Tuesday, January 16, 2018

Slow capital spending this year as well and more

The government’s capital spending hovered around Rs47 billion in the first six months of the fiscal year, which is only 14 percent of total capital budget of Rs335.2 billion allocated for 2017-18. Three main reasons for underutilisation of the capital budget: (i) flooding in Terai in August delayed progress in implementing infrastructure projects; (ii) state and federal elections meant that government staff were deputed to conduct and monitor elections, and workers returned back to their hometown to cast vote; and (iii) confusion over transfer of projects to local bodies and implementation agency. Other reasons include delay in preparation of detailed project design, land acquisition, establishment of project management offices and preparation of procurement plans.

  1. Increase investment in physical and social infrastructures
  2. Sound fiscal management and governance regimes
  3. Coherent planning and policies among the three tiers of government
  4. Bureaucratic reform for better budget execution and public service delivery
  5. Accelerated post-earthquake reconstruction

In Nepal, half a dozen contractors exercise monopoly over construction contracts. The cartel holds sway over entire construction administration and political sector. They huddle together before bidding for large infrastructure projects. […]After the deal, the contractors divide civil works among themselves. The contractor who is receiving the contract proposes a cost one percent less than the estimated cost. In order to show it was a competitive bidding, another contractor of the group proposes a slightly higher cost. As a result, one of the group members wins the contract.

In the last few years, against the fundamental principles of law, procurement policies have been modified so that only certain companies can bid for tender without any competition or by limiting competition. The report details how collusion affected more than Rs 25 billion worth of road projects.

Local bodies lack planning and budgeting expertise

Local bodies in Gulmi have been approving short-term populist programs instead of medium-term projects that help to raise local productive capacity. They don’t have the capacity to do planning, select projects and approve budget. 

Resunga municipality approved 648 project, of which 103 are of NRs10,000-NRs50,000. There are 211 projects with a budget of just NRs100,000. Similarly, they have allocated NRs30.6 million to upgrade 150 local roads. Isma village council (gaupalika) has approved 42 drinking water projects, of which 10 have allocations below NRs300,000. 

Govt to break up Air India into four parts to speed up privatisation process

The proposed privatisation of Air India Ltd has gained momentum, with the government deciding to break the airline into four units and offer to sell at least 51% in each of them besides transferring most of the non-core debt owed by the carrier to its own balance sheet. The core airline business comprising Air India and Air India Express—the low-cost overseas arm—will be offered as one company, and the process will be completed by the end of 2018, minister of state for aviation Jayant Sinha said in an interview with Bloomberg on Monday. Its regional arm, ground handling and engineering operations will also be sold separately in the same process.

The government has also eased rules allowing foreign airlines to buy a stake of up to 49% in Air India with prior government approval but with the caveat that substantial ownership and effective control of Air India will remain with Indian nationals as is the case with all domestic airlines. The airline has a fleet of about 140 planes, with a 17% share of traffic on routes linking India to international destinations and about 13% share of the domestic market.

Monday, January 15, 2018

Five key economic challenges for the next government

It was published in The Kathmandu Post, 15 January 2018, p.6

Nepalis hope that a stable government will result in coherent and consistent policies

The strong performance of the left alliance in the local, provincial and federal elections has reignited discussion about c. The public is hoping that a stable government will result in coherent and consistent policies to accelerate economic growth, generate adequate jobs and create the ground for shared prosperity. Furthermore, with substantial division and devolution of authority among the three tiers of government, expectations for better accountability of public operations and efficiency in services delivery have gone up. 

The next government faces key economic challenges to accelerate growth and turn Nepal into a middle-income country besides achieving most of the Sustainable Development Goals by 2030. It should prioritise investment in large-scale infrastructure projects, fiscal management, coherent planning and policies, improved budget execution and accelerated post-earthquake reconstruction. These will help, to some extent, the economy to transition from remittance-backed activities to more stable sources of growth that not only generate adequate jobs but are also inclusive. 

Quick look

Before delving into the challenges, let us first have a quick look at the state of our economy in the past decade. Economic growth has been low and volatile, averaging just 4.2 percent. Lack of adequate and meaningful jobs has led to large-scale outmigration. Budget execution remains dismal as just 72 percent of the planned capital budget, which itself is low given the vast spending needs in infrastructure, was utilised. Tax revenue is barely sufficient to cover ballooning recurrent spending and post-earthquake reconstruction is too slow as just 11 percent of the damaged houses have been rebuilt so far. 

