Wednesday, January 11, 2017

Growth prospects for Nepal and India in FY2017

Here are the major highlights from Global Economic Prospects January 2017:

Global growth is estimated at 2.3% in 2016 and is projected to grow marginally to 2.7% in 2017 due to “receding obstacles to activity in commodity exporters and solid domestic demand in commodity importers”. 
  • Increasing policy uncertainty in major economies (particularly in the US and Europe), financial market disruptions (amidst tighter global financing conditions) and weakening potential growth are some of the downside risks.
  • Fiscal stimulus in the advanced economics could push GDP growth up. 
  • Weak investment and productivity growth are affecting medium-term prospects. Structural reforms to boost potential growth (support domestic demand and reinvigorate investment) should be a medium-term priority. In advanced economies, low or negative real equilibrium interest rates constrain effectiveness of monetary policy and may necessitate supportive fiscal policies.
  • Investment in human and physical capital is essential to meet the skills and infrastructure needs to support long term growth. Other measures include rebuilding policy space, addressing vulnerabilities, and enhancing international integration (trade and FDI).
  • Commodity prices, particularly oil, are expected to increase. Agricultural prices are projected to remain stable as maize, wheat and rice stocks are at high levels.

  • Indian economy is expected to grow at 7.0% in FY2017 (ending on 31 March 2017), 7.6% in FY2018 and 7.8% in FY2019 and FY2020. Higher infrastructure spending, strong demand-led manufacturing activity, and regulatory reforms will support growth till the medium term.  
  • The demonetization shock in India affected growth prospects in the third quarter. Fourth quarter growth is affected by weak private sector investment (excess capacity, corporate deleveraging and credit constraints). 
    • Demonetization may be beneficial over the medium term because of liquidity expansion, which will help to lower lending rates.  
  • High growth up to second quarter of FY2017 was “underpinned by robust private and public consumption, which offset the slowing fixed investment, subdued industrial activity and lethargic exports”. Consumption was supported by low energy costs, increases in public sector wages and pension and favorable monsoon (which boosted rural and urban incomes).
  • Reduction in administered prices and low energy costs eased inflationary pressures. 
  • South Asian regional growth is estimated at 7.1% in 2017 and 7.3% in 2018 supported by robust domestic demand

UPDATE (2017-01-17): In its WEO Update January 2017, the IMF trimmed India's GDP growth for FY2016/17 to 6.6% (one percentage point lower than its October 2016 forecast) and 7.2% for next fiscal year (0.4 percentage point lower than its October 2016 forecast), thanks to the demonetization shock.

  • Nepalese economy is expected grow at 5.0% in FY2017 (ending 15 July) and 4.8% in FY2018. 
    • Favorable monsoon and expected acceleration post-earthquake reconstruction will underpin growth along with the normalization of trade after the four-and-a-half-month long border blockade.
    • Deceleration of remittance inflows may constrain consumption and investment. Medium-term growth will be supported by continued post-earthquake reconstruction, uptick in manufacturing activity, and favorable tourism activities. 
  • Surge in post-earthquake reconstruction related imports and deceleration of remittances will worsen current account balance.
  • Demonetization shock spillovers from India to Nepal, through trade and remittance channels may affect growth.

Wednesday, December 21, 2016

Impact of demonetization of Indian notes in Nepal

It was published in The Kathmandu Post, 20 December 2016. 

The surprise decision to withdraw the two highest denomination Indian currency notes by Indian Prime Minister Narendra Modi on 8 November has led to confusion and uncertainty not only in India, but also in neighbouring countries where Indian currency is freely used as a medium of exchange. The administrative unpreparedness and the ensuing management mess in India have put Nepali policymakers, traders and ordinary people, who use the Indian currency for various purposes, in a terrible fix.

The close economic integration between the Nepali and the Indian economy, especially in trade, employment, remittance inflows, tourism and investment, means that the demonetisation drive in India is having ripple effects on the Nepali economy as well. Unfortunately, the Nepali monetary and fiscal authorities cannot do much to mitigate its direct impact as the shock is entirely exogenous and its fallout poorly managed.

Economic ties

Almost all macroeconomic indicators in Nepal are influenced by the fiscal and monetary changes in India. Imports from India accounted for about 62 percent of total imports in 2016. The total value of imported goods—ranging from petroleum products and vehicle parts to chemical fertilisers and agricultural goods—from India is equivalent to about 23 percent of gross domestic product (GDP). Similarly, exports to India accounted for about 56 percent of total exports. The two countries have a trade and transit treaty—although it was knocked sideways during the four-and-half-month-long crippling supplies blockade—that cuts deeper than any other multilateral and regional trade agreements. Investment commitment and tourist inflows (recreational as well as religious) have also been the highest from India. Nepal has pegged its currency to the Indian rupee at a rate of NRs1.6 to IRe1 since 1993, partially contributing to macroeconomic stability even in times of tumultuous politics. Furthermore, the Indian market is a stable employment destination for seasonal Nepali migrant workers.

Against this backdrop, the ripple effects of any changes to fiscal or monetary policies in India are bound to be felt in Nepal too. In the demonetisation case, the transmission mechanism would most likely be more pronounced through depleted savings (although transient in nature) of seasonal workers, setbacks to informal trade flows and investment in small and medium enterprises, and lower spending by Indian tourists. For Nepali citizens using services in India, such as students, pilgrims and medical patients, it would be a nightmare to implement their plans without Indian currency in hand.

