[Adapted from Prem Khanal’s article published in The Week, Republica daily, January 7, 2010, p.1. A good rundown of the major macroeconomic issues in the Nepali economy.]
Oh, the economy! yet more jitters
Prem Khanal
As the realty sector slips deeper into financial distress and the law and order situation weakens further in a highly fluid political landscape, a new threat of painful economic slump is gathering force in the Nepali economy, indicating gloomy days ahead.
Like 2010, which was marked as a year when the Nepali economy was confronted with two unfamiliar headwinds – hefty deficit in the balance of payment, and an alarming rise in banks’ exposure to risky loans – the half-yearly indications give little convincing hope that the sluggish economy will make a headway to growth and expansion in 2011.
Grim economic data coming from such previously promising sectors as the financial sector has also deepened fears that the Nepali economy is heading to a crisis more rapidly than many were expecting. Weakening governance, worsening lawlessness, deepening power shortage, and shrinking realty sector are the four deadly toxics that will be the major ills of Nepal’s economic sickness in 2011.
Weak governance, which is breeding corruption in almost every segment of the society, is the foremost challenge that the country is facing since of late. As a result, along with the monetary corruption that has been Nepal’s chronic problem since long, policy level corruption has also lately become rampant, according to government officials familiar with the development. In fact, the deadly coexistence of weak governance and lawlessness is the single biggest barrier to the country’s economic development.
Further impacts of weakening governance have been directly reflected on the worsening law and order situation, thanks to the weak morals of law enforcement agencies wracked by long-running political maneuverings. Organized extortion in tie-ups with political cadres and personnel of law enforcement agencies is rampant, which is fuelling prices of goods and services, thus weakening investor confidence and polluting business environment. The shrinking flow of fresh loans to the private sector and sliding share market – the two quick barometers to gauge investor confidence – clearly reflects what a bad business climate Nepal has at present.
Likewise, power shortage, which is expected to reach a climax of 14-hour cuts a day in the summer, though less than last year’s horrible 16-hour load shedding, will continue to slice off productivity and efficiency of Nepal’s industrial and service sectors. As a result, few entrepreneurs have been able to install expensive diesel power plants of their own while leaving many others, mainly medium- and small-scale electricity-dependent businesses, to no other option than to limit their productive activities during power-on hours. In either case, the cost of production unnaturally swells, due to which many domestic products, which are doing pretty well at least in the internal market, are fast losing their market share to cheep Chinese imports, forcing Nepali entrepreneurs in turn to squeeze their production and cut labor force.
Seriously, too, the lethal coexistence of politically mollycoddled militant laborers and power cuts will further drag the Nepali industrial sector, whose contribution to the national economic pie has shrunk to 6.25% from 9% in 2001/02 and even more painful downturns are to be expected in the days to come.
The obvious impacts of a shattered private sector will be more distinctly visible in the economy. There will be no expansion of the existing productive capacity, let alone prospects of new ventures coming in, thereby resulting in further squeezing of the job market. So there will be a further weakening of much-needed competition in the job market for labor due to which laborers are unlikely to see their pay being raised. This, in turn, will instigate migration of unskilled and semi-skilled as well as highly skilled manpower that are the most essential factors to bring momentum to Nepal’s long-stalled development. As it is, the trend of mass exodus of unskilled and semi-skilled laborers to Malaysia and the Gulf States and highly skilled manpower to the US will continue to accelerate.
The current recession in the construction sector that is not only a major job provider after agriculture and industry but also the sector with the strongest backward and forward linkages, is adding many new challenges to the yawning economy. The side effects of the realty slump will emerge. First, loss of jobs will shrink the disposable income of laborers, weakening overall effective demand, while lack of cash-rich buyers will bring a prospect of ready-to-move apartments being remained unsold for months, if not years. Secondly, the downturn of construction industry will bring a spillover effect to construction-dependent sectors, ranging from cement factories to steel rolling mills to sanitary fittings to paint industry and other suppliers.
