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Accepting Foreign Capital
Lessons from Recent Crises
By Robert E Litan
It is important in managing financial risks not to treat
all foreign capital alike. For emerging markets that do not have well
established reputation in the capital markets and must borrow, if at all,
in other countries' currencies, policy makers must take into account both
the costs and benefits of different types of capital before welcoming
each unconditionally. Moreover, the outcome of that calculation depends
critically on macroeconomic factors and institutional conditions. What
is a right policy for one set of conditions may not be right for another.
Shot-term capital
Perhaps the central issue raised by the Asian and Russian
financial crises is whether short term capital - borrowings with short
maturities and portfolio equity that can be suddenly withdrawn - is "too
hot" for emerging market countries to handle. It is tempting to answer
"yes", since short-term capital inflows are also like fire:
if not handled properly or used in the right environment, they can burn
down a country's financial system - and its economy - in very short order.
Moreover, if the structures that are burning - in this case countries
- are located close to one another, at least in the psychology of investors,
then a raging fire can spread quickly, much as the currency depreciations
during the Asian crisis swept contagiously through the region.
So much for the downside of short-term money, which have
been all too evident. There are also advantages that can be too easily
ignored. Foreign purchases of equities can add needed liquidity to domestic
securities markets, which in the long run are important for financing
the growth of new businesses in emerging market countries and weaning
financial systems away from reliance on banks as intermediaries. A key
advantage of the capital markets is that investors take their risks without
implicit or explicit guarantees of being protected if they are proven
wrong. In contrast, bank depositors are often implicitly or explicitly
provided with government insurance on their deposits, which can encourage
excessively imprudent lending by the banks unless properly supervised
and restrained (which even regulators in developed countries have proved
incapable of doing from time to time).
Moreover, even short-term borrowed money can have its
benefits - by enabling domestic companies to borrow at cheaper interest
rates than would be the case if no such funds were available at all. Presumably,
it was these benefits that induced the International Monetary Fund to
change its policy in 1997 to encourage the dismantling of capital controls
of any type.
Deceptive costs
A key lesson learned from the recent financial crises,
however, is that the costs of relying on short-term money - especially
funds borrowed in a foreign currency - can significantly outweigh the
benefits, under certain conditions. Most importantly, the costs of borrowing
short-term in foreign currency can be especially deceptive and ultimately
quite dangerous when a nation pegs its exchange rate to another, such
as the dollar. The costs are deceptive because in the short run, such
borrowing looks like an easy way to make money, borrow at low interest
rate in the foreign currency and invest the proceeds in higher yielding
assets in the home countries. But this only worked so long as the exchange
rate is pegged. At the first sign that country's foreign exchange reserves
are insufficient to meet the demand, domestic borrowers will dump their
own currency in a frantic effort to obtain the foreign currency in which
they borrowed. That, in essence, is what happened in Asia in 1997-98.
Short-term borrowing in foreign currency can also prove
dangerous if a nation's financial institutions are weak and not well supervised.
After all, it was the failure of Thai banks that triggered the Asian financial
crisis by causing a loss of confidence in that nation's economic management
and in its currency. The damage arguably would have been significantly
reduced had the Thai Baht been floating all along. In that event, domestic
borrowers would have had to factor in exchange rate risk when borrowing
funds abroad and almost certainly would not have been so enthusiastic
in running up foreign debts in the first place.
Long term capital
The cost-benefit calculation for long term capital inflows
- foreign direct investment - is quite different. The costs of FDI are
largely psychological or political. Citizens and their policy makers may
feel that their national cultures are threatened by the purchase of what
are viewed to be "national assets". Such feelings are not confined
to many developing countries that, until recently, have resisted FDI.
Not until its economy ran into trouble did Japan begin to open up to foreign
investment - primarily as a way to minimize the costs of rescuing bankrupt
companies or financial institutions. Even the United States, the leading
destination of FDI in the world, feared the buyout of certain famed buildings
and companies in the 1980s (but now no longer seems to mind when much
larger acquisitions are completed).
The benefits of incoming foreign direct investment, in
contrast, are quite tangible. Unlike portfolio capital, FDI inherently
is "sticky" : significant equity stakes in domestic companies
cannot be readily liquidated, especially during a crisis. Moreover, with
foreign funds comes valuable foreign know-how and skills, which gradually
seep out throughout a local economy as employees move to other firms or
start their own. The United States, for example, learned much from Japanese
companies that came to the country during the 1980s– just-in-time
inventory management and worker dominated quality control circles - which
have revolutionized much of the U.S. manufacturing sector.
