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Break the cycle

JAN 14 -

The Nepali economy did relatively well last year if you look at the numbers in the most recent IMF Article IV report (publicly released on www.imf.org/nepal). Growth of 4.6 percent was above expectations and average inflation dropped to 8.3 percent.  Agriculture was strong, as was the service sector. The external balance of payments was in record surplus, allowing the Nepal Rastra Bank (NRB) to build further its cushion of foreign exchange reserves. Total public debt also remained low by international comparison, at only 33 percent of GDP.

But this favourable outcome had as much to do with good fortune as with policies. A timely monsoon boosted agriculture; and remittances surged—partly because of a depreciating rupee. Lower overall inflation stemmed from the good harvest and lower global commodity prices, but non-food inflation was stubbornly high. Government economic policies were generally prudent, which is an accomplishment in the current political context, but not the guiding hand behind higher growth or lower inflation.

And while growth was higher than expected, it was not high enough to meet some of Nepal’s most pressing concerns—such as creating jobs to absorb new entrants to the labour force, make a notable dent in poverty, or start Nepal on a road to building durable national wealth.

From a longer-term perspective, Nepal is falling behind in some important ways. Average GDP growth over the past 10 years has been only about four percent, compared with 6.5 percent in Central Asia, and over seven percent in developing South and Southeast Asia. The share of industry in Nepal’s GDP dropped from an average of 21 percent during 1990-2001 to 16 percent during 2001-12. Dependence on inward remittances as a source of income has increased—rising from 10 percent of GDP in 2001/02 to over 23 percent in 2011/12, while exports dropped by half as a share of GDP during the same period.

Structurally as well, there are signs of strain. Public infrastructure is falling behind the needs of the economy. Power generation is insufficient, leading to frequent load shedding. Transport infrastructure is also in need of expansion. The financial sector is under strain from over-exposure to a moribund real estate market. Key pieces of legislation related to financial sector reform are on hold until a new constituent assembly can be elected. And definitive action to address losses at the state oil and electricity companies is also delayed.

Set this against an increasingly challenging external environment. The IMF’s forecast for global growth is 3.3 percent in 2012 and 3.6 percent in 2013, down from a projection of 4 percent and above at this time last year. Risks are on the downside—with a 1 in 6 chance that global growth will fall below 2 percent (see www.imf.org/weo). In the region, real GDP growth in India is projected at only 5.6 percent in 2012/13 and 6 percent in 2013/14, compared with average growth of eight percent in the last five years.

While challenges are many, there is yet room for guarded optimism. Nepal has considerable potential. Many of the pre-requisites for higher and sustained levels of growth are in place—including a pragmatic approach to macroeconomic management, a generally liberal view on trade and investment, and substantial goodwill with international financial institutions and the donor community.  We all want Nepal to succeed, but it will take hard work, compromise, and willingness to accept and support change.

What can be done? Political consensus is key. Recent research (see IMF Working Paper WP/11/12, How Does Political Instability Affect Economic Growth) confirms a very intuitive point—political instability negatively affects growth. But even if consensus on big political issues is unattainable in the short run, it is critical for major parties to agree on a few common planks of sound macroeconomic management, and separate them from political wrangling.  The regrettable delay over the budget (which even now is a second-best outcome) is a prime example.

Success hinges on structural reform.  Financial sector vulnerabilities need to be addressed. A safe, sound, and efficient financial system is needed to ensure it is able to intermediate savings into private investment. Financial losses at state companies need to be eliminated and their efficiency increased, and the transparency of government operations should be enhanced.  A focus on competitiveness and improving the business environment is also essential. This includes reforms to boost the attractiveness of Nepal as a destination for investment, build infrastructure, and improve the efficiency of spending on education and health to ensure the workforce is healthy and smart.

Macroeconomic policies also need to be strengthened to address emerging pressures. Monetary policy should focus on containing inflation. Fiscal policy should be contained within the envelope of the official budget, supported by strong public financial management and a concerted effort to implement badly needed investment spending. Taxpayer money—whether that of Nepali taxpayers or taxpayers in donor countries supporting Nepal—must be used efficiently. This is where the IMF stands ready to help, with advice, technical assistance, and broader support.  

Schneider is IMF mission chief in Nepal

Posted on: 2013-01-15 08:43


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