The prime premise in Clarence Ayres' Theory of Economic Progress (1962) is that the pace of advance in a society is driven by cumulative technological evolution. Technology is not tools alone but encompasses irreducibly the human skills and ideas necessary to make and use tools for instrumental purposes. Technological progress depends on the flexibility of the counterpart institutional setting. The degree of institutional resistance or opposition inheres in five ceremonial features: social stratification; a system of conventions, or mores; the potency of magical beliefs or ideology; the emotional conditioning of socialization; and the mystical rites and ceremonies that codify and intensify the institutional patterns of behavior (viii). In his most celebrated phrase, Ayres wrote, "Thus what happens to any society is determined jointly by the forward urging of its technology and the backward pressure of its ceremonial system" (ix). Surprisingly, his challenging thesis has rarely been applied as an overarching f ramework to guide practical development policy work in sectors at the country level.
This field report sketches Nepal's economic conditions, explains the motivation for forwarding information technologies in the context of financial sector reforms, and identifies the founts of institutional resistance to their adoption. To date, these institutional obstructions have remained sufficiently powerful to slow to a crawl the pace of technological innovation in Nepal's financial sector.
Nepal's peoples are among the poorest in the world, enjoying a per capita income of $246 in 2002 (HMGN 2002, 13). The traits associated with a very low average income are amply represented. About 90 percent of the population is dependent upon subsistence agriculture, the annual output of which is predicated on the incertitude of the monsoon. In the poorest regions, up to 70 percent of all families live below the poverty line. Population growth of 2.3 percent per year contributes to the intransigence of poverty, causes regional food shortages, and prompts migration into the urbanizing Kathmandu Valley. The country's difficult terrain and weak public administration combine to impede the delivery of government services in the hills and mountains. Extremely high transport costs thwart merchandise movements and limit the extent of the market. A Maoist insurgency is active in sixty of the country's seventy-five districts. Persistent attacks have damaged the already thin rural infrastructure, destroyed schools and g overnment buildings, and inflicted more than 5,000 casualties in the past four years (IMP 2002, 6).
Despite these challenges, Nepal's economy grew at annual rates in the range of 4 to 6 percent during the 1990s. From 2001 to the present, the economy has stalled. Exports have been negatively affected by adverse global economic conditions. Manufacturing has slumped. Tourist revenues have dropped sharply. During the 199 1-2001 period of moderate growth, the service sectors played a leading propulsive role. Three subsectors--trade, restaurants, and hotels; transport, communications, and storage; and finance and real estate--grew at annual rates in the range of 5 to 8 percent (Adams 2001, 10). Despite grave balance sheet weaknesses, management deficiencies, and an immature regulatory environment, Nepal's financial sector contributed noticeably to the country's commercial and service expansion. Between 1995 and 2001, financial deepening occurred at an appreciable rate. As ratios to nominal GDP, savings deposits rose from 10 to 19 percent, fixed deposits from 11 to 16 percent, and demand deposits from 4 to more th an 5 percent (5).
In this setting, the government and the international development agencies seized upon financial sector reform as a potentially high-payoff area for institutional reform and modernization. Following the lessons of the Asian crisis, corporate governance, accounting standards, and the regulatory regime were to be strengthened in tandem with the financial sector reforms, most of which were directed at eliminating direct government ownership and management of commercial banks and other financial institutions.
Financial Sector Reform
Within the Asian Development Bank (ADB), this multidimensional program of institutional reform became known as the Corporate and Financial Governance (CFG) initiative, which has been given shape and direction through a sequence of grants and loans. In attempting to implement CFG reforms in Nepal after 1998, we adopted Ayres' technology-ceremonialism dichotomy as the basis for our policy design. The intuition was that CFG had to move in close orchestration with the introduction of information and communications technology (ICT). The combined payoff of CFG and ICT would add a full two percentage points to Nepal's GDP growth, moving it into the 7 to 8 percent range (Adams 1999). Credit flows would be redirected from capital-intensive to labor-intensive activities, so there would be employment and poverty-reduction benefits.
Although Ayresian theory formed the bedrock of our strategy, the marriage of CFG and ICT found much support in the logic of new institutional economics. Our review of the ADB's lending to the Agricultural Development Bank of Nepal (ADBN) pointed out that high transactions costs kept many farmers from taking our small loans. Farmers had to walk for hours, or even days, to reach an ADBN branch. Although most were illiterate, they had to complete forms and obtain documentation on land ownership. Few loans were issued in a timely manner. Information costs made it difficult for loan officers to select the most creditworthy borrowers and to monitor loan use and repayment. With many small rural branches, the ADBN network was afflicted with high internal information costs and delays in data processing. In consequence, the regional and central offices had little idea what their overall loan portfolios looked like, what proportion of loans was non-performing, and even whether the ADBN was solvent (Adams and Brunner 19 97). At about this same time, the government, the ADB, and other international development agencies recognized the futility of trying to upgrade the components of Nepal's financial sector on an individual basis. A consensus quickly emerged that a comprehensive, integrated secrorial reform strategy was required (Nepal Rastra Bank 2000; DFID 2000; World Bank 2002).
