Nepalese economy in FY2014: Real sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here is an earlier blog post on FY2015 GDP growth and inflation forecasts.

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Gross domestic product (GDP) grew by an estimated 5.2% in FY2014, up from 3.5% in FY2013, as a result of the bumper agricultural harvest, moderate recovery in construction, and robust services activities backed by high remittance income (Figure 1). The services sector contributed about six-tenths of the GDP growth, largely coming from wholesale and retail trade; and transport, storage and communication activities. The agriculture sector’s contribution to the GDP growth stood at three-tenths and the industry sector contributed about one-tenth.

In the agriculture sector, which comprises almost 35% of GDP and provides livelihood to about 76% of households, growth rebounded to an estimated 4.7%, the highest in the last six years. The timely and favorable rainfall, and the adequate supply of agricultural inputs, including chemical fertilizers, boosted production of both summer and winter crops.[2] According to the Ministry of Agriculture Development, paddy production is projected to increase by 12%, up from a 11.2% decrease in FY2013. Similarly, maize production is estimated to increase by 9.9%, up from an 8.3% decrease in FY2013. Wheat production is projected to increase by 6.1%, up from 2.0% in FY2013. Paddy, maize and wheat accounted for 52.5%, 23.3% and 20.1%, respectively, of total cereal production in FY2013 (Figure 2).

The industry sector, which comprises a mere 15% of GDP, grew by an estimated 2.7%, marginally up from its 2.5% growth rate in FY2013, as construction, and electricity, gas and water grew modestly despite a slowdown in manufacturing. The timely budget and modest acceleration in actual capital expenditure (though still low compared to the planned expenditure) propelled construction activities growth to 2.9%, up from 1.9% in FY2013. Manufacturing activities grew by 1.9%, the lowest rate in the last five years, primarily due to the impact of long hours of power cuts, persistent supply-side constraints, and the rise in cost of production due to the increased prices of imported raw materials. Concrete, sugar, aluminum materials, vanaspati ghee, paper, biscuits and beer production fell by over 30% in the first two quarters of FY2014. The average capacity utilization of key industries remained at 49.9% in the first half of FY2014, slightly higher than the 44.7% capacity utilization recorded in the first half of FY2013.[3]

The remittance-induced consumption demand propelled services sector growth to an estimated 6.1%, the highest growth rate in the last six years. The services sector, which comprises about 51% of GDP, grew by 5.2% in FY2013. Within the services sector, wholesale and retail trade— whose share in GDP was 14.9% in FY2014, higher than the share of the industry sector— grew by an estimated 8.8%, two percentage points higher than in FY2013 (Table 1). Wholesale and retail trade’s contribution to GDP stood at 1.32% in FY2014, up from 0.98% in FY2013, reflecting the strong growth of remittance inflows, which boosted consumption demand of imported goods. The increase in the number of tourist arrivals and its positive impact on spending boosted hotel and restaurant activities by an estimated 7.1%, up from 5.5% in FY2013. Driven largely by the robust increase in communication related activities, the transport, storage and communication sub-sector grew by 7.5%, marginally up from 7.4% growth in FY013. The slow recovery of real estate, renting and business sub-sector, which grew by 3.0% from 2.7% in FY2013, reflected the tight sectoral credit policy imposed by the central bank on banks and financial institutions.[4]

Table 1: Sub-sectoral growth and share of GDP

	Growth		Share of GDP
Sub-sector	FY2013R	FY2014P	FY2013R	FY2014P
Agriculture and forestry	1.1	4.7	33.5	32.6
Fishing	2.7	4.9	0.4	0.5
Mining and quarrying	3.3	3.7	0.6	0.6
Electricity, gas and water	0.3	4.8	1.3	1.2
Manufacturing	3.7	1.9	6.4	6.1
Construction	1.9	2.9	6.9	6.8
Wholesale and retail trade	6.8	8.8	14.5	14.9
Hotels and restaurants	5.5	7.1	1.9	2.0
Transport, storage and communications	7.4	7.5	8.9	8.7
Financial intermediation	-0.9	1.8	3.9	3.8
Real estate, renting and business activities	2.7	3.0	8.8	8.4
Public administration and defense	5.5	5.7	2.0	2.4
Education	5.9	6.0	5.8	6.4
Health and social work	5.6	5.5	1.4	1.5
Community, social and personal services	4.6	4.7	3.7	4.1

Source: Central Bureau of Statistics

On the expenditure side[5], consumption accounted for an estimated 91.1% of GDP, up from 89.9% of GDP in FY2013 (Figure 3), indicating the increasing consumption demand stimulated by growing remittance income.[6] Gross capital formation stood at an estimated 37.1% of GDP, contributed mostly by the increase in gross fixed capital formation (GFCF) from 22.6% of GDP in FY2013 to 23.1% of GDP in FY2014 despite a decrease in stocks from 14.3% of GDP in FY2013 to 13.9% of GDP in FY2014. Public and private GFCF were an estimated 4.7% and 18.5% of GDP, respectively. Despite these high investment figures, the impact on growth and employment is pretty nominal, most probably due to the inefficiency of investment management arising from the lack of efficiency-enhancing prerequisites related to physical and social infrastructures, and the inability to unwind expenditures in underperforming and unfeasible projects.

