Global Competitiveness Report 2014-15: Nepal ranks 102 out of 144 countries

According to the latest Global Competitiveness Report 2014-15, Nepal ranked 102 out of 144 countries. This is an improvement from 117 in GCR 2013-14, and 125 in the two years before that.

In the three main components of GCI, Nepal ranks 100 out of 144 countries in basic requirements for competitiveness (institutions, infrastructure, macroeconomic management, and health and primary education); 115 in efficiency enhancers (higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, and market size); 124 in innovation and sophistication (business sophistication and innovation).

The major contributors to the improved overall ranking are good progress on macroeconomic management (rank 37), health and primary education (rank 75), and financial market development (rank 75). Within macroeconomic management, the major contributors are the low government budget balance (rank 11) and low public debt (rank 38). Within health and primary education, the major contributor is the high net primary education enrolment (rank 19). Within financial market development, the major contributors are financing through local equity market (rank 47) and legal rights index (rank 29).

[The numbers are impressive, but the mechanics of getting there is not that straightforward. For instance, the good budget balance is not due to impressive fiscal management, but because of the inability of the government to spend allocated money combined with robust revenue mobilization, thanks to rising revenue from taxes on imported goods financed by remittances. For a low-income country like Nepal, which has huge financing need to close the infrastructure deficit, running a modest fiscal deficit without jeopardizing fiscal sustainability and macroeconomic stability is generally a good option.]

Nepalese businessmen think that the top five problematic factors for doing business are government instability, corruption, inadequate supply of infrastructure, policy instability, and inefficient government bureaucracy.

Financial stability in Nepal – 2014 v.1

The Nepal Rastra Bank (NRB) biannually publishes financial stability report (FSR), which comes out with a lag of about six months. The latest FSR reports developments up to mid-January 2014.

Below are key highlights of the report.

Financial system:

• The financial system in Nepal consists of banking and non-banking systems. Banking system includes commercial banks, development banks, finance companies, and micro-finance financial institutions, and NRB permitted cooperatives and FINGOs. Non-banking system includes CIT, EPF, postal saving bank, insurance companies, cooperatives, Nepse, and merchant banking institutions.
• These together total 285 BFIs and other financial institutions. BFIs total 211 and represent 88.7% of total assets and liabilities.
• Total assets and liabilities of NBL, RBB and ADB— the three state-owned commercial banks— are equivalent to 15.9% of GDP. They serve 26% of total deposit account holders and 44% of total borrowers. Their combined branch network cover 33.9% of total commercial bank branches. However, they just have 80 ATMs.

Liquidity:

• Excess liquidity due to a surge in remittance inflows and the sluggish growth in private sector credit. It suggests a general lack of favorable investment climate.
• Excess liquidity adding costs as banks have to pay interest on deposits, and hence are disinclined to lower lending interest rates.
• Liquid assets to deposit ratio is higher than the regulatory requirement.
• Repeated OMO through reverse repos and outright sale auction to mop-up excess liquidity not effective to resolve the issue beyond the short-term.
• All BFIs restricted from accepting institutional deposit over 60% of their total deposit.
• Prompt Corrective Action (PCA) now based on capital adequacy and liquidity situation. Liquidity Monitoring and Forecasting Framework (LMFF) covers class A, B, and C BFIs.

Non-performing loan (NPL):

• Overall, NPL level is about 4.3%, but there are significant variations within BFIs. Total NPL of commercial banks and development banks stood at 2.6% and 4.6%, respectively by mid-July 2013. NPL of finance companies stood at 15.7%.
• Real estate concentration is still high even though it is coming down as old real estate investments are gradually maturing. Residential housing loan is expanding.
• 44.5% of total loan is backed by actual real estate.

Capital adequacy ratio (CAR):

• Regulatory CAR for commercial banks, development banks and finance companies is 11%, 10% and 10%, respectively.
• Regulatory requirement of paid-up capital is NRs2 billion, NRs640 million and NRs200 million for commercial banks, development banks and finance companies, respectively.
• CAR of commercial bank stands around 11.3%. CAR of development banks and finance companies stand at 15.4% and 15.9%, respectively. It suggests that these are well capitalized.
• Commercial banks and development banks are reporting under Basel II framework. Finance companies are following Base I format for reporting.

