Sunday, August 18, 2013

Unusual Structural Transformation: Is Nepal stuck in a low growth trap?

The sectoral value addition and its movement against per capita GDP in the chart above indicates that high growth in Nepal won’t be sustained unless the industrial sector is strengthened along with the promotion of high value agriculture production and services activities. Else, growth will continue to be determined by the monsoon (agriculture sector) and remittances-backed consumption demand of mostly imported goods (low productive, low value added services sector activities such as wholesale and retail trade, real estate and housing, among others).

Interesting observations:

  • While the decline of agriculture sector is accompanied by the increase of services sector in Nepal, it is the opposite in India and South Korea, where the decline of agriculture sector was accompanied by rise of industrial sector. The intersection of these trends occurred at US$323 per capita GDP (in 1972) in South Korea and US$ 465 per capita GDP (in 2001) in India. This probably reflects the early industrialization drive along with steady accumulation of human and institutional capitals in South Korea. 
  • Services sector tends to grow consistently in both India and South Korea. However, there is a sharp increase in India circa 1980.
  • In China, though the decline of agriculture sector is accompanied by the increase of services sector, the industrial sector contribution is mostly higher than the contribution of agriculture and services sectors.
  • In Nepal, the decline of agriculture sector is accompanied by the increase of services sector (mostly low-value added activities like real estate, retail and wholesale trade, transport, etc— the demand for which is directly related to the remittance-backed consumption demand of imported goods traded in these sectors, implying that employment generation and domestic value addition are pretty low). Meantime, the industrial sector is continuously tanking. The intersection between decline of agriculture sector and increase of services sector occurred at around US$219 per capita GDP. It was circa 1998, the time when Nepal benefited favorably for a short time period from the Nepal-India trade treaty of 1996 (no value addition requirement in manufacturing goods exported to India). However, this was also the time when the Maoist insurgency started to heat up, forcing large number of people to migrate out of rural areas. Meantime, the inclement investment climate led to closure of many firms in the industrial sector, resulting in loss of jobs, high value production and productive activities. Consequently, those who migrated to urban areas and new entrants to the labor force either opted to seek employment overseas or engage in low value added, low paying services sector activities domestically. The high inflow of remittances has further fueled this process.
  • While in high growth and emerging countries, industrial sector plays a focal role in sustaining the transition from low value added production and productivity to high value added production and productivity, this whole feature is missing in Nepal’s case. Hence, the transition from low value added and low productivity agriculture production to low value added and low productivity services sector activities. This is resulting in a low growth trap, that too sustained by remittances-backed consumption demand of imported goods and the resulting trading activities. There is little domestic value addition and growth multiplier.

Overall, the message is that the ongoing structural transformation of Nepali economy appears abnormal and the economy is stuck in a low growth trap (mostly below 5%) sustained by robust remittance inflows and the monsoon. The only way to break free of it is to tackle head-on the binding constraints to economic activities, especially in the industrial sector.

Monday, August 12, 2013

Remittances in Nepal: Boon or Bane?

Below is the abstract of a recent paper published in The Journal of Development Studies (authored by yours truly!) :) 

Nepal is one of the highest recipients of remittances (percentage of GDP) in the world. For a small land-locked economy battered by a decade-long Maoist insurgency (1996–2006), prolonged political instability, slow growth rate and large exodus of youths for employment overseas, high inflow of remittances bears a huge significance both at micro and macro levels. Exploring various facets of high migration and remittances, this article shows remittance-induced Dutch disease effects and policy laxity to improve investment climate in Nepal. Since it is costly to sterilise the impact of remittances each year, it might be prudent to learn to live with it and gradually channel remittances to productive usages with a goal to boost productivity.


Tuesday, August 6, 2013

Nepal 128th innovative nation (out of 142)

According to the latest Global Innovation Index 2013, Nepal has ranked 128 out of 142 countries. In GII 2012, Nepal ranked 113 out of 142 countries. This year’s GII used 84 indicators, including the quality of top universities, availability of microfinance, venture capital deals, to gauge both innovation capabilities and measurable results.

