CBS projects Nepal's GDP to grow at 4.0% in FY2021

On 30 April 2021, Central Bureau of Statistics (CBS) estimated that Nepal’s economy will likely grow by 4% in FY2021, up from 2.1% contraction in FY2020 (this is revised estimate). The projected growth rate is far less than the government’s target of 7% owing to the severe impact of COVID-19 pandemic on economic activities and mobility of labor and capital. If we factor in the base effect, there is hardly any steam left in the economy in FY2021. The data is based on latest rebased national accounts, which are now reported in FY2011 prices instead of FY2001 prices.  FYI, fiscal year (FY) starts from mid-July of t-1 year and ends on mid-July of t year (for instance, FY2021 refers to the period between mid-July 2020 and mid-July 2021). 

According to FY2020 revised data, while industrial and services output contracted by 3.7% and 4.0%, respectively, agricultural output increased by 2.2%, which is lower than 5.2% in FY2019, owing to delayed monsoon, shortage of chemical fertilizers, use of substandard seeds, and an armyworm invasion. A country-wide lockdown in Nepal started on 24 March 2020 (which was towards the end of second month of third quarter) and lasted well into the fourth quarter. Lockdown was relaxed in September 2020. The country did not fully open at least until the end of 2020 (international travel remains restricted though).

Overall, in FY2021, agricultural, industrial and services sectors are projected to grow at 2.6%, 5.0% and 4.4%, respectively. Agricultural sector will likely contribute 0.8 percentage points, industrial sector 2.4 percentage points, and services sector 2.4 percentage points to the overall projected GDP growth of 4.0%. These projections are based on eight to nine months data and the assumption that economic activities will gradually pick up from mid-May 2021. 

Several local administrations imposed lockdown in April 2021 in response to the increasing number of Covid-19 cases as the second wave sweeps the nation. The CBS made the latest projections based on the (unrealistic) assumption that lockdowns and economic activities will ease after two weeks and that there will be substantial improvement in accommodation and food service activities (basically, domestic tourism). Given the unrealistic nature of this assumption and that most of the economic activities typically happens in the last two quarters of fiscal year, the actual growth estimate will likely be revised downward in subsequent revisions. In fact, it may actually either show contraction or near zero growth.

Agricultural output is projected to grow at 2.6%, up from 2.2% in FY2020, largely due favorable monsoon and a surge in agricultural labor (lockdowns forced reverse migration and contributed to more migrant workers’ engagement in agricultural work) having a positive effect on paddy output. 

Industrial output is projected to grow at 5.0%, up from a contraction of 3.7% in FY2020. Within industrial sector, electricity, gas and air conditioning subsector is expected to grow by 7.7%, down from 25.6% growth in FY2020 (this was due to substantial addition of new hydroelectricity to the national grid). All other industrial activities are expected to grow at a modest pace, mainly thanks to the base effect. 

Mining and quarrying activities are estimated to grow by 7.5%, up from a contraction of 2.2% in FY2020 as mining and quarrying of stones, sand, soil and concrete affected by the lockdowns were allowed to operate as restrictions eased. A boost in construction activities is expected to positively affect mining and quarrying as well. Construction activities are projected to grow by 5.6%, up from 5.0% contraction in FY2020 as supplies of construction materials normalize, and households, commercial and infrastructure projects pickup pace after a slack last year. 

Manufacturing activities are projected to increase by 3.9%, up from 8.6% contraction in FY2020. In addition to the COVID-19 related lockdowns and containment measures, manufacturing sector has been suffering from low private sector investment, and loss of both domestic and external markets due to eroding cost and quality competitiveness. Stable supply of electricity and improved industrial relations were not sufficient to drastically boost manufacturing output as expected. Manufacturing activities may not actually recover to the pre-pandemic level in the short-term. 

Electricity, gas, steam and air conditioning supply is expected to increase by 7.7%, down from 25.6% growth in FY2020, on expectation that a part of Upper Tamakoshi hydroelectricity projects will come online by mid-July 2021. Water supply, sewerage, waste management and remediation activities are expected to increase by 1.6%, down from 2.1% growth in FY2020, thanks to the expected supply of drinking water to households from the Melamchi water supply project. Both Upper Tamakoshi and Melamchi proejcts have faced multiple time and cost overruns. 

Services output is projected to grow at 4.4%, up from 4% contraction in FY2020. Last year, wholesale and retail trade; transport and storage; and accommodation and food service activities within services sector contracted as these high-contact activities were severely affected by lockdowns and social distancing rules. There was also a drastic drop in import and sale of agricultural and industrial goods. In FY2021, however, the CBS is projecting these subsectors, which together account for 22% of GDP, to bounce back (although much of it will be base effect, which refers to the tendency of achieving an arithmetically high rate of growth when starting from a very low base). Wholesale and retail activities are expected to increase by 5.6%, up from a contraction of 5% in FY2020, as supplies disruptions ease and consumer demand pickup. The CBS is also projecting transportation and storage activities to pickup pace, growing by 6.1% from a contraction of 13.4% in FY2020. This as well hinges on the assumption that travel and tourism activities will gradually recover. Accommodation and food service activities are expected to increase by 11.2%, making it the fastest growing subsector in FY2021, as domestic tourism picked up pace after the FY2020 lockdowns were eased. 

