Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 3172-NEP

STAFF APPRAISAL REPORT

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

October 29, 1981

Industrial Development and Finance DivisionProjects DepartmentSouth Asia Regional Office

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

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CURRENCY EQUIVALENTS

Currency Unit = Nepalese Rupee (Rs)

US$ 1.00 = Rs 13.2Rs 1.00 = US$ 0.076

FISCAL YEARS

HMG - July 16 - July 15IDA - July 1 - June 30UNDP - January 1 - December 31

PRINCIPAL ABBREVIATIONS

ADB - Asian Development BankADBN - Agricultural Development Bank of NepalCIDB - Cottage Industry Development BoardCIED - Cottage Industry Export Development Division - Trade

Promotion CentreCGC - Credit Guarantee Corporation, Private LimitedCSI - Cottage and Small IndustriesDCVI - Department of Cottage and Village IndustriesEmporium - Cottage and Handicraft Sales EmporiumHMG - His Majesty's Government of NepalISC - Industrial Services CentreNBL - Nepal Bank LimitedNIDC - Nepal Industrial Development CorporationNRB - Nepal Rastra BankRBB - Rastriya Banijya BankSBI - State Bank of IndiaTPC - Trade Promotion CentreUNDP - United Nations Development Programme

FOR OFFICIAL USE ONLYNEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

Table of Contents

Page No.

1. INTRODUCTION AND SUMMARY ............... 1

II . SECTORAL SETTING . . . . . ..... *.... *.*....*.*.*.* 2A. Economic Setting ....................... 2B. Industrial Structure and Performance ......... 3C. Role of Cottage and Small Industries ......... 3D. Industrial Policy Framework ................. . 5E. Financing of CSis ............................ 7F. Commercial and Technical Services ............ 9

III. SCOPE AND STRATEGY IN SELECTED SUBSECTORS ........ . 10A. Woolen Carpets and Garments .......... ...... 10B. Cotton Handloom Products .................. 13C. Metal Crafts ............................ . 15D. Forest Based Products ................. . 16E. Selected Agroindustries ................ . 17

IV. THE PROPOSED PROJECT ............ .. ................ 19A. Objectives, Strategy and Institutional

Arrangements ........ ...... * ......... ...... 19B. Subloan Component ...................... . 22

1. CSI Refinance Fund - Rastra Bank ......... 222. Eligibility, Terms and Conditions ........ 243. Credit Guarantee Scheme ........ ..... . 264. The Participating Banks ....... ...... . 26

C. Commercial and Technical Service Components 311. Export Development - Trade Promotion

Centre .. 312. Extension Services and Development

Centres - CIDB ...... .34

3. Raw Material Arrangements - Companiesand the Emporium. 36

4. Coordination and Monitoring andPreparation for Expansion . .38

5. UNDP Financing for Training and TechnicalAssistance . .40

D. Policies Affecting Cottage Industries 41

This report is based on the findings of an appraisal mission which visitedNepal in June/July 1980. The mission comprised N. Barry, C. Bam, S. Kandel(IBRD/IDA) and J. Starkey (Consultant).

This document has a restricted distribution and may be used by recipients only in the performance of 1their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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TABLE OF CONTENTS (continued)

Page No.

V. THE PROPOSED CREDIT ............................... 42

VI. PROJECT BENEFITS AND RISKS ........................ 45

VII. RECOMMENDATIONS ...................... 47

ANNEX 1: Supporting Tables

Table 1 Indicators of Performance in CSIsTable 2 Gandaki Zone - Commercial Bank Branches and Cottage Industry

ConcentrationsTable 3 Probable Locations of Performance Contracts in Gandaki Zone -

Year 1Table 4 Projected Project Benefits - Export Earnings, Output,

EmploymentTable 5 Optimistic, Pessimistic and Expected Results with and without

the ProjectTable 6 Estimated Credit Requirements to be Met under the ProjectTable 7 Interest Rate Structure of Credit InstitutionsTable 8 Costs and Sources of Finance for Commercial and Technical

Service ComponentsTable 9 Summary of UNDP Financing for Training and ConsultancyTable 10 CSI Fund Financial ProjectionsTable 11 Estimated Distribution of Subloans by SizeTable 12 Estimated Disbursement Schedules - IDA and UNTDP

ANNEX 2: Supporting Documents Available in Project File

ANNEX 3: Maps of Project Area

Map 1 Nepal, Cottage and Small Industries Project, Project Area(IBRD No. 15389)

Map 2 Nepal, Cottage and Small Industries Project, Craft Concentrationsin Gandaki Zone (IBRD No. 15390).

NEPAL

APPRAISAL OF A COTTAGE AND SMALL INDUSTRIES PROJECT

I. INTRODUCTION AND SUMMARY

1.01 In the Sixth Five Year Plan (1980-1985), His Majesty's Governmentof Nepal (HMG) is giving priority to cottage industry development, to supple-ment rural earnings and expand non-traditional exports. At HMG's request, aportion of an IDA Technical Assistance Credit (659-NEP) was used for an inten-sive two year project preparation study. The proposed project, an outgrowthof the study and successive IDA missions to Nepal, would involve an IDA creditof SDR 5.7 million (US$6.5 million equivalent) with a US$4.5 million subloancomponent and US$2.0 million for commercial and technical services in promis-ing product groups. The project also would incorporate a US$2.0 million UNDPgrant, to be executed by the Bank and implemented by the appropriate agenciesof HMG, for most training, consultancy and marketing inputs of the project.

1.02 The project area would be limited to the Kathmandu Valley 1/ andGandaki Zone, with the objectives of strengthening services at the center andimplementing product-specific schemes which could be replicated in other hillareas where cottage industries are concentrated. Kathmandu Valley has themajority of export-oriented cottage units and the headquarters of the majorcommercial, banking and public agencies. Gandaki Zone typifies the rural hillareas but has relatively large craft clusters and reasonable road links withKathmandu. Commercial and technical services would focus on those major prod-uct groups with strong market prospects and problems which can be addressedwithin a project: carpets, woolen and cotton handloom garments, metal crafts,forest products and selected agroindustries.

1.03 Where feasible, private commercial organizations would be used forinput supply, marketing and training, since exporters and agents have market-ing knowhow and have demonstrated the ability to organize cottage industryproducers in Kathmandu Valley. Under the project, the Trade Promotion Centre(TPC) would provide exporters with assistance in market contacts and productadaptation, and would engage selected exporters to extend their commercialnetworks to craft clusters in the hills. Capabilities of the three banksdealing with cottage and small industry (CSI) loans would be increased, withpartial refinance and credit guarantees from the central bank, attractivespreads, and training of appraisal and supervision officers. These bankswould make loans to individual cottage and small enterprises, related marketagents, and input supply companies developed under the project. While com-mercial agents would be the major organizers, public institutions dealing withCSIs would have responsibilities in training, filling some gaps in commercialservices, and creating a positive and stable policy environment for industrialgrowth. The Cottage Industry Development Board would build its extensionservices and provide integrated assistance to more remote cottage industryclusters; the Emporium would procure and distribute cotton yarn and organizeinstitutional marketing of handloom products; and the Industrial ServicesCentre would do monitoring and evaluation. Coordination of project inputswould be provided by the Ministry of Industries through a CSI Coordinating

1/ Kathmandu, Lalitpur, and Bhaktapur Districts.

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Committee chaired by the Secretary, Ministry of Industries and supported byfull-time staff.

1.04 To date, IDA's involvement in industrial development in Nepal hasbeen limited. IDA Credit 705-NEP has provided US$4 million to the NepalIndustrial Development Corporation (NIDC) for foreign exchange portions of

industrial subloans. Subloans have averaged about US$155,000; commitmentshave been slow, reflecting problems in promotion, limited prospects formedium and large industry, and NIDC's inadequate local currency resources.Two rural development projects have included small experimental cottageindustry components (Credits 617-NEP and 939-NEP). However, these deal without-stations of agencies which require improvements in strategy, organiza-tion and incentives at the center. Under the IDA Technical Assistance Cre-dit (659-NEP), preparation of the proposed cottage industry project has beenfinanced and some industrial subsector feasibility studies have been under-taken. The proposed cottage industry project provides IDA with the oppor-tunity to play a significant role in shaping assistance to one of the morepromising productive sectors in Nepal. Analyses and discussions during pro-ject preparation already have resulted in improvements in overall strategy,institutional arrangements and industrial policies affecting CSI development.Training and consultancy to prepare the implementing agencies for the projecthave been undertaken, with UNDP financing. HMIG views the proposed cottageand small industries (CSI) project as the lead project in its program toexpand CSI production and exports during the Sixth Five Year Plan period. Bybuilding institutional capabilities and replicable programs, the proposedproject should have significant immediate and long-term impact on earnings,output and exports from cottage and small industries.

II. SECTORAL BACKGROUND

A. Economic Setting

2.01 Nepal remains one of the least developed countries, with annualper capita incomes averaging about US$140. Agriculture, accounting for morethan 60% of GDP and 75% of exports, provides a livelihood to over 90% of thepopulation. Food production has not kept pace with population growth; overthe period 1967-77, growth of foodgrain output averaged 1.5% p.a., whilepopulation grew at 2.6%. Stagnation in agriculture limited growth in othersectors, and GDP grew by only 2.4% p.a. in real terms during the Fifth Devel-opment Plan period (1975-80). The economic situation deteriorated furtherin 1979/80: GDP decreased by about 1% and, with major crop losses due topoor monsoons, crop output probably declined by roughly 4%. Industrialgrowth continued to be curbed by supply bottlenecks, delayed preparationof public sector projects, and limited potential for large industry. Thisweak performance led to accelerated inflation and a widening trade deficit,largely due to reduced rice exports and a surging import bill for oil andfoodgrains. The situation improved somewhat during 1980/81, due to a goodmonsoon and consequent increases in agricultural production.

2.02 Agricultural growth will not be sufficient to meet Nepal's needs.In the hills and mountains, which contain two-thirds of the population butonly one-third of the arable land, population pressures have pushed cultiva-

tion onto marginal land and average yields have declined; food productionmeets only two-thirds of minimum subsistence needs. While hydropower andtourism offer opportunities to increase foreign exchange earnings, thesesectors do not generate the needed employment. In industry, the SixthFive Year Plan (1980-1985) gives priority to promotion of CSIs, to generateearnings for the hill population and strengthen the trade balance by in-creasing exports of non-traditional goods.

B. Industrial Structure and Performance

2.03 Role of Industry. Although small and at an early stage, Nepal'sindustrial sector represents the largest non-agricultural income source,accounting for over 5% of GDP, as officially calculated. 1/ About 70%of industrial output involves agroprocessing; textiles, apparel andleather account for about 14%; and forest products represent about 8%.About half of industrial output is produced in 12 public enterprises;most public firms face difficulties due to low productivity, inappropriatepricing policies, and technical and managerial weaknesses. About 20% ofthe value added in private industry is produced in 3,500 registered, mainlysmall scale firms, employing 35,000; the remaining 80% comes from unregis-tered, mainly rural CSIs. The skill base in CSIs is large, with over onemillion working full or part time in about 400,000 mainly household enter-prises.

2.04 The low level of industrial development reflects the paucity ofobvious opportunities. Constraints to industrial development include:limited natural resources; a small domestic market with low purchasingpower 2/; a landlocked position which increases costs of raw material im-ports and exports; competition from India; and absence of entrepreneurialand technical skills for modern industry, making import-substitution dif-ficult and exports of most modern industrial products unlikely. In viewof these problems, Nepal needs to adopt a highly selective approach toindustrial development. Performance of public enterprises needs to beimproved. Promotion of CSIs can yield substantial employment and foreignexchange benefits at relatively low cost. Prospects for increasing exportsof carpets, metal crafts and wool and cotton handloom garments are good.Development of CSIs is crucial in view of their predominance, labor inten-sity, export potential and ability to provide substantial supplementary

* earnings to the hill population. To realize this potential, CSIs needimproved access to credit and effective technical and commercial services.

1/ In Nepal, GDP calculations do not include many cottage industry activi-ties which are conducted at the household level.

2/ Cash incomes of the majority of inhabitants are less than US$50 p.a.;in hill regions most transactions are on a barter basis.

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C. Role of Cottage and Small Industries

2.05 Under the new Industrial Enterprise Act, the definition of cottageindustries for purposes of fiscal incentives and technical services includesthose with fixed investment, including land and buildings, of up to Rs 500,000in rural areas and Rs 800,000 in urban areas. 1/ Small scale industrieswould be defined as those with fixed investment not exceeding Rs 2 million. 2/In view of past inflation, these changes seem appropriate. Over 80% of the3,500 registered industries have fewer than 10 employees; these small firmsmill grain, extract oil, and produce a limited range of consumer goods. Mostcottage industries are household units; fixed assets range from Rs 100 to Rs15,000 and annual output per worker varies from Rs 100 to Rs 10,000 (Annex 1,Table 1).

2.06 Subsectoral Distribution. Major cottage industry subsectors arewoolen and handloom items, agro-based operations and forest products. In ex-ports, carpets, metal crafts, woolens and cotton garments account for about95% of sales. Five major subsectors have identified export or local marketpotential: woolen carpets and garments; cotton handloom fabrics and finishedproducts; metal curios and utensils; food processing; and forest-based products.

2.07 Geographical Distribution. Bagmati and Gandaki Zones account forroughly 60% of cottage industries in Nepal (Annex 3, Map 1). Kathmandu Valleyholds sizeable concentrations of wool, cotton and metal CSIs. In the six dis-tricts the Gandaki, almost all units are operated by poor hill families whoprovide goods and services for the rural subsistence economy. Agroindustriesare widely dispersed, but in wool, cotton and forestry products, Gandaki holdsover 40 clusters 3/ of 100 to 200 cottage units each (Annex 3, Map 2).

2.08 Constraints. In most hill areas, purchasing power, already belowsubsistence levels, is stagnant; local markets offer limited scope for expan-sion in most CSI products. Seasonal demands from agriculture mean that ruralworkers are available for cottage industry production for about two-thirds ofthe year. In exports manufactured by CSIs, Nepal's landlocked position re-sults in high transport costs which add a sizeable margin to export prices ofthe lower value items. Most craftsmen are not entrepreneurs; their tradition,scale, and knowledge hamper growth beyond the household level and necessitateservices by market agents to provide inputs and sell finished products.Institutional constraints are serious. Public programs to assist CSIs have

1/ Previously, cottage industries were defined as those with fixed invest-ment of up to Rs 200,000, including land and buildings; small industrieswere considered as those with fixed investment not exceeding Rs 500,000.

2/ Credit under the proposed project would be available for cottage and"modern" small firms with fixed assets of up to Rs 800,000 after thesubloan is made, as NIDC is established to meet the credit needs of thelarger end of the small industry sector.

3/ Locations of the main craft clusters in Gandaki are depicted in Annex 1,Tables 2 and 3; and in Annex 3, Map 2.

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been weak. Private agents, who play a major role in input supply, qualitycontrol and marketing in the Kathmandu Valley, have not had sufficient incen-tives to extend commercial networks to craft clusters in the hills. Exportershave inadequate market information, face delays in licensing and shipment, andhave insufficient credit access. If the more serious of these constraints areaddressed, CSI potential could be tapped, particularly for exports.

2.09 Export Potential. CSI exports have increased by about 35% p.a. since1972/73, from a low base, and already constitute about 15% of cottage industryoutput and the majority of non-traditional manufactured exports. In 1980/81,exporters marketed over Rs 140 million in woolen, handicraft and handloomitems; sales to tourists generated another Rs 50 million. Studies of exportpotential in Europe and the United States 1/ indicate prospects for handknot-ted Nepalese carpets, woolen knitwear, cotton handloom garments and metal-ware. Except in carpets, for which existing markets are relatively strong,Nepal will need to combine its exotic image with competitive price, quality,and responsiveness to western fashion trends. Concentrations of traditionalskills at relatively low wages can be utilized as a strong production base.The 80 to IOU exporters of cottage industry products are among Nepal's chiefassets; it is they who have increased exports, despite the substantial diffi-culties. While at present, these exporters work mainly with cottage units inKathmandu Valley, their market contacts and organizing knowhow can be tappedin mobilizing production from the hills. In Gandaki about 30 craft clustersinvolving about 5,000 producers have reasonable access to the main roads andcan be competitive, if products are adapted and production geared to exports(Annex 3, Map 2); transport costs to Kathmandu are marginal and can be out-weighed by lower wages in rural areas. However, exporters would need directincentives to help cover the initial costs of extending their networks torural CSI clusters. In addition to these direct incentives to promote ruralemployment, handicraft exporters need assistance in adapting products to meetconcrete market prospects.

2.10 If systematic marketing, technical and credit services are provided,expanded production to meet export demand would be expected to generate aboutUS$30 million in incremental foreign exchange over four years, providing sig-nificant additional earnings to CSIs, equivalent to roughly 40,000 manyearsof additional employment (paras 6.01-6.03). While the majority of productionfor export would continue to come from Kathmandu, rural Gandaki Zone couldgenerate as much as 30% of this growth.

2.11 Local Potential. Local market prospects in most product groups aremore limited. Analysis of HMG's statistics on legal industrial imports indi-cates that less than 10% of the value could be replaced by reasonably compe-titive products from domestic CSIs. Not only is local purchasing power small,but in several product lines demand is price inelastic. There is, however,significant import-substitution potential in handloom products, and in agro-processing if crop output can be expanded; some scope for expansion alsoexists in building materials, implements and footwear. Public sector andtourist markets are promising, particularly in processed foods and textiles.

1/ These two marketing surveys of Nepalese CSI export potential wereprepared as part of the project preparation study.

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D. Industrial Policy Framework

2.12 In the Sixth Five Year Development Plan (1980-85), HMG recognizesthe need to promote private industrial investment by reducing bureaucraticcontrols and providing effective fiscal and export incentives; to achievethese objectives, HMG has revised its industrial policy. iDMG used consul-tancy services, financed by UNDP and executed by the Bank under preparatoryassistance for the proposed project, in helping to finalize a revised Indus-trial Enterprise Act. The new Act, incorporating some recommended improve-ments, was passed in August 1981 and is with His Majesty for approval andissuance. While the Act includes improvements in income tax and export in-centives, the mission's recommendations on more liberal industrial approvalprocedures and a streamlined fiscal incentive system have not been fullyincorporated. Development of rules and procedures, needed to ensure effec-tive implementation of the Act, could incorporate some of these recommenda-tions. The following section summarizes the mission's recommendations andmodifications planned by HMG on policies with direct effects on CSI develop-ment (para 4.53).

2.13 Fiscal Incentives. The Act introduces product lists and sizecategories for CSIs, with different licensing requirements and fiscal incen-tives for various groups. Such scaling is cumbersome and unlikely to havesignificant impact on profits or economic benefits of the enterprises. Themission recommended a simple fiscal system for all CSIs; any differentialincentives should be based on in-depth subsector analyses to ensure thatefficient CSIs are promoted.

2.14 Registration and Licensing. The Act envisages registration ofCSIs which seek incentives. While this is reasonable, the mission recom-mended that registration procedures do not inhibit CSIs from receivingcredit and technical services; rules and procedures for the Act shouldclarify this aspect. Also, the Act specifies a number of organized smallindustry product lines which would require licensing in addition to regis-tration. While this licensing would not affect most cottage enterprisesit would represent an increase in controls and delays for some, in contrastto H4GN's stated objectives of reducing controls during the Sixth Five YearPlan period.

2.15 Joint Ventures. Under the Act, foreign investment would be al-lowed only in medium and large industries, with priority to enterprisesemploying sophisticated technology. The mission recommended that foreignpartners also be encouraged in export-oriented light industries to help withorganization of production and marketing channels; foreign participation byboth manufacturing concerns and trading companies dealing in CSI productsshould be considered. The mission also recommended establishment of a "onestop office" to assist potential foreign investors in procedural matters.

2.16 Export Incentives and Procedures. HMG intends to introduce tem-porary income tax holidays and import duty drawbacks for exporting firms.Most CSIs, which would pay only nominal duty on imports of equipment and rawmaterials, are too small to import directly. The majority purchase fromtraders who pay regular import duty, pass on the cascading effect of a sales

tax, and charge high prices during periods of scarcity. Under the Act HMGextends import concessions to private limited companies importing inputsfor CSIs, provided that CSI producers and exporters are shareholders (paras4.40-4.43). This measure is expected to provide effective incentives inthe formation of companies importing key CSI inputs in bulk.

