Real estate, housing and banking crises postponed in Nepal

[It was published in Republica, January 25, 2012, p.6]

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Crisis postponed

The slowdown in real estate and housing sector, which was enjoying unnatural growth thanks to high remittance inflows and easy credit from bank and financial institutions (BFIs), is affecting pretty much every aspect ranging from land transaction to restaurant and dance bar business to political donations. The investors and BFIs are increasingly worried about the future of this sector and banking industry.

Nepal Rastra Bank (NRB) has been gradually rolling out a number of corrective policy initiatives aimed at defusing risks faced by BFIs and real estate and housing sector. Meanwhile, Ministry of Finance (MoF) recently introduced a ‘relief package’ to prop up this still overheated sector. The short-term, trigger happy measures of the MoF will not revitalize the realty sector and the BFIs will still be in troubled waters. Importantly, it won’t address the core problems.

The MoF extended the deadline for reducing real estate and housing lending to 25 percent of total credit until mid-July 2013 and raised personal home loan threshold to Rs 10 million. Fearing excessive risk to BFIs, the NRB last year directed them to bring down their exposure to realty sector to 25 percent, from about 30 percent, of total loan portfolio. It also restricted personal home loan at Rs 8 million.

But, the BFIs were not in a position to comply with these directives and hence the NRB extended compliance deadline for few more months. Still, the BFIs were unable to adjust their loan portfolio according to the directives of the NRB. The MoF, on recommendation of High Level Financial Sector Coordination Committee, stepped in to provide a short-term reprieve to the BFIs and real estate sector.

Another important decision was to allow developers to categorize regular apartments as service apartments. This will modify composition of loan portfolio of BFIs by allowing them to change loan headings of apartments from real estate to service sector. Moreover, the MoF has decided to offer housing loans at concessional rates to all civil servants and office bearers of constitutional bodies. It is also mulling over opening the apartment sub-sector to foreigners.

These measures have reduced regulatory compliance burden of BFIs, indirectly encouraged them to lend more money to real estate and housing sector, and ultimately might help prevent further downslide in prices. But, they do nothing to address the core problems—unhealthy competition among too many BFIs and correction of overly inflated real estate and housing prices.

The rapid growth in the number of BFIs in the absence of proportional rise in depositor base and diversification of banking portfolios led to cutthroat competition in enticing depositors (institutional, government and individual) and borrowers. The BFIs competed unhealthily to attract depositors, who enjoy steady source of remittance inflows, by offering flamboyant and unsustainably high interest yielding deposit schemes. The little distinction in playing field for all categories of BFIs, which were allowed to swell to over 220 (including 31 commercial banks, 89 development banks, 79 finance companies, and 21 micro-credit institutions) by the NRB, amidst limited investment opportunities led to concentration of lending to one particular sector—real estate and housing.

To reap quick returns, the BFIs showed little prudence to appraise if the borrowers would be able to honor interest and principal payments on time. After all they have compulsion to lend (both short term and long term) more money in order to give returns on deposits to short term depositors, who are constantly in search of BFIs offering high interest.

Hence, money continued to flow to real estate and housing sector— estimated to be over Rs 120 billion—without much scrutiny, leading to multifold rise in their prices in matter of months. People took out loans to purchase inflated real estate and housing assets. Land transaction peaked at local land offices and investors and agents became millionaires overnight. But, it was just a bubble. It started to lose air when growth of remittance inflows slowed down in 2009 as a result of the global financial and economic crises. All of a sudden real estate and housing prices tumbled.

Half constructed buildings, unsold land plots, and ‘ghost apartments’ were apparent. The BFIs jacked up lending rates, further putting pressure on borrowers. They were unable to recoup interest and principal payments on time, leading to a liquidity crunch. Fortunately, with prudent interventions by the NRB, there is now liquidity surplus in the market.

Given this backdrop it is clear that the crises were engendered by unhealthy competition among BFIs and unnaturally high growth of real estate and housing prices. The postponement of deadline to meet the lending threshold to this sector will neither resolve the core problems nor avert a potential banking crisis. It will only delay the inevitable consolidation of BFIs and correction of real estate and housing prices. Furthermore, shifting headings of loans from commercial apartments to service apartments is a clever way to enable BFIs to comply with 25 percent loan threshold.

