The Neocolonial Path to Power

The Neocolonial Path to Power
Himal Southsian, August 2010
By: Dipak Gyawali

Nepal’s strategy of developing its power sector based on capacity-building to meet the needs of its own commerce and industry is far from perfect, but it is a better long-term bet than Bhutan’s much-touted model.

Many Nepalis would be shocked to hear that Bhutan will face load-shedding from the coming winter. The citizens of Nepal have, after all, been told for decades that Bhutan has done a great job of developing hydroelectricity, that it has earned significant money by exporting electricity to India, and thus it has been able to achieve the highest per capita income in Southasia. Conversely, Nepal has been ridiculed for wallowing in ‘empty nationalism’ and stirring ‘needless’ controversies over the Mahakali Treaty of 1996 (for water sharing on the Mahakali River) as well as hydropower projects such as the West Seti, both of which involve export of electricity to India.

The socialist and communist leaders of Nepal, seemingly suffering from a sense of moral and intellectual inferiority, have been unable to give a fitting reply from the standpoint of their ideologies. Such a reply would need to point out that it is questionable whether a development path that requires relinquishing defence and foreign policy to a foreign power is beneficial for the country in the long term. Party intellectuals advising politicians and political parties who only see revenue inflow and ignore vital diplomatic and strategic issues are in truth unwittingly pleading to be colonised. Nepal’s chronic load-shedding problem should then come as no surprise when these ‘Brahmins behind the throne’ fail to see the political economy hidden behind the load-shedding that is imminent in Bhutan.

At first glance, Bhutan certainly appears to have achieved better hydropower development than its Himalayan neighbour. Three times smaller in landmass and with a population one-fiftieth of Nepal’s, the current generating capacity of Bhutan (at 1488 megawatts) is twice that of Nepal. The Punatsangchhu-I hydro plant, under construction with a 60 percent grant and 40 percent soft loan from India, will add another 1020 MW by 2016. Such cheap development capital means that Bhutanese consumers pay a mere INR 1.30 per unit of electricity, allowing them to cook food and heat homes with electricity. Currently, about 70 percent of the 123,000 households in Bhutan have access to electricity, and by 2013 the entire country is expected to be electrified.

In comparison to Nepal, these would be considered significant achievements. And so, one may well ask, if these are the facts, why is the Bhutanese model wrong? And, incidentally, how is it that the country is on the threshold of load-shedding? Though Bhutan has twice the electricity-generation capacity of Nepal, around 80 percent of its electricity is exported to India, leaving only about 300 MW for consumption in Bhutan. Of this, only 80 MW is for domestic use, while the rest goes to southern Bhutan to be consumed by various Indian-owned industries, such as cement factories, lured here by the availability of cheap electricity. Subsidised electricity has led to booming demand, which grew by 19 percent from 2007 to 2008, increasing a further 27 percent in 2009 and 54 percent in 2010. As a result, Bhutan will be compelled to reduce its consumption by around 25 MW via load-shedding this coming dry season, worsening as demand continues to escalate till 2016, when Punatsangchhu-I comes online.

Innovative hydrocrats
This five-year load-shedding scenario is a planning failure born of a faulty political economy. But Bhutan’s supply problems are mild, unlike Nepal’s chronic power crisis precipitated by its unstable politics. While no magic wand can make electricity shortages disappear, Bhutan has already begun to take appropriate corrective measures. Importing electricity from India remains an option, but it is an expensive one, as Thimphu will have to import power at almost twice the rate at which it exports. India, despite its close friendship with Bhutan, cannot provide cheap power to its smaller neighbour due to its own 10,000 MW electricity shortage in the grid of North India, a fact not understood by today’s Nepali politicians.

The search for demand-side management options has led to other alternatives to Bhutan’s load-shedding problem: biogas for cooking and solar panels to heat water to reduce power consumption during peak hours every day. Economic incentives are being looked at to encourage industries to develop their own captive hydropower. Another option would be to build ‘pump storage’ schemes below existing power plants, which would pump water up to reservoirs during the night for use during next day’s peak time. Bhutan has also put forth the idea of an ‘energy bank’, whereby it would store surplus power generated during the rainy season in India, dipping into this ‘account’ in the dry months. Such a system of ‘energy barter’ would be far cheaper for Bhutan than direct purchase, and Thimphu is already in negotiations on this issue with New Delhi. Nepal’s Water and Energy Commission likewise initiated a policy of energy barter in 1992, but the mirage of the Mahakali and political infighting has left such innovative thinking in limbo.

Exploring new power policies beyond the straitjacket imposed by hegemonic Indian plans, Bhutan’s hydrocrats have initiated medium-sized plants more suited to Bhutan’s economy. The 126 MW Dagachu and the 208 MW Nikhachu schemes are being developed using a public-private partnership model supported by the Kyoto Protocol’s Clean Development Mechanism, which has come about in the wake of international concerns over global climate change. Recent changes in water policy require all power exporters to give 15 percent of their energy free to the Bhutanese grid as royalty. Such changes demonstrate the evolving Bhutanese understanding that an export-oriented policy alone does not strengthen a country’s energy security. Yet while there is immense potential to develop small- and medium-sized hydropower schemes, agreements with India preclude this option on cost grounds. Consequently, rather than ending load-shedding in two years, Bhutan has been compelled to wait until 2016 to achieve this goal.

As in Nepal, vagaries of the weather possibly related to climate change have led to severe winter droughts in recent years, and Bhutan’s rivers have been drying out significantly from January to May. Since the country only has ‘run-of-the-river’ hydropower plants, without monsoon water stored in reservoirs, they do not produce more than a third of their installed capacity in the dry season. If reservoirs are built that store the monsoon flow, more power can be generated in the dry season when the capacity of run-of-river plants has drastically reduced production. But, as is also the case in Nepal, Bhutan has limited locations on which small- and medium-storage hydropower plants can be built, and the locations that do exist might not be economically viable due to rapid reservoir sedimentation. Also, large reservoirs permanently flood fertile and populated valleys, and Thimphu seems reluctant to go this route. The feasibility study of the 4000 MW Sunkhosh is now complete, but Bhutanese officials do not seem interested to push it. During a recent four-day stay in Thimphu, this writer heard a uniform refrain from many officials: We cannot be confrontationists like you Nepalis – but inundation projects are our last priority, to be done only if the pressure from India becomes too strong to resist.

Slow, small but sure
A multipurpose hydroelectric storage project is similar to a factory that produces multiple goods. If the costs incurred in the construction of the factory, including the loan and interest repayment, are included in the price of just a single item, it will yield little profit, and could even fail to sell in a competitive market. Furthermore, if other goods produced are then distributed free of cost, there is likely to be disagreement and infighting between the various consumers. Besides electricity, storage dams provide flood control, irrigation, fisheries, navigation and tourism, from which different economic actors benefit in varying degrees. As Nepal (and India) has not built any significant multipurpose project, its policymakers have no idea how these benefits can be allocated in an equitable manner, nor how the political, economic, social and environmental issues need sorting out.

Thimphu, on the other hand, seems more aware of these concerns. It has taken a position in its talks with New Delhi that at least 50 percent of the benefits of a storage dam are in areas outside the electricity sector, which must be accounted for.

For example, the regulated water released in the dry season would lead to massive agricultural expansion in the plains, and flood-control benefits would result when the summer peak flood is lopped off to be stored in the reservoirs. As Bhutan does not have any Tarai plains, it is the downstream riparian areas that will reap the non-power benefits from reservoir projects in upstream Bhutan. New Delhi hopes to capture these valuable benefits from regulated water released from storage reservoirs in the dry season and, through its river-linking plan, to transport such waters to the dry western part of the country. This would also ensure that Bangladesh does not become a ‘free rider’ beneficiary, benefiting from the regulated dry season flow coming from Bhutanese dams. While the Bhutanese model of developing its hydropower for export in return for royalties might have been profitable in earlier years, it is today creating more problems than benefits.

The export-oriented path that Bhutan has taken cannot be an option for Nepal, unless it forsakes its independent foreign and defence policies. From a political-economic perspective, the Bhutanese model is one of neocolonial resource extraction. If the much ballyhooed ‘new Nepal’ were to adopt a similar policy, it would be tantamount to its political masters admitting their incapacity to develop Nepal as a self-reliant and independent economy. Growth in hydroelectricity production cannot be the sole standard by which to measure success. After all, a plantation economy using slave labour can produce more efficiently than an independent economy crawling along the path of capacity development. A rent-seeking, royalty-earning model might enrich governments, politicians and senior bureaucrats for some time, much like the Arab sheikhdoms, but it does nothing to develop national capacity – which is what development is, in the true sense.

Even though Nepal’s demand for electricity currently far outstrips supply, the development of small and medium hydropower plants over the last three decades has led to significant ‘upstream-downstream’ sector capacity built in the economy. Despite state indifference due to the Nepali hydrocracy’s infatuation with foreign aid, the survey, design, geo-technical engineering, contracting, construction and some equipment manufacture and maintenance are now done by Nepalis in small factories and consultancy services, for projects from a few hundred kilowatts to some 20 MW. The importance of such capacity is evident from the fact that Bhutanese power managers, during visits to the Bhutanese gomba (monastery) located in the Boudha area of Kathmandu, also take the opportunity to visit nearby factories to procure services for plant maintenance in Bhutan. The biggest complaint of Bhutanese officials, on the other hand, is that their contractors, rather than working to build national capabilities in these areas, only serve as rent-seeking middlemen for Indian contractors, thus defeating the commendable government policy of ‘Bhutanisation’.

