The root of energy crisis (deficit) in Nepal

Ambition without vision
Painful and drastic reforms are needed in the NEA and NOC to realise energy goals

The economic devastation caused by the April 2015 earthquake and trade blockade for about four months have reignited discussion over production and import diversification, and economic self-sufficiency. It has become a hot topic amongst politicians, talking heads, opinion makers and the public in general. Ministers are making bold statements about self-sufficiency. Prime Minister KP Oil even promised that his government will end load-shedding within one year and connect every household to gas pipelines. 

As events unfold and experts debate on its possibility, it appears this will likely be an ambition without a vision and a good homework, mainly due to the lack of willingness to overhaul management, jurisdiction and operations of Nepal Electricity Authority (NEA) and Nepal Oil Corporation (NOC).

Binding constraint

The most binding constraint to economic growth is the inadequate supply of infrastructure, especially electricity. This is not only stymieing industrial activities, but also leading to an increase imported fuel, which is widely used by small and medium enterprises to sustain their operations even if they have to incur higher costs. Fuel import accounts for about 20% of total imports (about $1 billion annually) and is larger than the total value of merchandise exports. The cost of production using imported fuel— procured and distributed through Nepal Oil Corporation (NOC) — is expensive relative to hydroelectricity and hence the prices of goods and services in the market are also relatively higher compared to other comparable cities around the world. 

Against this backdrop, the biggest policy bang for a buck lies in accelerating electricity generation— both hydropower and alternative sources such as solar and wind— to meet demand. It will not only reduces demand for imported fuel, but also increases fiscal revenues, economic growth and new jobs. However, over the past 100 plus years very little has been achieved due to the politicization of the entire sector (Pharping hydro power started generating electricity on 22 May 1911). 

Without a complete overhaul of management, financial and operational efficiency of NEA and NOC, energy self-sufficiency would continue to remain a distant dream. Despite all the promises, politicians have shown little credible interest in overhauling these two public enterprises as it cuts across party lobbyists, unions, syndicates, employment for cronies, and periodic financial bonanza.

Inefficient institutions

The NEA and the NOC more or less solely procure and sell electricity and fuel, respectively. They are operating without competitors and dictating quantity purchased from suppliers on their own. It leaves a huge space for financial and distribution malgovernance— often with the tacit support of politicians and lobbyists.

Both the public enterprises are financially bankrupt. The NEA’s operating loss amounted to about 0.4% of GDP in FY2015. About Rs27 billion outstanding debt was written-off in FY2012 to make it financially viable and to make it worthy for investor’s consideration. However, it continues to accumulate losses as electricity prices are not adjusted to reflect cost of production or purchase. Meantime, little has been done to reduce technical losses, one of the highest in the world. Total peak time supply is barely 55% of total demand, leading to load-shedding of between 12 and 16 hours a day (contingent upon the level import from India). 

The NOC is in a more perilous state as it has no long term investment assets to bank on for revenues. The management and distribution inefficiency, and mismatch between buying and selling prices of fuel and gas have turned NOC into an infamously inefficient public enterprise. In FY2014, its losses amounted to about 0.4% of GDP as domestic fuel and gas prices were kept low despite high international prices. With low fuel prices internationally for over a year and reluctant downward adjustment of domestic fuel prices, it is in a much better shape now. Although its accumulated debt amounts to about 1.12% of GDP, it nevertheless is planning to distribute bonus earned from the revenues generated by charging high prices to consumers (with the commitment to cover past losses). 

Hollow commitment

Any political commitment or speech on reforming these two public enterprises is an additional political capital for parties, and they have not shied away from capitalizing on that. For instance, during the second Constituent Assembly election, Nepali Congress promised to generate 5,000 MW of electricity within five years and achieve economic growth of 8-10%. UML promised to complete all major hydropower projects (both storage and run-of-the-river types) within 10 years by involving the private sector and also end load-shedding in five years. Meanwhile, the UCPN-M promised to end load-shedding in three years and develop 10,000 MW, 20,000 MW and 25,000 MW in the 10, 20, and 40 years respectively. 

