FDI inflows to Nepal are starting to increase

Here is a good news. The latest data from UNCTAD shows that total FDI inflows to Nepal in 2011 were US$95.49 million, up from US$86.74 million in 2010 and US$38.56 million in 2009. FDI inflows as a share of gross fixed capital formation (GFCF) have also increased to 2.5 percent in 2011 from 2.2 percent in 2010.

In Nepal, the growth rate of FDI inflows between 2011 and 2010 were 10 percent (it were 125 percent the previous year). South Asia saw a 23.8 percent increase in FDI inflows, including 30.6 percent in India. In terms of total FDI inflows to South Asia (US$34.79 billion), India’s share was 90.69 percent (US$31.54 billion) and Nepal’s was 0.27 percent (lower than its share in 2010, when FDI inflows to Nepal was 0.30 percent of total FDI inflows to South Asia).

FDI inflows to South Asia in 2011
Country	US$ million	Growth rate, 2011-2010	% of SAR inflows	% of GFCF	Ranking (out of 182)
					Attraction	Potential
Afghanistan	83.41	-60.52	0.24	2.03	168	159
Bangladesh	1136.40	24.43	3.27	4.02	144	89
Bhutan	13.87	-14.70	0.04	2.08	174	134
India	31554.03	30.61	90.69	6.39	59	3
Maldives	281.55	32.94	0.81	72.42	68	126
Nepal	95.49	10.09	0.27	2.48	175	150
Pakistan	1327.00	-34.37	3.81	5.34	127	50
Sri Lanka	300.00	-37.19	0.86	2.08	159	68

The inward FDI attraction index ranking in 2011 was 175 out of 182 countries. The Inward FDI Attraction Index ranking is based on the average of a country’s percentile rankings in FDI inflows and in FDI inflows as a share of GDP.

Furthermore, the inward FDI potential index ranking in 2011 was 150 out of 182 countries. The Inward FDI Potential Index ranking is based on the simple average of a country's percentile rank in each of the economic determinants areas (market attractiveness, availability of low cost labor and skills, enabling infrastructure, presence of natural resources). A country's ranking within each group of determinants is based on the simple average of the country's percentile rank of each variable included in the group.

Determinants of FDI potential:

• Market attractiveness (GDP, Per capita GDP, Real GDP growth)
• Availability of low cost labor and skills (labor force in manufacturing, unit labor cost in manufacturing)
• Enabling infrastructure (electric power consumption, road density, paved roads, rail lines, linear shipping connectivity index, telephone lines, mobile cellular subscription, fixed broadband internet subscribers)
• Presence of natural resources (arable land, exports of fuels, exports of ores and metals)

Country rankings by Inward FDI Potential Index (out of 182), 2011
Economy	Market attractiveness	Availability of low-cost labor and skills	Enabling infrastructure	Presence of natural resources	Overall rank
Afghanistan	124	93	170	118	159
Bangladesh	66	..	125	86	89
Bhutan	108	..	116	144	134
India	24	1	79	5	3
Maldives	89	..	72	173	126
Nepal	142	65	146	145	150
Pakistan	94	6	101	55	50
Sri Lanka	42	23	80	137	68

The table above shows that Nepal has the lowest FDI potential in South Asia. In market attractiveness it is tied with Afghanistan, our neighbors have more availability of low-cost labor and skills, enable infrastructure is second worst in South Asia, and presence of natural resources is also not that great. Now, in the latter one note that it has nothing to do with hydropower potential; its more related to ores and metals.

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Globally FDI flows in 2011 surpassed the pre-crisis average – reaching US$1.5 trillion, but it still remained more than 20 percent below their 2007 peak. The report projects a moderate but steady rise, with global FDI reaching US$1.8 trillion in 2013 and US$1.9 trillion in 2014, barring any macro-economic shocks.

FDI inflows in 2011 increased across all major economic regions. Flows to developing countries reached a record US$684 billion, up by 11 percent. However, FDI recession continued in Africa and LDCs.

