Thursday, April 26, 2018

CBS projects Nepal's GDP to grow at 5.9% in FY2018

On 25 April, Central Bureau of Statistics (CBS) estimated that Nepal’s economy would likely grow by 5.9% in FY2018, down from 7.4% in FY2017 (and 0.2% in FY2016). This is slightly lower than 6% revised growth target during mid-year review of FY2018 and 7.2% target set during the budget speech for FY2018. Last year’s 7.4% growth (at basic prices, FY2001=100) was the highest since FY1994, when GDP grew by 7.9%. That was largely a base effect

In FY2018, agricultural, industrial and services sectors are projected to grow by 2.8%, 8.8% and 6.9%, respectively. Agricultural sector contributed 0.9 percentage points, industrial sector 1.3 percentage points and services sector 3.5 percentage points to the overall projected GDP growth of 5.9%. These projections are based on eight to nine months data. 

Specifically, construction sector is projected to grow at the fastest rate (10.6%, down from 12.4% in FY2017) followed by mining and quarrying (10.5%, down from 13.7% in FY2017). Two consecutive years of double-digit growth of these sub-sectors indicates acceleration of post-earthquake reconstruction of public and private infrastructure. Overall, robust industrial activities is underpinned by post-earthquake reconstruction and improved supply of electricity (manufacturing growth is equally strong at 8%). Rising inward tourism and associated activities also contributed to hotels and restaurants growth of 9.8%, up from 7.3% in FY2017.

Agricultural output is projected to grow at the slowest rate at 2.8%, down from 5.2% in FY2017, largely due to the decline in paddy output (negative 1.5%), which has a weigh of 20.8% in overall AGDP basket due to the uneven monsoon rains and flooding in Terai region. Agricultural commercialization, availability of chemical fertilizers and irrigation facilities were not sufficient to offset the denting effect of unfavorable weather pattern. 

Industrial output is projected to grow at 8.8%, down from 12.4% in FY2017. Construction, and mining and quarrying activities are projected to contribute 0.7 and 0.05 percentage points, respectively, to overall GDP growth. Mining and quarrying of stones, sand, soil and concrete have intensified in response to large and growing demand for reconstruction activities. Similarly, construction activities intensified thanks to progress in large infrastructure projects such as Melamchi water supply and Upper Tamakoshi hydroelectricity (both are expected to be completed this year). Manufacturing sector is projected to grow at 8% and contribute 0.5 percentage points to overall GDP growth. Stable supply of electricity and improved industrial relations have contributed to strong manufacturing output growth. Its share of GDP has increased marginally to 6.4% from 6.2% in FY2017. Electricity, gas and water sub-sector is projected to grow at 5.8%, down from 20.5% in FY2017, due to an expected 82 MW of additional energy generation by the end of FY2018 (it was 118 MW in FY2017). 

Services output is projected to grow at 6.6%, down from 7.4% in FY2017. Within service sector, hotels and restaurant, and public administration & defense grew by 9.8% and 9.6%, respectively (higher than 7.3% and 9.1%, respectively, in FY2017). Record tourist arrivals and stable supply of electricity underpinned the robust hotels and restaurants growth. Tourist arrivals increased by 24.9%, reaching a record 940,218 in 2017, up from 753,002 in 2016. 

Expenses related to three tiers of elections and additional wages and allowances for public officials deputed to local bodies and for reconstruction works are expected to support public administration and defense sub-sector’s growth. Meanwhile, wholesale and retail trade (which accounts for about 13.6% of GDP) is projected growth at 9.1%, up from 9.6% in FY2017 on account of higher import of goods and increase in production of industrial and agricultural related goods.  Financial intermediation is projected to grow by 6.4%, largely contributed by income of NRB, BFIs, insurance board and companies, securities board, EPF and CIF among others. Health and social work subsector is projected to grow grow by 6.3%  due to the increase in number of patients at hospitals and healthcare activities in and of public and private sectors. Similarly, community, social & personal services sub-sector is projected to grow by 5.5% on account of public spending at central and local levels, and entertainment services provided by public and private FM radio stations. Transport, storage and communications; real estate, renting & business activities, and education sub-sectors are projected to grow at a lower rate than in FY2017.  

