Tuesday, November 29, 2011

Nepal’s top ten exports to and imports from India and China

Alternatively, it can also be India’s and China’s top imports from and exports to Nepal, if we assume that exports from Nepal to India (or China) equal imports by India (or China) from Nepal.
In 2010, the top ten exports of Nepal to India were textiles; ferrous metals; chemical, rubber, plastic; crops; beverages and tobacco product; metals; vegetables, fruits, nuts; food products; minerals; and leather products. Basically, its primary commodities. Meanwhile, the top ten exports of Nepal to China were wood products; metal products; textiles; mineral products; leather products; wearing apparel; chemical, rubber, plastic; machinery and equipment; vegetable oils an fats; and crops. Basically, no high value added products.

In 2010, the top ten imports of Nepal from India were petroleum, coal products; chemical, rubber, plastic; ferrous metals; machinery and equipment; mineral products; textiles; transport equipment; food products; motor vehicles and parts; and metals. Basically, the imports (demand) from India are pretty much price inelastic. Hence, the widening trade deficit, no matter what happens to the economy! Meanwhile, the top ten imports of Nepal from China were wearing apparel; textiles; electronic equipment; machinery and equipment; leather products; vegetables, fruits, nuts; chemical, rubber, plastic; manufacturers; metal products; and motor vehicles and parts. Basically, most of these are price elastic. The problem is that Nepal cannot produce them as competitively as the Chinese producers do because of the industrial ills and high cost of labor.

Interesting stuff:
  • The total value of top ten exports by Nepal to India is approximately USD 226 short of the value of top import (petroleum, coal products) from India. Nepal’s top export to India (textiles) is just USD 20 million higher than the value of textiles import from India.
  • The total value of top ten exports by Nepal to China is approximately 16 times less than the top import (wearing apparel) from China. China’s tenth top export to Nepal (motor vehicles and parts) is USD 4.6 million higher than Nepal’s top export (wood products) to China.
The data is sourced from UNCOMTRADE database using WITS. It is at 2-digit level (GTAP nomenclature). I will have a similar blog post about India’s and China’s top ten exports to and imports from world.
Here is previous blog post on the growth rate, exports, imports and Nepal’s trade deficit with China and India.

Monday, November 28, 2011

Total road network in Nepal (1974-2010)

An insufficient supply of infrastructure is identified as the major binding constraint to growth in Nepal. Road network is one of most important infrastructures that helps in opening up new markets, linking markets, and enhancing development of supply chains, among others.


*First eight months data

In 1974/75, total road network created was 3173 kilometer, of which 1575 km was black topped, 416 km was graveled, and 1182 km was fair weathered roads. In 1990/91, total road network created was 8328 kilometer, of which 3083 km was black topped, 2181 km was graveled, and 3064 km was fair weathered roads. In 2000/01, total road network created was 17702 kilometer, of which 4566 km was black topped, 3786 km was graveled, and 7350 km was fair weathered roads. In 2010/11, total road network created was 21455 kilometer, of which 6874 km was black topped, 5036 km was graveled, and 9545 km was fair weathered roads. Overall, construction of fair weathered road is increasing more than the other two.

Nepal signs Double Tax Avoidance Agreement with India

Nepal and India signed Double Tax Avoidance Agreement (DTAA) on November 27, 2011. It follows the Bilateral Investment Promotion and Protection Agreement (BIPPA) signed on October 21, 2011. It replaces the agreement signed in 1987.

Here is a piece by Rameshore Prasad Khanal, economic advisor to the PM.

[…] Having witnessed the process of negotiations until perhaps the final shape of the agreement emerged, it´s quite a story.

However, let me first begin with the opinion widely gaining currency immediately after the signing of the deal -- now famously known by the acronym BIPPA -- that Nepal could not get the Tax Agreement concluded which could have benefited the country and instead signed the one that would be in the Indian interest. This is the reasoning based on the analogy that what we do first is always in their interest and what we delay or cannot accomplish would have been in our interest. Both are mutual agreements and are in the interest of both the countries.

Nevertheless, the advantage would go to the one who maximizes the opportunities that these agreements open up. In fact, more than the Tax Agreement, Nepal would gain from BIPPA, as we need huge investments to meet our infrastructural needs and scale up manufacturing operations so that extra manpower from agriculture could be shifted to lucrative manufacturing jobs. We already had a Tax Agreement signed in 1987. This was generally sufficient for elimination of the chance of imposing taxes in the two countries for the same income. Any Indian company doing business in Nepal under the Nepalese law and paying taxes for such income would not be required to pay tax in India to the extent it is paid in Nepal. If tax liability in India is more than in Nepal then such a taxpayer would pay only the difference. As far as the elimination of the incidence of double taxation is concerned, the new Tax Agreement does not add substantial value. In that sense, considering the new Tax Agreement a better deal for us than BIPPA is just an expression of ignorance.

The pertinent question here is why the two countries agreed to have a new agreement completely replacing the 1987 agreement.

Tax Agreements between two countries are the outcomes of mutual consultation, but in recent years they draw heavily on the model Tax Conventions issued by OECD or the UN.
All past agreements that Nepal concluded are based on the two conventions. Both these conventions change frequently in light of the emerging trade and investment issues among countries. Particularly after 9/11, OECD model has seen dramatic changes that took tough negotiations between countries. Many countries saw tax havens as either a source of terrorist financing or place where terrorist could park money without much scrutiny. This is a threat to security everywhere. As a result, many countries thought that information exchange between tax authorities could help track down not only cases of deliberate default of tax but also location of illegal money. OECD Model Tax Convention now includes significant provisions for information exchange that can be used for tax purposes or even for any other purpose as per the law. A contracting state cannot decline to supply information just because the information is held by a bank or other financial institution or any trustee.

As India is obliged to follow OECD model because of its commitment in G-20, the request for amendment to 1987 agreement came from India some four years ago. Initial attempts to hold bilateral negotiations on the proposed amendment failed because of frequent change of government on our side. Finally, the negotiation started after the formation of a new government following the Constituent Assembly election.

During the first round of negotiations, our system was not comfortable on the inclusion of “information exchange” clause. It took quite a while for us to realize that the information exchange clause could actually be used to our advantage. The reason is that those who evade Nepali taxes usually siphon off money to the Indian financial market.
On the contrary, Indians evading taxes often stash money in highly secretive Swiss Banks (however, this is now no longer possible as Switzerland is also willing to share information that is kept as bank secrets provided Swiss government is requested for details of the suspected funds). The agreement empowers Nepal´s tax authorities to seek assistance of Indian counterparts in locating funds that escaped the Nepali tax net. This is certainly a good provision.

Aside from this entirely new elaborate feature, the new agreement reduces the number aggregate of days in a year to 90 only (from earlier 183) for a consulting or service business set up to be termed as “resident” for the purpose of taxation. This certainly increases Nepal´s tax base as there are more Indian consulting companies working in Nepal than our companies working in India. The new agreement reduces the rate of tax dividends paid by the resident company of Nepal to the resident company of India to five percent if the Indian company is holding at least 10 percent of the shares of the Nepali resident company.