Just as significant, the influx of FDI can help local
regulators as well by bringing cutting edge technologies to local shores.
This is especially important in the financial arena, where foreign financial
institution not only help educate domestic regulators about sophisticated
financial practices, but in certain cases have seen their top officials
move to the helm of domestic central banks or bank supervisory agencies.
Safety nets
The financial chapter in the Quality of Growth [a world
Bank publication], while devoting relatively little attention to crisis
management, constructively points out the importance of the often neglected
role of adequate social safety net programs in cushioning the economic
pain that financial crises inevitably entail. The chapter does not discuss,
however, the important role that unemployment compensation programs, in
particular, can play in minimizing this pain. Yet these, too, have their
limitations in emerging markets because of limited government budgets
and other pressing social needs. In addition, much of the labor force
in these countries often is informal and thus cannot be counted on as
a source of revenue for financing unemployment compensation (as employees
in developed countries are, with their modest payroll contributions to
these funds). An important role for such international financial institutions
as the World Bank is to assist in the initial financing of unemployment
compensation programs, perhaps on a matching basis, with the size of the
government match scaled to the per capita income of the country.
The IMF's role
Finally, no discussion of crisis management can be complete
without dealing with the role of the Bank's sister organization the International
Monetary Fund. Although I do not have the space here to give the subject
the treatment it deserves, I conclude with two observation.
First, to its credit, the Fund has established with its
refusal to lend to Russia in the fall of 1998 and to a lesser extent,
its similar stance vis-avis Ecuador several months later, that emergency
financing is not automatic. Investors now have been put on notice that
their funds are at risk and it is vital that the Fund does not change
that impression in the future. Toward that end, the Fund should not hesitate
to allow, if not insist upon, the imposition of standstills on repayment
of both public and private debt in order to buy time to allow more orderly
restructurings. In the meantime, the Bank and the Fund should continue
to work with countries to establish viable bankruptcy procedures and institutions
so that if another crisis should occur, such restructurings - either formal
or voluntary - will proceed far more smoothly than they have done so far
in most Asian countries.
Second, at the same time, the Fund must avoid imposing
a laundry list of conditions on its loans, elements of which have little
to do with restoring credibility (such as reducing tariffs on selected
commodities). Extraneous conditions not only undermine the legitimacy
of the Fund as well, since it is unlikely that the failure to meet them
will trigger a cutoff of the Fund's emergency loans.
In sum, the world has come a long way since the 1997-98
financial crises. By and large, the economies of the countries have bounced
back, while interest and exchange rates have returned roughly to pre-crisis
levels. The hope is that all concerned have learned at least some lessons
that can help avoid such crises in the future.
(Litan is vice president and director, Economic Studies Program, and
Cabot Family chair in Economics at the Brookings Institution. This article
is excerpted from Development Outreach, Vol 3 No. 1, a quarterly publication
of the World Bank Institute)
Strategic Alliance of SMEs
By Rukma Shumsher Rana
 I
wish to admit I am not an expert of small and medium scale industry. My
experience in the industrial area is strictly within large industry, a
sector in which we industrialists have our total preoccupation in how
to enter the vast Indian market with maximum concession in various duties.
This is a joke going around that we all are more concerned by the Indian
budget than by that of our own country. Instead of trying my hand at something
I know less about, I would like to limit myself to some important generalities.
Let me start with some statistics. The
small and medium scale industries (SMIs) far outdate large modern ones
of today. It is therefore quite obvious that their number is also a quite
large.
1. There are 35,494 establishments in
SMI sector in Nepal as of mid-April, 2001 (end Chaitra, 2058), which
accounts for 99% of total (Large+Medium+Small) industrial establishments.
2. SMIs have a fixed capital outlay
of Rs. 75,506 million till mid-April, 2001 which accounts for 41% of
total fixed capital outlay of the industry sector.
3. SMIs have provided employment opportunity
for 498 thousand people which accounts for 90% of the total employment
in industrial sector of Nepal.
4. SMEs contributed nearly 12% in GDP
in 1999 whereas it was merely 4.1% in 1978/79 (i.e., 20 years back).
Despite improving statistics, reality
is that out of total establishments, as per informal sources, more than
50% of the registered units in cottage, small and medium scale industries
are not in operation. More than 60% of those in operation are either sick
or running far below the installed capacity.
