"Consolidating federalism and maximising finance for development are some of our key priorities"

  17 min 7 sec to read
"Consolidating federalism and maximising finance for development are some of our key priorities"

This year marks the World Bank Group's 50th anniversary of its engagement with Nepal. In 1969, the multilateral development agency provided its first credit to Nepal for telecommunications sector development. As Nepal is passing through a major phase of political and economic transformation, the bank is also expanding its support to the country. Mukul Humagain of New Business Age talked with Faris Hadad-Zervos, the World Bank’s country manager for Nepal on a wide range of issues, from the country’s transition to federalism, current macro-economic situation to the bank's future assistance. Excerpts:

As Nepal has started practising federal system of governance, how has the World Bank prioritised its Nepal support strategy?
We believe institutionalising federalism is one of the support areas of the World Bank. The bank's work in Nepal is governed by its five-year country partnership framework that focuses on three pillars issues. These three pillars are - one focusing on institutions for sustainable development, the second for jobs creation and the third one on resilience climate shocks as well as micro-economic shocks. The underlying thing for all of them is the major transformation that is happening in Nepal. So everything must be seen through the lens and prism of the federalism transition. This is, basically, the changing of the entire architecture of Nepal in terms of the economy, governance and everything.

Our engagement is quite simply that what we are doing now must be seen through the prism of federalism. This implies action by the World Bank on a number of parts. One is, we are working, on the request of the government of Nepal, along with the United Nations Development Programme (UNDP) on federalism capacity needs assessment. This is a need assessment that has been consulted across the seven provinces as well as with the central government. We hope to have the report of Federalism Capacity Need Assessment (FCNA) out by end of October.

The idea of carrying FCNA is to understand the challenges and needs and then how the development partners will engage in that. In parallel with this, we are also shifting the bulk of our projects to focus, where appropriate, on execution at the sub-national levels.

The idea is development projects must be executed to reach the beneficiaries at the local level and to the extent possible be executed by the sub-nationals but they have to be underpinned by the national policies. And, this is where the government at central level is very important.

Once FCNA report is out, then we will know the exact needs. However, there are now increasing questions over federalism within Nepal arguing over whether the state can sustain it or not.  How is the bank accessing this transformation?
I come from the US where we are almost in the third century of federalism transition. Most of my colleagues whether from Germany or Switzerland come from centuries upon centuries of federalism transition. Many successful countries, developing countries that are transiting to federalism whether Kenya, Indonesia, have been doing this for a number of years and they are still going through the process. The transition to federalism is the fundamental change in the whole DNA of this country. This is a profound change, and it is beginning of a process that takes years to unfold and unveil. I don't think any country in the world has an answer to how long it will take because all of us who have been doing this for centuries are still grappling with it. It is a continuous process. Yes, there have been setbacks and there will continue to be setbacks. Any transformative change in the world has setbacks otherwise it is not transformative. This is part and parcel of having a new constitution and social contract with the people to fundamentally alter the way Nepal functions. We have to look at the fact that in less than three years since operationalising federalism, some of the key legislations have been passed. The adjustment and transfer of staff to the sub-nationals is moving at a rapid pace, some execution of public investment projects is already happening. The fact is you have seven provinces and 753 local governments; some of them require significant capacity building, that is true. This is a long journey and to expect to have arrived there in two years, in my view, is very unrealistic.

Are we taking the right steps, Yes. Will there be pitfalls along the way? Yes. How do we prepare for those? It is critically important to have a roadmap on what is the storyline for federalism, what are the priority needs. The roadmap, the storyline has to exist, it has to be championed somewhere and it has to be owned by the seven provinces and local level governments.

When development partners start engaging at the sub-national level, where there is a huge capacity gap, how does this engagement at the sub-national level unfold? How does the World Bank intend to help Nepal overcome capacity gap issues?
I would say early and organised engagement is the answer. I think there is no substitute to having a very important roadmap that sets in place, not only for development partners but the government, a framework about how to engage with local level that identifies the capacity needs. This is where the federalism capacity comes out but we have to engage soon in a very responsible way. We as development partners also have a duty of care to Nepal by making sure that when we engage, we are also coordinated.
We have been engaging and it is very important to engage early but in a responsible way in coordination with the central authorities and in a way that empowers first and foremost the provincial governments and the local governments to carry out the duty of development but not at the expense of creating disorder. In that regard, bringing and ensuring, the central government has also a role to play in terms of providing a common framework.

We have been engaging with development partners as well as central government i.e. Ministry of Finance, Ministry of Federal Affairs and General Administration and National Natural Resources and Fiscal Commission. We are already working closely with municipalities in the case of urban road infrastructure, certain tourism projects, water and sanitation.

