Monday, March 12, 2018

Banking cartel in Nepal in the veil of an association

Recently, Nepal Bankers’ Association (NBA) decided to punish NIC Asia, a member commercial bank, by excluding it from interbank lending, which is crucial for managing immediate liquidity needs among banks. A rising interbank rate indicates tight liquidity in the banking system. Interbank rate has been rising in recent months, thanks to liquidity pressures arising from deceleration of remittance income and low capital spending (the latter case is normal).

What did NIC Bank do? Well, it broke away from collusion among 28 commercial banks, under the veil of a professional association, and started offering higher interest rates on deposits, which NBA has fixed (with “informal understanding”) at 11%. It started offering 12% on fixed deposit and 10% on savings deposit. The NBA went up in arms with NIC Asia and threatened to scrap its NBA membership in addition to barring it from interbank lending. Meanwhile, Nepal Rastra Bank (NRB), the central bank (which has been one of the most ineffective under the current leadership), remains indifferent to the tussle between NBA and NIC Asia.

Few things to consider here:
  • First, NBA is behaving like a cartel, manned by CEOs who thrive on moral hazard, that preaches free market but engages in anti-competitive practices to fix deposit rates (but not lending rates). Even Development Bankers’ Association lent support to NBA because they usually offer deposit rates one or two percentage points higher than commercial banks (same with their lending rates). They feel threatened by NIC Asia encroaching on their interest rate territory. In principle, any bank should be allowed to fix their own deposit and lending rates.
  • Second, NBA argues that without a ceiling on deposit rates, lending rates will spiral up. If banks offer 11% interest on deposit  and with 5% minimum cost of managing funds, final retail lending rate can easily go over 16%. This increases cost for individual borrowers and firms. NBA argues that its measures will help to stabilize interest rates and economy.
  • Third, it is not the job of NBA to decide on stabilizing interest rates. The NRB has interest rate corridor in place to do this. If NBA can dictate interest rates, then what is the relevance of NRB? Repeated financial crisis is a sign that NRB has been window dressing real issues: that systemic risks to financial sector are recurring and are exacerbated by faulty banking practices and corporate malgovernance. NRB increased capital base to NRs8 billion from NRs2 billion to force merger of the banks. But, the banks found a way out to be a NRs8 billion capital bank and avoid merger (cause too many managers will lose jobs and promoters/board will not be able to dictate lending terms to suit them or their businesses). The way NRB implemented the capital increase requirement was inherently faulty as it didn't achieve the main objective to reduce the number of banks. 
  • Fourth, the current NBA vs. NIC Asia fiasco has its root in Nepal having too many banks for a restricted depositor base. They can't survive without collusion/carteling. It's getting late to clean up the banking system. Same with hospitals, schools, colleges, airlines, etc. Syndicates and cartels rule almost all sectors. 
Update (2018-03-14): NIC Asia gives into the demand of NBA (informally assisted by the NRB). NIC Asia has now agreed to offer returns within the threshold created by the NBA. Meanwhile, the NRB has issued a directive on interest rate spread, which cannot be more than 5% (it was 6% before). Any BFI violating this requirement will not be allowed to distribute bonus and cash dividend next fiscal year. They will also be barred from opening new branches in places others than local bodies where there are no existing bank branches. Also, they won’t be able to avail refinancing facility on loans (except for those related to post-earthquake reconstruction of houses).

Thursday, March 8, 2018

Actual capital spending estimated at 70% of planned capital budget for FY2018

From The Kathmandu Post: The government is all set to introduce austerity measures, as its budget deficit is widening due to higher recurrent expenditure, error in calculation of savings in the last fiscal year and low mobilisation of foreign grants. The government’s budget deficit—revenue plus grants minus expenditure—stood at Rs49 billion as of Tuesday, which is around 1.9 percent of the gross domestic product, according to the Ministry of Finance. This deficit had stood at Rs35.5 billion in mid-January.

“This shortage of funds at the central level has prompted us to cut down on spending. However, only unnecessary spending would be slashed,” said Finance Minister Yuba Raj Khatiwada. The austerity measure includes lower spending in purchase of vehicles, fuel and office materials, including computers, according to Finance Secretary Shankar Prasad Adhikari. “Also, number of foreign trips would be reduced,” Adhikari said. “However, adequate funds will be provided to ongoing projects that are making good progress.”

The government has projected capital spending to stand at 70 percent of the allocation at the end of the fiscal year. The government had earmarked Rs335.2 billion for capital spending. But actual spending till the end of the fiscal year is likely to stand at Rs234.6 billion, according to the Finance Ministry. The government had spent only 65 percent of the capital budget in the last fiscal year. 

The Ministry of Finance (MoF) has revised economic growth forecast for the current fiscal year to over 6 percent from 7.2 percent predicted in the beginning of 2017-18. Some of the reasons for the downward revision are fall in production of paddy, which makes major contribution to the gross domestic product, and reduction in consumption due to fall in remittance income.

From The Kathmandu Post: Investment Board Nepal (IBN) and Finnish joint venture Nepwaste initialed a project development agreement (PDA) on Wednesday for the management of solid waste in the Kathmandu Valley, IBN said in a press statement. 
Nepwaste will undertake Package Number 1 of the Kathmandu Valley Integrated Solid Waste Management Project which covers Kathmandu Metropolitan City and nine neighbouring municipalities: Budhanilkantha, Nagarjun, Tokha, Tarakeshwor, Gokarneshwor, Sankharapur, Dakshinkali, Kageshwori-Manohara and Chandragiri.

As per the PDA, Nepwaste will collect a service charge of Rs219 per household per month to pick up their garbage. Nepwaste will build a landfill site at Bancharedanda in Nuwakot and a transfer station at Teku in Kathmandu to manage the solid waste. The company will also set up processing and recycling units at the landfill site. The garbage collected from homes will be segregated into biodegradable and non-biodegradable waste. The company will turn the trash into compost fertilizer, petroleum products and natural gas besides generating up to 5 MW of electricity. Most of the solid waste will be recycled, and only 20 percent will be put in the landfill site. 

