Impending Financial Disaster in Nepal

My first piece in 2011 is related to the financial and real estate/housing sectors in Nepal. I believe that these two sectors will be severely affected by decline in housing and real estate prices and loan defaults within a year or two. Comments on this piece have been very .

Nepal has 31 commercial banks, and hundreds of development and finance companies. Without a substantial surge in depositor and borrower bases, the number of banks are mushrooming, particularly due to rise in remittances inflows. They have invested way too much in one sector, created asset and housing bubbles, and are now struggling to recover loans and meet profit targets. It is already late to contain the damage, but it is not too late (hopefully). The central bank has to make difficult decisions soon and it will definitely hurt one or the others sectors.

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Impending financial disaster

Nepal has been struggling to maintain macroeconomic balance for a couple of years now. Low growth rate, high unemployment, balance of payments deficit, widening trade deficit, and high and sticky inflation are some of our pressing existing macroeconomic challenges. Now, add to that list an impending financial disaster, engendered largely by the bank and financial institutions (BFIs) themselves and to some extent by Nepal Rastra Bank (NRB), our central bank.

While the latter ignored the unhealthy development in financial sector, let new BFIs prop up without even evaluating if our economy needs so many of them, and took damage control measures of late, the former is in desperation to survive amidst cutthroat competition, which is getting nasty by the day. The BFIs’ inability to effectively cope with the existing pressure on deposit and lending, and to attain unsustainable profit targets might lead to a situation where all profits are private but losses are social, i.e. taxpayers pay the cost of reckless behavior of few sectors in the economy.

Looking at the existing business structure of the real estate and housing sector and the BFIs, it is very likely that their unjustified growth will end soon, raising fear of destabilizing not only the very conduit from where the public is facilitated with credit but also derailing the entire economy. The existing path on which these two sectors are hurtling toward bears the hallmark of the recent housing, financial, and economic crises in the West. It all starts with pumping of too much money in one sector, which after few years of unnatural and unsustainable growth crashes down and puts pressure on the BFIs, leading to defaults, extremely vulnerable financial institutions, and squeezing of credit to all sectors in general.

Before going into detail about symptoms of the impending financial disaster, let me first discuss how the bigwigs of the BFIs are behaving irresponsibly and are trying to scuttle reforms introduced, albeit lately, by the NRB.

Recently, they made a high pitch about the central bank being anti-market when it regulated CEO’s pay; capped lending to the realty and housing sector; and directed the banks to ensure that interest rate difference on various kinds of savings accounts is not more than two percentage points. The negative and nonsense drumbeating by the bigwigs of the banking sector was so incriminating that the central bank governor Dr. Yuba Raj Khatiwada felt compelled to make a statement that he and the NRB are not market unfriendly.

Ironically, the very next day the executives tacitly agreed to cap savings account interests between 4-6 percent. Without shame the Nepal Bankers’ Association (NBA) argued that the banking bigwigs reached “a gentleman’s agreement” to cap interest rates. The same executives who were defending free market colluded to cap interests on savings accounts. This is carteling and an outright hypocrisy. They played the same anti-market game in May 2010 when they colluded to limit interest rate on fixed deposits at 12 percent. The main problem is not financial regulation; it is that we simply have way too many BFIs serving a narrow depositor and borrower base.

Behind the unnecessary activism of the banking sector in pressing their demand, resisting regulation, and trying to circumvent the NRB’s directives lies a bitter truth: some of the BFIs very existence is at stake. They are trying to buy time before the inevitable disaster hits them. This is largely of their own making by imprudently running after short term gains over long term sustainability. The crux of the matter lies at the reckless lending to the urban-centric real estate and housing sector, which is starting to tumble after few years of rapid growth.

First, lending to this sector is unjustified by future growth prospects. This urban-centric sector contributes around 7.8 percent of our GDP and is the highest growing sector in the past six years. Buoyed by easy finance and loans, real estate transactions and housing complexes are rising rapidly. Sometimes artificial demand is created just to jack up prices. This is evident from the fact that our shaky economic fundamentals do not justify multifold increase in land prices in a matter of days. Moreover, liquidity is pumped into this sector without properly assessing risks and the ability of borrowers to repay loans. The BFIs are hardly distinguishing between normal and subprime markets.

