Current State of Nepali Economy

Chandan Sapkota
South Asia Watch on Trade, Economics and Environment (SAWTEE)
May 2, 2012

Presented at guest lecture for MBS 2nd year at Shanker Dev Campus, May 2, 2012, Kathmandu
2012-05-02 Chandan Sapkota Blog: www.sapkotac.blogspot.com 1 Website: www.chandansapkota.wordpress.com

Presentation Outline
Economy at a glance Macro economy External sector Financial sector Sophistication of products Binding constrains to growth Investment climate Readiness to change So
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Economy at a glance

Low growth, low job opportunities, fledging industrial sector, high prices, low savings, high imports and consumption, and remittances-fueled impact-less investment cycles; But, bright spots are emerging

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Pre-reformed panchayat (Import substitution era) Reformed panchayat (Structural adjustment era) Constitutional monarchy (Economic liberalization) Maoist insurgency (Reform policies in paper, WTO accession) Post-revolution (Sweeping changes underway, BFIs growth) Growth below 5%, low employment High consumption High recurrent but low development expenditure; might have exp growth>revenue growth Low investment, saving, and FDI Fiscal deficit going up Trade deficit unsustainable Inflation creeping up, food and fuel insecurity Remittance economy Manufacturing sector going downhill Financial sector troubles Poor investment climate due to load-shedding, labor problems, political instability Good development: Poverty and inequality down, forex reserves up, investment in infra
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Average annual growth rate (%)

4.99 4.62 4.33

3.91

3 2.60

1971-1979
Pre-reformed panchayat

1980-1991
Reformed panchayat GDP

1992-1996
Constitutional monarchy

1997-2006

2007-2010

Maoist Post revolution insurgency

GDP per capita

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Macro economy

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Economic Growth and Per Capita GDP Growth

7 735 800 6

700
600 4.63 500

GDP and per capita GDP growth rate (%)

4 3.19 3 300 400

200 100 0 2005/06 2006/07 2007/08 2008/09 Real GDP growth 2009/10 2010/11R 2011/12P Real per capita GDP growth Nominal per capita GDP

GDP growth rate declining after reaching 6.1% in 2007/08 Expected to increase in 2011/12 , thanks to high agriculture production (particularly paddy, which contributes 21% to agri GDP, production to increase by 13.7%) Per capita GDP is rising; Nominal GNDI is expected to be US$931 in 2011/12 Official unemployment rate is 2.1%. Real unemployment rate estimated to be around to 46% Rural population: 83% of total population
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Nominal per capita GDP (US$)

Sectoral Contribution to GDP

100% 90%

80%
70% 60% 50%

46.13

49.74

50.91

51.49

51.17

49.48

48.28

50.31

16.86

40% 30% 20% 10% 0% 2000/01

37.01

16.18

16.08

16.23

15.32

14.61

14.29

14.02

34.08

33.02

32.28

33.51

35.91

37.43

35.68

2005/06

2006/07

2007/08

2008/09

2009/10

2010/11R

2011/12P

Agriculture sector

Industry sector

Services sector

Contribution of agri sector coming down (around 40% in 1992/93) Industrial sector , which is the most important in terms of employment and sustainable growth, is weakening Services sector is absorbing labor from agriculture sector (apart from those migrating abroad for work) and is the largest employment provider. Contributes over 50% to GDP. Structural transformation???
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Manufacturing sector
10
9.03

8
7.59 7.48 7.34

6.97 6.34 6.17 6.17

0 2000/01 -2
Manufacturing (growth rate) Agriculture and forestry (growth rate) Manufacturing (Share of GDP) GDP growth rate

2005/06

2006/07

2007/08

2008/09

2009/10

2010/11R

2011/12P

Manufacturing sectors contribution to GDP declining. It has negative growth rate in 2007/08 and 2008/09 Agriculture sector growth bumped up GDP growth rate. But, its decline didnt have similar effect. Why? Services sector is pretty much providing base for whatever growth we have. Sustainable growth of over 5% is not possible without robust industrial sector (mainly manufacturing). It is also the source for stable employment and income opportunities. Interface between agriculture and industrial sector: agro-processing or linking agri and industrial sector.
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Saving, Investment and Consumption

25 92 91.5 Saving and investment (%of GDP) 20 19.2 19.62 91 Consumption (%of GDP) 90.5 90 89.5 11.66 9.98

