No change in NRs. exchange rate with IRs., for now!

I was contemplating writing an article on why the pegged exchange rate between Nepalese currency and the Indian currency should be kept as it is at least for now. A recent IMF mission to Nepal observed the same:

“The peg should remain the key macroeconomic policy priority, and monetary policy needs to be fully consistent with this objective. Interest rates need to be maintained above those prevailing in India and the Nepal Rastra Bank’s (NRB) liquidity management needs to be strengthened. When a general liquidity injection is not needed for the system, liquidity provision to sound individual banks with liquidity shortages should take place at penalty rates or at the bank rate under heightened supervision.

“Risks in the financial sector have been building up and need to be addressed urgently. Over the past years, accommodative monetary policy, weak supervision, and proliferation of financial institutions have led to rapidly rising asset prices and overextension of banks. Going forward, the financial system needs to adapt to an environment of slower growth and is likely to see deteriorating asset quality. The mission welcomes the NRB’s directives regarding prudential limits on credit-to-deposit ratios, real estate exposure, loan-to-value ratios, as well as the reintroduction of a minimum Statutory Liquidity Ratio. However, it is critical that these limits are enforced, and not diluted. In this respect, appointing a new governor who can provide strong and stable leadership for the NRB going forward is urgent. The authorities should also pass the revised Banking and Financial Institutions Act (BAFIA), encourage bank consolidation, refrain from issuing new licenses for the time being, and proceed with the restructuring of state-controlled banks.

FTAs in Asia in a chart

Source

Export-led growth 2.0

A very interesting note about the future and trend of export-led growth by Canuto, Haddad and Hanson from PREM division at the World Bank. Does the slackening of import demand due to the global financial crisis from the world’s biggest importers, the US and the EU, mean that export-led growth model is dead? Not really. In fact, a new model is emerging out.

The increasing import demand from rapidly growing economies like China, India, and Brazil is filling up the slack left by weak import demand in the US and the EU. This means that South-South trade is partly picking up the slack. In fact, BRIC import share nearly doubled, from 9 percent to 17 percent, between 1996 and 2008. Other low and middle income counties increased their share of import demand from 8 to 19 percent. Meanwhile, import demand from high-income countries declined from 88 percent to 69 percent in the same time frame. The world trade flow is changing and South-South trade is picking up. Also, middle-income countries are driving export diversification of low-income countries. The export diversification index (concentration index) of low-income countries has seen an improvement of 10 percent between 1997 and 2007 (this means exports moving from being spread evenly across four products to seven products; note that three sectors namely petroleum products, food, and iron and steel accounted for 76 percent of low-income countries’ trade between 1998 and 2006). Is this a sign of export-led growth 2.0?

Due to the global financial crisis world merchandise imports fell by 36 percent between 2007Q4 and 2009Q2. It was thought that the slackening import demand from the main importers would imperil growth in the developing countries. However, they argue that most of the recent growth in low-income developing countries’ export was driven by import demand in other developing countries. This means that low-income developing countries will continue to rely on developing countries for export growth. To increase South-South trade further, they recommend reduction in non-tariff barriers, which account for nearly two-thirds of the protection faced by low-income exporters and upper-middle-income markets.

Recession in the big importers

Due to the intensity of financial crisis spilling into the real economy in the US and the EU, low-income countries that depend on exports of oil and apparel to these economies will suffer more. Mexico and Central American countries rely heavily on the US final demand. Similarly, Nigeria might feel a stronger pinch as it exports most of its oil to the US. Also, the 39 Sub-Saharan African countries that have preferential access in export of apparel to the US market under the AGOA might see decline in demand. Meanwhile, developing Europe, Central Asia, and MENA region might see slackening import demand from the EU. Between 2000 and 2008, the US and the EU-25 absorbed about 20 percent of low-income countries’ export growth. Of this 20 percent, nearly half comes from petroleum products. Apparel accounts for an additional 4.3 percent.

South-South trade is picking up

As the prominent importers’ import demand slow down, it is increasing in low- and middle-income countries. Between 1996 and 2008, import share from BRIC is up from 9 to 17 percent; from low- and middle-income countries up from 8 to 19 percent; and from high-income countries down from 88 to 69 percent. What is driving export growth in low income countries? It is rapid growth in the emerging economies (BRIC). They argue that higher growth rate in low- and middle- income countries explain 51 percent of export growth in low-income MENA region, 42 percent in low-income EU and Central Asia, and 21 percent in low-income Sub-Saharan Africa.

All this means that selective industrial policy could still be an important element of national economic policy in the low income countries. Also, there is already some form of rebalancing happening in global exports and imports.

For an earlier piece on the past and future of export-led growth model see this blog post.

Why do bad governments persist?