It makes no difference to borrowers’ ability to honor interest and principal payments on time and the BFIs’ ability to recoup them. The BFIs have already put up around 1000 units of land and housing for auction in the second quarter of this fiscal year. Even though the starting prices are below than what the BFIs would expect, they are still not finding buyers. The president of Nepal Finance Companies’ Association argues that as much as 75 percent of real estate sector borrowers are not honoring interest payments. At the end of the day, the loans might be stacked up in the non performing loans (NPLs) category of the BFIs. Note that high NPLs means unhealthy state of BFIs, which might require restructuring at the cost of taxpayer’s money or with donor’s assistance like it was done with the two largest state-owned commercial banks.

The plain fact is that there has to be consolidation of BFIs and correction of real estate and housing prices. The government has to offer adequate incentives for BFIs to go for merger and acquisition. When the entire future of banking industry is in line, we should not be quibbling over tax holidays, management positions, and overly high capital requirements.

Meantime, the banking industry should also diversify its loan portfolio, ensure sound corporate governance, introduce innovative packages and seek investment opportunities outside of the handful of traditional sectors. Taking stock of the paucity of investment opportunities for BFIs, the NRB recently outlined opportunities and made it mandatory by mid-July 2013 for them to lend at least 10 percent of total loan and investment portfolio to agriculture and energy sectors.

Regarding the real estate and housing sector, which contributes just over 8 percent to GDP, price correction is inevitable and the government has to let markets adjust to real price levels rather than trying to artificially prop it up. The political leaders and their financiers and supporters have substantial interest in this sector and without a rise in prices some of them will see their financial worth wipe off completely.

The MoF introduced ‘relief package’ not to correct markets, but to alleviate their hardship. There are even suggestions to prop up real estate and housing markets outside of the major cities. Other than pacifying party supporters and businessmen funding the political leaders, these measures will do very little to steer this sector in the right path. It is time to call off gambling in this sector and let markets determine the course this time.

[Published in Republica, January 25, 2012, p.6]

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Bhutan, Mongolia and Nepal: Contribution of natural resources to growth

Here is a highly recommended piece about Mongolia’s obsession with mining in the Gobi desert and its plan to reap benefits out of its sale. Mongolia is trying to exploit its natural resources and focus on something where it has comparative advantage on rather than getting bogged down on debate over resource rights and resource curse. It is doling out money to its citizen and is setting up a fund to channelize income from mining (just like Norway and Botswana are doing with earning from petro fuel and diamond respectively) to fund development activities.

While reading the article, I kept thinking about the sorry state of hydropower in Nepal, the victory of never-ending discussion and talks over actual construction and the apprehension of being dominated by big foreign investors (and the countries they represent). For someone who is always thinking of spurring growth, increasing exports, jacking up per capita income, and providing appropriate social protection to the needy people, all the objections and hindrances sound totally nonsense. Much has been written about Nepal’s hydropower potential. I won’t attempt to repeat them here—just Google it!

Let me give comparative stats and discussion (extracted from various sources) on Bhutan, Mongolia and Nepal—all are landlocked—and shed light on how the first two are successfully exploiting their natural resources on which they have comparative advantage and how the latter is lost in the never-ending debate, fear of domination by alien investors and smugness over the running waters.

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Mongolia:

• GDP size: $11.02 billion (PPP in 2010)
• Per capita income: $3,600 (PPP in 2010)
• Population: 3.133 million (July 2011 est.)
• Real GDP growth: 6.1% in 2010
• In the third quarter of 2011 Mongolia’s economy grew by 21% compared with the same period in 2010.
• More than 80% of its exports are minerals, a proportion expected to rise in a few years to 95%.
• Mongolia makes mining geologists salivate over its known riches and unexplored potential—for copper, coal, gold, silver, uranium, molybdenum, and on and on. Some 3,000 mining licences have been issued.
• The IMF expects growth to average 14% a year between 2012 and 2016. In 2013, the year production is due to begin in earnest at OT (Oyu Tolgoi, or “Turquoise Hill”), it is forecast to reach 22.9%. Others think it will be at least twice that.
• The project is a joint venture between the Mongolian government (34%) and Ivanhoe Mines of Canada (66%), which is in turn 49% owned by Rio Tinto, the mining giant that is managing OT and has put up most of the money.
• This mine will produce 450,000 tonnes of copper a year, making it one of the world’s five biggest mines, as well as being a big gold producer. And it will have a life of at least 50 years.
• From 2013 its sales will start adding an average of about five percentage points a year to the national growth rate up to 2020, when its impact on the economy will peak.
• By November last year over $3 billion had already been spent on OT, a figure that will rise to $6 billion by 2013 and $10 billion by 2020. For Mongolia, a $6 billion economy, this is enormous.
• Mongolian coal production is expected to increase from about 16m tonnes a year now to 40m by 2020 and 240m by 2040. Again China provides a ready market, but the mining boom has exacerbated Mongolian fears of a Chinese takeover by commercial stealth.
• Economists fret about a “resource curse”, or “Dutch disease”. […]For economists, the resource curse is a risk Mongolia has little option but to take. […] its comparative advantage is in commodities and mining services. There is no point in trying to compete in manufacturing with “the biggest factory on the planet” next door in China.

