ASIAN DEVELOPMENT BANK JFPR: NEP 26015

GRANT ASSISTANCE

(Financed by the Japan Fund for Poverty Reduction)

TO THE

KINGDOM OF NEPAL

FOR

OPTIMIZING PRODUCTIVITY OF POOR WATER

USER ASSOCIATIONS

To be implemented in conjunction with the

SECOND IRRIGATION SECTOR PROJECT

(Loan 1437-NEP)

August 2003

CURRENCY EQUIVALENTS (as of 1 July 2003)

Currency Unit – Nepalese rupee/s (NRe/NRs)

NRe1.00 = $0.01321 $1.00 = NRs75.65

The Nepalese rupee is pegged to the Indian rupee (Re) at a rate of NRs1.60 = Re1.00, and is fully convertible on all current account transactions.

ABBREVIATIONS

ADB Asian Development Bank CBO community-based organizer CMC credit management committee DADO District Agricultural Development Office DFID Department for International Development DOA Department of Agriculture DOI Department of Irrigation EA executing agency FMIS farmer-managed irrigation system IA implementation agencies IDD irrigation development divisions JFPR Japan Fund for Poverty Reduction MFI microfinance institution MOA Ministry of Agriculture NGO nongovernment organization NRB Nepal Rastra Bank O&M operation and maintenance PIM project implementation memorandum PIU project implementation unit RCF revolving credit fund RMDC Rural Microfinance Development Center SISP Second Irrigation Sector Project WUA water user association

NOTE

In this report, “$” refers to US dollars.

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CONTENTS

Page MAP

I. INTRODUCTION 1 II. BACKGROUND AND RATIONALE 1 III. THE JFPR PROJECT 2

A. Objectives 2 B. Scope 3 C. Cost and Financing 4 D. Implementation Arrangements 4 E. Impact Assessment 8 F. Risks, Assumptions, and Assurances 8

IV. THE PRESIDENT’S DECISION APPENDIXES 1 JFPR Project Framework 10 2 Cost Estimates and Financing Plan 12 3 JFPR Project Structure 13 4 General Terms of Reference for Project 14

Implementation Unit and Microfinance Institutions 5 Expected Impact on Poverty Reduction 16

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I. INTRODUCTION 1. The Asian Development Bank (ADB) approved a loan to the Government of Nepal for the Second Irrigation Sector Project (SISP).1 The SISP aims to increase agricultural productivity and improve farm incomes in farmer-managed irrigation systems (FMIS) to reduce poverty among small/marginal farmers and increase rural employment. The project proposed for grant financing under the Japan Fund for Poverty Reduction (JFPR), will be linked to SISP, and will enhance its objective by optimizing irrigated agricultural productivity through improved extension and provision of microcredit and skills training for seasonal input purchase and income generation. The JFPR Project was identified through extensive consultations with relevant agencies, nongovernment organizations (NGOs), and the communities concerned. This report is based on the outcome of the discussions held during several loan review missions. Stakeholder recommendations were reflected in the design of the JFPR Project. The Government concurred with the JFPR Project in April 2003. The project framework is in Appendix 1.

II. BACKGROUND AND RATIONALE 2. In Nepal, 42% of all households are estimated to live below the poverty line.2 Figures vary by ecological region – higher in the mountain areas (56%) than in the hills (42%) or the terai (41%). Rural-urban differences in the incidence of poverty are more pronounced – 44% in rural areas compared with 23% in urban areas. The trend shows deterioration in the poverty situation since 1984/85.3 Poverty in Nepal is attributed to low economic growth, low agricultural productivity, inadequate opportunities for nonfarm income generation, low social and economic infrastructure, and a relatively high rate of population growth. In rural areas, especially those in the isolated hills and terai, the low productivity of land and labor resources under an erratic rainfall regime is exacerbated by poor input supply and inadequate infrastructure. For poorer households, the main staple, rice, is often in short supply in any given year. Increased agricultural productivity to ensure food security is a major goal of the Government. 3. SISP is helping the poor farmers with rehabilitating the existing FMIS as well as developing new ones, and also providing them with basic training for operation and maintenance (O&M). However, with the experience in implementing SISP, it is now felt that providing irrigation alone improves farm productivity by only 15 to 20% while the expected gains could be as high as 40 to 50%. The wide gap is due to poor farmers’ failure to use improved seed and lack of appropriate extension training. Unavailability of improved seed also discourages farmers from optimizing fertilizer applications as the seed of outdated varieties do not respond to higher fertilizer doses. At SISP’s appraisal, it was envisaged that extension services provided through project activities by the Department of Agriculture (DOA) would lead to increased use of modern inputs. But the provision of improved seed on a wider scale is still beyond the capacity of DOA.4 Although the National Agricultural Research Council has evolved modern crop varieties suitable for Nepalese farming conditions, NARC itself and other DOA

1 ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the

Kingdom of Nepal for the Second Irrigation Sector Project. Manila. 2 The World Bank. 1999. Nepal: Poverty at the Turn of the Twenty-First Century. The estimated poverty line was

NRs4,404 per person per annum in 1996 prices. 3 ADB. 2000. Nepal: Poverty Situation Analysis and Reduction Efforts. Draft final report. 4 DOA has good technical capacity at its national institutions and main outreach centers. However, its district-level

staff is mandated to service the farmers in the concerned district at large and is not necessarily able to give specialized assistance to farmers in the designated subproject areas.