Persistent effect

The effect of these factors will most likely be gradual, yet persistent, resulting in downward pressures on economic growth.

First, India is a popular employment destination for seasonal workers, who migrate for short-term unskilled work, especially during lean agricultural period. Survey estimates show that India accounts for over 41 percent of the total stock of Nepali overseas migrants and they send about 20 percent of total remittance inflows. A unique feature about the Indian market is that it provides unhindered seasonal employment to a large number of unskilled Nepali workers compared to other employment destinations such as the Gulf countries and Malaysia. An open labour market, language familiarity and low cost of migration may be the most important factors for such a trend. Furthermore, members of the poorest households across Nepal, especially from the plains and the mid-hills, tend to migrate to India for short-term work. They include members of households affected by last year’s earthquakes.

Note that this group of unskilled migrant workers earn a stipulated daily wage in cash, which they usually save in higher denomination notes that are easier to carry back home. The demonetisation shock has made this group of people, many of whom do not have a bank account, the most vulnerable and hapless. Their cash savings are on the verge of being worthless, and they cannot afford to queue outside banks for hours. Worse, they are probably not paid for the daily work they are doing due to the lack of cash in their employer’s vault. The remittance income of this group of migrant workers normally constitutes one the strongest pillars of the consumption-based local economic activities back in their villages. This is now at risk.

Second, recent estimates show that just 29 percent of total imports from India are transacted through letter of credit, that is through the formal banking system. It means a substantial portion of imports is settled in cash or other means such as bank drafts or travellers’ checks to mainly avoid taxes and bureaucratic hassles. Also, surveys on informal trade show that informal agricultural imports from India account for about 15 percent of total formal imports. The total informal merchandise imports from India may well be over 30 percent of total imports. As these are mostly settled in cash by small- and medium-scale traders, a shock to this process will generate a slow but persistent impact on the Nepali economy.

Third, small-scale investments—in retail and wholesale trade, agro and manufacturing enterprises—along the border areas do not flow through the formal banking process. They are transacted locally in cash. We will continue witnessing a slowdown there as well. Additionally, there is a real possibility of a decline in the number of Indian tourists and their spending capacity in Nepal. Tourism related purchases are settled in cash, especially by Indian tourists who drive into Nepal for a short vacation over a weekend.

Now what?

These are a few potential transmission channels through which the demonetisation shock will have a downward effect on economic activities in Nepal. That said, there still is much uncertainty over the stability of the Indian currency market and the normalisation of administrative mess to match demand for and supply of new notes.

Nepal cannot do much directly, but that does not mean that the central bank and government should stay idle and wait for a response from their Indian counterparts. The amount of higher denomination Indian rupee in circulation in Nepal is far higher than the paltry IRs34 million said to be in the banking system. India will not be paying much attention to our troubles when its own administrative and banking capacities are deficient to deal effectively with the ensuing chaos.

Our government and the central bank cannot turn their back on the poor seasonal migrant workers, general public and traders, and point to the evolving perplexity in India. They need to work proactively to address the troubles faced by the public and small- and medium-scale traders. Furthermore, local economic activities need to be closely monitored, especially in areas with high seasonal migration to India.

Tuesday, October 18, 2016

NPC, MOF and the failure of planning in Nepal

It was published in The Kathmandu Post, 14 October 2016. 

Constraints on effective development planning are pretty much the same now as they were in the 1960s

The Ministry of Finance (MoF) and the National Planning Commission (NPC) are the two most important government agencies responsible for designing fiscal policy, which primarily consists of prioritising public expenditure and mobilising internal (tax and non-tax revenue) and external (grants and loans) resources. They also oversee formulation of laws and policies that have fiscal implications, prepare medium- and long-term development plans and advise the government on the optimal path to achieving political-economic priorities.

However, with their existing administrative structure, leadership style, and roles and responsibilities, these two crucial agencies are increasingly ineffective in fiscal management and economic planning. Ministers, secretaries and joint secretaries from other ministries regularly complain about the implementation hurdles in these bodies such as delays in budget approval, insufficient fund allocation, and a heavy-handed approach to the selection of sector-specific projects. This lack of effective inter- and intra-ministry coordination and haphazard project planning contribute to the low capital spending. Last year, for example, only 56 percent of planned spending was expended. The functional and administrative structure of the MoF and the NPC, which was created about six decades ago and marginally tweaked in successive years, cannot effectively respond to the fiscal management and economic development challenges the country faces now.

Recurring issues

Despite the socio-political changes over the decades, the constraints on effective development planning and its implementation are pretty much the same now as they were in the 1960s. In a 1972 paper titled ‘Why Planning Fails in Nepal?’ published in the journal Administrative Science Quarterly, Aaron Wildavsky (the then dean of the Graduate School of Public Policy, University of California at Berkeley) outlines the probable reasons: “insufficient information, few and poor project proposals, inability to program foreign aid, opposition of the finance ministry, and severely limited capacity to administer development.” The paper highlights the ritualistic meetings at the NPC and its lack of authority; inadequate attention to boost absorption capacity by determining targets and outlays; lack of competent and relevant officials at the helm of planning and budget execution; and the rise in recurrent expenditure due to shoddy capital spending.

