12 post-2015 development agenda relevant to Asia and the Pacific

Below are the 12 post-2015 development agenda (relevant to Asia and the Pacific) proposed in a new joint study by ESCAP, ADB and UNDP:

1. Zero income poverty – The region should build on its recent achievements in poverty reduction and set an ambitious goal of ‘zero poverty’.

2. Zero hunger and malnutrition – The aim should be universal food security, through among other things, much more attention to agriculture.

3. Gender equality – Gender will need to be assessed comprehensively, with more indicators on empowerment and on violence against women.

4. Decent jobs for everyone of working age – This would require full and productive employment and government commitment as an ‘employer of last resort’ translated into an explicit recognition of employment goals and targets in all policies and programmes.

5. Health for all – Priority should go to maternal, newborn and child health, universal access to sexual and reproductive health, including family planning, and to reducing the prevalence of communicable diseases and controlling the spread of non-communicable diseases.

6. Improved living conditions for all – Everyone should have access to safe and sustainable drinking water and sanitation, as well as basic energy services.

7. Quality education for all – This should start with early childhood care and education, followed by higher quality education at all levels, including adult literacy and lifelong learning, and providing learning and life skills for young people and adults.

8. Liveable cities – The poorest city dwellers should have effective shelter and secure tenure along with essential social infrastructure. They should also have access to affordable, safe and energy-efficient mass transport.

9. Environmental responsibility and management of natural resources – This will mean protecting critical ecosystems while reducing resource intensity and avoiding overexploitation of natural capital. At the same time countries will need to address climate change.

10. Disaster risk reduction – The region has witnessed natural disasters that have wiped out long-term development efforts. Any new development agenda should help mainstream disaster risk reduction in national budgets and development programmes.

11. Accountable and responsive governments – There is a call for more accountable, transparent and effective government at both national and local levels for more capable and efficient management of public resources and service delivery.

12. Strong development partnerships and reformed global governance – Countries in Asia and the Pacific will benefit from global and regional partnerships to manage global public goods, particularly in finance, health, trade, technology transfer, environment, and climate change. The reform of global governance should reflect the Asia-Pacific ascendance in the global economy. The prospect and scope of financial and economic crises and commodity price volatility must be minimized in order to protect development gains.

Linking smallholders to markets

A majority of farmers are smallholders and supporting them is the key to a sustained structural transformation and poverty reduction. Linking them with markets would do a great deal in moving forward in that direction.

It would require (according to to a new report by ODI—Leap & Learning: Linking Smallholders to Markets):

• Business case for smallholders and their partners in supply chains (enabling rural investment climate and provision of public goods)
• Good linking approaches (facilitation, learning, flexibility, clear exit strategies)
• Organizing the links (private sector participation, contracting, cooperatives)

Necessary condition:

• An enabling investment climate (peace, security, macroeconomic stability, property rights, rules pertaining to standard and measurement)
• The provision of rural public goods provisioned by the state (roads, power, education, healthcare, drinking water, agriculture R&D)

Also, enhancing access to inputs, technical advise, insurance, credit and other financial services is required.

Nepalese economy in FY2013: External sector

[This blog post is adapted from Nepal’s Macroeconomic Update, August 2013, published by the ADB. Here is a previous blog post on real sector, fiscal sector and monetary sector.]

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EXTERNAL SECTOR

Exports

Export performance has continued to be sluggish. Merchandise exports (fob) registered a decline of 2.9% in FY2013 in US dollar terms, down from a growth of 6% in FY2012.[1] Exports in FY2013 totaled $981 million, down from $1 billion in FY2012, reflecting weak export demand as well as the continued decline in competitiveness arising from the rising costs of production, power shortages, and political uncertainties. Overall, merchandise exports declined to 5.1% of GDP in FY2013 from 5.3% of GDP in FY2012.

The top five exports to India were pulses ($64.1 million), raw jute ($56.5 million), rice barn oil ($32.8 million), stone and sand ($46.9 million), and polyester yarn ($43.9 million. Meanwhile, the top five exports to other countries were woolen carpets ($69.3 million), readymade garments ($35.2 million), pulses ($30.5 million), pashmina ($18.9 million), and tanned skin ($11.5 million). While the export of agriculture and processed goods is increasing, garments and manufacturing are decreasing (Figure 29).

Figure 1: Top five exports to India and third countries ($ million)

Source: Nepal Rastra Bank

Imports

Merchandise imports (cif) in dollar terms grew by 10.8%, up from 4.5% in FY2012. Of the total imports of $6.2 billion in FY2013, 19.6% was oil imports. In US dollar terms this is equivalent to $1.2 billion, higher than value of the country’s total exports. In FY2012, oil imports accounted for 20.3% of total imports. The high quantity of oil imports reflects the rising demand for petroleum products largely due to the persistent and long hours of power cuts and the depreciating Nepali rupee. Overall, merchandise imports increased to 32.2% of GDP in FY2013 from 29.6% of GDP in FY2012.

The five top imports from India were petroleum products ($1,222.3 million), vehicle & spare parts ($300 million), steel billets ($254.5 million), medicine ($152.2 million), and other machinery and parts ($137.1 million). Top imports from other countries were gold ($297.9 million), telecommunication equipment ($153.9 million), crude soya oil ($121.2 million), silver ($100.2 million), and other machinery and parts ($92.8 million).

Figure 2: Top five imports from India and third countries ($ million)

Source: Nepal Rastra Bank.

Remittances

Remittance income has continued to grow with increased labor migration reaching $4.9 billion (25.5% of GDP) in FY2013, from $ 4.4 billion (23.4% of GDP) in FY2012. Growth of labor migration (those who obtained permits from the Department of Foreign Employment) was 17.9%, higher than the 8.4% growth in FY2012. However, remittance inflow growth decelerated to 11.3% from 26.6% in FY2012. The country received $4.9 billion in workers’ remittances in FY2013, up from $4.4 billion in FY2012. Despite the growth of migrants, the growth of remittance inflows declined partly because: (i) the relatively high wage offering countries such as South Korea and Japan slashed demand for Nepali workers by 24.8% and 17.1%, respectively; and (ii) the demand for Nepali workers in Israel, Lebanon, Afghanistan, Bahrain and Qatar, among others, also fell.

Figure 3: Remittances (% of GDP) and number of labor migrants

Source: Department of Foreign Employment and Nepal Rastra Bank.

A total of 453,543 migrants left to work overseas in FY2013 (daily average of 1,243 migrants), up from 384,665 in FY2012 (daily average of 1,054 migrants). Malaysia, Qatar, Saudi Arabia and the United Arab Emirates have remained the top destinations for Nepali migrants. These destinations combined account for over 85% of total overseas labor migration (Figure 32). As a share of total migration, labor migrants to Malaysia increased from 25.6% in FY2012 to 34.6% in FY2013, largely because of the relatively attractive pay packages offered by Malaysian companies, especially in the industrial and plantation sectors. Consequently, the growth of remittance inflows is expected to be higher in FY2014.[2] In FY2013, the surge in workers’ migration to Malaysia and other countries more than offset the decline in the number of migrants to the countries listed above.

Figure 4: Destination-wise distribution of labor migrants

Note: Migrants to India are not included as they do not require employment permits.

Source: Department of Foreign Employment.

