The state of cooperatives in Nepal

The financial sector in Nepal is still adjusting to the jolt it experienced after the decline in real estate and housing prices in mid-2011, triggered by slowdown in remittances growth as a result of global economic slowdown. Several corrective measures by NRB and MoF have been fairly successful in containing the situation for now. Note that the core structural, governance and operational problems of the BFIs remain the same. Minor adjustment is not the way to sustainable financial sector in Nepal. More here.

Anyway, beyond the developments in the BFIs, the activities of cooperatives have largely been ignored. Since the NRB is not mandated to supervise and monitor cooperatives, the Department of Cooperatives— which severely lacks technical capabilities and resources—is facing a hard time managing them. Bankers and government officials are worried that the risky deposit and lending activities of cooperatives might hit the whole financial sector hard.

A lot of information is still muddy due to the lack of clear and consistent data on the activities of cooperatives. Better understanding of the nexus between BFIs and cooperatives, lending activities, risk portfolios, state of NPLs, operational efficiency, viability and sustainability is urgently needed in order to not only avoid a potential financial turbulence, but also to ensure an improved access to finance, and inclusive growth and development.

The chart and table give an initial grasp of the state of cooperatives in Nepal. Nearly half of the cooperatives are Savings and Credit co-ops (whose share of total lending and deposits is 78.78% and 70.52% respectively). And, almost 20% of co-ops are in Kathmandu Valley. Most of their lending is in real estate and housing sectors and loans are usually given without satisfying internal due diligence process.

The table shows the financial state of cooperatives vis-a-vis the BFIs. Its amazing that cooperatives have larger deposit and lending volume than development banks and finance companies.

State of cooperatives and BFIs in FY2012
Financial institution	Deposit (Rs bn)	Lending (Rs bn)	Number
Cooperatives (2012)	139.54	134.03	26501
Bhaktapur	6.07	6.13	525
Lalitpur	13.52	13.25	929
Kathmandu	80.55	60.22	3578
BFIs (mid-July 2012)	1071.39	779.56	213
Commercial	867.99	612.32	32
Development	127.3	100.61	88
Finance	76.14	66.63	70
Microcredit	5.18	17.75	23

The proliferation of cooperatives (about one cooperative per 1000 people) and their lending concentration in sectors that might see drastic price adjustments (or is happening right now) could trigger a financial crisis within this loosely regulated semi-banking sector. Worse, the crisis might seep into the BFIs (Class A, B and C institutions) and eventually the real sector. Uncertain times ahead for the financial sector in Nepal!

Illicit financial outflows from Nepal 2001-2010

A latest report from Global Financial Integrity (GFI) has ranked Nepal 58 out of 143 countries in terms of average annual illicit financial flows— the cross-border movement of money that is illegally earned, transferred, or utilized— between 2001 and 2010. On an average, from Nepal, between 2001 and 2010 US$801 million was illegally earned, transferred, or utilized.

Furthermore, cumulative illicit outflows in hot money narrow plus and trade misinvoicing components were US$355 million and US$7.658 billion. In total, this makes US$8.013 billion total illicit outflows from Nepal. The largest illicit outlflows came from trade misinvoicing (export under-invoicing and import over-invoicing).

The figures are based on Hot Money Narrow Plus Trade Mispricing method (HMN+GER) non-normalized methodology. This methodology doesn’t include trade mispricing in services, same-invoice trade mispricing, hawala transactions, and dealings conducted in bulk cash. Last year’s report used a trade mispricing and external debt data and found that the total illicit financial outflows from Nepal over the period 2000-2009 was US$6.0 billion (cumulative outflows from 1990 to 2008 was estimated at US$9.1 billion). It uses the official balance of payments and trade data reported to the IMF by member countries and external debt data reported by those countries to the World Bank.

The GFI notes that illicit financial flows “generally involve the transfer of money earned through illegal activities such as corruption, transactions involving contraband goods, criminal activities, and efforts to shelter wealth from a country's tax authorities”.

Overall, crime, corruption, and tax evasion cost the developing world US$858.8 billion in 2010, just below the all-time high of US$871.3 billion set in 2008—the year preceding the global financial crisis. From 2001 to 2010, developing countries lost US$5.86 trillion to illicit outflows. 

In South Asia, India saw the largest illicit financial outflows, followed by Bangladesh, Nepal, Sri Lanka, Pakistan, Afghanistan, and Bhutan and Maldives. 

Total illicit financial outflows from South Asia (USD million)
HMN + GER	2007	2008	2009	2010
Afghanistan	0.00	0.00	41.24	110.19
Bangladesh	2737.35	848.42	648.94	2367.17
Bhutan	136.56	0.00	0.00	0.00
India	4922.82	26819.56	279.42	1613.34
Maldives	4.02	0.00	0.00	0.00
Nepal	584.15	883.29	1551.31	1883.95
Pakistan	505.17	727.80	298.14	729.00
Sri Lanka	165.16	0.00	0.00	880.65

The GFI has called for increasing transparency in the international financial system as a means to curtail the illicit flow of money. The ones related to Nepal include (i) reforming customs and trade protocols to detect and curtail trade mispricing, which is done to avoid duties or taxes; (ii) harmonizing predicate offenses under anti-money laundering laws across all Financial Action Task Force cooperating countries; (iii) ensuring that the anti-money laundering regulations already on the books are strongly enforced.

Nepal has the highest minimum wage in South Asia? - Part II

The blog post about changes in minimum wages in South Asia and the rapid rise in wages in Nepal, which meant that we might not have comparative advantage in labor cost, created quite an interest among readers. The wages (monthly minimum wage in US$) was for manufacturing sector only. In this blog post I am presenting further analysis, based on the latest ILO Global Wage Report 2012-13, using national level monthly minimum wage data. At the outset, note that labor productivity in Nepal appears to be decreasing (see this blog post for more).