For holding below 10 percent the applicable rate is 10 percent. As the rate of dividend tax in Nepal is already low the reduction simply reflects the existing laws of the country. Similarly, the applicable rate of tax on interest payment from a person of one country to the person of another country has been reduced to 10 percent. The new agreement includes provision for the taxation of capital gains, which was not covered in the earlier agreement. The income of Nepali students studying in India will not be subject to Indian taxation for six years. This limit earlier was only three years.

The most significant feature of the new agreement is that anyone living a cozy life in India by defaulting on Nepali taxes in the past can now be brought to book. Nepali tax authorities can obtain assistance of Indian authorities to collect any revenue claims, not just income tax, from a person living in India whose taxes are due in Nepal. If the request is so made the Indian authorities will use the powers as per their law as though they were collecting their own tax arrears. If there is a request from Indian side, Nepali authorities should certainly reciprocate.

Friday, November 25, 2011

Types of non-tariff barriers (NTBs)

With fast decline in tariffs due to multilateral, regional, bilateral and unilateral liberalizations, non-tariff barriers (NTBs) have become the most important trade policy tool of almost all countries. Some of the commonly used NTBs, sourced from Hiau Looi Kee and Cristina Neagu’s presentation, are listed below:

  • Origin of materials and parts
  • Import license fees
  • Customs inspection fees
  • Testing requirement
  • Direct consignment requirement
  • Requirement to pass through specified port
  • Service charges
  • Labeling requirements
  • Certification requirement
  • Processing history
  • Systems Approach
  • Temporary geographic prohibition for SP
  • Conformity assessments related to SPS
  • Traceability information requirements
  • Certification required by the exporting agencies
  • Storage and transport conditions
  • Microbiological criteria on the final product
  • Quarantine requirement

Tariffs and NTBs can be either substitute or complementary depending on context. To protect key sectors, countries might increase ad valorem equivalent of NTBs by the same magnitude (keeping protection at its optimal level) of a decrease resulting from slashing tariffs, making them substitutes. Meanwhile, trade policies influenced by interests parties through lobbies and government’s care about social welfare as well as campaign contributions would be to both tariffs and NTBs, making it complementary.

NTBs are harder to implement than tariffs as the latter are more transparent in nature. Some NTBs (like RoO) affect multiple industries while tariffs are more targeted. NTBs are not primary revenue generators as tariffs are, which are important for developing countries.

The authors conclude that tariffs and NTBs could be substitutes within importer-HS6 products, comparing across exporters. Example: preferential tariffs often come with RoO requirements. Also, tariffs and NTBs could be compliments within importer-exporter pair, comparing across products. Example: products that have low tariff barriers often have lower NTBs.

Thursday, November 24, 2011

Infrastructure and education are key to unleashing entrepreneurship

Ghani, Kerr and O’Connell argue it is entrepreneurs who create jobs and there is a “strong link between initial levels of young and small firms and subsequent job growth”. They maintain that even though there are not enough entrepreneurs in India (and other South Asian countries) for its stage of development, cities and states that have embraced entrepreneurship have created more jobs than those that have not. So, entrepreneurs create jobs. But, what creates or attracts them? Its physical infrastructure and an educated workforce. It is especially true for manufacturing and services sectors. The authors argue that “supportive industrial structure for input and output markets are strongly linked to higher entrepreneurship rates”.

The authors define entrepreneurship as the presence of young establishments, less than three years old, in the formal manufacturing sector. There area also other characteristics of entrepreneurship such as self-employment, firm size, ownership, entry and innovation.


Some of the findings are:

  • Their estimate derived from Indian data suggests that a ten percent increase in initial entrepreneurship in a region-industry in 1989 was associated with a 1.3 percent higher rate of employment growth to 2005.
  • While infrastructure and an educated workforce encourage entry to entrepreneurs, strict labor regulations discourage them to enter the formal sector.
  • Start-ups are more frequent in cities with common labor needs and have customer-supplier relationships with cities’ incumbent businesses.
  • For jobs creation, policymakers should focus on promoting entrepreneurship locally. Since educated labor force is a crucial factor for the entry of new entrepreneurs, establishment of local colleges and education institutions should be promoted. [Just look at the number of start-ups and the growth of education institutions in Nepal. They have moved positively and youths are at the forefront of this phenomena.] Similarly, infrastructure such as roads, electricity and telecommunication are prerequisites for enticing entrepreneurs.
  • South Asian countries need to work more on developing infrastructure, improving education, lowering entry costs, reducing regulatory burdens, and developing financial access to unleash business creation and job growth.
  • It is estimated that almost one million new workers will join the labor force every month for the next two decades in India.

Wednesday, November 23, 2011

Road to Busan: Aid effectiveness in Nepal

[It was published in Republica, November 23, 2011, p.6]

Road to Busan

Chandan Sapkota and Rita Shrestha

Between November 29 and December 1 stakeholders associated with the aid industry are gathering in Busan, South Korea, for Fourth High Level Forum on Aid Effectiveness. The summit will review progress made since the last high level forum and make commitments to set new agendas for donor’s involvement in development sector. A group of ‘sherpas’—who are elected representatives of developed and developing countries— is working on commitments to be endorsed at Busan, according to the Organization for Economic Co-operation and Development ( OECD).

The summit is held against the backdrop of the food, fuel, financial and economic crises; concern over aid reduction by donors in the face of the Euro crisis and persistently high unemployment and stagnant growth in the US; increasing role of Southern donors; and climate change concerns. It will determine how over US$160 billion will be spent annually. Importantly, it will dictate how approximately US$1 billion will be spent in Nepal by donors. Hence, for a country whose 26 percent of total annual budget is funded by aid money (both loan and grants), the deliberations and outcomes of this summit are highly significant.

The Busan summit is the fourth in a series that started in 2002 with the First High Level Forum, organized in Rome, which for the first time outlined three principles of aid effectiveness. It was followed by Second High Level Forum in Paris in 2005, which outlined five principles of aid effectiveness. Then Third High Level Forum was organized in Accra in 2008. It accentuated the need to achieve the goals of the second forum and proposed further improvement in the areas of ownership, partnerships and result-oriented activities. The five principles outlined in the Paris Declaration (PD) — ownership, alignment, harmonization, results, and mutual accountability— remain a cornerstone of the evaluation of aid effectiveness.

In order to get a clear picture of what aid has or has not achieved so far with so much assistance, the PD set targets for 13 indicators covering all the five principles. The 2011 Survey on Monitoring the Paris Declaration shows that while at the global level only one out of the 13 targets has been met, there has been ‘considerable progress’ towards meeting the remaining 12 targets. In a way, this shows that the aid industry has failed to meet its own target and has opened up avenues for further criticisms from those who accuse them of inhibiting growth and development in developing countries.

According to a recent country report on monitoring of PD, published by the Ministry of Finance (MoF), the performance on aligning donors’ activities with respect to that of Nepal’s strategies for achieving goals such as poverty reduction, improving institutions and tackling corruption (also referred to as ownership) is well below the target set for 2010 by OECD. This indicates that aid alignment remains a challenge in Nepal. Specifically, technical assistance (over 25 percent of total aid) remains one of the least coordinated activities of donors. No wonder every big or small donor agency is organizing multiple and duplicate conferences and training programs, and publishing reports to just spend the allocated money.

