Trampling on Nepal

by Lori Udall

IT'S A FIVE-DAY WALK from the nearest road to get to the proposed site of the Arun III dam in the pristine Arun River valley in western Nepal. That will soon change if plans are carried out to construct a planned 74.4 mile-long access road through the valley. The road and the rest of the dam project are expected to generate an influx of up to 10,000 construction workers and their families who will jeopardize the lives and cultures of 450,000 indigenous people and threaten over 100 species of endangered and rare flora and fauna.

Although the Arun III project is the first in a series of three dams scheduled to be built in the valley, there has been no cumulative environmental impact assessment for the entire scheme.

The World Bank is slated to lend $175 million for the massive hydroelectric project; other major donors include the Asian Development Bank ($127 million), Japanese Overseas Economic Cooperation Fund ($163.3 million) and Germany's KFW ($124.4 million).

 On October 24, the Arun Concerned Group (ACG), a coalition of Nepalese non-governmental organizations filed the first claim against the World Bank in the newly created Inspection Panel, an independent appeals mechanism set up by the Bank to investigate claims from people directly affected by Bank projects. The ACG claim charges that the Bank violated its policies and procedures during the preparation of the Arun III hydroelectric project.

The ACG believes that there are alternatives to the project that are less expensive, less environmentally and socially damaging, and that would have the advantage of building domestic industrial capacity and developing hydropower more evenly throughout Nepal. While Arun III will be largely dependent on international contractors, the ACG contends that a range of small to medium dams could be planned, built and run by domestic companies. ACG questions the prudence of building the $1 billion project - which is almost one and half times the annual national budget of Nepal. The claim against the Bank submits that the Bank violated its policies on economic evaluation of projects, as well as policies in other areas such as energy, information disclosure, environment and indigenous people during the preparation of Arun III.

"It is highly risky for a weak economy such as Nepal to put all funding into one costly project" says Bikash Pandey, an engineer with Alliance for Energy, a Nepalese non-governmental organization. "It's no exaggeration to say that Nepal's economic future is at stake," warns Gopal Siwakoti, a lawyer with the Arun Concerned Group. "Nepal is a poor country and this megaproject is completely inappropriate for it. But the World Bank is ignoring viable alternatives that will meet our energy needs at a lower cost."

 Local hydro experts such as those affiliated with the Alliance for Energy have been promoting alternatives to Arun III for more than a year. The Alliance for Energy has put forward to the Bank and the Nepalese government a concrete set of alternative proposals which include small and medium scale dam projects of up to 100 megawatts, which could be developed in a number of river basins spread evenly throughout Nepal and could easily meet the growing demand for electricity. These projects could be developed and built in less time than Arun III, and would have the advantage of providing electricity to rural communities. According to the Alliance, the alternatives would be less environmentally harmful because the proposed sites are already near existing roads.

The U.S. government has also questioned the wisdom and economics of the project in a recent draft report released by the U.S. Agency for International Development in October 1994. The study contradicted the World Bank's analyses of Arun III. It said that Arun was not the lowest cost solution to the problem of Nepal's future power generation and that at this juncture Arun III would be a risky investment for Nepal. The study raised a series of questions about the Bank's economic analysis and risk assessment and concluded, "The thrust of all our results is that a prudent planner would postpone the construction of Arun by several years while developing credible responses to these as yet unanswered questions." The study was requested by the U.S. Executive Director to the World Bank, who will be one of 24 Executive Directors to vote on project approval.

Concerns about the high cost of the project have even generated controversy inside the Bank. The issue is reported to have polarized the entire South Asia Country Department, which includes Nepal, Bhutan and Bangladesh. Martin Karcher, a World Bank division chief in the South Asia Country Department quit his job over his strongly held belief that the project would put Nepal at unnecessary economic risk.