The impact of remittances on Madhesh

Tarai Human Rights Defenders Alliance (THRD Alliance) has come up with an interesting study (don’t have an online link yet!) on the social impact of remittances in Madhesh. It is based on perception survey of 476 households (only joint families whose male member had left for work overseas after getting married) in five VDCs of Mahottari district (Pigauna, Simardahi, Suga, Dhirapur, and Kalhuwabagiya).

Interesting findings:

• Average rate of interest on loan for foreign employment is as high as 36% (I guess it must be through informal means, which is not mentioned in the report). Still, around 87 percent of the respondents said that migration was a correct move (around the same percent of respondents said that the main reason for their family members to migrate is for money).
• The money sent by migrants is pretty much finished while paying back loans.Around 86 percent said that they used remitted money to pay loans. But, around 60% said they would want returnees to engage in business. Around 45 percent of the respondents said that they received at most Rs 100,000 per year (1.89 percent said at least Rs 500,000).
• Migrants are duped by overseas employment agents. One manpower sent worker promising monthly salary of 850 Dhirams, but when he reached Qatar he got just 550 Dhirams.
• Around 97 percent of respondents said that they receive money from money transfer agencies (hundi 0.84 percent).
• Around 54 percent of respondents said that their family members sent them mobile phone sets as the first remitted item (computer/laptop 15 percent). No wonder 96 percent of them said that they communicate with their overseas family members using mobile phone.
• Around 33 percent of remittance money was spent on food and clothing (education and health 30 percent and 13 percent respectively). Around 35 percent said that this has changed their food and clothing habit (increase in social status 25 percent).
• Strained relationship between in-laws and married women whose husband is overseas for employment.

The report states that the selection of five out of seventy-seven VDCs of Mahottari district was done randomly, but it doesn’t mention the method for it. Also, is Mahottari the best representative district in all of Madhesh (share of migrants from Mahottari is around 3.97 percent of total migrants)? These two crucial things— which helps to give a sense of reasonable extrapolation and potential inferences from the trend observed in the survey data— have not been explained in the report. Nevertheless, most of the conclusion and recommendation apply to not only Madhesh but the whole of Nepal.

For those interested, here is a case study on the impact of remittances in social, economic and political lives of Dalit and Muslim in Tarai. Here is an excerpt from the UN report:

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[…] parents are spending more on school education but that 90% of the youths in their late teens are more concerned about buying mobile phones and motorbikes and having fun rather than studying. Once they realize that their father cannot afford their increasing expenditure, they too want to go abroad. He is also concerned about growing alcohol consumption even amongst otherwise very traditional Muslim families. Mangal Sada, a Dalit who spent three years working abroad, is now quite disheartened to know that his only son is in “bad company” and probably abuses both alcohol and drugs. He says that the living conditions of his family are without doubt much better now but he had to pay a heavy price for that.

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For more on the impact of remittances on the economy, read previous blog posts here, here, here and here.

Remittances have both advantages and disadvantages. While it is boosting household’s income and expenditure capacity, it is bringing changes to social behavior (like increase in nuclear families, shortage of workers for agriculture and forestry related works, and dependency syndrome right at the household level, among others). Meanwhile, it has created a shortage of labor in industrial sector, displacement of domestic manufacturing by imported goods, widened trade deficit, and made policymakers complacent in enacting real policy reforms that would help boost domestic production and channel remittances for productive purposes.

A combo of four different charts below shows district-wise population growth rate, household size, absentee (migrant) population and remittance inflows. Read more on this issue here.

Export and import via major customs offices in Nepal

Ever wondered which custom office is the busiest and does the most trade related transactions? Well, here is a chart that shows exports and imports via major custom points in Nepal in FY 2010/11.

Out of the total export of Rs 64.27 billion in FY 2010/11, 36.05 percent went through Biratnagar customs, followed  by Birgunj (23.32 percent), TIA (17.87 percent), Mechi, Bhairahawa , Dry port in Sirsiya (2.98 percent), Nepalgunj, Krishnanagar, Tatopani and Kailali.

Out of the total import of Rs 394.33 billion, 45.33 percent came though Birgunj customs, followed by Biratnagar (13.84 percent), Bhairahawa (13.77 percent), Dry port (10.06 percent), Tatopani, Nepalgunj, Mechi, Krishnanagar, and Kailali.

