The perilous state of Nepal’s state-owned enterprises

A majority of the state-owned enterprises (SOEs) are running budget deficits for long time on top of mounting loan and debt. Only one or two SOEs are making profits mainly due to monopoly powers. As competition intensifies, these SOEs’ account might also go into the red. The top three politicized, corrupt, and perennially loss making SOEs are Nepal Electricity Authority (NEA), Nepal Oil Corporation (NOC), and Nepal Airlines Corporation (NAC). Keeping them alive with the existing management structure and operation system has meant choking development funding and widening fiscal deficit. All these SOEs had sizable profits before they became infested with corruption and a recruiting tool/job bank for political parties.

The solution is simple: adjust market prices according to international prices, and domestic demand and supply (for NEA and NOC); and for NAC it is just cleaning the entire enterprise with better management and less politicization.  To do this in a sustainable fashion, privatization is one potentially viable option. The other option is to break up monopoly  and monopsony powers of NEA and NOC and operate them under a PPP model with complete management and financial independence.

Below I detail the state of NEA, NOC and NAC. I will have further comments on this issue in later posts.

For electricity, per unit investment is NRs 8.97, but is sold at NRs 6.57 per unit (a loss of NRs 2.40 per unit). The NEA’s total income is NRs 1.5 billion but its yearly operating expense is NRs 1.65 billion. Its total loss is about NRs 19.47 billion, several times more than its total assets. It still needs to pay around NRs 500 million each to India and power contractors. More details here. It was running in profit until FY2058/59.

During fiscal year 2009/10 the annual peak demand reached 885.28 MW, a 8.96 percent growth over the peak demand in previous fiscal year. Annual energy demand recorded 4367.13 GWh out of which 3076.69 GWh was met by domestic power generation, 612.58 GWh was imported, and 667.860 GWh was managed through load-shedding (Nepal Electricity Authority 2010). Currently, power outages have reached up to 14 hours a day. Since supply of electricity is trailing behind demand for electricity by over 50 percent (on an average the demand is 900 MW, but supply is around 450 MW), especially during dry season, it has affected pretty much everyone in the country. Due to acute power crunch cost of production of industries is going up, cost competitiveness of Nepalese products is decreasing, industries are closing down, production is being winded down, a shortfall in domestic production is leading to an increase in imports of even the most basic goods and services (contributing to widening trade deficit), and future growth potential is being severely crippled. It will take years to make up for the lost growth potential due to the ongoing energy crisis even if the power outages are solved in five years time.

For fuel, NOC is running a deficit of NRs 15 billion. Right now, it is incurring a loss of NRs 8.1 in a liter of petrol, NRs 23.42 in a liter of diesel, NRs 13.61 in a liter of kerosene, and NRs 322.6 in a cylinder of LPG gas. It has been maintaining a profit of NRs 7.6 in aviation fuel.It means that the monthly loss is about NRs Rs 1.96 billion. Why so? Because NOC is beset with corruption, political infringement in management, poor governance, and poor accountability. The financial health of NOC is so worse that the no financial institution is willing to lend money to it against any guarantee. Recently, the government had to implore Employment Provident Fund (EPF) to lend NRs 2 billion and ask India to give NRs 3 billion line of credit to resolve fuel shortage for two months. It is just a very short term band aid to a recurrent problem, which needs structural adjustment (it may be painful).

NOC is probably the most politicized SOE in Nepal. Due to long running structural issues, mainly disinclination to adjust domestic fuel prices with international prices, NOC is running huge deficit. As I alluded to before, tt is a recurrent problem. It happened before, is happening now, and will happen in the future if the structural constraints underlying the poor performance of NOC, and market and labor rigidities are not addressed in time. Apart from stopping leakages and ensuring efficiency in the whole process, there is no option but to make domestic petroleum prices consistent with international prices.

The country cannot repeatedly bail out NOC by slashing development expenditure.  Unless we find an alternative to petroleum products, there is no simple fix. The demand for petroleum products is pretty much inelastic, so even if prices change, quantity demanded will not decrease. It means the contribution of imports of petroleum products on balance of trade deficit will continue unabated. Worse, long power outage is forcing firms to use petrol or diesel to run generators. This has further hiked demand, leading to higher imports. So, unless we address this situation, reduce dependence on petroleum products, and find alternative sources of energy, the problem will persist more rigidly that it had persisted in the past. The long term solution is to generate hydroelectricity by injecting large amount of investment sourced from both domestic and foreign sources. There is no easy fix unless we fundamentally change the way we have been producing and consuming energy in this country.

