Nepal: Recent Political and Economic Developments, and Country Operations

This is an update on the situation in Nepal, and reports on the implementation of the country
strategy and program of the Asian Development Bank (ADB), including portfolio performance. It
is being circulated to the Board in lieu of a country strategy and program update for Nepal, as
previously indicated in the Board Information Paper dated 19 October 2005.1

I. CURRENT DEVELOPMENT TRENDS AND ISSUES

A. Political Developments

1. The political situation in Nepal remains fluid with a further hardening of the positions of
the palace and the political parties. In a major development on 9 October 2005, the Election
Commission announced that elections would be held in all 58 municipalities on 8 February 2006.
On 12 October, the King announced that parliamentary elections would be held by mid-April
2007. The King called on the political parties and the insurgents—the Communist Party of Nepal,
Maoist (CPN/M)—to shun agitation and violence and participate in the elections. The major
political parties have, however, announced a boycott of both elections, saying that the current
regime is unconstitutional and that the political and security environment is not conducive to free
and fair elections. In their campaign against the King’s direct rule, parties recently began
demanding an end to the constitutional monarchy and a shift to "total democracy", reflecting a
major hardening of their position. Whether they mean a republican state is, however, unclear.
The parties are also demanding elections to a constituent assembly under an all-party interim
government. Significantly, this, and the establishment of a republic, also have been key demands
of CPN/M.

2. More recently, leaders of key political parties and CPN/M have been holding informal
dialogue on a possible alliance, and exploring whether a way out of the political stalemate can be
found. In a significant positive development on 22 November 2005, the two mainstream political
parties (Nepali Congress and United Marxist-Leninist) leading the seven-party alliance and
CPN/M issued separate statements on a 12-point accord to work towards restoring democratic
rule. The key point of understanding between them is a move towards nationwide elections to a
constituent assembly. This signals CPN/M’s willingness to join the political mainstream, and also
a breakthrough in ending the political confrontation between the political parties and CPN/M for
the first time since the conflict started. The palace’s reaction to this major development is not yet
clear. While it could lead to a lasting solution to the ongoing conflict and political crisis, the
process of moving forward and reaching accord with the palace will be challenging. The
international community is closely involved in this development and will continue to play a major
role. Pressure internally and from the international community for the CPN/M to formally
renounce armed violence, and for the palace to reach out to the political parties to achieve a
national consensus to end the crisis, is likely to build.

3. Although the Government has not reciprocated, CPN/M’s 3-month unilateral ceasefire is
holding reasonably well. Fighting between the security forces and CPN/M has diminished and
civilian casualties have dropped dramatically. Civil society and the general public are demanding
an extension of the ceasefire beyond its planned expiry date on 2 December 2005, which now
seems more likely in view of the understandings reached between the political parties and
CPN/M.

4. The international community supports elections in principle; however, most believe the
environment for local and parliamentary polls does not yet exist. Reconciliation among the
constitutional forces and a peace dialogue with CPN/M are considered necessary before
elections can be held. The recently promulgated Media Ordinance limiting media reporting and
ownership has been criticized as being inconsistent with a conducive environment for democratic

1
ADB. 2004. Nepal: Recent Political and Economic Developments (IN. 274-05). Manila.
 2

elections. The donor community—especially those who channel a significant part of their
development assistance through international and domestic nongovernment organizations
(NGOs)—are also concerned about the recently issued ”code of conduct” to regulate NGO
activities. In its first comprehensive report to the UN General Assembly in August 2005, the
Office of the High Commissioner for Human Rights (OHCHR) cited serious human rights abuses
by both the security forces and CPN/M. However, the report acknowledged the Government’s
cooperation during OHCHR’s investigations. More recently, OHCHR noted that the overall
security situation had improved since the ceasefire and that the Government had released most
political detainees.
5. The local donor group agrees on the need to remain engaged in Nepal and to continue
assistance wherever it is possible to do so safely and effectively, in view of widespread poverty
and vulnerability of the country. Since 1 February 2005, 11 donors have provided a total of $320
million for 27 projects (Appendix), while continuing to take a cautious approach. Having provided
$235 million in FY2005 (ending June 2005), the World Bank is currently processing two
projects—a higher education project for $60 million (50% grant and 50% loan) and a grant
project for $40 million to augment the Poverty Alleviation Fund—for Board consideration in
December 2005. In addition, two other projects totaling about $120 million are under processing
for approval in early 2006. The Department for International Development (DFID) of the United
Kingdom is also expected to sign a grant agreement with the government later this month on a
health project for $32 million. Most other bilateral donors are also continuing to provide new
assistance. While ADB, WB and IMF are focused more on progress of the Poverty Reduction
Strategy’s (PRS) reform and development agenda, bilateral donors are also concerned about
progress on peace, democracy and human rights issues, and the environment for channeling
assistance directly through NGOs and INGOs.