Furthermore, other problematic issues outlined in the paper are the under-execution of capital budget; the cumbersome and obstructive processes at the MoF and the NPC to release funds for already approved projects; a tug-of-war between the NPC and the MoF in planning, financing and monitoring of projects; high staff turnover; low incentive to perform better; deficient technical education of divisional heads (joint secretaries) or project directors; and a culture of waiting for orders from above to skip decision-making on management and implementation issues by project directors. In essence, “economic development is only a sometime thing for them”, concludes Wildavsky.

These were some of the administrative and operational issues hindering planning and implementation back in 1972, when the economy was still closed to competition and trade. Fast forward to 2016 and these issues still remain the same despite the economy’s liberalisation, entry into the global and regional trade regimes, a devastating decade-long Maoist insurgency, and a sea of change on social, economic and political fronts. It, unfortunately, points to the fact that these two agencies have failed to evolve to confront the emerging economic and development challenges.

In every monthly or quarterly project portfolio meetings, these issues are discussed without much sense of responsibility. The ministries point fingers at the MoF and the NPC, and vice versa. At best, they end up forming a committee to study the constraints and recommend appropriate remedies. This drama of project planning, budget approval and implementation and formation of countless committees is repeated in every budget cycle.

The MoF officials act as if they are the ultimate authority to decide on project selection, planning and financing and, at times, even impose their will on the line ministries by controlling budget allocation and approval. Meanwhile, the NPC veering off its intended path is lost in the political and bureaucratic quagmire. It has become a toothless organisation with no tangible authority to make line ministries follow the path outlined in the medium- and long-term development plans. Its top leadership has remained unstable and busy in inaugurating insignificant workshops, attending futile overseas seminars and bickering with politicians over petty projects. The core functions of development planning and policy advising to the government are forgotten. Amidst this mess, the line ministries are seeking guidance on project preparation, planning, funding and implementation along with appropriate policies and laws.

Restructuring the two agencies

The corridors of the MoF and the NPC are most abuzz during budget preparation. But except for the fruitless yet ritualistic portfolio meetings, they remain largely silent during the phase of budget execution. Hollow steps are taken to deal with issues on project implementation by forming countless committees and subcommittees while, in reality, real progress is as elusive as it was six decades ago.

This has to change now. As a start, the functional and administrative restructuring of the MoF and the NPC should be initiated. The NPC should focus on designing and monitoring medium- to long-term development agenda with a time-bound action plan to be implemented by the line ministries, on assisting the line ministries in project readiness, including public private partnership projects, and on advising the government on fiscal and development issues. Additionally, given the shortage of investment-ready projects, the NPC should work with line ministries to come up with a project bank, which may include shovel-ready projects that could be taken up for implementation if funds are available.

Meanwhile, the MoF needs to focus on fiscal management—expenditure and debt management and resource mobilisation (revenue and foreign aid). It still lacks a centralised public debt management office, which could effectively shoulder the responsibility of managing domestic and foreign debt. Instead of micromanaging the line ministries’ projects, the MoF should focus on arranging and approving funds to the projects that need it the most. Furthermore, its Chief Economic Advisor’s office, Economic Policy Analysis Division, Revenue Management Division, and Budget and Programme Division need to be more agile and effective. They all should facilitate, not hinder, project implementation across all ministries.

Tuesday, September 27, 2016

Efficiency and integrity in public procurement in Nepal

This piece is adapted from the issue focus section of Macroeconomic Update Nepal, Vol.4, No.2, published by Asian Development Bank, Nepal Resident Mission.

I. Introduction

Many medium to large-scale development projects in Nepal are plagued by implementation delays and cost overruns. At the core of such recurrent hurdles is inefficient public procurement, contributed by a range of factors such as legal and policy complications, lack of required human resources to manage contracts, political intervention at management and operational levels, weak leadership by project directors and their high turnover, and prolonged delays by oversight and judicial agencies to clear contentious procurement. Consequently, project implementation is slow with cost and time overruns, quality of infrastructure construction is not up to the taxpayers’ expectation, and disbursement is slow and below target. These all result in low capital expenditure, insufficient jobs creation, and sluggish economic growth.

Efficiency and integrity in public procurement (of goods, works and services) enhance value for money and accelerate project implementation, which in turn stimulates private sector activities and innovations. Furthermore, if done in the right way and on time to maximize the value for taxpayers’ money, public procurement could be used as a strategic policy tool to address the myriad of economic, social and environmental challenges faced by the country.[1] Hence, efficiency and integrity in public procurement—equivalent to around 12% of GDP[2]— is vital to not only accelerate project implementation, but also to achieve medium-term goal of graduation from LDC category and long-term goal to be a middle income country by 2030, which also is the target date to achieve the Sustainable Development Goals (SGDs).

Public procurement is done when taxpayers’ money and/or grants and loans funded by development partners are used to finance public goods and services, including building of roads, airports, dry ports, hydroelectricity, irrigation canals, drinking water facilities, school and hospital buildings, and consultancy/advisory services. Unscrupulous procurement practices (resulting in wasteful capital spending in the last quarter of fiscal year) tends to increase recurrent spending in the next several years, since the sub-standard fixed assets need to be maintained more frequently. Furthermore, implementation delays unnecessarily prolong the project construction and completion, which ultimately is a drain of public funds. Hence, if done in the right way, efficient public procurement, which makes spending effective and has the potential to yield substantive savings (on whole-of-life cost basis),[3] contributes significantly to create the foundation for economic growth to take off on a high and sustainable path.

