Wednesday, September 27, 2017

Schooling is not enough, learning is important too

Just attending school itself is not enough. Learning is equally important in primary and secondary schools to boost wages and opportunities later in life, according to World Development Report 2018. It dubs the current state of educaiton a “learning crisis”.
  • In rural India, nearly three-quarters of students in grade 3 could not solve a two-digit subtraction such as 46–17, and by grade 5 half could still not do it. 
  • In urban Pakistan in 2015, only three-fifths of grade 3 students could correctly perform a subtraction such as 54–25, and in rural areas only just over two-fifths could.
  • In Kenya, Tanzania, and Uganda, when grade 3 students were asked to read a simple sentence like “The name of the dog is Puppy,” three-quarters did not understand what it said.
  • In Uruguay, poor children in grade 6 are assessed as “not competent” in math at five times the rate of wealthy children.
  • By the end of primary school, only 5 percent of girls in Cameroon from the poorest quintile of households have learned enough to continue school, compared with 76 percent of girls from the richest quintile.
Teaching-learning relationships breakdown due to: 

(i) Malnutrition, illness, low parental investments, and harsh environment associated with poverty would mean that children come to school unprepared to learn

(ii) Teachers lacking the skills or motivation to teach effectively 

  • Across 14 Sub-Saharan countries, the average grade 6 teacher performs no better on reading tests than the highest-performing grade 6 students;  
  • In seven Sub-Saharan countries, one in five teachers was absent from school during recent unannounced visits by survey teams, with another fifth of teachers at school but absent from the classroom
(iii) Educational inputs fail to reach classrooms or to affect learning (textbooks don’t reach schools or even when they reach the students don’t get it on time)

(iv) Poor management and governance undermine schooling quality (ineffective school leadership; no set goals that prioritize learning; lack of autonomy for schools; ineffective community engagement)

It recommends countries to:
  • Design student assessments to gauge their learning
  • Create conducive environment for learning, including addressing stunting and promoting brain development through early nutrition and stimulation, using technologies, strengthening school management
  • Increase accountability by mobilizing all stakeholders and create political will for education reform

Thursday, September 21, 2017

Nepal's medium-term macroeconomic challenges

It was published in Nefport#30 (pp.58-62), Nepal Economic Forum 

Except for a few episodes of growth spurts, economic growth has largely been low yet volatile in Nepal, mostly stagnating below 5 percent. Similarly, inflation has been stubbornly high, mostly settling in between 6 percent and 12 percent. Public expenditure absorption capacity is receding but revenue mobilization is robust on the back of taxes on remittance-financed imports and domestic consumption. Outstanding public debt is only about a quarter of gross domestic product (GDP). External sector is largely stable, but is vulnerable to fluctuation of remittance inflows. Financial sector is relatively stable, but remains exposed to asset-liability mismatches arising from recurring sources, including reckless lending growth amid slowdown in deposit growth, ever-greening of troubled assets and mismanagement. Meanwhile, unemployment remains high. 

This scenario does not portray an economy that is macroeconomically sound with robust fundamentals to support high and sustainable inclusive economic growth. Instead, it resembles an economy that is susceptible to macroeconomic imbalance triggered by a few exogenous factors, including fluctuation of remittance income, monsoon rains, trade and supplies disruptions, and political instability. These challenges need to be properly diagnosed and addressed (to exploit low hanging fruits) as the country marches towards its overarching goal to become a middle-income country by 2030. Specifically, medium-term macroeconomic challenges emerge from low capital formation, fiscal mismanagement, stubbornly high inflation, and financial and external sectors vulnerabilities.

Base effect blessing

Some analysts quickly point to the impressive growth and inflation numbers in FY2017 and argue that the economy may have reached an inflection point from where the trajectory will be upward and stable. GDP growth (at basic prices) increased to an estimated 6.9 percent and inflation moderated to 4.5 percent in FY2017. These largely reflect a ‘base effect’ blessing and to some extent the government’s efforts to improve electricity supply and accelerate reconstruction works. In FY2018, the base effect will quickly dissipate. Hence, it will be difficult to attain FY2018 growth and inflation targets of 7.2 percent and 7.5 percent, respectively, unless the factors supporting growth and inflation are much stronger than in FY2017. This is unlikely to be the case.

