Saturday, March 15, 2014

In-depth analysis of Nepal’s export competitiveness

I. Introduction

Despite being a member of multilateral and regional trade blocs, and having entered into bilateral free trade agreement with India, Nepal’s export performance has remained weak. Nepal has been unable to fully utilize the market access and tariff concessions offered by trading partners, primarily due to crippling supply-side constraints. These have become strong and persistent constraints to export competitiveness. As a land-locked country and with its currency pegged to the Indian rupee, Nepal’s trade concentration (and deficit) with India is notably high. Over the years, the composition of its export basket has hardly changed. Given its strategic location between India and the People’s Republic of China (PRC), and the market access concessions received so far, there exists a huge opportunity to not only reduce trade deficit by increasing exports and substituting imports, but also to stimulate economic activities and create jobs by promoting export-oriented industries.

II. Export Performance and Structure

Nepal’s export performance has been dismal, with the export growth lagging far behind import growth and its share in GDP shrinking. While merchandise exports grew by an average of 0.7%, merchandise imports grew by 13.6% over FY2009-FY2013.[1] Exports reached as high as 13.1% of GDP in FY2000. Since then, it has declined consistently, reaching just 4.5% of GDP in FY2013 (Figure 1). The export basket is dominated by light manufactured and agriculture goods (66% and 23.5%, respectively, of total exports in FY2013). Export of manufactured goods also peaked in FY2000 (9.8% of GDP). It has declined since then, bringing down total exports. Export of manufactured goods was a mere 3% of GDP in FY2013. Nepal exported US$633 million of manufactured products in FY2011. The main manufacturing exports are textiles and fabrics, iron and steel, readymade garments, and non-ferrous metals (Figure 2). Exports to India account for about 60% of Nepal’s total export (Figure 3).

Figure 1: Evolution of exports, FY1976-FY2013

Source: Nepal Rastra Bank

Figure 2: Composition of export in 2011 (US$907.6 million)
 
Source: UN COMTRADE

 Figure 3: Direction of manufacture exports in 2011

Source: UN COMTRADE

The degree of production specialization is declining.  While the level of overall specialization has been low for a long time, a particularly worrisome aspect is the rapid decline of specialization in producing labor-intensive and resource-intensive manufactured goods, which was positive up until FY2007 (Figure 4). Furthermore, Nepal’s existing export capabilities are not advanced as the export basket is dominated by low-value added agriculture and manufactured products. Assets and capabilities (embedded knowledge) required to produce a particular good are normally imperfect substitutes for producing another good of similar nature (differentiated in some aspects only). Hence, the probability that Nepal produces a new export item is closely related to the closeness (or proximity) of that product with another product it is already producing.[2] In this sense, given that Nepal’s installed capabilities are concentrated in the production of low-value added manufactured and agriculture products, the potential comparative advantage in the production and export of new products is also linked to the existing capabilities. With the existing set of infrastructures and other pre-requisites for export competitiveness, the new export products will likely be somewhat similar, in terms of value addition and production capabilities, to the existing ones.[3] There is hardly any substantive change in the composition of the export basket and market diversification (Figure 5).

Figure 4: Specialization index

Source: United Nations Conference on Trade and Development (UNCTAD)

Note: The specialization index compares the net flow of goods (exports minus imports) to the total flow of goods (exports plus imports). The index ranges from -1 to 1, with positive value indicating that an economy has net exports (implying that the country also specializes in the production of that product). Negative value indicates that the country imports more than it exports (resulting in net consumption). This measure of specialization, which can be computed at each product level, normalizes trade balance and enables comparison across countries and product groups by removing biases arising from the size of the economy.

Figure 5: Composition of export basket in 2003 and 2010


Source: The Growth Lab, Center for International Development, Harvard University; http://www.hks.harvard.edu/centers/cid/programs/growth-lab
Note: The charts are called “Tree maps”. The total area represents total exports of Nepal in a given year. The smaller rectangular areas represent the share of each product in total export. The exported products are grouped according to the broader commodity group they belong to (SITC rev.2 code) and are colored accordingly. For instance, red color shows the group of manufacturing goods. The percentage shows the share of trade represented by that good.

A jump from the existing basic production capability (low-value added manufactured and agriculture products) to a more complex production capability (high-value added manufactured and agriculture products, electronics, and equipment)will require greater provision of critical infrastructures, technology transfer and adoption, competitive environment and innovation, enhancement of skills, supportive regulatory and institutional frameworks, and overall macroeconomic stability. These will also contribute to a meaningful structural transformation that is characterized by a high and inclusive growth together with an equitable rise in per capita income.

III. Treaties and Policies

Nepal is the first Least Developed Country (LDC) to become a member of the World Trade Organization (WTO) (on 23 April 2004) through a full working party process. Its membership was approved at the Cancun Ministerial Conference in September 2003. Nepal is also a member of two regional trade agreements (RTAs), namely the Agreement on South Asian Free Trade Area (SAFTA) and the Bay of Bengal Initiative for Multi-sectoral Technical and Economic Cooperation (BIMSTEC) Free Trade Agreement (FTA).[4] Similarly, Nepal has signed a FTA, which is reviewed and renewed every seven years, with India.[5] Nepal’s exports are also getting preferential access under Generalized System of Preferences (GSP) to developed countries’ markets. Furthermore, the European Union has offered duty-free, quota-free access to all export items under its ‘Everything but Arms’ initiative. Regarding trade promotion and investment, Nepal signed the Trade and Investment Framework Agreement with the United States in 2011, and bilateral investment protection and promotion agreements with France, Germany, the United Kingdom, Mauritius, Finland, and India.

