Nepal’s Fierce MCC Debate

Nepal’s Minister of Finance Gyanendra Bahadur Karki, seated left, and acting CEO of Millennium Challenge Corporation Jonathan Nash, seated right, sign the Nepal Compact, as Joint Secretary at the Nepal Ministry of Finance Baikuntha Aryal, standing left, and U.S. Deputy Secretary of State John J. Sullivan, standing right, look on Thursday, Sept. 14, 2017 in Washington.

Nepal is still trying to cement the political changes set in motion by the 2006 democratic movement. That year, the autocratic monarchy was forced to hand over executive powers to people’s representatives. Later in the year, Maoist guerrillas and the government signed a Comprehensive Peace Agreement, formally ending a decade-long civil war. An interim constitution was written in 2007.

This was followed in 2008 by an election to a Constituent Assembly, tasked with writing a permanent charter for the country. Even though the constitution was to be written within two years, the job could not be done even in four, and the assembly had to be dissolved in 2012. Then, in 2013, a second Constituent Assembly was elected, and it duly delivered a constitution in 2015 – albeit amid much controversy.

The new constitution buttressed Nepal’s republican image and heralded a new era of federalism.

The first set of three-tier elections – federal, provincial, and local – were held in 2017 under the new constitution, and the next round is due to kick off in April 2022. There are many hurdles to overcome to institutionalize federalism and consolidate recent democratic gains. COVID-19 continues to batter Nepali lives and livelihoods. Yet the country seems preoccupied with a comparably trivial issue: a bilateral grant agreement.

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Enter the MCC

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The Millennium Challenge Corporation (MCC) came into being in 2004 through an act of the U.S. Congress. Following the 9/11 terror attacks in 2001, the United States became increasingly concerned with potential sources of global hostility against it, particularly in the developing world. Unless those in the poorer parts of the world are economically empowered, it concluded, the U.S. would continue to face terror threats. There was also a realization that the traditional American bilateral aid body, USAID, mired in red tape and repeatedly failing to deliver on its promises, was not up to the task.

The MCC emphasized a competitive process for selecting grant recipients and said its projects would be led and administered by host countries. Nepal had expressed an interest in MCC grants in 2012 but only at the end of 2014 did the country qualify to sign a compact. Under the compact, the United States would provide $500 million while Nepal would pitch in $130 million for vital energy and road projects.

As a rough overview, the U.S. part of the fund would be spent on setting up a 400KV transmission line and related infrastructure that would allow Nepal to trade in electricity with India. The Nepali part would be used in the maintenance of the country’s most important highway.

It was Maoist Prime Minister Baburam Bhattarai who first took the initiative to apply for the compact in 2012. Nepal qualified for it in 2014 when Sushil Koirala of the Nepali Congress, the country’s oldest and traditionally the strongest democratic party, was in power. The compact itself was signed in 2017 under the leadership of Sher Bahadur Deuba, another Congress leader.

K.P. Oli, former prime minister and current leader of the CPN-UML, Nepal’s biggest (communist) party, was also in favor of the compact’s endorsement while he was in power. Thus the three biggest political parties of Nepal have at different times supported the MCC Nepal compact.

What, then, is the source of the current controversy? To understand its genesis, we have to go back in time.

History of Nepal-U.S. ties

Nepal established diplomatic relations with the United States in 1947, becoming the second country to do so after the U.K. As the “Quit India” movement in India, seeking to end British rule, gained ground in the second half of the 1940s, Nepal’s Rana rulers – who, to prolong their autocratic rule had virtually cut off the country from the rest of the world for over a century – felt threatened. Doing the bidding of the British government in India was the reason the Ranas had been able to stay in power for so long.

As British rule in India started shaking, the Ranas searched for new sources of support further afield. Desperate, they now wanted to expand the country’s interactions with the rest of the world, and the Americans obliged. The rationale behind the Americans’ outreach to Nepal was clear enough. Here was a country next door to Tibet, where communist China was expanding its influence. Today, Nepal’s geopolitical value has only increased for the Americans with the continuing economic and military rise of India and China.