Lately, the government has been promising to end load-shedding within a year (mostly by importing from India) and generate 10,000 MW within ten years by declaring an energy emergency (similar one came in 2008 as well followed by a Ten Year Hydropower Development Plan in 2009). Also, the government has allowed the private sector to procure and distribute fuel, technically breaking the monopoly of NOC. 

Painful reforms

A lot of painful drastic reforms are needed to realize even a fraction of these promises. Unfortunately, the political parties are not up to the speed and have been unwilling to forgo representing the special interest groups. This has been the main reason behind the delay in cost evaluation of projects, prolonged and contentious procurement (the earlier energy minister even snatched regular management jurisdiction of NEA to her ministry’s chamber), and trading of generation licenses. The politically-affiliated unions at the NEA and affiliates in districts are further complicating the situation by demanding unjustified compensation and shares. Similarly, the NOC has been a plump earning source for unscrupulous traders and political affiliates. 

The bureaucracy is more hesitant than before to complete procurement and necessary project clearances on time. There is delay in constructing transmission lines and signing power purchase agreements, which has been put on hold on the misguided belief that the country will have surplus power during wet season from FY2018. The demand for electricity is never linear in an energy-hungry country like Nepal. Electricity acts as an alternative source of energy to fuel and is convenient as well as relatively cheap. Hence, immediately after the fuel blockade, the demand for electricity was so high that the NEA’s transformers exploded. The actual latent demand for electricity is much higher than the one estimated by the NEA.

Painful reforms are needed to reform these two public enterprise and the sectors they represent. To avoid irregularities, discretionary power of ministry and management should be minimized and a rule-based system (breaking up production, transmission and distribution aspects), inscribed in an Act, should be enacted. This means overhauling procurement processes, requirements for preliminary project assessment, inter-ministry and inter-department coordination, efficient and responsible human resources, and politics free decision-making and operations. Unfortunately, it is easier said than done.

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It was published in The Kathmandu Post on 15 February 2016

Key economic achievements under late PM Sushil Koirala

Former Prime Minister and President of Nepali Congress (NC) party, Sushil Koirala passed away yesterday at the age of 78. He was known for a simple lifestyle and a clean career. Here are the key economic achievements during his tenure:

• Landmark power development agreements (PDA) was singed for 900MW Upper Karnali and 900MW Arun-3 hydroelectric projects worth over $2 billion
• Power Trade Agreement (PTA) was signed with India
• 18th SAARC summit was successfully organized with agreements on vehicle movement and energy cooperation, among others.
• 6,720MW Pancheswar Multipurpose Project got some momentum
• Presided over the successful completion of post-disaster needs assessment
• Successfully organized the International Conference on Nepal's Reconstruction in March 2015 Donors committed about $4 billion for Nepal's post-earthquake reconstruction
• Successfully concluded the political transition with the promulgation of a new constitution in September 2015
• FDI commitment of about $2.7 billion in FY2015
• A Public Private Partnership (PPP) Policy was approved
• Put in good and able technocrats/policymakers at key bodies such as National Planning Commission

On the economics front, he will be remembered most for helping to lay groundwork for major investment projects and reform measures. That is quite an achievement in itself (even if the results are not quick) given the relative performance under the leadership of previous premiers. The April 2015 earthquake and subsequent aftershocks, plus the trade blockade (for four and a half month) dented growth prospects and inflicted immeasurable hardship to common folks, but these were beyond Koirala's power. With the lifting of the blockade at the borders, lets hope that economic recovery will be fast (and that the government and bureaucrats will work faster than before for that). 

For now, lets thank the former PM for his decades long service to the nation and for presiding over one of the most scandal-free governments. RIP.

Pic courtesy: Republica

5 points about the low oil prices and one point about the Nepalese economy

Five main points from an article in The Economist about the low oil prices, plus one additional note on the Nepalese economy.

Over the past 18 months oil price has decreased by about 75%, from $110 a barrel to below around $25. 

1. Oil importers are gaining and exporters losing as reflected in their trade balance and fiscal numbers. India has used this occasion to boost revenue by increasing excise duty on fuel without altering much the retail price. Meanwhile, Gulf countries are cutting down subsidies and other countries like Russia are slashing public spending to maintain fiscal prudence to some extent. Venezuela has already declared an economic state of emergency (partly got to do with the political and economic mismanagement).

