Saturday, October 23, 2010

Extremely optimistic account of the Nepali economy

Have you ever thought of arguments (and justification of them) to optimistically look at the Nepali economy from investor’s point of view? Given the sorry state of the Nepali political economy, it is very hard to convince investors, both domestic and foreign, to invest in Nepal. I wrote a very positive account of the Nepali economy on request by a Nepali diplomat (name and designation withheld) so that the diplomat can convince foreign investors to feel comfortable investing in Nepal. Read the account below. It might sound wildly and unrealistically upbeat!

A bit lengthy, but still it gives a pretty good and optimistic account of what’s up with the current state of the Nepali economy, where it is heading, and why to invest here. Apologies if it infuriates the already frustrated minds, and if it excites (leading to nothing!) for the overly optimistic minds! Any suggestions to add more optimistic points welcome!!

Nepali Economic Outlook [Optimistic version 1.0]

After years of low economic growth, the Nepali economy is finally ratcheting up the growth path, thanks to relatively conducive political developments since 2006. Make no mistake by thinking that with the end of the Maoist insurgency, things are all calm and business environment has been like pre-1996 era. But, in post-2006 era, things are not as bad as it were during 1996-2005. This is at least an improvement.

The economy is gradually recuperating and is poised to take off once the new constitution is promulgated, weeding out a lot of lingering political and economic uncertainties. There are plenty of reasons to remain optimistic about the Nepali economy.

Economic outlook:

The real GDP growth rate post-2006 has been better than it was in the first half of this decade. After a long time, the real GDP growth rate was 5.8 percent in fiscal year 2007/08. The average growth rate in the past years is close to 4 percent. As political uncertainties subside, investment in productive sectors is expected to increase. This is expected to boost growth rate above 5 percent. With the existing state of export capabilities and sophistication, Nepal is expected to grow at an average annual rate of 5.49-6.69 percent over the period 2010-2030.[1]

Ceteris paribus, the growth rate in 2011 and 2012 is expected to be 4 percent and 4.2 percent, respectively[2]. This projection is based on the existing political and economic trends. The Nepali economic situation is expected to improve as the political parties iron out thorniest issues soon. The resulting improvement in political situation will spur consumption and investment in sectors ranging from manufacturing to tourism to hydropower to real estate.

By 2012, Nepal’s economy is projected to be around US$ 18 billion, population of 31 million, and per capita GDP of over US$ 579. Encouragingly, Nepal’s current account balance is expected to be one of the bests in South Asia. It is projected that in 2012 Nepal will have current account balance of negative 0.1 percent of GDP. Compare this with negative 2.1 percent and negative 3.9 percent of respective GDPs of India and Pakistan.

The existing government budget deficit is 3.3 percent of GDP, which is close to the limit the EU members are required to maintain. The balance of payments (BOP) is slightly in the red, with Rs 2.62 billion deficit, thanks to the decline in growth of remittances following the global economic crisis. Due to import restrictions on certain luxury items and favorable trade credit liabilities, the BOP deficit is narrowing down. Nepal is having BOP deficit almost after three decades. It is expected to be in surplus by next year as remittances growth recover to the pre-crisis level because of strong growth prospects in India, Malaysia and the Gulf countries.[3]

In 2012, private consumption, government consumption, fixed investment, exports and imports are expected to register growth rates of 4.2, 4, 6, 6, 6.6, and 5.8 percentages, respectively. Except for government consumption and imports, the growth rates of all other variables that determine real growth rate will be higher than in preceding years. This is good news. The private sector will grow more than the government sector.

Due to sticky prices following the rise in global petroleum prices and food prices during 2007 and 2008, the inflation is slightly above 10 percent right now. It is expected to be single digit by 2011. The central bank of Nepal has already formulated monetary policies to tame inflation. It has tightened lending to sectors that have been pushing prices up and is loosening lending to productive sectors, where the inflow of investment will increase employment and output (aggregate supply), rather than just upping aggregate demand.

To achieve over 5 percent growth rate by 2013, the government came up with an investment plan in July 2010.[4] It aims to lower absolute poverty to below 21 percent, generate 200,000 jobs, and ensure private investment equaling about 64 percent of the estimated total investment needed to achieve over 5 percent growth rate by 2013.

Overall, medium and long run growth prospects look very encouraging.

Business environment:

As the political parties iron out political, social and economic differences and pave a way for the introduction of a new constitution under multi-party framework, business environment is expected to improve. It will clear uncertainties about the economic ideology that Nepali economy will adhere to. At present, government instability, corruption and political instability are identified as the three most problematic factors for doing business in Nepal.[5] Tax regulations and tax rates are the least problematic factors for doing business. So, the major constraints to growth of businesses will potentially be resolved by the end of 2010.

