India's improving economic outlook

Here are major highlights from IMF’s 2018 IV report on the Indian economy: 

Following disruptions caused by November 2016 demonetization and July 2017 GST rollout, the economy is stabilizing. Real GDP growth slowed to 6.7% in FY2018 (April 2017-March 2018) but is expected to increase to 7.3% in FY2019 and 7.5% in FY2020 on account of strengthening investment and robust private consumption. 

Headline inflation averaged 3.6%, a 17-year low, due to low food prices thanks to favorable monsoon rainfall, agricultural sector reforms (pulses buffer stock, national agriculture market, crop insurance, irrigation), subdued domestic demand, and currency appreciation. It is expected to increase to 5.2% in FY2019 owing to the recent depreciation of the Indian rupee along with higher oil prices, housing rent allowances and agricultural minimum support prices. 

Current account deficit is expected to increase to 2.6% of GDP due to rising oil prices and strong import demand. Remittances are expected to increase slightly. High forex reserves and strong FDI inflows have helped contain external vulnerabilities. External position remains broadly consistent with fundamentals. 

Fiscal consolidation is expected as FY2019 Union Budget targets fiscal deficit of 3.3% of GDP (but a 3.6% GDP in IMF terms). India’s Fiscal Responsibility and Budget Management Review Committee recommended the government to cap public debt level to 60% of GDP by FY2023. Considering the general elections to be held by May 2019, the government is accelerating implementation of ongoing reforms rather than initiating new ones. 

Monetary policy is expected to remain tight on account of higher inflationary pressures as output gap narrows to -0.3% of potential GDP. India follows an inflation-targeting monetary policy framework (helps lower sticky inflation expectations), which dictates it to maintain CPI inflation between 2% and 6%. More needs to be done to improve NPAs and recapitalized public sector banks. The recent fraud at a public sector bank indicates how vulnerable is the financial sector to poor governance and operations. 

India’s GDP is US$2,602 billion; per capita GDP is US$1,942;  total population is 1.32 billion (with 33.1% residing in urban areas); poverty headcount ratio at $1.90 a day is 21.2; and Gini index is 35.2.

Risks to the economy are on the downside. Key external risks include higher global oil prices and tighter financial conditions. Key internal risks include tax revenue shortfalls and delays in addressing the twin bank-corporate balance sheet problems. The plan to recapitalize PSBs announced in October 2017 will add at least 0.8% of GDP to public debt (financed through recapitalization bonds). 

Structural reforms are needed in labor, land and product markets. 

Here is a collection background issue papers covering GST, fiscal discipline in Indian states, FDI, labor market reforms and agricultural sector reforms.

Subnational regulations and competitive populism

It was published in The Kathmandu Post, 07 August 2018.

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Competitive populism

An emerging but entirely predictable major headache for federal government is the tendency of subnational governments to engage in a race-to-the-bottom revenue policy. Provincial and local governments have introduced overlapping tax regimes and are openly sparring with the federal government to assert their rights as per their own understating of power mentioned in the constitution. 

The uncertainty over tax regime and the subnational government’s jurisdiction with respect to mobilizing certain type of taxes have unnerved business community and potential investors. A competitive populism instead of cooperative and competitive federalism will have negative consequences on budget execution and investor sentiment. Note that this has happened even when the ruling Nepal Communist Party has two-thirds majority at federal as well as subnational levels. 

Subnational budget

All seven provinces as well a majority of local governments have introduced fiscal year 2018/19 (FY2019) budget, the first under the federal set up. Federal transfers (fiscal equalization, conditional, special and matching grants) and revenue sharing form the basis for their budget. In fact, total federal fiscal transfer and revenue sharing account for over 90% of provincial budget. They plan to cover remaining budget gap by raising revenue (province 2 and Karnali governments plan to borrow one billion rupees internally as well). Provincial and federal budget together tops Rs1552 billion, of which about 28.6% consists of capital budget. Similarly, a majority of the 753 local governments have presented FY2019 budget in line with federal and provincial fiscal transfers and revenue sharing. They plan to raise revenue by imposing local taxes when their expenditure plan is in excess of fiscal transfers and revenue sharing.

