Nepal | Economy | Recession | Inflation | Budget | Human Capital | Policies
Dr. Kalpana Khanal started her career as an Associate Professor of Economics at Nichols College in the United States where she taught economics, finance, and public finance for close to a decade.
Earlier she did her Ph.D. in Economics on ‘Exchange Rate Policy in Development Theories: To Fix or to Float in the Case of Nepal’.
In the middle of the pandemic, she decided to move back to Nepal to remain closer to her family. For the past two years, she has been spearheading the Center for Economics and Infrastructure Policy Research at Policy Research Institute (PRI) where she is also a Senior Research Fellow.
PRI is a government think tank that reviews public policies, programs, and strategies through research and analysis and provides policy recommendations to the government, carries out studies on diverse public sectoral issues, and serves as an interface of knowledge and policy formulation.
Sakshi Agrawal interviewed Dr. Khanal to get a better grasp of Nepal’s present economic condition and her analysis of the recent budget.
What’s your observation about Nepal’s present economic status?
Economists measure the health of the economy using gross domestic product (GDP), which is the total production in the economy during a given period of time in monetary terms.
Nepal’s growth is expected to shrink to 2.16% this fiscal year, which had an earlier forecast of close to 5%. So the reality is quite different.
Nepal’s industrial growth is negative while the agriculture and service sectors are positive. If we further break down, we can see that construction, industrial production, and wholesale and retail trade are also facing negative growth rates.
There were recent reports Nepal's economy is in recession. Some argue it's not the case. Others suggest ground realities are different. Businesses are experiencing difficult times. Inflation is high. Just a while ago, some critical macroeconomic indicators such as foreign exchange reserves were in the red zone. Can you clear the air?
The technical definition of a recession is that when the GDP growth declines for continuous two quarters, it’s a recession. Nepal’s growth has been shrinking for almost 3 to 4 quarters now. So, technically we are in a recession.
When we specifically look into how the private sector is doing or how businesses are faring, many shutters (shops) or businesses are closing down in cities outside of Kathmandu, such as Butwal or even Kathmandu.
Businessmen are complaining they are having a hard time paying off their interest back. All of these signal recession in reality too.
Data also shows that consumption in the fiscal year 2078/79 was 94.2% of GDP, which went down to 93.6 % in the current fiscal year. Declining consumption means demand has shrunk, which leads to low production and employment.
All these indicate Nepal’s economy is in a slump.
Compared to Nepal’s present economic status, what are your thoughts on the recent budget — promising or just a ritual budget?
Some private sector policies are impressive. You can now open up a company with Rs. 100, which is a good signal, and is expected to formalise the informal sector.
The budget is also committed to improving the digital Nepal framework, which is the need for time. In the social sector, they have mentioned a few good programs like improving social security coverage through programs such as Womb to Death (Kokh dekhi sok samma). The budget for social security programs has been raised to Rs 157 billion.
Another focus area is improving domestic as well as foreign direct investment (FDI). For example, the budget has announced the removal of the threshold for foreign investment in the IT sector, where the FDI was already open but had a minimum investment threshold of Rs 20 million. The need for blending development finance with private finance as well as FDIs to develop infrastructure investment funds and minimise risk for investors is also outlined in this budget.
These are in the right direction.
What do you think are bad policies and programs? What are areas of concern?
Few policies are just repetitions.
The revival of the Sansad Bikash Kosh (Constituency Development Fund) was unimpressive. First, it contradicts the mandate of federalism. Second, it is an extension of this trend of spreading out the budget into small projects that will not bring significant contributions economically.
The budget or resources should be channelised into projects with strategic importance for changes at the micro and macro levels. If you see the past trend, several projects have remained incomplete because the budget allocation is inadequate. Rather, the budget has been dispersed out in many areas, and as a result, many ongoing projects remain in limbo.
As we discussed, there are good and bad in the budget. Considering the current economic situation, do you believe the budget will help revive the economy?
Countries like America or Denmark or other developed countries introduce specific stimulus packages to help the economy. In our case, right after Covid, our monetary policy had some specific provisions like easy credit to help the economy out of Covid. Presently, I didn’t see any specific stimulus package targeted towards Covid, perhaps because technically the “pandemic clause” has been lifted but its impact still lingers.