B. Recent Economic Developments and Outlook2

6. GDP growth slipped to 2% in 2005 after recovering to 3.2% in FY2004, due to lower
agriculture output and weak performance of the service and industry sectors. Despite the
increase in security spending3 and civil servant allowances, the fiscal position remained stable in
FY2005 with a low budget deficit of 1.1% of GDP, largely due to underspending of the capital
budget and improved revenue collection. Inflation increased to 4.5% in FY2005 from 4% in
FY2004, reflecting the increase in petroleum prices, and VAT rate. The external payments
position remained stable with strong remittance inflows offsetting the weak tourism and export
performance. Total foreign exchange reserves in FY2005 stood at $1.5 billion, equivalent to 8
months of imports.

7. The results of the recent Nepal Living Standards Survey (NLSS) II show that despite the
conflict, poverty declined sharply to 31% in 2004 from 42% in 1996. A three-fold increase in
remittance inflows along with higher nonagriculture incomes and agriculture wages, rapid
urbanization, and a decline in fertility were the major contributors. Considerable progress is
reflected in almost all welfare indicators: average per capita income, adult literacy, employment,
and access to electricity and piped water supply. Human development indicators relating to the
Millennium Development Goals, such as education and infant and child mortality rates, have also
improved significantly. However, inequality between income and ethnic groups and between
geographical regions has widened.

8. Assuming no deterioration in the security and weather conditions, a GDP growth rate of
3% is likely in FY2006. A sustained increase in remittance inflows will continue to stabilize the
external payments position. The fiscal deficit is forecast to remain at about 2% of GDP. The IMF
is monitoring the budget to ensure that development expenditures in general and social sector

2
For more details on economic performance, see the Quarterly Economic Update on Nepal published by ADB’s Nepal
Resident Mission.
3
Security spending has been increasing since FY2002. It has increased consistently from about 2.3% of GDP prior to
FY2002 to about 3% of GDP in the past 3 years.
 3

spending in particular are not squeezed by security spending. Inflation is expected to increase to
5% as the increase in petroleum prices and the VAT rate takes full effect. Notwithstanding the
stable macroeconomic situation and the progress in poverty reduction, Nepal’s growth and
poverty reduction objectives face significant risks, including political instability, conflict, a
deteriorating investment climate,4 and a slowdown in the economic reform process. Nepal’s top
priority must be to ensure political reconciliation and establish peace.

9. The recent IMF–World Bank debt sustainability analysis indicated that Nepal could be
eligible for debt relief under the highly indebted poor countries (HIPC) initiative. ADB’s analysis
also showed that, while Nepal’s external debt situation was sustainable until 2001, it had
deteriorated in recent years mainly because of poor export performance, which was related to
the conflict. ADB is working with IMF and the World Bank to further assess Nepal’s debt
sustainability. At the Government’s request, ADB also undertook a preliminary analysis of Nepal
opting for debt relief under HIPC.

C. Reform and Project Implementation Environment

10. The environment for economic reforms has become more challenging since the King
imposed direct rule on 1 February 2005. In particular, the polarization between the palace and
the political parties has made it difficult for the Government to move ahead with the reform
agenda of the PRS. Moreover, the Government is more focused on fighting the insurgency than
on the development agenda. However, the intensive policy dialogue between ADB, IMF, and the
World Bank—often jointly—and the Government has helped the Government to restart the
reform process and achieve some progress in recent months. A number of long-pending and
important ordinances have been promulgated, and several more are being actively pursued
(paras.19 and 24). The IMF’s recently concluded Article IV Mission acknowledged the
Government’s efforts to focus on the economic reform agenda. Furthermore, if the temporary
ceasefire continues to hold and develops into a credible peace process, the environment for
reform and development should improve significantly.

