Report No. 9076-NEP Nepal Nonfinancial Public Enterprises Sector Report (In Iwo V\Iunes) Volinie 1 -Mairn Report January 16, 1991 A~sia CoMnr11V D)epa)rtment I Asia Techn (l I)epartmunt FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents nmay not otherwise be disclosed wi ithout WVorld Banki authorization. CURRENCY EQUIVALENTS (As of March 1990) Currency Unit - Nepalese Rupee (NR$) US$1.00 - NR$28.90 NR$1.00 - US$0.035 FISCAL YEAR (FY) Mid June - Mid July WEIGHTS AND MEASURES Metric System FOR OFFICIAL USE ONLY LIST OF ACRONYMS ADB Asian Development Bank AIC Agricultural Inputs Corporation ATF Agriculture Tools Factory BBF Bhaktkapur Brick Factory BJM Biratnagar Jute Mills BISF Bansbari Leather and Shoe Factory BOD Board of Directors CCD Corporations Coordination Division CE Chief Executive DDC Dairy Development Corporation EC Executive Chairman GM General Manager HCC Himal Cement Company HCIL Hetauda Cement Industry Limited HMG His Majesty's Government HTI Hetauda Textile Industry IFC International Finance Corporation JCF Janakpur Cigarette Factory MIS Management Information System MOA Ministry of Agriculture MOF Ministry of Finance MOI Ministry of Industry NFC Nepal Food Corporation NIDC Nepal Industrial Development Corporation NPC National Planning Commission NRB Nepal Rastra Bank NTL National Trading Limited PE Public Enterprise (nonfinancial) PSC Public Service Commission QC : Quality Control RDL Royal Drugs Limited RJM Raghupati Jute Mills STC Surya Tobacco Company T&T Trade and Transit This document has a restricted distribution and may be used by recipients only in the performance of their official duties Its contents may not otherwise be disclosed without World Bank authorization. NEPAL NONFINANCIAL PUBLIC ENTERPRISES SECTOR REPORT Table of Contents Page No. Executive Summary . . . . . . . . . . . . . . . . . . . . . . . i I. PE ROLE AND PERFORMANCE . . . . . . . . . . . . . . . . . 1 A. Introduction and Background . . . . . . . . . . . . . 1 B. PE Performance . . . . . . . . . . . . . . . . . . . . 4 C. Financing of the PEs ... . . . . . . . . . . . . . . 11 D. Discussion and Core Issues . . . . . . . . . . . . . . 13 II. THE POLICY AND REGULATORY FRAMEWORK . . . . . . . . . . . 14 A. Investments and the Regulatory Environment . . . . . . 15 B. Administration of Regulations . . . . . . . . . . . . 19 C. The Pricing Regime . . . . . . . . . . . . . . . . . . 21 III. GOVERNMENT SUPERVISION, CONTROL AND PERFORMANCE MONITORING ... . . . . . . . . . . . . . . . 26 A. Introduction and Summary . . . . . . . . . . . . . . . 26 B. Government Oversight Agencies . . . . . . . . . . . . 28 C. Existing Monitoring and Reporting Systems . . . . . . 31 D. Options for Reform ... . . . . . . . . . . . . . . . 32 IV. INTERNAL MANAGEMENT . . . . . . . . . . . . . . . . . . . 36 A. Introduction and Summary . . . . . . . . . . . . . . . 36 B. Managerial Capability ... . . . . . . . . . . . . . 38 C. Functional Areas ... . . . . . . . . . . . . . . . . 39 D. Financial Management ... . . . . . . . . . . . . . . 42 E. Options for Reform ... . . . . . . . . . . . . . . . 44 V. EMPLOYMENT, COMPENSATION AND LABOR RELATIONS . . . . . . . 49 A. Introduction and Summary . . . . . . . . . . . . . . . 49 B. Employment Regulations ... . . . . . . . . . . . . . 50 C. Salary and Wage Structure . . . . . . . . . . . . . . 55 D. Labor Relations .... . . . . . . . . . . . . . . . 57 E. Options for Reform ... . . . . . . . . . . . . . . . 60 This report is based on the findings of a World Bank mission to Nepal in March/April 1990, comprising C. Ramsay (Mission Leader), A. Agbonyitor, P. Thuyet, S. Paul, S. Torabi, J. Baker (Consultant), J. Plummer (Consultant), K. Koirala (Consultant), and P. Pant (Consultant). -ii- Table of Contents (Cont'd) Page No. VI. PRIVATIZATION AND DIVESTITURE . . . . . . . . . . . . . . 64 A. Introduction .... . . . . . . . . . . . . . . . . . 64 B. Constraints and Issues ... . . . . . . . . . . . . . 66 C. Strategy for Privatization and Divestiture . . . . . . 69 VII. STRATEGY FOR PE REFORM ..76 A. Overview .76 B. Implementation P.E. Reform . . . . . . . . . . . . . . 78 C. Implementation Plan ... . . . . . . . . . . . . . . 81 ANNEXES 1.1 Official List of PEs I.2 Legal Status of PEs 1.3 Capacity Utilization of Selected PEs I.4 PEs Dividend Distribution Statement T.5 Commercial Bank Loan to PEs Under HMG/Nepal Guarantee 1I.1 Ministry of Supplies: Role of Government in Pricing, Distribution and Marketing of Essential Commodities IV. Enterprise Profiles (Volume II) V.1 Comparison of PE and Civil Service Pay Scales V.2 Salary Analysis: Public Enterprises and Private Sector V.3 Salary Analysis: Joint Ventures V.4 Output Per Employee in Public and Private Sectors V.5 Supply and Demand for Skilled and Qualified Manpower VI.1 Company Valuation EXECUTIVE SUMMARY Background i. In the 1960s and 1970s Nepal relied heavily on piblic sector enterprises to promote economic growth. By the mid-1970s, more than 60 public enterprises had been established, in many instances with substantial financial and technical assistance from multilateral and bilateral donors. Although support for creating new public enterprises diminished subsequently because of existing units' poor performance, public enterprises still play a major role in economic activity in Nepal. Currently, the 64 officially listed public enterprises control major sectors of the economy. In the financial sector, two state banks, Nepal Bank Limited and Rastriya Banijya Bank, account for about 80Z of commercial bank assets. Nonfinancial public enterprises have virtual monopolies in commercial energy (including oil, electricity and coal), domestic air transportation, basic utilities such as telecommunications and water, and the importation of basic inputs such as chemical fertilizers. Manufacturing PEs (M.PEs) account for over 70Z of the domestic market for tobacco products, 62Z for cement, 55Z for sugar and 45Z for leather goods, in addition to substantial production of beverages, agricultural tools, textiles and drugs. Although they constitute numerically less than 3Z of the total number of manufacturing establishments relative to the private sector, MPEs represent a disproportionate share of fixed assets (36Z), value added (29Z) and employment (25Z). ii. Given the importance of the public enterprises, their current poor performance constrains the growth and efficiency of economic activity in Nepal. This report examines the performance of Nepal's nonfinancial public enterprises (referred to subsequently as PEs), with emphasis on the manufacturing PEs on which relatively little systematic analysis has been done and the trading PEs, which are the primary recipients of government subsidies. The report examines the budgetary impact of PE under-performance, assesses the factors, both external and internal to the PEs, which have contributed to their poor performance, and, taking into account existing social, political and economic constraints, recommends short-, medium- and long-term reform strategies. The analysis draws extensively on the results of a survey of ten manufacturing and two trading PEs. Volume Two contains detailed enterprise profiles based on this survey. Preparation of this report was coordinated with an IMF report on PE pricing and subsidy issues; recommendations in both reports on these issues are consistent. iii. The report concludes that PEs are likely to become an increasing burden on Government because of their poor financial performance. The PEs absorbed over 20Z of Government revenues on average over the past three years, with manufacturing and trading PEs accounting for about half of total allocations. Production levels and efficiency are below potential for most MPEs. Few are cost competitive relative to imports or similar enterprises in other developing countries. Of the 28 MPEs in operation, only four have generated profits consistently, two incur large losses and the remainder are only marginally profitable. Trading PEs have the largest financial losses. - ii - Over the past five years cumulative lobses of loss-making manufacturing and trading PEs exceeded NRs 1.5 billion. Financial losses have eroded government equity in the PEs; six of the ten MPEs in the .ample survey had negative or declining net worth. Five of seven trading PEs have a negative net worth. Actual financial performance is likely to be even worse than indicated since poor accounting standards and records understate the PEs' financial weaknesses. Deficiencies include lack of physical verification and revaluation of assets and inadequate provision for depreciation, bad debt and obsolete stock. Few PEs have internal funds to finance capital replacement costs. There is little indication that the performance of the manufacturing and trading PEs will improve in the foreseeable future. Even the few profitable PEs are beginning to show declining profitability and will eventually require support. Thus, PE debt repayment, working capital requirements, and rehabilitation and modernization costs are becoming a growing burden on Government. Constraints and Issues iv. The PEs' poor performance is due in part to real economic and physical constraints, such as poor quality and inadequacy of domestic raw materials, unreliable supply of power, obsolete technology and defective machinery. However, the PEs' policy and operating environment also provide little incentive to increase production efficienocy and achieve financially sustainable operations. Deficiencies exist in all areas critical to enterprise performance. Key problems highlighted in the report are the following: X Conflicting objectives, inconsistent policies and lack of clear performance guidelines have lessened PE accountability and weakened managers' incentives to perform. The Government has a multiplicity of often conflicting objectives for the PEs, including employment generation, meeting basic needs, providing rural services and generating financial returns through dividends, but little guidance has been given to enterprises to assist them in prioritizing or making tradeoffs among these often conflicting objectives. * The industrial and regulatory environment in Nepal shield enterprises from competitive pressures and fosters managerial inertia. Barriers such as output price controls and commodity trade agreements which support sole, state-sponsored supply of some products, limit private sector entry into some industries. At the same time, nonviable MPEs are seldom closed. In many instances, government measures such as payment of guaranteed debt, direct government subventions and tax rebates are used to support financially weak enterprises. * Weaknesses in the policy environment are compounded by an ineffective, procedure-bound system of supervision and control by government oversight agencies which limit the PEs' ability to respond to changes in their environment even if they had adequate incentives to do so. Formal and informal government control of pricing, investment, employment and other operational decisions - iii - contribute to lengthy and inflexible decision-making processes that frequently result in suboptimal decisions that adversely affect enterprises' financial health, and efficiency. The regulatory framework of the Public Services Commission (PSC), which controls all major staffing and employment decisions, limits the PEs' ability to adjust their staffing requirements to their needs. With the emphasis on detailed control of the PEs, government oversight agencies have failed to exercise strategic control; little guidance has been pro:ided to enterprises to help develop long-term strategies nor has long-term planning been emphasized. Furthermore, despite the multiplicity of oversight agencies, there is little effective performance monitoring. • PEs suffer from severe managerial deficiencies which would limit their ability to operate efficiently even under a less restrictive supervisory regime. The PE boards, comprised mainly of government officials, reinforce the use of civil service norms and practices rather than a commercial approach to management. This perspective of the boards is further reinforced by many chief executives who are retired or ex-government officials with no prior commercial experience. * The PEs are critically short of expertise in functional areas vital to commercial operations. While many PEs have excess levels of clerical and unskilled workers, in general there is a scarcity of skilled technical staff and operators. In most enterprises, corporate planning is virtually nonexistent, marketing is extremely weak, production management is poor, and there is little emphasis on manpower planning and personnel management. Even more important from the perspective of performance monitoring and internal controls, are the existing deficiencies in financial management and accounting practices and standards. The accuracy of most financial data is questionable. Poor accounting systems mask financial weaknesses and give managers little warning of potential problems. v. Over the years, the Government has recognized the PEs' growing problems and announced various policy initiatives but few of these have been implemented. Reforms proposed under the Seventh Plan (1985-1990) -- including PE div.-estiture, liquidation and consolidation, greater selectivity in new PE investments, increased autonomy for PE managers and introduction of performance incentives -- have not been acted on. With the exception of .a few trading PEs which became inoperative following loss of their markets and were liquidated, the Government continues to support many sick enterprises. Half- hearted attempts to privatize PEs have failed. Establishment of new PEs continues, driven more by availability of funding than by the strategic nature of the investment. Proposals to introduce a system of PE performance monitoring could not be effectively implemented. This failure to translate policy initiatives into concrete actions reflects a lack of government commitment and a failure.to achieve consensus among various interest groups as well as a lack of technical capability within the Government to design and manage effective implementation plans. It is therefore clear that to be successful, any PE reform strategy in Nepal must take into account the socio- - iv political environment and the Government's weak implementation capacity and should focus on the institutional arrangements essential for successful implementation. Strategy for Reform vi. The reform strategy proposed in the report recognizes that the problems facing PEs in Nepal are severe and cannot be solved in the short term. The multiple roles played by the PEs and the many vested interest groups make it difficult to build the consensus needed to achieve reform. Their operating environment provides little incentive for enterprises to function commercially. The supervisory and control regime which has had such a dysfunctional impact on PE autonomy and managerial incentive is well entrenched, and restructuring or dismantling this will take time. Furthermore, the key managerial functions essential for good performance and accountability, which are so poorly developed within the enterprises, require time and effort to establish. Nevertheless, given the poor and deteriorating performance of the PEs, there is now an urgent need to start corrective action. A broad strategy for PE reform should: (a) aim, as a matter of priority, to significantly improve the policy and regulatory framework for PEs and for the industrial sector in order to promote the private sector and increase the pressure on PEs to operate as efficient commercial entities. Key measures include (i) removing existing barriers to entry of private sector firms and improving the administration of industrial incentives and regulations; (ii) removing barriers to exit by limiting government support for weak PEs; (iii) replacing discriminatory direct controls on MPEs to purchase domestic raw materials by flexible incentives to motivate both public and private sector interest in using local resources; and (iv) liberalizing the price control system while making any remaining subsidies explicit and channeling them to clearly identified target groups. The number of goods subject to price control under the Essential Commodities Act should be reduced and pricing authority delegated to managers of PEs operating in competitive markets; (b) encourage divestiture/privatization of PEs wherever possible, while recognizing existing constraints to privatization and divestiture in the short term. Given the scarce managerial and financial resources in the public sector, privatization and divestiture, including liquidation or closure of nonviable PEs, by reducing the number of enterprises remaining in the public sector will make the task of planning and implementing PE reform more manageable. Essential to successful privatization is the development of clear policy guidelines which would indicate Government's objectives for privatization and divestiture, describe the institutional arrangements for managing the process, indicate how the potential costs of privatization, e.g., financing of debt restructuring and redundancy payments, would be met, and outline the Government's strategy with respect to redeployment of staff, foreign participation, concentration of ownership, management/employee - v - participatioi, etc. Classifying and ranking PEs, the first step in a PE reform program, will identify several candidates for privatizat on. However, given the underdeveloped capital markets and poor tinancial performance of many enterprises, the pace of privatization will be largely determined by the extent of investor interest and the effectiveness of measures to encourage management and employee participation and attract foreign as well as local investors. (c) develop a program of reform and restructuring for PEs that would remain in the public sector. The aim would be to achieve a more appropriate and sustainable balance between PE autonomy and accountability and to provide greater incentives to PE managers to perform. Priority actions would include the following: establishing efficient operational and financial performance as priority objectives while providing compensation to PEs which must incur costs to pursue social obiectives (structural changes such as transfer of noncommercial functions to Development Boards or goverimernt departments should be considered); reforming government oversight to emphasize strategic guidance and monitoring of appropriate performance targets with clear delineation of the role of each government agency; improving the quality of board members, and operational managars; granting PEs more autonomy, especially in pricing and employment decisions, while providing improved incentives for efficient operations; establishing sound accounting and internal management systems; and taking steps to reduce redundancies and improve the quality of PE labor. For many enterprises, additioral financial resources will be required to write-off or restructure debt and rehabilitate or upgrade machinery in order to ensure the financial health of restructured enterprises and increase production efficiency. Implementing Reform vii. Based on other countries' restructuring experience, a comprehensive reform of the PE sector in Nepal, and institutional restructuring in particular, can be expected to take a minimum of 5-7 years. The institutional capacity and experience required to implement a large-scale privatization program and effect all required reforms simultaneously for a large number of PEs appears not to exist in Nepal. Thus, the report recommends that Government adopt a phased approach to implementing its PE reform. Initial reform efforts in the near term will provide valuable feedback to design of later reform programs. viii. It is essential at the outset that government states unambiguously its objectives and proposed strategy for PE reform so that clear signals are provided to both Government officials and PE managers and staff of expected changes in the role and function of PEs. Thus, an essential prerequisite to implementing PE reform is that government issue a PE policy and strategy statement along the lines discussed in para (vi) which would provide the framework for implementing more specific reform measures. In particular, governments intention to (a) operate PEs on a fully commercial basis, - vi - (b) provide separate financing for noncomme cial activities undertaken by PEs and (c) reduce the number of public enterprises through a program of privatization and divestiture, should be emphasized. ix. In the initial phase of implementing reform, Government should begin to address broad policy and institutional issues at the same time that it restructures selected enterprises and initiates its privatization program. In particular: (a) for Policy and Institutionai Refcrm, measures which should be initiated during the initial phase include: (1) reviewing pricing and industrial policies and regulations with the aim of improving the competitive and regulatory environment of both public and private sector companies; (2) reviewing existing PSC regulations in order to simplify and streamli.te current procedures; (3) developing accounting standards to increase the reliability of financial data; and (4) establishing training programs to improve the quality of the labor force. (b) for Privatization, divestiture of easily saleable PEs identified as priority candidates for privatization (e.g., financially viable PEs in competitive markets which are attractive to the private sector 'as is') can begin while Government continues to prepare detailed action plans for less attractive candidates and to finalize measures to address constraints and issues likely to affect a larger privatization program. The UNDP financed/IFC executed technical assistance program agreed with the previous GoveLnment can provide needed expert assistance. Experience of this process should feed into and strengthen plans for further privatization. (c) for PE Restructuring, instead of attempting to introduce reforms simultaneously in all the PEs which would remain in the public sector, restructuring should begin with a small group of PEs for which there is a clear rationale for public ownership (e.g., strategic enterprises or PEs in monopoly or quasi-monopoly markets), Restructuring of selected enterprises could proceed while detailed restructuring plans are being developed for remaining enterprises. x. Restructuring enterprises which will remain in the public sector will be the more difficult task. It is recommended that in the initial phase of enterprise restructuring, a group of four or five PEs be selected from a ministry whose leadership is interested in reform. The Ministry of Industry is probably the best candidate. Four or five of its nearly 30 PEs could be identified for which there is a clear rationale for public ownership. Priority sho'.d be given to those PEs for which the fiscal impact of restructuri g would be significant. Recently established PEs and those not yet operational, which cannot be privatized in the short-term, could also be included in Phase 1 since they are less likely to have the deep-seated problems of other PEs, and action now could forestall future problems. Where relevant, a subsector approach to restructuring should be pursued. For the selected PEs, priority should be given to (a) reconstituting the Boards of Directors to include technical, financial and management specialists from the - vii - private sector and (b) appointing qualified chief executives and senior management teams. Appointment of competent and experienced managers is critical to the improvement of internal management functions and practices. Once qualified managers are in place, the tasks of strengthening internal management functions, preparing corporate plans, etc., should be their responsibility under the supervision of their boards. fechnical and financial assistance should be provided to help the selected PEs strengthen internal systems and upgrade and rehabilitate their machinery where necessary. xi. It is recommended that the oversight function and management of PE restructuring in Phase 1 be the responsibility of a special PE unit which can be established within the selected line ministry. As part of the reform process, the unit, with exp2rt assistance, would identify candidates for Phase 1, develop revised operating guidelines and secure Cabinet approval for required modifications in rules and regulations applicable to selected PEs. As part of its oversight function, the unit would also negotiate targets with the PEs, supervise their performance and implement a modified profit-linked bonus scheme for selected PEs. xii. Depending on progress made in Phase 1, in about the third year of the program, the experience with the reform of the selected PEs should be evaluated by an interministerial task force, to see whether enough had been learned to be able to adapt this approach to reform to the rest of the PEs. This task force should have the mandate to design the larger reform program including recommending the government agency or other organization which would initiate and oversee the expanded reform program, designing an improved performance evaluation system and performance-linked incentives, defining the role of sector ministries and other oversight agencies and identifying any other institutional mechanisms for strengthening PE performance. Organization of the Report xiii. The main report is organized around three basic themes. The first chapter analyzes the PEs' economic importance, financial and oporational performance and impact on the Government's budget. The subsequent four chapters discuss the factors contributing to the PEs' poor performance. Chapter II discusses the competitive and regulatory environment, including investment policies, price controls and the administration of regulations and incentives. Chapter III discusses government supervision, control and performance monitoring. This is followed by a discussion of the deficiencies in internal PE management in Chapter IV and more specific details on employment and compensation issues in Chapter V. Each of these chapters presents options for reform of key problem areas and is preceded by a brief introduction and summary. Chapters VI and VII discuss the recommended PE reform strategy. Chapter VI focusing on a strategy for privatization and divestiture, and Chapter VII on the strategy for PEs that would remain In the public sector, including presentation of a phased action plan. I. PE ROLE AND PERFORMANCE A. Introduction and Background The Economic Importance of PEs 1.1 Nepal''s public enterprise sector accounts for about 62 of non- agricultural GDP and 9? of formal sector employment, and is important because it dominates activities basic to the economy. Currently, the officially listed public enterprises consist of 64 units, of which 8 are engaged in finance and the other 56 in non-financial activities. The non-financial public enterprises (PEs) include those in manufacturing (28), trade and commerce (7), energy (4), utilities and transportation (4) with the rest in education, information and other services. In the financial sector, two state commercial banks - Nepal Bank Limited and Rastriya Banijya Bank - account for about 80? of commercial bank assets. PEs have virtual monopolies in electricity and domestic air transportation, basic utilities such as telecommunications and water, and play a key role in the industrial sector. Overall, the combined formal and informal manufacturing share of GDP is estimated at 10?; manufacturing accounted for 18? of formal sector employment in 1990.1/ The manufacturing public enterprises (MPEs) account for 362 of fixed assets, 29? of value added, and 251 of employment in the manufacturing sector. The MPEs dominate the production of cement (62Z), agrolime and chemical lime (80Z), sugar (55?), tobacco products (702) as well as petroleum. products and agricultural tools. In commerce, the trading PEs have a monopoly of the importation of chemical fertilizers, oil and coal. The PEs absorbed an Lverage of over 202 of Government revenues in the past three years. In 1989, outstanding loans to the non-financial PEs accounted for 132 of total commercial bank credit. 1.2 Estimates understate the size and scope of PE activities in Nepal because the legal codes do not distinguish clearly between private and public sector concerns. The official list of PEs (Annex I.1) reflects only part of government investment in public enterprises. Officials in Nepal often refer to 'First Generation' PEs which come directly under government control; they are owned wholly or partially (with more than 51? shares) by the state and listed officially as PEs. Since existing PEs can invest in subsidiaries, there are 'Second Generation' PEs which have majority control by the First Generation units, most often jointly with the private sector. Lastly, there are 'joint ventures' in which the state and existing PEs control a total of 50Z shares. The enterprises in which the state and other PEs have minority share control are not listed officially as public concerns. For example, the Nepal Industrial Development Corporation is a First Generation PE with majority share control (80?) in Himal Cement which is a Second Generation PE. Himal Cement, in turn, has a minority (30?) share interest in the Housing Management Company which is listed as a private concern. The subsidiary 1/ If construction is excluded, manufacturing employment (150,000) is about i22 of formal sector employment. See World Bank, "Nepal, Relieving Poverty in a Resource Scarce Economy", May 1990. -2- arrangement is sometimes set up to enable the private party to gain access to a needed input, as seen in the link between the Housing Management Company and the cement subsector. In other cases, as in Janakpur and Setti tobacco companies, the arrangement enables the PE to expand in the same industry. Thus, many of the enterprises considered as private entities in Nepal are owned partially by the state and its agencies.2/ The Origin and Evolution of the PEs 1.3 The social and political sentiments that gave rise to the develop- ment of the public enterprise sector in Nepal are often traced to the 1962 Nepalese Constitution which provides for maximum participation by the general public in economic development. Only one PE, established under the Commercial Bank Act in 1937, existed in Nepal in the mid-1950s, and utilities, such as telecommunications, drinking water and sewerage, electricity, and transport, existed as government departments. PE expansion accelerated during the 1960s to the late 1970s. However, unlike in most developing countries, the growth of Nepal's PEs was not based on the nationalization of private companies; in many cases, new enterprises were created with the support of external donors, including China, USSR, Netherlands, Japan and multilateral agencies. In other cases, units already existing as Government departments were converted into statutory corporations and other kinds of autonomous bodies. The Government also took over two private companies that were on the verge of closure, in order to save jobs. By the end of the Fourth Five Year Plan in 1974, sixty PEs were in operation. 1.4 The PEs were established under several statutes and controlled by various government bodies as shown in Annex I.2. This was considered necessary in order to devise appropriate forms of government control and to provide PEs with precise performance objectives and operational guidance. Enterprises established under the Corporation and the Development Board Acts, for example, are owned wholly by the state. Corporations are generally expected to at least break even, while Development Boards are not expected to be commercially viable. The MPEs of interest in this report were set up under the Company Act, and the trading PEs were set up under the Corporation Act. Enterprises created under the Company Act are expected to have more flexibili- ty under their management boards. In theory, such PEs can invite private participation. They are expected to be financially profitable and to make contributions to Government income. In practice, 311 the PEs have multiple objectives, involving commercial and social service functions and in all cases, they have to comply with Government directives and a myriad of overlap- ping regulations. Interest in PE expansion began to diminish by the mid-1970s because of existing units' poor performance and growing resource claims by other Government activities. Thus, during the Fifth and Sixth Five Year Plan 2/ For the purpose of dividend collection, the Financial Controller General keeps records of all PEs in which the state or other PEs has shares; currently, there are about 100 of these PEs. Examples of PEs with public sector minority shares include Salt Trading Corporation, Judha Match, Soaltee, Hetauda Leather and Pokhara Bread Factory, etc. - 3 - periods ending in 1985, new investments continued, but on a smaller scale. Four new enterprises were established during the Sixth Five Year Plan period.3/ Allocations for PE investments fell by 232 (in terms of constant 1980 GDP deflator), and the share of these investments in the development budget declined from 23? in 1986/87 to 12Z in 1988/89. Overview of PE Objectives and Policies 1.5 This section provides an overview of PE objectives and policies. It does not address issues related to the exchange rate regime, trade policy and other broad policies.4/ The policies outlined here are those that affect the PEs directly and have contributed significantly to undermining the PEs' performance. They include policies resulting in poor PE investments, controls on PE output pricing, restrictions on PE access to inputs, and government control of PE management decisions, such as PE employment and compensation, etc. These policies were influenced by conflicting PE performance objectives. The PEs are expected to build the country's infrastructure, to develop industries which the private sector would otherwise neglect, to contribute to production and achievement of self-sufficiency in basic goods and services, to promote employment generation, and to serve as instruments for enhancing the control of Nepalese nationals over economic activity. At the same time, since many PEs, in particular the MPEs, were set up under the Company Act, many of them are listed in the stock exchange and are expected to be financially profitable. 1.6 By the start of the Seventh Plan period (1985-90), PE policies began to emphasize efficiency and for the MPEs, higher quality of production rather than capacity expansion. The main elements of stated PE reform policies included divestiture, liquidation of nonviable units, PE management incen- tives, and enhancement of the operational autonomy of managers. In reality, proposals were not effectively implemented. Liquidation was confined to five trading PEs. For example, the national rice mill and rice exporting companies which became inoperative through loss of markets were closed down. Also, some units, for example, the Nepal Fuelwood Corporation and the Timber Corporation were amalgamated. However, there was little progress in divestiture as reform efforts turned out to be half-hearted (para. 6.2). Similarly, price controls were not dismantled, regulated monopolies were not allowed to adjust their tariffs,5/ and there was no follow-up on programs to improve PE performance by enhancing managerial autonomy, monitoring performance, and providing incentive bonuses for managers. Effective implementation has been hindered by a lack of consensus on the role of the PEs. The lack of transparency of the 3/ They are Bhrikuti Paper, Butwal Textile, Lumbini Sugar and Nepal Paper. 4/ The recent CEM, "Nepal: Maintaining Structural Reforms and Managing Public Resources" (March 30, 1990) has a detailed discussion of recent reforms and developments in trade and industrial policies. 