The World Bank board has recently approved Youth Employment Transformation Initiative (YETI) Project, which the bank says is aligned with the Prime Minister Employment Programme (PMEP). How will this project run as there is already controversy over it and will it directly fund the PMEP?
The YETI Project is aligned with the Prime Minister's Employment Programme and any other programmes in the government that is seeking to provide sustainable employment opportunities. This is a separate but highly complementary programme that helps to ensure that the noble efforts of the Prime Minister Employment Programme are actually strengthened by creating systems to match the demand for employment with the provision of employment. The other objectives are to provide a system that can regularly follow-up and monitor the beneficiaries, to find the people who truly need it, and if they are the ones who are getting access to employment. Our intention is to ask how do we complement the national system, how do we strengthen it and how to meet the need of sustainability and avoid fragmentation.

This project focuses on system and data. There will be employment generation but that will be done through a process that complements PMEP but tries to really focus on sustainability. Let us remember the Prime Minister and Labour Minister have asked us to engage in this.

This year happens to be the 50th anniversary of the World Bank's engagement with Nepal. How will the banks assistance unfold in the next six to 12 months?
This year is very important for the World Bank. This is the 50th anniversary since the first World Bank project- in telecom sector - was approved in 1969. We have quite a large programme in Nepal. Currently there are 24 projects. We expect by the end of this fiscal year, our programme to reach and to exceed $ 3 billion. However, more importantly, we are addressing the key issues including the foreign direct investment (FDI), human capital and transition to federalism.

Some of the key priorities are further consolidating federalism, making fiscal federalism more efficient and maximising finance for development. We are looking at the projects that unlock the potential of the private sector in Nepal by creating the right ecosystem. In infrastructure, we are focusing on strategic roads both north-south and east-west.

Nepal’s weak absorptive capacity to utilise foreign support and aid is often cited as one of the key reasons behind the ineffective development results. What is the understanding of major development partners like the World Bank in this respect? Do you think there is a problem with planning and that the Nepali leadership does not have the will as well?
I would say that it would be impractical to say that Nepal does not have constraints and there was not massive room for improvement in terms of how much we execute. This is largely a responsibility of both parties, certainly the government of Nepal and the development partners.

For development partners like us, we have a duty to make sure, when we're doing things, we're trying to look at system and processes that make sure that we are highly coordinated and don't exert additional burden on the government of Nepal. This becomes more important now when we are federalising our development programmes to sub-national governments with varying degree of strengths. Having said that, it is important, on the part of the government of Nepal, to continue to focus on implementation and absorptive capacity. It is not an easy process. It is expected to be particularly challenging in the next few years as the federalism transition unfolds. Nevertheless, there are a few quick things we can do, one is ensuring public procurement policy in practice, and the other is, providing stability in the turnover of government officials managing projects. If we can tackle these two issues, I think we can accelerate.

Nepal’s external sector is under stress with the widening Balance of Payment and Current Account Deficit and depleting forex reserve. How is World Bank assessing Nepal’s macroeconomic position? Is the country capable of withstanding external economic shocks?
There are two parts to the answer to this question- is Nepal in trouble and are we doing the right thing to address the issue. I do not think we are in trouble. The public debt is roughly 30 percent of the GDP and external debt that is largely concessional is 17 percent of the GDP. This indicates that Nepal is in a pretty good shape.  The current account deficit has been rising and the Finance Minister himself has been sighting this as something to focus on. The current account deficit is widening because of the growth in imports and remittance growth has stabilised. Though reserves have fallen, it is still enough to cover 6-7 months of imports. So, is there a crisis, my answer is no. Is there a reason to tackle the issue, absolutely yes.

We need to focus on export competitiveness as Nepal is only exporting a handful of products. The other is the FDI issue. Exports of goods and services is only 11 percent of the GDP. At the same time, the growth in the exports is only on services, predominantly in tourism. The import of goods and services is 35 percent of the GDP. So we have a situation where we now have to work to make sure we do not have a period of sustained trade deficit which, financed by remittances, then boost consumption and what happens is, it affects the competitiveness.

So, the challenge is how to turn this remittance-based model of economic activity to an export-based model. This is fundamentally the problem and I think we need to focus at the micro-level. This is why we're keen on this investment ecosystem. Second is quality of exports, to become globally competitive and third is producing better services. I think Nepal is in good shape but we need to really look at what is the overall storyline and whether we starting to create the ecosystem right now.

The World Bank in its last Nepal update has said that Nepal requires a transformative change in the FDI environment. There have been some changes. How do you review the recent changes that have taken place in our FDI environment? And are the changes enough or is there more to be done?
We have to commend the government for sending clear messages on the importance of the private sector. I think the fact that the government held the investment conference, the fact that they have been trying to do something is really commendable. In my experience, particularly in talking with the Finance Minister and other authorities, the fact that there is an openness to address this, is something that is very promising. And look, you can see it if you look at the macro numbers. The fact that the private sector’s share of GDP is growing, people are actually reacting to it. So we have data and evidence to show that Nepal is improving.  My job is how to make sure that that percentage goes as high as humanly possible and gets translated into FDI.