In addition to these treaties, Nepal has initiated a number export promotion programs and policies. Nepal’s medium and long term plans and policies highlight the need to boost exports by enhancing value addition, mainstreaming trade, and increasing employment in trade-related sectors. The approach paper for the new Three-Year Plan (FY2014-FY2016) sets targets of NRs100 billion worth of exports by FY2016, NRs1 billion of export of each product listed in the Nepal Trade Integration Strategy (NTIS) 2010, and reduction of the trade deficit to 20% of GDP (from the existing 27% of GDP). The government also rolled out an updated trade policy in 2009 with an objective to reduce the trade deficit by promoting exports, and to boost income and employment opportunities in trade related activities.[6] Consistent with the main objectives of Trade Policy 2009 and to formulate an export-led inclusive growth strategy, the government adopted the Nepal Trade Integration Strategy (NTIS) 2010. It identified 19 key commodities and services[7] with ‘export potential’, the major export destinations for them, and product-specific promotion strategies.

The Industrial Policy 2010[8] emphasizes high-value added production, employment generation, promotion of domestic industries, and facilitation of forward and backward linkages in the industrial sector. Its specifies the provision of additional facilities and incentives such as customs and excise duty refund on imported raw materials and intermediate goods if they are used in the production of export items. It also aims to promote Special Economic Zones (SEZs) and institute a ‘one-window’ policy for all industrial activities.

Given the export performance so far, Nepal has not been able to fully utilize the benefits that come with being a member of the multilateral and regional trading blocs, and the market access concessions offered by the developed countries. Furthermore, the trade and investment promotion policies are not effectively implemented to boost exports. Both external and internal factors have contributed to this, but the latter one seems to be more crippling than the former.

IV. Crippling Constraints

External constraints include non-tariff barriers (NTBs) such as rules of origin, and technical, sanitary, and phytosanitary standards related barriers. Even if tariff barriers are coming down and almost 97% of export items are accorded duty free, quota-free access to the developed countries’ markets, the NTBs are somewhat negating the potential gains by increasing fixed costs, thus eroding cost competitiveness. Nepal faces sanitary and phyto-sanitary barriers to market entry in the OECD countries, India, and PRC.[9] Similarly, technical barriers and hassles at customs point are more prevalent in the region, including PRC. Government support in the form of subsidies to key sectors such as agriculture in OECD countries and India has reduced relative competitiveness of Nepal’s agricultural exports.

Internal constraints are more crippling than external constraints as they negatively impact production capacity of domestic firms and erode cost competitiveness of export items. Market access concessions (exogenous factor) alone will not promote Nepal’s exports. A key to boosting Nepal’s exports is to enhance its production and supply capacity, which currently continues to fall short of demand. In FY2013, the average capacity utilization of industries was just 58% (Figure 6).The major factors that affect supply capacity and erode export cost competitiveness are: (i) lack of adequate and quality infrastructure, (ii) political instability and strikes, (iii) recurring labor disputes, (iv) lack of skilled human resource, (v) deficient research and development investment and innovation in the private sector, and (vi) policy inconsistencies and implementation paralysis.

Figure 6: Capacity utilization of industries
Source: Economic Activities Report (FY2012 and FY2013), Nepal Rastra Bank
Note: Study areas were Kathmandu, Biratnagar, Janakpur, Birgunj, Pokhara, Siddarthanagar, Nepalgunj and Dhangadi

Lack of adequate and quality infrastructure: The inadequate supply of electricity has severely constrained both production and potential comparative advantages of Nepal’s exports. Firms are not able to operate manufacturing plants and machines at full capacity due to the shortage of electricity. They are compelled to depend on generators that use petroleum fuel to power machines, increasing cost of production and eroding cost competitiveness of goods. According to the Enterprise Survey 2013, the percentage of firms owning or sharing a generator jumped to 50.5% in 2013 from 15.8% in 2009. Furthermore, generators met, on an average, 34% of electricity demand. [10] About 69% of firms identified electricity as a major constraint in 2013.[11]

Similarly, the inadequacy of existing transport infrastructure and logistical hassles has also increased production costs and lowered export competitiveness. The major trade routes need upgrading as it is chocking the flow of traffic and increasing the cost of transportation. About one-third of the manufacturing firms identified bad transport facility as a major constraint in 2013. Furthermore, the lack of adequate facilities for warehousing, handling equipment, scanning machines, testing laboratories, and basic information and communication technology (such as harmonized automated customs management systems) have restrained trade flows. 13.  Nepal consistently stands out as a country with one of the poorest logistical and enabling trade infrastructures in the world. In fact, Nepal slipped to 151 position out of 155 countries in the Logistics Performance Index (LPI) 2012. It ranked 147 in 2010 and 130 in 2007.[12] On the specific components of LPI, while there has been an improvement in the customs score and ranking, it has deteriorated in the case of infrastructure and logistics competence (Figure 7). Similar is the case with Global Enabling Trade Ranking (GETR), which shows that the enabling environment, including trade-related infrastructure and customs, for trade has deteriorated over in the last couple of years. Nepal’s ranking deteriorated from 110 in 2009 to 118 in 2010 and 124 in 2012.

Figure 7: Nepal’s logistics performance ranking
Source: Logistics Performance Index 2012, World Bank
Note: The numbers in parentheses indicate the number of countries included in the ranking.

