Economy

These are vastly different topics, but in some ways they reflect both Nepal’s crisis and its opportunities.

The Maoist insurgency is affecting all areas of life - from villages to the commercial and industrial centres of the country. Nepal’s economy performed poorly last year. And although there are some encouraging signs, rising Maoist violence, continuous strikes, and increased extortion and intimidation are driving down the profit margins of many companies. Foreign investment has declined by 47% for the first quarter of Nepal’s fiscal year and it is likely to continue on a downward trend unless Nepal can deal with the Maoist insurgency, increase transparency and reduce regulatory barriers and bureaucratic red tape.

His Majesty’s government and international donors can assist in arresting these trends, but the future of Nepal really lies with the success of private business. And why? Nepal continues to have one of the highest rates of population growth in the world. In 1963 there were 8 million Nepali - now 40 years - a little over a generation later there are 24 million. The manifestation of a larger problem and opportunities. The answer: jobs, jobs, jobs and more jobs.

Business is the best way to provide widespread employment, raise the standard of living, and develop capital to invest in improved services. Business is the best way to provide the means to support Nepal’s growing population, overcome Nepal’s geographical limitations, and help Nepal realize its promising potential.

The country desperately needs private sector’s help, its vision and its initiative. They should look beyond their profit margins and winning the next lucrative contract. They should invest in the employees and their families. They should volunteer to help those less fortunate. By this, not only can the businesses enjoy improving the community’s living standard; they can realize a practical business return - reducing support for the Maoists by removing popular resentment that is, in turn, caused by to the lack of services.

I am sure, no businessperson likes to acknowledge that he or she has been confronted with demands to pay Maoist extortions or “donations,” as they so euphemistically call them. Many choose to be quiet and simply pay. By conceding to terrorist demands, however, they contribute to the environment of fear and violence. The businesses as a group can join together to face this threat.

As a foreign diplomat, - not as a Nepali - it is easier for me to say this. It is more easily said than done. However, with every rupee paid, another bullet is purchased. With every payment made the businessmen only encourage the Maoists to continue to extort.

Only the strong can stand up and be counted. And, as a group, the businessmen can do wonders to stop the vicious cycle, shed light on their darkness, and create a better and a sounder climate for investment that will create the stable and prosperous Nepal that we all want and what all thinking and caring Nepalis want. Public outreach to highlight the costs of Maoists exactions to the nation and to the public welfare is one way to counter their hypocritical and self-serving claims of concern for the common man and woman.

I congratulate the private sector of Nepal for Nepal’s entry into the WTO. This membership will expand the range of opportunities available. These opportunities, however, are also accompanied by a number of new challenges.

Accession into the WTO brings important benefits for Nepal. Nepal can benefit by joining the international trading system, which in essence will help to reduce the cost of Nepali made goods in the long-term and serve as a boost to exports. The challenges, like the benefits, however, are numerous.

Meeting all of its commitments to WTO will be tough for Nepal. Especially for some protected sectors in the economy, but the outcome of being a member of this organization are tremendous.

A second benefit Nepal will receive from WTO membership is the opportunity to enhance its climate for trade and investment, which will lead to a higher level of economic growth and enhance the quality of life. Key to achieving this benefit will be establishing and respecting the rule of law and transparence that are fundamental to overcoming poverty and attracting additional sources of foreign direct investment.

The WTO provides a modern forum to make the global trading climate more effective. It allows us to work together on common goals and to discuss our differences.

WTO is a long-term effort that delivers good governance to facilitate international trade and investment. However, the immediate political and social tensions being exploited by the Maoists must be addressed in order for the kingdom to move forward into the international trading system. The elements of both of these tensions can be addressed simultaneously by dedicated support from the business community.

The US is committed to Nepal’s being an active and viable member of the World Trade Organization and is working on a technical assistance program, as are other donors, to make its accession a true success. We look forward to working with Nepal to create a better global trading environment and partnership.

(Malinowski is US Ambassador in Nepal and this article is based on his speech at an interaction held recently in Kathmandu)

ADB is assisting the Government to develop a new macroeconometric model for Nepal. Unlike earlier models, the present macro-model is a Keynesian income expenditure model where GDP is endogenously determined by demand. A special feature of this macro model is that, being a polar model, it permits checking the robustness of forecasts of the other existing models, which take supply-sided approaches with GDP treated as an exogenous variable.

