Tuesday, September 23, 2014

State of manufacturing establishments in Nepal

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

The Central Bureau of Statistics (CBS) released the findings of National Census of Manufacturing Establishments (NCME) 2011/12 in June 2014. The census is carried out every five years and it covers all manufacturing firms engaging 10 or more persons.

The manufacturing census shows an increase in the number of light manufacture activities, but a decline in the number of slightly heavier manufacturing activities, indicating the impact of load-shedding in scaling-up and sustaining higher valued-added industrial activities. Between 2006/07 and 2011/12, the number of operating manufacturing establishments increased by 18.3%, mostly contributed by the growth of food and beverages; tobacco products; apparel; leather; leather products and footwear; wood products; chemical and chemical products; rubber and plastic products; non-metallic mineral products; fabricated metal products; machinery and equipment; and furniture manufacturing. Meanwhile, textiles; printing and publishing; basic metal; and transport equipment saw a decline in the number of manufacturing establishments.

The increase in the number of light manufacturing establishments has also increased the number of employees by 14.8%, reaching 194,989 employees in 2011/12. However, the average number of employees per manufacturing establishment has declined to 48 in 2011/2 from 57 in 2001/02.

Compared to the last NCME, wages and salaries nearly doubled, reaching NRs16.4 billion. With value of inputs totaling NRs241.8 billion and value of outputs totaling NRs322.6 billion, the total value addition reached NRs80.0 billion— a 97% growth between 2006/07 and 2011/12.

The efficiency of manufacturing establishments in the use of inputs seems to be eroding as evidenced from the increase in inputs as a percentage of output, and a decline in output input ratio. Input as a percentage of output stood at 75 in 2011/12, one percentage point higher than in 2006/07. Similarly, output input ratio was 1.33 in 2011/12, lower than 1.36 in 2006/07. A better measure of the efficiency of the use of inputs is value-added output ratio, which discounts the effect of inflation. Value-added output ratio is consistently decreasing, reaching 0.25 in 2011/12 from 0.37 in 1991/92— indicating that the manufacturing firms are using inputs more inefficiently and are incurring increasing cost of inputs as well.

Labor productivity (value added per employee) increased to NRs414,000 in 2011/12 from NRs241,000 in 2006/07. However, labor productivity growth was 71.8%, lower than wages and salaries growth of 104.4% (or growth of wages and salaries per employee of 78.1%) over the same period. At an annualized average rate, while labor productivity grew by 11.4% over 2007-2012, wages and salaries increased by 12.2%.

The number of districts with manufacturing establishments has dropped to 64 in 2011/12 from 67 in 2006/07. About 88% of the manufacturing firms are located in 23 districts, with the top five being Rupendehi, Kathmandu, Morang, Sunsari, and Parsa.

About 40.7% of total manufacturing firms reported that they have not been able to fulfill market demand, primarily due to the underutilization of capital arising from load-shedding, lack of raw materials, labor shortages, lack of finance and lack of skilled manpower. Furthermore, about 84.7% of firms reported that the lack of electricity was having impact on their operations. 

Overall, manufacturing sector has been weakening over the past several years. Its share of GDP declined to an estimated 5.6% in FY2014 from 8.2% of GDP in FY2002. The average growth rate has been a mere 3.2% in the last five years.

Saturday, September 20, 2014

Mainstreaming environment for economic growth and poverty reduction in Nepal

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here are earlier blog posts on real sector, fiscal sector, monetary sector, external sector, and FY2015 growth and inflation outlook.

Mainstreaming environment for economic growth and poverty reduction in Nepal[1]

I. Introduction

Nepal is endowed with rich natural resources (abundant water resources, forest and fertile lands, and unique landscape), a strategic geographical setting[2], and physical, biological, and cultural diversities. One of the major challenges for the government is to not only achieve high and inclusive economic growth, but also to ensure that it is environmentally sustainable, crucial for accelerating poverty reduction and sustaining the gains of the last. Economic activities without due consideration for environmental sustainability may start tapering off in the medium-term, undermining prosperity in the long run. Hence, high and sustainable economic growth becomes vital for sustained poverty reduction and creation of productive employment.

Nepal’s gross domestic product (GDP) growth pattern has so far has been minimally damaging to the environment as the industrial sector’s contribution to growth has been relatively low at one-tenth of the overall growth. The services sector's contribution has been the largest, but a majority of the goods are manufactured outside of Nepal and are imported for consumption, which is financed by remittance income. Agricultural sector’s contribution to GDP growth is dependent on the monsoon rains and the timely availability of agricultural inputs, most notably chemical fertilizers.

As investments are ramped up to generate increased electricity, develop infrastructure, and expand manufacturing activities in the short to medium term to achieve higher growth rate and create jobs, a key challenge would be to ensure that these activities are environment-friendly so that the resulting growth is not only high and inclusive, but also sustainable. Else, haphazard construction of infrastructure— including roads, water supply, irrigation, and hydro power plants— without the necessary due diligence for environmental sustainability may result in high socioeconomic costs to the country in the long run. In addition to these economic activities, the country's traditional agricultural practices also need to balance the need to boost land productivity and the optimal use of inputs.

II. State of the Environment: An Overview

As an indication of the overall low level of industrialization, Nepal’s per capita carbon dioxide (CO2) emission has been generally low, registering an average growth of just 7% in the last decade. In fact, Nepal’s per capita CO2 emission (in metric tons) is just 2.7% of China’s and the lowest among the regional economies (Figure 41). This also reflects the fact that Nepal’s GDP growth is largely driven by rain-fed agriculture production and services underpinned by remittance-induced demand for imported goods. Together these two sectors contribute about 90% of the GDP growth[3]. Hence, at this initial stage of development and the still relatively low level of environmental risks, Nepal has an opportunity to pursue industrialization in an environmentally sustainable manner by adopting the latest green industrial technology. However, there is a growing and emerging threat from the rate of loss of forests, particularly for habitat, illegal timber trade, forest fire, overgrazing, and uncontrolled extraction of medicinal plants.