On the flip side, some of the budgetary programmes if implemented well will help the circular flow in the economy. For instance, government consumption has gone down which means that the government is not spending much on buying inputs for infrastructure projects, which translates into lower demand for the private sector. If there is not enough demand, the private sector is not going to produce.
The one thing the government could do better is sincerely execute all the programs and projects outlined in the budget.
But we make plans and programs that are not implementable. That's what our history shows. We need to work on developing implementable programs. The government must improve its resource absorption capacity to increase capital spending.
Do you think that the budget has missed out on some important policies or programs?
Instead of focusing on a few strategically important projects, it has outlined too many projects, some of which may not be that important. Also, I am not sure if the proposed projects and policies are based on any economic analysis — a viability study or a cost-benefit analysis. Projects are proposed without ensuring or allocating enough resources.
The lack of evidence-based budget-making makes the budget look like a wish list and a well-written piece of literary work. The question remains, will they happen in reality?
The recent budget has announced a tax on outbound students and outbound Nepali tourists as well. There are tax hikes in many other areas too. What are your thoughts on the tax for tourists and students?
The government has introduced a 5% luxury tax on travel packages. Maybe that's fair enough. If you can afford to take a foreign vacation, then maybe you can pay a 5% extra tax. The question is why 5%? How did you reach that rate? Why not 1% or 2%? Is there any solid basis for the number like some kind of economic analysis or just a random estimation?
There's no point in raising the tax if there is no potential for larger revenue.
Similarly, there’s a 5% tax hike on 5-star hotel stays. The tourism industry is slowly reviving. An impact forecast of the tax hike on tourism inflow was desirable. Additionally, charging taxes for students going abroad is not the logical way to address the student retention issue.
Nepal has been facing delays in infrastructure projects. Delays mean time and costs overrun which affects their overall financial feasibility. On the other hand, these delays also mean that the government hasn’t been able to meet its capital expenditure target, which has many economic ramifications such as recurring credit crisis. Occurring year after year, this has become a serious problem, yet the solution seems elusive. How do we overcome it?
Bureaucrats, project directors, and people in the policymaking circle all know where the problem boils down to — with the implementation.
I was quite excited to see this year's budget incorporate some of our policy recommendations. This indicates that the government knows the solutions. But how are they going to be implemented?
At this critical juncture, we must be action-oriented. For example, the government should finance larger projects that give quick outcomes. Project implementation goes through several steps feasibility study, land acquisition, project documentation, environmental impact assessment (EIA), site clearance, procurement plans, and more. Projects that have been through all these steps should receive priority.
Also, one of the grievances of hydro project managers is that they have to go through tedious bureaucratic processes for the EIA. This budget mentions streamlining the process and making the procurement policy more efficient.
The budget also has plans to introduce a central database of domestic construction companies, which can be helpful in assessing domestic capabilities. Adequate domestic capability means a lesser need to conduct international bidding. This way we could prioritise our domestic construction workers and companies. Again, the implementation aspect is yet to be seen.
Nepalis have been experiencing high inflation for the past many years. People are worried about their living standards, especially the low-wage population. Both monetary policies and fiscal programs haven’t been able to address the problem as many experts argue. How do you analyse the situation and what can be the immediate solutions?
We need to understand what's causing the high inflation. External reasons are the primary factors behind our high inflation than domestic factors.
Firstly, the whole world lived through Covid-19 disrupting the global supply chain. The fuel price went up. Commodity prices such as wheat and oil went up. Petroleum is input for almost all industries, and oil price is one of the indicators of the macroeconomy. When that goes up, the price of output also goes up. They have a direct relationship.
Nepal is a net importer of oil and we are still reliant on petroleum. That's another reason why we need to transition to a hydro-powered economy and become self-reliant on energy. We have to channel our energy towards domestic consumption.
The second reason is due to the appreciation of US dollars. Due to the global recession, including in big countries like the European Union and China, the exchange rate with the dollar, which is the international currency, has also surged. The dollar price has never been this high. Because of this surging exchange rate, our inflation rate is high. Our government has no influence on these external factors.