2.17 Exporters often do not obtain the full benefit of exchange rateincentives due to faulty operation of the Export Valuation Committee, whichis to set standard prices for most export products. Standard prices forcarpets and garments cannot incorporate differences in product quality ormarkets. Unit prices set by the Valuation Committee often are undervalued,discouraging product improvement. The Committee meets irregularly and oftendoes not adjust prices to reflect cost increases. As such, the ValuationCommittee represents a serious impediment to the development of non-tradi-tional exports in Nepal. It has been recommended that the Valuation Com-mittee be abolished. With the recent removal of the dual exchange ratesystem, the original rationale for the Export Valuation Committee no longerapplies, and HMG is considering abolishing it.

2.18 Transportation Costs. A major obstacle to exports is the trans-port cost arising from Nepal's landlocked position. Transport costs canoutweigh the advantage of lower labor costs in Nepal, pricing low value,large volume items out of the market. It has been recommended that HMGdevelop a transport sector policy and take concrete steps to address theissue. Short-term improvements in transport arrangements for non-tradi-tional exports which merit early consideration include: low air freightrates to Bangladesh, Bangkok, and Colombo by the Royal Nepal Airlines Cor-poration to enable sea-shipment from ports other than highly congestedCalcutta 1/; negotiating with India to extend to Nepal its rebates on inter-national freight; organizing air cargo charter flights with internationalairlines consolidating export shipments; and improving cargo handling andwarehousing facilities at Tribhuvan Airport. Based on the appraisal mis-sion's recommendation, UNDP plans to finance a consultant to help organizethe cargo facilities under a transport project.

2.19 Export Financing. Preshipment export financing, important in ex-port growth, is difficult to obtain in Nepal. The appraisal mission recom-mended that HMG consider establishing an export credit guarantee scheme, whichcould start in Nepal Rastra Bank (NRB). 2/ At a minimum, NRB should reiterateits earlier guidelines, advising commercial banks on conditions under whichthey should extend preshipment finance.

1/ Net incremental foreign exchange earnings through increased exportswould far exceed revenue losses from this measure according to a teamwhich worked in Nepal during 1981 on a UNCTAD-ESCAP project for "Assis-tance to Least Developed Landlocked Countries."

2/ Detailed recommendations regarding export financing are provided in areport by the International Trade Centre in January 1980.

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E. Financing of CSIs

2.20 During the latter part of the 1970s, total demand for credit in-creased rapidly. In 1977/78, credit by the banking system rose by 36%,outstripping the increase in deposits. While there was some expansion inlending to industry and agriculture, most bank lending to the private sec-tor flowed to trade, particularly for imports. Rapid credit expansiongenerated demand pressures which contributed to the deteriorating balanceof payments and the accelerating inflation rate. In 1978/79, growth ofdomestic credit decreased to 21%; lending to the private sector fell,largely due to tighter credit controls from the NRB. Total industrialcredit, which nearly doubled in 1977/78, increased by less than 5% in1978/79, with banks' reduced resources lent mainly for commerce.

2.21 The banking system encompasses two government-owned commercialbanks (Nepal Bank Ltd. and Rastrya Banijya Bank), the Agricultural Devel-opment Bank (ADBN), the Nepal Industrial Development Corporation (NIDC),and the Provident Fund Corporation. Since 1970, the commercial banks andADBN have expanded their share in the total assets of the financial sector.Nepal Rastra Bank (NRB), the central bank, has instructed the commercialbanks to lend 7% of total deposits to small agricultural, industrial andservices enterprises; however, these targets have not been accompaniedby training in project evaluation, margins to make small loan operationsprofitable, or adequate credit guarantee provisions. As a result, lendingunder the "priority sector scheme" has averaged only about 5% of total de-posits and most CSI loans still are made on the basis of clients' collateralrather than evaluation of project viability. ADBN, which focusses on agri-cultural lending, also finances small agro-based and cottage industries,based on project evaluation. Industrial credit to larger industries isprovided by NIDC. During the Sixth Five Year Plan period, HMG intends tostrengthen the banks' programs and capabilities in meeting credit needs ofCSIs and related commercial concerns. Training of over 20 key staff of NRBand the banks has been provided in India and the Philippines and localtraining of about 100 CSI officers has been arranged with State Bank ofIndia during November and December 1981.

2.22 The 300,000 cottage and small scale units in Gandaki and theKathmandu Valley have a potentially large demand for credit; however, marketlinks, raw material supply arrangements, and production methods would haveto be improved before large amounts could be absorbed fruitfully by cottageindustries. Also, the banks need to upgrade their CSI staff and creditoperations. The project would require about Rs 67 million (US$5.1 million)in institutional term credit over a three year commitment period, for cot-tage units, related commercial agents, organized small industries and rawmaterial supply companies (Annex 1, Table 6). This would represent an an-nual increase of about 20% in CSI lending by the two commercial banks andADBN, which is reasonable if training and incentives in CSI lending areimproved.

2.23 Interest Rates and Inflation. Until recently, commercial banksmade short term loans at 13-18% p.a; NIDC provided long term finance for

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larger industries at 11-14% 1/; ADBN lent to CSIs at 8-12%; and commercialbanks offered medium term credit to CSIs at 10% under the priority sector

scheme (Annex 1, Table 7). The tNepal Rastra Bank recently decided to ra-tionalize interest rates and eliminate the gap between regular commerciallending rates and rates for CSIs, with all rates to reflect inflationarytrends and enable the banks and ADBN to increase the spreads between depositsand lending rates. Medium term inflation projections, previously estimatedto be 10-13%, have now dropped; the anticipated annual rate for 1981/82 isabout 8%, reflected the good mansoon and resulting improvements in agricul-tural production. Medium and long term loans to cottage industry, includingthose under the proposed project, would be made at rates which are positivein relation to medium term inflation projections and consistent with termrates for all industry in Nepal. The initial rate for CSI loans would be11%; this rate for CSI would be reviewed at least annually and adjusted tomaintain positive real interest rates and consistency with commercial bankrates for term loans to large industry (para 4.11).

F. Commercial and Technical Services

2.24 HMG recognizes that public technical and commercial services forCSIs have been inadequate. The final draft Sixth Five Year Plan containsmeasures to modify and improve public and private services to CSIs; thesebuild on and are consistent with the institutional arrangements under theproposed project. The Department of Cottage and Village Industries (DCVI),the government agency which has been responsible for CSI development, hasprovided some formal training and technical extension through regional anddistrict offices. tiowever, the majority of DCVI officers have no technicalbackground; tight controls over departmental salaries and financial manage-ment preclude performance incentives and flexible operations; and DCVI hasconcentrated on administrative tasks such as registration and licensingrather than promoting development of CSIs. A Cottage Industry DevelopmentBoard exists, which has wide powers for commercial and developmental func-tions, but CIDB never has been made truly operative; during the Sixth FiveYear Plan period (1980-85), HMG intends to shift extension services anddevelopment functions from DCVI to the CIDB, beginning with the projectarea.

2.25 Public agencies' commercial services for cottage industries areparticularly weak. National Trading Ltd. has imported metal and wool yarn,but supplies have been sporadic, prices have been high to cover costs oflosing items, and NTL never has been a significant factor in imports ofthese two comrmodities, which are vital for export-oriented cottage indus-tries. The Cottage Industries and Handicraft Sales Eraporium imports about15% of the total cotton yarn supply; about 10 large and 100 small cottonyarn importers account for the majority of yarn operations. The Emporium's

1/ Commercial banks' interest rates vary depending upon the type of enter-prise and the collateral provided by clients. NIDC's interest ratesvary by location and type of industry.

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efforts at cottage industry retail sales have not been successful, but theEmporium has served as a stabilizing factor in cotton yarn imports and has

a comparative advantage in marketing to the public sector; the Emporium'sservices are to be strengthened in cotton-related areas.

2.26 The Trade Promotion Centre (TPC) is perceived as the governmentagency most concerned with the problems of private exporters. However, TPChas had limited resources and technical staff, and market information andsales promotion activities have been ad hoc and sporadic. HMG intends tohave TPC play a more active and systematic role in promoting non-traditionalexports, particularly in cottage industry products. TPC recently has estab-lished a Cottage Industry Export Development Division to provide exporterswith assistance in product adaptation in response to specific market re-quirements, and to mobilize exporters to extend their commercial networksto rural cottage industry clusters. Exporters provide the majority of mar-keting, input supply and technical services to cottage industries in Nepal.Private commercial agents have built-in performance incentives; highersalaries enable them to attract, retain and motivate qualified staff to doraw material supply, quality control and purchasing. HMG's strategy, asreflected in the Sixth Five Year Plan and the proposed project, would focuson encouraging the private commercial sector to expand their services toCSIs.

III. SCOPE AND STRATEGY IN SELECTED SUBSECTORS

3.01 Project preparation involved detailed analyses of problems, poten-tial and assistance needs in five major CSI subsectors: carpets and otherwoolen products; handloom fabric and garments; metal crafts; forestry-basedproducts; and selected agroindustries. RMG and IDA chose these subsectorsdue to their importance, market prospects and problems which could be ad-dressed within a project. The project preparation study, sponsored by DCVIand performed by ISC staff with 30 manmonths of outside specialists, con-sisted of two phases. Phase I involved a survey of cottage industries inGandaki and Bagmati Zones. 1/ Through the survey, clusters of cottage in-dustries were identified, CSI operations analyzed, and public and privateservices observed. In Phase II, product specialists did detailed analysesof the key product groups and made proposals on institutional arrangements,subsector components and costs. Also, export potential studies for Nepalesewoolen, cotton and handicraft products were performed in the United Statesand selected European countries. 2/ IDA missions were active in this projectpreparation and performed additional analyses, particularly on needed re-forms in institutional services and policies affecting CSIs. The prospects,problems and proposed strategies for developing the major cottage industrysubsectors are outlined below.

1/ Aggregated statistics from this survey are presented in Annex 1, Table1.

2/ Detailed reports on the survey, subsector analyses, export potentialstudies and final recommendations are available in the project file.

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A. Wool Carpets and Garments

3.02 Characteristics. In Nepal, about 97,000 spinners and weavers in46,500 units make woolen carpets, garments, and rugs; fixed investment inthe industry is about Rs 135 million; annual output totals roughly Rs 240million. Kathmandu Valley and Gandaki Zone account for about 20% of woolenproduct output and employment. About 70% of the Rs 75 million in carpetsand wool garments exported in 1980/81 were made in Kathinandu, with the re-mainder coming from Gandaki Zone and other rural areas. Net foreign ex-change earnings constitute about 60% of export value. Most of the 13,200workers in 6,900 household units in the project area make traditionalblankets, rugs and jackets for rural markets; due to limited and stagnantlocal demand, these weavers work an average of 50-60 days, earning aboutRs 360 annually from their work in wool. In contrast, annual earnings ofcarpet weavers in Kathmandu average Rs 5,000.

3.03 Potential. There is strong immediate potential for expandingproduction and exports of Tibetan hand knotted carpets, 1/ due to goodNepalese designs and established contacts with importers. The carpetsproduced in Nepal are not direct substitutes for Persian-style carpets;however, Iran's exodus has resulted in buyers seeking new sources for avariety of ethnic carpets. While Nepal's carpet exports have been growingat 30-55% annually for the last five years and now constitute the secondlargest manufactured export, Nepal still represents less than 0.5% of theworld carpet trade. Market surveys indicate that a 35% annual increasein Nepalese carpet exports can be maintained if the production base is ex-panded, wool imports secured, and market contacts broadened; without theseinputs, growth would be likely to slow to about 20%. These inputs would belikely to generate incremental foreign exchange earnings of about Rs 160million (US$12.1 million) over four years, with incremental local valueadded of about US$7 million equivalent (Annex 1, Tables 4 and 5). Sinceabout 90% of the existing carpet loom capacity is utilized, additional loomswould be required to meet the production increase of about 35,000 metersannually. With each meter requiring about 23 days of spinning, weaving andfinishing, a 35% annual expansion represents about 12,000 additional manyears by the end of 1984 assuming a 200 day working year. About 40% of theworkers required are unskilled, for carding, spinning, and finishing.

3.04 The high value added of carpets makes it possible for rural unitsto be competitive; transport of wool to and finished carpets from weavingconcentrations in Gandaki adds only Rs 21 to the costs of a Rs 1,200 carpet,more than outweighed by lower labor costs in the hills. 2/ In Gandaki,

1/ While carpet production began with Tibetan refugees, the success hasresulted in spreading of production to Nepalese units. Now, Nepaleseworkers account for over 70% of production of carpets.

2/ Daily earnings average Rs 13 in Kathmandu Valley; with wages represent-ing about 54% of production costs, rural wages would need to be 3,/ lowerto make products competitive.

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about 1,500 of the weaving families are located in 12 rural clusters; thesefamilies have skills in spinning and weaving from making blankets on tradi-tional looms. With introduction of carpet looms and adaptation of skillsfrom rugs to Tibetan carpets, several of these concentrations could bemobilized for export markets. With initial training and organization of in-put supply, orders and quality control, Gandaki could contribute about 20-30% to Nepal's growth in carpet exports over the next three years, providing

additional earnings of up to Rs 2,300 (US$175) annually to rural weaverfamilies who now live below subsistence levels.

3.05 The other product lines with strong export prospects, particular-ly in US markets, are woolen jackets and hand knits. The current trend inwestern markets is for products designed specifically to suit US and Europeanfashions rather than for ethnic outerwear. To meet competition, Nepaleseexporters would need close relationships with buyers and designers to respondquickly to fashion trends. While prices are competitive and buyers appreci-ate the quality of wool from Nepal, improvements in sizing and finish areneeded.

3.06 The attraction of expanding jacket and knitwear production in thehills is that existing equipment and methods would be used; piece rate wagesare attractive, yielding about Rs 10 per day for knitters, Rs 12 for weavers,and Rs 25 for tailors. If the necessary improvements in design and marketingare made, traditional household production methods could yield a competitiveproduct. Given the small present export base, project inputs could generatea 30% annual increase in exports of this product, lifting exports from aboutRs 5 million in 1978/79 to about Rs 15 million by 1984, creating about 5,000additional man years of employment, with annual incremental earnings averag-ing Rs 860 (US$65) per worker. 1/ In the absence of specific project inputs,export earnings probably would not grow by more than 10% annually, since therough quality of the products available has limited appeal in export markets(Annex 1, Tables 4 and 5). While knitting and weaving operations could beperformed in traditional craft concentrations in the hills, tailoring andready-made garment operations are mainly in Kathmandu; skills and economiesof scale in garment production would make it advantageous to weave woolenyardage for jackets in the hills but do sewing operations in Kathmandu.

3.07 Needs and Strategy. Major constraints in expanding carpet exportsare wool supply and production capacity. Insufficient imports of Bhanglungwool have caused price increases, 2/ and inadequacy of supplies have limitedoutput, foreign exchange earnings and ability to meet orders. At present,National Training Ltd. imports only about 60 tons of Bhanglung wool from Chinaunder a barter agreement; prices are high and operations inefficient. The

1/ Assuming a 100 day work year which is reasonable, given seasonality ofdemand for woolen garments.

2/ Wool prices doubled from Rs 22 to Rs 42 per kilogram from 1978 to 1979;with about 6 kg of wool required per meter of carpet, this increasedproduction costs by about Rs 120 per meter, reducing profitability fromabout 40% to about 30%.

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remaining 340 tons are imported, mainly from Tibet, often unofficially, byprivate traders. Although Tibet produces large quantities of Bhanglung wool,China is expanding its own carpet exports, aided by its Most Favored Nationstatus. Other sources also may have to be tapped; New Zealand appears prom-ising, since it produces a variety similar to Bhanglung wool at comparableprices. No public sector organization is judged sufficiently competent toarrange bulk wool imports; a private company, structured to assure fair pricesto the producers, is being formed to help ensure stable availability of woolfor the carpet and garment industry. About Rs 2.5 million in financing wouldbe required to launch this company, enabling it to purchase in bulk and holdthe required stocks of wools and dyes (paras 4.41-4.43).

3.08 Another problem is the high cost of air freighting carpets; dueto unreliability and delays in sea shipment from Calcutta, Nepalese exportersair freight carpets, adding 20% to the CIF cost of a carpet shipped to Europeand 40% to the US versus 5% and 10% for sea shipment. With air freight,goods are received in one to two weeks vs. one to three months by sea. Advan-tages of air could be reduced by cutting manufacturing and handling time andby air freighting to Colombo, Chittagong or Bangkok and sending goods by seafrom there (para 2.18).

3.09 Modifications in design and sizing, coupled with improved marketlinks, are prerequisites for sizeable market penetration in woven or knittedwoolen garments. Production costs would be reduced in both carpets and gar-ments by introducing some simple equipment at a few key points in the pro-cess (e.g., carding and milling) and by improving speed and quality throughshort upgrading courses and in-house extension services. Credit requirementsof the project for units making carpets and other woolen products are esti-mated to be Rs 11.0 million from 1981 to 1983. Most CSI subborrowers areexpected to be household units employing an average of two family members;however, about 20%o of the loans to wool units are expected to be to unitsemploying about 10 workers (Annex 1, Table 6). Exporters who supply rawmaterials, organize decentralized producers and market products would needabout Rs 7.0 million in term credit. The raw material supply company im-porting wool yarn would need about Rs 3-4 million in credit over the com-mitment period (para 4.42).

B. Cotton Handloom Products

3.10 Characteristics. The project area contains about 20,500 handloomunits employing 25,500; about 85% of the looms are in clusters in KathmanduValley with the remaining 15% in Gandaki. Fixed investment per job averagesRs 690 and annual output per worker, Rs 2,900. The product range is extremelylimited; most units produce simple shirting, saree material and bedcoverings.Prices of Nepalese handloom products are less than Indian imports by 5-10%in simple shirting and bedcover material but more for sarees and towelling;productivity on flyshuttle looms is comparable, averaging one meter per hourfor simple weaves.

3.11 About 44% of the looms are traditional waist looms, 55% are fly-shuttle hlandlooms, and 1% are pedal looms. Waist looms, used mainly in rural

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Gandaki, are only 20% as efficient as fly shuttle looms, and the narrow loomwidth limits product possibilities. Pedal looms, which do shedding, picking

and beating automatically, are still more efficient with one-shift capabi-lities of 15 meters vs. 6 to 8 meters on fly shuttle looms. However, thehigher costs of pedal looms are warranted only for simple weaves which do notrequire frequent stoppages for design formation. Scarcity of power, marketuncertainty, and the desirability of focussing on products with higher valueadded make the Rs 1,000 flyshuttle loom a viable alternative to the Rs 4,500pedal loom.

3.12 In rural Gandaki, weavers in household units work only about 30days a year, due to inadequate yarn supply, local marketing difficulties,inferiority of waistloom technology, and requirements from agriculture duringone-third of the year. In Kathmandu Valley most weavers work about 180 daysand in concentrations such as Kirtipur are employed for up to 270 days a year;however, daily earnings often are low with weavers engaged in less profitablelines for the low end of the local market. Kathmandu Valley has a strongerhandloom tradition, easier access to yarn and markets, and produces betterquality; however, productivity on the flyshuttle loom is similar in Gandakiand Bagmati Zones. With improved equipment and methods, rural Gandaki couldbe competitive, since transport costs to bring yarn in and take cloth out ofrural clusters would add only about 0.3% to 4.0% to the cost of a meter,which would be outweighed by lower rural wages.

3.13 Local Market Potential. Nepal produced only 15% of the cloth whichit purchased in 1979/80 1/, the remainder having been imported. Some importswere in synthetics; however, a sizeable portion was simple Indian handloomsarees, shirting, bed sheets, furnishing fabrics and towels. With laborrepresenting about 40% of production costs at current Nepali wage rates, itis worthwhile for Nepal to buy yarn and gain the value added and employment.If Nepal could increase import substitution of cotton cloth by 10% per year,an additional 3,300 people would be employed annually. 2/ The most promisingproducts are shirting, dhakka cloth, and furnishing fabric. Daily earningsaverage Rs 10 in these lines. In Gandaki, where weavers need to upgrade loomsand methods to achieve competitive price and quality, institutional demand canbe tapped. Government departments, hospitals, schools and private hotelsimport at least Rs 20 million annually in bed sheets, uniforms and furnishingfabrics; hill weavers can gain efficiency and steady earnings by producingstandard products, gradually moving into more competitive consumer markets.

