Has Nepal exhausted the sources of growth?

Not really. But the government officials tend to think so. They are making high pitch over implementing import-substituting and import consumption curbing measures. I disagree. This is a very convenient conclusion to the most pressing challenge of the Nepalese economy. We need to think hard and better to find a way out of this economic mess. It is doable without resorting to import substituting policies.

I think in order to narrow down the balance of trade and balance of payments deficits, the government should instead look for ways to  boosting exports and to channeling domestic transfers to productive sectors. If there is a need to curb imports, then the imports of luxury items should be curbed; not daily consumption goods that Nepalese producers cannot produce at the same international price quality. There is a danger of further inflaming inflation rate if more tariff on imports of consumption goods are imposed. For further discussion, read my latest op-ed here. 

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Convenient Conclusions?

At the end of each fiscal year, the Ministry of Finance (MoF) publishes Economic Survey (ES), which provides rundown of the state of the economy in that year. It is one of the closely watched reports published annually by the MoF. The message of ES 2009/10 is hardly surprising: the economy is in a mess, growth is sluggish, and macroeconomic troubles are imminent. The policies being contemplated are aimed at curbing consumption rather than creating opportunities to channel disposable income, fuelled by the inflow of remittances, to productive sectors. This is misguided policy. Industrial and exports sectors could still be the primary sources of growth.

The economic growth rate (real GDP) in the current fiscal year 2009/10 is estimated to be 3.5 % - lower than 4.0 % achieved last year. Government argues that the decline in production of crops (blaming monsoon and adverse weather for growth stagnation!) and sluggish non-agricultural sectors contributed to the slowdown of Nepal’s growth engine. The non-agricultural sectors were (and are) plagued by frequent but fickle bandas, deteriorating industrial relations and labor strikers, power shortages, and supply-side constraints such as deficient supply of infrastructure. Meanwhile, real per capita GDP is nevertheless expected to increase by 2.3 %, reaching US$ 562 per year - about 20 % higher than last year’s figure.

As a percentage of GDP, gross investment is expected to increase to 38.2 % as compared to 31.9 % in the last fiscal year. Meanwhile, gross national savings is expected to decline to 9.4 % from 9.7 % of GDP in the same time frame. The gap between gross domestic savings and gross investment, as a percentage of GDP, is expected to be negative 28.8 %. It is widening by about six percentage points from last year’s figure. This essentially means that we are consuming more and have little money to fund projects and trigger capital accumulation.

The net export of goods and services is estimated to expand by almost ten percentage points to a negative 28.4 % of GDP. Exports are estimated to decrease to 9.2 % of GDP from 12.4 % last year. Meanwhile, imports are estimated to increase to 38.1 % of GDP from 34.6 % last year. Hence, trade deficit is expected to widen by 41 %. The growth of remittances income is expected to slow down to 7 % from 47 % last fiscal year. The contribution of remittances to GDP is expected to stand at 19 %, compared to 21.2 % last fiscal year. This is leading to current account deficit of Rs 27.60 billion, which is an estimated negative 2.3 % of GDP. Note that the current account balance was Rs 41.44 billion surplus last year. Overall, the BOP deficit is projected to be Rs 19.57 billion.

These numbers matter because if we want to avoid macroeconomic crisis, we have to figure out a way to reduce BOP deficit, maintain sufficient policy space for fiscal expansion in productive sectors and roll out social protection programs for the vulnerable and poor people. The only way to do this is to either boost exports or to find ways to reduce imports. Both are difficult routes. But, based on experiences from other successful economies, the former is preferred, however improbable it might seem at the moment.

Just because there is widening BOT deficit, declining growth of remittances, surging BoP deficit, and perennially sluggish agricultural sector, it does not make sense to resort to curbing imports, especially for consumption purposes. Even if import consumption curbing and import-substituting policies are rolled out, it will not slow the flow of money outside the country because consumption habits and preferences, fuelled by the flow of remittances, hardly change. It is encouraging that the government is mulling over promotion of production of agro-products so that the country won’t have to rely on agro-products on external markets. This is expected to narrow down BOP deficit. However, can the Nepali producers satisfy domestic consumers by providing them with equally competitive and varied products?

It feels like the policymakers have in principle concluded that we have exhausted the sources of growth. They are talking about curbing consumption rather than looking to channel some portion of consumption demand to investment spending. To stimulate economic activities, we need to find new sources of growth. This could be either through stimulation of domestic economic activities for internal consumption and investment purposes or by finding novel ways to increase exports. Implementation of widespread import curbing and import substituting measures is certainly not needed - only the import of luxury goods needs to be reduced.

