Chandan Sapkota's blog

Sunday, August 19, 2012

Nepal’s lost priority: Seeking more market concessions or boosting productive capacities first

Published in Nepali Times, Issue #618 (17 AUG 2012 - 23 AUG 2012).

Nepal can be more competitive by improving investment climate and upgrading infrastructure

CHANDAN SAPKOTA

Each time a Nepali delegation attends bilateral trade talks, one issue never changes: plea for duty free access and concessions. They seem to forget the fundamental factor that will enable us to export more is the ability to competitively produce goods and services in the first place.

It is not that tariff and non-tariff barriers are unimportant to increase exports. The fact is that these largely help in trade facilitation, whose importance is high only when we are able to boost production competitively. Sadly, this is not the case right now. Rather than begging for more concessions during trade talks, the primary focus should be on effectively tackling constrains faced by the industrial sector, improving investment climate, and then seeking bilateral assistance to enhance production efficiency. Otherwise, even if we get greater market access and concessions, we won't be able to fully utilise them.

For instance, at the Nepal-China Consultative Meeting on Monday, Nepal requested China to help decrease rising bilateral trade deficit, which reached Rs 45.7 billion in 2010-11, by offering favourable market access, among others. China already provides zero tariff facility to 4,721 export items of Least Developed Countries, including Nepal. Though some of the export items of interest to us are not included in that list, Nepal is simply unable to take advantage of the zero tariff facility on other goods. The reason is that even with such concessions our exporters are unable to competitively produce goods to compete with Chinese counterparts.

The only way China could help us narrow down trade deficit is by investing in the prerequisites for competitive production: supply of electricity and technology transfer in the agriculture and manufacturing sectors. Other than this there is very little China can do to decrease bilateral trade deficit because Nepal is rapidly losing the market pie to more competitive producers and is also importing more Chinese goods each year.

Similarly, during a meeting between commerce secretaries of Nepal and Bangladesh in July, Nepal asked Bangladesh to provide concessional market access to 146 products, to which the latter agreed in principle. Nepal has requested such concessions with almost all trading partners, including India and the US. The irony is that despite knowing that our producers and exporters will be unable to utilise such concessions without improvement in industrial relations and investment climate, we still plead for them by wasting resources and energy.

For instance, Nepal gets duty free access for almost all manufactured goods exported to India. Still we are unable to take advantage of it due to domestic production constrains. A case in point is the export of iron and steel, whose total import by India was $8.3 billion in 2010. Of this, Nepal's share was just 1.22 per cent. Note that Nepal gets duty free access to the Indian market like no other country. The minor non-tariff hiccups in trade with India don't fully account for our inability to increase exports there.

Nepal has an unsustainably high merchandise trade deficit (25 per cent of GDP). The rapidly increasing imports are primarily financed by remittances. Exports started declining rapidly after 2000-01, the same year the Maoist insurgency intensified, as a result of disruption in production and deteriorating investment climate. Driven by lack of employment opportunities, the same year also marked the beginning of the exodus of a large number of youths for overseas employment. It resulted in high remittance inflows (around 20 per cent of GDP). In 1997-98, income from exports constituted the largest share (37 per cent) of total foreign exchange earnings. Currently, while its share is less than nine per cent, remittances contribute a whopping 62 per cent to total forex reserve.

The high dependence on remittance financed imports as a result of low domestic output and uncompetitive exports is widening the trade deficit. To decrease the gap, there is no other option but to increase production and exports. What is barring us from doing so? Inadequate supply of infrastructure and poor investment climate are the two key factors.

First, firms are operating below potential due to insufficient supply of electricity and lack of workforce. Second, cost of production is rising due to the compulsion to run diesel guzzling generators and multiple hurdles along the poorly maintained trade routes. Third, poor investment climate arising from labour militancy, extortion, frequent strikes, disruption of supply chain, and high cost imposed by syndicates along with rising cost of doing business in general are eroding industrial strength.

These are making production uncompetitive and exacerbating our ability to utilise readily available market potential abroad. Solving these should be the first priority of our leaders instead of begging for market concessions during each bilateral trade talk. It is the responsibility of not only the Ministry of Commerce and Supplies, but all line ministries, political parties and the private sector.

