Thursday, March 3, 2011

How will India’s fiscal budget affect Nepali economy?

The Indian Finance Minister Pranab Mukherjee presented to the Indian parliament a fiscal budget of around US$278.38 billion for the next fiscal yar (April 1, 2011- March 31, 2012). Since Nepal shares an open border with India and has also pegged its currency with Indian rupee, the fiscal policies (both expenditure and tax) of India affect the Nepali economy as well. Here is a list of issues officials at the finance ministry in Nepal will have to grapple with while rolling out next fiscal year’s budget (July 16, 2011-July 15, 2012).

  • Inflation in India (expected at 5%) will affect price levels in Nepal. The increase in purchasing power (indirectly) due to subsidies and indexing MGNREGA wages (IRs 100 in real terms) to consumer price index will not help to decrease prices of essential items; it will either maintain status quo or an increase in prices. In real terms, the Indian consumers would not lose that much. But, Nepali consumers will lose (both in real and nominal terms). Also, purchasing power of average families will increase by over IRs 2000 due to upping of personal income tax exemption (at IRS 180,000). The nominal increase in demand will further increase demand in the Indian market. If it affect general prices, then Nepal will also bear the brunt. But, if it increases real expenditure on sectors with idle resources (including travel and recreation), then Nepal might benefit.
  • The increase in services tax (hotel, airfares, branded products, etc. of 10 percent) might make Nepali destinations relatively cheaper. However, nothing concrete can be said on this regards as it all depends on relative (cost of production) prices on the sectors concerned between the two countries.
  • Indian farm and fertilizer subsides will affect Nepali agricultural prices as Nepal imports a lot of food products from India. Meanwhile, Nepal has agreed to eliminate Agricultural Reform Fee (ARF) for Indian agro-good, making Indian agro products further cheaper in the Nepali market. It might make some agro-products cheaper in the product market. But, it might also erode our agriculture production and employment (especially that of commercial ones).
  • The decision to impose higher tariff on gold will further widen gold price differential between Nepal and India. Nepal will have to increase tariff on gold to discourage gold smuggling to India and to not let balance of payments deficit further widen.
  • Similarly, prices of fuel have not been revised. So, some price differential on the two sides of the border is very likely, leading siphoning off of fuel from Nepal to India. It will not only affect domestic availability of fuel but also widen trade deficit as Nepal buys fuel at international prices from IOC and sells it in the domestic market at a little deflated price.

I will add more on later posts.

Trade and Labor Market Outcomes

This paper reviews a new framework for analyzing the interrelationship between inequality, unemployment, labor market frictions, and foreign trade. This framework emphasizes firm heterogeneity and search and matching frictions in labor markets. It implies that the opening of trade may raise inequality and unemployment, but always raises welfare. Unilateral reductions in labor market frictions increase a country's welfare, can raise or reduce its unemployment rate, yet always hurt the country's trade partner. Unemployment benefits can alleviate the distortions in a country's labor market in some cases but not in others, but they can never implement the constrained Pareto optimal allocation. We characterize the set of optimal policies, which require interventions in product and labor markets.

Full paper by Helpman, Itskhoki, and Redding (2011) here.