Thursday, April 14, 2016

Nepal was the third largest remittance recipient in 2014

As a share of its GDP, Nepal was the third largest recipient of remittances in 2014 (see the latest Migration and Development brief by WB). Remittance inflows to Nepal amounted 29.2% of GDP in 2014. Tajikistan and Kyrgyz Republic received remittances amounting to 36.6% of GDP and 30.3% of GDP, respectively. In 2015, remittance inflows to Tajikistan and Kyrgyz Republic was $2.6 billion and $1.7 billion, respectively. In Nepal, it is estimated to be about $7 billion. 

The remittance inflows soared last year immediately after the earthquake and has been one of the most important income sources (sans faster government aid) of the earthquake-affected households. Increased inflows to finance daily household needs has been one of the most vital coping strategies of the affected households.

In 2015, Nepal received remittances from around 35 countries. The highest bilateral remittance inflows was from Qatar ($2.02 billion), followed by Saudi Arabia ($1.8 billion), India ($1 billion), UAE ($803 million) and the United States ($332 million). Qatar and Saudi Arabia absorbed about 124,368 and 98,246 migrants respectively in 2015. Malaysia was the most popular destination with 202,828 migrants in 2015, but the remittance inflows from Malaysia are lower than from other destination ($185 million). This probably might be due to the lower wages and less working hours plus the informal inflows. Or/and, the WB's estimation might have simply missed the realistic figures. For instance, remittances from Japan to Nepal are shown to be zero, but the money transfer agencies are doing brisk business (eg. Kyodai/IME Japan). Most of the countries waived remittance costs immediately after the earthquake, leading to a surge in inflows. 

Interestingly, India received $2.7 billion as remittances from Nepal in 2015. These bilateral remittance estimates are computed using data on migrant stocks, host country incomes and origin country incomes. Here is a cautionary note from the authors: "These are analytical estimates based on logical assumptions and derived from a global estimation of bilateral remittance flows worldwide. They are not actual officially reported data. The caveats attached to these estimates are: (a) the data on migrants in various destination countries are incomplete; (b) the incomes of migrants abroad and the costs of living are both proxied by per capita incomes in PPP terms, which is only a rough proxy; and (c) there is no way to capture remittances flowing through informal, unrecorded channels."

Here is a chart showing the migration and remittances trend after natural disasters.

Wednesday, April 13, 2016

Reality and requirements for Nepal-China accords to work

Nepal needs serious homework to benefit from accords with China, including the important one on transit

The agreements signed between Nepal and China during Prime Minister KP Oli’s state visit has in theory ended the sole dependence on India for utilizing the transit right of a landlocked country. Furthermore, theoretically it has also increased the odds of procuring petroleum fuel and other essential supplies either from or through China. It marks a remarkable symbolic departure from the exclusive foreign, trade and transit relations Nepal has had with India for decades. The impetus for this was triggered by the supplies disruption between Nepal and India, and the latter’s cold reception and subsequent reaction to the promulgation of a new constitution last year.

Practically, it bears little significance unless Nepal upgrades existing connectivity as well as constructs new commercial custom points with China, reduces cost of doing business, establishes trust among traders on both sides, and boosts productive capacity by taking decisive action on policy and implementation fronts. 

New agreements

Nepal and China released a 15-point joint statement, which was missing during PM Oli’s state visit to India, detailing the new understanding and agreements on a range of issues. The most consequential one is the Agreement on Transit Transport, whose operational details (protocol of the agreement) are yet to be worked out. The Chinese government will also “seriously consider” to provide enhanced market access to tradable goods and start work on joint feasibility study of Nepal-China Free Trade Agreement. It also includes promises to conclude a commercial deal on the supply of petroleum products. 

Frustrated by the acute shortage of essential goods and supplies for about five months, analysts and the general public were quick to extol the agreements and are hoping for uninterrupted supplies and unhindered trade. However, operationalizing such agreements is not quick and easy. It requires serous homework, especially on our side, on policy, infrastructure, financial and procedural fronts. The usual tardiness of bureaucracy and meddling politicians will potentially slowdown implementation.

Trade and investment

The open border, state of infrastructure, business and family relations, language, free movement of labor, and the currency peg form the bedrock of Nepal’s trade relations with India. These are missing in the case with China and hence implementation will be even slower and difficult.