2. All oil producers are maintaining or increasing their output share in the market. Despite OPEC being a cartel it is unable to dictate prices. Some of its members are pumping out oil below average cost (at times even below marginal cost). Iran is entering the market (with potential output of about 3 million to 4 million barrels a day). The shale gas boom has boosted oil output in the US from 5mb/d in 2008 to over 9mb/d in 2015. Oil glut is here to stay according to latest estimates. 

3. OPEC members such as Saudi Arabia (top producer) want to continue pumping oil to suppress prices with hopes of driving shale producers in the US out of the market. However, innovations and efficient production lines have lowered marginal cost of shale gas producers to about $15 a barrel.

4. Overall commodities prices are falling and investment is also declining or put on hold. The slowdown of Chinese economy (about 6.9% growth in 2015 after almost a quarter of a century) is further depressing global demand and investment. Corporate debt is increasing, especially those of state-owned and private companies operating along the oil supply chain.

5. With low commodity prices, stock market volatility edging on the upper side, and lower private investment, the major worry for advanced economies struggling to accelerate growth is lower sticky general prices, i.e. prices are struggling to go higher and hence inflation remains subdued. It means economic growth is also low. Interest rate rise in the US (first time after 2008) will potentially slow down the initial momentum in heating up prices and will make USD stronger. It means currencies of other countries will depreciate somewhat relative to the dollar. Global growth forecast for 2015 is not that great, although the US and India stand out as exceptions. 

6. Meanwhile, in Nepal, the supplies blockade at Birgunj/Raxual (the most important custom point) and other places continues. An acute fuel and supplies shortage is ruining the economy. Mismanagement by state-owned companies, mainly NEA and NOC, is further adding woes to the already depressed situation. At present, the Nepalese economy is beyond the point where you would typically categorize as being in an emergency-- it is in a desperate situation and requires drastic measures to recover fast. Production and supplies networks are either dislocated or destroyed, and household and business incentives are transformed in a way that won't serve the economy well. Black-marketing and carteling are prevalent. Remittances (amounting to about 28% of GDP) are sustaining the economy despite all other numbers going south. Public expenditure performance remains horribly diminished (in the first half of FY2016 capital spending is about 6% of planned expenditure in FY2016-- politicians and bureaucrats can blame the earthquake and blockade, but how much have they done on their part honestly to accelerate public spending in infrastructure?), and inflation is edging even higher (will remain above 10% as supply-side constraints continue to exert pressures on prices of goods and services, and inflationary expectations edge up higher every month). Amidst all of these sits a coalition government (with a jumbo cabinet) that is failing to realize and accept the magnitude and severity of the problem. Painful, deep institutional and governance reforms are required now. This primarily includes strengthening institutions by overhauling them (including labor reforms)-- reforming NEA (with its present governance structure, it is the biggest hurdle after lobbyists & politicians, to Nepal's energy future), NOC, NA, establishing PPP office, passing a plethora of reforms without putting many hooks (the parliamentarians are unnecessarily doing this at the committees these days-- and without much study on its ramifications later on), procurement reforms, public service delivery, etc. These are very tough reforms and political parties have a lot to lose given the links between employee unions, corporate houses, lobbyists, intellectuals and politicians. Cosmetic reforms ain't gonna cut it now.

2016 growth outlook for South Asia

The latest Global Economic Prospects 2016, the World Bank's flagship publication, has revised downward its growth forecast for India, Nepal and Pakistan and revised upward by 0.2 percentage points for Bangladesh (in fiscal year basis). 

Indian economy is expected to grow by 7.8% in FY2016 (ends 31 March 2016), the highest in South Asia, followed by Bangladesh (6.7% in FY2016 that ends on June 30), Pakistan (5.5% in Fy2016 that ends on June 30), and Nepal (1.7% in FY2015 that ends on 15 July). All numbers are at market prices.

 

Overall, growth in India will drive the regional outlook. Investment will pick up as exports may slightly recover and remittance inflows will likely moderate as oil-rich GCC countries witness slower growth. Domestic demand will remain strong. 

Higher public spending in infrastructure, the recent hike in public sector wages and pick up in exports following amendments to labors will support higher growth in Bangladesh.

The slow reconstruction work after the earthquake and the supplies disruptions will lower growth in Nepal. 

