Festival season economics

Today’s TKP has interesting numbers related to income and expenditure shocks during festival season (Dashain, Tihar and Chhat):

• More than Rs 15 billion enters the economy during the season in the form of salaries and allowances.
• 10 percent of the total remittance inflows enters the country during this period. Between mid-September and mid-October 2011, remittance inflows was Rs 28 billion.
• Most of the goods consumed are imported.
• Revenue mobilization, hinged on remittances financed imports (custom duty and VAT), is the highest during festival month.
• FNCCI estimates daily transaction of Rs 13 billion during festival month.

Normally, festivals give a boost to the economy: quarterly growth rate and employment numbers go up, retail activities pick up, internal tourism is high and so forth. However, in a remittances dependent economy with declining manufacturing strength (which dropped to around 6% of GDP last year), festivals do not have substantial multiplier effects as is seen in other countries. The ones who gain are traders (who import goods and sell it in the Nepali market), workers in the formal sector (think of one month extra bonus!), revenue department (customs duty and consumption taxes on imported goods), middlemen (who rig prices and supplies especially in agricultural sector) and jewelry businesses (South Asian household's fascination with jewelry during festival seasons is quite unique!) among others.

The economy does not get much stimulus because most of the goods and services consumed during festival season are not produced domestically using our own workforce, i.e. value addition is very low, if any. Unless we solve the supply-side constraints faced by industrial sector (mainly power crunch, poor infrastructure, labor disputes, lack of innovation and R&D, and policy implementation paralysis), the outlook appears grim. Worse, if monsoon becomes unfavorable, then growth rate might plunge more than anticipated. Prolonged political uncertainty is another damper on investor’s confidence. As of now, it seems the ever-increasing transactions during festival season is going to widen trade deficit (merchandise trade deficit was Rs 424.07 billion in 2011/12 compared to Rs 332.97 billion in 2010/11-- around 24% of GDP) further.

Now, Nepal cannot solve all of the supply-side constraints at once. Nepal doesn't have the financial resources, political will and institutional strength to do that. It could at least work on improving industrial relations, implement the promised provisions in several policy documents, encourage private sector to engage in R&D by offering fiscal and other incentives and gradually work on meeting energy demand.

Anyway, enjoy the festivals!

High cost load-shedding reduction plan

So, the government has instructed the Ministry of Finance (MoF) to give Rs 5.4 billion grant to Nepal Electricity Authority (NEA) to help it meet the plan to limit load-shedding to 12 hours coming dry season. According to reports, the NEA needs Rs 2.80 billion annually to operate its thermal plants and another Rs 2.60 billion to import additional energy from India. Import price of energy is Rs 7.23 per unit, but it costs Rs 9.69 in total due to technical leakage.

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The plan had proposed for the early construction of the 400kv Dhalkebar-Mujjaffapur inter-boarder transmission line, generating 40 MW of energy from diesel plants (39MW in Duhabi, Morang, and 14.4MW in Hetauda), importing 200 MW additional energy from India and purchasing energy from captive plants of local industrial units, among others. The MoE has already asked the Finance Ministry to release Rs 330 million to build the transmission line.

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Looks like a pretty expensive plan. But, then it is necessary to lower load-shedding hours. The real task is to assess if the benefits of such expensive, temporary load-shedding reduction plan/action outweigh the costs of having long load-shedding hours. If such episodes are regular feature each year, then will it be sensible to invest, say, five years worth of this implicit subsidy in energy generation (investing Rs (5*5) billion = Rs 25 billion in hydro power in one go!)? More grants to NEA means more subsidy that is not properly targeted (same thing with subsidies on diesel and LPG). It would mean more pressure on fiscal balance and diversion of money allocated for development works. It has huge opportunity cost.

The country faces a stark choice: either continue plundering taxpayer’s hard earned money by subsidizing a hugely inefficient sector (and institution) or suffer for a bit more but then pump huge sum of money in the sector that will eventually erase the need for subsidy in the first place. Seems like the government is trying to tread the middle path, which presumably is also politically palatable. Anyway, these are difficult times and getting over it requires making difficult choices and decisions.

Here is a link to an article on the impact of load-shedding. Also, here is a link to a blog post that details the size of Indian market for Nepali goods and services.

