Cartels everywhere

I am posting the following observation on this blog because a lot of people had strong opinion about it. Context: Water association called for a strike and halted water supply since Thursday (withdrawn on Sunday).

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A toxic mix of entrepreneurs, politicians and politico-entrepreneurs guided by quick gains from business and politics = Continuation of cartels and syndicates, though illegal, who bring the government to its keens and force it to backtrack decisions made in the interest of the public. As a result, you have cartels running the show from essential items to luxury goods supply:

(i) Water cartels shutting down supply because the government is trying to enforce strict standards; (ii) Petro cartels halting supply because the government isn't increasing commission and is monitoring their businesses for regulatory compliance; (iii) Gold cartels pulling down shutters because the government is inspecting their businesses in order to stop adulteration and to make them comply with weighing standards; (iv) Truck cartels halting vehicle movement because they are not allowed to charge three times the normal fare; (v) Taxi cartels calling for sudden chakka jam because they are not allowed to rig meters and charge astronomical fares to travelers; (vi) Veggie cartels shutting down veggie supply because the government wants to lower middlemen commission and regulate the market for any wrongdoing; (vii) Bus cartels vehemently opposing new vehicle addition to specified routes even though a majority of the existing ones are best suited for scrap works; (viii) Construction cartels resorting to violence in districts to win contracts for public construction, which are hardly constructed to the standard.

Few examples of how the cartels run the political and economic spheres in Nepal. Meantime, the government is just trying to adjust to these, without an urge to go hard on them.

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Sourced from Facebook.

The importance of a strong manufacturing sector for structural transformation

Dani Rodrik writes:

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Except for a handful of small countries that benefited from natural-resource bonanzas, all of the successful economies of the last six decades owe their growth to rapid industrialization. If there is one thing that everyone agrees on about the East Asian recipe, it is that Japan, South Korea, Singapore, Taiwan, and of course China all were exceptionally good at moving their labor from the countryside (or informal activities) to organized manufacturing. Earlier cases of successful economic catch-up, such as the US or Germany, were no different.

Manufacturing enables rapid catch-up because it is relatively easy to copy and implement foreign production technologies, even in poor countries that suffer from multiple disadvantages. Remarkably, my research shows that manufacturing industries tend to close the gap with the technology frontier at the rate of about 3% per year regardless of policies, institutions, or geography. Consequently, countries that are able to transform farmers into factory workers reap a huge growth bonus.

To be sure, some modern service activities are capable of productivity convergence as well. But most high-productivity services require a wide array of skills and institutional capabilities that developing economies accumulate only gradually. A poor country can easily compete with Sweden in a wide range of manufactures; but it takes many decades, if not centuries, to catch up with Sweden’s institutions.

Consider India, which demonstrates the limitations of relying on services rather than industry in the early stages of development. The country has developed remarkable strengths in IT services, such as software and call centers. But the bulk of the Indian labor force lacks the skills and education to be absorbed into such sectors. In East Asia, unskilled workers were put to work in urban factories, making several times what they earned in the countryside. In India, they remain on the land or move to petty services where their productivity is not much higher.

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Important message: A meaning structural transformation would require “an industrialization drive, accompanied by the steady accumulation of human capital and institutional capabilities to sustain services-driven growth once industrialization reaches its limits.”

Cautionary note:

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But this time-tested recipe has become a lot less effective these days, owing to changes in manufacturing technologies and the global context. First, technological advances have rendered manufacturing much more skill- and capital-intensive than it was in the past, even at the low-quality end of the spectrum. As a result, the capacity of manufacturing to absorb labor has become much more limited. It will be impossible for the next generation of industrializing countries to move 25% or more of their workforce into manufacturing, as East Asian economies did.

Manufacturing industries will remain poor countries’ “escalator industries,” but the escalator will neither move as rapidly, nor go as high. Growth will need to rely to a much greater extent on sustained improvements in human capital, institutions, and governance. And that means that growth will remain slow and difficult at best.

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Recent depreciation of Nepali rupee: Causes and impacts

Further to the earlier blog post, here is an updated analysis of the recent weakening of the Nepali rupee.