5/ Domestic telecommunications tariffs have not been adjusted since 1985; electricity tariffs were adjusted once in the past 5 years. -4- budgeLary proces.s and the obscure mpthods of PE financing (para. 1.20) contribute to unQorstating the magnitude of the PE's drain on resources, which dilutes the urgency attached to the implementation of reforms. Also, there are concerns about the extent to which reforms would lead to a concentration of basic industries in a few hands. In addition, the role of erstwhile socialist countries, such as USSR, China, East Germany and India, in financing and developing most of the early PEs has a left a legacy that emphasizes broad social functions rather than commercial viability. The legacy has created an ambivalence about needed changes in the role of the PEs and the acceptable scope for reforms. This ambivalence is reflected even in announced PE policies following recent political changes in Nepal. The Scope of the Study 1.7 In view of previous work on other sectors,6/ this report places more emphasis on the MPEs on which relatively little systematic work has been done, and on the trading enterprises, which have been major sources of PE losses. The background work for the study involved a survey of ten MPEs 71 and the two trading PEs. All units in the survey are First and Second Generation enterprises with majority or total public sector ownership. The two trading enterprises included in the survey, the Agricultural Inputs Corporation (AIC) and Nepal Food Corporation (NFC) account for over 9OZ of the total losses of those PEs which consistently make losses. The manufacturing PEs surveyed account for about 70X of Government share investment in the manufacturing PE sector and include the major loss-making and profitable units. Data on production, employment, incomes, statements, balance sheets, etc., weve developed for all the enterprises surveyed. Also, enterprise managers were interviewed by Bank Staff and Consultants. The survey provides a picture of the performance pattern and key reform issues for the manufacturing and trading PEs. B. PE Performance 1.8 This section focuses on the PEs' performance problems. The fact that the PEs have multiple performance objectives involving commercial and non-commercial activities makes it difficult to apply comprehensive indicators to assess their performance. Most often, however, poor commercial performance 6/ Works for other sector PEs include: World Bank, "Nepal Power Subsector Review', 1988; and "Commercial Bank Problem Analysis and Strategy Study" (in progress). Also the "Fifth Telecommunication Project", 1989; and "Water Supply, Sanitation and Drainage Project", 1990, have covered analysis of their respective sectors. 7/ MPEs included in the survey were Agricultural Tools Factory, Ltd (ATF). Bansbari Leather and Shoe Factory (BLSF), Bhaktapur Brick Factory, Ltd (BBF), Dairy Development Corporation (DDC), Hetauda Cement Industry, Ltd (HCIL), Hetauda Textile Industry (HTI), Himal Cement, Ltd (HCC), Janakpur Cigarette Factory (JCF), Raghupati Jute Mills, Ltd (RJM) and Royal Drugs Ltd (RDL). - 5 - has limited PE activities, frustrating the achievement of even the non-commercial objectives. This section evaluates the performance of the manufacturing and trading PEs using three inter-related indicators of production, cost competitiveness and financial profitability. The Manufacturing PEs 1.9 Manufacturing is a fast expanding sector in Nepal; the annual growth rate in total average output exceeded 12Z during the decade ending 1987/88,8/ though this has declined since the T&T impasse. The sector is also becoming more diversified. With trade reforms and export incentives, new activities in ready-made garments and carpets, for example, have grown at average real rates of 402 and 66Z, respectively, during the last decade. On the other hand, the relative importance of traditional industries, including jute goods and grain products, has declined. The contribution of manufacturing to exports also increased significantly, rising from 382 in 1983/84 to nearly 80Z in 1988/89 with the development of new export sectors such as carpets and garments. 1.10 MPE Production. The growth rate for MPE average annual output during the decade ending in 1987/88 was about 1OZ, compared to over 12Z for the manufacturing sectors as a whole. While growth of export-oriented industries has been a significant component of private manufacturing growth, MPE output has been concentrated in a few import-substitution products, notably cement, sugar, and tobacco goods. Output growth was aided by virtual PE monopoly domination of fast growing industries, investments in new capa- city, and selective increases in capacity utilization. MPEs currently account for over 70Z of the domestic market for tobacco products, 62Z for cement, 55Z for sugar and 45Z for leather goods, in addition to substantial production of beverages, agricultural tools, and textiles (Table 1.1). Since 1985/86, new capacity was created by the completion of Hetauda Cement, Setti Cigarette, and Lumbini Sugar. Also, capacity utilization doubled in some existing units, such as Janakpur Cigarette, Birgunj Sugar, and Hetauda Textiles during 1981-88 (Annex 1.3). 1.11 Despite the aggregate increase in output, the pattern of MPE production has been unstable. Output performance is below potential for many MPEs, and cost efficiency remains poor (para. 1.12]. Even with the existing opportunities for import-substitution under the Government's self-sufficiency objectives, capacity under-utilization remains a serious problem for many products, such as dairy products, cement, bricks, tiles, and pharmaceutical products. In 1987/88, for example, capacity utilization was about 41Z for the Dairy Development Corporation and between 50Z-60Z for the cement and drug units, compared to expected levels of over 80Z (Annex I.3). The problem is due in part to real economic factors, such as poor quality and inadequacy of domestic raw materials and unreliable power supply. In addition, Government controls compounded these problems. For many MPEs, the lack of adequate raw 8/ See Nepal, "Census of Manufacturing Enterprises", 1976/77 and 1986/87; Bureau of Statistics, "Nepal's Manufacturing Sector (1976/77 to 1986/88)"; Ministry of Industries, 1989. - 6 - Table 1.1: SELECTED PE PROUCTION Averago Share of Change Market In Output (Y 9 (!Q Ch6n6 In output (0 1-988 89 84-FYSB isub/se o18/87 1987/86 1986/6- MPEs - C- nt LXe62.0 83.0 - 81.6 19.9 -S.9 of wh icoT Himal 15.0 11.3 6.4 84.6 29.0 -26.0 Matsuda 47.0 87.7 - 110.4 16.7 2.1 Jut. Goods Lb 32.9 -6.4 -9.6 -34.6 89.6 -23.3 Sugar /c 66.2 14.1 19.0 46.1 -2.0 - T*xt;l- /d 7.0 4.4 1S 2 1.1 8 -1.9 -0.0 Cigarette O 70.0 6.9 12.9 11.4 -1.9 -0.6 Leather /f 46.0 1.2 -6.5 -7.1 36.8 1.4 Tr 2Ti 40.6 7.7 6.3 9.5 4.8 - Brick A Tile /S N.A 8.6 -3.0 16.6 2.8 - Agricultural Toola 10-20 -2.8 -9.2 -7.4 8.0 -2.7 Troding PE (Sales Volume) FR-iiTizors i 100 7.2 2.0 8.4 14.6 .88 Foodgrain Li 2 4.2 0.0 4.7 - -5.6 La Aggregato production for Hisa) Coent *nd Hltauds Factory. Raghupati Jute Mill. Le Birgunj Sugar only. Hetaud Textilo. /- Janekpur C;garette dansbari Leather. Nepal Tea DOvelopment Corporation. Total for Shaktapur and Herishidi enterprises. Conversion: 1 roof til- = 4 bricks. 1 floor tile 1 brick. /l Agricultural Inputs Corporation. Nepal Food Corporation. Source: CCD, Ministry of Finance. materials is for the most part an outcome of Government policy and restrictions. For example, Dairy Development Corporation's (DDC's) low capacity utilization was due to restrictions on imported inputs, mainly powdered milk. Also, investment policies encouraged capacity expansion in the cement industry for reasons of self-sufficiency, though the quality of raw materials was known to be poor. In the cases of leather goods and textiles, intervention in MPE operational decisions and resulting lack of operational flexibility undermined their effectiveness relative to the private sector in purchasing raw materials. Growing demand from the private sector for inputs and thie MPEs' inability to compete effectively contributed to a lower PE share of input purchases and therefore a lower capacity utilization. These problems were exacerbated by lack of reliable access to power, particularly for the cement and brick industries which depend on imported coal. 1.12 Cost Competitiveness. Both the inadequate supply of raw materials and capacity under-utilization contributed to the high cost of MPE production. Cost efficiency is critical if the MPEs are to compete effectively and sustain their viability relative to imports. Since the MPEs' outputs are tradeables, this section evaluates cost efficiency relative to the border prices for a sample of major products. Table 1.2 shows the cost effectiveness of a sample of enterprises in paper, cement, jute, and sugar. The Cif and fob costs shown in the table are based on the existing exchange rate regime and the production costs relate to the level of capacity utilization indicated. Only two enterprises in the sample, namely Himal Cement and Bhrikuti Paper, are cost tive on a long-term (three-year average) basis. However, it has a temporary edge due to quotas on Indian sugar exports and a transitory boom in the world market. The high cost of Lumbini Sugar is expected to decline with increased capacity utilization, though competitiveness relative to import costs is uncertain. Raghupati Jute Mill has uneconomic costs relative to the export (fob) price. Interest costs for Raghupati are high, equivalent to 27Z of total costs. Over-employment is a serious problem, and wage costs account for 402 of total costs. Raghupati would be uneconomic even if operated on a sunk cost basis. In the cement industry, Hetauda is uncompetitive relative to imports. It has inadequate raw materials and a weak capital structure with interest costs accounting for about 302 of total costs. Hetauda may be marginally competitive on a sunk cost basis, but even then it requires additional investments to reach the new raw materials sources needed to increase capacity utilization. Even for those units which have the potential to be viable, such as Himal, the scope for sustained performance is fragile. Table 1.2: EFFICIENCY OF PRODUCTION COSTS - SELECTED MPEs (Dollar values in constant 1987 figures) C ..f. Capacity Cost of Nepal f.o.b. Utilization Production Border to (%) (USS) La (USS) India Cement (Hotauda) b 69 103 96 Cement (IHimal) Lc 65 74 96 Paper (Bhrikuti) /d 87 765 831 - Sugar (Birgunj) Is 93 389 361(462) /f - Sugar (Lumbini) Lg 26 608 381(462) f - Juts (Raghupati) /h 74 761 - 638 /a Cost estimatev do not includ- taxos and import tariffs and thus indicate competitiveness in a more liberalized regime. /b Production cost based on tho average for 1987/88 and 1988/89. Li Cost figures based on the average for 1986/87-1988/89. Based on 1987/88 figure only. International paper prices very with quality between US$700 and US33,000. The figure quoted is for comparable quality c.i.f. Singapore. Th c.i.f. price for sugar is the average for 1987/88, 1988/89 and 1989/90. The number in parenthesis is the current import cost from Third countries. The current import cost from India is about US3330. t 1988/89 budget figures. Export (fob) price and average costs for 1986/87-1988/89. Source: CCD, Ministry of Finance. Himal's viability will depend on Nepal's accord with India and its continued access to the Indian market for relatively cheaper coal which accounts for 75Z of its energy requirements.9/ 1.13 The high MPE production costs reflect several factors. Some PEs (e.g. Hetauda Cement) have turned out to be uneconomical due to risky investment, low quality raw materials and cost overruns during implementation. Comparative advantage is not necessarily considered in making MPE investment decisions, which lead to lower quality projects. Technology obsolescence and defective machinery inflate PEs' costs since they lack funds to modernize and upgrade equipment. Interventionist policies also limit efficiency improve- ments and cost reductions over time. A case in point, as already noted, is the restrictive raw material policy and consequent low capacity utilization. In another example, over-employment and the imposition of employee compensa- tion packages on the MPEs are major reasons for the high wage costs of Raghupati Jute. Also, in the sugar sector, investment policies have resulted in the choice of low quality projects rationalized by social rather than efficiency considerations [para. 2.31. Procurement and project implementation delays due to Government control of PE decisions further contribute to the higher cost situation of the PEs. 1.14 Financial Performance. The PE's financial performance has been poor even with nominal tariff protection of, for example, 35Z on cement and IOOZ on tobacco products. Only 5 of the 25 operating MPEs 10/ generated profits consistently during 1984/85-1987/88 (Table 1.3). In the best year, 1986/87, Janakpur Cigarette and Birgunj Sugar accounted for 80Z of the NRs 111 million profit. Even Janakpur's profitability relates to its virtual monopoly position during the 1980s and a 10OZ tariff. Birgunj's surpluses are due more to the performance of its by-product beverage division than to efficient sugar production per se. The largest losers are Hetauda Cement and Raghupati Jute Mills. Hetauda Cement's operating profits and net income have been negative from the start of production because of large capital costs and a heavy debt burden which resulted from cost overruns. Raghupati Jute Mill suffers from a declining world market for jute, inefficient technology, and overemployment. Although the remaining MPEs have less severe operational or financial constraints, most are only marginally profitable, and their periodic surpluses are not adequate to cover previous losses. Ir many instances, the financial problems posed by losses and low operating profits are exacerbated by an increasing commercial bank debt service burden. Dividend contributions are minimal at less than one percent of government equities. Only two enterprises, Janakpur Cigarette and Birgunj Sugar, generated dividends consistently, averaging NRs 6.4 million a year during 1984/85-1988/89. Nepal Industrial Development Corporation generated an additional NRs 2.0 million, and there were minor contributions from Royal Drugs and Judha Match (Annex 1.4). 9/ Third country (i.e. non-Indian) coal imports are very expensive due mainly to higher transportation and transaction costs. For example, the costs of coal imported from Indoz.sia are double that from India. 10/ Only 25 of the 28 MPEs were actually operational. -9- 1.15 During the period 1984/85 - 1988/89, the MPE's overall rate of return on assets was negative (Table 1.3). The direct consequence of these fina.ncial losses has been an erosion of equity (Table 1.4). Ten PEs listed in Table 1.4, of which six are part of the survey, either have negative or declining net worth. Accumulated losses have eroded over NRs 1.0 billion (equivalent to 13Z ot 1988/89 Government revenues) of initial Government investments. This performance, poor as it is, does not reveal the true nature of the financial problems facing the MPEs. The severity of the financial situation has been masked by poor accounting standards, including lack of physical verification and revaluation of assets, inadequate provision for depreciation, bad debt, and obsolete stock. In turn, the weak accounting systems mask financial weaknesses and do not give managers early warning of potential problems. Few PEs have internal funds to finance capital replace- ment costs. Thus, ultimately, debt repayment, working capital requirements, and rehabilitation and modernization costs will become a growing burden on the Government. Table 1.3: PE PROFITS (Before Taxes) (in NRs million) Cumu- lative 1984/85 1985/86 1988/87 1987/88 l988/89Lb total MANUFACTURING PEs Total Profits for profitable MPEs 81.6 65.6 110.8 106.2 -1.9 362.1 Of which: Janakpur Cigarette Factory 57.7 41.3 76.6 76.4 17.3 Birguni Sugar Factory 17.3 8.0 12.3 21.0 - Himal Cement 2.8 2.3 8.6 -0.7 -18.9 Hetauda Textile -0.2 0.8 11.7 7.8 8.1 Royal Drugs 4.2 3.4 1.6 2.7 -1.0 Total Losses for unprofit. MPEs -26.4 -165.5 -183.1 -134.8 -133.6 -633.3 Of which: Hetauda Coment Industry - -119.4 -147.0 -101.0 -89.2 Raghupati Jute Mills Ltd. -18.0 -30.6 -10.4 -17.2 -26.2 Dairy Development Corporation -3.3 0.9 -18.6 -11.6 11.0 Bansbarl Leather -3.8 -4.5 -4.8 -4.9 -4.9 Agricultural Tools - -1.3 -2.8 0.4 - Bhaktapur Bricks & Tiles -1.5 -0.6 -1.5 -0.6 -3.2 Total profits for manu- facturing PEs 66.2 -99.9 -72.5 -28.6 -136.4 -281.2 TRADING PEs Total for Profitable Units 17.3 74.2 144.4 130.6 74.6 441.0 Of which: Nepal Oil Corporation 16.9 88.0 130.9 111.2 23.1 Timber Corporation /a -4.8 -12.6 10.0 14.1 - National Trading 6.2 20.7 3.6 6.0 61.6 Losses for unprofit. Units -219.0 -160.1 -110.8 -205.8 -188.6 -872.1 Of which: Nopal Food Corporation -80.0 -96.0 -81.0 -137.0 -128.0 Agriculture Inputs Corporation -139.0 -54.1 -49.8 -88.6 -68.8 Totai profits for Trading PEs -201.7 -76.9 33.6 -75.1 -112.0 -431.1 Includes Fuel Corporation. Sc EstimatesC Source: CCD, Ministry of Finance, and mission survey data. - 10 - Table 1.4: SELECTED PE NET WORTH (in NRs million) 1986/88 1987/8 Amount X of Assets zo-unt Xof Assets MANUFACTURING PEs Dairy Development Corporation 18.2 14% -12.3 -0.6% eansberi Leather & Shoe Factory 8.6 26% -1.2 -3X Raghupati Jut* Mills Ltd. -88.4 -107% -118.6 -139X Balaju Textile Industry 4.8 n.s. 0.6 n.s. Hetauda Cement Industry 681.3 37X 333.8 26X TRADING PEs The Timber Corporation of Nepal -10.3 n.a. -19.6 na. Agriculture Inputs Corporation -109.0 -16X -221.9 -28X Nepal Food Corporation -461.2 -1401 -442.4 -86X Tobacco Development Company Ltd. -2.8 n.a. -3.9 na. Nepal Trading Corporation -7.2 ns. -12.3 n.s. Source: CCD, Ministry of Finance and mission survey data. Date cover PEs with declining or negative not-worth. 1.16 In addition to those factors affecting MPE production costs dis- cussed above, and to world market price fluctuations in commodity exports such as jute, financial losses also stem from administrative pricing policies and from pressure exerted on the PEs to maintain non-viable activity centers for social reasons. For example, between 1986/87-1988/89, the price of DDC's output was controlled at 93X of costs. Though output price controls have been relaxed somewhat, DDC still faces controls on imported inputs and on the price of local raw milk. Similarly, sugar prices are controlled and subsidized at below world market prices. The Trading PEs 1.17 There are nine trading PEs, including the energy (oil, coal, and fuelwood) PEs. As a group, the trading PEs are the largest source of finan- cial losses (Table 1.3). Five of the trading PEs have negative net-worth (Table 1.4). Two units included in the survey, namely, AIC and NFC, are the main culprits. The large financial losses arise from the use of these enterprises for social service objectives and from interventionist policies, such as price controls, quantitative rationing, and pressure on the PEs to maintain nonviable trading centers. Price controls have had the worst effect on the trading PEs. In the case of NFC, for example, controlled below market prices cover only 93Z of foodgrain costs in the Kathmandu Valley and 412 in the mid-eastern region. Similar controls over chemical fertilizer prices affect AIC. The lack of financial stability has undermined deliveries. The delivery of subsidized goods is poor, and units are plagued by supply short- ages. Also, despite stated welfare objectives, subsidized goods do not reach clearly identified target groups. Existing pricing policies, recommended reforms, and the performance of the trading PEs are discussed in more detail in Chapter 2. ^ 11 - Analysis and Discussion 1.18 The evolution and performance of the manufacturing and trading PEs suggests continuing difficulties. There is no indication that performance will improve, nor that the financing burden they put on the Government will be relieved significantly in the foreseeable future. Even operating the finan- cially weak PEs on a sunk cost basis would require new equity infusions and to finance guaranteed debt, to pay liabilities due to accumulated losses, and meet working capital needs. Also, the few profitable units are beginning to show declining profitability and will eventually require support. As the private sector is expanding, the MPEs' market share is diminishing. More importantly, the private sector is targeting the relatively more lucrative segments of the markets in the Kathmandu Valley and Terai. For example, under this pressure, the market share of the most profitable KPE, Janakpur Company, has fallen from 95% to 70Z, despite steady growth in production. Similarly, Hetauda Textiles and Bansbari Leather's market shares have fallen. Continued erosion of the market share of the more profitable brands of MPE products is likely as newly licensed private investments come on stream. As discussed earlier, the MPEs are at a disadvantage due to various factors and policies which limit their capacity to respond flexibly to market conditions. Under existing circumstances, as the private sector expands and its shares in the relatively more lucrative markets grow, the MPEs will increasingly be left with less profitable markets, mainly in the hill region where transportation and transaction costs are higher, incomes lower, and profit margins, if any, negligible. Unless major policies are introduced to improve the situation, PE performance will be characterized by growing financial losses and rising demands on the Government for financial support. C. Financing of the PEs 1.19 This section discusses the budgetary burden arising froma the PE's poor performance. Poor financial performance and lack of internal savings compel the PEs to depend principally on the central Government and its financial institutions for support.ll As shown in Table 1.5a, there are several kinds of MPE demands for government subsidies or transfers: (i) current subsidies which include allocations to cover losses due to controls on PE output prices, transportation subsidies to finance the transportation costs of deliveries to inaccessible areas, and operational subsidies to finance other PE losses; and (ii) capital subsidies and new equity to cover PE debt and to finance new PE investment. Government financing of PEs takes various forms. They include: equity participation financed directly from Government revenues; bond issues by Government to strengthen the asset base of the PEs; external loans guaranteed by Government and channelled to the PEs; external 11/ Some of the PE financing issues are discussed in the recent Country Economic Report,"Nepal: Maintaining Structural Reforms and Managing Public Resources", March 1990, Chapter 3D. - 12 - grants provided to the PEs as equity; proceeds from commodity aid for the most part retained by PEs instead of being paid to counterpart funds;12/ and tax exemptions granted to sick PEs as prescribed under the industrial code. In addition to budgetary subsidies, credit from domestic financial institutions is a major source of support for the PEs. Most of this is guaranteed by the Government which has had to assume payment in cases of default. Of the NRs 2.2 billicn credit outstanding from commercial banks to the non-financial PEs by July 1989, NRs 1.4 billion 13/ (652) was guaranteed by the Government (Annex I.5). PE default on these loans has created a burden on the budget. Government payment of PE guaranteed debt amounted to NRs 780 million during 1986/87-1989/90, and an additional higher amount remains to be paid. NRs 700 million is budgeted for FY91. 1.20 Budgeted allocations to the PEs do not reflect the full extent of PE dependence on Government because the budgetary process lacks transparency. This lack of transparency has caused understatement of the costs of PE inefficiency and contributed to undermining the urgency of reforms. The main factors in the understatement of PE resource claims are: direct donor dis- bursements to projects which are later transferred to Government upon comple- tion; donor payments for technical assistance that are ofter channelled directly to service providers; tax rebates for sick PEs that are prescribed under the Industrial Act, but not re.-lected in enterprise accounts; and proceeds from counterpart funds from commodity aid that is expected to be paid into government account, but is instead retained by the PEs. Table 1.5a gives a flavor of these off-budget expenditures for three major public utilities, estimated from discrepancies between payments recorded in the budget and those received according to enterprise accounts. The estimates of off-budget allocations exclude tax rebates which are not documented in PE or Government accounts. Even so, estimated off-budget expenditures for these three enter- prises alone were equivalent to 382 of total budgeted expenditures for seventeen major enterprises. In fact government allocations to PEs, including off-budget transfers, are about three times higher than the contributions made by PEs to revenues. The share taken by trading and manufacturing PEs from the Government's budget accounted for about half of all allocations to the PEs during 1985186 - 1988/89. PE deficits as a percent of GDP increased from O.5Z in 1986/87 to 2.9Z in 1988/89. Ta",,e 1.5b shows consolidated public sector operations for the central Government and nonfinancial PEs and includes 12/ The inability of AIC to meet obligations regarding payment of counterpart funds to Government account is becoming a source of concern among donors (see "Performance Audit Report on the Second Intensification Program). For AIC, the cumulative retained proceeds from commodity aid was estimated at Rs 420 million in 1989. 13/ This amotunt was reduced to Rs 1.01 billion through negotiation with the banks durlng which the interests accrued on unpaid interest arrears were waived (See Annex I.5). Rastra Bank estimated total PE commercial bank credit outstanding in Mid-April 1990 at Rs 2.22 billion, comprising principal of Rs 1.04 billion and interest of Rs 1.18 billion. - 13 - adju';trm;its to eliminate double counting. PE expenditures show increasing l n re'-ources relativo to the stagnant pattern of PE contributions to Gover8:rr.t revenues. PE expenditures amounted to an equivalent of 17Z of Govern:.nent revenues in 1986/87 and to over 30Z in 1988/89. Table 1.5a: PE CLAIMS ON GOVERNMENT INCOME La (NRs million) 1988/87 1987/88 1988/89 Budgeted Commercial Bank Loans paid by Government /b 300 - 80 Retained Counterpart Funds from Aid 176 29 58 Covernment Equity 210 293 313 Direct Subsidies (Grants) 64 69 296 Net Lending 811 9B 602 Total Budgeted 831 687 1,328 Off-Budget Lc 1,731 916 499 Total 2,668 1,602 1,827 La Table covers 17 PEs on which data are available: Agricultural Inputs Corporation; Nepal Food Corporation; Bansbari Leather; Bhaktapur Brick and Tiles; Dairy Development Corporation; Hetauda Cement; Hetauda Textile; Himal Cement; Janakpur Cigarette; Raghupati Jute Mill; Royal Drugs; Nepal Trading Limited; Nepal Telecommunication Corporation; Nepal Water Supply Corporation; Nepal Water Supply Corporation; Nepal Airlines Corporation; Nepal Electricity Authority. t PE loans guaranteed by Government. Data cover Water, Telecommunication and Electricity Enterprises. Source: Data from CCD and IMF estimates. Table 1.6b: SUMMARY OF PUBLIC SECTOR OPERATIONS (NRs million) Total Revenue and Grants 1986/87 1987/88 1988/89 Total Revenue and Grants 7,818 9,676 10,017 Total Revenue 6,333 7,698 8,128 Of which PEs 609 398 630 Foreign Grants 1,286 2,077 1,889 Total Expenditures 11,184 16,428 18,170 Of which PEs 1,099 2,368 2,800 PEs in percent of Total Expenditures 9.8 16.3 16.6 PEs in percent of Revenue 17.4 31.0 36.0 PEs in percent of GDP 1.9 3.6 3.8 Source: Data from CCD and IMF estimates. D. Discussion and Core Issues 1.21 Several factors account for the poor and deteriorating performance of Nepal's .ianufacturing and trading PEs. To summarize, the key factors which are ame-.abi' to influencp by Government and PE officials are: conflicting PE - 14 - perf0,aireP 0jje(tives; poor quality of investments; competitive policy and a reg, 'litotry erzvi rimment which do not motivate PE efficiency; inappropriate i';:;!;l ixiS; )Government controls, weak monitoring, and performance .v.Lu. i'.z; :d internal deficiencies in PE management, including inadequate inre;;.] planniig, and control, and poor marketing, production, and financial :i;j e;I,ent . A,Iditional factors, relating to world demand and the policies of T..:,:'iI!ig coutt ries, are outside the direct influence of Government. relate-] to inadequate infrastructure are also beyond the control of th e*t.' etpt ises themselves. The need for public enterprise reform is widely recogn zed in Nepal and has been espous,d in various Government documents and putuLv statements. The main objectives of announced reforms have been to re.eve the PE finar.cing burden on the Government, improve and expand the production of basic goods, and promote industrial efficiency and expansion to create more jobs. Despite efforts, the implementation of reforms has had limited success. Under existing circumstances of increasing constraints on Governm,ent incoine, there is limited scope of depending on Government invest- ment to expantd industrial growth to fulfill stated objectives in a sustained fashion. 14/ 1.22 An action program should be a first step in attempts at a renewed reform effort. Such a program should be directed at the restrictive aspects of the et,abling environment as well as at specific enterprises. The program shou.d sharpen the PEs' performance objectives. It should also address the concerns of constituencies which have resisted the implementation of previous reforms and adopt a flexible approach in the use of instruments, such as privatization, restructuring and liberalization. For example, given concerns about foreign ownership of basic MPEs, privatization should have options for private management control as well as ownership change. Also, restructuring should include options for compensating affected employees. Retained subsidies should be explicitly funded and channelled to target groups. The action program should include measures to improve transparency of PE claims on resources to expose the full costs of poor performance and subsidies. II. THE POLICY AND REGULATORY FRAMEWORK 2.1 This chapter focuses on the policy environment for the PEs. In many instances, government policies which affect the PEs also affect their private sector counterparts. In fact, the distir.ction between public and private enterprises in Nepal is sometimes blurry since there is close interaction between the two sectors through private ownership in Second Generation PEs and joint ventures. A confluence of complex factors has shaped the policy environment in Nepal. Some of these factors have already been the subject of 14/ Population pressure on land and growing landlessness already suggest that agricultural development offers little scope for fast growth and significant improvement in poverty in Nepal. See citation under footnote 6. - 15 - studies and reform efforts.l5/ They include the country's landlocked position, the highly protectionist regime of India which borders Nepal and the susceptibility of Nepal's economy to external influences which limit the scope for independent policies. Also, the difficult terrain and inadequate transportation networks create segmented markets and limit spatial competition. Other factors are low incomes and a consumer-oriented approach to development, based on the delivery of basic need, and sentiments regarding enhancing the control by nationals over economic activity. The influence of these factors is reflected in the intricate formal policies and informal practices that regulate economic activity in Nepal. Policies relating to investments, administration of regulation and pricing as they affect the PEs relative to the private sector are discussed below. A. Investments and the Regulatory Environment 2.2 Until the second half of the 1980s, Nepal's system of industrial regulations was very restrictive. Investment licensing, registration and quantitative capacity controls were used to ration investments, and in most instances, PE investments received priority over the private sector. But this is changing. The Industrial Enterprises Act of 1987 exempted many enterprises from investment licensing regulations. These include: unautomated cottage industries having fixed assets less than NRs 700,000; small and medium scale enterprises with fixed assets up to NRs 10 million which do not require foreign exchange for raw materials; and large scale enterprises with fixed assets in excess of NRs 10 million which require foreign exchange allocations for no more than 40Z of raw materials. In addition, joint public-private ventures and some 44 enterprises gazetted in the budget are exempted from licensing procedures. These changes plus automatic registration have eased bureaucratic and quantitative barriers limiting private investment. There are, however, outstanding issues regarding the role an- et'ficiency of public sector investments, restrictions on entry and exit, and linits on PE access to raw material inputs. Industrial Investment 2.3 Low investment quality is ba underlying reason .cr the MPEs' poor performance and a handicap relative to the private sector. More importantly, poor investments undermine efforts to improve the manufactu-'ing PEs' performance and to expand Nepal's industrial sector. The nt-rent policy for First Generation PEs is to invest in industries which the .-i?ate sector would otherwise neglect. For the Second Generation PEs, investment decisions are in principle delegated to the enterprises and their Boards of Directors, provided such investments are in designated "priority" sectors. But because of the broad scope of the priority sectors, investment policies do not provide a strategic focus for efficient manufacturing investments. Also, the .'nks between investment policies and other aspects of industrial policy are weak. For example, despite discussions in the Government about privatization, PE 15/ See, for example, the recent Nepal CEM: "Maintaining Structural Reforms and Managing Public Resources," March 30, 1990. Also, there is work in progress concerning effective protection. - 16 - pro;eets are being planned or being implemented in various sectors, including leather, cement, sugar, dairy, foundry, tobacco and textiles. 2.4 Most often, the Government's development plans have guided the choice of projects t3 be funded. Officially, the procedures for screening prr;ects require elaborate bureaucratic overview often i:.olving evaluation by the Economic Services Center and approval by donor funding sources, line m:n-stries, the Corporation Coordination Division of the Ministry of Finance and the Planning Commission. But in the screening process, issues of the efficiency of investments and viability assume less importance than broader we&fare considerations. Though broad development may not necessarily be incompatible with efficiency, manufacturing investment decisions are often driven by basic needs, self-sufficiency, and employment generation, factors which tend to undermine the viability of projects. In addition, the project evaluation process is often handicapped by inadequate information, resulting in the under-estimation of costs, over-optimistic assessment of raw material sources and, ultimately, financially weak investments. 2.5 Projects have been retained despite serious doubt about their viability, particularly where job creation and self-sufficiency are of paramount concern. This has been the case, for example, with Hetauda Cement, the Foundry, Raghupati Jute and Morang Sugar. For example, to save jobs, Raghupati Jute Mill and Morang Sugar 16/ were reopened by Government after they were closed down by the private sector; Hetauda Cement was implemented despite doubts about the quality and adequacy of local raw materials, and the Foundry was endorsed though the feasibility analysis suggested uncompetitive costs relative to imports. Also, delays in implementation are a source of concern. Various factors, including constraints on government funding, procurement and technical assistance needs contribute to slow implementation and cost overruns. Hetauda Cement, for example, was completed four and a half years behind schedule with a cost overrun amounting to nearly 70Z of the original plan estimates; Udaypur Cement currently under implementation is also likely to be delayed. Entry and Exit 2.6 Subtle barriers limit closure of non-performing PEs. Consequently, these barriers also limit private entry into some industries. There is a continuing dominant role of PE production in industries even where liberaliza- tion could help expand private sector supply to meet basic needs objectives. PEs virtually monopolize major trading activities, including fertilizer, oil and coal; and they dominate the formal manufacturing sector in cement produc- tion, sugar, tobacco products and, to a lesser extent, textiles. This dominant role of the PEs has been weakened somewhat by smuggling and by recent indus- trial reforms, but the policy regime still favors the status quo for the non-performing PEs, restricting new entrants. Output price controls, for example, have created disincentives for private sector entry. Agreements on commodity trade between Indian and Nepalese PEs have supported sole, 16/ Morang Sugar is now under the management of the Salt Trading Company which has majority, about 80Z, private sector control and 20Z state and PE shareholding. - 17 - state-sponsored supply of some products. Also, since private participation in state dominated sectors requires investment in costly fixed assets, unsteady policies have contributed to deterring such investments. The monopolistic controls have adverse consequences, creating managerial inertia and fostering inefficient operations. 