Reimagining GDP and measures of economic prosperity

Joe Stiglitz on the usefulness of GDP as a measure of wellbeing:

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[...]After six years of consultation and deliberation, we reinforced and amplified our earlier conclusion: GDP should be dethroned. In its place, each nation should select a “dashboard”—a limited set of metrics that would help steer it toward the future its citizens desired. In addition to GDP itself, as a measure for market activity (and no more) the dashboard would include metrics for health, sustainability and any other values that the people of a nation aspired to, as well as for inequality, insecurity and other harms that they sought to diminish.

These documents have helped crystallize a global movement toward improved measures of social and economic health. The OECD has adopted the approach in its Better Life Initiative, which recommends 11 indicators—and provides citizens with a way to weigh these for their own country, relative to others, to generate an index that measures their performance on the things they care about. The World Bank and the International Monetary Fund (IMF), traditionally strong advocates of GDP thinking, are now also paying attention to environment, inequality and sustainability of the economy.

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OECD's Better Life Initiative lists 11 indicators to gauge the quality of life: housing, income, jobs, community, education, environment, civic engagement, health, life satisfaction, safety, and work-life balance.

Stiglitz argues that the use of prices as a proxy for value- believing that in a competitive market prices measure relative value of goods and services- is problematic. 

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[...]Over time, as economists focused on the intricacies of comparing GDP in different eras and across diverse countries and constructing complex economic models that predicted and explained changes in GDP, they lost sight of the metric's shaky foundations. Students seldom studied the assumptions that went into constructing the measure—and what these assumptions meant for the reliability of any inferences they made. Instead the objective of economic analysis became to explain the movements of this artificial entity. GDP became hegemonic across the globe: good economic policy was taken to be whatever increased GDP the most.

[...]It would have been nice, of course, if we could have come up with a single measure that would summarize how well a society or even an economy is doing—a GDP plus number, say. But as with the GDP itself, too much valuable information is lost when we form an aggregate. Say, you are driving your car. You want to know how fast you are going and glance at the speedometer. It reads 70 miles an hour. And you want to know how far you can go without refilling your tank, which turns out to be 200 miles. Both those numbers are valuable, conveying information that could affect your behavior. But now assume you form a simple aggregate by adding up the two numbers, with or without “weights.” What would a number like 270 tell you? Absolutely nothing. It would not tell you whether you are driving recklessly or how worried you should be about running out of fuel.

That was why we concluded that each nation needs a dashboard—a set of numbers that would convey essential diagnostics of its society and economy and help steer them. Policy makers and civil-society groups should pay attention not only to material wealth but also to health, education, leisure, environment, equality, governance, political voice, social connectedness, physical and economic security, and other indicators of the quality of life. Just as important, societies must ensure that these “goods” are not bought at the expense of the future. To that end, they should focus on maintaining and augmenting, to the extent possible, their stocks of natural, human, social and physical capital. We also laid out a research agenda for exploring links between the different components of well-being and sustainability and developing good ways to measure them.

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New five year plan in Nepal and effectiveness of right to education in India

15th five-year plan targets minimum 9.4pc annual growth

From The Himalayan Times: The preliminary draft of the concept paper of the 15th five-year plan (fiscal year 2019- 20 to 2023-24) prepared by the National Planning Commission — the apex body responsible for formulating the country’s development vision — has set a target to achieve a minimum average economic growth of 9.4 per cent per annum in the next five years. However, the economy can grow up to 10.1 per cent per annum in the next five years based on different scenarios, as per the draft. The government had last introduced a five-year periodic plan in 2001, which lasted till 2006.

The preliminary draft of the concept paper of the five-year periodic plan states that the country can achieve economic growth of between 9.4 per cent and 10.1 per cent every year in between fiscal years 2019-20 and 2023-24. Similarly, the draft of the periodic plan envisions that the country’s agriculture sector can witness an average growth of 5.6 per cent per annum in the next five years while the industrial sector can witness average growth of 17.1 per cent per annum. Likewise, the services sector is expected to witness 9.9 per cent growth per annum in between fiscal years 2019-20 and 2023-24.

The draft of the 15th five-year plan also states that the contribution of the services sector in the gross domestic product (GDP) can reach 57.6 per cent by fiscal 2023-24. Similarly, the contribution of the agriculture sector and industrial sector in the national GDP can reach 22.1 per cent and 20.3 per cent, respectively. The 15th five-year periodic plan will be based on the slogan of ‘Generating Prosperity and Happiness.’

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The Right to Education Act: Trends in Enrollment, Test Scores, and School Quality

From a NBER working paper (Shah and Steinberg): The Right to Education Act in 2009 guaranteed access to free primary education for all children in India ages 6-14. This paper investigates whether national trends in educational data changed around the time of this law using household surveys and administrative data. They find four important trends:  

• School-going increases after the passage of RTE, though this increase is more pronounced in “primary activity” NSS data than in official enrollment statistics
• Test scores decline dramatically after 2010 in both math and reading
• School infrastructure, including pupil-teacher ratios, appears to be improving both before and after RTE 
• The number of students who have to repeat a grade falls precipitously after RTE is enacted, in line with the official provisions of the law

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Nepal's fares better than most South Asian countries on the state of human capital

This year’s World Development Report focuses on the changing nature of work and the importance of productive human capital. The report argues that there is no need to become overly fearful of robots taking over jobs that have traditionally been done by humans. 

Technological progress (innovation) reshapes work, and firms adopt new ways to produce goods and services and to expand markets. Governments too can make use of technology to delivery effective public services. Differences in human capital now will have profound implication on productivity of the next generation of workers. 

Key highlights:

Technology changes the nature of labor demand, especially it reduces demand for low skilled workers but raises premium on high-order cognitive skills. This is especially true in the case of manufacturing jobs in some advanced economies and middle-income countries. But then technology has provided new opportunities to create new jobs, increased productivity and helped to deliver effective public services. 