The U.S. presence, meantime, has over the years had a strong symbolic value for Nepal, offsetting the oft-troubling implications of India-China interactions. Nepal seems to suffer irrespective of the state of India-China relations. Although India and China are currently at loggerheads and thus competing for influence in Nepal, there have been times the two countries have together undermined Nepal’s interest.

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For instance, in 2015, they agreed to expand trade through Lipulekh, a Nepal-India-China trijunction, without consulting Nepal. There is an old fear that India and China could between them settle Nepal’s fate – thus the logic for the presence of a strong third actor like the United States.

Yet the Nepali communists have never accepted this logic.

Communist Doubts of Americans

Communist parties of various persuasions have been active in Nepal since the 1940s. They have always looked suspiciously at Nepal’s attempts to reach out to Western powers, particularly the Americans. When Nepal established diplomatic ties with the United States in 1947, Nepali communists had denounced the Rana rulers for selling out to the “imperialists.”

With time, these communist forces have gained in power: right now, two of the country’s three biggest democratic parties – including its biggest – subscribe to communism. They also naturally tilt toward China and away from the U.S. Their suspicion of the Americans has grown as the China-U.S. geopolitical rivalry heats up.

China has cultivated Nepal’s communist parties for some time. It was instrumental in the 2018 merger of the CPN-UML and CPN (Maoist Center) to form the Nepal Communist Party (NCP), which ruled Nepal until recently with a near two-thirds majority in the federal parliament. China was banking on the new party to secure its interests in Nepal. Although the combined party has now split, most communist leaders continue to be enamored with China.

But China has also been canny enough to understand the volatile Nepali politics. It has thus courted non-communist parties too. Today there are strong pro-China constituencies in almost all Nepali political parties, including in the Nepali Congress and parties from Tarai plains, both of which have traditionally been closer to India. This partly explains the strong political resistance to the MCC Nepal compact.

On their part, whatever Chinese officials say in public, they want to scuttle the compact, which they see as a part of the Indo-Pacific Strategy (IPS) aimed at curbing China’s rise.

“China has repeatedly said it does not have any problem with Nepal’s MCC compact so long as it is limited to helping Nepal’s development initiatives,” said Upendra Gautam of China Study Center (CSC), a Kathmandu-based think-tank. “But therein lies the rub: Nepali authorities have not been able to convince the Chinese that there is no strategic component to the compact.”

The problem, in Gautam’s view, is that the credibility of Nepali political actors is rather low in Chinese eyes. This will be the case “so long as Nepal’s foreign engagements continue to determine its domestic politics – and not the other way round.”

But Chinese attempts at influence and the pro-China tilt of Nepali communists would perhaps have been insufficient to delay compact ratification had the Americans not complicated things for themselves.

The U.S. Embassy and visiting American diplomats stress there is no link between the MCC (conceived in 2004) and the IPS (2017). The rumors that the compact is a part of the IPS are thus baseless. But there have been instances of top American diplomats – like then-Acting Deputy Assistant Secretary for South Asia David J. Ranz and then-Assistant Deputy Secretary of State Alice Wells – saying that the MCC was indeed an integral part of the IPS. Moreover, the MCC finds a mention in the U.S. National Security Strategy as far back as 2002, something which the Nepali communists have latched on to.

Nonetheless, before Ranz linked the MCC with the IPS while on visit to Nepal in May 2019, the opposition to the compact was rather mute. After all, each government that came to power in Nepal after 2012 had in one or the other way endorsed it.

The MCC being a part of the IPS is problematic for Nepal as the bulk of its political class sees the U.S. strategy as an anti-China project. Nepal, in their view, cannot allow its soil to be used against its neighbor. This constituency in Nepal continues to get all kinds of moral and material support from China. (That is, however, not to imply that ordinary Nepalis are okay with the idea of a distant power using Nepal against China.)