The military junta of Burma, Robert Mugabe of Zimbabwe, Mahmoud Ahmadinejad of Iran, Kim Jong Il of North Korea and (the former King of Nepal) and so on. Why do these regimes persist even when there are severe crises in their country? Why do they not include more talented individuals in the ruling bodies, which is comprised of old, conservative leaders who are completely oblivious of the changing world and changes brought about by globalization? Even in democratic societies why do incompetent politicians once appointed remain in power for long periods of time?

 

Acemoglu et al. argue that it has to do with a “degree of incumbency veto-power”, i.e. the extent of retention of current members of government in the next government.

We emphasise that many regimes, ranging from shades of imperfect democracy to various forms of autocracy, afford a degree of incumbency veto power to current key members of the government. Once they are in power, they can be removed, but they are also in a position to be part of a new government that replaces some of the other members of the government.

The degree of incumbency veto-power loosely corresponds to how many of the current members of government need to be part of the next government. In an ideal democracy, there needs to be no overlap between today's government and tomorrow's. An imperfect democracy would, on the other hand, give some degree of incumbency veto power. For example, out of several key members of a cabinet, one would need to remain in power to create continuity ("somebody who knows how to turn off the lights"), or to prevent the entire cabinet from seizing power.

Our argument is that even this type of minimal incumbency veto power can lead to the persistence of highly inefficient governments, consisting of several incompetent members. Moreover, such governments would be unwilling to include more competent members, even if this would greatly increase the efficiency of the government and the incomes of both the citizens and the members of the cabinet.

The reason is that the inclusion of a more talented new member might open the door for several more rounds of changes in the composition of government, ultimately displacing those currently in power. For example, applying such ideas to the Iranian context, the supreme leader Ali Khamenei and Mahmoud Ahmadinejad would be afraid of including more talented technocrats in the regime, because then they could be part of a move to form another, better government that might exclude Ali Khamenei or Mahmoud Ahmadinejad.

Even though this mechanism looks at first as if it can only have a small impact on the competence level of the government, we show that even a minimal amount of incumbency veto power can make the worst possible government emerge and persist forever. The logic is again the same. The worst government would remain in power when all of its members prefer to be part of the ruling government rather than live under a more competent government, and anticipate that the inclusion of even a slightly more talented politician would destabilise the system.

But,

It appears that authoritarian regimes such as the rule of General Park in South Korea or Lee Kuan Yew in Singapore may be beneficial or less damaging during the early stages of development, while a different style of government, with greater participation, may be necessary as the economy develops and becomes more complex.

Is Nepali export passé?

In my latest column, I discuss Nepal’s exports sector; what specific products Nepal was exporting, is exporting, and could produce and export with comparative advantage. For this column, I rely on the analysis of product space and a study I had done before.

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Is Nepali export passé?

The exports sector is rapidly loosing its foothold in the economy, leading to closure of firms, unemployment, and loss of revenue needed to finance key development projects. With hopes of reviving rapidly declining exports starting 1997, the government is lobbying for trade treaties with the US and regional partners. Before wasting time and resources in signing trade pacts that have little relevance to Nepal’s exports sector, we need to seek answers to fundamental questions regarding our exports capability. 

How competitive are Nepali products in the international market? Do we still have or can produce goods that could be exported with comparative advantage? How connected is production structure of different products, i.e. their ‘proximity’? Can we use the existing inputs (labor and capital) used in production of one good to produce a new exportable product (i.e. ‘nearby’ good)? These questions need unequivocal answers before we sign new trade treaties. Remember that no matter how many concessions we give and trade treaties we sign, if they do not aid our exports sector, it is of no use. Just opening up the economy does not mean that our exports and economy will grow. What we export determines the future of Nepal's exports sector and economy.

Studies have shown that assets and capabilities needed to produce a particular kind of product are imperfect substitutes for the inputs needed to produce other goods. Though the degree of asset specificity needed for the production of imperfect substitutes differ, they nevertheless can be used in one way or the other in production of both goods. A country's capability to produce one good is somehow tied with the installed capability in production of other similar goods, i.e. 'nearby goods'. 

Sustained growth in exports is achieved by upgrading production of existing items to production of products that are not wholly different from them in terms of the use of inputs. It is easier to upgrade production if there is a high degree of input and structural complementarities in production of existing goods and services. The overall connectedness of an economy’s export basket, i.e. similarity in use of inputs (labor and capital) used to produce different exportable goods, affects the pace of upgrade and structural transformation of the economy.

How 'connected' are inputs of the products produced in Nepal? Are there any 'nearby' exportable products? Answers to these questions would reveal what products Nepal is exporting and, importantly, could export with comparative advantage.