How big is the Indian market for Nepal?

Nepal is inherently dependent on India for pretty much everything. All of the petroleum products are imported from India. India is the biggest market for Nepal’s exports and imports (informal trade is also equally large). It is further facilitated by the free flow of goods (there are no tariffs imposed on manufacturing goods exported to India, but there exists some NTBs) and services between the two countries.  Each year, the largest share of FDI comes from India (also see this). Nepal is also importing increasingly large amount of electricity from India (this should have been the opposite!). Nepal signed BIPPA and DTAA with India last year. Nepal has pegged its currency to Indian rupee (maintaining which has been a cornerstone of Nepal’s monetary policy) and about one-third variability in prices is determined by the ones prevailing in the Indian market. India provides the only exit point for third country trade of Nepal. Overall, Nepal is economically, culturally, religiously and historically linked to India and the Indian economy.

Against this backdrop, it is often said that Nepal has a high potential to grow rapidly given the huge market potential in neighboring India and China, the two emerging economic giants of Asia. Most of the commercial investments mention India as a promising market at some point of the proposal or business plan. Now, how big really is the Indian market for Nepali goods and services?

The adjoining five states matter the most than any other states of India because the cost of trade in these five states is relatively lower given their proximity and possibly complementary production structure. The adjoining five states are Uttarakhand, Uttar Pradesh, Bihar, West Bengal and Sikkim.

The table below provides a snapshot of the potential number of customers (proxied by population size), increasing demand (proxied by real per capita income growth) and economic prospect (proxied by real GDP growth) of the adjoining five states, India and Nepal.

NPL-IND	Uttarakhand	Uttar Pradesh	Bihar	West Bengal	Sikkim	INDIA	NEPAL
Population in 2011, million	10.12	199.58	103.81	91.35	0.61	1210.19	26.6
Real GDP growth*	11.56	6.90	12.11	7.32	16.20	7.93	4.47
Real per capita income growth*	9.31	4.92	10.82	6.17	12.25	6.26	3.04

*Average between 2007/08 and 2011/2012; Source:Compiled from Planning Commission (India), and Economic Survey 2012 and Census 2011 (Nepal)

According to Indian Census 2011, the total population of the five adjoining Indian states is 400 million. The total population of India and Nepal is 1.21 billion and 26.6 million respectively. On an average, between 2007/08 and 2011/12, all the adjoining Indian states had real growth rate of about or above 7 percent. Real per capita growth was above 6 percent in all but Uttar Pradesh. With the relatively low real growth rate and per capita growth rate of Nepal, there exists a tremendous opportunity for Nepal to catch up if only it could cater to the already available markets with what they need the most: electricity.

Now, Nepal itself is facing long load-shedding hours. If Nepal is able to generate adequate electricity (that means facilitating construction of small, medium and big hydro projects with all possible support to investors), then it can consume first what is needed and then export the rest to the energy hungry adjoining Indian states. It would be a win-win strategy for both Nepal and India. India would be able to fulfill some of its electricity demand by importing from Nepal. Nepal would see huge investment, competitive manufacturing and export sectors, spurring of economic activities, new jobs, higher income, and robust agriculture and industrial sectors. It will also strengthen fiscal position as revenue rises and could help maintain macroeconomic stability.

So, how big is the demand for electricity in the adjoining Indian states? Overall, India is anticipating 14,856 MW of electricity deficit (10 percent of total requirement) during peak time in 2012/13. Total energy requirement is estimated to be 985,317 GWh (India uses MU instead of GWh) but availability is expected to be 893,371 GWh only, resulting in 91,946 GWh of deficit. FYI, in India, kilowatt hour is referred to as a unit of energy and a million units (MU) is a gigawatt hour (GWh).

The table below shows requirement, availability and shortage of energy in the adjoining Indian states, whole of India and Nepal in 2011/12. Bihar had the highest shortage of electricity (21 percent of total energy requirement). Overall, throughout the year India had 8 percent shortfall of energy and Nepal had 20 percent.

