Monetary transmission in developing countries

Usually, when we talk about monetary policy, it is customary to link this with standard econ theories. For instance, it is well established that increase in money supply increases inflation. But then in countries like Nepal, money supply (or central bank’s interest rate) has hardly any effect on inflation (even correlation is very weak). Why? Because of exchange rate pegged to Indian rupee, almost 60 percent of total imports originating in India, slowly adjusting oil prices, huge informal economy, supply-side constraints and very limited reach of financial institutions (just 20 percent of households take loans from banks). The theoretical relationship between money supply and inflation is not that straight forward when it comes to applying it on the ground in developing countries with under-developed financial sector.

Montiel and Mishra argue that the application of conventional monetary transmission would require “an economy with a highly developed and competitive financial system in order to be effective.” Two strong messages that are relevant to Nepal come from their research:

• Inflation targets set during the announcement of monetary policy should be modified to take the imperfect monetary transmission into account. (They recommend to the extent of postponing setting inflation target!).
• Weak monetary transmission weakens the argument for floating exchange rates and capital account restrictions.

Below are excerpts from their article in Ideas for India (btw, an excellent website for easy-to-read, evidence-based articles focused on the Indian economy): 

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That includes: a strong institutional environment, so that loan contracts are protected and financial intermediation is conducted through formal financial markets; an independent central bank; a well-functioning and highly liquid interbank market for reserves; a well-functioning and highly liquid secondary market for government securities with a broad range of maturities; well-functioning and highly liquid markets for equities and real estate; a high degree of international capital mobility; and a floating exchange rate. These features are typically taken for granted in the OECD but the same assumptions cannot be made for developing countries.

 

[…] First, the complete absence or poor development of domestic securities markets suggests that both the short-run and long-run interest rate channels will be weak. Second, small and illiquid markets for assets such as equities and real estate will tend to weaken the asset channel. Third, in countries that are imperfectly integrated with international financial markets and tend to maintain relatively fixed exchange rates, the exchange rate channel will tend to be completely absent, or relatively weak.

[…] If the banking industry is non-competitive, changes in banks’ costs of funds may be reflected in bank profit margins, rather than in the supply of bank lending. If a poor institutional environment increases the cost of bank lending, banks may conduct lending activity in a manner that weakens the effects of monetary policy actions on the supply of loans by using reserves as a buffer to sustain their lending to low-cost customers when the central bank tightens credit conditions and to avoid lending to high-cost customers when the central bank loosens credit conditions.

[…] We find a much weaker link between the policy instrument (central bank interest rates) and money market rates in poorer economies than for advanced and emerging economies, both in the short and in the long run. We find a similar result for the link between money market rates and bank lending rates in the short term, and while differences in long-term effects are not as pronounced, they remain weaker in low-income countries. Most importantly, changes in money-market rates explain a much smaller proportion of the variance in bank lending rates in low-income countries than in either advanced or emerging economies.

[…] We interpret the evidence presented in our research, as well as that of the broader literature, as creating a strong presumption that in the financial environment that tends to characterise many developing economies, monetary policy is likely to have both weak and unreliable effects on aggregate demand. If this is true, the stabilisation challenge in developing countries is acute indeed, and identifying the means of enhancing the effectiveness of monetary policy in such countries is an important challenge for policymakers and researchers alike.

When domestic monetary policy is weak and unreliable, activist policy is less desirable, and the adoption of policy regimes that raise the stakes associated with attaining publicly-announced monetary objectives, such as a target rate of inflation, should be postponed or their design should be modified to take the uncertainty about monetary policy effects into account. In addition, weak and unreliable monetary transmission weakens the arguments for floating exchange rates as well as for capital account restrictions under fixed exchange rates.

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The full paper is here.

