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Completion Report

Project Number: 36195 Loan Number: 2002 December 2008

Nepal: Public Sector Management Program

CURRENCY EQUIVALENTS

Currency Unit – Nepalese rupees (NRe/NRs)

At Appraisal At Project Completion 17 February 2003 21 August 2006

NRe1.00 = $0.0157 $0.0153 $1.00 = NRs63.40 NRs65.00

ABBREVIATIONS

ADB Asian Development Bank DDC district development committee EA executing agency GATT General Agreement on Tariffs and Trade MOF Ministry of Finance MTEF Medium Term Expenditure Framework NIDC Nepal Industrial Development Corporation PCR program completion report SDR special drawing rights TA technical assistance VAT value added tax

NOTES

(i) The fiscal year (FY) of the Government and its agencies ends on 15 July. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2006 ends on 15 July 2006.

(ii) In this report, "$" refers to US dollars.

Vice-President X. Zhao, Vice-President, Operations Group 1 Director General K. Senga, South Asia Department Director B. Hitchcock, Nepal Resident Mission (NRM), South Asia Department Team leader R. Tuladhar, Sr. Programs Officer, NRM Team Member N. Nakarmi, Administrative Assistant, NRM

CONTENTS

Page

BASIC DATA i

I. PROGRAM DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 1 A. Relevance of Design and Formulation 1 B. Program Outputs 2 C. Program Costs 7 D. Disbursements 7 E. Program Schedule 7 F. Implementation Arrangements 7 G. Conditions and Covenants 8 H. Related Technical Assistance 9 I. Consultant Recruitment and Procurement 9 J. Performance of Consultants, Contractors, and Suppliers 9 K. Performance of the Borrower and the Executing Agency 9 L. Performance of the Asian Development Bank 10

III. EVALUATION OF PERFORMANCE 10 A. Relevance 10 B. Effectiveness in Achieving Outcomes 11 C. Efficiency in Achieving Outcome and Outputs 12 D. Preliminary Assessment of Sustainability 12 E. Institutional Development 12 F. Impact 13

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 13 A. Overall Assessment 13 B. Lessons 14 C. Recommendations 14

APPENDIXES 1. Program Framework 16 2. Implementation Status of Public Sector Management Program Policy Conditions 21 3. Status of Privatization and Liquidation of Public Enterprises 28 4. Utilization of Counterpart Fund Generated by the First Tranche 30 5. Status of Compliance with Loan Covenants 32 6. Technical Assistance Completion Report 35

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BASIC DATA A. Loan Identification 1. Country 2. Loan Number 3. Program Title 4. Borrower 5. Executing Agency 6. Amount of Loan 7. Program Completion Report Number

Nepal 2002 Public Sector Management Program Nepal Ministry of Finance SDR24.649 million ($35 million) 1084

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness – In Loan Agreement – Actual – Number of Extensions 6. Closing Date – In Loan Agreement – Actual – Number of Extensions 7. Terms of Loan – Interest Rate – Maturity (number of years) – Grace Period (number of years) 8. Terms of Relending (if any) – Interest Rate – Maturity (number of years) – Grace Period (number of years)

-- Second-Step Borrower

17 February 2003 28 February 2003 9 June 2003 11 June 2003 8 July 2003 10 July 2003 10 July 2003 10 July 2003 None 30 June 2005 21 August 2006 1 Grace Period—1%; Amortization Period—1.5% 24 8 Not Applicable

9. Disbursements a. Dates Initial Disbursement

14 July 2003

Final Disbursement -

Time Interval -

Effective Date

10 July 2003

Original Closing Date

30 June 2005

Time Interval

23 months

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b. Amount ($ ‘000)

Category or Subloan

Original Allocation

Last Revised

Allocation

Amount

Canceled

Net Amount

Available

Amount

Disbursed

Undisbursed Balance

01 24.649 14.085 10.564 14.085 14.085 - Total (SDR) 24.649 14.085 10.564 14.085 14.085 - Total ($ equivalent) 35.000 19.731 15.686 19.731 19.731 -

10. Local Costs (Financed) - Amount ($) Not Applicable - Percent of Local Costs Not Applicable - Percent of Total Cost Not Applicable C. Program Data Program Performance Report Ratings

Ratings Implementation Period

Development Objectives

Implementation Progress

From 10 July 2003 to 31 December 2003 Satisfactory Partly Satisfactory From 1 January 2004 to 31 December 2004 Partly Satisfactory Partly Satisfactory From 1 January 2005 to 31 December 2005 Partly Satisfactory Partly Satisfactory From 1 January 2006 to 31 December 2006 Partly Satisfactory Partly Satisfactory From 1 January 2007 to 31 January 2007 Partly Satisfactory Partly Satisfactory D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Inception Mission 08-13 Oct 2003 2 10 a Review Mission 1 24 Feb-03 Mar 2004 2 22 a Review Mission 2 23-27 Aug 2004 1 2 a Review Mission 3 16 Mar-01 Apr 2005 2 34 b Review Mission 4 31 Jul-04 Aug 2006 2 10 b Program Completion Review* 12-22 May 2008 1 9 b

a-Professional Staff, b-National Officer *The program completion report was prepared by R. Tuladhar, Senior Programs Officer, Nepal Resident Mission

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I. PROGRAM DESCRIPTION 1. On 8 July 2003, the Asian Development Bank (ADB) approved a loan of SDR24.649 million ($35 million at the prevailing exchange rate) for the Public Sector Management Program at a time when Nepal was embarking on its first poverty reduction strategy in the face of a sharp economic downturn from the impact of the ongoing civil conflict and political turmoil. The Program’s objective was to support the Government in the implementation of its poverty reduction strategy embodied in the Tenth Plan (FY2003–FY2007) by addressing key policy and institutional constraints to strengthening the Government’s resource position over the medium term, and laying the foundation for accelerating pro-poor growth in support of poverty reduction. The Program covered three broad components: (i) strengthening the fiscal position of the Government, (ii) facilitating the Government’s disengagement from public enterprise management and ownership, and (iii) strengthening public and corporate sector governance. The Program Framework is in Appendix 1.

2. In conjunction with the loan, ADB provided the advisory technical assistance (TA) 4141-NEP: Supporting Government Disengagement from Public Enterprises1 to assist the Government in undertaking public enterprises-related reforms and managing the Program. 3. This report evaluates the program design and its implementation until September 2006, when the Program was cancelled. The report also evaluates the current status of the reforms under the Program, taking into account the lack of reliable data and institutional memory in the counterpart agencies. (Conflict and frequent political changes have resulted in a large turnover of many government officials associated with program design and implementation).

II. EVALUATION OF DESIGN AND IMPLEMENTATION A. Relevance of Design and Formulation 4. The Program was designed to support the Government in implementing the Tenth Plan, the main objective of which was to reduce poverty through high levels of sustainable and broad-based economic growth, effective basic social services delivery, rural infrastructure development, targeted programs, and good governance. Given the challenges the Government was facing in implementing the poverty reduction strategy, especially the severe resource constraints imposed by rising security spending and declining revenue collection, the Program’s focus on strengthening the fiscal position was timely and relevant. It also supported prioritizing development projects and improving the budget process through the Medium Term Expenditure Framework (MTEF), which aimed to prioritize budget allocations to development projects based on their potential to contribute to poverty reduction. The privatization of non-performing public enterprises and introduction of policies to contain their liabilities were also aimed at strengthening the Government’s resource position. The aim of the public sector governance component to right size the civil service, support devolution of public services to local bodies, and improve public sector accountability and transparency was consistent with the Tenth Plan’s strategic thrusts of effective delivery of basic social services and good governance. 5. The Program was in line with the poverty reduction objective of ADB’s country operational strategy 2000–2004 and its strategic elements such as decentralization, improving basic social services, and private sector development. Although the Government’s poverty

1 ADB. 2003. Supporting Government Disengagement from Public Enterprises. Manila (TA 4141-NEP, approved on 8 July 2003)

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reduction strategy was launched only in July 2002, poverty reduction was the overarching goal in ADB’s country operational strategy and continues to be so in its country strategy and program 2005–2009. The country strategy and program stresses the need for sound macroeconomic management, strengthening public service delivery through local communities, and improving the investment climate. The Program, therefore, remains broadly relevant. 6. ADB consulted with other development partners, both bilateral and multilateral, while designing the Program. Regular consultations were undertaken with the International Monetary Fund and World Bank to ensure coordination and synergy with their similar reform programs, the Poverty Reduction Growth Facility and Poverty Reduction Support Credit, respectively. There were no changes in the agreed-upon reform measures during program implementation. B. Program Outputs 7. The detailed policy actions (36 tranche conditions) and their status of implementation are given in Appendix 2. Implementation of the main policy actions and achievement of the intended Program outputs are assessed in the following paragraphs.

1. Strengthen the Fiscal Position of the Government

i. Improving Expenditure Management

8. To strengthen public expenditure management, the Program supported prioritization of development projects, effective utilization of allocated budgets, and introduction of measures to control budget transfers to public enterprises and their contingent liabilities. With the objective of effectively prioritizing its expenditures and enhancing implementation of poverty-focused projects, the Government developed the MTEF in 2002 as a three-year rolling budget framework based on a more realistic estimate of budget resources. A set of objective criteria2 was a key element of the MTEF for prioritizing the portfolio of development projects that had grown too large relative to available budget resources. All development projects were prioritized based on these criteria in two ways beginning in FY2002. First, the existing project portfolio was consolidated by eliminating or amalgamating projects that did not meet the MTEF criteria in two steps—reducing the number of projects from 731 in FY2001 to 633 in FY2002, and then to 434 in FY2003. The portfolio size has since been reduced to about 407 projects currently through further consolidation and closure of completed projects.

9. The second prioritization approach was more far reaching. The prioritized projects through the first approach were classified into three categories (P1, P2, and P3) in order of priority based on the above criteria and a budget process was developed that ensured adequate budget allocation to projects on a priority basis in the event of a revenue shortfall, i.e., full budget allocation to P2 and P3 projects only after ensuring full allocation to P1 projects. The MTEF also introduced an important system of medium-term programming—at the project, sector, and national levels—based on realistic resource estimates to establish the vital link between the annual budget and the periodic development plan. While the MTEF was applied to

2 The criteria include contribution to poverty reduction, regional balance, level of government involvement, people’s

participation, and participation of local bodies in line with decentralization. While the criteria were modified slightly in FY2007 to give emphasis to reconstruction and rehabilitation in the post-conflict transitional period, additional efforts are under way for further refinement.

