Hypocrisy of Nepali banking sector

Just yesterday the bigwigs of the Nepali banking sector were making a high pitch about the central bank being anti-market, forcing the governor to make a statement that he and the central bank are not market unfriendly. He argued that the central bank is just trying to regulate markets to encourage healthy competition. The central bank has capped executives pay, set loans to realty sector at 10 percent and to housing sector at 30 percent, and directed banks to ensure that interest rate difference on various kind of saving accounts is not more than 2 percentage points.

Now, we have first hypocrites of 2011: bigwigs of the Nepali banking sector! The same bankers who were complaining about “market-unfriendly” practices of the central bank are behaving like masters of cartel by capping savings interests at 4-6 percent. The Nepal Bankers’ Association (NBA) said that “a gentleman’s agreement” has been reached to cap savings rate between 4 and 6 percent. Gentleman’s agreement—WHAT? That is deliberate collusion to manipulate competition and is nothing less than CARTELING, which is infinitely market unfriendly than the central bank’s decision to bring about healthy competition in the banking sector. They played the same anti-market game in May 2010 when they agreed to limit interest rates on fixed deposits at 12 percent.

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New commercial banks, however, have been given permission to fix higher rate by a margin of as much as 1.5 percentage point, he said, adding that the NBA will soon hold a meeting of chief executives of all 30 banks this week to formalize its implementation. Once the new decision comes into effect, depositors who were already enjoying as much as 10.5 percent annual interest returns on savings will find their return drop to 6 percent.

This will also reduce the prospect of salary account holders and other accounts holders enjoying far better returns than now. So far, the banks were providing just 2 percent annual interest returns to such accounts holders.Some of the bankers, however, noted that the new move could be risky particularly given the latest trend of customers becoming more interest sensitive and their competitors like development banks and financial institutions offering as much as 13.5 percent.

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They increasingly look like gangsters (albeit gentleman-style!) when one looks at the way they have been pressing their demand, resisting regulation, and trying to circumvent central bank’s directives. When will they realize that they are fostering unhealthy competition. They are digging their own hole deeper and deeper by offering too much loan to the real estate and housing sector without properly assessing if the loans are normal or subprime (in fact, they find no difference). They are charging high interest on loans and are in desperation to attract deposits by offering flamboyant schemes, just to meet unsustainable profit targets. First, they attract depositors offering them promises of high interest rates. When money is deposited, they change interest rates without even informing the depositors. Likewise, with the borrowers, who will have no option but to default if the same dirty trick goes on for a year or two.

The real estate and housing sector is going to cool down as supply will far outstrip demand soon. This urban-centric bubble will create ‘ghost houses’ waiting for customers to either rent them or buy them. Prices will come down and the borrowers will not be able to honor principal and interest payments on time. The banks will be in deep trouble due to their proportionally high exposure to one particular sector. Additionally, since the growth of the number of BFIs has proportionately outpaced the growth of depositors base, some of the BFIs will surely go down or will be forced to merge. The entire economy is going to suffer because of the unhealthy competition among BFIs and market-unfriendly acts of the banking executives. The sooner the central bank further clamps down on them, the better it is for the economy. We must be ready to let go some troubled BFIs.

The heads of BFIs have to realize that there are simply too many of them running after more or less the same corporate and non-corporate customers. Some of the BFIs have to either merge or go down under. There is no other option. Playing with interests on loans and capping interest on savings are just attempts to buy time before the inevitable disaster hits them. Wake up before it is too late (actually, it is already late!).The day of reckoning is coming soon.

We are looking for a major financial disaster in Nepal soon, if they go with business-as-usual approach of playing with interests on deposits and loans to attain unsustainable profit targets, urban-centric operation, favorable lending to bubbling sector that has weak foundation, and encouraging trading rather than entrepreneurship. The tendency to seek short term gains over long term sustainability is a recipe for disaster with severe negative externalities, i.e. it will not only affect the BFIs, but also the public who are not a direct party to the activities of BFIs.

