Monetary transmission in developing countries

Usually, when we talk about monetary policy, it is customary to link this with standard econ theories. For instance, it is well established that increase in money supply increases inflation. But then in countries like Nepal, money supply (or central bank’s interest rate) has hardly any effect on inflation (even correlation is very weak). Why? Because of exchange rate pegged to Indian rupee, almost 60 percent of total imports originating in India, slowly adjusting oil prices, huge informal economy, supply-side constraints and very limited reach of financial institutions (just 20 percent of households take loans from banks). The theoretical relationship between money supply and inflation is not that straight forward when it comes to applying it on the ground in developing countries with under-developed financial sector.

Montiel and Mishra argue that the application of conventional monetary transmission would require “an economy with a highly developed and competitive financial system in order to be effective.” Two strong messages that are relevant to Nepal come from their research:

• Inflation targets set during the announcement of monetary policy should be modified to take the imperfect monetary transmission into account. (They recommend to the extent of postponing setting inflation target!).
• Weak monetary transmission weakens the argument for floating exchange rates and capital account restrictions.

Below are excerpts from their article in Ideas for India (btw, an excellent website for easy-to-read, evidence-based articles focused on the Indian economy): 

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That includes: a strong institutional environment, so that loan contracts are protected and financial intermediation is conducted through formal financial markets; an independent central bank; a well-functioning and highly liquid interbank market for reserves; a well-functioning and highly liquid secondary market for government securities with a broad range of maturities; well-functioning and highly liquid markets for equities and real estate; a high degree of international capital mobility; and a floating exchange rate. These features are typically taken for granted in the OECD but the same assumptions cannot be made for developing countries.

 

[…] First, the complete absence or poor development of domestic securities markets suggests that both the short-run and long-run interest rate channels will be weak. Second, small and illiquid markets for assets such as equities and real estate will tend to weaken the asset channel. Third, in countries that are imperfectly integrated with international financial markets and tend to maintain relatively fixed exchange rates, the exchange rate channel will tend to be completely absent, or relatively weak.

[…] If the banking industry is non-competitive, changes in banks’ costs of funds may be reflected in bank profit margins, rather than in the supply of bank lending. If a poor institutional environment increases the cost of bank lending, banks may conduct lending activity in a manner that weakens the effects of monetary policy actions on the supply of loans by using reserves as a buffer to sustain their lending to low-cost customers when the central bank tightens credit conditions and to avoid lending to high-cost customers when the central bank loosens credit conditions.

[…] We find a much weaker link between the policy instrument (central bank interest rates) and money market rates in poorer economies than for advanced and emerging economies, both in the short and in the long run. We find a similar result for the link between money market rates and bank lending rates in the short term, and while differences in long-term effects are not as pronounced, they remain weaker in low-income countries. Most importantly, changes in money-market rates explain a much smaller proportion of the variance in bank lending rates in low-income countries than in either advanced or emerging economies.

[…] We interpret the evidence presented in our research, as well as that of the broader literature, as creating a strong presumption that in the financial environment that tends to characterise many developing economies, monetary policy is likely to have both weak and unreliable effects on aggregate demand. If this is true, the stabilisation challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challenge for policymakers and researchers alike.

When domestic monetary policy is weak and unreliable, activist policy is less desirable, and the adoption of policy regimes that raise the stakes associated with attaining publicly-announced monetary objectives, such as a target rate of inflation, should be postponed or their design should be modified to take the uncertainty about monetary policy effects into account. In addition, weak and unreliable monetary transmission weakens the arguments for floating exchange rates as well as for capital account restrictions under fixed exchange rates.

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The full paper is here.

Private sector allowed to import LPG in Nepal

The government has finally opened up import of LPG by private players. Chandi Lumbini Gas Storage Company has been permitted to import liquefied petroleum gas (LPG) from Malaysian petroleum giant Petronas from the end of October. It will hopefully lower NOC's deficit as most of the users in commercial scale can now get LPG from the new private company (that too with ease, lets hope!). Additionally, (hopefully) consumers do not have to wait in queue at retail stores to get a LPG cylinder.

Excerpts from a news story in The Kathmandu Post:

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Chandi Lumbini will buy gas and oil from Petronas, mix and refine the fuels at IndianOil Petronas at Haldia and then sell LPG in Nepal.

[...]The company said it would make bulk deals and its LPG would be used for commercial purposes only. It has invited Nepali bottling plants, auto filling plants and bulk consumers interested in doing LPG business. The company said that even NOC can buy its products.

[...]Chandi Lumbini made a fresh bid to be allowed to import LPG after the government announced a dual cylinder system from Oct 17. Under the plan, LPG would be sold in colour-coded cylinders, red for household use and blue for commercial use. LPG in blue cylinders will be sold at the actual price while red cylinders will be sold at a subsidised rate.

The proposed system will allow Chandi Lumbini to sell its products at the commercial rate. At present, NOC incurs a loss of Rs 363.60 on a cylinder, resulting in monthly losses of Rs 436 million.

[...]Nepal and India signed a Petroleum Supply Agreement in 1974 appointing IOC as the sole supplier of fuel to Nepal. Prior to that, major oil companies based in India like Exxon and Chevron used to retail fuel directly in the Nepali market.

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It is good that the government is allowing private players in this hugely inefficient and fiscally burdensome sector. At the outset, just because private players enter the market doesn't mean things will be alright given a hugely distorted procurement, distribution and consumption networks. The challenge would be to stop leakages, i.e. not allowing commercial users to purchase discounted cylinders. It would require strict supervision and oversight of the entire process. Else, things won't improve much.

Assessment of Nepali economy by the IMF (2012/13)

The IMF has just released the preliminary findings and recommendations 2012 Article IV Consultation discussions.The usual narrative about economic growth, expenditure concerns, and sustainability of economy by remittances holds.