Financial stability:

• BFIs are not adequately capitalized to absorb the shocks— hold higher percentage of deposits on their total liabilities portfolio.
• Low business volume, rising funding costs, increased regulatory costs of higher capital requirements and liquidity buffers have become normal features.
• Paid-up capital and total capital increased due to mergers, IPO issuance by new banks, and further increment in paid-up capital by banks.
• As a share of GDP, total deposit and total credit have expanded. So has total credit to total deposit ratio, but this is still below the regulatory requirement, suggesting more room for BFIs to extend further credit for economic activities. But, credit to deposit ratio of B and C class institutions in totality exceeds the regulatory provision.
• 22 commercial banks remain vulnerable in case of deposit withdrawal by 15% and more. Overall vulnerability test suggests that commercial banks are in less vulnerable position than other types of BFIs.
• Only foreign banks and financial institutions can invest in shares of Nepalese banking sector. Foreign non-BFIs have to sell shares to Nepalese citizen or institution by mid-July 2015.

Governance:

• Lack of sound corporate governance practices, strong interconnectedness among financial institutions and promoters
• Poor assessment of risks (credit, liquidity, foreign exchange and operation)
• Growing risk from shadow banking activities.
• BFIs failing to establish a sound link between risk management, capital structure and lending.
• Lack of professional management, increasing unproductive assets, loan recovery problems, discouraging pay incentives, unsustainable profit targets, inadequate risk management practices, etc.
• Sound regulatory and supervisory authority needed to control malpractices of cooperatives.
• Stress testing mandatory for class A, B and C BFIs. It has to be reported back to the NRB.
• BFIs need to audit their information system and submit audit report by January 2015.
• No concrete provision to address interconnectedness so far. Interconnectedness occurring through inter-bank deposits and lending, investment by single promoter in more than one BFI, private placements, consortium lending, investment in government bonds, debentures, national certificate of savings, national debentures, etc.

Consolidation of BFIs:

• Small and financially poor BFIs merging with stronger ones.
• Moratorium on licensing of new Class A, B and C BFIs.
• Merger promoted to lower operating costs, bring about economies of scale, and diversify market share. Following the merger bylaws, 55 financial institutions have merged with each other and formed 23 institutions.

Interest rates:

• BFIs need to bring interest spread rate to 5% by FY2014. Base rate need to be reported by class A, B and C BFIs.
• Inflation is eating up, on an average, 4% return on deposits, i.e. real interest rates have fallen.
• The repo rate, 91-day T-bill rate, and inter-bank rate— important measure of short-term money market rate and indicate liquidity situation— remained low.

Labor productivity and wages in Nepal

Labor strikes in manufacturing and services sector have intensified in Nepal, especially after 2006. The strikes are usually organized by left-leaning trade unions, who get substantial backing from their affiliated political parties. Nepal probably has one of the forceful and unionized labor, at times displaying militant behavior, in South Asia. The repeated manufacturing and services sector strikes are based on demands for wage hikes, allowances, better facilities, etc. Minimum wages are reviewed every two years and fixed trilaterally (unions, employers and government). At the moment, manufacturing sector minimum wage in Nepal one of the highest in the region, but productivity growth has not kept pace with it, resulting in erosion of cost competitiveness. More on this here and here.

In this blog post, I wanted to share a simple chart that shows the disconnect between wage growth and productivity growth in the manufacturing sector. Especially between 2007 and 2012, while labor productivity (measured by value added per employee) increased at an annual rate of 11.4%, wages, salaries & other benefits per employee increased by 12.2%. The data comes from the latest census of manufacturing establishments.

Here is another chart showing the comparatively high minimum wage in Nepal relative to its per capita GDP and the regional economies. One of my friends (Brad) shared this chart.

Nepal’s manufacturing sector has been shrinking over the past several years. Its share of GDP declined to an estimated 5.6% in FY2014 from 8.2% of GDP in FY2002.

Nepal’s poverty based on various poverty lines

There is an ongoing debate on whether the most widely used $1.25 per day (PPP 2005) poverty line truly reflects the cost of basic needs. There are other measures of poverty such as the Multidimensional Poverty Index and the national poverty line.