Political instability and strikes: Over the past few years, frequent political and union related strikes along the main trade routes have disrupted production and distribution of goods and services. This has led to an increase in the ‘lead time’ (the amount of time between the placing of an order and the receipt of the goods ordered), which together with the natural high trading costs of being a land-locked country have contributed to an increase in delivery costs. In South Asia, Nepal has the highest export lead time (days) for land supply chain[13] (Figure 8), largely due to the 777 km of land supply chain[14], which is the longest and the most expensive when compared with other countries in the region. According to Doing Business 2014, it still takes 11 documents, 42 days and US$2,295 to export a container (Figure 9 and Figure 10). Furthermore, the business community has repeatedly complained about the high costs imposed by truck syndicates, leading to rise in cost of production.[15]

Figure 8: Export lead time (days) for land supply chain)
Source: Logistics Performance Index 2012, World Bank

Figure 9: Documents, time and cost of export
 
Source: Doing Business 2014, IFC

Figure 10: Export across borders

Source: Doing Business 2014, IFC

Recurring labor disputes: The recurring labor disputes, especially after FY2006, have been one of the thorniest issues in the industrial sector. It has not only disrupted production, but also contributed to the loss of established markets abroad and the closure of domestic firms. The garment industry has been hit the hardest. Once the highest foreign currency earner, the industry is now struggling to maintain and fulfill orders in time, especially after the end of the Multi-fiber Agreement (MFA) in 2005. By abolishing the quota regime, the end of MFA created a level playing field for all garments exporters to the US, resulting in the loss of market share to low-cost yet competitive exports from other countries. Nepal has one of the highest minimum wages in South Asia (Figure 11), but also one of the lowest labor productivities.[16] On an average, the annual labor productivity growth contracted by 6.8% in 2013, much larger than the 4% dip in 2009.

Figure 11: Monthly minimum wage in South Asia ($, current prices)

Source: ILO Global Wage Report 2013

Lack of skilled human resource: The lack of qualified human resources as well as the shortage of workers due to large-scale migration has affected production. Garment and pashmina productions are hit by the shortage of workers of all skills range. The exodus of youths has put pressures on wages, increasing industrial sector wages by an average annual rate of 10% since FY2006. The gap between the demand for and supply of workers of all skills range has hampered production, operations, management and marketing of goods and services.

Deficient research and development: The private sector itself has not been able to scale up research and development investment and training of staff, resulting in hardly any major product innovation in the entire production chains. The Nepalese exporters seem to be more reliant on market concession abroad than promoting efficiency gains and innovation within their own factories. In 2013, 26.1% of firms on average had their own website and only 8.2% had an internationally recognized quality certificate. Furthermore, only 31.9% firms offered formal training to staffs.

Policy inconsistencies and implementation paralysis: While the government has introduced elaborate policies, their implementation remains weak. The trade policy introduced in 1983 was updated in 1992 and 2009, along with the formulation of elaborate sectoral promotion strategies for export potential goods (Diagnostic Trade Integration Study [DTIS] in 2004 and NTIS in 2010). For example, after two decades of delay, the establishment and operationalization of the special economic zone (SEZ) in Bhairahawa has finally been initiated without the passage of the SEZ Act. Similarly, the ‘one window’ facility for exporters and provisions like ‘no work, no pay’ remain unimplemented. Several institutional arrangements envisaged in the trade and investment policies have not been formed. In a way, there has been policy inconsistencies (instability) and policy implementation paralysis. There is a possibility that the existing set of policies and sectoral promotion strategies may be termed ineffective without first fully implementing them and taking adequate time to evaluate the actual output.

V. Export Opportunities

Due to the nature and scope of the FTA with India and the pegged exchange rate, there exists tremendous potential for Nepal’s exporters to cater to the increasing demand for goods and services in India.[17] The five border Indian states—namely Uttarakhand, Uttar Pradesh, Bihar, West Bengal and Sikkim—have a combined population of over 400 million, average real GDP growth of over 7%, and average real per capita income growth of over 6% (except in Uttar Pradesh, which had 5% growth over FY2008-FY2012). Furthermore, along with the agreement to upgrade trade infrastructure at new customs points and to provide assistance to enhance technical skills, a number of outstanding tariff, para-tariff and non-tariff barriers were resolved in December 2013 during the Inter-Governmental Committee meeting between Nepalese and Indian commerce secretaries. This was followed by the ‘Bali package’ agreed during the Ninth Session of the Ministerial Conference of the WTO in January. The Bali package, as a part of the agreement on trade facilitation measures, includes provision for assistance to LDCs to enhance their infrastructure and build capacities of customs administration. On top of these, China and several developed countries, including the US, have accorded duty-free, quota-free entry to almost 97% of exported items.

Against this backdrop and the recent weakening of Nepalese rupee against convertible currencies, which makes Nepal’s exports relatively cheaper, there exists opportunities for Nepal to boost exports by addressing some of the supply-side constraints even in the short term. Nepal could better coordinate and utilize Aid for Trade (AfT) offered by development partners to boost not only software but also hardware aspects of trade. Similarly, other trade related technical assistance (TRTA) and the support from Enhanced Integrated Framework (EIF) to enhance sectoral technical, marketing, branding and processing capacities could be fruitful.[18]

To tackle some of the supply-side constraints in the short term, the government needs to ensure proper implementation of some of the provisions outlined in trade and industrial policies, especially those related to the promotion of export-oriented sectors and the 19 sectoral support strategies elaborately detailed in the NTIS 2010.

In the long term, an important export product as well as a stimulant to export-oriented sector is energy, particularly hydropower export to India.[19] Nepal’s immense water resource endowment and the potential to sustainably harness them make it a unique export item in itself. Furthermore, the adequate supply of hydroelectricity may substantially reduce the cost of production and also give rise to firms that could operate at various stages of the supply chains. Similarly, tourism is another export service whose further promotion may increase not only visitor inflows, but also revitalize hotel industry and associated businesses. However, this would require adequate upgrading of necessary tourism related infrastructure and services at various key destinations. Nepal ranked 112 out of 140 countries in the Travel & Tourism Competitiveness Report 2013, with even lower ranking in air transport infrastructure (121), ground transport infrastructure (137), tourism infrastructure (130), and ICT infrastructure (127). Encouragingly, Nepal ranks sixth in the world terms of price competitiveness in travel and tourism industry.

