90270 v1 A Vision for Nepal Policy Notes for the Government THREE “I”S FOR GROWTH: INVESTMENT, INFRASTRUCTURE, INCLUSION Investment Infrastructure Inclusion VOLUME 1 | SYNTHESIS REPORT A Vision for Nepal Policy Notes for the Government THREE “I”S FOR GROWTH: INVESTMENT, INFRASTRUCTURE, INCLUSION Investment Infrastructure Inclusion VOLUME 1  |  SYNTHESIS REPORT Vice President Phillip Le Houerou Country Director Johannes Zutt Sector Director Ernesto May Sector Manager Vinaya Swaroop Task Team Leader Aurélien Kruse Markus Kitzmüller Johannes Widmann © The World Bank Group, Nepal All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Published by: The World Bank Group Nepal Office P.O. Box 798 Yak and Yeti Hotel Complex Durbar Marg, Kathmandu, Nepal Tel.: 4226792 Fax: 4225112 www.worldbank.org/np www.facebook.com/WorldBankNepal Design and Printed by: Print Communication, 4241355 Printed and bound in Nepal Table of Contents Abbreviations--------------------------------------------------------------------------------------------------------------------------------------------------- vi Acknowledgements------------------------------------------------------------------------------------------------------------------------------------------- ix Executive Summary-------------------------------------------------------------------------------------------------------------------------------------------- x SYNTHESIS REPORT Introduction----------------------------------------------------------------------------------------------------------------------------------------------1 Nepal’s Recent Development Experience--------------------------------------------------------------------------------------------------------3 Economic growth and structural transformation----------------------------------------------------------------------------------------4 Achievements and Remaining Challenges in Poverty Reduction and Human Development-------------------------------8 Introducing the 3 “I”s--------------------------------------------------------------------------------------------------------------------------------------- 10 Investment---------------------------------------------------------------------------------------------------------------------------------------- 11 Infrastructure------------------------------------------------------------------------------------------------------------------------------------- 13 Inclusion------------------------------------------------------------------------------------------------------------------------------------------- 16 Summary and Conclusion-------------------------------------------------------------------------------------------------------------------------------- 21 Key Policy Priorities----------------------------------------------------------------------------------------------------------------------------------------- 22 List of Figures FIGURE 1: The opportunity cost of current growth----------------------------------------------------------------------------------------------------4 FIGURE 2: Nepal’s growth trajectory at a plateau------------------------------------------------------------------------------------------------------5 FIGURE 3: Per capita income has increased only slowly, despite slower population growth----------------------------------------------5 FIGURE 4: Shifting drivers of growth and the rise of services---------------------------------------------------------------------------------------6 FIGURE 5: Basic services dominate the landscape-----------------------------------------------------------------------------------------------------6 FIGURE 6: Total investment too slow to support dynamic growth--------------------------------------------------------------------------------7 FIGURE 7: Bottlenecks to investment----------------------------------------------------------------------------------------------------------------------7 FIGURE 8: Nepal’s population clustered above the poverty line-----------------------------------------------------------------------------------9 FIGURE 9: The 3 “I”s for growth---------------------------------------------------------------------------------------------------------------------------- 10 FIGURE 10: China’s experience; Investment driven Growth----------------------------------------------------------------------------------------- 11 FIGURE 11: Biggest constraints to firms’ operations in Nepal-------------------------------------------------------------------------------------- 11 FIGURE 12: Revenue Gap and TD losses------------------------------------------------------------------------------------------------------------------ 14 FIGURE 13: Poverty reduction remains a rural challenge-------------------------------------------------------------------------------------------- 16 FIGURE 14: Production area of Apples (top) and Walnuts, 2010/11 (bottom)----------------------------------------------------------------- 17 FIGURE 15: Nepal Social Protection system: impact on poverty and inequality-------------------------------------------------------------- 19 List of Tables TABLE 1: Poverty headcount disaggregated-----------------------------------------------------------------------------------------------------------8 TABLE 2: Investment needs per year by sector------------------------------------------------------------------------------------------------------ 13 A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT v   Abbreviations ADB Asian Development bank ADBL Agriculture Development Bank Limited ADS Agriculture Development Strategy AML-CFT Anti-Money Laundering – Counter Financing of Terrorism BAFIA Banks and Financial Institutions Act BFI Banking and Financial Institution BIS Bank for International Settlement BOP Balance of Payments CIAA Commission for the Investigation of Abuse of Authority CIB Credit Information Bureau CIP Country Investment Plan CIT Corporate Income Tax CSR Corporate Social Responsibility DCGC Deposit and Credit Guarantee Corporation DCGF Deposit and Credit Guarantee Fund DDC District Development Committee DfID Department for International Development DMLI Department of Money Laundering Investigation DOI Department of Industry DoLIDAR Department of Local Infrastructure Development and Agricultural Roads DOR Department of Roads DPC Development Policy Credit DWSS Department of Water Sanitation and Sewerage EFA Education for All EGRA Early Grade Reading Assessment EVENT Enhanced Vocational Education and Training Project FCGO Financial Comptroller General Office FDI Foreign Direct Investment FI Financial Institution FIP Foreign Investment Policy FITTA Foreign Investment and Technology Transfer Act FIU Financial Intelligence Unit FMIS Financial Management Information System FRP Financial Restructuring Plan FSMD Financial Sector Management Division vi   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT GA Government Guarantee GFCF Gross Fixed Capital Formation GFMIS Government Financial Management Information System IA Indemnity Agreement IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IPP Independent Power Producer IRD Inland Revenue Department JPM Joint Monitoring Program KUKL Kathmandu Upatyaka Khanepani Limited LLA Land Lease Agreement LPI Logistic Performance Index MDG Millennium Development Goal MDTF Multi Donor Trust Fund MFI Micro Finance Institute MIGA Multilateral Investment Guarantee Association MoAD Ministry of Agriculture Development MoF Ministry of Finance MoFALD Ministry of Federal Affairs and Local Development MOHP Ministry of Health and Population MoPIT Ministry of Physical Infrastructure and Transport NARC National Agriculture Research Council NASA National Assessment of Student Achievement NASDP National Agriculture Sector Development Plan NBL Nepal Bank Limited NEA Nepal Electricity Authority NEGRP National Early Grade Reading Program NIDC Nepal Industrial Development Corporation Ltd. NLSS Nepal Living Standards Survey NMIP National Management Information Project NOC Nepal Oil Corporation NPC National Planning Commission NPL Non Performing Loans NRB Nepal Rastra Bank NRBA Nepal Rastra Bank Act NSNS Nepal Safety Net Survey NWSC National Water Supply Company OAG Office of the Auditor General OCR Office of Company Registrar OECD Organisation for Economic Co-operation and Development ORA Operational Risk Assessment PAC Public Accounts Committee PDA Project Development Agreement PEFA Public Expenditure and Financial Accountability PFM Public Financial Management PFMRP Public Financial Management Reform Program PPA Power Purchase Agreement PPMO Public Procurement Monitoring Office PPP Public Private Partnerships PRG Partial Risk Guarantee A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT vii   RBB Rastriya Banijya bank ROSC-A&A Report on Observance of Standards and Codes – Accounting and Auditing ROW Right of Way SCB State Controlled Bank SME Small and Medium Enterprises SMLE Small Medium and Large Enterprises SP Social Protection SPFMP Strengthening Public Financial Management Project SSRP School Sector Reform Program T&D Transmission and Distribution TEVT Technical Education and Vocational Training TIA Tribhuvan International Airport TIN Taxpayers Information Network TSA Treasury Single Account USAID United States Agency for International Development VDC Village Development Committee WHT Withholding Tax WUA Water Users Association WUC Water Users Committee viii   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT Acknowledgements This report was undertaken jointly by the South and Sanitation Specialist), PatricK Verissimo Asia Poverty Reduction and Economic Manage- (Lead Rural Development Specialist), Albertus ment team, the South Asia Chief Economist Voetberg (Lead Health Specialist), Preeti Kudesia Office and the Nepal Country Management (Sr. Health Specialist), Manav Bhattarai (Health Unit. The core team included Aurélien Kruse (Sr. Specialist), Saurav Bhatta (Sr. Economist), Jas- Country Economist, Task Team Leader), Markus mine Rajbhandary (Social Protection Specialist), Kitzmüller (Economist, Task Team Leader), Yasuhiko Matsuda (Sr. Governance Specialist) Johannes Widmann (Sr. Country Officer, Task and Charles Undeland (Sr. Governance Special- Team Leader), Saurav Rana (Consultant), Rajib ist). Upadhya (Sr. external Affairs Officer), Trishna Thapa (Communications Associate) and Sunita Feedback and guidance was received from Yadav (Program Assistant). peer reviewers, Martin Rama (Chief Economist SAR), Wolfgang Fengler (Lead Economist) and The drafting team and authors of the individual Jose Calix (Lead Country Economist), as well notes included Gabi Afram (Sr. Financial Econo- as Johannes Zutt (Country Director), Tahseen mist), Sabin Shrestha (Senior Financial Sector Sayed (Country Manager), Ernesto May (Sector Specialist), Bigyan Pradhan (Senior Operations Director) and Vinaya Swaroop (Sector Manager). Officer), Rama Venkateswaran (Lead Financial Additional feedback was usefully provided by Management Specialist), Robert Jaoude (Pro- Hiramani Ghimire (Sr. Governance Specialist), gram Coordinator), Jie Tang (Program Leader) Keith Leslie (Consultant), Miguel Laric (Economic , Rabin Shrestha (Senior Energy Specialist), Advisor – DfID), and Sudyumna Dahal (Con- Farhad Ahmed (Sr. Transport Specialist), Dominic sultant), Roshan Bajracharya (Sr. Economist), Patella (Transport Specialist), Shideh Hadian (Sr. Gayatri Pathak (Temporary) and Bandita Sijapati Infrastructure Economist), Silva Shrestha (Water (Consultant). A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT ix   Executive Summary Nepal needs a new economic model to achieve To redefine Nepal’s growth model, public faster and sustained growth as well as further policy should focus on 3 “I”s: Investment, In- improvements in human development and frastructure, and Inclusion. Investment is the poverty outcomes. Economic growth, while ro- bedrock of a sustainable growth model but in bust at around 4 percent annual average since Nepal, the state, firms and households critically 2005, is far from the level needed to achieve the under-invest, with gross fixed capital formation government’s ambitious targets. The economy, between 19.9 and 22.2 percent of GDP over the highly dependent on remittances, lacks the nec- past decade (compared to 30 percent or more in essary dynamism. While substantial gains have fast-growing countries in East Asia). In order to been made to reduce poverty and expand access unlock investment as well as to