Governance And Institutional Risks And Challenges In Nepal

Executive SummaryThis report was written to inform thepreparation of the country partnershipstrategy of the Asian Development Bankin Nepal for 2020–2024.regulations, and guidelines are then developedby sector ministries in line with the relevant acts.Laws and regulations are not changed arbitrarilyand are publicly available in Nepal.Political and economic context. Nepalhas been through tumultuous politicalchanges in the last 3 decades, including adecade-long armed struggle (1996–2006)and 7 constitutions in the last 70 years. On20 September 2015, the newly adoptedconstitution transformed Nepal into a federaldemocratic republic with three governmenttiers: central (federal), provincial (x7) and local(x753). Each tier has legislative, executive, andjudicial functions and authority under exclusiveand shared jurisdictions. Governments in allthree tiers were formed in early 2018 followingelections in 2017.The National Planning Commission (NPC),Ministry of Finance (MOF), and sectorministries are responsible for developmentplanning and budgeting. The government’sdevelopment strategy is outlined in the mostrecent development plan, the FourteenthThree-Year Plan (FY2017– FY2019), whichis currently under implementation. It aims toachieve socioeconomic transformation andreduce poverty through high economic growth,productive employment, and fair distribution.Gross domestic product. Nepal’s grossdomestic product (GDP) growth averaged4.3% over the past decade. The fiscal deficithas widened from an average of 1.2% of GDPin the past decade to 3.2% in FY2017 and 6.7%in FY2018. Inflation has also been stubbornlyhigh, averaging 9% in the last decade largelydue to supply-side constraints, including anticompetitive practices, as noted in ADB’s NepalMacroeconomic Update and the Nepal Budget2019 Analysis.Policies, strategies, and planning. TheConstitution of Nepal provides the legalframework and basis for policy formulation.There is a formal procedure in preparing andendorsing legal acts following an extensivediscussion in Parliament. Necessary policies,viiiInstitutional arrangements in the federalstructure. The transition from a unitary to afederal system of governance remains challengingwith several laws yet to be formulated andenacted, institutional arrangements at allgovernment levels yet to be finalized, and policiesand guidelines yet to be prepared. Substantialoverlaps, duplications, and ambiguities amonggovernment tiers remain.Most sector ministries and departments at thefederal level have been downsized or restructuredas several functions have been devolved tosubnational governments (SNGs). Executing andimplementing agencies of several ADB fundedprojects have been changed, and regional anddistrict offices previously under federal sectorministries have been closed. This has disruptedservice delivery as the provincial governmentsare only newly established and local governmentsdo not have adequate institutional capacity

Executive Summaryprograms leading to spending innonprioritized areas. Also, severalprojects are listed under priorityprojects and are considered more onpolitical grounds than on strategicimportance.to undertake all the assigned functions. Thefunctioning of the SNGs has also been affectedby the lack of human resources and low capacityof several staff members.Public institutions. Institutional developmentand strengthening of public institutions,particularly at the SNG level, is one ofthe key reform priorities for the efficientimplementation of federalism, and where ADBcould provide policy advisory and technicalsupport through its programs and projects.It will be important to assess the agencies thatare executing and implementing projects.The implementation modalities of ongoingprojects may need to be adjusted, and pipelineprojects may need to include institutionalstrengthening plans.Public financial management (PFM). ThePublic Expenditure and Financial AccountabilitySecretariat reported in 2015 that out of28 performance indicators, 16 improved,10 remained unchanged, and two deteriorated,which shows an overall improvement in PFM.Nonetheless, there are several PFM-relatedchallenges and risks, including:(a)(b)Fiscal indiscipline: While there arefinancial laws and regulations to instillfiscal discipline, they are not fullycomplied with and are poorly enforced.The annual reports of the Office of theAuditor General (OAG) in the last fewfiscal years have reported widespreadfinancial irregularities and indiscipline,such as high variances (up to 21 times)and “bunching” of capital expenditure(70%) at the end of the fiscal year,which increases the risk of poor servicedelivery, financial mismanagement,and poor quality infrastructure.Disconnect between planning andbudgeting: An analysis of the federalbudget data of the past 5 years showspoor prioritization of projects and(c)High fiduciary and corruption risks:Nondigitization of financial functions,an inadequate number of PFMexperts, weak technical capacity ofaccountants, poor internal control,and weak enforcement of correctivemeasures against flagged irregularitiesand recommendations of OAGare additional challenges that haveincreased fiduciary and corruptionrisks, particularly in SNGs.(d)Implementation of fiscal federalismin SNGs: This is a challenge giventhe poor institutional capacity, weakPFM system, inadequate human andfinancial resources, and insufficientknowledge and experience. Whilethe huge dependency of SNGs oncentral transfers can be reduced byincreasing domestic resources andrevenue mobilization (DRM), this ispossible only after putting in place theappropriate institutional mechanisms,policies, and capacity development,which are yet to be initiated.SNG support. Given the substantial numberof PFM challenges in SNGs, it is recommendedthat ADB’s support in PFM be at the SNGlevel. Improved PFM systems in SNGs willsupport ADB’s operations, mainly agricultureand natural resources (ANR), education, andurban and water sectors as most programs andprojects in these sectors are implemented bySNGs under the federal structure. ADB shouldconsider a PFM-focused program as a criticalarea of engagement. Some of the other reformareas that would address the risks are listedbelow. These areas could be supported throughix