Information and communication is expected to grow by 1.5%, down from 2.3% growth in FY2020.  Financial intermediation is projected to grow by 5.8%, higher than 4.8% in FY2020, reflecting improved income of NRB, BFIs, insurance board and companies, securities board, EPF and CIF. Real estate activities are expected to increase by 2.6%, marginally up from 2.4% in FY2020. Human health and social work activities are expected to increase by 6.5%, up from 5.3% in FY2020. The other services sector activities are also expected to grow at a rate higher than in FY2020. 

On the expenditure side, consumption is expected to increase by 5.2%, up from 3.6% in FY2020. Public and private fixed investment are expected to increase by 1.6% and 8.3%, respectively, up from contraction of 4.2% and 15.1%, respectively, in FY2020. Net exports are expected to grow at 5.1%, thanks to muted imports growth but a further contraction in exports. 

Here are quick takeaways from the latest GDP projection.

First, lockdowns, supplies and travel disruptions, and social distancing rules affected almost all sectors, especially industrial and services activities. Consumption increased marginally but investment bounced back from a contraction by 29.5%. In FY2021, lockdowns in many parts of the country started in the last quarter of fiscal year. Note that most of the economic activities happen in the second half of the fiscal year, more so in the last quarter (except for in FY2019 and FY2020). 

Second, given the lack of preparedness for a surge in cases; overwhelmed healthcare system; lack of adequate fiscal and monetary lifelines during the second wave that is ravaging lives and livelihoods; slow vaccination drive; disruptions to labor, capital and product mobility; supplies disruptions; and political instability, economic activities may not actually recover beyond the base effect in FY2021. Capacity utilization of firms will be hit due to lockdowns, supplies disruption and market uncertainties. It will affect private investment. A lack of employment opportunities both in formal and informal sectors will curtain household income and consumption. Similarly, the inability of the government to boost capital spending will also affect mining and quarrying, and construction activities -- affecting the growth of industry sector. Manufacturing and exports are not expected to recovery anytime soon. Against this backdrop, the economy might hardly grow (or it may even contract for second year in a row). So, the CBS’s assumption that economic activities may not be affected much after two weeks of lockdown, i.e., mid-May 2021 (it has already been extended for two weeks more in Kathmandu valley and other parts of the country) is unrealistic. It floated the same assumption when it released provisional national accounts estimate last year. 

Third, agricultural output would have grown higher than 2.6% if it were not for the shortage agricultural inputs, mainly chemical fertilizers. Procurement of chemical fertilizers has been mired in decision-making delays and lack of advanced planning. 

Fourth, the government does not have much fiscal firepower to launch temporary social protection schemes targeted at households and businesses affected by the deadly second wave of COVID-19 that started from mid-April 2021. There is hardly any fiscal space left with fiscal deficit projected to hit around 6-7% of GDP in FY2021. If the government allocates funds for new elections, then it might lead to scaling back of public spending as revenue mobilization slows down in tandem with the expected decline or muted growth in economic activities. It might also affect the banking sector, which might see demand for new credit decrease after a slight increase in the first half of FY2021. Firm bankruptcies due to cashflow problems, and a subsequent rise in non-performing assets of BFIs are real possibilities, especially after the regulatory forbearance on loan moratorium is lifted and refinancing opportunities dry up. MSMEs, which do not have much cash reserves to cushion against negative shocks, will bear the brunt of the crisis.

Fifth, the size of Nepali economy is estimated at USD 36.1 billion. Per capita GNI of USD 1196 and per capital GDP of USD 1191. GNDI (GNI + net current transfers incl remittances) is estimated to reach 124.8% of GDP. Gross domestic savings (GDP – consumption) is around 6.6% of GDP, reflecting high level of consumption. The country’s population in FY2021 is estimated to be 30.3 million. 

COVID-19 related economic scarring

The IMF’s WEO April 2021 includes a chapter on the possible persistent effects of the pandemic on economic activities (scarring). It notes that the emerging markets and low-income countries are expected to face greater scarring due to their limited policy space to launch relief measures for struggling households and firms. It argues that the crisis could result in substantial and persistent damage to supply potential and extend scarring due to diminishing labor force participation, bankruptcies, and disruption of production networks. The longer the recession, the more likely the effects will be permanent, especially in countries with the prevalence of small firms and shallow capital markets. Persistent supply disruptions could result from the loss of economic ties in production and distribution networks as job destruction and firm bankruptcies increase— these tend to lower productivity growth and slowdown capital accumulation. These could dampen investment and employment, and cripple productivity growth for an extended period of time. 

The IMF states that although financial instabilities have been largely avoided this time and the spillovers of the pandemic’s initial impact on high contact-intensive service sectors are limited, the scale of the impact could still represent a large shock to the economy. It estimates that the global output in 2024 could be 3% lower than the anticipated pre-pandemic output. However, the degree of scarring varies by country. Policymakers could limit scarring by providing support to the most-affected sectors and workers while the pandemic is ongoing. To address long-term GDP losses, countries need to focus on remedial policies for the setback to human capital accumulation, boost investment, and support reallocation of workers and firms (retraining, reskilling, and insolvency procedures).

