Tuesday, February 28, 2012

Where is the danger of political polarization and extremism greater?

It is greatest in countries with:

  • relatively recent histories of democracy,
  • existing right-wing extremist parties, and
  • electoral systems that create low hurdles to parliamentary representation of new parties.

But, the greatest threat is when depressed economic conditions are allowed to persist. Read more here.

Creeping prices: What determines food and nonfood prices in Nepal?

[It is published in today’s Republica, p.6].

Creeping prices

In the mid-term review of monetary policy, the central bank argued that inflation, which is a measure of the increase in general prices of goods and services over a period of time, target of 7 percent for this fiscal year won’t be met. Instead, it stated that inflation will be around 8 percent. Unsurprisingly, it is not the first time inflation target has been revised upward. The dynamics of the causes of price fluctuations in the economy has discombobulated Nepalese experts and policymakers for a long time. Given the unique yet evolving market integration between Nepal and India, the ineffectiveness of monetary tools to tame rising prices, and the increasing influence of oil prices on general price level, tackling inflation in Nepal would require both policy tools as well as earnest political commitment to correct market distortions.

Generally, inflation is determined by money supply in long term. In short term, it is determined by demand and supply pressures, which are in turn affected by the relative elasticity of wages, prices and interest rates. In Nepal’s case, monetary tools such as increase in interest rates and decrease in money supply have not been used specifically to control inflation because there is hardly any correlation between M2—a broad measure of money supply and a key indicator used to forecast inflation—and prices of goods and services. Instead, our prices have historically been following the prices in the Indian economy, thanks to the pegged exchange rate and free flow of goods and services across the open border. Furthermore, policy interventions (mostly fiscal tools such as taxes and expenditure) have been more or less consistent with changes in the Indian economy. Interestingly, this link has been weakening following the global food, commodities and fuel prices hike after 2007 for two main reasons: increasing imports of petroleum products and domestic market distortions. Policy makers preparing firepower to tame rising prices should take note of these evolving changes.

A recent study by the IMF economists showed that almost a third of the variability in domestic inflation can be attributed to the prices in India and movements of international oil prices. While food price increases contributed to about three-fourths of overall rise in price level, monetary factors mattered more for nonfood price inflation than for food price inflation. It indicates rampant domestic food market distortions and rise in domestic financing for imported durables. Overall, food prices have been more volatile than nonfood prices in the economy. The study found that the responsiveness of food price inflation was significant and quick to spillovers from India’s food prices and the global oil price fluctuations before 2007. However, after 2007 the impact of fluctuating oil prices is more persistent than the spillovers of food prices prevalent in the Indian economy. Even though petroleum prices do not change readily in our economy as they do in the international market, the price fluctuations are seen directly and indirectly in the cost of imported inputs (and final products) used by agricultural, industrial and service sectors.

These findings are not in line with an earlier held belief and research finding (including a 2007 study of similar nature by Edimon Ginting of the IMF) that inflation in India and inflation in Nepal tend to converge and the pass through of inflation from India to Nepal takes about seven months. With the changing composition of imports from India and the large share of petroleum products in import basket, this has been changing since 2007, thanks to increasing demand for fuel to power machines, generators and vehicles. Currently, the pass through time of food and nonfood prices from India to Nepal has shortened and international oil prices have greater impact than what it was thought to have before.

It is not that the prices are entirely determined by external factors. Domestic supply-side factors also matter, particularly market distortions. Note that when global food prices spiked in 2007 and 2010, being a net food importing country, domestic food prices also went up. But, when global food prices moderated, domestic prices did not normalize accordingly. Why did prices remain stubbornly sticky at high level? Well, it is because of supply-side factors such as strikes, hoarding, black marketeering, deliberate withholding of supplies and inventory, distortion of agriculture prices by middlemen, and agricultural trade hurdles imposed by our neighbors, among other factors. These have increased uncertainty and expectation of future rise in input cost. The inflationary expectation arising from the uncertainty over supply of fuel and cooking gas, its rising prices at global level, and supply-side constraints have primarily contributed to the series of food and nonfood price hikes in recent months. That said, prices are also pushed up by demand factors, especially consumption demand fuelled by high remittance inflows. However, consumption has been high (around 92 percent of GDP) for a long time, so it does not justify the stubbornly high and sticky prices.

The changing pattern of the impact of oil prices, inflation in India and the uncertainty over supply conditions have important policy implications. First, the policymakers need to factor in the volatile oil prices when they estimate targets for inflation rate as domestic prices are deviating from the prices in the Indian market. Second, monetary tools have little traction on inflation and inflationary expectation in the short term. Fiscal tools such as lowering levies on petroleum products and subsidizing inputs might help to moderate prices. However, these too have drawbacks as they tend to widen budget deficit, and confound policymakers in managing the tradeoff between taming high prices and maintaining fiscal space. Third, resolving supply-side constraints seems to be the most promising, yet most difficult, intervention to lower rising prices. Promising because it will correct markets and link production with demand, but difficult because it requires more political than policy action. Fourth, prices will continue to remain volatile and high unless the government reduces load-shedding hours and matches power generation with power demand. Else, people will continue to demand more fuel each year, which means more shortages as the government cannot procure enough of it because of its inability to supply adequate funds to NOC without a substantial increase in revenue generation and reduction in allotted expenditure for other sectors. Note that the import of petroleum products increased by around 50 percent last year and the total earning from merchandise export was Rs 10 billion short of the total value of petroleum import.

The evolving factors that are pushing food and nonfood prices up have to be well comprehended to better design macro policies aimed at reducing high inflation, which is eroding real purchasing power of people. Along with the prices in the Indian economy, international oil prices, and domestic supply-side constraints (including market distortions) are having strong bearing on inflation in Nepal. To bring down inflation back to the desired level, effective monetary and fiscal policies have to be formulated and enacted by considering these factors.

[Published in Republica, February 28, 2012, p.6]

Friday, February 24, 2012

Why Nations Fail?

