Tuesday, April 29, 2014

NEPAL: CBS forecasts FY2014 GDP growth rate to be 5.2%

The Central Bureau of Statistics (CBS) has come up with preliminary estimates of national accounts for FY2014. It projects real GDP growth (basic prices) at 5.2% in FY2014, up from 3.5% revised estimated for FY2013 but lower than the government’s target of 5.5% targeted in the FY2014 budget. The main driver of growth is projected to be services sector (growth of 6.1%), followed by agriculture sector (growth of 4.7%, up from a sluggish 1.1% in FY2013) and industry sector (growth of 2.7%).

The size of the economy is projected to be US$19.4 billion in FY2014, slightly up from US$19.2 billion in FY2013. In Nepalese rupee, the size of the economy in FY2014 is projected to be NRs1.9 trillion.

GDP growth rate (basic prices)
Composition of GDP (%)

GDP (current producers prices)

GDP, NRs billion
GDP, $ billion

In terms of contribution to GDP growth, 62% is expected to come from services sector, followed by 31% from agriculture sector and the rest 7% from industry sector. In FY2013, the unfavorable monsoon and the shortage of chemical fertilizers brought down agriculture sector’s contribution to 11%, the same as industry sector’s contribution. The rest 78% was of FY2013 GDP growth came from services sector. 

Among the sub-sectors, wholesale and retail trade is projected to grow by 8.8%, up from 6.8% in FY2013. It is followed by other services sub-sectors such as transport, storage and communication (7.5%), hotels and restaurants (7.1%), and education (6%) among others. Real estate, renting and business sub-sector is projected to grow by 3%, marginally up from 2.7%. Agriculture and forestry sub-sector is projected to grow by 4.7%, up 1.1% in FY2013.

While manufacturing growth is projected to slow down to 1.9% from 3.7% in FY2013, construction growth is projected to recover, albeit slowly, to 2.9% from 2% a year earlier. The share of manufacturing in GDP is continuing to decline, reaching an estimated 6.1% of GDP in FY2014. Similarly, industry sector is also projected to shrink to 14% of GDP from 14.6% of GDP in FY2013.

While gross national savings are projected to increase (46.4% of GDP in FY2014) on account of the high remittance inflows, gross domestic savings are declining (8.9% of GDP in FY2014) reflecting the high consumption (91.1% of GDP in FY2014). Exports of goods and services are projected to recover slightly to 12.1% of GDP from 10.7% of GDP in FY2013, but the larger increases in imports of goods and services further widened trade deficit (goods and services).

Per capita GDP in local currency is estimated to grow by 12.4%, up from 9.4% in FY2013. However, due to the depreciation of Nepalese rupee against the US dollar, per capita GDP in US$ terms is projected to decline. In FY2014, per capita GDP is projected to be US$703 (NRs69,919). The high inflow of remittances is seen in the large different between per capita GDP (and also per capita GNI, which includes net factor income from abroad as well) and per capita GNDI (which includes net transfers from abroad on top of per capita GNI). In FY2014, per capita GNI and per capita GNDI are projected to be US$717 and US$967 (NRs71,305 and NRs96,155, respectively).

Few explanations to note here:
  • Real estate sector is struggling to grow as the 25% lending cap to real estate and housing fixed by central bank is helping to lower BFIs exposure to this sector.
  • The high growth of services activities are primarily driven by remittances-backed consumer demand of mostly imported goods. Hence, services sector activities are the largest contributor to GDP growth and also a major revenue generator for the government.
  • The favorable monsoon and timely availability of agricultural inputs jacked up agriculture sector growth. The MOAD projected paddy, maize and millet production to grow by 12%, 9.9% and 6.1%, respectively. In FY2013, while paddy and maize production decreased by 11.2% and 9.3%, respectively, millet production grew by a mere 2%.
  • The less than expected growth of construction sector indicates the slow capital expenditure despite the timely full budget in FY2013.
  • Despite the improving political environment, the manufacturing sector failed to pick up. In fact, its growth rate is projected to decline to 1.9% from 3.7% in FY2013. It reflects the structural bottlenecks and persistent supply-side constraints.
Starting this year, the CBS has also come up with quarterly estimates of GDP. It is supplying seasonally unadjusted and seasonally adjusted quarterly data. This is a good initiative. Now, the CBS should work on producing timely quarterly data (for FY2104, the first two quarters data are produced so far) and the annualized growth rate based on these.

Earlier, the ADB, the WB, and the IMF projected GDP growth at 4.5%.

