Exports and cost of production in Nepal and India

Here is an interesting article about how the rising cost of production and the resulting loss of overseas markets are shifting carpet production from low-end to high-end lately.

Excerpts from the article:

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Hurt by rise in production cost of carpets and tough competition in the market, Nepali carpet producers and exporters have shifted focus on high-end carpets on which competition is relatively low.

Nepali exporters are facing tough time retaining their market in overseas countries due to flooding of cheaper low-quality carpets there.

“We are gradually losing our markets for normal carpets. To stay in the business and beat our competitors, we are gradually switching to production and export of high-quality carpet,” Anup Bahadur Malla, president of Nepal Carpet Exporters´ Association, told Republica.

Lengthy economic slowdown in European countries and high competition in US has dragged down the demand for Nepali carpets as customers there prefer cheaper carpets supplied by other countries.

“That is why we are putting focus on high-end carpets on which we have comparative advantage,” said Malla. He further added that share of high-end carpets on total carpet exports has increased to around 50 percent from less than 20 percent recorded a couple of years ago.

Nepali entrepreneurs are producing and exporting 100-knot carpets which are made from a mixture of natural fiber and wool.

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Cost of production

Excerpt related to the cost of production in Nepal and India.

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Cost of production of 60-knot carpet hovers around $80 per square meter. Production cost of the same variety hovers around $45 per square meter in India, according to the exporters.

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It is not that Nepal’s production (export sophistication) is shifting up the value chain due to product innovation and high productivity. The incongruous shift in production to high-end carpets is due to the compulsion arising from the inability to compete in even low-end production— an odd phenomenon given that Nepal still has one of the lowest per capita GDP in Asia and is largely an agriculture-based economy [but high consumption is fueled by increasing remittance inflows, which fund burgeoning imports]. Traditionally, with this sort of income level, comparative advantage should be on the production of low value added goods and services due to cheap labor costs, and as innovation kicks in and income rises, production shifts to high value added goods and services. It is essentially a structural transformation from low value added production, low productivity sectors (usually comparative advantage based) to high value added, high productivity sectors (both comparative as well as competitive advantage based). Also, increasingly high productivity in agriculture sector usually provides a foundation for high growth in industrial sector.

Unfortunately, this is not happening. Due to low growth and the dearth of job opportunities, thanks to protracted political uncertainty and half-hearted policy initiatives on this front, a large number of youths are going abroad for jobs, consequently creating a shortage of workers in almost all sectors. As an upshot of this, share of remittances backed, consumption driven services sector is growing at a rapid pace (about 50% of GDP) while industry sector is squeezing (about 15% of GDP, which is almost equal to the share of retail and wholesale trade).

Some might argue that its like in India where services sector is also huge and growing relative to agriculture and industry. However, in Nepal’s case, the rising share of services sector in GDP is not coming from high value added production (ITC, BOPs, innovation, etc.), but from low value added production, which too is dependent on remittances for growth (exogenous factor). Hence, the whole process is not ‘organic’ but kind of distorted (and without much multiplier effect).

A course correction is needed, which will require boosting productive capacity of the economy (supply-side stuff driven by both public and private investments) and the proper management of increasing remittance inflows so that more of it is spent on capital formation and less on consumption (currently stands at 2.4% and 78.9%, respectively).

Anyway, going back to the faltering exports, below are some of the reasons, mostly arising from rise in production costs (more here):

• Political instability and strikes, and its impact on production costs
• Lack of electricity (also see this, this and this)
• Poor industrial relations, plus highest minimum wage in South Asia but low productivity
• Lack of innovation and R&D by private sector, and reliance on concessions for survival
• Policy inconsistency and policy implementation paralysis
• High inflation, which increases nominal cost of production
• High cost of inputs (arising from globally high prices and lately the depreciation of Nepali rupee against third currencies)

With this background, the solutions to break this cycle are no-brainer!

Remittances revisited: Bilateral remittance inflows to Nepal

A lot has already been written about remittances in Nepal. Below I present two charts showing bilateral remittance inflows in 2011 and the total monthly inflows to Nepal over the years. All data sourced from the World Bank’s database and this latest brief.

In 2011, Nepal received an estimated US$4.22 billion in remittance from 30 countries. The top five destinations were Qatar (US$1.69 billion), India (US$1.39 billion), the US (US$276 million), the UK (US$192 million), and Thailand (US$112 million). Remittance inflows in 2011 was about 22% of GDP, making Nepal the six highest remittance receiver (as a share of GDP).

