Thursday, August 24, 2017

Brief snapshot of Nepalese economy in FY2017

Since the full year FY2017 (mid-July 2016 to mid-July 2017) provisional data is available, except for some public finance variables, this post will try to give an overall picture of the performance of the economy. I will have a brief outlook for FY2018 in the next blog post. 

Real sector

Central Bureau of Statistics (CBS) estimated that Nepal’s economy (gross value added at basic prices) would likely grow by 6.9% in FY2017, sharply up from 0.01% in FY2016 and 3% in FY2015. It projected agricultural, industrial and services will grow by 5.3%, 10.9% and 6.9%, respectively. Base effect, favorable monsoon, improved electricity supply, normalization of supplies and tourism activities contributed to the rosy economic activities. For detailed analysis, see this.

Fiscal sector

Both recurrent and capital spending grew at a rate higher than in FY2016. Overall, expenditure grew by 46%, up from 15.3% in FY2016, led by acceleration of reconstruction works (including distribution of first and second tranche of grants) and some progress in capital spending. But, the overall pattern of spending did not change even though budget was announced one-and-a-half months prior to the start of the fiscal year. It was argued that this will give ministries adequate time to get approval for spending and initiate preparatory project planning (especially procurement documents), all of which were expected to accelerate capital spending. Specifically, the idea was to finish all preparatory work and start issuing tender notices and in some cases finalize contractors before the start of festival season (September-November). However, this was not the case. 

First, the spending pattern (i.e. quality of spending) hardly changed despite the early approval of budget. Almost 60% of the actual capital spending happened in the last quarter and 41.2% in the last month. It raises doubt over the quality of spending. Second, capital spending absorption capacity has receded. Just 65.5% of planned capital budget was spent in FY2017 (NRs204.3 billion spent vs NRs311.9 billion planned). Although it is slight higher than 58.6% in FY2016 (when the economy was crippled by trade and supplies disruptions), it is still lower than 76% in FY2015 (when earthquakes struck around the last quarter of fiscal year). As a share of GDP, capital spending increased to 7.9% of GDP, up from 5.4% of GDP. The planned capital spending in FY2017 was 12% of GDP. For more on capital spending, see this.  

In FY2017, total spending reached an estimated 27.8% of GDP (recurrent 19.9% of GDP and capital 7.9% of GDP). Total expenditure including net lending was 29.9% of GDP. Revenue mobilization was higher than targeted, thanks to the normalization of imports/supplies and pickup in economic activities. Revenue mobilization reached 23.4% of GDP (including tax revenue of 21.1% of GDP). VAT and customs tariffs contributed 26.3% and 24.3%, respectively to the overall revenue mobilized in FY2017. Foreign grants increased to 2.9% of GDP as reconstruction aid started to materialize gradually.

These together resulted in a fiscal deficit of about 3.6% of GDP. Primary deficit was 0.6% of GDP. Overall, expenditure growth was faster than revenue growth, leading to a larger fiscal and primary deficit. This is okay for now given the reconstruction and investment needs of an economy with low per capita income. However, the priority should be to enhance quantity as well as quantity of capital spending (and to rein in rising recurrent spending). Outstanding public debt stood at around 25% of GDP (figures up to Q3FY2017). For a quick review of FY2018 budget, see this.
Monetary sector

Inflation moderated substantially to 4.5% in FY2017, down from an average 9.1% over FY2010-FY2016, thanks to normalization of supplies & base effect, low inflation in India, low and stable administered fuel prices, bumper agricultural harvest due to favorable monsoon, and improved energy supply. Specifically, food inflation dropped to 1.9% from 10.9% in the previous year, and non-food inflation slumped to 6.5% from 9.2% in the same period. Prices grew at a negative rate in the case of vegetable, fish and meat, ghee and oil, transportation and communication. In fact, prices of all items in the CPI basket decreased except for sugar and sugar products. If you look at monthly inflation figures, there is a deflationary trend in the case of food and beverage prices since January 2017.