11. In the prevailing political and security situation, ADB has intensified its monitoring and
assessed ADB’s portfolio performance at regular intervals. These assessments, including the
most recent one in September 2005, consistently show that the impacts of the security situation
on project implementation before and after 1 February are not significantly different, and much
less than had been anticipated. Most project implementation delays are attributable to the weak
institutional capacity of executing and implementing agencies and a slowdown in decision
making, especially on procurement and policy matters. The assessments also suggest that
adoption of conflict-sensitive approaches in implementing projects permitted most project
activities to be reasonably effective even in an environment characterized by conflict. In
particular, projects that are well targeted, designed, and implemented with active participation of
beneficiary communities generally experience fewer disruptions, even in conflict-affected areas.
Other donors’ experience of project implementation is similar to that of ADB.

D. Implications for Country Strategy and Program

12. The 2004 country strategy and program (CSP) analyzed Nepal’s conflict in depth,
recognizing the risks posed by the conflict to the country operations, and suggested the need to
support an inclusive, participatory, and transparent development process designed to address
the root causes of the conflict. Considering the country context, the CSP proposed a conflict-
sensitive operational approach to development assistance in Nepal in the current environment.
Accordingly, a project implementation strategy was also embedded in the CSP which requires
realistic and conflict-sensitive project designs and implementation modalities, focusing on more

4
For the impact of the conflict on the economic growth, refer Ra, S. and Sing, B. 2005. Measuring the Economic
Costs of Conflict: the Effect of Declining Development Expenditures On Economic Growth, Asian Development
Bank, NRM Working Paper Series, No. 2, June 2005.
 4

intensive community and beneficiary participation in all stages of project processing and
implementation, better targeting of the poor and disadvantaged, mainstreaming social inclusion,
and finally transparency and accountability of project activities at the local level. A review of the
CSP a year after its preparation suggests that its strategic development objectives remain valid
in the current context and, hence, should continue to guide ADB’s operations in Nepal over the
medium term. The present government has affirmed its support to the PRS and the 21-point
agenda announced by the King in February is also consistent with the latter.

13. Addressing governance and corruption concerns in Nepal is a top priority for ADB.
Specific safeguards, such as public audits to curb corruption, are being built into ADB-assisted
projects and programs. Fostering partnerships between the Government, the private sector,
NGOs, and community-based organizations (CBOs) to reinforce transparency and accountability
and institutionalize more robust service delivery mechanisms is also being built into project
designs and implementation. ADB has been supporting the Government as it implements its
anticorruption strategy, and has provided critical assistance to the Commission for the
Investigation of the Abuse of Authority and the National Vigilance Centre to strengthen their
anticorruption capacity.

14. Notwithstanding the need to continue development assistance to Nepal, implementing

development programs remains challenging. Deepening polarization between the palace and the
political parties poses the most serious risks to implementing development assistance, and these
risks could increase in the short term. To mitigate them, ADB (i) closely monitors the political and
security situation and field conditions in project sites; (ii) closely collaborates with donors in
monitoring and assessing the situation and in designing and implementing projects; (iii) routinely
undertakes thorough reviews of the ongoing portfolio to adapt to new realities on the ground; and
(iv) is very cautious in loan signings and effectiveness of previously approved projects,5 and in
processing ADB’s 2005 country program and the future program for 2006-2008. However, if the
ceasefire is sustained and translates into an effective peace process, and reconciliation is
seriously pursued, additional assistance to support the Government’s reconstruction and peace
building efforts may be needed in coordination with other partners.

II. IMPLEMENTATION OF THE COUNTRY STRATEGY AND PROGRAM

A. Progress Towards Achieving CSP Outcomes

15. The 2004 CSP, being ADB’s first attempt at a results-based country strategy, features a
results framework. It defines the results sought by the government to which ADB would
contribute during the CSP implementation period (2005–2009). The results framework helps to
plan, design, and implement the CSP. It also provides a basis for monitoring and evaluation and
mid-course adjustments of ADB’s assistance with a clear focus on development results.
Implementation of the pilot results-based CSP is in the initial stages, and thus it is too early to
meaningfully assess progress. However, despite the complex political and security context, the
government has taken encouraging steps in developing some core elements of results-based
management (RBM) for planning, budgeting, implementing and monitoring development results.
While the PRS provides a medium-term development strategy and priorities aimed at poverty
reduction, the Medium Term Expenditure Framework implemented since FY2002 provides an
important basis to link the PRS to the annual budget through prioritization of available resources.
The Immediate Action Plan (IAP)—initiated since FY2003—has also institutionalized an annual
process to implement the priority reforms of the PRS. As part of the government’s efforts to
ensure results-orientation of the PRS, a Poverty Monitoring and Analysis System (PMAS) has
been developed, sector-specific business plans are being prepared, full devolution of public
service delivery is being initiated in 14 pilot districts, and a District Poverty Monitoring and