The table below shows the latest estimates of remittance inflows for 2012 (previous estimate here). It is in an increasing trend. Total remittance inflows in 2012 is estimated at US$4.95 billion.

Migrant remittance (US$ million)
Year	Inflows	Outflows
2008	2727.1	5.3
2009	2985.6	12.3
2010	3468.9	32.4
2011	4216.9	39.2
2012e	4953.3

Nepal's economy is largely dependent on remittances and migration for growth (services sector), consumption, imports, poverty reduction, jobs, and overall macroeconomic stability.

Remittances have been crucial in supporting services sector growth, which then affects overall economic growth. The expansion of services sector to over 50% of GDP is partly attributed to the rise in consumption demand backed by remittances. Its impact is quite visible in sectors such as real estate and housing, financial intermediation, retail and wholesale trade, transportation and communication, hotels and restaurants, and education. Similarly, it has ensured external sector stability by pushing current account and balance of payments in surplus despite ballooning trade deficit. Had it not been for remittances, Nepal would not have been able to afford such a high level of imports (around 25% of GDP). Foreign exchange reserves contribution by remittances is about 63% (24% of GDP). Gross national savings are also high (35% of GDP).

Meanwhile, it has supported revenue mobilization, with about 70% of tax revenue coming from customs duty and consumption tax (consumption fueled imports supported by higher purchasing power due to high remittances).

At the household level, the decline in poverty and inequality (Gini coefficient based on consumption) is largely attributed to increasing remittances, which 56% of households received in 2011. Household consumption is primarily financed by remittances (about 79% of remittance is used for consumption purpose). Similarly, the extra boost to income from remittances has enabled households to send children to private schools and afford better healthcare services.

At the institutional level, it has fostered policy complacency as policy makers do not have to do much to balance the macroeconomy or reduce poverty as it is automatically done by remittances. Unfortunately, it is leading to a ‘vicious policy cycle’—high inflow of remittances is exerting low pressure to improve policy weaknesses, which then is leading to inadequate investment climate reforms and low private investment. It leads to subdued growth rate with limited job opportunities, forcing more migration and more inflow of remittances.

The biggest risk to Nepal’s economy is to sustain this process. Given the lackluster policy attention devoted to this issue, it is unlikely that the policymakers will do anything substantial to address the issues in the near future. Nepal needs to channel remittances to productive usages, especially to finance long term development needs such as infrastructure, urban development and municipal services. The main challenge for the government, private sector, and development partners is to find out a way to decrease remittance income going to consumption and channel it to productive usages. As of now, only 2.4% of remittance income of a household is used for capital formation.

India’s existing economic institutions could not cope with strong growth: Raghuram Rajan

Raghuram Rajan, the chief economic adviser to India’s Ministry of Finance, argues that economic growth slowed down in India due to two reasons:

• As India’s existing economic institutions could not cope with strong growth, its political checks and balances started kicking in to prevent further damage.
• Investment slowdown began as political opposition to unbridled development emerged. The resulting supply constraints exacerbated inflation.

He prescribes the following solutions:

1. India must improve supply, which means shifting from consumption to investment.
• By creating new, transparent institutions and processes, which would limit adverse political reaction.
2. Over the medium term, axe the thicket of unwieldy regulations.
• One example of a new institution is the Cabinet Committee on Investment, which has been created to facilitate the completion of large projects. By bringing together the key ministers, the committee has coordinated and accelerated decision-making, and has already approved tens of billions of dollars in spending in its first few meetings.
3. India needs less consumption and higher savings.
• The government has tightened its own budget and spent less, especially on distortionary subsidies.
• Households also need stronger incentives to increase financial savings.
• New fixed-income instruments, such as inflation-indexed bonds.
• Lower inflation.
• Lower government spending and tight monetary policy are contributing to greater price stability.

Urbanization and politics in Bangalore

Here is an interesting article about the urbanization challenge in Bangalore, the IT hub of India, that has a population of 8 million and more than 5 million vehicles ply the city’s roads.

Below is an excerpt from the article:

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In the heart of the city, a Congress party candidate, Dinesh Gundu Rao, greeted voters in a middle-class neighborhood this month. His campaign workers burst firecrackers, beat drums and showered him with marigold petals. Women peeped from balconies and windows. “Remember to vote for me, sister,” Gundu Rao called out.

