This piece is adapted from Macroeconomic Update Nepal, Vol.4, No.2, published by Asian Development Bank, Nepal Resident Mission.
The lingering impact of the catastrophic earthquakes in FY2015, slow post-earthquake reconstruction, and crippling trade and supplies disruption resulted in gross domestic product (GDP) growth of just 0.8% in FY2016. The earthquake-led disruption of economic activities, especially in agricultural and industrial production, struggled to recover as reconstruction and rehabilitation efforts could not pick up speed. This was exacerbated by the trade and supply disruption between September 2015 and February 2016. The combined effect was quite disruptive for the economy as GDP growth dipped to its lowest level since FY2002. Agricultural output grew by an estimated 1.3%, marginally higher than 0.8% in FY2015. Meanwhile, industrial output registered a negative growth of 6.3% in FY2016, sharply down from 1.5% growth in FY2015. The services sector, which accounts for about 53% of GDP and is the key driver of GDP growth, grew by 2.7%, lower than 3.6% after the earthquake in FY2015 and 6.2% in FY2014. The outlook for FY2017 is moderately optimistic and hinges depending on the scale of recovery of agricultural output given the normal monsoon, the scope and pace of post-earthquake reconstruction and rehabilitation, budget execution, and remittance inflows. Considering these factors, GDP growth is forecast at 4.8% in FY2017.
The trade and supply disruption affected public spending although the pattern of spending, with heavy bunching up in the last quarter, was no different from previous years. Capital spending stalled for almost five months as the severe shortage of fuel and construction materials paralyzed project implementation as well as post-earthquake reconstruction. Budget under-execution has been a major fiscal issue in Nepal. The estimated actual capital spending was just 56.3% of planned capital spending in FY2016, sharply down from about 76% in the last five years. Meanwhile, actual recurrent spending was 75.6% of planned recurrent spending in FY2016, a significant drop compared to an average 90% in the last five years. Overall, expenditure grew by 13%, with recurrent and capital spending growth at 7.9% and 32.6%, respectively— lower than the growth rates in FY2015.
The continuous reforms in revenue administration, gradual broadening of the tax base, and the higher import bill (mostly financed by remittance income) resulted in robust revenue performance over the last decade. Total revenue grew by 18.9%, higher than the 13.7% growth in FY2015 but lower than the 20.5% growth in FY2014. Despite the five months long trade and supply disruption, revenue growth accelerated in the last five months of FY2016 as imports gradually normalized along with the clearance of the backlog of goods stuck at various customs points along the Nepal-India border. As a share of GDP, tax revenue mobilization increased significantly, reaching 18.8% of GDP in FY2016, up from 9.8% of GDP in FY2007. Non-tax revenue amounted 2.7% of GDP in FY2016. Total revenue growth averaged 20% in the last five years.
The robust revenue mobilization but disappointing expenditure performance resulted in a fiscal surplus equivalent to 1.4% of GDP in FY2016. The country ran a fiscal surplus in FY2013 and FY2014, but a fiscal deficit (of about 0.7% of GDP) in FY2015. For a country with one of the lowest per capita incomes in Asia, running a fiscal surplus indicates chronic problems associated with budget execution. A fiscal policy anchored on a modest deficit to finance productivity-enhancing infrastructure would not jeopardize fiscal sustainability. Nepal faces an estimated infrastructure financing gap of between 8% and 12% of GDP annually until 2020. Ramping up public spending on physical and social infrastructures, including those related to post-earthquake reconstruction, is essential for accelerated, employment-centric and inclusive economic growth. Primary surplus— fiscal balance before interest payment on public debt— increased to 3.8% of GDP. Nepal has been running a primary surplus since FY2012. Combined with the low and declining outstanding public debt (about 27.6% of GDP), it indicates that the government has ample fiscal space to ramp up productivity enhancing public capital investment without jeopardizing fiscal sustainability. However, a major constraint for doing that is the eroding expenditure absorption capacity.