NPL-IND	Uttarakhand	Uttar Pradesh	Bihar	West Bengal	Sikkim	INDIA	NEPAL
Energy requirement (GWh)	10,513	81,339	14,311	38,679	390	937,199	5,195
Energy availability (GWh)	10,208	72,116	11,260	38,281	384	857,886	4,179
Energy shortage (GWh)	305	9,223	3,051	398	6	79,313	1,016

Source: Compiled from Central Electricity Authority of India and Nepal Electricity Authority

In 2011/12, during peak load, Bihar had the largest shortfall (14.43 percent). Sikkim had a surplus supply of about 5 percent of total energy demand. Overall, India had deficit of 10.63 percent. These figures look miniature in front of 43.64 percent energy shortfall in supply compared to demand in Nepal during peak load. No wonder folks had their electronic equipment (for those who do not have alternatives such as invertors and/or solar batteries) nonoperational for over 15 hours each day during dry season. There exists a huge demand for electricity internally. If energy generation surpasses the internal demand, then there already is a readymade market for it in the adjoining Indian states.

NPL-IND	Uttarakhand	Uttar Pradesh	Bihar	West Bengal	Sikkim	INDIA	NEPAL
Energy peak demand (MW)	1,612	12,038	2,031	6,592	100	130,006	1,027
Energy peak supply (MW)	1,600	11,767	1,738	6,532	95	116,191	579
Energy peak shortage (MW)	12	271	293	60	(5)	13,815	448

Source: Compiled from Central Electricity Authority of India and Nepal Electricity Authority

Next year, Uttarakhand is expected to face 24.28 percent shortage of electricity (total) requirement. Sikkim is expected to have 87.53 percent surplus. Overall, India is expected to face 9.33 percent electricity shortage. During peak time, Uttar Pradesh alone is expected to see 2123 MW shortage of electricity. Energy requirement in Nepal next year is estimated to be 5350 GWh. During peak load, the demand for electricity in Nepal in 2012/13 is estimated to be 1163 MW. In 2016/17 and 2024/25 peak load is forecasted to be 1641 MW and 2951 MW respectively in Nepal.

Anticipated in 2012-13 (MU=GWh)
NPL-IND	Requirement	Availability	Deficit	Peak time deficit (MW)
Uttarakhand	11,322	8,573	2,749	86
Uttar Pradesh	87,153	70,509	16,644	2,123
Bihar	14,550	11,609	2,940	774
West Bengal	44,409	43,674	735	214
Sikkim	489	917	(428)	(41)
INDIA	985,317	893,371	91,946	14,856
NEPAL	5,350

Source: Compiled from Central Electricity Authority of India and Nepal Electricity Authority

BTW, of the total energy generation in 2011/12 in India, central government’s share was 41.54 percent, state government 41.94 percent, private IPPs 12.77 percent, private utilities 3.16 percent, and import from Bhutan 0.60 percent. In Nepal, of the total energy availability, the share of NEA hydro was 56.42 percent, NEA thermal 0.04 percent, import from India 17.85 percent and purchase from IPPs 25.69 percent.

There you go. Nepal already has a huge demand for electricity and if it is able to generate in excess of the domestic demand, then there is also a readymade, energy hungry market right next door. There is nothing to lose from generating more electricity by judiciously exploiting our natural endowment. Nepal has a bright future if it can continuously light bulbs and fire up electronic equipment!

Apart from the brief outline of Nepal’s dependence on India, below is a combo picture showing the increasing reliance on the Indian market for exports and imports.

Trade concentration with India is very high. The share of trade deficit with India in fiscal year 1974/75 was 78.81 percent. It decreased to 26.55 percent in fiscal year 1988/89 and then started increasing rapidly in the last two decades, reaching 65.87 percent in fiscal year 2010/11. The total trade deficit in 2010/11 was NRs 331.84 billion. Nepal is selling high amount of dollars to purchase Indian rupee, which in turn is used to purchase goods from India. Competitiveness of Nepali export items is going down. The main reasons are: lack of adequate supply of infrastructure (mainly electricity), political instability/strikes, labor disputes, lack of innovation by private sector, and government’s inability to implement key reforms enshrined in major policy documents.