The other long-term measure to boost export competitiveness includes investment in either construction of new or upgrading of existing road network along the major trade corridors. Also equally important is the strategy to retain workers and develop their skills so that the export-oriented sectors do not face shortage of workers of all skills range. The increase in the cost of production due to high wages could be partially offset by enhancing operational efficiency and productivity of workers.[20] The upgrading of skills could also benefit migrant workers, who would be able to secure semi-skilled to skilled jobs overseas, allowing them to earn more income and remit more money back home. Properly matching skills development to the structure of industry as they evolve according to the pace of global value chain development and competition is a key to sustaining manufacturing sector growth in the medium to long term.
Regional economic cooperation in areas such as cross-border connectivity, regional trade facilitation measures, and energy trade will help reduce the cost of trade and bring about efficiency gains throughout the production cycle and value chains. Furthermore, more cooperation in trade and investment, and monetary and financial services will help promote exports by facilitating investments in priority sectors and credit flows to high-return sectors. The South Asia Subregional Economic Cooperation (SASEC) initiative—a regional economic cooperation investment-oriented partnership between Bangladesh, Bhutan, India and Nepal—is already working on building multi-modal transport networks and logistics hubs to facilitate trade. Similarly, SASEC is also working on developing a regional energy market, increase energy availability, improve energy trade infrastructure, and create a harmonized legal and regulatory frameworks.

VI. Conclusion

To fully utilize the substantial market access concessions it already has and to boost exports, Nepal needs to significantly improve its supply-side capacities.[21] This will require adequately addressing the crippling constraints—lack of adequate and quality infrastructure; political instability and strikes; recurring labor disputes; lack of skilled human resource; deficient research and development; and policy inconsistencies and implementation paralysis— to industrial activities, and a timely and effective implementation of the policies and sectoral strategies that are already in place.

The country also needs to properly utilize the technical assistance offered through various financing windows by multilateral and regional trading blocs, and development partners. This will also help boost private sector activities in export-oriented sectors, which is mostly dominated by small and medium enterprises. In the long term, along with improvements in the investment climate, the government will need to substantially increase investment in energy, transport corridors, skills development, technology transfer and adoption, supportive regulatory and institutional frameworks including SEZs, and overall stable macroeconomic environment. These are critical for product and market diversification as well as product sophistication to stay competitive and to make exports an important driver of inclusive growth, which is essential to absorb an estimated 633,000 new entrants annually to the job market by 2020.[22]




[1] Note that the growth rates are computed after converting exports and imports into US dollars using the yearly average buying exchange rate.
[2]R.Hausmann and B. Klinger. 2007.The Structure of the Product Space and the Evolution of Comparative Advantage. CID Working Paper No. 146. http://www.hks.harvard.edu/var/ezp_site/storage/fckeditor/file/pdfs/centers-programs/centers/cid/publications/faculty/wp/146.pdf
[3]It is also indicative of two things: (i) the export-oriented firms have failed to add much new capabilities, and (ii) the government’s initiative on this front is insufficient.
[4] SAFTA has been effective since 1 January 2006, and its member countries have committed to reduce tariff to a maximum of 5% on all tariff lines except for the items in sensitive list by 1 January 2016. Nepal joined BIMSTEC in February 2004.
[5] Nepal has also signed bilateral trade agreements with several countries, including PRC, Bangladesh, Sri Lanka, Pakistan, the UK, the US, and South Korea.
[6] It identified 19 products under the Special Focus Area (garments, woolen carpets, pashmina and silk products, and handicrafts) and Thrust Area Development (tea, vegetable seeds, large cardamom, pulses, floriculture, gold and silver ornaments as well as gems and stones, processed leather, ginger, herbs and essential oils, handmade paper and paper products, woolen craft products, coffee, honey, oranges, and vegetables) with an elaborate scheme to promote their production and export. While the products under the Special Focus Area are labor-intensive and already have established markets abroad, the ones under the Thrust Area Development are high potential export items.
[7] The products are cardamom, ginger, honey, lentils, tea, noodles, and medicinal herbs/essential oils in agro-product category; handmade paper, silver jewelry, iron and steel, pashmina, and wool products in craft and industrial goods category; and tourism, labor services, IT and BPO services, health services, education, engineering, and hydroelectricity in services category. Additionally, five more potential export products/sectors pointed out in the report are transit trade services, sugar, cement, dairy products and transformers.
[8]Among other commitments and provisions, the industrial policy also promises flexible labor policy, including the ‘no-pay-for-no-work’ policy. It allows for easy exit from business for promoters, freeing them from long-term labor and other liabilities. Tax and income rebate incentives and easy credit are offered to export-oriented firms. It promises tax holiday for 10, 7, and 5 years to firms that invest respectively in highly underdeveloped (21 districts), undeveloped (15 districts) and less developed (24 districts) areas, respectively.
[9] See: SAWTEE. 2012. Training Course on International Trading System. Kathmandu: South Asia Watch on Trade Economics and Environment.
[10] The situation is even worse for large firms with 100 plus employees. About 99% of large firms owned or shared generators and they supplied 38.4% of total electricity demand.
[11] This is slightly lower than 75.6% in 2009 probably because more firms were resorting to using generators to bridge the gap between demand for and supply of power.
[12] The total number of countries included in LPI in 2012, 2010 and 2007 was 155, 155 and 150, respectively.
[13] For port or airport supply chain, the export lead time is the highest (6 days) in Nepal when compared to other countries in the region.
[14] According to LPI 2012, this includes ‘the point of origin (the seller’s factory, typically located either in the capital city or in the largest commercial center) to the buyer’s warehouse’.
[15] Some traders also argue that the fixed transportation cost (trucks mainly) set by syndicates/cartels is higher than the combined cost of vehicle operation and transport bottlenecks.
[16] In 2011, the productivity of Nepalese a garment worker was 9.6 pieces of shirt in an 8-hour shift, whereas it was 25.5, 18.6 and 16 for Chinese, Bangladeshi and Indian worker, respectively. See: http://ceslam.org/index.php?pageName=newsDetail&nid=1109
[17] Furthermore, the bilateral trade cost of Nepal with India is the lowest. Compared to the trading cost with India, the bilateral trade cost with Bangladesh, PRC, the UK and the US is 2.9, 2.1, 2.5, 2.3 times higher, respectively.  For more on bilateral trade costs, see International Trade Costs by ESCAP and World Bank.
[18] Currently, EIF is supporting value chain development of ginger and pashmina in Nepal.
[19] Except for Sikkim, all other four bordering Indian states faced an estimated peak time deficit of 3,200 MW of electricity. Specifically, the peak time deficit in Uttarakhand, Uttar Pradesh, Bihar and West Bengal were approximately 24.3%, 19.1%, 20.2%, and 1.7%, respectively in FY2013.
[20] McKinsey& Company noted that Bangladesh’s garment industry, despite the recent tragedies, has been successful in offsetting rising wage costs by enhancing efficiency and boosting supply capacities. Readymade garment export of Bangladesh accounts for over 10% of GDP and 75% of total exports revenue. See: http://www.mckinsey.com/insights/consumer_and_retail/bangladesh_the_next_hot_spot_in_apparel_sourcing
[21] For instance, the applied ad valorem tariff on Nepal’s iron and steel export to India is zero while India’s bound tariff on such imports is, on an average, 25%. Even with this attractive market concession, Nepal’s share of iron and steel export in India’s total import was just 1.2% in 2010, i.e. India imported US$8.3 billion worth of iron and steel in 2010, but Nepal’s share was just US$102 million. Note that this included all iron and steel export of Nepal, meaning that Nepal is unable to fully utilize the existing market concession without boosting its supply capacity of those products in which it has comparative advantage (usually denoted by revealed comparative advantage greater than unity). For more, see: R. Adhikari and C. Sapkota.2012. A Study on Nepal India Trade. Kathmandu: South Asia Watch on Trade Economics and Environment.
[22] UNCTAD estimates the number of new entrants (working age population) to the job market will reach 633,000 annually by 2020, up from 550,000 in 2012 and 465,000 in 2005. See: UNCTAD. 2013. Least Developed Countries Report 2013. Geneva: United Nations Conference on Trade and Development. http://unctad.org/en/PublicationsLibrary/ldc2013_en.pdf