The main cause of sluggish growth rate is slowdown in economic activities engendered primarily by unstable and highly unpredictable internal political bickering, creating uncertainty in markets. The bandas, destructive activities of militant youth wings and combative labor unions, donation campaign, supply-side constrains, and power shortages, among others, are the strongest constraints on economic activity. Rather than addressing these thorny non-economic issues headlong, the government is taking them as unalterable. These non-economic factors are also contributing to rise in inflation rate, which is hovering around 12 percent.

The contraction in external markets is not an issue for decline in Nepal’s exports. It is our inability to export goods that are price and quality competitive. The same non-economic factors discussed earlier and the inability to implement production and trade-promoting measures affected competitiveness of this sector.

The economy is in a messy condition. But, it is not unmanageable. The BOP deficit can be fixed, exports increased, and manufacturing sector propped up, if only we start by addressing the most binding non-economic constraints.

[Published on Republica, July 14, 2010, pp7]

Reading research papers 101

Excellent piece from Daniel Drezner. Below is his recommendation. Read the full discussion here.

1)  If you can't read the abstract, don't bother with the paper.  Most smart people, including academics, don't like to admit when they don't understand something that they read.  This provides an opening for those who purposefully write obscurant or jargon-filled papers.  If you're befuddled after reading the paper abstract, don't bother with the paper -- a poorly-worded abstract is the first sign of bad writing.  And bad academic writing is commonly linked to bad analytic reasoning. 

2)  It's not the publication, it's the citation count.  If you're trying to determine the relative importance of a paper, enter it into Google Scholar and check out the citation count.  The more a paper is cited, the greater its weight among those in the know.  Now, this doesn't always hold -- sometimes a paper is cited along the lines of, "My findings clearly demonstrate that Drezner's (2007) argument was, like, total horses**t."   Still, for papers that are more than a few years old, the citaion hit count is a useful metric.

3)  Yes, peer review is better.   Nothing Megan McArdle wrote is incorrect.  That said, peer review does provide some useful functions, so the reader doesn't have to.  If nothing else, it's a useful signal that the author thought it could pass muster with critical colleagues.  Now, there are times when a researcher will  bypass peer review to get something published sooner.  That said, in international relations, scholars who publish in non-refereed journals usually have a version of the paper intended for peer review. 

4)  Do you see a strawman?  It's a causally complex world out there.  Any researcher who doesn't test an argument against viable alternatives isn't really interested in whether he's right or not -- he just wants to back up his gut instincts.  A "strawman" is when an author takes the most extreme caricature of the opposing argument as the viable alternative.  If the rival arguments sound absurd when you read about them in the paper, it's probably because the author has no interest in presenting the sane version of them.  Which means you can ignore the paper. 

5)  Are the author's conclusions the only possible conclusions to draw?  Sometimes a paper can rest on solid theory and evidence, but then jump to policy conclusions that seem a bit of a stretch (click here for one example).  If you can reason out different policy conclusions from the theory and data, then don't take the author's conclusions at face value.  To use some jargon, sometimes a paper's positivist conclusions are sound, even if the normative conclusions derived from the positive ones are a bit wobbly.  

6)  Can you falsify the author's argument?    Conduct this exercise when you're done reading a research paper -- can you picture the findings that would force the author to say, "you know what, I can't explain this away -- it turns out my hypothesis was wrong"?  If you can't picture that, then you can discard what you're reading a a piece of agitprop rather than a piece of research. 

7)  Fraudulent papers will still get through the cracks.  Trust is a public good that permeates all scholarship and reportage.  Peer reviewers assume that the author is not making up the data or plagiarizing someone else's idea.  We assume this because if we didn't, peer review would be virtually impossible.  Every once in a while, an unethical author or a reporter will exploit that trust and publish something that's a load of crap.  The good news on this front is that the people who do can't stop themselves from doing it on a regular basis, and eventually they make a mistake.  So the previous rules of thumb don't always work.  The  publishing system is imperfect -- but "imperfect" does not mean the same thing as "fatally flawed." 

Dani Rodrik on the ideology of markets

"Unlike economists and politicians, markets have no ideology. As long as they make money they do not care if they have to eat their words.  They simply want whatever “works”—whatever will produce a stable, healthy economic environment conducive to debt repayment. When circumstances become dire enough, they will even condone debt restructuring—if the alternative is chaos and the prospect of a greater loss.

This opens up some room for governments to maneuver. It permits self-confident political leaders to take charge of their own future.  It allows them to shape the narrative that underpins market confidence, rather than play catch-up.

But to make good use of this maneuvering room, policymakers need to articulate a coherent, consistent, and credible account of what they are doing, based on both good economics and good politics. They have to say: “we are doing this not because the markets demand it, but because it is good for us and here is why.”