In both cases, banks will face extreme heat as they will face great difficulties in recovering their loans from the borrowing sectors. This will fuel loan defaults and expose the non-performing aspects of the banking system which will not only put new strains on banking health but also lower the banks’ profitability. These will as well add jitters to an already shrinking stock market. Though it may be a little earlier to say, but many familiar with the inside stories of Nepal’s banking system believe that a time bomb has already started ticking.
The shrink in consumption due to the looming economic slowdown will ease imports, which will be a good development for the central bank that is fighting hard against the deficits seen in the balance of payment – the balance between inflow and outflow of foreign currency – as a decline in imports will help lower trade deficit and the whopping current account deficit.
However, lower imports, particularly of durables goods and vehicles, will have a negative impact on the government’s target of notching revenues up by 20% to Rs 216 billion. Predictions show that slowing vehicle imports and other durable household goods, due mainly to rising lending rates together with squeezing consumption, will make the government’s task of achieving its revenue target indeed difficult for the first time in recent years.
So, how to deal with the situation?
One of the tools widely prescribed and practiced to deal with such a situation is to bring a stimulus package to pump huge amount of money into the economy through expansionary fiscal and monetary policy, so as to generate jobs and raise effective demands.
However, there are many constraints to such measures to improvise the Nepali economy. The first challenge is inflation, which is already close to 9%. Undoubtedly, it will soon jump to double digits when the economy fully realizes the impacts of the recent fuel price hikes along with rising prices of staples in India, from where Nepal imports these increasingly priced goods in the coming weeks. In such a scenario, any additional pumping of money into the economy will fuel inflation, thereby sprouting many economic as well as social ills.
Another risk is, as the domestic industrial base is extremely weak to immediately respond to rise in demand, such a measure will fuel imports and end up in bringing some additional revenue to the government’s coffer rather than creating jobs at the domestic front. Likewise, a stimulus policy will flare up budget deficit, which is already on the borderline, bringing devastating effects to fiscal balance.
Like in other countries, the stimulus fund can be used in infrastructure development which can immediately generate a large number of jobs. But Nepal’s implementation capacity is so weak, lengthy and complicated that it may take years to initiate a project launched to fight looming recession on the doorstep.
Yet behind the grim outlook, some faint hopes flicker on the horizon. Undoubtedly, remittances – the backbone Nepal’s present economy – will continue to grow as worker-hosting countries recuperate from the past year’s painful global economic recession. In fact, there will be a huge demand for labor, among other hosts, from the United Arab Emirates (UAE) when it starts its major constructions for the 2018 Olympics.
Good news has also emerged from the nastily erratic agriculture sector. Reports that paddy production, which alone contributes 7.5% to Nepal’s GDP, has increased by an encouraging 11% this year, along with the healthy growth in maize and millet production also means that the agro-based rural income will grow this year, along with overall agricultural yield that is estimated to hover around 2% against last year’s 1.1%.
So, the combined effects of the rise in disposable income among rural farmers along with the continuing, albeit moderate, growth in remittance economy, most of which is used in consumption, will help float an overall demand. But it will certainly be weaker than what the economy saw last year. Despite some slackness in the wholesale and retail business and financial intermediation sectors, the non-agricultural sector is expected to maintain a moderate growth of 3.5-4.5%, thanks to a healthy growth expected from the hospitality and tourism sector as well as transport and communication sectors.
So the overall economic growth is expected to remain at around 3.5% – almost at the same level as of last year’s. So, be ready for yet another “glorious year” to be marked in Nepal which, after all, is the slowest growing economy in South Asia.
(MERs), which does not correct for price differences across economies but may be more relevant for practical business purposes. Ranking with MERs show that the E7 overtaking process is slower but equally inexorable. The Chinese economy would still be likely to be larger than that of the US before 2035 and the E7 would overtake the G7 before 2040. India would be clearly the third largest economy in the world by 2050, well ahead of Japan and not too far behind the US on this MER basis. In 2009, India’s share of world GDP at MERs was just 2%. By 2050, this share could grow to around 13%. MERs factor in the likely rise in real market exchange rates in emerging economies towards their PPP rates. This could occur either through relatively higher domestic price inflation in these emerging economies, or through nominal exchange rate appreciation, or (most likely) some combination of both of these effects.