I am waiting for this book by Acemoglu and Robinson to come to my desk. Here is a blog devoted to the book. And, below is the summary of what is in the exciting book:

Is it culture, the weather, geography? Perhaps ignorance of what the right policies are?

Simply, no. None of these factors is either definitive or destiny. Otherwise, how to explain why Botswana has become one of the fastest-growing countries in the world, while other African nations, such as Zimbabwe, the Congo, and Sierra Leone, are mired in poverty and violence?

Daron Acemoglu and James Robinson conclusively show that it is man-made political and economic institutions that underlie economic success (or the lack of it). Korea, to take just one of their fascinating examples, is a remarkably homogeneous nation, yet the people of North Korea are among the poorest on earth while their brothers and sisters in South Korea are among the richest. The south forged a society that created incentives, rewarded innovation, and allowed everyone to participate in economic opportunities. The economic success thus spurred was sustained because the government became accountable and responsive to citizens and the great mass of people. Sadly, the people of the north have endured decades of famine, political repression, and very different economic institutions—with no end in sight. The differences between the Koreas is due to the politics that created these completely different institutional trajectories.

Based on fifteen years of original research, Acemoglu and Robinson marshal extraordinary historical evidence from the Roman Empire, the Mayan city-states, medieval Venice, the Soviet Union, Latin America, England, Europe, the United States, and Africa to build a new theory of political economy with great relevance for the big questions of today, including:

  • China has built an authoritarian growth machine. Will it continue to grow at such high speed and overwhelm the West?
  • Are America’s best days behind it? Are we moving from a virtuous circle in which efforts by elites to aggrandize power are resisted to a vicious one that enriches and empowers a small minority?
  • What is the most effective way to help move billions of people from the rut of poverty to prosperity? More philanthropy from the wealthy nations of the West? Or learning the hard-won lessons of Acemoglu and Robinson’s breakthrough ideas on the interplay between inclusive political and economic institutions?

Tuesday, February 21, 2012

Estimates of informal agriculture trade between Nepal and India

The official data shows that out of total merchandise exports of Rs 64 billion in fiscal year 2010/11, export to India was Rs 43.36 billion (around 67.63 percent of total merchandise exports). This covers official data only. A recent estimate shows that the value of informal imports of agriculture goods alone from India is close to Rs 54.75 billion.

Meanwhile, the estimated value of Nepal’s informal agriculture exports to India is estimated to be Rs 9.86 billion. In total, the value of informal agriculture trade between India and Nepal is close to Rs 65 billion. The data is based on a recent survey (perceptional survey with informal traders, government officials, carriers and knowledgeable persons) along the major adjoining border towns -- Kakarbhitta, Biratnagar, Birgunj, Bhairahawa and Nepalgunj.

The cause for opting for informal channels: tariff differential on third country goods between Nepal and India (and its reflection on retail prices), export restriction of certain agriculture products by India, additional duties and non-tariff barriers are some of the factors, and hassle at custom points.

Here is more:

  • Birgunj customs accounts for 60 percent of total informal import of farm products, followed by Biratnagar and Nepalgunj customs with share of 14 percent and 11 percent respectively. Such trade at Kakarbhitta and Bhairahawa customs stands at 9 and 6 percent of total informal trade of agro-products respectively.
  • Informal import of farm products through Birgunj and Biratnagar customs was worth Rs 32.65 billion and Rs 7.46 billion respectively. Similarly, agricultural products worth Rs 5.07 billion, Rs 5.91 billion and Rs 3.63 billion were estimated to have been imported through informal channels via Kakarbhitta, Nepalgunj and Bhairahawa customs respectively.
  • Paddy is the major agriculture item imported through informal channels from India. Its share in total informal agriculture imports from India stands at around 27 percent. Similarly, rice (21 percent), sugar (12 percent), edible oil (8 percent), and lentil, fish, poultry, powdered milk and oilseeds (3-4 percent) are the other agriculture products imported from India through informal channels.
  • Informal exports through Biratnagar customs account for half of Nepal´s informal exports of farm products to the southern neighbor, followed by Biratnagar (around 30 percent). Nepalgunj, Kakarbhitta and Bhairahawa customs come third, fourth and fifth in the list.
  • Betel nuts top the list of farm products traded through informal channels. It accounts for 47-52 percent of Nepal´s total farm exports to India, followed by hides and skins (18-21 percent), apple (11-12 percent) and garlic (11-12 percent).
  • Informal trade of ginger, orange, big cardamom, onions, turmeric, pig, poultry, powdered milk and jute products is on the rise.

Saturday, February 18, 2012

Links of Interest (2012-02-18)

Industrial policy works for smaller firms (If governments must provide investment subsidies to domestic firms, there is a much larger bang for their buck if they target small businesses rather than larger ones.)

Demand composition and the trade collapse of 2008–09 (The Great Trade Collapse was mainly caused by the crash in global demand.)

Non-tariff measures and supply chain (NTBs may add many trade costs along the supply chain and, in a world where production is fragmented across countries, they are associated with development traps.)

The figure below shows traded goods prices along the supply chain. Different policies apply to each part of the supply chain. Market distortions in international shipping specifically affect the difference between the free-on-board and cost-insurance-and-freight prices; import customs procedures then affect the landed duty-paid price; and restrictions on the size or hours of retail operations affect the difference between the wholesale and retail price.

The impact of natural disasters on developing countries' trade flows (Due to natural disasters such as earthquakes, floods, and volcanic eruptions exports of disaster-hit small developing countries decline by 22 percent and the observed impact tends to last for about three years. Exports of larger developing countries, on the other hand, are not significantly affected.)

What explains high unemployment? The aggregate demand channel (The decline in aggregate demand driven by household balance sheet shocks accounts for almost 4 million of the lost jobs from 2007 to 2009, or 65% of the lost jobs.)

