Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 59291-NP

Public Disclosure Authorized PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT IN THE AMOUNT OF SDR 8.80 MILLION (US$13.75 MILLION EQUIVALENT)

AND A

Public Disclosure Authorized PROSPOSED GRANT IN THE AMOUNT OF SDR 7.20 MILLION (US$11.25 MILLION EQUIVALENT)

TO

NEPAL

FOR THE URBAN GOVERNANCE AND DEVELOPMENT PROGRAM: Public Disclosure Authorized EMERGING TOWNS PROJECT

APRIL 6, 2011

Sustainable Development Department Urban and Water Unit South Asia Region

This document has a restricted distribution and may be used by recipients only in the

Public Disclosure Authorized performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

CURRENCY EQUIVALENTS

(Exchange Rate Effective February 28, 2011)

Currency Unit = NEPALESE RUPEES NPR1 = US$0.014 US$1 = NPR72.43

FISCAL YEAR July 16 – July 15

ABBREVIATIONS AND ACRONYMS

ADB Asian Development Bank BOT Build Operate and Transfer CBO Community Based Organization CBS Central Bureau of Statistics CDO Chief District Officer DDC District Development Committee DTCO District Treasury Controller Office DUDBC Department of Urban Development and Building Construction ED Executive Director EO Executive Officer FNCCI Federation of Nepalese Chambers of Commerce and GIZ Deutsche Gesellschaft für Internationale Zusammenarbeit GmbH GTZ Deutsche Gesellschaft für Technische Zusammenarbeit GmbH GON Government of ID Institutional Development IDA International Development Association IEG Independent Evaluation Group IGFT Intergovernmental fiscal transfer IPR Implementation Progress Report IUFR Interim Unaudited Financial Report KfW Kreditanstalt für Wiederaufbau LBFC Local Bodies Fiscal Commission LBFAR Local Body Financial Administration Regulation LDF Local Development Fund LGAF Local Governance and Accountability Facility LGCDP Local Governance and Community Development Programme LSGA Local Self Government Act LSGR Local Self Government Regulations MCPM Minimum Conditions and Performance Measures MLD Ministry of Local Development MOF Ministry of Finance MPPW Ministry of Physical Planning and Works MuAN Municipal Association of Nepal PRAN Program for Accountability in Nepal PFM Public financial management ii

PFS Project Financial Statement TDF Town Development Fund TLO Tole Lane Organizations UC Users Committee UDLE Urban Development through Local Efforts UDTC Urban Development Training Centre UEIP Urban Environmental Improvement Project UNCDF United Nations Capital Development Fund UNDP United Nations Development Programme VDC Village Development Committee WB World Bank WUC Water Users Committee

Regional Vice President: Isabel M. Guerrero Country Director: Susan G. Goldmark Sector Director: John Henry Stein Sector Manager: Ming Zhang Task Team Leader: Balakrishna Menon Parameswaran Co-Task Team Leader Tashi Tenzing

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Table of Contents

I. Strategic Context...... 1 A. Country Context ...... 1 B. Sectoral and Institutional Context ...... 1 C. Higher Level Objectives to Which the Project Contributes ...... 6 II. Project Development Objectives ...... 6 A. PDO ...... 6 B. Project Beneficiaries ...... 6 C. PDO Level Results Indicators ...... 7 III. Project Description ...... 7 A. Project Components ...... 7 B. Project Financing ...... 11 C. Lessons Learned and Reflected in the Project Design ...... 11 IV. Key Risks and Mitigation Measures ...... 13 V. Implementation ...... 14 A. Institutional and Implementation Arrangements ...... 14 B. Results Monitoring and Evaluation ...... 17 C. Sustainability ...... 18 VI. Appraisal Summary ...... 18 A. Economic and Financial Analysis ...... 18 B. Technical ...... 20 C. Financial Management ...... 21 D. Procurement ...... 22 E. Social (including Safeguards) ...... 22 F. Environment (including safeguards) ...... 23 Annex 1: Results Framework and Monitoring ...... 26 Annex 2: Detailed Project Description ...... 30 Annex 3: Implementation Arrangements ...... 40 Annex 4: Operational Risk Assessment Framework (ORAF) ...... 60 Annex 5: Implementation Support Plan ...... 63 Annex 6: Team Composition...... 65 Annex 7: Economic and Financial Analysis of Sub-projects – Rules of Engagement ...... 66 Annex 8: Town Development Fund – Current Status and Roadmap for Development ...... 70 Annex 9: Town Selection Methodology and Profile of Participating Towns ...... 74

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DATA SHEET

NEPAL

URBAN GOVERNANCE AND DEVELOPMENT PROGRAM:

EMERGING TOWNS PROJECT

PROJECT APPRAISAL DOCUMENT

SOUTH ASIA REGION Sustainable Development Department

Date: April 6, 2011 Sector(s): Sub-National Government Administration Country Director: Susan G. Goldmark (100%) Sector Director: John Henry Stein Theme(s): Municipal Finance (30%); Municipal Sector Manager: Ming Zhang Governance and Institution Building (40%); Access to Team Leader(s): Balakrishna Menon urban services and housing (30%) Parameswaran, Tashi Tenzing EA Category: B Project ID: P120265 Lending Instrument: Specific Investment Loan (SIL) Project Financing Data: Proposed terms: [ ] Loan [ x ] Credit [ x ] Grant [ ] Guarantee [ ] Other: Source Total Amount (US$M) Total Project Cost: 35.13 Parallel financing: 3.00 Borrower: 5.00 Community/ 2.13 Total Bank Financing: IBRD 0.00 IDA 25.00 New 0.00 Recommitted Borrower: (GON) Responsible Agency: Ministry of Physical Planning and Works (MPPW) Contact Person: Dr. Mahendra Subba, Deputy Director General, Department of Urban Development and Building Construction Telephone No.: +977-1-4257312 Fax No.: +977-1-4262729 Email: [email protected] Estimated Disbursements (Bank FY/US$ m) FY 2011 2012 2013 2014 2015 2016 2017 Annual 0.10 2.4 5.5 6.5 5.5 4.0 1.0 Cumulative 0.10 2.5 8.0 14.5 20.0 24.0 25.0

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Project Implementation Period: Start: July 2011 End: July 2016 Expected effectiveness date: July 15, 2011 Expected closing date: July 31, 2016 Does the project depart from the CAS in content or other ○ Yes ● No significant respects?

If yes, please explain: Does the project require any exceptions from Bank policies? ● Yes ○ No Have these been approved/endorsed (as appropriate by Bank ● Yes ○ No management? Is approval for any policy exception sought from the Board? ○ Yes ● No

If yes, please explain: The audit reports for the ongoing Nepal Social Safety Nets Project (IDA Credit 4750-NP and IDA Grant H 579-NP) and the Rural Access Improvement and Decentralization Project (IDA Credit 4664-NP and IDA Grant H 525-NP), which are implemented by the Ministry of Local Development (MLD), were not received by the due date. In accordance with the provisions of BP 10.02 Annex A, an exception by the Vice President of Operational Policy and Country Services and by the Vice President and Controller was approved for the presentation of this operation to the Board while the delayed audit reports are awaited. Does the project meet the Regional criteria for readiness for ● Yes ○ No implementation? If no, please explain: Project Development Objective: The Project Development Objective (PDO) is to improve delivery and sustainable provision of basic services and priority infrastructure in the participating . Project Description: The Project consists of three components. Component 1 - Service Delivery Improvement: provision of Municipal Grants to the participating municipalities to improve municipal service delivery, operation and maintenance (O&M) of infrastructure, social mobilization, community development and capacity building; Component 2 - Socio-economic Infrastructure Development: provision of sub-project financing to improve socio-economic infrastructure in the participating municipalities; and Component 3 - Institutional Development: support for the institutional strengthening of and provision of project management assistance to the participating municipalities, the Ministry of Local Development (MLD), the Town Development Fund (TDF), the Department of Urban Development and Building Construction (DUDBC) and various project implementing units established for implementing the project.

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Safeguard policies triggered?

Environmental Assessment (OP/BP 4.01) ● Yes ○ No Natural Habitats (OP/BP 4.04) ● Yes ○ No Forests (OP/BP 4.36) ● Yes ○ No Pest Management (OP 4.09) ○ Yes ● No Physical Cultural Resources (OP/BP 4.11) ● Yes ○ No Indigenous Peoples (OP/BP 4.10) ● Yes ○ No Involuntary Resettlement (OP/BP 4.12) ● Yes ○ No Safety of Dams (OP/BP 4.37) ○ Yes ● No Projects on International Waters (OP/BP 7.50) ○ Yes ● No Projects in Disputed Areas (OP/BP 7.60) ○ Yes ● No Conditions and Legal Covenants:

Loan/Project Description of Condition/Covenant Date Due Agreement Reference Minutes of Prepare detailed consolidated annual work program and June 30, 2011 Negotiations budget for FY2011/12. - Para 13 FA - Prepare detailed consolidated annual work program and April 30 of preceding Schedule 2, budget for subsequent FYs. FY, starting April 30, Section I.I.1 2012 FA – Article Adopt final Project Operations Manual (POM), satisfactory Effectiveness IV 4.01 to the World Bank. FA - Sign Memorandum of Understanding (MOU), satisfactory Prior to participating Schedule 2, to the World Bank, with participating municipalities. municipality Section E 4 receiving Municipal (e) Grants under component 1 FA - Sign Sub-project Financing Agreement, satisfactory to the Prior to participating Schedule 2, World Bank, with participating municipalities. municipality Section F 2 receiving Sub-project Financing under component 2 FA – Sign Subsidiary Agreement, satisfactory to the World Disbursement Schedule 2, Bank, with the TDF. condition for Section IV B component 2 1 (b) and Minutes of Negotiations – Para 10 FA – Section Approve relevant items of the TDF Business Restructuring Disbursement IV B 1 (b) Action Plan condition for Component 2

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FA – Establish Project Management Team (PMT) and Project Prior to participating Schedule 2, Support Team (PST) in each municipality. municipality Section E 4 receiving Municipal (a) (b) and Grants under Section F 2 component 1 and (ii) (D) (E) Sub-project Financing under component 2 FA - Article Sign financing agreement for co-financing (through parallel December 31, 2011 V 5.01 (b) financing arrangements) the Institutional Development and Minutes component. of Negotiations – Para 8

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I. Strategic Context

A. Country Context

1. Nepal is going through transformational times: it has come out of a decade long internal conflict, moved from monarchy to federal republic and elected a Constituent Assembly to frame a new Constitution; put four coalition governments in office; and witnessed peace and reconciliation process being constantly tested by political instability. Nevertheless, in the midst of this turmoil, the nation also stands on the threshold of promise and opportunity like rarely before: despite challenges, democracy is thriving; the poor and the excluded are finding new avenues for voice; and, finally, a federal Nepal with provisions for political and economic inclusion of the most vulnerable groups is anticipated to emerge in the not too distant future.

B. Sectoral and Institutional Context

2. Two momentous developments are reshaping Nepal’s development paradigm. The first is urbanization—whereby unprecedented numbers of Nepalese are moving from remote villages to small towns and larger cities in search of peace, economic opportunities and social well-being, a forceful process that is reshaping Nepal’s economic and human geography. The second concerns the political, social and economic transformation of Nepal into a federal State—the bedrock of which would be a democratic and inclusive local governance system that maximizes people's stake in the State by making the government downwardly accountable and by ensuring equitable distribution of resources across localities. As these two developments unfold, their paths are also starting to intertwine with major ramifications for the future of the country.

A rapidly changing demographic and economic profile

3. Nepal’s urban population growth is beating all estimates. Nepal, like its South Asian neighbors, is undergoing a major urban transition. Between 1971 and 2000, while the national population doubled, the urban population grew seven-fold—from less than half a million out of a total population of 12 million, to nearly 3.3 million out of 23 million (CBS 2001)1. The urban population growth was about three times higher than the national growth rate of 2.1% p.a. in the early 2000s. It was projected around 2000 that by 2010 the total urban population would become 4.4 million. However, belying those estimates, by 2007 the number of urban dwellers was already approaching 5 million (World Bank 2009).

4. This people shift has been accompanied by a socio-economic shift too. While the urban areas contributed only 29% to the GDP in 1975, today that figure is estimated to be more than 65%, according to the Ministry of Finance (MOF). Between 1985 and 1999, the urban economy grew at nearly twice the pace of the rural economy and the average per capita product of the urban population was 4.6 times higher than that of the rural population (ADB 2000).2 The non-agricultural sector grew rapidly, driven by the growth of exports, greater public investment and increased demand for urban services. Since larger urban areas are viewed as investment centers with rising property values, financial services and infrastructure, most of the overseas remittances also end up

1 CBS. Statistical Year Book of Nepal, 2001. 2 Asian Development Bank. Nepal Urban Sector Strategy Volume I-II. 2000. 1 in these areas. Urbanization was a powerful driver of poverty reduction too. Whereas the incidence of poverty declined from 43 to 35% in rural areas (or, 2.7% p.a.) between 1995-96 and 2003-04, in urban areas it more than halved from 22 to 10% (or, 9.7% p.a.). There were also far greater returns to poverty reduction in urban areas compared to rural areas (World Bank 2006).3 Furthermore, urbanization was also key to changing social relations between advantaged and disadvantaged ethnic groups—thus members of lower castes appeared to be taking advantage of better opportunities in urban areas by migrating from rural areas at above average rates.

5. Yet, rapid urbanization is challenging urban infrastructure and service delivery. Nepal's existing urban infrastructure and services are grossly inadequate to serve its growing urban population. For example, only 66% of urban households have access to piped drinking water. Many municipalities provide less than 50 liters of water per capita per day. The share of blacktopped roads in urban centers was a mere 10%. In the entire country, only 3 cities have some sewerage facilities, but even here the installed systems are outdated and the trunk lines have broken down. Much of the solid waste in cities is dumped openly on river banks and vacant plots, with little concern for environment or public health. If urbanization continues at the current trend, these problems are likely to exacerbate, with potential impacts on political and social stability.

6. Economic growth is tied to urban agglomeration. The benefits of urbanization are visibly associated with improved access and mobility of people, products, and eventually capital along the main road corridors. Growth and urbanization beyond is concentrated along the East– West highway and five North-South corridors—mostly as urban agglomerations of larger towns surrounded by a string of smaller towns. The urban hierarchy comprises 1 metropolitan municipality, 4 sub-metropolitan municipalities, 53 municipalities, 132 or so small towns which are in the pipeline to become municipalities, and a large number of rural growth centers along highway corridors that are stepping into an increasingly urban future. Much of the urban population growth is now happening in the smaller urban centers. Despite their role in creating rural–urban linkages, many of these towns are developing haphazardly. Their ability to serve as intermediate economic centers is impeded by lack of planning and deficient services. Furthermore, their industrial base is narrow due to poor infrastructure, shortages in skilled labor, and high production costs (ADB 2001).

7. Urban growth will likely continue unabated. Nepal’s rather dramatic urbanization process is expected to continue for the foreseeable future due to several push and pull factors. Rising natural disasters, the declining role of agriculture, and the general attraction of towns and cities as centers of jobs, education and healthcare, and greater security have stimulated large scale migratory flows towards urban areas. Urbanization is a key driver in Nepal’s development and for that reason it should be accorded greater policy and investment attention. The key challenge going forward is that of maximizing the economic opportunities offered by urbanization and agglomeration while securing environmental sustainability and social equity.

Political economy of devolution and local governance

8. There is consensus on devolution. The armed conflict from 1996 to 2006 has taken a heavy toll on political stability. Despite a Peace Agreement in 2006 and the election to the Constituent Assembly in 2008, at the national level, politics remains subject to periodic bouts of gridlock. While

3 World Bank. Resilience amidst conflict: an Assessment of Poverty in Nepal, 1995-96 and 2003-04, 2006. 2 fundamental disagreements exist between the main political parties on a number of key issues, there is a surprising convergence to support devolution and turn Nepal into a federal State. This is partly based on lessons learnt from the conflict that, Nepali communities want a greater say in the allocation of resources and delivery of services. The principles and process of establishing autonomous local bodies are to be spelt out in the new Constitution and the associated legal and institutional framework—and the details of this are to be worked out by the Constituent Assembly. Clearly, its outcomes are likely to have major implications regarding the governance, financing and management of cities and towns in Nepal.

9. Local governance is in transition. In 1990, a new constitution was adopted with decentralization as a guiding principle. Towards that end, three separate Acts in 1992 established Village Development Committees (VDC), Municipalities and District Development Committees (DDC) as democratically elected local bodies with defined structures, responsibilities and functions. The vision of democratic local government with greater responsibility for development and service provision was given further impetus through the Local Self-Governance Act of 1999 and its accompanying regulations. However, the term of the elected local bodies expired in 2002. Following this, neither local elections were held, nor the mandate of the existing local bodies extended. Local administrations now work under appointed executive officers. In many localities, there are the so-called all-party mechanisms (APMs), established to advise local bodies. Although these are reportedly working well in some places, without any formal legal or institutional mandate, there are uncertainties about their roles, responsibilities and accountability relationships.

10. Well-functioning and democratically-elected local bodies are important for reestablishing accountable national governance. Decentralization and localization are an integral part of conflict resolution and reconciliation process. Many also view it as essential to reduce Nepal’s entrenched socio-economic and spatial inequities and inequalities. A local government system that is inclusive, accountable and effective, especially to the most marginalized groups, in the context of a federal Nepal, will be key to its social-economic and political transformation, even if that journey will likely be long, challenging and often beset with uncertainty.

11. Nepali urban local governments have a pivotal role to play in its current decentralization and urbanization transition, in managing service delivery and enabling local economic development, ensuring inclusionary development, and fostering peace and political reconciliation.

12. Service delivery and local economic development: In Nepal, agglomeration benefits of urbanization are clearly apparent. Yet, addressing its negative externalities and creating an enabling local environment is vital to capture urbanization benefits. The costs of not coming up with comprehensive urban programs will be high, and, in this context, smaller towns are a good place to start, if only because they are for now more manageable, and perhaps more open to management.

13. Poverty alleviation and inclusionary development: One big driver for a federal Nepal is ensuring more equitable sharing of resources—vertically, between the central state and the local state, and horizontally, between diverse regions. With decentralization, local governments will play a pivotal role in poverty reduction efforts. Although Nepal's poverty is largely rural, its reduction has worked much better in urban areas. Solutions to rural poverty also have an urban dimension. Further, poverty will become an increasingly urban phenomenon with rapid urbanization, if it is not

3 addressed adequately. Already urban disparities are quite marked, but remain largely un-targeted by poverty reduction initiatives. Finally, as elsewhere, in Nepal, urban poverty has a more brutal face to it—that of physical deprivation combined with loss of social capital.

14. Peace and political reconciliation: Rural-to-urban migration over the course of the conflict period underscores the role of urban areas, especially the smaller towns, in providing security and economic opportunity to the affected populations. With political debates shifting to Kathmandu and the largely rural political parties seeking inroads into urban areas with rapidly changing ethnic and socioeconomic profiles, there is growing political importance to towns and cities. If urban centers fail to provide a conducive political, socio-economic and physical environment due to deficits in effective governance and service delivery, then there are implications for the sustainability of peace and political reconciliation.

Government policies and programs

15. The rapid growth of urban areas and their growing economic importance are setting off changes in policy focus. The 2008 National Urban Policy was a milestone. Its objectives include balanced national urban structure and reduction of poverty; clean and developed urban environment; and effective urban management. The Government of Nepal’s (GON) Three Year Interim Plan (TYIP) calls for developing large urban centers as regional economic centers and linking them with medium and small growth centers through improved infrastructure; prioritizing urban management; developing small towns by improving their linkages with the hinterlands; and getting municipalities and urbanizing VDCs to work together.

16. The Government’s commitment to decentralization at the highest level is well documented. The TYIP thus emphasizes good governance at the local level, and, in this context it supports restructuring local bodies on the basis of geography, population, resources and means, and service delivery; strengthening local bodies and making them the primary implementer of urban plans, and transitioning central agencies into focusing on policy formulation and monitoring; encouraging a rights-based approach to formulation and implementation of local level plans and programs; directly transferring funds to local bodies; and mobilization and sharing of revenues between local bodies.

What are other partners doing?

17. Traditionally, donors have provided very little support to the urban sector. This has, however, started to change; today, the Asian Development Bank (ADB), the Deutsche Gesellschaft für Internationale Zusammenarbeit GmbH (GIZ) and the United Nations Development Programme (UNDP) are among the major donors working on urban development issues in Nepal. The ADB is financing water supply, drainage and sanitation facilities in small towns through the Small Towns Water Supply and Sanitation Projects (STWSSP I and II) and supporting infrastructure development in a few large municipalities through the Urban Environment and Infrastructure Projects (UEIP I and II). Among the programs to control haphazard urbanization, manage smaller towns and market centers, and provide better services are the recently completed Decentralized Local Self Governance Support Program and the Rural Urban Partnership Program, both supported by the UNDP. Finally, there is the Urban Development through Local Efforts Programme (udle), supported by the GIZ since 1987, to strengthen municipal governance and financing and to reduce urban poverty.

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18. Donors are also actively engaged in decentralization and local governance issues. The centerpiece of this is the Local Governance and Community Development Programme (LGCDP), launched in 2008, supported by a number of donors and implemented by the Ministry of Local Development (MLD). The LGCDP aims to “provide a national programme framework for achieving improvements in the system of local governance and community development” with the underlying intention of moving “the local governance and community development sector towards a Sector Wide Approach for decentralisation.” It seeks to reduce poverty through inclusive, responsive, and accountable local governance as well as participatory community-led development.

19. Nonetheless, what is needed is a comprehensive approach—one that complements ongoing donor initiatives and reconciles the economic, environmental and social facets of urban growth with the politics of decentralization and state restructuring.

Rationale for World Bank involvement

20. Both decentralization and municipal development are areas where Bank assistance has been active and successful around the world.4 The Bank has a definite edge in helping the Government develop a comprehensive approach combining a wide range of advisory and technical assistance initiatives with appropriate forms of investment support.

21. In 2009/10, a programmatic NLTA on Emerging Towns was undertaken by the Bank to reengage in the sector, scope out key issues, and identify challenges and opportunities. A number of studies, consultations and field visits were carried out under this rubric. Three important recommendations regarding Bank engagement in the sector came out of this exercise: • Stand-alone policy dialogue and technical assistance have limited chances of sustainable impact in the sector unless accompanied by on-the-ground interventions that can demonstrate positive results;5 • The ADB is currently supporting infrastructure development in several large cities (Kathmandu valley, , Birganj and ), while the GIZ is providing technical assistance to municipalities across the country. Bank assistance, it was deemed, should target fast growing secondary towns—the 53 municipalities and other smaller towns, often collectively referred to as emerging towns in Nepal’s urban parlance—which can support and complement the larger cities in their region; and • Bank’s support should long-term and programmatic, in line with GON’s move towards consolidating support in the urban sector, and comprehensive in nature, supporting both infrastructure and institutional development.

22. The Bank is also developing, in parallel, an output-based aid (OBA) pilot project to improve solid waste management in select emerging towns. The proposed project and the OBA pilot will be closely aligned to ensure mutual synergies.

4 See Independent Evaluation Group’s following reports: Decentralization in Client Countries: An Evaluation of World Bank Support, 1990-2007 (2008), and Special Study on Improving Municipal Management for Cities to Succeed (2008). 5 Our past experience with Kathmandu underlines this. In the late-1990s, the Bank supported a City Development Strategy for Kathmandu, which was aimed at longer term engagement in the sector and with the city. That did not happen and the Bank lost the urban engagement for the next decade, while conditions in the city itself worsened. 5

C. Higher Level Objectives to Which the Project Contributes

23. In addition to being fully consistent with and supportive of Government’s TYIP priorities for local governance and urban development, the project will contribute to three key pillars of the current Nepal Interim Strategy Note (ISN) — promoting capable state structures and systems and fostering accountable institutions, laying the foundation for sustainable and inclusive economic growth, and enhancing equitable access to services. Weak and unaccountable institutions that cannot provide basic services to citizens and constraints to connectivity and movement of people, goods, and services have been identified as key causes of conflict and low growth. Further, focusing initially on smaller towns will help address grievances about the unbalanced development pattern in Nepal, with most resources and the elites centered in the Valley. Support for smaller municipalities along key economic and transportation corridors will also complement other Bank interventions that strengthen marketing and transportation links around the country.

II. Project Development Objectives

A. PDO

24. The Project Development Objective (PDO) is to improve delivery and sustainable provision of basic services and priority infrastructure in the participating municipalities. The PDO is in line with GON’s own vision for balanced urban development and strengthened local governance in the country, as outlined in the NUP and the TYIP.

25. The initial target group included emerging towns which are municipalities and have population between 25,000 and 65,000, based on 2010 population projections. Out of 30 such towns, the following 6 towns located along two important North-South corridors have been selected for this phase of the project: Mechinagar, Dhankuta and in the East, and Lekhnath, Baglung and Tansen in the West. These towns were selected based on a combination of demographic, socio- economic and spatial factors. First, preference was given to emerging towns with high economic growth potential, good financial and management capacity and well connected to the surrounding urban space, while also taking into account the town’s poverty profile. Filters for security and the presence of donor-supported urban projects were then applied to generate the shortlist of candidate towns. The municipal authorities of all 6 towns have confirmed their readiness to participate in the project. Further details of town selection and a profile of the selected towns are provided in Annex 9. Additional towns could be in a subsequent phase, depending on project’s progress.

