Nepal Nonfinancial Public Enterprises Sector Report · 2016. 7. 12. · Nepal. This report examines the performance of Nepal's nonfinancial public enterprises (referred to subsequently

Report No. 9076-NEP

NepalNonfinancial Public Enterprises Sector Report

(In Iwo V\Iunes) Volinie 1 -Mairn Report

January 16, 1991

A~sia CoMnr11V D)epa)rtment I

Asia Techn (l I)epartmunt

FOR OFFICIAL USE ONLY

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents nmay not otherwisebe disclosed wi ithout WVorld Banki authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS(As of March 1990)

Currency Unit - Nepalese Rupee (NR$)US$1.00 - NR$28.90NR$1.00 - US$0.035

FISCAL YEAR (FY)

Mid June - Mid July

WEIGHTS AND MEASURES

Metric System

FOR OFFICIAL USE ONLY

LIST OF ACRONYMS

ADB Asian Development BankAIC Agricultural Inputs CorporationATF Agriculture Tools Factory

BBF Bhaktkapur Brick FactoryBJM Biratnagar Jute MillsBISF Bansbari Leather and Shoe FactoryBOD Board of Directors

CCD Corporations Coordination DivisionCE Chief Executive

DDC Dairy Development Corporation

EC Executive Chairman

GM General Manager

HCC Himal Cement CompanyHCIL Hetauda Cement Industry LimitedHMG His Majesty's GovernmentHTI Hetauda Textile Industry

IFC International Finance Corporation

JCF Janakpur Cigarette Factory

MIS Management Information SystemMOA Ministry of AgricultureMOF Ministry of FinanceMOI Ministry of Industry

NFC Nepal Food CorporationNIDC Nepal Industrial Development CorporationNPC National Planning CommissionNRB Nepal Rastra BankNTL National Trading Limited

PE Public Enterprise (nonfinancial)PSC Public Service Commission

QC : Quality Control

RDL Royal Drugs LimitedRJM Raghupati Jute Mills

STC Surya Tobacco Company

T&T Trade and Transit

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties Its contents may not otherwise be disclosed without World Bank authorization.

NEPAL

NONFINANCIAL PUBLIC ENTERPRISES

SECTOR REPORT

Table of Contents

Page No.

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

I. PE ROLE AND PERFORMANCE . . . . . . . . . . . . . . . . . 1

A. Introduction and Background . . . . . . . . . . . . . 1B. PE Performance . . . . . . . . . . . . . . . . . . . . 4C. Financing of the PEs ... . . . . . . . . . . . . . . 11D. Discussion and Core Issues . . . . . . . . . . . . . . 13

II. THE POLICY AND REGULATORY FRAMEWORK . . . . . . . . . . . 14

A. Investments and the Regulatory Environment . . . . . . 15B. Administration of Regulations . . . . . . . . . . . . 19C. The Pricing Regime . . . . . . . . . . . . . . . . . . 21

III. GOVERNMENT SUPERVISION, CONTROL ANDPERFORMANCE MONITORING ... . . . . . . . . . . . . . . . 26

A. Introduction and Summary . . . . . . . . . . . . . . . 26B. Government Oversight Agencies . . . . . . . . . . . . 28C. Existing Monitoring and Reporting Systems . . . . . . 31D. Options for Reform ... . . . . . . . . . . . . . . . 32

IV. INTERNAL MANAGEMENT . . . . . . . . . . . . . . . . . . . 36

A. Introduction and Summary . . . . . . . . . . . . . . . 36B. Managerial Capability ... . . . . . . . . . . . . . 38C. Functional Areas ... . . . . . . . . . . . . . . . . 39D. Financial Management ... . . . . . . . . . . . . . . 42E. Options for Reform ... . . . . . . . . . . . . . . . 44

V. EMPLOYMENT, COMPENSATION AND LABOR RELATIONS . . . . . . . 49

A. Introduction and Summary . . . . . . . . . . . . . . . 49B. Employment Regulations ... . . . . . . . . . . . . . 50C. Salary and Wage Structure . . . . . . . . . . . . . . 55D. Labor Relations .... . . . . . . . . . . . . . . . 57E. Options for Reform ... . . . . . . . . . . . . . . . 60

This report is based on the findings of a World Bank mission to Nepal inMarch/April 1990, comprising C. Ramsay (Mission Leader), A. Agbonyitor, P.Thuyet, S. Paul, S. Torabi, J. Baker (Consultant), J. Plummer (Consultant),K. Koirala (Consultant), and P. Pant (Consultant).

-ii-

Table of Contents (Cont'd)

Page No.

VI. PRIVATIZATION AND DIVESTITURE . . . . . . . . . . . . . . 64

A. Introduction .... . . . . . . . . . . . . . . . . . 64B. Constraints and Issues ... . . . . . . . . . . . . . 66C. Strategy for Privatization and Divestiture . . . . . . 69

VII. STRATEGY FOR PE REFORM .. 76

A. Overview .76B. Implementation P.E. Reform . . . . . . . . . . . . . . 78C. Implementation Plan ... . . . . . . . . . . . . . . 81

ANNEXES

1.1 Official List of PEsI.2 Legal Status of PEs1.3 Capacity Utilization of Selected PEsI.4 PEs Dividend Distribution StatementT.5 Commercial Bank Loan to PEs Under HMG/Nepal Guarantee

1I.1 Ministry of Supplies: Role of Government in Pricing, Distribution andMarketing of Essential Commodities

IV. Enterprise Profiles (Volume II)

V.1 Comparison of PE and Civil Service Pay ScalesV.2 Salary Analysis: Public Enterprises and Private SectorV.3 Salary Analysis: Joint VenturesV.4 Output Per Employee in Public and Private SectorsV.5 Supply and Demand for Skilled and Qualified Manpower

VI.1 Company Valuation

EXECUTIVE SUMMARY

Background

i. In the 1960s and 1970s Nepal relied heavily on piblic sectorenterprises to promote economic growth. By the mid-1970s, more than 60 publicenterprises had been established, in many instances with substantial financialand technical assistance from multilateral and bilateral donors. Althoughsupport for creating new public enterprises diminished subsequently because ofexisting units' poor performance, public enterprises still play a major rolein economic activity in Nepal. Currently, the 64 officially listed publicenterprises control major sectors of the economy. In the financial sector,two state banks, Nepal Bank Limited and Rastriya Banijya Bank, account forabout 80Z of commercial bank assets. Nonfinancial public enterprises havevirtual monopolies in commercial energy (including oil, electricity and coal),domestic air transportation, basic utilities such as telecommunications andwater, and the importation of basic inputs such as chemical fertilizers.Manufacturing PEs (M.PEs) account for over 70Z of the domestic market fortobacco products, 62Z for cement, 55Z for sugar and 45Z for leather goods, inaddition to substantial production of beverages, agricultural tools, textilesand drugs. Although they constitute numerically less than 3Z of the totalnumber of manufacturing establishments relative to the private sector, MPEsrepresent a disproportionate share of fixed assets (36Z), value added (29Z)and employment (25Z).

ii. Given the importance of the public enterprises, their current poorperformance constrains the growth and efficiency of economic activity inNepal. This report examines the performance of Nepal's nonfinancial publicenterprises (referred to subsequently as PEs), with emphasis on themanufacturing PEs on which relatively little systematic analysis has been doneand the trading PEs, which are the primary recipients of government subsidies.The report examines the budgetary impact of PE under-performance, assesses thefactors, both external and internal to the PEs, which have contributed totheir poor performance, and, taking into account existing social, politicaland economic constraints, recommends short-, medium- and long-term reformstrategies. The analysis draws extensively on the results of a survey of tenmanufacturing and two trading PEs. Volume Two contains detailed enterpriseprofiles based on this survey. Preparation of this report was coordinatedwith an IMF report on PE pricing and subsidy issues; recommendations in bothreports on these issues are consistent.

iii. The report concludes that PEs are likely to become an increasingburden on Government because of their poor financial performance. The PEsabsorbed over 20Z of Government revenues on average over the past three years,with manufacturing and trading PEs accounting for about half of totalallocations. Production levels and efficiency are below potential for mostMPEs. Few are cost competitive relative to imports or similar enterprises inother developing countries. Of the 28 MPEs in operation, only four havegenerated profits consistently, two incur large losses and the remainder areonly marginally profitable. Trading PEs have the largest financial losses.

- ii -

Over the past five years cumulative lobses of loss-making manufacturing andtrading PEs exceeded NRs 1.5 billion. Financial losses have eroded governmentequity in the PEs; six of the ten MPEs in the .ample survey had negative ordeclining net worth. Five of seven trading PEs have a negative net worth.Actual financial performance is likely to be even worse than indicated sincepoor accounting standards and records understate the PEs' financialweaknesses. Deficiencies include lack of physical verification andrevaluation of assets and inadequate provision for depreciation, bad debt andobsolete stock. Few PEs have internal funds to finance capital replacementcosts. There is little indication that the performance of the manufacturingand trading PEs will improve in the foreseeable future. Even the fewprofitable PEs are beginning to show declining profitability and willeventually require support. Thus, PE debt repayment, working capitalrequirements, and rehabilitation and modernization costs are becoming agrowing burden on Government.

Constraints and Issues

iv. The PEs' poor performance is due in part to real economic andphysical constraints, such as poor quality and inadequacy of domestic rawmaterials, unreliable supply of power, obsolete technology and defectivemachinery. However, the PEs' policy and operating environment also providelittle incentive to increase production efficienocy and achieve financiallysustainable operations. Deficiencies exist in all areas critical toenterprise performance. Key problems highlighted in the report are thefollowing:

X Conflicting objectives, inconsistent policies and lack of clearperformance guidelines have lessened PE accountability and weakenedmanagers' incentives to perform. The Government has a multiplicityof often conflicting objectives for the PEs, including employmentgeneration, meeting basic needs, providing rural services andgenerating financial returns through dividends, but little guidancehas been given to enterprises to assist them in prioritizing ormaking tradeoffs among these often conflicting objectives.

* The industrial and regulatory environment in Nepal shieldenterprises from competitive pressures and fosters managerialinertia. Barriers such as output price controls and commodity tradeagreements which support sole, state-sponsored supply of someproducts, limit private sector entry into some industries. At thesame time, nonviable MPEs are seldom closed. In many instances,government measures such as payment of guaranteed debt, directgovernment subventions and tax rebates are used to supportfinancially weak enterprises.

* Weaknesses in the policy environment are compounded by anineffective, procedure-bound system of supervision and control bygovernment oversight agencies which limit the PEs' ability torespond to changes in their environment even if they had adequateincentives to do so. Formal and informal government control ofpricing, investment, employment and other operational decisions

- iii -

contribute to lengthy and inflexible decision-making processes thatfrequently result in suboptimal decisions that adversely affectenterprises' financial health, and efficiency. The regulatoryframework of the Public Services Commission (PSC), which controlsall major staffing and employment decisions, limits the PEs' abilityto adjust their staffing requirements to their needs. With theemphasis on detailed control of the PEs, government oversightagencies have failed to exercise strategic control; little guidancehas been pro:ided to enterprises to help develop long-termstrategies nor has long-term planning been emphasized. Furthermore,despite the multiplicity of oversight agencies, there is littleeffective performance monitoring.

• PEs suffer from severe managerial deficiencies which would limittheir ability to operate efficiently even under a less restrictivesupervisory regime. The PE boards, comprised mainly of governmentofficials, reinforce the use of civil service norms and practicesrather than a commercial approach to management. This perspectiveof the boards is further reinforced by many chief executives who areretired or ex-government officials with no prior commercialexperience.

* The PEs are critically short of expertise in functional areas vitalto commercial operations. While many PEs have excess levels ofclerical and unskilled workers, in general there is a scarcity ofskilled technical staff and operators. In most enterprises,corporate planning is virtually nonexistent, marketing is extremelyweak, production management is poor, and there is little emphasis onmanpower planning and personnel management. Even more importantfrom the perspective of performance monitoring and internalcontrols, are the existing deficiencies in financial management andaccounting practices and standards. The accuracy of most financialdata is questionable. Poor accounting systems mask financialweaknesses and give managers little warning of potential problems.

v. Over the years, the Government has recognized the PEs' growingproblems and announced various policy initiatives but few of these have beenimplemented. Reforms proposed under the Seventh Plan (1985-1990) -- includingPE div.-estiture, liquidation and consolidation, greater selectivity in new PEinvestments, increased autonomy for PE managers and introduction ofperformance incentives -- have not been acted on. With the exception of .a fewtrading PEs which became inoperative following loss of their markets and wereliquidated, the Government continues to support many sick enterprises. Half-hearted attempts to privatize PEs have failed. Establishment of new PEscontinues, driven more by availability of funding than by the strategic natureof the investment. Proposals to introduce a system of PE performancemonitoring could not be effectively implemented. This failure to translatepolicy initiatives into concrete actions reflects a lack of governmentcommitment and a failure.to achieve consensus among various interest groups aswell as a lack of technical capability within the Government to design andmanage effective implementation plans. It is therefore clear that to besuccessful, any PE reform strategy in Nepal must take into account the socio-

- iv

political environment and the Government's weak implementation capacity andshould focus on the institutional arrangements essential for successfulimplementation.

Strategy for Reform

vi. The reform strategy proposed in the report recognizes that theproblems facing PEs in Nepal are severe and cannot be solved in the shortterm. The multiple roles played by the PEs and the many vested interestgroups make it difficult to build the consensus needed to achieve reform.Their operating environment provides little incentive for enterprises tofunction commercially. The supervisory and control regime which has had sucha dysfunctional impact on PE autonomy and managerial incentive is wellentrenched, and restructuring or dismantling this will take time.Furthermore, the key managerial functions essential for good performance andaccountability, which are so poorly developed within the enterprises, requiretime and effort to establish. Nevertheless, given the poor and deterioratingperformance of the PEs, there is now an urgent need to start correctiveaction. A broad strategy for PE reform should:

(a) aim, as a matter of priority, to significantly improve the policyand regulatory framework for PEs and for the industrial sector inorder to promote the private sector and increase the pressure on PEsto operate as efficient commercial entities. Key measures include(i) removing existing barriers to entry of private sector firms andimproving the administration of industrial incentives andregulations; (ii) removing barriers to exit by limiting governmentsupport for weak PEs; (iii) replacing discriminatory direct controlson MPEs to purchase domestic raw materials by flexible incentives tomotivate both public and private sector interest in using localresources; and (iv) liberalizing the price control system whilemaking any remaining subsidies explicit and channeling them toclearly identified target groups. The number of goods subject toprice control under the Essential Commodities Act should be reducedand pricing authority delegated to managers of PEs operating incompetitive markets;

(b) encourage divestiture/privatization of PEs wherever possible, whilerecognizing existing constraints to privatization and divestiture inthe short term. Given the scarce managerial and financial resourcesin the public sector, privatization and divestiture, includingliquidation or closure of nonviable PEs, by reducing the number ofenterprises remaining in the public sector will make the task ofplanning and implementing PE reform more manageable. Essential tosuccessful privatization is the development of clear policyguidelines which would indicate Government's objectives forprivatization and divestiture, describe the institutionalarrangements for managing the process, indicate how the potentialcosts of privatization, e.g., financing of debt restructuring andredundancy payments, would be met, and outline the Government'sstrategy with respect to redeployment of staff, foreignparticipation, concentration of ownership, management/employee

- v -

participatioi, etc. Classifying and ranking PEs, the first step ina PE reform program, will identify several candidates forprivatizat on. However, given the underdeveloped capital marketsand poor tinancial performance of many enterprises, the pace ofprivatization will be largely determined by the extent of investorinterest and the effectiveness of measures to encourage managementand employee participation and attract foreign as well as localinvestors.

(c) develop a program of reform and restructuring for PEs that wouldremain in the public sector. The aim would be to achieve a moreappropriate and sustainable balance between PE autonomy andaccountability and to provide greater incentives to PE managers toperform. Priority actions would include the following:establishing efficient operational and financial performance aspriority objectives while providing compensation to PEs which mustincur costs to pursue social obiectives (structural changes such astransfer of noncommercial functions to Development Boards orgoverimernt departments should be considered); reforming governmentoversight to emphasize strategic guidance and monitoring ofappropriate performance targets with clear delineation of the roleof each government agency; improving the quality of board members,and operational managars; granting PEs more autonomy, especially inpricing and employment decisions, while providing improvedincentives for efficient operations; establishing sound accountingand internal management systems; and taking steps to reduceredundancies and improve the quality of PE labor. For manyenterprises, additioral financial resources will be required towrite-off or restructure debt and rehabilitate or upgrade machineryin order to ensure the financial health of restructured enterprisesand increase production efficiency.

Implementing Reform

vii. Based on other countries' restructuring experience, a comprehensivereform of the PE sector in Nepal, and institutional restructuring inparticular, can be expected to take a minimum of 5-7 years. The institutionalcapacity and experience required to implement a large-scale privatizationprogram and effect all required reforms simultaneously for a large number ofPEs appears not to exist in Nepal. Thus, the report recommends thatGovernment adopt a phased approach to implementing its PE reform. Initialreform efforts in the near term will provide valuable feedback to design oflater reform programs.

viii. It is essential at the outset that government states unambiguouslyits objectives and proposed strategy for PE reform so that clear signals areprovided to both Government officials and PE managers and staff of expectedchanges in the role and function of PEs. Thus, an essential prerequisite toimplementing PE reform is that government issue a PE policy and strategystatement along the lines discussed in para (vi) which would provide theframework for implementing more specific reform measures. In particular,governments intention to (a) operate PEs on a fully commercial basis,

- vi -

(b) provide separate financing for noncomme cial activities undertaken by PEsand (c) reduce the number of public enterprises through a program ofprivatization and divestiture, should be emphasized.

ix. In the initial phase of implementing reform, Government should beginto address broad policy and institutional issues at the same time that itrestructures selected enterprises and initiates its privatization program. Inparticular:

(a) for Policy and Institutionai Refcrm, measures which should beinitiated during the initial phase include: (1) reviewing pricingand industrial policies and regulations with the aim of improvingthe competitive and regulatory environment of both public andprivate sector companies; (2) reviewing existing PSC regulations inorder to simplify and streamli.te current procedures; (3) developingaccounting standards to increase the reliability of financial data;and (4) establishing training programs to improve the quality of thelabor force.

(b) for Privatization, divestiture of easily saleable PEs identified aspriority candidates for privatization (e.g., financially viable PEsin competitive markets which are attractive to the private sector'as is') can begin while Government continues to prepare detailedaction plans for less attractive candidates and to finalize measuresto address constraints and issues likely to affect a largerprivatization program. The UNDP financed/IFC executed technicalassistance program agreed with the previous GoveLnment can provideneeded expert assistance. Experience of this process should feedinto and strengthen plans for further privatization.

(c) for PE Restructuring, instead of attempting to introduce reformssimultaneously in all the PEs which would remain in the publicsector, restructuring should begin with a small group of PEs forwhich there is a clear rationale for public ownership (e.g.,strategic enterprises or PEs in monopoly or quasi-monopoly markets),Restructuring of selected enterprises could proceed while detailedrestructuring plans are being developed for remaining enterprises.

x. Restructuring enterprises which will remain in the public sectorwill be the more difficult task. It is recommended that in the initial phaseof enterprise restructuring, a group of four or five PEs be selected from aministry whose leadership is interested in reform. The Ministry of Industryis probably the best candidate. Four or five of its nearly 30 PEs could beidentified for which there is a clear rationale for public ownership.Priority sho'.d be given to those PEs for which the fiscal impact ofrestructuri g would be significant. Recently established PEs and those notyet operational, which cannot be privatized in the short-term, could also beincluded in Phase 1 since they are less likely to have the deep-seatedproblems of other PEs, and action now could forestall future problems. Whererelevant, a subsector approach to restructuring should be pursued. For theselected PEs, priority should be given to (a) reconstituting the Boards ofDirectors to include technical, financial and management specialists from the

- vii -

private sector and (b) appointing qualified chief executives and seniormanagement teams. Appointment of competent and experienced managers iscritical to the improvement of internal management functions and practices.Once qualified managers are in place, the tasks of strengthening internalmanagement functions, preparing corporate plans, etc., should be theirresponsibility under the supervision of their boards. fechnical and financialassistance should be provided to help the selected PEs strengthen internalsystems and upgrade and rehabilitate their machinery where necessary.

xi. It is recommended that the oversight function and management of PErestructuring in Phase 1 be the responsibility of a special PE unit which canbe established within the selected line ministry. As part of the reformprocess, the unit, with exp2rt assistance, would identify candidates for Phase1, develop revised operating guidelines and secure Cabinet approval forrequired modifications in rules and regulations applicable to selected PEs.As part of its oversight function, the unit would also negotiate targets withthe PEs, supervise their performance and implement a modified profit-linkedbonus scheme for selected PEs.

xii. Depending on progress made in Phase 1, in about the third year ofthe program, the experience with the reform of the selected PEs should beevaluated by an interministerial task force, to see whether enough had beenlearned to be able to adapt this approach to reform to the rest of the PEs.This task force should have the mandate to design the larger reform programincluding recommending the government agency or other organization which wouldinitiate and oversee the expanded reform program, designing an improvedperformance evaluation system and performance-linked incentives, defining therole of sector ministries and other oversight agencies and identifying anyother institutional mechanisms for strengthening PE performance.

Organization of the Report

xiii. The main report is organized around three basic themes. The firstchapter analyzes the PEs' economic importance, financial and oporationalperformance and impact on the Government's budget. The subsequent fourchapters discuss the factors contributing to the PEs' poor performance.Chapter II discusses the competitive and regulatory environment, includinginvestment policies, price controls and the administration of regulations andincentives. Chapter III discusses government supervision, control andperformance monitoring. This is followed by a discussion of the deficienciesin internal PE management in Chapter IV and more specific details onemployment and compensation issues in Chapter V. Each of these chapterspresents options for reform of key problem areas and is preceded by a briefintroduction and summary. Chapters VI and VII discuss the recommended PEreform strategy. Chapter VI focusing on a strategy for privatization anddivestiture, and Chapter VII on the strategy for PEs that would remain In thepublic sector, including presentation of a phased action plan.

I. PE ROLE AND PERFORMANCE

A. Introduction and Background

The Economic Importance of PEs

1.1 Nepal''s public enterprise sector accounts for about 62 of non-agricultural GDP and 9? of formal sector employment, and is important becauseit dominates activities basic to the economy. Currently, the officiallylisted public enterprises consist of 64 units, of which 8 are engaged infinance and the other 56 in non-financial activities. The non-financialpublic enterprises (PEs) include those in manufacturing (28), trade andcommerce (7), energy (4), utilities and transportation (4) with the rest ineducation, information and other services. In the financial sector, two statecommercial banks - Nepal Bank Limited and Rastriya Banijya Bank - account forabout 80? of commercial bank assets. PEs have virtual monopolies inelectricity and domestic air transportation, basic utilities such astelecommunications and water, and play a key role in the industrial sector.Overall, the combined formal and informal manufacturing share of GDP isestimated at 10?; manufacturing accounted for 18? of formal sector employmentin 1990.1/ The manufacturing public enterprises (MPEs) account for 362 offixed assets, 29? of value added, and 251 of employment in the manufacturingsector. The MPEs dominate the production of cement (62Z), agrolime andchemical lime (80Z), sugar (55?), tobacco products (702) as well as petroleum.products and agricultural tools. In commerce, the trading PEs have a monopolyof the importation of chemical fertilizers, oil and coal. The PEs absorbed anLverage of over 202 of Government revenues in the past three years. In 1989,outstanding loans to the non-financial PEs accounted for 132 of totalcommercial bank credit.

1.2 Estimates understate the size and scope of PE activities in Nepalbecause the legal codes do not distinguish clearly between private and publicsector concerns. The official list of PEs (Annex I.1) reflects only part ofgovernment investment in public enterprises. Officials in Nepal often referto 'First Generation' PEs which come directly under government control; theyare owned wholly or partially (with more than 51? shares) by the state andlisted officially as PEs. Since existing PEs can invest in subsidiaries,there are 'Second Generation' PEs which have majority control by the FirstGeneration units, most often jointly with the private sector. Lastly, thereare 'joint ventures' in which the state and existing PEs control a total of50Z shares. The enterprises in which the state and other PEs have minorityshare control are not listed officially as public concerns. For example, theNepal Industrial Development Corporation is a First Generation PE withmajority share control (80?) in Himal Cement which is a Second Generation PE.Himal Cement, in turn, has a minority (30?) share interest in the HousingManagement Company which is listed as a private concern. The subsidiary

1/ If construction is excluded, manufacturing employment (150,000) is abouti22 of formal sector employment. See World Bank, "Nepal, Relieving Povertyin a Resource Scarce Economy", May 1990.

-2-

arrangement is sometimes set up to enable the private party to gain access toa needed input, as seen in the link between the Housing Management Company andthe cement subsector. In other cases, as in Janakpur and Setti tobaccocompanies, the arrangement enables the PE to expand in the same industry.Thus, many of the enterprises considered as private entities in Nepal areowned partially by the state and its agencies.2/

The Origin and Evolution of the PEs

1.3 The social and political sentiments that gave rise to the develop-ment of the public enterprise sector in Nepal are often traced to the 1962Nepalese Constitution which provides for maximum participation by the generalpublic in economic development. Only one PE, established under the CommercialBank Act in 1937, existed in Nepal in the mid-1950s, and utilities, such astelecommunications, drinking water and sewerage, electricity, and transport,existed as government departments. PE expansion accelerated during the 1960sto the late 1970s. However, unlike in most developing countries, the growthof Nepal's PEs was not based on the nationalization of private companies; inmany cases, new enterprises were created with the support of external donors,including China, USSR, Netherlands, Japan and multilateral agencies. In othercases, units already existing as Government departments were converted intostatutory corporations and other kinds of autonomous bodies. The Governmentalso took over two private companies that were on the verge of closure, inorder to save jobs. By the end of the Fourth Five Year Plan in 1974, sixtyPEs were in operation.

1.4 The PEs were established under several statutes and controlled byvarious government bodies as shown in Annex I.2. This was considerednecessary in order to devise appropriate forms of government control and toprovide PEs with precise performance objectives and operational guidance.Enterprises established under the Corporation and the Development Board Acts,for example, are owned wholly by the state. Corporations are generallyexpected to at least break even, while Development Boards are not expected tobe commercially viable. The MPEs of interest in this report were set up underthe Company Act, and the trading PEs were set up under the Corporation Act.Enterprises created under the Company Act are expected to have more flexibili-ty under their management boards. In theory, such PEs can invite privateparticipation. They are expected to be financially profitable and to makecontributions to Government income. In practice, 311 the PEs have multipleobjectives, involving commercial and social service functions and in allcases, they have to comply with Government directives and a myriad of overlap-ping regulations. Interest in PE expansion began to diminish by the mid-1970sbecause of existing units' poor performance and growing resource claims byother Government activities. Thus, during the Fifth and Sixth Five Year Plan

2/ For the purpose of dividend collection, the Financial Controller Generalkeeps records of all PEs in which the state or other PEs has shares;currently, there are about 100 of these PEs. Examples of PEs with publicsector minority shares include Salt Trading Corporation, Judha Match,Soaltee, Hetauda Leather and Pokhara Bread Factory, etc.

- 3 -

periods ending in 1985, new investments continued, but on a smaller scale.Four new enterprises were established during the Sixth Five Year Planperiod.3/ Allocations for PE investments fell by 232 (in terms of constant1980 GDP deflator), and the share of these investments in the developmentbudget declined from 23? in 1986/87 to 12Z in 1988/89.

Overview of PE Objectives and Policies

1.5 This section provides an overview of PE objectives and policies. Itdoes not address issues related to the exchange rate regime, trade policy andother broad policies.4/ The policies outlined here are those that affectthe PEs directly and have contributed significantly to undermining the PEs'performance. They include policies resulting in poor PE investments, controlson PE output pricing, restrictions on PE access to inputs, and governmentcontrol of PE management decisions, such as PE employment and compensation,etc. These policies were influenced by conflicting PE performance objectives.The PEs are expected to build the country's infrastructure, to developindustries which the private sector would otherwise neglect, to contribute toproduction and achievement of self-sufficiency in basic goods and services, topromote employment generation, and to serve as instruments for enhancing thecontrol of Nepalese nationals over economic activity. At the same time, sincemany PEs, in particular the MPEs, were set up under the Company Act, many ofthem are listed in the stock exchange and are expected to be financiallyprofitable.

1.6 By the start of the Seventh Plan period (1985-90), PE policies beganto emphasize efficiency and for the MPEs, higher quality of production ratherthan capacity expansion. The main elements of stated PE reform policiesincluded divestiture, liquidation of nonviable units, PE management incen-tives, and enhancement of the operational autonomy of managers. In reality,proposals were not effectively implemented. Liquidation was confined to fivetrading PEs. For example, the national rice mill and rice exporting companieswhich became inoperative through loss of markets were closed down. Also, someunits, for example, the Nepal Fuelwood Corporation and the Timber Corporationwere amalgamated. However, there was little progress in divestiture as reformefforts turned out to be half-hearted (para. 6.2). Similarly, price controlswere not dismantled, regulated monopolies were not allowed to adjust theirtariffs,5/ and there was no follow-up on programs to improve PE performanceby enhancing managerial autonomy, monitoring performance, and providingincentive bonuses for managers. Effective implementation has been hindered bya lack of consensus on the role of the PEs. The lack of transparency of the

3/ They are Bhrikuti Paper, Butwal Textile, Lumbini Sugar and Nepal Paper.

4/ The recent CEM, "Nepal: Maintaining Structural Reforms and ManagingPublic Resources" (March 30, 1990) has a detailed discussion of recentreforms and developments in trade and industrial policies.

5/ Domestic telecommunications tariffs have not been adjusted since 1985;electricity tariffs were adjusted once in the past 5 years.

-4-

budgeLary proces.s and the obscure mpthods of PE financing (para. 1.20)contribute to unQorstating the magnitude of the PE's drain on resources, whichdilutes the urgency attached to the implementation of reforms. Also, thereare concerns about the extent to which reforms would lead to a concentrationof basic industries in a few hands. In addition, the role of erstwhilesocialist countries, such as USSR, China, East Germany and India, in financingand developing most of the early PEs has a left a legacy that emphasizes broadsocial functions rather than commercial viability. The legacy has created anambivalence about needed changes in the role of the PEs and the acceptablescope for reforms. This ambivalence is reflected even in announced PEpolicies following recent political changes in Nepal.

The Scope of the Study

1.7 In view of previous work on other sectors,6/ this report placesmore emphasis on the MPEs on which relatively little systematic work has beendone, and on the trading enterprises, which have been major sources of PElosses. The background work for the study involved a survey of ten MPEs 71and the two trading PEs. All units in the survey are First and SecondGeneration enterprises with majority or total public sector ownership. Thetwo trading enterprises included in the survey, the Agricultural InputsCorporation (AIC) and Nepal Food Corporation (NFC) account for over 9OZ of thetotal losses of those PEs which consistently make losses. The manufacturingPEs surveyed account for about 70X of Government share investment in themanufacturing PE sector and include the major loss-making and profitableunits. Data on production, employment, incomes, statements, balance sheets,etc., weve developed for all the enterprises surveyed. Also, enterprisemanagers were interviewed by Bank Staff and Consultants. The survey providesa picture of the performance pattern and key reform issues for themanufacturing and trading PEs.

