NEPAL: THE COST OF THE MAOIST INSURGENCY

UNCLAS SECTION 01 OF 05 KATHMANDU 002367

SIPDIS

STATE FOR SA/INS; STATE FOR INR; LONDON FOR POL/GURNEY; NSC
FOR MILLARD; USAID FOR ANE/SA: BUNDY

E.O. 12958: N/A
TAGS: PREL PTER ECON EAID EFIN NP
SUBJECT: NEPAL: THE COST OF THE MAOIST INSURGENCY


--------------
Summary
--------------


1. (U) The seven-year Maoist insurgency in Nepal has taken a
tremendous toll on the already impoverished Nepalese economy.
The impact of the conflict is obvious in the floundering
tourist sector, the depressed foreign investment climate,
stalled economic development projects, crippled
infrastructure, and the sharp increase in security spending.
Various studies indicate that the loss to Gross Domestic
Product (GDP) over the seven-year period is in the range of
USD 740 million to USD 1 billion. The cost to reconstruct
public and private infrastructure destroyed by the Maoists
will amount to around USD 54 million. On the foreign
investment front, reports from Nepal's Department of
Industries paint a bleak picture for foreign direct
investment, which declined by over 47 percent in the first
quarter of the Nepalese fiscal year 2003/04. END SUMMARY.

--------------
Loss in Gross Domestic Product
--------------


2. (U) The seven-year Maoist insurgency has taken a
tremendous toll on Nepal's economy. Various studies indicate
that the loss to Gross Domestic Product (GDP) over the
seven-year period is in the range of USD 740 million to USD 1
billion. For the first time in nineteen years, during the
year 2001/02, real GDP registered negative growth (-0.46%
according to revised GON figures) due mostly to the increase
of Maoist violence, destruction of infrastructure, losses due
to strikes, and decrease in investor and consumer confidence
domestically.


3. (U) Although government revenues (estimated at USD 729.1
million) increased 12 percent in 2002/03, the GON has
outstripped this growth in revenues with increased spending
(total GON expenditures amount to USD 934 million). For
example, during this timeframe, security spending (including
military, police and armed police expenditures) amounted to
USD 182 million (or 25 percent of government revenues).
Total development spending (including items like education,
health, construction projects) equaled USD 370 million (or
50.7 percent of government revenues),and other government
spending (administrative, salaries, etc.) totaled USD 564.2
million.

--------------
A Challenging Investment Climate
--------------


4. (U) Insecurity, uncertainty, and forced Maoist extortions,
coupled with inadequate government security and poor
infrastructure, create a challenging investment climate in
Nepal. In October 2003, the Department of Industry (DoI)
reported a decrease in foreign direct investment (FDI) of
over 47 percent, during the first quarter of the Nepalese
fiscal year (which began in July) totaling NRs. 383.38
million (USD 5.1 million). The same period the previous year
recorded FDI of NRs. 733.79 million (USD 9.1 million).


5. (U) During the early years of Nepal's new democracy in the
1990s, there was a sharp increase in FDI as a result of
economic liberalization and stabilization under the G.P.
Koirala administration in part spurred by USAID programs.
FDI for 1992/93 totaled a staggering, for Nepal, USD 365
million. The G.P. Koirala administration pursued
privatization, opened certain sectors to foreign investment,
and reduced regulatory and financial barriers. The following
year, however, a change in government, corruption
allegations, and a decrease in investor confidence resulted
in a decline of 79 percent in FDI (to about USD 76 million).
Foreign investment experienced a slight increase (to about
USD 179 million) again under the Sher Bahadur Deuba
administration, but investment in Nepal has yet to reach the
levels experienced during 1992/93.


6. (U) The recent problems of foreign investment were
exemplified in the German-supported hydropower joint venture
known as the Middle Marsyangdi Hydroelectric Project.
Recently, the 70-megawatt power project was terminated,
citing security concerns around the project site and a
contract dispute with the Nepal Electricity Authority (NEA)
over 48 million Euros overdue to the German investor. (Note:
News reports indicate that work on the project was halted on
10 October after the Maoists ambushed a project vehicle and
killed two workers. End Note.) The termination of this
project amounts to a loss of about USD 190 million.
(Comment: The Bhote Koshi hydroelectric power plant (an
American investment) has also had contractual and payment
problems with NEA. Given the history of the NEA at times
skating around the sanctity of contracts, in addition to
increased security concerns, it is unlikely that there will
be a significant increase in hydropower sector from foreign
investment in the near future. End Comment.)