This trend also indicates that the existing pattern of environmental challenges has little to do with the pace of economic growth. It is more affected by factors such as poor engineering and safeguards in unplanned infrastructure development, deforestation, haphazard solid waste management, land degradation, unsustainable and indiscriminate use of pesticides and agrochemicals, and unplanned urbanization. Even though these do not directly and significantly impact economic growth in the short term, they have the potential to indirectly decelerate the pace of growth in the medium to long term. The World Bank estimates that environmental degradation costs between 5% and 10% of GDP in Nepal, India, Bangladesh and Pakistan.[4]

The diversified biological resources, besides maintaining ecosystem equilibrium, provide ecological goods to local people and have great economic value to the rural population. Unfortunately, there is a steady degradation of forests over the last five decades. While the total forest area comprised 43.8% of total land in FY1965, it declined to 37.3% in FY2013 (Figure 42), with significant deforestation happening along the mid-hills and Terai belts. Forest areas have been encroached to expand farmland, settlement, infrastructure development and at times for timber trade. Nepal lost 2.7 million hectares of forest between 1965 and 2013, with an average annual de-vegetation of 56,710 hectares. Altogether 0.96 million hectares of total forest and shrub land is estimated to be lost to farming, urban, and infrastructural development over 1965-2013. The major causes of forest degradation are clearing trees for meeting household fuel wood demand, unstructured semi-processing of agriculture products, illegal in-country or trans-boundary timber sales, overgrazing, uncontrolled extraction of medicinal and aromatic plants (MAPs) and non-timber forest products (NTFPs), and forest fire. Poaching and illegal hunting of wildlife and their declining habitat has adversely affected wildlife population and their biodiversity value.

The rate of loss of forests is alarming, which has affected natural habitat, biodiversity and ecosystem. This has happened despite there being twenty protected areas, comprising of 10 national parks covering 1.08 million hectares, 3 wildlife reserves of 0.1 million hectares, 1 hunting reserve of 0.13 million hectare, and 6 conservation areas of 1.54 million hectares. These collectively cover 19.4% of the total area. Furthermore, approximately 1.23 million hectares of forest is managed by 17,685 community forest user groups. In addition, there are 9 Ramsar sites covering a total area of 34,445 hectares of land.

Land degradation is also an issue in all geographical areas of Nepal, affecting land productivity. Land degradation is primarily caused by water induced erosion, landslide, surface exposure, top soil erosion, riverbank cutting, floods, silt deposition, water logging, deforestation, and wind erosion. About 45.4% (6.7 million hectares) of the country’s total land area is affected by water induced erosion and about 4.0% (0.6 million hectares) by wind erosion. The area affected by flood is estimated to be about 8,987 sq. km and by waterlogging about 7,297 sq. km. The vulnerability to inundation and water logging in Tarai plains bordering India has increased due to the embankment of along the East-West highway dykes and barrages both within and across the border. Overall, about 2.2% of total land area (0.6 million hectares) is uncultivable due to flooding or soil erosion, up from 1.2% of total land in 2001 (0.3 million hectares). The Tarai belt and Far-western development region bear thet burnt of flooding or soil erosion leading to uncultivable land (Figure 43). Of the total uncultivable land, soil erosion, chemical degradation, and physical degradation contributed 65.6%, 3.4% and 31%, respectively in 2011 (Figure 44).



Meanwhile, higher stocking rates, uncontrolled grazing and haphazard lopping of fodder trees have reduced average productivity of grazing area in subtropical and temperate zones. The subalpine grasslands, mainly used for seasonal pasturage, are losing their productivity due to high stocking rates and overgrazing, lack of good management practices, and the invasion of non-herbage shrub and other non-edible species that are gradually replacing palatable grass species.

Nepal is second richest country for water availability in the world, possessing about 2.3% of the world water resources. Nepal possesses 12 BCM of groundwater, of which 5.8 BCM can be extracted annually, both in shallow and deep aquifers, without any adverse effects. Altogether 38 rivers have been dammed till early 2014 with an installed capacity of 700 MW. The Government of Nepal and the private sector installed, until 2012, micro hydropower plants (22 MW installed capacity; potential 100 MW), solar photovoltaic home system (300,000 no. equivalent to 6.78 MW; potential 4.5 kWh/m2/day), biogas plants (280,000; potential 1.9 million), improved cooking stoves (663,000; 2.5 million), improved water mills (7,600; potential 30,000), and wind power plants (10 kW; potential 3,000 MW). There is potential of producing 1.1 million ton biofuel (Jatropha curcas) in the country. The rivers in lower Siwaliks and rivulets in Middle Mountain and High Mountain regions have been partially dammed for surface irrigation with total command area of 0.96 million ha in the wet season.

Despite these potentials, there is acute water shortage in the urban centers because of unplanned urbanization, encroachment of water sources, and degradation of land as well as forests. For instance, static water level (SWL) and pumping water level (PWL) have depleted in Kathmandu Valley as a result of overuse, lack of water conservation practices, and haphazard construction. While SWL and PWL were 48.1 meters and 67.6 meters in 1976, respectively, in Bansbari of Kathmandu, it went up to 80.6 meters and 136.1 meters, respectively, in 1999.[5] This most likely has increased further in the last one-and-a-half decade given the rapid urbanization and increase in settlement areas in Kathmandu Valley.

The unplanned urbanization along with large-scale rural to urban migration has strained resources in major urban centers, resulting in rise in pollution and waste. It is further compounded by the misuse of pesticides and agrochemical, thus endangering the public’s health. For instance, the continued migration to Kathmandu Valley, unplanned urbanization and the resulting noise level has led to average recorded noise level higher than the on recommended by World Health Organization (WHO). In Kathmandu Valley, major centers such as Kupandole, Putalisadak, Thamel, Kalanki, Balaju industrial area, Maitighar, and Suryabinayak have day time noise level above the one prescribed by the WHO (Figure 45).

With just 0.6% of total area, Kathmandu Valley accounted for 9.5% of total population in 2011 and had a population density of 2,800 person per sq.km. In 2001, Kathmandu Valley accounted for 7.1% of total population and had a population density of 1,830 persons per sq.km. The lack of adequate measures to address air and water pollution affects economic growth as it negatively impacts public health, thus reducing productivity and escalating health costs. As a result of the air pollution in Kathmandu Valley, a disproportionate number of patients suffering from respiratory and cardiovascular ailments are admitted to hospitals each day.[6]

The Environmental Performance Index (EPI) 2014 ranks 139 out of 178 countries. Specifically, even when compared to countries with similar per capita income, on air quality[7], Nepal ranks 177 out of 178 countries (Figure 46). Furthermore, air quality in Kathmandu fails to meet WHO guidelines for safe levels. Air quality is represented by annual mean concentration of particulate matter of less than 10 microns of diameter (PM10) [ug/m3] and of less than 2.5 microns (PM2.5) in cities.[8] Mechanical processes such as construction activities, road dust re-suspension and wind produce PM10 and combustion sources (wood and biomass fuels) mostly produce PM2.5. Kathmandu’s annual average air quality levels stood at 50 μg/m3 and 114 μg/m3 for PM2.5 and PM10, respectively. These are far higher than the WHO guidelines of 10 μg/m3 and 20 μg/m3 for PM2.5 and PM10, respectively. While most of the regional cities in South Asia as well as other major cities in Asia fail to meet the WHO guidelines, the levels in Kathmandu is particularly high relative to these cities as well (Figure 47).