One of my senior and a reputed policymaker says, “Can the banks (collude in fixing) play with interest rates as the Nepal Oil Corporation (NOC) plays with the price of petroleum products? What is the difference between BFIs and NOC?” Couldn’t have put the situation any better! They gotta be responsible citizens. Their hypocrisy has to stop.

Lessons for developing countries from China’s and India’s growth successes

Amelia U. Santos-Paulino and Guanghua Wan argue that the growth successes of China and India offer three main lessons for the developing countries: (i) absorption of surplus labor, (ii)raising of domestic and foreign investment, (iii) and support for R&D.

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Surplus labour from traditional agricultural sector has shifted to the progressive industrial sector, promoting industrialization. Characteristics of China’s labour market include an extensive rural-urban inequity, rapid rural-urban migration despite various restrictions, and high and rising real wages in the formal sectors. Furthermore, China’s comparative advantage in labour-intensive activities—alongside the scaling-up of its production and export baskets—has iterated with an improvement in the investment climate. This is steep with a continuous, virtuous circle of growth. 

Foreign investment has not only helped in overcoming the shortage of capital, but also in stimulating economic growth through various spillover effects. Accompanying FDI is the expansion of the private firms and multinational corporations (MNCs). In India and China, labour-intensive firms tend not to locate in mid-sized or large cities as compared to smaller ones, due to higher wages, training and attrition costs. Although labour regulations in China and India deter firms from locating in the larger cities, firms in the export sector prefer to be in large cities. Proximity to inputs within the city has a positive impact on firm location. These findings have important policy implications for urban governance, infrastructure, labour and environmental policies, which are key issues for growth and development.

China and India’s export productivity and specialization patterns are in line with those of wealthier and more advanced economies. This empirical finding challenges the traditional assumption that knowledge creation is exclusively the domain of advanced economies. Drivers of such change include investment in knowledge and innovation activities and the growing link between high-tech companies and local research. FDI and multinational enterprises’ investment in knowledge-creating activities, such as R&D, is concentrated in a few emerging countries. China and India are considered two of the top ten destinations for foreign R&D expansion. China has experienced the strongest growth in scientific research, surpassing any country, whether developed or developing. India has also built up prominent research records, with an extraordinary expansion of peer-reviewed studies in material sciences.

The exports of information, communication and technology (ICT) have been key in driving the Southern Engines’ economic success, mostly in China and India. Empirical analysis shows that Chinese exports have experienced rapid growth since the early 1990s; the country’s market share in both Japan and the USA has risen sharply; most of the Chinese ICT exports are attributed to foreign firms; and the shrinking market shares on third markets (i.e., other Asian developing countries) may be the result of multinationals’ relocation rather than intensified competition from Chinese exports. India’s experience reveals an unparalleled paradigm of the role of technological progress, and the transmission channels through which macroeconomic fundamentals can explain the country’s economic success, primarily by inducing changes in productivity. Changes in labour market antagonisms and investment market frictions (such as taxing labour income) did not play a significant role. The Indian experience in targeting productivity evokes that of other successful Asian economies such as Japan in a similar stage of development, or during the take off process.

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The role of government has been crucial in bringing about this change.

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First, a key lesson from China’s experience is the adoption of a pragmatic approach to economic reforms (which was the turning point in China’s economic development), and the adaptive capacity of the countries’ economic agents to this process. Second, industrial policy has been at the heart of development policies and strategies in developing countries, although not particularly so in India. As in the case of other strategies and economic reforms, this policy’s implementation produced varied outcomes, and with different levels of success. Third, trade and the liberalization of commercial policies have played a primary role in the Southern Engines’ growth success.

The interface of trade liberalization and domestic reforms has contributed to their success, akin to developing and transition countries. Decentralization and privatization of state-owned enterprises is another area of policy accomplishment. Also, the formulation of economy-wide development strategies should be a balanced outcome of the government and private agent decisions and choices, reflecting at the same time the country’s evolving and comparative advantages. These policies and processes should also adjust to the continually changing global economy.