The figure below shows that up until 2005, Nepal had the second lowest minimum wage (US$33.54 per month) in South Asia. In 2006, it increased by 35.21%, the highest increase than any other South Asian country,  to reach US$45.36 per month. As of 2011, Nepal has the highest minimum wage in South Asia (US$83.76 per month), followed by Pakistan (US$82.17 per month), India (US$ 64.07 per month), Sri Lanka (US$51.22 per month), and Bangladesh (US$40.46 per month)—and which partially explains the increasing manufacturing sector investment in Bangladesh (also dubbed as the next RMG sourcing hotspot by McKinsey).

Regarding the growth rate of minimum wages, Nepal had the largest average growth (2006-2011) both in dollar and local currency terms. Bangladesh and Sri Lanka are taken out of the picture because of lack of full data for the period mentioned above. The average monthly minimum wage (2006-2011) in Nepal increased by 17.77% in dollars and by 18.67% in local currency. For comparative purpose, I have used official exchange rate (local currency unit per US$, period average) to convert local currency wages into US$. The currency movement makes a difference in sales and profits, which will then, to some extent, influence investment or expansion decisions (depreciation along with strong domestic and overseas demand is normally good). Here the minimum wage for Bangladesh corresponds to that of garment sector; overall private sector for India, Nepal and Pakistan; and manufacturing sector for Sri Lanka. All minimum wage data refer to that of unskilled workers in non-agriculture enterprises.

With regard to real wage (in local currency), on average between 2006 and 2011, Nepal had the highest  growth rate (of 5.3%), followed by Bangladesh 3.1% and Pakistan, 2.1% (India and Sri Lanka had negative real wage growth).

Furthermore, the nominal mean daily wage has increased by 127% and 98% in agriculture and non-agriculture sectors, respectively, between 2003/04 and 2010/11 (i.e., between the two household surveys).

Well, in one of the aspects crucial for new investment or expansion of existing investment, Nepal is already at the losing end [Note that, higher wages are not bad in itself as long as they are matched by rise in productivity]. It is further amplified by long hours of power cuts, political instability, excessive labor unionism, low productivity, infrastructural bottlenecks (inadequate and uneven supply of roads, water supply, etc.) and policy unpredictability as well as paralysis.  Against this backdrop, enticing investment in manufacturing sector is a daunting challenge.

Due to high focus on energy and transport (the above listed investment hiccups are less persistent in these sectors) and attractive incentives, foreign investors have planned for sizable investments in key sectors. However, these won’t immediately boost employment and spur economic activities, except for construction sector workers and construction materials produced domestically, throughout the 15 sectors that make up the GDP. With the relaxation of the most binding constraint, i.e. energy shortage, almost all sectors are expected to experience better economic activities. Until then the challenge is to entice investments in other sectors as well. For this the resolvable constraints have to be resolved with decisive political will (like labor issues, skills upgradation, targeted application of import tariffs—eg. agriculture inputs are taxed more than final product) in order to boost efficiency and productivity. The pressing needs are to achieve higher economic growth, generate enough employment opportunities and institutionalize inclusive growth and development activities without negatively impacting efficiency, competitiveness and productivity.

How globally connected is Nepal?

A report released last month, DHL Global Connectedness Index (GCI) 2012, ranks Nepal 133 out of 140 countries, the same as last year’s ranking, in terms of global connectedness or globalization. Nepal has the lowest ranking in South Asia region. In South Asia, India is steadily improving connectedness, ranking 62 out of 140 countries, followed by Sri Lanka (rank 75), Bangladesh (rank 91)and Pakistan (rank 102).

The report notes that Nepal has higher breadth (98th) than depth (137th). Among Nepal’s component level depth ranks, its highest is on outbound international students (41st) and its lowest is on merchandise exports (140th). Over half of Nepal’s merchandise exports goes to India and has a trade pillar ranking of 136 out of 140 countries (also read the changing narrative of the state of Nepal’s globalization).

Depth measures how much of a country’s activities or flows are international versus domestic by comparing the size  of its international flows with relevant measures of its domestic economy (usually as a share of GDP). Breadth complements depth by looking at how broadly the international component of a given type of activity is distributed across countries (usually diversification of sources for the scores in the pillars).

They are based on scores in four pillars, namely trade, capital, information and people. The depth dimension provides Nepal’s outward and inward depth scores and ranks at the component and pillar levels. Using the same pillars as in depth, the breadth dimension considers the intra-regional share of each Nepal’s flows. The components of trade are merchandise trade (% of GDP), services trade (% of GDP); capital components are FDI stock (% of GDP), FDI flows (% of GFCF), portfolio equity stock (% of GDP) and portfolio equity flows (% of GDP); information components are speed of internet bandwidth, cost of international phone calls, cost of printed publications trade; and people components are migration (% of population), tourists departure and arrival per capita, international students.

The Netherlands retained its 2010 position as the world’s most connected country. Of the top ten most connected countries in 2011, nine of them are located in Europe, which is the world’s most connected region. Meanwhile, Sub-Saharan Africa is the least connected region today, but Sub-Saharan African countries averaged the largest increases in connectedness over the past year, with their gains driven primarily by the trade pillar.

GCI measures the depth and breadth of countries’ trade, capital,  information, and people flows. Twelve distinct components  of connectedness are incorporated across those four pillars. Overall, richer countries tend to have deeper and broader global connections than poorer countries. Smaller countries tend to lead on depth while larger countries tend to lead on breadth.

In the latest Global Information Technology Report 2012 as well Nepal ranked poorly at 128 out of 142 countries in terms of network readiness. Insufficient development of ICT infrastructure has limited its ability to leverage information and communications technologies to boost country competitiveness. It has stifled entrepreneurship and innovation.

The state of energy security and access in Nepal

We often hear that Nepal has a huge potential (and possibly comparative advantage) in hydropower generation. So far this has been a trigger-happy statement that makes political leaders and bureaucrats smug about what Nepal has in store to usher the economy on a high growth path, and competitive production and manufacturing bases. Unfortunately, in reality, the country reels under increasing power cuts, sometimes reaching as high as 18 hours a day, during dry season. Amidst the increasing politicization of hydropower sector, weak institutions, and pockets of hostility toward investment originating from certain countries at a time when there is inadequate finance available to realize even a medium sized project, the competitiveness of economy is eroding and exports are declining, leading to a situation where high remittance inflows are providing a lifeline support to the economy.