Friday, August 17, 2012

Links of Interest (2012-08-17)

Links to (and excerpts from) some of the interesting news and papers.

Syndicates and distortions in Nepal (The Economist):

[…] “This is the main reason for their reckless driving,” said the nation’s top traffic cop. “There is a syndicate system, a cartel. The cartel is very powerful…it is very difficult to fight against them.”

High fares, poor services and an atrocious safety record are the result. In the past few weeks scores have died in bus wrecks on difficult mountain roads around the country. Drivers are said to joke that the driving licence is a “licence to kill”.
Last week the transport industry went on strike, throwing millions of daily routines out of joint. They were demanding that the government concede to 15 demands. The authorities had been willing to meet 14 of them.
[…]The transport cartels erect high barriers to entry (the right to ply a city route reportedly costs as much as a new minibus) and they enjoy the support of powerful politicians. “These are among the biggest donors to political parties and they send the most people to rallies and strikes,” says Chandan Sapkota of Satwee, an economics think-tank.
But what ails the transport sector is also the case in every other lucrative industry. Every political party is involved. The country has been run in the same manner through periods of royal autocracy and multi-party democracy alike.

Dutch disease starts to take toll on economy (The Himalayan Times): Also see this blog

“Remittance has financed imports, leading to an unsustainably high merchandise trade deficit, which has reached as high as 26 per cent of GDP,” another trade researcher Chandan Sapkota, said, adding that the remittance-financed high imports have also been crucial for revenue generation as over 50 per cent of total tax revenue is coming from consumption tax. The country’s import has increased by four times to Rs 419.57 billion — in the first 11 months of the last fiscal year — from Rs 125.5 billion in the fiscal year 2002-03.

[...] But remittance has also been responsible for the Dutch disease effect, which is the loss of competitiveness of non-resource tradable sector — exports sector — due to the appreciation of the exchange rate after substantial inflow of resources from one particular sector –– remittance, according to Sapkota.

Remittances and Dutch disease in Nepal (Karobar Economic Daily):

"रेमिट्यान्सले आर्थिक वृद्धिमा नकारात्मक असर परेको र बढ्दो निर्भरताले नेपालका लागि यो ‘डच–रोग’ बन्न लागेको एक अध्ययनले देखाएको छ ।

साउथ एसिया वाच अन ट्रेड, इकोनोमिक्स एन्ड एन्भायरोन्मेन्ट (सावती)का शोधकर्ता चन्दन सापकोटाले गरेको ‘नेपालमा रेमिट्यान्स : वरदान या अभिशाप’ विषयक अध्ययनमा रेमिट्यान्सले डच रोगको प्रभावलाई प्रेरित गरेको उल्लेख छ । लगानी वातावरण बनाउन नीतिगत सुधारमा ढिलो भइसकेको निष्कर्ष अध्ययनको छ ।

[…]“रेमिट्यान्स प्राप्तिले नेपाल पनि यही मानसिकताको सिकार भएको छ,” अर्थशास्त्री प्रा. डा. विश्वम्भर प्याकु¥यालले भने, “कुल गार्हस्थ्य उत्पादन (जीडीपी)मा २५ प्रतिशत योगदान रहेको रेमिट्यान्सको दिगो उपयोगमा जोड दिन आवश्यक भइसकेको छ ।”

उनले रेमिट्यान्सको नकारात्मक असर न्यूनीकरणका लागि आवश्यक कदम चाल्न ढिला भइसकेको पनि बताए । “जीडीपीमा कृषि र गैरकृषि क्षेत्रको योगदानको अवस्था परिवर्तन भए पनि कृषिमा निर्भरता घट्न सकेको छैन,” उनले भने, “कृषि क्षेत्रको उत्पादकत्व बढाउन रेमिट्यान्स उपयोग गर्न सकिन्थ्यो ।”