3.14 Export Potential. India exported US$77 million in handloom clothin 1979; Nepal exported about US$150,000. In the same year, India exportedUS$450 million in garments, over 50% being of handloom cloth; Nepal's garmentexports in 1979 totalled US$666,000. With the quotas affecting Indian andother exporters in US and European markets, there is scope for Nepalese

1/ The project area supplies about 7% of this effective demand.

2/ Assuming six meters per day per worker with a 200 day working year,which is reasonable given seasonal labor requirements from agriculture;if the working year were 150 days, the number employed would be 4,000.

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exports, particularly if foreign collaboration can be arranged. 1/ The mostlikely areas for export expansion are shirts, casual wear, furnishing fabric,and table linens. In the short term, only a small portion of Gandaki's loomscould be geared for export, making bolts of cloth with finishing done inKathmandu; however, the thousands of skilled weavers in Kirtipur, Luvu andBhaktapur of Kathmandu Valley could be organized for export-oriented handloomcloth production if marginal improvements in looms, methods, and designs aremade and if production from these concentrations is organized.

3.15 Needs and Strategy. Handloom units, not in a position to importyarn in bulk, need to rely on traders. Fragmented purchasing precludes volumediscounts and systematic yarn supply arrangements; during periods of scarciLy,prices increase by 20-30% and the yarn available often is not of the varietiesin demand. The nature of producers and traders in cotton handloom productsand the limited profitability of the industry at present make it unlikely thatthe private sector will solve the cotton yarn supply problem. Services bythe Emporium need to be improved significantly with better purchasing, inven-tory control and personnel management; bulk procurement from Indian andChinese mills would reduce yarn prices by 5-10%.

3.16 In addition to yarn supply constraints, the narrow range of Nepalihandloom products limits their competitiveness with Indian varieties in localand export markets. Assistance is needed in product adaptation and designdevelopment, in response to concrete market opportunities (para 4.27 and4.37). Credit to upgrade equipment and finance working capital requirementsis needed; about Rs 5.8 million in credit for the CSI handloom units and aboutRs 6.0 million in term credit for the organizers would be needed from CY1981-83 (Annex 1, Table 6). The Emporium would need about Rs 5.0 million incredit over the three year commitment period for import and distribution ofcotton yarn and handloom accessories and for wholesale operations to meetpublic sector cotton handloom needs (para 4.44).

C. Metal Crafts

3.17 Characteristics. The main center of metal crafts is Patan Cityin the Kathmandu Valley, which accounts for about 90% of total production(Annex 3, Map 1). Metal curios and utensils represent a small but highlyprofitable product group. About 340 units employ 1,000 workers who produceabout Rs 77 million worth of artistic and utility items; metal craft exportsreached Rs 37 million in 1978/79, constituting about 35% of cottage industryexports; annual wages average about Rs 3,600. The existing products includeartistic statues and ritual objects, filigree art works and domestic metalutensils. Production technology is traditional: lost wax casting is used inmanufacturing metal statues and bronze utensils, and simple beating andsoldering is employed for copper and brass utensils and studded filigreeartwork.

1/ It is unlikely that Nepal would face garment import quotas until annualexports exceed US$30 million, as was the case in Sri Lanka. Furthermore,garments of handloom cloth are in a category which is less sensitiveto protectionism in Western markets.

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3.18 Potential. While export growth has been rapid during the pastfive years, maintenance of this pace will require product diversification,increased metal supplies, and selective improvements in technology to competewith India and other metal craft exporters. Some market scope exists forreligious brass and bronze work, particularly to Europe and Asia, both as artobjects and lower priced curios. Growth prospects are good in filigree workand for hammered copper and brass culinary ware, with some design modifica-tion. If production is expanded, raw materials are secured, and designmodifications responding to market requirements are made, exports of metalcrafts could provide incremental foreign exchange earnings of Rs 145 million(US$11 million) over the 1981-84 period, relative to export earnings withoutproject inputs (Annex 1, Table 4). Since most metal craft units are inLalitpur, credit, technical and raw material services could be provided withrelative ease and efficiency.

3.19 Needs and Strategy. The sporadic supply and high price of metaland other inputs are major constraints; the need for volume imports of metalis increasing with local scrap becoming scarce. At present, craftsmen de-pend upon private traders who often charge three times their import prices,particularly in periods of scarcity. These importers pay import duties andsales taxes; craftsmen, who are exempt from both, usually are too small toimport directly. Members of the Nepal Handicrafts Association are estab-lishing a private limited company to import required raw materials in bulkfor supply to manufacturers at reasonable prices (para 4.41-4.43). Under theIndustrial Enterprises Act, HMG has made provisions to exempt such companiesfrom import duties and sales taxes (para 2.16). With bulk purchasing andreasonable profits to such a company, metal prices to CSIs could be reducedby up to 200%. Metal craft producers also have difficulty obtaining credit.Finished metal handicrafts are not accepted by the banks as collateral sincevalue on these items is difficult to assess; no pre-export financing isavailable to execute orders against letters of credit. About Rs 5 millionin term credit would be required in the project area for fixed investmentand permanent working capital in the 1982-1984 commitment period, for metalcraft units, related agents and the input company. Training and consultancyon selective improvements in traditional methods, tools and designs would beprovided (para 4.36), and exporters would be assisted in product modification,quality control, and increased export contacts (para 4.28).

D. Forest Based Products

3.20 Characteristics. About 125,000 people make forest-based productsin the project area; most work during slack periods of the agriculturalcycle. Raw materials used are indigenous bamboo, reeds, grass and timber.Main items are utility containers and floor matting. Most furniture makingand wood carving skills are found in Kathmandu Valley. Production of bambooproducts and reedware is concentrated in Gandaki Zone (Map 2); fixed invest-ments in these lines average Rs 100, generally in very simple tools. Annualoutput value of forest based products in the project area is an estimated Rs20 million.

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3.21 Potential. Raw material available would be sufficient to supporteven a threefold expansion in production. Sizeable producer concentrationsexist which would facilitate cost effective services and marketing. InGandaki, 7,500 units in 9 clusters are within 20 miles of district headquar-ters with road connections to Kathmandu; Kathmandu Valley holds about 3,000units in 13 clusters. The existence of large producer concentrations, theample supply of local raw materials, and the extremely low fixed investmentsmake bamboo, reed and straw products an attractive area for expansion. How-ever, local markets are saturated. If improvements are made in sizing andworkmanship, tourist markets for traditional products could be tapped. Thereis some scope for exports of basketry and knocked-down furniture. In bothU.S. and European markets, there is always demand for a small quantity of"typical" baskets to provide variety. However, to realize sizeable growth,Nepal would need to be competitive with the Philippines and China, the mainnew entrant; attractive air freight rates and more efficient sea shippingarrangements would be necessary for volume exports of baskets. Packabledesigns are needed. Thus, bamboo and reed items, while appealing from anemployment viewpoint, are likely to grow slowly relative to the other majorproduct groups. Sizeable immediate export potential exists for expanded woodcarving in Kathmandu Valley.

3.22 Needs and Strategy. Production is constrained by: lack of commer-cial orientation and resistance to change among craftsmen who now producebamboo and reed goods mainly for household needs during free time; use oftraditional tools and methods which often limit productivity and qualityoutput; lack of effective credit or marketing services; and the need to makeimprovements in workmanship, seasoning, sizing and design of existing prod-ucts. Services of public institutions would be improved and private agentsmotivated to address these needs (paras 4.32 and 4.37). Credit requirementsin the project area, mainly for working capital, have been estimated at Rs2 million over the three year period (Annex 1, Table 6). With improvementsin methods and tools and adequate credit during 1981-1983 commitment period,production value from forest-based products could increase by roughly Rs 3million over what it would have been without the project; additional employ-ment by the end of 1984 would be about 144,000 mandays.

E. Selected Agroindustries

3.23 Characteristics. The project area contains about 103,000 agro-based units employing 140,000, processing about Rs 181 million 1/ worth ofgoods, with fixed investment of about Rs 18 million. The food subsectorincludes a wide range of activities. Rice beating, paddy pounding, ghee andkhuwa making, and beekeeping are rural household activities pursued on aseasonal, part time basis to supply household needs and provide marginalincome supplements; these activities are dispersed throughout rural Gandaki.

1/ This includes about Rs 118 million in service units milling rice, wheatand oil. The production figures in Annex 1, Table 1 do not includethese service units.

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Commercial units, concentrated in Kathmandu Valley and towns of Gandaki,include milling, bakeries, and units making noodles and sweets. Millingoperations often are of the integrated type, encompassing rice milling, flourmaking and oil expelling. If the unit is located properly, it gets businessthroughout the year, after harvesting of paddy, maize, wheat and mustardseed.

3.24 Potential. Intensive agricultural development efforts, plannedfor Gandaki Zone, are expected to result in increased output of agriculturalcommodities, which would create requirements for milling operations and otheragro-processing facilities. Also, there are lines in which the unit itself"makes" the raw materials; beekeeping, such an activity, is simple, requireslimited capital investment in improved hives and honey extractors, and demandslittle time; parts of Syangya, Gorkha, and Lamjung Districts of Gandaki havevegetation suitable for beekeeping. Potential for adding value to existingagricultural commodities also exists in the project area; fruits, herbs andginger available in Gandaki could be dried; some of the estimated 50% ofhousehold's surplus milk can be processed into cheese; and processing costsof milling operations can be reduced through improved water wheels and up-graded metal grinders. Honey, marmalade, dried fruits, and dairy productshave strong demand from trekkers and hotels, with prospects for import sub-stitution. Some relatively organized small units have been established,mainly in Kathmandu Valley, to provide jams, juices, and butter and otherprocessed foods for the tourist markets; with improved quality control andsome modernization, some of these units could produce competitive products.Prospects for effective institutional assistance to household agro-enterprisesare more limited since many "units" pursue these activities mainly to meethousehold requirements; local rural purchasing power is limited; and thedispersal of these units hinders commercial organization.

3.25 Needs and Strategy. Since most agroindustries process locallyavailable inputs for regional markets, commercial service needs would belimited, particularly for standard operations such as grain and oil mill-ing. For honey, dairy, fruit and herb products catering to tourist orexport markets, services to improve quality control and commercial con-tacts would be required. ADBN has done detailed preparation for agroin-dustrial projects, particularly beekeeping; ADBN provides some commercialand technical services in addition to credit. The CIDB would have a smallunit to provide technical services to agroindustries. While at the out-set, the primary market for processed foods would be local and touristmarkets, the Trade Promotion Centre plans to include honey, cheese, driedginger and herbs in its promotion of forestry-based products. Creditrequirements in the project area for food processing and other agroindus-trial CSIs are estimated to be Rs 10-12 million 1/ over the three year

1/ The Asian Development Bank (ADB) and IFAD are financing two agriculturalprojects, with small agroindustrial components, through ADBN. However,overlap between the proposed IDA Credit and theqe projects is minimal:ADBN plans only about 30 milling operations, us kyd'opov-er. in theproject area and the cottage industry component o. the IFai project wouldnot be executed until CY83, to provide time to learn from experienceunder the IDA-financed CSI project.

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commitment period. ADBN projects about Rs 3 million for beekeeping opera-tions including hives, extractors, packing facilities and working capital.Average subproject costs for agroindustrial CSIs, including fixed investmentsand permanent working capital, are estimated to be Rs 30,000 for grain andoil milling, Rs 65,000 for beaten rice, Rs 52,000 for bakeries, Rs 85,000for noodle making, Rs 25,000 for confectionary operations, and Rs 20,000 toRs 130,000 for solar drying of ginger, fruits and vegetables, depending uponthe scale of the enterprise. 1/ In addition to credit, for those more or-ganized CSIs, the project would provide finance for viable household agro-enterprises; ADBN anticipates lending to beekeeping cooperatives for whicheach household enterprise would require Rs 500-Rs 3,000 depending uponthe number of hives.

IV. THE PROPOSED PROJECT

A. Objectives, Strategy and Institutional Arrangements

4.01 Objectives. The proposed project is designed to help achieve HMG'sobjectives of increasing earnings and generating foreign exchange throughexpanded CSI activity by: (a) building programs and capabilities of keycommercial, public and banking institutions to provide effective services toviable CSIs; (b) implementing innovative, product-specific schemes in Bagmatiand Gandaki Zones which could be replicated in other areas; and (c) providingimproved, simplified incentives to encourage efficient production and expandedsales of CSI products. A major objective would be to tap marketing knowhowand organizing skills of private exporters and other commercial agents inproviding training and commerical services to cottage industries.

4.02 Scope. The first project would focus on Kathmandu Valley and theGandaki Zone, which account for over half of the cottage industry output inNepal (Map 1). The geographical scope could be broadened in subsequent pro-jects, once services are strengthened and schemes tested. Since KathmanduValley holds the headquarters of banking, public service and private commer-cial agencies, efforts to upgrade institutions would be facilitated. GandakiZone typifies the rural hill areas but has relatively large craft clusters androad links with Kathmandu. Commercial and technical service components wouldfocus on product groups which have: strong growth potential once methods andservices are upgraded; artisan concentrations to enable efficient services;and high present or potential value added. Carpets, woolen and cotton hand-loom garments, metal crafts, forest products and selected agroindustries wouldbe the major groups.

1/ The average size of agroindustries under the proposed project is expectedto be higher than for existing operations, due to inflationand the emphasis on commercial operations.

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4.03 Institutional Arrangements. The proposed project would: buildcapabilities of the banks for CSI credit; mobilize private organizationsfor most commercial functions; and help public sector organizations tofocus on promotion, extension, and filling some gaps in private commercialservices. Strengthening of institutional programs and staff training wouldbe major elements. The two commercial banks and ADBN would be responsiblefor term credit to CSIs, market agents involved directly in cottage indus-try production, input supply companies for metal and wool, and the Emporium.The Cottage Industry Export Development Division of TPC would assist ex-porters in improving products, output and exports; TPC would engage selectedexporters as "performance contractors" to extend their service networks toselected rural cottage industry clusters with reasonable access to roads.The CIDB would provide extension and design facilities in Kathmandu Valleyand commercial services in more remote areas of Gandaki Zone. The Emporiumwould concentrate on bulk imports of cotton yarn and handloom equipment,and on institutional marketing. The Industrial Services Centre would beresponsible for monitoring and evaluation, and for preparation of subsequentprojects, building on the experience gained in the Kathmandu Valley andGandaki Zone. The Ministry of Industry would provide project coordination.These institutional arrangements are consistent with those outlined for allof Nepal under the Sixth Five Year Plan; by providing sizeable training andconsultancy inputs under this first project, private, public and bankingcapabilities would be built, enabling more rapid development of the CSI sec-tor in the future.

4.04 Components. A cottage and small industries project of aboutUS$12.0 million equivalent is recommended with IDA contributing about US$6.5million and UNDP about US$2.0 million. Under the subloan component, the twolocal commercial banks (Nepal Bank Ltd. and Rastriya Banijya Bank) and theAgricultural Development Bank would be responsible for term lending to CSIs,related market agents, and input supply companies. These lending activitieswould be encouraged and strengthened by:

(a) supplying US$4.5 million equivalent to help fill the gapbetween term lending requirements of CSIs and related com-mercial agents in the project area and credit resourcesavailable for this sector;

(b) establishing a CSI Refinance Unit within Nepal Rastra Bankto do rapid subproject review and provide partial refinanceof eligible subloans made by the participating banks; and

(c) encouraging the banks to increase lending to viable CSIsand related commercial concerns by providing the bankswith attractive spreads, effective guarantees, and trainedCSI officers at headquarters and by key branches.

Under the commercial and technical service components, private and publicservices to CSIs in key product groups would be improved by:

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(a) supporting the Cottage Industry Export and Product Devel-opment (CIED) Division within TPC to assist exporterswith market contacts, product development, and strength-ening of the supply base. Product specialists, sales andexposure trips, performance contracts, and two foreignpromotional offices would be financed;

(b) reactivating the CI Board to assume responsibility forpublic development services to CSIs, with product specificextension services in Kathmandu Valley, an improved Handi-craft Design and Promotion Centre, and integrated servicesto selected cottage industry clusters in areas of GandakiZone which are not covered by private commercial agents;

(c) strengthening the Emporium's handloom operations by pro-viding an advisor and seed capital for procurement anddistribution of cotton yarn, handloom accessories, andtextiles in the project area;

(d) providing advisory services to the Rastra Bank's CSI Re-finance Unit and training for CSI staff of NRB and theparticipating banks; and

(e) funding ISC staff and consultancy for monitoring, andevaluation and preparation of subsequent projects.

4.05 Financing Plan. Total costs for the CSI project would be aboutUS$12.0 million equivalent of which IDA would finance US$6.5 million or54%, and UNDP 17%. For the subloan component, the IDA US$4.5 million wouldcover 100% of the portion refinanced by the Nepal Rastra Bank, equivalentto 80% of the subloan amounts made by the participating credit institutions,and averaging 64% of subproject costs. Under the commercial and technicalservice elements, IDA would provide US$2.0 million to cover the costs of theIMPACT centres, performance contract payments, 50% of incremental staffingcosts and related expenditures, equipment for subsector development centres,vehicles, and seed capital for the Emporium (Annex 1, Table 8). The com-mercial and technical service component also would include about US$2.0million in UWIDP grant funds for training and consultancy (Annex 1, Table9); HMG would contribute Rs 6.6 million (US$500,000) to cover half of in-cremental staff and related expenditures, as well as land and buildings forthese components; Rastra Bank would contribute Rs 5 million (US$379,000) tothe CSI Refinance Fund, mainly to cover the lag between refinance by NRB andits withdrawals from IDA. H1MG would provide 20% of the CSI subloan amountsmade by ADBN which are not eligible for IDA disbursements, since ADBN doesnot have sufficient deposits (para 4.22); these requirements are estimatedto be Rs 6.6 million (US$500,000) over the disbursement period. Duringnegotiations, agreement was reached that HMG and Rastra Bank would make thenecessary annual allocations to execute the project. The following tablesummarizes project costs and sources of finance:

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Project Financing Plan(in US$ million)

HMG/NRB/IDA UNDP Agencies Banks CSIs Total

Subloan Component(a) Term Credit for

CSIs and Agents 4.50 - 0.50 0.63 1.40 7.03(b) NRB - Administrative

and Revolving Fund - - 0.42 - - 0.42

Subtotal, SubloanComponent 4.50 - 0.92 0.63 1.40 7.45

Commercial and Technical Services(a) TPC - Export Development 1.00 0.99 0.14 - 0.02 2.19(b) CIDB 0.74 0.55 0.28 - - 1.57(c) Emporium 0.09 0.09 0.02 - - 0.20(d) ISC 0.05 0.03 0.04 - - 0.12(e) Training and Consultancy

for NRB and Banks - 0.24 0.02 - - 0.26(f) Unallocated and other 0.08 0.12 0.01 - - 0.21

Subtotal, Services 2.00 2.02 0.51 - 0.02 4.55

TOTAL 6.50 2.02 1.43 0.63 1.42 12.00

B. Subloan Component

1. CSI Refinance Fund - Rastra Bank

4.06 The Nepal Rastra Bank (NRB) 1/ recognizes that target setting forCSI lending has not been effective, and that to develop sound CSI lendingoperations in the banks, specialized staff, attractive spreads, effectiveguarantees, and adequate refinance are needed. The proposed project wouldhelp meet these requirements. A CSI Refinance Fund, with its own policies,procedures, staff, and financial resources, is being established in NRB, tochannel IDA funds. Staff of the Fund would: review appraisal reports andrefinance CSI subloans submitted by participating banks; monitor appraisal,supervision and collection standards; collect repayments of refinanced amounts;and report regularly to the CSI Coordinating Committee and IDA.

4.07 Organization and Staffing. The CSI Refinance Unit to administerthe Fund would be within the Banking and Credit Division of the Nepal RastraBank. The CSI Fund would be headed by a manager, assisted by an outsideadvisor financed under the project. Other professional staff would total

1/ Nepal Rastra Bank, the Central Bank, was established and operates pur-suant to the Nepal Rastra Bank Act of 1955.

