Tuesday, March 20, 2018

Macroeconoimc situation in FY2018 and beyond

It was published in The Kathmandu Post, 19 March 2018, p.8

Economy is not expected to meet its initial growth target due to poor planning and allocation, but there is hope for next fiscal year

The recently released mid-term reviews of the fiscal year (FY) 2017/18 by the Nepal Rastra Bank (NRB) and the Ministry of Finance (MoF) point to challenging macroeconomic times ahead. Briefly, the economic growth prospect looks less optimistic than previously envisaged, high revenue growth is tapering off, capital budget under-execution is chronic but recurrent spending is increasing, inflation will likely accelerate to around 6 percent, bank credit is getting tighter, and the external situation is deteriorating.

Against this backdrop, the appointment of Yubaraj Khatiwada as finance minister by Prime Minister KP Sharma Oli is the right decision. Khatiwada is an economist with wide ranging experience in development planning and monetary policy. This appointment has rekindled hope for a better-managed, less politicised MoF and budgetary system. Khatiwada now faces multiple challenges to steer the economy in the right direction towards a meaningful, job-rich structural transformation. Managing finances and achieving accelerated economic prosperity will require fiscal prudence, efficient government operations, coherent prioritising and planning among the three tiers of government, and private sector friendly reforms to increase both domestic and foreign investments in productive sectors.

Not rosy

The MoF has revised down its economic growth target for FY2017/18 to six percent from an overly ambitious 7.2 percent set before the beginning of the fiscal year. Even the revised target is a bit ambitious because monsoon rains were uneven and will most likely affect agricultural output significantly. Similarly, deceleration of remittances is slowing down economic activity accounted for by services, which are also affected by tighter loan disbursements to the private sector by banks and financial institutions. These two forces will outweigh gains from the encouraging industrial activities (thanks to an improved supply of electricity and a modest pickup in reconstruction and investment) and the temporary growth boost coming from elections-related expenditure.

On the fiscal front, the situation is not encouraging despite the fact that the budget was unveiled one and a half months prior to the start of FY2017/18, indicating chronic issues with budget execution that are exacerbated by political interference, bureaucratic incompetence, deficient management capacity of contractors, weak monitoring and evaluation systems, and poor governance. In essence, it reflects allocative inefficiency and structural weaknesses in project planning, preparation and implementation. The MoF expects just 70 percent of the planned Rs335.2 billion capital budget to be spent in FY2017/18, lower than the average 72.2 percent in the last five years. 

Ironically, line ministries are asking for an additional Rs326 billion from the MoF at a time when total government receipts (revenue and grants) are expected to be about 95 percent of planned receipts. It will lead to a larger than expected fiscal deficit in FY2018. Note that the government has already raised 80 percent of the planned gross domestic borrowing (89 percent of planned net domestic borrowing) for the entire FY2017/18. More government borrowing than planned will further aggravate the liquidity crunch and put upward pressure on retail interest rates.

On the monetary front, the developments are equally worrisome. Credit disbursement growth continues to outpace deposit mobilisation growth (seven percent and 6.9 percent, respectively) and most banks are near the regulatory threshold for the credit to core capital-cum-deposit (CCD) ratio of 80.Consequently, private sector credit has slowed down and money supply growth is close to a six-year low. Interbank rate has been rising and the Nepal Bankers’ Association, which is increasingly acting like a cartel and is promoting anti-competitive practices to hide banking inefficiencies and corporate mal-governance, is lobbying with its member banks to limit the interest rates on deposits. Inflation is also ratcheting up, from a low of 4.6 percent in FY2016/17, and is expected to be around six percent. 

On the external front, exports have picked up but imports were even more robust (13.4 percent and 15 percent growth respectively). The widening of the trade deficit together with deceleration of remittances is pushing the current account into negative territory. At this rate, even the overall balance of payments will be negative for the first time since FY2009/10 (after which Nepal knocked on the doors of the IMF for emergency lending to balance its books).

