Saturday, February 25, 2017

Nepal (mid-year FY2017) and India (FY2016/17): Brief macroeconomic overview

Nepal: Mid-year review of FY2017 budget and monetary policy

The Ministry of Finance released its mid-year review of FY2017 budget. It increased revenue target but lowered expenditure target. There is not much change in expenditure pattern. Actual capital spending was just 11.3% of planned capital spending. However, the government is targeting to bump this to 84% by the end of the fiscal year. Around 49% of total revenue target was achieved by mid-year. 

The NRB also released its mid-year review of FY2017 monetary policy and macroeconomic situation. Inflation averaged 5.8% on the back low fuel and commodity prices, good monsoon-led boost in agricultural output, normalization of supplies and decreasing inflation in India. Current account slipped in the negative territory due to the widening of trade deficit and deceleration of remittance inflows. 

The NRB also tweaked accounting rules on computing CCD ratio. It has allowed BFIs to discount 50% of productive lending (plus lending to deprived sector and lending to agro sector at subsidized interest rate) while computing the CCD ratio. This essentially gives a breathing space to many BFIs that are close to the mandatory threshold of 80. It frees up about NRs130 billion for extra lending (by mid-year BFIs lent about NRs254 billion to productive sector).  

India: Macroeconomic overview (IMF)
  • Real growth (at market prices) projected to slow to 6.6% in FY2016/17 and then rebound to 7.2% in FY2017/18
  • Normal monsoon rainfall but suppressed private consumption demand (due to demonetization shock)
  • Low inflation of around 4.7% (temporary demand disruptions due to demonetization, good agricultural harvest due to good monsoon, collapse of global commodity prices, supply-side measures, tight monetary policy stance) 
  • Reduced external vulnerabilities (CA deficit to remain low and international reserves to cover around 8 months of import), and large terms of trade gain (increased by 2.22% in 
  • FY2013/14, 2.5% in FY2014/15, and 7% in FY2015/16)
  • Focus on fiscal consolidation and quality of public spending (FY2015/16 budget deficit of around 3.9% of GDP; FY2016/17 budget on track to reach 3.5% of GDP target)
  • Implementation of key structural reforms including GST (has the potential to raise medium-term growth to above 8%), using Aadhaar identification and bank accounts to make direct benefit transfers, formalization of inflation targeting framework, new Bankruptcy Act
Key challenges: persistently high household inflation expectations, large fiscal deficits, excess capacity in key industrial sectors, strains in financial and corporate balance sheets, the extent of cash shortages, external vulnerabilities (global financial market volatility including from US monetary policy normalization and weaker-than-expected global growth).

Wednesday, February 22, 2017

Liquidity/credit crunch and mid-year review of monetary policy

In its mid-term review of monetary policy for FY2017 the central bank appears overly accommodative by tweaking accounting rules to compute local currency credit to core capital plus local currency deposit ratio (CCD ratio in popular lingo). It has allowed BFIs to discount 50% of productive lending (plus lending to deprived sector and lending to agro sector at subsidized interest rate) while computing the CCD rato. This essentially gives a breathing space to many BFIs that are close to the mandatory threshold of 80. It frees up about NRs130 billion for extra lending (by mid-year BFIs lent about NRs254 billion to productive sector). At the core of it, the BFIs indirectly got what they wanted— more space to lend irrespective of deposit growth. This is a temporary measure with a sunset clause (ending mid-July 2017). 

But then will this kind of overly accommodative measure by the central bank foster moral hazard (i.e., the BFIs don't have an incentive to guard against reckless lending risk when they know that they will be somehow protected from its consequences = privatize profits, socialize losses)? The BFIs have been indirectly rescued by the central bank again and again. Initially, it was due to the accumulation of high non-performing assets before 2000, then it was due to aggressive lending to real estate, housing and hire purchase around 2012, and now due to reckless lending even when they clearly knew that deposit growth was and is going down. This pattern of making deliberate (or not!) mistake and then the central bank coming to their rescue in one way or the other is amazing!