NEPAL: ADB forecasts 3.8 percent growth in 2012/13

In its latest Asian Development Outlook Update 2012, the ADB has revised down Nepal’s economic growth rate for 2012/13 to 3.8 percent from an earlier estimated of 4 percent. The main reasons are delay in monsoon (and its impact on agriculture output), shortage of fertilizers and partial budget. The forecast is in line with what analysts have been predicting. Last week, the IMF also raised concern that growth will come down due to late monsoon, continued slowdown in industrial output and slow growth in India. Inflation in 2013 is forecasted to be 8.5 percent.

Meanwhile, ADB projects Asia’s growth to drop to 6.1 percent in 2012, and 6.7 percent in 2013, down significantly from 7.2 percent in 2011. Specifically, India’s gross domestic product is expected to grow by 5.6 percent in FY2012 (which ends March 2013) and 6.7 percent in FY2013, a significant drop from ADB’s earlier projections of 7.0 percent and 7.5 percent, respectively, for the two years.

The ADB argues that the shock emanating from Europe’s sovereign debt crisis and sharp fiscal consolidation in the US pose the biggest downside risk for Asian economies. Fortunately, it says, most of the Asian countries have enough space to launch countercyclical policy interventions.

The ADO 2012 update recommends economies to enhance productivity and efficiency to increase prosperity. Specifically, it sees a particularly vital role of a high value modern services sector, whose constrains to expansion are lack of human capital, inadequate infrastructure and restrictive regulations.

Below is a revised outlook of Nepali economy (adapted from the ADO Update 2012, p.101):

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GDP grew by 4.6% in FY2012 (ended in July 2012), up from 3.8% a year earlier. Good weather allowed a bountiful harvest, and robust increases  in tourist arrivals and migrant worker remittances underpinned the  recovery. Inflation moderated to 8.3% from near double digits in the  previous year as food price hikes abated, but non-food inflation remained  high, reflecting increases in the administered prices of fuels. Although  banks’ liquidity constraint eased, growth in credit was slow because  there were few attractive investment opportunities. Political uncertainties  continued, marked by the dissolution of the Constituent Assembly on  27 May without agreement on a new constitution. Revenue collection grew robustly, but there was under-spending on capital projects, reflecting  limited implementation capability. The external position strengthened as remittances and tourism receipts offset a widening trade deficit.

In FY2013, GDP growth is expected to dip to 3.8%—falling below the  ADO 2012 forecast of 4.0%—as the late monsoon and fertilizer shortages undermine agriculture and as the inability to approve a budget for all  of FY2013 creates fiscal drag. Remittance inflows and tourist arrivals  will sustain expansion in services, but growth in industry will remain constrained by persistent power outages, sporadic fuel shortages, and  long-standing structural bottlenecks and policy distortions.

Prices in FY2013 will be under pressure from needed upward  adjustments to domestic fuel prices to limit losses at the Nepal Oil Corporation, and from continued high inflation in India mirrored in Nepal by the currency peg. The Update inflation forecast is raised to 8.5%. The current account balance is expected to improve moderately, as forecast in April.

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Jobs for development and good development policies for jobs

The latest World Development Report 2013 is focused on jobs. The main point is that jobs in developing countries pay off far beyond income alone as it is the best insurance against poverty and vulnerability.

The report shows that providing jobs reduces poverty and it also empowers women to invest more in their children. It also offers alternatives to conflict and makes fragile countries stable.

The best things about WDRs are new policy relevant evidence and the steering of development debate, to some extent,in a single contemporary topic. Below are excerpts from WDR 2013:

• Jobs with the greatest development payoffs are those that make cities function better, connect the economy to global markets, protect the environment, foster trust and civic engagement, or reduce poverty. Critically, these jobs are not only found in the formal sector; depending on the country context, informal jobs can also be transformational. Productivity is lower in informal sector but then formalizing it doesn’t guarantee greater efficiency.
• More than 3 billion people are working worldwide. But, nearly half work in farming, small household enterprises, or in casual or seasonal day labor, where safety nets are modest or sometimes non-existent and earnings are often meager.
• More than 620 million young people are neither working nor studying. To keep employment as a share of the working-age population constant, in 2020 there should be around 600 million more jobs than in 2005, a majority of them in Asia and Sub-Saharan Africa.
• In 10 of 18 Latin American countries, changes in labor income explain more than half the reduction in poverty, and in another 5 countries, more than a third.