Balance of Payments

Although the country’s external situation continues to be stable, it weakened somewhat in FY2013. Overall, the balance of payments surplus declined to $786.5 million (4.1% of GDP) in FY2013 from $1.6 billion (8.6% of GDP) in FY2012. The year saw a widening of the trade deficit to $5.3 billion (27.1% of GDP) from $4.6 billion (24.3% GDP) in FY2012. The surge in the trade deficit coupled with the deceleration of remittance inflows (growth of 11.3% in FY2013 as against 26.6% in FY2012) sharply lowered the current account surplus of $941.3 million (4.9% of GDP) in FY2012 to $651 million (3.4% of GDP) in FY2013. Both the capital account and financial account registered a significant decline (by 30.8% and 47.8%, respectively) in FY2013. Foreign direct investment registered a decline of 9%, totaling $103.6 million, down from $113.9 million in FY2012. Gross foreign exchange reserves increased from $5.0 billion in FY2012 to $5.6 billion in FY2013, sufficient to cover 10.1 months of import of goods and non-factor services.

Figure 5: External sector (% of GDP)

Source: Nepal Rastra Bank; NRM staff estimates.

Exchange Rate

The Nepali rupee has been continuously depreciating against the US dollar since October 2012, closely following the currency movement of the Indian rupee, to which it is pegged (Figure 34). Overall, the Nepali rupee depreciated by 25.7% between 15 July 2011 and 15 July FY2012 and a further 7.2% between 15 July 2012 and 15 July 2013.

The concerns over the economic slowdown in India, its large current account deficit, and the continued economic woes in the Euro Zone along with concerns over the curbing of quantitative easing by the US Federal Reserve Bank have triggered the weakening of the Indian rupee. The NRB has little traction on exchange rate movements. The sharp depreciation of the Nepali rupee has a number important macroeconomic implications: (i) weaker financial health of Nepal Oil Corporation due the persistent gap between its import costs and selling price, (ii) increased overall import bill as Nepal’s imports are relatively price inelastic, leading to a wider trade deficit; (iii) increased inflation as higher import prices get reflected in retail prices; (iv) increase in Nepal Electricity Authority’s payments to independent power producers whose prices are denominated in foreign currency, and (v) increase in debt service payments. On the positive side, remittance inflows will increase as migrant workers will have more incentives to remit money back home.[3] Similarly, exports could rise to some extent (but subject to recovery of external demand and increase in domestic industrial capacity utilization, which stands at around 60%).

Figure 6: Daily nominal exchange rate (NRs per $)

Source: Nepal Rastra Bank.

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Notes:

[1] The exchange rate used is the average of monthly rates. It was NRs 72.1, NRs 80.7 and NRs 87.7 per dollar in FY2011, FY2012 and FY2013, respectively.

[2] Note that it could still be lower than the 26.6% growth in FY2012.

[3] It may be noted that almost 80% of remittances flowing to households is used for daily consumption and just 2.4% in capital formation.

[Presentation] Remittances in Nepal: Boon or Bane?

Fore more, see an earlier blog post on the same issue.

Nepalese economy in FY2013: Monetary sector

[This blog post is adapted from Nepal’s Macroeconomic Update, August 2013, published by the ADB. Here is a previous blog post on real sector and fiscal sector.]

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MONETARY SECTOR

Inflation

Although inflation (year-on-year average CPI) moderated to 8.3% in FY2012 from 9.6% in FY2011, it climbed to 9.9% in FY2013, higher than the 9.5% revised target set during the mid-term review of the FY2013 monetary policy. It consistently remained above 10% till mid-December 2012, declined to 9.8% in mid-January 2013, increased to double-digits for the two subsequent months, and then moderated during the last four months of FY2013. Overall, inflation remained higher in all the months of FY2013, except for the last two months, compared to the level in the corresponding months in FY2012 (Figure 1). The high prices reflected the low agriculture harvest, high prices in India, cost escalation due to the depreciation of Nepali rupee, upward adjustment of administered fuel prices[1], power shortages and persistent supply-side constraints.

Figure 1: Year-on-year inflation (% change) Source: Nepal Rastra Bank.

Overall, both food and non-food inflation rates increased in FY2013. While food and beverage prices increased by 9.7% from a rate of 7.7% in FY2012, non-food and services prices continued the increasing trend, reaching a rate of 10.1% in FY2013 from 9% in FY2012 and 5.4% in FY2011 (Table 1). The increased food prices reflects the low agriculture harvest, rise in transport cost transmitted to retail prices[2], and the higher import prices of agriculture products. Meanwhile, the high non-food and services prices, which has a 53.2% weight in the overall CPI index, reflects the price increase of imported goods due to higher external prices as well as the depreciation of the Nepali rupee. On the domestic side, persistent structural bottlenecks and supply-side constraints have contributed to keeping prices at a higher level. Structural bottlenecks include low quality human resources and deficient skills, weak backward and forward linkages, fragmented value chains, negligible research and development (R&D) investment, distorted labor market characterized by high minimum wages and low productivity, and policy inconsistencies, among others. Furthermore, supply-side constraints include the lack of adequate supply of electricity, transport bottlenecks, lack of raw materials leading to high import content of manufactured goods, inadequate supply of key inputs to boost productivity, and strikes, among others.

Table 1: Average annual inflation (% change)

Year	Overall	Food	Non-food
FY2010	9.6	15.1	4.9
FY2011	9.6	17.7	5.4
FY2012	8.3	7.7	9.0
FY2013	9.9	9.7	10.1

Source: Nepal Rastra Bank.

Compared to prices in FY2012, food and beverage inflation remained higher in FY2013 in all months except in mid-October 2012 and the last two months of FY2013 (Figure 2). Non-food and services inflation remained higher till mid-January 2013 when compared to the prices in the corresponding months in FY2012 (Figure 3).

Figure 2: Year-on-year food inflation (% change)

Source: Nepal Rastra Bank.

Figure 3: Year-on-year non-food inflation (% change)

Source: Nepal Rastra Bank.

FY2014 Outlook

Despite the expected improved agriculture harvest, considering the wage pressures, persistently high price level in India, the rise in administered fuel prices, and the continued depreciation of the Nepali rupee, CPI inflation in FY2014 is forecast at 10.5%, higher than the government’s target of 8%. Civil service salaries were increased by 18% and allowances by NRs 1,000 per month in the FY2014 budget. Meanwhile, the non-agriculture sector workers’ minimum wage was revised up by 29% (Figure 4). Petroleum fuel prices were revised upward on 11 August 2013. While the good harvest will help lower food price pressures (which has a 46.8% weight in the CPI), the overall impact might be lower because the domestic supply is insufficient to meet total domestic demand, making Nepal a net food importing country. For instance, according to the Trade and Export Promotion Center, import of agricultural goods was over NRs 100 billion (about 20% of total imports) in FY2013.

Figure 4: Minimum wage, inflation and wage growth

Source: ILO Global Wage Report 2012-13; NRM staff estimates.

Money Supply

As a result of the slowdown in the growth of net foreign assets[3] of the banking sector— the difference between the value of assets owned abroad and the value of domestic assets owned by non-residents—money supply (M2) growth declined to a rate of 16.4% in FY2013 (NRs 185.1 billion) from 22.7% in FY2012 (NRs 209 billion). Net foreign assets grew by only 18% (NRs 68.9 billion), down from a 59.5% growth rate (NRs 131.6 billion) in FY2012 (Figure 5). The significant rise in imports, the deceleration of remittance inflows, and lower foreign grants led to the slow growth in holdings of net foreign assets.

Figure 5: Monetary sector (% change)

Source: Nepal Rastra Bank.

