GOVERNMENT AMBIGUITY KNOCKS FRAGILE ECONOMIC RECOVERY OFF TRACK Business 360

Government ambiguity knocks economic recovery off track

In the first week of December 2021, Nepal signed a deal with the International Monetary Fund (IMF) to avail extended credit facility (ECF) of $400 million for three years as the country started reeling under alarming balance of payments (BoP) deficit due to skyrocketing imports. As compared to the corresponding period of the previous fiscal year, imports have surged by 61.6% in the first quadrimester of this fiscal to Rs 650.29 billion.

“Nepal’s gross foreign exchange reserve will cover only 7.2 months of imports, which is a pessimistic scenario for a country like Nepal which lacks stable source of foreign exchange earnings,” says Nara Bahadur Thapa, former Executive Director of the Research Department of Nepal Rastra Bank. “Countries like Nepal must maintain foreign exchange reserves to cover at least eight months of import of goods and services.”

Inflow of remittance and foreign assistance have plummeted since the beginning of this fiscal, which has put pressure on the country’s foreign exchange reserves. Remittance, which plays a key role in lubricating economic activities and backing imports, went down by 7.8% to $2.62 billion in the first quadrimester as compared to the same period of the previous fiscal year.

In July 2019, Nepal had foreign exchange reserves that were sufficient to cover only 7.4 months of imports, however the problem could escalate this year due to plummeting remittance, foreign assistance, and prolonged backlash of Covid 19 pandemic in the tourism sector which is one of the major sectors for foreign exchange earnings.

The government has initiated some patch-work policy arrangements to address the dire situation as there is no hope that the reimbursement of foreign assistance will help improve the BoP situation in the immediate future.

Nepal Rastra Bank has curtailed the import of certain goods deemed luxury by the government by issuing a provision of cent per cent of cash margin to open letter of credit (LC). These are on the import of alcohol, various cosmetic items, wigs/eyebrows, furniture, sugar, panela/palm sugar, honey, bubble gum, all kinds of drinks, cloves, umbrella and sticks, marble and tile, construction materials, bottles (made of glass and metal), silver and silver powder, chairs, cages and playing cards.

Similarly, 50% cash margin is required for the import of automobiles, auto-rickshaws, ambulances and hearse vans, etc.

On a similar vein, Nepal had obtained rapid credit facility (RCF) from the IMF in fiscal 2009-10 to handle the BoP crisis and also curbed the import of some products, including gold. However, after the BoP crisis of fiscal 2009-10, the country has not faced BoP deficit of that magnitude in the last decade.

Back then, remittances plummeted due to the adverse impact of the global financial crisis in Gulf countries and Malaysia, the major labour destinations, and rampant import of gold and other commodities dented the foreign exchange reserves.

BoP despite the current account deficit started widening from the beginning of this fiscal when imports surged drastically as life started to return to some form of normalcy.

A country’s BoP reflects the overall position of current account, capital account and financial account. The current account records the flow of goods and services in and out of a country, including tangible goods, service fees, tourism receipts, and money sent directly to other countries either as aid or to families. Financial account measures the increase or decrease in international ownership assets that a country is associated with, while capital account measures the capital expenditures and overall income (foreign investment, foreign loan/grant, investment of commercial banks in foreign countries in foreign currency) and the foreign currency loans availed by the private sector of the country. There could be longer term liability in capital account as it deals with foreign loans and investment as well.

The current account deficit surged exponentially to Rs 223.19 billion in the first quadrimester of this fiscal against a surplus of Rs 19.01 billion in the corresponding period of the previous fiscal. Similarly, BoP deficit escalated to Rs 150.38 billion in the review period as compared to Rs 110.65 billion surplus of the previous fiscal, according to Nepal Rastra Bank.

The underlying drivers for the huge BoP and current account deficit are the skyrocketing imports, continued backlash of the pandemic on the tourism sector, negative growth of remittances and low disbursement of foreign aid. The country witnessed a deficit of Rs 31.19 billion in service trade in the first quadrimester of this fiscal. Such deficit surged by 78% as compared to the corresponding period of the last fiscal year. Nepal had been enjoying surplus status in service trade since long despite a huge deficit in goods trade in the past, however it has been gradually losing its strength in service trade in recent years, according to the central bank.

Bhuvan Kumar Dahal, outgoing CEO of Sanima Bank and former President of Nepal Bankers Association (NBA), shares that decline in remittances is a common phenomenon when imports surge heavily. It is believed that traders use illegal means like hundi/hawala to settle the payment of imports that are largely under-invoiced in import bills.