-------------- --------------
Imbalance in Security Versus Development Expenditures
-------------- --------------

7. (U) According to GON figures, security spending in
1997/98 amounted to USD 75 million (or 9 percent of the GON
budget) whereas the estimated expenditure for 2002/03
amounted to USD 182 million (or 16.3 percent of the GON
budget). This increase has had serious implications for the
on GON,s development spending, which during the same
timeframe actually declined by 18.5 percent. Development
spending for 1997/98 amounted to USD 428 million or about 52
percent of the budget, whereas spending in 2002/03 amounted
to USD 369.7 million or 33 percent of the budget.


8. (U) The GON currently has earmarked NRs. 14.74 billion
(equivalent to USD 199 million) for security purposes.
Recent news reports refer to a supplemental budget request of
NRs 1.8 billion (equivalent to about USD 24 million) from the
Defense Ministry. The additional moneys were requested to
improve troop mobilization and surveillance/intelligence
capabilities. During a meeting with international donors in
September 2003, Minister of Finance Dr. Prakash Chandra
Lohani indicated that the GON might reallocate the NRs. 1.7
billion (equivalent to USD 22.9 million) earmarked for the
election fund to address pressing security needs. (Comment:
Although a large portion of Nepal's security spending is
directly related to the insurgency, it is not accurate to
attribute the entire increase in security expenditures to
this purpose. Since Nepal is a major and welcomed
contributor to UN Peacekeeping Missions, recent UN
deployments to Liberia, etc. should be taken into account.
In addition, replacement of military hardware as a result of
normal wear and tear should also be figured into this
equation. End Comment.)


9. (U) That said, international aid commitments declined by
more than 50 percent during the first 11 months of 2003,
according to figures complied by the Foreign Aid Coordination
Division at the Ministry of Finance. The commitments made by
bilateral and multilateral aid agencies amounted to NRs. 5.57
billion (equivalent to USD 77 million) in comparison to over
NRs. 12 billion (equivalent to USD 162 million) for the same
period last year. (Note: These GON numbers on foreign aid
do not capture all foreign aid flows. The Ministry of
Finance only keeps track of the aid that flows to and through
the Ministry--it does not track aid provided to individual
NGO and INGO groups in Nepal. End Note.) Nepal is highly
dependent on foreign assistance for its development
investment and the decrease in aid commitments comes at a
critical juncture in Nepal's development history. The
decrease in aid commitments is coupled with an increase of
international donors' criticism of human rights violations
and political uncertainty. When Post requested data on the
absorption rate of international donor moneys, government
sources within the Central Bureau of Statistics and the
Ministry of Finance indicated that the information was "not
available."


10. (U) Despite the stark contrast between security and
development expenditures, development spending is projected
to increase by nearly 53 percent under the GON,s Tenth Plan.
In the past four months alone, development spending rose by
22 percent, in part due to recently approved World Bank
concessional loans of USD 70 million under its Poverty
Reduction Support Credit program.


11. (U) As a result of pressures from bilateral donors, the
World Bank, the Asian Development Bank and International
Monetary Fund, there appears to be a new focus on development
sectors like health, education, rural drinking water and
local infrastructure. Nepalese planners understand that
unless they increase development spending they risk losing
support from the international donor community. For example,
recent news reports claim that the Danish and German donors
might be considering reducing or pulling development funds
out of Nepal as a result of growing dissatisfaction with the
insurgency, lack of governance and human rights abuses. The
Dutch government is considering cutting assistance to a
number of countries, a list that apparently would include
Nepal.

--------------
Destruction of Infrastructure
--------------


12. (U) Although it is difficult to determine the exact cost
of the destruction of physical private and public
infrastructure as a result of the insurgency, the generally
accepted figure falls in the range of NRs. 18 to 26 billion
(equivalent USD 243 million to 356 million). (Comment:
Record keeping is poor, and the definition of "destruction"
varies widely. In some cases, infrastructure may have been
merely damaged, rather than destroyed, and remains more or
less functional. Nonetheless, for a country on the edge like
Nepal which has huge unmet infrastructure needs, any damage
to infrastructure is disturbing. End Comment.)


13. (U) Data from a variety of sources indicate that, on a
sectoral basis, the destruction to property amounts to:
-- Telecommunication Facilities: USD 9.46 million;
-- Electricity Plants and Facilities: USD 3.87 million;
-- Village Development Committee (local government) Offices:
USD 5 million;
-- Radio Transmission Stations: USD 81 thousand;
-- Airports: USD 4 million;
-- Roads, Bridges, infrastructure-related offices: USD 62
thousand; and,
-- Banks (includes property loss and cash looted by Maoists):
USD 7.6 million.

--------------
Cost of Reconstruction
--------------


14. (U) The National Planning Commission released a report in
July 2003 that indicates the cost of reconstruction amounts
to about USD 54 million. The report break downs the estimate
for rebuilding infrastructure as follows:

-- Local government buildings: USD 3.5 million;
-- Infrastructure associated with the ministries of tourism,
water resources, communication and physical planning: USD
22.9 million;
-- Electricity Sector: USD 4.7 to 5.4 million;
-- Communications Sector: USD 5.4 to 6 million;
-- Airport Reconstruction: USD 3.3 to 4 million;
-- Road and bridge reconstruction: USD 5.4 million;
-- Agriculture Sector: USD 2.7 million; and,
-- Educational-related property: USD 1.3 million.