The whole process of designing expenditure priorities and revenue policy is supposed to be cooperative and competitive so that all tiers of government have synchronized and coherent plans to boost economic activities (and probably help the government realized its overarching motto “Prosperous Nepal, Happy Nepali”, irrespective of how that is measured or what is means!). This appears not to be the case right now. Several provincial and local governments are at loggerheads with the federal government over their jurisdiction in designing revenue policy. Note that they don’t have much say over expenditure priorities owing to the fact that the constitution is clear on what public services they must provide and how federal transfers are to be utilized for that purpose. 

Fiscal management

The subnational governments are aspirational and want to do more with larger budgets, which require more and bigger sources of revenue. Besides fiscal transfers and revenue sharing, they have limited options: internal loan, raising taxes and widening tax net as well as taxable economic or social activities. Currently there is a lack of clarity on procedures and regulatory framework to raise internal loans. So, most of the subnational governments have resorted to either raising taxes and/or including any economic activities under the tax net. This has pitted the subnational governments against the federal government, leading to a regulatory regime that looks like a race to the bottom and especially damaging to improving investment climate.  

For instance, province one has imposed district export tax on agricultural and forest items against the spirit of the constitution. Upon a challenge by the federal government that intra and inter province movement of goods should be free, province one government renamed it sales tax. All they did was to change the name of tax but keeping its distortive nature intact. Similarly, province two is imposing natural resources tax, province five is charging entry fee to Indian vehicles, province seven is imposing a fee on registration and renewal of industries, province three is imposing export tax, and Karnali province is imposing taxes on inter-district export of mining and quarrying items. Meanwhile, several local governments have drastically increased or introduced taxes on tourism, transport and small business activities— the lifeline of local economies and employment. 

This kind of uncertainty and tax policy disarray kills the spirit of federalism rooted in cooperative and competitive interaction among the three tiers of government. Two course corrections are important going forward. 

First, the federal government should immediately work to resolve this matter as this kind of uncooperative federalism harms local businesses and potential investment. Ministry of Finance, Prime Minister’s Office, National Planning commission and Ministry of Federal Affairs and General Administration need to work together with subnational governments to create not only a coherent and consistent expenditure plan, but also a revenue policy that is unambiguous to business community and one that is geared toward boosting local economic activities. Unfortunately, the federal government itself is weak in fiscal management and governance exercise, evidenced by the dismal capital budget execution record and its singular focus on mobilizing revenue. The subnational governments are thinking that their success lies in raising more revenue to fund more recurrent spending type commitments they made to voters before the elections. Alas, this is fiscally fatal, kills entrepreneurship and harms investment prospects. Confusion is also cropping up due to the delay by the federal government to introduce laws and policies to implement the constitution. 

Second, the federal government should facilitate competitive federalism between provincial and local governments to boost investment and commerce. They should be focusing on attracting investment in their region by rolling out regulations that eases cost of doing business, provides tax and land concessions, and raises productivity by supplying necessary infrastructure. Furthermore, the subnational governments should compete to attract more fiscal transfers by improving budget execution as more meaningful and efficient projects of subnational governments tend to attract more fiscal transfers. 

The subnational governments must compete to attract more investment and to boost growth instead of competing on regulatory regimes that sets them on a path to the bottom. 

Action room to resolve implementation issues, Chinese funded infrastructure bank, empty treasury and more

Government to set up ‘Immediate Problem Solving Centre’ at PMO

From The Kathmandu Post: The government is set establish an Immediate Problem Solving Centre at the Prime Minister’s Office (PMO) in order to address legal, institutional and administrative issues at priority projects and service delivery of the government agencies. The centre, to be known as ‘Action Room’, will have a separate set of staff under the PMO secretary. Armed with video conferencing and telephony facilities, the centre will allow the prime minister to instruct the ministers, secretaries and project chiefs directly to instantly address the issues that arise in key priority projects and service delivery, according to PMO officials.