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Bhutan:

• GDP size: $3.875 billion (PPP in 2010)
• Per capita income: $5,500 (PPP in 2010)
• Population: 708,427 (July 2011 est.)
• Real GDP growth: 6.7% (2010)
• Bhutan has the potential to develop a capacity of 23,760 MW, of which only 5% has been tapped so far. Under the current year plan, the installed hydropower generation capacity is projected to rise from 1,488 MW in 2007 to 1,602 MW in 2013, with the planned commissioning of the 114 MW Dagachu hydropower project.
• The share of electricity (taxes plus dividends) in domestic revenue is expected to rise from about 43 percent in 2008/09 to over 53 percent by the end of the 10FYP. Hydropower exports constitute about two-fifths of total exports.
• The power sector generates the highest revenue, followed by tourism and banking sector. Hydropower contributes to more than 40% of domestic revenue.
• The first hydropower project (360 kW) in Bhutan was constructed on the Samteling Chhu in Thimphu. This mini-hydro electric plant was commissioned in 1967. During the 1970s, Bhutan and India began to look more closely into channeling the hydropower potential.
• Bhutan is exporting 1,200 megawatts to India and Bangladesh is also seeking power import from Bhutan.

• By 2020, the government plans increase generation capacity to 10,000 MW, about seven times the present level. To attain this goal, Bhutan and India have agreed to develop 10 hydropower projects together.

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Nepal:

• GDP size: $35.81 billion ((PPP in 2010)
• Per capita income: $1,200 (PPP in 2010)
• Population: 29.391 million (July 2011 est.)
• Real GDP growth: 4.6% (2010)
• Electricity demand-supply gap of around 400 MW
• Over 16 hours of load-shedding during dry season
• Power generation target has been revised to between 10000 MW to 20000 MW (in ten years time) depending on which political party is at the helm of power. These are just lofty talks with no concrete plan of action.
• Read more on hydropower woes here

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UPDATE (2012-01-26): Here is the PM’s economic adviser arguing that we should be thinking about generating hydropower first, not upstream-downstream benefits before the hydropower is developed. The benefit of providing enough electricity to the power hungry households and businesses  is far greater than the constant drumbeating of upstream and downstream benefits by some NGOs whose sustainability depends on opposing such investments on the pretext of environment damage and upstream-downstream benefits. These should be looked upon at and are important issues. But, I don’t think these come before we generate hydropower in the first place. Highly recommended write up by Rameshwore Prasad Khanal.

The impact of the EU debt crisis and global economic downturn on Nepalese economy

Here are some of the major points related to Nepal from a newly released Global Economic Prospects (GEP) 2012. The implications of the EU debt crisis and global economic downturn on the Nepalese economy is also discussed below. Here is an earlier post related to growth prospects of South Asia.

Nepal’s prospect:

• Law and order problems, and persistent and extensive infrastructure bottlenecks (electrical shortages are reflected in widespread load-shedding and unreliable delivery), reduced real GDP growth to 3.5 percent in FY2010/2011 (ending June-2011) from 4.6 percent in FY2009/10.
• GDP growth rate is forecasted to be the lowest in the region. In 2012 and 2013, GDP growth rate is forecasted to be 3.5% and 3.8% respectively. Considering fiscal year (July 16 through July 15), GDP growth rate is forecasted to be 3.6% and 4% in FY 2012/13 and 2013/14 respectively.

