Nepal needs structural reforms to raise productivity and economic growth, says the IMF

The IMF, in its latest 2011 Article IV Consultation with Nepal, argues that Nepal needs to work on enacting structural reforms to raise productivity and potential growth. Nepal’s productivity growth has not kept pace with neighboring countries and lacks competitiveness. Furthermore, it notes that banking sector risks have intensified due to the proliferation of BFIs amidst weak supervision. Maintaining macroeconomic stability and managing financial sector risks are the two most challenging tasks of the Nepalese economy. The IMF thinks that the exchange rate with India is overvalued and is hampering Nepal’s competitiveness.

The report report notes that “living standards in Nepal have improved markedly over the past decade thanks to increased remittances, supportive social programs, and generally prudent fiscal policy that almost halved public debt as a share of GDP”. Here is a previous assessment by the IMF.

Prospects for 2011/12

• It expects the Nepalese economy to grow at 3.8 percent in 2011/12 (revised downward from preliminary estimate released in August), with good agriculture output compensating for subdued non-agriculture activity.
• Inflation is expected to be 8 percent due to an expected moderation in India’s inflation and a stabilization of commodity prices.
• The external current account deficit is projected to remain around 1 percent of GDP, but the import cover of foreign reserves is expected to decline.
• The target to limit net domestic financing to 2 percent of GDP might not be achievable due to moderate economic activity and a significant increase of current spending.
• Total revenue and grants are expected to be 18.3% of GDP, but expenditure is expected to be 21% of GDP.
• Net domestic financing is expected to increase to 3.3% of GDP from 2.8% of GDP in 2010/11.
• Money supply growth is expected to 11.1% from 9.5% in 2010/11.
• Gross investment is expected to be 32.8% of GDP and gross savings is expected to be 32% of GDP.
• Current account is expected to remain negative by around US$ 156 million. Trade deficit is expected to touch 24.4% of GDP. Exports growth is expected to be 9%, but imports growth are expected to be 10.8%.
• With the expected reserves, Nepal is expected to fund imports of goods and services of 5 months only, down from 5.4 months in 2010/11 and 6 months in  2008/09.

Performance in 2010/11

• Inflation has remained high, averaging about 9.5 percent in 2010/11.
• The balance of payments was under pressure for most of the year due to high oil prices, slowing remittances, and weakening competitiveness, though it ended with a modest surplus.
• The adoption of the budget by the Constituent Assembly was delayed by 7 months due to the political situation.
• Revenue and spending underperformed the budget targets, net domestic financing exceeded its target, and large losses were incurred by the Nepal Oil Company. Reflecting these developments and heightened stress in the banking system, growth slowed to 3.5 percent from 4.5 percent the previous year.
• Mixed progress was made in implementing policy commitments under the Rapid Credit Facility (RCF), approved in May 2010.
• In the banking sector, asset quality has deteriorated and liquidity pressures increased following the bursting of a bubble in the real estate market, to which banks are significantly exposed.
• In response, monetary policy eased and liquidity support was extended to institutions in stress, regulatory forbearance measures were implemented, and a widening of deposit insurance was announced. Restructuring of the weak state banks and reform of key bank legislation have been delayed.

Needed reforms

• Address the substantial risks in the financial sector with utmost priority. The existing regulatory forbearance is unsustainable.
• There is a need to strengthen supervision, regulatory environment, and banks’ corporate governance.
• Improving the central bank’s emergency liquidity facilities. Develop an effective crisis management framework that would facilitate timely intervention and resolution of problem banks.
• Strictly enforce the moratorium on new bank licenses.
• Timely adoption of the 2011-12 budget with an appropriate target for net domestic financing.
• Boost revenue by further strengthening administration and refocusing the tax structure toward domestic sources.
• Phase out unproductive subsidies while safeguarding pro-poor spending.
• Introduce an automatic fuel price adjustment mechanism to limit the losses of the Nepal Oil Corporation.
• The exchange rate peg has served Nepal well and continues to be a near-term policy priority, and safeguarding it requires a firmer monetary policy stance and targeted rather than blanket liquidity provision for solvent banks facing short-term pressures.
• The exchange rate appears overvalued, and stressed the importance of boosting productivity.
• If sustained and significant downward exchange-rate pressure were to emerge, preservation of official reserves and an adjustment of the peg would need to be considered.