The COVID-19 pandemic resulted in a combination of supply and demand shocks. Pandemic-induced lockdowns reduced effective productive capacity as some firms were forced to close or operate at below capacity than usual times, and some had to reorganize production on account of physical distancing between workers, which in turn lowered productivity. The initial supply shocks spilled over to other sectors through production networks. Meanwhile, demand decreased due to reduced mobility and as precautionary savings increased amidst heightened uncertainty. The initial supply shock also led to a decline in demand as workers earned either less or were laid off outright, which decreased private savings.  

After recessions or health shocks in the past, technology adoption, employment, and capital accumulation suffered, leading to extended period of economic slowdown. For instance, unemployment continued to remain high and lowered labor force as discouraged workers exited the labor market. Extended period of unemployment affects skills deterioration, delays labor market entry for young workers, negatively affects educational achievement in the long-term (especially, parental job losses adversely affect children’s schooling and future labor market outcomes)— all affecting human capital accumulation. Similarly, recessions also dampen investment, slowing down physical capital accumulation, which affects productivity though slower technology adoption. Also, business bankruptcies permanently affect productivity due to the loss of firm-specific know-how. Decline in research and development, and increase in resource misallocation also affect productivity permanently. 

The pandemic has already caused some form of supply-side scarring from lower productive capacity and demand-side persistent preference shits. The report three particular features of the crisis on scarring:

1. Although lower than after the global financial crisis in 2008, the prospects for scarring from COVID-19 are substantial. This time there is relative financial stability following the COVID-19 shock thanks to large-scale fiscal and monetary measures. Previously, financial crisis resulted in deep recessions, which then led to persistent output losses. However, this time financial stress could easily build up as loan defaults increases after debt service moratoriums and several regulatory forbearances are phased out. These affect productivity, and efficiency of labor and capital inputs. 

Lower-skilled workers have seen a disproportionately large decline in employment and business exits of small businesses are increasing. 

2. Some sectors have not recovered after productivity shocks in the past and that the spillovers from COVID-19 shocks are still sizable (despite high-contact sectors are less central to production networks). Scars become persistent due to lower productivity growth and slower capital accumulation. 

Note that scarring in the labor market may be larger than in previous recessions because of permanent shrinkage of some high-contact sectors. For instance, some student in low-income countries may not be fully able to switch to virtual learning and this could have devastating implications on human capital accumulation. Similarly, physical capital shrinkage could also amplify scarring because of sector-specific idle capital in the case of high-contact sectors, and large corporate debt buildup that lowers investment by more leveraged firms. 

The pandemic related disruptions to upstream (from customers to focal sector of interest) and downstream (from suppliers to focal sector of interest) production networks could have knock-on effects on productivity of connected firms. Productivity could also suffer if small businesses close down in high-contact sectors but large companies strengthen their market power. The increased digitization and innovation in production and delivery processes could offset some of the adverse productivity shocks though. 

The report finds that adverse productivity shock (supply shock) in own sector results in 5% lower total gross value added for up to five years after the shock. Government spending shock is not statistically significant on total GVA. For spillover shocks, downstream effects are dominant, highlighting the importance of supply shocks arising from COVID-19. The ‘own effect’ is larger for high-contact sectors such as wholesale and retail trade, hotels and restaurants, entertainment and personal services, transportation, education, healthcare, and construction.  

3. Global losses are smaller than during the global financial crisis largely due to unprecedented policy support and contained financial stability risks. That said, medium-term output losses from the shock are still sizable, but they exhibit significant variation across economies and regions. The IMF estimates that the COVID-19 shock will lower world output by 3% in 2024 compared to the pre-pandemic projections (over the same period, output losses were 10% in the case of global financial crisis). However, emerging and developing economies will likely have deeper scars than advanced economies, thanks partly due to the larger pandemic-related fiscal responses in the latter and faster access to vaccines. Particularly, economies more dependent on travel and tourism, and those with larger service sectors, are expected to experience more persistent losses.  

Medium-term scarring is contingent on: (i) the path of the pandemic and associated containment measures, (ii) impact of the pandemic shock on high-contact sectors, (iii) adaptation capability of firms and workers to a lower-contact working environment and lower-contact transaction, and (iv) the effectiveness of policy response to limit economic damage.  

Depending on the level of fiscal space, the IMF recommends countries to 

• Reverse setbacks to human capital accumulation and encourage employment by ensuring adequate resources for healthcare, early childhood development programs, education, worker retraining and investment in digital literacy, expansion of social safety nets, and support for displace workers.
• Support productivity by allowing exit of nonviable firms, active labor market policies (help workers transition between jobs by retraining, public employment services, public work schemes, wage subsidies, and support for self-employment/micro-entrepreneurs), and facilitate resource reallocation (to improve labor mobility and reduce product market rigidities). Other measures include promotion of competition, innovation and technology adoption. 
• Boost investment in infrastructure, particularly green infrastructure to help crowd-in private investment. Repairing corporate balance sheet to reduce debt overhand will also promote investment. Improved bankruptcy and debt restructuring mechanisms help to reallocate productive capital. 