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the development (capital) expenditure part of the budget at the outset of the Tenth Plan, it has also been extended to cover the recurrent part of the budget since FY2006. In addition, the MTEF has been rolled out to the district level, starting with three districts initially and extending to an additional seven districts. While about 70% of the development projects were classified initially as P1, the proportion gradually increased to about 87% in FY2008, indicating further consolidation of the portfolio of development projects. 10. To further enhance the utilization of budget resources, the Government introduced a performance-based budget release mechanism on a pilot basis in December 2002. It has subsequently been extended to all development projects. Under this mechanism, all P1 projects are being provided one-third of their annual budget at the outset of a fiscal year, with subsequent budget releases subject to performance in terms of both budget utilization and physical progress. Although the performance-based budget release system continues to be implemented for all projects resulting in enhanced project implementation and more effective budget utilization, some practical difficulties are being encountered in enforcing this system uniformly across all projects based on the same criteria, given the difficulty in assessing the performance of projects that are different in nature. The need for some modification of the performance criteria has emerged. 11. Under the Program, the Government was required to prepare and implement a time-bound action plan beginning in FY2004 to reduce budget transfers to public enterprises, their contingent liabilities, and the exposure of creditors. A task force, constituted in October 2003 and chaired by the Joint Secretary of the Corporation Coordination Division of the Ministry of Finance (MOF), prepared an action plan to this effect in February 2004. However, the action plan insufficiently identified the public enterprises’ contingent liabilities and the necessary details for implementation of its recommendations. Irrespective of these deficiencies, there have been no concrete actions on the task force’s recommendations.

ii. Strengthening Revenue Mobilization and Management

12. To help the Government generate more revenues, the Program envisaged formation of a task force to prepare and implement a comprehensive revenue mobilization strategy focusing on strengthening value added tax (VAT) collection, reducing exemptions, improving collection of tax arrears and customs valuation, and strengthening the performance of the Inland Revenue Department. The revenue task force was constituted in January 2003, chaired by a member of the National Planning Commission (NPC) and comprised representatives of relevant government agencies, the private sector, and academia. Based on the recommendations of the task force in the above areas, the Government increased the VAT rate from 10% to 13% in FY2004, launched an intensive public awareness program in FY2006 to improve business compliance with VAT billing, and fully automated VAT administration. The Government also established the Large Tax Payers’ Office within the Inland Revenue Department in January 2003 to improve services to large tax payers (through information technology-based tax registration, filing, and payment systems), which has had a significant positive impact on VAT and income tax collections. However, while the task force had recommended a three-year schedule for elimination of VAT exemption on various goods and services starting in FY2004, implementation has been limited with the removal of exemptions from only a few items such as raw mustard oil, various seeds, kerosene, and certain commercial and professional services. 13. The Government launched a three-year customs reform program in 2003 focusing on improving the valuation of imported goods, simplification of the customs clearance procedure, modernization of customs administration and physical facilities, and post-clearance audit. As

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part of the reform program, the automated systems for customs data (ASYCUDA) have been extended to seven more customs points (from three at appraisal) and a new Customs Act and implementation regulations (in line with World Trade Organization and Kyoto conventions) were promulgated in May 2008, leading to adoption of the General Agreement on Tariffs and Trade (GATT) valuation system. While these reform measures have contributed to some improvement in overall customs administration and increased customs duty collection, much remains to be done in improving the valuation system through effective implementation of the ASYCUDA at the various customs points and full adoption of the GATT valuation system. 14. The Government filled 58 of the 70 vacant professional staff positions in the Inland Revenue Department in May 2003 enhancing the department’s tax administration capacity and the effectiveness of tax reforms. In view of the perennial problem of creation of vacant positions through natural attrition and the lengthy process of filling them, the amendment of the 1992 Civil Service Act in 2007 has made provisions for temporary filling of vacant positions and shortened the regular recruitment process. The Government also introduced a performance-based monitoring system in the Inland Revenue Department and Department of Customs in FY2004 based on a set of key performance indicators relating to the improvement of tax collections, conduct of tax audits, and collection of tax arrears, among other items. The monitoring system was further enhanced in FY2007 by introducing a cash incentive scheme with encouraging results in selected tax offices, including the Large Tax Payers’ Office of the Inland Revenue Department in the towns of Dharan and Nepalgunj, and the Inland Container Depot in Birgunj. Plans are underway to gradually extend this scheme to other tax offices.

2. Disengagement from Public Enterprises Ownership and Management

15. To strengthen the poverty focus of public expenditure, the Program envisaged containing and gradually reducing budget expenditures on public enterprises and their contingent liabilities through specific short- and medium-term measures. Key short-term actions included capping aggregate employment in public enterprises, improving the management of public enterprises by reconstituting their boards and clearing audit backlogs, and privatizing or liquidating selected public enterprises. A government decision in July 2003 restricted public enterprises from creating additional employment positions and recruiting for vacant positions, which gradually reduced the aggregate number of employees in public enterprises through retrenchment. The Government also issued a directive in December 2002 to reconstitute public enterprise boards by limiting the number of board members and appointing industry and trade professionals. While most public enterprise boards were downsized to 4 or 5 members, these boards have not been effectively professionalized as senior bureaucrats have been appointed as chairmen or chief executive officers in most cases without adopting the required competitive recruitment process. While only 20 of the total 38 public enterprises had their audits for FY2002 completed at the outset of the Program, the number of public enterprises that complied with this requirement for FY2005 improved to 30.

16. The Program envisaged reviving the Government’s privatization program through short- as well as medium-term measures. In the short term (within the Program period), the Government sought to privatize or liquidate nine public enterprises by settling their dues to employees, financial institutions, and other creditors in accordance with prevailing laws. In order to overcome bureaucratic hurdles and ensure timely decisions on privatization or liquidation actions, the management and supervisory responsibility of these public enterprises was transferred to MOF through a government decision in June 2003. The current privatization or liquidation status of the nine public enterprises selected under the Program is in Appendix 3. To date, five public enterprises have been privatized or liquidated. Although their liabilities have

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been substantially settled, liquidation of three public enterprises remains incomplete due to the pending sale of assets and litigation issues involving employees seeking higher compensation. No privatization or liquidation action has been taken so far on one public enterprise.

17. The Government was also required to complete operational review of two state-owned financial institutions—the Agriculture Development Bank of Nepal (ADBN) and Nepal Industrial Development Corporation (NIDC)—and prepare strategies and action plans for their restructuring. The operational reviews were completed in July 2003. Accordingly, a restructuring plan was prepared for ADBN in 2005 and was followed by significant restructuring, including partial divestment.3 While the operational review recommended dissolution of NIDC in view of its high non-performing loans, no restructuring plans have been prepared for it so far. Although the Government has not yet taken any clear decision on the future of NIDC, it was incorporated as a Class C4 financial institution under the Banks and Financial Institutions Act in 2005.

18. For effective management of privatization in the longer term, a medium-term privatization strategy and labor retrenchment policy were developed in January 2005 in close consultation with relevant government agencies and other key stakeholders, and with the support of TA 4141 (footnote 1). The draft privatization strategy proposed establishment of an autonomous agency to carry out privatization transactions more effectively and efficiently. The labor retrenchment policy—prepared under the supervision of the Department of Labor and endorsed by the Central Labor Advisory Board—proposed a systematic and transparent approach while undertaking labor retrenchment in public enterprises. Although the recommendations of the Government’s high-level public enterprise reform committee in 2007 were in line with the earlier proposals, no clear decisions have been taken.

19. The Program also envisaged improving the legal framework for strengthening corporate governance through enactment of new company, insolvency, and secured transactions laws. The insolvency and secured transactions laws were first promulgated as ordinances in September 2005 and the company law (also as an ordinance) in October 2006. They were later enacted by the interim Parliament as acts in late 2006. While working regulations for the Insolvency Act were issued in 2007, such regulations were not considered necessary for the Secured Transactions Act and the Company Act since these were self-contained. These laws are aimed at improving corporate and financial governance, including orderly exit for firms. However, except for the Company Act, the Insolvency and Secured Transactions Acts are not yet fully operational as the necessary institutions (e.g., a commercial bench, insolvency administration office, and secured transactions registry) have not yet been established. However, the Company Registrar’s Office has been designated in the interim for licensing liquidators under the Insolvency Act.

3. Strengthen Public Sector Governance

20. This component of the Program sought to complement and reinforce the civil service reform and anticorruption measures initiated under the Government’s broader governance reform and decentralization programs, particularly in the areas of reducing the size of the civil

3 The restructuring, supported under L2268/Grant0059–NEP: Rural Finance Sector Development Cluster Program I

(approved in November 2006), included incorporation under the Company Act. As a result of which ADBN is now referred to as Agriculture Development Bank Limited.

4 The Bank and Financial Institutions Act was promulgated in 2006 to properly regulate all banks and financial institutions. The Act classifies all banks and financial institutions into four categories (A, B, C and D) based on their paid-up capital.

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service, devolving public services, enhancing transparency and accountability of the civil service, and improving public sector auditing and accounting standards and practices.

21. To reduce the size of the civil service, the Government issued an order in September 2002 to eliminate 7,500 of the 10,000 vacant civil service positions, mostly at lower levels (levels 3 and 4), with the intent to outsource such services. Accordingly, about 7,500 vacant positions have been eliminated. An order was also issued in May 2003 freezing recruitment in levels 3 and 4 non-gazetted vacant positions.5 This has been further reinforced by the amended Civil Service Act 2007, which seeks to eliminate civil service positions of levels 4 and below.

22. For strengthening decentralization, the Local Bodies Fiscal Commission approved a poverty-based formula in January 2003 for allocating block grants to the district development committees (DDCs). The formula—based on different weights assigned to district human development indicators, geographic area, population, and remoteness—continues to be applied in allocating grants to the 75 DDCs. In this context, the Government also approved a policy on local government service provisions in the Local Self-Government Act 1999 for empowering the DDCs to manage their personnel affairs. While a draft act was prepared in this regard, its enactment has been shelved in view of the political changes in recent years, the proposed new constitution, and the expected state restructuring to decentralize governance and make the state more inclusive, democratic and progressive.

23. To ensure effective delivery of public services, the Government decided to transfer the management of public schools to school management committees in 2003, including the recruitment of new teachers. Accordingly, about 3,500 of some 29,000 public schools have been transferred to the local communities (against the program target of 100 schools), which has led to improved school management through social audits and direct participation of stakeholders in the decision-making process. Also, to promote more sustainable rural infrastructure development at the local level, the Government transferred the district development offices operating under the Department of Local Infrastructure and Agriculture Roads as district technical offices under the DDCs. However, as the staff of district technical offices are recruited by the Department of Local Infrastructure and Agriculture Roads, these offices are not fully accountable to DDCs. For district technical offices to be made fully accountable, legal and institutional provisions will need to be made for DDCs to manage their own personnel affairs through enactment of the proposed local service act. However, as an interim measure, the accountability of district technical offices to DDCs has been enhanced by the Civil Service Act of 2007, which provides for the central government to assign technical staff to district technical offices for longer periods. 24. To complement the four anti-corruption laws promulgated in April 2002, the Government took additional measures to improve accountability and transparency under the Program. In particular, the Government implemented the legal provision in the Anti-corruption Act of 2002 by ensuring compliance by all civil servants of class 26 and above with the requirement of declaring their incomes and property, which constitute a preventive anti-corruption measure. The Government also initiated implementation of a comprehensive anti-corruption strategy in January 2007. In this process of increasing transparency, accounting and auditing boards were also established in March 2003, which have since developed a series of accounting and auditing standards for compliance by both the private and public sector. 5 Non-gazetted refers to clerical category of employees in Nepal’s service, which comprises five levels—level-less to

level four. 6 Class 2 refers to one of the four classes of employees in the ‘officer’ category of Nepal’s civil service—Class 3,

Class 2, Class 1 and Special Class.