Digital technologies allows firms to scale up or down production quickly; and platform marketplaces allows faster diffusion of technology to benefit general public.   

Three types of skills are particularly important: advanced cognitive skills (complex problem solving), socio-behavioral skills (teamwork), and skill combinations predictive of adaptability (reasoning and self-efficacy). 

Investing on human capital, especially education and health, must be a priority for governments. Policy measures include investing in people through nutrition, healthcare, quality education, jobs and skills. Accumulation of knowledge, skills and health helps citizens realize their potential and make them productive. Investment in physical and human capital complements each other. Creating formal jobs, better access to internet, investment in roads and municipal infrastructure, and social protection are vital to enhance human capital. Focusing on early childhood, tertiary education, and adult learning outside jobs could help in adapting to skills readjustment. 

The changing pattern of jobs and skills landscape necessitates social protection as well. Eight in 10 people in developing countries receive no social assistance, and 6 in 10 work informally without insurance. The report recommends expanding social protection coverage to cover the neediest people (and eventually universal coverage), exploring the feasibility of universal basic income, and placing community health workers on the government’s payroll. 

To create fiscal space, developing countries need to increase tax base (such as property taxes in urban municipalities and excise duty on sugar or tobacco), enhance efficiency of public administration (indirect taxes, reforming subsidies, closing global tax loopholes) and reduce the size of informal sector. Addressing informality in the absence of social protection for workers is a challenging policy issue.

Human Capital Index

The WDR 2019 also includes Human Capital Index (HCI), which measures “the amount of human capital that a child born in 2018 can expect to attain by age 18, given the risks of poor health and education that may exist in the country where she lives”. HCI ranges between 0 and 1, with a higher score indicating that a child born today achieves full health (defined as no stunting and survival up to at least age 60) and completes her education potential (defined as 14 year of high-quality school by age 18). 

Specifically, it is a composite score of five indicators: (i) the probability of survival to age five; (ii) a child’s expected years of schooling by her 18th birthday; (iii) harmonized test scores as a measure of quality of learning; (iv) adult survival rate (fraction of 15 year olds that will survive to age 50); and (v) the proportion of children who are not stunted. Indicators (ii) and (iii) is a measure of expected years of quality-adjusted schooling, which combines quantity and quality of education. Indicators (iv) and (v) are related to health dimension. 

For instance, Nepal has a HCI score of 0.49, meaning that a child born today in Nepal will only be half as productive as she could have been relative to the benchmark of complete education and full health. You could also think this of as the possibility of doubling GDP in the future if Nepal reaches the benchmark of complete education and full health. Nepal’s HCI is higher than the average for South Asia region.

On Nepal and South Asia:

Nepal ranked 102 out of 157 countries covered in the report. India ranked 115 (and has rejected the findings). Sri Lanka ranked 74.

Human Capital Index: A child born in Nepal today will be 49 percent as productive when she grows up as she could be if she enjoyed complete education and full health. In 2017, the HCI for Nepal is higher than what would be predicted for its income level. 

• In South Asia, Sri Lanka had the highest HCI score (0.58) followed by Nepal (0.49), Bangladesh (0.48), India (0.44), Afghanistan (0.39), and Pakistan (0.39).

Probability of Survival to Age 5: 97 out of 100 children born in Nepal survive to age 5. 

• In South Asia, probability of survival to age 5 is the highest in Sri Lanka (99 out of 100 children), followed by Bangladesh and Nepal, India, Afghanistan and Pakistan. 

Expected Years of School: In Nepal, a child who starts school at age 4 can expect to complete 11.7 years of school by her 18th birthday. 

• In South Asia, expected years of school is highest in Sri Lanka (13), followed by Nepal, Bangladesh, India, Pakistan and Afghanistan. 

Harmonized Test Scores: Students in Nepal score 369 on a scale where 625 represents advanced attainment and 300 represents minimum attainment.

• In South Asia, students’ harmonized test scores is the highest in Sri Lanka (400) followed by Nepal, Bangladesh, India, Afghanistan and Pakistan. 

Learning-adjusted Years of School: Factoring in what children actually learn, expected years of school is only 6.9 years. Children in Nepal can expect to complete 11.7 years of pre-primary, primary and secondary school by age 18. However, when years of schooling are adjusted for quality of learning, this is only equivalent to 6.9 years: a learning gap of 4.8 years.

• In South Asia, learning-adjusted years of school is the highest in Sri Lanka (8.3 years), followed by Nepal, Bangladesh, India, Afghanistan and Pakistan.

Adult Survival Rate: Across Nepal, 85 percent of 15-year olds will survive until age 60. This statistic is a proxy for the range of fatal and non-fatal health outcomes that a child born today would experience as an adult under current conditions.

• In South Asia, adult survival rate is the highest in Bangladesh and Sri Lanka (0.87), followed by Nepal, Pakistan, India and Afghanistan. 

Healthy Growth (Not Stunted Rate): 64 out of 100 children are not stunted. 36 out of 100 children are stunted, and so at risk of cognitive and physical limitations that can last a lifetime.

• In South Asia, Sri Lanka has the highest fraction of kids under 5 NOT stunted (0.83), followed by Nepal, Bangladesh, India, Afghanistan and Pakistan. 

UNDP’s HDI and WB’s HCI are complementary. HDI is a composite index of life expectancy, education and per capita income. HCI is also a similar index but it links the five indicators to (future) productivity and income levels. In other words, it shows how improvements in the current education and health outcomes shape the productivity of the next generation of workers. HCI touches upon SDGs 3 and 4. 

Meanwhile, India 

Liquidity conundrum in Nepal and more

Liquidity conundrum 

The interbank rate went below 3% and the central bank offered to mop up liquidity (NRs 2 billion through 14 day deposit collection auction) to ensure real interest rate stays between 3% and 7% (what it calls an interest rate corridor). However, BFIs offered NRs3.9 billion. This is contradictory to the claim by BFIs that there is liquidity/credit shortage. Most BFIs are hitting the CCD limit of 80% now. 