“Remember to get clean water for us,” replied a woman in a green sari. Another told him about the broken sewage pipes, and a third pointed to a foul-smelling garbage pile on the road.

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Very much applicable to Nepal's rapidly growing urban centers as well.

Nepal-India Trade: State of non-tariff barriers

[This blog post is sourced from one of the studies (workshop presentation slides here) yours truly was involved in about a year ago while working at SAWTEE. I think sharing analytical excerpts from the comprehensive report will be helpful to interested readers and researchers. This blog post focuses on non-tariff barriers on Nepali exports to the Indian market. Here are earlier blog posts on the state of tariff barriers and para-tariff barriers; the issues surrounding pegged exchange rate between Nepal and India; the confidence on the Indian rupee in Nepal; and the size of Indian market for Nepal.]

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State of non-tariff barriers

[Unless otherwise noted, most of the information in this section is sourced from Trade Policy Review of India by the WTO Secretariat, (WTO 2011)]

The Indian government requires importers to satisfy various procedural measures. According to Doing Business 2012, it takes 9 documents, 20 days and US$1070 per container to import goods into India.

Table 1: Import procedures in India

Import procedures	Duration (days)	Cost (US$)
Documents preparation	8	400
Customs clearance and technical control	4	120
Ports and terminal handling	5	200
Inland transportation and handling	3	350
Total	20	1,070

Source: World Bank

Meanwhile, the following import documents are required to import goods in India for various purposes, including imports for consumption, warehousing, transshipment, transit, re-importation, and imports for special economic zones (SEZs):

• Bill of entry/landing
• Cargo release order
• Certificate of origin
• Commercial invoice
• Customs import declaration
• Inspection report
• Packing list
• Technical standard certificate
• Terminal handling receipts

Importers need to file a bill of entry either electronically (Electronic Data Interchange system—EDI) or manually. They also need to fill in supporting documents such as packing list, and bill of lading/airway bill if the bill of entry is processed manually. Furthermore, import licence, whenever it is applicable, must be obtained from the Director General of Foreign Trade (DGFT) and sanitary and phytosanitary certificates from the Ministry of Agriculture. Custom declaration should also be submitted.

For goods imported under a preferential trade agreement or under an export incentive scheme and for qualification for duty reduction, additional documentation such as country of origin (COO) is required. It applies to most of the Nepalese goods exported to India. According to the Indian Customs’ rule, the bill of entry may be filed prior to the arrival (within 30 days of arrival) of goods to allow for faster clearance. Furthermore, a landing charge (for loading, unloading, and handling) of 1% of the c.i.f. value is added to the c.i.f. value to compute transaction value.

Goods imported for consumption in the Indian market are cleared after payment of applicable duties and charges. But, for imports cleared for warehousing, a bill of entry, filed with all supporting documents as required for goods for home consumption is required. The applicable duty is determined by Custom and is paid at the time of ex-bond clearance, for which an ex-bond bill of entry[1] has to be filled. The final duty rate is determined when an import declaration is presented for warehoused goods to be imported into the domestic tariff area (DTA). The warehoused goods may be moved from one warehouse to another without payment of taxes (including inter-state taxes). Inter-state tax would be payable only if the movement from one warehouse to another constitutes an inter-state sale on which case the transaction would be subjected to sales tax, entry tax (charged by some states[2]), and octroi if goods are sold to a warehouse located in the State of Maharashtra.

There could be delay in clearance of goods exported to India for the following reasons, for which a custom officer may raise doubt:

• A significantly higher value at which identical or similar imports at (or about) the same time, in comparable quantities and comparable commercial transaction, were assessed
• The sale value involves an abnormal discount/reduction from the ordinary competitive price
• The sale involves special discounts limited to exclusive agents
• There are mistakes in the declaration of goods such as description, quality, quantity, country of origin, and year of manufacture or production
• The import declaration is incomplete, e.g. lack of brand, grade, and any other specification that could have a bearing on assessing the value of the goods
• Fraudulent manipulation of documents

Rules of origin (ROO)

Preferential rules of origin are applied under regional and bilateral trade agreements. The maximum foreign content requirements range from 30 percent to 70 percent. For Nepal, it is 70 percent and change in 4-digit tariff classification. The other criteria to determine origin is sufficient transformation and change in tariff classification. There are also product specific ROO under the SAFTA (for 180 products).