Figure 1: Contributions to GDP growth (percentage points)
Source: Central Bureau of Statistics

Overall, the economy has not reached an inflection point and the performance of key macroeconomic variables will continue to be underpinned by the same exogenous factors such as monsoon and remittances. The gradual deindustrialization beginning FY1997 (i.e., coinciding with the Maoist insurgency) hasn’t stopped as this sector barely constitutes 14 percent of GDP now, down from a high of 22.3 percent of GDP in FY1996 (the outcome of liberalization and structural reforms initiated in the early 1990s). 

Macroeconomic challenges

The current state of macroeconomics will not support a rapid structural transformation, whereby the pace and pattern of economic growth and development are supported by a vibrant industrial sector, higher absorption of unemployed workforce in productive sectors, and production of high-valued, high-productivity goods and services across all sectors. Five key macroeconomic challenges will dictate the nature of structural transformation Nepalese economy will be undergoing during the medium term. 

First, sources of growth have to be reliable, i.e. less reliance on monsoon rains for agricultural output growth and on remittances-backed demand for services output growth. A substantial proportion of the variability of GDP growth is caused by volatility of agricultural output growth, which is dictated largely by monsoon rains as irrigation network is too limited to substitute for water shortfall during weak monsoon. For a more dependable source of growth, capital formation must increase so that the most binding constraint to economic growth— inadequate supply of infrastructure, mainly energy, transport, and irrigation— is addressed head-on. Hence, a major macroeconomic challenge in the medium-term would be to enhance quantity as well as quality of public and private investment. 

Public gross fixed capital formation averaged just 5.8 percent of GDP in the last five years. This needs to increase to about 8-12 percent of GDP annually. The public sector has to lead the way by accelerating capital spending, which has been affected by structural weaknesses in project preparation and implementation; low project readiness; bureaucratic hassle in project approval and sanctioning of spending authority; weak project and contract management; and political interference at planning, management and operational stages. Public capital spending averaged just 4.8 percent of GDP in the last five years. Furthermore, almost 60 percent of the actual capital spending happened in the last quarter and 41.2 percent in the last month, raising doubts over the quality of spending. Low quality of capital investment tends to increase operation and maintenance budget, which is a part of recurrent spending, for the next few years. 

Figure 2: Monthly share of actual annual spending (percent)
Source: Financial Comptroller General Office (FCGO)

Furthermore, private gross fixed investment, which averaged 21.6 percent of GDP in the last five years, also needs to increase so that total gross fixed investment is at least above 30 percent of GDP. Currently, total gross fixed investment is below the average for low-income countries. In addition to enhancing capital spending absorption capacity, private sector investment needs to be facilitated by implementing laws, policies and regulations that are already in place and by amending those that are deemed deficient. The current state of policy implementation paralysis is deterring both domestic as well as foreign investment. Net FDI inflows are barely one percent of GDP.

Second, while there a need to enhance quality and quantity of capital spending, there is also a need to contain growth of recurrent spending, which is almost equivalent to tax revenue. This calls for a bit of fiscal discipline although public debt is only a quarter of GDP. Just because there is ample fiscal space does not mean that recurrent spending can be indefinitely increased to satisfy politician’s voter base and supporters (including local contractors) by doling out incoherent pet projects and cash handouts. Better fiscal management is especially important in the federal setup. Additionally, revenue leakages (through under-invoicing of imported goods and tax waivers) need to be plugged in and tax sources diversified in order to mobilize enough revenue to cover rising recurrent spending and to maintain sound fiscal balance.

Figure 3: Expenditure and revenue overview (share of GDP)
Source: Budget speech, Ministry of Finance

Third, stubbornly high inflation has to be lowered by primarily addressing supply-side constraints as monetary policy does not have much traction to contain it due to pegged exchange rate between Nepalese and Indian currency and the fact that almost 60 percent of imports, including fuel and cooking gas, are sourced from India. Average annual inflation of around 8.7 percent in the last ten years is too high, and discourages investment and saving. Supply-side issues such as shortage of electricity and fuel, high transport and wage costs, low productivity, and excessive labor unionizing for political reasons are threats to lowering inflation and accelerating industrialization. Ideally, inflation in Nepal should not deviate much from that prevalent in India. The central bank and the government need to pay special attention to transitory and structural factors driving inflation.