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institutions lack outreach to multiply seed while giving the requisite training to seed multipliers.5 Likewise, despite an ADB loan,6 access of poor farmers to short-term credit, which is essential for enhancing their production and incomes, is extremely limited, and no financing is available for multiplying seed and establishing a revolving fund for microcredit under SISP. As a result, the real impact of the irrigation schemes is less than their potential. JFPR financing is required to bridge this gap and provide (i) synergy among the three main components of modern agriculture: seed, water, and fertilizer; and (ii) additional income-generating opportunities to the poorest beneficiaries through microcredit. 4. The innovation in JFPR support lies in the provision of a full service package, along with intensive community mobilization, to fill the gap in the productivity of substantial investments in irrigation facilities. A vigorous campaign for seed multiplication by farmers and the private sector will be carried out. A demand-responsive extension system will be developed for the target areas and farmers to ensure that the modern package of seed-water-fertilizer is applied in optimal doses at appropriate times in the crop cycle. A sustainable structure will be developed for delivery of microcredit so that beneficiaries have financing available for inputs and income- generating activities of women. In addition, by helping to increase productivity, the JFPR Project will contribute to the sustainability of SISP and enhance its poverty reduction impact through a broad-based improvement in the quality of crop production and other income-generating activities. JFPR support will go to the selected subprojects that meet the specific performance criteria in terms of the self-sustained irrigation O&M, thereby providing incentives to subproject beneficiaries to improve their performance through their self-help efforts. 5. Grant financing for the JFPR Project is justified, given the innovative concept and a high potential for long-term sustainability of irrigation investments in Nepal. Lessons from similar approaches adopted at a modest level and scope under the SISP show that the JFPR Project on a wider scale will work effectively and could later be replicated across Nepal. SISP having been under implementation since 1996, the proposed JFPR Project could not be included as a component. The Government considers these activities to be a pilot and will not borrow under a loan. Stand-alone technical assistance (TA) is also not justified as JFPR support covers investment activities, which cannot be financed under a normal TA. Essentially, the JFPR grant is a seed investment to leverage support for innovative productivity-enhancing activities in agriculture and other income-generating activities in selected SISP subproject areas.

III. THE JFPR PROJECT A. Objectives 6. The long-term objective is to optimize the productivity of poor and marginal farmers in FMIS developed under SISP, and thus improve their income potential and reduce poverty. A specific objective is to increase the income of small and marginal farmers, particularly women,

5 These tasks require appropriately funded outreach programs and active private sector involvement – elements that

do not exist in Nepal on a large scale. However, a few local NGOs, funded by bilateral agencies, i.e., Deutshe Gesellschaft fur Technische Zusammenarbeit (GTZ) and the Department for International Development (DFID), have been successfully carrying out similar activities in some areas. For instance, DFID is currently funding the Seed Sector Support Project, for $4.75 million equivalent, that started in February 1998. This project is operating in 10 hill districts of Eastern, Western, and Far Western Regions. The overall goal is to raise the living standards of hill farming families and disadvantaged women farmers through, among others, seed multiplication and its associated training programs. Over 100 seed producer groups have been formed with effective linkage with private seed traders.

6 ADB. 1998. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Kingdom of Nepal for the Rural Microfinance Project. Manila.

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and generate employment opportunities in rural areas. The immediate objective is to improve seed multiplication and support other income-generating activities to enhance the poverty reduction impact of SISP while strengthening the capacity for the communities for sustainable credit management. B. Scope 7. The JFPR Project has five components: (i) seed multiplication, (ii) microenterprises for women, (iii) training, (iv) project management, and (v) benefit monitoring and evaluation. It will last for 3.5 years and will cover about 100 subprojects of SISP, focusing on the subprojects and their water user associations (WUAs) that meet the specific performance criteria in terms of (i) achieving the stipulated irrigation targets with enrollment of more than 70% of the beneficiaries as WUA members, and (ii) satisfactory O&M of the facilities with local resource mobilization.7 The training component will last during the JFPR project period, while the revolving fund for microcredit will become self-financing and sustainable on a long-term basis. 8. Seed Multiplication. Start-up financing will be made available as loans to about 4,000 progressive and enterprising small and marginal farmers for seed multiplication in 100 subprojects.8 Both cereals and vegetable seeds will be multiplied. Foundation/basic seeds will be supplied by agencies of the Ministry of Agriculture (MOA) and/or private traders. Seed multipliers will form groups and receive specialized training in agricultural extension, storage, and marketing through the District Agricultural Development Office (DADO), eligible NGOs, or local private experts. The activities will initially focus on areas where existing seed programs are ongoing, and then replicated in other areas with provision of necessary support services. The participants will receive loans for 18 months. A revolving credit fund (RCF), totaling $275,000, will be established for this component.