As of now, what is the state of energy security and access in Nepal, which has electrification rate of about 61.2%, the second lowest in South Asia region? It has the lowest electric power consumption in the region (91 per capita kWh).  The latest Global Energy Architecture Performance Index (EAPI) 2013 ranks Nepal 101 out of 105 countries in EAPI, which is composed of three sub-indices, namely economic growth and development (rank: 89— measured through the energy intensity, cost of energy imports, share of mineral products in export, and a combination of GDP per capita and HDI); environment sustainability (rank:13— measured through the carbon intensity of energy use, share of non-carbon energy sources in the energy mix, levels of outdoor air pollution, and water scarcity); and energy access and security (rank: 103— measured through import dependence, diversity of supply, quality of electricity supply, and access to modern forms of energy). In short, it shows that the state of energy security and access is pathetic in Nepal. It further reinforces the argument that Nepal needs to urgently ramp up investments in energy generation (largely hydropower) to achieve faster and inclusive economic growth and a competitive economic base.

The top ranked nations are Norway, Sweden, France, Switzerland and New Zealand. From South Asia, India is ranked at 62, Sri Lanka 69, Pakistan 88, and Nepal 101. The energy architecture is defined as “the integrated physical system of energy sources, carriers and demand sectors shaped by business, government and civil society”.

The four mutually supportive pillars required for greater energy security and access are:

• Policy initiatives, especially clear rules, price signals and risk-return incentives
• Technology and infrastructure to address specific challenges in the value chain
• Market structures that enables producers to meet consumers’ needs efficiently
• Human capital to constantly innovate and stay competitive

These are necessary to generate economic growth and development in an environmentally sustainable way while providing energy access and security for all.

Confidence on the Indian rupee in Nepal

There is an interesting story in yesterday's Republica (“Nepali village using Indian currency only”, p.10) about the use of Indian currency for daily transaction purpose in Sonvarsa VDC of Siraha district. Sonvarsha is located 6 km from Laukaha market in India.

Below is an excerpt from the article:

---

“We accent IC only from our customers. It might be surprising for people of other places but it’s a common practice here,”  Ram Datta Yadav, a vegetable vendor at a local fair, said. he further said that other traders are also using IC in local markets.

Ram Udgar Yadav, a local customer also said local people use IC to purchase goods as they trust Indian currency more than Nepali banknotes. “Even if we wish to exchange Nepali rupees, we have a compulsion to pay high exchange rate,” he said.

Nabin Yadav of Bharanwarajpur of Siraha also said that all the transactions from real estate to household goods takes place through Indian currency. “Traders also expect IC from the buyers and buyers also find it more convenient to make purchases in IC,”added he.

---

This short article provides a sense of the increasing confidence on the Indian currency in the border towns in Nepal. Recently, there was a shortage of Indian currency in the exchange market and the banks are pretty strict in giving Indian rupee. The central bank had imposed a cap on daily IC withdrawal from ATMs in India. Indian currency of less than or equal to IRs 100 can be freely used in Nepal for daily transaction purpose. Also, people having bank accounts in Nepal can easily withdraw Indian rupee from ATMs in India.

The increasing confidence on the Indian rupee in turn reflects the declining confidence on the Nepali rupee. Nepali rupee is pegged to Indian rupee at IRs 1= NRs 1.60 since 1993. In real terms (adjusted for inflation in both countries), the exchange rate with India is appreciating, eroding the competitiveness of Nepali goods and services (see the figure below). In its 2012 Article IV consultation, the IMF also argued that there has been an overvaluation (REER) of Nepali rupee against Indian rupee. Over 50% of exports and imports goes to and comes from India (informal trade is also pretty high). India provides the only exit point for third country trade. India is the sole supplier of petroleum fuel and LPG to Nepal. Nepal has a huge trade deficit with India. Importantly, there is free flow of goods and labor between the two countries. More on this topic here.

While the Indian economy is surging ahead, the Nepali economy is struggling to achieve even 5% growth rate. The pegged currency provides a cushion for Nepali economy in terms of its ability to combat inflation and maintain some form of macroeconomic stability. The high inflation in Nepal, lingering political uncertainty, unresolved infrastructural as well as structural constraints, receding absorption capacity along with low capital expenditure, unfavorable industrial relations and gloomy growth prospects have induced people to hold stronger currency instead of a struggling one. Hence, the tendency to hold Indian rupee and do transaction with it is not surprising. People perceive that Nepali currency might further lose value in real terms in the coming days. In fact, despite official exchange rate remaining constant since 1993, the ground reality in the border towns is that traders and retailers transact IRs 100 with NRs 163 (even NRs 165).

So far the central bank has been able to maintain supply of Indian rupee more or less to the required amount (discount the occasional spikes in demand for IRs created by currency speculators informally) by even selling over US$1 billion of reserves to purchase IRs. As long as remittances continue to increase and forex reserve keeps rising, there won’t be much issue as imports will get easily financed. If something goes wrong in this process (say decline in reserves), then the economy will be in trouble.

The solution would be to restore confidence on the Nepali rupee. For this to happen, growth prospects should be good; manufacturing output and exports have to increase; more investment has to come into sectors that have the capacity to relax critical binding constraints; interest rates have to be generally higher than in India; industrial and investment climate have to be good; and inflation has to be controlled to the extent possible by tackling the resolvable supply-side constraints. 

Average annual growth rate, 1992/93-2009/10
	Nepal	India
Real GDP	4.39	7.03
Agriculture	3.14	3.03
Industry	4.13	7.30
Services	5.26	8.61
Exports	9.50	14.05
to India	22.27
Imports	15.24	14.35
from India	18.31
Inflation	6.90	7.10
Nepal's trade with India (Rs billion)
	1992/93	2009/10
Exports	1.62	39.99
Imports	12.54	217.11
Trade deficit	10.92	177.12
Exchange rate (NRs/IRs)
Nominal	1.6	1.6
Real	1.36	1.92

Article IV Consultation 2012: Assessment of the Nepali economy by the IMF

In this year’s Article IV Consultation, the IMF has warned that the political uncertainty is complicating macroeconomic management in Nepal. The usual narrative about economic growth, expenditure concerns, and greater reliance on remittances for financing consumption and imports holds.

