Policy challenges facing low income countries due to re-emerging vulnerabilities

In its latest brief, the IMF argues that at present the low income countries (LICs) have limited fiscal space and larger current account deficits than prior to the crisis. The lower macroeconomic policy buffers and additional risk factors would mean that LICs are more vulnerable to both internal (additional financing needs due to natural disasters) and external shocks (Euro zone shock, oil and food price shocks).

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Under a euro-centered growth shock, the median LIC would suffer a significant loss in output, fiscal balances would worsen, and more than half of all LICs would see reserve coverage fall below three months of imports. External financing needs would also rise. Given donors’ fiscal constraints, aid is unlikely to come to the rescue as it did in 2009. Countries would either have to take on more nonconcessional debt, deplete reserves, or make pro-cyclical policy adjustment. The IMF would also likely be called upon to provide additional financial assistance.

The effects of a protracted global growth slowdown would be less severe in the short run. However, due to permanent output losses that accumulate over time, the effect would be substantial in the medium term. Absent adjustment, additional external financing needs would mushroom: since this is unsustainable, almost all LICs would need to adjust to some degree depending on prevailing cyclical conditions, supported by Fund financing. Policymakers would have to balance their adjustment decisions with the need to support or maintain growth and preserve priority spending.

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The IMF argues that a spike in global food prices would have less severe effects on fiscal and external gaps than the other shocks, it would have larger impact on inflation and poverty due to the high weight of food in consumer baskets. Meantime, a spike in global oil prices would create additional financing needs for LICs comparable to the euro-centered growth shock.

NEPAL: With GDP growth rate estimated at 3.6% (lower than in FY2012), inflation 8%, international reserves (in months on next year imports) 6.5 months, fiscal balance –0.8% of GDP, positive current account, and gross public debt at 27.4% of GDP, Nepal fares much better than other LICs in FY2013 in terms of macro and external sector stability. However, there are downside risks from low agriculture output, high oil and fuel prices, and weak demand from developed countries.

The impact of labor income on poverty

How much does changes in labor earnings influence poverty (by income source)? A recent study by Inchauste et al. (2012) shows that change in labor income was the largest contributor to poverty reduction in 16 countries. Specifically, labor income accounted for more than half of the change in poverty in 10 countries and over 40% in another four countries.

Now, why has labor income increased? The reasons could be more working people, higher earnings per workers, changes in occupation structure or sectoral composition of employment, and improved human capital (education, skills and experience) among others. The authors focus on Bangladesh, Peru and Thailand to find out the answer. Their analysis shows that the largest contributor was labor-market related factors such as returns to land and experience in Bangladesh, returns to land in Peru, and returns to education and experience in Thailand. In other words, it is the increase in real earnings and higher productivity. 

Furthermore, the study shows that a declining dependency rate accounted for over a fifth of the reduction in poverty in 10 countries (more impact in Paraguay and Costa Rica) and transfers and other non-earned incomes account for over a quarter of the reduction in poverty in 9 countries. The authors looked into the major factors that impact poverty: growth rate, redistribution, demographics, growth in labor income and growth in non-labor income. It doesn’t account for the impact of increase in access to and quality of public services that are not part of household income.

The non-labor incomes (as a result of targeted social protection programs) were relatively more important in accounting for changes in extreme poverty (US$2.5 a day) in Argentina, Brazil, Chile, Costa Rica, Ecuador, Romania and Thailand.

Interestingly, the study shows that, in Nepal, employment and earnings, followed by non-labor income (public transfers and remittances) and declining dependency rate, had the largest impact on poverty. In contrast to this finding, an analysis of poverty in Nepal between the same time period (1995/96 and 2003/04—first and second living standards surveys) done in 2006 by the World Bank showed that the increase in remittances contributed between one-third to one-half of overall reduction in headcount poverty rate (from 42 percent to 31 percent). There has been a drastic change in household consumption and income profile in Nepal since 2004. While 23.4% of households received remittances in 1996 and 31.9% of households in 2004, it increased to 55.8% in 2011.

Between 2004 and 2011, overall remittance income increased from Rs 46 billion to Rs 259 billion (in 2011, internal remittances were Rs 51 billion and external remittance were Rs 208 billion). Per capita remittances increased from Rs 2100 to Rs 9245 over the same period. The impact of transfers (remittances) has been much more higher in reducing poverty between 2004 and 2011 than between 1996 and 2004 (note that it is in terms of consumption, not income). Remittances have tremendously boosted consumption expenditure of poor households. More on the impact of remittances on Nepali economy here.

The table below gives a snapshot of poverty, remittances and labor income in Nepal between 1995/96 and 2010/11.