Net claims on government[4]— direct loans and government securities held by the central bank— fell by 5.2% (minus NRs 8.4 billion), a further decline from the 0.3% fall recorded in FY2012. Following surplus liquidity especially during the beginning of the fiscal year, the banking sector’s credit to private sector rebounded with a growth of 20.2% (NRs 163.2 billion) from 11.3% growth (NRs 82.5 billion) in FY2012.

Deposit and Credit

The BFIs mobilized NRs 176.3 billion (reaching a total of NRs 1,188 billion) in deposits in FY2013, lower than NRs 188.6 billion mobilized in FY2012. This translates into a growth of 17.4%, down from 22.9% in FY2012. While commercial banks and development banks increased deposit mobilization by 17.9%, and 27.1%, respectively, finance companies saw a decline in deposit mobilization by 9.6% (Figure 6). The modest acceleration of government expenditure in the last few months due to the delayed full budget and the low deposit interest rates (due to adequate liquidity in the banking sector) resulted in the low deposit growth. The reduction in the number of finance companies from 70 in FY2012 to 59 in FY2013 also contributed to reduced deposits.

Figure 6: Growth of deposits (% change)

Source: Nepal Rastra Bank.

Total credit (loans and advances) from BFIs increased by 18.6% (NRs 180.2 billion), up from a rate of 13.2% in FY2012 (NRs 112.8 billion). However, loans and advances of non-commercial bank BFIs decreased in FY2013. Credits from commercial banks grew by 19.1% in FY2013, up from a rate of 17% in FY2012. However, credit from development banks decreased by 13.1%, down from 23.6. Similarly, credit from finance companies decreased by 5.8%, down sharply from its earlier rate of 23.3% in FY2012 (Figure 7). Credit to the private sector (by category A, B and C BFIs) increased by 20.8% (NRs 161.9 billion) from a rate of 12.2% (NRs 84.9 billion) in FY2012, with commercial banks, development banks, and finance companies registering growth rates of 21.6%, 28.3% and 1.3%, respectively. Reflecting the NRB’s push to increase credit to productive sectors, there was increased lending to industrial, agriculture, energy, and construction sectors. Credit flows to agriculture and energy sectors were 6.7% and 3.3% of total loans by BFIs in FY2013, respectively.

Figure 7: Growth of credits (% change)

Source: Nepal Rastra Bank.

Liquidity Management

The NRB mopped up NRs 8.5 billion through open market operations (outright sale auction), which has traditionally been one of the monetary tools to manage liquidity in the banking sector.[5] This amount was slightly lower than that transacted (NRs 8.4 billion) in FY2012. NRB mopped up NRs 3.5 billion in mid-September 2012 (at weighted average interest rate of 1.01%) and NRs 5 billion in mid-October (at a weighted average interest rate of 0.94%) of 2012. The higher remittance inflows[6] and periodic liquidity injection through open market operations and Standing Liquidity Facility (SLF) addressed initial concerns, arising from the low government expenditure, over liquidity shortage. The BFIs utilized NRs 55 billion of SLF (with 8% interest rate) in FY2013, up sharply from NRs 5.6 billion in FY2012.

Meanwhile, the central bank injected NRs 285 billion into the banking sector in FY2013, up from NRs 258.3 billion in FY2012, by purchasing $3.2 billion from the commercial banks. To finance the burgeoning imports from India, NRB sold $3.1 billion in the Indian money market and purchased Indian currency equivalent to NRs 274.4 billion in FY2013. In FY2012, the NRB had sold $2.7 billion to purchase Indian currency equivalent to NRs 213.9 billion.

Interest Rates

Although the short-term interest rates were lower in the first six months of FY2013 compared to those in the same period in FY2012, they rose in later months due to the tightening of liquidity in the banking sector as a result of the low government expenditure (Figure 8). The 91-day treasury bills weighted average rate was lower in the first five months of FY2013 and higher in the rest of the months of FY2013 when compared to those in the corresponding months in FY2012. Similarly, the inter-bank weighted average interest rate among commercial banks was lower throughout the first six months of FY2013 than what was seen in the same period in FY2012. It started to increase from the second half of FY2013, reflecting the apprehension of the banks over the liquidity shortage arising from deceleration of remittance inflows (and hence demand deposits) and low capital expenditure (along with significant government budget surplus). In FY2013, after the introduction of the full budget in the ninth month, short term interest rates started to fall. Overall, the weighted average annual short term interest rate (interbank and 91 day T-bills rates) was higher in FY2013 than in FY2012.

Figure 8: Year-on-year interbank and 91-day treasury bills rate (% change)

Source: Nepal Rastra Bank.

In FY2013, the weighted average deposit rate of commercial banks was around 5% and the weighted average lending rate was around 12%, resulting in the interest rate spread of around 7%. The spread rate sharply dropped from 8.8% in October 2012 to 6.8% in July 2013, suggesting the gradual improvement in banking sector efficiency. In the meantime, the average base rate of commercial banks was 9.8%, slightly higher than in January 2013 when the central bank mandated commercial banks to publish their base rates. The mandatory provision to publish base rates is expected to make lending rates more transparent and competitive.  

Securities Market

As investor’s confidence rebounded following the formation of a new election government, the stock market turnover sharply increased to NRs 22 billion from NRs 10.3 billion in FY2012 and NRs 6.7 billion in FY2011. As a share of market capitalization, the turnover amounted to 2.1%, 2.8% and 4.3% in FY2011, FY2012 and FY2013, respectively (Figure 9). Of the total turnover, the commercial banks’ share was 64% in FY2013 (NRs 14.1 billion), up from 54.6% in FY2012 (NRs 5.6 billion). A higher share turnover indicates more liquid shares of a listed company. Note that Nepal’s stock market is still developing and does not always respond meaningfully to policy changes and political developments.

Figure 9: Stock market turnover (NRs billion)

Source: Nepal Stock Exchange.

The Nepal Stock Exchange (NEPSE) index increased sharply by 33% (518.3 points) in FY2013 from an increase of only 7.4% (368.3 points) in FY2012. Similarly, stock market capitalization surged by 39.7% to NRs 514.5 billion (30.2% of GDP) in FY2013, following a much lower growth rate of 13.8% in FY2012 (market capitalization NRs 368.3 billion, 24% of GDP). The total number of listed companies increased to 230 from 216 in FY2012, indicating the willingness of more companies to go public, raise capital and trade shares in the secondary market (Figure 10).

Figure 10: Stock market performance

Source: Nepal Stock Exchange

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Notes:

[1] Fuel prices were increased in September 2012.

[2] Following the rise in administered fuel prices, insurance and maintenance cost, transport fares were increased by at least 9% and 16% for general transport and trucks (freight), respectively.

[3] The balance sheet of monetary authorities is composed of assets and liabilities. Assets consist of net foreign assets and net domestic assets (net claims on government and claims on the private sector). Liabilities consist of currency issued and deposits. Both net foreign assets and net claims on government affect reserve money and hence the money supply. A decline in net foreign assets, denominated in local currency in the monetary survey, and the banking sector’s net credit to government reduces the money supply. Net foreign assets are associated with the fluctuations in foreign exchange reserves (in the balance of payments account).

[4] To facilitate the analysis of the central bank’s financing of government operations, claims on the government are recorded in net basis. The net credit to the government means creation of high-powered money, i.e. monetary base (currency in circulation plus reserves of banks in the central bank).

