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.