B. PE Performance

1.8 This section focuses on the PEs' performance problems. The factthat the PEs have multiple performance objectives involving commercial andnon-commercial activities makes it difficult to apply comprehensive indicatorsto assess their performance. Most often, however, poor commercial performance

6/ Works for other sector PEs include: World Bank, "Nepal Power SubsectorReview', 1988; and "Commercial Bank Problem Analysis and Strategy Study"(in progress). Also the "Fifth Telecommunication Project", 1989; and"Water Supply, Sanitation and Drainage Project", 1990, have coveredanalysis of their respective sectors.

7/ MPEs included in the survey were Agricultural Tools Factory, Ltd (ATF).Bansbari Leather and Shoe Factory (BLSF), Bhaktapur Brick Factory, Ltd(BBF), Dairy Development Corporation (DDC), Hetauda Cement Industry, Ltd(HCIL), Hetauda Textile Industry (HTI), Himal Cement, Ltd (HCC), JanakpurCigarette Factory (JCF), Raghupati Jute Mills, Ltd (RJM) and Royal DrugsLtd (RDL).

- 5 -

has limited PE activities, frustrating the achievement of even thenon-commercial objectives. This section evaluates the performance of themanufacturing and trading PEs using three inter-related indicators ofproduction, cost competitiveness and financial profitability.

The Manufacturing PEs

1.9 Manufacturing is a fast expanding sector in Nepal; the annual growthrate in total average output exceeded 12Z during the decade ending1987/88,8/ though this has declined since the T&T impasse. The sector isalso becoming more diversified. With trade reforms and export incentives, newactivities in ready-made garments and carpets, for example, have grown ataverage real rates of 402 and 66Z, respectively, during the last decade. Onthe other hand, the relative importance of traditional industries, includingjute goods and grain products, has declined. The contribution ofmanufacturing to exports also increased significantly, rising from 382 in1983/84 to nearly 80Z in 1988/89 with the development of new export sectorssuch as carpets and garments.

1.10 MPE Production. The growth rate for MPE average annual outputduring the decade ending in 1987/88 was about 1OZ, compared to over 12Z forthe manufacturing sectors as a whole. While growth of export-orientedindustries has been a significant component of private manufacturing growth,MPE output has been concentrated in a few import-substitution products,notably cement, sugar, and tobacco goods. Output growth was aided by virtualPE monopoly domination of fast growing industries, investments in new capa-city, and selective increases in capacity utilization. MPEs currently accountfor over 70Z of the domestic market for tobacco products, 62Z for cement, 55Zfor sugar and 45Z for leather goods, in addition to substantial production ofbeverages, agricultural tools, and textiles (Table 1.1). Since 1985/86, newcapacity was created by the completion of Hetauda Cement, Setti Cigarette, andLumbini Sugar. Also, capacity utilization doubled in some existing units,such as Janakpur Cigarette, Birgunj Sugar, and Hetauda Textiles during 1981-88(Annex 1.3).

1.11 Despite the aggregate increase in output, the pattern of MPEproduction has been unstable. Output performance is below potential for manyMPEs, and cost efficiency remains poor (para. 1.12]. Even with the existingopportunities for import-substitution under the Government's self-sufficiencyobjectives, capacity under-utilization remains a serious problem for manyproducts, such as dairy products, cement, bricks, tiles, and pharmaceuticalproducts. In 1987/88, for example, capacity utilization was about 41Z for theDairy Development Corporation and between 50Z-60Z for the cement and drugunits, compared to expected levels of over 80Z (Annex I.3). The problem isdue in part to real economic factors, such as poor quality and inadequacy ofdomestic raw materials and unreliable power supply. In addition, Governmentcontrols compounded these problems. For many MPEs, the lack of adequate raw

8/ See Nepal, "Census of Manufacturing Enterprises", 1976/77 and 1986/87;Bureau of Statistics, "Nepal's Manufacturing Sector (1976/77 to1986/88)"; Ministry of Industries, 1989.

- 6 -

Table 1.1: SELECTED PE PROUCTION

AveragoShare of ChangeMarket In Output

(Y 9 (!Q Ch6n6 In output (01-988 89 84-FYSB isub/se o18/87 1987/86 1986/6-

MPEs- C- nt LXe62.0 83.0 - 81.6 19.9 -S.9

of wh icoTHimal 15.0 11.3 6.4 84.6 29.0 -26.0Matsuda 47.0 87.7 - 110.4 16.7 2.1

Jut. Goods Lb 32.9 -6.4 -9.6 -34.6 89.6 -23.3Sugar /c 66.2 14.1 19.0 46.1 -2.0 -T*xt;l- /d 7.0 4.4 1S 2 1.1 8 -1.9 -0.0Cigarette O 70.0 6.9 12.9 11.4 -1.9 -0.6Leather /f 46.0 1.2 -6.5 -7.1 36.8 1.4Tr 2Ti 40.6 7.7 6.3 9.5 4.8 -Brick A Tile /S N.A 8.6 -3.0 16.6 2.8 -Agricultural Toola 10-20 -2.8 -9.2 -7.4 8.0 -2.7

Troding PE (SalesVolume)FR-iiTizors i 100 7.2 2.0 8.4 14.6 .88Foodgrain Li 2 4.2 0.0 4.7 - -5.6

La Aggregato production for Hisa) Coent *nd Hltauds Factory.Raghupati Jute Mill.

Le Birgunj Sugar only.Hetaud Textilo.

/- Janekpur C;garettedansbari Leather.

Nepal Tea DOvelopment Corporation.Total for Shaktapur and Herishidi enterprises. Conversion: 1 roof til- = 4 bricks. 1 floortile 1 brick.

/l Agricultural Inputs Corporation.Nepal Food Corporation.

Source: CCD, Ministry of Finance.

materials is for the most part an outcome of Government policy andrestrictions. For example, Dairy Development Corporation's (DDC's) lowcapacity utilization was due to restrictions on imported inputs, mainlypowdered milk. Also, investment policies encouraged capacity expansion in thecement industry for reasons of self-sufficiency, though the quality of rawmaterials was known to be poor. In the cases of leather goods and textiles,intervention in MPE operational decisions and resulting lack of operationalflexibility undermined their effectiveness relative to the private sector inpurchasing raw materials. Growing demand from the private sector for inputsand thie MPEs' inability to compete effectively contributed to a lower PE shareof input purchases and therefore a lower capacity utilization. These problemswere exacerbated by lack of reliable access to power, particularly for thecement and brick industries which depend on imported coal.

1.12 Cost Competitiveness. Both the inadequate supply of raw materialsand capacity under-utilization contributed to the high cost of MPE production.Cost efficiency is critical if the MPEs are to compete effectively and sustaintheir viability relative to imports. Since the MPEs' outputs are tradeables,this section evaluates cost efficiency relative to the border prices for a

sample of major products. Table 1.2 shows the cost effectiveness of a sampleof enterprises in paper, cement, jute, and sugar. The Cif and fob costs shownin the table are based on the existing exchange rate regime and the productioncosts relate to the level of capacity utilization indicated. Only twoenterprises in the sample, namely Himal Cement and Bhrikuti Paper, are costtive on a long-term (three-year average) basis. However, it has a temporaryedge due to quotas on Indian sugar exports and a transitory boom in the worldmarket. The high cost of Lumbini Sugar is expected to decline with increasedcapacity utilization, though competitiveness relative to import costs isuncertain. Raghupati Jute Mill has uneconomic costs relative to the export(fob) price. Interest costs for Raghupati are high, equivalent to 27Z oftotal costs. Over-employment is a serious problem, and wage costs account for402 of total costs. Raghupati would be uneconomic even if operated on a sunkcost basis. In the cement industry, Hetauda is uncompetitive relative toimports. It has inadequate raw materials and a weak capital structure withinterest costs accounting for about 302 of total costs. Hetauda may bemarginally competitive on a sunk cost basis, but even then it requiresadditional investments to reach the new raw materials sources needed toincrease capacity utilization. Even for those units which have the potentialto be viable, such as Himal, the scope for sustained performance is fragile.

Table 1.2: EFFICIENCY OF PRODUCTION COSTS - SELECTED MPEs(Dollar values in constant 1987 figures)

C .. f.Capacity Cost of Nepal f.o.b.

Utilization Production Border to(%) (USS) La (USS) India

Cement (Hotauda) b 69 103 96

Cement (IHimal) Lc 65 74 96

Paper (Bhrikuti) /d 87 765 831 -

Sugar (Birgunj) Is 93 389 361(462) /f -

Sugar (Lumbini) Lg 26 608 381(462) f -

Juts (Raghupati) /h 74 761 - 638

/a Cost estimatev do not includ- taxos and import tariffs and thus indicate competitiveness in amore liberalized regime.

/b Production cost based on tho average for 1987/88 and 1988/89.Li Cost figures based on the average for 1986/87-1988/89.

Based on 1987/88 figure only. International paper prices very with quality between US$700and US33,000. The figure quoted is for comparable quality c.i.f. Singapore.Th c.i.f. price for sugar is the average for 1987/88, 1988/89 and 1989/90.The number in parenthesis is the current import cost from Third countries. The currentimport cost from India is about US3330.

t 1988/89 budget figures.Export (fob) price and average costs for 1986/87-1988/89.

Source: CCD, Ministry of Finance.

Himal's viability will depend on Nepal's accord with India and its continuedaccess to the Indian market for relatively cheaper coal which accounts for 75Zof its energy requirements.9/

1.13 The high MPE production costs reflect several factors. Some PEs(e.g. Hetauda Cement) have turned out to be uneconomical due to riskyinvestment, low quality raw materials and cost overruns during implementation.Comparative advantage is not necessarily considered in making MPE investmentdecisions, which lead to lower quality projects. Technology obsolescence anddefective machinery inflate PEs' costs since they lack funds to modernize andupgrade equipment. Interventionist policies also limit efficiency improve-ments and cost reductions over time. A case in point, as already noted, isthe restrictive raw material policy and consequent low capacity utilization.In another example, over-employment and the imposition of employee compensa-tion packages on the MPEs are major reasons for the high wage costs ofRaghupati Jute. Also, in the sugar sector, investment policies have resultedin the choice of low quality projects rationalized by social rather thanefficiency considerations [para. 2.31. Procurement and project implementationdelays due to Government control of PE decisions further contribute to thehigher cost situation of the PEs.

1.14 Financial Performance. The PE's financial performance has been pooreven with nominal tariff protection of, for example, 35Z on cement and IOOZ ontobacco products. Only 5 of the 25 operating MPEs 10/ generated profitsconsistently during 1984/85-1987/88 (Table 1.3). In the best year, 1986/87,Janakpur Cigarette and Birgunj Sugar accounted for 80Z of the NRs 111 millionprofit. Even Janakpur's profitability relates to its virtual monopolyposition during the 1980s and a 10OZ tariff. Birgunj's surpluses are due moreto the performance of its by-product beverage division than to efficient sugarproduction per se. The largest losers are Hetauda Cement and Raghupati JuteMills. Hetauda Cement's operating profits and net income have been negativefrom the start of production because of large capital costs and a heavy debtburden which resulted from cost overruns. Raghupati Jute Mill suffers from adeclining world market for jute, inefficient technology, and overemployment.Although the remaining MPEs have less severe operational or financialconstraints, most are only marginally profitable, and their periodic surplusesare not adequate to cover previous losses. Ir many instances, the financialproblems posed by losses and low operating profits are exacerbated by anincreasing commercial bank debt service burden. Dividend contributions areminimal at less than one percent of government equities. Only twoenterprises, Janakpur Cigarette and Birgunj Sugar, generated dividendsconsistently, averaging NRs 6.4 million a year during 1984/85-1988/89. NepalIndustrial Development Corporation generated an additional NRs 2.0 million,and there were minor contributions from Royal Drugs and Judha Match(Annex 1.4).

9/ Third country (i.e. non-Indian) coal imports are very expensive duemainly to higher transportation and transaction costs. For example, thecosts of coal imported from Indoz.sia are double that from India.

10/ Only 25 of the 28 MPEs were actually operational.

-9-

1.15 During the period 1984/85 - 1988/89, the MPE's overall rate ofreturn on assets was negative (Table 1.3). The direct consequence of thesefina.ncial losses has been an erosion of equity (Table 1.4). Ten PEs listed inTable 1.4, of which six are part of the survey, either have negative ordeclining net worth. Accumulated losses have eroded over NRs 1.0 billion(equivalent to 13Z ot 1988/89 Government revenues) of initial Governmentinvestments. This performance, poor as it is, does not reveal the true natureof the financial problems facing the MPEs. The severity of the financialsituation has been masked by poor accounting standards, including lack ofphysical verification and revaluation of assets, inadequate provision fordepreciation, bad debt, and obsolete stock. In turn, the weak accountingsystems mask financial weaknesses and do not give managers early warning ofpotential problems. Few PEs have internal funds to finance capital replace-ment costs. Thus, ultimately, debt repayment, working capital requirements,and rehabilitation and modernization costs will become a growing burden on theGovernment.

Table 1.3: PE PROFITS (Before Taxes)(in NRs million)

Cumu-lative

1984/85 1985/86 1988/87 1987/88 l988/89Lb total

MANUFACTURING PEs

Total Profits for profitable MPEs 81.6 65.6 110.8 106.2 -1.9 362.1Of which:Janakpur Cigarette Factory 57.7 41.3 76.6 76.4 17.3Birguni Sugar Factory 17.3 8.0 12.3 21.0 -Himal Cement 2.8 2.3 8.6 -0.7 -18.9Hetauda Textile -0.2 0.8 11.7 7.8 8.1Royal Drugs 4.2 3.4 1.6 2.7 -1.0

Total Losses for unprofit. MPEs -26.4 -165.5 -183.1 -134.8 -133.6 -633.3Of which:Hetauda Coment Industry - -119.4 -147.0 -101.0 -89.2Raghupati Jute Mills Ltd. -18.0 -30.6 -10.4 -17.2 -26.2Dairy Development Corporation -3.3 0.9 -18.6 -11.6 11.0Bansbarl Leather -3.8 -4.5 -4.8 -4.9 -4.9Agricultural Tools - -1.3 -2.8 0.4 -Bhaktapur Bricks & Tiles -1.5 -0.6 -1.5 -0.6 -3.2Total profits for manu-facturing PEs 66.2 -99.9 -72.5 -28.6 -136.4 -281.2

TRADING PEs

Total for Profitable Units 17.3 74.2 144.4 130.6 74.6 441.0Of which:Nepal Oil Corporation 16.9 88.0 130.9 111.2 23.1Timber Corporation /a -4.8 -12.6 10.0 14.1 -National Trading 6.2 20.7 3.6 6.0 61.6

Losses for unprofit. Units -219.0 -160.1 -110.8 -205.8 -188.6 -872.1Of which:Nopal Food Corporation -80.0 -96.0 -81.0 -137.0 -128.0Agriculture Inputs Corporation -139.0 -54.1 -49.8 -88.6 -68.8Totai profits forTrading PEs -201.7 -76.9 33.6 -75.1 -112.0 -431.1

Includes Fuel Corporation.Sc EstimatesC

Source: CCD, Ministry of Finance, and mission survey data.

- 10 -

Table 1.4: SELECTED PE NET WORTH(in NRs million)

1986/88 1987/8Amount X of Assets zo-unt Xof Assets

MANUFACTURING PEs

Dairy Development Corporation 18.2 14% -12.3 -0.6%eansberi Leather & Shoe Factory 8.6 26% -1.2 -3XRaghupati Jut* Mills Ltd. -88.4 -107% -118.6 -139XBalaju Textile Industry 4.8 n.s. 0.6 n.s.Hetauda Cement Industry 681.3 37X 333.8 26X

TRADING PEs

The Timber Corporation of Nepal -10.3 n.a. -19.6 na.Agriculture Inputs Corporation -109.0 -16X -221.9 -28XNepal Food Corporation -461.2 -1401 -442.4 -86XTobacco Development Company Ltd. -2.8 n.a. -3.9 na.Nepal Trading Corporation -7.2 ns. -12.3 n.s.

Source: CCD, Ministry of Finance and mission survey data.Date cover PEs with declining or negative not-worth.

1.16 In addition to those factors affecting MPE production costs dis-

cussed above, and to world market price fluctuations in commodity exports such

as jute, financial losses also stem from administrative pricing policies and

from pressure exerted on the PEs to maintain non-viable activity centers for

social reasons. For example, between 1986/87-1988/89, the price of DDC's

output was controlled at 93X of costs. Though output price controls have been

relaxed somewhat, DDC still faces controls on imported inputs and on the price

of local raw milk. Similarly, sugar prices are controlled and subsidized at

below world market prices.

The Trading PEs

1.17 There are nine trading PEs, including the energy (oil, coal, and

fuelwood) PEs. As a group, the trading PEs are the largest source of finan-

cial losses (Table 1.3). Five of the trading PEs have negative net-worth

(Table 1.4). Two units included in the survey, namely, AIC and NFC, are the

main culprits. The large financial losses arise from the use of these

enterprises for social service objectives and from interventionist policies,

such as price controls, quantitative rationing, and pressure on the PEs to

maintain nonviable trading centers. Price controls have had the worst effect

on the trading PEs. In the case of NFC, for example, controlled below market

prices cover only 93Z of foodgrain costs in the Kathmandu Valley and 412 in

the mid-eastern region. Similar controls over chemical fertilizer prices

affect AIC. The lack of financial stability has undermined deliveries. The

delivery of subsidized goods is poor, and units are plagued by supply short-

ages. Also, despite stated welfare objectives, subsidized goods do not reach

clearly identified target groups. Existing pricing policies, recommended

reforms, and the performance of the trading PEs are discussed in more detail

in Chapter 2.

^ 11 -

Analysis and Discussion

1.18 The evolution and performance of the manufacturing and trading PEssuggests continuing difficulties. There is no indication that performancewill improve, nor that the financing burden they put on the Government will berelieved significantly in the foreseeable future. Even operating the finan-cially weak PEs on a sunk cost basis would require new equity infusions and tofinance guaranteed debt, to pay liabilities due to accumulated losses, andmeet working capital needs. Also, the few profitable units are beginning toshow declining profitability and will eventually require support. As theprivate sector is expanding, the MPEs' market share is diminishing. Moreimportantly, the private sector is targeting the relatively more lucrativesegments of the markets in the Kathmandu Valley and Terai. For example, underthis pressure, the market share of the most profitable KPE, Janakpur Company,has fallen from 95% to 70Z, despite steady growth in production. Similarly,Hetauda Textiles and Bansbari Leather's market shares have fallen. Continuederosion of the market share of the more profitable brands of MPE products islikely as newly licensed private investments come on stream. As discussedearlier, the MPEs are at a disadvantage due to various factors and policieswhich limit their capacity to respond flexibly to market conditions. Underexisting circumstances, as the private sector expands and its shares in therelatively more lucrative markets grow, the MPEs will increasingly be leftwith less profitable markets, mainly in the hill region where transportationand transaction costs are higher, incomes lower, and profit margins, if any,negligible. Unless major policies are introduced to improve the situation, PEperformance will be characterized by growing financial losses and risingdemands on the Government for financial support.

C. Financing of the PEs

1.19 This section discusses the budgetary burden arising froma the PE'spoor performance. Poor financial performance and lack of internal savingscompel the PEs to depend principally on the central Government and itsfinancial institutions for support.ll As shown in Table 1.5a, there areseveral kinds of MPE demands for government subsidies or transfers: (i)current subsidies which include allocations to cover losses due to controls onPE output prices, transportation subsidies to finance the transportation costsof deliveries to inaccessible areas, and operational subsidies to financeother PE losses; and (ii) capital subsidies and new equity to cover PE debtand to finance new PE investment. Government financing of PEs takes variousforms. They include: equity participation financed directly from Governmentrevenues; bond issues by Government to strengthen the asset base of the PEs;external loans guaranteed by Government and channelled to the PEs; external

11/ Some of the PE financing issues are discussed in the recent CountryEconomic Report,"Nepal: Maintaining Structural Reforms and ManagingPublic Resources", March 1990, Chapter 3D.

- 12 -

grants provided to the PEs as equity; proceeds from commodity aid for the mostpart retained by PEs instead of being paid to counterpart funds;12/ and taxexemptions granted to sick PEs as prescribed under the industrial code. Inaddition to budgetary subsidies, credit from domestic financial institutionsis a major source of support for the PEs. Most of this is guaranteed by theGovernment which has had to assume payment in cases of default. Of the NRs2.2 billicn credit outstanding from commercial banks to the non-financial PEsby July 1989, NRs 1.4 billion 13/ (652) was guaranteed by the Government(Annex I.5). PE default on these loans has created a burden on the budget.Government payment of PE guaranteed debt amounted to NRs 780 million during1986/87-1989/90, and an additional higher amount remains to be paid. NRs700 million is budgeted for FY91.

1.20 Budgeted allocations to the PEs do not reflect the full extent of PEdependence on Government because the budgetary process lacks transparency.This lack of transparency has caused understatement of the costs of PEinefficiency and contributed to undermining the urgency of reforms. The mainfactors in the understatement of PE resource claims are: direct donor dis-bursements to projects which are later transferred to Government upon comple-tion; donor payments for technical assistance that are ofter channelleddirectly to service providers; tax rebates for sick PEs that are prescribedunder the Industrial Act, but not re.-lected in enterprise accounts; andproceeds from counterpart funds from commodity aid that is expected to be paidinto government account, but is instead retained by the PEs. Table 1.5a givesa flavor of these off-budget expenditures for three major public utilities,estimated from discrepancies between payments recorded in the budget and thosereceived according to enterprise accounts. The estimates of off-budgetallocations exclude tax rebates which are not documented in PE or Governmentaccounts. Even so, estimated off-budget expenditures for these three enter-prises alone were equivalent to 382 of total budgeted expenditures forseventeen major enterprises. In fact government allocations to PEs, includingoff-budget transfers, are about three times higher than the contributions madeby PEs to revenues. The share taken by trading and manufacturing PEs from theGovernment's budget accounted for about half of all allocations to the PEsduring 1985186 - 1988/89. PE deficits as a percent of GDP increased from O.5Zin 1986/87 to 2.9Z in 1988/89. Ta",,e 1.5b shows consolidated public sectoroperations for the central Government and nonfinancial PEs and includes

12/ The inability of AIC to meet obligations regarding payment of counterpartfunds to Government account is becoming a source of concern among donors(see "Performance Audit Report on the Second Intensification Program).For AIC, the cumulative retained proceeds from commodity aid wasestimated at Rs 420 million in 1989.

13/ This amotunt was reduced to Rs 1.01 billion through negotiation with thebanks durlng which the interests accrued on unpaid interest arrears werewaived (See Annex I.5). Rastra Bank estimated total PE commercial bankcredit outstanding in Mid-April 1990 at Rs 2.22 billion, comprisingprincipal of Rs 1.04 billion and interest of Rs 1.18 billion.

- 13 -

adju';trm;its to eliminate double counting. PE expenditures show increasingl n re'-ources relativo to the stagnant pattern of PE contributions to

Gover8:rr.t revenues. PE expenditures amounted to an equivalent of 17Z ofGovern:.nent revenues in 1986/87 and to over 30Z in 1988/89.

Table 1.5a: PE CLAIMS ON GOVERNMENT INCOME La(NRs million)

1988/87 1987/88 1988/89

Budgeted

Commercial Bank Loans paid by Government /b 300 - 80Retained Counterpart Funds from Aid 176 29 58Covernment Equity 210 293 313Direct Subsidies (Grants) 64 69 296Net Lending 811 9B 602Total Budgeted 831 687 1,328

Off-Budget Lc 1,731 916 499

Total 2,668 1,602 1,827

La Table covers 17 PEs on which data are available: Agricultural Inputs Corporation; Nepal FoodCorporation; Bansbari Leather; Bhaktapur Brick and Tiles; Dairy Development Corporation;Hetauda Cement; Hetauda Textile; Himal Cement; Janakpur Cigarette; Raghupati Jute Mill; RoyalDrugs; Nepal Trading Limited; Nepal Telecommunication Corporation; Nepal Water SupplyCorporation; Nepal Water Supply Corporation; Nepal Airlines Corporation; Nepal ElectricityAuthority.

t PE loans guaranteed by Government.Data cover Water, Telecommunication and Electricity Enterprises.

Source: Data from CCD and IMF estimates.

Table 1.6b: SUMMARY OF PUBLIC SECTOR OPERATIONS(NRs million)

Total Revenue and Grants 1986/87 1987/88 1988/89

Total Revenue and Grants 7,818 9,676 10,017

Total Revenue 6,333 7,698 8,128Of which PEs 609 398 630

Foreign Grants 1,286 2,077 1,889

Total Expenditures 11,184 16,428 18,170

Of which PEs 1,099 2,368 2,800PEs in percent of Total Expenditures 9.8 16.3 16.6PEs in percent of Revenue 17.4 31.0 36.0PEs in percent of GDP 1.9 3.6 3.8

Source: Data from CCD and IMF estimates.

D. Discussion and Core Issues

1.21 Several factors account for the poor and deteriorating performanceof Nepal's .ianufacturing and trading PEs. To summarize, the key factors whichare ame-.abi' to influencp by Government and PE officials are: conflicting PE

- 14 -

perf0,aireP 0jje(tives; poor quality of investments; competitive policy and areg, 'litotry erzvi rimment which do not motivate PE efficiency; inappropriate

i';:;!;l ixiS; )Government controls, weak monitoring, and performance.v.Lu. i'.z; :d internal deficiencies in PE management, including inadequate

inre;;.] planniig, and control, and poor marketing, production, and financial:i;j e;I,ent . A,Iditional factors, relating to world demand and the policies ofT..:,:'iI!ig coutt ries, are outside the direct influence of Government.

relate-] to inadequate infrastructure are also beyond the control of

th e*t.' etpt ises themselves. The need for public enterprise reform is widely

recogn zed in Nepal and has been espous,d in various Government documents andputuLv statements. The main objectives of announced reforms have been tore.eve the PE finar.cing burden on the Government, improve and expand the

production of basic goods, and promote industrial efficiency and expansion tocreate more jobs. Despite efforts, the implementation of reforms has hadlimited success. Under existing circumstances of increasing constraints onGovernm,ent incoine, there is limited scope of depending on Government invest-ment to expantd industrial growth to fulfill stated objectives in a sustainedfashion. 14/

1.22 An action program should be a first step in attempts at a renewedreform effort. Such a program should be directed at the restrictive aspectsof the et,abling environment as well as at specific enterprises. The programshou.d sharpen the PEs' performance objectives. It should also address theconcerns of constituencies which have resisted the implementation of previousreforms and adopt a flexible approach in the use of instruments, such asprivatization, restructuring and liberalization. For example, given concernsabout foreign ownership of basic MPEs, privatization should have options forprivate management control as well as ownership change. Also, restructuringshould include options for compensating affected employees. Retainedsubsidies should be explicitly funded and channelled to target groups. Theaction program should include measures to improve transparency of PE claims onresources to expose the full costs of poor performance and subsidies.

II. THE POLICY AND REGULATORY FRAMEWORK

2.1 This chapter focuses on the policy environment for the PEs. In manyinstances, government policies which affect the PEs also affect their privatesector counterparts. In fact, the distir.ction between public and privateenterprises in Nepal is sometimes blurry since there is close interactionbetween the two sectors through private ownership in Second Generation PEs andjoint ventures. A confluence of complex factors has shaped the policyenvironment in Nepal. Some of these factors have already been the subject of

14/ Population pressure on land and growing landlessness already suggestthat agricultural development offers little scope for fast growth andsignificant improvement in poverty in Nepal. See citation under footnote6.

- 15 -

studies and reform efforts.l5/ They include the country's landlockedposition, the highly protectionist regime of India which borders Nepal and thesusceptibility of Nepal's economy to external influences which limit the scopefor independent policies. Also, the difficult terrain and inadequatetransportation networks create segmented markets and limit spatialcompetition. Other factors are low incomes and a consumer-oriented approachto development, based on the delivery of basic need, and sentiments regardingenhancing the control by nationals over economic activity. The influence ofthese factors is reflected in the intricate formal policies and informalpractices that regulate economic activity in Nepal. Policies relating toinvestments, administration of regulation and pricing as they affect the PEsrelative to the private sector are discussed below.

A. Investments and the Regulatory Environment

2.2 Until the second half of the 1980s, Nepal's system of industrialregulations was very restrictive. Investment licensing, registration andquantitative capacity controls were used to ration investments, and in mostinstances, PE investments received priority over the private sector. But thisis changing. The Industrial Enterprises Act of 1987 exempted many enterprisesfrom investment licensing regulations. These include: unautomated cottageindustries having fixed assets less than NRs 700,000; small and medium scaleenterprises with fixed assets up to NRs 10 million which do not requireforeign exchange for raw materials; and large scale enterprises with fixedassets in excess of NRs 10 million which require foreign exchange allocationsfor no more than 40Z of raw materials. In addition, joint public-privateventures and some 44 enterprises gazetted in the budget are exempted fromlicensing procedures. These changes plus automatic registration have easedbureaucratic and quantitative barriers limiting private investment. Thereare, however, outstanding issues regarding the role an- et'ficiency of publicsector investments, restrictions on entry and exit, and linits on PE access toraw material inputs.

Industrial Investment

2.3 Low investment quality is ba underlying reason .cr the MPEs' poorperformance and a handicap relative to the private sector. More importantly,poor investments undermine efforts to improve the manufactu-'ing PEs'performance and to expand Nepal's industrial sector. The nt-rent policy forFirst Generation PEs is to invest in industries which the .-i?ate sector wouldotherwise neglect. For the Second Generation PEs, investment decisions are inprinciple delegated to the enterprises and their Boards of Directors, providedsuch investments are in designated "priority" sectors. But because of thebroad scope of the priority sectors, investment policies do not provide astrategic focus for efficient manufacturing investments. Also, the .'nksbetween investment policies and other aspects of industrial policy are weak.For example, despite discussions in the Government about privatization, PE

15/ See, for example, the recent Nepal CEM: "Maintaining Structural Reformsand Managing Public Resources," March 30, 1990. Also, there is work inprogress concerning effective protection.

- 16 -

pro;eets are being planned or being implemented in various sectors, includingleather, cement, sugar, dairy, foundry, tobacco and textiles.

2.4 Most often, the Government's development plans have guided thechoice of projects t3 be funded. Officially, the procedures for screeningprr;ects require elaborate bureaucratic overview often i:.olving evaluation bythe Economic Services Center and approval by donor funding sources, linem:n-stries, the Corporation Coordination Division of the Ministry of Financeand the Planning Commission. But in the screening process, issues of theefficiency of investments and viability assume less importance than broaderwe&fare considerations. Though broad development may not necessarily beincompatible with efficiency, manufacturing investment decisions are oftendriven by basic needs, self-sufficiency, and employment generation, factorswhich tend to undermine the viability of projects. In addition, the projectevaluation process is often handicapped by inadequate information, resultingin the under-estimation of costs, over-optimistic assessment of raw materialsources and, ultimately, financially weak investments.