India accounted for 65.5 percent of total export and 63.5 percent of total import in FY2015. The figures for China are 2.6 percent and 12.9 percent, respectively. Accordingly, balance of trade with India was 62.2 percent of total trade deficit and 14.2 percent with China. The currency peg, which has remained unchanged since 1993 and has generally fared well for Nepalese economy given the fragile economic and infrastructure fundamentals, has supported the large and growing trade with India. Nepal’s top exports to India are light manufacture goods such as textiles, polyster yarns, zinc sheet, jute goods and some agro-processed items like juice. 

The Nepal India trade treaty allows for duty free access of manufacturing goods to India, a major incentive for Nepalese exporters to continue production despite the relatively high cost. Similar tariff preferences are not available with China and the duty free access it allows to its market is applicable to all least developed countries (LDCs) as per its commitment during the global trade negotiations. Nepalese exporters face a relatively high transaction cost and tough competition in the Chinese market. Tanned skin, handicraft, woolen carpet and noodles are the top export items to China. Interestingly, these light manufacture goods are produced by importing intermediate goods from India itself. This dynamics is not going to change anytime soon given the industrial base and its sophistication.

Regarding imports, the most important one is petroleum product, which accounts for about 20 percent of total import and is higher than the total value of merchandise exports. India has been the sole supplier of petroleum fuel, which is the largest import item followed by vehicles and spare parts, rice and paddy, and other machinery parts used in Nepal’s industrial sector. Meanwhile, Nepal’s top imports from China are telecommunication equipment, electrical goods and chemical fertilizers. 

Looking at the existing composition of export and import, it is not hard to notice that the basic items required by households and business community are actually imported from India and given the state of infrastructure, exchange rate regime, financial and business connectivity, it is not going to change overnight. For instance, due to the long distance and rugged terrain as well as Chinese taxes, importing fuel from China is about two times expensive than importing from India. 

If we look at investment, Indian investment is concentrated in manufacturing and energy sectors, while Chinese investment is focused on energy and services sectors. Overall, Indian investment is higher than Chinese investment. Meanwhile, Indian airlines bring in the largest number of visitors to Nepal, but the share of Indian and Chinese tourists is 17.1 percent and 15.7 percent, respectively with the latter growing at the fastest rate. Indian and Chinese foreign aid commitment is about 9.2 percent and 3.5 percent, respectively, of total aid commitment.

The other most important aspect is the open labor market in India, which absorbs a majority of the seasonal migrants from poor households from upper part of far-west and mid-west and the Terai belt. The remittances from India is an important source of the household’s expenditure. This access is missing in the case of China. Proximity-wise and cost-wise, the Indian market will continue to be more attractive than the Chinese market.

Ensuring viability

How can Nepal benefit from the renewed rapprochement with China on political-economic front, but also gradually lessen the over dependence on India? Given the state of infrastructure, trade and investment pattern, and business relations, there is little to gain in the short term. Like it or not, Nepal’s dependence on India for trade, investment and third country access will not decrease any time soon. In the medium to long run, a major effort to match the infrastructure, financial and business connectivity with China could be a game changer. 

However, this is easier said than done given the bureaucratic and political tardiness in implementing major infrastructure projects. Nepal has a lot of internal homework to do in terms of large public investment in infrastructure for enhanced connectivity, energy generation, capacity development, and country-specific export target based on Nepal’s comparative advantage.

Else, the agreements with China will bear no meaning beyond symbolism and we will continue to depend on India for pretty much everything used by households and businesses. The Chinese market is open, but is not easy to access and penetrate. Nepal is in a long haul to operationalizing the agreements with China and benefit from it.

It was published in The Kathmandu Post, 11 April 2016

Friday, April 8, 2016

One year since the Great Gorkha earthquake

It is nearly a year since the catastrophic 7.8 magnitude earthquake struck Barpak, Gorkha. The massive earthquake on 25 April 2015 at 11:56 AM and subsequent aftershocks (two powerful 6.7 magnitude on 26 April and 7.3 magnitude on 12 May) caused widespread damage to lives and properties. About 9,000 were dead and 22,000 injured. Around 602,257 and 285,099 private houses were fully and partially damaged, respectively, forcing thousands of people to seek temporary shelter under tents and tarpaulin sheets. 