On the expenditure side, GDP (at market prices) grew by 6.3%, down from 7.9% in FY2017. Consumption decelerated but public fixed investment (public GFCF) grew robustly (14.9% growth compared to 4.1% growth in FY2017) but private GFCF growth declined to 15.9% (down from 56.6% in FY2017). While import of goods and services is projected to grow at 14.8%, export of goods and services is projected to grow at just 4.4%. The largest increase in contribution to GDP growth is coming from public investment. 
Few preliminary observations:

First, the growth boost is coming from reconstruction works albeit at a modest pace. Two consecutive years of double-digit growth of mining & quarrying, and construction points to this fact. Also, it is largely driven by public investment (potentially includes accounting of transfers to local bodies that is not spent yet). In fact, public GFCF is expected to grow by 14.9%, sharply up from 4.1% in FY2017 . This is also reflected by the 9.6% growth of public administration and defense. So, the negative impact of unfavorable weather is more than offset by increase in public spending (need to see how much of the projected spending is actually realized as capital spending till mid-April was just 35% of  budget capex) on elections, reconstruction, and mining & quarrying activities. Last year, growth was driven by private GFCF. 

Second, retail and wholesale trade’s growth projection is a bit optimistic given that remittances, which finances imports, has been decelerating and most of the increase in imports is account for by capital goods as opposed to daily consumable retail and wholesale goods. However, the expectation is that the dent in demand caused by deceleration of remittances, which mainly finances imported consumable goods, will be more than offset by direct and indirect elections related expenses, which also increase demand for daily consumable goods and services. There is massive temporary employment (police personnel, poll observers, awareness campaigns, etc), and expenses on travel, food and retail goods during elections. A marginal optimistic growth projection for retail and wholesale trade activities makes a huge different to overall growth rate because its share in GDP is the largest and also contributes the most to GDP growth rate. 

Third, except for hotels & restaurants, public administration & defense sub-sectors all other services activities decelerated compared to FY2017. So, the boost is actually coming from public spending on reconstruction and elections, and partly from increased tourism activities. Some folks might quickly interpret it as a resurging Nepalese economy. This may be a bit misplaced because FY2017’s growth of 7.4% at basic prices (7.9% at market prices) was largely due to base effect (recovering from lingering effects of earthquakes in FY2015 and crippling trade blockade in FY2016 as well as favorable monsoon), improved energy supply, and some pick-up in reconstruction. This year’s growth should also be seen from that perspective but the driver is public spending on reconstruction and elections. This in no way means that the economy will continue to grow at this rate in FY2019 unless there is at least a comparable acceleration in public capital spending and private economic activities (apart from other usual factors such as favorable monsoon, which is likely given forecast so far). 

Fourth, some of the reasons for higher growth this year are pretty much the same (Melamchi and Upper Tamakoshi, reconstruction, etc) as in last year. This indicates that if public capital spending accelerates, then it gives a good boost to overall GDP growth.

Fifth, per capital GDP has increased to US$1003.6, thanks to a double-digit growth of nominal GDP (13.8%, down from 17.3% in FY2017 – highest since FY2010) and a slight appreciation of Nepalese rupee vs US$ (CBS assumes constant population growth rate of 1.4%). Note that CBS used monthly average middle of buying and selling rates during the first eight months (NRs102.96). Usually, monthly average of buying rate is used. It was NRs102.75 in the first eight months of FY2018. Per capita GDP and size of GDP might change a bit once the full fiscal year monthly average exchange rate is available sometime around mid-August. But, note that real GDP per capita growth is 4.9% and nominal GDP per capita growth is15.8%. For now, the size of the economy is projected to increase to US$29.3 billion from US$25 billion in FY2017. 

Sixth, per capita gross national disposable income (which factors in remittances as well) is projected to be US$1296.6, up from US$1159.2. 

Seventh, the claim that the previous government handed over a badly managed economy doesn’t stand now at least with respect to real sector (note that this is different from the claim of a badly managed fiscal situation when there was change of guard at MoF). Fiscal, monetary (particular financial) and external sectors will see deterioration anyway in FY2018. 

Eight, as mentioned in previous blog posts the economy can sustain growth of over 7% with an appropriate mix of macroeconomic strategies, financial arrangements, smart project execution, and supportive institutions and policies. Government has an important role to play in providing critical infrastructure, addressing market failures, designing a growth-enhancing tax regime, and implementing business-friendly policies to usher in a meaningful structural transformation. It also needs to enhance both the quantum and quality of public capital spending to over 8 percent of GDP annually. Given the sound fiscal space, though Nepal doesn’t have a shortage of funds until medium-term, a dearth of capacity to fully execute the budget and finish projects on time may prove problematic.

Finally, FY2018 and FY2017 figures are provisional and revised, respectively. 

Tuesday, April 10, 2018

Can highly productive services activities make up for the decline in manufacturing sector?

Many developing and emerging economies are seeing a shift of workers from agriculture to services, bypassing the manufacturing sector, which has traditionally been a stable jobs creator with significant boost to overall economic activities. The latest WEO April 2018 devotes a chapter on this structural shift and investigates if it is bad at all. In short, the decline of manufacturing jobs may not hurt growth or raise inequality “provided that the right policies are in place”. 