If all technical assistances/capacity building in one sector are to be aligned and coordinated, then a lot of the Kathmandu based donors will find it hard to spend money. Most of their expertise is on technical assistance, which by the way opens up avenues to employ consultants from donor countries themselves. This has created an oversupply of consultants and reports. Usually, hiring certain number of consultants for technical assistance, irrespective of their need, is included as conditionality in assistance packages. The PD infringes on interests and incentives of donor countries, who in principle want to tie up aid to serve interests of their domestic constituencies as well as that of recipient country. At times, the seeming incompatibility of interests and incentives has led to the disinclination of donors to follow the government’s procurement and implementation mechanism, which are aimed at better coordinating aid. In terms of aid predictability, the situation has not improved much as is evident from the wide variation between commitment and disbursement.

In harmonizing aid activities, there has been some improvement in implementing program based approaches but the performance as of now (31 percent) is still short of the OECD target for 2010 (66 percent). Additionally, evaluating the progress in managing for results, the report notes that though the overall framework and procedures to carry out aid activities are already in place, the quality of results-based programming and monitoring is still below expectation. Donors have not fully used the Medium Term Expenditure Framework and the Poverty Monitoring and Analysis System. Note that only 41 percent of total aid inflow is recorded in the budget systems. The government has concluded that donor support is not always “sufficiently consistent and sustained” and they respond more to advocacy activities and less to securing resources to executing the very lessons learned from such activities and capacity building sessions. Furthermore, donors have spread their wings in more sectors in 2009 than they had in 2005, which means that aid fragmentation has in fact increased instead of the goal of decreasing it. Right now the donors lack clear exit strategies to sustain the progress made through technical assistances.

In mutual accountability for development results by both donors and government, there has been some progress but not of the expected level. Sector-wide Approach (SWAp)—which brings together all stakeholders within any sector— in health and education has shown impressive results, but according to the report, there still is not enough interaction between donors and government on matters regarding aid effectiveness. The government is trying to bring in all aid activities under the Foreign Aid Policy (FAP), whose draft is being widely circulated among all stakeholders. However, the policy is still not enacted allegedly due to objections by some donors, who think that FAP as of now, if implemented, will restrict them from fully implementing their own programs under their own guidelines. Moreover, due to the high concentration of donors and their missions (which increased to 341 in 2010 from 262 in 2007), our government officials are becoming more responsive to them rather than to their own citizens.

The Busan summit will take up these issues, formulate new strategies and make commitments drawing lessons from country review reports such as the one prepared by our MoF. The evolving global economic scenario after 2008 means that aligning donors’ domestic interests regarding country ownership, aid alignment and tied-aid will be even more challenging than it were when the PD was crafted. Meanwhile, convincing Southern donors to adhere to the PD principles will face resistance as they are still guided primarily by commercial and foreign policy interests, which are not entirely compatible with the PD. Nepal receives approximately US$ 140 million per year from Southern donors, namely India, China, Kuwait, OPEC Fund, and Saudi Development Fund.

The aid commitment, priorities and strategies of donors, both Development Assistance Committee (DAC) and non-DAC (read as Northern and Southern donors respectively), in Busan will have important implications for development activities in our country. It will primarily determine the course of development interventions before the deadline for achieving the MDGs expires in 2015. By forging a new consensus on development cooperation, the donors have the task of convincing the public that their activities are driven more by the need of the people than by their own self interests.

Sapkota is associated with South Asia Watch on Trade, Economics & Environment; Shrestha is with Alliance for Aid Monitor Nepal. The views expressed are personal.

Monday, November 21, 2011

Food deficit and insufficient inputs

Food deficit in Nepal is mainly the result of insufficient inputs in the production process, conversion of food grain into animal feed, erratic rainfall, delayed monsoon and poor land husbandry. The crop yield data show big yield gaps (the gap between attainable yield and the national average yield). The gap is three tons per hectare for wheat, three tons per hectare for maize and two tons per hectare for rice. Thus, over a million hectares of cultivable land yield below average. Agro scientists in Nepal often complain that there is not enough money for research and awareness programs aimed at farmers, which would be of enormous help in reducing these gaps. Unavailability of quality seeds, fertilizers and plant-protection chemicals for the crops are other important factors. Moreover, the government does not have enough space to store all of the food grain produced in the country; instead traders across the border store Nepali harvest, thus leading to seasonal shortages. If the farmers are supported with proper inputs in time and storage facilities are improved, we can attain the goal of food sufficiency in a not too distant future. Also, if the farmers could store rainwater during monsoon for its use in the dry season, millions of tons of additional yield can be achieved. None of these measures require genetic manipulation of seeds, which is Monsanto’s forte. 

Read more by Krishna Bahadur Karki here.

My take on food security in Nepal here (research brief) and here. Here is a link to a detailed paper on high food prices in South Asia.

Sunday, November 20, 2011

Crisis and creative destruction

Well, economic crisis does not necessarily mean exit of uncompetitive firms and entry of competitive ones. This is shown by Hallward-Driemeier and Rijkers in a new paper whose abstract is as follows:

Using Indonesian manufacturing census data (1991-2001), this paper rejects the hypothesis that the East Asian crisis unequivocally improved the reallocative process. The correlation between productivity and employment growth did not strengthen and the crisis induced the exit of relatively productive firms. The attenuation of the relationship between productivity and survival was stronger in provinces with comparatively lower reductions in minimum wages, but not due to reduced entry, changing loan conditions, or firms connected to the Suharto regime suffering disproportionately. On the bright side, firms that entered during the crisis were relatively more productive, which helped mitigate the reduction in aggregate productivity.

Saturday, November 19, 2011

Analytical framework of the economic crisis in the US and the EU

Mohamed A. El-Erian explains what happened and what needs to happen in the Western economies:

Each development, and certainly their occurrence in tandem, points to the historic paradigm changes shaping today’s global economy – and to the anxiety that comes with the loss of once-dependable anchors, be they economic and financial or social and political.

Restoring these anchors will take time. There is no game plan as of now, and historic precedents are only partly illuminating. Yet two things seem clear: different countries are opting, either by choice or necessity, for different outcomes; and the global system as a whole faces challenges in reconciling them.

Some changes will be evolutionary, taking many years to manifest themselves; others will be sudden and more disruptive. Yet, as complex as all of this sounds – and, by definition, paradigm changes are complicated affairs that, fortunately, seldom occur – a simple analytical framework may help shed light on what to look for, what to expect and where, and how best to adapt.

The framework relies on an often-used analytical shortcut: identifying a limited set of explanatory variables in what statisticians call “a reduced-form equation.” The objective is not to account for everything, but rather to pinpoint a small number of variables than can explain key factors, albeit neither perfectly nor fully.

Using this approach, it is possible to argue that the future of many Western economies, and that of the global economy, will be shaped by their ability to navigate four inter-related financial, economic, social, and political dynamics.

The first relates to balance sheets. Many Western economies must deal with the nasty legacy of years of excessive borrowing and leveraging; those, like Germany, that do not have this problem are linked to neighbors that do. Faced with this reality, different countries will opt for different de-leveraging options. Indeed, differentiation is already evident.