The PMO action room will help solve the problems at different ministries through cross-ministry coordination, among others. “In fact, the action room will be developed as a body to keep tabs on the monitoring bodies in the ministries to ensure timely completion of project works and service delivery,” said a PMO official.  The PMO is looking for space to setting up the action room. It has already arranged a team of staff, including a secretary, a joint-secretary, an under-secretary and three section officers. It plans to add some technical staff. The government is drafting a regulation to govern operations of the action room and establish a mechanism for monitoring and solving problems at the ministry levels.

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NRA work stalls without a CEO

From The Kathmandu Post: The process of extending deadline for obtaining second tranche of housing grant has been in limbo as the National Reconstruction Authority (NRA) is without Chief Executive Officer. Yubaraj Bhusal had stepped down as the NRA chief in the second week of July, following the Oli-government’s decision on July 5 to revoke all the political appointments made by the erstwhile government led by Sher Bahadur Deuba after August 30, 2017.

A meeting of the NRA Advisory Council scheduled on July 6, which was supposed to take call over the matter, did not convene due to the government decision which had revoked the appointment of NRA CEO. NRA Deputy Spokesperson Manohar Ghimire said, “There would certainly be repercussions over the top position at the NRA which is vacant at the moment. There are a number of issues that need to be resolved,” 

A frequent change in NRA leadership due to political meddling has severely hit the reconstruction process even though three years have passed since the horrifying disaster struck the country that killed nearly 9,000 lives, leaving tens of thousands homeless. The authority had set mid-July 2018 deadline for quake survivors to obtain Rs150,000—the biggest chunk in Rs300,000 housing reconstruction aid handed out by the government. 

According to the agency mandated to carry out the reconstruction works post the Gorkha Earthquake, around 250,000 households have yet to receive second tranche of the government aid. Following the earthquake, the government decided to provide Rs200,000 per household in private housing rebuilding aid. It later increased it to Rs300,000 to be distributed in three installments—Rs 50,000, Rs 150,000 and Rs 100,000. The NRA also has to address several other issues urgently as the meeting of the NRA Advisory Council and Steering Committee cannot convene in the absence of chief executive.

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Govt to set up Rs 100bn infra development bank under Chinese investment

From The Himalayan Times: The government has approved the proposal to form an infrastructure development bank under Chinese investment. A Cabinet meeting recently agreed in principle to form such a mega bank under Chinese investment, which will have paid-up capital of Rs 100 billion, informed Rajan Khanal, secretary at the Ministry of Finance (MoF). Following the Cabinet’s nod, MoF is currently holding bilateral discussions with China to set up the bank as soon as possible. The Chinese-investment bank needs to have at least 20 per cent domestic share.

In August last year, Nepal Rastra Bank (NRB) had brought ‘Licensing Policy for Infrastructure Development Bank 2017’ opening licence for Nepal Investment Development Bank (NIDB), which will have paid-up capital of Rs 20 billion. Likewise, MoF officials informed that Indian investors have also expressed interest to set up an infrastructure development bank in Nepal.

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Govt treasury empty after haphazard spending in last month

From myRepublica: The government treasury is now empty following irrational budget distribution at the end of the fiscal year that ended Monday. Not a single penny has been left from the previous fiscal year , according to officials of the Ministry of Finance (MoF). This fiscal indiscipline on the part of the current government is sure to have serious consequences as it may trigger internal borrowing right from the first month, just as the previous government had done this time last year. The internal borrowing may exert further pressure on cash available for lending in the banking sector, shrinking the growth of the private sector, said two MoF officials who have direct knowledge of the matter.

The government spent about 33 percent of the total allocated budget for development purposes of Rs 335 billion, or Rs 110 billion, in the 12th month . A total of Rs 27 billion was paid out for the purpose on a single day in the last month. Overall payment by the government in the last month (mid-June to Mid-July) hovered at around 28 percent of the total budget of Rs 1,278. Economists have criticized this eleventh hour spending, questioning the motives and rationale.