The figure shows the daily nominal exchange rate between Nepali rupee and US dollar. The Nepali rupee, which is partially convertible, is consistently weakening against major global currencies especially after FY2011. 

The yearly average exchange rate (buying) was Rs 70.20 per dollar in FY2007. It dropped to Rs 64.72 in FY2008, then climbed to Rs 76.58 in FY2009 before dropping to Rs 74.24 in FY2010 and Rs 72.47 in FY2011. It sharply depreciated to Rs 80.73 in FY2012. It has depreciated even more in FY2013 so far, reaching Rs 93.65 on 20 June 2013 (selling rate was Rs 94.25). Between 16 July 2011 (start of FY2012) and 20 June 2013, the Nepali rupee has depreciated by about 32%. 

Nepal has been maintaining a pegged exchange rate to the Indian rupee for a long time. The peg of NRs 1.60= IRs 1.0 has not been revised since 1993. Hence, the exchange rate with other currencies depends on the movement of the Indian rupee against convertible currencies. There is little the central bank can do to influence the exchange rate of Nepali rupee vis-à-vis convertible currencies. That said, the fluctuations in exchange rate do affect current account balance (mainly trade balance and remittance inflows), inflation, debt payments, and dollar denominated obligatory transactions/investments in Nepal. More on this in a minute, but for now let us focus on the causes of the sharp depreciation of Nepali rupee against the convertible currencies. 

As mentioned earlier, the exchange rate would follow the movement of Indian rupee vis-à-vis the convertible currencies. The weakening of Indian rupee is caused by both internal and external factors. First, the slow economic performance along with the setback in passing investor friendly policy reforms/legislation have lowered investor’s confidence, resulting in weak capital inflows. This combined with the high current account deficit have led investors to sell off debt in the Indian market, which alternatively means less demand for Indian currency. Second, the rise in imports of petroleum products and gold (recently the Indian government even raised tariff on gold import to 8% from 6%) has led to high dollar demand in the Indian market, which also means less demand for Indian currency. Third, the continued slowdown and uncertainty (economic and sovereign debt) in the EU have meant that investors are still looking for safe place for investment, which traditionally is either gold or the US dollar. Hence, the demand for US dollar is going up. Fourth, investors are expecting the US Federal Reserve to curb its massive quantitative easing (QE) by the end of this year, prompting them to demand dollar well in advance in anticipation of tighter liquidity and high interest rate later on. 

Some of these are recent phenomena and might change quickly (such as the perception about the Indian economy in response to investor friendly policy gestures), leading to fluctuations in exchange rate. But, some of these are persistent ones (such as the uncertainties surrounding recovery in the EU economies), leading to higher demand for dollar. While the latter strengthens the dollar and pushes it up each year, the former induces fluctuations at higher level. Hence, Nepali rupee (following the path of Indian rupee) is consistently depreciating as well as fluctuating at high level. Indian investors are anticipating IRS 60 per dollar soon, which could mean NRs 96 per dollar. But, it is contingent upon the factors discussed earlier. 

Now, how would this impact Nepali economy? 

First, a depreciating currency usually makes exports competitive, leading to rise in export earnings. Unfortunately, Nepal cannot take full advantage of this because of the high cost of production arising from power shortages, labor disputes (high minimum wage not commensurate with productivity compared to other South Asian economies), high import content of manufactured goods (thus driving up cost of raw materials as currency depreciates), and other structural bottlenecks as well as supply-side constraints (low quality human capital, low R&D, and strikes, among others). Furthermore, the weak EU and the US economies has meant a weaker demand for imports there (our exports) as well. 

Second, it will affect imports and might worsen current account balance depending on the level of remittance inflows, which have registered a slower growth (both in dollar and rupee terms) thus far this fiscal year. For the same quantity of goods, everything else remaining constant, importers will have to pay more to purchase dollars to pay foreign suppliers. It will jack up imports bill. Usually, a depreciating currency would translate into weakening of import demand. But, since Nepal’s import is relatively price inelastic (i.e., change in quantity imported is less than the change in import price), there won’t be much impact (also petroleum fuel import is a major component of total import). Moreover, given the consumption behavior, which is hinged on remittances-backed imported goods and services, and the weak domestic production base, it is unlikely that imports will do down. That said, it might also increase tax revenue from imported goods. 