As expected, custom points along the border with India does the most transaction. Trade deficit in FY 2010/11 was Rs 331.84 billion. Trade facilitation and the cooperation between various stakeholders at custom points play a major role in enhancing economic competitiveness and trade performance. Looking at the combo picture of the state of infrastructure at Birgunj Customs Office (total trade via Birgunj was Rs 193.76 billion in FY 2010/11), which is one of the most important custom points in Nepal, it is unsurprising that Nepal ranks 149 out of 151 countries in trade logistics related infrastructure.

Here is a story related to mixed result in export of NTIS products.

What defines apparel exports after the end of MFA?

Here is an interesting summary of the shift in apparel sector after MFA in 2005. Excerpts:

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Many expected that the shifts in apparel production across countries after the MFA would be mainly driven by wage differences because apparel is labor intensive. Wage differences, however, only explain 30 percent of the variation in the change in exports across countries. For example, China was predicted to gain while nearly all other countries lost. But, in fact, other large Asian apparel exporter countries, such as Bangladesh, also increased exports. Other countries, such as Hong Kong SAR, China, Mexico, and Honduras, experienced falling exports and market shares. Therefore, export gains were not simply due to a shift from higher-wage countries to lower-wage countries. Countries that gained the most, including India, Bangladesh, Vietnam, and Pakistan,  implemented proactive policies specific to the apparel industry. While wage differences explain some of the production shifts, domestic policies targeting the apparel sector, ownership type, and functional upgrading of the industry perhaps played a more important role.

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Once apparel exports was one of the star products of Nepal. But, this sector is now fast losing competitiveness. Where and how did it go horribly wrong? The answer lies in an inability to foresee the changes brought about by globalization. Policy makers and garment investors failed to notice quite obvious signs of change in the international market. They failed to design corrective policies to restructure the outdated domestic garment industry. Instead of addressing the constraints that were making the garment industry uncompetitive, they basked on the already secured preferential agreements and wasted valuable time and resources in securing more of them.

Nepal's export of RMG
Fiscal year	Rs billion	Growth rate
1998/99	8.15
1999/00	11.12	36.44
2000/01	11.62	4.50
2001/02	7.96	-31.50
2002/03	12.02	51.01
2003/04	10.22	-14.98
2004/05	6.72	-34.25
2005/06	6.58	-2.08
2006/07	4.71	-28.42
2007/08	3.32	-29.51
2008/09	4.35	31.02
2009/10	3.76	-13.61
2010/11	4.08	8.67

How to judge effectiveness of fiscal policy?

Here is Abba Lerner (1943):

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“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound."

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Source: Abba Lerner (1943). “Functional Finance and the Federal Debt.” Social Research 10(1): 38–51.

Currency depreciation and carpet exports

So, carpet exporters are benefiting from depreciation of Nepali currency against the US dollar. Analysts have doubted if Nepal will ever benefit from weak rupee because almost 60 percent of trade gets pretty much unaffected by it, thanks to the pegged exchange rate. With respect to exports to EU, the economic mess there is lowering demand. But, the strong US dollar meant that it is relatively cheaper for them to purchase Nepali goods. Our exporters are expected to benefit from it. But, the irony is that in order to take advantage of falling rupee, we need to have sufficient inventory to supply as and when needed. Unfortunately, Nepal doesn’t have it. So, the inability to take benefit from falling rupee. However, carper exports seem to be rising even when volume of exports has declined.

Excerpts from a news story in Republica:

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Despite the drop in volume of exports, Nepali hand-knotted carpet exporters enjoyed 40 percent rise in their income over the first ten months of 2011/12, thanks to strengthening of the US dollar.

Owing to almost 25 percent depreciation of Nepali rupee, Nepali exporters during the period received on average Rs 8,018 per square meter of hand-knotted carpet. They were receiving on average just Rs 5,103 per sq meter and Rs 5,669 per sq meter in the same period of 2009/10 and 2010/11 respectively.

"Thanks to the exchange rate gain, hand-knotted carpet fetched a total of Rs 4.84 billion over the first ten months of 2011/12, even though the export volume remained low at 603,631 sq meters," reads a report of Trade and Export Promotion Center (TEPC).