• Exports to the EU and the US might slowdown. Exports to Europe (in particular textiles and clothing) are more sensitive to a decrease in consumer demand. It will further affect industrial output (mainly manufacturing ones).
• Current account balance was estimated to be –2.9% of GDP in 2010, which is forecasted to decline to –2.7% of GDP and –2.3% of GDP in 2012 and 2013 respectively. The strong earning from tourism sector and remittance inflows is offset by widening trade deficit, partly tied to deterioration in terms of trade and domestic supply-side conditions. Terms of trade losses are estimated at about 4.3 percent of GDP for Nepal (1.9 percent of GDP for the region in aggregate)—(estimated January through September 2011 terms of trade impacts relative to 2010).

• Remittance inflows might take a hit (a decline of around 0.5 to 1 percent of GDP in case of moderate and severe crisis respectively) depending on the economic condition in the Gulf, affecting current account and balance of payments, consumption expenditure and import of durables.
• Inflationary pressure might continue.The upswing in prices reflects high international food and fuel prices, and imported inflation from India (as Nepal‟s local currency is pegged to the Indian rupee). Sustained elevated inflationary pressures have also led to a rise in inflation expectations.

• Foreign assistance might get a hit if fiscal consolidation in high-income countries results in cuts to overseas development assistance.
• Fiscal space has diminished when compared to 2007 level.
• These on top of the domestic supply-side constraints will impede GDP growth, exports and industrial output.
• The slowdown in global commodity prices (energy, metals, raw materials, minerals, fertilizers, and agriculture) might be a relief. But, with tensions rising in the Middle East, energy prices are going up North recently. Also, the continued depreciation of Nepalese rupee against major currencies (except the Indian rupee) will put further strain on retail prices (via the high import prices channel). Meanwhile, slowdown in demand for Nepalese exports in the EU and the US might mean a stunted exports sector, provided that it also fails to boost market pie in the Indian and regional markets.

• Exposure (investment) to a sudden withdrawal of European bank assets is relatively small (almost without any risk or negligible).

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Macroeconomic condition, 2008-2013
	2008	2009	2010	2011*	2012*	2013*
Real Expenditure Growth
1. GDP at market prices	4.8	5.3	4.5	4	3.5	3.8
2. Private consumption	3.9	3.9	4.9	4.9	4.1	4.1
3. Government consumption	6.9	13.1	17.8	13.5	10.1	9.3
4. Fixed investment	4	6	5.6	0.3	-0.2	3.2
5. Exports, GNFS	-1.4	17.5	34.4	22.1	9.4	5
6. Imports, GNFS	4.3	13.9	18.6	13.5	8.1	6
Contribution to GDP Growth
1. Private consumption	3	3	3.7	3.7	3.1	3.2
2. Government consumption	0.6	1.2	1.8	1.5	1.3	1.2
3. Fixed investment	0.8	1.2	1.2	0.1	0	0.6
4. Net exports	-0.3	3	6.6	5.4	2.7	1.5
Price Deflators
1. GDP at market prices	16.4	-6.2	17.8	5.3	4.1	6.1
2. Private consumption	14.8	-6.3	17.7	11.1	10.5	11.4
3. Exports, GNFS	17.4	-7.6	10.2	4.8	11.9	16.6
4. Imports, GNFS	19.6	-6.4	12.2	8.2	15.6	19.5
Share of GDP
1. Private consumption	76.6	75.5	75.8	80.5	85.6	90
2. Government consumption	10.3	11.2	12.1	13.7	15.5	17.2
3. Fixed investment	20.3	20.5	20.1	20.1	20.6	21.6
4. Change in stocks	9.2	9.5	8.1	7.3	6.7	6.2
5. Total investment	..	..	..	..	..	..
6. Exports, GNFS	16.1	17.7	21.3	24.8	28	31.1
7. Imports, GNFS	34.6	37.3	40.3	45.1	52.1	59.9
Memo
1. Nominal GDP (USD billions)	13	12.8	15.8	17.3	18.7	20.7
2. Population (millions)	28.8	29.3	29.9	30.4	31	31.5
3. GDP per capita, current USD	451.8	437.6	528.5	570	605.4	655.6
4. Real per capita GDP growth	4	2.4	2.6	1.7	1.8	2.4
5. USD Fx rate	64.9	76.6	74.6	75.4	75.4	73.7

Source: Global Economic Prospects 2012, World Bank; *Forecast for 2011, 2012, 2013

EU debt crisis and weak global demand will affect South Asia’s growth prospect in 2012 and 2013

In its newly released Global Economic Prospects (GEP) 2012, the World Bank argues that GDP in South Asia slowed to an estimated 6.6 percent in 2011, from 9.1 percent in 2010, reflecting a sharp slowdown industrial production and trade in the second half of last year. The slowdown in the region is led by India, which accounts for 80 percent of South Asia’s GDP.

