Wednesday, March 25, 2015

Nepal’s economic outlook for FY2015 and FY2016

The economic outlook is less favorable than in FY2014 (ends 15 July 2014)  because agricultural output is crimped by a weak monsoon and the political situation is fluid. The Constituent Assembly, the second of which was elected in November 2013, failed again to write a new constitution, this time by the 22 January 2015 deadline agreed by all political parties. There is yet no unanimity among the political parties on how to proceed. Many of the outstanding issues that the earlier Constituent Assembly failed to resolve remain contentious, leaving uncertainty over the future course of politics regarding such basic matters as the number, names, and functions of proposed federal states, as well as on the overall structure of governance.

The weak monsoon and such natural disasters as floods and landslides will affect the output of paddy, maize, and millet. Industry may see better conditions in the medium term following the government’s strong commitment under the FY2015 budget to ease business regulations by introducing updated policies and legislation, though a downside risk is that the unsettled political environment will derail legislative action. Nevertheless, news from the power sector bolstered business and investor confidence. The government concluded project development agreements in the first half of FY2015 for two 900-megawatt hydroelectricity projects promoted by Indian investors.

Considering the unfavorable monsoon and the lingering political uncertainty, GDP growth is projected to slow to 4.6% in FY2015, less than the government’s revised target of 5.0%. The Ministry of Agricultural Development projects paddy output to drop by 5.1%, and maize by 6.0%. Almost half of growth will come from services, particularly robust growth in wholesale and retail trade, tourism, and transport and communications. The reform-oriented budget calls for higher capital expenditure and for total planned spending to increase to 23.7% of GDP, up by 5 percentage points. This should help to underpin growth, especially in construction, even if capital spending falls modestly short. Assuming a stable political situation, a normal monsoon, a timely budget and its effective execution, and strong remittance inflows, GDP growth is expected to rebound to 5.1% in FY2016.

Despite the expected agricultural shortfall—and an increase in civil service salaries and allowances for a second consecutive year—average inflation is expected to continue to slow to 7.7%, lower than the target set by the central bank in its 2015 monetary policy, as neighboring India experiences markedly lower inflation and the drop in international oil prices passes through as lower administered fuel prices. Food inflation is expected to ease somewhat but will remain elevated owing to the smaller domestic harvest. Inflation is projected to edge lower in FY2016 to 7.3% on a better harvest, broadly stable oil and commodity prices, and central bank’s progress in efforts to rein in excess bank liquidity.

The external position is expected to weaken in FY2015 with lower surpluses in the current account and overall balance of payments. Though export growth is expected to stay at 5.0% and import growth to slow to 10.0% on lower prices for petroleum imports, the improvement in the trade deficit will likely be offset by some slowing in remittance inflows, narrowing the current account surplus to 2.7% of GDP. A pickup in export growth, strong remittance inflows and tourism receipts, and continued low global oil prices are expected to boost the current account surplus to 3.5% of GDP in FY2016.

Adapted from Asian Development Outlook 2015, Nepal chapter.

Saturday, March 7, 2015

Realizing the demographic dividend in Nepal

This blog post is adapted from Macroeconomic Update Nepal, February 2015.


The Central Bureau of Statistics (CBS) released new estimates for population for the next twenty years based on Population Census 2011. It shows that by 2031, Nepal’s population will hit 33.6 million in 2031, comprising of 51.4% female and 48.6% male. Similarly, urban population will reach 30.2% of total population in 2031 from 17.1% of total population in 2011. The country will still have a substantial share of population (69.8%) residing in rural areas as defined in the Population Census.

Total population is projected to grow by 1.4% until 2018, 1.3% over 2019-2021, 1.2% over 2022-2023, 1.1% over 2024-2025, 1.0% over 2026-2027, 0.9% over 2028-2029, and 0.8% over 2030-2031. The urban and rural population growth rates are projected to follow similar path.

The share of population of 15-49 age cohort is projected to increase from 50.6% in 2011 to 55.5% in 2031. Furthermore, the share of population below 24 years is projected to peak at 51.5% in 2018 and then gradually decline to 41.8% in 2031. The share of youth (15-24 years as per the UN definition) is projected to peak at 21.3% of total population in 2020 and then decline gradually to 16.4% of total population in 2031. According to the definition of youth prevalent in Nepal, the youth population (16-40 years) stood at 40.3% of total population 2011. This is expected to increase to 43.3% of total population in 2011.

The declining population growth rate and dependency ratio, rising life expectancy along with declining fertility and child mortality, and gradually peaking working age population or that of the youth population indicates that the country is reaching the unique point where it could exploit this demographic change to spur economic growth, provided that effective public policy is implemented. Else, this demographic bulge will continue to be a burden to the economy, resulting in more temporary outmigration for work overseas.

The economy needs to generate enough job opportunities by investing heavily in infrastructure (energy, transport, ICT, urban development) and human capital (quality and relevant education and healthcare) to galvanize the youth into building a strong and resilient economy, which should be characterized by a meaningful structural transformation and an accelerated inclusive economic growth process. The country will also have to effectively utilize knowledge, experience, and technology of other successful counties to ensure that such a process picks up high momentum in this short window of opportunity. Then only the youth will be able to more productive and competitive during their working years.

Saturday, February 28, 2015

Major highlights of India’s budget for FY2016

Indian Finance Minister Arun Jaitley presented the budget for 2015-16 (FY2016 starts 1 April 2015 and ends 30 March 2016) today to the parliament. It is the first full budget by PM Modi’s government following the landslide election victory last year. Indian PM Narendra Modi termed it a “pro-growth budget” and a “pro-poor budget”. Essentially, the budget has a medium-term narrative with a strong focus on sustainable fiscal finance and accelerated economic growth.