The GII 2013 is calculated as the simple average of two sub-indices. The innovation input sub-index gauges elements of the national economy which embody innovative activities grouped in five pillars: (1) Institutions, (2) Human capital and research, (3) Infrastructure, (4) Market sophistication, and (5) Business sophistication. The innovation output sub-index captures actual evidence of innovation results, divided in two pillars: (6) Knowledge and technology outputs and (7) Creative outputs.

Nepal’s ranking (out of 142 countries) in the sub-indices and the pillars within them are listed below:

  • Innovation input sub-index (129)
    1. Institutions (125)
    2. Human capital and research (130)
    3. Infrastructure (122)
    4. Market sophistication (123)
    5. Business sophistication (97)
  • Innovation output sub-index (123)
    1. Knowledge and technology outputs (127)
    2. Creative outputs (106)
  • Innovation efficiency ratio [Output sub-index by input sub-index] (77)

Now, why is innovation important for a struggling economy like Nepal? It is because to remain competitive (both in factor and product markets), Nepal has to innovate, which would mean finding new ways of doing business to enhance productivity and efficiency. It has been argued that innovation leads to a virtuous circle, i.e. once a critical threshold is reached, investment entices investment, talent entices talent, and innovation generates more innovation. This way the economy can remain competitive, create employment opportunities with high paying jobs, and attract a steady flow of new investments. The decline of exports and increasingly higher imports replacing domestic production have been a glaring feature of the lack of innovation in Nepali economy.

The urgent need is to focus on the enables for making the economy competitive, i.e. stable institutions (including political stability), adequate accumulation of human capital, adequate supply of infrastructure, and more investments in R&D both in public and private sectors.

Excerpts from the GII 2013 report below:


Switzerland and Sweden’s performance reflects the fact that both countries are leaders in all components (pillars) of the GII, consistently ranking in the top 25. The United Kingdom has a well-balanced innovation performance (ranking 4th in both input and output), in spite of a relatively low level of growth in labor productivity. The United States continues to benefit from its strong education base (especially in terms of top-rank universities), and has seen strong increases in software spending and employment in knowledge-intensive services. The US was last in the GII top 5 in 2009, when it was number one.

Through several of its analytical chapters, the 2013 edition of GII explores how innovation has benefitted from ‘local specifics’ in different parts of the world. One key message is that too many innovation strategies have been focused on trying to replicate previous successes elsewhere, like Silicon Valley in California. However, fostering local innovation requires strategies that should be deeply rooted in local comparative advantages, history and culture. They should be combined with a global approach to reach out to foreign markets, and attract overseas talent.

The creation of an environment that could unleash the potential for innovation for all in a sustainable manner is the way to unlocking the true, tangible potential of value creation; it will lay the groundwork for societal change and develop a framework for cohesive synergies through collaboration.


Saturday, August 3, 2013

How can money supply growth not increase when CRR and SLF are reduced?

The Nepal Rastra Bank (NRB) on 21 July introduced the monetary policy for FY2014 largely supporting the budget’s growth and inflation targets of 5.5% and 8%, respectively. Overall, the monetary policy is loose and there is a provision to increase directed lending to deprived and priority sectors (at least 12% of total credit to agriculture and energy sectors).

One of the interesting things about this year’s monetary policy is the unchanged money supply growth target in the face of a decline in cash reserve ratio (CRR) and Standing Liquidity Facility (SLF). The CRR has been reduced by 100 basis points to 5%, 4.5% and 4% for commercial banks, development banks and finance companies, respectively. Similarly, SLF for commercial banks, development banks and finance companies has been reduced to 12%, 9%, and 8%, respectively. In FY2013, SLF for commercial banks, development banks and finance companies was 15%, 12%, and 10%, respectively. The bank rate is unchanged at 8%. Despite these, the central bank has left unchanged money supply growth at 16%.

The reduction in CRR and SLF increases monetary base and then eventually money supply.