It was a natural disaster most were expecting, but the government and households were awfully unprepared— the government either had lax household and settlement policies, or/and did not enforce housing codes strictly; the households (mostly in urban areas) compromised safety standards to save money. Lessons were learnt or so the politicians, bureaucrats and the public said during the first few months of the disaster. Then the simple lessons inculcated only after a terrible tragedy evaporated in thin air as politicians paid lip service only, bureaucracy got mired in the usual maze infested with rent-seeking mentality, and the affected households did what they need to do to get by normal lives (by starting rebuilding houses on their own). It’s a sad story about reconstruction that did not happen even after a year into the disaster. Availability of funds was not a problem given the generous aid pledges during reconstruction conference.

First, a quick snapshot of the events thus far: A post disaster needs assessment (PDNA) was completed within two month. It estimated the cumulative damage and loss to be about $7.1 billion (33.3% of FY2015 GDP). The cumulative need for recovery (Building Back Better concept) was estimated to be $6.7 billion, of which almost half was needed for housing and settlement. The earthquake either destroyed or damaged cultural heritage, schools, health posts, houses, agricultural farms, irrigation system, financial sector infrastructure, communications, roads, hydroelectricity plants, livelihoods, and tourism infrastructure, among others. 

After the completion of PDNA, the government organized International Conference on Nepal’s Reconstruction (ICNR) on 25 June 2015 to raise funds for reconstruction. Bilateral and multilateral development partners made generous pledges to help the affected households get back on feet again. About $4 billion, which was larger than the estimated public sector needs, was pledged with a belief that the government would speed up the establishment of reconstruction authority and make it operational without delay. The initial expectation was that some form of relief would be distributed before the winter. This was to be followed by cash grant of about $2000 to rebuild destroyed houses so that some of the damaged houses could be rebuilt before the arrival of monsoon (June to September 2016). Then the expectation was that the government would plan resettlement where required and build back better the damaged infrastructure, which would help reinvigorate the economy, create employment opportunities and prepare the household better when the next disaster strikes (Nepal is in a seismically active zone). Alas, these remained unrealized expectations. More on this in a minute.

  • Total damage estimated at $7.1 billion. Total recovery needs estimated at $6.7 billion. 
  • Total reconstruction aid pledged by bilateral and multilateral donors was around $4 billion.
  • About 9,000 dead and 22,000 injured.
  • About 602,257 and 285,099 private houses were fully and partially damaged, respectively.
  • About 2,673 and 3,757 public buildings were fully and partially damaged, respectively.
  • Earthquake struck in the tenth month of FY2015. The earthquake chopped 1.5 percentage points off an estimated 4.6% growth in FY2015 in a no-earthquake scenario. GDP growth and per capita GDP estimated at 3.0% and $762 in FY2015. Services sector was hit the hardest.
  • An additional 700,000-982,000 people were pushed below the poverty line. This translates into an additional 2.5%-3.5% of the estimated population in 2015 pushed into poverty compared to the no-earthquake baseline scenario of about 21%. About 50%-70% are from rural central hills and mountains, where the vulnerability prior to the earthquake was already high.
  • An ordinance was promulgated to establish National Reconstruction Authority (NRA) and to start reconstruction activities. 
  • The FY2016 budget and monetary policy were focused on rehabilitation and reconstruction. About $910 million (3.8% of GDP) was earmarked for reconstruction related work ($740 million for the NRA and $170 million to be spent through sector ministries during the interim period, i.e. till the NRA was operational).
  • The FY2016 budget included NRs200,000 (about $2000) for each household that has lost its house due to the earthquake. To address the shortage of labor for reconstruction, skill training is planned for 50,000 people in the areas of masonry, plumbing, and electrical works.