(Adapted from Nepal Macroeconomic Update, February 2014, Vol.2, No.1, published by ADB. Executive summary here.)

Wednesday, March 12, 2014

Interesting results from Nepal's Agriculture Census 2011/12

The Central Bureau of Statistics (CBS) released the National Sample Census of Agriculture Nepal 2011/12 in December 2013. The decennial census shows the major trends in the agriculture sector and choices of agricultural households. About 83% of farmers’ main source of income comes from agriculture, and there are 3.8 million holdings in the country, up from 3.3 million in FY2002.

The average area of holding is decreasing, indicating a faster rate of increase in total number of holdings than the total area of holdings.


Cropping intensity is increasing as farmers may be using the same piece of land, subject to the planting cycle of crops and cropping season, many times for planting crops.



River/lake/pond is the largest source of irrigation.


The number of households growing vegetables increased by 97.6%. Plantation area of vegetables, potato, other cash crops and spices increased between FY2002 and FY2012.


The number of goats far outpaces the number of all other livestock.


The share of agricultural households taking loans to finance farming operations has decreased to 22%.


Credit from non-institutional or informal sources is the main source of loans.


About 41.8% of agricultural households reported the need for agricultural loan primarily to start livestock/poultry farming and to purchase agricultural inputs.


Majority of the agricultural households still use local seeds.


The largest quantity of minerals and chemical fertilizers is used for paddy production.



(This is adapted from Nepal Macroeconomic Update, February 2014, Vol.2, No.1, published by ADB. Executive summary here.)

Tuesday, March 11, 2014

Economic agenda of major political parties in Nepal

Prior to the second Constituent Assembly (CA) election on 19 November 2013, the major political parties published their election manifestos, which among others included their economic vision and plans for an accelerated and inclusive economic growth. Following the peaceful election, Nepali Congress (NC) emerged as the party with the highest number of CA representatives, followed by Communist Party of Nepal Unified Marxist-Leninist (CPN-UML), and Unified Communist Party of Nepal (Maoist) [UCPN-M].

The economic agenda of the main three political parties have a lot of similarities. Overall, they agree on a strong economy based on three pillars— namely public, private and cooperatives sectors— and are committed to liberal economic principles with a greater role of the private sector. There is also agreement on the special role of cooperatives in agriculture sector, and the need for foreign direct investment and foreign aid to bridge the financing gap, particularly in physical and social infrastructures. The political parties have underscored the importance of a favorable investment climate to facilitate investments in the priority sectors, particularly energy, tourism, agriculture and industry. In energy sector, the political parties’ focus is on meeting the growing energy demand and ending load-shedding in the short term. In agriculture sector, the focus is on modernization, commercialization and diversification of production. In tourism sector, the political parties accentuate the need to build vital tourism infrastructures and to entice domestic as well as foreign visitors. In industry sector, they have committed to promote an investment friendly environment, including cessation of bandhs/strikes. Human resources development with a focus on critical skills to sustain a high growth rate and to generate employment opportunities is also a common feature in the political manifestos. The other common priorities include transport and communications, road and rail networks, and completion of national pride projects.

The major highlights of economic vision and agenda of the three largest political parties are as follows.

