Assessment of Nepali economy by the IMF (2012/13)

The IMF has just released the preliminary findings and recommendations 2012 Article IV Consultation discussions.The usual narrative about economic growth, expenditure concerns, and sustainability of economy by remittances holds.

Macroeconomic outlook remains challenging. Strong agriculture production and growth in services sector boosted real GDP growth to 4.6 percent despite fledging industrial sector. Non-food and services (mostly of imported nature) prices exerted more pressure on inflation last year as a result of depreciation of currency and increase in fuel prices. High remittance inflows has contributed to keeping current account and balance of payments in surplus. Lower fiscal deficit than expected points to the inability to spend on capital projects. Good revenue mobilization helped keep deficit and public debt on a stable footing.

Here is the outlook for short term:

• GDP growth expected to decline due to late monsoon, continued weakness in industrial output and slow growth in India.
• Inflation is likely to miss targets and remain at around 8-9 percent range.
• BoP surplus is likely to decline as growth of remittances moderates.
• Delay in adopting a full-year budget for 2012/13 could further dampen investment and growth.
• A full-year budget—limiting the deficit to about 2 percent of GDP, consistent with macroeconomic and debt sustainability—should be adopted as soon as possible.
• High levels of capital spending to meet Nepal’s pressing infrastructure needs and support medium-term growth. But, its challenging.
• Further strengthening of tax administration and collection will be vital, as will a focus on collecting arrears.
• Tighter expenditure management and cash planning will also be key to ensuring that government and donor-supported investment projects are implemented.
• Large losses of NOC and NEA are unsustainable.
• Recommends adoption of an automatic price adjustment mechanism to contain losses of NOC.
• The exchange rate peg to the Indian rupee should remain the key monetary policy priority. It means maintaining interest rates higher than in India.
• Excess liquidity generated by strong remittance growth in 2011/12 should be mopped up by tightening monetary policy.
• Weak supervision, liberal licensing policy in previous years and exposure to real estate sector remains a risk for financial sector. NRB’s corrective steps have been useful in containing spread of risks.
• Implementation of revised NRB Act to allow for swift intervention of problem banks, rigorous implementation of the prompt corrective action framework, and strengthened supervision and enforcement of prudential regulations.

Very brief but entirely appropriate diagnosis and recommendations by the IMF. You will have to wait for the full 2012 Article IV Consultation report to dig deeper into these issues.

Last year, the IMF recommended the government to boost productivity to stay competitive. Some of the recommendations remain the same.

Reforming power sector: Right tariff with right management

World Bank economists and energy specialists argue that the solution to blackouts in India is to reflect cost of production in power tariffs (prices) and efficient management of and by power companies (plugging in leakages, expanding access to energy, good customer services, proper maintenance). It happened in Gujarat, West Bengal (public enterprise) and Delhi (private enterprise). The suggestions are quite pertinent to the ongoing works in reforming Nepal's troubled NEA (after tariff rationalization).

Below are excerpts from the article:

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At their heart, blackouts boil down to two issues: underutilised capacity and insufficient capacity. The former is a result of inadequate maintenance of old plants and the persistent shortage of domestic coal. This can be resolved by using imported coal. But that is very expensive and the additional cost does not get reflected in tariffs.  For their part, most distribution companies have resorted to load shedding, rather than buying surplus short-term power, on account of their dire financial position.

Insufficient capacity requires a long-term solution. The financial viability of State utilities is a pre-condition for attracting investments in this sector. This requires a coherent set of actions involving reductions of system losses, adequate tariffs that are revised at regular intervals and transparent competitive bidding for new investments.

Fortunately, we don’t have to look far for solutions. India has a number of examples of public (Gujarat, West Bengal) and private (Mumbai, Delhi) power sector companies that have good management practices, are well regulated, provide homes and industries with uninterrupted power supply and earn reasonable profits.

So what have these states done differently? First, they have significantly reduced their transmission and distribution losses, which devour a third of the power in other states. These companies upgraded their networks and cracked down on power theft, which enabled them to generate additional revenues that further improved operations.  Note that peak power deficits in May 2012 were just 1% in West Bengal and 1.2% in Gujarat, as compared to 9.2% in the rest of India.