In Nepal, the hydropower sector is soon to test its political leadership, with a new electricity bill pending in Parliament. If passed as drafted, the Electricity Act would reward exporters of electricity with tax breaks but would penalise those developing hydropower for Nepali consumption. This would push Nepal inexorably towards a neocolonial political economy similar to that of Bhutan’s, and away from the slow but self-reliant development path pursued so far. Fortunately, thanks to the activism shown by members of the National Association of Community Electricity Users Nepal (NACEUN), members of Parliament from across the political spectrum have tabled 142 fundamental amendments that would re-define the Act towards a self-reliant, ‘national capacity enhancement’ model. We may not have to wait too long to see which historic path the country will take, the Bhutanese or the Nepali.

Mr. Gyawali was Nepal’s Minister for Water Resources during 2002-03.

Systemic crisis?

Systemic crisis?
Republica, 4-Mar-2010
Dr. Prakash Chandra Lohani

Dr. Lohani is the co-chairman of Rastriya Janashakti Party.

Nepal’s neighbors, both India and China, are the fastest-growing economies in the world today. Even Bihar considered as sick and feudal in the Indian Union is now growing at a breakneck speed of over 10 percent. In fact, Nepal’s neighborhood is emerging in economic terms as one of the most dynamic and vibrant in Asia. Nepal, on the other hand, remains in a state of hope as well as despair. There is the hope that this new dynamism in the region can be a powerful stimulus to Nepal’s own economic ambitions. The private sector in Nepal has sensed this opportunity. In spite of increasing lethargy and corruption in the government, new initiatives from the private sector in tourism, hydropower generation and even information technology come into focus.

On the other hand, there is also despair in view of the uncertain political situation and the inability of the political leaders to arrive at a consensus on providing a new constitutional framework for the nation. While political wrangling for power continues in a naked fashion, the ability of the government to provide even basis services continues to deteriorate. In the name of political transition, even gross violation of legal norms and values are accepted in a routine manner as if it is the best that can be expected under the circumstances. As of now, there is very little discussion on economic issues. There seems to be an unstated assumption that the permutation and combination for political power can continue indefinitely since the economy will take care of itself. In the months to come, this might prove to be a costly mistake.

The Binding Constraint

The main challenge facing the Nepali economy is political. It is reflected in the deteriorating law and order situation in the country and a pervasive feeling among the people that the government is not able to protect the life and property of the people. A recent report by a credible human rights organization mentions that in the year 2009, 41 people have been killed by the state and another 432 by non-state actors many of whom claim to be at war with the state (Annapurna Post, Feb 20). Similarly, forced extortion from the business community in the name of donation continues even though it is strictly prohibited by the peace agreement. For the business community, partisan rather than legal protection is becoming the best policy of survival. Similarly, a weak legal system and a governmental decision mechanism that thrives on rent-seeking reduce private profitability in investments and becomes the reason for the export of capital.

In this sense, the most important binding constraint to economic growth in Nepal at present is the lack of consensus among the political parties about the future institutional arrangements in the nation. This is reflected in the inability of the coalition headed by the relatively moderate United Marxist Leninist party and the opposition, the hardliner Unified Maoist party, to reach a consensus on the future shape of the constitution that is to be promulgated by May 2010.

Political uncertainty as the most important binding constraint has created fertile ground for impunity to corruption. Rent-seeking in the bureaucracy has become a rule rather than an exception discouraging private as well as foreign investments. The attitude that anything is possible if one has the “right connection and protection” makes a mockery of the concept of the rule of law.

The primacy to politics even if it means ignoring economic issues has encouraged the politicization of the bureaucracy and state enterprises. Formally, there is the Public Service Commission to assure merit and order in the bureaucracy. In practice, however, top-level bureaucrats are being pigeonholed in terms of their allegiance to different political parties. This has literally created a situation where government employees in decision-making positions are being goaded to maximize the interest of the ruling party/parties in the government irrespective of its effects on the delivery capacity of the government. When a new government is formed, which is rather frequent since the average tenure of a government is only about a year before it has to resign, the first interest of the new minister is to appoint his “own” people in top managerial positions including the board of directors of state enterprises under his ministry so as to insure that his commands and interests that often try to maximize private gain at public cost are obeyed.

Similarly, there is a virtual scramble to have the secretary in the ministry a person who is considered sympathetic to the minister or the party that he represents. In this setting, the bureaucracy faces an incentive structure that is partisan and not focused on the interest of the people. This is a problem that plagued Nepal’s politics and bureaucracy in the past even during the parliamentary era. However, after the people’s movement leading to the declaration of the republic, the problem has been assuming serious proportion. Now, there is not even a pretense to merit and impartiality. In the mad rush to have one’s “own” people appointed in top positions, including constitutional organs, there is often disagreement within the government and between the government and the opposition leading to agonizing delays and a sense of paralysis in the system.

The post of the governor of the Central Bank has been remaining vacant and yet the government is unable to make a decision because of disagreement within the ruling coalition. The same sense of indecision and paralysis plagues the appointment in different constitutional organs because the opposition and the government cannot agree on the candidates.

Politics as a binding constraint to economic development also manifests in the total insensitivity of the political parties to consider the economic implications of their decisions to the common people and the business community. Labor strikes are frequent and shutdowns of national highways and production facilities as political pressure tactics have become routine. There is hardly a day when some or all parts of the country are not under forced strikes or similar political agitation directly affecting transport and production of goods and services. Labor unions now increasingly under the influence of the Maoist party have been pressing for a “once-hired, never-fired” policy which discourages both national and foreign investments in labor-intensive manufacturing. This is reflected in the fact that contribution of the industrial sector to GDP has actually declined: It was 23.8 percent in 1999/2000 and 16 percent in 2008/2009. In this setting, for people looking for investment opportunities inside the country, real estate becomes an attractive sector.

The Crisis Ahead

While political uncertainty and lawlessness is the most important binding constraint in the growth of Nepali economy, it remains ignored by the political parties. Rising remittances to the tune of 40 percent during the last two years has helped to cover the distortions, inequities and lost opportunities. However, there are clear indications that the next few months are going to be difficult. What we may witness in the next few months is a sudden rise in systemic risk leading to an economic crisis that could be devastating.

During the last two years, the GDP of Nepal has increased by an average of 3.8 percent. However, the gross disposable income of the people (GDIP) has been increasing at 8 percent because of abnormal growth in remittances to the tune of 40 percent annually. It is this new inflow of remittance income that is responsible for rising government revenue based on imports and abnormal increase in land prices and land speculation. Banks flush with new cash, and hankering for an ever-increasing level of profit, have been eager to join the gravy train. Some of them have been reckless in their credit policies ignoring the normally prudent relationship between credit and deposit. The profit of the financial sector has remained attractive and bank managers have been the highest paid officials in the private sector with a certain measure of glamor.

However, all this may now be threatened because of three reasons. First, the growth rate of remittances has decreased from 40 percent in the fiscal year 2008/2009 to just 10 percent during the last five months of the current fiscal year. This is bound to affect the liquidity of the banking system. Second, the central bank, afraid that land speculation that has already reached a “bubble” proportion will precipitate a new financial crisis, has tightened credit to the real estate sector along with other across the board lending restrictions. This will affect the balance sheet position of real estate speculators after a certain time lag. Third, the continuing political uncertainty seems to have increased people’s preference for cash, gold and/or export of capital. Thus, during the last five months (July-Dec 2009) total bank deposits have gone up by only 4.6 percent, much lower than 8.2 percent for the same period last year.

All these three reasons combined have created an extraordinary liquidity crunch in the banking system with interest rates shooting for the sky. Naturally, the real estate sector is now going to feel the pinch. Once this happens, the balance sheet position of some banks may come under serious strain leading to a financial crisis that our power-centered politicians have blissfully ignored. If such a scenario materializes, the political cost in terms of a new social turmoil will be extremely serious. It will emerge as a systemic crisis that will be hard to contain.

BoP Deficit & Remedies

One of the better columns on Nepal's Balance of Payment (BoP) problem. Couple of comments (a) in every year going back to 1975 (that's when NRB data become available), Nepal has suffered trade deficit (b) 85% Nepal's trade deficit is in the big 4-items machinery, fuel, mfg good and chemicals&drugs. Those items ex-fuel already have very high import tariffs; so Nepal may not be able to do much to curtail them. The solution is therefore to increase exports competitiveness (c) talking about exports competitiveness, NRs depreciation must be on the agenda. NRs160/IRs100 exchange has been intact since 1992 and that absolutely does not make sense given the relative growth of India and Nepal, and more importantly, ballooning trade deficit with India - between 2002-08 Nepal's trade deficit increased by Rs. 102 billion, and of that Rs. 75 billion increase was with India.