Hopeful signs

Despite this gloomy prognosis, there are reasons to be optimistic about the next fiscal year, and beyond. Finance Minister Khatiwada has been frank about the tight budgetary situation, and public and private sector reforms needed to enhance quality and accelerate quantity of capital spending and private investment. He took over an economy that was weak due to mishandling of economic affairs, priorities and governance by the previous government. Additionally, due to a base effect, progress in key macroeconomic variables—especially economic growth and inflation—will automatically be lower than in FY2016/17.

That said, two key priorities are crucial to boost economic activities and jobs creation in the coming years. First, better budget execution starts with allocative efficiency, i.e. shelving projects from the budget speech that are not shovel-ready. A comprehensive mapping of existing projects that are not performing well and are wasteful, and a coherent planning of fundamental policies and priorities at all tiers of government are essential to ensure that the working style of the MoF is not business as usual.

The Chief Economic Advisor’s office within the Finance Ministry could be adequately resourced, both finance and human capital wise, to carry out these tasks along with an objective assessment of the state of the economy. Additionally, resisting populist measures in the FY2018/19 budget and ensuring fiscal discipline by being mindful of widening revenue-expenditure asymmetry is important. Khatiwada recently argued for austerity measures to curb wasteful recurrent spending, widening of the tax net and plugging in of revenue leakage. 

Second, Khatiwada should push for ‘second generation reforms’ to boost domestic and foreign investment. A number of investment-friendly legislation were amended or newly-passed by the previous parliament. These should be supplemented by policies, regulations, guidelines and institutional frameworks for timely implementation. Furthermore, several important legislation need to be either amended or passed anew, including those related to foreign investment and public private partnership. The lower tiers of government also need capacity enhancement to bring coherent laws, policies, regulations and guidelines to run the government and attract investment to stimulate local economies.

Monday, March 12, 2018

Banking cartel in Nepal in the veil of an association

Recently, Nepal Bankers’ Association (NBA) decided to punish NIC Asia, a member commercial bank, by excluding it from interbank lending, which is crucial for managing immediate liquidity needs among banks. A rising interbank rate indicates tight liquidity in the banking system. Interbank rate has been rising in recent months, thanks to liquidity pressures arising from deceleration of remittance income and low capital spending (the latter case is normal).

What did NIC Bank do? Well, it broke away from collusion among 28 commercial banks, under the veil of a professional association, and started offering higher interest rates on deposits, which NBA has fixed (with “informal understanding”) at 11%. It started offering 12% on fixed deposit and 10% on savings deposit. The NBA went up in arms with NIC Asia and threatened to scrap its NBA membership in addition to barring it from interbank lending. Meanwhile, Nepal Rastra Bank (NRB), the central bank (which has been one of the most ineffective under the current leadership), remains indifferent to the tussle between NBA and NIC Asia.

Few things to consider here:
  • First, NBA is behaving like a cartel, manned by CEOs who thrive on moral hazard, that preaches free market but engages in anti-competitive practices to fix deposit rates (but not lending rates). Even Development Bankers’ Association lent support to NBA because they usually offer deposit rates one or two percentage points higher than commercial banks (same with their lending rates). They feel threatened by NIC Asia encroaching on their interest rate territory. In principle, any bank should be allowed to fix their own deposit and lending rates.
  • Second, NBA argues that without a ceiling on deposit rates, lending rates will spiral up. If banks offer 11% interest on deposit  and with 5% minimum cost of managing funds, final retail lending rate can easily go over 16%. This increases cost for individual borrowers and firms. NBA argues that its measures will help to stabilize interest rates and economy.
  • Third, it is not the job of NBA to decide on stabilizing interest rates. The NRB has interest rate corridor in place to do this. If NBA can dictate interest rates, then what is the relevance of NRB? Repeated financial crisis is a sign that NRB has been window dressing real issues: that systemic risks to financial sector are recurring and are exacerbated by faulty banking practices and corporate malgovernance. NRB increased capital base to NRs8 billion from NRs2 billion to force merger of the banks. But, the banks found a way out to be a NRs8 billion capital bank and avoid merger (cause too many managers will lose jobs and promoters/board will not be able to dictate lending terms to suit them or their businesses). The way NRB implemented the capital increase requirement was inherently faulty as it didn't achieve the main objective to reduce the number of banks. 
  • Fourth, the current NBA vs. NIC Asia fiasco has its root in Nepal having too many banks for a restricted depositor base. They can't survive without collusion/carteling. It's getting late to clean up the banking system. Same with hospitals, schools, colleges, airlines, etc. Syndicates and cartels rule almost all sectors. 
Update (2018-03-14): NIC Asia gives into the demand of NBA (informally assisted by the NRB). NIC Asia has now agreed to offer returns within the threshold created by the NBA. Meanwhile, the NRB has issued a directive on interest rate spread, which cannot be more than 5% (it was 6% before). Any BFI violating this requirement will not be allowed to distribute bonus and cash dividend next fiscal year. They will also be barred from opening new branches in places others than local bodies where there are no existing bank branches. Also, they won’t be able to avail refinancing facility on loans (except for those related to post-earthquake reconstruction of houses).

