Friday, February 26, 2016

Impact of trade blockade on inflation and external sector

Earlier, I briefly gave an outline of the impact of trade blockade on government expenditure and revenue in the first half of FY2016. Here is a follow up brief blog on the impact of trade blockade on inflation and external sector stability. A good mid-year FY2016 snapshot is provided by the IMF team here.

Inflation is creeping up fast: from 6.9% in mid-August 2015 to 12.1% in mid-January 2016. The last four months (when the supplies disruptions due to blockade was ongoing) had inflation higher than the corresponding months in FY2015. The deviation from Indian inflation was also higher in all the first six months of FY2016, which indicates not only the impact of the blockade (which is the primary source), but also the impact of supply-side constraints and anti-competitive practices within Nepal. Overall, food inflation (has 43.91 weight on CPI basket) was 15.2% in mid-January and non-food inflation was 9.7%. The blockade barred Nepali traders from importing goods at a relatively cheaper prices as a result of the sustained low oil prices globally. 

The impact of the earthquake, supply disruptions (which affected travel and operation of manpower agencies), and slow demand from migrant workers from employment destination overseas (particularly due to the impact of low global oil prices in oil producing countries in the Gulf and Malaysia) lowered the number of workers leaving for work overseas. 

However, workers' remittances have been increasing. At $3.1 billion by mid-year FY2016, it is higher than $2.8 billion by mid-year FY2015— a growth rate of 9.8% in dollar terms. This may slowdown in towards the end of FY2015 and in FY2016.

The decline in trade deficit (as blockade drastically lowered exports and imports) and an increase in workers’ remittance inflows boosted current account balance and balance of payments. Merchandise exports were down by about $178.5 million in the first half of FY2016 from the level in the corresponding period in FY2015. Similarly, imports went down by $1.2 billion, with oil imports plunging down by $381.6 million and non-oil imports by $790.1 million compared to the first six months of FY2015. Consequently trade deficit was down by $993 million. Current account surplus was $1.4 billion. Forex reserves are also up.

Few points:
  • Inflation may not come down anytime soon even though inflation in India is projected to be around 4.0% to 4.5% in the next fiscal year. Fuel and gas supplies have improved but they are far below the demand right now. Its lingering impact will continue to keep food and non-food prices at elevated levels. 
  • The hiring freeze by Malaysia is another major worry as it accounts for about 40% of total overseas employment. Similarly, the slowdown in Gulf countries due to low oil prices may depress the demand for Nepalese workers. Hence, remittances inflows may be affected negatively (even after factoring in the weak Nepalese currency against the USD). This may pose challenges in external sector stability, particularly current account balance and forex reserves.
  • Exchange rate of Nepalese currency vis-à-vis the US dollar may remain volatile, following the movement of Indian rupee against the dollar.
  • Depending on how event unfolds in the remaining months, GDP growth may swing anywhere between negative 1.8% to positive 0.5% in FY2016. Inflation will probably remain in the double-digits. Current account surplus will likely decrease.

Friday, February 19, 2016

Impact of trade blockade on expenditure and revenue

The fiscal situation till the mid-year of FY2016 looks pretty bad. All components under the expenditure and revenue headings are down. It can mostly be attributed to the supplies/trade blockade, which went on for about four and a half month and whose impact will linger on in the months ahead as well. This lingering effect will continue to impact growth and inflation well into the next fiscal year. The supplies blockade is going to be more damaging to the already weak economic fundamentals than is commonly perceived by politicians and some analysts. There is no fast-track recovery without fast-track measures!

To recover quickly, more than doubling of effort both on bureaucratic and trade/supplies fronts is required. It means accelerating spending by taking unconventional measures as and when required. The unconventional measures I am talking about is bypassing of some of the hurdles in project implementation and procurement clearances (more ambitious leaders would even go for quick amendment of Acts and roll out updated policies) in key infrastructure projects, mostly energy, roads, urban and irrigation sectors. The rationale is simple: two doses of extraordinary economic shocks (earthquake and blockade) have crippled the economy and hence ordinary ways of doing projects and decision-making are not going to make a dent. It will require higher level decision (Cabinet and political) plus aggressive bureaucratic work to get thing in order as soon as possible. This is not the time to wait for months to bring out policies and amendments to Acts, and then think of starting work.

