Brief overview of the white paper on economy released by finance minister

On 30 March 2018, Finance Minister Dr. Yuba Raj Khatiwada released a white paper on the current state of the economy, challenges and opportunities. He did a good job in laying out an honest assessment of the economy and doesn’t shy away from saying that things are bad with respect to fiscal capacity, financial sector instability, remittances-induced consumption of imported goods and tax revenue based on it, deteriorating external sector, lackluster economic activities and large unemployment. What Dr. Khatiwada said is nothing new, but what is good is that there is hardly any finance minister who was as candid as he is in laying bare the bad stuff about the economy. 

However, what the white paper doesn’t mention is how this government is going to tackle these problems, especially with respect to implementing the laws and policies in earnest, enhancing allocative efficiency in budget making processes and its implementation, and creating incentives to ensure that the public sector does what it is supposed to, i.e. provide services to people by minimizing hassles, facilitating investments by removing regulatory bottlenecks, creating a time-bound project based medium-term economic vision with clear implementation modality, etc. Let us hope that these will be reflected in the policies and programs of the government, and budget (the former due few days before budget presentation in mid-May). 

Here are brief highlights from the white paper:

• This government inherited an economy that was in a challenging situation: spending programs without ascertaining funds, ad hoc non-budgetary projects and plans, deteriorating financial sector, deceleration in remittance inflows, etc. Tax revenue is not enough to fully cover recurrent spending. 
• Fiscal imprudence is rife. Quality of public services is below the expected standard. Expenditure-revenue asymmetry is widening given the increase in administrative cost in the federal set up. Decreasing age to receive elderly allowance, ignoring MTEF, assigning unqualified projects for multiyear contract (outstanding liability itself is NRs200 billion now, and one ministry has been allowed to go for multiyear contracting for 239 projects worth a cumulative NRs122 billion), hiring excess teachers or lecturers in contract without adequate homework, doling out healthcare subsidies without including them in budget, passing a law allowing early retirement of public servants with golden handshake at a time when more of them are needed at local bodies, etc are some of the examples of imprudence.
• Capital spending is too low despite budget being unveiled one and a half months prior to the start of FY2018. Spending pattern hasn’t changed as most of the capital spending is happening in the last quarter. Same reasons are being recycled for low capital spending: forest clearance, lack of construction materials (clinker, stones, sand, soil, etc), inter-agency coordination, etc. Post-earthquake reconstruction is too slow.
• Financial sector has very weak links to real sector and is not aiding productive economic activities. Banking services are of traditional nature. Productive sector lending is not that encouraging. There is unhealthy competition in setting interest rates in banking sector. 
• Deindustralization is going on. Improved electricity supply has been helpful since last year, but increase in transaction cost, low share of institutional investors compared to individual investors, narrow market for industrial goods, and high dependence on imported raw materials and intermediate goods are some of the unresolved issues. Lack of adequate and quality infrastructure is crippling economic activities.  
• Investment climate is not that encouraging. Investors are in wait-and-see mode with respect to investment in Nepal. This is aggravated by the fact that Nepal’s image in tackling anti-money laundering activities and implementing associated laws is not that assuring. Nepal will face a review of its activities on this front in 2020/21.
• Except for NT and government-backed commercial banks, all other public enterprises are operating without much success. Their product quality, price, timeliness and responsiveness to consumer demand is disappointing. 
• Privatization exercise has been broadly unsuccessful. Privatization modality, valuation, and process were not based on ground realities. Rent on lease of public enterprises’ assets is too low. Privatized SOEs have not operated as per the understanding and objectives during privatization.  
• Nepal aims to graduate from LDC category to a developing country status by 2022. Nepal fulfilled two of the non-income criteria three years ago but deferred early graduation due to low income per capita and the vulnerabilities to per capita income shocks.
• Nepal is committed to achieving 17 SDGs and 169 targets within it by 2030. 
• Opportunities: federal set up (35,041 elected representatives at local level, 550 elective representatives at provincial level and a stable government) and expectation of better public service delivery; a youth bulge signaling demographic dividend; commitment from neighboring countries and multilateral development institutions to increase investment; natural resources
• Next steps: improvement in policy and administrative capacities to increase domestic and foreign investment; public, private and cooperative partnership; fiscal prudence and better allocative efficiency; strengthen revenue administration and increase revenue (widen tax net, control leakages, electronic billing, etc); capacity building of local and provincial governments to manage expenditure and mobilize revenue, etc.