Private sector allowed to import LPG in Nepal

The government has finally opened up import of LPG by private players. Chandi Lumbini Gas Storage Company has been permitted to import liquefied petroleum gas (LPG) from Malaysian petroleum giant Petronas from the end of October. It will hopefully lower NOC's deficit as most of the users in commercial scale can now get LPG from the new private company (that too with ease, lets hope!). Additionally, (hopefully) consumers do not have to wait in queue at retail stores to get a LPG cylinder.

Excerpts from a news story in The Kathmandu Post:

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Chandi Lumbini will buy gas and oil from Petronas, mix and refine the fuels at IndianOil Petronas at Haldia and then sell LPG in Nepal.

[...]The company said it would make bulk deals and its LPG would be used for commercial purposes only. It has invited Nepali bottling plants, auto filling plants and bulk consumers interested in doing LPG business. The company said that even NOC can buy its products.

[...]Chandi Lumbini made a fresh bid to be allowed to import LPG after the government announced a dual cylinder system from Oct 17. Under the plan, LPG would be sold in colour-coded cylinders, red for household use and blue for commercial use. LPG in blue cylinders will be sold at the actual price while red cylinders will be sold at a subsidised rate.

The proposed system will allow Chandi Lumbini to sell its products at the commercial rate. At present, NOC incurs a loss of Rs 363.60 on a cylinder, resulting in monthly losses of Rs 436 million.

[...]Nepal and India signed a Petroleum Supply Agreement in 1974 appointing IOC as the sole supplier of fuel to Nepal. Prior to that, major oil companies based in India like Exxon and Chevron used to retail fuel directly in the Nepali market.

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It is good that the government is allowing private players in this hugely inefficient and fiscally burdensome sector. At the outset, just because private players enter the market doesn't mean things will be alright given a hugely distorted procurement, distribution and consumption networks. The challenge would be to stop leakages, i.e. not allowing commercial users to purchase discounted cylinders. It would require strict supervision and oversight of the entire process. Else, things won't improve much.

Assessment of Nepali economy by the IMF (2012/13)

The IMF has just released the preliminary findings and recommendations 2012 Article IV Consultation discussions.The usual narrative about economic growth, expenditure concerns, and sustainability of economy by remittances holds.

Macroeconomic outlook remains challenging. Strong agriculture production and growth in services sector boosted real GDP growth to 4.6 percent despite fledging industrial sector. Non-food and services (mostly of imported nature) prices exerted more pressure on inflation last year as a result of depreciation of currency and increase in fuel prices. High remittance inflows has contributed to keeping current account and balance of payments in surplus. Lower fiscal deficit than expected points to the inability to spend on capital projects. Good revenue mobilization helped keep deficit and public debt on a stable footing.

Here is the outlook for short term:

• GDP growth expected to decline due to late monsoon, continued weakness in industrial output and slow growth in India.
• Inflation is likely to miss targets and remain at around 8-9 percent range.
• BoP surplus is likely to decline as growth of remittances moderates.
• Delay in adopting a full-year budget for 2012/13 could further dampen investment and growth.
• A full-year budget—limiting the deficit to about 2 percent of GDP, consistent with macroeconomic and debt sustainability—should be adopted as soon as possible.
• High levels of capital spending to meet Nepal’s pressing infrastructure needs and support medium-term growth. But, its challenging.
• Further strengthening of tax administration and collection will be vital, as will a focus on collecting arrears.
• Tighter expenditure management and cash planning will also be key to ensuring that government and donor-supported investment projects are implemented.
• Large losses of NOC and NEA are unsustainable.
• Recommends adoption of an automatic price adjustment mechanism to contain losses of NOC.
• The exchange rate peg to the Indian rupee should remain the key monetary policy priority. It means maintaining interest rates higher than in India.
• Excess liquidity generated by strong remittance growth in 2011/12 should be mopped up by tightening monetary policy.
• Weak supervision, liberal licensing policy in previous years and exposure to real estate sector remains a risk for financial sector. NRB’s corrective steps have been useful in containing spread of risks.
• Implementation of revised NRB Act to allow for swift intervention of problem banks, rigorous implementation of the prompt corrective action framework, and strengthened supervision and enforcement of prudential regulations.