2.5 Projects have been retained despite serious doubt about theirviability, particularly where job creation and self-sufficiency are ofparamount concern. This has been the case, for example, with Hetauda Cement,the Foundry, Raghupati Jute and Morang Sugar. For example, to save jobs,Raghupati Jute Mill and Morang Sugar 16/ were reopened by Government afterthey were closed down by the private sector; Hetauda Cement was implementeddespite doubts about the quality and adequacy of local raw materials, and theFoundry was endorsed though the feasibility analysis suggested uncompetitivecosts relative to imports. Also, delays in implementation are a source ofconcern. Various factors, including constraints on government funding,procurement and technical assistance needs contribute to slow implementationand cost overruns. Hetauda Cement, for example, was completed four and a halfyears behind schedule with a cost overrun amounting to nearly 70Z of theoriginal plan estimates; Udaypur Cement currently under implementation is alsolikely to be delayed.

Entry and Exit

2.6 Subtle barriers limit closure of non-performing PEs. Consequently,these barriers also limit private entry into some industries. There is acontinuing dominant role of PE production in industries even where liberaliza-tion could help expand private sector supply to meet basic needs objectives.PEs virtually monopolize major trading activities, including fertilizer, oiland coal; and they dominate the formal manufacturing sector in cement produc-tion, sugar, tobacco products and, to a lesser extent, textiles. This dominantrole of the PEs has been weakened somewhat by smuggling and by recent indus-trial reforms, but the policy regime still favors the status quo for thenon-performing PEs, restricting new entrants. Output price controls, forexample, have created disincentives for private sector entry. Agreements oncommodity trade between Indian and Nepalese PEs have supported sole,

16/ Morang Sugar is now under the management of the Salt Trading Companywhich has majority, about 80Z, private sector control and 20Z state andPE shareholding.

- 17 -

state-sponsored supply of some products. Also, since private participation instate dominated sectors requires investment in costly fixed assets, unsteadypolicies have contributed to deterring such investments. The monopolisticcontrols have adverse consequences, creating managerial inertia and fosteringinefficient operations.

2.7 In a small economy, continued operation of nonviable PEs contributesto restricting private industrial expansion. Financing policies help to avoidexit and to sustain poorly performing PEs. The industrial code and theCompany Act have provisions regarding liquidation and closure, but theapplication of these laws has often been frustrated by resistance of PEemployees and constituencies who provide inputs and other services to theaffected enterprises, such as farming groups. The poor state of PE financesalso limits the scope for compensating those affected adversely by closure.In addition, Government budgetary subsidies and guaranteed credit schemes havesustained the sick PEs. The guaranteed credit schemes have added to theburden on the Government since in the many cases of default that haveoccurred, the Government has had to honor the payments, helping to sustain thefinancially weak PEs.17/

Raw Material Import Substitution

2.8 Another restrictive aspect of the regulatorv environment is thelimit on PE access to imported raw materials. These restrictions generally donot apply to the private sector, which creates differences in quality andcosts between private and PE production. The restrictions aimed at fosteringthe development of import-substitution raw material sources have beenrationalized by the landlocked nature of the country and by the need to raiseincome levels to create demand for manufactured goods. Notwithstanding themerits of these objectives, the prospects for effective raw material substitu-tion are considered low, given the relatively lower prices of agriculturalgoods in India.18/ As currently implemented, the policy mainly hasaffected the MPEs in dairy, jute goods, textiles and tobacco products, and theresults so far have been mixed. The Dairy Corporation, for example, has takenadvantage of the restrictions to expand the collection of local surplus rawmilk. Insufficient domestic sources and seasonal shortages have, however,contributed to low capacity utilization--below 60Z. The pressure on RaghupatiJute to buy from domestic sources has only served to strengthen the hands ofcollusive middlemen, resulting in high raw jute costs relative to neighboringmarkets. Also, Janakpur Company has had limited success in developing rawmaterial sources of appropriate quality and has remained dependent on Indiantobacco imports for about 80Z of its raw material needs after over twenty

17/ Total Government guaranteed credit to the PEs as of July 1989 amounted toNRs 1.41 billion of which overdue interest accounted for NRs 899.76million. Government payment of overdue guaranteed debt to the commercialbanks amounted to NRs 780 million during 1987/88-1989/90.

18/ See 'Import-Substitution in Nepalese Agriculture: Nature, Structure andImpact", 1986. As indicated by this report, Nepal has advantages inimport-substitution production in only paddy and wheat, and could pursuepartial substitution for sugar cane and cotton.

- 18 -

years of operation. The major consequence of the policy on raw materials isto impose high, uncompetitive costs and low rates of return on the KPEs. IfGovernment insists on this policy, it has to address the question of who--MPEsor the budget--should carry the cost burden.

Options For Reforms

2.9 Because external factors limit independent policies, Nepal facesdifficulties in its efforts to create a policy environment conducive to effi-cient PE activities. More so than most developing countries--as was evidentduring the T & T impasse--Nepal has to emphasize accord with its neighbor andpursue flexible policies that will give industries scope to respond quicklyand effectively to the complex environment. In this context, this sectiondiscusses options for deregulating PE investments and industrial activities.

Deregulation and PE Policy Reforms

2.10 Deregulation of economic activity is critical for facilitatingentry, promoting efficient investments, and giving all firms scope to respondflexibly to events in Nepal's complex situation. Continued poor PEperformance is making it increasingly clear that the lingering controls onentry and the sanctioning of uneconomic projects on the grounds of self-sufficiency are compromising efficiency and undermining the prospects forindustrial expansion. The limits to entry need to be addressed in variousways. For the trading PEs, one option is to continue with the policy ofmodifying agreements that support sole supplying agencies in, for example,oil, coal and fertilizer, etc. In the case of industry, the recentliberalization of investments could be extended further by creating 'freesectors,' such as jute, textiles, cement, etc. Investment licensing in the'free sectors' would be waived, and registration would remain automatic torelieve the administrative burden on the Directorate of Industries. Fullystate-owned investments in the free sectors could be restricted to thecompletion and rehabilitation of existing units.

2.11 Exit of non-performing PEs needs to be enforced. The Company Actand the Industrial Enterprises Act have provisions for closure, but these havenot been applied effectively. For example, the liquidation of the non-performing foodgrain exporting PEs which lost their markets has dragged on foryears. Affected employees were redistributed among other PEs but theoutstanding debt has remained a burden on the commercial banks and theGovernment, while payments to the liquidators continue to mount. PE financingreforms and labor compensation schemes would provide options for forcing theexit of non-performers. Government has made a start in financial reform bylimiting guaranteed commercial bank loans, and the banks have introducedceilings on lending to the PEs. Other sources of PE financing, such asbudgetary subsidies and tax rebates for sick PEs, should be made transparent,limited in scope, and made contingent on tangible improvements in performance.

2.12 The pressures and discriminatory direct controls on the MPEs topurchase domestic raw materials should be replaced by flexible incentives tomotivate both public and private enterprise interest in using local resources.Where the potential for efficient domestic raw material production exists,instruments, such as premia on imported raw materials should be employed toencourage raw material import-substitution in a manner consistent with a

- 19 -

liberal trade regime. A system parallel to the duty drawback scheme forindirect exporters could be considered. The institution of Developmient Boardsis well known in Nepal and could be used more effectively to de-linkcommercial activities from broad development and social service activities.For example, to accentuate the commercial orientation of the PEs, raw materialdevelopment should be transferred to Development Boards and Extension Serviceagencies. PEs which are compelled to deliver social services need to adoptseparate accounting for commercial and social service activities (para. 4.35).

B. Administration of Regulations

2.13 The administration of industrial regulations in Nepal ischaracterized by bureaucratic requirements and delays which affect PEactivities more than those of the private sector, since the PEs have lessscope to circumvent the regulations by operating through informal channels.Government is aware that delays in the administration of reforms are becominga serious problem.19/ Paradoxically, the need for improved administrationof industrial policies and incentives is becoming increasingly important as

the Government continues its efforts to liberalize the economy. The recenttrade and industrial policy reforms illustrate the nature of the problem. Therecent reforms include a simplification of the tariff systemwhich now has 10 basic rates instead of the former 87. The old range of

tariffs has been reduced from between zero and 450Z to a maximum basic tariffof 100X with additional duties to countries other than India of between 25?

and 55Z. Also, hard currency imports were liberalized using open generallicensing, a flexible passbook system and an auction system with varyingpremia for consumer goods and luxury items. A duty drawback scheme wasintroduced, and investment incentives were improved. The industrial codeprovides an average nominal protection of about 30? based on the type ofproduct and has no stated differential tariffs for the PEs.20/ Thoughliberalization of imports is desirable, it can give incentives to smuggle.This is particularly so for imports on open general license and industrialimports under the passbook system with no foreign exchange premium. In 1989,for example, a third of convertible currency imports came under the passbooksystem (Annex II.1). Thu', while import administration has improved, theeasier access to indust? l1 goods has been accompanied by internal regulationsand approval requirements, such as for production, sales, exports, externalexchange transaction, etc., aimed at limiting smuggling and tax evasion.Furthermore, the administration of incentives requires inspection anddocumentation to validate applications for the incentive claims introducedunder the industrial reforms.

2.14 The causes of deficient implementation are various. First, theprocess of setting up and empowering institutions to effect reforms has beenslow. Incentives and regulations which depend on estimating production as wellas effective protection coefficients, for example, require skilled staff to

19/ See "Background Paper on the Administration of Industrial Incentives", a

report prepared for the Ministry of Industry HMG/Nepal and UNDP, March

1990.

20/ A study of the effective protection rates is currently in progress.

- 20 -

administer them. Second, imprecise legislation has affected implementation.Provisions in the reform Acts were in conflict with other legal codes, and, insome cases, the measures on which to base the determination of the incentiveallowances were ambiguous. The Industrial Enterprises Act and the Income TaxRegulation, for example, have conflicting provisions regarding depreciationallowances, and neither provides the precise income concept on which to basethe computation of rebates. In some cases, the ambiguities contributed toundermining the authority of the administrative agencies; in other cases, theyinadvertently expanded the discretionary power of the agencies, resulting incase by case bargaining and delayed resolution. Third, frustrations werecaused by inadequate budgetary allocations to support incentive refunds.

Improving the Administration of Regulations

2.15 At first glance, the first best option for addressing the issue ofpoor administration of regulations might appear to be liberal reforms thatwould preempt as much as possible the need for such regulatory procedures.However, in the specific Nepalese environment, that option is more limited.For example, third country consumer luxuries are currently imported under anauctioning system which has premia on foreign exchange. Industrial goods, onthe other hand, are imported under the passbook or open general license systemat lower exchange rates. Extending the auction system to cover industrialgoods would raise import costs and reduce the need for regulations to controlre-exports to India, but this is relevant for only a few commodities. In manycases, a premium high enough to make re-exports to India unattractive wouldinflate the costs of imported industrial inputs and undermine domesticindustries' competitiveness. Thus ultimately, the issue of efficientadministration has to be addressed.

2.16 The Government is already considering measures to improve thesituation, and some reforms were introduced in the 1990/91 budget. Forexample, import duty rebates which were not being properly administered wereabolished; under the old system, these duties were first collected andsubsequently refunded individually. Other measures being considered includereforming the funding of incentive schemes, amending conflicting regulationsand disseminating information on procedures. The options for improving theadministration of incentives include abolishing a broad range of taxes thatare subject to refund under the incentive scheme, providing larger budgetaryallocations to support incentive payments, and establishing escrow accountsfrom which refunds could be paid without necessarily subjecting the financingof such refunds to budgetary considerations. The implementation ofregulations could also be improved by amending conflicting legal codes toreconcile the relevant provisions of the Industrial Enterprises Act and theIncome Tax Act. The Government is considering options to achieve thisobjective including establishing: (i) which of the Acts should be adopted incomputing depreciation allowances and (ii) which Act should prevail generallywhen there is a conflict. There is also a need to disseminate informationabout new rules and incentives and to clarify the application of newregulations. Because of poor accounting standards, Government is consideringthe use of pamphlets to provide information on how incentive and regulatoryschemes actually apply. The illustrations could cover basic concepts such asgross income, net income, value added, effective protection rates, and othermeasures needed to determine incentive claims. Last, but not least, is the

- 21 -

need to strengthen the institutions which administer incentives andregulations.

C. The Pricing Regime

Administrative Pricing and Subsidies

2.17 Nepal has an elaborate price control system. It applies to both theprivate sector and the PEs, but it is enforced more stringently for the PEs.As in most countries, there is a statute which empowers Government to protectthe delivery of essential services in times of crisis. But in addition, Nepalhas the Essential Commodities Control Act which authorizes the Government tocontrol the production, distribution, and pricing of some 29 listed 'essen-tial" commodities to ensure adequate access for consumers. The list includesconstruction materials, clothing, fruits, paper, chemicals, and staples (AnnexII.I). There is, in addition, a subset of "most essential" goods andservices, such as, fertilizer, dairy, sugar, foodgrain sales by the NFC, andlife line utilities, which have price controls and subsidies. The legal codesprovide roles for a hierarchy of institutions in pricing and distributiondecisions. They include the Council of Ministers, enterprise boards, andcommittees of zonal administrators. Policy decisions in India also havesignificant influence on pricing decisions in Nepal. India's interventionistpolicies, such as subsidies, export bans, quotas, and generally high tariffscreate wide discrepancies between Indian prices and the prices ofcorresponding products in Nepal. The proximity to India and the far largersize of that economy often compel Nepal to follow parallel pricing policies tolimit smuggling and tax evasion.

2.18 Table 2.1 illustrates the cost and price structure for selectedproducts. The disparities between costs and prices partly reflect theinefficiency of some units relative to competitive import costs. For the mostpart, however, they reflect Government controls and interaction with Indianpolicies. In the cases of Hetauda Cement and Raghupati jute, for example,production costs are uncompetitive relative to cif costs and export marketprices, respectively. Himal Cement and Bhrikuti Paper cover full costs,though their prices are set below import prices to support basic needsobjectives. Sugar price is also controlled below average import cost, becauseit is considered an essential commodity. Finally, the trading PEs also facecontrols. NFC's prices are below cost, having been fixed silLce 1986; theprices vary from 93Z of costs in the Kathmandu Valley to 412 in the Mid-Eastern region. Fertilizers are also highly subsidized; they are obtained atcompetitive international prices and from aid sources, but sold at below cost.Nepal's fertilizer sale prices are based on Indian border sale prices whichcarry high subsidies from the Indian Government. Nepal's cost recovery ratiosfor complex and urea fertilizers, which together account for 902 of sales, are52Z and 62Z, respectively (Table 2.1).

2.19 In May 1985 and again in December 1989, the Council of Ministersissued policy statements to liberalize the pricing of PE goods and services.Under the latter reforms, PEs are grouped into three categories as shown inTable 2.2. First, for PEs operating in competitive markets, the enterprise'sBoard of Directors has the authority for pricing items. Second, for monop-olized activities, the Board has the authority to established break evenprices and to change them up to a 1OZ margin without Government approval.

- 22 -

Third, for subsidized items, the Board similarly has authority to changeprices up to a 1OZ margin. The implementation of these policies has beenuneven, as ministries still influence pricing decisions through representationon enterprise boards, and the new policies do not overrule earlier regulationsand statutes.

2.20 Rigidity is a major flaw of the pricing regime. The involvement ofseveral bureaucracies in pricing decisions requires that conflicting interestsbe reconciled on an ad hoc basis. Prices tend to be fixed for long periods,and the subsequent necessary sharp increases are often politically unpopular.There are difficulties with coordinating pricing policy with other policies,and price regulations sometimes affect incentives set up under tradeliberalization policies. For example, putting fertilizer imports on opengeneral license does not motivate private importation because controlledfertilizer sale prices are below import costs. The system contributes toeroding the financial position of the supplying agencies, limiting theircapacity to sustain and expand deliveries. The subsidies are not targetedtowards clearly identified beneficiaries, although they are rationalized bywelfare considerations. The methods of price regulations provide littleincentive for private sector suppliers, creating dependence on the PEs evenwhere the costs of private sector deliveries are demonstrably lower.

Liberalizing the Price Control System

2.21 In recent years the Government has tended to use price controls andsubsidies as a tool for poverty alleviation. However, the principles thatcould guide pricing policy have in fact been applied to utilities inNepal.21/ For tradeable goods, it is conventional to base pricingdecisions on the domestic currency value of border prices plus adjustments forinternal transportation and transaction costs. The pricing of nontradeables,on the other hand, is normally based on the opportunity costs of resources,normally long-run marginal costs, or average costs if they are more practical.In both cases, the mechanism for effecting the pricing system depends on themarket structure. In the case of monopolies, these principles would be usedby a central authority to regulate prices. The price may be based on a movingaverage to limit the adverse impact of international market fluctuations (ashas been done for fertilizer pricing in Bangladesh). In the case of PE goodswhich face competition from domestic or foreign producers, it is normal toabolish price regulations and allow enterprise managers to respond to marketmovements. In this regard, the coordination of trade and pricing policies isimportant for effective deregulation. If the import prices for certain itemsare liberalized, for example, the corresponding domestic prices should beliberalized to reinforce the motivation of competitive behavior. Governmentsmay deviate from these pricing principles for broad development or equityreasons, but the beneficiaries should be targeted, and the costs of andsources of financing for the deviation should clearly be identified.

21/ Reforms based on marginal cost principles have been developed and arebeing applied in the pricing of energy, water and telecommunications.See, for example, World Bank: Nepal, Power Subsector Review, 1988.

- 23 -

2.22 This section discusses price and industrial deregulation forspecific cases and institutions. Pricing reforms are a sensitive matter,since they can provoke resistance from those adversely affected. Reformsshould aim at gradually moving towards a more liberal regime while making anyremaining subsidies explicit and channelling them to clearly identified targetgroups. Government should provide legal backing for announced policies which,go far, have not been implemented due to legal ambiguity. The EssentialCommodities Act, for example, could be updated to reflect the PE pricing

Table 2.1: SELECTED PE PRICES PER METRIC TON (UT)

C.1.1.Cost of Ex-factory NepalProd. Pric- Border lb(USO) (USO) (USS)

Manufacturing PEo /a

Coemnt (Hotauda) /c 103 89 96Cement (Himal) Id 74 86 96Paper (Bhrikuti) /- 765 770 831Sugar (Birguni) if 389 409 361 (462)/hJute (Raghupati) /g 761 677 -Milk por 1000 liters (Dairy Dev. Corp.) Li 403 373 -

AvoerageAverage Controlled CostCost Price Recovery

Nepal Food Corporation (Paddy A Rice) (NRa) (NRs)

Eastern Region 11,680 7,490 61Central Rogion (Kathmandu) 7,981 7,410 93Woetern Rogion 11,222 7,290 e5Mid-Western Rogion 20,889 8,840 41For-Western Region 12,919 8,000 62

IndianNepal Nepal Bord-rCost Price Price

Agricultural Inputs Corporation Li (NR) (NRs) k (NROs

Amoni Sulphate 8,062 3,111 2,722Complex 8,492 4,602 4,289DAP LI 9,976 6,319 6,243Pota'I 6,769 2,316 2,265TSP 8,886 3,963 3,830Urea 6,361 4,070 3,626

L Figures for the Manufacturing PEa ore in constant 1987 prices, using InternationalManufacturing Value Index as doflator.

Lb Ci.f. prices are based on competitive international prices plus adjustment forinsurance and transportation to Nepal border.

c Production cost based on the average costs of 1987/88 and 1988/89.Average 1986/87 - 1988/89.Based on 1988 figures only.

/f The c.i.f. price for sugar is the average price of 1987/88, 1988/89 and 1989/90. Forthe number in parenthesis, see (h).

/D Jute is exported to India at prices below cost. Fob price is 3638. See Table 1.2.Tho figure in parenthesis is based on January 1990 Third country prices; the currentc.i.f. import cost from India is about 3330.

LI Cost and prico figures are averages for 1986/87, 1987/88 and 1988/89. Pricos wereincroased in 1989, enabling DDC to break even In that year.

Li Cost figures obtained by taking the average of 1987/88 and 1988/89 wholosale costsfor AIC. They reflect c.i.f. import costs to Calcutta plus transportation andhandling costs to Nepal.

k CControlled prices last adjusted on November 8, 1989.Cost figure for 1988/89 only.

- 24 -

Table 2.2: PRICE POLICY FOR CORPORATIONS, ISSUED DECEMBER 14, 1989

PEs Under Competitive Morket Pricinm.Board of Directors have pricing author ty.

1. Janakpur Cigarette Factory2. Himal Cemnt3. Raghupati Jute Mill4. H-taudo Cement5. Brick and Tile Factory - Harishidi8. Bhaktapur Brick Factory7. Royal Drugs Limited8. Agricultural Tools Factory9. National Construction Company, Nepal10. Nepal Transport Corporation11. Agrolime Industry12. Timber Corporation of Nepol13. National Trading Limited14. Bonsbari Shoe Factory16. Medicinal Herbs Production and Processing Company18. Nepal Teo Development Corporation17. Cottage and Handicraft Sales Emporium18. Nepol Transit and Warehouse Company19. N-pal Film Corporation20. Balaju Textile Industry21. titauda Textile Industry22. Dairy Development Corporation23. Nepal Orient Magnesit.24. Bhrikuti Paper26. Nepal Rosin and Turpentine26. Economic Services Center27. Udaypur Cement Factory28. Foundry Development Corporation29. Cultural Corporation30. Ratna Recording Corporation31. Nepal Television

PEs Under Price Control.Board of Directors can change price up to 10% without Covernment approval.

32. Nepal Electricity Authority33. Nepal Telecommunication Corporation (Internal)34. Nepal Oil Corporation35. Tobacco Development Corporation38. Birgunj Sugar37. Lumbini Sugar38. Drinking Water and Sewerage Corporation39. Royal Nepal Airlines (Internal)40. Gorkhapatra Corporation41. Janak Education Material Center Ltd.

Enterprises which receive subsidies.Board of Directors can change price up to 10% without Government approval.

42. Agricultural Inputs Corporation43. Industrial District Management Limited44. Nepal Food Corporation46. Nepal Resettlemv.ent Company

policies announced by the Council of Ministers (para. 2.19). Similarly,Government should consider narrowing the current list of 29 essential items(Annex II.1) covered by the Act. The Act's application could be limited toitems that are explicitly subsidized and targeted for the poor. A secondissue is to strengthen the PE managers' pricing authority. The price policyfor PEs issued by the Council of Ministers in December 1989 gives theauthority for pricing competitive goods to PE Boards. But implementation of

- 25 -

this policy has not been even, since some ministries continue to exertpressure on pricing decisions through representation on Enterprise Boards.Government needs to consider transferring pricing authority from the Board ofDirectors to PEs' Chief Executives and operational managers. Pricing policyreview needs to be considered for specific PEs, such as DDC, the sugar units,NFC, and AIC. Specific options for these PEs are discussed below.

2.23 Since 1988, DDC has faced restrictions on imported inputs, and onthe price of the local substitute on which it must depend. Output prices arealso controlled, and dairy sales are not targeted for the lowest incomegroups. In fact, since on-farm consumption and sales to low income groups aresatisfied by unpasteurized milk, DDC serves relatively higher incomeconsumers. An output price increase of 252 enabled DDC to break even in 1989,but previous financial losses have eroded its equity base, and DDC has anegative net worth. Pricing and institutional reforms that should beconsidered include: (a) abolishing controls on DDC's output prices andinvesting the authority for pricing in the Chief Executive and operationalmanagers; and (b) transferring welfare and livestock development services toThe Dairy Development Board and other extension service agencies. In the caseof sugar, price controls and subsidies need to be relaxed as they provide noincentives for choosing between third country and Indian sources. A flexiblepolicy would motivate switching between import sources as dictated by pricechanges.

2.24 Controls on NFC's prices also need to be liberalized. Foodgrainprices have been fixed for NFC since 1986, and the proportion of costsrecovered range from 93Z in the Kathmandu Valley to 41? in the Mid-WesternRegion. NFC accounts for less than 22 of total foodgrain consumption, andmost of its sales are in the Kathmandu area. In 1988/89, for example, theValley absorbed 51? (17345 metric tons) of paddy and coarse rice sold by NFC.NFC's activities are neither commercially oriented nor clearly targetedwelfare programs. Accumulated losses during 1984/85-1988/89 amounted to overNRs 502 million, and guaranteed overdue commercial bank debt exceeds NRs 600million. The options for reforming NFC are limited. The commercialization ofNFC is not a feasible option. For various reasons, NFC's costs are higherthan private sector costs, and break even prices are above market prices. InApril-May 1989, for example, the market price for par-boiled and coarse ricewas between NRs.7170-7940 per metric ton in the Kathmandu Valley, compared toNFCs cost of NRs.7961. The option of turning NFC into a price stabilizationagency needs to be carefully examined; there are indications that foodgrainprice stabilization will not be feasible in Nepal. Nepal's scope for effectivebuffer stock management and price stabilization is limited bv the closecorrelation between Terai and Indian foodgrain prices, and those betweenKathmandu Valley and the Terai.22/ Other options for NFC could include thefollowing: phasing out all subsidies in the urban areas; targeting subsidies

22/ "Market Intervention for Price Stabilization of Foodgrains in KathmanduValley". Nepal Agricultural Projects Service Center, March 1989.

- 26 -

on the Hill districts only; replacing subsidized foodgrain deliveries toGovernment employees with cash payments; and turning NFC into a social serviceagency with a skeletal staff and infrastructure for disaster and droughtrelief.

2.25 Fertilizer price subsidies also need to be reformed. Under previousreforms, the Government raised fertilizer prices above corresponding Indianborder prices, opened wholesale fertilizer distribution to the private sector,and transferred pricing authority from the government to AIC's GeneralManager. But fertilizer importation is still a Government monopoly as pricecontrols and subsidies provide no incentives for private participation. AIChas made persistent losses resulting in a negative net worth and is keptafloat through various kinds of subsidies with a cumulative total of NR 1.5billion, equivalent to 2Z of 1988/89 GDP. Fertilizer use per acre in Nepal isuneven, but among the lowest in Asia. Fifty eight percent (77,371 metric tonsin 1989), of AIC's fertilizer is sold in the Kathmandu Valley. Fertilizerdistribution is quantitatively rationed. Supplies are often inadequate,leading to shortages and illegally high prices. Fertilizer priceliberalization is controversial politically, but maintaining the status quowould ignore the budgetary burden and the fertilizer shortages which undermineagricultural development programs. A recent pricing policy (Table 2.2) callsfor reducing subsidies further. Options to be considered if subsidies arereduced include expanding the role of private distributors to includewholesale supply and allowing private importation of chemical fertilizers.Fertilizer imports could be maintained on open general license and fertilizerthat has been obtained through commodity aid could be auctioned. In addition,priority should be given to strengthening AIC's internal financial reporting;In particular, an effort should be made to improve the accounting for the useof counterpart funds from commodity aid. An ongoing ADB study on AIC willprovide further guidance on required AIC reforms.

III. GOVERNMENT SUPERVISION, CONTROL, AND PERFORMANCE MONITORING

A. Introduction and Summary

3.1 Supervision and control refers to the Government's oversightfunctions with respect to PEs. As the sole or majority shareholder, KMG'sresponsibility is to exercise strategic control over its PEs and to ensurethat their performance is consistent with the objectives and policies set forthem. A structure of control and performance monitoring has long been inplace in Nepal, some of which (e.g., the Corporation Coordination Division[CCD]) date as far back as 1975. A total of seven agencies control PEoperations, the more important of which are the Cabinet, Line Ministries, theFinance Ministry, and the Public Service Commission (PSC).23/ The centralproblem with the current system is that excessive government interference and

23/ The PSC's role will be discussed later in Chapter V, which focuses onemployment compensation and labor relations issues.

- 27 -

bureaucratic control exercised through these controlling agencies haveseriously constrained PE performance. The control environment has undercut PEautonomy in most areas of management, making it difficult to hold managersaccountable for performance.

3.2 This chapter discusses (a) the role of Cabinet and other governmentoveLsight agencies, including the legal framework which establishes the basisfor formal Government control of the PEs, and (b) the existing monitoring andreporting systems which are administered primarily by CCD in the Ministry ofFinance. Section B discusses the role of government oversight agenciesincluding CCD, while Section C reviews the existing monitoring and reportsystem. The main conclusions are that existing procedures for performancemonitoring are relatively ineffective and that the Government and, in par-ticular, the line ministries, have not exercised strategic control of the PEs.Little effort has been made to provide guidance to PEs to help achieve abalance between social objectives and PE efficiency requirements. Moreover,they have failed to: (a) set clear sector policies; (b) foster a long-termstrategic focus in the enterprises by placing emphasis on corporate orstrategic planning; and (c) effectively monitor and evaluate PE performance.Instead, the role of government agencies has evolved into one of detailedcontrol and interference in PE operations, including review of many Boarddecisions and control of procurement, investments, and employment.

3.3 Recommendations for medium and long term reform discussed in SectionD include clearer delineation of the role of oversight agencies with greateremphasis on strategic rather than operational control. Thus, the role of lineministries would be to establish long-term sector objectives and sectorperformance targets, monitor overall sector performance, and establish pricingpolicies for monopoly firms. The Ministry of Finance would approve largecapital investments and subsidies. Within broad guidelines, decisions onprocurement, etc., would be left to the PE boards and managers. A government-wide oversight function, ideally located in the Prime Minister's office oralternatively, delegated to MOF, would monitor and evaluate PE performance,implement perfoLmance incentive schemes, identify key issues emerging acrossthe PE sector as a basis for taking anticipatory action, and establishnonsector-specific policies which affect all PEs. The Cabinet and the PrimeMinister's role would be to make key appointments, decide on incentives, andensure consistency across ministries.

3.4 To be effective, reform of the government oversight structure mustbe done within the context of a broader PE reform strategy which would alsoinclude measures to reform the policy environment and strengthen the enter-prises, in order to increase pressure on the PEs to perform while buildingtheir capacity to respond to changes in their environment. The institutionalcapacity and experience required to effect needed reforms simultaneously for alarge numiber of PEs appears not to exist in Nepal. Thus, the strategy for PEreform discussed in Chapter 6 proposes a phased PE reform program. In thefirst phase, an interrelated package of reforms of relevant policies, ofgovernment oversight and control, and of internal PE management would beimplemented for a selected group of PEs. Experience gained in this interimphase would be used in the design of a broader PE reform program.

- 28 -

B. Government Oversight Agencies

3.5 The four main government agencies or bodies which exercise controlover PEs in Nepal are the Cabinet, which appoints PE Chief Executives andformulates policy on PE management, the line ministries, which oversee theirPEs, the Finance Ministry, which approves financial assistance for PEs, andthe Public Service Commission (PSC), which regulates PE personnel policy.Other controlling agencies, such as the National Planning Commission (NPC),the Auditor General's Office, and the Parliament Committees which exerciselegislative control, are less influential. Some are ineffective in theirfunctions for a variety of reasons. Others are simply ignored by PEs.