The PDA has given a transition period of three months for the project developer to take over the existing waste management system. The company has to hand over the project to the government after 20 years, and pay around Rs3 billion in royalties during the period. IBN has said it will now start PDA negotiations with Clean Valley Company which will undertake waste management in Lalitpur Metropolitan City and adjoining municipalities besides Kirtipur and Bhaktapur under Package Numbers 2 and 3. The estimated cost of the project is Rs5 billion for the first package and Rs2 billion for the second and third packages.

Wednesday, February 28, 2018

Finance Minister plans NRs600 billion investment in infrastructure and more

From The Kathmandu Post: On Monday, the corporation invited proposals from potential ground handling service providers at Kansai International Airport in Osaka, Japan. It had made a similar call to prospective ground handling service providers at Incheon International Airport in Incheon, South Korea last Friday.  NAC invited bids for ground handling services at King Khalid International Airport in Riyadh, Saudi Arabia last December. As per the initial proposal, the national flag carrier has planned to operate four weekly flights to Riyadh, three weekly flights to Incheon and two weekly flights to Osaka. 

Recently, the Tourism and Civil Aviation Ministry named three international long-haul routes for NAC to serve after it receives its two wide-body aircraft on order in the next three months. The carrier has borrowed Rs24 billion from the Citizen Investment Trust (CIT) and the Employees Provident Fund (EPF) to buy the planes.

NAC had planned to fly to the Japanese capital of Tokyo, but this did not happen as the air service agreement (ASA) between Nepal and Japan has designated Kansai International Airport in Osaka. The Tourism Ministry is also preparing to revise the ASA with Japan to permit Nepali carriers to fly on other routes in Japan. Apart from NAC, several private carriers like Buddha Air have planned to serve Japan to bring high-end tourists to Nepal. Nepal and Japan signed the ASA in 1993 allocating 400 weekly seats. The national flag carrier used to fly to Osaka via Shanghai until 2008 when it was forced to suspend the route due to lack of aircraft.

Finance Minister plans NRs600 billion investment in infrastructure

From Karoabar: Finance Minister Dr. Yubaraj Khatiwada is planning NRs600 billon public and private investment in infrastructure. NRs100-200 billion will come from the government and the rest from the private sector. Some of his commitments to private sector representatives are as follows:

  • Reform legal and policy related bottlenecks to spur private sector investment
  • Implement SEZ Act to address issues surrounding land and other clearances (land prices are escalating too high, increasing cost of production for firms)
  • Reduce time for approvals needed for private investment
  • Improve customs administration to control leakages
  • Consult with NRB to address frequent bouts of liquidity shortage
  • Prioritize industrialization and services sector

Saturday, February 24, 2018

Government reduces number of ministries from 29 to 17 and more

The government’s decision to downsize the number of ministries from 29 to 17 will enhance efficiency and lessen the burden on state coffers even if the move does not suffice to sustain funding in the federal structure, officials have said. Officials said the decision will enhance the efficacy of the government, will improve governance and cut state expenditures, among others. But experts point to a more pressing problem—of huge costs in the provinces and the local level. They suggest that the government look for ways to curb regular expenditures in the federal units.

Office of Prime Minister and Council of Ministers (OPMCM)
  1. Ministry of Finance
  2. Ministry of Foreign Affairs
  3. Ministry of Defense
  4. Ministry of Physical Infrastructure and Transport
  5. Ministry of Health and Population
  6. Ministry of Federal Affairs and General Administration
  7. Ministry of Information and Communications
  8. Ministry of Law, Justice and Parliamentary Affairs
  9. Ministry of Culture, Tourism and Civil Aviation
  10. Ministry of Education and Sports
  11. Ministry of Home Affairs
  12. Ministry of Forest and Environment
  13. Ministry of Water Resources and Energy
  14. Ministry of Industry, Commerce and Supplies
  15. Ministry of Labor, Employment, Women and Children
  16. Ministry of Urban Development, Drinking Water and Sanitation
  17. Ministry of Agriculture, Cooperatives and Land Management

At this rate of work, it will take another eight years to upgrade Bhairahawa airport to an international airport

The much-delayed international airport project in Bhairahawa has achieved a measly 10 percent physical progress in 2017, and if it continues at the same rate, it would take another 8 years to finish, the project financer Asian Development Bank (ADB) said on Friday. The ADB has expressed concern over the slow performance of the contractor of the Gautam Buddha Airport, which is being upgraded into an international facility, and has raised doubts that the project would be completed by the extended deadline of June 2019. The multilateral development finance institution has already informed the government that it would not be able to finance the project further after its initial deadline in December 2017, in view of its slow progress. However, it has been weighing options that if the contractor improves its performance until mid-March, the project’s financing could continue, according to the officials at the Civil Aviation Authority of Nepal (Caan)—the project’s executing agency.

On November 13, 2013, the Civil Aviation Authority of Nepal (Caan) awarded the Rs6.22 billion contract to upgrade the airport to China’s Northwest Civil Aviation Airport Construction Group. Of the total project cost, the ADB has provided $58.50 million ($42.75 in loans and $15.75 million in grants), the Opec Fund for International Development (OFID) has provided a $15 million loan and Caan will bear the rest of the cost as counterpart funding. The national pride project has been envisaged to serve the fast-rising business and industrial hub of Bhairahawa and facilitate international pilgrimage tourism to Lumbini, the birthplace of the Buddha.

Poor get identity cards only

The government is planning to distribute “poor ID cards” to those falling below the poverty line. However, there is no concrete plan yet to provide them with social security allowance, medical insurance, skills training, essential goods at subsidized rate, and free education among others. 