Table 2: India’s ROO under PTAs, 2011

Preferential trade agreements	Maximum foreign content requirements	Minimum cumulative local content requirements
South Asian Free Trade Areas (SAFTA)a	60% of the f.o.b. value (LDCs:  70%;  Sri Lanka:  65%) and change in tariff classification	50% of the f.o.b. value, 20% of the f.o.b. valueb and change in tariff classification
South Asia Preferential Trade Arrangement (SAPTA)	60% of the f.o.b. value (LDCs:  70%)	50% of the f.o.b. value (LDCs:  40%)
Nepal	70% of the f.o.b. value and change in four-digit tariff classification	n.a.
Least developed countries (LDCs)	70% of the f.o.b. value and change in tariff classification for not wholly produced or obtained category	70% of the f.o.b. value and change in tariff classification for not wholly produced or obtained category

n.a.    Not applicable.
a    Product specific ROO apply.
b    Domestic value content in the exporting country.

Source: WTO. 2011. Trade Policy Review India: Report by the Secretariat. Trade Policy Review, Geneva: World Trade Organization (WTO).

Import restriction depending on import price

The imports of certain goods (24 tariff lines) are subject to import restrictions depending upon their import price (see Table 2). These imports are restricted (i.e. subject to a license) when the c.i.f. price is lower than the minimum price. According to the Indian authorities, the minimum import prices are set taking into account domestic and international prices and quality (WTO 2011).

Table 3: Items whose import is free, subject to minimum import price, 2010/11

HS code	Description	Minimum import price
0802.90.11	Betel nuts:  whole	IRs 35/kg
0802.90.12	Betel nuts:  split
0802.90.13	Betel nuts:  ground
0802.90.19	Betel nuts:  other than above
4012.11.00	Retreaded tyres, of a kind used on motor cars,	US$175/unit for buses, lorries, bigger size vehicles, and light commercial vehicles
4012.12.00	Retreaded tyres:  of a kind used buses or lorries
4012.13.00	Retreaded tyres:  of a kind used on aircraft	US$25/unit for passenger vehicles
4012.19.10	Other tyres:  for two wheelers
4012.19.90	Other tyres
4012.20.10	Used pneumatic tyres:  for buses, lorries, and earth moving equipment	US$175/unit
4012.20.20	Used pneumatic tyres:  for passenger automobile vehicles	US$25/unit
6802.10.00	Tiles, cubes, and similar articles	US$50/kg
6802.21.10	Marble tiles
6802.21.20	Marble monumental stone
6802.21.90	Other monumental or building stone
6802.91.00	Marble, travertine, and alabaster
6802.92.00	Other calcareous stone
6810.11.10	Cement bricks	US$50/kg
6810.11.90	Other building blocks and bricks
6810.19.10	Cement tiles for mosaic
6810.19.90	Other articles of cement
6810.91.00	Articles of cement:  prefabricated structural components for building or civil engineering
6810.99.10	Concrete boulder
6810.99.90	Other articles of cement

Source: WTO. 2011. Trade Policy Review India: Report by the Secretariat. Trade Policy Review, Geneva: World Trade Organization (WTO).

Import quotas

India maintains import quotas for marble and similar stones (HS 2515.11.00, 2515.12.10, 2515.12.20, and 2515.12.90) and for sandalwood (HS 4403.99.22). Quotas are established annually and administered on an MFN basis and it does not maintain bilateral quotas. Imports of the products in 415 sensitive items (up from 300 items in 2007) are monitored by the authorities. The monitored sensitive items include milk and milk products, fruits and vegetables, pulses, poultry, tea and coffee, spices, food grains, edible oils, cotton and silk, marble and granite, automobiles, parts and accessories of motor vehicles, products produced by small scale industries, and other products (bamboos, cocoa, copra, and sugar).

