Friday, November 29, 2019

Indian economy continues to slow down

Indian economy continues to slowdown. The latest estimate of economic activities by the government shows that GVA growth was 4.3% in the second quarter (July-September 2019) of fiscal year 2019-20. GDP growth at producers’ prices was 4.5%, the lowest in the last 25 quarters (quarterly GDP grew by 4.3% in Q4 FY2013). In terms of GVA growth (basic prices), this is the lowest quarterly growth rate since the availability of quarterly data (2011-12 constant price series).

Growth in all sector slowed down compared to Q2 FY2019. Agricultural output is estimated to increase by 2.1%, much lower than 4.9% in Q2 FY2019 but slightly higher than in the first quarter. However, industrial output slumped the most. It is estimated to grow by just 0.5% in Q2 FY2020, far lower than 6.7% in the corresponding quarter in last fiscal. Similarly, services sector is estimated to grow by 6.8%, which is also lower than the previous quarters. 

Within industry sector, manufacturing output actually contracted. It is expected to grow at a negative 1% compared to 6.9% in Q2 FY2019. Mining and quarrying output is expected to grow by 0.1%, which is better than negative 2.2% growth in Q2 FY2019, but lower than 2.7% in Q1 FY2020. Construction is continuing to slowdown too with growth of just 3.3%, also lower than the growth rates in the corresponding quarter in previous fiscal years. Electricity, gas and water supply activities are also slowing down. 

Within services, all activities are nosediving expect for public administration and defense related services. 

If we look at expenditure side of GDP data (which is basically GVA plus taxes minus subsidies), then we will see a drastic fall in gross capital formation (basically investment). It consists of gross fixed capital formation, change in stock and valuables. Gross capital formation growth is expected to be just 0.5%, the lowest in the last 22 quarters. GFC contracted (negative growth of 4.9% in Q4 FY2014). There is an improvement in net exports because exports growth remained stable but imports growth decreased slightly. Private consumption growth is almost stable but public consumption growth is picking up, albeit slowly. Essentially, the 4.5% GDP growth (producers’ prices) attributable to slight pickup in consumption but a drastic slowdown in investment. 

So, whats happening? Consumption demand is still weak, domestic credit is tight (partly contributed by the mess in non banking financial institutions) and investment in construction & infrastructure is slacking, weak external demand is slowing down exports and manufacturing, and consumer as well as investor sentiment is not that great. Core industrial output is slumping. It appears the structural reforms such as GST, bankruptcy law and slashing of corporate taxes are not yielding results in the short term (and they are not expected to do so). What is needed right now is fiscal policy that stabilizes the economy and brings it up to the growth sustained in the past. This requires more and faster government spending in sectors that can give high return (infrastructure investment) or some kind of fiscal transfers in rural sector (agricultural households) or significant efficiency enhancement of public capital investment. This might help stimulate demand in the short-term. However, this risks increasing fiscal deficit. There is a trade off, and managing is both good economics and art of managing consumer and investor expectations. 

The RBI will most likely go for another round of rate cut.

Wednesday, November 6, 2019

Undershooting the macroeconomic targets

It was published in The Kathmandu Post, 21 October 2019. Related detailed blog post here.

For the last fiscal year, 2018-19, the government had targeted a gross domestic product (GDP) growth of 8 percent. During that time, it promised that Nepal would experience double-digit growth within a few years. The government claims that the economy is in far better shape than when it inherited it from the previous government, because of policies and effectiveness of government operations. By vowing to overhaul public spending capacity, investment regulations, and governance, it has set an even higher growth target (8.5 percent) for 2019-20.

The latest data released by the government and the central bank show that economic performance is actually far behind the stated targets. The government failed to achieve most of the macroeconomic goals set during the beginning of the fiscal year. It indicates underperformance relative to its unrealistic targets.

Worse than expected

The economy is expected to grow at 6.8 percent at basic prices (7.1 percent at market prices) in 2018-19, lower than the government’s target. The government is claiming that since this is the third consecutive year of growth being over 6 percent, the Nepali economy is in a solid footing with strong economic and institutional fundamentals. Unfortunately, the reality is a bit different. In a way, the last three growth episodes are idiosyncratic. In 2016-17, the growth rebound was essentially a base effect because of the rock bottom economic activity in the previous two years due to the 2015 earthquake and India’s trade blockade. In 2017-18, it was due to temporary fiscal stimulus related to post-earthquake reconstruction and elections that drastically increased demand for goods and services. In 2018-19, it was good agricultural harvest underpinned by a favourable monsoon, post-earthquake reconstruction related fiscal stimulus, and tourism and real estate activities. Surprisingly, industrial output has contracted (especially manufacturing activities), and foreign direct investment has declined. This is in contrast to the Oli-led administration’s grand promises, of building the right policy environment and promoting political stability, at investment and infrastructure summits.