The government will distribute such ID cards to poor people from five villages of five districts within this month. It has already done survey in 25 districts. The five villages are Bhagwanpur (1886, Siraha), Fikkal (1604, Sindhuli), Nishikhola (1563, Baglung), Swamikratrik (1638, Bajura) and Mohanyal (2386, Kailali). The government aims to distribute such ID cards to 391,831 poor people identified in 25 districts. The total number of poor people is estimated to be around 1.9 million.

Monday, February 19, 2018

Tentative priorities of the left alliance led government and more

From Kantipur: A team formed to chart out policies and programs priorities for the new government has submitted report to PM KP Sharma Oli and chairman of CPN-MC Pushpa Kamal Dahal. Here are the key priorities:
  • Replace gas and petroleum fuel with electricity use within five years
  • One industrial area in each province
  • Establish waste processing and disposal center and generate electricity out of it
  • Establish polytechnique institute in each local body
  • Upgrade zonal hospitals to medical college
  • Government to establish medical college
  • Retain National Planning Commission
  • Revive National Trading Limited
  • Widen tax net
  • Reduce government expenditure

From The Kathmandu Post: Nepal has abandoned the plan of relying on the non-income criteria framed by the United Nations (UN) to graduate from the Least Developed Country (LDC) category, fearing the transition would significantly reduce the flow of foreign aid and deprive the country of other international support measures.

“We have decided not to graduate based on non-income criteria as our capacity needs to be enhanced in various areas,” NPC Vice Chairman Swarnim Wagle told journalists on Sunday. In March, 2015, a meeting of the UN Committee for Development Policy (UNCDP), a body under the UN Department of Economic and Social Affairs, had told Nepal that it was eligible for LDC graduation under non-income criteria. During that meeting, the UNCDP had said it would review Nepal’s case again in March, 2018 and confirm whether it was ready for graduation.

UN data show that Nepal’s per capita gross national income stood at $659 during 2015 review meeting, which was way below the UN threshold. However, Nepal had achieved a score of 26.8 in Economic Vulnerability Index, which was 5.2 points more than the UN threshold. Also, Nepal had scored 68.7 in Human Assets Index, which was 2.7 points more than the UN threshold. “But we have told the UN that some of the indicators for graduation are irrelevant to us and issues that are important for Nepal’s economic and human capital development have not been incorporated in the formula for LDC graduation,” Wagle said.

From The Kathmandu Post: Nepal will have to fork out about Rs1,770 billion per year till 2030, or around 68 percent of the last fiscal year’s gross domestic product (GDP), to attain the SDGs, says the report, ‘Sustainable Development Goals - Status and Roadmap: 2016-2030’, which highlights major issues and challenges that the country needs to reckon with to implement SDGs.

A big chunk of this investment, or 55 percent, will have to come from the government, adds the report released on Sunday by the National Planning Commission (NPC) Vice Chairman Swarnim Wagle. This investment, which hovers around Rs973.5 billion per year, is around 76 percent of the government’s budget for the current fiscal year. Most of the public investment will go towards poverty reduction, followed by agriculture, health, education, gender, water and sanitation, transport infrastructure, climate action, and governance. The public investment requirement is expected to be the lowest in tourism followed by energy, industry, and urban infrastructure, mainly housing, where private and household investment will be required.

The private sector is expected to contribute about Rs382 billion per year to meet the SDGs and households are expected to finance up to 5 percent of the total SDG investment requirement, which comes to around Rs88.5 billion per year. The incremental financing resources of cooperatives available for SDGs, according to the NPC report, are estimated at about Rs25 billion annually, while NGOs are expected to mobilise about Rs20 billion per year to meet the SDGs. 

This implies arranging funds to meet SDGs will be a tough nut to crack for the government. The NPC has said domestic financing through revenue mobilisation and internal borrowing could finance about 62 percent of the public sector SDG investment requirement while foreign aid, both grants and loans, would finance another 20 percent of the public sector financing needs if the overall foreign aid pie grows by at least 10 percent during 2016-2020 period, 5 percent during 2021-25 and 2 percent thereafter. This means inflow of foreign aid will have to double from existing levels to meet the SDGs, which will raise country’s dependence on overseas development assistance (ODA). 

Friday, February 16, 2018

Challenges for the new Oli-led government and more

CPN-UML chairman KP Sharma Oli was appointed prime minister on February 15, his second stint as PM (and 38th PM of the country). His government will face a number of economic challenges (including the fact that the mid-year FY2018 review doesn't indicate a rosy picture) over the medium term. Here are some of them:
  • Boosting investor confidence is crucial to increasing private sector domestic and foreign investment. In addition to updating a few remaining archaic laws and policies, the next government needs to fully implement the recently amended acts and policies regarding industrial enterprises, special economic zones, labor relations and export promotion.
  • Fiscal management will be challenging considering the expected large revenue-expenditure asymmetry at the federal, provincial and local levels. Unable to cover expenditure needs during the first few years, provincial and local governments will demand large transfers from the central government. Fiscal transfer and grants already account for 50 percent of recurrent spending. 
  • Fundamental policies and priorities of all tiers of government have to be synchronized to create a coherent plan and strategy for economic development. Additionally, revenue policies should not overlap so that businesses do not have to pay the same tax to both local and provincial governments.
  • Budget preparation and its execution by all tiers of government will also be challenging. Provincial and local governments do not have prior experience in preparing time-bound budgets and, more importantly, implementing them. They will rely more on fiscal transfer than their own revenue sources. The center should adhere to a rule-based fiscal transfer regime considering objective measures such as population, income per capita, area, state of infrastructure, governance, tax effort and fiscal discipline.
  • Reconstruction must pick up speed since very little has been achieved in the last two years. It needs to be made less political and more result-oriented. The prime minister could proactively monitor progress and resolve hurdles, especially those cropping out of intra- and inter-agency noncooperation.
  • Financial sector management will be crucial as well. BFIs are short of loanable funds because their CCD ratio was close to the regulatory threshold of 80. Credit disbursement growth is higher than deposit mobilization growth amidst remittance inflows continuing to decelerate and government capital spending stagnating like in the past. A tight lending scenario arising from BFIs misplaced operational practices and priorities, and government's inability to spend the money it collected as revenue calls for proactive and effective governance of BFIs as well as finding ways to unfreeze the credit market without distorting incentives (no moral hazards please). Else, credit to private sector will squeeze, which will impact economic growth prospect.
  • Managing the fallout of deceleration of remittance inflows. This will affect households, macroeconomy and institutions. 