This is creating market disequilibrium, i.e. the supply of real estate and housing complexes is outstripping demand, leading to a decline in prices. The media reports indicate that real estate prices have already gone down by 30 percent. Be prepared to brace for even lower prices. As prices dip, borrowers will be unable to honor principal and interest payments on time, forcing the BFIs to restructure loans and variably increase lending rates. Buyers will cancel booking even after paying the minimum required down payment. Soon we will see ‘ghost’ apartments, i.e. empty apartments waiting for customers to either buy or rent them. This will ultimately hit the BFIs.

Second, the uber-generous BFIs are chasing after short term gains without properly assessing borrowers’ ability to repay interest and principal on time. As of November 2010, credit flow of commercial banks to land and buildings sector was Rs 284 billion out of a total of Rs 415 billion, representing about 69 percent of total credit flows with assets guarantee. Since a lot of this credit went to the real estate and housing sector, which is facing a hard time due to declining prices, the vulnerability of BFIs to an ultimate busting of this sector is pretty high.

Now, you might be wondering why the BFIs are lending so much to just one sector. Well, the reason is that the rapid increase in number of BFIs without a proportional increase in depositor base intensified cutthroat competition to attract both depositors and borrowers, and put the BFIs in desperation to meet unsustainable profit targets. Despite knowing the fact that the incredulous profit targets can only be achieved in the short term by putting the foundation of the entire banking sector at risk in the long term, the BFIs played the risky game (by lending too much to one sector) as if everything was normal.

Still, BFIs are offering interest rates above 12 percent in savings account. In June 2010 and July 2004 it was just above 7.7 percent and 5 percent, respectively. Meanwhile, the maximum lending rate has been over 18 percent. In June 2010 and July 2004 it was 14 percent and 11.5 percent, respectively. Due to limited playing field and increasing competition, some of the banks are even offering high interest on a daily basis on demand deposits, which usually does not happen. Since this is unsustainable and is putting the entire financial sector at risk, the central bank capped lending to overly heated sectors and interests differential in deposits. To circumvent this decision the BIFs are capping interests on saving accounts and are variably increasing lending rates without properly informing borrowers. It will increase chances of more defaults.

The development in the housing and real estate sector and the ad hoc decisions of the BFIs do not augur well for the economy. We might end up with empty apartments and ‘ghost’ houses if things continue to go the way they are going right now. Playing with interest rates on loans and savings is just an attempt to buy time before the inevitable disaster hits the BFIs. It is good to acknowledge and rectify mistakes before it is too late.

The tendency to seek short term gains over long term sustainability is a recipe for disaster with severe negative externalities, i.e. it will not only affect the BFIs, but also the public who are not a direct party to the activities of financial sector, and real estate and housing sector. Before these two sectors put the entire economy at risk, strong safeguards should be put in place. It might mean making painful decision of letting some BFIs to either fail (remember Nepal Development Bank?) or forced to merge, and help to rapidly cool down the urban-centric real estate and housing sector.

[Published in Republica, January 15, 2011, p6]

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Climate Change in Peru

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Glacier melt hasn't caused a national crisis in Peru, yet. But high in the Andes, rising temperatures and changes in water supply over the last 40 years have decimated crops, killed fish stocks and forced villages to question how they will survive for another generation.

Without international help to build reservoirs and dams and improve irrigation, the South American nation could become a case study in how climate change can destabilize a strategically important region, according to Peruvian, U.S. and other officials.

[..] Peru is home to 70 percent of the world's tropical glaciers, which are also found in Bolivia, Ecuador and Chile. Peru's 18 mountain glaciers, including the world's largest tropical ice mass, are critical to the region's water sources for drinking, irrigation and electricity.

