Labor and business regulations in Nepal

This a part of a series of analysis on growth diagnostics of the Nepalese economy. For discussion of a set of constraints on economic activity in Nepal see this post. Also, see this column and this blog post.

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The fact that manufacturing sector is losing competitiveness both in the domestic and international market at a time when there is an increase in urban population and improvement in educational attainment suggest that the current labor market rules and regulations are playing a role in constraining economic activity in the economy. In fact, one of the standard indicators for measuring business regulation and labor activity, Doing Business Indicators, shows that the quality of business regulations is bad and the country is mired with red tape and labor restrictions.

If the current trend of political interference continues, then labor and business regulations will be the most binding constraint in the coming years. Politically indoctrinated labor unions and youth wings are at loggerheads with the industrial sector right now. They have been demanding higher minimum wages, which was revised in 2009. The tension between the youth wings and labor unions and industries has led to closure of many firms. Worse, this has forced multinational companies to close down factories and has aided capital flight from the country. Colgate Palmolive, a multinational company, was forced to shut down operation due to labor disputes. Meanwhile, due to labor disputes and energy shortage, industrial productivity has declined by over 50%.

In WB’s Doing Business ranking, Nepal has slipped in ranking by 10 positions from 111 to 121 between 2008 and 2009 (see Figure 1). This means that the cost of doing business in Nepal is rising, particularly due to complex labor disputes. Note that this has been a recent phenomenon, especially after various youth wings and unions started forcefully closing down factories demanding higher minimum wages and better working conditions. As stated earlier, this could potentially be the strongest constraint in the future but it still is not strong enough to qualify as the binding constraints as bad infrastructure and corruption did in our earlier analysis.

Figure 1

Source: Doing Business Report 2008 and 2009

Nepal has one of the most cumbersome hiring and firing practices in the world. The difficulty of hiring index and firing index are the highest in the region. Firing provision is very rigid and employers are required to hire temporary workers as permanent after 245 days of work. This has fostered disincentives among investors. Hiring regulations have slightly improved in the last four years but it is still considered unfriendly to business. There has been no attempt to ease firing regulations. Nepal’s firing index is the highest in South Asia (see Figure 3).

Figure 2

Figure 3

Source: Doing Business Reports

Starting a business is also not that easy in Nepal. There has been hardly any improvement in this front in the past four years. It still takes 7 procedures[1] and 31 days to start a business. These figures have not changed since 2004. The cost of starting a business remains pretty high but the good news is that it is decreasing in recent years.

Table 1

Source: Doing Business Reports

Labor and business regulations (inflexibility of the labor market and industrial relations) do not necessarily threaten the economy as the most binding constraints because most of them are being relaxed since 2004. The existing labor dispute is a recent phenomena and it is expected to subside in the coming months because the government has already revised the minimum wage, the main cause of conflict between the unions and the private sector. Change in the labor regulations has not have a substantial effect on industrial productivity and GDP growth rate. Hence, labor and business regulations do not qualify to become the binding constraint on growth.

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[1] The seven procedures are: (1) Verify the uniqueness of the proposed company name, (2) A professional verifies and certifies the memorandum and articles of association, (3) Buy a stamp to be attached to registration form, (4) File documents with the Company Registrar’s Office, Department of Industry, (5) Make a company seal/rubber stamp, (6) Register with the Inland Revenue Office, the Ministry of Finance, and (7) Enroll the employees in the Provident Fund.

Zero regulatory reform in Nepal in 2009/10

In 2009/10, Kazakhstan made it easier to start a business, reduced time required to deal with construction permits, increased protection for investors and facilitated trading across borders. Similarly, Rwanda facilitated credit flows to local firms and reduced time to trade goods across borders. Peru made it easier to register property. Cape Verde and Tajikistan made it easier to pay taxes. Hungary eased the process of closing down a business. With regulatory reform in a number of other areas as well, these countries are some of the top reformers in 2009/10. 

What did Nepal do? Well, it did nothing. There were zero reforms. Once again, doing business in Nepal has not improved. In fact, it has become difficult, as shown by the decrease in its ranking by four positions. In 2008/09 it ranked 112, but in 2009/10 its rank is 116, according to IFC’s latest report Doing Business 2011, which ranks 183 economies on key aspects of business regulation for domestic firms.There were zero reforms formulated and implemented last year. Blame bandas, destructive activities of militant youth wings and combative labor unions harassing investors, donation campaign, supply-side constrains, power shortages, incessant political instability, corruption, and industrial strike and insecurity, among others ailments inflicting the Nepali economy. A rule based system ensures predictability and reduces uncertainty, facilitating entrepreneurship if the rules are business-friendly. This is missing in Nepal.

While the rest of the world reformed business regulation, making it easier for entrepreneurs to unleash their creative (and destructive) instincts, Nepal did not do anything last year. India made the most progress among South Asian countries. Singapore is still the most favorable place to do business, followed by Hong Kong, New Zealand, the UK, the US, Denmark, Canada, Norway, Ireland, and Australia. This year’s top ten economies which reformed the most are Kazakhstan, Rwanda, Peru, Vietnam, Cape Verde, Tajikistan, Zambia, Hungary, Grenada, and Brunei Darussalam.

India implemented 18 business regulation reforms in seven areas covered by the report. These reforms focused on technology—electronic business registration, electronic filing for taxes, an electronic collateral registry, and online submission of customs forms and payments. Similarly, Bangladesh made it easier to start business by setting up online registry system. It also sharply reduced property-transfer tax. Maldives allowed registered companies to own land as long as all company shares are owned by Maldivians.