Key findings of Nepal Living Standards Surveys
	NLSS I	NLSS II	NLSS III
Survey year	1995/96	2003/04	2010/11
Absolute poverty (% of population)	41.8	30.8	25.16*
Gini coefficient	32.2	41.4	32.94
Remittances
Percentage of household receiving remittances	23.4	31.9	55.8
Total amount received (Rs billion)	13	46	259
From within Nepal	6	11	51
From outside Nepal	7	35	208
Share of total amount of remittances received by household
From within Nepal	44.7	23.5	19.6
From India	32.9	23.2	11.3
From other countries	22.4	53.3	69.1
Wage employment
Share of agriculture sector in wage employment	53	37	35
Share of non-agriculture sector in wage employment	47	63	65
Mean daily wage (Rs)
Agriculture	40	75	170
Non-agriculture	74	133	263

Enhancing efficacy of government in new times

Recognizing the crucial role governments play in supporting the economy (especially during times of crisis) and providing foundations for private sector dynamism, McKinsey & Company has started the McKinsey Center for Government (MCG). Along with it came the first publication titled ‘Government Designed for New Times’, which contains discussion on the role of government in the coming days, ways to boost efficiency and induce effective execution of key decisions.

Below is a summary of some of the contributor’s views on the role of government and ways to enhance its efficacy. [The Nepali government can learn a lot from international best practices in making government productive and government services effective and efficient.]

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Five lessons learnt by Tony Blair, former prime minister of Great Britain and Northern Ireland, in leading government transformation:

• Governance (particularly government effectiveness or capacity in government to get things done) should be at the heart of political debate.
• Aim for systemic change, not incremental change to allow government to keep pace in a rapidly changing world (emerging new economic powers; new technologies in communications, energy and medicine; climate change; financial crisis).
• Right conceptual analysis leads to best systemic change and delivery as the best policy comes from a clear, rigorous intellectual approach.
• The people that enact policy and the ones that gets appointed to key posts matter. Management skills are better in private sector. It is better for public sector employees to spend some years in private sector and then come back to public sector.
• Governments around the world can learn from each other.

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Michael Fullan, special adviser to the premier and minister of education in Ontario, offers four directional advise to improve all systems in reasonably short period of time:

• Accountability dilemma (building accountability within the system rather than relying on external control)
• Policy-overload dilemma (don’t develop plans that are too complex, too vague, and contain too many priorities; be focused)
• Capacity-building dilemma (development of individual and group efficacy, especially in skills, resources and motivation)
• Sustainability dilemma (accountability, policy focus and capacity building might lead to sustainability)

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Diana Farrell, co-founder of McKinsey Center for Government, discusses how governments can do more and better with less (in short, tap into the mission-driven mind-set of public sector employees).

• Design and execute multiyear reforms that goes beyond mundane initiatives designed to improve management capability. Aim for big reforms and make big (not incremental) shifts in amount of time, energy and resources required. E.g. expenditure and revenue plans, employment plans, etc)
• Invest in capabilities needed for success, especially employing best practices in technology and operations, organization and human resources, and budgeting and finance. E.g. vocational education, updated data, implement the latest proven project management techniques)

NEPAL: Proejcted agriculture production in FY 2012/13

The shortage of fertilizers and low and late monsoon during peak paddy planting season are expected to lower economic growth rate (unless industrial and services sector pick up rapidly, which seems negative as of now). So, how much is the expected decline in agriculture production in 2012/13?

Prabhakar Ghimire reports (his blog here) that the Ministry of Agriculture and Development estimates food production to decline by 563,000 MT.

• Paddy production to fall by 14.2%. Total paddy output is expected to drop by 720,000 tons this year compared to 5.07 million tons recorded last year. Plantation was done in just 91% of total paddy land. Dhanusha and Siraha, key paddy producing districts, reported plantation in just 49 percent and 50 percent of paddy land
• Maize production to fall by 10%. Total maize production is expected to drop by around 164,000 tons.
• Demand for cereals could rise by 100,000 tons to 5.3 million tons this year.
• At least 27 districts will face food deficit this year.

About 76.3% of households in Nepal depends on agriculture for livelihood and 83% of the population lives in rural areas. Paddy contributes around 21% to agriculture production, which then account for about 35% of GDP. Paddy and maize are the major cereals consumed by a majority of households.

Meanwhile, global food prices is increasing. According to the latest Food Price Watch, global food prices increased 10% between June and July 2012 with staples such as wheat increasing 25% in the period. The high global food and fuel prices gets reflected in domestic prices as almost half of the total food demand is fulfilled by imports. It tends to affect poor and vulnerable the most, while pushing back people just above the poverty line back under it. 