expand access to services, achieving further progress will require to services and opportunities for all, public infra- more determined and targeted state intervention. structure is critical, but Nepal is under-connect- The 3 “I”s for growth Investment A more inclusive The potential society will reduce for a virtuous risk of conflict circle exists and strengthen Infrastructure between the investment Investment and climate. Infrastructure. Inclusion x   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT ed and under-powered. Finally, growth alone will Investment needs per year by sector 2011-2020 not ‘deliver’ continued fast progress on inequality Sector Average share of GDP, in % and poverty reduction unless the growth model Electricity 3.3 - 4.5 is calibrated for inclusion, which in turn can help Transport 2.3 - 3.5 sustain dynamic growth. Water & sanitation 1.1 - 1.6 To allow public and private investment to Irrigation 1.0 - 1.5 flourish, a more conducive environment is Telecom 0.3 - 0.4 needed. In Nepal, the main building blocks of improving the environment for investment Solid Waste 0.2 - 0.3 would include: Total 8.2 - 11.8 Source: World Bank 2014 (i) Strengthening the financial sector: to make it more resilient to shocks, more efficient in in- all sectors. Necessary investment would need to termediating savings for productive use, and address both a quantity and quality deficiency, better able to reach those firms and house- particularly in the two central infrastructure sec- holds currently un- or under-served. tors: transport and energy. A minimum reform (ii) Improving the investment climate: to remove agenda would include: the obstacles that firms (domestic and for- eign) face in setting-up and expanding op- (i) Unlocking Nepal’s hydro-potential: out of an erations in Nepal. This agenda would focus economically viable 43,000 MW, Nepal has an on alleviating the regulatory burden on firms, installed generation capacity of only 746 MW reducing non-wage costs of labor, effectively (July 2013), of which 704 MW is grid-connect- incentivizing production for export and offer- ed. But the peak demand can reach 1,095 MW ing foreign investors easier access to Nepal. and suppressed demand may be significantly (iii) Streamlining public financial management: higher. Hence, focusing on core bottlenecks to leverage the significant fiscal space that that currently hold back public and private in- Nepal enjoys and enable public expenditure vestment will be needed. This includes putting management to work better. This would re- NEA on a sound financial footing, enhancing quire aligning budgets to policy priorities, the policy framework to provide appropriate boosting utilization and ensuring greater incentives to private investors, and enhancing value for each rupee spent. policies for the compensation of affected per- sons (including those living along power line The state has a key role to play –and adequate rights-of-way). fiscal space– to boost infrastructure, which (ii) Expanding connectivity within Nepal and with is central to meeting both investment for its neighbors: this would require improving growth and inclusion challenges. Good public the efficiency of spending on transport infra- infrastructure is necessary to crowd-in private in- structure through more attention on mainte- vestment in the first place. Moreover, improved nance and better coordination across imple- supply of energy and transport connectivity menting agencies, as well as greater focus on can help small producers grow their business – transformational interventions, such as the with better access to markets– and households Fast Track (Kathmandu-Terai) project. to make effective use of social services. But Ne- (iii) Improving the supply of water and sanitation pal’s infrastructural challenges are formidable. services: this would involve a two pronged ap- World Bank estimates suggest infrastructure proach to improve the sustainability of rural investment needs per year of between 8 and12 water supply schemes and incentivizing ur- percent of GDP (in 2010 terms) until 2020 across ban providers to deliver better services. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT xi   Higher growth is a necessary but insufficient (ii) Expanding the opportunity set of all Nepalis: condition for reducing poverty and inequal- through interventions in the health and edu- ity at a fast pace. Past achievements have been cation sectors to remove remaining social enabled to a large extent by the private contri- and economic barriers to access to services butions of Nepal’s migrants and highly resilient and to enhance service quality in order to le- communities. In order to walk the extra mile, ac- verage access gains. tive promotion through inclusive public policies (iii) Enhance the poverty impact of social protec- will be needed to reach remaining pockets of tion programs: by limiting further prolifera- deep, entrenched poverty, ensure that opportu- tion of programs, strengthening core admin- nities –not just income- are effectively available istrative systems and developing a program to all Nepali and to provide those vulnerable with explicitly designed to address poverty and adequate protection against shocks. A more in- other priority risks and vulnerabilities. clusive society –thus defined- would not only be (iv) Preparing for decentralization: because the conducive to social stability, but also enable all move to a federal state will imply a funda- Nepalis to project themselves in the future and mental administrative restructuring, it is key effectively participate, through greater invest- to ensure that the administrative systems ments in human and physical assets, in growing are in place for service delivery to proceed the economy. The building blocks of such an ex- and that the new roles of each level of gov- panded inclusion agenda could include: ernment are clear and funded. At a mini- mum, the Government should establish the (i) Boosting agricultural productivity and diver- institutions that will be responsible to steer sity: because any gains in the agricultural the transition process and determine inter- sector, which accounts for over one third of governmental financial flows and develop GDP and employs around three-quarters of a framework for transferring tasks and staff Nepal’s population, would immediately and across levels of government. automatically reach the poor. This could be achieved by public initiative to boost coop- Nepal has a fantastic opportunity to lay solid eration and research in agricultural technolo- foundations for future prosperity. The frame- gies as well as targeted programs to develop work outlined above is proposed as an input for agribusiness and value chains with export discussion and backed-up by detailed analysis in potential. the Policy Notes and the synthesis report. xii   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT Introduction 1. A Nepalese proverb states that “opportuni- key challenges for Nepal in the middle run will be ties come, but do not linger”, and in Nepal the to unlock its resources – public and private – for time to seize them is now. Indeed, missed op- investment. Given that efficient infrastructure is at portunities do stick around: the failure to create the center of a dynamic investment climate, the and nurture a dynamic growth environment has immediate task will be to tap Nepal’s hydropower long lasting negative effects – so called opportu- potential to solve energy bottlenecks and boost nity costs – in terms of welfare and development. public income through electricity trade with India In recent years, Nepal has not fared as well as its and other neighboring countries. Another imme- peers and neighbors in South Asia. But with in- diate priority is to develop transport infrastructure creased political stability comes the opportunity to assure connectivity across the country and ac- to catch up, by fully leveraging the country’s un- cess to markets, including foreign ones. tapped potential. 3. Inclusion policies are highly complemen- 2. Nepal has achieved important progress in tary – and in fact integral – to growth strate- the past, but the current growth model needs gies. On the one hand, growth alone does not to be re-engineered for further and faster im- guarantee commensurate improvements in hu- provements to materialize. Today, economic man development or a fair distribution of related growth in Nepal is essentially attributable to con- benefits; on the other hand greater inclusion can sumption – backed by remittance transfers – and a also promote faster growth. First, it would be significant expansion of the services sector. This is misguided to assume that the impressive prog- problematic because investment – not consump- ress achieved to date in reducing poverty and tion – is needed to expand the economy’s produc- inequality will continue automatically and in lin- tive potential going forward, while the industrial ear fashion: this is because the poverty reduction sector offers greater potential to achieve produc- elasticity to growth diminishes in the absence tivity gains and integration in global value chains, of supportive policies. In fact, many countries as well as to absorb excess labor. A glaring mani- at more advanced stages of economic develop- festation of Nepal’s investment deficit is the coun- ment have struggled to bring poverty preva- try’s formidable infrastructure gap. Moreover, it lence below the 25% mark where Nepal has ar- may not be wise to assume that surplus labor can rived today. Moreover, fast progress in the past be indefinitely absorbed oversees nor is it optimal materialized from a low starting point and much from a social point of view. In other words, faster more needs to be done in Nepal to promote growth is needed “at home” to create jobs domes- true equality of opportunity, social mobility as tically for Nepal’s youth. It follows that one of the well as to leverage significant gains in access to A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 1   services by respective improvements in quality. tion. Because Nepal faces a myriad of challenges, Second, more inclusive societies, where all have identifying those that are most binding and ur- access to similar opportunities irrespective of gent is a precondition to developing plans that initial economic and social conditions, also grow are workable, prioritized and that can be effec- faster. Because individuals and households have tively monitored. Articulating such a vision that greater incentives to invest into human capital reflects the aspirations of the Nepali people is and the future. the government’s prerogative. In this report, the World Bank simply seeks to facilitate such discus- 4. The policy notes propose a framework to sions by outlining the possible contours of a mini- promote faster, sustainable and inclusive mum agenda focused on 3 “I”s for growth: invest- growth in Nepal. Today, the country is charac- ment, infrastructure and inclusion. In doing so, the terized by persistent weakness in its investment policy notes implicitly recognize the importance climate and infrastructure, jointly constituting of implementation (and related institutional) chal- significant constraints to exploiting the country’s lenges across all areas by focusing the proposed full growth potential. Although Nepal was able reform agenda on feasible policies and quick wins to achieve solid improvements in human devel- that can be achieved realistically in the short run. opment in spite of these constraints and even Implementation of those policies can kick start a during conflict, future development, further pov- virtuous policy cycle, while signaling to prospec- erty eradication and progress towards an inclusive tive investors that the Nepali authorities are seri- Nepalese society will crucially depend on achiev- ous about and focused on reforms. ing faster economic expansion. This will be done by creating an attractive business environment for 6. This synthesis note lays out a strategic vi- investment and forcefully resolving infrastructure sion for Nepal’s development, based on 3 bottlenecks. Higher growth, in turn, needs to be “I”s for growth. The next two sections provide calibrated for inclusion to ensure that the benefits a short analysis of Nepal’s recent and current of greater prosperity are adequately shared, with growth model and performance. It puts into per- additional safeguards so that those vulnerable or spective the substantial achievements in human unable to exploit or access the opportunities al- development and poverty reduction the model lowed by higher growth are not left behind. In enabled, and its limitations in moving towards short, the overall development challenge for Ne- faster growth, middle income status and shared pal is to promote faster, sustainable and inclusive prosperity. Then, the concept of the 3 “I”s is intro- growth. The government has the great opportu- duced in more detail, explaining why the chosen nity and responsibility to build strong foundations dimensions are so central in the short to middle for the future, not only through a new constitu- run. The last section summarizes and concludes tion, but also through implementing a focused with key policy recommendations presented in a and strategic development vision. summary table. Each of the subjects discussed in this synthesis note are covered in greater depth – 5. Developing a clear vision is a first necessary including detailed analysis and policy recommen- step, which must be matched by implementa- dations – in individual policy notes. 