Glaciers in the South American Andes are melting faster than many scientists predicted; some climate change experts estimate entire glaciers across the Andes will disappear in 10 years due to rising global temperatures, creating instability across the globe as they melt.

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More here

What is causing food price volatility?

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Changing petroleum prices, crop yields, food stock levels, and exchange rates are the main culprits, but trade policies and a lack of reliable, up-to-date data are also driving the volatility.

In what is potentially an even more worrying trend, implied volatility—which represents the market’s expectations of how much the price is likely to move in the future and can only be inferred from the prices of derivative contracts such as options—has been increasing steadily since the mid-1990s. The implied volatilities of three key staple foods—soybeans, maize, and wheat—show a clear upward trend, indicating a steady increase in uncertainty.

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So argues Hafez Ghanem, Assistant Director-General of the Food and Agriculture Organization. Specifically, volatility in four variables—petroleum prices, crop yields, food stock levels, and exchange rates— significantly increases food price fluctuations.

Causes:

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First, petroleum price volatility—which tends to be high—translates to food price volatility through transportation costs and fertilizer prices. The link has become even stronger with the advent of biofuels, which require food crops as inputs and can therefore change food prices.

Second, because the demand for food is inelastic, small changes in supply can lead to big changes in prices, meaning that even limited crop yield volatility can have large effects on food price fluctuations. The role of crop yield variability is only expected to rise as extreme weather events become more common.

Third, food price volatility is inversely related to the level of food stocks—as stocks fall, price volatility rises. Both public and private actors have lowered stocks in recent years. This trend may be reversing itself, however, as countries are revising their reserves policies in response to recent bouts of volatility.

Finally, changes in exchange rates, especially of major exporting countries, translate to changes in international food prices. Thus, as macroeconomic factors lead to more volatile exchange rates, food price volatility also rises.

[…]an additional cause of price volatility: the lack of reliable, up-to-date information on crop supply and demand, stocks, and export availability.

[…]it is possible to argue that increased speculation contributed to higher food price volatility.

[…]real factors such as production shortfalls in key exporting countries—and not speculation—triggered the two recent bouts of volatility (in 2007–2008 and 2010).

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Solutions:

• Yield-enhancing investments (R&D in infrastructure that promote irrigation as well as drought-resilient crops and their hybrids)
• Trade policies (completion of the Doha Round of negotiations so that trade distorting subsidies can be reduced, and perhaps include tighter rules on export restrictions)
• Improving market transparency (information about both the real market and related financial transactions)
• Reforming policies for grain-based biofuels (introducing call options for biofuels—a market-compatible instrument—would guarantee that producers shift grain from producing biofuels to providing food during crises—a mutually beneficial outcome)
• Review stock policies (adequate emergency food stocks, or strategic reserves, must be maintained at the national, regional and global levels)
• Financing instruments (institutions need to act ex ante and provide import-financing or -guarantees to alleviate credit and foreign exchange constraints)
• Commodity exchanges (regulatory frameworks governing commodity exchanges must also be reviewed to reduce speculative behavior and thus limit volatility)

Chinua Achebe on Africa’s hope

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AFRICA has endured a tortured history of political instability and religious, racial and ethnic strife. In order to understand this bewildering, beautiful continent — and to grasp the complexity that is my home country, Nigeria, Africa’s most populous nation — I think it is absolutely important that we examine the story of African people.

In my mind, there are two parts to the story of the African peoples ... the rain beating us obviously goes back at least half a millennium. And what is happening in Africa today is a result of what has been going on for 400 or 500 years, from the “discovery” of Africa by Europe, through the period of darkness that engulfed the continent during the trans-Atlantic slave trade and through the Berlin Conference of 1885. That controversial gathering of the leading European powers, which precipitated the “scramble for Africa,” we all know took place without African consultation or representation. It created new boundaries in ancient kingdoms, and nation-states resulting in disjointed, inexplicable, tension-prone countries today.