Preferential trade agreements and the world trade system

    • Despite the proliferation of PTAs in recent years, the actual amount of liberalization that has been achieved through PTAs is actually quite limited.
    • At least a few studies point to significant trade diversion in the context of particular PTAs and thus serve as a cautionary note against casual dismissals of trade diversion as a merely theoretical concern. Equally, adverse effects on the terms-of-trade of non-member countries have also been found in the literature.
    • While the literature has found mixed results on the question of whether tariff preferences help or hurt multilateral liberalization, the picture is different with the more elastic tools of trade policy, such as antidumping duties (ADs); the use of ADs against non-members appears to have dramatically increased while the use of ADs against partner countries within PTAs has fallen.
    • Despite the rapid expansion of preferences in trade, intra-PTA trade shares are relatively small for most PTAs; multilateral remain relevant to most member countries of the WTO.

Conditional versus unconditional cash transfers in Burkina Faso

Compared with control group households, conditional cash transfers significantly increased the number of preventative health care visits during the previous year, while unconditional cash transfers did not have such an impact. For the conditional cash transfers, money given to mothers or fathers showed beneficial impacts of similar magnitude in increasing routine visits.

China's Growing Role in Africa: Myths and Facts

China’s emergence as a major player in Africa’s trade, investment, and aid has led many to question the nature of its involvement. Critics say that China is only interested in resources, its exports to Africa threaten local industries, and it is displacing Africa’s traditional partners, like the United States. True, China is a large user of commodities and has a vital interest in developing Africa’s natural resources, but it is not just on a resource hunt. Moreover, the adverse impacts on Africa of China’s increased exports, both in internal and external markets, appear to be limited to specific industries such as garments. And despite their differences in priorities and approaches, China and the United States can complement each other in some areas. Africa has much to gain if it uses its leverage wisely.

Beyond Keynesianism : Global infrastructure investments in times of crisis

As the world recovers only slowly from the 2008 financial crisis and Europe is facing a looming debt crisis, concerns have increased that the "new normal" -- a period of high unemployment, low returns on investment, high risks, and low growth -- may become protracted in advanced economies. If growth remains weak, unemployment rates and debt levels will be slow to recede. Consequently, the global recovery may continue to be fragile for years to come. What the world needs now is a growth-lifting strategy. This strategy could take the form of a global infrastructure initiative. Since debt levels are high, governments in the United States and Europe could increase demand and support growth through investments in bottleneck-releasing infrastructure projects that are self-financing. An infrastructure initiative should, however, go beyond the borders of advanced countries and include developing countries. Economic and social returns to infrastructure investments tend to be high in developing countries, which have become increasingly important drivers of global growth. At the same time, infrastructure investments require capital goods, most of which are produced in high-income countries. Scaling up infrastructure investment in developing countries could therefore help generate a virtuous cycle in support of a global recovery.

Friday, February 17, 2012

Competitiveness of Nepal’s services sector

People usually focus on merchandise trade while analyzing trade performance because it is easier to access data at the most disaggregated level. But, what about the services sector of Nepal? There are many studies that have superficially looked  at services trade potential. But, the dynamism of this sector and its potential to ensure structural transformation are studied less than it is for merchandise trade (two recent studies that look at India’s services sector are here and here). Here is last year’s blog post about the relative competitiveness of services trade in comparison to merchandise trade.

Nepal is bearing negative trade balance in services trade since 2005 (see figure below). The total services trade deficit in 2010 was around US$199 million, up from US$137 million in 2009. Out of the six services sub-sectors that Nepal exports and imports, there was positive trade balance in communication services, government services, and other business services only in 2009 and 2010. Even among these three, notice that trade surplus in two sub-sectors is decreasing, but it is increasing in other business services (see table below). Surprisingly, in travel sub-sector, the trade deficit was US$58 million (US$344 million export and US$402 million import). I think due to the Nepal Tourism Year 2011 campaign and record number of visitors, trade balance in travel sub-sector might be better in 2011.

Now, how competitive is Nepal’s services sector? Let us look at the relative comparative advantage (RCA) index, which is simply the ratio of the share of a country’s total exports of a particular product of interest in its total exports to the share of world exports of the same product in total world exports. A country is said to have revealed comparative advantage if the RCA index is greater than unity. It is calculated as RCAij=(xij/Xit)/(xwj/Xwt), where xij and xwj are the values of country i’s exports of product j and world exports of product j, and Xit and Xwt refer to the country’s total exports and world total exports. Computing RCA index for Nepal’s exports of each services sector category reveals that Nepal actually enjoys comparative advantage in all of them (this despite the fact that there is trade deficit in three of the six sub-sectors).

2008 2009 2010 2008 2009 2010
Product name RCA index Trade balance (US$ million)
Total services 1.52 1.47 2.23 -128.09 -136.86 -199.07
Transportation 0.37 0.59 0.63 -304.62 -233.07 -241.42
Travel 4.23 5.00 4.55 -45.93 -20.56 -58.09
Communications services 5.59 4.54 8.62 40.91 16.11 3.13
Insurance services 0.10 0.19 0.06 -29.79 -25.41 -29.59
Other business services 1.11 1.31 1.87 -6.41 35.79 63.25
Government services, n.i.e. 26.73 11.46 10.63 217.75 90.28 63.65

Source: Author’s computation based on ITC’s Trade Map database

Clearly, Nepal is unable to exploit the services sector market potential despite having comparative advantage in its trade. The problems faced by exports sector in general are:

  • Inadequate supply of infrastructure, including power outages
  • Political instability
  • Labor militancy and rising cost of production
  • Lack of innovation, R&D and overdependence on market concessions
  • Inadequate supply of required human capital
  • Policy implementation paralysis

In terms of employment, 65.7 percent of total employed are in agriculture sector, 13.4 percent in industrial sector, and 20.1 percent in services sector (data as of 2001). The value addition of agricultural sector, as percent of GDP, was 33.8 percent in 2009, with annual value added growth of 2.2 percent. The industrial sector value added ( percent of GDP) was 15.9 percent with annual value added growth of 1.78 percent. The manufacturing sector value added ( percent of GDP) was 7 percent with annual value added growth of –0.5 percent in 2009 (it was 2.6 percent in 2007). The services sector value added was 50.2 percent with annual value addition growth of 5.9 percent in 2009. Now, look at the employment being generated. Though the services sector contributes more than 50 percent of our GDP, it employs only 20 percent of the total employed.