नेपालले संक्रमणकालीन अर्थतन्त्र व्यवस्थापन गर्न नसकेको प्याकु¥यालले बताए । “रेमिट्यान्स प्राप्तिले शोधनान्तर बचत र विनिमय सञ्चितिका सूचकमा मात्र जोड दिए बृहत् अर्थतन्त्रलाई सम्हाल्न गाह्रो हुन्छ,” उनले भने

Determinants of Donor Generosity: A Survey of the Aid Budget Literature

[…]aid inertia, the donor country’s GDP per capita, the existence of an independent aid agency, and colonial history have a robust and quantitatively relevant impact on countries’ aid efforts. Among the potential substitutes for aid, remittances exert a robust effect. Excluding year fixed effects, political globalization, Russian military capacity, peer effects, aid effectiveness, and government debt also play a significant role.

What explains political institutions? Evidence from colonial British America

[…]In a recent paper (Nikolova 2012), I argue that institutional change depends on labour market conditions: elites opt for liberal representative institutions when labour is scarce, and vice versa. I use a unique data set covering a period of relatively rapid change in representative institutions in the thirteen British American colonies from their very establishment to the American Revolution. In contrast to theories arguing that inequality is the primary determinant of the quality of political institutions (Boix 2003, Acemoglu and Robinson 2005), I show that liberal representative institutions may arise even in cases of high inequality, as the positive impact of labour scarcity outweighs the usual negative relationship between inequality and democracy. The relative fluidity of political institutions in this setting and time period also questions the validity of arguments linking institutions to historical persistence. In terms of implications for contemporary countries, the theory predicts that as autocratic regimes – such as China – face more binding labour constraints, democracy will be more likely to emerge.

[…]My analysis emphasises the importance of labour market structure in addition to inequality in explaining the evolution of political institutions in colonial British America. But just how relevant is the political experience of these colonies for explaining more recent institutional change? Female enfranchisement in Western Europe and the US coincided with the end of the First World War, which made male workers scarce (see Braun and Kvasnicka 2011). Similarly, countries with a labour shortage in particular occupations have point-based immigration schemes that grant citizenship and the associated political rights to qualified candidates. For instance, Canada and Australia have special programmes giving permanent residence to highly skilled immigrants. Therefore, the findings of my research provide a different angle to the debate in the literature on what pushes institutional change.

The fiscal cost of trade liberalisation

[…]Our argument is not that trade liberalisation is bad per se. In the long run a fall in tariffs will have a positive impact on welfare as it increases the efficiency of the tax system. However we point out that the net effect will always be negative for countries which are trapped in a low tax-capacity equilibrium, precisely those countries which were characterised by low revenue collection even before they decreased tariffs. We indeed observe that nearly a third of countries which experience a fall in trade tax revenues never recover the lost revenues through other means in our sample. Other countries will suffer from a short-run loss, but will be better off in the long-run.

Technical aid on public sector financial management has always been the poor parent of official development aid (OECD 2010). Both the evidence and the theoretical framework we develop point to the need to increase efforts to improve developing countries’ capacity to raise taxes. Our model suggests in particular that the gains from trade liberalisation can be obtained by investing in tax capacity. Building more efficient tax administrations in developing countries may lead them to open up to trade as they will no longer need to levy tariffs to raise revenue, though other protectionist motives for raising tariffs may be at play.

Top tax payers in Nepal are the banks (The Kathmandu Post) – It says a lot about investment climate and remittance inflows!

The service sector has emerged as the biggest income tax payer to the government even as the manufacturing sector have been reeling due to infrastructure- and labour-related problems.

Among the top 10 companies that were the highest income taxpayers last fiscal year 2011-12, only Surya Nepal could make it on highest taxpayers’ list this year. All the other companies are from the service sector with as many as seven banks and two telecom operators making the list.

Wednesday, August 15, 2012

KFC, Pizza Hut closure: A setback for foreign investors in Nepal

KFC and Pizza Hut in Nepal, operated by Devyani International Nepal, closed down the fast food outlets for indefinite period following militancy shown by ad-hoc committee of All Nepal Hotel and Restaurant Workers Union-Revolutionary (ANHRWU-R), the Maoist (Baidya faction) party affiliated trade union which was trying to register one at the Department of Labor.