The pressure on the government has already started as it has to disburse immediately a total of Rs 78.66 billion-- Rs 21 billion for provinces and Rs 57.66 billion for the local levels-- as part of conditional grants, and these were payable on Tuesday, the first day of the fiscal year. The government needs further disbursements of Rs 16.76 billion and Rs 45.16 billion by August 10 to the provinces and local levels respectively as equalization grants . “Government has no choice but go for internal burrowing as early as possible,” added an official. In a change from the past year, the payment of equalization grants was separated and scheduled on August 10 in order to evade pressure for fiscal transfers to subnational governments in the Appropriation Act 2075.

Import-based revenue account for 45% of tax revenue in Nepal

Finance ministers in their budget speech focus exclusively on two issues: new or augmented expenditure programs and revenue mobilization plan to cover additional expenditure without drastically increasing budget deficit (although this and previous finance ministers unveiled budgets with larger-than-expected deficits). Implementable reform measures to enhance public service delivery and effective budget execution are usually missing or mentioned cursorily. The core focus of expenditure plan and associated reform measures are to attain high and inclusive economic growth by transitioning the remittance and monsoon based economy to a one that is based on more robust sources of growth (industrialization, commercial agriculture, tourism, innovation, etc). For this, the government requires both revenue and knowledge transfer (comes usually with foreign grants, loans and investment).

However, meeting revenue target supersedes all other objectives of MOF (which sometimes is labelled Ministry of Revenue instead of Finance). The strategy for meeting ever-higher revenue target is dependent on import related taxes and duties, and revenue administration’s efficacy. The core strategy of raising more revenue from duties on imports to finance an ever-increasing expenditure plan that aims to change the structure of the economy is at some level self-defeating (unless the expenditure plan, i.e. budget execution, is realized faster than expected to create a base for generating higher non-trade/import related revenue). Else, we are always at the mercy of remittance income!

Anyway, this dynamics is not going to change anytime soon and the economy will continue to bank on customs duties and taxes on trade as a core source of tax revenue to finance expenditure. The share of trade related revenue (total customs revenue including taxes on exports, VAT on imports, import duties in the form of excise duty) in tax revenue is about 46%. In FY2018, this was equivalent to about 9.6% of GDP.  Note that total tax revenue is about 21.9% of GDP). Non-tax revenue is about 2.3% of GDP. Total receipts (tax and non-tax revenue plus foreign grants) is about 25.4% of GDP. 

Import related revenue increased from 6.5% of GDP in FY2012 to 9.6% of GDP in FY2018. It is projected to be about 11.6% of GDP in FY2019.  This indicates how much the economy is reliant on import-based revenue to finance its rising expenditure. As long as imports are increasing, largely financed by remittance income, tax revenue will continue to rise. It will rise even more if excise duties on some imported goods are increased. There isn’t much room to raise trade/custom tariffs due to various multilateral and bilateral treaties.  

Total expenditure was about 34.8% of GDP (23.3%, 7.9% and 3.6% as recurrent, capital and financial provision expenditures, respectively). From FY2019 onward, federal government has to share 30% of VAT and 30% of domestic excise duty collections with subnational governments (it further squeezes available revenue sources and without a reduction in expenditure, it increases federal budget deficit). 

Kerung-Kathmandu railway, cartelish NBA and dysfunctional ICP

Kerung-Kathmandu railway ‘most significant step in history of bilateral cooperation’

From The Kathmandu Post: Nepal and China have signed a landmark accord to develop a cross-border railway line that will connect the Tibetan town of Kerung with Kathmandu, calling the Cooperation for Railway Connectivity “as the most significant initiative in the history of bilateral cooperation”. The two sides signed the memoranda of understanding on Thursday following hour-long delegation-level talks at the Great Hall of the People.

This follows nine agreements signed by Nepali and Chinese public and private sector companies on Wednesday, with major ones being: Investment Board Nepal (IBN) and Huaxin Cement Company of China to develop a Rs15-billion Huaxin Narayani Cement; Butwal Power Company and Sichuan Investment Group (SCIG) to work together on Marsyangdi Cascade to produce 1,000 megawatt electricity; Nepal Electricity Authority and China’s State Grid Corporation will construct a 159-km Kerung-Galchhi transmission line.

