Sunday, July 11, 2010

State of the Nepalese economy in FY 2009/10

Prem Khanal's has an excellent piece about the state of the Nepalese economy in fiscal year 2009/10. Khanal is one of the very few journalists whose pieces about the economy makes sense to me. There is a lot of chatter about the state of the Nepalese economy but very few can articulate the right issues from the right angle as Khanal does. To get updated about the present state of the Nepalese economy, this piece (copied below) by Prem dai is highly recommended!

Amid deepening political uncertainty, fiscal year 2009/10 is ending on Friday on a pessimistic note. Worse still, grim economic data coming out of both the real and financial sectors deepen fears that a much-needed economic revival is anything but certain.

Along with some ´incurable chronic syndromes´ like yawning growth gap, stagnant manufacturing and agriculture sectors, dwindling exports, sustained high inflation and rising recurrent expenditures, the impoverished economy has lately been exposed to a set of new and unexpected challenges coming mainly from the financial sector.

Financial sector

The stomach-churning mismatch between the inflow and outflow of foreign currency reflected in terms of deficit in the Balance of Payments (BOP) fuelled mainly by a breathtaking rise in trade deficit, slowing remittance growth and shortage of liquidity in the banking system was the distressful financial problem that hit the country this year.

However, worries created by the alarming deficit in BOP towered above all else, as it has shaken the economy to its very foundations.

The country experienced a stunning squeeze in foreign currency reserves, which is crucial for settling international payment obligations like repaying loans and financing imports, among other things. As a result, import capacity declined to 6.6 months from almost 10 months recorded at the beginning of the fiscal year.

Though the BOP deficit is shrinking slowly to come down to Rs 17 billion, it can anytime reemerge to spark a financial crisis, as the government has not taken concrete steps toward correcting a widening trade deficit.

According to latest central bank data, the trade deficit recorded till mid-May surpassed total remittances that the country received during the period. Even more, the mismatch between imports and exports is so big that Nepal´s total export finances only 16 percent of imports.

It is a fact that the country has limited options for dealing with the problems. After the collapse of Nepal´s traditional export pillars, woolen carpets and readymade apparel, it has neither competitive exportable products nor a convincing plan to develop such products in the medium term.

The alarming disparity between bloated consumption that is fueling imports on one hand and squeezing exports on the other is the root cause of present economic problems, says Keshab Acharya, chief economic advisor at the Ministry of Finance.

Since boosting exports is not possible in the near future, curbing consumption by means of both tariffs and non-tariff measures is the most suitable treatment for the problem, he added.

Similarly, Nepal´s financial sector, one of the few sectors that had enjoyed virtually uninterrupted expansion during the last decade, faced another problem of liquidity shortage. Though the problem was detected around September, it quickly escalated into something chronic by February, pushing the inter-banking lending rate to a record 13 percent.

The liquidity shortage, which has now eased to some extent, has already resulted in a rise in both lending and deposit interest rates. It is good that the deposit rate has increased, providing some relief to depositors who have been reeling under negative interest rates for years.

However, rapid rise in lending rates has raised concern as such a rise can discourage investors. Many of them are unable to withstand the heat of a five percentage point increment in lending rates within less than a year.

Many industries have lost their financial viability even before coming into operation. Such developments, if allowed to go unchecked for some time, will slow down both investments and consumption and eventually drag down an already sluggish growth.

Sustained high inflation continues to be another challenge. Though it has eased lately, it still hovers at over 10 percent - three percentage points more than target. And the latest fuel price increment is likely to aggravate inflation further.

Real sector

The glum outlook in the real sector continued this year. Economic growth rate was squeezed to 3.5 percent, lower than last year´s growth, as the economy continued to be the victim of a murky business environment, power shortage and insecurity.

Like in past years, agricultural production that grew by 1.05 percent against an annual population growth of 2.27 percent not only dragged down the overall growth but also increased dependency on imported food grain. A decline of 11 percent in paddy production, the mainstay of Nepal´s agro-production, was the most frustrating development.

Gloomy performance by the agricultural sector that provides a livelihood to two-thirds of the population and commands a one-third contribution to the national economy, means the poverty situation is likely to worsen this year.

However, per capita income recorded an impressive 16.7 percent growth to Rs 41,851--US$ 562 -- thanks to continued healthy growth in incomes from overseas, including workers´ remittances. Similarly, domestic savings as a percentage of GDP declined slightly to 9.36 percent, fueling consumption and widening the savings- investment gap.

Fiscal balance

With widening mismatch between expenditure and revenue, cracks have appeared in fiscal management, as the budget deficit by the third week of June soared to Rs 15 billion compared to Rs 4.7 billion recorded last year.

The terrific growth in revenue mobilization seen in the first half of the fiscal year has now lost steam and hovers around 24 percent, a growth level almost equal to the rise in total expenditure.

However, an impressive growth of over 35 percent, more than the recurrent expenditure growth rate, in capital expenditure remained one of the few achievements of the year. The total capital expenditure on cash basis has touch Rs 50 billion, which is 71 percent of the revised estimate.

The Ministry of Finance is hoping to hit the revised capital expenditure target of Rs 84.71 billion this year. The increased expenditure capacity at major projects was mainly due to the adoption of a multi-year contract awarding system and electronic bidding procedures.

Foreign aid

Low absorption of foreign aid continued to be a major problem, as disparity between the realized and committed amounts of foreign aid continued to widen.

As of the third week of June, the government has mobilized around Rs 27 billion whereas commitment in foreign aid is more than double that. Of the amount, the government received Rs 23 billion as grant against a revised target of Rs 42.7 billion while Rs 4 billion was received as loan, against the target of Rs 15 billion.