Current State of Nepali Economy

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

May 2, 2012

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 Blog: www.sapkotac.blogspot.com

Website: www.chandansapkota.wordpress.com

Blog: www.sapkotac.blogspot.com

Website: www.chandansapkota.wordpress.com

Chandan Sapkota 1

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…

2012-05-02 Chandan Sapkota 2

Economy at a glance Economy at a glance

2012-05-02

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…

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…

Chandan Sapkota 3

2.60

4.33

4.99

3.91

4.62

0

1

2

3

4

5

6

1971-1979 1980-1991 1992-1996 1997-2006 2007-2010

Pre-reformedpanchayat

Reformedpanchayat

Constitutionalmonarchy

Maoistinsurgency

Post revolution

Average annual growth rate (%)

GDP GDP per capita

•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)

•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)

2012-05-02

•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

•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

Chandan Sapkota 4

Macro economy Macro economy

2012-05-02 Chandan Sapkota 5

Economic Growth and Per Capita GDP Growth

•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

•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

2012-05-02

3.19

4.63

735

0

100

200

300

400

500

600

700

800

0

1

2

3

4

5

6

7

2005/06 2006/07 2007/08 2008/09 2009/10 2010/11R 2011/12P

No

min

al

pe

r ca

pit

a G

DP

(U

S$

)

G

DP

an

d p

er

cap

ita

GD

P g

row

th r

ate

(%

)

Real per capita GDP growth Real GDP growth Nominal per capita GDP

Chandan Sapkota 6

Sectoral Contribution to GDP

•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???

•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???

2012-05-02

37.01 34.08 33.02 32.28 33.51 35.91 37.43 35.68

16.86 16.18 16.08 16.23 15.32

14.61 14.29 14.02

46.13 49.74 50.91 51.49 51.17 49.48 48.28 50.31

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2000/01 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11R 2011/12P

Agriculture sector Industry sector Services sector

Chandan Sapkota 7

Manufacturing sector

•Manufacturing sector’s 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 didn’t 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.

•Manufacturing sector’s 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 didn’t 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.

2012-05-02

9.03

7.59 7.48 7.34 6.97

6.34 6.17 6.17

-2

0

2

4

6

8

10

2000/01 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11R 2011/12P

Manufacturing (growth rate) Agriculture and forestry (growth rate) Manufacturing (Share of GDP) GDP growth rate

Chandan Sapkota 8

Saving, Investment and Consumption

•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

•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

2012-05-02

11.66

9.98

19.2 19.62

86.5

87

87.5

88

88.5

89

89.5

90

90.5

91

91.5

92

0

5

10

15

20

25

2000/01 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11R 2011/12P

Co

nsu

mp

tio

n (

%o

f G

DP

)

Sa

vin

g a

nd

in

ve

stm

en

t (%

of

GD

P)

Gross Domestic Saving as percentage of GDP Gross Fixed Capital Formation as percentage of GDP

Final Consumption Expenditure as percentage of GDP

Chandan Sapkota 9

Revenue, Expenditure, Aid, Inflation and Budget Deficit (% of GDP)

•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.

•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.

2012-05-02

0

5

10

15

20

25

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)

Chandan Sapkota 10

External sector External sector

2012-05-02 Chandan Sapkota 11

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.

•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.

2012-05-02 Chandan Sapkota 12

Export Markets

2012-05-02 Chandan Sapkota 13

Export and Import Destinations in 2010

2012-05-02

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

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

Chandan Sapkota 14

Major Export and Import items

2012-05-02

• 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)

• 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)

Chandan Sapkota 15

BoP and Forex Reserves

•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?)

•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?)

2012-05-02

0

50

100

150

200

250

300

350

-20

-10

0

10

20

30

40

50

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

Fo

rex

re

serv

es

Bo

P

Balance of Payments (Rs billion) Forex reserves (Rs billion)

Chandan Sapkota 16

Remittances and Migrants

•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 WB’s and CBS’s 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 (MoF’s and NPC’s role??), real estate bubble, symptoms of Dutch Disease, inflation, consumption binge, high imports, increase in wages of casual labor

•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 WB’s and CBS’s 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 (MoF’s and NPC’s role??), real estate bubble, symptoms of Dutch Disease, inflation, consumption binge, high imports, increase in wages of casual labor

2012-05-02

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0

5

10

15

20

25

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

Nu

mb

er

of

mig

ran

ts (

mil

lio

n)

Re

mit

tan

ces

(% o

f G

DP

)

Remittances (% of GDP) Number of migrants (million)

Chandan Sapkota 17

Remittances, Poverty and Inequality

•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???

•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

25.2

30.8

41.8

24.82

53.13

67.97

0

10

20

30

40

50

60

70

80

2010 2003 1995

Poverty headcount (%) in Nepal

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

WB (US$ 1.25 a day)

Chandan Sapkota 18

Financial sector Financial sector

2012-05-02 Chandan Sapkota 19

Deposit, Credit, M2 and Bubbles

•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)

•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

0

5

10

15

20

25

30

0

10

20

30

40

50

60

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

M2

gro

wth

De

po

sit

an

d c

red

it (

% o

f G

DP

)

Total deposit (% of GDP) Total credit (% of GDP) Money supply growth (M2)

Chandan Sapkota 20

Product sophistication Product sophistication

2012-05-02 Chandan Sapkota 21

Product Sophistication and Income Per Capita

2012-05-02

• The sophistication of production is associated with income level of countries.

• Sophistication of Nepal’s production and exports is low.

• Reasons? Both endogenous and exogenous factors

• The sophistication of production is associated with income level of countries.

• Sophistication of Nepal’s production and exports is low.

• Reasons? Both endogenous and exogenous factors

Chandan Sapkota 22

Product Space

2012-05-02 Chandan Sapkota 23

Sophistication of Nepal’s exports

2012-05-02 Chandan Sapkota 24

Sophistication of India’s exports

2012-05-02 Chandan Sapkota 25

Sophistication of USA’s exports

2012-05-02 Chandan Sapkota 26

What Determines Manufacturing Competitiveness?

2012-05-02

• 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

• 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

Chandan Sapkota 27

Binding constrains to growth Binding constrains to growth

2012-05-02 Chandan Sapkota 28

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.

•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.

•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.

•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.

2012-05-02

•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.

•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.

Chandan Sapkota 29

Nepal’s Infrastructure and Per Capita Income

2012-05-02 Chandan Sapkota 30

Investment climate Investment climate

2012-05-02 Chandan Sapkota 31

2012-05-02

•Political instability is the major constraint to doing business in Nepal. Next biggest constraint is load-shedding, 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.

•Political instability is the major constraint to doing business in Nepal. Next biggest constraint is load-shedding, 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.

Chandan Sapkota 32

Readiness to change Readiness to change

2012-05-02 Chandan Sapkota 33

How Ready Is Nepal to Change?

2012-05-02

Chandan Sapkota 34

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)

2012-05-02 Chandan Sapkota 35

So… So…

2012-05-02 Chandan Sapkota 36

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 industry-labor relations

• End policy implementation paralysis (failure of financial sector reform–unable to punish defaulters, but took loan to rescue govt-backed banks, resistance to economic reforms– labor policies , economic policies)

2012-05-02 Chandan Sapkota 37

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 non-

financial) • 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!)

2012-05-02 Chandan Sapkota 38

Comments/Questions? Comments/Questions?

2012-05-02

Thank you Thank you

Chandan Sapkota 39