It happened last year as well (and in the past as well) and the NRB came to their rescue by bending rules to compute CCD. Now, the BFIs are again seeking help from both NRB and MOF to help them increase deposit as remittance inflows are decelerating and public capital spending is not too high till the first half of FY2018 (two main sources of deposit of BFIs). It is a classic case of moral hazard: repeatedly running into the same self-inflicted problem (a result of faulty operations and management) and seeking relief from the regulatory (which, surprisingly, has done what BFIs wanted on regulatory front in this particular issue). It would further foster this behavior if MOF and NRB agrees to offer NRs80 billion (from its treasury surplus of NRs330 billion) as deposit to BFIs to rescue them from the current mess.

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Arbitrary increase in cement and steel rod prices

Federation of Contractors Association of Nepal (FCAN) alleges that price of cement has gone up by Rs 100 per bag (50 kg), while steel rod has become dearer by Rs 7 per kg compared to prices before the provincial and federal elections. A bag of OPC cement is being retailed at Rs 910, while steel rod now costs Rs 85 per kg. Contractors say this is a deliberate increase in prices but producers say it is because cost of raw materials (clinkers and transportation) increased. 

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Paddy output to decrease by 1.5% in FY2018

Paddy output is expected to be about 5.15 million tons, down 1.49% from FY2107 on account of late and uneven pattern of monsoon, and flooding in August in Terai plains. MOAD had earlier projected a record paddy harvest. The latest estimate is not going to lower agricultural output growth as the country has seen abundant maize harvest, according to MOAD.

The production of summer crops—paddy, maize, millet and buckwheat—is expected to grow 1.87% to 8.03 million tonnes this fiscal year. In FY2017, the country recorded its largest paddy production in history with a 21.66 percent jump to 5.23 million tonnes.

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Understanding of primary school students in community schools dismal

About 60% of primary school students (class 2 and 3) in community schools cannot even write a simple sentence in Nepali language, according to Ministry of Education. The result is based on a survey of 72,538 students in 2,650 community schools in 11 districts. 

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Rural indicators point to worsening farm distress in India

"Sluggish wage growth, lower crop planting, fluctuating prices paint a dismal picture for farmers and the agriculture sector.

Planting of wheat, the main winter crop, between October and early January was 5% lower than a year ago due to lower sowing in Madhya Pradesh by close to a million hectares; area under oilseeds was lower by over 5%. Rajasthan accounted for most of the decline in oilseed cultivation because of 0.7 million hectares lower sowing of mustard. Similarly, data on nominal rural wages, a bellwether for rural demand, is showing sluggish growth. According to the labour bureau, in October 2017, nominal rural wages for ploughing (men) rose 6.6% year-on-year."

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India's Economy Faces an Ominous New Year in 2018

Mihir Sharma writes: "Just as growth appears to be no longer a pressing problem, another familiar threat has reappeared: India’s macroeconomic numbers don’t look quite as stable as they should.

India is snowed under with sovereign and quasi-sovereign paper; it seems like practically every state government and public-sector company wants a piece of India’s bond market. In response to this flood of debt, the yield curve has steepened by a whole percentage point since July. And the government made things even worse by announcing at the end of December that it would borrow more money from the markets this financial year than planned -- a fallout, perhaps, of uncertainty about revenues in the first year of the new indirect tax system. In other words, it’s not exactly the best time for Modi to be planning new spending. 

[…]The federal government is supposed to bring its fiscal deficit down to 3 percent of GDP this year; that’ll be a near-impossible task if transfers to farmers are also to be increased."

Schooling is not enough, learning is important too

Just attending school itself is not enough. Learning is equally important in primary and secondary schools to boost wages and opportunities later in life, according to World Development Report 2018. It dubs the current state of educaiton a “learning crisis”.

Examples:

• In rural India, nearly three-quarters of students in grade 3 could not solve a two-digit subtraction such as 46–17, and by grade 5 half could still not do it. 
• In urban Pakistan in 2015, only three-fifths of grade 3 students could correctly perform a subtraction such as 54–25, and in rural areas only just over two-fifths could.
• In Kenya, Tanzania, and Uganda, when grade 3 students were asked to read a simple sentence like “The name of the dog is Puppy,” three-quarters did not understand what it said.
• In Uruguay, poor children in grade 6 are assessed as “not competent” in math at five times the rate of wealthy children.
• By the end of primary school, only 5 percent of girls in Cameroon from the poorest quintile of households have learned enough to continue school, compared with 76 percent of girls from the richest quintile.

Teaching-learning relationships breakdown due to: 

(i) Malnutrition, illness, low parental investments, and harsh environment associated with poverty would mean that children come to school unprepared to learn

(ii) Teachers lacking the skills or motivation to teach effectively 

• Across 14 Sub-Saharan countries, the average grade 6 teacher performs no better on reading tests than the highest-performing grade 6 students;  
• In seven Sub-Saharan countries, one in five teachers was absent from school during recent unannounced visits by survey teams, with another fifth of teachers at school but absent from the classroom

(iii) Educational inputs fail to reach classrooms or to affect learning (textbooks don’t reach schools or even when they reach the students don’t get it on time)

(iv) Poor management and governance undermine schooling quality (ineffective school leadership; no set goals that prioritize learning; lack of autonomy for schools; ineffective community engagement)

It recommends countries to:

• Design student assessments to gauge their learning
• Create conducive environment for learning, including addressing stunting and promoting brain development through early nutrition and stimulation, using technologies, strengthening school management
• Increase accountability by mobilizing all stakeholders and create political will for education reform

Rapid economic transformation in Nepal

It was published in The Kathmandu Post, 20 March 2017

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Rapid economic transformation

Implementing the vision would require consistent and committed political leadership, and a competent bureaucracy

Kenichi Yokoyama & Chandan Sapkota

Nepal has set a long-term vision to graduate from the Least Developed Country (LDC) category by 2022 and attain a prosperous, middle-income country status by 2030. The National Planning Commission is leading efforts to chart a bold and time-bound economic development roadmap to attain these goals. In this regard, the remarkable economic transformation of several Asian economies in a matter of a few decades provides important lessons for Nepal in its quest to achieve rapid, sustainable and inclusive economic growth. 