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C. Program Costs 25. The net adjustment costs were estimated at $36.7 million at the time of appraisal, after deducting the non-cash program costs and the amount the Government had already spent from its own resources before the Program was approved. Based on this estimate, ADB provided a loan in the amount of SDR24.649 million ($35 million equivalent at the prevailing exchange rate) from the special fund resources. The loan proceeds were withdrawn for the purposes of financing foreign currency expenditures incurred for eligible items for procurement as specified in Schedule 3 of the Loan Agreement, including those incurred within 180 days prior to the date of loan effectiveness. The counterpart funds generated from the loan proceeds were to be used to meet the costs associated with the implementation of the Program, in particular the payment of dues to staff and other liabilities of public enterprises to be privatized or liquidated, and administrative costs required to implement the Program. D. Disbursements

26. The loan was to be disbursed in two unequal tranches. The first tranche of SDR14.085 million ($19.73 million equivalent at the prevailing exchange rate) was disbursed on 14 July 2003 upon compliance with the policy conditions specified in the policy matrix and loan effectiveness. While the second tranche of SDR10.564 ($15.69 million equivalent at the prevailing exchange rate) was expected to be disbursed upon compliance with the remaining policy conditions about 15 months later, it was cancelled in September 2006 after the Government was unable to comply with several policy conditions even with the extension of the loan closing date by one year until June 2006. 27. The counterpart funds generated from the first tranche were allocated for expenditures in FY2004. The utilization of the counterpart funds is in Appendix 4, which shows that only 34% was spent on public enterprise reform and the remainder was spent on other development projects. However, government records show an expenditure of about around $30 million equivalent in FY2004–FY2008 for settling public enterprises’ liabilities under the Program. E. Program Schedule 28. At appraisal, the program period was designed for two and a half years, beginning in July 2003 and ending in December 2005. Accordingly, the loan closing date was 30 June 2005. However, as several second-tranche conditions were not fulfilled within this time frame, ADB extended the loan closing date until 30 June 2006 at the Government’s request. As the Government was still unable to fulfill the second-tranche conditions within the extended period due to the extenuating political circumstances, the Government and ADB agreed to close the loan. As a result, the loan account was closed on 21 August 2006. F. Implementation Arrangements 29. MOF, as the executing agency (EA), was responsible for overall implementation of the Program. MOF’s Budget Division was designated as the program implementation unit with the responsibility for ensuring effective coordination and implementation of the Program, and for monitoring the use of loan proceeds. In view of the weak technical and institutional capacity of the Corporation Coordination Division of MOF (the implementing agency for the public enterprise reform component of the Program), a privatization coordination support committee was established under the existing privatization committee chaired by the Minister of Finance to

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guide the Corporation Coordination Division and ensure effective implementation of the privatization and liquidation process. 30. Other key agencies involved in program implementation were the NPC; ministries of Local Development, General Administration, Labor, and Education; and the Inland Revenue and Customs departments of MOF. A program coordination committee was also established, chaired by the chief secretary and comprising the secretaries of MOF and other relevant line ministries, and the deputy governor of Nepal Rastra Bank, to address major inter-ministerial coordination and implementation issues. 31. However, some of the program components were not implemented fully in line with the above arrangements. In view of its heavy workload and limited staff resources, the program implementation unit was unable to effectively coordinate and monitor implementation of the Program, requiring the support of TA 4141 in monitoring program implementation and preparing progress reports in adequate detail. Also, the effectiveness of the program coordination committee’s role was limited, partly because the major implementation issues faced by the Program were systemic and related to the prevailing political instability. The implementation arrangement for the public enterprise reform component was especially impractical as the privatization coordination support committee was viewed as an unnecessary bureaucratic layer without any significant value addition to the implementation process. Therefore, the privatization and liquidation process was essentially carried out through the existing institutional framework. G. Conditions and Covenants 32. The policy matrix (Appendix 2) included 21 policy conditions for ADB Board’s consideration and the release of the first tranche of the loan, and 15 conditions for the release of the second and final tranche. The status of these conditions at the time of loan closure and the program completion review (PCR) is summarized in Appendix 2. The Government fully completed the reform measures for the 21 first tranche conditions. At the time of loan closure, the Government fully or substantially complied with 8 of the 15 second-tranche conditions relating to implementation of revenue measures, introduction of performance targets for tax offices, enactment of corporate and financial governance laws, settlement of liabilities of public enterprises, elimination of vacant positions in the civil service, policy on local governance service, capacity building of district technical offices, and issuance of working regulations under the Institute of Chartered Accounts Act. The remaining seven conditions that were partly or not complied with relate to public enterprise reform: privatization or liquidation of nine selected public enterprises, adoption of a medium-term privatization strategy and labor retrenchment policy, reconstitution of public enterprise boards, an action plan to reduce public enterprises’ contingent liabilities, and a restructuring plan for NIDC. The Government has achieved some progress since loan closure in August 2006, particularly in privatizing additional public enterprises, although it regressed in one of the partly-complied conditions relating to reconstitution of the public enterprise boards. The status of compliance of the second-tranche conditions at the PCR remained at eight fully or substantially complied with, and seven partly or not complied with. 33. The status of compliance with non-tranche loan covenants (Schedule 5 of the Loan Agreement) at the time of the PCR is summarized in Appendix 5. Of the 18 covenants, the Government complied with 12 and partially complied with 4. The partially-complied covenants relate to effective functioning of the program coordination committee, adequate and proper staffing of the program implementation unit and the privatization coordination support committee (Loan Agreement, Schedule 5, paras, 1-3), and continuation of reforms under the Program. The

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two covenants that were not complied with relate to preparation of the Government’s PCR and establishment of a system of semi-annual performance reporting by all public enterprises (Loan Agreement, Schedule 5, paras. 10 and 17). H. Related Technical Assistance 34. ADB provided a TA grant (TA 4141) for supporting the Government’s disengagement from public enterprises under the Program to assist in developing an effective privatization process, implementing a fair policy for labor retrenchment in public enterprises, and communicating effectively with stakeholders. International and domestic consultants were engaged to support the Government in this regard. Key outputs of the TA included a medium-term privatization strategy, and a labor retrenchment and communications policy in consultation with key stakeholders. However, these have yet to be adopted by the Government. The TA also supported the program implementation unit in monitoring and reporting on the Program’s implementation progress and Corporation Coordination Division in developing a management information system framework for semi-annual reporting of public enterprises’ performance. However, the Corporation Coordination Division has not yet been able to institute the reporting system, mainly due to weak capacity and staff resource constraints. Overall, the TA outputs had little impact on the Government’s disengagement from public enterprise ownership and management. A TA completion report is provided in Appendix 6. I. Consultant Recruitment and Procurement 35. No consultants were engaged using financing from the program loan. Individual international and domestic consultants were recruited in accordance with ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time) to provide the consultancy services required for TA 4141. No deviations from agreed-upon procedures occurred, and no disagreements between the EA and ADB occurred regarding consultant selection. J. Performance of Consultants, Contractors, and Suppliers 36. Overall, the consultants engaged under TA 4141 delivered the tasks identified in the terms of reference at an acceptable level of quality and timeliness. The consultants who assisted in the preparation of the medium-term privatization strategy and labor retrenchment policy performed under difficult circumstances posed by the prevailing political instability. No contractors or suppliers were directly engaged under the loan. K. Performance of the Borrower and the Executing Agency 37. The Borrower and the EA demonstrated strong ownership of the Program during processing and the initial stages of implementation. However, program implementation was disrupted and slowed since political instability followed the change in government in June 2004, followed by further changes. Overall, the three-year program period saw four changes in government, three of which lasted less than a year each. In addition, the program period was marked with continuous political turmoil instigated by the conflict and political parties agitating against the successive Governments that had been appointed by the King, and the King’s eventual direct takeover of government. Under these circumstances, there was a lack of strong political leadership and champions to spearhead reforms either under the Program or the country’s overall reform process. The persistent political instability severely constrained the performance of the EA and various implementing agencies, and in particular, key policy decisions, including the proposed medium-term privatization strategy.

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38. In addition, weak institutional capacity and human resource limitations in key government agencies, such as the Corporation Coordination Division and program implementation unit, also posed significant constraints to effectively implement and monitor reform measures under the Program. While TA 4141—and a parallel TA supported by the United Kingdom’s Department of International Development—helped to address these constraints to some extent, the lack of adequate counterpart staff and proper skills mix limited capacity building. As a result, despite their commitment to and ownership of the reform measures under the Program, the performance of the Borrower and the EA was constrained by the difficult political environment and is rated as partly satisfactory. L. Performance of the Asian Development Bank 39. ADB responded in a timely, proactive, and appropriate way by supporting the implementation of the poverty reduction strategy through the Program. The process comprised 12 months from the initial policy dialogue with the Government to loan approval. ADB was able to disburse the first tranche of the loan less than a week after approval by ADB’s Board. 40. ADB held consultations with various government agencies, political leaders, development partners, and private sector representatives during preparation of the Program. The Program was formulated in close coordination with the World Bank’s Poverty Reduction Support Credit and the International Monetary Fund’s Poverty Reduction Growth Facility, which were both approved in November 2003. ADB also helped the Government in securing financing from the United Kingdom’s Department of International Development for the technical inputs required for the privatization and liquidation of public enterprises. 41. ADB closely monitored the implementation of the Program until its closure through five missions (one inception and four review missions) that engaged in intensive policy dialogue with the Government. Apart from the formal missions, ADB regularly interacted with senior officials of the new incoming Governments to apprise them of the objectives of the Program and seek their support in accelerating implementation. In view of the lack of progress in the implementation of certain reform measures, ADB should have undertaken more frequent review missions. However, the frequent changes of government and continued political turmoil limited this possibility. Overall, ADB’s performance is rated as satisfactory.

III. EVALUATION OF PERFORMANCE

A. Relevance 42. The Program, which was designed to support the Government in implementing its poverty reduction strategy, at a time when it was facing an economic downturn and fiscal crisis, was highly relevant. However, the Program was less relevant with respect to the political economy. The Program design responded appropriately to the strategic objectives of the poverty reduction strategy—mobilizing additional domestic resources, prioritizing public expenditure, and more effective public service delivery. The Program was also consistent with ADB’s country operational strategy aimed at reducing poverty by supporting broad-based economic growth and strengthening public service delivery through decentralization, good governance, and improved resource mobilization. However, certain program components, especially the substantial institutional restructuring of public institutions under the privatization component, were unrealistic in the unstable political environment. Also, the program formulation and design were not fully coherent, particularly with respect to the corporate governance

11

program subcomponents, whose linkage with the objective of other public sector management-related reform actions was weak. On balance, the Program is rated as relevant. B. Effectiveness in Achieving Outcome 43. The expected outcomes of the Program were: (i) improved revenue generation, (ii) prioritized public expenditure, (iii) disengagement from public enterprises, and (iv) improved public sector governance and service delivery. Government revenue increased by more than one percentage point of gross domestic product (GDP), from 10.6% in FY2002 to 11.7% by the end of the Program period,7 and by more than two percentage points of GDP by FY2008. At the same time, public expenditures were prioritized within the MTEF resulting in consolidation of the portfolio of development projects from 731 in F2002 to 407 in FY2008, and increased budget allocation from NRs66 million per project in FY2002 to about NRs158 million in FY2008. These reforms helped to restore fiscal stability throughout the program period—the budget deficit decreased from 3.6% of GDP in FY2002 to 1.6% in FY2006, although it has edged up to about 2.0% in the recent years on account of increased expenditures relating to the peace process. Reforms related to reducing budget transfers to public enterprises and containing their contingent liabilities were not undertaken, although budget transfers declined during the program period. 44. Progress in disengaging from public enterprise management and ownership was limited. Five of the nine public enterprises selected under the Program were fully privatized or liquidated, employment was generally controlled in all public enterprises, and potential increases in the liabilities of the nine public enterprises were contained by retrenching their staff and settling outstanding liabilities of about NRs2.3 billion. The revamping of the privatization and labor retrenchment process, a key reform measure to sustain the privatization program, was, however, not undertaken. The reconstitution of public enterprise boards for professionalizing their management was also only partially implemented. 45. To improve public administration, the Government right-sized the civil service by eliminating the targeted 7,500 non-gazetted (footnote 4) vacant positions and freezing new recruitment in the remaining 2,500 vacant positions, reducing the risk of filling these posts through political pressure and patronage. These policy actions were further reinforced by the amended Civil Service Act of 2007 that provided for the gradual elimination of non-gazetted civil service posts of levels 4 and below. The system for the mandatory declaration of incomes and properties by public officials (Class 2 and above) complements the computerized personnel information system in the Ministry of General Administration and provides a basis for investigating corruption cases, but follow-up mechanisms to ensure full compliance are lacking. Although an anticorruption strategy was approved, it has not been effectively implemented. The foundation for improving the accounting and auditing standards has been laid for both the private and public sector through establishment of accounting and auditing boards, and issuance of accounting and auditing standards. Significant reforms were introduced for increased devolution, including the effective application of a poverty-based formula for allocating block grants to DDCs and transferring the management of a substantial number of public schools to local communities. While a draft local service act was prepared proposing a local service commission for a more decentralized personnel management (exceeding the

7 However, revenue collection declined to 10.8% of GDP in FY2006, which included the extended program period.

This was due to political upheaval during that year leading to the overthrow of the monarchy and restoration of multiparty democracy and peace.