The catch is that some services sector activities are very similar to manufacturing activities in terms of levels, growth rates, and convergence of output per worker (labor productivity). Therefore, the ongoing structural transformation, although unconventional, could be beneficial if these services sector activities are promoted. 

Here are key highlights from the study:

  • Transport, telecommunications, and financial and business services have higher levels and growth rates of output per worker than manufacturing. Furthermore, productivity convergence (and per capita as well) is similar to manufacturing activities, i.e. it grows faster where it is relatively low, allowing countries with low initial productivity levels to catch up toward those with higher levels.
  • Highly productive service sectors such as communications, finance, and business activities have been attracting workers faster than other sectors. The shift of employment from agriculture to services since the 2000s has benefited aggregate labor productivity in emerging market and developing countries across all regions—and especially in sub-Saharan Africa.
  • On policy front, barriers to international trade in services (much higher than in the case of goods trade) need to be reduced so that “highly-productive service sectors is not constrained by the growth of domestic demand”. Skills enhancement is more needed in the case of tradable service subsectors (financial and business services). In addition to improving business and investment climate, strengthening human capital and physical infrastructure could unlock productivity growth across all economic activities. 
  • Changes in overall inequality are mostly explained by rising inequality within sectors, rather than changes in sector size due to reallocation of workers. This is based on a sample of 20 advanced economies. The level of labor income inequality within industry (70 percent of which is accounted by manufacturing) is somewhat lower than within services. The biggest factor driving changes in aggregate inequality in advanced economies since the 1980s has been the increase in earning differences in all sectors—rather than the decline of industry jobs. 

Monday, April 9, 2018

Government goes hard on transport syndicates

From The Kathmandu Post: The Department of Transport Management on Friday directed all its offices to open route permits on all the roads for competitive distribution. The DoTM recently amended the Transport Management Directives- 2004, which allows for any company to get route permits in any parts of the country in a hassle-free manner.

Following the disruption caused by a group of 11 passenger transport committees operating on the route east of Koteshwor, the transport department amended the directives to allow more carriers to openly compete in the sector. The DoTM has done away with recommendation from such committees, a hurdle for new entrants in seeking route permits.“Syndicate in public transport has persisted because the existing committees do not accept new entrants. Now, new companies won’t need such reference from these committees, meaning anyone interested in the market for healthy services can apply for road permit in any part of the country after registering with the DoTM,” said Aryal. Earlier, only those receiving approval from such committees would get the licence to operate. 

Syndicates, which exist in different parts of the country, block entry of interested companies, who provide better facilities to passengers often at cheaper rates, to curb competition.

From Setopati/Nagarik: Meanwhile, bus fares has come down following the entry of new companies. Kavre Bus Association has asked all its members to put up a notice in their public buses outlining fares for designated routes. This has come after Sajha Yatayat and Mayur Yatayat, both much organized companies and offering better services, started charging NRs35 for travel from Banepa to Kathmandu. Earlier, the local bus syndicate was charging NRs40 for the same distance. 

The present government has gone pretty hard on the syndicates. This is quite unusual and unheard of in the previous years (even when the same party was leading the government). A comfortable majority at federal and provincial and at a majority of local bodies has led to a strong government that can stand up to organized syndicates. Now, the government needs to be similarly tough on other syndicates as well. Syndicates are illegal by law (Transport Act 2049) and the Supreme Court had issued several orders asking the government to implement the law. A deep connection between quasi-political businessmen and politicians meant that the syndicates were politically protected. Furthermore, clamping down on syndicates may help to widen the tax base as syndicates because since syndicates are established under Organizations Act 2034, they do not pay taxes and operate like an NGO. Now, the government wants such syndicates to register as a company following Companies Act 2007. 

Saturday, April 7, 2018

Attributional discord in the white paper on economy

It was published in The Kathmnadu Post, p.7, 06 April 2018

Despite shortcomings on attribution and cherry picking of data, the white paper is a good reflection of the economic state

The white paper on the state of the economy presented by Finance Minister Dr. Yuba Raj Khatiwada on March 28 stirred intense debate on economic conditions over the past week. While some applauded the finance minister for honestly presenting a gloomy assessment, others criticised him for cherry-picking statistics to amplify negative aspects so that blame could be attributed to the previous administration.

Barring minor flaws due to statistics based on provisional and revised data as well as different comparator years, the overall message that the economy is structurally not sound and is under intense fiscal stress is the right diagnosis. A course correction is not possible without properly diagnosing chronic structural and administrative issues restraining a meaningful structural transformation.