3.6 The Cabinet. Although the Company Act stipulates that the Chairmanof the Board should be elected by the Board, in practice the Chief Executiveis nominated by the line ministry and appointed by the Cabinet. The Cabinetalso decides the composition of the Board. Frequently, the same person isappointed as Chairman of the Board and Chief Executive or General Manager (GM)(e.g., Janakpur Cigarette Factory, Ltd.), but more often the Cabinet appointsa full-time GM and a part-time Chairman who is usually the Secretary orAdditional Secretary of the line ministry. Although a 1985 Cabinet decision(para. 3.9) specified that 'the selection of general managers should be basedupon qualification, skill, experience, commitment to national creeds andperiodic plans, etc.,' there seems to be no clear criterion or discerniblepattern for these appointments. The terms of appointment also vary. TheCompany Act specifies that the Chief Executive can only be appointed for amaximLu of two terms. However, in practice the same Executive Chairman or GMis usually allowed to continue in position until further orders are received.On the whole, the Cabinet, as the highest authority, has not paid enoughattention to its ownership role, in that it has emphasized broader nationalinterests rather than PE efficiency and profitability in making decisionswhich affect PEs.

3.7 The Line Ministry. As is the case in many countries which lack asystem of performance-oriented control, line ministries in Nepal basicallyoperate a bureaucratic, procedure-bound control system similar to currentpractice in government departments. Line ministries control PEs through theirinvolvement in several areas, including recommending candidates for ChiefExecutives, serving on the loard of Directors, and approving borrowings,investments, and major procurements. The mandate for line ministries tocontrol PEs is clear in the acts under which PEs have been established(including the Company Act) but not well defined (para. 3.13). As a result,the areas of involvement evolve through practice, and the specifics are notreferred to in any consolida.ed document. Despite their heavy involvement inrunning the PEs, the line ministries have not done an adequate job in areaswhere Government oversight is important, such as setting sector policies,requiring and approving corporate plans and, more importantly, evaluating andmonitoring performance. In the absence of a performance-based control system,the line ministries' bureaucratic controls tend to be excessive, interferingin operational matters. Government interference was cited as a problem inseveral areas by managers of PEs that were included in the sample survey.Most interference involved pricing decisions. Also, government interferencein PEs' investment decisions, including discouragement of additional invest-

- 29 -

ments, R&D, and technological improvements, were indicated by a'l PEssurveyed. Cases of political interference are widespread, although they arenot easilv documented. Several PEs indicated that decisions on location ofproduction centers, sales offices, and distribution centers were influenced bypolitical pressures on board members. Several cases of pressures for employ-ment by politicians and bureeucrats were reported. Most of these pressuresare 'covert' and informally channelled through Board members and HMGofficials, not necessarily via line ministry officials. Requests for politi-cal donations for a variety of purposes are also reportedly made by theministries, which decide the amount to be donated.

3.8 Ministry of Finance. The Finance Ministry exercises control throughits CCD Division (para. 3.10) whose mandate is to monitor PE progress and tocoordinate PE policies in consultation with the concerned ministries. It alsohas a representative on the majority of PE Boards. MOF exercises greaterdirect control over loss-making PEs, which have to rely on subsidies andgrants; it participates in the preparation of their budgets, approves dis-bursements, and ensures more frequent reporting and monitoring. Budgets ofPEs requiring Governument subsidies must be formally approved by MOF. Subse-quently, disbursements are approved for each four month period, based onexpenditures and the work program proposed for that period. Beginning lastyear, the Finance Ministry was also brought in to assess (through CCD) andapprove all PE capital investments, including those of 'second generationPEs.' Dividend payments by PEs also require MOF approval, although this hashappened rarely in practice as most PEs are making losses. Current regula-tions require non-financial PEs to distribute 50 percent of after-tax profitsas dividends.

3.9 Apart from dealing with the loss-making PEs, the Finance Ministry'srole in PE finances in general has perhaps been overlooked, especially whenthe line ministries do not have an effective financial control system inplace. Under its broad terms of reference, CCD is supposed to play a role inthis area, but its reduced status and limited personnel make it little morethan a PE subsidy approval office (see below). Monitoring the financialsituation of PEs in Nepal has fallen between line ministries and the FinanceMinistry, with the result that responsibility is diffused. Only when a PEaccumulated losses require subsidy is the Finance Ministry's controlling roleactivated, because these subventions affect government finance.

3.10 CCD, which was originally established in 1975 as the CorporationCoordination Council (CCC) in the Prime Minister's office, was transferred tothe Finance Ministry in 1980 where it became a ministry division. As such,CCD seems to have a smaller role than its predecessor, although in theory itretains the same functions, which are to:

(a) improve PEs' corporate management;

(b) bring about uniformity in PEs' internal administration;

(c) classify the PEs as per their objectives and scope of activities;

(d) advise HMG on PEs' pricing policies;

- 30 -

(e) bring about uniformity in the accounting system;

(f) advise on ways and means for coordination of policies between theministries and the PEs;

(g) advise measures for upgrading thc quality and capability ofcorporate personnel;

(h) make continuous, periodic and special study of PEs and keep theconcerned ministry and corporations informed of the findings of suchstudies;

(i) review whether or not any corporation has worked according to itsdefined objectives and programs;

(j) advise HMG on matters of dissolution, amalgamation, expansion and/orcreation of corporations;

(k) receive periodic progress reports from the corporation in order toexamine whether recommendations made by CCD and approved by HMG havebeen implemented, bring implementation failures to the notice of theconcerned ministries, and suggest measures to solve problems identi-fied; and

(1) advise HMG on any other matter relating to public corporations.

3.11 Clearly these numerous functions are ambitious even for a properlystaffed central PE authority. CCD has not been able to carry out most of theindicated functions because it lacks professional staff and adequate support.For the moment, its staff of three professionals, all at the level of sectionchiefs, are mainly busy with approvals of releases of budget subsidy funds forPEs, and can spare little time for anything else. CCD's offices are poorlyequipped, and support staff is minuscule. In part because of its lowerstatus, CCD has not played a major role as a central monitoring authority; infact, although all PEs are required to send monthly and four-monthly reportsto CCD in line with government procedures for performance monitoring(para. 3.16), only loss-making PEs which require subsidies consistently complywith this requirement.

3.12 Partly as a result of staff constraints and lack of professionalskill, CCD's work on PEs' performance evaluation has been superficial.Although the current evaluation system, which is based on a 1985 Cabinetdecision, provides for (a) a reward of 10 percent of profits for ChiefExecutives of PEs which exceed targeted profits or minimize targeted losses,(b) a review of the position of those Chief Executives whose enterpriseachieved less than 15 percent of the annual target, and (c) removal of thosewhose enterprises fall 25 percent or more below the target, none of thesemeasures have been implemented. At the end of each fiscal year, CCD evaluateschief executives' performance against agreed targets but these evaluationreports are not acted upon. The lack of follow-up reflects underlyingconcerns that the data is unreliable and PE targets overconservative.

- 31 -

3.13 The Legal Framework. The extent of formal government control ofspecific PEs depends on the legal framework under which they were established.Thirty-eight of the 64 PEs, including the majority of the manufacturing PEs,were established under the Company Act, six under the Corporation Act, threeunder the Development Board Act, and the remainder under special acts. TheCompany Act, which was first promulgated in 1964 and amended several times,most recently in 1979, is a detailed standard company law for the establish-ment of private companies. In theory, enterprises established under theCompany Act are expected to have greater managerial autonomy and are subjectto the same system of control as a private company, i.e., through the boardand general assembly. However, a 1964 amendment to include PEs in the Actstipulated that PEs shall 'comply with the orders and directives issued by theappropriate departments." This general directive limits the autonomy providedunder the Company Act by giving open-ended authority to line ministries tocontrol and direct PE operations. Although line ministries need to retainsome control of sector PEs to ensure that their operations are in line withthe sector's development policies and strategies, since their authorityappears unlimited, the PEs continue to function essentially as extensions ofGovernment departments rather than as commercial companies.

3.14 Enterprises established under the Corporation Act and DevelopmentBoard Act are owned wholly by the state and as such come more securely underGovernment control. In contrast to Company Act companies, financialprofitability is not a priority objective for these enterprises; corporationsare generally expected to break even, and Development Board companies are notexpected to be commercially viable. The Government therefore exercisestighter control as part of the process of approval of subsidies and governmenttransfers.

C. Existing Monitoring and Reporting Systems

3.15 Despite the fact that most of the elements needed for effectiveperformance monitoring were detailed in the 1985 Cabinet decision, inpractice, the existing reporting system is ineffective. There is no properperformance monitoring and as indicated, procedures for evaluating PE managersand providing rewards and punishment based on performance have not been imple-mented (para. 3.12). This is both a function of the lack of adequatelytrained staff in CCD to implement the system as well as the poor financial andother reporting systems at the firm level as discussed in Chapter IV.

3.16 The existing reporting system was intended to facilitate performancemonitoring and provide the basis for evaluation of PE managers. At the timeof budget preparation, normally April/May, CCD compiles annual operationaltargets for each PE which are published in a public document known as the'Yellow Book." Prior to publication, these targets are discussed at CCDduring a series of meetings with PE managers, with the participation of lineministry and the Planning Commission staff. These meetings are the onlyopportunity for CCD to meet with representatives of all PEs including thosewhich do not need financial assistance. Since CCD staff lack the capacity toevaluate the appropriateness of the targets, most targets remain unchangedfrom those originally proposed by the PEs; only reductions in targets comparedto previous years trigger detailed scrutiny. PEs are required to submit

- 32 -

reports monthly, four-monthly, and annually to the line ministries, withcopies to CCD, indicating their performance with respect to the agreedtargets. The reporting format is more or less standard for all PEs. Achieve-ment figures are recorded against targets for production, sales, andinventory. The figures are presented by products in case of multi-productfirms, e.g,. drugs (RDC), agricultural inputs (AIC).

3.17 The main vehicle for periodic progress monitoring are four-monthlyreview meetings chaired by the Secretary of the Ministry or the Ministerhimself. The Ministry of Industry also has a mid-term (six months) review inaddition to annual review. In these review meetings, the emphasis seems to bemore on meeting targets than on profit (the form does not have a column onprofit) or other measure of efficiency. This system is clearly not perfor-mance-oriented as the information required does not give a clear and accuratepicture of performance. Verbal reporting and exchanges made during thesemeetings may add a qualitative complement to the system, but they cannotsubstitute for more systematic performance monitoring. At present the lineministries do not have separate units to monitor their PEs. An expert fromthe Netherlands is currently working on an MIS for the Ministry of Industry,but the requirements for a better system of reporting and monitoring will gobeyond external controlling agencies' capabilities; it would require firstthat PEs improve their financial and other management reporting systems inorder that meaningful data is produced.

D. Options for Reform

3.18 Any reform of the supervision and control structure should take intoaccount the fact that HMG is not monolithic and that different ministries andagencies tend to exercise control separately and often in an uncoordinatedfashion. Similarly, effective oversight is not possible without certain basicconditions being met at the enterprise and board levels. As discussed inChapter 4, PEs' existing internal weaknesses will limit their ability torespond even if necessary changes are made in the policy environment and inthe supervision and control system. Hence it is important to strengthen thePE's internal management in parallel with changes in the policy environmentand Government's oversight structure.

3.19 The basic challenge in the supervision and control of PEs is tocreate a viable balance between enterprise autonomy and accountability forperformance. This balance requires that those who perform the oversightfunction should exercise 'strategic control,' leaving 'operational control' tothose responsible for the PEs' internal management. There are five areas ofsupervision and control essential for maintaining this balance, namely, makingkey appointments in PEs, agreeing long-term goals and strategy, agreeing onannual performance targets, reviewing actual performance and linking it toincentive policies, and identifying key issues emerging across the PE sectoras a basis for taking anticipatory action.

3.20 Key appointments here refer to board members and the chief execu-tive. Long term goals and strategy are derived from corporate and strategicplanning exercises (para. 4.34). They may entail new investments, diversifi-cation, or divestiture; these have obvious implications for sec )r policies

- 33 -

and programs. Since such decisions set the long term directions for theenterprise, government concurrence is essential. It is within this frameworkthat annual or short term targets are developed. Government must agree on keyperformance targets with the PEs. In establishing targets, more emphasisneeds to be placed on those related to key commercial objectives, i.e.,profitability, efficiency and financial prudence. At the end of the year, theactual performance could be compared with the agreed targets to see whethernegative variances are due to controllable or uncontrollable factors (from thePE's standpoint). Policies on rewards and penalties linked to performance areimportant to ensure that managers are motivated to pursue agreed performancegoals. Finally, it is part of the oversight function to track general issuesthat affect all PEs and to take action in advance to deal with them. Individ-ual ministries are not likely to play this role because they lack the broadoverview that only a government-wide oversight body can provide.

3.21 In the case of Nepal, the key agencies relevant to the oversightfunction are the sector ministries, MOF and the Prime Minister's Office.Clear delineation of the role of various sector agencies is crucial to reformof the Government supervision and control structure. The sector ministries'oversight role stems from the fact that PEs play a major role in implementingsector policies and programs. MOF performs the resource allocation functionthat concerns all PEs and the sector ministries. The Cabinet and the PrimeMinister's role is critical for key appointments, decisions on incentives, andensuring consistency across ministries. Ideally, the Government oversightfunction should be located in the Prime Minister's office, although for avariety of reasons, it may be delegated to MOF. In fact, HMG had originallyset up CCD in the Prime Minister's office, but decided subsequently to shiftit to MOF.

- 34 _

PROPOSED STRUCTURE OF GOVERNMENT OVERSIGHT

Cabinet

* Appointment of board members, chief executive* Approval of PE incentive policies

Government Oversight Body

* Monitoring and evaluation of PE performance, implementingperformance incentives schemes

* Nomination of board members with input of secto ministries, MOF* Establishing financial targets, dividend policy* Long-term planning and coordination across sector ministries.

MOF

* Approval of large capital investments* Approval of subsidies

Sector Ministries

* Pricing policies for monopolies* Establishing long-term sector objectives and sector specificperformance targets

* Monitoring overall sector performance against sector objectivesand targets

* Nothing else

3.22 Basic Tasks of Supervision and Control. Four tasks have to beperformed by HMG (through the appropriate oversight agencies) in order toensure effective control over PE performance.

(a) Approval of PE's corporate and strategic plans, thereby concurringwith the boards' long-term plans for the enterprise. Approval bythe Ministry of Finance is essential, especially when governmentfunds have to be committed to finance future growth ordiversification. Otherwise, approvals from key government agenciescan be given to plans through their representatives on the board,which is the proper forum for such approvals (para. 4.28).

(b) MOF approval of the annual budget in so far as subsidies or injec-tion of government equity or debt is required by PEs. Budgetapproval in all other cases should be left to the PE boards on whichkey government agencies would be represented. However, the budget,in conjunction with the corporate plan, should be used by theGovernment oversight body to negotiate reasonable goals for profitgeneration and cost efficiency with PE boards. This process willnot be effective unless the HMG staff who negotiate with PEs are

- 35 -

themselves well versed in enterprise management and commercialpractices. Experience with the foregoing type of negotiation couldprovide a basis for developing annual performance agreements orcontracts with individual PEs. Targets or goals could be built intosuch agreements, provided HMG could make firm commitments onresources and support to the PEs. These agreements also requirethat PE managements have the autonomy required to achieve mutuallyagreed annual targets. Once performance contracts are agreed on, itwould not be necessary to have monthly reviews of progress byministries as is now done. Monthly or quarterly ministerial reviewof the production of certain essential goods may still be necessaryas part of the line ministries' sector-wide monitoring function, butthey should not be confused with the review of the overallperformance of PEs.

(c) Review of the performance of each PE at the conclusion of the budgetyear or of the period of performance agreement. For a sub-&t ofimportant PEs, a progress report every six months would also beuseful. The focus of the review should be on the critical targetsor variables and not on other details which should be left to theboards to monitor.

(d) Establishment of a performance linked system of rewards andpenalties. PEs will attach importance to the review process onlywhen they stand to gain or lose from the results of the review.Given the problems faced by HMG with the 1985 incentive scheme, itis important that careful attention should be given to designing aneffective performance linked system of rewards and penalties. Auseful initial step would be to relate incentives to an easilymeasurable indicator of profit or minimization of loss. Furtherrefinements in this scheme could be made through a process oflearning over time. The credibility of a performance linked incen-tive scheme will depend not only on its rationality, but also on theprocess used to arrive at the final judgment or decision. Theprocess should be fair and transparent and be undertaken by personsperceived to be qualified and impartial. For example, it would bedesirable to have the central oversight agency for PEs, headed by asenior person at the level of a general manager with adequateknowledge of PE operations. The manager of the oversight agencyshould be free to engage consultants or other specialists to under-take special assignments for the agency.

- 36 -

IV. INTERNAL MANAGEMENT

A. Introduction and Summary

4.1 The sample of twelve public enterprises which were investigated indepth (see Volume II, Annex IV) provides a reasonable basis for a diagnosisand overview of the internal management problems of Nepal's publicenterprises. The sample PE data confirm that performance problems are severeand pervasive. Both external and internal factors have contributed to thisphenomenon. This chapter examines the nature and scope of the latter, namely,the internal management deficiencies of the Nepal manufacturing and tradingPEs. Section B discusses deficiencies in managerial capacity, Section Cdeficiencies in functional areas, and Section D deficiencies in financialmanagement. Enterprise projects for each of the sample PEs are provided inAnnex IV. These profiles provide (a) data on the enterprises' organizationand management, marketing and production, personnel and financial management;(b) identifies the PEs' major problems; and (c) suggests preliminary optionsfor improving the performance of each PE. The discussion in this chaptersummarizes the problems detailed in the enterprise profiles. Some of theinternal problems discussed in this chapter are directly or indirectlyaffected by external factors that were discussed in earlier chapters.Furthermore, government control over recruitment and salaries, discussed inChapter V, indirectly affects the quality and motivation of the staff workingin the enterprises. These factors constrain PE performance by weakeninginternal management. This is different, for example, from government controlover PE product prices, which tends to affect PE performance directly. Otherexternal factors that are increasingly affecting enterprise performance areobsolete technology and defective machinery, which contribute to productionmanagement problems.

4.2 The internal management problems identified in this chapter can bedivided into four broad categories: (a) poor managerial capability, includingproblems of leadership and guidance at the level of the board of directors andthe chief executive; (b) deficiencies in functional areas, includinglimitations in the internal systems of planning and control, inadequacies inthe marketing and distribution functions of the enterprise, and productionmanagement problems; (c) manpower and labor relations problems; and(d) inadequate financial management systems and practices. There are majorgaps and weaknesses in all the key management functions of the PEs ashighlighted in Table 4.1 and the interrelations among them clearly add to theseverity of the problem. Thus, when the marketing function is neglected,finished goods inventories may pile up, adding to the production planning andmanagement problems on the shop floor. When quality control or maintenance isneglected in the course of production, it becomes increasingly difficult tomarket the goods produced by the enterprise. Poor accounting systems andpractices tend to make it difficult for the top level PE management to performthe functions of planning and control. The neglect of the latter functions,on the other hand, reduces the pressure to introduce and sustain goodaccounting and financial practices such as information systems.

- 37 -

TABLE 4.1: KEY INTERNAL PROBLEMS OF SAMPLE PEs

AIC ATF BBF BLSF DDC HCIL HTI HCC J NCE RJM RDL/. General Management1. Rigid organization structure X X X X X X X X X X X X2. Absence of corporate planning X X X X X X X X X X X3. Non-participative management

culture X X X X X X X X X X X X4. Bureaucratic leadership X X X X X X X X X X5. Inadequate internal monitoring

and control X X X X X X X X X X6. Lack of MIS X X X X X X X X X X X X

11. Marketing1. Lackof marketingplan X X % X X X X X X X X X2. Lack of market information

and analysis X X X X X X X X X X X X3. Inadequate sales promotion

effort X X X X X X X X X X X X4. Inadequate product development

and diversification X X X X X X X X X X X X5. Absence of cost effective

distribution system X X X X

1ll. Financial AccountinQ1. Major deficiencies in

accounting procedures X X X X X X X2. No management of financial

resources X X X X X X X X X X X X3. No professional accounts staff X X X X X X X X X X X X4. Absence of commercial

accountingpolicies X X X X X X X X X X X X5. Inadequate controls and

interna! audit X X X X X X X X X X X

IV. Production and Technoloav1. Obsolete and sub-standard

technology X X X X X2. Frequent machine breakdown

due to worn out machines X X X X3. Shortages of imported

raw materials X X X4. High inventory levels X X X X X5. Inadequate QC facilities X X X X

V. Manpowerand Labor Relations1. Overstaffing and staff

redundancies X X X X X X X X X X X2. High proportion of

temporary staff X X X X X X X X X X X X3. Inadequate training and

management developmentfacilities X X X X X X X X X X X X

4. Limited opportunities forcareer advancement X X X X X X X X X X X X

5. Labor disputes X X X X X X6. Lack of efficiency based

incentfve system X X X X X X X X X X X X

- 38 -

4.3 Section D, which examines options for reform, emphasizes that theremedy does not lie in improving any single aspect or function, Sut inupgrading the entire set of interrelated management functions. Thus, measuresneed to be taken to: (a) diversify and change the role of the Board;(b) appoint competent, commercially oriented chief executives and seniormanagers; (c) upgrade the quality of staff and strengthen functional areaswithin the organization; and (d) improve managerial and financial informationsystems and practices. The quality of policy guidance provided by PE boardscan be enhanced by changing their composition. Technical, financial, andmanagement specialists from the private sector should be included on PE boardsand government representation should be limited to representatives from keyministries. The policy of appointing retiring civil servants to PE Boardsshould be discontinued, except as an interim arrangement. Instead, chiefexecutives should be selected on the basis of commercial and entrepreneurialorientation and experience. Once competent chief executives and seniormanagers are in place, they should be given the mandate to carry out theinternal changes needed to strengthen functional areas and improve financialand managerial systems and procedures. If necessary, they should be providedwith external assistance to help carry out diagnostic studies and implementreform.

B. Managerial Capability

4.4 In Nepal, the manner in which boards are constituted and their styleof functioning may have inadvertently paved the way for poor PE performance.Except in a few cases, PE boards consist solely of government officials.Several dysfunctional consequences have followed from this practice. First,these officials tend to reinforce the use of civil service norms and practicesrather than commercial approaches to enterprise management. In general, thereal autonomy available to the PE gets eroded as a result of this tendency,and the PE may behave more like an extension of its parent ministry than as acommercial entity. For example, a PE may be free with respect to productpricing. The board, however, may exercise informal control over pricing forvarious reasons and in effect, restrict the autonomy the PE is supposed tohave. Second, the civil servants' tendency towards preoccupation with short-term problems gets carried over to the PE which as a result tends to neglectlong-term tasks. This is exacerbated by the absence on the boards of outsideprofessionals and persons with business experience who might have kept thistendency in check by encouraging a more careful assessment of the policy andcompetitive environment and by assisting in the formulation of suitablestrategies to cope with existing constraints. Furthermore, senior and moreexperienced government officials are unable to give much time to boardmeetings, and the number of such meetings which get postponed because of theunavailability of senior officials is not insignificant. Lower levelofficials representing the Government on several PE boards, on the other hand,may be able to attend, but are unable to provide the kind of guidance andbreadth of experience that PEs could benefit from. Routine problems anddecisions therefore get precedence over strategic concerns in most boards.Third, boards of the type described above are more susceptible to be used as a

- 39 -

conduit for political interference and favors than more independentboards.24/ Non-governmental members on the boards would have acountervailing influence.

4.5 The dominant practice in Nepal is to appoint civil servants as chiefexecutives of PEs. In some cases, retiring or retired officials have beenappointed to these posts. Many chief executives in the public sector havethus had no prior commercial experience. They tend to reaffirm theperspectives that the boards already reflect. For example, they may beespecially likely to operate with a short-term horizon if they expect to goback to a ministry after their brief tour of duty. Since both the board andthe chief executive come from a civil service background that takescentralization for granted, it is natural that delegation to lower levels isnot encouraged. An unintended consequence of all this is that problems anddecisions get referred upwards with the chief executive or board dealing withmatters that other managers should have been asked to do. Instead ofproviding policy guidance and overall leadership and evaluation ofperformance, the PEs' top management end up being overloaded with tasks thatare less critical to the enterprises' survival and growth.

C. Functional Areas

4.6 Planning and Control. An important function of corporate leadershipis to appraise the firm's external environment and to develop long-termstrategies for ensuring its healthy future development. In Nepal, it wasfound that only one PE in the sample, Hetauda Cement, had paid any attentionto corporate planning. Some had engaged in mechanical projections of trendsto meet the National Planning Commission's requirements. Hardly any PE hasthe expertise or motivation to engage in long-term corporate planning, partlybecause the pressures from the board are to focus on the short term.Hetauda's corporate plan, for example, was prepared by a firm of internationalconsultants. Even with respect to short-term planning, it is not clear thatmanagers and work teams at different levels contribute to goal setting andfollow up actions. Targets are set mainly to conform to the guidelines of thePlanning Commission and the Ministry of Finance. An important reason for thepoor PE performance must be sought in the non-participative style ofmanagement that seems to prevail and the consequent apathy and lack ofcommitment it generates among other managers and work teams. Planning andcontrol are top management functions, that provide the framework within whichother members in the organization function. Ministerial review of productior.and sales every foar months is not a substitute for internal planning andcontrol systems. There is little evidence that careful internal monitoring ofPE performance is taking place. The kind of accounting systems and practicesnecessary to undertake monitoring do not exist in most PEs. Where internalmonitoring systems have been developed, such as in DDC, they reflect theemphasis on production rather than other measures of performance andefficiency.

24/ Independent in the sense that the presence of non-officials could lead tomore diverse views and proposals in the board which may or may notnecessarily be in line with official government views.

- 40 -

4.7 Marketing Function. The sample survey of PEs shows that sales havedeclined in six out of the 12 enterprises. While the trade and transitproblem was partly to blame, the trend demonstrates that increasingcompetition in some industries is also beginning to make an impact. Five ofthe six companies, JCF, BLSF, BBF, DDC, and HTI, are losing market share todomestic private sector competitors or to imports. If this trend continues,PE marketing weaknesses will have a markedly adverse effect on performance.The practice of cost plus pricing which many PEs reportedly follow does nottake into account competitive market factors. The sample survey suggests thatthe cost plus pricing approach followed by rour PEs has begun to make themuncompetitive. The neglect of the marketing function stems partly from theindifference to corporate planning referred to above. Analysis of marketshares and research on the segmentation of markets and consumer preferenceswill be undertaken only when the competitive environment and market demand areperceived to be priority issues from a long term point of view. Even thoughmost PEs have marketing departments, marketing plans, research, promotion andinformation systems are either non-existent or extremely weak. Marketingstaff often lack skills and experience in these subjects. Productdistribution channels and systems also appear to be inappropriate or poorlyorganized. Thus, four of the twelve PEs in the sample have their owndistribution outlets at the retail level, which may no longer be costeffective or necessary. In the cigarette industry, Janakpur Cigarette Factory(PE) owns its own retail outlets while its new private competitor sells itsproducts through private retailers.

4.8 The most important problem caused by weak marketing is indifferenceto clients and services. As long as monopoly prevails, this may not bereflected in poor financial performance (as was true of the cigarette companyprior to start up of its private sector competitor). The lack of attention toproduct development observed in practically all PEs is evidence of the impactof their limited client orientation. When competition increases in theenvironment, however, PEs which ignore the marketing function will pay a heavyprice. In a competitive setting, products and services have to be adapted andimproved to meet changing client needs and new developments in the industry.This is a missing function in the sample PEs studied.

4.9 Production Management. In six of the ten manufacturing PEssurveyed, production has declined over the past five years. Obsoletetechnology and frequent breakdowns of machinery and equipment arecharacteristic of almost all PEs. As a result, they incur heavy repair andmaintenance expenses. The situation is further aggravated by frequentshortages of raw material inputs and spare parts, and by power failures. Mostof these are problems caused by factors beyond the control of PE managers.There are, however, internal management problems which have also contributedto declining PE production and productivity:

(a) Six out of the ten manufacturing PEs surveyed are reported to beholding excessive inventories of both raw materials and finishedgoods. This locks up considerable working capital borrowed at highinterest rates. In part, this is a response to the general shortagesituation PEs face. On the other hand, a major contributing factor

- 41 -

is the absence of inventory planning and management, an importantingrediernt in production management.

(b) Quality control facilities appear to be adequate in half of the PEsstudied!. However, there is hardly any attentiorn paid to researchand development (R&D), which reinforces the finding that productdevelopmont is neglected. Weaknesses in quality control and R&Dalso retlect the low pt:iority given to consumers and theirpreferences.

(c) The management of spare parts and supplies has been a severe problemin most PEs. PE's links with different donors who supplied theoriginal equipment have exacerbated the problem. But the fact thatsuch shortages are pervasive even in the textile PEs shows thatthere also may be an internal management problem in this Area due topoor inventory management and production scheduling practices.

4.10 Manpower and Labor Relations. A major finding of the sample surveyis the lack of manpower planning at the enterprise level and the widespreadpractice of overstaffing. The latter cannot be attributed solely todeficiencies in manpower planning. As indicated in Chapter V, employmentcreation is seen as a major public sector objective, which, coupled with thepolitical pressures PE managers face, has contributed to overmanning. In onecase, retrenched workers from one PE were absorbed in another in view of thedifficult unemployment situation. Overstaffing exists more at the lowerclerical/worker level where recruitment is made without a careful analysis ofwork loads. As discussed in Chapter V, apart from overstaffing, several otherpersonnel and labor relations problems were found in the sample PEs. Keyissues, many of which are due not only to external regulations but also tolack of managerial initiative, can be summarized as:

(a) Low Salaries. PE salary structures are such that lower levelemployees are paid wages which compare favorably with those in theprivate sector but compensation packages for higher level managersand professionals are less-attractive. Consequently, PEs find itdifficult to attract and retain qualified managers, engineers andother professionals.

(b) Lack of Performance Linked Incentives. The bonus system providedfor under the Bonus Act (para. 5.24) applies universally to allemployees and is unrelated to individual performance andproductivity. Essentially, these bonuses are considered as normaladditions to income and do not necessarily contribute to efficientperformance. Furthermore, the absence of good performanceevaluation systems and the prevalent non-participative managementstyle are reported to have had an adverse impact on employees'morale and motivation.

(c) Lack of Attention to Staff Development. Overstaffing, especially atthe lower levels, and barriers to the dismissal of employees havemeant that there is very little mobility among staff. On the otherhand, there is a lack of attention to their training and

- 42 -

development. This applies equally well to the training of middlelevel managers. The failure to match the staff to their tasksthrough training and to upgrade the skills of higher level staff hasno doubt contributed to the poor PE performance.

D. Financial Management

4.11 The majority of PEs suffer from extremely weak financial managementand thus have very low levels of financial controls. The major weaknesses inPE financial management are deficiencies in accounting procedures, poormanagement of financial resources, lack of professional accountants, neglectof the training and development of accounting staff, absence of commercialaccounting policies, and inadequate financial controls and internal audit.Inappropriate organizational structures and the absence of up-to-date jobdescriptions further contribute to inefficient financial management.

