Nepal’s fiscal cliff

Todd Schneider, IMF’s mission chief for Nepal, argues that the lack of a full budget and the expenditure for FY2013 thus far set at the actual expenditure in FY2012 is leading to a situation where real expenditure (i.e., accounting for inflation) is contracting while rising revenue mobilization is pulling off money from people’s hands and storing it in the savings account of the government.

The inability of the government to spend money when so much of development works—particularly those related to infrastructure, which helps boost productivity— need to be accomplished is simply exerting unnecessary inertia on Nepal’s growth engine. Consequently, high government savings are resulting in liquidity strain (not the only reason, but one of the main reasons) in the banking sector. All of these will surely hit growth rate, which is already restrained by expected low agriculture production due to unfavorable monsoon, which IMF expects not to cross 3%.

In effect, there is a real expenditure contraction. This could be Nepal’s unintended “fiscal cliff”, emanating, as usual, from the lack of political consensus and the inability to separate basic budgetary processes from political influence.

Excerpts from Todd’s article:

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The move back toward political cooperation and consensus could help address the sharp reduction in government spending that has arisen in the absence of a formal, detailed government budget for 2012/13—known in some circles as Nepal’s “fiscal cliff”.

There are several reasons for this regrettable state of affairs. First, the 2011/12 government budget was under-executed—particularly for investment spending where only about 73 percent of the budget was actually spent. This under-performance was then used as the base for the spending ordinance passed in late November 2012.

Second, the 2012/13 budget ordinance of Rs 351 billion is a nominal figure—taking no account of inflation. So if projections for year-end inflation turn out to be accurate, spending could fall by another 9 percent in real terms.

The lack of a full budget with line-item allocations has further dampened expenditures. The budget ordinance was politically expedient, but lacked the detail that would allow government ministries to spend—and spend wisely.

Consequently, more money is being taken out of the economy via tax than is being put in by expenditure. As a result, government deposits are rising at the central bank, and liquidity available to commercial banks has dropped, putting upward pressure on interest rates and challenging monetary policy.

[…]Quick executive action on an appropriation ordinance (to allow line ministries to spend) would be the first step. Speeding up the approval process for investment projects would also help. Looking ahead, another year of badly-needed economic growth should not be lost to infighting and indecision over the next budget. The risks are high given the short time left to hold elections and forge a new consensus government before the beginning of the 2013/14 fiscal year in July. Political cooperation is needed to put the budget above the political fray, manage government spending in line with existing national priorities, and “do business” as normally as possible. How this is to be done should be decided now, as the budget is being formulated. Transparency and an inclusive dialogue on budget priorities should be an integral part of political parties’ agenda for the next several months, with the common objective of starting 2013/14 with a full-year budget in place. This opportunity to step back from the edge of Nepal’s fiscal cliff should not be missed.

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Todd has hit the nail on the head here. Highly recommended article.

Even if we account for 10% inflation, the actual expenditure allocation should have been around Rs 396 billion (including Rs 7 billion for election and Rs 3 billion for rehabilitation of Maoist combatants). The budget allocation is usually higher than actual expenditure, probably around Rs 430 billion for FY2013.

The political parties need to reach a consensus that FY2014 budget will not end up having the same fate as FY2013 budget. If not, there will be even more real expenditure contraction (and even more steeper ‘fiscal cliff’). For the sake of accounting purpose as well, Nepal needs to present a full budget for FY2013 however late it is, and set the stage for a full budget for FY2014. More on these in later blog posts when I have free time.

Fostering competitive spirit among federal states

Milan Vaishnav of Carnegie Endowment explains the lack competition in good policy formulation, experimentation and implementation among Indian states in this article. He states: “Federalism, in theory anyway, creates a marketplace for public policy, in which the best policies eventually take hold and are replicated across units, while the worst are relegated to the dustbin of history.”