All of us are aware that in 1990's decade,
especially after Nepal India Trade Treaty of 1991 and 1996, Nepal's industrial
sector has grown steadily with encouraging exports also to India. In this
decade, Nepal's exports also to the third countries were remarkable. The
export of manufactured and processed goods with value addition in Nepal
accounted for more than 80% of the total export in 1999. This is a very
significant improvement compared to the figures of a decade back when
our processed exports and numbers of processed exportable items were very
low. According to the available information, the number of industrial
products manufactured in the country has crossed 250 items and around
half a dozen of them contribute significantly in the national export list
which are being exported mainly to India, Germany, the USA and some other
western countries.
In the past 10 years, Nepal's export to
third countries have increased five times and the exports to India by
14.5 times. In totality, Nepal's export increased by seven times. Likewise,
Nepal's import from third countries, India and in totality increased by
four times, 5.5 times and 4.5 times respectively.
Irrespective of these changes in the last
decade, how much have we exported to or imported from SAARC region except
India? While talking about Nepal's foreign trade with third countries,
so far we have been continuously neglecting or underestimating the important
markets around us. When we think about trading with third countries, or
WTO, we always consider about the western and European market. But the
reality is somewhat different. Nepal is in South Asia and most of our
products are ultimate consumer oriented. We have 1/4th of the total population
of the world within SAARC region. If we add the population of China, it
covers half of the world's population. Again when we count the population
of Asia as a whole, more than 2/3rd of the world's population is within
the Asian Continent. With the data of the population, I want to indicate
that more than 2/3rd of the world's consumer market is around us.
From the statistics of international trade
of our own from 1996/97 to 1999/2000, it is clear that the transaction
of Nepal with our close neighbors is very nominal. In view of the size
of market around us, our trade with SAARC countries other than India should
have been more than what has been achieved. On one hand, we are preparing
to enter WTO, and on the other, we have not been able to enter even into
our neighbouring markets except India and our trade with SAARC countries
other than India have never been more than 3% so far ! Actually, these
markets are more or less similar. We have acquired additional route to
Bangladesh after a long approach with India, but we have done nothing
to utilize it so far.
As seen from the statistics, out of total
industrial establishments, more than 98% are SMIs and out of total SMI
establishments, less than 2% are in joint ventures. It should be easier
to have joint ventures in SMIs rather than in large industries. I think,
the picture is easy to see.
Regarding the strategic alliances for
SMIs in Nepal, I would like to specially mention that most of the SMEs
are not established in such industrial area where physical infrastructure
is available. The existing industrial areas are not suitable for export
promotion. Because of this reason, Most of the SMIs, and large industries
as well have remained very uncompetitive. That is why, we are demanding
for Exports Promotion Zones(EPZ) where every physical infrastructures
would be ready. The government has to be very fast in construction of
such EPZ at different parts of the country. Three ICDs have been already
completed, the Broad Gauge Railway has touched Sirsia of Nepal. Construction
of EPZ at Birgunj, Biratnagar, Bhairahawa, Kathmandu ( for air cargo)
and IT park at Banepa as well as expected additional Broad Gauge Railway
link to Biratnagar and Bhairahawa will definitely augment the industrialization
and export promotion of Nepal. Such industries can be further enhanced
by strategic alliances among the complementary establishments.
Dabur
Nepal's experience on Strategic Alliance
In our company Dabur Nepal Pvt. Ltd (though
it is large industry) we have some strategic alliance in financing, technical
know-how, supply of partial raw materials, use of brand names, and marketing
with Dabur India Limited. Strategic alliance between big and small is
however not just one of using spare capacity. Therefore, Dabur Nepal has
many strategic alliance partners based on practical mutual benefits. Since
2/3 years back, we have started a "Green House" at Banepa. The
main objective of this green house is to prepare seeds and small plants
for our farms at various parts of Nepal, depending upon the suitability
of climate for the concerned herbs. Dabur alone cannot cultivate and fully
supervise all these farms spread over Marpha in Mustang, Gunchha in Sindhupalchowk,
Kakani in Nuwakot, Hunde in Manang, Gobreli/Vijaya Nagar, Meghauli in
Chitwan, Buthanilkantha in Kathmandu, Khawa in Jiri, Simara, Sitalpur
and Dabur's own farm in Bara, Nagarkot in Bhaktapur and Jyoti Farm in
Parsa. They all together cover an area of 70-80 hectares. Some of them
are on term lease and in some local farmers are cultivating the herbs
themselves with technical supervision from Dabur Nepal. We have the strategic
alliance with them for technical supervision free of cost, supply of seeds
and plants on cost and buy-back guarantee of their production. In some
cases, where farmers hesitate to do cultivation on their own for fear
of risks, the company takes their land on lease for a short period, and
demonstrates the cultivation. When the local farmers are convinced and
become ready for cultivation on their own, the company provides them facilities
for the same.
