Friday, January 31, 2020

Industrial stress in Nepal

It was published in The Kathmandu Post, 31 January 2020.

An increase in both installed capacity and capacity utilisation is needed to reinvigorate the industrial sector.

The government is touting that the economy is on a solid footing with high growth prospects. It has set 8.5 percent growth target for the fiscal year 2019-20 (henceforth the fiscal year 2020) hoping that the slew of investment-related legislation passed in the last two years will help accelerate industrial output.

But the reality is that the industrial sector is hardly picking up, and the private sector is complaining of a sales slowdown, an inventory pileup, and difficulties in loan repayment. The economy is undergoing an industrial capacity glut owing to a rapid increase in installed capacity in a short period, but tepid output demand.

This is a result of the government’s failure to deliver on its promise of accelerated physical and social infrastructure development. Capital spending in the first half of the fiscal year 2020 is around 15 percent, which is lower than last year. Overall industrial output, especially manufacturing and construction, has been decelerating since the fiscal year 2017. Public fixed capital investment has also contracted. Even the import of intermediate or final capital goods is decreasing. Without improved budget execution, especially capital spending, the situation will likely get worse for the industrial sector.
Low utilisation

According to Economic Activity Study Report published by the Nepal Rastra Bank, the average industrial capacity utilisation in the fiscal year 2019 stood at 57.1 percent, lower than the average capacity utilisation in the two preceding years. Industrial capacity utilisation is the actual production capability utilised with respect to the total potential output of the industry. Given fixed installed capacity, it typically points to a slowdown in industrial activities owing to depressed public and private demand. It could also point to a rapid increase in installed capacity but lower production due to slower growth rate of demand. 

Insufficient demand for industrial goods, input constraints such as raw materials or electricity, and a drastic increase in installed capacity without a proportionate increase in market demand are some of the causes for low capacity utilisation. Although the availability of electricity to run machinery plants is not a significant constraint now, insufficient demand together with a drastic increase in installed capacity in a short period is leading to a low rate of industrial operation. Capacity utilisation of over 85 percent is considered to be optimal for industries in terms of cost of production and profitability.

The latest data on economic activity indicates bullish investment in some sectors, especially after the 2015 earthquake. For instance, installed cement output growth averaged 28 percent since the fiscal year 2015. It translates into 3.8 million metric tonnes of additional installed capacity over the fiscal year 2015 level (alternatively, 2.7 times more installed capacity). Similarly, installed iron processing and allied activities output growth averaged 28 percent during fiscal years 2015-2019. It translates into doubling of production capacity in a matter of just four years.
While installed capacity has increased drastically, capacity utilisation has not kept pace. For instance, the capacity utilisation of the cement sector has dropped dramatically to 40 percent from about three-quarters just two years ago. In fact, it is now at its lowest since comparable data started to become available.

This indicates a lack of or misplaced understanding of the pace and trajectory of reconstruction activities. Investors in sectors such as cement and iron were over-optimistic about the prospects in these sectors. They expected that a stable government with a strong political mandate would be able to accelerate capital spending. The banks and financial institutions also got swayed by the narrative of strong infrastructure-related demand due to temporary fiscal stimulus. They generously extended loans to cement and iron industries. Unfortunately, less than expected pickup in reconstruction activities meant that these industries were not able to increase production in line with the increase in installed capacity.
Meanwhile, installed capacity for bricks production has decreased—an average 46 percent decline annually since the fiscal year 2015. In post-earthquake related reconstruction-led economic activities, we typically expect demand for complementary goods to increase too. Bricks are a complementary good with respect to cement, iron and steel, as all of these are used together during reconstruction or building work. The rapid increase in installed capacity of cement and iron and steel production but a sharp decrease in installed capacity of bricks production seems incongruous.

This aside, an interesting observation from the data is that installed beer production capacity increased by an average 171 percent annually after the fiscal year 2015—a tenfold increase in production capacity in a matter of four years. Capacity utilisation of the beer industry is almost cent percent.