Water and energy consumption in Nepal

The information is derived from from a recent report on green growth in Asia and the Pacific. The domestic water use per capita (471 cubic meters per capita in 2000) in Nepal is below the estimated minimum requirement. Leakage, inadequate water quality, inefficient domestic water use, and underinvestment in providing access to basic services are common features in countries with low water use per capita. No surprise that people in major urban centers can run their taps just for few hours each week. The work to channel water supply from Melamchi is yet to be realized ever after so many years of commencement of its construction.

Domestic material (including energy) consumption is pretty low (fifth lowest—2.64 tons per capita in 2005) compared to other countries in the continent. It signals potential for future growth by exploiting the available materials for consumption and production. Furthermore, per capita energy use is the third lowest (14.36 gigajoules per capita), followed by Myanmar and Bangladesh, in Asia and the Pacific. Note that countries with high energy use per capita tend to have high HDI value.

Recommendations for green growth and resource sustainability:

  • Infrastructure investments should be guided by the principles of sustainability, accessibility, and social inclusiveness.
  • “Natural infrastructure” provides valuable but undervalued economic inputs. Natural capital investments will help to secure critical ecosystem services (such as water regulation and flood control), achieve cost savings on infrastructure development, improve human and environmental security and can strengthen climate adaptation efforts through ecosystem-based adaptation approaches. Sustainable management of natural capital also enhances the potential for ecosystem services for economic transformation—for example where eco-tourism potential is developed as an economic development strategy. Investments should be targeted at key ecosystem services that hold particular value for their economies and societies.
  • Sustainable agriculture is a critical aspect of maintaining and building natural capital.
  • Greening of growth requires integrated strategies that support systemic change in integrated, complementary and mutually reinforcing ways. The complexity of challenges faced means that a clear vision, targets and monitoring approach are required. Also needed are targets and indicators that give policy-relevant information on the extent to which the economy is “growing green.”
  • To ensure greater resilience, domestic policies should also encourage diversification in key sectors, such as industry, agriculture and energy.
  • Approaches that enhance the capacity of communities and economies to resist initial shocks and to self-organize and adapt to changing conditions will be increasingly important.
  • A transition to a green economy requires governance that is effective, fair and

Wednesday, February 15, 2012

Job guarantee vs. income support program in Argentina

Pavlina R. Tcherneva argues that job guarantee program and income support plan should be combined to bring out an employer-of-last-resort programs in Argentina. Tcherneva argues: “An examination of the Argentine experience based on survey evidence and fieldwork reveals that poor women overwhelmingly want paid work opportunities, and that a policy such as the JG or the ELR cannot only guarantees full employment and macroeconomic stabilization, but it can also serve as an institutional vehicle that begins to transform some of the structures and norms that produce and reproduce gender disparities.”

Tcherneva evaluates the transformation of Argentina's Plan Jefes, a job guarantee program, to Plan Familias, an income support plan, and finds that it represents a step backward for women by removing a number of benefits and reinforcing gender stereotypes. Paid work matters to women, says Tcherneva, and public employment plays a special role in providing an opportunity to work outside the home, especially for the poorest and most vulnerable of this group.

Employer-of-last-resort (ELR) programs can enhance individual well-being, so the role of fiscal policy extends beyond the goals of full employment and economic stability. The best way to combine the goals of basic income and job guarantees is to design a universal program in the form of an ELR, supplemented by a universal child allowance and income support for the sick and the retired.

Major constraints faced by firms operating in Nepal

Though based on data from 2009, here is a snapshot of the major constraints faced by firms operating in Nepal. These problems are still persistent. See all of the survey results here and the Enterprise Survey report here.

A majority of the firms identified political instability as the main constraint to sound business environment in Nepal. For firms in South Asia and low income countries, political instability is not that big of a constraint as it is to Nepalese firms. However, electricity is a bigger constraint to firms in South Asia than it is for Nepal (as perceived by firms). Interestingly, for other constraints the proportion of surveyed Nepalese firms think the constraints faced by them are not as pressing as those thought by firms in the region.

Now, the surveyed firms think that power outages is eating up their strength and revenue. Manufacturing firms are losing 28.2 percent of annual sales due to power outages. For retail sector, it is 25.6 percent. A recent study by the central bank found that the average capacity utilization of industrial sector in the last fiscal year was 54 percent, thanks to persistent power outages and labor problems.

Saturday, February 11, 2012

Pure hogwash: Improved state of Nepalese economy and the present government’s role

This article is published in today’s Republica. It has generated strong (also interesting) response.

Pure hogwash

Desperate to give a positive message to public that the government is doing the needful to spur growth and job creation, the concerned authorities are echoing a similar line these days: The economy is back on track and investment climate is getting better. The officials at the prime minister’s office, the central bank and the finance ministry argue that growth will be 5 percent this fiscal year and the economy will see a surge in investment. Furthermore, they are asserting that the improvement in select macroeconomic indicators will entice foreign investment and spur jobs creation.

Nonsense. The fact is that the economy is still stuck in the same quagmire of low growth, low job opportunities, fledging industrial sector, high prices, low savings, high imports and consumption, and remittances-fueled impact-less investment cycles. The said rosy outlook is due to favorable exogenous factors. There is hardly any real policy change to induce structural transformation required to put the economy on a high growth path. All we have got is hastily designed grand plans and hollow promises to implement them.