  • Monetary base = currency in circulation + reserves of banks in central bank
  • Money supply = currency in circulation + demand deposits

When you reduce CRR, banks’ reserves in the central bank goes down, allowing them to lend more, which, ceteris paribus, increases the magnitude of money multiplier (the ratio of money supply to monetary base). Even if you keep money multiplier unchanged but increase monetary base, money supply increases. Alternatively, the only way you could have a constant money supply is by reducing money multiplier to such an extent that the total value of money multiplier times the increased monetary base is unchanged from last year, i.e. it would result in constant money supply growth. This seems to be a pretty daunting task for the central bank to hold on to. With the rise in the number of migrants and the incentive to remit more money back home due to the depreciation of Nepali rupee, net foreign asset is set to increase. It means the central bank has to print more Nepali rupees to match the extra incoming dollars. This automatically leads to an increase in money supply. Or am I missing here something?

One argument is that the NRB plans to channel the extra expected increase in lending (due to reduced CRR and SLR) to productive sectors, where the absorption capacity is relatively higher and would exert weak demand-push inflationary pressures. But, irrespective of channeling more credit to productive sectors, the conundrum is: how is the central bank planning an unchanged money supply growth by reducing reserve requirements?

Monday, July 29, 2013

Why economic history is important to understanding economics

Kevin H O’Rourke explains why studying the history of economic thought/economic history is vital to understanding economics and putting the current events in context. Excerpts from the article below:


Most obviously, it forces students to recognise that major discontinuities in economic performance and economic policy regimes have occurred many times in the past, and may therefore occur again in the future. These discontinuities have often coincided with economic and financial crises, which therefore cannot be assumed away as theoretically impossible. A historical training would immunise students from the complacency that characterised the “Great Moderation”. Zoom out, and that swan may not seem so black after all.

As Robert Solow points out, “the proper choice of a model depends on the institutional context” (Solow 1985, p. 329), and this is also true of the proper choice of policies. Furthermore, the 'right' institution may itself depend on context. History is replete with examples of institutions which developed to solve the problems of one era, but which later became problems in their own right.

Doing economic history forces students to add to the technical rigor of their programs an extra dimension of rigor: asking whether their explanations for historical events actually fit the facts or not. Which emphatically does not mean cherry-picking selected facts that fit your thesis and ignoring all the ones that don't: the world is a complicated place, and economists should be trained to recognise this. An exposure to economic history leads to an empirical frame of mind, and a willingness to admit that one’s particular theoretical framework may not always work in explaining the real world. These are essential mental habits for young economists wishing to apply their skills in the work environment, and, one hopes, in academia as well.

[…]economic history is a rich source of informal theorising about the real world, which can help motivate more formal theoretical work later on.


Wednesday, July 24, 2013

Book chapter: Assessment of India’s MGNREGA public works program

Here is our contribution (co-authored) to a new book on social protection, growth and employment published by the UNDP. It is about the assessment of India’s Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), the national employment guarantee scheme that has already provided employment to over 50 million households. It guarantees a minimum of 100 days a year of paid employment (at state fixed minimum wage rate for unskilled manual labor) to all rural households. More about the program here.

The chapter in the book is an abridged version of an earlier comprehensive assessment(Employing India: Guaranteeing Jobs for Rural Poor) jointly published by Carnegie Endowment and the UNDP.

Below are some of the main points adapted from Chapter 6 (Guaranteeing Jobs for the Rural Poor: An Assessment of India’s MGNREGA Public Works Programme) of the book:


Introduction

[…]we address the macroeconomic and distributional implications of running an employment generation programme such as the NREGA, including the indirect employment effects it has through its secondary effects on other sectors. Second, we look at the programme’s impact on prices and hence on the cost of living of rural households. Third, we consider the programme’s economic and distributional effects when land productivity increases. Finally, we briefly discuss the extent to which leakages, in the form of hiring non-poor workers, would change the programme’s economy-wide impact, as well as the impact of changing the size of NREGA through a contraction/expansion of its budget.