[5] However, it may be noted here that in Nepal it is increasingly being used to sell T-bills and bonds in order to raise funds to finance government expenditure rather than to manage liquidity in the banking sector. Furthermore, the liquidity injection by purchasing dollars from the commercial banks is used to manage liquidity in the banking sector.

[6] Note that despite the decline in the growth rate of remittance inflows, total remittance inflows continued to increase.

Nepalese economy in FY2013: Fiscal sector

[This blog post is adapted from Nepal’s Macroeconomic Update, August 2013, published by the ADB. Here is a previous blog post on real sector.]

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FISCAL SECTOR

Expenditure Performance

The expenditure performance in FY2013 was adversely affected by the disruption in budget preparation as a result of the political uncertainties following the dissolution of the Constituent Assembly in May 2012.[1] Growth of both recurrent and capital expenditures (revised estimates in nominal terms) slowed in FY2013, resulting in a mere 3% growth in total expenditure, compared to over 15% in the previous years (Figure 1). Also, the FY2013 budget was underspent, more significantly in the case of capital expenditure, reflecting the impact of the delayed budget as well the weak project implementation capacity. Actual expenditures in FY2013 were 90.5% of the total budget allocation, 92.5% of the total recurrent budget, and 81% of the total capital budget. Expenditure performance was also dismal in terms of GDP. As a share of GDP, total expenditures (including net lending) were 19.4% in FY2013, down from an average of 19.7% in the previous five years. The FY2013 budget was not the first casualty of the political impasse. The issuance of FY2009, FY2010 and FY2011 budgets were also delayed by several months, adversely affecting the expenditure, especially capital expenditure, performance during these years.

Figure 1: Total, recurrent and capital expenditures growth (% change)

Note: Total expenditure excludes net lending

Source: Budget Speech various years; NRM staff estimates.

Figure 2: Total, recurrent and capital expenditures (% of GDP)

Note: Total expenditure excludes net lending.

Source: Budget Speech various years; NRM staff estimates.

Within recurrent expenditures, transfer (grants) to local bodies and for social work grew by 1.4% in FY2013, down from 14.5% growth in FY2012. Recurrent expenditures related to social security and use of goods and services[2] increased by 24.2% and 16.9%, respectively. A substantial portion of recurrent expenditures is spent as grants/transfer to local bodes and social work (42%) and compensation of employees (25%).

Figure 3: Recurrent expenditures (% of GDP)

Source: Budget Speech FY2014.

While both recurrent and capital expenditures have slowed in FY2013, capital expenditure has consistently been dismal since FY2009, reflecting the impact of political instability on development activities. Capital spending actually experienced a negative growth in FY2011. As a percentage of GDP, it halved from 6.6% in FY2009 to 3.1% in FY2013.[3] The key factors impeding capital expenditure are: (i) lack of project readiness, in terms of timely preparatory activities such as land acquisition, establishment of project management offices, and preparation of procurement plans; (ii) delays in the budget release processes at various stages (iii) delays in procurement process; and (iv) overall weak project planning and implementation capacity. A higher quantum as well as quality of capital spending is essential to address the country’s severe infrastructure bottlenecks, to achieve other social development objectives, and to lay the foundation for higher and inclusive growth.

Within capital expenditures, while land purchase and building construction registered negative growth rates, vehicle purchase and expenditure for plant and machinery grew by 50.4% and 18.8%, respectively. The expenditure for civil works increased just by 3%, reflecting the delayed full budget and the procedural hassles in approval of and procurement for projects. Except for civil works— which was 2.1% of GDP in FY2013, down from 2.3% of GDP in FY2012 and 2.5% of GDP in FY2011— none of the eight sub-headings within capital expenditures was above 1% of GDP (Figure 4).

Figure 4: Capital expenditures (% of GDP)

Source: Budget Speech FY2014.

5. As in the previous years, FY2013 also saw a bunching of spending, especially capital spending, towards the last few months. Almost one-fourth of total expenditure was done in the last month and 48% in the last three months. Of the total capital spending, 43% was spent in the last month and 64% in the last three months (Figure 5). It raises concerns about not only the absorptive capacity, but also the procedural and procurement delays along with unrealistic expenditure planning of the capital budget.

Figure 5: Monthly spending (cash basis) in FY2013, NRs billion

Source: Nepal Rastra Bank.

Revenue Performance

Unlike expenditures, revenue performance has been resilient to the political disruptions. Revenue collection has been sustained with a 21.2% growth, reaching NRs 296 billion (17.4% of GDP) in FY2013. This is higher than the budget target of NRs 289.6 billion. Tax revenue increased by 22.6%, reaching NRs 259.6 billion. As a share of GDP, tax revenue mobilization jumped remarkably from 13.8% in FY2012 to 15.3% in FY2013 (Figure 6). Several factors have contributed to this, including the ongoing reforms to modernize and strengthen revenue administration, efforts to broaden the tax base and the rising import bill due to the depreciation of the Nepali rupee and growing remittance income. Some of the important reforms undertaken in recent years include: (i) information and communication technology based tax returns filing and payment systems; (ii) establishment of a data link with Company Registrar’s Office to enhance tax compliance; (iii) measures to reduce tax compliance cost[4]; (iv) strengthening of the tax monitoring and audit system; (v) measures to widen the tax net for various tax categories; and (vi) implementation of the Any Branch Banking System (ABBS) for large tax payers.

Figure 6: Tax revenue (% of GDP)

Source: Ministry of Finance; NRM staff estimates.

While value added tax (VAT) and vehicle tax collections decreased in FY2013, collections from all others sources grew by at least 20% (Figure 7). Customs, income tax and excise duty collections increased by 31%, 28% and 21%, respectively. They had grown by 21.7%, 25.5% and 15.2%, respectively, in FY2012. The deceleration in VAT collections is attributed to the lower growth of VAT on production; goods, sales and distribution; and service and contracts—all of which registered growth slowdown by over 15 percentage points. Overall, the largest contribution to total revenue came from VAT (28.2%), followed by income tax (22.6%), customs (19.2%), and excise duty (12.4%) (Figure 8). Taxes on remittances-induced imports and consumption constitute around 70% of the total tax revenue mobilization. Specifically, import and non-import related indirect revenue account for about 50% and 20%, respectively, of total tax revenue. It suggests a tax structure disproportionally tilted towards import-based revenues.[5] Accordingly, the political instability, and to some extent economic growth, seems to have an insignificant impact on revenue generation.

Figure 7: Revenue growth (% change)

Source: Nepal Rastra Bank.

Figure 8: Composition of total revenue in FY2013

Source: Nepal Rastra Bank.

The ongoing tax reforms need to be continued to sustain the current revenue growth rate in order to finance the rising recurrent expenditures, and more importantly to scale up the sluggish capital expenditure. The effective implementation of the Inland Revenue Department (IRD) Strategic Plan 2012/13-2016/17 along with the subsequent IRD Reform Plan 2012/2014/2015 is essential to boost revenue mobilization and efficaciously enhance the capacities of the various agencies involved in revenue collection. This is particularly important if IRD’s revenue targets –tax revenue equivalent to 18% of GDP, income tax 5.5% of GDP, VAT 5.6% of GDP, and excise duty 3.2% of GDP—are to be achieved by 2017.

