Nepal’s Monetary Policy for FY 2011-2012

I forgot to post it even though I wrote it few days back. So, here it is, my take on the monetary policy for fiscal year 2011-2012.

Major highlights:

• CRR to be 5 percent (decrease by 0.5 percentage points)
• Growth rate target of 5%
• Inflation target of 7%
• BoP surplus target of Rs 5 billion
• Forex Reserve targeted to finance at least 6 months of imports
• Broad money supply target 12.5%
• Domestic credit growth target 13.7%
• Credit growth to private sector target 14%
• Banks deposits growth target of13 percent growth, up by Rs 87 billion to Rs 756 billion
• Bank rate (policy rate) unchanged at 7 percent. The penal rate, which NRB has been charging while issuing finances to the BFIs, has been left unchanged at 3 percent of over 91-day Treasury Bill rate or bank rate, whichever is higher.
• NRNs allowed to open dollar account.
• Foreign exchange facility raised to US$ 2,500 at one instance and up to US$ 5,000 in total in a year by showing relevant document (mainly passport). NRB has also allowed Nepalis returning from foreign country to carry up to US$ 1,000 on behalf of Nepalis residing abroad for giving it to their family members back home.
• Deprived sector lending for BFIs increased by 50 basis points. Commercial banks, development banks and finance companies would need to lend 3.5%, 3% and 2.5% respectively of their total loan portfolio to the deprived sector.They will need to raise such loans by 50 basis points every year for the next three years.
• The central has bank agreed to let BFIs issue loans in foreign currency in priority sectors like hydropower and infrastructure.
• Intensify actions against willful defaulters that took loans of Rs 10 million or more from BFI
• To strictly enforce prudent corporate governance in the BFIs and punish players that flout its norms
• Legal actions against borrowers that use loans, taken for one stated purpose, to run different unproductive businesses
• Loans of Rs 1.5 million at zero interest rate to the micro-finance institutions--the category D financial institutions--if they opened branches in 9 remote districts where access to finances is pretty low.

More highlights here. Here is the full text in Nepali language.

Quick comments:

• A sudden decline in BoP deficit and a surplus of Rs 1 billion due to reimbursement of foreign aid (grant and loan), pension of Gurkhas, and government expenditure is expected for FY 2010/11. The deficit was around Rs 12 billion in the first eleven months of FY 2010/11.
• Bringing down CRR by 0.5 percentage points will not solve the liquidity crisis, whose roots lie in the number of BFIs, which meant that the more they are, the more money they need to keep up their deposit and loan targets.
• GDP growth, inflation and BoP targets are very unlikely to be achieved. These targets are follow up of the targets mentioned in the budget. It is NRB’s religion to do that. But, it should be more honest in advising the government on what can be achieved and what not. GDP growth target is hard to achieve due to loss in productivity and power outages and other non economic constraints. High and sticky inflation has more to do with supply-side constraints and the NRB can do very little to tame it. Partly, it is also due to rising food prices, which are unlikely to come down. BoP target is hard to achieve because we are in the same mess as we were two years ago.
• It is very disappointing that the NRB has not brought clear policy framework to incentivize BFIs to go for merger or acquisition. Nepal’s financial sector needs consolidation and the BFIs will not do it on their own and will wait till the last moment when the NRB will be forced to step in.
• The bank rate should have been lower (it should be always lower than inter-bank rate). Since inter-bank rate is very high, it would not hurt to lower bank rate below 7%. The lower the bank rate, the higher will be credit withdrawal by banks from NRB. This would have reduced strain in short term liquidity in the market.  
• Emphasis on channeling credit to deprived sectors and in rural areas is noteworthy of this monetary policy.
• Overall, it is a weak policy that will do very little to bring Nepali economy out of the mess it is in right now.

Where is all the money going?

Prithivi Man Shrestha reports that a large portion of the aid money that comes in the form technical assistance (TA) is unaccounted for in Nepal.

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According to the OAG report 2011, of the total Rs 17.19 billion received by the country as technical assistance in the fiscal year 2009-10, it is not clear where 87.43 percent (Rs 15.02 billion) of it went. Of that aid, 6.3 percent was spent for consultants, 3.57 percent for goods and 2.70 percent went for trainings and seminars. “It is necessary to make such aid transparent by classifying the programme and areas it goes to,” the report states.