II. Key Highlights of the Amended PPA 2016

The recently amended Public Procurement Act (PPA) 2016, which has come about after prolonged revisions and delays, dictates public procurement in Nepal. In line with the amended PPA, procurement policy, operating guidelines and necessary administrative changes (including capacity enhancement) need to be rolled out to effectively implement it. The amended PPA includes procurement methods such as lump sum, catalogue shopping, limited tendering and buy back method (which is a new addition to the methods of procurement).

Preparation and approval of estimates: Cost estimate is not required, except works, for procurement up to NRs100,000. Regarding the approval of estimates, the officials involved in the design or estimation, checking or approval and the consultant involved, shall be responsible and subjected to legal action if the revised estimate is more than 25% of the initial estimate or due to defective design or abnormal estimation. In the previous version of the PPA, cost estimate was not required for procurement of up to NRs25,000.

Qualification of bidder or proposer: No qualification requirements is prescribed for the procurement of a construction work with cost estimate less than NRs 20 million  unless the procuring entity has decided that the work requires qualification criteria. In the previous version of the PPA, no qualification requirements were needed for the procurement of a construction work with cost estimate less than NRs 6 million.

Invitation to bid: A re-invitation with reduced submission period may be given if no bids/ proposals are submitted within the stipulated time or all the submitted bids/ proposals are non-responsive. The period shall be at least 15 days for national competitive  bidding and at least 21 days for international competitive bidding. However, in case no bids/ proposals are submitted during re-invitation period or all of the submitted bids/ proposals are non-responsive and there will be loss to the procuring entity (or some activity of the PE will be affected), then the procuring entity may re-invite the bid by giving at least seven day notice for national bidding. Else, it could procure following the methods specified under Section 8, with approval from one level higher authority. Furthermore, works within the prescribed estimate amount under national competitive bidding may be procured competitively only from domestic bidders. In the previous version of the PPA, in the case of procurement of construction work, preference was given according to the sub-section (1) of section 12 of the Construction Entrepreneur Act, 1958.

Withdrawal or modification of bid: A bidder has to make a sealed application 24 hours prior to the deadline for submission if it intends to modify or withdraw its bid unless the bid is submitted through electronic submission. In the previous version of the PPA, a bidder may, prior to expiry of the deadline for the submission of bids, make a sealed application for modification to or withdrawal of bid that a bidder has once submitted.

Acceptance of bid and procurement contract: A performance security of 5% is levied if the bid price is up to 15% below the estimate. An additional performance security equivalent to half the difference between the bid price and the amount that is 15% below the estimate is needed if the bid price is lower than 15% of the estimate.

Provision of advance: The procuring entity, after the agreement, may provide advance of up to 20% of the contract amount by getting a bank guarantee to the supplier, construction entrepreneur or service provider. Initially half of the advance is provided, and the other half is given based on the utilization of the initial advance. Moreover, except under the provision of Section 10(5), the payment for advance is made to a specially opened account for the contract. The contract may be terminated if the contractor misuses the advance payment.

Variation order: The variation of up to 5% may be done by gazette II class officer, up to 10% by Gazetted I class officer, up to 15% by department chief, between 15% and 25% by Secretary, and 25% and above by the Council of Ministers. However, for the procurement of amount less than NRs6 million, the department chief may approve the variation order in excess of 15%. In the previous version of the PPA, a variation order above  15%  was issued as per the decision by the Council of Ministers.

Price adjustment in procurement contract: Unless otherwise provided in the procurement contract, if price needs to be adjusted in the course of implementation of a procurement contract having duration exceeding 12 months, then the competent authority may adjust the price. In the previous version of the PPA, the duration period was 15 months. 

Mechanism for dispute settlement: Contract agreement will include provision of dispute settlement through prevailing law on arbitration if the dispute cannot be settled amicably.

Termination of contract and remedy: The procuring entity may terminate procurement contract if the supplier, consultant, service provider or construction entrepreneur does not perform as per contract, or its conduct is not as specified in section 62(2) or it misuses the advance payment. If the contract is terminated because the contractor did not start, abandoned or did not attain progress as per the agreement, the procuring entity may terminate the contract anytime. If the contract is terminated as per section 59(7), the full amount of performance security shall be forfeited. Any additional amount to complete the remaining work shall be recovered as amount due to the government. The remaining work after the termination of contract may be completed by inviting financial proposal from the remaining bidders selected under section 25 by giving 15 day notice. Meanwhile, the approval of one level higher authority is required prior to requesting for financial proposal as per section 59(9). In the previous version of the PPA, the procuring entity could terminate procurement contract if the supplier, consultant, service provider or construction entrepreneur did not perform as per the contract.

Blacklisting: If a bidder selected pursuant to section 27 or a consultant selected pursuant to section 38 does not come to sign the contract, then it may be blacklisted.

Hindrance of procurement process: The authority authorized to investigate is required to request any document from the procuring entity with due consideration to not hinder the procurement process as far as possible.