Few comments:

• Let us be fair here. Some of the problems have been building up for a long time and the finance minister and the party he represents were at leadership position during those times as well. So, the economic ills are not exclusively the outcome of the previous government. It would be good to resist from mud-slinging cause there may be a boomerang effect. Most of the leaders of the left alliance are not new and they are equally a part of the process that brought the economy to this state.  
• In the past, communist governments were more fiscally imprudent than non-communist governments although the last Deuba-led government is an exception.
• On privatization, there is a broad sweeping statement that it has failed. Privatization is not bad in itself. When it got started in 1992, it was the need of the hour given the economic realities. However, the process of handing over SOEs to private sector without fair valuation and assessment of economic potential was badly managed. That is giving privatization itself a bad name. And communist governments have been at the forefront of raising this issue for issue’s sake. They have neither undone privatization nor worked to remedy some of flaws in the process. In fact, they have been willing participants as and when opportunity arose. Its a management problem and this should not be overlooked while asserting that the concept of privatization itself is wrong. 
• The white paper chides redistributive policies, but then says the government will adhere to the election manifesto of left alliance (which is more redistributive than what we have seen so far). 
• Let us wait for the program and policies, and budget to see what this government will do different and how it is going to do that. Till then adequate reasons to give benefit of doubt!

Priorities of PM Oli-led government and more

Priorities of PM Oli-led government (from his address to diplomatic community on 27 March 28, 2018):

1. Nationalism: “protection of our sovereignty, territorial integrity, national independence, and fulfilment of our national interest”
2. Democracy and fundamental freedoms: “We believe that democracy is irreversible and no one can snatch it now from us.”
3. Social justice based on equality: “We stand firm on achieving social justice that ensures equitable opportunities and equal protection to all sections of our society.”
4. Stability, progress and development: “Any attempt to undermine peace and stability will not be tolerated at any cost and will be dealt with firmly and resolutely. There is no space for violence in our society.”
5. Good governance: “We will also pursue a policy of zero-tolerance against corruption. Our aim is to ensure corruption-free governance. We will adopt an efficient and smart mode of service delivery so that people can feel the change.”
6. Broad-based, inclusive and sustainable development: “We have a strong resolve to attain rapid economic growth to underpin political transformation.”

Here is an outline of the previous version of the priorities of left alliance. We need to see further specifics on this government's economic vision, and strategy to achieve them within a given time frame. 

• 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

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Bad loan ‘evergreening’ in Nepal

From The Kathmandu Post: Haphazard credit disbursement that created irreparable holes in the balance sheet of erstwhile Apex Development Bank has exposed long-suspected counterintuitive practice of ‘evergreening’ of bad loans in the banking sector, which could contaminate and even bring down the entire financial sector. A loan restructuring directive approved by the board of directors of the development bank on September 13, 2015 had included a provision that enabled the management to disburse fresh loans to settle the outstanding credit, says an on-site inspection report prepared by the Nepal Rastra Bank (NRB), the banking sector regulator, a copy of which has been obtained by the Post. This implies the bank’s board, whose job is to ensure good governance, had officially allowed the management to evergreen the loan book.

Evergreening takes place when banks provide additional loans to borrowers who are unable to service their debt on time. The additional loan is then used to repay the instalments of the outstanding loan. This is a counterintuitive practice because it prevents banks from issuing good loans, as available fund is diverted to borrowers holding low-quality loans. This creates a vicious circle and the financial institution ultimately finds itself in a position where it can no longer issue good loans, thus exerting pressure on capital adequacy ratio, an indicator to gauge the credit disbursement capacity of banking institutions.

Apex Development Bank was engaged in this malpractice for quite some time. This is evident from the practice of issuing loans to the same group of borrowers and diverting credit to the same group via other borrowers, according to the report, which was submitted to the NRB on January 12, 2017, or a month after the extension of final approval for merger between NCC Bank and Apex Development Bank.