12

requirement under the Program), it was shelved in view of the political changes and proposed state restructuring. Overall, the Program is rated as less effective. C. Efficiency in Achieving Outcome and Outputs 46. A number of second tranche and non-tranche conditions, mostly relating to the privatization component of the Program, were not met as scheduled. These could not be implemented and were still outstanding at the time of the PCR mainly due to the frequent changes in government and the volatile political situation, which stalled decision making and policy actions. Political instability also adversely affected the EA’s and the implementing agencies’ performance, and the overall management and coordination of reforms under the Program, leading to delays in implementation. In view of the lack of any significant progress, even after extension of the loan closing date, the second tranche was cancelled. However, despite the cancellation, the Government spent 50% more than the first tranche proceeds from its own source for settlement of the public enterprises’ liabilities. The adjustment costs were limited to the privatization component. Although no such expenditures were involved in other program components, reforms under the Program resulted in clear economic benefits, including substantial revenue growth, savings from public expenditure prioritization and the potential increase in public enterprise liabilities, and savings (estimated at about NRs400 million per annum) on the wage bill through downsizing of the civil service. Despite the difficult political environment, the EA and the implementing agencies enjoyed a satisfactory working relationship. ADB’s response to the requests from the Government was timely and appropriate. In view of the mixed results, the Program is rated as less efficient. D. Preliminary Assessment of Sustainability 47. Key reforms under the Program such as streamlining privatization of public enterprises, reducing budget transfers to public enterprises and containing their liabilities, and a transparent policy for labor retrenchment were not undertaken. As a result, the fiscal burden and risks arising from non-performing public enterprises and their contingent liabilities remain unaddressed. In addition, the new coalition Government that came to power in September 2008 proposed in its FY2009 budget statement reviving two of the operationally-closed public enterprises selected for privatization or liquidation under the Program. In other cases, despite reform actions, there were no adequate monitoring and follow-up actions on enforcement of the Insolvency and Secured Transactions Acts, implementation of the anti-corruption strategy, and operationalization of the information on income and property declaration by public officials. However, reforms in the area of revenue mobilization and devolution are being sustained with additional policy actions by broadening the tax base and further strengthening tax administration, and increasing resource transfers to local bodies and poor and underdeveloped regions of the country. Overall, the Program is rated as less likely to be sustainable. E. Institutional Development 48. The Program envisaged a key institutional reform for streamlining the privatization process and retrenchment of labor. Since the related reform measures were not undertaken, the proposed institutional development did not take place. However, the Program did contribute to institutional development in other areas. With the establishment of the Large Tax Payers’ Office and introduction of performance targets and a performance-based incentive system, tax administration has improved in the Inland Revenue and Customs departments. Similarly, MOF’s and NPC’s expenditure management and budgeting process have significantly improved with the adoption of the MTEF and its prioritization criteria for development projects, although the

13

improvement at the ministry level has been limited. Additionally, the civil service has been right-sized to some extent with the freeze on new recruitment of lower-level staff and elimination of vacant positions. The transfer of public schools to local school management committees has improved management of these schools and strengthened community-based institutions. The Program was also instrumental in the establishment of national accounting and auditing boards and the issuance of regulations for implementation of the Chartered Accountants Act that strengthened the Institute of Chartered Accountants. Overall, the Program’s contribution to institutional development is rated as moderate. F. Impact 49. Fiscal stability is a key positive impact of the Program, although it is difficult to isolate such impacts from those caused by other factors. However, it can be argued that without the consolidation and prioritization of development projects, the traditional practice of spreading the scarce budget resources thinly across a large number of projects would have continued leading to a sharp rise in public spending and jeopardizing fiscal stability. Similarly, without the freeze on new recruitment in the civil service and public enterprises, and elimination of vacant positions, there could have been the risk of a large number of politically-motivated recruitments in the frequently-changing political regimes that would have caused serious fiscal stress. In the same vein, the outstanding liabilities of public enterprises could have grown larger with the Government having to allocate more funding for their settlement in future. 50. In the absence of training and rehabilitation for those public enterprise employees retrenched under the Program, there could have been a loss of welfare for them and their dependents. However, since most of the public enterprises privatized or liquidated under the Program were already operationally-closed, the employees’ welfare can be considered to have, in fact, improved after the Program facilitated the payment of long-pending dues.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS A. Overall Assessment 51. Overall, the Program is rated as partly successful with partial achievement of the intended outcomes. Although its design was highly relevant in terms of the country’s needs, it was less relevant in terms of taking in account the political economy and weak institutional capacity. The Program design was also less efficient in terms of coherence and focus as it was overloaded with too many complex reform components, while being thin on policy conditions under each component in terms of number and substance. This served to weaken the Program’s impact. The delivery of program outputs and outcomes was less effective and less efficient. Despite the Government’s sincere efforts, the political turmoil and escalation of the conflict seriously hampered policy decisions and program implementation. Without these disruptions, the Program would have perhaps been more successful in achieving the intended outcomes. However, the Program performed well in a number of other areas of the reform agenda. In particular, the Program contributed to preserving fiscal stability in the face of deteriorating revenue collection and rising expenditure through improved tax administration and effective public expenditure management. Other substantial reforms include devolution of public service delivery with respect to education, right-sizing of the civil service, and increased resource transfer to poorer regions of the country. B. Lessons

14

52. The successes and failures of the Program point to a number of lessons. First, the vulnerability of reform programs to the political environment, especially in a conflict situation, needs to be fully understood. Even without the political upheaval in 2005, many of the reforms under the Program—especially those relating to institutional restructuring and privatization of public enterprises—would have been difficult to implement in the prevailing political environment in 2003. Political stability is essential for the success of such reforms. As the Program was designed at a time of substantial political and economic uncertainty, the political situation should have been closely monitored and carefully assessed. This would have ensured a more realistic program design and more successful outcomes. 53. Second, the complexity and long-term processes of poverty reduction and economic and public sector reform need to be recognized. One short-duration program loan can have only a limited impact on poverty reduction. When designing reform programs, outputs, objectives, and development goals need to be more realistically and logically linked with policy conditions. 54. Third, program design needs to be focused with adequate and substantive policy conditions for achieving intended impacts. Reforms under the Program were thinly spread, which made implementation complex and resulted in unclear and limited outcomes. The Program would have been more effective and efficient with fewer components and more substantive reform measures under each component. For example, the elimination of the vacant positions and freezing of new recruitment for vacant non-gazetted civil service positions alone cannot be expected to result in a significant and clear impact on Nepal’s public sector governance, which suffers from many other weaknesses and constraints. 55. Fourth, program design also needs to be coherent for maximizing outcome and impacts. In addition to being thin, the linkage of policy conditions on the three corporate governance laws with other Program components aimed at strengthening public sector management and governance was weak. The linkage was also weak with the Program’s overall objective of helping the Government to implement its poverty reduction strategy. 56. Fifth, capacity-building support has to be deeply woven into a reform program. The advisory TA attached to the Program was more focused on achieving the short-term program outputs, rather than on building capacity within government institutions to manage and sustain such reforms in future. C. Recommendations

1. General 57. The lack of focus and coherence of the Program components can be partly attributed to the inadequate preparatory work done during the design stage. The Program was formulated based on a small scale TA8 which focused only on the privatization component. No substantive analytical and preparatory work was undertaken for other components. Given the weak institutions in Nepal for policy analysis and formulation, reform programs in the future should be designed based upon more comprehensive preparatory and analytical work. 58. ADB needs to have detailed discussions with the Government during the country program and strategy process about a long-term view on interventions in sectors such as public

8 ADB. 2002. TA 3889-NEP: Privatization and Liquidation of Public Enterprises approved on 24 June 2002.

15

sector management and governance to ensure reform programs are designed to include sustainable approaches. 59. To the extent possible, ADB should seek to support government programs rather than graft new ones. This would ensure stronger government ownership and more effective program implementation. This is especially applicable in the areas of governance and public sector management where some amount of capacity exists in key ministries.

2. Specific Recommendations   60. The new Government’s decision to revive some closed public enterprises is worrying and constitutes a reversal of past reforms. The revival of these public enterprises with new capital injection will not only have adverse fiscal implications but will also create an undesirable precedent for other closed and non-performing public enterprises. Considering the mounting pressure on government finances from the high demand for improved public services and ambitious investment plans, the fundamental premises as well as the objective of the Program’s public enterprise reform component remain valid even in the changed political context. The review of the Government's own high-level public enterprise reform committee in 2007 confirms that the proposal prepared under TA 4141 remains appropriate. The Government should, therefore, reconsider its decision and instead pursue policy actions on the Program’s partly fulfilled and unfulfilled public enterprise reform conditions. In addition, the Government should take this opportunity to revisit its privatization policy in a broader perspective, including the public-private partnership modalities with a view to adopt a more effective and renewed privatization strategy to deal with non-performing public enterprises and their drain on the scarce public resources. Equally important is the proper identification of public enterprises’ contingent liabilities and devising a strategy to contain and reduce them over time. Subject to the Government’s commitment to these reforms, ADB may consider providing assistance for this exercise as the Program design overlooked the Government’s capacity to undertake this difficult task. 61. Continued reform efforts are also needed to sustain other reform measures under the Program, particularly in areas where certain adjustments are necessary to make reforms more effective and relevant in the changed political context. For example, it would be important to review the project prioritization criteria under the MTEF to reflect the new Government’s emphasis on promoting an inclusive development process and reconstruction and rehabilitation activities in the post-conflict transitional period. Similarly, it seems desirable to adjust the poverty-based formula for allocating development grants to DDCs and to extend this principle to the village development committees and municipalities.