The IMF projects real GDP growth to decline to 3.8% in FY2013, thanks to unfavorable monsoon which affected agriculture production, slower services activity due to a potential decline in remittance growth, and a slowdown in growth in India (lower export demand, weaker inward investment, and possibly less remittances). The IMF’s latest growth projection exactly matches the ADB’s latest projection in ADO Update. But, while ADB projected inflation to be at 8.5%, the IMF projects it to be 8.3%.

Some notable observations and suggestions include:

• Quasi-fiscal liabilities continued to rise through financial losses at the Nepal Electricity Authority and Nepal Oil Corporation. Build political consensus to adopt an automatic price adjustment mechanism while putting in place well-targeted subsidies to protect the vulnerable.
• Significant restructuring of the financial system has yet to emerge, and balance sheet risks from concentrated exposure to a moribund real estate market are high.
• Focus on sound policies and structural reforms should be maintained. In 2011, the IMF suggested to enact structural reforms to raise productivity and potential growth.
• Enact a full budget and strengthen public management to ensure full executive of capital budget.
• Enhance revenue mobilization efforts but saw work on further tax and customs administration reforms.
• Targeted and well sequenced acceleration of financial sector reforms, including the amendment of NRB Act to improve the governance of the financial sector.
• A tightening of monetary policy may be used to signal commitment to price stability and support exchange rate peg.
• Open market operations and regular auction of T-bills good to mop up excess liquidity.
• Enhance the business environment, remove infrastructure bottlenecks, increase transparency, and improve governance.

The projection of major macroeconomic indicators for FY2013 are shown in the table below.

Indicator	2009/10	2010/11	2011/12e	2012/13f
Real GDP growth	4.8	3.9	4.6	3.8
CPI (period average)	9.5	9.6	8.3	8.3
Total revenue and grants (% GDP)	18	17.7	18.3	18.1
Expenditure (% GDP)	18.8	18.6	18.2	18.6
Broad money (%change)	14.1	12.3	22.7	12.5
Domestic credit (%change)	16.8	14.6	8	14.4
Private sector credit (%change)	14.2	13.9	11.3	13
Gross investment (%GDP)	37.1	32.5	32.8	32.9
Private investment (%GDP)	30	25.3	25.7	26
Central government (%GDP)	7.1	7.3	7.1	6.9
Gross national saving (%GDP)	34.7	31.6	37.5	33.5
Current account (%GDP)	-2.4	-1	4.7	0.6
Trade balance (%GDP)	-25.6	-23.6	-23.7	-27.3
Gross official reserves (US$ million)	2,844	3,085	4,307	4,595
Public debt (%GDP)	35.4	33.3	33.3	31.3
GDP at market prices (Rs billion)	1,193	1,368	1,557	1,750
GDP at market prices (US$ billion)	16	19	19.4	20.3

Here is the IMF’s preliminary assessment released on September. The assessment in 2011 is here.

Does debt relief to indebted farmers boost investment and productivity?

According to a new WB policy research working paper by Martin Kanz, the debt relief to indebted farmers (given by the Indian government) didn’t increase investment and productivity. In June 2008, the Indian government waived debt owed by poor farmers (US$14.4 billion = 1.6% of GDP) to commercial and cooperative banks between 1997 and 2007. The small and marginal farmers owning less than two hectares of land got 100% debt waiver and farmers owning over two hectares got 35% debt relief if the remaining 75% was settled (in drought-affected districts, 25% or Rs 20,000 relief, whichever is greater, if the remainder is settled).

The three major findings of the study that should be considered while unveiling similar programs in the coming days are:

• Debt relief failed to reintegrate recipient households into formal lending relationships. Kanz found that the households that had all of their debt cancelled borrowed, on average, 6 percentage points less from formal sector sources than households in the control group.
• Debt relief doesn’t increase investment or productivity of beneficiary households. The productivity of debt relief households after end of the program declined in absolute terms and lagged up to 14 percentage points behind the productivity of households in the control group.
• Debt relief strongly affects the expectations of households regarding the reputational consequences, i.e. they get singled out in the market and might face borrowing constraints in the future. It might lead to decline in investment (risk profile of debt relief households goes up).

Below is the abstract from the paper:

---

This paper studies the impact of a large debt relief program, intended to attenuate investment constraints among highly-indebted households in rural India. It isolates the causal effect of bankruptcy-like debt relief settlements using a natural experiment arising from India's Debt Relief Program for Small and Marginal Farmers -- one of the largest debt relief initiatives in history. The analysis shows that debt relief has a persistent effect on the level of household debt, but does not increase investment and productivity as predicted by theories of debt overhang. Instead, the anticipation of future credit constraints leads to a greater reliance on informal financing, lower investment and a decline in productivity among bailout recipients. The results suggest that one-time settlements may be insufficient to incentivize new investment, but can have significant real effects through their impact on borrower expectations.

---

Repeated bail out of indebted households could induce moral hazard and deteriorate rural credit markets (plus investments).These debt reliefs are usually politically motivated and serve to boost popular rating and perception while impacting budget balance. Here, I am not saying that there shouldn’t be debt relief at all of heavily indebted farmers. The issue is that if such reliefs are to be repeated or voters expect one from their elected representatives, then it might promote a dangerous trend where households keep on piling up debt beyond their means on expectations that one day it will be waived by a populist leader. Debt relief of indebted farmers has to be highly targeted and it shouldn’t have any whiff of popularity.

In 2008, the then finance minister of Nepal also introduced debt relief (following the Indian example) of poor and indebted farmers. Even though the money is already spent (via the state-backed BFIs), the effectiveness of this one-off intervention is yet to be evaluated.

Nepal was the sixth highest receiver of remittances (% of GDP) in 2011

Migrant workers’ remittances have been the lifeline of Nepali economy. The ballooning trade deficit, high level of consumption, and still high real estate and housing prices, are largely financed by remittances, which is estimated to be about US$5.12 billion in 2012, up from US$4.22 billion in 2011. The figure for 2011 is 22.3% of GDP, which makes Nepal the sixth highest receive of workers’ remittances, as a share of GDP, in the world (last year as well it as the same). The increasing remittances have been crucial in maintaining overall current account and balance of payments surplus (except for in 2010 and 2011 for CAB and 2010 for BoP). More on the costs and benefits of remittances here and here.