Some, like Greece, face such a parlous situation that it is difficult to imagine any outcome other than a traumatic default and further economic turmoil; and Greece is unlikely to be the only Western economy forced to restructure its debt. Others, like the United Kingdom, have moved quickly to take firmer control of their destiny, though their austerity drives will inevitably involve considerable sacrifices.

A third group, led by the US, has not yet made an explicit de-leveraging choice. Having more time, they are using the less visible, and much more gradual, path of “financial repression,” under which interest rates are forced down so that creditors, including those on modest fixed incomes, subsidize debtors.

De-leveraging is closely linked to the second variable – namely, economic growth. Simply put, the stronger a country’s ability to generate additional national income, the greater its ability to meet debt obligations while maintaining and enhancing citizens’ standards of living.

Many countries, including Italy and Spain, must overcome structural barriers to competitiveness, growth, and job creation through multi-year reforms of labor markets, pensions, housing, and economic governance. Some, like the US, can combine structural reforms with short-term demand stimulus. A few, led by Germany, are reaping the benefits of years of steadfast (and underappreciated) reforms.

But growth, while necessary, is insufficient by itself, given today’s high unemployment and the extent to which income and wealth inequalities have increased. Hence the third dynamic: the West is being challenged to deliver not just growth, but “inclusive growth,” which, most critically, involves greater “social justice.”

Indeed, there is a deep sense that capitalism in the West has become unfair. Certain players, led by big banks, extracted huge profits during the boom, and avoided the deep losses that they deserved during the bust. Citizens no longer accept the argument that this unfortunate outcome reflects the banks’ special economic role. And why should they, given that record bailouts have not revived growth and employment?

Calls for a fairer system will not go away. If anything, they will spread and grow louder. The West has no choice but to strike a better balance – between capital and labor, between current and future generations, and between the financial sector and the real economy.

This leads to the final variable, the role of politicians and policymakers. It has become fashionable in both America and Europe to point to a debilitating “lack of leadership,” which underscores the extent to which an inherently complex paradigm change is straining traditional mindsets, processes, and governance systems.

Unlike emerging economies, Western countries are not well equipped to deal with structural and secular changes – and understandably so. After all, their histories – and certainly during what was mislabeled as the “Great Moderation” between 1980 and 2008– have been predominantly cyclical. The longer they fail to adjust, the greater the risks.

Those on the receiving end of these four dynamics – the vast majority of us – need not be paralyzed by uncertainty and anxiety. Instead, we can use this simple framework to monitor developments, learn from them, and adapt. Yes, there will still be volatility, unusual strains, and historically odd outcomes. But, remember, a global paradigm shift implies a significant change in opportunities, and not just risks.

Foreign demand for Nepalese coffee outstrips supply

The National Tea and Coffee Development Board (NTCDB) argues that foreign demand for Nepalese coffee is far higher than supply. It maintains that the annual demand for Nepali coffee is more than 4,000 tonnes but production is only 400 tonnes. If this is true, then here is an export potential product that won’t require export potential study! And, the contribution of donors working in the promotion of this product is commendable. Nepal is exporting coffee mainly to Japan, the US, and the EU.

With increasing demand, international agencies and local people have been attracted to investing in the sector. “With aid from INGOs, coffee production is projected to reach 8,000 tonnes within a decade,” said Bhandari. INGOs like Helvetas, Winrock and PACT Nepal have been supporting coffee farming.

There are more than 26,000 people engaged in coffee production. Syangja, Palpa, Lalitpur, Ramechhap, Ilam and Gulmi have been identified among 40 coffee growing districts as the main producers of coffee in the country.

Good prospects have led to expansion of coffee farming. According to the NTCDB, the area under coffee cultivation increased to 1,752 hectares in 2010-11 from 1,630 hectares in 2009-10.

Similarly, increasing domestic production has resulted in a decline in imports. Annual coffee imports plunged to Rs 12.51 million from Rs 84.40 million three years ago.

Executive director of the board Raman Prasad Pathak said that demand for Nepali coffee was on the rise due to its better taste and production system which does not use chemicals.

Despite massive demand, the country exported a mere 279.76 tonnes of coffee worth Rs 93.08 million in the last fiscal year. However, the figure is more than double compared to the previous year when exports amounted to 120 tonnes worth Rs 67.5 million.

Coffee Production
Fiscal year Plantation area (Hectares) Production (M.T.)
1994/95 135.7 12.95
1995/56 220.3 29.2
1996/97 259 37.35
1997/98 272.2 55.9
1998/99 277.1 44.5
1999/00 314.3 72.4
2000/01 424 88.7
2001/02 596 139.2
2002/03 764 187.5
2003/04 952 217.5
2004/05 1078 250
2005/06 1285 391
2006/07 1396 460
2007/08 1145 265
2008/09 1531 334

Friday, November 18, 2011

Corruption (rate) at Raxual custom

Corruption at custom check points between Nepal and India border is an accepted practice now—just ask the traders how much they have to pay extra money per truck. Now, it looks like the cost of import of goods has increased because the commission rate on 71 products entering Nepal via Raxual custom has been increased. It is reported that almost 60 percent of goods imported from India come through this custom point. Almost 1000 truck enter through this point each day.

According to this media report, Indian agents revealrf that commission (corruption) money is added to the normal fare for truck/vehicle service. It is reported that around 50 lakhs Indian rupee per day is collected as commission by Indian officials, who then let trucks enter the Nepal side of the border. This means Nepalese consumers will have to pay even for the amount illegally raked in by Indian border officials because the final retail price of imported goods includes all formal and informal costs incurred by importer.

Here are the rates:

  • Corruption rate for import using cart, truck and rail is different.
  • For small quantities, the corruption rate is IRs 800 per cart.
  • For each truck full of potatoes, the corruption rate is IRs 2000, onion IRs 3000, and maize IRs 3500. For coal it is IRs 3000.
  • Commission equivalent to one percent of total cost of machinery.

These are institutional non tariff barriers to trade!

Return to investment in education

Using Indonesia Family Life Survey, this WB policy research working paper shows that return to upper secondary schooling in Indonesia is as high as 50 percent per year of schooling for those very likely to enroll in upper secondary schooling, or as low as -10 percent for those unlikely to do so. Furthermore, returns to the marginal student (14 percent) are well below those for the average student attending upper secondary schooling (27 percent).

Meanwhile, the chart below shows returns to investment in education by level in few countries. The estimation for Nepal is that of 1999. More on why education is not a binding constraint to growth in Nepal is explained here.

Thursday, November 17, 2011

Labor growth and finance

This paper combines firm-level data from 89 countries with updated country-level data on financial structure, and uses two estimation approaches. It finds that in low-income countries, labor growth is swifter in countries with a higher level of private credit/gross domestic product; the positive effect of bank credit is especially pronounced in industries that depend heavily on external finance; and banking development is positively associated with more physical and human capital investment. These findings are consistent with predictions from new structural economics. In high-income countries, labor growth rates are increasing in the level of stock market capitalization, which is also consistent with predictions from new structural economics, although the analysis is unable to provide evidence that the association is causal. It finds no evidence that small-scale firms in low-income countries benefit most from private credit market development. Rather, the labor growth rates of larger, capital-intensive firms increase more with the level of private credit market development, a finding consistent with the history-based political economy view that banking systems in low-income countries serve the interests of the elite, rather than providing broad-based access to financial services.