2   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT Nepal’s Recent Development Experience 7. Nepal’s recent development trajectory has 9. At the same time, the fight against poverty been atypical, reflecting the country’s unique is far from over. Two challenges stand out. First, sources of strength and resilience as well as while poverty has fallen significantly in recent fragility. Most countries that emerge out of con- years, there are still pockets of entrenched depri- flict experience growth accelerations (linked to vation including in Nepal’s more remote regions reconstruction), while poverty and human devel- and marginalized communities. Reaching these opment outcomes (more dependent on systemic pockets –and walking the extra mile of poverty improvements) tend to lag. Nepal offers a mirror reduction – will be significantly harder. Second, image of this standard pattern. Its economy has while most Nepalis are now above the poverty grown reasonably, but comparatively slower than line, a large majority remains precariously close in the past and its neighbors and peers in South to it. This means that the risks of falling back into Asia. Moreover, structural transformation charac- poverty are still high for many and the scope for terized by a growing contribution of light manu- families to accumulate the capital (including hu- facturing and integration in international value man) needed for sustainable prosperity remains chains if anything, has taken place in reverse. limited. This calls into question the dynamic potential for economic expansion in the future. By contrast, 10. Inequality in access to key opportunities poverty has been reduced sharply, while most also remains high. Income equality is only one indicators of human development and access to dimension of an inclusive society, which, ide- services have improved, albeit remaining at basic ally, should also deliver equality of opportunity levels and with enduring concerns over quality. (the ability for all to achieve their full potential irrespective of initial conditions). In Nepal, while 8. Therefore, the main challenge going forward there has been notable progress in expanding will be to rekindle growth and to put the econ- the reach of social services, inequalities in access omy on a permanently higher expansion path. persist significantly at all but the most basic lev- This implies focusing on investment-led growth – els of provision. Moreover, the quality of even rather than consumption – which is necessary to basic education and health services is too low achieve economic diversification (and to actually to offer their beneficiaries a meaningful chance give the manufacturing sector a chance). It is also at increasing their prospects of becoming more necessary to increase the potential to reap pro- productive and competitive participants in to- ductivity gains in existing sectors. morrow’s labor markets. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 3   Economic growth and structural transformation 11. In order to make a major development 12. The civil war which lasted almost a decade leap towards middle income status, Nepal – from 1996 to 2006 – coincided with a clear should strive to boost middle-run real GDP kink in Nepal’s hitherto ascending growth growth to around 7%1. While possible in theory, trajectory. From the late 1960s / early 1970s such an increase in average annual growth from onwards, growth began to pick up significantly the current 4.2% (2005-2013) will require tapping and steadily (on average), albeit with significant Nepal’s growth potential to the fullest through swings. It started at a low average of just under substantial recalibration of the country’s growth 2% between 1965 and 1974 but rose consistently model towards investment. Even under favor- to 3.2% and 5.2% in the following two decades, able conditions such as solid public finances, a respectively. Growth also became significantly stable and well financed current account balance less volatile. While economic activity swung (through solid export performance and stellar re- sharply until the mid-1980s, with peaks at 8.3% mittance growth) and increasing agricultural and and 9.7% in 1981 and 1984 followed by sharp de- service sector output, long run growth projec- celerations, the band narrowed thereafter with tions remain in the 4-5% range. Hence, Nepal’s growth oscillating between a onetime low of growth challenge is nothing less than formidable 1.7% and a high of 8.2% in the following decade. and will need maximum political determination However, while this relative stability remained across all major policy areas. during the years of conflict (1996-2006), the pace of growth slowed down significantly – though not dramatically – by a full percentage point on average. Going forward a key challenge will be FIGURE 1: The opportunity cost of current growth to achieve greater stability and higher growth concomitantly. GNI per capita under various growth assumptions 1800 13. Economic activity did not rebound once hostilities subsided. The absence of a clear-cut 1600 peace dividend can be explained in a variety of 1400 ways. First, though protracted and deadly, the 1200 civil war in Nepal did not result in a significant de- struction of physical infrastructure, nor did it trig- 1000 ger massive inflows of aid and investment once 800 it ended. Second, while active conflict effectively subsided, the conflict’s legacy of political instabil- 600 ity (with a rocky transition from autocratic rule to 400 multiparty democracy) has persisted until today. 200 14. Rather than the absence of a sharp ‘one 0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 off’ growth spurt following the conflict, a more worrisome feature of Nepal’s recent With 4.5 percent With 7 percent economic performance has been the fail- Source: Authors’ calculations 1 More precisely, assuming an average GNI growth rate of 7 percent from FY2014 onwards and a constant annual population growth rate of 1.2 percent, Nepal would achieve lower middle income status as defined by a GNI per capita>1035 US$ by 2020, while maintaining the current 4.2 percent annual growth would yield this outcome only by 2025. 4   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT ure to maintain the steady rise in the rate of FIGURE 2: Nepal’s growth trajectory at a plateau growth. Indeed, since 2005 the average rate of 10 economic growth has remained close to 4%. This GDP growth (annual %) failure to rekindle growth in the aftermath of the civil war has resulted in a gradual de-linkage be- 8 tween Nepal and the rest of South Asia. While Nepal’s GDP per capita has been consistently 6 below that of Bangladesh, India or Pakistan, the gap has increased sharply as the latter countries 4 experienced strong and sustained growth accel- erations. In 1995, at the onset of the civil war, the 2 difference in GDP per capita between Nepal and Bangladesh was US$35. By the end of the con- flict, in 2005, it had widened to US$100. Seven 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 years later it stood at almost US$200 indicating Nepal’s failure to maintain, let alone close the -2 gap with its faster growing neighbors. -4 15. The apparent “growth plateau” at which Nepal appears to have arrived – and possibly Avg. Growth 1.98 3.22 5.16 4.10 4.18 remained stuck – has been associated with annual % 1965-74 1975-84 1985-94 1995-04 2005-13 (i) a shift in the drivers of economic growth, Source: World Bank, World Development Indicators and (ii) low levels of investment. Nepal has not followed the path of structural transformation typically experienced in fast growing emerg- FIGURE 3: Per capita income has increased only slowly, despite slower population growth ing economies. Although Nepal remains over- whelmingly rural, the contribution of agriculture GDP Per Capita (2005 USD) to total value added has been declining steadily. 1200 While it made up three fourth of total gross do- 1000 mestic product in the mid-1970s, that share has fallen to under 35% today. Until the mid-1990s 800 and the onset of conflict, the relative decline in agriculture benefited both industry and services 600 – each gaining importance in roughly equal pro- portions. However, after that, there was an inflex- 400 ion with the share of industry falling from a peak 200 of 23% in 1996 to a paltry 15% today. By contrast, the relative contribution of services in GDP grew 0 from 36% at the onset of civil war to over half of 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 the total today. In the period from 2005 to today, industrial growth was negatively correlated with Nepal Bangladesh India Pakistan overall growth indicating the declining contribu- tion of industry to economic growth2. Source: World Bank, World Development Indicators 2 and possibly even –although this would require fuller documentation- the adverse effect of remittance driven real appreciation on Nepal’s external competitiveness A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 5   FIGURE 4: Shifting drivers of growth and the rise of services 16. An important question is whether the Gross Value-Added as % of GDP services sector constitutes a solid foundation 80 for future economic expansion. The extent 70 to which Nepal’s services sector can drive faster 60 growth in the future is doubtful for at least two 50 reasons. First, unlike in India, the services sector 40 is overwhelmingly informal and unsophisticated 30 with little potential for productivity growth or 20 generating spillover effects. The services sec- 10 tor – in terms of contribution to GDP – is domi- 0 nated by wholesale and retail trade, followed by 1975 1980 1985 1990 1995 2000 2005 2010 community and social services, real estate and Industry Agriculture Services education services. In terms of growth, the most Coefficient of correlation with overall growth dynamic subsectors have been community and Value-Added Growth Agriculture Industry Services social services, health and social work and edu- 1974-1984 0.81 0.39 0.78 cation. Second, the expansion of the services 1985-94 0.68 0.36 0.33 sector has been closely linked to the dramatic 1995-2004 0.49 0.74 0.81 rise in remittance transfers, whose potential for 2005-2012 0.65 -0.48 0.84 further growth appears limited (given already very high levels). Source: World Bank, World Development Indicators (and authors’ calculations) FIGURE 5: Basic services dominate the landscape 17. The economy-wide potential for growth has been depressed by low levels of public Service Sub-Sectors Shares of GDP, 2012/13 and private investment, despite available fi- nancing. Gross fixed capital formation (GFCF) Wholesale and Retail Trade as a share of GDP has risen only moderately be- Hotels and Restaurant tween FY05 and FY10, from 20% of GDP to a peak Transport, Storage and Communications of 22.2% before ebbing again down to just above Financial Intermediation 21% in FY13, significantly below the shares ob- Real Estate, Renting and Business served in other South Asian countries (Pakistan Public Administration and Defence excepted). During that period, government Education GFCF has remained in a narrow band between Health and Social Work 2.7% and 4.7% of GDP, falling to a paltry 3.5% of Other Community, Social and Personal Service GDP in 2013. Strikingly, such modest levels of investment are not symptomatic of tight fiscal balances and/or excessive recurrent spending: Other Community, Social and Personal Service 8.7 between FY10 and FY13, the budget balance has Health and Social Work 7.3 oscillated between a low (deficit) of 1% of GDP Education 5.9 and a high (surplus) of 2% of GDP in FY13 – with Public Administration and Defence 4.7 Nepal the only country in South Asia to report a budget surplus in that year. Likewise, private Real Estate, Renting and Business 2.4 investment has remained subdued despite ex- Financial Intermediation 3.7 pressed potential interest of foreign investors Transport, Storage and Communications 6.1 (and Nepal’s unexploited hydroelectric capacity) Hotels and Restaurant 5.6 and high private external inflows amounting to Wholesale and Retail Trade 5.2 over 25% of GDP. The spectacular growth in re- 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 mittance transfers in recent years has translated into a buildup of liquidity in the financial system Average Growth Rates of Service Sub-Sectors, 2008/09-2012/13 (Constant Prices) but relatively low uptake by the private sector in Source: Nepal Rastra Bank 6   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT terms of credit. Moreover foreign direct invest- FIGURE 6: Total investment too slow to support dynamic growth ment has increased but from a minuscule base (from US$38 million in FY10 to US$102 million Public Gross Fixed Capital Formation (% of GDP) in FY13) and remains marginal as a share of GDP 25 (0.5% in FY13). 