Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 48297- NP

INTERNATIONAL DEVELOPMENT ASSOCIATION

AND

INTERNATIONAL FINANCE CORPORATION

INTERIM STRATEGY NOTE

FOR

NEPAL

FOR THE PERIOD FY 2010-2011

May 7,2009

Nepal Country Team, World Bank Group South Asia Region

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The last Country Assistance Strategy for Nepal (Report No. 26509-NEP) was discussed on November 18,2003 and Interim Strategy Note was discussed on January 22,2007

WB Vice PresidentIIFC Regional Director Country DirectoriCountry Manager Task Team Leader Co-Task Team Leader

Currency and Eauivalents Currency Unit = Nepali Rupee o\JRs.)

US$l = NRs. 79.78 (as o f May 5,2009)

IDA IFC Isabel Guerrero Paolo M. Martelli Susan Goldmark Per Kjellerhaug Philip O’Keefe Rita Bhagwati Roshan Bairacharva Raieev GoDal

Fiscal Year Nepal: July 16-July 15 (fiscal year starting on July 15,2008 i s designated as FY08/09) World Bank: July 1-June 30 (fiscal year starting on July 1,2008 i s designated as FY09)

This joint IDA-IFC draft Interim Strategy Note (ISN) was prepared under the guidance o f Susan Goldmark, IDA Country Director, and Per Kjellerhaug, IFC Country Manager, by a team led by Philip O’Keefe, Task Team Leader (TTL) and Roshan Bajracharya, co-TTL. The IFC team integral to the development o f the I S N was led by Shamsher G. Singh, Head o f Strategy and Coordination, Rita Bhagwati, Senior Economist and Rajeev Gopal, Operations Officer.

The ISN Core Team included: Myrna Alexander, Stephanie Borsboom, Daniel Boyce, Sean Bradley, Christine Kimes, Rajashree Paralkar, Hisan Shishido, and Rajib Upadhya. Core team support was provided by: Kiran Gautam and Lal ima Maskey.

The following country team members and other colleagues have also made important contributions to the draft strategy: Gayatri Acharya, Rajendra Dhoj Joshi, Vikram Menon, Bigyan Pradhan, Tashi Tenzing, from IDA; Neeraj Gupta, Roger Handberg, Shaun Mann, Bradford Roberts, Rajesh Sinha, Nilesh Srivastava from IFC; and Edward Be l l (consultant). The team also acknowledges the contribution and guidance received from the IDA- IFC Secretariat led by Nigel Twose and including Deepa Chakrapani and Vyajayanti Desai.

Special thanks are extended to the Government o f Nepal counterpart team and World Bank Group development partners for their contributions.

FOR OFFICIAL USE ONLY

CEA CMU

CPA CPAR

Country Environmental Analysis NPC National Planning Commission Country Management Unit OECD Organization for Economic Cooperation &

Comprehensive Peace Agreement PAF Poverty Alleviation Fund Country Procurement Assessment PEFA Public Expenditure & Financial

Development

I Report

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

I Accountability

NEPAL

INTERIM STRATEGY NOTE

TABLE OF CONTENTS

Executive Summary ...................................................................................... i

Motivating the Interim Strategy ............................................................................................ 1 Country Context ....................................................................................................... 2

(a) Political and Security Developments ...................................................................... 2 (b) Economic Background ............................................................................................ 3 (c) Poverty and Social Development ........................................................................... 6

Government o f Nepal’s Emerging Development Strategy ................................... 9 The Bank Group Interim Strategy ....................................................................... 10

Proposed Approach ofthe Strategy ...................................................................... 10 Principles Underlying the Strategy ....................................................................... 12 The Overarching Goal and Proposed Pillars o f the Interim Strategy ................... 13 Proposed WBG Program and Instruments ............................................................ 28

I S N Process ............................................................................................................. 36

A .

B . C .

(a) (b) (c) (d)

D .

TABLES

Table 1 : Indicators o f Macroeconomic Performance. FY 04-08 .............................................. 4 Table 2: Selected Social Indicators for mid- 1990s and 2000s. Various Years ......................... 8

BOXES

Box 1 : The Pressing Challenges in the Tarai ........................................................................... 3 Box 2: Nepal Development Strategy Paper and Growth Assumptions .................................... 7 Box 3: Community Service Delivery o f School Education . a Unique Nepalese Tradition ..... 8 Box 4: Observations from the Previous CAS/ISN Implementation ....................................... 12 Box 5: Proposed ‘Peace Filter’ for Bank Group Operations in Nepal .................................... 16

APPENDICES

Appendix I Debt Sustainability Analysis ......................................................... 37 Appendix I1 Donor Mapping at Sector Level ...................................................... 52 Appendix I11 Governance and Risks Assessment .................................................. 54 Appendix IV IEG - Country Assistance Evaluation ............................................. -57 Appendix V Summary o f CAS Consultations ..................................................... 60 Appendix V I Country Financing Parameters ....................................................... 63

ANNEXES

Annex A 1 : Annex A 2 : Annex B2: Annex B3: Annex B3: Annex B4: Annex B4: Annex B5: Annex B6: Annex B7: Annex B 8 : Annex B 8 : Annex B9:

Key Economic & Program Indicators . Change f rom Last I S N ............... 64 Nepal at a Glance .................................................................. 65 Selected Indicators o f Bank Portfolio Performance and Management ......... 67 IDA Indicative Program Summary ................................................. 68 IFC and MIGA Program Summary ................................................. 69 Indicative Non-lending Activities - IDA .......................................... 70 Indicative Non-lending Activities - I F C ......................................... 71 Poverty and Social Development Indicators ...................................... 73 Key Economic Indicators ............................................................ 74 Key Exposure Indicators ............................................................. 75 Status o f Bank Group Operations and Grants ..................................... 76 Statement o f IFC’s Held and Disbursed Portfolio ................................. 77 I S N Results Framework ............................................................... 78

Map (IBRD 36921)

NEPAL Interim Strategy N o t e

Executive Summary

i. Nepal i s a country at crossroads, an “open moment” in its history. Nepal’s decade- long conflict formally ended in November 2006. In 2008, the country voted in a Constituent Assembly (CA), named a President, elected a Prime Minister, formed a coalition government, and set about the task o f writing a new constitution by 2010, with a new round o f elections planned for 201 1. It also abolished the monarchy and declared Nepal a federal democratic republic, vastly altering administrative and decision-making powers. Over the next two years, the country wil l continue to confront long-standing development challenges at a time o f global economic downturn. The challenges o f the transition were highlighted on M a y 4, 2009, with the resignation o f the Prime Minister, which i s expected to result in a period o f heightened polit ical uncertainty. The former Prime Minister, however, will head a caretaker government until polit ical realignments stabilize and a new government i s formed. The key challenges facing a new Government at this juncture are to rebuild the legitimacy o f the state, sustain the peace, maintain law and order, and deliver benefits to those traditionally excluded and to society at large.

ii. Nepal i s one of the poorest countries in the world, averaging GDP per capita of US$470, with adverse - though improving - social indicators. There are wide discrepancies depending on geographic location, ethnicity, caste and gender. Nevertheless, progress on social indicators in the last decade and more has been impressive: the poverty rate and gap f e l l sharply, and a number o f MDG indicators improved markedly. However, inequality increased sharply. Prudent fiscal management was pursued and the economy grew moderately despite the conflict. Nepal has been able to retain much o f i ts basic infrastructure, functioning bureaucracy and service delivery mechanisms.

iii. Significant challenges remain. A new government needs to be formed, and the law and order situation remains difficult, with continued regional, ethnic and political tensions. By 2007, remittances approached 25 percent o f GDP, making Nepal vulnerable to a reversal which could fuel unrest. So far, a l l indicators are holding up. Nevertheless, the impact o f the global crisis may hurt exports, tourist arrivals and remittances. So, even though Nepal has many strengths, the pace and severity o f crisis witnessed elsewhere in the wor ld - combined with Nepal’s already fragile situation - strongly caution against complacency.

Draft National Development Strategy and the World Bank Group’s response

iv. Nepal’s development agenda is closely intertwined with peace building. The Maoist coalition Government produced a draft o f i t s development strategy for the next three years. This was built upon the previous government’s Three Year Interim Plan which expires in July 2010. The draft strategy contains a strong emphasis on spurring investment, j ob creation and growth, while reducing inequality and exclusion. Consistent

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with the previous plan, the draft highlights investments in power, roads, education, health, water supply and local development, and improved social protection. Agriculture, rural finance and rural institutions also play a significant role in the strategy.

Given the transitional nature of Nepal’s current situation, with a new government to be formed, a new constitution being drafted and elections for the federal state expected in 2011, the Bank Group has prepared an Interim Strategy Note (ISN) covering FYlO and 11. This jo in t IDA- IFC strategy aims to leverage Bank and IFC resources and realize synergies. It builds on the areas which have shown to be robust and to modalities o f implementation tailored to Nepalese traditions. Further, we are also taking on board the lessons o f working in countries in post-conflict situations: to be modest and to keep it simple. The strategy will improve our project’s sensitivity to the root causes o f the conflict and social tensions by adopting a “peace filter”. In addition, we are prepared to respond to possible effects o f the global downturn and/or sustained polit ical fragility.

The overarching goal is promoting the complementary processes o f pursuing peace and development. During consultations with the Government, donors and c iv i l society, three thematic pillars emerged supporting that goal. Cutting across these pillars i s the unifying goal to help Nepal to consolidate peace, the essential underpinning o f development and poverty reduction. Social inclusion runs across a l l o f these themes as one o f the foundations for the new Nepal.

The three intertwined pillars o f the jo in t IDA- IFC strategy are: (i) promoting capable state structures and systems and fostering accountable institutions which addresses the cluster o f challenges in adapting and constructing the public systems, institutions and capacities needed for the new Nepal; (ii) laying the foundation for sustainable, inclusive and equitable economic growth which focuses on over-coming constraints in the productive sector in terms o f job-creation, productivity, connectivity and sustainability; and (iii) enhancing equitable access to the benefits of growth, services and social inclusion which concentrates on expanding and honing social programs to increase opportunities and wellbeing, especially for the poor and excluded.

Proposed Bank Group Program

IDA: Nepal can benefit from an IDA15 allocation o f SDR488.8 million along with trust funds supporting global and regional initiatives. The I S N covers last two years o f IDA15 (FYlO-11) with the overall indicative envelope o f SDR332.3 million, with the average annual allocation o f about SDRl66 mill ion. IDA’S indicative lending program envisages about four to f ive new operations per year that would entail investment operations - some on the basis o f sector-wide approaches. A proposed series o f Development Policy Credit (DPCs) to address critical policy constraints would only proceed if the triggers for such lending are met. IDA’S lending program would be complemented with non-lending services, adapted to Nepal’s expectations o f just-in-time advice and taking a more programmatic approach. Consistent with the recommendation o f the recently completed Country Assistance Evaluation, we have maintained flexibil i ty in the proposed strategy which will allow US to respond quickly to the changing circumstances in the country. This includes possibility o f project redesign during supervision when this i s required to achieve results.

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i x . ILC: IFC expects to expand its exposure in Nepal by potentially committing US$15- 20 million on average annually, depending on the availability o f viable investments and improvements envisaged in the business climate. IFC’s investment program will be accompanied by technical and advisory services in areas including infrastructure, financial markets, improving the business climate and capacity building. Most o f these commitments will potentially be in infrastructure (mainly hydropower) and the financial sector. In addition, IFC will facilitate trade by partnering with Nepalese banks under i t s Trade Finance program and support projects that have a positive foreign exchange impact in sectors such as tourism, airlines and agribusiness exports.

x. Portfolio Manapement and Monitorinp Results: Weak governance and security risks make implementation even more challenging at this juncture. A comprehensive risk assessment, including governance and anti-corruption (GAC)-related risks, was used to help design the proposed strategy and to make portfolio management and business processes more sensitive to those risks. The strategy includes a partial results framework in keeping within the ISN ’s two-year timeframe that identifies key actions, processes and intermediate outputs, more than indicators o f specific outcomes.

xi. Aid Manapement and Donor Harmonization: Thirty eight donors operate in Nepal. Although the I M F ’ s last program with Nepal ended in 2007, the Government may consider renewed support. The challenge for donors i s to transition from scattered donor projects and programs outside Government to harmonized delivery through Government systems and institutions. However, Government needs to strengthen i ts capacity to manage resources efficiently with greater focus on results. Joint portfolio reviews occur with the Government and include action plans to improve performance. Sector-wide approaches are operating in the health and education sectors, and are planned for rural roads, rural water supply and sanitation, and possibly agriculture.

xii. The Decentralized Kathmandu Office: The Bank Group’s presence in Nepal has increased substantially since the end of conflict. The I F C re-opened i ts office, co- located with the Bank, in 2008 and there has been an increase in international and Nepalese staff based in Kathmandu. One o f the lessons o f working in post-conflict countries i s that the Bank tended to have insufficient numbers o f staff on the ground. This had been the case in Nepal. Already, the impacts on the timeliness and diversity o f pol icy engagement have been noted by the Government o f Nepal (GON) and other development partners in a number o f cases.

xiii. Mitipatin2 Risks: The Bank Group faces substantial risks working in Nepal, but it i s also a time of enormous opportunity. The proposed strategy attempts to take those risks into account, both in design and modalities o f implementation. Nevertheless, not all o f the significant political, social and economic risks facing Nepal can be mitigated, and the I S N proposes approaches to the portfolio in the event o f more acute and/or sustained economic and polit ical difficulty. At the same time, Nepalis have shown remarkable resilience throughout their history. Thus, this i s a period not only o f risk but also great opportunity. While many o f the political, economic and social transitions outlined in this I S N will not be completed in a two-year period, the directions which are set and the progress made in the coming years will be critical to these processes.

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NEPAL Interim Strategy Note

Motivating: the Interim Stratew

1. Nepal i s a country at a cross-roads, an “open moment” in i t s history, that if properly managed can change the nation. Over the next two years, the country will continue to confront long-standing development challenges at a time o f global economic downturn and in the face o f polit ical uncertainties. Recent events suggest that the coming period will be critical as a new government i s expected to be formed and polit ical alignments stabilize. The key challenge for the new Government wil l be to rebuild the legitimacy o f the state, sustain the peace, maintain law and ‘order, and deliver tangible benefits to those traditionally excluded and to society at large. It will be undertaking several diff icult transitions at the same time. Despite the very real challenges, together the transitions present an opportunity to move to the goal o f a “new Nepal” which i s stable and peaceful, inclusive o f a l l i t s citizens, prosperous and accountable to i t s people. The transitions include:

Moving from conflict topeace. While hostilities have ceased, Nepal i s s t i l l seeking to secure a robust peace. Consolidating peace remains the overarching priority for the country. Ongoing violence, regional tensions, c iv i l disturbance and considerable polit ical fragility slow the consolidation o f the peace and create risks o f escalation. At the same time, Nepal did not have a typical conflict period collapse. The basic administrative systems o f the state continued to function during conflict, growth slowed but remained mildly positive, and progress on key social indicators and access to basic services did occur. Policies to build a robust peace underpin developmental policies, and successful implementation o f developmental policies will help to build sustainable peace. Defining the new republican Nepali state and “rules of the game” in the post- monarchy era. Traditionally, Nepal has had feudal polit ical relations, with power concentrated among certain social groups and geographically in the Kathmandu Valley. The conflict, the popular uprisings o f Jana Andolan I1 in 2006 and the 2008 election results provided a mandate for changing the polit ical dispensation and power structures that was unimaginable only a short t ime ago. While important steps have been taken - such as agreement by a l l parties on a “federal” republic - recent events indicate that defining the new state in the constitution will present major challenges for building consensus across party, regional, ethnic and social lines. Transforming social and economic relations. Nepal’s traditional social relations marginalized many o f i t s diverse social groups and a clear mandate exists for greater inclusion o f a l l citizens in the “new Nepal”. The opportunity and challenge in light o f this mandate i s to create a notion o f shared citizenship which moves away f rom traditional patronage politics and results in competing and multiplying demands. Citizenship defined in terms o f both rights and responsibilities - based on full inclusion o f Nepal’s diverse social groups in political, economic and social l i fe - can become a solid basis for national unity.

2. None o f the transitions underway in Nepal are easy. The fact that the country faces them simultaneously increases the challenges and associated risks. The situation i s made even more diff icult in the face o f uncertainty about the potential impacts o f the global crisis

on Nepal and the timeframe over which such impacts are l ikely to manifest. However, Nepalis have shown remarkable resilience throughout their history. Thus, this i s a period not only o f risk but also enormous opportunity. While many o f the transitions will not be completed in a two-year period, the directions which are set and the progress made in the coming years will be critical to these processes. In this light, the preparation o f the Bank Group’s Interim Strategy Note (ISN) i s timely.

A. Country Context

(a) Political and Securitv DeveloDments

3. A decade-long conflict between the forces of the Government o f Nepal (GON) and the People’s Liberation Army (PLA) of the Unified Communist Party of Nepal- Maoist’ (UCPN-M) formally ended in November 2006 with the signing o f the Comprehensive Peace Agreement (CPA). The armed conflict imposed a heavy to l l in terms o f human suffering, with more than 14,000 killed, large numbers displaced (with estimates ranging from around 25,000 to 100,000 people), and unknown numbers wounded, tortured or “disappeared”. Major destruction o f social and economic infrastructure occurred, along with further erosion o f trust between the state (and i t s agents) and the population at large, particularly where the fighting was the worst.

4. Nepal’s progress since the end of the conflict in maintaining peace and defining new political arrangements has been significant, but is vulnerable to setbacks, as recent events demonstrate. In 2008 the country made progress on several fronts: it voted in a Constituent Assembly (CA), abolished a feudal monarchy, named a President, elected a Prime Minister, formed a coalition government, and set about the task o f writing a new constitution. The C A i s by far the most diverse and representative polit ical body ever elected in Nepal. The UCPN-M emerged as the biggest winner in the elections, but fe l l short o f a majority. Nepali Congress (NC), long the dominant party, finished a distant second and formed the opposition, while the Unif ied Marxist Leninist (UML) party finished third and until very recently was part o f the UCPN-M-led coalition government, which also included Madhesi parties. One o f the CA’s f i rs t acts in M a y 2008 was to declare Nepal a federal democratic republic. The Interim Constitution gives the C A two years to 2010 (with no more than six months extension) to deliver a new constitution. Political parties have been cooperating to complete this complex task, which will be followed by another round o f elections in 201 1. However, the resignation o f the Prime Minister on M a y 4, 2009, and the attendant uncertainties as efforts are made to form a new government, adds new dimensions to existing challenges.

5. While the conflict has ended, the political and security situation in the country remains challenging. Key elements o f the peace agreements are not being fully addressed, and the political discourse around these issues remains partisan. Three issues stand out as potential flash-points for polit ical discord. These are military integration and the reform o f the armed forces (with limited progress on democratization and integration o f the Nepal

Originally called the Communist Party o f Nepal-Maoist, it was renamed the Unified Communist Party o f Nepal-Maoist (UCPN-M) following i t s merger with a smaller group.

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Army and the People’s Liberation Arm?); the role o f and control over party-affiliated youth groups (which have been intensifying their tactics o f violence and intimidation); and a surge in divisive regional-cum-identity politics which also pose challenges to state building and security. In the past two years, there has been considerable unrest, mainly in the Tarai region (Box l), though also we l l beyond that, frequently bringing economic activity to a standstill through rol l ing bandhs (strikes). Government attempts to resolve this situation have been unsuccessfui. Finally, the polit ical transition has created opportunities for groups to mobilize support on the basis o f ethnic and caste identity, including Dali ts and Janajatis. Though several partners are advising on aspects o f the security sector, there appears to be l i t t le joint planning or an agreed approach with the Government.

Box 1: The Pressing Challenges in the Tarai

The Tarai, the densely populated southern plains o f Nepal, i s where much o f the country’s industry has traditionally been located. Twenty two districts make up the Tarai, which occupies 17 percent o f Nepal’s land area and i s home to nearly 48 percent o f the total population. Because o f migration from the hill regions and the porous border wi th India, the Tarai now has an extremely heterogeneous and complex population, the majority o f which are Madhesi (who officially account for 3 1.2 percent o f Nepal’s population), but with people o f hill origin making up over one-third o f the Tarai population. Apart from mainstream Madhesi political parties and representatives o f other ethnic and linguistic groupings in the Tarai representing diverse interests (e.g. Tharus), armed groups have proliferated in the past two years, adding to the sense o f lawlessness and impunity pervading parts o f the country. The declared interest o f some o f these groups i s to take control o f the region, its resources, and associated political and economic power. W h i l e some o f these groups are funded largely through extortion and derive their strength through intimidation, they also draw on long-standing feelings o f exclusion from decisions made in Kathmandu. Violence has caused government administration to s h r i n k back to district headquarters and civ i l servants and businessmen to fear l iv ing in or visiting affected areas. There i s danger that tensions between diverse political and social groups in the Tarai could deteriorate. If that occurs, the damage to Nepal’s main trading routes, investment and livelihoods could be far worse than during the “People’s War” which was largely concentrated in Nepal’s hill regions.

(b) Economic Background

6. The economy of Nepal has shown a great deal o f resilience, with modest growth averaging 3.35 percent per annum realized from FYO1/02 to FY07/08. This helped social indicators to improve impre~s ive ly .~ Prudent fiscal management was pursued, notwithstanding strong pressure for higher security spending (Table 1). As a result, when peace arrived, growth rebounded to 4.7 percent in FY07/08. This was also aided in part by good weather, the buoyant regional setting and higher tourist arrivals, among other factors.

7. During the conflict, the economy became increasingly dependent on remittances from Nepalese workers abroad, estimated as one-third o f the working age male population, or 3 to 4 mi l l ion people. By 2007, remittances from countries other than India exceeded US$2 b i l l ion and, if estimated inflows from India are included, the total approached 25 percent o f GDP. These inflows kept the economy afloat during diff icult times. Remittances contributed to higher consumption and spending on education, housing and other real

* This issue was the catalyst in the Prime Minister’s resignation, wi th open disagreement between the President, several political parties (including coalition partners) and the Nepal Army on one hand and the Prime Minister and UCPN-M on the other.