9. Microenterprises for Women. In the households of the targeted 100 subproject areas, about 10,000 women will form groups and receive skills training for income-generating activities, i.e., vegetable-fruit gardening, animal husbandry, and other suitable cottage industries. About 5,000 among them are targeted to avail of loans for start-up financing for a 12-month cycle. The main target will be women in the poor households belonging to the WUA. However, if found socially and logistically feasible, poor women from nonirrigator households will also be included in the program. RCF, totaling $275,000, will be established for this component.

10. The JFPR grant of microfinance for seed multiplication and microenterprises will be managed by the Rural Microfinance Development Center (RMDC), which will relend to the eligible microfinance institutions (MFIs) including NGOs, microfinance development banks, and credit cooperatives having MFI licenses. These MFIs will implement the microfinance activities in the selected subproject sites. RMDC will establish RFC to further relend to the MFIs. Detailed operational procedures will be provided in the project implementation memorandum (PIM) and its associated manuals.9 7 Under SISP, there are 285 subprojects covering over 40,000 hectares (ha) in 35 districts of Eastern and Central

Regions. An average area per subproject is about 140 ha, while an average household owns/operates about a 1-ha farm. Considering the average family size of 7, and assuming that the multiplied seed will be utilized by the other farmers in the subproject area, it is estimated that about 145,000 people would directly benefit from this project.

8 In the target subproject areas, rural households’ access to credit is extremely limited. Financing from formal sectors is limited, cumbersome, and requires collateral. Financing from informal sources, if available at all, would bear an interest rate in excess of 40%. The training opportunities to productively use borrowed capital are almost nonexistent.

9 ADB will prepare the PIM and give it to the executing agency (EA) at the start of the JFPR Project.

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11. Training. Training will cover (i) formation of beneficiary groups and developing their capacity for savings and credit activities; (ii) agricultural extension, storage, and marketing; (iii) skills training for women to undertake income-generating activities, i.e., for vegetable-fruit gardening, animal husbandry, and local cottage industry; and (iv) on-farm water management to support the seed multiplication and microenterprise activities mentioned earlier. MFIs will serve the identified borrower groups using the re-lent fund from RMDC, with resource persons mobilized from DOA, Department of Irrigation (DOI), NGO/MFIs, and other institutions engaged by the project implementation unit (PIU) to conduct specialized training as necessary. In addition, RMDC will give MFIs training in microfinance management,10 whereas the PIU using the JFPR grant will engage capable MFIs to train about 20 WUAs to strengthen their capacity to operate as savings and credit cooperatives as a pilot. About 100 community-based organizers (CBOs) will be selected, trained, and deployed by PIU in the potentially eligible schemes to monitor the performance of WUAs and facilitate their stipulated operations. 12. JFPR Project Management. The Government will give project management support at the central, regional, and district levels by providing staff and office space. The Government will also share vehicles and equipment. The JFPR Project will provide support for administration, O&M of the existing motorcycles and vehicles, office equipment and supplies, domestic travel, and workshops/seminars. There will be a significant element of beneficiary involvement through WUAs. 13. Benefit Monitoring and Evaluation. A regular and effective benefit monitoring and evaluation system will be institutionalized through irrigation development divisions (IDDs). Field data collected by CBOs in collaboration with WUAs will be collated and analyzed by IDD staff under the guidance of the PIU consultant. All data will be stored at IDD. A special care will be taken to ensure that most deserving and poor members of WUAs benefit from this project. C. Cost and Financing 14. The total cost of the JFPR Project is estimated at $1,160,000 equivalent. ADB will provide $1,000,000 equivalent to be financed on grant basis by the Japan Fund for Poverty Reduction, funded by the Government of Japan. The Government of Nepal will finance $100,000 equivalent from its own resources to cover the cost of office accommodation, counterpart staff, and training facilities. Beneficiaries will contribute at least 10% capital in loan investments. The detailed costs and financing plan are in Appendix 2. D. Implementation Arrangements

1. Executing and Implementing Agencies 15. A small PIU will be established in DOI and the consultant engaged by ADB will take overall responsibility in coordinating and managing the JFPR activities. Under direction of and in coordination with the PIU in DOI, RMDC will be responsible for managing the fund for the microfinance activities. DOI will work closely with DOA for relevant works including provision of specialized technical services such as seed multiplication. DOI will appoint a JFPR project coordinator, who will coordinate the activities and be responsible for overall JFPR project management. A project steering committee (PSC) will be set up and chaired by the director general of DOI, with the JFPR project coordinator as member-secretary. Members will comprise the program director of the Crop Development Directorate in DOA, regional directors of DOI and 10 Up to about 5% of the annual relending volume will be provided by PIU from non-RCF source of JFPR fund to

RMDC for this purpose, to be disbursed based on the actual training given.