We should continue to focus on laws that really have to balance where Nepal’s own storyline was and is, with the reality that investors couldn’t care less where Nepal was and is. Investors care about ‘Nepal Vs Country X’. So it has to be competitive with international practices.

Laws alone are not enough, regulations and practices are equally important. We need to focus on getting two, or three, or four transactions of different types and running it through the system, identifying every bottleneck that emerges, removing those bottlenecks if they are unfair. And, lastly, codifying this into a practice where if there’s a change in official anywhere, that she or he is going to follow the same rules as their predecessor. So, the investment summit was absolutely necessary but insufficient. The next steps we do, is what will make it sufficient.

What about private equity and venture capital, which has emerged as an alternative source of financing? What needs to be done?
Those are very important for Nepal. There has been a lot of work, and there has been a rise. Even from ourselves, the World Bank with IFC, we have been investing a little bit in many of these internal venture capitals, so this is a very promising thing. There are different types of investments, there are different payback periods, and all of them need different instruments. I think you need the trinity of the financial sector, securities, stock market and a deepening bond market.

The World Bank, in its recent report, suggested Nepal's central bank to reduce the number of commercial banks from the existing 28 to 15, and then eventually to ten. What exactly is the World Bank implying with this suggestion? Why do you think it has become important for Nepal to reduce the number of banks?
The macro-prudential decision by the government to reduce the number of banks is, first and foremost, a sovereign decision. The World Bank simply suggests. What the World Bank is doing is, we are sharing the international experience and saying what other countries have done in situations like this. Look at the size of the industry in Nepal and look at the certain potential risks that could face financial institutions of that size. This is not about Nepal; this is about what other countries are doing. Every country in the world has to, in terms of the policy, balance the risks of having few banks with the risk of having many banks that are small. We all know from international experience, again, that banks also have economies of scale. So, what we are saying is, globally governments have looked at the risk of having too few banks versus the risk of having small banks. They have looked at the fact that banks have economies of scale and they look at the importance of debt to GDP and all these capital adequacy ratios, and they have come to a decision regarding the size. We leave it at that. The government is effective enough to see the nature of this and what is the optimal number of banks. That is the point we are trying to make.

One of the issues related to the Nepali banking sector is their inefficiency to fund large infrastructure projects. But the government is aggressively pursuing a few large infrastructure projects. What could be the mode of financing infrastructure projects in the future? What role does the World Bank play in realising these projects?
What we have seen elsewhere in the world is that there is a whole menu of developing infrastructure projects. As such, there has to be a whole menu of different instruments to do so. They could range from equity, venture capital, bond issuance, etc. Our optimal scenario, in support of the government and the people of Nepal, is to create an ecosystem where all of these instruments exist. The banking sector is effective enough to provide some of it. The bond market is going to be very important. A lot of countries that have done really well, have a lot of debt and a lot of bond debt. But, those debts are in the local currency. So, we want to get to the point where Nepal has that. Further development of the local currency bond market is very important.  The idea is to work to make sure that when any investor who wants to come in or any developer will be able to contemplate the ideas – “Should I go for equity, should I go for debt?” etc. and that Nepal furnishes all of them.

For Nepal, the Belt and Road Initiative (BRI) and the Asian Infrastructure Investment Bank (AIIB) have presented an alternative source of funding. How does the World Bank, as a leading donor agency, view this development? And how is it different from AIIB?
Usually, competition happens where there are scarce opportunities or resources. The development agenda is much bigger than all of us. Certainly, the needs, not only in Nepal but elsewhere, far exceed the ability of the World Bank to finance them. Thus, we welcome any new entrants that are partnering with us to help find developmental solutions to this. I was with my management team two months ago on a two-day retreat with AIIB to see how we can collaborate in Nepal and other regions in Asia. We have been working with AIIB since day one. I myself have been engaging with them regularly and we exchange information and we help each other as much as possible. As you know, the World Bank has been supporting AIIB in terms of setting and developing its own procurement financial management and environment and social safeguards. So we have been working together from day one, and that comes from the recognition that we can’t do this by ourselves, so any new entrants that can help us find developmental solutions are very much welcome.

Is there any sort of partnership that the World Bank and AIIB will be having in the near future?
The World Bank is guided by the government of Nepal and its engagement in Nepal. We work very closely with the Ministry of Finance, who is our guide on this. And we have certainly been working with the Ministry of Finance, the World Bank and AIIB together to find areas of collaboration and we are very hopeful that we will have some kind of announcement soon.

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