Now, nearly a year since the earthquake, the progress is rather disappointing. Few points:
  • The political wrangle between CPN-UML and NC to appoint the CEO of NRA delayed the passage of the NRA bill. During the NC’s time in the government (coalition with CPN-UML) it had appointed a CEO. However, when the CPN-UML led the coalition government, it demanded that a new CEO be appointed. The disagreement over this persisted for about two months. Finally, after eight months the NRA bill was passed (creating too many committees and layers within it) and a new CEO was appointed. 
  • The NPC handled the work of the NRA while the political infighting was ongoing. It approved many programs, which the NRA has asked ministries to get them approved again. 
  • The NRA is struggling to get things done on time. Even the Prime Minister, who himself chairs the executive committee within NRA, has come down heavily on the NRA for its snail pace work.
  • The NRA is not getting enough human resources and coordination from the bureaucracy to start the preliminary program, especially identification of victims and distribution of cash grant for house reconstruction. Senior bureaucrats have shown strong disinclination to transfer to NRA
  • At the local level, the political parties are trying to usurp the cash distribution process by demanding representation in local committees, under whose recommendation victims are to be identified. This is for the sake of “ownership”. There are also cases of inflated number of victims (dummy victims).
  • The CEO is not taking decisive action despite having unparalleled powers as per the NRA Act. Seeking the presence of political leaders for cash distribution in far off villages is not logical. In one case, cash distribution was delayed because some political leaders were not available.
  • The earthquake affected households have been expecting the promised cash grant for housing for almost a year now. About five months of supplies disruption has not only escalated prices of housing materials, but also created severe shortage of essential supplies in the market. The raw materials used for constructing the houses are in short supply and those that are available are sold at inflated prices. In this respect, the earthquake affected households are even requesting the government to build the houses instead of grant. They are willing to contribute labor for such reconstruction. See this and this episode of BBC Sajha Sawal. 
  • The trade blockade/supplies disruption negatively affected reconstruction planning and works. Its impact will linger on till the supplies and prices normalize to previous levels.
  • There is inadequate coordination among I/NGOs for relief distribution. Affected households are complaining of similar goods (blankets and tarpaulin sheets, etc) being distributed by many I/NGOs. And distribution is centered in some places only. The NRA has to coordinate this in the strict sense.
  • Reconstruction hasn’t started. Even a consolidated planning for reconstruction is not done yet. 
  • There is a possibility that the NRA won’t be able to utilize all the funds pledged during the ICNR last year. The more delay in utilizing the funds, the higher the changes of it being restructured for use in other purposes.
The lingering impact of damages caused by the earthquake and supplies disruption will suppress potential growth and employment opportunities. 
  • GDP growth in FY2016 was initially projected on the higher side because of the expectation of speedy cash distribution and initiation of reconstruction projects. This impact of the trade blockade for about five months and the delayed reconstruction activities will depress growth prospects in FY2016 and beyond. The agricultural output forecast is also disappointing. Some households in the earthquake affected districts have not cultivated their fields due to the uncertainty over housing.
  • Inflation will also continue to be at elevated levels, primarily due to the lingering impact of the supplies disruption.
  • There is a slowdown in the rate of overseas migration because of the cooling of demand for workers in GCC (this in turn is due to the continued low oil prices). Malaysia is implementing measures to discourage foreign workers and is also levying extra taxes on income. This means a slowdown in migration rate and ultimately deceleration of remittance inflows. It will increase the number of unemployed youths in the economy and also put pressure on external sector stability. Current account surplus will decline and if imports rebounds to normal levels, then it may as well be negative.
  • Rehabilitation and reconstruction should primarily aim at increasing productivity-enhancing public capital investment. This is a key to ensuring structural transformation whereby high value-added and high-productivity sectors are more dominant than low value-added and low-productivity sectors in the medium term. Promoting agribusiness, industrial capacity, innovation and high-productivity services need to be at the center of such a reconstruction and structural transformation strategy. In addition to higher investment, this will require reforms on institutional, legal, regulatory, and capacity enhancement fronts.
Overall, the earthquake, the severe supplies disruption and the delay in starting reconstruction projects do not bode well for the economy. It a combination of misplaced politics, ineffective bureaucracy and a lost NRA (which will try to accelerate processes in the next two weeks to show that things are moving ahead despite it being slow-- a common escape argument popular in the bureaucracy!)

Thursday, March 10, 2016

The use and abuse of p-values and statistical significance

Here is the American Statistical Association's (ASA) official policy statement on p-values and statistical significance.


Increased quantification of scientific research and a proliferation of large, complex datasets in recent years have expanded the scope of applications of statistical methods. This has created new avenues for scientific progress, but it also brings concerns about conclusions drawn from research data. The validity of scientific conclusions, including their reproducibility, depends on more than the statistical methods themselves. Appropriately chosen techniques, properly conducted analyses and correct interpretation of statistical results also play a key role in ensuring that conclusions are sound and that uncertainty surrounding them is represented properly.