xExecutive Summaryindependent, accountable, and capableof delivering increased and better publicservices, it should be prioritized andsupported.ADB’s investment projects and programs,technical assistance, knowledge solutions, andpolicy dialogues.(a)Conduct an assessment of institutionalarrangements for PFM at all governmentlevels and potential risks for ongoingand pipeline projects. This will provideinformation on the implementationof the federal system and any specificreform measures that ADB shouldbe taking within the portfolio or inprogram and project design to facilitateimplementation of the federal system ormitigation of PFM risks.(b)Establish a program and project bank,a database of projects and programs,including sector categorizationand prioritization of the projectsbased on objectively defined criteriaand project readiness, followed bypreparation of realistic procurementplans, and linking multi-yearbudgeting with the project bank.(c)Strengthen internal control and internalaudit in line with the Public Expenditureand Financial Accountability Secretariat(PEFA) national and subnationalrecommendations of 2015 and asguided by ADB supported policyadvisory technical assistance onstrengthening subnational publicmanagement in Nepal.(d)Digitalize the PFM system, includingthe information management, and assetmanagement systems. This will requirerobust implementation strategies.A capacity development plan should bea part of the reform plan.(e)Prepare a well-functioning fiscalfederalism framework with equitabledistribution of resources and clearfunctional assignments. Sinceincreased DRM will make SNGs moreProcurement. The Public ProcurementAct (PPA), 2007 and Public ProcurementRegulation (PPR), 2007 form the legalframework for procurement in Nepal and arebased on international standards. The PPA isapplicable to all public procurements with opencompetitive bidding as the default method ofpublic procurement. The Public ProcurementManagement Office (PPMO) has developed androlled out a web-based electronic governmentprocurement (e- GP) system.The country and sector procurement assessmentreport was prepared in 2016 to identify countryand sector level issues that hinder procurementprocesses and suggest mitigation measures. TheCountry/Sector Procurement Assessment Report(CSPAR) was updated in July 2018. Based onthe CSPAR 2016 and the 2018 update, Nepal’sprocurement risk is rated “Substantial” (nationallevel), and for sectors from “Substantial toModerate” (on a scale of “High,” “Substantial,”“Moderate” and “Low”). Based on PEFA 2015,the overall assessment on procurement relateddimension (PI- 19) is B on of a scale of A, B, C, Dwith A being the best.Some major challenges and risks in procurementinclude:(a)The PPMO has weak institutionalcapacity, including inadequate humanresources and procurement experts,absence of procurement databases andinformation management systems, andpoor implementation and enforcementof laws and regulations.(b)Weak contract management ofprocuring entities causes time and costoverruns in projects. According to thePPMO annual report 2017, not a singleinfrastructure project in Nepal has been

Executive Summarycompleted on time and one of themajor causes has been weak contractmanagement.(c)There is a mismatch between contractsize and capacity of local contractors.By bidding beyond capacity, contractorsfail to complete projects on time.(d)Situations of joint ventures with ghostconsultants and contractors lead todelays and poor quality outputs.(e)Situations of abnormally low bid priceslead to delays, nonperformance, andlow-quality products.Corruption. Nepal is ranked 124 out of 180countries, with a score of 31 (100 is the leastcorrupt) in the Transparency InternationalCorruption Perception Index 2018. Thisindicates that corruption is endemic in Nepal.The Commission for Investigation of Abuseof Authority (CIAA) is the apex constitutionalbody that investigates corruption by publicofficials. Despite having a sound legal frameworkand political party leaders and governmentauthorities routinely speaking out againstcorruption, eliminating corruption in Nepalremains an elusive goal. Some of the majorchallenges in combating corruption include:(a)poor implementation and enforcementof rules and regulations(b)weak institutional capacity of oversightinstitutions(f)Unwarranted slicing of procurementpackages to dissuade competition isagainst the procurement law.(g)There is collusion between bidders andprocuring entities. It is estimated thatabout 51% of firms in Nepal give gifts tosecure government contracts, which ismore than twice the regional average.(c)increasing impunity due to negligibledepartmental and legal actions againstthose guilty of corruption and severalcorruption cases remaining uncoveredor unpunished(h)Technical problems in operating thee-GP system lead to use of the oldsystem and increased procurementrisks.(d)increased costs of doing businessin Nepal (bribery in the form of“facilitation payments” is widespreadin the distribution of permits andapprovals, public procurement,contract awards, and when registeringa business)Making the e-GP system (developed under theADB-financed Strengthening Public ManagementProgram) fully functional with adequate technicalbackstopping support is a reform priority whichADB should consider supporting. This will reduceprocurement related risks, such as collusionand intimidation, and increase efficiency andtransparency.Given the critical importance of PPMO inmonitoring and regulating public procurement,institutional strengthening of PPMO is keyto addressing procurement risks, includingmechanisms to detect and deter collusivepractices among bidders and procuring entities.ADB support should focus on strengtheningPFM and procurement systems to addresscorruption risks.Use of country systems. ADB generally usescountry systems in Nepal for the administrationof loans and grants but for TA projects, ADBfollows its own system for procurement andfinancial management. ADB’s assistance toNepal in the form of loans and grants is fully“on-budget,” whereas the TA projects are“off- budget.”xi