Budget Balance

Due to the issuance of partial budgets in FY2013, its restraining impact on spending and the then caretaker government’s lack of authority to raise domestic debt (until after the full budget was approved on 9 April 2013), the year ended with an unusual budget surplus equivalent to 0.4% of GDP, compared to a deficit of 2.2% in FY2012 and 2.4% in FY2011 (Figure 9).[6] Total net domestic borrowing amounted to a surplus of NRs 2 billion as domestic amortization far surpassed domestic borrowing. Meanwhile, net foreign loans amounted to only NRs 0.7 billion.[7] While the budget surplus and low levels of borrowing are desirable from macroeconomic stability standpoint, this is not optimal for the country given the need for increased capital investment to support higher growth. While maintaining net domestic borrowing at around 2% of GDP (as generally recommended by the International Monetary Fund), Nepal could still run a moderate budget deficit, without compromising macroeconomic stability, to finance the huge investment needs, estimated at about 8.5% of GDP over 2010-2020.[8]

Figure 9: Budget balance (% of GDP)

Note: Budget balance = Expenditure (including net lending) – Revenue (including grants). Net lending is equal to internal loans and domestic share investment minus internal loan refund.

Source: Ministry of Finance; NRM staff estimates.

Public Debt

Nepal’s overall public debt (domestic and external) has been consistently declining, reaching 31.7% of GDP in FY2013. Total external debt decreased to 19.6% of GDP in FY2013 from 20.1% of GDP in FY2012. Similarly, total domestic debt declined to 12.2% of GDP in FY2013 from 13.9% of GDP in FY2012, reflecting low domestic borrowing as a result of the delayed full budget. In FY2012, both external and domestic debts were higher than in FY2011 (Figure 10). Total debt service payments have increased to 16.5% of revenue in FY2013 from 14.5% in FY2012. However, external debt service payments have declined to 9.8% of exports of goods and non-factor services in FY2013 from 10.6% in FY2012. The rise in domestic debt service payments corresponds to the increased domestic borrowing. Overall, the declining stock of public debt and debt service payments indicate prudent fiscal and public debt management.

Figure 10: Public debt (% of GDP)

Source: Financial Comptroller General Office, Ministry of Finance.

Public Enterprises

The overall performance of the public enterprises (PEs) remained weak in FY2012. Of the 37 PEs, 21 made losses and one did not make any transaction. 8 PEs that earned profit in FY2011 made losses in FY2012. Compared to a net profit of NRs 6.7 billion in FY2011 (0.5% of GDP), FY2012 saw a loss of NRs 3.5 billion (0.2% of GDP), with a majority of it being incurred by Nepal Oil Corporation (NRs 9.5 billion) and Nepal Electricity Authority (NRs 9.9 billion). The combined losses of Nepal Oil Corporation and Nepal Electricity Authority amounted to 1.3% of GDP in FY2012. The Government’s pension related obligations (basically unfunded liabilities) increased by 25.9% to NRs 21.2 billion. Nepal Telecom’s (NT) profit of NRs 12.1 billion in FY2012 (0.9% of GDP) compensated most of the losses incurred by PEs.

Figure 11: Profit and loss of select PEs (% of GDP)

Source: Ministry of Finance; NRM staff estimates.

The cumulative liabilities of PEs have been around 1.8% of GDP, with unfunded liabilities of 1.4% of GDP and contingent liabilities of 0.4% of GDP. The unfunded liabilities (salary, pension, social security contribution, health care, and recurrent costs, among others, that the PEs cannot finance themselves) have increased steadily from 1% of GDP in FY2009 to 1.4% of GDP in FY2012. However, the contingent liabilities (state guarantees of loans, defaults of PEs, and clean-up liabilities of privatized PEs, among others) have decreased from 1.7% of GDP in FY2009 to 0.4% of GDP in FY2012. This has contributed to the overall decline in liabilities relative to FY2009 (Figure 12). The increase in unfunded liabilities reflects the occasional salary and allowance hikes in the public sector.

Figure 12: Unfunded and contingent liabilities (% of GDP)

Source: Ministry of Finance; NRM staff estimates.

Either privatization or liquidation of loss making PEs needs to be accelerated to reduce the budget drain. The weak financial position of PEs has led to large unfunded liabilities, especially for pension and other related retirement benefits, which could ultimately become government liabilities. It may be noted that due to the lack of accurate and updated data, the contingent liability of PEs presented here are conservative estimates. It is possible that the government will be exposed to much higher levels of liabilities. In this regard, fiscal and macroeconomic stability could potentially be subject to significant risks.

 

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Notes:

[1] Due to the caretaker status of the then government and the lack of broader political consensus, a timely and full budget could not be introduced for FY2013. Instead, the budget was introduced on a piecemeal basis on 15 July 2012 (one-third of the actual expenditure in FY2012); 20 November 2012 (two-thirds of actual expenditure in FY2012); and 9 April 2013 (a full budget consolidating the previous two partial budgets). The size of the full budget was NRs 404.8 billion, with an outlay of NRs 279.1 billion (78.9%) for recurrent expenditures, NRs 66.1 billion (16.3%) for capital expenditures, and NRs 59.7 billion (14.7%) for financing (loan and share investments, and debt servicing).

[2] Use of goods and services consists of (i) rent & services; (ii) operation and maintenance of capital assets; (iii) office materials and services; (iv) consultancy and other services fee; (v) program expenses; (vi) monitoring, evaluation and travel expenses; (vii) recurrent contingencies; and (viii) miscellaneous.

[3] Prior to FY2012, ADB adjusted capital expenditure by deducting internal loans and domestic share investment to be consistent with GFS 2001

[4] The cost of collection per NRs 1000 has decreased from NRs 16.4 in FY2007 to NRs 12.7 in FY2011.

[5] For more on the tax revenue structure in Nepal, see: IMF. 2011. Selected Issues: Nepal’s Tax Regime. Washington, DC: International Monetary Fund. http://www.imf.org/external/pubs/ft/scr/2011/cr11319.pdf

[6] Budget balance is computed as expenditures (including net lending) minus revenue (including grants).

[7] As a share of GDP, net foreign loans and net domestic borrowing were negative 0.04% and surplus 0.12%, respectively in FY2013. In FY2012, they were negative 1.4% and 1% of GDP, respectively.

[8] Bhattacharyay, B. 2010. Estimating Demand for Infrastructure in Energy, Transport, Telecommunications, Water and Sanitation in Asia and the Pacific: 2010-2020. ADBI Working Paper 248. Tokyo: Asian Development Bank Institute. Available: http://www.adbi.org/workingpaper/2010/09/09/4062.infrastructure.demand.asia.pacific/

Nepalese economy in FY2013: Real sector

[This blog post is adapted from Nepal’s Macroeconomic Update, August 2013, published by the ADB.]

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REAL SECTOR

 

Performance in FY2013

Adversely affected by the unfavorable monsoon, the shortage of chemical fertilizers during the peak summer crops[1] planting season, continued slowdown in industrial activities and the delay in introducing a full budget, gross domestic product (GDP) growth dipped to an estimated 3.6% in FY2013, down from 4.5% in FY2012. The major contribution to overall GDP growth came from the services sector which contributed about four-fifths of the GDP growth, up from about two-fifths in FY2012, largely due to the rise in remittances-induced consumption demand. While agriculture contributed about two-fifths of the GDP growth in FY2012, it declined to less than one-fifth in FY2013 (Figure 1). The industrial sector’s contribution remained below one-fifth in the last three years, mainly reflecting the slowdown of manufacturing and construction activities.

Figure 1: Supply-side contributions to growth, FY2009-FY2013

Note: Sectoral contribution to growth is computed as a particular sector’s share of gross value added GDP times its growth rate.

