nepal binding constraings bishwambhar pyakurel

7/31/2019 Nepal Binding Constraings Bishwambhar Pyakurel

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Nepals Binding Constraintsto Growth

Bishwambher Pyakuryal

Professor of Economics

Tribhuvan University

UN/ESCAPBangkok30 September 2009

I. Introduction

Sequencing of Nepals political changes: firstdemocratic movement in early 1990; second peoplesmovement in 2006, and declaration of FederalDemocratic Republican State on Wednesday, May 28,2008.

Overemphasis of political restructuring hasovershadowed the need for economic restructuring.

ADB, DFID, and ILO-supported initiative indiagnosing growth constraints and identifyingopportunities in Nepal is just completed.


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II. Issues for assessing growth constraints

Inability to produce export products and failure tomaintain real exchange rate regime with IC

The gross foreign exchange reserves Rs. 212.6billion (US$ 3.1 billion) compared to Rs. 165.1 billionin mid-July 2007

The workers remittances rose by 42.5 per cent (Rs.142.7 billion) by contributing to 17.4% to the GDP. Itscontribution in gross foreign exchange reserves is

approximately 33 per cent. Such growth is encouraging but not sufficient to

replace Nepal's dependency on foreign loan.

II. Issues for assessing growth constraintsContd.

93742600Philippines

93909960Malaysia

105195160Sri Lanka

94390480Thailand

87276120Indonesia

90130110Bangladesh

72271180China

81205130India

100100100Nepal

UNI T LABORCOST (C)

VALUE ADDED PERWORKER (B)

LABOR COST PERWORKER (A)

COUNTRY

Cost Competitiveness Indicators

Table 1: Index of Cost Competitiveness Indicators of Nine AsianCountries, 1999

Note:A = average labor cost per worker manufacturing, B = value added per unit of labor, C =labor cost per unit of output manufacturing according to the internationally accepted definitionof the U.S. Department of Commerce.


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II. Issues for assessing growth constraintsContd.Deteriorating trade & diversion of foreign

exchange reserve

The ratio of merchandise trade deficit to GDPis 20.0% (Rs. 165.3 billion)

Trade deficit w/India is 64 per cent of the totalmerchandise trade (Rs. 105.9 billion)

Import upsurge from India is 24.7% against

just 3.5% from other countries

Increased import and purchase of IC worth70,602.53 million by selling US$

II. Issues for assessing growth constraintsContd.Increasing debt liability, and cut back in public sector

investment

The country is experiencing a diversion of resourcesfrom productive sectors and fulfilling the terms of

increasing debt liability The budgetary allocation shows a cut back on public

sector investment and inadequate infrastructuredevelopment to attract potential investors

The low infrastructure expenditure can be said as thesingle most important macro constraint on Nepal'seconomy.


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III. Reason for identifying growth constraints

Nepal government has adopted expansionaryfiscal policy in the budget 2009/10.

First, there is a need to reconcile betweeninflationary economic forces and expansionaryfiscal policy. Secondly, this situation necessitatesdiagnosing growth constraints and possibilities forincreasing future investments.

IV. Selected Growth Constraints

It is advisable to find out the likelyconstraints for growth before makinginvestment decisions.

If Nepals infrastructure is a constraint togrowth, then we need to find out whatinfrastructure e.g. power, transportation,telecommunications etc. are relativelyimportant constraints to growth?


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IV. Selected Growth Constraints.Contd

(a) Low investment rate

In 1995, Nepals investment rate (25.2%) wasvery close to India (26.2%). Bangladesh(19.1%), Pakistan (18.5%) and Sri Lanka(24.2%) were lagging behind Nepal. But, since2007, only Pakistan is lagging behind Nepal.

IV. Selected Growth Constraints.ContdFig1: Investment Rate of Nepal from 1975-2006 (% of GDP)

0

5

10

15

20

25

30

InvestmentRate(%ofGDP)Source: Economic Surveys, MOF


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(b) Low domestic savings rate

Domestic Saving Rate is lowest in South Asia and it isalmost one third of Bhutan. The highest Gross DomesticSaving was in 2000 (15.17 percent of GDP).

It is interesting to note that GNI per capita increased bymore than fifty percent from the year 1995 to 2006 (WDI,2008) but Gross Domestic Saving decreased from 14.8percent in 1995 to 9.4 percent in 2006 indicating the fact

that low domestic saving rate is one of the majorconstraints for growth.

IV. Selected Growth Constraints.ContdFig 2: Gross Domestic Saving 1975-2006 (% of GDP)

GDP: Gross Domestic ProductSource: Economic Survey (various issues), MOF

0

2

4

6

8

10

12

14

16

GrossDomesticSaving(%ofGDP)


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Although there is deficit trade balance, currentaccount surplus is maintained cause of largeamount of workers remittance, which increased by23.9 percent annually from 1991-2006.