Third, the rise in import bill will be reflected in the final prices of retails goods and services. Specifically, the rise in cost of petroleum imports will either lead to worsening of the already bad balance sheet of NOC or increase prices of petroleum fuel in the market, depending on whether the government opts for price rationalization or absorption of costs in terms of subsidy (its has implications on fiscal sustainability too!). It might then have spillover effects on transport and retail prices. Ultimately, it will mean inflation, which is above 10% so far this year, will further go up. 

Fourth, there is an incentive to remit more money to Nepal when currency depreciates. We have seen this in FY2012 as well. It will positively impact financial sector liquidity and current account balance. A part of the marginal increase in cost of imported goods due to weakening currency would be offset (in terms of purchasing power) by the marginal increase in purchasing power due to higher remittance income (of course, it will be limited to remittance receiving 56% of households).

Fifth, entities such as NEA will have to make larger payments to companies— Bhote Koshi and Khimiti hydropower projects— with which it has power purchase agreement in dollars. It will worsen its already bad balance sheet. Furthermore, the country’s (foreign) debt service payment goes up when currency depreciates.

More on the exchange rate here.

Weakening Nepali rupee

On 7 October 2012, the exchange rate was NRs 82.39 per US dollar. On 20 June 2013, it was NRs 93.65 per US dollar. It indicates a nominal depreciation of about 14%. Compared to the level in 16 July 2011, the nominal depreciation is about 32%. In the last twenty days, the depreciation is about 4%. 

Since Nepal has pegged its currency to the Indian rupee, the exchange rate closely follows the path of the Indian rupee against the dollar. More on the recent rocky path of rupee later.

Higher government wages may reduce corruption in poorer countries

So says a new paper by de Haan et al. (2013). They argue that government wages have a significant negative impact on corruption when income is $8,842 or less. Very interesting findings that is intuitive as well.

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Using this new database, we construct a relative government wage indicator as the ratio of government wages to the average wages in the manufacturing sector and estimate the relationship between corruption and this indicator, controlling for other variables that previous studies found to be related to corruption. When the impact of government wages on corruption is assumed to be linear, as previous studies do, we find that one unit increase in the wage indicator, which is equivalent to raising government wages by the average of wages in manufacturing reduces corruption, measured on a scale from zero to six, by only 0.35. This result suggests that using government wages to combat corruption is rather costly, similar to the conclusion by Van Rijckeghem and Weder (2001).

However, the nature of corruption might be different at different levels of economic development. In low-income countries, corruption often consists of petty corruption, which involves tiny amounts of money, appears in a rampant manner and is easy to detect. Road bribery in India, where traffic policemen openly collect bribes from passing trucks (Bardhan 2006), or the extra payment to obtain a birth certificate in Cambodia (Feinberg 2009) are typical examples. In high-income countries, petty corruption is less common because wages are above subsistence level. Corruption in these countries, if present, involves more secret deals, brings about larger payoffs, and is more difficult to detect. Government wages will arguably be less effective to combat the latter form of corruption.

By including an interaction term between government wages and economic development, we allow the impact of government wages on corruption to vary with the level of economic development. Controlling for a large number of other determinants of corruption and country specific effects (which in our view are important because corruption changes very slowly and appears to be country specific), we find that the estimated coefficient of government wages is negative but the coefficient of the interaction term is positive. This suggests that the role of government wages in reducing corruption decreases as countries become richer.

Government wages have a significant negative impact on corruption when income is $8,842 or less. Above this income level, no significant relationship can be established. The impact of government wages on corruption is moderated by the level of income per capita. The poorer a country is, the stronger the negative impact of higher government wages on corruption is.

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How about Development Impact Bonds?

The Development Impact Bonds (DIB) Working Group (co-chaired by Owen Barder, Center for Global Development) has put out an innovative idea to enhance the effectiveness of development interventions by taking into account two crucial aspects: the complexity of delivery and the need for adaptation and flexibility.

DIBs are “outcomes-based contract that can bring together the private sector, civil society organisations, governments and donors, in a way that captures and complements the strengths which each player can bring to achieve development  outcomes, and buttressing their respective weaknesses.”