The latest remittances update by Ratha, Aga and Silwal notes that worldwide remittances, including those to high-income countries, are expected to total US$534 billion in 2012, and projected to grow to US$685 billion in 2015. They forecast remittances to developing countries to grow at an estimated 7.9% in 2013, 10.1% in 2014 and 10.7% in 2015 to reach US$534 billion in 2015. Developing countries are expected to receive US$406 billion in remittances in 2012. In terms of absolute flows, India is estimated to receive the highest remittances (about US$70 billion), followed by China (US$66 billion), the Philippines (US$24 billion), Mexico (US$24 billion), Nigeria (US$21 billion), Egypt (US$18 billion), Pakistan (US$14 billion), Bangladesh (US$14 billion), Vietnam (US$9 billion) and Lebanon (US$7 billion). The overall estimated growth of remittances for 2012 is slight lower than earlier forecast, reflecting the weak economic projections in Europe, the GCC countries, Russia and the US.

It is just formal flows. The real flows, including those from informal channels, is expected to be even higher. The size of remittance flows to developing countries is almost three times the ODA. In Nepal’s case, it is five times the ODA. By the way, the total remittance outflows in 2012 from Nepal is estimated at US$39 million, up from US$32 million in 2011.

The strong economic activities in the Gulf helped boost remittance inflows to Nepal, and South Asia and MENA regions. Additionally, the depreciation of local currency against the major foreign currencies also encouraged migrants to remit more money home (the “sale effect”). South Asia is estimated to receive US$109 billion in migrant workers’ remittances in 2012 and is forecast to receive US$144 billion in 2015 (see the table).

Migrant remittance Inflows (US$ million)						Remittances as a share of GDP, 2011 (%)
Country	2008	2009	2010	2011	2012e	0.0%
Bangladesh	8,941	10,521	10,850	12,068	13,736	10.9%
Bhutan	4	5	8	10	10	0.6%
India	49,977	49,468	54,035	63,011	69,797	3.4%
Maldives	6	5	3	3	3	0.1%
Nepal	2,727	2,986	3,469	4,217	5,115	22.3%
Pakistan	7,039	8,717	9,690	12,263	13,933	5.8%
Sri Lanka	2,947	3,363	4,155	5,193	6,312	7.4%

India to launch nationwide direct cash transfer scheme

After the hugely popular MGNREGA, which guarantees 100 days of employment per year to an adult member of  a below poverty line (BPL) household at a stipulated wage rate (equal to wage of manual agriculture worker), launched in 2006, the UPA government is launching another social protection program of a similarly massive scale: direct cash transfer of Rs 32,000 per family per year. This amount is almost three times the average annual earning of a BPL household.

The cash transfer will replace subsidies for kerosene, LPG, pension payments as well as wages from job guarantee schemes. Anyone familiar with the burden of subsidies and social protection payments in the developing world will realize how big and far-reaching the new reform initiative is going to be.

The welfare program is big on all counts: expected big multiplier impact as a result of cash transfers directly to poor household’s account, big central and state governments spending bill, big administration to implement the program, and big political step ahead of the election in 2014. Compared to MGNREGA, the new program is much, much more bigger (annually IRs 40,000 crore for MGNREGA against Rs 400,000 crore for cash transfers). The Indian government says that the cash transfer scheme will be "fiscally neutral" since existing indirect subsidies is to be replaced by direct cash transfers. Sounds incredible. Lets see how close they can get to the target of fiscal neutrality (India’s fiscal deficit is increasing and is a cause for concern for the MoF and the markets).

The program is to be launched on 1 January 2013 and expected to be completed by April 2014. The basis for cash transfer to BPL households is the Aadhar, which provides unique identification number to each resident and will enable them to, among others, open bank accounts where the government will directly transfer cash-- cutting middlemen, administration hassles and leakages.

Below is an infographic from The Times of India:

The upcoming challenge would be to ensure that the money is spent by BPL households to uplift their living standards or to move to a higher productive and efficient consumption and productive activities. Else spending the transferred money (usually by male head of household) in something that is not related to activities that contribute to enhancing welfare of the BPL household members is going to result in less than desired outcome from the massive social welfare intervention.

Impact of a 4 degree hotter world

In its new report (Turn Down the Heat: Why a 4°C Warmer World Must be Avoided), the World Bank has warned of “a cascade of cataclysmic changes that include extreme heat-waves, declining global food stocks and a sea-level rise affecting hundreds of millions of people” if the global community fails to act on climate change, which might heat up Earth by 4 degree Celsius (4°C)— above pre-industrial levels—by end of this century. It says that the current greenhouse gas emissions pledges are insufficient to bring down projected temperature rise.

An interesting part of such studies is the key findings, which seeps into the policy document of development agencies, I/NGOs and governments. Anyway, here are some of the key findings:

• Global temperature is now 0.8°C above preindustrial levels. It could cross 4°C by the end of the century in the absence of collective efforts by global community.
• Extreme heat waves will be experienced during almost all summer months in many regions. Increase of 6°C or more would be expected in the Mediterranean, North Africa, Middle East and parts of the US.
• Likely rise in sea level by 0.5 to 1 meter by 2100. Many small islands may not be able to sustain their populations.
• Most vulnerable regions are in the tropics, sub-tropics and towards the poles.
• Agriculture, water resources, human health, biodiversity and ecosystem services are likely to be severely impacted.
• CO2 concentration has increased from 278 ppm in preindustrial time to 391 ppm in September 2012 with rate of rise now at 1.8 ppm per year.
• Emissions of CO2 are at 35000 million metric tons per year and projected to rise to 41000 million metric tons per year in 2020.
• Over the last decade the average rate of sea-level rise has increased to about 3.2 cm per decade. With this rate, it could be over 30 cm of additional sea-level rise in the 21st century. Limiting temperature to 2°C would likely reduce sea-level rise by about 20 cm by 2100 compared to a 4°C world.
• Record minimum Arctic sea ice in September 2012, halving the area of ice covering the Arctic Ocean in summers over the last 30 years.
• The heat wave of 2010 in Russia claimed 55000 lives. It also resulted in 25% crop failure, burned areas at more than 1 million hectares and cost US$15 billion. With 4°C rise in mean temperature, such heat waves are likely to be a normal feature.
• The 202 drought in the US impacted about 80% of agricultural land, making it the most severe drought since the 1950s.
• Substantial increases in stunting due to malnutrition are projected to occur with warming of 2°C to 2.5°C, especially in Sub-Saharan Africa and South Asia, and this is likely to get worse at 4°C.