Overall, the modelling exercise reported in this chapter indicates that, since its inception, the programme has had a positive impact on economic activity beyond the immediate and direct impact of wage payments to the poor people who participate in it. It finds both that the economy as a whole benefits from the programme and also that each major population group does as well. Poor workers in rural areas benefit the most through direct employment creation. Secondary welfare impacts through the creation of demand in other sectors of the economy are larger for higher-income groups than for poor people. In that sense, the programme’s distributional effects are not positive. The impacts are significant yet small due to the programme’s relatively small size in relation to the Indian labour markets. This negative distributional impact, however, is very small and does not modify the programme’s overall progressive redistribution of income in the Indian economy.

[…]Overall programme performance according to the various sources varies significantly according to the specific feature under scrutiny and the geographical location. Independent studies and social audits detail weaknesses and failures, which, although in many cases they raise concerns about the implementation of the programme, also suggest that on the whole it is lowering poverty. The 2009–2010 National Household Survey data confirm that the programme is reaching poor people and is contributing to social inclusion by increasing the participation of deprived social groups and women; it also confirms a strong variance across states in the degree to which the programme accomplishes its objectives.

[…]Given the potentially far-reaching effects of employment generation programmes, economy- wide modelling is a particularly useful tool to analyse their impact in the economy at large. The section below presents the results obtained from an economy-wide model that replicates the characteristics of the NREGA. We identify the beneficiaries according to those defined by the programme, using the coverage and actual composition of workers identified by the programme in 2009–2011, and assuming that the programme only hires low-skilled workers. We also run a separate simulation to look at the impact of an increase in agricultural productivity associated with the implementation of the Act. The data used in this model correspond to a national Social Accounting Matrix (SAM) built for 2003, before the inception of the Act.

Modeling

[…]We first model an employment generation programme with a budget equivalent to 0.65 percent of GDP, which approximately corresponds to the actual size of the NREGA in fiscal year 2009–2010. The simulation consists of an increase in public expenditures equivalent to 0.65 percent of GDP to hire workers and pay for the necessary materials for construction and the wages of the administrative and few technical staff required by the projects. The simulated increase in public expenditures closely follows the actual composition of the budget in 2009–2010. The payment of wages to workers under the Act is equivalent to 0.43 percent of GDP, expenditures in intermediate inputs are equal to 0.19 percent of GDP, and the payment for government services is equivalent to 0.03 percent of GDP. In proportional terms, 66 percent of programme expenditures go directly to wages for beneficiaries, 5 percent to administration expenses and 29 percent to purchase inputs for the implementation of projects.

In the model we draw labour from rural households in proportions approximating those in the Act in 2009–2010. We assume that the labour hired is divided in equal parts between illiterate male and female workers and that these workers belong to the poorest 60 percent of rural households of SCs and STs and to the poorest 30 percent of households of OBCs and others. The payment of wages to these workers is further inputted into the income of the households from which workers are drawn. The cost of intermediate input materials and administrative expenses, which are assumed to include payments to school- and college-educated workers, represent about one third of the budget, in accordance with the actual budget reported by the programme in the period under consideration.

Results

[…]Results indicate that running an employment generation programme such as the one under the NREGA has a positive macroeconomic impact. An allocation of resources equivalent to 0.65 percent of GDP increases GDP by about 0.4 percent. The programme’s overall expansionary effect is in accordance with the basic notion of a Keynesian balanced budget multiplier, plus the additional demand generated from the shift in income towards poor households with a high marginal propensity to consume.

The programme’s distributional impact is also positive. Simulation results indicate an increase in welfare among poor rural households and a marginal increase among poor urban households. The implementation of the programme carries a cost, which comes in the form of a decline in welfare for rich people in both urban and rural areas, since the programme is financed through income taxes and ‘forced’ savings.

Overall the Act generates an expansion of activity and changes in the composition of production across sectors that result in a progressive redistribution of income towards poor people. The main effects are a sizable redistribution from rich people in urban and rural areas to poor people in rural areas, a marginal redistribution from the same groups to poor people in urban areas and an overall redistribution from urban to rural areas.