Source: Central Bureau of Statistics.2013

The agriculture sector, which comprises almost 35% of GDP and provides livelihood to about 76% of households, grew at a mere 1.3%, down from 5% in FY2012 and 4.5% in FY2011. Despite a good winter crop[2] harvest—resulting from the timely and favorable winter precipitation and availability of agriculture inputs— total cereal production dropped by 7.6% owing to the late and inadequate monsoon, and shortage of chemical fertilizers.[3] The production of paddy, maize and millet dropped by 11.3%, 8.3% and 3%, respectively. An increasing proportion of farmers are using chemical fertilizers for the production of mainly summer crops and to some extent for the winter crops. For instance, about 70% of paddy growers used chemical fertilizers in FY2011 compared to 66.4% in FY2004 (Figure 2).

Figure 2: Percent of growers that used chemical fertilizers

Source: Nepal Living Standards Survey 2010/11.

The industrial sector, which comprises a mere 15% of GDP, continued the lackluster performance, registering an estimated growth of 1.6%, down from 3% in FY2012 and 4.3% in FY2011. Within this sector, mining and quarrying, and construction grew by 5.5% and 1.6%, respectively. However, the growth of manufacturing, and electricity, gas and water declined to 1.9%, and 0.2%, respectively. Manufacturing activities have slowed mainly due to the long hours of power cuts, unfavorable industrial relations, persistent supply-side constraints and the rise in the cost of production due to increased prices of imported raw materials. Similarly, the lack of a timely and full budget, which severely affected construction related public and private capital expenditures, and the continued weak implementation capacity of public agencies led to the weak growth of construction activities, and hence, its weak contribution to GDP growth (Figure 1).

Despite a moderate deceleration of remittance inflows, the remittances-induced consumption demand propelled the services sector growth to an estimated 6%, up from 4.5% in FY2012. Within the services sector, wholesale and retail trade—whose share in GDP is 14.4%, nearly equal to that of the industry sector—grew sharply by 9.5%, up from 3.1% in FY2012. Hotel and restaurant activities grew by 6.8%, marginally up from 6% in FY2012, reflecting the sustained increase in tourist arrivals. However, the real estate sub-sector growth declined to 1.6% from 3% in FY2012, mainly due to its slow recovery after the slump in FY2011 and the lending cap (a maximum of 25% of total loans to real estate and housing) imposed by the Nepal Rastra Bank (NRB) on BFIs. Overall, the services sector activity grew faster than industrial and agricultural activities (Table 1).

Table 1: Sub-sectoral growth rate[4]

	Growth rate		Share of GDP
Sub-sector	FY2012R	FY2013P	FY2012R	FY2013P
Agriculture and forestry	4.94	1.21	35.36	34.33
Fishing	7.55	4.04	0.39	0.41
Mining and quarrying	5.03	5.45	0.56	0.58
Electricity, gas and water	8.41	0.2	1.21	1.27
Manufacturing	3.63	1.85	6.28	6.17
Construction	0.22	1.57	6.81	6.91
Wholesale and retail trade	3.05	9.54	13.67	14.42
Hotels and restaurants	5.96	6.84	1.7	1.82
Transport, storage and communications	5.74	6.73	8.57	9.2
Financial intermediation	3.47	6.65	4.52	4.2
Real estate, renting and business activities	2.97	1.64	8.3	8.48
Public administration and defense	4.99	3.31	2.03	1.89
Education	5.02	4.11	5.47	5.39
Health and social work	9.95	6.95	1.4	1.38
Community, social and personal services	6.65	5.2	3.74	3.55

Source: Central Bureau of Statistics.2013

On the expenditure side[5], consumption accounted for an estimated 90.7% of GDP, up from 88.5% in FY2012 and 85.5% in FY2011, reflecting the increasing consumption demand stimulated by the growing remittance income.[6] While capital formation hovered around an average of 37% of GDP, gross fixed capital formation (GFCF) has been around 21% of GDP. The private sector accounted for the largest share of GFCF (17.2% of GDP in FY2013). Despite the high investment figures, the impact on growth and employment is pretty nominal probably either due to the measurement errors or the hugely inefficient capital investment. Net exports jumped to a negative 28.5% of GDP in FY2013, up from the negative 23.4% of GDP in FY2012 (Figure 3), reflecting the massive rise in imports of goods and non-factor services—38.8% of GDP from 33.4% of GDP in FY2012. Exports of goods and non-factor services increased only marginally to an estimated 10.3% of GDP. While the high imports are supported by high remittance income, the slowing exports are a result of the persistent supply-side constraints affecting both production and competitiveness.

Figure 3: GDP by expenditure

Source: Central Bureau of Statistics

Gross domestic savings have declined to an estimated 9.3% of GDP from 11.5% in FY2012 and 14.5% in FY2011 (Figure 4). It indicates that a majority of the residents’ income is spent on consumption, which is mostly met by imported goods. Meanwhile, the high national savings (38.4% of GDP in FY2013) reflects the high remittance inflows. It has also contributed to a positive savings-investment gap (computed as the difference between gross national savings and gross capital formation) in the last two years. Though per capita GDP increased to $713[7] in FY2013 from $709 in FY2012, it is still lower than $720 in FY2011. The fluctuation in per capita GDP is partly attributed to the depreciation of Nepali rupee against the US dollar. The size of Nepal’s economy expanded to an estimated $19.4 billion in FY2013, marginally up from $19 billion in FY2012.

Figure 4: Savings, investment, exports and imports (% of GDP)

Source: Central Bureau of Statistics

Domestic investment commitment: Total domestic capital investment (fixed capital plus working capital) commitment increased remarkably by 41.6% in FY2013, up from a decline of 6.6% in FY2012. As a share of GDP, it reached 7% in FY2013 from 5.5% in FY2012, largely attributed to over 50% increase in investment commitment in energy, tourism and mineral sectors. Overall, of the total investment commitment in FY2013, 72.4% was in energy sector, followed by manufacturing (11.1%), services (8.6%), and tourism (6%) (Figure 5). As a share of GDP, investment commitment in energy sector went up from 3.6% in FY2012 to 5.1% in FY2013.

Figure 5: Domestic capital investment commitment, NRs billion

Source: Department of Industry

Foreign direct investment (FDI) commitment: FDI commitment, approved by the Department of Industry, sharply increased to NRs26 billion in FY2013, up from just NRs7.1 billion in FY2012. As a share of GDP, it increased to 1.5% in FY2013 from 0.5% in FY2012, mainly attributed to the increase in investment commitment in all sectors and specifically in manufacturing, services and tourism sectors, whose share of total FDI commitment was about 16.7%, 39.8%, and 15.2%, respectively (Figure 6). Country-wise FDI commitment shows that although India still accounts for the highest share (22.3% in FY2013) it is in a declining trend (32.2% in FY2012 and 69.7% in FY2010). Meanwhile, China’s share of total FDI commitment is steadily increasing, reaching 21.9% in FY2013 from 13.8% in FY2012 and 11.8% in FY2011. It may be noted that despite the increase in FDI commitment in FY2013, actual FDI inflows, as per the balance of payments, marginally decreased from NRs9.2 billion in FY2012 (0.6% of GDP) to NRs9.1 billion in FY2013 (0.5% of GDP).