Second, these states have increased tariffs at regular intervals and consumers pay higher tariffs in return for regular, high-quality power supply. In Gujarat, for instance, consumers pay Rs. 5.3 per unit of power; in Mumbai, Rs. 5.86; and in West Bengal, Rs. 5.78. While these tariffs are only 10% higher than average tariffs in other states, lower losses and better efficiency imply that these companies are profitable.

So where can other states begin from? Power utilities in other states must reduce their financial losses through sound management practices and tariff rationalisation. But consumers will rightly demand regular power supply with better voltage before they are willing to pay a higher tariff. West Bengal demonstrated the importance of earning credibility with consumers before raising tariffs. Just three years after improvements in power supply and energy access, improved customer service and negligible dependence on state subsidies, the utility got approval for the required tariff increase under the new government. Similarly, in Delhi, private distribution companies were incentivised to reduce losses in a time-bound manner during the reform period, before receiving a tariff hike.

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 More here.

Per capita GDP after correcting for government inefficiency

In a new research note, WB's Francesco Grigoli and Eduardo Ley argue that correcting for wastage of government inputs from GDP would "significantly" reorder the living standards rankings. Below is the abstract of the paper (full text here).

It is generally acknowledged that a government's output is difficult to define and its value is hard to measure. The practical solution adopted by national accounts systems is to equate output value to input costs, but well-documented inefficiencies in government activities make this approximation questionable. One solution is to purge from gross domestic product (GDP) the fraction of government inputs that is wasted. This note illustrates such a correction, computing corrected per capita GDP on the basis of two studies that estimate efficiency scores for several dimensions of government activities. Results show that the correction could be significant and reorder the rankings of living standards.

The percentage of GDP losses due to public waste in education and health is estimated as high as 4.2 percent for Brazil!

Links of Interest (2012-09-18)

Promoting social mobility (Equity and efficiency can be achieved by focusing investments in the early years, while also following up with later investments.)

Lesson from Japan: Do low interest rates boost growth? (Supply alone won't do anything if there is no demand for it. Low rates hardly boost "private demand, private risk-taking or entrepreneurship" if the economy is largely dependent on revenue externally, i.e. from exports, where economic conditions have nosedived.)

Nepali private sector in interested in PPP in agriculture sector

The private sector body also said the existing policy does not address the risks inherent in engaging the private sector in the farm sector and as a result, the country has not been able to take advantage of the opportunities in the agriculture sector. NCC urged the government to bring a policy that facilitates both the private sector and farmers to market access, provide loans in nominal interest rates, set up organic and chemical fertiliser factories, among others.

IRs 100 = NRs 168 in informal market (Officially, NRs 1.60 is pegged at IRs 1. The main reasons are high demand for IRs arising from increasing imports and cross-border smuggling of IRs.)

Traders attributed this surge in IC value in the black market to increasing smuggling of goods that created shortage of the currency. They said smuggling of sugar, food items, readymade garment and shirting and suiting, among others, has surged ahead of the festivals. Smuggling of motor parts, hardware and electronics are also on the rise.

NEA to hold study on 10 storage-type projects

The Nepal Electricity Authority (NEA) has selected 10 storage-type hydropower projects with a collective capacity of 2,652MW to carry out a feasibility study. The 10 projects are among the 31 projects approved by the Japan International Cooperation Agency (JICA) for further study. NEA had conducted a pre-feasibility study on 65 projects last year under the funding JICA, of which 31 projects were approved, NEA officials said.

The 10 projects are Madi Khola (199 MW), Lower Jhimruk (142 MW), Nalsinghgadh (400 MW), Chehera-I (149 MW), Naumure (245 MW), Dudhkoshi (300 MW), Sunkoshi-III (536 MW), Khokhajor (111 MW), Adhikhola (180 MW) and Lower Badhigad (380 MW).

NEA so far has issued survey licences to independent power producers for projects with a collective capacity of 11,645MW electricity, but all the projects are ROR type.

NEA is also studying 14 projects with total capacity of about 4,000MW. Of them, 11 are storage-type projects.

