Saturday, May 8, 2010

Definite economic meltdown with indefinite bandas in Nepal

My latest piece is about the economic costs of the Maoist-imposed strike in Nepal. Yesterday, due to public and diplomatic pressure, the Maoist party ‘postponed’ the conflict (as if imposing strike is their property right!). My point is simple: if the parties continue with strikes, then the Nepali economy will collapse. Here and here are my previous costs estimate of bandas.


Impending Economic Tsunami

Definite economic meltdown with indefinite bandas

Pretty much everything is in a standstill since May 1. The UCPN-Maoist has imposed an indefinite strike to topple the government. In a nation of over twenty-eight million people, few hundred of thousands of supporters, both willing and reluctant, are bused into cities, including Kathmandu, to show discontent over the ruling of the existing government.

This is battering the ailing economy hard. The political leaders need to understand that there will be no peace and the constitution would mean very little if there is an economic tsunami.

A dysfunctional economy will inflict more pain than the political upheavals we have been witnessing since 1996. Without urgent remedial policies for the collapsing economy, no matter who and which party runs the government, the situation will only get bad. Most of the causes of and remedies for the collapsing economy can be traced back to an unstable political climate and persistent strikes. More on this in a minute.

First, lets be clear about the deteriorating macroeconomic situation. The official inflation rate has been hovering around 12 percent and is not expected to come down anytime soon if supply-side constraints persist. For the first time in more than three decades, the balance of payments (BOP) is in deficit, reaching Rs 23.53 billion in the first eight months of this fiscal year against a surplus of Rs 32.58 billion in the same period last fiscal year. This is primarily caused by a decline in the growth of remittances and a soaring trade deficit. Bandas and political instability are two of the main factors causing soaring trade deficit.

Trade deficit reached Rs 206.07 billion, a 62.9 percent growth against 29.5 percent growth in the first eight months of last fiscal year. Exports declined by 8 percent while imports surged by 43.9 percent. Meantime, remittances reached Rs. 146.93 billion, a 9.9 percent growth as compared to 58.9 percent growth last year. The rapid rise in trade deficit is drawing down official reserves, which is sufficient to fund only 6.6 months of merchandise and service imports. We used to have reserve enough to fund nine months of imports. Worse, current account deficit (% of GDP) is expected to be in the negative territory and GDP growth rate to stagnate around 4 percent for at least until 2015, according to the IMF's estimate.

On top of this, there is liquidity crunch in the market. Recently, we experienced a severe shortage of domestic currency. The Indian rupee is gradually becoming a favored currency option due to loss of confidence in the Nepali rupee. While the housing sector is bubbling, other productive sectors are suffocating with a lack of liquidity. The central bank has already injected net liquidity of Rs 69.1 billion so far this year. The commercial banks are jacking up interest rates, making it harder for investors to withdraw money and serve interest payments. Despite high interest rate, deposit growth is lower than last year's. The inter bank lending rate increased by 8.85 percent from 6.38 percent. This means that even banks are wary of lending to each other. Most of the variables are progressively getting bad. Much worse is yet to come, if the current political instability, strikes, bandas, and economic stalemate persist.

How does this affect an ordinary citizen? Well, the worse these variables get, the precarious the situation will become because markets will lose confidence in the economy. It will result in closure of many factories. Unemployment rate, which is around 46 percent, will increase as firm will lay off workers and freeze hiring. Worse, would-be entrepreneurs will withhold investment. With a deteriorating situation, foreigners will pull out their investment from sectors ranging from consumer goods to hydropower. Importers will also lose confidence in the ability of domestic firms to supply goods in time, leading to cancellation of orders as was done by the Wal Mart and Gap Inc at the height of the last revolution. The need for social safety nets will increase and livelihood of many rural people will perish as intermediate buyers quit markets. Ultimately, the most vulnerable people will be hit by the strongest tides of the tsunami. The poor will be the ultimate losers. The politicians will be the last one to get hit, if they do.

In terms of costs to the economy, in a worst-case scenario, a back-of-the-envelope estimation of the costs of bandas shows that per banda day the economy bleeds 88 percent of the total value of goods and services produced in a day. This one shot, standalone estimation also shows that the industrial sector would suffer Rs 346 million per day. An average Nepali citizen of working age population would lose Rs 117 per banda day.

