The inauguration of Nepal's biggest-ever hydropower project, the $428 million Kali Gandaki A, by King Gyanendra has been delayed because of a dispute over an unauthorised and shady transfer of cost overruns to the project's Italian contractor.

During its five-year construction period, all major political figures in Nepal were involved in a decision sanctioning this questionable variation. What's more, the additional amount was paid between 1997-2002 without the approval of the board of Nepal Electricity Authority (NEA).

All in all, the decision has cost the country $50 million, and this will have to be paid back to the banks that underwrote the project by the next generation of Nepali taxpayers. The government seems unlikely to be able to recover the money because of a weak legal position. The Italians, far from showing signs of paying it back, are now pressuring NEA to pay out another $5 million as compensation for delays in the project.

The power plant is located on the Gandaki Bend, one of Nepal's most suitable sites for a run-of-the river scheme. The dam at the headworks ( top, right) diverts water through a six km tunnel with a head of 124 m to the powerplant generating 144 MW. The saga of how such a splendid project got messed up has to do with greedy politicians probably manipulated by unscrupulous contractors, and international creditors which didn't seem to care how the money was spent as long as it was spent.

When the civil works contract for the project was being awarded in 1997, NEA approved a $130 million bid by the Italian consortium, Impreglio SpA. An open-ended bill of quantities (BOQ) contract was signed and by last year, the contractor and the American engineering consultant Morrison Knudsen International Inc (MKI) had ended up billing NEA $180 million. The extra $50 million was quietly paid out over a period of five years by NEA officials without even informing their board. The ADB and Japan Bank for International Cooperation which funded the project did not question the extra payment.

During the construction period, there were some geological complications, including the need to desand a mountain flank at Mirmi to protect the headworks. That overrun, insiders say, could have only amounted to maximum $20 million. It was only in April when Impregilo sought a clearance letter to settle the final account of the project that the government realised that an excess $50 million had been paid for civil works.

Alarmingly, even the Auditor General's report, which is yet to be made public, has not accounted for this discrepancy. Private auditors considered only the initially agreed $130 million while drawing up the AG's report, according to insiders. "Now that even the Auditor General has failed to notice the extra money paid, the issue may just fizzle out," he told us.

NEA sources say the main loophole for corruption was the contract itself. Instead of a fixed-price agreement in which the contractor cannot charge for major variation (similar to the contract in the private-built Khimti project) the NEA-Impreglio contract is under the 'Fidic' system, which makes the consultant all-powerful to recommend the cost of any work or equipment.

That contract was signed in 1997 during the Deuba coalition government with the RPP. MKI was allowed to recommend for the contractor $50,000 at a time in extra costs, and if the government failed to pay the amount it was liable to pay interest on the amount. NEA sources told us the contractors would demand more money, the consultants would approve it, and politicians of the day leaned on NEA management to OK it.

They said the ADB would always back the consultant, no questions asked. "The bank was always pressuring us to increase the threshold of money the consultant was allowed to recommend," recalls one ex-NEA official. "The consultant supported the contractor, the bank backed the consultant. It was like a fox guarding the chicken coop."

Both ADB and MKI representatives declined interviews for this article, saying the dispute was between NEA and the contractor. We asked NEA's Kali Gandaki project director, Jivendra Jha, if the contract was flawed. He replied: "Under the agreement, the price escalation is allowed according to the increase in the international price indices. The $131 million was only an initial figure, the price was subject to increase depending on conditions in the future."

Under the BOQ system, the builder is allowed to claim for accumulated bills under any heading. What made things easier for the contractor was a consultant that readily recommended extras. "These contracts are really faulty, the entire risk is borne by the Nepali consumer," said another NEA ex-board member. "You are going to see the same thing happening with the Middle Marsyangdi Project because they have the same BOQ contract."

Having noticed the unauthorised payment of $50 million, the previous Chand government tried desperately to recover part of it by instructing Banca Intesca in Milan to retain Impreglio's performance and retention bonds. Impreglio promptly took the matter to the Italian courts to free up the money.

The court issued a stay order which was only vacated last week, but Nepal is still not in a position to lay its hands on the bonds because it does not have the necessary counter bank guarantee here. Without that, NEA officials told us, the cash cannot be transferred.

In the middle of all this, Impreglio reportedly offered to give up its $5 million claim for delays in the project caused by the royal massacre and political disturbances on condition that it got a clearance letter of the settled accounts. But NEA refused.

We also approached Impreglio's Fabrijio Calbi for his side of the story, which he declined. The company's Nepal representative also refused to speak to us on the record. NEA and Impreglio are now talking about coming to an amicable settlement. But even if that happens, NEA, successive past government and the Nepali Congress, UML and RPP that lead them have a lot to answer for.

In addition, there has to be a lot more scrutiny of the contracts for future projects so that there are no loopholes for payoffs to allow questionable cost overruns. Otherwise, officials say, despite our vast hydropower potential Nepal will keep on having one of the most expensive electricity tariffs in the world. And that means the Nepali people once more end up subsidising the corruption of their elected leaders.