Bibek Subedi writes in The Kathmandu Post: International Finance Corporation (IFC), the private sector lending arm of the World Bank Group, is in the final stages of floating bonds worth $500 million in local currency in Nepal. The multilateral lender has sought permission from Nepal Rastra Bank (NRB) to issue the instruments. IFC had obtained approval from the Finance Ministry to issue rupee bonds two years ago, but it could not do so due to lack of legal provisions. 

Last year, the Securities Board of Nepal (Sebon) amended the Securities Registration and Issue Regulation, and opened the way for international financial institutions like IFC to issue local currency bonds. Subsequently, IFC applied for permission at NRB to issue bonds worth $500 million in Nepali currency. After getting the central bank’s go-ahead, IFC will have to obtain permission from Sebon, the regulator of the securities market. IFC, according to sources close to it, is planning to invest the funds raised from the bond issuance in areas like hydropower and commercial agriculture, among others. Both institutional and individual investors will be allowed to purchase the bonds issued by IFC. 

Thursday, February 15, 2018

NEPAL: Mid-year review of FY2018

Here is a brief rundown of the economic situation in the last six months (mid-July 2017 to mid-January 2018) of FY2018. 

In a nutshell, growth prospects look less optimistic than previously thought (unless this changes after the formation of new left alliance led government), inflation will accelerate but likely to stay within 7%, capital budget under-execution remains a chronic issue but fiscal deficit might widen a bit, credit disbursement growth will likely outpace deposit mobilization growth, and deceleration of remittance amidst widening trade deficit would mean a larger current account deficit.

Agricultural output growth is expected to be lower than expected. Industrial and services output activities are supported by continued improvement in electricity supply and some pick up in post-earthquake related construction activities. Gross value added growth will likely be between 4.5% and 5.0% in FY2018 as all three major sectors grow less than in FY2017.

Budget execution, especially capital spending, continues to remain dismal. The government spent just 14.1% of the total NRs335.2 billion earmarked for capital spending in FY2018. However, the government spent 41.1% of NRs803.5 billion allocated as recurrent spending. Revenue mobilization increased by 20.7%, reaching NRs335.1 billion (out of which tax revenue was NRs297 billion). 

Inflationary pressures are building up as reconstruction activities accelerate and fuel prices increase. Furthermore, rising prices in India will also exert additional pressure on prices of goods and services in Nepal. 

CPI inflation averaged 3.5% in the last six months, down from 5.8% in the corresponding period in FY2017. Food inflation reached 2.4% in mid-January 2018, up from negative 0.7% in mid-January 2017. Prices of veggies, milk products, fruits, ghee and oil and cereals among others have increased in recent months. Non-food inflation decelerated to 5.3% from 6.2% in the corresponding period in FY2017 as prices of clothes and footwear, and furnish and household equipment moderated on account of improved supplies situation and steady supply of electricity. Inflation will likely be below 7% in FY2018.

Money supply grew by 6.7% compared to 8.1% in the first six months of FY2017 as net foreign assets decreased on account of the deceleration of remittance inflows. Deposit mobilization by BFIs increased by 6.9% but credit increased by 7%. Credit to private sector increased by 11.9%. The share of institutional deposits in total deposit of BFIs is about 44.3%. 

NRB mopped up NRs129.2 billion through open market operations (deposit collection auction, 14 days deposit collection auction under interest rate corridor, and reverse repo auction). Meanwhile, it injected NRs69.3 billion (14 days repo auction under interest rate corridor and outright purchase auction).  

NRB provided refinance facility totaling NRs12.1 billion, out of which just NRs1.12 billion was for housing loan at 2% concessional interest rate for post-earthquake reconstruction of houses (for which NRB provides refinance facility at zero percent interest to BFIs).
The weighted average 91-day T-bills rate increased to 5.8% from 1.7% in the first six months of FY2017. The weighted average inter-bank rate among commercial banks increased to 4.4% from 2.7% by mid-January 2017. It indicates tight liquidity situation in the banking sector as most BFIs were short of loanable funds because their CCD ratio was close to the regulatory threshold of 80.  

External sector

Trade deficit increased by 15.1% in the first six months of FY2018 compared to 74% in the corresponding period in FY2017. While exports increased by 13.4% (reaching NRs41.1 billion), imports increased by 15% (reaching NRs534.2 billion). With balance of trade on goods and services amounting to negative NRs478.9 billion and workers remittances of NRs340.5 billion (a deceleration by 0.5% as the number of out-migrants decreased by 1.8%), current account deficit widened to NRs75.7 billion, up from a deficit of NRs1.2 billion in the first six months of FY2017. FDI inflows was NRs14.3 billion (up by 93.9%). Consequently, balance of payments deficit was NRs6.7 billion (down from a surplus of NRs45 billion in the first six months of FY2017).

In US dollar terms, merchandise exports increased by 18.7% while merchandise imports increased by 19.7% in the first six months of FY2018, resulting in merchandise trade deficit of US$4.6 billion. CAD reached US$737.5 million and BOP deficit reached US$65.1 million. Gross foreign exchange reserves was US$10.5 billion, which is enough to cover import of goods and services for 10.6 months.