Their storyline needs to convince their electorates as well as the markets. If they succeed, they can pursue their own priorities and maintain market confidence at the same time."

More here. Krugman adds more here.

Listen to Lord Keynes!

"A wide gulf, therefore, is set between the ideas of lenders and the ideas of borrowers for the purpose of genuine investment; with the result that the savings of the lenders are being used up in financing business losses and distress borrowers, instead of financing new capital work.

At this moment the slump is probably a little overdone for psychological reasons. A modest upward reaction, therefore, may be due at any time. But there cannot be a real recovery, in my judgment, until the ideas of lenders and the ideas of productive borrowers are brought together again; partly by lenders becoming ready to lend on easier terms and over a wider geographical field, partly by borrowers recovering their good spirits and so becoming readier to borrow. If the diagnosis is right, the slump may pass over into a depression, which might last for years."

Déjà vu! The 2008/09 crisis seems like the one witnessed in 1930s. More here.

Is monetary policy relevant in Africa?

John Weeks, Professorial Research Associate, Center for Development Policy Research (CEPR), SOAS, argues that the IMF is mistaken in emphasising the reliance on monetary policies in sub-Saharan Africa because few countries have viable domestic markets for government bonds or commercial banking sectors interested in lending for private-sector investment. As a result, central banks often have to offer high rates of interest on government bonds to induce banks to buy them. Thus, a significant share of the public budget is diverted into debt servicing that ends up fattening banking profits.

In most sub-Saharan countries the demand by commercial banks for bonds does not readily respond to changes in the interest rate. One reason is that there is little competitiveness in domestic bond markets and another is that the bonds of African governments have extremely low credit ratings from Standard and Poor’s or Moody’s—if they are rated at all.

The main impact of the central bank’s raising of the bond interest rate will be to induce commercial banks to replace loans to the private sector with government bonds because the relative return from the former has fallen. This is a perverse result because when bonds increase the assets of commercial banks, they should expand their creation of credit. But because of the high yields received by banks on government securities, it is profitable for them to hold excess reserves instead of lending. 

This process is fundamentally different from the so-called ‘crowding out’ of private investment, about which the IMF repeatedly warns national policymakers. But the ultimate effect is the same. ‘Crowding out’ allegedly occurs when government borrowing to cover public expenditures competes with private borrowing. The dynamic that we are describing is different because the increase in the central bank rate does not originate from a need to cover public expenditure, but from the false expectation that the higher rate would appreciate the exchange rate and reduce inflationary pressure. 

The conclusion is pretty surprising (at least if we consider standard economic theories): "The reality in sub-Saharan Africa is that, with very few exceptions, monetary policy has no meaningful impact on inflation or the real exchange rate."

State of the Nepalese economy in FY 2009/10

Prem Khanal's has an excellent piece about the state of the Nepalese economy in fiscal year 2009/10. Khanal is one of the very few journalists whose pieces about the economy makes sense to me. There is a lot of chatter about the state of the Nepalese economy but very few can articulate the right issues from the right angle as Khanal does. To get updated about the present state of the Nepalese economy, this piece (copied below) by Prem dai is highly recommended!

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Bumpy Economic Road Brings No Cheer

 

Amid deepening political uncertainty, fiscal year 2009/10 is ending on Friday on a pessimistic note. Worse still, grim economic data coming out of both the real and financial sectors deepen fears that a much-needed economic revival is anything but certain.

Along with some ´incurable chronic syndromes´ like yawning growth gap, stagnant manufacturing and agriculture sectors, dwindling exports, sustained high inflation and rising recurrent expenditures, the impoverished economy has lately been exposed to a set of new and unexpected challenges coming mainly from the financial sector.

Financial sector

The stomach-churning mismatch between the inflow and outflow of foreign currency reflected in terms of deficit in the Balance of Payments (BOP) fuelled mainly by a breathtaking rise in trade deficit, slowing remittance growth and shortage of liquidity in the banking system was the distressful financial problem that hit the country this year.

However, worries created by the alarming deficit in BOP towered above all else, as it has shaken the economy to its very foundations.

The country experienced a stunning squeeze in foreign currency reserves, which is crucial for settling international payment obligations like repaying loans and financing imports, among other things. As a result, import capacity declined to 6.6 months from almost 10 months recorded at the beginning of the fiscal year.

Though the BOP deficit is shrinking slowly to come down to Rs 17 billion, it can anytime reemerge to spark a financial crisis, as the government has not taken concrete steps toward correcting a widening trade deficit.

According to latest central bank data, the trade deficit recorded till mid-May surpassed total remittances that the country received during the period. Even more, the mismatch between imports and exports is so big that Nepal´s total export finances only 16 percent of imports.