Nepali Congress (NC)
  • Achieve 8-10% GDP growth by creating favorable investment climate and by initiating second phase of industrial reforms. Graduate Nepal to a middle income country within 20 years. 
  • Raise average per capita income to NRs.100,000 per annum (US$1000) in the next five years. 
  • Reduce agriculture dependent population to 55%. Increase manufacturing sector’s share to 10% of GDP in next five years. Ensure an inclusive economic growth by promoting energy, infrastructure, agriculture, tourism, and industrial sectors. 
  • End load-shedding in the next three years. Additionally, end load-shedding in industrial areas and Kathmandu in the next two years. Develop National Energy Security by consulting with all political parties. Generate 5,000 MW of electricity in the next five years.
  • Develop a competitive and globally integrated economy. Promote export-oriented and import substituting industries, and construct dry ports inside industrial zones itself. Ensure good industrial relations and promote industries to utilize domestic raw materials and generate employment opportunities. 
  • Establish at least one chemical fertilizer company under a PPP model in the next five years. Increase year-round irrigated land from 36% of agricultural land to 50% in the next five years. Increase number of foreign visitors to 2.5 million in the next 10 years. Develop tourism sector as the main foreign currency earner and employment generator, and ensure adequate funding for the development of Lumbini area.
  • Develop 20 modern secondary towns along the Mid-hill Highway. Develop Biratnagar, Hetauda and Nepalgjunj as industrial city; Birgunj as commercial city; Bharatpur as medical city; Butwal-Bhairahawa as tourist city; Dhangadi as green city; Pokhara as film and tourist city; and Dhulikhel-Banepa as educational and medical city. 
  • Address barriers constraining access to education/skills, and access to financial and capital markets. 
  • Guarantee 100 days of employment per year to a member of a household living below the poverty line. 
  • Build modern, 21st century infrastructure through reliable road, railway, airport and communication networks. Connect each Village Development Committee with all-weather roads. Complete Postal Highway, Mid-hill Highway, and Kathmandu Nijgarh Fast Track roads in the next five years.  
  • Gradually reduce dependence on foreign aid by strengthening internal revenue system. Foreign aid to be mobilized in national pride projects and infrastructure development, commercialization of agriculture and development of skilled human resources as well as technology transfer.
Communist Party of Nepal (CPN UML)
  • Graduate Nepal from LDC category to a developing country status in the next five years by making substantial progress in per capita income, social and infrastructure development, and human development indicators. 
  • Distribute NRs5 million grant to each Village Development Committee. 
  • Guarantee housing to 0.5 million homeless people in the next five years and ensure zero homeless people in 10 years’ time. 
  • Absorb at least 300,000 new entrants to the job market by creating employment opportunities.
  • Reduce maternal mortality rate to zero in the next five years. 
  • End load-shedding, ensure universal access to energy, and connect all district headquarters with electricity grid in the next five years.  
  • Connect all district headquarters with blacktopped all seasons road and ensure road access to at least 95% of settlement in the next five years. Complete Upper Karnali, West Seti, Budi Gandaki, Upper Marsyangdi, Lower Arun, Tamakoshi III, Arun III, and Upper Tamor hydropower projects in the next 10 years by involving the private sector.
  • Develop one model village and ensure facilities at par with those available in developing countries.
  • Initiate construction of an international airport in Nijgarh, and finish construction of regional airports in Bhairahawa and Pokhara in the next five years. Increase the number of visitors to two million.
  • Ensure good industrial relations and ensure labor security through contribution based Social Security Fund. Promote domestic and foreign investment, and develop export-oriented industries that use domestic raw materials.
  • Human resources development through technical and scientific education, and integrated skills development training. 
United Communist Party of Nepal (Maoist) [UCPN-M]
  • Graduate Nepal from LDCs to a middle income country within 20 years and a developed country within 40 years. Increase annual per capita income to $1,400 within 5 years, $3,300 in 10 years, $10,700 in 20 years, and $40,000 in 40 years. 
  • Employment and production centric double-digit growth and in 15 years times attain self-sufficiency with shared prosperity. Achieve 7.9% growth in the first five years, and 11%, 12.4% and 12.2% growth in the next 10, 20 and 30 years. 
  • Formulate action plan for rapid modernization and commercialization of agriculture sector; develop hydropower and energy with utmost priority and as a national campaign; and develop road, railway, ropeway, airport, canal and large physical infrastructure to achieve double digit growth.
  • End load-shedding in the next three years. Develop 10,000 MW, 20,000 MW, and 25,000 MW of electricity in the next 10, 20, and 40 years. The ratio of reservoir to run-of-river projects to be maintained at 30:70. Ensure universal access to electricity within 10 years. Achieve an average 13.2% growth in industry, hydropower and construction sectors. 
  • Raise Nepal’s Human Development Index score to 0.781 from the current 0.462.
  • Ensure two-thirds investments from private sector by attracting domestic and foreign investors. Gradually increase domestic investment to completely substitute foreign loans in 40 years. 
  • Ensure 180 days of employment to a member of each household living below the poverty line. 
(This is adapted from Nepal Macroeconomic Update, February 2014, Vol.2, No.1, published by ADB. Executive summary here.)

Saturday, March 8, 2014

NEPAL: Mid-fiscal year 2014 macroeconomic review


The positive political outlook, expected increase in agriculture production following the favorable monsoon, modest improvement in capital expenditure following the timely full FY2014 budget, and a strong services sector performance supported by remittance income are expected to boost GDP growth (at basic prices) to 4.5% in FY2014, up from 3.6% in FY2013. However, the forecast is lower than the government’s 5.5% target due to the less than expected increase in capital spending and a slightly lower services sector. In addition to the improvements in agriculture production, both domestic and foreign investment commitments increased remarkably in the first half of FY2014.


Despite the timely full budget, expenditure performance was not satisfactory in the first half of FY2014. Of the total planned expenditure of NRs.517.2 billion, only 30.3% was spent largely due to the lower than expected capital spending. The slow pace of spending so far indicates that the capital budget will likely continue to be underspent as in the previous year. If the utilization of the capital budget remains at the same level as in FY2013 (81% of total planned capital expenditure), then the total capital spending in FY2014 is projected to be about 3.5% of GDP, lower than the 4.4% of GDP projected in the budget but slightly higher than 3.1% of GDP in FY2013. There is an urgent need to ramp up both the quantum and quality of capital spending as it not only ‘crowds in’ private investments, but also helps create the foundations for the lackluster growth to take off on an employment-centric, high, inclusive and sustainable growth path.


