Wednesday, June 9, 2010

Charting a path of destruction…

The Nepalese finance minister thinks that import substitution is the policy to go if exports cannot be increased.

Minister Pandey said that the government would give priority to import substitution as there were little prospects for export growth any time soon. The country suffered a deficit of Rs. 22 billion in its balance of payments due to rising imports and decreasing exports in the first nine months of the current fiscal year. Remittance is also not expected to grow more than 10 percent this year. “In this situation, our approach should be import substitution,” he said.

I don’t know if the reporting is accurate, but if it is, then its unfortunate that the finance minister is receiving very bad advise. Does not make sense to me!

The exports tanked due to a lack of price and quality competitiveness of export items, faulty economic policies for decades, bad industrial relations, labor disputes, remittance-blinded economy, and messy political system. The declining exports (further compounded by the global economic crisis and declining growth rate of remittances) but unsustainable levels of imports led to a balance of payments deficit of around Rs 22 billion. Earlier, the perennial balance of trade deficit was negated by high inflow of remittances. Due to the global economic slump, remittances slowed (more on remittances here) but balance of trade deficit continued to worsen, pushing balance of payments into the negative territory. Add to this injury, the pains of persistent double digit inflation rate. The macroeconomic situation was never in such a bad shape.

Forgetting this bitter, self-inflicted wound, the finance minister is looking for inward looking policies, which failed miserably before the 1990s. What Nepal needs is not import-substituting policy but industry-promotion policies, a carefully crafted industrial policy (also see this to check out my list of priority industries) to ‘lead the market’ and to ‘follow the market’ depending on the structure and capacity of domestic industries. This might resuscitate the dying Nepali exports industry, probably boosting exports.

There has to be a better way to channel remittances in the productive sector. The central bank has to do a serious soul searching this time to figure out why the remittances inflow was so badly managed, leading to a terrible real estate bubble and an extremely vulnerable banking sector.

Also, reduce red tapes in the hydropower sector. Follow Bhutan’s strategy in the hydropower sector. These will potentially close the hole in BOP. There is a way out to rescue the economy. Import substituting policy is NOT a way out of the crisis. Address the core causes; do not go for unsustainable band aid policies.

Fix the political instability (also see this) and harassment of the business sector. Here is one simple plan. Also check out my take on what is holding back growth in Nepal and the growth strategies. Here is a discussion about the binding constraint on Nepal’s growth engine.

On a side note, I think the plan of generating more employment in the agricultural sector is a day dream. There is no credible plan to do this.