There was much furor in Nepal about the Trump administration’s “US Strategic Framework for the Indo-Pacific,” made public at the start of 2021. Its aim of bolstering India’s military capabilities in order to offset China’s was suspect in Nepal, where India continues to be seen as a meddling big brother.

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But not everyone blames the historical baggage of Nepali communists for the compact imbroglio. According to Khadga KC, professor at the Department of International Relations and Diplomacy at Tribhuvan University in Kathmandu, “You can never overlook the anti-imperial bent of Nepali communists. But I believe something else is also at play behind the political opposition to the compact.”

KC, echoing Gautam, says more than anything else the controversy reflects Nepal’s unstable internal political dynamics. He blames the Nepali political class’s immature decision-making. For instance, Nepal’s Ministry of Foreign Affairs was largely bypassed when the MCC compact was still under discussion before 2017, nor were foreign policy experts consulted.

Specific Objections

Nepal’s communist parties have raised some pointed objections to the MCC compact: its supposed precedence over Nepal’s constitution, the need for its parliamentary approval, a project under it impeding a proposed Nepal-China railway line, its auditing by American rather than Nepali auditors, it being a part of the IPS – plus a few more. Whether you believe these accusations depends on which side of the political fence you are on.

The charge that the MCC compact is above the national charter arises from the compact’s Article 7.1, which states: “The Parties understand that this Compact, upon entry into force, will prevail over the domestic laws of Nepal.” As the constitution is the supreme law of the land, many have interpreted this to mean that the compact supersedes the constitution, thereby undermining Nepal’s sovereignty.

The Millennium Challenge Account-Nepal (MCA-Nepal), a Nepal government entity set up to implement the MCC compact, has time and again clarified that there is no question of the compact prevailing over the constitution. Moreover, say its backers, this clause will only be applicable in case of disputes and the contract’s possible termination.

Interestingly, in the original MCC compact signed in 2017, there is no mention of parliamentary endorsement. Nepali negotiators had refused to agree to it – no previous bilateral grant agreement had required such endorsement. The Americans relented at the time. But they continued to push for parliamentary ratification. Confusingly, Nepal’s own treaty law seems to suggest such a project of long-term consequence requires parliamentary nod.

“It is only right that the parliament should ratify it,” said Bhojraj Pokharel, former chief election commissioner and an active member of Nepali civil society. “Parliamentary endorsement will make us complete the project on time and inside estimated cost, something which we cannot say about other Nepali projects.”

Pokharel believes strict MCC clauses like the project’s completion within five years are merit-worthy. “Decision-making in Nepal is hard. The MCC compact tries to simplify it to an extent,” he said.

Moreover, the MCC compact was something Nepal lobbied for. As the country produces more electricity than it consumes, it needs cross-border transmission lines to sell power abroad. Good roads are also in short supply.

Krishna Gyawali, the national coordinator of the Office of the Millennium Challenge Corporation (OMCC), the forerunner to MCA-Nepal, who was also involved in compact negotiations, said the transmission lines and roads under the compact are in keeping with Nepal’s own development master-plans. “As the Nepali side proposed the projects, it is wrong to imply that the Americans choose them for strategic reasons,” he added.

The Compact’s Politicization

Whatever the merits or demerits of the MCC compact, it has been badly politicized. The split in the Nepal Communist Party partly owed to the MCC compact. While K.P. Oli, the then-party leader and prime minister, was in favor of its endorsement by parliament, two other senior leaders were strongly opposed to it, arguing that the compact should be endorsed only after amendments. The MCC debate thus helped exacerbate old intra-party feuds.

The MCC issue has become so toxic that Nepal’s major political parties, given a choice, would steer clear of it. Current Prime Minister Sher Bahadur Deuba has been pushing for the compact’s parliamentary endorsement, and so has his Nepali Congress party. But other parties are hesitant. Going into elections, they don’t want to be projected as “selling their country to the Americans.”