Friday, April 25, 2014

Nepal Economic Update: FY2013 performance, FY2014 outlook and excess liquidity

This blog post is adapted from summary section of Nepal Economic Update (April 2014) published by the World Bank's Nepal office. Earlier, the ADB published Macroeconomic Update (February 2014) [presentation here] and Asian Development Outlook 2014 [presentation here]. The special focus on the WB's update is dealing with excess liquidity. ADB focused on boosting Nepal's export competitiveness

The enabling environment for development has improved but opportunities need to be effectively leveraged through focused policy action. The successful election of a new parliament and subsequent formation of a popularly mandated government provide a more conducive environment for private sector activity and economic policy. The uncertainties brought about by Nepal’s prolonged political transition and electoral period have acted as a break on private sector investment and diverted attention of the bureaucracy away from difficult and important reforms. Going forward, it will be important for the government to signal, from the start, that increased political stability will be put to profit to tackle the country’s formidable challenges. This will involve a balancing act to ensure that the arduous process of constitutional drafting can be carried-out in tandem with regular and improved government operations.

Nepal has significant resources in the form of remittances from abroad, but the economy cannot use these resources in a productive manner to enhance the overall welfare of all citizens. The budget process does not work -funds cannot be used to build decent infrastructure that would bring in the private sector- and inefficiencies in the financial sector hinder the optimal allocation of resources to private agents. In view of these challenges, the GoN should set a new course for policy and tackle emerging risks. The appointment of a new Finance Minister with deep experience and reformist credentials is a positive sign and initial declarations of Minister Mahat committing to “take forward the second round of reforms […] in partnership with the private sector” are also encouraging.

Specific priorities include:
  1. Developing a growth promotion vision/agenda: because the numerous challenges facing Nepal make achieving clarity over policy goals and priorities particularly difficult. The Nepalese authorities have formulated the aspiration of graduating to “developing country” status by 2022, but have not articulated the vision for development that would underpin it and identify those policies and reforms that are the most urgent. In the absence of such clear prioritization, the process of development planning is likely to remain un-strategic.
  2. Resolving Nepal’s ‘fiscal paradox’: Nepal, today, is in a paradoxical situation. It is the only country in South Asia to record a budget surplus (helped by buoyant revenue growth), its level of indebtedness is modest, it is flush with liquidity (thanks to large remittance inflows) and yet it struggles to maintain investment at already low levels. Fiscal discipline is a means to an end, but in Nepal it appears to be pursued as an end in itself, with the government unable to plan and implement the budget. This bottleneck needs to be addressed urgently.
  3. Boosting investment: Faster and sustained economic growth will not be possible without higher levels of investment but Nepal’s model of growth appears premised on remittance financed consumption. The public sector has a key role to play to unlock investment by: (i) providing a friendlier environment for the private sector –domestic and foreign- to find it attractive to bid for projects in Nepal, and (ii) developing the essential public infrastructure needed for firms to thrive and private funds to be crowded-in. The fate of Nepal’s “National Pride Projects” demonstrates that such synergies are not currently taking place.
  4. Tackling enduring financial sector risks and managing excess liquidity: Uncertainty over the true health of the financial sector remains the single most important macroeconomic risk for Nepal. First, although unlikely, a financial sector crisis would have devastating effects on public finances and economic growth. Second, the ability of the financial sector to provide adequate credit to deserving borrowers is currently hampered by inter alia (i) distortionary policies (ii) low levels of effective access to finance, (iii) poor risk management practices by monetary authorities and banks amplified by deficient information, and (iv) limited recourses of banks vis-à-vis delinquent borrowers. As a result, the financial sector is operating at sub-optimum and the current excess liquidity in the system is largely a reflection of this state of affairs.
After a difficult year in FY13, the economy is poised to recover, albeit modestly. In FY13, Nepal achieved only modest growth of 3.6%. This was due largely to poor performance of the agricultural sector as well as very modest levels of industrial activity. The only source of relief came from the services sector. The main difference in FY14 is expected to come from the agricultural sector with expanded production on the back of a good harvest, while strong remittance inflows will continue to drive services sector expansion.