Macroeconomic outlook remains challenging. Strong agriculture production and growth in services sector boosted real GDP growth to 4.6 percent despite fledging industrial sector. Non-food and services (mostly of imported nature) prices exerted more pressure on inflation last year as a result of depreciation of currency and increase in fuel prices. High remittance inflows has contributed to keeping current account and balance of payments in surplus. Lower fiscal deficit than expected points to the inability to spend on capital projects. Good revenue mobilization helped keep deficit and public debt on a stable footing.

Here is the outlook for short term:

• GDP growth expected to decline due to late monsoon, continued weakness in industrial output and slow growth in India.
• Inflation is likely to miss targets and remain at around 8-9 percent range.
• BoP surplus is likely to decline as growth of remittances moderates.
• Delay in adopting a full-year budget for 2012/13 could further dampen investment and growth.
• A full-year budget—limiting the deficit to about 2 percent of GDP, consistent with macroeconomic and debt sustainability—should be adopted as soon as possible.
• High levels of capital spending to meet Nepal’s pressing infrastructure needs and support medium-term growth. But, its challenging.
• Further strengthening of tax administration and collection will be vital, as will a focus on collecting arrears.
• Tighter expenditure management and cash planning will also be key to ensuring that government and donor-supported investment projects are implemented.
• Large losses of NOC and NEA are unsustainable.
• Recommends adoption of an automatic price adjustment mechanism to contain losses of NOC.
• The exchange rate peg to the Indian rupee should remain the key monetary policy priority. It means maintaining interest rates higher than in India.
• Excess liquidity generated by strong remittance growth in 2011/12 should be mopped up by tightening monetary policy.
• Weak supervision, liberal licensing policy in previous years and exposure to real estate sector remains a risk for financial sector. NRB’s corrective steps have been useful in containing spread of risks.
• Implementation of revised NRB Act to allow for swift intervention of problem banks, rigorous implementation of the prompt corrective action framework, and strengthened supervision and enforcement of prudential regulations.

Very brief but entirely appropriate diagnosis and recommendations by the IMF. You will have to wait for the full 2012 Article IV Consultation report to dig deeper into these issues.

Last year, the IMF recommended the government to boost productivity to stay competitive. Some of the recommendations remain the same.

Reforming power sector: Right tariff with right management

World Bank economists and energy specialists argue that the solution to blackouts in India is to reflect cost of production in power tariffs (prices) and efficient management of and by power companies (plugging in leakages, expanding access to energy, good customer services, proper maintenance). It happened in Gujarat, West Bengal (public enterprise) and Delhi (private enterprise). The suggestions are quite pertinent to the ongoing works in reforming Nepal's troubled NEA (after tariff rationalization).

Below are excerpts from the article:

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At their heart, blackouts boil down to two issues: underutilised capacity and insufficient capacity. The former is a result of inadequate maintenance of old plants and the persistent shortage of domestic coal. This can be resolved by using imported coal. But that is very expensive and the additional cost does not get reflected in tariffs.  For their part, most distribution companies have resorted to load shedding, rather than buying surplus short-term power, on account of their dire financial position.

Insufficient capacity requires a long-term solution. The financial viability of State utilities is a pre-condition for attracting investments in this sector. This requires a coherent set of actions involving reductions of system losses, adequate tariffs that are revised at regular intervals and transparent competitive bidding for new investments.

Fortunately, we don’t have to look far for solutions. India has a number of examples of public (Gujarat, West Bengal) and private (Mumbai, Delhi) power sector companies that have good management practices, are well regulated, provide homes and industries with uninterrupted power supply and earn reasonable profits.

So what have these states done differently? First, they have significantly reduced their transmission and distribution losses, which devour a third of the power in other states. These companies upgraded their networks and cracked down on power theft, which enabled them to generate additional revenues that further improved operations.  Note that peak power deficits in May 2012 were just 1% in West Bengal and 1.2% in Gujarat, as compared to 9.2% in the rest of India.

Second, these states have increased tariffs at regular intervals and consumers pay higher tariffs in return for regular, high-quality power supply. In Gujarat, for instance, consumers pay Rs. 5.3 per unit of power; in Mumbai, Rs. 5.86; and in West Bengal, Rs. 5.78. While these tariffs are only 10% higher than average tariffs in other states, lower losses and better efficiency imply that these companies are profitable.

So where can other states begin from? Power utilities in other states must reduce their financial losses through sound management practices and tariff rationalisation. But consumers will rightly demand regular power supply with better voltage before they are willing to pay a higher tariff. West Bengal demonstrated the importance of earning credibility with consumers before raising tariffs. Just three years after improvements in power supply and energy access, improved customer service and negligible dependence on state subsidies, the utility got approval for the required tariff increase under the new government. Similarly, in Delhi, private distribution companies were incentivised to reduce losses in a time-bound manner during the reform period, before receiving a tariff hike.

"

 More here.

Per capita GDP after correcting for government inefficiency

In a new research note, WB's Francesco Grigoli and Eduardo Ley argue that correcting for wastage of government inputs from GDP would "significantly" reorder the living standards rankings. Below is the abstract of the paper (full text here).

It is generally acknowledged that a government's output is difficult to define and its value is hard to measure. The practical solution adopted by national accounts systems is to equate output value to input costs, but well-documented inefficiencies in government activities make this approximation questionable. One solution is to purge from gross domestic product (GDP) the fraction of government inputs that is wasted. This note illustrates such a correction, computing corrected per capita GDP on the basis of two studies that estimate efficiency scores for several dimensions of government activities. Results show that the correction could be significant and reorder the rankings of living standards.