Of the total 75 agreements signed in 2009-10, a total of 67 were related to 22 ministries, but there was no information on eight agreements and the amount spent, according to the OAG.

The government’s policy is to reduce the size of the TA by enhancing the capacity of civil servants, but the size of the TA reveals that donors still don’t believe in the capacity of Nepali civil servants.

“Multilateral donors including the World Bank and the Asian Development Bank and even bilateral donors prepare most of the project documents themselves by using the TA,” said Kailash Raj Pokharel, under secretary at the Finance Ministry. “We have been preparing such documents for small projects only.”

Officials said that the size of the TA remained so big as donors didn’t trust the capability of Nepali bureaucrats. The amount peaked this year with the inclusion of most of the possible projects operating in the country. Not only the size of the TA but also the number of TA projects peaked this year to reach 229 from 96 a year ago.

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Usually, TA is used to pay for consultancy services, purchasing goods and equipment and trainings and seminars. Most of it goes to the donor countries themselves though it gets reported as being received by recipient country when they report such figures to OECD and their own governments. In Nepal, donors have pledged Rs 45.23 billion for ongoing technical assistance (TA) related projects. This is half the total foreign aid (grants and loans) estimated for the fiscal year 2011-12.

Given the interest of donors in promoting their own personnel (in terms of employment) and capital (in terms of using resources sourced from their countries)—this is important to their citizens—it is understandable that the size of TA might not go down or halted at all. In doing so the donors also do care (or they should) about results on the ground, i.e. whether their effort has produced intended results, which is doubtful most of the time. Most of the donors’ expertise is in brining ‘experts’ to write reports. They have very little knowledge of what works on the ground. Else, more than US$ 12 billion that Nepal received since 1960 would have made a significant dent in an economy whose size is just US$ 12 billion. To further fine-tune their interest (and Nepal’s to some extent) the donors have their own development strategy paper, which should have largely adapted the National Planning Commission’s actual paper.

That said, aid has made good impact on education and health sectors. No doubt about that. In other sectors such as promoting trade, assistance has been restricted to writing reports on how best to implement a given agenda or a product. Most of the money is spent on studies, seminars, and conferences—all of which will involve personnel and capital from the donor countries at some stage. Some of the money goes back. Some stays back in the form of short term employment and reports that detail how best to implement a strategy or tackle constraints.

The irony is that substantial aid to actually tackle the identified constraints hardly comes from most of the donors (save the WB, ADB, India and China). Our policymakers and stakeholders are pretty clear on the constraints, but still reports are written to identify the constraints, which are actually identified by talking to policymakers and stakeholders in the first place. The baseline is that if we already know what the constraints are, then why not pump in resources (monetary, human, technical) to tackle them directly, and not waste money in writing yet another report that adds very little value to the already overfull stock of knowledge. Money should not be wasted in writing reports unless they are essential to guide policy in changed and evolving circumstance. Leave that to the academicians and policy wonks. The donors and policymakers should focus on projects that gives the biggest bang for buck, which is in the interest of the citizens of the donor countries and recipient country. And, in the case of Nepal, we already have such projects identified since a long time. One reason they are not implemented could be that the donors cannot cough up enough resources to make them happen in reality. Other might be that the government is simply not caring too much to implement them.

Mainstreaming trade in Nepal: Trade policy, agricultural policy, and industrial policy compared

A brief (Policy Brief 6-- Nepal)  published by the FAO evaluates mainstreaming of trade by reviewing three different policies supporting trade (the trade chapter in the Three Year Interim Plan 2007-10 which was Nepal’s PRSP, Nepal Trade Policy 2009, and Nepal Trade Integration Strategy 2010); three on agriculture (National Agriculture Policy 2004, agriculture chapter in the PRSP, and Agri- business Promotion Policy 2006); two on industrial policy (industry chapter in the PRSP and Nepal Industrial Policy 2010); and one food security policy (food security section in the PRSP). Below are the main points from the brief.

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Policy papers show considerable consistency on vision, goals and orientation – On the whole, there is considerable consistency on the overall vision, goal and orientation of policies (e.g. contribute to growth and poverty reduction, inclusiveness, market-led growth, liberal economic and trade policies, increased role for the private sector). They also indicate a strategic shift towards supporting value-chains as a whole rather than concentrating efforts at the primary production end as was the case in the past.