This should not have happened especially this year, which the Maoist-led coalition government declared as Investment Year (irrespective of its relevance after the partial budget unveiled in July). The manufacturing output has already nosedived due to supply-side constraints, including labor related disputes. Its contribution to GDP is just below 6 percent. Merchandise exports remain below 5 percent of GDP.

Things are not completely clear right now:

The management says some workers trying to open union beat up managerial staff and gave threats to their life.
The workers (especially leader of the protesting folks) argue that nothing of the sort alleged by the management happened. They were just trying to register a union.

Few comments:

Before the truth comes out, it will be hard to say who is right.
Based on past experiences, the workers (especially those from unions who are dictated by political party bosses) have faulted badly. Read here and here. Also, remember this time when the unions stroke a deal with the industrialists to not go for strikes for four years. What happened to that commitment?
According to the Nawaraj Bhatta (president of the ad-hoc committee of ANHRWU-R), a team of 66 staff members had applied for the registration of ANHRWU-R at the Labor Office on August 7. But, some workers were surprised that their names appeared on the list without their consent. Is there any room for doubt that some rigging did happen?
As a result of the dispute, 180 workers have become unemployed. They were earning at least Rs 20,000 per month (this is higher or equal to what Nepali migrant workers usually get for unskilled jobs in Malaysia and the Gulf). The management is adamant that it will stick to “no work, no pay”—something that will flare the fight between the two seemingly warring sides.
In these kinds of tussle, the unions usually presume that the management will ultimately yield to their demands because of the high fixed cost (sunk cost) and interference by political leaders. However, in the case of international investors we have seen it quite clearly that this gamble won’t work. Evidence: remember how Colgate Palmolive and Surya Nepal Private Limited’s (SNPL) packed shut down production and left the country. You guess who is on the losing side?
The policy inconsistency of government and stance inconsistency of trade unions (that have been using extralegal means to press their demands) are bleeding the industrial sector. Vested interests of trade union bosses and their bosses of political parties are actually costing dearly not only the industrial sector but also the jobs of naïve workers, who are in a mirage that they are truly represented by their union leaders and politicians (most of whom are past their retirement age). Closing down Surya Nepal cost 650 direct and 1400 indirect employment.
Read this article that explains how labor militancy is leading to strike-unemployment cycle. This statement is even valid right now: “If you have lost a job, are potentially going to lose, or cannot get one in the market, then blame the outrageous, militant youth wings and the politicians who incite the unions to go on a destructive path.” Read this article that explains the disconnect between outrageous labor demands not matched by labor productivity. Unions need to match up the increase in wages by productivity. While wages increased by multiple folds in the last decade, labor productivity increased by just, on average, 1.10 percent.
The bottom line is that this is a very unfortunate development. The faster the government resolves it, the lower will be the damage. Too bad it happed just when FDI were starting to increase after years of close disappointing performance.

Saturday, August 11, 2012

Linkages between trade and climate change

Here is how trade contributes to climate change: The reduction in average tariffs in major export destinations and the booming trade has also increased production and economic activities. This means it has also increased GHG emissions, which are the major causes of climate change as humans are mostly responsible for the increase in temperature especially in the last 50 years.

In a new research note (the above figure is extracted from the same paper), Canuto and Onder provide that three ways through with trade intensity affects emissions.

Increased trade means increased production, which means increased emissions—scale effect
Greater specialization on production and export of goods might lower or increase emissions depending on the production structure, i.e. if it is polluting or non-polluting economic activity (think of coal and hydroelectricity respectively)— composition effect
Technology transfer might promote ‘cleaner’ ways to produce goods— technique effect

Here, 3 would reduce emissions; 2 would result in neutral outcome as, theoretically, if everyone specializes in production where they have comparative advantage, then one might focus on emission boosters and others emission reducers, leading to existing levels of emissions; 1 would increased emissions.

The questions faced by policymakers is: How to boost prosperity without increasing emissions and the lowest cost possible? Looks like 3 is the best option but then it might not be fully financially and technically viable when viewed from developing country perspective. The added cost of adopting such method of production at the country level (i.e. without international common standards) would mean decrease in price competitiveness and loss of export markets. Hence, the unwillingness of rapidly growing economies to comply with strict emission reduction standards.