Figure 6: FDI commitments and actual inflows, NRs billion

Source: Department of Industry; Nepal Rastra Bank

FY2014 Outlook

The outlook for FY2014 is more optimistic than that for FY2013. The adequate monsoon and supply of chemical fertilizers[8] during the past few months are expected to boost agriculture production. According to the Ministry of Agriculture Development, the agriculture production, especially summer crops, is expected to increase sharply as a result of the active pre-monsoon and normal monsoon rains, and the adequate supply of agricultural inputs, especially chemical fertilizers. About 92% of paddy fields have been planted this summer. It was 64% in FY2013. Approximately 80% of total rainfall occurs between June and September. Furthermore, the timely full budget for FY2014 is expected to give added momentum to capital expenditure, especially construction sector activities, while the expected robust remittance inflows will continue to support services sector growth. Based on these developments and assumptions, GDP growth (at basic prices) is forecast at 4.5% in FY2014. Over half of the contribution to this growth rate is expected to come from the services sector, followed by about two-fifths from agriculture. In view of the long-term nature of the structural constraints and the likely distractions in the run-up to the upcoming elections and immediately after the elections, the industry sector is expected to contribute only marginally to GDP growth (Figure 7). Note that the budget and monetary policy have set an ambitious GDP growth target of 5.5% for FY2014 primarily on the assumption of a high agriculture sector growth rate. Meanwhile, the approach paper to Three Year Interim Plan (FY2014-FY2016) has set an average annual GDP growth target of 6% by mainly assuming services sector growth of 7%.

Figure 7: Sectoral contributions to growth, FY2011-FY2014

Source: Central Bureau of Statistics; NRM staff estimates.

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Notes:

[1] Mostly paddy, maize, millet, buckwheat and summer potato.

[2] Mostly wheat, barley, potato, winter tomato, cauliflower and cabbage.

[3] About 25% of the total estimated demand of 586,000 MT of chemical fertilizers was supplied at a subsidized price through Agriculture Inputs Company Ltd (AICL), a government entity, in FY2013. Total budget for subsidy of prices on chemical fertilizers was NRs 6 billion. The procurement of required fertilizers was affected by the delayed full budget in FY2013.

[4] R and P denote revised estimate and provisional estimate, respectively. Any reference to GDP for FY2012 and FY2013 in this Macroeconomic Update refers to revised and provisional estimates, respectively.

[5] The GDP by expenditure figures are prone to measurement errors as change in stocks is computed residually, which also includes statistical discrepancy/errors. It was an estimated 16.6% of GDP in FY2013. A large residual indicates that a significant portion of the GDP is either unexplained or could not be directly attributed to its components, i.e. consumption, investment and net exports.

[6] It may be noted that even though final consumption with respect to GDP is very high, the actual domestic consumption expenditure made up only 62.2% of GDP in FY2013, down from 65.1% in FY2012. This is due to the surge of net exports (or, export minus import) in FY2013, i.e. the consumption expenditure on imports of goods and nonfactor services.

[7] US$ 1 = NRs 87.7 in FY2013 and US$1 = NRs 80.7 in FY2012.

[8] Though the AICL supplied only about a quarter of the total fertilizer demand, farmers did not face a shortage during the planting season. This is probably due to imports from India by the private sector and individuals through informal channels.

Will Nepal graduate from LDC category by 2022?

[This blog post is adapted from the issue focus of Nepal’s Macroeconomic Update, August 2013, published by the ADB.]

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GRADUATION FROM LDC CATEGORY

Background

The government’s recently approved approach paper to the Three Year Plan (TYP) FY2014-FY2016 envisions uplifting Nepal from the current Least Developed Country (LDC) category to a developing country status by 2022. In the previous TYP FY2010-FY2013, the government had targeted graduation by 2030. The rapid increase in the country’s per capita gross national income (GNI) as well as significant progress on key social indicators has encouraged the government to aim for this ambitious target, which is incidentally in line with the Istanbul Programme of Action (IPoA), 2011-2020, an outcome of the United Nations Least Developed Country (UNLDC) IV meeting held in Istanbul on 9-13 May 2011. The IPoA aims to enable half (24 out of the 48) of the LDCs meet the criteria for the graduation by 2020. It also recommends LDCs to integrate the IPoA into their national and sectoral development programs and strategies.

LDCs are low-income countries suffering from the most severe structural impediments to sustainable development. They benefit from special support measures from the donor community and preferential treatment in trade agreements. They get preferential market access to developed countries and are provided special non-reciprocal treatment in regional and bilateral trade agreements. The European Union provides duty-free access to imports of all products from LDCs under its ‘Everything but Arms’ (EBA) initiative. Furthermore, the Enhanced Integrated Framework (EIF)—a multi-donor, multi-agency program—assists LDCs in boosting their trade related capacities, including operational support to national implementation arrangements related to trade strategy, preparing and updating the Diagnostic Trade Integration Study, and supporting activities on mainstreaming trade. Meanwhile, the bilateral donors have pledged to provide official development assistance (ODA) equal to 0.7% of their GNI. Some donors such as Japan even provide concessional loans with a 0.01% interest rate and a 40-year repayment period (including a 10-year grace period). Similarly, multilateral development banks provide grants and concessional lending to LDCs.

Criteria and Process for Graduation from LDC Status

Graduating from the LDC category requires progress on three indicators relating to the income-generating capacity of a LDC, its stock of human capital, and its structural vulnerability to exogenous shocks. Specifically, the following criteria are considered[1]: (i) Low-income criterion (based on a three-year average estimate of per capita GNI [World Bank Atlas method[2]] higher than $1,190); (ii) progress in Human Assets Index (HAI), which comprises (a) nutrition (percentage of population undernourished), (b) health (mortality rate of children aged five years or under), and (c) education (gross secondary school enrolment ratio and adult literacy rate); and (iii) progress on Economic Vulnerability Index (EVI), which comprises (a) population size, (b) remoteness, (c) merchandise export concentration, (d) share of agriculture, forestry and fisheries in gross domestic product (GDP), (e) share of population living in low elevated coastal zones, (f) instability of exports of goods and services, (g) victims of natural disasters, and (h) instability of agricultural production.

After determining threshold levels for each of the criteria every three years, the Committee for Development Policy (CDP) reviews the progress made by LDCs and recommends a country for graduation[3] from the LDC category provided that the country is eligible at two successive triennial reviews. At least two of the three criteria or per capita GNI higher than twice the threshold (and with a high probability that it will be sustained) must be met to be eligible for graduation. Following the recommendation by CDP and subsequent endorsement by the UN Economic and Social Council (ECOSOC), the UN General Assembly (GA) takes note of it[4], three years after which a country will graduate from the LDC category. So far, Botswana, Cape Verde and the Maldives are the only countries that have graduated from LDC category. Samoa is set to graduate in January 2014. While Tuvalu and Vanuatu are recommended for graduation, Angola and Kiribati met the criteria for graduation once and will be reviewed again in 2015.

The latest thresholds for graduation from the LDC category are (i) per capita GNI of $1,190 or more, (ii) HAI of 66 or more, and (iii) EVI of 32 or less. At least two of the three criteria must be met to qualify for graduation. Alternatively, a country also qualifies for graduation if its GNI per capita is $2,380 or more, irrespective of its HAI and EVI scores. The graduation thresholds are usually 20% above the per capita GNI threshold for inclusion, 10% above the HAI threshold for inclusion, and 10% below the EVI threshold for inclusion. 