During the colonial period, struggles were fought, exhaustingly, on so many fronts — for equality, for justice, for freedom — by politicians, intellectuals and common folk alike. At the end of the day, when the liberty was won, we found that we had not sufficiently reckoned with one incredibly important fact: If you take someone who has not really been in charge of himself for 300 years and tell him, “O.K., you are now free,” he will not know where to begin.

This is how I see the chaos in Africa today and the absence of logic in what we’re doing. Africa’s postcolonial disposition is the result of a people who have lost the habit of ruling themselves, forgotten their traditional way of thinking, embracing and engaging the world without sufficient preparation. We have also had difficulty running the systems foisted upon us at the dawn of independence by our colonial masters. We are like the man in the Igbo proverb who does not know where the rain began to beat him and so cannot say where he dried his body.

People don’t like this particular analysis, because it looks as if we want to place the blame on someone else. Let me be clear, because I have inadvertently developed a reputation (some of my friends say one I relish) as a provocateur: because the West has had a long but uneven engagement with Africa, it is imperative that it also play an important role in forging solutions to Africa’s myriad problems. This will require good will and concerted effort on the part of all those who share the weight of Africa’s historical albatross.

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More by Chinua Achebe here. He is the author of an awesome book Things Fall Apart.

Nepal, South Asia, and Developing Countries Compared

Nepal’s real GDP growth is expected to be 3.7% and 4% in 2011 and 2012, respectively. Exports growth will initially decline to 5.6% and then rise to 7.3% in 2012. Meanwhile, imports growth will decline to 6.3% and then increase to 6.9% in 2012. Both exports and imports (as a share of GDP) are expected to decline in 2012. Exports are expected to be 11% of GDP and 9.9% of GDP in 2011 and 2012, respectively. The figures for imports for the same period are 26.1% and 23.7%.

That said, how does Nepal’s existing economic performance and forecasts compare with the South Asian region, neighboring countries, and developing countries. Below are some of the comparative charts. All data are sourced on 2010-01-14 from Global Economic Prospects 2011 website. The data for 2011 and 2012 are projections. Nepal’s standing among the web of bars is indicated by an arrow (just ensuring that you don’t get lost looking for Nepal!). SA, DEV, WLD, PAK, NPL, LKA, BGD, CHN, IND stand for South Asia, Developing Countries, World, Pakistan, Nepal, Sri Lanka, Bangladesh, China, and India, respectively. All of these are bar charts. I was too lazy to come up with something simpler to understand the data! :-)

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First, Nepal’s real GDP growth rate is the second lowest in the region and is expected will remain that way in 2012, well below the level reached in 2008. Blame the political impasse, power outages, supply bottlenecks, high and sticky inflation, labor disputes, and low business and consumer sentiment, among others. South Asia’s growth will be robust, thanks largely to the bustling economic activities in India (and to some extent Bangladesh). As a whole, developing countries will have higher growth rate than the world average (which has a negative real growth rate in 2009).

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Second, Nepal’s exports (share of GDP) will continue to decline, while that of developing countries, China, and India will continue to grow or at least remain steady. Pakistan has one of the lowest exports (share of GDP) in the South Asian region. Blame the political impasse, uncompetitive export-oriented sector, power outages, supply bottlenecks, high and sticky inflation, labor disputes, and low business and consumer sentiment, among others

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Third, Nepal’s imports (share of GDP) are expected to be higher than exports, but will slightly decrease.Still, Nepal’s imports (share of GDP) are higher higher than most all the countries in the region (except for China’s, which is expected to increase imports in 2012). The world and developing countries average of imports are higher than that of Nepal. In 2009, imports was the highest in Nepal than in all the countries and regions looked in this post. Thanks to remittances, declining domestic production, and a slight appreciation of Nepali currency vis-à-vis dollar (due to high inflation rate).

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Fourth, total investment (share of GDP) in Nepal is higher than in world average, Pakistan, Sri Lanka, and Bangladesh. But, why is GDP growth rate and industrial production low? It might be because Nepal has a greater change in stocks (share of GDP) than others countries that have low total investment than Nepal’s [Note: Fixed investment + Change in stocks = Total investment]. But, the high total investment and low growth and industrial production indicate low productivity and uncompetitive economic structure. Total investment in India, China, developing countries average, and South Asia is higher than in Nepal.