The main source for the claim of 5 percent economic growth, which is likely to be not achieved, comes from the estimation by Ministry of Agriculture and Cooperatives (MoAC) that there will be bumper agriculture production, especially record paddy harvest. Agriculture sector constitutes about 33 percent of GDP and engages 83 percent of the population. Paddy is a major part of daily food consumption and contributes 21 percent to agricultural GDP. The officials have estimated that a 13.7 percent increase in paddy production will be enough to satisfy domestic demand, export surplus, and push up economic growth to 5 percent. Now, looking at the cheerful faces of ministers and policymakers, one wonders about their contribution in all this. Well, it is not because of any substantial policy change that agriculture production has increased; it is due to timely monsoon. The Bhattarai-led government cannot claim credit for this. A blip in agriculture production this year like it happened in 2007/08—when agriculture sector grew by 5.8 percent, leading to GDP growth of 6.1 percent— and its impact on growth does not mean that our economy is set on a track of high growth.

Furthermore, the main source for the claim of a favorable macroeconomic situation is a recently released macroeconomic update of the first five months of this fiscal year, which was misconstrued by leaders who are eager to show that economic indicators are sound during their tenure. The central bank’s figures reveal a huge balance of payments (BoP) surplus—an accounting record of all monetary transaction made between Nepal and all other countries—which reached Rs 61.19 billion. Similarly, current account—which is the aggregate 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) — registered a surplus of Rs 24.89 billion. Another noticeable improvement was in foreign exchange reserves, which reached US$ 4.31 billion and is enough to finance imports of up to 9.3 months.

This definitely sends a good message about the state of our macroeconomy to absorb external shocks and repayment ability. Again, it was achieved not because of any sudden miraculous change in policies, but because of external factors. The increase in BoP surplus has to do more with massive increase in remittance inflows and improved services sector earnings. Remittance inflows increased by 37.9 percent between the first five months of this and last fiscal years. Transfers increased by 29.5 percent, including substantial excise refund by India. Services sector earnings increased by 46.4 percent. Some of these transfers are cyclical and some are just flukes in the account sheet. Meanwhile, forex reserves have improved mainly because of the increase in remittance inflows and depreciation of Nepalese currency against the dollar by approximately 17 percent. During the same period, reserves in Nepalese rupee increased by 35.4 percent, but in dollar terms the increase was just by 12.4 percent.

Just by looking at these numbers it defies logic to argue that investment environment has improved and economy is back on track. In fact, quick estimate based on the level of merchandise exports and imports so far this year shows that the total annual figures will hover around Rs 65 billion and Rs 400 billion respectively. Trade deficit will increase more than last year because of massive rise in imports of petroleum products, but it will be countered by rising remittance inflows and transfers, resulting in positive current account.

The very problems that have been plaguing the economy for a decade now are continuing to eat away its strength. There is nothing noteworthy the Maoist-led governments have done to address them after 2006. The average growth rate in the last decade was just 4.1 percent, with agriculture and non-agriculture growth rate averaging 3.18 percent and 2.34 percent respectively. Imports have reached about 32 percent of GDP and exports are merely 9 percent of GDP. Gross domestic savings are just 7 percent of GDP, signaling the dearth of domestic investment needed to launch big infrastructure projects. It is still very much a consumption fuelled economy, where increasing domestic production deficit is comfortably filled in by imports, which is financed by remittances. Development budget is heavily dependent on foreign aid and domestic revenue is inadequate to finance even recurrent expenditure. Many farmers in Terai and Hilly regions are short of adequate fertilizers needed to increase agriculture production, progress in repairing old and completing new irrigation projects has been frustrating, and food insecurity in remote areas remains as problematic as it were before due to weak distribution mechanism.

Meantime, domestic industries are gradually perishing. The power woes are stubbornly persistent and the grand plan of reducing load-shedding by importing power from India and by operating diesel plants never fructified. Rationing of electricity and persistent labor problems have forced industries to operate at barely 45 percent capacity. Labor unions have again started to show indifference and irresponsible attitude towards industrial development by shutting down manufacturing plants owned by both domestic and foreign investors (the latest saga being the closure of Unilever Nepal, one of the few remaining MNCs after 1996). Firms are unable to secure enough fuel to run their generators. Restaurants are pulling their shutter down due to shortage of cooking gas. Following the moderation in prices for a few months, inflation has started to creep up due to rise in prices of petroleum fuel, persistent supply-side constraints, and rise in retail prices of daily consumable goods and services. The threat to private property and forceful land grabbing by Maoist party’s cadres are still there. Safe appropriation of returns to investment is getting increasingly tough. Interest rates are high despite liquidity surplus in the banking sector. Enthusiastic entrepreneurs are dejected due to the lack of appropriate physical and regulatory infrastructure along with a supportive bureaucracy. In such a situation, one wonders how PM Bhattarai is aiming to entice US$1 billion of foreign investment, let alone investment commitment, in six months time when the total FDI in 2010 was barely US$39 million.

The claim of economic revolution by this government is pure hogwash. The economy is stuck in the same mess as it was before. The government has done nothing substantial to put it on the path of high growth, let alone address the short term constraints. The recent good news about bumper agriculture production, improved reserves and BoP surplus has nothing to do with policy changes by this government. Importantly, improvement in these indicators alone does not indicate an improved macroeconomy set to welcome more investment and ready to brace growth rate of over 5 percent.

[Published in Republica, February 11, 2012, p.6]

Thursday, February 9, 2012

Impact investing in Nepal

Here is a piece by Shabda Gyawali, published in Republica, about the prospect of impact investing in Nepal.

Small is beautiful

by Shabda Gyawali

Foreign Direct Investment (FDI) can bring great advantage to the host country. It fuels economic growth, helps reduce poverty, creates employment opportunities and assists building of physical infrastructures. With the same intention, the government has decided to observe 2012-2013 as Nepal Investment Year and setup Nepal Investment Board (NIB) to spur and facilitate foreign investments in the country.