5
The cautious approach to operations in Nepal in the present context is spelled out in the Board Information Paper of
19 October 2005 (footnote 1).
 5

Analysis System has been prepared to introduce and streamline the RBM process at different
tiers of the government.

16. The PMAS is an ambitious undertaking, given the weak institutional capacity of
Government institutions. Significant capacity building will therefore be needed to implement the
results-based CSP effectively. Strengthening the capacity of key Government institutions is a
major focus of the CSP. In addition to policy dialogue, ADB has been engaging with key
government agencies to promote better understanding of results-based management and to
institutionalize it as a management tool to achieve development results. Regional and country-
focused technical assistance is being prepared to strengthen the capacity of government
institutions at central and local levels and to help the Government establish stronger links
between development programs, their monitoring and evaluation, and policy feedback, and to
mainstream results-based management in the Government’s and ADB’s poverty reduction efforts
in Nepal. In close partnership with the Government, and based on experience of implementing
the PRS, ADB is also updating and enhancing the CSP results framework by establishing clearer
baseline data, specific tracking indicators, and medium-term targets relating to the PRS goals
and intermediate outcomes and outputs, to which ADB would contribute. This process ensures
better alignment of the CSP results framework with that of the PRS and builds strong
Government ownership of the results-based management process.

17. However, given the weak capacity of the Government, institutionalization of results-based
management will require sustained efforts over a long period. It is very important to recognize
that, if the political risks persist or increase over the medium term, achieving ambitious targets in
development effectiveness would be more challenging.

B. Progress in the Country Strategy and Program Focus Areas

1. Socially Inclusive Development

18. Poverty and inequality in Nepal remain concentrated among the rural poor, women and
disadvantaged caste-based and ethnic groups who have limited access to productive
opportunities, basic social services, and social safety nets. However, there has been some
recent progress in mainstreaming gender, ethnicity and caste concerns. The percentage of
women in the civil service increased from 8% in 2004 to 10% in 2005. The Government has
shown greater willingness to mainstream issues of gender, ethnicity, and caste into project
design and implementation. The Government has also initiated a gender-responsive budget
system from FY2006, initiated gender auditing of selected districts’ periodic plans, and
introduced an incentive system to encourage the private sector to recruit more women
employees. The recently promulgated Civil Service Ordinance, 2005, supported under ADB’s
Governance Reform Program (GRP) provides for increased representation of women, ethnic
groups, and disadvantaged castes in the civil service. The Gender Equality and Empowerment of
Women Project approved in 2004 (loan signing is pending) will help in advancing Nepali
women’s socioeconomic conditions through a process of economic, social, legal, and political
empowerment of poor rural women. In addition, ADB will continue to assist the Government to
address gender, ethnic, and caste discrimination by supporting inclusive public policies,
mainstreaming antidiscrimination measures in ADB-supported projects and reform programs,
and strengthening institutional capacity to promote social inclusion.

2. Governance

19. Direct rule by the King since 1 February, the past record of the cabinet, and several other
actions of the Government are considered to have weakened its commitment to democracy,
peace, and human rights. The Government’s refusal to reciprocate when CPN/M declared a
unilateral ceasefire; its lack of interest in reconciliation with the political parties; OHCHR’s recent
report on the state of human rights abuses; the recently issued media ordinance and code of
conduct for international and domestic NGOs; and the role and conduct of the Royal Commission
 6

for Corruption Control (RCCC) have increased concerns about good governance. However,
there has been significant progress in fulfilling several reform conditions under the ADB-
supported GRP (mainly in the area of civil service reforms). Implementation of this program has
been off-track for the past 2 years. The provisions in the recently promulgated Civil Service
Ordinance substantially fulfill four of the seven outstanding second tranche conditions under the
GRP. These pertain to developing a more meritocratic, inclusive, efficient and effective civil
service. Four important laws for strengthening corporate and financial governance—the
Securities, Secured Transactions, Insolvency, and Company ordinances, which had been
pending for the past 3-4 years—have also been promulgated recently. Although progress on
decentralization has been constrained by the absence of elected local bodies, the Government
has been increasingly devolving delivery of key public services (such as education, health, rural
electricity, and agriculture extension services) to local authorities and communities. It is also
piloting devolution of all public services in 14 selected districts. Further, a number of important
laws relating to good governance—procurement, competition, fiscal transparency, and local
service ordinances—are being prepared. During the CSP period, ADB assistance will continue to
support social inclusion and good governance in Nepal