The percentage of GDP losses due to public waste in education and health is estimated as high as 4.2 percent for Brazil!

Links of Interest (2012-09-18)

Promoting social mobility (Equity and efficiency can be achieved by focusing investments in the early years, while also following up with later investments.)

Lesson from Japan: Do low interest rates boost growth? (Supply alone won't do anything if there is no demand for it. Low rates hardly boost "private demand, private risk-taking or entrepreneurship" if the economy is largely dependent on revenue externally, i.e. from exports, where economic conditions have nosedived.)

Nepali private sector in interested in PPP in agriculture sector

The private sector body also said the existing policy does not address the risks inherent in engaging the private sector in the farm sector and as a result, the country has not been able to take advantage of the opportunities in the agriculture sector. NCC urged the government to bring a policy that facilitates both the private sector and farmers to market access, provide loans in nominal interest rates, set up organic and chemical fertiliser factories, among others.

IRs 100 = NRs 168 in informal market (Officially, NRs 1.60 is pegged at IRs 1. The main reasons are high demand for IRs arising from increasing imports and cross-border smuggling of IRs.)

Traders attributed this surge in IC value in the black market to increasing smuggling of goods that created shortage of the currency. They said smuggling of sugar, food items, readymade garment and shirting and suiting, among others, has surged ahead of the festivals. Smuggling of motor parts, hardware and electronics are also on the rise.

NEA to hold study on 10 storage-type projects

The Nepal Electricity Authority (NEA) has selected 10 storage-type hydropower projects with a collective capacity of 2,652MW to carry out a feasibility study. The 10 projects are among the 31 projects approved by the Japan International Cooperation Agency (JICA) for further study. NEA had conducted a pre-feasibility study on 65 projects last year under the funding JICA, of which 31 projects were approved, NEA officials said.

The 10 projects are Madi Khola (199 MW), Lower Jhimruk (142 MW), Nalsinghgadh (400 MW), Chehera-I (149 MW), Naumure (245 MW), Dudhkoshi (300 MW), Sunkoshi-III (536 MW), Khokhajor (111 MW), Adhikhola (180 MW) and Lower Badhigad (380 MW).

NEA so far has issued survey licences to independent power producers for projects with a collective capacity of 11,645MW electricity, but all the projects are ROR type.

NEA is also studying 14 projects with total capacity of about 4,000MW. Of them, 11 are storage-type projects.

Supply intervention:  MoCS giving PEs Rs 35.8m to ensure smooth supply of food commodities

The Ministry of Finance (MoF) has agreed to provide Rs 35.8 million to the Ministry of Commerce and Supplies (MoCS) for providing direct subsidy to state undertakings involved in the supply of food commodities, keeping in view the upcoming festivals. Breaking the tradition of cross subsidy system under which state-owned enterprises were given tax and other privileges to enable them recoup the loss while dealing with subsidized goods, the MoCS first time is providing direct subsidy to public enterprises (PEs). The MoCS adopted new subsidy system after PEs reported loss while trading commodities like rice, sugar, salt and goats, among others, during last year´s festive season.

Under the proposed subsidy, NFC, STC and NTL will have to sell rice, salt and sugar at rates lower by Rs 5, Rs 2 and Rs 5 per kg respectively compared to market price.

Govt fails to implement MRP: Consumer activists termed the move just a 'publicity propaganda'

The government failed to publish maximum retail price (MRP) in Nepal Gazette (Rajpatra) today, as it has promised. Ministry of Commerce and Supply Management has promised to publish it today in the Gazette that could ensure the implementation of the MRP from today.

“There has been not any preparation to publish it in the Nepal Gazette ,” said secretary of the Ministry of Law, Justice, Constituent Assembly and Parliamentary Affairs Bhesh Raj Sharma.

“No file has reached the ministry related to maximum retail price,” he added. According to the process, concerned ministry should forward the file to Ministry of Law, Justice, Constituent Assembly and Parliamentary Affairs to publish notice in the Gazette.

According to the Clause 1 of Essential Commodities Control (Authorisation) Act 1961, the government decision on maximum retail price becomes effective only after the publication in Nepal Gazette.

Trade facilitation matters!

Economists celebrate trade not only because they love watching ships cross the Pacific and cargo planes land at Paris Charles-de-Gaulle but also because increased trade demonstrably raises income and improves living standards. This column argues that a powerful way to boost trade is by focusing on trade facilitation, i.e. improving both hard infrastructure like ports and railways, and soft infrastructure such as shipping logistics.

India's economic slowdown reflects both structural and cyclical factors

Post MDGs development priorities and assistance

Dani Rodrik assesses the relevant of MDG indicators and the global development or assistance framework in the post-MDG era:

Contribution of MDGs:

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[…]Clearly, however, the MDGs were a public-relations triumph, which is not to belittle their contribution. Like all worthwhile PR efforts, the MDGs served to raise awareness, galvanize attention, and mobilize action – all for a good cause. They amplified the global conversation about development and defined its terms. And there is evidence that they got advanced countries to pay more attention to poor nations.

Indeed, the MDGs possibly had their clearest impact on aid flows from rich to poor countries. A study by Charles Kenny and Andy Sumner for the Center for Global Development in Washington, DC, suggests that the MDGs not only boosted aid flows, but also redirected them toward smaller, poorer countries, and toward targeted areas like education and public health. However, aid was not directly linked to performance and results, and it is much more difficult to know whether it had the desired impact overall.

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Recommendations for the post-MDG development framework:

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[…]First, a new global compact should focus more directly on rich countries’ responsibilities. Second, it should emphasize policies beyond aid and trade that have an equal, if not greater, impact on poor countries’ development prospects.