Here are the major highlights of the budget:

  • GDP growth target of between 8% and 8.5%.
  • Inflation target of below 6% (as per RBI’s strategy)
  • Revenue target (includes net tax revenue to center, non-tax revenue, recoveries of loans, and other receipts) of 8.7% of GDP
  • Expenditure target of 12.6% of GDP
    • Capital expenditure target of 3.4% of GDP
  • As a share of GDP, both revenue and expenditure targets appear lower than the provisional figure for FY2014
    • Capital expenditure allocation is nevertheless increased
  • Fiscal deficit target of 3.9% of GDP
    • Fiscal deficit target of 3.0% of GDP over three years
    • Additional fiscal space will go into funding infrastructure investment
  • Primary fiscal deficit (fiscal deficit minus interest payments) target of 0.7% of GDP

  • Revenue reforms:
    • Reduce corporate tax from 30% to 25% over the next four years
    • Rationalization of various tax exemption and incentives
    • Efforts to implement GST from next year
    • No change in rate of personal income tax
    • Basic custom duty for some imported goods increased
      • Metallurgical coke from 2.5% to 5%
      • Tariff rate on iron and steel and articles of iron and steel increased from 10% to 15%
      • Tariff rate on commercial vehicle increased from 10% to 40%
  • Divestment in loss-making units as well as some strategic divestment
  • Stress on cutting subsidy leakages, not subsidies themselves. Rationalization of subsidies on cards
  • NITI Ayog and States to work for the creation of a Unified National Agriculture Market
  • Micro Units Development Refinance Agency (MUDRA) Bank to be created for refinancing all micro-finance institutions that lend to small businesses through Pradhan Mantri Mudra Yojana
  • A sharp increase in outlays for roads and railways
    • National Investment and Infrastructure Fund (NIIF) to be established
    • Tax free infrastructure bonds for rail, road and irrigation projects
    • PPP mode of infrastructure development to be revisited & revitalized
    • 5 new ultra mega power projects, each of 4,000 MW
    • NITI Ayog to have units for innovation promotion platform and self-employment and talent utilization incubation
  • Public Debt Management Agency to be set up in FY2016 by bringing both external and internal borrowings under one roof
  • Sovereign Gold Bond as an alternative to purchasing metal gold scheme to be developed
    • Gold import duty remains at 10%
  • Main priorities: agriculture, education, health, MGNREGA, rural infrastructure including roads, manufacturing through Make in India program, catalyze private investment
  • To make India the manufacturing hub of the world through Make in India and Skill India programs

Five major challenges identified in the budget:

  • Agricultural income under stress
  • Increasing investment in infrastructure
  • Decline in manufacturing
  • Resource crunch in view of higher devolution in taxes to states
  • Maintaining fiscal discipline

Below is a snapshot of the performance of Indian economy sourced from Economic Survey 2014-15, Vol.2

Tuesday, February 24, 2015

Increasing public investment is critical to support aggregate demand and economic growth

Nobel laureate Michael Spence lays out the case for higher productivity-enhancing public investment when aggregate demand is weak, as negative demand shocks continue to emerge from: (i) excessive debt used into unproductive activities, or that they have not led to much productivity gains, leading to excess debt and falling asset prices; and (ii) demand suppressed by high unemployment in Europe along with the excessive regulation of non-tradable sector in Japan, both constraining economic activities.

Structural reforms are hard to implement in the short-term. Stabilization measures are usually the medicine for short-term demand deficiency.

The solution for now: jack up productivity-enhancing public investment.


That brings us to the third factor behind the global economy's anemic performance: underinvestment, particularly by the public sector. In the US, infrastructure investment remains suboptimal, and investment in the economy's knowledge and technology base is declining, partly because the pressure to remain ahead in these areas has waned since the Cold War ended. Europe, for its part, is constrained by excessive public debt and weak fiscal positions.

In the emerging world, India and Brazil are just two examples of economies where inadequate investment has kept growth below potential (though that may be changing in India). The notable exception is China, which has maintained high (and occasionally perhaps excessive) levels of public investment throughout the post-crisis period.

Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns. Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.


And, monetary policy alone won’t be sufficient. Fiscal policy together with structural reforms are essential:


Though monetary stimulus is important to facilitate deleveraging, prevent financial-system dysfunction, and bolster investor confidence, it cannot place an economy on a sustainable growth path alone – a point that central bankers themselves have repeatedly emphasized. Structural reforms, together with increased investment, are also needed.

Given the extent to which insufficient demand is constraining growth, investment should come first. Faced with tight fiscal (and political) constraints, policymakers should abandon the flawed notion that investments with broad – and, to some extent, non-appropriable – public benefits must be financed entirely with public funds. Instead, they should establish intermediation channels for long-term financing.

At the same time, this approach means that policymakers must find ways to ensure that public investments provide returns for private investors. Fortunately, there are existing models, such as those applied to ports, roads, and rail systems, as well as the royalties system for intellectual property.


The way to do this would be: (i) G-20 nations increase public investment; and (ii) multilateral and regional development institutions mobilize private capital to fund public investment.


That is why the G-20 should work to encourage public investment within member countries, while international financial institutions, development banks, and national governments should seek to channel private capital toward public investment, with appropriate returns. With such an approach, the global economy's “new normal" could shift from its current mediocre trajectory to one of strong and sustainable growth.


A lesson for Nepal: Increase both the quantum and quality of capital spending first. It is just 3.3% of GDP right now. It need to be increased to at least 8% of GDP in the medium term and also GFCG has to be bumped up to around 30% of GDP. The other associated point is that such investment has to be productivity-enhancing.