3. Agriculture and Rural Development

20. The NLSS II findings clearly indicated that the traditional rural economy is transforming,
albeit slowly. This is reflected in increasing commercial orientation of agriculture and growth of
the non-farm rural economy. Devolution of agriculture program and budgeting responsibilities to
district offices in 2003 and finalization of Irrigation Regulations in 2004 have created a conducive
policy environment for local civil society and private sector involvement in this sector. In
December 2004, the government approved the Local Infrastructure Development Policy 2004 to
make local infrastructure policy and strategy consistent with the Local Self-Governance Act
1999. This forms an important basis for further development of the sector and will help to
harmonize donor and government interventions.

21. Agriculture and rural development continues to be the major focus of ADB’s assistance.
The ongoing portfolio and the future program are built on important lessons learnt from recently
closed projects. ADB’s assistance aims to strengthen infrastructure and connectivity (rural
access and irrigation), and the market orientation of agriculture and livestock production.
Assistance in these areas is being supported by major policy and institutional reforms to reduce
public intervention and foster public–private partnerships.

4. Energy

22. Power sector growth has been minimal because of the inability of the Nepal Electricity
Authority (NEA) to operate commercially. A number of measures have been taken to improve the
long-term financial sustainability of the power sector—including a semiautomatic tariff adjustment
mechanism and legislation to control electricity theft—but their implementation has been very
slow. Electricity tariffs have not been adjusted for the last 4 years, despite NEA’s deteriorating
financial position and system losses have increased. ADB is helping NEA to be more
commercially oriented and to improve its efficiency by unbundling its operations. This will also
help to give more of the rural population access to electricity.

5. Transport

23. Progress in the transport sector has been mixed. There has been reasonable progress in
the construction of new national roads, but not of district roads. Fifteen district headquarters
remain unconnected, and the construction of rural roads to promote rural connectivity and
commercialize agriculture has been slow because of the security situation and weak institutional
capacity. The Government has identified developing north–south transit corridors linking the
People’s Republic of China (PRC) and India through Nepal as a priority for investments. Projects
 7

in the current portfolio and in the pipeline are aimed at improving connectivity between all parts
of the country and facilitating trade between Nepal and its neighbors.

6. Water Supply and Sanitation

24. Three major ordinances—Nepal Water Supply Corporation (NWSC), Kathmandu Valley
Water Supply Management Board, and Water Supply Tariff Fixation Commission—were passed
in April 2005. They will pave the way for far-reaching reforms of the state-owned NWSC and for
the introduction of private sector management of Kathmandu Valley's water supply system.
However, implementation of these reforms depends critically on recruitment of a private sector
operator for the Kathmandu Valley water supply system. The Government has also taken a
number of policy decisions to improve delivery of water and sanitation services in the peri-urban
and rural areas by reorienting its role as a facilitator and devolving implementation activities to
beneficiary communities and local bodies. These policy decisions include adoption of the Rural
Water Supply and Sanitation (RWSS) National Policy, the RWSS Strategy, 2004, and the RWSS
Action Plan, 2004. ADB's assistance in the peri-urban and rural water supply subsectors has
been instrumental in facilitating this policy shift and ADB will continue to work with the
Government to strengthen community-based implementation and management of water supply
and sanitation services.

25. Implementation of the Melamchi Water Supply Project is being reviewed by ADB and
other donors participating in the project. On the legal side, the Supreme Court has constituted a
special bench, which is currently hearing the writ petition relating to the constitutionality of RCCC
and the bail cases of former Prime Minister Deuba and Minister of Physical Planning and Works
(MPPW). The former Secretary of MPPW was released on bail on 27 October. Only former Prime
Minister Deuba and the Minister of MPPW, remain in detention.