This necessity is more than evident from the dismal half-year fiscal numbers. The public expenditure absorption capacity has been hopelessly eroding (see the chart below). By mid-year FY2016, actual capital spending was just 7.2% of planned capital spending for the entire FY2016. Now, this is lower than 12.6% achieved in the corresponding period in FY2015 (before the April 2015 earthquake). At this rate, it is impossible to spend Rs208.9 billion planned capital spending in FY2016 (reconstruction budget makes up almost half of it). By mid-February, actual capital spending was just 9.09% of planned capital spending.

On the revenue front, the story is the same and there was little the government could do (on expenditure side, despite the blockade no one was restricting the bureaucrats and government to prepare necessary project planning and tender documentation, which really sets the stage for faster spending in the second half of fiscal year). Revenue in all sub-headings were below the half-year target. 

Total revenue mobilization was just 34.6% of FY2016 target. It is lower than 46.9% mobilization in the corresponding period in FY2015. Tough road ahead to achieve the target but, not as tough as it would be to achieve expenditure targets (because most of the revenue is autonomous in the sense that increase in imports automatically raises revenue if the revenue officials do the job rightfully). The government has revised down the revenue target to Rs430.34 billion (against original target of Rs475 billion).

In a nutshell, the dismal half yearly fiscal numbers reflects the crippling impact of trade/supplies blockade. Without aggressive efforts in budget execution, the revised 2% growth target for FY2016 is too ambitious. Here is more on the impact of the earthquake and blockade.

Wednesday, February 17, 2016

The root of energy crisis (deficit) in Nepal

Ambition without vision
Painful and drastic reforms are needed in the NEA and NOC to realise energy goals

The economic devastation caused by the April 2015 earthquake and trade blockade for about four months have reignited discussion over production and import diversification, and economic self-sufficiency. It has become a hot topic amongst politicians, talking heads, opinion makers and the public in general. Ministers are making bold statements about self-sufficiency. Prime Minister KP Oil even promised that his government will end load-shedding within one year and connect every household to gas pipelines. 

As events unfold and experts debate on its possibility, it appears this will likely be an ambition without a vision and a good homework, mainly due to the lack of willingness to overhaul management, jurisdiction and operations of Nepal Electricity Authority (NEA) and Nepal Oil Corporation (NOC).

Binding constraint

The most binding constraint to economic growth is the inadequate supply of infrastructure, especially electricity. This is not only stymieing industrial activities, but also leading to an increase imported fuel, which is widely used by small and medium enterprises to sustain their operations even if they have to incur higher costs. Fuel import accounts for about 20% of total imports (about $1 billion annually) and is larger than the total value of merchandise exports. The cost of production using imported fuel— procured and distributed through Nepal Oil Corporation (NOC) — is expensive relative to hydroelectricity and hence the prices of goods and services in the market are also relatively higher compared to other comparable cities around the world. 

Against this backdrop, the biggest policy bang for a buck lies in accelerating electricity generation— both hydropower and alternative sources such as solar and wind— to meet demand. It will not only reduces demand for imported fuel, but also increases fiscal revenues, economic growth and new jobs. However, over the past 100 plus years very little has been achieved due to the politicization of the entire sector (Pharping hydro power started generating electricity on 22 May 1911). 

Without a complete overhaul of management, financial and operational efficiency of NEA and NOC, energy self-sufficiency would continue to remain a distant dream. Despite all the promises, politicians have shown little credible interest in overhauling these two public enterprises as it cuts across party lobbyists, unions, syndicates, employment for cronies, and periodic financial bonanza.

Inefficient institutions

The NEA and the NOC more or less solely procure and sell electricity and fuel, respectively. They are operating without competitors and dictating quantity purchased from suppliers on their own. It leaves a huge space for financial and distribution malgovernance— often with the tacit support of politicians and lobbyists.

Both the public enterprises are financially bankrupt. The NEA’s operating loss amounted to about 0.4% of GDP in FY2015. About Rs27 billion outstanding debt was written-off in FY2012 to make it financially viable and to make it worthy for investor’s consideration. However, it continues to accumulate losses as electricity prices are not adjusted to reflect cost of production or purchase. Meantime, little has been done to reduce technical losses, one of the highest in the world. Total peak time supply is barely 55% of total demand, leading to load-shedding of between 12 and 16 hours a day (contingent upon the level import from India). 

The NOC is in a more perilous state as it has no long term investment assets to bank on for revenues. The management and distribution inefficiency, and mismatch between buying and selling prices of fuel and gas have turned NOC into an infamously inefficient public enterprise. In FY2014, its losses amounted to about 0.4% of GDP as domestic fuel and gas prices were kept low despite high international prices. With low fuel prices internationally for over a year and reluctant downward adjustment of domestic fuel prices, it is in a much better shape now. Although its accumulated debt amounts to about 1.12% of GDP, it nevertheless is planning to distribute bonus earned from the revenues generated by charging high prices to consumers (with the commitment to cover past losses). 