Thursday, March 8, 2018

Actual capital spending estimated at 70% of planned capital budget for FY2018

From The Kathmandu Post: The government is all set to introduce austerity measures, as its budget deficit is widening due to higher recurrent expenditure, error in calculation of savings in the last fiscal year and low mobilisation of foreign grants. The government’s budget deficit—revenue plus grants minus expenditure—stood at Rs49 billion as of Tuesday, which is around 1.9 percent of the gross domestic product, according to the Ministry of Finance. This deficit had stood at Rs35.5 billion in mid-January.

“This shortage of funds at the central level has prompted us to cut down on spending. However, only unnecessary spending would be slashed,” said Finance Minister Yuba Raj Khatiwada. The austerity measure includes lower spending in purchase of vehicles, fuel and office materials, including computers, according to Finance Secretary Shankar Prasad Adhikari. “Also, number of foreign trips would be reduced,” Adhikari said. “However, adequate funds will be provided to ongoing projects that are making good progress.”

The government has projected capital spending to stand at 70 percent of the allocation at the end of the fiscal year. The government had earmarked Rs335.2 billion for capital spending. But actual spending till the end of the fiscal year is likely to stand at Rs234.6 billion, according to the Finance Ministry. The government had spent only 65 percent of the capital budget in the last fiscal year. 

The Ministry of Finance (MoF) has revised economic growth forecast for the current fiscal year to over 6 percent from 7.2 percent predicted in the beginning of 2017-18. Some of the reasons for the downward revision are fall in production of paddy, which makes major contribution to the gross domestic product, and reduction in consumption due to fall in remittance income.

From The Kathmandu Post: Investment Board Nepal (IBN) and Finnish joint venture Nepwaste initialed a project development agreement (PDA) on Wednesday for the management of solid waste in the Kathmandu Valley, IBN said in a press statement. 
Nepwaste will undertake Package Number 1 of the Kathmandu Valley Integrated Solid Waste Management Project which covers Kathmandu Metropolitan City and nine neighbouring municipalities: Budhanilkantha, Nagarjun, Tokha, Tarakeshwor, Gokarneshwor, Sankharapur, Dakshinkali, Kageshwori-Manohara and Chandragiri.

As per the PDA, Nepwaste will collect a service charge of Rs219 per household per month to pick up their garbage. Nepwaste will build a landfill site at Bancharedanda in Nuwakot and a transfer station at Teku in Kathmandu to manage the solid waste. The company will also set up processing and recycling units at the landfill site. The garbage collected from homes will be segregated into biodegradable and non-biodegradable waste. The company will turn the trash into compost fertilizer, petroleum products and natural gas besides generating up to 5 MW of electricity. Most of the solid waste will be recycled, and only 20 percent will be put in the landfill site. 

The PDA has given a transition period of three months for the project developer to take over the existing waste management system. The company has to hand over the project to the government after 20 years, and pay around Rs3 billion in royalties during the period. IBN has said it will now start PDA negotiations with Clean Valley Company which will undertake waste management in Lalitpur Metropolitan City and adjoining municipalities besides Kirtipur and Bhaktapur under Package Numbers 2 and 3. The estimated cost of the project is Rs5 billion for the first package and Rs2 billion for the second and third packages.