Bhutan's growth will remain strong on account of progress in major hydropower projects (three are expected to come online by 2017, boosting exports to India and fiscal revenues).

Regional growth (at market prices, constant 2010 USD) is expected to be slightly better than last year: 7.3% in 2016 versus 7.0% in 2015 (calendar year basis).

UPDATE (2016-01-08): The IMF team has produced an excellent set of charts depicting fiscal, external and monetary sectors developments (especially relevant to see the developments since the earthquake and the trade disruptions along the border).

Nepalese economy in 2015: Triple whammy of earthquake, blockade and bad politics

Triple whammy: 2015 was a notably bad year for the economy on three fronts

The April earthquake destroyed physical infrastructure and livelihoods, the trade embargo has disrupted economic activities, and finally Prime Minister Oil-led government is undermining already weak institutions of the country. Among these natural, economic and governance shocks inflicted on the Nepali people and the battered economy, the impact of tinkering with institutions for political gains may potentially turn out to be more debilitating for the nation in the long term.

Catastrophic earthquake

The earthquake and its subsequent aftershocks killed more than 9,000 people, damaged property and public infrastructure, lowered economic growth and per capita income, and thus, increased poverty. Gross Domestic Product (GDP) growth of Nepal dropped by over 1.5 percentage points to 3.0 percent from an estimated 4.6 percent in a no-earthquake scenario. Similarly, nominal per capita income was lowered by about $23. An additional 700,000 to 982,000 people were pushed below the poverty line. The monetary value of the damage was estimated to be about $6.7 billion, almost half of it attributed to housing and human settlement. This natural disaster disrupted and dislocated production networks and distribution systems, whose impact on the economy will linger for years to come unless they are quickly rebuilt following more resilient standards.

The international community liberally launched an unprecedented scale of humanitarian assistance, most notably led by India, Japan, China, and the United States. Equally generous were the financial commitments for reconstruction—to the tune of $4 billion—by bilateral donors and multilateral institutions like Asian Development Bank, World Bank and International Monetary Fund. The 2016 budget anchored on these financial commitments and appropriated about $910 million (3.8 percent  of GDP) for rehabilitation and reconstruction work.

Understandably, expectations were high and there was consensus on accelerating reconstruction with the accepted ‘build back better’ principles. However, the delay in decision making by the government, the seemingly sluggish bureaucracy, and the egotistic political infighting for the National Reconstruction Authority (NRA) frustrated the quake victims and international community. The NRA bill was passed eight months after the earthquake and key decisions of the previous government overturned to suit political interests. While the political apparatus appeared colder and callous than expected when it came to accelerating the reconstruction, the increasingly lethargic bureaucracy seemed inept in swiftly handling normal bureaucratic assignments. Consequently, actual public capital spending is barely above 75 percent of planned spending. Worse, despite the availability of resources, relief distribution and reconstruction are slow and painful.

The blockade

The blockade came immediately after the promulgation of the constitution on September 20. Given that almost 60 percent of Nepal’s trade is with India and it is the only supplier of petroleum fuel and cooking gas, the disruptions at major custom points are virtually stalling and derailing economic activities. It will have far-reaching consequences on the economic potential, production linkages within and among sectors, employment generation, and stability of capital flows.

The Tarai region accounts for about 51 percent of agricultural output, 52 percent of industrial output and 40 percent of services output. It houses about half of the population, which is quite heterogeneous in terms of ethnicity, class, culture, language, literacy, income profile, and employment opportunities. The trade and transportation disruptions in this region have a knock-on effect on production and distribution networks throughout the country. The lack of fuel and cooking gas is crippling household as well as business activities. The uncertainty over market demand and supply has either delayed or destroyed agricultural harvesting, depleting an important source of employment and income source for about 75 percent of the population who depend on agriculture for livelihood.

The blockade-induced shortage of chemical fertilisers is turning fertile agricultural fields into barren lands, and the lack of raw materials and fuel has delayed almost all development projects that are critical to not only accelerate existing economic growth, but also to expand the boundaries of potential growth and employment opportunities. Consequently, for the first time in over two-and-a-half decades, the economy may probably grow at a negative rate. Meantime, prices of general goods and services will stay high, public capital spending may be even lower, more youths may seek employment opportunities overseas, and more households will be pushed below the poverty line.