Figure 4: Contributions to inflation (percentage points)
Note: For Nepal, FY2015 (mid-July to mid-July) = 100; for India, FY2012=100 (April-March) 
Source: Nepal Rastra Bank; Reserve Bank of India

Fourth, financial sector stability is another macroeconomic challenge over the medium-term. Financial sector troubles are recurring, typically caused by accumulation of unbalanced portfolio, lax monitoring and supervision, and asset-liability mismatch. As experienced in the past, a sudden credit squeeze arising from such factors leads to erosion of confidence on and efficacy of the regulator. The central bank needs to enhance its capacity to enforce monetary rules and regulations, and intensify monitoring and evaluation of banks and financial institutions. Consolidation of financial sector; better quality and diversification of portfolio; and expansion of traditional as well as new financial services throughout the country are some of the unfinished tasks for the central bank. Furthermore, the central bank needs to think beyond buying and selling of government bills and bonds as a core monetary policy instrument. As such, back-loading of budgetary spending in the last month of fiscal year drastically increases liquidity in the first quarter of next fiscal year and then it begins to get tighter in the next two quarters, heightening interest rate volatility. 

Fifth, the gap between demand for and supply of materials needed for post-earthquake reconstruction and the inelastic nature of import demand would mean that import growth will likely remain high in the next few years. Meanwhile, without much improvement in supply-side constraints and implementation of investment-friendly laws and policies, export growth may be at most moderate. Given forecast of low fuel prices globally due to supplies glut as well as subdued demand, investment will likely continue to slowdown in the major fuel and commodity exporting countries, some of which employ a large number of Nepalese migrant workers. This would mean either continued deceleration or tepid growth of remittance inflows, potentially resulting in current account deficit. The widening trade deficit coupled with decelerating remittances resulted in a current account deficit of 0.4 percent of GDP in FY2017, the first deficit since FY2011. Note that Nepal’s low per capita income, limited production base, and the need to import materials for reconstruction necessitate tolerance to moderate level of current account deficit in the medium term. However, the government and the central bank need to keep an eye on the level of balance of payments and foreign exchange reserves so that it is enough to sustain at least 7 months of import of goods and services. 

Figure 5: External sector (share of GDP)
Source: Nepal Rastra Bank

Tuesday, September 19, 2017

MCC grant to Nepal: Can it be completed without time and cost overruns?

It was published in The Kathmandu Post, 18 September 2017.

A matter of time

Government transitions and failure to maintain consistent policies over time may hamper investment grant pledges

On September 14, Finance Minister Gyanendra Bahadur Karki and Millennium Challenge Corporation (MCC) acting CEO Jonathan Nash signed a $500 million grant agreement for investment in the energy and transportation sectors. This assistance is especially significant for two reasons: it is the single largest one-time grant assistance by a development partner, and no cost and time overruns are entertained once the grant becomes effective.

A large one-time grant amount equivalent to about two percent of Nepal’s gross domestic product by a specialised foreign aid agency, which uses a fairly transparent yet rigorous selection methodology to assess eligible countries, is in itself a significant positive development for Nepal. However, the challenge would be to complete the projects considered under the assistance without cost and time overruns, which unfortunately are also the two most common yet unresolved issues concerning public capital spending in Nepal.

Binding constraints

The MCC selected Nepal to develop a five-year compact program in December 2014 after Nepal met the eligibility requirement, which includes sound performance in about one and a half dozen independent policy indicators related to democratic governance, economic freedom and investment in citizens. Earlier, a threshold program, which has a smaller grant assistance than the compact program, in December 2011 led to a rigorous analysis of Nepal’s growth constraints and identification of potential areas for policy improvement. The diagnostics study—an update of a 2009 study led by Asian Development Bank—identified four key constraints to growth: policy implementation uncertainty, inadequate supply of electricity, high cost of transport and challenging labour relations.