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five at the outset 1/: two for analysis and review; one to administer

the credit guarantee scheme; one for monitoring and reporting; and onefor accounting and disbursements. Four of these officers already havereceived intensive training in CSI lending and refinance operations, inIndia and the Philippines, financed under the UNDP-financed, Bank-executedpreparatory project; training of the remaining officers has been arrangedfor November-December 1981 (para 4.51). 2/ The manager and professionalstaff appointed to the Fund would have qualifications, training, and ex-perience acceptable to IDA. The manager would need to be experiencedin industrial appraisal, management, and development of procedures forproject review and supervision. For the other officers, experience inindustrial refinance and bank supervision would be satisfactory. Priorto credit effectiveness, management and staff for the CSI Fund, acceptableto IDA, would be in place.

4.08 Policies and Procedures. A draft statement of policies andoperating procedures, which would provide a satisfactory basis for theCSI Fund's operations, has been prepared and discussed during appraisal;the Board of Directors has agreed with the substance of the Statement (An-nex 2). Prior to credit effectiveness, Rastra Bank would need to adoptsuch a statement and accounting procedures satisfactory to IDA; any sub-sequent modifications would require IDA agreement. The statement wouldoutline procedures for: review of subprojects; monitoring of bank acti-vities; and methods and conditions of refinance. For subloans of over Rs20,000 (US$1,500), the Fund would review appraisals prepared by the banksprior to granting refinance; for smaller subloans, refinance would begranted on the basis of the participating bank's appraisal showing thesubproject to be eligible, financially viable and having appropriate lend-ing terms. However, a 20% random sample of these smaller subloans wouldbe subject to a more detailed post-approval review of technical, financialand marketing aspects. To ensure expeditious review of subloan applicationsof above Rs 20,000, the Fund would need to complete its procedures withinthree weeks of receiving the application. The review procedures are designedto ensure that about 30% by number and 86% by amount of subloans receivepreapproval review by the CSI Fund (Annex 1, Table 11). Appraisal standardswould be checked through this process; the CSI Fund would monitor the banks'supervision standards through review of follow-up reports and field visitsto a sample of subprojects. Banks would submit quarterly reports to the Fundfor review, aggregation and submission to IDA and the CSI Coordinating Com-mittee (para 4.48).

1/ If the volume of work justifies an increase in this number, expansionof staff would take place during project implementation.

2/ In addition, two staff members of NRB's training institute have com-pleted training with the State Bank of India, to enable NRB to pro-vide continuous local training on CSI appraisal and supervision forofficers of the banks.

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2. Eligibility, Terms and Conditions

4.09 Eligibility for Refinance. Three banks are expected to participate

in the CSI project: the two commercial banks, Nepal Bank Ltd. and RastriyaBanijya Bank, and the Agricultural Development Bank. Other financial insti-tutions also would be eligible if HMG, IDA and NRB agree that they have soundoverall credit operations and have complied with the conditions of participa-tion in the project. To be eligible for refinance, each participating bankwould need to have complied with minimum staffing and training requirementsand have adopted standards and procedures acceptable to IDA (para 4.16).Enterprises eligible for subloans under the project would be: manufacturingand marketing concerns engaged directly in the production of cottage industryproducts; and CSIs with fixed investment, after the subloan, of up to Rs800,000 (US$60,600). Only CSIs with fixed costs per job not exceeding Rs12,000 (US$900) after the subloan would be eligible for credit. Eligibleinvestment enterprises could be owned by private individuals, partnerships,incorporated bodies, or cooperatives. The maximum subloan size would be Rs800,000, 1/ including fixed investment and permanent working capital financ-ing. Subloans would be to help finance foreign and local costs of fixedassets and permanent working capital 2/ in either new or expansion subpro-jects. The credit would not be allocated among the participating banks.Exporter organizations engaged by the Trade Promotion Centre as "performancecontractors" in Gandaki Zone would be eligible, provided the credit institu-tion's standards of viability are met. 3/ Refinance to projects of marketagents for production facilities located in Kathmandu Valley would be limitedto no more than 30% of the total refinance granted under the project.

4.10 In most cases, banks would provide no more than 80% of the subpro-ject cost, leaving 20% to be financed by sponsors. Exceptions could be madefor existing artisans with established markets requiring subproject amountsof under Rs 5,000 (US$380); for these, the banks could recommend waiving the20% minimum and provide up to 100% of the total subproject amount. 4/ In allcases, the CSI Fund would refinance a maximum of 80% of the bank's subloanamount. Each bank would assume full repayment risks on refinance; amountsdue would be repayable to the Fund on a fixed schedule, corresponding to the

1/ Except in the case of the raw material supply companies and the Emporium(paras 4.42 and 4.45).

2/ This would not include fluctuating or seasonal working capital, whichwould be financed through separate loans by the commercial banks.

3/ "Performance contractors" (para 4.33) would be eligible for a secondloan; normally, these second loans would be made only after the per-formance contractor had demonstrated regular repayment for one yearafter the grace period had expired.

4/ For exporters serving as performance contractors, TPC would pay up to 20%of subproject costs and the borrower would contribute at least 10% asequity; commercial banks would provide the remainder provided that thesubloan portion does not exceed 80% of total subproject costs.

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subloan amortization. IDA would reimburse the CSI Fund of NRB for 100%of refinanced amounts for eligible subloans, on the basis of monthly orquarterly requests.

4.11 Terms and Conditions. The initial lending rate by the participat-ing banks to eligible subborrowers would be 11%, consistent with minimumcommercial rates for term loans to industry in Nepal. The onlending ratesand spreads would be reviewed at least annually with adjustments made asnecessary to ensure that: (a) CSI term lending rates remain consistent withrates for term loans to all industry; (b) these rates are positive in relationto medium terms inflation projections; and (c) spreads are adequate to coverthe banks' administrative costs and to induce them to expand CSI lending. TheCSI lending rate established for the project would be applied to all CSI loansmade by the participating credit institutions, except in a few areas definedas remote, for which the Industrial Enterprises Act specifies that rates of2% less than the prevailing rate would be applied. The list of remote areaswould need to be satisfactory to IDA, to ensure that only mountainous areasnot served by substantial cottage industry development programs are includedas remote areas. Maturities on subloans refinanced under the project wouldbe from 18 months to 7 years, including grace periods ranging from 3 months to2 years; banks would determine appropriate maturities and grace periods foreach subloan based on the subproject's debt service ability. To help ensurecredit access by smaller enterprises, the refinance rate would be adjustedto provide banks with a spread of 6% for subloans of up to Rs 20,000 and 4%for subloans of over Rs 20,000. Larger spreads for smaller subloans wouldcompensate the banks for the higher administrative costs as a percentage ofsubloan size.

4.12 CSI Fund Resources. The CSI Fund's resources would comprise theUS$4.5 million IDA credit component plus an initial contribution by NRB ofat least Rs 5 million (US$379,000). A small portion of the Rs 5 millionwould be used to meet the Fund's initial operating costs; the majority wouldprovide a revolving fund to cover the time lag between the Fund's refinanceof the banks' subloans and its withdrawals from IDA. Rastra Bank wouldprovide Rs 5 million prior to credit effectiveness and, thereafter, makeavailable additional funds as needed to operate the CSI Fund. The Fund'sspread would be set at 2% p.a., which is appropriate in view of the antici-pated costs and the initial contribution. It is expected that after threeyears of operation, the Fund would begin accumulating operating cash sur-pluses; initially, the low level of average outstandings would result inoperating cash losses, partially offset by income from NDB's investmentcontribution (Annex 1, Table 10).

4.13 Institutional and Training Needs. Prior to credit effectiveness,the CSI Refinance Fund would need to have been established in a manneracceptable to IDA, including: suitably qualified management and staff(para 4.07); an approved statement of policies, operating procedures, andaccounting practices (para 4.08); and Rs 5 million provided by NRB asinitial capitalization of the CSI Refinance Fund. Outside training in CSIlending operations, financed under the UNDP preproject facility, has beencompleted for the review officers and bank liaison officer of the CSI Fund.A suitable outside advisor, with experience in CSI lending and refinance

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operations, would be recruited to assist the manager of the Fund. Thispost, financed by UNDP under the project, would be for 24 man-months(US$170,000).

3. Credit Guarantee Scheme

4.14 To encourage the banks to relax their collateral requirements forsubloans refinanced by the Fund, NRB would establish a CSI credit guaranteescheme. The NRB guarantee scheme, to be available to the participatingbanks only for CSI subloans refinanced by NRB under the project, would beadministered by the staff of the CSI Fund. Coverage would be provided forup to 75% of the subloan amount and a premium of 1% p.a. on the guaranteedamount outstanding would be charged; this 1% premium would be added to NRB's2% spread. During the initial three years, participation in the schemewould be mandatory for all subloans refinanced under the project and wouldbe automatic once refinance is granted from NRB. The scheme would havereasonably liberal claim procedures; the banks would be able to claim oncetheir auditors certify a debt as bad or irrecoverable. HMG would pay intothe scheme an initial amount of Rs 2 million and would pay in furtheramounts on an annual basis to maintain the capitalization of the scheme atno less than 10% of the guarantees outstanding. Suggested operating proce-dures were outlined during appraisal and discussed during negotiations, withagreement in substance reached (Annex 2). Prior to credit effectiveness,the credit guarantee scheme would have to be established with policies andprocedures satisfactory to IDA, and the initial capital contribution paid.

4.15 At present, commercial bank loans to the priority sector arecovered by the Credit Guarantee Corporation Private Limited (CGC), in whichthe Rastra Bank holds 50% of the shares and the two banks, 25% each. How-ever, this company, which relies entirely on share capital and an inadequateguarantee premium for resources, is seriously undercapitalized. Further-more, the banks bear 50% of the guarantee schemes' credit risk on their ownloans. To ensure that subloans under the proposed project have adequateguarantee coverage, a separate scheme would be established in NRB; oncethe CGC is suitably strengthened and is in a position to undertake furtherguarantee operations, the scheme could be transferred, if mutually agreedby HMG, Rastra Bank, and IDA. During negotiations, agreement was reachedon minimum capitalization, equity structure, premium level and proceduralimprovements which would need to take place prior to transferring to the CGCthe guarantee function for CSI subloans refinanced under the proposed project;these conditions were outlined in a side letter.

4. The Participating Banks

4.16 NRB would issue a set of operating instructions to each of thethree banks; these instructions would outline procedures and respective obli-gations of the CSI Fund and the banks under the project. 1/ NRB's instructions

I/ These instructions would take the place of participation agreementsbetween the refinance institution and the banks. Management of NepalRastra Bank is opposed to participation agreements since NRB's positionvis a vis the banks makes instructions binding. While not ideal, theseinstructions would be adequate, provided that the contents were accept-able to the banks and IDA.

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would stipulate each bank's duty to: (a) assign and train an agreed mini-mum number of qualified CSI staff for head office units and key branches;(b) prepare appraisals of a satisfactory standard for each subloan; (c)supervise subprojects to ensure proper utilization of funds and monitorprogress; (d) adhere to the terms of lending and repayment of refinance;and (e) submit quarterly reports on activities, subproject portfolio andarrears in a format prescribed by the CSI Fund, with all satisfactory toIDA. The operating procedures also would emphasize means to address twomajor lending problems faced by banks in Nepal: diversion of funds from

the stated purpose and difficulties in enforcing repayments by instalment.Measures to control abuses, some of which are already in practice in Nepal,include: direct payments to suppliers; disbursements in kind; a systemof coupons redeemable against approved raw material supplies; and partialdisbursements, closely controlled by frequent supervision visits. Therefinance terms would require repayments by instalment and banks would beexpected to exert all possible pressure on subborrowers to honor thisarrangement. The principal features of the operating instructions werediscussed with the management of the Rastra Bank and the banks duringappraisal (Annex 2); agreement was reached on the substance of the in-structions during negotiations. Prior to credit effectiveness, NRB wouldhave issued instructions, satisfactory to IDA to at least two of the par-ticipating banks, with these banks having complied with the agreed minimumstaffing and training requirements; the banks would need to confirm thatnecessary actions had been taken and policies confirmed to implement NRB'sinstructions.

4.17 The Commercial Banks. The larger and more established of thetwo commercial banks is Nepal Bank Ltd. (NBL), which is 51% owned by HMGand 49% held by private Nepali citizens. It accounts for approximately 65%of deposits and 61% of loans and advances of the commercial banking system;Rastriya Banijya Bank (RBB), which is wholly owned by HMG, consitutes thebalance. Both banks have extensive branch networks; NBL has a total of fiveregional offices and 133 branches, while RBB has four regional offices and98 branches. The majority of commercial bank loans are short term, 1/usually without rollovers. Collateral is the basis for most lending deci-sions. Project appraisal capabilities are limited due to the shortage ofsuitably trained staff. Both banks are instructed to lend at least 7% oftheir deposit liabilities to "priority sector clients. However, the totaladvances to this sector constitute less than 6% of deposits. 2/ The proposedproject would assist the banks in developing project-based lending by ensur-ing that trained CSI officers were assigned to headquarters and key branchesin the project area and by helping to establish sound appraisal, disburse-ment, supervision and collection practices for CSI lending operations. Also,since most CSI subloans would be made to units in identified concentrationsof activity in Gandaki Zone and Kathmandu Valley, logistical problems andadministrative costs of appraisal and supervision would be reduced.

1/ Usually from 3 months to 2 years; maturities rarely exceed 3 years.

2/ Including indirect financing by the purchase of bonds and loans to theAgricultural Development Bank. Excluding this, advances to the sectorwere 4.8% of deposits.

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4.18 Nepal Bank Limited. NBL has 24 offices in Gandaki and 22 in theKathmandu Valley. Total lending to the priority sector has totalled Rs 24.9million, of which Rs 11.1 million (45%) was made to 596 clients in the cot-

tage industry and service 1/ subsector; 62% of this was to 339 clients inthe central development region, encompassing the proposed project area. Theoutstanding balance of CSI loans as of June 15, 1979 was Rs 9.5 million or0.7% of total outstandings. In addition, NBL had advanced Rs 30 million toADBN and held Rs 20 million of its debentures, bringing NBL's total directand indirect loans to the priority sector to 5.2% of all loans and invest-ments and 3.9% of deposit liabilities, well short of the mandatory 7%. Noproper arrears data are available, but total amounts in arrears as a per-centage of the portfolio are thought to be as much as 20% for CSI loans.The bulk of priority sector loans are processed by the branches and approvedby regional offices. Disbursements are usually in instalments against proofof purchase, to avoid diversion of funds; Nepal Bank attempts to superviseborrowers during disbursement and throughout the period of the loan. How-ever, proper supervision has been made difficult by lack of trained staff 2/and logistical problems in rural areas.

4.19 To participate in the proposed project, NBL would establish a headoffice CSI unit, reporting through the credit manager to the general managerand staffed by a CSI unit chief and at least four officers. The head officeunit would appraise larger projects, supervise branch performance and reviewsubloan proposals. At the zonal level, each office would have two CSI offi-cers. Twenty key branches have been identified in the project area; eachbranch would have at least one trained officer assigned full time for CSIwork. Four CSI officers for the headquarters unit have received trainingin India, financed under the UNDP preparatory project; local training priorto project implementation, to be provided for about 30 CSI officers andtheir immediate supervisors, has been arranged for November-December 1981(para 4.25); trained officers would be assigned to CSI work for at least twoyears. 3/ Approval of loans of up to Rs 10,000 would be made by the branchmanager; zonal managers would approve loans of up to Rs 20,000; and largerloans would be approved at head office. It is anticipated that roughly 950subloans would be approved by NBL under the proposed project; this wouldrepresent an average of one approval per month by each CSI officer over thethree year commitment period.

1/ Loans to services mainly involving transport, trade and repair enter-prises, represent a small proportion of the total.

2/ Nepal Bank has 22 officers who have received formal training in smallagricultural and industry lending in India. However, several of theseofficers are not directly involved in priority sector lending opera-tions.

3/ Seven officers of NBL, to be assigned to CSI units at headquarters andzonal offices, have undergone training with the State Bank of India(SBI) during December-January 1980, with financing under the UNDPproject preparation facility. Local courses on CSI appraisal andsupervision will be conducted in November-December 1981, with parti-cipation of SBI training staff (para 4.51).

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4.20 Rastriya Banijya Bank. Twenty-eight of RBB'S 98 branch officesare in the proposed project area; 23 are in Bagmati and only 5 are inGandaki Zone. Priority sector lending by RBB over the 1974-79 periodtotalled Rs 47.7 million, including Rs 24.1 million in 2,098 loans forcottage industry; 816 of them have been in the central development regioncovering the proposed project area. Outstandings at June 15, 1979 totalledRs 18.6 million for 1,700 cottage industry loans. In addition, RBB hasloaned Rs 10 million to ADBN, bringing the total direct and indirect lendingto the priority sector to 5.2% of loans and advances and 4.4% of depositliabilities, below the mandatory 7%. Arrears data are not available, butare thought to be somewhat higher than Nepal Bank's figures. RBB has aspecial section with five officers in its head office Loan and InvestmentDepartment, reviewing applications for priority sector loans in excess ofRs 20,000 (US$1,520). The department head has authority to approve loansup to Rs 50,000; the deputy general manager, up to Rs 75,000; and the gen-eral manager up to Rs 200,000. Disbursements of loan proceeds rarely aredone on an instalment basis and RBB does not undertake regular supervisionof its clients unless the loans are overdue at full maturity.

4.21 RBB would establish a separate CSI unit under the direct supervi-sion of the general manager and staffed by a unit manager and four officers.At the zonal level, each office would have a unit manager responsible to thezonal manager, and two officers. In 20 key branches, officers would beappointed full time for CSI operations for a minimum of two years. Prior toparticipation in the project, the CSI officers and their immediate supervisorswould undergo training (para 4.25). 1/ The present delegation of authoritywould be amended to allow zonal managers to approve loans of up to Rs 20,000and the general manager up to the maximum under the project. With this dele-gation, it is anticipated that branch offices would process some 400 loansand the head office about 100. The head office unit would coordinate GSIoperations and supervise CSI lending operations of zonal and branch offices.

4.22 Agricultural Development Bank of Nepal. ADBN, the main institutionfor agricultural credit, has 173 offices including 107 small depots, 61 branchesand sub-branches, four regional offices, and the head office in Kathmandu.The proposed project area holds 35 offices, 13 in Gandaki and 22 in Bagmati.Resources are provided by share capital and borrowings, including four linesof credit from the Asian Development Bank (ADB). 2/ Domestic borrowings in-clude refinance from the NRB, and direct borrowings from and debentures heldby the commercial banks. ADBN does not have the advantages of sizeabledeposit mobilization and, due to shortages of refinance funds at NRB, ADBNis experiencing difficultues in raising sufficient local resources. Also,lending to risky agricultural areas, high administrative costs and a decline

1/ RBB and ADBN each have sent seven officers for training in CSI appraisaland supervision with SBI; local training for CSI branch officers, financedby UNDP, will take place in February-March.

2/ ADB's fourth credit to ADBN includes some financing of agroindustriesusing mini-hydroplants. About Tk 2.6 million (US$200,000) of this isexpected to be lent in Gandaki Zone, which has been taken into account inthe credit projections for the proposed IDA project (Annex 1, Table 6).

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in spreads resulted small net losses by ADBN in FY79 and FY80. Neverthe-less, ADBN's lending and operating standards and procedures are more ad-vanced that those of the commercial banks. Loans are made largely on the

basis of project appraisals. In addition, ADBN has a policy of regularand close supervision of projects, to the extent that field staff availa-bility makes this possible. Disbursements are made by instalment afterinspections, and ADBN has pioneered the use of disbursements by coupon orin kind to curtail diversion of funds. Given these skills and procedures,and ADBN's capabilities in technical services to agroindustries, ADBN'sparticipation in the proposed project would be beneficial.