Nepal’s internal and external balances are sound but not for the right reasons.
  • The combination of low expenditure and robust revenue growth accounted for a large budget surplus and declining debt. With a significant increase in foreign grants the overall government surplus ballooned to NRs 56.0 billon. Reflecting this comfortable fiscal position the GoN did not issue any fresh T-Bills in the first half of FY14 and domestic debt fell to NRs 217.61 billion. While much of the blame for low rates of budget execution and important bunching had been blamed, hitherto, on delayed budget approval, this was not the case in FY14 when a full budget was unveiled on day one of the fiscal year. In other words, Nepal is yet to come to grips with deep structural inefficiencies in the process of budget planning, formulation and execution.
  • Nepal’s external position is comfortable thanks to large remittance inflows. On the external side Nepal has benefited from the depreciation of the rupee but also –and much more significantly- from a sharp further increase in inward remittances, which are expected to amount to over 30% of GDP in FY14.

Monetary policy has sought to achieve a delicate equilibrium between controlling inflation and supporting economic activity but the optimal balance may evolve and call for corrections. Significant inflation, close to double digits, appears to have become a feature of the Nepali economy. While expanded agricultural output may contribute to dampen inflationary pressure, the significant growth in the money supply may eventually generate inflationary expectations and second round effects as well as translate into lower reserves. From that view point, the evolution of the quantity and quality of credit to the private sector will be important to monitor.

For FY14, the outlook is cautiously optimistic. The previous assessment estimated that growth would reach 4-4.5% in FY14, essentially driven by increased agricultural output and improved execution of the budget. While the pace of capital expenditure may be below initial expectations, inward remittance inflows have been significantly above projected levels and should provide an additional boost to the services sector. On balance therefore, growth is projected to reach 4.5%, especially if capital spending picks up in the second half of the year.

As remittances have become a defining feature of the Nepali economy the country must learn to manage excess liquidity. The significant buildup of liquidity in the financial sector reflects both strong push factors (remittance inflows translating into a build-up of net foreign assets) and weak pull factors (slowing credit growth and loose monetary policy). In the short term, the NRB will need to strike a delicate balance between encouraging sound credit growth –so as to not compromise economic activity objectives- and containing inflation. At present this balance is particularly difficult to achieve because of uncertainties over the true health of the banking sector, weak risk management systems and market failures. In the short run, the NRB may need to expand its toolset to deal with excess liquidity. In the medium run, resolving structural bottlenecks to efficient credit market functioning is a precondition for monetary policy to operate more smoothly and efficiently and for ample available resources to be allocated to grow Nepal’s productive potential.

Sunday, April 20, 2014

Third highest remittance inflows (% of GDP) to Nepal in 2012

According to the latest Migration and Development Brief No.22, official remittance inflows to Nepal reached 24.7% of GDP in 2012, which makes Nepal the third largest remittance recipient in the world. Migrants remitted an estimated US$5.2 billion to Nepal in 2013 (equivalent to about 25% of GDP). The amount of remittance outflows was just US$50.3 million in 2012.

The average growth of remittance inflows over the last five years has been around 14%, boosted by both the increased number of migrant workers leaving the country and the higher incentives to send more money back home as a result of the depreciation of Nepali rupee against major convertible currencies. Increased remittance inflows are greatly boosting banking sector liquidity in FY2014, leading to a situation where BFIs are increasingly investing in near zero interest bearing T-bills in the absence of good investment projects. More on remittances in Nepal here and here.

Top remittance recipients

As a share of GDP in 2012, the top five remittance recipients were Tajikistan (51.9%), Kyrgyz Republic (31.4%), Nepal (24.7%), Moldova (24.6%) and Samoa (23.5%). In 2010, Nepal was the sixth highest remittance recipient in the world.

In US$ term, India received $70 billion in 2013, followed by China ($60 billion), the Philippines ($25 billion), Mexico ($22 billion) and Nigeria ($21 billion).

In South Asia, while India received the highest amount of remittances, Nepal was the highest recipient as a share of its GDP. As a share of total remittance inflows to South Asia, India receives about 63.2% and Nepal 4.7%.

Remittance inflows
2013e (US$ million)
Share of GDP, 2012
Sri Lanka

  • The WB estimates remittance inflows to development countries at $404 billion in 2013, up 3.5% from 2012. It is expected to grow by an annual average of 8.4%, increasing total remittance inflow to developing countries to $436 billion, $473 billion and $516 billion in 2014, 2015 and 2016, respectively.
  • South Asia is expected to see remittances growth of 6.6%, 7.3%, and 7.5% in 2014, 2015 and 2016, respectively, increasing remittance inflows to $118 billion, 127 billion and 136 billion over the same time periods.

Friday, April 18, 2014

Fishing sector in Nepal

Fishing sector in Nepal is growing (though not at a faster rate given the growing internal demand). Its share of GDP reached 0.62% in FY2013, up from 0.48% in FY2002. There is a huge and growing domestic demand for fish, which is taken as a substitute for meat products (even by some vegetarians I know of!). Nepal’s fish import was over NRs2.7 billion in FY2013 (about NRs1.45 billion from India and NRs1.29 billion from PRC).

