US embassy cable - 03KATHMANDU2367

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, Maoist Insurgency 
SUBJECT: NEPAL: THE COST OF THE MAOIST INSURGENCY 
 
 
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Summary 
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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. 
 
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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. 
 
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A Challenging Investment Climate 
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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.) 
 
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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. 
 
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Destruction of Infrastructure 
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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. 
 
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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. 
 
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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.) 
 
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Additional Factors 
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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. 
 
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Comment: A Caveat 
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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