In a visit where connectivity was the political buzzword, the two sides agreed to encourage Nepali and Chinese airlines to operate additional direct flights between the two countries. They will also speed up the construction of the Pokhara International Airport.

Though it was not explicitly stated which of the China-assisted projects fall under BRI, the two sides agreed to intensify implementation of the MoU on Cooperation under the Belt and Road Initiative to enhance connectivity, encompassing such vital components as ports, roads, railways, aviation and communications within the overarching framework of trans-Himalayan Multi-Dimensional Connectivity Network.

**Here is an excerpt from joint statement between Nepal and the PRC:

The two sides agreed to intensify implementation of the Memorandum of Understanding on Cooperation under the Belt and Road Initiative to enhance connectivity, encompassing such vital components as ports, roads, railways, aviation and communications within the overarching framework of trans-Himalayan Multi-Dimensional Connectivity Network. The two sides also agreed to take practical measures to promote cooperation in all fields contained in the MOU. The Nepali side conveyed its readiness to facilitate more Chinese investment in infrastructure building and in other productive sectors. In this regard, the Nepali side expressed its willingness to welcome further investment from Chinese enterprises and, in accordance with Nepali laws and regulations, simplify the related approval procedures on applications related to land, taxes and visas in an efficient manner, and create a favourable investment climate and business environment for Chinese enterprises.

Both sides agreed to reopen the Zhangmu/Khasa port at an early date; improve the operation of the Jilong/Keyrung port; ensure the sound operation of Araniko Highway; and carry out the repair,maintenance and improvement of Syaphrubesi-Rasuwagadhi Highway and push forward the construction of a bridge over Karnali river at Hilsa of Pulan/Yari port at an early date. To ensure the inter-connectivity and smooth running of the infrastructures above, the Nepali side will complete the disaster treatment around the Tatopani Port and along the Arniko Highway, maintain Kathmandu-Syaphrubesi Highway in operational condition.

Both sides expressed happiness over the signing of the MOU on Cooperation for Railway Connectivity. They underscored it as the most significant initiative in the history of bilateral cooperation and believed that it would herald a new era of cross-border connectivity between the two countries. Both sides agreed to make good use of the long-term communication mechanism on railway cooperation between government departments and promote railway cooperation. The Chinese side agreed to provide such support as in technology and personnel training.

The two sides agreed to encourage Chinese and Nepali airlines to launch/operate more direct flights between the two countries in accordance with provisions of the bilateral air service agreement between the two countries. Both sides will coordinate closely to speed up the construction of the Pokhara International Airport so that it would start operation at an early date.

The two sides expressed satisfaction over the successful commercial operation of China-Nepal cross-border optical fiber cable and agreed to further strengthen cooperation on information and communications for mutual benefit.

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Birgunj ICP fails to please importers

From MyRepublica: Importers claim that the transportation of goods through the ICP has been inefficient and costlier than before. Although the replica infrastructures were constructed in both sides of the Nepal-India border so as to ease and advance trade and customs, the experience importers have faced transporting goods through the ICP is far from what was expected.

Om Prakash Sharma, president of Birgunj Chamber of Commerce stated: “The ICP has created more problems and the entry process of vehicles is very slow. As a result, containers are lined up for up to 25 kilometers.” He added, “Besides, the Indian security forces are not well-behaved. Entering the ICP, which was built to strengthen mutual trade relations, gives people the feeling as if they are entering an army camp and drivers are thus not willing to enter the ICP. Extortion of funds by Indian security forces is prevalent and at an increasing trend outside the ICP. Those who do not give the demanded money have to wait for an entire week and have also faced manhandling by the security forces outside the ICP. However those who pay between IRs 500 to IRs 1,000 per vehicle, are easily allowed to enter the ICP. 