BoP deficit & remedies
Republica
Bhim Prasad Bhurtel
b.p.bhurtel@gmail.com

Presently, Nepal is witnessing a negative Balance of Payment (BoP) after more than seven years. A BoP is an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country’s exports and imports of merchandise trade and service, financial capital and transfer payments for a specific period, usually a year, and is prepared in a single domestic currency for the country concerned. BoP deficit means the payment exceeding the receipts of any country to the external sector particularly in one year. A BoP deficit is a particularly serious issue for a supply-deficient economy like Nepal.

In the current fiscal year 2009/10, Nepal’s foreign trade deficit reached nearly 100 billion and the export-import ratio soared to 84:16. Previously, despite a huge trade deficit, the BoP situation was in favor of Nepal because of huge remittance inflow. According to Nepal Rastra Bank, in the last fiscal year, the total size of merchandise goods and service was 220 billion which was balanced by 210 billion of remittance inflow, 27 billion foreign loans and grants, 18 billion of transfer payments such as pensions and gratuity earned abroad. The BoP surplus was 41 billion during the last fiscal year.

However, in the first quarter of the current fiscal year, BoP deficit stood at 20 billion. Alternatively, it can be said that Nepal had to pay 20 billion more than its earnings from abroad. In other words, Nepal’s net foreign asset declined by 20 billion and the foreign currency reserve declined by 31 billion during the same quarter. This includes the increase in IMF quota by 6.28 billion and the 4 billion that declined due to exchange rate fluctuation. The merchandise trade deficit reached 96.21 billion, an increase of 48.9 percent, and the service sector deficit reached 5 billion.

CAUSES OF BOP DEFICIT
There are two primary reasons: Implicit and explicit. The implicit causes of BoP deficit are the decline in remittance inflow after the global financial meltdown and the recent Dubai crash, decline in export capacity and escalating import of goods, especially gold. Import records of the first quarter of the current fiscal records 12billion worth of petroleum imports, 8 billion worth of vehicles and spare parts and, surprisingly, 19.26 billion worth of gold.

The explicit causes are policy-related. The first inherent cause of BoP deficit is the perennial low economic growth despite an increase in aggregate demand and national income due to remittance inflow, as a result of which people have more disposable income to consume luxury and necessary goods. However, our economy suffers from supply deficiency as domestic products could not meet the larger section of aggregate domestic demand and supply depended heavily upon imported goods.

The second cause is the fixed exchange rate of the Indian and Nepali currencies and corresponding adjustment with the US Dollar. The trade deficit with India in the last fiscal year was 103 billion. Nepali currency was overvalued with dollar while it remained fixed with Indian currency for more than ninth months that resulted in imports becoming cheaper, which soared. On the other hand, exports became uncompetitive and fell.

Third, Nepal has a high marginal propensity to imports because we do not have comparative advantage in the production of manufactured goods due to lack of adequate infrastructure, the small economy of scale in production, lack of investment incentives, colossal energy crisis, low industrial productivity, political instability and perennial labor disputes. Therefore, increase in national income due to remittance inflow and the “cosmetic” growth in domestic product due to foreign aid and remittance are marinating the gross domestic consumption— it will eventually result in a big increase in imports.

Fourth, after joining World Trade Organization (WTO), Nepal now has to struggle to compete with developed countries due to mandatory provisions. This has caused a considerable decline in Nepal’s export, manufacturing and agriculture sector. For example, the garment and the carpet industry were seriously impacted after the enforcement of the Multi-Fiber Agreement and agro-export suffered because of Sanitary and Phyto-Sanitary Measures—this has led to a persistent deficit in the balance of trade. On top of it, we are flooded by the massive surge of foreign goods due to liberalization of international trade.

The fifth reason – recession in developed countries – also escalated Nepal’s trade deficit. Exports could not increase because Nepal’s main trading partners in North America, Europe and Japan experienced negative economic growth in 2008-9 and they imported less from abroad and obviously our exports too declined worsening the current account.
The sixth key reason for the BoP deficit in Nepal is the growing trend of studying abroad in the UK, USA, Canada, Australia and other countries. Similarly, capital flight also contributed to BoP deficit.

Last but not least, the foreign currency earning tourism sector has not fully revived due to political uncertainty and ultimately it contributed to the BoP deficit.

REMEDIES
The short-term measure should aim at immediate response measures such as controlling wayward gold import, currency devaluation and imposing extra duties on imported luxury goods to minimize total import.

Long-term remedies are more policy-based. The first is to develop the economy’s competitiveness by enhancing national production capacity to meet the aggregate domestic demand and thus overcome the problem of supply deficiency. The energy crisis should be tackled as soon as possible. Import of petroleum should be reduced through alternative energy, including promotion of bio-fuel. Second, as tourism is a key to increasing foreign reserve, its development will help to amortize the BoP deficit. Third, to tackle the ongoing gold hoarding caused by speculation, the portfolio investment opportunities should be created and the stock market should be made reliable.

Fourth, the import substitution industry such as pharmaceuticals should be promoted. Export industries should be provided heavy subsidizes to make them competitive domestically as well as dump goods abroad. Fifth, to improve and sustain remittance inflow, the quality of foreign-bound workers should be developed by implementing skill-development programs. If a skilled human resource can be sent abroad, even a small number of them can earn significant remittance. Sixth, some tariff and non-tariff protectionist measures should also be used to prevent the BoP deficits within the WTO framework for least developed countries.

Seventh, Nepali currency should be devaluated with Indian currency to correct the virtual strength of Nepali currency. Eighth, the exchange rate policy, export-import policy, industrial policy, fiscal policy and monetary policy should be used simultaneously. Ninth, the Nepal-India trade deficit being another key factor should be resolved. Nepal should take political as well as diplomatic initiatives to do so.

Lastly, to create a conducive environment for investment, the new constitution should address the overall grievances of the people within the stipulated time and end the chaotic transition phase as transition results in more panic than an economic recession. BoP will always favor Nepal only if we are able to execute these tasks effectively. Myopic policy measures won’t serve in the long term.

Woes at Tribhuvan International Airport

Snailport
Congestion at Tribhuvan International Airport
NepaliTimes, Issue #488 (05-Feb-10 to 11-Feb-10)
Dewan Rai and Suvayu Dev Pant

Long gone are the days of booking travel on weekly outbound flights.

International aircraft arrivals increased by 8.41 per cent and domestic aircraft arrivals by 19.72 per cent in the first nine months of 2009 compared to the same period in 2008. Currently, 25 international airlines operate 35 flights a day and there are eight domestic airlines and five choppers. Kingfisher and Alpine Air will soon join that fleet and three other foreign airlines hope to follow suit.

Yet there have been no major additions to infrastructure. "Our airport doesn't meet the requirements for an international airport, so it is very difficult to accommodate all the tourists," says Amar Bahadur Shakya of the Civil Aviation Authority of Nepal (CAAN).

There is one runway at Tribhuvan International Airport (TIA), no arrow bridge to connect docked planes directly to the terminal, and seven internal bays - when 23-25 are necessary - for just three wide-body and four narrow-body aircraft. Aggravating the air traffic congestion is the fact that most airlines prefer the 10am-5pm time slot, largely because Nepal's terrain makes flying at night dangerous. Inevitably, there have been flight delays.

Congestion within the airport has also increased. The number of international passengers increased by 9.63 per cent and domestic passengers by 35.15 per cent in the first 10 months of 2009, compared to the year before. Although the airport was designed for only 1000 passengers daily, the actual turnover today is close to 2000. Likewise, the departure lounge was designed for 350 but sees up to 1000 passengers daily. Congestion at the air terminal may even have contributed to the death of a Korean woman, of a heart attack, three weeks ago.

Such problems were anticipated long ago, but officials have been slow to respond. A master plan drafted in 1996 was never executed. But there is more movement now. The airport will operate 24 hours a day, in light of Visit Nepal Year 2010, and offer discounts to airlines that operate outside of the 10am-5pm slot. A Visual Flight Rules system will be installed, along with improved lighting on the central runway, to make night-flying safer. The domestic terminal will be refurbished and an area will be set aside for choppers.

There will also be changes to airport infrastructure to make room for more passengers. TIA's Managing Director Dinesh Prasad Shrestha says, "With assistance from the Asian Development Bank, TIA will be realigning the immigration and hand baggage checking areas to accommodate more passengers waiting to board. The waiting lounge will be expanded as well." It is hoped these projects will be completed within two years.

But a total overhaul of the Air Traffic Management (ATM) system may be necessary further down the line. Most airports around the world use analog technology to enable the surveillance, supervision and navigation of air traffic. However, the volume such technology can handle is nearing saturation point in Nepal, leading to a rise in the risk of accidents. "We must digitise ATM and use satellites, which have a wider, bird's eye view of air traffic, have a much higher saturation point, and could eliminate the mistakes that analog technology causes," says ATM expert Niraj Aryal.

Nepal stands to gain more from such changes than other countries because its geography and weather - which cause most domestic air crashes - make analog technology unreliable. Though ATM authorities are looking into this possibility, it will require huge investments and careful coordination with foreign governments.

Perhaps we're better off getting the basics right first.