Analysis of Nepal's 1985 'product space', which is a network of relatedness between products, shows that it had comparative advantage in production of labor-intensive goods. Specifically, it had comparative advantage in production of trousers, breeches of textile fabrics; skirts of textile fabric for women; undergarments of textile fabrics for women; textile men shirts; other textile outer garments; sacks and bags of textile materials; twine, cordage, ropes & cables; and women dresses of textile fabrics. In garments and textiles sector, the two most promising products, based on global market size and proximity of products, were undergarments knitted of cotton and footwear. Furthermore, the most promising products for the upgrade of export mix were in machinery industry. The products that had relatively large market size abroad and a fair degree of proximity in domestic production structure were electronics microcircuits; radio broadcast receivers for vehicles; and photographic cameras, parts & accessories.

Nepal was producing very few agricultural goods with comparative advantage. The agricultural goods that had comparative advantage were leather of other bovine cattle & equine leather; leather or other hides or skins; shellac, seed lac, stick lac, resins, gun resins, etc; art, collector species & antiques; fresh or dried grapes; fixed vegetable oil; beans, peas, lentil & other legume vegetables; and other cereal meals & flours. The proximity between agricultural products was very low, signaling the fact that ‘connectedness’ in this sector was weak and transition to new exportable agricultural products was difficult.

In 2000, the number of products produced with comparative advantage was higher than in 1985. In fact, pretty much all products that could be manufactured using the installed capacity used in production of comparatively advantageous goods in 1985 were produced in 2000. This means that there indeed was some upgrade in Nepal's exports mix. Some of the products were undergarments excluding shirts of textile fabrics; other outer garments & clothing knitters; other made up articles of textile materials; blouses of textile fabrics; suites & customs made of textiles for women; knitted jerseys, pullovers twin sets; and knitted synthetic undergarments, among others products. Not surprisingly, due to lack of nearby products and low proximity, the agricultural sector did not contribute new exportable product in 2000.

Analysis of Nepal’s latest product space shows that the following products are 'nearby' and could be produced and exported with comparative advantage: prepared or preserved crustaceans; frozen fish fillets; pyrotechnic articles; potatoes; electrical transformers; candles & matches; sinks & wash basins;  fresh and chilled fish; statuettes & other ornaments; travel goods, handbags, briefcases and purses; frozen vegetables; footwear; building & monumental stone; art & manufacturing of carving or moulding materials; leather apparel & clothing accessories; manufactured goods;  oranges, mandarins, clementines and other citrus; and temporarily preserved fruits, among other products. Based on domestic total production and global market size, there are very few promising exportable agricultural products. Note that the existing products in the export basket are outside of the clusters of goods that would enhance value-addition and utilize sophisticated technology.

Between 1985 and 2000, there was some form of transformation in production structure of the economy. Unfortunately, during this decade, the economy failed to keep up with the previous pace of transformation. Why? It is potentially because of strong constrains such as a lack of adequate infrastructure and low appropriability arising from labor disputes, corruption and strikes. Unless these constraints are addressed with decisive public policy, it will be hard to produce new exportable products and accelerate economic transformation.

[Published in Republica, February 28, 2010, pp.6]

Export-led growth: Past and Future

How did Germany, Finland, Japan, Korea, China, Malaysia, Thailand, Taiwan and Singapore manage to enjoy export-led growth and not others? Is there still room for export-led growth? Shahid Yusuf has a very interesting blog post about this issue. He argues that export-led growth model might not be dead yet but it would be difficult to repeat the same successful feat enjoyed by the ‘high achievers’.

The successful countries specialized in high-valued, sophisticated products, leading to constant innovation and thus high productivity and sustained competitiveness.

Some facts about export-led growth:

• Fast growing economies relied on a mix of manufacturing activities with electronics, transport, textiles, and engineering industries. The share of manufacturing sector is over 25% of GDP.
• Electronics industries provided a necessary stepping stone to industrial maturity and technological deepening. The share of electronics in manufactured exports averaged 40%.
• Innovation in electronics, automotive and engineering industries sustained competitiveness and enhanced productivity.
• Exports of manufactures remain one of the most important sources of growth.
• Investment to develop manufacturing industries and necessary supporting infrastructure averaged over 30% of GDP. The source for most of the investment was domestic.

Even if there is a stock of resources (investment and capital requirements) ready to be deployed in the economy, countries may not necessarily achieve high marks as the successful countries that relied on export-led growth. Why? How did the successful export-led growth countries become successful? Yusuf points to some necessary conditions required for this to happen:

• Political and macroeconomic stability
• Openness (the US market after the Cold War proved to be an elastic source of demand for imports); The EU also opened up its market. The countries that facilitated domestic production managed to export more when conditions were ripe.
• Advancement in technology allowed outsourcing and offshore production.
• Open trading environment facilitated the mobility of people and diffusion of ideas.