4.23 At June 15, 1979, ADBN's outstandings totalled Rs 410.6 million,of which 17% was long term, 53% medium and 30% short term. Branch managershave authority to approve loans up to Rs 10,000; regional offices have ap-proval authority for up to Rs 200,000; the general manager has full autho-rity for CSI loan approvals. To participate in the proposed project, ADBNwould create a separate CSI unit at head office with a manager and fourofficers. Twenty key branches, expected to account for the bulk of CSIlending, have been identified and at least 20 full-time CSI officers wouldbe assigned to them for a period of no less than three years. No change inthe present delegation of authority is proposed. Branches are expected toappraise about 600 projects over the three year commitment period. The headoffice is expected to review and appraise a further 200 projects.

4.24 To meet its domestic currency requirements for the 20% of sub-loan amounts not covered by refinance, ADBN would require an estimated Rs6 million over the project period with at least Rs 2 million transferredby HMG prior to ADBN's participation in the project. In addition, fundswould be required to help ADBN finance the cost of any arrears as the pro-ject does not provide for rescheduling of refinance obligations to theRastra Bank. During negotiations agreement was reached that HMG would makethe necessary funds available to ADBN, or suitable terms.

4.25 Training and Institutional Needs. Six weeks of training in Indiaand the Philippines for 21 officers of NRB and the participating creditinstitutions, financed under the UNDP preparatory facility, have been com-pleted. Local training courses of three to four weeks for about 110 CSIofficers from the participating banks has been arranged with the State Bankof India for November-December 1981. The completion of training for theagreed level of CSI personnel would be a condition of each bank's participa-tion under the Credit. In addition, shorter 1 to 2 week appreciation coursesfor about 20 managers and supervisory personnel of the banks would be pro-vided in December 1981 to ensure that branch managers are aware of the ob-jectives and procedures of the project. The project also would provide forlocal courses and about 12 foreign training slots for NRB and the partici-pating banks each year (US$70,000). A major institutional benefit of thesubloan component would be to help the commercial banks introduce projectappraisal as the basis of credit decisions, which should have a direct in-fluence on overall credit policies. Also, since the project would includecommercial as well as credit services for identified concentrations of arti-sans under the project, the banks' coverage of CSIs can be expanded, whilereducing risks and administrative costs. Also, procedures for disbursement,supervision and amortization by instalment would influence the banks' oper-ations in other areas.

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C. Commercial and Technical Service Components

1. Export Development - Trade Promotion Centre

4.26 Development of cottage industry exports has to respond to specificmarket opportunities. Recognizing this need, HMG approved and providedinitial budgetary funding for the establishment of a Cottage Industry ExportDevelopment (CIED) Division in the Trade Promotion Centre. This Divisionwould provide exporters with assistance in making market contacts, adaptingproducts, and developing the export-oriented supply base. Product groupsfor immediate attention would be carpets, woolen jackets and knitwear, cottonhandloom garments and household articles, metal crafts, and wood and fiberitems.

4.27 Functions. The CIED Division would assist exporters in expandingproduction and sales in cottage industry lines by:

(a) providing exporters with practical consultancy in productadaptation, technical improvements in production, andorganization of the decentralized production base;

(b) improving links between exporters and major importing coun-tries by establishing IMPACT offices 1/ in New York andFrankfurt;

(c) organizing and financing trade missions to importing coun-tries and trips to neighboring countries which are leadingexporters of similar products; and

(d) engaging exporters as performance contractors to establishservice networks for selected clusters of artisans in ruralareas, concentrating in Gandaki Zone.

4.28 Organization and Staffing. In Kathmandu, CIED would consist of:a general manager; product managers for carpets, woolen and cotton garments,metal crafts, and forestry products; and officers responsible for information,monitoring, and accounts. One assistant would be provided in each section.Four district officers would be assigned to Tanahu, Syangja, Kaski, and Gorkhain Gandaki Zone to monitor the performance contracts (para 4.32). Attractivesalaries would be provided to product managers and district officers to at-tract highly motivated staff who can learn quickly. TPC has transferred fourTPC officers to CIED-Kathmandu. The other nine officers, recruited from otherinstitutions involved in industry, would be hired or deputed for a minimum oftwo years. TPC plans to hire these officers and send them for outside train-ing during November 1981. Costs for establishment, staffing, vehicles andoverhead costs for CIED-Kathmandu during the three year implementation periodare estimated to be Rs 4.5 million (US$340,000).

4.29 Foreign Offices. The extension of CIED-Kathmandu would be smallIMPACT offices of the TPC in New York and Frankfurt. These offices are ofcritical importance in assuring that production activities in the project

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respond to market realities. The major functions of these offices wouldbe to:

(a) establish and update information on products, prices, andsupply capabilities of Nepalese exporters and producers inthe priority cottage lines, using this information to pro-mote CSI products among potential importers;

(b) provide TPC and Nepalese exporters with current informationon market possibilities and fashion trends, attending thepermanent and temporary trade fairs, tapping knowledge ofimporters and getting information on competitors' productsand prices;

(c) prepare and follow up on Nepalese participation in tradefairs and individual exporter's sales trips;

(d) organize consultancy on design, using information avail-able on raw materials, existing designs, and productioncapabilities;

(e) provide feedback from importers on designs, sizing, andprices without necessitating their taking trips to Nepal;and

(f) perform necessary trouble shooting, followup and liaisonon cottage export orders from Nepal, linked by telex toTPC, helping build Nepal's reputation for reliability.

4.30 Each TPC IMPACT office would have one Nepalese staff member andtwo from the importing country. Since skills required to design systemsand establish operations for the centres are different from the salescapabilities for ongoing management, a firm would be hired to establish theNew York IMPACT Centre, at a cost of about US$50,000. The New York IMPACToffice would be established by July 31, 1982; operations of the Frankfurtoffice would be launched by July 31, 1983, with systems adapted from theNew York office. UNDP would cover full costs of staff, travel, rent andoverhead expenditures. Estimated staff costs for the New York office wouldbe US$150,000 for the project period, plus US$40,000 for short term consul-tancy. Rent, furniture, telex, and overhead expenditures would be roughlyUS$86,000 for the three year period. For Frankfurt, staff costs for twoyears of initial operations are estimated to be US$120,000 equivalent;consultancy, US$40,000; and establishment and operating expenditures,US$49,000. A detailed action program and cost estimates for launching andoperating these offices have been prepared (Annex 2).

4.31 Consultancy. Product specialist consultants would be attached toeach of the four product units of the CIED Division of TPC, Kathmandu, andone general consultant would be hired to assist the CIED Director in overalloperations. These five consultants would be hired for one year each at atotal cost of US$420,000; TPC would have an option to extend the contracts.The product specialists, with their Nepalese counterparts, would provide con-crete assistance to exporters on improving designs, quality, and production

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methods, and in organizing the decentralized supply base in Gandaki Zone andKathmandu Valley. Consultants would have strong knowledge and successfulexperience in introducing production and quality improvements in the rele-vant product lines. In addition, short term consultants in more specializeddesign technology and export promotion operations would be financed(US$190,000). Measures to promote exports, product adaptation and develop-ment of supply capabilities probably would include financing of a firmspecialized in intensive preparation for and organization of single countrytrade fairs, working closely with the New York IMPACT office. The project

would incorporate about US$150,000 to sponsor this integrated approach withconsultants assessing the most promising cottage lines and exporters, workingwith them on product adaptation, and then arranging single country fairs.This approach, which has proved effective in Bangladesh and Sri Lanka, wouldbe introduced in about month 9, once initial work has been done throughproduct specialists in Kathmandu and the IMPACT Centre in New York.

4.32 Performance Contracts. Skills in sales, input supply and organ-ization of cottage production are concentrated among the growing number ofmedium scale exporters. The project would assist these agents and inducethem to extend commercial services beyond Kathmandu Valley by engaging themost qualified as "performance contractors to develop selected cottageindustry clusters in rural Gandaki and Bagmati. Contracts would specify theexporter organization's phased responsibilities for training, input supply,orders, quality control, and processing facilities over a two to three yearperiod. Contracts would provide grant payments to cover specified initialcosts in establishing rural operations. Prospective performance contractorswould need to prepare their proposed programs for selected rural craftclusters; these proposals would be evaluated by TPC. 1/ Pilot phases wouldbe built into most contracts. Performance contract payments could beutilized for: staff to provide training to upgrade artisan skills andintroduce modified product lines; raw material expenditures during thepilot production phase when skills are being developed to meet exportstandards; and a portion of costs of establishing quality control agentsand depots in Gandaki Zone. Performance contract payments would constituteno more than 20% of total subproject costs, or Rs 200,000 (US$15,200) 2/whichever is lower. The remainder would be financed from sponsor's equityand bank term credit; minimum equity contributions would be 10% of totalproject costs. The performance contractors would require term credit fromthe banks to cover the majority of their financing needs for processing andstorage facilities, centralized production in certain processes, and per-manent working capital. Subloans for performance contracts and related CSIswould be eligible for NRB refinancing under the proposed project (para4.10); in most cases, the contractors would seek credit for the permanent

1/ About 15 exporters have visited Gandaki Zone and are preparing theirproposals. TPC has arranged trips to Gandaki to visit the ruralconcentrations of woolen cotton and fiber producers; about 30 ex-porters have expressed active interest in participating.

2/ These maximum amounts exclude sales and exposure trips to be financedby TPC under the project.

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working capital needs of the artisans in their networks while individualCSIs would borrow directly from the banks for their equipment needs (Annex1, Table 6). Since each performance contract would cover rural CSI con-centrations, credit and commercial services would be facilitated.

4.33 Most contracts would be established in Syangja, Tanahu, Kaski andGorkha of Gandaki, since these districts hold sizeable craft concentrationswithin reasonable access of trunk roads (Annex 1, Table 3 and Annex 3, Map2). Up to five contracts would be available for rural areas of KathmanduValley. About 25 contracts would be financed from the US$310,000 projectallocation, with each contract covering 1 to 3 panchayat clusters of 100to 150 units each. 1/ Payments by TPC would be made on a quarterly basisagainst completion of agreed tasks, checked by field-level TPC staff. Flex-ibility would be maintained; contracts could be revised, upon mutual agree-ment by the contractor, TPC, and IDA as experience is gained. A statementof policies and procedures for the CIED Division, including norms foroperating the contracts, prepared during appraisal, has been ratified bythe Board of Directors of TPC (Annex 2).

4.34 Sales and Exposure Trips. About US$225,000 would be provided for25 to 35 sales trips for performance contractors and about 30 to 40 tripsfor exporters and manufacturers to expose them to marketing and productionmethods neighbouring countries with successful experience exporting similaritems. The CIED Division of TPC would be responsible for organizing thesetrips.

4.35 Funding and Procedures. The Trade Promotion Centre would estab-lish a Cottage Industries Export and Product Development Fund to finance theabove activities. The Fund would be managed by the CIED Division under thegeneral direction of TPC's Executive Chairman and Board of Directors. Priorto January 1, 1982, the Fund would need to be established with an agreedstatement of policies and operating procedures, an action program for thesecond six months of FY 81/82, and adequate staff and long-term consultantsin place in the CIED Division. The New York IMPACT office would be estab-lished by July 31, 1981 and operations of the Frankfurt office would belaunched by July 31, 1982. Annual action programs, prepared by CIED-Kathmandu, would be sent to IDA by each May 31 for the second and thirdfiscal years. IDA would need to approve selection, action programs andcontractual terms performance contracts. IDA and UNDP would disburseagainst regular statements of actual expenditures, with documentationprovided on consultancy payments and expenditures for trips; 1MG would coverhalf of the costs of staff and operating expenditures and provide TPC withbudgetary allocations to cover the project expenses, including the IDA andUNDP financed amounts.

1/ Most contracts are expected to be in carpets, woolen fabrics, andcotton handloom products (Annex 1, Table 3); however, a few contractsin reed and bamboo products are expected in Gandaki, metal craft net-works in rural Kathmandu Valley would be eligible and export-orientedagroindustrial CSIs such as beekeeping could be covered by performancecontracts in years 2 and 3 of the project.

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2. Extension Services and Development Centres - CIDB

4.36 Strategy. The Cottage Industry Development Board would be reac-tivated, taking over responsibility for development activities from DCVI inKathmandu and in Gandaki Zone. 1/ The CIDB would be responsible for: (a)technical extension services in Kathmandu Valley; (b) extension and manage-ment of subsector development centres in areas of Gandaki zone which are tooremote to interest private performance contractors; and (c) operations of animproved Handicraft Design and Promotion Centre. During appraisal, draftsof the following key statements were prepared: policies and procedures forthe CIDB; an organizational chart and staffing requirements; and a year Iaction program (Annex 2). These were discussed during negotiations withagreement in substance reached. Adoption of a statement of policies andoperating procedures, financial rules, reorganization along subsector lines,and hiring and training of minimum staff would need to be completed byJanuary 1, 1982. The CIDB would provide annual action programs to IDA, forconcurrence, by May 31 of each year.

4.37 Operations and Functions. The CIDB would take over the training,production, and industrial service sections of DCVI headquarters, organizinginto subsector divisions: cotton textile, woolen, metal, forestry-basedproducts, agroindustries and others. These divisions would design andoversee subsector-specific extension programs and development centres, trainCIDB staff and leading village craftspeople as trainers, and provide directextension services and short-term training in Kathmandu Valley. In additionto subsector divisions, the CIDB would have a monitoring, reporting, andcoordination division for regional projects and an accounting and adminis-tration division. Local staff costs and related expenditures for headquar-ters would cost Rs 2.8 million (US$210,000) over three years; about 50% ofthis cost would be incremental since a portion of staff would be shiftedfrom DCVI. Specialist consultants would be connected with the four majorsubsector cells for six months to help train the CI Board trainers andlaunch extension services and development centre programs (US$190,000).Costs for short-term training and consultancy for CI Board staff and ar-tisans would total about US$290,000. A parallel but smaller subsectororganization in an office in Gandaki would be organized to provide backupservices to the cotton handloom, wool and forest products developmentcentres in Gandaki. The CIDB would launch and manage about six wool, sixhandloom, and four forestry products development centres in Gandaki overthe three year commitment period to service household artisans in selectedclusters, mainly of Lamjung, Upper Kaski, Gorkha, and possibly Manang. 2/Services of these subsector development centres would be similar to thoseof private performance contractors, but the centres would cover more remote

1/ The Sixth Five Year Plan envisages that the CI Board would be chargedwith responsibility for executing cottage industry components of thislead project as well as small CSI components of integrated ruraldevelopment projects which receive outside financial assistance.

2/ These are areas too remote to be of immediate interest to privateperformance contractors.

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areas, have longer training periods, and concentrate on local markets.Services would include upgrading skills, purchasing raw materials, offeringpre- and post-processing facilities, procuring finished products and supply-ing them to the Emporium and private traders. Costs of equipment and work-ing capital for these centres would total about Rs 4.8 million (US$360,000);about 1,300 units would be serviced. The Handicraft Design and PromotionCentre in Kathmandu would be revamped with qualified management and result-oriented staff to provide prototype designs and samples to exporters andCI Board centres, and to develop appropriate technologies for use in CIBoard centres and extension programs. Costs for these improvements wouldtotal about Rs 2.5 million (US$190,000). A breakdown of costs for the CIBoard elements is provided in Annex 1, Table 8.

4.38 Organization. To reactivate the CI Board, the original legisla-tion would not need to be changed. The composition of the Board of Direc-tors has been modified to include representatives of the Ministries ofIndustries and Finance, TPC, ISC, the Rastra Bank and at least two privatesector representatives engaged in manufacturing and marketing of cottageindustry products. The Director General of DCVI would be the chief execu-tive during the transitional period, assisted by a Chief Coordinator ofCIDB; subsequent selection of a full time executive is planned.

4.39 Staffing. Only the most qualified and motivated of DCVI's staffwould be transferred to the CIDB. Except in cases of extremely qualifiedtechnical persons, DCVI staff of over 45 years of age would not be trans-ferred to the CIDB, since the work would be heavily field-oriented. Totalstaffing costs for the project would be about Rs 5.4 million (US$410,000),including Kathmandu, Gandaki, Design Centre and subsector development centrestaff. Staff would be hired to the Board, deputed from othiei organizationsfor at least two years, or hired on a fixed contract basis. The financialrules for the Board would need to grant the Cottage Industry Board autonomyin personnel hiring and payment of performance incentives, within agreedlimits. The Cottage Industry Board would provide sufficient salaries andincentives to attract and retain qualified, motivated staff for cottageindustry work particularly in rural areas. 1/ These aspects are covered inthe draft statement of policies and operating procedures, upon which agree-ment in substance was reached during negotiations; such a statement wouldneed to be ratified by the CIDB by January 1, 1982.

3. Raw Material Arrangements - Companies and Emporium

4.40 Sporadic availability and resultant price volatility of wool,cotton yarn and metal represent significant problems in the priority cottagesubsectors identified under this project. Services by the National TradingLtd. (NTL) and the Emporium have not been satisfactory (paras 3.07, 3.19).Import duty and sales tax rebates are granted only to cottage manufacturers,

1/ The statutes of the CIDB enable it to pay performance bonuses; thesewould be paid based upon staff within the subsector cells, the DesignCentre, and subsector development centres exceeding established perform-ance targets.

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4.41 Private exporters and manufacturers intend to establish two pri-vate limited companies to import wool and metal in bulk, to assure stableprices, availability and adequacy of types of raw materials. Under theIndustrial Enterprises Act, the same reduced import duties and sales taxrebates which apply to CI producers would be applied to such companiesimporting on behalf of member producers and exporters (para 2.16). In thecase of wool, it also would be useful if the company could be authorized byHMG to negotiate with China, although bulk purchasing from New Zealand andAustralia also is viable (para 3.07). Membership would consist mainly ofexporters and manufacturers in wool or metal products respectively; minorityshares of not more than 10% could be held by the Emporium. Importers, whocould not hold more than 20% collectively, could provide procurement knowhowand contacts; the Emporium could help monitor procurement and sales to seethat raw materials were sold at reasonable prices. The Handicraft Associa-tion would assure legitimacy of members in the metal company; a similarassociation is being organized for woolen products. Each company would havea board of directors consisting of a general manager, and representatives ofexporters and manufacturers holding shares, and, if requested, the Emporium.

4.42 The companies would start on a limited scale. If initial opera-tions are successful, the scope would be expanded. Estimated financingrequirements of the two companies, including term credit portions eligiblefor IDA financing, are as follows: for the metal importing company, rawmaterial stocks for six months (Rs 2 million) 1/ and office, storage andstaffing expenses for one year (Rs 500,000) 2/; and for the wool importingcompany, raw material stocks for six months (Rs 2.5 million), and overheadsby Rs 400,000. Additional funds could be made available, once successfuloperations are demonstrated.

4.43 At least twenty percent of financing requirements would come fromequity of the shareholders. The remaining 80% would be provided by thecommercial banks. Top executives of Nepal Bank Ltd. have indicated thatNBL would be willing to be the banker for these companies. Maximum totallending limits would be enforced during year 1 of operation to ensure thecompanies are established on a strong footing before attempting to supplythe majority of input requirements of the industry. Medium term creditrequirements would be covered under the project, with partial refinance ofbank loans by the CSI Unit of Rastra Bank (para 4.10). Short term creditneeds would be supplied through normal loans, probably from NBL. As acondition of disbursement, the respective company would have to be legallyestablished, with articles of association, membership composition, paid incapital, a financing plan and a year I action program satisfactory to IDA.Regular reports on operations would be submitted to IDA, on a quarterlybasis.

1/ Calculated on the basis of 30% of annual metal requirements for metalworking industry in Kathmandu Valley.

2/ Under the assumption that overheads for subsequent years will befinanced out of company profits.

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4.44 Cotton Yarn, Equipment and Cloth--Emporium. Under the project,the Emporium would concentrate on improving its procurement and distributionof cotton yarn and critical equipment needed by cottage industries in theproject area. The Emporium also would provide an outlet for CSI handloomproducts from the CI Board development centres by taking public institu-tional orders and subcontracting these to CI Board centres. During thethree year implementation period, the Emporium would make available itsservices in bulk procurement and distribution of cotton yarn and handloomaccessories to: about six performance contractors for clusters in Gandakiand about three in rural Kathmandu Valley; and about six handloom develop-ment centers of the Board in Gandaki. Each of these agents would be ex-pected to service 50 to 150 looms, with each loom requiring the Emporiumto hold an equivalent of Rs 2,500 of yarn, representing three months ininput requirements. By year 3, it is expected that the Emporium would needabout Rs 5.0 million to meet these needs of the project. The Emporium wouldstock yarn and equipment and collect textiles for the project in Kathmanduand Pokhara; performance contractors and the CI Board would be responsiblefor other transport and storage.

