Monday, July 18, 2011

Evolution of economic development theory

Here is Justin Lin’s chart:

More on Lin’s New Structural Economics here.

Nepal’s FY 2011/12 budget: Finance Minister Adhikari’s disappointing budget

A review of the budget for FY 2011/12 presented by Finance Minister Bharat Mohan Adhikari to the parliament on July 16, 2011. Here is a summary of the budget.

Adhikari’s disappointing budget

Like last year, the drama during the presentation of the budget for fiscal year 2011/12 to the parliament by Finance Minister Bharat Mohan Adhikari was no less shameful and humiliating. Last year, the then Finance Minister Surendra Pandey’s was manhandled and his briefcase snatched and smashed by UCPN (Maoist) affiliated parliamentarians. This year the budget speech was delayed due to obstruction by the United Democratic Madhesi Front (UDMF), which argued that their demands were not incorporated in the budget. Meanwhile, Adhikari and his team leaked the budget to journalists and then later on in the website of Ministry of Finance before he even finished reading the full text. The budget speech brought to end the series of drama involving white paper and supplementary budget, and the furor created by cooperatives biased program and policies.

Instead of commenting on the various programs and handsome allocation for social sector and various marginalized communities and groups, I will focus on the macroeconomic challenges that the budget is addressing or should have addressed. It has largely failed to do so.

Budget allocation for FY 2011-2012 
Rs, billion Percent of total budget Percent increase from last FY
Total expenditure 384.9 100 13.91
Recurrent  266.61 69.27 40.09
Capital 72.61 18.86 -43.95
Financing (loan & share investment) 25.38 6.59
Principal repayment 20.3 5.27 10.21

Development expenditure

202.56 52.63 13.41

General administration expenditure

182.34 47.37 14.47
Total Income 317.83 82.57 12.71
Revenue 241.77 62.81 11.60
Principal refund 5.93 1.54
Foreign grants 70.13 18.22 7.33
Deficit 67.07 17.43 19.96
Deficit financing 67.07 17.43 19.96
Foreign loans 29.65 7.70 33.38
Domestic borrowing 37.41 9.72 11.07
 FY 2011-12 full annex

Let us start with some basic statistics. The mammoth expenditure plan is 14% higher than last year’s budget and 25.67% higher than the revised estimate. Of the total Rs 384.9 billion expenditure, recurrent expenditure accounts for 69.27%, capital expenditure 18.86%, financing (new addition to the budget’s expenditure heading) 6.59%, and principal repayment 5.27%.

The total income (earlier it used to be total revenue) to partially finance the expenditure is estimated to be Rs 317.83, which is 82.57% of total budget and 12.71% increase from last year. Of this income, revenue would account for 62.81% of total budget, principal refund 1.54% and foreign grants 18.22%.

This leaves a hole in the expenditure-income balance sheet of around Rs 67.07 billion, which is 17.43% of total budget and 19.96% increase over last year. This deficit is to be covered by foreign loans and domestic borrowing accounting for 7.70% and 9.72% of total expenditure respectively.

Based on expenditure allocation, education sector is top priority, followed by local development, and physical planning and works. While it has addressed some of the issues in the social sector, which is usually done in every budget, it has failed to address our pressing macroeconomic challenges: low growth rate, high inflation, balance of payments deficit, ballooning trade deficit, eroding competitiveness of our economy and its productive capacities, slump in manufacturing sector, and liquidity and banking crises. These should have been prioritized more than the obsession with cooperatives, which are seen as a panacea to all the problems in every sector or product. The budget should ideally focus on what gives us the biggest bang for buck to resolve the above mentioned economic challenges.

First, the size of the budget is ever-increasing without having much impact on the economy. Before increasing its size, we should analyze if last year’s budget targets were met. GDP growth rate was expected to be 4.5%, inflation 7% and BoP surplus of Rs 9 billion. None of these targets were achieved. In reality, GDP growth rate is expected to be 3.5%, inflation is still hovering around 10%, and BoP deficit is to be around Rs 12 billion. Without any concrete plan to resolve the thorny issues in non-agricultural sector, FM Adhikari expects growth rate to be 5%, inflation below 7% and balance of payments (BoP) to remain positive. There is no vision to realize these targets and by looking at the existing plans they won’t be realized. Worse, it might be even exacerbate them.