The report states that the regional deceleration in growth reflects internal and external headwinds. On the domestic front, more restrictive macroeconomic policy stances, aimed at reducing stubbornly high inflation and unsustainably large fiscal deficits, have contributed to weaker domestic demand. Higher borrowing costs, elevated inflation, moderating economic activity and some local factors (e.g. policy uncertainty, stalled reforms, and deteriorating political and security conditions) have contributed to a significant slowdown in investment growth.

 

Here are major points from the report (related to South Asia):

• Exports are negatively affected by weaker foreign demand. Demand for the region’s exports of goods and services is projected to slow in calendar year 2012 and lead to a near halving of export growth to 11.6 percent in 2012, from 21 percent in 2011, due to stagnant GDP in the European Union and the projected global slowdown, including the influence of tighter monetary policy in China and fiscal consolidation in Europe.

 

• The Euro Area represents about one-fourth of South Asia‟s merchandise export market, of which Germany and France account for 40 percent and 20 percent, respectively.
• Terms of trade losses are estimated at about 1.9 percent of GDP for the region in aggregate, led by a 4.3 percent of GDP decline for Nepal, while Bangladesh and Sri Lanka saw a smaller negative impact of close to 1.5 percent of GDP, and India and Pakistan saw negative impacts of close to 1.8 percent of GDP (estimated January through September 2011 terms of trade impacts relative to 2010).

• Remittances have grown only modestly.
• The slowdown reflects moderation in domestic demand, given a deceleration in investment growth that has faced headwinds of rising borrowing costs, high input prices, slowing global growth and heightened uncertainty.
• The region’s GDP growth is projected to ease further to 5.8 percent in 2012, before strengthening to 7.1 percent in 2013.
• Regional growth is estimated to have exceeded the long-term average of 6 percent (1998-2007), reflecting above trend activity in Bangladesh, India and Sri Lanka.
• High inflation and fiscal deficits remain concerns going forward.
• Household spending has been curbed by persistently rising prices cutting into real incomes and higher borrowing costs.

• South Asian governments have limited space with which to introduce fiscal stimulus measures, due to large fiscal deficits, and the possibility of monetary easing is constrained by sustained high inflationary pressures.

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Forecast:

• A deepening of the Euro Area crisis would lead to weaker export growth, worker remittances and capital inflows to South Asia.
• Trade: The Euro Area represents about one-fourth of South Asia’s merchandise export market, with Bangladesh, the Maldives and Sri Lanka particularly exposed to a downturn in European demand for merchandise. Moreover, export financing from Europe, an important component of trade credit, is particularly vulnerable to drying up, as was the experience during the 2008 financial crisis.
• Remittances: Worker remittances remain a critical source of foreign exchange in South Asia—equivalent to 20 percent of GDP, as of 2010, in Nepal, 9.6 percent in Bangladesh, 7 percent in Sri Lanka and 5 percent in Pakistan. If the global conditions were to deteriorate sharply, remittances growth could stall, resulting in weaker incomes, weaker foreign currency earnings and slower domestic demand growth within the region.
• Finance: Financial sector impacts through heightened global risk aversion (reversal of capital inflows, higher international borrowing costs and slowing FDI) are likely to be felt strongest in India, which is the most integrated with global financial markets, along with the Maldives and Sri Lanka, where 2012 external financing needs (current account financing and external debt repayments) are projected to reach 9.8 percent, 18 percent and 7 percent of GDP, respectively. Countries heavily reliant on foreign assistance, such as Afghanistan, Nepal and Pakistan, could be hit hard if fiscal consolidation in high income countries were to result in cuts to overseas development assistance.
• South Asia’s exposure (investment) to a sudden withdrawal of European banks is relatively small and limited to ‘core’ countries.