Divergent recovery and policy options

In the latest edition of World Economic Outlook (WEO, April 2021), the IMF states that without the extraordinary fiscal and monetary policies, the pandemic would have resulted in an economic contraction three times larger than the current estimates. 

GDP growth

The IMF is projecting the global economy to grow at 6% in 2021, up from an estimated contraction of 3.3% in 2020, and moderate to 4.4% in 2022. These revised projections are higher than earlier estimates owing to the favorable effect of easing of lockdowns, adapting to new ways of working, substantial fiscal support in advanced economies, and an anticipated vaccine-led recovery in the second half of 2021. The IMF projects global growth to moderate to 3.3% over the medium term as the damage to supply chains scars output capacity and aging in advanced economies slows down labor force growth.

Inflation

Inflation in advanced economies is projected to rise to 1.4% in 2021, up from 0.4% in 2020, and 1.9% in 2023. In EMDEs, inflation is projected to remain stable at around 3% from 2021-2023, up from 2.8% in 2020.

The IMF expects price volatility to be short lived and that inflation will return to its long-term average as remaining slack subsides gradually and commodity-driven base effects fade away. Commodity prices, particularly oil, are expected to firm up in the months ahead. But, overall subdued inflation outlook reflects labor market conditions as well, especially subdued wage growth and weak worker bargaining power that are compounded by high unemployment, underemployment, and lower labor force participation rates. 

The IMF notes that unless output gaps become positive and very large for an extended period of time, and monetary policy does not react to rising inflation expectations, inflation is unlikely to increase much. It also does not expect monetary policy to be used primarily to keep government borrowing costs low at the expense of price stability as most economies have independent central banks. 

External sector

On external sector, the IMF projected global trade to accelerate to 8.4% due to the rebound in merchandise goods. But, cross-border services trade (travel and tourism) is expected to remain subdued. 

Divergent effects

The output losses have been divergent. The most affected are the economies that rely on tourism and commodity exports and those with limited fiscal space to respond to the crisis. Many countries entered the crisis without much fiscal space and the ability to mount an effective healthcare policy response. The WEO states that economic situation now (and eventual recovery) is influenced by factors such as the proportion of ‘teleworkable’ jobs, share of employment in small and medium enterprises, capital market deepening, size of informal sector, and quality of and access to digital infrastructure. 

The economic recovery since the second half of 2020 has been led by strong demand for products suitable for working from home and pent-up demand for durable goods such as automobiles. Industrial output is now at pre-pandemic level, but contact-intensive services activities have remained depressed. Likewise, although merchandise trade is back to the pre-pandemic levels, cross-border trade in services remains subdued.  

Unemployment and underemployment remain at elevated level. Labor force participation rate has dropped despite wage and jobs retention programs in many countries. The report notes that youth, women, less educated workers, and informally employed are hardest hit by the pandemic. Poverty (additional 95 million people) and income inequality are likely to increase. The unequal setback to schooling could further exacerbate inequality. 

Asset markets have been surging, thanks to policy stimulus and expectations of a vaccine-driven normalization. However, the IMF notes that the divergence between valuations and broader economic prospects raise financial stability risks. 

GDP loss

The IMF projects the average annual loss in per capita GDP over 2020–24, relative to pre-pandemic forecasts, to be 5.7% in low-income countries and 4.7% in emerging markets. In advanced economies the losses are expected to be 2.3%. Unlike the global financial crisis in 2008, the substantial policy support in response to the pandemic has averted a financial crisis, and medium-term losses are expected to be lower than in 2008 (about 3% lower). However, the emerging markets and low-income countries are expected to face greater scarring owing to their limited policy space. 

Fiscal authorities provided relief to households and firms in the form of transfers, wage subsidies, liquidity support, expansion of safety net such as unemployment insurance and nutrition assistance. Financial regulators facilitated credit provision by easing classification guidelines for nonperforming loans, relaxing provisioning requirements for banks, reducing risk weights on bankruptcy proceedings, and flexibility regarding bank capital requirements. 

The IMF estimates that policy actions such as automatic stabilizers, discretionary measures, and financial sector measures contributed about six percentage points to global growth in 2020. 

Economic outlook

There is considerable uncertainty over the economic outlook though. The WEO notes that it is contingent on the path of the health crisis including vaccine effectiveness against new variants, the effectiveness of policy actions to limit persistent economic damage (scarring), the evolution of financial conditions and commodity prices, and the adjustment capacity of the economy. 

Vaccine procurement and distribution are uneven with broad vaccine availability in advanced economies and some emerging market economies. Since vaccine deployment will be staggered across regions, spread of new variants forcing occasional and localized lockdowns is possible. However, the IMF notes that these may not constrain economic activities like in the initial lockdowns because they will be more targeted and that people and firms have adapted to remote work. 

The size of fiscal package will also drive the nature of recovery. The fiscal package unveiled by the US government will boost growth in the US in 2021 and provide sizable positive spillovers to its trading partners, the WEO states. The IMF expects debt service costs to remain manageable across advanced economies because their debt profile is largely dominated by long-term and sometimes negative-yielding bonds. However, it notes that EMDEs will have limited fiscal support now, but as revenue mobilization improves with pickup in economic activities and crisis-related expenditures unwind, they will have lower fiscal deficits than now. But high debt service costs are expected in EMDEs. 