Excerpts from the Working Group’s report:

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Development Impact Bonds (DIBs) respond to both of these  imperatives. They use private investment flows to provide upfront risk  capital for development programmes, only calling on donor funding  to repay that capital (plus a potential return) once clearly defined and  measured development outcomes are achieved.

Under a DIB, all interested parties agree a desired social outcome and a metric for measuring success. Private investors bank-roll a programme to achieve the outcomes. The programme itself is carried out by specialised service providers, and investors are paid back by an outcome funder (usually a donor agency) if – and only if – independently verified evidence shows that the programme has been successful.  The greater the measured success of the programme, the greater the return to investors, up to a cap. Typically, an intermediary organisation will coordinate between investors, the outcome funder, and service providers, representing the parties not in the room and negotiating an agreement that fits the needs of all.

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Recommendations by the DIB Working Group:

• Donors should establish a DIB Outcomes Fund and investors should establish DIB Investment Funds, which would enable these actors to share risks and pilot a range of DIB models.
• DIB pilots should be evaluated rigorously and a group of donors and philanthropic organisations should set up a DIB Community of Practice to share and accelerate learning.
• DIBs should be open by design. Openness will accelerate confidence in DIBs for investors, governments, service providers and taxpayers and help to build a high quality market. Donors and foundations should establish a research data protocol which would provide a standard of data and facilitate information-sharing.
• DIB parties will have to accept the high transactions costs of early DIB pilots. Foundations should consider subsidising these costs by providing funding to catalyse the development of a DIB market.

Monsoon and agriculture production in FY2013 in Nepal

FY2013 has been a disappointing year for Nepal, both politically and economically. Political disagreement continues (though with a slightly optimistic pointer following a technocratic government and its mandate to hold elections by December 2013). 

On the economic front, it has been even more disappointing. Real GDP growth (at basic prices) is projected to drop to 3.6% in FY2013, down from 4.5% in FY2012 (ADB projected it to be 3.5%; the IMF says it might be even below 3%), thanks to the unfavorable (late and low) monsoon, shortage of chemical fertilizers during peak planting season, a slight decline in growth of remittances, and the continually weak industrial sector. 

GDP_NEPAL	FY2011	FY2012R	FY2013P
GDP growth rate (basic prices)	3.85	4.48	3.56
Primary Sector	4.48	4.98	1.31
Secondary Sector	4.4	2.96	1.49
Tertiary Sector	3.42	4.51	6.03
Composition of GDP (%)
Primary Sector	37.37	36.31	35.32
Secondary Sector	14.94	14.30	14.35
Tertiary Sector	47.69	49.39	50.33

The Ministry of Agriculture Development (MoAD) has come up with new estimates for agriculture production for FY2013. And, its not good (more here), thanks mostly to the unfavorable monsoon:

• Production of paddy and maize declined to 4.5 million tons and 1.99 million tons, respectively (a drop by 11.3 percent and 8.3 percent, respectively).
• Production of millet also went down by 3 percent to 305,588 tons.
• Production of wheat, barley and buckwheat increased by 2 percent, 6 percent and 0.3 percent, respectively to 1.88 million tons, 36973 tons and 10,056 tons.
• Total food surplus will decline to 408,000 tons this year from 8 86,000 tons recorded in the last fiscal year.
• Total food available for consumption in the form of milled rice and flour will remain at 5.64 million tons. Around 5.24 million tons of food is needed to feed an estimated 27.5 million people whose per capita consumption has been recorded at 191 kg.
• Rice deficit of 900,000 tons, but  maize and wheat surpluses of 262,000 tons and 1.05 million tons, respectively.
• Number of districts facing food deficit has increased by six to 33 in FY2013.
• Food production in Tarai expected to drop to 429,238 tons in FY2013 from 777,600 tons in FY2012.
• Similarly, mountain and hilly regions to record deficit of 15,767 tons and 5,029 tons respectively in FY2013.

The importance of agriculture for inclusive development and to support modest economic growth cannot be overstated. About 76.3 percent of households in Nepal depend on agriculture for livelihood and 83 percent of the population lives in rural areas, which is mostly agriculture dependent. Furthermore, the agricultural sector constitutes about 35 percent of the country's GDP.