4.45 During year 1, about Rs 2.2 million (US$167,000), or three monthsworth for about 400 to 500 units, would be needed. Under the project, theEmporium would be eligible for medium term bank credit to meet these needs,under the same terms and refinancing arrangements as for other eligiblesubprojects. The project could cover the 20% equity requirement of theEmporium which would be made as a seed capital grant to help enable Nepalesehandloom producers to upgrade quality and improve price. 1/ The 20% equityis expected to equal about Rs 1.2 million by year 3, assuming a gradualbuildup of stocks to Rs 5 million. HMG would make these seed capital fundsavailable; the equivalent in cotton yarn or handloom accessories procured bythe Emporium would be eligible for IDA disbursements. This assistance tothe Emporium on commercial operations for the handloom sector is considerednecessary because of fragmentation of private commercial agents and the needto upgrade quality before major expansion scope can be tapped. If HMG andIDA agree that the Emporium has performed well in these cotton-related acti-vities and that diversification would be useful, during the initial periodloans for expansion in other lines could be made eligible for project, theEmporium.

4.46 The cotton yarn operations under the project would represent asizeable expansion in the Emporium's importing and sales activities. 2/ The

1/ The Rs 1.2 million equity is roughly equivalent to paying the interestrate charges if the Emporium were to borrow for their total financingrequirements. This seed capital is judged necessary to provide adevelopment period for improving price and quality of handloom products;during this period normal interest charges on yarn and accessory pur-chases would not be passed on to handloom weavers.

2/ From 1976/77 to 1978/79, the Emporium's annual turnover in yarn rangedfrom Rs 1.5 million to Rs 6.2 million; assuming three months worth werestocked, average stocks ranged from Rs 300,000 to Rs 1.5 million.Assuming that sales to project agents would be incremental, the Emporiumwould be expected to double its yarn stocks by the end of year 1 of theproject.

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project would provide a procurement advisor for six months, with the optionby the Emporium to extend the contract for six additional months if re-quired. The advisor would assist the Emporium in improving its procurementprocedures, with particular attention to bulk procurement, more systematicinformation gathering on producers' requirements, and inventory managementmethods. In addition to this advisor's assistance, the International TradeCentre intends to provide the Emporium with regular information on pricetrends and alternative sources of cotton yarn.

4.47 The Emporium would maintain its procurement procedures, obtainingat least three quotations from different suppliers for each order of cottonyarn. The Emporium would maintain separate accounts for this yarn fund,including amounts utilized by each project agent. Prior to disbursementsfor this component, the Emporium would: ratify a statement of policies andprocedures for this fund; establish separate accounts; and have hired theadvisor. The Emporium would provide IDA, by May 31 of each year, annualaction programs for the subsequent fiscal year.

4. Coordination, Monitoring and Preparation for Expansion

4.48 Coordination. The implementing agencies would be responsiblefor carrying out their specific activities and responsibilities within thebroad framework of objectives, guidelines and procedures which would beagreed between HMG and IDA in the credit, subsidiary loan, and projectagreements, and in the implementation plans. In view of the complementarynature of the activities of the various agencies, mechanisms would beestablished to help ensure adequate coordination at headquarters and dis-trict levels. At the district level, the TPC and CIDB would be operatingin different areas of Gandaki; therefore, meetings between the banks andone technical assistance agency would be needed. Local government offi-cials would be consulted as required. At headquarters, a CSI CoordinatingCommittee would be established to review progress of the project, facili-tate coordination among the implementing agencies, and ensure that remedialmeasures are taken if necessary. The Coordinating Committee would bechaired by the Secretary, Ministry of Industry; key members would includerepresentatives of the National Planning Commission, Ministry of Finance,Ministry of Commerce and Supplies, Rastra Bank, Cottage Industry Board,Trade Promotion Centre, Emporium, the Industrial Services Centre and rep-resentative private sector delegates from cottage industries and exporterorganizations. 1/ Monthly meetings would be held during the initial yearof operations, after which the coordinating committee would meet at leastquarterly. The Joint Secretary of the Ministry of Industry would be a keycontact point and decision maker, to help resolve problems without havingto elevate them to the CSI Coordinating Committee; one senior officer wouldbe assigned full-time to provide day-to-day coordination. ISC, as thetechnical arm of the Committee, would do informal liaison.

4.49 Monitoring and Evaluation. Each implementing agency would installits own monitoring and reporting system, summarizing findings in the quarterly

1/ A Steering Committee for the CI Development Study, with similar com-position, has been meeting regularly for the last year.

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reports. The Industrial Services Centre would collect and collate thesereports as well as do independent monitoring of inputs, impact, and integra-tion of the various components. The ISC monitoring staff, working closely

with the agencies to maintain a good understanding or operations of eachcomponent, would submit the quarterly report to the members of the CSI commit-tee. In addition to this regular monitoring and reporting, a formal review

would be conducted by HMG and IDA after eighteen months of credit effective-ness; this would enable formal modifications to be made, if necessary, andwould facilitate preparation of other projects. Four man-months of consul-tancy services, completed in February 1981, were provided to assist ISC indeveloping the overall monitoring and evaluation system for the project,and to work with each implementing agency on its own reporting system (para4.51). The CSI project would cover four man-months of consultancy on moni-toring over the project implementation period (US$30,000).

4.50 Preparation for Next Projects. It is envisaged that HMG, IDA andother donors would be prepared to make sizeable financing available to CSIsonce the implementing agencies are strengthened and the most successfultypes of assistance are determined through experience under the first pro-ject. ISC would do surveys of 20 to 30 districts which are either repre-sentative or which have particularly strong potential for CSI development;most districts would be from hilly areas where cottage industries are con-centrated. On the basis of district surveys, discussions with the imple-menting agencies and consultants, and evaluation of the first project, ISCwill make proposals for strategies and components for area and productschemes. The project would finance six full time ISC staff to work on moni-toring and project preparation tasks; in addition, funds would be allocatedfor survey staff and expenditures (US$90,000 equivalent). Outside consul-tancy to ISC in project preparation is not envisaged; ISC is experienced inpreparation of cottage industry projects and can tap knowhow of specialistsassigned to the implementing agencies.

5. UNDP Financing for Training and Technical Assistance

4.51 UNDP project preparation financing of about US$224,000 has beenprovided. The Bank is the executing agency; NRB and the Ministry of In-dustry are the implementing agencies. Most elements of this preparatoryassistance are expected to be completed by January 1981. Main componentshave included:

(a) foreign and local training in CSI lending for staff, thebanking institutions: NRB, NBL, RBB and ADBN;

(b) outside training and exposure trips for management and spe-cialists of the Cottage Industry Board, Trade PromotionCentre, Emporium, and private exporters; and

(c) consultancy services to help finalize the Industrial Enter-prise Act including foreign investment aspects (para 4.53);develop the monitoring and evaluation system for the project(para 4.49); and help prepare TPC and exporters to implementactivities to be financed from the Cottage Industry Exportand Product Development Fund. 1/

1/ Consultances in monitoring and evaluation and on the Industrial Enter-prises Act have been completed. Orientation and training in Nepal arescheduled to begin in January 1982.

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4.52 In addition to this project preparation facility, about US$2.0million in UNDP grant funds would be provided for technical assistance,training and marketing inputs under the proposed project. These componentsare of critical importance in building capabilities of private and publicinstitutions. The elements and costs are outlined in Annex 1, Table 8 re-flect understandings reached with representatives of the relevant ministries,Planning Commission, Nepal Rastra Bank, other implementing agencies 1/, andthe UNDP. These training, consultancy, and marketing inputs would be partof the proposed Cottage and Small Industries Project; NRB, the Ministry ofIndustry and the Ministry of Commerce and Supplies would be the implementingagencies; and the Bank would be the executing agency. As the executingagency, the Bank would make the final selection and contractual arrangementsfor consultants financed by UNDP under the project. About US$110,000 millionwould be needed in CY 1981, US$1.06 million in 1982, and about US$680,000 in1983 (Annex 1, Table 12). During negotiations, HMG presented a copy ofHMG's request that UNDP make this funding available for the proposed CottageIndustry Project. Prior to credit effectiveness, the UNDP Project documentwould need to have been signed.

D. Policies Affecting Cottage Industries

4.53 The new Industrial Enterprises Act, passed by the Panchayat inAugust 1981 and awaiting Royal assent and issuance, contains several measureswhich improve incentives for CSIs and related commercial agents. However,further improvements in industrial policies and procedures, outlined inparas 2.12-2.18, would increase profitability and incentives in CSI devel-opment. The new Industrial Policy and the Industrial Enterprises Act werediscussed during negotiations. The IDA delegation expressed the need forfurther improvements, through rules and other measures, in the followingareas: (a) simplified fiscal incentives for CSIs; (b) provisions for foreigncollaboration; (c) extension of import concessions to input supply companieswhich are composed of private exporters and CSIs in the relevant productgroup; (d) streamlining of export procedures; and (e) planned steps forimproving transport arrangements and export financing (paras 2.12-2.19).If necessary, a portion of the contingency fund of the segments of theproject financed by UNDP or IDA could be utilized for short-term advisorsto address key policy and procedural needs of the sector. The projectcontains provisions for a continued dialogue between HMG and IDA on policiesaffecting CSIs.

1/ Consultancy to be financed by UNDP under the proposed CSI project isoutlined in the relevant sections of this report: paras 4.07, 4.30,4.31, 4.37, 4.46, 4.47, 4.49 and 4.52.

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V. THE PROPOSED CREDIT

5.01 Lending Arrangements. The proposed IDA credit of SDR 5.7 million(US$6.5 million equivalent), consisting of a US$4.5 million equivalentsubloan component and a US$2.0 million technical and commercial servicecomponent, would be made available to HMG on standard IDA terms and condi-tions. In addition, a US$2.0 million UNDP grant for training, consultancyand marketing inputs would be executed by the Bank, implemented by theMinistry of Industry and NRB. The credit is expected to be committed inabout three years and disbursed in about 3.5 years from the date of crediteffectiveness. Annex 1, Table 9 provides a breakdown of the portion to befinanced by UNDP. For the subloan component, HMG would onlend the proceedsto NRB for the account of CSI Fund to cover disbursements to refinanceeligible SCI subloans made by the three participating banks. The proceedswould be onlent tq NRB in rupees with HMG bearing the foreign exchange riskon repayments to IDA. Repayment by NRB to HMG would be on a fixed amorti-zation schedule. During negotiations, it was agreed that the CSI Fund ofNRB would repay HMG after fourteen years, to enable funds to be revolvedat least twice. During the fourteen years, the funds would be relent bythe CSI Fund to the participating banks for refinance of CSI loans. Thesearrangements are specified in the draft Project Agreement, and will beincorporated a Subsidiary Loan Agreement between HMG and NRB. The commer-cial and technical service component, including the portion financed byUNDP and executed by IDA, would cover specific items of training, consul-tancy, equipment and staffing expenses for the participating agencies. TheCSI Fund would be responsible for the portion of the technical servicecomponent allocated to NRB and the participating banks. The other serviceelements would be under the respective implementing agencies; each wouldhave separate action plans, withdrawal, and reporting requirements. HMGNwould need to provide full budget allocations for the technical and mar-keting service components regardless of whether the project element isto be financed by HMGN, IDA or UNDP. The proceeds of the technical andcommercial components would not be recovered directly; these componentsare of critical importance in building institutional capabilities as wellas addressing key marketing, input supply and technical upgrading needs.

5.02 Onlending Terms. The participating banks would charge CSI sub-borrowers a standard annual interest rate of not less than 11% with ratesreviewed at least annually and revised to assure positive, commercialinterest rates and consistency with rates for term loans to industry inNepal. The banks would maintain spreads of at least 4% for subloansabove Rs 20,000 and 6% for subloans of up to Rs 20,000. The CSI Fundwould receive a minimum spread of 2% to cover administrative costs, and1% as a premium for the credit guarantee scheme. The CSI Fund of NRBwould pay HMG an interest charge of 4-6% p.a. on the refinance amountsoutstanding in its account. Agreement on minimum interest rates, spreadsand review and adjustment procedures was reached during negotiations (para4.11).

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PROPOSED ANNUAL LENDING RATES AND SPREADS

Size of Banks' SubloanUp to Rs 20,000 Above Rs 20,000

(%) (%)

(a) Initial final onlending rate 11 11(b) Minimum spread to participating bank 5 4(c) Minimum spread to CSI Fund, NRB 2 2(d) Credit guarantee premium, NRB 1/ 1 1(e) Minimum onlending rates to NRB by HMG 2 4

No commitment fee would be charged on the subloan component due to the mul-tiple institutions involved and the snmall scale nature of the subborrowers.

5.03 Initial Contribution to the CSI Fund. Prior to credit effective-ness, NRB would pay into the CSI Fund the initial contribution of at leastRs 5.0 million. This contribution would be used to cover initial operatingcosts as well as the time lag between NRB's refinancing and reimbursementfrom IDA (para 4.12). NRB would make additional contributions to the CSIFund as needed. Surpluses generated by the Fund and any benefit derivedfrom a longer repayment term to HMG than that granted to the banks would beploughed back into the Fund and used to increase the amount available forrefinancing eligible CSI prospects.

5.04 Subloan Size and IDA Review. The maximum subloan size would beRs 800,000 (US$60,600), except for the raw material supply companies and theEmporium. Refinance by the CSI Fund would cover 80% of the subloan amounts.The average size of subloans is expected to be about Rs 31,700 (US$240)resulting in a total of about 2,000 subprojects; including organized SSIs,market agents, and raw material supply companies, the project would involveabout 2,200 subloans averaging Rs 311,000 (S$23,560). In view of the largenumber and small sizes of subloans, simplified review and approval procedureswould be used to keep administrative costs and processing times within reason-able bounds. In refinancing subloans of below Rs 20,000, the CSI Fund woulddo a rapid check on the eligibility of the subproject, its financial viabilityand the adequacy of proposed subloan terms. Periodically, the CSI Fund wouldundertake a detailed post-approval review of a 20% sample of appraisal reportssubmitted to check that appropriate appraisal standards are being maintained. 2/For subloans of over Rs 20,000, a detailed review by the CSI Fund would berequired prior to NRB's approval of refinance and reimbursement applicationsto IDA. To ensure expeditious review of these subloans, the Fund would com-plete its procedures within three weeks of receiving completed applicationsfrom the banks. In claiming reimbursement from IDA, the Fund would certify

1/ Credit guarantee premiums would be 1% on amount guaranteed which isoutstanding, not on the full subloan amount.

2/ In the initial period, the CSI Fund staff would pay closer attention tothese smaller projects at the time of approval to provide the participat-ing banks with immediate feedback on appraisal standards. Once thesestandards have been firmly established, full implementation of postapproval sampling can take place.

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that subprojects meet eligibility criteria, are financially viable, and thatsubloan terms are appropriate. IDA's prior review and approval would berequired for refinance applications for all performance contracts, marketagents, raw material supply companies and CSIs requiring subloans in excessof Rs 330,000 (US$25,000). This procedure is expected to result in detailedpre-approval review by the CSI Fund of some 370 subprojects, 20% by numberand 84% by amount. IDA would review, prior to authorization, about 90 sub-projects, 5% by number and 60% by amount of all subprojects (Annex 1, Table11). IDA supervision missions would review appraisal standards on smallersubprojects.

5.05 Procurement. Participating banks would be responsible for ensur-ing that items procured for subprojects are suitable, reasonably priced andthat sponsors have canvassed the main sources of supply; the CSI Fund wouldmonitor these procurement procedures. Contracts for goods or servicesprocured outside Nepal costing the equivalent of US$5,000 or more per item,or US$20,000 or more per contract, would be on the basis of internationalshopping with at least three quotations. Since it would be difficult andcostly to seek quotations for smaller contracts, these provisions would notapply, but participating banks would maintain appropriate records of themethod of procurement for post-review by the CSI Fund staff and IDA super-vision missions. Procurement of goods and services under the technical andcommercial service component would be made according to procedures of theCIDB, TPC and other implementing agencies (Annex 2). Procurement of vehi-cles and equipment would be fully dbcumented.

5.06 Disbursement. Estimated schedules of disbursements for the IDA-and UNDP-financed portions of the project are presented in Annex 1. Table 12.All subloan disbursements for eligible foreign or local expenditures wouldqualify for 80% refinancing by the CSI Fund. IDA would reimburse 100% of therefinance granted by the CSI Fund, resulting in IDA funds covering about64% of total subproject costs. 1/ The average foreign exchange content ofsubprojects is estimated to be about 30%. Given the large number of subproj-ects involve6 and :he small subloan sizes, normal DFC procedure of disbursingagainst expenditures on individual subproject accounts would be inappropriate.Accordingly, for refinance of subloans of Rs 330,000 (US$25,000) or less, theCSI Fund would claim reimbursement from IDA on the basis of periodic certifiedstatements of expenditure. For these subprojects, documentation would not besubmitted to IDA for review but suitable documentation, 2/ evidencing expendi-ture would be provided by the bank and retained by the CSI Fund. The state-

1/ The ratio would be somewhat higher depending on the number of subproj-ects where the sponso-'s contribution is waived in whole or in part(para 4.iO). As this is likely to be confined largely to smaller loansthe aggregate of subp-oject costs covered by IDA financing is likely tobe only marginally nigher than o4%.

2/ Excluding expenditure on permanent working capital.

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ments of expenditure and the supporting documentation 1/ would be auditedannually and an audit certificate would be presented to IDA. For refinancingof subloans of over Rs 330,000, full documentation of expenditures would besubmitted to IDA. For elements of the technical and commercial servicecomponent implemented in Nepal, IDA would disburse against 100% of foreignexpenditures for equipment, vehicles and raw materials, imported directlyand for locally manufactured equipment and raw materials purchased ex-fac-tory; 80% of expenditures for other equipment procured locally; 50% ofstaffing and related expenditures according to agreed action programs; and100% for performance contract fees. For those elements of the technical andcommercial service component, withdrawal applications would be submitteddirectly to IDA by the implementing agency, accompanied by certificates ofexpenditures on staffing, and documentation of other expenditures; thedocuments for which would be retained by each agency and made available toIDA supervision missions for inspection. In the case of the IMPACT centresin New York and Frankfurt, IDA would disburse 100% of equipment, consulting,staffing costs, and other operating expenditures; HMG would establish con-tractual arrangements for establishment and operation of the IMPACT centres.

5.07 Repayment Schedules. The maturity for subloans refinanced bythe CSI Fund would be 18 months to 7 years, including an appropriate graceperiod. Repayments of refinance by the participating banks would be onthe basis of a composite schedule reflecting the consolidated amortizationschedules of individual subloans, fixed at the time refinance is granted andnot subject to rescheduling. As the commitment period would be about threeyears, repayments by the banks would stretch over about 10 years. A fixedamortization schedule of 14 years for repayment of the US$4.5 million sub-loan component from the CSI Fund would be arranged to enable revolving ofthe funds and to increase the effective amount available for CSI refinance.Agreement on these terms was reached during negotiations.

5.08 Reporting, Accounts and Auditing. The CSI Fund would submitquarterly reports to IDA and to the CSI Coordinating Committee, through ISC;the main report would aggregate the individual quarterly reports of parti-cipating banks, covering activities, portfolio data, collection and arrearsperformance, and supervision results. In addition, the CSI Fund wouldsubmit a quarterly statement of its own refinance activity and details ofdisbursements. In addition, the CSI Fund would prepare annual reports onperformance of the participating banks; these reports would present ananalysis of the banks t quarterly reports including a projection of commit-ments, refinance, and withdrawals from IDA. The CSI Fund also would presentits assessment of the standards of the banks and propose improvements. Thereport also would include the audited annual report of the Fund, prepared ina form acceptable to IDA, and the audited annual reports of the banks. Theannual reports should be submitted within six months from the end of thefiscal year. An independent auditor, acceptable to IDA, would audit allproject accounts. The auditor also would be responsible for providingaudits covering certificates of expenditure (para 5.05). Each bank wouldmaintain separate accounts for subloans and documentation on disbursements

1/ Documentation would include: names and locations of subborrowers; thetotal of each subloan; disbursements during the period for each sub-

loan; and the branch of the lending institution handling the loan.