Demise of garment industry

Demise of garment industry
Republica, 19-Jan-10
By Chandan Sapkota
schandan@gmail.com

Few people realized that 2010 began with unfavorable news for the Nepali economy. The garment industry, once the highest foreign exchange earner for Nepal, has almost disappeared. In fact, only one firm still exports readymade garments to the US, once the biggest market for this industry. The growing Indian market has been the focus of attention of the few remaining firms that are struggling to survive. The demise of the garment industry demonstrates the failure of our trade promotion and industrial policy. To avoid recurrence of similar event, it is vital that we assess the causes of the downfall of garment industry and learn lessons from our mistakes.

An article in Republica accurately reflects the importance of the garment industry: “Through the first 16 years of journey, the industry with over 1,200 active production units in 2000 occupied about 7.2 percent share of the total manufacturing sector, earned one-third of the total export income, witnessed investment climb to Rs 6 billion and directly employed 90,000 people, supporting livelihood of 450,000 persons.”

Alas, this glory is now lost. Exports to the US, which previously accounted for more than 80 percent of total garment exports, have been insignificant this year. Less than 10 firms remain in operation. Hundreds of thousands of employees have been laid off. The country has lost a reliable source of revenue. Worse, the failure of this industry has led to the collapse of the whole exports sector.

Where and how did it go horribly wrong? The answer lies in an inability to foresee the changes brought about by globalization. Policymakers and garment investors failed to notice the quite obvious signs of change in the international market. They failed to design corrective policies to restructure the outdated domestic garment industry. Instead of addressing the constraints that were making the garment industry uncompetitive, they basked on the already secured preferential agreements and wasted valuable time and resources in securing more of them.

In 1990, the WTO’s member countries signed the Agreement on Textiles and Clothing (also known as the Multi-Fiber Agreement), which eliminated quotas on the trade of textiles and clothing. This was to be implemented in four phases; commencing with 16 percent reduction in quota of 1990’s imports. Thus, it was known two decades ago that all quotas in this sector would be abolished. There was ample time to invest and restructure the Nepali garment industry. However, both investors and policymakers turned a blind eye to the necessity for the reorganization of this industry.

Traditionally, the Nepali garment industry grew not because its products were competitive and superior, but because it got preferential access to the markets in the US and the EU. The guaranteed market access for Nepali garments and the imposition of quota on exports from countries that had advanced capital and competitive production mechanism meant that even if our products were not competitive in terms of price and quality, they were still exported without any restriction on quantity.

Prior to the first phase of quota elimination in 1995, Nepal had five years to upgrade its production structure so that firms could expand their size and tap synergies to exploit economies of scale, i.e. as you produce more of the same good, the average cost would decline. This would, in principle, improve price competitiveness of Nepali garments. Unfortunately, it never happened. Meanwhile, garment investors in countries such as China, India, Vietnam, Cambodia, and Sri Lanka, with the help of their governments, were already working to ensure the competitiveness of their products and the consolidation of their production. They were already preparing for the competitive international garment market after 2005.

The first phase of quota elimination in 1995 was followed by further quota eliminations of 17 percent in 1998, 18 percent in 2002, and finally 49 percent at the end 2004. The second phase of quota elimination hit the Nepali garment industry and the overall exports very hard, leading to a collapse of total exports, which have not recovered to the level reached in 1997. Though this was a catastrophic blow to the whole export-based sector, it was not appropriately heeded by investors and government. During the 10-year transition phase of MFA, the production structure in Nepali garment industry hardly changed. Most of the firms had small-scale production units with little cost advantage in production. Some of the intermediate goods that were used to produce final output were simply imported from third countries whose garments’ exports were subjected to quota restrictions, marginally redesigned, and stamped with ‘Made in Nepal’ tag for export. This meant that producers were merely acting as distributors to earn quick profits, often by gimmickry. There was very little creativity used in enhancing productivity, efficiency, marketing and distribution. Meanwhile, the investors paid little attention to product diversification and eroding competitiveness of their products.

While other governments actively engaged in upgrading their garment industry by establishing Garment Processing Zones, Export Promotion Zones, increasing consultancy for better management, and extending capital and credit to their garment investors, the Nepali government ignored the aggressive steps taken by other countries and did pretty much nothing. It simply requested more preferential agreements. It also failed to encourage and help investors find niche markets abroad. In addition, the government was unable to ensure the security of investors and the smooth flow of goods across the Nepali border. Frequent strikes along the main highways led to an increase in transportation cost. This also increased the risk of delivery problems, leading to an escalation in the final price of garments. It further eroded the price competitiveness of Nepali garments. To make matters worse, trade unions and militant youth wings made a mockery of property rights by occupying and confiscating private property, and forced an increase in wages and allowances, irrespective of labor productivity. The lack of a regular power supply also aggravated the situation.

The downfall of the Nepali garment industry illustrates some important lessons, which could be used to avoid a similar fate befalling other export-based industries. The Nepali government should not be hankering after preferential export terms; it should be investing and ensuring that domestic firms are competitive in terms of price and quality and are constantly innovating to keep up with cut-throat competition in the international market. Meanwhile, it is imperative that the government keep investors and supply chains away from the clutches of the militant youth wings and the unions. An industrial policy and trade promotion policy designed to address these issues is a need of the hour to keep our industrial base intact.

2010: Nepal's macroeconomic outlook

2010: Nepal's macroeconomic outlook
Republica, 20-Jan-2010
By BISHWAMBHER PYAKURYAL

As a result of the ongoing economic downturn, we may not see an expansion in global economic activities. However, we should be thankful that the world economy, for now, has at least been spared from speculative damages. But in Nepal, all three villains namely recession, inflation, and depression are still going strong and hurting macroeconomic fundamentals. These three factors continue to injure Nepal’s economy. The following paragraphs attempt to justify my statement.

If recession is taken as a business cycle contraction because of reduced economic activities, this also indicates a period where there is a reduction in a country’s GDP for at least two quarters. Nepal has experienced contraction, the first symptom of recession, whereby the country has even exceeded several quarters of sustained recession. Going by the statistical information received from the Ministry of Agriculture and Co-operatives (MoAC), we can see a weak performance in the production of major cereal grains that induced a decrease in GDP. We can see, in the second quarter of FY 2009/10, there has been a decline in paddy and maize production by around 11 percent and 4 percent respectively as compared to FY 2008/09. These two products together assume 10 (paddy 7.5) percent share in GDP and about 27.5 (paddy 20.75) percent share in agricultural output. Therefore, as major crops exhibited relatively lower yield, there is not much hope to meet the growth target of 5.5 percent in the year 2009/2010. The logical estimate for growth would be around 4.2 percent. This should explain that Nepal is still under recessionary pressure and therefore has been victimized by the first villain—recession.

The second villain is inflation. Considering the trend and impact of inflation, it is found that the annual average consumer inflation increased to 13.2 percent in 2008/09 compared to an increase of 7.7 percent in 2007/08. The annual average price rise of food and beverages group was 16.7 percent. The year-on-year (y-o-y) consumer price inflation rose to 11.4 percent in mid-July 2009 from 12.1 percent in the previous year. Although less, in comparison to the level of mid-July 2009, the y-o-y inflation as measured by the consumer price index remained at 9.9 percent in mid-November, 2009. The news remains bad with regards to the price related to sugar and related products during 2008/09. During the first four months of FY 2009/10, price indices of sugar and sugar-related products increased by the highest rate of 50.6 percent compared to an increase of 37.6 percent in the same period the previous year.

Thirdly, with regards to depression, which can be defined as a situation with high unemployment rate and loss of trade, the scenario is again weird. Let us consider the labor market policies that refer to measures that target individuals or households to ensure a minimum standard of living. Labor policies have been more frequently pronounced in recent years in the expectation that it safeguards the laborers from unforeseen eventuality. The ultimate goal of the government should be to make economic growth compatible to workers’ advantages. In this regard, investment is the key element, which helps in increasing demand by creating jobs. This is what is not happening at all since no employment opportunities are being created. The labor market is still unable to address the job demands of vulnerable groups of people including youths, displaced households and freed but unemployed bonded laborers.

It is projected that the demographic transition currently underway in the region will result in population increasing by 31 percent between 2000 and 2020, compared to about 60 percent in the preceding 20 years. Given the failure in formulating policies for absorbing additional workforce, the problem of social inclusion will accelerate. At present, a number of policies are in operation, including enhancement of employment opportunities through the expansion of economic and social development activities, promotion of labor-intensive businesses for increasing access of the poor to employment opportunities, implementation of income generation and employment programs targeting the backward class and geographical regions, increasing professional efficiency and ensuring basic rights of laborers in a balanced way, and maximizing foreign employment opportunities by producing skilled human resources. Information as to how many jobs were created as a result of implementation of these policies during the plan period is, however, not yet available.

By definition, depression is also a loss of trade. From this perspective, the third enemy seems to becoming more influential in hurting Nepal’s external sector. In 2008/09, as against 13.5 percent rise in exports, imports soared by 28.2 percent in comparison to an increase of 14 percent in the previous year. It is sad that this sector has exhibited a dismal picture in the first four months of FY 2009/10. Exports declined by 23.7 percent against the upsurge of 38.1 percent in the corresponding period of the previous year. Exports to India alone fell by 19.1 percent but imports rose by 28.9 percent compared to its growth of 23.7 percent last year during the review period. An upsurge in the import of vehicles, electrical equipment, machineries, medical equipment, aircraft and communication equipment, their spare parts and tools, etc. were responsible for the rise in total imports. The continuing deterioration in external sector justifies Nepal wrestling with depression.