A short list of such policies would include: carbon taxes and other measures to ameliorate climate change; more work visas to allow larger temporary migration flows from poor countries; strict controls on arms sales to developing nations; reduced support for repressive regimes; and improved sharing of financial information to reduce money laundering and tax avoidance.

Notice that most of these measures are actually aimed at reducing damage – for example, climate change, military conflict, and financial crime – that otherwise results from rich countries’ conduct. “Do no harm” is as good a principle here as it is in medicine.

This kind of reorientation will not be easy. Advanced countries are certain to resist any new commitments. But most of these measures do not cost money, and, as the MDGs have shown, setting targets can be used to mobilize action from rich-country governments. If the international community is going to invest in a bold new public-relations initiative, it might as well focus on areas where the potential payoffs are the greatest.

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On the post-MDG era, here is a link to a presentation based on Nepal country study for the forthcoming European Report on Development 2012/13.

Shashi Tharoor argues that the next focus should be in Goal 8, which calls for a “global partnership for development” with four specific targets: “an open, rule-based, predictable, non-discriminatory trading and financial system”; special attention to the needs of least-developed countries; help for landlocked developing countries and small island states; and national and international measures to deal with developing countries’ debt problems.”

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[…]The time has come to reinforce Goal 8 in two fundamental ways. Developed countries must make commitments to increase both the quantity and effectiveness of aid to developing countries. Aid must help developing countries improve the welfare of their poorest populations according to their own development priorities. But donors all too often feel obliged to make their contributions “visible” to their constituencies and stakeholders, rather than prioritizing local perspectives and participation.

[…]We must change the way the world goes about the business of providing development aid. We need a genuine partnership, in which developing countries take the lead, determining what they most acutely need and how best to use it. Weak capacity to absorb aid on the part of recipient countries is no excuse for donor-driven and donor-directed assistance. The aim should be to help create that capacity. Indeed, building human-resource capacity is itself a useful way of fulfilling Goal 8.

Doing so would serve donors’ interest as well. Aligning their assistance with national development strategies and structures, or helping countries devise such strategies and structures, ensures that their aid is usefully spent and guarantees the sustainability of their efforts. Donors should support an education policy rather than build a photogenic school; aid a health campaign rather than construct a glittering clinic; or do both – but as part of a policy or a campaign, not as stand-alone projects.

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Inflationary pressures on Nepali economy

It was published in Nepali Times, ISSUE #622 (14 SEPT 2012 - 20 SEPT 2012).

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Sticky prices

Steep inflation and mounting food prices will leave a big dent in Nepalis' wallets this festive season

In its its latest annual macroeconomic update, the central bank estimated inflation to be at 8.3 per cent, higher than the seven per cent target set in the budget and monetary policy for 2011-12. Nepalis who are struggling to cope with rising prices, especially food prices, find this figure hard to digest. Inflation is eroding people's purchasing power, who spend around 65.1 per cent of their consumption expenditure on food, and is hitting low income earners
the most.

The central bank's figure is low because it gives 46.82 per cent weight to food prices and 53.18 per cent to non-food and services prices while determining inflation, which means that non-food prices have more influence on inflation. Such practice is inconsistent with a recent research that that shows hike in food prices contributes about three-fourths of overall inflation.

The price movements, especially of food items, in the huge informal economy and the current debatable weight given to food and non-food items mean that official inflation figures underestimate the actual prices people pay in the market every day. The central bank's figures which show a decline in food and beverage inflation from 14.7 per cent in 2010-11 to 7.7 per cent in 2011-12 do not reflect reality.

Prices in Nepal have historically moved in tandem with prices in India, thanks to our pegged exchange rate and huge volume of imports. About one-third of price variability here is determined by prices in India. After 2007-08, when the global economy was struck by food, fuel, and financial crises, prices in Nepal started to remain stubbornly sticky at high level. It showed one directional changes only in response to food production and availability domestically, ie when supplies went down, prices went up. But when supplies moderated, prices remained sticky at high level. What happened?

As monetary policies (money supply and interest rate) have little traction on inflation in Nepal, supply side constraints and oil prices are weighing heavily on food and non-food prices. Since aggregate consumption has always been high (about 90 per cent of GDP) for a long time, there is very little extra pressure coming from demand side. Major pressure is exerted by supply side factors along with unjustified price speculation and rigging of product and factor markets by middlemen.

First, some wholesalers have deliberately withheld stocks to bump up prices in order to earn abnormal profits on the eve of Dasain and Tihar when the demand for essential food and non-food items is pretty much price inelastic (demand hardly changes with respect to changes in prices).

Second, though recurrent bandas temporarily disrupted distribution of essential items, wholesalers and retailers capitalised on the strikes to stick to higher prices even after the normalisation of supplies. Third, middlemen are distorting prices and calculatingly keeping them high. For instance, transportation cost and some leakages do not fully justify more than 50 per cent increase in prices of fruits and vegetables after they reach Kalimati from Dharke of Dhading. Powerful politically affiliated middlemen and associations act both as monopsonists (only they purchase food from farmers), and monopolists (only they sell food to wholesalers), in effect depriving farmers of the true price by stifling competition and also burdening consumers with artificially inflated prices.

Fourth, each time supply disruption occurs and oil prices are raised, there is inflationary expectations in the market, especially among retailers who preemptively up prices and keep it higher than the norm of taking 10 to 20 per cent profit only.

Fifth, the frequent hike in fuel prices and load-shedding hours have increased cost of production, which are ultimately reflected in the retail prices. Such fluctuations affect costs at production site, distribution chains, and retail stores. Furthermore, the continually rising imports of goods, especially those from outside of India, and the depreciation of the Nepali rupee have further pushed up prices.

Now, what can the government do about this?