The crux of this mess lies in political instability and bandas. There is already a vicious strike-unemployment cycle in the economy. In terms of GDP per capita, we are the poorest nation in Asia. Frequent and fickle bandas will make us even poorer. In a country that has approximately 70% of the population live below $1.25 a day and has high population growth rate, income per capital will only go down and poverty will only increase.The most unfortunate situation is that even though we have money (budget surplus of Rs 4.40 billion in the first eight months of FY2009-10) to spend, we are not being able to do so due to politically-induced disruptive activities even at local level. 

The UCPN(M) should take some responsibility for the deteriorating macroeconomic situation. The economically destructive activities of YCL; incessant pressure exerted by militant labor unions on the weak industrial sector; forced donation campaign tantamount to illegal tax collection; deliberately inflicting troubles in firms operated by foreign companies; disruption of supply lines; and a threat to life and property of entrepreneurs are the infamous activities mostly associated with the largest party in the parliament.

If they are returning to power, then they will have to explain to the citizens how they are going to rescue Nepal from the impending economic tsunami. The CPN(M) have not uttered a single word about their economic policy to ward off the grave challenges confronted by our economy. 

Dahal and Bhattarai must explain, in plain terms, at least their strategy to salvage the economy; to revive the industrial sector; to return back illegally confiscated property; to provide employment to thousands of indoctrinated and duped YCL cadres who have been promised jobs and other opportunities; to provide safety nets to the laid off workers from the industrial sector; to rehabilitate its indoctrinated supporters; to address starvation in the Western region; and to reduce poverty. They need to realize that people did not join CPN-Maoist because of their belief in the failed Marxist-Leninist doctrines, but because of poverty and state apathy in instituting an inclusive society. These cannot be addressed by imposing bandas and by trying to topple the government with pernicious political strategy.

[Published in Republica, May 6, 2010, pp.7]

A brief history of economic crises

The past 180 years offer a smorgasbord of financial crises to study. They include:

  • The crisis of 1825-1826 – This global contagion affected Europe and Latin America. Greece and Portugal defaulted.
  • The crisis of 1890-1891 – Argentina defaulted and suffered bank runs. Baring Brothers faced failure. The U.K. and the U.S. were among the nations affected by this crisis.
  • The panic of 1907 – Bank runs hit Europe, North America, Latin America and Asia.
  • The Great Depression – Commodity prices cratered. Interest rates and inflation soared during this global meltdown.
  • The downturn of 1981-1982 – Commodity prices plunged. U.S. interest rates reached the highest levels since the Depression. This crisis hit most emerging markets.
  • The debt crisis of the 1980s – Widespread sovereign defaults, hyperinflation and currency devaluations primarily hurt developing African and Latin American nations.
  • The Japanese crisis of 1991-1992 – Real estate and stock market bubbles burst in Japan and the Nordic nations, also affecting other European economies. Japanese real estate prices still hadn’t returned to prebubble levels nearly two decades later.
  • The “tequila crisis” of 1994-1995 – The Mexican currency collapse ensnared emerging economies in Latin America, Europe and Africa.
  • The Asian contagion of 1997-1998 – This crisis began in Southeast Asia and spread to Russia, the Ukraine, Colombia and Brazil.
  • The global contraction of 2008 – The bursting of the U.S. subprime real estate bubble triggered stock market crashes, currency collapses and banking crises.

The financial crises shares the following common themes:

  • Capital inflows predict financial crises – “Capital flow bonanzas,” as in the U.S. in 2005, characteristically preceded the Big Five crashes and, later, the 2008 subprime meltdown.
  • A wave of financial innovation often leads to crisis – The creation of new mortgage-related mechanisms intended to reduce risk boosted the 2005-2006 housing boom.
  • A housing boom often portends a financial crash – Prices can take years to recover. After the Spanish, Norwegian, Finnish and Swedish crashes, home prices took four to six years to hit bottom. In Japan, real estate prices remained low 17 years after the boom.
  • Financial liberalization often precedes a crisis – Throughout the 1980s and 1990s, financial crises almost inevitably followed spates of loosened financial regulation.

Source: This time is different: Eight centuries of financial folly