Resilience Amidst Conflict - Assessment o f Poverty in Nepal (1996-2004), 2006.

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property investment. In particular, ha l f the reduction in poverty incidence noted below i s directly l inked to remittances.

Table 1: Indicators of Macroeconomic Performance, FY 04-08

I Table 1: Indicators of the Macroeconomic Performance, FY04-08

economic Growth:

Annual Data FY04 FYOJ N O 6 FY07 wan

Period Average FYQS-QQ ~ ~ 0 2 - 0 6 F Y O ~ - F Y O ~

Government Finances: Government Revenue Growth Government Expenditure Growth Government Budget Balance1 GDP

10.9 14.4 1.3 21.4 22.6 6.5 10 9 11.8 19.9 22.8 -2.9 -2.8 -3 8 -4.1 -4.0

Balance of Payments

Expolt Value Gmwth (in US$) 14 7 11.2 2.2 4.9 6.9 impolt Value Gmwth (In US$) 15 8 12.2 17.3 11.9 14.1 Current Awunt Balance IGDP 2.7 2.0 2 2 0.5 1.2 Gross Foreign Exchange Reserves 8.2 7.4 7.6 7.5 7.0 (in months of impolts of goods and selvices)

Monetaly data Broad Money Growth Domestic Credit Growth

Inflation: consumer prices

12.8 8.3 15.4 14.0 18.0 9.0 13.9 16.3 12.0 21.2

13 9 8.3 22.0 13.1 6.9 21.4 -7.3 -3.5 -4.1

6.5 5.3

-8.6 7.3

5.9 13.0 0.9 7.3

17.0 10.2 16.0 18.5 11.1 16.6

4.0 4 5 8.0 6.4 8.0 8.0 4.8 7.2

memo:

NPV of debt, in percent of

Nepal: Indicative External Debt Burden Indicators Indicative ThreShoM 2004105 2005106 2006107 Projected Average (2007108- 2027128)

EXPOltS 150.0 172.0 163.0 148.0 116.0 GDP 40.0 28.0 25.0 22.0 15.0 Revenue 250.0 213.0 211.0 163.0 114 0

Debt Secvices. in percent of Expolts 20 0 9.0 9.0 11.0 7.0 Revenues 30.0 12.0 12.0 12.0 ’ 6.0

Source. GaN. IMF and Staff csurnaes.

8. Some projections for FY08/09 put annual growth at around 3.5 percent, less than the 4.7 percent achieved in FY07-08. Besides the deteriorating economic environment, growth in FY08/09 has been affected by floods during the last monsoon season, poor rains this winter, and serious power shortages across the entire country. Given the present global uncertainties and labor unrest, growth for the next two years o r so will l ikely be less than what the Government would l i ke to see.4 On the fiscal side, projections for the fiscal deficit in FY08/09 stand at about 4 percent o f GDP, in l ine with past performance. So far, FY08/09 has been a banner year in terms o f revenue collections, which have jumped 34 percent largely reflecting the GON’s greater collection efforts. At the same time, capital expenditures have fallen by 17 percent, reflecting the learning curve that the new G O N was undergoing in managing i t s development program. Because o f the cash build-up, the GON suspended i t s borrowing program for the last six months o f the current fiscal year. At the same time, Nepal’s balance o f payments continues to be in surplus, despite i t s chronic trade deficit, thanks to remittances which have continued to increase to date. Foreign exchange

The Government i s working on a medium-term framework starting FY09/10. An IMF mission had been expected in the near future to assist in the budget process and to help frame a set o f consistent medium-term projections. The Bank team i s in contact with the Fund to assess the timing of next steps.

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reserves remain ample - equivalent to about nine months o f imports. The banking system, while underdeveloped, i s sizeable relative to some other countries in South Asia, with about one-third o f deposits in two large public banks. The past three years have seen a rapid expansion o f financial institutions and credit fueled by loose monetary conditions and aggressive lending by smaller, newer banks. Non-performing, polit ically motivated lending and willful defaulters, along with weak regulation and compliance, underscore the vulnerabilities o f the system and the need for continued strengthening o f the financial sector.

9. While stable macroeconomic management and modest growth over the past decade are to Nepal’s credit, this performance underscores the opportunity costs that conflict imposed on the economy. Nepal has fallen behind i ts neighbors on many fronts. Domestic investment during the past ten years has been low as compared to the 1990s. This i s particularly evident for public sector investment, which was typically about 5-6 percent o f GDP in the 2000.5, two percentage points less than in the 1990s. Private sector investment f e l l quite sharply as the conflict expanded, but has rebounded somewhat. Private investment increased two percentage points o f GDP in FY07/08, reaching around 18 percent o f GDP, although there i s concern that this might have helped fuel a real estate price bubble. The structure o f the economy has shifted gradually over the conflict period: agriculture now stands at about 33 percent o f the economy (down from 38 percent), industry at about 16 percent (down from 20 percent), and services have grown to 51 percent. This mirrors what has been happening in the labor force, and the urban-rural shares o f population: the rural population has dropped to about 80 percent from 84 percent o f the total. Nepal continues to rank poorly on measures such as “Doing Business”, and largely missed benefiting from the robust growth o f i t s two neighbors, India and China.

10. The dependence on remittances has made Nepal increasingly vulnerable to the adverse impact o f the current global financial crisis. As Nepal i s largely isolated from international financial markets, the direct impact o f the crisis so far has been minimal.5 Nevertheless, indirect negative effects are expected on export proceeds, tourist arrivals and remittances, which could affect the balance o f payments, local consumption, savings and investment and the overall fiscal position. Tighter liquidity, fall ing collateral value and increased defaults could also potentially impact the financial sector. Among these risks, a significant drop in remittances would be the most serious. N o t only are remittances the country’s single largest source o f foreign exchange - with exports at only 7 percent o f GDP - they are a major source o f income spent on consumer goods (often imported), services such as health and education, and investment in housing and small businesses. Cutting o f f this l i fe l ine could have a serious impact on growth and the ability o f vulnerable groups to make ends meet. The discontent o f the unemployed, combined with returning workers facing poor employment prospects in Nepal, might spill over to an already delicate social situation. The risk o f further deterioration o f law and order would only exacerbate the weak investment climate, worsening the overall situation.

11. Still, Nepal has a number of strengths as it manages its economy over the next two years. The nature o f Nepal’s exports and i ts tourism sector, combined with available data on

According to the Bank’s policy note, “The Global Economic Crisis: Assessing Vulnerability with a Poverty Lens”, o f February 2009, Nepal’s exposure to the crisis i s considered medium, with the country having some fiscal space to react to the crisis, along with a medium institutional capacity to do so.

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remittances to this point, suggest that the impacts on Nepal are l ikely to be gradual.6 To date, remittances, tourist and export flows are maintaining the 2008 levels although, in the case o f remittances, it i s too early to say if recent inflows represent one-time repatriation o f saving^.^ The balance o f payments position now appears manageable, as fall ing remittances are l ikely to feed into lower demand for imports (and could even help cool an overheated property market). Moreover, Nepal’s debt levels are l ow by international standards, and i ts fiscal situation, albeit fragile, benefits from impressive revenue growth and liberal aid availability (80 percent o f capital expenditure and 28 percent o f the total budget). This ought to give Nepal some room to run a counter-cyclical policy. Finally, despite the conflict, Nepal retains much o f the basic infrastructure, functioning bureaucracy and local service delivery mechanisms to meet many o f the economic challenges for inclusive growth. These are assets on which it can build. Nonetheless, the pace and severity o f the crisis witnessed elsewhere in the developing wor ld - combined with Nepal’s fragile situation and the additional uncertainties due to recent polit ical developments - strongly caution against complacency. Key indicators (in particular net labor migration and remittances) require careful monitoring and the Government and donors should develop contingency plans. B o x 2 discusses the country’s macroeconomic outlook and challenges.

(c) Povertv and Social DeveloDment

12. Nepal i s one of the poorest countries in the world, with GDP per capita of US$470, and with adverse, though improving, social indicators.8 In 2007/08, it ranked 142”d in the world on the Human Development Index, with l i fe expectancy o f 63 years and adult literacy at 63 percent for 2008.’ In addition to i t s poverty, the armed conflict which ran from 1996 to 2006 imposed a heavy to l l in terms o f human lives. Nepal also presents a range o f diversities which contribute to a r ich cultural fabric but create challenges for state building. These include diverse topography o f mountains, hills and plains, with some o f the most remote and inaccessible areas in the world. The country has huge ethnic and linguistic diversity and wide discrepancies in social and economic standing depending on geographic location, ethnicity, caste and gender.

Most o f Nepal’s exports, 70 percent, are commodities sold to India. With respect to tourism, about 60 percent o f tourist arrivals are from Asia, with India accounting for the single largest share (20 percent) (2007 figures). ’ Recent data on remittances show a significant increase, likely partially due to exchange rate depreciation. Ne t migration o f Nepalis i s s t i l l positive, wi th local labor agencies expecting most foreign labor contracts to be honored. T h i s could change, however, when contracts expire and are not renewed. * The GDP per capita figure i s the GON figure. The World Bank estimates GNI per capita (Atlas method) as US$340 per-capita in 2007.

Literacy based on UNESCO EFA data for population 15 years and over.

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Box 2: Nepal Development Strategy Paper and Growth Assumptions

The draft National Development Strategy Plan (FY10-12) aims to “bring about visible positive changes ir the lives o f common people through lasting peace and promoting economic dynamism with distributivt justice”. The overarching goal o f draft NDSP i s to promote the complementary process o f promotini development and sustaining peace though inclusive growth and expanded services to the people. To meet the expectations o f i t s people, the draft NDSP aims for an ambitious target o f 7 percent GDE growth in FY10, rising to 8.5 percent in FY12. To achieve this outcome, it assumes that with peace an( political stability, higher and more efficient expenditures can be made in social sectors and economic infrastructure. It also assumes that the private investment climate will improve significantly, with change! in industrial policy and institutional reforms that include improved law and order and increased flexibiliq in labor markets. IPPs would start investing in the power sector as impediments to investment are removed Also assumed i s fairly expeditious recovery of India and the rest of the world from the global recession an( good weather conditions that support agriculture. With expansion o f economic and development activities revenue collection and aid absorption capacity are also expected to increase. If most of these assumption; - particularly regarding policy improvements and stability - are met, growth can reach or even exceed ! percent annually in the medium term. But the Government recognizes that downside risks are significant in the coming few years. The growtl scenario i s at risk given the global downturn that affects Nepal’s major trading partners and destinatioi economies for Nepali migrant workers. Internal disturbances could continue in the run-up to the nex election as the new constitution i s drafted, and the investment climate may not improve if labor militanc! and load shedding continue. A more conservative range of scenarios during the I S N period i s presented below, taking into consideratioi these risks and the current level o f economic activity, the impact of global downturn on Nepal’s majo trading partners and the limited ability of the economy to take advantage o f India’s growth. The lower end o f the ranges are realistic projections for the coming years and are the basis of the framework for the IS>

riod.

GDP growth (real)

GDP per capita (US $)

GDP Deflator

Inflation (CPI) As oercent of GDP - Fiscal Revenues

Grants

Total expenditures

Current Exp.

Capital Exp.

Deficit before grants

Deficit after grants

Financing

Dom. (net,incl.adj.)

External (net)

Historical av.

1990 Av.2002- S 2007 2008

4.9 3.2 5.3

194 313 468

69 118 146.1

10 5 7.7

9.0 11.2 12.8

1.7 2.1 2.8

16.4 15.0 17.6

10.3 10.5 11.2

6.8 4.8 6.5 7.4 3.9 4.8

5.7 1.8 2.0

5.7 1.79 2.03

2.3 0.4 0.6

3.4 1.4 1.4

WB estimates

2009 2010 2011 2012

3.6 3.5-4.3 3.8-4.8 4-5.5

461 487 516 548

161.2 172.5 182.8 193.8

12.0 7.0 6.0 6.0

15.0 15.2 15.5 15.5

3.0 3.0 3.0 3.4

18.3 19.1 20.4 21.5

13.3 13.5 14.3 15.0

5.0 5.6 6.1 6.5

3.3 3.9 4.9 6.0

0.3 0.9 1.9 2.6

0.28 0.90 1.90 2.60

0.4 0.9 1.1 0.4 0.5 1.0 1.5

(0.6)

National Development

3.9 8.1

5

14.5 16.7

4.0 5.1

22.5 25.6

14.6 15.0

7.9 10.6

8 8.9

4 3.8

4 3.7

2.6 1.7

1.4 2

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13. While Nepal remains a very poor country, progress on a number of social indicators has been impressive, especially in light o f the conflict (Table 2). Between the mid-1990s and mid-2000s, the poverty rate and gap f e l l sharply,” and MDG indicators such as primary enrollment, educational gender parity, under-5 mortality, infant mortality (IMR) and immunization coverage improved markedly. However, some o f these successes create new challenges, such as meeting the “bulge” o f children entering secondary education, and some o ld problems (in particular, high malnutrition rates among children) remain. Inequality has r isen to the highest level in South Asia and presents a major challenge to contain and, if possible, reverse.

Indicator Headcount poverty rate Gini coefficient

Net primary school enrollment Gender parity ratio in primary

Table 2: Selected Social Indicators for mid-1990s and 2000s, Various Years

Mid-1990s Latest available 42% (1995-96) 31% (2003-04) 34.2 (1995-96) 41.4 (2003-4)

67.5% (1995) 89.1% (2007) 0.66 (1995) 0.96 (2007)

Under 5 mortality rate (per 1000) IMR (per 1000 live births) Full immunization coverage

I education I I I

118 (1996) 61 (2006) 79 (1996) 48 (2006)

43% (1996) 83% (2006)

14. A distinctive feature of basic service delivery in Nepal i s the importance of community involvement. To some extent this was always present in the absence o f the state in remote regions. Community involvement in service delivery i s increasingly evident in recent years in education, health care, rural water and sanitation, micro-hydro and community forestry. While in some areas the spread o f community management was accelerated by the challenges for Government during the conflict, in sectors such as education it built o n a long tradition o f community involvement (Box 3).

Box 3: Community Service Delivery of School Education - a Unique Nepalese Tradition

Unt i l 1939, only two government schools delivered modern education in Nepal. The establishment o f the f r s t community school in 1940 marked the beginning o f community initiatives in education. Every school established in Nepal from 1940 to 1971 was a community school. In 1971, the government replaced community-based boards o f directors with government-appointed committees. The most glaring negative consequences o f government management o f schools were teacher absenteeism and a serious fimding gap. Responding to extreme public dissatisfaction wi th school quality, the Parliament in 2001 amended the Education Act, paving the way for the transfer o f public schools back to community management. The cornerstone o f the amendment was the formation o f school management committees (SMCs) comprised o f parents, thereby making SMCs accountable to parents. SMCs have wide ranging powers that include hiring teachers, mobilizing resources, power to approve budgets and al l expenditure decisions. In 2002, the government announced a program o f voluntary transfer o f schools to communities wi th an assurance that it would continue to provide financial and technical assistance. To date, communities manage over 20 percent o f schools with the support o f the donor community, including IDA, under an ongoing SWAp. Community management has benefits which include increased levels o f resource mobilization, community monitoring, community participation in school activities and greater commitment o f teachers.

Updated poverty statistics w i l l not be available before 20 1 1. 10

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B. Government o f NeDal’s Emerging Development Stratew

15. Nepal’s development agenda is closely intertwined with its peace building agenda. The CPA broadly defines key success criteria for achieving peace and development in Nepal, among others, as: (i) ending discrimination o f a l l kinds; (ii) state restructuring and enhancing the state’s accountability to citizens, people’s empowerment, provision o f fundamental rights and access to basic services; and (iii) better governance, including economic and social rights, transparency and anti-corruption. The theme o f change i s one that the voters o f Nepal have clearly endorsed, but what this entails - and the constraints to be overcome - remain uncertain. The high hopes o f the population create challenges for policymakers in terms o f expectations on the scope, depth and timetable for change.

16. The Maoist coalition Government prepared a draft development strategy built on the foundations o f the Three Year Interim Plan prepared by the previous seven party coalition Government. The vision i s to build a peaceful, prosperous and just new Nepal. The Government initiated preparation o f this three-year National Development Strategy Paper (NDSP) in November 2008. The idea was to build on the existing Three-Year Interim Plan (which ends in FY09/10), extending it to FY11/12. A draft strategy was shared with the donor community in April 2009 for comments.” The National Planning Commission Vice Chairman drove the NDSP process, with technical teams focusing on the macro framework, economic policies, social sectors, infrastructure and governance. The NDSP will be further reviewed and refined after the new government i s formed. A Nepal Development Forum i s expected to be held sometime thereafter.

17. The draft NDSP outlines GON’s approach to peace and development in the country. I t elaborates on the peace building agenda and the mutually reinforcing linkages between peace and development. The overarching vision o f the draft NDSP i s a peaceful, prosperous and integrated Nepal, which assures both efficiency and distributive justice to i t s citizens. To this end, the objective o f the draft NDSP i s “...to bring visible positive changes in the lives o f common people through lasting peace, and promoting economic dynamism with distributive justice”. The NDSP draft notes that it builds o n the Three-Year Interim Plan, the Interim Constitution o f Nepal and the Millennium Development Goals (MDGs). In pursuing the vision and objectives, the draft NDSP outlines the fol lowing priorities which reflect a high degree o f convergence with those in the Three Year Plan:

0

0

Social development.

Sustainable peace building.

Pursuing employment-oriented and broad-based high economic growth. Improved governance and service delivery systems. Investment in infrastructural development (physical, social and economic).

Inclusive development and targeted programs.

Harnessing international cooperation and regional economic prosperity for national development (including trade integration and foreign direct investment).

Consultation Draft o f Nepal Development Strategy Paper, National Planning Commission, April 2009.

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18. I n addition to these strategic priorities, the draft NDSP identifies a number of more specific “major thrust areas” which received wider support during NDSP consultations. These include:

0

0

0

0

0

19.

Agricultural transformation, with a focus on commercialization o f agriculture and food and nutritional security. Specific infrastructure focus on hydropower, irrigation, roads and airports, tourism, information and communications technology, institutional infrastructure and reforms in trade and investment policies. Empowerment o f the population in governance and judicial reforms, and service delivery by governmental, non-governmental and private sector actors. Emphasis on basic social services, notably basic and secondary education, health services, and water and sanitation. Emphasis on social security and inclusion, especially for vulnerable groups such as disabled people, women, the elderly and marginalized social groups, as well as commitment to including such groups in the public sector and developmental programs.

As i s appropriate given Nepal’s recent history, peace building receives special attention in the current version of the NDSP. The draft NDSP notes that i t s peace and development strategies are “intertwined in a holistic and comprehensive framework o f peace and development so as to ensure synergies between the opposite faces o f the same coin”. The priorities under the peace building pi l lar o f the draft NDSP therefore reflect a mix o f policies and directions which are directly related to deepening the peace process, and others which reflect broader objectives o f social harmony and equitable development, with an eye towards promoting socio-economic conditions conducive to avoiding future conflict. The measures specific to the peace process include: delivering on the commitments under the peace process, in particular the CPA; supporting peace building institutions (including local ones), strategies and processes; relief, rehabilitation, reconciliation and reintegration o f conflict-affected persons; security sector reforms; cantonment management; and transitional justice. The broader “conflict prevention” priorities include: promoting employment through public works; inclusive and democratic state restructuring; having a “pro-peace” constitution; and addressing socio-economic disparities in both spatial terms and across social groups. The polit ical developments o f M a y 2009 highlight the importance o f the peace agenda but also the ongoing challenges and complexities that it involves.

C. The Bank Group Interim Stratem

(a) Proposed Approach of the Stratem

20. I n light o f the transitions currently underway in Nepal, we propose to present an Interim Strategy covering FYlO and FY11.12 The ongoing peace process i s s t i l l fragile, with many milestones yet to be met and risks o f further setbacks; the polit ical transition will not be complete until approval o f a new constitution in 2010/11 and fresh elections in 201 1;

l2

Products dated March 2006. T h i s i s consistent with OP 2.10 and OP 2.30, along with BP 2.30 and the Guidelines to Staff for CAS

10

the new Government to be formed after elections will need time to translate i t s vision for the new Nepal into specific policies and programs that the Wor ld Bank Group could support. The current global economic crisis adds further uncertainty. An Interim Strategy will thus help the Bank Group and the Government exercise the flexibility needed to deal with these uncertainties and lay the basis for a full Country Assistance Strategy (CAS). As a contingency in light o f the electoral cycle, we are including in this I S N a tentative outline o f a FY 12 program. This has the added advantage o f synchronizing with the three-year planning horizon used by Government and the rest o f the donor community. This I S N follows the f i rs t Interim Strategy for FY07-09 and the last CAS for FY04-06.13 The proposed ISN reflects considerable continuity with both the last CAS and ISN, emphasizing the areas o f strength but suggesting more flexibility to respond to opportunities and challenges (see B o x 4 and Appendix IV on the findings o f Independent Evaluation Group’s Country Assistance Evaluation).

21. We are also taking on board the lessons of working in countries in post-conflict situations. The first lesson i s to be modest in terms o f outcomes. While Nepalis have demonstrated strong resilience, the current transition i s demanding on a l l actors in society. These demands would only increase if Nepal were to confront at the same time a significant economic downturn. We will focus on fundamentals and step-by-step change, as Nepal’s capacities will be stretched and could be diverted from long-term development to immediate needs should the peace progress falter andor the impact o f the global crisis manifest i t s e l f in a sharp downturn. The second lesson i s the need to be sensitive to the root causes o f the conflict and social tensions. Some actors may value peace and stability over efficiency and equity, while others may take advantage o f the transition to press for their own interests. This may make structural reforms more diff icult. The third lesson i s to remain flexible and open to changes in the lending program as wel l as restructuring projects in response to evolving circumstances. Analytical work must also be designed to be timely and responsive to rapidly evolving needs. While the above lessons are crucial, in many pol icy areas the Bank Group can continue to share global experiences, help lay the foundations for state building, and continue to help improve basic service delivery for Nepal’s poor.