Globally, 117 economies carried out 216 regulatory reforms in the past year alone. They eased regulations to start and operate a business, strengthened transparency and property rights, and improved efficiency of commercial dispute resolution and bankruptcy procedures. Doing Business gives higher scores in some areas for stronger property rights and investor protections, such as stricter disclosure requirements in related-party transactions. The ranking is based on perception of business environment of domestic, primarily smaller companies and regulations that applies to them through their life cycle.

It ranks economies based on nice areas of regulation: (i) getting credit, (ii) dealing with construction permits, (iii) registering property, (iv) getting credit, (v) protecting investors, (vi) paying taxes, (vii) trading across borders, (viii) enforcing contracts, and (ix) closing a business.

The ranking is not a holy grail to judge the entire aspects related to business environment in an economy. It is perceptional and businesses actually say what they think is obstructing their progress, regardless of costs and benefits associated with regulation, its viability in a given economy, macroeconomic conditions, infrastructure, workforce skills and security. Still, it shows something that is very important to entrepreneurship and the creation of jobs in the formal sector. The report was first launched in 2003.

In each of the nine topics, the economies that improved the most in 2009/10 are Peru (getting credit), Congo DR (dealing with construction permits), Samoa (registering property), Ghana (getting credit), Swaziland (protecting investors), Tunisia (paying taxes), Peru (trading across borders), Malawi (enforcing contracts), and Czech Republic(closing a business). The economies of East Asia made it easiest of all for local firms to do business.

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Nepal’s case:

Ease of doing business (rank)	116
Starting a business (rank)	96
Procedures (number)	7
Time (days)	31
Cost (% of income per capita)	46.6
Minimum capital (% of income per capita)	0
Dealing with construction permits (rank)	130
Procedures (number)	15
Time (days)	424
Cost (% of income per capita)	192.1
Registering property (rank)	25
Procedures (number)	3
Time (days)	5
Cost (% of property value)	4.8
Getting credit (rank)	89
Strength of legal rights index (0-10)	6
Depth of credit information index (0-6)	2
Public registry coverage (% of adults)	0
Private bureau coverage (% of adults)	0.3
Protecting investors (rank)	74
Extent of disclosure index (0-10)	6
Extent of director liability index (0-10)	1
Ease of shareholder suits index (0-10)	9
Strength of investor protection index (0-10)	5.3
Paying taxes (rank)	123
Payments (number per year)	34
Time (hours per year)	338
Total tax rate (% of profit)	38.2
Trading across borders (rank)	164
Documents to export (number)	9
Time to export (days)	41
Cost to export (US$ per container)	1960
Documents to import (number)	10
Time to import (days)	35
Cost to import (US$ per container)	2095
Enforcing contracts (rank)	123
Procedures (number)	39
Time (days)	735
Cost (% of claim)	26.8
Closing a business (rank)	107
Time (years)	5
Cost (% of estate)	9
Recovery rate (cents on the dollar)	24.5

Two good practices cited in the report:

• Allowing out-of-court enforcement while supporting access to credit is one of the most favorable in Nepal.
• Registering Property: The Finance Act 2008 has reduced the fee for transferring a property from 6.0 percent to 4.5 percent of the property’s value.

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A ranking on competitiveness of economies is published by the World Economic Forum. The latest Global Competitiveness Report 2010/11 shows that government instability/coups, corruption, and policy instability are the three most problematic factors for doing business in Nepal. These are followed by inefficient government bureaucracy, inadequate supply of infrastructure, restrictive labor regulations, and poor work ethic in national labor force. Interestingly, tax regulations and tax rates are the least problematic factors for doing business in Nepal. It means that the biggest constraint is political.

The GCR identified Switzerland as the most competitive nation. Among 139 countries, Nepal ranks 130th in terms of competitiveness with a score of 3.34 (7 being the highest; Switzerland has a score of 5.63). Last year, Nepal ranked 125th, which means that the economy's competitiveness declined by five positions. Look at the South Asian countries, India ranks 51th (two positions down from last year); Bangladesh ranks 107th (one position down); Pakistan ranks 123th (twenty-two positions down); and Sri Lanka ranks 62nd (17 positions up).

The Global Competitiveness Index (GCI) is based on 12 pillars of competitiveness, providing a comprehensive picture of the competitiveness landscape in countries around the world at all stages of development. The pillars are: institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation.

Doing Business Report 2010--Nepal edition

The IFC has published its annual ease of doing business ranking-- Doing Business Report-- yesterday. This recent report is seventh in a series of annual reports published by the IFC and the World Bank. The report, Doing Business 2010: Reforming through Difficult Times, lists Singapore as a consistent and top reformer this year as well. The other top reformers on the list are New Zealand, Hong Kong, the US, the UK, Denmark, Ireland, Canada, Australia, Norway, and Georgia. Here is the full ranking. Here is an overview.

The report notes that despite global economic crisis, over 70 percent of the 183 economies covered by the report made progress. Reformers around the world focused on making it easier to start and operate businesses, strengthening property rights, and improving commercial dispute resolution and bankruptcy procedures.Two-thirds of the reforms recorded in the report were in low- and lower-middle-income economies. For the first time a Sub-Saharan African economy, Rwanda, is the world’s top reformer of business regulation, making it easier to start businesses, register property, protect investors, trade across borders, and access credit. The top ten reformers for this year are Rwanda, Kyrgyz Republic, Macedonia, FYR, Belarus, UAE, Moldova, Colombia, Tajikistan, Egypt, and Liberia. Rwanda has made fascinating progress in almost all the indicators.

The major indicators used are: starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and closing business. Note that these indicators do not assess market regulation or the strength of the financial infrastructure; macroeconomic conditions, infrastructure, workforce skills and security.

