Current State of Nepali Economy

Chandan Sapkota

Annapurna Post, 12 January 2014

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Presentation Outline

Economy at a glance

Macro economy

External sector

Sophistication of products

Binding constrains to growth

Investment climate

Major economic challenges for CA II

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Economy at a glance

2014-01-12

Low growth, low job opportunities, fledging industrial sector, high prices, low

savings, high imports and consumption, and remittances-fueled impact-less

investment cycles; But, bright spots are emerging…

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2.60

4.33

4.99

3.91

4.62

0

1

2

3

4

5

6

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

Pre-reformedpanchayat

Reformedpanchayat

Constitutionalmonarchy

Maoistinsurgency

Post revolution

Average annual growth rate (%)

GDP GDP per capita

•Pre-reformed panchayat (Import substitution era)

•Reformed panchayat (Structural adjustment era)

•Constitutional monarchy (Economic liberalization)

•Maoist insurgency (Reform policies in paper, WTO accession)

•Post-revolution (Sweeping changes underway, BFIs growth)

2014-01-12

•Growth below 5%, low employment

•High consumption

•High recurrent but low capital expenditure; might have exp growth>revenue growth

•Low investment, saving, and FDI

•Trade deficit unsustainable

•Inflation creeping up, food and fuel insecurity

•Remittance economy

•Manufacturing sector going downhill

•Financial sector troubles

•Poor investment climate due to load-shedding, labor problems, political instability, policy inconsistency and implementation paralysis

•Good development: Poverty and inequality down, forex reserves up, investment in infra

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Macro economy

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Per Capita GDP

•GDP growth rate declining after reaching 6.1% in 2007/08

•Expected to increase in 2011/12 , thanks to high agriculture production (particularly paddy, which contributes 21% to agri GDP, production to increase by 13.7%)

•Per capita GDP is rising; Nominal GNDI is expected to be US$931 in 2011/12

•Official unemployment rate is 2.1%. Real unemployment rate estimated to be around to 46%

•Rural population: 83% of total population

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718 706 717

3.46

2.27

0

100

200

300

400

500

600

700

800

0

1

2

3

4

5

6

7

FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012R FY2013P

No

min

al

pe

r ca

pit

a G

DP

(U

S$

)

Re

al

pe

r ca

pit

a G

DP

gro

wth

ra

te (

%)

Nominal Percapita GDP (US$) (right axis) Real per capita GDP growth

Sectoral Contribution of GDP

•Contribution of agri sector coming down (around 40% in 1992/93)

•Industrial sector , which is the most important in terms of employment and sustainable growth, is weakening

•Services sector is absorbing labor from agriculture sector (apart from those migrating abroad for work) and is the largest jobs provider. Contributes over 50% to GDP.

•Structural transformation???

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34.1 33.0 32.3 33.5 35.9 37.4 36.3 35.32

16.2 16.1 16.2 15.3 14.6

14.9 14.3 14.35

49.7 50.9 51.5 51.2 49.5 47.7 49.4 50.33

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012R FY2013P

Agriculture sector Industry sector Services sector

Unusual structural transformation

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• Graduation from LDC category to developing country status by 2022? Stuck in a low growth trap? • The decline of agriculture sector is accompanied by the increase of services sector (mostly low-value added

activities like real estate, retail and wholesale trade, transport, etc— the demand for which is directly related to the remittance-backed consumption demand of imported goods traded in these sectors, implying that employment generation and domestic value addition are pretty low.

• The intersection between decline of agriculture sector and increase of services sector (circa 1998) occurred at around US$219 per capita GDP.

Contributions to growth

•Manufacturing sector’s contribution to GDP declining. It has negative growth rate in 2007/08 and 2008/09

•Agriculture sector growth bumped up GDP growth rate. But, its decline didn’t have similar effect. Why?

•Services sector is pretty much providing base for whatever growth we have.

•Sustainable growth of over 5% is not possible without robust industrial sector (mainly manufacturing) and high value, high productivity agri and services activities. It is also the source of stable employment and income opportunities.

•Interface between agriculture and industrial sector: agro-processing or linking agri and industrial sector.

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3.8

4.5

3.6

0

1

2

3

4

5

FY2011 FY2012R FY2013P

CBS

Sectoral contributions to growth

Agriculture Industry

Services GDP growth at basic prices

7.59 7.48 7.34 6.97

6.34 6.20 6.28 6.17

-2

-1

0

1

2

3

4

5

6

7

8

9 Manufacturing sector in Nepal

Manufacturing (Share of GDP) Manufacturing (growth rate)

GDP growth rate (basic prices)

Saving, Investment and Consumption

•Domestic saving is extremely

•Consistently high investment but output??

•Foreign direct investment was about US$103.6 million in 2013.

•Consumption is very high at around 90% of GDP.

•Domestic production down; remittances up; imports up

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82

83

84

85

86

87

88

89

90

91

92

0

5

10

15

20

25

30

35

40

45

FY2009 FY2010 FY2011 FY2012R FY2013P

Co

nsu

mp

tio

n

Sa

vin

gs

an

d i

nv

est

me

nt

Share of GDP

Final consumption expenditure Gross domestic saving Gross national saving

Exports of goods and services Imports of goods and services Gross fixed capital formation

Fiscal sector (% of GDP)

•Total expenditure higher than total revenue

•Filled by foreign aid (grants and loans) and domestic borrowing

•Inflation is still high (will rise further due to the impact of high petroleum products and market distortions)

•Budget surplus in FY2013.