20 18. Understanding and overcoming the con- 2011 2012 2013 straints to both public and private investment 15 is probably the single most important devel- opment challenge for Nepal in the short term. 10 Addressing some of these constraints, such as po- litical instability or the competitive disadvantage 5 brought about by real currency overvaluation (under the combined impact of the peg to India’s 0 Afghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka currency and large inflows of private transfers) may not be politically feasible or economically desirable in the short run. However, much can Nepal: Savings and investment (%GDP) 45 still be done to boost investment and put Nepal back on a higher growth trajectory. At minimum, 40 policies should target core bottlenecks to private 35 investment including a weak investment climate 30 and a massive infrastructure gap. 25 20 15 10 5 0 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 Total GFCF Gross domestic savings Gross national savings Source: World Bank, World Development Indicators and Nepal Rastra Bank FIGURE 7: Bottlenecks to investment Low investment High cost of finance Low returns to economic activity Low economic Low private appropriability (social) returns of the (social) returns Finance availability: NO - Low real interest rates - Excess liquidity in banking system Poor human Deficient Bad geography?: Poor policy Poorly - Poor responsiveness of capital? infrastructure?: YES and NO environment?: functioning investment to exogenous : NO YES - Difficult terrain YES markets?: increases in investible funds Modest - Private supply of - Proximity to - Political YES and NO - Remittances driving returns to energy vibrant markets instability - Loss of external consumption and feeding education - Predominance - Policy competitiveness asset bubbles / skills of infrastructure uncertainty - Product Financial intermediation: premium non-intensive - Corruption diversification YES: activities - Labor employer - Low effective access to conflicts finance Source: Authors’ elaboration based on growth diagnostic studies A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 7   Achievements and Remaining Challenges in Poverty Reduction and Human Development 19. Despite relatively modest growth, Nepal rising incomes from self-employment in farm- has achieved major strides in poverty reduc- ing, wage employment in non-agricultural (rural) tion and human development. Over the past fif- jobs and remittance receipts accounting for three teen years, real per capita consumption has grown fourths of the increase in incomes of the bottom by an average of 3.5% per year and the Human De- two quintiles. With the population dependent on velopment Index has improved at a rate of 2.6% agriculture stable at 15 million (due to declining per year through 1980-2010. In terms of poverty, family size and people moving out of agriculture) some 25% of the Nepali population found them- agriculture income growth (around 3% per year) selves below the poverty line in 2010-11 a sig- registered fully as per-capita income growth on nificant drop of about 30 percentage points from the back of higher returns to agricultural inputs 1995-96. Using the international poverty line of and rising wages in the rural economy. Purchasing Power Parity (PPP) US$1.25 per capita per day, the proportion of poor in the population 21. Although improvements in living standards halved to 24.8% and Nepal ‘overtook’ both Bangla- have been shared across all parts of the country desh and India in terms of poverty prevalence. (ecological belts, regions and ethnic groups) and have in fact been faster among lower expendi- 20. Most of the poverty reduction, reflecting ture classes, poverty prevalence continues to Nepal’s low level of urbanization, occurred in vary widely across areas, regions and groups rural areas. Nearly 92% of the poverty reduction while remaining essentially a rural phenomenon. happened in the rural areas of the country with Over the period 2004-05 to 2010-11 every expendi- TABLE 1: Poverty headcount disaggregated 2010-11 Poverty Estimates Incidence Distribution of the Region Poverty Poverty gap Headcount rate Poor population Total population gap (x100) squared (x100) Urban 15.5 3.2 1.0 11.7 19.0 Rural 1: Poverty headcount disaggregated 27.4 TABLE 6.0 2.0 88.3 81.0 Eastern 21.4 3.8 1.0 19.8 23.3 Central 21.7 5.0 1.8 30.8 35.7 Western 22.2 4.3 1.4 16.9 19.2 Midwestern 31.7 7.7 2.7 16.4 13.0 Far western 45.6 10.7 3.8 16.0 8.8 Mountain 42.3 10.1 3.5 11.8 7.0 Hill 24.3 5.7 2.1 42.8 44.2 Terai 23.4 4.5 1.3 45.4 48.7 Mountains 42.3 10.1 3.5 11.8 7.0 Urban - Kathmandu 11.5 2.8 1.0 2.6 5.7 Urban - Hill 8.7 1.7 0.5 1.5 4.4 Urban -Terai 22.0 4.3 1.3 7.5 8.6 Rural Hills - Eastern 15.9 2.9 0.8 4.0 6.3 Rural Hills -Central 29.4 8.5 3.7 10.8 9.3 Rural Hills - Western 28.0 5.3 1.8 10.5 9.5 Rural Hills - Mid and Far Western 36.8 8.9 3.1 13.3 9.1 Rural Terai - Eastern 21.0 3.7 0.9 9.6 11.6 Rural Terai - Central 23.1 4.1 1.1 13.9 15.1 Rural Terai - Western 22.3 4.4 1.4 5.9 6.6 Rural Terai - Mid and Far Western 31.1 7.2 2.5 8.5 6.9 Nepal 25.2 5.4 1.8 100.0 100.0 Source: World Bank staff estimates based on 2010-11 NLSS. 8   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT ture class enjoyed a rise in per capita consumption FIGURE 8: Nepal’s population clustered above the poverty line with the poorer classes experiencing the greater increase, thereby lowering overall inequality. None- 6 theless important contrasts remain. Poverty is sig- nificantly higher in rural than in urban areas (27.4% vs. 15.5%) and highest in the Far-Western develop- ment regions (45.6%) and Mountainous ecological Percent regions (42.3%). Nearly 90% of the poor live in rural 4 areas but poverty prevalence and share in the total are otherwise inversely related with most of Nepal’s poor found in the central regions (with relatively low prevalence), the Tarai and Hills. 2 22. Overall consumption inequality is low but nonmonetary dimensions of inequality (such as health and education outcomes) paint a different picture. With a GINI coefficient at 30% in 2010-11, Nepal is one of South Asia’s most equal countries in 0 terms of per capita consumption, with urban areas 0 1 2 3 4 5 Daily consumption / $1.25 PPP slightly more unequal than rural but only modest differences between the more (Eastern) and less Source: Authors’ calculations based on the Nepal Living Standards Survey 2010 (Western) equal regions. At the same time, regional 24. Finally, although fewer households than ever consumption and subjective poverty rankings differ remain below the poverty line, a majority of the greatly. For instance people living in relatively less population is still clustered just above the line poor urban areas and the poorest mountain areas making vulnerability to shocks a salient issue. The both feel underprovided in schooling and health- vast majority of Nepalis consumes less than twice the care. Among the ecological zones the sharpest lack bare minimum that defines the boundary with pover- regarding the availability of public goods provision is ty. Moving to a more inclusive and resilient society will felt in mountain areas, with over 25% reporting inad- mean finding a growth path that maximizes gains not equate schooling against 16% in the Terai. only for those that still live in utter deprivation but also for lifting the majority of the population economically 23. Access to public goods has improved signifi- and socially, while providing sufficient support and cantly but with widening gaps between income social protection along the way so that households groups and consequent gaps in opportunity and do not face the risk of falling into poverty and can le- social mobility. Most multi-dimensional indicators verage effective protection against adverse shocks to of poverty have declined sharply over the past fifteen invest into the future. years as public provision of education and health infrastructure – and services –the most immediate 25. To sum up, promoting further inclusion will priorities for a developing country such as Nepal – require both faster growth and determined poli- complemented private provision made affordable by cies. First, poverty reduction will continue to be trib- rising remittance incomes. The largest improvements utary to productivity gains in agriculture; hence sup- were in the categories “child out of school”, “time tak- porting agricultural development and diversification en to primary school” and “safe deliveries” while more is essential both on efficiency and equity grounds. modest gains were recorded for improvement in un- Second, social policies should strive to equalize basic dernourishment, sanitation and access to reasonable opportunities – starting with health and education – cooking fuels. While multi-dimensional indicators if only because increasing the scope for mobility and of poverty declined for consumption-impoverished returns to human capital incentivizes households to people as well, they did so at a slower pace than for invest into the future. Third, Nepal can strengthen the population as a whole. Moreover the quality of its social safety nets, to allow households and indi- services delivered is low and presumably also unequal viduals to effectively deal with shocks, which also across types of beneficiaries. As a result, opportunities promotes investment and entrepreneurship: this in remain unequally distributed with one’s “possibility turn can be done at minimal fiscal cost by streamlin- set” largely predetermined by conditions at birth, in- ing existing programs and targeting them better at cluding ethnic, socio-economic, and geographic fac- those who need them most. tors as well as gender. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 9   Introducing the 3 “I”s 26. The proposed pillars of a development vision to the attractiveness of the business/trade environment, for Nepal can be summarized by three “I”s: invest- thereby increasing overall investment across sectors and ment, infrastructure and inclusion. The three “I”s kick-starting growth. In other words, the key challenge is capture the fundaments of a dynamic and successful to break the vicious circle and build and improve energy long term growth environment or, in other words, a and transport infrastructure, a task that will involve signif- set of necessary policy challenges to be addressed in icant and well-targeted public investment, strategically the near term, rather than a fully-fledged roadmap enhanced through donor funds, loans and leveraged for the long run. Ideally, getting these fundamentals private financing. right will begin to unleash Nepal’s full growth po- tential through 1) allowing market forces and policy 28. Inclusive policies are required, because the gains makers to jointly allocate resources efficiently (e.g. from faster growth may not necessarily be distributed through public and private investment for infrastruc- equally among people with different levels of income ture), and 2) providing the public as well as private or among different geographic areas, and because services, infrastructure and macroeconomic environ- equalizing opportunities in turn incentivizes house- ment necessary for dynamic sectors to thrive and cre- holds to invest. In order to boost shared prosperity, the ate equal opportunities. growth model should be calibrated towards inclusive- ness, taking into account relevant aspects of Nepalese 27. Investment and infrastructure are intrinsically economic and social structure as well as geography to linked to each other. That link, however can be as much maximize inclusion. Three key strategic and highly com- a vice as a virtue for an economy. On the one hand, as is plementary areas stand out. First, given that three in four the case for Nepal today, severe infrastructure gaps act as Nepalis and most of the poor and marginalized groups a disincentive for private investment, both domestic and work in agriculture, gains from increasing productivity foreign. However, private investment is critically needed and diversification in the sector would immediately and to finance an extensive portfolio of necessary but ex- directly be owned by a large share of the population, pensive infrastructure projects. On the other hand, this without further need to rely on redistribution. Second, vicious circle can become virtuous: once investment in in- a more inclusive society can only come about if basic frastructure bears fruit, it almost certainly will contribute opportunities are equalized irrespective of income status, community / identity or geography. Nepal has done well FIGURE 9: The 3 “I”s for growth in reducing income inequality but opportunities remain largely predetermined by initial conditions. Moreover, the fact that a majority of the population remains clustered Investment above but close to the poverty line means that vulnerabil- ity is high for households, which depresses their ability to A more inclusive The potential invest in the future. To meet the next set of inclusion chal- society will reduce risk of for a virtuous lenges, targeted health and education efforts will be need- Infrastructure circle exists conflict and strengthen the between ed to level the playing field and ensure that all Nepalis have Investment and investment climate. Infrastructure. a fair chance in tomorrow’s job market while. Enhanced social safety nets should ensure that those vulnerable are Inclusion protected and fewer Nepalis are left behind. Third, Nepal is on the brink of implementing a federal structure, however, decentralization needs to be “managed for inclusion” in or- der to avoid pitfalls that could increase inequality. 10   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT Investment 29. The key to accelerating growth in a sus- pertain in Nepal’s banking sector, mainly fueled tainable way is investment. Top growth per- by ever greening of bad (non-performing) loans formers such as China have clearly shown the and the probable inflation of reported capital virtues of investment driven growth (see Figure adequacy ratios. The government does not have 10), underlining the crucial role that investment adequate regulatory and supervisory tools or plays in infrastructure development, technology sufficient operational capacity to identify or ad- upgrading, knowledge spillovers and structural dress financial sector vulnerabilities, nor would it change. be able to efficiently manage and limit the sig- 30. Nepal’s investment rate has been rela- FIGURE 10: China’s experience; Investment driven Growth tively low compared to its regional peers, re- flecting a triple challenge on the supply side 60 3E+11 of investment. Gross fixed capital formation 50 2.5+11 has remained in a narrow band between 19.9% of GDP and 22.2% of GDP over the past decade. 40 2E+11 Furthermore, FDI has been stagnant at around 30 1.5E+11 US$100 million per year, a number that is well below the average given Nepal’s economic and 20 1E+11 population size. 10 .5E+11 31. First of all, there exist substantial barriers 0 0 to private investment. Beyond the fact that 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 political instability remains the top constraint identified by Nepalese firms in the most recent GDP growth (annual %) Foreign direct investment, net inflows (BoP, Enterprise Survey (World Bank 2013), lack of re- Gross capital formation (% of GDP) Current US$)right axis liable electricity, often limited access to finance Gross savings (% of GDP) Portfolio equity, Net inflows (BoP, current US$) right axis. as well as costs due to labor issues continue to dis-incentivize investment. While little can be Source: World Bank, World Development Indicators done in the short term to address political stabil- ity concerns or energy bottlenecks, there are low FIGURE 11: Biggest constraints to firms’ operations in Nepal hanging fruits for reform which can signal the Government’s commitment to attracting private investment, such as improving access to finance Major/very severe obstacle to day-to-day operations in Nepal for households and firms, alleviating the regula- (2009 vs. 2013) tory burden and allowing more flexibility in labor 100% 2013 markets, while FDI and export-oriented activities 80% 2009 can also be proactively encouraged. More de- 60% tailed analysis and concrete policy recommenda- 40% 20% tions are included in the policy note: “Towards a 0 more effective investment climate”. Political instability Electricity Corruption Access to finance Transport Informal competition Access to land Courts Customs & trade regulations Crime, theft and disorder Tax rates Business licensing and permits Tax administration Inadequately educated workforce Telecommunications Labor regulations 32. Second, weakness in the macroeconomic environment in general, and risks to financial sector stability in particular constitute ad- ditional constraints. Significant solvency risks Source: Enterprise Survey for Nepal, 2013 A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 11   nificant fiscal costs3 of a potential financial crisis. management capacity gap, also regulation and Hence, an important policy priority will be to set supervision of all relevant subsectors must rest up a crisis management toolkit, ranging from a on solid legal footing and be implemented by sound resolution framework to deal with banks capable institutions with clear mandates and no in trouble to a strengthened deposit insurance conflicts of interest between sector promotion scheme. and supervision (e.g. for class D banks). These is- sues are covered in more detail in the policy note 33. As far as supply of and access to finance “Consolidating financial sector stability”. is concerned, a variety of constraints are pres- ent. First, as a likely result of prolonged risk aver- 34. Third, a major public sector challenge will sion after the financial liquidity crisis of 2011 and be to unlock efficient and well-targeted pub- perceived lack of investment opportunities, a lic investment. Similar to private sector invest- bank driven “voluntary” credit squeeze, (i.e. the ment, its public counterpart does not appear to decision to maintain relatively high interest/ be per se constrained due to lack of availabil- lending rates although demand remains well be- ity of funds. The key question to be addressed low supply) creates excess liquidity in the system. here is: why is the state actually under-investing Second, the market structure of Nepal’s banking relative to its potential? The answer lies in Ne- sector causes additional problems. On one end pal’s formal Public Financial Management (PFM) of the spectrum, 4 large state-owned banks systems and processes, which are well defined need to be restructured, basically removing the through acts and rules, but exhibit critical gaps implicit state guarantee of their liabilities that in strategic and targeted budget formulation, ex- provides an unfair advantage over private com- ecution and oversight. These gaps have resulted petitors. On the other end, the market increas- in low levels of effective utilization, significant ingly presents itself as fragmented among small bunching of expenditures (with associated con- (class C and D and non-regulated cooperative) cerns over the quality of spending) and height- lending and deposit institutions. Here, the small ened fiduciary risk. The most pressing areas for scale of the individual business presents a strong policy intervention span the whole spectrum of viability challenge in that absence of scale usu- PFM, from a need to strengthen budget formula- ally makes for high costs, increased risk taking tion and preparation, to boost effective and well and limited hedging or portfolio diversification. governed execution and capital spending, to The exposure of class A banks to cooperatives re- improve transparency and oversight along the mains relatively small (3-5%) but may still be an way. Furthermore, ongoing reforms need to be issue in light of limited/thin bank capital bases. embedded in and sequenced according to a lon- Ultimately, due to the fact that MFIs do not rig- ger term strategic vision for PFM. This will help orously engage in credit reporting and bottom to create the necessary institutional backbone of the pyramid borrowers often take advantage and implementation capacity along the way to of multiple credit lines, over indebtedness may ultimately sustain benefits from reform. Relevant pose a significant risk to “micro-financial stabil- background and policy recommendations can be ity” and lead to severe negative social impact. found in the policy note: “Building PFM systems to In this respect, and related to the above crisis deliver more and better spending”. 3 The IMF estimates the average fiscal cost of a banking crisis in Nepal at around 22% of GDP, with an output loss range of 31-98% and a reserve losses and depreciation range of 28-32% cumulative over the first 2 crisis years. (IMF 2012) 12   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT Infrastructure 35. Infrastructure plays a central role in the vi- TABLE 2: Investment needs per year by sector 2011-2020 sion for Nepal’s development and growth. Not Sector Average share of GDP, in % only is it at the core of the challenge to unleash Electricity 3.3 - 4.5 (private) investment and support strong growth Transport 2.3 - 3.5 of almost any possible composition. But it also is Water & sanitation 1.1 - 1.6 a fundamental pillar in building the bridge from Irrigation 1.0 - 1.5 economic growth to promoting inclusion and Telecom 0.3 - 0.4 shared prosperity through its direct impact on Solid Waste 0.2 - 0.3 the life of the poor and marginalized. Total 8.2 - 11.8 (Source: World Bank 2014) 36. The direct and indirect linkages between in- vestment in infrastructure and economic growth as well as management systems become condu- are well-known. By providing access to remote cive to a “build-maintain” approach rather than its (unconnected yet populated) areas, roads or bridges costly current alternative, “build-neglect-rebuild”. In make private investment possible. Likewise, by giv- addition, besides the above outlined necessary im- ing entrepreneurs access to services such as elec- provements in the broader, regulatory investment tricity or telecommunications, public investment climate, public investment will have to increase its in critical parts of infrastructure networks enables strategic focus not only generally (as outlined above corresponding private investment. Furthermore, ef- in the context of PFM), but also with respect to in- ficient infrastructure investment fosters indirect GDP frastructure in particular. In order to maximize the magnifiers, which increase private capital durabil- impact of each Nepalese Rupee spent, infrastructure ity, labor productivity, economies of scale, and hu- investment planning should have clear priorities, be man capital development via health and education sequenced accordingly, be subject to economic and channels. Investment can also offset private capi- financial viability analysis, and executed by a techni- tal adjustment costs, which by reducing the need cally capable government agency, in this case the to hedge against disruptions in business, can free National Planning Commission. up more private capital for re-investment, thereby generating a positive feedback loop. Ultimately, in- 38. Although 75% of Nepalis have access to frastructure, acting as an intermediate input in the electricity, both the quality and overall level production process, eventually