Delivery shortfall

The primary source of this is the inability of the government to fulfil its promises. Domestic investors got bullish when the government promised political stability and 10 per cent-plus growth within five years. They invested a large sum of money to either add capacity in existing establishments or establish newer ones. Banks also generously lent money to these investors, assuming that public infrastructure investment would accelerate.

Consequently, the industrial sector is now in stress due to excess installed capacity and low utilisation. They are also facing cash flow problems to repay loans. It could potentially increase non-performing assets or force banks to evergreen bad assets, thus increasing banking sector vulnerabilities.

Low capacity utilisation results in low profitability because industries cannot lower per-unit costs or attain economies of scale. It also reduces the employment prospect of parttime and fulltime workers as there is less opportunity to work more hours or engage in overtime work. This limits a worker’s earnings. Low capacity utilisation also limits opportunities for import substitution. At present, capacity utilisation of soap, pashmina, processed tea, animal feed, sugar, and biscuit industries—all having the potential to substitute imports—have decreased.
A rapid increase in installed capacity but a decline in capacity utilisation is not desirable considering Nepal’s economic and demand dynamics. An increase in both installed capacity and capacity utilisation is needed to reinvigorate the industrial sector and to sustain 6 percent-plus economic growth rate over the medium term. There is also a need to boost cost and quality competitiveness of goods to substitute imports. A higher rate of industrial capacity utilisation together with a stable and competitive supply of inputs such as electricity and enabling infrastructure will be helpful in this regard.

Similarly, other helpful strategies are boosting public capital spending, promoting agro-processing sectors, supplying adequate enabling infrastructure crucial for increasing production and productivity, operationalising special economic zones, and creating an investment-friendly environment in practice.

Tuesday, January 28, 2020

India 2025 and price collusion in Nepal

Ejaz Ghani writes in Financial Express: Will India become a $5-trillion economy in 2025? There are two contrasting outlooks: optimistic and pessimistic. Both views are grounded in reality. The optimistic view is that growth will be propelled higher by rise of the middle class, young demographics, and changes in globalisation. The pessimistic outlook is that poor physical and human infrastructure will transform India’s demographic dividend into a disaster.

[...]Both the optimistic and pessimistic outlooks are backed by equally strong arguments. Both views agree that growth is not automatic, and it should not be taken for granted. India’s demographic dividend and the rise of the middle class is a time-bound opportunity. In particular, it provides policymakers an incentive to redouble their efforts to tap into demographic dividend by improving physical infrastructure to promote entrepreneurship and job creation.

Pluralism in development is of great value today. India’s growth will be driven by competitive federalism and increased competition between the states. A move towards increased expenditure flexibility in favour of the states presents an opportunity to align local development needs and priorities with the resources available. The challenge is to find out what works best, in what context, and in what setting. This is not just about structural transformation, and a shift from agriculture to industry, but the ‘ownership of process’. Where India ends up in 2025 will depend a lot on what choices are provided today, and what actions are taken to reshape tomorrow.

Manufacturers of building materials fail to give reason for price hike

Krishna Prasain writes in The Kathmandu Post: Manufacturers of building materials have failed to give a reason for the recent hike in the prices of their products. The government had given cement and iron rod producers until Monday to explain the price increase, but there has been no response from them. Last week, the department had summoned the manufacturers and asked them to provide a valid reason for the price increase following complaints from consumer rights activists that building materials had become dearer by 10-20 percent over a month.

According to Rabi Singh, president of the Federation of Nepal Contractors Association of Nepal, the price of iron rods increased by Rs12 per kg over a month. “The price of iron rods swelled from Rs58-61 per kg in December to Rs69-74 per kg currently,” he said. Singh said that prices of PPC cement and OPC cement, which used to cost Rs490-540 and Rs600-680 per sack respectively, had bloated by Rs20-30 per sack. “It is clear that cement factories have formed a cartel and raised the prices without any basis,” said Singh. Around two months ago, the prices of construction materials such as cement, iron rod, gravel, brick and sand had plunged by 30-40 percent which traders attributed to a slowdown in Indian economy.

Sunday, January 12, 2020

Book review: Unleashing the Vajra

It was published in The Kathmandu Post, 11 January 2020

Sujeev Shakya’s ‘Unleashing the Vajra’ attempts to find a way forward to Nepal’s economic transformation.