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Profile of Avinash Dixit in F&D magazine

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Dani Rodrik, professor of international political economy at Harvard, says Dixit was the best classroom teacher he ever had—he never treated anything as silly or obvious. “No matter how stupid a question seemed, he would stop, raise his hand to his chin, narrow his eyes, and think a long time about it, while the rest of us in the classroom would roll our eyes at the stupidity of the questioner,” said Rodrik. “Then he would say, “Ah, I see what you have in mind . . . ,” and he would roll out an answer to a deep and interesting question the student had no idea he had asked.”

“What makes him special,” says former student Kala Krishna, now an economics professor at Penn State, “is that more than anyone else I know, he sees economics as an inescapable part of life: from books, movies, negotiating with a taxi driver—everything has economic content. He truly loves economics, and you can see how much he is enjoying himself doing it.”

Others praise his wit. “Avinash Dixit is one of my favorite economists, in part because he has a trait that is extremely rare among economists: a good sense of humor,” said Steven D. Levitt, coauthor of the best-selling book Freakonomics.

[…] What became known as the “Dixit-Stiglitz” model underpins a huge body of economic theory on international trade, economic growth, and economic geography—a model tapped by Paul Krugman, who won the Nobel Prize in 2008.

The model, first published in 1977, became a building block for others in the new fields of endogenous growth theory and regional and urban economics—what journalist David Warsh described as “one of those economical and easy-to-use ‘Volkswagen’ models that were the hallmark of MIT”.

[…] Apart from game theory and his eponymous model, Dixit is known for seminal work on microeconomic theory, international trade and growth, and development. But his varied interests have moved him to write extensively about governance, the role of institutions, law, and democracy in development, and political polarization. He says his most cited work is Investment under Uncertainty, written in 1994 with Robert Pindyck of MIT, about how firms make investment choices.

That book points out the inherent irreversibility of most business investment decisions. Dixit and Pindyck suggest a way to deal with the risks posed by irreversibility: wait before acting. Waiting is valuable because with time comes additional information whose value would be lost had the irreversible decision already been made.

Dixit has advocated the same approach in other fields, and it is at the heart of a paper based on an episode of the popular TV show Seinfeld, in which a young woman must make decisions about using her finite supply of contraceptive sponges.

[…] While Dixit acknowledges the importance of democracy, property rights, contract enforcement, and the provision of public infrastructure and services that support private economic activity, he is scathing about attempts to draw up a menu of items that underpin development in low-income countries.

“There’s a long, long tradition of people offering recipes which don’t work out,” he says. He stirred things up with a lecture at the World Bank in 2005 that he said he hoped would be provocative and critical, but “evenhandedly so.”

In many cases, he argued in that lecture, the accumulated research on the role of institutions in development stopped short of giving useful or reliable policy prescriptions. “I hope to give everyone some incentives to think further and harder.”

In a subsequent talk at the Reserve Bank of India, he said that in general “bottom-up and organically generated reforms will work better than imposed top-down ones.”

[…] “Going forward, I think some of the most fruitful research will come from a better integration of financial theory and macroeconomic theory. It may be supplemented by better recognition of rare major events, something that already exists in financial theory, but is less assimilated into financial practice than it should be.

“But the real fault was not so much in economic theory as, if you like, in the political and business world, where people actually swallowed some of the simplistic views about the wonder of markets too much without recognizing the hundreds of qualifications that Adam Smith and a number of others have told us about, and we should all have known about.”

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Read more of Dixit’s profile here

Sources of revenue in the Nepali economy

The total revenue in FY 2007/08, 2008/09, and 2009/10 was Rs 107.6 billion, Rs 143.5 billion and Rs 179.9 billion, respectively. Between FY 2008/09 and 2009/10 total revenue increased by 25.4%.

Revenue derived from VAT is the highest (29.7% of total revenue = Rs 53.46 billion), followed by customs (19.5% =  Rs 35.03 billion), income tax (18.7% =  Rs 33.65 billion), excise (13.5%), registration fee (3.1%), vehicle tax (1.4%), educational service tax (0.1%), and non-tax income (14% = Rs 25.28 billion). These are provisional figures for fiscal year 2009/10, sourced from the macroeconomic indicators 2009/10, NRB. Between 2008/09 and 2009/10, revenue from excise increased by 49.6%, vehicle tax by 38.8%, educational service tax by 1036.2%, value added tax by 35%, customs by 31.6%, income tax by 22.4% and non-tax revenue by 23.3%.