Furthermore, chemical fertilizer use has increased drastically since FY2010. After ending chemical fertilizers subsidy due to high fiscal costs and heavy leakages, the government again introduced such subsidies in FY2008. Over time, this led to the ‘crowding-out’ of private sector even though the government’s subsidy covered just 25% of total fertilizer demand. A large portion of the fertilizer demand is met through informal supply (estimated to be about two-thirds of total use and often sub-standard ones) from bordering Indian cities, where fertilizer is subsidized by the Indian government as well.[9] With no official private sector suppliers, the government supplied 185,000 metric tons of chemical fertilizers (urea, DAP and potash) in FY2013 (Figure 48) and provided partial subsidy equivalent to NRs 6 billion. The chemical fertilizer usage was 57 kg per hectare in FY2013, up from 47 kg per hectare in FY2012.[10]

III. Key Challenges

The key environmental issues faced by the country are: (i) unharmonious, outdated and ineffective environment related policies and guidelines; (ii) seemingly irreversible degradation as a result of the increasing human pressure on land, water and forests; (iii) poorly engineered or totally non-engineered rural roads and infrastructure causing watershed degradation, landslides and soil loss; (iv) increasing desertification in the Trans-Himalayan region due to deforestation; (v) climate change induced drying up of water sources; (vi) lack of national digitized hazard maps for disaster risk management planning; (vii) extensive clearing of forest and uncontrolled extraction of river bed materials from Siwalik; (viii) risk of land subsidence due to over extraction of groundwater, particularly in Kathmandu Valley; (ix) increasing level of air and water pollution, solid waste management, and sanitation and health hazards in rapidly growing urban areas; (x) lack of institutional capacity and technical knowhow within the department of environment; and (xi) weak coordination among disaster management related agencies, low level of preparedness, rudimentary early warning system, and lack of post disaster rehabilitation programs.

The major key challenges directly related to boosting economic activities are as follows:

Environmentally weak infrastructure development: The growth of the rural as well as semi-urban road networks, often either with poor or no engineering at all, has helped in the establishment of new towns, and linked with or opened up new market centers. However, these kinds of road construction have also come at a cost, particularly the non-engineered rural roads in the hills and mountains, which have been noted to have accelerated landslides, gully erosion, and loss of forest resources and natural habitats. Investment in hydropower is growing with both public and private sector investment. Even in hydropower projects, especially the small size ones developed particularly by the private sector, environmental sustainability of the infrastructure in terms of cumulative impacts through strategic and realistic environmental assessment is seldom conducted. Furthermore, large leakages in electricity distribution reduce net supply, forcing households to opt for pollution-intensive sources of energy.

Unplanned urbanization: The improved connectivity and the decade-long conflict caused large-scale migration from rural to urban areas, increasing urban population to about 17.1% in 2011 from 13.9% in 2001. Subsequently, urban and semi-urban towns have emerged rapidly and without much planning. The erratic, unplanned, and haphazard expansion of such town has led to undersupply of urban amenities, putting tremendous pressures on the available resources. Furthermore, the lack of public awareness on the benefits of planned urbanization and poor municipal management has compounded the problem, leading to intensified soil, air and water pollution, degraded land and vegetation, and unsanitary waste disposal. The annual population growth rate in Kathmandu Valley alone was 4.3%, much higher than 1.4% average for the entire country over 2001-2011. In 2011, Kathmandu Valley had a population of 2.5 million (Figure 49) and population density of 2,800 persons per sq.km. Urban amenities and municipal management have not grown proportionally to the growth in urban population and the pressure on the available resources.

Misuse and indiscriminate use of pesticides and agrochemicals: The use of pesticides, insecticides and herbicides, various growth hormones and other agrochemicals has considerably increased in commercial agriculture and animal husbandry. However, their improper application has caused environmental and health hazards such as respiratory and skin diseases, and demise of critically endangered birds and mammals after scavenging dead livestock or insects treated with chemicals. Furthermore, it has also caused environmental problems following the seepage of pesticides to and contamination of water bodies. A total of 1,098 pesticides were registered in Nepal in 2013, up from 651 in 2010. Recently, there have been growing instances of inedible fresh vegetables and food products due to the overuse of pesticides and agrochemicals. A strict market monitoring mechanism and public awareness on the optimal usage of such production as agricultural inputs are required to lower the risks of health hazard. Furthermore, proactive promotion organic farming would also be useful.

Improper solid waste management (SWM): A huge amount of solid water is generated in the municipalities, most notably 457 metric tons per day in FY2012, up from just 29.9 metric tons per day in FY2007, by Kathmandu. Unfortunately, only 6 municipalities dispose of waste in sanitary landfill sites, which also not properly managed. Municipalities spent an average of 10% of their total budget on SWM, of which 60-70% is used for street sweeping, 20-30% for transport, and rest for final disposal. The lack resources and proper planning have been constraining municipalities’ capability to manage the increasing waste. In the absence of proper landfill sites, most of the municipalities directly dump the collected waste in rivers, forest or agriculture fields, increasing not only health hazards but also productivity of land. Furthermore, no separate arrangement exists to manage hazardous and medical wastes. Interventions including policy formulation, adoption of 3R (reduce, reuse and recycle) principle, capacity building of local bodies, public participation and public-private partnership are few interventions that may be helpful in developing an effective SWM program.

IV. Government’s Strategy

The concept of environmental protection and conservation has been embedded in the periodic national development plans since 1962. Till the 6th periodic plan (1980-85), the government prioritized forest conservation and watershed management, wildlife conservation, water and sanitation, and urban management. Since 1985, major environmental mainstreaming initiatives were undertaken, environment-friendly policies were introduced, and environment management strategies were integrated into the sector plans. Thus far, Nepal is a signatory to 21 environment related international conventions.

Currently, the environmental priorities of the government include: (i) forest conservation and management through community participation; (ii) wildlife and biodiversity conservation through establishing protected areas; (iii) reducing vulnerability to the impacts of climate change; (iv) disaster relief and risk management; (vi) environmental sustainability in development projects; (vii) achieving the Millennium Development Goals; (viii) improving air quality and waste management in urban areas; (ix) use of alternate renewable energy and energy efficient technology in rural areas; (ix) watershed management –ecological restoration in fragile Siwalik range; and (x) improved drinking water and sanitation.

Environment Protection Act (EPA), 1997 and Environment Protection Rule (EPR), 1997 (amended in 2007) are the two major legal provisions aimed at minimizing the adverse environmental impact due to development activities, and integrating environmental sustainability into development projects. These legislations have made either Initial Environment Examination (IEE) or Environment Impact Assessment (EIA) mandatory for government and private sector projects, safeguarding environmental and social issues in all development projects. However, the weak government capacity for effective implementation and monitoring of IEE/EIA recommended mitigation measures has been a long running issue in Nepal. There is also a need for updating the one-and-a-half decade old EPA and EPR in the context of emerging environmental and climate change issues.