However, the regulatory environment for business influences how well firms cope with the crisis and are able to seize opportunity when recovery begins. Where business regulation is transparent and efficient, it is easier for firms to reorient themselves and for new firms to start up. Efficient court and bankruptcy procedures help ensure that assets can be reallocated quickly. And strong property rights and investor protections can help establish the basis for trust when investors start investing again.

So, how come the countries that are always in the top ten list consistently and persistently sticking around the top. It is because:

They follow a longer-term agenda aimed at increasing the competitiveness of their firms and economy. Such reformers continually push forward and stay proactive. They do not hesitate to respond to new economic realities. Consistent reformers are inclusive. They involve all relevant public agencies and private sector representatives and institutionalize reforms at the highest level. Successful reformers stay focused, thanks to a long-term vision supported by specific goals. 

In South Asia, Pakistan was the top reformer, followed by Maldives, Sri Lanka, Bangladesh, Nepal, Bhutan, India, and Afghanistan. It is surprising that India is in the second last position in South Asia.

How is Nepal doing this year?

Nepal’s rank is unchanged at 123 position in terms of ease of doing business. Specifically, starting a business was harder in Nepal (rank 87 in 2010 but 75 in 2009); dealing with construction permits was slightly harder (rank 131 in 2010 and 130 in 2009); employing workers also became difficult (rank 148 in 2010 but 147 in 2009); registering property became easier (rank 26 in 2010 and 29 in 2009); getting credit became difficult (rank 113 in 2010 but 109 in 2009); protecting investors became harder (rank 73 in 2010 but 70 in 2009); paying taxes also became harder (rank 124 in 2010 but 111 in 2009); trading across borders became cumbersome (rank 161 in 2010 but 159 in 2009); no change in enforcing contracts (ranking maintained at 122); and no change in closing business (ranking maintained at 105).

Overall, there was improvement in just one indicator-- registering property. Nepal’s Finance Act 2008 reduced the fee for transferring a property from 6 percent to 4.5 percent of the property’s value. Nepal did not make doing business any easier in the economy this year as well and it languished at the bottom. It is kind of expected because of transportation obstructions, forced closure of industries, labor union strikers, depleting industrial security, no improvement in infrastructure, severe power shortage, and labor market rigidities.

In order to start a business in Nepal, it still takes 7 procedures, 31 days and cost equivalent to 53.6 percent of income per capita. This cumbersome process and high cost exist despite no minimum capital requirement for starting a business. Compare this with doing business in South Asia: it takes 7.3 procedures, 28.1 days, cost equivalent to 27 percent of income per capita, and minimum capital requirement equivalent to 26.9 percent of income per capita.

In dealing with construction permits (the procedures, time, and costs to build a warehouse, including obtaining necessary licenses and permits, completing required notifications and inspections, and obtaining utility connections), it takes 15 procedures, 424 days, and cost equivalent to 221.3 percent of income per capita. Compare this with South Asia,it takes 18.4 procedures, 241 days, and cost equivalent to 2310.6 percent of income per capita. Compare this with OECD average: it takes 15.1 procedures, 157 days, and cost equivalent to 56.1 percent of income per capita.

In employing workers, the difficulty of hiring index is 67, rigidity of hours index is zero, difficulty of redundancy index is 70, rigidity of employment index is 46, and redundancy costs is equal to 90 weeks of salary. Compare this with South Asia:  the difficulty of hiring index is 27.8, rigidity of hours index is 10, difficulty of redundancy index is 41.3, rigidity of employment index is 26.3, and redundancy costs is equal to 75.8 weeks of salary. And, to OEDC average: the difficulty of hiring index is 26.5, rigidity of hours index is 30.1, difficulty of redundancy index is 22.6, rigidity of employment index is 26.4, and redundancy costs is equal to 26.6 weeks of salary. Note that each index assigns values between 0 and 100, with higher values representing more rigid regulations. The Rigidity of Employment Index is an average of the three indices.

In registering property, it takes 3 procedures, 5 days and cost 4.8 percent of property values. Compare this with South Asia: it takes 6.3 procedures, 105.9 days and cost 5.6 percent of property values. And to OECD average: it takes 4.7 procedures, 25 days and cost 4.6 percent of property values.

In getting credit, strength of legal rights index is 5, depth of credit information index is 2, public registry coverage (% of adults) is zero, and private bureau coverage (% of adults) is 0.3. Compare this with South Asia: strength of legal rights index is 5.3, depth of credit information index is 2.1, public registry coverage (% of adults) is 0.8, and private bureau coverage (% of adults) is 3.3. And with OECD average, strength of legal rights index is 6.8, depth of credit information index is 4.9, public registry coverage (% of adults) is 8.8, and private bureau coverage (% of adults) is 59.6. Note that the Legal Rights Index ranges from 0-10, with higher scores indicating that those laws are better designed to expand access to credit. The Credit Information Index measures the scope, access and quality of credit information available through public registries or private bureaus. It ranges from 0-6, with higher values indicating that more credit information is available from a public registry or private bureau.

In protecting investors, extent of disclosure index is 6, extent of director liability index is 1, ease of shareholder suits index is 9, and strength of investor protection index is 5.3. Compare this with South Asia: extent of disclosure index is 4.3, extent of director liability index is 4.3, ease of shareholder suits index is 6.4, and strength of investor protection index is 5. And with OECD average, extent of disclosure index is 5.9, extent of director liability index is 5, ease of shareholder suits index is 6.6, and strength of investor protection index is 5.8. Note that the indicators above describe three dimensions of investor protection: transparency of transactions (Extent of Disclosure Index), liability for self-dealing (Extent of Director Liability Index), shareholders’ ability to sue officers and directors for misconduct (Ease of Shareholder Suits Index) and Strength of Investor Protection Index. The indexes vary between 0 and 10, with higher values indicating greater disclosure, greater liability of directors, greater powers of shareholders to challenge the transaction, and better investor protection.