No doubt, there is persistent poverty (households remain in poverty over time due to their low asset base) and chronic poverty (households fall in poverty due to their inability to protect themselves from shocks), which demands both the promotional role of the state to reduce poverty by enhancing the assets base of the households and protective role that prevents vulnerable households from adverse shocks. Even though South Asia is found to have given too much emphasis on macroeconomic reforms, the study shows that liberalization efforts in this region failed in bringing about a shift of labor and other resources from low-productivity primary sector to high-productivity manufacturing sector. A modest liberalization can have significant impact on economic performance whereas piecemeal reform in many countries as a result of complex political bargaining has a greater chance of constraining the growth.

The aforementioned reasons have created a regime of uncertainty and unpredictability to guarantee acceptable level of consumption, savings and investment. Therefore, Nepal, in recent months, has considered a policy that uses higher interest rates to control the bubble created from real estate business. Similarly, as countries have experienced that substantial hikes in policy rates damage the real economy by affecting growth and employment, Nepal has to wait and see the likely impact of tight monetary policy recently announced by Nepal Rastra Bank. However, the challenge in Nepal is to understand properly if there could be any relationship between monetary policy and asset prices since the inherent contradiction in our policy could be damaging as the government has adopted expansionary fiscal policy. To conclude, the macroeconomic difficulties are certain to give birth to livelihood shocks at the household level unless the short-, medium- (Three Year Plan under preparation) and long-term policies are prepared based on professionally-acceptable economic forecasting.

Is the banking crisis (in Nepal) real?

Is the banking crisis real?
Myrepublica, 27-Dec-09
DR RAGHAB D PANT

With the publication of Current Macroeconomic Situation by the Nepal Rastra Bank recently, based on data of the first three months of the current fiscal year, there have been discussions among the public and in the media arguing that the economy has been hit by three problems at the same speed. They are: (i) the problem in the banking sector due to concentration of its loan – 60.9 percent (or Rs 263 billion, which is equivalent to 30 percent of gross domestic product) of the outstanding loan to be precise – with the security of land and buildings; (ii) decline in the growth of inflow of remittances; and (iii) deficit in the balance of payments totaling Rs 19 billion in the first three months of the current fiscal year. In the first three months of the last fiscal year, the country had experienced a surplus of 8 billion in its balance of payments.

The first problem, however, is not new: It was there and published for public information in the monthly report of the Nepal Rastra Bank. In August, 2009, for example, the total loan with the security of land and buildings was also precisely 60.9 percent of the total and almost the same in September, 2008 (Nepal Rastra Bank, Current Macroeconomic Situation, Monthly Reports, various issues). So, it was a normal affair—though the way we Nepalis used to run the banking system, it was sure to hit the tsunami soon.

Suddenly, in a few newspapers on Dec 17, there was news that the economy is in the midst of serious problems supported by the statement of the Secretary of Finance. According to the Finance Secretary, the decline in the growth rate of remittances and increase in the trade deficit due to rise in import and decline in export were the main reasons of the problem and “ if we did not attempt to reduce import soon, the exchange rate of Nepali currency vis-à-vis Indian currency need to be depreciated.” (Nagarik, Dec 17).

I am perhaps naive, but how can we reduce import when the growth in real income – popularly known as gross domestic product (GDP) at constant prices – is substantially lower than the growth in nominal income? This means that trade deficit will continue to grow as long as there is high receipts from remittances and slow growth in GDP.

In Nepal, the receipts from remittances have been the single most important factor determining the level and direction of economic activities of the country, both at the micro and macro levels. A marginal instability in this source will disturb the foundation of the economy and is expected to be more dangerous than the current political problem.

The foreign exchange reserve of the banking system has been increasing due to rising receipts from remittances and this source has helped the individual family to increase its consumption in excess of the rise in income from domestic source. The import, however, has to go up to meet the increase in national consumption at a rate higher than the growth in real income. This has led to the deterioration in the foreign trade balance of the country but, at the same time, it has been instrumental for the increase in government revenue due to rising receipts from import duties.

As far as the exchange rate is concerned, it is also an old problem. We have been writing since the past several years about the need to depreciate the exchange rate of Nepali currency vis-à-vis Indian currency due to several reasons, including (i) rising deficit in merchandise trade account and , presumably, (ii) capital flight due partly to political disturbances and due partly to difference in the productivity of capital between the two countries (For details, see Exchange Rate Management: The Emerging Problem and the Options, The Himalayan Times, June 2, 2008).

Against this background, I don’t see any new problem emerging; it is the continuation of the same old problem except that the government is not yet ready to change the exchange rate of the Nepali currency. On the contrary, they are trying to find a way to impose some restrictions on the import of goods and services from India to maintain current exchange rate. In fact, the central bank, according to newspaper reports, has already issued several directives to the commercial banks to impose restrictions on financial transaction with India. (The Kathmandu Post, Dec 18) Otherwise, it is not a new problem and the Ministry of Finance is well aware of the situation of the banking system as it has representation in the Board of Directors of the Nepal Rastra Bank too. So the main question is: What were the members of Board of Directors of the Nepal Rastra Bank doing when the country was certain to hit the iceberg?

The problem does not look so serious in the short run but overtime it may get worse. The foreign exchange reserve of the monetary authorities, for example, was sufficient for more than 10 months of import in October, 2008, but declined to reach 8.5 months of import in October, 2009, due partly to the continuous increase in import and due partly to the decline in the foreign exchange reserve in the current fiscal year. The most important factor, however, was the maintenance of unrealistic exchange rate. Again, the government is determined to maintain the same exchange rate that was in use, to the best of my knowledge, in the Panchayat period.

For the general public, myself included, the critical issue is the loan against the security of land and buildings which, as indicated earlier, is 60 percent of the total since the past several years. Now, for the commercial banks, the central bank has capped the investment limit for the realty sector at 40 percent of the total loan portfolio by 2012/13 informing the public at the same time that only two banks out of 27 banks have crossed the 40 percent exposure limit (Republica, Dec 19). It looks somewhat strange. Firstly, if only two banks have crossed the exposure limit, why such a big issue? Secondly, how did Nepal Rastra Bank calculate the loan to the so-called realty sector as the information made available to the general public shows the concentration of loan of the banking system against the security of land and buildings to 60 percent of the total. (Monthly Economic Report of the Nepal Rastra Bank, various issues) It appears that the officials of the Ministry of Finance and the central bank have unnecessarily magnified the problem, and still no new measures, except those designed to maintain the current exchange rate, have been undertaken.

The financial problems, by nature, can deteriorate at a rapid rate as the current experiences of the developed countries and that of East Asian countries in the nineties suggest. In Nepal’s case, when the situation gets worse, the concerned ministers may use the occasion for world tours in the name of looking for foreign employment for our young boys. International migration, however, cannot solve domestic problems, and a paper by the staff of the International Monetary Fund as early as 2006 shows that remittances cannot be , and never have been, used as substitute for capital flows or foreign investment. Now is the time to change the direction of the economy with priority on domestic employment and production rather than on foreign employment and remittances. The central bank should start lending a hand to job creation.

The political parties have not yet felt the need to take initiative in the area of economic management. Let us hope that they will change the direction soon. If the politicians refuse to learn from the history of the present crisis, to reuse the term once made popular by Paul Krugman, they will condemn all of us to repeat it

BOP Crisis: Dire problem, few options

BOP Crisis: Dire problem, few options
Myrepublica, 21-Dec-09
By PREM KHANAL

[NOTE: NepaliEconomy.com disagrees with the author's arguments. Please read the comment at the end of the post]

The impact of deepest slump in the global economy since World War II to Nepal´s economy was far less calamitous than many had feared.

However, emerging indicators in the domestic front have deepened fears that the aftermath of the global financial crisis will be more dangerous than many expect, as the country faces the worst-ever Balance of Payment (BOP) deficit.

Worrisome is the fact that the unexpected decline in the growth rate of remittance -- country´s economic backbone, which many believe as the time-lag effect of global crisis -- has pushed the economy on the brink, with no immediate sight of stabilization.

Not that all these cracks in the economy appeared all of a sudden. There were enough warnings, overheated consumption to be the main. When annual date was released in July, government experts, at least the central bank, could have easily sensed the looming crisis when national disposable income recorded an alarming increment of over Rs 200 billion in a year to touch Rs 1,193 billion last year.

Wasn´t it predictable that the economy was about to see a huge misbalance in foreign trade when consumption reached 92 percent of GDP last year while domestic production continued to shrink and exports remained stagnant? However, the authority concerned blissfully ignored such warnings.

Though it is too early to gauge the gravity of the BOP crisis and jump into a pessimistic conclusion, worst is that Nepal has too little things in hand to correct it.