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Banks agree to cap interest rates, again

From The Himalayan Times: The Nepal Bankers’ Association (NBA) has once again decided to regulate deposit rates without providing assurance of reining in runaway lending rates. This is an indication that commercial banks are more interested in reducing their expenses by forcefully lowering deposit rates, while maximising their income by keeping lending rates high.

The NBA today barred all 28 commercial banks from offering annual interest of over 11 per cent to retail depositors who park money in fixed deposit accounts. The interest threshold on funds deposited by institutional depositors in fixed accounts has been set at 10.5 per cent. The NBA has also said yields on money parked in savings deposit accounts should not exceed seven per cent.

Here is my earlier pieces on interest rate volatility, slack NRB, and cartelish NBA.

Brief overview of the first provincial FY2019 budgets

As per the constitutional provision, finance and planning ministers of the seven provinces presented their FY2019 budget to their respective provincial assemblies in mid-June. The budget envelope is very close to estimated federal fiscal transfer and revenue sharing. This is the first time the provinces have presented a full budget (earlier they presented a trimmed version of FY2018 budget wholly based on fiscal transfers from the federal government).

Province 1 has the highest budget, followed by province 3 and province 2. The provinces have used federal fiscal equalization and conditional grants as well as their share of federal revenue to cover recurrent and capital spending. Capital budget for provincial projects and recurrent budgets for social services (education, healthcare, etc) are pretty much dictated by the way the federal government allocates grants to them. Karnali is the sole province that has allocated spending under financial provision (which is generally used for internal loan and share investment in public enterprises or investment projects). Here is general budget envelope:

• Province 1: NRs35.9 billion 
• Province 2: NRs29.8 billion
• Province 3: NRs35.6 billion
• Province 4: NRs24.0 billion
• Province 5: NRs28.1 billion
• Karnali: NRs28.3 billion
• Province 7: NRs25.1 billion

Federal transfers (fiscal equalization, conditional, special and matching grants) and revenue sharing form the basis for their revenue plan. In fact, total federal fiscal transfer and revenue sharing account for over 90% of provincial budget. The highest internal revenue target is set by province 3 (NRs 9.3 billion), followed by province 1 (NRs 3.7 billion) and province 5 (NRs2.4 billion). The lowest internal revenue target is set by province 2 (about NRs10 million). 

A substantial portion of the budget is allocated for capital spending (federal fiscal transfer constitutes almost all of the capital budget of five provinces). This in a way is consistent with the fiscal equalization and conditional grants from the federal government, which categorizes such spending as recurrent expenditure. So, the total size of the budgeted capital expenditure is going to increase now. Technically, this was the case before as well because sub-national governments were using them in capital projects, but this time there will be proper record of how much is spent at provincial level. There is such allocation for local governments too, but it may be difficult to aggregate their spending like in the case of the first two tiers of government.  

Provinces 2 and Karnali are planning to borrow about one billion rupees to finance budget deficit. It is not clear how exactly they are going to do it (or there are rules and regulations ready for them to do so). So, during the first year of operation itself, these two provinces are going to take loans to cover budget deficit.

Note that this is the first time the provinces are going to actually implement budget on their own, i.e. under their own jurisdiction and accountability mechanism. Previously, these were dictated by federal government. Now, the likelihood of effective and robust governance and accountability feedback is much higher. This should ideally get reflected as higher capital budget absorption rate (federal government’s track record in this is terrible). 

The size of provincial budget is small right now. These will increase as they gradually master the art of raising internal revenue and budget making. It would be interesting to see how they will implement their budget. But for that they will need a slew of subnational laws, policies, regulations and institutional frameworks. So expect under-spending for some years and messy implementation, planning and budget making process. Currently, the budget documents and speeches are either not well prepared following prescribed standard format or are similar to the federal budget speech (province 5 has a pretty good one though). The provincial budgets are truly distributive if we consider the size of their revenue.  

Total budget allocation (federal and provincial) is as follows: 

• Budget: NRs1522 billion (about 44% of GDP)
• Recurrent: NRs930.8 billion (61.2%), about 27% of GDP – this includes fiscal transfers/grants to subnational governments, which then use it to cover both capital as well as recurrent expenses
• Capital: NRs435.1 billion (28.6%), about 12.5% of GDP
• Financial provision: NRs156.1 billion 

Here is an overview of FY2019 budget (more details here and here)

Interview: Ample ground to be optimistic

It was published in Business 360, June 2018.