affects the levels of of electricity supply/consumption remains aggregate income, output and employment. extremely low. Even with a large hydropower potential, chronic underinvestment in Nepal’s 37. However, Nepal faces significant funding power sector has been leading to severe supply gaps for essential infrastructure projects. World shortfalls. Nepal has 84,000 MW of theoretical Bank estimates suggest infrastructure investment hydropower potential out of which 43,000 MW needs per year of 8-12% of GDP (in 2010 terms) are economically viable. The installed genera- until 2020 across all sectors. Necessary investment tion capacity is merely 746 MW as of July 2013, of would need to address both a quantity and quality which 704 MW is grid-connected, while the peak deficiency, particularly in the two big and central demand can reach 1,095 MW. In addition, since infrastructure sectors: transport and energy. Given most of the hydropower plants are of run-of-riv- the difficulty to break the vicious investment – in- er type, the available generating capacity is low frastructure circle in the short run, the importance during dry seasons (472 MW in November 2012) to use scarce resources in a highly efficient man- when the system demand is high (1,095 MW in ner must be underlined. Hence, a first crucial step November 2012). In 2012, the supply-demand involves strengthened focus on rehabilitation and gap was recorded to be around 1,228 GWh which maintenance of assets, where the ex-ante mindset was resolved through load shedding.4 According 4 NEA Annual Report, 2013 A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 13   FIGURE 12: Revenue Gap and TD losses investment. The fact that key risks, such as NEA pay- ment default, would have to be covered by a reluc- Year on year cash losses and T&D loss levels 28.60% 28.91% 28.55% tant government, since Nepal still does not have a 25.43% 3000 30.00% financially and technically robust power sector able 0 (5027) (6962) (6089) (8550) 15.00% to internalize such risks without government back- (3000) stops, dampens private investment appetite and NR Million USD 51.73 0.00% (6000) Million USD 66.29 would need to be addressed. USD 75.79 Million Million -15.00% (9000) USD 93.08 Million 40. Furthermore, lack of transmission capac- (12000) -30.00% FY09 FY10 FY11 FY12** ity significantly undermines the rationale for Revenue gap (NRs Million) T&D loss levels (%) added generation. Transmission line projects Source: Nepal Energy Authority have suffered prolonged delays due to disputes on compensation for the right of way (ROW). Com- to the Independent Power Producers’ Association pensation disputes with affected communities of Nepal (IPPAN), load shedding could cost the have resulted in unacceptable delays. Under one country almost US$1billion a year in lost revenues. World Bank-funded project, which had been under implementation for 10 years, a major transmission 39. The poor financial performance of the pow- line could not be completed due to a dispute over a er utility is dis-incentivizing private investors, minor 3.8 km ROW stretch. Another project funded thereby stalling the required investments to by an international donor could not be completed scale up power production to meet demand. The and has become a stranded asset due to the same Nepal Electricity Authority (NEA) has been suffering type of unresolved dispute. While government from severe financial losses since tariff charges are laws and regulations allow adequate compensa- about 25% lower than the cost of service. While high tion for transmission projects, NEA does not have a system loss (around 26.5% now) results in high costs, clear corporate policy for compensation and often poor quality of services contributes to strong public compensates at 10% land value of the ROW. Hence, resistance to tariff increases. In addition, inadequate there is need for a transmission line ROW compen- power sector policies are also halting investments sation policy that provides justifiable compensa- and construction. With generation being competi- tion for restricted land use within the legal frame- tive (almost 34% of generated power comes from In- work of Nepal taking into account the location and dependent Power Producers - IPPs), and NEA being land use. Concrete policy steps required to remove the single buyer in the downstream market, poten- these core bottlenecks are outlined in the policy tial NEA payment default, in addition to other coun- note: “Unlocking Nepal’s Hydropower Potential”. try risks such as political force majeure or exchange rate or operational risks, are major bottlenecks for 41. Improving connectivity throughout Nepal is sizable private investment in large hydropower gen- a key consideration for ensuring that economic eration. Hence, reducing cost of service and achiev- growth can pick up and is inclusive. Access to mar- ing cost recovery of tariffs will be first crucial steps to kets (e.g. in rural agriculture), private sector activities, achieve financial sustainability of NEA and the pow- social services, or assistance during emergency events er sector. The tariff reform would need to consider a directly depends on the quality of transport services. step-wise approach to deal with social impacts and However, to achieve transportation connectivity in allow tariff adjustment, with indexation to inflation, Nepal is very demanding. While many transport chal- foreign exchange rates, tariff categories restructur- lenges are new and unprecedented, notably those ing, as well as cross-subsidies among consumer cat- related to urbanization, effective maintenance of exist- egories to address impacts on the poor. In parallel, a ing infrastructure remains the foremost challenge to corporate development plan for NEA (based on the improving transport services. Given that maintenance prepared financial restructuring plan) should detail is extremely cost effective vis-à-vis new construction, the technical and financial improvements and the the GoN’s most important challenge will be to ensure implementation of a loss reduction master plan. Ad- that maintenance work is actually implemented. Cur- ditionally, lack of proper policies for providing gov- rent monitoring mechanisms for maintenance grants ernment guarantees to mitigate the above outlined stop at the level of expenditures, which is insufficient to risks constitutes yet another major hurdle for private ensure that maintenance funding actually achieves its 14   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT intended purpose. Cost effectiveness gains even more managing rapid motorization more effectively will importance given that there is no short term solution be critical for improving transport and the urban to satisfying the level of investment needed to improve environment and overall welfare in the Kathmandu Nepal’s transport infrastructure. Neither GoN nor the valley. In particular, investments to improve public development community can fund the entirety of transport facilities, bus services and pedestrian infra- transport investments that Nepal will need to drive de- structure would have a far reaching impact for resi- velopment. And PPPs to leverage private investment dent’s mobility, safety and ultimately their health (The are no panacea to fill funding gaps as private develop- average concentration of course particulates -PM106 ers may finance infrastructure investment in exchange - in the Kathmandu valley’s air between 2003 and for financial returns only. Further, the debt and equity 2006 was more than six times the World Health Or- instruments they use to do this will require repayment ganization’s standard.). Policy steps required to im- (with interest and dividends). Hence, PPPs as imple- prove the provision of transport services are detailed mentation tools should be seen mainly as efficiency in the policy note “Connecting Nepal”. enhancing and risk allocating mechanisms. 44. Similarly to energy and transport, there are 42. The transport sector is also facing a gover- major issues with quality and sustainability of nance challenge. The fact that roughly 70% of water and sanitation services. While indicators of transport spending occurs in the last trimester of access to water and sanitation services are in line each fiscal year shows that the budgeting, planning, with regional averages, the quality of services is procurement, and contract management processes variable and tends to be deteriorating overall, espe- applied throughout the transport sector need to cially in the Kathmandu Valley. In rural areas, where work more smoothly. The capacity of local govern- schemes are relatively simple, there are high levels ment entities and the accountability framework that of non-functionality. In both urban and rural areas applies to their transport sector investment activities investment is needed – with an estimated annual also requires significant improvement. At the na- investment need between 1.2 and 1.6% of GDP be- tional level overlapping institutional roles and man- tween 2011 and 2020 – but public policy has tended dates, particularly for urban transport interventions to overemphasize asset creation rather than long that simultaneously aim at improving physical in- term asset management and service delivery. At the frastructure, traffic management, and policies, adds same time, private sector provision remains anemic. complexity to the functioning of the sector. Further- more, necessary efforts to build capacity within the 45. The water sector suffers from major short- Ministry of Federal Affairs and Local Development comings in governance, lack of financial viabil- (MoFALD), in charge of the local (rural) road network, ity and strategic and sustainable planning. First, and Ministry of Physical Infrastructure and Transport existing assets need to be properly maintained in (MoPIT), in charge of the strategic (national) road order to improve their sustainability and lifetime network, will benefit from consistently channeling return on investment. Absence of clear governance greater portions of development partner support structures reduces accountability of service provid- through their fiduciary and technical systems. ers and hence the quality of services, particularly in urban areas. Second, as in the energy sector, service 43. From a strategic investment perspective, providers are not able to recover costs through user two efforts crucial to Kathmandu’s development fees, further aggravating incentive misalignment should be envisaged. First, a ‘fast track’ alternative and quality deteriorations. This also makes improve- connection between Hetuada and Kathmandu ments in environmental performance more difficult. would yield estimated potential time savings of 4-5 Ultimately, sector planning is inadequate and the hours and potential fuel savings in the order of NPR lack of a clear strategy at this point threatens sustain- 3,000 (US$30) per one-way trip for a heavy truck5. ability of vital water and sanitation services. Mea- Preliminary economic analysis conducted in 2008 sures to increase the sustainability of rural schemes forecasts economic rates of return in excess of 30%, and improve the quality of urban services are pro- while rough cost estimates came in at approxi- posed in the policy note “Increasing the sustainability, mately US$1 billion. Second, within Kathmandu, coverage and quality of water and sanitation services.” 5 Asian Development Bank “North South Fast Track Project: Final Report,” May 2008 6 PM10 is particulate matter of measuring less than 10 microns (.01 millimeters) in diameter. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 15   Inclusion 46. Inclusion is a necessary condition for both those that expand the opportunities of all Nepali further poverty reduction as well as growth to lead a productive and healthy life – would and, despite substantial progress, Nepal still drive overall output growth by allowing greater has a long way to go to make poverty history numbers to participate more productively in to- and effectively promote equal opportunities morrow’s job market. For those that remain left for all. Economic growth is a necessary but not behind, because of exclusion or age, social safety sufficient condition for poverty reduction and nets will need to be relied upon. equity. Indeed, achieving better living standards for those at the bottom of the income distribu- 47. Expanding productivity in Nepal’s large tion and reducing Nepal’s current dependence agricultural sector is an obvious priority to on foreign labor markets will be almost impos- simultaneously expand overall output and sible in the absence of significantly higher over- achieve poverty reduction. Agriculture is still all levels of economic activity. But growth alone the second largest contributor to value added will not be sufficient. First, the poverty reduction in the economy – it makes up over one-third elasticity of growth is not linear and removing of GDP- and, more importantly it still employs entrenched pockets of poverty and deprivation around three-quarters of the population. About will require targeted policies. Second reducing 92% of the poverty reduction achieved over the income inequality is not an end in and of itself: last seven years took place in rural areas, and just as important is to ensure that opportunities incomes in the rural areas are expected to con- to fulfill one’s capabilities are also equalized. On tinue to drive poverty reduction over the medi- that front Nepal can still do much better. Third, um-term due to the concentration of the poor in a majority of Nepali remain dangerously close to the countryside. This is because, despite recent poverty levels, rather immobile in social terms gains, Nepal’s agriculture remains characterized and vulnerable to shocks. Taken together, poli- by low productivity, the use of traditional crops cies to equalize the opportunities playing field and methods and overly dependent on weather and to protect those most vulnerable to shocks outcomes. Recent underperformance in agricul- can boost private investment in human and ture points to the need to modernize agriculture physical capital and reinforce growth further. through increased productivity, commercializa- These challenges call for calibrating growth to tion and diversification. promote inclusion and shared prosperity objec- tives. Moreover, inclusive policies – specifically 48. A shift away from traditional subsistence agriculture to a more diversified production has the potential to raise output and incomes, FIGURE 13: Poverty reduction driven by rural income especially in remote areas. As a consequence Faster reduction in rural areas Narrowing wage differential between 3.5 agriculture and non-agriculture of poverty, the rural population prioritizes food 66 security through local subsistence agriculture, 3 Ratio of agriculture to non-agri wages Annualized change in headcount 64 whose output is of low value, thereby perpetuat- 2.5 62 ing a vicious cycle of low income leading to low 60 2 output. Breaking this pattern will require initia- 58 tive to leverage available technological advanc- 0.5 56 es, particularly for food grains, through strategic 1 54 cooperation with India as well as revamping ag- 52 0.5 ricultural subsidies and refocusing investment 50 0 48 on research and extension. Crop diversification Urban Rural Total 1995/96 2003/04 2010/11 away from low value cereal production to cash 1996-04 2004-11 crops has high potential especially in Western Nepal—the regions with the highest and most Source: WB Poverty Diagnostic Study 2013, NLSS 16   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT severe incidence of poverty. High-value agricul- FIGURE 14: Production area of Apples (top) and Walnuts, 2010/11 (bottom) tural products include fruits, nuts, spices, herbs, certain vegetable products and livestock prod- ucts for which there is a growing demand on the Indian market and an opportunity for Nepal to export. 49. A key policy challenge would therefore be to assist with the diversification through in- creasing the role of the private sector in pro- viding input supply, developing agricultural value-chains as well as to identify and sup- port production of non-traditional crops for the Indian market. This could be done by refo- cusing the role of the state away from input pro- duction with the private and cooperative sectors weighing-in. Relevant experience of commercial seed production comes from projects like the Seed Sector Support Project, funded by United Kingdom’s Department for International Devel- opment (DfID), which helped organize and train Nepalese farmers in vegetable seed production and expanded the amount of vegetable seed for sale. In assisting the private and cooperative sec- tor, the government should provide facilitation, quality control, policies and regulations, informa- tion, and monitoring and evaluation in order to ensure that subsistence orientated smallholding farmers have access to markets and information. The government can provide further support to Source: Agriculture Atlas of Nepal (2012) smallholding farmers and agro-enterprises by developing competitive value chains to increase jor driver of agricultural growth. The government the value added through a strengthened Agri- should prioritize more efficient management of business Promotion Unit of the Ministry of Agri- irrigation systems through better governance culture (MoAD). mechanisms and promoting water users as- sociation. Additional gains can be reaped from 50. Boosting productivity and accelerating revamping and refocusing agriculture subsidy private sector-led growth in agriculture will programs. Programs like the US$42 million fertil- require targeted measures by the govern- izer subsidy program have proven ineffective in ment. While encouraging the private sector to bringing materials appropriate in type and vol- take the lead in providing input supply, the gov- ume, while starving research and extension ser- ernment can assist agribusiness development vices of adequate budget allocations. It would be through reducing transaction costs for farmers more efficient to streamline the subsidy program by bridging infrastructure gaps, providing better and reallocate resources to research and exten- access to financial products and supporting se- sion, while also permitting Nepal’s research and lected commodity value chain development. In extension staff to engage with Indian agricul- particular, lack of adequate infrastructure, such tural research systems, public and private. A de- as roads for market access and irrigation systems tailed set of policy recommendations is provided are inhibiting agriculture productivity growth. in the policy note: “Towards a more productive, Improving irrigation infrastructure will be a ma- commercialized and diversified agriculture”. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 17   51. For the benefits of growth to be equitably high-quality services possibly reinforcing access distributed among the population, access to inequities. opportunities needs to be improved. Nepal has done well in expanding the reach of social 53. Increasing access to key opportunities services and in achieving poverty reduction de- requires better targeted incentives so that spite modest economic expansion. This is a re- those needing them more receive support in flection of strong resilience anchored in a high- higher quantity. In other words a key prereq- level of community engagement and enabled uisite to expanding opportunities is to make by the decisive contribution of Nepal’s migrants sure that existing programs in health, education – with remittances almost entirely channeled and social protection are reaching the poor and to daily consumption and education expenses. those otherwise excluded. While education ac- However, Nepal can do better still by leveraging cess improved in Nepal, there are still high levels these traditional sources of resilience through of inequality in net attendance rates and qual- smarter and better targeted public interventions ity of education outcomes based on poverty, to expand opportunities of all, and specifically ethnicity and geography. Disparities increase the poor and marginalized. In particular, the progressively at higher levels of education. For focus should be on targeted interventions to example, in 2010 secondary (grades 9-12) atten- equalize access to health care, and education dance for the poorest and second poorest quin- beyond primary. Additionally the expansion of tile was 18% and 26%, respectively. Scholarships access should be matched by focus on quality so for poor students at post basic levels of educa- that investments in social infrastructure are ef- tion could result in more equalized educational fectively leveraged. Local service delivery needs attainment and opportunities over time. A key to be managed transparently, efficiently and fair- policy target should therefore be to develop a ly in order to improve the legitimacy of the gov- strategy for expanding poverty-targeted schol- ernment as service provider. Taking these steps arships especially at the secondary and tertiary will help to make growth more sustainable in the levels while phasing out category-based scholar- long-term and assist Nepal in successfully reach- ship programs. ing a higher level of development. 54. Similar challenges are present in the 52. Access to education and health services health sector, which also often fails to reach are key drivers of opportunity and more can the poor. In 2011, 78% of births in the richest be done still to ensure that access is more quintile took place in health facilities, but the equitability and quality enhanced. Nepal has corresponding number was only 11% for the made good progress in expanding the supply of bottom quintile. Only about 54% of the poorest education and health services. But there remain 40% of Nepali are satisfied with the availability concerns about inequities in effective access to of quality health care, as opposed to 67% of the and the quality of these opportunities. Several richest 20%. Furthermore, high out-of-pocket groups of individuals are systematically less able expenditures for health care constitute a sig- to access opportunities due to circumstances, nificant poverty trap: based on 2003 data about including parental income, location of residence 6.7% of households fall below the poverty line and other factors. For Nepal to successfully in a given year as a consequence of these ex- make poverty history as well as to enable great- penses. A key policy initiative would therefore er investment by households into human and improve targeting to allow the poor to better uti- physical assets, children, women and the young lize health services and increase their nutritional need to be able to access the same set of oppor- status. Any policy initiative in the health sector tunities regardless of socioeconomic and other should also be geared toward reducing out-of- constraints. Furthermore, lack of decentralized pocket expenditures of the poor for healthcare. accountability in the health, education and so- This could be achieved through targeting de- cial protection sectors hinder the provision of mand and supply side financing schemes for the 18   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT poor and testing options for moving towards a explicitly targeted at the poor and feature con- national health-insurance scheme. siderable levels of under-coverage, leakage and administrative inefficiency. In addition, Nepal’s 55. Another key prerequisite to lift people out social protection system is fragmented and un- of poverty will be to provide them with skills coordinated—delivered by a range of line minis- enabling them to find better jobs and become tries and agencies, which results in possible ben- socially mobile. Nepal is facing a youth bulge efit duplications or gaps in effective safety net with significant shifts in its demographics (57% coverage. Coverage is limited with only 17.5% of the population is aged between 15-59 years of Nepali either directly or indirectly benefiting according to the 2011 Census), but limited skills from a cash transfer program, well below the cur- prevent people from transitioning into the type rent poverty rate of 25%. Benefits also accrue of jobs that could lift them out of poverty. Chal- more or less equally across income quintiles, lenges remain in increasing workers’ productiv- e.g. the richest quintiles are as likely to receive ity and technical skills in both the formal and an old-age pension as the poorest. Social insur- informal sectors, as well as domestic and abroad. ance programs cover only 7% of the total popu- Over 300,000 workers migrate abroad each year lation, mostly public sector retirees. Targeting is for employment purposes, providing the remit- mostly by category (age, ethnicity, etc.) regard- tances that currently fuel growth and poverty re- less of recipients’ income and welfare status.7 duction. But of those migrants, more than 75% Furthermore, the system lacks the necessary ad- are engaged in low-skilled jobs. To tackle this ministrative setup to support monitoring and challenge, Nepal needs to develop a program for informed policy-making as well as efficient pro- skills development with an employment focus, gram administration such as a transparent and fostering partnerships between the public and reliable payment system. the private sectors, while giving special atten- tion to skills demand in the informal sector and 57. Central to improving Nepal’s social protec- for migrating labor. Greater detail on feasible tion system would be to: (i) limit further prolif- opportunity-equalizing policies is provided in eration of social protection programs while final- the policy note: “Improving opportunities for all to izing the social protection policy framework as escape from poverty”. a basis for guiding future decisions to introduce new schemes, and/or phase out or reform some 56. A more efficient and poverty-focused so- of the current ones, (ii) invest in strengthening cial protection system is needed to effectively the administrative systems, starting with the address extreme poverty and prevent vulner- largest programs and eventually making them a able people from falling into poverty. The common management platform across programs existing social protection system is inadequate and ministries, and (iii) address the effective cov- for providing reliable safety nets to the poor erage gaps in the current mix of social safety net and vulnerable. Social protection spending in programs based on robust analysis of existing Nepal has increased substantially in recent years poverty, risks and vulnerabilities. In addressing from around 1% of GDP in 2004/05 to more than 3% in 2011/12. Yet despite this increase, social protection programs, including cash transfers FIGURE 15: Nepal Social Protection system: impact on poverty and inequality and scholarships, have only a limited impact Poverty Rate Gini Coefficient on reducing poverty and inequality. As shown Current 25.2% 0.328 in Figure 15 below, according to World Bank In absence of social insurance programs 26.6% 0.329 estimates, the poverty headcount would only In absence of social assistance (cash transfer+scholarships) programs 25.7% 0.330 increase marginally by 0.5 percentage points In absence of cash transfer programs 25.6% 0.330 (from 25.2% to 25.7%) in the absence of social In absence of scholarship programs 25.3% 0.329 assistance programs. Most programs are not Source: World Bank team estimates from NLSS 3 analysis 7 Exceptions are the two public works programs managed by the Ministry of Federal Affairs and Local Development (MOFALD) which target districts characterized by food insecurity and/or high incidence of poverty. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 19   the risks and vulnerabilities that are inadequate- involves creating a high level institution with ex- ly covered in the current mix of programs, it will panded powers to coordinate the entire process be necessary to consider explicit targeting of the as well as a dedicated body to oversee the de- poor, irrespective of the specific method chosen velopment and evolution of intergovernmental to do so, in order to ensure the limited fiscal re- financial arrangements. In turn, ensuring that all sources are most efficiently deployed to provide levels of government are adequately funded to maximum safety nets for those in need. Specific carry out their missions will require detailed un- steps in that direction are proposed in the policy bundling and costing of such functions as well note: “Toward a streamlined, efficient and poverty as predefined mechanisms to ensure periodic focused social protection system.” and evidence based review. Secondly, because the bulk of key social and economic services will 58. Last but not least, the eventual transition be delivered locally, in a new federal state, it is to a federal state structure will have far reach- of utmost importance that the new subnational ing implications for service delivery and, if governments have both the required technical not managed well, could result in service de- capacity and resources (financial and human) to livery failures, heightened political tension deliver services. Although lagging regions will as well as greater geographic inequities. First, get greater control over their destinies, the chal- the transition foreshadowed by the work of the lenge for them will be greater as they will be lack- first Constituent Assembly would involve the ing –relatively – technical and financial capacity creation of two entirely new levels of subnation- and experience, and may find it difficult to attract al government with expanded responsibilities. core human resources in management, adminis- Their creation will trigger profound restructur- trative and service delivery functions. Therefore ing of the mission and size of the central admin- it will be key to ensure that there is a plan in place istration, and a considerable transfer of powers, to (i) transfer functions over time in a way that assets, and resources (both fiscal and human). balances the need to deliver on effective trans- International experience suggests that this is fer of power and the need to build adequate extremely difficult both logistically and politi- core capacity (ii) promote a restructuring of the cally. It is therefore imperative that this process civil service in which special attention and incen- is managed through the creation of specific insti- tives are built in to prevent severe skills gaps in tutions with the resources, independence, man- the country’s lagging regions. The key building date and analytical capacity needed to succeed. blocks of such a plan are presented in the policy Following international experience, this typically note: “Preparing for decentralization”. 20   A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT Summary and Conclusion 59. Nepal’s new government is facing a daunt- and refine the main policy prescriptions, as well ing growth challenge; however, international as (ii) move over time toward more granular di- experience suggests that removing key bind- agnostics within each sector. ing constraints to investment and strategic policy making can alter a country’s growth 61. The 3 “I”s framework outlines how a potential and trajectory significantly. The pur- policy focus on investment, infrastructure pose of this note is to offer precisely such strate- and inclusion can create a dynamic and sus- gic input into the identification and prioritization tainable growth environment in the middle of core areas for policy intervention. It is worth run. First, a stable financial sector, a condu- reemphasizing that Nepal has a lot going for it: cive investment climate and strategic public reasonable economic diversification (relative to investment can go a long way to create virtu- its income), valuable resources, highly resilient ous investment-infrastructure circles, not only communities and newfound political stability. boosting overall economic activity but also di- The challenge is to get the fundamentals into rectly benefitting poor and remote segments of place for enabling Nepal to live up to its eco- Nepal’s population. Second, to promote shared nomic potential. prosperity and move towards sustainable high growth, a focus on agricultural productivity as 60. While the overview chapter lays out a stra- an initial broad welfare enhancing platform can tegic vision for growth, individual policy notes complement efforts to enhance opportunities provide complementary in depth information along the income, ethnic and geographic distri- and sector specific policy recommendations. bution of Nepalis. Third, ongoing decentraliza- They outline a set of options for the government tion bears large potential to increase efficiency to consider and can serve as a basis for dialogue in public social and administrative service pro- between stakeholders. This is the beginning of a vision but will need to be actively managed and conversation with significant scope to (i) reshape calibrated along the way. A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 21   22   Key Policy Priorities 1. Prepare a corporate development plan for NEA, outlining technical and financial improvements and a loss reduction master-plan 1. Accelerate the enactment of the NRB Amendments Bill and 2. Update the Power Investment new DCGT Bill Development Agreement to provide coverage of country risks 2. Build FSMD capacity to through guarantees for obligations manage the divesture of NBL and A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT of government entities define a clear mandate for RBB Unlock Nepal’s hydro-potential: Strengthen the financial sector: to 3. Formulate a transmission focusing on core bottlenecks that make it more resilient to shocks, more 3. Develop an overall strategy ROW policy that provides currently hold back public and private efficient in intermediating savings and toward access to finance justifiable compensation for investment alike. extend its reach. Infrastructure 4. Streamline licensing restricted land use within the legal Expand connectivity within Nepal Improve the investment climate: to procedures at the OCR and DOI framework taking into account and with its neighbors: through remove the obstacles that firms face in land location and use 5. Review the Bonus Act to more efficient spending and focus on setting up and expanding operations transformational projects. provide additional flexibility 4. Prioritize maintenance of in Nepal. transport assets over new 6. Revamp the export subsidy Improve the supply of water and Streamline public financial constructions and enhance and export finance schemes sanitation services: through better management: to leverage the monitoring mechanisms for Inclusion sustainability of rural schemes and significant fiscal space the Nepal enjoys. 7. Scale up the TSA system into a maintenance accountability of urban providers. Financial Management IS 5. Codify criteria for transport investment selection to insulate 8. Front load the approval of the process from political feasibility studies, workplan and interference procurement documents prior to budget approval 6. Get the fast-track project back on track by stabilizing the project 9. Develop national norms and environment, preparing technical rates for project costing fundamentals and updating cost and traffic projections Boost agricultural productivity and further proliferation of programs, diversity: through cooperation and strengthening core administrative research in agricultural technologies and systems and developing a program programs to develop agribusiness and explicitly designed to address value chains poverty and other priority risks and vulnerabilities. Expand the opportunity set of all Nepali: through interventions for high Prepare for decentralization: by quality health and education sectors. setting up the institutions required to manage the transition and clarifying Enhance the poverty impact of social mandates and functions of each level of protection programs: by limiting government. 1. Identify and acquire improved agricultural 4. Develop a strategy for expanding the 7. Consolidate social protection programs technologies from abroad and leverage spill- coverage of poverty-targeted scholarships under one administrative system and monitor ins from India through closer cooperation especially at secondary and tertiary levels, while the performance of the system against a set of phasing out categorically targeted programs national indicators 2. Encourage private sector participation in seed production and refocus the role of 5. Ensure that NASA is institutionalized and 8. Create a strong finance commission with its government on regulation and facilitation learning outcomes are monitored systematically own technical secretariat capable of conducting financial analysis and to devise and manage 3. Identify and support non-traditional high 6. Establish a contracting / purchasing inter-governmental transfers value production targeted to the Indian market capacity at MoHP A VISION FOR NEPAL POLICY NOTES FOR THE GOVERNMENT 23   The World Bank Group Nepal Office P.O. Box 798 Yak and Yeti Hotel Complex Durbar Marg, Kathmandu, Nepal Tel.: 4226792 Fax: 4225112 Email: infonepal@worldbank.org www.worldbank.org/np www.facebook.com/WorldBankNepal