In paying taxes, an entrepreneur have to make 34 payments per year, spend 338 hours per year preparing tax stuff, pays 16.8 percent tax on profits, labor tax and contributions equal to 11.3 percent, other taxes equal to 10.7 percent and total tax rate is 38.8 percent of profit. Compare with South Asia: an entrepreneur have to make 31.3 payments per year, spend 284.5 hours per year preparing tax stuff, pays 17.9 percent tax on profits, labor tax and contributions equal to 7.8 percent, other taxes equal to 14.2 percent and total tax rate is 40 percent of profit. Compare with OECD average: an entrepreneur have to make 12.8 payments per year, spend 194.1 hours per year preparing tax stuff, pays 16.1 percent tax on profits, labor tax and contributions equal to 24.3 percent, other taxes equal to 4.1 percent and total tax rate is 44.5 percent of profit.

In trading across borders, it takes 9 documents, 41 days, and costs US$ 1764 per container to export a standardized shipment of goods. Meanwhile, it takes 10 documents, 35 days, and US$ 1825 to import a standardized shipment of goods. Compare this with South Asia: it takes 8.5 documents, 32.4 days, and costs US$ 1364.1 per container to export a standardized shipment of goods, while it takes 9 documents, 32.2 days, and US$ 1509.1 to import a standardized shipment of goods. And with OECD average: it takes 4.3 documents, 10.5 days, and costs US$ 1089.7 per container to export a standardized shipment of goods, while it takes 4.9 documents, 11 days, and US$ 1145.9 to import a standardized shipment of goods.

In enforcing contracts (commercial), it takes 39 procedures, 735 days, and costs 26.8 percent of claim. Compare this with South Asia: it takes 43.5 procedures, 1052.9 days, and costs 27.2 percent of claim. And with OECD average: it takes 30.6 procedures, 462.4 days, and costs 19.2 percent of claim.

In closing a business (resolve bankruptcies), it takes 5 years, costs 9 percent of estate and recovery rate is 24.5 cents on the dollar (claimants recover from the insolvent firm). Compare with South Asia: it takes 4.5 years, costs 6.5 percent of estate and recovery rate is 20.4 cents on the dollar. And with OECD average: it takes 1.7 years, costs 8.4 percent of estate and recovery rate is 68.6 cents on the dollar.

The state of no reform

My latest op-ed is based on two reports released last month. One measures how business-friendly  an economy is and the other measures how competitive a given economy is. Nepal does not do well in both the rankings. I argue that the main reason for stalemate in reforming reforms is because of a lack of consensus (political) on economic issues, mainly economic growth and broad-based economic development. I think the political parties need to agree on and abide by the principle of rules-based economic system so that the messier political rattle does not infect economic reforms as has been in the past.

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State of no reform

Two crucial reports related to the state of Nepali economy concerning business-friendly environment, competitiveness and the economy’s overall openness were released last month by two reputed institutions. Given the level of political turmoil and a complete disregard for the need to stimulate the economy by reforming key sectors and resolving major stumbling blocks that have been impeding economic activities, it is no wonder that the reports painted a bleak picture of the economy. In a nutshell, last year, dirty political game and bickering for more political clout and wealth clouded the need for forging a consensus on chalking out an actionable inclusive plan for structural transformation of the lagging economy.

Probably the most important report that is looked upon closely by business community and donors is the Doing Business Report 2010. It shows that the progress in fine-tuning reforms that would make doing business in the economy easier stagnated at a low level. Among 183 economies, Nepal’s standing in the easy of doing business ranking is 123. Compared to the year before, doing business was not any easier last year. It is a well-known fact, but hardly acknowledged by the politicians, that economic activities are severely constrained by transport obstructions, forced closure of industries, labor union strikers, depleting industrial security, dilapidated and a short supply of infrastructure, severe power shortage and labor market rigidities. These issues have been reflected in various indicators used in the reports.

The Doing Business Report, published annually by the International Finance Corporate (IFC), ranks countries on the ease of doing business by looking at 10 key indicators. Singapore has been consistently ranked as the most easiest/favorable nation in doing business. In South Asia, Pakistan was the top reformer, followed by Maldives and Sri Lanka. Rwanda – the same country that lived through genocide in 1994 and experienced a complete collapse of political and economic institutions – is one of the top reformers.

Led by a dedicated statesman, President Paul Kagame, the Rwandan economy has been growing registering impressive growth rates. Such a strong political resolve and leadership is virtually absent in the Nepali political economy where leaders are more interested in amassing political clout and wealth than building a consensus to leave economic activities free of political interference.

Looking at specific indicators, it becomes clear where the economy stands on various issues. Starting a business was even harder this year, slipping down in ranking by 12 points to 87 from 75 last year. It takes seven procedures to start a business—verification of the uniqueness of proposed company name; verification and certification of memorandum by a professional; purchase of stamp to be attached to registration form; filing documents with the Company Registrar’s Office; making company seal; registering with Inland Revenue Office; and enrolling the employees in the Provident Fund. The whole process takes at least 31 days and costs 53.6 percent of income per capita.