For imported goods, there is little it can do to influence prices because they are determined externally. For those goods produced and sold domestically, especially food items, there is no other option but to strictly supervise distortionary activities by the movers and shakers of the market. It means clamping down on middlemen, setting up fruit and vegetable wholesale markets in strategic shopping locations, monitoring retail prices, and booking those who deliberately withhold supplies against the existing supply policies. Furthermore, the government could also lower import tariffs on food items, raw materials, and intermediate goods.

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Impending rise in food prices in South Asia

With late and low monsoon in South Asia and droughts in major food producing and exporting countries, there are worrying sings that food prices might escalate in the coming months. The FAO Food Price Index averaged 213 points in July 2012, up 12 points from June. Though this is still less than the peak of 238 points reached in February 2011, the point is that overall food prices have started to increase again due to upward price pressures coming from grain, sugar and oil/fats prices. This has come amidst disappointing news about monsoon rains, and floods and droughts in major grain producing nations. South Asia will get particularly affected by this as festival season, when demand for daily consumed food items is higher than normal times, is just around the corner in India, Nepal and other countries in the region.

In its August food price update, the FAO stated that the adverse maize and corn production prospects in the US due to droughts and setback in wheat production in Russia, Kazakhstan, and the Ukraine (which accounts for nearly a quarter of global wheat export) amidst projected sharp rise in demand from livestock sector are driving prices upward. Furthermore, untimely rains in Brazil, the largest sugar exporter in the world, have raised concerns about sugarcane production and its prices in the coming months.

In South Asia, India, which is also the largest producer and exporter of food items, had 21 percent less rainfall than average. The Indian government is considering releasing grains stored in government warehouses around the country. In Nepal, agriculture production is projected to be lower than last year’s due to late and low monsoon and the shortage of fertilizers during peak planting season. Other countries in the region also are one way or the other affected by late monsoon, floods and droughts this year. Consequently, the prospects of high food prices are real and will impact food security situation in the region.

Keeping in mind the impending rise in food prices during and after the festival season, South Asian nations need to be prepared to take actions both at national as well regional level. First, emergency release from stock should be the priority to stabilize prices. Second, market imperfections arising from rigging of prices by middlemen or cartels should be monitored. Third, building crucial agriculture infrastructure such as irrigation and roads for market access also helps as only about one-fifth to two-fifth of farmers are “significant participants” in agriculture markets. Fourth, targeted food subsidies and social protection programs should be designed and implemented well in advance. Fifth, large grain producing and exporting nations like India should refrain from export bans as the other countries in the region are net food importers.

Additionally, realizing the destabilizing impact of droughts on global grain production and contribution to keeping prices high since 2007, in a recent report the FAO highlighted the “need for to transform the way water is used- and wasted- throughout the entire food chain”. Conserving water by using it more “sustainably and intelligently”—such as modernization of irrigation, better storage of rainwater at farm level, recycling and re-using, pollution control, and substitution and reduction of food waste— will not only help boost food production and stocks, but also is an important climate change adaptation strategy. As 75 percent of South Asia’s poor people live in rural areas and depend on rain-fed agriculture, changing the way water is used in agriculture is crucial for supporting livelihoods, sustainably boosting production and controlling food prices. Globally, one-third of food for human consumption is either lost or wasted.

South Asian governments need to closely monitor the prospects for rapidly spiraling food prices and implement appropriate remedial measures as and when required. Else, it will once again push thousands of people below the poverty line, increase vulnerability and heighten food insecurity.

Also, see Trade & Development Monitor, August 2012.

Nepali labor unions demand medal weighing 1kg for 20 years of service

Nepal has seen a lot of labor union activism especially after 2006. The labor unions, who are dictated by political party bosses, have time and again faulted badly despite their claims that their strikes (sometimes destructive!) are aimed at exercising their rights and fair pay. Fair enough as long as it is limited to that.

But, it ain’t given their past record. Read here and here (the demand for rise in wages and perks is not matched by rise in labor productivity!). Remember this time when the unions stroke a deal with the industrialists to not go for strikes for four years? Keeping true to commitments/promises is a tall order for them. Recently, KFC and Pizza Hut were closed down (partly due to labor dispute). Difficult industrial relation/restrictive labor regulation is one of the most problematic factors for doing business in Nepal.

These aside, the mother of all demands by labor unions (affiliated to UCP (Maoist) and CPN-UML)  is this: According to a news report published in Nagarik daily, workers shut down Hotel Greenwich Village demanding, among others, gold medals weighing 1kg for 20 years of service.

Demands include the following (there are 22 points in total):

• Gold medal weighing 1.01 kg for those working for 20 years and 0.550 kg for those working for 15 years in the hotel
• Hike in wages
• Health insurance of up to Rs 50,000 for family
• New clothes and shoes every six months
• Annual salary equal to 16 months of pay

No comments!

Competitiveness of Nepali economy unchanged

The latest Global Competitiveness Report 2012-2013 shows that Nepal’s ranking in competitiveness has remained unchanged at 125 out of 144 countries. Last year, Nepal’s ranking was also 125 out of 142 countries. Nepal’s ranking is the lowest in South Asia, where the most competitive economy is India (last year it was Sri Lanka).

	GCI 2012-2013		GCI 2011-2012	GCI 2010-2011
Country	Rank (out of 144 countries)	Score	Rank (out of 142 countries)	Rank (out of 139 countries)
India	59	4.32	56	51
Sri Lanka	68	4.19	52	62
Bangladesh	118	3.65	108	107
Pakistan	124	3.52	118	123
Nepal	125	3.49	125	130

Competitiveness is defined as “the set of institutions, policies, and factors that determine the level of productivity of a country”.The ranking is based on global competitiveness index, which comprises of 12 categories – the pillars of competitiveness – which together gives a picture of a country’s competitiveness landscape. The pillars are: institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication and innovation.