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There are signs that the government will not and won’t be able to adhere to the recommendations of the IMF. Here are few examples:

• The call for a moratorium on new bank licenses will not be adhered to as the government has pretty much made up its mind to upgrade Sanima Bank to commercial bank category from development bank category. The priority should have been consolidation of BFIs in all the four categories. The recent banking troubles can be attributed to the large number BFIs amidst weak supervision and limited playing field, among others. Read my earlier long pieces on the same issue here and here.
• With the recent plan to integrate up to 6,500 Maoist combatants in the national army, provide rehabilitation package of Rs 0.6 million to Rs 0.9 million to a combatant depending on his rank, and cash incentive of half million to 800,000 million rupees to combatants opting out of integration as well as rehabilitation package, the government will need at least an additional Rs 10 billion on top of the amount allocated in the budget. It means the plan to stick net domestic borrowing to 2% of GDP (it was 2.8% of GDP in 2010/11) will be breached (also due to weak economic activities leading to low growth of revenue receipts and high growth of current expenditure). Donors have already signaled that they don’t have funds allocated for this new development.
• The banking sector reforms are slow. There still is not a dedicated fund or facility (something like the Troubled BFIs Relief Package) to look after troubled BFIs. Things are done in ad hoc basis.
• Keeping inflation below 10 percent will be a challenge because of the hike in transport prices; a potential hike in petroleum prices (India recently did it); high demand for diesel and petrol to run generators during the dry season when load-shedding could reach up to 16-19 hours a day, leading to high NOC losses plus increase in general prices as cost of production increase.
• With plans to introduce Employment Guarantee Scheme and a number of other employment-focused programs, there will be pressure on finding funding sources, given higher growth of recurrent expenditures than revenue receipts. The employment guarantee scheme could cost as much as 1.29 percent of GDP (or 2.14 percent of budget).
• The exchange rate won’t be changed even though it appears overvalued right now.
• The trade deficit is expected to further worsen without the needed industrial reforms to boost competitiveness of Nepalese exported items.

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Selected Economic Indicators (IMF estimate and projection)
	2008/09	2009/10	2010/11 (Est.)	2011/12 (Proj.)
Output and prices (annual percent change)
Real GDP	4.4	4.6	3.5	3.8
Non-agricultural GDP	4.1	5.4	3.1	2.9
CPI (period average)	12.6	9.6	9.5	8
CPI (end of period)	11.1	9	9.4	8.1
Fiscal Indicators (in percent of GDP)
Total revenue and grants	16.6	18	18.4	18.3
Expenditure	19.2	19	20.1	21
Expenses	16.4	16.1	16.8	17.7
Net acquisition of NFA	2.8	2.9	3.3	3.3
Net lending/borrowing	-2.6	-1	-1.8	-2.7
Net acquisition of FA	-0.4	-1	-1.2	-1.1
Net domestic financing	3	2	2.8	3.3
Money and credit (annual percent change)
Broad money	27.3	14.1	9.5	11.1
Domestic credit	27.1	16.8	13.2	15
Private sector credit	29	14.2	11.8	6.4
Velocity	1.6	1.6	1.7	1.7
Investment and saving (in percent of nominal GDP)
Gross investment	31.5	35.8	35	32.8
Private	24.6	28.6	27.1	24.8
Central government	6.9	7.2	7.9	8
Gross national saving	35.7	33.4	34.1	32
Balance of payments
Current account (in millions of U.S. dollars)	536	-378	-167	-156
In percent of GDP	4.2	-2.4	-0.9	-0.8
Trade Balance (in millions of U.S. dollars)	-2,707	-4,078	-4,474	-4,975
In percent of GDP	-21.1	-26	-24.4	-24.4
Exports value growth (percent change)	0.5	-6.1	13.9	9
Imports value growth (percent change)	14.1	36.4	10.4	10.8
Gross official reserves (in millions of U.S. dollars)	2,907	2,844	3,098	3,180
In months of imports of goods and services	6	5.4	5.4	5
Memorandum items
Public debt (percent of GDP)	39	36	34	35
GDP at market prices (in billions of Nepalese rupees)	988	1,171	1,327	1,487
GDP at market prices (in billions of U.S. dollars)	12.9	15.7	18.3	20.4
Exchange rate (Nrs/US$; period average)	76.9	74.5	72.4	…
Real effective exchange rate (eop, y/y percent change)	3.5	7.3	…	…

Imports substituting local production deficit in Nepal

Nothing surprising if you follow trade theory, but seeing it happen in real time is definitely interesting!