III. Implications for Public Procurement Management

The PPA has been amended after an iteration of discussion with a range of stakeholders. Overall, the added or amended provisions are in the right direction. For instance, the onus of timely and quality procurement is placed on the chief of the procuring entity (department, division or section of a project or program), including the completion of the task within the stipulated time. Additionally, in order to make procurement official more accountable, a provision on non-compliance is added. Specifically, the amended PPA has included a provision that  “Ensuring completion within the set time by conducting regular supervision, monitoring, and quality control measures to implement or to cause to implement the procurement agreement made under this act, will be the responsibility of the chief of the concerned public entity.” This opens up the possibility of prosecution of underperformers.

The other positive aspects of the amended PPA are that e-bidding is now explicitly mentioned and six additional direct procurement methods are added, facilitating the procurement by public enterprises. These include: (i) procurement of goods and services between two public entities; (ii) public entities/enterprises doing business by competing with private sector; (iii) procuring aviation, aircraft and associated equipment; (iv) procuring goods and services on rates fixed by international organizations; (v) procuring goods and services for organizing programs and promotional activities outside the country; and (vi) procuring goods and services by diplomatic mission.

Another important amendment is the provisions to facilitate fast decision-making on matters related to cost variation. For instance, department heads can approve variation of up to 15%, between 15% and 25% by the concerned Secretary, and on and above 25% by the Cabinet. Although an additional layer of committee is added in this process, the overall amendment will likely speed up review and approval of variation, which is one of the most contentious issues in public procurement and has been delaying project implementation. A related positive amendment concerns the shortening of price adjustment applicable for contracts exceeding 12 months instead of 15 months in the previous version of the PPA. This price adjustment is applicable to the contract procured under the multi-year contract that is tendered.

On the institutional side, regulatory function of PPMO has been strengthened to include additional functions to (i) issue necessary manuals; work procedures; and technical notes required for procurement methods such as turnkey, EPC, schedule rate contract, and management contracts, etc.; (ii) review and cause to review after procurement, (iii) develop roaster of contractors, consultants, suppliers, and  service providers regarding their procurement qualification and experience, (iv) issue electronic procurement guidelines, (v)  certify/ accredit procurement experts, and (vi) forward case to competent authority for necessary action if the procurement carried out by the public entity is found to be contradicting with the PPA, its rules, work procedure, or guidelines. PPMO has been entrusted sole responsibility to maintain a national e-GP system and the PPA has provisioned that the method of submitting the bids through e-bidding shall be in accordance with the procedure approved by PPMO. Public entity may adopt only electronic- procurement procedure partially or completely in public procurement. In other words, public entity, based on the capacity, may phase out the paper based submission to obtain full benefit of the e-GP system.

Furthermore, the amended PPA has explicitly mentioned that the procurement process will not apply to the following methods and a separate working procedure to procure goods, services and works may be issued: (i) design and build; (ii) turn key/EPC; (iii) design, build and operate; (iv) public private partnership/build operate and transfer; (v) framework agreement; (vi) cost replacement; (vii) management agreement; (viii) exchange; (ix) installments; (x) buy on lease; (xi) buying land properties; and (xii) operation and maintenance or management procurement based on performance. These are an improvement because the previous version of the PPA was silent on these methods and had created confusion especially on the procurement related issues for public private partnership projects.

Remaining Gaps. While these amendments are expected to make procurement timely and efficient, thus helping to accelerate project implementation, a number of shortcomings also appear in the amended PPA. These need to be gradually addressed over time as it may slowdown the speed of project implementation.

The additional penalty (forfeiture of bid security and other financial penalties to the bidder) imposed in case the contract is not signed is impractical as merely putting a stringent provision may not help to get a good contractor. There is a need for concurrently improving the quality of selection. Specifically, any deficiencies of the bids (such as serious errors in a price bid) that may oblige the bidder to withdraw later, need to be detected and such bid be duly rejected. Similarly, reduced rebidding time, in case the first round of bidding fails, does not necessarily provide fare treatment to new bidders or lead to the most efficient selection of a contractor.

The amended PPA also provided clearer provision of dealing with the low bids, by specifying the level of additional performance guarantees. While this can provide clarity to deal with such circumstances, the issue of low price bidding needs to be dealt with by strengthening the technical evaluation, thereby effectively rejecting the insufficiently experienced and skilled bidders, which is one of the causes of the low price bidding. On this account, within the context of PPR amendment, PPMO is considering the introduction of one-stage two envelope (1S2E) selection process, in which technical and financial evaluation is separately undertaken. Likewise, there is a need for strengthening the disciplines of contract management for higher compliance with cost, time, and quality in executing the works after contract signing.     

The earlier draft PPA had included a provision of additional advance without bank guarantee, which could be used for the additional deployment of construction materials and equipment. The provision was entirely removed from the final PPA. This could have provided a basis for meeting such requirements, with specification of how the paid amount was to be guaranteed (through material valuation or bank guarantee).

Furthermore, the increase in threshold of works contract/tender without requiring bidders’ qualifications up to NRs 20 million (current threshold is NRs 6 million) may foster malpractice in the construction industry. First, entry of insufficiently experienced and skilled contractors can undermine the timeliness, quality, and cost of the works. Second, contractors may prefer to register a new firm every time they bid for a new contract whenever the firm’s past performance record was poor. This has the potential to undermine capacity development of the construction industry. Third, the absence of qualification for such contracts may result in irregular practices with political pressures.  Such system may best be introduced after establishment of sound registration and performance recording system of the contractors.