The crisis could still result in substantial and persistent damage to supply potential and extend scarring due to diminishing labor force participation, bankruptcies, and disruption of production networks. It argues that the longer the recession, the more likely that the effects will be permanent, especially in EMDEs where the prevalence of relatively small firms and shallow capital markets could dampen investment and employment for an extended period of time. These may cripple productivity growth too. 

The IMF expects monetary policy to remain accommodative and tighten only gradually as recovery takes hold. It also expects oil prices to increase as OPEC+ producers curb supply. The strong rebound in PRC will put upward pressure on metal prices. Food prices are also expected to increase in 2021. 

Policy response

Against this backdrop, the IMF recommends policymakers to prioritize policies prudently including strengthening social protection with wider eligibility for unemployment to cover the self-employed and informally employed; adequate resource for healthcare, early childhood development programs, education, and vocation training; and investment in green infrastructure to accelerate the transition to lower carbon dependence. Policy support should be flexible such as shifting lifelines, reallocations, and linked to improvements in activity, but they should safeguard social spending and avoid inefficient spending outlays. Anchoring short-term support in credible medium-term frameworks is key. Economies facing high debt burden should consider creating fiscal space through increased revenue mobilization and reduced wasteful subsidies.

It recommends policy responses to be tailored to the stage of the pandemic, strength of the recovery, and structural characteristics of the economy. As the pandemic continues, policies should focus on prioritizing the healthcare spending, providing well-targeted fiscal support, and maintaining accommodative monetary policy. As recovery progresses, policymakers should limit long-term economic scarring by broadening productive capacity and increasing incentives for an efficient allocation of productive resources. 

Differences in consumption aggregates and poverty estimates in South Asia

In a paper published in the latest edition of Asian Development Review (Vol.38. No.1), Islam, Newhouse and Yanex-Pagans study how differences in the construction of consumption aggregate in South Asian countries contribute to total error (arising out of nonsampling error and the error in the process of determining the international poverty line) in international extreme poverty measurement. Methodology and questionnaire for household survey differ among the countries, contributing to total error of the subsequent international extreme poverty line obtained for each country. They examine how sampling and survey design; spatial deflation to account for cost-of-living differences and intertemporal deflation; and construction of nominal consumption aggregate contribute to total error. 

Some factors that affect total error are incomplete coverage of the country’s population, errors in measuring consumption data, errors in calculating the poverty line, use of the consumer price index (CPI) to deflate prices in a manner that may not be consistent with the consumption patterns of the poor, and geographic differences in prices.

On sampling and survey design, the paper examines (i) sampling design, (ii) monetary welfare measure, (iii) food consumption questionnaire and data collection methods, (iv) self-production and meals outside home, (v) nonfood durables, (vi) durables, (vii) housing expenditures, and (viii) health and education expenditures. 

Among these, there exists significant differences in the way food consumption data are collected, especially the number of food items in the consumption questionnaire. Inclusion of more food items tend to increase levels of reported consumption, leading to lower reported poverty rate. While Pakistan has the lowest number of food items (69) listed in the survey, Sri Lanka has the highest (227). Bangladesh has 141, Bhutan 130, India 143, Maldives 92, and Nepal 74. For nonfood items, Afghanistan has the lowest number of items (38) and Maldives has the highest number of items (483). India has 338 and Nepal 95. 

Consumption data are collected either using diary method (households record all consumption data over a certain period in a notebook) and/or recall method (households list what they consumed over a specific past reference period). Length of consumption recall is also different. Lowering the recall period have increased reported consumption by households, which resulted in poverty rates falling by half in India. The authors note that “this simple change in the method of collecting data “lifted” 175 million Indians out of poverty”. 

The South Asian countries also have different questionnaires for the value of consumption of self-produced food and meals from outside home. For instance, Bangladesh, Pakistan and Sri Lanka do not account for food expenditures on meals outside the household as a part of their consumption aggregate. Note that consumption of food eaten outside the home is shown to raise extreme poverty rate. Similarly, Maldives and Pakistan do not account for consumer durables, and in Afghanistan and Nepal it is imputed. In the case of housing, all countries except Maldives include actual rent for urban and rural areas. They also include imputed rent except for (India and Maldives). All countries include health and education expenditure (except for Nepal in the case of health expenditure). 

Spatial deflation is used to adjust cost-of-living differences, which lowers the possibility of overestimation of poverty in rural areas and underestimation in urban areas (since an urban household needs to spend more to maintain the same standard of living as that of a rural household). Use of appropriate regional price indexes is important in this regard, but this could be challenging to construct. All South Asian countries do spatial deflation when they calculate their national poverty estimates, but when calculating international extreme poverty rates, the World Bank spatially deflates consumption aggregates in Bhutan and Nepal only. Bhutan uses survey-based price index to deflate prices, but Nepal and Bangladesh use an implicit spatial price index to deflate prices. The authors show that using spatial deflation is important in the case of international extreme poverty estimates, especially given the fact that without spatial deflation urban areas have less poverty and rural areas have more poverty. They recommend collecting regional price data for different durable and nondurable goods, and services. They also suggest collecting rental cost of housing at regional level so that imputation for rental rate of owner-occupied housing could be done suitably. 