--------------
Case Study: Tourism
--------------


15. (U) Several incidents over the past four years have
caused a decline in the travel and tourist industry including
the 1999 Indian Airlines hijacking, the 2001 royal family
massacre, the 2001 September 11 attacks on the World Trade
Center, 2002/03 Severe Acute Respiratory Syndrome (SARS),and
escalation in Maoist violence coupled with general political
instability in the country. According to a 2002 World Bank
study, the travel and tour industry contributes about 10
percent to Nepal's GDP. Earnings in the industry declined by
50 percent in 2001 from the previous year. News reports
allege that the loss to the sector in 2001 and 2002 totaled
over USD 81 million. Narendra Bajracharya, President of the
Hotel Association of Nepal, states that hotel occupancy rates
have declined by 25 to 35 percent since 2001, this has had a
crippling effect on the industry. When asked about hotel
closures as a result of the decline in occupancy rates,
Bajracharya indicated that no figures are available.


16. (U) During the January-August cease-fire (not the peak
season),tourist arrivals increased by 15 percent to 172,394.
Interestingly, the break in the cease-fire on 27 August has
had apparently little impact in dampening tourist arrival
numbers, according to Department of Immigration figures.
Numbers reported in September 2003 are up 25 percent in
comparison to September 2002 numbers, and October 2003
arrivals increased by over 41 percent in comparison the
October 2002. However, while low-spending backpacker
tourists are still coming, the higher-end older travelers
definitely have decreased. While many of the hotels in
Kathmandu are now filled, it is at a room charge a quarter of
the past normal rates.


17. (U) The Maoists continue to indicate that they will not
target tourists. However, foreign visitors regularly are
faced with extortion and harassment when traveling outside
the Kathmandu Valley. (Note: October and November are the
peak trekking season in Nepal, and many of those traveling
made plans prior to the break in the cease-fire. Rather than
canceling and paying penalties, American travelers stopping
by the Embassy's Consular Section have indicated that they
are accepting the additional risks associated with trekking
in Nepal. End Note.)

--------------
Additional Factors
--------------


18. (U) Additional indices of the economic cost of the
insurgency include:
-- Figures from the Private and Boarding Schools Organization
of Nepal (PABSON) indicate that 2,300 schools outside the
Kathmandu Valley closed during 2003 as a result of the
insurgency. Consequently, over 425,000 students are now
unable to attend school.

-- Faced with a decrease in domestic employment opportunities
and possible forced conscription in the Maoist's "Peoples
Army," the Department of Labor and Employment Promotion
reports an increase of 28 percent during 2002/03 in Nepalese
seeking work abroad. The country earns more than USD 1
billion annually in foreign remittances, which amounts to 18
percent of GDP.

-- The Economist Intelligence Unit's November 2003 Country
Report estimates that the 18 - 20 September general strike
cost the Nepalese economy about NRs. 3 billion (or USD 41
million). Media reports from the period reported that a
majority of businesses and educational institutions were
intimidated and adhering to the strike.

--------------
Comment: A Caveat
--------------


19. (U) It is a daunting task to assess the cost of the
insurgency. GON and private industries, figures are
sometimes over estimated or not tallied in a uniform manner.
For example, although the GON could provide dollar figures
for the destruction of infrastructure, we found data on how
these figures were calculated either unavailable or not
updated on a regular basis.


20. (U) Comment Continued. Nepal's economic future is
bleak: low social indicators, poor basic infrastructure,
inadequate means to get goods to the market, and general
failure to diversify or focus on product marketing. These
problems coupled with the increase in Maoist violence, create
an uncertain future for the Nepalese economy. The evidence
compiled from Post's research portrays a downward trend in
the economy and for society as a whole. Continued security
demands on the GON budget, coupled with a decrease in foreign
investment and international assistance, bode poorly for
Nepal's economic and development future. It is clear that
Nepal's downward economic trend is gaining momentum. No
single sector of the economy is in a position to bring it
back into economic growth. Revenues from tourism have
plummeted, and the next largest foreign exchange earner, the
ready-made garment industry, is facing a precarious future
when quotas are eliminated in December 2004 under the
Multi-fibre Agreement. Without dramatic change, Nepal may be
heading into a downward spiral of poverty, destruction, and
stalled socio-economic development, fed by the insurgency.
(Note: Graphs with further information have been e-mailed to
the SA/INS Desk Officer. End Note.) End Comment.
MALINOWSKI