Download Nepal’s Binding Constraints to Growth I. Introduction

UN/ESCAP
Bangkok
30 September 2009
Nepal’s Binding Constraints
to Growth
Bishwambher Pyakuryal
Professor of Economics
Tribhuvan University
I. Introduction
ƒ Sequencing of Nepal’s political changes: first
democratic movement in early 1990; second peoples’
movement in 2006, and declaration of Federal
Democratic Republican State on Wednesday, May 28,
2008.
ƒ Overemphasis of political restructuring has
overshadowed the need for economic restructuring.
ƒ ADB, DFID, and ILO-supported initiative in
diagnosing growth constraints and identifying
opportunities in Nepal is just completed.
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II. Issues for assessing growth constraints
ƒ Inability to produce export products and failure to
maintain real exchange rate regime with IC
• The gross foreign exchange reserves ↑ Rs. 212.6
billion (US$ 3.1 billion) compared to Rs. 165.1 billion
in mid-July 2007
• The workers’ remittances rose by 42.5 per cent (Rs.
142.7 billion) by contributing to 17.4% to the GDP. Its
contribution 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 constraints
Contd.
Cost Competitiveness Indicators
Table 1: Index of Cost Competitiveness Indicators of Nine Asian
Countries, 1999
COUNTRY
LABOR COST PER
WORKER (A)
VALUE ADDED PER
WORKER (B)
UNIT LABOR
COST (C)
Nepal
100
100
100
India
130
205
81
China
180
271
72
Bangladesh
110
130
90
Indonesia
120
276
87
Thailand
480
390
94
Sri Lanka
160
195
105
Malaysia
960
909
93
Philippines
600
742
93
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 definition
of the U.S. Department of Commerce.
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II. Issues for assessing growth constraints
Contd.
Deteriorating trade & diversion of foreign
exchange reserve
• The ratio of merchandise trade deficit to GDP
is 20.0% (Rs. 165.3 billion)
• Trade deficit w/India is 64 per cent of the total
merchandise 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 worth
70,602.53 million by selling US$
II. Issues for assessing growth constraints
Contd.
Increasing debt liability, and cut back in public sector
investment
• The country is experiencing a diversion of resources
from productive sectors and fulfilling the terms of
increasing debt liability
• The budgetary allocation shows a cut back on public
sector investment and inadequate infrastructure
development to attract potential investors
• The low infrastructure expenditure can be said as the
single most important macro constraint on Nepal's
economy.
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III. Reason for identifying growth constraints
ƒ Nepal government has adopted expansionary
fiscal policy in the budget 2009/10.
ƒ First, there is a need to reconcile between
inflationary economic forces and expansionary
fiscal policy. Secondly, this situation necessitates
diagnosing growth constraints and possibilities for
increasing future investments.
IV. Selected Growth Constraints
• It is advisable to find out the likely
constraints for growth before making
investment decisions.
• If Nepal’s infrastructure is a constraint to
growth, then we need to find out what
infrastructure e.g. power, transportation,
telecommunications etc. are relatively
important constraints to growth?
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IV. Selected Growth Constraints….Contd
(a) Low investment rate
• In 1995, Nepal’s investment rate (25.2%) was
very close to India (26.2%). Bangladesh
(19.1%), Pakistan (18.5%) and Sri Lanka
(24.2%) were lagging behind Nepal. But, since
2007, only Pakistan is lagging behind Nepal.
IV. Selected Growth Constraints….Contd
Fig1: Investment Rate of Nepal from 1975-2006 (% of GDP)
30
25
20
15
10
5
0
Investment Rate (% of GDP)
Source: Economic Surveys, MOF
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IV. Selected Growth Constraints….Contd
(b) Low domestic savings rate
• Domestic Saving Rate is lowest in South Asia and it is
almost one third of Bhutan. The highest Gross Domestic
Saving was in 2000 (15.17 percent of GDP).
• It is interesting to note that GNI per capita increased by
more than fifty percent from the year 1995 to 2006 (WDI,
2008) but Gross Domestic Saving decreased from 14.8
percent in 1995 to 9.4 percent in 2006 indicating the fact
that low domestic saving rate is one of the major
constraints for growth.
IV. Selected Growth Constraints….Contd
Fig 2: Gross Domestic Saving 1975-2006 (% of GDP)
16
14
12
10
8
6
4
2
0
Gross Domestic Saving (% of GDP)
GDP: Gross Domestic Product
Source: Economic Survey (various issues), MOF
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IV. Selected Growth Constraints….Contd
• Although there is deficit trade balance, current
account surplus is maintained ‘cause of large
amount of workers remittance, which increased by
23.9 percent annually from 1991-2006.