The threshold applied to international bidders may violate WTO as well as procurement procedures of multilateral development banks (MDBs). Country system needs to be harmonized to MDBs procurement standard. This provision will restrict participation of international bidders in domestic market and may open up avenues for political pressure to frequently change the thresholds, which will lead to unpredictable procurement environment in the country.[4] Similarly, the provision to allow withdrawal of bid only before 24 hours of the deadline is impracticable. Bidders should be allowed to withdraw their bids at any point in time before the bid submission deadline.

IV. Way forward

Almost all of capital spending and some capital formation related components of recurrent spending (such as use of grant to local bodies to build local infrastructure, operation and maintenance, etc.) are subjected to public procurement in Nepal, which together amount to 12% of GDP. Efficiency and integrity in procurement for goods, services and works is vital to accelerate project implementation and enhance the quality of spending, which eventually leads to higher, sustainable and employment-centric inclusive economic growth. This in turn is essential to graduate from LDC category by 2022, and to become a middle income country by 2030 along with the achievement of the SDGs.

Public procurement is governed by the recently amended PPA 2016. While the amendments or addition of new provision are expected to lead to timely and efficient procurement, a number of shortcomings need to be gradually addressed over time. Additionally, timely implementation of the amended PPA by rolling out updated policy, regulations, operational guidelines and manuals, and institutional setup is equally important. For instance, fully rolling out e-bidding system is urgently required, given that the present system still requires that original bid security must be submitted on paper, which undermines the effectiveness of e-submission of bids.  This will help to make public procurement efficient, transparent and rules based. Similarly, the evaluation bids should be completed within the stipulated timeframe and payment of contract processed on time.

The government needs to ensure that transaction costs are not prohibitively high, which is a natural barrier for the participation of small and medium contractors, whose capacity needs to be enhanced. E-procurement, which creates a marketplace characterized by equal access and competition under a transparent framework, needs mainstreaming along with the capacity enhancement of implementing agencies, contractors, and other stakeholders. It lowers the likelihood of rent-seeking opportunities as it minimizes in-person contacts before bid submission and during bid evaluation. A rigged tendering process in the absence of e-procurement stifles competition, leading to lower quality of goods, works or services at higher cost.

The executing and implementing agencies need to boost their capacity on technical and administrative matters related to efficient procurement, including clarity about the scope and nature of work, contract management methodology, and the associated financial aspects of procurement design and processing. A lack of professionalism remains one of the major weaknesses. Public procurement is a specialized profession requiring effective integration of technical, financial, and legal requirements in its process of preparation, contractor selection, and execution. Competent human resources required for its efficient execution are critical. It essentially is a strategic policy lever/function of the government as opposed to mundane administrative service.

A careful procurement planning and effective performance monitoring yield value for taxpayers’ money used for public procurement. This is equally important throughout the procurement life cycle: preparation of bids, submission and evaluation of bids, awarding contracts and executing contracts with sound contract management, which is another critical subject for efficient execution of infrastructure investments in Nepal while duly controlling time, cost, and quality. (See Box 4.) Exception to the rule (bypassing the amended PPA) and breaching threshold procurement should be minimized in order to maximize the utility of taxpayer’s money and to leverage the bulk purchasing power of the government.
[1] OECD. 2016. Public Procurement for Sustainable and Inclusive Growth. Paris.
[2] Average of capital spending, grant/transfer to local bodies and use of goods and services over the last five years.
[3] It refers to (potential) cost savings throughout the lifetime of the projects despite the short-term cost being relatively higher. Exclusive focus on short-term savings, for instance awarding contract to those bidding under a reasonable cost estimate (in other words, below threshold procurement) and those with weak contract management, priority may lead to cost overruns and higher recurrent costs in the subsequent years. A combination of low cost and quality consideration in awarding contracts could result in long-term cost savings.
[4] For example, the proposed PPR amendment has provision that procurement of cost estimate from NRs 20 million ($200,000 equivalent) to NRs1 billion ($10 million equivalent), bidding may be among domestic contractors only.

Thursday, September 22, 2016

Economic and social risks from declining overseas migration & decelerating remittance inflows

It was published in The Kathmandu Post, 20 September 2016. Previous posts on remittances and migration here.

Nepal needs urgent reforms to deal with challenges stemming from a deceleration in remittance inflows

If there is one consistent narrative about Nepal over the last two decades, it must be about migration and remittances. Political and development activities in the country have always remained volatile. While political culture is punctured by intra- and inter-party fighting and external interference, economic development is beset by stalled projects and implementation complexities arising from sub-standard procurement and eroding bureaucratic capacity. However, migration and remittances have been notably resilient to internal and external shocks, providing a crucial support to the economy characterised by high unemployment and slow economic growth but a significant demand for imported goods and services.

Lately, this citadel of stability is starting to crumble following the persistently low fuel prices and sluggish economic growth in most developed and emerging economies. The economic stress, at least in terms of macroeconomic numbers, arising from the gloomy global outlook is gradually being felt in Nepal too. It could soon become a prime trigger factor for economic and social instability. The almost muted response from the politicians and the bureaucracy to this distressing development is mindboggling and irresponsible.