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There is ample ground to be optimistic, but it all depends on how the government does its business

Sapkota was in Nepal in May for a brief visit during which he was part of an event titled ‘Ke Samriddhi, Kosko Samriddhi’ in which he spoke about the current economic state of Nepal, and his ongoing research and findings.

B360 had an opportunity to question Sapkota about Nepal’s economy and challenges. Excerpts from the interview:

During your presentation at the event organised by Nepal Economic Forum, you stated that if the government invests in a sector, then private investment will also increase by about threefold. You also mentioned in one of your articles that private gross fixed investment, which averaged 23% of GDP in the last five years also needs to increase so that total gross fixed investment is at least above 30% of GDP. What are the key areas that you have identified which the government and private sector should invest in? Why?

Increasing both private and public investment in productivity and enhancing infrastructure is essential to accelerate economic activities and to achieve GDP growth of over 7%. Gross fixed capital formation is gradually increasing since FY2015 but it is still below the average of low income countries. The government should create an enabling legal, regulatory and institutional framework to facilitate domestic and foreign investment. It should also make a concerted effort to increase capital spending to around 8% to 12% of GDP annually.

Investment in seven key sectors has the potential to accelerate growth, which could be inclusive as well as sustainable: high value agriculture, road and air transport, tourism, energy, light manufacturing, urban development, and education/ICT and skills. These strategic sectors have their own characteristics that make them stand out as the most promising ones given Nepal’s per capita income, market access to key export destinations, demography, natural resources, macroeconomic stability, geography and ability to quickly absorb technology transfer and technical know how.

In one of your recent articles published in a daily newspaper, you mentioned “the appointment of Yubaraj Khatiwada as finance minister by Prime Minister KP Sharma Oli is the right decision given the likelihood of inflation to rise to 6%, bank credit getting tighter, and the external situation deteriorating.” Do you still hold that thought?

Dr. Yubaraj Khatiwada as a finance minister at this critical juncture is the most appropriate decision given the options the left alliance (now Nepal Communist Party) had. Although his white paper had serious shortcomings, especially on attribution of accumulated economic ills and bad aspects of privatisation to Nepali Congress only (the communist parties also led the government in the past and they either did nothing or contributed to aggravate the situation), he managed to portray an honest assessment of the core economic issues over the last decade.

Yes, GDP growth was stellar in the last two years, but we should not forget that these are probably outliers (FY2017 was base effect and FY2018 was fiscal stimulus in the form of elections spending and post earthquake reconstruction). This should not mask the reality that growth remains volatile and is dictated by monsoon rains and remittance income; inflation is ratcheting up; capital spending is chronically low given the budgeted amount; financial sector is beset by recurring asset liability mismatches and liquidity squeezes; and trade deficit is ever-increasing. Prudent fiscal and external sector management are essential to macroeconomic stability, which is a key determinant of private domestic and foreign investment.

With a background in economics, policymaking at National Planning Commission and as governor of Central Bank, Dr. Khatiwada has the required understanding on these issues to lead the Finance Ministry at this point in time. However, he will face a hard time managing expectations, promoting competitive federalism, and ensuring a coordinated calibration of policies.

As an economist, how do you forsee Nepal’s future considering that we continue to count on monsoon and remittance to lift us up economically. Moreover, in FY 2017 the GDP growth was at 7.4% but Central Bureau of Statistics (CBS) estimates 5.9% in FY 2018. Agricultural output and industrial output are estimated to be down in 2018 in contrast to 2017.