2.7 In a small economy, continued operation of nonviable PEs contributes to restricting private industrial expansion. Financing policies help to avoid exit and to sustain poorly performing PEs. The industrial code and the Company Act have provisions regarding liquidation and closure, but the application of these laws has often been frustrated by resistance of PE employees and constituencies who provide inputs and other services to the affected enterprises, such as farming groups. The poor state of PE finances also limits the scope for compensating those affected adversely by closure. In addition, Government budgetary subsidies and guaranteed credit schemes have sustained the sick PEs. The guaranteed credit schemes have added to the burden on the Government since in the many cases of default that have occurred, the Government has had to honor the payments, helping to sustain the financially weak PEs.17/ Raw Material Import Substitution 2.8 Another restrictive aspect of the regulatorv environment is the limit on PE access to imported raw materials. These restrictions generally do not apply to the private sector, which creates differences in quality and costs between private and PE production. The restrictions aimed at fostering the development of import-substitution raw material sources have been rationalized by the landlocked nature of the country and by the need to raise income levels to create demand for manufactured goods. Notwithstanding the merits of these objectives, the prospects for effective raw material substitu- tion are considered low, given the relatively lower prices of agricultural goods in India.18/ As currently implemented, the policy mainly has affected the MPEs in dairy, jute goods, textiles and tobacco products, and the results so far have been mixed. The Dairy Corporation, for example, has taken advantage of the restrictions to expand the collection of local surplus raw milk. Insufficient domestic sources and seasonal shortages have, however, contributed to low capacity utilization--below 60Z. The pressure on Raghupati Jute to buy from domestic sources has only served to strengthen the hands of collusive middlemen, resulting in high raw jute costs relative to neighboring markets. Also, Janakpur Company has had limited success in developing raw material sources of appropriate quality and has remained dependent on Indian tobacco imports for about 80Z of its raw material needs after over twenty 17/ Total Government guaranteed credit to the PEs as of July 1989 amounted to NRs 1.41 billion of which overdue interest accounted for NRs 899.76 million. Government payment of overdue guaranteed debt to the commercial banks amounted to NRs 780 million during 1987/88-1989/90. 18/ See 'Import-Substitution in Nepalese Agriculture: Nature, Structure and Impact", 1986. As indicated by this report, Nepal has advantages in import-substitution production in only paddy and wheat, and could pursue partial substitution for sugar cane and cotton. - 18 - years of operation. The major consequence of the policy on raw materials is to impose high, uncompetitive costs and low rates of return on the KPEs. If Government insists on this policy, it has to address the question of who--MPEs or the budget--should carry the cost burden. Options For Reforms 2.9 Because external factors limit independent policies, Nepal faces difficulties in its efforts to create a policy environment conducive to effi- cient PE activities. More so than most developing countries--as was evident during the T & T impasse--Nepal has to emphasize accord with its neighbor and pursue flexible policies that will give industries scope to respond quickly and effectively to the complex environment. In this context, this section discusses options for deregulating PE investments and industrial activities. Deregulation and PE Policy Reforms 2.10 Deregulation of economic activity is critical for facilitating entry, promoting efficient investments, and giving all firms scope to respond flexibly to events in Nepal's complex situation. Continued poor PE performance is making it increasingly clear that the lingering controls on entry and the sanctioning of uneconomic projects on the grounds of self- sufficiency are compromising efficiency and undermining the prospects for industrial expansion. The limits to entry need to be addressed in various ways. For the trading PEs, one option is to continue with the policy of modifying agreements that support sole supplying agencies in, for example, oil, coal and fertilizer, etc. In the case of industry, the recent liberalization of investments could be extended further by creating 'free sectors,' such as jute, textiles, cement, etc. Investment licensing in the 'free sectors' would be waived, and registration would remain automatic to relieve the administrative burden on the Directorate of Industries. Fully state-owned investments in the free sectors could be restricted to the completion and rehabilitation of existing units. 2.11 Exit of non-performing PEs needs to be enforced. The Company Act and the Industrial Enterprises Act have provisions for closure, but these have not been applied effectively. For example, the liquidation of the non- performing foodgrain exporting PEs which lost their markets has dragged on for years. Affected employees were redistributed among other PEs but the outstanding debt has remained a burden on the commercial banks and the Government, while payments to the liquidators continue to mount. PE financing reforms and labor compensation schemes would provide options for forcing the exit of non-performers. Government has made a start in financial reform by limiting guaranteed commercial bank loans, and the banks have introduced ceilings on lending to the PEs. Other sources of PE financing, such as budgetary subsidies and tax rebates for sick PEs, should be made transparent, limited in scope, and made contingent on tangible improvements in performance. 2.12 The pressures and discriminatory direct controls on the MPEs to purchase domestic raw materials should be replaced by flexible incentives to motivate both public and private enterprise interest in using local resources. Where the potential for efficient domestic raw material production exists, instruments, such as premia on imported raw materials should be employed to encourage raw material import-substitution in a manner consistent with a - 19 - liberal trade regime. A system parallel to the duty drawback scheme for indirect exporters could be considered. The institution of Developmient Boards is well known in Nepal and could be used more effectively to de-link commercial activities from broad development and social service activities. For example, to accentuate the commercial orientation of the PEs, raw material development should be transferred to Development Boards and Extension Service agencies. PEs which are compelled to deliver social services need to adopt separate accounting for commercial and social service activities (para. 4.35). B. Administration of Regulations 2.13 The administration of industrial regulations in Nepal is characterized by bureaucratic requirements and delays which affect PE activities more than those of the private sector, since the PEs have less scope to circumvent the regulations by operating through informal channels. Government is aware that delays in the administration of reforms are becoming a serious problem.19/ Paradoxically, the need for improved administration of industrial policies and incentives is becoming increasingly important as the Government continues its efforts to liberalize the economy. The recent trade and industrial policy reforms illustrate the nature of the problem. The recent reforms include a simplification of the tariff system which now has 10 basic rates instead of the former 87. The old range of tariffs has been reduced from between zero and 450Z to a maximum basic tariff of 100X with additional duties to countries other than India of between 25? and 55Z. Also, hard currency imports were liberalized using open general licensing, a flexible passbook system and an auction system with varying premia for consumer goods and luxury items. A duty drawback scheme was introduced, and investment incentives were improved. The industrial code provides an average nominal protection of about 30? based on the type of product and has no stated differential tariffs for the PEs.20/ Though liberalization of imports is desirable, it can give incentives to smuggle. This is particularly so for imports on open general license and industrial imports under the passbook system with no foreign exchange premium. In 1989, for example, a third of convertible currency imports came under the passbook system (Annex II.1). Thu', while import administration has improved, the easier access to indust? l1 goods has been accompanied by internal regulations and approval requirements, such as for production, sales, exports, external exchange transaction, etc., aimed at limiting smuggling and tax evasion. Furthermore, the administration of incentives requires inspection and documentation to validate applications for the incentive claims introduced under the industrial reforms. 2.14 The causes of deficient implementation are various. First, the process of setting up and empowering institutions to effect reforms has been slow. Incentives and regulations which depend on estimating production as well as effective protection coefficients, for example, require skilled staff to 19/ See "Background Paper on the Administration of Industrial Incentives", a report prepared for the Ministry of Industry HMG/Nepal and UNDP, March 1990. 20/ A study of the effective protection rates is currently in progress. - 20 - administer them. Second, imprecise legislation has affected implementation. Provisions in the reform Acts were in conflict with other legal codes, and, in some cases, the measures on which to base the determination of the incentive allowances were ambiguous. The Industrial Enterprises Act and the Income Tax Regulation, for example, have conflicting provisions regarding depreciation allowances, and neither provides the precise income concept on which to base the computation of rebates. In some cases, the ambiguities contributed to undermining the authority of the administrative agencies; in other cases, they inadvertently expanded the discretionary power of the agencies, resulting in case by case bargaining and delayed resolution. Third, frustrations were caused by inadequate budgetary allocations to support incentive refunds. Improving the Administration of Regulations 2.15 At first glance, the first best option for addressing the issue of poor administration of regulations might appear to be liberal reforms that would preempt as much as possible the need for such regulatory procedures. However, in the specific Nepalese environment, that option is more limited. For example, third country consumer luxuries are currently imported under an auctioning system which has premia on foreign exchange. Industrial goods, on the other hand, are imported under the passbook or open general license system at lower exchange rates. Extending the auction system to cover industrial goods would raise import costs and reduce the need for regulations to control re-exports to India, but this is relevant for only a few commodities. In many cases, a premium high enough to make re-exports to India unattractive would inflate the costs of imported industrial inputs and undermine domestic industries' competitiveness. Thus ultimately, the issue of efficient administration has to be addressed. 2.16 The Government is already considering measures to improve the situation, and some reforms were introduced in the 1990/91 budget. For example, import duty rebates which were not being properly administered were abolished; under the old system, these duties were first collected and subsequently refunded individually. Other measures being considered include reforming the funding of incentive schemes, amending conflicting regulations and disseminating information on procedures. The options for improving the administration of incentives include abolishing a broad range of taxes that are subject to refund under the incentive scheme, providing larger budgetary allocations to support incentive payments, and establishing escrow accounts from which refunds could be paid without necessarily subjecting the financing of such refunds to budgetary considerations. The implementation of regulations could also be improved by amending conflicting legal codes to reconcile the relevant provisions of the Industrial Enterprises Act and the Income Tax Act. The Government is considering options to achieve this objective including establishing: (i) which of the Acts should be adopted in computing depreciation allowances and (ii) which Act should prevail generally when there is a conflict. There is also a need to disseminate information about new rules and incentives and to clarify the application of new regulations. Because of poor accounting standards, Government is considering the use of pamphlets to provide information on how incentive and regulatory schemes actually apply. The illustrations could cover basic concepts such as gross income, net income, value added, effective protection rates, and other measures needed to determine incentive claims. Last, but not least, is the - 21 - need to strengthen the institutions which administer incentives and regulations. C. The Pricing Regime Administrative Pricing and Subsidies 2.17 Nepal has an elaborate price control system. It applies to both the private sector and the PEs, but it is enforced more stringently for the PEs. As in most countries, there is a statute which empowers Government to protect the delivery of essential services in times of crisis. But in addition, Nepal has the Essential Commodities Control Act which authorizes the Government to control the production, distribution, and pricing of some 29 listed 'essen- tial" commodities to ensure adequate access for consumers. The list includes construction materials, clothing, fruits, paper, chemicals, and staples (Annex II.I). There is, in addition, a subset of "most essential" goods and services, such as, fertilizer, dairy, sugar, foodgrain sales by the NFC, and life line utilities, which have price controls and subsidies. The legal codes provide roles for a hierarchy of institutions in pricing and distribution decisions. They include the Council of Ministers, enterprise boards, and committees of zonal administrators. Policy decisions in India also have significant influence on pricing decisions in Nepal. India's interventionist policies, such as subsidies, export bans, quotas, and generally high tariffs create wide discrepancies between Indian prices and the prices of corresponding products in Nepal. The proximity to India and the far larger size of that economy often compel Nepal to follow parallel pricing policies to limit smuggling and tax evasion. 2.18 Table 2.1 illustrates the cost and price structure for selected products. The disparities between costs and prices partly reflect the inefficiency of some units relative to competitive import costs. For the most part, however, they reflect Government controls and interaction with Indian policies. In the cases of Hetauda Cement and Raghupati jute, for example, production costs are uncompetitive relative to cif costs and export market prices, respectively. Himal Cement and Bhrikuti Paper cover full costs, though their prices are set below import prices to support basic needs objectives. Sugar price is also controlled below average import cost, because it is considered an essential commodity. Finally, the trading PEs also face controls. NFC's prices are below cost, having been fixed silLce 1986; the prices vary from 93Z of costs in the Kathmandu Valley to 412 in the Mid- Eastern region. Fertilizers are also highly subsidized; they are obtained at competitive international prices and from aid sources, but sold at below cost. Nepal's fertilizer sale prices are based on Indian border sale prices which carry high subsidies from the Indian Government. Nepal's cost recovery ratios for complex and urea fertilizers, which together account for 902 of sales, are 52Z and 62Z, respectively (Table 2.1). 2.19 In May 1985 and again in December 1989, the Council of Ministers issued policy statements to liberalize the pricing of PE goods and services. Under the latter reforms, PEs are grouped into three categories as shown in Table 2.2. First, for PEs operating in competitive markets, the enterprise's Board of Directors has the authority for pricing items. Second, for monop- olized activities, the Board has the authority to established break even prices and to change them up to a 1OZ margin without Government approval. - 22 - Third, for subsidized items, the Board similarly has authority to change prices up to a 1OZ margin. The implementation of these policies has been uneven, as ministries still influence pricing decisions through representation on enterprise boards, and the new policies do not overrule earlier regulations and statutes. 2.20 Rigidity is a major flaw of the pricing regime. The involvement of several bureaucracies in pricing decisions requires that conflicting interests be reconciled on an ad hoc basis. Prices tend to be fixed for long periods, and the subsequent necessary sharp increases are often politically unpopular. There are difficulties with coordinating pricing policy with other policies, and price regulations sometimes affect incentives set up under trade liberalization policies. For example, putting fertilizer imports on open general license does not motivate private importation because controlled fertilizer sale prices are below import costs. The system contributes to eroding the financial position of the supplying agencies, limiting their capacity to sustain and expand deliveries. The subsidies are not targeted towards clearly identified beneficiaries, although they are rationalized by welfare considerations. The methods of price regulations provide little incentive for private sector suppliers, creating dependence on the PEs even where the costs of private sector deliveries are demonstrably lower. Liberalizing the Price Control System 2.21 In recent years the Government has tended to use price controls and subsidies as a tool for poverty alleviation. However, the principles that could guide pricing policy have in fact been applied to utilities in Nepal.21/ For tradeable goods, it is conventional to base pricing decisions on the domestic currency value of border prices plus adjustments for internal transportation and transaction costs. The pricing of nontradeables, on the other hand, is normally based on the opportunity costs of resources, normally long-run marginal costs, or average costs if they are more practical. In both cases, the mechanism for effecting the pricing system depends on the market structure. In the case of monopolies, these principles would be used by a central authority to regulate prices. The price may be based on a moving average to limit the adverse impact of international market fluctuations (as has been done for fertilizer pricing in Bangladesh). In the case of PE goods which face competition from domestic or foreign producers, it is normal to abolish price regulations and allow enterprise managers to respond to market movements. In this regard, the coordination of trade and pricing policies is important for effective deregulation. If the import prices for certain items are liberalized, for example, the corresponding domestic prices should be liberalized to reinforce the motivation of competitive behavior. Governments may deviate from these pricing principles for broad development or equity reasons, but the beneficiaries should be targeted, and the costs of and sources of financing for the deviation should clearly be identified. 21/ Reforms based on marginal cost principles have been developed and are being applied in the pricing of energy, water and telecommunications. See, for example, World Bank: Nepal, Power Subsector Review, 1988. - 23 - 2.22 This section discusses price and industrial deregulation for specific cases and institutions. Pricing reforms are a sensitive matter, since they can provoke resistance from those adversely affected. Reforms should aim at gradually moving towards a more liberal regime while making any remaining subsidies explicit and channelling them to clearly identified target groups. Government should provide legal backing for announced policies which, go far, have not been implemented due to legal ambiguity. The Essential Commodities Act, for example, could be updated to reflect the PE pricing Table 2.1: SELECTED PE PRICES PER METRIC TON (UT) C.1.1. Cost of Ex-factory Nepal Prod. Pric- Border lb (USO) (USO) (USS) Manufacturing PEo /a Coemnt (Hotauda) /c 103 89 96 Cement (Himal) Id 74 86 96 Paper (Bhrikuti) /- 765 770 831 Sugar (Birguni) if 389 409 361 (462)/h Jute (Raghupati) /g 761 677 - Milk por 1000 liters (Dairy Dev. Corp.) Li 403 373 - Avoerage Average Controlled Cost Cost Price Recovery Nepal Food Corporation (Paddy A Rice) (NRa) (NRs) Eastern Region 11,680 7,490 61 Central Rogion (Kathmandu) 7,981 7,410 93 Woetern Rogion 11,222 7,290 e5 Mid-Western Rogion 20,889 8,840 41 For-Western Region 12,919 8,000 62 Indian Nepal Nepal Bord-r Cost Price Price Agricultural Inputs Corporation Li (NR) (NRs) k (NROs Amoni Sulphate 8,062 3,111 2,722 Complex 8,492 4,602 4,289 DAP LI 9,976 6,319 6,243 Pota'I 6,769 2,316 2,265 TSP 8,886 3,963 3,830 Urea 6,361 4,070 3,626 L Figures for the Manufacturing PEa ore in constant 1987 prices, using International Manufacturing Value Index as doflator. Lb Ci.f. prices are based on competitive international prices plus adjustment for insurance and transportation to Nepal border. c Production cost based on the average costs of 1987/88 and 1988/89. Average 1986/87 - 1988/89. Based on 1988 figures only. /f The c.i.f. price for sugar is the average price of 1987/88, 1988/89 and 1989/90. For the number in parenthesis, see (h). /D Jute is exported to India at prices below cost. Fob price is 3638. See Table 1.2. Tho figure in parenthesis is based on January 1990 Third country prices; the current c.i.f. import cost from India is about 3330. LI Cost and prico figures are averages for 1986/87, 1987/88 and 1988/89. Pricos were incroased in 1989, enabling DDC to break even In that year. Li Cost figures obtained by taking the average of 1987/88 and 1988/89 wholosale costs for AIC. They reflect c.i.f. import costs to Calcutta plus transportation and handling costs to Nepal. k CControlled prices last adjusted on November 8, 1989. Cost figure for 1988/89 only. - 24 - Table 2.2: PRICE POLICY FOR CORPORATIONS, ISSUED DECEMBER 14, 1989 PEs Under Competitive Morket Pricinm. Board of Directors have pricing author ty. 1. Janakpur Cigarette Factory 2. Himal Cemnt 3. Raghupati Jute Mill 4. H-taudo Cement 5. Brick and Tile Factory - Harishidi 8. Bhaktapur Brick Factory 7. Royal Drugs Limited 8. Agricultural Tools Factory 9. National Construction Company, Nepal 10. Nepal Transport Corporation 11. Agrolime Industry 12. Timber Corporation of Nepol 13. National Trading Limited 14. Bonsbari Shoe Factory 16. Medicinal Herbs Production and Processing Company 18. Nepal Teo Development Corporation 17. Cottage and Handicraft Sales Emporium 18. Nepol Transit and Warehouse Company 19. N-pal Film Corporation 20. Balaju Textile Industry 21. titauda Textile Industry 22. Dairy Development Corporation 23. Nepal Orient Magnesit. 24. Bhrikuti Paper 26. Nepal Rosin and Turpentine 26. Economic Services Center 27. Udaypur Cement Factory 28. Foundry Development Corporation 29. Cultural Corporation 30. Ratna Recording Corporation 31. Nepal Television PEs Under Price Control. Board of Directors can change price up to 10% without Covernment approval. 32. Nepal Electricity Authority 33. Nepal Telecommunication Corporation (Internal) 34. Nepal Oil Corporation 35. Tobacco Development Corporation 38. Birgunj Sugar 37. Lumbini Sugar 38. Drinking Water and Sewerage Corporation 39. Royal Nepal Airlines (Internal) 40. Gorkhapatra Corporation 41. Janak Education Material Center Ltd. Enterprises which receive subsidies. Board of Directors can change price up to 10% without Government approval. 42. Agricultural Inputs Corporation 43. Industrial District Management Limited 44. Nepal Food Corporation 46. Nepal Resettlemv.ent Company policies announced by the Council of Ministers (para. 2.19). Similarly, Government should consider narrowing the current list of 29 essential items (Annex II.1) covered by the Act. The Act's application could be limited to items that are explicitly subsidized and targeted for the poor. A second issue is to strengthen the PE managers' pricing authority. The price policy for PEs issued by the Council of Ministers in December 1989 gives the authority for pricing competitive goods to PE Boards. But implementation of - 25 - this policy has not been even, since some ministries continue to exert pressure on pricing decisions through representation on Enterprise Boards. Government needs to consider transferring pricing authority from the Board of Directors to PEs' Chief Executives and operational managers. Pricing policy review needs to be considered for specific PEs, such as DDC, the sugar units, NFC, and AIC. Specific options for these PEs are discussed below. 2.23 Since 1988, DDC has faced restrictions on imported inputs, and on the price of the local substitute on which it must depend. Output prices are also controlled, and dairy sales are not targeted for the lowest income groups. In fact, since on-farm consumption and sales to low income groups are satisfied by unpasteurized milk, DDC serves relatively higher income consumers. An output price increase of 252 enabled DDC to break even in 1989, but previous financial losses have eroded its equity base, and DDC has a negative net worth. Pricing and institutional reforms that should be considered include: (a) abolishing controls on DDC's output prices and investing the authority for pricing in the Chief Executive and operational managers; and (b) transferring welfare and livestock development services to The Dairy Development Board and other extension service agencies. In the case of sugar, price controls and subsidies need to be relaxed as they provide no incentives for choosing between third country and Indian sources. A flexible policy would motivate switching between import sources as dictated by price changes. 2.24 Controls on NFC's prices also need to be liberalized. Foodgrain prices have been fixed for NFC since 1986, and the proportion of costs recovered range from 93Z in the Kathmandu Valley to 41? in the Mid-Western Region. NFC accounts for less than 22 of total foodgrain consumption, and most of its sales are in the Kathmandu area. In 1988/89, for example, the Valley absorbed 51? (17345 metric tons) of paddy and coarse rice sold by NFC. NFC's activities are neither commercially oriented nor clearly targeted welfare programs. Accumulated losses during 1984/85-1988/89 amounted to over NRs 502 million, and guaranteed overdue commercial bank debt exceeds NRs 600 million. The options for reforming NFC are limited. The commercialization of NFC is not a feasible option. For various reasons, NFC's costs are higher than private sector costs, and break even prices are above market prices. In April-May 1989, for example, the market price for par-boiled and coarse rice was between NRs.7170-7940 per metric ton in the Kathmandu Valley, compared to NFCs cost of NRs.7961. The option of turning NFC into a price stabilization agency needs to be carefully examined; there are indications that foodgrain price stabilization will not be feasible in Nepal. Nepal's scope for effective buffer stock management and price stabilization is limited bv the close correlation between Terai and Indian foodgrain prices, and those between Kathmandu Valley and the Terai.22/ Other options for NFC could include the following: phasing out all subsidies in the urban areas; targeting subsidies 22/ "Market Intervention for Price Stabilization of Foodgrains in Kathmandu Valley". Nepal Agricultural Projects Service Center, March 1989. - 26 - on the Hill districts only; replacing subsidized foodgrain deliveries to Government employees with cash payments; and turning NFC into a social service agency with a skeletal staff and infrastructure for disaster and drought relief. 2.25 Fertilizer price subsidies also need to be reformed. Under previous reforms, the Government raised fertilizer prices above corresponding Indian border prices, opened wholesale fertilizer distribution to the private sector, and transferred pricing authority from the government to AIC's General Manager. But fertilizer importation is still a Government monopoly as price controls and subsidies provide no incentives for private participation. AIC has made persistent losses resulting in a negative net worth and is kept afloat through various kinds of subsidies with a cumulative total of NR 1.5 billion, equivalent to 2Z of 1988/89 GDP. Fertilizer use per acre in Nepal is uneven, but among the lowest in Asia. Fifty eight percent (77,371 metric tons in 1989), of AIC's fertilizer is sold in the Kathmandu Valley. Fertilizer distribution is quantitatively rationed. Supplies are often inadequate, leading to shortages and illegally high prices. Fertilizer price liberalization is controversial politically, but maintaining the status quo would ignore the budgetary burden and the fertilizer shortages which undermine agricultural development programs. A recent pricing policy (Table 2.2) calls for reducing subsidies further. Options to be considered if subsidies are reduced include expanding the role of private distributors to include wholesale supply and allowing private importation of chemical fertilizers. Fertilizer imports could be maintained on open general license and fertilizer that has been obtained through commodity aid could be auctioned. In addition, priority should be given to strengthening AIC's internal financial reporting; In particular, an effort should be made to improve the accounting for the use of counterpart funds from commodity aid. An ongoing ADB study on AIC will provide further guidance on required AIC reforms. III. GOVERNMENT SUPERVISION, CONTROL, AND PERFORMANCE MONITORING A. Introduction and Summary 3.1 Supervision and control refers to the Government's oversight functions with respect to PEs. As the sole or majority shareholder, KMG's responsibility is to exercise strategic control over its PEs and to ensure that their performance is consistent with the objectives and policies set for them. A structure of control and performance monitoring has long been in place in Nepal, some of which (e.g., the Corporation Coordination Division [CCD]) date as far back as 1975. A total of seven agencies control PE operations, the more important of which are the Cabinet, Line Ministries, the Finance Ministry, and the Public Service Commission (PSC).23/ The central problem with the current system is that excessive government interference and 23/ The PSC's role will be discussed later in Chapter V, which focuses on employment compensation and labor relations issues. - 27 - bureaucratic control exercised through these controlling agencies have seriously constrained PE performance. The control environment has undercut PE autonomy in most areas of management, making it difficult to hold managers accountable for performance. 3.2 This chapter discusses (a) the role of Cabinet and other government oveLsight agencies, including the legal framework which establishes the basis for formal Government control of the PEs, and (b) the existing monitoring and reporting systems which are administered primarily by CCD in the Ministry of Finance. Section B discusses the role of government oversight agencies including CCD, while Section C reviews the existing monitoring and report system. The main conclusions are that existing procedures for performance monitoring are relatively ineffective and that the Government and, in par- ticular, the line ministries, have not exercised strategic control of the PEs. Little effort has been made to provide guidance to PEs to help achieve a balance between social objectives and PE efficiency requirements. Moreover, they have failed to: (a) set clear sector policies; (b) foster a long-term strategic focus in the enterprises by placing emphasis on corporate or strategic planning; and (c) effectively monitor and evaluate PE performance. Instead, the role of government agencies has evolved into one of detailed control and interference in PE operations, including review of many Board decisions and control of procurement, investments, and employment. 3.3 Recommendations for medium and long term reform discussed in Section D include clearer delineation of the role of oversight agencies with greater emphasis on strategic rather than operational control. Thus, the role of line ministries would be to establish long-term sector objectives and sector performance targets, monitor overall sector performance, and establish pricing policies for monopoly firms. The Ministry of Finance would approve large capital investments and subsidies. Within broad guidelines, decisions on procurement, etc., would be left to the PE boards and managers. A government- wide oversight function, ideally located in the Prime Minister's office or alternatively, delegated to MOF, would monitor and evaluate PE performance, implement perfoLmance incentive schemes, identify key issues emerging across the PE sector as a basis for taking anticipatory action, and establish nonsector-specific policies which affect all PEs. The Cabinet and the Prime Minister's role would be to make key appointments, decide on incentives, and ensure consistency across ministries. 3.4 To be effective, reform of the government oversight structure must be done within the context of a broader PE reform strategy which would also include measures to reform the policy environment and strengthen the enter- prises, in order to increase pressure on the PEs to perform while building their capacity to respond to changes in their environment. The institutional capacity and experience required to effect needed reforms simultaneously for a large numiber of PEs appears not to exist in Nepal. Thus, the strategy for PE reform discussed in Chapter 6 proposes a phased PE reform program. In the first phase, an interrelated package of reforms of relevant policies, of government oversight and control, and of internal PE management would be implemented for a selected group of PEs. Experience gained in this interim phase would be used in the design of a broader PE reform program. - 28 - B. Government Oversight Agencies 3.5 The four main government agencies or bodies which exercise control over PEs in Nepal are the Cabinet, which appoints PE Chief Executives and formulates policy on PE management, the line ministries, which oversee their PEs, the Finance Ministry, which approves financial assistance for PEs, and the Public Service Commission (PSC), which regulates PE personnel policy. Other controlling agencies, such as the National Planning Commission (NPC), the Auditor General's Office, and the Parliament Committees which exercise legislative control, are less influential. Some are ineffective in their functions for a variety of reasons. Others are simply ignored by PEs. 3.6 The Cabinet. Although the Company Act stipulates that the Chairman of the Board should be elected by the Board, in practice the Chief Executive is nominated by the line ministry and appointed by the Cabinet. The Cabinet also decides the composition of the Board. Frequently, the same person is appointed as Chairman of the Board and Chief Executive or General Manager (GM) (e.g., Janakpur Cigarette Factory, Ltd.), but more often the Cabinet appoints a full-time GM and a part-time Chairman who is usually the Secretary or Additional Secretary of the line ministry. Although a 1985 Cabinet decision (para. 3.9) specified that 'the selection of general managers should be based upon qualification, skill, experience, commitment to national creeds and periodic plans, etc.,' there seems to be no clear criterion or discernible pattern for these appointments. The terms of appointment also vary. The Company Act specifies that the Chief Executive can only be appointed for a maximLu of two terms. However, in practice the same Executive Chairman or GM is usually allowed to continue in position until further orders are received. On the whole, the Cabinet, as the highest authority, has not paid enough attention to its ownership role, in that it has emphasized broader national interests rather than PE efficiency and profitability in making decisions which affect PEs. 3.7 The Line Ministry. As is the case in many countries which lack a system of performance-oriented control, line ministries in Nepal basically operate a bureaucratic, procedure-bound control system similar to current practice in government departments. Line ministries control PEs through their involvement in several areas, including recommending candidates for Chief Executives, serving on the loard of Directors, and approving borrowings, investments, and major procurements. The mandate for line ministries to control PEs is clear in the acts under which PEs have been established (including the Company Act) but not well defined (para. 3.13). As a result, the areas of involvement evolve through practice, and the specifics are not referred to in any consolida.ed document. Despite their heavy involvement in running the PEs, the line ministries have not done an adequate job in areas where Government oversight is important, such as setting sector policies, requiring and approving corporate plans and, more importantly, evaluating and monitoring performance. In the absence of a performance-based control system, the line ministries' bureaucratic controls tend to be excessive, interfering in operational matters. Government interference was cited as a problem in several areas by managers of PEs that were included in the sample survey. Most interference involved pricing decisions. Also, government interference in PEs' investment decisions, including discouragement of additional invest- - 29 - ments, R&D, and technological improvements, were indicated by a'l PEs surveyed. Cases of political interference are widespread, although they are not easilv documented. Several PEs indicated that decisions on location of production centers, sales offices, and distribution centers were influenced by political pressures on board members. Several cases of pressures for employ- ment by politicians and bureeucrats were reported. Most of these pressures are 'covert' and informally channelled through Board members and HMG officials, not necessarily via line ministry officials. Requests for politi- cal donations for a variety of purposes are also reportedly made by the ministries, which decide the amount to be donated. 