Thursday, February 8, 2018

Competitive populism in Nepal

It was published in The Kathmandu Post, 07 February 2018, p.6

Non-budgetary, ad hoc, populist decisions will exert additional pressure on the already stressed fiscal situation

On January 24, a cabinet meeting chaired by Prime Minister Sher Bahadur Deuba approved a proposal to lower the age of eligibility for receiving social security allowance from the existing 70 years to 65 years. The government also decided to increase household grants by Rs100,000 for the reconstruction of earthquake and flood damaged houses.

At a time when the country is struggling to find adequate resources to cover the initial costs associated with setting up offices for the local bodies and provincial assemblies, this irresponsible decision by a caretaker government is going to have long term fiscal consequences. The cabinet decision is going to increase spending by at least Rs110 billion, which is equivalent to about 3.8 percent of GDP.

These non-budgetary, ad hoc, populist distributive decisions will exert additional pressure on the already stressed budgetary situation. Worse, the next government will find it incredibly hard to undo the populist decisions made by this government. It is unusual for a caretaker government led by a prime minister whose party has suffered one of the most humiliating electoral defeats to take such fiscally irresponsible decision that will have long-term implications on the economy and handicap the next government in terms of managing the budget for their signature electoral commitments.

Can’t sustain

The Deuba-led government has been just as fiscally irresponsible as the communist-led governments in the past. Doling out populist social security allowances has been a major selling point to secure elderly votes during elections. In 1994, the then Prime Minister Manmohan Adhikari-led government decided to hand out Rs300 monthly to those who were 70 years and above. This amount was later increased to Rs1000 and then in fiscal year (FY) 2017, the then Finance Minister Bishnu Prasad Poudel doubled the amount to Rs2000. Consequently, the government spent around Rs24 billion last year on old age allowance. The FY2018 budget has earmarked Rs36 billion for allowances to senior citizens, single women, Dalits, endangered indigenous people or ethnic groups, and physically challenged people. Overall, the government spent Rs88.6 billion in social security (allowances, scholarship and retirement benefits) in FY2017 and has allocated Rs102.6 billion for this purpose in FY2018, which is equivalent to about 8 percent of the entire budget and one-third of capital spending.

Granted that it is the state’s responsibility to look after those who are unable to take care of themselves for various reasons including financial constraints. However, the state’s generosity should be in line with available resources. Else, more money meant for building hydropower, roads, airports, schools and hospitals will have to be diverted to fulfil social security commitments which are used for consumption purposes. Furthermore, the government will have to borrow more to fulfil its recurrent spending commitments. This is not good for the economy as it increases the fiscal deficit (revenue minus expenditure) and eventually hurts the private sector through an increase of interest rates and relative appreciation of currency. For an economy with a low per capita income like ours, it is okay to have a modest level of fiscal deficit as long as internally and externally borrowed money is used to build capital assets. However, if it is used to cover recurrent spending, then the economy heads toward a fiscal slippery slope.

This is exactly where the caretaker government is taking the economy, making it harder for the upcoming left government to fulfil their own election commitments. By lowering the age for receiving senior citizen allowance to 65, the government instantly added around 0.65 million additional recipients. This means an additional Rs15.5 billion on top of the Rs25.2 billion paid to the one million citizens who are of 70 years and above. Cumulatively, this comprises around 1.4 percent of the GDP. Considering the population growth of the cohort aged 65 and above in the next five years, we are looking at an annual average additional cost of Rs16 billion in elderly allowance (or cumulatively, Rs80 billion by 2022). If we consider the additional cost of revising eligibility to 55 years for those residing in the Karnali region, Dalits and single mothers then the liability of the state will be even higher. Since growth of recurrent spending is surpassing growth of tax revenue, it will be difficult for the state to fulfil its spending commitments. Add the fact that more than Rs200 billion is needed to cover initial administrative costs to make local and provincial bodies functional in the next few years, and the budgetary situation looks frightening. 

Cabinet also decided to increase the grant given to each eligible household for reconstruction of earthquake, flood and fire damaged buildings by NRs100,000. This instantly widened the spending envelope by Rs96 billion (about 3.3 percent of GDP) in the middle of the fiscal year. Note that less than 15 percent of the 767,705 households eligible for housing grants have completed construction of houses so far and the reconstruction authority is struggling to disburse the second tranche of housing grants. Such grant distribution for flood and fire victims is almost negligible even months after the devastating disasters.

Competitive populism

Instead of resolving the administrative and policy bottlenecks related to infrastructure and reconstruction projects, the caretaker government is intent on splurging state resources wilfully on commitments for which it won’t be held accountable for. Proposals having far reaching consequences for the economy have been tabled in the cabinet meeting without adequate discussion with government agencies, particularly the Ministry of Finance and National Planning Commission. Although the next government will find it very hard to undo some of these populist measures, it should convene a committee to review fiscally fatal decisions taken by the caretaker government in the last few months.

However, if it engages in competitive populism by increasing elderly allowance to Rs5,000 as per its election manifesto, then the fiscal situation would further worsen. The elderly allowance itself will be around Rs101 billion (Rs 63 billion for those 70 and above years old, and an additional Rs38 billion for those in 65-69 age cohort), equivalent to about 3.4 percent of GDP. Increasing the treasury’s burden on unproductive spending without having the means to sufficiently cover them will erode whatever sound fiscal position we had in the past. Balance between populism and fiscal prudence should be of utmost priority now.

Correction: The then PM Adhikari-led government decided to give NRs100 to those 75 and more years old.

Wednesday, February 7, 2018

National Assembly polls in Nepal today and more

From The Kathmandu Post: Polls for 32 Upper House seats today. The new constitution adopted in 2015 envisages a bicameral parliament. Elections for the House of Representatives were held in November-December last year. The election authority said the vote will clear the way for it to announce the results of the House of Representatives under the Proportional Representation (PR) category.

In the 59-member NA, elections are held for 56 seats while the remaining three are appointed by the President on the recommendation of the government. Eight each are elected from one province—three from women’s quota, one from Dalits, one from disabled or monitory communities and three others from the open category.