Progress on effective environment protection and management is hampered by weak governance, political instability, and slack implementation of environment related Acts and Rules. Deforestation, degradation in Siwalik Range and lower hills, over harvesting of medicinal plants and non-timber forest products, use of explosives and chemicals for fishing in rivers, excessive groundwater abstraction, unwarranted mining in riverbed and on fragile area, environmental degradation in urban areas (air and water pollution, solid wastes), conversion of fertile arable land into built-up areas are the results of weak enforcement of the existing legislation.

V. Recommendations

Some of the major recommendations to stimulate environment-friendly inclusive economic growth are as follows:

  • Strengthen the country safeguards system
  • Promote environment friendly infrastructure development
  • Promote planned and regulated urban growth
  • Encourage environment-friendly and climate resilient agriculture
  • Stop land degradation and desertification
  • Protect terrestrial and aquatic ecosystem and biodiversity
  • Mainstream climate change risks
  • Scale up renewable energy
  • Effective disaster risk management (DRM)

VI. Conclusion

Currently, one of the major challenges faced by the country is to ensure not only a high and inclusive economic growth, but also to make it environment-friendly. Economic activities without due consideration for environmental sustainability may start tapering off in the medium-term, and then possibly retard prosperity in the long term. Thus far, since growth is largely driven by exogenous factors such as monsoon-fed agriculture production and remittances-induced services sector growth, economic activities have been at best minimally damaging to the environment. This is also reflected in the declining share of industrial sector in GDP. However, as a major push for electricity generation, infrastructure development and stimulation of manufacturing activities takes place in the short to medium term to achieve a high growth rate and to create productive employment opportunities, the challenge would be to ensure that these activities are made environment-friendly so that the resulting growth is not only high and inclusive, but also sustainable.

The low per capita carbon dioxide emission compared to other regional economies and the shrinking of industrial sector means that the existing pattern of environmental challenges has little to do with the pace of economic growth. It is affected more by other factors such as poor engineering and safeguards embedded in infrastructural undertakings, deforestation, haphazard solid waste management, land degradation, unsustainable and indiscriminate use of pesticides and agrochemicals, and unplanned urbanization. In effect, these point to the lack of implementation of existing safeguards, obsolete legal frameworks, and institutional slackness as well as weakness. The existing pattern of environmental challenges has to potential to decelerate the pace of growth in the medium to long term.

Overall, Nepal’s forest area is depleting, land degrading, groundwater is drying up, pollution is increasing in major urban areas, and the use of pesticides and agrochemicals is increasing. This poses a number of challenges directly affecting economic activities: (i) environmentally weak infrastructure development; (ii) unplanned urbanization; (iii) misuse and indiscriminate use of pesticides and agrochemicals; and (iv) improper solid waste management. Though the government introduced a number of key legislations, which may need updating to reflect the present context, and embedded environment protection and conservation in its periodic plans, the implementation aspect has been rather disappointing— resulting in delays in the implementation of development projects.

The government could take a number of measures to stimulate environment-friendly inclusive economic growth such as: (i) strengthen the country safeguards system; (ii) promote environment-friendly infrastructure development; (iii) promote planned and regulated urban growth; (iv) encourage environment-friendly and climate resilient agriculture; (v) cease land degradation and desertification; (vi) protect terrestrial and aquatic ecosystem and biodiversity; (vii) mainstream climate change risks; (ix) scale up renewable energy; and (x) prepare effective disaster risk management. 

[1] This section was written in collaboration with Deepak Bahadur Singh, Senior Environment Officer at NRM. It draws in supporting information from a forthcoming report titled Country Environment Note Nepal 2014.

[2] Although Nepal lies near the northern limit of the tropics, because of rugged topography, there is a wide range of climates experienced from the summer tropical heat and humidity of the lowlands to the colder dry continental and alpine winter through the middle and northern mountainous region. The remarkable differences in climatic conditions are due to the enormous range of altitude within a short north-south distance. Nepal possesses eight ecological zones: lower tropical zone, upper tropical, subtropical, temperate, subalpine, alpine, Trans-Himalayan and Nival (Tundra and Arctic). The tropical and subtropical zones occupy 58%, temperate zone 12%, subalpine 9%, alpine 8%, Trans-Himalayan 8% and Nival 5% of the country’s land area.

[3] ADB. 2013. Macroeconomic Update Nepal August 2013. Vol1. No.2. Kathmandu.


[5] CBS. 2014. Environment Statistics of Nepal 2013. Kathmandu: Central Bureau of Statistics.

[6] A. Lodge. 21 March 2014. Has Air Pollution Made Kathmandu Unlivable?. The Guardian. http://www.theguardian.com/cities/2014/mar/21/air-pollution-kathmandu-nepal-liveable-smog-paris

[7] It is a composite of three indicators: (i) air pollution- average exposure to PM2.5 (fine particulate matter); (ii) PM2.5 exceedance; and (iii) household air quality – indoor solid fuel usage.

[8] WHO. 2005. Air Quality Guidelines for Particulate Matter, Ozone, Nitrogen dioxide, and Sulfur dioxide - Global Update 2005. Geneva: World Health Organization. http://www.who.int/phe/health_topics/outdoorair/outdoorair_aqg/en/

[9] The Agriculture Sector Performance Review estimates that about two-thirds of total fertilizer demand in Nepal met by supplies through informal sources. Total chemical fertilizer demand is estimated to be about 0.6 metric tons.

[10] MOF.2014. Economic Survey 2012/13. Kathmandu: Ministry of Finance.

Wednesday, September 17, 2014

Nepalese economy in FY2014: External sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here are earlier blog posts on real sector, fiscal sector, monetary sector, and FY2015 growth and inflation outlook.

I. Exports

The weak currency, which improved price competitiveness, modest pickup in production following the improvements in political situation, and strong external demand increased exports. In US dollar terms, merchandise exports (free on board [fob]) rebounded with a growth of 5.1%, up from a decline of 2.9% in FY2013. The country exported merchandise goods worth $1.03 billion, up from $981 million in FY2013. Overall, merchandise exports increased to 5.2% of GDP in FY2014 from 5.1% of GDP in FY2013.

The top five exports to India were zinc sheet ($63.1 million), textiles (59 million), polyster yarn ($52.6 million), juice ($45.2 million), and jute goods ($43.9 million). Meanwhile, the top five exports to other countries were woolen carpet ($75.2 million), readymade garments ($43.1 million), pashmina ($21.3 million), pulses ($20.9 million), and tanned skin ($11.4 million) (Figure 35).

