VZCZCXRO1446
OO RUEHCI
DE RUEHKT #1142/01 1621310
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O 111310Z JUN 07
FM AMEMBASSY KATHMANDU
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UNCLAS SECTION 01 OF 04 KATHMANDU 001142 
 
SIPDIS 
 
SIPDIS 
 
MANILA FOR ADB 
 
E.O. 12958: N/A 
TAGS: PREL PGOV ETRD EAID SENV NP
SUBJECT: MELAMCHI: ADB'S $350 MILLION DREAM IN JEOPARDY 
 
REF: KATHMANDU 3228 
 
Introduction 
------------- 
 
¶1. (SBU) The future of the Asian Development Bank's (ADB) USD 
350 million Melamchi Water Supply Project has grown 
increasingly uncertain since the new Maoist Minister for 
Physical Planning and Construction, Hisila Yami, decided in 
early May to postpone awarding the contract for the 
management of the Kathmandu Vally Water Utility to a private 
British firm, Severn Trent Water International (STWI).  Yami 
announced on May 8 that she intended to review the cabinet 
decision of the previous government to follow ADB's 
recommendation to award the contract to STWI.  Despite strong 
statements by ADB that if the contract were not awarded by 
May 15, ADB would terminate its loan commitment, the GON 
failed to act.  STWI, which had already extended the deadline 
for the award nine times, pulled out on May 21.  On May 22, 
ADB announced that it would not extend the loan commitment 
for the project beyond June 30.  On June 6, Paul Heytens, the 
new Nepal Asian Development Bank (ADB) Director, told the 
Ambassador that the Melamchi Water Supply Project was a very 
important project for the ADB.  However, Heytens stated that 
the ADB had to consider the larger issue of continuity of 
reforms.  The GON's refusal to honor its reform commitments 
sent, he said, a very negative message to donors and 
investors.  On June 8, the GON decided to ask ADB not to pull 
out, but instead explore new alternatives, including 
rebidding the management contract. 
 
The Project Outline 
------------------- 
 
¶2. (SBU) The scheme for the Melamchi Water Supply Project was 
first adopted in 1992 as a comprehensive, long-term solution 
to the chronic water shortages in the Kathmandu Valley. 
(Note: The daily supply of water in the Kathmandu Valley 
meets only 50 percent of the demand (reftel A) End Note.) 
Despite the high cost, bringing water from the Melamchi 
Valley through a man-made tunnel appears to be the only 
realistic and sustainable means to supply drinking water to 
the Kathmandu Valley.  The current Asian Development Bank 
(ADB) project actually consists of two projects; one for the 
construction of the tunnel, infrastructure and water supply 
system, "The Melamchi Water Supply Project" (MWSP), and the 
second for the improvement of the water supply utility in 
Kathmandu, "The Kathmandu Valley Water Services Sector 
Development Program" (KVWSSDP).  The second project was 
initiated in recognition of the fact that the supply 
infrastructure and lack of bulk water sources was not the 
sole cause of Kathmandu's chronic water shortage: The poor 
performance of Nepal Water Supply Corporation (NWSC) was also 
a major problem.  Management reforms and restructuring were 
deemed necessary to justify investment in the supply 
infrastructure. 
 
The Reforms 
----------- 
 
¶3. (SBU) Despite repeated efforts over a number of years, 
including the provision of extensive capacity building 
technical assistance, the NWSC did not succeed in providing 
better service.  As a result, the ADB re-designed the project 
to link investments in physical infrastructure with major 
institutional reforms.  The Bank considered engagement of the 
private sector water service management company essential for 
the success of the project due to the likely politicization 
of a public company.  On December 18, 2003, the Asian 
Development Bank approved loans of USD 15 million for the 
Kathmandu Valley Water Services Sector Development Program 
(KVWSSDP) for institutional reforms and the introduction of 
private sector participation through a performance-based 
 
KATHMANDU 00001142  002 OF 004 
 
 
management contract for managing water supply and wastewater 
service delivery in the Kathmandu Valley.  These reforms 
included restructuring of the NWSC and the establishment of 
three new entities: the Kathmandu Valley Water Supply 
Management Board (KVWSMB), the water authority responsible 
for policy setting and asset owning; Kathmandu Upatyaka 
Khanepani Limited (KUKL), the water utility operator 
responsible for the operation and management of the water 
supply and wastewater systems; and the Water Supply Tariff 
Fixation Commission (WSTFC), the board responsible for 
regulation and protection of consumer interests. 
 