7. Education

26. Progress in the education sector is reflected in higher net enrollment of girls and boys,
and disadvantaged ethnic groups in primary, lower secondary, and secondary education.
However, further efforts are needed to reach students from disadvantaged caste and ethnic
groups and to improve the efficiency and quality of education at all levels. Given weak teacher
capacity, ADB has been assisting in improving the quality of education by restructuring the
scattered teacher training institutions under an apex body to train teachers in an integrated and
coordinated manner. Teacher education also needs to be significantly improved. ADB is helping
to provide market-oriented skills training to create employment opportunities for the growing
unemployed youth population. ADB’s future assistance is aimed at providing a more holistic
support to the education sector by combining investments with assistance for improving policies,
planning, and management.

8. Regional Cooperation

27. Nepal has assumed an active role in the ADB-supported South Asian Subregional
Economic Cooperation (SASEC) program to promote subregional cooperation among
Bangladesh, Bhutan, India, and Nepal. SASEC has made steady progress during the past 3
years. The participating countries have established development action programs for priority
subregional projects in the transport, energy, trade, industry and private sector, environment,
tourism, and information and communication technology sectors. Potential cooperation areas
with direct relevance to Nepal include hydropower development, rural electrification,
improvement of cross-border access to India and Bangladesh, and development of a subregional
tourism master plan. Nepal’s recent accession to the World Trade Organization and the Bay of
Bengal Initiative for Multi-Sector Technical and Economic Cooperation has also improved the
prospects for regional cooperation significantly. Nepal is also considering development of a
transit corridor between the PRC and India through Nepal, possibly with ADB support.
 8

C. Aid Coordination and Development Partnerships

28. The Government chairs the Nepal donor group (NDG), which comprises all bilateral and
multilateral donor agencies and meets every 2 months to review conflict and development
issues. The NDG also oversees 12 thematic groups, many of which are chaired or co-chaired by
the Government. The reform and development group, comprising the 7 most important donor
agencies, including ADB, is the main forum for Government–donor dialogue on reform,
development, and harmonization in Nepal. The RDG also monitors the annual Immediate Action
Plan (IAP)—priority reforms/policy actions—on a quarterly basis.

29. Following the Rome and Paris Declarations, ADB stepped up harmonization efforts with
other donors in Nepal. Country-level joint action plans between ADB and DFID and the Agency
for German Technical Cooperation (GTZ) have been prepared and are being implemented to
facilitate coordination and collaboration in key areas of assistance to Nepal. The Nepal Resident
Mission (NRM) has also significantly enhanced collaboration with the World Bank to achieve
strategic alignments and synergies in program formulation and implementation in support of the
objectives of the PRS. A joint harmonization framework with the World Bank is currently being
prepared.

30. At the project and program level, ADB along with the World Bank and the Japan Bank of
International Cooperation (JBIC) has been conducting Joint Portfolio Performance Reviews with
the government since 2001, including a recent one in September 2005. A number of co-financing
agreements have also been reached with various bilateral development partners for ongoing and
future projects, with significant collaboration on important institutional and policy reforms as well.

III. PORTFOLIO PERFORMANCE

32. Nepal’s portfolio performance has been deteriorating steadily since 2001. While
disbursement ratios were above 20% in the years preceding 2001, they have fallen to below 10%
since then (Table 1), well below the ADB-wide average of 17-18%. A careful analysis of the
impact of various factors on project implementation and portfolio performance in Nepal suggests
that the key factors causing the decline are the severe political instability resulting in frequent
changes of government, which has in turn sharply slowed down decision making. This has
particularly delayed procurement, consultant recruitment, and policy decisions and actions under
both project and program loans, prolonging project implementation periods. The average
implementation period of ADB-assisted projects that have closed in the past 10 years in Nepal
was over 8 years, compared with the planned 5-year period. Slow implementation, especially
with regard to large projects such as the Melamchi Water Supply Project, has dragged down
disbursement ratios, although it appears that the conflict per se has not significantly affected
portfolio performance as yet.
Table 1: Disbursement Trends
Year Disbursement Contract Award ratio Disbursement ratio a
($ Million) (%) (%)
1996 71.8 14.8 18.3
1997 100.9 59.9 21.8
1998 105.3 30.4 28.0
1999 70.4 13.4 21.2
2000 91.4 15.6 37.0
2001 57.2 11.2 16.6
2002 28.2 3.7 8.4
2003 33.6 8.2 7.1
2004 22.0 7 4.4
b
2005 32.6 12 5.0
a
Disbursement ratio is defined as the ratio of total disbursement over the undisbursed balance at the beginning of the
year.
b
Figures shown are the most likely achievements to the end of 2005, based on a review carried out in June 2005.
The net loan amount of approved loans which have become effective has been added to the opening balance.
 9