“We had anticipated that remittances could plunge during the pandemic, however, ironically we witnessed an encouraging growth of remittances as imports plummeted due to the worsening situation caused by the pandemic,” says Dahal. “Imports started to surge exponentially after the situation eased and remittances inflow started declining simultaneously. It is believed that the traders present underinvoiced import bills of lavish products (in which the customs slap high duty) and settle payments through illegal means like hundi. Otherwise, there is no reason behind the decline in remittances,” he states.

There is an interesting trend in Nepal that remittances decline when the stock market rallies. Stock investors encourage their kids living in foreign countries to buy property (in foreign countries) from their windfall gains in the stock market and the money goes through hundi because the country doesn’t allow taking away money officially to purchase home/land or embrace entrepreneurship in foreign countries.

Increased public debt narrows fiscal space

According to the Ministry of Finance (MoF), which deals with foreign assistance – both loans and grants, has said that foreign assistance commitment has declined substantially. According to the International Economic Cooperation Coordination Division (IECCD) of the MoF, foreign aid commitment has declined by 34.5% to stand at Rs 55.94 billion in the first quarter of this fiscal as compared to Rs 85.39 billion in the corresponding period of the previous fiscal.

The portion of grants is nominal in this fiscal. As per MoF, of the total commitment worth Rs 55.94 billion, only Rs 5.81 billion is grant and Rs 50.13 will be availed as loans. Foreign assistance from the three major donors covers almost 91% of the aforementioned resource commitment; namely Asian Development Bank (36.3%), World Bank (33.6%) and International Fund for Agricultural Development (20.8%).

Keshav Acharya, former advisor to the MoF, says that even developed and developing countries are in a dire need of resources due to increased liabilities caused by the Covid 19 pandemic. There is fierce competition among countries to avail resources to address socio-economic challenges that have emerged due to the pandemic. Most of the development aid commitment is focused on coping with the challenges caused by the Covid 19 pandemic.

Federalism: Costly affair

Nepal’s public debt has increased exponentially in the last four years along with the rise in resource demand in the new administrative setup of the country. Three layers of the government have been formed in the federal setup along with work division (functions) fund for the functionaries has been arranged.

The MoF has said that the country’s debt to GDP (gross domestic product) ratio is 40.5% or the country’s public debt was equivalent to 40.5% of the GDP till last fiscal 2020-21. “Increasing debt has narrowed down the fiscal space,” states senior economist Dilli Raj Khanal, “Mobilisation of such resources (debt) must be tied hand in hand with quality infrastructure, asset creation, productivity enhancement as well as employment. However, the country is laggard in growth despite mobilisation of a large chunk of debt that simply shows greater degree of inefficiency in resource mobilisation.”

Government’s capital expenditure is merely 7% in the first five months of the current fiscal. The government has earmarked Rs 439.65 billion under development budget heading, however, less than Rs 30 billion has been spent by mid-December. Development projects have slowed to a crawl this year as compared to the two previous consequent fiscal years despite the pandemic hitting the country hard during that time.

Slow development expenses have had an adverse effect on money supply in the market, and banks and financial institutions have been facing liquidity crunch. Suppliers of construction materials have been affected with demand shocks. It is obvious that the government should prioritise the creation of more jobs through massive infrastructure development activities in the aftermath of the pandemic. However, the government has failed to do so. The Replacement Act has envisioned to spend 10% of the capital budget in the first quarter of the fiscal and 10% in each month for a whole year to achieve the desired goal.

The MoF recently introduced a patch-work policy that allows commercial banks to issue loans in the productive sector against 80% of the consolidated fund that belongs to the local governments. However, experts have said that this is only a temporary remedy. The government must expedite capital expenditure that will automatically address the problem of liquidity crunch and resources (loans) will be easily available for the private sector to conduct business activities. “Government expenses and uninterrupted business activities from the private sector are key to spur growth and address the current challenges of unemployment and underemployment,” reiterates Dahal. “The policy introduced by the central bank to curb imports could lower illegal means of resource embezzlement like hundi and increase in remittances will increase the deposits in banks and financial institutions. This will help the private sector to easily avail loans and interest rate on credit will also go down along with increased deposits.”

Otherwise, the import-led growth model will push the country into the vicious cycle of BoP deficit, liquidity crunch and pressure on foreign exchange reserves. The country must come out from this trap and promote production-led economy and pay due attention to efficient or output oriented use of resources.”

READ ALSO: 

Share This Post

Pushpa Raj Acharya

Pushpa Raj Acharya writes on private sector development, governance reform, taxation, trade/investment and financial sector. He is in journalism since 2007. He had served for Karobar Daily, Republica, The Himalayan Times and Annapurna Post before he started writing for Business 360. He is former president of the Society of Economic Journalists- Nepal (SEJON). He has interest in multimedia journalism & advocates for ethical and responsible journalism.

Related Post

    Leave a Reply

    Rate this post

    Your email address will not be published. Required fields are marked *