Economic structure

So far, Nepal’s economic transformation is not supported by growth-enhancing structural change. Economic structure and labour have shifted from low productivity agricultural to low productivity services, bypassing the industrial sector. In 1984, agricultural, service-based and industrial  sectors accounted for 61 percent, 26 percent and 13 percent of gross domestic product (GDP) respectively. Currently, while the agricultural sector accounts for 33 percent and the service sector a whopping 52 percent of GDP, industries account for just 15 percent of GDP. In effect, there is a gradual deindustrialisation since the industrial sector peaked at 23 percent of GDP in 1997.

Consequently, GDP growth has been low and volatile, depending mostly on the monsoon rains and remittance-fueled consumption demand in the service sector. Per capita GDP growth averaged just 2.6 percent in the last three decades, reaching $746 in 2016. Similarly, real annual GDP growth averaged 4.2 percent in the last three decades. GDP growth was above 8 percent in two instances only: in 1981 and 1984. In 1994, it grew by 7.9 percent. The economy has to grow by an average 8 percent each year to achieve its goal of becoming a middle-income country. 

Asian experience

The Asian experience—for instance the cases of Japan, Hong Kong, Singapore, Thailand, and Malaysia—provides valuable insight to initiate rapid structural transformation. 

These economies invested heavily in fundamentals and guided the economy with a clear vision, resulting in rapid and sustained economic growth. Initially, the structure of the economy was transformed by increasing the size and dynamism of the industrial sector. Agriculture played an important role by increasing labour and land productivity, stimulating growth in backward and forward linkages such as agro-processing, and releasing labour to help industrialisation. These were supported by stable fiscal and monetary policies that were occasionally unorthodox, and an investment-friendly policy regime. These strategies led to a sustained high growth rate. 

Furthermore, they invested heavily in infrastructure as a foundation for production and trading, prioritised human capital formation, fostered technology transfer, and strengthened institutions. This enhanced and sustained economic competitiveness and high per capita income levels. These measures were crucial in boosting productivity and value addition in the industrial sector, and in diversification and sophistication of productive services such as financial and IT systems. Here, well-planned and developed urban infrastructure was a critical catalyst.

In essence, pragmatic industrial promotion strategies along with access to markets, capital and technologies of more advanced economies helped these economics to rapidly take-off and boost per capita income. A clear and pragmatic development vision, incremental reforms to boost critical physical and social infrastructure, and strong institutional fundamentals and ownership underpinned this transformative process. 

Lessons for Nepal

The global investment, trade and financial regimes are different now compared to the times when these economies were taking-off and growing at high rates. As a latecomer, Nepal doesn’t have the same privileges, untapped potential and preferential market access opportunities. However, it does have significant opportunities to spur high growth by catering to the needs of the growing internal and favourable external markets through hydroelectricity, light manufacturing goods, high value agriculture products, tourism, and information technology development. Overall, raising productivity across all sectors will be the key. 

Note that enhancing per capita income to a middle-income level will be conditional on the correct positioning of micro and macro fundamentals. Faster catch-up is easier at this stage if productivity of agricultural and industrial sectors increases rapidly. In particular, a competitive manufacturing sector, which produces tradable goods, absorbs more labour, provides sustained sources of income and boosts entrepreneurship, is essential to move up the ladder of industrialisation. 

Nepal could point the macro fundamentals in the right direction by increasing the quantum and quality of investment in agriculture, transport, energy, urban development, education and skills, and healthcare. Nepal could also make progress by controlling inflation, improving governance and rolling out private sector friendly reforms. Some of these measures are an integral part of the government’s “second generation reforms”. However, the lack of effective implementation of policies and timely budget execution are subduing growth potential. Similarly, the micro fundamentals that need to be addressed are labour relations, land reforms, and anti-competitive practices, which are fostering inefficiencies and stifling growth opportunities in all sectors.

As the backbone of the economy, agriculture supports growth and livelihoods and lowers price volatility. Thus, enhancing land and labour productivity is crucial for a meaningful transformation. Productivity could be increased by using new technology and shifting traditional cropping practices to more high value added activities such as livestock, fruits, vegetables and agro-processing. It should be supported by transport networks, development of value chains, credit flows, irrigation and marketing.These call for well-structured programming and implementation of the Agriculture Development Strategy.  

Following the enhancement of agriculture, strengthening the industrial sector is vital for generating meaningful jobs and accelerating growth. Provisioning of infrastructure and supportive policy and institutional reforms are critical. Also necessary are pragmatic industrial promotion strategies, which could range from import replacement and export promotion that hinge on increasing domestic value added and employment, to establishing functional industrial zones and economic corridors. A range of industrial and trade policies/strategies are periodically updated and approved, but their effective implementation is not getting much attention.  

Nepal has a latecomer advantage in the light manufacturing sector, which normally absorbs semi-skilled labour force—similar to the workers who migrate overseas. Hence, it could get spill over demands from countries where wages are rising fast, provided that factors that supress competitiveness such as inadequate power supply, high cost of transport, and labour relations are addressed. Nepal could then gradually produce sophisticated goods that require higher knowledge, management skills and technology transfer. This would also complement high productivity services, ie moving from trading businesses to IT services, travel and tourism, and educational and healthcare services. 

Government’s role

The government has an important role to play in providing critical infrastructure, addressing market failures, designing a growth-enhancing tax regime, and implementing business-friendly policies to usher in a meaningful structural transformation. It also needs to enhance both the quantum and quality of public capital spending to over 8 percent of GDP annually. Given the sound fiscal space, though Nepal doesn’t have a shortage of funds until medium-term, a dearth of capacity to fully execute the budget and finish projects on time may prove problematic. 

