Cost of finance in Nepal

This is a part of a series of analysis on growth diagnostics of Nepali economy. For discussion of other constraints see these blog posts.

In the growth diagnostics methodology, high cost of finance is divided into two parts: (i) Bad international finance and (ii) Bad local finance (which includes low domestic savings and poor intermediation). Below I discuss all of them.

1.1. Bad international finance

Access to international finance sources seems not to be an important issue for the Nepali economy. It has been consistently drawing out loans and credits from major donor agencies (mainly the IMF and the WB’s IBRD loans and IDA credits) at a comfortable medium and long term interest rate.

The international reserve situation is also comfortable as compared to other LICs. Since 1970, total external debt (% of GNI) consistently increased up until 1993. It then decreased until 1997 and rose again, reaching a peak of 60% in 1999. However, this has declined after that and now it is below 40% of GNI. This level is pretty good as compared to other countries with similar income level. The encouraging news is that it is in a decreasing trend. Moreover, CPIA debt policy rating is 3.5, above the average rating for LIC (ranking goes from 1 low to 6 high).

The central government debt (% of GDP) was alarmingly high before 2002. Though this is still high, it is in a decreasing trend in recent years. The good thing is that external debt is decreasing, government debt is also decreasing, and CPIA rating is well above the average for LIC. These indicators are inconsistent with a hypothesis that bad external finance is a binding constraint on economic growth.

Bad local finance

1.2. Poor intermediation

In the domestic front, it appears that investment is not responsive to interest rate, i.e. investment is roughly insensitive to interest rate.

From 1998 to 2006, interest rate was decreasing but the response on investment was not as expected. As lending rates declined, gross fixed capital formation also declined, indicating the unresponsiveness of investment to changes in interest rates. This indicates that it was not the cost of finance (interest rate) that brought down investment, but rather the low level of expected returns. Even when lending rates were declining, businesses were not willing to take out loans because of appropriability concerns engendered microeconomic risks, particularly high corruption and cumbersome labor and business regulations. Importantly, it was also due to low returns caused by deficient supply of infrastructure. As for investment in the economy, it has been consistently increasing over the past decade.

 

Getting credit from the banking system is not difficult in Nepal when compared to high growth economies like Maldives and Bhutan. Though getting credit rank has increased by seven positions (i.e. it is becoming harder to get credit) between 2008 and 2009, it is not unique to Nepal’s case. In fact, getting credit became difficult more or less in the same proportion in all the countries in South Asia.

Source: Doing Business Reports

Meanwhile, the increasing inflow of remittances and less investment opportunities in the economy has led to accumulation of excessive liquidity in the banking sector, which has partly inflated the real estate sector recently. Additionally, the previously high Non Performing Loans (NPL) are decreasing these days, thanks to strict measures taken by the central bank and the government. The level of NPL (% of total loans) was 60% in 2002, 30% in 2003, and 15% in 2006. The domestic banking sector is also in a good shape after the government initiated banking reforms five years ago. The two largest national banks with huge NPLs were handed over to private management companies four years ago. Since then they have recovered substantial loan payments from willful defaulters and turned the otherwise negative balance sheets into positive one. The central bank has been proactive in regulating the banking sector. It has even taken over ailing commercial and development banks.

Bad finance due to poor intermediation is not an issue at least in the present context. It, therefore, cannot be a binding constraint on growth.

1.3. Low domestic savings

Looking at savings, though domestic savings is fluctuating and is not that different from the level in 1976, gross savings is increasing since the past decade. As discussed earlier, this is aided by huge inflow of remittances to the tune of over 16% of GDP in 2006 and 18% of GDP in 2007. Moreover, the interest rate on savings deposit is also very low, indicating that banks have comfortable reserves and liquidity. On the lending front, the lending rate has been record low in recent years, indicating the willingness of banks to lend money to the private sector.

These data and analysis are inconsistent with the hypothesis that bad finance caused by low domestic saving is the binding constraint on growth, at least for now.

This shows that high cost of finance (bad international finance and bad local finance) is not the binding constraint on growth. However, this does not mean that it is not an issue of concern in the economy. What it means is that this issue is not as strong and important in terms of kick starting GDP growth rate as is the binding constraint—bad infrastructure.

What really is poverty reduction?

Owen Barder argues that poverty reduction should not be understood just as a wholesale concept of decreasing poverty through economic growth. He argues that donors should not focus on a narrow dimension of poverty reduction (growth) as it marginalizes other legitimate objectives such as chronic poverty or provision of social services in countries that cannot otherwise afford them. Chronic Poverty Research Center has been publishing chronic poverty reports that more or less is similar to Barder’s emphasis on objectives other than just growth in reducing poverty.

Poverty reduction has other dimensions, including enabling the poor to live better lives through long-term, redistributional transfers while their country is developing, even with programs that might not contribute to growth. The focus on poverty reduction through growth ignores such key tradeoffs as that between reducing current and future poverty, and between addressing the causes and symptoms of poverty.

Because donor agencies do not recognize these different objectives explicitly, there are important negative consequences for the choice and management of individual aid programmes, and for donors’ ability to make transparent and evidence-based decisions about the composition of their portfolio. Aid could be more effective if there were greater recognition of the different dimensions of poverty reduction and if this was recognized in the objectives for and incentives in aid agencies.

There is an ethical case for a global system of social justice that provides long-term, redistributional transfers of resources to the world’s poor, to enable them to lead better lives while their country is developing, even if there is no expectation that these transfers will accelerate economic development. Reasonable people can disagree about whether this is desirable but the existing hegemonic definition of poverty reduction does not sufficiently acknowledge this as a legitimate goal or permit a meaningful discourse about how it might be achieved.