Earlier, there were studies that looked at the impact of climate change on growth and trade. By analyzing the historical fluctuation in temperature in 125 countries between 1950 and 2003, Dell, Jones and Olken (ungated version here) found that it does not have significant economic impact in rich countries, but in poor countries one standard deviation increase in mean annual temperature reduces economic growth by 0.69 percentage points. It impacts agriculture and industrial outputs, political stability, and leadership transitions.  In a research note, Canuto and Onder discuss three ways through with trade intensity affects emissions.

1. Increased trade means increased production, which means increased emissions—scale effect
2. Greater specialization on production and export of goods might lower or increase emissions depending on the production structure, i.e. if it is polluting or non-polluting economic activity (think of coal and hydroelectricity respectively)— composition effect
3. Technology transfer might promote ‘cleaner’ ways to produce goods— technique effect

Additionally, a recent analysis of land-surface temperature by Berkeley Earth shows that the rise in average world land temperature is approximately 1.5°C in the past 250 years, and about 0.9°C in the past 50 years. Importantly, it shows that humans are responsible for the increase in temperature especially in the last 50 years.

Policy challenges facing low income countries due to re-emerging vulnerabilities

In its latest brief, the IMF argues that at present the low income countries (LICs) have limited fiscal space and larger current account deficits than prior to the crisis. The lower macroeconomic policy buffers and additional risk factors would mean that LICs are more vulnerable to both internal (additional financing needs due to natural disasters) and external shocks (Euro zone shock, oil and food price shocks).

---

Under a euro-centered growth shock, the median LIC would suffer a significant loss in output, fiscal balances would worsen, and more than half of all LICs would see reserve coverage fall below three months of imports. External financing needs would also rise. Given donors’ fiscal constraints, aid is unlikely to come to the rescue as it did in 2009. Countries would either have to take on more nonconcessional debt, deplete reserves, or make pro-cyclical policy adjustment. The IMF would also likely be called upon to provide additional financial assistance.

The effects of a protracted global growth slowdown would be less severe in the short run. However, due to permanent output losses that accumulate over time, the effect would be substantial in the medium term. Absent adjustment, additional external financing needs would mushroom: since this is unsustainable, almost all LICs would need to adjust to some degree depending on prevailing cyclical conditions, supported by Fund financing. Policymakers would have to balance their adjustment decisions with the need to support or maintain growth and preserve priority spending.

---

The IMF argues that a spike in global food prices would have less severe effects on fiscal and external gaps than the other shocks, it would have larger impact on inflation and poverty due to the high weight of food in consumer baskets. Meantime, a spike in global oil prices would create additional financing needs for LICs comparable to the euro-centered growth shock.

NEPAL: With GDP growth rate estimated at 3.6% (lower than in FY2012), inflation 8%, international reserves (in months on next year imports) 6.5 months, fiscal balance –0.8% of GDP, positive current account, and gross public debt at 27.4% of GDP, Nepal fares much better than other LICs in FY2013 in terms of macro and external sector stability. However, there are downside risks from low agriculture output, high oil and fuel prices, and weak demand from developed countries.

The impact of labor income on poverty

How much does changes in labor earnings influence poverty (by income source)? A recent study by Inchauste et al. (2012) shows that change in labor income was the largest contributor to poverty reduction in 16 countries. Specifically, labor income accounted for more than half of the change in poverty in 10 countries and over 40% in another four countries.

Now, why has labor income increased? The reasons could be more working people, higher earnings per workers, changes in occupation structure or sectoral composition of employment, and improved human capital (education, skills and experience) among others. The authors focus on Bangladesh, Peru and Thailand to find out the answer. Their analysis shows that the largest contributor was labor-market related factors such as returns to land and experience in Bangladesh, returns to land in Peru, and returns to education and experience in Thailand. In other words, it is the increase in real earnings and higher productivity. 

Furthermore, the study shows that a declining dependency rate accounted for over a fifth of the reduction in poverty in 10 countries (more impact in Paraguay and Costa Rica) and transfers and other non-earned incomes account for over a quarter of the reduction in poverty in 9 countries. The authors looked into the major factors that impact poverty: growth rate, redistribution, demographics, growth in labor income and growth in non-labor income. It doesn’t account for the impact of increase in access to and quality of public services that are not part of household income.

The non-labor incomes (as a result of targeted social protection programs) were relatively more important in accounting for changes in extreme poverty (US$2.5 a day) in Argentina, Brazil, Chile, Costa Rica, Ecuador, Romania and Thailand.

Interestingly, the study shows that, in Nepal, employment and earnings, followed by non-labor income (public transfers and remittances) and declining dependency rate, had the largest impact on poverty. In contrast to this finding, an analysis of poverty in Nepal between the same time period (1995/96 and 2003/04—first and second living standards surveys) done in 2006 by the World Bank showed that the increase in remittances contributed between one-third to one-half of overall reduction in headcount poverty rate (from 42 percent to 31 percent). There has been a drastic change in household consumption and income profile in Nepal since 2004. While 23.4% of households received remittances in 1996 and 31.9% of households in 2004, it increased to 55.8% in 2011.

Between 2004 and 2011, overall remittance income increased from Rs 46 billion to Rs 259 billion (in 2011, internal remittances were Rs 51 billion and external remittance were Rs 208 billion). Per capita remittances increased from Rs 2100 to Rs 9245 over the same period. The impact of transfers (remittances) has been much more higher in reducing poverty between 2004 and 2011 than between 1996 and 2004 (note that it is in terms of consumption, not income). Remittances have tremendously boosted consumption expenditure of poor households. More on the impact of remittances on Nepali economy here.