Very brief but entirely appropriate diagnosis and recommendations by the IMF. You will have to wait for the full 2012 Article IV Consultation report to dig deeper into these issues.

Last year, the IMF recommended the government to boost productivity to stay competitive. Some of the recommendations remain the same.

Reforming power sector: Right tariff with right management

World Bank economists and energy specialists argue that the solution to blackouts in India is to reflect cost of production in power tariffs (prices) and efficient management of and by power companies (plugging in leakages, expanding access to energy, good customer services, proper maintenance). It happened in Gujarat, West Bengal (public enterprise) and Delhi (private enterprise). The suggestions are quite pertinent to the ongoing works in reforming Nepal's troubled NEA (after tariff rationalization).

Below are excerpts from the article:

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At their heart, blackouts boil down to two issues: underutilised capacity and insufficient capacity. The former is a result of inadequate maintenance of old plants and the persistent shortage of domestic coal. This can be resolved by using imported coal. But that is very expensive and the additional cost does not get reflected in tariffs.  For their part, most distribution companies have resorted to load shedding, rather than buying surplus short-term power, on account of their dire financial position.

Insufficient capacity requires a long-term solution. The financial viability of State utilities is a pre-condition for attracting investments in this sector. This requires a coherent set of actions involving reductions of system losses, adequate tariffs that are revised at regular intervals and transparent competitive bidding for new investments.

Fortunately, we don’t have to look far for solutions. India has a number of examples of public (Gujarat, West Bengal) and private (Mumbai, Delhi) power sector companies that have good management practices, are well regulated, provide homes and industries with uninterrupted power supply and earn reasonable profits.

So what have these states done differently? First, they have significantly reduced their transmission and distribution losses, which devour a third of the power in other states. These companies upgraded their networks and cracked down on power theft, which enabled them to generate additional revenues that further improved operations.  Note that peak power deficits in May 2012 were just 1% in West Bengal and 1.2% in Gujarat, as compared to 9.2% in the rest of India.

Second, these states have increased tariffs at regular intervals and consumers pay higher tariffs in return for regular, high-quality power supply. In Gujarat, for instance, consumers pay Rs. 5.3 per unit of power; in Mumbai, Rs. 5.86; and in West Bengal, Rs. 5.78. While these tariffs are only 10% higher than average tariffs in other states, lower losses and better efficiency imply that these companies are profitable.

So where can other states begin from? Power utilities in other states must reduce their financial losses through sound management practices and tariff rationalisation. But consumers will rightly demand regular power supply with better voltage before they are willing to pay a higher tariff. West Bengal demonstrated the importance of earning credibility with consumers before raising tariffs. Just three years after improvements in power supply and energy access, improved customer service and negligible dependence on state subsidies, the utility got approval for the required tariff increase under the new government. Similarly, in Delhi, private distribution companies were incentivised to reduce losses in a time-bound manner during the reform period, before receiving a tariff hike.

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 More here.

Per capita GDP after correcting for government inefficiency

In a new research note, WB's Francesco Grigoli and Eduardo Ley argue that correcting for wastage of government inputs from GDP would "significantly" reorder the living standards rankings. Below is the abstract of the paper (full text here).

It is generally acknowledged that a government's output is difficult to define and its value is hard to measure. The practical solution adopted by national accounts systems is to equate output value to input costs, but well-documented inefficiencies in government activities make this approximation questionable. One solution is to purge from gross domestic product (GDP) the fraction of government inputs that is wasted. This note illustrates such a correction, computing corrected per capita GDP on the basis of two studies that estimate efficiency scores for several dimensions of government activities. Results show that the correction could be significant and reorder the rankings of living standards.

The percentage of GDP losses due to public waste in education and health is estimated as high as 4.2 percent for Brazil!