Prospects for Graduation

Although Nepal has already met the EVI criterion, it still has to either increase its per capita GNI by US$770[6] or HAI score by 6.17 before 2015 to be eligible for consideration for graduation. This is because eligibility conditions should be fulfilled during two successive triennial reviews, and the CDP will now review the progress only in 2015. After the review, Nepal will have to sustain the progress through 2018, the next triennial review, only after which the CDP will recommend for graduation. It will then be endorsed by ECOSOC and the UN GA takes note of it (between one and three years). Then only can Nepal graduate by 2022, provided that a transition strategy is prepared for implementation and the thresholds do not change.[7] An alternative path for Nepal’s graduation would be for it to increase its per capita GNI by US$1,960 well before 2022, irrespective of its progress on the HAI and EVI threshold requirement. Overall, substantial efforts would be needed for Nepal to graduate from the LDC category by 2022 particularly in the income front. Nevertheless, an encouraging certainty is that the country will be making clear and substantial progress towards graduation.

Post-LDC Graduation Scenario

The post-graduation scenario will also remain challenging, mostly arising from the implications of the loss of LDC status and associated benefits such as development assistance and preferential treatments in international trade. The concessional lending as well as market entry preferences accorded to Nepali exports in several developed and emerging economies will most likely be eroded. Therefore, prior to the graduation, Nepal needs to strengthen the pre-requisites required to support a stable and high growth rate and continue the momentum on the social development front. It calls for: (i) full and productive utilization of the available development assistance and trade preferences to tackle supply-side constraints, promotion of high value exports, and search for niche markets abroad; and (ii) reorientation of the ongoing structural transformation to strengthen the industrial sector’s and high value production’s contribution to GDP, which will help stabilize the growth rate, raise the income level and create high paying jobs.

The available resources and assistance to tackle the most binding constraints to economic activities have to be effectively utilized with an objective to sustain high growth and rapid poverty reduction. Meanwhile, the challenging task is to make the GDP growth more responsive to industrial sector growth and the high value agriculture production and services activities instead of the less productive and low value agriculture and service sector activities. At the core of it, political stability and good governance are the necessary conditions to effectively make this happen. Overall, the challenges to adequately meet the pre-requisites for high growth and a sustained development path in the post-graduation era are: (i) structural bottlenecks (low quality human resources and deficient skills, weak backward and forward linkages, fragmented value chains, negligible research and development investment, distorted labor market characterized by high minimum wages and low productivity, and policy inconsistencies, among others); and (ii) supply-side constraints (the lack of adequate supply of electricity, transport bottlenecks, lack of raw materials leading to high import content of manufactured goods, inadequate supply of key inputs to boost productivity, and political disturbance, among others).

There is also a need to reorient the ongoing process of structural transformation, especially considering the production disruption caused by the decade-long civil conflict, the exodus of migrant workers, and Nepal’s accession to the WTO. The shift of workers and economic activities to less productive services sector activities instead of the industrial sector being a focal point for their absorption is not normal and doesn’t contribute much to creating a strong foundation for the economy to take off on a high and inclusive growth path in the post-LDC graduation era.[8] The low value added activities such as real estate and housing; wholesale and retail trade; hotels and restaurants; transport and storage, among others constitute almost 34% of GDP, which is equal to that of the agriculture sector’s share of GDP. The manufacturing[9] sector’s share is only about 6.2% of GDP. In fact, the wholesale and retail trade, which is mostly based on imported goods, is larger than mining and quarrying; manufacturing; electricity, gas and water; and construction combined (i.e. the industry sector). Nepal’s industrial sector has been consistently underperforming; and for its income level, though the services sector’s contribution to GDP is relatively high, its impact on growth and employment generation is low (Figure 4). Furthermore, the increase in per capita income as countries get richer is initially associated with the expansion of industrial sector and then after a certain income level, its contribution starts to moderate. However, even with one of the lowest per capita incomes in Asia and the Pacific, Nepal’s industrial sector’s contribution seems to have tanked and have been consistently declining (second chart in Figure 4).

Figure 4: Sectoral value added, per capita GDP and structural transformation

Note: The first three charts agriculture, industry and services sectors valued added (% of GDP) to the log of per capita GDP of China, India, Nepal, Bangladesh, Japan and South Korea over 1960-2012. The last chart shows the evolution of sectoral value added with respect to log of per capita GDP. It shows that the decline of agriculture sector is accompanied by the increase of services sector while the industrial sector is already declining.

Source: NRM staff estimates based on data from World Development Indicators.

A meaningful structural transformation to sustain a high and sustainable growth in the post-LDC graduation era would require beforehand a strong industrial sector and high value added agriculture and services sector activities, with an employment centric strategy to absorb the surplus labor. To promote higher productivity, high value-added production and high income generation, the agriculture sector requires adequate and appropriate commercialization, provision of necessary infrastructure and technology to link with the industrial sector, and promotion of agribusiness activities such as agro-processing, storage, and warehousing, among others. Similarly, for high productivity and value added services sector activities, there needs to be strong backward and forward linkages with the industrial sector along with the narrowing of skills gap required in the market, increase in R&D investment to promote innovation, and investment in education and health sectors to boost the capacity of the economy to sustain progress and prosperity. This would partly position and help sustain the industrial sector as an engine of inclusive growth.[10]

Conclusion

A high and sustainable growth and development in the post-LDC graduation era would require the effective utilization of the current resources to create the pre-requisites for the economy to take off on a high, inclusive, employment-centric and sustainable growth path. Furthermore, there is a need to reorient the ongoing structural transformation to ramp up industrial sector activities and to promote higher value and productive agriculture and services activities.

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Notes:

[1] These are reviewed every three years by CDP. The latest review was done in 2012. The next triennial review will take place in 2015.

[2] The Atlas method is used by the World Bank to estimate the size of economies in terms of gross national income (GNI) in US dollars. According to the World Bank, ‘a country's GNI in local (national) currency is converted into US. dollars using the Atlas conversion factor, which uses a three-year average of exchange rates to smooth effects of transitory exchange rate fluctuations, adjusted for the difference between the rate of inflation in the country (using the country's GDP deflator), and that in a number of developed countries (using a weighted average of the countries' GDP deflators in SDR terms). The resulting GNI in U.S. dollars is divided by the country's mid-year population to obtain the GNI per capita.’ For more: http://go.worldbank.org/IEH2RL06U0

[3] Inclusion in the LDC category requires lower thresholds for all the three criteria: GNI per capita of $992 or less, HAI of 60 or less and EVI of 36 or more. All three criteria must be met.

[4] It is expected that the recommendation for eligibility by CDP, the endorsement by ECOSOC and the UN GA taking note of it happen within three years. It might take longer if the UN GA delays taking note of the endorsement by ECOSOC.

[6] Based on data from the 2012 triennial review, which used 2008-2010 average GNI per capita (US$420). The latest three year average (2010-2012) GNI per capita of Nepal is US$616.7 (Atlas method), which means GNI per capita has to increase by at least US$573 to reach the respective threshold for graduation.

[7] For more, see http://www.unohrlls.org/en/ldc/164/

[8] Asia 2050: Realizing the Asian Century provides strategies on how to avoid the middle income trap as per capita income rises along with economic advancement. See: ADB. 2011. Asia 2050: Realizing the Asian Century. Manila: Asian Development Bank.

[9] According to industrial classification, manufacturing is a part of industrial sector, which also comprises of mining and quarrying; electricity, gas and water; and construction.

[10] For this to happen, the country needs to tackle head-on the binding constraints to industrial sector growth, including amicable resolution of labor disputes to create a win-win situation for both workers and employers, and the promotion of FDI to not only increase investment but also to impart critical knowledge and expertise on advanced technologies, innovations, and entrepreneurship.