Wednesday, February 28, 2018

Finance Minister plans NRs600 billion investment in infrastructure and more

From The Kathmandu Post: On Monday, the corporation invited proposals from potential ground handling service providers at Kansai International Airport in Osaka, Japan. It had made a similar call to prospective ground handling service providers at Incheon International Airport in Incheon, South Korea last Friday.  NAC invited bids for ground handling services at King Khalid International Airport in Riyadh, Saudi Arabia last December. As per the initial proposal, the national flag carrier has planned to operate four weekly flights to Riyadh, three weekly flights to Incheon and two weekly flights to Osaka. 

Recently, the Tourism and Civil Aviation Ministry named three international long-haul routes for NAC to serve after it receives its two wide-body aircraft on order in the next three months. The carrier has borrowed Rs24 billion from the Citizen Investment Trust (CIT) and the Employees Provident Fund (EPF) to buy the planes.

NAC had planned to fly to the Japanese capital of Tokyo, but this did not happen as the air service agreement (ASA) between Nepal and Japan has designated Kansai International Airport in Osaka. The Tourism Ministry is also preparing to revise the ASA with Japan to permit Nepali carriers to fly on other routes in Japan. Apart from NAC, several private carriers like Buddha Air have planned to serve Japan to bring high-end tourists to Nepal. Nepal and Japan signed the ASA in 1993 allocating 400 weekly seats. The national flag carrier used to fly to Osaka via Shanghai until 2008 when it was forced to suspend the route due to lack of aircraft.

Finance Minister plans NRs600 billion investment in infrastructure

From Karoabar: Finance Minister Dr. Yubaraj Khatiwada is planning NRs600 billon public and private investment in infrastructure. NRs100-200 billion will come from the government and the rest from the private sector. Some of his commitments to private sector representatives are as follows:

  • Reform legal and policy related bottlenecks to spur private sector investment
  • Implement SEZ Act to address issues surrounding land and other clearances (land prices are escalating too high, increasing cost of production for firms)
  • Reduce time for approvals needed for private investment
  • Improve customs administration to control leakages
  • Consult with NRB to address frequent bouts of liquidity shortage
  • Prioritize industrialization and services sector

Saturday, February 24, 2018

Government reduces number of ministries from 29 to 17 and more

The government’s decision to downsize the number of ministries from 29 to 17 will enhance efficiency and lessen the burden on state coffers even if the move does not suffice to sustain funding in the federal structure, officials have said. Officials said the decision will enhance the efficacy of the government, will improve governance and cut state expenditures, among others. But experts point to a more pressing problem—of huge costs in the provinces and the local level. They suggest that the government look for ways to curb regular expenditures in the federal units.

Office of Prime Minister and Council of Ministers (OPMCM)
  1. Ministry of Finance
  2. Ministry of Foreign Affairs
  3. Ministry of Defense
  4. Ministry of Physical Infrastructure and Transport
  5. Ministry of Health and Population
  6. Ministry of Federal Affairs and General Administration
  7. Ministry of Information and Communications
  8. Ministry of Law, Justice and Parliamentary Affairs
  9. Ministry of Culture, Tourism and Civil Aviation
  10. Ministry of Education and Sports
  11. Ministry of Home Affairs
  12. Ministry of Forest and Environment
  13. Ministry of Water Resources and Energy
  14. Ministry of Industry, Commerce and Supplies
  15. Ministry of Labor, Employment, Women and Children
  16. Ministry of Urban Development, Drinking Water and Sanitation
  17. Ministry of Agriculture, Cooperatives and Land Management

At this rate of work, it will take another eight years to upgrade Bhairahawa airport to an international airport

The much-delayed international airport project in Bhairahawa has achieved a measly 10 percent physical progress in 2017, and if it continues at the same rate, it would take another 8 years to finish, the project financer Asian Development Bank (ADB) said on Friday. The ADB has expressed concern over the slow performance of the contractor of the Gautam Buddha Airport, which is being upgraded into an international facility, and has raised doubts that the project would be completed by the extended deadline of June 2019. The multilateral development finance institution has already informed the government that it would not be able to finance the project further after its initial deadline in December 2017, in view of its slow progress. However, it has been weighing options that if the contractor improves its performance until mid-March, the project’s financing could continue, according to the officials at the Civil Aviation Authority of Nepal (Caan)—the project’s executing agency.