Switzerland tops the overall ranking for four consecutive year. It is followed by Singapore, Finland, Sweden and Netherland in the top five competitive nations. The least competitive nations are Burundi, Sierra Leone, Haiti, Guinea and Yemen. The report notes that troubled economies in the Euro zone areas—Portugal (49th), Spain (36th), Italy (42nd) and Greece (96th)— “continue to suffer from competitiveness weaknesses in terms of macroeconomic imbalances, poor access to financing, rigid labour markets and an innovation deficit”.

In the emerging markets (BRICS), China is ranked at 29th position, Brazil 48th, South Africa 52nd, India 59th, and Russia 67th.

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Nepal’s case:

Given the political stalemate and lack of introduction of new reform to boost competitiveness along with implementation of existing ones, it is no surprise that there is no improvement in ranking. In 2011-2012, ranking jumped by five positions to 125 compared to 2010-2011 rankings. In 2009-10, Nepal’s ranking was 125 out of 133 countries and in 2010-11, the ranking was 130 out of 139 countries.

Nepal is still a factor-driven economy but its macroeconomic environment is better than that of other factor-driven economies. Its labor market efficiency is below the standard of other factor-driven economies. Nepal still has a long way to go to become an efficiency-driven and then innovation-driven economy.

In basic requirements (institutions, infrastructure, macroeconomic environment, and health and primary education), Nepal’s ranking is 121 (same as last year) out of 144 economies. In efficiency enhancers (higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, and market size), Nepal’s ranking is 126 (an improvement by one position). In innovation and sophistication factors (business sophistication and innovation), Nepal’s ranking is 133 (down by one position). In overall competitiveness index, basic requirements, efficiency enhancers, and innovation and sophistication factors have 60 percent, 35 percent and 5 percent weight respectively.

The best ranking is in macroeconomic environment at 56 out of 144 counties (last year it was 50, which means a bit deterioration this year). Ranking in gross national savings (% of GDP) is 18 and government budget balance (% of GDP) 48. Ranking in women in labor force (ratio to men) is 13.The worst ranking is in infrastructure at 143 out of 144 countries (in quality supply of electricity as well it is 143).

The rankings in the 12 pillars of competitiveness are (last year’s in bracket) : institutions 123 (124), infrastructure 143 (141), macroeconomic environment 56 (50), health and primary education 109 (115); higher education and training 128 (129), goods market efficiency 121 (125), labor market efficiency 125 (128), financial market development 91 (100), technological readiness 129 (130), market size 95 (98); business sophistication 127 (125) and innovation 133 (134).

The report also includes results from perception survey (of business community) on the most problematic factors for doing business. The chart below shows the results. Government instability, corruption, inefficient government bureaucracy, policy instability and restrictive labor regulations are perceived as the top five problematic factors for doing business in Nepal.

Impact of temperature increase on economic growth

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 impacts in rich countries, but in poor countries one standard deviation increase in mean annual temperature reduces economic growth by 0.69 percentage points.

A one degree rise in temperature is associated with a 2.66 percentage points reduction in growth of agricultural outputs. in poor countries (for rich countries it is 0.22 percentage points). Also, their results show that an additional 100mm of annual rainfall is associated with 0.18 percentage points higher growth in agricultural output in poor countries and 0.16 percentage points higher growth in agricultural output in richer countries.

Furthermore, high temperature negatively impacts industrial value-added and political stability. They find that a one degree higher temperature in poor countries is associated with 2.04 percentage points lower growth in industrial output.

Overall, higher temperature is associated with political instability in poor countries. Specifically, an additional one degree change in temperature in poor countries is associated with a 2.7 percentage points increase in the probability of any change in POLITY (i.e. Policy IV index which rates political system in each country annually from –10 as fully autocratic and +10 as fully democratic). Political instability impacts factor accumulation and productivity growth. Using another dataset of leadership change, they show that a one degree rise of temperature raises the probability of leader transitions by 3.1 percentage points in poor countries.

Below is the abstract from their paper:

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This paper uses historical fluctuations in temperature within countries to identify its effects on aggregate economic outcomes. We find three primary results. First, higher temperatures substantially reduce economic growth in poor countries. Second, higher temperatures may reduce growth rates, not just the level of output. Third, higher temperatures have wide-ranging effects, reducing agricultural output, industrial output, and political stability. These findings inform debates over climate's role in economic development and suggest the possibility of substantial negative impacts of higher temperatures on poor countries.

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Source: Dell, Jones and Olken (2012); Panels A and B plot the change in average annual growth against the change in average annual temperature between the periods 1970-1985 and 1986-2000, for rich and poor countries respectively.

MGNREGA Sameeksha: Excellent anthology of research studies on the world’s largest public works program

The Indian government has come out with a comprehensive review of the available reports and papers on MGNREGA, the largest public works program in the world. Below are excerpts from an article based on the MGNREGA Sameeksha—An anthology of research studies on the Mahatma Gandhi National Rural Employment Guarantee Act, 2006-2012.

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[…] Has the MGNREGA really built assets, or has it just been a compendium of useless earth work? Has it created a lazy workforce that is affecting our work culture? Has it negatively affected agriculture by drying up the labour market? Has the MGNREGA become the biggest source of corruption in rural India? Has it failed to arrest distress migration? Has it helped household income, and reduced hunger in the poorest households?

[…] the oft-repeated aggressive assertion that MGNREGA does not build useful assets has been made without the support of any study to justify this claim. These assertions arise very often from fleeting visits to roadside worksites, with insufficient time for anything more than an anecdote. This off-the-cuff dismissal of “useless earth works” arises from a group which often lives on the other side of a fractured India, for whom mud and dirt become synonymous! It also raises the pertinent question of what indeed is a productive asset — a village tank that recharges 40 wells, or only a work of brick and mortar.