Political gains

Finally, there is an institutional shock inflicted by the present government that will probably have far reaching financial and operational consequences. The government is scrambling to contain the fallout of the delayed reconstruction and blockade on the economy and the population. However, without political resolution to the Tarai issue and easing of the blockade, economic recovery is almost impossible. So far, the government’s steps to address these are not up to the mark.

The rhetoric does not match the unfolding reality. First, the supplies blockade has abetted black market transactions, and distorted household and business incentives. Smuggling and black marketing of goods and fuel are now considered more lucrative than farming and other productive means of livelihood. Cartels, syndicates, unions and lobbyists are running the show more freely than before, affecting decision-making and operations at key state-owned enterprises and in almost all sectors.

Meantime, the prime minister is expanding the Cabinet and hastily dividing ministries in a way that defies logic. These institutionally damaging steps are taken for political survival, which unfortunately has again superseded concerns about the economy, employment and development. Normally, in order to add one more office, a detailed organisation and management survey is conducted and properly vetted at various layers of bureaucracy and government. By ignoring this process and creating confusion in an already lethargic bureaucracy, the government is further weakening its performance, eroding bureaucratic capacity, creating more layers of bureaucratic maze, and affecting public spending and services delivery. It does not bode well for the economy.

Overall, it was a year of triple whammy of delayed reconstruction, supplies blockade and a bad precedent of tinkering institutions for political gains.

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It was published in The Kathmandu Post on 04 January 2015.

The quality of politicians and economic growth

The quality of growth depends on the quality of politicians you elect! 

That’s the main point of a working paper by Prakash, Rockmore and Uppal, who summarized their findings in a VoxEU column. Apparently, the findings are based on their working papers, but a link to it is not provided yet in the column. Anyway, intuitively the results do not seem surprising if you look at the developing countries that have weak institutions and the same politicians or their associates being elected repeatedly.

Excerpts from the article:

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Despite a history of widely contested and transparent elections, and the presence of a vibrant and open media, India is electing an increasing number of politicians facing criminal charges. This share has risen from 24% of members of the Indian Parliament in 2004 to 34% in 2014 (New York Times 2014). While the election of criminally accused candidates to public office is concerning in any context, it is especially so for India. Large quantities of funds are distributed by the government through a wide variety of interventions and programmes, which have been plagued by costly scandals with losses in the hundreds of billions of dollars (Sukhtankar and Vaishnav 2015). A severely understaffed judiciary and police force, resulting in an extremely slow judicial system, exacerbate this problem. Taken together, these realities create a context in which an influx of criminally accused politicians could be especially costly for an economy.

Using information on the charges filed against candidates, we estimate the causal effect of electing criminally accused politicians to the State Assembly on the subsequent economic activity in their constituency. In particular, we focus on elections in 20 Indian states during the 2004 to 2008 period. Since economic data are not systematically available for constituencies, we rely on satellite data on the intensity of night-lights. These data have been increasingly used to proxy for economic growth, as studies find a strong relationship between GDP and night-light intensity at the sub-national level (Bleakley and Lin 2012, Henderson et al. 2012, Hodler and Rashky 2014, Storeygard 2014). 

[…]We find that the election of an accused politician leads, on average, to roughly a 22 percentage point lower yearly growth in the intensity of night lights. Based on conversions between GDP and night lights, this is roughly 5.61% to 5.86% GDP growth per year (as compared to the 6% otherwise). Overall, these results highlight the high aggregate economic costs of electing lower quality politicians (i.e. criminally accused) and point to likely significant individual costs in foregone access to public services.

[…]We find a strong negative effect of electing politicians accused of financial or serious charges. In contrast, politicians who are only accused of either non-financial or non-serious charges do not have a negative impact on economic outcomes. We also find that the size of the negative effect increases with the number of underlying accusations. These results show that the specific accusations and charges matter, and the costs increase with the severity of the accusation.

[…]When we examine the accumulation of these costs, we find that the effects only appear in the later years of the politician’s term. There is no apparent effect in the initial years. We believe that this is explained by the need for politicians to collaborate with local bureaucrats to engage in corrupt activity (Iyer and Mani 2012). After elections, bureaucrats frequently change positions so it takes a certain amount of time for corruption politicians and bureaucrats to identify each other. Additionally, the effects of neglected public infrastructure, such as roads, may take some time to slow down economic activity.