• From the year 2000-2006, remittance was 75
percent of trade balance and 89 percent of
saving-investment gap. For two consecutive years
from 2000, remittance exceeded the savinginvestment gap.
• It indicates that saving is not a problem for
Nepalese economy. But decline in remittance
inflow may seriously affect the economy.
(c) Investment Constraints
(i) Labor and Technology
• Nepal’s total factor productivity growth rate is about fifty
percent of India, which has contributed negatively.
Table 2: Total Factor Productivity- Nepal Vs India
Period
Growth Rate
Nepal
Growth Rate
Adjusted
Growth Rate
India
Growth
Rate
Adjusted
1980-1984
0.57
1.34
0.58
0.57
1985-1989
1.24
1.47
2.63
2.64
1990-1994
2.27
0.14
2.01
2.02
1995-1999
0.14
0.64
2.90
2.90
19802000
1.11
0.91
2.08
2.08
Source: APO
Note: Growth rate adjusted for business fluctuations
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(c) Investment Constraints….contd
• Nepalese manufacturing sector is dependent on India for skilled labor. ILO
study reports that manufacturing sector hires about 15 percent of total skilled
labor force from India.
• Similarly, Nepal's position in the Labor related regulation is also poor in
comparison to other south Asian countries.
Table 3: Comparison of Labor-Related Regulations with Regional
Countries
Difficulty of Rigidity of Hiring Index hours Index
Afghanistan
0
Bangladesh
44
Bhutan
0
India
0
Maldives
0
Nepal
67
Pakistan
78
Sri Lanka
0
Firing costs Rigidity of Non‐wage Difficulty of Employment Labor Cost (% (weeks of wages)
of salalry)
firing Index Index
40
30
23
0
0
20
40
35
0
104
0
20
7
1
10
20
70
30
17
56
0
0
0
0
9
20
70
52
10
90
20
30
43
11
90
20
60
27
15
169
Investment Constraints……contd.
ii. Infrastructure
• Infrastructure in Nepal is one of the poorest
and Road density is smallest in the region.
• Road density is least in Midwestern region.
Population to road ratio is highest in Western
Development Region. In other words, in this
region more people use fewer roads.
• Distribution of road network is highly unequal.
More than fifty per cent of the total road
network is concentrated in Terai. See Table 4
and Fig. 3 below:
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Investment Constraints……contd.
Table 4: Road Network in Three Geographic Regions
Region
Mountain
Total Length
of Roads
(Km)
Population
Influenced
Per Km. of Road
(Nos.)
Road Density
(Km./100
sq.Km)
742
2274.743
1.431962
Hill
7590
1350.608
12.38719
Tarai
8504
1318.492
24.9978
Source: Calculated from DoR, 2006
Investment Constraints……contd.
Fig 3: Road Network in Three Geographic Regions
Source: Calculated from DoR, 2006
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Investment Constraints……contd.
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
Investment Constraints……contd.
• Nepal study shows that if transportation time is
reduced by fifty per cent, then it may result in
higher income through the increased fertilizer
use and yield (MoICS, 2004).
• Other important constraint is electricity tariff,
which is one of the highest in South Asia.
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Investment Constraints……contd.
Figure 5: Electricity Tariff ($/KWh, 2000)
Bangladesh
0.041
0.065
Pakistan
Sri Lanka
0.079
India
0.043
Nepal
0.093
Source: MOICS, 2004
Investment Constraints……contd.
•
•
The overall infrastructure situation for attracting
investment is very dismal. Expensive and irregular
electricity, small and low quality road network,
expensive and deficient transportation are some of the
examples.
Infrastructure quality score shown in the Figure 6
reveals that Nepal, in fact, has the poorest
infrastructure in comparison to other South Asian
neighboring countries. Highest possible score is seven
out of which Nepal secures only 1.9. Nepal's position
with this score is 119 out of 125 countries in the world.
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Investment Constraints……contd.
•
•
Both quality and expenditure for infrastructure is very low. Nepal spends < 1%
of total GDP on infrastructure against 4.8 percent of India.
Study shows that Nepal needs to invest US$ 3.44 billion (12.22 percent of
GDP) for the period of 2008-2012 in order to achieve eight per cent growth
rate.