In dealing with construction permits, it takes 15 procedures, 424 days and costs 221.3 percent of income per capita. Note that it takes 424 days and costs 221.28 percent of income per capita to just build a warehouse. Meanwhile, due to pressure from politically-backed trade unions to increase wages and welfare at a time when production is decreasing, it is of little surprise that employing workers has also become difficult. The rigidity of employment index (a composite index of difficulty of hiring index, rigidity of hours index and difficulty of redundancy index) is 46. For South Asia and OECD, it was 26.3 and 26.4 respectively. A higher value represents more rigid regulations.

The only indicator in which Nepal made progress was in registering property. Nepal’s ranking went up by three positions to 26 from 29 last year. It takes three procedures, five days and costs 4.8 percent of property value to register a property. This improvement came along with the passage of the Finance Act 2008, which reduced the fee for registering a property from 6 percent to below 4.8 percent of the property’s value.

However, getting credit from financial institutions was not any easier; the ranking slipped down by four positions to 113 from 109 last year. Similarly, Nepal did a bad job in protecting investors, leading to decline in ranking by three positions to 73 from 70 last year. There was no progress in making transactions transparent, sorting out liability issues for businesses and the ability of shareholders to sue officers and directors for misconduct.

Despite an increase in revenue generation, partly attained by forcing tax evaders to pay taxes, the process of paying taxes was not any simpler; ranking dropped by 13 positions to 124 from 111 last year. An entrepreneur had to make 34 payments a year, spend 338 hours per year preparing tax documents and pay 38.8 percent of profit as taxes (with 11.3 percent of profit as labor tax and contributions). Likewise, trading across borders was also cumbersome. Among all the indicators, ranking in ‘trading across borders’ was the worst (down by two positions to 161 from 159 last year). Similar poor result was seen in The Global Trade Enabling Report 2009, which ranks countries based on their efficiency at border administration and environment conducive to trade, where Nepal ranked 110 out of 121 countries incorporated in the study. It takes nine documents, 41 days and costs US$1764 per container to export a standardized shipment of goods. Additionally, it takes 10 documents, 35 days and US$1,825 per container to import a standardized shipment of goods.

There was no progress in enforcing commercial contracts and in simplification of closing down a business. From the evolution of a payment dispute to its settlement, it takes 39 procedures, 735 days and costs 26.8 percent of claim to enforce a contract. Additionally, to resolve bankruptcies, it takes 5 years, costs 9 percent of estate and the recovery rate is 24.5 cents on each dollar.

Overall, there were no discernible reforms in easing bottlenecks associated with doing business in the country. Nepal lacked what strong reformers had: A long-term inclusive agenda involving relevant public agencies and private sector representatives for institutionalization of reforms aimed at increasing the competitiveness of firms and economy.

Meanwhile, in the Global Competitiveness Report 2009-2010, published annually by the World Economic Forum (WEF), Nepal ranks 125 out of 133 countries, highlighting the fact that due to a lack of progressive reforms, the economy is one of the most uncompetitive in the world. The state of infrastructure and technological readiness is so horrible that it ranks 131 and 132 respectively. Note that bad infrastructure has already been identified as the most binding constraint on economic growth. Overall, the report notes that Nepal had four “advantages” and 116 “disadvantages” in making the nation globally competitive. The economy is still factor driven and lacks the capacity for innovation and a business culture conducive to stimulating entrepreneurial activities.

Though these reports have deficiencies in accurately rating the true status of an economy, they do, however, show some interesting trends in increasing/decreasing red tapes in an economy. They highlight areas where reforms are dearly needed in order to stimulate entrepreneurial activities. Reforms can be piecemeal and experimental. It could be as simple as extending the opening hours at the borders (like in Rwanda) if commercial activity is picking up during favorable season.

Having grand reforms idea is worthless if the political leaders do not forge a consensus to create rules-based economic structure, where all political actors work to attain a common goal, i.e. broad based economic growth and keep politics out of the activities and reform proposals that are geared towards that goal. This is missing in the Nepali political sphere. No wonder the economy is without any discernible reform!

Doing Business Report 2009

The IFC and WB have just published an annual report on the ease of doing business in countries around the world. The report, which is widely covered in the media and is taken as one of the tools to gauge investment and business climate in a country, states that the top ten reformers in 2007/08 are: Azerbaija, Albania, Kyrgyz Republic, Belarus, Senegal, Burkina Faso, Botswana, Colombia, Dominican Republic, and Egypt. It tracks ten stages in the "lifecycle of a business" and ranks countries on their regulatory ease of doing business. Here is the report overview.

The indicators used in the report are: starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and closing a business. The rankings do
not reflect such areas as macroeconomic policy, quality of infrastructure, currency volatility, investor perceptions, or crime rates.

Singapore leads the global rankings on the overall regulatory ease of doing business for a third consecutive year. New Zealand is runner-up, and the United States third. Bahrain and Mauritius join the ranks of the top 25 this year.

The top 25 are, in order, Singapore, New Zealand, the United States, Hong Kong (China), Denmark, the United Kingdom, Ireland, Canada, Australia, Norway, Iceland, Japan, Thailand, Finland, Georgia, Saudi Arabia, Sweden, Bahrain, Belgium, Malaysia, Switzerland, Estonia, Korea, Mauritius, and Germany.

Sadly, the report states that "no major reforms were recorded." Nepal rank is 121 on the list. In South Asia, Maldives has the highest ranking (69), followed by Pakistan (77), Sri Lanka (102), Bangladesh (110), Nepal (121), India (122), Bhutan (124), and Afghanistan (162).

I will have more on the ease of doing business in Nepal and in South Asia discussion in later posts.

I am getting late for class now!