With targeted and adequate support from government and development partners, fishing sector has the potential to be a good showcase for (i) import substitution, (ii) commercialization of agriculture, and (iii) source of jobs.

[Fish farm in Chanauli, Chitwan]

Currently, the government is providing some subsidies (for instance, electricity cost is half the normal rate per unit = about NRs 4 per unit), which needs to be better targeted and perhaps continued (given the fact that one of the countries from where Nepal imports fish heavily subsidizes its agriculture sector). The fish culture and research centers of the government need upgrading along with efficient operations. The fish farming sites strategically located around the country have to be connected by road network. Furthermore, there has to be better and more storage facilities.

Relevant capacity building of fish farmers would help in optimizing land utilization around fish farms (= further commercialization plus diversification of income source). Affordable access to finance and better linkages between farm-gate and wholesale/retail centers are two never ending constraints. All these basic initiatives could help Nepalese fish farmers produce better fishes and compete with relatively cheaper imported fishes.

[We enjoyed fresh fish curry during a recent trip to a fish farm in Chanauli, Chitwan. The farm is owned by one of my friends who recently quit business journalism to start commercial fish farming.]

Monday, April 14, 2014

Taming high inflation in Nepal

[This blog post is adapted from Nepal country chapter of Asian Development Outlook 2014. The FY2014 and FY2015 outlook here.]

Average inflation has surpassed 9% in each of the past 5 years except for FY2012, when it was only slightly less. Inflation at 12.6% in FY2009 was the highest in the past 2 decades, largely driven by 17.4% rise in the price of food, which occupies a 46.8% share of the consumer price index basket. Since then, food inflation has slowed but remains high, averaging 11.7% in the past 4 years. Similarly, inflation for other items and services has surpassed 9% in the past 2 years. Taming high inflation, which erodes consumers’ purchasing power and makes producers less competitive, is one of the country’s major macroeconomic challenges.

Inflation in Nepal tends to move in tandem with inflation in India, which is Nepal’s largest trading partner and with whose currency Nepal has pegged its rupee. According to a study by the International Monetary Fund, inflation in India and international oil price movements account for about one-third of the variability in Nepal’s inflation. Moreover, after FY2007 inflation became more responsive to changes in international oil prices and the nominal effective exchange rate. Food price inflation, which has contributed about three-fourths of all consumer price index inflation in recent years, is more responsive to spillover from oil price movement and India’s food inflation. The impact of international oil price movements seems more pernicious because a rise in petroleum product prices is quickly felt in the price of chemical fertilizers and transportation. Monetary factors affect both food and nonfood inflation, but their effect tends to fade away quickly.

Other factors that have driven inflation in recent years are weak currency, wage pressures, and supply-side constraints. The depreciation of the Nepalese rupee against the currencies of its trade partners has inflated costs not only for final goods but also for imported raw materials and intermediate goods. Furthermore, 161 products, mostly industrial raw materials, are imported from India in exchange for US dollars. Supply-side constraints such as power outages, transportation bottlenecks, and market price distortions imposed by middlemen and syndicates have also played major roles in keeping inflation high. These factors appear to have intensified since FY2007, when inflation in Nepal started to diverge from its usual path in tandem with inflation in India. Syndicates’ arbitrary hikes in transportation costs and the widening gap between farm gate prices and retail prices— estimated to be at least 40% in the case of fresh vegetables— have propped up high inflation.

Though the government has banned syndicates and anticompetitive practices, enforcement remains weak. Effective market supervision and monitoring are needed to rectify market distortions. Another need is to check inflationary expectations by ensuring prudent fiscal and monetary policies. A way to diminish inflationary expectations would be to remove uncertainty over supplies of motor fuel and cooking gas. Appropriate steps to boost agricultural production would also help meet market demand and limit the impact of imported inflation. Taming inflation requires that financial policies and structural bottlenecks alike be effectively addressed.

Friday, April 11, 2014

Effects of remittances on Nepalese economy

This post is adapted from a feature story published on Al Jazeera's website. For more on remittances in Nepal, see earlier blog posts.

Remittances have been responsible for poverty reduction, increase in foreign exchange reserves, and caused dependency.

Solukhumbu, Nepal - During a community meeting in an unlit concrete building perched on a mountain terrace, Dom Kulung stands to address the small crowd.