On November 13, 2013, the Civil Aviation Authority of Nepal (Caan) awarded the Rs6.22 billion contract to upgrade the airport to China’s Northwest Civil Aviation Airport Construction Group. Of the total project cost, the ADB has provided $58.50 million ($42.75 in loans and $15.75 million in grants), the Opec Fund for International Development (OFID) has provided a $15 million loan and Caan will bear the rest of the cost as counterpart funding. The national pride project has been envisaged to serve the fast-rising business and industrial hub of Bhairahawa and facilitate international pilgrimage tourism to Lumbini, the birthplace of the Buddha.

Poor get identity cards only

The government is planning to distribute “poor ID cards” to those falling below the poverty line. However, there is no concrete plan yet to provide them with social security allowance, medical insurance, skills training, essential goods at subsidized rate, and free education among others. 

The government will distribute such ID cards to poor people from five villages of five districts within this month. It has already done survey in 25 districts. The five villages are Bhagwanpur (1886, Siraha), Fikkal (1604, Sindhuli), Nishikhola (1563, Baglung), Swamikratrik (1638, Bajura) and Mohanyal (2386, Kailali). The government aims to distribute such ID cards to 391,831 poor people identified in 25 districts. The total number of poor people is estimated to be around 1.9 million.

Monday, February 19, 2018

Tentative priorities of the left alliance led government and more

From Kantipur: A team formed to chart out policies and programs priorities for the new government has submitted report to PM KP Sharma Oli and chairman of CPN-MC Pushpa Kamal Dahal. Here are the key priorities:
  • Replace gas and petroleum fuel with electricity use within five years
  • One industrial area in each province
  • Establish waste processing and disposal center and generate electricity out of it
  • Establish polytechnique institute in each local body
  • Upgrade zonal hospitals to medical college
  • Government to establish medical college
  • Retain National Planning Commission
  • Revive National Trading Limited
  • Widen tax net
  • Reduce government expenditure

From The Kathmandu Post: Nepal has abandoned the plan of relying on the non-income criteria framed by the United Nations (UN) to graduate from the Least Developed Country (LDC) category, fearing the transition would significantly reduce the flow of foreign aid and deprive the country of other international support measures.

“We have decided not to graduate based on non-income criteria as our capacity needs to be enhanced in various areas,” NPC Vice Chairman Swarnim Wagle told journalists on Sunday. In March, 2015, a meeting of the UN Committee for Development Policy (UNCDP), a body under the UN Department of Economic and Social Affairs, had told Nepal that it was eligible for LDC graduation under non-income criteria. During that meeting, the UNCDP had said it would review Nepal’s case again in March, 2018 and confirm whether it was ready for graduation.

UN data show that Nepal’s per capita gross national income stood at $659 during 2015 review meeting, which was way below the UN threshold. However, Nepal had achieved a score of 26.8 in Economic Vulnerability Index, which was 5.2 points more than the UN threshold. Also, Nepal had scored 68.7 in Human Assets Index, which was 2.7 points more than the UN threshold. “But we have told the UN that some of the indicators for graduation are irrelevant to us and issues that are important for Nepal’s economic and human capital development have not been incorporated in the formula for LDC graduation,” Wagle said.

From The Kathmandu Post: Nepal will have to fork out about Rs1,770 billion per year till 2030, or around 68 percent of the last fiscal year’s gross domestic product (GDP), to attain the SDGs, says the report, ‘Sustainable Development Goals - Status and Roadmap: 2016-2030’, which highlights major issues and challenges that the country needs to reckon with to implement SDGs.

A big chunk of this investment, or 55 percent, will have to come from the government, adds the report released on Sunday by the National Planning Commission (NPC) Vice Chairman Swarnim Wagle. This investment, which hovers around Rs973.5 billion per year, is around 76 percent of the government’s budget for the current fiscal year. Most of the public investment will go towards poverty reduction, followed by agriculture, health, education, gender, water and sanitation, transport infrastructure, climate action, and governance. The public investment requirement is expected to be the lowest in tourism followed by energy, industry, and urban infrastructure, mainly housing, where private and household investment will be required.