During the same period last year, Nepal had exported 698,517 square meters of carpet that fetched foreign currency worth Rs 3.96 billion only. In the same period of 2009/10, Nepal had exported 652,517 sq meters of woolen carpets earning Rs 3.33 billion.

TEPC data shows that Nepali exporters mainly received a blow from European markets as demand there shrank in the wake of Euro zone crisis. But exporters found new markets in the US, which for the first time emerged as the biggest single importing country of Nepali carpets.

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Now, calculating the export value in US dollar terms will give us a rough figure of the contribution depreciation to boosting earnings in Nepali rupee.

NEPAL: Product space, export sophistication and structural transformation

Here is a combo of interesting figures that shows the evolution of merchandise export sophistication (or production sophistication) of Nepal since 1970. Overall, it shows that there has been little enhancement in the sophistication of Nepali exports or production. It is clearly seen in the product spaces, which are the network showing global similarities in production knowhow required by products. The nodes represent products, which are colored according to the color legend of the product communities they are in. The node size is proportional to global trade in that product and the links connect products that tend to be exported by the same countries.

The black square dots indicates that those products are exported with comparative advantage (RCA>1). Nepal’s export is concentrated in low value products, mainly textiles and garments. The USA’s export is concentrated in high value products, which require more advanced capabilities, such as machinery, chemical, health and electronic products. Though India’s export is slowly moving and diversifying to the core of the product space, i.e. high value products, it is also producing textiles and garments and other low value products with comparative advantage (also more competitively than Nepal).

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It is argued that the assets and capabilities needed to produce a good are imperfect substitutes for those needed to produce another good “but their degree of asset specificity will vary” (Hausmann & Klinger, 2007). The probability that a country makes a new product is strongly related to the proximity of the product with other products the country already makes. It means that a country’s capability to produce one good is somehow tied with the installed capability in the production of other similar goods, i.e. “nearby goods”. Bailey Klinger provides an interesting metaphor: “products are like trees and firms are like monkeys.” Structural transformation involves the movement of monkeys from the poor part to rich part of the forest. It is easier for monkeys (firms) to jump short distance (i.e. to change products that use similar pre-existing factors).

The level of sophistication of exports determines the income level of a country and its growth rate. Importantly, the level of economic complexity indicates the nature of future economic growth and the ability to produce new goods and move from low-value added to high value-added goods. Sophistication comes from either increasing the quality of currently produced goods or from a move into new and more sophisticated products.

New capabilities to usher structural transformation are not acquired suddenly. It takes time and is more “easily accumulated if they are combined with that already exists”. Again, a country can diversify its production by moving from the products that it already produces to others that require a similar set of embedded knowledge. Think it of this way: it is easier to move production from undergarments to pants than from undergarments to engines. We can figure out how far products currently not exported with comparative advantage are from the ones that are exported with comparative advantage and are within nearby range of existing production capacities of an economy. It is easier to produce “nearby” products than a product that is “far away” because the capabilities to produce similar but slightly differentiated products already exists in the economy. Eventually, what a country exports matters in determining its future course of growth and pace of structural transformation.

So, the capability to produce higher value products is accumulated over time based on the existing capabilities. In Nepal’s case, export-oriented sectors have not added much new capabilities. Worse, even the existing capabilities are being lost due to a slew of internal (lack of innovation, R&D and survival based on margin of preference in export destinations) as well as external constraints (mainly supply side constraints, including lack of adequate power and infrastructure, labor problems, policy inconsistency and policy implementation paralysis). More on Nepal’s problems with exports here, here and here (for services sector sophistication, see here)

Now, what drives sophistication of production and exports? Anand, Mishra and Spatafora argue that “an educated workforce, external liberalization, and good information flows are important prerequisites for developing sophisticated goods and services”. Meanwhile, manufacturing competitiveness (in turn sophistication) is determined by

• Government forces (education policies; energy policies; economic, trade, labor, financial and tax policies; science and technology policies; manufacturing and infrastructure policies)
• Capabilities (innovation; technology; process; infrastructure)
• Market forces (demographic, macroeconomic)
• Resources (human, materials, energy, financial)