The Nepalese vegetable market is flooded with Indian veggies lately. Why? Because Nepal does not produce enough to satisfy local demand. Again, why so? Because of increasing urbanization and lack of local manpower (youth go abroad to work in the Gulf and other employment destinations creating shortage of labor). The substitution effect is in full swing in Kalimati veggie market. Veggies import from India and China (and even Bhutan) is gradually increasing.

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“Share of Nepali vegetables has been going down due to shortage of farm workers and growing housing and real estate in key farm areas,” Arjun Aryal, director of Kalimati Fruit and Vegetable Market Development Board  (KFVMDB), told Republica.

According to him, Nepal has been highly dependent on India for lemon, onion and pointed guard as production of these vegetables is nominal in the country.

Bharat Khatiwada, a trader in the Kalimati market, said the share of Indian vegetables in Kalimati has risen with every passing year. Vegetable from India is supplied directly to Kalimati market. However, Nepali farmers are supplying their produce to other cities in addition to the capital.

“Volume of Nepali vegetables is going down in Kalimati as farmers are looking for new and lucrative markets than Kathmandu where Indian suppliers are delivering their products directly to the Kalimati market,” said Khatiwada.  

According to KFVMDB, India-supplied vegetables make for 26 percent or 52,000 tons of the total arrival of vegetables in Kalimati during the fiscal year 2010/11. The share of vegetables imported from the southern neighbor was 25 per cent or 44,000 tons of the total arrival during the fiscal year 2009/10.

The board´s data shows that supplies of vegetables from China covered two percent or 4,000 tons during the fiscal year 2010/11, up from one percent or 1,760 tons recorded the previous year. Nepal has been importing garlic and onions from China whereas potatoes are the key import from Bhutan.

Similarly, Bhutan has been contributing one percent or 2,000 tons of the total supplies to the Kalimati market. Daily arrivals of vegetables to the Kalimati market averaged at 200,000 tons.

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Now, the question is what is happening to net welfare of Nepalese consumers? With rising domestic wages, low production, high imports, and high food prices, it won’t do justice to say consumer welfare is increasing! Both the market and nonmarket forces are at play here and are helping to keep prices sticky at high level. But, fundamentally, if consumers’ purchasing power increase then they will consumer even by importing if the domestic market cannot satisfy their demand. It can be good sometimes, but not always. As of now, with trade deficit over 20% of GDP, it may not be a good choice for Nepal.

The impact of internet on economic growth

James Manyika and Charles Roxburgh of the McKinsey Global Institute have a very interesting study about the impact of internet on economic growth and prosperity. They argue that the internet accounted for 21 percent of the GDP growth in mature economies over the past 5 years. If you include emerging economies of China, India and Brazil, then the internet contributed to 11 of GDP growth over the past five years.

Their research shows that internet accounts for, on average, 3.4 percent of GDP across the large economies that make up 70 percent of global GDP (13 countries). The total estimated worldwide contribution of internet is $1.672 trillion (2% of global GDP). If internet were a sector, then it would have a greater weight on GDP than agriculture or utilities.

Are we in an era of internet-led growth and prosperity? The study found that internet maturity like in the past 15 years correlates with an increase in real per capita GDP of $500 on average during the period. Quite interestingly, their survey also showed that 75 percent of the economic impact of the internet “accrued to traditional companies that would not define themselves as pure internet players”.

Furthermore, the study states that “while large enterprises and national economies have reaped major benefits from this technological revolution, individual consumers and small, upstart entrepreneurs have been some of the greatest beneficiaries from the Internet's empowering influence.”

What’s next?

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[…]we are still in the early stages of the transformations the Internet will unleash and the opportunities it will foster. Many more technological innovations and enabling capabilities such as payments platforms are likely to emerge, while the ability to connect many more people and things and engage them more deeply will continue to expand exponentially.

As a result, governments, policy makers, and businesses must recognize and embrace the enormous opportunities the Internet can create, even as they work to address the risks to security and privacy the Internet brings. As the Internet’s evolution over the past two decades has demonstrated, such work must include helping to nurture the development of a healthy Internet ecosystem, one that boosts infrastructure and access, builds a competitive environment that benefits users and lets innovators and entrepreneurs thrive, and nurtures human capital. Together these elements can maximize the continued impact of the Internet on economic growth and prosperity.