The future is definitely not bleak if the government manages finances prudently, synchronises fundamental policies and priorities of all tiers of government to create a coherent economic development plan and strategy, increases productivity-enhancing investment, and relaxes rigid business regulations by continuing “second generation reforms”. Delivery of committed outputs within a stipulated time by both government agencies and private contractors will be something we need to watch out for. These alone have the potential to transition the economy from remittance-backed activities to more stable sources of growth that not only generate adequate jobs but also are inclusive. Therefore, yes, there is ample ground to be optimistic, but it all depends on how the government does its business, i.e. facilitates investment or just rolls out redistributive programs to please voter base.

For Nepal to become a middle-income country by 2030, what are its major macroeconomic challenges?

As mentioned earlier, the core challenge is to transition from a remittance-dependent economy to one that is largely driven by domestic factors. In order words, we need to ensure that the pace and pattern of economic growth and development are supported by a vibrant industrial sector, higher absorption of unemployed workforce in productive sectors, and production of high-valued, high-productivity goods and services across all sectors. I see six key macroeconomic challenges:

• Sources of growth have to be reliable, which means less reliance on monsoon rains for agricultural output growth and on remittance-backed demand for services output growth. This is possible by increasing investment to tackle the most binding constraints to growth, i.e. inadequate supply of infrastructure (energy, transport and irrigation).
• Fiscal management will be challenging given large spending needs and stagnating growth of revenue. This is aggravated by low quality and quantum of public capital spending.
• High and volatile inflation which is affected by both domestic supply-side constraints and prices in India which is another major challenge to boost private investment.
• There is a lingering risk of financial sector instability arising from recurring sources (accumulation of unbalanced portfolio, lax monitoring and supervision, and asset-liability mismatch).
• Slow progress post-earthquake reconstruction would mean local economic activities below potential.
• Increased import amidst stagnating exports and decelerating remittance income will widen current account deficit and reduce foreign exchange reserves. This needs to be managed well by promoting export and import competing domestic production of goods and services.

How does the general understanding that the country’s economic state is dictated by its political state matter? And what does it say about Nepal where political stability has been reduced to a concept? Is this a problem you have identified to the whole of South Asia?

Generally, political stability increases investor confidence and hence investment, which then contributes to accelerate economic activities. Even with some degree of political instability, some countries (such as Bangladesh) have managed to clock in high and sustained growth rate largely due to stable and effective bureaucracy. This is the missing piece in Nepal. Changes to government leadership are followed by changes to bureaucracy resulting in high turnover of staff in key projects and erosion of institutional memory. It substantially reduces pace of work as new staff have to reinvent the wheel in terms of understanding project’s physical and financial work plan. Furthermore, new staff are usually hesitant to fully own reform initiatives (for policy formulation or amendment of existing ones) agreed with stakeholders in the past.

Two of your research interests are South Asian economy and policy analysis. Which one country in South Asia do you think has the potential to rise economically because of the introduction of correct policies?

India is obviously the most dynamic economy in South Asia. The present government has initiated landmark reforms on digitization, tax structure, healthcare, rural agriculture, monetary policy committee, bankruptcy, industrialisation and easing of business regulations. No wonder the ruling party and its allies have swept power in 21 of 29 states.

How do cartels and syndicates affect a country’s economic cycle? Recently the government of Nepal set a firm tone against transport syndicate. Demand for dismissal of cartels in the banking sector, pharmacy, food industry is high from the civil society. Your thoughts.

Cartels/syndicates tend to protect member business interests by capturing markets, i.e. preventing creative creation and creative destruction (which in effect help them to either control prices or quantity or both). These anti-competitive practices are fostered through political or business patronage and stifle innovation. These are most prominent in transport and banking sectors, resulting in high cost of doing business. There is collusion among construction companies and a handful of them secure all the big contracts. The level of capture of contracts, permits and business exclusivity is staggering. There is so much of interlinkages between politics and cartels that it is hard to do away with them in one go. There are cartels in public transport, freight and petroleum transport, agriculture, education, healthcare, banks and airlines, among others. However, recent government effort to clamp down hard on transport syndicates and contractors is a welcome move. We will need to see if these efforts are just window dressing of core problems to placate voter base or they are genuine reform measures that the government will take to a logical end. Nepal still does not have a competition commission to look at these issues at the institutional level.