Appendix 1 16

PROGRAM FRAMEWORK

Design Summary

Performance Indicators and Targets

Monitoring Mechanisms

Assumptions and Risks

Outputs 1. Public expenditure management

prioritized Reduced Government budgets transfers and contingent liabilities to public enterprises

2. Public revenue management

improved Monitoring capacity of tax administration improved

3. Disengagement from public enterprises;

legal environment for orderly establishment, transparent commercial operators, corporate governance, and orderly exit of companies improved

Development of resources allocated in accordance with the categorization of projects based on their poverty impact Performance-based budget release for priority projects Government implementation of the government-approved action plan to reduce budget transfers and contingent liabilities beginning in fiscal year (FY) 2004 Increase in revenue-to-gross domestic product (GDP) ratio each year, and by at least one percentage point over the program period, as compared with the end of the Ninth Plan Essential allocated positions to Internal Revenue Department filled with no change over the program period Measurable performance targets for tax offices and senior tax officials made applicable to raise revenue mobilization performance Publication of new company, insolvency, and secured transaction laws in the Nepal Public Gazette Public enterprise boards reconstituted as to include only professionals

Progress reports by the Ministry of Finance (MOF) Annual Government budgets Asian Development Bank (ADB) review missions Annual Government budget Quarterly reports of the project implementation unit reflecting trends in revenue mobilization and staffing position of the Inland Revenue Department Inland Revenue Department reports on tax mobilization efforts of the 21 field offices Relevant national public gazettes Relevant government orders Reports of Office of Auditor General (OAG) and audit reports of individual public enterprises

Assumptions Government committed to taking the necessary measures to improve the fiscal situation to enable it to implement the Tenth Plan’s poverty reduction target Improved Internal security situation Assumptions Adequate capacity of implementation organizations Technical expertise and support sufficient to conduct transactions

Appendix 1 17

Design Summary

Performance Indicators and Targets

Monitoring Mechanisms

Assumptions and Risks

Corporate governance of public enterprises improved Contingent liabilities contained Privatization process streamlined

Government to transfer to MOF management and supervisory responsibility of public enterprises to be liquidated/ or privatized Government order issued to cap additional employment in public enterprises

Report of the task force on labor rationalization in public enterprises

Continued government support

Goal Reduction in poverty by assisting the Government to implement its poverty reduction strategy

Poverty incidence reduced from 38% to 32% in line with the Tenth Plan’s poverty reduction strategy target Improved key social and poverty indicators as specified in the Tenth Plan

Streamlined resource mobilization and expenditure pattern as indicated in the Tenth Plan and Medium-Term Expenditure Framework (MTEF) Poverty-focused prioritization of annual expenditure in line with the Tenth Plan and MTEF Economic, social, and poverty statistics MOF statistics Program progress reports

Assumptions Political and macro-economic stability Containment of the internal conflict and negotiating a peace process Strong political commitment to reforms across the political spectrum

Objectives Support implementation of the Government’s poverty reduction strategy as embodied in the Tenth Plan by focusing on strengthening (i) the fiscal position, (ii) disengaging the Government from public enterprise management and ownership, and (iii) public and corporate sector governance

Improved fiscal position, especially allocation of higher budgetary resources for development expenditure, as specified in the Tenth Plan and MTEF Reduced budgetary transfer to public enterprises, liquidation of public enterprises, and adoption of a medium to long-term strategy for divestment

Tenth Plan and MTEF Annual budgets of the Government Implementation progress of the revenue mobilization action plan

Assumptions Strong commitment of the Government to address the current fiscal problems No deterioration in domestic security situation

Appendix 1 18

Design Summary

Performance Indicators and Targets

Monitoring Mechanisms

Assumptions and Risks

Right-sizing civil service, decentralization and devolution, and improved public sector accountability Improved legal and institutional environment for the corporate sector

Announcements in the Nepal Public Gazette of various actions involving public enterprises and civil service Program progress reports ADB reviews

Government support for privatization of state-owned institutions as stated in FY2003 budget and the economic reforms program of October 2002

Accounting and auditing frequency enhanced Public sector governance improved and public administration streamlined ; public services decentralized; accountability and transparency of civil servants improved; and public sector accounting and auditing improved

Report of task force on labor rationalization in public enterprises submitted; Government approves and adopts Nine public enterprises liquidated or privatized, staff retrenched, and liabilities paid Strategy and action plan for streamlining Government divestiture from public enterprises operational and being implemented At least 18 FY2002 audits conducted Portfolio audit and operational reviews completed for Agriculture Development Bank of Nepal and Nepal Industrial Development Corporation 7,500 vacant positions eliminated Freeze on recruitment for vacant positions Enhanced capacity of local bodies to manage devolution Transfer of school management of about 100 primary schools to local communities

Relevant government orders Ministry of Local Development’s orders

Assumptions Government committed to disengage from public enterprises and reform their management Assumptions Government committed to pursuing the Decentralization Implementation Plan and improving governance to accomplish the Tenth Plan’s poverty reduction targets

Appendix 1 19

Design Summary

Performance Indicators and Targets

Monitoring Mechanisms

Assumptions and Risks

District technical offices strengthened and district infrastructure development offices made accountable to district development committees Enhanced personnel information system Anti-corruption strategy approved and implementation begun Establishment of national accounting and auditing standards boards for public sector accounting Implementation regulations issues for Chartered Accountants Act

Program implementation unit reports on the functioning of district technical offices and on the relationship between district development committees and the district infrastructure development committees Government’s capacity-building efforts for local bodies New guidelines on the implementation of anti-corruption strategy Relevant Government orders for establishing national accounting and auditing standards boards

Government allocation of sufficient funds to support capacity building for local bodies to manage devolution

Inputs and Activities SDR24,649,000 ($35 million equivalent) from ADB’s Special Fund resources to partially finance adjustment costs related to Public Sector Management Program reforms ADB support through a $425,000 technical assistance (TA) grant for implementing disengagement from public enterprises and capacity building for implementing agencies, along with proposed Department for International Development support of $1.2 million to finance transaction administrators for liquidation and privatization of public enterprises Public expenditure management project list streamlined

SDR14,085,000 ($20 million equivalent) disbursed as first tranche (FY2003) SDR10,564,000 ($15 million equivalent) disbursed as second tranche (FY2005) Effective consultants support to Privatization Committee in completing liquidation and privatization transactions and streamlining privatization process At least 160 development projects (or 25% of existing projects) dropped or amalgamated

Regular progress reports, statistics, and review missions

Assumptions Adequate and timely provision of skilled staff and facilities Program ownership by the Government

Appendix 1 20

Design Summary

Performance Indicators and Targets

Monitoring Mechanisms

Assumptions and Risks

Share investments in public enterprises reduced Public revenue management • Revenue mobilization improved • Monitoring capacity of tax administration

improved Disengagement from public enterprises • Company, secured transactions, and

insolvency laws passed and implementing regulations issued

• Government order to limit public enterprise board representation to professionals

• Government order to contain overall staffing in public enterprises

• Plan to contain budget transfers and debt, and guarantees exposure of public enterprises

Government’s share investment in public enterprises reduced by about 50% by June 2005 Revenue-to-GDP ratio increase of one percentage point per year over the program period compared with FY2002 (the final year of Ninth Plan) Additional staffing of essential positions in the Inland Revenue Department and improved revenue mobilization efforts in field offices Publication of acts and regulations in Nepal Public Gazette Relevant government orders Creation of functional implementation agency, strategy in place and implemented Eighteen public enterprises providing their audited financial statements for FY2002

• Privatization process streamlined • Office of Auditor General to conduct

audits to update statements for at least 18 public enterprises

Public sector governance improved • Public administration streamlined • Public services decentralized Accountability and transparency of civil servants

Elimination of at least 7,500 vacant positions, and recruitment freeze for vacant positions until the end of the program period Local communities managing at least 100 primary schools Extended personnel information system functional, and anti-corruption strategy approved

ADB = Asian Development Bank, FY = fiscal year, GDP = gross domestic product, IRD = Inland Revenue Department, MTEF = Medium Term Expenditure Framework, SDR = special drawing rights Source: Asian Development Bank

Appendix 2 21IMPLEMENTATION STATUS OF

PUBLIC SECTOR MANAGEMENT PROGRAM POLICY CONDITIONS

Reform Measures

Implementation Status at Loan Closure (August 2006)

Status at Program Completion Review (November 2008)

1. Strengthen the Fiscal Position of the Government 1.1 Government to approve the Tenth Plan, supporting the poverty reduction strategy (PRS), in line with the Medium-Term Expenditure Framework (MTEF). (TC1)

Tenth Plan was approved in February 2003 with the PRS embedded in it. The Tenth Plan/PRS was anchored to a three-year rolling MTEF. Complied

The Three-Year Interim Plan (FY2008–FY2010) prepared upon conclusion of the Tenth Plan continues to focus on poverty reduction. It also places special emphasis on an inclusive development process, and reconstruction and rehabilitation in the post-conflict transitional period. The Interim Plan continues to be broadly based on the MTEF, which has been extended to cover both recurrent and capital expenditures. The MTEF is also being gradually extended to the district level. Complied

A. Improve Expenditure Management 1.A.i. Government to allocate budget for FY2003 based on a classification of development projects using objective criteria specified in the Tenth Plan and the MTEF. (TC1)

All development projects were classified into P1, P2 and P3 categories in terms of priority based on a set of criteria reflecting the poverty reduction objective of the MTEF and Tenth Plan. Budgets for FY2003 and subsequent years have been formulated within the framework of the MTEF and implemented accordingly. Complied

The MTEF process has been sustained, resulting in a prioritized project portfolio. However, the prioritization criteria need adjustments to reflect the development priorities in the post-conflict transitional period (e.g., a stronger focus on inclusiveness and rehabilitation and reconstruction activities, which are the strategic thrusts of the interim plan). A task force has been constituted to review the prioritization criteria. Complied

1.A.ii. Government to reduce the total number of projects by 25% by eliminating or amalgamating at least 160 projects categorized as low priority in FY03 in accordance with the criteria established under (1A.i.). (TC1)

The total number of projects was reduced from 731 in FY2001 to 633 in FY2002 and 434 in FY2003 through merging, dropping of less priority projects, and closure of completed projects. The number has however increased to 449 and 463 in FY2004 and FY2005, but this was due to new projects meeting the prioritization criteria and inclusion of some donor-supported projects that were previously off-budget. Complied

Further consolidation has been achieved bringing down the number of projects to about 400 in FY2007. This has increased average budget allocation per project from NRs79.8 million in FY2002 to NRs159.5 million in FY2007. Complied

1.A.iii. Government to prepare and commence implementation of a performance-based budget release mechanism for priority projects. (TC1)

This was introduced as a pilot in December 2002. It continues to be implemented with certain modifications to enhance implementation of priority projects and to accelerate development spending. Complied

The budget release mechanism has been sustained with an automatic release of the first trimester budget. The budget release for the subsequent trimesters is based on physical and financial progress in the previous trimesters. Complied

Appendix 2 22

1.A.iv. Government to approve a time-bound action plan for public enterprises (PEs) to reduce budget transfers on revenue account, contingent liabilities, and exposures of creditors with implementation beginning in FY2004. (TC2)

A Ministry of Finance (MOF) task force (constituted in June 2003) prepared a draft background paper and a draft action plan to this effect, but these lacked clear identification of contingent liabilities and measures to reduce these over time. TA 41419 consultants helped the Corporation Coordination Division (CCD), MOF prepare a policy proposal to contain and reduce PEs’ contingent liabilities in June 2005, by improving the draft action plan. However, there has been no further Government action. Not Complied

No further action has been taken. There is a need for a more comprehensive exercise to estimate the contingent liabilities of public enterprises, including the ones resulting from flawed processes and the implication of such liabilities for the Government’s resource position. Not Complied