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Direct contribution of tourism is estimated at 4% of GDP in 2017

From The Kathmandu Post: Nepal’s travel and tourism sector injected Rs195 billion into the economy and supported more than 1.02 million jobs directly and indirectly last year, according to the latest report of the World Travel and Tourism Council (WTTC). The report said that 497,500 jobs were generated directly out of the total jobs supported by the industry last year.

According to the report, the direct contribution of tourism to the GDP was Rs99.8 billion in 2017, which is 4 percent of the total GDP. This is forecast to rise by 4.9 percent in 2018 and then by 3.8 percent annually to Rs152.4 billion in 2028. The total contribution of the travel and tourism industry to the GDP was Rs195 billion, 7.8 percent of the GDP in 2017. This is projected to rise by 3.9 percent annually to Rs299.5 billion, or 8.2 percent of the GDP, in 2028. This primarily reflects the economic activity generated by industries such as hotels, travel agencies, airlines and other passenger transportation services, excluding commuter services. It also includes, for example, the activities of the restaurant and leisure industries directly supported by tourists.

The country received Rs72.5 billion in foreign exchange earnings from tourists last year. More than 940,000 tourists visited Nepal in 2017, up 24.86 percent from 2016. 

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Bharatpur metropolitan city passes a local law to hike taxes

From myRepublica: Office of the Municipal Executive, Bharatpur Metropolitan Office, has increased registration fee for applications from Rs 10 to Rs 25, while fee for getting relationship certificate has been increased to Rs 100 from existing Rs 25. Similarly, fee for registration of gold and silver shops has been increased to Rs 25,000 (for A category) and Rs 15,000 (for B category) from the Rs 1,008. The business tax for running a restaurant and hotel has been increased from Rs 1,500 to Rs 125,000. Earlier, such rates were in range of Rs 500 to Rs 12,000 only.

Likewise, the metropolis has also hiked the fees for services like getting certificates of family details, certifying birth dates, issuing character certificates, fee for connection of drinking water lines, and ownership transfer. Fee for all of these services has been increased to Rs 575 from Rs 190. 

Bharatpur Metropolitan City introduced the new tax rates by endorsing the Financial Act from the Municipal Executive meeting in January. Tax rates have been hiked by up to 20 times. Bharatpur Metropolitan City has defended the decision to hike tax rates, stating that the metropolis needs for resources to 'strengthen its financial status'. Chitwan Chamber of Commerce and Industry (CCCI), on Tuesday, submitted a memorandum to the Office of the Municipal Executive, Bharatpur Metropolitan Office, drawing the attention of the municipal officials toward tax rate hike. CCCI have also said that the Act has no clarity on segregating villages and towns in respect to levying taxes. 

Macroeconoimc situation in FY2018 and beyond

It was published in The Kathmandu Post, 19 March 2018, p.8

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Challenging times

Economy is not expected to meet its initial growth target due to poor planning and allocation, but there is hope for next fiscal year

The recently released mid-term reviews of the fiscal year (FY) 2017/18 by the Nepal Rastra Bank (NRB) and the Ministry of Finance (MoF) point to challenging macroeconomic times ahead. Briefly, the economic growth prospect looks less optimistic than previously envisaged, high revenue growth is tapering off, capital budget under-execution is chronic but recurrent spending is increasing, inflation will likely accelerate to around 6 percent, bank credit is getting tighter, and the external situation is deteriorating.

Against this backdrop, the appointment of Yubaraj Khatiwada as finance minister by Prime Minister KP Sharma Oli is the right decision. Khatiwada is an economist with wide ranging experience in development planning and monetary policy. This appointment has rekindled hope for a better-managed, less politicised MoF and budgetary system. Khatiwada now faces multiple challenges to steer the economy in the right direction towards a meaningful, job-rich structural transformation. Managing finances and achieving accelerated economic prosperity will require fiscal prudence, efficient government operations, coherent prioritising and planning among the three tiers of government, and private sector friendly reforms to increase both domestic and foreign investments in productive sectors.

