7 million equivalent for a telecommunications project. Since then, 28 additional credits have been approved, bring:ng total IDA assistance to Nepal to US$326.5 million equivalent, net of cance:lations. In view of Nepal's many development needs, this assistance has been for projects in a wide variety of sectors. Six of these sectors account for about 79% of IDA credits by amount: irrigation/agriculture (US$110.2 million for nine projects); water supply and sewerage (US$46.3 million for three projects), power (US$40.8 million for one project); telecommunications (US$21.7 million for three projects); highways (US$19.2 million for two projects); and rural development (US$19.0 million for two projects). The proposed credit would be tihe second in FY83, bringing the total amount of IDA assistance to Nepal to US$345.5 million equivalent, net of cancellations. No Bank loans have been made to Nepal. TFC made its first investment in Nepal (US$3.1 million) in a hotel project in Kathmandu in FY75. In addi-:ion, IFC approved a loan of US$6.23 million equivalent to Nepal Orind Magnesite (Private) Limited (i.e. a private company) on Narch 16, 1982. The loan was to help finance a US$24.9 million project to mine and process magnesite ore. Annex II contains a summary statement of Bank Group operations a, of September 30, 1982, and notes on the execution of ongoing IDA projects. It shows certain delays in the implementation of some of these projects, particularly during the initial periods. The delays have been largely due tD Nepal's limited technical and managerial capabilitiec. In order to assist Nepal in coping with this con- straint, considerable technical assistance is being given by Bank Group  staff, including our Resident Representative in Katlhnmandu. As a result, the rate of disbursements is improving; during FY81 and FY82. US$27.8 million and US$28.5 million equivalent, respectively, was disbursed compared to USq65.1 million equivalent disbursed uirirng the entire previous 10 vears. Project completion reports have been prepared for four projects--First Telecommunica- tions (Credit No.166, US$1.7 million equivalent), First Highways (Credit No. 223, US$2.2 million equivalent), Tourism (Credit No. 291, US$3.2 million equivalent), and Birganj IrrSga-ion (Ciedit No. 373, US$6.0 million equiv- alent). All four projects experienced delays in implementation, and institu- tional improvements were less than anticipated; however, all four generated acceptable rates of return. A completion report on the Settlement Project (Credit: No. 505, US$6.0 million equiai'len)n has also been written and is under review. 20. Bank Group lending to Nepal has so far been at a modest level com- pared to the country's need for external. assistance, The international community has shown considerable interest in Nepal's economic development and, to date, the shnortage of funds hias nGt been a major bottleneck. The main constraint cn the utilization of increased aid has been Nepal's limited absorptive capacity, affecting the pace of project preparation and implemen- tation, The Bank Group has been assisting the Gover^nment in project prepara- tion through a Technical Assistance Credit (Credit No. 659-NEP, US$3.0 mil- lion equivalent) and by acting as Executing Agency for a number of technical assistance projects financed by UNDP. 21. The Bank Group's current lending strategy places major emiphasis upon the directly productive sectors (particularly agriculture) and the develop- ment of complementary infrastructure, including manpower training programs and facilities, transport, and hydroelectric power. For agriculture, the basic strategy is to assist Nepal maintain overall foodgrain self-sufficiency and where possible promote exports of agricultural products. This strategy has two major elements: (a) to assist in building tha irrigation infrastruc- ture in the Terai mainr7 to increase paddy productionir and (b) to help reduce the food deficits in the Hills both through rural development projects which emphasize increasing food production, and more recently through a specific Hill food projects. To increase the chances for the success of these efforts, the Bank has, at the same ticm.e, assisted in the improvement of agricultural extension as well as the provision of other inputs including credit. Projects are being prepared in forestry, leather industry, agricul- tural manpower development, highways and hydroelectric power. PART IlI - THE AGRICULTURE SECTOR 22, AgricuLture dorminat`es the econorLy, and crop production accounts for about 60% of agricultural output. Food crops are growmn on about 90% of the total cropped area, Paddy is the predominant crop with maize, wheat, millet  -7- and barley being of lesser importance. Cash crops are grown on some 240,000 ha or about 10% of the total cropped area. Oilseeds are cultivated over some 125,000 ha while jute, sugarcane and tobacco are grown on 56,000 ha, 23,000 ha, and 8,000 ha respectively. 23. The production of major foodgrains, except for wheat, has not been satisfactory over the past decade and has not kept pace with the rate of population increase which averaged 2.6% per annum. Moreover, increased production was largely due to area expansion, since average yields, again with the exception of wheat, declined somewhat. Many factors contributed to this decline including generally decreasing soil fertility, loss of land through erosion, cultivation of marginal lands, higher cost and irregular supply of fertilizers, inadequate agricultural advice and other supporting services, and inappropriate pricing policies. The Government is taking measures to overcome these constraints, including, for example, development of irrigation down to secondary and field level infrastructure to permit intensive crop production, formulation of suitable forestry and soil conser- vation programs, improvements in input supply and extension services and development of manpower training programs. Cash crops, however, fared better due to more favorable prices, and growth averaged about 3.5% annually through the 1970s. 24. Nepal's Sixth Plan (1980/81-1984/85) envisages crop intensification as a means of increasing food supplies and of improving self sufficiency in the production of raw materials required for agro-based industries serving domestic needs and export markets. To meet the latter needs, the Plan emphasizes the development of cash crops sucL as sugarcane, tea, tobacco, oilseeds and jute in the Terai and high value crops likce ginger, medicinal plants, spices, cardamom and sericulture in the hills. Cash Crops 25. The total value of cash crops produced in 1978/79 was US$110.0 M, equal to about 9% of agricultural GDP. In the same year, Nepal exported cash crops worth US$27.0 M (about one quarter of merchandise exports) out of which the contribution of jute was 88%. Imports oi- commodities such as tobacco, tea, sugar and vegetable oil in 1978/79 amournted to US$3.0 M. 26. Oilseeds. Mustard and rapeseed are t:he principal oilseeds and are grown mostly after maize or early paddy crop: exports amounted to nearly US$2 million in 1978/79. In recent years oilseed production has increased annually by about 3% but yields remain low, due to delays in sowing, insect attacks, inadequate input use and poor cultivation practices. HMGN plans to introduce groundnut cultivation on a large scale in order to manufacture vegetable oil. 27. Jute. Jute has been Nepal's second most important export crop (after rice) and is largely grown in the Terai with production having  -8- increased by 1.5% per year during the 1970s and exports which had averaged 17 000 'IT annually during 1969-73, increased to 27,000 MT during 1975-78. However, world market prospects are not promising at the moment and exports have declined somewhat. 28. Sugarcane. Sugarcane is mostly grown in the Terai under rainfed conditions in rotation with food crops. Processing of white sugar is done by three sugar mills (with a total crushing capacity of 2,400 MT/day) and a few other smaller units which make brown sugar and gur (unrefined sweetener). Sugarcane yields are low because of a variety of factors: (a) poor extension services (currently the responsibility of the Birganj Sugar Factory) and inadecuate research support, (b) low levels of fertilizers and pesticides usage, (c) poor seed and lack of timely cultural operations, (d) inadequate amounts of short term credit3 and (e) difficulties in transportation of cane due tc a poor road network. 2'o Tobacco. Tobacco is a w-