Background:  A Rocky Road 
------------------------- 
 
¶4. (SBU) The initial estimated cost of the total Melamchi 
project was more than USD 464 million.  A coalition of donors 
and investors was formed to support the large and complex 
undertaking.  In 2005, two of the investors, the Norwegian 
Agency for International Development (NORAD) and the Swedish 
International Development Cooperation Agency (SIDA), pulled 
out due to the King's seizure of political power, leaving a 
funding gap in the project of approximately USD 100 million. 
Despite the adverse political environment and serious funding 
issues, the ADB extended its loan commitment into 2007 to 
give the GON time to make the necessary institutional 
reforms.  To date, the GON has carried out most of the 
difficult reform measures, including the establishment of the 
three new entities.  The signing of a management contract 
(MC) with a private sector water service management company 
was the final step in the lengthy reform process that the GON 
committed to more than three years ago. 
 
Hisila Yami Kills the Deal 
-------------------------- 
 
¶5. (SBU) On May 8, the new Maoist Minister for Physical 
Planning and Construction, Hisila Yami, refused to award the 
water utility operator management contract to UK's Severn 
Trent Water International (STWI) as recommended by the ADB. 
Yami  cited concerns about STWI's record and complained that 
the contract had been sole sourced.  (Note: A few of STWI's 
misdeeds include: the company was found guilty of over 
charging British consumers; the company was expelled from 
Guyana before completing its contract, and the company's 
contract in Trinidad and Tobago was terminated due to local 
public protests. End Note.)  In his June 6 meeting with the 
Ambassador, Paul Heytens, the new Nepal ADB Director, 
acknowledged that STWI did not have a perfect record, but 
defended ADB's decision, explaining that STWI had been 
selected through a rigorous international competition. 
Heytens told the Ambassador that claims that the contract had 
been sole sourced were incorrect.  Four bidders, who were all 
international companies, were pre-qualified and short listed. 
 However, Heytens explained, due to the political instability 
and related economic risk, the other three bidders had pulled 
out of the competition.  Moreover, Heytens commented, the 
negations between the government and STWI had been difficult 
and protracted.  STWI had extended the validity of its 
proposal nine times, with the last extension expiring on May 
¶15. 
 
Privatization 
------------- 
 
¶6. (SBU) In defense of her decision to prevent the award of 
the contract, Yami also expressed concerns over 
"privatization," the placing the management contract for the 
distribution of drinking water in "foreign hands."  Heytens 
stated that the label "privatization" was not accurate, as 
government assets were not being transferred to a private 
company.  He explained that, in a market economy, it is 
common for the private sector to be involved in service 
 
KATHMANDU 00001142  003 OF 004 
 
 
provision.  The real issue, he stressed, was how to ensure 
proper governance (i.e. checks and balances) for better 
service delivery to the people.  Governance arrangements had 
been very carefully prepared over the last three years for 
the KUKL, KVWSMB, and WSTFC through enactment of new laws, 
appointments of qualified Nepali managers, and broad-based 
representation at these entities.  Heytens stressed that the 
appointment of a private management contract was a key 
covenant in ADB's funding commitment.  While ADB was open to 
involving local consultants, no Nepali company met ADB's bid 
requirements for the management contract, and from the bank's 
perspective there was no alternative to a private management 
contract.  At the end of the bidding process STWI was the 
only eligible company still at the table. 
 
A New Management Project 
------------------------ 
 
¶7. (SBU) On May 21, STWI released a statement that it was 
pulling out of the project.  In response to the Ambassador's 
question about the possibility of rebidding the contract, 
Heytens replied that ADB did not have much flexibility given 
that the bidding process had already lasted nearly two years. 
 Heytens explained that this was actually the third attempt 
in the history of Melamchi to recruit a private water supply 
operator.  Two unsuccessful attempts has been made between 
1998 and 2002 with World Bank support.  Thus, the failure to 
complete the current tendering process is likely to 
complicate future efforts to attract international bidders in 
the water sector, and would significantly delay a 
comprehensive solution to the acute water shortages in the 
Kathmandu Valley. 
 