22. Nepal has been selected as a Bank Group-wide pilot country for a fully integrated and enhanced joint strategy which leverages Bank and IFC resources and realizes synergies. Building upon the co-location o f the IFC and Bank offices, the past year has seen greater collaboration and interaction between the Bank and IFC in Nepal, particularly in financial markets, infrastructure and business enabling environment. In preparing this jo in t strategy, IFC and Bank staff held sector-specific consultations and jo in t ly participated in drafting and reviews. In addition, private sector consultations led by I F C in Kathmandu were coordinated with the Bank team and IFC advised on the jo in t donor consultation agenda. Such interactions, supported by the IDA- IFC Secretariat, are to continue during I S N implementation.

The f i rs t ISN, dated January 22,2007, Report no. 381 19-NEP, covered 18 months to August 2008.

11

13

Box 4: Observations from the Previous CASDSN Implementation

The Independent Evaluation Group (IEG) has prepared a Country Assistance Evaluation (CAE) to be discussed with the Committee for Development Effectiveness in May 2009. The CAE examines whether: (a) the objectives of Bank assistance were relevant; (b) the Bank’s assistance program was effectively designed and consistent with i ts objectives; and (c) the Bank’s program achieved its objectives and had a substantial impact on the country’s development during this period.14 During the period covered (FY03- 08), IEG considers that the goals of the Bank assistance program remained broadly aligned with the 2003 PRSP: improving governance and development effectiveness by bringing resources to grassroots levels, but with increased emphasis on growth and inclusion.

Wh i le recognizing that Nepal’s considerable political turmoil and changes had a major impact on CAS implementation during the period under review, one o f the CAE’s conclusions i s that l i t t le progress was made against CAS stated objectives in two of the four main strategic themes - achieving broad based growth and good governance. T h i s was partly because specific objectives under these two pillars are considered by IEG to have been unrealistic and overly ambitious given country circumstances. On the other hand, IEG’s evaluation concludes that some progress was made in social inclusion, especially with regard to mainstreaming inclusion in sector projects and, to a lesser extent, achieving greater diversity in the civil service. IDA’S program was most relevant and successful in social development, particularly in improving and expanding health services, significantly increasing access to basic education, and increasing access to safe drinking water in rural areas. In addition, even in those pillars showing less progress in meeting objectives, there were some notable achievements despite the very difficult country circumstances.

Based on these experiences and in light of the challenges ahead, IEG believes that IDA should inject more realism into future country strategy and program design, retaining flexibility to adjust to changing country circumstances and consulting widely with national stakeholders and development partners throughout program design and implementation. In terms o f sectors and instruments, the CAE recommends: making agriculture and rural development the centerpiece o f the assistance program; establishing a mechanism to track the impact o f the PAF on poverty and social inclusion (and adjusting its design as needed to optimize the benefits to the poor and socially excluded); and continuing support for public finance management and other institutional reforms through policy-based lending, if feasible, or through sectoral SWAPS which have proven successful in health and education.

Regarding IFC’s operations in Nepal, the IEG notes that as the political and security situation deteriorated in 1999, IFC withdrew its local field presence and had very limited activities from 1999-2006. IFC’s inability to develop successful investment projects through much of the decade can be largely attributed to the difficult investment environment. Since 2006, IFC’s gradual re-engagement in Nepal has resulted in two GTFP investments, an investment in a domestic airline, a pipeline of investment projects in the financial sector, and a constructive dialogue with the government on business enabling environment issues. T h i s approach o f cautious re-engagement has the potential for replication in other post-conflict countries.

(b) PrinciDles Underlvinp the Stratew

23. In light o f the above challenges the Bank Group’s strategy should:

Be driven by and aligned with country priorities. In addition to grounding i t s thematic and operational priorities in the Three Year Interim Plan and draft NDSP, the strategy has followed a participatory process to ensure that the alignment with country priorities reflects a representative spectrum o f views in Nepali society. Joint consultations with ADB and DFID in three regions o f the country and Kathmandu

l4 The CAE covers three CAS documents: (i) the CAS Progress Report discussed at the Board in December 2002; (ii) the CAS presented in November 2003; and (iii) the Interim Strategy Note presented in February 2007.

12

gathered the inputs o f a wide range o f c iv i l society actors into the strategy development process. An ongoing client perception survey will also contribute to framing how we implement the strategy. An overarching element o f the strategy i s to be fully supportive o f the consolidation o f peace in Nepal, which i s the sine qua non o f stability and development.

Be harmonized and coordinated with the support provided by other development partners using common management arrangements where feasible. For the ISN, jo in t strategy consultations have been undertaken with ADB and DFID. In addition, the Ministry o f Finance i s completing a mapping exercise o f donor support in a l l sectors to provide the basis for discussions on how to increase complementarity and selectivity across donor programs. To provide an improved framework for aid effectiveness, the Ministry o f Finance has prepared a draft new foreign aid policy inspired by the Paris Principles and commitments made in Accra and Doha. An action plan on aid effectiveness has also been developed and i t s implementation will be monitored during the ISN period.

Build on the Bank’s and IFC’s areas of comparative advantage and capture synergies. Because -of the strong presence o f other development partners and because o f our own capacity constraints, the Bank and I F C have to be selective in Nepal, based on our strengths and areas where we have the human and financial resources to deliver.

Retain a degree of modesty, consistent with the country and global environment and timeframe o f the ISN. Given the multiple uncertainties, the I S N should not propose an overly ambitious program. Activities will concentrate on areas where the Bank Group has demonstrated strengths and a cautious “one step at a time” approach in areas o f expanded or new engagement. In addition, the program needs to have a “do no harm” approach which places emphasis on the sensitivity to conflict.

Be flexible to respond to the fluid situation and Nepal’s evolving needs. This i s especially so in light o f the global downturn and Nepal’s complex polit ical situation and points to the need for “just-in-time” responses. Careful monitoring o f the impact o f the crisis on the country should conditions worsen will be critical. The short-run responsiveness o f the program to the uncertain impacts o f the crisis i s unusually important and underlines the need for careful attention to governance, enhanced portfolio monitoring and risk mitigation strategies.

(c) The OverarchinP Goal and Prouosed Pillars o f the Interim Stratew

24. Reflecting the above challenges and principles of engagement, three thematic pillars have emerged that support the overarching goal o f pursuing the complementary processes o f consolidating peace and promoting development. Consultations revealed a strong consensus on the three themes and the relevance o f the donor community in helping Nepal address them. There i s also a demand for strategies and approaches that would function regardless o f the risks that the country faces in the next few years. This recognizes that progress on Nepal’s main transitions i s hard to predict, even more so in light o f the

13

recent polit ical developments and the current global financial crisis. Nepal’s main transitions could proceed steadily (albeit at different speeds), they could stall, or there may even be deterioration with external developments exacerbating local conditions. The proposed I S N program aims to be durable and robust to these eventualities. The broad stance o f the Bank Group’s approach, the proposed pillars and options - with peace and readiness to respond with emergency support as cross-cutting themes - are outlined below.

25. I n designing the ISN program, we have focused on strengthening the implementation and performance o f the current portfolio. The overall emphasis i s on “keeping it simple”. Firstly, this means having a solid core o f the program which either involves completing existing operations or building on past areas o f effective engagement. This should enhance the robustness o f the program to the uncertainties in the present environment. Secondly, it means continuing the emphasis on community-based operations, while opening cautiously in other areas. With new or expanded areas o f engagement, the strategy i s to start small and expand based on a track record o f performance. Thirdly, it means minimizing the number o f projects which may place high demands on project implementation capacity and fiduciary systems.

26. We have also structured the I S N to be prepared for the contingency o f a significant decline in economic growth arising from the current global crisis. It this were to happen, it would l ikely be triggered by a significant decline in foreign exchange earnings, especially from remittances, Nepal’s area o f greatest vulnerability. This would fuel fall ing consumption, revenues and liquidity, weakening both the state’s capacity to respond to the crisis and the financial sector’s ability to counteract the negative impacts. The slowdown in economic activity would have the dual effect o f increasing poverty and aggravating social tensions. Hence, in preparing the ISN, we were conscious o f the need to preempt if we can and respond in case an emergency response i s needed, identifying those areas which are amenable to quick turn-around and quick impact.

Overarching Goal: Building a Peaceful, Prosperous and Just New Nepal

27. Cutting across the I S N pillars i s the unifying goal of helping Nepal to consolidate peace, the essential underpinning of development and poverty reduction. IDA’S direct contribution to the peace process has been the financing for compensation to conflict-affected groups through a transparent process under the on-going Emergency Peace Support project. The Bank would also support South-South knowledge exchanges on peace building efforts with countries such as South Afr ica and Rwanda. As well, sector operations such as education, health, rural roads, irrigation and water supply, could address some o f the immediate needs for reconstruction o f damaged public facilities. Based on our engagement to date, comparative advantage and the current programs and plans o f other partners, it i s proposed that IDA continue to be selective in engaging on other aspects o f direct peace building supp~rt.’~ Equally, IFC’s contribution toward peace building would be v ia the second order effects o f i t s focus on investment, improving the husiness climate and job creation, and could come in the future through linkages and community programs associated

A range o f donors are involved in direct support to the peace process, including several UN agencies, the EU, DFID, India, the Norwegian, Swiss and German governments, INGOS and others. Two mechanisms coordinate programming and monitoring o f this support: the Nepal Peace Trust Fund (chaired by GON), and the UN Peace Trust Fund. Specific donorhilateral support i s described in Appendix IL

14

15

with i t s advisory and investment activities. Neither IDA nor IFC envisage direct support for security sector reform.

28. I n order to ensure that the ISN contributes to peace building in Nepal, there will be a structured effort to make the portfolio more conflict sensitive, taking into consideration the underlying causes as well as consequences o f conflict. IDA i s committed to trying to ensure that a l l new interventions “do no harm” and, where possible, enhance peace building, j ob creation, and social inclusion. This would be done through social risk analysis that would identify: (i) at the strategy level, inconsistencies between the choice o f instrument and program and the macro- and micro-level context analysis; (ii) at project design level, issues relating to selection o f beneficiaries and locations and to the real or perceived interests o f other (indirect) stakeholders; and (iii) at project implementation level, concerns relating to implementation arrangements and their consequences on voice and participation, the selection and competence o f contracted partners, and the transparency o f decision-making.

29. A specific screening tool - or “peace filter” - has been prepared and will be piloted in the coming months for projects under preparation. I t draws on best practices o f social mobilization and the extensive work by the international community over the last 10- 15 years, including efforts by the Bank, on conflict. The peace filter will help project teams to focus on a range of issues during the preparation and implementation processes, including: national and local level polit ical dynamics; the security situation in given areas of operation; transparency and accountability in decision-making and resource use; and inclusion, voice and benefit capture. In operationalizing this tool, linkages will be made with other risk assessment tools regarding governance, anti-corruption and fiduciary risk assessment frameworks, as we l l as social mobilization practices that promote inclusion. Since employment generation i s seen as a critical factor in maintaining social stability, the peace f i l ter would also track employment effects in relevant projects. The approach o f the proposed peace filter i s presented in B o x 5 and i s being piloted on a sample o f projects under preparation. Based on these pilots, the fi lter will be refined.

The Strategy’s Three Pillars

30. Supporting the overarching goal of promoting peace and development, the proposed strategy is organized around the three interlocking themes that emerged during consultations within the Bank Group and with the Government, donor partners and civil society. These are also consistent with priorities of the Three Year Interim Plan. The f i rs t pi l lar addresses the cluster o f challenges facing the state in adapting and constructing the systems, institutions and capacities needed for the new Nepal. The second focuses on overcoming constraints and bottlenecks faced by the productive sector, especially in terms o f productivity, connectivity and sustainability. The third concentrates on expanding and honing programs and activities that can increase opportunities and well-being, especially for the poor and excluded. These three pillars reinforce each other, with a more capable and accountable state essential for building confidence and pol icy predictability that then channels into an improved business climate, which in turn generates employment and demands for greater provision o f public goods and services by the state. Social inclusion runs across al l o f these themes as one o f the foundations for the new Nepal. Within each o f these pillars, the strategy identifies specific areas where the Bank Group can make a difference.

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Box 5: Proposed ‘Peace Filter’ for Bank Group Operations in Nepal

The I S N proposes a peace f i l ter tool for task teams to use in the selection, design and implementation o f operations. The intention i s to proactively seek opportunities to promote social harmony, build social capital and sustain and create jobs, as well as identify and mitigate potential sources o f conflict. The fi l ter identifies key conflict and political economy issues for task teams to consider early in project design, appraisal and supervision. The aim i s to respond to those issues which: (i) are likely to affect project outcomes in the areas where benefits are being delivered; and (ii) may arise due to the project’s operating environment. In applying the filter, task teams w i l l f i r s t disaggregate the different direct and ancillary benefits that w i l l f low from the project and may be contested by different stakeholders. Against the backdrop o f the project’s national and local context, the task teams w i l l then identify who controls those benefits, the criteria on which they are allocated and how such information i s circulated in the public domain. Teams would then integrate this information as appropriate into the risk identification worksheet developed during project preparation and appraisal. Mitigation actions to prevent harm and maximize positive impacts can then be prioritized and targeted accordingly.

The f r s t part o f the filter, drawing on poverty and social impact analysis (PSIA) tools, identifies and qualifies direct and indirect project benefits. The second part helps task teams to better understand the national and local level environment in which projects w i l l operate, and prompts them to seek information from internal and external sources. The final f i l ter would provide guidance on where such information can be found in Nepal. The last set o f questions focuses on the analysis o f important direct and secondary benefits by the different beneficiaries, decision makers and other stakeholders in order to better identify the social dynamics around given aspects o f the project as well as discuss any potential mechanisms to strengthen the positives.

The Nepal Country Management Unit i s committed to supporting this conflict-sensitive approach to operations in the country. During the I S N period, a team with ski l ls and knowledge in social and peace related areas o f analysis should be available to support task teams to apply this filter, and, more importantly, assist in appropriate follow-up o f operations during implementation.

Pillar 1: Promotinp Cavable State Structures and Svstems and Fostering Accountable Institutions

31. The ISN period will be a crucial time for the country as it moves towards sustaining peace and defining the structure of a new federal state. K e y polit ical leaders recognize that lasting peace depends on being able to deliver tangible results, and that hinges on the effectiveness o f the state in delivering on i ts promises. In this period, the country will seek to refine - and in some cases redefine - public sector management systems and the institutional framework and modalities for the interaction o f the state and i ts citizens. The Bank Group proposes to support these processes through several channels, but with a clear recognition o f the need to focus on areas o f comparative advantage within an agenda that i s very wide, contingent on polit ical consensus and where many development partners are active.

32. I n this light, the first pillar focuses on three areas o f engagement: (i) strengthening core public sector management systems which are robust to eventual decisions on the shape o f the State; (ii) making selective contributions on defining the institutional framework for the new state, with a particular focus on decentralized administration; and (iii) helping to articulate and implement new “rules o f the game”, including transparency,

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accountability, and anti-corruption among key players, including the private sector, and strengthening institutions for regulation and governance. IDA will concentrate on public institutions, while IFC will focus on corporate governance in the private sector. IFC’s init ial efforts in raising corporate governance awareness in Nepal will focus on the banking sector and on large founder-owned f i rms. Improved corporate governance in the private sector, followed by IFC investments, could be a powerful demonstration to market leaders.

33. In consultations with the GON, development partners and the country team, there is clear endorsement for IDA remaining closely engaged on core public sector management systems. This has been an area o f strength in IDA’S engagement to date and would include areas such as public financial management (PFM) reform and institutional strengthening, public procurement capacity strengthening, core governance functions, and enhanced monitoring and evaluation (M&E) systems. This support for strengthening country systems would have added benefits in terms o f facilitating donor harmonization and enhancing aid effectiveness (see para. 77). Consolidating and building on past achievements in governance and public sector management i s seen by a l l players as a sine qua non for an effective state and implementation o f public policies. It i s therefore proposed to continue support through a mixture o f analytical and advisory activities (AAA) and pol icy dialogue. The PFM agenda would also be a core element o f the proposed Development Policy Credits (DPCs) if triggers for budgetary support lending are met (see para. 68).

34. I n the field of PFWfinancial accountability, numerous challenges need to be addressed. This proposed program builds on the PFM review carried out in 2005 and the Public Expenditure and Financial Accountability (PEFA) Action Plan which benchmarks Nepal’s performance in the areas o f fiscal discipline, strategic allocation o f resources, efficiency, transparency and accountable management o f public finances. That benchmarking showed that Nepal was particularly lagging in managing payment arrears, tax collections and the effectiveness o f both internal and external audits. A recent assessment o f public sector accounting and auditing further revealed the need to accelerate movement towards internationally accepted accounting and auditing standards. IDA will continue to work closely with the Government and development partners to consolidate achievements and prioritize actions year by year. This includes sustaining technical support on basic budgeting and treasury functions; outreach and consensus building on the need for these reforms among public and c iv i l society stakeholders; leveraging information technologies such as Integrated Financial Management Information Systems (IFMIS); strengthening the audit function o f the Auditor General; and moving from rules-based to principles-based accounting in line with international standards. The I S N will also support a sound institutional development plan and strengthen performance monitoring. This will be supported through ongoing PEFA Action Plan Implementation AAA and could be included in the proposed DPCs.

35. In the area of public procurement, legal reforms have been enacted but institutional capacity needs to be further strengthened. Continuing reforms in public procurement i s a challenging task, as it requires concerted efforts at al l levels. In order to address these challenges, IDA will work closely with the Government and development partners to improve procurement performance, including strengthening the capacity o f the Public Procurement Monitoring Office (PPMO) to implement the new procurement law (developed with past IDA support), implementing e-government procurement (e-GOP) systems, helping to establish procurement performance monitoring indicators as agreed in the

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PEFA action plan, and supporting movement towards full alignment o f the procurement law with international standards. To this end, a joint Government-donor review team has developed recommendations to enforce a more effective procurement system in terms o f both policy and implementation, and IDA i s committed to implement the recommendations. IDA’S procurement engagement i s being supported through an Institutional Development Fund (IDF) grant, and could be further supported through PEFA Action Plan Implementation AAA and inclusion in a DPC program. Finally, one o f the growing concerns i s that public procurement processes are being undermined at times by acts o f intimidation to deter competition. This could affect donor willingness to provide resources through Government systems.

36. I n addition to supporting core public sector management, the I S N proposes to engage selectively on the framework for effective decentralized administration and service delivery. The work o f the Constituent Assembly in drafting a new constitution i s expected to lead to dramatic changes to the state as it decentralizes. Ensuring the viabil ity o f new levels o f government i s a key element, as i s making sure that the hierarchy o f functions and responsibilities between the new layers o f administration enhances service delivery, especially for the poor. This i s particularly important in a country which has a long tradition o f community management and where the capacities o f local bodies - where they exist - were weakened during the conflict. The C A has requested that IDA contribute to the consultative process by providing advice and analytical work on fiscal federalism, building on the above work on public financial management and global knowledge. This would center on fiscal transfers, equalization (horizontal and vertical), expenditure and revenue assignment, and the economic viabil ity o f federal states. The Bank team proposes to produce a series o f notes and workshops under a Fiscal Federalism AAA funded by the Governance Partnership Facility (GPF) (see para. 37). Complementary to the Bank’s support for community-driven development (CDD), we would engage in a dialogue on the role o f local governing bodies, which i s being coordinated by the GON through the Local Governance and Community Development Program (LGCDP). A proposed Local Governance Study under the GPF or other trust fund would help to further define options for what could be an appropriate engagement for IDA.

37. The broader governance and anti-corruption agenda is also part o f this focus on building the new state. Rethinking the role o f the state and i ts attendant core institutions under the new constitution creates a window o f opportunity to strengthen Nepal’s governance framework. Nepal presently rates relatively poorly on governance measures, with corruption one o f the growing concerns. Anchoring this part o f the proposed strategy would be efforts to enhance transparency and accountability, strengthen citizens’ voice and engagement, promote performance-results based results management and establish new “rules o f the game”. The specific areas in which IDA proposes to engage are: (i) advice and assistance to promote and operationalize the potentially powerful new Right to Information (RTI) Law. This would include the “demand” side o f promoting use o f the RTI to access information and the “supply” side o f the capacity o f public agencies to be responsive to RTI requests; (ii) . support to strengthen social accountability mechanisms in service delivery, including non- lending TA on demand side approaches in Bank operations and country systems, and technical advice, capacity building, and grant funding for mainstreaming social accountability tools (e.g. citizens score cards and social audits); and (iii) strengthening M&E systems both at national level and sub-national levels, including participatory approaches. The umbrella tool for this engagement would be the recently-approved GPF for

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implementation o f governance and anti-corruption (GAC) initiatives, with specific outputs in the identified areas such as a Social Accountability Mainstreaming Review and Right to Information Implementation Non-Lending TA. Enhanced project supervision and use o f tools such as technical audits would complement this effort.

38. The interface of the state and the private sector i s a further important area o f activity. In terms o f the new rules o f the game, IDA and I F C would exploit their respective comparative advantage. IFC would focus on corporate governance and improvement in investment climate v ia support for the Business Advisory Forum which will facilitate public- private dialogue, while IDA would support regulatory reform in banking and telecommunications, for example, and the role o f the Central Bank in banking supervision. Possible reform o f the Bankruptcy L a w i s another area for IFC. IDA would also help the new Government develop a framework for public-private partnerships (PPPs), and IFC would provide support for PPP projects through transaction advisory services and investment, once a functional PPP pol icy framework i s in place. Some o f these themes could be part o f a possible series o f DPCs.