He points at a fellow 20-something man and instructs earnestly: "Once we are educated here, if we leave, we must return with the intent to develop our community."

The message is received well enough with nods. But then Kulung twists the logic a bit: "We don’t need money. We cannot just send money back from Malaysia or India or Gulf countries. That isn’t solving the problem. Money is not enough."

Some in the crowd appear puzzled - others relieved.

Cheskam is among the most remote communities in Nepal - one of the world’s poorest countries - several days walking from the nearest road. Residents in this area traditionally made a living by farming or walking three days to Mount Everest for seasonal work as porters on mountaineering expeditions.

But in the past decade, those traditional sources of income have been eclipsed by an opportunity to make good money, fast, by traveling abroad to work.

Nearly 1,500 Nepalis migrate abroad for work each day. At least 2.2 million Nepalis work abroad – and that figure is believed to be an undercount as many more cross the open border with India regularly.

Last year they sent back about $4bn, nearly a quarter of the country’s gross domestic product.

While the outflow of labour and inflow of money has had undeniable impact, some analysts warn of the toll such changes are taking on the country’s economy - both at the household level and for the country as a whole.

“You can’t find an aspect of any Nepal citizen’s life these days that is not touched by remittances,” said Chandan Sapkota, an economist with the Asian Development Bank in the capital Kathmandu.

Remittances have been responsible for poverty reduction, increase in foreign exchange reserves, and the expansion of banks and financial institutions.”

But, he warned: “The money from remittances is an enormous cushion for Nepal - until something bad or unexpected happens.”

‘Double-edged sword’

A 2011 World Bank report called this cushion the “vicious policy cycle of large remittance” in Nepal, and warned that “no country has ever succeeded in sustaining growth and job creation on remittance alone”.

Jagannath Adhikari, a poverty and economic development analyst, called remittances and migration “a double-edged sword for Nepal,” pointing to a 2011 report he authored on the impact of labour out-migration on rural Nepal.

“There are real dangers in over-dependence on labour migration and remittances,” said Adhikari. “But the adverse impacts or the possible dangers are not that obvious and thus are not discussed.”

Yurendra Basnett, a research fellow at the London-based Overseas Development Institute (ODI), said “The current state of mass migrant out-flow is a reflection of the complete collapse of Nepal’s economy.”

The majority of Nepali labour migrants who travel through official channels go to Malaysia, or Gulf countries such as Qatar and the United Arab Emirates, to work in factories or on construction sites.

While watchdogs such as Amnesty International and Human Rights Watch have highlighted abhorrent working conditions there, other observers say the roots of abuse lie at home in Nepal.

“The underbelly of the remittance success story is that there are few people drawing lines between the horrible conditions these workers can face in their destinations and the conditions at home,” said Basnett.

Basnett, who is an economist, argued that: “The people migrating into these conditions are acting as rational actors - yes there is coercion and manipulation in some cases, but ultimately we have to connect the lack of opportunities at home to the horrid conditions abroad.”

Despite poor work conditions abroad, the number of Nepalese seeking to migrate is holding steady.

‘Dutch disease’

“The money coming in from work being done outside the country has led to an explosion in consumer demand - so much so that the domestic markets cannot provide everything the buyers want. So we see imports increasing,” said Sapkota.

Sapkota has warned of the potential onset of “Dutch disease” as a result of remittances in Nepal, a situation where a substantial spike in revenue from a single industry can have adverse impacts on the rest of the economy.

“A lot of this money coming into the country is being earned outside the country, and being spent on products that were manufactured outside the country - not really contributing to Nepal, per se, much at all,” he said.

The evidence of the negative impact of a remittance boom, Sapkota said, is obvious throughout the country.

“Remittances have driven up tax revenue to the point where the government has operated at a surplus despite lagging behind in the basic infrastructure developments - such as roads and electricity - that would encourage investment in Nepal in the first place,” he said, pointing to increased tax revenues from imported goods, which are purchased with remittance income.

According to Adhikari, Nepal’s reliance on remittance money has had a range of dangerous effects.

"Dependence on remittances and confidence that the in-flow will remain so high means that if there is a shock in terms of decline in that money, the country’s economy will have no way to cope," he explained, also pointing to productive labour Nepal lost with so many people working abroad.

Basnett put the blame squarely on the "rent-seeking elite class running the country".

“There is a lot of apathy when it comes to updating Nepal’s economic policies because the people in charge are making a lot of money off of how things are running now by extracting resources that they haven’t directly earned,” he said, adding Nepal’s economic policies have not been updated since 1992.