• In many developing countries, where farming and self-employment are prevalent and safety nets are modest at best, unemployment rates can be low. Quality and not just the number of jobs is vitally important.
• 6 out of 7 workers in Eastern Europe and Central Asia are wage earners, but 4 out of 5 workers in Sub-Saharan African are farmers or self-employed.
• More women than men are in non-wage work in low- and lower-middle income countries. In middle-income countries women are more likely to be wage workers, though too often they earn less than men.
• In Sub-Saharan Africa, 10 million youth enter the labor force every year, but in many middle-income countries the population is aging and in some the labor force is shrinking.
• There is 22 times difference in productivity (gap) between manufacturing firms in the 90th and 10th percentiles in India. Meanwhile, there is 9 times difference in productivity (gap) between manufacturing firms in the 90th and 10th percentiles in the US.

• Nonwage work represents more than 80 percent of women’s employment in Sub-Saharan Africa— but less than 20 percent in Eastern Europe and Central Asia.

• Rapid urbanization is changing the composition of employment. More than half the population in developing countries is expected to be living in cities and towns before 2020.The growth of the nonagricultural labor force will vastly exceed the growth of the agricultural labor force.
• On average across developing countries, between 7 and 20 percent of jobs in manufacturing are created within a year, but a similar proportion disappear.

• Tradeoffs among improving living standards, accelerating productivity growth, and fostering social cohesion arguably reflect a measurement problem, more than a real choice. If growth indicators captured the intangible social benefits from jobs, from lower poverty to greater social cohesion, a growth strategy and a jobs strategy would be equivalent. But a growth strategy may not pay enough attention to female employment, or to employment in secondary cities, or to idleness among youth. When potentially important spillovers from jobs are not realized, a jobs strategy may provide more useful insights.

Recommendations to increase jobs:

• Maintain solid fundamentals – including macroeconomic stability, an enabling business environment, human capital, and the rule of law.
• Labor policies should not obstruct job creation, but then they should also provide access to voice and social protection to the most vulnerable.
• Identify jobs that would do the most for development given their specific country context, and remove or offset obstacles to private sector creation of such jobs.

Relevant in Nepal’s context:

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In conflict-affected countries, the most immediate challenge is to support social cohesion. Employment for ex-combatants or young men vulnerable to participation in violence takes on particular importance. With fragile institutions and volatile politics, attracting private investment and connecting to global value chains may be out of reach for quite some time. Yet construction can boom even in poor business environments, and it is labor intensive. Investments in infrastructure can not only support social cohesion through their direct employment impact, they can also be a step in preparing for future private sector job creation.

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[All figures/pictures extracted from WDR 2013.]

Monetary transmission in developing countries

Usually, when we talk about monetary policy, it is customary to link this with standard econ theories. For instance, it is well established that increase in money supply increases inflation. But then in countries like Nepal, money supply (or central bank’s interest rate) has hardly any effect on inflation (even correlation is very weak). Why? Because of exchange rate pegged to Indian rupee, almost 60 percent of total imports originating in India, slowly adjusting oil prices, huge informal economy, supply-side constraints and very limited reach of financial institutions (just 20 percent of households take loans from banks). The theoretical relationship between money supply and inflation is not that straight forward when it comes to applying it on the ground in developing countries with under-developed financial sector.

Montiel and Mishra argue that the application of conventional monetary transmission would require “an economy with a highly developed and competitive financial system in order to be effective.” Two strong messages that are relevant to Nepal come from their research:

• Inflation targets set during the announcement of monetary policy should be modified to take the imperfect monetary transmission into account. (They recommend to the extent of postponing setting inflation target!).
• Weak monetary transmission weakens the argument for floating exchange rates and capital account restrictions.

Below are excerpts from their article in Ideas for India (btw, an excellent website for easy-to-read, evidence-based articles focused on the Indian economy): 

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That includes: a strong institutional environment, so that loan contracts are protected and financial intermediation is conducted through formal financial markets; an independent central bank; a well-functioning and highly liquid interbank market for reserves; a well-functioning and highly liquid secondary market for government securities with a broad range of maturities; well-functioning and highly liquid markets for equities and real estate; a high degree of international capital mobility; and a floating exchange rate. These features are typically taken for granted in the OECD but the same assumptions cannot be made for developing countries.