Internally, the government can cross-check if some markets or some cities have price manipulation at the local level. They can control that. But macro inflation is mostly because of external factors.
In economic theory, industrialisation is considered as the take-off stage of a modern economy. In Nepal’s case, the manufacturing sector's contribution to GDP has remained low. We’re still an agriculture economy while there’s much happening in the service sector too, and now there are talks about transitioning into a digital economy considering its potential. For industrialisation, we have limitations — geography, wage, and infrastructure. How do you analyse this situation?
Historically speaking, when the share of the agriculture sector in the GDP declines, the manufacturing sector share increases. That didn’t happen in our case. The service sector has been the major contributor, which some people call premature deindustrialization.
I would say we need to be strategic. Times are changing. We cannot expect ourselves to be like Japan or South Korea. Due to our landlocked geography, it's almost difficult for us to be exporters.
The world is digitising and Covid-19 expedited the process. Given our demographic dividend and our youth’s inclination toward digitisation, the focus should lie on the home production of digital outputs. For instance, digital service packages such as Business Process Outsourcing (BPO).
Having said that, we also need to emphasise certain industries whose inputs are produced within Nepal so that we can gear towards backward linkages.
12 sectors were identified as having a competitive advantage. These include cardamom, ginger, tea, medicinal and aromatic plants, fabrics, textiles, yarn, and rope; leather, remittance generating services, IT & BPO and IT engineering and tourism. In those sectors, we need to focus on how backward linkages can be maintained.
Additionally, we need to focus on niche indigenous products exclusive to Nepal. This year plans and programs have emphasised branding and exporting Himalayan spring water. Being a country with rich water resources, branding and marketing it to the Middle East or other countries is a good option. But we need to be clear about the logistics and identify our markets first.
Similarly, entry for new businesses into an already existing market is extremely difficult. The door is not open to everyone who wants to approach the business in new ways. A few business conglomerates can influence politicians and bureaucrats and try to extract benefits from tax and policy loopholes. Syndicate or monopoly in the export business needs to be removed to open it up for all interested producers and promote competition.
Demographics dividend has been the talk of the town for years now and there are concerns that the window has started closing. When we analyse our workforce, there is an immense skill and knowledge gap. Too few quality universities. There's a perception that opportunities are limited, which is justified to think that way. In the meantime, there is a substantial exodus of students and labourers happening. What is the solution to this problem?
I agree it is sad. But migration has pull and push factors. As long as there is a huge wage differential between some parts of the world and others, the trend will continue. People will move out for better opportunities, an obvious tendency.
To counter that, we need to come up with rewarding opportunities right at home, and we need to start at the foundational level. The foundation would be to provide sellable and quality education like technical or vocational. We need to invest from kindergarten to 10th grade to high school.
We have ten years to produce excellent human capital for the next ten years. This has to be done very strategically and especially within the given context that after 12th grade, the youth would prefer to move out.
We can also leverage the ICT sector to create better opportunities.
In the short run, we must provide unskilled labour with vocational training — to help them secure a proper job, which will increase the remittance flow too if they opt for foreign employment. If the labour decides to eventually return to Nepal, we can formalise their skills with a certification that will help them get jobs based on their skill set and encourage them to become entrepreneurial.
There’s an immediate need for short, mid, and long-term solutions — starting from education, giving opportunities to returnees, and training the workforce — which will help in retention. We cannot retain all. That's impossible. But if the number goes down, that's still a win.
How do you analyse this demographic situation if I ask you how would Nepal’s economy turn up, let’s say, five years down the line if the current trend persists? Do you think Nepal can sustain itself in the long term under this scenario?
Relying on remittance is not a viable solution from the long-run perspective. In the short run, however, there is no immediate alternative.
We have to slowly phase down this dependency. Currently, the remittance-to-GDP ratio is around 25%. The aim should be to gradually bring it down to 10% - 12%
During the Covid-19 years, we saw that remittances plummeted because it depends on external shocks where we don’t have any influence. Subsequently, our economy was hit hard. These shocks can occur frequently.
I know it's not going to change drastically in the next five years. Yet we have to make those short-term, mid-term, and long-term strategies to manage our future economy.
Edit by Sabin Jung Pande
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