But the 2009 trade policy focuses exclusively on exports and thus misses out on some broader development issues that trade policy needs to address – The trade chapter of the PRSP identified as one fundamental problem the trade sector’s weak linkages with the domestic economy and raw materials, but provided no analysis or guidance on how this would be reversed. Indeed, many of Nepal’s prominent export products that developed during the past 2-3 decades are heavy users of imported raw materials. Nepal’s 2009 trade policy and 2010 integration strategy, both with exclusive focus on exports, also largely miss out on this “quality” of trade issue. For example, there are no serious analyses on what policies and incentives would encourage export-oriented industries that use local materials and have strong linkages. The exclusive focus of the trade policy on exports is one reason for missing out on these issues because many of the issues are related to importables, notably the food and agro-industry sub-sectors. These include, for example, the structure of import tariffs and protection, including tariff escalation, and incentives to import-competing industries. These are also important development issues for the agriculture and industrial policies. A trade policy is not an export policy and needs to be balanced in looking after the needs of all productive sub-sectors.

The desire to promote priority export products likely to be undermined by weak mainstreaming process – While the trade chapter of the PRSP did not have a list of priority products, 19 such products were identified in the 2009 trade policy (and a similar list in 2010 trade integration document). This approach to focusing resources on selected products is consistent with similar practices in other countries. But the process needs to be improved considerably. First, it is not clear why the lists in the two trade papers that came within two years are not identical. Second, the 2010 industrial policy did not refer to the list in the 2009 trade policy and has its own list of priority products, but covering almost everything and thus undermining the very notion of priority. Third, agricultural policy does not have such a list, although both trade and industrial policies list many agricultural products. The experience with Nepal’s 1995 Agricultural Perspective Plan, which took a similar approach of listing priority products is not positive, in large part due to lack of mainstreaming across policies. No attempt has been made in the trade or other policies to learn from that experience. There is thus a real risk that support to priority products – in whichever policy document they belong to – might continue to remain weak.

Should Nepal’s PRSP be designed differently? - Nepal designated its 11th development plan as the PRSP. Being similar in design to the previous periodic plans, this differs considerably from the PRSPs in most other countries. While there are some advantages, having 20 or so separate, stand-alone sectoral chapters also comes with disadvantages. One is the challenge to ensure that policies at the sectoral and macro level, including trade policy, are mainstreamed consistently. In this format, mainstreaming essentially depends on the ability of the National Planning Commission to ensure coordination and synergy. The studies note several weaknesses on this. A related problem with this format is that there are often two policy documents – the chapters of the PRSP and respective national policies. Maintaining consistency between these two sets of papers appears to be a challenge. An alternative format to the traditional plan is the focused PRSPs like those in Ghana and Tanzania, for example.

Lack of baseline statistics on product-specific support is a serious handicap for prioritizing trade support measures – While policy papers specify priorities (e.g. export products), it is hard to discuss prioritization and resource reallocation for lack of disaggregated statistics on public outlays and incentives/subsidies. This is the situation across the board – from agricultural research, provision of industrial and export incentives, to commodity development. In trade policy and elsewhere, provisions are made for one or more incentive schemes, typically involving subsidies, and yet it is no where explained how these policies were determined nor if these schemes were effective in the past. With the increasing focus on value chains, statistics on outlays along the chains have also become essential, but are mostly missing currently.

The process of stakeholder consultations needs strengthening - Stakeholder consultations are increasingly being organized. But the quality of these meetings needs strengthening. In Nepal’s case, participation of the private sector from the business and industry side has been strong but is lacking on civil society, farm organizations and independent analysts. The more serious issue is with the effectiveness of such meetings. Typically, not having prepared evidence-based briefs on the issues being debated and circulated in advance, stakeholders’ inputs are limited. Interestingly, similar weaknesses were noted for meetings of inter-ministerial committees and task forces. In some cases, even important ministries have been missing altogether, e.g. the Ministry of Agriculture is not even represented in the high level Boards created in the 2009 trade and 2010 industrial policies, despite the fact that at least half of the targeted priority products are agricultural.