Anyway, the point here is to show the percentage of population living below the various poverty lines, and let folks make their own judgment about the adequacy of this to cover the cost of basic needs.

Here I have used five poverty lines (all PPP 2005 $) and the corresponding poverty percentage in 2010/11 is given below:

• $1.25 a day: 24.8%
• $1.50 a day: 36.5%
• $2.00 a day: 57.2%
• $2.50 a day: 71.8%
• $3.00 a day: 81.2%

The striking thing about this is that despite the remarkable progress in absolute poverty reduction, as measured by $1.25 a day, (thanks mainly to remittances, agricultural wages, urbanization and improved access to social services), almost 60% of the folks are living below $2 a day poverty line. Alternatively, most folks are earning between $1.25 a day and $2.00 a day. It implies a high probability (and subdued/latent vulnerability) of sliding below the absolute poverty line in case of income shock such as the disruption in remittance inflows. To reduce the vulnerability, per capita income growth and jobs have to be driven by high and sustainable GDP growth, which could be achieved by investing in critical infrastructures (energy, transport, irrigation, ICT, etc). Else, the dent in poverty reduction is not going to be deep and wide enough.

Interested folks can compute here the percentage of population living below various poverty lines . In order to get the monthly poverty line, multiple the poverty figure a day by 365 and divide it by 12. Here I have used the monthly poverty line with one decimal point. You might get slightly different figures if the decimal points are larger. Anyway, it won’t make much difference.

Costs of climate change and adaptation to Nepal

A new ADB report on the costs of climate change and adaptation (full report here) argues that Nepal would see economic losses equivalent to up to 2.2% of annual GDP by 2050, widening to 9.9% by the end of the century. If mitigation and adaptation steps are taken, the damage could be limited to around 2.4% of GDP by 2100.

The report states that Nepal’s agriculture sector may reap short-term gains from warmer temperatures and melting snow and ice, (annual rice production could increase by as much as 16% in Nepal’s hills and mountains by 2080) but the glacial retreat and uncertainty about the summer monsoon’s start and end dates may reduce crop yields, causing food insecurity. Furthermore, melting glaciers, if suddenly breached, could cause catastrophic flooding downstream, posing risks to both human settlements and hydropower systems. In mountainous areas, landslides are likely to increase, threatening lives and infrastructure. Deteriorating and dwindling forests will result in habitat losses for some of the country’s rich flora and fauna, including snow leopards, undermining the country’s appeal for ecotourists.

• The regional climate model projections indicate temperature increases of 1.6°C -2.0°C in 2030, 2.3°C–2.9°C in 2050, and 3.4°C–5.0°C in 2080.
• For the terai region, the temperature change is likely to be 1.9°C in 2030, 2.5°C in 2050, and 4.6°C in 2080.
• The ensemble mean from GCMs indicates a temperature change of about 3.0°C–4.0°C by the end of the 21st century with high agreement (high confidence level).
• The country is likely to have negative precipitation departure over the three periods: –3.9% to –5.0% in 2030, –1.7% to –2.0% in 2050, and –0.9% to +2.9% in 2080.
• The A1B scenario indicates that precipitation departure for the terai region is likely to be –2.60% in 2030, –0.04% in 2050, and +3.72% in 2080.
• Precipitation projections for the 21st century from the GCM ensemble mean indicate wide variations and low level of agreement among models. Hence, there is very little confidence in the rainfall projections for the country.

In South Asia, the Maldives and Nepal would be the hardest hit, losing up to 12.6% and 9.9% of their economies, respectively, every year, by 2100. Meanwhile, Bangladesh would lose 9.4%, India 8.7%, Bhutan 6.6%, and Sri Lanka 6.5%.

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The cost of climate change adaptation measures in South Asia will depend largely on how the global community tackles the issue, the report says, noting that if the world continues on its path, the region will need to spend at least $73 billion, or an average of 0.86% of its GDP, every year between now and 2100 to adapt to the negative impacts. On the other hand, if countries act together to keep the rise in global temperatures below 2.5°C, the cost of South Asia shielding itself from the worst of the impacts would be nearly halved to around $40.6 billion, or 0.48% of GDP.