In a September 1994 interview with the Environmental Defense Fund (EDF), Karcher asserted that the high cost of the project could displace important future investments in Nepal in social sectors such as health, education and nutrition. Karcher stated that Bank management gave him little support in attempting to develop a targeted poverty alleviation program in Nepal, while focusing intensively on Arun. "My feeling was that the project was not being handled in an objective and even-handed manner," Karcher said. "Since senior management seemed committed to the project, a serious and open debate was no longer possible, and even common sense questions were being dismissed. All the available energy went into building the case in favor of the project, rather than examining alternatives."

The World Bank responded to Karcher's interview by claiming that his views were outdated and that the Bank had since revised its economic analysis for Arun III. However, Karcher has stuck to his original charges. "The project is not in conformity with the Bank's poverty alleviation strategy for Nepal," said Karcher. "Its an unbalanced use of Bank funds with an overemphasis on energy which will crowd out investments in the social sector and other high priorities such as rural infrastructure and agriculture."

 In 1993, the World Bank was forced to withdraw from the Sardar Sarovar (Narmada) dam in India after years of intense international and Indian public pressure. The withdrawal was widely viewed as a major victory for environmental and human rights activists. But the Bank wants to be sure the Narmada withdrawal did not set a precedent for major infrastructure projects and is using Arun III as its proving ground. Joe Wood, the Bank's vice president for South Asia, has made several public statements to the effect that the Bank's credibility as a funding partner for large- scale and controversial infrastructure projects is at stake, and if the Bank backs down on Arun it will become more difficult in the future for Bank management to bring large-scale projects before the Board of Executive Directors for approval. "If we don't do it, the signal we'd send out is that the Bank can no longer support infrastructure projects like this," said Wood in a recent interview with the Wall Street Journal. "That would take away what the Bank can do for small counties like Nepal, which have no other source of financing to turn to." But the credibility of the Arun project in the eyes of key bilateral co- funders such as the Japanese government is a more immediate problem for the Bank.

The Japanese government's Overseas Economic Cooperation Fund (OECF), one of the bilateral funders of the Arun III project, was also stung by international criticism for its co-financing role in the discredited Sardar Sarovar dam and is now indecisive on Arun III. The Government of Japan jolted Bank confidence in July 1994 by informing Bank officials that it would not publicly commit itself to co-financing the Arun project until it completed its own independent assessment of the project. This caused the World Bank to postpone the July 26 board approval date, which has not been rescheduled.

In August, in a highly unusual move, the Japanese government sent two separate delegations to Nepal to conduct assessments and meet with Nepalese officials and non-governmental representatives. One team was from the Overseas Economic Cooperation Fund and the second team included Bureau Directors from the Ministries of Finance, Foreign Affairs and International Trade and Industry. The participation of such high-level Japanese officials in this type of investigation is unprecedented. In the wake of these moves from the Japanese government, the Bank has been working aggressively behind the scenes to convince the Japanese to fund the project.

The Arun III debate is occurring at a politically volatile time inside Nepal. In July, Prime Minister Korirala resigned and disbanded the parliament. Even though there was only a "caretaker" government in place, Bank management seemed determined to continue with project preparation and approval. On October 18, 1994, the chief opposition leader in Nepal, Communist Party head Madhav Kumar Nepal, wrote to Lewis Preston, expressing his concern over the perceived attempt to lock in a deal on Arun III before a permanent government is in place. "Formal and meaningful discussion about the proposed project with the availability of basic project documents and information in advance has not yet taken place in Parliament," he wrote, adding that "Arun III must be reviewed by the new government in light of the ongoing controversies before Nepal makes any commitment to such projects." National elections inside Nepal took place on November 15th and the Communist Party won the most seats in parliament and is forming the new government. This development could change the debate on Arun inside Nepal.

 Out of all the recent developments around Arun III, one of the most critical for the Bank will be its actions vis-a-vis its own inspection panel. The inspection panel was set up by Executive Directors in the wake of the Narmada controversy to act as an independent mechanism to investigate complaints about Bank management's violations of internal policy and procedures. Non-governmental organizations, donor governments and legislators are all monitoring the development of this untested public accountability mechanism. If the Bank approves the Arun III project before the panel investigates the extensive Arun III complaints, it could undermine the effectiveness of the panel and the credibility of the Bank's stated commitment to public accountability.