I am sure many large industries have similar
arrangements. The two large joint industries in Nepal, viz. Nepal Lever
Limited and Colgate Palmolive have also such alliance for supply of raw
material, packing materials, and marketing of their products with their
parent companies in India and other subsidiary companies in Nepal, which
have benefited both parties without losing their entity.
In conclusion, small and medium scale
industries need an intensive study. Their importance to the national economy
can never be minimised. the vast area which serves the daily needs of
the country has to be protected and nurtured so as to become a strong
base where the real industrialisation of Nepal can take roots.
(Rana is the President of
Nepal-India Chamber of Commerce & Industry and Chairman of Dabur Nepal
Pvt. Ltd. This article is adapted from a paper Rana presented at National
Conference on Small & Medium Scale Enterprises jointly organised recently
in Kathmandu by Center for Development and Governance and FNCCI.)
Forecasting 2001 Budget
Though delayed by almost 40 days than scheduled, the
budget for the coming fiscal year is being presented to the parliament
in the second week of July after a sufficiently long pre-budget exercise.
Unlike in the past when various sections of the society would start lobbying
only around the time the finance minister would sit down to write the
final budget speech normally the latter half of June , this year such
lobbying had started around March in anticipation that the budget would
be presented early May or late April, as promised last year when the budget
was presented on May 30.
Moreover, one would also say that the pre-budget exercise
this time has continued almost throughout the year. The high level Public
Expenditure Review commission (PERC) set up as promised in the last budget
speech, in a way kept the budget debate alive during its work and even
after its submission of the report.
Based on all these pre-budget exercises, the size of
the coming budget is expected to be around Rs. 107 billion, according
to an estimation made by former governor of Nepal Rastra Bank Satyendra
Pyara Shrestha in a paper he presented at a seminar held by Management
Association of Nepal (MAN). This amount, he suggests, should be bifurcated
into Rs. 46 billion for regular expenditure and Rs. 61 billion for development
expenditure. However, in the same program, another economist Dr. Minendra
Rijal projected it to be Rs. 83 billion with Rs 46 billion for regular
and Rs. 37 billion for development expenditure to be borne by Rs. 52 billion
as revenue collection, Rs. 6 billion as foreign grants and Rs. 17 billion
as foreign loan.
But Dr. Rijal also expected the finance minister to bloat
the total budget figure to Rs. 94 billion targeting development expenditure
at Rs 48 billion, revenue collection at Rs. 57 billion, foreign grants
at Rs. 11 billion and foreign loans at Rs 19 billion.
Meanwhile, the country's apex chamber, FNCCI, has submitted
a list of its own suggestions to the finance minister. Though it is most
likely that the finance minister as in the past, will take FNCCI suggestions
as only a ritual and will oblige by following the other side of the ritual,
i.e. making a huge noise of accepting some of the business community's
suggestions, while totally forgetting about most of others, the apex chamber's
suggestions are worth taking into consideration.
As in the past, FNCCI has pleaded for tax incentives
for investment by various ways such as allowing accelerated depreciation,
recognizing all promotional and advertisement expenses, providing VAT
incentives for higher scale of operation and income tax holiday for infrastructure
projects. Going by the past trends, or more particularly the experience
of the last year, it is most likely that these suggestions will be rejected.
As may be recalled, the finance minister last year imposed tax also on
income from exports and dividend and created hurdles in duty drawback
procedures.
Of course, it is easy for the finance minister to dismiss
the private sector's demand for tax concessions as it is a general tendency
for the private sector to keep on demanding concessions, and for the government
to keep on raising the rates and expanding the net. Sensing exactly that,
the Nepali private sector has tried to show ways to the minister to raise
the tax collection by ensuring better tax compliance. The logic: Nepali
private sector is not complying to the tax requirements because of a number
of flaws in the existing tax system. Remove the flaws, and there will
be more people paying taxes, ultimately resulting into higher collections.
Those flaws are mainly in is the behavior of revenue
administration, FNCCI argues as in the past. The animosity of the private
sector with tax authorities is so high that FNCCI has gone to the extent
of demanding such an arrangement in which the dialogue between the tax
payer and tax official is strictly in writing.