B. Project Beneficiaries

26. The key beneficiaries in this initial phase are the municipal authorities in the 6 towns and the citizens served by them. The total population of these towns was projected to be around 280,000 in 2010, a good number of whom are expected to benefit, direct or indirectly, by the project. Based on preparatory studies, access to basic municipal services in these towns is low: for example, the share of households with access to piped water within premises ranges from 56% in Baglung to 31% in Dhankuta, while those having improved sanitation varies from 61% in Baglung to 34% in Lekhnath; and even as 24% of municipal roads in Baglung are blacktopped, the corresponding number in Mechinagar is only 4%. The project is expected to improve the quantity and quality of infrastructure

6 and services in these towns. The citizens of the 6 municipalities will be served by municipal institutions and authorities that are more capable and responsive to their constituents.

27. In addition, key institutions at the central level, namely the MPPW, the MLD, the TDF and the DUDBC, will be important beneficiaries. These agencies play key roles in making policy, regulating, financing, managing and overseeing the urban sector and municipal governments. Institutional assessments affirm that these agencies are currently unable to discharge their mandated responsibilities fully and effectively due to systemic institutional weaknesses. With state restructuring, their roles as national agencies are going to change as well as escalate. The project will help them develop systems and procedures, and capacitate their personnel to discharge their current and future mandates efficiently and effectively. Such system strengthening could lay the basis for expanding Bank support to Nepali municipalities.

C. PDO Level Results Indicators

28. Achievement of the PDO will be measured based on a combination of citizen satisfaction and sector performance indicators. Two citizen satisfaction indicators and one sector performance indicator, noted below, will be monitored. With regard to sector performance indicators, the scope of improvement will be measured on a case-by-case basis based on the sector and nature of the interventions, which will be identified and prioritized by each participating municipality on a demand-driven basis, reflecting local priorities and capacity. • Percent increase in citizens who say that the infrastructure services offered by the municipality better meet their needs than the previous year. • Percentage increase in citizens who report that they have participated in planning meetings at the ward level than the previous year. • Total number of people benefited from urban services and infrastructure improvements, of which females and from disadvantaged groups

29. Baseline, mid-term and end-of-project surveys will be carried out under the project to monitor outcome indicators. Further, municipal indicators are periodically collected and monitored under the MLD M&E framework, supported by the LGCDP, for evaluating local government performance. The project will piggyback on this system as well as provide resources to strengthen it further. The definition and use of outcome and intermediate outcome indicators and the arrangements for results monitoring are described in Annex 1 and 3.

III. Project Description

A. Project Components

30. The Emerging Towns Project (ETP) is an important first step of a potentially longer term programmatic engagement by the Bank to support Nepal in its decentralization and urbanization transitions, under the rubric of the Urban Governance and Development Program (UGDP). In the initial phase, the project will help improve planning, delivery and sustainable provision of basic services and priority infrastructure in 6 participating municipalities, while reforming systems and procedures and capacitating personnel of key central agencies associated with urban sector. Based

7 on the lesson learned, systems established and institutions strengthened, over time, this support will then be extended to additional municipalities.

31. The project comprises three components: Service Delivery Improvement, Socio-economic Infrastructure Development and Institutional Development. The three components are interdependent like the cogs of a machine—they support and complement each other, both functionally and temporally. Details of this programmatic framework are provided in Annex 2.

32. Component 1 - Service Delivery Improvement ($5m): Although the intergovernmental fiscal system (IGFS) in Nepal has witnessed notable improvements in recent times, further reforms are needed to address fiscal gaps, rationalize the multiple and confusing fund flows to municipalities, improve clarity and predictability in grant rules and systems, and strengthen reporting mechanisms. This component will, over time, aim to establish rules, and capacitate systems for improving the transparency, predictability and rationality of the grant system to municipalities. This will enable the Bank to potentially wholesale support for the IGFT system to municipalities.

33. The participating municipalities will be supported through Municipal Grants that will top up their existing fiscal transfers. The amount to each municipality will be based, for now, on Government’s detailed formulas and guidelines which take into account variables such as population, area, poverty and performance, and channeled through MLD’s existing fund flow channels. The MLD block grants support recurrent (salaries and office expenditures) and capital expenditures (local service delivery items), social mobilization and capacity building, with clear guidelines for each category. The Municipal Grants will support all the above categories except recurrent expenditures, under the same set of rules. The rules and operating procedures of utilizing Municipal Grants will be described in the Project Operations Manual (POM). Should a need arise in future, as part of reforms, these rules and operating procedures will amended, as needed.

34. The Municipal Grants are aimed at helping the local body gain greater credibility with its constituents through immediate service delivery improvements and on-the-ground community development initiatives. At least 35% of the capital expenditure part of the Grant will be set aside for pro-poor and community-oriented schemes. The Grants will also help improve O&M of existing assets and allow procuring flexible local capacity support. A description of the IGFT system for municipalities and further details of Component 1 are presented in Annex 2.

35. Component 2 - Socio-economic Infrastructure Development ($23.5 m): This component will lay the foundations for a rational and transparent system of capital financing of urban infrastructure embedded within the overall intergovernmental fiscal framework. It will support expansion and/or rehabilitation of core service infrastructure and strategic economic infrastructure. The objective of this component is to assist municipalities in developing infrastructure that will lead to improved services and greater socio-economic benefits for residents and businesses.

36. This component will provide municipalities with infrastructure grants, loans, and technical assistance grants. The effective loan/grant (L/G) allocation will be determined by the L/G policy of the TDF, which will manage this component. The overall funding envelope for each municipality will be determined on the basis of its population, poverty and performance, with additional criteria developed and added over time. The actual commitments to a municipality will, however, depend

8 on its financial sustainability, readiness of a pipeline of feasible sub-projects, project management capacity and other criteria. The municipalities will need to identify, prioritize and initiate sub- projects themselves, in consultation with their stakeholders, and submit formal application to the TDF. They will be supported with consultants for feasibility studies and engineering designs. The TDF will finance the sub-projects under its standard product lines and operations.

37. The TDF is an autonomous agency, set up with GIZ assistance in 1987 and owned by GON, mandated to provide financing and technical support for urban infrastructure development. In 1989, a credit of NR 147 million was provided by the World Bank to the TDF. In later years, the agency has received three grants from the Kreditanstalt für Wiederaufbau (KfW) and four loans from the ADB. For most part of its operation, the TDF has maintained a small but relatively well-managed portfolio, with adequate internal financial ratios and collection rates ranging from 80 to 95%. However, repayments under STWSSP I, which closed in December 2006, have been weak—around 56% overdue by recent estimates. Because of this, the TDF has defaulted to the Government. Initial assessments suggest that this has been caused by a host of design and institutional issues.

38. The TDF, with Bank and GIZ support, has developed a Business Strategy and Action Plan, which will serve as a roadmap for addressing immediate critical issues and longer term institutional strengthening. The TDF has maintained an ad hoc financing policy based on its source of funds. As part of reforms, a uniform financing policy has been developed. Sub-projects will now be clubbed into three groups, namely social infrastructure, urban/utility infrastructure, and revenue generating/commercial infrastructure. Under the new policy, loans and grants will now be administered separately. Social infrastructure will receive the highest share of grants (up to 80%), followed by urban infrastructure (up to 60%), and then revenue generating infrastructure (up to 30%). The municipalities will have to provide own or community cash contribution of about 10% of the total sub-project cost. This will ensure greater local ownership and sustainability of investments. They will also have to meet certain standards with regard to key financial ratios, as well as establish that they possess or are willing to establish adequate fiduciary systems.

39. The participating municipalities have already developed an initial pipeline of sub-projects, which are being scrutinized currently for their feasibility. Most of participating municipalities will be ready to implement their initial pipeline of feasible sub-projects by the start of project implementation. However, it is expected that the weak capacities of the municipalities will constrain them from taking on large and/or multiple sub-projects in the early stage. To address this, the municipalities will be provided with various forms of capacity support. Financing will be opened to additional municipalities when the project is expanded at a later stage. Annex 2 provides further details of Component 2, while Annex 8 provides further details on TDF.

40. Component 3 - Institutional Development (ID, $6.63 m): This component will support institutional strengthening of participating municipalities, the MPPW, the MLD, the DUDBC and the TDF, as well as program management activities. The participating municipalities have undertaken detailed institutional assessments, while some have prepared capacity development plans with LGCDP support. While each municipality will determine its priority areas for strengthening, the broader objective of this component is to establish a fairly standard framework for municipal institutional development, which is noted here with further details in Annex 2: • enhancing strategic urban planning and social/community development strategies;

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• reorganization and strengthening of internal structures, processes and human resources; • improving public accountability by strengthening local PFM systems; • strengthening technical and financial capabilities and enhancing downward accountability and inclusionary practices in service provision, with emphasis on poor and vulnerable.

41. A mobile expert team, called the Municipal Support Team (MST), will help municipalities in implementing the ID component. It will work hand-in-hand with municipal officials in introducing and operationalizing the new systems and procedures. This will be complemented with specialized top down training, where relevant, delivered by the Urban Development Training Centre (UDTC). On top, the municipality will be free to utilize a share of its block and municipal grants to procure need-based support for the capacity building of its personnel and communities. They will be required to assign adequate local staff for ID activities and are expected to use the new systems in about three years of implementation of the ID component.

42. In view of the need to strengthen institutional capacity at all levels of government in the urban sector, the ID component will also help build systems at the central level. Institutional reforms in the MLD, the DUDBC, and the TDF follow comprehensive political economy and institutional assessments which have guided the development of medium term institutional action plans. With regard to specific areas of support, the ID component will: • reform and strengthen the capacity of the MLD and the Local Bodies Fiscal Commission (LBFC) to manage IGFTs to municipalities better, as well as enhance the capabilities of UDTC in specific areas of municipal capacity building; • support a major refurbishment of the TDF by supporting the implementation of a Business Strategy and Action Plan; and • strengthen policies, systems and personnel in the areas of urban development, periodic planning, enforcement and urban information systems in DUDBC.

43. This component will also support project coordination and management activities, both at the center and in the municipalities, in areas such as (i) project specific M&E; (ii) the ESMF and grievance redressal mechanisms; (iii) logistics and equipment; (iv) IEC; (v) financial management and procurement; and (vi) studies, workshops and program expansion activities. Project management activities will be coordinated by a Project Coordination Office (PCO), while the overall ID component will be managed by the DUDBC.

44. The ID component reflects a strong synergy with a number of other ongoing programs and partners, including the LGDCP. In particular, it will be jointly financed by the Bank and the GIZ. While the Bank financing will flow as a grant to the Government, the GIZ funds will be channeled through parallel financing arrangements. A Memorandum of Understanding (MoU) spelling out the details of the partnership and the financing arrangements is being developed between the GON, the Bank and the GIZ. The need for a small number of international consultants to provide critical support in key areas has been discussed and agreed with the Government. Further details of Component 3, including assessments of project institutions, contents of institutional development support, and details of partnership with other agencies are spelt out in Annexes 2 and 3.

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B. Project Financing

Lending Instrument

45. The project will be financed as a Specific Investment Loan (SIL). Alternative instruments such as an Adjustable Program Lending and Development Policy Loan were considered, but not deemed suitable for the sector under the current circumstances. Over the medium term, the focus will be on transitioning towards wholesaling approach to supporting the system of urban local governments in Nepal.

Project Cost and Financing

Table 1: Project Cost by Component1/2 Project Municipality/ Component IDA % GON % GIZ % % cost ($m) Communities Service Delivery 5.00 5.00 100 - - - - - Improvement Socio-economic Infrastructure 23.50 16.37 69.7 5.00 21.3 - 2.13 9 Development Institutional Development 6.63 3.63 54.8 - - 3.00 45.2 - - Total 35.13 25.00 5.00 3.00 2.13 1/ Detailed costs are provided in Annex 2. 2/ Cost do not add up due to rounding errors.

C. Lessons Learned and Reflected in the Project Design

46. The ETP is Bank’s first investment since the late-1980s in the urban sector and the first ever operation directly targeting local governments in Nepal. Because of this, the Bank had to study relevant global experiences as well as that of other similar programs/projects in Nepal.

47. The LGCDP mid-term review report cautions about fiduciary risks at the local level due, in part, to the lagging demand side measures, delayed release of funds to local bodies and insufficient capacity development measures. It underscores that the scrutiny and engagement of civil society is critical to reducing fiduciary risk and achieving equitable and inclusive service delivery, as well as emphasizes the need for very robust approaches to local level capacity development and social mobilization, noting that, due to piecemeal approaches, organizational/system issues are neglected. On a positive note, the report highlights the success in monitoring the performance of local governments through the Minimum Conditions and Performance Measurement (MC/PM) system, which has potentially led to improvements in planning and programming, public financial management, good governance and transparency. The Project Completion Report of the STWSSP I recommends adopting a bottom-up, demand-driven approach to selecting sub-projects and the need for capacitating communities to ensure the sustainability of assets created. The Bank has also made a detailed assessment of the factors, both design and institutional, leading to weak loan repayment and other financial issues under the STWSSP I.

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48. The 2008 Independent Evaluation Group’s (IEG) study on municipal development projects (MDPs) observes that, among the three dimensions of municipal management—planning, finance and service provision—support for strengthening municipal finance most often yielded successful results. Hence, it recommends that the Bank should continue to support tightened municipal financial management, own-revenue raising, and municipalities being brought to local credit markets when appropriate conditions are present. The study also notes that “wholesale MDPs that have assisted many municipalities have yielded better outcomes than retail MDPs…. Retail MDPs might perform better if they incorporated more of the winning elements of wholesale MDPs, such as performance-based incentives and a focus on finance.” Finally, the study urges more frequent use of cost-benefit or cost-effectiveness analysis which would help MDPs’ municipal clients select the best investments and achieve outcomes efficiently.

49. The most successful aspects of Bank support for decentralization, according to a 2008 IEG study, pertained to the legal frameworks for intergovernmental relations, the frameworks for intergovernmental fiscal transfers, and sub-national financial management. Other things equal, Bank support brought better results where there was consensus around the reform within the country prior to Bank engagement and when the support was combined with incentives for institutional reform at the sub-national level. The study encourages the adoption of a more results-based approach to decentralization by helping develop capacity for M&E that focuses on local outcomes rather than on the process of decentralization. Going forward, the study concludes that the Bank’s support for decentralization can be strengthened with more timely and coordinated analytical work, by better coordinating fragmented sectoral interventions, and by accompanying support for policy reform with technical assistance to strengthen local government capacity.

50. These experiences and lessons have been factored into the project design:

• There is strong in-country support for decentralization and stronger local governments, although there is less clarity or convergence on the precise priorities or modalities. One element of Bank engagement is to help GON obtain greater clarity on those priorities and modalities through deeper dialogue, more programmatic engagement and use of multiple instruments (among them, this project and other policy and technical assistance initiatives);

• The project aims to improve systemic capacities by mainstreaming implementation through existing institutions and systems and strengthening them incrementally from within, and by providing an array of flexible resources and tools to municipalities for capacity development. It is clear that the project should treat the current phase to test approaches and develop systems to eventually support the system of urban local governments in Nepal and through that, a larger set of municipalities;

• Strengthening the national fiscal and financing frameworks for local government finance is an overarching goal. A key element of this is the TDF reform and strengthening, and ensuring that sub-project financing is based on a rational financing policy and solid internal systems (including capacity to undertake solid cost-benefit/cost effectiveness analysis—see also section VI.A and Annex 7), while investing substantially in sub-national PFM strengthening and local revenue mobilization through incentives and capacity development;

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• The project piggybacks on the MLD M&E (including the MC/PM) system to evaluate the performance of the participating municipalities, monitor local outcomes and determine the performance dimension of the block and Municipal grants. The ID component also sets aside resources for further strengthening of the MLD M&E system; and

• Considerable attention is being devoted to ensure broad and deep stakeholder buy in at all levels. National and town level political economy analyses were undertaken to better understand key stakeholders and their positions. Extensive public consultations were part of the preparations. Substantial civil society stake and oversight in project implementation is envisaged through enhanced social mobilization, adopting a bottom up implementation approach, and ensuring that public expenditures prioritized, implemented in some cases and monitored by the community. These are further described in Annex 3.

IV. Key Risks and Mitigation Measures

51. Key risks which can affect the PDO are noted below. Detailed risks assessments are part of the Operational Risk Assessment Framework and the Governance and Anti-Corruption Action Plan.

52. Uncertainty surrounding federalism and change in state structures: The emerging Constitution envisages changes in state structures, with a key role for local governments. However, due to delays in finalizing the Constitution by the current deadline of May 2011, the current local government structure might very well be in place for most of the initial project phase. However, municipalities are viewed as among the most stable political and administrative local entities. Project implementation arrangements are mainstreamed within prevailing institutional structures and systems. They can evolve, as needed, once the country’s new federal structure is in place.

53. Weak accountability at the local level: In general, local accountability is a serious challenge. The absence of elected local officials poses major implementation risks. There are uncertainties regarding the formal roles, responsibilities and accountability relationships of APMs, for example. Further, there are serious risks of fund misuse, especially around the tendering processes. Finally, avoiding capture by elites and ensuring broad-based inclusion of citizens, especially vulnerable groups, in planning, allocation of resources and delivery of services, will be a key challenge.

54. Detailed local level political economy analysis and institutional assessments were undertaken for each participating municipality to plot risks at every stage and design mitigation measures. The municipalities will receive assistance to strengthen their PFM systems and personnel; the feasibility of piloting e-bidding will be explored at the municipal level; and procurement audits will be conducted on a routine basis. Finally, there is considerable emphasis on ensuring broad based inclusion and social accountability. The project, with the support of the Local Governance and Accountability Facility (LGAF)6 will focus on identifying key drivers of social accountability in each participating municipality, testing 2-3 key social accountability tools customized to each municipality and evaluating their effectiveness on a periodic basis.

6 LGAF, supported under the LGCDP, is envisaged as a semi-autonomous body which will finance a range of activities including information to and interactions within communities, as well as between communities and local governments on corruption issues, promotion of social audits, support to community vigilance groups and support to local media for critical and informed coverage of local governance issues. 13

55. Limited capacities at all levels: Detailed fiduciary and institutional assessments were completed for the DUDBC, the MLD, the TDF and the municipalities. These studies reveal that technical, financial and managerial capacities at these institutions need considerable strengthening. Annex 2 provides detailed analysis of the institutional issues in these agencies. Project design takes current capacities into consideration. The project includes a strong institutional strengthening component which will be jointly supported by the Bank and the GIZ. The project will also draw from ongoing institutional development initiatives supported by the LGCDP.

V. Implementation

A. Institutional and Implementation Arrangements

56. A full description of implementation arrangement is presented in Annex 3. Two key principles have guided the formulation of the implementation arrangements: • Political economy: the prevailing political economy of state restructuring demands clarity in institutional arrangements and consistency with government systems, so that they can evolve with changing state structures and institutions. • Systems approach: as challenging as this is, the project adopts an institutional approach that emphasizes reforming and strengthening existing systems by working from within, rather than creating ring-fenced arrangements that insulate the program from the system.

57. Central arrangements: At the national level, the MPPW will be the executing agency and the MLD will be the co-executing agency for the project. They will ensure that the project is implemented smoothly in line with the agreed objectives. A Project Steering Committee (SC) chaired by Secretary, MPPW and co-chaired by Secretary, MLD will ensure overall program coordination, provide policy level guidance, and monitor progress on a regular basis. The Steering Committee will comprise senior officials from key ministries and agencies, along with a Project Director (PD), 2 representatives of the participating municipalities, representatives of the Municipal Association of Nepal (MuAN) and the Federation of Nepalese Chamber of Commerce and Industries (FNCCI), and a renowned urban/municipal expert from the civil society. The World Bank and the GIZ will be observers in the SC.

58. On a day to day basis, implementation will be coordinated by a Project Coordination Office (PCO) attached to DUDBC, which will serve as the Secretariat to the SC. It will comprise a PD, who will serve as the Secretary to the SC, as well as three Component Managers (CMs), representing the MLD, the TDF and the DUDBC. Considering that three agencies are involved centrally, the implementation arrangements emphasize maximum operational autonomy for each agency in the management and implementation of its component—i.e., component related decision- making will be fully carried out by the respective agencies. The PCO, led by the PD, will play a coordinating and facilitating role to all three components by preparing consolidated work plans, facilitating implementation by each agency and ensuring coordination across components/agencies and with other agencies and the donors, getting various project related approvals, checking overall quality control, and ensuring timely processing and release of fund to the respective agencies. The PCO will be supported by a small contingent of staff. The CMs will be responsible for managing their respective components within their parent agency, coordination with the PCO and other components, timely reporting, and managing fund requests via the PCO.

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59. The Municipal Management Division (MMD) within MLD will manage the Service Delivery Improvement component. It will also be responsible for implementing activities associated with the institutional development of MMD, the LBFC and the UDTC. Within the MMD, the Under Secretary in charge of the Municipal Planning Section (MPS) will serve as the Component Manager (CM 1). S/he will be supported by designated staff for project-related procurement and financial management. The CM 1 will determine the Bank-financed Municipal Grant amounts for each municipality and ensure that they are disbursed to the municipalities that have met the eligibility criteria in a timely and predictable fashion under the same institutional arrangements and concurrently with the regular government block grants. Expenditures under such grants will be appropriately tracked and reported. In consultation with the respective agencies, the CM 1 will also manage all project-financed institutional development activities of the MLD, the LBFC and the UDTC, based on institutional development plans that are being finalized for each agency.

60. The TDF will manage the Socio-economic Infrastructure Development component. It will also implement its own institutional development activities. While the selection of sub-projects will be undertaken by each municipality, the TDF will manage the fund, appraise sub-projects selected by the municipalities for their technical and financial feasibility, and assess the ability of municipality to meet its obligations associated with the investments. The identification, structuring, approval, and financing of sub-projects will follow the standard procedures of the TDF, which will also monitor and verify construction progress and quality and perform post-construction monitoring of O&M to support timely loan repayment by municipality. The Chief Financial Officer (CFO) of the TDF will serve as a Component Manager (CM 2). S/he will prepare detailed annual work-plans (including a list of ready sub-projects and expected disbursements for the year) and progress reports, manage and coordinate the institutional development activities of the TDF, ensure coordination with other project components/agencies and the donors, prepare withdrawal applications, and ensure timely fund availability. The TDF will have a dedicated fiduciary and safeguards support team.

61. The DUDBC will coordinate the institutional development component. A Senior Planner from its Planning Section, who will be the component manager (CM 3), will prepare work plans and progress reports, ensure coordination with other components/agencies and donors, and ensure timely fund availability for the activities via the PCO. While the DUDBC will implement its own institutional development plan, the institutional activities for the municipalities will be managed by the PCO. A key element of the support for municipalities will be the MST—a mobile team of experts who will support the municipalities. They will be centrally managed by the PD, who will also procure core equipment for municipalities.

62. Local arrangements: The project implementation will be mainstreamed at the municipality level mostly through existing systems, but with a focus on internal reforms and incremental institution building. At the working level, a Project Management Team (PMT) will be set up within the municipality, comprising, at the minimum, the Executive Officer, as the Project Coordinator, and the section chiefs of four key sections, namely planning/engineering, finance, social mobilization and administration. The Project Coordinator will be responsible for smooth on-the- ground implementation, ensuring internal and external coordination and fiduciary and safeguards compliance, submitting reimbursement requests, and providing progress reports. S/he shall

15 designate one of the section heads as the Deputy Project Coordinator to provide day-to-day support. The PMT, in reality, is an extension of the current municipal executive structure with emphasis on improved operational coordination between key sections. By mainstreaming implementation via existing municipal structures and providing a range of flexible and need-based ID support, it is expected that the overall capacity of the municipality will be augmented in a sustainable manner over time. Nevertheless, to fulfill project-specific fiduciary, safeguards, monitoring and reporting requirements, the PMT shall be assisted by a Project Support Team (PST) of municipal staff or consultants. In addition, the MST will also support the PMT in matters of project management.

63. In the absence of elected local councils, municipalities are routinely consulting with local APMs. The project will support the use of Municipal Grants to build the capacity of APM members to enable them discharge their advisory and oversight roles more effectively. Nevertheless, studies have highlighted the need for robust accountability structures which can cause broader stakeholder buy in and ensure adequate voice to vulnerable groups at the local level. These structures, noted below, will be sensitive to local ethnic and demographic composition, and political economy: • at the apex level, a Municipal Coordination Committee (MCC) comprising the Executive Officer, the APM and a range of civil society stakeholders, including representatives of tole organizations, dalits, janjatis and other vulnerable groups, local businesses, line agencies, etc. The MCC will provide a platform for these stakeholder groups to deliberate on critical local development issues and help resolve major city-level bottlenecks.

• at the local level, ward committees that will form the primary unit for social mobilization, local planning, expenditure prioritization and budgeting, selection and implementation of local service delivery initiatives, and providing local oversight.

64. The municipalities will design and structure the sub-projects, but often require help for this. They can obtain support from a number of sources, among them the MST, relevant government agencies, or consultants financed by themselves or the project via the TDF. The municipalities will also undertake the construction themselves, or contract construction companies following standard procurement rules under the project and sub-project guidelines set by the TDF. Construction supervision must be performed by qualified staff/consultants and the municipality may request assistance for this as part of sub-project financing.

65. Frequent transfer of officials is an acute issue in Nepal. The Bank has sought assurance from the Government regarding stability of key project-related staff, especially at the center, covering the PCO, the TDF, the MLD and the DUDBC. In particular, it is critical to ensure that the PD and the CMs are retained for at least the first two years of project implementation.