B. Strengthen Revenue Mobilization and Management 1.B.i. Government to appoint a task force to prepare a comprehensive revenue mobilization strategy specifying measures to strengthen Value Added Tax (VAT) collection, reduce VAT exemptions, and improve collection of income tax and excise tax arrears, and valuation of imported goods. (TC1)

The Task Force was constituted on 6 January 2003, and submitted its recommendations on 19 May 2003. Complied

The report remains relevant and valid for broad guidance for reforming the revenue system. Its recommendations are being gradually implemented. Complied

1.B.ii. MOF to implement recommendations of the task force specified in 1.B.i. in the budgets of FY2004 and FY2005. (TC2)

Many of the Task Force’s recommendations pertaining to strengthening VAT collection (including increase of VAT rate from 10% to 13% and enforcement of VAT billing at the retail level) and improvement of customs valuation are being implemented. However, VAT exemption has been eliminated only for a few items. For the collection of income tax and excise arrears, a tax clearance commission has been constituted which has been somewhat effective. Substantially Complied

While the recommendations of the task force pertaining to elimination of VAT exemptions have not been fully implemented, many other important reforms have been introduced, including strengthening of VAT, income and excise tax administration; establishment and strengthening of the large taxpayers office; establishment of information technology-based filing of tax returns, tax assessment and payment systems; implementation of a three-year customs reform program aimed at improving customs valuation and modernizing and improving customs administration. Additional reforms are underway with the creation of an additional position of a Secretary within MOF to oversee revenue mobilization. Complied

1.B.iii. Government to appoint qualified staff to fill vacancies for all essentials positions in the Inland Revenue Department (IRD). (TC1)

54 vacant positions were filled in May 2003 but vacant positions are a perennial problem due to natural attrition. Complied

The amended Civil Service Act 2007 has shortened the time needed to fill vacancies due to natural attrition, which usually comprise about 3–4% of vacancies. Complied

9 ADB. 2003. TA 4141-NEP: Supporting Government Disengagement from Public Enterprises. Manila, (approved on 8 July 2003)

Appendix 2 23

1.B.iv. MOF to develop and adopt measurable performance targets for tax offices and senior tax officials. (TC2)

The performance-based monitoring system, established in IRD and Customs Department in FY2004, is based on monitoring indicators such as amount of tax collected, collection of arrears, and conduct of audits, among others. Complied

The performance-based monitoring system has been enhanced by linking it with an incentive scheme in the large taxpayer’s office, and in certain other IRD offices and customs points. The incentive scheme has been successful in collecting significantly higher revenue of about 10–15%. Complied

2. Disengagement from Public Enterprise Ownership and Management 2.i. Government to approve Insolvency Ordinance, Company Ordinance, and Secured Transactions Ordinance. Government to publish the ordinances in the Nepal Gazette (NG) and to issue implementation regulations for the ordinances. (TC2)

The ordinances were re-approved and re-submitted to the Palace in April 2005. While the Insolvency Ordinance and Secured Transactions Ordinance were promulgated in September 2005, regulations and necessary institutions are not yet in place for implementing and enforcing them. Substantially Complied

All three ordinances were enacted as acts by the interim Parliament in 2006. Insolvency regulations have also been issued, but regulations are not necessary for the Company Act and the Secured Transactions Act. While the Company Registrar’s Office has been designated as an interim institution for conducting preliminary work under the Insolvency Act, other critical institutions (e.g., the Secured Transactions Registry, a Commercial Bench, and Insolvency Office) have not been established for enforcement of these business laws. Substantially Complied

2.ii. Government to approve an order to reconstitute boards of PEs so as to include only professionals, except PEs with their own special acts. (TC1)

On 9 December 2002, Government approved a directive and a set of criteria for reconstituting PE boards. Complied

Complied

2.iii. Relevant line ministries to implement the order specified in 2.ii. (TC2)

Most of the PE boards have been reconstituted in line with the government order, limiting the size of the boards to 4-5 members. However, the process of appointing senior board members (chair persons and CEOs) has not been transparent and competitive as required by the government order. Partly Complied

While the size of public enterprise boards continue to be small in most cases, professionalization of the boards has not happened. In fact, the practice of political appointments has resumed in some cases. Not Complied

2.iv. Government to transfer the management and supervisory responsibility of line Ministries of PEs approved for privatization and liquidation to MOF. (TC1)

On 6 June 2003, the Government approved transfer of the management and supervisory responsibility of PEs for privatization to MOF. Complied

Complied

2.v. Government to continue the cap on aggregate employment in PEs, with the cap automatically reduced subsequent to each retrenchment. (TC1)

Government decision of 8 July 2003 restricted creation of additional positions and recruitment in vacant positions without prior MOF approval. The aggregate number of employees in PEs declined to 40,709 in FY2004 and 37,482 in FY2006 from 42,269 in FY2003.Complied

The number of aggregate public enterprise employees declined to 36,974 in FY2007. Complied

Appendix 2 24

2.vi. Government to close and initiate irrevocable liquidation process of 5 PEs through liquidation order for companies or publication of the dissolution of corporations in the NG, as applicable. (TC1)

Nepal Coal, Cottage and Handicraft, Hetauda Textile, Himal Cement, and Agriculture Tools were closed and liquidation process initiated. Agriculture Tools was later substituted by Lumbini Sugar. Complied

Complied

2.vii. Government to settle all dues to staff arising from the liquidation of the PEs under 2.vi., including retrenchment and other outstanding liabilities, in accordance with relevant legislation, internal rules, and negotiated agreements. (TC2)

Liabilities to all employees of Nepal Coal, Cottage and Handicraft, and Hetauda Textile have been settled. Settlement of such liabilities are 98% and 80% complete in Himal Cement and Lumbini Sugar, respectively. Substaintially Complied

Dues of Nepal Coal, Cottage and Handicraft, Hetauda Textile, and Lumbini Sugar have been fully settled. Dues of Himal Cement have only been partially settled as a result of legal disputes. The liquidation process of Agriculture Tools has also resumed. Substaintially Complied

2.viii. Government to take all necessary actions to complete liquidation or privatization through settlement of dues to creditors arising from liquidation, sale of assets, and transfer of unsold assets of PEs to Government under 2.vi. (TC2)

Cottage and Handicraft has been fully liquidated. Hetauda Textiles’ assets have not yet been disposed of. Lumbini Sugar’s liabilities have not yet been fully settled. Partly Complied

Nepal Coal and Cottage and Handicraft Emporium were de-registered in January 2008. Lumbini Sugar has been privatized. Staff liability and property disposal are still pending in Himal Cement. A decision has been taken to liquidate Agriculture Tools also, and a liquidator is being appointed. Liquidation of Hetauda Textile has been stalled due to the difficulty in selling the fixed assets. FY2009 Budget has proposed to revive it. Partly Complied

2.ix. Government to approve a divestiture plan for four additional PEs to be privatized or liquidated within FY2004. (TC1)

Bhaktapur Bricks, Birgunj Sugar, Nepal Rosin and Turpentine, and Nepal Transport Corporation (NTC) were selected for privatization/liquidation. NTC was later substituted by another PE—National Construction Company Nepal (NCCN) as Government decided to retain parts of NTC. Complied

Complied

2.x. Government to have privatized or initiated the irrevocable liquidation of PEs under 2.ix. including settlement of dues to PE staff and taking all necessary actions to settle other liabilities to creditors as specified in 2.vii. and 2.viii. (TC2)

Both Bhaktapur Bricks’ and Rosin and Turpentine’s assets have been sold/leased and liabilities settled. Birgunj Sugar’s assets have not yet been disposed of. No action has been taken on NCCN. Partly Complied

While dues of Birgunj Sugar have been substantially settled, its liquidation remains incomplete due to indecision on the sale and disposal of assets. FY2009 Budget has proposed to revive it. Privatization or liquidation action on NCCN is still pending. Partly Complied

2.xi. Government to approve and Government to commence implementation of a medium-term strategy for streamlining privatization/liquidation of PEs. (TC2)

A draft strategy prepared with the assistance of TA 4141 consultants was submitted to MOF in January 2005. The draft strategy recommended establishment of an autonomous privatization authority to implement the privatization/liquidation decisions of the Government. Government’s decision was pending. Not Complied

The Government formed a high-level public enterprise reform committee in 2007 to review the proposal prepared under TA 4141. While the Committee essentially endorsed the earlier proposal, Government’s decision remains pending. Not Complied

Appendix 2 25

2. xii. MOF to establish a task force to develop a policy for labor rationalization in PEs. (TC1)

A Task Force headed by Joint Secretary, CCD, MOF was constituted on 2 July 2003. Secretaries of MOF and Ministry of Labor (MOL) agreed with transfer of the function to MOL and the Central Labor Advisory Board. Complied

Complied

2. xiii. Government to approve and adopt policy, developed in consultation with representatives of labor and management of PEs, for labor rationalization of PEs under 2.xii. (TC2)

TA 4141 consultants helped MOL prepare a draft policy document which was endorsed by Central Labor Advisory Board and submitted to CCD, MOF in May 2005 to be incorporated in the proposed privatization strategy. MOF’s decision was pending.

Not Complied

No further action has been taken. Not Complied

2.xiv. Government to ensure completion of audits for FY2002 for 18 PEs. (TC1)

Audits of 30 PEs were completed for FY2002, and 27 for FY2003. Complied

Thirty PEs completed their audits for FY2005, and 20 public enterprises for FY2005. Complied

2.xv. Government to complete operational review of Agriculture Development Bank of Nepal (ADBN) and Nepal Industrial Development Cooperation (NIDC) and prepare strategies and action plans for their restructuring. (TC2)

The reviews were completed in July 2003. Government adopted the recommended restrucuturing plan for ADBN and restructuring measures—recapitalization, voluntary early retirement, organizational restructuring, incorporation under the new Bank and Financial Institutions Act, and gradual divestment of Government’s ownership – have been substantially completed. No restructuring plan has been prepared for NIDC. Government decided to restructure and privatize it by FY2005 and pursue liquidation if unsuccessful. However, no actions were taken on either options. Partly Complied

Restructuring of ADBN is well underway. No further actions have been taken on preparing a restructuring plan for NIDC, although it has been incorporated as a Class C financial institution under the Bank and Financial Institutions Act. The Government’s plan for NIDC remains unclear. Partly Complied

3. Strengthen Public Sector Governance Civil Service Reform 3.i. Government to approve an order eliminating 7,500 vacant civil service positions and implement elimination of 1,500 vacant positions. (TC1)

Government issued the order on 11 September 2002 and nearly 2,000 vacant positions were eliminated by June 2003. Complied

Complied

3.ii Government to fully implement order specified in 3.i. (TC2)

About 7,260 vacant positions have been eliminated to date. Substantially Complied

About 7,500 vacant positions have been eliminated. Recruitment in the remaining or newly vacant positions is being conducted through a careful review process. In addition, no new positions are being created. Complied

Appendix 2 26

3.iii. Government to issue an order freezing new recruitment for vacant non-gazetted civil service positions. (TC1)

Ministry of General Administration (MOGA) issued an order on 14 May 2003 suspending new recruitment of non-gazetted staff at levels 3 and 4. This freeze on recruitment has continued. Complied

The amended Civil Service Act 2007 reinforces this order. The Act provides for the automatic elimination of vacant positions in the classless category. Promoting Class 4 civil servants automatically to Class 3, the Act provides for elimination of all Class 4 positions. Class 3 positions will be eliminated once they fall vacant. The services being provided by staff of these classes are to be outsourced. Complied