More on Doing Business 2009 report

I have already discussed about the Doing Business 2009 report in a previous blog post. More on the report here. Here, I will focus on Nepal and South Asia. All the South Asian economies saw their ranking slip by some positions in this year’s report. This does not mean that the countries backtracked on earlier reforms. Other economies reformed more and better than the South Asian economies and hence climbed up the ranking, thus pushing the South Asian economies’ ranking down.

Sadly, on the ten index considered on the report, Nepal did not enact reform on a single one of them. The report flatly states, “No major reforms were recorded” in Nepal. Among the 181 countries considered in the report, Nepal’s overall ranking in the ease of doing business is 121, which is ten positions down from last year’s ranking of 111.

More on Nepal and South Asia:

• The report states that it takes 7 procedures, 31 days, and costs 60.20 percent of income per capita to start a business in Nepal.
• In the construction business it takes 15 procedures and 424 days (highest in South Asia), and costs 248.40 percent of per capital to get a construction permit.
• The rigidity of employment index is 42 (Maldives has the lowest rigidity of employment index), and firing cost is equal to 90 days of salary (Afghanistan has the lowest firing cost in South Asia).
• It still takes 3 procedures and 5 days, and costs 6.30 percent of property values to register property (Bhutan has the lowest in South Asia).
• According to the report, the strength of legal rights index, which takes into account how collateral and bankruptcy laws facilitate the rights of borrowers and lenders, is 5 in Nepal (Bangladesh and India have the highest value in South Asia). Meanwhile, the strength of investor protection index for Nepal is 5.30 (Bangladesh has the best protection system with an index score of 6.70).
• In terms of enforcing contracts, it takes 39 procedures and 735 days, and costs 26.80 percent of claim to enforce contract in Nepal. This shows how rigid and inefficient out courts are to resolve commercial disputes. Bhutan has the lowest costs to enforce contracts. Additionally, for a typical firm, it takes 5 years and 9 percent of estate to go through the process of insolvency.
• For a typical entrepreneur, it requires 34 payments and 408 hours per year, and costs 34.10 percent of profit to pay taxes.
• Furthermore, it takes 9 documents and 41 days, and US $1764 per container for an entrepreneur to export a typical item from Nepal. In the import front, it takes 10 documents and 35 days, and US $1900 per container to import a typical item.

The state of corruption in Nepal

This is a part of growth diagnostics exercise on the Nepali economy I did in the past three months. Low appropriability due to corruption is one of the strongest constraints holding back economic activity in the Nepali economy. Here are similar posts on diagnostics of the economy.

This analysis shows that corruption is the second strongest constraint on economic activity in Nepal. In almost all the standard ratings and analysis on corruption and regulatory regime so far, Nepal has not fared well when compared to countries with similar income level. Similarly, a survey of business personnel, conducted by the World Economic Forum (WEF), shows corruption as the third most problematic factor for doing business in Nepal.

Source: World Governance Indicators 1996-2007[1]

In the figure above, the data correspond to 95% confidence level. In 2003, Nepal was better than 50% of the countries on control of corruption. This slid down to 30% in 2007, meaning that control of corruption has become less effective and 70% of the countries considered in the report have better anticorruption measures in place than Nepal.

In CPIA transparency, accountability and corruption index in the public sector, Nepal had a score of 2.5 in 2006 and 3.0 in 2007 (1=low and 6=high). The figure below shows how Nepal compares with other low income countries in this rating. The Country Policy and Institutional Assessment (CPIA) rates countries against a set of 16 criteria grouped in four clusters: (a) economic management; (b) structural policies; (c) policies for social inclusion and equity; and (d) public sector management and institutions. The World Bank produces it.

Even though Nepal’s rating in transparency and corruption in public sector is not that different from other lagging low income countries, the median (and also mean) score of 3.0 is still not considered to be business-friendly.

The Corruption Perception Index 2008, published annually by Transparency International (TI), also shows corruption to be at a high level. Among the members of SAARC bloc, Nepal is ranked as the country with the fourth highest level of corruption. Overall, Nepal was ranked 124 out of 180 countries included in the report.

Source: CPI 2008 (1=highly corruption and 10=highly transparent)

In regulatory quality for controlling corruption, Nepal fares pretty bad. In fact, as shown by WGI, Nepal’s regulatory quality in 2007 was not that different from that in 1996. Still more than 70% of the countries have better regulatory quality than Nepal.

Source: World Governance Indicators 1996-2007

Moreover, in a survey conducted by the WEF for Global Competitiveness Report 2008-2009, business executives ranked corruption as the third most problematic factor for doing business in Nepal. The business sector is more worried about corruption than macroeconomic risks such as tax rates and regulations and human resources.

Source: Global Competitiveness Report 2008-2009

In addition, there is evidence that firms are taking alternative routes to avoid corruption and taxation at customs. It is estimated that 40% of trade with India occurs through informal channels.This shows that traders are bypassing the normal system- a feature of a binding constraint.

All these reports and rankings show that corruption is one of the strongest constraints on stimulating entrepreneurial activity in Nepal.

In an earlier post I argued that bad infrastructure is the most binding constraint on growth in Nepal (well, after that post I have refined my argument further with much better information and analysis. I will post the whole discussion on bad infrastructure later in a different blog post). However, corruption also seems to be equally binding.

It is easier for policymakers to zero in on policies to relax constraints if we can identify the most binding one so that relaxation of that constraint would lead to largest change in the objective function (i.e. growth rate).Taking note of this argument and WLOG, it is consistent to argue that bad infrastructure is the biggest constraint because improving on this constraint in the short term is much easier (and faster) than clamping down on corruption, which is already institutionalized in the economic and social system. This constraint (corruption) cannot be relaxed in the same time as is the case with infrastructure. Therefore, it cannot produce bigger change than relaxation of infrastructure does in the same period. Based on this argument, I argue that bad infrastructure is the most binding constraint on economic growth in Nepal. (However, this does not mean that we do not tackle corruption, which is equally strong constraint as is bad infrastructure. I am just trying to be a little bit more practical in terms of optimal use of resources in the short run. Moreover, the main purpose of this exercise is to identify the most binding constraint on economic activity in Nepal).