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Doing Business 2012: Nepal Edition

Doing Business 2012: Nepal
DB rank 2011	110
DB rank 2012 (out of 183 economies)	107
Improvement in ranking (position)	3
Topic ranking
Topics	DB 2012 Rank	DB 2011 Rank	Change in Rank
Starting a Business	100	95	-5
Dealing with Construction Permits	140	161	21
Getting Electricity	99	102	3
Registering Property	24	23	-1
Getting Credit	67	64	-3
Protecting Investors	79	74	-5
Paying Taxes	86	90	4
Trading Across Borders	162	161	-1
Enforcing Contracts	137	137	No change
Resolving Insolvency	112	113	1
Starting a Business
Indicator	Nepal	South Asia	OECD
Procedures (number)	7	7	5
Time (days)	29	23	13
Cost (% of income per capita)	37.4	21.6	4.7
Paid-in Min. Capital (% of income per capita)	0	19.1	14.1
Dealing with Construction Permits
Indicator	Nepal	South Asia	OECD
Procedures (number)	13	16	14
Time (days)	222	222	152
Cost (% of income per capita)	753.3	980	54.1
Getting Electricity
Indicator	Nepal	South Asia	OECD
Procedures (number)	5	6	5
Time (days)	70	145	103
Cost (% of income per capita)	1,995.80	1,775.90	92.8
Registering Property
Indicator	Nepal	South Asia	OECD
Procedures (number)	3	6	5
Time (days)	5	103	31
Cost (% of property value)	5	7.3	4.4
Getting Credit
Indicator	Nepal	South Asia	OECD
Strength of legal rights index (0-10)	7	6	7
Depth of credit information index (0-6)	3	3	5
Public registry coverage (% of adults)	0	1.7	9.5
Private bureau coverage (% of adults)	0.3	5.8	63.9
Protecting Investors
Indicator	Nepal	South Asia	OECD
Extent of disclosure index (0-10)	6	5	6
Extent of director liability index (0-10)	1	4	5
Ease of shareholder suits index (0-10)	9	6	7
Strength of investor protection index (0-10)	5.3	5	6
Paying Taxes
Indicator	Nepal	South Asia	OECD
Payments (number per year)	34	28	13
Time (hours per year)	326	281	186
Profit tax (%)	17.2	18.6	15.4
Labor tax and contributions (%)	11.3	7.7	24
Other taxes (%)	3	18.2	3.2
Total tax rate (% profit)	31.5	44.4	42.7
Trading Across Borders
Indicator	Nepal	South Asia	OECD
Documents to export (number)	9	8	4
Time to export (days)	41	32	11
Cost to export (US$ per container)	1,960	1,590	1,032
Documents to import (number)	9	9	5
Time to import (days)	35	33	11
Cost to import (US$ per container)	2,095	1,768	1,085
Enforcing Contracts
Indicator	Nepal	South Asia	OECD
Time (days)	910	1,075	518
Cost (% of claim)	26.8	27.2	19.7
Procedures (number)	39	43	31
Resolving Insolvency
Indicator	Nepal	South Asia	OECD
Time (years)	5	2.9	1.7
Cost (% of estate)	9	8	9
Recovery rate (cents on the dollar)	24.5	29	68.2

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In terms of ease of doing business, Nepal ranked 107 out of 183 countries. Last year, Nepal’s ranking was 110 (non adjusted figure was 116). It is quite an improvement in terms of easing doing business in the country. Most of the push is contributed by making property registration easy, by enacting measures to protect investors and by improving enforcement of contracts.The Finance Act 2008 has reduced the fee for transferring a property from 6 percent to 4.5 percent of the property’s value.In 2011 Nepal improved oversight and monitoring in the court, speeding up the process for filing claims. This is the only reform enacted in terms of easing procedures to do business this year.

Here is how Nepal compares with the regional average:

• Best regional performance in registering property -- ranked 24 overall (regional average is 123). In Nepal, you need 3 procedures, takes 5 days and costs 5% of property value to get a property registered. The corresponding figures for the region are 6, 103, and 7.3.

• In terms of protecting investors, Nepal’s performance in the region was the best -- ease of shareholder suits index (0-10) is 9 (regional average is 6).

• In terms of enforcing contracts, Nepal’s performance was the best in the region -- 39 procedures to enforce a contract (regional average is 43)

• Lowest regional performance in cost of starting a business -- 37.4 % of income per capita (regional average is 21.6% of income per capita)

• In the ten indicators, ranking climbed up in four of them (when compared to previous year): dealing with construction permits, getting electricity, paying taxes, and resolving insolvency.

More here