Wednesday, September 11, 2019

How did Nepali economy perform in FY2019?

  • Positive point: Three consecutive years of high GDP growth
  • Concerning points: Weak budget execution, revenue growth below target, inflation inching up (natural given high GDP growth), continued tight liquidity and high interest rates, large fiscal and current account deficits, lower FDI, depleting foreign exchange reserves (although at OK level)
  • Things to watch out for: Whether high growth rate is sustainable without significant improvement in public capital budget execution and higher private investment (domestic and foreign), structural and institutional reforms (procurement, land, environment, human resources and labor market, laws and regulations), and sound governance

1. CBS estimated that the economy would grow at 6.8% (GDP at basic prices) in FY2019. At market prices, it is expected to grow at 7.1%. This marks three consecutive years of above 6% growth rate. In FY2019, bumper agricultural harvest and pickup in services sector activities contributed the most to the GDP growth. Specifically, agricultural, industrial and services sectors are projected to grow by 5.0%, 8.1% and 7.3%, respectively. Agricultural sector contributed 1.6 percentage points, industrial sector 1.3 percentage points and services sector 3.9 percentage points to the overall projected GDP growth of 6.8%. These projections are based on eight to nine months data.

2. Specifically, electricity, gas and water sub-sector is projected to grow at the fastest rate (12.4%, up from 9.8% in FY2018), followed by wholesale and retail trade (10.9%, down from 12.3% in FY2018), mining and quarrying (9.5%) and construction (8.9%). These indicate accelerated work in hydroelectricity generation and ongoing construction as well as pickup in reconstruction related activities (public as well as private housing and infrastructure). The high wholesale and retail trade activities are related to the burgeoning import growth and remittance income. Overall, robust agricultural output is underpinned by favorable monsoon and timely availability of agricultural inputs, and high services sector output is supported by wholesale & retail trading, tourism and real estate activities. Industrial sector slowed down a bit compared to FY2018.

3. On the expenditure side, GDP (at market prices) grew by 7.1%, up from 6.7% in FY2018. Consumption accelerated but public fixed investment (public GFCF) decelerated, indicating a slowdown in capital spending. A much higher increase in import and a slower increase in export meant that net export was negative.

4. On fiscal sector, capital expenditure absorption capacity continues to remain low despite the budget being unveiled one and a half month prior to start of FY2019. The government argued that it spent the first few months in designing spending procedures and directives, and laws related to investment promotion and procurement. It also said that small projects were delegated to local governments, but was not so forthright in delegation of spending and monitoring authority. This also contributed in low capital spending. Furthermore, delays in land acquisition, environment clearance, lengthy procurement processes, lack of inter-agency coordination, etc continued to bog down the extent and the effectiveness of public spending. As per the data from FCGO, actual capital spending is projected to be about 75.9% of planned capital spending. Similarly, actual recurrent spending is projected to be 84.6% of planned recurrent spending. Recurrent and capital expenditures are projected to be 20.6% and 6.9% of GDP, respectively. These were 23% and 7.9% of GDP in FY2018. FCGO used to publish monthly budgetary expenditure and revenue previously. Very strange that it is not publishing them on time these days (even quarterly public debt data are not published regularly). These are preliminary figures. Actual figures will probably show slightly higher recurrent but a bit lower capital expenditures. Also, there isn't much change in spending pattern too, with over 50% of spending bunching in the last quarter. 

5. Meanwhile, based on the latest revenue data published by the central bank in its macroeconomic situation report, revenue growth is estimated to be about 17.4%, much lower than the government’s target. Total revenue will be around 24.8% of GDP. The share of VAT is the highest (28.1%), followed by income tax (22.6%), customs (18.1%) and excise duty (14.2%) among others. Considering the expenditure under-performance and high level of revenue mobilization (although short of the target), fiscal deficit will likely be around 6% of GDP. A higher fiscal deficit is exerting pressure on current account balance too.

6. Annual CPI inflation averaged 4.6%. Here, note that usually the central bank computes annual average inflation as the average of monthly inflation, in which case it will be 4.7%. However, the central bank used the average of monthly CPI index to compute annual inflation for FY2019. Why to be inconsistent in FY2019 only (probably, to side with the lower inflation figure or just a mistake)? In any case, let us use the 4.6%, which is slightly higher than the inflation in FY2018. Both food and beverage, and non-food and services inflation increased in FY2019. In food and beverages, the highest increase in prices was that of alcoholic drinks and tobacco products (no surprise here as the government increased taxes and excise duty). In non-food and services, the highest increase in prices was that of housing and utilities, clothes and footwear, and transportation (higher fuel prices, depreciation of currency as well as strong consumer demand). 