xiiExecutive SummaryADB’s loans and grants proceeds are reflectedin the government’s treasury system but theyare transferred to special accounts under thegovernment’s consolidated fund and managed asagreed between ADB and the government, and inaccordance with ADB’s Loan and DisbursementHandbook, so the system is partially used.Regarding ADB’s project accounting, ADBrequires implementing agencies to maintainseparate project accounts and records for ADBfunded projects and their financial statements areaudited by the Office of Auditor General (OAG).ADB uses country systems for nationalcompetitive bidding for procurement of goodsand services under specified thresholds. Forprocurement above specified thresholds, aninternational competitive bidding process as perADB’s guidelines is used.There are systemic issues that need to beaddressed before further advancements in theuse of country systems in PFM can be made.These include incomplete digitization of thePFM system that is integrated with other datamanagement systems, and low institutionalcapacity of SNGs. The PFM system is not yetfully established, digitized, or functional in thesegovernments. Strategic interventions throughpolicy reforms and technical assistance needto be provided to federal and SNGs to improvethe overall PFM system. Only then can ADBanticipate fully using the country system in PFM.Full use of the country system in procurementrequires significant reforms, including(a)institutional strengthening of thePublic Procurement Monitoring Office(PPMO),(b)upgrading and operationalizing the e-GPsystem with provisions for adequatetechnical support,(c)revision of Nepal’s Public ProcurementAct to make public procurement morecompetitive and include internationalpolicies and practices, and(d)strengthening of oversight agencies.Until these reforms are undertaken, ADB shouldcontinue the current approach of using thecountry system for national competitive biddingand ADB’s system for international competitivebidding.Governance risks and challenges within sectors.A summary of the specific risks and challengesin sectors where ADB Nepal has operations isprovided below.(a)Agriculture and Natural Resources:The policy environment in this sector,particularly in the agriculture subsector,is weak. For example, in the absenceof an agriculture act, contract farming,leasing, public–private partnerships,and access to agricultural finance arelacking. The sector also suffers fromweak institutional capacity, which hasnegatively affected planning, budgeting,project design and implementation,undertaking procurement processes,contract management, and financialmanagement. Poor links betweenbudget and sector plans, ineffectivefinancial management, and weakspending capacity of implementingagencies are other PFM challenges inthe sector. Weak compliance with rulesand regulations, and poor contractmanagement are also procurementchallenges. According to CIAA andOAG, ANR receives the highest numberof complaints on substandard qualityof works and misuse of public funds.Institutional assessment of ongoing

Executive Summary(ii) institutional assessments andstrengthening plans for localgovernments, including a PFMreform plan; and(iii) preparation of procurementguidelines specific to the sector.and new projects is recommendedto make appropriate institutionalarrangements under the federal contextand to identify areas that need to bestrengthened, particularly at the SNGlevel.(b)Education: Although the federalconstitution of Nepal has functionallyassigned education responsibilities toall three levels of government, schoolsector duties are mostly assigned tolocal governments. Due to the poorinstitutional and technical capacityof local governments and in theabsence of a clear demarcation ofroles, responsibilities, and coordinationmechanisms among the governmenttiers, the risk of poor service deliveryin education has further increased.Inadequate allocation of financialresources, fiscal indiscipline, andinefficient expenditures leading to poorservice delivery and high fiduciary risksare the major PFM risks in this sector.In terms of procurement, poor capacityfor procurement functions, particularlyat the SNG level, is a significantchallenge which will increase the risk ofimplementation delays, noncompliancew

challenges and risks, including: (a) Fiscal indiscipline: While there are financial laws and regulations to instill fiscal discipline, they are not fully complied with and are poorly enforced. The annual reports of the Office of the Auditor General (OAG) in the last few fiscal years have reported widespread