Read the full paper by Cull and Xu (2011).

Monday, November 14, 2011

The sources of food and nonfood inflation in Nepal

Inflation rate in Nepal reached double-digit for three consecutive years now and is now just above 9 percent. What are sources of inflation in Nepal? Is it following Indian price level? Is it being affected by demand side or supply side or both? How much is it affected by food prices? How much traction M2 (money supply) has on inflation in Nepal? In order to bring down the persistently high and sticky price level, policymakers need to first know the sources of inflation and then devise policies accordingly. The IMF recently published a study that looks into the sources of inflation in Nepal.

Using a VAR model to estimate the impact of external spillovers from India, international oil prices, nominal effective exchange rate, and domestic monetary factors, the study finds that inflation (both food and non-food) in Nepal is mainly driven by inflation in India and movements of international oil prices. These two factors account for more than one-third of the variability in domestic inflation. Since inflation in Nepal have been historically following inflation in India but not after 2007/08, the analysis uses two datasets: full dataset ranging from 2001 to 2011 and a sub dataset ranging from 2007 to 2011. The latter dataset shows that inflation in Nepal is deviating from India’s inflation and is becoming more responsive to oil prices. Note that Nepal has open border and pegged its currency with India.

Overall inflation

  • Monetary factors matter more for nonfood price inflation than for food price inflation. But, its effects fade out quickly. (Earlier I wrote that M2 does not have traction on inflation). Monetary tools have not been used to manage inflation.
  • The appreciating nominal effective exchange rate has a negative and lagged impact on inflation only between 2007 and 2011 dataset. [It might be due to rising imports in recent years.]
  • Responsiveness to international oil prices and exchange rate has increased lately. That is why international oil prices show a stronger effect in the 2007-2011 dataset.
  • Food price increases have contributed about three-fourths of overall CPI inflation, while nonfood prices contributed the remaining one-fourth. Food price inflation has been more volatile than nonfood price inflation.

Food price inflation

  • The responsiveness of food price inflation is significant and quick to spillovers from India’s food inflation and oil price movements. Furthermore, the impact of oil prices is more persistent than India’s food inflation. It intensified in recent years. It might be because the price of petroleum products gets reflected faster in the price of chemicals and fertilizers used in agriculture production, transportation cost of agriculture products and use of energy in irrigation, says the report.
  • Nominal effective exchange rate has a negative effect on food inflation with a lag of about three months in 2007-2011 dataset only.
  • Monetary responsiveness to food price inflation is significant in 2007-2011 dataset, but the effect fades out quickly.

Nonfood price inflation

  • Monetary responsiveness to nonfood price inflation is strong in both full and subset dataset series (with largest impact on the full dataset). But, the effects are short.
  • Nonfood price inflation responds to Indian food and nonfood inflation as well as international oil prices (strongly since 2007).
  • Nominal effective exchange rate has a negative effect on nonfood price inflation between 2007-2011 dataset only.

In a study of similar nature in 2007, Edimon Ginting shows that inflation in India and inflation in Nepal tend to converge in the long run, but the pass through of inflation from India to Nepal take about seven months. Now, this seems to have been violated especially after 2007 due to the strong impact of petroleum prices.

Here is how there is disconnect between Indian and Nepalese inflation rates. I wrote this one last year and is still valid. 

  • In the long term, inflation is primarily affected by money supply. In the short term, it is affected by demand and supply pressures, which in turn are dictated by relative elasticity of wages, prices and interest rates. The inflationary pressure in the short term could drag into medium term and long term, leading to high inflation for an extended period of time. It happens if prices and wages are too sticky at high level, i.e. once prices and wages rise either due to demand or supply pressure, or both, even if pressures subside, they continue to remain at high levels. This is happening in the economy since 2007.
  • One of the reasons why prices remain sticky at high levels (i.e. domestic prices do not come down even when market conditions normalize) is because of various non-economic factors constraining the functioning of markets.
  • The global economy was struck by a rapid rise in commodity and food prices in 2007, severely affecting net food importing developing countries like Nepal. Several countries, including India, banned export of key agricultural items imported by Nepal. The shortage of agricultural goods led to rapid rise in domestic prices. Then came a sudden rise in global fuel prices in 2008, leading to a drastic increase in petroleum prices in the domestic market. This directly reduced real disposable income because a substantial portion of the population banks on petroleum products for daily need. It also shot up cost of production of domestic producers, resulting in rising prices of consumer goods and services. The combined effect of the rise in food, commodity, and fuel prices led to spiraling prices starting 2007.
  • Unfortunately, when fuel, commodity and food prices cooled down in the international market, the hangover persisted in our economy. Prices stubbornly remained sticky at high levels. Exogenous factors such as supply bottlenecks due to extended periods of bandas and strikes led to shortage of essential items. Additionally, hoarding, black marketeering, deliberate withholding of supplies and inventory, and agricultural trade hurdles imposed by our neighbors contributed to keeping prices higher even after the normalization of market forces.
  • These series of events contributed to higher inflationary expectations, leading to a situation where workers, employers, producers, wholesalers and retailers started inflating wages and prices on expectation that inflation will go up. The final outcome was a permanently higher inflation. It might go even higher if the supply side constraints and inflationary expectations are not timely and adequately addressed.

Here is another piece I wrote in 2009 and the arguments still hold true.

Sunday, November 13, 2011

Policy implementation paralysis in Nepal

[This was published in Republica, November 12, 2011, p.6]

Policy implementation paralysis

Here is a snapshot of the current state of our economy: Economic growth is stagnant at under 4 percent, well short of fiscal budgetary targets and the Three Year Interim Plan. A lack of job opportunities in the domestic economy is compelling over 20,000 workers to seek employment abroad every month. General prices of goods and services have been stubbornly sticky at near double-digit level. The fragile financial sector and real estate activities have not recovered yet. The manufacturing sector is shrinking, productivity is declining, competitiveness of Nepali products is eroding in the international market and imports are ever-surging, which has resulted in widening of the trade deficit. Expenditure growth is higher than revenue growth and the growing saving-investment gap has led to inflow of foreign aid worth 25 percent of budget. High inflow of remittances has precariously balanced the economy right now.

All of these have occurred not because we lack good policies, but because there is laxity in implementing existing policies and enacting new ones that will directly stimulate economic activities.

Anyone trying their hands at innovative and entrepreneurial stuff, those who are actively looking for job opportunities and those frequenting local retail stores might have realized that the current state of economic affairs is simply unsustainable. Unfortunately, most of our political leaders and policymakers, far removed from the concerns of the regular folks, are unaware of the fact that the status quo is unsustainable. It is high time they acknowledged that new reforms and effective implementation of the already enacted ones are vital to break the economic impasse.

Thus the government should focus on effectively implementing the enacted economic and trade reforms and formulate new ones that directly address the constraints to growth of key sectors. Equally importantly, it should also ensure that the implementation of reforms is overseen by qualified and informed policymakers and political leaders.