Meanwhile, inflation has been stubbornly high, averaging 8.7 percent, and the financial sector is beset by recurring asset liability mismatches and liquidity squeezes. Trade deficit is ever-increasing while remittance inflows are decelerating, resulting in a current account deficit last year. Absolute poverty has declined sharply, but most households are clustered just above the poverty threshold, making them vulnerable to a plunge into poverty in case of negative shocks to incomes or assets. Workers’ remittances are the only factor keeping the economy afloat by sustaining household demand, increasing revenue from remittance-financed ever-increasing imports, creating a constant stream of short-term deposits for banks, and maintaining external stability despite a burgeoning trade deficit. 

Breaking the dependence on remittance and diversifying sources of growth to more stable factors are crucial to achieving high, sustainable and inclusive economic growth. However, this is not going to be easy, and probably is not even possible to accomplish in the next five years. The next government could at least create a political, bureaucratic, regulatory and institutional basis for the economy to rely on stable sources of growth. We can have more reliable sources of growth with increased public and private sector investment in physical and social infrastructures; sound fiscal management and governance regimes; coherent planning and policies among the three tiers of government; bureaucratic reform to ensure better budget execution and public service delivery; and accelerated post-earthquake rehabilitation and reconstruction.

Prudent management is key

First, 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, labour relations and export promotion. The slow response from the government to proposals on infrastructure investment, and the myriad of hassles investors have to face while getting project, financial, land and environment clearances, do not enthuse them. Private gross fixed investment averaged just 21.6 percent of GDP in the last five years. The next government needs to work proactively to ensure that this reaches at least 30 percent of GDP. 

The biggest fear investors have right now is over the taxation regime under the left government, especially when it comes to fulfilling the grandiose welfare and distributive commitments in the election manifesto. The business community is worried that the left government will increase taxes to raise funds to fulfil some of the commitments. Additionally, they are also concerned about paying the same tax to both provincial and local bodies. 

Second, 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. The central government will itself try to raise recurrent spending to fulfil commitments made during the elections by either borrowing more or raising tax revenue. The former entails more domestic borrowing (since donors do not usually cover recurrent spending) which may worsen liquidity shortages and exert upward pressure on retail interest rates. The latter is possible if tax rates are hiked or/and more people and businesses are brought inside the tax net besides plugging revenue leaks.

Third, fundamental policies and priorities of all tiers of government have to be synchronised 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. 

Fourth, 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 centre 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. 

Fifth, 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. 

Overall, the next finance minister will have a hard time managing expectations, promoting competitive federalism and ensuring a coordinated calibration of policies.

Saturday, January 13, 2018

Local bodies allowed to award 1MW hydropower license and more

MOFALD has allowed local governments to award hydropower project developer license for up to one megawatt and monitor the projects. Local governments could issue project licenses for up to 1MW after technical clearance from the Department of Electricity Development. The local councils, however, will not need clearance from the department when they draft laws and policies to govern the hydropower sector. The Local Governance Act-2017 has given authority to 753 local bodies to issue permits for hydel project development in their areas.

Nepal has ended its sole dependence on Indian companies for internet connectivity by opening up links to Chinese companies. Nepal Telecom and China Telecom Global launched their services after they wrapped up the laying of optical fiber cables between Kerung in China and Rasuwagadi in Nepal, about 50-km north of Kathmandu. The optical cables from China are connected to the optical fibre hub of Nepal Telecom at Sundhara, Kathmandu. From Sundhara, the state owned telecom service provider of Nepal will provide internet service to its customers all over the country.

Currently, the speed of Chinese fiber link via Rasuwagadhi border will be 1.5 gigabits per second per second (gbps) in the initial phase. Nepal is receiving up to 25 gbps from India. Nepal has optical fiber link with India through Bhairahawa, Birgunj and Biratnagar. More than 60 percent of Nepal’s 28 million people had access to the internet in 2017, up from just 19 percent in 2012.

More than 1.55 million tourists visited Lumbini in 2017, representing a 20.75 percent increase. Among them, 1.25 million were domestic visitors, and 301,240 foreign visitors (including 155,444 Indian visitors).

There were 48,528 visitors from Sri Lanka, Thailand (27,603), Myanmar (21,531), China (15,770), South Korea (5,103), Vietnam (5,043), Bhutan (2,278), the UK (1,677), Germany (1,636) and Australia (1,625). Tourists from 87 countries made the trip to Lumbini last year. A majority of foreign tourists visiting Lumbini are handled by Indian tour operators. They enter Lumbini overland from across the Indian border, and spend a few minutes looking around.