Pillar 2: Laving the Foundation for Sustainable and Inclusive Economic Growth

39. As in any country, the key driver for sustainable poverty reduction in Nepal is growth. In the case o f Nepal, this dimension has heightened importance because o f the sensitivity o f sustaining peace to the generation o f tangible benefits for the population and risks o f the global crisis. As a result, the Bank will continue to monitor macro-developments and to assess the economy’s vulnerabilities particularly with respect to remittances and the financial sector, and will engage with the new Government to examine mitigation measures and contingency planning. Over the longer term, with an improved global situation and lasting peace, higher growth performance i s feasible. This wil l require renewed consumer and business confidence and reductions in the costs o f doing business. Actions are needed on several fronts. The f i rs t i s maintaining macro-economic stability and increasing fiscal space for growth and, second, improving the investment climate for private sector-led growth through implementation o f reforms that remove structural and regulatory constraints, enhance accountability, and increase policy predictability. However, it should be stressed that a critical prerequisite for increased private investment i s an improvement in the law and order situation in the country. On the fiscal front, on-going non-lending TA i s focused on preparation o f a Medium-Term Expenditure Framework and the centrality o f the budget as an instrument o f policy. This will be enhanced by a Public Expenditure Review (PER), with a focus on critical sectors, including health, education and roads (including maintenance).

40. Cognizant of the ISN’s two year coverage, IDA and IFC will adopt a two- pronged approach under this pillar. This entails helping to lay the foundations for achieving higher growth and employment in the medium to long term, and focusing immediate attention on enhancing productivity. Nepal has considerable untapped potential for long-term growth: i t s hydro-power and water resources are vast and it i s we l l positioned between two giant markets - China and India. Numerous niche markets in agriculture are s t i l l to be exploited. Tourism - with Nepal’s obvious natural attractions - can also play an important role. But new investments alone will not be enough. Our approach will involve ensuring linkages between the I S N support under Pillar One on the broad governance and state building initiatives to activities under this pi l lar geared at alleviating sector constraints.

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IFC’s support for the Business Advisory Forum will be an important mechanism to build that linkage. Towards this end, the Bank Group will focus on the fol lowing areas:

4 1. Inclusive growth will require raising agriculture productivity and expanding off-farm employment. A centerpiece o f the country’s current strategy going forward i s to transform the agriculture sector f rom subsistence based to commercial production as well as to reduce on-farm underemployment and increase more productive off-farm employment. The current thinking i s to encourage high value commodities and programs to focus on market orientation and trade promotion. IDA did not have an active lending program in Nepal during the last I S N period, but i s now re-engaging with the proposed Agriculture Commercialization and Trade Project. At the same time, there are opportunities in a variety o f commodities with potential for niche market exports (e.g., tea, ginger, cardamom, specialty coffees, honey, non-timber products, horticulture, and off- season vegetables) which could be explored by IFC. While direct investment opportunities in Nepalese agribusiness companies are l imited due to size, I F C will look to support agribusiness growth through two distinct investment strategies. As a means to increase the financing flows, it will consider wholesale financing relationships with local commercial banks to increase lending. In addition, IFC will invest in funds focused on agribusiness. It has recently invested in two funds, India Agri Fund which supports agribusiness and investments in the South Asia region, and IFC SME Ventures, a global initiative which can provide direct financing as wel l as advisory assistance to small agribusiness players in Nepal for which IFC direct financing may not be available. IFC’s agribusiness advisory services can complement the work done by IDA and other donors v ia investment climate and business enabling environment work. IFC will also explore support to IDA’S agriculture commercialization project with technical assistance and investments through the IFC S M E Venture Fund. For IDA, this entails possible investment in programs that improve access to agricultural inputs - including expansion o f irrigation coverage, extension and knowledge, and access to market towns. The two past coalition governments have asked for support to address the wide gap in uptake o f improved technologies by farmers required to raise productivity, and this i s expected to remain a priority. IDA will provide analytical support within a broader policy engagement as part o f a non-lending Revitalizing Agriculture TA. These interventions and associated policy dialogue with the GON and donors could lead to a programmatic and coordinated support to the sector, possibly through a sector wide approach, down the road. To date, IDA’S focus in irrigation has been mostly on rehabilitation o f farmer- managed irrigation schemes in the hills and the Tarai. The I S N proposes to continue the existing irrigation operation and also help to develop medium irrigation systems through a proposed Small and Medium Sized Irrigation Project. However, this i s contingent upon improved performance o f the ongoing small-scale irrigation project.

Agriculture and Irrigation:

42. Infrastructure and Connectivitv: Years o f under-investment in infrastructure are partly responsible for current levels o f low economic development. This has happened across the board - in power, roads, other transport and telecommunications. Improving and expanding access i s important to reducing the cost o f doing business, enhancing productivity, and improving access to markets and information. Investment in infrastructure i s one o f the areas in which the synergies between IFC and IDA are particularly strong. IFC would need to have a solid pol icy framework in place before it could’ support PPPs, and thus IFC’s operations would be determined based on progress in establishing a PPP policy which would benefit from non-lending TA and advice from IDA. Synergies are also evident in planning for the long term. IDA could help finance feasibility studies and project preparation and

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studies to develop financially viable infrastructure projects, and I F C , where feasible, could provide long-term limited recourse financing to credible private sector sponsors and/or transaction advisory services to government to expand the private sector’s role in infrastructure. Key sectors where such support may be targeted include power, roads, renewable energy, information technology, airports and airlines.

43. The negative impact of years of under-investment i s perhaps most highly visible in the power sector with load shedding o f up to 16 hours per day in the winter o f 2008/2009. Twin actions are anticipated. First, on the supply side, in order to support the GON’s policy to jumpstart investment in power, IDA will continue to strengthen the achievements o f the on-going power sector portfolio through investments in transmission, generation rehabilitation and distribution strengthening. In the short term, emergency additional financing i s proposed for the Power Development Project. The longer-term agenda, in which both IDA and IFC will play a role, includes new medium-sized hydro-power generation and associated transmission capacity to connect Nepal to i t s neighbors for export o f power. IDA would likely keep i ts support to mid-size or smaller investments under the proposed Mid- Sized Power Generation Project if appropriate projects can be developed. IDA also initiated an ESMAP-funded AAA on Removing Barriers in Hydropower. Given the extreme shortage o f power in Nepal, IFC’s foremost strategic priority i s to support hydropower development, mainly hydropower generation across a range o f project sizes. IFC’s support for large hydro- projects, l ikely to come up for financing only at the end o f the I S N period, will be dependent on progress in establishing cross-border transmission l ines to export power f rom Nepal to India and other neighboring countries. In the near term, IFC will consider financing expansions o f existing hydropower projects, which may be the fastest available response to the power crisis. I t i s also studying early-stage opportunities where IFC could partner with the private sector and finance project preparation and studies to develop viable projects. The downside risk will come from the private sector’s lack o f confidence in National Electricity Authority’s (NEA) capacity to deliver on PPAs and a possibly dif f icult polit ical situation that deters private investment.

44. On the demand side, IDA i s providing ESMAP-funded TA to the NEA to identify and assess opportunities to improve efficiency and quality o f service, reduce peak capacity deficits, and reduce costs o f power supply through implementation o f demand side management measures. Just-in-time advisory support i s also being provided to help design and launch the NEA 2009 Compact Florescent Lights (CFL) Distribution Program which will ultimately target installation o f 450,000 o f these lights for evening peak load reduction. In turn, IFC i s l ikely to pursue opportunities with the private sector on energy efficiency, including an advisory project with local banks on Sustainable Energy Finance, and a possible Risk Sharing Facility with local banks to boost energy-efficiency lending. The objective o f the proposed Advisory Services project i s to improve the financial performance o f Nepalese industry by reducing energy costs and, at the same time, reduce emissions o f greenhouse gases.

45. Constraints to connectivity and movement of people, goods and services have been identified as root causes of conflict and low growth. Given i ts mountainous geography and land-linked position, transportation and communications are vital sectors for Nepal. At present, Nepal has some o f the highest costs o f trade reflecting both poor connectivity and the lack o f functioning trade agreements with i ts neighbors. Removing barriers (e.g. restrictions on trucks, customs procedures) and improving infrastructure would

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do much to increase trade and investment. Exports currently only account for 7 percent o f GDP and Nepal has a l o w density o f road system (less than 100 km o f road per 1000 square km o f land area, as against almost 1600 km in Bangladesh). The roads sector, one o f the consistent priorities o f public policy over time, i s an area in which IDA and IFC can collaborate. This might be the case o f strategic roads, for example, depending on the evolution o f PPPs. The road sector presents challenges: while there i s much to do in this sector, there are substantial risks. These are being addressed through close attention to sector governance, including an on-going Road Construction Sector Analysis Note which will inform planned risk mitigation measures to ensure the quality o f the current and future roads portfolio. This should also provide a base for expanding IDA investment in strategic roads under the proposed Roads Sector Development Additional Financing, which would facilitate road links to district headquarters and serve as trunk routes for planned districts roads expansion to link rural markets to production centers. This, plus an assessment done through the peace filter mechanism, should also provide a basis for undertaking the proposed Rural Access Improvement and Decentralization Project Additional Financing.

46. Assistance for emerging towns requires further dialogue to elaborate what this would entail beyond marketing and transportation links. This will be done under the Emerging Towns Programmatic AAA, which will inform a possible Emerging Towns Project. In other areas o f connectivity, IFC has recently financed a domestic airline which helps improve regional connectivity within Nepal, and could expand i t s participation in the air transport sector through advisory support to the GON on building airports outside o f Kathmandu and in supporting private airlines going into India. IDA would not likely engage in this area. In the area o f telecommunications, we do not anticipate expanding direct IDA support beyond the closing Telecommunications Project which helped strengthen government regulatory capacity, spectrum management and rural telephony. However, an ongoing trust-funded Information Inpastructure for Growth AAA would continue policy engagement, which might be built on under possible DPCs.

47. Expanding Access to Finance. Access to financial services remains limited for most people and small businesses in Nepal, even though the banking system and credit have expanded rapidly in recent years. Under the ISN, IFC will take the lead to enhance access to finance and increase financial inclusion, with IDA concentrating i t s efforts on the continuation o f central bank reform and related regulatory issues o f banking supervision under the ongoing Financial Sector TA project. IFC’s program will explore potential investment and advisory services for the following: (i) institution building (supporting strong, we l l managed SME-oriented commercial banks, infrastructure related institutions, microfinance sector); (ii) developing financial infrastructure (supporting modernization o f a credit information’bureau, a secured transaction registry, and - depending on demand from the new Government - helping to develop payment and clearing systems, a rating agency, and a central depository and automated clearing in capital markets). IFC’s immediate impact would come from working with the credit bureau and the secured transaction registry that will be lodged within the same unit, Le., the Credit Information Bureau; (iii) using technology and a Small and Medium Enterprise Survey to expand banking into underserved rural areas; and (iv) enhancing regional integration (trade finance facilities for local banks). IFC’s potential investment in an infrastructure related financing institution would not probably materialize as strategic foreign investors refrain f rom investing during the continuing global downturn. O n the advisory side, IFC’s Small Enterprise Development Facility (SEDF) will complement investment projects where feasible and continue to work

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with partner banks on credit review strategies for S M E lending. Finally, within the framework o f building regulatory reform mechanisms, SEDF i s working to build capacity o f stakeholders to address micro-regulatory and modernization issues.

48. Private sector-led emdovment. Peace is not sustainable nor can the economy reach its potential if jobs are not created within domestic borders. Private sector development i s critical for generating off-farm employment. While recent figures are not available, as o f 2003-04, Nepal was characterized by moderate (low) unemployment rates in urban (rural) areas, but by worryingly high underemployment in rural areas (of around 20 percent) and among women in urban areas. Some 500,000 youth enter the labor force each year with l o w education completion rates, on the one hand, and few places open for them to continue their education at a higher level, on the other. While migration has been an outlet for some 3-4 mi l l ion Nepalis and a major source o f income, that door could close as the effects o f the current global economic crisis cause the receiving countries to shed labor. These conditions only heighten the importance o f harnessing the energies o f the private sector to create well-paying jobs in the country. IFC’s contribution to private sector growth comes through three channels: (i) direct investments across agriculture, manufacturing and services; (ii) working with the Bank to highlight constraints to private sector investment (both domestic and external); and (iii) improving the investment climate. Based on the jo in t IDA- IFC Investment Climate Assessment (ICA), IFC will work with the Bank to engage the GON in advancing reforms to streamline regulations for business entry, operation and exit, rationalizing inspections and certification regimes, accreditation for export markets, and simplifying the tax regime. IFC’s Investment Climate Reform Project (ICRP) which has started work with the Ministry o f Industry on the Special Economic Zone (SEZ) regime i s planning to engage the GON on regulatory reform under the Business Advisory Forum in 2009. The implementation o f some reforms in the near term, such as enactment o f a reformed Special Economic Zone Law, could have a significant impact on attracting FDI and generating employment. In turn, IDA will concentrate on the macro-framework, understanding the sources o f growth and the dynamics and options through an ongoing Migration and Remittances Programmatic AAA. I t will also engage in a Jobs and Skills Development Programmatic AAA and continue work on education. Beyond that, the Adolescent Girls’ Employment (AGE) Initiative will support a program to enhance school-to- work transition for young women. The p i lo t i s expected to provide an entry point for more sustained engagement on youth employment in coming y.ears.

49. Nepal i s the “water tower” of the Ganges River Basin and yet i ts water resources remain largely untapped, and its population highly vulnerable to water hazards. The development and management o f water resources will not only support growth nationally, but wil l also provide capacity to adapt to climate change in the Ganges basin where impacts will likely manifest in increased floods, droughts and glacier lake outbursts. With more than 6,000 rivers, Nepal has immense water resource wealth and a central role to play in regional water management. The country’s terrain has the potential for wor ld class, multipurpose reservoirs and hydropower sites that could generate 40,000-80,000 MW o f power (now only 600MW developed), as wel l as mitigate floods and provide irrigation. But the country has negligible water storage infrastructure, and i ts institutional capacity and information systems for water management are weak. At this stage, we anticipate continuing to work in irrigation, micro-hydro and rural water supply. Nepal will also benefit from the recently initiated regional work on interconnectedness o f water resources. Under the South Asia Water Initiative (SAWI), Nepal

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Water resource manaaement, environment and climate chanae.

will receive support to strengthen i ts national capacity for water management, deepen understanding o f Nepal’s role in regional water dynamics, and explore opportunities for water infrastructure investments in a trans-boundary basin context. An important product i s the hydro-economic modeling o f the Ganges River, which will be done for the f i rst time. This can help to lay the basis for further support down the line, together with the Water Resources and Climate Change AAA already initiated. Given the short timeframe o f the ISN, and the uncertainties o f the transition and the potential impacts o f the global crisis, during the I S N period activities will be launched to identify and establish the pre-conditions for a large-scale water infrastructure project. The activities will include technical assistance to help the Government update their river basin master plans so that potential projects can be considered within a broader basin context, and to improve the framework for resettlement and benefit- sharing.

50. I n addition, enhanced focus i s needed on the environment and climate change. Climate change i s likely to intensify the extreme hydrological variability and monsoons which deliver about 80 percent o f the annual country’s rainfall in just three months. Devastating floods routinely affect large, very poor populations (as seen in the Koshi floods o f 2008)’ with extreme low-flows fe l t across the Ganges basin into Bangladesh. Nepal has been selected as one o f the countries for the Pilot Program for Climate Resilience (PPCR) under the Climate Investment Fund (CIF). PPCR funding will help to address strategically some o f the above-mentioned climate-related issues. In addition, IDA will pursue dialogue on issues o f environment and climate change, including building on the findings o f the Country Environment Analysis (CEA) in areas such as the current dialogue on environment monitoring. The CEA follow-up i s expected to focus on strategic environment and social assessment o f the hydropower sector and on solid waste management in smaller towns. In addition, IDA would focus on avoided deforestation which would be financed under the Forestry Carbon Partnership Facility. Helping the country deal with disasters - such as floods, but also earthquakes - i s part o f the Bank’s continuing non-lending TA for disaster and emergency management. IDA, in collaboration with the Global Fund for Disaster Risk Reduction (GFDRR), will also explore the possibility o f project support to reduce disaster risks.

5 1. Tourism sector: Among Nepal’s sources o f growth and employment, tourism i s both a historically important sector and one the country i s aiming to expand. Tourism accounts for about 8 percent o f foreign exchange earnings and 2008 was one o f the best years in recent times in terms o f the number o f arrivals. The potential i s there for expansion but, l ike many private sector-led endeavors, the overall investment climate and prevailing economic conditions are the determining factors on when and how this sector could take off. The GON aims to double tourism arrivals in the next two to three years, particularly focusing on religious and regional markets, and to see tourism revenues shared more equitably, with an emphasis on sustainability and eco-tourism. But the present global downturn could dampen demand especially from non-regional visitors. Moreover, tourism in Nepal suffers f rom the absence o f a strategy, poor infrastructure and logistics, and a need to strengthen spillovers to the rural poor. At this stage, the main contribution by IDA and IFC would be by addressing some o f the overall constraints to private sector development, in collaboration with DFID, which has been asked by the Government to take the lead. For IDA, one o f the specific links to tourism i s the proposed work on environmental sustainability and conservation. The Bank will support the GON’s application for a GEF grant to strengthen protected area management, particularly for tiger habitats in a landscape approach. IFC will

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also provide TA to support a program to implement locally operated tourism portals for Nepal which will increase the share o f booking revenue to local hotels. The program expects to include 50 Nepali hotels.once it i s operational.

Pillar 3: Enhancing equitable access to services and social inclusion

52. Growth alone i s insufficient if Nepal i s to realize its goal of building a society which offers opportunities and inclusion for all its citizens. Moreover, given the vulnerabilities o f the Nepalese economy to the global economic downturn and the continuing risks o f set-backs in the peace process, it i s doubly important for there to be strong social services and livelihood opportunities, especially for the poor. Supporting equitable access to basic social services and livelihood opportunities’ and efforts to promote social inclusion and sustainable social protection programs are thus key elements o f the strategy. The promotion o f basic service access and inclusion i s also closely l inked to the country’s peace-building agenda, with improved services providing the tangible benefits o f peace, particularly for the rural poor, and to the needed response to an economic downturn should that happen. Past outcomes and the GON’s priority on inclusive development and human capital suggest a strong continued role for the Bank in this area. Coordinated efforts with DFID on addressing social inclusion and increased efforts through trust funds to address social accountability in our projects i s part o f this approach.

53. This pillar proposes to strengthen core diagnostics and continue programs in sectors where we are already engaged (education, health, rural water, micro-hydro and poverty alleviation through community driven development efforts). In addition, analytical work on social protection will be pursued. In terms o f empowerment o f communities and vulnerable groups, we propose to continue the ongoing Poverty Alleviation Fund Project (PAF 11) which promotes grassroots livelihood and community infrastructure, as wel l as engagement by local level institutions and bottom-up accountability. The PAF i s now sharing information so that i t s projects are incorporated into district development plans and many o f the sub-projects are co-financed by local governments. Early results f rom the impact evaluation indicate that PAF i s having a positive income effect on households and communities. Increased engagement with local governments and building their capacity for service delivery would be important elements o f the ongoing involvement through this program. These activities would need to be coordinated with and complementary to the local governance and community development program. IFC i s also exploring further support for livelihood activities among the poor through helping commercial and microfinance banks develop their SMEhural lending strategies. The final element o f the basic services theme i s deepening o f the rural water program and continued involvement in the micro-hydro sector and alternative energy sources, as discussed below.

54. A common element across several of the areas of engagement in this pillar i s a strong role for communities in service delivery. The role o f communities has proven to be remarkably robust throughout the conflict. One o f the important issues in the decentralization discussions in the Constituent Assembly i s how to sustain the benefits o f community involvement as formal local administrative structures are created and/or assume new roles. It i s felt that the Bank has useful experience to offer in terms o f sustaining the strengths o f community service delivery and “bottom up” accountability. In the I S N period, engagement through community-based operations and dialogue i s l ikely to be an important vehicle for contributing to the debates on the appropriate roles o f communities and the state.

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In this light, the community focus o f the current and proposed portfolio i s not only about service delivery but also about the emerging governance structure o f the country and the compact between the state and i t s citizens. There is, thus, a close linkage between the agenda under Pillar Three and the broader governance and state-building support under Pillar One.

55. While progress on poverty to 2003-04 was impressive, it i s vital to obtain an up-to-date insight on living standards, particularly in light of the global crisis. The next round o f the household survey i s overdue and the I S N proposes to support a new Nepal Living Standards Survey (NLSS), and to fol low with an updated Poverty Assessment. This i s however contingent on receiving donor co-financing to fund the survey. In addition to new data, this will continue the capacity enhancement o f the National Bureau o f Statistics which was initiated with the previous survey. Further progress on poverty monitoring systems that capture dimensions o f exclusion and gender biases could be supported as part o f the potential DPC series, and the team will also remain aware o f needs for more rapid updates as the global crisis evolves.

Povertv diamostics and monitoring:

56. Education: Despite the conflict, Nepal has undertaken significant reforms in the education sector which have yielded some impressive results in areas such as primary enrollment and gender parity (see Table 2). These reforms include: (a) the transfer o f public schools to community management; (b) government financing for unaided community schools; (c) introduction o f per capita financing o f schools; (d) opening o f textbook printing and distribution to the private sector; (e) decentralizing higher education, along with introducing formula-based funding and cost sharing; and (0 government financing for community campuses. A number o f these reforms have been supported by a range o f donors, including IDA, under the Second Higher Education Project and Education for All (EFA) SWAP. Assuming these reforms are maintained, the proposed School Sector Reform SWAP operation would extend reforms to cover the whole school sector and universal education to grade 8, with a focus on quality, accreditation and means-based financial assistance to students. The team also proposes that education be included in the proposed Public Expenditure Review as well as trust fund-financed analytical work on governance and institutional risks, among other topics.