Like politicians, most economic analysts in Nepal invoke historical perspectives or dated ideologies to justify present policies or political alliances. Learning from past successes or failures to consistently argue about the future is largely missing in both academic and political circles.

Sujeev Shakya, a prolific writer on socio-economic issues in Nepal, stands out in his latest book Unleashing the Vajra. He tries to understand the past—particularly starting from Nepal Sambat or 879 CE, which was replaced by the Rana rulers with Bikram Sambat in the 1850s—to make the future right. The book is a continuation of the hugely popular Unleashing Nepal, and a recent one in Nepali language titled Arthat Arthatantra. These two books focus on unleashing the economic potential of Nepal, advocacy of a capitalist welfare state, and suggestion to lay the groundwork for youths to reinvigorate the economy.

In the new book, with a grand belief that “economic transformation required not just financial and management skills, but also societal transformation, moving towards an equitable society with sound civic behaviour, empathy and integrity”, Shakya questions the basics of Nepali culture, consumerism, conduct, and convergence of economic activities with the two neighbours—India and China. He asserts that if Nepalis focus on their own cleanliness and the cleanliness of their houses, surroundings and politics, then such collective behaviour could lead to a cleaner neighbourhood, city and finally the country.

As always, Shakya starts with an optimistic tone. He reminds readers Nepal got wealthy by being a notable trade link between India and China during the 17th century. The country now has the opportunity to unleash its economic potential and take advantage of the two most populous countries and emerging economic powerhouses in our neighbourhood. Unfortunately, according to Shakya, we barely have two decades to realise the glorious past.

The past

Just a year after the death of Prithvi Narayan Shah, Adam Smith’s economic principles rooted in the magic of the invisible hand in creating market equilibrium and efficiency gains started gaining popularity in the West. In contrast, the rulers in Nepal, who thought of the economy as their sole privilege, imposed a state-directed heavy-handed approach, which stifled economic growth and prosperity. The restrictions imposed on land ownership, constraints on private enterprises, limits on the workforce, and the emergence of rent-seekers with tacit or explicit backing from the leaders are still the core features of our economy.

The modern-day rent-seeking feudal lords, both in politics and the private sector, have relied on extractive political and economic institutions to stifle prosperity—to advance their own interests in critical sectors such as agriculture, healthcare, education, construction, finance, and transportation.

Shakya calls them “cartelpreneurs.” There are “donorpreneurs” too. They have mastered the art of thriving on mediocrity—“too much success threatens their own employment, too little threatens loss of funds”. The donorpreneurs tend to set the development narrative and do not prefer the country to graduate out of foreign aid.

Shakya is equally critical of the private sector. He argues a section of the Nepali private sector thrived by taking advantage of preferential tariff between Nepal and India. Specifically, they imported goods from third countries via India, and either sold it to visiting Indian tourists by charging higher prices or re-exported them to India. This trading practice based on tariff arbitrage is prevalent to this day.

In response, India sometimes imposes quota and slaps countervailing duty on our exports. Recently, palm oil has become the top export to India although it is not even produced in Nepal. Similar was the case with betel nuts, whose export volume outstripped total domestic production. Shakya argues the Nepali private sector lobbied for a protectionist regime so that they could earn supernormal profits, which they shared with the political class. A recent example of this is the sugar cartel that successfully lobbied for import ban, increased prices to the surprise of the prime minister, and dilly-dallied repayment to poor sugarcane farmers. Similar is the case with milk, taxis, construction, and agriculture cartels.

The future

The section focusing on events after 2008 is more interesting and perhaps relevant to get a clue of what the future holds for the Nepali economy.

Shakya thinks hydropower, agriculture, tourism, services and infrastructure are the keys to unlocking and unleashing Nepal’s economic potential, i.e. the vajra. Exploiting this potential to enhance our prosperity requires Nepal to hitch its “wagon to the fast-moving engines” of our two giant neighbours. Eventually, he wants to see InChiNep collaboration that creates win-win-win situation for the three countries. It makes strategic sense since India and China are coming closer despite the occasional foreign policy hiccups. For instance, Indian Prime Minister Narendra Modi and Chinese President Xi Jinping met sixteen times between 2014 and 2019, and the two countries aim to increase trade volume to $100 billion by 2020.