Not rosy

The MoF has revised down its economic growth target for FY2017/18 to six percent from an overly ambitious 7.2 percent set before the beginning of the fiscal year. Even the revised target is a bit ambitious because monsoon rains were uneven and will most likely affect agricultural output significantly. Similarly, deceleration of remittances is slowing down economic activity accounted for by services, which are also affected by tighter loan disbursements to the private sector by banks and financial institutions. These two forces will outweigh gains from the encouraging industrial activities (thanks to an improved supply of electricity and a modest pickup in reconstruction and investment) and the temporary growth boost coming from elections-related expenditure.

On the fiscal front, the situation is not encouraging despite the fact that the budget was unveiled one and a half months prior to the start of FY2017/18, indicating chronic issues with budget execution that are exacerbated by political interference, bureaucratic incompetence, deficient management capacity of contractors, weak monitoring and evaluation systems, and poor governance. In essence, it reflects allocative inefficiency and structural weaknesses in project planning, preparation and implementation. The MoF expects just 70 percent of the planned Rs335.2 billion capital budget to be spent in FY2017/18, lower than the average 72.2 percent in the last five years. 

Ironically, line ministries are asking for an additional Rs326 billion from the MoF at a time when total government receipts (revenue and grants) are expected to be about 95 percent of planned receipts. It will lead to a larger than expected fiscal deficit in FY2018. Note that the government has already raised 80 percent of the planned gross domestic borrowing (89 percent of planned net domestic borrowing) for the entire FY2017/18. More government borrowing than planned will further aggravate the liquidity crunch and put upward pressure on retail interest rates.

On the monetary front, the developments are equally worrisome. Credit disbursement growth continues to outpace deposit mobilisation growth (seven percent and 6.9 percent, respectively) and most banks are near the regulatory threshold for the credit to core capital-cum-deposit (CCD) ratio of 80.Consequently, private sector credit has slowed down and money supply growth is close to a six-year low. Interbank rate has been rising and the Nepal Bankers’ Association, which is increasingly acting like a cartel and is promoting anti-competitive practices to hide banking inefficiencies and corporate mal-governance, is lobbying with its member banks to limit the interest rates on deposits. Inflation is also ratcheting up, from a low of 4.6 percent in FY2016/17, and is expected to be around six percent. 

On the external front, exports have picked up but imports were even more robust (13.4 percent and 15 percent growth respectively). The widening of the trade deficit together with deceleration of remittances is pushing the current account into negative territory. At this rate, even the overall balance of payments will be negative for the first time since FY2009/10 (after which Nepal knocked on the doors of the IMF for emergency lending to balance its books).

Hopeful signs

Despite this gloomy prognosis, there are reasons to be optimistic about the next fiscal year, and beyond. Finance Minister Khatiwada has been frank about the tight budgetary situation, and public and private sector reforms needed to enhance quality and accelerate quantity of capital spending and private investment. He took over an economy that was weak due to mishandling of economic affairs, priorities and governance by the previous government. Additionally, due to a base effect, progress in key macroeconomic variables—especially economic growth and inflation—will automatically be lower than in FY2016/17.

That said, two key priorities are crucial to boost economic activities and jobs creation in the coming years. First, better budget execution starts with allocative efficiency, i.e. shelving projects from the budget speech that are not shovel-ready. A comprehensive mapping of existing projects that are not performing well and are wasteful, and a coherent planning of fundamental policies and priorities at all tiers of government are essential to ensure that the working style of the MoF is not business as usual.

The Chief Economic Advisor’s office within the Finance Ministry could be adequately resourced, both finance and human capital wise, to carry out these tasks along with an objective assessment of the state of the economy. Additionally, resisting populist measures in the FY2018/19 budget and ensuring fiscal discipline by being mindful of widening revenue-expenditure asymmetry is important. Khatiwada recently argued for austerity measures to curb wasteful recurrent spending, widening of the tax net and plugging in of revenue leakage. 

Second, Khatiwada should push for ‘second generation reforms’ to boost domestic and foreign investment. A number of investment-friendly legislation were amended or newly-passed by the previous parliament. These should be supplemented by policies, regulations, guidelines and institutional frameworks for timely implementation. Furthermore, several important legislation need to be either amended or passed anew, including those related to foreign investment and public private partnership. The lower tiers of government also need capacity enhancement to bring coherent laws, policies, regulations and guidelines to run the government and attract investment to stimulate local economies.

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).

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

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.

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IBN, Nepwaste sign deal for waste management

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.

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