Consistently lower actual GDP growth than what was projected during budget speeches indicates that the government is not keeping its promises at the policy and operational levels. Consider the case of poor budget execution. While presenting the 2018-19 budget, the finance minister argued that the government would be spending over 90 percent of the capital budget and avoid expenditure bunching in the last quarter of the fiscal year. In reality, actual capital spending was just three-fourths of budgeted capital spending and over 40 percent of it was either spent or settled in the last month. It shows that budget execution undershot the target, and there was no change in spending pattern, raising concerns over the quality of spending. Moreover, actual capital spending is projected to be 6.9 percent of GDP, which is actually lower than in 2017-18. This is also reflected in the expenditure side of GDP data, as a deceleration of public gross fixed capital investment (think of the setback in completing large infrastructure projects such as Melamchi and Upper Tamakoshi).

Revenue performance was also below the target. A revenue growth target of about 30 percent—a feat achieved just once in the last decade—was too ambitious in the first place. The finance minister had asserted that the government would achieve it (to finance increasing recurrent expenditure) by plugging in leakages, broadening the tax net and implementing administrative reforms. Unfortunately, the lower than expected GDP growth rate and a slowdown in imports, which is the source of over 45 percent of tax revenue, meant that revenue growth fell below 20 percent. Expenditure under-performance but less than expected revenue mobilisation means that fiscal deficit will remain at a high level.

On the monetary front, inflation averaged 4.6 percent, much lower than the targeted 6.5 percent but higher than 4.2 percent in 2017-18. Higher fuel prices, depreciation of the currency and strong consumer demand propped up the prices of goods and services. Meanwhile, the money supply in the economy and credit to the private sector were not only lower than in 2017-18, but they were also below the central bank’s target. Liquidity shortage, caused primarily due to aggressive credit growth relative to deposit growth, persisted and interests rose to even higher levels. This increased the cost of financing for the private sector. In fact, the interbank rate (the rate at which banks and financial institutions lend to each other) is at its highest level since the last financial crisis in the fiscal year 2011-12. The stock market is more volatile than ever.

On the external front, a lower rate of import growth compared to export growth and steady remittance inflows despite a decline in the number of outmigrants resulted in a narrower current account deficit. However, the balance of payments slipped into the negative territory, the first time in the last nine years. The decrease in net foreign direct investment partly contributed to this. Consequently, foreign exchange reserves were just enough to cover 7.8 months of import of goods and services, down from 9.4 months in 2017-18.

Change is required

The government has again set ambitious targets for 2019-20 without notable changes to its operational strategy and policy facilitation. The latest consensus GDP growth forecast is between 6 percent and 6.5 percent, much lower than the 8.5 percent target set by the government. Despite the unfavourable monsoon, strong services sector output (contributed by steady remittance inflows and high tourist arrivals ahead of Visit Nepal 2020) together with ongoing post-earthquake reconstruction will support growth of around 6 percent. Achieving growth rate higher than 6.5 percent will require the government to address structural issues related to land acquisition, environmental clearances, investment-friendly regulations, productivity-enhancing infrastructure, human resources and the efficacy of the usually lethargic bureaucracy. It is a race against time for the powerful government with a two-thirds majority in Parliament to address these structural bottlenecks.

Given the way the government is implementing the budget, it is unlikely that there will be a drastic change in capital spending absorption capacity and revenue mobilisation, leading to a wider fiscal deficit and a higher level of public debt. Furthermore, investors are not entirely convinced by the government’s band-aid approach to solving structural issues plaguing private investment. Most of the commercial deals in infrastructure these days are settled at the government-to-government level, bypassing the usual competitive procurement among private companies. Liquidity issues are far from being resolved, and interest rate volatility will continue. The external sector is also projected to deteriorate next year.

Against this backdrop, the likelihood of the government missing its own targets again is quite high. The existing way of formulating the budget and its execution, coordination with the various tiers of government, tinkering policies to resolve structural issues instead of overhauling decades-old laws and policies, and slow pace of bureaucracy (be it due to politicisation or sheer inability) are not going to result in a vibrant economy that can sustain a near double-digit growth rate.