Implementing the vision of a rapid economic transformation would require consistent and committed political leadership, and a competent bureaucracy. This would form the institutional fabric that helps translate good economics into good politics with economic development as the core theme. It ensures shared prosperity, makes reversibility of policies costly, enhances individual’s and firm’s confidence in the economy, and encourages the bureaucracy to provide faster and better service delivery.

With an appropriate mix of macroeconomic strategies, financial arrangements, smart project execution, and supportive institutions and policies, it is reasonable for Nepal to be upbeat about the possibility of a meaningful economic transformation and attainment of the long-term vision.

Yokoyama is Country Director of Asian Development Bank, Nepal resident mission; Sapkota is an economist. Views expressed in this article are personal

Accelerating Post-earthquake Reconstruction for Faster Recovery in Nepal

This is adapted from the issue focus section of Macroeconomic Update, August 2015, Vol.3, No.2 (executive summary here, and FY2016 growth and inflation outlook here). It includes FY2015 update on real, fiscal, monetary and external sector, and growth and inflation outlook for FY2016. It provides a comprehensive macroeconomic assessment, including fiscal sustainability, after the April 25 earthquake.

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I. Introduction

A catastrophic 7.8 magnitude earthquake struck Barpak of Gorkha district on 25 April at 11:56 AM. In between numerous aftershocks of below 5 magnitude, two powerful 6.7 magnitude (26 April) and 7.3 magnitude (12 May) aftershocks shook a large part of the country, particularly central and western administrative regions. It caused further damage to the already weakened houses and physical infrastructure, and also triggered numerous landslides in the rural areas. The calamity has added a new challenge to Nepal’s short-to-medium term economic growth and development prospects.

The completion of post disaster needs assessment (PDNA), establishment of a National Reconstruction Authority (NRA) the reconstruction-focused budget and monetary policy for FY2016, and the gradual improvement in political environment have put in place the key prerequisites for the execution of reconstruction programs. Now, effectively operationalizing the NRA along with immediate planning and strategizing of reconstruction projects is critical for ensuring a fast and inclusive recovery. The NRA’s and sector ministries’ ability to swiftly prepare and implement the viable reconstruction projects will be a key determinant for speedy restoration of livelihoods and economic recovery.

The estimated 700,000-982,000 additional people pushed below the poverty line by the earthquake-induced income shock need to be pulled back above the line by providing them with jobs, skills and social protection as appropriate. The post-reconstruction programs need to be well coordinated, ensure ‘building back better’, and be an integral part of the larger goal of meaningful structural transformation of the economy.

II. Damages to lives and property

Over 8,800 were confirmed dead and 22,309 injured. Furthermore, 602,257 and 285,099 private houses were fully and partially damaged, respectively, forcing thousands of people to seek temporary shelter under tents and tarpaulin sheets. Furthermore, 2,673 and 3,757 public buildings were fully and partially damaged, respectively. To prioritize rescue and relief operations, the government declared 14 districts as severely affected (mostly in the central and western regions) although the earthquake has affected 31 of Nepal’s 75 districts.

III. Post disaster needs assessment

According to PDNA estimates, the cumulative damage and loss amount to 33.3% of GDP ($7.1 billion) and the cumulative need for recovery is estimated at $6.7 billion (31.5% of GDP). PDNA was spearheaded by the National Planning Commission with the support of various government agencies, development partners and civil society. It included 21 sectoral and thematic assessments.

 

Damages, losses and needs ($ billion)
Sector	Included sectors	Damage	Loss	Total needs
Social	Cultural Heritage, Education, Health and Population, Housing and Human Settlements	3.5	0.5	4.0
Productive	Agriculture, Financial Sector, Industry and Commerce, Irrigation, Tourism	0.6	1.2	1.2
Infrastructure	Communications, Community Infrastructure, Electricity, Transport, Water and Sanitation	0.5	0.1	0.7
Cross-Cutting	Gender, Social Protection, Nutrition, Employment & Livelihoods, Disaster Risk Reduction, Environment and Forestry, Governance	0.5	0.3	0.8
Total		5.1	2.1	6.7

Source: National Planning Commission

Of the total estimated recovery needs, about 50% is for rebuilding private housing and settlement. Productive and infrastructure clusters need 17.3% and 11.1%, respectively. These amount to about 5.5% and 3.5% of GDP, respectively. The recovery needs requirement for agriculture, education, electricity, and transport is estimated at $156 million, $397 million, $186 million, and $282 million, respectively. Furthermore, recovery of the tourism sector and restoration of cultural heritage are estimated to require $387 million and $206 million, respectively.

IV. Impact on economy

On 8 June 2015, the Central Bureau of Statistics estimated the macroeconomic impact of the earthquake. GDP growth (basic prices) is estimated to decline by over 1.5 percentage points to 3.0% in FY2015. Pre-earthquake growth estimate for FY2015 was 4.6%. Although the earthquake struck Nepal only in the tenth month of FY2015, the impact on GDP growth is sizable, especially on the services sector.

GDP growth (at basic prices), %

Source: Central Bureau of Statistics

Agricultural sector is expected to grow by 1.9%, industry by 2.7%, and services by 3.9%, down from earlier no-earthquake scenario forecasts of 3%, 3.5%, and 5.8%, respectively. The sharp drop in agricultural output is primarily due to the negative impact of delayed and weak monsoon in the first half of FY2015, and later the loss of livestock due to the earthquake.

The slowdown in the industry sector is due to the drastic drop in quarrying (stones, aggregates, sand and soil extraction slowing down in the affected districts, and the government’s policy to temporarily halt construction activities till mid-July 2015); manufacturing (physical damage, labor shortage, and weak demand); and construction (policy to temporarily halt construction activities, and low production of construction materials, among others).