Hollow commitment

Any political commitment or speech on reforming these two public enterprises is an additional political capital for parties, and they have not shied away from capitalizing on that. For instance, during the second Constituent Assembly election, Nepali Congress promised to generate 5,000 MW of electricity within five years and achieve economic growth of 8-10%. UML promised to complete all major hydropower projects (both storage and run-of-the-river types) within 10 years by involving the private sector and also end load-shedding in five years. Meanwhile, the UCPN-M promised to end load-shedding in three years and develop 10,000 MW, 20,000 MW and 25,000 MW in the 10, 20, and 40 years respectively. 

Lately, the government has been promising to end load-shedding within a year (mostly by importing from India) and generate 10,000 MW within ten years by declaring an energy emergency (similar one came in 2008 as well followed by a Ten Year Hydropower Development Plan in 2009). Also, the government has allowed the private sector to procure and distribute fuel, technically breaking the monopoly of NOC. 

Painful reforms

A lot of painful drastic reforms are needed to realize even a fraction of these promises. Unfortunately, the political parties are not up to the speed and have been unwilling to forgo representing the special interest groups. This has been the main reason behind the delay in cost evaluation of projects, prolonged and contentious procurement (the earlier energy minister even snatched regular management jurisdiction of NEA to her ministry’s chamber), and trading of generation licenses. The politically-affiliated unions at the NEA and affiliates in districts are further complicating the situation by demanding unjustified compensation and shares. Similarly, the NOC has been a plump earning source for unscrupulous traders and political affiliates. 

The bureaucracy is more hesitant than before to complete procurement and necessary project clearances on time. There is delay in constructing transmission lines and signing power purchase agreements, which has been put on hold on the misguided belief that the country will have surplus power during wet season from FY2018. The demand for electricity is never linear in an energy-hungry country like Nepal. Electricity acts as an alternative source of energy to fuel and is convenient as well as relatively cheap. Hence, immediately after the fuel blockade, the demand for electricity was so high that the NEA’s transformers exploded. The actual latent demand for electricity is much higher than the one estimated by the NEA.

Painful reforms are needed to reform these two public enterprise and the sectors they represent. To avoid irregularities, discretionary power of ministry and management should be minimized and a rule-based system (breaking up production, transmission and distribution aspects), inscribed in an Act, should be enacted. This means overhauling procurement processes, requirements for preliminary project assessment, inter-ministry and inter-department coordination, efficient and responsible human resources, and politics free decision-making and operations. Unfortunately, it is easier said than done.

It was published in The Kathmandu Post on 15 February 2016

Wednesday, February 10, 2016

Key economic achievements under late PM Sushil Koirala

Former Prime Minister and President of Nepali Congress (NC) party, Sushil Koirala passed away yesterday at the age of 78. He was known for a simple lifestyle and a clean career. Here are the key economic achievements during his tenure:
  • Landmark power development agreements (PDA) was singed for 900MW Upper Karnali and 900MW Arun-3 hydroelectric projects worth over $2 billion
  • Power Trade Agreement (PTA) was signed with India
  • 18th SAARC summit was successfully organized with agreements on vehicle movement and energy cooperation, among others.
  • 6,720MW Pancheswar Multipurpose Project got some momentum
  • Presided over the successful completion of post-disaster needs assessment
  • Successfully organized the International Conference on Nepal's Reconstruction in March 2015 Donors committed about $4 billion for Nepal's post-earthquake reconstruction
  • Successfully concluded the political transition with the promulgation of a new constitution in September 2015
  • FDI commitment of about $2.7 billion in FY2015
  • A Public Private Partnership (PPP) Policy was approved
  • Put in good and able technocrats/policymakers at key bodies such as National Planning Commission
On the economics front, he will be remembered most for helping to lay groundwork for major investment projects and reform measures. That is quite an achievement in itself (even if the results are not quick) given the relative performance under the leadership of previous premiers. The April 2015 earthquake and subsequent aftershocks, plus the trade blockade (for four and a half month) dented growth prospects and inflicted immeasurable hardship to common folks, but these were beyond Koirala's power. With the lifting of the blockade at the borders, lets hope that economic recovery will be fast (and that the government and bureaucrats will work faster than before for that). 

For now, lets thank the former PM for his decades long service to the nation and for presiding over one of the most scandal-free governments. RIP.

Pic courtesy: Republica