Belt and Road Initiative offers an opportunity for Nepal to not only secure financing for infrastructure projects, but also to get out of the ‘India-locked’ mentality. Meanwhile, making procedures easier for Indian investors, tourists and traders in Nepal could boost investment in key sectors and strengthen people-to-people relationship. Additionally, he thinks there are more opportunities if Nepal deepens integration with ‘East South Asia’— a region comprising Bangladesh, Bhutan, Nepal, and north-east India. Enhancing borders to promote trade and commerce, better and well-connected infrastructure, and easier movement of labour with proper documentation should facilitate integration in this bloc. Shakya ambitiously bats for Border Economic Zone, which could facilitate connectivity clusters along the border and substantially ease rules for flow of labour, capital and goods.

On the nature of economic governance, rather than choosing between capitalism and socialism, Shakya prefers a capitalist welfare state, where free enterprises are regulated as per global standards and that the government will have enough revenue to tackle chronic poverty and inequality. This is a hotly and perpetually debated topic in economics. Unfortunately, the discussion on this topic in the new book is a rehash of the arguments already made in the previous two books. Similar is the case with the discussion on long-term economic vision, which pretty much narrates what is already being drafted by the National Planning Commission. Readers may find something refreshing in the chapters where he passionately discusses the need for societal transformation via individual transformation, i.e. bring changes at individual level and then collectively at the neighbourhood, city and country levels.

The book does not offer an in-depth analysis of how and why Nepali economy is the way it is now and the future direction. Inquisitive readers may seek answers beyond the usual narrative of potential for economic transformation by utilising internal resources and by promoting trade and connectivity with India and China. Unfortunately, the book does not offer much beyond the assertion that Nepal has only two decades to realise the glorious past. It would have been more informative if the author dug deeper on why the specific two decades timeframe, what needs to be done, and what happens if we don’t.

That being said, the book provides a good overview of the historical underpinnings of today’s achievements or impediments, and the opportunities that may be utilised. It provides thoughtful perspectives for readers who have an interest in economic and foreign policies, and plenty of food for thought for those who want to explore the issues academically. The book is primarily targeted for general readers who are interested in comprehending the successes and mistakes in the past, and opportunities going forward. 

Thursday, January 9, 2020

Indian government estimates GDP to grow at 5% in FY2020

India’s National Statistics Office has released first advance estimates of national income for FY2020. The estimates are based on benchmark-indicator method with data up to seven to eight months. GVA growth at basic prices is expected to grow at 4.9%, much lower than 6.6% in FY2019 and an average of 7.3% in the last five years. GDP at market prices (GVA plus net taxes on products including import duties) is expected to grow at 5%. It is much lower than 7% target set by the government. Eventually, when the actual estimate for FY2020 is released after a year or so, even 5% advance estimate may look a bit optimistic.

The provision GDP growth estimate for FY2019 is 6.8% and the average in the last five years was 7.5%. The sharp downward revision of annual estimate is in line with the slowdown seen in the quarterly estimates (up to Q2 FY2020) released last month. FY2020 GDP growth estimate of 5% is the lowest since FY2009, when it grew by 3.1%. Here is the IMF's latest Article IV assessment.

It looks like a broad-based slowdown. Almost all sectors are expected to slowdown in FY2020. Agricultural output is estimated to grow at 2.8%, which marks three consecutive years of slowdown. Industrial output is also expected to slowdown further to 2.5%. It marks four consecutive years of deceleration of industrial output. Similarly, services output is expected to growth at 6.9%, which marks five consecutive years of deceleration of services output. 

Within industrial sector, mining & quarrying output is expected to grow at 1.5%, marginally higher than 1.2% in the previous year. However, manufacturing output growth is expected to slump to 2%, much lower than 6.9% in the previous year. Electricity, gas and water supply activities are expected to growth by 5.4%. Construction activities are expected to grow at 3.2%, much lower than 8.7% in the previous years. It reflects the slowdown in private consumption as well as investment, especially on capital and core industrial goods.