Our economy will remain competitive only if we align production and employ resources in such a way that output base gradually shifts from production of low value added goods to high value added goods. It will lead to an increase in growth rate, job opportunities, revenue, production level, and foreign reserves as our export items gain deeper foothold in the international market. For this to happen, the economy needs to undergo structural transformation along with the enhancement of productivity.

In its latest Article IV Consultation with Nepal, the IMF also argued that Nepal needs to enact structural reforms to raise productivity and growth. It maintains that macroeconomic stability and managing financial sector risks are the two most challenging tasks right now. Given the current state of our economy, it expects real economic growth of 3.8 percent in 2011/12, which is revised downward from its preliminary estimate released in August. It means that economic activities are expected to slow down even more than what was projected few months back.

Now, to check further slowdown in growth (which is expected to remain below 4 percent till 2015 with the current state of affairs) and maintain macroeconomic stability, we need meaningful implementation of structural and policy reforms. It means controlling unproductive expenditure, raising revenue, increasing exports and decreasing trade deficit, maintaining sound balance of payment, controlling high inflation, addressing supply-side constraints, and ensuring soundness of the financial sector, among others. Without effectively implementing the already enacted reforms and adopting new ones that will generate high growth and employment, all of these economic challenges will remain unaddressed. Sadly, the existing laxity shown by policymakers and political leaders on this front is costing us dearly in terms of lost industrial output and eroding competitiveness of our exports.

For instance, as outlined in the Industrial Policy 2010, the government has been unable to implement ‘no-pay-for-no-work’ policy and one-window facility to all industrial woes. Similarly, the same policy document promises easy exit from business for promoters, freeing them from long-term labor and other liabilities. Unfortunately, all of these also remain unrealized as is evidenced by the difficulty in exiting the market by the labor strike stricken Surya Nepal’s garment manufacturing unit in Biratnagar. The policy implementation paralysis is leading to protracted industrial disputes, high cost of production resulting from power cuts and high labor costs, and numerous supply-side impediments. These are eroding investors’ confidence In our economy. Worse, labor cost in Nepal is already the highest in South Asia. The total annual labor cost is US$ 1889 per year in Nepal while the figures for Bangladesh, India, Pakistan and Sri Lanka are US$ 789, US$ 943, US$ 1052 and US$ 1619, respectively. Additionally, the parliament has not yet passed the Special Economic Zones (SEZs) Act at a time when the construction of first SEZ in Bhairawa is nearing completion. Without this bill to operationalize SEZs, approximately Rs 1 billion worth of investment will go down the drain. Moreover, the government has not also been to implement various export promotion and industrial policies that have been enacted since 2009.

It is no surprise that the eroding competitiveness of our economy is vividly reflected in recent comparative studies. First, the global competitiveness report shows that Nepal is one of the most uncompetitive economies in South Asia, ranking 125 out of 142 countries. Nepal’s labor market efficiency is ranked below that of other factor-driven economies. Worse, Nepal’s infrastructure ranking is the second worst out of the 142 economies. The business community thinks that government instability—followed by inefficient government bureaucracy, policy instability, corruption, and lack of infrastructure among others— is the most problematic factor for doing business. Second, according to the latest Doing Business report, the cost of starting business (37.4% of income per capita) in Nepal is far higher than the average for South Asia (21.6% of income per capita). In terms of export facilitation, there has not been any improvement in the last couple of years. It still takes 9 documents, 41 days, and US$ 1960 to export a container.

Third, according to the latest Gallup poll, the Nepalese people feel that a lack of political leadership and corruption are the main factors preventing economic growth. In the survey, 64% of respondents who were dissatisfied with the current economic conditions said that a lack of political leadership was the main factor behind poor economic performance. Almost the same percentage of respondents felt that corruption is impeding our potential economic growth path. It shows that a lack of political will to project economic agendas before political agendas, misinformed political leaders at the helm of decision making bodies, and corruption are the main reasons for the policy implementation paralysis.

To address the macroeconomic problems and economic hardships faced by households, there is no option other than to increase productivity and competitiveness of our economy by seriously implementing the already enacted reforms and introducing new ones aimed at boosting growth and employment. The laxity in implementing agreed policies and half-hearted commitment to enact needed reforms is not helping to resolve our economic woes.

Friday, November 11, 2011

Cash incentives for export promotion in Nepal

My presentation on policy study on cash incentives for export promotion in Nepal. The event was organized by the FAO. Here is my earlier take on cash incentives issue.

Cash Incentives for Export Promotion in Nepal

Tuesday, November 8, 2011

Determinants of financial flows from BRICs to LICs

Turns out BRICs lend more to low income countries with weaker institutions. Interestingly, interests on loans are higher for countries that have weak institutional indicators (i.e. higher the risks, higher the interest rates). And, land-locked, resource-scarce low income countries receive less financing than resource-rich countries. Below is the abstract from a working paper by Nkunde Mwase of the IMF.

BRICs development financing flows have increased significantly and are expected to become more prominent in the post-crisis era. We investigate the potential implications on the country-allocation of loan commitments and the degree of concessionality using a panel vector autoregression model and single equation dynamic panel estimation.We find that BRICs lend more to LICs with weaker institutions. Land-locked, resource-scarce LICs receive significantly less financing than other resource-rich LICs. The degree of concessionality is negatively correlated with the amount of loans and positively correlated with better institutional indicators suggesting that the higher the risks, the higher the required returns that BRICs expect.

Monday, November 7, 2011

Links of Interest (2011-11-07)

Europe Sneezes, India Catches a Cold (Europe was the target for 18 percent of India’s exports, compared with 10 percent headed for the US. Collapse of the euro could instigate a host of protectionist measures that would disrupt global trade.)

The Contribution of Chinese FDI to Africa's Pre Crisis Growth Surge

In the 3 years before the 2008 Financial Crisis, GDP growth in sub Saharan Africa (averaged over individual economies) was around 6%, or 2 percentage points above mean growth rates for the preceding 10 years. This period also coincided with significant Chinese FDI flows into these countries, accounting for up to 10% of total inward FDI flows for certain countries in these years. [...]Our individual results vary by year and country, but there are several year/country combinations where Chinese FDI contributed to an additional one half of a percentage point or above to GDP growth. These results suggest that a significant, even if in some cases small, portion of the elevated growth in sub Saharan Africa in the three years before the Financial Crisis and also in the two years afterwards (2008-2009) can be attributed to Chinese inward investment.

Unconditional Convergence by Dani Rodrik (Here is another one by Rodrik)

Unlike economies as a whole, manufacturing industries exhibit unconditional convergence in labor productivity. The paper documents this finding for 4-digit manufacturing sectors for a large group of developed and developing countries over the period since 1990. The coefficient of unconditional convergence is estimated quite precisely and is large, at 3.0-5.6 percent per year depending on the estimation horizon. The result is robust to a large number of specification tests, and statistically highly significant. Because of data coverage, these findings should be as viewed as applying to the organized, formal parts of manufacturing.

On aid and growth: Reflections ahead of Busan (The links below show that aid has positive impact on growth. Beware of the fact that there are studies that also show aid does not buy growth. Meanwhile, Raghuram Rajan and Arvind Subramanian argue that aid inflows have systematic adverse effects on a country's competitiveness, as reflected in a decline in the share of labor intensive and tradable industries in the manufacturing sector, but private-to-private flows like remittances do not seem to create these adverse effects.They argue that these effects stem from the real exchange rate overvaluation caused by aid inflows.)