Inflation (year-on-year average consumer price index [CPI]) increased by 9.9%, higher than 7.2% increase in FY2015, as the unfavorable monsoon affected agricultural output and the trade disruption created a severe shortage of essential goods, including cooking gas and petroleum products. Overall, food prices and non-food prices contributed 4.8 and 5.1 percentage points to overall inflation. Looking forward, the expected bumper agricultural harvest due to the normal monsoon, expected subdued inflation in India, low fuel and commodity prices and normalization of trade and supplies will likely lower general prices of goods and services in FY2017 despite the demand-side pressures emanating from the earthquake related fiscal stimulus, especially the committed $2000 grant to over half a million affected households. Consequently, food and non-food inflation are projected to contribute 4.3 and 4.2 percentage points, respectively to overall inflation forecast of 8.5% in FY2017. The possibility of supplies disruption arising from natural disasters and political instability is a major downside risk to the inflation forecast.
Money supply (M2) grew by 19.5%, reaching NRs366.8 billion, supported by a robust increase in net foreign assets. However, it is marginally lower than the 19.9% growth in FY2015 owing to the decrease in net domestic assets. The BFIs mobilized NRs328 billion (reaching a total NRs2016.8 billion) in deposits in FY2016, higher than NRs282 billion mobilized in FY2015, as higher remittance inflows (despite the decrease in the number of migrant workers) and slower government expenditure boosted deposits. Total credit (loans and advances) of BFIs increased by 23.3% (NRs360 billion) in FY2016, up from 17.5% growth in FY2015 (NRs229.3 billion). Credits by commercial banks grew by 25.9% (NRs327.9 billion), up from a rate of 18.8% in FY2015. Responding to the persistent excess liquidity in the banking sector in FY2016, the Nepal Rastra Bank (NRB) mopped up liquidity equivalent to NRs235.9 billion through reverse repo auctions— one of the short-term tools used by the central bank to manage liquidity— at weighted interest rates between 0.0001% and 1.3%; NRs9 billion through outright sale auctions at weighted interest rate between 1.06% and 2.88%; NRs297.5 billion through deposit auction at a weighted interest rate of 0.85%; and NRs49.1 billion by selling NRB bonds. The short-term interest ratesfluctuated throughout the year and were slightly higher than in the corresponding months in FY2015.
The balance of payments surplus reached $1.8 billion (8.5% of GDP) in FY2016, up from $1.4 billion in the previous year. The large merchandise trade deficit, which declined to 30.3% of GDP from 31.3% of GDP in FY2015, was partially offset by workers’ remittances, which hit a record 29.6% of GDP, resulting in a current account surplus of $1.3 billion (6.2% of GDP), up from 5.1% of GDP in FY2015. Meanwhile, FDI inflows increased to $55.8 million from $44.2 million in FY2015. Gross foreign exchange reserves increased from $8.1 billion in FY2015 to $9.7 billion in FY2016, sufficient to cover 14.1 months of import of goods and non-factor services. The Nepalese rupee continued to remain weak against the US dollar, closely following movement of the Indian rupee, to which the currency is pegged since 1993. Overall, the Nepalese rupee depreciated by 5.2% between mid-July 2015 and mid-July 2016.
This edition of Macroeconomic Update’s issue focus delves into the efficiency and integrity of public procurement and its effects on accelerating inclusive economic growth. Many medium to large-scale development projects in Nepal are plagued by implementation delays and cost overruns. At the core of such recurrent hurdles is inefficient public procurement, contributed by a slew of factors such as legal and policy complications, poor performance of contractor, lack of required human resources to manage contract and high staff turnover, political meddling at management and operational levels, weak leadership by project directors, and prolonged delays by oversight and judicial agencies to clear contentious procurement. Consequently, project implementation is slow with cost and time overruns, quality and scale of infrastructure construction is not up to the taxpayers’ expectation, and disbursement is slow and below target. All these result in sluggish economic growth and
insufficient jobs creation.
Efficiency and integrity in public procurement (of goods, works and services) accelerate project implementation, which in turn enhances capital spending and positively affects economic growth, research and development (innovation), stimulation of private sector activities and jobs creation. Furthermore, if done in the right way and on time to maximize the value for taxpayers’ money, public procurement could be used as a strategic policy tool to address the myriad of economic, social and environmental challenges faced by the country. Hence, efficiency and integrity in public procurement— equivalent to around 12% of GDP— is vital to not only accelerate project implementation, but also to achieve medium-term goal of graduation from LDC category and long-term goal to be a middle income country by 2030, which also is the target date to achieve the Sustainable Development Goals (SGDs).