Services output is expected to grow at 6.9%, the lowest growth rate since FY2009. Within services sector, trading, hotels & restaurants, transportation and communication activities are expected continue decelerating. Similarly, financial, real estate and professional activities are also expected to grow at a slower pace than in the previous year. But then public administration, defense and other services are expected to grow at 9.1%, higher than 8.6% in the previous year. 

On the expenditure side, while both consumption and investment are expected to decelerate net exports are expected to recover. Government consumption is expected to grow at a rate slightly higher than in the previous year, reflecting the front-loading of government spending in the first two quarters of FY2020. However, private consumption is expected to grow at 5.8% only, the lowest since FY2013. Gross capital formation (generally investment) is expected to grow at 1.5%, much lower than 4.3% in FY2019 and 12.9% in FY2018. Within GCF, fix capital investment is expected to nosedive. GFCF is expected to grow at 1% only, a sharp dive from 10% growth in the previous year. Similarly, change in stocks is also expected to slowdown. Meanwhile, a larger slowdown in imports compared to slowdown in exports meant that net export growth is positive. 

Nominal GDP growth is estimated to be 7.5%, much lower than 12% target set in the FY2020 budget speech.

Tuesday, January 7, 2020

IFC allowed to issue local currency bonds in Nepal, spending cut to lower deficit in India, and more

From The Kathmandu Post: The International Finance Corporation has received permission from the government to issue Nepali currency bonds in international markets but will have to reinvest the capital collected back in Nepal for at least three years. The private sector lending arm of the World Bank Group got approval from the Cabinet to issue Nepali currency bonds worth $20 million outside Nepal in November last year. This is the first time an international agency has been granted approval to issue Nepali currency bonds in international markets.

Some conditions:
1. The IFC cannot return the invested money before three years.
2. It will have to deposit the capital within three months from the date the bonds are issued.
3. The amount should be invested in the productive sector, such as industry, infrastructure and tourism, among others

The IFC will hedge the foreign exchange risks through the private sector window of the International Development Association, also an arm of the World Bank Group. The IFC has yet to state the interest rate at which the bonds will be issued. But the central bank has suggested that the Finance Ministry decide the interest on investment through microfinance institutions at not more than 8 percent.

Govt plans to cut spending to curb fiscal deficit

From livemint: India's government is likely to cut spending for the current fiscal year by as much as 2 trillion Indian rupees as it faces one of the biggest tax shortfalls in recent years, three government sources said.

The government has spent about 65% of the total expenditure target of 27.86 trillion rupees till November but reduced the pace of spending in October and November, according to government data. A 2 trillion-rupee reduction would be about a 7% cut in total spending planned for the year. In October and November, government spending increased by 1.6 trillion rupees, nearly half the 3.1 trillion it spent in September. The fiscal year starts April 1 and ends March 31. Lack of demand and weak corporate earnings growth in the economy led to lagging tax collections this year. Analysts said growth will be hurt.

The government is likely to keep the fiscal deficit under 3.8% of gross domestic product, sources said, while letting it slip from its earlier set target of 3.3% for the year.

Globalization in transition: The future of trade and value chains

From Although output and trade continue to increase in absolute terms, trade intensity (that is, the share of output that is traded) is declining within almost every goods-producing value chain. Flows of services and data now play a much bigger role in tying the global economy together. Not only is trade in services growing faster than trade in goods, but services are creating value far beyond what national accounts measure. Using alternative measures, we find that
  • Services already constitute more value in global trade than goods.
  • All global value chains are becoming more knowledge-intensive. 
  • Low-skill labor is becoming less important as factor of production. 
  • Contrary to popular perception, only about 18 percent of global goods trade is now driven by labor-cost arbitrage.
Three factors explain these changes: 
  • Growing demand in China and the rest of the developing world, which enables these countries to consume more of what they produce
  • Growth of more comprehensive domestic supply chains in those countries, which has reduced their reliance on imports of intermediate goods
  • The impact of new technologies