7. M2 (broad money) expanded by 15.8%, driven by private sector credit growth. However, M2 growth in FY2019 is lower than the central bank’s target (and the one in FY2018) owing to the decline in net foreign assets. Overall credit to private sector expanded by 19.1%, lower than in FY2018.

8. Deposits at BFIs increased by 18%, lower than 19.2% in FY2018. Credit (loans & advances) grew by 20.7%, lower than 23.3% in FY2018. Deposits growth of all class A, B and C BFIs slowed down. Credit by development banks increased but that by commercial banks and finance companies decreased compared to the growth in previous year. However, credit growth of commercial banks was still higher than its deposit growth. Agriculture sector credit grew by 42.5% (primarily because processing of tea, coffee, ginger and fruits and primary processing of domestic agro products were included in agriculture  from October 2017. Prior to this, most of these were under production). Credit to construction sector grew by 22.2%. Similarly, credit to mining, transport equipment production and fitting (includes aircraft and aircraft parts); transportation, communications and public services (includes electricity), and consumable loan (includes gold & silver) grew at a faster rate than the previous year. However, credit to industrial production; metal production, machinery and electrical tools and fitting; wholesale and retail trade; finance, insurance and fixed assets (includes real estate); and service industries slowed down.  Of the outstanding credit up to mid-July 2019, the largest share (21.1%) is that of transportation, communications and public services; followed by agriculture, consumable loan, service industry, and construction, among others. 

9. The weighted average inter-bank rate has been increasing. At 4.2% in FY2019, the weighted average inter-bank rate is the highest since FY2011, when it was 8.4%. In mid-July 2018, it was 2.96%. It decreased for few months and then started to rise again, peaking  at 6.91% in mid-June 2019. In mid-July 2019, it was 4.52%. Similarly, 91-day treasury bill rate also followed similar pattern, reaching 4.97% in mid-July 2019. It indicates tight liquidity in the banking sector arising from two sources: (i) faster credit growth than deposit growth (to maintain profit margin banks had to increase loans after the sharp increase in paid-up capital); and (ii) lower than expected public capital spending. CRR and repo rates remained unchanged, but SLF rate reduced by 50 basis points in FY2019. SLF is the money BFIs borrow from NRB by keeping government bills as collateral for five days. Inter-bank rate refers to transaction among A & B, A & C, B &B, B & C and C & C class banks and financial institutions. 

10. Commercial banks have broadly adhered to the deposit and loan related regulatory requirements. Capital adequacy ratio stood at 13.51% as of mid-April 2019 against the minimum 11% (minimum CAR 10% plus 1% buffer). CCD was about 77.73%. NPL started to increase since mid-July 2018, reaching 1.67% of total loan in mid-April 2019. Interest rate corridor did not help much to lower interest rate volatility. FY2018 monetary policy changed the way to compute interest rate corridor (between 3% and 7%), with SLF rate being the upper bound and two-week term deposit rate being the lower bound. FY2020 monetary policy decreased these by 50 basis points.

11.  By mid-July 2019, 735 local levels (out of 753) have presence of commercial banks. Total number of BFIs licensed by NRB increased to 171 by FY2019 from 151 in the previous year. There are 28 commercial banks, 29 development banks, 23 finance companies, 90 microfinance financial institutions, and one infrastructure development bank. The number of class A, B and C category BFIs decreased, but the number of microfinance financial institutions increased from 65 to 90 last year. With the rapid expansion of credit and stricter enforcement of banking regulations, the number of blacklisted borrowers is also increasing—reaching 2,842 by FY2019, up from 1,335 in FY2018.

12. According to data from Department of Customs, in US dollar terms, exports increased by 10.3%, reaching US$ 862.6 million. The growth rate of export is lower than last year. Exports to India increased but exports to China and other countries decreased. Meanwhile, imports grew by 5.3%, reaching US$12.6 billion. The growth rate of import is lower than last year. Consequently, trade deficit increased much slowly than last year, reaching US$11.7 billion. India accounted for about 65% of Nepal’s exports and imports in FY2019. As a share of GDP, exports, imports, trade deficit and total trade were 2.8%, 40.9%, 38.1% and 43.8% of GDP, respectively. Export to import ratio was 6.8.