57. Health: Significant progress on health outputs has been achieved and some key outcomes have improved markedly over time. The 2004 Nepal Health Strategy aimed to increase access to and use o f essential health services, in particular for the underserved. The ongoing Health Sector Program SWAP helped consolidate donor-supported efforts behind the strategy, and increase public expenditure levels and effectiveness through an emphasis on basic health services. I t also initiated decentralization or deconcentration o f management authority and promoted PPPs. Although use o f essential health care services expanded across the board, the emphasis on the inclusion agenda was more l imited until recently, when the constitutional right to health care was translated into a pol icy o f free essential health care. At the same time, much remains to be done, with some health outcomes stubbornly adverse (e.g. under 5 malnutrition stands at around 40 percent). Different dimensions o f women’s health, access to reproductive and family planning services, and maternal services, along with HIV/AIDS, malaria and non-communicable diseases, are also lagging. Specific targeted interventions continue to be needed to address rapid disease outbreaks. An example i s IDA’S support under the on-going Avian Flu Project which i s addressing both animal and human health components.

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58. I n collaboration with a broad range of partners, the Ministry of Health has recently initiated the preparation o f i ts next sector strategy. Emphasizing inclusion and equity, the government i s expected to put renewed efforts into decentralization, human resource management, interaction o f the public, private and community sectors in health service delivery and governance. While maintaining a strong focus on maternal and chi ld health, it seeks to address the health challenges noted above. The I S N proposes to continue to support these efforts through a new Health Sector SWAP and to engage in elements o f the health agenda such as HIV/AIDS. Analytical work in the areas o f non-communicable diseases and health sector governance i s also proposed to underpin this dialogue.

59. Social Protection: Nepal does not have a robust safety net for the vast majority, beyond traditional informal structures. The social protection system in Nepal i s characterized by fragmented interventions across different ministries and between the public and donor sectors. At the same time, enhanced emphasis has been placed on transfer programs to promote equity and protect the most vulnerable. Such programs are l ikely to be even more important as the impacts o f the global crisis are felt in Nepal. National counterparts have identified the following potential areas that could benefit from technical and diagnostic advisory services: the overall vision and strategy for the social protection system, support for implementation o f the planned public pension reform, consolidation and improvement o f targeting systems (in social protection and beyond), improving delivery o f flagship safety net programs such as social allowances and public works, reforms o f social care services, and building M&E systems and the evidence base in the sector. IDA i s responding to these needs through a Programmatic Social Protection AAA (building on earlier analytical work on pensions) and through the safety net component o f the Emergency Food Crisis Project. The team also proposes that social protection be a core element o f the pol icy framework for any budgetary support operations during the I S N period and would be integrated within the AAA work on ski l ls and employment. If well-designed, well-targeted and sustainable safety net programs are identified, it might be possible to incorporate them within an emergency response operation, in case such support i s required to address the negative impact o f the global economic downturn.

60. Expanding safe water and sanitation in rural areas will be crucial to improving the living standards of the poor. The Government estimates water supply coverage at about 77 percent and sanitation coverage at 46 percent. I t s goal i s to raise those levels over the coming years. However, 10 percent o f existing schemes reportedly need rehabilitation and more than hal f need major repairs. The traditional approach to service delivery, particularly in rural areas, was top-down and contractor-led. Community involvement was minimal and users had no ownership over the system, paying l itt le if anything towards operation and maintenance. Therefore, under the ongoing Rural Water and Sanitation project, an inclusive community driven approach has been adopted, to encourage more robust service delivery with an emphasis o n accountability. Results show that community ownership i s yielding more sustainable water supply and sanitation services, as they are operated and maintained by the communities who play the lead role in their planning, design and implementation. In collaboration with DFID, UN, JICA, Finland and the ADB, we propose to support the Government’s efforts to develop a framework for a rural water and sanitation SWAP during this I S N period.

Rural Water Sumlv and Sanitation:

61. Micro-Hvdro and other Enerm Sources: Off-grid rural modern energy and electrification programs have been making a slow but steady contribution to economic

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and human development in rural Nepal. Considering the challenging operating environment o f Nepal, this i s a significant achievement. Demand for electricity in rural Nepal will continue to be very high for years to come, and as part o f the Bank’s wider energy sector engagement, it i s proposed to sustain the support to micro-hydro village electrification schemes through the ongoing power operation and the PAF, with a strong role for the community in the planning, implementation and operation o f these schemes. To complement these micro-hydro schemes, IDA will request support from the Global Partnership on Output Based Aid for the ongoing biogas program, which replaces traditional sources o f energy used by the rural populations with modern biogas plants delivering clean energy to meet cooking and lighting needs. Finally, to learn more about how electrification affects rural families, we are carrying out an ESMAP-financed AAA study on Social Impacts of Rural Energy.

(d) ProDosed WBG Promam and Instruments

62. (a) I&: I n the near term, the Bank Group and ADB are expected to be Nepal’s largest donors. Nepal’s I D A 1 5 allocation for FY09-FY 11 i s SDR488.8 mi l l ion (about US$782 mill ion) against the IDA14 allocation o f SDR324 mil l ion. The I S N covers last two years o f IDA15 (FYlO-11) with the overall indicative envelope o f SDR332.3 million, with the average annual allocation o f about SDRl66 mill ion. FY 10- 1 1 allocations are indicative only and actual annual allocations will depend on: (i) total IDA resources available, (ii) the country’s performance rating; (iii) the performance and assistance terms o f other IDA borrowers; (iv) the terms o f IDA’S assistance to Nepal (grants or credits); and (v) the number o f IDA-eligible countries.16 Nepal’s performance has recently been upgraded from “red” to “yellow” on account o f i t s improved debt sustainability position. This has allowed for an increase in total resources for Nepal but also altered the terms under IDA15 to 55 percent credit and 45 percent grant (as against 100 percent IDA grant in FYOS), but this can change if the debt sustainability position changes.

63. (6) ILC: IFC’s committed exposure in Nepal is US37.5 million as of February 2009 in six projects and US%7.2 million for the account of participants. Infrastructure, mainly power generation and one airline investment, accounts for 84 percent o f the portfolio. Because o f the conflict, IFC was not active in Nepal over the last few years; however, as the situation evolved, IFC re-opened an office in Kathmandu in January 2008, with the objective o f scaling up both investment and advisory operations. An Infrastructure Advisory Team was also set up in N e w Delh i in 2007 to scale up provision o f infrastructure advisory services in the region, including Nepal. Going forward, IFC expects to expand i ts exposure in Nepal by potentially committing US$15-20 mi l l ion on average annually during the ISN, depending on political stability, the availability o f viable investments and improvements envisaged to the business climate. IFC’s investment program will be accompanied by complementary technical assistance and advisory services in a range o f areas’ including infrastructure, financial markets, improving the business climate and capacity building. Most commitments potentially will be in infrastructure (mainly hydropower) and the financial sector. In addition, IFC will facilitate trade by partnering with Nepalese banks under i t s Global Trade Finance Program (GTFP) and support projects that have a positive foreign exchange impact in sectors such as tourism, airlines and agri-business exports.

l6 IDA allocations are made in SDRs, and the US$ equivalent i s dependent upon the prevail ing exchange rate.

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64. The previous sections outline how the Bank Group would proceed if the global economic crisis does not have acute impacts on Nepal. Four to five new operations per year for IDA would be prepared, with one or two potential investments per year expected for IFC. The program would be paced, taking into account the demands o f the current transition on a l l actors, the step-by-step approach on the governance front, the investment climate and the fragilities o f the peace process. For IDA, that would entail mainly the extension o f existing programs in health, education, power and rural roads, often with the C D D focus that has proven robust under conflict (Annex B3). There would be an increased emphasis on agriculture and new areas, such as emerging towns, would proceed on a programmatic basis. The proposed series o f DPCs that would address critical policy constraints would only proceed if the triggers for such lending are met. However, given that this i s a transition period in which a new government has s t i l l to be formed, we need to adopt a flexible approach to respond to opportunities and retreat when constraints inhibit effective engagement.

(c) Potential impact of the global economic crisis:

65. If, instead, the impacts of the global economic crisis on Nepal are more acute and/or sustained, an alternative approach would reconfigure the IDA program to emphasize quick, targeted actions that could help the poor and vulnerable and preserve o r create jobs to cushion the effects of the crisis. Such an emergency response would front load the program. It would retain the emphasis on health and education which are vital and would accelerate already planned programs andor expand ongoing programs to alleviate poverty and stimulate j ob creation. This would be the case o f support for labor intensive programs such as rural roads and the PAF project. Another jobs-related program could be modeled after the Emergency Food Support operation which has been working successfully. Under this scenario, the IDA would consider emergency budget support, with a focus on the areas that have already been identified as potential reform candidates as part o f DPCs (see para. 68). The acute economic crisis scenario would have to be considered in light o f other risks, including that o f a deteriorating political situation (see para. 85).

66. Under such a crisis scenario, IFC would also reconfigure its approach. If the situation deteriorates, IFC would focus more on advisory services. If Nepal’s corporate sector were unable to raise both domestic and international financing, I F C could step up i ts program o f assistance, f i rst by focusing on the provision o f liquidity and long-term financing to i t s few existing strong and well-managed clients on an “as-needed” basis. Second, IFC’s S M E Venture Fund, designed for quick disbursement, could increase i ts share for Nepal to mitigate the reduced f l ow o f credit and advice to SMEs. Finally, I F C could also provide short t e rm liquidity support through senior loans and trade facilitation support v ia the GTFP. IFC would also explore utilization o f i t s global crisis response initiatives such as the Bank Recapitalization Fund.

67. (d) Range of Instruments: The proposed strategy will be supported by a range of instruments for engagement under both scenarios. Both I F C and IDA will employ a combination o f financing and technical, analytical and advisory services. For IDA, lending will continue to be predominantly in the form o f Sector Investment Loans (SILs). Some o f this investment lending would be based on sector-wide approaches (SWAps) in sectors where donors and the Government agree on the policy and results framework and how to work together collaboratively. In some cases, there may be pooled resources, combined with IDA fiduciary oversight. In other sectors, development partners may agree on common management arrangements that rely on enhanced fiduciary support such as use o f

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procurement agents. In line with the Bank’s commitment to increase harmonization and improve aid effectiveness, we would l ike to see SWAps play an increased role in the Nepal program. Mov ing forward, we expect to work with the Government and donors to define SWAP frameworks in rural water and sanitation and for rural roads and trail bridges, in addition to the existing ones for health and education. To ensure that our engagement in program-based approaches i s wel l informed by analysis o f sectoral risks, we propose to carry out sector risk assessments with GPF funding for the health sector, and possibly education, as wel l as for a l l future sectors in which SWAps are to be adopted. IDA will closely monitor performance o f SWAps under the ISN, including difficulties with procurement or reversal o f reforms which could endanger use o f the pooling mechanism.

68. Based on GON’s request for budgetary support, a series of programmatic Development Policy Credits (DPCs) may form part of the IDA program. Reform triggers for budgetary support include a stable macro/medium-term fiscal framework and a clear development strategy. Any DPCs would be single tranche operations, supporting completed policy actions. So far, we have identified the fol lowing as possible areas for reforms to be addressed within a DPC series: (i) deepening implementation o f the P S M agenda with a focus on budget reforms, auditing and accounting systems, accountability and other dimensions o f PFM; (ii) adopting and implementing a social protection strategy, including areas relating to pension reform, targeting mechanisms and M&E; (iii) continuing the strengthening o f banking sector regulations and compliance, secured transactions, collateral registries, etc.; (iv) enhancing private sector development and improving the investment climate, including telecommunications regulation, spectrum management, ICT, hydro-power licensing procedures, other aspects o f PPPs, etc.; and (v) improving overall fiscal and macro-management, with particular emphasis on effectiveness o f public spending on areas such as road maintenance and the social sectors, as informed by the PER. These potential initiatives will require prior policy dialogue, advice and AAA.

69. Continuing our analytical engagement i s an essential part o f the proposed program, but during the ISN consultations, national counterparts raised concerns about the timeliness and utility o f past non-lending assistance. They expressed l imited appetite for “big” Bank reports. At the same time, the client and other partners clearly value the rigor and scope o f the Bank’s analytical work. The consensus i s to undertake more programmatic AAA which incorporates a “just-in-time” response to client needs. This entails: (i) initially scoping out the task and defining a range o f issues that the GON and we agree are important; (ii) carrying out the analytical work in such a way that intermediate products, including workshops, are produced as the work proceeds; (iii) interacting with the client on a regular basis during the course o f the work; and (iv) packaging the intermediate and final products into focused, accessible presentations and workshops for pol icy makers, while preserving the full extent and depth o f the analysis for particular audiences. W e have moved towards this approach in FY09 and will continue it during the I S N period. As the new Government articulates i t s development vision, we expect substantial opportunities for non-lending technical assistance.

70. The indicative non-lending program for IDA presented in Annex B4 emphasizes areas which underpin the wider program and/or provide diagnostics building blocks for the next programming cycle. The listed program i s the “core” AAA program o f tasks which are either ongoing or core mandates and needs o f the wider program that would be financed by the Bank’s administrative budget. The N L S S requires substantial trust fund

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resources to complete. In addition, the team will mobilize trust funds for areas such as analysis o f education reforms, the health sector, disaster risk management (under the GFDRR), the PPCR (the first ‘adaptation pilot’ o f the Climate Investment Funds), and other areas. A number o f additional AAA tasks are either ongoing or proposed, but are funded entirely from trust funds and hence do not appear in this core l i s t o f AAA.

71. The IFC program in Nepal will seek to design and implement coordinated programs (rather than projects) particularly in environmentally friendly “green” infrastructure, financial sector, agribusiness, climate change and business enabling environment (Annex B4). This i s aligned with the three strategic pillars o f IFC’s regional South Asia Strategy which include: (a) improving economic inclusion through increasing private sector investment in labor-intensive and export-oriented industries, bridging the infrastructure gap, improving access to finance for the underserved and accelerating rural growth; (b) addressing climate change through renewable energy investments and projects which focus on clean energy; and (c) supporting regional integration through intra-regional trade facilitation and investment.

72. Like IDA, IFC will support the pillars of the proposed strategy through a mix of investment and advisory services. IFC’s investment services currently include US dollar loans, trade finance lines, and minority equity stake in companies. I F C will continue to provide long-term and counter-cyclical financing for companies that are unable to access financing on appropriate terms. IFC’s additionality in Nepal comes through providing longer tenor than that available in the market, patient equity capital, global and regional expertise and experience, and TA to enhance areas such as corporate governance and management o f environmental and social risks. IFC will continue to respond to client needs through initiatives such as IFC S M E Ventures, Infraventures, and transaction advice, as well as to crisis situations through the Bank Recapitalization Fund. Local currency debt financing i s essential for companies and sectors that generate local currency revenues. However, as o f now IFC does not have a local currency product, which could pose a constraint in providing financing for large scale infrastructure hydro-projects with revenues in local currency.

73. (e) Monitoring Performance and Results: Although a formal results framework i s not necessarily part of an ISN,17 we have prepared a partial framework that reflects Nepal’s circumstances. This framework anticipates modest results, as the country i s undergoing a major transformation o f i t s constitution, polit ical structures and governmental institutions. With only a two-year timeframe, the results matrix (Annex B9) focuses on key actions, processes and intermediate outputs. Only in areas with mature programs, such as education, health, rural water supply and sanitation, and rural roads, are we able to include outcome indicators. Reflecting the substantial risks facing the Nepal program, we have taken those risks into account in the results matrix, providing an assessment o f the l ikelihood o f the milestones and outcomes being realized.

74. We will also track progress by the country in meeting its challenges. This includes the monitoring o f Nepal’s progress towards meeting the MDGs, as we l l as tracking

The I S N covering FY07-08 did not incorporate any results features. 17

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indicators under the IDA Results Measurement System.” W e will continue to monitor Nepal’s relative standing in global surveys such as “Doing Business’’ and WBI’s Governance Indicators. Project by project, we will endeavor to enhance tracking and reporting with increased attention to inclusion and job creation, to the extent that underlying data permits, as part o f the application o f the peace filter to new operations. The goal i s to build the evidence base and capacity for M&E more systematically for both Bank operations and country-wide indicators.

75. cr) Portfolio Munupement: IDA’S Nepal portfolio has faced challenges, but efforts are ongoing to enhance portfolio quality. As o f M a y 2009, the Nepal portfolio consists o f 16 active IDA operations and seven recipient-executed trust funds with net commitments o f US$803.3 mi l l ion and US$29.9 million, respectively. The undisbursed IDA balance totals US$468.7 million, while US$21.2 mi l l ion remains to be disbursed from the trust funds. In terms o f portfolio quality, four projects are considered at risk, reflecting overall country conditions and weak FM and procurement performance. These four projects have a combined commitment o f US$198.6 million, representing 25 percent o f total net IDA commitments. Over the past year, the Government and the Bank have initiated efforts to rectify project performance, including project restructurings. At present, only one project - the Irrigation and Water Resource Management Project - i s rated unsatisfactory with respect to implementation and none i s rated as unsatisfactory on development objectives. Nevertheless, more than hal f the portfolio i s rated as moderately satisfactory on implementation progress, highlighting the need for intensive fo l low up and support. Moreover, the uncertainties o f the transition, combined with generally l o w institutional capacity, weak systems o f governance and accountability, Nepal’s geography, and i t s diverse socio-cultural setting, a l l make implementation challenging. Physical security remains a concern in certain areas. Continued monitoring o f the portfolio via the peace filter i s intended to keep a watch on such concerns.

76. Building on the pilot exercise carried out for the India program, Nepal has recently undertaken a comprehensive assessment of risks, including those relating to GAC (see Appendix I11 for details). This assessment revealed that the portfolio faces substantial risks even though risks have been reduced by the judicious choice o f project instrument and design in the on-going portfolio. Two-thirds o f active projects are CDD, are implemented with community involvement, and/or already incorporate demand side accountability mechanisms. On the other hand, four projects are considered as high risk from a GAC perspective. O f these four, the Telecommunications Sector Reform Project i s to close soon; the risks o f the Emergency Peace Support Project were exhaustively analyzed and mitigation measures put in place as part o f project design when it was approved one year ago; and the Financial Sector TA Project i s now closely supervised f rom the field. This leaves the last high risk project, the Rural Access Improvement and Decentralization Project (rural roads). A review o f risks and mitigation measures i s presently ~ n d e n v a y . ’ ~ Support from the GPF will be used to reinforce mitigation measures in several on-going projects, with

l8 In some cases, these indicators would have to be adapted to Nepal’s circumstances. For example, the indicator on rural access would be framed as the percentage o f the rural population within four hours’ walk from all weather roads in the case o f the hills, or two hours’ walk in case o f the plains.

A review i s presently being carried out, along with the preparation o f a GAC Plan, to put in place additional mitigation measures. T h i s wi l l be done prior to appraisal o f the request for additional financing.

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additional support for strengthening demand side social accountability mechanisms anticipated from other trust funds.

77. (g) Aid Manapement and Donor Harmonization: Thirty eight donors are active in Nepal. In addition to the Asian Development Bank, a number o f development partners plan to support substantial programs in Nepal, with the largest being DFID, the European Commission, Japan, Norway, the United States, Germany, and Denmark. India provides substantial aid, including in-kind, and China i s also an important development partner. Reliable and comparable data on external assistance have been diff icult to compile, as much aid i s provided off-budget. In early 2009, the Ministry o f Finance updated information on existing donor commitments to gain greater clarity on planned donor support by sector over the next three years (Appendix 11). To deepen this process, M O F launched a comprehensive mapping exercise at the project level which i s expected to be completed shortly. This will be used to identify gaps, duplications, and opportunities for consolidation, with the goal o f improving aid effectiveness.

78. The challenge for donors is to support the government to manage the transition from scattered donor projects and programs outside government, to harmonized delivery through government. In 2009, the Ministry o f Finance began to meet with donors periodically to share information and promote coordination. In addition, the donors meet frequently to exchange information and to agree on jo in t approaches. The Utstein group, composed o f bilateral donors, meets regularly and the Wor ld Bank and ADB participate as observers. At the operational level, coordination efforts are being consolidated and expanded, and some progress has been made towards targets set out in the Paris Declaration and on Fragile States principles. In late 2008, the Wor ld Bank, DFID, ADB, and JICA conducted the fourth jo in t portfolio review with the GON and agreed on an action plan to improve performance. Harmonization efforts are most advanced in sectors which have operationalized SWAps (such as the health and education sectors). Efforts are underway to replicate these examples in other areas, with potential SWAps for rural roads, rural water supply and sanitation, and possibly in agriculture.

79. IDA’S Nepal country team is closely coordinating with the IMF team. The Fund approved a three-year Poverty Reduction and Growth Facil ity (PRGF) arrangement in November 2003, amounting to SDR49.9 mi l l ion (70 percent o f quota), and i t s last review was completed in November 2007. The Government broadly met the arrangement’s quantitative criteria under a diff icult conflict situation, but implementation o f structural reforms has been slow. The Government may consider a successor PRGF arrangement with the Fund, and a mission i s expected to discuss preparation o f the FY09/10 budget.

80. (h) Communications and outreach: As part o f implementing the ISN, the Bank will expand its outreach to civil society groups and strengthen its public information services beyond Kathmandu. In addition to the Bank’s Public Information Center (PIC) in Kathmandu, we hope to establish two satellite PICs in partnership with universities in Pokhara and Biratnagar. The PIC program will be retooled to strengthen dialogue and outreach. PIC products will be redesigned to meet the needs o f non-English language speakers. The PIC in Kathmandu i s the local affiliate o f the Global Development Learning Network and i ts activities will be tailored to contribute to the knowledge agenda o f the Bank and development partners.

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81. Communications will be integrated into Bank projects, analytical work and knowledge management. The External Affairs unit will work proactively with project teams to design communications components and to strengthen capacity towards ensuring compliance with Nepal’s Right to Information Law. Emphasis will be placed on the use o f radio, which i s the medium o f choice for most Nepalis. In addition, a client survey will be completed in late FY09 to inform implementation o f the ISN. Respondents include representative samples from government, project beneficiaries, c iv i l society, private sector and media. Focus groups are being organized to discuss how best to use the findings o f the survey.