Canuto and Onder argue that “trade may help mitigate climate change, as long as the temptation to resort to inappropriate trade policies is avoided.” For this, implementation mechanisms need to be very explicitly well defined in multilateral agreements. To make trade and climate change policies compatible, they say:

[…] multilateral investigations are necessary for jointly accepted trade and climate policies. Careful and detailed definitions of implementation tools and procedures are crucial in preventing the undesired protectionist consequences of trade policies.

Regarding Nepal’s emissions level, here are some stuff from a previous blog post:

As expected, emission levels are very low in Nepal. But, annual temperature change between 2045-2065 (relative to the control period 1961-2000) is projected to be higher than in even Bangladesh, China, India and the USA. Hot days and warm nights are expected to increase by 2.5 days and 8 days respectively between 2045-2065 (relative to the control period 1961-2000).

The figure below compares CO₂ emissions, projected annual temperature change and projected change in hot days/warm nights (2045-2065).

And, here is how climate change will impact agriculture production and trade in South Asia:

Climate change affects agricultural yield, which in turn has a strong bearing on economy and livelihoods. It alters comparative advantage in the trade of agricultural goods. Due to an expected decline in yields, potential restrictions on food trade and food- price inﬂation, food insecurity might increase. Against such a backdrop, apart from attempts to reduce agricultural as well as non-agricultural emissions and smoothen trade ﬂows, adequately funded and concerted adaptation measures have to be implemented in South Asia.

Wednesday, August 8, 2012

Nepal ranks 79 out of 105 countries in food security

The EIU has come up with a new global food security index by considering three factors (corresponding weights in brackets): affordability (40%), availability (44%), and quality and safety (16%). The 1996 World Food Summit defines food security as the state in which people at all times have physical, social, and economic access to sufficient and nutritious food that meets their dietary needs for a healthy and active life.

Out of the 105 countries, Nepal’s overall rank is 79 with a score of 35.2 (low rank and high score are better). The overall index is composed of 25 indicators related to the three main factors. The table shows ranking of South Asian countries with the most favorable conditions for food security. Its no wonder that Nepal’s ranking is the lowest in the region in terms of affordability given that the food prices have been higher than non-food prices (see this blog post, and also this, this and this paper).

The report notes that Nepal’s major strength with regards to food security are

Nutritional standards
Volatility of agricultural production
Agricultural import tariffs
Food safety (most run by multilateral agencies and NGOs)

And major weakness are:

Public expenditure on agricultural R&D
Food consumption as a share of household expenditure
Gross domestic product per capita
Diet diversification
Protein quality

FOOD SECURITY INDEX
OVERALL SCORE			AFFORDABILITY
Rank	Country	Score	Rank	Country	Score
62	Sri Lanka	47.4	61	Sri Lanka	45.6
66	India	45	70	India	38.4
75	Pakistan	38.5	78	Bangladesh	33
79	Nepal	35.2	79	Pakistan	32.9
81	Bangladesh	34.6	91	Nepal	22.6
AVAILABILITY			QUALITY & SAFETY
Rank	Country	Score	Rank	Country	Score
52	India	51.3	56	Pakistan	55.5
58	Sri Lanka	49.2	70	Sri Lanka	46.8
71	Nepal	43.8	73	India	44.2
81	Bangladesh	37.6	74	Nepal	42.6
82	Pakistan	37.4	92	Bangladesh	30.4

Overall, the top five countries having the most favorable conditions for food security are the US, Denmark, Norway, France and Netherlands.

Affordability is composed of sub-indicators namely food consumption as a share of household expenditure, proportion of population under global poverty line, gross domestic product per capita, agricultural import tariffs, presence of food safety net programs, access to farmer financing. In affordability, the US, Switzerland, Netherlands, Norway and Australia are top ranked countries.