II. Imports

Merchandise imports (cost, insurance freight [cif]) in dollar terms grew by 13.9%, up from 10.9% growth rate in FY2013. Of the total imports of $7.1 billion, 19.1% was oil imports. In US dollar terms, this is equivalent to $1.4 billion, higher than the value of the country’s total merchandise exports. The high quantity of oil imported is mainly attributed to the rising demand for petroleum products as a result of the persistent and long hours of power cuts and the weak currency. Overall, merchandise imports increased to 36.1% of GDP in FY2014, up from 32.3% of GDP in FY2013.

The top imports were petroleum products, iron and steel, transport and vehicle parts, machinery and parts, and electronic and electrical equipment. The five top imports from India were petroleum products ($1,340.7 billion), vehicle and spare parts ($336.5 million), steel billets ($251.9 million), other machinery and parts ($158.9 million), and medicine ($154.3 million). The top imports from other countries were gold ($253.1 million), crude soybean oil ($150.9 million), telecommunication equipment ($143.1 million), silver ($129.8 million), and other machinery and parts ($111 million) (Figure 36).

III. Remittances

The large increase in the number of migrant workers and the incentives to remit more money back home as a result of the weak currency have boosted workers’ remittance inflows, which reached a record 28.2% of GDP in FY2014, equivalent to $5.5 billion (Figure 37). In US$ terms, remittance inflows grew by 11.9%, up from 11.3% growth in FY2013.[1] This follows a 16.4% growth of migrant workers (those who obtained permits form the Department of Foreign Employment).

A total of 527,814 migrants legally left to work overseas in FY2014 (daily average of 1,446), up from 453,543 in FY2013 (daily average of 1,243). Malaysia, Qatar, Saudi Arabia, and UAE have remained the top employment destinations for low to semi-skilled Nepalese migrant workers (Figure 38). They together accounted for 92% of total migrant workers in FY2014. As a share of total migrants, Malaysia’s share increased from 34.6% in FY2013 to 40.6% in FY2014, and Qatar’s share increased from 20% to 24.4% over the same period.

IV. Balance of Payments

The country’s external situation strengthened in FY2014 with the balance of payment surplus reaching $1.3 billion (6.6% of GDP). Though this is an impressive increase from the $786.5 million (4.1% of GDP) surplus in FY2013, it is still lower than the $1.6 billion (8.6% of GDP) surplus in FY2012 (Figure 39). The large merchandise trade deficit, which reached 30.9% of GDP, was partially[2] offset by workers’ remittances, which reached 28.2% of GDP, and export resulting in a current account surplus of $917.2 million (4.7% of GDP), up from 3.4% of GDP in FY2013. While capital transfers increased by 47.6%, financial transfers decreased by 24.9% as a result of the 68.5% fall in foreign direct investment, which saw a sharp decline from $103.6 million in FY2013 to a mere $32.6 million in FY2014. Gross foreign exchange reserves increased from $6.1 billion in FY2013 to $6.8 billion FY2014, sufficient to cover 10 months of imports of goods and non-factor services.

V. Exchange Rate

The rate of depreciation of the Nepalese rupee has subsided in the latter months of FY2014 closely following the currency movement of the Indian rupee, but it still remains weak (Figure 40). Overall, the Nepalese rupee depreciated by 19.9% between 15 July 2011 and 25 July 2012 and a further 6.7% between 15 July 2012 and 15 July 2013. It depreciated by 0.9% between 15 July 2013 and 15 July 2014. The weak currency increased exports, the import bill, remittance inflows, and losses of Nepal Oil Corporation.


[1] In local currency, the growth rate was 25% in FY2014, up from 20.9% growth in FY2013.

[2] Overall, the net goods, services and income balance was a negative 28.1% of GDP, which was offset by net transfers equivalent to 32.7% of GDP, resulting in current account surplus equivalent to 4.7% of GDP.

Sunday, September 14, 2014

Nepalese economy in FY2014: Monetary sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here are earlier blog posts on real sector, fiscal sector, and FY2015 growth and inflation outlook.

I. Inflation

Although inflation (year-over-year average CPI) moderated in FY2014 compared to 9.9% in FY2013, it still remained elevated at 9.1% as the effect of the substantial moderation in non-food prices was partly neutralized by the sustained rise in food prices. Food and non-food prices increased by 11.6% and 6.8%, respectively. They increased by 9.7% and 10.1%, respectively in FY2013. Overall, while food prices contributed to 5.4 percentage points to overall inflation, non-food prices contributed 3.6 percentage points in FY2014 (Table 2). Despite the good agricultural harvest and moderating prices in India, the high food prices, which have a 53.2% weight in the overall CPI index, indicate domestic distortions in the food distribution system, and the high fuel prices and transport cost transmitted to wholesale and retail prices. The price of cereals and grains, vegetables, meat and fish, and fruits increased by over 10%, and together they contributed 4.1 percentage points to the overall inflation, and almost 76% of food inflation. The subsiding of non-food prices reflect the gradual strengthening of Nepalese rupee, despite it still being weaker than a few years back, as it closely follows the currency movement of Indian rupee vis-à-vis the dollar.

Table 2: Annual inflation (% change)

Inflation (Y-o-Y)
Year Average  Food Non-food
FY2010 9.6 15.1 4.9
FY2011 9.6 14.6 5.3
FY2012 8.3 7.7 9.0
FY2013 9.9 9.7 10.1
FY2014 9.1 11.6 6.8

Inflation has remained elevated due to a combination of structural bottlenecks, domestic supply-side factors, high inflationary expectations, and exogenous pressures such as the ongoing weakness of the currency despite some strengthening in the latter part of the year. Structural bottlenecks include weak backward and forward linkages, fragmented value chain and distribution systems, low productivity and policy inconsistencies. Supply-side constraints include the lack of adequate supply of electricity, transport bottlenecks, lack of raw materials leading to high import content of processed and light manufactured goods, and the inadequate supply of key inputs to boost productivity. Credible strategies to tame elevated inflation would help dampen inflationary expectations.

Inflation gradually increased from 7.9% in mid-August 2013, reached a high of 10.3% in mid-December, and then started to moderate, reaching 8.1% in the last month of FY2014. Compared to the prices in the corresponding months in FY2013, inflation was lower in all months except the last three months in FY2014 (Figure 21). Similarly, compared to prices in FY2013, food and beverage prices remained higher for all months except mid-August and mid-September (Figure 22). Non-food and services prices moderated in all the months compared to the level in corresponding months in FY2013 (Figure 23).