Excerpts from the article below:

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The nature of federal fiscal relations, the concentration of power in state capitals and the absence of a venue for cross-state exchange of ideas are all biased against a more competitive federalism in India. If India’s states are to truly serve as effective laboratories for improving public policy, they must be liberated from these institutional impediments. Institutions are notoriously sticky, yet there are a few signs of hope on the horizon. Notwithstanding incentives to the contrary, India’s states often do manage to spur policy experimentation—but it just is not always clear how these experiments add up. We have Chhattisgarh linking smart cards to the Public Distribution System, Andhra Pradesh evaluating the impact of contract teachers on primary education, Gujarat reforming electricity by linking higher user fees to guaranteed service provision—the list goes on. This demonstrates that state governments can take initiative and ministers are able to carve out space to experiment when the conditions are right. But the next step is much harder: fostering an environment of learning across states. One positive development in this regard is the Planning Commission’s recent proposal to streamline the number of centrally sponsored schemes while increasing the amount of flexibility that states have with respect to programming funds. According to the draft proposal, centrally sponsored schemes would set aside up to 20 percent of allocated funds (10 percent for flagship schemes) for “flexible spending” by the states, which would give them the space to encourage local experimentation.

Inadvertently, the recent reform to allow greater foreign direct investment (FDI) in multi-brand retail could also provide a learning opportunity for states. Although it was characterized as a defeat at the time, the center’s decision to allow states to decide whether to the implement the new FDI regulations will create, as it were, a “treatment” and “control” group. Those states standing on the sidelines waiting to see whether the adopters sink or swim will have a golden opportunity to learn from their peers. If this counts as a policy defeat, India may well need many more like it.

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Trade finance gap in Asia is estimated at $425 billion

Based on a survey conducted in the fourth quarter of 2012 to identify and quantify gaps in trade finance, the Asian Development Bank (ADB), in its latest brief, estimates that $1.6 trillion of demand for trade finance is unmet (Asia’s share of unmet global trade finance is $425 billion).

Furthermore, it estimates an increase of 5% in availability of trade finance could result in an increase of 2% in production and 2% more jobs. Trade finance affects trade volume, business expansion, and job creation.

For international banks, the main factors that was perceived to aggravate the trade finance gap are

• Previous dispute or unsatisfactory performance of issuing banks
• Issuing bank’s low credit ratings
• Low country credit ratings
• Basel regulatory requirements
• Issuing bank’s weak capacity
• Lack of dollar liquidity
• High transaction costs or low fee income

Does export promotion programs work in long term?

The evaluation of export promotion program in Tunisia shows that while beneficiaries initially saw faster export growth and greater diversification across destination markets and products, after three years the growth rates and the export levels of beneficiaries were not significantly different from those of non-beneficiary firms.

Excerpts from the paper by Cadot, Fernandes, Gourdon and Mattoo below:

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This paper evaluates the effects of the FAMEX export promotion program in Tunisia on the performance of beneficiary firms. While much of the literature assesses only the short-term impact of such programs, the paper considers also the longer-term impact. Propensity-score matching, difference-in-difference, and weighted least squares estimates suggest that beneficiaries initially see faster export growth and greater diversification across destination markets and products. However, three years after the intervention, the growth rates and the export levels of beneficiaries are not significantly different from those of non-beneficiary firms. Exports of beneficiaries do remain more diversified, but the diversification does not translate into lower volatility of exports. The authors also did not find evidence that the program produced spillover benefits for non-beneficiary firms. However, the results on the longer-term impact of export promotion must be interpreted cautiously because the later years of the sample period saw a collapse in world trade, which may not have affected all firms equally.

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Chart of the week: Favored channels of ODA delivery in fragile and non-fragile nations

Below is an illustrative chart (sourced from OECD’s publication Fragile States: Resource Flows and Trends) that shows the amount of aid money entering a country through various channels.

In Nepal, a large portion of foreign aid goes "non reported" and those reported are channeled through public sector, followed by NGOs, multilateral agencies, and others. No aid flowing through PPP (understandably so considering the lack of viable PPP institutional and regulatory frameworks). The report notes that Nepal is chronically under-aided (p.88, Box: 3.1).