India’s missing middle class

Excerpts from The Economist magazine: 
Many companies around the world are looking to India for a repeat performance of China’s middle-class expansion. India is, after all, another country with 1.3bn people, a fast-growing economy and favourable demography. And China’s growth is flagging, at least by the standards of the past two decades. Companies which made a packet there, both incomers such as Apple and locals like Alibaba, are seeking pastures new. Firms that missed the boat on China or, like Amazon and Facebook, were simply not allowed in, want to be sure that they do not miss out this time.
But for some of the firms trying to tap this “bird of gold” opportunity, as McKinsey once called it, an awkward truth is making itself felt: a lot of this middle class has little money to spend. There are many rich people in India—but they number in the mere millions. There are a great many more who have risen above the poverty line—but not so far above it that they spend much on anything other than feeding their families. And there is less in between the two than meets the eye.
In dollar terms, growth in Indian e-commerce in 2017 was comparable to a week or so of today’s growth in China. India’s mean GDP per head is just $1,700, and 80% of the population makes less than that. Adjust for purchasing-power parity by factoring in the cheaper cost of goods and services in India and you can bump the mean up to $6,600. But that is less than half the figure for China and a quarter of that for Russia. Only 78m Indians are making close to $10 a day (250,000 rupees annually). To get in the top 1% of earners, an Indian needs to make just over $20,000. Adjusted for purchasing-power parity, that is a comfortable income, equating to over $75,000 in America. India’s middle class may be far from wealthy but the rich are truly rich. There are over 200,000 millionaires in India.
Another gauge is whether people can afford the more basic material goods they crave. For Indians, that typically means a car or scooter, a television, a computer, air conditioning and a fridge. A government survey in 2012 found that under 3% of all Indian households owned all five items. The median household had no more than one.
Over 90% of workers are employed in the informal sector; most firms are not large or productive enough to pay anything approaching middle-class wages. Poor diets mean that 38% of children under the age of five are so underfed as to damage their physical and mental capacity irreversibly.
Whether India’s consumer class numbers 24m or 80m, that is more than enough to allow some businesses to thrive—plenty of fortunes have been made catering to far smaller places. But businesses assuming the consumer pivot in India is the next unstoppable force in global economics need to ask themselves why it already looks to have run out of puff—and whether it is likely to get a second wind any time soon.

Rising food prices pushed India’s retail inflation in December to 5.21%, intensifying pressure on RBI to raise policy rates in the next few months. India’s factory output growth leapt to a 17-month high in November, partly the effect of a lower year-ago base in the aftermath of demonetisation, and retail inflation also quickened to a 17-month high, confirming that an economic recovery is underway amid rising price risks. The economy has been hurt by the lingering impact of the invalidation of high-value banknotes in November 2016 and disruptions caused by the goods and services tax, introduced on 1 July.

Tuesday, January 9, 2018

Liquidity conundrum in Nepal and more

The interbank rate went below 3% and the central bank offered to mop up liquidity (NRs 2 billion through 14 day deposit collection auction) to ensure real interest rate stays between 3% and 7% (what it calls an interest rate corridor). However, BFIs offered NRs3.9 billion. This is contradictory to the claim by BFIs that there is liquidity/credit shortage. Most BFIs are hitting the CCD limit of 80% now. 

It happened last year as well (and in the past as well) and the NRB came to their rescue by bending rules to compute CCD. Now, the BFIs are again seeking help from both NRB and MOF to help them increase deposit as remittance inflows are decelerating and public capital spending is not too high till the first half of FY2018 (two main sources of deposit of BFIs). It is a classic case of moral hazard: repeatedly running into the same self-inflicted problem (a result of faulty operations and management) and seeking relief from the regulatory (which, surprisingly, has done what BFIs wanted on regulatory front in this particular issue). It would further foster this behavior if MOF and NRB agrees to offer NRs80 billion (from its treasury surplus of NRs330 billion) as deposit to BFIs to rescue them from the current mess.

Federation of Contractors Association of Nepal (FCAN) alleges that price of cement has gone up by Rs 100 per bag (50 kg), while steel rod has become dearer by Rs 7 per kg compared to prices before the provincial and federal elections. A bag of OPC cement is being retailed at Rs 910, while steel rod now costs Rs 85 per kg. Contractors say this is a deliberate increase in prices but producers say it is because cost of raw materials (clinkers and transportation) increased. 