Decentralization and Devolution 3.iv. The Local Bodies Fiscal Commission to approve a poverty-based formula for allocation of block grants to the local bodies. (TC1)

The Commission, headed by the Vice-Chairman of National Planning Commission, approved a poverty-based formula on 18 January 2003. The formula is based on four criteria—district-level human development index, population, geographical area, and remoteness. The formula has been effectively applied in allocating the development grants to the District Development Committees (DDC). Complied

The formula continues to be applied in allocating the grants to DDCs. There is, however, a recognition that the weights attached to the four criteria need to be adjusted to make the allocation more poverty-oriented. Complied

3.v. The Ministry of Local Development (MLD) to approve a policy paper on the local government service provisions in the Local Self-Governance Act 1999. (TC2)

MLD prepared and approved a policy paper to this effect through wide consultation within the Government and with other stakeholders. MLD also prepared a draft Local Service Act based on the policy paper. Complied

The proposed Act has not been enacted due to the dramatic political changes in recent years. Given the proposed the state restructuring along federal lines, the proposed Act will need to be revisited once the governance structure becomes clearer. Complied

3.vi. Government to (i) issue an operational directive to transfer school management including recruitment of new teachers to communities, and (ii) approve transfer of school management to about 100 local school management committees (SMCs) which are reconstituted in accordance with Education Regulations. (TC1)

Operational directive has been issued and about 1,200 schools were transferred to the reconstituted SMCs by mid-July 2003, and about 2,000 schools by mid-2006. Complied

By mid-July 2008, more than 35,000 have been transferred to SMCs. Management of these schools has reportedly improved. Complied

3.vii. Government to take appropriate measures to make district infrastructure development offices accountable to DDCs. (TC1)

Government passed a decision of 31 January 2003 placing district infrastructure development offices under the DDCs. Complied

As district technical office (DTO) staff are still being recruited by the Government, these offices are still not fully accountable to DDCs. To make district technical offices fully accountable, DDCs will need to be empowered to manage their personnel affairs, which is the aim of the proposed Local Service Act. The amended Civil Service Act 2007 provides for deputation of central government staff to DDCs for longer periods to somewhat enhance the DTOs’ accountability to DDCs. Complied

Appendix 2 27

3.viii. MLD to approve an action plan to strengthen implementation and monitoring capacity of district technical offices, and initiate implementation of the action plan. (TC2)

The Department of Local Infrastructure Development and Agriculture Roads prepared extensive action plans for capacity building of DTOs, for implementation through Government’s own resources as well as donor assistance. DDCs have also initiated their own efforts to strengthen their DTOs. Capacity development of DTOs is an integrated component of virtually all projects. Complied

Capacity building of district technical offices is being carried out regularly as part of the Department of Local Infrastructure and Agriculture Road’s annual programs. Complied

Improve Accountability and Transparency 3.ix. Government to implement legal provision regarding declaration of income/property by civil servants; declaration of class 2 and above civil servants to be completed. (TC1)

Government issued a notice in the Nepal Gazette (NG) on 19 August 2002 directing all civil servants to submit their income/property declaration within a month to MOGA. Government has been implementing the legal provision on an annual basis, and data on income/property declaration has been computerized at MOGA. Complied

Complied

3.x. Government to approve a comprehensive anticorruption strategy that will include both preventive and prosecution measures. (TC1)

Government approved the Strategy on 27 January 2003. Complied

Complied

3.xi. Government to constitute national accounting and auditing standards boards for the corporate sector accounting and auditing. (TC1)

The boards were constituted on 10 March 2003 and published in NG. Complied

Accounting and auditing standards have been developed and will come into force beginning in FY2009. Complied

3.xi. Government to issue implementation regulations for the Chartered Accountants Act. (TC2)

The regulations were approved by MOF on 15 November 2004.Complied.

Complied

ADBN = Agriculture Development Bank of Nepal, CCD = Corporation Coordination Division, DDC = district development committee, DTO = district technical office, FY = fiscal year, IRD = Inland Revenue Department, MLD = Ministry of Local Development, MOF = Ministry of Finance, MOGA = Ministry of General Administration, MOL = Ministry of Labor, MTEF = Medium Term Expenditure Framework, NCCN = Nepal Construction Company Nepal, NG = Nepal Gazette, NIDC = Nepal Industrial Development Corporation, NTC = Nepal Transport Corporation, PE = public enterprise, PRS = poverty reduction strategy, SMC = school management committee, TC1 = First Tranche Conditions, TC2 = Second Tranche Conditions, VAT = Value Added Tax Source: Asian Development Bank

Appendix 3 28

STATUS OF PRIVATIZATION AND LIQUIDATION OF PUBLIC ENTERPRISES

Unsettled Public

Enterprise Liabilities as of 30

April 2008

Expenditure on Settlement of Public Enterprise Liabilities as of 30 April 2008

(NRs. millions)

Public Enterprises

Year Operation

Closed

Privatization Modality

Date of Decision on Privatization

No. of Employees Retrenched

Remaining Employees

Last Year of Audit

NRs. (millions)

Staff Retrenchment

Financial Institutions

Other Liabilities

Present Status of Liquidation/ Privatization

Nepal Coal Limited

2002 Liquidation 05-Feb-03 42 0 Up to January

2007

-- 6.50 - - Deregistered by Company Registrar's Office on January 2008.

Cottage and Handicraft Emporium Limited

2002 Liquidation 05-Feb-03 137 0 FY 2004 -- 46.40 43.90 19.60 Deregistered by Company Registrar's Office in July 2005.

Hetauda Textile Factory Limited

2001 Liquidation 05-Feb-03 1011 0 FY 2006 29.6 253.60 121.60 - Asset disposal pending. Government proposes to revive it.

Himal Cement Limited

2002 Liquidation 25-Feb-03 527 35 FY 1996 243.95 210.00 - - Liquidation hampered by litigation and legal issues pertaining to disposal of assets.

Bhaktapur Brick Factory Limited

2002 Privatization 18-Mar-03 354 0 FY1999 0.50 137.80 32.10 19.15 Land/building leased and plant/ machinery sold.

Birgunj Sugar Limited

2001 Privatization 28-Feb-03 741 183 FY2003 2.00 370.00 255.60 117.50 Assets disposal pending. Government proposes to revive it.

Appendix 3 29

Unsettled

Public Enterprise Liabilities as of 30

April 2008

Expenditure on Settlement of Public Enterprise Liabilities as of 30 April 2008

(NRs. millions)

Public Enterprises

Year Operation

Closed

Privatization Modality

Date of Decision on Privatization

No. of Employees Retrenched

Remaining Employees

Last Year of Audit

NRs. (millions)

Staff Retrenchment

Financial Institutions

Other Liabilities

Present Status of Liquidation/ Privatization

Nepal Rosin and Turpentine Limited

2004 Privatization 23-Feb-03 470 0 FY2007 54.00 90.00 35.00 36.90 Land/building leased and plant/machinery sold.

Lumbini Sugar Limited

2005 Privatization 13-Jul-03 872 22 Up to February

2007

98.5 313.61 149.48 20.20 Land/building leased and plant/machinery sold.

National Construction Company Nepal

Ongoing Liquidation No decision yet

32 46 FY 2006 57.10 17.31 - - Public enterprise in partial operation. No decision on privatization.

TOTAL 4,186 286 485.65 1,445.22 637.68 213.35

Source: Ministry of Finance

Appendix 4 30

UTILIZATION OF COUNTERPART FUND GENERATED BY THE FIRST TRANCHE

Ministry Description Amount (NRs)Ministry of Agriculture and Cooperatives Potato, Vegetable, and Masala Development Programme 5,529,033.49 Animal Health Service Programme 7,317,586.82 Total 12,846,620.31 Ministry of Water Resources Repair, Maintenance Projects 56,248,352.87 Total 56,248,352.87 Ministry of Physical Planning and Construction Mechi Highway (Phidim—Taplejung Sector) 23,500,000.00 Rapti High (Salyian—Musikot Sector) 42,500,000.00 Other Continuous Central Level Road Projects 5,469,829.36 Basantpur—Terhathum 8,536,963.68 Basantpur—Chainpur-Khandbari 1,881,336.04 Katari—Okhaldhunga 28,785,000.00 Galchhi—Devighat 14,946,251.25 Baglung—Beni-Jomsom 618,348.78 Surkhet—Ranimatta-Dailekh 11,980,137.41 Jaya Prithvi Bd. Shisan Road (Khodape-Bajhang) 13,418,225.37 Postal Roads 19,829,173.77 Dabasthal Kainidanda Chaurjahari—Dolpa 19,000,000.00 Karnali Highway—Manma 26,500,000.00 Musikot—Burtibang Road 24,500,000.00 Kathmandu Valley City Road 70,423,167.77 Beshisahar—Chame 10,390,000.00 Bridge Construction Programme 30,881,013.59 Machine Maintenance 14,096,619.84 Rural Development through Small Market Development 2,885,270.95 Integrated Action Plan (Urban Development) 3,848,917.12 Special Physical and Infrastructure Area Development Project 5,500,000.00 Urban Development Project 15,270,225.45

Appendix 4 31

Ministry Description Amount (NRs)

Building Construction Act, Government Building Construction and Record 8,765,450.59

Total 403,525,930.97 Ministry of Local Development District Development Committee Grant 499,881,330.85 Total 499,881,330.85 Ministry of Finance - Contingencies State Owned Enterprises Reform Program 502,398,765.00 Total 502,398,765.00 Grand Total 1,474,901,000.00

Source: Office of the Auditor General, Nepal.

Appendix 5 32

STATUS OF COMPLIANCE WITH LOAN COVENANTS

Covenant Reference in Loan Agreement

Status of Compliance

1. MOF, as Program Executing Agency, shall bear the overall responsibility for the timely implementation of the Program. It shall do so under the guidance of the Program Coordination Committee (PCC), chaired by the Chief Secretary, and including the Secretaries of MOF, Ministry of General Administration (MOGA), Ministry of Industry, Commerce and Supplies (MOICS), MLD, and the Deputy Governor of Nepal Rastra Bank (NRB). The Chief Secretary shall designate a Joint Secretary at the Government Secretariat to coordinate with the PCC members and their ministries. The PCC shall be responsible for (a) coordination of activities among line ministries; and (b) monitoring of the progress of the reforms. The PCC shall meet whenever necessary, but in any case not less than once every quarter.

Schedule 5 I (Para. 1)

Partially Complied

2. MOF shall establish a PIU to ensure the timely preparation and implementation of Program measures other than those related to the Public Enterprise (PE) component of the Program. Other than the full-time PIU head, who is at the level of Joint Secretary, the PIU shall be staffed by at least two full-time government officials with extensive experience in policy reform, Program management and financial accounting. The PIU head shall report directly to the Finance Secretary. The PIU shall act as the secretariat for the PCC and shall be responsible for preparing the four monthly progress reports as well as brief monthly updates on the status of implementation of all Program measures.

Schedule 5 I (Para. 2)

Partially Complied

3. The Program component related to the Borrower’s disengagement from PEs shall be facilitated by the Privatization Committee, which shall establish a Privatization Coordination Sub-Committee (PCSC) in MOF. The PCSC shall be staffed by at least five fulltime government officials with extensive experience in privatization and liquidation. The staff of the MOF Corporation Coordination Division shall also report to the PCSC on privatization and liquidation matters.