The gravity of the situation can be imagined by the finance
secretary's remarks in a pre-budget meet of the revenue administrators
which were quoted by the daily newspapers on the following days of the
meet. Therefore, demanding a more proper tax administration, FNCCI has
suggested to set up a permanent Board of Revenue with independent experts
that will have quasi-judicial powers to dispose of tax related disputes
in a speedy manner.
Pointing out the problem of slackening demand, FNCCI
has called for inducing consumption. For this, it has suggested to leave
more disposable income in the hands of households by reducing personal
income tax.
But the major source of expenditure in Nepal is still
the government as its expenditure accounts for nearly 22% of GDP. And
recognizing that, FNCCI has asked the government to raise its investment
in infrastructure projects such as roads, power and alternative transport
(railway). The message is to reduce regular expenditure and free the resources
for infrastructure. But as a substantial portion of the regular expenditure
is to go for debt servicing (21.33 % as budgeted for 2000-2001), this
suggestion may be accepted only if the finance minister dares to reduce
the expenditure, both in regular and development, adopting suggestions
of PERC. Though mild from world standards PERC's suggestions are going
to be very difficult for the finance minister to adopt them all in this
budget.
As an alternative, and also as the supplement to government
expenditure, FNCCI has also suggested to encourage private sector participation
in infrastructure project by promoting BOT or BOOT. But as seen by the
experience in Kathmandu-Hetauda tunnel road project and controversies
flared up about privately developed power projects (Khimiti and Bhote
Koshi), there is still a lot to do before BOT or BOOT in Nepal can be
really attractive for investors. Noting that about 20% of total development
expenditure goes to hydro-power development through Nepal Electricity
Authority, Dr. Rijal also has argued that if HMG is able to attract substantial
amount of foreign direct investment or foreign resources for hydro-power
generation and distribution, telecommunication, higher education, urban
hospitals and drinking water projects and road construction, a lot of
public financial resources will be released for spending on social sectors.
Another important demand of FNCCI is on the duty drawback
procedure which was, as the business community complains, made more complicated
and impractical by the last budget. Presenting the situation on duty drawback
as of mid-April 2001, FNCCI has stated that out of 3,134 applications
filed during the nine months of the current fiscal year with the One Window
Committee, 1,383 were pending with some Rs. 300 million as claims. Additionally,
some Rs. 89 million, which the committee had already decided by then to
return to the private sector, was lying unreturned.
As the arrear was because of insufficient allocation
for this purpose in 2000-2001 budget (only Rs. 200 million against the
estimated requirement of Rs. 1440 million), FNCCI has suggested for procedural
simplification so that the duty drawback amount can be adjusted at, or
returned from, the customs points themselves while importing and exporting
goods. This will do away with the unnecessary procedural delays in availing
this facility, it has argued.
In a set of last minute suggestions, FNCCI has mentioned
its target of raising Nepal's per capita income to US $ 500 per annum
within five years and US$1000 within 10 years, and suggested to target
8-10% growth rate for the economy and to bring a special policy to encourage
non-resident Nepalis to invest in Nepal. Though a number of countries
have actually achieved growth rates as those, the target seems really
over ambitious for Nepal for which last year's 6% growth rate was a matter
of celebration.
By New Business Age Reporter
FNCCI Suggestions
Encourage new investment by measures to
· Reduce pay-back period
· Reduce cost of funds
· Reduce transaction cost
Induce consumption by
· Increased public expenditure on infrastructure projects
· Encouraged private participation in infrastructure
projects
· Increasing minimum taxable income of a household
to
Rs. 100,000 per annum
Promote following promising sectors
· Agribusiness
· Alternate transport system (e.g. railway)
· Pharmaceuticals, research labs, IT
For increased tax compliance, do followings
· Minimize permit requirements
· Automatic acceptance of self assessed tax returns
· Set up permanent Board of Revenue with quasi-judicial
powers
· Set up tax settlement commission
· Make tax administrators personally liable for losses
caused by them
· Give up the practice of taxing turnover instead of
income
For export promotion
· Have a long-term strategy
· Treat export traders as equal to export manufacturer
· Develop product specific export zones
· For auction export, recognize deferred payment
· Set aside enough budget for duty refund
· Recognize ATA Carnet
Others
· Set up technology upgradation fund
· Allow contract labour freely
· Make it easier to exit the business if one wants
· Encourage contract manufacturing
· For WTO, bring necessary laws
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