Tuesday, August 10, 2010

(Nepalese) Remittance reflection (wonkish)

I was writing this blog post while at transit in Doha International Airport (DIA). Now, I am finally posting it today. With very limited internet connection and a bit busy schedule, it took me days to post this blog!
 
I was drinking caffe latte at Coffee Beanery, a coffee shop inside Doha International Airport (DIA). I talked to Aakash Gaihre, a resident of Nawalparasi now working temporarily at the coffee shop. All around the place, I could see one of the backbones of the Nepalese economy-- migrant Nepalese workers like Mr. Gaihre working at various locations in Doha, Gulf countries, and other various nations-- sweating to remit back home. The obvious question is: how far has their sweating in the Gulf helped the Nepalese economy and the people? Seeing these people working long hours and saving pennies to send back home, I kept on wondering the proper role of remittances in the economy.
 
First, remittances contributes almost 20% of GDP of Nepal. Mainly because of remittances, despite huge balance of trade deficit, balance of payments (BOP) was always in the positive terrain. This has changed recently as the global economic crisis put a dent on remittances inflow, leading to a negative BOP (trade deficit does not show any sign of slowing down). Now, it is creating trouble in maintaining sound fiscal and monetary policies.
 
Second, since BOP was always in surplus, the policymakers and central bankers did not put serious thought to managing the influx of money. It was a blessing to those who wanted to do nothing to steer the economy. The hang of the inflow of remittances was so strong that very few policymakers and analysts cared about channeling the money into productive sectors for investment purposes. Hence, the industrial sector growth was (and is) at one of its lowest points.
 
Third, following the second point, since managing investment spending via remittances was a forgone priority, the money went into unproductive sectors (think this as those sectors that do not increase domestic investment, employment, and create a foundation for long run growth). The contribution of remittances in stimulating the real sectors is minimal. Sectors such as construction, real estate, and banking flourished beyond anyone’s expectations.
 
The banking sector became a big fat kid from a slim one. New banks popped up with flamboyant names and schemes. The central bank, meanwhile, did nothing to tame the situation. It realized that too late. After governor Khatiwada took over gears of the country’s monetary policy, things began to thaw. Liquidity in unproductive sectors was squeezed, foreign currency holding was tightened as pressure on changing the pegged exchange rate mounted, interest rates jacked up, and banks proliferation was put on a hold along with scaling up of capital requirements. These measures were too late. As far as if these measures are too little, we’ll have to see how the players in the unproductive sectors play their cards by taking advantage of loopholes in the changed policy.
 
Due to political instability, squeezing returns on investment and profit margin, banks avoided lending to traditional employment-generating sectors. Instead, money was channeled into construction, real estate, and import-consumption sectors.
 
The construction and real estate sectors transformed from a thin kid to a very obese one. It, however, remained a kid as there was no domestic innovation in these sectors. Thus, there was no foundation laid for long term growth. Cheap loans with extra low interest rates, thanks to remittances inflow, helped in increasing the breadth and height of houses in and around city centers. A large proportion of the construction materials were imported. It would have been fine if they were sourced from the domestic economy. It wasn’t. The demand for these items was so high that the supply simply could not satisfy it, leading to price-quantity equilibrium at a higher point. The high price was not due to changes in demand and supply at the factor market, but due to mismatch of desire, demand and supply at the product market. All it did was to fuel up prices without an increase in per capital income that is backed by stimulation of domestic economy.
 
Also, as migration increased to urban areas, the demand for apartments and consumer goods went up. Since supply is highly inelastic in the short run, rents went up as well. The high price of construction materials, rent, and cheap money put pressure on prices of other items to swell up. Thus, Nepal is seeing a huge rise in prices. Earlier, you could purchase a bottle of coke for Rs.10. Now it costs over Rs 25. The increase in price during the previous five years is more than one hundred percent, while the inflation rate has only increased by less than ten percentage points. This indicates that prices have been artificially jacked up throughout the economy. The cost of living in nominal as well as real terms has gone up. The central bank and policymakers remained silent amidst all these undesirable developments in the economy. Again, the source of all these: remittances.
 