To attract foreign investment, NIB is launching promotional events like road shows in countries like India, UK and the US. NIB is targeting foreign firms that have the resources to invest in mega projects in sectors like energy, tourism, infrastructure development and commercial agriculture. Dr. Baburam Bhattarai-led cabinet has also passed Investment Board Act, which facilitates investments above Rs. 25 billion through single window policy. A population of 28 million, rising per capita income (mainly due to remittance), demographic dividend, underexplored natural resource, and Non Residential Nepalis’ global network provides enormous market size and opportunities for investors in Nepal.
Having said that, the government and other enthusiasts needs to recognize that simply declaring 2012-2013 as Investment year won’t be enough to attract foreign investment. Capital inflow in a particular country depends on domestic and international macroeconomic situation and investment climate. For a traditional foreign investor the risk in Nepal is very high. According to the World Bank established international sovereign rating standard, Nepal is rated CCC+. With this rating, Nepal is boxed under “High Default risk” category.

Additionally, due to perpetual “in-house” hurdles like militant labor, extortion, local opposition, arbitrary government policies, red tape, corruption, and bandas, Nepal’s foreign private capital attracting capability is also undeveloped and fragile. In 2010, Nepal attracted the least amount of private commercial capital in the South Asian region. According to the World Investment Report 2011, Nepal was ranked 134 out of 141 countries in the Inward FDI Performance Index. Despite the potential market opportunity in Nepal, traditional large scale investors will continue to be reluctant to invest until issues like high investment risk and cost of capital are addressed.

While the government should continue scouting for large scale investors through Nepal Investment Board, it should also create appropriate environment to lure in a small but a growing breed of financers called Impact Investors. These investors are willing to take investment risk in developing countries like Nepal and understand the market dynamics of low income countries to reduce the cost of capital through innovative financial products. The capital they deploy intends to create (beyond financial returns) positive social and environmental impact.

These investors believe in building entrepreneurial culture and invest in small businesses that use market-based approaches to provide scalable solutions to socio-economic problems. Investments are generally made in sectors that serve the people at the base of the economic pyramid (those earning less than US $3,000 per annum). Impact investors target sectors like affordable education, healthcare, renewable energy, access to finance and sustainable agriculture. While government or charity solutions will sometimes provide these products or services, impact investment can complement government and philanthropic capital to reach more people.

In recent year a board range of organisations has shown interest in adopting impact investing model in developing countries. The list includes but is not limited to investment banks, sovereign wealth funds, and endowments, philanthropic foundations and international development organizations. Traditionally, inflow of foreign capital (not including remittance) in developing countries like Nepal has taken place in the form of investment designed to maximize financial returns, with no consideration of its social impacts.

Likewise, foreign aid is structured to maximize social returns, with no expectation of monetary returns. Impact investing provides a platform to blend capital from both foreign aid and foreign investments to support entrepreneurship culture in developing world. The impact investor operates in the missing middle and fills the capital gap above micro-financing and below institutional financing. They structure their investment vehicles (like venture capital/private equity fund and investments in businesses) in the form of equity, quasi-equity and debt. Some of the investors are also willing to accept below-market financial returns in order to maximize social and environmental returns.

To the best of my knowledge, there are no impact investing funds currently operating exclusively in Nepal. However, there are few initiatives in the pipeline. One of them is Ventures Nepal, one of the funds in the International Financial Corporation’s (IFC) SME Ventures program, which will provide risk capital financing and complementary advisory services to small businesses in Nepal. With the fund size of US $10 million, Venture Nepal aims to make risk capital investments of up to US $500,000 in small and medium enterprises (SMEs).

Another is Dolma Development Fund (DDF), structured as a non-profit domiciled in United Kingdom, which is currently raising US $10 million for investment in SMEs in Nepal. DDF plans to deploy the money over a period of 3-5 years with a focus on target sectors like rural connectivity (internet/mobile), healthcare, affordable private education, clean drinking water, eco-tourism and off-grid renewable.

Small businesses are the backbone of any developing economy. Not only do small businesses/startups help job creation and poverty reduction they also bring wealth of replicable innovations to market. Attracting more impact investors in the Nepal means more startups will have access to capital. The scope of impact investing extends beyond meeting capital shortage though; it also includes establishing infrastructure and overlaying networks of intermediaries, institutions and investors.

Thus, one of the top priorities of NIB should be to put in place regulatory incentives and safeguards to attract impact investors. This will help build entrepreneurial culture and provide capital for sustainable growth and job creation. In the short run, it is the small-size foreign investments that will build appropriate FDI friendly environment in Nepal before the country can attract large scale commercial capital.

Wednesday, February 8, 2012

Development-led globalization vs. finance-led globalization

“The term finance-driven globalization characterizes the dominant pattern of international economic relations during the past three decades,” the report says. “This is intended to convey the idea that financial deregulation, concerted moves to open up the capital account and rapidly rising international capital flows have been the main forces shaping global economic integration. . . . Financial markets and institutions have become the masters rather than the servants of the real economy, distorting trade and investment, heightening levels of inequality, and posing a systemic threat to economic stability.”

“Financial and other resources should be channelled towards the right kinds of productive activities. Industrial development remains a priority for many developing countries…but a wider sectoral approach, including a focus on the primary sector in many least developed countries, is needed to ensure that measures to diversify economic activity are consistent with job creation, the security of food and energy supplies, and effective responses to the climate challenge”.

“rebalancing will need a global new deal that can ‘lift all boats’ in developed and developing countries alike. It is a basic truth that people everywhere want the same thing: a decent job, a secure home, a safe environment, a better future for their children and a government that listens to and responds to their concerns.

Here is more from the latest UNTCAD report titled Development-led globalization: Towards sustainable and inclusive development paths.