Worsening foreign trade balance needs to be blamed first for the crisis. Country´s trade deficit -- that grew by a whopping 47.6 percent during the first quarter of the current fiscal compared to same period last year -- was one of the principal causes for the over three-fold increment in BOP deficit in a year. In theory, a country needs to boost export and curb imports to check the widening trade deficit.

Grim exports data of the country itself speaks volumes about intensity of the crisis. Nepal´s persistent problem is that any attempt to boost exports is constrained by lack of products that can compete in the foreign market. Even some past efforts to find new exportable commodities capable of competing with Chinese products in global market failed.

However, Nepal can at least make renewed efforts to breathe a new lease of life to dying traditional twin export pillars -- woolen carpets and readymade garments. The government can restart a fresh diplomatic effort to secure the US and European markets to revive these two commodities. It can think of providing a short-term subsidy for sheep farming in Nepal´s mountainous region to alter long-running dependency on expensive imported wool to make our woolen carpet competitive in the global market.

Checking imports by raising taxes or imposing additional duties can be one option to curtail consumption. But, such a step will fuel the already high inflation and will also hurt domestic demand that can ultimately add woes to long-running economic sluggishness.

Still tourism is one sector where we have a clear and undisputed advantage and it is the only sector that has the potential to correct BOP misbalance. But, current political landscape is less hospitable to promote the sector, as the political turmoil seems deepening rather than moving toward settlement.

Promoting Foreign Direct Investment (FDI) is one of the powerful and widely used instruments to make financial account, which witnessed an alarming 118 percent decline during the first quarter, surplus. However, Nepal can expect no FDI as long as the activities of militant trade union are not brought under control and labor laws are made flexible to balance the interests of both employers and employees.

Make no mistake, the BOP crisis is just a flicker for now. The divesting bang is imminent if prudent action is not taken immediately.

Banking on real estate

Banking on real estate
NepaliTimes, Issue #46 (10-Apr-09 to 16-Apr-09)

When the real estate bubble bursts, it shouldn't take banks down with it

Banks in Nepal seem to be thriving. According to Nepal Rastra Bank, Nepali commercial banks hold close to Rs 470 billion in deposits, but for banks to be profitable they have to put this deposit to work.

Given the poor business climate and soaring property prices, it is a fair guess? this cash is feeding the real estate bubble. Such a bubble driven by excess credit fueled liquidity is exactly what brought many US banks to their knees, and there is a good lesson there for us.

As property prices went up, banks in the US found increasing their real estate loan portfolio an easy way to boost earnings. They not only kept loans in their own balance sheet, but packaged them into securities which were sold to investors worldwide, further increasing the demand for mortgage loans. Borrowers were approved for loans they were not capable of paying and many jumped on the bandwagon assuming that real estate prices could only go up.

What initially started as a problem in the subprime loans or loans made to risky borrowers, has spread to prime loans as decreasing real estate prices and increasing unemployment rate are putting even credit worthy borrowers at risk. As a result, banks are now stuck with hundreds of billions of dollars in real estate loans, some of which are practically worthless, and are thus forced to book billions of dollars in losses. The massive loans are threatening the solvency of some US banks. The FDIC has seized more than 21 failing banks so far in 2009 alone.

We are inside a real estate bubble in Nepal, and this bubble could burst. Among other things, the excess cash available to drive prices higher may not be there in the future. The global economic slowdown is already impacting on the remittance flow into Nepal which will reduce the liquidity in the banking sector and the money chasing real
estate assets.

When the bubble bursts, not only will many Nepalis feel much poorer from reduced property prices, but their deposits in banks could also be at risk if banks that are overexposed to real estate lending face defaults, threatening their ability to meet obligations to depositors. The margin of error for Nepali financial institutions, and the public, is very small. Unlike most other countries, there is no established deposit insurance program in Nepal and it is questionable that Nepal Rastra Bank has the ability to manage a run on the banks.

Outstanding loans of commercial banks to the real estate sector grew at a staggering rate to Rs 17.9 billion in February from Rs 6.6 billion just a year earlier. The questions to ask the banks are: what percentage of outstanding loans is real estate related, including both direct and indirect loans where real estate asset is kept as collateral? How will the real estate price reduction affect the performance and recovery of these loans? Have the banks done a sensitivity test for the worst case scenario and are they adequately capitalised if that scenario materialises?

The government and Nepal Rastra Bank should also look into the feasibility of instituting a deposit insurance program up to a certain threshold. Such a program can be funded from the premium paid by the deposit-taking institutions and the premium should be based on the risk assessment of each participating institution.

It is not too late for Nepal, but it is time to ask tough questions to the banks and the regulator and focus on risk management so that when this real estate bubble ultimately bursts, it doesn't take the banking sector down with it.

Raju Sitaula is a banking professional based in New York.

Inflation woes

ekantipur, 12-Mar-09
BISHWAMBHER PYAKURYAL

A country where almost 48 percent of the children below age five are underweight and 75 percent of the pregnant women are anaemic largely because of inadequate dietary intake, escalating food prices are a serious policy challenge. Households that are net buyers of food are hit hard by an increase in food prices. The Household Budget Survey 2008 conducted by Nepal Rastra Bank shows the average monthly expenditure of rural households to be Rs. 11,942, out of which food accounts for 44.09 percent. Since there is a strong link between the expenses of the poor and food price fluctuations, this expenditure pattern shows that Nepal's low-income groups are facing a severe economic hardship because of food price inflation.

In the past, when the inflation rate in India was high, panchayat bureaucrats used to blame India for exporting its inflation to Nepal. The domestic policy was not very often questioned. It is, therefore, a matter of surprise why the government now keeps quiet instead of informing the people that despite India's inflation being at a historic low and food prices showing a declining trend, the country has failed to import India's lower inflation rate.

The inflation rate in India has come down to a 15-month low of 3.36 percent for the week ended mid-February, 2009. This has happened because of cheaper food items and manufacturing products due to an economic slowdown in the Indian economy. Therefore, as there was a fall in the overall wholesale price index-based inflation, there has been an overall fall in the inflation rate.

Nepal's year-on-year consumer inflation remains at 14.4 per cent. The 14 plus percent rate of inflation has remained stable since the last quarter of the fiscal year 2007/08. This price rise has been driven by a significant rise in food and beverages prices (18.3 percent) and high prices in the non-food and services group. Bandhs, infrastructural difficulties and high transportation costs are, of course, responsible. But how is it possible that Nepal's high price economy is inelastic to India's low level inflationary regime under open border informal economic practices?

There is plenty of literature available on the Indo-Nepal informal trade. A study conducted by Nepali and Indian scholars shows that informal trade from India to Nepal stands at US$ 196 million and from Nepal to India at US$ 193 million. Interestingly, this situation shows that tariffs and quantitative restrictions between the two countries are not barriers. If this was the case, it would have been inevitable for Nepal's imported goods to be made accessible at much lower prices.

The Nepalese people have been denied moderate food prices for both domestic products and Indian imports. Compensating the loss from the trade in goods has also not been possible for the last few years. Statistics released by the Central Bureau of Statistics shows the manufacturing production index declining by 1.4 percent in 2007/08 compared to a growth of 2.6 percent in the previous year. Recent evidence shows that despite some successes in creating supporting infrastructure, trade in manufactured goods is going through difficult times in most South Asian nations. In 2007/08, the merchandise trade deficit widened by 22.2 percent to Rs. 165.3 billion compared to an increase of 19.2 percent in the previous year. Nepal's alarming trade deficit with India is largely because of a decline in the export of vegetable ghee, textiles, chemicals, rosin and readymade garments.

Nepal's policy has failed to link export trade with other sectors such as agriculture, forestry and tourism. There are incomplete legal and institutional reforms. No alternative schemes have yet been brought out to address the declining trade and competitiveness of readymade garments after the expiry of the Multi-Fibre Agreement. Nepal still faces inadequate and poor infrastructure and underutilization of the existing dry ports.

The success of a trade policy is reflected in its impact on government revenues, the well-being of the people and strength in creating an investment environment. As trade has not been directed towards this end, the Three-Year Interim Plan's objective to reduce the trade deficit by 15 percent of GDP seems difficult to achieve.

South Asia's future in trade in services has recently been presented in a regional work entitled Trade in Services in South Asia: Opportunities and Risks of Liberalization. Edited by Saman Kelegama of the Institute of Policy Studies, Colombo, the publication offers an overview of the state of the service trade in the region. Economic growth advances when the service sector grows. In the 10 years from 1993-2003, South Asia's exports of commercial services increased fourfold, i.e., from US$ 7.9 billion to US$ 29 billion. Currently, the service sector provides more than 60 percent of the GDP in many countries. Its contribution to the GDP in South Asia ranges from 32.48 percent in Nepal to 58.1 percent in India.

India's share in world service exports has increased from 0.5 percent in 1995 to 2.3 percent in 2005. In Pakistan, service trade has been growing faster than merchandise trade. In Sri Lanka, key sectors of the service economy are linked to foreign competition by carefully assessing the impacts of liberalization on the economy. Bangladesh has seen a growth in the service sector for the last three decades. This sector has grown faster than the overall GDP in the past decade.