Links of Interest (2012-09-18)

Promoting social mobility (Equity and efficiency can be achieved by focusing investments in the early years, while also following up with later investments.)

Lesson from Japan: Do low interest rates boost growth? (Supply alone won't do anything if there is no demand for it. Low rates hardly boost "private demand, private risk-taking or entrepreneurship" if the economy is largely dependent on revenue externally, i.e. from exports, where economic conditions have nosedived.)

Nepali private sector in interested in PPP in agriculture sector

The private sector body also said the existing policy does not address the risks inherent in engaging the private sector in the farm sector and as a result, the country has not been able to take advantage of the opportunities in the agriculture sector. NCC urged the government to bring a policy that facilitates both the private sector and farmers to market access, provide loans in nominal interest rates, set up organic and chemical fertiliser factories, among others.

IRs 100 = NRs 168 in informal market (Officially, NRs 1.60 is pegged at IRs 1. The main reasons are high demand for IRs arising from increasing imports and cross-border smuggling of IRs.)

Traders attributed this surge in IC value in the black market to increasing smuggling of goods that created shortage of the currency. They said smuggling of sugar, food items, readymade garment and shirting and suiting, among others, has surged ahead of the festivals. Smuggling of motor parts, hardware and electronics are also on the rise.

NEA to hold study on 10 storage-type projects

The Nepal Electricity Authority (NEA) has selected 10 storage-type hydropower projects with a collective capacity of 2,652MW to carry out a feasibility study. The 10 projects are among the 31 projects approved by the Japan International Cooperation Agency (JICA) for further study. NEA had conducted a pre-feasibility study on 65 projects last year under the funding JICA, of which 31 projects were approved, NEA officials said.

The 10 projects are Madi Khola (199 MW), Lower Jhimruk (142 MW), Nalsinghgadh (400 MW), Chehera-I (149 MW), Naumure (245 MW), Dudhkoshi (300 MW), Sunkoshi-III (536 MW), Khokhajor (111 MW), Adhikhola (180 MW) and Lower Badhigad (380 MW).

NEA so far has issued survey licences to independent power producers for projects with a collective capacity of 11,645MW electricity, but all the projects are ROR type.

NEA is also studying 14 projects with total capacity of about 4,000MW. Of them, 11 are storage-type projects.

Supply intervention:  MoCS giving PEs Rs 35.8m to ensure smooth supply of food commodities

The Ministry of Finance (MoF) has agreed to provide Rs 35.8 million to the Ministry of Commerce and Supplies (MoCS) for providing direct subsidy to state undertakings involved in the supply of food commodities, keeping in view the upcoming festivals. Breaking the tradition of cross subsidy system under which state-owned enterprises were given tax and other privileges to enable them recoup the loss while dealing with subsidized goods, the MoCS first time is providing direct subsidy to public enterprises (PEs). The MoCS adopted new subsidy system after PEs reported loss while trading commodities like rice, sugar, salt and goats, among others, during last year´s festive season.

Under the proposed subsidy, NFC, STC and NTL will have to sell rice, salt and sugar at rates lower by Rs 5, Rs 2 and Rs 5 per kg respectively compared to market price.

Govt fails to implement MRP: Consumer activists termed the move just a 'publicity propaganda'

The government failed to publish maximum retail price (MRP) in Nepal Gazette (Rajpatra) today, as it has promised. Ministry of Commerce and Supply Management has promised to publish it today in the Gazette that could ensure the implementation of the MRP from today.

“There has been not any preparation to publish it in the Nepal Gazette ,” said secretary of the Ministry of Law, Justice, Constituent Assembly and Parliamentary Affairs Bhesh Raj Sharma.

“No file has reached the ministry related to maximum retail price,” he added. According to the process, concerned ministry should forward the file to Ministry of Law, Justice, Constituent Assembly and Parliamentary Affairs to publish notice in the Gazette.

According to the Clause 1 of Essential Commodities Control (Authorisation) Act 1961, the government decision on maximum retail price becomes effective only after the publication in Nepal Gazette.