  • Arndt, Channing; Jones, Sam; and Tarp, Finn (2010) argue that aid has a positive and statistically significant causal effect on growth over the long run, with confidence intervals conforming to levels suggested by growth theory. Aid remains a key tool for enhancing the development prospects of poor countries.
  • Tseday Jemaneh Mekasha and Finn Tarp argue that meta-analysis show that effect of aid on growth is positive and statistically significant.
  • Katarina Juselius, Niels Framroze Møller, and Finn Tarp argue that their study provides “broad support for a positive long-run impact of ODA flows on the macroeconomy. For example, we find a positive effect of ODA on investment in 33 of the 36 included countries, but hardly any evidence supporting the view that aid has been harmful. From a methodological point of view our study documents the importance of transparency in results reporting in particular when the statistical null does not correspond to a natural economic null hypothesis. Our study identifies three reasons for econometrically unsatisfactory results in the literature: failure to adequately account for unit roots and breaks; imposing seemingly innocuous but invalid data transformations; and imposing aid endogeneity/exogeneity without testing.”
  • Channing Arndt, Sam Jones, and Finn Tarp argue that aid stimulates growth and reduces poverty through physical capital investment and improvements in health.

Nepal government is making employment database to match workers with employers

Nepal’s IT industry attracts US’s IT firm’s attention (“The number of IT companies in the country working for American companies has significantly gone up. In recent months, some of the local companies have been acquired by the US-based companies and also the number of new companies with tie-ups with American companies is on the rise.”)

Inequality drags down Nepal’s HDI ranking

Even though Nepal´s performance improved on human development, the country ranked 157th out of 187 countries in Global Human Development Index (HDI), down from last year´s ranking at 138th position.

The drop in position, however, was recorded not because Nepal performed badly on income, education and health -- three key areas that Human Development Repot (HDR) focuses on, but because this year´s ranking was done after adjusting inequality in all those areas, according to officials.

Justin Lin explains Development Thinking 3.0 (Here is a link to the full paper on Lin’s rejoinder to Kruger, Stiglitz, and Rodrik’s comment on his paper on New Structural Economics.)

Sources of electricity in Asia

Mountainous countries generally depend on hydropower to generate electricity. Fast growing economies depend more on fossil fuels to generate most of their electricity. Nepal derives all of its electricity from hydropower. The figure in the left is adapted from this ADB 2010 report (p.38). Burenei Darussalam depends entirely on carbon fuels. Check out the Asian countries’ dependence on carbon fuels, hydropower, and other fuels for their power needs.

The curious case of Nepali electricity supply is noteworthy here. Despite having one of the highest hydropower potentials, Nepal is facing acute shortage of electricity. Load-shedding is a normal phenomena year round (blackouts could be as long as 18 hours a day during dry season). There is huge demand for electricity in the market—meaning high returns to investment, albeit with high gestation period—but still supply cannot remotely match up the demand.

Sunday, November 6, 2011

World Hunger Report 2011: High & volatile prices in the future as well

The World Hunger Report 2011 argues that high and volatile prices are set to continue in the coming days. Key message from the FAO report are copied below:

  • Some large countries were able to insulate themselves from the crisis through restrictive trade policies and functioning safety nets, but trade restrictions increased prices and volatility on international markets.
  • Demand from consumers in rapidly growing economies will increase, population will continue to grow, and further growth in biofuels will place additional demands on the food system. On the supply side, there are challenges due to increasingly scarce natural resources in some regions, as well as declining rates of yield growth for some commodities. Food price volatility may increase due to stronger linkages between agricultural and energy markets, as well as an increased frequency of weather shocks.
  • Because food represents a large share of farmer income and the budget of poor consumers, large price changes have large effects on real incomes. Thus, even short episodes of high prices for consumers or low prices for farmers can cause productive assets – land and livestock, for example – to be sold at low prices, leading to potential poverty traps. In addition, smallholder farmers are less likely to invest in measures to raise productivity when price changes are unpredictable.
  • Changes in income due to price swings can reduce children’s consumption of key nutrients during the first 1 000 days of life from conception, leading to a permanent reduction of their future earning capacity, increasing the likelihood of future poverty and thus slowing the economic development process.
  • The benefits go primarily to farmers with access to sufficient land and other resources, while the poorest of the poor buy more food than they produce. In addition to harming the urban poor, high food prices also hurt many of the rural poor, who are typically net food buyers. The diversity of impacts within countries also points to a need for improved data and policy analysis.
  • Domestic food prices increased substantially in most countries during the 2006–08 world food crisis at both retail and farmgate levels. Despite higher fertilizer prices, this led to a strong supply response in many countries. It is essential to build upon this short-term supply response with increased investment in agriculture, including initiatives that target smallholder farmers and help them to access markets, such as Purchase for Progress (P4P).
  • In order to be effective at reducing the negative consequences of price volatility, targeted safety-net mechanisms must be designed in advance and in consultation with the most vulnerable people.
  • Restrictive trade policies can protect domestic prices from world market volatility, but these policies can also result in increased domestic price volatility as a result of domestic supply shocks, especially if government policies are unpredictable and erratic. Government policies that are more predictable and that promote participation by the private sector in trade will generally decrease price volatility.
  • Investment in agriculture remains critical to sustainable long-term food security. For example, cost-effective irrigation and improved practices and seeds developed through agricultural research can reduce the production risks facing farmers, especially smallholders, and reduce price volatility. Private investment will form the bulk of the needed investment, but public investment has a catalytic role to play in supplying public goods that the private sector will not provide. These investments should consider the rights of existing users of land and related natural resources.

Saturday, November 5, 2011

Nepal needs structural reforms to raise productivity and economic growth, says the IMF

The IMF, in its latest 2011 Article IV Consultation with Nepal, argues that Nepal needs to work on enacting structural reforms to raise productivity and potential growth. Nepal’s productivity growth has not kept pace with neighboring countries and lacks competitiveness. Furthermore, it notes that banking sector risks have intensified due to the proliferation of BFIs amidst weak supervision. Maintaining macroeconomic stability and managing financial sector risks are the two most challenging tasks of the Nepalese economy. The IMF thinks that the exchange rate with India is overvalued and is hampering Nepal’s competitiveness.

The report report notes that “living standards in Nepal have improved markedly over the past decade thanks to increased remittances, supportive social programs, and generally prudent fiscal policy that almost halved public debt as a share of GDP”. Here is a previous assessment by the IMF.

Prospects for 2011/12

  • It expects the Nepalese economy to grow at 3.8 percent in 2011/12 (revised downward from preliminary estimate released in August), with good agriculture output compensating for subdued non-agriculture activity.
  • Inflation is expected to be 8 percent due to an expected moderation in India’s inflation and a stabilization of commodity prices.
  • The external current account deficit is projected to remain around 1 percent of GDP, but the import cover of foreign reserves is expected to decline.
  • The target to limit net domestic financing to 2 percent of GDP might not be achievable due to moderate economic activity and a significant increase of current spending.
  • Total revenue and grants are expected to be 18.3% of GDP, but expenditure is expected to be 21% of GDP.
  • Net domestic financing is expected to increase to 3.3% of GDP from 2.8% of GDP in 2010/11.
  • Money supply growth is expected to 11.1% from 9.5% in 2010/11.
  • Gross investment is expected to be 32.8% of GDP and gross savings is expected to be 32% of GDP.
  • Current account is expected to remain negative by around US$ 156 million. Trade deficit is expected to touch 24.4% of GDP. Exports growth is expected to be 9%, but imports growth are expected to be 10.8%.
  • With the expected reserves, Nepal is expected to fund imports of goods and services of 5 months only, down from 5.4 months in 2010/11 and 6 months in  2008/09.