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DOA, representatives from the National Planning Commission and the Ministry of Finance, a senior representative from RMDC, PIU consultant, and officials from the Nepal Resident Mission of ADB. The PSC will meet every 3 months or when required. 16. The implementation agencies (IAs) for the microfinance activities will be selected from MFIs including NGOs, microfinance development banks, and savings and credit cooperatives having MFI licenses that meet a set of criteria: (i) registered with the Nepal Rastra Bank (NRB) as a financial intermediary, (ii) at least 3 years experience in microcredit with a demonstrated ability to mobilize poor households and savings so that the total savings balance of all households is at least 20% of loans outstanding, (iii) a loan recovery rate of at least 90%, (iv) institutional management capability, and (v) the ability to report microcredit-related financial and operational information. For continued participation, the MFIs will have to (i) maintain an annual recovery rate of at least 98%; (ii) comply fully with the terms and conditions for repayment of all loans received from RMDC; (iii) comply with training requirements for employees and beneficiaries; (iv) submit accurate, timely, and standardized reports including financial statements as required by RMDC; and (v) comply fully with NRB regulatory requirements and the auditing requirements of RMDC and the JFPR Project. 17. The JFPR Project will start in October 2003 and will be completed in March 2007. The project structure is in Appendix 3.

2. Implementation Procedures 18. For project implementation, the PIU in collaboration with the Regional Irrigation Directorate (RID) and IDD will undertake an information campaign for each SISP subproject regarding the criteria and activities to be supported under JFPR. A reputed local MFI meeting the specified criteria will be engaged by the PIU in coordination with RMDC to work under contract with the PIU for start-up activities to prepare JFPR implementation plans for a cluster of eligible subproject WUAs, based on their place of operations and capacity. The WUAs will be selected with the advice of the PIU consultant who will prepare implementation plans in consultation with the concerned WUAs, IDDs, and DADOs.11 In each subproject, a six-member credit management committee (CMC) with a chairperson, a co-chairperson and a secretary will be established to facilitate the process. CMC has seed multiplication and women microenterprise subcommittees with the latter comprising women beneficiaries. The MFIs will also identify appropriate CBOs during the process, to be trained and engaged by the PIU. For each subproject, a staff in the concerned IDD will be assigned as subproject coordinator. After the PIU approves the implementation plan with the assistance of the consultant, the assigned agents will implement the plan. 19. Using the JFPR grant provided to RMDC and re-lent to them, the selected MFIs will implement microfinance activities, including forming groups of potential borrowers and skills development training, in coordination with the CMCs who play a facilitating role. DOA and DADO staff will be responsible for providing foundation/base seed and training in seed multiplication, although the activities may be provided by eligible private sector resource persons as appropriate. DOI and IDD staff will also give training in on-farm water management to support the seed multiplication and microenterprise activities. In about 20 subprojects, and with the advice of the PIU consultant, the PIU will engage capable MFIs to undertake training to develop WUA/CMC capacities as savings and credit cooperatives, which would eventually make them eligible to undertake microfinance activities directly under RMDC or under private banks 11 The contract between PIU and the selected MFIs will be effective up to the approval of the JFPR implementation

plans, after which the MFIs will start to work with RMDC for microfinance operations.

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without any intermediaries. The subproject coordinator will be responsible for monitoring the quality of the services provided, and report to the PIU if the concerned service providers need quality improvement. The PIU consultant, ADB missions, and other assigned external monitor will also review and monitor performance. The general terms of reference for the PIU and MFIs are in Appendix 4.

3. Relending and Onlending Arrangements for Microcredit Activities 20. In response DOI’s decision on the eligible subprojects, RMDC will receive the JFPR grant and relend the proceeds to the IAs at a rate covering its required spread for an end rate to the IAs of about 6.5%. The cost of the project funds for RMDC will be reviewed by ADB periodically as needed. Funds re-lent to the IAs for the purpose of providing loans to subborrowers will be for an initial period of 24 months with quarterly payment of interest only; subject to satisfactory performance, they may be extended to 36 months with quarterly repayment of interest and semiannual repayments of principal. 21. The IAs will onlend to subborrowers to finance seed multiplication and women enterprise activities. The subborrowers will be able to borrow up to 75-90% of the total investment (estimated at $50-$75) for 12-18 months. Borrowers will have to form groups and save up to 10 % of the income, for which they will receive a stipulated rate of interest payment. Loan funds will be made available to the borrower in one installment. No collateral will be required. Loans will be given against a group guarantee. Repeat loans will be available provided the first loans are repaid on time. The interest rate charged on loans will be market-based. CMC will help the MFIs to (i) guide potential borrowers to prepare loan requests, (ii) review such requests and give approval, (iii) disburse loans, (iv) collect repayment, and (vi) mobilize savings among their members.

4. Linkages to the ADB-Financed Project 22. The counterpart project (SISP) has four main components: (i) strengthening the WUAs, (ii) improving and constructing FMISs, (iii) providing vehicles and equipment, and (iv) providing agricultural extension services. SISP has training for WUAs, but the provision of modern seed and microcredit was expected to come through other projects and a loan from the World Bank. However, due to the vast and disperse nature of the agriculture sector in Nepal, the intended beneficiaries under SISP could not be serviced as intensively as proposed here. With the proposed JFPR Project, the impact of SISP on poverty will significantly improve.