He called migration a “safety valve” for decision-makers. “Remittances that come back feed into the system through taxes and by temporarily pacifying the people on the receiving end of the money.”

Beyond returns

But others argue remittances mean more to Nepalese society than just the cash that flows in.

“So much more comes back from migrant labour than just money,” said Drupad Choudhury, programme manager for the International Centre for Integrated Mountain Development (ICIMOD) in Kathmandu. “Remittances are flows of more than just cash - they bring information, ideas, and trends, and all of these things can influence life here in Nepal.”

For example, an experimental project was recently launched to examine whether remittance in-flows could influence building codes in Kathmandu. Nepal’s sprawling capital carries the highest seismic risk in the world and a major earthquake would kill hundreds of thousands, in part because of explosive population growth and a remittance-fueled ungoverned construction boom.

But the implications could go beyond material impact as well.

“Because migrant workers come from such a range of backgrounds - class, ethnicity, geography, and so on - and then return home having seen the world, having earned some money, my hope is that this flow will fundamentally change political vision,” said Basnett.

“A farmer who a generation ago would have had his political views shaped by interactions in his own rural district, and maybe a few trips outside to other parts of Nepal, now has exposure to Kathmandu, to the abuses of the migration system, to an understanding of what rich countries are like. And that will all inform what he thinks of Nepal’s leaders and the demands he makes on them,” he said.

But until policy changes improve the domestic investment environment, migrant labourers and the money they earn and send home will continue to operate according to what Sapkota calls “a scheme of sweet pain”.

“The system as it is today is sweet for the government time and time again and painful for the people who are doing the work,” he said.

Wednesday, April 9, 2014

An interesting theory on inequality: Wealth gap (including inherited) will be the main issue in the long run

An interesting review of Thomas Piketty's Capital in the 21st Century by Matt Yglesias at Vox.

The main point is that: Wealth to income ratio & rate of return on capital to GDP growth ratio are increasing = Top very few already wealthy are getting wealthier and wealthier = Widening inequality

Matt summarizes:

[1] The ratio of wealth to income is rising in all developed countries.
[2] Absent extraordinary interventions, we should expect that trend to continue.
[3] If it continues, the future will look like the 19th century, where economic elites have predominantly inherited their wealth rather than working for it.
[4] The best solution would be a globally coordinated effort to tax wealth.
Highly concentrated income was in the hands not just of the top 10 or 20 percent of households but the top 1, 0.1, or even 0.01 percent. [...]The dynamic towards wealth inequality is built into capitalism rather than any one country's economic policies. [...]In the long run the economic inequality that matters won't be the gap between people who earn high salaries and those who earn low ones, it will be the gap between people who inherit large sums of money and those who don't. [...]Piketty says we are headed for a world of patrimonial capitalism where the Forbes 400 list will be dominated not by the founders of new companies but by the grandchildren of today's super-elite.

Basically, inherited wealth + higher retention of income from the use of factors of production make wealthy folks even wealthier. Looks like an accumulative process that kick-starts entrepreneurship up to a certain threshold but then widens income inequality after that threshold is breached. Finding a fine balance/non-static equilibrium may be the trick now (= at least some form of progressive redistribution without stymieing entrepreneurship). Piketty advocates a global wealth tax.

Thursday, April 3, 2014

Infrastructure gap in South Asia: Between 6.6% and 9.9% of GDP per year

A latest World Bank report argues that South Asia faces infrastructure gap (transport, electricity, water supply and sanitation, solid waste, telecommunications and irrigation) of between US$1.7 trillion and US$2.5 trillion (at current prices) until 2020 [US$1.4 and US$2.1 trillion at 2010 prices]. 

In terms of GDP, it amounts to between 6.6% and 9.9% per year (spread evenly over the years until 2020). Overall, infrastructure investment in South Asia was 6.9% of GDP in 2009. Infrastructure investment in India accounts for, on average, 79% of total investment in South Asia. Nepal’s share is just 1%, second lowest to Bhutan’s 0.2%. To close the infrastructure gap, the report suggests going for a mix of investment in infrastructure stock and implementation of supportive reforms.


In terms of access to infrastructure services in Nepal, 47 per 100 people had telecom access (2011), 75% of population had electricity access (2010), 35% of population had access to improved sanitation (2011), 88% of population had access to improved water (2011), total road network was 0.8 km per 1000 people (2008), and 54% of roads were paved (2008). Nepal’s telecom access per 100 people was the lowest in South Asia. These provide an indication of how large the unmet infrastructure demand is.