Thursday, October 17, 2019

Tariff war and policy uncertainty leading to synchronized global slowdown

In its latest World Economic Outlook (October 2019), the IMF argues that the global economy is in a synchronized slowdown, thanks to rising trade barriers and increasing geopolitical tensions. It has downgraded global growth for 2019 to 3%, the slowest pace since the global financial crisis a decade ago. Specifically,
  • US-China trade tension will reduce the level of global GDP by 0.8% by 2020
  • Growth is affected by idiosyncratic country-specific factors in emerging market economies. Growth in Argentina, Iran, Turkey, Venezuela, Saudi Arabia, India, Russia, Brazil, Mexico, China, etc are expected to slowdown
  • Growth weakened in China because of regulatory efforts needed to rein in debt and macroeconomic consequences of increased trade tensions
  • Growth slowed down in India because of corporate and environmental regulatory uncertainty in addition to the concerns regarding the soundness of nonbank financial sector. 
  • Growth is also affected by structural factors such as low productivity growth and aging demographics in advanced economies
So, what is causing the weak growth? 
  • Sharp deterioration of manufacturing activity 
  • Global trade affected by higher tariffs
  • Prolonged trade policy uncertainty affecting investment and demand for capital goods

What is supporting growth?
  • Services sector is keeping labor markets afloat and wage growth and consumption spending healthy in advanced economies. This may not last long due to weaknesses in the US and Euro area.
  • Monetary policy is supporting growth by easing policies amidst the absence of inflationary pressures and weakening economic activity. 

What are the risks to growth?
  • Heightened trade and geopolitical tensions including Brexit-related risks
  • These could lead to shift in risk sentiment, financial disruptions, and a reversal of capital flows to emerging market economies 
  • Low inflation is constraining monetary policy and its effectiveness

What is needed to rejuvenate growth, especially to boost confidence and reinvigorate investment, manufacturing, and trade?
  • Undo the trade barriers, rein in geopolitical tensions, and reduce domestic policy uncertainty. Tariffs should not be used to target bilateral trade balances. Cooperation to resolve roots of dissatisfaction is needed (resolve deadlock over WTO dispute settlement mechanism; modernize WTO rules to encompass e-commerce, subsidies and technology transfer, etc)
  • Monetary policy needs to be coupled with fiscal support where fiscal space is available. If borrowing costs are low, then countries should borrow more to invest in social and infrastructure capital 
  • If monetary policy is supporting growth, then macroprudential regulation should be the norm to prevent mispricing of risk and excessive buildup of financial vulnerabilities
  • Sustainable growth requires structural reforms to boost productivity, improve resilience, and lower inequality. These reforms are more effective when good governance is already in place (applies to emerging market and developing economies)

Although global growth will inch up to 3.4% in 2020 it is still a downward revision from the April 2019 projection. This is supported by growth rebound in emerging market and developing economies. The ‘recovery’ is not broad-based and remains vulnerable because of the expected slowdown in major economies like the US, Japan, and China.

South Asian outlook
  • Nepal is clocking in the highest GDP growth in FY2019. In FY2020 Bhutanese economy is expected to grow at 7.2%, followed by Indian economy 7.0% and Nepali economy 6.3%.
  • Nepal is projected to have the highest inflation rate, 6.1%, in FY2020.
  • Maldives is expected to have the highest current account deficit, 15.7% of GDP, in FY2020, followed by Nepal (10% of GDP)
GDP growth
Sri Lanka
Sri Lanka
Current account balance (% of GDP)
Sri Lanka

Wednesday, October 16, 2019

New cross-border transmission line, 762 MW Tamor reservoir project, projected GDP growth of 6.4%

From The Kathmandu Post: Nepal and India have agreed to fund a second high-capacity cross-border transmission line connecting Butwal to Gorakhpur in India through a commercial entity with both countries pledging equal equity in funding of the project. The agreement on Tuesday followed a two-day, Seventh Joint Steering Committee and Joint Working Group meeting on Nepal-India Cooperation in the Power Sector in the southern Indian city of Bengaluru. The meeting concluded with agreements on implementation and financing modality of the 135 kilometre-long, 400 kV transmission line and formalisation of an energy banking mechanism between the two South Asian neighbours.