The effect of deceleration of remittance is quite visible in monetary aggregates and external sector. Money supply (M2) growth moderated to 15.5% (from 19.5% in FY2016) due to the slump in net foreign assets, which grew by just 8.6% (compared to 25.3% in FY2016). Credit to private sector decelerated but government borrowing increased. Overall, deposit growth was 14%, but credit growth was 17.8% (both are lower than in FY2016). Credit and deposit growths of development and finance companies were even negative. About 29.8% of the total increase in lending in FY2017 (NRs.304.4 billion) went to wholesalers and retailers, followed by industry, finance & insurance, services, and construction. As a share of GDP, M2, total deposit and total credit stood at 99.7%, 88.5% and 86.2% respectively in FY2017. 

The slow deposit growth (caused by deceleration of remittances and slow government spending) and little room for credit expansion by BFIs (some were hitting the capital to deposit ratio of 80) resulted in volatile interest rates. The weighted average deposit and lending rates were 4.5% and 9.9%, respectively in FY2017 (both higher than in FY2016). Similarly, interbank lending and 91-day treasury bills rate increased to 2.6% and 1.45% (again both higher than in FY2016). Rates for 14 days deposit auction and 14 days repo auction (liquidity management policy tools used by the NRB) averaged 0.25% and 4.87%, respectively. Reverse repo rate was 1.58%. 

Non-performing loans continue to decline, reaching 1.63% of total loan by mid-April 2017. Capital adequacy ratio is above the regulatory threshold (10% plus 1% buffer).

Overall, inflation is moderating, but retail interest rates are rising indicating the deficiency of liquidity management tools (liquidity was ample towards the last month of FY2017 and first quarter of FY2018).

The stock market too remained volatile with NEPSE index closing at 1582.7 at the end of FY2017, down from a high of 1818.2 in FY2016. The number of listed companies decreased to 208 from 230 in the previous year. Stock market capitalization decreased to 71.4% of GDP from 84.1% of GDP in FY2016. Stock market turnover was NRs205 billion (0.011% of market capitalization). Commercial banks had the largest share (about 46.5%) of total turnover, followed by insurance and development banks.

External sector

External sector deteriorated in FY2017. The normalization of supplies (after crippling trade embargo in FY2016) resulted in modest export growth but a large import growth. In US dollar terms, merchandise export (fob) increased by 9.8% but merchandise import (cif) increased by 29.4%, leading to increase of merchandise trade deficit by 31.6%. Meanwhile, workers’ remittances continued to decelerate (in NRs terms). While it grew by 4.6% in Nepalese rupee terms (slower than in the last three years), it grew by 4.7% in US dollar terms (slightly higher than 2.1% in FY2016). The deceleration/slow growth of remittances is due to the decrease in the number of overseas migrant workers. On an average, 1,093 migrant workers left the country daily in FY2017, down from 1,147 in FY2016, 1,405 in FY2015 and 1,446 in FY2014. Workers’ remittances was US$6.6 billion (about 26.8% of GDP).

Nepal’s export is crippled by structural bottlenecks as well as supply-side constraints, and import demand of fuel and durables/construction materials is somewhat inelastic due to the wide gap between production and demand in the economy. Meanwhile, given that remittance inflows are likely to continue to slowdown, current account may be in negative territory for the next couple of years. For more on the impact of slowdown in remittance inflows, see this.

Overall, merchandise trade deficit reached 34.5% of GDP, but net transfers (includes remittances) was just 32.8% of GDP and net services and income balance were just 1.3% of GDP, resulting in current account deficit of 0.4% of GDP. The last time Nepal had CAD was in FY2011. FDI inflows increased to US$127.5 million from US$55.8 million. Balance of payments surplus decreased to 3.2% of GDP from 8.4% of GDP in FY2016. Gross foreign exchange reserves stood at US$10.1 billion, which is enough to cover 11.4 months of import of goods and services. 

Nepalese currency appreciated by 3.8% vis-à-vis US dollar at the end of FY2017 after five years of continuous depreciation. 

In a nutshell, the Nepalese economy in FY2017 recovered fast from the slump triggered by crippling supplies disruption, political instability, lingering effects of 2015 earthquakes and slow reconstruction in FY2016. Growth was one of the highest in recent decades, but this is largely a base effect blessing. Revenue mobilization surged past the target as supplies normalized and economic activities started to pick up. Expenditure was higher, but not of expected level especially capital spending. Inflation was lower but retail interest rates are rising as deficient liquidity management took a toll on credit flows. The banking sector also contributed to this by engaging in reckless lending to a select (unproductive) sectors. External sector deteriorated with current account in the negative territory (but it was expected).