13. The largest export to India in FY2019 is a new entry—palm oil (US$91.8 million). Nepal does not produce palm oil but traders may be importing raw materials from third countries, process domestically to add at least 30% value, and then export it to India taking advantage of the preferential tariff. In fact, import of crude palm oil increased by 152.2%, reaching US$41.7 million. The second largest export item to India was polyster yarn, followed by jute goods, juice, cardamom and textiles, among others. Export of pulses, polyster yar, noodles, pashmina, handicraft goods, vegetables, jute goods, thread, and readymade garments grew by over 20%. The largest export to China are handicraft, woolen carpet, noodles and readymade garments. The largest export to other countries are woolen carpet, readymade garments, pashmina, pulses and herbs, among others. 

14. The largest import from India in FY2019 was petroleum product (almost US$2 billion), followed by vehicles & spare parts, MS billet, machinery parts, rice and medicine, among others.  Import of raw cotton, bitumen, fruits, textiles, readymade garments, molasses sugar, electrical equipment, and vegetables grew by over 30%. The largest import from China are telecommunication equipment, readymade garments, electrical goods, machinery parts, and television parts. The largest import from other countries are gold, aircraft spare parts, coal, crude soybean oil and silver, among others. 

15. The number of migrant workers continues to decline steadily after peaking in FY2014. Outbound migrant workers decreased by 32.6% because of a massive drop in outmigrants to Malaysia (9,999 in FY2019 versus 104,207 in FY2018). The government stopped issuing labor permits to potential migrant workers to Malaysia to implement the G2G deal, which ensures cost-free migration and labor rights. But, it is not implemented as expected. Moreover, outmigration for work to all major destinations except Japan, Afghanistan, UAE and Saudi Arabia decreased in FY2019. However, this has not lead to a decrease in remittance inflows probably because more migrant workers are using formal banking channel to remit income back home and that Nepalis residing or studying in developed countries are remitting more money back home. Remittance inflows reached US$7.8 billion, which is equivalent to about 26.8% of GDP.

16. A lower rate of import growth compared to export growth slowed down the deterioration of trade deficit. Remittance inflows decelerated (7.7% growth in FY2019, down from 10.5% in FY2018) but the country received higher grants than year, resulting in a marginal improvement in net transfers. With net transfers of 28.7% of GDP and net income balance of 1.2% of GDP, and trade deficit (goods and services) of 37.5% of GDP, current account deficit was 7.7% of GDP, slightly lower than 8.2% of GDP in FY2018. Balance of payments recorded a deficit of US$598.7 million, the first in the last nine years. Meanwhile, net FDI decreased by 31%, reaching US$116 million (0.4% of GDP). Gross foreign exchange reserves reached US$10.6 billion, which is enough to cover 9.4 months of import of goods and services. Nepali rupee depreciated by 0.02% against the US dollar in mid-July 2019 compared to the same period last year. 

Overall, here is a snapshot: 
  • The economy grew at over 6% for three consecutive years, thanks to bumper agricultural harvest, post-earthquake related reconstruction, stable supply of electricity and pickup in services sector activities. So, consumption accelerated but public investment slowed down. 
  • Public capital spending decreased but higher recurrent spending will lead to a fiscal deficit of around 5% to 6% of GDP. 
  • Inflation inched higher on account of higher food and non-food prices of goods and services. 
  • Broad money growth (M2) was below the central bank’s target. Credit expansion outstripped deposit expansion with construction and agricultural sectors receiving more loans than before. 
  • Retail deposit and loan interest rates as well as inter-bank rate increased, indicating tight liquidity situation in the banking sector. 
  • The number of migrant workers is decreasing but remittance inflows are increasing, suggesting more use of formal banking channel and higher remittance from non-traditional employment destination. 
  • There is not much change in composition of exports and imports. 
  • A lower rate of import growth compared to export growth slowed down the deterioration of trade deficit. This along with improved net transfers resulted in lower current account deficit than last year. 
  • Balance of payments slipped into the negative territory for the first time in nine years. 
  • Forex reserves are down but are enough to cover 0.4 months of import of goods and services. FDI inflows decreased.
  • Here is an earlier posts on FY2020 budget and FY2020 monetary policy