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[1] ^{The chart shows the percentile rank of Nepal on control of corruption, one of the governance indicators considered by Kaufmann and Kraay. Percentile rank indicates the percentage of countries worldwide that rate below the selected country. Higher values indicate better governance ratings. Percentile ranks have been adjusted to account for changes over time in the set of countries covered by the governance indicators. The dashed lines indicate the statistically-likely range of the governance indicator. For instance, a percentile rank of 75% with the dashed lines at 60% to 85% has the following interpretation: an estimated 75% of the countries rate worse and an estimated 25% of the countries rate better than the country of choice.}

Need for immediate relief for industrial sector in Nepal

This was published in Republica, September 12, 2011, p.6. Here is a piece on the same issue by Milan Mani Sharma of Republica.

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Relief for industrial sector

At a time when the public’s confidence on bureaucracy and political leaders is ebbing down to arguably the lowest level after skyrocketing of hope following the 2006 revolution, the newly appointed Prime Minister Dr. Baburam Bhattarai’s team has announced a slew of “relief” measures to convince Nepali people that the new government feels and fathoms the desperation for tangible change. While some of the measures are consistent with the major party’s political agenda and are outright populist, they are nevertheless required in one form or the other. Pundits and talking heads can preemptively debate on the intention and nature of the relief package, but the application of these initiatives merit some time. Their success has to be judged against the intended objective and efficacy.

Now, as much as the public needs relief package, the industrial sector also deserves immediate measures to kick-start jammed growth engine and jobs creation. It needs immediate relief for two main reasons. First, due labor related problems and policy inconsistency, the investor’s morale and market confidence are pretty low right now, leading to withholding and withdrawal of investment plans. Second, due to lack of adequate supply of infrastructure and supply-side constraints, industrial output is declining and cost of production is rising, leading to low economic activities, stagnation in employment generation, and loss of competitiveness.

Unless the industrial sector gets the badly needed relief from these constraints, the dream of attaining double-digit growth—also reiterated by Finance Minister Barsa Man Pun as soon as he assumed office and trumpeted by the UCPN (Maoist) bigwigs multiple times– won’t be realized. High growth will not be attained just by customary assistance to agriculture sector—whose output and volatility largely depends on the monsoon— by offering fertilizer subsidies, investment in irrigation and promotion of agriculture cooperatives. High and sustained growth requires structural change and more reliance on industrial activities.

Unfortunately, our industrial sector— which constitutes mining and quarrying; manufacturing; electricity, gas and water; and construction sectors—has been consistently losing ground. Currently, its contribution to GDP is approximately 14 percent only. Meanwhile, manufacturing sector is fast losing strength, bringing down its contribution to GDP to 6 percent. Note that a strong and sustained growth of manufacturing sector means more jobs, stimulation of economic activities, and a high but less volatile growth rate. We just have to look at our neighbors—China and India—for example.

It does not come as a surprise that the dismal performance of industrial sector, particularly manufacturing sector, is also reflected in the export-oriented sector, one of the most important sectors through which our economy gets foreign exchange reserves. The latest annual macroeconomic data released by the central bank shows that total exports are estimated to be just Rs 64.6 billion in 2010/11, down from Rs 76.7 billion in 2008/09 but up from Rs 60.8 billion in 2009/10. When the data was released the authorities were quick to point out that exports have increased by 6.1 percent, which is higher than 5.4 percent growth of imports. There is nothing to be exuberant about on this one as the high growth rate of exports was relative to previous year when exports plunged by Rs 7 billion. A slight improvement when the base is too low obviously gives a larger bump in growth rate! Also, the relatively low growth rate of imports has to do with decrease in imports of certain commodities, thanks to restrictive policies imposed by the government.

The situation has gotten so worse that we cannot even finance our petroleum imports (Rs 75.07 billion in 2010/11) by exports revenue. Diversification of exported product and destination is not happening as our export basket is squeezing and we are increasingly dependent on India for both exports and imports. Overall, exports of goods and services have declined from as high as 27 percent of GDP in 1997 to less than 15 percent today. Meanwhile, imports of goods and services have exploded to 28 percent of GDP. This has resulted in total trade deficit of around 22 percent of GDP. Similarly, an estimated Rs 2.93 billion of balance of payments surplus following two successive years of deficit has more to do with a fluke of handsome transfers and reimbursements as our economic fundamentals have not changed much. Our current account deficit is still negative despite a surge in remittances.

You might be wondering how all these dismal numbers are related to the above-mentioned call for industrial relief. Well, persistent labor dispute, which exacerbated after the UCPN (Maoist) affiliated unions formally entered the industrial sector as an organized group plus the destructive activities of Young Communist League (YCL), hit investor and market confidence pretty hard. It led to closures of multinational companies and withholding of investment spending. The unruly activities of trade unions, which are run by people who care more about themselves and party leaders rather than job security and welfare of workers they claim to represent, was continuing even when the relief package was announced. Recently, it cost us Surya Nepal Private Limited’s Biratnagar-based garment manufacturing unit. The popular Fire and Ice restaurant in Thamel is the latest victim of few unruly trade union members who are trying to dictate management level appointment, which is beyond their jurisdiction and obligation. Furthermore, the inadequate supply of infrastructure (power and roads network) and other constraints such as policy inconsistency, security, and sporadic blockade of major trade routes are also contributing to withdrawal of investment, capital flight and closure of firms. Domestic investors are moving to service sector (save hotel and restaurants) that has relatively low union pressure and less cost of doing business.