Fig 6: Infrastructure Quality Score of South Asian Countries
Infrastructure Quality Score
Bangladesh
2.3
India
Nepal
3.3
1.9
Pakistan
Srilanka
3.4
3
http://siteresources.worldbank.org/INTEXPCOMNET/Resources/2.01_Overall_Infra
structure_Quality.pdf
Investment Constraints……contd.
•
In terms of telecommunications, Nepal has lowest
number of telephone subscriber per 100 people in
South Asia. Fixed line and mobile phone subscribers
(per 100 people) in 2006 remained at 5.9244 for
Nepal. 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 of
subscriber per 100 people, study shows telephone
doesn’t seem to be a constraint to investment and
growth.
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Investment Constraints……contd.
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 and
half decade.
Table 6: Governance Indicators for Nepal, Percentile Rank (0-100)
Governance
Indicators
Voice and
Accountability
Political
Stability
Government
Effectiveness
Regulatory
Quality
Rule of Law
1996
1998
2000
2002
2003
2004 2005
2006 2007 Region
Avg.
15.4 22.6
28
46.4
42.3
43.3
24.5
25.5
18.3
13.9
26.9
23.6
14.4
6.7
5.3
2.9
1.4
2.9
2.9
19.3
36
36
40.8
37
34.1
22.3
15.2
21.8
21.8
36.5
22.9
31.7
28.3
31.7
33.2
31.2
25.9
26.3
26.7
31.9
51.4
52.9
44.8
42.4
37.1
32.4
23.8
33.3
31
38.3
Investment Constraints……contd.
•
Similarly frequent bandh is deteriorating smooth functioning of business sector.
Figure 7: Number of Days of Bandh (Excluding Indefinite Bandh)
City
District
Region
Country
36
24
21
13
2
4
Total
May
April
March
2
June
3
February
December
5
32
January, 2008
November
45
3
October
May
April, 2007
21 13
5
2
August
4
1
9
September
7
July
8
June
9
Source: Various News Papers
Note: This chart doesn't include Bandh called for indefinite period.
District: One district
Region: Two or more district
City: City or part of highway in one district e.g. Bhairahawa-Sunauli highway
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Investment Constraints……contd.
Fig 8: Share of Bandh for City to Country (Excluding Indefinite
Country
5%
City
25%
Region
42%
District
28%
Source: Various News Papers
(V) Conclusion & Recommendations
• Overall macroeconomic positions look OK. The challenge
is to sustain growth against the existing constraints of
poor infrastructure, underperformance of agriculture,
inadequate skills and technology and unsatisfactory
corporate and political governance.
• Major task is to ensure equity to make growth inclusive.
• The Heritage Foundation's Index of Economic Freedom
uses relatively objective scoring system to rate countries
on a 1-to-5 (good-to-poor) scale, under a series of
headings.
• 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 pervasive
corruption), contributing to an overall score of 3.5.
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(V) Conclusion & Recommendations….contd
• Review shows, investors demand the revision of
the rigid Labor Act, 1992 to avoid labor market
rigidity. Other equally important acts such as
Bankruptcy and Mergers Act should be enacted
without further delay to reduce investor's risk.
• It is important for the government and private
sector to find out the reasons why increased
FDI has not been very significant in the growth
of Nepalese GDP in absolute as well as in the
relative sense (http://ideas.repec.org).
(V) Conclusion & Recommendations….contd
• The value of Nepal’s new Human Empowerment Index
(HEI) is 0.463 (including social, economic and political
indicators into a composite index of empowerment). The
economic empowerment is lowest at 0.337, which
reflects the low level of income, limited access to
productive assets and lack of gainful employment
opportunities (Nepal HDR, 2004).
• Gross domestic savings rate in Nepal is low but total
savings rate is higher than investment rate indicating the
possibility of generating additional resources for
investment.
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(V) Conclusion & Recommendations….contd
• Banks are holding more funds than they are
required to, however, investment in larger
infrastructure projects suffers as there is a
limited access to international financial markets.
• The survey of foreign affiliates in Nepal shows
that majority of the projects with capital
participation from developed countries are
small-scale projects with individual investors.
There is a predominance of JVIs even when
100 per cent equity ownership is allowed. This
is the area to be investigated.
(V) Conclusion & Recommendations….contd
• The draft Industrial Policy, 2002; Industrial
Development Perspective Plan: Vision 2020 and
Foreign Investment Policy, 2002 are relatively
better designed. In the revised policies,
provision for enhancing NRN’s involvement in
Nepal’s development initiatives be ensured.
• The new government should get rid of weaker
administrative practices and conservative
attitudes towards business.
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