Anti-dumping and countervailing measures

India imposes anti-dumping duties and countervailing measures to protect domestic industry from the impact of unfair trade practices. The anti dumping duties may remain in place for five years unless revoked earlier or extended by the relevant authority. According to the WTO, between January 2006 and 31 December 2010, India initiated 209 anti-dumping investigations against 34 trading partners (WTO 2011). The products involved included chemicals and products thereof, plastics and rubber and products thereof, base metals, and textiles and clothing. As of December 2010, 207 anti-dumping measures were in force, compared with 177 on 30 June 2006. According to the WTO, India did not take any countervailing actions during the same period. Measures were applied on 30 trading partners.[3] The majority were applied on China (67 or 32.4 percent of the total), Korea, Rep. of (19 or 9.2 percent), Chinese Taipei (19 or 9.2 percent), Thailand (14 or 6.8 percent), the EU or its members states (12 or 5.8 percent), and Japan, Malaysia, and the United States (9 or 4.3 percent each).

Standards

Indian standards are established based on the provisions of the Bureau of Indian Standards (BIS) Act 1986 and BIS Rules 1987. The BIS is responsible for formulating and enforcing standards for 14 sectors. These include production and general engineering; civil engineering (as of 1 January 2011); chemical (15 October 2010); electro-technical (1 July 2009); food and agriculture (9 June 2010); electronics and information technology (1 April 2010); mechanical engineering (1 April 2010); management and systems (1 Oct 2010); metallurgical engineering (6 July 2010); petroleum, coal, and related products (1 July 2010); transport engineering (1 January 2011); textile (1 April 2008); water resources (1 April 2010); and medical equipment and hospital planning (1 January 2011).[4] There were around 18,623 Indian standards as of 31 March 2010 and about 84 percent were harmonized with international standards.

Table 4: Standards imposed by BIS, 2007-10

	Aug-07	Sep-08	2009/10a
Total number of standards in force	..	..	..
Total number of Indian standards in force	18,470	18,592	18,592
Per cent equivalent to international standards	..	..	84

..    Not available.
a    31 March 2010.

Source: WTO. 2011. Trade Policy Review India: Report by the Secretariat. Trade Policy Review, Geneva: World Trade Organization (WTO).

Certification and conformity assessment

Around 81 products are subject to the mandatory BIS certification mark.[5] As of May 2011 there were more than 1,000 products under voluntary certification. The requirements for the use of the BIS certification mark are the same for domestic and imported products. Foreign producers who wish to export products subject to mandatory certification must obtain a license from the BIS. Foreign manufacturers must set up a liaison/branch office in India to obtain a license if the BIS has not signed a MOU with the country where the manufactured goods originate. The fees under the Foreign Manufacturers Certification Scheme, in place since 1999, are INRs1000 for the application, US$300 for processing, US$2,000 for marking, and a unit rate fee, which varies according to the product. The BIS license is granted to the factory address at which the manufacturing takes place and the final product is tested to assess compliance with the relevant Indian standards. After receiving a license the user must pay an annual fee of INRs 1,000, as well as a quarterly fee for units of production marked. The latter is fixed according to product.

Labeling

Packaged commodities must bear a label securely affixed. These labels should include the: name, trade name or description of food contained in the package; ingredients used; name and address of manufacturer or importer; net weight or measure of volume (in accordance with the metric system based on the international system of units) of contents; item/package sale price (MRP INRs __) (inclusive of all taxes); month and year of manufacture or packaging; date of expiry[6]; license number where relevant; and name, address or e-mail if available of person or office to be contacted in case of a complaint.

For products containing natural flavoring substances, the common name of the flavors should be mentioned on the label. The label should also indicate the animal origin of gelatine in products that contain it. The Ministry of Health and Family Welfare has recently notified the quantitative ingredient declaration requirement as an additional labeling requirement for food. More specific labeling requirements exist for specified products, such as infant milk substitutes and infant foods, bottled mineral water, and milk products.

Labels must be in Hindi (Devnagiri script) and in English. In certain instances, they must be written in the language of the locality where the product is ultimately sold. This increases distribution costs, since India has 16 official languages, and food processing companies often do not know which pallet of food products will be transported to a specific State. The requirement that packaging must specify the maximum retail price of the product, including taxes, is a further complication, since sales taxes are levied at the state level.

Sanitary and phytosanitary measures (SPS)

The main institutions involved in the establishment and implementation of SPS measures for food items are the Ministry of Health and Family Welfare, the Department of Animal Husbandry, Dairying, and Fisheries; the Directorate of Plant Protection, Quarantine and Storage; the Bureau of Indian Standards; and other state government agencies.