Availability is composed of sub-indicators namely sufficiency of supply (average food supply and dependency on chronic food aid), public expenditure on agricultural R&D, agricultural infrastructure (existence of adequate crop storage facilities, road infrastructure, and port infrastructure), volatility of agricultural production, and political instability. In availability, Denmark, Norway, France, the US and Netherlands are the top ranked countries.

Quality and safety is composed of sub-indicators namely diet diversification, nutritional standards (national dietary guidelines, national nutrition plan or strategy, and nutrition monitoring and surveillance), micronutrient availability (dietary availability of vitamin A, animal iron and vegetal iron), protein quality, and food safety (agency to ensure the safety and health of food, percentage of population with access to portable water, and presence of formal grocery sector). In quality and safety, Israel, France, the US, Portugal and Spain are the top ranked countries.

The figure below shows the overall food security index score with respect to per capita GDP, poverty, agriculture infrastructure, and political stability risk. Nepal’s position is marked by a red dot. The yellow dots are South Asian countries. Needless to say, Nepal’s standing is quite low in all of them (except for poverty).

Crowding out of the private sector in fertilizer supply in Nepal

Here is a classic case of distortion of incentives and ‘crowding out’ of private sector in fertilizer supply.

Initially, when there was no subsidy in fertilizer, there was adequate supply in the market despite high prices. Then the Maoist-led government introduced fertilizer subsidy in 2007/08 and started increasing the subsidy amount in successive years. The supply by AICL, which is assigned to procure fertilizer and sell it at subsidized rate, undercut the market price. The private sector importers were unable to compete and survive at the prices offered to farmers by AICL through local cooperatives. Gradually, they got crowded out from the market. Since the government could not allocate adequate funds to subsidize fertilizer, AICL was unable to procure enough of it, leading to acute shortage during peak paddy planting season. AICL is able to meet only 20-25 percent of the demand for fertilizers. See this blog post for more.

Here are excerpts from an interesting piece on the same issue by BR Kaini, a former chairperson of AICL Board:

[…] Various surveys conducted in the past (ASPR in 2000/2001 and OPM in 2001/2002) estimated fertilizer usage ranges from 56.0kg to 58.0kg nutrient/hectare. But if we consider only the amount of fertilizer imported from formal sources for calculating per hectare use of fertilizers, it would be less than 30kg. This clearly indicates that about 50 percent fertilizer used in Nepal is imported from informal sources, which is both illegal and unreliable. Therefore, ensuring an adequate supply of fertilizer to farmers in the country has always been a challenge for the government.

The government has, however, changed fertilizer policies several times in a bid to ensure a smooth supply of fertilizers in the country. In this context, the government has recently re-introduced a subsidy on 25 percent chemical fertilizers of the total requirements. This new subsidy policy is now being implemented and the percentage of subsidized fertilizers is gradually increasing every year.
Nepal’s fertilizer supply growth rate is negative while the demand growth rate is over 15 percent (approximately) every year. AICL is meeting only 20 to 25 percent of the present demand of fertilizers in Nepal. Private importers have almost given up this business because of their inaccessibility to subsidy. Hence; there is a glaring gap between the projected demand and supply of fertilizers. The average supply gap is reported to be around 46 percent. In order to reduce this gap and make fertilizers available to farmers in time, some measures are imperative.

Read the full article here. Kaini also proposes some remedial measures, ranging from a study to estimate the real demand for fertilizer to domestic production and a fertilizer agreement at the regional level.

Sunday, August 5, 2012

Difference between farm price and wholesale price of fruits and veggies

Here is an interesting piece about the lawlessness in Kalimati wholesale market for fruits and vegetables. Kantipur’s Lokmani Rai reports the distortions created by YCL, the Maoist party’s youth wing, and syndicated business.

Below is a snapshot of the difference between farm price and wholesale price of fruits and veggies.

Price difference (Rs per kilo), 2012-08-03
Item	Farming site (Dharke, Dhading)	Wholesale market (Kalimati, Kathmandu)	%difference
Tomato	25	48	52.08
Pumpkin threads (per roll/mutha)	8	15	53.33
Pear	15	35	42.86
Bitter melon	16	35	45.71
Cauliflower	18	40	45.00
Cucumber	27	35	77.14

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