Friday, September 19, 2008

First budget of the Federal Democratic Republic of Nepal

Today Finance Minister of Nepal Baburam Bhattarai presented budget of around Rs 236 billion ($3.23 billion) to the parliament. As expected, this year’s budget is bigger than last year’s budget and is already being termed ‘populist’ and ‘inflated’. More here. Read the full budget speech here.

The nice thing about this budget is that it takes sectoral issues seriously this time. It has rightly prioritized hydropower, tourism, and agriculture sector as top industries and has emphasized on the industrialization of agricultural sector. This is exactly what I had argued for in last time’s Op-Ed. I had argued for prioritizing hydropower and tourism sector for now and then to work on creating a good investment climate along with establishment of SEZs so that the sluggish manufacturing industry could be a major player in GDP. The budget has also aimed increase investment in agriculture, which is a good news for a country where more than 70 percent of the population is dependent on agriculture. But bailing out the poor farmers through cash could be very difficult. This mimics the Indian policy of bailing out poor farmers in in last year’s budget.

Long story short, considering the constraints to the economy at present and basing policies on reality, I am partially happy with this budget, which has been more pragmatic and better than I had thought before.

Though agriculture, infrastructure, health and education will be major areas of public investment, the budget will rate hydropower and tourism high on its priority, he added.

Dr Bhattarai indicated that the new government might not continue the past ones' privatization policy. "We will activate public enterprises, then issue their shares to people and employees, and run them under the public-private partnership modality," he said.

He reaffirmed the past governments' actions to deal with loan defaulters stringently. But at the same time, he tagged banks as 'parasites'. "Banks have completely ignored the real sector and focused only on serving able groups. This situation must be corrected," he stated.

However, the aim of achieving a double digit growth within five years (specifically, after two years) is very ambitious and I would need very convincing progress and policies to believe that this will be a reality. Bhattarai wants to take two years to prepare the country to get ready to set off in a double digit growth trajectory. However, given the threats to private property (even the Maoist’s party land reform minister grabbed land by force), bottlenecks in supply side, and sluggish manufacturing sector, I would be very hesitant to aim for a double digit growth rate. In a realistic basis, I would first aim for sustaining present growth rate of 5% for the next two years, then scaling it up by 2% for the next two years, then based on the investment climate and the level of structural changes in the economy, I would aim for a double digit growth rate.

The other issue that is sidelined in this context is monetary policy. Right now, inflation rate (7.7%)is more than the GDP growth rate and is expected to remain higher next year (about 7-8%). The injection of more money in the economy (especially by increasing wages to the tune of Rs 12 billion and bailing out poor debt ridden farmers, increasing expenditure by almost 60%) would put pressure on price level. With shortages of different goods and the advent of big festivals, expenditure is expected to shoot up. Moreover, the full effect of global rise in commodity and fuel prices is yet to be seen in the economy. This central bank would not let inflation rate get out of control (imagine how the IMF would bark at the central bank if this happens!). This means rise in interest rate and dampening of banking credit to firms and individual borrowers. It is unclear how monetary policy would be harmonized with the expansionary fiscal policy.

I don’t think inflation would be a major issue unless it crosses 10% limit. The ‘double digit’ number (inflation, not growth rate) would discourage investors. So, as along as it is under this limit (like in India and China), a slightly inflationary GDP growth rate would be tolerable for two or three years. But, this should not be let built on increasing expectations, which would lead to flight of capital and cash from the country.

Sources of finance:

Out of the estimated sources of financing for the current year, Rs 129 billion 215 million would be borne from the current source of revenue. Out of the total foreign assistance of Rs 65 billion 793.8 million, Rs 47 billion 93.2 million would be borne by foreign grant, and Rs 18 billion 700.6 million by foreign loan. However, there would be a deficit of Rs 41 billion 11.6 million even by mobilising both the sources.

With the same institutions still reigning bureaucracy and the same problems plaguing the economy, I wonder how the current administration is aiming to implement the ambitious budget.

Update: there is an increase in budget for the hydropower and transportation sector (113% and 77.14% respectively). This is a good news on fiscal side (concerns, on monetary policy remains high, as mentioned above.

Rs. 13 billion 910 million proposed for the road transport sector, which is an increase of 77.14 per cent in comparison to the revised expenditure of the last fiscal year.

Rs. 12 billion 690 million proposed for the power sector, which is an increase of 113 per cent in comparison to the revised expenditure of the last fiscal year.

A high-level power sector development committee under the chairmanship of the Prime Minister to be established to materialise the objectives of producing and utilizing 10,000 MW hydro powers in the next 10 years.

I will go over the budget speech in detail after my monetary theory class this afternoon. I will write more about the quantity and quality of stuff on the budget tomorrow.

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