The report shows that Nepal faces a financing need of between 8.24% and 11.75% of GDP per year until 2020 (at 2010 prices). The cumulative investment requirement over 2011-2020 (at 2010 prices) is estimated between US$13 billion and US$18 billion. 

Specifically, the financing needs to bridge the infrastructure gap are as follows:
  • Transport: 2.32% to 3.49% of GDP
  • Electricity: 3.34% to 4.46% of GDP
  • Water supply and sanitation: 1.08% to 1.62% of GDP
  • Solid waste: 0.24% to 0.30% of GDP
  • Telecom: 0.27% to 0.40% of GDP
  • Irrigation: 0.99% to 1.48% of GDP
  • Total: 8.24% to 11.25% of GDP

A 2010 ADBI study showed national investment need of about US$1.3 billion per year until 2020. As a share of GDP, it amounts to around 8.48% of GDP. Sector-wise investment need was 1.65% GDP for transport, 0.59% GDP for electricity, 5.14% of GDP for ITC and 1.10% of GDP for water and sanitation.

Nepal’s existing infrastructure investment hovers around 5% of GDP. There is a need to scale up investments especially in electricity and transport as the inadequate supply of these are the most binding constraints on growth.

Some of the policy recommendations proposed by the study are as follows:
  • Rehabilitate and maintain existing assets
  • Reform service providers and ensure financial/operational sustainability (no political interference and appropriate incentives to perform efficiently)
  • Establish solid legal, policy and regulatory frameworks (including PPPs)
  • Decentralize service provision
The report assesses the infrastructure gap using a four-step process: (i) where a country is today (infrastructure investment as a share of GDP); (ii) where a country would like to be at a given point in time; (iii) financing and policy options available at present to march towards the goal; and (iv) the remaining financial gap that will be needed to be bridged.

Wednesday, April 2, 2014

Nepal's economic outlook for FY2014 and FY2015

[This blog post is adapted from Nepal country chapter of Asian Development Outlook 2014.]

A significant drop in agriculture and delay in introducing a full budget dragged down GDP growth. Inflation remained high, and the current account surplus contracted as remittance inflows decelerated. Growth is expected to pick up with a favorable monsoon, the timely adoption of a full budget, and political stability following the successful Constituent Assembly election in November 2013. 

Economic performance 

GDP growth decelerated to 3.6% in FY2013 (ended 15 July 2013) because of an unfavorable monsoon, a shortage of chemical fertilizers, and the delay in introducing a full FY2013 budget. Agricultural output growth slowed sharply to 1.3%, the lowest rate in the past 5 years, while services grew by 6% on improvements in wholesale and retail trade and in hotels and restaurants. Industry continued to languish, growing by a mere 1.6% as persistent electricity shortages, labor disputes, and political uncertainty soured the investment climate. 

Inflation crept up to average 9.9% in FY2013, even as prices for food and for other goods and services moderated from highs at the beginning of the year, to bring overall inflation to 7.7% in the 12 months to the end of the fiscal year. Subsequently, the low agricultural harvest and high prices for agricultural imports from India pushed up food inflation sharply to bring overall inflation to 9.7% in the month of January 2014. 

The delayed presentation of a full budget, which was introduced only in the 9th month of FY2013, combined with weak implementation capacity in the government sharply curtailed total expenditure growth to 3.6%. Importantly, only 81% of the budget allocation for capital expenditure was actually spent, coming to a mere 3.1% of GDP. Strengthened revenue administration, a broadened tax base, and a boost in imports propelled tax revenue 22.6% higher, to bring total revenue including grants up to 19.8% of GDP, exceeding 18.6% a year earlier. As a result, the overall budget balance turned from deficits in recent years to a surplus equal to 0.4% of GDP.

Reflecting the central bank’s push to increase credit to productive sectors, lending to agriculture, industry, and energy picked up, and credit to the private sector grew by 20.2%, accelerating from 11.3% in the previous year. Construction, wholesale and retail trade, services, and mines saw the largest increases in lending. The increases in lending to construction, at 16.4%, and to retail and wholesale trade, at 22.9%, indicate recovery in these sectors from a slowdown in the previous year. The annual average weighted lending rate remained stable at around 12%.

The current account surplus narrowed to 3.4% of GDP, mainly on deceleration of remittance inflows and a surge in the trade deficit . Exports declined by 2.9% as demand slowed and supply-side constraints hurt competitiveness. Merchandise imports grew by 10.8%—largely because reliance on imports to meet domestic demand continued to intensify despite the weakening of Nepalese rupee, and demand for petroleum products rose—pushing the trade deficit up to 27.1% of GDP. Growth of remittance inflows eased to 11.3% after the large 26.6% expansion in the previous year, yet remittances still amounted to 25.6% of GDP. The overall balance of payments surplus moderated to $786.5 million, and foreign exchange reserves increased to $5.6 billion, equivalent to 8.9 months of imports of goods and services.