Fiduciary arrangements

66. Delegation of authority for project implementation: The project will be implemented within the framework of Government’s financial management system. Following the approval of the annual work program and budget submitted through the PCO, spending authority will be delegated by the Secretary, MOF to the secretaries of MPPW and MLD. A dedicated budget code under the

16 project will be created for both MPPW and MLD7. The Secretary, MPPW will further delegate authority to the Director General, DUDBC to implement the ID component of the DUDBC; to the Executive Director (ED), TDF to implement the Socio-economic Infrastructure Development component and the ID activities of the TDF; and to the PD for project management activities and the municipal ID activities. The Secretary, MLD will delegate spending authority to CM 1 for managing the Municipal Grants and the ID activities of the MLD.

67. Budget arrangement and fund flows: The project will have a separate identifiable budget head with two subheads – one for MPPW and the other for MLD – in the “Red Book.” Funds will flow directly from District Treasury Controller Officer (DTCO) to the PCO, the MLD, the TDF, and the DUDBC for their respective components. Based on annual work plan and budget, endorsed by the SC, the PCO will communicate the procurement and disbursement plans for the year to the Bank (and the GIZ) prior to May 1 of each year. Capital financing, Municipal Grants and operating expenditures will be pre-financed by the Government under reimbursable heading. The PCO will consolidate expenditure statements from all the three agencies and submit documents to the Bank for reimbursement or replenishment. For this purpose, a Special Designated Account will be established in US Dollar at the Nepal Rashtra Bank (NRB), under terms and conditions acceptable to the Bank. The PCO will manage the Special Designated Account and designate the signatories to operate it, which will be normally the PD and the Finance Officer. Transaction-based (traditional) disbursement procedures will be applied for withdrawal of funds from the project.

B. Results Monitoring and Evaluation

68. The detailed results framework and baseline indicators are presented in Annex 1. The PD will be responsible for overall monitoring and reporting of results, in close coordination with the CMs and the participating municipalities. S/he will monitor the PDO results indicators (the Citizen Satisfaction indicators and the Sector Performance indicators). This will include responsibility for finalizing and updating the list of relevant sector performance indicators for each municipality over the course of project implementation. The project will support household surveys at inception, mid- term and completion, which will provide information on PDO result indicators.

69. The baseline indicators noted in Annex 1 are largely based on secondary sources collected during preparation phase. This will updated after completion of baseline survey by September 2011. The list of relevant sector performance indicators for each municipality will be defined during the first year of project implementation when the pipeline of sub-projects is finalized, and will be updated on an annual basis subsequently. For example, if a participating municipality prioritizes water and solid waste investments for funding under the project, the relevant indicators for water and solid waste will be the two PDO sector performance indicators monitored in that municipality. Given that the sectors of interventions are not known ex ante, the baseline survey will collect data for all the sector performance indicators in the participating municipalities.

70. The three CMs will be responsible for monitoring the results and collecting and compiling the intermediate results indicators for their respective components. The CMs will submit annual

7 Separate budget code is envisaged for this Project for both MPPW and MLD. Eventually, through institutional development efforts in enhancing financial management capacity, the aim is to integrate the budget for municipal grants under the MLD within the existing budget code for conditional grants 17 progress reports to the PD covering their intermediate results indicators. The PD will compile the information received and produce a consolidated report on an annual basis. The institutional arrangements and capacity for M&E at the local level are very weak. The project will help build basic monitoring and reporting capabilities in participating municipalities. It will help municipalities set up systems and indicators and train staff in monitoring and reporting on both process and results side. The M&E Advisor in the MST will help municipalities in this regard.

C. Sustainability

71. There are two important sustainability issues. The first one concerns the sustainability of institutional changes brought by the project at the central level. The project supports reforms and institutional changes that have high government ownership. For example, the proposal for comprehensive strengthening of TDF has high degree of ownership both within TDF and the government. Similarly, MLD is currently engaged in trying to improve the frameworks for fiscal transfers and capital grants to municipalities through its block grant and reserve fund windows. Project support will help MLD with sound policy advice and technical support in this area.

72. The second issue pertains to the sustainability of infrastructure assets created at the local level. In this regard, the longer term technical and financial feasibility of proposed investments will be vetted by the TDF before approval for financing. This will include assessment of the economic and financial sustainability of sub-projects (depending on the nature of the sub-project) and O&M capabilities of the participating municipalities. Further, the ID component aims at improved capabilities in engineering and project and asset management, revenue mobilization and expenditure management within participating municipalities. This is expected to strengthen the ability of the municipalities to maintain infrastructure assets sustainably. Overall, programmatic support by the Bank will consolidate systems and long term sustainability both at national and local levels.

VI. Appraisal Summary

A. Economic and Financial Analysis

73. Service Delivery Improvement component: Given the discretionary nature of the Municipal Grants, the spending choices of the participating municipalities cannot be determined a priori. It is therefore not possible to use conventional economic analysis to estimate the economic rates of returns associated with this component. The economic justification for this component is therefore mostly based on the impact that the Municipal Grants are expected to have on the overall sustainability of the capital investment program funded under Component 2.

• First, the Municipal Grants will provide much needed discretionary resources to improve service delivery standards, conduct routine maintenance works and address the most urgent service delivery needs of the poor and disadvantaged groups. These small scale interventions are expected to complement the larger scale capital works, and ultimately improve the overall economic rate of returns of the capital investment program. • Second, the Municipal Grants are expected to improve the economic sustainability of the new capital investments by better aligning asset creation with O&M capabilities and by enhancing the municipalities’ ability to operate and maintain the new assets.

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• Third, the top-up grants will enhance the borrowing capacity of the municipalities and therefore broaden the menu of investment options that are fiscally sustainable.

74. Evidence from countries where similar funding mechanisms have been implemented also suggests that a decentralized funding approach can yield significant economic benefits (as opposed to a more centralized funding approach).8 First, empirical evidence suggests that funding mechanisms that support local institutional processes lead to greater accountability of municipal authorities vis-à-vis their constituencies. Second, Municipal Grants can also improve productive efficiency by reducing the transaction costs which are associated with centralized financing of municipal infrastructure. Third, providing discretionary resources to municipalities is likely to improve allocative efficiency as they are situated closer to the citizens than the central government. The project will review the allocative and production efficiencies of Municipal (and block) Grants on a sample basis during implementation.

75. Socio-economic Infrastructure Development component: The identification and prioritization of sub-projects will be made by each participating municipality on a demand-driven basis, reflecting its infrastructure priorities and borrowing capacity. The economic and financial benefits of the sub-projects cannot therefore be measured ex-ante. The TDF will have responsibility for evaluating the economic and financial viability of the sub-projects based on standard appraisal models and methodologies detailed in the “guidelines for the economic and financial analysis of sub-projects” (included in the OM). The rules for determining sector eligibility and conducting financial and economic analysis of sub-projects are detailed in Annex 7 and summarized below.

• Sector eligibility: The following urban infrastructure sectors will be eligible for financing: (a) Social and community infrastructure: examples of possible projects include basic health centers, community centers, public toilets, green spaces, slum upgrading, etc. (b) Urban and utility infrastructure: water, sewerage, solid waste and municipal roads. (c) Revenue generating/commercial infrastructure: markets, eco-tourism parks, parking spaces, shopping centers, etc.

• Financial Analysis: A fiscal sustainability assessment will be conducted routinely for each municipality, and complemented by a financial viability analysis at the sub-project level. (a) Fiscal sustainability is a minimum requirement for all sub-projects, as it aims to ascertain that the sub-projects are financially sustainable for the municipality as a whole. All sub-projects need to be within the fiscal capacity of the participating municipalities, to be assessed as per the terms of financing for the sub-project, which include debt service coverage ratio of 0.3 or less and total revenue to expenditure to at least 1.0; (b) A financial viability analysis will be undertaken for all commercial/revenue-generating infrastructure sub-projects and all urban/utility infrastructure sub-projects with some revenue-generating potential (water, sewerage and solid waste). A sub-project is considered financially viable if the Financial Rate of Return (FRR) is above 12%.

8 See, for example: World Bank (2008). Implementation Completion Report (ICR). Uganda: Second Local Government Development Program; World Bank (2009). Implementation Completion Report (ICR). Philippines: Local Government Finance and Development Project; and World Bank (2004). Project Appraisal Document. Tanzania: Local Government Support Program. . 19

• Economic Analysis: There are two levels of economic analysis: cost effectiveness and cost- benefit analysis. (a) Cost effectiveness analysis needs to be carried out for all sub-projects. Its objective is to demonstrate that the selected option is the most cost effective for a given level of output. (b) A full cost-benefit analysis is required for all commercial/revenue-generating infrastructure sub-projects over US$1 million and all urban/utility infrastructure sub- projects over US$ 1 million with quantifiable benefits (water, roads and solid waste). These sub-projects will be considered economically viable if they demonstrate an Economic Rate of Return (ERR) equal or greater than 12 percent. An exception will be granted for those urban/utility infrastructure sub-projects that are shown to meet basic needs requirements based on the following sector rules: (i) Any road sub-project aiming to rehabilitate the existing municipal road network or to build one or two lane municipal roads is considered a basic needs sub-project and is therefore exempted from a full cost–benefit analysis. (ii) Any solid waste sub-project aiming to build adequate capacity to collect and transport solid waste for a 10 year horizon, based on reasonable projections of population and per capita solid waste, is considered to meet basic needs requirement and is therefore exempted from a full cost-benefit analysis.

B. Technical

76. The key design questions relevant to the project are two:

• Is the combination of block grants and capital financing (through, both grants and debt) appropriate for municipalities in the current Nepali context?

77. This project takes an integrated view of the fiscal framework concerning urban local governments. Public finance literature identifies three broad avenues of local government financing: own revenues, intergovernmental transfers and debt financing. The project aims to employ each of these in a mutually reinforcing manner within an integrated fiscal framework. Thus block grants (which are part of vertical revenue sharing arrangement) provide support for routine service delivery, especially ensuring that public goods with significant externalities are delivered to the poor, while incentivizing improved local revenue mobilization and expenditure management. Own revenues reflect the benefits (and costs, at the margin) citizens obtain from their local governments—thus, in principle, improved responsiveness and efficiency in services will lead to higher own revenues. Both own revenues and block grants together form the foundation for improved local services. They also provide the basis for accessing capital financing, which includes grants and loans. Linking fiscal resources with debt financing ensures greater sustainability.

78. A good number of Bank urban/municipal projects separate the fiscal and financing dimensions of local government finance, especially while investing in urban infrastructure. This project is premised on the argument that the local financing arrangements should include both the fiscal and financing side within an integrated framework for efficient and responsive service delivery, and sustainable capital investments. Nepal’s emerging frameworks for fiscal federalism provide the right setting to test this approach.

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• Is mainstreaming implementation through existing country systems the right approach?

79. By opting against ring-fenced or projectized implementation arrangements, there is the risk of systemic institutional weaknesses and limited capacities constraining implementation, especially in the early stages. However, the team senses an opportunity here to work with existing systems, which are undergoing change in roles, functions and orientation, and effect systemic institutional reforms over time. This will not only improve the sustainability of institutional reforms and investments, but also provide the Bank an opportunity to work with the Government on broader decentralization issues and strengthen programmatic engagement. Agreement with the Government regarding staff continuity for key positions, especially those receiving training with project support, will further ensure that the capacities are retained in key agencies for a reasonable period.

C. Financial Management

80. Detailed political economy and institutional studies provide comprehensive information on fiduciary gaps and risks. The Bank is working at the municipal level for the first time. Further, both the TDF and the DUDBC have not worked with the Bank for a long time. Although the Bank has worked with the MLD in a few other operations, its fiduciary capacity remains weak. Due to the need for extensive coordination between various agencies and stakeholders, and that all these agencies are relatively new to Bank procedures, the fiduciary risk is rated High, and following mitigation measures being worked out in close partnership with the GIZ and through the PPF, the residual fiduciary risk is Substantial. Further details of this are provided in Annex 3.

81. The PCO will play a critical role with regard to financial management and reporting of the project. It will ensure that separate books of accounts by component are maintained for the project and that accounts are prepared on a cash basis. It will prepare consolidated Implementation Progress Reports (IPRs) and Project Financial Statements (PFS) covering the use of funds by all three central agencies and the participating municipalities. The IPR will report total project investments separated by activity, so that the utilization of IDA funds for all the components can be monitored at the aggregate level. It will show the sources and uses of funds, output monitoring report, procurement management report, and narrative progress report in formats acceptable to the Bank. They will be produced on a trimester basis and submitted within 45 days from the end of the preceding trimester. Each component will maintain accounts as per the guidelines specified in the POM. The CMs will provide component information to the PD for trimester reporting.

82. Municipalities are required to follow the financial and accounting systems prescribed in the Local Entities Financial Administration Regulation and the Local Self Governance Act. The MLD has also recently issued detailed guidelines under the Municipality Grant Operation Procedures 2067 (2011) regarding the utilization and reporting of municipal grants. According to these guidelines, all funds are disbursed to the “B” account of the municipality, which is a non-operating account. On approval of the annual budget and work plan, the amounts are then transferred to the “C” accounts of the municipality, which are operating accounts, under five heads. The total unspent amount at the year end is transferred to main account and, out of this, the amount to be frozen is refunded back to the DTCO. The guidelines also prescribe detailed formats for financial and physical reporting on expenditures. Overall, there is a system which allows tracking of funds, including Bank funds, which will be further clarified in the POM, to address any gap or weakness.

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D. Procurement

83. Procurement under the ID component will consist of Goods and Services required by each of the central agencies and the PCO. Procurement under the Socio-economic Infrastructure Development component will be implemented by the municipalities, where it will include Works contracts related to municipal socio-economic infrastructure and small value Goods contracts.

84. Detailed capacity assessments of the central agencies and municipalities reveal that, while the three central agencies have dedicated procurement sections/units and also have some familiarity with procurement under donor-funded projects, the municipalities are very weak in this regard. To address this, it is proposed that the PCO take a lead role in building the capacity of the municipalities through organization of procurement training, guidance, on-demand assistance in development of bid documents and evaluation, and review of select transactions to ensure compliance with the legal agreement. The overall risk rating is Substantial.

E. Social (including Safeguards)

85. Social Assessment (SA) and Social Management Framework (SMF): SA was carried out in the participating municipalities as a part of detailed town profile studies and political economy analysis. These studies provide information regarding socio-economic, cultural and demographic aspects of the participating municipalities, describe their needs and investment priorities, and analyze existing political situation and power relations, inequality and exclusion risks for dalits and janjatis, the presence and role of CSOs/CBOs, and prevailing social accountability practices. Based on these studies, a SMF has been prepared. The SMF focuses on three key issues: (i) involuntary resettlement; (ii) social equality and inclusion (indigenous people/vulnerable communities); (iii) social accountability/demand side governance.

86. Involuntary resettlement: The SMF analyzes the country legal frameworks and existing social management practices for land acquisition and resettlement, gaps vis-à-vis Bank’s Operational Policy 4.12 and provides a Resettlement Policy Framework (RPF), including an Entitlement Matrix and implementation arrangements compliant with Bank’s safeguard requirements. The RPF is based on similar instruments used for other World Bank financed projects in Nepal. The land acquisition and resettlement impacts of potential sub-projects are not known. However, proposed activities such as ring roads, water supply, drainage, land management, and tourism development may involve land acquisition and resettlement. Based on an institutional analysis indicating low capacity of the implementing agencies, the SMF also provides a capacity building and technical support plan.

87. Social equality and inclusion: Studies show that around 40% people living in the participating municipalities are poor. In particular, janjatis, dalits and other vulnerable groups live in chronic poverty and exclusion. The GON has several legislations, as well as clear guidelines to municipalities regarding pro-poor investments benefiting dalits, janjatis and poor women through block grants and infrastructure finance.9 Compliant with these guidelines, Bank’s Operational

9 In 2002, the Nepal Parliament passed a bill establishing the National Foundation for Upliftment of Indigenous Nationalities. The GON has recognized 59 indigenous communities. Article 35 of the Interim Constitution, 2007 states that, “the State has compulsory obligation to pursue a policy of uplifting the economically and socially backward 22

Policy 4.10 on the Indigenous People and the ILO Convention 169,10 the SMF has formulated an Indigenous People and Vulnerable Communities Development Framework (IP-VCDF), which offers generic guidelines to the municipalities to address the needs of vulnerable communities, and sets out procedures for assessing impacts and preparing and implementing IP-VCDPs (along with RAPs) for specific sub-projects.

88. Social accountability: The SMF discusses various national laws requiring social accountability measures,11 and indicates gaps in practice across municipalities. It points out deficits in responsiveness and risks of elite capture in varying degrees in the participating municipalities. The SMF articulates key principles for strengthening social accountability and demand side governance through measures such as: (i) public disclosure strategies; (ii) community and citizen scorecards involving user groups and CBOs for public monitoring of services and local economic development; and (iii) grievance redress mechanisms.

89. Consultations: Stakeholder consultations are held at three stages: (i) overall project design, (ii) sub-project preparation, and (iii) implementation. At the design stage, stakeholder consultations were held in the 6 municipalities with the municipal personnel, the APMs, the private sector and the CBOs during the preparation of town profiles, political economy studies and the SMF. These consultations covered issues of security, functioning of municipalities, the role of APMs, user groups and CBOs, citizen accountability, budgets, periodic plans, and infrastructure needs. Consultations were also conducted at the country level to facilitate interaction with and among the municipalities. A summary of these consultations has been provided in the SMF, which also provides guidelines for holding free, prior and informed consultations with janjatis, dalits and other vulnerable groups during project implementation.

F. Environment (including safeguards)

90. Environmental concerns of the project are related to infrastructure activities under Components 1 and 2, while institutional activities under Component 3 may lead to better environmental performance, as this includes environmental management and related capacity building. Town profiles of participating municipalities provide a fair idea of potential sub-projects, even though their precise locations and types are not known ex ante. The average size of TDF- supported infrastructure has been in the range of $400,000 to $600,000 in the past. The Municipal indigenous peoples, madhesi, dalit, marginalized communities, and workers and farmers living below the poverty line, by making a provision of reservation in education, health, housing, food sovereignty and employment, for a certain period of time.” The TYIP (2007-10) includes policies for inclusive development of adivasi, janajatis and other vulnerable groups. The Local Self-Governance Act, 1999 commits municipalities for the promotion, preservation, and protection of language, religion, culture of indigenous people and their welfare. 10 Nepal is a signatory to ILO 169, which is a legally binding instrument providing recognition of indigenous peoples’ collective rights in key areas, including cultural integrity, consultation and participation, self-government and autonomy, land, territory and resource rights, and non-discrimination in the social and economic spheres. 11 Article 27 of the Interim Constitution guarantees right to information to the citizen, while the Right to Information Act, 2064 (2007) aims to make the functions of the state transparent and accountable to citizens. The Good Governance (Management & Operation) Act, 2064 (2008) aims to make public administration pro-people, accountable, transparent, inclusive and participatory. Clause 25 (1) requires government offices to maintain Citizen's Charter; Clause 28 (1) provides for people’s participation; Clause 30 provides for public hearing; and Clause 31 refers to grievance management.

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Grants will support relatively smaller size activities. The GON has therefore prepared an Environmental Management Framework (EMF) which is consistent with the Government’s and the Bank’s requirements. The EMF will be applied to mainstream environmental concerns in infrastructure sub-project planning and implementation.

91. The Framework requires that: (i) environmental factors are applied during early stages of sub-project identification and prioritization and in the planning and design of infrastructure; (ii) each sub-project is subjected to environmental screening for which criteria and format has been developed; (iii) depending on the assessed environmental risks, infrastructure sub-projects may need to adapt generic Environmental Codes of Practice (ECP) provided in the EMF, or may need to have an Environmental Management Plan (guidance provided in the EMF), or may be subject to limited environmental assessment (called IEE in Nepal’s legal terminology) or full environmental assessment (EIA, as per Nepal’s legal terminology). Sub-projects requiring full EA are generally discouraged during prioritization. This must be ready prior to finalization of the detailed sub-project report; (iv) incorporation of the environmental mitigation measures in the infrastructure plan, detailed design, costs, specifications, Bill of Quantity, contract clauses and bid documents needs to be confirmed prior to bid invitation; (v) while regular environmental supervision will be provided by PMT in each municipality, there will be trimesterly environmental monitoring by MLD for component 1 and joint TDF-PCO team for component 2 activities. In addition, an independent external agency will be recruited for annual environmental monitoring, if needed.

92. Assessments made during preparation of EMF indicate that majority of the sub-projects are expected to have limited environmental impacts. However, a few infrastructure sub-projects with higher environmental risks have not been ruled out. The Government will obtain Bank’s No Objection for TOR, EA and EMP of all infrastructure sub-projects requiring full EA, and first limited EA sub-project from each municipality, as well as 5% of all limited EA sub-projects.

93. The EMF has been widely discussed with the stakeholders, including the implementing agencies, and has been publically disclosed. As indicated by the assessment made during EMF preparation, the environmental management capacity of the municipalities and the central agencies is relatively weak. The EMF contains environmental capacity strengthening measures.

G. Other Safeguards Policies Triggered

Table 3 : Safeguards Policies by Project Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) [X] [ ] Natural Habitats (OP/BP 4.04) [ X] [] Pest Management (OP 4.09) [ ] [X] Indigenous Peoples (OP/BP 4.10) [X] [ ] Physical Cultural Resources (OP/BP 4.11) [X ] [] Involuntary Resettlement (OP/BP 4.12) [X] [ ] Forests (OP/BP 4.36) [X] [ ] Safety of Dams (OP/BP 4.37) [ ] [X] Projects on International Waterways (OP/BP 7.50) [ ] [X] Projects in Disputed Areas (OP/BP 7.60) [ ] [X]

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94. Note: PCR OP/BP 4.11 is triggered because there are cultural sites of local significance in each of the participating municipalities. NH OP/BP 4.04 is triggered because it is possible that, though uncertain, some activities in Lekhnath Municipality may be implemented close to the lakes. Forest OP/BP 4.36 is triggered because there are small patches of forests in and around some of the participating municipalities. Depending on the nature and location of sub-projects, these resources may or may not be affected (positively or negatively). Environmental screening and assessment will investigate these aspects, and environmental management plan and environmental codes of practice of sub-projects would include measures to prevent, mitigate and manage adverse impacts and enhance positive ones.

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Annex 1: Results Framework and Monitoring

NEPAL: Urban Governance and Development Program: Emerging Towns Project

Results Framework

Project Development Objective (PDO): To improve delivery and sustainable provision of basic services and priority infrastructure in the participating municipalities.

Cumulative Target Values Responsibil Description PDO Level Results Unit of Data Source/ Baseline Frequency ity for Data (indicator

Indicators* Core Measure Methodology YR 1 YR 2 YR3 YR 4 YR5 Collection definition etc.)

CITIZEN SATISFACTION Indicator One: Percentage 0 - - 5 - 10 Baseline, Project PCO in Municipal Percentage increase in the point mid-term household coordination infrastructure citizens who report that the increase (YR3) and survey. with the services include: infrastructure services over at project municipaliti municipal roads, offered by the municipality baseline. closure es. drainage, drinking better meet their needs than (YR5). water, sewerage and the previous year. solid waste. Weighted average across participating municipalities. Indicator Two: Percentage 0 - - 5 - 10 Baseline, Project PCO in Weighted average Percentage increase in point mid-term household coordination across participating citizens who report that they increase (YR3) and survey. with the municipalities. have participated in planning over at project municipaliti meetings at the ward level. baseline. closure es. (YR5). SECTOR PERFORMANCE Indicator Three: Number, - - - 50,000 - 100,000 Mid-term Progress PCO in Cumulative number Total number of people percentage (10%) (10%) (YR3) and report. coordination of people who benefited from urban services of females at project with the benefited from urban and infrastructure and closure municipali- services and improvements, of which disadvant- (YR5). ties. infrastructure

26 females and from aged improvements disadvantaged groups. groups. (aggregated and by sector). Percentage of beneficiaries that are female and from disadvantaged groups (Dalits, adivasis, janajatis, Muslims, Madhesis). INTERMEDIATE RESULTS

Intermediate Result (Component One - Service Delivery Improvement): Sustainable delivery of basic services supported through top-up block grants to participating municipalities. Intermediate Result indicator Percent of 0 25% 25% 35% 35% 35% Annually. Progres PCO and Municipal grant One: Municipal Grant Municipal s report. MLD, in allocated to programs allocated to programs Grant allocated coordinati benefiting women, targeting women, children to capital on with children and and disadvantaged groups. projects. the disadvantaged groups, municipali as a share of total ties. Municipal Grant allocated to capital projects. Intermediate Result indicator Number. 0 25,000 50,000 Mid-term Progres Cumulative number of Two: Direct beneficiaries of (YR3) and s report. municipal population capital projects financed by at project who directly benefit the Municipal Grant. closure from capital projects (YR5). financed by the Municipal Grant. (aggregated) Intermediate Result (Component Two – Socio-economic Infrastructure): Priority infrastructure in participating municipalities constructed and/or rehabilitated. Intermediate Result indicator Percent of 0 60% 70% 80% 80% 90% Annually. Progres PCO and Number of approved One: approved sub- s report. TDF, in sub-projects that are Approved sub-projects that projects. collaborati on track in meeting are on track in meeting their on with their target target infrastructure the infrastructure objectives. municipali objectives, as a share ties. of total approved sub- projects.