3.8 Ministry of Finance. The Finance Ministry exercises control through its CCD Division (para. 3.10) whose mandate is to monitor PE progress and to coordinate PE policies in consultation with the concerned ministries. It also has a representative on the majority of PE Boards. MOF exercises greater direct control over loss-making PEs, which have to rely on subsidies and grants; it participates in the preparation of their budgets, approves dis- bursements, and ensures more frequent reporting and monitoring. Budgets of PEs requiring Governument subsidies must be formally approved by MOF. Subse- quently, disbursements are approved for each four month period, based on expenditures and the work program proposed for that period. Beginning last year, the Finance Ministry was also brought in to assess (through CCD) and approve all PE capital investments, including those of 'second generation PEs.' Dividend payments by PEs also require MOF approval, although this has happened rarely in practice as most PEs are making losses. Current regula- tions require non-financial PEs to distribute 50 percent of after-tax profits as dividends. 3.9 Apart from dealing with the loss-making PEs, the Finance Ministry's role in PE finances in general has perhaps been overlooked, especially when the line ministries do not have an effective financial control system in place. Under its broad terms of reference, CCD is supposed to play a role in this area, but its reduced status and limited personnel make it little more than a PE subsidy approval office (see below). Monitoring the financial situation of PEs in Nepal has fallen between line ministries and the Finance Ministry, with the result that responsibility is diffused. Only when a PE accumulated losses require subsidy is the Finance Ministry's controlling role activated, because these subventions affect government finance. 3.10 CCD, which was originally established in 1975 as the Corporation Coordination Council (CCC) in the Prime Minister's office, was transferred to the Finance Ministry in 1980 where it became a ministry division. As such, CCD seems to have a smaller role than its predecessor, although in theory it retains the same functions, which are to: (a) improve PEs' corporate management; (b) bring about uniformity in PEs' internal administration; (c) classify the PEs as per their objectives and scope of activities; (d) advise HMG on PEs' pricing policies; - 30 - (e) bring about uniformity in the accounting system; (f) advise on ways and means for coordination of policies between the ministries and the PEs; (g) advise measures for upgrading thc quality and capability of corporate personnel; (h) make continuous, periodic and special study of PEs and keep the concerned ministry and corporations informed of the findings of such studies; (i) review whether or not any corporation has worked according to its defined objectives and programs; (j) advise HMG on matters of dissolution, amalgamation, expansion and/or creation of corporations; (k) receive periodic progress reports from the corporation in order to examine whether recommendations made by CCD and approved by HMG have been implemented, bring implementation failures to the notice of the concerned ministries, and suggest measures to solve problems identi- fied; and (1) advise HMG on any other matter relating to public corporations. 3.11 Clearly these numerous functions are ambitious even for a properly staffed central PE authority. CCD has not been able to carry out most of the indicated functions because it lacks professional staff and adequate support. For the moment, its staff of three professionals, all at the level of section chiefs, are mainly busy with approvals of releases of budget subsidy funds for PEs, and can spare little time for anything else. CCD's offices are poorly equipped, and support staff is minuscule. In part because of its lower status, CCD has not played a major role as a central monitoring authority; in fact, although all PEs are required to send monthly and four-monthly reports to CCD in line with government procedures for performance monitoring (para. 3.16), only loss-making PEs which require subsidies consistently comply with this requirement. 3.12 Partly as a result of staff constraints and lack of professional skill, CCD's work on PEs' performance evaluation has been superficial. Although the current evaluation system, which is based on a 1985 Cabinet decision, provides for (a) a reward of 10 percent of profits for Chief Executives of PEs which exceed targeted profits or minimize targeted losses, (b) a review of the position of those Chief Executives whose enterprise achieved less than 15 percent of the annual target, and (c) removal of those whose enterprises fall 25 percent or more below the target, none of these measures have been implemented. At the end of each fiscal year, CCD evaluates chief executives' performance against agreed targets but these evaluation reports are not acted upon. The lack of follow-up reflects underlying concerns that the data is unreliable and PE targets overconservative. - 31 - 3.13 The Legal Framework. The extent of formal government control of specific PEs depends on the legal framework under which they were established. Thirty-eight of the 64 PEs, including the majority of the manufacturing PEs, were established under the Company Act, six under the Corporation Act, three under the Development Board Act, and the remainder under special acts. The Company Act, which was first promulgated in 1964 and amended several times, most recently in 1979, is a detailed standard company law for the establish- ment of private companies. In theory, enterprises established under the Company Act are expected to have greater managerial autonomy and are subject to the same system of control as a private company, i.e., through the board and general assembly. However, a 1964 amendment to include PEs in the Act stipulated that PEs shall 'comply with the orders and directives issued by the appropriate departments." This general directive limits the autonomy provided under the Company Act by giving open-ended authority to line ministries to control and direct PE operations. Although line ministries need to retain some control of sector PEs to ensure that their operations are in line with the sector's development policies and strategies, since their authority appears unlimited, the PEs continue to function essentially as extensions of Government departments rather than as commercial companies. 3.14 Enterprises established under the Corporation Act and Development Board Act are owned wholly by the state and as such come more securely under Government control. In contrast to Company Act companies, financial profitability is not a priority objective for these enterprises; corporations are generally expected to break even, and Development Board companies are not expected to be commercially viable. The Government therefore exercises tighter control as part of the process of approval of subsidies and government transfers. C. Existing Monitoring and Reporting Systems 3.15 Despite the fact that most of the elements needed for effective performance monitoring were detailed in the 1985 Cabinet decision, in practice, the existing reporting system is ineffective. There is no proper performance monitoring and as indicated, procedures for evaluating PE managers and providing rewards and punishment based on performance have not been imple- mented (para. 3.12). This is both a function of the lack of adequately trained staff in CCD to implement the system as well as the poor financial and other reporting systems at the firm level as discussed in Chapter IV. 3.16 The existing reporting system was intended to facilitate performance monitoring and provide the basis for evaluation of PE managers. At the time of budget preparation, normally April/May, CCD compiles annual operational targets for each PE which are published in a public document known as the 'Yellow Book." Prior to publication, these targets are discussed at CCD during a series of meetings with PE managers, with the participation of line ministry and the Planning Commission staff. These meetings are the only opportunity for CCD to meet with representatives of all PEs including those which do not need financial assistance. Since CCD staff lack the capacity to evaluate the appropriateness of the targets, most targets remain unchanged from those originally proposed by the PEs; only reductions in targets compared to previous years trigger detailed scrutiny. PEs are required to submit - 32 - reports monthly, four-monthly, and annually to the line ministries, with copies to CCD, indicating their performance with respect to the agreed targets. The reporting format is more or less standard for all PEs. Achieve- ment figures are recorded against targets for production, sales, and inventory. The figures are presented by products in case of multi-product firms, e.g,. drugs (RDC), agricultural inputs (AIC). 3.17 The main vehicle for periodic progress monitoring are four-monthly review meetings chaired by the Secretary of the Ministry or the Minister himself. The Ministry of Industry also has a mid-term (six months) review in addition to annual review. In these review meetings, the emphasis seems to be more on meeting targets than on profit (the form does not have a column on profit) or other measure of efficiency. This system is clearly not perfor- mance-oriented as the information required does not give a clear and accurate picture of performance. Verbal reporting and exchanges made during these meetings may add a qualitative complement to the system, but they cannot substitute for more systematic performance monitoring. At present the line ministries do not have separate units to monitor their PEs. An expert from the Netherlands is currently working on an MIS for the Ministry of Industry, but the requirements for a better system of reporting and monitoring will go beyond external controlling agencies' capabilities; it would require first that PEs improve their financial and other management reporting systems in order that meaningful data is produced. D. Options for Reform 3.18 Any reform of the supervision and control structure should take into account the fact that HMG is not monolithic and that different ministries and agencies tend to exercise control separately and often in an uncoordinated fashion. Similarly, effective oversight is not possible without certain basic conditions being met at the enterprise and board levels. As discussed in Chapter 4, PEs' existing internal weaknesses will limit their ability to respond even if necessary changes are made in the policy environment and in the supervision and control system. Hence it is important to strengthen the PE's internal management in parallel with changes in the policy environment and Government's oversight structure. 3.19 The basic challenge in the supervision and control of PEs is to create a viable balance between enterprise autonomy and accountability for performance. This balance requires that those who perform the oversight function should exercise 'strategic control,' leaving 'operational control' to those responsible for the PEs' internal management. There are five areas of supervision and control essential for maintaining this balance, namely, making key appointments in PEs, agreeing long-term goals and strategy, agreeing on annual performance targets, reviewing actual performance and linking it to incentive policies, and identifying key issues emerging across the PE sector as a basis for taking anticipatory action. 3.20 Key appointments here refer to board members and the chief execu- tive. Long term goals and strategy are derived from corporate and strategic planning exercises (para. 4.34). They may entail new investments, diversifi- cation, or divestiture; these have obvious implications for sec )r policies - 33 - and programs. Since such decisions set the long term directions for the enterprise, government concurrence is essential. It is within this framework that annual or short term targets are developed. Government must agree on key performance targets with the PEs. In establishing targets, more emphasis needs to be placed on those related to key commercial objectives, i.e., profitability, efficiency and financial prudence. At the end of the year, the actual performance could be compared with the agreed targets to see whether negative variances are due to controllable or uncontrollable factors (from the PE's standpoint). Policies on rewards and penalties linked to performance are important to ensure that managers are motivated to pursue agreed performance goals. Finally, it is part of the oversight function to track general issues that affect all PEs and to take action in advance to deal with them. Individ- ual ministries are not likely to play this role because they lack the broad overview that only a government-wide oversight body can provide. 3.21 In the case of Nepal, the key agencies relevant to the oversight function are the sector ministries, MOF and the Prime Minister's Office. Clear delineation of the role of various sector agencies is crucial to reform of the Government supervision and control structure. The sector ministries' oversight role stems from the fact that PEs play a major role in implementing sector policies and programs. MOF performs the resource allocation function that concerns all PEs and the sector ministries. The Cabinet and the Prime Minister's role is critical for key appointments, decisions on incentives, and ensuring consistency across ministries. Ideally, the Government oversight function should be located in the Prime Minister's office, although for a variety of reasons, it may be delegated to MOF. In fact, HMG had originally set up CCD in the Prime Minister's office, but decided subsequently to shift it to MOF. - 34 _ PROPOSED STRUCTURE OF GOVERNMENT OVERSIGHT Cabinet * Appointment of board members, chief executive * Approval of PE incentive policies Government Oversight Body * Monitoring and evaluation of PE performance, implementing performance incentives schemes * Nomination of board members with input of secto ministries, MOF * Establishing financial targets, dividend policy * Long-term planning and coordination across sector ministries. MOF * Approval of large capital investments * Approval of subsidies Sector Ministries * Pricing policies for monopolies * Establishing long-term sector objectives and sector specific performance targets * Monitoring overall sector performance against sector objectives and targets * Nothing else 3.22 Basic Tasks of Supervision and Control. Four tasks have to be performed by HMG (through the appropriate oversight agencies) in order to ensure effective control over PE performance. (a) Approval of PE's corporate and strategic plans, thereby concurring with the boards' long-term plans for the enterprise. Approval by the Ministry of Finance is essential, especially when government funds have to be committed to finance future growth or diversification. Otherwise, approvals from key government agencies can be given to plans through their representatives on the board, which is the proper forum for such approvals (para. 4.28). (b) MOF approval of the annual budget in so far as subsidies or injec- tion of government equity or debt is required by PEs. Budget approval in all other cases should be left to the PE boards on which key government agencies would be represented. However, the budget, in conjunction with the corporate plan, should be used by the Government oversight body to negotiate reasonable goals for profit generation and cost efficiency with PE boards. This process will not be effective unless the HMG staff who negotiate with PEs are - 35 - themselves well versed in enterprise management and commercial practices. Experience with the foregoing type of negotiation could provide a basis for developing annual performance agreements or contracts with individual PEs. Targets or goals could be built into such agreements, provided HMG could make firm commitments on resources and support to the PEs. These agreements also require that PE managements have the autonomy required to achieve mutually agreed annual targets. Once performance contracts are agreed on, it would not be necessary to have monthly reviews of progress by ministries as is now done. Monthly or quarterly ministerial review of the production of certain essential goods may still be necessary as part of the line ministries' sector-wide monitoring function, but they should not be confused with the review of the overall performance of PEs. (c) Review of the performance of each PE at the conclusion of the budget year or of the period of performance agreement. For a sub-&t of important PEs, a progress report every six months would also be useful. The focus of the review should be on the critical targets or variables and not on other details which should be left to the boards to monitor. (d) Establishment of a performance linked system of rewards and penalties. PEs will attach importance to the review process only when they stand to gain or lose from the results of the review. Given the problems faced by HMG with the 1985 incentive scheme, it is important that careful attention should be given to designing an effective performance linked system of rewards and penalties. A useful initial step would be to relate incentives to an easily measurable indicator of profit or minimization of loss. Further refinements in this scheme could be made through a process of learning over time. The credibility of a performance linked incen- tive scheme will depend not only on its rationality, but also on the process used to arrive at the final judgment or decision. The process should be fair and transparent and be undertaken by persons perceived to be qualified and impartial. For example, it would be desirable to have the central oversight agency for PEs, headed by a senior person at the level of a general manager with adequate knowledge of PE operations. The manager of the oversight agency should be free to engage consultants or other specialists to under- take special assignments for the agency. - 36 - IV. INTERNAL MANAGEMENT A. Introduction and Summary 4.1 The sample of twelve public enterprises which were investigated in depth (see Volume II, Annex IV) provides a reasonable basis for a diagnosis and overview of the internal management problems of Nepal's public enterprises. The sample PE data confirm that performance problems are severe and pervasive. Both external and internal factors have contributed to this phenomenon. This chapter examines the nature and scope of the latter, namely, the internal management deficiencies of the Nepal manufacturing and trading PEs. Section B discusses deficiencies in managerial capacity, Section C deficiencies in functional areas, and Section D deficiencies in financial management. Enterprise projects for each of the sample PEs are provided in Annex IV. These profiles provide (a) data on the enterprises' organization and management, marketing and production, personnel and financial management; (b) identifies the PEs' major problems; and (c) suggests preliminary options for improving the performance of each PE. The discussion in this chapter summarizes the problems detailed in the enterprise profiles. Some of the internal problems discussed in this chapter are directly or indirectly affected by external factors that were discussed in earlier chapters. Furthermore, government control over recruitment and salaries, discussed in Chapter V, indirectly affects the quality and motivation of the staff working in the enterprises. These factors constrain PE performance by weakening internal management. This is different, for example, from government control over PE product prices, which tends to affect PE performance directly. Other external factors that are increasingly affecting enterprise performance are obsolete technology and defective machinery, which contribute to production management problems. 4.2 The internal management problems identified in this chapter can be divided into four broad categories: (a) poor managerial capability, including problems of leadership and guidance at the level of the board of directors and the chief executive; (b) deficiencies in functional areas, including limitations in the internal systems of planning and control, inadequacies in the marketing and distribution functions of the enterprise, and production management problems; (c) manpower and labor relations problems; and (d) inadequate financial management systems and practices. There are major gaps and weaknesses in all the key management functions of the PEs as highlighted in Table 4.1 and the interrelations among them clearly add to the severity of the problem. Thus, when the marketing function is neglected, finished goods inventories may pile up, adding to the production planning and management problems on the shop floor. When quality control or maintenance is neglected in the course of production, it becomes increasingly difficult to market the goods produced by the enterprise. Poor accounting systems and practices tend to make it difficult for the top level PE management to perform the functions of planning and control. The neglect of the latter functions, on the other hand, reduces the pressure to introduce and sustain good accounting and financial practices such as information systems. - 37 - TABLE 4.1: KEY INTERNAL PROBLEMS OF SAMPLE PEs AIC ATF BBF BLSF DDC HCIL HTI HCC J NCE RJM RDL /. General Management 1. Rigid organization structure X X X X X X X X X X X X 2. Absence of corporate planning X X X X X X X X X X X 3. Non-participative management culture X X X X X X X X X X X X 4. Bureaucratic leadership X X X X X X X X X X 5. Inadequate internal monitoring and control X X X X X X X X X X 6. Lack of MIS X X X X X X X X X X X X 11. Marketing 1. Lackof marketingplan X X % X X X X X X X X X 2. Lack of market information and analysis X X X X X X X X X X X X 3. Inadequate sales promotion effort X X X X X X X X X X X X 4. Inadequate product development and diversification X X X X X X X X X X X X 5. Absence of cost effective distribution system X X X X 1ll. Financial AccountinQ 1. Major deficiencies in accounting procedures X X X X X X X 2. No management of financial resources X X X X X X X X X X X X 3. No professional accounts staff X X X X X X X X X X X X 4. Absence of commercial accountingpolicies X X X X X X X X X X X X 5. Inadequate controls and interna! audit X X X X X X X X X X X IV. Production and Technoloav 1. Obsolete and sub-standard technology X X X X X 2. Frequent machine breakdown due to worn out machines X X X X 3. Shortages of imported raw materials X X X 4. High inventory levels X X X X X 5. Inadequate QC facilities X X X X V. Manpowerand Labor Relations 1. Overstaffing and staff redundancies X X X X X X X X X X X 2. High proportion of temporary staff X X X X X X X X X X X X 3. Inadequate training and management development facilities X X X X X X X X X X X X 4. Limited opportunities for career advancement X X X X X X X X X X X X 5. Labor disputes X X X X X X 6. Lack of efficiency based incentfve system X X X X X X X X X X X X - 38 - 4.3 Section D, which examines options for reform, emphasizes that the remedy does not lie in improving any single aspect or function, Sut in upgrading the entire set of interrelated management functions. Thus, measures need to be taken to: (a) diversify and change the role of the Board; (b) appoint competent, commercially oriented chief executives and senior managers; (c) upgrade the quality of staff and strengthen functional areas within the organization; and (d) improve managerial and financial information systems and practices. The quality of policy guidance provided by PE boards can be enhanced by changing their composition. Technical, financial, and management specialists from the private sector should be included on PE boards and government representation should be limited to representatives from key ministries. The policy of appointing retiring civil servants to PE Boards should be discontinued, except as an interim arrangement. Instead, chief executives should be selected on the basis of commercial and entrepreneurial orientation and experience. Once competent chief executives and senior managers are in place, they should be given the mandate to carry out the internal changes needed to strengthen functional areas and improve financial and managerial systems and procedures. If necessary, they should be provided with external assistance to help carry out diagnostic studies and implement reform. B. Managerial Capability 4.4 In Nepal, the manner in which boards are constituted and their style of functioning may have inadvertently paved the way for poor PE performance. Except in a few cases, PE boards consist solely of government officials. Several dysfunctional consequences have followed from this practice. First, these officials tend to reinforce the use of civil service norms and practices rather than commercial approaches to enterprise management. In general, the real autonomy available to the PE gets eroded as a result of this tendency, and the PE may behave more like an extension of its parent ministry than as a commercial entity. For example, a PE may be free with respect to product pricing. The board, however, may exercise informal control over pricing for various reasons and in effect, restrict the autonomy the PE is supposed to have. Second, the civil servants' tendency towards preoccupation with short- term problems gets carried over to the PE which as a result tends to neglect long-term tasks. This is exacerbated by the absence on the boards of outside professionals and persons with business experience who might have kept this tendency in check by encouraging a more careful assessment of the policy and competitive environment and by assisting in the formulation of suitable strategies to cope with existing constraints. Furthermore, senior and more experienced government officials are unable to give much time to board meetings, and the number of such meetings which get postponed because of the unavailability of senior officials is not insignificant. Lower level officials representing the Government on several PE boards, on the other hand, may be able to attend, but are unable to provide the kind of guidance and breadth of experience that PEs could benefit from. Routine problems and decisions therefore get precedence over strategic concerns in most boards. Third, boards of the type described above are more susceptible to be used as a - 39 - conduit for political interference and favors than more independent boards.24/ Non-governmental members on the boards would have a countervailing influence. 4.5 The dominant practice in Nepal is to appoint civil servants as chief executives of PEs. In some cases, retiring or retired officials have been appointed to these posts. Many chief executives in the public sector have thus had no prior commercial experience. They tend to reaffirm the perspectives that the boards already reflect. For example, they may be especially likely to operate with a short-term horizon if they expect to go back to a ministry after their brief tour of duty. Since both the board and the chief executive come from a civil service background that takes centralization for granted, it is natural that delegation to lower levels is not encouraged. An unintended consequence of all this is that problems and decisions get referred upwards with the chief executive or board dealing with matters that other managers should have been asked to do. Instead of providing policy guidance and overall leadership and evaluation of performance, the PEs' top management end up being overloaded with tasks that are less critical to the enterprises' survival and growth. C. Functional Areas 4.6 Planning and Control. An important function of corporate leadership is to appraise the firm's external environment and to develop long-term strategies for ensuring its healthy future development. In Nepal, it was found that only one PE in the sample, Hetauda Cement, had paid any attention to corporate planning. Some had engaged in mechanical projections of trends to meet the National Planning Commission's requirements. Hardly any PE has the expertise or motivation to engage in long-term corporate planning, partly because the pressures from the board are to focus on the short term. Hetauda's corporate plan, for example, was prepared by a firm of international consultants. Even with respect to short-term planning, it is not clear that managers and work teams at different levels contribute to goal setting and follow up actions. Targets are set mainly to conform to the guidelines of the Planning Commission and the Ministry of Finance. An important reason for the poor PE performance must be sought in the non-participative style of management that seems to prevail and the consequent apathy and lack of commitment it generates among other managers and work teams. Planning and control are top management functions, that provide the framework within which other members in the organization function. Ministerial review of productior. and sales every foar months is not a substitute for internal planning and control systems. There is little evidence that careful internal monitoring of PE performance is taking place. The kind of accounting systems and practices necessary to undertake monitoring do not exist in most PEs. Where internal monitoring systems have been developed, such as in DDC, they reflect the emphasis on production rather than other measures of performance and efficiency. 24/ Independent in the sense that the presence of non-officials could lead to more diverse views and proposals in the board which may or may not necessarily be in line with official government views. - 40 - 4.7 Marketing Function. The sample survey of PEs shows that sales have declined in six out of the 12 enterprises. While the trade and transit problem was partly to blame, the trend demonstrates that increasing competition in some industries is also beginning to make an impact. Five of the six companies, JCF, BLSF, BBF, DDC, and HTI, are losing market share to domestic private sector competitors or to imports. If this trend continues, PE marketing weaknesses will have a markedly adverse effect on performance. The practice of cost plus pricing which many PEs reportedly follow does not take into account competitive market factors. The sample survey suggests that the cost plus pricing approach followed by rour PEs has begun to make them uncompetitive. The neglect of the marketing function stems partly from the indifference to corporate planning referred to above. Analysis of market shares and research on the segmentation of markets and consumer preferences will be undertaken only when the competitive environment and market demand are perceived to be priority issues from a long term point of view. Even though most PEs have marketing departments, marketing plans, research, promotion and information systems are either non-existent or extremely weak. Marketing staff often lack skills and experience in these subjects. Product distribution channels and systems also appear to be inappropriate or poorly organized. Thus, four of the twelve PEs in the sample have their own distribution outlets at the retail level, which may no longer be cost effective or necessary. In the cigarette industry, Janakpur Cigarette Factory (PE) owns its own retail outlets while its new private competitor sells its products through private retailers. 4.8 The most important problem caused by weak marketing is indifference to clients and services. As long as monopoly prevails, this may not be reflected in poor financial performance (as was true of the cigarette company prior to start up of its private sector competitor). The lack of attention to product development observed in practically all PEs is evidence of the impact of their limited client orientation. When competition increases in the environment, however, PEs which ignore the marketing function will pay a heavy price. In a competitive setting, products and services have to be adapted and improved to meet changing client needs and new developments in the industry. This is a missing function in the sample PEs studied. 4.9 Production Management. In six of the ten manufacturing PEs surveyed, production has declined over the past five years. Obsolete technology and frequent breakdowns of machinery and equipment are characteristic of almost all PEs. As a result, they incur heavy repair and maintenance expenses. The situation is further aggravated by frequent shortages of raw material inputs and spare parts, and by power failures. Most of these are problems caused by factors beyond the control of PE managers. There are, however, internal management problems which have also contributed to declining PE production and productivity: (a) Six out of the ten manufacturing PEs surveyed are reported to be holding excessive inventories of both raw materials and finished goods. This locks up considerable working capital borrowed at high interest rates. In part, this is a response to the general shortage situation PEs face. On the other hand, a major contributing factor - 41 - is the absence of inventory planning and management, an important ingrediernt in production management. (b) Quality control facilities appear to be adequate in half of the PEs studied!. However, there is hardly any attentiorn paid to research and development (R&D), which reinforces the finding that product developmont is neglected. Weaknesses in quality control and R&D also retlect the low pt:iority given to consumers and their preferences. (c) The management of spare parts and supplies has been a severe problem in most PEs. PE's links with different donors who supplied the original equipment have exacerbated the problem. But the fact that such shortages are pervasive even in the textile PEs shows that there also may be an internal management problem in this Area due to poor inventory management and production scheduling practices. 