III. Money Supply

Money supply[1] (M2) grew by 19.1%, reaching NRs250.1 billion, on the back of a significant growth of net foreign assets[2], which compensated for the one percentage points slowdown in net domestic assets (Figure 25). M2 growth was 16.4% in FY2013 (NRs185.1 billion). The large net foreign asset holdings— registering a 27.2% growth (NRs127.1 billion) in FY2014, up from 18% growth rate in FY2013 (NRs68.9 billion)— were supported by a higher rate of remittance inflows and increased foreign assistance. The increase in money supply was reflected in the 17.7% growth of narrow money (M1) and 11.8% growth of time deposits. As a share of GDP, money supply, net foreign assets and net domestic assets stood at 81.2%, 31.1%, and 50.1%, respectively, in FY2014.

Net claims on government[3] — direct loans and government securities held by the central bank— decreased by 16.4% (NRs27.5 billion) from an increase of 3% in FY2013, reflecting the large increase in government deposits compared to the bank and financial institutions’ (BFIs) claims on the government. The overall credit to the private sector slowed down, registering a growth of 18.3% compared to 20.2% growth in the previous year. It indicates the lack of immediate bankable investment opportunities despite the declining lending rates offering by BFIs, which have had excess liquidity for over a year. As a share of GDP, total credit to the private sector stood at 7.3% in FY2014, down from 9.9% in FY2013.

IV. Deposit and Credit

The BFIs mobilized NRs218.7 billion (reaching a total of NRs1406.8 billion) in deposits in FY2014, higher than the NRs176.3 billion mobilized in FY2013, as higher remittance inflows and the acceleration of government spending in the last quarter of FY2014 boosted deposits. This translates into a growth of 18.4%, higher than 17.4% growth in FY2013. Deposit mobilization of commercial banks, development banks and finance companies increased by 17.8%, 29.1% and 5.7%, respectively (Figure 26). The cumulative deposit mobilization reached 72.9% of GDP in FY2014.

Total credit (loans and advances) of BFIs increased by 14.4% (NRs165.5 billion) in FY2014, down from 18.6% growth in FY2013 (NRs180.2 billion). Credits of commercial banks grew by 13.7% (NRs128.8 billion), down from a rate of 19.1% in FY2013. Similarly, credits of development banks and finance companies grew by 27% (NRs47.4 billion) and 4.3% (NRs3.9 billion), respectively (Figure 27). Credit to the private sector (by category A, B and C BFIs) increased by 18.7% (NRs176.1 billion), down from 20.8% growth rate (NRs162 billion) in FY2013, with commercial banks and development banks registering growth of 18.7% and 29.3%, respectively. Credit to private sector from finance companies declined by 2.1%. Despite the positive political outlook and declining lending rates, the growth rate of credit to the private sector fell due to the low demand emanating from the lack of immediate bankable investment projects and the cap on lending to certain sectors (particularly the property market) that had seen bubbles in the previous years. Cumulatively, 21.6% of the total lending went to wholesale and retail traders, followed by 19.6% to industry, 10.5% to construction, and 8.0% to finance, insurance and fixed assets (Figure 28). The total credit of BFIs reached 68.1% of GDP in FY2014.

On a sectoral basis, 25.8% of the increase in credit by BFIs was absorbed by wholesale and retail traders (NRs25.8 billion), followed by industry (NRs18.1 billion), construction (NRs13.2 billion), services (NRs15.8 billion), and agriculture (NRs11.1 billion) (Figure 29). While lending to construction sector is recovering after it hit a low in FY2011, lending to real estate has declined for two consecutive years (Figure 30) — reflecting the pickup in residential housing and infrastructure related activities, but a slowdown in real estate market.

V. Liquidity Management

In FY2014, the NRB mopped up a net liquidity equivalent to NRs602.5 billion through reverse repo auctions— one of the short-term tools used by the central bank to manage liquidity— at a weighted average interest rate of 0.16%, and NRs8.50 billion through outright sale auctions at a weighted interest rate of 0.05%. The central bank did not use reverse repo auctions in FY2012 and FY2013. However, it mopped up NRs8.5 billion at a weighted average interest rate of 0.97% in FY2013. The reverse repo auctions for eleven consecutive months and the declining rate shows the increasing appetite of BFIs to park their excess liquidity with the central bank as deposit growth outpaced credit growth. Accordingly, BFIs did not use the standing liquidity facility in FY2014. Despite the repeated bouts of reverse repo auctions, the declining interest rates, and the slowdown in lending growth, the continuing excess liquidity indicates structural issues in the banking sector.

To finance burgeoning imports from India, the NRB sold $3.14 billion in the Indian money market and purchased Indian currency equivalent to NRs308 billion. In FY2013, the NRB sold $3.12 billion to purchase Indian currency equivalent to NRs277.4 billion. The central bank also injected NRs343.5 billion into the banking sector by purchasing $3.52 from the commercial banks.

VI. Interest Rates

The excess liquidity, which peaked to NRs70 billion in November 2013 before declining to NRs40 billion towards the end of FY2014[4], throughout the year pushed short-term interest rates below 1% (Figure 31). The 91-day treasury bills weighted average rate was 0.25% in mid-August 2013, which declined to 0.02% in mid-July 2014 and averaged 0.13% in FY2014, much lower than 1.77% in FY2013. Similarly, inter-bank rate dropped from 0.3% in mid-August 2013 to 0.16% in mid-July 2014, and averaged 0.22% in FY2014, much lower than 1.77% in FY2013. 

The weighted average deposit and lending rates fell as the BFIs struggled to boost lending amidst excess liquidity (Figure 32). The weighted average deposit rate of commercial banks dropped to 4.09% in mid-July 2014 from 5.13% in mid-August 2013. It has fallen consistently from a high of 6.17% in mid-July 2012. Similarly, the weighted average lending rate fell to 10.55% in mid-July 2014 from 12.1% in mid-August 2013. The weighted average interest spread stood at 6.5% by mid-July 2014.

VI. Securities Market

The increasing investor confidence following the successful second CA elections in November 2013, lower deposit rates and excess liquidity in the banking sector significantly boosted stock market turnover, which peaked to NRs77.3 billion in FY2014 from NRs22 billion in FY2013 (Figure 33). The commercial bank’s share in total turnover was 65% (NRs37 billion). A higher share turnover indicates more liquid shares of a listed company. Note that Nepal’s share market is still developing and it does not always respond meaningfully to policy change and political developments.

The Nepal Stock Exchange (NEPSE) index reached 1036.1 in mid-July 2014, exactly double the index level of 518.3 reached in mid-July 2013. Stock market capitalization sharply increased to 54.8% of GDP in FY2014 (NRs1057.2 billion) from 30.4% of GDP in FY2013 (NRs514.5 billion). The total number of listed companies increased to 237 from 230 in FY2013, indicating the willingness of more companies to go public to raise capital and trade shares in the secondary market (Figure 34).