The private sector is expected to contribute about Rs382 billion per year to meet the SDGs and households are expected to finance up to 5 percent of the total SDG investment requirement, which comes to around Rs88.5 billion per year. The incremental financing resources of cooperatives available for SDGs, according to the NPC report, are estimated at about Rs25 billion annually, while NGOs are expected to mobilise about Rs20 billion per year to meet the SDGs. 

This implies arranging funds to meet SDGs will be a tough nut to crack for the government. The NPC has said domestic financing through revenue mobilisation and internal borrowing could finance about 62 percent of the public sector SDG investment requirement while foreign aid, both grants and loans, would finance another 20 percent of the public sector financing needs if the overall foreign aid pie grows by at least 10 percent during 2016-2020 period, 5 percent during 2021-25 and 2 percent thereafter. This means inflow of foreign aid will have to double from existing levels to meet the SDGs, which will raise country’s dependence on overseas development assistance (ODA). 

Friday, February 16, 2018

Challenges for the new Oli-led government and more

CPN-UML chairman KP Sharma Oli was appointed prime minister on February 15, his second stint as PM (and 38th PM of the country). His government will face a number of economic challenges (including the fact that the mid-year FY2018 review doesn't indicate a rosy picture) over the medium term. Here are some of them:
  • Boosting investor confidence is crucial to increasing private sector domestic and foreign investment. In addition to updating a few remaining archaic laws and policies, the next government needs to fully implement the recently amended acts and policies regarding industrial enterprises, special economic zones, labor relations and export promotion.
  • Fiscal management will be challenging considering the expected large revenue-expenditure asymmetry at the federal, provincial and local levels. Unable to cover expenditure needs during the first few years, provincial and local governments will demand large transfers from the central government. Fiscal transfer and grants already account for 50 percent of recurrent spending. 
  • Fundamental policies and priorities of all tiers of government have to be synchronized to create a coherent plan and strategy for economic development. Additionally, revenue policies should not overlap so that businesses do not have to pay the same tax to both local and provincial governments.
  • Budget preparation and its execution by all tiers of government will also be challenging. Provincial and local governments do not have prior experience in preparing time-bound budgets and, more importantly, implementing them. They will rely more on fiscal transfer than their own revenue sources. The center should adhere to a rule-based fiscal transfer regime considering objective measures such as population, income per capita, area, state of infrastructure, governance, tax effort and fiscal discipline.
  • Reconstruction must pick up speed since very little has been achieved in the last two years. It needs to be made less political and more result-oriented. The prime minister could proactively monitor progress and resolve hurdles, especially those cropping out of intra- and inter-agency noncooperation.
  • Financial sector management will be crucial as well. BFIs are short of loanable funds because their CCD ratio was close to the regulatory threshold of 80. Credit disbursement growth is higher than deposit mobilization growth amidst remittance inflows continuing to decelerate and government capital spending stagnating like in the past. A tight lending scenario arising from BFIs misplaced operational practices and priorities, and government's inability to spend the money it collected as revenue calls for proactive and effective governance of BFIs as well as finding ways to unfreeze the credit market without distorting incentives (no moral hazards please). Else, credit to private sector will squeeze, which will impact economic growth prospect.
  • Managing the fallout of deceleration of remittance inflows. This will affect households, macroeconomy and institutions. 

Bibek Subedi writes in The Kathmandu Post: International Finance Corporation (IFC), the private sector lending arm of the World Bank Group, is in the final stages of floating bonds worth $500 million in local currency in Nepal. The multilateral lender has sought permission from Nepal Rastra Bank (NRB) to issue the instruments. IFC had obtained approval from the Finance Ministry to issue rupee bonds two years ago, but it could not do so due to lack of legal provisions. 

Last year, the Securities Board of Nepal (Sebon) amended the Securities Registration and Issue Regulation, and opened the way for international financial institutions like IFC to issue local currency bonds. Subsequently, IFC applied for permission at NRB to issue bonds worth $500 million in Nepali currency. After getting the central bank’s go-ahead, IFC will have to obtain permission from Sebon, the regulator of the securities market. IFC, according to sources close to it, is planning to invest the funds raised from the bond issuance in areas like hydropower and commercial agriculture, among others. Both institutional and individual investors will be allowed to purchase the bonds issued by IFC.