As many as 83 candidates from 13 parties had filed their nominations. Six of them have withdrawn from the race, the candidacy of one was revoked while 24 were elected unopposed. This has left 52 candidates vying for 32 positions, according to the EC. All the eight members were elected unopposed in Province 2, requiring no elections there. Although there are 2,056 voters in total, only 1,677 will cast the vote with polls not required in Province 2. There are 443 Provincial Assembly (PA) members and 1,234 local government representatives as voters. The vote of a PA member weighs 48 while that of a local unit representative has a value of 18. 

The country had a unicameral legislature after the Interim Constitution was authenticated on January 25, 2007 until the dissolution of Legislature-Parliament on October 14, 2017.

Antonio Nucifora and Martin Raiser write on Future Development blog: Brazil finds itself once again with a big fiscal deficit and rapidly rising public debt. A team from the World Bank set out to answer these questions with a comprehensive review of public spending in Brazil. The new report, A Fair Adjustment, concludes that much of Brazil’s public spending benefits the relatively well off more than the poor, so there is room for serious fiscal adjustment without harming those most in need of government programs.

A fair adjustment would reduce transfers to the better off, and could preserve—even increase—spending on such programs. A fair adjustment would mean changing things in three areas: public pensions, government salaries, and benefits for big business.

Public pensions: The biggest source of savings is the country’s public pension system, which ran a deficit of nearly 4.5 percent of GDP last year. Brazil spends a lot more on social security than countries with much older populations. More than one-third of this gap is because of generous benefits to the richest 20 percent; more than four fifths of the deficit accrues to the top 60 percent.

Government salaries: Another way would be to cut back on public sector pay which is 70 percent higher than private sector wages; the OECD average is 11 percent. Tax exemptions, interest subsidies, and direct transfers to business are a third area of potential savings. At 4.5 percent of GDP in 2016, they are almost 10 times the spending on Bolsa Familia. Brazil has been an innovator in social policy: Conditional cash transfers—which aim to reduce poverty by making government help contingent upon receivers’ actions—were first introduced in Brazil. But while Brazil’s Bolsa Familia program is internationally acclaimed, it accounts for just half a percent of GDP.

Benefits for big business: Government benefits for the better off are also provided as tax benefits for private health insurance and in free public higher education, attended mainly by students from wealthier families. 

All in all, A Fair Adjustment report identified programs totaling some 8 percent of GDP, which could be cut back without hurting the poor. The savings could be used to restore fiscal balance and secure spending on tested social transfers and critical infrastructure investments.

SC issues interlocutory stay order in Sumargi case

From myRepublica: The Supreme Court on Tuesday issued an interlocutory stay order in favor of businessman Ajaya Raj Sumargi, allowing him to use Rs 2 billion which was transferred from a foreign bank and subsequently frozen by  Nepal Rastra Bank. A single bench of Justice Tej Bahadur KC issued the order on condition that the amount would not be taken to any foreign country and it would not affect a money laundering case involving the amount.

Stating that there was no valid ground to stop the amount from being used, the apex court has also said that  the decision of the central bank to freeze the amount was having an adverse effect on Sumargi's industrial activity. A total of Rs 12 billion was transferred to the accounts of different companies owned by Sumargi from the countries including Mauritius, Cyprus and other countries in 2010 as foreign direct investment. An amount of Rs 8 billion was already withdrawn from the bank accounts of Nepal Investment Bank Limited and Nabil Bank while the order allows Sumargi to use Rs 2 billion. Another Rs 2 billion still remains frozen in the bank accounts. 

The Nepal Rastra Bank had frozen the amount citing the lack of valid source of income for it.  Seeking the intervention of the apex court, Subas Chandra Paudel, the authorized person of Nepal Satellite Telecom Pvt Ltd had moved the apex court on Sunday with the writ petition.

Energy Min mulling to dump deal with CTGC

Bibek Subedi writes in The Kathmandu Post: The Energy Ministry has been mulling to scrap the contract signed between the Nepal Electricity Authority (NEA) and China Three Gorges Corporation (CTGC) for the development of the West Seti Hydropower Project after the Chinese company threatened to pull out from the deal unless the state-owned power utility revised the power purchase rate. Last December, CTGC wrote to Investment Board Nepal (IBN) saying that it would drop the project if the NEA didn’t revise its guideline for the power purchase rate. 

The Chinese company has said that the rate offered by the guideline doesn’t make the project bankable. According to the guideline, reservoir-type projects like the West Seti will get Rs12.40 per unit during the dry season which lasts from December to May, and Rs7.10 per unit during the wet season which lasts from June to November. 

Sunday, February 4, 2018

Cooperatives under the local bodies and more

Cooperatives under the local bodies

The government has started handing over cooperatives to local bodies. The new constitution allows all three tiers of government to register, monitor, promote and regulate cooperatives, which do not fall within the mandate of the central bank despite substantial deposit mobilization and credit disbursement. 
  • Total number of cooperatives: 34,512 (13,886 savings and credit cooperatives)
    • Under state government’s jurisdiction:  1,000
    • Under local government’s jurisdiction: 33,363
    • Under federal government’s jurisdiction: 150
  • Total direct employment generated: 57,000
  • Total credit mobilization: NRs400 billion
  • Share capital: NRs94 billion
  • Share members: 6,754,273

The Law Ministry has resolved the long-standing dispute between the Energy Ministry and the Investment Board Nepal (IBN) over authority to issue licence to large hydropower projects with an installed capacity of 500MW or more. In its letter to the Energy Ministry on Friday, the Law Ministry has said the former has the sole authority to issue survey licences for hydropower projects and that issuing such licences will not encroach IBN’s jurisdiction nor violate the provision of Investment Board Act.