Despite an increase in exports, the high import demand— backed by high remittance income in the absence of domestically produced alternatives—further widened net exports, reaching an estimated negative 28.2% of GDP in FY2014 from 26.8% of GDP in FY2013. The increase in price competitiveness as a result of the weak currency pushed exports of goods and non-factor services to an estimated 12.1% of GDP, up from 10.7% of GDP in FY2013. Meanwhile, imports of goods and non-factor services increased to 40.3% of GDP in FY2014 from 37.5% of GDP in FY2013. The major factors affecting supply capacity and cost competitiveness of exports sectors are: (i) lack of adequate and quality infrastructure; (ii) political instability and strikes; (iii) recurring labor disputes and low productivity; (iv) lack of skilled human resources; (v) deficient research and development investment and innovation in the private sector; and (vi) policy inconsistencies and implementation paralysis.[7]

Gross domestic savings declined to an estimated 8.9% of GDP from 10.1% of GDP in FY2013 and 14% of GDP in FY2011. It indicates that a majority of the residents’ income is spent on consumption, which is mostly fulfilled by imported goods. Meanwhile, the substantial increase in gross national savings— from 40.3% of GDP in FY2013 to an estimated 46.4% of GDP in FY2014— reflects the record high remittance inflows, which reached 28.2% of GDP in FY2014. It has also contributed to a positive savings-investment gap[8] (an estimated 9.4% of GDP in FY2014) in the last three consecutive years. Though per captia GDP increased to an estimated $713.8[9] in FY2014 from $709.5 in FY2013, it is still lower than $715.8 in FY2012 (Figure 4). The fluctuation in per capita GDP is partly attributed to the depreciation of Nepalese rupee against the US dollar. Reflecting the high per capita remittance inflows, nominal per capita gross national disposable income reached an estimated $981.6 from $923.7 in FY2013. Per capita GNI stood at $727.9 in FY2014. The size of Nepal’s economy expanded to an estimated $19.7 billion in FY2014, marginally up from $19.3 billion in FY2013.

Domestic investment commitment: Total domestic capital investment (fixed capital plus working capital) commitment increased remarkably by 142% in FY2014, up from a rate of 42% in FY2013. As a share of GDP, it reached 15% in FY2014, up from 5.5% in FY2012, largely due to an astounding 158% increase in investment commitment in the energy sector. Overall, of the total investment commitment of NRs289 billion in FY2014, 77.3% was in the energy sector, followed by construction (12.1%), manufacturing (6.3%), and tourism (2%) (Figure 5). As a share of GDP, investment commitment in the energy sector went up from 5.1% in FY2013 to 11.6% in FY2014, indicating the rising investor confidence emanating from the strong commitment by the new coalition government to introduce investor-friendly reforms in a range of sectors, including energy. Energy sector development is the top priority of the new government.

Foreign direct investment (FDI) commitment: FDI commitment, approved by the Department of Industry, reached NRs20.1 billion in FY2014, marginally up from NRs19.8 billion in FY2013 (Figure 6). It translates into a growth of just 1.5% compared to 115% in the previous year. Consequently, as a share of GDP, it stood at a mere 1.04%, lower than 1.2% of GDP in FY2013. That said, while the FDI commitment in manufacturing, mineral, service and tourism sectors decreased, the energy sector saw an impressive 306% growth, mostly coming from India and China—which together accounted for 91% of the total energy FDI commitment. Country-wise FDI commitment shows that the People’s Republic of China (PRC) surpassed India as the top FDI source country with a 36.4% share of total FDI commitment in FY2014. The other top FDI source countries are South Korea, Cook Islands, USA, Japan, British Virgin Islands, and Singapore— together accounting for about 20% of total FDI commitment. It may be noted that despite the increase in FDI commitment, actual FDI inflow, as per the balance of payments, significantly decreased from NRs9.1 billion in FY2013 (0.5% of GDP) to NRs3.2 billion in FY2014 (0.2% of GDP).

 

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[1] R and P denote revised estimate and provisional estimate, respectively. Any reference to GDP for FY2013 and FY2014 in this Macroeconomic Update refers to revised and provisional estimate, respectively.

[2] Major winter crops are wheat, barley, potato, winter tomato, cauliflower and cabbage. Major summer crops are paddy, maize, millet, buckwheat and summer potato.

[3] Capacity utilization of key industries in FY2013 was 57.8%, the same as in FY2012.