[…] by and large, show that sustainable assets have been created. A study of the best performing water harvesting assets in Bihar, Gujarat, Rajasthan, and Kerala for instance show the potential of these works where a majority of the assets studied had a return on investment of well over 100 per cent, with investment costs recovered in less than one year! Perception-based surveys, including those carried out by the National Sample Survey Organisation (NSSO) in three States showed that the vast majority of assets were being used, and the people found them useful.

[…] it has provided livelihood and income security, decreased the incidence of poverty, increased food intake, reduced mental depression, positively affected health outcomes, and been successful as a self targeting scheme — as the poorest and most marginalised communities have sought work. In many States, it has decreased gender differential in wages, increased real wages accompanied by an increase in agricultural productivity and growth. This increase in agricultural productivity could be due to the watershed and water harvesting works, as well as the land development work on the fallow private lands of SC, ST and BPL families to make them productive. The studies do not bear out the assertion that MGNREGA has caused a shortage of farm labour.

[…] poor implementation in many places. Average wages paid are lower than minimum wages; there is a distressing delay in the payment of wages; demand is not properly captured (an NSSO survey found 19 per cent of people who wanted work did not get it); dated receipts for work applications are not properly given; and the payment of unemployment allowance is a rarity. There is a shortage of staff, and there are many instances of irregular flow of funds. Non-compliance with proactive disclosure provisions such as muster rolls being available at worksites continues to be a problem in some States. As a result, leakages and corrupt practices continue to exist. While social audits in Andhra Pradesh have significantly increased awareness and identified fraud, Sameeksha notes that social audits are a facade in most other States.

[…] Ten crore bank and post office accounts have been opened, bringing about financial inclusion, and reduced corruption in wage payments, but the delay in payments through such accounts is a major cause of distress.

[…] thanks to the MGNREGA offering alternative work, hundreds of bonded labour (Saheriya adivasis) in Rajasthan freed from generations of bondage. People have been saved from destitution in Uttar Pradesh, Bihar, Orissa, and Chhattisgarh, women have been empowered and are participating in huge numbers in Tamil Nadu, and the programme is even showing very positive results in “non-NREGA” States like Himachal Pradesh and Kerala.

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For more on MGNREGA, see previous blog posts here.

Load-shedding’s load on the Nepali economy

It was published in Nepali Times, ISSUE #620 (31 AUG 2012 - 06 SEPT 2012).

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Load on the economy

Besides the inconvenience, long hours of load-shedding will severely stunt the country's economic growth

Looking at the poor monsoon rains, rising demand and close to stagnant electricity production, Nepal Electricity Authority (NEA) projected that without immediate remedial measures load-shedding during winter could reach as high as 20 hours per day.

Prime Minister Baburam Bhattarai convened a meeting of stakeholders and asked them to limit load-shedding to 12 hours like last year. The Ministry of Energy (MoE) then floated a proposal whose immediate implementation would help the government reach its target. The plan includes construction of a 15 km transmission line to carry electricity from India during winter, operation of multi-fuel plants in Duhabi and Hetauda, construction of the Khimti-Dhalkebar transmission line, reduction of leakages, purchase of additional electricity from India, and expediting work in hydro projects.

However, as it stands now, the reality is that load-shedding will definitely go beyond 12 hours. There are no quick fixes to our power crisis unless production catches up with soaring demand. Meantime, as in previous years, hours of darkness will continue to erode the competitiveness of Nepali goods and services, weaken the industrial sector, widen trade deficit, and jeopardise fiscal balance.

Currently, electricity demand during peak time is around 1000MW, but supply is barely 700MW during summer and 400MW during winter, which includes total NEA production from hydro and thermal, purchase from the private sector, and import from India.

Of the total availability, NEA supplies 55 per cent (including both hydro and thermal), private sector contributes 27 per cent, and 18 per cent is imported from India.

As a result of increase in purchasing power boosted by remittances, trading services are booming. Furthermore, new consumers, which doubled between 2005 and 2011, seeking electricity from the grid are also increasing annually. While demand increases by around 100MW every year, electricity production is moving at a snail's pace.

First, due to the inadequate supply of electricity, firms will be forced to depend on petroleum products (especially diesel, which carries the most weight in NOC's losses and whose consumption more than doubled between 2007-08 and 2010-11) to power up their factories and offices. This will increase the cost of production and erode competitiveness of Nepali goods and services. Since cost of domestically produced goods might be higher than the cost of imported goods of similar nature, industrial activities may continue to further slowdown. Besides, power generated from diesel run generators can fulfil only 25 per cent of total electricity demanded by firms.

Nepal is already ranked as the least competitive economy in South Asia with high cost of doing business. According to Enterprise Survey (ES) 2009, lack of electricity is the second biggest obstacle to investment and is inflicting losses of 27 per cent of annual sales.

Second, exports, especially those of the manufacturing sector, will continue to be hit by mounting costs, leading to further slowdown of manufacturing output, which has already declined from 7.6 per cent of GDP in 2004-05 to 5.8 per cent of GDP in 2011-12. Meanwhile, new investments except for in services and hydropower sectors might decline as in the past. Worse, some of the existing firms will go out of business and most will operate below potential. All of these will hit economic activities and employment opportunities.

Third, the rise in demand for petroleum products will mean long queues at petrol pumps and rationing of LPG cooking gas. The NOC will see its balance sheet deteriorate as it is forced by the government to subsidise diesel, kerosene and LPG. The increasing import of petroleum products, which was about Rs 96 billion against total merchandise export of about Rs 65 billion last year, will further widen the trade deficit. Generally, consumption of petroleum products is inversely related to the supply of electricity.