Tim Harford’s 2010 in figures

An interesting compilation of the most interesting events and news of 2010 compiled by FT’s Tim Harford. Here is a rundown, by the FT team, of the major expected events in 2011.

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Nepal’s industrial and export interests in the Doha Round

My last op-ed for this year! It is about Nepal’s industrial and export interests in the upcoming Doha Round of trade negotiations under the WTO. I outline what Nepal’s interests are, what it should do, and why it should align with the LDCs in trade negotiations.

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Doha Round & Nepal

Amidst the euphoria and repeated interaction between ministry officials and businessmen regarding cash incentives on exports, there is a different storm brewing, albeit quietly, in the international trade regime. Trade analysts and representatives in other countries are gearing up to outline country agenda for the next Doha Round (DR) of trade negotiations under the WTO. While they are working on ensuring the reflection of their domestic industrial and export interests in the upcoming trade negotiations, and possibly a passage of the DR, Nepali bureaucrats, industrialists and exporters are running after cash incentives on exports. They seem to be oblivious and unbothered by declining exports competitiveness and our national agenda for the next round of trade negotiations.

In 2011, the DR will dominate trade talks globally. Unfortunately, our bureaucrats and business community are unprepared for this. They are oblivious of our industrial and export interests and how to include them in common agenda of Least Developed Countries (LDCs).Their unpreparedness and halfhearted engagement in trade talks should not be surprising. Precisely because of this, since Nepal joined the WTO on April 23, 2004, becoming the first LDC to join the trading bloc through full working party negotiation process, its exports performance has been very disappointing.

For starters, Doha Round, which started in November 2001, is the ongoing trade negotiation round that aims to lower trade barriers globally. Multiple rounds of negotiations failed because of disagreement over agricultural subsidies in the US and the EU, industrial tariffs and non tariff barriers, services and special trade measures. The latest negotiation broke down due to India’s insistence on the inclusion of special safeguard mechanism (SSM), a measure designed to protect poor farmers by allowing countries to impose tariff on certain agricultural goods in case of rapid price volatility. Though it is believed that the developing countries would benefit from the passage of the DR, various studies show only a handful of countries would reap the benefits.

Not only do we don’t know the developmental impact of the DR, we also have no clue how specifically it will aid Nepal’s industrial and export sectors. The most reasonable estimates show that Nepal would see meager gains. A World Bank study showed that total gains from the DR would be as low as $96 billion and only $16 billion would go to developing countries. Worse, half of all the benefits that would go to the developing countries would be reaped by just eight countries (Argentina, Brazil, China, India, Mexico, Thailand, Turkey and Vietnam). For South Asia, real income gains would be about US$2.5 billion. India alone is expected to gain US$ 1.7 billion. That leaves US$ 0.8 billion for the rest of South Asia. It shows that there is very little gains at store for Nepal. Worse, terms of trade, the relative prices of a country’s export to import, is expected to worsen, putting further strain on exports and hurting net food importer LDCs like Nepal. Additionally, another study by Carnegie Endowment shows that total gains from trade would be even lower (between US$ 32-55 billion) than the WB’s estimate, with rich nations getting $30 billion; middle income countries like China, Brazil and South Africa getting $20 billion; and poor countries getting $5 billion (about $2 per head).

Even if the gains are meager, Nepal should not ignore multilateral trade negotiations. We should not be a mute spectator during trade negotiations. It should actively support LDCs’ agenda. That way it can reap benefits offered to all LDCs plus lobby for special measures to ramp up our industrial and export sectors.

Nepal should be pushing for the inclusion of its industrial and trade interests in LDCs’ common agenda. Since a substantial portion of our trade happens with our neighbors, our bureaucrats and negotiators, while supporting LDCs’ agenda, should also push for special concessions such as greater transit rights and non tariff barriers to landlocked LDCs. Pushing for favorable trade measures to exploit regional markets is in our national interest. It will further help penetrate regional markets, where the transaction and transportation costs related to trade are lower than in the EU and the US. Mind you, the latter markets are also important, but all LDCs will have uniform privileges in these markets. Nepal needs those privileges plus greater preferences in the regional markets, where trade complementarities are pretty high.