“Section 9 of the Investment Board Act does not give the IBN authority to issue survey licence of any kind of hydropower project, while Section 4 of the Electricity Act clearly allows the Energy Ministry to issue such licence,” reads the letter by the Law Ministry. “The IBN’s role in implementing the hydropower projects comes only after the survey is completed when the investment is required for the project development.” The letter further said the project’s exact installed capacity is determined only after the survey is completed. The Law Ministry’s explanation has limited the IBN’s role to arranging the fund for development of hydropower projects, while endorsing the Energy Ministry’s recent decision to award a survey licence of the Betan Karnali and Bheri-1 projects to Betan Karnali Sanchayakarta Hydropower Company and Vidhyut Utpadan Company respectively.

Excerpts from an interview with Indian FM Arun Jaitley:

GST: In India we started in the first few months itself. Today we are already thinning the 28% bracket. The mood in the GST Council is that as collections rise, this should be thinned to the extent that only non-merit and luxury items remain in it. But that will be contingent on an increase in the revenues itself. And I think this is already work in progress. There is hardly a GST Council meeting where rationalisation of taxes on a few dozen items does not take place. It is only at a later stage that you can think of converging the 12% and 18% slabs into the standard rate. […]I believe that non-compliance is a curse on the compliant taxpayer because he not only pays his share but also pays the larger share of those who do not comply.

Spending: In any area, whether it is the social sector, or infrastructure, or defence, we increase expenditure every year. We would have loved to increase more. Having been defence minister I know the requirements are more. But the fact is—it’s the size of the cake which has to be shared. Unless the cake enlarges, the only other option is to enlarge the fiscal deficit.

Formalization: Demonetisation had three impacts—it helped us reduce the quantum of cash; it increased the tax base and ended the anonymity of cash transactions; and it encouraged digitisation. GST is more of a voluntary compliance. […]Input Tax Credit is the best anti-evasion measure you have. Now with other anti-evasion measures that will slowly come into place, I think GST will start formalising the sector faster.

Agricultural output: There is a storage challenge, and the problem of market prices falling below the Minimum Support Prices because of a glut. We have overcome the shortage era. We also have to ensure more non-farm income income. What is the capacity of the rest of the system to get people out of agriculture to other areas of the economy?

Populist budget: It is not a populist budget. It may be popular because it blends both economy and politics.

Thursday, February 1, 2018

Saudi job restriction rule to hurt Nepalis and more

The Minister of Labour and Social Development have issued a decision to restrict work in 12 activities and occupations to Saudi men and women to enable their employment in the private sector.

From September 11 this year, sales jobs will be reserved for Saudi citizens in four categories: cars and motorcycles; ready-made garments, children’s clothes and men’s accessories; home and office furniture; and home kitchenware. From November 9, this rule will extend to the sale of: electronics and electric appliances; watches; and eyewear. From January 7, 2019, the rule will apply to the sale of medical equipment and appliances; building and construction materials; car spare parts shops; carpet and floor covering stores; and finally sweet shops.

Nepalis with good educational qualification used to work as accountants, engineers, sales, electronics, hardware, contracting companies, cashiers, and supermarkets. They will be deprived of these opportunities as well. Saudi Arabia had the highest number of Nepali migrant workers at 138,529 in the fiscal year 2015-16.

A trading company established during the cold war era has been laid to rest in Nepal. NTL used to sell agricultural, construction and machinery goods in the Nepalese market by importing them from Russia since private sector was not up to the task then. The competitive private sector after economic liberalization and a series of unfortunate political interference bankrupted the trading company. Three main reasons as follows:

  1. Government forced NTL to absorb the cost of golden handshake for employees of bankrupt Himal Cement Company, where NTL had 15% share. The government never returned NRs430 million to NTL.
  2. In 1996, the then PM Sher Bahadur Deuba led government gave license to a private company to sell duty free liquor, which was exclusively done by NTL. In 1998 late PM Girija Prasad Koirala led government revoked the license. Then in 2001 when Sher Bahadur Deuba became prime minister, his government gave license to sell duty free liquor to the same private company. 
  3. In 2009, the then finance minister Baburam Bhattarai completely barred public and private companies to sell duty free liquor (even closed down the one at the international airport). NTL had already taken out NRs500 million loan to import duty free item, including NRs320 million. Since NTC was barred from selling duty free liquor and it had to go through a lengthy bureaucratic approval process to sell it at retail rates in the market, it started incurring huge administrative losses. Also, its retail cost was high because of high administrative costs and inefficiencies. NTL incurred huge losses after this. Consequently, MOF froze its assets and barred it from doing trading business. In 2011, the then PM Baburam Bhattarai led government took a decision to sell 18 ropanies of NTL’s land and establish petroleum and gas industry. The government changed and the then PM Khil Raj Regmi led government revoked the decision of the previous government. Meanwhile, NTL was left in an operational limbo but its losses continued to accumulate. 

Nepal sends feasibility report of cross-border transmission line to China

The Nepali Energy Ministry has sent the initial feasibility report of a cross-border transmission line to be constructed on the Nepali side to China, a senior official of the ministry said. Nepal had requested China to provide assistance for the construction of the Rasuwagadhi-Kerung (Geelong) Cross-Border Transmission line during former Nepali Prime Minister KP Sharma Oli's visit to China in March 2016.

With the hydropower plants being constructed along the proposed transmission line, Nepali officials said that 400 KV transmission line has been necessary along the route to transform power for the hydropower projects being constructed and those which are about to kick off construction. The Energy Ministry has selected the project for potential financing under the China-proposed Belt and Road Initiative. The country had signed a Memorandum of Understanding with China to become part of the initiative in May 2017.