After its accession to the WTO, Nepal has liberalized the service sector rather aggressively with the participation of the private sector including the foreign sector. Given a strong institutional foundation to discourage anti-competitive practices, Nepal has potential in tourism, higher education and health services. The Maldives has visible advantages from the service sector largely from tourism. Bhutan has begun to explore the possibility of benefiting from the service sector. Tourism and electricity are their major service exports.

As trading in manufacturing goods is not performing well, and trading services especially in tourism, health, education and labour can be attractive for consumers beyond SAARC, there is a strong need to develop advanced service infrastructure to boost the region's share in the global service trade.

To ensure benefits from service trade, Nepal should learn to grasp offensive and defensive interests through multi-sectoral dialogue and debate with different stakeholders. As regulation in health, education, finance and environment is crucial, it is important to correctly understand the difference between over-regulation and effective regulation.

A large part of the service trade data is intangible. Serious home work needs to be done to analyse it to develop common interests in the region. A notable challenge South Asia faces is striking a balance between the medium-term hazards of increased unemployment and the longer-term benefits of increased competitiveness. Achieving this goal would mean formulating a viable policy on trade in services for sustainable development.

The author is a professor of economics at Tribhuvan University.

The road to 10,000 MW

ekantipur, 14-Feb-09
Peeyush Tiwari

The issue of hydropower development is once again in the spotlight. Unlike in the past, the present government seems quite serious about the development of hydropower in the country and attaining the much talked about goal of generating 10000 MW in 10 years and two digit growth figure within the next three years. Honestly, water resources is by far the only resources we can really bank upon; since other resources such as petroleum are out of the question, and the industrial resource is still a far cry. Similarly, our experience with tourism shows that we have not been able to actually leapfrog in economic development as expected.

Nepal's water resources have been by far a wasted asset. Though its potential is never undermined, we have not been able to tap into this goldmine and reap the benefits. Although water resources have seemingly unlimited uses, looking into the picture, and the overall development of the nation at stake, hydropower seems to be the only option. That is, if we are talking about being export oriented and such. The much hyped 83,000 MW potential and 43,000 MW which the experts believe to be economically viable indicates that our power market must be export-oriented. And given Nepal's geographical location, it is clear that India is our only market. The chairman of Power Trading Corporation of India (PTC), Mr. T.N. Thakur, during his visit to Nepal has clearly indicated that within the next 10 years, India is looking forward to develop 50,000 MW of hydropower, though it will need 140,000 MW of power within that time. It doesn't need a rocket scientist to understand that there should be supply when there is demand in the market. It is estimated that the cost of generating 10,000 MW of energy would cost about NRs. 200 billion. Since such a huge investment is not quite practical for a fragile economy like ours, and for the local investors, investing in hydropower is regarded as too big a gamble. This is where the issue of attracting foreign investors comes in.

In the last decade, the country has seen some landmark agreements regarding foreign investments in the hydropower sector. In 1995, the government of Nepal signed a deal with SMEC for the development of the 750 MW West Seti Hydroelectric project. This agreement was signed as a Public Private Participation (PPP), with the government of Nepal investing 15 percent (with loan from ADB). Similarly, the past year saw the agreements reached between the government of Nepal and Sutlej Jal Vidyut Nigam (SJVN) for the development of the 402 MW Arun-III hydel project, and GMR-ITD Consortium for the development of 300 MW Upper Karnali Project.

The issue of water resources management has been fiercely debated. Some people have preset notions about the dealings with India and have repeatedly raised the issue of past deals such as the Koshi, Gandaki and Mahakali Treaties where Nepal did not quite receive the benefits it was entitled to. During his visit to Nepal, the Indian State Minister for Energy and Commerce, Mr. Jairam Ramesh said in a televised interview that we must not spend our time pondering over the past; that we must look into the future and work towards it. India will try to reap as much benefit from a deal as it can. It is their duty towards their people. That's what we too must do. It's our duty to get good deals out of our agreements. In the recent agreements of Arun-III, Upper Karnali and West Seti, I think our country has got good deals with the private developers. These projects are to be implemented on the Build Own Operate Transfer (BOOT) principle, where the projects would be handed over to the Government of Nepal "in good running condition" after 30 years of operation. So, if the goal of 10,000 MW in 10 years is attained and all the power is exported, we will have at least 1000 MW for free, which is nearly double what we have been able to generate in the past 100 years.

However, to attain such goal, the challenges need to be met. Investors are a sensitive lot. The government needs to ensure that there is an investment-friendly environment so that they can feel safe to invest here. Having potential alone doesn't guarantee investors. For example, we could not find any investors for the 650 MW Burhi Gandaki. Even after calling the Expression of Interest (EOI) twice, no investors turned up. We must take an example of the Tata Motors pullout from Singur after investing billions; we cannot afford to bear such a letdown. We must work our best to convince the investors that investing in Nepal wouldn't be risky. The issues regarding displacement of locals and ecosystem are in place; but we must look for the proper management of such issues. An example can be made of the 18,200 MW (stated to be finally 22,400 MW) Three Gorges Project of China, where 1.2 million people were successfully relocated.

Lastly, after the recent political breakthrough, it's high time for the country to attain an economic breakthrough. As Mr. Jairam Ramesh had said, all this time we have been born members of the NATO (No Action Talk Only). Now we need to change that perspective. Concrete measures need to be taken to transform this decade into a decade of economic revolution, as finance minister Dr. Baburam Bhattarai hinted in his budged speech. It's imperative that we now do something so that the next generation will regard the first decade of the 21st century as the dawn of development.

Service (not) included

We still don't understand the link between good service and revenue
NepaliTimes, Issue #438 (13-Feb-09 to 19-Feb-09)
ARTHA BEED

Last week, when the Beed was taking a few friends out late one evening, it was shocking to see a city that should be gearing up to receive hoards of visitors in the next few years so customer-unfriendly. Restaurants were behaving as if they were doing us a favour by even letting us step into their eateries. A five star hotel refused to serve us even when we told them it was still half an hour till their official closing time.

The deterioration in quality of service in the hospitality sector in Nepal is of serious concern. Everyone revisiting Nepal for the first time in a decade can tell the difference between the world class service people used to get and the crass service we get now. It's not just the fault of the workers in hotels and restaurants. In the bid to share out the service charge, the establishments have created a monster that they cannot tame. In the myopia of splitting that 10 per cent, both the establishment and the workers have lost the focus on the person who actually pays them that 10 per cent.

Nepali orientation towards service is traditionally very poor. Look at our tax offices. The people who pay taxes honestly are penalised. Why would someone be willing to pay the highest tax rates when one can find a way of investing the taxes to be paid over many years and get away with paying just 10 per cent? What is the additional service one gets from the state for diligently paying taxes? Similarly, when you go to the offices of the Employee Provident Fund, you are not treated as a customer. Like the restaurant owner, the state seems to think it is doing you a favour by keeping your money. It takes ages to get your own money back, and one has to bribe the official with tea money just to withdraw one's own hard-earned savings.

The dis-service issue is everywhere. You take a cab and pay a horrendous amount that has no correlation with the price of petrol. You pay a high mobile phone tariff to use your gadget as an antiquated pager. You pay for cable television and never get to watch anything because the cable operator does not have backup power. In fact, the state electricity utility, which provides power only eight hours a day, is just a backup power supplier. You pay the highest airport tax in the region and never get a trolley to cart your luggage. You pay for food products and the weight on the packets never matches the weight of the contents. You barely question why yoghurt prices shoot from Rs 40 to Rs 68 per litre in a span of a couple of months. When you run out of mains water because there is no electricity to pump it at the allocated time, you patiently wait four days for a tank to be delivered, but it doesn't turn up.

If the Nepali economy is to grow then businesses must seek to understand the wants and needs of the customer. If businesses and the government are to start generating revenues, they need to take care of the customer who holds the purse strings. Nepal Tourism Board as well as the numerous tourism bodies and hospitality entrepreneurs could start by taking a long hard look at themselves before springing into action.

In this new republic, customer may not be king, but customer should be president.

Commentary: Nepali companies need to adopt and adapt if they want to survive

Nepali Times, Issue #437 (6-Feb-09 to 12-Feb-09
ASHUTOSH TIWARI

While teaching a weekly course on corporate governance in an evening program at a management college last year, one requirement I had for students was to visit and study two Nepali companies, and write about those companies' corporate governance practices. That is, explain how those companies were directed and controlled for stronger business results.

Most students wrote about public companies such as banks and manufacturing units, in part because information obtained from them could be verified from other sources.

The two key findings were as follows:

Family on Board: The board composition of most Nepali-owned public companies raised too many red flags. Unqualified relatives and family members of the founders were assigned seats on the company's board to such an extent that even nominally public companies were ran like family businesses under the control of a patriarch who brooked no dissent.

With the independence of the Board thus compromised, hiring was mostly about getting relatives, friends and loyal hangars-on into the company.

Often, there was no audit committee to make sure that the company's financial reporting was truthful. And the Board members themselves ran the companies on a day to day basis, telling the hand-picked management staff what to do and not do. Besides, with no one questioning their actions, such Board members found it easier to repeatedly use the company assets for personal use with little thought to what shareholders might say.

Indeed, if we examine why some Nepali financial institutions went into receivership in the last three years, the inherently faulty composition of their boards-which then led to board members' treating banks as personal piggy-banks?comes up as trigger point that eventually led to their downfall.