4.10 Manpower and Labor Relations. A major finding of the sample survey is the lack of manpower planning at the enterprise level and the widespread practice of overstaffing. The latter cannot be attributed solely to deficiencies in manpower planning. As indicated in Chapter V, employment creation is seen as a major public sector objective, which, coupled with the political pressures PE managers face, has contributed to overmanning. In one case, retrenched workers from one PE were absorbed in another in view of the difficult unemployment situation. Overstaffing exists more at the lower clerical/worker level where recruitment is made without a careful analysis of work loads. As discussed in Chapter V, apart from overstaffing, several other personnel and labor relations problems were found in the sample PEs. Key issues, many of which are due not only to external regulations but also to lack of managerial initiative, can be summarized as: (a) Low Salaries. PE salary structures are such that lower level employees are paid wages which compare favorably with those in the private sector but compensation packages for higher level managers and professionals are less-attractive. Consequently, PEs find it difficult to attract and retain qualified managers, engineers and other professionals. (b) Lack of Performance Linked Incentives. The bonus system provided for under the Bonus Act (para. 5.24) applies universally to all employees and is unrelated to individual performance and productivity. Essentially, these bonuses are considered as normal additions to income and do not necessarily contribute to efficient performance. Furthermore, the absence of good performance evaluation systems and the prevalent non-participative management style are reported to have had an adverse impact on employees' morale and motivation. (c) Lack of Attention to Staff Development. Overstaffing, especially at the lower levels, and barriers to the dismissal of employees have meant that there is very little mobility among staff. On the other hand, there is a lack of attention to their training and - 42 - development. This applies equally well to the training of middle level managers. The failure to match the staff to their tasks through training and to upgrade the skills of higher level staff has no doubt contributed to the poor PE performance. D. Financial Management 4.11 The majority of PEs suffer from extremely weak financial management and thus have very low levels of financial controls. The major weaknesses in PE financial management are deficiencies in accounting procedures, poor management of financial resources, lack of professional accountants, neglect of the training and development of accounting staff, absence of commercial accounting policies, and inadequate financial controls and internal audit. Inappropriate organizational structures and the absence of up-to-date job descriptions further contribute to inefficient financial management. 4.12 Accounting Systems and Procedures. The accuracy and timeliness of the preparation of the basic books of account vary considerably from one PE to another. Thus of the twelve PEs studied, the Janakpur Cigarette Factory produces annual accounts within three months of the end of the year, whereas the Agricultural Inputs Corporation takes 22 months. While all twelve PEs studied operate a manual double entry bookkeeping system based on accruals accounting, only six reconcile their books each month, and of these only three present monthly income statements. Given the delays in the presentation of accounts, the subsequent audit letter is too outdated to be of use to PE managements or external agencies. 4.13 The financial reports are not only too late, but often also incomplete and inaccurate for purposes of internal control and external review. Current assets are overstated because of inadequate provision for bad debts and obsolete stocks. Since the are no cash and flow of funds statements, it is difficult to analyze the causes of declining net worth. Depreciation provisions are too low, assets are often overstated because fixed assets are nct physically verified or revalued, and the asset lives used in calculating depreciation allowances are too long. As a result, profits are overstated. Expenditure is deferred to following years without justification or prudence. Thus, accounts can be cosmetically adjusted to show a better picture in the current year at the expense of future years, giving an erroneous impression of profitability. Cumulative interest, subsidies due, counterpart funds and contingent liabilities are rarely provided for, thus current assets and, more particularly, current liabilities are understated. The financial information reported to the PE boards is thus inadequate and unreliable in many respects. 4.14 Budgetary Control and Financial Planning. All PEs prepare annual budgets but they are not used as a financial management tool. For example, no financial plans are prepared to show how production or cost targets are to be achieved. Variances from budget are not routinely analyzed or explained. Nor are budgets revised to reflect changing conditions in the course of the year. As a result, budgetary control is not effective, and the effective utilization of available resources is not assured. Long-term financial planning is not undertaken in any PE, making it difficult to assess the future effects of - 43 - current decisions. Cash flow management is inadequate or non-existent. To a large extent, this reflects the neglect of corporate planning by PE management referred to previously. Only those PEs in working capital difficulties ictively monitor their cash balances, and even these do not plan their cash usage over the subsequent weeks or months. Thus, the use of bank overdrafts and loans is not always efficient and interest charges are incurred unnecessarily. 4.15 Control of Assets. While physical rontrol of cash within PEs is on the whole adequate, stocks and fixed assets are poorly monitored and controlled. To ensure physical control of cash, most depots and outlying branches have two bank accounts, a non-operating account for sales revenue and an operating account for expenses. The non-operating account remits deposits in full to the head office for later reconciliation to sales returns. Amounts of petty cash maintained on the premises are kept tc a minimum. In contrast, there is little control of stock and fixed assets. Inventories are often overstated, and fixed assets are misstated, camouflaging the PE's true capital base. Stock is generally only counted annually and fixed assets are rarely subject to any inspection, verification, or revaluation. Reconciliation to stock and fixed asset records, which are inadequately maintained, is difficult, time consuming, and rarely satisfactory. 4.16 Insufficient emphasis is placed on internal audit. Staff from this function are continually diverted to other duties and recommendations in audit reports are not acted on by management. Thus, the function lacks credibility within the PE. External auditors place emphasis on compliance with internal regulations rather than best accounting practice. For example, more attention is paid to the PEs' compliance with tendering procedures than on the adequacy of provisions for obsolete stock or doubtful debt. 4.17 The key effects of this lack of financial control within the PEs are: (a) It is difficult for HMG, line ministries, funding agencies or potential investors to assess the PEs' true financial health or monitor performance because they cannot rely upon the accuracy or timeliness of the accounts or reports produced. (b) The available financial information lacks credibility with banks funding agencies, and investors. In the absence of long-term plans, banks cannot assess PEs' future ability to meet repayment schedules. (c) Lack of realistic long-term plans makes it impossible for HMG to judge the relative costs and benefits of continuing to support each PE. Investment in a PE should be appraised like any other project on the basis of the future benefits expected. It is difficult to assess the future financial performance because of the paucity of historic data and impossible to quantify the possible social benefits. 4.18 Organization and Training. PEs' organizational structures for financial functions do not reflect actual reporting lines. The heads of - 44 - finance are unaware of the best practice in this area; thus few structures have been reviewed or amended in the past five years, and staff do not have up-to-date job descriptions. Staff frequently perform an entirely different function from those implied by their titles, which results in confused reporting lines and responsibilities. For example, an internal auditor was found to be performing the function of a statistical officer. In part, the reluctance to change structures is due to the perceived difficu_ties in moving posts under the PSC regulations (para. 5.5). The number of staff employed in the finance function varies from 6 to 64 and bears no relation to the department's workload. This is, in part, due to the lack of well defined structures or job descriptions which had lead to overstaffing in many enterprises. 4.19 The relative lack of accounting standards and financial and accounting traiaing have exacerbated the problems in the financial area. There is a tendency for the finance function to be restricted to bookkeeping rather than financial management. There are less than 70 chartered accountants in Nepal, none of whom work for the 12 PEs studied. A few of the finance staff have Bachelor of Commerce degrees, but this training is rather theoretical and difficult to apply to practical situations. The syllabus covered is adequate, but the emphasis is on theory rather than on practical examples and case studies. 4.20 Most staff performing accounting functions have been trained on the job, often perpetrating poor accounting practices. In general, there is little awareness of accounting best practice, i.e., accountants do not know the standard of most modern methods of accounting for transactions. Each staff member has a very narrow field of understanding of accounting because of limited training and exposure. It is essential that formal accountancy training is made more widely available within both the public and private sectors. E. Options for Reform 4.21 The weaknesses and gaps in internal management functions are clearly influenced by some of the factors external to the PEs discussed in other chapters. Thus PSC guidelines on PE employment have a direct bearing on the personnel and labor relations problems mentioned above. The policy environment that restricts competition induces PEs to neglect the marketing function and efficient production practices (e.g., quality control). The existing government policies governing the oversight of PEs encourages the latter to be short term oriented rather than to pay careful attention to performance planning and control. Constraints on the autonomy of PEs and political interferences lead PE managers to divert their attention from their proper management functions. The interaction between external factors and internal management thus results in an overall weakening of enterprises' accountability for efficient performance. 4.22 The deficiencies in PE management discussed are pervasive in almost all the PEs surveyed and cover all the basic functions of enterprise wrnagement. In a few cases, some aspects of a specific function are being dealt with adequately. However, when all other functions are weak, even those - 45 - PEs are characterized by a wide sprectrum of deficiencies, as interactions among deficient functions set in motion a downward spiral of poor performance. Thus, the remedy does not lie in improving any single aspect or function, but in upgrading the entire set of interrelated management functions. 4.23 The foregoing review also shows that weaknesses or gaps in terms of management systems and practices are only one part of the problem. The other and equally important part of the problem lies in the inadequacies in the quality, experience, and incentives of the personnel managing and operating the PEs. This, as has already been pointed out, is due to a combination of the constraints in the policy environment and other factors external to the PEs, and the neglect of the training and development function within the enterprises. Thus, improving PE performance will require not only reform of the management systems and practices but also strengthening and upgrading of the quality and motivation of PE employees. 4.24 Reform of PE Boards. The board of directors of an enterprise is HMG's primary instrument for the management and control of PEs. Its composition, functions, and the quality and incentives of its members therefore assume special importance. As the sole shareholder of PEs, HMG would no doubt want boards of directors to represent its interests. Nevertheless, board members who are responsible for PE performance also have to look after PE interests and must represent their enterprises' viewpoints wherever necessary before HMG. This applies in particular to government members on boards who, of necessity, must play a dual role. 4.25 Although HMG is the sole shareholder of PEs, it is in HMG's interest not to have PE boards of directors consisting solely of government officials. HMG's representation on boards should be limited to one senior official from the sector ministry and one from any other ministry which has a direct stake in that enterprise. MOF representation is warranted only on the boards of the key PEs. The rest of the board members should be drawn from outside of Government, based on the relevance of their experience, their knowledge of the industry or other such characteristics. HMG has already adopted this practice in some PEs such as RNAC. It is now a question of extending the same approach to other PEs. The board of directors should consist of seven to ten members, depending on the size and complexity of the PEs involved. A larger board may satisfy a wide range of interest groups, but is not conducive to effective policy making, team work, and good management control. What is important is that the board has the benefit of relevant views and experiences before final decisions are taken on important policy issues. 4.26 HMG currently appoints PE board chairmen and General Managers. In a few PEs, the chairman and chief executive (General Manager) are one and the same person. In other cases, the chairman is a part-time Government official while the chief executive is a full time General Manager. In the latter case, it may be a good practice for HMG to appoint a part-time chairman and to have the board appoint the General Manager. The General Manager is more likely to look for guidance from the board which has appointed him under this condition, thus minimizing internal conflicts. If there is a legal barrier to the adoption of this practice, an alternative would be for HMG to make this - 46 - appoitntment solely on the basis of the board's recommendation or on the basis of a panel proposed by it. 4.27 Since government representation on boards is essential, it is important that senior HMG officials are appointed to them. This prtctice, h-.eot, has several limitations. First, senior officials, especially Sr ;K.:EiQS, ' are very busy. They are not often able to give adequate time to board work and meetings. Second, conflicts of interest can arise. Senior officials are deeply involved in sensitive political issues, and it may be difficult for them to permit a board to make truly autonomous decisions. It is for this reason that in some countries, nonofficials have been appointed .hairmen of PE boards. Alternatively, most boards should have full-time chairmen who are also chief executives. The counterargument is that there is a shortage of high level managerial manpower in Nepal who could perform this dual role. An abrupt end to the current practice is perhaps unrealistic. Nevertheless, moving away from the practice of appointing senior HMG officials as board chairmen is an option HMG should consider. 4.28 The responsibility of PE boards should be to set long term goals, to decide on key policy matters, and to monitor and guide enterprise performance. Detailed operational decisions should be delegated to the PE managers. The current practice of board decisions being reviewed again within the parent ministries and MOF needs to be reformed. It is important to distinguish between two types of decisions. Some decisions such as investments, expansion, etc., that require additional funds from Government should be reviewed and approved by HMG. In other matters within the purview of the board to decide, it is counterproductive for ministries to review board decisions again. In such cases, board members who represent the concerned ministries should present the latters' views to the boards before they make formal decisions. Such members should do preparatory work before board meetings so that final decisions are taken with the full knowledge of HMG views. This change would greatly reduce the wastage of time and enhance PE autonomy. This approach would require that HMG board members have adequate staff support in their respective agencies to help them prepare for board meetings, especially in respect of policy issues which are directly relevant to their constituencies. 4.29 Enterprise Level Reform. At the enterprise level, the thrust of the reform should be on strengthening the internal PE management including strengthening the management functions, systems, practices, and technical and managerial capabilities. This should be supplemented with modernization and rehabilitation of physical equipment and machinery in PEs where this is a precondition for enhancing management effectiveness. 4.30 From a long-term perspective, improved PE management will depend on a better quality of employees than exists at the present time. There is aot only overstaffing in many PEs, especially at lower levels, but also a lack of skills and experience in critical managerial and technical positions. Even under the most favorable conditions, elimination of excess staff and upgrading the quality of personnel are long term tasks. Any reform program should initiate action on these fronts, but must recognize that drastic personnel changes or improvements cannot be accomplished in the short run. The only 47 - exception to this concerns enterprise chief executives and senior management teams. These are key appointments, and the reform program should give special attention to selections and the terms and conditions of their appointments. The practical tasks of improving management functions and practices cannot be accomplished without competent and experienced senior managers being in charge in the PEs. 4.31 Appointment of Chief Executives and Senior Managers. Enterprise level reform should begin with a review of chief executives. In some cases, it may be appropriate to appoint competent civil servants to senior PE positions. However, appointing retired civil servants to such positions, should not continue to be normal practice. PEs are commercial organizations for the most part, operating in a turbulent external environment. Their leaders have not only to be adept at their business, but should also be willing and able to assume risks and provide guidance and support to others under them to do the same. This requires a different style of leadership than is prevalent in the civil service. When civil servants are likely to return to their parent ministries after a short tour of duty in PEs, the problem is compounded as they will not identify with or be committed to the long term interests of the PEs. Furthermore, they are inclined to reinforce civil service practices and conformity in PEs instead of encouraging the use of autonomy. For all these reasons, chief executives should be selected on the basis of their commercial and entrepreneurial orientations and experience and their capacity to provide leadership to the large groups of employees they are called upon to manage. The same criteria should apply to other senior managers, who should also be competent in their special areas of work. If qualified, internal candidates should be considered for senior management positions, but the search should by no means be limited to internal candidates. 4.32 In general, the terms and conditions of the staff employed at lower levels in PEs tend to compare favorably with those in the private sector. At the senior levels, however, PEs will find it difficult to attract qualified persons. Greater flexibility has to be shown in remuneration offered to chief executives so that competent, experienced managers can be attracted and retained. Governments typically have to moderate the extent of variations in pay, but can use special supplements or create special categories of pay scales to get over these inherent constraints. 4.33 The appointment of PE chief executives and senior management teams should receive priority precisely because they are critical to the improvement of internal management functions and practices. Some areas for improvement are indicated below, but with the full understanding that only competent, experienced managers will be able to plan and implement the relevant management systems and practices. 4.34 Planning and Control. Strengthening internal planning and control systems should be a high priority for all PEs. A key role of the chief executive is to initiate medium to long term corporate planning as well as short term (e.g., annual) operational planning organically linked to the former. Managers will need the support of their boards and HMC in this effort to shift the focus from short-term preoccupations to longer-term strategic - 48 - choices. Long-term or strategic plans should be prepared on an ongoing basis. Their preparation should involve a careful review of enterprise objectives, strengths and weaknesses, likely environmental changes (including potential competition), and identification of future opportunities consistent with the resources that can be mobilized. The development of the resulting strategy sh.ulJ preferably involve all levels of management in order to enable common ideas and plans to be shared on a broad basis within the PE. Operational plans shouLd be derived from the strategic plans and be reinforced by internal control systems to monitor progress and performance variances. Incentiv-s are relevant in this context as they can provide inducement for close monitoring and control. No control system can operate without a good accounting and financial management system, and its development is a prerequisite for effective management control. 4.35 Accounting and Finance. The use of professionally trained accountants and of consistent and internationally acceptable accounting practices are essential for the creation of modern accounting systems in PEs. Nepal does not have a published standard for accounting and auditing practice, nor an accounting authority. Consequently, companies do not generally comply with international standards, and accounting policies vary. The adoption of international accounting and auditing standards would improve the comparability, consistency, and accuracy of the accounts presented. A proposal for the formulation oL an accounting institute in Nepal is awaiting HMG approval. Such an institute would form a suitable vehicle for the improvement of standards, regulation of accountants, and promotion of training initiatives. Intensive training and the use of consultants are the only ways to deal with the critical shortage of accounting skills. The improvements which have resulted from local consultancy advice are very encouraging. For example, JCF now has accounting and auditing manuals, RJM has caught up on its accounting backlog, and NFC produces monthly reconciliations. More PEs should be given financial assistance or incentives to improve their internal accounting systems so that their accounting statements can become more reliable and so that they can exercise better financial control. Each PE should aim to (a) maintain and reconcile monthly, up-to-date double entry accruals-based ledgers; (b) prepare monthly income statements; (c) maintain an accounting system and procedures manual; (d) maintain accurate records of assets, particularly capital assets and inventory; and (e) produce annual accounts within three to four months of the close of the fiscal year. PEs which are required to provide social services should have separate accounts for commercial and non-commercial activities. The organization of the finance function should be clear and embody basic segregation of duties. Staff should receive training in the systems to be operated in addition to their formal accounting training. PE's accounting policies should be clearly defined and follow international accounting practices. The development of long-term financial plans and the use of annual and monthly budgets as a management tool must follow the improvement of accounting practices. All these are building blocks for the design of good planning and control systems in PEs. 4.36 Marketing Management. Improvement of the marketing function is the third area that deserves special attention in the reform package. Corporate strategy can to some extent offer guidance on the market segments to be served or developed. Investment in market research or at least in the collection and - 49 - analysis of market information is urgently required in many PES, especially those already facing competition. On the basis of such research and analysis, promotional strategies may have to be developed in some cases, and in others, changes in the product mix may be warranted. Marketing managers also need to pay increased attention to pricing and distribution practices. In a competitive setting, more rational pricing and efficient distribution arrangements are essential ingredients for improved performance. The skills required to perform these functions do not always need to be created in-house, since consultants can be called upon to provide support for specialized areas of work such as market research and the design of promotional strategies. 4.37 The foregoing discussion highlights management functions and practices which need strengthening in most PEs. There are other functions (e.g., inventory control, production scheduling) which also need improvement, but only in some PEs. The specifics of the internal reforms required in individual PEs will therefore tend to vary. As noted earlier, a careful review of the internal management and operations of each PE should be undertaken after a qualified chief executive with a mandate to improve PE performance is in position. Special task forces with strong internal participation could then be set up to manage the diagnostic process. External assistance and advice through donors and consultants can also be built into this process. Since the elements and priorities of the resulting reform packages will vary among enterprises, it is important that HMG should treat this problem on a case by case basis. V. EMPLOYMENT, COMPENSATION AND LABOR RELATIONS A. Introduction and Suxmnary 5.1 Employment policies and practices are two of the major factors that affect public enterprise performance in Nepal. Almost all enterprises surveyed during the mission indicated employment and labor-related issues as impediments to improving the efficiency and competitiveness of the enterprise. Therefore, a successful PE reform program cannot be achieved without address- ing some of the critical employment and labor problems that affect the entire PE sector. This chapter reviews the existing regulatory framework for PE employment with emphasis on the policies most in need of reform. Issues related to employment regulations are discussed in Section B, the salary and wage structure in Section C and labor relations in Section D. Section E discusses options for improvement in key areas. It should be noted that data on employment, as in other areas, is fragmented and rather inadequate. However, the analysis attempts, to the extent possible, to overcome these serious data constraints and relies largely on information extracted from the sample survey of twelve PEs. 5.2 The main conclusions are as follows. First: The rigidity and lack of flexibility of existing regulations governing PE employment policies have adversely affected PEs' operational efficiency and effectiveness. Delays in decision making and the limited autonomy of managers with respect to staffing decisions make it difficult for PEs to adjust their staffing to meet the needs - 50 - of a commercial organization. Existing procedures also restrict PEs' ability to hire qualified and experienced professionals in senior positions and to motivate staff by rewarding good performers and firing or discipl'ning poor performers. Overstaffing, particularly at lower clerical and administrative levels, is common in most PEs. Second, while low renumeration is a universal problem which affects all sectors, for the PE sector additional problems stem from (a) efforts to link PE wages and benefits to civil service salary scales; (b) PEs' lack of flexibility to adjust compensation packages to attract and retain skilled staff; and (c) inadequate wage differential between highly skilled and unskilled staff. These factors all serve to demotivate PE staff and to limit the PEs' ability to attract and retain qualified staff. Third, existing labor legislation is outmoded, inadequaLe, and provides little basis for coping with emerging industrial problems. Conflicts between the acts and associated regulations make interpretation of the rules and their application to industrial disputes difficult. Neither management nor labor feels that current legislation adequately meets their needs. Finally, industrial and vocational training in Nepal is inadequate. Existing training institutions provide an insufficient number of technical staff to meet industrial needs. At the same time, there is duplication of effort, inconsistencies in the level of training, and lack of coordination between training programs and enterprise needs. Most enterprises lack a well-developed training program, relying instead on on-the-job training, which is less valuable when the overall level of expertise is low and when systems and procedures inadequate or nonexistent. 5.3 Key recommendations for reform include changing the role of the Public Service Commission (PSC) to one of providing broad guidelines on employment principles, combined with some performance monitoring, rather than one involving detailed interference and strict control and approval of each step in the employment process. Existing rules and regulations need to be revised to increase flexibility and to allow more discretion to managers. Bureaucratic approval procedures applicable to various aspects of PE employment need to be reduced and streamlined. Within broad guidelines, PE managers should be given more autonomy to set their salary and wage structure according to their priorities, employees' qualifications and productivity, market conditions, and the firm's financial performance. In enterprises with high levels of overstaffing, an appropriate strategy would be to take steps to restrict future staff growth combined with measures to progressively reduce existing redundancies. Thus, a freeze on hiring of unskilled nontechnical administrative and clerical staff could be put into effect. For existing redundancies, development of incentive schemes for early retirement or voluntary departures and enhancement of end of service benefits should be considered. Finally, existing labor legislation should be reviewed, and enterprises should place more emphasis on training and staff development. Training programs should form part of corporate and business plans. On-site training programs run by external training agencies and on-the-job training as part of external technical assistance should be encouraged. B. Employment Regulations 5.4 The rules and regulations governing all aspects of PE employment are determined centrally by the Public Service Commission (PSC), which is also responsible for the regulatory framework for civil service employees. The - 51 - rigidity and lack of flexibility of this centrally determined regulatory framework is considered by many PE managers to be a factor contributing to the PEs' poor performance. All major decisions on hiring, firing, salary structure, promotions, and disciplinary actions in PEs have to be carried out, not only in accordance with the PSC's detailed guidelines, but also with PSC's prior approval. Thus, PE managers have little autonomy with respect to staffing decisions, even though these decisions have a direct impact on their operational efficiency and effectiveness. The result is that PE managers are unable to adjust their staffing requirements to their needs and to the market environment. 5.5 The PSC was established in 1951 as part of the Nepal Interim Constitution. In 1959. it was constitutionalized and became an indepLndent body of the constitution reporting directly to the king. It has a chairman and four commission members. The Commission has five regional offices and about 400 staff. Its general mandate is to develop and ensure implementation of the general principles of public service, which includes civil service employment, as well as those of the corporate bodies. In essence it is -- or should be -- a regulatory and advisory body on general principles of public employment. However, in practice its role has become one of detailed control of employment matters that should be the prerogative of PE managers. PSC's guidelines provide not only general rules on employment principles but also set out detailed rules and procedures that have to be followed on all matters related to conditions of service such as recruitment, transfers, promotions, disciplinary actions, training, rewards, and punishments. PSC also supervises and inspects PEs to ensure that employment conditions comply with PSC's regulatory framework. Following are some of the specific aspects of PE employment regulations most in need of reform. 5.6 Recruitment. Prior to 1966, the PEs recruited and selected employees without interference from the PSC. With the first amendment of the Constitution of Nepal in 1967, PSC was assigned the task of recruiting and selecting PE employees. However, realizing the difficulties faced by both PEs and PSC in this arrangement, the second constitutional amendment (1975) restricted PSC's role to advice and supervision. According to the existing regulatory framework, each enterprise has a Padpurti Samiti (recruitment committee) responsible for selection and recruitment of new staff. PSC has issued uniform guidelines to be followed by all these committees. While nominally the PEs have considerable discretion in recruitment of their personnel, in practice PSC has to approve the creation of every post and the recruitment of all staff above level six. This includes approval of job descriptions, job specifications, qualifications, and selection process, etc. The level and structure of PE employment is parallel to the civil service and uniform across all PEs. It consists of 12 levels of which levels 1 to 5 are unskilled and lower level administrative/clerical staff, and levels six and above are officers and professionalltechnical staff with at minimum a university degree. 5.7 The problem with the present recruitment practice is that obtaining step by step approval from PSC is a lengthy and highly hierarchical process which takes several months; as much as a year is not unusual. Furthermore, PSC, as the ultimate approving authority, can hold recruitment requests for an - 52 - even longer period or question the nature of the job or candidate. Not only recruitment requires PSC's approval; creation of any new position above level six also has to be approved by PSC. This regulation particularly constrains PEs in the hiring of technical professionals who are in high demand and often lost to the private sector in this lengthy process. The creation of a new technical post can take as long as six months due to procedural delays by PSC. Since PSC does not have the capacity and required technical skills to approve qualifications and specifications for technical and professional positions, its input in the process is an added bureaucratic step that causes recruitment delays, without compensating benefit. At the same time, on the basis of PSC regulations, no one can be hired above level 7 regardless of his/her qualification and expertise. This is yet another constraint to PEs hiring highly qualified and experienced professionals which puts them at a disadvan- tage relative to the private sector. 