My latest piece is based on the latest macroeconomic review 2009/10 published by the central bank of Nepal. My point is that despite substantial reduction in BOP deficit, the economy is still in a mess: low growth, low employment, high inflation, growth less investments in few sectors, and consumption fuelled economy, thanks to remittances, among others. The way BOP deficit declined has nothing to do with addressing these important variables.
Last week, the central bank came up with encouraging news that Balance of Payments (BoP) deficit declined from Rs 20 billion in the first quarter of 2009/10 to Rs 2.62 billion when the annual figures were compiled. Commentators were quick to extol stringent steps taken by the central bank to restrain imports of certain goods. The decline in BoP deficit has given some respite to policymakers, at least in the short term with regards to restoring market confidence that they can competently manage transactions between Nepal and the rest of the world.
Though this is welcoming news, it does not mean that other macroeconomic variables are also on the right track vis-à-vis existing monetary and fiscal policies. The core problems that led to BoP deficit beginning first quarter of last fiscal year have not been resolved yet. Worse, fresh indicators about the competitiveness of the economy show that the economy is still plagued by structural constraints, leading to alarming lending and consumption levels without reasonably proportional impact on growth and employment. We are still stuck in the same economic mess as before—widening trade deficit, high inflation, slow economic growth, low employment, and rigid non-economic constraints.
Our economy’s BoP is composed of three sections: Current account, capital account and financial account (there is ‘balancing item’ as well to account for statistical errors). Current account is the sum of balance of trade (exports minus imports of both merchandise goods and services), net factor income (such as interests and dividends), and net transfer payments (such as remittances, foreign aid, and pensions). This is the most important part of BoP with regards to its bearing on our economy’s growth, employment, exchange rate, and inflation. Despite the decline in BoP deficit, our current account is still in a very bad shape, implying that the main economic and non-economic issues are not resolved yet. Unless they are addressed, any fix on BoP accounts is of temporary, unsustainable nature.
Merchandise exports are down by 9.7 percent to Rs 61.13 billion in 2009/10. Last year, it was up by 14.2 percent reaching Rs 67.70 billion. Exports to both India and other countries declined. Meanwhile, merchandise imports have surged to Rs 378.80 billion, a growth of 33.2 percent. It grew by 28.2 percent, reaching Rs 284.47 billion in 2008/09. Imports from India and other countries grew by 34.2 percent and 31.8 percent, respectively. Consequently, trade deficit widened by 46.5 percent, reaching Rs 313.67 billion. In 2008/09, it rose by 33.3 percent and amounted Rs 216.77 billion. Trade deficit with India and other countries rose by 46.75 percent and 46.7 percent, respectively. This indicates an unfavorable balance of trade situation. It is simply unsustainable as we cannot forever import more than what we can afford to.
The reason why BoP was in surplus in previous years (Rs 44.66 billion in 2008/09) was because of high inflow of remittances, which checked current account from deteriorating amidst rising negative balance of trade. As growth rate of remittances inflows went down, thanks to declining demand of Nepali workers following the global economic crisis, current account went into the red, dragging overall BoP in its direction.
Current account deficit amounted to Rs 32.35 billion as against a surplus of Rs 41.44 billion in FY 2008/09. Capital account, which reflects a net change in national ownership of assets, surplus doubled this year to Rs 12.58 billion, up from Rs 6.23 billion in 2008/09. Financial account deficit was Rs 3.70 billion as against Rs 21.20 billion surplus in 2008/09. As a result, the overall BoP situation came down from a deficit of about Rs 20 billion in the first quarter to Rs 2.62 billion by the year’s end. The transfers and earnings from capital account are insufficient to negate widening trade deficit, which is dragging overall BoP in the negative terrain.
The decline in BoP deficit by the fourth quarter of 2009/10 looks like progress, isn’t it? Yes, but there is nothing to cheer about. There is no major change in indicators that will keep BoP accounts in a comfortable space in the coming years. Unless we find a way to narrow down the trade deficit – primarily by exporting more, and encouraging domestic production and consumption instead of imports of pretty much everything ranging from luxurious to non-luxurious goods and services – the problems associated with BoP deficit will not be adequately addressed. Continuing to bank on remittances and trade credit liabilities to even out BoP account is not a smart idea and policymaking.
It should be realized that in terms of productive capacity of the economy, prospect of future growth and employment scenarios, we are still very much deep in the same mess we were at the beginning of this year when BoP deficit was record high. In fact, we are actually going deeper into the mess. The ratio of exports to imports has declined from 23.8 to 16.1. Economic growth rate plunged from 3.9 percent to 3.5 percent. Inflation is still double-digit. Worse, amidst supply side constraints, cartelling and increasing money supply, inflation will probably creep up and stagnate at high level. Additionally, consumption has increased by 0.3 percentage points to 90.6 percent of GDP, and domestic savings is worryingly low at 9.4 percent of GDP.
The message is clear: We are still deep into economic mess, and the way BoP deficit declined by the fourth quarter of 2009/10 has not and will not contribute to us getting out of low growth, low employment, high prices and remittances-fueled impact-less investment cycles. This is further substantiated by the latest Global Competitiveness Report which ranks Nepal as the least competitive nation in South Asia. Globally, Nepal is 125th (out of 139 countries) most competitive nation!
[Published in Republica, September 16, 2010, pp.7]