For airline, NAC has been embroiled in repeated scandals related to purchase of aircrafts, appointment of staffs, loans and so forth. It has been a recruiting tool for the major political parties. Its losses are mounting (over NRs 2 billion; its total asset is worth NRs 16.80 billion). It has just two big aircrafts (one was just repaired after months of grounding the plane at TIA) and three small aircrafts for domestic flights.  And it is running a budget deficit. At one time NAC was the pride of the nation. It had 21 aircrafts, including eight Twin Otters, two Boeing 727s and two 757s. It was also one of the biggest foreign currency earners. Unfortunately, at a time when domestic and international airlines are making profits by operating flights in Nepal, it is sad to see that Nepal Airlines is running a deficit again and again.

Nepalis prefer South Korea to the Gulf for employment

Proof: Just see the number of people lined up to submit application for Korean language test. Nepali workers get better facilities and salary in South Korea than in the Gulf. South Korea is taking 7100 Nepalis this year under its EPS program, which takes in workers from about 15 countries. Remittances have been the backbone of the Nepali economy. It amounts to almost 23 percent of GDP.

Signs of progress in Zimbabwe

Praveen Kumar over at the Africa Can…End Poverty blog writes:

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In the two years since the Government of National Unity (GNU) was formed and Zimbabwe dollarized fully, there have been encouraging developments on the economic front.

The economy grew at nine percent in 2010, following on six percent in 2009. Government revenues climbed to 29 percent GDP in 2010; they were just three percent of GDP in 2008. And the banking sector which had dis intermediated almost fully during the hyperinflation grew its dollar deposits briskly to around 30 percent of GDP at the end of 2010. But election talk has suddenly mushroomed in 2011, setting off political competition that could slow down Zimbabwe’s return to normalcy.

This good performance starts from a low base; the economy had contracted by more than 45 percent from 1999-2008. Furthermore, world prices of commodities, such as platinum, tobacco and gold, which are Zimbabwe’s main exports, have been on the rise. Weather has been good in the past two years. But the point is that Zimbabwe was able to make good use of these conditions. There was a supply response to high prices in agriculture and mining, and manufacturing showed signs of life. And importantly, some key economic institutions such as the revenue agency performed. These are the good economic genes.

The revival of agriculture goes against commonly held wisdom. Redistribution of erstwhile large commercial farms to indigenous Zimbabweans has been largely achieved. There is a widespread concern about disputed titles and insecure tenure. Yet smallholder agriculture appears to be moving.

The number of smallholder farmers in tobacco has increased sharply. Output of tobacco, maize, and cotton is recovering. The yields are nowhere near their previous levels. But then Zimbabwean agriculture has undergone a huge structural change and some yield losses, particularly those due to the reduction in average farm size, could be permanent. The ability of farmers to respond to price incentives is a strong signal that policy distortions in the sector are minimal and markets are functioning well. In the long run structural constraints could bind however.

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The Rise of the Rest

I just finished reading Fareed Zakaria’s book The Post-American World and the Rise of the Rest. It is quite an interesting and easy to read book. Zakaria, one of my favorite commentators, explores the rise of America, its declining power and the rise of the rest of the world (mostly few emerging economies like India, China, Russia, Brazil, South Korea, Japan and Turkey, among others). His main point, commonly sensed and very true, is that America’s superpower status (and ability to influence global diplomacy, economics and military power) is waning as the rest of the world rises, both economically and politically, but no country will replace America as the superpower. It will just have to live with a little bit of diminished influence (political and economic) but still will wield the most power to influence global politics and economics. To smooth out the transition, he recommends America to not be Britain (during its imperial rule and how it got diminished), but be Bismark, who tried to project Germany as the center of engagement in power (America has to become the pivot of world’s international system).

He tries to make a point that the world is in transition, both economically, politically and militarily. First, Britain (and the Western world) rose during the Industrial Revolution and made great strides in economic, technology, military and political fronts. Then the USA rose during the beginning of the 20^th Century and sidelined Britain’s global power. Now, the rest of the world is rising, which will wane America’s global influence, but will not depose it as the superpower. It will remain the sole superpower but will not wield the same power it had during and after the WW II.

Excerpts from the book:

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[…] The United States never could have arrived at such a position had there not been nations willing to lend it the money. That’s where the economic and political empowerment of the developing world—the “rise of the rest,” as I call it—comes in, and it’s best symbolized by the rise of China.