A third source of total error is the way standardized consumption aggregates are computed compared to the national consumption aggregates. Here, standardized consumption aggregate refers to the one obtained from the standardized consumption datasets created by the World Bank. It basically reclassifies expenditure items into the various categories used in the International Comparison Program (ICP). However, note that the method of data collection and questionnaire design affect standardization. The authors show slightly different average per capita consumption using the standardized and the national consumption aggregates. Not much difference, but in the case of India there is notable difference because of imputed rents for home owners. Also, standardization decreases housing expenditure in Nepal, Bhutan and Sri Lanka. 

The authors shows that standardization of consumption aggregate also changes share of particular item on total consumption expenditure. In Nepal, while food items account for 57% of national consumption expenditure, the standardized value is a bit less at 53%. Standardization reduces the share of food expenditure in consumption aggregate in all South Asian countries except Sri Lanka. 

The standardization of consumption aggregates increases poverty rate in Bangladesh, Bhutan Pakistan, and Sri Lanka. However, they authors show that it decreases the international extreme poverty rate in India, Maldives and Nepal.  

Energy sector prospect in Nepal

In an excellent article about energy sector in Nepal in New Business Age, Rupak D Sharma argues that given the large generation capacity in pipeline and the prospect of supply outstripping demand, there is no choice but to export electricity (to India and perhaps Bangladesh) in the short-term and then work to increase per capita electricity consumption over the medium-term. Above all, escalating cost of production needs to be controlled.

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[...]A total of 15 new projects built by the private sector added 135.39 MW of electricity to the national grid in the last fiscal year. Two projects of NEA, 60MW Upper Trisuli 3A Hydroelectric Project and 14MW Kulekhani III Hydroelectric Project, also came into operation that year. The energy sector is expected to see an addition of over 800 MW of electricity in this fiscal year alone if the 456MW Upper Tamakoshi Hydroelectric Project comes online. What’s more, 131 additional private sector-led projects with a combined capacity of 3,157.19 MW are under construction. And another 112 private sector-led projects with a combined capacity of 2,124.77 MW are in different stages of development, according to NEA’s latest annual report.

[...]Nepal’s energy generation cost has significantly gone up over the years due to a hike in project development cost. A few years ago, the cost of building a hydroelectric project used to hover around Rs 150 million per MW. The cost has now surged by 33 percent to Rs 200 million per MW. This has made electricity expensive, raising the spectre of restricting domestic consumption and making energy generated in Nepal uncompetitive in the foreign market.

[...]In a typical hydropower project, construction materials, such as cement, steel and aggregates, command a weight of about 40 percent in the total development cost, according to Pradhanang. Labour costs make a contribution of around 20 percent to the total cost, while soft costs, such as engineering design and management, command a weight of 25 percent. The share of the cost of electromechanical items in total project development cost stands at about 15 percent.

Over the years, labour costs have surged as most of the youths have left the country for labour destinations in the Gulf, Malaysia and other countries across the globe, creating a shortage of workers. At the same time, prices of construction materials, such as cement, steel and aggregates, have steadily gone up. Each kg of TMT 500D steel now costs Rs 95, as against Rs 75 two years ago. In India, the same product can be bought for INR 34-47 (Rs 54.4-75.2) per kg in the retail market. Cement is also a lot cheaper in India, where a 50-kg bag of OPC can be fetched for INR 300-350 (Rs 480 to Rs 560). The same quality and quantity of cement costs Rs 700 in Nepal, up from Rs 650 in early 2019.

[...]NEA will be in a position to export 25 to 30 MW of electricity round the clock in the next three months, according to NEA Managing Director Hitendra Dev Shakya. By the upcoming rainy season, that capacity will rise to 450 MW. The portion of surplus energy will continue to rise in the coming years, as NEA has already signed agreements to purchase 5,978.13 MW of electricity from 341 private developers, which is four times the current installed capacity. Nepal will not be able to consume all this electricity in the short run, as its electricity demand currently stands at around 1,500 MW; and it will take several more years to increase domestic consumption. This indicates lots of energy will go to waste if it is not exported.

[...]the Indian government in 2021 issued a procedure for cross-border imports and exports of electricity. The procedure, which has been welcomed by Nepal’s private sector power producers, has finally paved the way for government entities and the domestic private sector to export power to India. [...]Yet one question that many ask is whether India needs Nepal’s electricity as its supply has exceeded demand for over two decades. India currently has an installed capacity of approximately 375,325 MW whereas its peak electricity demand stands at 184,033 MW. Nonetheless, India may want to buy Nepal’s electricity as it generates over 60 percent of its energy through thermal sources such as coal, which are not clean. Since India is looking to migrate to clean sources of energy, Nepal may find a small market to sell its electricity. Lately, there are also talks of selling Nepal’s electricity in the Indian spot power market, where prices are relatively higher.

[...]NEA has reached a conclusion that there is no alternative to exporting power in the short run as the domestic market is not in a position to rapidly enhance its electricity consumption. But in the long run Nepal will have to enhance its energy consumption capacity, as electricity is a raw material and if value is added to it to generate other products the country will be able to generate higher returns.