Sectoral contribution to GDP:

Agriculture: Due to unfavorable monsoon, the growth rate of agriculture sector came down to below 2 percent last year. It, however, was close to 6 percent in fiscal year 2007/08. With timely and favorable monsoon in the years ahead, this sector is expected to grow. Meanwhile, the government has prioritized seven agro-products as having high export potentials. It is accumulating and pumping in resources in production and marketing of these products. It will further boost investment and production, leading to a positive impact on the growth of the whole agriculture sector.[6]

  • High priority agro-products identified by NTIS 2010[7]: cardamom, ginger, honey, lentils, tea, noodles, and medicinal herbs/essential oils

Manufacturing: The manufacturing sector was hit hard by the decade-long insurgency. Nepal lost competitiveness on several fronts. However, post-2006 this sector is gradually recuperating. After years of below 2 percent growth, it registered 4.4 percent growth rate in 2006. It grew close to 4 percent this year. It is expected to pick up heat as soon as the political situation gets normal.

Recently, the government updated the industrial policy of 1992 and made it consistent with the existing structure of the Nepali economy.[8] The new industrial policy promises flexible labor policy, including the ‘no-pay-for-no-work’ principle. It allows easy exit from business for promoters, freeing them from long-term labor and other liabilities. Tax and income rebate incentives and easy credit are offered to export-oriented firms. It promises tax holidays for 10, 7, and 5 years to firms that invest respectively in highly underdeveloped (21 districts), undeveloped (15 districts) and less developed (24 districts) areas. It also aims to promote Special Economic Zones (SEZs) and institute ‘one-window’ policy for all industrial activities. It aims to promote value-added industries and facilitate supply and adoption of new technology to increase production and productivity. The government promises to purchase goods that are produced by domestic firms if there is 30 percent value-addition in the final product. Furthermore, it offers to establish a bunch of public institutions to promote trade. It aims to upgrade technical and skill-related aspects of the existing administrations related to the industrial sector.

  • Priority industrial products identified by NTIS 2010: handmade paper, silver jewelry, iron and steel, pashmina and wool products

Services: It is the most resilient and fastest growing sector in Nepal. Its average annual growth rate has been above 4 percent in the last decade. In the last three years, it has been growth at an average rate of above 6 percent.

The finance sector has seen tremendous growth, with around 27 commercial banks, 79 development banks, 79 finance companies, 18 micro finance institutions, and 25 insurance companies. A total of 22 new bank and financial institutions came into operation last fiscal year alone. Furthermore, branch expansion of commercial banks is also increasing, with a total of 966 branches, 214 more than in mid-July 2009, by mid-July 2010.

In the last five years, construction and real estate sectors grew at an average of 4.5 percent and 7 percent annually, respectively. In real estate, credit flow doubled from Rs 7.71 billion to Rs 14.92 billion in the past two fiscal years. Construction sector is one of the most booming sectors in the Nepali economy. The inflow of remittances, which account for almost 20 percent of GDP, is being channeled into construction and real estate sectors. It has tremendous growth prospect, especially in and around district headquarters as rural population gradually migrates to well-off areas. This sector is projected to register annual growth rates of at least 5 percent in the next five years.

Tourism is another sector that will see huge investment next year, thanks to intense campaign and progressive reforms targeting Nepal Tourism Year 2011.[9] The major political parties have promised to not resort to strikes, which severely crippled the tourism industry after 1999. The last time such a mega campaign was launched was in 1998 when around 464,000 tourists visited Nepal, earning US$24.8 million in revenue. The Nepali tourism industry has come a long way since 6,179 visitors visited Nepal in 1962. It increased to 509,752 (378,712 by air and 131,040 by land) in 2009. The government plans to bring in a million visitors in 2011. The government is planning to attract 40 percent of the targeted visitors from India and China. This sector will see one of the highest growth rates in the next few years.

  • Priority services sectors identified by NTIS 2010: tourism, labor, IT and BOP, health, education, engineering, and hydro-electricity

FDI situation: With the existing reforms in place, foreign direct investment (FDI) is expected to increase in the coming years. Last fiscal year, FDI commitment of reached Rs 9.1 billion (171 joint venture projects approved by Department of Industries as against 230 projects with Rs 6.3 billion approved last year). Last fiscal year, sector-wise new joint ventures include 50 in tourism, 72 in services, 37 in manufacturing, 1 in construction, 2 in agriculture, 5 in energy, and 4 in mining. It is expected to provide over 7848 jobs. Investment commitment from India is highest, followed by Mauritius, Canada, and China. A total of 34 countries are given approval for foreign investment in fiscal year 2009/10.