“The sides have agreed to build the transmission line with 20 percent of equity investment and 80 percent debt,” said Energy Minister Barsha Man Pun. It was decided that a company would be formed under the modality within three months and to have a project implementation agreement, within six months.The decision came a month after the Nepali and Indian energy ministers expressed optimism over both sides coming to terms on the development modality of the proposed 400 kV New Butwal-Gorakhpur transmission line project.

HIDCL, Power China to build 762MW Tamor hydel

From The Himalayan Times: The government has awarded the 762-megawatt Tamor reservoir hydropower project to a Nepali and Chinese joint venture firm. Hydroelectricity Investment and Development Company Ltd (HIDCL) of Nepal and state-owned Power China Corporation will construct the project on government-to-government (G2G) basis. Construction of the Tamor project is expected to start from next fiscal and be completed by 2025.

During Chinese President Xi Jinping’s two-day state visit to Nepal, the Investment Board Nepal (IBN) and Ministry of Energy, Water Resources and Irrigation (MoEWRI) awarded the contract to HIDCL-Power China to build the project under the public-private-partnership (PPP) model. Minister for Energy, Water Resources and Irrigation, Barsha Man Pun, informed that the government has also signed an agreement with Power China to build the 156-megawatt Madi multipurpose hydropower project which is located in Rolpa district. As per an initial study, the project cost is around $39 million.

Earlier, HIDCL and Power China had jointly submitted a project development proposal at the IBN to build both the projects with a share structure of 46:54 per cent for the Tamor project, with the Nepali firm investing 46 per cent and Power China investing 54 per cent of the project cost. Similarly, in Madi multipurpose hydropower project, HIDCL will manage 26 per cent and Power China will manage 74 per cent of the total investment.

World Bank projects Nepal’s GDP growth rate to average at 6.5%

From myRepublica: The World Bank has projected the growth of Nepal’s gross domestic product (GDP) to average at 6.5% over the current fiscal year – FY2019/20 and the next fiscal year – FY2020/21.The medium-term outlook is supported by government consumption and investment, according to the bank. Reasoning strong services and construction activity due to rising tourist arrivals and higher public spending, the international financial institution made the growth projection for Nepal. 

According to the report, growth on the supply side will be driven by services, underpinned by steady remittance inflows and high tourist arrivals whereas investment and government consumption are expected to be the main drivers of growth on the demand side. The tourist arrivals will be supported by the Visit Nepal 2020 campaign, the completion of the second international airport and the construction of big hotels in the country.

Wednesday, September 11, 2019

How did Nepali economy perform in FY2019?

  • Positive point: Three consecutive years of high GDP growth
  • Concerning points: Weak budget execution, revenue growth below target, inflation inching up (natural given high GDP growth), continued tight liquidity and high interest rates, large fiscal and current account deficits, lower FDI, depleting foreign exchange reserves (although at OK level)
  • Things to watch out for: Whether high growth rate is sustainable without significant improvement in public capital budget execution and higher private investment (domestic and foreign), structural and institutional reforms (procurement, land, environment, human resources and labor market, laws and regulations), and sound governance

1. CBS estimated that the economy would grow at 6.8% (GDP at basic prices) in FY2019. At market prices, it is expected to grow at 7.1%. This marks three consecutive years of above 6% growth rate. In FY2019, bumper agricultural harvest and pickup in services sector activities contributed the most to the GDP growth. Specifically, agricultural, industrial and services sectors are projected to grow by 5.0%, 8.1% and 7.3%, respectively. Agricultural sector contributed 1.6 percentage points, industrial sector 1.3 percentage points and services sector 3.9 percentage points to the overall projected GDP growth of 6.8%. These projections are based on eight to nine months data.

2. Specifically, electricity, gas and water sub-sector is projected to grow at the fastest rate (12.4%, up from 9.8% in FY2018), followed by wholesale and retail trade (10.9%, down from 12.3% in FY2018), mining and quarrying (9.5%) and construction (8.9%). These indicate accelerated work in hydroelectricity generation and ongoing construction as well as pickup in reconstruction related activities (public as well as private housing and infrastructure). The high wholesale and retail trade activities are related to the burgeoning import growth and remittance income. Overall, robust agricultural output is underpinned by favorable monsoon and timely availability of agricultural inputs, and high services sector output is supported by wholesale & retail trading, tourism and real estate activities. Industrial sector slowed down a bit compared to FY2018.