This diagnostic study formed the basis for selection of energy and transport sectors for investment, and sectorial reforms under the compact program. A series of stakeholder consultations—including public and private sectors and donors—were held to identify fairly large investment projects that could be completed within five years and that have the potential to yield substantive outcomes by tackling some of the most binding constraints to economic growth.

Out of $630 million (including $130 million as counterpart investment by the government), about $520 million is planned for the electricity transmission project, under which 300 kilometres of high voltage electricity transmission network will be built and capacity of the country’s energy regulator enhanced. This kind of infrastructure is crucial for supporting transmission of power generated by various hydroelectricity projects across the country and for greater electricity trade between Nepal and India. Around $55 million is earmarked for road maintenance, under which 305 kilometres of road will be built and rehabilitated. The remaining amount is allocated to cover project administration costs, including procurement and monitoring and evaluation expenses.

No overruns

The actual implementation of projects will probably start towards the end of 2018 after they are investment-ready, i.e. procurement packages are finalised, significant proportion of land is acquired, detailed implementation plan is outlined and implementation offices are established. Once implementation starts they have to be completed within five years and without any cost overruns. Else, the unspent grant amount will be returned to the MCC. Against this backdrop, if the same structure of project implementation including staff deputation, policies and laws are going to govern the MCC’s investment projects, then there is little room to be optimistic that it will be completed within five years.

Execution of capital budget is hamstrung by a maze of bureaucratic and structural factors, leading to under spending as well as heavy bunching of spending in the last quarter of every fiscal year. For instance, in 2016/17, the budget was approved one and a half months prior to the start of fiscal year, which in principle gave the ministries time cushion to get approval for spending and initiate preparatory project planning (especially procurement documents). Still, 60 percent of actual spending happened in the last quarter, and 41.2 percent in the last month itself, raising doubts over the quality of spending. Worse, just 65.5 percent of planned capital budget was spent. This pattern of spending, and deficient expenditure absorption capacity, has been persistent irrespective of which political party leads the government.

Capital budget execution is affected by structural weaknesses in project preparation and implementation; low project readiness; bureaucratic hassles in project approvals and sanctioning of spending authority; weak project and contract management; and political interference at planning, management and operation stages. These issues are common across all projects irrespective of investment amount and duration.

Political interference

The exact details about the implementation modality of MCC’s projects in Nepal are not known yet. The MCC usually establishes its own local office to manage and oversee project implementation, which is fairly independent, rigorous and transparent. Meanwhile, the government procures land and secures environment clearances along with preparation of procurement documents before implementation starts. Unfortunately, the government does not have a good track record of completing these preparatory works on time.

Two specific issues are of particular concern regarding implementation. First, the upcoming provincial and federal elections will result in a new political structure along with changes in government leadership, as a coalition government would be a defining feature because no party is likely to secure the necessary majority in Parliament. This in turn would entail transfer of government staff loyal to ruling parties to large project management or implementation offices, leading to snags in implementation and opening up of avenues for funds misappropriation.

For instance, the Communist Party of Nepal-Unified Marxist Leninist (CPN-UML) led coalition government in 2016 abruptly decided to not renew the contract of former secretary Krishna Gyawali, who was serving as a national coordinator of MCC Nepal upon appointment by the previous Nepali Congress (NC) led coalition government. Similarly, the same government terminated the contract of Radhesh Pant, former CEO of Investment Board Nepal, in 2016, even though Pant’s contract was renewed for an additional term by the NC-led coalition government. The case with the CEO of National Reconstruction Authority is also similar. These kinds of unceremonious contract terminations and transfers to put party loyalists in key positions affect project implementation timelines and escalate costs. The MCC’s projects need to be insulated from this kind of party-based selfish political incursion.

Second, Nepal needs to retain its score above median (threshold score) each year for a majority of policy indicators. For instance, worsening of governance may pull down the country score below the yearly median. Failure to have a satisfactory score in a majority of the policy indicators would also lead to either suspension or termination of grant assistance.