Gloomy state

The white paper provides a brief overview of the context under which the government inherited the economy from the previous administration, followed by discussion on structural constraints that are limiting investment in productive sectors and contributing to chronic capital budget under-execution. Furthermore, it touches upon volatility and weak governance of financial sector, and reminds readers of the ever-increasing trade deficit.

Overall, the tone of the white paper is definitely gloomy, but rightly so. There is nothing wrong in saying loud and clear that structural economic foundations are not strong and are largely supported by remittance income, especially after 2001 when the Maoist insurgency intensified and severely crippled economic activities. Besides financing large trade deficit, remittance inflows, which is decelerating since 2015, support consumption demand, revenue collection, and deposit mobilisation by banks. Unemployment remains high. Tradable activities continue to shrink with respect to non-tradable activities. The business as usual policy and budget making, bureaucratic conduct, private sector priorities, and governance regime are major constraints that need to be addressed to change the structure of the economy.

It also details glaring allocative inefficiency and structural weakness during budget execution, leading to chronic underutilisation of capital budget. In fact, rising expenditure-revenue asymmetry and fiscal imprudence—both are tying the hands of finance ministry to secure funds for new projects and forcing it to sell large amount of treasury bills and bonds to bridge fiscal gap—are the core highlights of the white paper. It essentially sets a narrative for the government to introduce the next budget.

Similarly, the finance minister implicitly outlined the central bank’s inability to reduce recurring financial sector volatility and systemic risk, and lack of higher productive sector lending, which currently is mandated at 25 percent of total credit by banks. He also highlighted the on-going deindustrialisation due to a slew of supply-side constraints that have remained constant despite multiple changes to government leadership. Dr Khatiwada reiterated the government’s commitment to graduate from LDC category by 2022, and achieve middle-income country status and 169 SDG targets by 2030.

Divided opinions

Despite a frank economic narrative, the white paper has divided opinion among economists and politicians along party lines.

First, white papers are supposed to be an objective assessment of the current state of economy and priorities areas of the government. Since 2008, at least three finance ministers (all from communist parties) presented a white paper either to introduce party-based flagship distributive programmes or to bring a supplementary budget. Dr Khatiwada’s white paper is different in both tone and narrative, but errs in attribution of the long-running economic problems to fiscal follies of the previous administration and failure of privatisation initiated during the 1990s when Nepali Congress was leading the government. Successive communist-led governments and policymakers are equally a part of the process that led the economy to this state.

Privatisation back then was the need of the hour given the weak macroeconomic and fiscal situation. It is not necessarily bad given inefficient government operations and state-led production of cigarettes and alcohol, and trading of consumer goods. However, the process of valuation and assessment of economic return were not properly managed, leading to few investors securing lucrative contracts at nominal rates. Note that privatisation was needed to reduce inefficient government spending, increase revenue and stimulate private sector activities. Barring for a few sectors, it worked well for the economy. The left alliance cannot ditch this reality and reconstruct its own party-based narrative against privatisation, which they nevertheless actively promoted when in power.

Second, there is no doubt that the economy is fiscally broke. Critics point to the large treasury surplus accumulated at the central bank to dispute this fact. However, we need to be mindful of the fact that such treasury savings cannot be used readily as it consists of savings for designated funds, balance of local authorities, and bond commitments. Furthermore, whatever cash surplus is there is because of an underspent capital budget accumulated over the last several years. To finance spending in a given year, the government has to use resources mobilised in that year (outlined in fiscal budget approved by parliament). Fiscal profligacy and imprudence of the previous government and lump sum, non-freezable transfers to local bodies have led to a large budget deficit by the middle of this fiscal year. The country cannot afford to take domestic and foreign loans to finance ballooning recurrent spending.

Third, barring some cherry picking of statistics to amplify bad economic condition, the white paper is unlikely to scare away investors, who in fact appreciate an honest assessment. They make their own judgment about ground realities and the government’s commitment to investment reforms.

Fourth, Dr Khatiwada chided redistributive policies and advocated fiscal prudence, but then said that the government will stick to fulfilling election manifesto of left alliance, which in its current form is more redistributive than what we have seen so far. It needs to be seen how he manages to walk the talk. 

Overall, despite shortcoming on attribution and cherry picking of some data, the white paper is a good reflection of the current state of the economy. We need to wait to see how this is reflected in program and policies, and budget for 2018/19, which Dr Khatiwada will present next month.

The finance minster discussed the controversies surrounding the white paper and priorities of this government in a interview with Setopati here. And, here is an audio recording of his interaction with stock brokers, upon whom he goes pretty hard.