From the year 2000-2006, remittance was 75percent of trade balance and 89 percent ofsaving-investment gap. For two consecutive yearsfrom 2000, remittance exceeded the saving-

investment gap. It indicates that saving is not a problem for

Nepalese economy. But decline in remittanceinflow may seriously affect the economy.

(c) Investment Constraints

(i) Labor and Technology Nepals total factor productivity growth rate is about fifty

percent of India, which has contributed negatively.Table 2: Total Factor Productivity- Nepal Vs India

2.082 .080 .911 .111 9 8 0 -2 0 0 0

2.902.900.640.141995-1999

2.022.010.142.271990-1994

2.642.631.471.241985-1989

0.570.581.340.571980-1984

I n d i a

G r o w t hRateAd jus ted

Grow th RateNepa l

G rowth RateAd jus ted

G rowth RatePer iod

Source: APONote: Growth rate adjusted for business fluctuations


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(c) Investment Constraints.contd

Nepalese manufacturing sector is dependent on India for skilled labor. ILOstudy reports that manufacturing sector hires about 15 percent of total skilledlabor force from India.

Similarly, Nepal's position in the Labor related regulation is also poor incomparison to other south Asian countries.

Table 3: Comparison of Labor-Related Regulations with RegionalCountries

Difficulty of

HiringIndex

Rigidity of

hoursIndex

Difficulty of

firingIndex

Rigidityof

Employment

Index

Nonwage

LaborCost(%

ofsalalry)

Firingcosts

(weeksof

wages)

Afghanistan 0 40 30 23 0 0

Bangladesh 44 20 40 35 0 104

Bhutan 0 0 20 7 1 10

India 0 20 70 30 17 56

Maldives 0 0 0 0 0 9

Nepal 67 20 70 52 10 90

Pakistan 78 20 30 43 11 90

SriLanka 0 20 60 27 15 169

Investment Constraintscontd.

ii. Infrastructure

Infrastructure in Nepal is one of the poorestand Road density is smallest in the region.

Road density is least in Midwestern region.

Population to road ratio is highest in WesternDevelopment Region. In other words, in thisregion more people use fewer roads.

Distribution of road network is highly unequal.More than fifty per cent of the total roadnetwork is concentrated in Terai. See Table 4and Fig. 3 below:


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Table 4: Road Network in Three Geographic Regions

2 4 . 9 9 7 81318 .4928 5 0 4Tarai

1 2 . 3 8 7 1 91350 .6087 5 9 0Hi l l

1 . 4 3 1 9 6 22274 .7437 4 2Mounta in

Road Dens i ty( K m ./ 1 0 0sq .Km)

Popu la t ionI n f l u e n ce dPer Km. of Road(Nos. )

To ta l Leng tho f Roads( K m )Region

Source: Calculated from DoR, 2006


Fig 3: Road Network in Three Geographic Regions

Source: Calculated from DoR, 2006


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Investment Constraintscontd.Figure 4: Density of the total road network (Km.roads /

square Km. land area)-2003*

Source: IRF World Road Statistics*Data for India and Afghanistan corresponds to 2002 and 2004respectively


Nepal study shows that if transportation time isreduced by fifty per cent, then it may result inhigher income through the increased fertilizeruse and yield (MoICS, 2004).

Other important constraint is electricity tariff,which is one of the highest in South Asia.


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Figure 5: Electricity Tariff ($/KWh, 2000)

Source: MOICS, 2004

0.093

0.043

0.079

0.065

0.041

Nepal

India

Sri Lanka

Pakistan

Bangladesh


The overall infrastructure situation for attractinginvestment is very dismal. Expensive and irregularelectricity, small and low quality road network,expensive and deficient transportation are some of theexamples.

Infrastructure quality score shown in the Figure 6reveals that Nepal, in fact, has the poorestinfrastructure in comparison to other South Asianneighboring countries. Highest possible score is sevenout of which Nepal secures only 1.9. Nepal's positionwith this score is 119 out of 125 countries in the world.


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http://siteresources.worldbank.org/INTEXPCOMNET/Resources/2.01_Overall_Infrastructure_Quality.pdf

Both quality and expenditure for infrastructure is very low. Nepal spends < 1%of total GDP on infrastructure against 4.8 percent of India.

Study shows that Nepal needs to invest US$ 3.44 billion (12.22 percent ofGDP) for the period of 2008-2012 in order to achieve eight per cent growthrate.