Management mistakes: Often, managers at most companies have to perform in such a way that they hardly have time or interest to deepen the necessarily unglamorous tasks of cleaning up their company's innards that lead to long-term stability.

As such, most companies have lofty mission statements, but no code of ethics, no employee manuals and no agreed-upon and written operating procedures. True, not having these documents helps a manager consolidate power, especially when it comes to hiring his chosen people and then fixing pay packages. In practice, however, such control comes at the cost of enervating office politics that lead to low staff morale and low productivity.

Besides, the absence of such documents reduces the management to making decisions under pressure, and on an ad-hoc basis. When employees always have to guess what the management's decisions might be, that does not help the company to establish a culture of openness, predictability and accountability.

And it's no exaggeration to say that most trade union-related problems in Nepali companies have their start in the management's inability or reluctance to establish and maintain the basic standards of corporate governance.
In all fairness though, most public companies in Nepal do know about the importance of adopting stronger corporate governance practices. But their understanding is comparable to that of a couch potato comprehending the benefits of regular exercise.

My students learnt that the internal control mechanisms at companies they studied were too set to change anytime soon, though some have recorded progress in the presence of professional management and shareholders who ask pointed questions.

Still, the best hope lay in speeding up the magnitude of change in the external context of competition (for customers, managerial talents and resources) in such a way that the companies that want to grow are soon left with only one of two choices: either adopt better corporate practices so that decision rights are clear for stronger business results or exit from the marketplace all together.

Double-digit growth and the new NPC

Double-digit growth and the new NPC
ekantipur, 28-Dec-08
By Chandra Prasad Bhattarai

Laying foundations for a double-digit growth in Nepal in the next three years is an important vision of the 2008/09 national budget prepared by the current Maoist- led coalition government. Finance Minister Dr Baburam Bhattarai, who hails from the same party, presented this budget at Parliament last September. While discussing the required pace of economic growth, the minister had coined two contrasting approaches: "the crawling of snake" and "leap-frogging." He had referred the former approach to the current sluggish growth, which he wants to be replaced by the latter. The leap- frogging approach, according to the minister, will eventually help the national production grow by at least 10 percent annually.

This ambitious goal of the Finance Minister has since then been viewed skeptically by concerned professionals and Nepal's development partners alike. This unconvinced section's concern is quite obvious when viewed in the context of Nepal's history of 2 percent average annual economic growth in the last five decades. The suspicion itself, rather than the economy, has grown rapidly in the meantime. Several questions are coming forward, the most pertinent of them being what miracle will be done in Nepal to help the country to achieve a double digit growth in three years in such a growth-unfriendly economic environment.

One does not need to be an Einstein to come to a conclusion on how Nepal's economy is performing over the recent years. The economy is unceasingly characterized by deep rooted poverty, stagnant agriculture sector, widespread unemployment and underemployment, excessive dependency on foreign assistance, corruption, and weak service delivery system. The Nepalese industry sector, except for a couple of commodities, has always remained uncompetitive in the world market. Although there is huge potential in the tourism sector, the frequent strikes, closures, conflict of interests between the employers and employees, etc. have affected this sector critically. It is quite interesting to note that while the government constantly talks about private- public partnership in Nepal's development endeavors, the private sector was never ever so frustrated in the country's history.

Institutions and government policies can create rays of hope in such an environment. It has been established that sound policy environment and institutions are crucial for promoting growth. Nepal's immediate neighbors China and India have already shown the world how well an economy can grow if the policies are good and institutions are efficient. In a planned economy the central planning agency is instrumental in formulating appropriate policies that ultimately contribute to economic growth. In its monitoring role this agency attempts also to ensure that government policies, plans and programs are launched in an integrated way.

In Nepal, the National Planning Commission (NPC) is the one with these roles. This institution is in place since the country entered the planned development process in the mid 1950s. The NPC is mandated to provide guidelines, advice and suggestions to sectoral ministries. Its roles are vital and wide-ranging: it formulates the basic development policies, prepares periodic development plans, explores internal and external resources, determines annual budget ceilings for government agencies, formulates annual sectoral development programmes, monitors the implementation of development programmes and projects, and explores innovative approaches to sustainable development.

Immediately after the formation of the coalition government, the then existing NPC Vice Chairman and members had resigned from their respective positions to clear the way for the appointment of a new commission. The government has appointed a Vice Chairman and six Members. The stakeholders in Nepal's development process feel that the government's decision to appoint a competent person like Pitambar Sharma as the Vice Chairman of NPC is highly commendable. However, it’s been widely perceived that the government grossly failed to find real talents for the positions of NPC members. The political parties in the coalition government became totally unaware of the fact that they were supposed to recommend professionals with appropriate backgrounds. The key point is that while the Finance Minister's budget speech has definitely raised the people's aspirations for a better life, no one knows how appropriate economic policies the new Vice Chairman's team will deliver for the country to achieve a double- digit growth in the next three years.

The author is a development economist and can be contacted at cbhattarai@wlink.com.np

Global Economic Crisis and Nepal

Global Economic Crisis and Nepal
Nepalnews
By Dr. Kamal Raj Dhungel

Nepal will have insignificant impact of the global crisis because its domestic economic activities are sluggish which implies that it is already in the nearest point of recession. But there will be greater impact from the present global economic crisis. Millions of youths will lose their job in the foreign countries that reduces the remittance.

Recession is an economic term that refers to the phase of business cycle in which the existing policies and activities fail and the economy heads towards crisis. Business cycle is the process in which the economic activities vary around its long term growth trends. The cycle in values shifts over time between periods of relatively rapid growth of output which is termed as the recovery and prosperity. The same cycle later turns into the period of relative stagnation and or decline in economic activities namely the phase of contraction or recession. The occurrence of these phases one after another and their repetition in the short as well as long run is the natural process of business cycle. There are a number of indicators that exhibit particular phase in business cycle but are conventionally measured using the real gross domestic product (GDP).

While dealing with recession it will be relevant to cite here an old proverb - ‘a recession is when your neighbor loses his job and depression is when you lose your own job’. As descried above, recession is the phase of contraction in the business cycle when the economic activities are dawdling. Accordingly, the period of general economic decline specifically the decline in real GDP for two or more consecutive quarters indicates recession. United States of America, Britain, European Nations and even Asian countries including Japan are almost in recession according to the popular rule of thumb of two consecutive quarters of falling GDP.

International Monetary Fund (IMF) also has set a benchmark for recession with real GDP growth rate less than 3 percent implying a world recession. Its world economic outlook published on November 6, 2008 predicts that the world GDP growth would fall 2.2 percent in 2009, based on purchasing power parity (PPP) weights from 5 percent in 2007 and 3.7 percent in 2008. The situation would be more vulnerable in the coming days as some forecasts by private firms are even gloomier, with several now predicting global GDP growth to be no more than 1.5 percent in 2009. Provided the predictions are true, the world is heading into serious trouble.

At this rate, middle income counties are likely to suffer from recession from early 2009. The fast growing economies of East Asia including China and countries of South Asia including India will be affected by the recession sooner or later. Countries of the Middle East and ASEAN will also be affected by the global economic crisis. In return, Nepal’s economy will jeopardise as a result of the dripping in the economic activities of these countries.

Advanced and middle income countries are the main source of livelihood for lower income countries like Nepal. Nepal’s economy in particular depends on agriculture and foreign employment that are significantly providing employment to the growing population. Middle East, East and South Asia, Britain, Euro-zone, Australia, USA, and Canada are the destination countries where millions of youths of Nepal are employed. In recent years, remittance alone from these countries covers over 20 percent of the GDP.

Real estate is the fast growing business sector in domestic economic front of Nepal. A huge chunk of money has been invested in this sector from the private investors by taking loan from banks. The probability of this sector of being paralysed from the present crisis is high because there is a high correlation between the real estate business and remittance. Past experiences have proved that almost all the remittances have been invested in this sector in the urban areas of the country. If our youths lose foreign employment, their income will diminish as a result of which they will lose their capacity to buy real estate in a greater scale. Consequently, this sector will be affected faster than the others.

Reduction of poverty depends on the remittance as Nepal Living Standard Survey of 2003/04 revealed that the poverty reduced from 42 percent at the beginning of Ninth Plan period (1997) to 31 percent in 2003/04. Amidst the intensive conflict persisting during the period that slowed domestic economic activities, country achieved remarkable progress in reducing poverty. This achievement was not the gift of the domestic economic progress but a result of the remittance. In this juncture, the poverty reduction strategy of the nation will be affected by the global economic crisis.

Nepal will have insignificant impact of the global crisis because its domestic economic activities are sluggish which implies that it is already in the nearest point of recession. But there will be greater impact from the present global economic crisis. Millions of youths will lose their job in the foreign countries that reduces the remittance. Youths will return home because destination countries might probably ban foreign employees to secure their own jobless people. In essence, foreign employment sector will get more vulnerable which will have huge impact on the Nepalese economy.

Dhungel is Associate Professor, Central Department of Economics, Tribhuvan University. He can be contacted at: kamal.raj.dhungel@gmail.com.