•Very low capital expenditure.

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15.2

3.1

0

5

10

15

20

FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013R

Total expenditure Recurrent Capital

-3.0

-2.0

-1.0

0.0

1.0

FY2010 FY2011 FY2012 FY2013R

Overall budget balance

8.8 9.8 10.5

11.9 13.4 12.9

13.8 15.3

0

5

10

15

20

FY2006 FY2008 FY2010 FY2012

Tax revenue)

External sector

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Export, Import and Trade Deficit

•Exports is declining, especially after 1996 (so is the contribution of industrial sector and manufacturing sector to GDP).

•Exports of goods and services was 26% of GDP in 1997. It was 9.75% of GDP in 2010. It is expected to be 9.78% of GDP in 2011/12.

•Imports are ever-increasing, reaching 37% of GDP in 2010. It is expected to be 32.57% of GDP In 2011/12.

•Trade deficit is ever-widening reaching around 23% of GDP.

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Export Markets

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Export and Import Destinations in 2010

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

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Major Export and Import items

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• Major export items: Textiles, iron & steel, agriculture items

• Major import items: Fuels, electrical machines, transport equipment

• Income from merchandise exports is less than the total amount of money needed to import petroleum fuel

• Most of the import items are pretty much price inelastic to demand (thanks to remittances)

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Balance of payments (% of GDP)

•Current account balance negative in FY2010 and FY2011

•Remittances is the balancing variable

•Exports underperforming

•Imports ballooning

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5.1

-32.2

-27.1

0.4 3.4

0.6 0.7

4.1 6.3

25.5

-40

-30

-20

-10

0

10

20

30

Export (fob) Import (cif) Merchandisetrade balance

Servicesbalance

Currentaccount

Capitalaccount

Financialaccount

Balance ofpayments

Oil import Remittances

FY2011 FY2012 FY2013

Remittances and Migrants

•Remittance inflows: $4.9 billion in FY2013 (25.5% of GDP)

•Total number of migrants in FY2013: 453,543 (on average, 1054 each day)

•Benefits: BoP surplus, decline in poverty and inequality, increase in purchasing power (55.8% of households)

•Costs: Laxity in real policy reform and implementation, sectoral bubbles, symptoms of Dutch Disease, inflation, consumption binge, high imports, increase in wage premium (or reservation wage) of casual labor

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0

5

10

15

20

25

30

0

50

100

150

200

250

300

350

400

450

500

FY2005 FY2006 FY2007 FY2008 FY2009 FY2010 FY2011 FY2012 FY2013

Re

mit

tan

ces

(% o

f G

DP

)

Mig

ran

ts (

tho

usa

nd

s)

Overseas migrants Remittances (% of GDP)

Remittances, Poverty and Inequality

•Poverty headcount rate at 25.2% (without a change in consumption basket , the decline was even dramatic)

•Inequality decreased (Gini index 32.94 in 2010/11 from 41.4 in 2003/04)

•What caused? •Mostly remittances (bumped up income) -- nominal per capita consumption of the poorest households increased by 165 percent while that of richest households increased by 66 percent only

•Average household income of the poorest and richest 20 percent households increased by 297 percent and 133 percent respectively.

•Government policies? Roads, Education, Healthcare???

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25.2

30.8

41.8

24.82

53.13

67.97

0

10

20

30

40

50

60

70

80

2010 2003 1995

Poverty headcount (%) in Nepal

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

WB (US$ 1.25 a day)

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Product sophistication

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Product Sophistication and Income Per Capita

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

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

• Reasons? Both endogenous and exogenous factors

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Product Space

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Sophistication of Nepal’s exports

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Sophistication of India’s exports

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Sophistication of USA’s exports

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What Determines Manufacturing Competitiveness?

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• Strong government initiatives: • power outages • labor problems • access to finance • inadequate supply of

infrastructure • policy inconsistency • policy implementation

paralysis • Manufacturing capabilities:

• R&D • innovation

• Market condition: • macroeconomic uncertainty • Market distortions

• Resources: • lack of industrial raw

materials • high cost of finance

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Binding constrains to growth

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What is Holding Back Growth? •Inadequate supply of infrastructure (road network, communications, electricity, irrigation , storage, etc).

•During conflict infrastructures were destroyed, which reduced productive capacity of our economy.

•The poor quality of existing infrastructure and a virtual absence of linkages between production and manufacturing sites in the hilly and mountainous regions has not only stymied structural transformation and impeded a shift to new productive activities, it is also leading to a skewed spatial distribution of agents (firms and labor) and assets in the economy.

•Clustering of firms in urban centers (Kathmandu, Pokhara, Biratnagar, Birgunj and Terai region) due to conflict. These are also the places with relatively low transportation costs and high potential for economies of scale.

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•Inadequate supply of infrastructure is the most binding constraint to growth at present. But, this does not mean other constraints are irrelevant. •Policy to tackle this constraint head-on will create the biggest bang for a buck.

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Nepal’s Infrastructure and Per Capita Income

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Investment climate

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

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Major economic challenges for CA II

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Economic tasks for CA II

1. Management of migration and remittances

2. Fiscal management (timely and full budget)

3. Load-shedding reduction

4. Meaningful structural transformation

5. Export competitiveness

6. Labor disputes

7. Taming high inflation

8. Good governance

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Thank You!

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