5. Sustainability

23. Sustainability is envisaged through intensive training of WUAs, which are already legal entities registered under the Water Resources Act. WUAs will be turned into functional institutions that can run their own affairs without outside support and demand required services from line departments and MFIs by the end of the Project. Seed multiplication will become a profitable activity on its own and will be sustained through market forces. Preliminary projections made on the use of the credit fund – based on the anticipated repayment rate and rate of interest in line with the market in Nepal – show that it will cover the cost of administration and an allowance for loan losses (repayment defaults), as well as imputed capital cost, suggesting that a sustainable revolving fund can be achieved in due course. It is anticipated that a viable institutional base will be created for delivery of microcredit to the rural poor.

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6. NGO and Community Involvement 24. Community involvement is critical to the success of both projects. Beneficiaries were involved in the JFPR Project design. They will be consulted at every stage of implementation and will be at the center of the participatory evaluation of the project impact. On the basis of market forces, potential clients will decide whether it is worthwhile to get into seed multiplication activities that can be complex. The content and plans of the multifaceted training program will need inputs from the beneficiaries. The CMC and its members will be consulted before credit conditions and norms are finalized. The JFPR Project will start with awareness building and sensitization of potential beneficiaries through community mobilization. Community demand for credit and improved seeds is to be stimulated through self-assessment of the communities themselves. The communities will provide feedback on the flow of benefits through participatory evaluation. Local MFIs will play a lead role in community mobilization, credit operation, training, and impact evaluation.12

7. Fund Flow, Procurement, Consulting Services, and Disbursement 25. JFPR funds will be used for two main activities: project implementation and RCF. Two JFPR accounts will be established in NRB: one for RMDC for microfinance activities and the other for DOI for the rest of the activities. Specific details of this account will be provided in a PIM. The PIU will carry out overall project coordination and management, and disburse the necessary fund for implementing field-level activities except those under RCF, with the subproject coordinators in IDDs responsible for monitoring, reporting, and advising the PIU directly on the quality of services by MFIs and other service providers. The PIU will also provide the subproject coordinators with sufficient funds for necessary monitoring activities. 26. The PIU will be responsible for recruiting eligible MFIs with the assistance of the consultant engaged by ADB. For non-RCF activities, the PIU, in consultation with DOI, DOA, and WUAs of target subproject areas, will develop a 6-month work plan, which will be used to determine requests for the amount of advance payment. The amount will not exceed $100,000. Funds will be used primarily for the consultant, MFIs and CBOs, field visits and monitoring, training, administration, and equipment. Goods and services will be procured in accordance with ADB’s Guidelines for Procurement and Guidelines on the Use of Consultants. Given their size, all contracts will be awarded through local competitive bidding because the amounts involved will not exceed $500,000 per package. As to RCF activities, once the selected MFIs have determined – through the activities of the first year of the JFPR Project – the credit demand for its operations, ADB will transfer the requisite RCF amount to the RMDC account.

8. Performance Monitoring Indicators 27. Performance monitoring indicators relate to project implementation as well as impacts. Implementation-related indicators include contracted seed multipliers (number), start-up funds provided for seed multiplication (amount), CMCs established and trained (number), CBOs recruited and trained (number), beneficiaries covered in the awareness-building campaign and credit orientation (number), skills training for women (number), credit applications received (number), loans processed and disbursed (number and amount), loan repayment (amount), fund size (amount), administration costs (percent), repayment rate (percent), and loan arrears (percent). Impact indicators will include amount of improved seeds produced and marketed, number of farmers who adopted the package of seed-water-fertilizer technology and the

12 Local NGOs have successfully carried out similar activities under SISP.

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percentage of small and marginal farmers; number of women who received credit and started microenterprises, changes in rice yields and total production, changes in household income of JFPR beneficiaries, and changes in poverty in each subproject area.

9. Reporting, Accounts, and Audits 28. The PIU and RMDC will report on their respective JFPR activities quarterly. A detailed annual status report using the performance indicators is required. This report will be distributed to the Government and other stakeholders. The PIU and RMDC will maintain separate accounts and financial statements of the JFPR subprojects and have them audited annually by auditors acceptable to ADB and in accordance with sound auditing standards. Certified copies of the audited reports will be submitted to ADB in English, within 9 months after the close of the relevant financial year. E. Impact Assessment

1. Sustainable Poverty Reduction Impact 29. Given its seasonal nature and peculiar requirement for capital and foundation seed, seed multiplication involves a business risk that keeps the private sector away from the venture. The public sector (DOA) cannot reach out to small and poor farmers in the far-flung areas without external support. Seed multiplication and provision of requisite training along with microcredit at the farm level are viable options to bridge the productivity gap and get positive results in a short period. Since local MFIs work closely with the beneficiaries in their villages, by engaging CBOs,13 these activities could help the poor farmers break the low-input low-output vicious cycle of agricultural production. It is estimated that through increased production, the poverty gap will be reduced for 12,000 marginal and small farm households or 84,000 people. The estimated poverty reduction impact is discussed in Appendix 5.