Paddy output is expected to be about 5.15 million tons, down 1.49% from FY2107 on account of late and uneven pattern of monsoon, and flooding in August in Terai plains. MOAD had earlier projected a record paddy harvest. The latest estimate is not going to lower agricultural output growth as the country has seen abundant maize harvest, according to MOAD.

The production of summer crops—paddy, maize, millet and buckwheat—is expected to grow 1.87% to 8.03 million tonnes this fiscal year. In FY2017, the country recorded its largest paddy production in history with a 21.66 percent jump to 5.23 million tonnes.

About 60% of primary school students (class 2 and 3) in community schools cannot even write a simple sentence in Nepali language, according to Ministry of Education. The result is based on a survey of 72,538 students in 2,650 community schools in 11 districts. 

"Sluggish wage growth, lower crop planting, fluctuating prices paint a dismal picture for farmers and the agriculture sector.

Planting of wheat, the main winter crop, between October and early January was 5% lower than a year ago due to lower sowing in Madhya Pradesh by close to a million hectares; area under oilseeds was lower by over 5%. Rajasthan accounted for most of the decline in oilseed cultivation because of 0.7 million hectares lower sowing of mustard. Similarly, data on nominal rural wages, a bellwether for rural demand, is showing sluggish growth. According to the labour bureau, in October 2017, nominal rural wages for ploughing (men) rose 6.6% year-on-year."

Mihir Sharma writes: "Just as growth appears to be no longer a pressing problem, another familiar threat has reappeared: India’s macroeconomic numbers don’t look quite as stable as they should.

India is snowed under with sovereign and quasi-sovereign paper; it seems like practically every state government and public-sector company wants a piece of India’s bond market. In response to this flood of debt, the yield curve has steepened by a whole percentage point since July. And the government made things even worse by announcing at the end of December that it would borrow more money from the markets this financial year than planned -- a fallout, perhaps, of uncertainty about revenues in the first year of the new indirect tax system. In other words, it’s not exactly the best time for Modi to be planning new spending. 

[…]The federal government is supposed to bring its fiscal deficit down to 3 percent of GDP this year; that’ll be a near-impossible task if transfers to farmers are also to be increased."

Friday, January 5, 2018

Indian economic growth estimated to decelerate to 6.5% in FY2018

India’s Central Statistics Office has released first advanced estimates of national income for 2017-18 (FY2018) and the economic outlook doesn’t look good. GVA (at basic prices) in FY2018 is estimated to decelerate to 6.1% from a provisional estimate of 6.6%. This follows Q1FY2018 GVA growth of 5.6% followed by 6.1% in the following quarter. The effects of demonetization in November 2016 is still lingering and the hasty introduction of GST in July 2017 is affecting small and medium enterprises (although effect of both shocks/reforms are gradually tapering off). GDP is estimated to grow at 6.5%, down from 7.1% PE for FY2017.
Specifically, on the supply side, agricultural and industrial sectors are expected to grow at slower rates than in FY2017. Agricultural output is expected to grow at just 2.1%, down from 4.3% in FY2017, due to decrease in production of Kharif crops (monsoon crops such as rice, millet, maize, sugarcane, soyabean, etc) cauased by deficient and uneven pattern of south-west monsoon. Industrial output is estimated to decelerate to 4.4% from 5.6% in FY2017 due to the decline in manufacturing output (growth of 4.6% from 7.9% in FY2107). This is where the effects of demonetization and the uncertainty surrounding roll out of GST and its implementation are still affecting economic activities. Services output is estimated to grow at 8.3%, up from 7.7% in FY2017 thanks to expected improved performance of trading activities, hotels and restaurants, real estate and business activities. Overall, agriculture, industry and services sectors are estimated to contribute 0.3, 1.3 and 4.5 percentage points to GVA growth of 6.1% in FY2018.
On the expenditure side, both private and public consumption are estimated to slowdown, but gross fixed capital formation is expected to grow at 4.5% (up from 1.7% in FY2017 but lower than 6.5% in FY2016). Exports growth is estimated to remain stable but a double-digit import growth will worsen net exports.

Two observations: First, demonetization and GST are structural reforms whose payoff will be realized in the long term, but voters care about short-term and general elections are coming soon. Its lingering impact is going to been felt in the next few quarters too. Second, the government will face pressure to bring some form of immediate growth-enhancing fiscal measures in the budget for FY2018-19 (due in February).