4.12 Accounting Systems and Procedures. The accuracy and timeliness ofthe preparation of the basic books of account vary considerably from one PE toanother. Thus of the twelve PEs studied, the Janakpur Cigarette Factoryproduces annual accounts within three months of the end of the year, whereasthe Agricultural Inputs Corporation takes 22 months. While all twelve PEsstudied operate a manual double entry bookkeeping system based on accrualsaccounting, only six reconcile their books each month, and of these only threepresent monthly income statements. Given the delays in the presentation ofaccounts, the subsequent audit letter is too outdated to be of use to PEmanagements or external agencies.

4.13 The financial reports are not only too late, but often alsoincomplete and inaccurate for purposes of internal control and externalreview. Current assets are overstated because of inadequate provision for baddebts and obsolete stocks. Since the are no cash and flow of fundsstatements, it is difficult to analyze the causes of declining net worth.Depreciation provisions are too low, assets are often overstated because fixedassets are nct physically verified or revalued, and the asset lives used incalculating depreciation allowances are too long. As a result, profits areoverstated. Expenditure is deferred to following years without justificationor prudence. Thus, accounts can be cosmetically adjusted to show a betterpicture in the current year at the expense of future years, giving anerroneous impression of profitability. Cumulative interest, subsidies due,counterpart funds and contingent liabilities are rarely provided for, thuscurrent assets and, more particularly, current liabilities are understated.The financial information reported to the PE boards is thus inadequate andunreliable in many respects.

4.14 Budgetary Control and Financial Planning. All PEs prepare annualbudgets but they are not used as a financial management tool. For example, nofinancial plans are prepared to show how production or cost targets are to beachieved. Variances from budget are not routinely analyzed or explained. Norare budgets revised to reflect changing conditions in the course of the year.As a result, budgetary control is not effective, and the effective utilizationof available resources is not assured. Long-term financial planning is notundertaken in any PE, making it difficult to assess the future effects of

- 43 -

current decisions. Cash flow management is inadequate or non-existent. To alarge extent, this reflects the neglect of corporate planning by PE managementreferred to previously. Only those PEs in working capital difficultiesictively monitor their cash balances, and even these do not plan their cashusage over the subsequent weeks or months. Thus, the use of bank overdraftsand loans is not always efficient and interest charges are incurredunnecessarily.

4.15 Control of Assets. While physical rontrol of cash within PEs is onthe whole adequate, stocks and fixed assets are poorly monitored andcontrolled. To ensure physical control of cash, most depots and outlyingbranches have two bank accounts, a non-operating account for sales revenue andan operating account for expenses. The non-operating account remits depositsin full to the head office for later reconciliation to sales returns. Amountsof petty cash maintained on the premises are kept tc a minimum. In contrast,there is little control of stock and fixed assets. Inventories are oftenoverstated, and fixed assets are misstated, camouflaging the PE's true capitalbase. Stock is generally only counted annually and fixed assets are rarelysubject to any inspection, verification, or revaluation. Reconciliation tostock and fixed asset records, which are inadequately maintained, isdifficult, time consuming, and rarely satisfactory.

4.16 Insufficient emphasis is placed on internal audit. Staff from thisfunction are continually diverted to other duties and recommendations in auditreports are not acted on by management. Thus, the function lacks credibilitywithin the PE. External auditors place emphasis on compliance with internalregulations rather than best accounting practice. For example, more attentionis paid to the PEs' compliance with tendering procedures than on the adequacyof provisions for obsolete stock or doubtful debt.

4.17 The key effects of this lack of financial control within the PEsare:

(a) It is difficult for HMG, line ministries, funding agencies orpotential investors to assess the PEs' true financial health ormonitor performance because they cannot rely upon the accuracy ortimeliness of the accounts or reports produced.

(b) The available financial information lacks credibility with banksfunding agencies, and investors. In the absence of long-term plans,banks cannot assess PEs' future ability to meet repayment schedules.

(c) Lack of realistic long-term plans makes it impossible for HMG tojudge the relative costs and benefits of continuing to support eachPE. Investment in a PE should be appraised like any other projecton the basis of the future benefits expected. It is difficult toassess the future financial performance because of the paucity ofhistoric data and impossible to quantify the possible socialbenefits.

4.18 Organization and Training. PEs' organizational structures forfinancial functions do not reflect actual reporting lines. The heads of

- 44 -

finance are unaware of the best practice in this area; thus few structureshave been reviewed or amended in the past five years, and staff do not haveup-to-date job descriptions. Staff frequently perform an entirely differentfunction from those implied by their titles, which results in confusedreporting lines and responsibilities. For example, an internal auditor wasfound to be performing the function of a statistical officer. In part, thereluctance to change structures is due to the perceived difficu_ties in movingposts under the PSC regulations (para. 5.5). The number of staff employed inthe finance function varies from 6 to 64 and bears no relation to thedepartment's workload. This is, in part, due to the lack of well definedstructures or job descriptions which had lead to overstaffing in manyenterprises.

4.19 The relative lack of accounting standards and financial andaccounting traiaing have exacerbated the problems in the financial area.There is a tendency for the finance function to be restricted to bookkeepingrather than financial management. There are less than 70 charteredaccountants in Nepal, none of whom work for the 12 PEs studied. A few of thefinance staff have Bachelor of Commerce degrees, but this training is rathertheoretical and difficult to apply to practical situations. The syllabuscovered is adequate, but the emphasis is on theory rather than on practicalexamples and case studies.

4.20 Most staff performing accounting functions have been trained on thejob, often perpetrating poor accounting practices. In general, there islittle awareness of accounting best practice, i.e., accountants do not knowthe standard of most modern methods of accounting for transactions. Eachstaff member has a very narrow field of understanding of accounting because oflimited training and exposure. It is essential that formal accountancytraining is made more widely available within both the public and privatesectors.

E. Options for Reform

4.21 The weaknesses and gaps in internal management functions are clearlyinfluenced by some of the factors external to the PEs discussed in otherchapters. Thus PSC guidelines on PE employment have a direct bearing on thepersonnel and labor relations problems mentioned above. The policy environmentthat restricts competition induces PEs to neglect the marketing function andefficient production practices (e.g., quality control). The existinggovernment policies governing the oversight of PEs encourages the latter to beshort term oriented rather than to pay careful attention to performanceplanning and control. Constraints on the autonomy of PEs and politicalinterferences lead PE managers to divert their attention from their propermanagement functions. The interaction between external factors and internalmanagement thus results in an overall weakening of enterprises' accountabilityfor efficient performance.

4.22 The deficiencies in PE management discussed are pervasive in almostall the PEs surveyed and cover all the basic functions of enterprisewrnagement. In a few cases, some aspects of a specific function are beingdealt with adequately. However, when all other functions are weak, even those

- 45 -

PEs are characterized by a wide sprectrum of deficiencies, as interactionsamong deficient functions set in motion a downward spiral of poor performance.Thus, the remedy does not lie in improving any single aspect or function, butin upgrading the entire set of interrelated management functions.

4.23 The foregoing review also shows that weaknesses or gaps in terms ofmanagement systems and practices are only one part of the problem. The otherand equally important part of the problem lies in the inadequacies in thequality, experience, and incentives of the personnel managing and operatingthe PEs. This, as has already been pointed out, is due to a combination ofthe constraints in the policy environment and other factors external to thePEs, and the neglect of the training and development function within theenterprises. Thus, improving PE performance will require not only reform ofthe management systems and practices but also strengthening and upgrading ofthe quality and motivation of PE employees.

4.24 Reform of PE Boards. The board of directors of an enterprise isHMG's primary instrument for the management and control of PEs. Itscomposition, functions, and the quality and incentives of its memberstherefore assume special importance. As the sole shareholder of PEs, HMGwould no doubt want boards of directors to represent its interests.Nevertheless, board members who are responsible for PE performance also haveto look after PE interests and must represent their enterprises' viewpointswherever necessary before HMG. This applies in particular to governmentmembers on boards who, of necessity, must play a dual role.

4.25 Although HMG is the sole shareholder of PEs, it is in HMG's interestnot to have PE boards of directors consisting solely of government officials.HMG's representation on boards should be limited to one senior official fromthe sector ministry and one from any other ministry which has a direct stakein that enterprise. MOF representation is warranted only on the boards of thekey PEs. The rest of the board members should be drawn from outside ofGovernment, based on the relevance of their experience, their knowledge of theindustry or other such characteristics. HMG has already adopted this practicein some PEs such as RNAC. It is now a question of extending the same approachto other PEs. The board of directors should consist of seven to ten members,depending on the size and complexity of the PEs involved. A larger board maysatisfy a wide range of interest groups, but is not conducive to effectivepolicy making, team work, and good management control. What is important isthat the board has the benefit of relevant views and experiences before finaldecisions are taken on important policy issues.

4.26 HMG currently appoints PE board chairmen and General Managers. In afew PEs, the chairman and chief executive (General Manager) are one and thesame person. In other cases, the chairman is a part-time Government officialwhile the chief executive is a full time General Manager. In the latter case,it may be a good practice for HMG to appoint a part-time chairman and to havethe board appoint the General Manager. The General Manager is more likely tolook for guidance from the board which has appointed him under this condition,thus minimizing internal conflicts. If there is a legal barrier to theadoption of this practice, an alternative would be for HMG to make this

- 46 -

appoitntment solely on the basis of the board's recommendation or on the basis

of a panel proposed by it.

4.27 Since government representation on boards is essential, it is

important that senior HMG officials are appointed to them. This prtctice,

h-.eot, has several limitations. First, senior officials, especiallySr ;K.:EiQS, ' are very busy. They are not often able to give adequate time to

board work and meetings. Second, conflicts of interest can arise. Seniorofficials are deeply involved in sensitive political issues, and it may bedifficult for them to permit a board to make truly autonomous decisions. Itis for this reason that in some countries, nonofficials have been appointed.hairmen of PE boards. Alternatively, most boards should have full-timechairmen who are also chief executives. The counterargument is that there isa shortage of high level managerial manpower in Nepal who could perform thisdual role. An abrupt end to the current practice is perhaps unrealistic.Nevertheless, moving away from the practice of appointing senior HMG officialsas board chairmen is an option HMG should consider.

4.28 The responsibility of PE boards should be to set long term goals, todecide on key policy matters, and to monitor and guide enterprise performance.Detailed operational decisions should be delegated to the PE managers. Thecurrent practice of board decisions being reviewed again within the parentministries and MOF needs to be reformed. It is important to distinguishbetween two types of decisions. Some decisions such as investments,expansion, etc., that require additional funds from Government should bereviewed and approved by HMG. In other matters within the purview of theboard to decide, it is counterproductive for ministries to review boarddecisions again. In such cases, board members who represent the concernedministries should present the latters' views to the boards before they makeformal decisions. Such members should do preparatory work before boardmeetings so that final decisions are taken with the full knowledge of HMGviews. This change would greatly reduce the wastage of time and enhance PEautonomy. This approach would require that HMG board members have adequatestaff support in their respective agencies to help them prepare for boardmeetings, especially in respect of policy issues which are directly relevantto their constituencies.

4.29 Enterprise Level Reform. At the enterprise level, the thrust of thereform should be on strengthening the internal PE management includingstrengthening the management functions, systems, practices, and technical andmanagerial capabilities. This should be supplemented with modernization andrehabilitation of physical equipment and machinery in PEs where this is aprecondition for enhancing management effectiveness.

4.30 From a long-term perspective, improved PE management will depend ona better quality of employees than exists at the present time. There is aotonly overstaffing in many PEs, especially at lower levels, but also a lack ofskills and experience in critical managerial and technical positions. Evenunder the most favorable conditions, elimination of excess staff and upgradingthe quality of personnel are long term tasks. Any reform program shouldinitiate action on these fronts, but must recognize that drastic personnelchanges or improvements cannot be accomplished in the short run. The only

47 -

exception to this concerns enterprise chief executives and senior managementteams. These are key appointments, and the reform program should give specialattention to selections and the terms and conditions of their appointments.The practical tasks of improving management functions and practices cannot beaccomplished without competent and experienced senior managers being in chargein the PEs.

4.31 Appointment of Chief Executives and Senior Managers. Enterpriselevel reform should begin with a review of chief executives. In some cases,it may be appropriate to appoint competent civil servants to senior PEpositions. However, appointing retired civil servants to such positions,should not continue to be normal practice. PEs are commercial organizationsfor the most part, operating in a turbulent external environment. Theirleaders have not only to be adept at their business, but should also bewilling and able to assume risks and provide guidance and support to othersunder them to do the same. This requires a different style of leadership thanis prevalent in the civil service. When civil servants are likely to returnto their parent ministries after a short tour of duty in PEs, the problem iscompounded as they will not identify with or be committed to the long terminterests of the PEs. Furthermore, they are inclined to reinforce civilservice practices and conformity in PEs instead of encouraging the use ofautonomy. For all these reasons, chief executives should be selected on thebasis of their commercial and entrepreneurial orientations and experience andtheir capacity to provide leadership to the large groups of employees they arecalled upon to manage. The same criteria should apply to other seniormanagers, who should also be competent in their special areas of work. Ifqualified, internal candidates should be considered for senior managementpositions, but the search should by no means be limited to internalcandidates.

4.32 In general, the terms and conditions of the staff employed at lowerlevels in PEs tend to compare favorably with those in the private sector. Atthe senior levels, however, PEs will find it difficult to attract qualifiedpersons. Greater flexibility has to be shown in remuneration offered to chiefexecutives so that competent, experienced managers can be attracted andretained. Governments typically have to moderate the extent of variations inpay, but can use special supplements or create special categories of payscales to get over these inherent constraints.

4.33 The appointment of PE chief executives and senior management teamsshould receive priority precisely because they are critical to the improvementof internal management functions and practices. Some areas for improvementare indicated below, but with the full understanding that only competent,experienced managers will be able to plan and implement the relevantmanagement systems and practices.

4.34 Planning and Control. Strengthening internal planning and controlsystems should be a high priority for all PEs. A key role of the chiefexecutive is to initiate medium to long term corporate planning as well asshort term (e.g., annual) operational planning organically linked to theformer. Managers will need the support of their boards and HMC in this effortto shift the focus from short-term preoccupations to longer-term strategic

- 48 -

choices. Long-term or strategic plans should be prepared on an ongoing basis.Their preparation should involve a careful review of enterprise objectives,strengths and weaknesses, likely environmental changes (including potentialcompetition), and identification of future opportunities consistent with theresources that can be mobilized. The development of the resulting strategysh.ulJ preferably involve all levels of management in order to enable commonideas and plans to be shared on a broad basis within the PE. Operationalplans shouLd be derived from the strategic plans and be reinforced by internalcontrol systems to monitor progress and performance variances. Incentiv-s arerelevant in this context as they can provide inducement for close monitoringand control. No control system can operate without a good accounting andfinancial management system, and its development is a prerequisite foreffective management control.

4.35 Accounting and Finance. The use of professionally trainedaccountants and of consistent and internationally acceptable accountingpractices are essential for the creation of modern accounting systems in PEs.Nepal does not have a published standard for accounting and auditing practice,nor an accounting authority. Consequently, companies do not generally complywith international standards, and accounting policies vary. The adoption ofinternational accounting and auditing standards would improve thecomparability, consistency, and accuracy of the accounts presented. Aproposal for the formulation oL an accounting institute in Nepal is awaitingHMG approval. Such an institute would form a suitable vehicle for theimprovement of standards, regulation of accountants, and promotion of traininginitiatives. Intensive training and the use of consultants are the only waysto deal with the critical shortage of accounting skills. The improvementswhich have resulted from local consultancy advice are very encouraging. Forexample, JCF now has accounting and auditing manuals, RJM has caught up on itsaccounting backlog, and NFC produces monthly reconciliations. More PEs shouldbe given financial assistance or incentives to improve their internalaccounting systems so that their accounting statements can become morereliable and so that they can exercise better financial control. Each PEshould aim to (a) maintain and reconcile monthly, up-to-date double entryaccruals-based ledgers; (b) prepare monthly income statements; (c) maintain anaccounting system and procedures manual; (d) maintain accurate records ofassets, particularly capital assets and inventory; and (e) produce annualaccounts within three to four months of the close of the fiscal year. PEswhich are required to provide social services should have separate accountsfor commercial and non-commercial activities. The organization of the financefunction should be clear and embody basic segregation of duties. Staff shouldreceive training in the systems to be operated in addition to their formalaccounting training. PE's accounting policies should be clearly defined andfollow international accounting practices. The development of long-termfinancial plans and the use of annual and monthly budgets as a management toolmust follow the improvement of accounting practices. All these are buildingblocks for the design of good planning and control systems in PEs.

4.36 Marketing Management. Improvement of the marketing function is thethird area that deserves special attention in the reform package. Corporatestrategy can to some extent offer guidance on the market segments to be servedor developed. Investment in market research or at least in the collection and

- 49 -

analysis of market information is urgently required in many PES, especiallythose already facing competition. On the basis of such research and analysis,promotional strategies may have to be developed in some cases, and in others,changes in the product mix may be warranted. Marketing managers also need topay increased attention to pricing and distribution practices. In acompetitive setting, more rational pricing and efficient distributionarrangements are essential ingredients for improved performance. The skillsrequired to perform these functions do not always need to be created in-house,since consultants can be called upon to provide support for specialized areasof work such as market research and the design of promotional strategies.

4.37 The foregoing discussion highlights management functions andpractices which need strengthening in most PEs. There are other functions(e.g., inventory control, production scheduling) which also need improvement,but only in some PEs. The specifics of the internal reforms required inindividual PEs will therefore tend to vary. As noted earlier, a carefulreview of the internal management and operations of each PE should beundertaken after a qualified chief executive with a mandate to improve PEperformance is in position. Special task forces with strong internalparticipation could then be set up to manage the diagnostic process. Externalassistance and advice through donors and consultants can also be built intothis process. Since the elements and priorities of the resulting reformpackages will vary among enterprises, it is important that HMG should treatthis problem on a case by case basis.

V. EMPLOYMENT, COMPENSATION AND LABOR RELATIONS

A. Introduction and Suxmnary

5.1 Employment policies and practices are two of the major factors thataffect public enterprise performance in Nepal. Almost all enterprisessurveyed during the mission indicated employment and labor-related issues asimpediments to improving the efficiency and competitiveness of the enterprise.Therefore, a successful PE reform program cannot be achieved without address-ing some of the critical employment and labor problems that affect the entirePE sector. This chapter reviews the existing regulatory framework for PEemployment with emphasis on the policies most in need of reform. Issuesrelated to employment regulations are discussed in Section B, the salary andwage structure in Section C and labor relations in Section D. Section Ediscusses options for improvement in key areas. It should be noted that dataon employment, as in other areas, is fragmented and rather inadequate.However, the analysis attempts, to the extent possible, to overcome theseserious data constraints and relies largely on information extracted from thesample survey of twelve PEs.

5.2 The main conclusions are as follows. First: The rigidity and lackof flexibility of existing regulations governing PE employment policies haveadversely affected PEs' operational efficiency and effectiveness. Delays indecision making and the limited autonomy of managers with respect to staffingdecisions make it difficult for PEs to adjust their staffing to meet the needs

- 50 -

of a commercial organization. Existing procedures also restrict PEs' abilityto hire qualified and experienced professionals in senior positions and tomotivate staff by rewarding good performers and firing or discipl'ning poorperformers. Overstaffing, particularly at lower clerical and administrativelevels, is common in most PEs. Second, while low renumeration is a universalproblem which affects all sectors, for the PE sector additional problems stemfrom (a) efforts to link PE wages and benefits to civil service salary scales;(b) PEs' lack of flexibility to adjust compensation packages to attract andretain skilled staff; and (c) inadequate wage differential between highlyskilled and unskilled staff. These factors all serve to demotivate PE staffand to limit the PEs' ability to attract and retain qualified staff. Third,existing labor legislation is outmoded, inadequaLe, and provides little basisfor coping with emerging industrial problems. Conflicts between the acts andassociated regulations make interpretation of the rules and their applicationto industrial disputes difficult. Neither management nor labor feels thatcurrent legislation adequately meets their needs. Finally, industrial andvocational training in Nepal is inadequate. Existing training institutionsprovide an insufficient number of technical staff to meet industrial needs.At the same time, there is duplication of effort, inconsistencies in the levelof training, and lack of coordination between training programs and enterpriseneeds. Most enterprises lack a well-developed training program, relyinginstead on on-the-job training, which is less valuable when the overall levelof expertise is low and when systems and procedures inadequate or nonexistent.

5.3 Key recommendations for reform include changing the role of thePublic Service Commission (PSC) to one of providing broad guidelines onemployment principles, combined with some performance monitoring, rather thanone involving detailed interference and strict control and approval of eachstep in the employment process. Existing rules and regulations need to berevised to increase flexibility and to allow more discretion to managers.Bureaucratic approval procedures applicable to various aspects of PEemployment need to be reduced and streamlined. Within broad guidelines, PEmanagers should be given more autonomy to set their salary and wage structureaccording to their priorities, employees' qualifications and productivity,market conditions, and the firm's financial performance. In enterprises withhigh levels of overstaffing, an appropriate strategy would be to take steps torestrict future staff growth combined with measures to progressively reduceexisting redundancies. Thus, a freeze on hiring of unskilled nontechnicaladministrative and clerical staff could be put into effect. For existingredundancies, development of incentive schemes for early retirement orvoluntary departures and enhancement of end of service benefits should beconsidered. Finally, existing labor legislation should be reviewed, andenterprises should place more emphasis on training and staff development.Training programs should form part of corporate and business plans. On-sitetraining programs run by external training agencies and on-the-job training aspart of external technical assistance should be encouraged.

B. Employment Regulations

5.4 The rules and regulations governing all aspects of PE employment aredetermined centrally by the Public Service Commission (PSC), which is alsoresponsible for the regulatory framework for civil service employees. The

- 51 -

rigidity and lack of flexibility of this centrally determined regulatoryframework is considered by many PE managers to be a factor contributing to thePEs' poor performance. All major decisions on hiring, firing, salarystructure, promotions, and disciplinary actions in PEs have to be carried out,not only in accordance with the PSC's detailed guidelines, but also with PSC'sprior approval. Thus, PE managers have little autonomy with respect tostaffing decisions, even though these decisions have a direct impact on theiroperational efficiency and effectiveness. The result is that PE managers areunable to adjust their staffing requirements to their needs and to the marketenvironment.

5.5 The PSC was established in 1951 as part of the Nepal InterimConstitution. In 1959. it was constitutionalized and became an indepLndentbody of the constitution reporting directly to the king. It has a chairmanand four commission members. The Commission has five regional offices andabout 400 staff. Its general mandate is to develop and ensure implementationof the general principles of public service, which includes civil serviceemployment, as well as those of the corporate bodies. In essence it is -- orshould be -- a regulatory and advisory body on general principles of publicemployment. However, in practice its role has become one of detailed controlof employment matters that should be the prerogative of PE managers. PSC'sguidelines provide not only general rules on employment principles but alsoset out detailed rules and procedures that have to be followed on all mattersrelated to conditions of service such as recruitment, transfers, promotions,disciplinary actions, training, rewards, and punishments. PSC also supervisesand inspects PEs to ensure that employment conditions comply with PSC'sregulatory framework. Following are some of the specific aspects of PEemployment regulations most in need of reform.

5.6 Recruitment. Prior to 1966, the PEs recruited and selectedemployees without interference from the PSC. With the first amendment of theConstitution of Nepal in 1967, PSC was assigned the task of recruiting andselecting PE employees. However, realizing the difficulties faced by both PEsand PSC in this arrangement, the second constitutional amendment (1975)restricted PSC's role to advice and supervision. According to the existingregulatory framework, each enterprise has a Padpurti Samiti (recruitmentcommittee) responsible for selection and recruitment of new staff. PSC hasissued uniform guidelines to be followed by all these committees. Whilenominally the PEs have considerable discretion in recruitment of theirpersonnel, in practice PSC has to approve the creation of every post and therecruitment of all staff above level six. This includes approval of jobdescriptions, job specifications, qualifications, and selection process, etc.The level and structure of PE employment is parallel to the civil service anduniform across all PEs. It consists of 12 levels of which levels 1 to 5 areunskilled and lower level administrative/clerical staff, and levels six andabove are officers and professionalltechnical staff with at minimum auniversity degree.

5.7 The problem with the present recruitment practice is that obtainingstep by step approval from PSC is a lengthy and highly hierarchical processwhich takes several months; as much as a year is not unusual. Furthermore,PSC, as the ultimate approving authority, can hold recruitment requests for an

- 52 -

even longer period or question the nature of the job or candidate. Not onlyrecruitment requires PSC's approval; creation of any new position above levelsix also has to be approved by PSC. This regulation particularly constrainsPEs in the hiring of technical professionals who are in high demand and oftenlost to the private sector in this lengthy process. The creation of a newtechnical post can take as long as six months due to procedural delays by PSC.Since PSC does not have the capacity and required technical skills to approvequalifications and specifications for technical and professional positions,its input in the process is an added bureaucratic step that causes recruitmentdelays, without compensating benefit. At the same time, on the basis of PSCregulations, no one can be hired above level 7 regardless of his/herqualification and expertise. This is yet another constraint to PEs hiringhighly qualified and experienced professionals which puts them at a disadvan-tage relative to the private sector.

5.8 Promotion and Incentives. Promotions are also highly restricted byPSC's regulatory framework. PE managers are unable to promote staff unlessthey have been at their current level for a minimum of four years, and eventhen PSC has to approve it. This is a serious disincentive to employees,since they know that regardless of their productivity they cannot be promoteduntil they have been on the job the necessary number of years. Other perfor-mance-based incentive systems are also lacking, and PE managers have virtuallyno mechanism to motivate employees. The Bonus Act of 1947, (para. 5.24) whichwas amended in 1989, has provisions for distribution of bonuses to the workersand employees if a PE makes a profit. This bonus system has proved ineffec-tive for two reasons. First, it does not apply to many PEs since few areprofitable. Second, in the case of the few profitable PEs, the bonus haslittle motivational impact since it applies universally to all employees andworkers and does not relate to individual performance and productivity nordifferentiate between good and poor performers. The absence of performanceincentives results in low productivity, lack of initiative, frequent absentee-ism, and an overall demoralized work force. The problem is compounded byextremely restrictive and rigid rules for firing or disciplining poor per-formers. Firing is virtually not an option. Other disciplinary actions thathave been exercised occasionally all relate to non-performance issues and haveto be approved step by step by PSC.

5.9 Redeployment. The strict policy of job security for PE employeeshas resulted in increased growth in PE employment and redundancies andoverstaffing in several PEs. In the companies surveyed by the mission,estimates of overstaffing range anywhere from 20 to 50 percent. In the DairyDevelopment Corporation management estimates overstaffing at between 30 to 40percent. The Hetauda Cement Industry Limited is estimated to be more than 40percent overstaffed. Table 5.1 shows the increase in the number of employeesover a four year period for the twelve enterprises included in the samplesurvey. For some of the enterprises, the annual increase exceeds 10Z. Forexample, in Royal Drugs Limited, staff size grew by 46 percent in four years.Excluding RJM (the jute mill), on average the total employment of the samplePEs grew 12Z over the four year period. In general, there is littlecorrelation between the increase in employees and the enterprise's production,sales and capacity utilization. In fact, in some PEs there has been asignificant decline in production without a major change in employment.

- 53 -

Table 5.1: INCREASE IN EMPLOYMENT OF SAMPLE PEs

Total Number of Staff Growth Rate (Z)Name of Enterprise 1984/85 1988/89 Per annum Total

ATF 364 425 4.2 16.7BBF 461 472 - 2.4BLSF 519 549 1.4 5.7DDC 996 1,099 2.6 10.3HCC 757 838 2.7 10.7HCIL 815 993 5.5 21.8HTI 1,272 1,263 - -0.7JCF 2,179 2,727 6.8 25.1RDL 217 318 11.6 46.5RJM 2,292 1,559 -8.0 -32.0AIC 934 1,022 2.4 9.4NFC 1,198 1,161 -0.7 -3.1

Source: Mission data.

5.10 In Raghupati Jute Ltd. for example, redundancies were so severe as aresult of the decline in sales and production that management, with theapproval of PSC, laid off about 770 employees and reduced the size of itsworkforce from 2,292 to about 1,560 over four years. This cost a total of NRs10 million for gratuity and severance pay. However, according to the manage-ment, the mill is still overstaffed by about 500 persons; socio-politicalfactors as well as shortage of funds for severance pay, mean that the companyis unable to layoff additional employees.

5.11 Most of the excess staffing is in the lower administrative/clericallevels, while at higher technical/professional levels many enterprises areunderstaffed. For example, in the case of the Dairy Development Corporation,of a total of 1,099 employees only 63 are professional and technical andstaff. Table 5.2 illustrates staff distribution in the enterprises surveyed.Overstaffing at lower levels occurs partly because the regulatory frameworkmakes it easier to hire at those levels, since PSC's prior approval is notrequired, and partly because of political pressure.

5.12 Social and political pressure on the Government to create jobs is amajor cause of PE overemployment. With a scarcity of alternative employmentopportunities, public enterprises are often encouraged to maintain large workforces, even if they are financially weak. Few enterprises have been able toresist the political pressure to create jobs. Among the sample PEs, anexception is Hetauda Textile which has had a slight contraction in staff overthe past four years. Employment generation is considered one of the primarysocial objectives of public enterprises and therefore maintaining excessemployment is considered a positive step in achieving this objective. More

- 54 -

importantly, as discussed in Chapter 3, PE managers have very little incentiveto improve labor productivity and their enterprise's overall performance.Another reason for overemployment is that, under existing policies,termination of employment in PEs is even more difficult than in the civilservice. For example, civil service employees have the option of earlyretirement after 20 years of service, which can facilitate staff reduction inthe event of redundancies. Although some PEs are considering adopting similarmeasures, PE employees do not yet have this option.

Table 6.2: PE STAFF DISTRIBUTION (1986/89)

Staff Cstegorles

Nae of Manageril/ Skilled UnklledEnterprise Adminis. Technical Clerical Operatives Operatives Total

ATF 32 82 266 24 31 4268F 9 96 33 240 96 472BLSF 28 39 85 238 161 649SDC 46 s8 397 699 -- 1,099HCC 46 209 260 163 206 863HCIL 106 149 292 317 130 993:ITI 38 103 148 816 181 1,263JCF 666 NA 1,026 628 419 2,727RDL 13 32 NA 189 80 314RJM 22 NA 148 1,043 348 1,659AIC 140 NA 882 -- -- 1,022NFC 164 NA 997 -- -- 1,181

Total 1,294 787 4,511 4,244 1,631 12,447

X 10.4% 6.2% 38.2% 34.1X 13.1%

Soure-: Mission data.

5.13 The problem with excess staffing is not only in the direct costreflected in the wage bill,25/ but, more importantly, the longer term costof keeping nonviable and loss-making enterprises open for employment purposes.Managing a large workforce and excess staff is administratively andfinancially costly, particularly with the provision of numerous social andwelfare facilities, various allowances, bonuses, etc., which is the norm inthe PE sector. Furthermore, the presence of a large number of redundantemployees has a demoralizing and demotivating effect on the work environment.The managing director of one PE, in reference to this problem, indicated thathe has quietly asked some of the redundant staff not to show up at workbecause of the demoralizing effect they have on the other employees, as wellas the cost of their use of electricity, office space, etc. Finally,

25/ Wages and salaries as percentage of operating costs averaged 18% in 87/88for the 10 MPEs surveyed; Raghupati Jute (37Z) and Bhaktapur Brick (38Z)were the most labor intensive.