[…]Through indirect channels the benefits from the programme extend well beyond its direct beneficiaries. In our simulations, these positive effects extend to 90 percent of the rural population and 30 percent of the urban population. Although the effects are small, partly due to the small size of the programme relative to the size of the Indian labour market, they are nonetheless noticeable.

[…]the increase in labour income triggered by the programme — i.e. the indirect rise in labour income — is in the order of 0.11 percent. The small size of this effect is mainly because the direct wage payments of the programme represent no more than 8 percent of the total income earned by illiterate workers and 2 percent of the total annual income of the rural labour force. This result serves as a reminder that, as impressive as the NREGA programme is, it is still a small fraction of labour income in India.

[…]The simulated 1.5 percent increase in land productivity produces an appreciable rise in GDP, final demand and trade, ranging between 0.02 and 0.03 percent. The increase in agricultural productivity has a less positive impact on income distribution. Although the rise in productivity increases welfare across all household groups, the increase is larger for rich people and larger in urban than in rural areas.

[…]The effect on prices is so strong that even if the productivity hike decreases poor people’s income and, hence, consumption expenditures, the fall in the price of food implies such a strong rise in purchasing power that they end up better off than before. After the increase in productivity, poor people can buy more food and perhaps even increase purchases of other goods.

[…]Our simulation increasing land productivity has the expected result of expanding economic activity and enhancing aggregate welfare. It increases welfare and consumption expenditures across all households, both rural and particularly urban, and it amplifies activity in the agriculture, food-processing and service sectors.

[…]In the simulation results, however, increasing productivity also has a negative distributional impact due to a larger increase in the welfare of rich households. This result is driven by the high concentration of land in the hands of rich people. This result should not be interpreted as a criticism of the important objective of programmes such as the NREGA to increase productivity in agriculture.

[…]Our analysis suggests that the effects of leaks do not visibly change the programme’s macroeconomic impact. The presence of leakage in the implementation of a programme such as the NREGA should not be a major concern for policy makers considering its macroeconomic and distributive effects.


Wednesday, July 17, 2013

NEPAL: Macro snapshot of FY2014 budget

Finance Minister Shanker Prasad Koirala introduced a timely and full budget for FY2014 on Sunday. Shunning populist slogans, programs and policies, the budget prioritized hydropower and energy development; agriculture productivity and commercialization; physical infrastructure development; access to social education, health, drinking water and sanitation; tourism development; investor-friendly environment; export promotion; and good governance.

FY2014 budget targets

GDP growth (%) 5.5  
Inflation (%) 8  

Budget allocation for FY2014

Rs billion %
Budget allocation 517.2 100
       Recurrent  353.4 68.3
       Capital 85.1 16.5
       Financial provision 78.7 15.2
 
Projected total revenue 429.5 100
      Revenue 354.5 82.5
      Foreign grants 69.5 16.2
      Principal repayment 5.5 1.3
 
Budget surplus (+)/deficit (-) -87.7
 
Deficit financing 87.7 100
      Foreign loans 43.7 49.8
      Domestic borrowing 44.0 50.2

The total budget for FY2014 is Rs 517.2 billion, with Rs 353.4 billion for recurrent expenditures, Rs 85.1 billion for capital expenditures, and Rs 78.7 billion for financial provision. The total budget allocation for FY2014 is 27.8% higher than FY2013 budget allocation and 41.1% higher than the revised estimate of total expenditure in FY2013.



The projected total revenue is Rs 429.5 billion, with 82.5% of it coming from tax revenue, 16.2% from foreign grants, and 1.3% from principal repayment. This leaves the government with Rs 87.7 billion of budget deficit, whose financing would come from foreign loans and domestic borrowing of 49.8% and 50.2%, respectively, of the deficit.