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Intermediate Result indicator Percent of 0 10% 10% 20% 20% 20% Annually. Progres PCO and Number of approved Two: approved social s report. TDF, in sub-projects receiving Approved social and utility and utility sub- collaborati (cash and in-kind) sub-projects with projects. on with contributions from beneficiaries’ contributions. the beneficiaries, as a municipali share of total approved ties. social and utility sub- projects. Intermediate Result (Component Three – Institutional Development): Enhanced planning, financial and budgeting capacity for sustainable provision of municipal services in the participating municipalities. Intermediate Result indicator Percentage 15% 15% 15% 20% 20% 25% Annually. Progres PCO and Percentage annual One: annual increase. s report. DUDBC, increase in own source Increase in municipal own- in revenues (weighted source revenues. coordinati average across on with participating the municipalities). municipali ties.

Intermediate Result indicator Number. 0 0 1 3 6 6 Annually. Progres PCO and Two: s report. DUDBC, Number of municipalities in with funded O&M plans. coordinati on with the municipali ties.

Intermediate Result indicator D/E = 8 - - 7 - 6 Mid-term Progres PCO and The following three Three: DSCR =.56 1 1.2 (YR3) and s report. TDF. financial ratios will be TDF’s key financial ratios Collection 80% 90% at project monitored: (D/E, DSCR, collection rate) rate =75% closure -D/E= Debt/equity meet prescribed thresholds. (YR5). -DSCR = Debt service coverage ratio -Collection rate

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Intermediate Result indicator N = No - N Y1 Y2 Y2 Y2 Annually. Progres PCO and Four: Y1 = Yes s report. TDF. Standard project appraisal (established) systems established and Y2 = Yes applied to all TDF projects. (applied) Intermediate Result indicator N = No - N Y1 Y2 Y2 Y2 Annually. Progres PCO and Five: Y1 = Yes s report. DUDBC, Guidelines for enforcement (approved) in of planning byelaws and Y2 = Yes coordinati building codes approved by (applied) on with MPPW and implemented by the DUDBC in the participating municipali municipalities. ties.

Intermediate Result indicator N = No - N Y1 Y2 Y2 Y2 Annually. Progres PCO and Six: Y1 = Yes s report. MLD, in Systems and guidelines for (revised) coordinati fiscal transfers to Y2 = Yes on with municipalities revised based (implemented) the on good practice standards municipali and implemented. ties.

*Please indicate whether the indicator is a Core Sector Indicator (see further http://coreindicators) **Target values should be entered for the years data will be available, not necessarily annually.

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Annex 2: Detailed Project Description

The Emerging Town Project (ETP) is an important first step of a longer term and programmatic engagement by the Bank to support decentralization and urbanization in Nepal, improve urban governance and services and strengthen the role of cities in the socio-economic development of Nepal, under the rubric of the Urban Governance and Development Program (UGDP). In the initial phase, the project will help improve planning, delivery and sustainable provision of basic services and priority infrastructure in 6 emerging towns, while, concurrently reforming polices, strengthening systems and capacitating personnel in relevant central institutions. Based on the lesson learned and systems and institutions strengthened, over time, Bank support will then be wholesaled to a larger number of cities and towns in Nepal.

Fig. 2.1: Roll out of the UGDP: ETP program

Building inter-govt. systems and MLD TDF DUDBC institutions Inter-govt. Capital financing Urban/infra Fiscal Transfers [L+G] policy & monitoring Testing viable approaches to service delivery

6 Mid-size Municipalities

Wholesaling: supporting inter govt. fiscal system MLD TDF LINE AGS. (DUDBC/DWSS) IGFTs: block Grant Infra policy & grants & capital administration & deconcentrated grants debt financing & financing Wholesaling: improving urban infra and service delivery

Strengthening Urban LG System Regional/large-scale infra

The project comprises three components: Component 1 will support municipalities in improving their day-to-day service delivery, enhancing sustainability of infrastructure assets and supporting community development initiatives by topping up the IGFTs to municipalities; Component 2 will finance socio-economic infrastructure development by providing a blend of grants and loans for high-value social and economic infrastructure sub-projects, selected, structured and implemented by the municipalities; and Component 3 will support institutional development activities for strengthening the municipalities, the MPPW, the MLD, the TDF and the DUDBC. The three project components are interdependent and complement each other, both functionally and temporally, as depicted in the figure below.

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Fig. 2.2: Integrated project structure

C3: long term Building systems that can plan, finance and deliver sustainable services

In the initial phase, the program will target the following 6 emerging towns located along two important north-south economic corridors: Dhankuta, Itahari and Mechinagar to the East and Baglung, Lekhnath and Tansen to the West of Kathmandu. The cities were selected after detailed analyses of socio-economic criteria such as population, poverty, past performance and economic potential (including rural-urban linkages), along with presence of other complementary donor initiatives and prevailing security environment. The municipalities in these towns have confirmed their readiness to become part of the project. These participating municipalities are the pivot of the project. They will not only benefit from bulk of the investments, but will also be the implementing agents with full operational discretion for various local actions such as selection, structuring and implementing infrastructure sub-projects, prioritizing local public expenditure needs and community priorities, and executing local actions on institutional development.

Successful implementation of the project at the local level requires strong commitment, substantial efforts, and whole-hearted cooperation by the participating municipalities and their stakeholders. In order for ensuring adequate commitment and participation, the municipalities will sign a MoU with the Government, represented by the MPPW and the MLD. The MoU spells out the commitments and responsibilities of both the Government and the municipalities, with specific provisions, conditions, eligibilities in funding and implementing each of the three main project components. The MoU will be a performance agreement that includes conditions for the municipalities to obtain or disburse the funds under the project. The performance focus may result in higher allocations for better performing municipalities. This arrangement not only creates a healthy competition, but also helps smooth implementation of the project and timely disbursement of resources at the local level.

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The project also supports reforming and strengthening systems and institutions that have a vital role in regulating, supporting and overseeing the urban sector and urban local governments. Thus, the MLD, the TDF and the DUDBC will not only play a critical role in implementing this project, but will each benefit from comprehensive institutional development support. The allocation of roles and responsibilities of key agencies in project implementation is summarized below.

Table 2.1 Allocation of roles and responsibilities in implementing project components

Components PCO MLD DUDBC TDF Municipalities Component 1: Distribute block Utilize grants in Service Delivery grants and compliance with Improvement Municipal Grants the block grant via and Municipal intergovernmental Grant guidelines, fiscal channels and ensure timely reporting of use of Monitor grants. performance, and monitor the use of grants ensuring timely reporting. Component 2: Provide grants, Select, design, Socio-economic loans and technical structure, co- Infrastructure assistance for sub- finance, manage Development project sub-projects development and implementation, and monitor the implementation. Component 3: Undertake Implement ID in Implement ID Implement ID in Implement ID in Institutional program MLD in DUDBC TDF municipalities and Development coordination social and mobilization and management community activities development at local level Manage ID for municipalities

Component 1: Service Delivery Improvement ($5m)

The intergovernmental fiscal system in Nepal is going through a transition with increasing attention to issues of vertical and horizontal equity in resource and revenue sharing over the last few years. This is largely an outcome of the move towards greater decentralization and federalism. Thus IGFTs in Nepal have witnessed for example substantial augmentation in recent years. Despite this trend, the overall degree of fiscal decentralization is still small in resource terms—for example, the share of local expenditure to GDP is estimated between 1.15% and 1.5% and to total government revenues is between 5% and 8%.

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Although fiscal transfers to local bodies have generally risen over the past few years, the increases for municipalities have not been comparable to those for rural bodies. There still exists, by all accounts, a serious fiscal gap at the municipal level with regard to current expenditures and service delivery requirements. Currently there are multiple grant flows to municipalities through various intergovernmental channels, among them the Local Development Fee grant, the LGCDP top up grants, the Road Fund grant, other discretionary grants, etc. The MLD has been working towards greater clarity in IGFTs to municipalities. It has recently consolidated its own block grants with the LGCDP top up grants, as well as issued the Municipality Grant Operation Procedure 2067 (2011), stipulating rules for utilization and reporting of all municipal grants. Nevertheless, there is scope for much improvement, especially with regard to clarity in fiscal flows, rationality of horizontal distribution and predictability in timing. This component will, over time, help reform rules and capacitate systems for improving the transparency, predictability and rationality of the grant system for municipalities. Once these rules and systems are established, the project will potentially extend support to additional municipalities through the IGFS.

The participating municipalities will be provided Municipal Grants that will top up their existing fiscal transfers. The amount to each municipality will be based on MLD’s block grant guidelines, which take into account factors such as population, area, weighted poverty, good governance and responsive service delivery—assessed annually under the MC/PM system. The MLD block grants to municipalities can be used for recurrent and capital expenditures, social mobilization and capacity building. The capital part is further sub-divided into economic, social and physical infrastructure development; promotional sector (mostly national priorities); and target group development programs (pro-poor and community development). There are detailed guidelines regarding shares for, utilization of and reporting under each of these categories and sub- categories. The Municipal Grants will be eligible for all categories, but recurrent expenditures.

The Municipal Grants are aimed at topping up discretionary resources that will help the local body gain greater credibility of its constituents through immediate service delivery improvements and on-the-ground community development initiatives. At least 35% of the capital expenditures under the Grants will be set aside for localized pro-poor and/or community-oriented schemes targeted at vulnerable groups, women and children. The top ups will also enhance the borrowing capacity of the municipalities as well as help local authorities improve O&M of existing assets and procure need-based capacity support.

The Municipal Grants will be channeled through the existing IGFT channels by the Municipal Management Division (MMD) of the MLD on the advice of the LBFC. Further details of this are provided in Annex 3 on Implementation Arrangements. The Municipal Grants will generally follow the same rules for general block grants, with some additional caveats and guidelines for enhancing the performance dimension and ensuring greater community/pro-poor orientation in public expenditures. The municipalities will have to demonstrate prudent use of the funds, inter alia, by monitoring and reporting improvement in services or administration and ensuring that the prescribed share of Municipal Grant is used for pro-poor and community development activities.

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Component 2: Socio-economic Infrastructure Development ($23.50 m)

The objective of this component is to assist municipalities in developing infrastructure that will lead to improved services and greater socio-economic benefits for residents and businesses. The municipalities will determine investment priorities based on their development plans prepared in consultation with key local stakeholders. This component will support expansion and/or rehabilitation of core municipal infrastructure, including local roads, drainage, solid waste, health, education, parks, libraries, street lighting, and strategic economic infrastructure such as transportation terminals, toll roads, markets, tourism infrastructure, etc.

The TDF, a state-owned autonomous municipal financing agency, will manage Component 2 under its standard operations and regular product lines. It has been assisting municipalities in sub-project initiation, feasibility studies, engineering design, and project implementation; it also performs due diligence in project appraisal, disbursement and civil works in the form of technical assistance to municipalities. The current product mix of the TDF includes investment grants, soft and regular loans, and technical assistance grants, depending on a municipality’s classification as A, B or C, the type of the infrastructure, and the source of TDF funds. These norms, which are complex, ad hoc and not founded on sound financing principles, are being revised as part of overall TDF reform.

Under TDF’s new financing policy developed with Bank and GIZ support, loans and grants will be administered separately. Sub-projects will be clubbed into three broad categories, namely social infrastructure, urban or utility infrastructure, and revenue generating or commercial infrastructure. Social infrastructure refers to sub-projects in social sectors like basic health centers, community centers, public toilets, green spaces, slum upgrading, etc.; urban/utility infrastructure includes water, sewerage, solid waste and municipal roads, etc.; and revenue generating/commercial infrastructure comprises markets, tourism facilities, parking spaces, transportation terminals, etc. Social infrastructure will receive the highest share of grants (up to 80%), followed by urban/utility infrastructure (up to 60%) and revenue generating or commercial infrastructure (up to 30%). Municipalities will have to provide own or community cash contribution of about 10% of the total sub-project cost in order to receive grants. This own contribution can also be covered by loans in sub-projects with limited community contribution. As a result, the municipalities will make use of a combination of grants and loans to initiate an efficient and affordable mix of sub-projects by estimating their funds available for financing cash contribution (own revenues, block grants), the size of the eligible investment grant and their borrowing capacity. Municipalities will also have to meet certain minimum standards with regard to their key financial ratios,12 as well as establish adequate fiduciary systems.

Integrating this financing system into the overall intergovernmental fiscal framework (which aims to incentivize improved revenue mobilization and better expenditure management) provides a more rational basis for financing of urban infrastructure and services. The objective is to ensure that, at one end, broad public goods are supported through shared revenues, while, at the other end, revenue generating or commercially-oriented infrastructure are financed through a mix of other sources of financing, including debt, which more accurately reflect their true costs. Further,

12 For example, (i) total expenditure/total revenue not more than 1 and (ii) interest plus repayment/total revenue not more than 0.3. 34

it will also ensure that large scale municipal infrastructure projects with longer lifecycles are structured affordably, implemented efficiently and operated sustainably. The TDF reforms are closely coordinated with other donor agencies such as the KfW, which has long supported the agency, and the ADB, which has a number of programs operating through the TDF.

Funds from the Bank will be channeled to the TDF as part grant and part loan. In the initial stage it is expected that about two thirds of the funds will be channeled as grants and remaining one third as a loan at 1.5% interest rate with a maturity of 23 years and grace period of 8 years. This reflects the expected loan-grant mix that will be channeled to the participating municipalities based on their initial pipeline of sub-projects. These terms will be reviewed during the project mid-term or at a time agreed between the Bank and the Government and revised if needed.

The participating municipalities will need to identify, prioritize and initiate sub-projects themselves and submit formal application to the TDF. They can obtain support for feasibility studies and engineering designs from the MST, by hiring consultants on their own or with project support via the TDF, or from competent central agencies. They will receive (i) infrastructure grants offered in decreasing share for social, urban/utility, and revenue generating/commercial sub-projects; (ii) loans; and (ii) technical assistance grants for sub-project design, structuring and implementation. The effective loan/grant (L/G) allocation will be determined by the L/G policy of the TDF noted above, as well as by the demand for particular types of projects. The overall funding envelope for each municipality will be determined on the basis of its population, poverty and past performance. Additional criteria will be developed, tested and added over time. The actual commitments to a municipality will, however, depend on factors such as its financial sustainability, readiness of a pipeline of feasible sub-projects, project management capacity measured by progress in implementing approved sub-projects, and other criteria.

The 6 municipalities have already developed an initial pipeline of sub-projects that reflect their priorities and capacities. These are being scrutinized presently for their feasibility. Detailed engineering designs of eligible sub-projects are expected to be completed by project effectiveness. Several participating municipalities will be ready to implement their initial pipeline of feasible sub-projects by the start of project implementation. Those who are unable to do so will continue preparations and start sub-projects during the first or second year. They will be supported in this task by the TDF and the MST. Financing under Component 2 through the TDF will be opened to additional municipalities when the program is expanded at a later stage.

The average size of TDF-supported municipal infrastructure projects is foreseen in the range of $250,000 to $1.0 million initially. It is expected that the weak technical, managerial and financial capacities of the municipalities will constrain them from taking on large and/or multiple sub- projects in the early stage. Municipalities will be responsible for implementing and supervising their sub-projects and can obtain external support for this should they desire so. Larger sub- projects may be approved and implemented in a multi-year program. However, this will require the municipalities to enhance their planning, financing and project implementation capacity. To address this, the municipalities will be provided with support under Component 3.

Component 3: Institutional Development ($6.62 m)

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The Institutional Development (ID) component will support institutional strengthening of participating municipalities, the PPW, the MLD, the DUDBC and the TDF, as well as program management activities. Priority areas and detailed actions have been identified based on institutional assessments of and extensive dialogue with the said entities and other key stakeholders. The allocation of funds across the various entities is summarized in Table 2.2.

Table 2.2: Allocation of Funds for Institutional Development (US$ ‘000)1/

Agency/ Year 2011 2012 2013 2014 2015 2016 Contingency Total (10%) DUDBC 208.00 335.00 102.00 33.00 18.00 69.60 765.60 MLD 120.00 199.00 107.00 53.00 41.00 52.00 572.00 TDF 657.00 517.00 459.00 50.00 50.00 173.30 1,906.3 Municipalities 862.00 454.00 414.00 315.00 245.00 229.00 2,519.0 PCO/MPPW 31.50 213.00 95.00 236.00 74.00 133.00 78.25 860.75 Total 31.50 2,060.00 1,600.0 1,318.0 525.00 487.00 602.15 6,623.65 1/ The costs are indicative at this point. Based on progress in institutional development activities, they may be recalibrated during project implementation.

The participating municipalities will be the main focus of the ID component. All the 6 municipalities have undertaken institutional assessments, while some have prepared capacity development plans with LGCDP support. While each municipality will determine its priority areas for strengthening, the broader objective of this component is to assess, test and establish what would constitute a fairly standard framework for municipal institutional development, which would then enable the project to wholesale support to additional municipalities over time. The main areas identified for municipal capacity building are noted below.

Table 2.3: Institutional Development Program for Municipalities

Outcome Area Indicative list of tasks (This will be further clarified and revised based on actual needs of participating municipalities with the support of MST) 1. Urban Introducing computerized accounting, budgeting, MIS, and fiduciary, management internal control, treasury, cash management, and financial analysis Streamlining Introducing environmental and social safeguard, customer relations, existing systems and communication system establishing Strengthening community/citizen orientation of the municipality with computerized emphasis on vulnerable groups like janjatis, dalits, women, etc. systems, procedures Introducing complaint centers, citizens scorecards and website on urban Training: basic computer skills and urban management (classroom and management on-the-job)

Workshop on urban management 2. Strategic urban Urban planning, zoning, land use planning, building regulation and planning enforcement, environmental and social policy, impact assessment

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Enhancing urban Formulating local economic development plans and social/community planning systems, development strategies procedures, Establishing systems for urban planning, zoning, services, assets, and databases, and revenue management, including training of staff capacities, with Developing social and poverty profiles ICTs Classroom and on-the-job trainings on strategic urban planning 3. Asset Strengthening asset maintenance and refurbishment, procurement and management store management, capital improvement planning and public private Strengthening asset partnership management, project Strengthening project design, management, monitoring and contract design, procurement, management and contract Testing land pooling, where relevant management by Verification of municipal assets and establishing asset databases establishing Classroom and on-the job trainings and workshop on asset management systems, databases, and urban services and institutionalizing procedures 4. Urban services Establishing systems, procedures, capacities for managing urban Establishing services reliable, cost Introducing rules, procedures, systems and capacities for enhancing effective and urban cost recovery services Introducing procedures for performance measurement and quality control Testing PPPs 5. Own source Establishing systems, procedures, and capacities for revenue policy, revenues planning, and analysis and multi-year revenue enhancement program Improving own- Establishing systems, procedures, and capacities for revenue source revenues , administration (tariff setting, billing, collection, enforcement, and including property remedies) rate, other property Verification of tax bases and establishing taxation and service fee related revenues, databases rents, fees and Revenue potential studies (municipal own cost) charges, and asset Classroom and on-the job training for municipal staff on own-source proceeds revenue management 7. Goods and Equipment Indicative list for equipment subject to finalization by the MST. Goods Providing adequate and equipment will be procured at the center by the PCO to ensure cost equipment for efficiency and system compatibility institutional

37 development, Servers including hardware Laptops and desktop computers and software and LAN network w installation other equipment as Software (MIS + GIS) with license deemed required. Printers Plotter for GIS, zoning, urban planning High capacity printer for billing UPS Generators and furniture for municipal IT unit

The MST will help the participating municipalities in implementing the ID component. It will include experts on municipal management, MIS, social mobilization and community development, municipal and project finance, engineering, etc. The MST will provide on-the-job training, working hand-in-hand with municipal officials in introducing and operationalizing the new systems, procedures and instruments (HW/SW). This will be complemented with specialized training, where relevant, by the UDTC. On top, the municipality will be free to utilize a share of its block grants (including the Municipal Grants), as per the guidelines, to procure specialized/need-based capacity support. The participating municipalities will be required to assign adequate staff for ID activities and are expected to use their new systems with minor external support in about three years of implementation of the ID component.

Institutional capacity is very weak at all levels of government in the urban sector in Nepal. The ID component will, therefore, help build systems at the top level. Institutional reforms in key central level institutions such as the MLD, the DUDBC, and the TDF are based on comprehensive assessments which have led to institutional development action plans that respond to internal systems, processes and personnel. It must be noted here that, although all the three institutions will be covered under this component, considering the large scale institutional needs of these entities and the limited scope and resources available at this point, the activities under this component will prioritize areas that will directly support implementation of the other components of this project. Further, activities under this component will ensure full synergies with other partner programs and agencies, especially the udle and the LGCDP.

With regard to specific areas of support at the central level, the ID component, in a nutshell, will: • Reform and strengthen the capacity of the MLD and the LBFC to manage IGFTs to municipalities better, as well as enhance the capabilities of UDTC in specific areas of municipal capacity building. This will include: (a) reviewing and updating systems and guidelines for fiscal transfers to municipalities at MLD; (b) reviewing and updating systems and guidelines for municipal planning and management, as well as the MC/PM at MLD and LBFC; (c) updating/establishing curricula/training at the UDTC in fiscal decentralization, local revenue mobilization and expenditure management and local public financial management; and (d) essential ICT and MIS related equipment in the MLD and LBFC.

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• Support a major refurbishment of the TDF. The agreed Business Strategy and Action Plan will guide the institutional development of the TDF, and it covers, among other areas: (a) immediate actions aimed at restructuring and work-out of problem loans in the TDF; (b) establishing/strengthening units, systems, procedures, skills and capacities for project finance, fund and risk management, business development, human resources, financial management, procurement, MIS, and social and environmental safeguards; (c) improving TDF’s outreach to local governments; and (d) essential equipment, vehicles and office refurbishment.

• The institutional development of DUDBC will focus on: (a) developing a business strategy for DUDBC to help the agency address the challenges of decentralization and state restructuring; (b) developing/updating policies and guidelines, building systems and capacitating personnel in the areas of urban development, periodic planning, enforcement and urban information systems; and (c) strengthening urban information systems for better policy implementation and monitoring, and improving links between HQ and regional offices of DUDBC.

This component will also support project coordination and management activities, both at the center and in the selected municipalities. The set of activities that will be financed under this component includes, among other things: (i) project specific M&E; (ii) operationalizing the EMF and the SMF and supporting grievance redressal mechanisms at the central and local levels; (iii) logistics and equipment connected with project implementation and supervision; (iv) IEC; (v) financial management and procurement; and (vi) studies, workshops and project expansion activities. The project management component will be coordinated by the PCO.

The ID component reflects a strong synergy and joint approach in substance and financing with a number of other ongoing programs and partners, among them the GIZ, the KfW and the ADB. In particular, the ID component has been jointly designed (with the Government) and will be supported by the Bank and the GIZ together. The details of this cooperation are spelt out in Annex 3. Further, the activities under this component are harmonized with ongoing country programs, including those provided through the local body training academy and the UDTC, as well as with the LGCDP capacity development initiatives.

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Annex 3: Implementation Arrangements

Introduction

Detailed institutional assessments were carried out for all key agencies, both at central and local levels, as part of preparations. These institutional assessments along with other important considerations, noted earlier, have guided the formulation of the implementation arrangements.

Central arrangements

At the national level, the MPPW will be the executing agency and the MLD will be the co- executing agency for the program. Together they will ensure that the program is implemented in line with the agreed objectives, provide governmental oversight and be responsible for smooth implementation. A Project Steering Committee (SC) chaired by Secretary, MPPW and co- chaired by Secretary, MLD will ensure overall project coordination, provide policy guidance, and monitor progress on a regular basis. The Steering Committee will comprise Joint Secretary, MPPW; Joint Secretary, MLD; Joint Secretary, Foreign Aid Coordination Division, MOF; Joint Secretary (Infrastructure) and Joint Secretary (Local Governance), NPC; Director General, DUDBC; the ED, TDF; Project Director (PD) as the Member Secretary; 2 representatives of the participating municipalities (on a rotational basis); representatives of the MuAN and the FNCCI; and a renowned urban/municipal expert from the civil society. Representatives from the World Bank and the GTZ will join as observers in the SC.

On a day to day basis, implementation will be coordinated by a Project Coordination Office (PCO) attached to the DUDBC. The PCO will serve as the Secretariat of the SC. It will comprise a Project Director (PD), who will also serve as the Secretary to the SC, as well as three Component Managers (CMs), representing the MLD, the TDF and the DUDBC and in-charge of their respective components. The institutional arrangements emphasize maximum operational autonomy for each agency in managing and implementing its component, while the PCO will play a coordinating and facilitating role to all three components. It will receive annual work programs from the three agencies; review them for overall conformity with the project objectives; prepare a consolidated work program for review and approval by the SC and present this to the MPPW, the MLD, the NPC and the MOF for approval, as needed; ensure quality control of the reports submitted by each agency and present consolidated reports to the SC; facilitate implementation by the respective agencies and ensure coordination across individual components; coordinate with various ministries/agencies, the World Bank and the GIZ; ensure timely processing of fund requests; and facilitate timely release of funds to the respective agencies. The PD will be in charge of program management and s/he will be supported by the CMs and a small contingent of staff deputed by the Government and consultants financed by the program. The designated CMs from the TDF, the DUDBC and the MLD will be responsible for ensuring management of their respective components within each agency and coordination with other components as well as with the PCO; ensuring timely reporting to the concerned authorities and the PCO; and managing fund requests to donor agencies via the PCO.