[4] Responding to the busting of real estate and housing bubble, triggered by a decline in the growth of remittances in FY2011, and a build-up of non-performing loans, the central bank imposed a lending cap of 25% to this sector in FY2012. It contributed to the cooling down of prices in this sector.

[5] The GDP by expenditure data are prone to measurement errors as change in stocks is computed residually, which also includes statistical discrepancy/errors. Change in stocks was estimated to be 13.9% of GDP in FY2014. A large residual indicates that a significant portion of the GDP is either unexplained or could not be directly attributed to its components, i.e. consumption, capital formation and net exports.

[6] It may be noted that even though final consumption with respect to GDP is very high, the actual domestic consumption expenditure made up an estimated 62.9% of GDP in FY2014, down from 63.1% of GDP in FY2013 and 65.5% of GDP in FY2012. This is due to the surge in net exports (or export minus import) in FY2014, , i.e. the consumption expenditure on imports of goods and non-factor services.

[7] For more on Nepal’s export competitiveness, see the issue focus section of Macroeconomic Update, Vol.2, No.1, February 2014.

[8] Computed as the difference between gross national savings and gross capital formation.

[9] US$1=NRs98 in FY2014 and US$1=NRs87.7 in FY2013.

NEPAL: GDP growth and inflation forecast for FY2015

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2.

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GDP growth

The outlook for FY2015 is a bit less optimistic than that for FY2014, mainly due to the subnormal monsoon forecast and the likelihood of moderate El Nino conditions, which result in deficient rainfall and droughts. Not only did the monsoon rains arrive late this year[1], the overall rainfall also is expected to be lower— around 93% of the long term average[2]. This will potentially lower agriculture production in FY2015. It will be further exacerbated by the impact of natural disasters, particularly floods and landslides. However, with the gradual improvements in the political environment and the resurgence of investor confidence following the government’s commitment to unveil ‘second generation’ reforms to stimulate private investments, the industry sector s expected to perform much better than in the previous years. While he improved private sector confidence will likely boost manufacturing activities, the timely full budget with higher planned capital expenditures along with better project readiness, as well as increases in bank credit to personal housing may boost construction activities. The high inflow of remittances will continue to support robust service sector activities, especially wholesale and retail trade; transport, storage and communications; and real estate, renting and business activities.

Considering these developments, GDP growth (at basic prices) is forecast at 4.6% in FY2015, lower than both the FY2014 estimated growth rate and the government’s target of 6% set in the budget. Over six-tenths of the contribution to this growth rate is expected to come from the services sector, followed by one-tenth from the industry sector and the rest from the agriculture sector. Overall, the continuing robust services sector growth and a potential strong recovery of the industry sector will be partially offset by the anticipated decline in agricultural production, lowering the GDP growth rate in FY2015 compared to an estimated 5.2% in FY2014. In order to reach a 6% growth rate, assuming agriculture sector growth of 4.7% (which in reality in unlikely given the unfavorable monsoon), the non-agriculture sector has to grow by at least 6.7%, more than one percentage point higher than the growth rate in FY2014. Furthermore, assuming constant agriculture and services sectors growth as recorded in FY2014, the industry sector has to grow by a whopping 9% to achieve the government’s growth target. This would be challenging as industrial sector growth has averaged just 2.7% in the last three years.

Inflation

The expected low agriculture harvest, potential rise in administered fuel prices and transport cost, increase in public sector salary and allowance for two consecutive years, and disruptions in domestic distribution systems as a result of natural disasters and strikes will likely push up general prices of goods and services to 9.5% in FY2015. Furthermore, the heightened inflationary expectations will potentially exert further pressures on prices, especially that of key food products and clothing imported from PRC. The unfavorable monsoon will not only lower production and put pressures on food prices, but it might also encourage hoarding of major food products, creating additional pressures and further heightening inflationary expectations. That said, there is a high likelihood of a moderation of prices that pass-through imported goods from India and third countries as the ongoing stabilization of foreign exchange markets and increasing investors’ confidence on the Indian economy—thanks to the anti-inflationary stance by Reserve Bank of India Governor Raghuram Rajan and the credible, investor-friendly government led by Prime Minister Narendra Modi— might result in strengthening of the Indian currency in FY2015. Food and beverage, and non-food and services will likely account for about 60% and 40%, respectively, of the overall CPI inflation.

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[1] Monsoon rains were late by around two weeks. Normally monsoon rains enter on June 10 from the Eastern region, and gradually covering the entire country within a week. Approximately, 80% of total rainfall occurs between June and September.

[2] Indian Meteorological Department’s forecast in the second week of June 2014. Long term average refers to the 50-year average. For more, see: http://www.imd.gov.in/section/nhac/dynamic/weeklypress.pdf

Nepal Macroeconomic Update, August 2014

Here is the presentation on Macroeconomic Update Nepal, August 2014 from today’s media briefing.

Macroeconomic Update August 2014_2014-09-07

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.