3. On the expenditure side, GDP (at market prices) grew by 7.1%, up from 6.7% in FY2018. Consumption accelerated but public fixed investment (public GFCF) decelerated, indicating a slowdown in capital spending. A much higher increase in import and a slower increase in export meant that net export was negative.

4. On fiscal sector, capital expenditure absorption capacity continues to remain low despite the budget being unveiled one and a half month prior to start of FY2019. The government argued that it spent the first few months in designing spending procedures and directives, and laws related to investment promotion and procurement. It also said that small projects were delegated to local governments, but was not so forthright in delegation of spending and monitoring authority. This also contributed in low capital spending. Furthermore, delays in land acquisition, environment clearance, lengthy procurement processes, lack of inter-agency coordination, etc continued to bog down the extent and the effectiveness of public spending. As per the data from FCGO, actual capital spending is projected to be about 75.9% of planned capital spending. Similarly, actual recurrent spending is projected to be 84.6% of planned recurrent spending. Recurrent and capital expenditures are projected to be 20.6% and 6.9% of GDP, respectively. These were 23% and 7.9% of GDP in FY2018. FCGO used to publish monthly budgetary expenditure and revenue previously. Very strange that it is not publishing them on time these days (even quarterly public debt data are not published regularly). These are preliminary figures. Actual figures will probably show slightly higher recurrent but a bit lower capital expenditures. Also, there isn't much change in spending pattern too, with over 50% of spending bunching in the last quarter. 

5. Meanwhile, based on the latest revenue data published by the central bank in its macroeconomic situation report, revenue growth is estimated to be about 17.4%, much lower than the government’s target. Total revenue will be around 24.8% of GDP. The share of VAT is the highest (28.1%), followed by income tax (22.6%), customs (18.1%) and excise duty (14.2%) among others. Considering the expenditure under-performance and high level of revenue mobilization (although short of the target), fiscal deficit will likely be around 6% of GDP. A higher fiscal deficit is exerting pressure on current account balance too.

6. Annual CPI inflation averaged 4.6%. Here, note that usually the central bank computes annual average inflation as the average of monthly inflation, in which case it will be 4.7%. However, the central bank used the average of monthly CPI index to compute annual inflation for FY2019. Why to be inconsistent in FY2019 only (probably, to side with the lower inflation figure or just a mistake)? In any case, let us use the 4.6%, which is slightly higher than the inflation in FY2018. Both food and beverage, and non-food and services inflation increased in FY2019. In food and beverages, the highest increase in prices was that of alcoholic drinks and tobacco products (no surprise here as the government increased taxes and excise duty). In non-food and services, the highest increase in prices was that of housing and utilities, clothes and footwear, and transportation (higher fuel prices, depreciation of currency as well as strong consumer demand). 

7. M2 (broad money) expanded by 15.8%, driven by private sector credit growth. However, M2 growth in FY2019 is lower than the central bank’s target (and the one in FY2018) owing to the decline in net foreign assets. Overall credit to private sector expanded by 19.1%, lower than in FY2018.

8. Deposits at BFIs increased by 18%, lower than 19.2% in FY2018. Credit (loans & advances) grew by 20.7%, lower than 23.3% in FY2018. Deposits growth of all class A, B and C BFIs slowed down. Credit by development banks increased but that by commercial banks and finance companies decreased compared to the growth in previous year. However, credit growth of commercial banks was still higher than its deposit growth. Agriculture sector credit grew by 42.5% (primarily because processing of tea, coffee, ginger and fruits and primary processing of domestic agro products were included in agriculture  from October 2017. Prior to this, most of these were under production). Credit to construction sector grew by 22.2%. Similarly, credit to mining, transport equipment production and fitting (includes aircraft and aircraft parts); transportation, communications and public services (includes electricity), and consumable loan (includes gold & silver) grew at a faster rate than the previous year. However, credit to industrial production; metal production, machinery and electrical tools and fitting; wholesale and retail trade; finance, insurance and fixed assets (includes real estate); and service industries slowed down.  Of the outstanding credit up to mid-July 2019, the largest share (21.1%) is that of transportation, communications and public services; followed by agriculture, consumable loan, service industry, and construction, among others. 