[…] The rise of the rest is at heart an economic phenomenon, but the transition we are witnessing is not just a matter of dollars and cents. It has political, military, and cultural consequences. As countries become stronger and richer, and as the United States struggles to earn back the world’s faith, we’re likely to see more challenges and greater assertiveness from rising nations.

[…] if properly managed, the rise of the rest need not be destabilizing. America is not sinking fast, about to be replaced by a single country. Everyone is, in a deep sense, in this crisis together. Other countries can play major stabilizing roles. And not just in economics.

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My disagreement with this otherwise excellent weekend reading is that on page 154 he argues that “Buddha was Indian, and Buddhism was founded in India, but there are virtually no Buddhists in the country today”. This is simply untrue. Buddha was born in Lumbini, Nepal. He went to Bodhgaya to meditate and became Buddha (previously, he was known as Siddhartha Gautam). And, yes, there are Buddhists in India. It is pretty puzzling and surprising how Zakaria could have made this mistake and not crosschecked facts and historical accounts.

Anyway, it is an excellent book. Light and pleasant reading for one fine weekend.

Food price inflation and poverty in South Asia

A new ADB study (Global Food Price Inflation and Developing Asia) finds that a 10% rise in domestic food prices in developing Asia, home to 3.3 billion people, could push an additional 64 million people into extreme poverty based on the $1.25 a day poverty line. Also, if the global food and oil price hikes seen in early 2011 persist for the remainder of the year, economic growth in the region could be reduced by up to 1.5 percentage points.

The report estimates that a 10%, 20% and 30% increase in food prices would increase percentage of poor by 2.0, 4.1, and 6.1 percentage points respectively in Nepal. This translates into 0.55, 1.10, and 1.65 million people respectively. This calculation is based on food price elasticity of poverty. To address food insecurity, the Nepali government has planned to import 100,000 tons of rice (to be financed by WFP) and is releasing 30,000 tons of rice allocated for food deficit mid-and far-western regions. It is also subsidizing food prices at government depots.

The table shows corresponding figures for the other countries in South Asia (excluding Afghanistan and Maldives). It looks like rural India would have the largest impact of food price inflation on poverty. Sri Lanka faces the least impact (among South Asian countries) by food price inflation.

Food prices and poverty (USD 1.25-a-day poverty line) in South Asia
ADB 2011 estimate	Change in percentage of poor (in percentage points) with an increase in food prices by			Change in number of poor (in millions) with an increase in food prices by
	10%	20%	30%	10%	20%	30%
Bangladesh	2.5	5	7.5	3.83	7.65	11.48
Bhutan	1.8	3.5	5.3	0.01	0.02	0.03
India—Rural	2.9	5.8	8.8	22.82	45.64	68.45
India—Urban	2.1	4.3	6.4	6.68	13.36	20.04
Nepal	2	4.1	6.1	0.55	1.1	1.65
Pakistan	2.2	4.5	6.7	3.47	6.94	10.41
Sri Lanka	1.2	2.4	3.6	0.24	0.47	0.71

The report notes that production shortfalls caused by bad weather along with the weak US dollar, high oil prices and subsequent export bans by several key food producing countries have caused much of the upward global price pressure since last June, with double digit increases seen in the price of wheat, corn, sugar, edible oils, dairy products and meat. Rice prices are likely to continue their uptrend as the effects of La Niña persist, prompting consumers to seek less costly and less nutritious substitutes. Persistent structural and cyclical factors such as rising demand for food from wealthier emerging economies, changing diets, competing uses for food grains, shrinking available agricultural land, and stagnant or declining crop yields, are also causing the upward pressure.

In the longer term, structural adjustments are needed to secure food supplies. These include measures to improve crop productivity, increased infrastructure investments (e.g. irrigation and food transport/storage), stronger market integration, and closer global/regional cooperation on food production and supplies. Countries should refrain from export bans on food items.

Meanwhile, a different study by Maros, Martin and Hassan (2011) of the WB found that the food price rise of 2010-11 led to an average poverty change of 1.1 percentage points in low income countries and 0.7 percentage points in middle income countries. The net increase in poverty was 44 million people (falling below the $1.25 per day extreme poverty line).

A loner Paul Krugman!

New York magazine has an interesting profile of one of my favorite economists, Paul Krugman. The author portrays Krugman as a loner trying to counter unrealistic conservative ideas and policies from the left.

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[…] For Krugman, the path forward was perfectly clear: The only way to avert a deepening crisis was massive Keynesian stimulus. During the nineties in Japan, he had seen the nightmare alternative. Officials in Tokyo, faced with a very similar scenario, had done too little to stimulate the economy, again and again, and as their nation’s recovery stumbled, they found they were toggling an unplugged joystick.