- 55 -

overstaffing in many of the enterprises has created an environment stronglyresistant to the introduction of new technology su-h as computerization,restructuring programs, divestiture options, or other efficiency measures,which may result in reduction of employment.

C. Salary and Wage Structure

5.14 In general, the salary and wage structure is very low nationwide forall sectors -- public enterprises, civil service, as well as the privatesector. Therefore, this a universal problem that does not pertain only to thePEs. The problem with the basic salary scale is so acutc what it has been thetarget of one of the very first measures that the interim government has takenfollowing the recent political movements; a four-member commission oiasconstituted, headed by the Executive Director of the Nepal AdministrativeStaff College, to recommend changes in the salary and benefit structures ofpublic corporations.

5.15 PE salaries are determined centrally on the basis of a 12 level jobstructure. Initially, PE salaries were significantly higher than civilservice salaries, and therefore it was more attractive to join PEs than thecivil service. However, over the last few years there has been a freeze on PEsalaries, while civil service salaries have increased. As a result, thepresent salary structures of both are similar. A comparative survey of thesalary structure of selected public and private enterprises also indicatedthat there is no significant wage differential for similar occupations betweenthe private and public enterprises, except for the minimum wage. Annex V.1and V.2 give comparative salaries of public enterprises, civil service, andthe private sector. The official minimum wage is determined and reviewedperiodically by the Labor Ministry's Committee on Minimum Wage. Currently,the minimum wage is 640 NRs per month for unskilled workers and 800 NRs forskilled workers. However, this is so unrealistically low that the privatesector always pays considerably above that.

5.16 Fringe Benefits. To compensate for the very low salary structure,PEs provide a range of quite generous fringe benefits. These fringe benefitsare uniform in all PEs and apply equally to all levels of employees. Thefringe benefits may differ from one enterprise to another depending on thenature of operations, but in general they include:

- housing allowance 15Z of salary- provident fund gratuity 1O0 of salary- dasai bonus one month extra salary- medical allowance one month salary per year- tea allowance NRs 4 per daytransportation allowance NRs 4 per day- clothing for operators- dearness allowance 25 to 45 Z of basic salary

5.17 Following strikes at various enterprises, several PEs have enhancedthe fringe benefits package. For example, Nepal Rastra Bank (NRB) and NepalTelecom Corporation (NTC) increased staff allowances and, in some cases,

- 56 -

introduced new ones (see below). Other enterprises can be expected to followthis lead and increase their fringe benefits.

NRB Previous Revised

Education Allowance for Children NRs 40 per month NRs 150 per monthTiffin Allowance /a NRs 5 per day NRs 8 per dayTransportation Allowance NRs 125 per month NRs 250 per month

NTC

Education Allowance for Children NRs 100 per child(maximum 2) per month

Tiffin Allowance NRs 300 per month

Transportation Allowance NRs 200 per month

/a Tea allowance.

5.18 Major Issues. The main problem with the existing salary structureis its rigidity. PE salaries are centrally controlled and standardized, anduniform across all PEs with complete disregard for the firm's performance andability to pay. For example, better performing PEs. such as JanakpurCigarette, pay the same salaries to their managers and officers as those thatmake losses. The lack of PE autonomy and the disregard for enterprise per-formance, supply and demand etc., in determining salary and compensationpackages is a critical problem which results in low productivity anddemotivates employees.

5.19 Furthermore, unification of the PE salary structure with the civilservice is another problem which has brought the PEs (which should in mostcases be commercially oriented), closer to the civil service salary structurerather than to that of competitive corporate bodies. High job security, alongwith automatic and fixed salary increments based on seniority rather than onperformance and merit provides little incentive for PE managers and employeesto improve their job performance.

5.20 The combination of a standardized and uniform salary structure andthe strict regulatory framework for hiring. fiting, and promotions leaves PEmanagers with little power over their workforces. They can neither paysalaries to their employees which are commensurate with their performance norcan they hire qualified personnel except within rigid guidelines. Laying offredundant staff is literally impossible. The result, as described earlier, isan employee environment characterized by frequent absenteeism, undiscipline,and idle employees.

- 57 -

5.21 Wage and Salary Differentials. Inter-industry wage differentialsand regional wage differentials are very narrow. Thus, essentially there is auniform structure within the industry overall with respect to similar occupa-tions and skills stemming from the centrally controlled system. One positiveaspect of this narrow inter-industry differential is that enterprises do notlose employees to each other, and therefore this type of turnover is very low.

5.22 However, there are two major problems with respect to wage differen-tial in Nepal. One is that the wage differential between Nepal and itsneighboring countries is very wide. Some of the skilled workers andtechnicians move to neighboring countries, particularly Bhutan and Bangladesh,where they can get more money for the same kind of work. For example, themanaging director of Dairy Development Corporation indicated that he lostseveral of his trained technicians to neighboring countries.

5.23 The second problem is that inter-enterprise wage differentialsbetween various occupations are very narrow. Essentially, the inter-enterprise wage differentials are based on seniority and years of service anddo not take into consideration skill requirements and job qualifications. Forexample, the wage differential between skilled, semi-skilled and unskilledworkers is less thar. 100 NRs, and the differential between officer and non-officer levels is also very narrow (see Annex V.2). The problem is even moreserious since fringe benefits, often a greater part of the compensationpackage than direct pay, are almost the same for all employees from unskilledto managerial level. When the differentials in earnings between skilled andunskilled staff and technical and non-technical staff become so low, theycreate an environment of unfairness and dissatisfaction. Such lowdifferentials also erode the incentive for acquiring skills. If there islittle difference in the earnings of technical and non-technical staff,incentives for acquiring skills will have little effect.

D. Labor Relations

5.24 Existing Legislation. Nepal's labor legislation has a nearly 30-year history during which two laws of fundamental importance have beenenacted. These are: (i) the Nepal Factory and Factory Workers' Act, 1959 and(ii) the Bonus Act, 1974. There are a few other laws that have some applica-tions in labor management such as (i) the Industrial Apprentice Act, 1980,(ii) the Class Organization Act, 1979, and (iii) the Maintenance of EssentialServices Act, 1957. The Factory Act of 1959 contains substantive and proce-dural provisions on such diverse subjects as employment, wages, safety,welfare, industrial disputes, protection of women and child labor, hours ofwork, workmen's compensation, etc. The Act leaves the treatment of details tothe Factory Rules, 1963. The Bonus Act was passed in 1974. Its subsidiaryrules were enforced in 1978. The Act provides for the distribution of bonuses(10 percent of net profit) to the workers in the event of profits. However,no employee is to be paid a borus of more than 25 percent of his annual salaryin a fiscal year. The remaining amount, if any, is to be credited to theWelfare Fund.

5.25 The capacity of the labor relations system to develop and achieveits objectives is considerably influenced by this legal framework. The scope

- 58 -

and effectiveness of Nepal's labor legislation is very limited for thefollowing reasons:

(a) A large section of the industrial workforce is still outside thegamut of present labor legislation. Only less than 10 percent ofthe workforce comes within its preview; and

(b) There is considerable slackness in the enforcement of these Acts,even in those establishments where they are applicable.

5.26 The Factory Act is inadequate to cater to present needs. A numberof the Act's provisions are outmoded, especially those relating to employmentand conditions of work. The clauses relating to provisions for disputesettlement, wage fixation, and grievance handling are incomprehensive andinadequate. Labor conditions have evolved beyond these provisions andrendered them out-of-date. Considering the vast changes in the socio-economicand political conditions in Nepal during the last three decades, the adequacyof its provisions to meet current and emerging needs is questionable;conditions it sought to address no longer are the same.

5.27 In particular, the Factory Act appears inadequate to cope withemerging labor problems in the organized sector of the industry. Labor-management disputes have grown so frequent that it is cumbersome to resort tothe mechanisms provided by the Act. In some instances, there are conflictsbetween the Act and the Factory Rules of 1963, making interpretation of therules and their application to resolving industrial disputes difficult.Vagueness in the Factory Act and the delays involved in getting properclarification from the Labor Department further complicate and prolongsettlement of labor disputes, resulting in strikes, closures, and productionlosses. Although the intent of the law is to emphasize negotiations betweenparties and to permit legal proceedings only when this fails, it is the legalinvolvement which has emerged in recent years as the more dominant feature oflabor relations practice in the country. This has led to the criticism thatlegislation has inadvertently encouraged a litigatory approach in the laborrelations system.

5.28 Workers generally believe that the Labor Department is rather slowin implementing labor laws. Management tends to feel that its effectivenessin handling personnel problems has been significantly restricted by the legalframework within which it has to operate. Labor leaders seem to take the viewthat labor laws, while providing certain safeguards against unfair employerpractices, hamper the growth of strong labor organizations and do not encour-age the development of free interaction between parties through collectivebargaining. The Factory Act has secured certain minimum facilities for theworkers, but has also created an impression with employers that the minimum isalso the maximum in so far as these service conditions are concerned.

5.29 Labor Policy. Nepal has yet to develop a comprehensive and wellintegrated labor policy. Prevailing government labor policies are scatteredand fragmented and have to be found in various government decrees, pronounce-ments, ad hoc notifications, and a few pieces of legislation. The Sixth(1980-85) and the Seventh (1985-90) Plans both emphasized the importance of

- 59 -

the development and utilization of the labor force to optimize Nepal's socio-economic development. Some of the labor related objectives and strategies inthese plans are:

(a) ensuring optimum utilization of the labor force and taking measuresto enable the maximum number of people to contribute to thedevelopment process;

(b) strengthening and developing labor policy and administration;

(c) maintaining updated labor statistics;

(d) enhancing labor legislation to improve the relationship betweenlabor and management;

(e) improving industrial and vocational training;

(f) balancing demand and supply of labor; and

(g) making obligatory the use of indigenous labor obligatory for allindustrial enterprises and projects to the extent it is available.

5.30 Unfortunately, the above objectives/plans have not yet beenachieved. In fact, all twelve enterprises surveyed during the mission citedlabor-related issues among their major problems. Labor productivity is low,not only in comparison to international standards, but in comparison tosimilar neighboring countries. Annex V.4 shows a comparison of output peremployee in selected public enterprises and private firms. Laboradministration is poor and is becoming increasingly less effective. This ispartly because of the excessively bureaucratic regulations with respect tolabor employment which require prior approval by the Labor Department in manyaspects of labor-management relations, including disciplinary actions, trans-fers, provision of certain benefits, complaints etc., and partly because ofthe lack of clarity and inadequacy of the labor policies. Labor statisticsare virtually non-existent. Information on labor issues is available infragmented form from various documents and studies that have been carried out;however, they are neither updated nor consolidated to provide a reliablesource.

5.31 Training. Industrial and vocational training is inadequate. A 1988UNIDO study of 65 Nepalese establishments focusing on ma. er planning andhuman resource development for the industrial sector concluded there was acritical need for training and human resource development. This was found toba true particularly for mechanical skills at all levels: craftsmen,technicians, engineers, and electricians as well as electrical and chemicalengineers. Most of the companies reviewed during the mission did not have awell developed employee training program. Essentially, training is providedon an ad hoc basis depending on the availability of funds or grants frominternational donors. Often enterprises are unable to retain their fewtrained staff due to rigidities in the salary and incentive structure. Asindicated earlier, many trained technicians and engineers leave PEs, andsometimes even leave the country, for better pay.

- 60 -

5.32 Presently, there are three main sources of training and manpower

supply. These are: (a) Tribhuvan University; (b) the Directorate of Voca-

tional Training; and (c) sectorial training establishments. The important

agencies for sectorial training are: (i) Labor Supply Centers and VocationalTraining Centers of the Department of Labor; (ii) Cottage Industry Development

Board; and (iii) Small Business Promotion Project. These sectorial training

agencies try to provide training in the various skills needed by theindustrial sector. However, both the subject areas covered and the quantityof workers trained are inadequate to meet industrial needs. Other problems

include duplication of effort, inconsistencies in the level of training, and

lack of coordination between the training programs and enterprise needs.

5.33 Supply and Demand for Labor. There is no balance between labor

supply and demand. Redundancies of certain occupational groups and shortages

of others are indicative of this imbalance. The 1988 UNIDO survey also showed

serious imbalances between supply and demand for skilled and professionalmanpower. On the basis of this survey (Annex V.5) the most urgent need is for

basic mechanical skills, technicians, and engineers. It is only in theadministrative area that there is an ample number of trained people. The

survey also found that those enterprises that relied on non-Nepali labor had

fewer vacancies. In contrast, enterprises who were restricted in the employ-

ment of non-nationals had a high level of vacancies.

E. Options for Reform

5.34 The rigidity and lack of flexibility of the current regulations

governing PE employment and compensation policies clearly contribute to the

PEs' operational inefficiencies and low productivity. PSC needs to change its

focus. Its role should essentially be one of providing guidelines on employ-

ment principles and practices combined with some performance monitoring ratherthan detailed interference and strict control and approval of every step in

the employment process. HMG's employment policies should emphasize measures

to increase the productive use of human resources in both the public and

private sector. Employment generation needs to be placed in the context of

the Govsrnment's overall economic development strategy. Current PE problems

partially stem from the emphasis on employment generation as a primary

objective. In fact, employment growth should result from expansion of produc-

tive activity, and thus Government policies should be directed at (a) provid-

ing incentives and improving the environment for labor-intensive private

sector investments and (b) building human resource capability in order to

increase employment opportunities. Overstaffing in PEs, by limiting their

productivity and efficiency, reduces the resources available for expansion of

capacity and employment opportunities. While any actions which result in

significant decreases in staff may be politically unacceptable, the Govern-

ment's long-term strategy for PEs should reflect an emphasis on productive use

of human resources rather than employment growth per se.

5.35 The key employment issues to be tackled in any PE reform program arediscussed below. They include PSC's regulatory framework, PE overstaffing,salary and wage policies, and the skills deficiencies of the labor force.

- 61 -

5.36 PSC Regulations. The need to update and reform PSC's regulatoryframework has already been recognized by PSC officials, who indicated plans toFold a seminar to discuss areas most in need of reform. Such a seminar orworkshop is highly recommended. However, it is important that PE managementand employee representatives also participate in this seminar so that theconstraints and frustrations they experience are realistically reflected. Therevision of PSC's regulatory framework should aim to increase flexibility andallow more discretion to PE managers to make staffing decisions in response tomarket conditions. At the same time, the highly bureaucratic approvalprocedures applicable to various aspects of PE employment should, to theextent possible, be reduced and streamlined. Within broad guidelines, PEs'autonomy in making their staffing decisions should be substantially increased.At the same time they should be held accountable for results with respect toimproved efficiency, cost savings, and higher labor productivity. It must benoted that historically the experience with increased PE autonomy in staffingdecisions such as hiring, promotions, and disciplinary actions has been ratherdisappointing. According to PSC, such freedom had allowed prevalence offavoritism and undue discriminations. However, this has occurred partly as aresult of the lack of effective performance monitoring and evaluation systemsat the macro level and within enterprises. Therefore, it is important thatincreased autonomy is accompanied by development of an effective performancemonitoring and evaluation system so that the PEs can be held accountable fortheir decisions (para. 3.22(d)). Where social and political objectivesrequire PEs to maintain excess staff, the trade-offs and costs of suchobjectives should be transparent.

5.37 Introducing Performance Based Incentives. Currently, neitherpromotions nor bonuses are linked to performance. Therefore, an effectiveperformance-based incentive system needs to be developed and implemented attwo levels: i) at the governmental level, for provision of rewards to PEmanagers and bonuses to PEs whose performance has been good, as discussed inChapter 3; and ii) at the firm level, for departments, divisions, andindividual employees with high productivity. Development of internal perfor-mance incentive schemes should be the responsibility of PE managers.

5.38 Resolving Redundancy Problems. The best way to deal with overstaff-ing is to prevent it, since after it occurs, the situation it often becomes avery complex problem with its own high social-political cost, making itdifficult to resolve. However, since in Nepal the problem already exists, therecommended approach would be to combine measures to prevent furtheroverstaffing with efforts to progressively resolve the problem of existingredundancies. As a preventive measure, it is advisable to put in effect ahiring freeze for all PEs. The freeze should be limited to hiring ofunskilled, non-technical, administrative, and clerical staff, and should,exclude technical/professional staff who are in high demand and where PEs areshortstaffed. Although the impact of a freeze policy would not be immediatelynoticeable, over the long term by preventing further growth it wouldeffectively lead to gradual reduction of the workforce through naturalattrition.

5.39 For the existing redundancies, particularly in extreme cases, thefollowing measures are recommended:

- 62 -

a llk,-ment of incentive schemes for early retirement or voluntary-- artures. Such schemes are best developed on an enterprise-by-;,tezprise basis, depending on the extent of redundancies and thek-:,terprises' ability to pay. Government support and approval ofth-se schemes will obviously be required. In some cases, budgetary.!llocations or mobilization of external resources may be needed to-le¶lment the program. The Nepal Industrial Development Corporation

is iti the process of planning such schemes, including early retire-i:ent after 20 years (similar to the civil service plan) and goldenl:and shakes, which are expected to help reduce the number of redun-dtrlc ies.

(b) development and expansion of training and retraining programs to.,rovide necessary skills to redundant employees so they can bere(leployed in new jobs or transferred to other enterprises that are,U oped of those skills;

(c) development of programs for job creation. Private sector develop-ment and development of incentives for expanding private sectoractivities, particularly in medium- and small-scale industries, areamong the measures that would result in employment generation. The;overnment's employment generation policy should not focus only onthe public sector as a source of employment; the private sectorcoluld also be an important source of employment generation; and

(d) enhlancement of end-of-service benefits to facilitate lay offs of theexisting redundancies. This could include provision of seed moneyfor the laid off employees to enable them to start small businessesor to begin farming, etc.

5.40 Salary and Wages. Recent government review of PE salary and fringebenefits reflects awareness of the problems with the existing salary struc-ture. However, while an across-theboard, uniform increase in basic salaryand fringe benefits may alleviate some of the immediate problems of employees,if the underlying problems discussed above are not addressed, there will soonbe renewed pressures for salary adjustments. Reform of the salary and wagestructure must tackle the fundamental issues of increased autonomy for PEs,the incentive structure, and appropriate differentiation between jobs requir-ing high and low technical skills. Reform measures in some areas areimmediately achievable, while others will take more time. The objectiveshould be to have a comprehensive and well-integrated program that would beimplemented progressively or in phases.

5.41 The following are some broad reform options to be considered:

(a) The first and most fundamental reform measure is, as stated earlier,to provide increased autonomy to PE managers to make decisions thathave direct impact on their enterprises' productivity and efficien-cy. This includes, within broad guidelines, the flexibility to settheir salary and wage structure according to their priorities, tothe qualifications and productivity of employees, to marketconditions, to the firm's financial performance, etc. This

- 63 -

flexibility is crucial for PEs in competitive sectors. In the caseof PEs in monopoly sectors, establishing efficiency targets as partof Government's performance monitoring will moderate excessivesalary increases. The present lack of autonomy of PE managers withrespect to employment and salary decisions stems in part from theabsence of effective performance monitoring. Thus, governmentofficials feel that they can exercise control over the firms only bystandardizing employment conditions. However, in the process,accountability becomes so diffused that no one can be heldresponsible for poor PE performance.

(b) Second, attempts at unification of PE salaries with the civilservice further demotivate staff and should be stopped. Withinbroad guidelines, enterprise salary structures and incrementalsalary increases, as well as incentive schemes, should be decidedand approved by the PE boards and management.

(c) With respect to wage differentials, measures need to be taken todifferentiate between jobs requiring different qualifications andskill levels. Appropriate skill-based differentials will not onlyhelp PEs attract and retain skilled staff, but will also provide anincentive for workers to acquire additional skills.

(d) And finally, the whole structure of fringe benefits should berationalized. One option to be considered is delinking some of thebasic social and welfare benefits from PE employment. These couldthen become part of the overall social services provided for allgovernment employees. This would facilitate adjustments of PEworkforces. Currently, the PEs' role in providing basic social andwelfare benefits is a serious impediment to layoffs since retrenchedstaff lose access to basic health, housing, education benefits, etc.Consolidation and administration of these services elsewhere withinGovernment would reduce the administrative cost and resource re-quirement of these programs and allow the PEs to better focus ontheir primary operational objectives.

5.42 Training. Economic activity in Nepal is currently in transition.In manufacturing, new subsectors are being established and others are rapidlyexpanding. New technology is being introduced, and the product range ofmanufacturing goods is growing. Similarly, village and cottage industry isbeing encouraged to grow and increase their skills. In the light of thesedevelopments, the future demand for new skills and additional manpower willinvariably grow. Human resource development in Nepal, particularly technicaltraining, in Nepal will be a major undertaking. For PEs, development oftraining programs should become an integral part of corporate and businessplans. Better coordination needs to be developed between training andvocational agencies and the enterprises. Some enterprise specific trainingcould be provided on-site by external training agencies at the request of theenterprises. While the importance of on-the-job training should not beunderestimated, it is less valuable if the overall level of PE expertise is

- 64

low and systems and procedures are inadequate or nonexistent. Provision oftechnical assistance services in many enterprises can provide a vaiuableopportunity for effective on-the-job training that should be maximized byenterprise managers. In addition to enterprise specific training programs,HMv, in collaboration with professional associations, universities, andvocational training institutes, needs to develop training in areas common toall PEs, such as basic accounting, data processing, marketing and productionand inventory management.

VI. PRIVATIZATION AND DIVESTITURE

A. Introduction

6.1 Given the scarce managerial and financial resources in the publicsector, the success of a PE reform program will depend on reducing the numberof enterprises the public sector will continue to own and manage. The smallerthe number, the more manageable will be the task of planning and implementingreforms. Thus, privatization and divestiture, i.e. transfer of managementand/or ownership to the private sector and closure or liquidation of nonviablePEs, are important elements of any PE reform strategy. This chapter assessesexisting constraints to successful privatization in Nepal and outlines keyelements of a strategy for privatization and divestiture.

6.2 Over the years, governments in Nepal have endorsed privatization asone of the instruments for public enterprise reform. In reality, however,these efforts have been marked by hesitation and unwillingness to adopt mea-sures that would result in significant changes in managerial control. Isolat-ed attempts at divestiture dating back to the 1970s, for example, haveinvolved offers to transfer only partial ownership to the private sector, andsale offers restricted the amount of shares that an individual could acquire.The hesitation to proceed with privatization is attributed, in part, to sensi-tivity to political and social concerns, such as adequate participation ofnationals in the bid process and resistance from PE employees to divestiture.While Government's intention to privatize is referred to informally or impli-citly in various documents, there has been no formal/official statement thatclearly defines the Government's privatization policy objectives and strategy.Overall, there has been no significant effort to create an enablingenvironment for privatization, which would include addressing some of thefundamental issues that might affect successful implementation.

6.3 Given this background, it is not surprising that prior Governmentefforts to privatize have failed. For example, when Government attempted toprivatize Himal Cement in 1986, neither the enterprise nor the overallenvironment was ready. No financial statements were published, and investorswere given only seven days to submit proposals. The overall process was nottransparent and there was sensitivity amongst decision makers with respect toownership concentration and the ethnic origin of the prospective buyer. Hadthese issue. been adequately dealt with in advance this PE could now beoperating in the private sector. Instead, after negotiations with theprospective investor were concluded, the Government, faced with serious

- 65 -

resistance from both enterprise management and employees, including employeedemonstrations in front of the Prime Minister's office, was forced to breakoff the transaction.

6.4 Recognizing these problems, the Government more recently has takensteps to advance its plans for privatization. A small privatization committeewas established in late 1989 under the auspices of the Ministry of Financewith the mandate to develop a policy paper 'or white paper) outlining theGovernment's privatization strategy. The five member committee is chaired bythe Chairman of NIDC and includes the Chairman of the Securities ExchangeCommission, a Finance Ministry representative, a university professor, and aprivate sector representative. Interviews with various committee members inApril 1990 indicated that a draft of the white paper was being circulated forclearance. As well, the Government had agreed on the terms of a UNDPfinanced/IFC executed technical assistance program whereby IFC would:(a) provide input to Government in the development of a privatizationstrategy, (b) assist with privatization transactions, and (c) train HMGstaff.26/ Other privatization initiatives included two seminars on thesubject in August 1988 and March 1990. These seminars were positive initia-tives in that they increased the general awareness of the issues and optionsrelevant to privatization. They were also the first formal attempt to openthe subject for discussion and get the opinions of concerned parties. Whilepreliminary in nature, they nevertheless yielded useful feedback from publicofficials and the private sector and provided valuable input to the develop-ment of the white paper.

6.5 On the whole, the main constraint at this stage is that the overallenvironment is not conducive to large scale privatization. Insufficientpreparatory work has been done to build consensus among interested partners,develop operating policies and procedures, and prepare enterprises for privat-ization. Recent political changes are likely to further affect privatizationnot only because the interim Government may be reluctant to make major struc-tural changes but also because investors may perceive the political environ-ment as an additional risk. Therefore, while Government can proceed withprivatization of one or two enterprises, implementation of an expanded programwill require that some of the broader issues and constraints be addressed andadequate measures taken to create an enabling environment. This does not meanthat all these issues need to be resolved up front. Privatization is a verycomplex exercise and most of the issues can best be addressed on a case bycase basis. However, the overall political, social, and institutionalenvironment needs to be supportive if a larger privatization program is to besuccessful. Successful privatization of one of two enterprises as envisagedin the IFC supported technical assistance program, would provide valuableinput in the design of a larger privatization program.

26/ The form of the agreement was agreed but not signed shortly before thechange in government. It is unclear whether these initiatives have thesupport of the current Government.

- 66 -

B. Constraints and Issues

6.6 In preparing a more comprehensive privatization plan, potentialobstacles to or risks of privatization would need to be addressed, includinglegal, fiscal, administrative, employment and social issues, domestic capitalsources and potential foreign investment. Some of the general issues,constraints and risks of privatization that have been identified which shouldbe addressed as a prerequisite for implementation are discussed below.

Policy Framework

6.7 Presently, Nepal lacks a clearly defined policy framework thatdefines the Government's objective, strategy and scope for privatization.Development of a privatization policy statement would provide the basis forinitiation of the program. In the current environment, there is pervasiveambiguity and uncertainty among Government offi,ia's, PEs, prospectiveinvestors and the public in general on the Government's objectives andintentions. Prolongation of this period of uncertainty may adversely affectthe PEs whose performance may deteriorate further. The private sector'sconfidence in the Government's commitment to expand the private sector's rolein economic development may also be affected. Therefore, as a first step,Government needs to complete its white paper which should state clearly itsobjectives for privatization and divestiture, describe the institutionalarrangements for managing the process (para. 6.8), and indicate how thepotential costs of privatization, e.g. financing of debt restructuring andredundancy payments would be met (para. 6.11). To prevent difficulties duringimplementation, the white paper should indicate the Government's strategy withrespect to redeployment of staff, foreign participation, concentration ofownership, management/employee participation, etc.

6.8 Implementation Capacity. Adequate institutional arrangements wouldneed to be established to implement the program. Given that privatization isa multisectoral and complex exercise, involving a wide range of governmentagencies, financial institutions, and the private sector, it is important thatarrangements for managing the process establish a focal point for decisionmaking while allowing adequate attention to be paid to the concerns ofaffected groups. One approach that has been recommended by IFC would be toestablish an independent body, '--sisting of high level representatives fromall concerned parties, to guide - ; manage the privatization process. Theprimary objective of this body u-.,d be to ensure consistency of approach,coordination of efforts, and transparency and fairness of transactions. It isessential that the members of the commission have the standing in theirorganizations necessary to secure approvals and facilitate decision making.The Commission would need to be supported by an implementation unit, i.e., asmall technical team of experts, comprising financial analysts, sectorspecialists and lawyers who, with the support of specialist consultants, wouldcarry out the preparatory work including development of divestiture optionsand modalities, preparation of action plans, enterprise valuations and prep-aration of prospectuses. The technical team and its external advisors wouldalso manage transactions including negotiations with potential investors.Details of institutional arrangements for privatization have already been

67 -

discussed with IFG advisoLs (see Footnote 26 page 65). The issu:- here is theimportance of putting such an arrangement in place as soon as polssible so thata systematic approach can be adopted in moving the program forard.

6.9 Lack of Consensus. Presently, Government officials, policy makers,public enterprise managers and employees lack consensus on Government's pri-vatization initiative. This is partly because, as indicated above, theGovernment's privatization policy and strategy has not yet been clearlydefined, and therefore uncertainty on how it would affect the interests ofvarious groups has created unfavorable attitudes. Many Governmen- and PEofficials are opposed because it would reduce their authority and opportuni-ties for patronage, status, etc. While there seems to be no ideologicalproblem with privatization, the intellectual community may view privatizationunfavorably because of the perceived social and political costs. As well,there seems to be a prevailing mistrust of the private sector and a perceptionthat the private sector may not act in a socially responsible manner. Thereis also resistance in the labor force, mainly because many PEs are overs.affedand privatization is expected to result in major layoffs. Even among decisionmakers, government officials and the private investors who all favorprivatization in principle, there is widespread skepticism on how exactly theGovernment would implement it. Under these circumstances, the lack of consen-sus could be a major obstacle to the program's implementation even if otherissues were satisfactorily resolved. Privatization requires concerted effort,participation, and support of all parties involved. Therefore, deliberateefforts need to be made to build consensus within Government, public enter-prises, and the private sector with respect to the objective and implementa-tion of the program. Continuous and open dialogue between all concernedparties is key to building needed consensus. Special interest group workshopsand seminars should be organized to allow discussion of the major issues thatmay adversely affect certain groups; such as, redundancy issues, manage-ment/employee buy-ou.s, concentration of ownership by few investors, etc.Furthermore, there _.s a need for systematic dissemination of information, stepby step, as the program moves forward. Transparency will help build supportfor and acceptance of the program.

6.10 Labor Issues. The redundancies likely to result from privatizationis a socio-political issue that needs to be addressed. This does not meanthat the Government would necessarily have to resolve redundancy issues inspecific enterprises up-front. As indicated in Chapter V, many ot Theseissues can best be handled on a case by case basis. However, Government needsto adequately address the concerns of labor. Thus, it is important to developa broad strategy and guidelines for handling layoffs and dealing with staffredundancies. This would reduce the fear and resentment of the labor forceand facilitate advance planning by the Government and PEs so they couldrespond more effectively to both the social and financial aspects of theproblem. Posztive steps that could be taken to reduce the adverse imnact ofthis problem include development of programs for redeployment and retrainingof laid off employees, contracting out services to employees laid off as aresult of downsizing, provision of adequate severance pay and/or seed money sothat they can start small-scale farming or businesses, and early retirementpackages with golden hand shakes. As indicated below, some of these paymentscould be funded through a privatization/restructuring fund.

