Tuesday, August 3, 2010

The Future of Nepal’s exports

My latest op-ed is about the future of Nepal’s exports. I will post an extended version of this article in next blog post. I am a bit optimistic about the future of Nepal’s exports industry.


Future of Nepal’s exports

Everything ain’t good, but everything ain’t bad either

The prevailing perception among policymakers and analysts is that we are in an economic mess, the exports sector is doomed to fail, and imports will keep on imploding. With total merchandise exports and imports amounting to Rs 55.37 billion and Rs 343 billion, respectively, trade deficit has swelled to Rs 287.62 billion in the first eleven months of this fiscal year. The BOP deficit stands at around Rs 15 billion. The momentum of decline in exports and surge in imports looks unabated.

With no hopes of increasing exports, the idea of import-substituting policies, which is expected to at least curb imports and lower deficit, is seen as the policy of last resort. As I have argued before, these are convenient conclusions (see Convenient conclusions?, Republica, July 14) fostering misguided policy because if we can address non-economic constraints-- bandas, destructive activities of militant youth wings and combative labor unions, donation campaign, supply-side constrains, and power shortages--, then Nepal could see an increase in exports.

Curious why I remain optimistic than most of the pundits in Kathmandu? Allow me to explain. In South Asia, Nepal has one of the highest potentials for growth in the exports sectors. It could potentially export many new products with comparative advantage, if the right constraints on promotion, production, and accumulation of capabilities of key products are timely addressed.

A new study (As you sow so show shall you reap: From capabilities to opportunities) published by the Asian Development Bank (ADB) corroborates this view. It analyzes product spaces of 130 countries and ranks them on the basis of “Index of Opportunities”-- which is based on a country’s accumulated capabilities to undergo structural transformation and captures the potential for further product upgrading, growth, and development. A product space shows a graphical representation of all products exported in the world.

The good news is that the future of Nepal’s export industry and the economy’s potential to undergo structural transformation is not all that gloomy as has been portrayed by analysts. In the index, Nepal ranks second in South Asia with a score of 0.4729, following India which has a score of 0.8590. The higher the score, the better the potential to undergo structural transformation. Everything else remaining the same, a ten percent increase in the value of the index yields 0.31 percentage points of additional growth.

Among the 96 non-high income countries, Nepal ranks 33 while China and India rank second and third, respectively. For a country with this level of income per capita, Nepal’s standing is not bad at all. The exports sector is still capable of rebounding. There is no need to excessively fret about curbing imports just because exports are declining. With right policies in place, we can produce new products with high exports potentials and export with comparative advantage, thus inducing further structural transformation. With the existing state of capabilities, Nepal is expected to grow at an average annual rate of 5.49-6.69 percent over the period 2010-2030.

Ranking among 96 non-high income countries

Country EXPY EXPY-core Diversification Diversification-core Share- core Standardness Open forest Index of opportunities South Asian countries rank Non-high income countries (96) rank
India 0.6486 0.9328 0.9287 0.8611 0.6148 0.7917 0.8759 0.859 1 2
Nepal 0.4112 0.5926 0.4032 0.2214 0.3569 0.5219 0.2041 0.4729 2 33
Pakistan 0.3447 0.8006 0.48 0.1053 0.1421 0.4485 0.4379 0.4551 3 37
Sri Lanka 0.3259 0.8535 0.4279 0.1023 0.1546 0.4957 0.3657 0.4326 4 44
Bangladesh 0.2768 0.782 0.2386 0.0519 0.1387 0.2348 0.201 0.3576 5 73

The index is composed of seven indicators. Among the 96 non-high income countries, Nepal has a score of 0.4112 in the sophistication level of export basket, called “EXPY” and calculated as the weighted average of the sophistication of the products exported. Generally, countries with high EXPY tend to have high income per capita. A 10 percent increase in EXPY at the beginning of the period raises growth by about half a percentage point, according to a study by the ADB economist Jesus Felipe. For its given level of income, Nepal already has a pretty impressive level of sophistication of exports basket, although it needs enhancement if we want to enjoy the same level of sophistication as India and China have.

Furthermore, in “EXPY-core”, another measure of exports sophistication which looks at the core of the product space (machinery, chemical and metals), Nepal has a score of 0.5926. Note that even though the exports basket of Pakistan, Sri Lanka and Bangladesh are less sophisticated than Nepal’s, they nevertheless have high EXPY-core score, meaning that their exports sector has high-valued products that constitute a major portion of exports basket. No wonder they have higher exports revenue and, consequently, higher income per capita than Nepal’s. Nepal needs to improve on the exports of EXPY-core products.

In terms of exports diversification, Nepal’s score is 0.403, the second highest in South Asia. Diversification is measured by the number of products that a country exports with comparative advantage. Between 2001 and 2007, Nepal exported, on average, around 100 products with comparative advantage. Meanwhile, China and India exported 257 and 246 products, respectively. Looking closer at diversification of core products (“diversification-core”) only, Nepal has a score of 0.221 and exported less than 25 products with comparative advantage. In this category, China and India exported with comparative advantage 89 and 81 products, and had scores 0.9496 and 0.8611, respectively. Nepal’s score is not that discouraging given its income level.

The uniqueness of products exported by a country also matters in ensuring sustainability of exports sector and structural transformation. In terms of uniqueness of exports, termed “standardness”, Nepal has a score of 0.5219, while China and India have 0.7917 and 0.9352, respectively. Again, the standardness level of Nepal is better than that of countries with the same income level. Nepal’s good position in exports uniqueness and diversification is encouraging news for the listless, demoralized exports sector.

Policymakers and investors want to know the possibility of producing new products that could be exported with comparative advantage. “Open forest” analysis provides the answer. It basically shows how easy it is to produce “nearby” products than the ones that are “far away”. The capabilities to produce similar but slightly differentiated products (“nearby”) already exist in the economy and policies can be designed to facilitate this process. Nepal has a score of 0.2041, one of the lowest in South Asia, in “open forest” dimension of the index. It indicates the fact that the industrial sector needs revamping of its capabilities to produce goods that are sophisticated and are within close range of each others’ capital and resource requirements.

The exports industry is not done yet. There is no need to resort to widespread import curbing measures, especially of daily consumption goods. Exports can be increased if we could judiciously and decisively address non-economic constraints ailing the industrial sector and implement highly targeted and appropriate industrial and trade policies to augment capabilities. The product level analysis of sophistication of our exports basket reaffirms this conviction.

[Published in Republica, August 1, 2010, pp.6]