- 46 -

and procurement procedures. Each technical service agency would be ex-pected to prepare annual implementation programs and quarterly progressreports, which would be submitted to the CSI Coordinating Committee and toIDA. Separate accounts would be maintained by the implementing agencies forthe technical and commercial service elements; these project accounts wouldbe audited annually by an independent auditor acceptable to IDA.

VI. PROJECT BENEFITS AND RISKS

6.01 Benefits. The proposed project is geared to provide the effectivecredit, commercial, and technical services needed to tap growth potentialin CSI products, particularly for exports. The project is expected togenerate significant direct benefits in earnings and exports in the threedistricts of Kathmandu Valley and the six Districts of Gandaki Zone. Also,major general benefits are expected in the strengthening of private, bankingand public institutions, development of replicable product specific schemes,and improvement of industrial policies and procedures.

6.02 Under the subloan component, about 2,600 loans would be made bythe three participating banks; the majority of these would be for cottageunits, with about 50 to performance contractors and other market agents,100 to organized small industries, and 3 to 5 subloans to the input supplycompanies and the Emporium. The average subloan size for cottage unitswould be Rs 15,000 (US$1,200); average fixed costs per job would be aboutRs 3,200 (US$240), or Rs 1,900 (US$145) if agroindustrial units are excluded.About 15,000 workers in CSIs would be recipients of credit, directly andthrough performance contractors.

6.03 Since the project would cater mainly to cottage industries, com-mercial and technical services are at least as important as credit. Theeffective operations of the Cottage industry Export Development Division ofthe TPC and the IMPACT centres in New York and Frankfurt will be of partic-ular importance in providing needed market contacts, product adaptationinputs, and direct incentives to exporters in expanding their rural base.With the project inputs, it should be possible to maintain the 35% annualgrowth rate in exports of CI products; without the project, market, rawmaterial and credit constraints are likely to slow export growth to roughly20%. The project, thus, could generate incremental gross foreign exchangeearnings of roughly $27 million (US$15 million net) from 1981-1984; most ofthis growth is expected in carpets (44%) metal products (37%), and cottonand woolen garments (15%). This export growth would be equivalent to roughly10 million additional mandays of employment over the four year period. Inaddition to increasing mandays worked, a portion of the increased value addedof products could be passed on to artisans in the form of increased dailyrates; however, these potential benefits have not been included in the cal-culation. Most of the employment created would be in the form of additionaldays worked by existing artisans rather than new jobs created; this 10 mil-lion mandays is equivalent to 50,000 manyears of incremental employmentover the 1982-1985 period. Performance contract networks could provideregular employment to about 10,000 rural crafts people by 1985. About30% of the export earnings and employment is expected to come from Gandaki;without the project, the share of rural areas in export production would belikely to remain minimal (Annex 1, Tables 4 and 5).

- 47 -

6.04 While expanded production to meet local demand is constrainedby local purchasing power, the project is expected to generate roughly US$8million in additional output value for local sales, mainly in handloomproducts (67%) and agroprocessing (20%). The equivalent of about 14,000manyears of employment would be generated as a result (Annex 1, Table 4).

6.05 The project would not cause the creation of any new public in-stitutions; rather, public services to CSIs by existing agencies would bestrengthened substantially and private organizations would be used wherepossible. The organization, staffing and training of the CSI units ofRastra Bank and the three credit institutions should provide a core ofcapable staff in CSI project-based lending operations. The tiering ofspreads and provision of an effective guarantee scheme are geared to en-courage the banks to make term loans to small borrowers on the basis ofproject evaluation rather than collateral.

6.06 Risks. Several project elements represent new or expanded acti-vities for the implementing agencies. Therefore, the project preparationperiod has been long and intensive; training and consultancy before andduring implementation have been incorporated in most components; and projectelements have been pruned to what are judged to be within the capabilitiesof the respective implementing agencies. Still, it can be expected thatsome agencies would be more effective than others; risks that one agency'spoor performance would adversely affect overall success have been reducedby designing the project as a set of relatively discrete components and byincorporating a formal joint review after eighteen months of project imple-mentation; at that time, revisions could be made, shifting finance to moresuccessful elements and making modifications to improve performance.

6.07 The project's success is most sensitive on the marketing function;if orders are not acquired and executed effectively, expanded productionwill merely strap exporters and producers with debt. For this reason, theproject involves an integrated set of marketing components including threeexport-import offices, product specialists, and sales trips. There arerisks of abuse or failure on the private performance contracts; however,amounts involved are small relative to potential benefits and risks wouldbe reduced by disbursing in instalments against completion of tasks and byproviding the exporters with needed back-up services in product adaptationand sales promotion. Sizeable risks are implied in any project whichattempts to make a substantial impact on exports and rural earnings inNepal. The project incorporates a detailed monitoring and evaluation systemas well as formal and informal coordination mechanisms. The project wouldrequire frequent supervision by IBRD/IDA staff.

VII. RECOMMENDATIONS

7.01 Prior to negotiations, HMG provided IDA with a copy of HMG'sletter to UNDP confirming the intention to seek UNDP funds for training,consultancy and market inputs of the proposed project with IDA as theexecuting agency (para 4.52).

7.02 During negotiations, agreement was reached between IDA and HMG on:

- 48 -

(a) HMG's estimated annual budgetary allocations for commercialand technical service components and for ADBN (para 4.05,Annex 1, Table 8);

(b) onlending terms, conditions, margins, eligibility criteria,refinance arrangements, guarantee provisions and responsi-bilities of the banks under the subloan component, includingthose outlined in a Project Agreement with NRB (paras 4.08-4.16);

(c) establishment of a Cottage Industry Export Development Fundand Division in the Trade Promotion Centre, with a statementof policies and procedures, staffing and long-term consul-tants in place, and a year 1 action plan, all satisfactoryto IDA, by January 1, 1982 and establishment of IMPACT centres,under TPC, with operations beginning in New York by July 31,1981 and in Frankfurt by July 31, 1982, unless otherwiseagreed by IDA (paras 4.26-4.35);

(d) for each private limited company, legal establishment withstatutes, share composition, initial equity contributions,maximum loan amounts for Year 1, and auditing provisionssatisfactory to IDA prior to disbursements (para 4.40-4.43);

(e) reactivation of the CIDB, with responsibilities, financial rules,approved policies and procedures, a year 1 action program, andrecruitment and training of minimum staff, agreeable to IDA, byJanuary 1, 1982 (para 4.36);

(f) implementation plan for the project and requirement thatmajor commercial and technical service agencies submitannual action programs to IDA for concurrence by the May 31prior to fiscal years two and three (paras 4.35, 4.36, 4.43,and 4.47);

(g) for performance contracts, prior authorization by IDA ofeach contractor, the action program, and terms and condi-tions (paras 4.32-4.33);

(h) institutional responsibilities and mechanisms for coordination,monitoring, reporting and review, including a formal jointreview by HMG and IDA, eighteen months after credit effective-ness (paras 4.48-4.49);

(i) costs and administrative arrangements for elements of theproject to be financed by UNDP, executed by the Bank (para4.52; Annex 1, Tables 7 and 8); and

(j) measures planned by HMG to improve policies and proceduresaffecting CSIs and provisions for regular dialogue between HMGand IDA on these aspects (para 4.53).

- 49 -

7.03 The following conditions would need to be met prior to crediteffectiveness:

(a) establishment of the CSI Refinance Unit in NRB in a manneracceptable to IDA, including an approved statement of policiesand operating procedures, accounting practices, management andstaff, and initial capitalization provided by NRB (para 4.13);

(b) introduction by Nepal Rastra Bank of a credit guaranteescheme for SCI subloans under the project, with proceduresand capitalization satisfactory to IDA (para 4.14);

(c) issuance of instructions by NRB, satisfactory to IDA, toat least two participating banks, with these credit insti-tutions having complied with minimum CSI staffing andtraining requirements (paras 4.16, 4.19, 4.21, 4.24);

(d) signing of the UNDP Project Agreement by HMG, IDA and UNDP(para 4.52); and

(e) signing of a Subsidiary Loan Agreement, satisfactory to IDA,between HI4GN and Nepal Rastra Bank (para 5.01).

7.04 Conditions of disbursement for elements of the project implementedby the Emporium, would be adoption of policies and operating procedures,development of a Year 1 action program for cotton, equipment, and textileoperations in the project area, and appointment of an advisor, all satisfac-tory to IDA (para 4.47).

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

INDICATORS OF PERFORMANCE OF CSIs IN THE PROJECT' AREA -

No. of Fixed (A) Total (A) 2 Value of (A)Subsector No. of Units Workers Investment - Production- Raw Materials Fixed Inv./Worker (B) Prod./Worker (B) Value added/Prod.

Kathmandu Valley

Carpets 416 2,560 790 20,724 9,279 309 /3 8,095 0.55

Other Woolen Goods 230 1,154 3,941 8,661 2,751 3,415 /T 7,505 0.68

Handlooms 17,906 21,776 15,912 62,800 45,028 731 /5 2,884 0.28Metal Goods 337 998 1,395 10,220 7,037 1,398 10,240 0.31

Forest Based Goods 24,484 27,578 4,526 13,641 4,706 164 495 0.66

Agroindustries 23,493 30,234 8,476 106,403 (-) 280 3,519

AVERAGE/TOTAL 66,866 84,300 35,040 222,449 68,801 /8 416 2,639 0.41 /8

Gandaki Zone

Carpets 135 698 538 2,292 719 771 /3 3,284 0.69

Other Woolen Goods 6,162 9,835 571 6,428 2,833 65 /4 728 0.56

Handlooms 2,542 3,684 1,516 10,220 7,946 412 /5 2,774 0.22

Metal Goods 7 9 10 23 12 1,111 /6 2,556 o.48

Forest Based Goods 116,824 96,991 2,269 8,048 2,885 23 83 0.64

Agroindustries 78,925 91,459 10,090 74,731 () 110 817 (-)

AVERAGE/TOTAL 204,595 201,676 14,994 101,742 14,395 /8 74 504 0.47 /8

Total

Carpets 551 3,258 1,328 23,016 9,998 408 7,064 0.57

Other Woolen Goods 6,392 9,989 4,512 15,089 5,584 452 1,511 0.63

Handlsoms 20,448 25,460 17,428 73,020 52,974 685 2,868 0.27

Metal Good. 344 1,007 1,405 10,243 /7 7,049 1,395 10,172 0.31

Forest Based Goods 141,308 124,569 /9 6,795 21,689 7,591 54 174 0.65

Agroindustries 102,418 121,693 18,566 181,134 /10 (_) 153 1,488

AVERAGE/TOTAL 271,461 285,976 50,034 324,191 83,196 /8 175 1,134 0.42 /8

1/ Data for 1979. based upon Rs. prices and exchange rates operating during that year.

2/ Production refers to ex-factory value of output and is lower than sales value given in Annex 1 Table 4.

3/ Investment per worker in Gandaki Zone is higher than in Kathmandu due to a few large scale units in Tanahu district.

4/ The wide variations in fixed investment and output per worker since workers in Gandaki Zone work only part-time.

5/ Gandaki Zone has a few large units and fixed investment in these are higher than in large units in Rathmandu Valley.

6/ The small number of units in Gandaki Zone makes comparisons unreliable.

7/ Output figure given is an underestimate due to limited coverage of metal goods units.

8/ Total/everage excludes agrobased units, which normally operate as service enterprises.

9/ Employment figures for some units are not available and hence the figure given is an understatement.

10/ Includes Rs 117,917 which is the value of through-put in service-based industries i.e. rice, flour and oil milling.

(A) (Rs. 000)(B) Rs.(-) Not available

GANDAKI ZONE

Commercial Bank Branches and Cottage Industry Concentrations

District and Panchayat No.-of DistanceHeadquarters Bank Branches Location of Cluster Subsector Units (km.)

Kaski Pokhara (RBB) Armal Chhaharepani Wool, Garments, Handlooms, Fiber 650 11.2(Pokhara) Pardi (RBB) Pokhara Wool, Garpets, Handlooms, Metals 100 -

Bagar (NBL) Ghachowk Fiber 180 12.0Ghandruk Fiber 200 22.0

Pokhara (NBL) Dansing Handlooms, Wool, Garments 270 57.6

Syangja Waling (NBL) Syangja Handlooms 50 -

(Syangja) Bahakot Wool Garments plus Carpets 110 6.4Dansing Wool Garments plus Carpets 85 -

Kewareghajyang Fiber 200 23.0Panchmool Fiber 250 6.4 1

Syangja (NBL) Sri Krishna Gandaki Handlooms 200 35.2 W

Gorkha Gorkha (RBB) Manakamana Handlooms 200 19.2(Gorkha) Arughat Handlooms 100 28.8

Simjung Wool Garments 100 38.4Barpak Wool Garments 300 50.2

Manang Ghyan Wool Garments 100 25.6(Chame) Thoche Wool Garments 75 19.2

Tanahu Khaireni (NBL) Chhimkeswari Handlooms, Fiber 350 4.8(Damauli) Dumre (NBL) Damouli Wool Garments 30 -

Kahunsibapur Wool Garments 40 -

Manpang Fiber 190 13.0Damouli (NBL) Dhiringsundhara Handlooms 200 23.6

Lamjung Besisahar (RBB) Gaonsahar Handlooms 50 3.2(Besisahar) Besisahar (RBB) Dhodeni Wool Garments 250 22.4

Durandanda (RBB) Pasgaon Wool Garments, Handlooms 190 35.2

. >311~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ -

Probable Locations of Performance Contracts in Gandaki Zone - Year 1

.itaceDistance . No. of

Major Panchayat of Center Cluster Artisan

(km.) (km.) Clusters

Private Performance Contracts

Woolen Goods Kaski Pokhara - Pokhara 0 0 80- ArmaleChhaharepani 11.2 100

Syangja Syangja - Bahakot 0 6.4 110

Bazaar - Dansingh 16.0 85

Tanahu Damouli - Damouli 0 - 30

- Kahunsibapur 10.0 40

Gorkha Barpak - Barpak 30 - 300

- Simjung _ 5.0 100

Handloom Products Syangja Syangja - Syangja Bazaar 0 0 50 b

Bazaar - Panchmool 10.0 20

Srikrishna - Srikrishna 12 - 200

Gandaki Gandaki- Waling 4.0 17

Tanahu Chimkeswari - Chimkeswari 4 - 150

Ambu Ambu- Manakamana 6.0 200

(Gorkha)Kaski Pokhara - Pokhara 0 0 60

- Anmale 11.2 100

ChhaharepaniGorkha Arughat - Arughat 30 - 100

Gorakhkali - 20.0 20

Forestry Products Syangja Keware - Keware 10 - 750

Bhanjyang Bhanjyang- Waling 12.0 280

Banchmool - Panchmool 3 - 400

Tanahu Chimkeswari - Chimkeswari 4 - 700

Ambu Ambu- Bandipur 8.0 300

NEPAL

PROPOSED COTTAGE AND SMALL INDUSTRIES PROJECT

%OJp.W IPB9JEQ.C LENjF ITS(Rs mill ion, constant prices)

Estimated AverageCumulaivef Benefit lncreneotal Compound

Categories of Benefits 1980 1/ 1981 1982 1983 1984 (1981-1984) Benefits of Crowth Rateby Suhuectar Without With Without With Without Withh Without With Without With the Prroect Without With

(a) CorpetsEnpoets- (FOB) asd Tourist Sales 58 69.6 78.3 83.5 105.7 100.2 142.7 120.3 192.6 373.6 519.3 145.7 20.0 35.0Sales to Local Markets 2 2.1 2.2 2.2 2.3 2.3 2.5 2.4 2.7 9.0 9.7 0.7 5.0 8.0Total Output Value 60 71.7 80.5 85.7 108.0 102.5 145.2 122.7 195.3 382.6 529.0 146.4 19.6 34.3Employmsnt (Man days, 000) 1,990 2,378.1 2,669.9 2,842.4 3,582.0 3,399.6 4,815.8 4,069.6 6,477.5 12,689.7 17,545.2 4,855.5Earnings (Wages) 24 28.5 29.4 34.1 39.4 40,8 53.0 48.8 71.3 152.2 193.1 40.9

(b) Other Woolen CoodsEupor-t (FOB) 5 5.5 6.5 6.1 8.5 6.7 11.0 7.3 14.3 25.6 40.3 14.7 10.0 30.0Sales to Local Markets 18 18.4 18.7 18.7 19.5 19.1 20.2 19.5 21.1 75.7 79.5 3.8 2.0 4.0Total Output Value 23 23.9 25.2 24.8 28.0 25.8 31.2 26.8 65.4 101.3 149.8 48.5 4.0 29.9Emplaynent (Man days, 000) 1,280 1,330.1 1,402.4 1,380.2 1,558.3 1,435.8 1,736.3 1,491.5 3,639.7 5,637.6 8,336.7 2,699.1iaraluigu (Wages) 10 10.6 14.0 11.0 15.6 11.5 17.4 11.9 36.4 45.0 83.4 38.4

(c) Handloan Garments/ProduetsExports (FOB) 10 12.0 14.0 14.4 19.6 17.3 27.4 20.7 38.4 64.4 99.4 35.0 20.0 40.0Saleu to Local Markets 70 71.4 77.0 72.8 84.7 74.3 93.2 75.8 102.5 294.3 357.4 63.1 2.0 10.0Total Output Value 80 83.4 91.0 87.2 104.3 91.6 120.6 96.5 140.9 358.7 456.8 98.1 4.8 15.2Employment (Man days, 000) 1,950 2,032.9 2,218.1 2,125.5 2,542.3 2,232.8 2,939.6 2,352.2 3,434.4 8,743.4 11,134.4 2,391.0Farniogs (Wages) 12 14.2 17.7 14.9 20.3 15.6 23.5 16.5 27.5 61.2 89.0 27.8

(d) Metal CraftsExports (FOB) 40 46.0 54.0 52.9 72.9 60.8 98.4 70.0 132.9 229.7 358.2 128.5 15.0 35.0Sales to Local Markets 88 8.2 8.4 8.3 8.8 8.5 9.3 8.7 9.7 33.7 36.2 2.5 2.0 5.0Total Output Value 48 54.2 62.4 61.2 81.7 69,3 107.7 78.7 142.6 263.4 394.4 131.0 13.2 31.3Enployment (Mac days, 000) 270 304.9 351.0 344.3 459.6 389.8 605.8 442.7 802.1 1,481.7 2,218.5 736.8Earnings (Wages) 4 4.6 5.3 5.2 6.9 5.8 9.1 6.6 12.0 22,2 33.3 11.1

(a) Forest Based ProductsExports (FOB) and Tourist Sales 1 1.2 1.3 1.3 1.7 1.5 2.2 1.7 2.9 5.7 8.1 2,4 15.0 30.0Sales to Lacal Markets 12 12.2 12.4 12.5 12.7 12.7 13.1 13.0 13.5 50.4 51.7 1.3 2.0 3.0Total Output Value 13 13.4 13.7 13.8 14.4 14.2 15.3 14.7 16.4 56.1 59.8 3.7 3.1 6.0Employment (Man days, 000) 1,700 1,133.9 1,159.2 1,167.7 1,218.5 1,201.5 1,294.6 1,243.8 1,387.7 4,746.9 5,060.0 313.1Earnings (Wages) 6.6 6.8 7.0 7.0 7.3 7.2 7.8 7.5 8.3 28.5 30.4 1.9

(f) Food ProcessingEaports (FOB) 6 6.3 6.5 6.6 7,0 6.9 7.6 7.3 8.2 27,1 29.3 2.2 5.0 8.0Sales to Local Markets 60 61.8 63.6 63.7 67.4 66.6 71.5 67.5 75.7 258.6 278.2 19.6 3.0 6.0Total Output Value 66 68.1 70.1 70.3 74.4 72.5 79.1 74.8 83.9 285.7 307.5 21.8Enploy-ent (Man days, 000) 5,340 5,510.0 5,671.7 5,687.9 6,019.6 5,865.9 6,399.9 6,052.0 6,788.3 23,115.8 24,879.5 1,763.7Earnings (Wages) 40 44.1 45.4 45.5 48.2 46.9 51.2 48.4 54.3 184.9 199.1 14.2

TOTAL, tKEY SLBECTORS

Exports (FOB) 120.0 140.6 160.6 164.8 215.4 193.4 289.3 227.3 389.3 726.1 1,054.6 328.5 17.3 34.2Production for L.ocal Markets 250.0 174.1 182.3 178.2 195.4 182.5 209.8 186.9 225.2 721.7 812.7 91.0 2.3 7.3Total Output Value 290.0 314.7 342.9 343.0 410.8 375.9 499.1 414.2 644.5 1,447.8 1,897.3 449.5 9.3 22.1Employment 12,530.0 12,689.9 13,472.3 13,548.0 15,380.3 14,525.4 17,792.0 15,651.8 22,529.7 56,415.1 59,174.3 12,759.2 7.0 17.2Earnings (Wages) 96.6 108.8 118.8 117.7 137.7 127.8 162.0 139.7 209.8 494,0 628.3 134.3 9.7 21.4

I/ Sourc of mast actual figures is entrapolation from the ISC Interin Report, July 1979, which summari-ed findings of the detailed survey in the project area.