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Recommended measures:

• Given the lack of fiscal space in South Asia, inflationary pressures and consequent limited room for monetary policy easing, fiscal consolidation through greater revenue mobilization (particularly in Pakistan, Sri Lanka, Bangladesh, and Nepal) and expenditure rationalization (especially in India) could play a key role in helping to protect critical social programs.
• Expanding the drivers of growth also holds potential. With markets in the United States and Europe expected to experience prolonged weakness, South Asian countries have the opportunity to re-think and pursue new sources of growth in both domestic and external markets. This may include focusing on export growth toward faster growing emerging markets, as well as internal  market enhancements through structural and governance reforms. Such actions would help boost export demand, help raise investment, provide better jobs and generate an environment for more inclusive growth.

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Global scenario:

Last year was characterized by the Tohoku quake in Japan, the European debt crisis and the downgrade of the US sovereign ratings, which affected financial markets around the world. Below is an estimation of the losses:

• In a matter of five months, stock markets around the world recorded $6.5 trillion (or. 9.5 percent of global GDP) in wealth losses, with developing-country stock markets losing 8.5 percent of their value, from July-end 2011 and early January 2012.
• Gross capital flows to developing countries to plunged to $170 billion in the second half of 2011, only 55 percent of the $309 billion received during the same period of 2010.
• Yields on the sovereign debt of developing countries declined by an average of 117 basis points (between the end of July and early January), as did those of almost all Euro Area countries, including France (86 bps) and Germany (36 bps), as well as non-Euro Area countries such as the United Kingdom (18 bps).

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Major points from the report:

The World Bank has lowered its growth forecast for 2012 to 5.4 percent for developing countries and 1.4 percent for high-income countries (-0.3 percent for the Euro Area), down from its June estimates of 6.2 and 2.7 percent (1.8 percent for the Euro Area), respectively.

Global growth is now projected at 2.5 and 3.1 percent for 2012 and 2013, respectively. Using purchasing power parity weights, global growth would be 3.4 and 4.0 percent for 2012 and 2013, respectively.

It argues that slower growth is already visible in weakening global trade and commodity prices. Global exports of goods and services expanded by an estimated 6.6 percent in 2011 (down from 12.4 percent in 2010), and are projected to rise by only 4.7 percent in 2012.

Meanwhile, global prices of energy, metals and minerals, and agricultural products are down 10, 25 and 19 percent respectively since peaks in early 2011. Declining commodity prices have contributed to an easing of headline inflation in most developing countries. Although international food prices eased in recent months, down 14 percent from their peak in February 2011, food security for the poorest, including in the Horn of Africa, remains a central concern.

Developing countries have less fiscal and monetary space for remedial measures than they did in 2008/09. As a result, their ability to respond may be constrained if international finance dries up and global conditions deteriorate sharply.

Existing global economic conditions (which is far weaker than last year):

• Europe appears to have already entered recession.
• Growth in several major developing countries (Brazil, India and, to a lesser extent, Russia, South Africa and Turkey) has slowed, mainly reflecting policy tightening initiated in late 2010 and early 2011 in order to combat rising inflationary pressures.
• As a result, and despite relatively strong of activity in the United States and Japan, global industrial production and trade have slowed sharply.
• Global trade volumes declined at an annualized pace of 8 percent during the three months ending October 2011, mainly reflecting a 17 percent annualized decline in European imports.

Infographics of the evolution of Nepal’s export destination

Here is a series of infographics that shows the evolution of Nepal’s export destination. The data is sourced from WB data visualizer. It didn’t have such info for gross exports after 2003.

Top 10 export destination in 1990:

• United States (US$ 60.73 million)
• Germany (US$ 44.66 million)
• India (US$ 21.87 million)
• Switzerland (US$ 11.77 million)
• United Kingdom (US$ 7.80 million)
• China
• Iraq
• Italy
• Bangladesh
• Japan

Top 10 export destination in 1995:

• Germany (US$ 131.24 million)
• United States (US$ 103.03 million)
• India (US$ 67.51 million)
• Switzerland (US$ 9.30 million)
• Italy (US$ 7.18 million)
• United Kingdom
• China
• Austria
• Iraq
• Canada

Top export destination in 1998:

It was in 1998 when India became the top export destination of Nepal, thanks to the trade and transit treaty of 1996 (which eliminated value addition requirement for Nepalese exports to India. This provision was replaced with 30% VA in 2000 and Nepalese exports got a hit).