Schedule 5 I (Para. 3)

Partially Complied

4. The Borrower shall (i) ensure that the policies adopted and actions taken as described in the Policy Letter prior to the date of this Loan Agreement continue to be in effect for the duration of the Program period, and (ii) promptly adopt the other policies and take other actions included in the Program as specified in the Policy Letter and the Policy Matrix, and ensure that such policies and actions continue in effect for the duration of the Program period. More specifically, the Borrower shall ensure not to take any action which in effect would negate the liquidation or privatization of any PE for which the liquidation or privatization was agreed upon with the Bank.

Schedule 5 II (Para. 4)

Partially Complied (FY2009 budget

proposed to revive two

PEs selected for

privatization or liquidation under the

Program—Birgunj Sugar and Hetauda

Textile) 5. Immediately after the Effective Date, the Borrower shall establish, in

a manner satisfactory to the Bank, a Special Account at Nepal Rastra Bank for the specific purpose of depositing and utilizing the Counterpart Funds.

Schedule 5 III A (Para. 5 a)

Complied

Appendix 5 33

Covenant Reference in

Loan Agreement Status of

Compliance 6. Whenever the Borrower withdraws proceeds of the Loan from the

Loan Account, the Borrower shall promptly deposit into the Special Account the Rupees amounts equivalent to the amount of the proceeds so withdrawn.

Schedule 5 III A (Para. 5 b)

Complied

7. Except as the Bank may otherwise agree, the Counterpart Funds shall be utilized not later than the loan closing date, to meet the expenditures to be incurred pursuant to the provisions of paragraph 6 below.

Schedule 5 III A (Para. 5 c)

Complied

8. Separate accounts and records in respect of the Special Account shall be maintained in accordance with consistently maintained sound accounting principles and shall be audited annually by the Auditor General of Nepal in accordance with sound auditing standards. Certified copies of such audited accounts and records shall be furnished to the Bank promptly after their preparation but in any event not later than six (6) months after the close of the fiscal year to which they relate, or not later than six (6) months after the date of the closing of the Loan Account, as the case may be.

Schedule 5 III A (Para. 5 d)

Complied

9. The Borrower shall ensure that the Counterpart Funds are made available to meet the costs associated with the implementation of the Program, in particular and in this order of priority (i) the payment of all dues to staff of PEs relating to or following from retrenchment, whether as a result of statutory provisions or elsewise; this includes but is not limited to wages in arrears and other benefits such as pension contributions as well as severance benefits; (ii) payment of other liabilities of liquidated PEs, and (iii) administrative costs to implement the Program.

Schedule 5 III B (Para. 6)

Complied (While not all loan proceeds were utilized

for settling PE liability, the

Government used its own resources to

settle the necessary PE

liabilities) 10. The Borrower shall keep the Bank informed of, and the Borrower

and the Bank shall from time to time exchange views on, the progress made in carrying out the policies and actions set out in the Policy Letter and the Policy Matrix and in the formulation and implementation of new related policies.

Schedule 5 IV (Para. 7)

Complied

11. The Borrower shall promptly discuss with the Bank problems and constraints encountered during the implementation of the Program and appropriate measures to overcome or mitigate such problems and constraints.

Schedule 5 IV (Para. 8)

Complied

12. The Borrower shall keep the Bank informed of policy discussions with other multilateral and bilateral agencies that have implications for implementation of the Program, and shall provide the Bank with an opportunity to comment on any resulting policy proposals. The Borrower shall take the Bank’s views into consideration before finalizing and implementing any such proposals.

Schedule 5 IV (Para. 9)

Complied

13. The reports referred to in Section 4.05I of the Loan Agreement (the Program Completion Report) shall also (i) evaluate the implementation of the activities and outputs under the PSMP; (ii) assess and analyze the impact of the PSMP on the economy, including the social and poverty impacts; (iii) identify the lessons learned during the implementation of the PSMP; and (iv) identify future reform programs and assistance needed.

Schedule 5 V (Para. 10)

Not Complied

Appendix 5 34

Covenant Reference in

Loan Agreement Status of

Compliance 14. The Borrower shall ensure that for the duration of the Program

implementation, the budget allocations for block grants to local bodies shall stay at least at the level of FY02.

Schedule 5 VI (Para. 11)

Complied

15. The Borrower shall continue its overall policy of freezing new recruitment for non-gazetted vacant civil servant positions. For any exceptional recruitment for frozen vacancies, this shall only be done after a proper job assessment has been carried out and an agreement has been reached between MOF and MOGA.

Schedule 5 VI (Para. 12)

Complied

16. The Borrower shall ensure that the Company Ordinance, the Secured Transactions Ordinance and the Insolvency Ordinance shall be renewed on a six-monthly basis until such time as the Parliament is reconstituted, at which time the Ordinances shall be submitted to the Parliament for passage as Acts.

Schedule 5 VI (Para. 13)

Complied

17. The Borrower shall ensure that the taskforce established to develop the Policy on Labor Rationalization, shall include all stakeholders, including representatives of employees of PEs, line ministries responsible for PEs, the Ministry of Labor, MOF, labor unions, and independent experts on privatization and retrenchment issues.

Schedule 5 VI (Para. 14)

Complied (the policy was

formulated in consultation

with key stakeholders and endorsed by the Central

Labor Advisory Board)

18. The Borrower shall ensure that for all closed, liquidated or privatized PEs, whether in part or in whole, all obligations to employees relating to or following from retrenchment, whether as a result of statutory provisions or else wise, shall be complied with.

Schedule 5 VI (Para. 15)

Complied

19. The Borrower shall ensure that for all closed, liquidated or privatized PEs, whether in part or in whole, all necessary and appropriate actions shall be taken to comply with all obligations to creditors.

Schedule 5 VI (Para. 16)

Complied

20. Within three months of the Effective Date, MOF shall establish a system for semi-annual reporting by all PEs on their performance, profitability, balance sheet and cost flows.

Schedule 5 VI (Para. 17)

Not Complied

21. The Borrower shall ensure that in the event of sale of land, as core or noncore assets of PEs to be liquidated, closed or privatized, or any other action taken that might lead to resettlement effects, the Bank's policy on Involuntary Resettlement shall be complied with.

Schedule 5 VI (Para. 18)

Not Applicable

Appendix 6 35

TECHNICAL ASSISTANCE COMPLETION REPORT Division: Nepal Resident Mission/SARD

Amount Approved: $425,000.00

TA No. and Name TA 4141-NEP: Strengthening Government Disengagement from Public Enterprises Revised Amount: $425,000.00

Executing Agency: Ministry of Finance

Source of Funding:

Amount Un-disbursed:

$217,835.58

Amount Utilized: $207,164.42

Date Completion Date Original 30 Jun 2005

Actual 30 June 2006

Closing Date

Approval 08 July 2003

Signing 15 August 2003

Fielding of Consultants: 25 June 2004 Original

30 June 2006 Actual 13 December 2006

Description The technical assistance (TA) aimed to support effective disengagement of the Government from public enterprises and build the institutional foundation for the privatization and liquidation process. There is lack of adequate staffing and weak institutional capacity in the Corporation Coordination Division (CCD) of the Ministry of Finance, and inadequate institutional arrangements and processes to facilitate privatization. The hiatus in privatization activities since around 1997 resulted in drain of trained and experienced staff to other government offices and decline in capacity of CCD responsible for coordinating and overseeing the performance of public enterprises and privatization process. The need for a TA was identified during formulation of the Public Sector Management Program (the Program), a major reform component of which was privatization or liquidation of selected public enterprises and streamlining the Government’s privatization and liquidation process. Expected Impact, Outcome, and Outputs The expected TA impact was to streamline the Government’s privatization and liquidation process for taking forward privatization more effectively reducing the opportunities for political interference in the process and providing a more effective mechanism to overcome such obstacles should they arise. The expected TA outcome was development of an effective privatization and liquidation process and build government capacity for managing and supervising privatization transactions. The expected TA output was development of a privatization and liquidation strategy, a consistent labor policy for retrenchment of public enterprise employees, and a communications strategy for privatization and liquidation. Delivery of Inputs and Conduct of Activities Consultants: One international and 7 domestic experts were recruited for 39.9 person-months compared with 42 person-months originally envisaged. The inputs of all consultants were generally satisfactory. However, given the weak institutional capacity and lack of adequate and motivated counterpart staff in the targeted government offices (mainly CCD and the Budget Division of the Ministry of Finance), the consultants could not work as closely with counterpart government staff as expected. In addition, the consultants’ work was often disrupted by the political turmoil. In view of the lack of adequate capacity and staff resources in these offices, additional domestic experts (in addition to the original provisions under the TA) had to be engaged to help the executing agency in managing and monitoring implementation of the Program and fulfilling certain tranche and non-tranche policy conditions under it. Accordingly, following changes were made during the implementation of the TA:

• Minor change in scope approved in October 2004 to engage a corporate financial specialist to assist CCD in developing a framework for identifying public enterprises’ contingent liabilities and more effective reporting on their performance.

• Minor change in scope approved in March 2006 for additional domestic consultant inputs to help the program coordination unit (the Budget Division) within the Ministry of Finance to manage and monitor the overall implementation of the Program.

Appendix 6 36

Notwithstanding the weak capacity and inadequate counterpart staff, the executing agency fully met its requirements to provide office accommodation, information and other support for the TA activities. ADB monitored TA activities through review missions in conjunction with the review missions for the Program. Although only four review missions were fielded during Program and TA implementation (more frequent review missions could not be fielded due to the political disruptions and frequent changes in government), frequent informal meetings were held with the EA and consultants to monitor and guide TA activities. Evaluation of Outputs and Achievement of Outcome The outputs of the TA were: (i) a draft medium-term privatization strategy paper, (ii) a draft labor retrenchment policy and process for public enterprises, (iii) a framework for identification of and containing their contingent liabilities and reporting on their performance, and (iv) a report on monitoring and assessment of policy reforms under the Program. Although prepared in consultation with a wide range of stakeholders, the Government could not adopt the policy proposals (items i and ii), mainly due to the continued political turmoil and frequent changes in government throughout the Program and TA period. While the political situation has somewhat stabilized more recently, it remains to be seen whether the new Government will consider the TA outputs in its longer term reform and development agenda. The framework for identification of public enterprises’ contingent liabilities and reporting on their performance were also not adopted due to the weak capacity and lack of staff resources within CCD. The work of the program management consultants, however, effectively helped the executing agency in monitoring and assessing the reforms under the Program. Overall Assessment and Rating While the TA consultants’ outputs were generally timely and satisfactory, these could not be effectively implemented by the Government due to the extenuating political circumstances and weak institutional capacity within the targeted government offices. As a result, the related policy conditions under the Program were not fully complied. The TA was therefore only partly successful. Major Lessons: Program and TA design should fully take into consideration the prevailing political environment and the likely future scenario within which they are to be implemented. Equally important is a thorough assessment of the institutional capacity of the targeted government agencies in terms of availability of adequate counterpart staff, their competence and commitment to institutional reforms. Recommendations and Follow-Up Actions In view of the new Government’s intention to revive some of the operationally closed public enterprises, especially those selected for privatization or liquidation under the Program, ADB needs to engage in a policy dialogue with the Government to reconsider such policy decisions and encourage it to review and consider the policy recommendations of the TA. Prepared by

Raju Tuladhar

Designation

Senior Programs Officer, NRM, ADB