[...]Even if NEA defaults on 1,000 MW of payments, Rs 140 billion in bank credit will be at the risk of going sour, considering per MW construction cost of Rs 200 million and 70 percent debt facility that banks provide. This amount is over 2.5 times the net profit of all commercial banks in the last fiscal year. Such a huge scale of credit default will not only hit the banking sector, but the entire stock market and the economy.

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Reintegration of returning migrant workers

It was published in Pandemic Borders, Open Democracy, 16 March 2021.

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As COVID brings migrants home, how can Nepal reintegrate returning workers?

Money from overseas makes up a quarter of GDP, and the effects of the pandemic are putting a squeeze on an already struggling economy

For Nepal, like other developing countries that depend on migrant remittances, the COVID-19 pandemic has dealt a severe blow.

Money sent home by the thousands of Nepali migrant workers abroad amounts to about 25% of the country’s GDP, making it one of the most dependent countries on remittances in the world.

Reverse migration since the spread of COVID-19 has compounded unemployment problems in an already lockdown-battered economy. This means that timely and meaningful reintegration of the returning migrant workforce should be one of the top priorities, especially given that international travel and the global economy are not projected to fully recover any time soon.

Reverse migration

Since the lockdown started in March 2020, there has been a steady inflow of migrant workers returning to their home countries. Nepali migrant workers in India travelled by road, often walking for days to reach the border. Those in other countries were repatriated on special chartered flights operated by the government.

There is no official data on the exact number of migrant workers who have returned to Nepal since the lockdown, but in May the Nepal Association of Foreign Employment Agencies estimated that over half a million migrant workers wanted to return, especially from the Middle East and Malaysia.

The Nepali economy is facing a potential slowdown in remittance inflows. And while a 2018 labour force survey estimated unemployment at 11.4%, a more realistic number based on a broader measure of labour under-utilisation puts it as high as 39.3%. Amid a slowing economy, an influx of returning migrant workers will exacerbate unemployment even further.

Remittances have supported household consumption, propped up government finances (as revenue from imports financed by remittances alone account for 45% of total tax revenue), boosted banking sector liquidity and credit growth, increased household spending on healthcare and education, and helped to maintain external sector stability despite a ballooning trade deficit. All this means that the country will face a tough time reintegrating returning workers.

Reintegration

With the healthcare crisis requiring more public spending just to provide emergency relief, this severely curtails the country’s ability to effectively fund reintegration of returning migrant workers. The government estimated that it would need about $1bn just for employment programmes to deal with the impact of COVID-19.

A large gap between expenditure and revenue means that Nepal will need more international support to boost social protection-related spending in the next few years. Internally, it will have to reduce wasteful spending such as funding of pet projects, bailing out consistently underperforming state-owned enterprises, and non-targeted subsidies.

To enhance governance and targeting, it may be useful to use digital platforms to identify eligible beneficiaries of various government programmes and possibly transfer any cash handout directly to their bank accounts.

Another way to support returning migrants is to provide them with access to affordable credit to help those who are willing to start their own business ventures

In fact, there already exists social protection and public workfare programmes that can be better utilised to quickly engage returning migrant workers at the local level. For example, the Prime Minister Employment Program, which guarantees a maximum of 100 days of employment at subsistence wage, has been severely under-utilised so far. From July 2020, until March 3 this year, it provided an average of six days of work for 25,852 people out of 743,512 listed unemployed people in its roster.

The programme was launched in early 2019 to reduce youth dependency on overseas jobs and to create job opportunities within the country itself. Ramping up this programme with adequate budgeting and targeting could be beneficial in the short term to employ returning migrant workers.

Unfortunately, a fallout of the ineffectiveness of this programme was that many migrant workers who returned home are again actively pursuing job opportunities overseas. For instance, by September 2020, there were long queues of migrant workers at the Indian border points waiting for an opportunity to enter India for employment.

Technical and vocational education and certification could be another option for reintegrating migrants who are willing to enhance their skills and perhaps change profession. This could be done in partnership between government and businesses.

Another way to support returning migrants is to provide them with access to affordable credit to help those who are willing to start their own business ventures. Programmes such as Youth and Small Entrepreneurs Self-Employment Fund are set up to subsidise interest on loans for self-employment, and could be used for this.

The fund has not been as effective as expected largely owing to politicisation, a high interest burden even after subsidy, and approval hassles. Since its launch a decade ago, there are just 72,789 recipients, including 6,500 between July 2019 and July 2020. The central bank has also launched a scheme to issue subsidised loans at 5% interest to returnee migrant workers, among others. However, the uptake has been slow.

Successful reintegration would not be possible without accelerated economic growth as domestic employment opportunities will remain constrained, contributing to the “push factor” for outmigration which compel folks to migrate overseas for employment and safety.

Short-term economic stabilisation measures followed by structural reforms to ensure sustained and inclusive economic growth are required. In this process, more digitalisation, better targeting and, most importantly, sound governance will be vital.

Economic contraction in Nepal

It was published in The Kathmandu Post, 12 March 2021. An earlier blog post on the same issue here.

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We are witnessing an economic contraction

Revised and rebased statistics provide a more accurate picture of the economy.