Multiple impacts

Although statistics show unemployment in Nepal to be lower than in most developed countries (for instance, the latest annual household survey puts it at 3.6 percent), it should be noted that this does not include ‘discouraged’ workers, who are not considered as a part of the labour force. Hence, the actual unemployment is substantially higher, with some agencies estimating it to be over 45 percent. Given the low economic growth and deindustrialisation, especially after the start of the Maoist rebellion, such a high level of unemployment is unsurprising. This is one of the reasons why until last year about 1,400 working age men and women legally left the country daily to work overseas, primarily in Saudi Arabia, Qatar and Malaysia, which together account for about 80 percent of total overseas migration.

Unfortunately, the global economic slowdown (which lowers external demand), low oil prices and the subsequent decline in investment, especially in natural resources, construction and security services, are weakening economic activities in these countries. It is having a direct impact on the Nepali economy through the lower demand for migrant workers and the deceleration in remittance inflows.

The overseas migration growth averaged 14.2 percent between fiscal years 2012 and 2014. It started to decline as low fuel and commodity prices affected investment and subsequently the demand for migrant workers from countries such as Nepal. Consequently, the number of migrant workers decreased by 2.8 percent in FY2015 and then by a further 18.4 percent in FY2016. (The April 2015 earthquake also contributed to the slowdown.) The figures translate into a daily average of 1,446 migrant workers in FY2014, 1,405 in FY2015 and 1,147 in FY2016—a clear downward trend. Migration to Malaysia declined by a whopping 70 percent as it put a moratorium on new hiring and opened up foreign employment in private security services—earlier restricted to Nepali and Malaysian nationals only—to other countries as well. Furthermore, its overall economic growth is affected by low fuel and commodity prices.

The declining demand for Nepali migrant workers will have a direct impact on remittance inflows, which will then affect household and macroeconomic activities. The growth of the remittance inflows has remained robust, averaging 25.3 percent over FY2012-FY2015. It remained resilient ($6.2 billion in FY2016) compared to other inflows such as foreign direct investment and official development assistance. However, a deceleration in remittance inflows is a very likely scenario given the drastic decrease in the number of migrant workers in the last three years.

Amounting to about 29 percent of gross domestic product (GDP), remittances have been a major factor supporting economic growth, poverty reduction and household expenditure, irrespective of the household’s domestic income. A decline in remittance inflows would lower the services sector growth, which primarily depends on remittance-financed consumption of imported goods. Since services sector constitutes over 50 percent of GDP, it will bring down overall economic growth as well. Furthermore, lower remittance inflows would likely lower government revenue, which is largely generated from taxes levied on remittance-financed consumption. Another significant impact will be on current account balance, which can easily go into the negative territory like in FY2010 and FY2011. It could then lead to a negative balance of payments and lower foreign exchange reserves. Given the pegged exchange rate with India, high dependence on remittance income and the composition of imports, Nepal needs to maintain reserves to finance at least seven months of import. In FY2011, when remittance growth declined but was not negative, reserves were enough to finance just 7.3 months of import.

The deceleration in remittance income triggered by the slowdown in migration will affect household consumption expenditure (and subsequently poverty), fiscal balance (as high consumption-based revenue growth tapers off), financial stability (as deposit growth slows down), and external sector (as current account and balance of payments fall into the negative territory).

Economic and social blowback

Robust remittance inflows fostered laxity in reducing policy weaknesses and in facilitating sound investment climate as politicians and bureaucracy had to do little work to generate moderate growth of below 5 percent and to reduce poverty. This needs to change now given the deceleration in remittance inflows and the slowdown in the demand for Nepali migrant workers. Medium- and long-term reforms have to be rolled out and implemented to boost investment, lower inflation, and create appropriate investment instruments that can channel the short-term remittance deposits into long-term infrastructure financing. Meanwhile, faster post-earthquake reconstruction works could help create a modest number of unskilled and semi-skilled jobs, which match the employment needs of would-be migrants.

These reform measures could not only address the immediate economic challenges arising from the deceleration in remittance inflows, but also tackle the Dutch disease effects (which broadly refers to the decline in tradable sector, chiefly manufacturing, and an appreciation of real effective exchange rate) seen in the economy since 2000. The primary focus should be on the active facilitation of investment and on transforming from the current low value-added, low productivity activities to high value-added and high productivity activities.

Further delays in addressing these issues would make it difficult for the country to fend off the economic and social blowback arising from the slowdown in overseas migration and the deceleration in remittance inflows.

Tuesday, September 20, 2016

Electricity demand in Nepal in 2030

This piece is adapted from Macroeconomic Update Nepal, Vol.4, No.2, published by Asian Development Bank, Nepal Resident Mission. Executive summary is here and FY2017 economic outlook here.

In a report published by the Investment Board of Nepal (IBN) the total energy demand is projected to reach 33,433 gigawatt hour (GWh), which is equivalent to 6,358 mega watt (MW) at 60% system capacity factor in 2030. Additionally, accounting for transmission loss (1,211 MW), outages (2,523 MW), and the constant daily demand load curve, the required installed capacity to meet energy demand in 2030 is 10,092 MW in 2030. A lower system factor (arising from supplementary sources such as storage plants and capacity increases in renewables) would mean higher installed capacities to meet demand. At 50% system capacity factor, the required installed capacity to meet energy demand would be about 12,000 MW.

It uses the model for analysis of energy demand (MAED) to forecast energy demand in the next 15 years. This differs significantly from the linear energy demand projection. The model considers latent demand (for instance, switching from traditional cooling methods to air conditioning, from liquefied petroleum gas to electrical appliances to cook food, and from fuel to electricity to power up vehicles) in such forecast and takes into account the evolution of socio-economic, technological and demographic patterns.