It is a fact that the country has limited options for dealing with the problems. After the collapse of Nepal´s traditional export pillars, woolen carpets and readymade apparel, it has neither competitive exportable products nor a convincing plan to develop such products in the medium term.

The alarming disparity between bloated consumption that is fueling imports on one hand and squeezing exports on the other is the root cause of present economic problems, says Keshab Acharya, chief economic advisor at the Ministry of Finance.

Since boosting exports is not possible in the near future, curbing consumption by means of both tariffs and non-tariff measures is the most suitable treatment for the problem, he added.

Similarly, Nepal´s financial sector, one of the few sectors that had enjoyed virtually uninterrupted expansion during the last decade, faced another problem of liquidity shortage. Though the problem was detected around September, it quickly escalated into something chronic by February, pushing the inter-banking lending rate to a record 13 percent.

The liquidity shortage, which has now eased to some extent, has already resulted in a rise in both lending and deposit interest rates. It is good that the deposit rate has increased, providing some relief to depositors who have been reeling under negative interest rates for years.

However, rapid rise in lending rates has raised concern as such a rise can discourage investors. Many of them are unable to withstand the heat of a five percentage point increment in lending rates within less than a year.

Many industries have lost their financial viability even before coming into operation. Such developments, if allowed to go unchecked for some time, will slow down both investments and consumption and eventually drag down an already sluggish growth.

Sustained high inflation continues to be another challenge. Though it has eased lately, it still hovers at over 10 percent - three percentage points more than target. And the latest fuel price increment is likely to aggravate inflation further.

Real sector

The glum outlook in the real sector continued this year. Economic growth rate was squeezed to 3.5 percent, lower than last year´s growth, as the economy continued to be the victim of a murky business environment, power shortage and insecurity.

Like in past years, agricultural production that grew by 1.05 percent against an annual population growth of 2.27 percent not only dragged down the overall growth but also increased dependency on imported food grain. A decline of 11 percent in paddy production, the mainstay of Nepal´s agro-production, was the most frustrating development.

Gloomy performance by the agricultural sector that provides a livelihood to two-thirds of the population and commands a one-third contribution to the national economy, means the poverty situation is likely to worsen this year.

However, per capita income recorded an impressive 16.7 percent growth to Rs 41,851--US$ 562 -- thanks to continued healthy growth in incomes from overseas, including workers´ remittances. Similarly, domestic savings as a percentage of GDP declined slightly to 9.36 percent, fueling consumption and widening the savings- investment gap.

Fiscal balance

With widening mismatch between expenditure and revenue, cracks have appeared in fiscal management, as the budget deficit by the third week of June soared to Rs 15 billion compared to Rs 4.7 billion recorded last year.

The terrific growth in revenue mobilization seen in the first half of the fiscal year has now lost steam and hovers around 24 percent, a growth level almost equal to the rise in total expenditure.

However, an impressive growth of over 35 percent, more than the recurrent expenditure growth rate, in capital expenditure remained one of the few achievements of the year. The total capital expenditure on cash basis has touch Rs 50 billion, which is 71 percent of the revised estimate.

The Ministry of Finance is hoping to hit the revised capital expenditure target of Rs 84.71 billion this year. The increased expenditure capacity at major projects was mainly due to the adoption of a multi-year contract awarding system and electronic bidding procedures.

Foreign aid

Low absorption of foreign aid continued to be a major problem, as disparity between the realized and committed amounts of foreign aid continued to widen.

As of the third week of June, the government has mobilized around Rs 27 billion whereas commitment in foreign aid is more than double that. Of the amount, the government received Rs 23 billion as grant against a revised target of Rs 42.7 billion while Rs 4 billion was received as loan, against the target of Rs 15 billion.

NTIS 2010 & Comparative Advantage II

Jainendra Jeevan dissects some parts of the recently released Nepal Trade Integration Strategy (NTIS) 2010. For my take on the same issue, see this blog post. I focused on the technical part of the report and how it failed to look into comparative advantage of Nepali goods. Jeevan also looks into the same issue but delves into product-level comparative/alternative analysis. A good read!

He is a little bit more pessimistic than I am.

Well that is a different story; coming back to CA, lack of vision and political will along with weak administrative structure have resulted in poor implementation of all agricultural plans and programs so far, including the ‘20-year Agricultural Perspective Plan’ (APP). Therefore, in all likeliness, NTIS 2010 too will meet the fate of APP as capabilities and intention of politicians and bureaucrats haven’t changed any. Therefore, investing single-mindedly on products that have natural competitiveness and fixed cost advantages and on infrastructure and social sectors like education, health and food security should be our focus as diverting resources (both public and private) elsewhere is simply a misuse of the scarce means.