The report does not provide detailed adaptation cost projections on a country basis, although in the energy sector it notes that a rising gap between demand and supply could see Nepal face an annual adaptation bill of over $118 million in the 2030s, rising by another $100 million in the 2050s.

Almost all areas of South Asia will suffer as temperatures rise. While farmers in some parts of the region may benefit from warmer weather, overall the impact on agriculture will be negative. Annual rice production could increase by as much as 16% in Nepal’s hills and mountains by 2080, but drop as much as 23% in Bangladesh, Bhutan, India, and Sri Lanka by that time.

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Other highlights:

• Without global deviation from a fossil-fuel-intensive path, South Asia could lose an equivalent 1.8% of its annual gross domestic product (GDP) by 2050, which will progressively increase to 8.8% by 2100 on the average under the business-as-usual (BAU) scenario.
• The model suggests that the Maldives will be hardest hit in GDP loss, while Bangladesh, Bhutan, India, Nepal, and Sri Lanka are projected to face 2.0%, 1.4%, 1.8%, 2.2%, and 1.2%, respectively, loss of annual GDP by 2050.
• Should the global community take actions along the Copenhagen–Cancun agreements to keep the global mean temperature rise below or within 2oC, the region would only lose an average of 1.3% of GDP by 2050 and roughly 2.5% by 2100.

The story about migration and remittances in Nepal

This blog post is adapted from a NYT article published on 15 August 2014.

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In Nepal, a Better Life With a Steep Price

By GARDINER HARRISAUG

KATMANDU, Nepal — Picking up coffins at Tribhuvan International Airport here was once part-time work. Only a few arrived each week, not enough for a hearse driver to make a decent living.

Now, at least five turn up daily, the bodies shoehorned into white plastic-wrapped boxes. So, in 2009, Dipendra Prasad Acharya quit his job driving trucks to work full time in one of Nepal’s few growing industries — transporting the bodies of emigrant workers.

Mr. Acharya knows that his job is assured. At each pickup, he navigates around hordes of rangy young Nepali men and a growing number of women who mob the second-class departure terminal — some of whom are bound to return shrink-wrapped.

“The number of dead bodies keeps increasing,” he said, waiting for another coffin. “We ferry the dead to their home villages free of cost. The government pays me for my work.”

Nepal is a political and economic mess. A 10-year Maoist insurgency ended in 2006, but political leaders have since been unable to agree on a constitution. Despite vast hydropower potential, electricity is in such short supply that lights are extinguished for up to 14 hours each day. Manufacturing has declined for years, and now represents a paltry 6 percent of the country’s economy. Poverty is endemic, air pollution is choking, and health statistics are terrible.

With few jobs at home, the country’s youths have responded by leaving. The scale of emigration has astonished development economists, yet it continues to grow, increasing 37 percent in just the past two years.

On average, about 1,500 Nepalis officially left for jobs abroad each day in the 2014 fiscal year, up from six in 1996. Even more are thought to have left unofficially for India, though because the border is unchecked no one knows the precise figure. In some seasons, one-quarter of the country’s population may be working beyond the border, economists and manpower officials estimate.

No country in the world with at least 10 million people earns a greater share of its wealth from emigrant workers. Nepal has long been a destination for tourists eager to see the world’s highest mountains. But increasingly, even young Nepalis just visit.

The flood of foreign money — officially 25 percent of Nepal’s gross domestic product and unofficially as much as 40 percent — is rapidly transforming the country’s economy and culture. Sturdy brick homes now dot villages where only mud huts stood. Private schools flourish. With their husbands gone to work abroad, women venture from home more frequently, make more family decisions and have fewer babies.

“People that have come from abroad are more punctual,” said Ganesh Gurung, a sociologist at the Nepal Institute of Development Studies. “They don’t spit as much in public places.”

But backbreaking labor in Kuwait, Malaysia, Qatar and Saudi Arabia, the most popular destinations outside of neighboring India, has resulted in a troubling number of deaths. An investigation last year by the British newspaper The Guardian said that Nepalis were being used as slaves in Qatar to build facilities for the 2022 World Cup, and returnees have been found to have higher rates of H.I.V. and AIDS.