The table below gives a snapshot of poverty, remittances and labor income in Nepal between 1995/96 and 2010/11.

Key findings of Nepal Living Standards Surveys
	NLSS I	NLSS II	NLSS III
Survey year	1995/96	2003/04	2010/11
Absolute poverty (% of population)	41.8	30.8	25.16*
Gini coefficient	32.2	41.4	32.94
Remittances
Percentage of household receiving remittances	23.4	31.9	55.8
Total amount received (Rs billion)	13	46	259
From within Nepal	6	11	51
From outside Nepal	7	35	208
Share of total amount of remittances received by household
From within Nepal	44.7	23.5	19.6
From India	32.9	23.2	11.3
From other countries	22.4	53.3	69.1
Wage employment
Share of agriculture sector in wage employment	53	37	35
Share of non-agriculture sector in wage employment	47	63	65
Mean daily wage (Rs)
Agriculture	40	75	170
Non-agriculture	74	133	263

Enhancing efficacy of government in new times

Recognizing the crucial role governments play in supporting the economy (especially during times of crisis) and providing foundations for private sector dynamism, McKinsey & Company has started the McKinsey Center for Government (MCG). Along with it came the first publication titled ‘Government Designed for New Times’, which contains discussion on the role of government in the coming days, ways to boost efficiency and induce effective execution of key decisions.

Below is a summary of some of the contributor’s views on the role of government and ways to enhance its efficacy. [The Nepali government can learn a lot from international best practices in making government productive and government services effective and efficient.]

---

Five lessons learnt by Tony Blair, former prime minister of Great Britain and Northern Ireland, in leading government transformation:

• Governance (particularly government effectiveness or capacity in government to get things done) should be at the heart of political debate.
• Aim for systemic change, not incremental change to allow government to keep pace in a rapidly changing world (emerging new economic powers; new technologies in communications, energy and medicine; climate change; financial crisis).
• Right conceptual analysis leads to best systemic change and delivery as the best policy comes from a clear, rigorous intellectual approach.
• The people that enact policy and the ones that gets appointed to key posts matter. Management skills are better in private sector. It is better for public sector employees to spend some years in private sector and then come back to public sector.
• Governments around the world can learn from each other.

---

Michael Fullan, special adviser to the premier and minister of education in Ontario, offers four directional advise to improve all systems in reasonably short period of time:

• Accountability dilemma (building accountability within the system rather than relying on external control)
• Policy-overload dilemma (don’t develop plans that are too complex, too vague, and contain too many priorities; be focused)
• Capacity-building dilemma (development of individual and group efficacy, especially in skills, resources and motivation)
• Sustainability dilemma (accountability, policy focus and capacity building might lead to sustainability)

---

Diana Farrell, co-founder of McKinsey Center for Government, discusses how governments can do more and better with less (in short, tap into the mission-driven mind-set of public sector employees).

• Design and execute multiyear reforms that goes beyond mundane initiatives designed to improve management capability. Aim for big reforms and make big (not incremental) shifts in amount of time, energy and resources required. E.g. expenditure and revenue plans, employment plans, etc)
• Invest in capabilities needed for success, especially employing best practices in technology and operations, organization and human resources, and budgeting and finance. E.g. vocational education, updated data, implement the latest proven project management techniques)

NEPAL: Proejcted agriculture production in FY 2012/13

The shortage of fertilizers and low and late monsoon during peak paddy planting season are expected to lower economic growth rate (unless industrial and services sector pick up rapidly, which seems negative as of now). So, how much is the expected decline in agriculture production in 2012/13?

Prabhakar Ghimire reports (his blog here) that the Ministry of Agriculture and Development estimates food production to decline by 563,000 MT.

• Paddy production to fall by 14.2%. Total paddy output is expected to drop by 720,000 tons this year compared to 5.07 million tons recorded last year. Plantation was done in just 91% of total paddy land. Dhanusha and Siraha, key paddy producing districts, reported plantation in just 49 percent and 50 percent of paddy land
• Maize production to fall by 10%. Total maize production is expected to drop by around 164,000 tons.
• Demand for cereals could rise by 100,000 tons to 5.3 million tons this year.
• At least 27 districts will face food deficit this year.

About 76.3% of households in Nepal depends on agriculture for livelihood and 83% of the population lives in rural areas. Paddy contributes around 21% to agriculture production, which then account for about 35% of GDP. Paddy and maize are the major cereals consumed by a majority of households.

Meanwhile, global food prices is increasing. According to the latest Food Price Watch, global food prices increased 10% between June and July 2012 with staples such as wheat increasing 25% in the period. The high global food and fuel prices gets reflected in domestic prices as almost half of the total food demand is fulfilled by imports. It tends to affect poor and vulnerable the most, while pushing back people just above the poverty line back under it. 

A study (Global Food Price Inflation and Developing Asia) by ADB showed that a 10% increase in food prices will increase the number of poor people (in millions) living below US$1.25-a-day by 3.8, 0.01, 22.8, 6.7, 0.6, 3.5, and 0.2 in Bangladesh, Bhutan, rural India, urban India, Nepal, Pakistan, and Sri Lanka, respectively. More here (and also this one on targeted food subsidies).

Why fiscal stimulus worked in China?

The short answer, according to a new paper by Fardoust, Lin, and Luo, is that since the Chinese fiscal stimulus in 2008-09 focused on (i) investments in bottleneck-easing infrastructure projects, and (ii) countercyclical nature of expansionary subnational expenditure on well-chosen infrastructure projects that improved business climate, it worked. The latter one had the largest effect. 

Chinese stimulus money (US$586 billion—1.25% of China’s GDP in 2008) went to housing guarantees, rural construction, energy conservation and emissions reduction, infrastructure development, social services, industrial restructuring, and post-disaster reconstruction of Wenchuan.