Economic prospects

The economic outlook is more optimistic than in FY2013, considering the successful second Constituent Assembly election in November 2013 (following an 18-month hiatus from the end of the first assembly), the favorable monsoon, and expected  strengthening in remittance inflows. The successful political transition to a new government has boosted business and investor confidence. The Constituent Assembly is expected to pass legislation that will promote investment in key sectors and mandate structural reforms. However, there is a downside risk of political instability arising from continued disagreement among the major political parties over unsettled constitutional and governance issues, especially those of federalism and the nature of parliament and the executive. These issues have the potential to create hurdles to drafting a new constitution like those that stymied the earlier Constituent Assembly.

Selected economic indicators (%)

GDP growth
Current account balance (share of GDP)
Source: ADB estimates

Taking into account the favorable monsoon, more rapid growth of remittance inflows, and the timely introduction of a full budget—and assuming political stability—GDP is projected to grow by 4.5% in FY2014, somewhat less than the government’s target of 5.5%. Normal monsoon rains and adequate supplies of chemical fertilizers have allowed full paddy planting in most of the country. The budget—with a sharp 41.1% boost planned for expenditure and underpinned by positive political developments and clearer government direction—has strengthened business and investor confidence, and so prospects for a boost to industrial activity and exports. Higher remittance-backed consumer demand and an uptick in tourism will support services growth at around 5%. More than half of growth will come from services, and the balance largely from agriculture.

GDP growth is expected to pick up to 4.7% in FY2015, assuming a normal monsoon, a timely budget, continued strong remittance inflows, a revival in real estate and housing, and the better growth outlook in India.

Despite the improved agricultural harvest, numerous factors—wage pressures, upward adjustment of administered fuel prices, the continued weakening of the currency and high inflation in India, and persistent power shortages and other supply-side constraints—are expected to drive inflation up to 10%, well above the central bank’s targeted improvement to 8.5%. Notably, the FY2014 budget increased the civil service salary scale by 18% and provided an additional NRs1,000/month allowance for all government employees. Moreover, the minimum wage for workers outside of agriculture was raised by 29% in June 2013. Inflation is projected to ease only slightly to 9.5% in FY2015, even assuming a good harvest, an appreciable reduction of inflation in India, cautious monetary and fiscal policies, and subsiding domestic wage pressures.

The balance of payments is expected to remain strong in FY2014. Exports are projected to increase by 3.0%, reflecting improving external demand and the gain in cost competitiveness owing to currency depreciation. Imports are projected to grow by 15% on the back of an upturn in domestic demand. Despite the widening trade deficit, higher growth in remittance inflows and increased tourism will sustain a current account surplus at 3.6% of GDP, slightly improved from a year earlier. The increase in the number of migrant workers going abroad, higher pay packages, and stronger incentives to remit money as the home currency depreciates underpin a favorable outlook for remittance inflows. Assuming a further pickup in export growth, some  moderation in import demand, and a sustained advance in remittances, the current account surplus is expected to increase marginally in FY2015 to 3.7% of GDP. 

Even with a timely full budget for FY2014, capital expenditure may not be fully spent because of delays (some of them election related) affecting procurement, budget release, and the implementation of approved projects. No major tax changes have been made, and gains from ongoing revenue administration reform may not be sufficient to meet the revenue target of 19.9% set in the budget, especially if imports underperform budget forecasts. Nevertheless, with some shortfall in expenditure, the budget deficit is expected to be around 2.4% of GDP, as envisioned in the budget. 

The financial sector is stabilizing after the earlier excessive credit expansion and the subsequent break in the real estate boom in FY2011. FY2013 saw banks and other financial institutions consolidate further. The average capital adequacy ratio stands at 13.2%, well above the 10% threshold (plus 1% capital buffer), and real estate exposure continued to abate and is now well below the cap of 25% of loan portfolio that had been imposed by the central bank. Moreover, nonperforming loans declined to 3.8% of all loans. Nevertheless, banks and other financial institutions need to enhance their operational efficiency and explore further opportunities for consolidation. Credit and savings cooperatives, which fall outside of the purview of the central bank, need to be closely monitored, regulated, and supervised to ensure the soundness of the financial sector.