An Insider's Critique of Arun

In September 1994, the Environmental Defense Fund interviewed Martin Karcher, Division Chief for Population and Human Resources, Country Department 1 in the South Asia Region at the World Bank. Below is an excerpt from this interview.

EDF: In view of the Bank's claim that poverty alleviation, and specifically your area, population and human resources development, are its first priority, what is the rationale for funding this mega- project?

 Karcher: The basic rationale for the Arun project is that it will help generate economic growth, because you need electricity in order to promote industrial growth, including small scale industry and tourism. Let me make clear at the outset that I am not against the development of power in Nepal.

The country needs power, but what is at issue, in my mind, is the scale of the investments and the nature of risks one is taking with such a large project.

A related concern has to do with the fact that, whereas the World Development Report of 1990 calls for labor-intensive growth (labor often being the most plentiful resource in poor countries), I do not see that such large investments in the power sector lead to labor-intensive growth, certainly not in the short to medium term. Therefore, it seems to me that the government and the donors need to consider alternative investment programs and a more balanced pattern of development, which would generate more productive employment, particularly among the poor.

EDF: With total project costs close to $760 million, more than Nepal's entire annual budget, is the project not likely to crowd out many of the social investments that your division is interested in, such as expenditures for education, health and human resource development?

 Karcher: Even though the costs of the Arun project will be spread over eight or nine years, that has been a real concern of mine.

In Nepal, human resource development is still at a very early stage. The levels of education and health services, family planning services are still so inadequate that major investments are required. Nepal is presently developing the potential to expand those services quite rapidly.

My main concern has been about what happens in the medium term. When you have developed the capacity to provide better primary education, improve secondary and higher education and provide health and family planning services at the village level to reach very poor women, large investments in the power sector, once having started, are liable to crowd out investments in the social sectors.

It's possible to construct scenarios where that will not happen, but they usually rest on rather optimistic assumptions. The latest country economic memorandum of the World Bank on Nepal, issued last March, describes the set of measures the government of Nepal would have to implement over the next 10 or 12 years in order to avoid the crowding-out impact. I personally fear that those measures, which include revenue mobilization, strict recurrent expenditure control, investment prioritization and steep tariff increases, may be very difficult to implement and to sustain over a long period of time. I'm not casting doubts on the good intentions of the government of Nepal, but if and when the crunch comes, then I think there is a significant risk that the government will have to cut back on its priority programs in the social sectors, as well as in some other important sectors. Prudence would argue in favor of less risky alternatives.


EDF: What do you think of the economic analysis of the project?

Karcher: I have some serious reservations about the economic analysis. First, it was difficult to get hold of the economic analysis until quite late in the project processing cycle. Somehow that information wasn't being shared very readily.

Then, in January 1994, when we finally did get a copy of the draft staff appraisal report for the project, I found many problems with the analysis. At the sectoral level, there was no clarity as to what the composition of the government's overall investment program in power actually was and to what extent it was designed to serve export needs in addition to domestic consumption. Let us take it that the power development program was designed to meet domestic consumption. ... Why is it not equally important, perhaps even more important, to meet the needs for primary education, for water supply or for family planning services? Why is electricity consumption, a significant proportion of which goes to the better- off urban dwellers, more important than the needs of the poor, especially for an institution like the Bank which is primarily concerned about poverty alleviation?

EDF: What do you think about the estimated economic rate of return of 15.4 percent?

Karcher: I have not seen the latest documents. I had major concerns about the economic analysis which was first shared back in January. The methodology was based on the consumers' willingness to pay for electric power. First of all, how does one estimate that? What is the shape of the demand curve?

When I looked at the imputed economic value of a kilowatt hour in Nepal, I found that on average this was about seven and a half times what consumers were paying and I was wondering how is it possible that you can assume that the average Nepalese consumer would be willing to pay something like 53 cents per kilowatt hour, when we in Washington pay something like 7 or 8 cents? Obviously, if you use these kinds of values, any project becomes feasible and justified.