Supply intervention:  MoCS giving PEs Rs 35.8m to ensure smooth supply of food commodities

The Ministry of Finance (MoF) has agreed to provide Rs 35.8 million to the Ministry of Commerce and Supplies (MoCS) for providing direct subsidy to state undertakings involved in the supply of food commodities, keeping in view the upcoming festivals. Breaking the tradition of cross subsidy system under which state-owned enterprises were given tax and other privileges to enable them recoup the loss while dealing with subsidized goods, the MoCS first time is providing direct subsidy to public enterprises (PEs). The MoCS adopted new subsidy system after PEs reported loss while trading commodities like rice, sugar, salt and goats, among others, during last year´s festive season.

Under the proposed subsidy, NFC, STC and NTL will have to sell rice, salt and sugar at rates lower by Rs 5, Rs 2 and Rs 5 per kg respectively compared to market price.

Govt fails to implement MRP: Consumer activists termed the move just a 'publicity propaganda'

The government failed to publish maximum retail price (MRP) in Nepal Gazette (Rajpatra) today, as it has promised. Ministry of Commerce and Supply Management has promised to publish it today in the Gazette that could ensure the implementation of the MRP from today.

“There has been not any preparation to publish it in the Nepal Gazette ,” said secretary of the Ministry of Law, Justice, Constituent Assembly and Parliamentary Affairs Bhesh Raj Sharma.

“No file has reached the ministry related to maximum retail price,” he added. According to the process, concerned ministry should forward the file to Ministry of Law, Justice, Constituent Assembly and Parliamentary Affairs to publish notice in the Gazette.

According to the Clause 1 of Essential Commodities Control (Authorisation) Act 1961, the government decision on maximum retail price becomes effective only after the publication in Nepal Gazette.

Trade facilitation matters!

Economists celebrate trade not only because they love watching ships cross the Pacific and cargo planes land at Paris Charles-de-Gaulle but also because increased trade demonstrably raises income and improves living standards. This column argues that a powerful way to boost trade is by focusing on trade facilitation, i.e. improving both hard infrastructure like ports and railways, and soft infrastructure such as shipping logistics.

India's economic slowdown reflects both structural and cyclical factors

Post MDGs development priorities and assistance

Dani Rodrik assesses the relevant of MDG indicators and the global development or assistance framework in the post-MDG era:

Contribution of MDGs:

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[…]Clearly, however, the MDGs were a public-relations triumph, which is not to belittle their contribution. Like all worthwhile PR efforts, the MDGs served to raise awareness, galvanize attention, and mobilize action – all for a good cause. They amplified the global conversation about development and defined its terms. And there is evidence that they got advanced countries to pay more attention to poor nations.

Indeed, the MDGs possibly had their clearest impact on aid flows from rich to poor countries. A study by Charles Kenny and Andy Sumner for the Center for Global Development in Washington, DC, suggests that the MDGs not only boosted aid flows, but also redirected them toward smaller, poorer countries, and toward targeted areas like education and public health. However, aid was not directly linked to performance and results, and it is much more difficult to know whether it had the desired impact overall.

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Recommendations for the post-MDG development framework:

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[…]First, a new global compact should focus more directly on rich countries’ responsibilities. Second, it should emphasize policies beyond aid and trade that have an equal, if not greater, impact on poor countries’ development prospects.

A short list of such policies would include: carbon taxes and other measures to ameliorate climate change; more work visas to allow larger temporary migration flows from poor countries; strict controls on arms sales to developing nations; reduced support for repressive regimes; and improved sharing of financial information to reduce money laundering and tax avoidance.

Notice that most of these measures are actually aimed at reducing damage – for example, climate change, military conflict, and financial crime – that otherwise results from rich countries’ conduct. “Do no harm” is as good a principle here as it is in medicine.

This kind of reorientation will not be easy. Advanced countries are certain to resist any new commitments. But most of these measures do not cost money, and, as the MDGs have shown, setting targets can be used to mobilize action from rich-country governments. If the international community is going to invest in a bold new public-relations initiative, it might as well focus on areas where the potential payoffs are the greatest.

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On the post-MDG era, here is a link to a presentation based on Nepal country study for the forthcoming European Report on Development 2012/13.