Because of its history of state ownership and management and of earlier steps at liberalization, Nepal's banking sector contains a mixture of diverse units. Two commercial banks that have historically been state operated held 51 percent of the system's assets as of July 2001 (World Bank 2002, 8). These are the Rastriya Banijya Bank (RBB) and the Nepal Bank Ltd. (NBL). The ADBN is also owned by the government, as is the Nepal Industrial Development Corporation (NIDC). The non-bank sector includes the Nepal Stock Exchange, insurance companies, a provident fund, and a mutual fund. The Nepal Rastra Bank (NRB) is the nation's central bank and is now in transition to the role of independent regulator.
Although the structure of the sector conveys an initial impression of breadth and health, the conduct of the units is uneven. The RBB, NBL, ADBN, and NIDC have very high ratios of non-performing assets and are insolvent. Although the private banks with foreign partnerships are quite profitable, most of the locally managed ones have questionable balance sheets. The hundreds of finance companies, cooperatives, and microfinance units are poorly supervised and rarely audited. In contrast to the disarray in the formal sector,. Nepal's informal financial institutions are surviving, if not thriving. Moneylenders still provide the bulk of rural credit. Their interest charges appear high, but they have much lower transactions and information costs built into their total loan costs than do the ADBN or commercial banks. Their differentiated offerings are very competitive (Adams, Brunner, and Raymond 2003). Much cross-border trade with India is financed through the traditional hundi system, and the hawala network convey s more than 90 percent of migrant workers' remittances back to Nepal (Seddon et al. 2000).
The Function of In formation and Communication Technologies
Because financial sectors are information intensive and beset by high transactions costs, their modernization throughout the world has been keyed to changes in information and communications technologies. Financial reform and development in Nepal cannot proceed without a discontinuous leapfrogging in adopting fully modern ICT systems (Claessens, Glaessner, and Klingebiel 2001). Financial institutions and microfinance organizations elsewhere are increasingly relying on ICT to track loans and accounts and to provide timely management information. Nepal's small financial sector exhibits high costs per financial transaction because of the lack of intense competition, the absence of large economies of scale, and a dearth of positive network effects. These deficiencies limit the extent, quality, and variety of financial services, The economic benefits and costs of ICT for finance have rarely if ever been measured comprehensively in a poor institutional environment like that of Nepal. The costs are up-front, and th ey have been accurately estimated in Nepal. In contrast, the economic benefits, although pervasive and large, have a mixed public good and private good nature, with network externalities, and are thus far more elusive than the costs.
The paucity of Nepal's ICT services is acute. The telephone penetration rate in the Kathmandu Valley is about 20 percent. The rate is as low as 0.1 percent in rural areas. The joint venture banks account for about 10 percent of the total branches but have 60 percent of the computers. The RBB, NBL, and ADBN have a computer reliance rate of only about 7.5 percent. None of the public sector banks has networked branches. When corporate clients need to pay funds to accounts in other banks, they usually hold correspondence accounts in them. This is an inefficient and costly method of corporate cash management. The number of automatic teller machines (ATMs) is extremely low at about a dozen nationwide.
To mesh ICT installations with the unfolding financial reform program, a consultant team was mobilized to conduct a detailed technical, operational, and market analysis. This effort demonstrated the feasibility of deploying a national ICT network relying on well-established technologies. For the financial sector, the objective was to create an ICT system that knits together customers, banks, and regulators, as well as interfaces with the banks' internal mechanisms. ATMs and a payments-clearing system are illustrative. Credit card services, business and consumer credit reports, and other conventional functions could be encompassed. The absence of a modern payments system in Nepal is a bottleneck for financial sector development. A payments system would comprise central clearing functions now undertaken on stand-alone PCs or processed manually at the NRB.
Five Points of Potential Institutional Resistance
By mid May 2000, the CEO reform process was well underway, with HMGN, the private sector, professional and civic groups, and the major international development partners actively involved (Adams, Maskay, and Tuladhar 2002). A combined CFG-ICT proposal was being prepared for ADB. There was a convincing intellectual case for moving ahead. Subject to the usual uncertainties, estimates of internal rates of return on the ICT dimension were favorable. Then, over the next twelve months or so, the ICT component was prized from the CFG ingredients and eventually stalled. There were five Ayresian institutional clusters that could have stymied the ICT initiative, As the decision-making process played out, two were facilitative and three were obstructive. Unexpectedly, ceremonial resistance was highest where it was least anticipated.
An initial concern was whether customers and clients were prepared for the adoption of ICT services in banks, businesses, and households. Several rounds of field surveys dispelled this worry. Although it is hard to estimate demand for financial services that do not exist and have never been priced, we found great public interest in ICT-based financial services. There is much public discontent with the inefficiencies and costs of availing of current deposit and credit products and with their narrow range. The public has considerable pent-up effective demand. Score + 1 for ICT.