There are a few LDCs’ agenda that Nepal should support. First, seeking duty-free, quota free (DFQF) trade commitment on all products is in both Nepal’s and LDCs’ interests. The developed countries should agree to this even before the DR negotiations begin next year. It will show seriousness of the developed countries in creating a more liberal trade regime than the existing one, and assure other countries that protectionist measures, especially after the global economic crisis, will not cloud over progress made so far in multilateral trade regime. Since DFQF on all products would erode marginal preference enjoyed by some developing countries, Nepal should also push for securing some sort of marginal preference, over and above DFQF applicable to all LDCs. This could come in the form of low non tariff barriers and relaxed rules of origin for market assess in key regional and nonregional destinations. These are needed to sustain our exports given its existing level of low product sophistication and diversification. Furthermore, convincing and winning India’s confidence in our trade structure and system is in our long term national interest regarding industrial, export and economic growth.

Second, Nepal should also confirm to LDCs’ agenda on “bio-piracy”, which is the use of genetic resources and associated traditional knowledge without benefit sharing and prior consent. Nepal should push for full disclosure on the use of bio products native to a certain indigenous group, community or country. Third, on issues of intellectual property rights (IPR), especially concerning patent on medicines secured by western multinational pharmaceutical companies, Nepal should back LDCs’ agenda that such patents should not compromise on public health needs of the developing countries.

Fourth, regarding Aid for Trade (AfT), it is in our interest to seek adequate, reliable, and predictable funding for not only developing human resources and technical aspects of trade, but also concrete aspects such as funds for the construction of infrastructures along major trading routes. For instance, allocating meager sum of money for building awareness and technical capacity regarding trademarks and packaging will do little to overcome supply side constraints such as lack of roads, electricity, communication and storage facilities. Ensuring the latter would directly aid trade, employment and growth. Note that sometimes for small and medium enterprises, which are the mainstay of our economy, the cost of protecting trademark at the global level is higher than the total revenue generated from sales of such products. Nepal should push for a special facility whereby funds are available to fight trademark breaches in the international market.

Nepal needs smart bureaucrats and negotiators to not only fully understand both domestic and multilateral trade agendas, but also the art of successfully pushing for the inclusion of purely domestic industrial and export interests in the common agenda of LDCs. Along with largely confirming with the position of LDCs for the upcoming DR negotiations, Nepal should also seek greater preference, concession and market access, especially in the regional markets, where it has relatively higher competitive advantage than in the nonregional markets.

[Published in Republica, December 26, 2010, p.6]

Small and targeted unconditional transfers in India

Dutta, Howes and Murgai argue that unconditional cash transfers for the elderly and widows (pension schemes) in Karnataka and Rajasthan worked due to small size and relatively low level of leakage. Regarding scaling-up of the project, the authors caution that the outcome would depend on the likely impact of increased coverage on both targeting and leakage. They argue that increased coverage would most likely worsen targeting. Currently, leakages are low because levels of discretion are low. As program expands, avenues for leakages (bribes, diversion of funds) will be higher.

If the program is to be expanded, then the authors suggest:

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In the short term, the way forward  would be to expand the coverage among widows and the  elderly and to increase the size of the pension. This is a path  the Government of India has already embarked upon. In the  longer term, the policy question is whether it makes a sense to  expand the categories to whom social pensions are given.

Ultimately, one can imagine a situation in which, say, cash pensions are made to every holder of a BPL card, instead of, or as well as, an entitlement to buy subsidised food and/or to a guarantee to a minimum number of days of public employment.  With the National Right to Employment Guarantee Act, and the  decision of the government to support a Right to Food Act such  a scenario is far-fetched today. Moreover, as stressed above, little is known about how cash transfers would perform if scaled  up. Nevertheless, it is reassuring to know that calls for a greater  role in Indian social security policy for cash transfers are at  least not contradicted by the performance of India’s existing  cash transfers.

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