Shashi Tharoor argues that the next focus should be in Goal 8, which calls for a “global partnership for development” with four specific targets: “an open, rule-based, predictable, non-discriminatory trading and financial system”; special attention to the needs of least-developed countries; help for landlocked developing countries and small island states; and national and international measures to deal with developing countries’ debt problems.”

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[…]The time has come to reinforce Goal 8 in two fundamental ways. Developed countries must make commitments to increase both the quantity and effectiveness of aid to developing countries. Aid must help developing countries improve the welfare of their poorest populations according to their own development priorities. But donors all too often feel obliged to make their contributions “visible” to their constituencies and stakeholders, rather than prioritizing local perspectives and participation.

[…]We must change the way the world goes about the business of providing development aid. We need a genuine partnership, in which developing countries take the lead, determining what they most acutely need and how best to use it. Weak capacity to absorb aid on the part of recipient countries is no excuse for donor-driven and donor-directed assistance. The aim should be to help create that capacity. Indeed, building human-resource capacity is itself a useful way of fulfilling Goal 8.

Doing so would serve donors’ interest as well. Aligning their assistance with national development strategies and structures, or helping countries devise such strategies and structures, ensures that their aid is usefully spent and guarantees the sustainability of their efforts. Donors should support an education policy rather than build a photogenic school; aid a health campaign rather than construct a glittering clinic; or do both – but as part of a policy or a campaign, not as stand-alone projects.

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Inflationary pressures on Nepali economy

It was published in Nepali Times, ISSUE #622 (14 SEPT 2012 - 20 SEPT 2012).

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Sticky prices

Steep inflation and mounting food prices will leave a big dent in Nepalis' wallets this festive season

In its its latest annual macroeconomic update, the central bank estimated inflation to be at 8.3 per cent, higher than the seven per cent target set in the budget and monetary policy for 2011-12. Nepalis who are struggling to cope with rising prices, especially food prices, find this figure hard to digest. Inflation is eroding people's purchasing power, who spend around 65.1 per cent of their consumption expenditure on food, and is hitting low income earners
the most.

The central bank's figure is low because it gives 46.82 per cent weight to food prices and 53.18 per cent to non-food and services prices while determining inflation, which means that non-food prices have more influence on inflation. Such practice is inconsistent with a recent research that that shows hike in food prices contributes about three-fourths of overall inflation.

The price movements, especially of food items, in the huge informal economy and the current debatable weight given to food and non-food items mean that official inflation figures underestimate the actual prices people pay in the market every day. The central bank's figures which show a decline in food and beverage inflation from 14.7 per cent in 2010-11 to 7.7 per cent in 2011-12 do not reflect reality.

Prices in Nepal have historically moved in tandem with prices in India, thanks to our pegged exchange rate and huge volume of imports. About one-third of price variability here is determined by prices in India. After 2007-08, when the global economy was struck by food, fuel, and financial crises, prices in Nepal started to remain stubbornly sticky at high level. It showed one directional changes only in response to food production and availability domestically, ie when supplies went down, prices went up. But when supplies moderated, prices remained sticky at high level. What happened?

As monetary policies (money supply and interest rate) have little traction on inflation in Nepal, supply side constraints and oil prices are weighing heavily on food and non-food prices. Since aggregate consumption has always been high (about 90 per cent of GDP) for a long time, there is very little extra pressure coming from demand side. Major pressure is exerted by supply side factors along with unjustified price speculation and rigging of product and factor markets by middlemen.

First, some wholesalers have deliberately withheld stocks to bump up prices in order to earn abnormal profits on the eve of Dasain and Tihar when the demand for essential food and non-food items is pretty much price inelastic (demand hardly changes with respect to changes in prices).

Second, though recurrent bandas temporarily disrupted distribution of essential items, wholesalers and retailers capitalised on the strikes to stick to higher prices even after the normalisation of supplies. Third, middlemen are distorting prices and calculatingly keeping them high. For instance, transportation cost and some leakages do not fully justify more than 50 per cent increase in prices of fruits and vegetables after they reach Kalimati from Dharke of Dhading. Powerful politically affiliated middlemen and associations act both as monopsonists (only they purchase food from farmers), and monopolists (only they sell food to wholesalers), in effect depriving farmers of the true price by stifling competition and also burdening consumers with artificially inflated prices.

