Tuesday, May 3, 2016

Trade blockade was more damaging to Nepalese economy than the earthquake

The Central Bureau of Statistics (CBS) just released its GDP growth projection for FY2016. The growth projection is quite close to the latest IMF projection. It offers further clarity on the impact of the trade blockade and supplies disruption (which lasted for four and a half months) and the lingering effects of the earthquake.

Overall, GDP (at basic prices) is expected to grow at 0.8% in FY2016, lower than 2.3% in FY2015 (it is a revised figure, which provisionally was estimated at 3.0% after the earthquake). Agriculture sector is expected to grow at 1.3%, industry at a negative 6.4% and services at 2.7%. 

While the earthquake affected mainly central and western regions, the trade blockade and supplies disruption severely dented economic activities across the country. In this sense, the trade blockade and supplies disruptions were more devastating than the earthquake. Furthermore, the delay in distributing cash relief and housing grant, and in initiating reconstruction projects affected growth prospect. It itself was affected by the blockade as construction materials and fuel could not be imported. The trade blockade and supplies disruptions exacerbated the already weak economic activities and squeezed economic potential. Here are earlier blog posts on this issue: one year after the earthquake; impact of trade blockade on fiscal sector, and inflation and external sector

The debilitating impact of trade blockade and supplies disruptions is visible from the negative growth rate of mining and quarrying (-6.5%); manufacturing (-10.1%); electricity, gas and water (-1.7%); construction (-4.0%); wholesale and retail trade (-1.1%), and hotels and restaurants sub-sectors (-4.9%). Furthermore, within the services sector, growth rate of transport, storage and communications sub-sector was lower than in FY2015. 

All of these sub-sectors are import-dependent either for final goods or intermediate goods or raw materials (including petroleum fuel and cooking gas). The effect of these unexpected blows will linger on in the coming months as economic activities are severely disrupted and dislocated by the double whammy of earthquake and blockade/supplies disruption. The acceleration of reconstruction work will be a major factor to stimulate economic activities and to expand potential growth.

Given the reduction in paddy, wheat and millet production, the CBS's growth projection for agriculture sector looks optimistic. I think the revised figures later in FY2017 will show even lower GDP growth rate as figures are adjusted for agriculture and some services sub-sectors. It could be one of the lowest in the last few decades.

In FY2017, a lot will depend on the weather, normalization of imports and distribution networks (including fuel and cooking gas) and the scale and pace of reconstruction activities. The El Nino conditions are already contributing to droughts and forest fires have destroyed settlements and land. The monsoon rains may not be as plentiful as expected given the conditions so far. This is going to dent agricultural sector’s recovery. The bright spot is that reconstruction work may accelerate and housing grants may be finally distributed to all the eligible households. The former will stimulate domestic production of industrial goods and services. The latter will act as a direct fiscal stimulus that will increase consumption demand.

Also, both could reinforce each other and provide the necessary jolt to the sluggish growth rate. Fast recovery of the services sector will be contingent upon the rate of remittance inflows and normalization of supplies. Overall, considering these prospects and the low base effect, GDP growth could be around 5% to 6% (ambitious) in FY2017. The risk to this outlook is sluggish reconstruction work (plus budget execution), delayed normalization of supplies and a slowdown in remittance inflows. Realistically, it could be between 4% and 5%.

By the way, revised figure for FY2015 shows that real GDP grew by 2.3% in FY2015, meaning that the earthquake had a marginally large impact on the economy than previously estimated. Earlier, FY2015 growth was estimated at 3.0%, meaning that about 1.5% of growth was chopped off from the estimated growth of 4.6% in a no-earthquake scenario. Now, its 1.6% off the estimated growth of 3.9% in a no-earthquake scenario (the difference in pre-earthquake growth estimate is due to the updated actual figures for FY2014).

Structural change in China and its impact on other economies

Asian economies face headwinds from three weak factors: weak global recovery, weak global trade, and weak (rather moderating) Chinese growth. To deflect such headwinds, the economies need to focus on productivity-enhancing structural reforms, which are needed to rebalance demand-supply, reduce vulnerabilities, enhance efficiency, and to expand the frontier of potential growth. Meanwhile, monetary policies need to be harmonized not only in Asia, but among advanced economies as well.

What could be the potential spillovers from China’s economic transition toward a more sustainable growth? Note that China moving on this path (means living with slower growth than in the past years) would mean slower demand for raw materials and intermediate goods, which in turn means trouble for economies whose activities survive on exporting such goods to China (they are also facing slow global recovery [plus low commodity prices], which in turn is slowing down demand for final goods either made or assembled in China). Also China is beginning to produce more intermediate goods rather than importing them for use in final goods as before. The rebalancing of the sources of growth in the Chinese economy has consequences beyond its borders. 

China accounts for about one-half of regional growth and is an important factor in the regional supply chains.

According to the latest regional economic outlook, the IMF argues that:
  • Asia has become more sensitive to the Chinese economy (which is moving away from high public investment and exports to higher domestic consumption and services). The rebalancing of Chinese economy will have adverse short-term effects in the rest of Asia. This may be less painful for economies that respond to Chinese consumption demand. 
  • Estimates show that a 1 percentage point slowdown in Chinese growth translates into a 0.15–0.30 percentage point decline in growth for other Asian countries in the short term. Taiwan, South Korea and Malaysia are likely to be affected the most.
  • Commodity exporters such as Australia, Indonesia, Malaysia and New Zealand will suffer from slowdown in Chinese economy (as it imports a lot from them) and lower global commodity prices.
  • Disruption to the financial sector in China also poses risks to the global economy. Rapid credit growth, high levels of NPLs, large shadow banking, and growing corporate and local government debt may be disruptive and could affect cross-border financial linkages (forex markets, trade insurance, equity markets, etc)
Apart from the China factor, some economies also face economic and fiscal strain from natural disasters such El Nino and cyclone. El Nino conditions have worsened drought and lowered agricultural output in many economies, including Nepal and India.
The IMF recommends:

Although the global economic panorama remains turbulent, policymakers in Asia will need to continue to build on the region’s strengths. Harnessing Asia’s potential will call for strong implementation of a wide-raging policy agenda, including enhanced communication of policy frameworks and goals. Structural reforms, aided by fiscal policy, should support economic transitions and bolster potential growth. Monetary policy should remain focused on supporting demand and addressing near-term risks, including from large exchange rate depreciations and deflationary shocks. Policies to manage risks associated with high leverage and financial volatility will play an important role, including exchange rate flexibility, targeted macroprudential policies, and in some cases, capital flow measures. Finally, policy recalibration should not lead to a buildup in vulnerabilities.