The Municipal Management Division (MMD) within the MLD will implement the Service Delivery Improvement component, which will provide Municipal Grants to the municipalities, as

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well as be responsible for implementing activities associated with the institutional development of the MMD, the LBFC and the UDTC. Within the MMD, the Under Secretary in charge of the Municipal Planning Section (MPS) will serve as the Component Manager (CM 1). S/he will be supported by designated staff for project-related procurement and financial management.

Under the prevailing national system for fiscal transfers to municipalities, the LBFC advises the MMD on the annual allocations to municipalities based on the agreed national formula and guidelines for allocation of block grants. Within MMD, the MPS will determine the final allocations and inform the municipalities and the Finance Section of the MLD of the same. The actual disbursements are released by the Finance Section of MLD, which issues the authorization letter to the municipalities with copy to FCGO and the DTCO. The DTCO releases the funds on a trimester basis. The Bank-financed Municipal Grants will be channeled under the same institutional arrangements and concurrently with the block grants. It will finance capital expenditures, social mobilization and capacity building activities of the municipalities. The CM 1 will coordinate Municipal Grants activities and ensure that the funds are disbursed in a timely and predictable fashion. S/he will inform the PD if the participating municipalities have met the eligibility criteria for the Municipal Grants and the amounts allocated to them, submit work- plans, progress reports and withdrawal applications, and ensure coordination with other funds flowing to the municipalities.

The CM 1 will also manage all project-financed activities associated with the institutional development of MLD, the LBFC and the UDTC. S/he, in consultation with the respective agencies (specifically with the Member Secretary, LBFC and the Principal, UDTC), will prepare 5-year institutional development plans and annual work-plans based on the priorities assessed and agreed during project preparation phase. The annual work plan will be submitted to the PD, PCO after approval from the Secretary, MMD. As with the block grants, the CM 1 will also submit progress reports and withdrawal applications on a timely basis.

The MMD was established within MLD 10 years back. It is headed by a Secretary and has three sections, namely the Municipal Management, the Municipal Planning and the Environment Management . The MMD is responsible for setting the vision for municipal development in the country, as well as for a broad range of activities associated with regulation, resources transfers, institutional development and capacity support, and monitoring and oversight of municipalities. It is also charged with formulation and implementation of policies and plans for SWM and sanitation, representation on subjects related to municipal development fund and environmental issues of municipalities, and resource mobilization and coordination. Overall assessment suggests that the MMD has an increasingly important role in municipal affairs, but its capacities for the regulation, management and oversight of municipalities need strengthening. Much of the capacity support and oversight of municipalities are undertaken through external mechanisms like the MC/PM and programs like the udle. MMD’s human and financial resources are not fully compatible with its assigned functions. Some of its responsibilities overlap with the DUDBC and other ministries, with which the coordination needs to be improved.

The TDF will manage the Socio-economic Infrastructure Development component. The selection of investment priorities will be undertaken by each municipality, while the TDF will manage the fund, appraise sub-projects selected by the municipalities for their technical and financial

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feasibility, and assess the ability of municipality to meet its financial obligations associated with the investments. It will also implement institutional development activities associated with its own institutional strengthening.

The CFO of the TDF will serve as the Component Manager (CM 2). S/he will prepare detailed annual work-plans, which will include a list of ready sub-projects in participating municipalities and a plan for expected disbursement for the given sub-projects in the planned year. The CM 2 will keep the project pipeline and disbursement plan as a reference and regularly update them. The identification, structuring, approval and financing of sub-projects will follow the standard operating procedures of the TDF, which are now subject of revision.

According to the current rules and procedures, the TDF identifies a sub-project by screening a municipal sub-project application submitted in a standard Grant Application Form with supporting documents (e.g. availability of land). Based on a positive Pre-appraisal Report, the ED approves the sub-project idea and the TDF notifies the municipality in a Confirmation Letter. Municipalities are eligible to design and structure the sub-projects, but request expert support through a Grant Application Form for Study. The TDF then pays a consultant to work with the municipality to prepare feasibility study and detailed engineering design. The TDF appraises the sub-project based on the Final Report. TDF’s Project Appraisal Report sets financing terms, which is reviewed by the Loan and Grant Subcommittee before the ED finally approves the sub- project and sends a Notification Letter to the municipality. S/he then signs the Loan Agreement with the municipality, specifying the terms and conditions (e.g., maturity, grace period).

Municipalities select and contract construction companies following national procurement rules and norms set by the TDF, or undertake the construction themselves. Construction supervision must be performed by qualified personnel and the municipality may hire its own qualified consultants, request the TDF to finance and contract construction supervisor, or seek help of other government agencies. The TDF monitors and verifies construction progress and quality (Field Visit Reports) before disbursement, variation, or time extension, and particularly before disbursement of the Final Bill. It also performs post-evaluation to monitor O&M and support loan repayment by municipality or detect irregularities (Early Warning).

The CM 2 will also manage and coordinate the institutional development activities of the TDF. S/he will ensure that the agreed TDF Business Strategy and Action Plan are operationalized as per the timetable, prepare annual work plans and progress reports, monitor progress, ensure coordination with other program components, report to the PCO and the ED, coordinate with the World Bank and GIZ, prepare withdrawal applications, and ensure timely fund availability. The TDF will have a dedicated support team to assist the CM 2 in fiduciary and safeguards issues.

The current TDF, the successor to the Town Panchayat Development Fund (established in 1987) and the Town Development Fund Board (reconstituted in 1989), was set up as an autonomous corporate body in 1997, to provide financial and technical support to urban sector institutions, including urban local governments, which implement urban services and programs. The TDF is the only institution in the country presently providing debt financing to local governments. Several donor agencies like the GIZ, the KfW, the ADB and the World Bank have worked with TDF since its inception. Local governments in Nepal, especially municipalities and fast growing

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emerging towns, are its main clients. The GON, especially the MOF and the NPC, view it as a key institution that has an important role in the urban infrastructure development of the country.

For much of its two plus decades of operations, the TDF has effectively, even if in a limited way, supported urban local governments and financed urban infrastructure in Nepal. However, starting in the mid-2000s, during a period of management uncertainty, TDF saw its institutional and financial standing dip. On the institutional front, TDF is inhibited by an incoherent financing policy, inadequate systems for project appraisal, risk management, business development and loan recovery, and weak personnel capacities. On the financial front, repayments from several towns under the STWSSP and UEIP projects have been increasingly poor. Consequently, TDF has defaulted on its payments to GON and its key financial ratios have suffered a decline. To address this and undertake strategic institutional reform, the TDF has developed a Business Strategy and Action Plan, which will be implemented under the project. Further details on TDF, including the current institutional and financial issues and proposed reform package, are described in Annex 9.

Overall, the DUDBC, to which the PCO is institutionally attached, will coordinate the ID component across different agencies, in addition to implementing its own institutional development plan. A Senior Planner from its Planning Section will be the component manager (CM 3), who will prepare annual work plans and progress reports, ensure coordination with other components, report to the PCO and the DG, DUDBC, coordinate with the World Bank and the GIZ, prepare withdrawal applications, and ensure timely fund availability. The PCO will coordinate project management activities as well as institutional development activities for participating municipalities, especially the procurement and management of the MST and procurement of core equipment for the municipalities. The PD will work closely with the three central agencies, especially the MLD, with regard to the deployment and operation of the MST. S/he will ensure that the support provided by the MST is line with the institutional development plans of the municipality and coordinated with municipal capacity building efforts via UDTC.

The DUDBC, which is under the MPPW, had its origins in the Department of Building, which was established in 1963 to design, construct and supervise government buildings. After several rounds of restructurings over the course of years, the present day DUDBC was constituted in 2000 by merging the Departments of Housing & Urban Development and Building. Key functions and responsibilities of the DUDBC include formulation, planning and implementation of urban policies; formulation, planning and implementation of housing plans and policies; design construction, repair and maintenance of the government buildings; and management of Town Development Committees. Institutional assessment of the DUDBC has revealed that the agency is constrained by functional overlap with the MLD in areas of local planning and support to urban local governments, weak policy orientation with regard to urban development, poor coordination with MLD and other important agencies/entities in the urban sector, weak relations with municipalities and limited technical capabilities. Over the longer term, by recasting its roles and functions and strengthening its capabilities, the DUDBC could play a key role in the urban transformation of the country, especially in urban policy setting and monitoring.

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Local arrangements

The municipalities are responsible for implementing the local level activities including (i) utilizing the Municipal Grants, (ii) undertaking socio-economic investment sub-projects, and (iii) completing institutional development actions within their jurisdictions. The project will be mainstreamed at the municipality level mostly through existing systems, but with a focus on internal reforms and incremental institution building.

At the working level, a Project Management Team (PMT) will be set up within the municipality, comprising, at the minimum, the Executive Officer and the section chiefs of four key sections of the municipality, namely planning/engineering, finance, social mobilization and administration. The Executive Officer will serve as the Project Coordinator and be responsible for smooth on- the-ground implementation. S/he shall ensure coordination among sections, with the central agencies and local stakeholders, ensure fiduciary and safeguards compliance, submit reimbursement requests, provide progress reports, and so forth. S/he shall designate one of the section heads as the Deputy Project Coordinator, who will provide day-to-day support to the Project Coordinator. In most Nepali municipalities, including the 6 that are participating in the initial phase, these represent the core developmental and administrative sections. Should a municipality wish to include additional section heads in the PMT, it will be free to do so.

In addition, to fulfill specific project management activities, such as project-specific financial management, procurement, safeguards management, monitoring and reporting, the PMT shall be assisted by a dedicated Project Support Team (PST) with designated municipal staff or consultants in these areas. The PMT will also be supported by the MST in matters of day-to-day project management. The establishment of the PMT and the PST are conditions for any participating municipality to access project financing.

In the absence of elected councils, the challenge of making local administrations accountable and responsive to citizens becomes even more daunting. Although the municipalities are routinely consulting with local APMs, which have been provided some degree of formal recognition by the Government, local level political economy studies have highlighted the need for bringing about broader stakeholder buy in and ensuring that vulnerable groups have adequate voice in municipal decisions concerning use of public resources, prioritization of infrastructure and delivery of services. To that end the project will:

• support the use of Municipal Grants for building the capacity of APM members so that they can discharge their advisory and oversight roles more effectively, especially in areas of planning, budgeting, monitoring the delivery of services, and ensuring that the voice and needs of vulnerable groups are represented better in municipal decision making.

• establish, at the apex level, a Municipal Coordination Committee (MCC)—akin to the SC at the center—comprising the Executive Officer of the municipality, the APM and a broad range of civil society stakeholders including vulnerable groups. The MCC will meet at least once a trimester to deliberate on critical local development issues which need to be addressed under the project, review project progress, and help resolve major city-level bottlenecks.

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• strengthen ward committees, which will meet periodically for local planning, expenditure prioritization, selection of socio-economic sub-projects, delivery of local service, and so forth.

The 6 municipalities which are included in this phase of the project, while selected using clear criteria, are somewhat representative of municipalities in Nepal with population under 100,000. The issues and challenges that characterize these urban centers are common throughout Nepal. A detailed profile of these municipalities is provided in Annex 9. To summarize here, like many small and mid-size Nepali municipalities, they also face challenging urban transitions—rapid population growths that are not matched by expansion of economic opportunities, lack of fiscal resources, critical infrastructure deficits and poor urban services.

The participating municipalities are facing these enormous pressures with limited financial resources and human capabilities in a challenging political and policy environment. Over and above the lack of elected political leadership, these municipalities are characterized by administrative inefficiencies, capacity limitations, resource constraints and poor coordination amongst local development actors (including central government, lines agencies, NGOs and donors). Their ability to manage urban infrastructure and service programs are constrained by the limited number of staff available and weak technical capacities. Municipal level monitoring and reporting systems are weak and non-transparent. Financially too, the municipalities are in a poor state of health. Locally generated revenues are a small share of total revenues—less than 21% in all cases and going as low as 6% for Lekhnath—due to limited revenue base, while the IGFTs are often not predictable or timely. The accounts for only one of the 6 municipalities are considered to be good, while, worryingly, for many the operating deficit is growing and as a consequence, borrowing capacities are getting diminished.

Institutional profiles of these municipalities provide detailed analyses of the legal, technical, financial, administrative and other constraints faced by them, along with clear recommendations for addressing these. Further, some municipalities have prepared their own institutional development plans. The project will provide comprehensive support for the systemic development of municipalities, through a range of flexible mechanisms, noted above, that delivered from the top and mobilized from the bottom.

Financial Management, Disbursements and Procurement

Adequacy of financial management arrangements

Detailed institutional assessments of the 6 municipalities, as well as the MLD, the TDF, and the DUDBC have highlighted strengths and shortcomings in fiduciary aspects. These assessments have analyzed perceived risks and recommended mitigation measures to overcome them. They conclude that these municipalities are among the better-managed local bodies. However, the Bank is working at the municipal level for the first time. Both the TDF and the DUDBC have also not worked with the Bank in a long time. Although the Bank and the MLD are working together in a few operations, the agency needs further strengthening in financial management. Recommendations for strengthening financial management capacities made for each of these agencies will be addressed through the ID component.

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The Government has already established the PCO and appointed the PD and Component Managers. Further, Finance Officers in each of the central agencies have also been identified. Nevertheless, because there is a need for extensive coordination between various agencies and stakeholders, and that all these agencies are relatively new to Bank’s procedures, the fiduciary risk is rated High, and following some mitigation measures being worked out in close partnership with GIZ and through PPF advance, the residual fiduciary risk is rated Substantial.

Fiduciary arrangements

Delegation of authority for project implementation: Based on the approved annual work program and budget, spending authority will be delegated by the Secretary, MOF to the Secretaries of MPPW and MLD. The Secretary, MPPW will further delegate authority to the Director General, DUDBC to implement the DUDBC institutional development component; to the ED of the TDF to implement the socio-economic infrastructure development component and TDF-related institutional development activities; and to the PD, PCO for project coordination and municipal institutional development activities. The Secretary, MLD will delegate spending authority to the CM 1 for managing the Municipal Grants and its institutional development activities.

Budget arrangement and fund flow: The project will have a separate identifiable budget head in the Government’s Red Book, with sub-heads for MPPW and the MLD. Funds will flow directly from the DTCO to the PCO, the TDF, the MLD and the DUDBC for their respective components. Based on approved annual work plan and budget, the PCO will communicate to the Bank the procurement and disbursement plans for the year. Capital financing, block grants and operating expenditures will be pre-financed by the Government and later reimbursed based on consolidated accounts. The PCO will consolidate expenditure statements from all agencies and submit the documents to the Bank for reimbursement or replenishment. It will manage the Special Designated Account established in US Dollar at the NRB and designate signatories to operate the Account, which will normally be the PD and the project Finance Officer. Transaction-based disbursement procedures will be applied for withdrawal of project funds.

Planning and budgeting

TDF: The planning and budgeting process for the Socio-economic Infrastructure Development component will follow TDF’s current procedures. The annual budget prepared by TDF’s finance unit in consultation with other units is reviewed by the ED and submitted to the TDF Board. The Budget Committee formed by the Board reviews the budget in detail and provides recommendations to the Board, which then reviews and finally approves the budget. The TDF will prepare its work program and budget and submit to the PCO for project level consolidation.

MLD and DUDBC: The project will follow the Government’s existing financial management procedures as elaborated in the Financial Procedure Regulations (FPR). The annual budget will be based upon the work program that will be prepared by the MLD and the DUDBC and forwarded to the PCO for consolidation. The PCO will submit the annual work programs and budgets for the project to the NPC and the MOF through the MPPW, under standard government rules and procedures.

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Municipalities: As per the existing practice, prior to the beginning of each financial year the Executive Officer of the municipality shall prepare the annual budget, incorporating the activities funded under the project, and submit for various approvals. Based on the approved program, the municipality shall prepare and submit its sub-project funding proposals to the TDF.

Funds flow arrangements

Project funds will be allocated in the annual budget and the money will be released for the approved work program in three tranches. Prior to the approval of the work program and budget, one-third release of the previous year expenditures or projected expenditures for the first trimester, whichever is greater, will be made to the TDF through the respective DTCO. Capital financing and operating expenditures will be pre-financed by the Government under reimbursable heading, and reimbursed later based on consolidated accounts. Bank’s share of other expenditures, which includes Municipal Grants, capacity building and project management activities, will also be pre-financed through the Government’s consolidated fund and reimbursed later. Upon approval of the work program and budget, appropriate adjustments will be made against the advance for the first trimester release. The second and third trimester releases will be based on physical progress, as per Schedule 2 of the IPRs and PFSs.

Project financial accounting, reporting and internal controls

The PCO will ensure that separate books of accounts by component are maintained for the project and the accounts are prepared on a cash basis. The accounting information will be regularly updated to generate timely financial reports. The accounting system contains the following features: (i) application of consistent cash accounting principles for recording and reporting financial transactions; (ii) a well-defined chart of accounts that enables meaningful summarization of financial transactions for financial reporting purposes; (iii) maintenance of withdrawal monitoring register, records of SOEs and Designated Accounts register; (iv) the asset register; (v) monthly closing and reconciliation of accounts and statements; and (vi) the production of annual financial statements.

The PCO will prepare consolidated IPRs and PFS, covering the use of funds from all central agencies and the municipalities. The interim financial report of the IPRs will report total investments in the project separated by specific activity so that the utilization of IDA funds can be tracked and monitored at the aggregate level. The IPRs will show the sources and uses of funds, output monitoring report, procurement management report, and narrative progress report in formats that have been agreed upon during negotiations. They will be prepared on a trimester basis and submitted within 45 days of the end of the preceding trimester.

Component level: The CMs will provide component information to the PD for trimester reporting. Each component will maintain accounts as per the guidelines specified in the POM. The TDF currently maintains accounts according to the accounting manual prepared based on generally accepted accounting practices and using micro banking software which has capability for the proper recording of project financial transactions. It has a proper control system in place for the preparation and approval of transactions. Similarly, the DUDBC and the MLD will maintain accounts based on existing Government system, as specified in the POM.

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Municipality level: Existing municipalities following cash basis of accounting while newly formed municipalities are required to follow accrual basis of accounting from FY2010/11. Municipalities are required to follow the financial system, accounting system and format of the accounts described in the Local Entities Financial Administration Regulation and the Local Self Governance Act and Regulation.

The Municipality Grant Operation Procedure 2067 (2011) issued by MLD recently has detailed guidelines regarding utilization and reporting of municipal grants. They cover eligible grant utilization sectors, integrated plan preparation procedures, project selection, program/project implementation and management, monitoring and evaluation, budget authorization and disbursement procedures, grant fund management, and financial management and governance. According to new guidelines, all funds (including grant funds) are disbursed to “B” account of the municipality, which is a non-operating account called the Municipal Fund account. On approval of the annual budget and work plan, the amounts are then transferred to the “C” group accounts of the municipality, which are the operating accounts, under 5 heads broadly: unconditional grants, conditional grants, own revenues, donor/development partner funds, and miscellaneous. The total unspent amount at the year end is transferred to main account and the amount to be frozen is refunded to the DTCO.

The Municipality Grant Operation Procedure 2067 (2011) has also prescribed detailed formats for financial and physical reporting on both recurrent and capital expenditures. According to the prescribed format, the expenditures incurred from capital budget are to be reported on a trimester basis. It has also prescribed the other formats for reporting total physical and financial progress in each sector. Overall, there is a system that allows for tracking of expenses, which will be further strengthened under the project.

Financial management staffing

The PCO requires a strong team capable of coordinating financial management activities across different project agencies and components. It will create the position of a Finance Officer and appoint an experienced consultant to this position. At the component level, the central agencies will designate one qualified person for maintaining project accounts and coordinating with the Finance Officer at the PCO. The municipalities will also maintain adequate staffing for financial management. The participating municipalities have a finance/accounts section managed by municipal staff. The head of the finance/accounts team will be part of the PMT. The support team within the municipality will comprise staff for financial management. The municipalities will procure additional consultant support, if needed, using their own resources.

Internal audit

As fund releases, to be pre-financed by the government, are made through the respective DTCOs, they will carry out internal audits of the project. Internal audits will be carried out on a monthly basis. At the component level, the TDF’s internal audit is conducted by the professional accountant (having at least 10 years of experience and hired contractually) who reports to the ED. The TDF has decided to create an Internal Audit Department which will report to the ED and carry out regular internal audits. Internal audits in DUDBC and MLD are carried out through

48 the respective DTCO. The municipalities will conduct internal audit through their internal audit unit and submit internal audit report to the Executive Officer. Municipalities having annual income more than Rs.10 million should have the internal audit unit under officer level staff, while those having annual income less than Rs.10 million should have internal audit unit under non-officer level staff.

External audit

The annual audit13 requirements for the project (a consolidated audit report covering the use of funds by implementing agencies) that will be monitored in the Audit Report Compliance system (ARCS) are: Table 3.1: Audit Details

Implementing Audit Auditors Audit Due Date Agency PCO (in coordination Consolidated Project Financial OAG 6 months after with TDF, DUDBC Statements (including SOE the end of fiscal and MLD) Statement and Special year (January Designated Accounts) 15th) TDF Entity Financial Statements Private Auditor 6 months after appointed by the the end of fiscal TDF Board year (January 15th)

TDF external audit: Audit of the TDF will be conducted by the independent private auditor appointed by the Board in consultation with the Auditor General as per Section 22 of the TDF Act 1997, based on Nepal Standards on Auditing and terms of reference satisfactory to the Bank.

Financial Management Action Plan

Action to mitigate financial management risks, agreed between the Government and the Bank, are summarized below.

Table 3.2: Financial Management Action Plan

Action Responsibility Completion Date Assign two separate identifiable project budget lines for MOF April 30, 2011 MPPW and MLD in the Red Book for FY2011/12 MPPW MLD Prepare a detailed consolidated annual work program and PCO June 30, 2011 budget for FY2011/12 Adopt final POM acceptable to the Bank PCO Effectiveness condition

13 Standard Terms of Reference as agreed with the Auditor General and as acceptable to the Bank will be applied. 49

Action Responsibility Completion Date Develop a computerized Financial Management PCO December 31, 2011 Information System (FMIS) at the PCO.

Supervision Plan

The MLD, TDF and the DUDBC will work closely with the PCO and provide timely and comprehensive inputs related to financial management for the preparation of the IPRs and PFSs. Given the weak capacities of project institutions, the Bank will closely supervise fiduciary aspects related to financial management until key systems are in place. Key financial management work includes: (i) conducting ex-post reviews of financial management arrangements and SOE reviews; (ii) reviewing IPRs and audit reports and preparing summaries of such reports; and (iii) undertaking timely supervision missions and keeping the management informed of financial management issues. The implementation of the agreed financial management action plan will be closely monitored to ensure appropriate actions are being carried out in a timely manner. Particular attention will be paid to timely and accurate capture of financial information and comprehensive reporting, areas designated as a source of substantial financial management risk.

Disbursement

Allocation of grant proceeds: Disbursement under the proposed Bank credit/grant will be made as specified in Table 3.3, which indicates the sources, amounts, and percentages of financing for different categories of project expenditures.

Table 3.3: Allocation of Credit/Grant Proceeds

IDA Credit IDA Grant Category (US$) (US$) Municipal Grants under Service Delivery Improvements 2,750,000 2,250,000 component Sub-project financing under Socio-economic Infrastructure 10,027,000 6,344,000 Development component Goods and incremental operating costs under Institutional 973,000 Development component Consultants’ services, workshops and training under 2,450,000 Institutional Development component Project preparation advance 206,000 Total 13,750,000 11,250,000 Grand Total 25,000,000

Disbursement arrangements: Disbursements from the Bank will be made in accordance with traditional disbursement procedures including, full documentation for contracts above the Prior Review threshold or SOEs. To facilitate disbursements, a Designated Account in US Dollars will be established, which will be managed by the PCO. For major payments related to procurement of Goods and Services, the implementing agencies will request the PCO to use the special

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designated accounts for direct payments. For socio-economic investments, Municipal Grants, and small payments, including training and operating costs, GON will pre-fund the activities and then get reimbursed from the Bank.

PPF: The Government had availed a PPF advance for: (i) initial office setup, including basic logistics and equipment as well as support staff for project preparation; (ii) organizing workshops and essential training to the MLD, TDF and DUDBC staff; (iii) preparing an information, education and communication (IEC) strategy for the project and conducting IEC campaigns during preparations; (iv) preparing the EMF and the SMF; (v) conducting baseline survey; and (vi) identifying and preparing sub-projects in participating municipalities, including feasibility studies and detailed engineering designs, where relevant.

Use of Statement of Expenditures (SOEs)

SOEs will be used for the following expenditures: (i) training, workshop and study tours; (ii) incremental operating costs; (iii) contracts for Goods and Works costing less than USD 400,000 equivalent per contract; (iv) contracts for services of consulting firms costing less than USD 200,000 equivalent per contract; and (v) contracts for services of individual consultants costing less than USD 25,000 equivalent per contract. The Bank will closely review the SOE claims to ensure that funds are utilized for the intended purposes. Any ineligible expenditure will have to be refunded to the Bank.

Designated accounts

The PCO will maintain the Designated Account in US Dollars at the NRB, under terms and conditions acceptable to the Bank. The authorized allocations for the Special Designated Account will be $5.0 million. The Account will be managed under the joint signatures of the PD and the Finance Officer. The PCO will ensure that bank/cash books are reconciled with bank statements every month. It will submit replenishment applications for the Designated Accounts on a monthly basis, or when 25 percent of the authorized allocation has been used, whichever occurs first. Replenishment applications will be accompanied by reconciled statements from the bank in which the account is maintained, showing all Designated Account transactions. Supporting documentation will be maintained by the respective cost centers for at least one fiscal year after the year in which the last disbursement from the grant took place, and will be available for review by Bank staff and independent auditors.