2. Participatory Development Issues 30. Multiplying the seed of main crops through NGOs will be a financially sustainable operation involving local farmers. The impact of this component will also readily spread beyond the WUA members. The revolving fund for microcredit will help generate savings from the members and keep them sustainable in the long term. Skills training for women will have a structural impact on poverty reduction by adding new and profitable sources of income to the households. A pilot training program for WUAs under SISP has demonstrated that there are motivated and appropriately trained MFIs in Nepal that can readily implement on a sustainable basis a project such as the one being proposed here. F. Risks, Assumptions, and Assurances 31. A potential delay in implementation is an important risk. Another important risk is the lack of coherence in implementing the various components of the proposed JFPR Project. This is why implementation responsibility will be largely vested in MFIs and the communities themselves. However, particular attention will be paid to timely implementation of the training component, which will enable beneficiaries to take advantage of productivity and income- enhancing opportunities. Credit offtake by women may be slow because of lack of understanding of credit operations and income-generating activities. MFIs will have to be

13 This model has already been successfully tested under SISP.

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particularly sensitive to the needs of rural women. Markets may be lacking in some areas especially in the mountain regions. Both MFIs and WUAs/CMCs must make an effort to assess market potential.

IV. THE PRESIDENT’S DECISION 32. The President, acting under the authority delegated by the Board, has approved ADB administering assistance not exceeding the equivalent of $1,000,000 to the Government of Nepal, to be financed on a grant basis by the Japan Fund for Poverty Reduction, for Optimizing Productivity of Poor Water User Associations, and hereby reports this action to the Board.

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JFPR PROJECT FRAMEWORK

Narrative Summary Indicators and Targets Monitoring Mechanisms

Key Assumptions

Goal Reduced poverty in farmer managed irrigation schemes (FMISs)

Average annual household income raised by at least 30% from NRs31,500 by 2007

Participatory evaluation Project completion report

Goal Level High level of commitment of the Government and Water User Associations (WUAs)

Purpose Improve productivity of poor farmers in the FMISs developed under the Second Irrigation Sector Project (SISP) Increase employment and income of poor rural women on a sustainable basis

Productivity of wheat and paddy for 20,000 farm households in 100 subprojects increased by at least 25% from 2.75 to 3.50 tons/hectare by 2007 Sustainable microenterprises established for at least 5,000 poor rural women by 2007

Project completion report Postevaluation report

Purpose Level Output and input prices maintain at least their long-term average Government's microcredit reforms implemented effectively

Components/Outputs Seed multiplication Microenterprises for women Training

Start-up financing provided to 4,000 farmers for seed multiplication in 100 subprojects/WUAs (1,000 in 2005 and 1,500 each in 2006 and 2007) Start-up financing provided to 5,000 women in 100 subprojects (1,000 in 2005 and 2,000 each in 2006 and 2007) Credit management committees (CMCs) established in each participating WUA Community-based organizers (CBOs) selected and trained in as many subprojects by 2003 Specialized training conducted by resource persons for 100 WUAs CMC members trained in 100 subprojects Members of community mobilized in 100 subprojects Skills training given to 20,000 farmers and 10,000 women

Project progress reports Project completion report Project progress reports and Asian Development Bank (ADB) review missions

Component Level Ample foundation seed made available by Government research institutions Government's microcredit reforms implemented effectively Line agencies' commitment strong

Activities for Outputs Seed multiplication Start-up financing, foundation seed, and training provided to farmers Credit Revolving credit funds in 150 subprojects and as many CMCs established, operational procedures and manuals, developed

Start: 2Q 2004 Complete: 1Q2007 Responsible: microfinance institutions (MFIs), Department of Agriculture (DOA) Start: 2Q 2004 Complete: 1Q 2007 Responsible: microfinance institutions (MFIs)

Project progress reports and ADB review missions

Activity Level Ample foundation seed made available by Government research institutions Government's microcredit reforms implemented effectively

Appendix 1

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Narrative Summary Indicators and Targets Monitoring Mechanisms

Key Assumptions

Training Training of CBOs for intensive community mobilization; CMCs for financial management for microcredit, savings, and skills; and farmers for agricultural extension, storage, and marketing carried out

Start: 2Q 2004 Complete: 1Q 2007 Responsible: MFIs

Inputs Revolving credit Equipment and other capitals Supplies Training, workshops, seminars Consulting services Project Management Rural Microfinance Development Center (RMDC)/MFI services Contingencies

Resources $550,000 $20,000 $40,000 $60,000 $90,000 $90,000 $50,000 $100,000

Appendix 1

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COST ESTIMATES AND FINANCING PLAN

Input

1. Revolving Credit Facilities 275 275 0 0 0 5502. Civil Works 0 0 0 0 0 03. Equipment,Machinery,Materials and Other Capital Costs 10 10 0 0 0 204. Supplies 10 10 0 20 0 405. Training, workshops,seminars 20 10 30 0 0 606. Consulting Services 0 0 40 40 10 907. Project Management including management of specific components by PIU including CBOs 0 0 0 80 10 908. RMDC and MFI services (for handling and managing operation of RCF and microcredit and savings through the WUAs)

0 0 50 0 0 509. Contingencies 0 0 - 100 0 100

Subtotal JFPR financed 315 305 120 240 20 1,000Government contribution 10 20 25 40 5 100Civil society and others' contribution 0Contribution of the poor 30 30 60Total project costs 355 355 145 280 25 1,160 Note:* Detailed information required for Government of Japan and Controllers ** This information will be derived from the specific project components and the Project Framework of the Project design.