  • Potential sectors for FDI: infrastructure (road transport), tourism, hydropower, health services, education, hotel, manufacturing and agriculture projects identified by Nepal Trade Integration Strategy (NTIS) 2010, consultancy services
  • High priority industries according to IP 2010: IT, cement, hydropower, vehicle and motor parts, chemical fertilizer, bio-technology and adventure tourism
  • Priority industries according to IP 2010: Agriculture, forest-based Ayurvedic and homeopathic medicine, manufacturing, minerals and handicrafts

Trade: Imports have always been higher than exports. The readymade garment sector has been severely affected by the end of MFA in 2005 as it failed to compete with exporters from other countries. However, exports of other items are picking up. Last fiscal year, trade deficit was Rs 313.67 billion. It is expected to narrow down due to slowdown in imports and surge in exports.

Note that almost 60 percent of trade happens with India, with whom Nepal has free trade agreement. China has offered zero-tariff facility to 4721 exportable items to LDCs, including Nepal, and the Middle East and North Africa (MENA) is emerging as a potential export destination for Nepali goods and services. The US and the EU have been very important markets for Nepali items. Hence, Nepali exports sector could experience rosy years ahead. One of the main reasons to remain optimistic about Nepali exports sector is because of its fairly good sophistication of exports basket.

In terms of export sophistication, Nepal ranks 33 among 96 non-high income countries.[10] It is the second best standing in South Asia (the first one is India). Latest studies show good future of Nepal’s export industry and the overall economy’s potential to undergo structural transformation. For a country with this level of income per capita, Nepal’s export sophistication is pretty good. In terms of exports diversification, Nepal’s ranking is second best in South Asia.  Between 2001 and 2007, Nepal exported, on average, around 100 products with comparative advantage. China and India exported 257 and 246 products, respectively with comparative advantage. In terms of uniqueness of exported products, which determine the sustainability of exports sector and the potential to undergo structural transformation, Nepal’s standing is better than countries with similar income level.[11]

Why invest in Nepal?

  • · High rate of return in hydropower sector (high demand but low supply at present). After fulfilling domestic demand, surplus hydroelectricity can be exported to neighboring Indian states that are facing power deficit.
  • · High potential in tourism sector as Nepal is consistently identified as one of the leading tourist destinations in the world. Trips can be made to Tibet via Nepal. Visiting Nepal is less costly if it is included in trip plans to visit two of the largest and fastest growing economies in the world. Furthermore, as Nepal’s neighbors get wealthier, they would be visiting more and new places like the citizens of G20 countries do right now. Due to geographic proximity and cultural similarities, wealthier Indian and Chinese tourists might increase their frequency of visit to Nepal. This opens up a huge market in the tourism and hotel industries for investment right now.
  • · Growing middle class population with increasing purchasing power is entering into the market. They will demand high class education, health services, insurance, clothing, means of transportation, and timely leisure. It opens up largely untapped markets worth millions of dollars.
  • · An increasing number of educated youths and manpower, especially in the IT sector.
  • · Consistently expanding urban markets due to rural to urban migration internally.
  • · Rising growth of remittances as the major destinations for Nepali labor are expected to register strong growth in the coming years. New ventures can flourish if they are aimed at drawing in remittances for productive investment.
  • · Business-friendly environment expected after the political parties iron out differences and write a new constitution.
  • · The rapidly growing emerging giants neighboring Nepal are projected to be the first and the third largest economies by 2040. China has already replaced Japan as the second largest economy. As these economies continue to grow and people have high per capita income, they present a huge market for Nepali companies to cater to. Nepal can itself be a transit nation for trade between India and China. Due to its geographic (and cultural with India) proximity to China and India, transportation and transaction costs will be lower if goods and services are produced, supplied and traded from Nepal. Nepal could potentially become a Singapore for trade between India and China!
  • · There are over 350 million potential customers in the bordering Indian states that Nepali exporters could cater to, provided that they produce goods based on taste, preferences and purchasing power of the Indian customers. Furthermore, Nepal could piggyback on the success of over $15 billion software service exports industry in India, if it could work on enhancing human capital and incubating business units based on the needs of the software industry.
  • · As wages in China and India continue to increase and their population gets wealthier, Nepal can produce the same kinds of goods and services produced by India and China right now for exports. Nepal can export it to them.







[7] NTIS 2010 stands for Nepal Trade and Integration Strategy 2010. It is one of the crucial reports published by Ministry of Commerce and Supplies this year. It identifies 19 sectors that have “high export potentials”.