Procurement

Procurement description: Major share of procurement under the project rests with the municipalities. This includes infrastructure related Goods and Works contracts for construction or rehabilitation of critical socio-economic infrastructure. The average estimated cost of such works contracts is not expected to exceed $750,000 in most cases. There will also be small value Goods and Works contracts related to provision of routine municipal services and O&M of existing assets under the Service Delivery Improvement component. Finally, the municipalities are also likely to procure small value Goods/Equipment and services to strengthen their institutional capabilities. This may include procurement of small quantities of Goods/Equipment

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to assist setting up of ICT/MIS systems (including setting up an e-procurement system); design, supervision and management consultants for helping with the implementation of socio-economic infrastructure sub-projects; consultants for audits, local IEC activities and other specialized services on a need basis; stationery, and so forth. These will either be small value contracts with specialized agencies or contracts with local firms/individuals, selected competitively.

At the central level, procurement will be primarily related to the implementation of the ID component. Each of the central agencies, along with the PCO, will procure Goods and Services in line with their respective institutional development activities. This will include a variety of consultant services, ICT and office equipment, vehicles, office stationery, and so forth. The ID component is financed in parallel by the GIZ. There is a clear division of financing between the two agencies. Goods and Services procured using World Bank/Government funds, based on contract value, funds will follow ICB or NCB procedures as per the Nepal Procurement Act (2007). However, in case of ICB contracts, the specific procurement notice shall also be published in UNDB/dGMarket.

Procurement procedures: All NCB procurement will follow the procedures prescribed in the Nepal Procurement Act (2007) and related regulations subject to the following:

• bid documents shall be made available, by mail or in person, to all who are willing to pay the required fee;

• foreign bidders shall not be precluded from bidding and no preference of any kind shall be given to national bidders;

• bids shall be opened in public in one place, immediately after the deadline for submission of bids;

• qualification criteria (in case pre-qualifications were not carried out) shall be stated in the bidding documents, and if a registration process is required, a foreign firm declared as the lowest evaluated bidder shall be given a reasonable opportunity of registering, without let or hindrance;

• evaluation of bids shall be made in strict adherence to the criteria disclosed in the bidding documents, in a format and specified period agreed with the Association and contracts shall be awarded to the lowest evaluated bidders;

• rebidding shall not be carried out without the prior concurrence of the Association;

• extension of bid validity shall not be allowed without the prior concurrence of the Association (A) for the first request for extension if it is longer than four (4) weeks and (B) for all subsequent requests for extension irrespective of the period; and

• there shall not be any restrictions on the means of delivery of the bids.

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Procurement capacity: The Nepal Procurement Act mandates that procuring entities (which include public local bodies) will be responsible to ensure that procurement functions are carried out by persons trained and knowledgeable in public procurement. Although the Procurement Act came into force in 2007, very few procuring entities, and those too mainly at the center, have a dedicated procurement unit or officials who are knowledgeable and experienced in public procurement in accordance with the Law. In addition, the Government is yet to issue guidelines or manuals to assist procurement officials, or to institute comprehensive procurement training programs for procuring entities and officials at all levels. Past procurement reviews of decentralized procurement (district level) have shown that due to this capacity constraint, procurement procedures and documents are often not in compliance with the Law.

Detailed assessment of procurement capacities of the central agencies and the municipalities reveal systemic issues and capacity gaps. All the agencies follow the PPA 2006 and PPR 2007. The three central agencies have dedicated procurement sections/units. They also have some degree of dedicated human resources manning these sections with no staff vacancies at this point. Nevertheless, they face, to varying degrees, logistics, human resources and capacity issues. They also have limited familiarity with procurement under donor-funded projects. Although these agencies file biannual and annual procurement reports internally, none of them have a full- fledged procurement management information system. Out of the three central agencies only one (DUDBC) has introduced e-bidding recently.

At the local level, the municipalities also follow the PPA and the PPR, but do not have procurement manuals. The municipal procurement plans are often not integrated into the overall public financial management system. The ratio of bids submitted to documents distributed is very low, usually with submissions just meeting mandatory requirements. Monitoring of procurement process also needs strengthening. The local bodies have little understanding of procurement under donor funded projects. Finally, people's faith is the system is low and, as a result, the incentive to complain against perceived irregularities is lacking.

Procurement risk: The perceived risks and related remedial measures are described below:

Risk Remedies Staff capacity: Most of the responsible staff at (a) PCO will review procurement plans of the central agencies and in the municipalities each municipality to ensure it matches the do not have good knowledge of and experience approved activities and incorporates the in public procurement as per the procurement correct methods. law. Although they are able to prepare basic (b) PCO, with the support of the MST, will procurement plans, this is neither linked to the take the lead in preparing sample bid budget exercise nor is it used as a monitoring documents for Goods and Works, tool. Thus there is risk of incomplete incorporating provisions of the law and procurement planning, use of improper associated regulations, and in guiding the procedures and documents, poor monitoring municipalities in using these to develop and contract administration – and hence of need-specific documents. delayed and improper procurement. (c) Each municipality will create a dedicated procurement unit that is adequately staffed

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(e.g. one procurement official and assistant). (d) PCO will arrange, on a priority basis, exclusive procurement training of the nominated procurement staff at the Nepal Administrative Staff College. (e) PCO/TDF, as the case may be, will review and clear documents and procurement decisions for contracts estimated over $ 100,000. (f) Key procurement staff, especially those receiving training, will be retained for the duration of the project to the extent feasible. Prevalent national procurement environment: (a) PCO, with MST support, in coordination With the ongoing flux in the current national with the Public Procurement Monitoring politics there has been an associated increase in Office (PPMO) will assist municipalities to lawlessness and weakening of law and order set up and use the e-submission system that situation. As a result, malpractices in public has been developed by the Department of procurement (such as physical intimidation of Roads. This system will run in parallel with potential bidders, obstructing bid submission, the traditional manual bid submission collusion and manipulation) have increased. system. Further, the Government has announced that from this calendar year (i.e. mid April 2011) e- procurement will be mandatory for all public procurement contracts estimated above NRs 20 million (US$ 280,000 approximately).

Monitoring and reporting: With three different (a) Each municipality will mandatorily submit agencies in charge of managing activities under to the PCO trimesterly progress reports the three respective components, there is risk describing procurement status against the that activities under one component may take milestones stated in the approved project precedence over others leading to a delay in procurement plan. other activities. Further, due to inadequate procurement capacity of the municipalities (b) PCO will review these reports and there is a risk of inadequate procurement coordinate with each central agency (TDF, supervision and monitoring and delays in DUDBD, MLD) to formulate corrective receiving consolidated status reports. actions for any delays in procurement.

With the abovementioned remedies in place, the residual risk is rated as Substantial.

Procurement methods: All contracts for Goods and Works estimated to cost over $ 500,000 per contract shall be procured through ICB. For contracts with consulting firms whose estimated value is below $200,000 the shortlist may comprise entirely of national firms.

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Review thresholds: All ICB contracts, contracts for Works and Goods estimated over $400,000 per contract, all direct contracts, selection of consulting firms for assignments estimated to cost $200,000 or more, all single source contracts and contracts with individuals whose estimated value is over $25,000 per contract shall be subject to the Bank’s prior review. Environmental and Social (including safeguards)

Environment

Environmental Management Framework (EMF): The environmental concerns of the project are related to infrastructure/civil works that will be identified, selected and construction during implementation. The precise nature, size and position of the infrastructure/ civil works are not- known ex ante, except that they will be located in the participating municipalities and will be selected through a demand-driven and transparent process. The Government has therefore prepared an EMF for identifying, assessing and mitigating adverse environmental consequences that could result from the project supported infrastructure and civil works/activities. The main provisions of the EMF are: • Environmental consideration start early, during sub-project identification stage itself (the EMF contains environmental factors that needs to be considered while planning and design of different category of subproject); • Each infrastructure/civil works proposal will be subjected to environmental screening (the EMF contains Environmental Screening Format for the project). Screening will categorize sub-project in one of the four categories: (i) Category I - ineligible for funding because of highly significant environmental risks; (ii) Category II –sub-project requiring limited EA (or IEE) or full EA (or EIA). The GON will obtain No Objections for the TOR, EA and EMP of: (i) sub-projects requiring full EA; (ii) first limited EA sub- projects from each municipality; and (iii) 5% of all limited EA sub-projects; (iii) category III – sub-project requiring adoption of Environmental Codes of Practice (generic ECP are provided in the EMF); and (iv) Category IV subprojects that do not require formal investigation beyond screening, but subject to monitoring on sample basis during implementation. • Sub-projects with high environmental risks are generally discouraged (using ineligibility criteria and environmental factors in sub-project prioritization); • Sub-project plan, design, bidding documents, contract/agreement, etc. will incorporate environmental measures and recommendations of environmental screening, EMP, IEE, and EIA, and this will be confirmed prior to finalization of Detailed Project Report; • Compliance to and implementation of the environmental mitigation measures will be monitored at local and central levels; • Sub-project identification, selection, assessment and implementation will follow Environmental Consultation and Disclosure Framework as outlined in the EMF; and • The borrower will commission, as needed, an annual independent/third-party environmental monitoring of sample sub-projects.

Recognizing the weak environmental capacity of the directly involved institutions, government plan to strengthen environmental management capacity during the project implementation through the following measures (as outlined in the EMF):

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• Making institutional arrangement with designated staff at appropriate levels, with clear mandate and responsibilities to coordinate, oversee and manage environmental issues; • Enhancing environmental management related competency through technical assistance, undertaking special/focused studies as well as availing required services from other agencies, including the private sector, as required; • Organizing training and orientation at different levels, tailored to the needs of different actors: these activities will be planned and undertaken each year; and • Ensuring annual budget allocations and adequate logistics for environmental management activities.

Social

SMF implementation: The implementation of the social management framework (SMF) will involve: (i) carrying out land acquisition and resettlement activities required for socio-economic infrastructure to be undertaken by municipalities with TDF financing; (ii) planning and implementing vulnerable community development plans; and (iii) implementing social accountability/demand-side governance measures. The participating municipalities will be responsible for assessing and mitigating social impacts of sub-projects by planning and implementing adequate resettlement measures. The SMF describes procedures for social screening of sub-projects and survey of the affected people, consultations, resettlement planning and implementation, grievance redress, participatory monitoring, budgeting, timetable, coordination with civil works, etc.

While the safeguards planning and management will lie with the municipalities, the process and outcome will be monitored by the TDF, which will finance sub-project activities. Similarly, the municipalities will also assess the impacts of sub-projects on the IPs and VCs and plan and implement IP-VCDP for specific subprojects, which the TDF will monitor. The municipalities will interact with the Nepal Foundation of Indigenous Nationalities (NEFIN) and Dalit NGOs’ Federation (DNF) and other CSOs in planning and implementing the IP-VCDP. The social accountability/demand-side governance measures shall be strengthened with CSO participation and will involve engagement with the user groups, CBOs and citizen/stakeholder associations. The support of LGAF will be sought to implement the proposed measures for social inclusion, equality and accountability, which will be monitored by the MLD/PCO. These measures will be implemented in a phased and incremental manner and shall be reviewed at the end of two years and course corrections made, as required. The budget for implementing the RAP and IP-VCDP will be factored into the sub-project estimates.

Monitoring: The participating municipalities will have a broad-based and inclusive MCC, which will have representatives from CSOs, NEFIN, DNF, CBOs and user groups. The MCC will meet ever trimester for a participatory stocktaking of the implementation process and outcomes. The municipalities will also have a PMT, which will be responsible for day-to-day project planning and implementation, and it will include the social mobilization/community development section head. The municipalities will receive ideas and feedback on social development issues from the multi-stakeholder MCC, as well be monitored by the APM. While the TDF will monitor the management of involuntary resettlement impacts and the MLD will monitor the social inclusion, equality and accountability measures, the overall responsibility and ownership for monitoring the

56 implementation of the SMF will lie with the PD of the PCO. Upward monitoring will be done through social accountability measures discussed above.

Grievance Redress Mechanism (GRM): The borrower will establish a two stage GRM: at the municipality level the GRM will be chaired by the head of the APM, and comprise 3 representatives from CSO, CBOs. The GRM will be assisted by the social/community development officer. The complainant and the concerned municipal staff will be allowed to be present during the hearing for resolving the issue. At the project level, the GRM will be chaired by the PD and will include the three PCO members and representatives from MuAN and a CSO. In case of grievances relating to IPs, NEFIN will be invited to participate in the hearing process.

Implementation capacity: The project agencies by and large do not have substantive experience in LA and R&R. Therefore, sustained capacity building efforts are required to enhance SMF implementation capacity of key agencies such as the TDF and the municipalities. The borrower has experience in the areas of social inclusion, equity, indigenous people, and social accountability, which will be further strengthened through hands-on technical support with the help of qualified consultants. Both TDF and municipalities will receive strong initial technical support with a gradual phase out plan and develop their own capacity. They will be assisted by the MST, which will have a Social Development Advisor who will be responsible for guiding and monitoring the implementation of the SMF, including safeguards. Each municipality will have a social/community development officer. The Social Development Advisor will also provide training and orientation for key officials from the TDF, MLD and the municipalities for planning and implementing measures proposed in the SMF. S/he will also assist in social screening and RAP preparation for the initial pipeline of subprojects.

Budget: Resources for social inclusion, equality and accountability measures will come from the 35% of the capital expenditures for block and Municipal Grants earmarked for the poor and vulnerable groups, as well as from the capacity building share of the block and Municipal grants. The institutional development component will support capacity building measures for enhancing the implementation capacity in social inclusion and safeguards compliance.

Potential risks and mitigation options: The relative inexperience and limited capacity may affect the pace and quality of management of social safeguards, especially land acquisition and resettlement. Strong technical support backed by close monitoring will be used as a strategy for ensuring effective due diligence in LA and resettlement issues. The technical support from the PRAN and LGAF will contribute to the quality of measures for social accountability/ demands side governance.

Monitoring and Evaluation

The data required to monitor PDO results indicators will be collected through household surveys in the participating municipalities. Three household surveys will be conducted: at project inception, mid-term and project closure. The PDO results indicators will be used during project implementation to monitor citizens’ awareness and satisfaction with municipal provision of basic services and urban infrastructure in the participating municipalities, and to measure improvements in the provision and quality of basic urban infrastructure. The data required to

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monitor the intermediate results indicators will be collected and compiled annually by the respective Component Managers. The intermediate results indicators will be used to assess implementation progress of each sector component. A secondary data collection has been conducted during project preparation to collect baseline data in the participating municipalities.

The institutional arrangements for M&E will be based to the extent possible on individual agencies existing processes and systems. For example, the MLD on its own and via the LBFC (through the MC/PM system) has a dedicated M&E system and team for the monitoring and evaluation of municipalities. The TDF has built solid experience in monitoring sub-projects in municipalities since its establishment in 1989. The DUDBC has a long-standing experience working with municipalities, and is currently providing assistance to municipalities for the preparation of socio-economic development plans (periodic plans). The PCO will also benefit from the information-sharing agreement with the MLD M&E team, which has extensive experience in conducting household surveys in the municipalities. The existing M&E systems in the municipalities are weak. Most of municipal monitoring is input oriented. Further, the staff are not trained in M&E. Municipalities will be strengthened in M&E through the provision of technical support by the MST, which includes an M&E Advisor who will help the participating municipalities set up a basic M&E unit, provide training to staff and help ensure that the results feed into policy and program planning.

Role of Partners

The project is jointly supported by the GIZ (erstwhile GTZ), who will support the ID component through a parallel financing arrangement. Under the rubric of the udle, the GIZ has been actively engaged on urban and local government issues in Nepal for more than three decades. The udle is implemented by the MLD and the GIZ jointly. Furthermore, the KfW has provided financial assistance to the TDF through the Town Development Programme I, II and III, while GIZ/GTZ has provided policy support and technical assistance to both TDF and DUDBC. Through this long association, GIZ has established considerable credibility and institutional memory regarding urban local governance in Nepal. The udle will phase out at the end of March 2011 and will be followed by the new Nepal German bilateral program Subnational Governance (SUNAG), to be implemented by the MLD, the DUDBC, the TDF and the GIZ. The support of the ID component of ETP is an integral part of the SUNAG program proposal, which awaits approval from the German Ministry of Economic Cooperation and Development (BMZ). The start of SUNAG is planned for April/May 2011.

Table 3.4: Details of Financing of the ID Component (US$ ‘000)

Donor Agency IDA GIZ Total DUDBC 401.50 364.10 765.60 MLD 572.00 - 572.00 TDF 1,246.30 660.00 1,906.30 Municipalities 547.80 1,971.20 2,519.00 Project Coordination Office 860.75 - 860.75 Total 3,628.35 2,995.30 6,623.65

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The structure, activities and the costs of the ID component were jointly developed by the Bank and the GIZ working closely with the Government. Based on the comparative advantage of each agency, a parallel financing arrangement for the component has been agreed between the Bank and the GIZ with the endorsement of the Government. The GIZ will provide $3.0 million equivalent as support for the component. A draft MoU has been drawn up with details of this cooperation, including coordination modalities, financing and cost sharing details, monitoring and reporting arrangements. Further details of the financing arrangement, including the draft MoU and costing arrangements, are in the project files.

In addition, the program also aims to establish clear operational collaboration with the LGCDP, which is supported by a coalition of development partners. Areas of mutual interest and coordination include, among others, reforming and strengthening the IGFT systems, the monitoring and performance evaluation of the municipalities through the MC/PM system and strengthening local accountability with support of the LGAF.

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Annex 4: Operational Risk Assessment Framework (ORAF)

Project Development Objective(s)

The project development objective (PDO) is to improve delivery and sustainable provision of basic services and priority infrastructure in the participating municipalities.

PDO Level Results 1. Percentage increase in the citizens who report that the infrastructure services offered by the municipality Indicators: better meet their needs than the previous year. 2. Percentage increase in citizens who report they that have participated in planning meetings at the ward level. 3. Total number of people that benefited from urban services and infrastructure improvements, of which females and from disadvantaged groups.

Risk Category Risk Rating Risk Description Proposed Mitigation Measures

Project Stakeholder Risks MI The lack of inclusion of the Madhesi town in this A strong public information effort will be initial phase could be manipulated for political undertaken and future plans to integrate Madhesi ends with the accusation that it is against the towns into the longer-term program will be spirit of federalism and follows a long record of outlined. The economic and objective criteria used neglect of Madhesi demands by politicians in by the project for selecting the target towns during Kathmandu and the international community in this pilot phase will be documented and explained general. in public fora.

The current vacuum in local government Wide-ranging consultation and awareness raising structures, particularly the absence of elected effort has been undertaken. The project will build municipal bodies, leads to inadequate on lessons learned from existing community prioritization that fails to reflect community- oriented projects which have empowered defined needs and demands. communities to demand accountability and better governance. Key officials and civil society stakeholders in the municipalities will be supported in areas such as social mobilization, participatory planning, social audits, etc. to ensure priorities reflect community-identified needs. Block grant guidelines allow resources to be set aside for this. Additionally, range of demand side

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mechanisms will be channeled through parallel sources (LGAF, etc.). Local implementation arrangements include range of participatory structures, from community to town level.

Implementing Agency Risks MI Weak oversight and limited capacities at the Institutional development of all implementing local level and lack of continuity in staffing may agencies is a key focus of the project and result in slow implementation. implementation arrangements are mainstreamed within the institutions to ensure greater sustainability and capacity development.

TDF staff are permanent and will have a key role centrally on procurement and safeguards (along with PCO). Provisions in IDA FAs now specify team composition and continuity requirements. This requirement will be made applicable to all critical positions both at central and municipality levels.

Conflicts over purviews and mandates presently Implementation arrangements account for each not an issue, but may emerge between DUDBC, agency to have full autonomy to implement its TDF and MLD during project implementation, component via appropriate delegation of powers. presenting major challenges. Feasibility of applying the recently piloted e- Collusion among bidders and/or physical bidding in the roads sector project will be explored intimidation. at the municipal level (this depends on the size of the contract). Procurement audits will be conducted. Project Risks

• Design A retailing approach, working with a selected Based on initial experience with central agencies number of municipalities, becomes intensive and the 6 municipalities, efforts will be to adopt a L over the longer term. wholesaling approach over the medium term under the project.

• Social and The risks involve the capture by the parties of Keeping the ethnic and caste diversities in mind for Environmental decision-making on funds and projects and each selected municipality. CSOs will be included in ML continued exclusion of minority groups such as decision-making process to improve accountability dalits and janajatis, as well as women. The role and to ensure that minorities and women are

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of the parties, though in some ways positive, is included. The project design influenced by the not formalized to the degree that it would lead to Gender Equality and Social Inclusion Framework accountability and transparency. developed by the Bank in Nepal.

• Program and Donor

• Delivery Quality Given the inexperience of DUDBC, TDF and Extensive support has been provided to DUDBC municipalities in implementing projects and and TDF during preparation. Institutional ML unfamiliarity with Bank procedures, there is a development is a key project component. On-site likelihood of slow start-up. capacity support will be provided, including to municipalities via MST, during implementation.

Overall Risk Rating at Overall Risk Rating During Comments Preparation Implementation

ML MI

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Annex 5: Implementation Support Plan

In terms of Bank support and supervision, project implementation is expected to roll out in three distinct phases: initial phase; wholesaling phase and consolidation phase. Each phase demands its own order of skills and resources from the side of the Bank and partner entities. Details are noted below.

What would be the main focus in terms of support to implementation during:

Time Focus Skills Needed Resource Partner Role Estimate 0- 24 In the initial phase of the • Fiscal decentralization $500,000 GIZ will provide on- months project, the emphasis will be on • Municipal/project BB and TF the-ground skills in the following: finance certain areas, • improving understanding of • Urban economist including urban the political economy of • Municipal engineer management, decentralization and • Financial management municipal finance, deepening engagement with and procurement M&E, MIS, social key stakeholders; • Safeguards mobilization, etc. • putting in place critical • Demand side safeguards and fiduciary governance systems at the center and local • Political economy levels; • M&E • reforming rules and systems as well as strengthening the ability of MLD to manage the IGFTs to municipalities; • helping TDF implement the agreed Business Strategy and Action Plan, especially the workout of bad loans and other urgent/early actions; • completing baseline survey and communicating the results to municipalities and other key stakeholders; • putting in place basic M&E systems and standards at the central and local levels and capacitating relevant staff (in partnership with other programs and donors); • building sub-project pipeline in participating municipalities and implementing first set of sub-projects; • operationalizing municipal ID plans; • identifying key drivers of 63

social accountability in participating municipalities and piloting initiatives via external and partner arrangements; and • preparing ground for expanding the project to additional municipalities.

25-36 Transition phase will mark the • Fiscal decentralization $250,000 GIZ will continue to months scale up of Bank engagement • Municipal/project support ID through greater support for the finance component and intergovernmental system at the • Municipal engineer provide on-the- center and the expansion of the • Financial management ground project to more municipalities on and procurement implementation the ground. Greater sector • Safeguards support consolidation and improved • Demand side partnerships with other donors governance are also expected.

37+ In the consolidation phase, the • Municipal/project $150,000 program is expected to run for finance the most part smoothly with • Municipal engineer Bank support focusing more and • Financial management more on systems strengthening. and procurement • Safeguards

II. Skills Mix Required Skills Needed Number of Staff Weeks Number of Trips Comments Fiscal decentralization 12 6 The estimates for the Municipal/project 16 6 + local first 24 months. finance Some of the skills Municipal engineering 16 Local and staff are Social accountability 12 Local interchangeable. Urban economics 8 4 M&E 8 4 FM and procurement 8 each Local Safeguards (S&E) 8 each Local

III. Partners Name Institution/Country Role GIZ Germany Overall program partner and providing parallel financing for the ID component.

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Annex 6: Team Composition

World Bank staff and consultants who worked on the project:

Name Title Unit

Sumbo Adeyemo Program Assistant SASDU Aditya Adhikari Political Economy Expert Consultant Gabriela Aparicio Junior Professional Associate SASDU Kiran Ranjan Baral Sr. Procurement Specialist SARPS John Bevan Conflict Expert Consultant Junxue Chu Sr. Finance Officer CTRFC Drona Raj Ghimire Environmental Specialist SASDI Sunita Gurung Program Assistant SASDO Balakrishna Menon Parameswaran Sr. Urban Specialist and Team Leader SASDU Riaz Khan MIS and Institutional Development Expert Consultant Mihaly Kopanyi Sr. Infrastructure Specialist SASDU Satya N. Mishra Social Development Specialist SASDS Elisa Muzzini Economist SASDU Rajashree Paralkar Sr. Country Officer SACNP Bigyan Pradhan Sr. FM Specialist SARFM Aly Zulficar Rahim Social Development Specialist ECSS4 Krishnaswamy Rajivan Municipal Finance Specialist Consultant Silva Shrestha Research Analyst SASDU Bandita Sijapati Political Economy Expert Consultant Tashi Tenzing Sr. Sanitary Engineer and Co-team Leader SASDU Jeff Thindwa Lead Social Development Specialist WBI Mei Wang Sr. Counsel LEGES

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Annex 7: Economic and Financial Analysis of Sub-projects – Rules of Engagement

Sector eligibility

The following municipal infrastructure sectors will be eligible for financing:

• Social and community infrastructure: examples of possible projects include basic health care, community centers, child care centers, public toilets, green spaces, slum upgrading etc. • Utility and urban infrastructure: water, sewerage, solid waste and municipal roads. • Commercial and revenue generating infrastructure: markets, eco-tourism parks, parking spaces, shopping centers etc.