Monday, February 6, 2012

Time to set Sustainable Development Goals

With the possibility of recession in the EU and slowdown in major economies, policymakers the world over are looking for pragmatic policy initiatives to avert further hardships brought about by a series of crises—food, fuel, financial, economic, environment and sovereign debt. Given this backdrop and the increasing anxiety over the long term resilience of people and the planet, it is high time the world chose to integrate economic, social and environmental dimensions of development and move on the path of sustainable development, which has been defined as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs".

To this end, recently, the High-level Panel on Global Sustainability urged in its report presented to the UN Secretary-General Ban Ki-moon that in order to achieve sustainable development, the people should be placed at the center of any development strategy. By urging for the integration of social and environmental costs while determining world prices and measuring economic activities, it calls for a set of sustainable development indicators that go beyond the traditional approach of Gross Domestic Product, and recommends that governments develop and apply a set of Sustainable Development Goals that can mobilize global action and help monitor progress.

The 22-member panel, established by the Secretary-General in August 2010 to formulate a new blueprint for sustainable development and low-carbon prosperity, was co-chaired by Finnish President Tarja Halonen and South African President Jacob Zuma. The Panel’s final report, Resilient People, Resilient Planet: A Future Worth Choosing,” contains 56 recommendations to put sustainable development into practice and to mainstream it into economic policy. If fully implemented, these measures will have profound implications for societies, governments, and businesses.

The report argues that the eradication of poverty and improving equity must remain priorities for the world community and that empowering women and ensuring a greater role for them in the economy is critical for sustainable development. Furthermore, it calls for improving health and education; ending of subsidies on fossil fuels, which is around US$400 billion each year, and agricultural subsidies, which is also around US$400 billion in the OECD countries alone; changing financial market regulation to promote long-term, stable and sustainable investment; improving access clean water, sanitation and food; meeting the Millennium Development Goals (MDGs) and going beyond them; ensuring universal access to affordable sustainable energy by 2030; and having universal telecommunications and broadband access by 2025.

The Panel’s report underscores the importance of science as an essential guide for decision-making on sustainability issues. It calls on the Secretary-General to lead efforts to produce a regular Global Sustainable Development Outlook report that integrates knowledge across sectors and institutions, and to consider creating a Science Advisory Board or Scientific Advisor.

The report provides a timely contribution to preparations for the UN Conference on Sustainable Development (Rio+20) in Brazil in June 2012. A recently leaked draft agenda document for the Rio+20 asks countries to sign up for 10 new sustainable development goals for the planet and promise to build green economies at the first earth summit in 20 years. Importantly, the recommendation of the panel, if implemented, will put the world in a path of sustainable development that will not only propel prosperity, but also ensure measures to sustainably utilize natural resources and environment to meet that end.

As global population reaches 9 billion by 2040 and middle-class consumer increases by 3 billion over the next 20 years, the world will need at least 50 percent more food, 45 percent more energy and 30 percent more water. These cannot be addressed with the existing development paradigm. The world needs to adopt a new approach to the political economy of sustainable development to address the sustainable development challenges in a new and operational way. It is time to work for a sustainable planet, a just society and a growing economy.

Sunday, February 5, 2012

Book review: Economic growth and the private sector of Nepal

[This review was published in The Week (Republica), February 2, 2012]

An attempt to fill the void

Often students and researchers express frustration over the lack of books and journal publications about Nepali economy. It is even harder to get hold of a book that focuses exclusively on economic growth and private sector development in Nepal. Samriddhi, The Prosperity Foundation’s new book Economic Growth and the Private Sector of Nepal attempts to fill that void. Edited by Prateek Pradhan, the book has contributions from eleven authors who look into a range of issues – including economic reforms, stability, tourism, hydropower, state-owned enterprises, financial market, and trade – affecting Nepal’s economic growth and its private sector.

Prem Khanal delves into the resistance to economic reforms and its impact on democracy. He argues that the Panchayat regime plundered the state’s resources to influence the Referendum in 1980 and controlled licenses for production and imports, partially contributing to a balance of payments crisis and macroeconomic instability. This forced the country to knock on the doors of the IMF and the World Bank for loans to balance its budget sheets. No wonder, the Panchayat regime was unhappy with the implementation of Structural Adjustment Program in 1985, which forced austerity measures in a number of areas. The Nepali Congress government headed by the Prime Minister Girija Prasad Koirala enacted liberalization reforms after 1992 by introducing a range of policy reforms related to trade, labor, industry, investment, finance, and currency convertibility. Khanal provides a narrative of the evolution of this process and focuses on how resistance to reforms on three particular aspects –financial, labor, and public enterprises – attenuated faith in democracy.

He argues that it was precisely because of resistance to financial sector reforms that the two largest state-backed banks—Nepal Bank Limited and Rastriya Banijya Bank—failed to recoup bad loans and reduce share of non-performing assets in their portfolio. The resistance came from “financially powerful and politically influential defaulters.” It was aided by the incapacity of the central bank to effectively supervise the building up of bad loans in these banks. As the discussion starts to get interesting and enriching, Khanal stops there, leaving readers to wonder about the nature of resistance to financial reforms and the power dynamics between defaulters and political leaders. On labor reforms, he explains the opposition to change the rigid provisions, such as permanent status and hire and fire rules, in the Labor Act and its impact on industrial production and productivity.

The resistance to such reforms is continuing to this day, something apparent from the fact that the amended Labor Act of 1992 is still not enacted by the Parliament. Meantime, we are seeing the decline of industrial strength and demise of many sectors, chief among them the garment and textiles sector. Similarly, the resistance to restructure and reform financially insolvent and inefficient public enterprises has cost taxpayers billions of Rupees for decades now. Khanal tries to score the point that resistance to reforms has impeded economic growth and prosperity, diminished productive capacity, and fueled public discontent. It would have been even more revealing if Khanal had delved into the dynamics of the power play between interest groups and the political system, and its impact on Nepal’s private sector development. Nevertheless, his chapter is one of the few comprehensive contributions in the book.