While these projections may be on the higher side given the optimistic assumptions for sectoral growth and its pattern, the direction and magnitude of energy demand in the next 15 years points to a plausible scenario of large demand-supply deficit if the planned projects are not completed on time. This has to be accompanied by reform of the entire sector, including enacting and implementing the legal, regulatory, institutional and administrative reforms. NEA system losses are already one of the highest in the world. In FY2016 its system losses were 25.9%, up from 24.4% in FY2015. It largely reflecting a dated distribution system (including sub par transformers). The country faces a challenge to meet the energy demand given the slow pace of project implementation (generation, transmission and distribution).


Update: Lately, it has been reported that the new Minister for Energy Janardan Sharma has ordered new estimation of electricity demand. He has refused to take ownership of the study commissioned by the IBN in collaboration with the NPC. His main argument is that IBN is not the authorized body to estimate electricity demand. It should be Water and Energy Commission Secretariat (WECS). This is a useless argument and is an indication of the maze of bureaucratic hurdles (created by self-interested bureaucrats chasing and chased by lobbyists and politicians) and lack of ownership of a report published by a agency which is chaired by the Prime Minister. There is no need for another study by WECS, which will probably lead a committee to finalize a TOR for new consultant and then lobby for funds to finance the one-year-plus long study. If it goes through, then the contract would most likely go to one of the pseudo-consulting firms close to the bureaucrats or the politicians. Just another study report to employ currently unemployed pseudo-intellects.

The need is not for a similar study report for the sake of 'ownership'. The urgent need is to accelerate project implementation, especially the stalled hydro energy projects and administrative reform of the various agencies, including NEA and the energy ministry. The country doesn't have the luxury of time and resources to commission yet another study of long-term energy projection by the energy ministry. The priority should be to do the needful to ensure that the ongoing projects are completed on time.

Some bureaucrats, politicians and energy lobbyists have been objecting to the IBN's proactive role in promoting large-scale hydro energy projects since its establishment. They are not happy with the IBN as it is taking away their business interest and is really taking forward contentious projects in a short time. The energy sector needs to be protected from this group of bureaucrats, lobbyists and politicians.

Sunday, September 18, 2016

NEPAL: Growth and inflation outlook for FY2017

This piece is adapted from Macroeconomic Update Nepal, Vol.4, No.2, published by Asian Development Bank, Nepal Resident Mission. Executive summary is here.

FY2017 growth outlook

The outlook for FY2017 growth is moderately optimistic and hinges on the scale of recovery of agricultural output given the normal monsoon, the scope and pace of post-earthquake reconstruction and rehabilitation, budget execution, and remittance inflows. The monsoon rains were above normal and on time unlike in the past few years. Approximately, 80% of total rainfall occurs between June and September. The Ministry of Agricultural Development estimated that paddy transplantation has been higher than in previous years. Paddy transplantation averaged about 95% of 1.4 million hectares of rice field by the first week of August, much higher than 75% in FY2015. However, widespread flooding in the Terai region and mid-Hills, and landslides caused some damage to crops during the last week of July and the first week of August. The outlook for industrial and services output is contingent upon the evolving political situation, reconstruction work, pace of budget execution, recovery of tourism sector and remittance inflows. The scope and pace of reconstruction projects will affect demand for quarrying, manufacturing and construction activities, which largely dictates the trajectory of industrial output. Timely, effective and judicious budget execution, which includes both accelerated spending and reform measures, will be at the core of industrial and services sector recovery. Similarly, a slowdown in the growth of overseas migrants is bound to affect remittance inflows, which subsequently would affect the major components in the services sector.

Considering these developments and a cautiously optimistic outlook on reconstruction and political situation, GDP growth (at basic prices) is forecast at 4.8%, lower than the government’s target of 6.5% announced in the FY2017 budget speech. Agriculture, industry and services outputs are expected to contribute 0.7, 1.0 and 3.0 percentage points. A downside risk to the forecast is the more than expected damage caused by natural disasters, especially flooding and landslides, to agricultural output; slow rehabilitation and reconstruction works; the slow pace of budget execution; and depressed demand in services sector arising from the deceleration of remittance inflows.

FY2017 inflation outlook

Better agricultural harvest due to the normal monsoon, subdued inflation in India, low international fuel and commodity prices and normalization of production and supplies since February 2016 will likely lower general prices of goods and services in FY2017 despite the demand-side pressures emanating from the earthquake related fiscal stimulus. The prices of cereal grains, paddy, pulses and legume are expected to moderate on account of the favorable monsoon. However, the prices of alcoholic drinks and tobacco products will likely escalate due to the hike in its tariff rate in the FY2017 budget. Similarly, restaurant and hotel prices are also likely to increase as the rebound in tourism sector will stimulate demand. Meanwhile, normalization of supplies and cooling off of demand pressures in housing and utilities will drive the de-escalation of non-food and services inflation. Although furnishing and housing equipment may see a rise in prices on account of the increased demand arising from gradual revival of real estate and housing markets, its impact will not be large enough to offset the decline in prices of other items in the non-food and services basket. Consequently, food and non-food inflation are projected to contribute 4.3 and 4.2 percentage points, respectively to overall inflation of 8.5% in FY2017.