Because government agencies and ultimately the Parliament and the Cabinet must approve the ICT project investment, a good deal of work had to be done in the Ministry of Finance, the National Planning Commission, the Ministry of Science and Technology, and the Nepal Rastra Bank, among other HMGN divisions, to ensure that there were ample knowledge and support. Although there was never full accord, the balance in government was very much predisposed toward the combined CFG-ICT package. There was considerable excitement that Nepal was going to be in a regional leadership position when a national ICT grid was in place. Score +3 for ICT.
In three other institutional nexus the reception to ICT was chilly. The first team of consultants worked primarily under a directive to map out the technical contours of a national ICT system. On a secondary level, the report was favorable about the economic desirability of the network, which could be used for financial services, telephony, information transfers among government units, and educational content for rural schools. A second team was supposed to look at the demand for services and work closely on fitting ICT into the financial sector's needs. Their final report downplayed any public good or social benefit impacts and concluded that a narrowly focused system managed by a partnership of the private banks, with a minimum of governmental involvement, would be the only financially viable option. Score -1 for ICT.
A second blockage arose when the representatives of the commercial banks, working in the Bankers Association, could not agree even on proceeding with the reduced ICT model. We had been conscious of some classic collective action and game-theoretic conundrums, such as free riding or the prisoners' dilemma. These were no doubt significant but could be overcome with transparency and information sharing. Where we erred was in not recognizing that the fifteen or so banks did not constitute a banking sector in which more or less homogenous firms with similar interests operated. There was a big divide between the public and private sector banks in their readiness to move to computerization and ICT systems and in their human resource capabilities. In the private sector, the joint venture banks with foreign partners were already sophisticated and some had already adopted in-house systems. Some banks had branches; others did nor. A few banks were tied closely to big family commercial houses and were devised to soak up public deposits for use in the combine. Ultimately, the banks could not agree to set up a public-private corporation to manage a limited ICT-grounded payments system. Score -2 against ICT.
Finally, the reception of the ICT initiative in ADB's Manila headquarters was mixed. A final decision on a project is taken only after assessments are offered by various internal constituencies, Economists raised questions about the economic and environmental impacts. By chance, a specially recruited team of external consultants was looking at the process of financial sector reform in several South and Southeast Asian countries, including Nepal. After a brief visit, they asserted that Nepal did not need a domestic financial sector and recommended reliance on foreign partnerships and financial service imports. Their report to a senior official challenged the need for the CFG project, including the ICT component. Some of the staff members involved in the evaluation wondered if Nepal could support a far-flung network of communications towers. Gradually, the winds of opposition to the ICT plan strengthened, even though benefit-cost calculations were favorable. In the end, stratification, attitudinal conservatism, and mystical bureaucratic rites prevailed. Score -5 for halting ICT.
The Ayresian Lesson
There is a totally compelling case for the interlinked advance of financial sector reforms and the requisite technological accompaniments: computers, trained technicians, communications networks, and information systems. In Ayresian terms, what is still playing out in Nepal is a disjunction of the CFG and ICT dimensions of this evolutionary process. Oddly, the consumers, bank customers, and businesspeople of Nepal are receptive to, even eager for, improved services, and so is most of Nepal's government. The lags imposed on the adoption of a vigorous ICT initiative center on three supposedly modern and more informed institutional complexes. To move forward, it will be necessary to identify a consultancy that can provide the right mix of technical and economic knowledge, helpfully applied in Nepal. There is a need to go back to the bankers, and to civic and business groups, to inform and educate them about the pervasive benefits of ICT compared with the low risks. Finally, the case for ICT in Nepal, and in the rest of the least-developed Asian economies, needs to be put forth with force and logical clarity in Manila. Unfortunately, aid disbursements are driven much more by lender agendas than by local needs (Easterly 2002).
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International Monetary Fund (IMF). Nepal: 2002 Article IV Consultation-Staff Report. Washington, D.C.: International Monetary Fund, September 2002.
Nepal Rastra Bank. Financial Sector Strategy Statement. Kathmandu: Nepal Rastra Bank, 2000.
Seddon, David, et al. Foreign Labor Migration and the Remittance Economy of Nepal. Norwich, U.K.: Overseas Development Group, University of East Anglia, July 2000.
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John Adams is a Visiting Scholar at the Center for South Asian Studies of the University of Virginia, and Hans-Peter Brunner is a Senior Economist at the Asian Development Bank in Manila, Philippines. This paper was prepared for the annual meeting of the Association for Evolutionary Economics at the Allied Social Science Association meetings in Washington, D.C., January 3-5, 2003. The assessments and opinions expressed are solely those of the authors and should not be attributed to any of the organizations with which they are affiliated. Similarly, attitudes or actions ascribed to organizations or groups should be taken as generic and not as those of any particular individual in those organizations or groups. A number of documents and reports related to Nepal's financial sector reform process may be accessed at http://www.neat.net.np.…