Is Melamchi Dead? 
----------------- 
 
¶8. (SBU) Heytens explained that the ADB MWSP loan commitment 
would have expired at the end of March 2007, but was extended 
to the end of June 2007, with the expectation that final 
conditions, including the award of the management contract 
would be completed within this time frame.  ADB's Melamchi 
Mission chief Keiichi Tamaki was then scheduled to request 
ADB's board in Manila to extend the loan commitment through 
¶2013.  However, without appointment of a private management 
contractor, there would be no basis to argue for an extension 
of the funding commitment.  Heytens also emphasized that 
there was a larger issue of continuity of reforms and 
government.  He stressed that the GON's refusal to honor its 
reform commitments sent a very negative message to donors and 
investors.  Moreover, if the GON refused to come to the table 
prepared to sign the contract, it would be very difficult for 
ADB to ever find the same level of funding again. 
 
Yami Backing Down 
----------------- 
 
¶9. (SBU) Since May 8, Yami has reportedly backed away from 
her initial hard-line stance opposing any private management 
contract, but she remains adamant on not awarding the 
contract to STWI.  On June 8, the GON issued a statement 
asking ADB not to back out, but rather to work with the GON 
to find a way to implement the project through mutual 
agreement.  Yami reportedly wanted to explore "new 
alternatives", among them the appointment of a new management 
contractor through re-bidding or the exploration of ways to 
implement the project without a management contractor.  ADB 
officials on the other hand told Emboff June 8 that, if the 
GON wants Melamchi to happen, the GON will have to come back 
to ADB with a common vision and solid assurances and 
commitments. 
 
Future of Melamchi: Our Best Guess 
---------------------------------- 
 
KATHMANDU 00001142  004 OF 004 
 
 
 
¶10.  (SBU) ADB has given no indication that it would be 
willing to abandon the requirement for a private management 
contract.  To the contrary ADB has repeatedly stated that the 
requirement for a private management contract was a key 
convenant in the loan agreement.  Whether STWI would agree to 
come back to Nepal is also uncertain.  Still our guess it 
that, if Yami backs down, the ADB will try to save the 
project.  But that is a big "if." 
 
 
Melamchi's Effect On Future Development 
--------------------------------------- 
 
¶11. (SBU) The controversy that Hisila Yami has generated 
around the Melamchi project will undoubtedly have long-term 
consequences for the people of Nepal and the future of aid 
from the ADB, as well as other donors.  Yami's refusal to 
abide by the decision of the previous Cabinet sent a very 
negative signal to the outside world on the coalition 
Government's willingness to honor previous reform 
commitments, damaging its credibility with development 
partners and international investors.  Political continuity 
is essential to long-term development, and Yami's decision 
has undermined Nepal's credibility.  Future consequences are 
likely to include diminished overall development and reduced 
investment. 
 
Kathmandu Will Remain Thirsty 
----------------------------- 
 
¶12. (SBU) The negative economic ramifications are huge.  A 
substantially amount of money has already been spent on 
preparations for the project.  This amount includes USD 8.6 
million dispersed under an ABD loan which will have to be 
repaid regardless of whether the project is ever completed. 
In addition, the government has already spent over USD 14 
million for the acquisition of land  for access road and the 
supply infrastructure.  And then there is the water crisis. 
As there are no alternatives to Melamchi, the abandonment, or 
even further delay of the project, means that the population 
of Kathmandu will continue to suffer severe water shortages 
and unsanitary conditions.  Whether Yami's refusal to hand 
over Melamchi's management contract to Severn Trent is a 
demonstration of more anti-business, collectivist measures to 
come from the Maoists remains to be seen.  Yami may have 
backed herself into a corner she does not like and may yet 
try to save Melamchi.  Unfortunately, it is the people of 
Nepal who will likely suffer from Yami's lesson in real world 
economics. 
MORIARTY