- 68 -

6.11 Financing Privatization. There is no doubt that this is one of themost difficult issues to tackle. In fact, since one of the primarymotivations for privatization is to reduce the current and future burden ofthe PEs on the government's budget, the Government is likely to be reluctantand may find it difficult to allocate budgetary resources for a privatizationand restructuring fund. Nevertheless, given the financial difficulties ofsome of the enterprises and the frequent incidence of overstaffing,privatization of other than a few profitable PEs will necessitate allocationof resources. One way to deal with this is to establish aprivatization/restructuring fund. Some countries which have established suchfunds have been successful in mobilizing external and internal funds tosupplement Government funding. To reduce somewhat the amount of directGovernment budgetary allocation to the Fund, the first phase of privatization(para. 6.21) can focus on more marketable PEs. The proceeds from these salescould then be added to the restructuring/privatization fund. The fund wouldbe used to (a) restructure debt of weak PEs, (b) provide redundancy paymentsand other end of service benefits to employees, (c) provide retraining andtechnical assistance to retrenched staff and/or (d) provide seed money toemployees who wish start up small businesses.

Related Private Sector Issues

6.12 Policy and Regulatory Framework. Since privatization cannot beachieved without adequate private sector response, measures need to be takento encourage private sector investment and participation. Interviews with anumber of medium and large private investors indicated considerable dissatis-faction with the overall business environment. As discussed in Chapter 2,licensing, import and export procedures are excessively bureaucratic andcumbersome. CEOs of some private firms indicated that about 70 to 80Z oftheir time and the; top managers' time is spent in dealing with Governmentbureaucratic procedures. Credit availability and allocation appears to be amajor constraint. Furthermore, the present foreign exchange policy and lawsof repatriation are not conducive to third country foreign investment. Thereare contradictory laws and regulations and frequent policy changes. As oneprivate investor put it, 'if you find a law that gives an incentive to theprivate sector, there is always another law that takes it away.' Therefore,steps need to be taken to improve the business environment and to restore theprivate sectors' confidence in the economy. Public institutions that provideservice to the private sector need to be strengthened and current bureaucraticprocedures simplified and streamlined. Particular attention must be paid onthe one hand to making labor, pricing, investment and incentive (tax anddevelopment) regulations transparent, while on the other hand ensuring thatcustoms, sales and income tax regulations are enforceable.

6.13 Managerial and Technical Skills. Many public enterprise problemssuch as lack of managerial and technical specialists and absence of financialdiscipline extend to a lesser extent to the private sector. To help overcomethis, the private sector institutions in Nepal, such as the Chamber ofCommerce and the Young President's Organization, which are relatively welldeveloped and organized, should be supported and encouraged to expand businesspromotion programs, dissemination of information, entrepreneurship developmentand training. As well, joint venture arrangements with foreign investors who

- 69 -

have needed technical and managerial skills will accelerate training anddeve'lopment of local staff.

6.14 Financial Disclosure. Notwithstanding the proprietary audits under-taken by the Auditor General's Office, there are no financial regulationsgoverning the control, content, interpretation or audit of the books ofaccount of either public or private sector entities. Accordingly anyfinancial statements prepared and presented either in support of financialresults or projections must be treated with caution. Reliable financial datais essential to the development of capital markets in Nepal. If increasedprivate sector investment, and broad based share ownership in particular, isan objective, then the Companies Act must be refined to ensure that thetiming, structure, and content of accounts is consistent with internationalbest practice together with statutory penalties for non-compliance. Inaddition HMG should encourage the formation of a local institute ofaccountants to ensure adherence to revised regulations.

C. Strategy for Privatization and Divestiture

6.15 The first step in a PE reform program would be to agree on the PEswhich would be candidates for privatization, divestiture or liquidation.Separate strategies would then be devised for (a) enterprises to beprivatized/liquidated, and (b) those which would remain in the public sector.Key aspects of a privatization strategy are to identify enterprises with thebest prospect for divestiture, work out how to sell them and draw up a time-table for implementation. Divestiture of easily saleable enterprises can bestarted immediately through the present IFC initiative and the experiencegained from this work should feed into and strengthen plans for furtherprivatization. The process of developing a broad privatization plan cantypically be divided into two phases. Phase one involves establishing thepolicy framework for privatization, reviewing the policy and regulatoryconstraints on PE performance and objectives, identifying domestic and foreignsources of capital and categorizing and ranking PEs. Phase two would thenfocus on establishing a final ranking of PEs selected for divestitureaccording to their attractiveness to investors and preparing a time-phasedaction program for each enterprise, to include the most appropriate mode ofdivestiture, specific measures needed to overcome policy, legal andadministrative obstacles, a list of potential investors, and definition ofother pre-conditions for success.

Phase 1: Privatization Plan

Key elements of Phase One, preparation for privatization, are discussed below:

6.16 Government's Policy and Objectives: It is essential that at theoutset HMG articulate a clear policy framework for privatization. Clarifyingthe main objectives and priorities for divestiture is critical to classifyingand ranking enterprises, assessing the suitability of PEs for divestiture andidentifying the most appropriate mode of divestiture. As discussed earlier inSection B, potential obstacles to privatization need to be addressed. TheGovernment's privatization white paper should deal with these issues and spellout the institutional arrangements for managing the process.

- 70 -

6.17 Review of Policy and Regulatory Constraints on Performance andObjectives. An integral part of the privatization process is the need toaddress constraints posed by HMG's political and regulatory profile. HMG willneed to review constrai:-.ts at the national and sector levels, and assessparticular constraints on the privatization or restructuring of specificenterprises -- of particular relevance will be the development roles of PEs.Typical constraints will include legal and administrative obstacles, economicpolicy issues such as price deregulation and competition, employment mattersas they relate to the total level of employment as well as the treatment ofkey skill groups, fiscal questions including the impact of divestiture and/orrestructuring on HMG's budget and on counter-inflation policies, theacceptability of the liquidation of nonviable PEs, land ownership laws, andbanking and currency restrictions. A review of constraints would identify keypolicies that currently affect PE operations and the extent to which theseimpact on HMG's overall objectives. This will enable HMG to identify broadpolicy reform options and strategies to achieve its objectives. HMG can thenrank these options in terms of their overall soundness and efficiency as wellas their political acceptability. In parallel with examining the PE's policyand regulatory framework, HMG has to examine the needs of the private sector.It is essential that HMG create an enabling environment for the continueddevelopment of the private sector to ensure that once PEs are moved to theprivate sector, they can function efficiently (paras. 6.12).

6.18 Domestic and Foreign Sources of Capital. An important step inprivatization is to identify potential sources of capital and the type ofenterprise characteristics and divestiture packages that would attractinvestment. Domestic equity investment is not widespread in Nepal, and itsrole in the PE manufacturing divestiture program, where profitability is low,is likely to be, at best, small. The capacity to achieve broad-based shareownership is dependent on Government's success in developing Nepal's capitalmarkets and promoting employee/small holder participation. Fiscal andtaxation incentives need to be used more effectively to promote the flow ofprivate and institutional savings into equity investment (para. 6.12).

6.19 Enterprise Classification, Analysis and Ranking. Categorizing andranking PEs is an essential step in developing both an overall PE reformprogram as well as a privatization plan. Having established the reformsrequired at the macro level, HMG should then proceed to screen its PEportfolio at the micro level. The objective is to determine which activitiesshould continue to remain in the public sector and which should be turned overto the private sector or liquidated. Strategic PEs such as utilities, and PEsproviding primarily social services, may be among those Government may wish toretain. As well, PEs operating in monopoly or quasi monopoly markets whichrequire changes in government policies to increase competition or developmentof government regulatory capacity, may be candidates for divestiture only inthe medium to long term. PEs identified as candidates for divestiture may notnecessarily be attractive to the private sector and need to be further rankedaccording to their prospects for divestiture; viable PEs would be prioritycandidates. To classify and rank PEs, an assessment needs to be made of thecompetitive advantage and strategic attractiveness of each PE, with emphasison assessment of their markets, whether competitive or de facto monopolies,and on identifying the principal determinations of cash flow and

- 71 -

profitability. A basic profile for each enterprise will enable them to becategorized and ranked according to their prospects for divestiture and theneed for rehabilitation.

6.20 Key criteria for initial screening will be a function of HMG'sagreed objectives, but are likely to include:

- Nature of Market for Products and Services: to assess eachenterprise's competitive environment including trade barriers andpreferential access to markets and to identify enterprises thatGovernment may wish to retain;

- Potential Profitability: to identify the most attractive privatiza-tion candidates. JCF and portions of ATF are good examples;

- Visibility: to demonstrate to the public, at an early stage of theprocess, the benefits of privatization;

- Ease of Privatization: certain PEs should be attractive 'as is' andcould be sold quickly to demonstrate success;

- Maximization of Revenues: to meet specific government liquidityobjectives; the sample PE's examined would provide littleopportunity for this;

- Export and Domestic Market Potential: to identify growth potential;

- Other government criteria that will emerge in defining objectives.

6.21 The screening process will provide a broad understanding of thestructure, scope and potential of individual PEs and groups of PEs and allowHMG to assess their competitive advantage and strategic attractiveness. Theresults of this initial screerning will allow PEs to be ranked in five distinctcategories which will reflect their prospects for privatization:

- Category I The best candidates for divestiture in the near term;

- Category II Those suitable for divestiture in the medium term(i.e., hopefully one to two years) after somerestructuring;

- Category III Those requiring substantial rehabilitation orrestructuring but ;hich may be suitable fordivestiture in the longer term;

- Citegory IV Those deemed unsuitable for divestiture for strategicand/or social reasons but whose performance can beimproved by changes in policy, government oversightstructure, internal institutional strengthening andrestructuring or rehabilitation;

- 72 -

- Category V Inherently unprofitable PEs that should beliquidated.

The initial screening will provide a short list of priority privatizationcandidates in Category I. The focus of the privatization and divestiturestrategy would be on enterprises in Categories I, II, and V. Chapter VII,discusses the strategy fo' enterprises in categories .II and IV, which willremain in the public sector in the medium to long term.

Phase 2: Privatization Plan

6.22 In Phase Two, detailed implementation plans would be developed foreach enterprise with priority given to those identified in phase one aspriority candidates for privatization. Thus, phase would in fact overlap withimplementation. Thus privatization of priority candidates can beginimmediately following completion of enterprise specific action plans whilepreparation of implementation plans continue for remaining enterprises.

6.23 Enterprise Review. The outcome of the initial screening process inphase one will be a ranked list of enterprises to be restructured andprivatized. HMG will then need to develop a strategy for each enterprise,based on the dynamics of its sector, to move it along a continuum toprofitability and growth and determine the ownership structure most likely tofacilitate the transition to competitive performance.27/ The approachencompasses four phases: diagnosis, development of a business strategy,identifying key problems and restructuring needs; and development of actionplans.

(a) Diagnosis. In order to develop a long term strategy it is essentialto understand the short term needs of the PE. This entails a fullanalysis of the enterprise's operations. In overall terms theanalysis will include:

- Financial Analysis: revenue and profit trends, cashflowmanagement, liquidity, net worth, balance sheet structure;

- Policy Environment: pricing policy, tariffs, productspecifications, taxation, investment incentives, restrictionson raw material sourcing, market privileges;

- Market Dynamics: size and growth of market segments and keyindustry drivers;

- Competitors: size and growth of competitors, market shares,levels of profitability, competitive advantages;

27/ Where relevant, e.g., textiles, cement, a subsector approach should bepursued.

- 73 -

- Customers: profiles of the existing and potential customers ofthe enterprises customer's, key criteria for purchasingproducts;

- Operations: production processes, productivity analysis,performance against budgets;

- Price and Cost Analysis: cost structure by product/service,input sourcing and supplier management, distribution channels,price structure by product/service;

- Management Analysis: organization and management structure,information systems, planning and budgeting, employment andcompensation.

The sequence and deptri of the analyses will vary by enterprise. Theobjective in all cases will be to identify each enterprises'strengths and weaknesses as well as the strategic opportunities andthreats which will impact its long term profitability and growth.

(b) Business Strategy: The result of the analyses described above willprovide necessary information on the performance and problems ofeach pre-screened enterprise. The task then will be to determine asprecisely as possible the alternatives that can be pursued toresolve those problems and which alternative best meets the goals ofHMG. Strategic opportunities for each enterprise will depend on(a) its markets i.e. whether there is potential for increasedexpor';s or import substitution, (b) the competitive advantage of theenterprise, i.e. whether it has or can develop a competitiveadvantage over foreign and domestic suppliers, (c) opportunities forcost reduction, and (d) opportunities to expand employmentgenerating activities.

(c) Identifying Key Problems and Restructuring Needs. Obstacles toimplementing an enterprise's business strategy may be within theenterprise itself, in the policy and regulatory environment in whichit operates, or in the availability of resources for restructuring.The objective of the review of restructuring needs will be toidentify the root causes of the existing poor performance. Thiswill ensure that the proposed action plan for the enterprise will beachievable and effective.

(d) Action Plans. The Action Plan for each selected enterprise willconsist of a series of logical steps and a timetable to enable eachenterprise to achieve its strategic objectives. These will cover:

- Measures to return to or increase profitability, improve theproduction processes, reduce costs, increase market share,review pricing, etc. The focus will be on tackling existinginefficiencies at current levels of production in order toachieve increased profitability quickly with minimal newinvestment;

- 74 -

Development of an investment plan for repositioning the enter-prises in line with its long term strategy--increased domesticmarket share, entering export markets, vertical integration,diversifications and acquisitions;

- Proposals for changes in the policy framework necessary for theachievement of objectives; and

- Recommendations on the form of privatization and timing; e.g.,should restructuring be undertaken before or after sale?

6.24 Privatization Options. The business strategy and action plan foreach enterprise will allow assessment of the appropriate mode ofprivatization. Government policy and the specific needs of each enterprisewill determine whether privatization should take the form of transfer ofauthority for management, including resource allocation, to the privatesector, or the sale of assets. Where the lack of financial resources is amajor obstacle to enterprise restructuring, divestiture will transferresponsibility for strategic implementation to the private sector. Thedifferent forms of privatization that can be considered include:

- Public Stock Offering: under this form of privatization, theGovernment sells to the general public all or large blocks of sharesit holds in wholly or partly owned PEs. For a public offering to besuccessful it requires that: (a) PEs be sizable, going concernswith a reasonable earnings record or potential; (b) there isidentifiable liquidity in the local market and the capital market isadequately developed. Without strong capital markets, particularlyequity markets, a public offering will not generate sufficientresponse unless mechanisms are devised that allow the generalinvesting public to be reached. The main advantages of a publicoffering are that it permits wider shareholding but it requires thatadequate controls be in place to protect small investors (para.6.14).

- Private Sale -- Local and Foreign: under these transactions,Government sells all or part of its shareholding to a pre-identifiedsingle purchaser or group of purchasers. The transactions can takevarious forms, such as direct acquisition by another corporateentity or a private placement with a group of investors. Because oftheir flexibility, private sales are the preferred option with weakperforming PEs or PEs in need of strong owners with relevant indus-trial, financial and commercial expertise. Private placements mayalso be the only feasible alternative given the underdevelopedcapital market. The extent to which foreign ownership or participa-tion can be attracted will depend on the attractiveness of Nepal'sforeign investment code.

- Management/Employee Buy-outs: management/employee buy-outs are arelevant means of tre.nsferring ownership to management and employeesand may be a solution for PEs not otherwise saleable. This

- 75 -

divestiture option also constitutes an enormous incentive toproductivity.

Joint Ventures: the main characteristic of such a privatizationoption is that government is not disposing of ownership. Jointventures with foreign companies allow access to management, technol-ogy and markets.

- Contracting Out: this is a flexible method of introducing privatesector involvement to meet limited objectives. It takes three mainforms: (a) contracting out of public services by competitivetendering for the provision of specific activities; (b) managementcontracts which introduce private sector management into a govern-ment-owned enterprise; and (c) leasing, where a private operatorleases the assets of facilities owned by PEs and uses them toconduct business on its own account.

6.25 Practical options can be developed that blend different strategiesin order to accommodate stated objectives and unavoidable constraints.Relevant approaches include the adaptation of techniques including intensiveinformation campaigns and elaborate distribution networks for public offeringsof stock in the case of weak financial markets; combinations of publicofferings and private sales where the presence of a party or core group ofshareholders that is strong financially and technically is necessary to turnaround or sustain the PE; and infusion of new private equity in PEs needingrehabilitation coupled with the sale of government shares. Where transfer ofownership is not desired or feasible initially, leases and managementcontracts can be used, often to be followed later by transfer of ownership.

6.26 In reviewing the twelve PEs on which the mission focused, the methodof divestiture most appropriate to the type of capital resources was examined.These are discussed in the company profiles provided in Volume Two (Annex IV)and summarized in Table 6.1. The analysis should be developed further toidentify specific measures to overcome practical obstacles to divestiture. Ofparticular relevance will be the development role of specific PEs. Otherconstraints may include: (a) land ownership laws; (b) banking and currencyrestrictions; (c) pricing policies and laws that control redeployment ofworkers, pension and/or redundancy provisions.

6.27 Even in the case of enterprises that are deemed suitable for immedi-ate divestiture, it is often necessary to take supplementary measures toensure the success of the divestiture and to establish a basis for longer termperformance improvement. Such measures must provide a credible basis for

- 76 -

Table 6.1: PRIVATIZATION OPTIONS

Options Relevant to:

1. Divestiture of:(i) Entire enterprise ATF, BBF, JCF(ii) Minority shareholding RDL(iii) Profitable subsidiaries and/or Assets BLSF(iv) 'Packages' of profitable and

unprofitable business units ATF

2. Funding new investment with private BLSFshare issues to dilute Govt. shares

3. Joint ventures with domestic and/orForeign investors BLSF

4. Management or employee buy-outs BLSF, HTI

5. Management contracts and asset ATF, BBF, RDLleasing

believing that the enterprises have a profitable future. They could includerestructuring of corporate finances, strengthening of top management, and anycritically needed investments. These actions become even more important forenterprises that can only be divested in the medium to longer term.

6.28 The valuation of enterprises which are to be sold to the privatesector is a sensitive issue. It is a matter of fine judgement to ensure pric-ing which attracts willing investors while ensuring that public assets are notsold 'cheaply." Annex VI.1 discusses enterprise valuation including use ofthe discounted cash flow and network methods.

VII. STRATEGY FOR PE REFORM

A. Overview

7.1 The problems facing PEs in Nepal are severe and cannot be solvedin the short term. The multiple roles played by the PEs and the m,.ny vestedinterest groups make it difficult to build the consensus needed to achievereform. Their operating environment provided little incentive for enterprisesto function commercially. The supervisory and control regime wh'ch has hadsuzh a dysfunctional impact on PE autonomy and managerial incentive is wellentrenched, and restructuring this will take time. Furthermore, the key

- 77 -

managerial functions essential for good performance and accountability, whichare so poorly developed within the enterprises, require time and effort toestablish. In light of existing constraints a broad strategy for PE reformshould:

(a) aim, as a matter of priority, to significantly improve the policyand regulatory framework for PEs and for the industrial sector inorder to foster private sector development and increase the pressureon PEs to operate as efficient commercial entities. Key measuresinclude (i) removing barriers to entry of private sector firms(para. 2.10) and improving the administration of industrialircentives and regulations (para. 2.16); (ii) limiting governmentsupport for weak PEs (para. 2.11); (iii) replacing discriminatorydirect controls on MPEs to purchase domestic raw materials byflexible incentives to motivate both public and private sectorinterest in using local resources (para. 2.12); (iv) separating thePEs commercial and non-commercial activities through institutionalchanges (i.e. transferring non-commercial functions to developmentBoard or Government departments) or separately accounting for andmonitoring commercial and non-commercial functions (para. 2.12);(v) gradually liberalizing the price control system while making anyremaining subsidies explicit and channelling them to clearlyidentified target groups -- for PEs in competitive markets pricingauthority should be delegated to operational managers (para. 2.21-2.22) and (vi) streamlining regulations governing PE personnelpolicies to increase flexibility and provide greater autonomy to PEmanagers (paras. 5.36 and 5.41).

(b) encourage divestiture/privatization of PEs wherever possible, inorder to reduce PE demands on scarce managerial and financial publicsector resources, while recognizing existing constraints toprivatization and divestiture in the short term. Classification andranking of PEs as discussed in Chapter VI, is likely to identifyseveral potential candidates for privatization. However, given theunderdeveloped capital markets and poor financial performance ofmany enterprises the pace of privatization will be determined by theextent of investor interest and the effectiveness of measures tofoster management and employee participation and attract foreign aswell as local investors.

(c) develop a progrem of reform and restructuring for PEs that wouldremain in the public sector. This would include measures to changethe relationship between PEs and various government oversightagencies to emphasize strategic rather than operational control(paras. 3.19 and 3.22), strengthen PE Boards and managers in orderto change the organizational culture and provide the skills neededto manage commercial enterprises (paras. 4.25 and 4.31) developinternal management systems and rehabilitate and modernize equipmentwhere necessary.

- 78 -

B. Implementing PE Reform

7.2 Based on other countries' restructuring experience, a comprehensivereforn of tthe PE sector in Nepal, and institutional restructuring inparticular, can be expected to take a minimum of 5-7 years. The institutionalcapacity and experience required to implement a large-scale privatizationp),,rarm and effect all required reforms simultaneously for a large number ofPEs appears not to exist in Nepal. Thus, the report recommends thatGovernme.t adopt a phased approach to implementing its PE reform. Initialreform efforts in the near term will provide valuable feedback to design oflater reform programs.

7.3 It is essential at the outset that government states unambiguouslyits objectives and proposed strategy for PE reform so that clear signals areprovided to both Government officials and PE managers and staff of expectedchanges in the role and function of PEs. Thus, an essential prerequisite toimplementing PE reform is that government issue a PE policy and strategystatement along the lines discussed in para (vi) which would provide theframework for implementing more specific reform measures. In particular,governments intention to (a) operate PEs on a fully commercial basis,(b) provide separate financing for noncommercial activities undertaken by PEsand (c) reduce the number of public enterprises through a program ofprivatization and divestiture, should be emphasized.

7.4 In the initial phase of implementing reform, Government should beginto address broad policy and institutional issues at the same time that itrestructures selected enterprises and initiates its privatization program. Inparticular:

(a) for Policy and Institutional Reform, measures which should beinitiated during the initial phase include: (1) reviewing pricingand industrial policies and regulations with the aim of improvingthe competitive and regulatory environment of both public andprivate sector companies; (2) reviewing existing PSC regulations inorder to simplify and streamline current procedures; (3) developingaccounting standards to increase the reliability of financial data;and (4) establishing training programs to improve the quality of thelabor force.

(b) for Privatization, divestiture of easily saleable PEs identified aspriority candidates for privatization (e.g., financially viable PEsin competitive markets which are attractive to the private sector'as is') can begin while Government continues to prepare detailedaction plans for less attractive candidates and to finalize measuresto address constraints and issues likely to affect a largerprivatization program. The UNDP financed/IFC executed technical.assistance program agreed with the previous Government can provideneeded expert assistance. Experience of this process should feedinto and strengthen plans for further privatization.

(c) for PE Restructuring, instead of attempting to introduce reformssimultaneously in all the PEs which would remain in the public

- 7 9 -

sector, restructuring should begin with a small group of PEs forwhich there is a clear rationale for public ownership (e.g.,strategic enterprises or PEs in monopoly or quasi-monopoly markets).Restructuring of selected enterprises could proceed while detailedrestructuring plans are being developed for remaining enterprises.

7.5 Restructuring enterprises which will remain in the public sectorwill be the more difficult task. It is recommended that in the initial phaseof enterprise restructuring, a group of four or five PEs should be selectedfrom a ministry whose leadership is seriously interested in PE reform. TheMinistry of Industry (MOI) is probably the best candidate for this purpose.Four or five of its nearly 30 PEs could be identified for which there is aclear rationale for public ownership. Priority should be given to those PEsfor which the fiscal impact of restructuring would be significant. Recentlyestablished PEs and those not yet operational may also be included in phaseone, as they are less likely to have the deep seated problems of other PEs andaction now can forestall future problems. The oversight function andmanagement of the reform process in Phase One can be performed by the sectorministry concerned (MOI if it is selected by HMG). It is proposed that inphase one, a special PE Unit be created in the sector ministry that would beresponsible for these activities. As part of the reform process, the unit,with expert assistance, would identify candidates for Phase 1, develop revisedoperating guidelines and secure Cabinet approval for modifications in rulesand regulations applicable to PEs included in Phase 1.

7.6 For the selected PEs, the reconstitution of the boards andappointments of chief executives should be done as proposed in Chapter 3. Thetasks of strengthening internal management functions should be theresponsibility of the chief executives under the supervision of their boards.As recommended in Chapter 6 for enterprises selected for privatization,preparatory work should include diagnostic studies, development of a businessstrategy, identifying key problems and restructuring needs and developingaction plans. A staff audit may also be necessary to determine the skillrequirements and number of staff required in line with operational andcorporate plans. Local and/or international consultants can assist PEs withthis exercise. It is also likely that the PEs will need technical assistanceto help strengthen financial and management information systems. The selectedPEs should also be given access to financing if needed to upgrade andrehabilitate equipment.

7.7 During phase 1, as part of its oversight function, the unit in thesector ministry would plan and negotiate targets with PEs and supervise theirperformance. If necessary, CCD should continue to play its present role ofbudget approval in relation to the selected PEs, but in close collaborationwith this unit. At this stage, instead of designing a complex incentivescheme, the unit should attempt to refine the existing profit-linked bonusscheme to see how it could be adapted to motivate PE managers to perform asplanned. The new unit should be permitted to implement this incentive schemein the selected PEs.

7.8 Restructuring of selected enterprises must be lone in conjunctionwith, measures to address broader policy and employment issues. A committee

80 -

consisting of selected PE managers and PSC and employee representatives shouldbe set up to review existing PSC regulations with the aim of simplifying andstreamlining current procedures. Even more important, HMG needs to initiate areview of pricing and industrial policies and regulations to address issuesraised in Chapter 2 with the aim of improving the competitive and regulatoryenvironment of both public and private sector companies (para. 7.1). As well,development of accounting standards (para. 4.35), and establishment oftraining programs (para. 5.42) should be initiated in phase 1.

7.9 Depending on progress made in Phase 1, in about the third year ofthe program, the experience with the reform of the selected PEs should beevaluated to see whether enough has been learned by HMG to be able to adaptthis approach to reform of the remaining PEs. By then, there will be aclearer picture as to which PEs will in fact remain in the public sector. HMGmay wish to set up an inter-ministerial task force to undertake thisevaluation and to make specific proposals on the steps to be followed inimplementing subsequent reforms. These proposals should includerecommendations on which agency within HMG will initiate and oversee theexpanded reform program. Other tasks that this group should work out include:the design of an improved performance evaluation system and of performance-linked incentives, the definition of the roles to be played by the sectorministries, MOF and other relevant agencies in the oversight function of HMG(including examination of alternative organizational structures such ashold -.7 companies and the location of a Government-wide oversight function)and identification of any other institutional mechanisms for strengtheningPE performance.

7.10 In both phases of the reform program, HMG is likely to requiretechnical assistance to plan and follow up on specific actions. The Bank andother donors, if so requested, may consider providing the needed assistance inspecialized areas. Advice on the improvement of internal management, designof performance evaluation and incentive schemes, training and related capacitybuilding to perform the oversight function within HMG are among the areaswhich should receive high priority in terms of assistance. Key steps in a PEreform program are indicated in the implementation plan below. Where relevantparagraph references are provided to indicate where a more detailed discussionof each item can be found in the main report. An indication of timing isprovided to give a sense of the relative sequencing of activities within aseven-year period.

- 81 -

C. IMPLEMENTATION PLAN

Para.Ref. Actions Responsibility Timing

Phase 1

A. Policy Reform

Pricing:

2.20 Amend the Essential Commodities Cabinet Year 1

Act to reflect the new pricingpolicies and narrow the list ofcommodities covered by the Actto those which are explicitlysubsidized

Subsidies:

2.23 Agree subsidy programs to be Cabinet Year 1

retained and explicitly fundedand develop plan to target suchprograms on specific groups

Raw material development:

2.10 (a) Replace controls on PE raw Cabinet/MOA Year 1

material purchases withincentives

2.10 (b) Consolidate raw material Cabinet/MOA Year2-Year3

development services inDevelopment Boards andExtension Services

2.8 Promotion of Private Sectorinvestment in IndustrialSector:

(a) Amend the Industrial Cabinet/MOI Year 1

Enterprises Act by creatinga list of "free sectors"which require no licensingand which will be forprivate sector investmentexpansion only

- 82 -


2.13 (b) Streamline administration MOI Yearl-Year2of regulations andincentives throughdissemination ofinformation andclarification oflegislation

Employment/Human Resources

5.36 Review and streamline PSC PSC/ Yearl-Year2regulations Inter-

ministerialcommittee

5.42 Establish technical/accounting Government Year l-Year2training programs training

instituteswith privatesector assist-ance

Enterprise Level Reform Program

B. Classification/Privatization

6-17-6.22 Finalize Privatization White Paper

Identify priority candidates Cabinet/MOI 0-3 monthsfor privatization and thoseto remain in the publicsector in the medium tolong term

6.23-6.27 Develop Privatization Plan Cabinet/MOF 3rd-24thmonth

Privatization of selectedcompanies 9th month

onward

7.2-7.5 C. Enterprise Restructuring

Set up ministry level PE Cabinet/MOI 0-3 monthsmonitoring unit

Appoint technical advisors MOI 0-3 months

- 83 -


Select PEs for pilot phase MOI 0-3 months

Assess changes in existing MOI/Cabinet 3rd-6thrules and regulations essential monthin phase one and secure neededexemptions for selected PEs.