5.8 Promotion and Incentives. Promotions are also highly restricted by PSC's regulatory framework. PE managers are unable to promote staff unless they have been at their current level for a minimum of four years, and even then PSC has to approve it. This is a serious disincentive to employees, since they know that regardless of their productivity they cannot be promoted until they have been on the job the necessary number of years. Other perfor- mance-based incentive systems are also lacking, and PE managers have virtually no mechanism to motivate employees. The Bonus Act of 1947, (para. 5.24) which was amended in 1989, has provisions for distribution of bonuses to the workers and employees if a PE makes a profit. This bonus system has proved ineffec- tive for two reasons. First, it does not apply to many PEs since few are profitable. Second, in the case of the few profitable PEs, the bonus has little motivational impact since it applies universally to all employees and workers and does not relate to individual performance and productivity nor differentiate between good and poor performers. The absence of performance incentives results in low productivity, lack of initiative, frequent absentee- ism, and an overall demoralized work force. The problem is compounded by extremely restrictive and rigid rules for firing or disciplining poor per- formers. Firing is virtually not an option. Other disciplinary actions that have been exercised occasionally all relate to non-performance issues and have to be approved step by step by PSC. 5.9 Redeployment. The strict policy of job security for PE employees has resulted in increased growth in PE employment and redundancies and overstaffing in several PEs. In the companies surveyed by the mission, estimates of overstaffing range anywhere from 20 to 50 percent. In the Dairy Development Corporation management estimates overstaffing at between 30 to 40 percent. The Hetauda Cement Industry Limited is estimated to be more than 40 percent overstaffed. Table 5.1 shows the increase in the number of employees over a four year period for the twelve enterprises included in the sample survey. For some of the enterprises, the annual increase exceeds 10Z. For example, in Royal Drugs Limited, staff size grew by 46 percent in four years. Excluding RJM (the jute mill), on average the total employment of the sample PEs grew 12Z over the four year period. In general, there is little correlation between the increase in employees and the enterprise's production, sales and capacity utilization. In fact, in some PEs there has been a significant decline in production without a major change in employment. - 53 - Table 5.1: INCREASE IN EMPLOYMENT OF SAMPLE PEs Total Number of Staff Growth Rate (Z) Name of Enterprise 1984/85 1988/89 Per annum Total ATF 364 425 4.2 16.7 BBF 461 472 - 2.4 BLSF 519 549 1.4 5.7 DDC 996 1,099 2.6 10.3 HCC 757 838 2.7 10.7 HCIL 815 993 5.5 21.8 HTI 1,272 1,263 - -0.7 JCF 2,179 2,727 6.8 25.1 RDL 217 318 11.6 46.5 RJM 2,292 1,559 -8.0 -32.0 AIC 934 1,022 2.4 9.4 NFC 1,198 1,161 -0.7 -3.1 Source: Mission data. 5.10 In Raghupati Jute Ltd. for example, redundancies were so severe as a result of the decline in sales and production that management, with the approval of PSC, laid off about 770 employees and reduced the size of its workforce from 2,292 to about 1,560 over four years. This cost a total of NRs 10 million for gratuity and severance pay. However, according to the manage- ment, the mill is still overstaffed by about 500 persons; socio-political factors as well as shortage of funds for severance pay, mean that the company is unable to layoff additional employees. 5.11 Most of the excess staffing is in the lower administrative/clerical levels, while at higher technical/professional levels many enterprises are understaffed. For example, in the case of the Dairy Development Corporation, of a total of 1,099 employees only 63 are professional and technical and staff. Table 5.2 illustrates staff distribution in the enterprises surveyed. Overstaffing at lower levels occurs partly because the regulatory framework makes it easier to hire at those levels, since PSC's prior approval is not required, and partly because of political pressure. 5.12 Social and political pressure on the Government to create jobs is a major cause of PE overemployment. With a scarcity of alternative employment opportunities, public enterprises are often encouraged to maintain large work forces, even if they are financially weak. Few enterprises have been able to resist the political pressure to create jobs. Among the sample PEs, an exception is Hetauda Textile which has had a slight contraction in staff over the past four years. Employment generation is considered one of the primary social objectives of public enterprises and therefore maintaining excess employment is considered a positive step in achieving this objective. More - 54 - importantly, as discussed in Chapter 3, PE managers have very little incentive to improve labor productivity and their enterprise's overall performance. Another reason for overemployment is that, under existing policies, termination of employment in PEs is even more difficult than in the civil service. For example, civil service employees have the option of early retirement after 20 years of service, which can facilitate staff reduction in the event of redundancies. Although some PEs are considering adopting similar measures, PE employees do not yet have this option. Table 6.2: PE STAFF DISTRIBUTION (1986/89) Staff Cstegorles Nae of Manageril/ Skilled Unklled Enterprise Adminis. Technical Clerical Operatives Operatives Total ATF 32 82 266 24 31 426 8F 9 96 33 240 96 472 BLSF 28 39 85 238 161 649 SDC 46 s8 397 699 -- 1,099 HCC 46 209 260 163 206 863 HCIL 106 149 292 317 130 993 :ITI 38 103 148 816 181 1,263 JCF 666 NA 1,026 628 419 2,727 RDL 13 32 NA 189 80 314 RJM 22 NA 148 1,043 348 1,659 AIC 140 NA 882 -- -- 1,022 NFC 164 NA 997 -- -- 1,181 Total 1,294 787 4,511 4,244 1,631 12,447 X 10.4% 6.2% 38.2% 34.1X 13.1% Soure-: Mission data. 5.13 The problem with excess staffing is not only in the direct cost reflected in the wage bill,25/ but, more importantly, the longer term cost of keeping nonviable and loss-making enterprises open for employment purposes. Managing a large workforce and excess staff is administratively and financially costly, particularly with the provision of numerous social and welfare facilities, various allowances, bonuses, etc., which is the norm in the PE sector. Furthermore, the presence of a large number of redundant employees has a demoralizing and demotivating effect on the work environment. The managing director of one PE, in reference to this problem, indicated that he has quietly asked some of the redundant staff not to show up at work because of the demoralizing effect they have on the other employees, as well as the cost of their use of electricity, office space, etc. Finally, 25/ Wages and salaries as percentage of operating costs averaged 18% in 87/88 for the 10 MPEs surveyed; Raghupati Jute (37Z) and Bhaktapur Brick (38Z) were the most labor intensive. - 55 - overstaffing in many of the enterprises has created an environment strongly resistant to the introduction of new technology su-h as computerization, restructuring programs, divestiture options, or other efficiency measures, which may result in reduction of employment. C. Salary and Wage Structure 5.14 In general, the salary and wage structure is very low nationwide for all sectors -- public enterprises, civil service, as well as the private sector. Therefore, this a universal problem that does not pertain only to the PEs. The problem with the basic salary scale is so acutc what it has been the target of one of the very first measures that the interim government has taken following the recent political movements; a four-member commission oias constituted, headed by the Executive Director of the Nepal Administrative Staff College, to recommend changes in the salary and benefit structures of public corporations. 5.15 PE salaries are determined centrally on the basis of a 12 level job structure. Initially, PE salaries were significantly higher than civil service salaries, and therefore it was more attractive to join PEs than the civil service. However, over the last few years there has been a freeze on PE salaries, while civil service salaries have increased. As a result, the present salary structures of both are similar. A comparative survey of the salary structure of selected public and private enterprises also indicated that there is no significant wage differential for similar occupations between the private and public enterprises, except for the minimum wage. Annex V.1 and V.2 give comparative salaries of public enterprises, civil service, and the private sector. The official minimum wage is determined and reviewed periodically by the Labor Ministry's Committee on Minimum Wage. Currently, the minimum wage is 640 NRs per month for unskilled workers and 800 NRs for skilled workers. However, this is so unrealistically low that the private sector always pays considerably above that. 5.16 Fringe Benefits. To compensate for the very low salary structure, PEs provide a range of quite generous fringe benefits. These fringe benefits are uniform in all PEs and apply equally to all levels of employees. The fringe benefits may differ from one enterprise to another depending on the nature of operations, but in general they include: - housing allowance 15Z of salary - provident fund gratuity 1O0 of salary - dasai bonus one month extra salary - medical allowance one month salary per year - tea allowance NRs 4 per day - transportation allowance NRs 4 per day - clothing for operators - dearness allowance 25 to 45 Z of basic salary 5.17 Following strikes at various enterprises, several PEs have enhanced the fringe benefits package. For example, Nepal Rastra Bank (NRB) and Nepal Telecom Corporation (NTC) increased staff allowances and, in some cases, - 56 - introduced new ones (see below). Other enterprises can be expected to follow this lead and increase their fringe benefits. NRB Previous Revised Education Allowance for Children NRs 40 per month NRs 150 per month Tiffin Allowance /a NRs 5 per day NRs 8 per day Transportation Allowance NRs 125 per month NRs 250 per month NTC Education Allowance for Children NRs 100 per child (maximum 2) per month Tiffin Allowance NRs 300 per month Transportation Allowance NRs 200 per month /a Tea allowance. 5.18 Major Issues. The main problem with the existing salary structure is its rigidity. PE salaries are centrally controlled and standardized, and uniform across all PEs with complete disregard for the firm's performance and ability to pay. For example, better performing PEs. such as Janakpur Cigarette, pay the same salaries to their managers and officers as those that make losses. The lack of PE autonomy and the disregard for enterprise per- formance, supply and demand etc., in determining salary and compensation packages is a critical problem which results in low productivity and demotivates employees. 5.19 Furthermore, unification of the PE salary structure with the civil service is another problem which has brought the PEs (which should in most cases be commercially oriented), closer to the civil service salary structure rather than to that of competitive corporate bodies. High job security, along with automatic and fixed salary increments based on seniority rather than on performance and merit provides little incentive for PE managers and employees to improve their job performance. 5.20 The combination of a standardized and uniform salary structure and the strict regulatory framework for hiring. fiting, and promotions leaves PE managers with little power over their workforces. They can neither pay salaries to their employees which are commensurate with their performance nor can they hire qualified personnel except within rigid guidelines. Laying off redundant staff is literally impossible. The result, as described earlier, is an employee environment characterized by frequent absenteeism, undiscipline, and idle employees. - 57 - 5.21 Wage and Salary Differentials. Inter-industry wage differentials and regional wage differentials are very narrow. Thus, essentially there is a uniform structure within the industry overall with respect to similar occupa- tions and skills stemming from the centrally controlled system. One positive aspect of this narrow inter-industry differential is that enterprises do not lose employees to each other, and therefore this type of turnover is very low. 5.22 However, there are two major problems with respect to wage differen- tial in Nepal. One is that the wage differential between Nepal and its neighboring countries is very wide. Some of the skilled workers and technicians move to neighboring countries, particularly Bhutan and Bangladesh, where they can get more money for the same kind of work. For example, the managing director of Dairy Development Corporation indicated that he lost several of his trained technicians to neighboring countries. 5.23 The second problem is that inter-enterprise wage differentials between various occupations are very narrow. Essentially, the inter- enterprise wage differentials are based on seniority and years of service and do not take into consideration skill requirements and job qualifications. For example, the wage differential between skilled, semi-skilled and unskilled workers is less thar. 100 NRs, and the differential between officer and non- officer levels is also very narrow (see Annex V.2). The problem is even more serious since fringe benefits, often a greater part of the compensation package than direct pay, are almost the same for all employees from unskilled to managerial level. When the differentials in earnings between skilled and unskilled staff and technical and non-technical staff become so low, they create an environment of unfairness and dissatisfaction. Such low differentials also erode the incentive for acquiring skills. If there is little difference in the earnings of technical and non-technical staff, incentives for acquiring skills will have little effect. D. Labor Relations 5.24 Existing Legislation. Nepal's labor legislation has a nearly 30- year history during which two laws of fundamental importance have been enacted. These are: (i) the Nepal Factory and Factory Workers' Act, 1959 and (ii) the Bonus Act, 1974. There are a few other laws that have some applica- tions in labor management such as (i) the Industrial Apprentice Act, 1980, (ii) the Class Organization Act, 1979, and (iii) the Maintenance of Essential Services Act, 1957. The Factory Act of 1959 contains substantive and proce- dural provisions on such diverse subjects as employment, wages, safety, welfare, industrial disputes, protection of women and child labor, hours of work, workmen's compensation, etc. The Act leaves the treatment of details to the Factory Rules, 1963. The Bonus Act was passed in 1974. Its subsidiary rules were enforced in 1978. The Act provides for the distribution of bonuses (10 percent of net profit) to the workers in the event of profits. However, no employee is to be paid a borus of more than 25 percent of his annual salary in a fiscal year. The remaining amount, if any, is to be credited to the Welfare Fund. 5.25 The capacity of the labor relations system to develop and achieve its objectives is considerably influenced by this legal framework. The scope - 58 - and effectiveness of Nepal's labor legislation is very limited for the following reasons: (a) A large section of the industrial workforce is still outside the gamut of present labor legislation. Only less than 10 percent of the workforce comes within its preview; and (b) There is considerable slackness in the enforcement of these Acts, even in those establishments where they are applicable. 5.26 The Factory Act is inadequate to cater to present needs. A number of the Act's provisions are outmoded, especially those relating to employment and conditions of work. The clauses relating to provisions for dispute settlement, wage fixation, and grievance handling are incomprehensive and inadequate. Labor conditions have evolved beyond these provisions and rendered them out-of-date. Considering the vast changes in the socio-economic and political conditions in Nepal during the last three decades, the adequacy of its provisions to meet current and emerging needs is questionable; conditions it sought to address no longer are the same. 5.27 In particular, the Factory Act appears inadequate to cope with emerging labor problems in the organized sector of the industry. Labor- management disputes have grown so frequent that it is cumbersome to resort to the mechanisms provided by the Act. In some instances, there are conflicts between the Act and the Factory Rules of 1963, making interpretation of the rules and their application to resolving industrial disputes difficult. Vagueness in the Factory Act and the delays involved in getting proper clarification from the Labor Department further complicate and prolong settlement of labor disputes, resulting in strikes, closures, and production losses. Although the intent of the law is to emphasize negotiations between parties and to permit legal proceedings only when this fails, it is the legal involvement which has emerged in recent years as the more dominant feature of labor relations practice in the country. This has led to the criticism that legislation has inadvertently encouraged a litigatory approach in the labor relations system. 5.28 Workers generally believe that the Labor Department is rather slow in implementing labor laws. Management tends to feel that its effectiveness in handling personnel problems has been significantly restricted by the legal framework within which it has to operate. Labor leaders seem to take the view that labor laws, while providing certain safeguards against unfair employer practices, hamper the growth of strong labor organizations and do not encour- age the development of free interaction between parties through collective bargaining. The Factory Act has secured certain minimum facilities for the workers, but has also created an impression with employers that the minimum is also the maximum in so far as these service conditions are concerned. 5.29 Labor Policy. Nepal has yet to develop a comprehensive and well integrated labor policy. Prevailing government labor policies are scattered and fragmented and have to be found in various government decrees, pronounce- ments, ad hoc notifications, and a few pieces of legislation. The Sixth (1980-85) and the Seventh (1985-90) Plans both emphasized the importance of - 59 - the development and utilization of the labor force to optimize Nepal's socio- economic development. Some of the labor related objectives and strategies in these plans are: (a) ensuring optimum utilization of the labor force and taking measures to enable the maximum number of people to contribute to the development process; (b) strengthening and developing labor policy and administration; (c) maintaining updated labor statistics; (d) enhancing labor legislation to improve the relationship between labor and management; (e) improving industrial and vocational training; (f) balancing demand and supply of labor; and (g) making obligatory the use of indigenous labor obligatory for all industrial enterprises and projects to the extent it is available. 5.30 Unfortunately, the above objectives/plans have not yet been achieved. In fact, all twelve enterprises surveyed during the mission cited labor-related issues among their major problems. Labor productivity is low, not only in comparison to international standards, but in comparison to similar neighboring countries. Annex V.4 shows a comparison of output per employee in selected public enterprises and private firms. Labor administration is poor and is becoming increasingly less effective. This is partly because of the excessively bureaucratic regulations with respect to labor employment which require prior approval by the Labor Department in many aspects of labor-management relations, including disciplinary actions, trans- fers, provision of certain benefits, complaints etc., and partly because of the lack of clarity and inadequacy of the labor policies. Labor statistics are virtually non-existent. Information on labor issues is available in fragmented form from various documents and studies that have been carried out; however, they are neither updated nor consolidated to provide a reliable source. 5.31 Training. Industrial and vocational training is inadequate. A 1988 UNIDO study of 65 Nepalese establishments focusing on ma. er planning and human resource development for the industrial sector concluded there was a critical need for training and human resource development. This was found to ba true particularly for mechanical skills at all levels: craftsmen, technicians, engineers, and electricians as well as electrical and chemical engineers. Most of the companies reviewed during the mission did not have a well developed employee training program. Essentially, training is provided on an ad hoc basis depending on the availability of funds or grants from international donors. Often enterprises are unable to retain their few trained staff due to rigidities in the salary and incentive structure. As indicated earlier, many trained technicians and engineers leave PEs, and sometimes even leave the country, for better pay. - 60 - 5.32 Presently, there are three main sources of training and manpower supply. These are: (a) Tribhuvan University; (b) the Directorate of Voca- tional Training; and (c) sectorial training establishments. The important agencies for sectorial training are: (i) Labor Supply Centers and Vocational Training Centers of the Department of Labor; (ii) Cottage Industry Development Board; and (iii) Small Business Promotion Project. These sectorial training agencies try to provide training in the various skills needed by the industrial sector. However, both the subject areas covered and the quantity of workers trained are inadequate to meet industrial needs. Other problems include duplication of effort, inconsistencies in the level of training, and lack of coordination between the training programs and enterprise needs. 5.33 Supply and Demand for Labor. There is no balance between labor supply and demand. Redundancies of certain occupational groups and shortages of others are indicative of this imbalance. The 1988 UNIDO survey also showed serious imbalances between supply and demand for skilled and professional manpower. On the basis of this survey (Annex V.5) the most urgent need is for basic mechanical skills, technicians, and engineers. It is only in the administrative area that there is an ample number of trained people. The survey also found that those enterprises that relied on non-Nepali labor had fewer vacancies. In contrast, enterprises who were restricted in the employ- ment of non-nationals had a high level of vacancies. E. Options for Reform 5.34 The rigidity and lack of flexibility of the current regulations governing PE employment and compensation policies clearly contribute to the PEs' operational inefficiencies and low productivity. PSC needs to change its focus. Its role should essentially be one of providing guidelines on employ- ment principles and practices combined with some performance monitoring rather than detailed interference and strict control and approval of every step in the employment process. HMG's employment policies should emphasize measures to increase the productive use of human resources in both the public and private sector. Employment generation needs to be placed in the context of the Govsrnment's overall economic development strategy. Current PE problems partially stem from the emphasis on employment generation as a primary objective. In fact, employment growth should result from expansion of produc- tive activity, and thus Government policies should be directed at (a) provid- ing incentives and improving the environment for labor-intensive private sector investments and (b) building human resource capability in order to increase employment opportunities. Overstaffing in PEs, by limiting their productivity and efficiency, reduces the resources available for expansion of capacity and employment opportunities. While any actions which result in significant decreases in staff may be politically unacceptable, the Govern- ment's long-term strategy for PEs should reflect an emphasis on productive use of human resources rather than employment growth per se. 5.35 The key employment issues to be tackled in any PE reform program are discussed below. They include PSC's regulatory framework, PE overstaffing, salary and wage policies, and the skills deficiencies of the labor force. - 61 - 5.36 PSC Regulations. The need to update and reform PSC's regulatory framework has already been recognized by PSC officials, who indicated plans to Fold a seminar to discuss areas most in need of reform. Such a seminar or workshop is highly recommended. However, it is important that PE management and employee representatives also participate in this seminar so that the constraints and frustrations they experience are realistically reflected. The revision of PSC's regulatory framework should aim to increase flexibility and allow more discretion to PE managers to make staffing decisions in response to market conditions. At the same time, the highly bureaucratic approval procedures applicable to various aspects of PE employment should, to the extent possible, be reduced and streamlined. Within broad guidelines, PEs' autonomy in making their staffing decisions should be substantially increased. At the same time they should be held accountable for results with respect to improved efficiency, cost savings, and higher labor productivity. It must be noted that historically the experience with increased PE autonomy in staffing decisions such as hiring, promotions, and disciplinary actions has been rather disappointing. According to PSC, such freedom had allowed prevalence of favoritism and undue discriminations. However, this has occurred partly as a result of the lack of effective performance monitoring and evaluation systems at the macro level and within enterprises. Therefore, it is important that increased autonomy is accompanied by development of an effective performance monitoring and evaluation system so that the PEs can be held accountable for their decisions (para. 3.22(d)). Where social and political objectives require PEs to maintain excess staff, the trade-offs and costs of such objectives should be transparent. 5.37 Introducing Performance Based Incentives. Currently, neither promotions nor bonuses are linked to performance. Therefore, an effective performance-based incentive system needs to be developed and implemented at two levels: i) at the governmental level, for provision of rewards to PE managers and bonuses to PEs whose performance has been good, as discussed in Chapter 3; and ii) at the firm level, for departments, divisions, and individual employees with high productivity. Development of internal perfor- mance incentive schemes should be the responsibility of PE managers. 5.38 Resolving Redundancy Problems. The best way to deal with overstaff- ing is to prevent it, since after it occurs, the situation it often becomes a very complex problem with its own high social-political cost, making it difficult to resolve. However, since in Nepal the problem already exists, the recommended approach would be to combine measures to prevent further overstaffing with efforts to progressively resolve the problem of existing redundancies. As a preventive measure, it is advisable to put in effect a hiring freeze for all PEs. The freeze should be limited to hiring of unskilled, non-technical, administrative, and clerical staff, and should, exclude technical/professional staff who are in high demand and where PEs are shortstaffed. Although the impact of a freeze policy would not be immediately noticeable, over the long term by preventing further growth it would effectively lead to gradual reduction of the workforce through natural attrition. 5.39 For the existing redundancies, particularly in extreme cases, the following measures are recommended: - 62 - a llk,-ment of incentive schemes for early retirement or voluntary --artures. Such schemes are best developed on an enterprise-by- ;,tezprise basis, depending on the extent of redundancies and the k-:,terprises' ability to pay. Government support and approval of th-se schemes will obviously be required. In some cases, budgetary .!llocations or mobilization of external resources may be needed to -le¶lment the program. The Nepal Industrial Development Corporation is iti the process of planning such schemes, including early retire- i:ent after 20 years (similar to the civil service plan) and golden l:and shakes, which are expected to help reduce the number of redun- dtrlc ies. (b) development and expansion of training and retraining programs to .,rovide necessary skills to redundant employees so they can be re(leployed in new jobs or transferred to other enterprises that are ,U oped of those skills; (c) development of programs for job creation. Private sector develop- ment and development of incentives for expanding private sector activities, particularly in medium- and small-scale industries, are among the measures that would result in employment generation. The ;overnment's employment generation policy should not focus only on the public sector as a source of employment; the private sector coluld also be an important source of employment generation; and (d) enhlancement of end-of-service benefits to facilitate lay offs of the existing redundancies. This could include provision of seed money for the laid off employees to enable them to start small businesses or to begin farming, etc. 5.40 Salary and Wages. Recent government review of PE salary and fringe benefits reflects awareness of the problems with the existing salary struc- ture. However, while an across-the- board, uniform increase in basic salary and fringe benefits may alleviate some of the immediate problems of employees, if the underlying problems discussed above are not addressed, there will soon be renewed pressures for salary adjustments. Reform of the salary and wage structure must tackle the fundamental issues of increased autonomy for PEs, the incentive structure, and appropriate differentiation between jobs requir- ing high and low technical skills. Reform measures in some areas are immediately achievable, while others will take more time. The objective should be to have a comprehensive and well-integrated program that would be implemented progressively or in phases. 5.41 The following are some broad reform options to be considered: (a) The first and most fundamental reform measure is, as stated earlier, to provide increased autonomy to PE managers to make decisions that have direct impact on their enterprises' productivity and efficien- cy. This includes, within broad guidelines, the flexibility to set their salary and wage structure according to their priorities, to the qualifications and productivity of employees, to market conditions, to the firm's financial performance, etc. This - 63 - flexibility is crucial for PEs in competitive sectors. In the case of PEs in monopoly sectors, establishing efficiency targets as part of Government's performance monitoring will moderate excessive salary increases. The present lack of autonomy of PE managers with respect to employment and salary decisions stems in part from the absence of effective performance monitoring. Thus, government officials feel that they can exercise control over the firms only by standardizing employment conditions. However, in the process, accountability becomes so diffused that no one can be held responsible for poor PE performance. (b) Second, attempts at unification of PE salaries with the civil service further demotivate staff and should be stopped. Within broad guidelines, enterprise salary structures and incremental salary increases, as well as incentive schemes, should be decided and approved by the PE boards and management. (c) With respect to wage differentials, measures need to be taken to differentiate between jobs requiring different qualifications and skill levels. Appropriate skill-based differentials will not only help PEs attract and retain skilled staff, but will also provide an incentive for workers to acquire additional skills. (d) And finally, the whole structure of fringe benefits should be rationalized. One option to be considered is delinking some of the basic social and welfare benefits from PE employment. These could then become part of the overall social services provided for all government employees. This would facilitate adjustments of PE workforces. Currently, the PEs' role in providing basic social and welfare benefits is a serious impediment to layoffs since retrenched staff lose access to basic health, housing, education benefits, etc. Consolidation and administration of these services elsewhere within Government would reduce the administrative cost and resource re- quirement of these programs and allow the PEs to better focus on their primary operational objectives. 5.42 Training. Economic activity in Nepal is currently in transition. In manufacturing, new subsectors are being established and others are rapidly expanding. New technology is being introduced, and the product range of manufacturing goods is growing. Similarly, village and cottage industry is being encouraged to grow and increase their skills. In the light of these developments, the future demand for new skills and additional manpower will invariably grow. Human resource development in Nepal, particularly technical training, in Nepal will be a major undertaking. For PEs, development of training programs should become an integral part of corporate and business plans. Better coordination needs to be developed between training and vocational agencies and the enterprises. Some enterprise specific training could be provided on-site by external training agencies at the request of the enterprises. While the importance of on-the-job training should not be underestimated, it is less valuable if the overall level of PE expertise is - 64 low and systems and procedures are inadequate or nonexistent. Provision of technical assistance services in many enterprises can provide a vaiuable opportunity for effective on-the-job training that should be maximized by enterprise managers. In addition to enterprise specific training programs, HMv, in collaboration with professional associations, universities, and vocational training institutes, needs to develop training in areas common to all PEs, such as basic accounting, data processing, marketing and production and inventory management. VI. PRIVATIZATION AND DIVESTITURE A. Introduction 6.1 Given the scarce managerial and financial resources in the public sector, the success of a PE reform program will depend on reducing the number of enterprises the public sector will continue to own and manage. The smaller the number, the more manageable will be the task of planning and implementing reforms. Thus, privatization and divestiture, i.e. transfer of management and/or ownership to the private sector and closure or liquidation of nonviable PEs, are important elements of any PE reform strategy. This chapter assesses existing constraints to successful privatization in Nepal and outlines key elements of a strategy for privatization and divestiture. 6.2 Over the years, governments in Nepal have endorsed privatization as one of the instruments for public enterprise reform. In reality, however, these efforts have been marked by hesitation and unwillingness to adopt mea- sures that would result in significant changes in managerial control. Isolat- ed attempts at divestiture dating back to the 1970s, for example, have involved offers to transfer only partial ownership to the private sector, and sale offers restricted the amount of shares that an individual could acquire. The hesitation to proceed with privatization is attributed, in part, to sensi- tivity to political and social concerns, such as adequate participation of nationals in the bid process and resistance from PE employees to divestiture. While Government's intention to privatize is referred to informally or impli- citly in various documents, there has been no formal/official statement that clearly defines the Government's privatization policy objectives and strategy. Overall, there has been no significant effort to create an enabling environment for privatization, which would include addressing some of the fundamental issues that might affect successful implementation. 6.3 Given this background, it is not surprising that prior Government efforts to privatize have failed. For example, when Government attempted to privatize Himal Cement in 1986, neither the enterprise nor the overall environment was ready. No financial statements were published, and investors were given only seven days to submit proposals. The overall process was not transparent and there was sensitivity amongst decision makers with respect to ownership concentration and the ethnic origin of the prospective buyer. Had these issue. been adequately dealt with in advance this PE could now be operating in the private sector. Instead, after negotiations with the prospective investor were concluded, the Government, faced with serious - 65 - resistance from both enterprise management and employees, including employee demonstrations in front of the Prime Minister's office, was forced to break off the transaction. 