Still, in dozens of interviews, many of those who returned from the Middle East praised the working conditions there, though many also complained about poor living conditions and delays in getting paid. (A recent survey of Nepali migrant workers found that a quarter returned home because employers violated contracts, and female domestic workers in particular complained about excessive hours.)

“Before I went to Qatar, I’d never worked with safety equipment like safety belts and helmets and steel-toed shoes,” Kaplesh Mandal, a 30-year-old laborer, said in comments that were echoed by other men. “And there is traffic regulation. If we could get that here in Nepal, that would be really good.”

Migrants have transformed Katmandu, the jumping-off point for most official migration. Between 2001 and 2011, the city’s population grew 61 percent, to 1.7 million, while the country’s rose 14 percent, to about 26.5 million. Hundreds line up every day at the Narayanhiti Palace to apply for passports, a long and expensive process.

But no place has changed as much as the Dhanusha District, an agricultural region along the Indian border with low incomes and the highest share of emigrants’ families in the country. Much of the land is devoted to rice paddies, and yoked oxen are still the most common means of plowing.

Janakpur, the district capital, is a fetid warren of potholed streets, with some piled so high with rubble that they resemble a war zone. Roads outside the capital are largely dirt tracks over which vehicles rarely travel more than 15 miles per hour and people defecate openly throughout the day.

But hope has come to Dhanusha in the form of solid homes, a proliferation of radios and TVs, and good schools. There are also more bars for men who developed a taste for alcohol while abroad.

In 2007, Madan Deuba opened the Siddhartha English Boarding School, charging from $4 to $8 per child per month. In the seven years since, he has refurbished a small compound of whitewashed buildings and now has 400 day students. He hopes to continue expanding.

“Nearly all of the money I get comes from fathers and uncles who are working in Qatar or Saudi Arabia,” he said in an interview.

He has 11 teachers, and his students sprang to their feet when he entered classrooms. “Afternoon, sir,” the children sang in unison.

Fewer than half of Dhanusha’s adults can read, but the district’s emigrants invest substantially more in education than nonemigrants, a study found. Mr. Deuba said that his goal was to ready students for jobs abroad, although he said he never considered teaching Arabic.

A few blocks away, Munesa Khatun lived in a half-built brick home that her husband planned to finish when he returned from Saudi Arabia. But he died in that country. Now, one of their two sons works in Qatar and the other is waiting for a visa to join him, she said.

“I’m very frightened for my son because I don’t want him to die over there like his father,” Ms. Khatun said. “But we need money, and there is no other way to get it.”

Indeed, while foreign jobs have eased Nepal’s endemic poverty, they may be creating a vicious cycle that forces more and more people to leave by keeping the country’s currency and inflation high while hurting domestic production. Imports have surged, and little of the infrastructure needed for domestic growth has been built. Development economists are worried that Nepal’s lifeline may strangle it, either slowly or quite suddenly.

“If something were to happen in the gulf that affected the migration flow, Nepal would explode,” said Chandan Sapkota, an economist at the Asian Development Bank. “And neither policy makers, intelligence agencies nor the government here has any idea what to do about it.”

Who gets the fuel subsidy in reality?

Nepal Oil Corporation (NOC) is one of the largest loss making public enterprises in Nepal. In FY2012, NOC losses amounted to NRs9.5 billion (0.6% of GDP). It is practically operating with a negative net worth given the amount of debt it owes to EPF, CIF, the government and certain commercial banks. The NOC is the only entity in Nepal that is allowed to purchase petroleum fuel and LP gas from Indian Oil Corporation (IOC) and sell it in Nepal through private dealers. The irony is that it procures petroleum fuel at its own cost, but is forced to sell it at the price fixed by the government.

With such a pricing/institutional arrangement, the NOC is forced to sell petroleum fuel below the cost price, especially in the case of diesel and LP gas. The retail prices that do not fully reflect the NOC’s cost combined with the lack of dedicated government fund for that purpose mean that the NOC is forced to subsidize diesel and LP gas from its own purse. The losses accumulate to such an extent that the NOC is unable to pay the IOC, which then reduces fuel supplies. A severe shortage follows quickly, leading to rationing of fuel and LP gas through certain petrol pumps and retail shops. The shortage and ensuing uncertainty lead to rise in price of other goods and services as well (i.e. inflationary expectations push up prices after a lag of one to two weeks).