Component 3 Training

Component 4 Project

Management

Component 5 Benefit

Monitoring and Evaluation

Total (Input)

Japan Fund for Poverty ReductionCost Estimates ($ '000)

Component 1 Seed

Multiplication

Component 2 Micro-

enterprises for Women

CBO = community-based organizer, JFPR = Japan Fund for Poverty Reduction, MFI = microfinance institution, PIU = project implementation unit, RCF = revolving credit funds, RMDC = Rural Microfinance Development Center, WUA = water user association.

Appendix 2

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JFPR PROJECT STRUCTURE

Direct Guidance, Administration, and Supervision Technical Guidance and Assistance Coordination Funds Flow Performance Monitoring JFPR Plan Preparation

Irrigation Development

Divisions (IDD)

DOI/ PIU JFPR Coordinator and ADB Consultant

Microfinance Institutions

Seed Suppliers

WUAs/ CMCs/ Beneficiaries <Seed Multiplication> <Poor Women’s Microenterprise>

Department of Agriculture

(DOA)

Regional Irrigation

Directorate (RID)

District Agricultural

Development Office (DADO)

Rural Microfinance Development Center

ADB = Asian Development Bank, CMC = credit management committee, DOI = Department of Irrigation, JFPR =Japan Fund for Poverty Reduction, PIU = project implementation unit, WUA = water user association.

Appendix 3

14

GENERAL TERMS OF REFERENCE FOR PROJECT IMPLEMENTATION UNIT (PIU) AND

MICROFINANCE INSTITUTIONS (MFIs)

1. A project implementation unit (PIU) to coordinate and manage Japan Fund for Poverty Reduction (JFPR) activities will be established in the Department of Irrigation (DOI) headed by the JFPR project coordinator. At the field level, microfinance institutions (MFIs) including nongovernment organizations (NGOs) with MFI licenses will work with the water users associations (WUAs) and credit management committees (CMCs). With the assistance of the consultant engaged under the JFPR, the PIU will carry out these tasks:

(i) Undertake an information campaign for the JFPR Project and identify eligible subprojects that meet the specified criteria.

(ii) Identify and engage local MFIs with potential for participating in the project activities, assess their experience, staff qualification, gender awareness, and financial and managerial capacity, with the assistance of the consultant engaged by the Asian Development Bank (ADB) and in coordination with the Rural Microfinance Development Center (RMDC).

(iii) Supervise MFI activities to prepare the JFPR implementation plan for the concerned subproject WUAs.

(iv) Train and engage community-based organizers (CBOs) and supervise their activities through subproject coordinators assigned in the divisional or subdivisional offices.

(v) Coordinate with RMDC in implementing microfinance activities under the JFPR implementation plan.

(vi) Coordinate with the Department of Agriculture (DOA) and arrange for specific services that DOA needs to implement the JFPR plan.

(vii) Undertake impact evaluation with the support of CBOs and MFIs.

2. Following the project implementation memorandum, the selected MFIs engaged by the PIU during the initial stage will undertake these tasks:

(i) Prepare a time-bound and specific work plan within 1 month of contract award and present it to the PIU and ADB for review and concurrence.

(ii) Carry out participatory assessment of the demand for project services, i.e., seed multiplication, microcredit for women, training, and social mobilization.

(iii) In the eligible subprojects identified by the PIU, organize for all stakeholders orientation workshops, seminars, and discussion sessions on project objectives, scope, activities and procedural requirements.

(iv) Identify appropriate CBOs, and assist WUAs in establishing CMCs. (v) In consultation with the WUAs, CMCs, and potential beneficiaries, prepare

implementation plans for the designated subprojects, for approval by the PIU. 3. After the implementation plans are approved, the selected MFIs will receive loans from RMDC, and will undertake the following activities using the loan proceeds:

(i) Select eligible beneficiaries for participation in JFPR project activities, form groups, and organize saving activities by the group members.

Appendix 4

15

(ii) Undertake microcredit activities with the groups that have met the specified criteria. (iii) Prepare and provide the required skills training to subborrower groups. (iv) Coordinate with the PIU in providing specialized extension services for seed

multiplication. (v) Prepare and transmit regular quarterly and annual reports to the executing agency

and ADB.