33. Inappropriate project design also contributed to weak portfolio performance in Nepal. In
particular, projects/programs that are not ‘sensitive’ to the prevailing political and conflict
environment experienced greater implementation problems. By contrast, projects based on more
suitable and flexible implementation modalities (e.g., community-based approaches and sector
loans), projects with built-in conflict and political risk mitigation measures, and realistic policy
reforms tend to perform better. In this context, the project design and implementation framework
embedded in the 2004 CSP is critical to improving portfolio performance and achievement of
better development outcomes and impacts in Nepal. Project implementation environment in 2005
continued to be challenging although portfolio indicators are expected to stabilize at about the
rates/levels achieved in 2004.

34. Of the 23 loans in the current portfolio, 9 (34%) were rated as being ”at risk” as of
October 2005 (Table 2). Two of these are program loans, which are experiencing long delays
because of slow decision making related to political instability. Four of these projects “at risk” are
loans approved in 2003 and 2004, loan signing and/or effectiveness of which has been pending
due to the political developments since February 2005. If the implementation delays of these
projects are addressed, this will significantly improve the overall portfolio performance. ADB is
continuing to take a cautious approach in its operation in Nepal, particularly with respect to the
four pending loans, and is assessing the implementation environment for each of these loans.
These loans will be signed and declared effective only if the assessment suggests that they can
be implemented effectively and safely in the present environment.6

35. The frequency of ADB’s interaction with Government agencies to address implementation
issues has increased significantly in the past year. The Government has committed to taking
stronger measures to improve portfolio performance, including more frequent and closer
monitoring of project activities, advance procurement actions, and more upfront engagement to
ensure project quality at entry. Bimonthly project managers’ meetings, co-chaired by the
Secretary, Ministry of Finance, and the Country Director, NRM, are being held to address
implementation issues. Within ADB, delegation of project administration to the NRM has
increased over the last year, with the NRM currently administering 11 out of the 23 ongoing
projects, with more loans expected to be delegated soon. An Operations Review Mission
combining program and portfolio reviews in September 2005, in consultation with the
Government, identified tentative loan savings of about $26 million in the current portfolio. Steps
are being taken to realize these savings. A similar ‘spring-cleaning’ exercise provided $22 million
in loan savings in 2004. These are major initiatives led by NRM to restructure the ongoing
portfolio to improve its performance.

Table 2. Projects at Risk

Loan No. Loan Reasons for “at risk” rating

1811 Corporate and Financial Delayed implementation progress, and poor compliance with loan
Governance covenants and finalizing audited accounts and financial statements.
1820 Melamchi Water Supply Delayed implementation progress, and delayed compliance with
Project loan covenants.
1755 Small Towns Water Supply Delayed procurement process.
and Sanitation
1861 Governance Reform Program Delayed implementation due to political instability.
2002 Public Sector Management Delayed implementation due to political instability.
Program
2111 Skills for Employment Approved on 25 October 2004. The project is awaiting loan
effectiveness. All loan effectiveness conditions have been met.
Assessment of implementation environment will be undertaken in
the coming weeks.

6
Following a detailed security, political and institutional assessment of the Decentralized Rural Infrastructure and
Livelihood Project, which provided adequate confidence that the project could be implemented safely and
effectively, the project was declared effective on 26 October 2005. The assessment is posted on ADB’s intra-net
website.
 10

2071 Community Livestock Approved on 19 December 2003. The project is awaiting loan
Development Project effectiveness and the conditions for effectiveness have been met.
Assessment of implementation environment underway.
2102 Community-Managed Approved on 17 November 2004. The project is awaiting signing of
Irrigated Agriculture Sector loan agreement. All conditions for loan signing have been met.
Project Assessment of implementation environment underway.
2143 Gender Equity and Approved on 16 December 2004. The project is awaiting signing of
Empowerment of Women the loan agreement. Assessment of the implementation
environment suggests that the conditions to make the loan effective
have not been met due to weak Government commitment.
Therefore, a decision has been taken to withhold loan signing at
this stage.