Here is an article on the current liquidity/credit crunch and its causes. For more background, here is another long article on the causes of severe liquidity crunch around 2011/12. Briefly, the BFIs brought the troubles upon themselves by aggressively lending to few sectors to gain quick returns in such a way that the credit growth far outpaced deposit growth. Keep in mind the following points:
  1. Deceleration of remittance inflows was expected from last year because of the slowdown in growth of migrant workers. Remittance inflows are considered a stable source of deposits.  
  2. Credit growth expanded more than deposit growth even when BFIs knew the reality (i.e., #1)
  3. Ever-greening and at times imprecise classification of risky assets are tricks used by BFIs to navigate through the regulatory loopholes.
  4. Asset-liability mismatch is still an issue (think of the problems arising from using short-term deposits to lend to long-term projects)
Lets say the BFIs lend NRs130 billion extra loanable fund they have now because of the tweak in accounting rules till mid-July. Then what? Will they maintain CD ratio below the mandatory threshold with enough space to keep credit flowing even if deposit growth continues to dries down? How can we be assured that they will not continue to engage in reckless lending to meet unsustainably high profit targets? Will these practices lead to building up of non-performing assets? Any tweaking of monetary policy and established rules should be accompanied by clarity/direction on its expected consequences. 

The government might have feared that a sudden credit crunch will squeeze revenue growth from high contributing sectors and will also hurt economic activities. This would mean missing revenue and growth targets for FY2017 (you get a sense of this from the MOF's mid-year review of FY2017 budget). I think the central bank’s decision to tweak the accounting rules indirectly is aimed at addressing this issue rather than cleaning up the mess within the BFIs. Good for short term, but creates uncertainty in the medium term. Interest rates will likely stabilize. .

Lets not forget what the BFIs need to focus on: enhancing their capacity to roll out better operational and management practices. They should scrutinize loan proposals more intensely, invest more in research and personnel training, introduce innovative deposit and credit schemes, diversify their asset portfolio, lower unsustainable profit targets, improve corporate governance and continue consolidation efforts.

Anyway, there are good measures as well: revising down limit on personal overdraft loans to NRs7.5 million from NRs10 million (these are sometimes diverted to stock market, real estate and other speculative investments); limiting interest on call deposit to that of normal savings deposit; allowing issuance of foreign currency-denominated LOC for 90 days (lowers cost of borrowing for traders), limit on lending to personal vehicle purchase based on its value, etc. 

For now, lending rates will stabilize (lets hope deposit rates will rise by some percentage points). The liquidity/credit crunch will normalize as soon as capital spending accelerates (as usual in the last trimester). Addressing the liquidity/credit crunch brought upon themselves by the BFIs is a tricky issue for the central bank. There ain't no easy fix!

Tuesday, February 7, 2017

Nepal's self-inflicted liquidity/credit crunch

It was published in The Kathmandu Post, 07 February 2017.

The current liquidity crunch is the result of faulty operation and management of BFIs

The financial sector is in a temporary yet recurring state of disarray right now as a self-inflicted ‘liquidity crunch’ has handicapped most banks and financial institutions (BFIs). While the business community is unnerved by the rapid shrinkage of loanable funds and prospects of an interest rate hike, BFIs are struggling to stay within the mandated credit-to-deposit threshold. 

Nepal Rastra Bank (NRB) has rightly refused to increase the 80 percent threshold as it is one of the widely used tools to ensure the viability of the financial system and security of deposits. The liquidity/credit crunch is the consequence of flawed operation and management practices of BFIs.

BFIs are required to maintain at least 20 percent of their deposits in the form of very liquid assets, which means cash or assets that can be readily turned into cash. The credit to core capital plus deposit ratio should not exceed 80 percent. If they are close to the ceiling and are unable to attract more deposits, they need to hold back on aggressive lending. Any drop in deposits means that BFIs will have to lower credit growth too so that they do not overshoot the threshold.

To better secure deposits, reduce the number of BFIs and improve the financial sector, NRB instructed BFIs to increase their paid-up capital by mid-July 2017 (Rs8 billion for commercial banks). In response, several weak BFIs merged or were acquired by stronger ones. Others floated shares or are in the process of doing so. BFIs also had to increase credit growth to maintain a high profit target. Without many alternatives, they engaged in aggressive, unproductive and irresponsible lending to three particular sectors: real estate, hire purchase and share investment. Demand for loanable funds in these sectors is always high, and with little hassle and transaction cost, BFIs earn disproportionally large profits compared to lending to other sectors such as energy, agriculture, infrastructure and tourism. Underneath this lending practice lies ever-greening and at times imprecise classification of risky assets.

Socialise losses, privatise profits

Real estate prices began heating up after the earthquakes in 2015 following a few years of stability. Most BFIs had some room left for real estate lending, and due to lack of other bankable investment opportunities, they started issuing loans generously. Simultaneously, they increased margin lending, which contributed to a bullish stock market despite no noticeable change in economic fundamentals.

