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.