Wednesday, July 14, 2010

Has Nepal exhausted the sources of growth?

Not really. But the government officials tend to think so. They are making high pitch over implementing import-substituting and import consumption curbing measures. I disagree. This is a very convenient conclusion to the most pressing challenge of the Nepalese economy. We need to think hard and better to find a way out of this economic mess. It is doable without resorting to import substituting policies.
I think in order to narrow down the balance of trade and balance of payments deficits, the government should instead look for ways to  boosting exports and to channeling domestic transfers to productive sectors. If there is a need to curb imports, then the imports of luxury items should be curbed; not daily consumption goods that Nepalese producers cannot produce at the same international price quality. There is a danger of further inflaming inflation rate if more tariff on imports of consumption goods are imposed. For further discussion, read my latest op-ed here

At the end of each fiscal year, the Ministry of Finance (MoF) publishes Economic Survey (ES), which provides rundown of the state of the economy in that year. It is one of the closely watched reports published annually by the MoF. The message of ES 2009/10 is hardly surprising: the economy is in a mess, growth is sluggish, and macroeconomic troubles are imminent. The policies being contemplated are aimed at curbing consumption rather than creating opportunities to channel disposable income, fuelled by the inflow of remittances, to productive sectors. This is misguided policy. Industrial and exports sectors could still be the primary sources of growth.
The economic growth rate (real GDP) in the current fiscal year 2009/10 is estimated to be 3.5 % - lower than 4.0 % achieved last year. Government argues that the decline in production of crops (blaming monsoon and adverse weather for growth stagnation!) and sluggish non-agricultural sectors contributed to the slowdown of Nepal’s growth engine. The non-agricultural sectors were (and are) plagued by frequent but fickle bandas, deteriorating industrial relations and labor strikers, power shortages, and supply-side constraints such as deficient supply of infrastructure. Meanwhile, real per capita GDP is nevertheless expected to increase by 2.3 %, reaching US$ 562 per year - about 20 % higher than last year’s figure.
As a percentage of GDP, gross investment is expected to increase to 38.2 % as compared to 31.9 % in the last fiscal year. Meanwhile, gross national savings is expected to decline to 9.4 % from 9.7 % of GDP in the same time frame. The gap between gross domestic savings and gross investment, as a percentage of GDP, is expected to be negative 28.8 %. It is widening by about six percentage points from last year’s figure. This essentially means that we are consuming more and have little money to fund projects and trigger capital accumulation.
The net export of goods and services is estimated to expand by almost ten percentage points to a negative 28.4 % of GDP. Exports are estimated to decrease to 9.2 % of GDP from 12.4 % last year. Meanwhile, imports are estimated to increase to 38.1 % of GDP from 34.6 % last year. Hence, trade deficit is expected to widen by 41 %. The growth of remittances income is expected to slow down to 7 % from 47 % last fiscal year. The contribution of remittances to GDP is expected to stand at 19 %, compared to 21.2 % last fiscal year. This is leading to current account deficit of Rs 27.60 billion, which is an estimated negative 2.3 % of GDP. Note that the current account balance was Rs 41.44 billion surplus last year. Overall, the BOP deficit is projected to be Rs 19.57 billion.

These numbers matter because if we want to avoid macroeconomic crisis, we have to figure out a way to reduce BOP deficit, maintain sufficient policy space for fiscal expansion in productive sectors and roll out social protection programs for the vulnerable and poor people. The only way to do this is to either boost exports or to find ways to reduce imports. Both are difficult routes. But, based on experiences from other successful economies, the former is preferred, however improbable it might seem at the moment.
Just because there is widening BOT deficit, declining growth of remittances, surging BoP deficit, and perennially sluggish agricultural sector, it does not make sense to resort to curbing imports, especially for consumption purposes. Even if import consumption curbing and import-substituting policies are rolled out, it will not slow the flow of money outside the country because consumption habits and preferences, fuelled by the flow of remittances, hardly change. It is encouraging that the government is mulling over promotion of production of agro-products so that the country won’t have to rely on agro-products on external markets. This is expected to narrow down BOP deficit. However, can the Nepali producers satisfy domestic consumers by providing them with equally competitive and varied products?
It feels like the policymakers have in principle concluded that we have exhausted the sources of growth. They are talking about curbing consumption rather than looking to channel some portion of consumption demand to investment spending. To stimulate economic activities, we need to find new sources of growth. This could be either through stimulation of domestic economic activities for internal consumption and investment purposes or by finding novel ways to increase exports. Implementation of widespread import curbing and import substituting measures is certainly not needed - only the import of luxury goods needs to be reduced.
The main cause of sluggish growth rate is slowdown in economic activities engendered primarily by unstable and highly unpredictable internal political bickering, creating uncertainty in markets. The bandas, destructive activities of militant youth wings and combative labor unions, donation campaign, supply-side constrains, and power shortages, among others, are the strongest constraints on economic activity. Rather than addressing these thorny non-economic issues headlong, the government is taking them as unalterable. These non-economic factors are also contributing to rise in inflation rate, which is hovering around 12 percent.
The contraction in external markets is not an issue for decline in Nepal’s exports. It is our inability to export goods that are price and quality competitive. The same non-economic factors discussed earlier and the inability to implement production and trade-promoting measures affected competitiveness of this sector.
The economy is in a messy condition. But, it is not unmanageable. The BOP deficit can be fixed, exports increased, and manufacturing sector propped up, if only we start by addressing the most binding non-economic constraints.
[Published on Republica, July 14, 2010, pp7]