• India (US$ 136.43 million)
• United States (US$ 107.56 million)
• Germany (US$ 103.14 million)
• Bangladesh (US$ 9 million)
• France (US$ 7.36 million)
• Italy
• Austria
• United Kingdom
• Sri Lanka
• Iraq

Top 10 export destination in 2000:

• India (US$ 317.79 million)
• United States (US$ 192.16 million)
• Germany (US$ 105.52 million)
• United Kingdom (US$ 16.74 million)
• Belgium (US$ 11.40 million)
• France
• Japan
• Hong Kong, China
• Switzerland
• Spain

Top 10 export destination in 2003:

• India (US$ 341.79 million)
• United States (US$ 189.73 million)
• China (US$ 22.43 million)
• Germany (US$ 22.11 million)
• United Kingdom (US$ 13.60 million)
• Bangladesh
• France
• Japan
• Italy
• Portugal

Fast forward to 2011 (fiscal year 2010/11), the top exports destination were (total exports amounted to Rs 64.56 billion; data is sourced from TEPC trade data):

• India (Rs 42.87 billion)
• United States (Rs 4.39 billion)
• Bangladesh (Rs 3.47 billion)
• Germany (Rs 2.768 billion)
• U.K (Rs 1.389 billion)
• France
• Turkey
• Canada
• Italy
• China P.R

Overall, the number of countries Nepal sends goods to has increased but an increasing amount of volume (and revenue) is being concentrated to the Indian market. The phasing out of quotas and slashing of tariff rates in the European markets and the US have contributed to declining share of exports to these countries. At the end, Nepalese products could not compete with exports of similar nature from other countries. Here is a blog post on Nepal’s problems with exports.

Can aid tying work when there is pervasive corruption?

It seems like it does. Knack and Smets argue that aid tying can be an efficient response by donors when losses from corruption may rival or exceed losses from tying aid. It might be the reason why technocrats prefer binding conditionality, which politicians cannot breach to harness their vested interests, against loans or grants.

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This study tests two opposing hypotheses about the impact of aid fragmentation on the practice of aid tying. In one, when a small number of donors dominate the aid market in a country, they may exploit their monopoly power by tying more aid to purchases from contractors based in their own countries. Alternatively, when donors have a larger share of the aid market, they may have stronger incentives to maximize the development impact of their aid by tying less of it. Empirical tests strongly and consistently support the latter hypothesis. The key finding---that higher donor aid shares are associated with less aid tying---is robust to recipient controls, donor fixed effects and instrumental variables estimation. When recipient countries are grouped by their scores on corruption perception indexes, higher shares of aid are significantly related to lower aid tying only in the less-corrupt sub-sample. This finding is consistent with the argument that aid tying can be an efficient response by donors when losses from corruption may rival or exceed losses from tying aid. When aid tying is more costly, as proxied by donor country size and income, it is less prevalent. Aid tying is lower in the Least Developed Countries, consistent with the OECD Development Assistance Committee's recommendation to its members.

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Government sponsored think tanks in Nepal

PM Baburam Bhattarai feels that the country needs think tanks to give inputs to the government on matters related to foreign affairs and economic development. He is thinking of establishing Institute of Strategic and Foreign Affairs Studies and Institute of the Economic and Development Studies to be run with government grant.

A very positive initiative. The country needs a civilized clash of ideas and ideals with sounds analysis and policy research to distill the most apt economic policies and implications of proposed policies. The proposed think tanks should be given enough seed money to start independent policy analysis.

For too long, advocacy and debate on economic policies have been one-sided and project based (often guided by donor and private interests). The proposed think tanks should be run independently, without political, government and donor interference. The donors should not be asked to foot the bill for its establishment. Else, it will be no different than the several government sponsored media and policy analysis institutions. With regards to foreign policy, there already exists one (something like the Institute of Foreign Affairs).

It should have an independent board, which will hire staff and devise a plan to make the institutions self-sustaining in few years time. It will save the institutions from unnecessary political interference. The primary purpose should be to generate debate on new ideas and their implications. The government can get inputs from them in a strictly professional way. We already have National Planning Commission and the PM’s economic advisory council to deal with giving advise to the government on economic policies. The think tanks should be allowed to weigh in on those policies, facilitate informed debate and generate both alternative and supportive ideas.

A good initiative. It should be done in the right way.