9. The weighted average inter-bank rate has been increasing. At 4.2% in FY2019, the weighted average inter-bank rate is the highest since FY2011, when it was 8.4%. In mid-July 2018, it was 2.96%. It decreased for few months and then started to rise again, peaking  at 6.91% in mid-June 2019. In mid-July 2019, it was 4.52%. Similarly, 91-day treasury bill rate also followed similar pattern, reaching 4.97% in mid-July 2019. It indicates tight liquidity in the banking sector arising from two sources: (i) faster credit growth than deposit growth (to maintain profit margin banks had to increase loans after the sharp increase in paid-up capital); and (ii) lower than expected public capital spending. CRR and repo rates remained unchanged, but SLF rate reduced by 50 basis points in FY2019. SLF is the money BFIs borrow from NRB by keeping government bills as collateral for five days. Inter-bank rate refers to transaction among A & B, A & C, B &B, B & C and C & C class banks and financial institutions. 

10. Commercial banks have broadly adhered to the deposit and loan related regulatory requirements. Capital adequacy ratio stood at 13.51% as of mid-April 2019 against the minimum 11% (minimum CAR 10% plus 1% buffer). CCD was about 77.73%. NPL started to increase since mid-July 2018, reaching 1.67% of total loan in mid-April 2019. Interest rate corridor did not help much to lower interest rate volatility. FY2018 monetary policy changed the way to compute interest rate corridor (between 3% and 7%), with SLF rate being the upper bound and two-week term deposit rate being the lower bound. FY2020 monetary policy decreased these by 50 basis points.

11.  By mid-July 2019, 735 local levels (out of 753) have presence of commercial banks. Total number of BFIs licensed by NRB increased to 171 by FY2019 from 151 in the previous year. There are 28 commercial banks, 29 development banks, 23 finance companies, 90 microfinance financial institutions, and one infrastructure development bank. The number of class A, B and C category BFIs decreased, but the number of microfinance financial institutions increased from 65 to 90 last year. With the rapid expansion of credit and stricter enforcement of banking regulations, the number of blacklisted borrowers is also increasing—reaching 2,842 by FY2019, up from 1,335 in FY2018.

12. According to data from Department of Customs, in US dollar terms, exports increased by 10.3%, reaching US$ 862.6 million. The growth rate of export is lower than last year. Exports to India increased but exports to China and other countries decreased. Meanwhile, imports grew by 5.3%, reaching US$12.6 billion. The growth rate of import is lower than last year. Consequently, trade deficit increased much slowly than last year, reaching US$11.7 billion. India accounted for about 65% of Nepal’s exports and imports in FY2019. As a share of GDP, exports, imports, trade deficit and total trade were 2.8%, 40.9%, 38.1% and 43.8% of GDP, respectively. Export to import ratio was 6.8.

13. The largest export to India in FY2019 is a new entry—palm oil (US$91.8 million). Nepal does not produce palm oil but traders may be importing raw materials from third countries, process domestically to add at least 30% value, and then export it to India taking advantage of the preferential tariff. In fact, import of crude palm oil increased by 152.2%, reaching US$41.7 million. The second largest export item to India was polyster yarn, followed by jute goods, juice, cardamom and textiles, among others. Export of pulses, polyster yar, noodles, pashmina, handicraft goods, vegetables, jute goods, thread, and readymade garments grew by over 20%. The largest export to China are handicraft, woolen carpet, noodles and readymade garments. The largest export to other countries are woolen carpet, readymade garments, pashmina, pulses and herbs, among others. 

14. The largest import from India in FY2019 was petroleum product (almost US$2 billion), followed by vehicles & spare parts, MS billet, machinery parts, rice and medicine, among others.  Import of raw cotton, bitumen, fruits, textiles, readymade garments, molasses sugar, electrical equipment, and vegetables grew by over 30%. The largest import from China are telecommunication equipment, readymade garments, electrical goods, machinery parts, and television parts. The largest import from other countries are gold, aircraft spare parts, coal, crude soybean oil and silver, among others. 

15. The number of migrant workers continues to decline steadily after peaking in FY2014. Outbound migrant workers decreased by 32.6% because of a massive drop in outmigrants to Malaysia (9,999 in FY2019 versus 104,207 in FY2018). The government stopped issuing labor permits to potential migrant workers to Malaysia to implement the G2G deal, which ensures cost-free migration and labor rights. But, it is not implemented as expected. Moreover, outmigration for work to all major destinations except Japan, Afghanistan, UAE and Saudi Arabia decreased in FY2019. However, this has not lead to a decrease in remittance inflows probably because more migrant workers are using formal banking channel to remit income back home and that Nepalis residing or studying in developed countries are remitting more money back home. Remittance inflows reached US$7.8 billion, which is equivalent to about 26.8% of GDP.