Appendix 4

16

EXPECTED IMPACT ON POVERTY REDUCTION

1. The Japan Fund for Poverty Reduction (JFPR) Project aims to reduce poverty by optimizing the productivity of poor and marginal farmers in the small-scale irrigation schemes being developed under the counterpart project, the Second Irrigation Sector Project (SISP). Through better extension training and access to improved seed, farmers will increase their productivity. The JFPR Project will enhance communities' capacity for sustainable credit delivery. The current productivity gap will be narrowed, as farmers will reap greater benefits from irrigation. Availability of microcredit and access to specialized training will increase income and employment opportunities for women. It is anticipated that by the end of the JFPR Project, some 30,000 farmers will have access to improved seeds, and microcredit will be available to 5,000 women. The poverty of about 145,000 people will be reduced. The attached table gives a quantitative projection of the likely poverty reduction impact on potential beneficiaries. Gaps in the poverty rates (percentage shortfall of income from the poverty line) of marginal, small, medium, and large farmers are compared under three scenarios: without SISP, with realized income gains under SISP, and with potential income gains with the JFPR Project. It is evident that the JFPR Project will substantially reduce the poverty of marginal and small farmers while medium and large farmers will be lifted further above the poverty line. The indicative quantitative impact on the marginal and small farmers, who represent three quarters of all farmer households, is a major progress, considering that without the JFPR Project they would remain extremely vulnerable. For example, without the SISP, the poverty gap of marginal farmers was 70%, which was reduced to 52% with gains realized from SISP, and will further be reduced to 37% with the JFPR Project.

2. The marginal and small farmers and women in Nepal have historically suffered from different forms of inequalities, particularly in the distribution of land. Notwithstanding land reform, the distribution of landholding in Nepal has become more skewed over the past two decades. Low economic growth, political instability, low agricultural productivity and degradation of the environment, poor infrastructure, lack of access to capital and market, and inadequate opportunities for nonfarm employment, especially for women, have exacerbated the plight of families. SISP, complemented by the JFPR Project, will address many of these concerns within a reasonable time. SISP will provide efficient irrigation while the JFPR Project will enable the farmers to make optimal use of water and to broaden the income base by undertaking off-farm income- generating activities. Besides, the JFPR Project will introduce a strong gender-sensitive element to deal with the poverty and marginalization of rural women in Nepal.

3. The JFPR Project will provide improved agricultural extension, and storage and marketing support. It will establish a sustainable mechanism for credit deliveries to those who do not otherwise have access. This mechanism will enable the poor and women to initiate income-generating activities. There is a great deal of emphasis on intensive community mobilization to fill the agricultural productivity gap, to invest in skills training, and to organize and self-manage a microcredit system in the selected subproject areas. Water user associations (WUAs) will receive specialized training to be more responsive to the needs of marginal and small farmers. Due to the limited capacity of the Government, seed multiplication is ineffective and quality seeds are not available to farmers. This will change under the JFPR Project, which is designed to support efficient and sustainable seed multiplication through private initiatives and to make market forces guide seed distribution. One of the main emphases of social mobilization is to create a large body of credit-literate poor and women. Skills training will enable women to look for employment opportunities outside of their homes and/or to initiate income-generating activities of their own. In either case, family income will increase and poverty will be reduced.

Appendix 5

17

Table A5: Estimated Poverty Reduction Impact

Item Year 1 Year 2 Year 3Total number of farmers in the program 6,000 18,000 30,000% of farmers using optimal seed-water-fertilizer 40 60 100Number of farmers using optimal seed-water-fertilizer 2,400 10,800 30,000% increase in yield to fill productivity gap (according to the projection of SISP) 10

10 10

Additional increase in yield due to optimal use of input and water 15 15 15Projected per capita incremental income with SISP (NRs)

Marginal farmers 743 743 743Small farmers 867 867 867Medium farmers 4,131 4,131 4,131Large farmers 3,933 3,933 3,933

Increase in income attributable to JFPR Project Marginal farmers 743 743 743Small farmers 867 867 867Medium farmers 4,131 4,131 4,131Large farmers 3,933 3,933 3,933

Projected income per capita with JFPR Project Marginal farmers 2,831 2,831 2,831Small farmers 4,046 4,046 4,046Medium farmers 13,593 13,593 13,593Large farmers 13,811 13,811 13,811

Poverty line (NRs per capita) Hills 4,570 4,570 4,570Terai 4,370 4,370 4,370

Percentage distribution of farmer groups Marginal farmers 37 37 37Small farmers 37 37 37Medium farmers 15 15 15Large farmers 11 11 11

Number of JFPR farmers by group Marginal farmers 2,206 6,620 11,033Small farmers 2,218 6,658 11,086Medium farmers 913 2,740 4,566Large farmers 663 1,982 3,315

Poverty gap with realized income per capita with SISP Marginal farmers 52 52 52Small farmers 29 29 29Medium farmers -111 -111 -111Large farmers -121 -121 -121

Poverty gap with potential income per capita with JFPR Project Marginal farmers 37 37 37Small farmers 9 9 9Medium farmers -204 -204 -204Large farmers -209 -209 -209

Appendix 5

JFPR = Japan Fund for Poverty Reduction, SISP = Second Irrigation Sector Project.