The latest release of national accounts statistics—which generally refers to data pertaining to the value of economic activities computed using output, expenditure and income-based methods—by the Central Bureau of Statistics (CBS) is a welcome development. The rebased national account statistics, at 2010-11 prices, depicts a more accurate picture of economic activities, particularly the size of the economy and sectoral shifts in value-added economic activities or structural changes.

It shows that although the size of the economy increased to about US$35 billion, an upward revision by US$1.5 billion, gross domestic product likely contracted by 1.9 percent in the fiscal year 2019-20. The revised data also reveals that economic performance was weak even before the health, economic and livelihood mayhem created by the pandemic. The statistical bureau now needs to release back a series of national accounts statistics using the 2010-11 base so that comparative analysis and sectoral changes based on historical data can be appropriately construed.

Revised and rebased

Rebasing typically includes expanding coverage of economic activities, adding new or disaggregated sectors or changing the methodology used to measure economic activities so that they better reflect structural changes. For instance, the earlier industry sector comprised of four subsectors, but is now expanded to five subsectors by disaggregating electricity, gas and water into electricity, gas, steam and air conditioning supply; and water supply, sewerage and waste management. This facilitates tracking progress separately for the electricity and water supply subsectors—both of which are expected to add large capacities in the coming years.

The services sector has gone through the most changes, particularly inclusion or expansion of new economic activities. Transport, storage and communications activities are divided into two subsectors: transport and storage, and information and communication. Real estate, renting and business activities are divided into three subsectors. These and other changes have increased subsectors within the services sector to twelve, up from eight earlier.

The new data series is consistent with the international standard industrial classification of all economic activities (rev.4) and the system of national accounts 2008, which is the latest version of the international statistical standard for national accounts adopted by the United Nations Statistical Commission.

Using the old methodology and 2000-01 as the base year, and assuming early resumption of economic activities, the CBS estimated, in April 2020, that the GDP could grow by 2.3 percent. The government interpreted this as confirmation of the effectiveness of countercyclical fiscal and monetary measures rolled out to address the crisis. However, the latest revised data with the new 2010-11 base year reveals a completely contrasting picture: the economy will actually contract by 1.9 percent, thanks to a severe slump in industrial and services activities.

The agriculture sector is expected to grow by 2.2 percent, down from 5.2 percent in 2018-19, owing to a delayed monsoon, shortage of chemical fertilisers, use of substandard seeds and a fall armyworm invasion. The lockdowns also disrupted agricultural labour, harvest and supplies. Industrial output is projected to contract by 4.2 percent, down from 7.4 percent growth in 2018-19, as mining and quarrying, manufacturing, and construction activities were battered by subdued demand and lockdowns. Services output is projected to contract by 3.6 percent, down from 6.8 percent growth in 2018-19, owing to the severe impact of lockdowns and supplies disruptions on wholesale and retail trade, transportation and storage and accommodation and food service activities. These are high contact services activities, which together account for about 22 percent of GDP.

Importantly, the latest data captures the structural changes in the decade between rebasing. Between 2000-01 and 2010-11, the share of agriculture and industry sectors declined, but the services sector increased. This unusual structural change bypassed the industry sector, whose share in GDP declined to 14.7 in 2010-11 under the new base, down from 15.5 percent in the case of the old base. Last year it was barely 15.4 percent of GDP, almost the same as the wholesale, trade and repair subsector. Meanwhile, the data reveal a higher consumption level than earlier reported (91 percent of GDP), but lower investment, exports and imports.

The latest data release also changes the perception about some macroeconomic indicators. For instance, as a share of GDP, tax revenue, net domestic borrowing, outstanding public debt, money supply, exports, imports and remittances, among others, are now lower than previously estimated. These will be further revised when CBS releases actual figures next year.

Weak foundation

The data confirms that the economy was already performing poorly before the pandemic hit Nepal. Growth reached 9 percent in 2016-17 due to base effect, which refers to the tendency of achieving an arithmetically high rate of growth when starting from a very low base, and then started to decline steadily. It happened despite propping up consumption and investment through massive post-earthquake reconstruction efforts and national and subnational elections. The much-touted benefits of a stable government and expedited approval of investment laws and policies did not yield much of a result. The claim of creating a solid foundation for high economic growth (about double-digit annual average) and prosperity is losing steam. Political instability, bureaucratic hassles, bad governance, and low capital spending continue to affect private sector investment and growth momentum.

The CBS also released quarterly data which shows that the economy contracted by 15.4 percent in the fourth quarter of 2019-20 (mid-May to mid-July 2020) and by a further 4.6 percent in the first quarter of 2020-21 (mid-August 2020 to mid-October 2020). This points to the severe impact of lockdowns on high contact industry and services activities. Given that some services sector activities continue to remain affected throughout 2020-21 and the shortage of chemical fertilisers is affecting agricultural output, there is less likelihood of a sharp recovery in 2020-21 despite commendable progress in vaccination.

It is important for the bureau to release back series national accounts data that are consistent with the new base year. Additionally, the statistics bureau needs to release quarterly data for all sectors dating back to at least 2010-11. This is crucial to determine the historical trend and conduct a comparative analysis of sectoral composition and determinants of growth. Let us hope that CBS will publicise the full series data in its next release of preliminary growth estimates at the end of next month.