16. A lower rate of import growth compared to export growth slowed down the deterioration of trade deficit. Remittance inflows decelerated (7.7% growth in FY2019, down from 10.5% in FY2018) but the country received higher grants than year, resulting in a marginal improvement in net transfers. With net transfers of 28.7% of GDP and net income balance of 1.2% of GDP, and trade deficit (goods and services) of 37.5% of GDP, current account deficit was 7.7% of GDP, slightly lower than 8.2% of GDP in FY2018. Balance of payments recorded a deficit of US$598.7 million, the first in the last nine years. Meanwhile, net FDI decreased by 31%, reaching US$116 million (0.4% of GDP). Gross foreign exchange reserves reached US$10.6 billion, which is enough to cover 9.4 months of import of goods and services. Nepali rupee depreciated by 0.02% against the US dollar in mid-July 2019 compared to the same period last year. 

Overall, here is a snapshot: 
  • The economy grew at over 6% for three consecutive years, thanks to bumper agricultural harvest, post-earthquake related reconstruction, stable supply of electricity and pickup in services sector activities. So, consumption accelerated but public investment slowed down. 
  • Public capital spending decreased but higher recurrent spending will lead to a fiscal deficit of around 5% to 6% of GDP. 
  • Inflation inched higher on account of higher food and non-food prices of goods and services. 
  • Broad money growth (M2) was below the central bank’s target. Credit expansion outstripped deposit expansion with construction and agricultural sectors receiving more loans than before. 
  • Retail deposit and loan interest rates as well as inter-bank rate increased, indicating tight liquidity situation in the banking sector. 
  • The number of migrant workers is decreasing but remittance inflows are increasing, suggesting more use of formal banking channel and higher remittance from non-traditional employment destination. 
  • There is not much change in composition of exports and imports. 
  • A lower rate of import growth compared to export growth slowed down the deterioration of trade deficit. This along with improved net transfers resulted in lower current account deficit than last year. 
  • Balance of payments slipped into the negative territory for the first time in nine years. 
  • Forex reserves are down but are enough to cover 0.4 months of import of goods and services. FDI inflows decreased.
  • Here is an earlier posts on FY2020 budget and FY2020 monetary policy

Saturday, August 24, 2019

Water pollution endangers economic growth

According to a new WB report (Quality Unknown: The Invisible Water Crisis), the release of pollution upstream acts as a headwind that lowers economic growth downstream. Specifically, when Biological Oxygen Demand (BOD) – a measure of how much organic pollution is in water and a proxy measure of overall water quality – passes a certain threshold, GDP growth in downstream regions is lowered by a third. Meanwhile, in middle-income countries – where BOD is a growing problem because of increased industrial activity - GDP growth downstream of highly polluted areas drops by half.

High chemical fertilizer use has long-term consequences including stunting. Nitrate exposure in infancy wipes out much of the gain in height seen over the past half-century in some regions and harms children even in areas where nitrate levels are deemed safe. While an additional kilogram of nitrogen fertilizer per hectare increases agricultural yields by as much as 5%, the accompanying run-off and releases into water can increase childhood stunting by as much as 19% and decrease adult earnings by as much as 2%. This suggests a stark trade-off between using nitrogen to boost agricultural output and reducing its use to protect children’s health.

This report also reveals that enough food is lost due to saline waters each year to feed 170 million people every day – that’s equivalent to a country the size of Bangladesh. Such a sizable loss of food production to saline waters means food security will continue to be jeopardized unless action is taken. More salt in the water means less food for the world.

So, what can be done about it? First, there needs to be a reliable, accurate and comprehensive information about water quality. Second, prevention is better than cure. Sunlight is the best disinfectant but legislation, implementation and enforcement to reduce water pollution are equally important. Third, investment in wastewater treatment and reduce preventable pollution.

Tuesday, August 20, 2019

Tinkering at the margin

It was published in The Kathmandu Post, 16 August 2019

The governor of Nepal Rastra Bank, Chiranjibi Nepal, recently unveiled the central bank’s monetary policy for 2019-20 fiscal year. Amidst persistently high-interest rates, liquidity crunch, unresolved structural issues including inherent operational and management vulnerabilities, and deterioration of external sector, the governor unveiled an expansionary policy to support the government’s unrealistic 8.5 percent growth target.