Export-led growth might not be dead yet but for new entrants it won’t be as easy as it was for the successful countries in the past. Why?

• There is excess production capacity in most industries. It would be hard for new entrants to break into the already competitive market.
• The most important and largest exporter, the US, might not be able to live with debt-financed consumption binge. This means there will be weak demand for imports.
• Rising energy and resource costs.
• ICT/electronics revolution is almost over. So, innovation in manufactures might not be at the same rate as it was in the past. Green technology might be the next big driver for innovation and related manufactures but it is not certain.

If export-led growth model is dubious, then what would drive growth? Yusuf throws a Keynesian wand arguing that the state much play a larger role by investing in productive assets, infrastructure and services. A new balance will need to be struck between the guiding hand of the state and the hidden hand of the market.

I think there is still room for export-led growth for small landlocked country like Nepal because of its market and geographic proximity to growing economic giants, India and China. Nepal trades more than 60% of its goods and services with India.

Given the clear lack of benefits from the WTO regime, is there still room for export-led growth in Nepal? The answer is yes, provided that we focus on full integration into the regional markets and in signing FTAs with countries that possess potential markets for Nepali exporters. This also includes instituting right measures on trade facilitation and specialization on products that are relevant and within purchasing power of customers in targeted markets.

Charting out strategies to fully integrate with other SAARC nations would also help to stimulate investment and exports. Nepal exports more to SAARC members than it does to other nations. Nepal’s export to SAARC, as a share of its total exports, increased from 53.9 percent in FY 2003/04 to 72.5 percent in FY2007/08. Meanwhile, imports, as a share of total imports, from SAARC increased from 53.9 percent in FY 2003/04 to 67 percent in FY 2007/08. In this regard, expediting integration under SAFTA (and BIMSTEC) would produce more gains than from any other trading blocs. These two blocs (plus China) could be the most important markets for Nepali exports in the coming days. The future of export-led growth would depend on how much Nepal can capitalize from integrating with these markets with huge potential.

Dani Rodrik thinks export-led growth is not a passé yet:

Many countries are trying to emulate this growth model, but rarely as successfully because the domestic preconditions often remain unfulfilled. Turn to world markets without pro-active policies to ensure competence in some modern manufacturing or service industry, and you are likely to remain an impoverished exporter of natural resources and labor-intensive products such as garments.

Nevertheless, developing countries have been falling over each other to establish export zones and subsidize assembly operations of multinational enterprises. The lesson is clear: export-led growth is the way to go.

None of this implies a disaster for developing countries. Long-term success still depends on what happens at home rather than abroad. What is moderately bad news at the moment will become terrible news only if economic distress in the advanced countries — especially America — is allowed to morph into xenophobia and all-out protectionism; if large emerging markets such as China, India, and Brazil fail to realize that they have become too important to free ride on global economic governance; and if, as a consequence, others overreact by turning their back on the world economy and pursue autarkic policies. Absent these missteps, expect a tougher ride on the global economy, but not a calamity.

Eduardo Zepeda argues that the financial crisis has revealed the limitations of export-led growth but it still is an option. But, this strategy has to be combined with strategies that promote domestic market. Also, diversification is needed (especially avoiding over reliance on agricultural sector). Restoring selective industrial policy might be helpful.

As the financial crisis forces developed countries to rein in their spending on exports, export-dependent developing economies will be drained of much of their driver of growth and will be forced to shift to measures to expand domestic demand to maintain growth rates. Still, the export-led growth strategies of developing countries – and particularly that of China, which is most often cited -- have not caused today’s global imbalance. Trade openness and export diversification will remain key drivers for growth and development, but substitutes for currency undervaluation and large current-account surpluses will have to be found.

Aid and entrepreneurship in Rwanda

It is very simple: nobody owes Rwandans anything. Why should anyone in Rwanda sit back and feel comfortable that taxpayers in other countries are contributing money for our own well-being or development? Why should we not be doing what we are able to do and raise ourselves up to higher standards and achieve more and better and get out of this poverty that we find ourselves in. Change has to start in mind. And that is what we have been working on over time. Once the mind gets correct, the rest becomes simple.

This is the reason that we are focusing on creating an entrepreneurial mindset in every Rwandan. This mindset begins with a sense that one's life, choices and actions matter to the whole country. It begins with a clear understanding that business as usual is not acceptable. Every day, every Rwandan from all walks of life has a unique opportunity to change our country for the better.

That is from Rwandan President Paul Kagame. The Rwandan economy has been growing at an amazing rate. Rwanda is ranked as one of the top reformers in the latest Doing Business report.