[1] Money supply (M2) is the sum of net foreign assets and net domestic assets. Also called broad money, M2 is equal to narrow money (M1,) and saving and time deposits. M1 is equal to currency in circulation and demand deposits.

[2] The balance sheet of monetary authorities is composed of assets and liabilities. Assets consist of net foreign assets and net domestic assets (net claims on government and claims on the private sector). Liabilities consist of currency issued and deposits. Both net foreign assets and net claims on government affect reserve money and hence the money supply. A decline in net foreign assets, denominated in local currency in the monetary survey, and the banking sector’s net credit to government reduces the money supply. Net foreign assets are associated with the fluctuations in foreign exchange reserves (in the balance of payments account).

[3] To facilitate the analysis of the central bank’s financing of government operations, claims on the government are recorded in net basis. The net credit to the government means creation of high-powered money, i.e. monetary base (currency in circulation plus reserves of banks in the central bank).

[4] IMF.2014. Nepal Article IV Consultation 2014. Washington, DC: International Monetary Fund.

Friday, September 12, 2014

Nepalese economy in FY2014: Fiscal sector

This blog post is adapted from Macroeconomic Update, August 2014, Vol.2, No.2. Here are earlier blog posts on real sector and FY2015 growth and inflation outlook.

I. Expenditure Performance

Despite the timely full budget, the expenditure performance in FY2014 was unsatisfactory. The CA II elections, budget execution delays, and long-running procedural and procurement hassles constrained absorptive capacities[1], resulting in lower than targeted capital spending. Much of the bureaucracy was assigned to conducting the CA II elections, virtually stalling the capital expenditure related procedural approval and procurement activities for about three months. The estimated actual capital spending was 74.9% of planned capital expenditure in FY2014, lower than the 82.6% achieved in FY2013[2]. Meanwhile, actual recurrent spending was 84.2% of planned recurrent expenditure, also lower than the 88.7% in FY2013 (Figure 8). Overall expenditure grew by 19.6%, with recurrent and capital spending growth at 20.2% and 16.7%, respectively— all higher than their corresponding growth rates in FY2013 (Figure 9).

Within recurrent expenditures, compensation of employees increased by 27.6% as a result of the hike in public sector employees’ salaries by 18% and an additional allowance of NRs1,000. Grant to local bodies, use of goods and services[3], and interest and services payments increased by over 20%, but subsidies[4] decreased by 72.7% (Figure 10). Overall, recurrent expenditures are estimated to be 16.4% of GDP, higher than 14.6% of GDP in FY2013.

Capital spending continued to be low as in the previous FY, reaching just 3.3% of GDP in FY2014— marginally higher than the 3.2% of GDP posted in FY2013 but much lower than the targeted 4.4% of GDP in FY2014 (Figure 11). Apart from the slowdown engendered by the CA II elections, other persistent factors impeding capital spending are: (i) lack of project readiness, in terms of timely preparatory activities such as detailed project design, land acquisition, establishment of project management offices and required personnel, and procurement plans; (ii) delays in project approval and budget release; (iii) delays in procurement related processes; and (iv) overall weak project planning and implementation capacity[5]. The country needs to drastically increase capital spending, both quantum and quality, to address the large infrastructure deficit (estimated to be between 8% and 12% of GDP annually until 2020), to set the foundation for graduation from LDC category to a developing country status by 2022[6], and to achieve other social development objectives that are curial for inclusive economic growth.

Within capital expenditures, land purchase declined by 48.2%, faster than the rate of decline in FY2013. It indicates the difficulties surrounding land acquisition for infrastructure projects. Spending on building construction, plant and machinery, and research and consultancy grew by over 20%. Vehicle purchase grew by a whopping 248.7%, which could partly be attributed to the low base effect. The expenditure for civil works increased by just 11.2%, reflecting approval and procurement related delays. Except for civil works— which was 2.3% of GDP, the same as in FY2012 and FY2013— none of the eight sub-categories within capital expenditures was above 1% of GDP (Figure 12).

As in the previous years, FY2014 saw bunching of spending, especially capital spending, towards the last few months. Almost one-fourth of actual total public expenditure was done in the last month and 42.4% in the last three months. Of the actual capital spending, 37.8% was spent in the last month and 58.8% in the last three months (Figure 13). This pattern of spending is not much different from previous years, irrespective of the timeliness of issuance of budget. It raises concerns about not only the absorptive capacity, but also the structural issues concerning budget execution as outlined above.

The ballooning recurrent expenditure is a matter of concern as it remained about NRs4 billion higher than tax revenue in FY2014. Furthermore, the growth rate of recurrent expenditure has been higher than the growth rate of tax revenue in the last three years. Rationalization of recurrent expenditures— a significant portion of these go to public sector salary, and pension and social security related obligations—is required for creating the fiscal space needed to boost allocations for capital expenditure. Although capital spending allocation can be enhanced through increased domestic/international borrowing in the short to medium-term, in the long-term strengthening revenue mobilization and recurrent expenditure rationalization will be needed so as to reduce the reliance on increased borrowing.

II. Revenue Performance

Total revenue grew by 20.6%, marginally lower than its 21.2% growth in FY2013, reaching NRs356.8 billion (18.5% of GDP). It is higher than the budget target of NRs354.5 billion, thanks to the significant increase in non-tax revenue, which partly offset the lower tax revenue growth. While non-tax revenue grew by 23.8% as opposed to a decline by 2.7% in FY2013, tax revenue growth slowed down to 20.1% from 25.8% in FY2013. As a share of GDP, tax revenue mobilization has improved significantly, reaching 16.2% in FY2014, up from 15.3% a year earlier (Figure 14). The continuous reforms in revenue administration, broadening of the tax base, and the higher import bill resulted in robust revenue performance. Some of the notable reforms undertaken in recent years include: (i) information and communication technology based tax returns filing and payments systems; (ii) establishment of a data link with the Company Registrar’s Office to enhance tax compliance[7]; (iii) measures to reduce tax compliance costs; (iv) strengthening of tax monitoring and audit systems; (v) measures to widen the tax net for various tax categories; and (vi) implementation of the Any Branch Banking System (ABBS) for large tax payers.

Revenue mobilization from all sources, except vehicle tax, grew in FY2014. The growth rate of value added tax (VAT), excise duty, land registration fee, and non-tax revenue was higher than in FY2013. They increased by 20.9%, 23.8%, 32.5% and 23.8%, respectively. Income tax and customs revenue increased by 16.3% and 19.3%, respectively, lower than 28.1% and 31.1% in FY2013 (Figure 15). The deceleration in VAT collections is attributed to the lower growth of VAT on production; goods, sales and distribution; and service and contracts. Overall, VAT contributed the largest (28.3%) to total revenue mobilization, followed by income tax (21.8%), customs (19%), and excise duty (12.7%) (Figure 16). Taxes on consumption and imported goods, which are largely financed by remittance income, constitute a lion’s share of total tax revenue mobilization—around 70%. Furthermore, import-based revenues (custom duties, VAT, and excise on imports only) account for about 45% of total revenue.


