Tuesday, March 20, 2018

Macroeconoimc situation in FY2018 and beyond

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

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.