[…] Paul Krugman is a lonely man. That he is comfortable in his solitude, that he emphasizes its virtues, that his intelligence gives it a poetic gloss, none of this diminishes the poignancy of his isolation. Krugman grew up an only child and is deeply self-conscious. He will list his shortcomings as though he’d been preparing for the chance: “Loner. Ordinarily shy. Shy with individuals.” He is married but has no children nor—rare for a Nobelist—many protégés. When I asked him if there were any friends of his I could talk to in order to understand him better, he hesitated, then said, “That’s going to be hard.”

[…] Krugman had begun the work that would eventually win him the Nobel Prize—an aggressive revision of international trade theory—by the time he was in his mid-twenties, and so for nearly all of his adult life he has had good evidence for the proposition that he is smarter than just about everyone else around him, and capable of seeing things more clearly. Krugman is gleeful about being right, joyous in the revelation of his correctness, and many of his most visible early fights were with free-trade skeptics on the left. Of Robert Reich, for instance, Krugman wrote: “talented writer, too bad he never gets anything right.” He was a liberal and a Democrat, but even in 1999, when he was hired by Howell Raines to write his Times column, “I still saw equivalent craziness on both sides.”

[…] But Krugman’s writing voice—sarcastic, data-driven, flecked with just a little bit of maybe-there’s-a-bomb-in-the-wastebasket zeal—was perfect for the Internet. His self-certain empiricism matched liberal vanities as precisely as Rush Limbaugh’s stagy authenticity matches conservative ones, and he became a vehicle for the concentrating energies of the progressive generation of 2006.

[…] I ask Summers what he thinks is Krugman’s underlying complaint with the Obama administration. “Paul may be the smartest and most creative applied economic thinker of this era,” he says, “but there is some element of him that is like the guy in the bleachers who always demands the fake kick, the triple-reverse, the long bomb, or the big trade.”

The two economists have known each other since the late seventies, when they were both graduate students in Cambridge, and there were moments in conversation with Krugman that I began to suspect he viewed Summers as a one-man control group for his study of himself. They each share a high assessment of the other’s intellect (“Larry’s extremely smart—ask him and he’ll tell you,” Krugman says). Krugman’s sense of humor is built upon self-deprecation, and sometimes Summers’s sense of humor is built upon deprecating Krugman, too. In the early eighties, when the two worked together in the Reagan administration, Krugman realized that Summers had a talent for effectiveness—winning meetings, organizing subordinates, convincing economic novices of his point of view—that he himself could not hope to match. Summers became the insider and Krugman the outsider.

[…] I brought up the work of the legal scholar Cass Sunstein, now with the Obama administration, who has studied the radicalizing effects of ideological isolation—the idea, born from studies of three-judge panels, that if you are not in regular conversation with people who differ from you, you can become far more extreme. It is a very Obama idea, and I asked Krugman if he ever worried that he might succumb to that tendency. “It could happen,” he says. “But I work a lot from data; that’s enough of an anchor. I have a good sense when a claim has gone too far.”

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How agriculture supports structural transformation?

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“After 20 years of neglect by international donors, agriculture is now again in the headlines because higher food prices are increasing food insecurity and poverty. In the coming years it will be essential to increase food productivity and production in developing countries, especially in Sub-Saharan Africa and with smallholders. This however requires finding viable solutions to a number of complex technical, institutional and policy issues including land markets, research on seeds and inputs; agricultural extension; credit; rural infrastructure; storage; connection to markets; rural nonfarm employment and food price stabilization. This paper reviews what the economic literature has to say on these topics. It discusses in turn the role played by agriculture in the development process and the interactions between agriculture and other economic sectors; the determinants of the Green Revolution and discuss the foundations of agricultural growth; issues of income diversification by farmers; approaches to rural development; and finally issues of international trade policy and food security which are at the root of the crisis in agricultural commodity volatility in the past few years.”

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Read the full paper by Dethier and Effenberger (2011). Structural transformation is usually thought of as moving labor and production from agriculture to industrial sector. Development of agriculture sector would facilitate structural transformation. But, development of agriculture itself plays a vital role in bringing about structural transformation. They key is to raise productivity by using a range of factors, such as new technologies, farm size and access to land. The most difficult are institutional challenges related to market failures, missing markets and property rights. They argue that because agriculture links to small cities and rural areas, it can also be an engine of growth and provide employment opportunities for the rural non-farm economy.