15

89
88.5 88

10

87.5 87

0 2000/01 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11R 2011/12P Gross Domestic Saving as percentage of GDP Final Consumption Expenditure as percentage of GDP Gross Fixed Capital Formation as percentage of GDP

86.5

Saving is extremely low at 9.98% of GDP Investment is also low at 19.62 % of GDP (evidence shows that for high growth rate investment need to be above 25% of GDP for several years) Foreign direct investment was just US$39 million in 2010 (lowest in South Asia). Consumption is very high at around 90% of GDP. Domestic production down; remittances up; imports up
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Revenue, Expenditure, Aid, Inflation and Budget Deficit (% of GDP)

25

20

15

10

0 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10R 2010/11P

Budget deficit

Revenue

Expenditure

Grants and loan

CPI (annual growth)

Total expenditure surpasses total revenue Filled by foreign aid (grants and loans) and domestic borrowing Inflation is still high (will rise further due to the impact of high petroleum products and market distortions) Budget deficit was about 3.8% of GDP in 2010/11. Budget for 2012/13 is expected to be about Rs 425 billion, up from Rs 385 billion in 2011/12. Budget deficit will further widen because of expected payment to voluntarily retired PLA fighters and expenditure growth being higher than revenue growth.
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External sector

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Export, Import and Trade Deficit

Exports is declining, especially after 1996 (so is the contribution of industrial sector and manufacturing sector to GDP). Exports of goods and services was 26% of GDP in 1997. It was 9.75% of GDP in 2010. It is expected to be 9.78% of GDP in 2011/12. Imports are ever-increasing, reaching 37% of GDP in 2010. It is expected to be 32.57% of GDP In 2011/12. Trade deficit is ever-widening reaching around 23% of GDP.
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Export Markets

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Export and Import Destinations in 2010

India is the most important trading partner; relatively favorable market access

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Major Export and Import items

Major export items: Textiles, iron & steel, agriculture items Major import items: Fuels, electrical machines, transport equipment Income from merchandise exports is less than the total amount of money needed to import petroleum fuel Most of the import items are pretty much price inelastic to demand (thanks to remittances)
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BoP and Forex Reserves

50 350 40 300

30

250 Forex reserves

20 BoP

200

10

150

0 2002/03 -10 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10R 2010/11P

100

50

-20

Balance of Payments (Rs billion)

Forex reserves (Rs billion)

Balance of Payments (BoP) was in the red for two years (due to decline in growth of remittances and to some extent due to late transfers) Forex reserves are rising , but slowed down a bit in the past two years due to decline in growth of remittances Latest statistics for this fiscal year show that BoP (over Rs 60 billon) and forex reserves are in record levels (Is it a miracle of the policies of the government?)
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Remittances and Migrants

25 0.4 0.35 20 Number of migrants (million) 0.3 Remittances (% of GDP) 0.25 0.2 10 0.15 0.1 5 0.05 0 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10R 2010/11P 0

15

Remittances (% of GDP)

Number of migrants (million)

Each month around 29,000 Nepalis left the country in search for work abroad. The average growth of migrants between 2002/03-2010/11 was 17 percent. According to the WBs and CBSs estimate, remittance inflows increased by 327 percent and 547 percent respectively between 2004 and 2010. Benefits: BoP surplus, decline in poverty and inequality, increase in purchasing power (55.8% of households) Costs: Laxity in real policy reform (MoFs and NPCs role??), real estate bubble, symptoms of Dutch Disease, inflation, consumption binge, high imports, increase in wages of casual labor
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Remittances, Poverty and Inequality

80 70 60 50
41.8

Poverty headcount (%) in Nepal

CBS (National poverty line), 2010 figure cannot be compared with previous years
67.97

WB (US$ 1.25 a day)

53.13

40
30.8

30 20 10

25.2

24.82

0
2010 2003 1995

Poverty headcount rate at 25.2% (without a change in consumption basket , the decline was even dramatic) Inequality decreased (Gini index 32.94 in 2010/11 from 41.4 in 2003/04) What caused?
Mostly remittances (bumped up income) -- nominal per capita consumption of the poorest households increased by 165 percent while that of richest households increased by 66 percent only Average household income of the poorest and richest 20 percent households increased by 297 percent and 133 percent respectively. Government policies? Roads, Education, Healthcare??? 2012-05-02 Chandan Sapkota 18

Financial sector

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Deposit, Credit, M2 and Bubbles