NEPAL: Interesting flights data in FY2012

Here are interesting stats that I picked up from Sangam’s article in The Kathmandu Post:

• Domestic passenger movement dropped 0.55 percent to 1.575 million in 2012 (attributed to high domestic prices due to high fuel charges, less bandhs and more luxury coaches, slow economic growth and real estate activities, and low capital spending).
• The Nepali skies saw 70,877 flights in the review period, a drop of 10.49 percent.
• An average 195 planes took off and landed at TIA daily (Thats about 16 take offs and landing per hour if the domestic terminal opens for 12 hours a day).
• High fuel surcharge:
• Flying from Kathmandu to Bhadrapur now costs Rs 6,550 (Rs 3,250 fare and Rs 3,300 fuel surcharge), compared to Rs 4,200 in 2010.
• The normal airfare to Pokhara has soared to Rs 4,035 from Rs 2,500 two years ago. Fuel accounts for more than 30-35 percent of their overall operating cost
• Oligopolistic market:
• Buddha Air secured 60 percent of the market share among the seven commercial domestic airlines. The carrier flew 881,611 travelers in 2012, up 27.59 percent. Yeti Airlines took 28.74 percent.
• Yeti flew 452,806 travellers in 2012, a slim growth of 0.74 percent compared to 2011.
• Apart from these two rivals, all five airlines saw a negative growth.
• Collapse and irregular operation of struggling airlines like Agni Air, Guna Airlines and Sita Air benefited Buddha and Yeti.

Value added trade and global value chains

The global trade landscape is changing along with the development of sophisticated global value chains (intra-firm or inter-firm, regional or global). The gross trade figures hide the real value addition that takes place while a good or service is produced in a country or across countries. The WTO already has a website that details value added trade. Here is an earlier blog post based on it. Also, here is more on why value added is a better measure of trade.

In its latest report on global value chains, the UNCTAD argues that 80% of global trade takes place in value chains linked to transnational companies. It states that as much as 28% of gross exports is actually double counted due to non adjustment of value addition during each production process scattered across many countries. It also shows that production and trade of goods and services are linked at some stage.

It recommends developing countries to “engaging” in GVCs, “upgrading” along GVCs, and “leapfrogging” and “competing” via GVCs. The ideal outcome for developing countries would be to an increase in global value chain participation with higher value added goods and services. GVCs participation could help developing countries build their productive capacities (through technology dissemination and skill enhancement).

Excerpts from the latest UNCTAD report:

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GVCs make extensive use of services. While the share of services in gross exports worldwide is only around 20 per cent, almost half (46 per cent) of value added in exports is contributed by services sector activities, as most manufacturing exports require services (such as engineering work, software development, and marketing) for their production. In fact, a significant part of the international production networks of TNCs is geared towards providing services inputs, with more than 60 per cent of global foreign direct investment (FDI) channelled to services activities. By comparison, 26 per cent of FDI goes to manufacturing and 7 per cent to the primary goods sector. The picture is similar for developed and developing economies.

The majority of developing countries, including the poorest, are increasingly participating in GVCs. The developing-country share in global value-added trade increased from 20 per cent in 1990 to 30 per cent in 2000, and is over 40 per cent today. Again, the role of TNCs is critical, as countries with a higher presence of FDI relative to the size of their economies tend to have a higher level of participation in GVCs and a greater relative share in global value-added trade compared to their share of global exports.

GVC links in developing countries can play an important role in economic growth. Domestic value-added – that is, an improved capacity of an economy to produce a broader variety of goods, and goods of greater complexity – resulting from GVC trade can be very significant relative to the size of local economies. In developing economies, value-added trade contributes some 28 per cent to countries’ GDPs on average, as compared to 18 per cent for developed economies. Furthermore, there appears to be a positive correlation between participation in GVCs and GDP per capita growth rates. The economies with the fastest-growing GVC participation have GDP per capita growth rates some 2 percentage points above average.

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