The disruptions caused by the earthquake have been the most severe in the services sector. Overall, services growth is estimated to decline by about 2.1 percentage points to 3.9% in FY 2015. It grew by 6.4% in FY2014. Wholesale and retail trade; tourism activities (affects air transport, and hotel and restaurant businesses); real estate, renting and business activities; and education sub-sectors are the most affected.

Impact of earthquake on sectoral growth (%)

Source: Central Bureau of Statistics

Wholesale and retail trade grew by 9% in FY2014, but dropped to 3.4% after the earthquake (against the pre-earthquake forecast of 5.6%) in FY2015. This is primarily due to the slowdown in agricultural production and import of goods immediately after the earthquake. Hotels and restaurants suffered due to slowdown in tourist arrivals, physical damage to hotels and restaurants, and decline in domestic tourism. Furthermore, real estate activities were in line with the substantially lower land-related transactions (including buying and selling, renting, and operation of self-owned or leased real estate; and renting of machinery, equipment and personal and household goods). There was also a substantial slowdown in property renting business due to the physical damage to buildings.

Overall, agricultural, industry, and services sectors will contribute 0.6, 0.4, and 2.1 percentage points to GDP growth of 3% (at basic prices) in FY2015, respectively. Nepal’s GDP is estimated at $21.6 billion in FY2015 ($371 million less than what would have been in a no-earthquake scenario). The loss is equivalent to 1.5% of GDP, and about 62% of the total gross value added[1] (GVA) loss is accounted for by the services sector.

Value added output loss by sub-sector in FY2015 ($ million)

Source: Central Bureau of Statistics

Per capita income is estimated to decrease by $23 compared to the no-earthquake scenario (in which case per capita income would have been $785). Accordingly, real per capita income increased by just 0.6% against 3.6% in a no-earthquake scenario.

Nominal per capita GDP (US$)

Source: Central Bureau of Statistics

Inflation was moderating till mid-April 2015, but it started edging up as a result of the supply-side disruptions caused by the earthquake. Prices of both food and non-food items increased in the last three months of FY2015, resulting in an average inflation of 7.2%.

External sector stability remained robust as net transfers increased sharply than the rise in trade deficit, resulting in a current account surplus of 5.1% of GDP and a record foreign exchange reserves ($8.3 billion, which is sufficient to cover 11.2 months of import of goods and nonfactor services). However, this may not be sustained for long as import of construction items is expected to increase drastically in the next few years for the post-earthquake reconstruction programs. Consequently, growth of net transfers may stabilize as migrant workers deplete their present and anticipated savings by remitting early to help households meet immediate needs. Furthermore, remittance inflows may also slowdown if there is less demand for workers in the Gulf countries and Malaysia following the cost-free migration policy[2] implemented by the on July 2015. Hence, the current account balance may slip into the negative territory over the medium term and foreign exchange reserves may deplete to an equivalent of around 7 months of imports, which is also the recommended level of reserve adequacy to ensure external sector stability.[3]

V. Impact on poverty and MDGs

The severely earthquake-affected 14 districts account for about 13.6% of the total number of people living below the poverty line in Nepal. Among them, Dolakha, Makwanpur, Ramechap, Rasuwa, Sindhuli, and Sindhupalchowk have higher poverty rate than the national average of 25.2% in 2011. Similarly, nine have human development index (HDI) score lower than the national average.

Preliminary estimates show that the income shock as a result of the earthquake will likely push an additional 700,000-982,000 people below the poverty line. This translates into an additional 2.5%-3.5% of the estimated population in 2015 pushed into poverty compared to the no-earthquake baseline scenario of about 21%. About 50%-70% will come from rural Central hills and mountains, where the vulnerability prior to the earthquake was already high. The income shock is largely felt through the loss of livelihoods (including death and injuries to primary wage earners) and the loss of housing, productive assets (seeds, livestock, and farm equipment), and durable assets (assorted household items).

Beyond this monetary-based poverty estimates, a larger impact can be expected when factoring in multidimensional poverty, which includes additional factors such as water and sanitation services, disruption of schools and health services, and the possibility of an uptick in food insecurity. The poor and vulnerable are particularly dependent on local infrastructure (roads, bridges, health posts, and schools) for access to labor and commodity markets, and for accumulation of human capital (especially those of children). Reviving local economic activities and resumption of basic public services along with an accelerated implementation of reconstruction projects will be critical to make up for the setback on poverty reduction caused by the earthquake.

Furthermore, the progress towards achieving the Millennium Development Goals (MDGs), on which Nepal was mostly on track prior to the earthquake, is likely to be adversely affected, given the widespread damages to houses, classrooms, and health posts. It will also likely affect the country’s overarching goal to graduate from the Least Developed Country (LDC) category by 2022.

VI. International Conference on Nepal’s Reconstruction

On 25 June 2015, the government organized an international conference on Nepal’s reconstruction. High level representatives from over 50 countries and multilateral agencies participated in the conference.

ADB, represented by its President, Takehiko Nakao, pledged $600 million—including $200 million emergency assistance approved by its Board of Directors on 24 June—to support rebuilding of schools, roads, and public buildings. The government estimated the total pledge of assistance at $4.0 billion (equally spilt in grants and concessional loans). Of the total pledge, about 67% is new commitment ($2.7 billion). Cumulatively, India and the Peoples’ Republic of China committed $1.4 billion and $767 million, respectively. World Bank, Japan, the US and the EU pledged $500 million, $260 million, $130 million, and $117 million, respectively.

According to the PDNA, total public sector losses and damages amount to $1.7 billion, which excludes housing. The National Planning Commission estimated that about 57% of the recovery needs ($3.8 billion), including housing, will have to be shouldered by the government. In this respect, the total pledged amount was higher than the public sector recovery needs till the medium-term. However, a much higher amount of investment may be needed in the long-term to build better and earthquake-resilient public infrastructure throughout the country.