With a normal monsoon in FY2013 and timely availability of chemical fertilizers, agriculture sector might post a growth rates close to 5%. This combined with a rise in growth of remittance inflows, which supports services sector growth, might push overall GDP growth (at basic prices) well above 4%.

Low capacity utilization of Nepalese industries

The figure shows the capacity utilization, which is the realized portion of total production potential in the review period, of major industries in Nepal. The data for it are sourced from the survey  carried out twice a year by the Nepal Rastra Bank in key industrial areas such as Kathmandu, Biratnagar, Janakpur, Birgunj, Pokhara, Siddarthanagar, Nepalgunj and Dhangadi.

The latest survey findings reveal that the capacity utilization of domestic industries has improved to 45% of potential capacity in the first six months of FY2013, up from 38% in the same period in FY2012. However, this level is still low and indicates that Nepal’s industries are operating far below the potential capacity. Capital and labor employed by industries have not been able to use their potential fully to meet the actual production capacity. Capacity utilization of industries tends to be higher towards the end of the fiscal year, when there is also more electricity supply due to higher electricity production during wet season. The full year capacity utilization in FY2012 and FY2011 was 58% and 54%, respectively.

In the first six months of FY2013, six industries had capacity utilization above 50% of total potential production capacity. These are beer (77%), pashmina (77%), suti clothes (63%), soap (55%), processed tea (51%) and cement (50%). The capacity utilization of four industries was below 30% of total production potential capacity. These are vansapati ghee (27%), biscuit (26%), cigarette (23%) and sugar (11%). Note that production is seasonal for some products and hence production is either low or high depending on the planting and harvesting season. Looking at full year figures, garment, bricks, electric wire, and noodles had capacity utilization over 80% of total production potential in FY2012. Similarly, lowest capacity utilization was that of iron (29%), cigarette (24%), and vansapati ghee (22%).

Not only is the capacity utilization of industries is low, total production capacity of most industries itself is decreased. The production capacity of biscuit, sugar, beer, paper, soap, bricks, cement, electric wire and process leather decreased between FY2012 and FY2011. Meanwhile, production capacity of noodles, suti clothes, and iron increased. Looking at production capacity in the first six months of FY2013 and FY2012, production capacity of biscuit, noodles, beer, paper iron and electricity wire increased.

What is contributing to the low capacity utilization of Nepal’s industries? It has to do with persistent supply-side constraints and structural bottlenecks.

First, the lack of adequate supply of electricity is the major binding constraint. The long hours of power cuts, especially during dry season, severely curtails the operation hours of industries. This limits production below the potential. For those who can afford for it, diesel run generators are the savior. But, it comes with high per unit cost as well. It means uncompetitive production, resulting in loss of market. Ultimately, the lower market demand due to high per unit cost (slightly differentiated imported products become relatively cheaper) means lower production and below potential capacity.

Second, the recurring labor-industry disputes over wages, allowances and facilities have led to either closure or partial operation of manufacturing plants. Labor disputes prolong for days and this not only shuts down machineries, but also forces employers to incur higher cost of operation (capital stays idle and workers have to be paid even if they go on a strike). Nepal faces a situation where minimum wage in manufacturing sector is the highest in South Asia, but productivity is one of the lowest.

Third, the lack of innovation and research and investment leads to less than optimal utilization of available stock of capital. Workers are not adequately trained to operate and supervise operation of newly introduced machineries. Furthermore, the industry hardly invests in R&D and hence there is barely any innovation in production as well as marketing of products.

Some of the constraints are long running and immediate solutions are impossible. These include supply of adequate electricity and R&D leading to innovation. If Nepal wants to have a strong industrial sector in the medium term (say 5 to 10 years from now), then the groundwork has to be started in a war footing. This should include urgent preparation of all the necessary policy, regulatory, legal and institutional frameworks. With an earnest dialogue and assessment of the (un)competitiveness of Nepali production among labor unions, employers and government, labor-industry relations can be improved. It would help in enhancing capacity utilization in the short-term itself.

Overall, political stability and good governance are paramount to effectively utilize the potential of our industries.