These constraints are also identified as problematic factors for doing business in Nepal by the latest Global Competitiveness Report 2011-2012, which has ranked our economy as 125^th most competitive (out of 142) in the world. We are ranked the lowest in supply of electricity and second worst in supply of infrastructure. The ranking is miserable in labor regulation, labor market efficiency, productivity, security, production sophistication, and innovation. The business sector thinks government instability is the most problematic factor for doing business, followed by inefficient government bureaucracy, policy instability, corruption, inadequate supply of infrastructure, and restrictive labor regulation.

It is leading to an erosion of our industrial capacity, without which growing at a steady 5 percent growth rate—let alone a double-digit rate—is impossible. Hence, the call and need for immediate industrial relief. A tentative relief package could be: taming labor militancy and smoothening industrial relations; policy consistency on key issues related to investment regime and sectoral support; effective end of syndicate; credit at low interest rate to key sectors where we enjoy comparative advantage consistent with our land, labor and capital resource endowment; emergency measures to supply power for at least two shifts in manufacturing plants; fast track endorsement of investment plans and lowering cost of doing business in Nepal; enactment of SEZ bill; and industrial security. These are doable and are not populist measures.

PM Dr. Bhattarai and FM Pun are well aware of these constraints and the challenges faced by the industrial sector. Now, they should at least make an effort to bring out industrial relief package to restore confidence of investors and markets. Of course, they will face resistance from their own party and other vested interest groups. But, it should be rightly confronted with as demanded by the emergency nature of our eroding strength of industrial sector.

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Competitiveness of Nepali economy unchanged

The latest Global Competitiveness Report 2012-2013 shows that Nepal’s ranking in competitiveness has remained unchanged at 125 out of 144 countries. Last year, Nepal’s ranking was also 125 out of 142 countries. Nepal’s ranking is the lowest in South Asia, where the most competitive economy is India (last year it was Sri Lanka).

	GCI 2012-2013		GCI 2011-2012	GCI 2010-2011
Country	Rank (out of 144 countries)	Score	Rank (out of 142 countries)	Rank (out of 139 countries)
India	59	4.32	56	51
Sri Lanka	68	4.19	52	62
Bangladesh	118	3.65	108	107
Pakistan	124	3.52	118	123
Nepal	125	3.49	125	130

Competitiveness is defined as “the set of institutions, policies, and factors that determine the level of productivity of a country”.The ranking is based on global competitiveness index, which comprises of 12 categories – the pillars of competitiveness – which together gives a picture of a country’s competitiveness landscape. The pillars are: institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication and innovation.

Switzerland tops the overall ranking for four consecutive year. It is followed by Singapore, Finland, Sweden and Netherland in the top five competitive nations. The least competitive nations are Burundi, Sierra Leone, Haiti, Guinea and Yemen. The report notes that troubled economies in the Euro zone areas—Portugal (49th), Spain (36th), Italy (42nd) and Greece (96th)— “continue to suffer from competitiveness weaknesses in terms of macroeconomic imbalances, poor access to financing, rigid labour markets and an innovation deficit”.

In the emerging markets (BRICS), China is ranked at 29th position, Brazil 48th, South Africa 52nd, India 59th, and Russia 67th.

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Nepal’s case:

Given the political stalemate and lack of introduction of new reform to boost competitiveness along with implementation of existing ones, it is no surprise that there is no improvement in ranking. In 2011-2012, ranking jumped by five positions to 125 compared to 2010-2011 rankings. In 2009-10, Nepal’s ranking was 125 out of 133 countries and in 2010-11, the ranking was 130 out of 139 countries.

Nepal is still a factor-driven economy but its macroeconomic environment is better than that of other factor-driven economies. Its labor market efficiency is below the standard of other factor-driven economies. Nepal still has a long way to go to become an efficiency-driven and then innovation-driven economy.

In basic requirements (institutions, infrastructure, macroeconomic environment, and health and primary education), Nepal’s ranking is 121 (same as last year) out of 144 economies. In efficiency enhancers (higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, and market size), Nepal’s ranking is 126 (an improvement by one position). In innovation and sophistication factors (business sophistication and innovation), Nepal’s ranking is 133 (down by one position). In overall competitiveness index, basic requirements, efficiency enhancers, and innovation and sophistication factors have 60 percent, 35 percent and 5 percent weight respectively.

The best ranking is in macroeconomic environment at 56 out of 144 counties (last year it was 50, which means a bit deterioration this year). Ranking in gross national savings (% of GDP) is 18 and government budget balance (% of GDP) 48. Ranking in women in labor force (ratio to men) is 13.The worst ranking is in infrastructure at 143 out of 144 countries (in quality supply of electricity as well it is 143).

The rankings in the 12 pillars of competitiveness are (last year’s in bracket) : institutions 123 (124), infrastructure 143 (141), macroeconomic environment 56 (50), health and primary education 109 (115); higher education and training 128 (129), goods market efficiency 121 (125), labor market efficiency 125 (128), financial market development 91 (100), technological readiness 129 (130), market size 95 (98); business sophistication 127 (125) and innovation 133 (134).

The report also includes results from perception survey (of business community) on the most problematic factors for doing business. The chart below shows the results. Government instability, corruption, inefficient government bureaucracy, policy instability and restrictive labor regulations are perceived as the top five problematic factors for doing business in Nepal.