[…]we find that the number of incomplete road projects increases in constituencies represented by criminally accused candidates. Once again, the negative impact is driven by candidates who are accused of serious and financial charges throughout India.

[…]we convert our estimates into rough measures of GDP costs and find estimates ranging from 2.3 to 6.5 percentage point lower GDP growth per year for our main result. 

[…]instead of focusing on the overall outcomes (such as the delivery of public goods), voters focus on whether politicians can deliver targeted transfers to their specific group or caste. Not only are voters perhaps more likely to overlook accusations, but these accusations might serve as a signal of the politician's willingness to use the office to reward fellow group members (Chauchard 2014, Wade 1985).

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For Japan, raising inflation target and increasing wages by 5-10 percent may be better

While some countries are grappling with high inflation, Japan (and in relative terms the developed countries) are struggling with persistent low prices, stagnating wages, low economic growth despite massive monetary stimulus for the last few years, and unemployment. Monetary easing is considered more palatable compared to fiscal stimulus because of the latter's impact on fiscal deficit and public debt. But then when monetary sector has little traction on the real sector during these depressed times (low demand as well as cautious credit flows), the most effective antidote to persistently low prices and growth is fiscal stimulus as the multiplier tends to be higher (in the case of government spending in productivity-enhancing investment projects). So, when GDP grows (faster than fiscal deficit and public debt growth), things may look a little less scary. In some countries this requires policies to deliberately raise inflation, which may eventually stabilize fiscal situation!

Here is a nice piece by Blanchard and Posen of the Peterson Institute for International Economics (PIIE) on what Japan should be doing now to prop up prices and then GDP growth. In a nut shell, Japan may consider raising wages by 5-10% (wage growth has been pretty much insignificant for many years in Japan and it follows the inflation rate).

Excerpts from the article published in FT:

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Japan needs inflation, and more inflation than the 0.5 percent achieved with its quantitative easing (QE) program. The need is not for the usual countercyclical reasons, even if the economy is flirting with technical recession. Rather, the country needs meaningful positive inflation for reasons of fiscal stability.

[...]Together, Abenomics and the Bank of Japan's commitment to a 2 percent inflation target were intended to encourage a virtuous cycle from positive inflation to wage increases to greater consumption and so on. The central bank's large-scale asset purchases (Y80 trillion a month of Japanese government bonds) have helped: Inflation has fluctuated between 0.5 and 1.0 percent, an improvement over the deflation of the preceding two decades, and the yen has declined in two stages to Y120-plus to the dollar.

But that decline has proved insufficient to start an inflation cycle in the face of falling energy prices and the recent Chinese slowdown. Nominal wages rose only a little more than 1 percent in 2014 and 2015. For the average Japanese investor and consumer, inflation expectations have not budged.

Japan needs to jump-start a wage-price spiral of the sort feared from the 1970s, but that Abenomics rightly aspired to after 20 years of deflation. Such a cycle should be started by increasing nominal wages by 5 to 10 percent in 2016. Tripartite bargaining is practiced in Japan—i.e., annual nationwide wage negotiations for the unionized part of the Japanese labor force with government participation. A third of the country's workers are covered by these bargains, and many more (including management) have their wage adjustments set accordingly. Even part-time worker pay is correlated with this process. Such bargaining with government input can push wages up, just as in the past it has kept them down. In the 2014 and 2015 wage rounds, the Abe administration publicly advocated a rise in wages but did little else.

[...]The point is not to redistribute income from business to labor. If anything, employers and other price setters should be encouraged to pass on the increased costs from wages to consumer prices and try to maintain their profit margins. The Bank of Japan should maintain QE to accommodate this general price and wage increase until the cycle takes hold over a three-year period. This means replacing the current 2 percent inflation target with something much higher—such as 5 to 10 percent—for several years. This would be unlikely to cause accelerating double-digit inflation, but if it did, the Bank of Japan could easily stop that spiral. In parallel, the central bank should also aim for an exchange rate depreciation proportional to inflation, so as to keep the real exchange rate roughly constant.

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