6.4 Recognizing these problems, the Government more recently has taken steps to advance its plans for privatization. A small privatization committee was established in late 1989 under the auspices of the Ministry of Finance with the mandate to develop a policy paper 'or white paper) outlining the Government's privatization strategy. The five member committee is chaired by the Chairman of NIDC and includes the Chairman of the Securities Exchange Commission, a Finance Ministry representative, a university professor, and a private sector representative. Interviews with various committee members in April 1990 indicated that a draft of the white paper was being circulated for clearance. As well, the Government had agreed on the terms of a UNDP financed/IFC executed technical assistance program whereby IFC would: (a) provide input to Government in the development of a privatization strategy, (b) assist with privatization transactions, and (c) train HMG staff.26/ Other privatization initiatives included two seminars on the subject in August 1988 and March 1990. These seminars were positive initia- tives in that they increased the general awareness of the issues and options relevant to privatization. They were also the first formal attempt to open the subject for discussion and get the opinions of concerned parties. While preliminary in nature, they nevertheless yielded useful feedback from public officials and the private sector and provided valuable input to the develop- ment of the white paper. 6.5 On the whole, the main constraint at this stage is that the overall environment is not conducive to large scale privatization. Insufficient preparatory work has been done to build consensus among interested partners, develop operating policies and procedures, and prepare enterprises for privat- ization. Recent political changes are likely to further affect privatization not only because the interim Government may be reluctant to make major struc- tural changes but also because investors may perceive the political environ- ment as an additional risk. Therefore, while Government can proceed with privatization of one or two enterprises, implementation of an expanded program will require that some of the broader issues and constraints be addressed and adequate measures taken to create an enabling environment. This does not mean that all these issues need to be resolved up front. Privatization is a very complex exercise and most of the issues can best be addressed on a case by case basis. However, the overall political, social, and institutional environment needs to be supportive if a larger privatization program is to be successful. Successful privatization of one of two enterprises as envisaged in the IFC supported technical assistance program, would provide valuable input in the design of a larger privatization program. 26/ The form of the agreement was agreed but not signed shortly before the change in government. It is unclear whether these initiatives have the support of the current Government. - 66 - B. Constraints and Issues 6.6 In preparing a more comprehensive privatization plan, potential obstacles to or risks of privatization would need to be addressed, including legal, fiscal, administrative, employment and social issues, domestic capital sources and potential foreign investment. Some of the general issues, constraints and risks of privatization that have been identified which should be addressed as a prerequisite for implementation are discussed below. Policy Framework 6.7 Presently, Nepal lacks a clearly defined policy framework that defines the Government's objective, strategy and scope for privatization. Development of a privatization policy statement would provide the basis for initiation of the program. In the current environment, there is pervasive ambiguity and uncertainty among Government offi,ia's, PEs, prospective investors and the public in general on the Government's objectives and intentions. Prolongation of this period of uncertainty may adversely affect the PEs whose performance may deteriorate further. The private sector's confidence in the Government's commitment to expand the private sector's role in economic development may also be affected. Therefore, as a first step, Government needs to complete its white paper which should state clearly its objectives for privatization and divestiture, describe the institutional arrangements for managing the process (para. 6.8), and indicate how the potential costs of privatization, e.g. financing of debt restructuring and redundancy payments would be met (para. 6.11). To prevent difficulties during implementation, the white paper should indicate the Government's strategy with respect to redeployment of staff, foreign participation, concentration of ownership, management/employee participation, etc. 6.8 Implementation Capacity. Adequate institutional arrangements would need to be established to implement the program. Given that privatization is a multisectoral and complex exercise, involving a wide range of government agencies, financial institutions, and the private sector, it is important that arrangements for managing the process establish a focal point for decision making while allowing adequate attention to be paid to the concerns of affected groups. One approach that has been recommended by IFC would be to establish an independent body, '--sisting of high level representatives from all concerned parties, to guide - ; manage the privatization process. The primary objective of this body u-.,d be to ensure consistency of approach, coordination of efforts, and transparency and fairness of transactions. It is essential that the members of the commission have the standing in their organizations necessary to secure approvals and facilitate decision making. The Commission would need to be supported by an implementation unit, i.e., a small technical team of experts, comprising financial analysts, sector specialists and lawyers who, with the support of specialist consultants, would carry out the preparatory work including development of divestiture options and modalities, preparation of action plans, enterprise valuations and prep- aration of prospectuses. The technical team and its external advisors would also manage transactions including negotiations with potential investors. Details of institutional arrangements for privatization have already been 67 - discussed with IFG advisoLs (see Footnote 26 page 65). The issu:- here is the importance of putting such an arrangement in place as soon as polssible so that a systematic approach can be adopted in moving the program forard. 6.9 Lack of Consensus. Presently, Government officials, policy makers, public enterprise managers and employees lack consensus on Government's pri- vatization initiative. This is partly because, as indicated above, the Government's privatization policy and strategy has not yet been clearly defined, and therefore uncertainty on how it would affect the interests of various groups has created unfavorable attitudes. Many Governmen- and PE officials are opposed because it would reduce their authority and opportuni- ties for patronage, status, etc. While there seems to be no ideological problem with privatization, the intellectual community may view privatization unfavorably because of the perceived social and political costs. As well, there seems to be a prevailing mistrust of the private sector and a perception that the private sector may not act in a socially responsible manner. There is also resistance in the labor force, mainly because many PEs are overs.affed and privatization is expected to result in major layoffs. Even among decision makers, government officials and the private investors who all favor privatization in principle, there is widespread skepticism on how exactly the Government would implement it. Under these circumstances, the lack of consen- sus could be a major obstacle to the program's implementation even if other issues were satisfactorily resolved. Privatization requires concerted effort, participation, and support of all parties involved. Therefore, deliberate efforts need to be made to build consensus within Government, public enter- prises, and the private sector with respect to the objective and implementa- tion of the program. Continuous and open dialogue between all concerned parties is key to building needed consensus. Special interest group workshops and seminars should be organized to allow discussion of the major issues that may adversely affect certain groups; such as, redundancy issues, manage- ment/employee buy-ou.s, concentration of ownership by few investors, etc. Furthermore, there _.s a need for systematic dissemination of information, step by step, as the program moves forward. Transparency will help build support for and acceptance of the program. 6.10 Labor Issues. The redundancies likely to result from privatization is a socio-political issue that needs to be addressed. This does not mean that the Government would necessarily have to resolve redundancy issues in specific enterprises up-front. As indicated in Chapter V, many ot These issues can best be handled on a case by case basis. However, Government needs to adequately address the concerns of labor. Thus, it is important to develop a broad strategy and guidelines for handling layoffs and dealing with staff redundancies. This would reduce the fear and resentment of the labor force and facilitate advance planning by the Government and PEs so they could respond more effectively to both the social and financial aspects of the problem. Posztive steps that could be taken to reduce the adverse imnact of this problem include development of programs for redeployment and retraining of laid off employees, contracting out services to employees laid off as a result of downsizing, provision of adequate severance pay and/or seed money so that they can start small-scale farming or businesses, and early retirement packages with golden hand shakes. As indicated below, some of these payments could be funded through a privatization/restructuring fund. - 68 - 6.11 Financing Privatization. There is no doubt that this is one of the most difficult issues to tackle. In fact, since one of the primary motivations for privatization is to reduce the current and future burden of the PEs on the government's budget, the Government is likely to be reluctant and may find it difficult to allocate budgetary resources for a privatization and restructuring fund. Nevertheless, given the financial difficulties of some of the enterprises and the frequent incidence of overstaffing, privatization of other than a few profitable PEs will necessitate allocation of resources. One way to deal with this is to establish a privatization/restructuring fund. Some countries which have established such funds have been successful in mobilizing external and internal funds to supplement Government funding. To reduce somewhat the amount of direct Government budgetary allocation to the Fund, the first phase of privatization (para. 6.21) can focus on more marketable PEs. The proceeds from these sales could then be added to the restructuring/privatization fund. The fund would be used to (a) restructure debt of weak PEs, (b) provide redundancy payments and other end of service benefits to employees, (c) provide retraining and technical assistance to retrenched staff and/or (d) provide seed money to employees who wish start up small businesses. Related Private Sector Issues 6.12 Policy and Regulatory Framework. Since privatization cannot be achieved without adequate private sector response, measures need to be taken to encourage private sector investment and participation. Interviews with a number of medium and large private investors indicated considerable dissatis- faction with the overall business environment. As discussed in Chapter 2, licensing, import and export procedures are excessively bureaucratic and cumbersome. CEOs of some private firms indicated that about 70 to 80Z of their time and the; top managers' time is spent in dealing with Government bureaucratic procedures. Credit availability and allocation appears to be a major constraint. Furthermore, the present foreign exchange policy and laws of repatriation are not conducive to third country foreign investment. There are contradictory laws and regulations and frequent policy changes. As one private investor put it, 'if you find a law that gives an incentive to the private sector, there is always another law that takes it away.' Therefore, steps need to be taken to improve the business environment and to restore the private sectors' confidence in the economy. Public institutions that provide service to the private sector need to be strengthened and current bureaucratic procedures simplified and streamlined. Particular attention must be paid on the one hand to making labor, pricing, investment and incentive (tax and development) regulations transparent, while on the other hand ensuring that customs, sales and income tax regulations are enforceable. 6.13 Managerial and Technical Skills. Many public enterprise problems such as lack of managerial and technical specialists and absence of financial discipline extend to a lesser extent to the private sector. To help overcome this, the private sector institutions in Nepal, such as the Chamber of Commerce and the Young President's Organization, which are relatively well developed and organized, should be supported and encouraged to expand business promotion programs, dissemination of information, entrepreneurship development and training. As well, joint venture arrangements with foreign investors who - 69 - have needed technical and managerial skills will accelerate training and deve'lopment of local staff. 6.14 Financial Disclosure. Notwithstanding the proprietary audits under- taken by the Auditor General's Office, there are no financial regulations governing the control, content, interpretation or audit of the books of account of either public or private sector entities. Accordingly any financial statements prepared and presented either in support of financial results or projections must be treated with caution. Reliable financial data is essential to the development of capital markets in Nepal. If increased private sector investment, and broad based share ownership in particular, is an objective, then the Companies Act must be refined to ensure that the timing, structure, and content of accounts is consistent with international best practice together with statutory penalties for non-compliance. In addition HMG should encourage the formation of a local institute of accountants to ensure adherence to revised regulations. C. Strategy for Privatization and Divestiture 6.15 The first step in a PE reform program would be to agree on the PEs which would be candidates for privatization, divestiture or liquidation. Separate strategies would then be devised for (a) enterprises to be privatized/liquidated, and (b) those which would remain in the public sector. Key aspects of a privatization strategy are to identify enterprises with the best prospect for divestiture, work out how to sell them and draw up a time- table for implementation. Divestiture of easily saleable enterprises can be started immediately through the present IFC initiative and the experience gained from this work should feed into and strengthen plans for further privatization. The process of developing a broad privatization plan can typically be divided into two phases. Phase one involves establishing the policy framework for privatization, reviewing the policy and regulatory constraints on PE performance and objectives, identifying domestic and foreign sources of capital and categorizing and ranking PEs. Phase two would then focus on establishing a final ranking of PEs selected for divestiture according to their attractiveness to investors and preparing a time-phased action program for each enterprise, to include the most appropriate mode of divestiture, specific measures needed to overcome policy, legal and administrative obstacles, a list of potential investors, and definition of other pre-conditions for success. Phase 1: Privatization Plan Key elements of Phase One, preparation for privatization, are discussed below: 6.16 Government's Policy and Objectives: It is essential that at the outset HMG articulate a clear policy framework for privatization. Clarifying the main objectives and priorities for divestiture is critical to classifying and ranking enterprises, assessing the suitability of PEs for divestiture and identifying the most appropriate mode of divestiture. As discussed earlier in Section B, potential obstacles to privatization need to be addressed. The Government's privatization white paper should deal with these issues and spell out the institutional arrangements for managing the process. - 70 - 6.17 Review of Policy and Regulatory Constraints on Performance and Objectives. An integral part of the privatization process is the need to address constraints posed by HMG's political and regulatory profile. HMG will need to review constrai:-.ts at the national and sector levels, and assess particular constraints on the privatization or restructuring of specific enterprises -- of particular relevance will be the development roles of PEs. Typical constraints will include legal and administrative obstacles, economic policy issues such as price deregulation and competition, employment matters as they relate to the total level of employment as well as the treatment of key skill groups, fiscal questions including the impact of divestiture and/or restructuring on HMG's budget and on counter-inflation policies, the acceptability of the liquidation of nonviable PEs, land ownership laws, and banking and currency restrictions. A review of constraints would identify key policies that currently affect PE operations and the extent to which these impact on HMG's overall objectives. This will enable HMG to identify broad policy reform options and strategies to achieve its objectives. HMG can then rank these options in terms of their overall soundness and efficiency as well as their political acceptability. In parallel with examining the PE's policy and regulatory framework, HMG has to examine the needs of the private sector. It is essential that HMG create an enabling environment for the continued development of the private sector to ensure that once PEs are moved to the private sector, they can function efficiently (paras. 6.12). 6.18 Domestic and Foreign Sources of Capital. An important step in privatization is to identify potential sources of capital and the type of enterprise characteristics and divestiture packages that would attract investment. Domestic equity investment is not widespread in Nepal, and its role in the PE manufacturing divestiture program, where profitability is low, is likely to be, at best, small. The capacity to achieve broad-based share ownership is dependent on Government's success in developing Nepal's capital markets and promoting employee/small holder participation. Fiscal and taxation incentives need to be used more effectively to promote the flow of private and institutional savings into equity investment (para. 6.12). 6.19 Enterprise Classification, Analysis and Ranking. Categorizing and ranking PEs is an essential step in developing both an overall PE reform program as well as a privatization plan. Having established the reforms required at the macro level, HMG should then proceed to screen its PE portfolio at the micro level. The objective is to determine which activities should continue to remain in the public sector and which should be turned over to the private sector or liquidated. Strategic PEs such as utilities, and PEs providing primarily social services, may be among those Government may wish to retain. As well, PEs operating in monopoly or quasi monopoly markets which require changes in government policies to increase competition or development of government regulatory capacity, may be candidates for divestiture only in the medium to long term. PEs identified as candidates for divestiture may not necessarily be attractive to the private sector and need to be further ranked according to their prospects for divestiture; viable PEs would be priority candidates. To classify and rank PEs, an assessment needs to be made of the competitive advantage and strategic attractiveness of each PE, with emphasis on assessment of their markets, whether competitive or de facto monopolies, and on identifying the principal determinations of cash flow and - 71 - profitability. A basic profile for each enterprise will enable them to be categorized and ranked according to their prospects for divestiture and the need for rehabilitation. 6.20 Key criteria for initial screening will be a function of HMG's agreed objectives, but are likely to include: - Nature of Market for Products and Services: to assess each enterprise's competitive environment including trade barriers and preferential access to markets and to identify enterprises that Government may wish to retain; - Potential Profitability: to identify the most attractive privatiza- tion candidates. JCF and portions of ATF are good examples; - Visibility: to demonstrate to the public, at an early stage of the process, the benefits of privatization; - Ease of Privatization: certain PEs should be attractive 'as is' and could be sold quickly to demonstrate success; - Maximization of Revenues: to meet specific government liquidity objectives; the sample PE's examined would provide little opportunity for this; - Export and Domestic Market Potential: to identify growth potential; - Other government criteria that will emerge in defining objectives. 6.21 The screening process will provide a broad understanding of the structure, scope and potential of individual PEs and groups of PEs and allow HMG to assess their competitive advantage and strategic attractiveness. The results of this initial screerning will allow PEs to be ranked in five distinct categories which will reflect their prospects for privatization: - Category I The best candidates for divestiture in the near term; - Category II Those suitable for divestiture in the medium term (i.e., hopefully one to two years) after some restructuring; - Category III Those requiring substantial rehabilitation or restructuring but ;hich may be suitable for divestiture in the longer term; - Citegory IV Those deemed unsuitable for divestiture for strategic and/or social reasons but whose performance can be improved by changes in policy, government oversight structure, internal institutional strengthening and restructuring or rehabilitation; - 72 - - Category V Inherently unprofitable PEs that should be liquidated. The initial screening will provide a short list of priority privatization candidates in Category I. The focus of the privatization and divestiture strategy would be on enterprises in Categories I, II, and V. Chapter VII, discusses the strategy fo' enterprises in categories .II and IV, which will remain in the public sector in the medium to long term. Phase 2: Privatization Plan 6.22 In Phase Two, detailed implementation plans would be developed for each enterprise with priority given to those identified in phase one as priority candidates for privatization. Thus, phase would in fact overlap with implementation. Thus privatization of priority candidates can begin immediately following completion of enterprise specific action plans while preparation of implementation plans continue for remaining enterprises. 6.23 Enterprise Review. The outcome of the initial screening process in phase one will be a ranked list of enterprises to be restructured and privatized. HMG will then need to develop a strategy for each enterprise, based on the dynamics of its sector, to move it along a continuum to profitability and growth and determine the ownership structure most likely to facilitate the transition to competitive performance.27/ The approach encompasses four phases: diagnosis, development of a business strategy, identifying key problems and restructuring needs; and development of action plans. (a) Diagnosis. In order to develop a long term strategy it is essential to understand the short term needs of the PE. This entails a full analysis of the enterprise's operations. In overall terms the analysis will include: - Financial Analysis: revenue and profit trends, cashflow management, liquidity, net worth, balance sheet structure; - Policy Environment: pricing policy, tariffs, product specifications, taxation, investment incentives, restrictions on raw material sourcing, market privileges; - Market Dynamics: size and growth of market segments and key industry drivers; - Competitors: size and growth of competitors, market shares, levels of profitability, competitive advantages; 27/ Where relevant, e.g., textiles, cement, a subsector approach should be pursued. - 73 - - Customers: profiles of the existing and potential customers of the enterprises customer's, key criteria for purchasing products; - Operations: production processes, productivity analysis, performance against budgets; - Price and Cost Analysis: cost structure by product/service, input sourcing and supplier management, distribution channels, price structure by product/service; - Management Analysis: organization and management structure, information systems, planning and budgeting, employment and compensation. The sequence and deptri of the analyses will vary by enterprise. The objective in all cases will be to identify each enterprises' strengths and weaknesses as well as the strategic opportunities and threats which will impact its long term profitability and growth. (b) Business Strategy: The result of the analyses described above will provide necessary information on the performance and problems of each pre-screened enterprise. The task then will be to determine as precisely as possible the alternatives that can be pursued to resolve those problems and which alternative best meets the goals of HMG. Strategic opportunities for each enterprise will depend on (a) its markets i.e. whether there is potential for increased expor';s or import substitution, (b) the competitive advantage of the enterprise, i.e. whether it has or can develop a competitive advantage over foreign and domestic suppliers, (c) opportunities for cost reduction, and (d) opportunities to expand employment generating activities. (c) Identifying Key Problems and Restructuring Needs. Obstacles to implementing an enterprise's business strategy may be within the enterprise itself, in the policy and regulatory environment in which it operates, or in the availability of resources for restructuring. The objective of the review of restructuring needs will be to identify the root causes of the existing poor performance. This will ensure that the proposed action plan for the enterprise will be achievable and effective. (d) Action Plans. The Action Plan for each selected enterprise will consist of a series of logical steps and a timetable to enable each enterprise to achieve its strategic objectives. These will cover: - Measures to return to or increase profitability, improve the production processes, reduce costs, increase market share, review pricing, etc. The focus will be on tackling existing inefficiencies at current levels of production in order to achieve increased profitability quickly with minimal new investment; - 74 - Development of an investment plan for repositioning the enter- prises in line with its long term strategy--increased domestic market share, entering export markets, vertical integration, diversifications and acquisitions; - Proposals for changes in the policy framework necessary for the achievement of objectives; and - Recommendations on the form of privatization and timing; e.g., should restructuring be undertaken before or after sale? 6.24 Privatization Options. The business strategy and action plan for each enterprise will allow assessment of the appropriate mode of privatization. Government policy and the specific needs of each enterprise will determine whether privatization should take the form of transfer of authority for management, including resource allocation, to the private sector, or the sale of assets. Where the lack of financial resources is a major obstacle to enterprise restructuring, divestiture will transfer responsibility for strategic implementation to the private sector. The different forms of privatization that can be considered include: - Public Stock Offering: under this form of privatization, the Government sells to the general public all or large blocks of shares it holds in wholly or partly owned PEs. For a public offering to be successful it requires that: (a) PEs be sizable, going concerns with a reasonable earnings record or potential; (b) there is identifiable liquidity in the local market and the capital market is adequately developed. Without strong capital markets, particularly equity markets, a public offering will not generate sufficient response unless mechanisms are devised that allow the general investing public to be reached. The main advantages of a public offering are that it permits wider shareholding but it requires that adequate controls be in place to protect small investors (para. 6.14). - Private Sale -- Local and Foreign: under these transactions, Government sells all or part of its shareholding to a pre-identified single purchaser or group of purchasers. The transactions can take various forms, such as direct acquisition by another corporate entity or a private placement with a group of investors. Because of their flexibility, private sales are the preferred option with weak performing PEs or PEs in need of strong owners with relevant indus- trial, financial and commercial expertise. Private placements may also be the only feasible alternative given the underdeveloped capital market. The extent to which foreign ownership or participa- tion can be attracted will depend on the attractiveness of Nepal's foreign investment code. - Management/Employee Buy-outs: management/employee buy-outs are a relevant means of tre.nsferring ownership to management and employees and may be a solution for PEs not otherwise saleable. This - 75 - divestiture option also constitutes an enormous incentive to productivity. Joint Ventures: the main characteristic of such a privatization option is that government is not disposing of ownership. Joint ventures with foreign companies allow access to management, technol- ogy and markets. - Contracting Out: this is a flexible method of introducing private sector involvement to meet limited objectives. It takes three main forms: (a) contracting out of public services by competitive tendering for the provision of specific activities; (b) management contracts which introduce private sector management into a govern- ment-owned enterprise; and (c) leasing, where a private operator leases the assets of facilities owned by PEs and uses them to conduct business on its own account. 6.25 Practical options can be developed that blend different strategies in order to accommodate stated objectives and unavoidable constraints. Relevant approaches include the adaptation of techniques including intensive information campaigns and elaborate distribution networks for public offerings of stock in the case of weak financial markets; combinations of public offerings and private sales where the presence of a party or core group of shareholders that is strong financially and technically is necessary to turn around or sustain the PE; and infusion of new private equity in PEs needing rehabilitation coupled with the sale of government shares. Where transfer of ownership is not desired or feasible initially, leases and management contracts can be used, often to be followed later by transfer of ownership. 6.26 In reviewing the twelve PEs on which the mission focused, the method of divestiture most appropriate to the type of capital resources was examined. These are discussed in the company profiles provided in Volume Two (Annex IV) and summarized in Table 6.1. The analysis should be developed further to identify specific measures to overcome practical obstacles to divestiture. Of particular relevance will be the development role of specific PEs. Other constraints may include: (a) land ownership laws; (b) banking and currency restrictions; (c) pricing policies and laws that control redeployment of workers, pension and/or redundancy provisions. 6.27 Even in the case of enterprises that are deemed suitable for immedi- ate divestiture, it is often necessary to take supplementary measures to ensure the success of the divestiture and to establish a basis for longer term performance improvement. Such measures must provide a credible basis for - 76 - Table 6.1: PRIVATIZATION OPTIONS Options Relevant to: 1. Divestiture of: (i) Entire enterprise ATF, BBF, JCF (ii) Minority shareholding RDL (iii) Profitable subsidiaries and/or Assets BLSF (iv) 'Packages' of profitable and unprofitable business units ATF 2. Funding new investment with private BLSF share issues to dilute Govt. shares 3. Joint ventures with domestic and/or Foreign investors BLSF 4. Management or employee buy-outs BLSF, HTI 5. Management contracts and asset ATF, BBF, RDL leasing believing that the enterprises have a profitable future. They could include restructuring of corporate finances, strengthening of top management, and any critically needed investments. These actions become even more important for enterprises that can only be divested in the medium to longer term. 6.28 The valuation of enterprises which are to be sold to the private sector is a sensitive issue. It is a matter of fine judgement to ensure pric- ing which attracts willing investors while ensuring that public assets are not sold 'cheaply." Annex VI.1 discusses enterprise valuation including use of the discounted cash flow and network methods. VII. STRATEGY FOR PE REFORM A. Overview 7.1 The problems facing PEs in Nepal are severe and cannot be solved in the short term. The multiple roles played by the PEs and the m,.ny vested interest groups make it difficult to build the consensus needed to achieve reform. Their operating environment provided little incentive for enterprises to function commercially. The supervisory and control regime wh'ch has had suzh a dysfunctional impact on PE autonomy and managerial incentive is well entrenched, and restructuring this will take time. Furthermore, the key - 77 - managerial functions essential for good performance and accountability, which are so poorly developed within the enterprises, require time and effort to establish. In light of existing constraints a broad strategy for PE reform should: (a) aim, as a matter of priority, to significantly improve the policy and regulatory framework for PEs and for the industrial sector in order to foster private sector development and increase the pressure on PEs to operate as efficient commercial entities. Key measures include (i) removing barriers to entry of private sector firms (para. 2.10) and improving the administration of industrial ircentives and regulations (para. 2.16); (ii) limiting government support for weak PEs (para. 2.11); (iii) replacing discriminatory direct controls on MPEs to purchase domestic raw materials by flexible incentives to motivate both public and private sector interest in using local resources (para. 2.12); (iv) separating the PEs commercial and non-commercial activities through institutional changes (i.e. transferring non-commercial functions to development Board or Government departments) or separately accounting for and monitoring commercial and non-commercial functions (para. 2.12); (v) gradually liberalizing the price control system while making any remaining subsidies explicit and channelling them to clearly identified target groups -- for PEs in competitive markets pricing authority should be delegated to operational managers (para. 2.21- 2.22) and (vi) streamlining regulations governing PE personnel policies to increase flexibility and provide greater autonomy to PE managers (paras. 5.36 and 5.41). (b) encourage divestiture/privatization of PEs wherever possible, in order to reduce PE demands on scarce managerial and financial public sector resources, while recognizing existing constraints to privatization and divestiture in the short term. Classification and ranking of PEs as discussed in Chapter VI, is likely to identify several potential candidates for privatization. However, given the underdeveloped capital markets and poor financial performance of many enterprises the pace of privatization will be determined by the extent of investor interest and the effectiveness of measures to foster management and employee participation and attract foreign as well as local investors. (c) develop a progrem of reform and restructuring for PEs that would remain in the public sector. This would include measures to change the relationship between PEs and various government oversight agencies to emphasize strategic rather than operational control (paras. 