Many analysts had expected the central bank to take concrete measures to speed up the restructuring and consolidation of banks and financial institutions (BFIs). They were even planning actions like forced mergers. The idea was that this would result in efficient banking operations with lower management and operational costs, low interest rate volatility, innovation, and healthy competition. Instead, the central bank played it safe and prioritised an expansionary monetary policy. The concern over recurring bouts of a shortage of loanable funds and interest rate volatility remained on the backburner.

The central bank can influence interest rates charged to customers by BFIs and liquidity availability through conventional monetary policy tools that control the supply of money in the economy. For instance, lowering the cash reserve ratio—the minimum share of deposits that BFIs need to hold as reserves either in the form of cash or deposit with the central bank—frees up the funds available to the BFIs to loan out, and hence increases liquidity and lowers interest rates. Similarly, lowering statutory liquidity ratio—the share of deposits that BFIs have to maintain in the form of cash or approved assets and securities—also increases the money supply in the economy. Another measure is to change credit-to-core capital cum deposit (CCD) ratio threshold, which mandates the BFIs to lend a maximum of 80 percent of their deposits. The threshold for these remain unchanged in the monetary policy.

Volatile rates

Intending to lower interest rate volatility and improve monetary policy transmission, the central bank lowered thresholds for its interest rate corridor scheme. This sets a narrow band for the interest rate to fluctuate. The upper limit is lowered from 6.5 percent to 6 percent, repo rate (also called the policy rate) from 5 percent to 4.5 percent, and the lower threshold (term deposit rate) from 3.5 percent to 3 percent. It remains to be seen if this will actually lower retail interest rates because interest rates corridor, implemented since 2016-17, has not been much effective in reining in interest rate volatility.

The central bank has given continuity to directed lending to priority sectors including energy, tourism and agriculture. It has also boosted refinancing schemes, including lowering of interest rates for on-lending to priority sectors, and small and medium enterprises. Furthermore, it has extended the deadline to reduce the spread rate—the difference between deposit and lending rates—to 4.5 percent to mid-July 2020 instead of mid-July 2019. For BFIs that opt for a merger, the deadline is mid-July 2021.

These measures tinker existing regulations and accounting practices and hence address the underlying structural issues at the margin only. Furthermore, they may be insufficient to meet the core monetary policy targets—money supply growth of 18 percent, domestic credit growth of 24 percent and private sector credit growth of 21 percent, all higher than in the previous year. For instance, forcing the banks to maintain higher capital adequacy ratio plus countercyclical buffer (13 percent from 11 percent previously) will potentially lower their lending capacity and hence put upward pressure on interest rates, eventually slowing down credit expansion.

Credit crunch

The central bank has introduced two important measures to increase sources of deposits for BFIs and hence the availability of loanable funds.

First, it now allows BFIs to commercially borrow from not only foreign banks but also hedge and pension funds. Although this technically widens the sources of deposits for BFIs, it is unlikely that they will actively borrow money immediately from external sources due to risks associated with a higher cost of funds and the exchange rates.

Second, the central bank has mandated the BFIs to issue debentures or corporate bonds equivalent to at least 25 percent of paid-up capital. The expectation is that this will encourage BFIs to align their assets with their liabilities (i.e. discourage the tendency to use short term deposits to issue long term loans), and secure reliable sources of loanable funds in case they are close to the CCD threshold. If BFIs fail to meet this mandatory provision within this fiscal year, then they may be compelled to seek a merger. However, in the past, the central bank was too lenient. It repeatedly extended the timeline of what is supposed to be a mandatory provision (for instance, increased paid-up capital threshold, lower spread rate, and adherence to CCD threshold).

Regarding the external sector, the central bank has tightened loans to finance imported goods (especially vehicles) and the foreign exchange facility provided to Nepali citizens who visit abroad. Considering the deterioration of the balance of payments and depletion of foreign exchange reserves, the central bank is targeting to maintain reserves to finance seven months of imports. This is substantially down from barely two years ago, when reserves were large enough to sustain over ten months of imports. External sector stress will compound as exports, remittances and foreign investment growth stagnate or even decrease, but imports accelerate. The pegged exchange rate limits the central bank’s effectiveness to address external sector imbalance. Policy reforms to boost exports and foreign investment are crucial for this.

The success of the monetary policy will be judged in terms of how much interest rate decreases over time, sustainable credit expansion and lowering risks of asset-liability mismatch, further consolidation of BFIs and improved corporate governance, and external sector stability. Tinkering with productive sector lending has been a common feature of monetary policy, and this in itself will not help much to achieve the growth target.