III. Budget Balance

The robust revenue growth combined with the lower than expected expenditure resulted in a lower than average fiscal deficit[8] equivalent to 0.1% of GDP in FY2014 (Figure 17). Though this is better than the fiscal surplus equivalent to 0.7% of GDP in FY2013, it is still lower than the medium-term average fiscal deficit of about 2.2% of GDP. For a low-income country with a large financing need to bridge the infrastructure deficit, particularly in hydropower and transport, running a modest fiscal deficit without jeopardizing fiscal sustainability is desirable. Nepal faces an estimated infrastructure financing gap of between 8-12% of GDP until 2020. The total net borrowing amounted to NRs26.6 billion in FY2014 (1.4% of GDP).

IV. Public Debt

Nepal’s overall outstanding public debt (external and domestic) has been steadily declining, reaching an estimated 30.1% of GDP in FY2014 (Figure 18). Total external debt decreased to 18.4% of GDP in FY2014 from 19.7% of GDP in FY2013. Similarly, total domestic debt declined to 11.7% of GDP from 13% of GDP in FY2013, reflecting the lower than targeted domestic borrowing as a result of the wide gap between actual and planned expenditure. External debt service payments stands at around 9.8% of exports of goods and non-factor services. The declining stock of public debt and debt service payments generally indicate prudent fiscal and public debt management.

V. Public Enterprises

The overall performance of public enterprises (PEs) improved in FY2013 as a result of the lower than expected losses of Nepal Oil Corporation (NOC) and Nepal Electricity Authority (NEA). Of the 37 PEs, 17 made losses and one did not make any transaction. 4 PEs that incurred losses in FY2012 earned profits in FY2013. Compared to a net loss of NRs 3.5 billion in FY2012 (0.23% of GDP), FY2013 saw a surprising rebound with an estimated net profit of NRs 11.4 billion (0.7% of GDP). This is largely attributed to the substantial reduction in losses of NOC and NEA (Figure 19). As a result of the decrease in prices of crude oil in the international market and an increase in administered fuel prices, NOC’s losses dropped to NRs2.1 billion in FY2013 from NRs9.5 billion in FY2012. Similarly, NEA’s losses dropped to NRs4.6 billion from NRs9.9 billion, thanks mainly to the increase in electricity tariff by 20%, decline in exchange rate losses by NRs220 million, and reduction in provisioning for employees’ expenditure by NRs740 million.[9] The combined losses of NOC and NEA amounted to 0.4% of GDP in FY2013, down from 1.3% of GDP in FY2012. Nepal Telecom’s (NT) profit of NRs11.3 billion in FY2013 (0.7% of GDP) compensated for most of the losses incurred by PEs. The government is projecting a decline in net profit in FY2014 due to the expected rise in losses of NOC and NEA (equivalent to about 0.9% of GDP).

The cumulative liabilities of PEs increased from 1.8% of GDP in FY2012 to 2.5% of GDP in FY2013 as a result of the rise in both unfunded and contingent liabilities. The unfunded liabilities (salary, pension, social security contribution, health care, and recurrent costs, among others, that the PEs cannot finance themselves) have increased steadily from 1.0% of GDP in FY2009 to 1.6% of GDP in FY2013. A major contributor to the rise in unfunded liabilities is the hike in salary and allowances in the public sector. Meanwhile, contingent liabilities (state guarantees of loans, defaults of PEs, and clean-up liabilities of privatized PEs, among others) also increased in FY2013 after a steady decline in the past four years. It reached 0.9% of GDP in FY2013, up from 0.4% of GDP in FY2012. These have contributed to the overall increase in the reported liabilities (Figure 20).

Either privatization or liquidation of loss making PEs needs to be accelerated to reduce the budget drain. The weak financial position of PEs has led to large unfunded liabilities, especially for pension and other related retirement benefits, which could ultimately become the government’s liabilities. It may be noted that due to the lack of accurate and updated data, the contingent liability of PEs presented here are at best conservative estimates. It is likely that the government is exposed to much higher level of liabilities. In this regard, fiscal and macroeconomic stability could potentially be subject to significant risks. Continuing the adjustment of electricity tariffs and adjustment of fuel prices to reflect the true cost of production will help to lower the losses and liabilities.

[1] Absorptive capacity generally refers to the skills mastered by bureaucracy, state of infrastructure, and quality of institutions.

[2] Due to the caretaker status of the then government and the lack of broader political consensus, a timely and full budget could not be introduced in FY2013. Instead, the budget was introduced on a piecemeal basis on 15 July 2012 (one-third of the actual expenditure in FY2012), 20 November 2012 (two-thirds of the actual expenditure in FY2012), and 9 April 2013 (a full budget consolidating the previous two partial budgets). The planned capital spending was NRs66.1 billion in FY2013, of which NRs54.6 billion was spent.

[3] Use of goods and services consists of (i) rent & services; (ii) operation and maintenance of capital assets; (iii) office materials and services; (iv) consultancy and other services fee; (v) program expenses; (vi) monitoring, evaluation and travel expenses; (vii) recurrent contingencies; and (viii) miscellaneous.

[4] Subsidies include direct subsidies to non-financial public corporations and private enterprises only. Actual direct and indirect subsidies are much higher. This does not include subsidies for chemical and organic fertilizer, micro-hydropower projects, transportation subsidy for seed and fertilizer supply, and interest subsidies to farmers groups and cooperatives, among others.

[5] The Commission for Investigation of Abuse of Authority’s (CIAA) pro-active monitoring of corruption in bureaucracy has also delayed decision making, especially those related to procurement.

[6] For a detailed analysis on prospects for Nepal’s graduation to a developing country status by 2022, see: ADB. August 2013. Macroeconomic Update. Vol.1, No.2, Manila: Asian Development Bank.

[7] The cost of collection per NRs1,000 decreased from NRs16.4 in FY2007 to NRs12.7 in FY2011.

[8] Fiscal balance is computed as expenditures (including net lending) minus revenue (including grants). However, normal fiscal balance (revenue minus expenditure and net financing) was a surplus equivalent to 1.3% of GDP.

[9] The high losses of NEA are attributed to the rising electricity import, which is sold at suppressed rates, from India, and the still large provisioning for pension and gratuity of employees. The average electricity import price is NRs8.4 per unit, but the retail price is NRs8.04 per unit. Nepal imports around 200 MW of electricity during the dry season.

Wednesday, September 10, 2014

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.

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).


[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.