The imports of animal products into India require sanitary import permits issued by the Department of Animal Husbandry, Dairy and Fisheries and the permits must be obtained prior to shipping from the country of origin. The Department approves or rejects the application after an import risk analysis on a case-by-case basis. Permits are valid for six months and may be used for multiple consignments. A sanitary import permit is not a license, but a certificate verifying that India's sanitary requirements are fulfilled. Some imports of animal products also require an import license issued by Director General of Foreign Trade. The imports of animal products are only allowed through designated ports where animal quarantine and certification services are available (Amritsar, Bangalore, Chennai, Delhi, Hyderabad, Kolkata, and Mumbai). Imports of fish products are allowed through the port of Vishakhapatnam (in the State of Andhra Pradesh) and the land custom station at Petrapole (for imports from Bangladesh only).

Imports of plants and plant materials are regulated under the Destructive Insects and Pests Act 1914, the Plant Quarantine (PQ) (Regulation of Import into India) Order 2003, and international conventions. All plant and plant material consignments must be accompanied by a phytosanitary certificate issued by the national plant protection organization of the exporting country and an import permit issued by the officer in charge of the plant quarantine station. Products listed in Schedule VII of the PQ Order 2003may be imported without import permit but may be required to fulfill other conditions, such as fumigation. As in the case of imports of animal products, imports of plant and plant products may only enter the Indian territory through designated ports.[7]If commodities are found free from pests, they are cleared for import. If not, they must undergo fumigation with the accredited fumigation operators according to the Schedules V, VI, and VII of PQ Order 2003.[8] Fumigation is done at the importer's cost.[9]

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[1] It is used for clearance from the warehouse on payment of duty and is printed on green paper. See here. Goods imported for home consumption are cleared under bill of exchange for same and for re-export purpose under ex-bond clearance.

[2] Entry tax on goods is levied in several states, including Jammu and Kashmir, Himachal Pradesh, Rajasthan, Uttar Pradesh, Uttaranchal, Haryana, Punjab, Andhra Pradesh, Karnataka, Tamil Nadu, Kerala, Bihar, Assam, Orissa, Arunachal Pradesh, Chhattisgarh, West Bengal, Maharashtra, Goa, Madhya Pradesh, and Gujarat.

[3] Australia; Belarus; Bulgaria; China; the EU; France; Germany; Hong Kong, China; Indonesia; Iran; Japan; Kingdom of Saudi Arabia; Korea; Malaysia; New Zealand; Oman; Qatar; Russian Federation; Singapore; South Africa; Sri Lanka; Sweden; Switzerland; Chinese Taipei; Thailand; Turkey; the United Arab Emirates; the United Sates; and Viet Nam (WTO document G/ADP/N/209/IND, 19 April 2011).

[4] Bureau of Indian Standards online information, "Composition of Technical Committees". See http://www.bis.org.in/sf/composition.htm.

[5] For items subject to mandatory certification, see Bureau of Indian Standards online information: http://www.bis.org.in/.

[6] For products containing aspartame, it should not be more than three years from the date of packing.

[7] For the list of seaports, airports, and land frontiers in operation through which imports of plants are allowed, see Plant Quarantine (Regulation of Import into India) Order 2003, Schedule I.

[8] There are 357 registered fumigation agencies for methyl bromide fumigation and 157 for aluminum phosphide fumigation.

[9] Fumigation generally takes 24 hours with methyl bromide, and 7 to 10 days with aluminum phosphide.

Capital spending and economic growth in Nepal

This blog post is adapted from the issue focus of the ADB’s latest Macroeconomic Update (April 2013).

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Need to accelerate capital spending

In addition to the declining capital budget allocation in recent years, the actual capital expenditure itself is consistently lower than the budgeted amount (Figure 1). The struggle and consistent inability to spend on time the allocated capital budget has put the issues surrounding the quality of spending on the backburner. For a developing country with tremendous need to scale up infrastructure investments to tackle head-on the binding constraints to accelerated economic activities, reduced as well as underspent capital budget is a cause of concern. ‘Crowding in’ of private investments has not happened due to the failure to ensure adequate physical prerequisites, including infrastructure. Consequently, it is not only having an impact on productivity, but is also suppressing economic growth and jobs creation below the potential. Scaling up both quantum and quality of capital spending is vital to creating the foundations for the lackluster growth to take off on sustainable path.