Growth strategies for Nepal

That’s the title of my latest op-ed published in Republica, the print version of www.myrepublica.com. I am not satisfied with the content and analysis done by the policymakers for the Nepal Development Strategy Paper (NDSP). I discuss seven points that would potentially help Nepal attain a modest growth rate and would like them to be addressed in the final NDSP before it is presented to the donor community on May 15 this year.

First, given the geographical disadvantage, domestic policies should be synchronized with India’s and China’s economic policies in order to maximize neighborhood growth spillovers. Statistical evidence shows that the faster neighbors grow, the faster the landlocked country will grow. …

Second, rather than exclusively focusing on markets in the EU and the US, policies should be designed to maximize trading with our neighbors, India and China—the two emerging giants in the global economy. Tapping the untapped markets along the bordering states, where the transportation costs are low, by producing goods and services that are within the reach of the people residing there would be a fruitful exercise. …

Third, design policies to entice FDI in transport infrastructure and large- and small-scale hydropower projects. The government could substantially ease regulatory structure, ensure security of returns to investment and consistency of hydropower policy, resolve labor disputes, build grids to enhance connectivity and share risks with the private sector, among others. …

Fourth, to give the struggling industrial sector a breathing space so that they can compete in price and quality in the international market, the government should implement the provisions outlined in Investment Board and SEZ ordinances, which were recently passed by the cabinet. …

Fifth, the government should facilitate foreign investment in the tourism sector. Increasing visibility in the international tourism market, easing of visa restrictions, ensuring security, and, most importantly, improving tourism infrastructure such as road transport, airways, and ICT would help a lot. …

Sixth, the government should also facilitate foreign employment and inflow of remittances.  Not much needs to be said about the role of remittances, which already account for almost 20 percent of GDP.

Seventh, the policymakers should not forget that the high population growth rate is also constraining increase in GDP per capita. Either jobs creation in the industrial sector should be rapid enough to outpace the rate at which youths are entering the job market or the government should initiate measures to lower population growth rate.

Read the full op-ed for full discussion on these seven points.

The impact of global recession on poverty

It is estimated that an additional 55 to 90 million people will be trapped in extreme poverty in 2009 due to the worldwide recession. The number of chronically hungry people is expected to climb to over 1 billion this year, reversing gains in fighting malnutrition and making the need to invest in agriculture especially urgent.

The number of people living on under $1.25/day in the developing world in 2005 was 1.375 billion, or 25% of the population. The MDG target is to halve the 1990 poverty rate (41.7 percent) to 20.9% by 2015. With extreme poverty projected to fall to15% by 2015, it still appears the target will be met, but this may change as the poverty reduction rate slows with declining growth. Sub-Saharan Africa will not meet MDG1.

That’s from the Global Monitoring Report 2009: A Development Emergency. The report says that MDG of halving extreme poverty by 2015 from its 1990 level is still reachable but “risks abound”.

Links of Interest (04/22/09)

Is the Washington Consensus dead?

Duflo on what works for AIDS prevention: abstinence or risk reduction

Property rights and economic development

Girl sold for $40 (for prostitution)

Tracking violence using texting and GoogleMaps

Microfinance and gender returns to investment

Interesting finding coming out of this paper, which shows greater returns among men than among women (in the microenterprise sector). This difference is not explained by differences in ability, risk aversion, and entrepreneurial attitudes. It potentially resulted from the way money was invested by men and women.

This paper analyzes data from a randomized experiment on mean returns to capital in Sri Lankan micro-enterprises. The findings show greater returns among men than among women; indeed, returns were not different from zero for women. The authors explore different explanations for the lower returns among female owners, and find no evidence that the gender gap is explained by differences in ability, risk aversion, or entrepreneurial attitudes. Differential access to unpaid family labor and social constraints limiting sales to local areas are not important. However, there is evidence that women invested grants differently from men. A smaller share of the smaller grants remained in the female-owned enterprises, and men were more likely to spend the grant on working capital and women on equipment. The gender gap is largest when male-dominated sectors are compared with female-dominated sectors, although female returns are lower than male returns even for females working in the same industries as men. The authors examine the heterogeneity of returns to determine whether any group of businesses owned by women benefit from easing capital constraints. The results suggest there is a large group of high-return male owners and a smaller group of poor, high-ability, female owners who might benefit from more access to capital.

Crazy Nepali policymakers

How on earth is Nepal supposed to increase exports by 50% in five years? Never mind, this is another criticism of the Maoist government’s hi-fi but shallow strategy!

Few days after presenting a very unrealistic and bombastic development strategy paper, the policymakers in Nepal think they can link trade and poverty (the benefits of trade have gone to corrupt officials and few industrialists in the past) and increase exports by 50% in the next five years!

The government has set an ambitious target of increasing exports of goods and services by 50 percent in the next five years, at an average of 10 percentage points per annum. It has also set a plan of reducing country’s trade deficit by 15 percent in the same period.

“In order to boost exports, we are now trying to identify at least 15-20 potential products and services that have demand in the international market,” Commerce Secretary Purushottam Ojha told the consultation meeting of Nepal Development Forum in Kathmandu on Friday. “In this regard, the government is soon conducting Nepal Export Potential Study.”

The Study is not only expected to identify products and services of competitive and comparative advantage but also determine the impact export of those products and services can have on poverty reduction – the overarching goal of the country.

I doubt this will happen because of this analysis of Nepal’s product space and this condition of export dynamics. Aiming high is good but realistically, living within one’s reach and means is the best way to not build unnecessary expectations that cannot be met.

Crazy policymakers! Anyway, good luck to those who are tasked to come up with a paper to fulfill this purpose. The funny thing is that this claim has been made without first studying the potential of attaining this goal! It is like stating that a hypothesis is correct, and then proceeding to prove it assuming that it is right!!