My latest piece is about why cash incentive for exporters will not work when the binding constraints to exports growth and revenue are related to supply-side and slacking productive capacities.
Against the backdrop of declining exports and increasing imports, leading to widening trade deficit, last fiscal year the then Finance Minister Surendra Pandey announced export incentives in the form of cash returns to exporters that met certain value addition criteria. Though it initially filled in excitement in the export-oriented sector, the ill conceived program was not implemented due to lack of appropriate regulations. Now, without much consideration if such incentives will in fact work, the government is all set to give continuity to the same program and implement it through the upcoming budget.
Before such incentives are rolled out a pertinent question to ask is: How effective and optimal cash incentives will be in promoting Nepali exports? It seems cash incentives will not have much impact in our exports, encourage entrepreneurship and expand the exports basket. Instead, much more substantive impact might be seen if alternative incentive measures are implemented at pretty much the same cost.
During the budget for fiscal year 2010/11, cash incentives totaling two to four percent, based on value addition, of total exports value earned by exporting items to destinations except India was announced to boost exports and increase foreign exchange. Specifically, exporters of goods with up to 30-50 percent value addition were supposed to get 2 percent of total export revenue as cash incentive. Similarly, that with 50-80 percent value addition were supposed to get 3 percent cash incentive and for over 80 percent value addition the cash incentive was 4 percent of total exports revenue. The government allocated Rs 240 million for this program. Now, the Ministry of Commerce and Supplies (MoCS) has asked the government to provide such incentive to exporters exporting goods to India as well. Furthermore, it has even asked cash incentives as high as five percent of total exports revenue on products identified as having high “export potential” in Nepal Trade Integration Strategy (NTIS) 2010.
Export incentives (monetary, tax or legal) are given with the hope that exports and foreign reserves will increase and economic activities pick up in the export-oriented sectors, mainly manufacturing sector. Currently, both exports and manufacturing sectors are performing poorly. Exports and manufacturing are around 15 percent and 7 percent of GDP respectively. Any incentive geared toward increasing exports and its competitiveness sounds fine. But, these incentives should help in enhancing productive capacity as well and in making exports sustainable, especially after such incentives are pulled back.
For now, doling out cash to exporters that export the same items that fill up much of our exports basket is not a smart move and will neither make our exports competitive nor increase exports revenue as envisioned. Most of the items in the basket are losing competitiveness, both in terms of cost and quality. In our export-oriented firms, giving cash incentives will not decrease cost of production and make products cost competitive in the international market. Most of the allocated amount will be claimed by garment, textile and carpet manufacturers, whose exports are losing competitiveness. There will hardly be any value addition above the existing level in these products. Hence, in terms of enhancing productive capacities and competitiveness of the existing export-oriented firms, the scheme’s impact will almost be nil. Furthermore, there will be little change in terms of new exporters and new export items added to the exports basket.
Export incentive packages that increase productive capacity and address binding constraints to exports growth work more often than simply doling out cash based on certain value addition criteria. The same amount of money can be used to construct roads up to manufacturing plants or to provide credit and concessional loans to emerging entrepreneurs or to subsidize insurance premium during transportation of goods to the nearest port in India or to construct the much needed special economic zones. These measures will help enhance our exports and add to productive capacities more than the cash incentives.
It would also be wise to design such incentive packages so that they help in reducing time and cost incurred while exporting goods from Nepal. The Nepali exporters still face comparatively more hurdles in exporting goods than our neighbors in the region, giving them cost and time advantage. In trading across borders, which is one of the indicators of Doing Business ranking, Nepal is ranked 164 out of 183 countries. Moreover, Nepali exporters have to produce at least 9 documents and takes 41 days to process them before they are cleared for export. These numbers are one of the highest in the region. Furthermore, Nepal has one of the worst logistics related to exports and ranks 147 out of 155 countries in the latest Logistics Performance Index ranking. Nepal’s logistics ranking is worse than that of Afghanistan. Cash incentives to a few sectors and businessmen will do nothing to alleviate these problems. Instead the government should be looking into investing the allocated sum to reduce these hurdles for exporters. It will eventually make our exports competitive and might increase both exports volume and revenue.
Another reason why cash incentives will not increase exports earnings (share of GDP) is that it will not address the underlying cause for eroding export competitiveness at the first place: Supply side constraints such as poor infrastructure network, lack of reliable and adequate power supply, excessive labor unionism and militancy, lack of raw materials needed for our firms, and very few opportunities and avenues, on top of bureaucratic red tapes, for new entrepreneurs to enter the market.
Exports incentives should be wisely designed and implemented to address some of the supply side constraints and to enhance productive capacities of the export-oriented firms. Cash incentives to be reaped by few firms and businessmen will not address the main reasons why our exports are losing market pie in the increasingly competitive international market.
[Published in Republica, July 10, 2011. P.6]