One of the evil sides of remittances was (is) the change in consumption habit of households receiving hard-earned money from abroad. Households receiving money have changed their consumption behavior. And, it seems likely that it is not for good. The reason is that an influx of money without earning by the agent itself reduces the marginal value of money (perceptional only). Initially, aspiring migrants think that if they get a ticket to fly out of Tirbhuvan International Airport (TIA) or go across the border to neighboring Indian states, everything will be alright. Unfortunately, once they become migrants, they realize that it is not that easy to earn a living outside as has been perceived before their departure from Nepal. It takes days to find a “satisfying” job, salary is not that high especially for unskilled and semi-skilled jobs with respect to the costs of living, and saving money is a big and hard deal.
 
Saving involves trade-offs between individual wants/aspirations and households expectations back home. The migrants realize this once their first paycheck rolls in. Unfortunately, the households back home do not realize it. They remain in a thick cloud of optimism and expectation that money will flow in easily. And, it does in most of the cases. Households demand money, migrants send them. Things seem normal in the household. Since there is no end to how long money will continue to flow in, especially in the eyes of the households, they start spending the remitted money pretty much scot-free. The money is used to purchase goods and services that is beyond the budget and consumption behavior of the households. Spending on consumer goods, most of them imported, swells.
To facilitate the process, banks provide easy liquidity with all sorts of attractive schemes. Money to construct houses, buy apartments, motorbikes and other durable items is channeled easily. Meanwhile, money for daily consumption goods is hard to get. All this consumption binge impacts the prices of daily consumption goods, especially rice, beans, lentil, and vegetables, among others. The rise in prices of these daily essential consumption goods is partly due to price pressure created by excess liquidity and partly due to supply side constraints.  At the end of the day the ones who are affected the most are the very citizens who are either remitted money or not. To sustain, the whole process described above has to be repeated; this time with higher expectation, putting more pressure on the migrated population to send more money back home.
 
This is how remittances are changing the way we function in our society, chiefly affecting consumption and investment patterns. That being said, remittances also have positive sides. For households that need to graduate above the poverty line, remittances provides a lifeline of income. Their consumption habits remains the same until after they are comfortably above the poverty line. The BOP remains in a good position despite ballooning trade deficit.
 
Back to DIA. The coffee latte was amazing. I enjoyed drinking it while looking at two migrants working non-stop to save pennies to send back home. When will the households and policymakers understand the whole process associated with remittances? The downsides seem to be more than the upsides, if things remain the way it is right now. We can reverse the process, if policymakers give a little bit more attention (serious and substantive) to managing the influx of hard-earned money. Else, expectations begin to get bigger and economic management might get out of hand.
 
I am complaining too much here. Let me discuss some of the policy options that might be useful in averting mitigating the negative sides of the inflow of remittances. These might not be actionable reforms. Internalize at your own risk!
  • First, discourage sending money through informal channels like hundi. The amount of remittances and liquidity recorded is not the true figure as money received through hundi is hard to estimate. Give incentives to people to send money through formal channels (such as lowering transaction tariff).
  • Second, squeeze money flowing to unproductive sectors that do not add to the nation’s productive capacity. This means squeeze money in the construction and real estate sector. Tighten loans from banks to these sectors. Instead, increase loans (decrease interest rates) to productive sectors. 
  • Third, up lending to exports sector. Tax credits and tax rebates on exportable items. With that more tariffs on luxury items that are fattening balance of trade through high value of imports.
  • Fourth, keep a close eye on the banking sector. Things do not look that clear and interesting anymore. Banks are offering interest as high as 6 percent in just checking account. What is going on? Why are banks so desperate to attract deposit? Something bad is definitely coming. Caution!!
  • Fifth, fix the supply side constraints (plus non-economic constraints).
  • More discussion coming up!
[I had written a number of blog posts about remittances in Nepal. It is so painful to put up a link to all of them with an extremely limited and slow internet access. I will do it when I get back to a speedy connection. Also, I had some pictures relating to this blog post, but can’t upload them because of the same reason.]
 
See this blog post as well.