82. (0 The Decentralized Kathmandu Office: The Bank Group’s presence in Nepal has been substantially increased since the end of conflict. The IFC re-opened i ts office, co-located with the Bank, in 2008 which has facilitated the interaction and collaboration o f the two teams. Moreover, there has been an increase in internationally recruited staff based in Kathmandu which i s becoming a de-facto operational base for staff working on neighboring countries that have restrictions on staff travel and presence due to security concerns. One o f the lessons o f working in post-conflict countries i s that the Bank tended to have insufficient numbers o f staff on the ground. This had been the case in Nepal: there was no international staff, other than the Country Director, since early 2004. During 2008, eight joined and a l l Country Sector Coordinators are field-based. The impacts on the timeliness and diversity o f pol icy engagement have been noted by the GON and other development partners in a number o f cases. The delivery o f two emergency operations and preparation o f a third in the past 12 months are also testament to the positive impacts on responsiveness o f an enhanced f ield presence. That expansion i s expected to continue with the placement o f two more international staff by end-FY09. We further anticipate expanding numbers o f Nepali staff, who will strengthen our capacity to perform our fiduciary functions, enhance our capacity to deal with governance issues (with GPF support) and add the expertise needed to apply the peace f i l ter across the portfolio. This will take highly honed sk i l l s and knowledge o f the polit ical economy and effective ways to work in conflict sensitive situations. SWAps also need field presence and moving away f rom the “mission- based” supervision to day-to-day dialogue. IFC also plans to increase i t s staff presence in Nepal.

83. 0) Mitipatina Risks: The Bank Group faces substantial risks working in Nepal (see Appendix I11 on governance and risk assessment). The key challenge for the new Government i s to rebuild the legitimacy o f the state, consolidate the peace process and maintain law and order, and deliver tangible benefits to those traditionally excluded and to society at large. I t i s undertaking several diff icult transitions at the same time - political, economic and social - none o f which i s easy, as demonstrated by recent polit ical developments. At the same time, Nepal has embarked on the long road to reducing the risks o f weak governance and systemic corruption by strengthening the country’s overarching governance framework and institutional capacity. Long-lasting peace also hinges on progress in these areas. The fact that the country faces them simultaneously increases the associated risks, a situation made even more challenging in the face o f the global crisis and the uncertainty about i t s potential impacts on Nepal and the timeframe over which such impacts are l ikely to manifest.

84. and to enhance risk management through a number of dimensions:

The proposed Nepal program has been designed to take those risks into account

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Selectivity in the program i s informed by a comprehensive risk assessment o f the portfolio and interventions in different sectors. The program i s designed to “keep it simple” and to build on existing strengths, especially in areas in which past programs have been resilient and robust to conflict. The risk o f lack o f ownership when the government changes i s minimized, first, because the new government will l ikely include some coalition members from the previous government, and second, almost al l the proposed investment operations will be scaling up programs that were started and implemented by previous governments. Community management purposefully underpins most operations. CDD approaches, with communities taking decisions and managing programs, have built-in checks and balances and accountability mechanisms that reinforce effective implementation. We will try to “do no harm”. The addition o f a peace fi l ter to the project cycle for new IDA operations i s expected to heighten awareness and sensitivity to the risks associated with conflict situations that are often closely l inked to poor governance. Design options can then be addressed early in the cycle and monitored throughout project life. The program tries to avoid making commitments that would place high demands on “supply” side accountability and fiduciary systems while expanding support for mainstreaming “demand” side mechanisms such as score cards and social audits that can be reflected in Governance and Accountability Act ion Plans. Support for pol icy reforms, addressing areas such as regulatory reform in finance and telecom, could be on the basis o f single tranche operations and backed by solid AAA. We will continue to strengthen our own capacity to deal with these risks with a strong focus on enhanced fiduciary and supervision functions, as we l l as building in-house capacity to deal with governance and conflict.

Not all o f the risks facing Nepal can be mitigated and significant political, social and economic risks remain. We need to prepare and to the extent possible take preemptive action. The impact o f an economic crisis on new Bank Group investments was discussed previously (para. 65 and 66). Such a crisis would require both IDA and IFC to undertake contingency planning, now underway, close consultations with other donors, and monitoring o f the situation particularly with respect to remittances and the banking sector. Should there be a prolonged period o f polit ical stalemate, a deterioration in the polit ical situation or a renewal o f conflict that inhibits the Bank Group’s operations, IDA would: (i) adjust individual operations as needed to reflect the impact o f conflict v ia the peace filter; and/or (ii) scale back operations selectively and gradually, depending on other donor responses and the pace and extent o f the conflict and without creating “aid orphans”. This assumes that the basic functions o f government can continue and that adequate macro-management prevails and i s similar to the stance followed during the conflict period. I t would mean that IDA would l ikely continue to emphasize C D D approaches and basic social services while providing support for strengthening state systems. Finally, with respect to a third scenario in which the country faces deterioration along multiple fronts, the Bank Group would combine elements o f the two above responses, although a situation o f a sustained economic and political crisis might inhibit a workable response. N o matter how much effort goes into project readiness, due to an often unpredictable and volatile implementation environment, ongoing supervision will be required which adopts a proactive and flexible approach to achieving results. I t should be assumed that project design may need to be modified and

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provisions made for future adjustments through project restructuring during the implementation phase.

D. ISN Process

86. The I S N formulation process has involved consultations in Nepal and in Washington. Joint Bank Group strategy consultations with DFID and ADB and a strategy brainstorming with the three donors’ staff, Secretary o f Finance, National Planning Commission Vice Chairman and government planning and sector specialists were undertaken in Kathmandu in November 2008. The objective o f these consultations was to gather views from a variety o f stakeholders on where and how the three donors can be most effective in supporting Nepal’s development. This included c iv i l society actors, representatives o f the major polit ical parties, senior c iv i l servants and youth groups. Consultations were also undertaken in selected districts o f Nepal during October-November 2008. A summary o f the in-country consultations i s provided in Appendix V. Prior to the upstream review o f the I S N in February 2009, further consultations were held with G O N and development partners on the proposed principles and areas o f engagement, with positive responses. Another fuller review sponsored by the Ministry o f Finance with al l the major development partners was conducted in March 2009. The Ministry has been extensively consulted at each stage o f the process and the lending and analytical program reflects their assessment o f the Wor ld Bank Group’s comparative advantage and where we should engage.

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Appendix I: Debt Sustainability Analysis’

I. LOW INCOME COUNTRY-DEBT SUSTAINABILITY ANALYSIS (LIC-DSA)2

A. Size and Composition o f Public and Publicly Guarantee (PPG) Debt

1. Nepal’s total public debt stock is estimated at 47 percent of GDP at end 2007 (in nominal terms), o f which roughly 33 percent i s external debt. Public external debt i s estimated at US$3.2 billion, o f which about US$3 b i l l ion was owed to multilateral institutions, mostly IDA and the ADB. Bilateral debt stock i s estimated at about US$270 mill ion, with Japan as the largest creditor accounting for more than ha l f o f the bilateral debt. After remaining fairly constant at around 50 percent o f GDP since 1995, the external debt stock dropped by about 17 percentage points o f GDP during 2004-2007, as a result o f relatively l o w external loan disbursements and the appreciation o f the Nepalese rupee. The domestic debt stock accounts for around 14 percent o f GDP and constitutes an increasing share o f total public debt.

Figure 1.1 : Composition of External Debt, 2000101 -2006107 (In millions of US. dollars)

3500

3000

2500

2000

1500

1000

500

0 2000/01 2001/02 2002/03 2003/04 2004/05 2005/06 2006/07

1 a Multilateral H Bilateral 1

Source: Nepal RastraBank, FCGO and Computations.

B. Assumptions

’ Public debt dynamics are assessed using the Low-Income Country Debt Sustainability Analysis &IC-DSA) framework, which was jointly prepared by the IMF and the World Bank. The baseline macroeconomic scenario i s broadly the same as in the previous DSA. The initial net present value ofdebt has improved compared to the previous DSA due to the appreciation o f the Nepalese rupee and lower than projected loan disbursements in the interim. In view of the improved debt indicators, Nepal’s external dett dynamics are assessed to be subject to a moderate risk o f debt distress. This i s a change from the previous DSA, which classified Nepal as at high risk o f debt distress. Report- May 2,2008. This analysis, however, does not take into account the rapidly changing global economic conditions and the effect that they wil l have on Nepal’s exchmge rate and economic growth prospects.

The LIC-DSA produces different results from calculations under the enhanced HIPC Initiative because o f different methodologies.

37

2. the following key assumptions:

Baseline projections of public and publicly guaranteed (PPG) debt are based on

Real sector: Real GDP growth i s projected to r ise gradually from 3.8 percent FY07/08 and stabilize at 5.5 percent after FYlO/11, in line with growth rates observed in the early 1990s- a period o f relative stability-and supported by structural reforms and sound macroeconomic policies. In the longer term, Nepal’s vast untapped hydropower potential i s expected to contribute significantly to growth. Inf lat ion i s assumed to decline f rom around 6.5 percent FY07/08 to an average o f about 5 percent in the medium term in line with projected inflation developments in India and as supply bottlenecks are gradually alleviated. The exchange rate i s projected to depreciate against the dollar, in line with projected movements in the Indian rupee to which the Nepalese rupee i s pegged.

Fiscal sector: The revenue-to-GDP ratio i s projected to r ise f rom 13.5 percent in FY07/08 to 14.3 percent by FY14-28, owing to gradual improvements in revenue mobilization. The expenditure-to-GDP ratio rises from 19.5 percent in FY07/08 and assumed to be maintained at this level thereafte?. Off icial grants are assumed to average 3 percent o f GDP FY07/08- FY12/13 as donors are expected to support the peace process; from FY13/14 onwards official grants are projected to decline as a share o f GDP.

External sector: Exports o f goods and services are projected to average o f about 8 percent over the period, supported by tourism and growth in partner countries. Imports o f goods and services (in dollar terms) are expected to grow by an average o f 11 percent in the medium term, fuelled by remittances and in line with economic activity. Import growth during FY13/14-FY27/28 i s assumed to average 6.6 percent. The current account balance i s projected to deteriorate f rom a surplus o f 0.9 percent o f GDP in FY07/08 to a moderate deficit o f 1.6 percent o f GDP in FY27/28 driven by the development needs, with remittances declining gradually as a share o f GDP. New financing i s assumed to rise f rom about US$200 mi l l ion FY07/08 to US$450 mi l l ion FY 12/13; from FY 13/14 onwards off icial disbursements are expected to gradually decline as a share o f GDP. The grant element o f new borrowing i s assumed to gradually decline during the projection period, with an average o f 46 percent.

C. Baseline

PPG External Debt

3. A key feature o f the LIC-DSA framework is that it compares debt burden indicators to indicative policy-based thresholds. The thresholds are based on the empirical finding that low-income countries with stronger policies and institutions tend to have a higher debt carrying capacity. Nepal i s classified as a medium performer based on i ts three year average CPIA score during 2004-06. At end-2007, Nepal’s NPV o f public debt-to-exports ratio i s estimated at 148 percent (the relevant pol icy based indicative threshold i s 150 percent). The ratio i s projected to fal l to 129 percent by FY12/13 percent and 87 percent by

’ The projected increase in the fiscal spending in 2007/08 i s driven mainly by pre-election and election spending; higher costs associated with clearing Nepal Oil Corporation’s arrears, and increased donor flows.

38

FY27/28. Other indicators remain below the policy-based indicative thresholds throughout the projection p e r i ~ d . ~

Debt Service, in percent o f Exports

Revenues

4. I n the baseline scenario, debt burden ratios are projected to fall between 2007/08 and 2027/28 (Table 1.1). The NPV o f external public debt-to-GDP (20 percent to 12 percent), NPV o f external public debt-to-exports (148 percent to 87 percent); external public debt service-to-exports ratio (9 percent to 6 p e r ~ e n t ) ~ .

20 11 7 30 12 6

Table 1.1 : Indicative External Debt Burden Indicators

I Nepal: projected I

Total Public Debt

5. Domestic debt accounts for about 30 percent of total public debt at end-2007. Under the baseline scenario which does not take into account the possible negative impacts of the current global economic crisis on Nepal, the NPV o f public debt-to-GDP ratio declines from 35 percent at end FY07/08 to 26 percent by FY27/28 (Table 4 and Figure 1.3). Over the same period, the NPV o f public debt to-revenue ratio falls from 2 16 percent to 157 percent, and the public debt service-to revenue ratio decreases f rom 17 percent to 12 percent.

D. Sensitivity Analysis

6. vulnerability to shocks.

Stress tests and alternative scenarios suggest that Nepal’s debt profile i s

Total public debt: A shock modeled using real GDP growth at historical average minus one standard deviations FY09-10 results in the N P V o f debt-to-GDP ratio increasing from 35 percent in FY08 to 41 percent in FY28; the NPV o f Debt-to-Revenues-and-Grants ratio increases from 2 15 to 250 percent; and the debt service to revenue ratio increases from 17 to 23 percent. This scenario illustrates the importance o f the peace dividend to generate stronger

The baseline projections expect the current account, which has been historically a surplus in Nepal, to unwind gradually into a deficit, as spending and higher growth result in more imports o f goods and services and the surge in remittances stabilizes. The average current account deficit over the projection period 2008-28 i s a little over 1 percent o f GDP relative to the historical average o f a surplus current account o f 3.4 percent. The results o f the historical scenario, where the current account surplus o f 3.4 percent of GDP continues into the projection period, suggests negative borrowing and thereby steady declines in debt. In view o f this, debt i s constrained to zero in2018.

Given the high concessionality o f external debt, the debt service-to-exports ratio i s low, and at levels similar or lower than to most HIPCs after full HIPC debt relief. The ratio reflects de& service on existing debt and debt service on projected disbursements

39

real GDP growth and the impact o f deteriorating global economic conditions. Alternative scenarios reveal vulnerabilities from maintaining the FY08 fiscal stance (primary balance) which could result in the NPV o f debt-to-GDP ratio increasing f rom 35 FYOX to 44 percent FY28.

External debt: Bound tests indicate that the NPV o f debt-to-export ratio i s sensitive to shocks. Fol lowing a combined, half-standard deviation shock to export growth, GDP deflator, and net non-debt creating flows, the NPV o f debt-to-exports ratio increases significantly, peaking at near 300 percent FY 10, and stays above the threshold for most o f the projection period. Other bound tests (e.g. shocks to exports and non-debt creating flows) also cause the NPV o f debt-to-exports to break the thresholds. These results are partly driven by Nepal’s volatile export performance in the past decade. Shocks to other debt indicators, such as the NPV o f debt-to-GDP and debt service-to-revenue, result in trajectories below threshold values.

E. Staff Assessment

7. Based on the LIC-DSA, staffs conclude that Nepal’s external debt dynamics are subject to a moderate risk o f distress but vulnerable to shocks. The negative impact o f current global economic conditions and/or renewal conflict on Nepal’s economy could in fact resemble such a shock scenario. Since the last DSA in 2007, the init ial net present value o f debt improved due to the appreciation o f the Nepalese rupee6 and lower than projected loan disbursements in the interim. In contrast to the previous DSA, the baseline scenario does not indicate a protracted breach o f debt thresholds. In v iew o f this, Nepal’s external debt dynamics are assessed to be subject to a moderate risk o f debt distress. This said, bound tests reflecting shocks to export growth and non-debt creating flows could result in protracted breach o f the debt thresholds. The sensitivity analyses underscore the need to implement sound macroeconomic policies and reforms, including through raising the real GDP growth rate and achieving higher export growth. Stronger and more stable growth in exports contributing to higher GDP growth, combined with foreign financing at favorable terms- preferably through grants-would help Nepal make progress toward achieving i ts MDG targets while containing risks to debt sustainability.

The Nepalese rupee has in fact depreciated by more than 20 percent since November 2008.

40

Figure 1.2: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2008-2028 (In percentage)

45 NPV o f debt-to-GDP ratio ThreshLd I I I

1 1 1 1 1 1 1 1 1 1

Most extreme shock 35

Baseline

20 Historical scenario

15 - - -

2012 2017 2022 2027 2007

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200

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100

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I 2 j 1 I Baseline 20 -I I I I I I I I I I I I I I

I

- - I

Historical scenano

2012 2017 2022 2027 2007 Source: Staff projections and simulations.

41

Figure 1.3: Indicators of Public Debt Under Alternative Scenarios, 2008-2028 (In percentage) 1/ 50

45

40

35

30

25

20

15

10

5

0

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- Baseline

- --- No Reform

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2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028

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- ---

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Debt Service-to-Revenue Ratio 21

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- - N o R e f o r m - _

M o s t extreme stress test

2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028

iurce: Staff projections and simulations. 1/ Most extreme stress test i s test that yields highest ratio in 2018 2/ Revenue including grants.

42

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Appendix 111: Governance and R i s k s Assessment Nepal Portfolio

Introduction

1. As part o f the preparation o f the I S N for Nepal, the country team undertook in January 2009 a comprehensive review o f the r isks o f i t s portfolio and the implications o f those risks for future lending.' The methodology used was based on the p i lo t done for the India program in June-July 2008. The framework developed for India, and modified for Nepal, had been init ially constructed in order to address the systemic weaknesses in the management o f risks that had been identified in the Detailed Implementation Review (DIR) o f f ive health sector operations in India. Nepal was the second country in the Region to carry out this comprehensive risk assessment.

The Framework

2. funded with central G A C funds allocated to the South Asia Region.2 The key features are:

The framework below was developed with the assistance o f external consultants

It establishes a hierarchy o f risks, with overall project risks a function o f country, sector and project specific risks, with country risks overshadowing sector risks and sector risks overshadowing project specific risks. The approach builds on the Bank-wide Risk Identification Worksheet, standard for a l l new operations since 2007, and uses that system's four point scale-high, substantial, moderate and low. It takes the CPIA ratings on governance and corruption as the starting point for country risks. In the case o f Nepal, it added the risks o f confl ict based on the 2004 edition o f Post-Conflict Performance Indicators. Fol lowing the approach used by the Afr ica Region, the framework converts these numeric ratings to the H, S, M or L scale. In the case o f Nepal, the country risk rating i s substantial. I t adds a set o f questions to identify systemic risks at the sector level. At this point, there i s no generalized guidance on or measurement o f sector level risks so that teams do this based on their respective country and sector knowledge and operational experiences. I t does the same thing for project specific risks. In addition, it folds into those risks the IRS ratings on financial management, procurement and safeguards. The work sheet indicates the residual risk, after mitigation measures.

The risk assessment covers the following broad areas: political economy, governance, corruption, regulation, accountability, institutional capacity, policy coherence, quality and standards, project design, and implementation systems including procurement, FM and M&E. I t does not, however, address technical or other risks such as climate, acts-of-god, etc., that also could affect project outcomes. For the framework to be completely comprehensive these risks would have to be added. * The team that developed the framework, including the specific set o f questions to assess sector and project specific risks, comprised both external consultants and Bank staff, specialized in public sector management, public administration, governance, and operations. Preparation involved a review o f PADS, GAAPs, and ISRs, along with interviews with Bank staff, and a review o f sector studies, best practices on anti-corruption, corruption mapping, and experiences in the Bank and elsewhere.

1

54

The standard sets o f questions for both sector and project specific risks cover the broad range o f concerns about getting results on the ground and governance, including fraud and corruption. O n this last point, the questions do so by not rating the incidence o f fraud and corruption per se (which i s hard for anyone to know with precision) but by assessing some o f the underlying factors. These factors have been derived from available best practices, economic principles and theory, auditing and accounting, and risk management practices. Once sector risks and project specific risks are rated, the framework provides a risk “look-up” table that: (i) combines country, sector and project specific risks into an overall project risk rating; and (ii) ensures that a l l teams fo l low the same methodology thereby reducing discretion and incentive that individual teams may have to down grade risks. The risks can further be broken down, according to the particular risk posed in the questions, and analyzed separately.

The Questions Asked

3. The questions o f both the sector and project specific risks are framed as assertions, in the manner o f the COS0 (Committee o f Sponsoring Organizations) Risk and Opportunity Workshops and other survey^.^ Each assertion provides the two extremes: what would prevail if the risks were l ow and what would prevail if risks were high. The team can rate the risk o f each assertion high, substantial, moderate or low. Here are some examples:

Sector-wide risks. There are a set o f assertions that deal with the quality o f sector-wide regulations and institutions. One assertion probes the extent to which there i s a functioning regulatory set-up with the appropriate separation o f powers between the policy-making institution and the regulatory-compliance institutions. Other probes the extent to which quality standards exist, whether they provide the relevant benchmark, and whether they are adhered to. The risks would be highest i s there was no regulation, no separation o f powers, and no quality standards in the sector. Conversely risks would be the lowest if the response were the reverse with intermediate risks (substantial or moderate) in between. Project design and supervision risks: There are a set o f assertions that address the ease by which supervision and physical monitoring can be undertaken. These assertions probe, for example, whether the project i s dispersed across a wide geographic area (high risks) or concentrated in a single location (low risks); or whether the project involves multiple implementing agencies (high risk) or a single entity (low risks). Other examples are whether or not the implementing agency s i s n e w h o experience with the Bank (high risks) or existing with prior experience (low risks).

Mitipation of Portfolio Risks

4. The conclusion o f the risk assessment was that the Nepal program entails substantial risks. The team rated 13 sector and sub-sectors and fifteen active projects. The level o f

There i s potential to use COSO-like techniques to have anonymous voting o f the risks by participants and then a structured discussion on the ratings and the variations.

55

overall risks i s driven in large part by the country risks which are rated as substantial, reflecting CPIA ratings on systemic corruption and governance. This i s consistent with the ranking o f Nepal in the WBI’s Governance Indicators. Sector risks are also substantial reflecting the vulnerabilities in regulation in key sectors such as telecommunications and banking; in social protection due to the lack o f robust targeting and M&E systems; and in rural roads because o f the weaknesses in local administrations, combined with poor quality standards and the nature o f procurement.