Fourth, the government will have to fork out more money for petroleum subsidies (around Rs 10 billion last year), putting extra pressure on fiscal deficit, which stands at about four per cent of GDP. A portion of tax revenue collected from taxpaying citizens will unfairly be used to subsidise diesel consumed in large quantity by those who can afford it in the first place, making it the most off-target subsidy.

Based on the current pace of construction, demand will continue to outstrip supply at least until 2017. Excessive politicisation of the hydro sector and inefficiencies within NEA have been the two biggest hurdles so far. And unless construction of hydro projects and new investment are ratcheted up drastically, the outlook remains grim.

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Review of Nepali economy in fiscal year 2011-2012

The annual macroeconomic update published by the central bank is one of the few government documents I eagerly wait for each year. Finally, the macroeconomic update for 2011-2012 is out.  The state of some of the most important macroeconomic variables are briefly discussed below.

GDP

• GDP growth rate: NRB uses the same figures provided by the CBS, i.e. projection of 4.63 percent GDP. For more on these, see an earlier blog post here.

Merchandise trade

• Total exports was Rs 74.26 billion, total imports was Rs 461.67 billion and total trade deficit was Rs 387.74 billion, an increase by 15.4 percent, 16.5 percent and 16.7 percent respective when compared to the previous year.
• This was largely helped by depreciation of Nepali currency against the dollar. As a share of GDP, exports, imports and trade deficit were 4.77 percent, 29.63 percent, and 27.86 percent of GDP (share of import and trade deficit was higher than the previous year).
• Import of petroleum products was Rs 92 billion, a solid 23 percent increase from the previous year.

Balance of payments

• BoP surplus reached Rs 127.70 billion (US$1.57 billion) compared to Rs 2.18 billion (US$34.7 billion) in the previous year. The increase in BoP surplus in local currency was 5758 percent while that in dollar was 362 percent!
• Current account surplus was Rs 75.98 billion (US$ 909 million)compared to a deficit of Rs 12.94 billion (US$177 million) in the previous year. The improvement was due to substantial rise in growth of remittances and favorable services account.
• Remittances reached Rs 359.55 billion (US$4.41 billion). Net services balance was Rs 14.06 billion.
• FDI was Rs 9.20 billion (Rs 6.44 billion the previous year).

Forex reserves

• Forex reserves increased to Rs 439.46 billion (US$4.96 billion), up from Rs 272.15 billion (US$3.84 billion) the previous year.
• Reserves in convertible foreign exchange was US$3.87 billion. Reserves in inconvertible foreign exchange was IRs 60.39 billion.
• Annual average exchange rate in 2011-12 was US$1=NPR 81.02, up from NPR 72.27 in 2010/11.
• NRB purchased Indian currency equivalent to Rs 213.95 billion by selling US$2.66 billion in the Indian money market. It was US$2.74 billion (INR equivalent to Rs 198.15 billion) the previous year.

Tourism

• Inflow of tourists via air was 595262, with Indian tourists accounting for 28.32 percent of it. Indian tourists increased by 29 percent in y-o-y basis.
• Total tourists via air and land was around 750000.

FDI

• The DoI approved 227 joint venture projects with FDI commitment of Rs 7.14 billion. In 2010-2011, it was 209 projects with FDI commitment of Rs 10.05 billion.
• Largest number of JV approved were from China, followed by India, USA and South Korea.

Foreign employment

• The DoFE granted employment permits to 384665 Nepali migrant workers, an increase by 8.4 percent from last year.
• About 27.5 percent went to Qatar, 25.6 percent to Malaysia, 20.9 percent to Saudi Arab, 14.1 percent to UAE, 6.4 percent to Kuwait and 5.5 percent to other employment destination.

Inflation

• Inflation was 8.3 percent (provisional figure). It will be much higher when the actual figures are computed. The current market prices of goods and services do not justify the low figure. Even the central bank figures show that between Jun/Jul 2010-11 and Jun-Jul 2010-11, inflation was 11.5 percent.

Debt

• Domestic financing of budget deficit amounted to Rs 36.41 billion, which is about 2.3 percent of GDP.
• Total domestic debt was Rs 198.12 billion.

Revenue and expenditure

• Government expenditure increased by 11.9 percent to Rs 310.75 billion (up from Rs 277.62 billion the previous year). Recurrent expenditure was Rs 231.79 billion and capital expenditure was Rs 40.83 billion.
• Revenue was Rs 244.15 billion, up by 22.2 percent. VAT constituted 29.6 percent of total revenue, customs 17.8 percent, income tax 21.4 percent, excise 12.5 percent, and non-tax revenue was 15.4 percent.

Monetary situation

• Money supply (M2) increased by 22.7 percent against 12.3 percent increase in the previous year. Significant rise in foreign assets (net increase by 59.1 percent compared to 1 percent increase in the previous year) of monetary sector was the main reason behind this increase.
• Domestic credit increased by 8 percent, which is a slowdown from 14.6 percent increase in the previous year. Reasons: high revenue mobilization but low public expenditure plus low growth of claims on private sector (thanks to sectoral credit limit in unproductive sectors).
• Deposit mobilization increased by 22.9 percent (Rs 188.59 billion) compared to 12.9 percent (Rs 94.13 billion) the previous year. Reasons: high remittances and modest increase in export earnings.
• Loans and advances of BFIs increased by 13.2 percent (Rs 112.78 billion) compared to 15.1 percent (Rs 111.91 billion) the previous year. Reason: merger of some finance companies with commercial and development banks.
• As of mid-July 2012, there are 32 commercial banks, 88 development banks, 70 finance companies, 24 microfinance development banks, 16 NRB licensed cooperatives, 36 NRB licensed NGOs, and 25 insurance companies. In just a year, the number of finance companies decreased from 79 to 70.