3.19 and 3.22), strengthen PE Boards and managers in order to change the organizational culture and provide the skills needed to manage commercial enterprises (paras. 4.25 and 4.31) develop internal management systems and rehabilitate and modernize equipment where necessary. - 78 - B. Implementing PE Reform 7.2 Based on other countries' restructuring experience, a comprehensive reforn of tthe PE sector in Nepal, and institutional restructuring in particular, can be expected to take a minimum of 5-7 years. The institutional capacity and experience required to implement a large-scale privatization p),,rarm and effect all required reforms simultaneously for a large number of PEs appears not to exist in Nepal. Thus, the report recommends that Governme.t adopt a phased approach to implementing its PE reform. Initial reform efforts in the near term will provide valuable feedback to design of later reform programs. 7.3 It is essential at the outset that government states unambiguously its objectives and proposed strategy for PE reform so that clear signals are provided to both Government officials and PE managers and staff of expected changes in the role and function of PEs. Thus, an essential prerequisite to implementing PE reform is that government issue a PE policy and strategy statement along the lines discussed in para (vi) which would provide the framework for implementing more specific reform measures. In particular, governments intention to (a) operate PEs on a fully commercial basis, (b) provide separate financing for noncommercial activities undertaken by PEs and (c) reduce the number of public enterprises through a program of privatization and divestiture, should be emphasized. 7.4 In the initial phase of implementing reform, Government should begin to address broad policy and institutional issues at the same time that it restructures selected enterprises and initiates its privatization program. In particular: (a) for Policy and Institutional Reform, measures which should be initiated during the initial phase include: (1) reviewing pricing and industrial policies and regulations with the aim of improving the competitive and regulatory environment of both public and private sector companies; (2) reviewing existing PSC regulations in order to simplify and streamline current procedures; (3) developing accounting standards to increase the reliability of financial data; and (4) establishing training programs to improve the quality of the labor force. (b) for Privatization, divestiture of easily saleable PEs identified as priority candidates for privatization (e.g., financially viable PEs in competitive markets which are attractive to the private sector 'as is') can begin while Government continues to prepare detailed action plans for less attractive candidates and to finalize measures to address constraints and issues likely to affect a larger privatization program. The UNDP financed/IFC executed technical. assistance program agreed with the previous Government can provide needed expert assistance. Experience of this process should feed into and strengthen plans for further privatization. (c) for PE Restructuring, instead of attempting to introduce reforms simultaneously in all the PEs which would remain in the public - 7 9 - sector, restructuring should begin with a small group of PEs for which there is a clear rationale for public ownership (e.g., strategic enterprises or PEs in monopoly or quasi-monopoly markets). Restructuring of selected enterprises could proceed while detailed restructuring plans are being developed for remaining enterprises. 7.5 Restructuring enterprises which will remain in the public sector will be the more difficult task. It is recommended that in the initial phase of enterprise restructuring, a group of four or five PEs should be selected from a ministry whose leadership is seriously interested in PE reform. The Ministry of Industry (MOI) is probably the best candidate for this purpose. Four or five of its nearly 30 PEs could be identified for which there is a clear rationale for public ownership. Priority should be given to those PEs for which the fiscal impact of restructuring would be significant. Recently established PEs and those not yet operational may also be included in phase one, as they are less likely to have the deep seated problems of other PEs and action now can forestall future problems. The oversight function and management of the reform process in Phase One can be performed by the sector ministry concerned (MOI if it is selected by HMG). It is proposed that in phase one, a special PE Unit be created in the sector ministry that would be responsible for these activities. As part of the reform process, the unit, with expert assistance, would identify candidates for Phase 1, develop revised operating guidelines and secure Cabinet approval for modifications in rules and regulations applicable to PEs included in Phase 1. 7.6 For the selected PEs, the reconstitution of the boards and appointments of chief executives should be done as proposed in Chapter 3. The tasks of strengthening internal management functions should be the responsibility of the chief executives under the supervision of their boards. As recommended in Chapter 6 for enterprises selected for privatization, preparatory work should include diagnostic studies, development of a business strategy, identifying key problems and restructuring needs and developing action plans. A staff audit may also be necessary to determine the skill requirements and number of staff required in line with operational and corporate plans. Local and/or international consultants can assist PEs with this exercise. It is also likely that the PEs will need technical assistance to help strengthen financial and management information systems. The selected PEs should also be given access to financing if needed to upgrade and rehabilitate equipment. 7.7 During phase 1, as part of its oversight function, the unit in the sector ministry would plan and negotiate targets with PEs and supervise their performance. If necessary, CCD should continue to play its present role of budget approval in relation to the selected PEs, but in close collaboration with this unit. At this stage, instead of designing a complex incentive scheme, the unit should attempt to refine the existing profit-linked bonus scheme to see how it could be adapted to motivate PE managers to perform as planned. The new unit should be permitted to implement this incentive scheme in the selected PEs. 7.8 Restructuring of selected enterprises must be lone in conjunction with, measures to address broader policy and employment issues. A committee 80 - consisting of selected PE managers and PSC and employee representatives should be set up to review existing PSC regulations with the aim of simplifying and streamlining current procedures. Even more important, HMG needs to initiate a review of pricing and industrial policies and regulations to address issues raised in Chapter 2 with the aim of improving the competitive and regulatory environment of both public and private sector companies (para. 7.1). As well, development of accounting standards (para. 4.35), and establishment of training programs (para. 5.42) should be initiated in phase 1. 7.9 Depending on progress made in Phase 1, in about the third year of the program, the experience with the reform of the selected PEs should be evaluated to see whether enough has been learned by HMG to be able to adapt this approach to reform of the remaining PEs. By then, there will be a clearer picture as to which PEs will in fact remain in the public sector. HMG may wish to set up an inter-ministerial task force to undertake this evaluation and to make specific proposals on the steps to be followed in implementing subsequent reforms. These proposals should include recommendations on which agency within HMG will initiate and oversee the expanded reform program. Other tasks that this group should work out include: the design of an improved performance evaluation system and of performance- linked incentives, the definition of the roles to be played by the sector ministries, MOF and other relevant agencies in the oversight function of HMG (including examination of alternative organizational structures such as hold -.7 companies and the location of a Government-wide oversight function) and identification of any other institutional mechanisms for strengthening PE performance. 7.10 In both phases of the reform program, HMG is likely to require technical assistance to plan and follow up on specific actions. The Bank and other donors, if so requested, may consider providing the needed assistance in specialized areas. Advice on the improvement of internal management, design of performance evaluation and incentive schemes, training and related capacity building to perform the oversight function within HMG are among the areas which should receive high priority in terms of assistance. Key steps in a PE reform program are indicated in the implementation plan below. Where relevant paragraph references are provided to indicate where a more detailed discussion of each item can be found in the main report. An indication of timing is provided to give a sense of the relative sequencing of activities within a seven-year period. - 81 - C. IMPLEMENTATION PLAN Para. Ref. Actions Responsibility Timing Phase 1 A. Policy Reform Pricing: 2.20 Amend the Essential Commodities Cabinet Year 1 Act to reflect the new pricing policies and narrow the list of commodities covered by the Act to those which are explicitly subsidized Subsidies: 2.23 Agree subsidy programs to be Cabinet Year 1 retained and explicitly funded and develop plan to target such programs on specific groups Raw material development: 2.10 (a) Replace controls on PE raw Cabinet/MOA Year 1 material purchases with incentives 2.10 (b) Consolidate raw material Cabinet/MOA Year2-Year3 development services in Development Boards and Extension Services 2.8 Promotion of Private Sector investment in Industrial Sector: (a) Amend the Industrial Cabinet/MOI Year 1 Enterprises Act by creating a list of "free sectors" which require no licensing and which will be for private sector investment expansion only - 82 - Para. Ref. Actions Responsibility Timing 2.13 (b) Streamline administration MOI Yearl-Year2 of regulations and incentives through dissemination of information and clarification of legislation Employment/Human Resources 5.36 Review and streamline PSC PSC/ Yearl-Year2 regulations Inter- ministerial committee 5.42 Establish technical/accounting Government Year l-Year2 training programs training institutes with private sector assist- ance Enterprise Level Reform Program B. Classification/Privatization 6-17-6.22 Finalize Privatization White Paper Identify priority candidates Cabinet/MOI 0-3 months for privatization and those to remain in the public sector in the medium to long term 6.23-6.27 Develop Privatization Plan Cabinet/MOF 3rd-24th month Privatization of selected companies 9th month onward 7.2-7.5 C. Enterprise Restructuring Set up ministry level PE Cabinet/MOI 0-3 months monitoring unit Appoint technical advisors MOI 0-3 months - 83 - Para. Ref. Actions Responsibility Timing Select PEs for pilot phase MOI 0-3 months Assess changes in existing MOI/Cabinet 3rd-6th rules and regulations essential month in phase one and secure needed exemptions for selected PEs. Reconstitute PE Boards and Cabinet 6th-9th appoint chairmen and general month managers Appoint senior management teams MOI & Boards 12th-18th month Assess and arrange for MOI, MOF & 12th-18th technical assistance for PEs Donors month selected in phase one Carry out diagnostic studies, PE 18th-24th staff audits, prepare business Management month and operating plans and develop restructuring action plans Agree on corporate and annual MOI & Boards 24th-26th plans for PEs & on incentives month linked to performance Provide resources needed, if MOF/Donors 24th-26th any, for rehabilitation/ month redundancy payments Implement internal PE Year2-Year3 restructuring of pilot PEs - 84 - Para. Ref. Actions Responsibility Timing 7.6- Phase 2 7.7 Enterprise Reform Program Evaluate Phase 1 reforms Inter Year 3 ministerial task force & cabinet Prepare detailed plans for Inter- Year 3-4 Phase II: ministerial task force Agree on autonomy & performance Inter- Year 3-4 criteria, supervision ministerial mechanisms & incentives task force & Cabinet Establish restructuring fund Cabinet Year 3-4 Establish new oversight Cabinet Year 4 structure & appoint senior level personnel Assess and arrange for phased Ministries & Year 3-4 technical assistance program donors Initiate needed reforms in Relevant Year 4-7 sequence ministries & MOF Review & fine tune planning and Supervisory Year 4-7 implementation mechanisms agency - 85 - ANNEX 1.1 Page 1 of 2 OFFICIAL LIST OF PEs MANUFACTURING NO. ENTERPRISE LOCATION 1. AGROLIME INDUSTRY LTD. (1st GEN) KATHMANDU 2. AGRICULTURAL TOOLS FACTORY LTD. (lst GEN) BIRGUNJ 3. 3IRGUNJ SUGAR FACTORY (lst GEN) BIRGUNJ 4. BANSBARI LEATHER AND SHOES FACTORY LTD. (lst GEN) KATHMIANDU 5. BHAKTAPUR BRICKS FACTORY LTD. (lst GEN) BHAKTAPUR 6. BRICK AND TILE FACTORY LTD., HARISIDDHI (lst GEN) LALITPUR 7. DAIRY DEVELOPMENT CORPORATION (lst GEN) KATHMANDU 8. HETAUDA TEXTILE INDUSTRY LTD. (lst GEN) HETAUDA 9. HERBS PRODUCTION AND PROCESSING CO. LTD. (lst GEN) KATHMANDU 10. JANAKPUR CIGARETTE FACTORY (lst GEN) JANAKPUR 11. NEPAL TEA DEVELOPMENT CORPORATION LTD. (Ist GEN) JHAPA 12. RAGHUPATI JUTE MILLS (lst GEN) BIRATNAGAR 13. ROYAL DRUGS LTD. (lst GEN) KATHMANDU 14. HIMAL CEMENT COMPANY LTD. (2nd GEN) KATHMANDU 15. NEPAL ORIEND MAGNESITE (P.) LTD. (JV) SINDHUPALOOK 16. BHRIKUTI PAPER INDUSTRY LTD. (lst GEN) GAIDAKOT 17. HETAUDA CEMENT INDIJSTRY LTD. (lst GEN) HETAUDA 18. BALAJU TEXTILE INDUSTRY LTD. (lst GEN) KATHMANDU 19. BUTWAL SPINNING INDUSTRY LTD. (2nd GEN) BUTWAL 20. NEPAL METAL COMPANY (JV) RASUWA 21. LUMBINI SUGAR FACTORY LTD. (lst GEN) BHAIRHWA 22. NEPAL ROSIN AND TURPENTINE LTD. (lst GEN) DHANGADHI 23. NEPAL PAPER INDUSTRY (lst GEN) NEPALGUNJ 24. SETI CIGARETTE FACTORY LTD. (2nd GEN) DRANGADHI 25. UDAYPUR CEMENT INDUSTRY (lst GEN) UDAYPUR 26. NEPAL BITUMIN AND BARREL INDUSTRY (2nd GEN) AMLEKHGUNJ 27. NEPAL LUBE OIL LTD. (2nd GEN) AMLEKHGUNJ 28. NEPAL FOUNDRY PROJECT (lst GEN) ENERGY 1. NEPAL OIL CORPORATION (lst GEN) KATHMANDU 2. TIMBER CORPORATION OF NEPAL (lst GEN) HETAUDA 3. NEPAL COAL CORPORATION (2nd GEN) KATHMANDU 4. NEPAL ELECTRICITY AUTHORITY (lst GEN) KATHMANDU TRADING & COMMERCE 1. AGRICULTURE INPUTS CORPORATION (lst GEN) KATHMANDU 2. COTTAGE AND HANDICRAFTS EMPORIUM LTD. (lst GEN) KATHMANDU 3. NEPAL FOOD CORPORATION (lst GEN) KATHMANDU 4. NATIONAL TRADING LTD. (lst GEN) KATHMANDU 5. TOBACCO DEVELOPMENT CO. LTD. (lst GEN) JANAKPUR 6. SKIN COLLECTION & DEVELOPMENT CORPORATION (2nd GEN) KATHMANDU -86 - ANNEX 1.1 Page 2 of 2 OTHER PUBLIC UTILITIES 1. NEPAL TELECOMMUNICATION CORPORATION (Ist GEN) KATHMANDU 2. ROYAL NEPAL AIRLINES CORPORATION (lst GEN) KATHMA2DU 3. NEPAL TRANSPORTATION CORPORATION (lst GEN) KATHMANDU 4. DRINKING WATER & SEWERAGE CORPORATION (Ist GEN) KATHMANDU E^ONOMIC AND CULTURAL SERVICES 1. NEPAL TRANSIT AND WAREHOUSING CO. LTD. (lst GEN) KATHMANDU 2. NATIONAL CONSTRUCTION COMPANY OF NEPAL (lst GEN) KATHMANDU 3. GORKHAPATRA CORPORATION (lst GEN) KATHMANDU 4. NEPAL TELEVISION (lst GEN) KATHMANDU 5. RATNA RECORDING CORPORATION (lst GEN) KATHMANDU 6. ROYAL NEPAL FILM CORPORATION (2nd GEN) KATHMANDU 7. CULTURAL CORPORATION (lst GEN) KATHMANPU 8. JANAK EDUCATION MATERIALS CENTRE LTD. (lst GEN) BHAKTAPUR 9. NEPAL RESETTLEMENT COMPANY (lst GEN) KATHMANDU 10. ECONOMIC SERVICES CENTRE LTD. (2nd GEN) KATHMANDU 11. INDUSTRIAL ESTATE MANAGEMENT LTD. (2nd GEN) KATHMANDU 12. NEPAL ENGINEERING CONSULTANCY SERVICE CENTRE (lst GEN) KATHMANDU 13. AGRICULTURAL PROJECTS SERVICES CENTER (2nd GEN) KATHMANDU 14. BIO-GAS AND AGRICULTURAL IMPLEMENTS DEV. (2nd GEN) KATHMANDU FINANCIAL ENTERPRISES 1. AGRICULTURAL DEVELOPMENT BANK (lst GEN) KATHMANDU 2. NEPAL INDUSTRIAL DEVELOPMENT CORP. (lst GEN) KATHMANDU 3. RASTRIYA BANIJYA BANK (Ist GEN) KATHKANDU 4. NATIONAL INSURANCE CORPORATION (lst GEN) KATHMANDU 5. SECURITIES EXCHANGE CENTRE LTD. (2nd GEN) KATHMANDU 6. CREDIT GUARANTEE CORPORATION (P.) LTD. (2nd GEN) KATHMANDU 7. NEPAL BANK LTD. (lst GEN) KATHMANDU 8. NEPAL HOUSING FINANCE COMPANY (2nd GEN) KATHMANDU 9. NEPAL ARAB BANK LTD (JV) KATHMANDU Note: GEN = Generation JV - Joint Venture Source: Corporation Coordination Division, Ministry of Finance. - 87 - ANNEX 1.2 Page 1 of 4 LEGAL STATUS OF PUBLIC ENTERPRISES Mode of Creation and (Date of Establishment A. MINISTRY OF AGRICULTURE 1. Agriculture Development Bank Ag. Dev. Bank Ct, (1968) 2. Agriculture Inputs Corporation Corporation Act, (1974) 3. Agriculture Tools Factory Company Act, (1969) 4. AgroLime Industry Company Act, (1974) 5. Dairy Development Corporation Company Act, (1967) 6. Nepal Tea Dev. Corporation Company Act, (1967) B. MINISTRY OF INDUSTRY 7. Balaju Textile Industries Company Act, (1972) 8. Balaju Tentra Shala (P) Ltd. Company Act, (1960) 9. Balaju Tantra Shala Sanitary Engineering Ltd. Company Act 10. Bansbari Leather and Shoe Factory Company Act, (1965) 11. Bhaktapur Brick Factory Company Act, (1975) 12. Bhrikuti Paper Factory Company Act, (1975) 13. Birgunj Sugar Factory Company Act, (1964) 14. Butwal Spinning Mill Corporation Act, (1983) 15. Cottage Industry and Handicraft Emporium Company Act, (1966) 16. Gorakhkali Rubber Plant Company Act 17. Harisiddhi Brick & Tile Factory Company Act, (1970) - 88 - ANNEX I.2 Page 2 of 4 18. Hetauda Cement Factory Company Act, (1976) 19. Hetauda Textile Industry Company Act, (1974) 20. Himal Cement Company Company Act, (1970) 21. Integrated Textile Company Act 22. Janakpur Cigarette Factory Company Act, (1965) 23. Lumbini Sugar Factory Company Act, (1982) 24. Nepal Industrial Development Nepal Industrial Development Corporation Corporation Act, (1959) 25. Nepalgunj Paper Industry Company Act, (1983) 26. Raghupati Jute Mills Company Act, (1960) 27. Security Exchange Center Company Act, (1976) 28. Seti Cigarette Company Company Act 29. The Hides and Skins Cor?oration Company Act 30. Tobacco Development Co. Ltd. Company Act, (1971) 31. Udayapur Cement Factory Company Act C. MINISTRY OF FINANCE 32. Credit Guarantee Corporation Company Act, (1974) 33. Nepal Bank Limited Commercial Bank Act, (1937) 34. Provident Fund Corporation Provident Fund Act, (1961) 35. Rastriya Banijya Bank Commercial Bank Act, (1964) 36. Rastriya Beema Sansthan National Insurance Corp. Act, (1968) D. MINISTRY OF FOREST & SOIL CONSERVATION 37. Fuel(wood) Corporation Corporation Act, (1965) 38. Herb Production & Processing Ltd. Company Act, (1978) 39. Royal Drugs Ltd. Company Act, (1972) - 89 _ ANNEX I.2 Page 3 of 4 40. Rosin and Turpentine Company Company Act, (1982) 41. The Timber Corporation of Nepal Company Act, (1960) E. MINISTRY OF COMMUNICATION 42. Gorkhapatra Corporation Gorkhapatra Corp. Act, (1963) 43. Nepal Telecommunication Corp. Communication Corp. Act, (1969) 44. Nepal Television Communication Corp. Act, (1985) 45. Ratna Recording Corporation Communication Corp. Act, (1962) 46. Royal Nepal File Corporation Communication Corp. Act, (1971) F. MINISTRY OF COMMERCE 47. Jute Development and Trading Corporation Corporation Act, (1974) 48. National Trading Ltd. Company Act, (1962) 49. Nepal Coal Ltd. Company Act, (1985) 50. Nepal Transit & Warehousing (P) Ltd. Company Act, (1971) G. MINISTRY OF EDUCATION 51. Cultural Corporation Communication Corp. Act, (1972) 52. Janak Educational Materials Center Ltd. Communication Corp. Act, (1978) H. MINISTRY OF SUPPLIES 53. Nepal Food Corporation Corporation Act, (1974) 54. Nepal Oil Corporation Ltd. Company Act, (1971) 55. Nepal Lube Oil Company Act, (1985) 56. Nepal Bitusen & Barrel Industry Company Act - 90 - ANNEX I.2 Page 4 of 4 I. MINISTRY OF WATER RESOURCES 57. Drinking Water & Sewerage Corp. Dev. Board Act, (1973) 58. Nepal Electricity Authority Electricity Authority Act, (1985) J. MINISTRY OF WORKS AND TRANSPORT 59. National Construction Company of Nepal Company Act, (1961) 60. Transport Corporation of Nepal Corporation Act, (1965) K. MINISTRY OF TOURISM 61. Royal Nepal Airlines Corporation RNAC Act, (1962) Source: Lyell Ritchie, *Privatization Prospects in Nepal," 1987, Updated. - 91 - CAPACITY UTILIZATIOM OF SELECTED PUBLIC ENTERPRISES AnnualI A o... at,o Pc.¶q NMem of the Indua.t-o. Capac,ty 1080/81 1481/82 1982/83 1tl3/84 194/51fi9/8486 198S/87 1987/88 1908/69 Banabari Loather end Shoes 150000 98.76 86.30 68.40 74.08 48.00 60.60 76.00 68.00 75.33 Shoe . Fstory Processed Leath r 1,800.000 Sq.Ft. 96.65 64.93 04.77 107.83 91.80 64.00 78.00 105.63 106.20 Se i-Proceeed Lath*er 900.000 Sq.Ft. - 75.74 91.34 62.64 52.87 81.75 78.78 81.89 75.00 8irgunj Sugsr Factory S'.ar 13.500 M. Ton 44.89 94.95 106.1t 87.96 SS.26 70.19 102.04 98.68 68.9 eirgunj DOstillary Rectified Spirit 1.350,000 Lt. - 18.61 19.25 27.32 82.51 60.43 s. 44 87.02 68.89 J nakpur Ciasrette Cigarette 5.25 Factory 8illion Stick* 39.00 b8.00 68.00 78.00 60.20 89.50 100.00 98.29 97.70 Brick A Ti 1- Factory Brick 25 Heriaiddi Million 49.20 56.00 76.00 67.20 60.00 64.12 80.00 67.79 68.00 Bhaktapur Brick Brick 20 Factory Mill ion 50.50 61.50 89.50 75.00 74.00 68.50 71.00 65.50 68.00 Metauda T*xtil1 Cloth 110 Loe. Industry Motre. 28.75 42.73 48.34 52.07 54.00 61.60 69.06 59.07 54.05 Miamil Cement. Company Coment 128,400 M.Ton 70.71 70.77 77.00 79.68 65.6 69.2 41.1 3.0 - Agriculture Toole Factory Tools 450 MT 19.11 84.00 81.78 110.00 99.00 90.00 83.33 90.00 87.50 Ageo-Lime Industry Agro-Lim* 6,000 m.Ton - 6.22 8.69 9.00 19.83 8.72 4.34 8.33 Chemical Lim* 6.000 M.Ton 50.00 90.00 116.67 116.67 116.67 203.33 353.33 538.33 Hetauda Cement Factory Cecent M.Ton 231,750 - - - - - 23.70 49.80 58.20 59.40 Brikuti Paper Factory 3,000 M.Ton - - - - - - 49.73 81.13 90.00 DOC Milk; 36.6 oil. liters - 3.80 59.50 41.00 57.10 tDL Tablets: 200 mil. pieces 72.00 78.60 74.30 60.70 72.40 Liquid/Ointm nt.: 1.S million bottle, 73.30 92.70 98.00 80.00 77.30 R.J Hessian: 3.3 Thousand MT 72.70 90.90 72.70 78.90 57.60 Bags: 4.2 Thousand MT 109.50 78.60 66.7C 73.80 57.10 Twine: 0.3 Thousand MT 93.30 103.30 103.30 106.70 96.70 DOC * Dairy Oevelopmnt Corporation RDL Royal DOrug Limited RJM a Raghupati Jute Mill Sourco: Corporation Coordination Di.iaon, MOF. ANNEX I.4 PEs DIVIDEND DISTRIBUTION STATEMENT 1984/86 1985/88 1988/87 1987/88 1988/89 Nepal Bank Limited 1,938,460.00 3,101,620.00 1,033,840.00 2,684,800.00 4,648,898.00 N.I.D.C. 2,216,967.00 2,829,191.16 4,400,068.29 2,400,000.00 800,000.00 Janakpur Cigarottos Factory 3,088,906.00 6,218,113.00 4,600,000.00 - 3,000,000.00 National Insurance Corp. 390,000.00 56,6S5.66 1,170,000.00 - 1,603,333.33 Security Marketing A Cerviing Centre 32,278.51 Nepal Rastra Bank 76,930,402.87 90,033,415.94 96,141,728.59 110,000,000.00 172,782,624.47 Birgunj Sugar Factory 3,600,000.00 6,690,411.00 - 1,949,022.02 3,928,202.00 The Judhr Match Factory 604.00 604.00 - 448.00 - Salt Trading Corporation 241,360.00 289,600.00 289,600.00 77,200.00 193,000.00 Cottage and Handicraft Sales Centre 204,280.47 - - 74,083.73 - Rastria Banijya Bank - 1,000,000.00 - - Royal Drug Li;ited - 447,990.00 Agriculture Dovolopment Bank - 617,614.66 Loan Guarantee Corp. - 2,500.00 60,972.00 80,268.33 160,000.00 Nepal Oil Corp. - - - - 11,690,000.00 Total 87,642,137.85 109,888,215.20 106,688,098.88 117,186,582.08 198,493,9SS.80 Source: ANNEX I.6 COMMERCIAL BANK LOAN TO PUBLIC ENTERPRISES UNDER HMG/NEPAL GUARANTEE (As at July 16, 1989) (Rs ;n '000) S. Nepal Bank Ltd. Rastriya Banijya Bank Grand Total No. Far WestPublic Enterpris.sxport Co. Principal InterestL Total Principal Interestla Total Principal InterestL Total 1. Far Western Rice I Paddy Export Co. 20481 41002 61483 48488 88197 134696 e8989 127199 196168 2. Janakpur Rice A Paddy Export Co. 10600 14993 26493 8700 10147 16847 17200 25140 42340 3. Sagarmatha Rico A Paddy Export Co. 12000 26069 37089 12200 21347 33647 24200 46418 70616 4. Lumbini Rico A Paddy Export Co. 5000 8274 13274 2903 4723 7626 7903 12997 20900 S. Mechi Rice A Paddy Export Co. 24000 40800 64800 10183 17734 27917 34183 58634 927171 8. Raghupati Jute Mills 15000 13637 28e37 3eooo 22782 58782 61000 38419 87419 7. Nepal Food Corporation 204683 118729 323312 37171 73244 110416 241754 191973 433727 8. Nepal Transportation Corp. 1000 662 1862 1000 862 1662 9. Bhatnagar Jute Mills 29824 19949 49773 29824 19949 49773 10. Nepal Television 9400 1846 11045 9400 1645 11045 11. Nepal Oriend Magnesit. 29400 9330 38730 29400 9330 38730 12. Nepal Tea Development Corp. 2000 660 2560 2000 550 2550 GRAND TOTAL 331788 284760 ele648 163e45 236174 389819 485433 520934 1006357 /a Excludes penalty and others. Source: - 94 - - 95 - A!L. 1~1. *pas I of2 MINISTRY OF SUPPLIES ROLE OF GOVERNlENT IN PRICING. DIS1RIWJTION AND MARKETINC OF ESSENTIAL COWAT!ES 1. Set policy on supply and distribution of 'oost sseontiall commodities. Sot poliCy on supply *n6 distribution of food coemodities. 2. Conduct studies, research, surveys, analysis and training on supplies. 3. Supply Corporations: Nepal Food Corporation Timber Corporation, Energy Corporation, Cool Company, National Trading Limited, Nopnl Oil Corporation, Nepal Lube Oil, Nepal Situmn A Barrel Industry, Koshi A Naraysni Trading Company. 4. Administration on supply of *ssential cowmmodities, Including market administration, and price monitoring. 5. Maintain liaison with national, regional, international agenceso regarding supplies, and make arrangements for rogular and continued adequate supply of eusential consumable items to general public. 6. Liaison with Ministry of Commerce and make necessary arrangements regarding the import4tion, supply of essential consumable goods and construction materials. S.No. Name of Commodity Relating Agenceio Res. Ministry 1. Food: Rice/Paddy Nepal Food Corp. Min. of Supplies Fine Corse 2. Maize Nepal Food Corp. Min. of Supplies 3. Whoat Nepal Food Corp. Min. of Supplies Whoat/Flour Salt Trading Corp. Minm of Supplies 4. Flattened Rice Nepal Food Corp. Min. of Supplies S. Pulses Nepal Food Corp. Mn. of Supplies Pigeon Pea (Rahar) Black Gram 6. Salt Salt Trading Corp. Min. of Supplies 7. Sugar Salt Trading Corp. Mn. of Supplies Sugar Industries Hin. of Industries 8. Too Nopal Tea D-v. Corp. Min. of Agriculture 9. Oil Nepal Food Corp. Min. of Supplies Mustard Salt Trading Corp. Hin. of Supplies Soyaboen 10. Choe Salt Trading Corp. Hin. of Supplies (Butter S Vog.) 11. Milk Dairy Dev. Corp. Hin. of Agriculture (Milk, Baby Food, Powdered) 12. Vegetable Private Sector (Potato, Onion, Tomato) 13. Moat Private Sector (Buff, Mutton, Chicken, Pork, Fish) 14. Fruits Private Sector - 90 - ANNEX II.1 Page 2 of 2 S No. Name of Commodity Relating Agenci-s Res. Ministry (Mausom(C ; trus) Banana, Apple, Orange) 16. Spices Private Sec4vor (Cumin, Blackpepper, Ginger, Garlic, Chilli) Other Essential Goods 16. Medicine Snjha Swastha Swa Min. of Health Medicine Mgt. Dept. Singha Durbar Baidhys Khona 17. Cotton Clothes Cotton Industries Min. of Industries (Up to 40 Count) i8. Soap Soap Industries Mn. of Industries Detergent (Laundry) Toilet 19. Petroleum Products Nepal Oil Corp. Mn. of Supplies (Petrol, Kerosene, Diesel, Aviation Fuel) 20. Fertilizer Agri. Input Corp. Mn. of Agriculture 21. Fuel Mn. of Supplion Fuel Wood Indhnn Corp. Coal Nepal Coal Ltd. Mn. of Supplies Construction Material 22. Cement Cement Industries Mn. of Industries National Trad. Ltd. Min. of Supplies 23. Tore Steel Private Industries Mn. of Industri;s (Iron Rod) National Trod. Ltd. Min. of Supplies 24. G.I. Sheets National Trad. Ltd. Mn. of Supplios 26. G.I. A Polythine Pipe National Trod. Ltd. Min. of Supplies 26. Bricks Industry of Bricks Min. of Industries 27. Timber Timber Corporation Mn. of Supplies Educational Material 28. Writing & Printing Papor Industries Mn. of Industries Paper (Writing Copy, Pen, Ink, Pencil) 29. News Print National Trod. Ltd. Mn. of Supplies Source: - 97 - ANNEX V.1 NEPAL PUBLIC ENTERPRISE SECTOR STUDY Comparison of PE and Civil Service Pay Scales PEs Civil Service Levels Salary (NRs) Job Cate'ories Salary (NRs) Special Class 3,815 Secretary 3,970 11 3,425 Additional Secretary 3,470 10 3,025 Joint Secretary 3,025 9 2,410 Under Serretary 2,300 8 2,300 7 1,915 Assistant Secretary 2,050 6 1,750 Section Officer 1,750 5 1,145 Non Gaz. Class IV 1,145 4 940 Non Gaz. Class III 940 3 810 Non Gaz. Class II 810 2 720 Non Gaz. Class I 720 1 640 Peons etc. 640 tAL PIYI egm"ISE SCe0R STWY Salo"t Analysis Public Enterpriore Monthly Srick Cement Drugs Iron Jute Hilk Paper Steel Ter Yore Teati l- *i nm and Producti Prodcte wage Ti lee NR Per Month Operatives Peon 425 510 S10 510 510 392 510 510 510 510 425 510 Laborer 425 425 510 575 392 620 510 510 360 48S 545 Sei -ei led 465 465 645 700 575 429 700 575 575 450 552 6V0 Ski lled 552 552 915 750 644 815 545 545 eo0 598 *15 Techn i c i an Highly killod 898 1.400 750 915 :0 Technician 915 915 915 1,400 975 750 916 1.400 995 Engineers 1,400 1.,50 1.530 1.840 1.430 1,.51 1,530 1.530 1.925 Monageent Supervisor 1.430 515 1.400 730 1.400 Overser 2,740 915 Department manager 1530 1.840 1.840 1.430 1,925 1.,40 1.900 2,420 1.725 General Manager 3.050 4,300 2,300 2.740 3.050 Profei one i Junior 1.840 Senior 1,400 2,320 Administration Junior Clark 750 750 700 650 700 750 715 750 Clerk SO 750 700 815 615 915 715 *15 Senior Clerk 915 1.400 915 1.400 915 915 915 Support Staff Porronnel Officer 1,400 1.430 1.40C Computer Staff 1.400 Soloman 645 Marketing anager 1,400 Oers Source: UNID Manpower Planning and Hmamn RPource Developmnt for the Industrial Sactor (My 18). Selry Analw-ilk Peivatm Sector Monthly Brick Mininu- and Carpet* C-_ent Footwear Carwnt- Jut. Milk and Milk Paper St-el Sugar Yorn and Wage Tiles Products Product. Refining Teatlee Ntn per nnth Operative. Peon 425 650 500 500 525 S50 550 750 500 400 375 625 Laborer 425 750 600 425 550 550 780 610 425 625 G00 Se_; ski ied 466 600 600 626 750 600 978 6NO CO 475 900 Skilled S52 900 1.200 600 960 640 1,400 1.200 £80 1.00 Technicians Highly ski led 698 1.700 615 Technicinn 1.000 1,100 2.,00 1,500 1.400 1.300 Engineere 2.200 2,000 1.400 '0 Supervisor 1.200 1.0CO 1.850 1.600 2.5CO 60 1.200 l1.00 Over*e 1.200 1.500 1.000 1.400 DOpartmnt Manaer 1.00 1.300 2.000 2.300 a,s5o 3o0o 2.8O General Manseer 3.000 3,000 2.100 2.000 6.040 4,000 4.000 t.000 J,XO pri;eeeonnl Junior Senior Administration Junior Clark 1.000 JON 1.200 700 U15 Clert a00 1,200 660 G15 Senior Clerk 1.,00 1.100 1.000 Support Staff Pereonnael Officer 1,700 Cotater Staff Saleme_n 1,000 65 1.400 Marketing Managr 1.O 1.200 Others Source: U14P Manpower Planning and I"_n Reeource Oevelopment for the Industrial Sector (May 198). - 100 - ANNEX V.3 NEPAL PU8LIC ENTERPRISE SECTOR STUDY Sal Analysis Joint Ventures Monthly HULLPrivate Privat-/Foreign lnvestors Minimum rugs Fruit Plywood St I Ysrn and Wage Canning Products Textile NRa Per Month Operatives Peon 425 410 426 496 626 476 Laborer 425 410 426 666 626 475 Semi-skilled 486 486 egg 700 616 Skilled 562 562 776 800 860 Technicians Highly skilled 898 1,300 925 760 Technician 2,180 Engineers 1,430 3,000 2,160 Management Supervisor 816 1,680 1,600 Overseer 2,500 Department Manager 1,300 1L,000 2,910 2,860 General Manager 2,760 3,060 3,496 8,600 Professional Junior 630 800 Senior Administration Junior clerk 630 eso Clerk 830 915 800 660 Senior clerk 630 926 1,200 Support Staff Personnel Officer 1,300 Computer Staff 1,800 1,500 Salesmen 1,3e8 Source: UNIDO Survey 1988 - 101 - ANNEX V.4 NEPAL PUBLIC ENTERPRISE SECTOR STUDY OUTPUT PER EMPLOYEE IN PUBLIC AND PRIVATE SECTORS Sub-Sector Nos. Employed Output Unit Output per Employee Brick and Tiles Private 73 3,000,000 Pcs 41,096 HMG 456 14,274,400 Pcs 31,304 Milk and Milk Products Private 65 2,962,384 LTRS 45,575 HMG 804 22,700,685 LTRS 28,235 Leather Industry Private 152 1,301,773 SFT 8,564 HMG 452 1,450,085 SFT 3,208 Textiles Private 2,505 5,798,134 MTR 2,315 Private/Foreign 286 1,812,174 MTR 6,336 HMG 1,532 1,619,227 MTR 1,057 Jute Mills Private 4,323 10,842 MT 2.5 HMG 2,071 6,041 MT 2.9 Source: UNIDO, Manpower Planning and HRD for the Industrial Sector, May 1988. ANNEX V.6 NEPAL PUBLIC ENTERPRISE SECTOR STUDY Supply and Demand for Skilled and Qualified Manpower Occupational Current Future Needs Total Qualified Total Difference Classification Needs upto 1995/98 Demand Output from Supply Formal Training 1988 1990 1996 Skilled Mechani;cs 320 355 676 68 112 280 448 -1,062 Machinists 390 435 825 Electrician 285 332 617 29 68 146 232 -386 Weavers 2,100 5,600 Potters 10 10 20 -20 Tea Preparation 135 175 310 -310 Highly Skilled Mechanics 133 133 20 40 200 260 +46 Machinists 11 70 81 Tanneri s 6 6 -6 Textile Processors 12 12 -12 Technicians Machine 28 36 64 24 49 241 314 +250 Animal Feed 3 3 -3 Food 13 13 3 3 -10 Dairy 270 270 2 -268 Rubber 3 3 -3 Sugar 38 7 45 2 1 -42 Tea 10 10 -10 Leather 3 3 -3 Textile 59 16 75 -76 Plywood 3 3 -3 Engineers Mechanical 190 116 306 4 18 22 -284 Electrical 90 53 143 10 30 33 73 -70 Chemical 25 116 141 19 38 95 152 +11 Production 13 13 -13 Professional Pharmacist 3 68 71 8 16 4 26 -48 Food Technology 3 3 -3 Plastic Technology 3 3 -3 Plywood Technology 3 3 -3 Sugar, Alcohol 10 10 -10 Leather 20 20 -20 Tea 10 10 -10 Agronomist 7 7 -7 Source: UNIDO Survey 1988. - 1() 3 -~ ANNEX VI.I Page 1 of 2 COMPANY VALUATION 1. The valuation of enterprises being privatized is a sensitive issue. It is a matter of fine judgement to ensure pricing attracts willing investors while ensuring that public assets are not sold "cheaply'. A full valuation requires the analysis and appraisal of each PE including, inter alia, a review of its products, its management structure and organization, Its competitors, and its past and future financial performance as discussed in the previous section. HMG will need to assess. - The market's current rating of the industries in which PEs to be valued operate, by reference to the prices at which shares in broadly comparable companies are currently trading which will be limited in Nepal at present so comparative markets could be used as bench marks. - Recent acquisitions and takeovers and the prices achieved in recent sales of companies operating in broadly similar industries in both Nepal and in other developing economies; and - The rate of return expected within the industry. 2. On the basis of the financial information available on the PEs and the information about the industries in which they operate HMG will provide valuation opinions using both the following valuation methods: Discounted Cash Flow ("DCF") method and Net Worth method. (a) Discounted Cash Flow ("DCF') Method. The most appropriate approach to valuing the PEs will probably be on the basis of the future earnings capacity of each of the selected enterprises. the DCF technique bases the valuation on projected future operating cash flows discounted to their present value at a discount rate which reflects the opportunity costs of the investment funds and the risk of investment. The sum of the discounted future cash flows represents the net present value ("NPV") of the company. Subtracting the value of existing debt leads to the NPV of the investment opportunity for potential investors. The main use of the DCF valuation is to advise the HMG, as seller, on the best price that could be obtained from selling a particular enterprise. They can also be used in determining the price at which a floatation could take place. In the case of a trade sale the buyer will, of course, have to make his own judgement about the potential performance of the enterprise and the risks involved. (b) Net Worth. The purpose of calculating net worth is to see whether the value of the assets might exceed the value of the business as calculated by SCF methods. It is entirely possible that poorly performing PEs will have assets such as land which will be more valuable, in alternative uses, that the business could ever be. In - 14- ANNEX VI.1 Page 2 of 2 such cases there is a risk of asset stripping and it will be necessary for H-MG to be particularly cautious in this area. 3. HMG's stated objectives will influence the conditions for sales. Pricing raises the difficult issue of reconciling the need to maximize proceeds with other objectives. For example, while a certain type of transaction such as management/employee buy-out might yield HMG a minimal price, it might be preferable if it better addresses their economic, political and social objectives.