Underpinning many published scientific conclusions is the concept of “statistical significance,” typically assessed with an index called the p-value. While the p-value can be a useful statistical measure, it is commonly misused and misinterpreted. This has led to some scientific journals discouraging the use of p-values, and some scientists and statisticians recommending their abandonment, with some arguments essentially unchanged since p-values were first introduced.

In this context, the American Statistical Association (ASA) believes that the scientific community could benefit from a formal statement clarifying several widely agreed upon principles underlying the proper use and interpretation of the p-value. The issues touched on here affect not only research, but research funding, journal practices, career advancement, scientific education, public policy, journalism, and law. This statement does not seek to resolve all the issues relating to sound statistical practice, nor to settle foundational controversies. Rather, the statement articulates in non-technical terms a few select principles that could improve the conduct or interpretation of quantitative science, according to widespread consensus in the statistical community.

What is a p-value?

Informally a p-value is the probability under a specified statistical model that a statistical summary of the data (for example, the sample mean difference between two compared groups) would be equal to or more extreme than its observed value.

Six principles of p-value:

1. P-values can indicate how incompatible the data are with a specified statistical model.

A p-value provides one approach to summarizing the incompatibility between a particular set of data and a proposed model for the data. The most common context is a model, constructed under a set of assumptions, together with a so-called “null hypothesis.” Often the null hypothesis postulates the absence of an effect, such as no difference between two groups, or the absence of a relationship between a factor and an outcome. The smaller the p-value, the greater the statistical incompatibility of the data with the null hypothesis, if the underlying assumptions used to calculate the p-value hold. This incompatibility can be interpreted as casting doubt on or providing evidence against the null hypothesis or the underlying assumptions

2. P-values do not measure the probability that the studied hypothesis is true, or the probability that the data were produced by random chance alone.

Researchers often wish to turn a p-value into a statement about the truth of a null hypothesis, or about the probability that random chance produced the observed data. The p-value is neither. It is a statement about data in relation to a specified hypothetical explanation, and is not a statement about the explanation itself.

3. Scientific conclusions and business or policy decisions should not be based only on whether a p-value passes a specific threshold.

Practices that reduce data analysis or scientific inference to mechanical “bright-line” rules (such as “p < 0.05”) for justifying scientific claims or conclusions can lead to erroneous beliefs and poor decision-making. A conclusion does not immediately become “true” on one side of the divide and “false” on the other. Researchers should bring many contextual factors into play to derive scientific inferences, including the design of a study, the quality of the measurements, the external evidence for the phenomenon under study, and the validity of assumptions that underlie the data analysis. Pragmatic considerations often require binary, “yes-no” decisions, but this does not mean that p-values alone can ensure that a decision is correct or incorrect. The widespread use of “statistical significance” (generally interpreted as “p ≤ 0.05”) as a license for making a claim of a scientific finding (or implied truth) leads to considerable distortion of the scientific process.

4. Proper inference requires full reporting and transparency.

P-values and related analyses should not be reported selectively. Conducting multiple analyses of the data and reporting only those with certain p-values (typically those passing a significance threshold) renders the reported p-values essentially uninterpretable. Cherry-picking promising findings, also known by such terms as data dredging, significance chasing, significance questing, selective inference and “p-hacking,” leads to a spurious excess of statistically significant results in the published literature and should be vigorously avoided. One need not formally carry out multiple statistical tests for this problem to arise: Whenever a researcher chooses what to present based on statistical results, valid interpretation of those results is severely compromised if the reader is not informed of the choice and its basis. Researchers should disclose the number of hypotheses explored during the study, all data collection decisions, all statistical analyses conducted and all p-values computed. Valid scientific conclusions based on p-values and related statistics cannot be drawn without at least knowing how many and which analyses were conducted, and how those analyses (including p-values) were selected for reporting.

5. A p-value, or statistical significance, does not measure the size of an effect or the importance of a result.

Statistical significance is not equivalent to scientific, human, or economic significance. Smaller p-values do not necessarily imply the presence of larger or more important effects, and larger pvalues do not imply a lack of importance or even lack of effect. Any effect, no matter how tiny, can produce a small p-value if the sample size or measurement precision is high enough, and large effects may produce unimpressive p-values if the sample size is small or measurements are imprecise. Similarly, identical estimated effects will have different p-values if the precision of the estimates differs.