“The compact is unlikely to be endorsed before elections,” said Indra Adhikari, a Nepali commentator on geopolitics. “What you see is that every party that has been in power since the compact’s signing in 2017 has tried to sidestep the issue of its parliamentary endorsement, for instance by forming different partisan committees to study it.”

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The issue has been so poisoned that even Deuba is unsure about pushing it too hard. He knows he has little to gain from its parliamentary endorsement. On the other hand, added Adhikari, “it could cost him and his party [the] upcoming elections.”

The MCC has become a matter of heated debates in the ubiquitous tea-shops across the country. There are YouTube videos warning of the American military invading Nepal by using compact loopholes. Other write-ups and videos selectively pick up passages in the compact that seem to suggest it is above the national charter. Many Nepalis have come to believe these interpretations.

The MCC continues to insist that if Nepal does not endorse the compact soon, it will be terminated, just as happened in Sri Lanka, another South Asian country. But then they have been saying so for over a year while continuing to lobby for its endorsement. Perhaps it is a matter of prestige for the MCC folks. The Nepal compact’s termination, hot on the heels of what happened in Sri Lanka, could undermine the MCC’s legitimacy. But threatening to abrogate the compact and not doing so only fuels suspicions of ulterior motives.

The Larger Geopolitics

Compared to India, which had been notorious for interfering in Nepali politics, China had traditionally chosen a more hands-off approach – at least, that was the case until the 2006 changes. Until then the Chinese had the simple strategy of doing business with whoever was in power in Kathmandu, and their dealings were mostly economic. Only in the recent turmoil of the prolonged political transition has China started playing a more active part in Nepal’s domestic politics. If they don’t, they fear losing the geopolitical game to the growing “U.S.-India nexus.”

It is the Americans the Chinese are mostly worried about: In Beijing’s view, the United States is encouraging the Indians to make mischief, helping encircle China by using “soft spots” like Nepal. As China-U.S. geopolitical competition has intensified, so have China’s stakes in Nepal.

Concomitantly, there seems to be a growing realization in India, in light of the recent border tensions, that it cannot fight Chinese aggression alone. Whether New Delhi likes it or not, it has to have the U.S. on board. In many ways, it is a matter of choosing the lesser of the two evils.

And yet neither the Indians nor the Chinese are comfortable with a greater American presence in their backyard. Traditionally, India, following in the footsteps of British India, has tried to limit Nepal’s engagement with the rest of the world. It is suspicious of growing Chinese presence in Nepal, for obvious reasons. But the Indians are also not comfortable with American activism in the region.

Pramod Jaiswal, research director at the Nepal Institute for International Cooperation and Engagement (NIICE), a think tank, reckons India still wants to limit the American footprint in Nepal. Besides Nepal being India’s traditional backyard, “if the U.S. and China start competing for investment and influence in Nepal, where will India, the traditional hegemon here, be?”

He also does not see the point of the MCC debate. “If the Americans think Nepal serves their strategic purpose, they will be active here with or without the MCC. Thus while evaluating the compact we should analyze Nepal’s interests, rather than worry about pleasing or displeasing this or that power,” he said.

No Easy Way Out

The MCC, in a veiled threat, has said it cannot wait for Nepal to complete the next round of elections for the compact’s parliamentary endorsement. (The polls, at the earliest, will start on April 27, and it could be a year before all three levels of elections are completed.)

Meanwhile, opposition to the compact continues to build, including from its harshest and most influential critics.

Even if the improbable happens and the parliament somehow endorses the compact – Deuba seems intent on giving it one final push, even at considerable political risk – the victory will be Pyrrhic for the Americans. Having spent so much time and effort lobbying for it, often by going beyond diplomatic decorum, their public image in Nepal has been dragged through the mud over the past five years.

As for Nepal, again, the reverberations from the MCC compact dispute will continue to disturb domestic politics for years to come.