Fig 6: Infrastructure Quality Score of South Asian Countries

3

3.4

1.9

3.3

2.3

Srilanka

Pakistan

Nepal

India

Bangladesh

InfrastructureQualityScore


In terms of telecommunications, Nepal has lowestnumber of telephone subscriber per 100 people inSouth Asia. Fixed line and mobile phone subscribers(per 100 people) in 2006 remained at 5.9244 forNepal. It was 18.6356 in India; 36.6930 in Sri Lanka;24.9911 in Pakistan and 12.9911 in Bangladesh.

Although Nepal ranks lowest in the region in terms ofsubscriber per 100 people, study shows telephonedoesnt seem to be a constraint to investment andgrowth.


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iii. Political Stability and Governance

Governance indicator, as published by World Bank is deteriorating.It may be due to frequent change in government during last one andhalf decade.

Table 6: Governance Indicators for Nepal, Percentile Rank (0-100)Governance

Indicators

1996 1998 2000 2002 2003 2004 2005 2006 2007 Region

Avg.

Voice and

Accountability

46.4 42.3 43.3 24.5 25.5 18.3 13.9 15.4 22.6 28

Political

Stability

26.9 23.6 14.4 6.7 5.3 2.9 1 .4 2.9 2.9 19.3

Government

Effectiveness

36 36 40.8 37 34.1 22.3 15.2 21.8 21.8 36.5

Regulatory

Quality

22.9 31.7 28.3 31.7 33.2 31.2 25.9 26.3 26.7 31.9

Rule of Law 51.4 52.9 44.8 42.4 37.1 32.4 23.8 33.3 31 38.3


Source: Various News PapersNote: This chart doesn't include Bandh called for indefinite period.District: One districtRegion: Two or more districtCity: City or part of highway in one district e.g. Bhairahawa-Sunauli highway

Similarly frequent bandh is deteriorating smooth functioning of business sector.

Figure 7: Number of Days of Bandh (Excluding Indefinite Bandh)

April,2007

May

June

July

August

September

October

November

December

January,

2008

February

March

April

May

June

Total

8

1

4 5 3

21

2

9

2 35

3

24

9

4

7

35

13

2 2

36

1 1 24

City Distr ic t Re gion Countr y


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Source: Various News Papers

Fig 8: Share of Bandh for City to Country (Excluding Indefinite

City

25%

District

28%

Region

42%

Country

5%

(V) Conclusion & Recommendations Overall macroeconomic positions look OK. The challenge

is to sustain growth against the existing constraints ofpoor infrastructure, underperformance of agriculture,inadequate skills and technology and unsatisfactorycorporate and political governance.

Major task is to ensure equity to make growth inclusive. The Heritage Foundation's Index of Economic Freedomuses relatively objective scoring system to rate countrieson a 1-to-5 (good-to-poor) scale, under a series ofheadings.

Nepal rates poorly on investment-related indicators:capital flows and foreign investment (4, high barriers),property rights (4, low-level of protection), and regulation(4, bureaucratic delays, inefficiency, and pervasivecorruption), contributing to an overall score of 3.5.


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(V) Conclusion & Recommendations.contd

Review shows, investors demand the revision ofthe rigid Labor Act, 1992 to avoid labor marketrigidity. Other equally important acts such asBankruptcy and Mergers Act should be enactedwithout further delay to reduce investor's risk.

It is important for the government and privatesector to find out the reasons why increased

FDI has not been very significant in the growthof Nepalese GDP in absolute as well as in therelative sense (http://ideas.repec.org).


The value of Nepals new Human Empowerment Index(HEI) is 0.463 (including social, economic and politicalindicators into a composite index of empowerment). Theeconomic empowerment is lowest at 0.337, whichreflects the low level of income, limited access toproductive assets and lack of gainful employmentopportunities (Nepal HDR, 2004).

Gross domestic savings rate in Nepal is low but totalsavings rate is higher than investment rate indicating thepossibility of generating additional resources forinvestment.


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Banks are holding more funds than they arerequired to, however, investment in largerinfrastructure projects suffers as there is alimited access to international financial markets.

The survey of foreign affiliates in Nepal showsthat majority of the projects with capitalparticipation from developed countries aresmall-scale projects with individual investors.

There is a predominance of JVIs even when100 per cent equity ownership is allowed. Thisis the area to be investigated.


The draft Industrial Policy, 2002; IndustrialDevelopment Perspective Plan: Vision 2020 andForeign Investment Policy, 2002 are relativelybetter designed. In the revised policies,

provision for enhancing NRNs involvement inNepals development initiatives be ensured.

The new government should get rid of weakeradministrative practices and conservativeattitudes towards business.

nepal binding constraings bishwambhar pyakurel

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