Dr. Dandapani Paudel attempts to chart out a new approach to fiscal and monetary policy in general and articulate a new approach to the IMF’s and World Bank’s macro management strategies in particular. He argues that had it not been for remittances, the macroeconomic stability would have been horribly derailed by unsustainably high trade deficit. On top of currency stability, interest rate, fiscal deficit and debt, he outlines a set of additional indicators (inflation, real GDP growth, broad money supply, and trade deficit) to gauge macroeconomic stability. However, these are not new indicators and are in fact a part of the indicators to assess stability. As importantly, he also omits balance of payments (BoP) surplus as an important indicator of stability. It was precisely because of BoP deficit that Nepal took loans from multilateral donors to finance restructuring of the economy in 1985. While discussing the flaws of monetary and fiscal policies, Paudel falls short of linking them to economic growth and elaborate how deterioration of macroeconomic indicators affected private sector development over the years.

Meanwhile, Dr. Durga P. Paudyal reflects on development agendas for New Nepal and its relation to stability, prosperity and equality. He argues that there is no point bashing political leaders who seem to be more responsive to donors than to their own citizens when the entire system is flawed. While outlining how donors are corrupting political leaders and influencing them to be towed along with the donors’ development agendas, Paudyal accentuates the need to have a greater debate on forward-looking development policies. Unfortunately, he fails to provide the baseline arguments for a serious discussion on these issues. Equally importantly, he also falls short of explaining how these will affect stability, prosperity and private sector.

Dipendra Purush Dhakal focuses on tourism policies to spur economic growth. While outlining the evolution of policy initiatives for tourism development, starting with the Tourism Master Plan of 1952 and ending with the Tourism Vision 2020, he argues that the private sector has played a decisive role in this sector by constantly introducing a slew of innovative tourism packages. Dhakal maintains that success of tourism sector should not be measured by the number of tourist arrival, but by tourism receipts, average days of stay, and quality of services. Even though Dhakal emphasizes the role of private sector in tourism development, he overlooks the process of how that happened and in what way the government facilitated or hindered their participation. Gyanendra Lal Pradhan writes about growth through private sector-led hydropower development, which has so far been limited to 174MW. The country needs at least 2,500MW of electricity by 2015 to end load-shedding, and there is no alternative to this source of power supply, given the increasing demand for energy. Pradhan argues that lack of affordable credit, favorable purchasing agreements, and insecurity has been the biggest constraints to private sector-led hydropower development.

Rameshore Prasad Khanal writes about the sorry state of state-owned enterprises (SOEs) due to poor liability management. His contribution is more like a primer on liability management. Not all SOEs, whose contribution is around 11% of the GDP, suffer from the same problems, and liability management is an issue in only some of them. Note that out of the 36 public enterprises, 16 earned profits in 2009/10. A focused discussion on specific liability management issues of key SOEs and the hurdles in correcting them would have been more interesting to readers. The evolving operational domain of private sector and SOEs is also little explored.

Siddhant Raj Pandey writes about the role of financial market openness in capital inflows. He argues that even though the gradual opening up of the financial sector to international players has enhanced value and standard of domestic financial industry, without total capital account convertibility, however, the prospect for huge capital inflows is low. Pandey’s brief contribution lacks the depth needed to understand why capital inflows would remain subdued without total capital account convertibility and whether this is the main indicator looked at by foreign investors to decide on investing in Nepal. Many countries have not fully liberalized capital account, for fear of exchange rate volatility and sudden negative shocks on economy, but still have managed to entice huge sums of foreign investment.

Dr. Jagadish C. Pokharel discusses the benefits of connecting the country with the two bordering economic giants. Pokharel argues that Lumbini, Pokhara, Nijgad, and Kathmandu will be the economic centers in the future if appropriate infrastructure linking the economy with India and China are constructed. The export of herbal products to China and energy to India and tourism to both countries will generate tremendous benefits to the country, he asserts. Pokharel emphasizes the role of infrastructure, the most binding constraint to growth, in spurring growth but does not look at the role of private sector in this endeavor.

Ratish Basnyat has one of the most consistent and comprehensive contributions on international market access for Nepali exports. He outlines a range of supply-side constraints that are hampering exports growth, both in regional as well as international markets, despite being a member of free trade blocs like WTO, SAFTA, and BIMSTEC. He also argues that Nepal’s exports to India failed to pick up steam because our exporters relied more on tariff preference to India rather than increasing competitiveness of products. As the preferences are declining along with the liberalization of Indian economy, Nepali exporters are finding hard to compete there was well. The failure of private sector to read preference erosion correctly and do the needful on their part to sustain exports growth is to blame for the dismal performance. He argues for the creation of Infrastructure Development Fund, skill development, and area-specific product development for industrial and exports promotion.

On the same issue, Tarka Raj Bhatta writes about what needs to be done to boost export diversification and competitiveness. Despite being a very important and profound issue, Bhatta offers general arguments without substantive discussion on the role of private sector and the impact of low export diversification on growth. Finally, Shiv Raj Bhatt tries to explain how the Nepal-USA Trade and Investment Framework Agreement (TIFA) can help revive Nepal’s trade with the US. As with the preceding contribution, Bhatt offers general points without meaty discussion on how exactly Nepal can exploit the provisions in TIFA to boost exports to the US in the face of the slump in exports of garments, our main product of interest in the US market.

In general, the major strength of the book is that now we have a publication about growth and private sector. Apart from the few comprehensive contributions, the book is a disappointment to serious readers who are in hunt for substantive and measured arguments on growth and private sector development. Readers will wonder why the editor did not even have a foreword or an introduction or a chapter contribution. Furthermore, there is serious editing slackness with regard to clarity and consistency of arguments in some chapters (sometimes even in the same paragraphs), lack of complete reference, and up-to-date data. Contributors such as Khanal, Pradhan and Basynat have tried to focus on the core theme, but others have digressed from it, giving readers a sense of a lack of unifying theme or message that relates to the title of the book.

[Published in The Week, Republica, February 3, 2012, p.11]