V. COUNTRY ASSISTANCE PROGRAM (2005–2009)

36. The 2005-2009 country program is guided by the 2004 CSP for Nepal. The country
program focuses on helping the Government foster more inclusive development, improve basic
social services and infrastructure, promote private sector development, empower women and
other disadvantaged groups, and improve governance. Special emphasis is being placed on
project design to ensure that project objectives are fully in line with the CSP’s priorities, conflict-
sensitive, and results-oriented. ADB’s assistance program is fully aligned with the PRS.

37. The 2005–2007 lending program includes 11 firm projects with a total of $350 million.
Under ADF IX, Nepal could be eligible for up to 50% of the total amount as grant. However, in
view of the country’s situation, ADB has taken a cautious approach to processing new assistance
to Nepal. Accordingly, processing of the 2005 lending and non-lending program has been
delayed and a Country Programming Mission (CPM) scheduled in March-April this year was not
fielded. Following the cautious approach, Nepal may not receive any new loan assistance from
ADB in 2005. This will have implications for future assistance, and will be addressed during the
review of the overall country program in December 2005.

38. The 2005 non-lending program comprising 12 TAs and 1 Japan Fund for Poverty
Reduction grant supports institutional strengthening and capacity building, to enhance
development effectiveness. Processing of these TAs is continuing in close consultation with all
relevant donor partners. However, less than half of the TAs may be approved in 2005.
 Appendix

Various Donors' Foreign Aid Commitments to Nepal since February 2005 1

S. N. Date of Agreement Donor Name of the Project Type of Amount

Assistance ($ million)
1 8 February 2005 Germany Health Sector Support Programme Grant 0.9
2 14 February 2005 UK Seed and Livelihood Support Project Grant 5.9
3 21 February 2005 UK Health Sector Program Grant 56.3
4 21 February 2005 UK National HIV/AIDS Program Grant 28.1
5 7 March 2005 Japan Non-Project Grant Assistance Scheme Grant 14.4
6 7 March 2005 Japan Increase of Food Production (2 KR) Grant 2.9
7 10 March 2005 UK District and National Implementation of Nepal's Grant 0.8
Agriculture Perspective Plan
8 1 April 2005 France Food Security Program for Nepal (FSPN) Grant 0.4
9 20 April 2005 UK Rural Community Infrastructure Works Program (RCIW) Grant 3.7

10 10 May 2005 Japan Procurement and Transportation of Rice Grant 3.3

11 5 June 2005 UK Mobilize of Volunteers Grant 0.7
12 7 June 2005 IFAD Leasehold Forestry and Livestock Program Loan 10.6
Grant 1.2
13 9 June 2005 Japan Construction of Sindhuli Road (Section II: Sindhuli Bazar Grant 24.4
- Khurkot)
14 29 July 2005 Switzerland Nepal Swiss Community Forestry Project Phase V Grant 4.1
15 29 July 2005 USA Increased Private Sector Participation in Grant 1.5
Environmentally and Socially Sustainable Hydropower
Development
16 29 July 2005 USA Strengthened Governance of Natural Resources and Grant 4.0
Selected Institutions
17 29 July 2005 USA Increased Sustainable Production and Sales of Forest Grant 0.9
and High-value Agricultural Products
18 29 July 2005 USA Promoting Peace Through Improved Governance and Grant 2.9
Incomes in Targeted Areas
19 29 July 2005 USA Reduced Fertility and Protected Health of Nepali Grant 12.1
Families
20 1 August 2005 World Bank Rural Access Improvement and Decentralization Project Grant 32.1

21 1 August 2005 World Bank Economic Reform Technical Assistance Project (ERTA) Grant 3.0

22 3 August 2005 India Development of Infrastructures at Four Boarder Check Grant 72.3
Points along Nepal-India Boarder
23 15 August 2005 China Budgetary Support Grant 12.3
24 16 August 2005 Japan Construction of Primary Schools Grant 5.3
25 31 August 2005 UNDP Western Terai Landscape Complex Project Grant 13.1
26 31 October 2005 Finland Strengthening Environmental Administration and Grant 2.2
Management at Local Level
27 18 November 2005 Switzerland Vertical Shaft Brick Kiln Technology Transfer Project Grant 0.7
Phase II
Total 320
1
Excluding ADB's Skills for Employment Project ($20 million), loan agreement for which was signed on 2 February 2005.