Performance in 2010/11

  • Inflation has remained high, averaging about 9.5 percent in 2010/11.
  • The balance of payments was under pressure for most of the year due to high oil prices, slowing remittances, and weakening competitiveness, though it ended with a modest surplus.
  • The adoption of the budget by the Constituent Assembly was delayed by 7 months due to the political situation.
  • Revenue and spending underperformed the budget targets, net domestic financing exceeded its target, and large losses were incurred by the Nepal Oil Company. Reflecting these developments and heightened stress in the banking system, growth slowed to 3.5 percent from 4.5 percent the previous year.
  • Mixed progress was made in implementing policy commitments under the Rapid Credit Facility (RCF), approved in May 2010.
  • In the banking sector, asset quality has deteriorated and liquidity pressures increased following the bursting of a bubble in the real estate market, to which banks are significantly exposed.
  • In response, monetary policy eased and liquidity support was extended to institutions in stress, regulatory forbearance measures were implemented, and a widening of deposit insurance was announced. Restructuring of the weak state banks and reform of key bank legislation have been delayed.

Needed reforms

  • Address the substantial risks in the financial sector with utmost priority. The existing regulatory forbearance is unsustainable.
  • There is a need to strengthen supervision, regulatory environment, and banks’ corporate governance.
  • Improving the central bank’s emergency liquidity facilities. Develop an effective crisis management framework that would facilitate timely intervention and resolution of problem banks.
  • Strictly enforce the moratorium on new bank licenses.
  • Timely adoption of the 2011-12 budget with an appropriate target for net domestic financing.
  • Boost revenue by further strengthening administration and refocusing the tax structure toward domestic sources.
  • Phase out unproductive subsidies while safeguarding pro-poor spending.
  • Introduce an automatic fuel price adjustment mechanism to limit the losses of the Nepal Oil Corporation.
  • The exchange rate peg has served Nepal well and continues to be a near-term policy priority, and safeguarding it requires a firmer monetary policy stance and targeted rather than blanket liquidity provision for solvent banks facing short-term pressures.
  • The exchange rate appears overvalued, and stressed the importance of boosting productivity.
  • If sustained and significant downward exchange-rate pressure were to emerge, preservation of official reserves and an adjustment of the peg would need to be considered.

There are signs that the government will not and won’t be able to adhere to the recommendations of the IMF. Here are few examples:

  • The call for a moratorium on new bank licenses will not be adhered to as the government has pretty much made up its mind to upgrade Sanima Bank to commercial bank category from development bank category. The priority should have been consolidation of BFIs in all the four categories. The recent banking troubles can be attributed to the large number BFIs amidst weak supervision and limited playing field, among others. Read my earlier long pieces on the same issue here and here.
  • With the recent plan to integrate up to 6,500 Maoist combatants in the national army, provide rehabilitation package of Rs 0.6 million to Rs 0.9 million to a combatant depending on his rank, and cash incentive of half million to 800,000 million rupees to combatants opting out of integration as well as rehabilitation package, the government will need at least an additional Rs 10 billion on top of the amount allocated in the budget. It means the plan to stick net domestic borrowing to 2% of GDP (it was 2.8% of GDP in 2010/11) will be breached (also due to weak economic activities leading to low growth of revenue receipts and high growth of current expenditure). Donors have already signaled that they don’t have funds allocated for this new development.
  • The banking sector reforms are slow. There still is not a dedicated fund or facility (something like the Troubled BFIs Relief Package) to look after troubled BFIs. Things are done in ad hoc basis.
  • Keeping inflation below 10 percent will be a challenge because of the hike in transport prices; a potential hike in petroleum prices (India recently did it); high demand for diesel and petrol to run generators during the dry season when load-shedding could reach up to 16-19 hours a day, leading to high NOC losses plus increase in general prices as cost of production increase.
  • With plans to introduce Employment Guarantee Scheme and a number of other employment-focused programs, there will be pressure on finding funding sources, given higher growth of recurrent expenditures than revenue receipts. The employment guarantee scheme could cost as much as 1.29 percent of GDP (or 2.14 percent of budget).
  • The exchange rate won’t be changed even though it appears overvalued right now.
  • The trade deficit is expected to further worsen without the needed industrial reforms to boost competitiveness of Nepalese exported items.

Selected Economic Indicators (IMF estimate and projection)
  2008/09  2009/10 2010/11 (Est.) 2011/12 (Proj.)
Output and prices (annual percent change)
Real GDP 4.4 4.6 3.5 3.8
Non-agricultural GDP 4.1 5.4 3.1 2.9
CPI (period average) 12.6 9.6 9.5 8
CPI (end of period) 11.1 9 9.4 8.1
Fiscal Indicators (in percent of GDP)
Total revenue and grants 16.6 18 18.4 18.3
Expenditure 19.2 19 20.1 21
Expenses 16.4 16.1 16.8 17.7
Net acquisition of NFA 2.8 2.9 3.3 3.3
Net lending/borrowing -2.6 -1 -1.8 -2.7
Net acquisition of FA -0.4 -1 -1.2 -1.1
Net domestic financing 3 2 2.8 3.3
Money and credit (annual percent change)
Broad money 27.3 14.1 9.5 11.1
Domestic credit 27.1 16.8 13.2 15
Private sector credit 29 14.2 11.8 6.4
Velocity 1.6 1.6 1.7 1.7
Investment and saving (in percent of nominal GDP)
Gross investment 31.5 35.8 35 32.8
Private 24.6 28.6 27.1 24.8
Central government 6.9 7.2 7.9 8
Gross national saving 35.7 33.4 34.1 32
Balance of payments
Current account (in millions of U.S. dollars) 536 -378 -167 -156
In percent of GDP 4.2 -2.4 -0.9 -0.8
Trade Balance (in millions of U.S. dollars) -2,707 -4,078 -4,474 -4,975
In percent of GDP -21.1 -26 -24.4 -24.4
Exports value growth (percent change) 0.5 -6.1 13.9 9
Imports value growth (percent change) 14.1 36.4 10.4 10.8
Gross official reserves (in millions of U.S. dollars) 2,907 2,844 3,098 3,180
In months of imports of goods and services 6 5.4 5.4 5
Memorandum items
Public debt (percent of GDP) 39 36 34 35
GDP at market prices (in billions of Nepalese rupees) 988 1,171 1,327 1,487
GDP at market prices (in billions of U.S. dollars) 12.9 15.7 18.3 20.4
Exchange rate (Nrs/US$; period average) 76.9 74.5 72.4
Real effective exchange rate (eop, y/y percent change) 3.5 7.3