5. Mitigation measures built into project design helps to lower project specific risks. That brings down those risks overall to moderate. The main risk mitigation mechanism adopted in the Nepal portfolio has been the incorporation o f community management in the original project design. Aspects o f community management and community driven development are features o f ten o f the fifteen ongoing operations. While not perfect, and s t i l l subject to capture by elites, community management i s seen to enhance oversight and accountability and to offset risks o f procurement and quality. Further, this mode o f project implementation offsets the risks o f adequate supervision and physical inspection for operations in widely dispersed and hard to reach geographic areas. Going forward, community management will be a continuing feature o f new operations to the extent possible. In the case o f the four operations rated as high risk, mitigation measures are being taken. All four operations are closely supervised. In one case-the Telecommunications Sector project-it i s soon to close.

6. taking the fol lowing additional steps:

More broadly, in light o f the substantial risks in the portfolio, the Nepal program i s

Resources allocated to supervision and to fiduciary functions will be increased in FY 10 by about 10 percent. Specific t rus t funds, notably the GPF, are being mobil ized to: (i) advance the overall G A C agenda; (ii) undertake governance and institutional assessments o f sectors, particularly those in which IDA has or plans to adopt sector wide approaches; (iii) develop GAAPs for new IDA operations; and (iv) strengthen demand side accountability mechanisms in new operations and one-third o f the ongoing IDA portfolio. Additional expertise on governance and on peace and conflict will be brought into the country team with GPF support. Business processes are being reengineered to integrate the risk assessment, GAAP preparation, and Peace Filter into critical points in the business cycle.

56

Appendix IV: IEG Country Assistance Evaluation Summary of Conclusions and Recommendations

Introduction

1. IEG i s presently preparing a Country Assistance Evaluation (CAE) to be discussed with the Committee for Development Effectiveness in M a y 2009. The C A E examines whether: (a) the objectives o f Bank assistance were relevant; (b) the Bank’s assistance program was effectively designed and consistent with i t s objectives; and (c) the Bank’s program achieved i ts objectives and had a substantial impact on the country’s development during this period. Examining these questions allows the C A E to draw lessons and recommendations for future Bank assistance. The C A E covers three CAS documents: (i) the CAS Progress Report discussed at the Board in December 2002; (ii) the CAS presented in November 2003; and (iii) the Interim Strategy Note presented in February 2007. The goals o f the Bank assistance program over FY03-08 remained broadly aligned with the 2003 PRSP and unchanged: the focus was on improving governance and development effectiveness by bringing resources to grassroots levels but with increased emphasis on growth and inclusion.

M a i n Conclusions

2. While recognizing that Nepal’s considerable polit ical turmoil and changes had a major impact on CAS implementation during the period under review, one o f the CAE’s conclusions i s that l i t t le progress was made against CAS stated objectives in two o f the four main strategic themes -achieving broad based growth and good governance. Specific objectives under these two pillars are considered by IEG to have often been unrealistic and overly ambitious given country circumstances characterized by polit ical instability, conflict and insecurity, and similar issues. On the other hand, IEG’s draft evaluation concludes that some progress was made in the area o f social inclusion, especially with regard to mainstreaming inclusion in sector projects and, to a lesser extent, diversity o f the c iv i l service. Social development was the area where the Bank’s program was most relevant and successful, particularly in terms o f improving and expanding health services, significantly increasing access to basic education, and increasing access to safe drinking water in rural areas. In addition, even in those pillars showing less progress in meeting objectives, there were some notable achievements despite the very diff icult country circumstances.

3. The areas o f minimal or no progress included key parts o f the governance agenda - where the Bank’s strategy was considered to be highly relevant but strategy implementation was constrained by the country’s polit ical context - and sub-areas o f the broad-based growth agenda such as private sector development and agriculture and rural development. In the specific area o f public expenditure management, the Bank’s AAA was considered to have achieved some significant steps, such as passage o f a new Procurement Act, but the impact in terms o f the quality and efficiency o f PFM has been minimal so far.

4. Education i s one o f the areas where the Bank’s program was especially relevant and contributed to strong progress towards CAS objectives. Among the positive results, the enrollment o f girls and marginalized groups improved substantially through the Education for All program which i s being implemented under a Sector-Wide Approach (SWAP).

57

Measurable quality improvements were limited, however, and textbook distribution continues to be late. The community school management model, which i s currently being mainstreamed, has shown some good results but IEG believes that a number o f improvements are required to make it fully effective, such as putting in place a sound M&E system and ensuring that there are adequate mechanisms for funding schools in poorer areas. The financial condition o f higher education institutions improved modestly, but fe l l we l l short o f being sustainable. The sole new IDA project, Higher Education Project I1 (approved in 2007), i s innovative and flexible in i t s design and IEG considers the project outcome objectives to be highly relevant. Under the project, substantial progress has been made in terms o f improving access for under-privileged students, but project start-up was slowed due to political and security issues, the project executing agency s t i l l lacks administrative capacity, and a major teachers’ union has blocked implementation o f the plan to allow autonomy for the country’s largest university.

5. Health and Water and Sanitation are two sectors that showed substantial progress during the period under review. Through a successful SWAP which became effective in 2004, basic health care services improved, with an emphasis on poor and underserved populations, despite challenging operational conditions on the ground. T o the credit o f the SWAP, approximately 70 percent o f public funding now goes to support low-cost, cost- effective interventions o f Essential Health Care Services (EHCS). The significant increase in supply and accessibility to these services in districts with low health indicators i s interpreted as being at least partly responsible for improved health outcomes over time. The expansion o f public health facilities at the sub-national and community levels (sub-health posts, health posts, and primary health care centers) contributed to increased access for the poor and underserved populations. Nepal’s health indicators demonstrate significantly improved outcomes; for example, the infant mortality rate (IMR) declined f rom 79 deaths per 1,000 l ive births in 1996 to 64 in 2001 and 48 in 2006 while the maternal mortality declined from 539 per 100,000 l ive births in 1996 to 281 in 2006. A major persisting shortcoming i s the lack o f progress in addressing malnutrition, as Nepal’s level o f chi ld malnutrition remains among the highest in the world. The quality and access to sustainable rural drinking water and sanitation services improved over the period, in part thanks to the IDA-financed First Rural Water and Sanitation project, which used community-based approaches to facilitate provision o f demand-driven rural water and sanitation services, infrastructure and hygiene education. However IEG considers that the second project has thus far failed to achieve i ts development objectives related to sector institutional reforms.

6. Some progress was made with regard to social inclusion, one o f the main pillars o f the past strategies. Through i ts lending, IDA helped improve access to basic services for the socially excluded (in terms o f gender, caste or ethnicity). IDA and DFID jo in t ly produced a seminal piece o f analytical work on social inclusion that has contributed to the overall understanding o f these issues in Nepal and influenced the 2003 PRSP.’ The largest Bank- supported program, the Poverty Alleviation Fund (PAF), was deemed as effective in

See “Unequal Citizens: Gender, Caste, and Ethnic Exclusion in Nepal.” Published by the World Bank and DFID.

58

channeling funding to the socially excluded and supporting l ivelihood improvements, but weaker in terms o f improving access to services and institutional development.’

7 . Regarding IFC’s operations in Nepal, IEG report mentions that as the polit ical and security situation deteriorated in 1999, IFC withdrew i ts local f ield presence and had very l imited activities in Nepal between 1999-2006. To a large extent, IFC’s inabil ity to develop successful investment projects through much o f the decade can be attributed to the increasingly dif f icult investment environment. Since 2006, IFC’s gradual re-engagement in Nepal has resulted in two GTFP investments; an investment in a domestic airline, a pipeline o f investment projects in the financial sector, and a constructive dialogue with the government on business enabling environment issues. This approach o f cautious re- engagement has the potential for replication in other dif f icult investment climate countries.

Recommendations Moving: Ahead

8. Given the challenges facing Nepal, IEG believes the Bank could be more realistic and pragmatic, and consult widely and continually with national stakeholders. The new I S N should take into account the current circumstances with a flexible program that can be adjusted closely to the Government’s capacity and a changing polit ical and institutional context.

9. In terms o f sectors and instruments, the coming CAE will recommend more decisive support for agriculture and rural development, Le. placing this sector at the heart o f any new IDA strategy. It also suggests stepping up efforts to increase poor and marginalized people’s access to basic services, with a focus on supporting the expanded use o f delivery schemes that have been shown to have worked in Nepal. With regard to the PAF, the primary recommendation i s to establish a mechanism to track the extent to which i ts activities are effectively addressing poverty and the various dimensions o f social exclusion. An additional highlighted recommendation i s to continue support to public expenditures and public finance management. The SWAP model that has been successful in health and education could be applied to other sectors, such as water and sanitation or roads.

IEG’s draft report concludes that there i s little evidence that the PAF has been an effective instrument for poverty reduction and social inclusion. However, an impact evaluation of the PAF was recently completed and it i s currently being reviewed by the Bank team. I t will be considered by IEG as time allows.

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Appendix V: Summary of CAS Consultations (ADB, DFID, World Bank)

Background

1. During the months o f October and November 2008, the Asian Development Bank (ADB), the UK Department for International Development (DFID) and the Wor ld Bank Group (IDA and IFC) undertook jo in t consultations in order to gain insights f rom as wide an audience as possible on what role they should play in supporting the people o f Nepal. These consultations were joint ly undertaken as al l three agencies were in the process o f developing their new country assistance plans.

Consultation Process

2. The consultations were undertaken in three different regions o f Nepal (Central region - Pokhara; Eastern region - Biratnagar; and Western region - Nepalganj), as well as in Kathmandu. All consultations included a range o f stakeholders. The participants attending in Pokhara, Biratnagar, and Nepalganj included representatives f rom community organizations, polit ical leaders, c iv i l society, program personnel and others. The group in Kathmandu included the private sector, government, c iv i l society, academia, INGOs, NGOs, politicians, staff o f ADB, DFID and WB, sectoral staff o f government, youth, and donor agencies.

Summary of Findings

3. similar priorities. A summary o f these i s provided in the fol lowing table:

During both the consultations in the regions and Kathmandu, participants expressed

Consultations in regions 0 Peace and security

o Rehabilitation o f displaced and conflict- affected people, reconstruction o f damaged infrastructure

o Support for making the new constitution and state restructuring

o Integration o f armies o Special package programs for excluded

communities/ regions Job creatiodemployment /livelihoods o Self-employment and entrepreneurship

o MSME (micro, small and medium enterprise)

o Commercialization o f agriculture and NRM o Tourism promotion

hydropower, irrigation, communications) o Schools o Rural and agricultural roads, suspension

bridges

promotion

and micro-finance promotion

0 InJFastructure development (roads,

Consultations in Kathmandu Peace process o reconstruction, rehabilitation and

o Constitution making and state restructuring 0 Jobs and employment creation focus on youth)

o Market and ski l l oriented training and

o Promotion o f self-employment,

reintegration

education

entrepreneurship, MSME promotion 0 InJFastructure development

o Roads, hydropower, communications -. Social sector - Health, education, drinking

water o Equipped and functional health facilities o Awareness o f health programs o Facilitating equal access to health and

education Creating an enabling environment for private sector o Legal and policy reform and their

implementation with joint monitoring and

60

o Micro and small hydro power developmenthural electrification

o Health posts/facilities o Communication Centredfacilities . o River traininghigation for Madhesi districts

o Awareness programs on awareness creation

o Transparent program design, implementation

Good governance

at all levels

and monitoring and supervision (with people's participation)

o SociaVpublic audits o Reward and punishment system in GOs and

NGOs Social sector - inclusive access and effective service delivery (health - special focus on reproductive healtldsafe motherhood for women, education - focus on skill-based job- /market-oriented education and training etc.) o Equal and equitable access to quality health

services (priority to women's health - safe motherhood, reproductive health etc.)

o EmploymenVmarket oriented education and training for all (scholarships for poor and excluded groups)

o Clean drinking water for rural areas Specialprograms for single women, VAW disadvantaged groups Others: agriculture, N M support for M&E systems/mechanisms, involvement of community (especially poor and excluded in decision making;), capacity building and empowerment, private sector promotion.

follow-up by both GOs and the private sector Building human capital

o Awareness, education and training o Building and strengthening local institutions

(NGOs, cooperatives, CBOs)

o Transparency, accountability o Functioning monitoring and supervision

Good governance vor all stakeholders)

(with involvement o f stakeholders) Greater involvement andparticipation of youth

4. financial and technical support for:

The recommendations o f the participants for the three donor agencies were to provide

Growth and employment Greater emphasis on commercialization in support for agriculture, NRM, other IG and livelihoods programmes Capacity building o f Government Facilitate trust building among political parties Immediate rel ief ; and reconstruction, rehabilitation and reintegration Support for the peace process Support for constitution making, state restructuring including fiscal federalism Good governance

61

5 . Some suggestions on how this should be done were:

Support GON and people's priorities Implementation pluralism (through both GOs and NGOs) More transparency in donor programmes Ensure involvement and participation o f poor & excluded and youth; ensuring increased access to quality basic services (health, education, water and sanitation, etc.) Inclusive pol icy formulation Greater emphasis on developing appropriate and participatory M&E mechanism Special programs for mid- and far-West, and for youth Priority to local experts for technical assistance More effective donor coordination, and coordination with GON Budgetary support for government programs; basket funding based on priorities Real partnership with c iv i l society.

62

Appendix VI: Country Financing Parameters

Item

Cost sharing. Limit o n the proportion o f individual project costs that the Bank may finance

Recurrent cost financing. Any limits that would apply to the overall amount o f recurrent expenditures that the Bank may finance

Local costfinancing. Are the requirements for Bank financing o f local expenditures met, namely that: (i) financing requirements for the country’s development program would exceed the public sector’s o w n resources (e.g., f rom taxation and other revenues) and expected domestic borrowing; and (ii) the financing o f foreign expenditures alone would not enable the Bank to assist in the financing o f individual projects Taxes and duties. Are there any taxes and duties that the Bank would not finance?

Parameter

up to 100%

N o country- level limit

Yes

None

RemarkdExplanation

Financing o f Bank-supported projects i s fully integrated into the budget, and the Government has full ownership and leadership o f the NPPR exercise at the portfolio level. G o N has been increasing i t s efforts to improve overall expenditure management through a PEFA action plan, and i s also progressively moving towards program-based .approaches (SWAps) in a number o f sectors. Bank financing o f projects i s fully integrated into the budget and thus subject t o Nepal’s fiscal management regime anchored in the Med ium Term Expenditure Framework (MTEF), for which the Bank continues to provide technical assistance. The level o f recurrent cost financing would be reviewed on a case by case basis to ensure consistency with a prudent fiscal stance. Financing o f c i v i l servant salaries may be considered on a selective basis (for example through support for SWAps). The two requirements are met. At the project level, the Bank expects to finance local costs as required by the project’s development objectives.

The Bank may finance the costs o f taxes and duties as long as they are reasonable and non-discriminatory. As o f M a y 2009, no taxes are identified as unreasonable or discriminatory vis-a-vis Bank- financed Droiects.

63

Annex A I : Key Economic and Program Indicators -- Change from Last ISN

Economy

Growth rates (%) Real GDP /a Merchandise exports (in current US$) Merchandise imports (in current US$)

Inflation (GDP deflator %)

National accounts (% of GDP) Current account balance Gross fixed investment Ib

Public finance (% of GDP) /a Fiscal balance (including grants) Foreign financing

International reserves l a s months of goods imports) Program Lending (US$ millions)

IGross disbursements (US$ millions1

Forecast in Last ISN FY06 I FY07 I FY08

1.9 3.7 4.5 4.0 8.5 12.8 18.3 16.1 10.8

7.2 6.5 6.0

2.4 3.9 2.9 18.5 18.8 19.8

-1.7 -3.0 -3.2 0.3 1.7 1.5

8.9 8.4 7.9

0 145 21 0 67 80 110

/a.GDP at market price /b.GDP at factor cost. Source: Central Bureau of Statistics - 2008

Actual FY07 I FY08

3.2 4.7 2.3 -1.9 11.2 12.9

7.4 7.7

0.5 -0.3 21.3 21.8

-1.8 -2.0 1.4 1.4

12.4 11.3

105 380 75 81

64

Nepal at a glance 9/24/08

POVERTY and SOCIAL

2007 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 200107

PopulaQon (%) Labor force (%)

Most recent estimate (latest year available, 200107) Poverty (% of population below national poverty line) Urban population (% of total population) L ~ e expectancy at birth (years) Infant mortality (per 1,000 live births) Child malnutrition (% of children under Access to an improved water source Literacy (% ofpopulation age f5+) Gross primary enrollment (% of school-age populafior

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TREN

1987

GDP (US$ billions) 3.0 Gross capital forrnationlGDP 21.2 Exports of goods and services/GDP 11 8 Gross domestic savings/GDP 12 1 Gross national sawngdGDP 16.3

Current account balancelGDP Interest payments/GDP Total debffGDP Total debt service/exports Present value of debffGDP Present value of debffexports

-4.7 0.5

33.3 10.1

198797 199707

GDP 5.2 3 6 GDP per capita 2 6 1.4 Exports of goods and services

(average annual growth)

Nepal

28.1 340 9.7

2.0 2.8

31 17 63 46 39 89 49

126 129 123

1997

4.9 25 3 26.3 14 0 22 5

-0.8 0 5

49.1 5.2

2006

2.8 0 8

South LOW- Asia income

1,520 1,296 880 578

1,339 749

1.6 2.2 2.1 2.7

29 32 64 57 62 85 41 29 87 68 58 61

108 94 111 100 104 89

2006 2007

8.9 10.2 2 6 0 25 1 3 6 12 7 9 9

2 8 2 2 7 9

2.2 0.6 0.3

38.1 5.1

2007 2007-11

2 5 4 5 0.8 3 1

Development diamond"

Life

T

Gross primary

capita enrollment

A

Access to improved water

- Nepal - Low-lncom group

Economic ratios'

Trade

T

Capital formation

Domestic savings

I

Indebtedness

-Nepal ~ Low-income group

STRUCTURE of the ECONOMY

(% of GDP) Agriculture Industry

Services Manufacturing

1987 1997

50.7 41.4 15.8 22.9 6.2 9.5

33.4 35.7

Household final consumption expenditure 78.8 77.1

Imports of goods and services 20.9 37.7 General gov't final consumption expenditure 9.1 8.9

(average annual growth) Agriculture Industry

Services Manufacturing

1987-97 199747

2.9 3.4 8.7 3.5

10.6 1.9 6.3 3.7

Household final consumption expenditure General gov't final consumption expenditure Gross capital formation Imports of goods and services

2006

35.1 17.4 7.9

47.5

83.3 8.8

31.7

2006

1.8 4.5 2.0 3.8

2007

33.8 17.2 7.7

48.9

81.9 8.7

28.5

2007

1 .o 3.9 2.2 2.8

Growth of capital and GDP (%) B T

"9 n, "d "6 M 07 - GCF +GDP

Note: 2007 data are preliminary estimates. This table was produced from the Development Economics LDB database.

The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete.

65

PRICES and GOVERNMENT FINANCE

Domestic prices (77 change) Consumer prices implicit GDP deflatoi

Government finance (!A of GDP, includes cunentgrants) Current revenue Current budget balance

' Overall surplusldeficit

TRADE

(US$ millions) Total exports (fob)

Food and live animals Animal and vegetable oils Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (2000=100) Import price index (2000=100) Terms of trade (2000=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, loca//US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ mllllons) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment (net inflows) Portfolio equity (net inflows)

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1987

13.4 12.7

9.4 -0.7 -8.7

1987

138

503 62 43

128

1987

348 604

-256

-6 124

-138

156 -18

185 21.6

1987

986 0

392

35 0 5

131 130 37

1 0

94 81

1 79 4

75

1997

8.1 7.3

10.8 1 .o

-3.9

1997

1,160 51 35

318 1,750

123 21 7 242

1997

1,506 1,962 -456

8 410

-38

131 -94

657 57.0

1997

2,414 0

1,047

92 0

17

140 197 -1 1 23

0

146 55 9

45 8

38

2006

8.0 6.7

13.1 1.8

-1.6

2006

833 99 59

606 2,372

184 504 293

2006

1,216 2,832

-1,616

68 1,744

197

159 -355

1,797 72.3

2006

3,409 0

1,468

140 0

42

31 2 58

0 -7 0

0 43 31 12 11

1

2007

6.4 8.6

14.3 3.4

-1.4

2007

939

645 2,653

206 69 1 328

2007

1,347 3,225

-1,878

106 1,830

58

118 -176

2,008 70.5

2007

0 1,524

0 46

0 35 34 0

11 -1 1

Inflation (x)

l5 T

0 4 I

n7 n7 nd n6 nR 07 - GDP deflator --o- CPI

I Export and import levels (US$ mill.) I 2,000

1,000

0

O7 I 01 02 03 04 05 OB .Exports BImpolts I

Current account balance to GDP (%)

' T

I 01 02 03 04 05 06 07 I

Compositionof 2006 debt (US$ mill.)

5 81

43

A . IBRD E. Bilateral B - IDA D. Other multilateral F. Private C - IMF G - Short-term

Note: This table was produced from the Development Economics LDB database. 9/24/08

66

Annex B2: Selected Indicators* of Bank Portfolio Performance and Management As of 5/5/09

indicator 2006 2007 2008 2009 Portfolio Assessment Number of Projects Under Implementation a 12 13 16 16 Average Implementation Period (years) 2.8 2.9 3.0 3.6 Percent of Problem Projects by Number 25.0 23.1 6.3 6.3 Percent of Problem Projects by Amount 34.5 25.6 6.6 8.0 Percent of Projects at Risk by Number 25.0 30.8 25.0 25.0 Percent of Projects at Risk by Amount a, 34.5 29.5 19.8 24.7 Disbursement Ratio (%) e 20.6 28.6 25.7 17.8 Portfolio Management CPPR during the year (yes/no) Yes Yes Yes Yes Supervision Resources (total US$'OOO) 1,312 1,582 1,816 1,630 Average Supervision (US$/project) 109.3 121.7 11 3.5 101.9

Memorandum Item Since FY 80 Last Five FYs

Proj Eva1 by OED by Amt (US$ millions) 1,454.6 65.6 33.8 0.0 20.0 0.0

Proj Eva1 by OED by Number 69 2

% of OED Projects Rated U or HU by Number YO of OED Projects Rated U or HU by Amt

a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the

beginning of the year: investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio,

which includes all active projects as well as projects which exited during the fiscal year.