The table below provides income and expenditure snapshot of the FY2014 budget and the FY2013 revised estimate. Due to the lack of timely full budget and the inability to spend allocated money in time along with high revenue mobilization, there was net savings in FY2013.

FY 2014 budget targets FY2014 BE FY2013 RE
GDP growth target (%) 5.5 3.6
Inflation target (%) 8 9.9

Income and Expenditure FY2014 

 
Rs billion Rs billion
Projected total expenditure 438.5 311.7
      Recurrent  353.4 258.1
      Capital 85.1 53.6
   
Projected total revenue 424.0 337.6
      Revenue 354.5 295.7
      Foreign grants 69.5 41.9
   
Surplus (-)/deficit (+) 14.5 -25.9
   
Projected financing -14.5 23.5
      Net loan investment 24.5 12.8
      Net share investment 7.2 9.3
      Net foreign loans -27.4 -0.7
      Net domestic borrowing -18.8 -2.0

Some macro related points to consider (for more, see Economic Survey 2013 as well):

  • Recurrent expenditure allocation is really high. It is barely equal to tax revenue target. The growth in FY2014 budget allocation (BE) is 40.7%  over FY2013 revised estimate (RE). Rationalization of recurrent expenditures has to be thought of seriously.  Grants to local bodies and social service constitute 42% of recurrent expenditure, followed by compensation of employees (25%), use of goods and services (15%), and social security (15%). The allocation for compensation of employees, use of goods and services, grants, and social security increased by 30.4%, 88.3%, 40.6%, and 12.9%, respectively, compared to the revised estimate of respective expenditures in FY2013.

Note: FY2014 nominal GDP at producers’ prices assumed to be 14.7% (average of FY2012 and FY2013) higher than FY2013 provisional data. Revised estimate of revenue in FY2013 is higher than revised estimate of expenditure because of the inability of the government to spend the allocated budget in time, thanks to the lingering political uncertainties and delay in bringing out a timely and full budget.


  • Capital allocation has remained around 16.5% of budget allocation, but problems always arise during implementation. More challenges would prop up both scale and quality fronts in the run up to the CA elections (and possibly local body elections).
  • Revenue target is 20% in FY2014, down from 21% between FY2013RE and FY2012. Given the weakening currency and a potential slowdown in imports (due to depreciation, but we will have to see remittances growth to see the net impact), revenue target might be challenging. The existing reforms have to be sustained and its reach expanded to increase tax net and tax base.
  • Allocation for financial provision has been equal to or higher than capital expenditure. It includes internal loan investment, domestic share investment, and external (borrowing) amortizations and domestic (borrowing) amortization. This probably has direct relationship with the government’s continuous pumping in of money in public enterprises (last year only 2 of the 37 PEs gave dividends and 21 operated in losses) as well as high debt servicing as a result of higher borrowing. The combined loss of NOC and NEA was Rs 19.5 billion (1.27% of GDP in FY2012).
  • Domestic borrowing is getting larger than external borrowing. Interest on domestic borrowing (except for T-bills) is higher than interest on concessional loans from multilateral banks because the interest rate is usually pre-determined (much higher than market rates) before auction. Higher domestic borrowing might also impact liquidity situation in the banking sector. As a share of estimated FY2014 GDP, planned deficit financing is about 4.5% of GDP (2.2% of GDP foreign loans, and 2.3% of GDP domestic borrowing).
  • Growth target is ambitious and inflation target is conservative. The recent depreciation of the rupee (except against Indian rupee) might dampen not only revenue mobilization, but also exert pressures on prices as more than 50% weight in CPI index comes from non-food and services, which are mostly imported. Also, market prices will see upward pressures coming from the hike in salary and allowance of public employees. It is mostly going to be ‘push’ factors, complemented by the persistent supply-side constraints.


The blocks refer to the share of functional expenditure in total expenditure (including financing). The numbers (in Rs ‘000) is the amount of budget allocation or expenditure.


The blocks refer to the share of expenditure item in total economic affairs functional expenditure heading. The numbers (in Rs ‘000) is the amount of budget allocation or expenditure.