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.