The other profitable market segment that could absorb credit quickly was vehicle purchase whose import demand spiked after a lull triggered by a crippling supplies disruption last year. Lending to these sectors swelled so fast, and without proper scrutiny of sustainability of the balance sheet, that the total credit growth outstripped deposit growth. At the same time, deposit growth slowed because of a deceleration in remittance inflows and the inability of BFIs to offer innovative savings instruments. The situation exacerbated to such a level that BFIs are now imploring the central bank to temporarily increase the credit-to-deposit threshold to 85 percent.

Pleading for an increase in the upper limit is akin to begging for a subsidy so that BFIs can continue enjoying the profits from imprudent and unsustainable lending practices and meet their high profit targets year after year. This is utterly reckless and reeks of an intention to socialise losses but privatise profits. The central bank should remain steadfast in its policy on the credit-to-deposit rate and defend the measures required to ensure a prudent financial system.

We went through this kind of situation in 2011 when there was a slowdown in deposit growth and unhealthy and cutthroat competition to increase lending and the real estate bubble burst disrupting financial flows. It resulted in a severe liquidity crisis and a loss of confidence in the banking system after the then Vibor Bikas Bank knocked the doors of the central bank in June 2011 to either inject money or take over its management. Subsequently, NRB imposed a 25 percent cap on real estate and housing loans and implemented reforms to improve the health of the financial sector.

Incongruous arguments

BFIs still have not learnt from their mistakes. First, the recommendation by BFIs to increase the credit-to-deposit threshold is nonsensical. It will not solve the structural operational and management flaws on which they try to flourish. They point to a liquidity crunch, but react unenthusiastically when the central bank offers temporary liquidity facilities. It looks like BFIs just want to cover up their reckless and imprudent operations. Second, they argue that slow capital expenditure and a slowdown in deposit growth led to the credit crunch. Yes, that is true. But then these two factors (which tend to drive deposit growth) were expected anyway. Given that there has not been any change in the expenditure absorption capacity, low capital spending was entirely predictable when the fiscal budget was introduced. Similarly, overseas migration started declining immediately after the earthquake and remittances started decelerating from May 2016. This was also anticipated well in advance.

BFIs knew that they were close to the threshold as early as the beginning of 2016, but they still engaged in aggressive lending to quick return and unproductive sectors to attain high profit targets. Whining for an increase in the threshold by floating incongruous arguments is irresponsible. They presented the same arguments in 2011 too. BFIs should have been conservative on credit growth (and its quality), which should be consistent with deposit growth to avoid a sustained asset-liability mismatch. The central bank should not increase the threshold now. The situation will likely normalise in the last trimester when most of the capital spending happens.

Unless BFIs change their operational and management model, the same thing is going to happen again. They should scrutinise loan proposals more intensely, invest more in research and personnel training, introduce innovative deposit and credit schemes, diversify their asset portfolio, lower unsustainable profit targets, improve corporate governance and continue consolidation efforts.

Thursday, January 19, 2017

Melamchi and the mismanaged KUKL

It was published in The Kathmandu Post, 18 January 2017

Mismanaged KUKL

The organisation needs an urgent overhaul to ensure efficient distribution of Melamchi water

Once known for its financial and administrative mismanagement, Nepal Electricity Authority (NEA) is now the most talked about public enterprise that is giving hope of a bright future. Apart from the scheduled electricity generation and additional import from India, drastically reducing load-shedding would not have been possible without the administrative acumen of NEA’s Managing Director Kul Man Ghising, unflinching support by a majority of the board of directors, and strong support by Energy Minister Janardan Sharma.

Meanwhile, gross negligence by management, especially the chairman of the board of directors, and excessive political interference is turning Kathmandu Upatyaka Khanepani Limited (KUKL) into a new basket case of administrative and financial mismanagement. It is an alarming development requiring urgent attention of and intervention by the government. Else, the dream of channelling Melamchi’s water through the dry taps in Kathmandu will continue to remain a daydream despite the fact that the main tunnel work is going to be completed by 2017.

NEA as a model

After the Nepal Oil Corporation, NEA is probably the second-most decried and politically interfered public enterprise in Nepal. The combined financial loss—a direct product of administrative mess, political interference and a mismatch between cost and retail prices—of these two enterprises was about 0.7 percent of gross domestic product (GDP) in FY2014. The intermittent petroleum shortages and prolonged load-shedding was throwing regular life out of gear. Fortunately, the low oil prices in the international market and its ability to still charge high prices in the domestic market was a blessing in disguise for the NOC, which despite being embroiled in an administrative mess and political interference through the labour unions, has turned its negative balance sheet positive in the matter of a year.