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Population, Poverty, and Sustainable Development

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There is a very large but scattered literature debating the economic implications of high fertility. This paper reviews the literature on three themes: (a) Does high fertility affect low-income countries' prospects for economic growth and poverty reduction? (b) Does population growth exacerbate pressure on natural resources? and (c) Are family planning programs effective at lowering fertility, and should they be publicly funded? The literature shows broad consensus that while policy and institutional settings are key in shaping the prospects of economic growth and poverty reduction, the rate of population growth also matters. Recent studies find that low dependency ratios (as fertility declines) create an opportunity for increasing productivity, savings and investment in future growth. They find that lower fertility is associated with better child health and schooling, and better health and greater labor-force participation for women. They also indicate that rapid population growth can constrain economic growth, especially in low-income countries with poor policy environments. Population growth also exacerbates pressure on environmental common property resources. Studies highlight the deep challenges to aligning divergent interests for managing these resources. However, part of the pressure on these resources can be mitigated by reducing the rate of population growth. Although family planning programs are only one policy lever to help reduce fertility, studies find them effective. Such programs might help especially in the Sub-Saharan African region, where high fertility and institutional constraints on economic growth combine to slow rises in living standards.

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Read the full paper by Das Gupta, Bongaarts and Cleland (2011).

Third global review of Aid for Trade

The WTO release third global review of Aid for Trade (AfT). The report basically details the increase in AfT, its ‘effectiveness’ in Cape Verde (graduated from LDC club in 2008), Rwanda (top performer in Doing Business ranking), and the role of EIF in mainstreaming trade at national level and utilizing AfT. AfT assists developing countries to increase exports of goods and services, to integrate into the multilateral trading system, and to benefit from liberalized trade and increased market access. The assumption is that effective Aid for Trade will enhance growth prospects and reduce poverty, as well as complement multilateral trade reforms and distribute the global benefits more equitably across and within developing countries.

The main highlights:

• In 2009, aid-for-trade commitments reached approximately USD 40 billion, a 60% increase from the 2002-05 baseline. Other official flows to trade-related sectors doubled to reach USD 51 billion. Half of all aid for trade is provided in grant form, mainly to the poorest developing countries. 
• Disbursements have been growing steadily at 11-12% for each year since 2006 - reaching USD 29 billion in 2009 - indicating that past commitments are being met.
• Aid for trade to sub-Saharan Africa increased by 40% to reach USD 13 billion and Africa now receives the largest share among the different regions.
• The outlook for aid for trade is stable: last year in Seoul, South Korea, G20 leaders committed to at least maintain, beyond 2011, aid-for-trade levels reached over the years 2006-08. But some OECD countries are confronted with large budget deficits and find it difficult to respond adequately to the higher demand for aid for trade. Fortunately, there are positive signs that South-South co-operation continues to grow.

The wholly positive outlook of this report is not totally consistent with the five country study on the effectiveness of AfT carried out by SAWTEE and ICTSD. The country reports are forthcoming. I write a blog later on comparing this report with the country reports, which is more exhaustive and rigorous than the WTO report.

Is export-led growth dead?

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This paper traces the rise of export-led growth as a development paradigm and argues that it is exhausted owing to changed conditions in emerging market (EM) and developed economies. The global economy needs a recalibration that facilitates a new paradigm of domestic demand-led growth. Globalization has so diversified global economic activity that no country or region can act as the lone locomotive of global growth. Political reasoning suggests that EM countries are not likely to abandon export-led growth, nor will the international community implement the international arrangements needed for successful domestic demand-led growth. Consequently, the global economy likely faces asymmetric stagnation.

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Here is the full working paper by Thomas Palley. He concludes that we should abandon strategies aimed at attracting export-oriented foreign direct investment and institute a new paradigm based on a domestic demand--led growth model. Otherwise, the global economy is likely to experience asymmetric stagnation and increased economic tensions between emerging-market and industrialized economies.

Well, export-led growth strategy might be so for emerging markets and industrialized countries, but might be equally relevant to LDCs as it was for the now emerging markets. Canuto, Haddad and Hanson (2010) argue that the slack in demand in developed countries is filled up by the rising demand in emerging markets (including BRIC), leading to expansion of South-South trade. The middle-income countries are driving export diversification of low-income countries.The export diversification index (concentration index) of low-income countries has seen an improvement of 10 percent between 1997 and 2007 (this means exports moving from being spread evenly across four products to seven products; note that three sectors namely petroleum products, food, and iron and steel accounted for 76 percent of low-income countries’ trade between 1998 and 2006). This means that low-income developing countries will continue to rely on developing countries for export growth. They argue that this shift is leading to export-led growth 2.0. Export-led growth model is not really dead for low income countries.

Evolution of economic development theory

Here is Justin Lin’s chart:

More on Lin’s New Structural Economics here.