Thursday, May 19, 2016

About domestic resources and infrastructure financing in Nepal

There has been a lot of debate about the use of domestic funds to finance large-scale infrastructure projects, especially hydroelectricity, roads and airports. Let me provide a brief background and readers can see for themselves which claims made by ‘experts’ hold water and which ones are impractical and outlandish. 

First, issue about fiscal space to finance large scale projects. Nepal has a very low outstanding public debt (about 25.6% of GDP), with internal and external debt stock amounting to 9.5% and 16.1% of GDP, respectively. The outstanding public debt decreased drastically from about 52% of GDP in FY2005. This was a result of faster repayment of principal and interest (due to high revenue growth rate but eroding low expenditure capacity). Now, given the huge infrastructure deficit and low per capita income, Nepal can afford to increase it by few percentage points and use those money in productivity-enhancing infrastructure projects. Here is brief study on increasing public debt by 10 percentage points to finance post-earthquake reconstruction without jeopardizing fiscal sustainability (that is, maintaining the present level of primary balance). 

To increase this limit further needs attention on two fronts: (i) a higher growth rate (ideally above 5%), concessional nature of external borrowing and higher remittance-financed imports, which then boosts revenue; and (ii) drastic enhancement of absorption capacity. 

On the first point, no comment on growth rate as we know well what drives it in Nepal. But, the concessional financing may be drying up. The ADB is phasing out concessional lending in few years and Nepal may have to borrow at a rate between concessional rate (for low income countries) and nonconcessional rates (for lower to middle income countries). The WB is also moving in the same direction. AIIB financing may not be as concessional as those from the ADB and the WB. We will have to wait and see that one. Bilateral financing may or may not be equally generous in terms of interest and maturity, but the downside is that there are hooks on procurement and utilization of funds.

On remittance-financed imports, remittance inflows may not be as stable as before given the continued slump in oil prices and fiscal strain in the countries where Nepali workers go for employment. Remittance inflow is already decelerating, i.e. its growth rate is decreasing although the amount is rising.

On the second point, without drastic enhancement of absorption capacity, even concessional financing won’t come (disbursement happens after government spends money, submits the bills or details of spending to donors and then gets reimbursed). And it is no secret that spending absorption capacity is receding in the last couple of years. So, yes POTENTIAL financing options are available, but REALIZING it is an entirely different ball game. It is not as simple as it sounds. 

What about domestic financing (from treasury savings), domestic borrowing and using some forex reserves? Again, utilizing these is linked to macroeconomic balance and fiscal space. Given the occasional fiscal surplus (even primary balance is in surplus) the government can afford to run fiscal deficit IF the additional money is used in productivity-enhancing infrastructure projects in an accelerated manner. This is more and more unlikely given the receding disbursement rates of major projects and the usual legal, institutional and political hiccups overpowering project implementation. 

A lot of folks are also talking about pooling in the liquidity in the market and household savings apart from those in the banks (as seen when several IPOs being oversubscribed in recent years) to generate funds for large-scale infrastructure projects. But then this liquidity is transitory because of the adverse market conditions. Domestic financing will quickly dry up as soon as real estate and trading activities regain momentum, and BFIs see a favorable credit demand with less socio-political risk. Another aspect associated with this is the domestic borrowing by government through the selling of bills and bonds. This cannot be extended beyond 2-2.5% of GDP to maintain fiscal stability. This is already being practiced (as the government targets to raise around Rs50 billion annually). Higher domestic borrowing by government will push up lending rates (not good for private sector and households as it stifles growth and then subsequently revenue and then finally the funds available for such projects—boomerang!).

Additionally, most of the savings are for short term, but infrastructure financing is for long term. So pooling in money to explicitly finance large-scale infrastructure projects is difficult as folks don’t want to wait for years to get financial benefit. This is different from IPOs, where folks want to purchase shares with an objective to trade it at higher prices after the moratorium on selling is over after few months. Also, banks will be unwilling to invest in large amount in long-term projects out of the short-term deposits. Can you see the asset-liability mismatch there (and the troubles BFIs would be in)?

Next, what about treasury surplus? Again, it is not as easy as it sounds as the government has been using a portion of it as “carry over from last year” to finance the burgeoning (recurrent) expenditure. Not a new thing, but its size will deplete as soon as the government spends more on other projects across the country. If we pin much hope on treasury savings, then we are basically saying lets decrease capital spending in the rest of the country, save the money and then use it in few of the large infrastructure projects. The treasury savings (about Rs50 billion in the first nine months of FY2015) are there because the government is raising revenue (thanks to remittance-finance imports and consumption) that it cannot spend on in infrastructure projects. It is not an additional bonus to domestic financing that you can use for large-scale infrastructure projects! Importantly, at the core of it, it does not solve the problem: the government is not able to spend the money it appropriates for various infrastructure projects across the country. The focus should be in resolving this aspect and ensuring that major projects on an average spend over 90% of allocated money (but not 60% of those in the last quarter; preferably at least 50% by the first seven months of fiscal year).

Finally, what about the forex reserves (about $10 billion as of the ninth month of FY2016). Nepal cannot use this like that because it needs to maintain enough reserves to finance around 7 months of import of goods and services (given the peg to the Indian rupee, to fend off external shocks and the opportunity cost of holding reserves). And the amount of reserves fluctuates depending on remittance inflows and the level of import of goods and services.  

Overall, yes some room for domestic financing is there, but not as high as is being perceived by folks out there.

No comments:

Post a Comment