67

Annex B3: IDA Indicative Program Summary’ As o f 4/21/09

Fiscal Year Project Name

2009

2010

201 1

Emergency Food Support Project2 ,

Power Development Project AF Project for Agriculture Commercialization and Trade

Total FY09 = US$131 million

Rural Accesslmprovement and Decentralization Project AF School Sector Reform SWAP Health Sector SWAP Social Safety Net AF Development Policy Credit *

Total FYI 0 = US$350 - US$400 million

Mid-sized Power Generation Small and Medium Irrigation Emerging Towns Roads Sector Development AF Development Policy Credit*

Total F Y l l = US$250 - US$340 million

20 1 23 Rural Roads SWAP Rural Water Supply and Sanitation SWAP Agriculture SWAP Poverty Alleviation Fund (subject to evaluation completion, could be moved forward) Development Policy Credit*

* Certain triggers must be met before DPCs could be processed.

The IDA envelope for the I S N period (FY 10-1 1) i s indicative. Actual allocations in these years will depend on (i) total IDA resources available, (ii) the country’s performance rating; (iii) the performance and assistance terms o f other IDA borrowers; (iv) the terms o f IDA’S assistance to Nepal (grants or credits), and (v) the number o f IDA-eligible countries. U S $ equivalent i s dependent on prevailing exchange rate.

Actual - delivered in September 2008. Although FY12 i s outside the I S N period, an indicative pipeline i s listed since there i s high probability

68

2

3

that we will get into a ‘strategy gap’ period after I S N expiration and before a new CAS i s prepared.

Annex B3: IFC and MlGA Program Summary, FYO6-09 (as of March 12, 2009)

2006 2007 2008 2009

IFC Approvals (US$ millions) 0.0 4.0 0.0 10.0

Sector (%) Financial Markets (GTFP) Infrastructure

Total

Investment Instrument C%) Loans Equity Quasi-Equity Other (GTFP) Total

0% 100% 0% 0% 0% 0% 0% 100% 0% 100% 0% 100%

0% 0% 0% 100% 0% 0% 0% 0% 0% 0% 0% 0% 0% 100% 0% 0% 0% 100% 0% 100%

MlGA Guarantees IUS$ millions) 30 30 30 30

GTFP - Global Trade Finance Program

69

Annex B4: Indicative Non-Lending Activities (IDA) As o f 4/22/09

Task' Completion FY

For Completion in FY09 Technology in Microfinance 2009 Agriculture Insurance Feasibility Study 2009 Financial Sector SWAT Assessment 2009 Governance Note 2009 Evaluation o f Community Managed Schools 2009 Construction Sector Analysis 2009

Underway Hydropower - Removing Barriers (ESMAP) 20 10

2010

Investment Climate Assessment 2010 Information Infrastructure for Growth (AusAid) 20 10

Social Impacts o f Rural Energy (ESMAP) Energy Efficiency Study (ESMAP) 2010

Water Resources and Climate Change Fiscal Federalism (GPF)

Planned (preliminary) - Core AAA only' Right To Information Implementation (GPF) Local Government Study (GPF/other) Social Accountability Analysis (GPF) Nepal Living Standards Survey Poverty Assessment Public Expenditure Review PEFA Action Plan Implementation

Programmatic Activities Migration and Remittances Jobs and Skills Development Revitalizing Agriculture Support to Urban Development Social Protection TA (incl. DFID TF)

2010 2010

2010 2010 201 1 2010 201 1 201 1 201 1

2009-201 1 2009-201 1 2009-201 1 2009-201 1 2009-201 1

Includes activities funded from Bank Budget and Bank-Executed Trust Funds. Other sector-specific AAA tasks wi l l be undertaken based on further discussions with GON and country

team and taking into consideration the overall budget constraints and available t rus t fund resources during the FYs.

70

Annex B4: Indicative Non-lending Activities (IFC) As of 4/22/09

Task Completion FY

Financial Sector Activities

Credit Information Bureau (underway) 0 MOU signed on Nov. 2007

Legal framework reviewed Business Plan prepared RFP for hardware I software under WB project Procurement review

0 Drafting o f Directives for Central Bank Approval o f bidding documents by WB Draft CIB Act Public Awareness Training o f CIB staff Exposure and best practices visits o f regulators and stakeholders

Secured Transactions Registry (underway) Feasibility Study by FIAS

Cambodia exposure visit

Physical office establishment

Awareness campaign

Appointment o f Registrar by the GoN

Amend Secured Transaction Registry ActionDIotify Regulations

Service provider agreement with private operator

MSME Survey (underway) 0 RFP in September 2008 0 Survey to be finalized by 2009

Micro-Finance (underway) Preliminary scoping Explore investments with complementary advisory work Identify advisory leads in coordination with investments

Convergence (proposed)

Await Central Bank endorsement Scoping public-private sector interest (underway)

Partner Finance Institutions

Himalayan Bank Ltd. (underway) 0 Diagnostic

0 S M E strategy completed MOU signed in March 2007

Next steps to be discussed once S M E survey competed Renewal of MOU o f SEDF I1

2010

2012

2009

2010

2010

2010

Bank o f Kathmandu (underway)

71

2010

0 Diagnostic 0 M O U signed in May 2007 0 Strengthening o f credit operations (by October 2009)

Micro-finance services 0 Next steps discussed upon completion o f strengthening of credit

0 Renewal o f M O U for SEDF I1 Operations

Nepal Industrial and Commercial Bank (underway) Diagnostic M O U signed in February 2007 SME department restructuring Renewal o f M O U for SEDF I1

Business Enabling Environment/ICRP (underway) Economic Zone Regime Review

0 Regulatory Reform 0 Business Advisory Forum 0 Corporate Governance workshops

Agriculture 0 Support for IDA’S PACT projects (tentative )

Hydro-Power Sector Study to identify prospects (underway)

Energy Efficiency Support for investments in banks for on-lending to energy efficient projects (underway)

Infrastructure/Transport Sector 0

0

Joint work with Bank on PPPs Transaction advisory services for PPP (tentative)

Tourism Sector World hotel Link-web portal for automated hotel bookings (underway)

2010

2014

201 1

2009

2010

201 1

2010

72

Annex B5: Poverty and Social Development Indicators

POP U LATlO N Total population, mid-year (millions)

Urban population (% of population) Total fertility rate (births per woman)

POVERTY (% of population) National headcount index

Urban headcount index Rural headcount index

Growth rate (% annual average for period)

INCOME GNI per capita (US$) Consumer price index (2000=100) Food price index (2000=100)

INCOMEEONSUMPTION DISTRIBUTION Gini index Lowest quintile (% of income or consumption) Highest quintile (% of income or consumption) SOCIAL INDICATORS Public expenditure

Health (% of GDP) Education (% of GDP)

Net primary school enrollment rate (% of age group)

Male Female

Access to an improved water source (% of population)

Urban Rural

Total

Total

Immunization rate (% of children ages 12-23 months)

Measles DPT

Child malnutrition (% under 5 years) Life expectancy at birth (Years)

Total Male Female

Mortality Infant (per 1,000 live births) Under 5 (per 1,000) Adult (15-59)

Male (per 1,000 population) Female (per 1,000 population)

Births attended by skilled health staff (%) Maternal (modeled. per 100,000 live births)

Latest single year

1980-85

17.0 2.3 7.4 5.4

160 25 24

34 32

51 52 51

117 171

376 , 395

1990-95

21.7 2.5

10.9 4.6

200 72 71

2.0

63 83 42

78 96 76

56 54

58 58 58

84 I18

350 376

7

2001-07

28.1 2.0

16.8 3.1

30.9 9.6

34.6

340 140 104

47.2 6.0

54.6

1.6 3.4

79 84 74

89 94 88

85 89 39

63 63 64

46 59

235 21 1 830

19

Same regionlincome group

South Asia

1,520.4 I .6

29.2 2.8

880 140

0.9 2.7

85 88 83

87 94 84

65 64 41

64 63 66

62 83

251 172 500 41

Low- income

1,295.7 2.2

31.7 4.3

578 150

1.5

73 76 69

68 84 60

76 77 29

57 56 58

85 135

310 272 780 41

Note: 0 or 0.0 means zero or less than half the unit shown. Net enrollment rate: break in series between 1997 and 1998 due to change from ISCED76 to ISCED97. Immunization: refers to children ages 12-23 months who received vaccinations before one year of age or at any time before the survey.

World Development Indicators database, World Bank - 10 September 2008.

73

Annex B6: Key Economic Indicators

Actual

04/05. 05/06. 06/07.

100.0 32.5 16.6 50.9

94.2 21.3

3.0 18.3

13.6 32.7

10.2 29.7

9888

394 390

3.2

1.2

892.3 2659.3

105.4 1420.7

49.6 468.9

1 .o

2.3 11.2

11.9 15.9 10.6 5.3

-4.0 -1.8 1.5 1.4

54.5 14.0

111.3

-19.5 6.2

6.3 6.6 7.4

Indicator National Accounts (as %of GDP) la Gross Domestic Products /a

Agriculture Industv Services

Estimated

07/08.

. ..

Total Consumption Gross domestic fixed investments

Government Investment Private Investment

Exports (GNFS) Imports (GNFS)

Gross domestic savings Gross national savings

Memorandum Items Gross domestic products (US$ million at current prices) /a

GNI per capita (US$) GDP per capita (US$)

Real GDP annual growth rates ( % calculated at 2001 prices) /b

Real GDP annual per capita growth rates (%, calculated at 2001 prices) /b

Balance of Payments (US$ millions) Exports, Merchandise FOB Imports, Merchandise FOB Resource Balance Net Private transfers Current Account Balance

Official transfers

Memorandum items Resource balance (% of GDP) /b Annual growth rates (in %)

Merchandise exports (FOB) (excluding re-exports) Merchandise imports (FOB)

Public finance (as % of GDP at market prices) IC Total revenues Total expenditure

Current expenditure Capital expenditure and net lending

Overall deficit before grants Overall deficit after grants Domestic financing (net) Foreign financing (net)

Monetary indicators MPIGDPb

Growth of M2 (%) Private sector credit growth/total credit growth (%)

Price indices Real exchange rate (eop; percentage change- depreciation) /d Consumer price index (% change) (FYOO=IOO) GDP deflator (% change) (FYO0:lOO)

/a.GDP at factor cost. Source: Central Bureau of Statistics - 2008 h.GDP at market price /c.Consolidated central government operation, net terms. /d.lncludes use of IMF resourses.

100.0 35.2 17.1 47.7

92.0 20.7

3.0 17.7

15.2 30.7

12.0 29.6

7974

329 328

3.1

1 . I

843.9 2050.9

23 922.5 162.5 503.4

0.3

8.6 9.8

11.7 14.9 10.5 4.4

-3.2 -0.8 0.2 1.6

51.0 8.3

102.6

-7.5 5.7

100.0 33.6 16.7 49.7

94.5 21.5

2.8 18.7

14.0 32.5

9.3 30.1

871 5

352 350

3.7

1.8

850.1 2372 68.5

1350.8 196.7 458.7

0.8

2.5 11.0

10.8 14.5 10.2 4.3

-3.7 -1.6 1.4 1.3

53.1 15.6

112.8

-8.2 7.7

1oo.c 32.E 16.C 51.4

31 .i 21 , E

3.; 18.E

12.5 33.7

11,s 33.2

12254

47E 47c

4.7

2.E

951 3291.1

47,s 1271 -37.7 337.:

0.4

-1 .E 12,s

12.E 17.E 11.1 6.4

-4.E -2.c 1 .E 1.4

54.i 13.2

154.1

-3.7 7.; 7 7

74

Annex B7: Key Exposure Indicators

0 0 0 0 0 0 ' 0 0 0

1,396 1,468 1,524

Indicator

Total debt outstanding and disbursed (TDO) (US$m)a

Net disbursements (US$m)a

Actual I

04/05. 05106. 06/07.

3,330 3,385 3,623

9 55 238

168 1461 I 98 ITotal debt service (TDS) (US$m)a

Debt abd debt service indicators (%)

TDOlXGSb TDO/GDP TDSMGS ConcessionaVTDO

IBRD exposure indicators (%)

IBRD DS/public DS Preferred creditor DS/public DS (%)c IBRD DSMGS IBRD TDO (US$m)d Share of IBRD portfolio (%) IDA TDO (US$m)d

1

I

I I

3 3 3 45 38 35

8 14 11 87 89 90

0 0 0

Estimated

07108.

3,529

-95

152

2 29 10 90

0

0 0 0

1,509

a.lncludes public and publicly guranteed debt, private non-guranteed, use of IMF credits and net short-term capital b."XGS" denotes exports of goods and services, including workers' remittances. c.Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks,

d.lncludes present value of gurantees. e.lncludes equity and quasi-equity types of both loan and equity instruments.

the IMF, and the Bank for International Settlements.

75

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W P

8

8

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0

8

8

7

8

8

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8

8

2

0

2

8

8

2

0

2

8

8

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0

:

8

8

8

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8

7

ni

8

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ni

8

8

8

8

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a

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00 00

KATHMANDUKATHMANDU

DipayalDipayal

MahendranagarMahendranagar

BirendranagarBirendranagar

NepalganjNepalganj

TaulihawaTaulihawa BhairahawaBhairahawa

ButwalButwal

TansenTansen

PokharaPokhara

BharatpurBharatpur

DhankutaDhankuta

DharanDharan

IlamIlam

BhadrapurBhadrapur

BiratnagarBiratnagar

LahanLahan

RajbirajRajbiraj

JanakpurJanakpur

JaleswarJaleswar

MalangwaMalangwa

KalaiyaKalaiyaBirgunjBirgunj

HetaudaHetauda

BidurBidur

TribhuuvannagarTribhuuvannagar

DhangadhiDhangadhi

LalitpurLalitpurBanepaBanepa

BhaktapurBhaktapurDhulikhelDhulikhel

InaruwaInaruwa

DamakDamak

KoilabasKoilabas

RaxaulRaxaul

JogbaniJogbani

JaynagarJaynagar

SiliguriSiliguri

ChainpurChainpur

DadeldhuraDadeldhura

KailaliKailali

KohalpurKohalpur

TulsipurTulsipur

LibangLibang

PyuthanPyuthan

BaglungBaglung

TamghasTamghas

SandikharkaSandikharka

ParasiParasi

MuglingMugling

BesishaharBesishahar

BhikhathoriBhikhathori

JumlaJumla

NumNum

TaplejungTaplejung

PhidimPhidimBhojpurBhojpur

GaighatGaighat

SirahaSiraha

SindhulimadiSindhulimadi

GaurGaur

BhimphediBhimphedi

NaubiseNaubise

GorkhaGorkha

LamosanguLamosanguJiriJiri

KodariKodari

DarchulaDarchula

SaifaidiSaifaidi

AchhamAchham

AtariaAtaria

JajarkotJajarkot

ChisapaniChisapani

GulariyaGulariya

SalyanSalyan

BarhabiseBarhabise

DhuncheDhunche

BhaduareBhaduare

DholkebarDholkebar

RamechhapRamechhap

ChandragadhiChandragadhi

PARB

ATPA

RBAT

KATHMANDUKATHMANDU

LALITPURLALITPURKAVREKAVRE

BHAKTAPURBHAKTAPUR

SINDHUPALCHWAKSINDHUPALCHWAKNUWAKOTNUWAKOTDHADINGDHADING

RASUWARASUWA

BARDIYABARDIYA

SURKHETSURKHET

DAILEKHDAILEKH JAJARKOTJAJARKOT

BANKEBANKE

MUSTANGMUSTANG

MYAGDIMYAGDI

BAGLUNGBAGLUNG

SYANGYASYANGYATANAHUTANAHU

LAMJUNGLAMJUNGKASKIKASKI

MANANGMANANG

GORKHAGORKHA

SARLAHISARLAHI

SINDHULISINDHULI

RAMECHHAPRAMECHHAP

DOLAKHADOLAKHA

MAHO

TTAR

IMA

HOTT

ARI

DHANUSHADHANUSHA

KALIKOTKALIKOT JUMLAJUMLA

MUGUMUGU

HUMLAHUMLA

DOLPADOLPA

DARCHULADARCHULA

BAITADIBAITADI

DADELDHURADADELDHURA

KANCHANPURKANCHANPUR

KAILALIKAILALI

DOTIDOTI

ACHHAMACHHAM

BAJURABAJURA

BAJHANGBAJHANG

RUKUMRUKUM

SALYANSALYAN

ROLPAROLPA

DANGDANG

PYUTHANPYUTHAN

GULMIGULMI

ARGHAKHANCHIARGHAKHANCHIPALPAPALPA

NAWALPARASINAWALPARASIRUPANDEHIRUPANDEHIKAPILBASTUKAPILBASTU CHITWANCHITWAN

MAKWANPURMAKWANPUR

PARSAPARSA

BARABARA

RAUTAHATRAUTAHAT

OKHALDHUNGAOKHALDHUNGA

KHOTANGKHOTANG

UDAYPURUDAYPUR

SIRAHASIRAHA

SAPTARISAPTARI

DHANKUTADHANKUTA

MORANGMORANG

SUNSARISUNSARI

JHAPAJHAPA

ILAMILAM

TAPLEJUNGTAPLEJUNGSANKHUWASABHASANKHUWASABHA

SOLUKHUMBUSOLUKHUMBU

BHOJPURBHOJPUR TERHATHUMTERHATHUM

PANCHTHARPANCHTHAR

MAHAKAL IMAHAKAL IS E T IS E T I K A R N A L IK A R N A L I

B H E R IB H E R I

R A P T IR A P T ID H AWA L A G I R ID H AWA L A G I R I

G A N D A K IG A N D A K I

L U M B I N IL U M B I N I

N A R A Y A N IN A R A Y A N I

B A G M A T IB A G M A T I

JANAKPURJANAKPUR

SAGARMAHASAGARMAHA

K O S H IK O S H IM E C H IM E C H I

Koilabas

Raxaul

Jogbani

Jaynagar

Siliguri

Chainpur

Dadeldhura

Kailali

Kohalpur

Tulsipur

Libang

Pyuthan

Baglung

Tamghas

Sandikharka

Parasi

Mugling

Besishahar

Bhikhathori

Jumla

Num

Taplejung

PhidimBhojpur

Gaighat

Siraha

Sindhulimadi

Gaur

Bhimphedi

Naubise

Gorkha

LamosanguJiri

Kodari

Darchula

Saifaidi

Achham

Ataria

Jajarkot

Chisapani

Gulariya

Salyan

Barhabise

Dhunche

Bhaduare

Dholkebar

Ramechhap

Chandragadhi

Dipayal

Mahendranagar

Birendranagar

Nepalganj

Taulihawa Bhairahawa

Butwal

Tansen

Pokhara

Bharatpur

Dhankuta

Dharan

Ilam

Bhadrapur

Biratnagar

Lahan

Rajbiraj

Janakpur

Jaleswar

Malangwa

KalaiyaBirgunj

Hetauda

Bidur

Tribhuuvannagar

Dhangadhi

LalitpurBanepa

BhaktapurDhulikhel

Inaruwa

Damak

KATHMANDU

PARB

AT

KATHMANDU

LALITPURKAVRE

BHAKTAPUR

SINDHUPALCHWAKNUWAKOTDHADING

RASUWA

BARDIYA

SURKHET

DAILEKH JAJARKOT

BANKE

MUSTANG

MYAGDI

BAGLUNG

SYANGYATANAHU

LAMJUNGKASKI

MANANG

GORKHA

SARLAHI

SINDHULI

RAMECHHAP

DOLAKHA

MAHO

TTAR

I

DHANUSHA

KALIKOT JUMLA

MUGU

HUMLA

DOLPA

DARCHULA

BAITADI

DADELDHURA

KANCHANPUR

KAILALI

DOTI

ACHHAM

BAJURA

BAJHANG

RUKUM

SALYAN

ROLPA

DANG

PYUTHAN

GULMI

ARGHAKHANCHIPALPA

NAWALPARASIRUPANDEHIKAPILBASTU

CHITWAN

MAKWANPUR

PARSA

BARA

RAUTAHAT

OKHALDHUNGA

KHOTANG

UDAYPUR

SIRAHA

SAPTARI

DHANKUTA

MORANG

SUNSARI

JHAPA

ILAM

TAPLEJUNGSANKHUWASABHA

SOLUKHUMBU

BHOJPUR TERHATHUM

PANCHTHAR

MAHAKAL IS E T I K A R N A L I

B H E R I

R A P T ID H AWA L A G I R I

G A N D A K I

L U M B I N I

N A R A Y A N I

B A G M A T I

JANAKPUR

SAGARMAHA

K O S H IM E C H I

BANGLADESH

I N D I A

I N D I A

C H I N A

IND IA

To Muzaffarpur

To Ghazipur

To Purnia To

Dinajpur

To Gangtok

80° 82° 84° 86° 88°

80° 82° 84° 86° 88°

30°

28°

30°

28°

26°26°

NEPAL

PRIMARY ALL-WEATHER HIGHWAYS

GRAVELLED/EARTHEN ROADS

INTERNATIONAL AIRPORTS

DOMESTIC (PAVED) AIRPORTS

SELECTED TOWNS AND VILLAGES

MUNICIPALITIES

NATIONAL CAPITAL

DISTRICT BOUNDARIES

ZONE BOUNDARIES

INTERNATIONAL BOUNDARIES

IBRD 36921

APRIL 2009

N E P A L

T h i s map wa s p r o du c ed b y t h e Map De s i g n Un i t o f T h e Wo r l d Bank . T h e b ounda r i e s , c o l o r s , d enom i na t i o n s a nd a n y o t h e r i n f o r ma t i o ns hown on t h i s map do no t imp l y, o n t h e p a r t o f T h e Wo r l d BankG r oup , a n y j u dgmen t o n t h e l e g a l s t a t u s o f a n y t e r r i t o r y, o r a n yendo r s emen t o r a c c e p t a n c e o f s u c h b ounda r i e s .

0 5025 75

0 25 50 Miles

100 Kilometers