On September 14, Finance Minister Gyanendra Bahadur Karki and Millennium Challenge Corporation (MCC) acting CEO Jonathan Nash signed a $500 grant agreement for investment in the energy and transportation sectors. This assistance is especially significant for two reasons: it is the single largest one-time grant assistance by a development partner, and no cost and time overruns are entertained once the grant becomes effective.

A large one-time grant amount equivalent to about two percent of Nepal’s gross domestic product by a specialised foreign aid agency, which uses a fairly transparent yet rigorous selection methodology to assess eligible countries, is in itself a significant positive development for Nepal. However, the challenge would be to complete the projects considered under the assistance without cost and time overruns, which unfortunately are also the two most common yet unresolved issues concerning public capital spending in Nepal.

Binding constraints

The MCC selected Nepal to develop a five-year compact program in December 2014 after Nepal met the eligibility requirement, which includes sound performance in about one and a half dozen independent policy indicators related to democratic governance, economic freedom and investment in citizens. Earlier, a threshold program, which has a smaller grant assistance than the compact program, in December 2011 led to a rigorous analysis of Nepal’s growth constraints and identification of potential areas for policy improvement. The diagnostics study—an update of a 2009 study led by Asian Development Bank—identified four key constraints to growth: policy implementation uncertainty, inadequate supply of electricity, high cost of transport and challenging labour relations.

This diagnostic study formed the basis for selection of energy and transport sectors for investment, and sectorial reforms under the compact program. A series of stakeholder consultations—including public and private sectors and donors—were held to identify fairly large investment projects that could be completed within five years and that have the potential to yield substantive outcomes by tackling some of the most binding constraints to economic growth.

Out of $630 million (including $130 million as counterpart investment by the government), about $520 million is planned for the electricity transmission project, under which 300 kilometres of high voltage electricity transmission network will be built and capacity of the country’s energy regulator enhanced. This kind of infrastructure is crucial for supporting transmission of power generated by various hydroelectricity projects across the country and for greater electricity trade between Nepal and India. Around $55 million is earmarked for road maintenance, under which 305 kilometres of road will be built and rehabilitated. The remaining amount is allocated to cover project administration costs, including procurement and monitoring and evaluation expenses.

No overruns

The actual implementation of projects will probably start towards the end of 2018 after they are investment-ready, i.e. procurement packages are finalised, significant proportion of land is acquired, detailed implementation plan is outlined and implementation offices are established. Once implementation starts they have to be completed within five years and without any cost overruns. Else, the unspent grant amount will be returned to the MCC. Against this backdrop, if the same structure of project implementation including staff deputation, policies and laws are going to govern the MCC’s investment projects, then there is little room to be optimistic that it will be completed within five years.

Execution of capital budget is hamstrung by a maze of bureaucratic and structural factors, leading to under spending as well as heavy bunching of spending in the last quarter of every fiscal year. For instance, in 2016/17, the budget was approved one and a half months prior to the start of fiscal year, which in principle gave the ministries time cushion to get approval for spending and initiate preparatory project planning (especially procurement documents). Still, 60 percent of actual spending happened in the last quarter, and 41.2 percent in the last month itself, raising doubts over the quality of spending. Worse, just 65.5 percent of planned capital budget was spent. This pattern of spending, and deficient expenditure absorption capacity, has been persistent irrespective of which political party leads the government.

Capital budget execution is affected by structural weaknesses in project preparation and implementation; low project readiness; bureaucratic hassles in project approvals and sanctioning of spending authority; weak project and contract management; and political interference at planning, management and operation stages. These issues are common across all projects irrespective of investment amount and duration.

Political interference

The exact details about the implementation modality of MCC’s projects in Nepal are not known yet. The MCC usually establishes its own local office to manage and oversee project implementation, which is fairly independent, rigorous and transparent. Meanwhile, the government procures land and secures environment clearances along with preparation of procurement documents before implementation starts. Unfortunately, the government does not have a good track record of completing these preparatory works on time.

Two specific issues are of particular concern regarding implementation. First, the upcoming provincial and federal elections will result in a new political structure along with changes in government leadership, as a coalition government would be a defining feature because no party is likely to secure the necessary majority in Parliament. This in turn would entail transfer of government staff loyal to ruling parties to large project management or implementation offices, leading to snags in implementation and opening up of avenues for funds misappropriation.

For instance, the Communist Party of Nepal-Unified Marxist Leninist (CPN-UML) led coalition government in 2016 abruptly decided to not renew the contract of former secretary Krishna Gyawali, who was serving as a national coordinator of MCC Nepal upon appointment by the previous Nepali Congress (NC) led coalition government. Similarly, the same government terminated the contract of Radhesh Pant, former CEO of Investment Board Nepal, in 2016, even though Pant’s contract was renewed for an additional term by the NC-led coalition government. The case with the CEO of National Reconstruction Authority is also similar. These kinds of unceremonious contract terminations and transfers to put party loyalists in key positions affect project implementation timelines and escalate costs. The MCC’s projects need to be insulated from this kind of party-based selfish political incursion.

Second, Nepal needs to retain its score above median (threshold score) each year for a majority of policy indicators. For instance, worsening of governance may pull down the country score below the yearly median. Failure to have a satisfactory score in a majority of the policy indicators would also lead to either suspension or termination of grant assistance.

Sapkota is an economist