The following rule will be applied for the classification of the sub-projects:

A multi-sector economic infrastructure sub-project will be appraised as one integrated sub-project (i.e. appraisal rules for revenue generating infrastructure would apply) and not disaggregated into its sector- components. Commercial and revenue-generating infrastructure sub-projects tend to be multi-sector sub- projects. For example, an eco-tourism park may involve the building of urban infrastructure, such as a road, construction of bus stands and the rehabilitation of tourism facilities. The construction of the road will not be appraised as a standalone physical infrastructure project, but as part of the integrated tourism project.

Financial analysis of sub-projects

A fiscal sustainability assessment will be conducted on a regular basis for each municipality, and complemented by a financial viability analysis at the sub-project level.

Municipal- level fiscal sustainability

• Fiscal sustainability is a minimum requirement for all sub-projects, as it aims to ascertain that the sub- projects being undertaken are financially sustainable for the municipality as a whole. All sub-projects undertaken by the participating municipalities need to be within its fiscal capacity, to be assessed through a fiscal assessment as per the terms of financing for the sub-project.

• The fiscal sustainability analysis will be conducted on a regular basis (at least once per year) for all participating municipalities, and in compliance with the sub-project guidelines.

Project-level financial viability

• A financial viability analysis will be undertaken for all urban/utility infrastructure sub-projects having some revenue-generating potential (water, sewerage and solid waste) and all commercial/revenue generating infrastructure sub-projects. A sub-project is considered financially viable if the Financial Rate of Return (FRR) is above 12 percent. A cash flow analysis will be conducted as part of the financial analysis to assess the timing of disbursements and proceeds to ensure a net positive cash flow in each implementation year of the sub-project . • For commercial and revenue-generating sub-projects, the financial analysis is vital to prove that the sub-project is financially viable.

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• For urban/utility infrastructure sub-projects with some revenue generating potential (water and sewerage projects, solid waste projects), financial viability will be used as a tool to assess the revenue generating potential of the sub-projects. Water projects will need to recover O&M costs through tariffs.

• The financial analysis will be undertaken as part of the sub-project feasibility assessment and in compliance with the sub-project guidelines. The following documentation will be submitted: (i) note describing methodological approach and assumptions, (ii) excel model with cash flow analysis, calculations of FRR and sensitivity analysis, (iii) survey questionnaires and results of data collection if applicable (e.g. Willingness to Pay survey).

Economic analysis of sub-projects

There are two levels of economic analysis of sub-projects: cost effectiveness (a minimum requirement for all sub-projects) and cost-benefit analysis (to be undertaken for selected sub-projects based on rules noted below).

Cost effectiveness

• Cost effectiveness analysis is a minimum requirement and need to be carried out for all sub-projects (social, physical and economic infrastructure). The objective of the cost effectiveness analysis is to demonstrate that the selected sub-project option is the most cost effective for a given level of output.

• The cost effectiveness analysis will be conducted as part of the sub-project feasibility assessment. The following documentation will be provided to prove that the most cost effective design option has been selected: (i) list of sub-project parameters for which cost effectiveness analysis has been conducted, including justification for the parameters’ selection, (ii) quantitative analysis comparing unit costs of project alternatives for each of the selected parameters, including sensitivity analysis; (iii) identification of the cost effective solution. Cost effectiveness analysis will be undertaken in compliance with the project guidelines.

Cost-benefit analysis

• Projects requiring cost-benefit analysis need to demonstrate an Economic Rate of Return (ERR) equal to or greater than 12 percent.

• When required, cost benefit analysis will be conducted as part of sub-project feasibility assessment and in compliance with the sub-project guidelines. The following documentation will be included in the feasibility assessment: (i) short note describing methodological approach for cost benefit analysis and assumptions, (ii) excel model with quantitative assessment of ERR and sensitivity analysis; (iii) survey questionnaire and results of data collection if applicable (e.g. WTP survey).

• Cost-benefit analysis will be conducted for selected sub-projects based on the following rules: (a) Social infrastructure: A full cost-benefit analysis is not required for social infrastructure projects because benefits are always not quantifiable (e.g. health and environmental benefits).

(b) Urban and utility infrastructure: A full cost-benefit analysis will be carried out for urban and utility infrastructure projects meeting the following requirements: total project costs are over US$ 1 million; benefits are quantifiable (water, roads, solid waste). In addition, the following sector- specific rules will be applied:

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(i) All road sub-projects above US$1 million will require a full cost-benefit analysis unless investments are proved to meet basic needs requirements. Any road project aiming to rehabilitate the existing road network or to build one or two lane roads can be considered to meet basic needs and is therefore exempted from a full cost –benefit analysis. Adequate documentation needs to be provided as part of the sub-project feasibility study to prove that the road project meets the basic needs requirements specified above. All road sub-projects above US$ 1 million and beyond minimum investment requirements will require a full cost-benefit analysis.

(ii) All solid waste sub-projects with value above US$1 million will require a full cost-benefit analysis unless investments are proved to meet basic needs requirements. Any project aiming to build adequate capacity to collect and transport solid waste for a 10 year horizon, based on reasonable projections of population and per capita solid waste, can be considered to meet basic needs requirement and is therefore exempted from a full cost-benefit capacity. Adequate documentation needs to be provided as part of the sub-project feasibility study to prove that the solid waste project meets the basic needs requirements specified above. All solid waste sub- projects above US$ 1 million and beyond minimum investment requirements will require a full cost-benefit analysis.

(iii)All water sub-projects with value above US$ 1 million will require a full cost-benefit analysis.

o Commercial and revenue-generating infrastructure: A full cost-benefit analysis will be conducted for all commercial and revenue-generating infrastructure sub-projects over US$1 million to prove that the sub-project is economically justified.

The table below summarizes financial and economic analysis requirements by sub-project type.

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Table 7.1: Summary Table Economic and Financial Analysis of Sub-Projects

INFRASTRUCTURE SECTOR COMMERCIAL AND SOCIAL URBAN AND UTILITY REVENUE- GENERATING • Basic health care • Community • Eco-tourism center Examples of possible centers • Road • Market interventions in each • Public toilets • Sewerage • Water • Solid Waste • Shopping center sector • Green spaces • Parking space • Slum upgrading

Benefits Non Quantifiable Quantifiable Small Cost- Cost- Cost- (<= 1 Cost-effectiveness Cost-effectiveness effectiveness effectiveness effectiveness US$ 1m) Cost-effectiveness Economic (basic needs Cost- Analysis Large investments) Cost- Cost- effectiveness Cost-effectiveness ( >US$ Cost-benefit Analysis effectiveness effectiveness Cost-benefit Cost-benefit Analysis 1M) (investments beyond Analysis minimum requirements) Fiscal Fiscal Fiscal Fiscal sustainability sustainability sustainability Fiscal sustainability Financial Analysis sustainability Financial viability Financial Financial Financial viability (O&M) (solid waste) viability viability

Table 3.2: Summary Table Basic Needs vs. Additional Capacity Investments

Additional Capacity Sector Basic Needs (beyond minimum requirements) Construction of roads with more than two lanes Rehabilitation of existing road network, Roads connecting two points (i.e. a ring road, or a four lane construction of two lane road. road). Collection and transportation of solid waste for 10-year horizon based on reasonable Solid Waste Treatment and disposal of solid waste. projections of population and per capita solid waste.

Institutional arrangements for economic and financial analysis

The TDF will be responsible to make sure that the above processes, standards and thresholds are met for sub- projects financed by it. The TDF sub-project application will require such information from the municipalities who are responsible for carrying out the economic and financial analyses. Where needed, the municipalities will take support from external consultants to carry out this task.

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Annex 8: Town Development Fund – Current Status and Roadmap for Development

Introduction

The TDF was set up with a grant to on-lend for municipal infrastructure as part of an agreement between the GTZ and the GON in 1987. The TDF is fully owned by GON with an initial equity contribution of NR 12 million. Its historic milestones include: in 1989, the World Bank provided a credit of NR 147 million for financing municipal infrastructure in towns; of this TDF disbursed NR 124 million by project closure. In 1996, its legal status was strengthened under a separate act (TDF Act) that mandated the TDF with the twin objectives of providing technical assistance and debt finance to municipalities. The TDF currently has been managing donor programs of KfW and the ADB to provide municipalities loans, soft loans or grants for investments, and technical assistance for design and supervision management.

With Bank and GIZ support, the TDF carried out a major institutional and financial assessment in 2010. Key findings and recommendations were discussed with municipal stakeholders, the Bank, the GIZ, the KfW and the IFC at a national workshop. Based on this, the TDF has developed a Business Plan (with L/G Policy) which will serve as a longer term roadmap for strengthening the agency, as well as a Business Reorganization Action Plan (BRAP) for addressing key issues in short to medium term, including actions for workout of bad loans and problem projects. Both Business Plan and the BRAP were discussed with the Government at the highest levels (MOF, MPPW, MLD, and the TDF Board). The GIZ and the Bank have committed to work hand-in-hand to support this business and operational restructuring of the TDF, conditional to Government approval of and acting on relevant parts of the BRAP.

The following specific areas and actions will be closely monitored during implementation: • The TDF will maintain autonomy in sub-project appraisal, lending and disbursement. The ED and the CFO will be competent and capable professionals who will maintain control over day-to-day managerial, administrative and financial operations of the TDF. • The TDF will enhance its collection rates substantially by carving out bad loans, introducing new L/G policy with full agency control over lending, security, and disbursement decisions and strengthening the appraisal, risk management and collection systems. It is notable that collection rates in the 1990s and early 2000s, especially under Bank and KFW lines of credit, averaged around 90%. However, they dipped subsequently, especially under the STWSSP I and UEIP I projects, partly because sub-project decisions were assigned to GON agencies and delinked from the TDF. • The Business Plan spells out prudential norms and ratios that will make the TDF financially sustainable and meet the OP 8.3 compliance requirements of the Bank. The TDF will achieve this gradually by workout of bad loans and introduction of new lending policy and standard operating procedures, and strengthening institutional capacities. • Parts of the BRAP require Government approval and action, especially the detailed workout of bad loans, the debt-equity swap and the establishment of a debt service reserve fund (DSRF). Completing these actions are essential for the long term viability of TDF and the creation of a sustainable local debt financing market. • The Business Plan of the TDF introduces universal lending terms, including loan-grant mix, interest rates, maturities and grace periods. It should be noted, however, that there are no benchmark rates comparable to TDF terms (20 year maturity, 5 year grace). The business plan aims to meet the (future) market terms by the project closure.

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Current status

The TDF has accessed three lines of credit from KfW –TDP (NR 226 million), TDP 2 (NR 225 million) and TDP 3 (yet to be drawn). The TDF has so far drawn down and on lent the first line and disbursed NR 220 million out of the second line. The financing is on the basis of a loan-grant blend dependent on the financial strength of the municipality, the sector, and a formula based assessment of debt bearing capacity. All these three lines are grants to TDF, and the reflows from TDP 1and TDP 2 have enabled TDF to build up a revolving fund for future lending. This corpus of about NR 300 million is now invested in deposits since it is unavailable for TDF’s current expenditures or to meet debt service obligations to GON induced from other projects.

The TDF has also four lines of credit from ADB–STWSSP 1 (NR 907 million), UEIP 1 (NR 92.6 million), STWSSP 2 and UEIP 2. It has drawn down and on lent NR 882.5 million from the first line and disbursed NR 87.19 million out of the second line. The third line is yet to be drawn down. The financing is on the basis of a loan grant blend of 30:70 and for water, sanitation and drainage, with the loans made to water users associations in 29 small towns. The towns are preselected, the projects are often designed and the grants are disbursed by the Department of Water Supply and Sanitation (DWSS), while the loans are channeled through the TDF. The repayments from WUAs have been poor (NRS 118 million—approximately 56% overdue) and, as a result, the TDF has defaulted to GON (NRS 253 million).

TDF’s present situation can be explained stylistically as retailing donor finance, pricing loans which are largely unsecured, and spreads unlinked to costs. Further, the different sources of credit compete internally with different loan grant blends which do not permit efficient leverage. This situation hurts TDF business, as well as infrastructure creation from GON perspective. This current status is a result of two phases in TDF’s evolution. The first period, from inception up until mid-2000, positioned TDF as an institution that developed lending policies and financed entities based on appraisal with reasonable repayment rates. The second period, wherein TDF moved towards a retailing function of multilateral credit, has lead to its current state of affairs. This current mixture of part retailer and part financier makes business and business planning difficult and it is perhaps now opportune for the TDF and its key stakeholders, including the municipalities, to decide on strategic medium term options including two below.

If TDF were to focus on agency/retailing (little appraisal, fixed pricing and sector focus of the lender), then it would be better managed on a fee basis, like a traditional project management unit (PMU). In such event, its capital structure and viability would not be threatened. TDF’s business could then focus on improved client delivery, better monitoring of projects and professional accounting of fund flows, not unlike the dedicated PMUs in DWSS and DUDBC.

On the other hand, if TDF were to be a lender of relevance, it would need to become an open access, criteria-based fund, with a focus on performance which commercial finance can judge. This shift would imply cost-based pricing, tighter exposure norms and secure repayment mechanisms. While these shifts do not automatically imply market access (as these are dependent on supply of long tenor in Nepal), it would be desirable for at least four reasons; (i) it is in conformity with TDF’s Act; (ii) Nepal would require a lender of relevance and professionalism which commercial finance can bring; (iii) TDF has built substantial reserves from its earlier operations which provide a base for systemic lending; and (iv), importantly, from a policy and institutional perspective, GON views TDF as a key player who can channel debt for creation of urban infrastructure assets in a sustainable manner.

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Business Plan

The TDF business concept and Business Plan has emerged from the dialogue between GON, TDF, main donors, and other stakeholders (MuAN) over the last several months. The overarching objectives of this business restructuring include: (i) enhancing TDF’s financial and management capacity to finance municipal infrastructure development and leverage Government grants with debt financing; (ii) streamlining the procedures for supporting municipal infrastructure development by clean delineation of roles of grants and loans; (iii) phasing out ad hoc and donor based lending policies and moving towards a universal L/G policy; (iv) enhancing quality and sustainability of sub-projects by empowering TDF to be the sole agent to accept subproject initiation and appraise proposals based on strict assessment of feasibility, risk, and borrowing capacity, if the project financing includes loan; and (v) enhancing TDF professional capacity by implementing an Institutional Development Program with the support of donors, including the GIZ, the World Bank, the KfW and the ADB. The underlying considerations of the business restructuring are shortly explained below.

The GON and TDF stakeholders have decided that moving towards a lender of relevance is the preferred option through medium term, and have requested all stakeholders to invest in the institutional strengthening by weeding out agency/retailing activities. It is the combination of the two opposite roles which has led to the current situation. And this present moment offers an opportunity for TDF, GON and its development partners to invest in institution building so that TDF evolves into a proactive financier of urban infrastructure in Nepal.

This institutional development detailed in the BRAP is more in line with TDF’s own Act and mandate of an autonomous financial institution, capable of mobilizing, financing and recovering capital invested in urban infrastructure. This would involve becoming an open access and criteria- based financial institution eventually, which provides municipalities in Nepal an opportunity to leverage scarce government grants with debt finance. This option of Lender of Relevance would entail the following critical two steps: first, lending policies and procedures based on costs of funds and risks of lending rather than the source of finance; and second, separation of grant and loan, based on clear criteria and untied to debt finance, rather than loan-grant blends dependant on source of finance.

Alongside these measures, TDF also needs strong appraisal techniques which pay detailed attention to drivers of both sources of revenue as well as expenditure cycles. Most intermediaries use these discounted cash flows to estimate loan eligibility and structure the repayment terms. The standalone financial appraisal (with and without project revenues) is the beginning of detailed borrower-lender interaction–agreements on rate covenants, credit enhancements (reserve funds), and security mechanisms (escrow accounts, intercept mechanisms).

Implementation of these reforms would require changes in the organization, since this would involve apportioning personnel to these two core activities (grants and loans) such that there is some balance between the revenues from fees (grant activity) and from spreads (lending). Going forward TDF would also need to move towards reducing turnaround time for clients by employing a higher officer-support ratio capable of turning project ideas into loans. For these key functions, namely project finance, fund management, promotion of infrastructure development, the TDF would aim to in source these skills and at the same time develop a staff financing plan, balance the skill-set between grant making and loans, and bring down the ratio of operational costs by expanding business volumes and rationalization through attrition.

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All of the above reform measures, namely restructuring the balance sheet, common lending policies and security mechanisms, loan-grant separation and organizational changes, need support by all on the basis of a time-based BRAP, which is a core part of the Business Plan discussed below.

The benefits of these actions appear large—the TDF would be institutionally positioned to turn sub- project ideas into commissioned infrastructure assets, to make repetitive loans for municipal needs with strong recovery, and provide on top technical assistance. From GON’s standpoint there would be greater leverage of scarce budget resources, especially funds flowing to local bodies through the IGFT channels. This would ensure that credit is not substituted but enhanced, there is more systemic access for municipalities to finance infrastructure, and a potential for mobilizing domestic sources of finance. For TDF’s development partners there is an opportunity to assist GON in establishing a Lender of Relevance in the short run, and enable the beginning of linking domestic finance with urban infrastructure needs in Nepal in the medium to longer term.

Business Reorganization Action Plan

The business and operational reorganization of the TDF has been elaborated in the Business Plan prepared by the TDF management with the support of the GIZ and the World Bank. This Plan, which has been discussed and supported by key stakeholders, provides the conceptual and factual underpinning to the BRAP with immediate strategic actions for January-July, 2011 that sets up the framework for the five-year comprehensive business restructuring program (BRAP); the salient features and key actions are summarized below.

The BRAP includes actions completed in January 2011 that indicate the reform commitments of the GoN and the TDF Board. These include: Board approval of a workout plan and MOF approval of preferred workout option, namely to transfer GON loan on problem projects into TDF equity and mandate TDF to implement a workout plan. The most immediate actions include: (i) Cabinet approval of the TDF debt/equity swap with loan workout, and the conditionality for on-lending or on-granting IDA funds from GoN to TDF; (ii) Board approval of the Business Plan, the TDF capital structure after D/E swap, and the detailed BRAP; and (iii) for the TDF management a) to complete a detailed risk assessment of the problem projects with proposal of specific workout actions, including conditions for restoring technical sustainability, tariff and loan renegotiation etc.; b) to hire skilled staff for immediate improvement of appraisal, project management, and fund management capacities; and c) prepare Standard Operation Procedures in line with the new business organization of TDF, as per the BRAP.

The medium term actions are to be completed largely by the TDF management, some with Board approval as per the BRAP, including (i) implementing the Business Plan, the institutional development plan, and the BRAP; (ii) completing the workout program; (iii) strengthening project management, appraisal, fund management, risk management, financial management, (iv) enhancing the accounting, the financial reporting, and the MIS system; and then (v) expanding business pipeline; (vi) testing and introducing new systems, instruments such as using revolving fund, bonds, guarantees, and structuring public private partnerships; and (vii) improving the financial position of TDF, measured in terms of financial ratios such as D/E ratio (from 8:1 to 6:1), DSCR (from 0.56 to 1.2); and collection efficiency from (75% to 90%) by the end of the project.

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Annex 9: Town Selection Methodology and Profile of Participating Towns

Town selection methodology

Nepal, at 18 percent urban, is still at an incipient level of urbanization. The urban space comprises one metropolitan area (Kathmandu), three sub-metro areas (Lalitpur, Biratnagar and ), and 53 municipalities. Emerging towns with high prospect for economic growth constitute the “target” urban space for the project. For the purpose of this initial town selection, emerging towns were defined to include all municipalities with population in the 25,000 – 65,000 range (“eligible towns”). Based on 2010 population projections, there are 30 eligible towns, accounting for about 43 percent of total urban population in Nepal (excluding Kathmandu and the sub-metro areas).

Six towns have been short-listed from among the pool of eligible towns for the project. The methodology for the selection of the six towns was based on a three-step approach. First, clusters/corridors were selected based on a combination of factors related to demography, economics and connectivity. Second, eligible towns in the selected clusters/corridors were ranked based on the following four criteria: demographic, economic, municipal finance/management capacity and connectivity. Third, filters related to security, spatial factors and the presence of donor-supported urban development projects were applied to the long list of towns to generate a short list of candidate towns. Each methodological step is discussed below.

Step I: Selection of the clusters/corridors

There are five main North -South (N-S) economic corridors, or growth axes, that cut across the three ecological belts of the country (, hills and mountains). The five growth axes are referred to as the Eastern, Central, Western, Mid-Western and Far-Western corridors, based on the development region in which they are located. Each corridor consists of a main arterial road which links together a number of growth centers. The main growth centers in each corridor are Biratnagar (East), (Center), Butwal (West), (Mid-West) and (Far-West). Apart from these major five N-S axes corridors, there are minor N-S axes corridors in each development region. The objective of the corridor selection was to identify the clusters/corridors with the greatest economic potential. The five clusters/corridors were evaluated based on three equally weighted criteria: demography, economic conditions and connectivity. The following indicators were computed for each of the three criteria: • Demographic: total population, percent of urban population, and urban population growth rate; • Connectivity: urban population served by the economic corridor, peripheral urban population of regional economic centers, and accessibility; • Economic: per capita manufacturing value added, percentage of change in manufacturing value added in 2002 - 2007, percent of municipal non-farm population.

The Central, Western and Eastern clusters/corridors received the highest scores across all three criteria. Towns located in the three corridors and meeting the population range criteria (25-65k) were considered for the second step of the selection process.

Step II: Selection of towns

There are 25 eligible towns in the three selected corridors (9 in the Eastern, 8 in the Central and 8 in the Western). The 25 eligible towns were ranked based on the following four criteria: (i)

74 demographic, (ii) socio-economic conditions, (iii) financial and management capacity and (iv) connectivity. The four criteria were given equal weights. Preference was given to towns showing high growth potential, good financial and management capacity, and well connected to the surrounding urban space, while also taking into account the towns’ poverty profile. The following indicators were applied to measure towns’ performance with respect to the four criteria: • Demographic conditions: Higher scores were assigned to the largest towns, and to towns with above average population growth. • Socio-economic conditions: Higher scores were assigned to towns with an urban economic profile (measured by the percentage of households engaged in non-farm economic activities) and to towns with the highest economic growth potential (measured by per capita district GDP, manufacturing value added level and growth, and number of banks per 100,000 inhabitants). Higher score were also given to towns with the highest poverty level (measured by poverty level). • Financial and management capacity: The assessment of the financial and management capacity of the towns gave higher scores to towns with good financial status (measured by per capita revenues and own-source revenues as a share of total revenues) and to towns with good management and governance practice in place (based on MLD's MC/PM indicators, and whether towns have a Periodic Plan). • Connectivity: The connectivity analysis assigned higher scores to towns located on the corridor’s main highway and within 50 km radius of the main economic center in the corridor, and to towns with linkages to the surrounding rural areas (measured by the population living in small settlements located within a 25 km radius from the town).

A long list of towns was generated based on the scoring system. The indicators and the scoring system, the ranking of the towns and the composite scores based on the four criteria are available in the project files.

Step III: Identification of participating towns

A number of filters related to spatial factors, the presence of other donors and the security situation were applied to indentify the candidate towns. The following indicators were used as filters: • Towns located in N-S corridor (spatial factor): Towns located on or adjacent to the N-S axes corridors of the three development regions were identified as candidate towns. Towns located out of the corridors are filtered out. • Towns located in Kathmandu valley (spatial factor): Towns located in Kathmandu Valley were dropped from the list of candidate towns. • Presence of other donors: Towns where other donors (e.g. ADB and Saudi Fund) have a strong presence were dropped from the long list. Hence, towns in the Central Corridor were filtered out. • Security: Towns located in security sensitive areas were dropped from the list. The security situation was evaluated based on stakeholder knowledge of the local situation.