60 30 50 Deposit and credit (% of GDP) 25

40

20 M2 growth

30

15

20

10

10

0 2002/03 2003/04 2004/05 2005/06 2006/07 2007/08 2008/09 2009/10R 2010/11P

Total deposit (% of GDP)

Total credit (% of GDP)

Money supply growth (M2)

Credit > Deposit (share of GDP) its okay! Money Supply (M2) declined recently Real estate bubble in 2011 and also banking bubble:
Real estate prices skyrocketed in matter of days, banks lent way too much, prices crashed as remittances growth slowed, liquidity crisis, several banks in trouble, credit to real estate and housing to be brought down to 25% next year Banking bubble and unhealthy competition with 309 BFIs (including 32 commercial, 87 development, 80 finance) 2012-05-02 Chandan Sapkota 20

Product sophistication

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Product Sophistication and Income Per Capita

The sophistication of production is associated with income level of countries. Sophistication of Nepals production and exports is low. Reasons? Both endogenous and exogenous factors
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Product Space

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Sophistication of Nepals exports

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Sophistication of Indias exports

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Sophistication of USAs exports

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What Determines Manufacturing Competitiveness?

Strong government initiatives: power outages labor problems access to finance inadequate supply of infrastructure policy inconsistency policy implementation paralysis Manufacturing capabilities: R&D innovation Market condition:
macroeconomic uncertainly Market distortions

Resources: lack of industrial raw materials high cost of finance

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Binding constrains to growth

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What is Holding Back Growth?

Inadequate supply of infrastructure (road network, communications, electricity, irrigation , storage, etc). During conflict infrastructures were destroyed, which reduced productive capacity of our economy.

The poor quality of existing infrastructure and a virtual absence of linkages between production and manufacturing sites in the hilly and mountainous regions has not only stymied structural transformation and impeded a shift to new productive activities, it is also leading to a skewed spatial distribution of agents (firms and labor) and assets in the economy.
Inadequate supply of infrastructure is the most binding constraint to growth at present. But, this does not mean other constraints are irrelevant. Policy to tackle this constraint head-on will create the biggest bang for a buck.
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Clustering of firms in urban centers (Kathmandu, Pokhara, Biratnagar, Birgunj and Terai region) due to conflict. These are also the places with relatively low transportation costs and high potential for economies of sale.
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Nepals Infrastructure and Per Capita Income

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Investment climate

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Political instability is the major constraint to doing business in Nepal. Next biggest constraint is loadshedding, followed by labor problems. Many industries , including MNCs, have closed down. Capacity utilization of firm is 54 percent. Labor productivity growth was negative in manufacturing, retail and services sectors. Number of electrical outages in a typical month averaged 52 (average duration was 6.5 hours), inflicting loss of about 27 percent of annual sales. Approximately 15.7 percent of firms owned or shared a generator, which satisfied 24.6 percent of electricity demand by firms.
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Readiness to change

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How Ready Is Nepal to Change?

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Change Readiness of Nepal

Ability to manage and mitigate the risks associated with change and capitalize on the new resulting opportunities? Not so much!
Economic (macro framework, investment climate, economic openness, labor markets, economic diversification) Governance (public administration, financial regulation, risk management, state-business relations) Social (entrepreneurship, safety nets, ICT and innovation, human capital, civil society)
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So

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Accelerating Growth and Employment Opportunities

Tackle the most binding constraint head-on
Road networks (to link markets and production sites, and to facilitate trade) Electricity (to power up machines and reduce cost of production, stimulate entrepreneurship) Irrigation, communication

Restrain extractive political institutions creating extractive economic institutions Political stability and consensus on common economic agenda (at least on whose basis the Investment Board can work freely and without fear of political backlash) Channel remittances into productive sectors and smoothen industrylabor relations End policy implementation paralysis (failure of financial sector reformunable to punish defaulters, but took loan to rescue govtbacked banks, resistance to economic reforms labor policies , economic policies)
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Accelerating Growth and Employment Opportunities

Implement the existing policies such as Industrial Policy 2010, Trade Policy 2009, NTIS 2010. Generate qualified human capital (invest in quality education and vocational training) Promote agro-processing industries Governance and regulations (financial and nonfinancial) Social protection (especially those BLP and needy ones) Target policies to encourage youths to take up entrepreneurial activities (the nation is well on its way to capitalize the youth dividend). Promote healthy clash of ideals and ideas (its always good!)
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Comments/Questions?

Thank you

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