Figure 1: Receding capital expenditure

Source: ADB estimates based on data from Ministry of Finance

The budget allocation for capital expenditure was Rs 129.5 billion (38.3% of total budget) in FY2011, which dropped to Rs 92.6 billion (18.9% of total budget) in FY2012 and Rs 66.1 billion (16.3% of total budget) in FY2013.[1] While the budget utilization in the first six months of FY2012 was Rs 9.6 billion, it was Rs 7.7 billion in the corresponding period in FY2013, a decrease of 19.9%. The budget utilization in the same period in FY2011 was Rs 41.8 billion.

According to the line-wise budget headings for FY2013, capital expenditure consists of expenditure for the acquisition of fixed assets, including land acquisition, purchase and construction of building, furniture and fixtures, vehicles, machinery, public construction, capital improvement, and research and consultancy related to capital. Compared to the level of expenditure in the first six months of FY2012, expenditure in all of these headings except for capital formation, and research and consultancy declined in the corresponding period in FY2013 (Figure 3).[2] In the first six months of FY2013, capital expenditure was the highest in public construction (Rs 5.9 billion), followed by building construction, research and consultancy, capital improvements and land acquisition, among others. Capital spending usually starts to pick up beginning mid-year and then accelerates in the last trimester. Unfortunately, on top of low capital budget this fiscal year, expenditure has failed to pick up thus far. Even more worrisome is the indication that expenditure under public construction (roads, bridges, airports and other productive assets), which registered a negative growth of 16.6% in the first half of FY2013, is not going to pick up as expected.

Figure 2: Mid-year capital expenditure

Source: Mid-term FY2013 Budget Review, Ministry of Finance.

The lack of a timely full budget has been the main factor behind the low and ineffective capital expenditure. In FY2012, the delay in unveiling a full budget led to a dismal capital expenditure (about 3.3% of GDP, down from about 6.5% in FY2011). Worse, the delayed full budget for FY2013 has created shortage of funds in many development projects, including those funded by development partners. The projects supported by ADB alone are facing budget constraints of about Rs 17 billion.[3] As a result, disbursements of all donor-funded projects have been low. This will delay the completion of several development projects and programs. The procedural delays in requesting authorization for release of funds and the cumbersome procurement processes have further delayed capital spending. It is very likely that actual capital expenditure in FY2013 might be below 3.0% of GDP, which is lower than the level reached in FY2012.

The inability to ramp up capital spending is affecting the financial sector as well. On a cash basis, the government was running a surplus of about Rs 44 billion in the first six months of FY2013. The inability of the government to spend money, which usually flows via the banks and financial institutions, on time is also contributing to liquidity constraints. Consequently, the interbank lending rate is gradually increasing and reached 2.3% in the seventh month of FY2013, from 0.5% in the first month (Figure 17). Additionally, public capital expenditure dependent sectors (Figure 24) such as construction are not expected to pick up this year as well from a negative growth last year.[4] It not only affects employment creation, but also revenue mobilization, overall economic growth rate, and poverty reduction.

Figure 3: Construction sector and construction related capital spending, FY1975-FY2011

Source: ADB estimates based on data from MoF and CBS.

During the rest of FY2013, the government needs to accelerate capital spending through expedited approval of funding requests for projects, and allocating and releasing adequate funds for projects facing funding constraints, while cutting down delays in procurement process. However, it is also critical that the government is mindful of the quality of capital spending by ensuring sound allocation and quality utilization of the funds through sufficient internal and external control. Towards accelerating capital spending and augment its impact on economic growth, revenue mobilization, and job creation, the government should prepare and unveil a timely and full budget in FY2014 with sufficient capital budget allocation. At the same time, actions to enhance accountability and transparency of public management need to be accelerated, including the reforms for public financial management, public procurement, and other public governance functions.

 

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[1] The partial budget initially allocated Rs 51.3 billion (14.6% of partial budget) for FY2013.

[2] Further disaggregated data is not available yet.

[3] Based on ADB’s Second Quarterly Country Portfolio Review (QCPR) assessment.

[4] Figure 3 depicts the close relationship between construction sector (which is one of the components of GDP) and construction related capital spending by the government. It also shows the contribution of construction sector to GDP growth (computed as the share of construction in GDP multiplied by construction sector’s growth rate). Construction related capital spending consists of actual government expending in land development; industry & mining; transportation (roads, bridges, aviation & others); and electricity. On an average, these spending cumulatively account for over 50% of total capital spending.