The case with NEA is different though. It continues to have a negative balance sheet, generating loss amounting to about 0.6 percent of GDP in FY2016. The administrative, political and union related troubles continue to beset its financial health and public service delivery. It cannot revise upward retail electricity prices like the NOC and continues to sell electricity below the cost of production. Hence, the government’s decision to write off 26.5 billion rupees of accumulated debt in 2011 was not enough to turn around its negative balance sheet.

But NOC is still a lost cause, given its core troubles despite the improved financials thanks to external factors. But NEA is a beacon of hope despite its bad financials thanks to a capable managing director and the backing of the board of directors. The tireless effort, management shrewdness, and commendable drive to achieve allocative efficiency have led to a drastic reduction in power cuts, making the public and the business community happy.

Ending Kathmandu’s water woes

The kind of overhaul seen in NEA and its recent improvement in service need to be replicated in KUKL. KUKL is a semi-public organisation tasked with managing water supply distribution and sewer systems (including treatment plants) in Kathmandu. To avoid the fate of a failing public enterprise, KUKL was established as a public company, which could loosely operate like a public-private-partnership (PPP) entity. Although the private sector collectively has just a 15 percent share, it is nevertheless allowed to head the board and have an important say on key issues. While this was done in good faith, given the mess with public enterprises, it is becoming a bane for the future of KUKL.

A political, inefficient and carefree chairman of the board of directors (from the private sector) is trying to prolong his tenure and blocking human resources and administrative reforms that are required to enable KUKL to distribute and manage water from Melamchi, which is expected to be completed by 2017. Finishing Melamchi’s tunnel work and channelling water to Kathmandu is only half the story. Efficient management and distribution of over 300 million litres of water per day is the other equally important half of the story.

Kathmandu’s water woes will not end unless the government intervenes in order to mend three core issues: address current staffing; remove the obstructionist chair of board of directors; and stop political interference in personnel hiring and in putting water supply lobbyists (water bottlers and tankers suppliers) above KUKL’s interests.

KUKL should hire competent staff for the vacant positions and replace personnel who do not have the required abilities. These include engineers of varying skills, machine operators, mid-to-senior level sectoral management staff, and overseers. The current general manager is not getting timely and appropriate cooperation from the board chair to fill these positions and enhance capacity of the existing ones. It will affect service delivery of KUKL.

Furthermore, the current board chair is staying beyond his term limit by coaxing politicians, delaying annual general meetings (which have not taken place since 2014), and making KULK a dumping ground for employing politically affiliated personnel. An uncooperative board chair—who has been on KUKL’s board since 2008 and chairman since 2014—with no respect for corporate governance, and who interferes in day-to-day administrative issues can virtually immobilise other management staff, including its competent general manager. The current board chair, who has even lost confidence in his fellow board members, needs to be booted out of KUKL.

Taking action

KULK’s annual general meeting is scheduled for the third week of January. The government should use its rightful authority and coerce the board chairman out of KUKL. Furthermore, the two large private sector umbrella organisations that are represented in the board of directors of KUKL need to behave as professional private sector players and not do the bidding of politicians and lobbyists. The private sector representation is failing to deliver the kind of management skills and visionary leadership expected of them at KUKL.

KUKL needs the recent NEA-type management, ie a competent and respected managing director or general manager fully backed by the board of directors, to ensure that Melamchi water is timely and efficiently distributed to the people of Kathmandu.

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.

UPDATE (2017-01-24): In its latest assessment, the IMF has projected Nepal’s GDP to grow at 5.5% in FY2017 and inflation to undershoot the target.

The mission expects growth to reach 5.5 percent in FY 2016/17 (ending July 15). The normalization of economic activity is being supported by a good monsoon, accommodative monetary policy, and rising government spending. India’s sudden withdrawal of high-denomination banknotes is expected to have a limited impact on activity overall; bank holdings of Indian rupee currency are small but some corporates and households who hold such notes have seen their purchasing power affected. The main risk to the outlook pertains to failure of capital budget implementation to improve.
The normalization of prices in the aftermath of last year’s trade disruption is pushing down inflation which is expected to undershoot the authorities’ mid-2017 inflation target of 7.5 percent.

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.