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Fifth, Nepal’s GDP per capita (current US$) is the lowest and will be the lowest in 2012 among the regions and countries compared in this blog post. Real GDP per capita was US$ 431.1 in 2009 and is expected to reach US$ 581.9 and US$ 661.1 in 2011 and 2012, respectively. This is a growth of 1.8% and 2.1% in 2011 and 2012, respectively. In 2012, the average real GDP per capita of South Asia average, world average, developing countries average  is expected to be US$ 1,754.4,  US$ 10,143, and US$ 4,145.9, respectively. Meanwhile, in 2012, real GDP per capita of India, Bangladesh, Pakistan, Sri Lanka and China is expected to be US$ 1,980.8, US$ 773, US$ 1,163.9, US$ 3,167.7, and US$ 5,231.6, respectively. Nepal has a long way to go to catch up with these countries and regions.

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Nepal’s growth prospects in 2012

According to the latest Global Economic Prospects 2011,in 2012, Nepal is expected to have a nominal GDP of US$ 21.6 billion (2005 current prices), population of 31 million, GDP per capita of US$ 697.3, and real per capita GDP growth of 2.1%. Here is an earlier blog post about GEP 2011.

Real GDP growth is expected to be 3.7% and 4% in 2011 and 2012. Exports growth will initially decline to 5.6% and then rise to 7.3% in 2012. Meanwhile, imports growth will decline to 6.3% and then increase to 6.9% in 2012.

Private consumption is expected to contribute 3.3% to GDP growth in 2012, but government consumption is expected to contribute just 0.6%. Fixed investment and net exports are expected to contribute 1.2% of GDP growth and 1.3% of GDP growth in 2012.

As a share of GDP, private consumption is expected to be 75.3% and 74.4% in 2011 and 2012, respectively. Similarly, government consumption as a share of GDP is expected to be 11.1% in 2012; fixed investment 20.6%; change in stocks 7.2%; and total investment 27.9%.

Both exports and imports (as a share of GDP) are expected to decline in 2012. Exports are expected to be 11% of GDP and 9.9% of GDP in 2011 and 2012, respectively. The figures for imports for the same period are 26.1% and 23.7%. It means that trade deficit is expected to increase further. Exchange rate is expected to appreciate, probably due to weak dollar.

Nepali Macroeconomic Forecasts, 2008-2012
Indicator	2008	2009	2010	2011	2012
Real Expenditure Growth
GDP at market prices	5.3	4.7	3.3	3.7	4
Private consumption	4.9	4.5	3.8	4	4.1
Government consumption	6.8	19.3	5.5	5.8	6
Fixed investment	6	5.9	4	5	5.5
Exports, GNFS	-3.4	38.4	6.4	5.6	7.3
Imports, GNFS	7.5	20.2	6.8	6.3	6.9
Contribution to GDP Growth
Private consumption	3.9	3.6	3	3.2	3.3
Government consumption	0.6	1.7	0.6	0.6	0.6
Fixed investment	1.3	1.3	0.9	1.1	1.2
Net exports	-0.5	4.8	1	0.9	1.3
Price Deflators
GDP at market prices	-6.7	8.2	18.7	25.1	3.3
Private consumption	-8.9	11.3	14.5	22.2	2
Exports, GNFS	-5.8	6.4	-5	4	-9.4
Imports, GNFS	-4.6	7.9	-5.4	3.5	-8.9
Share of GDP
Private consumption	77.1	79.2	76.8	75.3	74.4
Government consumption	10	11.1	11.1	11	11.1
Fixed investment	21.1	21.2	20.8	20.6	20.6
Change in stocks	12.1	8.4	7.9	7.4	7.2
Total investment	33.2	29.6	28.7	28	27.9
Exports, GNFS	12.1	15.7	12.9	11	9.9
Imports, GNFS	32.7	37.4	30.8	26.1	23.7
Overall
Nominal GDP (USD billions)	11.2	12.6	15.5	20.1	21.6
Population (millions)	28.8	29.3	29.9	30.4	31
GDP per capita, current USD	388.1	431.1	518.9	661.1	697.3
Real per capita GDP growth	3.3	2.7	1.4	1.8	2.1
USD Fx rate	73.3	76	73.6	65	67.6