The application of the four above-mentioned filters reduced the sample of eligible towns from 25 to 8. The SC held a meeting on May 17th 2010 to review the methodology and approve the selection of towns. The SC selected the top six towns for inclusion in the project (out of the 8 towns in the shortlist). The selected towns are the following (estimated 2010 population within bracket):

Western Region • Baglung Municipality - Western Hill (30,000) • Tansen Municipality - Western Hill (30,000)

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• Lekhnath Municipality - Western Terai (60,000) Eastern Region • Itahari Municipality - Eastern Terai (65,000) • - Eastern Hill (26,000) • - Eastern Terai (56,000)

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PROFILE OF PARTICIPATING TOWNS – WESTERN REGION

ECONOMY and MUNICIPAL CAPACITY -

Baglung Tansen Lekhnath

The . A growing market town: Baglung is an important and . Economic ‘flat-lining’: Tansen is a hill town and . A ‘Garden City’ in the making: The Municipality Economy expanding market town. The population has increase market center with a current population estimated to be famously contains ‘Seven Beautiful Lakes’. Its economy is from around 20,000 in 2001 to an estimated 30,000 in the low 30,000s. It is one of the oldest municipalities based on tourism, agriculture and commerce. Lekhnath is a today. Businesses are also expanding; numbers have in Nepal. Population increase and economic growth, well known tourist destination attracting both domestic and increased in both the Municipality and surrounding however, have been muted over the past decade. The foreign tourists, including those trekking in and around the District, and non-farm activities are on the rise. Baglung Municipality has not developed as fast as have others in Pokhara Valley. Lekhnath is often referred to as the is developing as a major business centre of the the Country and in the western region. Nearly half of ‘Eastern Gateway to Pokhara’. Dhaulageri region. the formal sector business interviewed in the Sept 2010 . A growing municipality: Its population in 2001 was . A centre for migrants: The opening of mid-hill survey stated that the number of their employees had around 41,000. The current population estimate is some highway has lead to increased migration from the rural fallen over the last 2-3 years and around a third stated 60,000. Population growth rate of Lekhnath is around 5% areas to the Baglung, the economic catchment area of that employment number were static. annually. The number of businesses registered with the which continues to grow. The opening of the road to . Decline of traditional industries: Traditional industries Chamber of Commerce doubled between 2005 and 2010. Jomsom (a major destination of the trekkers and Hindu that have characterised Tansen (such as Nepali Dhaka, a Lekhnath is rated ‘excellent’ as an educational center, Pilgrims) from Pokhara via Baglung, is expected to traditional cloth used for women’s dresses and Nepali especially for higher education (due to Pokhara University). bring significant economic activities to the town. caps, and karuwa, a distinctive water jug made of metal) . Threatened assets: The economy of Lekhnath is Moreover, remittances accruing to the people of have declined, and market activity has shifted from underpinned by its environment assets. However, the lakes Baglung and the surrounding villages are extremely Tansen south to the nearby settlement of Butwal. are neither protected nor properly maintained; some are high. Butwal has expanded much faster than Tansen. overrun with invasive weeds; others have been encroached upon and suffer from eutrophication. Economic . Three expanding sectors: (i) commerce and industry, . The drivers of growth: (i) the development of tourism; . Strategically located and well endowed: Lekhnath has Drivers and (ii) professional services and (iii) tourism. (ii) the revitalisation and subsequent expansion of its many economic strengths and comparative advantages Potential Manufacturing and trading businesses have expanded as traditional industries; and (iii) the development of the including its strategic location, natural beauty, good have, financial institutions and educational facilities. Tansen town as a commercial and educational hub: weather, relatively unpolluted environment, easy access to Before 2007 there were 21 cooperatives; the number Kathmandu, high literacy rate and a range of tourism assets. o Tourism: Tansen is one an important medieval towns reached 60 in 2010. Furthermore, today there are 9 of Nepal with a number of historical and religious . A clear vision: The vision for the Municipality as expressed branches of national commercial banks and 5 branches sites. It is located adjacent to an internationally in its Periodic Plan is for Lekhnath to be a prosperous of development banks and financial institutions. renowned tourism destination (Annapurna region / ‘Garden and Tourist City’. The growth of Lekhnath could Expansion of the health sector is creating employment trekking circuit), and a short distance from Pokhara. lead to its amalgamation with near-by Pokhara. Due to the opportunities for local people. The largest campus in o Craft Industry: The demand for the traditional availability of land for expansion in Lekhnath, and between Dhaulagiri Zone is located in Baglung. Furthermore, a products of Tansen is high across Nepal and their both towns, the “Greater Pokhara Concept” is likely to number of boarding schools are located in the expansion in Tansen can be linked to the materialize through the gradual but steady amalgamation of Municipality. Relatively prosperous families have development of tourism in and around Tansen. the two towns. This amalgamation could become a major located in the Municipality in order to ensure that their o Professional and Commercial Services: Tansen driver of the regional economy and a counter-weight to the children gain access to these education facilities. already is a major educational center largely due to primate city Kathmandu economy. . Expanding government center: Baglung is the the presence of the 2,200 student strong Tribhuwan . Agricultural potential: The continuing development of location of a number of Government offices and a zonal Multiple College, which is part of Tribhuwan agriculture and fish farming and livestock rearing are also headquarters. Balung and the adjacent areas are host to University. Moreover, Medical College is drivers of the economy as is the further development of the units of Nepal Army, and Nepal Police and Armed one of the best education facilities of Western Nepal. 77

Police Force. The restructuring of the State of Nepal Tansen continues to act as an important market and educational services found within the Municipality. (into federal units) would likely boost Baglung as an service center for its hinterland. Lekhnath is also rich in orchids; the potential to develop administrative center given the town’s location and the . The Periodic Plan of Tansen (2009) is emphatic about floriculture activities is significant. The Kali Gandaki Hydro fact that it is relatively infrastructure rich in comparison the strengths of the Municipality and its potential to power station lies within the boundary of the Municipality, to other hill towns of western development region. develop as a Garden and Tourist City, The opportunity but, unfortunately, this is, no guarantee that the Municipality . Developing tourism potentially is the most important exists for Tansen to positively and successfully respond will receive a constant supply of electricity, and overcome future driver of the Baglung economy. This activity is to ‘Nepal 2011’ year of Tourism. Many of the the perennial problem of load-shedding which so many already established in Baglung which can develop as an businesses interviewed by the GHK are optimistic about businesses highlight across Nepal as a major constraint on important base station for trekking / climbing activities the future; 42% of the 26 formal sector business stated their expansion and profitability. in the Dhorpatan region. There are many sites of that they expected the number employed to increase, religious and cultural importance as well as scenic and and half of these businesses stated that they expected the recreational spots within and around the Municipality. business to expand in the near future. Municipal . Lack of funds: The Municipality has posted an . Lack of Funds: The Municipality has posted an . Lack of Funds: The Municipality has posted an operating Capacity operating deficit since 2005/06. The deficit was some operating deficit since 2005/06. The deficit was some deficit since 2005/06. That year it was NRs 1.84 million; NRs 5.55 million in 2007/08, rising to NRs 7.17 million NRs 4.14 million in 2007/08, falling to NRs 2.73 last year the corresponding figure was NRS 3.24 million. in 2008/09. The annual operational deficit is a clear million in 2008/09. The annual operational deficit is an The annual increasing operational deficit is an indication indication that the Municipality has to improve its indication that the Municipality has to improve its that the Municipality has to improve its financial financial management. financial management. management and needs financial support. . Good performance: Baglung ranks 3rd out of 58 . Good performance: Tansen is ranked 10th out of 58 . Good performance Lekhanath ranks 9th out of 58 municipalities on MCs. This is an excellent result and municipalities on MCs which cover local self municipalities on the MCs. This is a good result and bodes bodes well for the management of the development of governance; service delivery; transparency; and well for the Municipality taking on further responsibility. the Municipality. The Municipality is ranked 8th out of formation and functioning of committees. This is a The Municipality ranks 29th out of 58 municipalities on the 58 municipalities on the PM, another good ‘result’. positive score and outcome. The Municipality ranks 2nd PMs. The PM score is poor as regards planning and However, the PM score is poor as regards financial out of 58 municipalities on PMs. This is an excellent programming management (5 out of 18). management (14 out of 28) and planning and program outcome. The Municipality received full marks with management (8 out of 18). regard to organization and management. Municipal office infrastructure, participation of households in matching funds for community roads and TLOs and activeness in municipal affairs are very good in Tansen. The PM’s score, however, is poor as regards planning and programming management (6 out of 18).

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INFRASTRUCTURE CONSTRAINTS

Baglung Tansen Lekhnath

Water • About 56% of the population has access to piped water • The piped water supply coverage in Tansen is around • Water supply coverage is reasonable but not exceptional the supply within premises. Water is available for only 2 41%. (51% of households have piped water supply connections hours on alternate days. • Supply periods are limited to one hour on alternate days within premises). • There are isolated schemes on the periphery of the town only. The total number of connections is about 1,800. • Piped water supply is lacking in the hilly wards. characterised by low yielding sources, lack of treatment, Around 1,800 applications for new connections have and limited supply for 2-3 hours/day. remained pending for more than a decade due to the inability to augment the source. Roads • The roads connecting various wards within the • Nearly one fifth of all households in Tansen do not have • In 2010 there was only 126 kilometers of roadway in the municipality are still to be planned and constructed. direct access to a road. town; a mere 0.02 km per hectare. The density of roads is • Due to poor connectivity, many wards remain rural in • Only 13% of municipal roads are blacktopped or very low, about 2.28 km. character with subsistence farming being the dominant concrete. • Access to a road is poor; many have to travel a considerable form of economic activity. • Almost fifty four per cent of the roads are still earthen and distance before an all weather road is found. mostly inoperative during rainy season, Drainage • There is no sewerage system in Baglung. • Sewage is discharged to nearby gorges without any form • Lekhnath experiences frequent flooding, which is likely to Sewerage • The central market area of Baglung suffers from of treatment. get worse as the urban areas expand and densifies. Sanitation extensive surface runoffs. • About 11% of the population (mainly rural) still resort to • Sanitation is satisfactory. Only a very small percentage of open defecation. households, about 7%, are reported to be resorting to open • The city has only two public toilets; the level of operation defecation and maintenance is of the public toilets is not satisfactory. Solid Waste • Baglung does not have a waste treatment and disposal • Solid waste isn’t treated. There is a small incinerator in • The town does not collect waste from residential areas, facility. The waste is transported to a dump site which is the mission hospital for burning hazardous clinical waste. which is either burnt in small fires in residential areas or about 4 km away. • A semi aerobic land fill site with the capacity to manage dumped along roads and rivulets/streams, and thus an • The dump site is located on the bank of the River Kali solid waste for the period of 15 years (till 2024) is under environmental hazard. Gandak and has insignificant storage capacity. The waste construction by the Municipality pollutes the river; it is a major environmental health hazard. Other • -Load shedding continues to be a major problem for • The following issues were highlighted during • The main tourist assets of the town, the lakes, are Services industrial and business activities of Baglung, as is consultations: need to improve the water supply, deteriorating. The lakes are now in real danger of common throughout Nepal. inadequate urban services (e.g. solid waste management; extinction. The 2002 Master Plan that promised a • There is no organized bus park area in the town. The roads, electricity), poor traffic management and congested turnaround for the lakes has not been implemented. buses are parked in a small public area near the market. roads, and the need to stimulate the economy (tourism • Haphazard development (and land speculation) and an There isn’t enough land in the core area of the town development was highlighted). uncontrolled land-use pattern characterize the town. available for the bus terminal.

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PROFILE OF PARTICIPATING MUNICIPALITIES – EASTERN REGION

ECONOMIC POTENTIAL and MUNICIPAL CAPACITY

Itahari Mechinagar Dhankuta

The . Fast growing: Itahari Municipality is one of the . A ‘Transit Town’: Mechinagar is strategically located at the . A prosperous market settlement: The Municipality Economy fastest growing population centers in Nepal. The eastern end of Nepal. Transit activities, the trade of goods is a small but prosperous market settlement and trading estimated average annual population growth rate and services, and the movement of people define its center in Eastern Nepal consisting of two distinct areas; since 2001 for Itahari is 5.3%, approximately double economy. Mechinagar lies next to one of only four dry ports Dhankuta and Bazaars. Hile Bazaar is a trading that of the urban sector of Nepal in Nepal ( Inland Clearance Depot). centre while Dhankuta Bazaar is an administrative, . An urbanizing community: In 1997 when declared . Slow population growth: In 2001 the population of education and health service centre. The average annual a municipality Itahari was a small community of Mechinagar was some 50,000; today the corresponding per capita income is above the national average. around 20,000 people, many of who lived in a rural figure is estimated to be around 57,000, a growth rate below Agriculture and market trading are the mainstays of the setting. Today, Itahari is a thriving community with the average for the urban sector of Nepal. local economy. Other important non-farm activities include construction services, the manufacture of cloth a 2010 estimated population of some 65,000, the . A center of agricultural production: Mechinagar is located (especially Nepali hand-made thick cloth) and tea estates majority of which live in an urban environment. in one of the most productive agricultural regions of Nepal, . Steady industrialization: Non-farm employment and the Municipality has a comparative advantage as regards . Noted population and economic growth; the current has increased since 2001, and particularly since 2006 agro-processing industry, associated with tea herbs and the population is some 26,000, and is expected to reach following the ending of the insurgency. Whereas production of off-season vegetables. Many agro-based 38,000 in 2021. The number of businesses has been there were some 80 industrial businesses in the industries such as jute factories, sugar mills, rice mills and expanding. Records show that in Hile Bazaar the number Municipality in 2001, today the estimate is over 380. tobacco factories operate in the region. High value crops can of businesses has increased by about 100 a year over the Furthermore, records show a major increase in the be processed in Mechinagar prior to export to and last 2-3 years. Moreover, in 2005 there were only three number of businesses registered with the Chamber of Bangladesh. branch offices of commercial banks in the Municipality, by 2008 there were five, and today the estimate is seven. Commerce, from 836 in 2006 to around 2200 in . But muted economic development: Although there has 2010. been a recent increase in the number of businesses (particularly in the years following the end of the insurgency in 2005/06), slow growth characterizes the economy, and the population of Mechinagar remains relatively ‘poor’. The Municipal Profile and Poverty Map, April 2010 shows that the vast majority of the households of the Municipality are economically vulnerable, with an annual income of NRS 50,000 or less. Economic . Strategically located: The rapid growth of Itahari is . A ‘locational advantage’: Mechinagar is strategically . A varied and developing economy: The town has Drivers and a function of its favorable location. The located both nationally and within the wider region; it has potential to develop in the following areas: Potential Municipality is a strategic node on the East-West adequate land for urban expansion, and groundwater is not o Agriculture commercial farming and livestock rearing highway and North-South corridor of Eastern Nepal. an immediate constraint on expansion. in and around Dhankuta Municipality could be It is major market town, distribution centre, and the . The potential of the ‘Dry Port’:The town could be well developed if efficient commercial practices are

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transportation hub for the surrounding communities. suited to the expansion of commercial services associated introduced . In a ‘Growth Corridor’: Itahari is located near to with the development of Kakarbhitta (e.g. transport and o Educational Services - The Municipality could expand the major industrial town of Biratnagar, and in the related services, such as freight forwarding, logistics, as an educational hub, as has Darjeeling and Dehradun middle of the and Biratnagar Industrial customs and sanitary and phyto-sanitary services) and light in India. Growth Corridor. manufacturing associated with the production of garments o Tourism - The topography and climate of the area are and handlooms, attractive to domestic and Indian tourists. This . An economic counter-weight: Itahari in conjunction potential could be realized if, for example, Dhankuta with Biratnagar and Dharan, could act as the major . Industrial and agricultural potential: Mechinagar has the potential to expand its industrial base (linked to trade and becomes a base station for trekking activities in the economic driver for the Eastern Development region; Region, and become an important counter-weight to transit operations), develop services in support of the expansion of commercial agriculture in the surrounding o Commerce and Trading –The construction of the the primate city economy of Kathmandu. The key proposed Biratnagar road will allow the challenge is to enable Itahari to play a major and region, and ensure that its educational and health facilities serve the eastern development region of the Country. Municipality to expand and develop into an important catalytic role in the development of the Dharan and commercial hub in the region. Biratnagar Industrial Growth Corridor and thus become a major driver of the local and regional • Growing business confidence: The results of the business economies. survey shows that business confidence is strong and businesses prospects are improving. Municipal . Lack of funds. For the last two years the . Lack of Funds: The Municipality has posted an operating . Lack of Funds: The Municipality has posted an operating Capacity Municipality has not generated an operating surplus. deficit since 2005/06. The deficit was about NRs 3.66 deficit since 2006/07. Fortunately the deficit is not large. Indeed, the deficit was some NRs 1.99 million in million in 2007/08, rising to NRs 5.09 million in 2008/09. The deficit was NRs 0.38 million in 2007/08, but rising to 2008/09. The Municipality is heavily dependent on Further, the Municipality is dependent on external sources NRs 0.41 million in 2008/09. The cumulative annual external sources. The Municipality is looking to of funding. operational deficit is an indication that the Municipality Central Government Lines Agencies and Donors to . Average performance; getting better: Mechinagar ranks has to improve its financial management. fund nearly 90% of the investments presented in the 32nd out of 58 municipalities on MCs, and 12th out of 58 Municipal 5 Year Investment Plan. municipalities on PMs. However, the Municipality’s PM . Above average performance: Dhankuta ranks 13th out of . Average performance: The Municipality is ranked score is poor as regards local self governance (6 out of 22 58 municipalities on MCs (Minimum Conditions) which 26th out of 58 municipalities on PMs. The score is marks) and planning and program management (6 out of cover local self governance, financial management, much lower in relation to specific measures of local 18). service delivery and transparency, and formation and self governance, and effective planning and program function of Committees. Dhankuta Municipality is ranked management. The municipality is ranked 12th in MC 10th out of 58 municipalities on Performance Measures score. (PMs). The PM score, however, is poor in local self governance (13 out of 22) and particularly as regards planning and program management (3 out of 18).

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INFRASTRUCTURE CONSTRAINTS

Itahari Mechinagar Dhankuta Water • The coverage of piped water is estimated to be around • Coverage for Kakarbhitta and is adequate but • There is no centralized water supply system in Dhankuta, 44%. Furthermore, the treatment plant is not yet the supply system is old and in urgent need of and there is extreme shortage of water in the town. operational and, hence, the supply is delivered untreated. improvement. • Furthermore, the distribution system is chaotic as a result • The total capacity of water supply system may quickly • However, coverage for Itabhatta, which is around 26% of of indiscriminate connections. Most of the water pipes are become insufficient if the current rate of population the total municipal population, is nonexistent; the area exposed to the surface. Leakage is high. growth continues. remains un-served by piped water supply. Roads • The North-South and East-West Highways that bisect at • More than two thirds (66%) are gravel; Excluding • Only 18% of the roads can be classified as good (only 11% the Center of Itahari are heavily used and often highways only 4% municipal roads are black-topped. are black-topped) and the vast majority of roads do not congested, which is a major constraint on the further Roads are often in a poor state of repair. have roadside drains. As a result, effective and efficient economic development of the Municipality. • Effective and efficient transportation is impaired; transportation is impaired. • Only 11% are black-topped. congestion is common. Drainage • At present drainage is a problem and an environmental • Some core areas of the town have surface drainage. • Waste is being dumped and septic tank and latrines waste Sewerage hazard particularly during the Monsoon. Some portions Except in a few places, the drainage system appears to be are flowing directly into the water courses; surface water is of the city experience serious water logging. Sanitation maintained satisfactorily. being seriously polluted. There isn’t a sewerage system. • The town does not have a sewerage system. This is a • The is a lack of public toilets; septic tank and latrines • Approximately one third of the households do not have major environmental heath challenge. waste are flowing directly into the water courses; adequate individual toilets. toilet facilities are found in less than half the houses. • Open defecation is still practiced in a few areas Solid Waste • Itahari does not have sanitary landfill site. • The town does not have a sanitary land-fill site. • A newly constructed landfill site should come into • The existing dumping site is a serious environmental • The town does not have any other option but to dump the operation in 2011. The site has a composting yard, hazard, and can no longer hold the garbage. waste along the roads or used as road construction segregation yard, and incineration area. material. This practice poses a threat to the sub-surface environment. Other • The following issues were highlighted during • The problem of load shedding was frequently mentioned • The problem of haphazard building construction is visible Services consultations (June and September 2010) by Municipal by community stakeholders and respondents during in almost all wards and directly related to the lack of an and Community representatives; - limited social services, consultations (June and September 2010). effective land development policy such as hospital and educational facilities, and • Land speculation was another issue which, together with • Load shedding was mentioned during consultations (June inadequate urban services (e.g. solid waste management; the lack of effective land management, leads to sub- and September 2010) as a continuing problem. roads, electricity). optimal social and economic outcomes and major • The problems of road congestion, poor urban constraints on economic development. environmental services and load shedding were mentioned as ‘problems’ of Itahari by a number of the respondents (September 2010). 82

PROFILE OF PARTICIPATING TOWNS – SUMMARY INDICATORS

Demographic Economic Social/Institutional Financial Percent of Per Capita Registered Population Average Total Revenue Internally Population Businesses Slum Town Population growth Building MC PM Internally Generated 2010 (per 1,000 population 2001 rate Construction Score Score Generated - Revenue (estimate) people) (%) (2001-10) (2007-10) 2008/09 2008/09 2010 (NRS ‘Million) (NRS) WESTERN

Baglung 20,852 30,000 4.1% 47 175 1% 3rd 8th 11% 200 Tansen 20,431 30,000 3.1% 50 112 4% 10th 2nd 12% 234

Lekhnath 41,369 60,000 4.9% 31 336 8% 9th 29th 6% 94 EASTERN

41,210 65,000 5.3% 65 20% 12th 26th 20% 527 Itahari 1,563

Mechningar 49,060 57,000 3.0% 45 179 27% 32nd 12th 20% 359 Dhankuta 20,668 26,000 3.15% 59 64 2% 13th 10th 10% 224

Western Eastern Weighted Access indicator Unit Baglung Tansen Lekhnath Itahari Mechinagar Dhankuta Avg. Households with access to % of municipal piped water supply within 56 41 51 44 38 31 44 households premises.

Municipal solid waste % of total municipal 0** 40 0* 0** 0** 75 12 collected and safely disposed. solid waste

Municipal roads in good and % of total classified 24 13 7 11 4 11 10 fair condition (black-topped) roads

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Households with access to % of municipal improved sanitation (Septic 61 35 34 54 44 36 44 households tank and flush toilet) Percentage of municipal % of total classified roads that have surface 24 7 2 4 8 7 7.5 roads drainage

(*) No collection system, (**).No safe disposal.

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This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any NEPAL endorsement or acceptance of such boundaries. MUNICIPALITIES AND SMALL TOWNS NEPAL IN CORRIDOR CLUSTERS 30° N

SimikotSimikot CORRIDOR CLUSTERS DarchulaDarchula STUDIED MUNICIPALITIES MUNICIPALITIES BaitadiBaitadi GamgadhiGamgadhi PatanPatan CHINAC H I N A SMALL TOWNS DadeldhuraDadeldhura NATIONAL CAPITAL Dipayal-SilgadhiDipayal-Silgadhi JumlaJumla

JogbudhaJogbudha MAIN ROADS 29° N BhimdattaBhimdatta BudarBudar ManmaManma RAILROADS DulluDullu BanbasaBanbasa AtariyaAtariya NarayanNarayan KagbeniKagbeni INTERNATIONAL BOUNDARIES DhangadhiDhangadhi ChisapaniChisapani JomsomJomsom BirendranagarBirendranagar BhajaniBhajani TikapurTikapur BeniBeni ChhinyuChhinyu RajapurRajapur KushmaKushma HyangjaHyangja PokharaPokhara DumreDumre AbuAbu GulariyaGulariya KohalpurKohalpur

TulsipurTulsipur BazarBazar KhaireniKhaireni SyabrubensiSyabrubensi 28° N ShantipurShantipur PutaliPutali BBazarazar DhuncheDhunche NepalganjNepalganj TamghasTamghas VyasVyas ArughatArughat WalingWaling BetrawatiBetrawati RidiRidi KhairenitarKhairenitar DhadinDhadin RandipurRandipur RanipauwaRanipauwa Tansen BidurBidur ChautaraChautara BarabiseBarabise GaidakotGaidakot GajuriGajuri ButwalButwal KATHMANDUKATHMANDU BhimeshwarBhimeshwar ChanautaChanauta SunabalSunabal KKawasotiawasoti ParsaParsa PolunPolun RupandehiRupandehi BanepaBanepa DhulikhelDhulikhel BharatpurBharatpur BhimphediBhimphedi KrishnanagarKrishnanagar BardaghatBardaghat PanautiPanauti SiddharthanagarSiddharthanagar RamgramRamgram RatnanagarRatnanagar HetaudaHetauda KhadbariKhadbari TaulihawaTaulihawa (Bhairahwa)(Bhairahwa) ChainpurChainpur BHUTANBHUTAN CORRIDOR CLUSTERS AmtekhganjAmtekhganj BhojpurBhojpur TerhathumTerhathum JeetpurJeetpur SimaraSimara ChandranigahapurChandranigahapur BasantapurBasantapur 27° N CENTRAL INNER TERAI/TERAI CORRIDOR CLUSTER PokhariyaPokhariya BiratBirat ChowkChowk ManglungManglung KalaiyaKalaiya LalbandiLalbandi BirganjBirganj BardibasBardibas DharanDharan DhankutaDhankuta CENTRAL MOUNTAIN/HILL CORRIDOR CLUSTER BarahathawaBarahathawa ItahariItahari UrlabariUrlabari LetangLetang BirtamodBirtamod EASTERN HILL/MOUNTAIN CORRIDOR CLUSTER MalangawaMalangawa BhatgaunBhatgaun SurunggaSurungga GaurGaur LahanLahan SinuwariSinuwari BelbariBelbari EASTERN TERAI CORRIDOR CLUSTER InaruwaInaruwa DamakDamak RajbirajRajbiraj DuhabiDuhabi BhadrapurBhadrapur FAR WESTERN MOUNTAIN/HILL CORRIDOR CLUSTER HanumannagarHanumannagar RangeliRangeli AnarmaniAnarmani FAR WESTERN TERAI CORRIDOR CLUSTER BiratnagarBiratnagar MID WESTERN INNER TERAI CORRIDOR CLUSTER 26° N MID WESTERN MOUNTAIN/HILL CORRIDOR CLUSTER

26° N 27° N 28° N 29° N 30° NINDIAI N 31° N D I A WESTERN MOUNTAIN/HILL CORRIDOR CLUSTER BANGLADESHBANGLADESH WESTERN TERAI CORRIDOR CLUSTER JANUARY 2011

OTHER REGION IBRD 38363

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