A study (Global Food Price Inflation and Developing Asia) by ADB showed that a 10% increase in food prices will increase the number of poor people (in millions) living below US$1.25-a-day by 3.8, 0.01, 22.8, 6.7, 0.6, 3.5, and 0.2 in Bangladesh, Bhutan, rural India, urban India, Nepal, Pakistan, and Sri Lanka, respectively. More here (and also this one on targeted food subsidies).

Why fiscal stimulus worked in China?

The short answer, according to a new paper by Fardoust, Lin, and Luo, is that since the Chinese fiscal stimulus in 2008-09 focused on (i) investments in bottleneck-easing infrastructure projects, and (ii) countercyclical nature of expansionary subnational expenditure on well-chosen infrastructure projects that improved business climate, it worked. The latter one had the largest effect. 

Chinese stimulus money (US$586 billion—1.25% of China’s GDP in 2008) went to housing guarantees, rural construction, energy conservation and emissions reduction, infrastructure development, social services, industrial restructuring, and post-disaster reconstruction of Wenchuan.

Below is an abstract from their paper:

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China's government economic stimulus package in 2008-09 appears to have worked well. It seems to have been about the right size, included a number of appropriate components, and was well timed. Its subnational component was designed to maximize the impact of the stimulus package on the economy and minimize the potential procyclical elements that are usually built into subnational fiscal mechanisms in federal countries. Moreover, China's massive fiscal stimulus played an important role in the overall recovery of the global economy. Using a simple analytical framework, this paper focuses on two key factors behind the success of the stimulus: investments in bottleneck-easing infrastructure projects and countercyclical nature of subnational spending based on the assumption that well-chosen infrastructure projects could improve business climate and thereby crowd in the private investment. The paper concludes that the expansionary subnational government spending played a key role in strengthening the overall impact of the stimulus and sustaining growth. It also highlights the importance of public investment quality and cautions about the sustainability of local government financing through the domestic banking system and increases in local governments off balance sheet or contingent liabilities. These lessons may be of particular relevance today for China, as well as other countries, in formulating policy response to another global economic slowdown or crisis, possibly as a result of the Eurozone turmoil. For China, investing in urban infrastructure and green economy, as well as in higher quality and better targeted social services, will be crucial for improving income inequality and inducing a more inclusive growth path.

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It has more to do with the quality of public investment, i.e. the economy should have enough absorption capacities, which will help stimulate economic activities without jeopardizing inflation too much. Also, the source of such stimulus is important as a one-off investment by borrowing from domestic financial institutions or by increasing contingent liabilities of local governments is not going to be sustainable. The public investments have to be such that they exploit idle resources (human and capital) and are sustainable in the sense that the total costs are paid off in due course of time. It offers an important lesson for economies like Nepal that have constrained economic growth in the face of severe shortage of infrastructure (electricity, transport, urban services, etc.). Prudent management of resource allocation, project selection and quality investment (public, private or public private partnership) in these will have significant multiplier effects.

Doing Business 2013: No improvement in ease of doing business in Nepal

In its latest Doing Business 2013: Smarter Regulations for Small and Medium-Size Enterprises report, the IFC has ranked Singapore as the top economy in terms of ease of doing business. The other top ranked economies are Hong Kong (SAR, China), New Zealand, the United States, and Denmark. Last year as well, the same economies were in the top position.

The report ranks economies based on performance in ten indicators: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. This year’s report data cover regulations measured from June 2011 through May 2012.

Poland was the global top improver in the past year. The other economies that have made the most progress in several areas of regulation last year were Sri Lanka, Ukraine, Uzbekistan, Burundi, Costa Rica, Mongolia, Greece, Serbia, and Kazakhstan.

South Asia

In South Asia, Sri Lanka made the most progress and was ranked 81, followed by Maldives (95), Pakistan (107), Nepal (108), Bangladesh (129), India (132), Bhutan (148) and Afghanistan (168). Last year, Maldives ranked 79, followed by Sri Lanka (89), Pakistan (105), Nepal (107), Bangladesh (122), India (132), Bhutan (142) and Afghanistan (160). The regional average (in rank) was 117 in DB2012 but it was 121 in DB2013, reflecting either a worsening business regulatory environment or a stagnant one or significant progress by other regions (based on data revisions) or addition of new economies (this year Malta and Barbados were added).

Nepal

In terms of ease of doing business, Nepal ranked 108 out of 185 countries. Last year, Nepal ranked 107 out of 183 countries and in DB2011 Nepal’s ranking was 110. Between DB2012 and DB2013, Nepal did not enact a single reform aimed at easing business processes and regulations. Hence, the progress made by other economies dropped ranking one position below last year’s ranking (plus there was addition of two economies in this years report).