When the situation becomes unbearable, the government hastily arranges (plus guarantees) loans to NOC from the two large pension funds and commercial banks. At times, it is also followed by administered price hikes, resulting in protests and even bandhs (strikes) demanding rollback of such price hikes. Since it is politically sensitive and unpopular, the government refrains from allowing the NOC to harmonize domestic fuel prices with international prices (or its buying cost). There have cases where the same political parties have favored price hikes while in power, but opposed such moves while sitting on the opposition bench.

Currently, the NOC earns profit from the sale of petrol, kerosene and aviation turbine fuel. However, the losses from diesel and LP gas is so high that eventually NOC sees a big hole in its annual financial statement. Petrol consumption is just 31% of total diesel consumption. The NOC sells diesel and LP gas at around 15% and 45%, respectively, below the cost price. The consumption of diesel and LP gas has increased by an average of 9.8% and 14.2%, respectively, over the last decade. In FY2013, petrol, diesel and kerosene consumption was 221,679 KL, 716,747 KL and 24,721 KL, respectively. LP gas consumption reached 207,038 MT.

Now, the question is: Are the subsidies on diesel and LP gas justified? While a lot of the public transportation runs on diesel, increase in its price would trigger a sort of chain reaction: public fares go up, freight charges go up, prices of regular goods and services go up, salary and allowance go up, real interest becomes negative, investors get worries, etc. The underlying reason is that folks from across the consumption quintile use diesel for one or the other purpose and feel the heat.

The case of LP gas consumption is different though. About 17.7% of households use LP gas for cooking. Within it, the two poorest quintiles hardly consume LP gas. About 2.8%, 12.1%, and 55.8% of households in the third, fourth and richest quintiles use LP gas for cooking. Furthermore, while 58.8% of households in urban areas use LP gas for cooking, the figure in the case of rural areas is just 6.8%. Overall, about 64.4% of households use wood for cooking. Essentially, the government is subsidizing LP gas for the richest folks, residing in urban areas, who can actually afford to consume it even when retail prices reflect NOC’s buying cost. The losses from the sell of LP gas constitute a lion’s share of NOC’s total losses.

The irony is that every time administered fuel and LP gas prices are raised, student associations in public campuses (mostly affiliated to political parties) protest against it by clashing with police and by organizing bandhs (strikes) arguing that such hikes hurt the poor the most. However, statistics show otherwise. Knowingly or unknowingly, their protests, if successful in rolling back price hikes, seem to be favoring the richest households! It is baffling to a rational observer when the same folks do not mind spending NRs1200 or so on a bottle of whiskey (or any non-essential goods including beer, cold drinks and cigarette) each week, but vehemently oppose price hikes of just 10%-20% on LP gas. If NOC is allowed to adjust retail prices that reflect its buying cost, then the market would not see frequent bouts of shortages.

That said, few things need to happen with regard to NOC’s financial woes and regular fuel supplies:

• Check NOC’s leakages (transportation, commission, corruption, etc) and rationalize the number of staff
• Adjust retail prices to reflect NOC’s buying costs
• Provide targeted subsides so that the poorest folks do not have face an unbearable financial burden. The dual pricing of LP gas based on the color of cylinder may help.
• Depoliticize NOC’s board and its operations
• Establish a Petroleum Stabilization Fund so that it could be used to cover NOC’s losses if the government forces it to sell fuel below its buying rate. It could stabilize supplies.
• Control the unruly tanker association and petroleum entrepreneurs (?) association.
• End NOC’s monopoly by allowing private sector to both procure and sell petroleum fuel and LP gas.
• Taxes on petroleum fuel may need revising as it is prohibitively high.
• Dealers commission may need to be rethought. Also, quality of products sold through retail stores need to be checked frequently.

A marginal hike in administered fuel prices makes a huge difference in NOC’s balance sheet. For instance, the rise in administered fuel price and the decrease in oil price in the international market in FY2013 reduced NOC’s losses to NRs2.1 billion from NRs9.5 billion a year earlier. As consumption increased together with longer load-shedding hours, the government is projecting losses of about NRs10.2 billion (0.5% of GDP) in FY2014.