 

[…] First, the complete absence or poor development of domestic securities markets suggests that both the short-run and long-run interest rate channels will be weak. Second, small and illiquid markets for assets such as equities and real estate will tend to weaken the asset channel. Third, in countries that are imperfectly integrated with international financial markets and tend to maintain relatively fixed exchange rates, the exchange rate channel will tend to be completely absent, or relatively weak.

[…] If the banking industry is non-competitive, changes in banks’ costs of funds may be reflected in bank profit margins, rather than in the supply of bank lending. If a poor institutional environment increases the cost of bank lending, banks may conduct lending activity in a manner that weakens the effects of monetary policy actions on the supply of loans by using reserves as a buffer to sustain their lending to low-cost customers when the central bank tightens credit conditions and to avoid lending to high-cost customers when the central bank loosens credit conditions.

[…] We find a much weaker link between the policy instrument (central bank interest rates) and money market rates in poorer economies than for advanced and emerging economies, both in the short and in the long run. We find a similar result for the link between money market rates and bank lending rates in the short term, and while differences in long-term effects are not as pronounced, they remain weaker in low-income countries. Most importantly, changes in money-market rates explain a much smaller proportion of the variance in bank lending rates in low-income countries than in either advanced or emerging economies.

[…] We interpret the evidence presented in our research, as well as that of the broader literature, as creating a strong presumption that in the financial environment that tends to characterise many developing economies, monetary policy is likely to have both weak and unreliable effects on aggregate demand. If this is true, the stabilisation challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challenge for policymakers and researchers alike.

When domestic monetary policy is weak and unreliable, activist policy is less desirable, and the adoption of policy regimes that raise the stakes associated with attaining publicly-announced monetary objectives, such as a target rate of inflation, should be postponed or their design should be modified to take the uncertainty about monetary policy effects into account. In addition, weak and unreliable monetary transmission weakens the arguments for floating exchange rates as well as for capital account restrictions under fixed exchange rates.

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The full paper is here.

Private sector allowed to import LPG in Nepal

The government has finally opened up import of LPG by private players. Chandi Lumbini Gas Storage Company has been permitted to import liquefied petroleum gas (LPG) from Malaysian petroleum giant Petronas from the end of October. It will hopefully lower NOC's deficit as most of the users in commercial scale can now get LPG from the new private company (that too with ease, lets hope!). Additionally, (hopefully) consumers do not have to wait in queue at retail stores to get a LPG cylinder.

Excerpts from a news story in The Kathmandu Post:

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Chandi Lumbini will buy gas and oil from Petronas, mix and refine the fuels at IndianOil Petronas at Haldia and then sell LPG in Nepal.

[...]The company said it would make bulk deals and its LPG would be used for commercial purposes only. It has invited Nepali bottling plants, auto filling plants and bulk consumers interested in doing LPG business. The company said that even NOC can buy its products.

[...]Chandi Lumbini made a fresh bid to be allowed to import LPG after the government announced a dual cylinder system from Oct 17. Under the plan, LPG would be sold in colour-coded cylinders, red for household use and blue for commercial use. LPG in blue cylinders will be sold at the actual price while red cylinders will be sold at a subsidised rate.

The proposed system will allow Chandi Lumbini to sell its products at the commercial rate. At present, NOC incurs a loss of Rs 363.60 on a cylinder, resulting in monthly losses of Rs 436 million.

[...]Nepal and India signed a Petroleum Supply Agreement in 1974 appointing IOC as the sole supplier of fuel to Nepal. Prior to that, major oil companies based in India like Exxon and Chevron used to retail fuel directly in the Nepali market.

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It is good that the government is allowing private players in this hugely inefficient and fiscally burdensome sector. At the outset, just because private players enter the market doesn't mean things will be alright given a hugely distorted procurement, distribution and consumption networks. The challenge would be to stop leakages, i.e. not allowing commercial users to purchase discounted cylinders. It would require strict supervision and oversight of the entire process. Else, things won't improve much.