Even though the NRs163.4 billion mobilized in the first half of FY2014 is 21.5% higher than the revenue mobilized in the corresponding period in FY2013, it still is lower than the half year target set for this fiscal year. As a share of total targets, customs, value added tax (VAT), excise, land registration and income tax mobilization up to mid-year stood at 46.8%, 46.6%, 47.6%, 52.3% and 44.4%, respectively. Since import-based revenues account for around 45% of total revenue, the yearly revenue target may not be met as the depreciation of the Nepalese rupee against the dollar is slowing down import demand.


Inflation averaged 9.1% in the first half of FY2014, down from 10.7% in the corresponding period in FY2013. Inflation moderated in all the six months of FY2014 compared to their corresponding months in FY2013. The decline in prices is mainly driven by the sharp slowdown in non-food and services prices. However, the persistence of the high inflation level is supported by rising food and beverage prices, which averaged 11.5% in the first half of FY2014 against 9.8% in the same period in FY2013. Despite the expected improvement in agriculture harvest, the wage pressures, the persistently high price level in India, the rise in administered fuel prices, lower interest rates, the persistently weak Nepalese rupee and the supply-side constraints, average annual CPI inflation in FY2014 is forecast at 10.0%, higher than the government’s target of 8.5%.


Money supply increased by 9.0% in the first half of FY2014, higher than 4.8% in the corresponding period in FY2013, due to the large increase in remittance inflows and foreign assistance, which boosted net foreign asset holdings. The increase in money supply was reflected in the 8.9% growth of narrow money (M1) and 5.5% growth of time deposits. The increasing remittance inflows and the election related expenditures increased deposit mobilization by 8.0% in the first half of FY2014, up from 5.3% in the corresponding period of FY2013. However, lending growth slowed to 7.3%, from 10.7% in mid-January 2013, as credit to private sector fell given the lack of immediate bankable investment projects and the cap on lending to certain sectors. The large liquidity surplus in the banking system led to lower interest rates compared to the level in mid-January 2013. Proper management of excess liquidity is essential to ensure that hasty and risky lending does not fuel bubbles in key sectors, including the residential housing market. As investor’s confidence rebounded and excess liquidity prevailed, the Nepal Stock Exchange (NEPSE) index increased sharply by 143.2% (787.1 points) in mid-January FY2014, up from a decrease of 19.7% (323.6 points) in mid-January FY2013.


The country’s external situation strengthened on the back of a large increase in remittance inflows, gains in exports and a slowdown in imports. In the first half of FY2014, the balance of payments surplus increased to $788.1 million, up from $89.3million in mid-January in FY2013. The merchandise trade deficit widened to $2.8 billion, up from $2.6 billion in mid-January 2013. However, the surge in remittance inflows pushed the current account surplus to $554.6 million, sharply up from $50.7 million in the first half of FY2013. Gross foreign exchange reserves increased from $5.5 billion in FY2013 to $6.3 billion in mid-January 2014, sufficient to cover 10.2 months of import of goods and non-factor services.


This edition of Macroeconomic Update’s Issue Focus explores the various dimensions of Nepal’s export competitiveness. Given the country’s poor export performance so far, it is clear that Nepal has been unable to fully utilize the market access and tariff concessions offered by trading partners, primarily due to crippling supply-side constraints. These include the lack of adequate and quality infrastructure; political instability and strikes; recurring labor disputes; lack of skilled human resource; deficient research and development; and policy inconsistencies and implementation paralysis. The country needs to properly utilize the technical assistance offered through various financing windows by multilateral and regional trading blocs, and development partners. This will help boost private sector activities in export-oriented sectors, which is mostly dominated by small and medium enterprises. In the long term, along with improvements in the investment climate, the government will need to substantially increase investment in energy, transport corridors, skills development, technology transfer and adoption, supportive regulatory and institutional frameworks including SEZs, and overall stable macroeconomic environment. These are critical for product and market diversification as well as product sophistication to stay competitive and to make exports an important driver of inclusive growth, which is essential to absorb an estimated 633,000 new entrants annually to the job market by 2020.

(This is adapted from executive summary of Nepal Macroeconomic Update, February 2014, Vol.2, No.1, published by ADB.)

Thursday, March 6, 2014

Why Planning Fails (and ‘failed’) in Nepal?

I stumbled upon a 1972 paper written by Aaron Wildavsky— then dean of the Graduate School of Public Policy, UC Berkeley— and published in Administrative Science Quarterly (Vol.17, No.4, pp.508-528). The title and abstract of the paper caught my attention. Some of the observations and points made then have a striking resemblance to the present scenario, especially the development planning process, and its implementation and ownership. 

Yes, times have changed and a lot of institutional, administrative and regulatory frameworks are in place (they have evolved gradually), suggesting that there indeed has been some progress. But, the speed of the progress, given the amount of resources spent on planning and meeting expenditures, seems to have disappointed the people. Among other issues, what stroke me the most was that the issue about the gap between planned expenditure and actual expenditure is pretty much the same since the very first medium term plan was sketched out on October 31, 1949 (Mohan Shamshere was the Prime Minister then). Most of the plans were short-lived and so were the various forms of planning ministries and councils. It was around 1963 that the present National Planning Commission was created by dissolving the National Planning Council. After almost six decades of planning and despite so many 'reforms' to increase the quantum and quality of public expenditure, the issue of the low absorptive capacity of the government is still persistent (shows the gap between planned and actual expenditures). Not only this, there has also been a consistent gap between development targets and achievement by the end of each plan. [For interested readers, here is my take on why is Nepal poor?]