Monday, January 29, 2018

Key highlights from Economic Survey 2017/18 of Indian economy

1. Overview of the economy in 2017-18: 

  • GST launched
  • Twin balance sheet problem addressed by sending the major stressed companies for resolution under the new Indian Bankruptcy Code and implementing a major recapitalization package to strengthen the public sector banks.
  • Economy began to accelerate in the second half of the year. This should allow real GDP growth to reach 6.75 percent for the year as a whole, rising to 7-7.5 percent in 2018-19.
  • Fiscal deficits, current account and inflation were all higher than expected.
  • Rationalize government resources by redirecting them away from subsidies towards public provision of essential private goods and services at low prices, especially to the poor
  • Fiscal stasis: Tax to GDP ratio has remained at similar level for decades despite average economic growth of 6.5%
  • Current account vulnerability: Revive manufacturing and export more  
  • Downside risks come from high international oil prices, sharp correction of elevated stock prices
  • Policy agenda for next year: stabilizing GST implementation (remove uncertainty for exporters, facilitate easier compliance, expand tax base), completing the twin balance sheet problem resolution (4Rs: recognition, resolution, recapitalization and reforms), complimentary reforms to shrink unviable banks and allow greater private sector participation (privatize Air India)
  • Policy agenda for medium-term: creating more employment for youth, more focus on education to create an educated and healthy labor force, and raising farm productivity while strengthening agricultural resilience.

2. Large increase in registered indirect and direct taxpayers. A 50 percent increase in unique indirect taxpayers under the GST compared with the pre-GST system. Similarly, there has been an addition (over and above trend growth) of about 1.8 million in individual income tax filers since November 2016

3. States’ prosperity is correlated with their international and inter-state trade States that export more internationally, and trade more with other states, tend to be richer. But the correlation is stronger between prosperity and international trade.

4. To re-ignite growth, raising investment is more important than raising saving. Cross-country experience shows that growth slowdowns are preceded by investment slowdowns but not necessarily by savings slowdowns may not.

5. Own direct tax collections by Indian states and local governments are significantly lower than those of their counterparts in other federal countries. This share is low relative to the direct taxation powers they actually have.

6. Indian society exhibits strong son “Meta” Preference. Parents continue to have children until they get the desired number of sons. This kind of fertility-stopping rule leads to skewed sex ratios but in different directions: skewed in favor of males if it is the last child, but in favor of females if it is not the last

Thursday, January 25, 2018

Elderly allowance, fiscal burden and competitive populism

On January 24, PM Deuba led caretaker cabinet took an ill-conceived decision to lower minimum age eligibility to receive elderly allowance to 65 years from the existing 70 years. Currently, the government provides NRs2000 per month to citizens who are 70 years and above. There is intense debate on sustainability of such handouts without generating additional resources at a time when tax revenue is barely sufficient to cover recurrent spending

Here is how much it will cost to the treasury: the cabinet decision on Wednesday will cost an additional NRs16 billion each year in the next five years since it will have to include about 0.645 million new recipients in this ‘social security’ scheme. There are about 1.02 million people of 70 years and above age and they take around NRs25 billion. Cumulatively, old age allowance now amounts to about NRs40.7 billion (around 1.4% of GDP and 5.6% of revenue).
The cabinet also took a decision to increase housing grant to earthquake, fire and flood victims by NRs100,000 (making total NRs400,000). This alone would cost an additional NRs96 billion (767,705 eligible for earthquake related housing grant and 192,136 for flood related grant). In total, last Wednesday’s cabinet decision cost the economy an additional cost equivalent to about 3.8% of GDP. That’s insane. 

Now, this is a bait for the upcoming left alliance led government. They committed to raise old age allowance to NRs5000 in their elections manifesto. If they keep their promise, then it would cost NRs101 billion (NRs63 billion for 70+ and NRs38 billion for 65-69 years old), which is equivalent to 3.4% of GDP. It will be very difficult for the next government to raise the eligible age for old age allowance back to 70 years and above. And they probably won’t do it because they love such handouts in the first place. Recall that it was Man Mohan Adhikari led government that decided to distribute NRs300 monthly as old age allowance in 1994. Later on it was increased to NRs1000 and then UML’s Bishnu Prasad Poudel, when he was finance minister in 2016, doubled it to NRs2000. This has been a good selling point to attract elderly votes. The NC led caretaker government probably have thought they can claim credit for lowering eligibility age for elderly allowance and for increased housing grant. They did this without considering if the next government will have enough resources to fulfill them. Furthermore, it restricts the next government’s flexibility with respect to realigning budget on their signature programs. In short, its fiscal irresponsibility and imprudence. 
Overall, the caretaker government has added NRs80 billion extra burden on the next government over five years. The green section in the bar chart shows the additional burden inflicted by the caretaker government. 

Few points to consider:
  • First, the population projection comes from CBS’s estimation under medium variant scenario (more plausible decline in fertility and mortality levels along with appropriate effects on migration). The additional burden to treasury assumes that all eligible citizens will take the allowance. Practically, actual take up could be around 90% but then allocation needs to be made based on potential take up.
  • Second, FY2018 budget has earmarked NRs36 billion for allowances to senior citizen, single woman, dalits, endangered indigenous people or ethnic groups, and physically challenged people. The government spent NRs88.6 billion in social security (allowances, scholarship and retirement benefits) in FY2017 and has allocated NRs102.6 billion for FY2018, which is equivalent to about 8 percent of the entire budget and one-third of capital spending.
  • Third, those residing in Karnali region, dalits and single mothers are eligible to receive elderly allowance from 55 years onward (previously it was 60 years). So, the total additional burden will be even higher. Note that the above estimate does not consider administrative costs incurred while administering the welfare program. 
  • Fourth, this whole fa├žade by a caretaker government puts the next government in a bind. They will not be able to unroll the handouts, which means the next finance minister will have a tough time managing budget. A large increase in budget (using past savings as well as increasing deficit) is on the cards now as the next government will probably fall into the competitive populism trap.
  • Fifth, this cabinet decision was taken without adequate consultation with MOF and NPC. What were the advisers doing?
  • Sixth, it is better to provide health insurance cover rather than cash handouts. Remember that average life expectancy is increasing.
  • Seventh, here are the five key economic challenges for the next government.