The sheer increase in the size of the budget without corresponding increase in capital expenditure and the increase in salary and allowance of civil servants by 30.39 - 42.86% will exert inflationary pressure on the already high and sticky price level. In fact, capital expenditure has been slashed by at least 24% (if you exclude financing, it would be around 44%) to accommodate for salary hike and various pet projects of the political parties. This will not add to productive capacity of the economy but fuel up prices, which will most probably be double-digit for the whole year.

Second, there are hardly any specific programs to promote exports, whose decline along with ballooning imports have widened trade deficit to unsustainable level. This is also contributing to BoP deficit. Apart from half-hearted revenue incentives such as tax breaks and promise to enact Industrial Enterprise Act in line with Special Economic Zone Act, which is yet to be tabled in the parliament despite completion of necessary homework, there isn’t much for the exports sector. It says that export promotion incentives will be based on Nepal Trade Integration Strategy (NTIS) recommendations, which are to be further recommended by the concerned ministry. In fact, the budget for ‘mainstreaming industry, trade and service sector’—one of the seven pillars of our economy as identified by the National Planning Commission— is allocated Rs 7.24 billion only. The budget is ignoring the dire need to revive exports and manufacturing sectors.

Third, instead focusing on the second point mentioned above, FM Adhikari has wrongly diagnosed the economic challenges and focused in promoting cooperatives in virtually all sector and products. Various grants, concessional loans, and custom incentives are given to cooperatives by arguing that they will not only help in employment generation and to make economy self-reliant, but also to increase exports and in import substitution. This policy to sideline the private sector and encourage cooperatives to encroach in its terrain with the help of distorted policy will further affect economic growth and the ailing industrial sector. In fact, several of the promises made to the private sector in last year’s budget remain unfulfilled.

Fourth, the budget is inconsistent with Three Year Plan 2011-2013, which aims to achieve 5-6 percent growth rate, lower absolute poverty to below 21 percent, generate 200,000 jobs, and encourage private sector to invest 64 percent of the needed investment of Rs 359.3 billion. Looking at the way private sector has been sidelined and its genuine demands unaddressed, the budget will neither help to attain the kind of investment needed to realize the goals of the interim plan nor will achieve growth rate above 5%. The budget simply is not in sync with previous medium term policies.

Fifth, the budget has relaxed cap in disclosing sources of income while purchasing vehicle, shares, real estate and housing. Similarly, NRNs and foreigners are allowed to invest in share market and housing sector. This will help to address liquidity crunch to some extent. However, by doing so it has postponed the inevitable, i.e. restructuring and consolidation of the BFIs. Furthermore, the incentive for merger in the form of waving of registration fees is not enough to consolidate the financial sector. Importantly, a real danger is that the increased domestic borrowing (Rs 37.41) to finance deficit might mop up the already scarce liquidity from the market. This might crowd out private investment and further intensify liquidity crunch.

Sixth, foreign aid (grants plus loans) accounts for almost 26% of total budget, an increase by 13.9% over last year’s budget. Since the government was unable to mobilize even last year’s target, increasing target for this year is not going to be fruitful. Importantly, this target has been raised even after conceding in the budget that foreign aid absorption capacity is eroding. Similarly, the higher revenue mobilization target is not going to be realized if the failure in doing so last year is any indicator. Revenue collection in FY 2010/11 is to fall short by almost Rs 10 billion of the targeted Rs 216.64 billion.

Overall, the budget lacks focus and vision, and is biased toward cooperatives. This is a listless budget with no tooth to make real impact on productive capacity and to address the most pressing macroeconomic challenges.

[Published in Republica, 2011-07-17, p.6]