Below is an abstract from their paper:

---

China's government economic stimulus package in 2008-09 appears to have worked well. It seems to have been about the right size, included a number of appropriate components, and was well timed. Its subnational component was designed to maximize the impact of the stimulus package on the economy and minimize the potential procyclical elements that are usually built into subnational fiscal mechanisms in federal countries. Moreover, China's massive fiscal stimulus played an important role in the overall recovery of the global economy. Using a simple analytical framework, this paper focuses on two key factors behind the success of the stimulus: investments in bottleneck-easing infrastructure projects and countercyclical nature of subnational spending based on the assumption that well-chosen infrastructure projects could improve business climate and thereby crowd in the private investment. The paper concludes that the expansionary subnational government spending played a key role in strengthening the overall impact of the stimulus and sustaining growth. It also highlights the importance of public investment quality and cautions about the sustainability of local government financing through the domestic banking system and increases in local governments off balance sheet or contingent liabilities. These lessons may be of particular relevance today for China, as well as other countries, in formulating policy response to another global economic slowdown or crisis, possibly as a result of the Eurozone turmoil. For China, investing in urban infrastructure and green economy, as well as in higher quality and better targeted social services, will be crucial for improving income inequality and inducing a more inclusive growth path.

---

It has more to do with the quality of public investment, i.e. the economy should have enough absorption capacities, which will help stimulate economic activities without jeopardizing inflation too much. Also, the source of such stimulus is important as a one-off investment by borrowing from domestic financial institutions or by increasing contingent liabilities of local governments is not going to be sustainable. The public investments have to be such that they exploit idle resources (human and capital) and are sustainable in the sense that the total costs are paid off in due course of time. It offers an important lesson for economies like Nepal that have constrained economic growth in the face of severe shortage of infrastructure (electricity, transport, urban services, etc.). Prudent management of resource allocation, project selection and quality investment (public, private or public private partnership) in these will have significant multiplier effects.

Doing Business 2013: No improvement in ease of doing business in Nepal

In its latest Doing Business 2013: Smarter Regulations for Small and Medium-Size Enterprises report, the IFC has ranked Singapore as the top economy in terms of ease of doing business. The other top ranked economies are Hong Kong (SAR, China), New Zealand, the United States, and Denmark. Last year as well, the same economies were in the top position.

The report ranks economies based on performance in ten indicators: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. This year’s report data cover regulations measured from June 2011 through May 2012.

Poland was the global top improver in the past year. The other economies that have made the most progress in several areas of regulation last year were Sri Lanka, Ukraine, Uzbekistan, Burundi, Costa Rica, Mongolia, Greece, Serbia, and Kazakhstan.

South Asia

In South Asia, Sri Lanka made the most progress and was ranked 81, followed by Maldives (95), Pakistan (107), Nepal (108), Bangladesh (129), India (132), Bhutan (148) and Afghanistan (168). Last year, Maldives ranked 79, followed by Sri Lanka (89), Pakistan (105), Nepal (107), Bangladesh (122), India (132), Bhutan (142) and Afghanistan (160). The regional average (in rank) was 117 in DB2012 but it was 121 in DB2013, reflecting either a worsening business regulatory environment or a stagnant one or significant progress by other regions (based on data revisions) or addition of new economies (this year Malta and Barbados were added).

Nepal

In terms of ease of doing business, Nepal ranked 108 out of 185 countries. Last year, Nepal ranked 107 out of 183 countries and in DB2011 Nepal’s ranking was 110. Between DB2012 and DB2013, Nepal did not enact a single reform aimed at easing business processes and regulations. Hence, the progress made by other economies dropped ranking one position below last year’s ranking (plus there was addition of two economies in this years report).

• While the ranking in registering property has improved by two positions and ranking in getting electricity is unchanged, the ranking in all other indicators has declined. The largest decline (9 positions) is in dealing with construction permit indicator.
• In South Asia region, Nepal has the best ranking (21) in registering property. It requires 3 procedures, 5 days and 4.9% of property value to register a property in Nepal. The regional averages are 6 procedures, 100 days (250 days in Afghanistan), and 7.3% of property value.
• In terms of documents to export, Nepal has the worst performance in the region, requiring 11 documents against the regional average of 8. Sri Lanka has the best performance with just 6 documents required for exporting a container.
• In terms of number of procedures required to enforce contracts, Nepal has best performance in the region with 39 required procedures as against 43 for regional average.
• In terms of time taken to resolve insolvency, Nepal has the worst performance in the region. While it takes 5 years to resolve insolvency in Nepal, the regional average is 3 years (in Maldives it is just 1.5 years). Furthermore, recovery rate is also the lowest in Nepal (24.5 cents on the dollar) compared 29.1 for the region (50.6 for Maldives).

Nepal's ranking (out of 185 countries)
Topics	DB 2013 Rank	DB 2012 Rank	Change in Rank
Starting a Business	105	102	-3
Dealing with Construction Permits	97	88	-9
Getting Electricity	96	96	No change
Registering Property	21	23	2
Getting Credit	70	67	-3
Protecting Investors	82	79	-3
Paying Taxes	114	109	-5
Trading Across Borders	171	170	-1
Enforcing Contracts	137	136	-1
Resolving Insolvency	121	119	-2

Distance from frontier

This year, the report also provides a new measure called ‘distance from frontier’, which benchmarks economies to the frontier in regulatory practice. In other words, it measures the absolute distance to the best performance on each indicator. When compared across years, the distance to frontier measure shows how much the regulatory environment for local entrepreneurs in each economy has changed over time in absolute terms, while the ease of doing business ranking can show only relative change.

An economy’s distance to frontier is indicated on a scale from 0 to 100, where 0 represents the lowest performance and 100 the frontier. For example, a score of 60 in DB 2012 means an economy was 60 percentage points away from the frontier constructed from the best performances across all economies and across time. A higher score in DB 2013 indicates an improvement.

Compared to DB 2006, in DB 2013, in Nepal, there was improvement in all indicators except trading across borders. The largest improvement was in dealing with construction permits, followed by getting credit and starting a business. Overall, Nepal's ease of doing business improved by four percentage points (i.e. closer to the frontier by four percentage points) between DB 2006 and DB 2013.