2/ Export figures are based on Trade Promotion Ceotre statistics, with the assumption that about 806 of preseot cottage ind-stry product euports are made in the pro-ject area,

- 54 -ANNEX 1Table 5

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

OPTIMISTIC, PESSIMISTIC AND EXPECTED RESULTS

Growth Rates of Sales and Employment with and Without the Project

AssumptionaboutConditionsWithout the

Wit ProjectAnnual Compound it Optimistic ExpectedGrowth Rate thojet OpiitcPsiitCompoundover 1981-84 Project Growth Rates

(Z) t Without the With the Without the With theProject Project Project Project (M) Project Project

Export Sales 22.3 45.2 12.0 45.2 Export Sales 17.3 34.2

Local Sales 3.7 11.7 1.0 11.7 Local Sales 2.3 7.3

Total Sales Optimistic 12.6 28.8 6.0 28.8 Total Sales 9.3 20.7

Employment 9.5 22.8 4.3 22.8 Employment 7.0 15.0

Export Sales 22.3 28.8 12.0 28.8

Local Sales 3.7 5.8 1.0 5.8PessimisticTotal Sales 12.6 17.0 6.0 17.0

Employment 9.5 12.2 4.3 12.2

Cumulative Increeiental Benefits of the Project (1981-84)

Assumptionabout Conditions

Incremental Benefits Without Expected Incrementalof the Project the Benefits of the Pro-(1981-1984) With roject Optimistic Pessimistic ject (1981-1984)

the (Rs million)(Rs million) Project (amlin

Export Sales 511.2 683.2 Export Sales 328.5

Local Sales Optimistic 155.9 204.6 Local Sales 91.0

Total Sales 666.1 887.8 Total Sales 419.5

Employment | 20,406.9 27,242.5 Employment 11,089.6(man days,'000) (man days,'000)

Export Sales 125.5 297.5

Local Sales Pessimistic 39.1 87.8

Total Sales 164.6 385.3

Employment 3,776.1 10,611.7 a(man days,'000)

Source: HMG Government statistics and World Bank staff estimates

NEPAL

COTTAGE AND SMAl. INDUSTRIES PROJECT

Estimate etnts to be met under Project 1/

(Three-year Commitment Period)

(A) (B) (C) (D) (E) (F) (C) (H)

CreditAverage for

Average Permanent Average Average Average Individual Units under UnitsFixed Working Fixed Working Fl Units Contracts, Credit for under

Investment Capital Average Investment Capital and WC Needing Agents, or Individual PC or TotalCredit/ Credit/ Labor Credit/ Credit/ Credit/ Both F1 Development Units DC 3/ Credit byWorker Worker Unit 2/ Unit Unit Unit and WC Center 3/ (FxG) (DxH) Subsector

(Rs) (Es) (Persons) (Rs) (Rs) (Rs) (No.) (No.) (Rs 000) (Es ODD) (Ts 000)

I COTTAGE INDUSTRIES

(a) Woolen Carpets 1,700 4,400 5 8,500 22,000 30,500 100 700 3,050 5,950 9,000(b) Other Woolen Goods 1,400 2,800 3 4,200 8,400 12,600 50 300 630 1,260 1,890(c) Cotton Handloom 2,800 2,800 3 8,400 8,400 16,800 80 500 1,344 4,200 5,544(d) Metal Crafts 3,900 2,800 4 15,600 11,200 26,800 50 60 1,340 936 2,276(e) Forest Products 900 660 3 2,700 1,980 4,680 70 300 328 8I 1,138(f) Agro-industry 4/ 16,000 2,200 3 48,000 6,600 54,600 160 50 8,736 2,400 11,136

Subtotal, Cottage Industries 510 1,910 15,428 15,556 30,984

II ORGANIZED SMALL INDUSTRIES 8,800 16,500 6 52,800 99,000 151,800 100 15,180 15,180

III PERFORMANCE CONTRACTORS AND MARKET N.A. N.A. N.A. 140,000 300,000 440,000 50 22,000A~GENTS

IV RAW MATERIAL SUPPLY COMPANIES 300 3,300 3,600 3 10,800(INCLUDING EMPORIUM)

TOTAL ESTIMATED CREDIT REQUIREMENTS 78,964

(US$6 million)

1/ This would include the 80% of the loan eligible for refinance by NRB (US$4.5 miilion) and the 20% loan share by the banks.

2/ Most cottage industries receiving finance are expected to be household units employing an average of two family members; however, credit would also be provided to small or anizedunits which are found in carpets, cotton handlooms and metal crafts and which probably would emerge with stable commercial arrangements under the performance contract or CI Boardsystems. Thus, the average employment per unit increases; for example, if two out of every 10 subloans to carpet units are to small factory operations employing 15-20 workers,with the remaining eight for household units, the average number of workers per unit would be five.

3/ It is assumed that most units within performance contracts or development networks require only fixed investment loans, since raw materials would be supplied by most performancecontractors. Only the estimated number of units requiring credit are noted here, since not all units under performance contracts or development centers will require equipment loans.

4/ This includes organized small industries as well as household units. r

50|

ANNEX 1- 56- TabIQ 7

NEPAL

Interest Rate Structureof Credit Institutions

Effective as of July, 1980(in percent p.a.)

Deposit Rates

Savings deposits 9.0

Fixed deposits:

3 months 4.0

6 months 10.0

1 year 12.0

2 years and above 13.0

Lending Rates

Cottage and small scale industry andfarmers (fixed and working capital) 10.0

Agricultural Loans -/ (fixed and workingcapital) 4.0 - 14.0

Medium and large scale industry 2-/ (fixedcapital) 11.0 - 16.0

Medium and large scale industry (workingcapital) 3/ 14.0

Export bills 12.0

HMG Development Bonds 15.0

Other loans 16.0 minimum

Overdue loans 2.0 points more thanspecific rate.

1/ ADBN lends to cooperatives at 4.0 - 7.0 concessionary rates for specifiedproducts.

2/ Luxury goods producing industries have to borrow at 16.0.3/ Mostly short term loans.

Source: Nepal Rastra Bank, at the time of project appraisal.

- 57 -

ANNEX 1Table 8

NEPAL

COTTAGE INDUSTRY DEVELOPMENT PROJECT

Estimated Costs and Sources of Finance for Commercial and Technical Service Components

(Three-year Cormeitment Period)

(uss 000)

Total IDA IDA hMG/Component Cost Foreign Local UNDP Agency

1. TRADE PROMOTION CENTER

(a) CIED Division - Kathmandu l,615 220 285 985 145

(i) Establishoent costs 40 20 - - 20(ii) Local staff and expenditures 1/ 250 - 125 - 125

(iii) Long-tern consultants (60 manmonths) 2/ 420 - - 420 -(iv) Short-term consultants (24 manmonths) 190 - - 190 -(v) Sales and exposure trips for exporters 3/ 225 - - 225 -

(yi) Performance contract payments 310 150 160 - - 6/(vii) Integrated product development and fair 150 - - 150 -

(viii) Vehicles 50 50 - - -

(b) Impact Centers - New York and Frankfurt 535 535 - - -

ii) Consultancy to launch centers 2/ 50 50 - - -(ii) Staff from importing country and Nepal 4/ 270 270 - - -

(iii) Rent, materials, other operating expenses 135 135 - - -(iv) Short-tern consultants (18 manmonths) 1/ 80 80 - - -

SUBTOTAL, TRADE PROMOTION CENTER 2,170 755 285 985 145

2. COTTAGE INDUSTRY BOARD

(a) Headquarters and Gandaki Offices - Training and Extension 790 100 105 480 105

(i) Local staff, related expenditures 210 - 105 - 105(ii) Consultancy - subsector specialists (24 manmonths) 170 - - 170 -

(iii) Outside training of staff and artisans; short-term 310 - - 310 -consultants (24 manmonths)

(iv) Vehicles for Cottage Industry Board 100 100 - - -

(b) Handicraft Design and Promotion Center 195 50 50 70 25

(i) Incremental staff, operating expenditures 50 - 25 - 25(ii) Short-term consultancy (9 nanmonths) 70 - - 70 -

(iii) Equipment, land, buildings 75 50 25 - -

(c) Handloom Development Centers (6) 240 40 140 - 60

(i) Fixed investment (lad, buildings, equipment) 70 40 30 - -(ii) Staff 6n - 30 - 30

(iii) Working capital 110 - 80 - 30

(d) Wool Products Development Centers (6) 255 45 150 - 60

Ci) Fixed investment (land, buildings, equipment) 110 45 35 - 30(ii) Staff 60 - 30 - 30

(iii) Working capital 85 - 85 - -

(e) Fibre Products Development Centers (6) 85 15 40 - 30

(i) Land, building, equipment 40 15 10 - 15(ii) Staff 30 - 15 - 15

(iii) Working capital 15 - 15 - -

SUBTOTAL, COTTAGE INDUSTRY BOARD 1,565 250 485 550 280

3. EMPORIUM

(a) Incremental staff 20 - - - 20(b) Advisor (6 manmonths) 40 - - 40 -(c) Training and short-term consultancy 55 - - 55 -(d) Seed capital fund - yarn 85 85 - - -

SUBTOTAL, EMPORIUM 200 85 - 95 20

4. INDUSTRIAL SERVICES CENTER

(a) Local staff, monitoring and preparation 50 25 - - 25(b) Survey staff and expenditures 40 20 - - 20(c) Outside consultancy for monitoring (4 manmooths) 30 - - 30 -

SUBTOTAL, INDUSTRIAL SERVICES CENTER 120 45 - 30 45

5. NEPAL RASTRA BANK AND PARTICIPATING BANKS

(a) Advisor to CSI refinance unit (24 manmooths) 170 - - 170 -(b) Outside and local training of CSI staff of NRB and banks 85 - - 70 15

SUBTOTAL, BANKS 255 - - 240 15

* TOTAL, ALLOCATED COSTS 4,310 1,135 770 1,900 505

OTHER 235 75 60 100 10

TOTAL, COMMERCIAL AND TECHNICAL SERVICES 4,525 - 1,210 830 2,000 515

1/ IDA would pay 50% of salaries and related expenditures for incremental staff for the CIED of TPC - Kathmandu,the CI Board staff in the project area, and ISC.

2/ Long-term consultants at US$7,000 per month , short-term consultants at US$8,000 in Nepal, US$4,500 inimporting country. These amounts include fees, travel, expenses and insurance, but do not include any taxespayable in Nepal.

3/ The project would cover up to 90% of the coat of sales trips for performance contractors and up to 90% ofexposure trips in neighboring countries for qualified exporters and manufacturers of cottace industry products.

4/ Assumes that New York staff starts in month 5 of project and that Frankfurt staff begins in month 15.

5/ Differences between these estimates and those provided in the Summary table in para. 4.05 are due to rounding.

6/ Emportetr -uld so.trihut.- D tited 020,000 in fiDa.Cg the *-1-. -d .sp u.e. trips.

- 58 - ANNEX 1Table 9

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

Summary of UNDP Financing under the Project -

EstimatedCosts

(US$ 000)

Trade Promotion Center

(a) Cottage Industry Export Development Division, TPC

(i) One general advisor to the CIED manager for 12 months. Fourproduct specialists for 12 months each in carpets, woolen andcotton garments, metal crafts and forestry products, to workwith exporters and assist performance contractors; 420

(ii) Short-term consultants for 24 manmonths for advice on design,packaging and systems; 170

(iii) Integrated product adaptation and organization of single countryfair, 24-month involvement; 150

(iv) Sales trips to importing countries for performance contractors,and exposure trips to neighboring countries for CI exporters andmanufacturers. 225

Subtotal, CIED, TPC 965

II Cottage Industry Development Board

(a) Four specialists in wool, metal, cotton and forestry products for 6months each (with CT Board option to extend) to assist in training thetrainers, launching extension programs, and planning 4 productdevelopment centers in Gandaki; 170

(b) Training and exposure trips for CI Board staff and leading artisans;and short-term consultants; 310

(c) Short-term design consultancy to Handicraft Design and Promotion Center. 70

Subtotal, CI Board 550

III Cottage Industries and Handicraft Emporium

(a) Advisor on procurement, institutional marketing (6 manmonths); 45(b) Training for Emporium staff and short-term consultancy. 50

Subtotal, Emporium 95

IV Nepal Rastra Bank and Participating Credit Institutions

(a) Advisor to CSI Refinance Unit (24 manmonths); 170(b) Outside and local training to CSI staff of NRB and banks. 80

Subtotal, Banks 250

V Industrial Services Center

(a) Three manmonths of consultancy. 30

Total, Direct Costs 1,890

Administrative Costs and Miscellaneous 110

ESTIMATED TOTAL COSTS, UNDP 2,000

1/ Differences between costs in financing plan (para. 4.06) and in this Annex are due torounding.

ANNEX 1- 59 - Table 10

NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT

CSI FUND FINANCIAL PROJECTIONS

A. ASSUMPTIONS

1. Utilization- by commitment: 1st year 25% = Rs 13.5 million

2nd year 35% = Rs 18.93rd year 40% - Rs 21.6 "

54.Om- disbursements: 80% in year of commitment and 20% in following year- average maturity: five years including 6m of grace

2. CSI Fund administrative expenses (Rs)Pre-operating (6 months) 110,000First year 220,000Second year 242,000Third year 266,000Fourth year 293,000Fifth year 322,000

(at a 10% escalation)Capital costs for car, equipment, etc. Rs 300,000

B. CALCULATIONS (Rs million)

1. Disbursements Year 1 Year 2 Year 3 Year 4 Year 5

1st year 13.5 10.8 2.72nd year 18.9 - 15.1 3.83rd year 21.6 - - 17.3 4.3

54.0 10.8 17.8 21.1 4.3

2. Repayments

1st year 10.8 2.0 2.2 2.2 2.2 2.02nd year 17.8 - 3.6 3.6 3.6 3.63rd year 21.1 - - 4.2 4.2 4.24th year 4.3 - - _ .9 .9

2.0 5.8 10.0 10.9 10.7

3. Outstandings nil 8.8 20.8 31.9 25.3- disbursements 10.8 17.8 21.1 4.3 -- repayments (2.0) (5.8) (10.0) (10.9) (10.7)

8.8 20.8 31.9 25.3 14.6

Average O/S 4.4 14.8 26.4 28.6 20.0

Income to CSI @ 2%: .08 .30 .53 .57 .40

4. Cash Position: CSI Fund

Year 1 Year 2 Year 3 Year 4 Year 5Income .09 .30 .53 .57 .40Expenses .22 .24 .27 .29 .32

CASH FLOW/PROFIT (.13) (.06) .26 .28 .08Cumulative (.13) (.07) .19 .47 .55

5. Revolving Fund RequirementInitial Contribution to CSI Fund5.00 1.76 .07 (.50)Less: Capital costs (.30) - - -

Pre-operating costs (.11) - - -

Net 4.59 1.76 .07 (.50)Lag on 3m disbursements (2.70) (1.75) (.83) 4.21

1.89 .01 (.76) 3.71Add/less loss/profit (.13) .06 .26 .28

Investment 1.76 .07 (.50) 3.99

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

Estimated Distribution of Subloans by Size

Rs 0 - Rs 20,000 Rs 20,001 - Rs 300,000 Rs 300,001 - Rs 800,000 Total

Subsector Number Amount Number Amount Number Amount Number Amount

Carpets 750 6,200 47 1,400 3 1,050 800 9,000

Woolen Garments 330 1,400 20 500 - - 350 1,900

Cotton Handlooms 545 3,550 30 1,000 5 1,250 580 5,600

Metal Crafts 90 810 17 990 3 1,000 110 2,300

Forest Products 360 650 10 250 - - 370 1,100

Agro-Industry 30 400 175 7,500 5 3,000 210 11,100

Subtotal, CI 2,150 13,010 299 11,590 16 6,300 2,465 31,000

Organized SSI - - 70 5,900 30 9,280 100 15,180

Performance Contractors,Market Agents - - 15 3,000 35 19,000 50 22,000

Input Supply Companies,Emporium - - - - 3 10,800 3 10,800

TOTAL 2,150 13,010 384 18,100 84 42,800 2,618 78,980

PERCENTAGE 80% 16% 16% 24% 4% 60% 100% 100%

1/ With the exception of the raw material supply companies, Rs 800,000 would the the maximum subloan size. m x

p ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~

ANNEX 1

- 61 - Table 12

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

Estimated Schedule of Disbursements for the Proposed IDA Credit

IDA Fiscal Year and Quarter Disbursements in US$'000By Quarter Cumulative

FY82To March 31, 1982 100 100

June 30, 1982 310 410

FY83To September 30, 1982 350 760

December 31, 1982 400 1160March 31, 1983 480 1640June 30, 1983 550 2190

FY84To September 30, 1983 690 2880

December 31, 1983 780 3660March 31, 1984 950 4610June 30, 1984 1100 5710

FY85To September 30, 1984 620 6330

December 31, 1984 170 6500

Estimated Schedule of Disbursements for UNDP Financing

CY81December 31, 1981 110 110

CY82To March 31, 1981 150 260

June 30, 1981 350 610September 31, 1982 350 960December 31, 1982 210 1170

CY83To March 31, 1982 230 1400

June 30, 1982 150 1550September 31, 1983 150 1700December 31, 1983 150 1850

CY84To March 31, 1983 100 1950

June 30, 1983 50 2000

ANNEX 2- 62 - Page 1

NEPAL

COTTAGE AND SMALL INDUSTRIES PROJECT

Supporting Documents Available in Project Files

I. Project Preparation Documents

(a) Inception Report, Cottage Industry Project PreparationStudy, ISC.

(b) Interim Report, Preparation Study.

(c) ISC's Final Report and separate volumes on woolen, handloommetal, forestry-based and agro-industrial products.

(d) Export Potential for Selected Nepalese Products in USMarkets, by Consultants in Development for ISC.

(e) Export Potential Study for Nepalese Handicraft andTextile Products in Germany, France, Great Britainand Scandinavia, by FRIDA for ISC.

(f) Project Document for UNDP Pre-project grant for trainingand consultancy to prepare CSI implementing agencies.

II. Subloan Component

(a) Draft Statement of Policies and Operating Procedures forCSI Refinance Fund of Nepal Rastra Bank (NRB).

(b) Draft Operating Instructions from NRB to ParticipatingCredit Institutions.

(c) Draft Procedures for CSI Credit Guarantee Scheme underNRB.

(d) Draft Quarterly Reporting Forms for Subloan Component.

III. Trade Promotion Centre

(a) Consultant's Recommendations regarding Year 1 ActionProgram for CIED and Impact Centres in New York andFrankfurt.

ANNEX 2-63 - Page 2

IV. Cottage Industry Development Board

(a) Legislation establishing the CI Board.

(b) Draft Statement of Policies and Operating Procedures.

(c) Draft Year 1 Action Program.

(d) Organization Chart and Year 1 Staffing Requirements.

V. Industrial Policy

(a) Terms of Reference for consultant to help reviseIndustrial Enterprise Act.

(b) Consultant's report from August 1980 assignment.

(c) Industrial Enterprises Act, 1981.

VI. UNDP Project

(a) Project document for UNDP-financed, IDA-executed US$2.5million project for training, consultancy, and marketinginputs of CSI Project.

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