Fourth, each time supply disruption occurs and oil prices are raised, there is inflationary expectations in the market, especially among retailers who preemptively up prices and keep it higher than the norm of taking 10 to 20 per cent profit only.

Fifth, the frequent hike in fuel prices and load-shedding hours have increased cost of production, which are ultimately reflected in the retail prices. Such fluctuations affect costs at production site, distribution chains, and retail stores. Furthermore, the continually rising imports of goods, especially those from outside of India, and the depreciation of the Nepali rupee have further pushed up prices.

Now, what can the government do about this?

For imported goods, there is little it can do to influence prices because they are determined externally. For those goods produced and sold domestically, especially food items, there is no other option but to strictly supervise distortionary activities by the movers and shakers of the market. It means clamping down on middlemen, setting up fruit and vegetable wholesale markets in strategic shopping locations, monitoring retail prices, and booking those who deliberately withhold supplies against the existing supply policies. Furthermore, the government could also lower import tariffs on food items, raw materials, and intermediate goods.

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Impending rise in food prices in South Asia

With late and low monsoon in South Asia and droughts in major food producing and exporting countries, there are worrying sings that food prices might escalate in the coming months. The FAO Food Price Index averaged 213 points in July 2012, up 12 points from June. Though this is still less than the peak of 238 points reached in February 2011, the point is that overall food prices have started to increase again due to upward price pressures coming from grain, sugar and oil/fats prices. This has come amidst disappointing news about monsoon rains, and floods and droughts in major grain producing nations. South Asia will get particularly affected by this as festival season, when demand for daily consumed food items is higher than normal times, is just around the corner in India, Nepal and other countries in the region.

In its August food price update, the FAO stated that the adverse maize and corn production prospects in the US due to droughts and setback in wheat production in Russia, Kazakhstan, and the Ukraine (which accounts for nearly a quarter of global wheat export) amidst projected sharp rise in demand from livestock sector are driving prices upward. Furthermore, untimely rains in Brazil, the largest sugar exporter in the world, have raised concerns about sugarcane production and its prices in the coming months.

In South Asia, India, which is also the largest producer and exporter of food items, had 21 percent less rainfall than average. The Indian government is considering releasing grains stored in government warehouses around the country. In Nepal, agriculture production is projected to be lower than last year’s due to late and low monsoon and the shortage of fertilizers during peak planting season. Other countries in the region also are one way or the other affected by late monsoon, floods and droughts this year. Consequently, the prospects of high food prices are real and will impact food security situation in the region.

Keeping in mind the impending rise in food prices during and after the festival season, South Asian nations need to be prepared to take actions both at national as well regional level. First, emergency release from stock should be the priority to stabilize prices. Second, market imperfections arising from rigging of prices by middlemen or cartels should be monitored. Third, building crucial agriculture infrastructure such as irrigation and roads for market access also helps as only about one-fifth to two-fifth of farmers are “significant participants” in agriculture markets. Fourth, targeted food subsidies and social protection programs should be designed and implemented well in advance. Fifth, large grain producing and exporting nations like India should refrain from export bans as the other countries in the region are net food importers.

Additionally, realizing the destabilizing impact of droughts on global grain production and contribution to keeping prices high since 2007, in a recent report the FAO highlighted the “need for to transform the way water is used- and wasted- throughout the entire food chain”. Conserving water by using it more “sustainably and intelligently”—such as modernization of irrigation, better storage of rainwater at farm level, recycling and re-using, pollution control, and substitution and reduction of food waste— will not only help boost food production and stocks, but also is an important climate change adaptation strategy. As 75 percent of South Asia’s poor people live in rural areas and depend on rain-fed agriculture, changing the way water is used in agriculture is crucial for supporting livelihoods, sustainably boosting production and controlling food prices. Globally, one-third of food for human consumption is either lost or wasted.

South Asian governments need to closely monitor the prospects for rapidly spiraling food prices and implement appropriate remedial measures as and when required. Else, it will once again push thousands of people below the poverty line, increase vulnerability and heighten food insecurity.

Also, see Trade & Development Monitor, August 2012.