6. By itself, a p-value does not provide a good measure of evidence regarding a model or hypothesis.

Researchers should recognize that a p-value without context or other evidence provides limited information. For example, a p-value near 0.05 taken by itself offers only weak evidence against the null hypothesis. Likewise, a relatively large p-value does not imply evidence in favor of the null hypothesis; many other hypotheses may be equally or more consistent with the observed data. For these reasons, data analysis should not end with the calculation of a p-value when other approaches are appropriate and feasible.

Other approaches

In view of the prevalent misuses of and misconceptions concerning p-values, some statisticians prefer to supplement or even replace p-values with other approaches. These include methods that emphasize estimation over testing, such as confidence, credibility, or prediction intervals; Bayesian methods; alternative measures of evidence, such as likelihood ratios or Bayes Factors; and other approaches such as decision-theoretic modeling and false discovery rates. All these measures and approaches rely on further assumptions, but they may more directly address the size of an effect (and its associated uncertainty) or whether the hypothesis is correct.


Good statistical practice, as an essential component of good scientific practice, emphasizes principles of good study design and conduct, a variety of numerical and graphical summaries of data, understanding of the phenomenon under study, interpretation of results in context, complete reporting and proper logical and quantitative understanding of what data summaries mean. No single index should substitute for scientific reasoning.

Friday, February 26, 2016

Impact of trade blockade on inflation and external sector

Earlier, I briefly gave an outline of the impact of trade blockade on government expenditure and revenue in the first half of FY2016. Here is a follow up brief blog on the impact of trade blockade on inflation and external sector stability. A good mid-year FY2016 snapshot is provided by the IMF team here.

Inflation is creeping up fast: from 6.9% in mid-August 2015 to 12.1% in mid-January 2016. The last four months (when the supplies disruptions due to blockade was ongoing) had inflation higher than the corresponding months in FY2015. The deviation from Indian inflation was also higher in all the first six months of FY2016, which indicates not only the impact of the blockade (which is the primary source), but also the impact of supply-side constraints and anti-competitive practices within Nepal. Overall, food inflation (has 43.91 weight on CPI basket) was 15.2% in mid-January and non-food inflation was 9.7%. The blockade barred Nepali traders from importing goods at a relatively cheaper prices as a result of the sustained low oil prices globally. 

The impact of the earthquake, supply disruptions (which affected travel and operation of manpower agencies), and slow demand from migrant workers from employment destination overseas (particularly due to the impact of low global oil prices in oil producing countries in the Gulf and Malaysia) lowered the number of workers leaving for work overseas. 

However, workers' remittances have been increasing. At $3.1 billion by mid-year FY2016, it is higher than $2.8 billion by mid-year FY2015— a growth rate of 9.8% in dollar terms. This may slowdown in towards the end of FY2015 and in FY2016.

The decline in trade deficit (as blockade drastically lowered exports and imports) and an increase in workers’ remittance inflows boosted current account balance and balance of payments. Merchandise exports were down by about $178.5 million in the first half of FY2016 from the level in the corresponding period in FY2015. Similarly, imports went down by $1.2 billion, with oil imports plunging down by $381.6 million and non-oil imports by $790.1 million compared to the first six months of FY2015. Consequently trade deficit was down by $993 million. Current account surplus was $1.4 billion. Forex reserves are also up.

Few points:
  • Inflation may not come down anytime soon even though inflation in India is projected to be around 4.0% to 4.5% in the next fiscal year. Fuel and gas supplies have improved but they are far below the demand right now. Its lingering impact will continue to keep food and non-food prices at elevated levels. 
  • The hiring freeze by Malaysia is another major worry as it accounts for about 40% of total overseas employment. Similarly, the slowdown in Gulf countries due to low oil prices may depress the demand for Nepalese workers. Hence, remittances inflows may be affected negatively (even after factoring in the weak Nepalese currency against the USD). This may pose challenges in external sector stability, particularly current account balance and forex reserves.
  • Exchange rate of Nepalese currency vis-à-vis the US dollar may remain volatile, following the movement of Indian rupee against the dollar.
  • Depending on how event unfolds in the remaining months, GDP growth may swing anywhere between negative 1.8% to positive 0.5% in FY2016. Inflation will probably remain in the double-digits. Current account surplus will likely decrease.