• While the ranking in registering property has improved by two positions and ranking in getting electricity is unchanged, the ranking in all other indicators has declined. The largest decline (9 positions) is in dealing with construction permit indicator.
• In South Asia region, Nepal has the best ranking (21) in registering property. It requires 3 procedures, 5 days and 4.9% of property value to register a property in Nepal. The regional averages are 6 procedures, 100 days (250 days in Afghanistan), and 7.3% of property value.
• In terms of documents to export, Nepal has the worst performance in the region, requiring 11 documents against the regional average of 8. Sri Lanka has the best performance with just 6 documents required for exporting a container.
• In terms of number of procedures required to enforce contracts, Nepal has best performance in the region with 39 required procedures as against 43 for regional average.
• In terms of time taken to resolve insolvency, Nepal has the worst performance in the region. While it takes 5 years to resolve insolvency in Nepal, the regional average is 3 years (in Maldives it is just 1.5 years). Furthermore, recovery rate is also the lowest in Nepal (24.5 cents on the dollar) compared 29.1 for the region (50.6 for Maldives).

Nepal's ranking (out of 185 countries)
Topics	DB 2013 Rank	DB 2012 Rank	Change in Rank
Starting a Business	105	102	-3
Dealing with Construction Permits	97	88	-9
Getting Electricity	96	96	No change
Registering Property	21	23	2
Getting Credit	70	67	-3
Protecting Investors	82	79	-3
Paying Taxes	114	109	-5
Trading Across Borders	171	170	-1
Enforcing Contracts	137	136	-1
Resolving Insolvency	121	119	-2

Distance from frontier

This year, the report also provides a new measure called ‘distance from frontier’, which benchmarks economies to the frontier in regulatory practice. In other words, it measures the absolute distance to the best performance on each indicator. When compared across years, the distance to frontier measure shows how much the regulatory environment for local entrepreneurs in each economy has changed over time in absolute terms, while the ease of doing business ranking can show only relative change.

An economy’s distance to frontier is indicated on a scale from 0 to 100, where 0 represents the lowest performance and 100 the frontier. For example, a score of 60 in DB 2012 means an economy was 60 percentage points away from the frontier constructed from the best performances across all economies and across time. A higher score in DB 2013 indicates an improvement.

Compared to DB 2006, in DB 2013, in Nepal, there was improvement in all indicators except trading across borders. The largest improvement was in dealing with construction permits, followed by getting credit and starting a business. Overall, Nepal's ease of doing business improved by four percentage points (i.e. closer to the frontier by four percentage points) between DB 2006 and DB 2013.

Nepal has the highest minimum wage in South Asia?

Workers affiliated to various trade unions have time and again gone on strike demanding hike in wages and allowances. The recurring row over hike in wages and allowances between workers belonging to one or the other politically affiliated (and probably motivated) trade unions and businessmen has led to not only closure of national firms but also reputed international firms. Labor strikers have intensified particularly after 2006 and there has been an explosion of registered unions at the Department of Labor. The business community argues that it is not fair to demand wages and allowances beyond the capacity of the firms to pay them. The trade unions argue that they should be paid more because the cost of living has gone up. Their row has led to repeated revision of minimum wage.

A higher wage means high cost of production. In Nepal’s case, the cost of production is amplified by the inadequate supply of electricity (forcing firms to use diesel generators to run factories), high cost of raw materials, low innovation and strikes, among others. Along with the end of MFA in 2005 and the inability to compete with more competitive international players, high labor costs and strikes are also responsible for the decline of once thriving garment industry (and other manufacturing firms) of Nepal. In order to stay competitive, the government, labor unions and private sector have to work on enhancing efficiency and reducing cost of production (this can be achieved even if there is hike in wages, as seen in Bangladesh's case). Else, investors will be looking for less expensive manufacturing destinations, which would mean less investment, less jobs and low growth for Nepal.

The figure below shows that Nepal already has the highest minimum wage in South Asia. The minimum wage in Nepal increased from US$32.32 per month in 2007 to US$74.75 per month in 2012. In 2007, Nepal had the second lowest minimum wage in South Asia. In 2008, it doubled and since then minimum wage has been the highest in South Asia. Even if we consider the overall wage overheads (minimum wage and allowances), Nepal has the highest wage overhead costs in South Asia.

Now, the question here should be: is the increase in wages consistent with increase in productivity? See this article for the discussion on union strikes and productivity. The basic idea is that the marginal increase in wage should be matched by the marginal increase in productivity for long term survival of firms and employability of workers, i.e. increase in wage costs should be offset by increase in efficiency. As of now, in Nepal, it is not so as hike in wages (from an already relatively high level!) and increase in productivity are not in sync with each other. Bangladesh had synced it, i.e. the rise in wages was more than offset by increase in efficiency. No wonder, Bangladesh is the next hotspot in RMG sourcing.