Total aid pledged for reconstruction ($ million)

Source: Ministry of Finance; ADB staff estimates

VII. FY2016 Budget and Monetary Policy

The FY2016 budget is primarily focused on rehabilitation and reconstruction of physical and social infrastructure, housing and livelihoods after the catastrophic earthquake.

Completing of reconstruction work within the next five years is the most prominent agenda. It commits to fully operationalize the NRA soon, with a special implementation authority, effective leadership, and adequate financial resources. A total of NRs91 billion ($910 million or 3.8% of GDP) has been earmarked for reconstruction work, including $740 million (3.1% of GDP) for the National Reconstruction Fund, which will initially prioritize reconstruction of housing, public buildings, archeological structures, physical infrastructure, and enhancement of productive capacity. About $170 million is earmarked for sector ministries and agencies to carry out reconstruction works till the NRA is operational, i.e. an interim arrangement.

Planned reconstruction budget for FY2016 and composition of National Reconstruction Fund (NRs billion)

Source: FY2016 Budget Speech

The budget also includes NRs200,000 (about $2000) for each household that has lost its house due to the earthquake. To address the shortage of labor for reconstruction, skill training is planned for 50,000 people in the areas of masonry, plumbing, and electrical works.

Meanwhile, to assist government, Banks and Financial Institutions (BFI), and the public in their efforts toward accelerated post-earthquake recovery, Nepal Rastra Bank (the central bank) introduced a number of measures in the monetary policy for FY2016, including:

1. Zero percent refinancing facility for BFIs willing to provide loans at 2% interest to those households affected by the earthquake, provided that such households meet the requirements set by the government. Accordingly, households within and outside Kathmandu Valley can access the subsidized loans of up to NRs2.5 million and NRs1.5 million, respectively.
2. As announced in the FY2016 budget speech, the NRB will help assist in the establishment of an Economic Rehabilitation Fund, which will provide refinancing facility and interest subsidy to the business community affected by the earthquake.

Breakdown of reconstruction budget for FY2016
NRs billion	GON	Grant	Loan	Total	Share of aid
National Reconstruction Fund	16	36	22	74	78
Recurrent expenditure	8	15	12	35	77
Program expenses	2	0	0	2	0
Capital grants to institutions & individuals	6	15	12	33	82
Capital expenditure	8	21	10	39	79
Building construction	2	10	5	17	88
Civil works	6	11	5	22	73
Natural disaster relief & reconstruction	17	0	0	17	0
Recurrent expenditure	2	0	0	2	0
Capital expenditure	15	0	0	15	0
Civil works	5	0	0	5	0
Capital contingencies	5	0	0	5	0
Capital formation	5	0	0	5	0

Source: FY2016 Red Book; Budget Speech            

VIII. Effective reconstruction and recovery

Recovery has to be faster, better and smarter given that the country lies on an active geological fault lines. Drawing from ADB’s experience in post-disaster recovery in Asia and the Pacific region, ADB President Nakao highlighted, during the reconstruction conference, five principles for effective reconstruction that Nepal could follow:

1. Public as well as private buildings should be rebuilt to earthquake-resilient standards, fully applying the principle of “Build-Back-Better”.
2. Inclusiveness should be at the core of reconstruction effort. Special attention should be paid to the needs of the poor, rural residents, and other vulnerable social groups, who have suffered more from the earthquakes.
3. A robust institutional setup for reconstruction is pivotal to successfully execute reconstruction projects within the given timeframe. A strong leadership and competent human resources are vital for the success of the NRA.
4. Continuous enhancement of the institutional capacity of executing and implementing agencies along with the adoption of sound governance and fiduciary risk management systems for the reconstruction process are also important.
5. Effective donor coordination and strong government ownership of the entire process are also equally important for the success of the reconstruction projects.

He also emphasized that reconstruction should go hand in hand with development programs already planned, without affecting the latter.

IX. Accelerated recovery and structural transformation

The reconstruction authority’s and sector ministries’ ability to swiftly prepare and implement viable projects will underpin the scope and pace of reconstruction, and hence the recovery phase. A coherent reconstruction strategy has to be ideally aligned with the long-term economic development vision, which aims to increase per capita income to the level of a middle-income country before 2030. This is especially important because the PDNA covered earthquake-resilient reconstruction only in the affected areas, whereas this has to be implemented throughout the country. Adhering to the principle of Build-Back-Better, t rebuilding damaged houses beyond the set size, retrofitting standing buildings in Kathmandu Valley and affected districts, and nationwide resilience (such as ensuring housing and school safety across the country) need to be kept in mind while planning and initiating rehabilitation and reconstruction projects.

Overall, rehabilitation and reconstruction should primarily aim at increasing productivity-enhancing public capital investment. This is a key to ensuring structural transformation whereby high value-added and high-productivity sectors are more dominant than low value-added and low-productivity sectors in the medium term. Promoting agribusiness, industrial capacity, innovation and high-productivity services need to be at the center of such a reconstruction and structural transformation strategy. In addition to higher investment, this will require reforms on institutional, legal, regulatory, and capacity enhancement fronts.

Structural transformation

Source: Authors’ estimate

Private investment has been suppressed primarily due to the liberal product market (including imports), but an unreformed factor market (land, labor, and capital) after 1992 (the time when the first set of liberalization reforms were rolled out). This has led to stunted growth of the manufacturing sector and its declining share of GDP as imported-based activities expanded. Given this background, a higher quantum and quality[4] of capital spending is vital to boost aggregate demand, expand the growth potential of the economy, and increase per capita income. Higher productivity-enhancing public capital investment would also increase returns on private investment, resulting in higher private investment due to the ‘crowding-in’ effect. Such public investment over the medium term in physical and social infrastructure enhances productivity growth, encourages technological innovation, accelerates recovery and establishes a faster, inclusive, and sustainable growth pattern. However, in the long term, structural changes, especially in factor markets (land, labor, and capital), are required to sustain the growth pattern established through stabilization measures over the medium term.