Trade facilitation matters!

Economists celebrate trade not only because they love watching ships cross the Pacific and cargo planes land at Paris Charles-de-Gaulle but also because increased trade demonstrably raises income and improves living standards. This column argues that a powerful way to boost trade is by focusing on trade facilitation, i.e. improving both hard infrastructure like ports and railways, and soft infrastructure such as shipping logistics.

India's economic slowdown reflects both structural and cyclical factors

Post MDGs development priorities and assistance

Dani Rodrik assesses the relevant of MDG indicators and the global development or assistance framework in the post-MDG era:

Contribution of MDGs:

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[…]Clearly, however, the MDGs were a public-relations triumph, which is not to belittle their contribution. Like all worthwhile PR efforts, the MDGs served to raise awareness, galvanize attention, and mobilize action – all for a good cause. They amplified the global conversation about development and defined its terms. And there is evidence that they got advanced countries to pay more attention to poor nations.

Indeed, the MDGs possibly had their clearest impact on aid flows from rich to poor countries. A study by Charles Kenny and Andy Sumner for the Center for Global Development in Washington, DC, suggests that the MDGs not only boosted aid flows, but also redirected them toward smaller, poorer countries, and toward targeted areas like education and public health. However, aid was not directly linked to performance and results, and it is much more difficult to know whether it had the desired impact overall.

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Recommendations for the post-MDG development framework:

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[…]First, a new global compact should focus more directly on rich countries’ responsibilities. Second, it should emphasize policies beyond aid and trade that have an equal, if not greater, impact on poor countries’ development prospects.

A short list of such policies would include: carbon taxes and other measures to ameliorate climate change; more work visas to allow larger temporary migration flows from poor countries; strict controls on arms sales to developing nations; reduced support for repressive regimes; and improved sharing of financial information to reduce money laundering and tax avoidance.

Notice that most of these measures are actually aimed at reducing damage – for example, climate change, military conflict, and financial crime – that otherwise results from rich countries’ conduct. “Do no harm” is as good a principle here as it is in medicine.

This kind of reorientation will not be easy. Advanced countries are certain to resist any new commitments. But most of these measures do not cost money, and, as the MDGs have shown, setting targets can be used to mobilize action from rich-country governments. If the international community is going to invest in a bold new public-relations initiative, it might as well focus on areas where the potential payoffs are the greatest.

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On the post-MDG era, here is a link to a presentation based on Nepal country study for the forthcoming European Report on Development 2012/13.

Shashi Tharoor argues that the next focus should be in Goal 8, which calls for a “global partnership for development” with four specific targets: “an open, rule-based, predictable, non-discriminatory trading and financial system”; special attention to the needs of least-developed countries; help for landlocked developing countries and small island states; and national and international measures to deal with developing countries’ debt problems.”

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[…]The time has come to reinforce Goal 8 in two fundamental ways. Developed countries must make commitments to increase both the quantity and effectiveness of aid to developing countries. Aid must help developing countries improve the welfare of their poorest populations according to their own development priorities. But donors all too often feel obliged to make their contributions “visible” to their constituencies and stakeholders, rather than prioritizing local perspectives and participation.

[…]We must change the way the world goes about the business of providing development aid. We need a genuine partnership, in which developing countries take the lead, determining what they most acutely need and how best to use it. Weak capacity to absorb aid on the part of recipient countries is no excuse for donor-driven and donor-directed assistance. The aim should be to help create that capacity. Indeed, building human-resource capacity is itself a useful way of fulfilling Goal 8.

Doing so would serve donors’ interest as well. Aligning their assistance with national development strategies and structures, or helping countries devise such strategies and structures, ensures that their aid is usefully spent and guarantees the sustainability of their efforts. Donors should support an education policy rather than build a photogenic school; aid a health campaign rather than construct a glittering clinic; or do both – but as part of a policy or a campaign, not as stand-alone projects.

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