Here is an abstract of the paper:

Planning in Nepal has little to do with anything that happens in that country. Planned targets are not met. Planned expenditures are not made. This paper explores the reasons- insufficient information, few and poor project proposals, inability to program foreign aid, opposition of the finance ministry, and severely limited capacity to administer development -given for the failure of planning. Special attention is paid to the tortuous release of funds and the effort to overcome basic political and administrative factors through surface changes in the form of organization for planning. The author argues that planning cannot create the preconditions for its own success.


Excerpts from the paper (remember it was published in 1972 and think about its resemblance in the present context):


[…]the Review Room of the Planning Commission has gradually become a ritual with little influence on decision or implementation.
[…]In earlier plans the absorptive capacity of the administrative machinery used to receive a great deal of attention from our planners. In this plan there seems to be little consideration of the absorptive capacity of the instrument for development in determining targets and outlays.
[…]project preparation is very weak and project implementation is worse.
[…]Relatively few operating officials have a clear understanding of the techniques involved in this radical departure from their traditional methods.
[…]Recurrent costs will go up sharply in the future as the need for repair and maintenance grows. Should aid decline in the future, Nepal would be faced with a rising bill for past commitments that would give it little room to maneuver, whether dealing with next year’s budget or some future five-year plan.
[…]the Commission could not work in a vacuum. It was completely out of the government. It had no relationship to implementation.[…]no one who counted heed its advice, such as increasing tax rates and plugging leaks in customs. […]Juggling their demands with the requirements of some twenty foreign aid donors, all with something special in mind, proved no easy task. When it came to implementation of plans and projects, the Ministry of Finance, whose Secretary, Y.P. Pant, was also forceful and capable, seemed to the planners “willful, obstructive, overly cautious, and not at all in sympathy with modern ideas of development”.
[…]Underspending was chronic, release of funds intolerably slow, procedures cumbersome and obstructive.
[…]The Planning Commission is ineffective because it cannot issue directives. No one listens to it. […]a tug-of-war between planning and finance.[…]Planning can be made strong by delegating both executive power and money to the planner.[…]a single fertilizer project or other large scheme could take up the entire foreign exchange surplus. Finance is, therefore, inclined to be cautious.
[…]The main complaint of the planners is clear: they make the plan and somebody else holds the purse.
[…]A top planner is convinced that if you do not have control over those who control implementation, advice becomes merely theoretical.
[…]as expenditures increased, the administrative capacity of the country to spend become overtaxed. Underspending became a serious problem.
[…]some departments spent extravagantly. What is worse, they undertook unauthorized expenditures in desperate efforts to improve their spending performance.
[…]Of the many causes of undespending, delay in releasing funds after the have been authorized occupies a prominent place.
[…]There is tremendous delay in making new appointments, often lasting up to and beyond a year. 
[…]When the appointees do arrive they are often not qualified. People rarely end up with specialties for which they were trained, especially if they have been educated at foreign universities.
[…]Salaries are low, resulting in departures abroad or to private concerns. […]the more talented now have the option of joining international organizations…
[…]It is not that they are unwilling to work. On the contrary, they are eager. But once the slightest initiative is required, once there is any question of responsibility, they wait for orders. If the orders do not come, everything stops. […]There can be no spending unless someone wants to take responsibility for it.
[…]The technical education of department heads is a barrier to growth of risk taking and economizing behavior because it enables the defenders of the status quo to join defense of the administrative establishment with claims to higher levels of competence.
[…]The ministers themselves are concerned with bargaining at the national level and with making sure that projects are geared to providing political benefits. They do not deal with the administrative apparatus.
[…]The nation lacks information, expertise and management skills. It is subject to the usual fluctuations in the terms of trade and the availability of foreign aid. Maintaining its political life on an even keel occupies the concerted attention of its highest political leaders. Economic development is only a sometime thing for them. In the light of these circumstances the effort to plan the nation’s economic life for years to come cannot be done well. If implemented the results are likely to be poor. As things stand, we shall never have to find out.

Tuesday, March 4, 2014

Mid-term FY2014: Disappointing progress in planned government spending

The Ministry of Finance (MOF) released the mid-term review of FY2014 budget.  Despite the timely full budget, the government has been unable to spend money as expected. Particularly hit is capital expenditures, which are crucial to ‘crowd in’ private investments and create a foundation for growth to take off on a high and inclusive path.

As of mid-January 2014, the government was able to spend just 30.2% of total planned budget, 36.8% of planned recurrent expenditure, 13.5% of planned capital expenditure, and 18.5% of planned financing. The capital spending in the first half of FY2014 is actually lower than the proportion spent in FY2013, when the country did not even have a timely full budget.



The lack of absorption capacity and readiness of various government ministries to meet planned spending targets have also led the MOF to revise down the expenditure targets itself. Particularly, planned capital spending has been revised down to NRs71.7 billion, down from NRs.85.1 billion planned when the full budget was unveiled in mid-July 2013. The revised planned capital expenditure is about 3.7% of GDP, down from the planned 4.4% of GDP. Furthermore, the inability to spend money in full and on time is also reflected in the revised down planned foreign grants and loans.

The higher planned budget [40.1% higher than FY2013 revised estimate; and according to the latest mid-term review target 20.9% higher than FY2013RE] is upping inflationary expectations, contributing to the prices pressures that are keeping inflation at a higher rate. Why target for higher planned expenditure when the ministries cannot spend the amount already allocated to them? It is doing more harm than good. May be performance based allocation should be the rule for each of the ministries. It is high time the government increased its absorption capacity.


The government is maintaining its 5.5% GDP growth target, but has revised inflation target up to 8.5%. The total revenue target is also scaled down. The budget is expected to be in surplus again this year.