Source: Global Economic Prospects 2011; 2011 and 2012 are forecasts

Developing countries leading global recovery

According to the latest Global Economic Prospects 2011, global GDP (measured at 2005 market prices and exchange rates), which expanded by 3.9% in 2010, will slow to 3.3% in 2011, before it reaches 3.6% in 2012. Developing countries are expected to grow 7% in 2010, 6% in 2011 and 6.1% in 2012. They will continue to outstrip growth in high-income countries, which is projected at 2.8% in 2010, 2.4% in 2011 and 2.7% in 2012. The report notes that strong developing country domestic demand is leading the world economy but persistent financial sector problems in some high-income countries might threaten growth.

It notes that foreign direct investment (FDI) to developing countries  rose a more modest  16% in 2010, reaching  $410 billion after falling 40% in 2009. An important part of the rebound is due to rising South-South investments, particularly originating in Asia.

In many economies, dollar depreciation, improved local conditions, and rising prices for goods and services means that the real price of food has not risen as much as the U.S. dollar price of internationally traded food commodities. But, the report cautions that double-digit price increases of key staples in the past few months are pressuring households in  countries with an already-existing high burden of poverty and malnutrition. And, if global food prices rise further along with other key commodities, a repeat of the conditions in 2008 cannot be excluded.

The main short-term risks to the global economy include:

• the possibility of further market turmoil and contagion in Euro area sovereign debt markets;
• the possibility that very low interest rates in high-income countries induce a second boom-bust cycle among one or more developing countries; and
• the possibility that rising commodity prices threaten the recovery and or poverty reduction in developing countries.

About South Asia’s growth prospects, the report notes:

“The South Asia region is projected to post GDP growth of 7.9% on average over the 2011-2012 fiscal years, buoyed by vibrant growth in India. This compares with estimated growth of 8.7% in fiscal year 2010. The region benefited from aggressive demand stimulus measures, a revival in investor and consumer sentiment, and a resumption of capital inflows. A recent move toward tighter policy will likely need to be pursued further, given the region‟s high fiscal deficits (the largest among developing regions), high inflation and deteriorating current accounts.”

South Asia’s real GDP growth accelerated to an estimated 8.7 percent in FY2010-11 from 7.0 percent in FY2009-10, buoyed by very strong growth in India, which represents 80 percent of regional GDP. Excluding India, regional GDP growth (on a fiscal year basis) firmed, but to a more modest 5.1 percent from 4.3 percent the year before. On a calendar year basis, GDP for the region as a whole is estimated to have expanded 8.4 percent in 2010 after 5.3 percent in 2009, and to 4.8 percent in 2010 from 3.8 percent in 2009 if India is excluded.

In 2012, India, Pakistan and Bangladesh are  expected to grow at 8.7%, 3.8%, and 6.3%, respectively. Nepal is expected to grow at 4% in 2012.

Forecast summary, 2010-2012
Indicator	2010	2011	2012
South Asia
Real GDP	8.7	7.7	8.1
Real GDP (PPP)	8.7	7.7	8.1
Exports	7.4	8.8	10.3
Imports	6.2	9.4	10.3
Current account (%GDP)	-3.4	-2.9	-2.9
Developing Countries
Real GDP	7	6	6.1
Real GDP (PPP)	7.1	6.2	6.4
Exports	19.9	9.1	10.6
Imports	22	9.3	10
Current account (%GDP)	1.3	1	0.9
Nepal
Real GDP	3.3	3.7	4
Exports	6.4	5.6	7.3
Imports	6.8	6.3	6.9
Annual percentage change, unless indicated otherwise; 2011 and 2012 are estimates; table sourced on 2011-01-14