EDF: If there is this eight-fold higher figure for the cost of a kilowatt hour in Nepal as compared to Washington, obviously, this strains anyone's credibility. How can the task manager and the country manager proceed with such a project?

 Karcher: The economic analysis had to be redone. The problem, however, with waiting until such a late stage in the project before doing a proper economic analysis is that the opportunity to use the results of the analysis to shape the design of the investment program is then lost. The analysis merely serves to justify the project after the fact. ...

 Besides electric power, there are other important unmet needs in Nepal. Demand for electricity can be moderated simply by reducing the rate of new household connections. This may allow for meeting other priorities such as highway maintenance, for instance. ...

On my last trip in the country, while visiting primary schools being constructed with World Bank assistance, we found that on some stretches of road it was easier for us to drive alongside the road than on the road itself. I mention this to illustrate that the resource requirements just to preserve the existing stock of capital are enormous in Nepal, and we know from experience that the economic rates of return on road maintenance and rehabilitation programs are significantly above 15 percent.

Similarly, World Bank studies have found that investments in human resource development yield even higher returns, especially in low-income countries. Under those circumstances, how do we justify using an opportunity cost of capital as low as 10 percent if there are significant funding gaps and risks that such gaps will continue to exist? When I raised the question of using a higher opportunity cost of capital against which to assess the Arun project, I was told: "We have always used 10 percent; why change for this project?" I do not consider this a satisfactory answer to my question. This is not just an esoteric, theoretical question. It has practical consequences regarding the composition of the government's investment program. The higher the opportunity cost of capital, the less attractive the large capital-intensive hydro-projects become.

EDF: When you have had various questions about the affordability of the project, has there been a response?

 Karcher: I think I got a hearing. I want to be fair. If you look at the most recent country economic report, it is basically a public expenditure review for Nepal. It tries to see if the government proceeds with its full investment program in the power sector, including Arun, what the likely crowding out impact will be, and what measures the government will need to take in order to accommodate such large investments.

The bulk of the report is on that issue, and we were consulted, in the social sectors, about the needs. Initially, we were given an envelope for social sector investments which assumed a 5 percent real growth in social sector investments. We said this was absolutely insufficient, that if investments in the social sector only grow by 5 percent a year, the government would not even be able to meet its commitments under the basic and primary education project that IDA is funding, and it would not be able to invest as much in the health and population sector. So it was decided that the social sectors would get an 8 percent rate of increase. ...

 In real terms that means something. But it doesn't allow for a major expansion, say, in the number of teachers. It doesn't allow catching up with the huge backlog of children who don't attend school. It is sufficient to invest in quality improvements in education, but not in an expansion of the primary education sector [or for an] expansion of secondary education, which, on the basis of a report which the Bank has just completed, is another area where the needs are extremely large.

Moreover, in order to carve out the budgetary resources required to allow for an 8 percent yearly expansion in social sector spending, the government would have to implement and sustain a number of very difficult revenue mobilization and expenditure prioritization and control measures. They would need to achieve an unprecedented, high level of economic management and performance for Nepal.

EDF: Has your decision to retire from the Bank had anything to do with how the Arun project was handled and managed at the Bank?

 Karcher: Yes it has. It was not an easy decision, after 29 years with an institution that provided me with tremendous opportunities for professional growth.

My feeling was that the project was not being handled in an objective and even-handed manner. Since senior management seemed to be committed to the project, a serious and open debate was no longer possible and even common sense questions were being dismissed. All the available energy went into building the case in favor of the project, rather than examining alternatives.

By contrast, we received very little management support in our attempt to assist the government to formulate a targeted poverty alleviation strategy and program directed at those people who are too poor to participate in economic development.

As division chief and a member of the department's management team, I felt I shared in the responsibility for the decisions taken in the department, particularly for such momentous decisions as the power sector investment program, which can affect the fate of the whole country. And since I had serious reservations and misgivings, I felt that one way of making that statement more effectively than through my previous memos would be to say I no longer want to be part of the decision-making process.