X. Concerns over effective budget execution

One of the biggest unknowns following the decision to establish the NRA is its ability to fully execute the planned reconstruction budget in well-planned productivity-enhancing projects. This concern arises from the persistent budget execution shortfalls even under normal circumstances, which has further weakened in the last decade. As such, actual capital spending averaged about 72% in the last decade and about 60% is bunched in the last quarter. Furthermore, the actual capital spending (about 3% to 4 % of GDP) is far less than the required spending (of 8-10% of GDP) to close the infrastructure gap..

Planned and actual capital spending (% of GDP)

Note: Changed reporting system to Government Finance Statistics (GFS) 2001 in FY2012. In FY2011, actual reporting was done based on GFS 2001, but budget allocation was done based on earlier GFS.

Source: Ministry of Finance; NRM staff estimates

Capital spending is marred mainly by:

1. Bureaucratic hassles: project approval delays, and weak intra and inter-ministry coordination,
2. Structural weaknesses: limited appraisal, planning, and implementation capacity of line ministries (including the lack of medium-term expenditure framework), lack of strong pipeline of projects ready for implementation, cumbersome laws and regulations (procurement and procedural clearances), and allocative inefficiency,
3. Low project readiness: lack of feasibility studies and detail designs in advance, lack of well-planned procurement plans, and delays in land acquisition,
4. Weak project management: high staff turnover, lack of staff capacity, lengthy procurement process, weak contractor capacity, and weak contract management
5. High fiduciary risks in project implementation, particularly in rural areas when programs are implemented through local government having limited human resources and capacity,
6. Political instability and interference at operational level

The budget for FY2016 partially addresses this concern by giving the line ministries administering large projects the authority to spend the planned budget without getting prior approval from the NPC and the MOF. Similarly, multi-year contracts are allowed for some projects and the government has committed to restrict transfer key project staff subject to satisfactory progress in implementation. Deployment of managers, accountants, and technical staff is envisaged in village development committees starting with earthquake affected areas. However, other issues outlined above impeding regular capital spending remain unchanged and it is likely that $170 million allocated to various line ministries for reconstruction work may remain underspent at the end of FY2015.

With regard to spending by the NRA, the ordinance, which needs to be transformed into an Act without delay, governing its establishment gives it sweeping powers to do away with most of the hassles impeding accelerated capital spending. The authority is chaired by the Prime Minister and its CEO will independently handle the operations. The CEO, whose performance will be critical to accelerated reconstruction within the given timeframe, was still not appointed two months after the ordinance for its establishment was introduced. This already delayed the pace of implementation, especially concerning hiring of human resources, preparing a quick pipeline of projects, an associated action plan for investment, and its overall synchronization with the long-term development vision being envisaged by the NPC. The faster the NRA comes into operation, the faster will be the capital spending and ultimately completion of the reconstruction programs.

The NRA will have a critical role in managing the following crucial issues for accelerated reconstruction and recovery:

• Hiring competent human resources that can bring in new and smarter ideas and foster innovation (including reassigning competent civil servants from across government departments)
• Preparing a credible time-bound action plan for investment in reconstruction projects, including a sizable pipeline of potential projects
• Managing political interference in normal operations and preparation of reconstruction projects and ensuring an inclusive development process
• Ensuring line ministries’ full ownership of projects designed, approved and procured by the NRA
• Coordinating with development partners to ensure that the committed funds for reconstruction are realized within the given timeframe
• Engaging meaningfully youth, local communities, think tanks, specialized institutes, and civil society in reconstruction planning, design, implementation, monitoring, and evaluation
• Ensuring ‘crowding-in’ of private investment for reconstruction on public-private partnership (PPP) basis
• Outsourcing of managerial as well as non-managerial work (time and output-bound contractual arrangement for design, supervision, and management of reconstruction projects).

XI. Conclusion

The earthquake caused tremendous loss of lives and properties. It lowered economic growth rate, pushed about a million people below the poverty line, slowed progress on achieving some of the MDGs, and sapped investors and consumer confidence. The cumulative pledges during the international reconstruction conference exceeded the expected public sector needs for reconstruction. Now, the NRA and line ministries’ ability to swiftly prepare and implement viable projects will underpin the scope and pace of reconstruction and ultimately a better, faster and smarter recovery. The authority needs to be operationalized without delay and it has to chart out a coherent five-year reconstruction strategy by aligning it with the long-term economic development vision.

Accelerated reconstruction would require hiring of competent human resources, preparing a time-bound investment action plan, a strong pipeline of viable projects, outsourcing of design, monitoring and evaluation, political buy-in of proposed actions, and engaging youth, specialized institutions, and civil society at various stages of the project cycle. This would then ‘crowd in’ private investment as well, leading to a higher, sustainable, and inclusive economic growth. Overall, rehabilitation and reconstruction should primarily aim at increasing productivity-enhancing public capital investment, which is a key to ensuring structural transformation whereby high value-added and high-productivity sectors are more dominant than low value-added and low-productivity sectors in the medium term.

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[1] Gross output is the total value of all goods and services produced during the accountancy period (at basic prices). Intermediate consumption is the total value of goods and services consumed as inputs by production processes (at purchasers’ prices). Gross value added is the difference between gross output and intermediate consumption. Finally, GDP is equal to gross value added plus taxes minus subsidies.

[2] The Ministry of Labor and Employment directed overseas recruitment agencies to facilitate migration without financially burdening the migrant workers. This essentially means cost-free migration for workers seeking employment in Saudi Arabia, Qatar, Kuwait, the United Arab Emirates, Bahrain, Oman and Malaysia.

[3] IMF. 2015. Nepal: Request for Disbursement Under the Rapid Credit Facility. IMF Country Report No.15/224. Washington, DC. See: http://www.imf.org/external/pubs/ft/scr/2015/cr15224.pdf

[4] Low quality of capital spending escalates future recurrent costs associated with the project (such as operation and maintenance costs, staff required to monitor the project, etc)