Friday, February 19, 2016

Impact of trade blockade on expenditure and revenue

The fiscal situation till the mid-year of FY2016 looks pretty bad. All components under the expenditure and revenue headings are down. It can mostly be attributed to the supplies/trade blockade, which went on for about four and a half month and whose impact will linger on in the months ahead as well. This lingering effect will continue to impact growth and inflation well into the next fiscal year. The supplies blockade is going to be more damaging to the already weak economic fundamentals than is commonly perceived by politicians and some analysts. There is no fast-track recovery without fast-track measures!

To recover quickly, more than doubling of effort both on bureaucratic and trade/supplies fronts is required. It means accelerating spending by taking unconventional measures as and when required. The unconventional measures I am talking about is bypassing of some of the hurdles in project implementation and procurement clearances (more ambitious leaders would even go for quick amendment of Acts and roll out updated policies) in key infrastructure projects, mostly energy, roads, urban and irrigation sectors. The rationale is simple: two doses of extraordinary economic shocks (earthquake and blockade) have crippled the economy and hence ordinary ways of doing projects and decision-making are not going to make a dent. It will require higher level decision (Cabinet and political) plus aggressive bureaucratic work to get thing in order as soon as possible. This is not the time to wait for months to bring out policies and amendments to Acts, and then think of starting work.

This necessity is more than evident from the dismal half-year fiscal numbers. The public expenditure absorption capacity has been hopelessly eroding (see the chart below). By mid-year FY2016, actual capital spending was just 7.2% of planned capital spending for the entire FY2016. Now, this is lower than 12.6% achieved in the corresponding period in FY2015 (before the April 2015 earthquake). At this rate, it is impossible to spend Rs208.9 billion planned capital spending in FY2016 (reconstruction budget makes up almost half of it). By mid-February, actual capital spending was just 9.09% of planned capital spending.

On the revenue front, the story is the same and there was little the government could do (on expenditure side, despite the blockade no one was restricting the bureaucrats and government to prepare necessary project planning and tender documentation, which really sets the stage for faster spending in the second half of fiscal year). Revenue in all sub-headings were below the half-year target. 

Total revenue mobilization was just 34.6% of FY2016 target. It is lower than 46.9% mobilization in the corresponding period in FY2015. Tough road ahead to achieve the target but, not as tough as it would be to achieve expenditure targets (because most of the revenue is autonomous in the sense that increase in imports automatically raises revenue if the revenue officials do the job rightfully). The government has revised down the revenue target to Rs430.34 billion (against original target of Rs475 billion).

In a nutshell, the dismal half yearly fiscal numbers reflects the crippling impact of trade/supplies blockade. Without aggressive efforts in budget execution, the revised 2% growth target for FY2016 is too ambitious. Here is more on the impact of the earthquake and blockade.

Wednesday, February 17, 2016

The root of energy crisis (deficit) in Nepal

Ambition without vision
Painful and drastic reforms are needed in the NEA and NOC to realise energy goals

The economic devastation caused by the April 2015 earthquake and trade blockade for about four months have reignited discussion over production and import diversification, and economic self-sufficiency. It has become a hot topic amongst politicians, talking heads, opinion makers and the public in general. Ministers are making bold statements about self-sufficiency. Prime Minister KP Oil even promised that his government will end load-shedding within one year and connect every household to gas pipelines. 

As events unfold and experts debate on its possibility, it appears this will likely be an ambition without a vision and a good homework, mainly due to the lack of willingness to overhaul management, jurisdiction and operations of Nepal Electricity Authority (NEA) and Nepal Oil Corporation (NOC).

Binding constraint

The most binding constraint to economic growth is the inadequate supply of infrastructure, especially electricity. This is not only stymieing industrial activities, but also leading to an increase imported fuel, which is widely used by small and medium enterprises to sustain their operations even if they have to incur higher costs. Fuel import accounts for about 20% of total imports (about $1 billion annually) and is larger than the total value of merchandise exports. The cost of production using imported fuel— procured and distributed through Nepal Oil Corporation (NOC) — is expensive relative to hydroelectricity and hence the prices of goods and services in the market are also relatively higher compared to other comparable cities around the world. 

Against this backdrop, the biggest policy bang for a buck lies in accelerating electricity generation— both hydropower and alternative sources such as solar and wind— to meet demand. It will not only reduces demand for imported fuel, but also increases fiscal revenues, economic growth and new jobs. However, over the past 100 plus years very little has been achieved due to the politicization of the entire sector (Pharping hydro power started generating electricity on 22 May 1911). 