Reconstitute PE Boards and Cabinet 6th-9thappoint chairmen and general monthmanagers

Appoint senior management teams MOI & Boards 12th-18thmonth

Assess and arrange for MOI, MOF & 12th-18thtechnical assistance for PEs Donors monthselected in phase one

Carry out diagnostic studies, PE 18th-24thstaff audits, prepare business Management monthand operating plans and developrestructuring action plans

Agree on corporate and annual MOI & Boards 24th-26thplans for PEs & on incentives monthlinked to performance

Provide resources needed, if MOF/Donors 24th-26thany, for rehabilitation/ monthredundancy payments

Implement internal PE Year2-Year3restructuring of pilot PEs

- 84 -


7.6- Phase 27.7

Enterprise Reform Program

Evaluate Phase 1 reforms Inter Year 3ministerialtask force &cabinet

Prepare detailed plans for Inter- Year 3-4Phase II: ministerial

task force

Agree on autonomy & performance Inter- Year 3-4criteria, supervision ministerialmechanisms & incentives task force &

Cabinet

Establish restructuring fund Cabinet Year 3-4

Establish new oversight Cabinet Year 4structure & appoint seniorlevel personnel

Assess and arrange for phased Ministries & Year 3-4technical assistance program donors

Initiate needed reforms in Relevant Year 4-7sequence ministries &

MOF

Review & fine tune planning and Supervisory Year 4-7implementation mechanisms agency

- 85 -

ANNEX 1.1Page 1 of 2

OFFICIAL LIST OF PEs

MANUFACTURING

NO. ENTERPRISE LOCATION

1. AGROLIME INDUSTRY LTD. (1st GEN) KATHMANDU2. AGRICULTURAL TOOLS FACTORY LTD. (lst GEN) BIRGUNJ3. 3IRGUNJ SUGAR FACTORY (lst GEN) BIRGUNJ4. BANSBARI LEATHER AND SHOES FACTORY LTD. (lst GEN) KATHMIANDU5. BHAKTAPUR BRICKS FACTORY LTD. (lst GEN) BHAKTAPUR6. BRICK AND TILE FACTORY LTD., HARISIDDHI (lst GEN) LALITPUR7. DAIRY DEVELOPMENT CORPORATION (lst GEN) KATHMANDU8. HETAUDA TEXTILE INDUSTRY LTD. (lst GEN) HETAUDA9. HERBS PRODUCTION AND PROCESSING CO. LTD. (lst GEN) KATHMANDU10. JANAKPUR CIGARETTE FACTORY (lst GEN) JANAKPUR11. NEPAL TEA DEVELOPMENT CORPORATION LTD. (Ist GEN) JHAPA12. RAGHUPATI JUTE MILLS (lst GEN) BIRATNAGAR13. ROYAL DRUGS LTD. (lst GEN) KATHMANDU14. HIMAL CEMENT COMPANY LTD. (2nd GEN) KATHMANDU15. NEPAL ORIEND MAGNESITE (P.) LTD. (JV) SINDHUPALOOK16. BHRIKUTI PAPER INDUSTRY LTD. (lst GEN) GAIDAKOT17. HETAUDA CEMENT INDIJSTRY LTD. (lst GEN) HETAUDA18. BALAJU TEXTILE INDUSTRY LTD. (lst GEN) KATHMANDU19. BUTWAL SPINNING INDUSTRY LTD. (2nd GEN) BUTWAL20. NEPAL METAL COMPANY (JV) RASUWA21. LUMBINI SUGAR FACTORY LTD. (lst GEN) BHAIRHWA22. NEPAL ROSIN AND TURPENTINE LTD. (lst GEN) DHANGADHI23. NEPAL PAPER INDUSTRY (lst GEN) NEPALGUNJ24. SETI CIGARETTE FACTORY LTD. (2nd GEN) DRANGADHI25. UDAYPUR CEMENT INDUSTRY (lst GEN) UDAYPUR26. NEPAL BITUMIN AND BARREL INDUSTRY (2nd GEN) AMLEKHGUNJ27. NEPAL LUBE OIL LTD. (2nd GEN) AMLEKHGUNJ28. NEPAL FOUNDRY PROJECT (lst GEN)

ENERGY

1. NEPAL OIL CORPORATION (lst GEN) KATHMANDU2. TIMBER CORPORATION OF NEPAL (lst GEN) HETAUDA3. NEPAL COAL CORPORATION (2nd GEN) KATHMANDU4. NEPAL ELECTRICITY AUTHORITY (lst GEN) KATHMANDU

TRADING & COMMERCE

1. AGRICULTURE INPUTS CORPORATION (lst GEN) KATHMANDU2. COTTAGE AND HANDICRAFTS EMPORIUM LTD. (lst GEN) KATHMANDU3. NEPAL FOOD CORPORATION (lst GEN) KATHMANDU4. NATIONAL TRADING LTD. (lst GEN) KATHMANDU5. TOBACCO DEVELOPMENT CO. LTD. (lst GEN) JANAKPUR6. SKIN COLLECTION & DEVELOPMENT CORPORATION (2nd GEN) KATHMANDU

-86 -


OTHER PUBLIC UTILITIES

1. NEPAL TELECOMMUNICATION CORPORATION (Ist GEN) KATHMANDU2. ROYAL NEPAL AIRLINES CORPORATION (lst GEN) KATHMA2DU3. NEPAL TRANSPORTATION CORPORATION (lst GEN) KATHMANDU4. DRINKING WATER & SEWERAGE CORPORATION (Ist GEN) KATHMANDU

E^ONOMIC AND CULTURAL SERVICES

1. NEPAL TRANSIT AND WAREHOUSING CO. LTD. (lst GEN) KATHMANDU2. NATIONAL CONSTRUCTION COMPANY OF NEPAL (lst GEN) KATHMANDU3. GORKHAPATRA CORPORATION (lst GEN) KATHMANDU4. NEPAL TELEVISION (lst GEN) KATHMANDU5. RATNA RECORDING CORPORATION (lst GEN) KATHMANDU6. ROYAL NEPAL FILM CORPORATION (2nd GEN) KATHMANDU7. CULTURAL CORPORATION (lst GEN) KATHMANPU8. JANAK EDUCATION MATERIALS CENTRE LTD. (lst GEN) BHAKTAPUR9. NEPAL RESETTLEMENT COMPANY (lst GEN) KATHMANDU10. ECONOMIC SERVICES CENTRE LTD. (2nd GEN) KATHMANDU11. INDUSTRIAL ESTATE MANAGEMENT LTD. (2nd GEN) KATHMANDU12. NEPAL ENGINEERING CONSULTANCY SERVICE CENTRE (lst GEN) KATHMANDU13. AGRICULTURAL PROJECTS SERVICES CENTER (2nd GEN) KATHMANDU14. BIO-GAS AND AGRICULTURAL IMPLEMENTS DEV. (2nd GEN) KATHMANDU

FINANCIAL ENTERPRISES

1. AGRICULTURAL DEVELOPMENT BANK (lst GEN) KATHMANDU2. NEPAL INDUSTRIAL DEVELOPMENT CORP. (lst GEN) KATHMANDU3. RASTRIYA BANIJYA BANK (Ist GEN) KATHKANDU4. NATIONAL INSURANCE CORPORATION (lst GEN) KATHMANDU5. SECURITIES EXCHANGE CENTRE LTD. (2nd GEN) KATHMANDU6. CREDIT GUARANTEE CORPORATION (P.) LTD. (2nd GEN) KATHMANDU7. NEPAL BANK LTD. (lst GEN) KATHMANDU8. NEPAL HOUSING FINANCE COMPANY (2nd GEN) KATHMANDU9. NEPAL ARAB BANK LTD (JV) KATHMANDU

Note:GEN = GenerationJV - Joint Venture

Source: Corporation Coordination Division, Ministry of Finance.

- 87 -


LEGAL STATUS OF PUBLIC ENTERPRISES

Mode of Creation and (Date ofEstablishment

A. MINISTRY OF AGRICULTURE

1. Agriculture Development Bank Ag. Dev. Bank Ct, (1968)

2. Agriculture Inputs Corporation Corporation Act, (1974)

3. Agriculture Tools Factory Company Act, (1969)

4. AgroLime Industry Company Act, (1974)

5. Dairy Development Corporation Company Act, (1967)

6. Nepal Tea Dev. Corporation Company Act, (1967)

B. MINISTRY OF INDUSTRY

7. Balaju Textile Industries Company Act, (1972)

8. Balaju Tentra Shala (P) Ltd. Company Act, (1960)

9. Balaju Tantra Shala SanitaryEngineering Ltd. Company Act

10. Bansbari Leather and ShoeFactory Company Act, (1965)

11. Bhaktapur Brick Factory Company Act, (1975)

12. Bhrikuti Paper Factory Company Act, (1975)

13. Birgunj Sugar Factory Company Act, (1964)

14. Butwal Spinning Mill Corporation Act, (1983)

15. Cottage Industry and HandicraftEmporium Company Act, (1966)

16. Gorakhkali Rubber Plant Company Act

17. Harisiddhi Brick & Tile Factory Company Act, (1970)

- 88 -

ANNEX I.2Page 2 of 4

18. Hetauda Cement Factory Company Act, (1976)

19. Hetauda Textile Industry Company Act, (1974)

20. Himal Cement Company Company Act, (1970)

21. Integrated Textile Company Act

22. Janakpur Cigarette Factory Company Act, (1965)

23. Lumbini Sugar Factory Company Act, (1982)

24. Nepal Industrial Development Nepal Industrial DevelopmentCorporation Corporation Act, (1959)

25. Nepalgunj Paper Industry Company Act, (1983)

26. Raghupati Jute Mills Company Act, (1960)

27. Security Exchange Center Company Act, (1976)

28. Seti Cigarette Company Company Act

29. The Hides and Skins Cor?oration Company Act

30. Tobacco Development Co. Ltd. Company Act, (1971)

31. Udayapur Cement Factory Company Act

C. MINISTRY OF FINANCE

32. Credit Guarantee Corporation Company Act, (1974)

33. Nepal Bank Limited Commercial Bank Act, (1937)

34. Provident Fund Corporation Provident Fund Act, (1961)

35. Rastriya Banijya Bank Commercial Bank Act, (1964)

36. Rastriya Beema Sansthan National Insurance Corp. Act, (1968)

D. MINISTRY OF FOREST & SOIL CONSERVATION

37. Fuel(wood) Corporation Corporation Act, (1965)

38. Herb Production & Processing Ltd. Company Act, (1978)

39. Royal Drugs Ltd. Company Act, (1972)

- 89 _


40. Rosin and Turpentine Company Company Act, (1982)

41. The Timber Corporation of Nepal Company Act, (1960)

E. MINISTRY OF COMMUNICATION

42. Gorkhapatra Corporation Gorkhapatra Corp. Act, (1963)

43. Nepal Telecommunication Corp. Communication Corp. Act, (1969)

44. Nepal Television Communication Corp. Act, (1985)

45. Ratna Recording Corporation Communication Corp. Act, (1962)

46. Royal Nepal File Corporation Communication Corp. Act, (1971)

F. MINISTRY OF COMMERCE

47. Jute Development and TradingCorporation Corporation Act, (1974)

48. National Trading Ltd. Company Act, (1962)

49. Nepal Coal Ltd. Company Act, (1985)

50. Nepal Transit & Warehousing(P) Ltd. Company Act, (1971)

G. MINISTRY OF EDUCATION

51. Cultural Corporation Communication Corp. Act, (1972)

52. Janak Educational MaterialsCenter Ltd. Communication Corp. Act, (1978)

H. MINISTRY OF SUPPLIES

53. Nepal Food Corporation Corporation Act, (1974)

54. Nepal Oil Corporation Ltd. Company Act, (1971)

55. Nepal Lube Oil Company Act, (1985)

56. Nepal Bitusen & Barrel Industry Company Act

- 90 -


I. MINISTRY OF WATER RESOURCES

57. Drinking Water & Sewerage Corp. Dev. Board Act, (1973)

58. Nepal Electricity Authority Electricity Authority Act, (1985)

J. MINISTRY OF WORKS AND TRANSPORT

59. National Construction Companyof Nepal Company Act, (1961)

60. Transport Corporation of Nepal Corporation Act, (1965)

K. MINISTRY OF TOURISM

61. Royal Nepal Airlines Corporation RNAC Act, (1962)

Source: Lyell Ritchie, *Privatization Prospects in Nepal," 1987, Updated.

- 91 -

CAPACITY UTILIZATIOM OF SELECTED PUBLIC ENTERPRISES

AnnualIA o... at,o Pc.¶q

NMem of the Indua.t-o. Capac,ty 1080/81 1481/82 1982/83 1tl3/84 194/51fi9/8486 198S/87 1987/88 1908/69

Banabari Loather end Shoes 150000 98.76 86.30 68.40 74.08 48.00 60.60 76.00 68.00 75.33Shoe . Fstory

Processed Leath r1,800.000 Sq.Ft. 96.65 64.93 04.77 107.83 91.80 64.00 78.00 105.63 106.20

Se i-ProceeedLath*er 900.000Sq.Ft. - 75.74 91.34 62.64 52.87 81.75 78.78 81.89 75.00

8irgunj Sugsr Factory S'.ar 13.500M. Ton 44.89 94.95 106.1t 87.96 SS.26 70.19 102.04 98.68 68.9

eirgunj DOstillary Rectified Spirit1.350,000 Lt. - 18.61 19.25 27.32 82.51 60.43 s. 44 87.02 68.89

J nakpur Ciasrette Cigarette 5.25Factory 8illion Stick* 39.00 b8.00 68.00 78.00 60.20 89.50 100.00 98.29 97.70

Brick A Ti 1- Factory Brick 25Heriaiddi Million 49.20 56.00 76.00 67.20 60.00 64.12 80.00 67.79 68.00

Bhaktapur Brick Brick 20Factory Mill ion 50.50 61.50 89.50 75.00 74.00 68.50 71.00 65.50 68.00

Metauda T*xtil1 Cloth 110 Loe.Industry Motre. 28.75 42.73 48.34 52.07 54.00 61.60 69.06 59.07 54.05

Miamil Cement. Company Coment128,400 M.Ton 70.71 70.77 77.00 79.68 65.6 69.2 41.1 3.0 -

Agriculture TooleFactory Tools 450 MT 19.11 84.00 81.78 110.00 99.00 90.00 83.33 90.00 87.50

Ageo-Lime Industry Agro-Lim*6,000 m.Ton - 6.22 8.69 9.00 19.83 8.72 4.34 8.33

Chemical Lim*6.000 M.Ton 50.00 90.00 116.67 116.67 116.67 203.33 353.33 538.33

Hetauda Cement Factory Cecent M.Ton231,750 - - - - - 23.70 49.80 58.20 59.40

Brikuti Paper Factory 3,000 M.Ton - - - - - - 49.73 81.13 90.00

DOC Milk; 36.6 oil.liters - 3.80 59.50 41.00 57.10

tDL Tablets: 200mil. pieces 72.00 78.60 74.30 60.70 72.40

Liquid/Ointm nt.:1.S millionbottle, 73.30 92.70 98.00 80.00 77.30

R.J Hessian: 3.3Thousand MT 72.70 90.90 72.70 78.90 57.60

Bags: 4.2Thousand MT 109.50 78.60 66.7C 73.80 57.10

Twine: 0.3Thousand MT 93.30 103.30 103.30 106.70 96.70

DOC * Dairy Oevelopmnt CorporationRDL Royal DOrug LimitedRJM a Raghupati Jute Mill

Sourco: Corporation Coordination Di.iaon, MOF.

ANNEX I.4

PEs DIVIDEND DISTRIBUTION STATEMENT

1984/86 1985/88 1988/87 1987/88 1988/89

Nepal Bank Limited 1,938,460.00 3,101,620.00 1,033,840.00 2,684,800.00 4,648,898.00N.I.D.C. 2,216,967.00 2,829,191.16 4,400,068.29 2,400,000.00 800,000.00Janakpur Cigarottos Factory 3,088,906.00 6,218,113.00 4,600,000.00 - 3,000,000.00National Insurance Corp. 390,000.00 56,6S5.66 1,170,000.00 - 1,603,333.33Security Marketing A Cerviing Centre 32,278.51Nepal Rastra Bank 76,930,402.87 90,033,415.94 96,141,728.59 110,000,000.00 172,782,624.47Birgunj Sugar Factory 3,600,000.00 6,690,411.00 - 1,949,022.02 3,928,202.00The Judhr Match Factory 604.00 604.00 - 448.00 -Salt Trading Corporation 241,360.00 289,600.00 289,600.00 77,200.00 193,000.00Cottage and Handicraft Sales Centre 204,280.47 - - 74,083.73 -Rastria Banijya Bank - 1,000,000.00 - -Royal Drug Li;ited - 447,990.00Agriculture Dovolopment Bank - 617,614.66Loan Guarantee Corp. - 2,500.00 60,972.00 80,268.33 160,000.00Nepal Oil Corp. - - - - 11,690,000.00

Total 87,642,137.85 109,888,215.20 106,688,098.88 117,186,582.08 198,493,9SS.80

Source:

ANNEX I.6

COMMERCIAL BANK LOAN TO PUBLIC ENTERPRISES UNDER HMG/NEPAL GUARANTEE(As at July 16, 1989)

(Rs ;n '000)

S. Nepal Bank Ltd. Rastriya Banijya Bank Grand TotalNo. Far WestPublic Enterpris.sxport Co. Principal InterestL Total Principal Interestla Total Principal InterestL Total

1. Far Western Rice I Paddy Export Co. 20481 41002 61483 48488 88197 134696 e8989 127199 1961682. Janakpur Rice A Paddy Export Co. 10600 14993 26493 8700 10147 16847 17200 25140 423403. Sagarmatha Rico A Paddy Export Co. 12000 26069 37089 12200 21347 33647 24200 46418 706164. Lumbini Rico A Paddy Export Co. 5000 8274 13274 2903 4723 7626 7903 12997 20900S. Mechi Rice A Paddy Export Co. 24000 40800 64800 10183 17734 27917 34183 58634 9271718. Raghupati Jute Mills 15000 13637 28e37 3eooo 22782 58782 61000 38419 874197. Nepal Food Corporation 204683 118729 323312 37171 73244 110416 241754 191973 4337278. Nepal Transportation Corp. 1000 662 1862 1000 862 16629. Bhatnagar Jute Mills 29824 19949 49773 29824 19949 4977310. Nepal Television 9400 1846 11045 9400 1645 1104511. Nepal Oriend Magnesit. 29400 9330 38730 29400 9330 3873012. Nepal Tea Development Corp. 2000 660 2560 2000 550 2550

GRAND TOTAL 331788 284760 ele648 163e45 236174 389819 485433 520934 1006357

/a Excludes penalty and others.

Source:

- 94 -

- 95 -

A!L. 1~1.*pas I of2

MINISTRY OF SUPPLIES

ROLE OF GOVERNlENT IN PRICING. DIS1RIWJTION

AND MARKETINC OF ESSENTIAL COWAT!ES

1. Set policy on supply and distribution of 'oost sseontiall commodities. Sot poliCy onsupply *n6 distribution of food coemodities.

2. Conduct studies, research, surveys, analysis and training on supplies.

3. Supply Corporations: Nepal Food Corporation Timber Corporation, Energy Corporation, CoolCompany, National Trading Limited, Nopnl Oil Corporation, Nepal Lube Oil, Nepal Situmn ABarrel Industry, Koshi A Naraysni Trading Company.

4. Administration on supply of *ssential cowmmodities, Including market administration, andprice monitoring.

5. Maintain liaison with national, regional, international agenceso regarding supplies, andmake arrangements for rogular and continued adequate supply of eusential consumable itemsto general public.

6. Liaison with Ministry of Commerce and make necessary arrangements regarding theimport4tion, supply of essential consumable goods and construction materials.

S.No. Name of Commodity Relating Agenceio Res. Ministry

1. Food:Rice/Paddy Nepal Food Corp. Min. of SuppliesFineCorse

2. Maize Nepal Food Corp. Min. of Supplies

3. Whoat Nepal Food Corp. Min. of SuppliesWhoat/Flour Salt Trading Corp. Minm of Supplies

4. Flattened Rice Nepal Food Corp. Min. of Supplies

S. Pulses Nepal Food Corp. Mn. of SuppliesPigeon Pea (Rahar)Black Gram

6. Salt Salt Trading Corp. Min. of Supplies

7. Sugar Salt Trading Corp. Mn. of SuppliesSugar Industries Hin. of Industries

8. Too Nopal Tea D-v. Corp. Min. of Agriculture

9. Oil Nepal Food Corp. Min. of SuppliesMustard Salt Trading Corp. Hin. of SuppliesSoyaboen

10. Choe Salt Trading Corp. Hin. of Supplies(Butter S Vog.)

11. Milk Dairy Dev. Corp. Hin. of Agriculture(Milk, Baby Food,Powdered)

12. Vegetable Private Sector(Potato, Onion,Tomato)

13. Moat Private Sector(Buff, Mutton, Chicken,Pork, Fish)

14. Fruits Private Sector

- 90 -

ANNEX II.1Page 2 of 2

S No. Name of Commodity Relating Agenci-s Res. Ministry

(Mausom(C ; trus)Banana, Apple, Orange)

16. Spices Private Sec4vor(Cumin, Blackpepper,Ginger, Garlic, Chilli)

Other Essential Goods

16. Medicine Snjha Swastha Swa Min. of HealthMedicine Mgt. Dept.Singha DurbarBaidhys Khona

17. Cotton Clothes Cotton Industries Min. of Industries(Up to 40 Count)

i8. Soap Soap Industries Mn. of IndustriesDetergent (Laundry)Toilet

19. Petroleum Products Nepal Oil Corp. Mn. of Supplies(Petrol, Kerosene,Diesel, Aviation Fuel)

20. Fertilizer Agri. Input Corp. Mn. of Agriculture

21. Fuel Mn. of SupplionFuel Wood Indhnn Corp.Coal Nepal Coal Ltd. Mn. of Supplies

Construction Material

22. Cement Cement Industries Mn. of IndustriesNational Trad. Ltd. Min. of Supplies

23. Tore Steel Private Industries Mn. of Industri;s(Iron Rod) National Trod. Ltd. Min. of Supplies

24. G.I. Sheets National Trad. Ltd. Mn. of Supplios

26. G.I. A Polythine Pipe National Trod. Ltd. Min. of Supplies

26. Bricks Industry of Bricks Min. of Industries

27. Timber Timber Corporation Mn. of Supplies

Educational Material

28. Writing & Printing Papor Industries Mn. of IndustriesPaper (Writing Copy,Pen, Ink, Pencil)

29. News Print National Trod. Ltd. Mn. of Supplies

Source:

- 97 -

ANNEX V.1

NEPAL

PUBLIC ENTERPRISE SECTOR STUDY

Comparison of PE and Civil Service Pay Scales

PEs Civil Service

Levels Salary (NRs) Job Cate'ories Salary (NRs)

Special Class 3,815 Secretary 3,970

11 3,425 Additional Secretary 3,470

10 3,025 Joint Secretary 3,025

9 2,410 Under Serretary 2,300

8 2,300

7 1,915 Assistant Secretary 2,050

6 1,750 Section Officer 1,750

5 1,145 Non Gaz. Class IV 1,145

4 940 Non Gaz. Class III 940

3 810 Non Gaz. Class II 810

2 720 Non Gaz. Class I 720

1 640 Peons etc. 640

tAL

PIYI egm"ISE SCe0R STWY

Salo"t Analysis

Public Enterpriore

Monthly Srick Cement Drugs Iron Jute Hilk Paper Steel Ter Yore Teati l-*i nm and Producti Prodctewage Ti lee

NR Per Month

OperativesPeon 425 510 S10 510 510 392 510 510 510 510 425 510

Laborer 425 425 510 575 392 620 510 510 360 48S 545Sei -ei led 465 465 645 700 575 429 700 575 575 450 552 6V0Ski lled 552 552 915 750 644 815 545 545 eo0 598 *15

Techn i c i anHighly killod 898 1.400 750 915 :0Technician 915 915 915 1,400 975 750 916 1.400 995Engineers 1,400 1.,50 1.530 1.840 1.430 1,.51 1,530 1.530 1.925

MonageentSupervisor 1.430 515 1.400 730 1.400Overser 2,740 915Department manager 1530 1.840 1.840 1.430 1,925 1.,40 1.900 2,420 1.725General Manager 3.050 4,300 2,300 2.740 3.050

Profei one iJunior 1.840Senior 1,400 2,320

AdministrationJunior Clark 750 750 700 650 700 750 715 750Clerk SO 750 700 815 615 915 715 *15Senior Clerk 915 1.400 915 1.400 915 915 915

Support StaffPorronnel Officer 1,400 1.430 1.40CComputer Staff 1.400Soloman 645Marketing anager 1,400Oers

Source: UNID Manpower Planning and Hmamn RPource Developmnt for the Industrial Sactor (My 18).

Selry Analw-ilkPeivatm Sector

Monthly BrickMininu- and Carpet* C-_ent Footwear Carwnt- Jut. Milk and Milk Paper St-el Sugar Yorn andWage Tiles Products Product. Refining Teatlee

Ntn per nnth

Operative.Peon 425 650 500 500 525 S50 550 750 500 400 375 625Laborer 425 750 600 425 550 550 780 610 425 625 G00Se_; ski ied 466 600 600 626 750 600 978 6NO CO 475 900Skilled S52 900 1.200 600 960 640 1,400 1.200 £80 1.00

TechniciansHighly ski led 698 1.700 615Technicinn 1.000 1,100 2.,00 1,500 1.400 1.300Engineere 2.200 2,000 1.400 '0

Supervisor 1.200 1.0CO 1.850 1.600 2.5CO 60 1.200 l1.00Over*e 1.200 1.500 1.000 1.400DOpartmnt Manaer 1.00 1.300 2.000 2.300 a,s5o 3o0o 2.8OGeneral Manseer 3.000 3,000 2.100 2.000 6.040 4,000 4.000 t.000 J,XO

pri;eeeonnlJuniorSenior

AdministrationJunior Clark 1.000 JON 1.200 700 U15Clert a00 1,200 660 G15Senior Clerk 1.,00 1.100 1.000

Support StaffPereonnael Officer 1,700Cotater StaffSaleme_n 1,000 65 1.400Marketing Managr 1.O 1.200Others

Source: U14P Manpower Planning and I"_n Reeource Oevelopment for the Industrial Sector (May 198).

- 100 -

ANNEX V.3

NEPAL

PU8LIC ENTERPRISE SECTOR STUDY

Sal AnalysisJoint Ventures

Monthly HULLPrivate Privat-/Foreign lnvestorsMinimum rugs Fruit Plywood St I Ysrn andWage Canning Products Textile

NRa Per Month

OperativesPeon 425 410 426 496 626 476Laborer 425 410 426 666 626 475Semi-skilled 486 486 egg 700 616Skilled 562 562 776 800 860

TechniciansHighly skilled 898 1,300 925 760Technician 2,180Engineers 1,430 3,000 2,160

ManagementSupervisor 816 1,680 1,600Overseer 2,500Department Manager 1,300 1L,000 2,910 2,860General Manager 2,760 3,060 3,496 8,600

ProfessionalJunior 630 800Senior

AdministrationJunior clerk 630 esoClerk 830 915 800 660Senior clerk 630 926 1,200

Support StaffPersonnel Officer 1,300Computer Staff 1,800 1,500Salesmen 1,3e8

Source: UNIDO Survey 1988

- 101 -

ANNEX V.4

NEPAL


OUTPUT PER EMPLOYEE IN PUBLIC AND PRIVATE SECTORS

Sub-Sector Nos. Employed Output Unit Output perEmployee

Brick and TilesPrivate 73 3,000,000 Pcs 41,096HMG 456 14,274,400 Pcs 31,304

Milk and Milk ProductsPrivate 65 2,962,384 LTRS 45,575HMG 804 22,700,685 LTRS 28,235

Leather IndustryPrivate 152 1,301,773 SFT 8,564HMG 452 1,450,085 SFT 3,208

TextilesPrivate 2,505 5,798,134 MTR 2,315Private/Foreign 286 1,812,174 MTR 6,336HMG 1,532 1,619,227 MTR 1,057

Jute MillsPrivate 4,323 10,842 MT 2.5HMG 2,071 6,041 MT 2.9

Source: UNIDO, Manpower Planning and HRD for the Industrial Sector, May 1988.

ANNEX V.6

NEPAL


Supply and Demand for Skilled and Qualified Manpower

Occupational Current Future Needs Total Qualified Total Difference

Classification Needs upto 1995/98 Demand Output from SupplyFormal Training1988 1990 1996

SkilledMechani;cs 320 355 676 68 112 280 448 -1,062

Machinists 390 435 825

Electrician 285 332 617 29 68 146 232 -386

Weavers 2,100 5,600Potters 10 10 20 -20

Tea Preparation 135 175 310 -310

Highly SkilledMechanics 133 133 20 40 200 260 +46

Machinists 11 70 81Tanneri s 6 6 -6

Textile Processors 12 12 -12

TechniciansMachine 28 36 64 24 49 241 314 +250

Animal Feed 3 3 -3

Food 13 13 3 3 -10

Dairy 270 270 2 -268

Rubber 3 3 -3

Sugar 38 7 45 2 1 -42

Tea 10 10 -10

Leather 3 3 -3

Textile 59 16 75 -76

Plywood 3 3 -3

EngineersMechanical 190 116 306 4 18 22 -284

Electrical 90 53 143 10 30 33 73 -70

Chemical 25 116 141 19 38 95 152 +11

Production 13 13 -13

ProfessionalPharmacist 3 68 71 8 16 4 26 -48

Food Technology 3 3 -3

Plastic Technology 3 3 -3

Plywood Technology 3 3 -3

Sugar, Alcohol 10 10 -10

Leather 20 20 -20

Tea 10 10 -10

Agronomist 7 7 -7

Source: UNIDO Survey 1988.

- 1() 3 -~

ANNEX VI.IPage 1 of 2

COMPANY VALUATION

1. The valuation of enterprises being privatized is a sensitive issue.It is a matter of fine judgement to ensure pricing attracts willing investorswhile ensuring that public assets are not sold "cheaply'. A full valuationrequires the analysis and appraisal of each PE including, inter alia, a reviewof its products, its management structure and organization, Its competitors,and its past and future financial performance as discussed in the previoussection. HMG will need to assess.

- The market's current rating of the industries in which PEs to bevalued operate, by reference to the prices at which shares inbroadly comparable companies are currently trading which will belimited in Nepal at present so comparative markets could be used asbench marks.

- Recent acquisitions and takeovers and the prices achieved in recentsales of companies operating in broadly similar industries in bothNepal and in other developing economies; and

- The rate of return expected within the industry.

2. On the basis of the financial information available on the PEs andthe information about the industries in which they operate HMG will providevaluation opinions using both the following valuation methods: DiscountedCash Flow ("DCF") method and Net Worth method.

(a) Discounted Cash Flow ("DCF') Method. The most appropriate approachto valuing the PEs will probably be on the basis of the futureearnings capacity of each of the selected enterprises. the DCFtechnique bases the valuation on projected future operating cashflows discounted to their present value at a discount rate whichreflects the opportunity costs of the investment funds and the riskof investment. The sum of the discounted future cash flowsrepresents the net present value ("NPV") of the company.Subtracting the value of existing debt leads to the NPV of theinvestment opportunity for potential investors.

The main use of the DCF valuation is to advise the HMG, as seller,on the best price that could be obtained from selling a particularenterprise. They can also be used in determining the price at whicha floatation could take place. In the case of a trade sale thebuyer will, of course, have to make his own judgement about thepotential performance of the enterprise and the risks involved.

(b) Net Worth. The purpose of calculating net worth is to see whetherthe value of the assets might exceed the value of the business ascalculated by SCF methods. It is entirely possible that poorlyperforming PEs will have assets such as land which will be morevaluable, in alternative uses, that the business could ever be. In

- 14-

ANNEX VI.1Page 2 of 2

such cases there is a risk of asset stripping and it will benecessary for H-MG to be particularly cautious in this area.

3. HMG's stated objectives will influence the conditions for sales.Pricing raises the difficult issue of reconciling the need to maximizeproceeds with other objectives. For example, while a certain type oftransaction such as management/employee buy-out might yield HMG a minimalprice, it might be preferable if it better addresses their economic, politicaland social objectives.

Documents

Nepal Nonfinancial Public Enterprises Sector Report · 2016. 7. 12. · Nepal. This report examines the performance of Nepal's nonfinancial public enterprises (referred to subsequently