Without a complete overhaul of management, financial and operational efficiency of NEA and NOC, energy self-sufficiency would continue to remain a distant dream. Despite all the promises, politicians have shown little credible interest in overhauling these two public enterprises as it cuts across party lobbyists, unions, syndicates, employment for cronies, and periodic financial bonanza.

Inefficient institutions

The NEA and the NOC more or less solely procure and sell electricity and fuel, respectively. They are operating without competitors and dictating quantity purchased from suppliers on their own. It leaves a huge space for financial and distribution malgovernance— often with the tacit support of politicians and lobbyists.

Both the public enterprises are financially bankrupt. The NEA’s operating loss amounted to about 0.4% of GDP in FY2015. About Rs27 billion outstanding debt was written-off in FY2012 to make it financially viable and to make it worthy for investor’s consideration. However, it continues to accumulate losses as electricity prices are not adjusted to reflect cost of production or purchase. Meantime, little has been done to reduce technical losses, one of the highest in the world. Total peak time supply is barely 55% of total demand, leading to load-shedding of between 12 and 16 hours a day (contingent upon the level import from India). 

The NOC is in a more perilous state as it has no long term investment assets to bank on for revenues. The management and distribution inefficiency, and mismatch between buying and selling prices of fuel and gas have turned NOC into an infamously inefficient public enterprise. In FY2014, its losses amounted to about 0.4% of GDP as domestic fuel and gas prices were kept low despite high international prices. With low fuel prices internationally for over a year and reluctant downward adjustment of domestic fuel prices, it is in a much better shape now. Although its accumulated debt amounts to about 1.12% of GDP, it nevertheless is planning to distribute bonus earned from the revenues generated by charging high prices to consumers (with the commitment to cover past losses). 

Hollow commitment

Any political commitment or speech on reforming these two public enterprises is an additional political capital for parties, and they have not shied away from capitalizing on that. For instance, during the second Constituent Assembly election, Nepali Congress promised to generate 5,000 MW of electricity within five years and achieve economic growth of 8-10%. UML promised to complete all major hydropower projects (both storage and run-of-the-river types) within 10 years by involving the private sector and also end load-shedding in five years. Meanwhile, the UCPN-M promised to end load-shedding in three years and develop 10,000 MW, 20,000 MW and 25,000 MW in the 10, 20, and 40 years respectively. 

Lately, the government has been promising to end load-shedding within a year (mostly by importing from India) and generate 10,000 MW within ten years by declaring an energy emergency (similar one came in 2008 as well followed by a Ten Year Hydropower Development Plan in 2009). Also, the government has allowed the private sector to procure and distribute fuel, technically breaking the monopoly of NOC. 

Painful reforms

A lot of painful drastic reforms are needed to realize even a fraction of these promises. Unfortunately, the political parties are not up to the speed and have been unwilling to forgo representing the special interest groups. This has been the main reason behind the delay in cost evaluation of projects, prolonged and contentious procurement (the earlier energy minister even snatched regular management jurisdiction of NEA to her ministry’s chamber), and trading of generation licenses. The politically-affiliated unions at the NEA and affiliates in districts are further complicating the situation by demanding unjustified compensation and shares. Similarly, the NOC has been a plump earning source for unscrupulous traders and political affiliates. 

The bureaucracy is more hesitant than before to complete procurement and necessary project clearances on time. There is delay in constructing transmission lines and signing power purchase agreements, which has been put on hold on the misguided belief that the country will have surplus power during wet season from FY2018. The demand for electricity is never linear in an energy-hungry country like Nepal. Electricity acts as an alternative source of energy to fuel and is convenient as well as relatively cheap. Hence, immediately after the fuel blockade, the demand for electricity was so high that the NEA’s transformers exploded. The actual latent demand for electricity is much higher than the one estimated by the NEA.

Painful reforms are needed to reform these two public enterprise and the sectors they represent. To avoid irregularities, discretionary power of ministry and management should be minimized and a rule-based system (breaking up production, transmission and distribution aspects), inscribed in an Act, should be enacted. This means overhauling procurement processes, requirements for preliminary project assessment, inter-ministry and inter-department coordination, efficient and responsible human resources, and politics free decision-making and operations. Unfortunately, it is easier said than done.

It was published in The Kathmandu Post on 15 February 2016