Moreover, the present macro-model is better suited for policy analysis. In the production approach, GDP is predetermined in the model and this makes it difficult to analyze the impact of policy changes on GDP growth. Existing models usually assume different growth paths and examine the necessary policy changes to achieve the target growth rates. Nepal’s Tenth Plan (FY2003-FY2007), for example, specifies normal and low growth paths and then compares corresponding policy scenarios.

The Nepal Macroeconometric Model (NMM) starts with different sets of policy scenarios (defined by a set of policy instruments) and examines their implications for economic growth and other important macroeconomic variables. With the NMM, policymakers will, therefore, be able to evaluate “what if?” scenarios.

The NMM will also be used to conduct debt sustainability analysis. Managing the public debt within a sustainable level is one of the most important policy issues. In assessing debt sustainability, macroeconomic variables such as income growth rates and budget deficits are key factors. In previous models, these macroeconomic variables were independently forecast without verification of their internal consistency.

The NMM is a medium-sized annual macroeconometric model with 37 equations. There are 20 behavioral equations, and 17 are identities. Of the 59 variables in the system, 37 are endogenous and 22 are predetermined or exogenous. Among these, there are 5 policy variables: taxes, regular and development government expenditures, foreign borrowing, and the exchange rate. Given that Nepal’s exchange rate is pegged to the Indian rupee, monetary variables are not included in the list of policy variables.

The NMM is essentially a Keynesian income-expenditure model in which the expenditure side determines GDP and the supply side is not specified. Its basic features are drawn from the Korea Development Institute (KDI)’s macro model which was used to design the five-year development plans of Korea until 1993. As shown in the Figure, there are five building blocks in the NMM: final demand, prices, credit and money, government, and the balance of payments blocks. Once a shock occurs, whether it is external or policy related, it affects the economy directly or through the propagation mechanism across the five building blocks. Adjusting to the shock, all the variables go through a dynamic process until the economy finds a new equilibrium.

In the final demand block, private consumption is determined by disposable income and its distributed lags. Government consumption and investment are linked to the two government expenditures - regular and development expenditures - in the government block. Other determinants of government investment are the real interest rate and foreign borrowing. This specification addresses the fact that investment projects are pursued by the government mostly through external financing. The inclusion of the real interest rate in the investment equation provides a channel through which monetary shocks are transmitted to the real sector.

Considering the large volume of Nepal’s external trade with India, the determinants of imports and exports include Indian factors - imports from and exports to India – in addition to the usual determinants such as the exchange rate and GDP (in imports only). The Indian factors are also important in the price and exchange rate equations. The most important explanatory variable for the Nepal CPI is the Indian CPI, but M2 is also included in the price equation to link the monetary sector to the real sector. Because the Nepali rupee is pegged to the Indian rupee and is fully convertible on all current account transactions, the money supply is endogenously determined in the model: the change of net foreign assets of the central bank is directly linked to the overall balance in the balance of payments block. As the money supply is endogenously determined, interest rates are also an exogenous variable in the model. It is difficult to find a domestic variable that has explanatory power in the interest rate equation.

The NMM is intended to generate five and ten-year forecasts. Considering the rapidly changing economic structure of Nepal, a five-year forecasting horizon seems more relevant. In order to generate forecasts, future values for exogenous and policy variables are specified in advance. Three approaches are adopted. As a default baseline scenario, the model statistically forecasts future values for exogenous and policy variables. We find that AR(2) plus a time trend specification works best for most variables.

Nepal’s Tenth Plan (FY2003-FY2007), the current guide for economic policy in Nepal, specifies normal and low growth paths. Normal growth path assumes rapid restoration of political stability within the first year of the Plan and its target growth rate is 6.2% per annum. Low growth path expects prolonged political instability and assumes an annual average growth rate of 4.3%. In the NMM, in addition to the baseline scenario, two other policy scenarios - normal and low growth scenarios, are examined. In these scenarios, future values for policy variables are specified to match those of the corresponding variables in the Tenth Plan for comparison. Future values for exogenous variables are statistically specified as in the baseline scenario.

Forecasts for Key Macroeconomic Variables

(unit %)

Variables	FY1998-FY2002	FY2003-FY2007
	Actual	Baseline	Normal Growth	Low Growth
GDP	3.7	4.1	5.6	4.4
GDPN	8.5	10.3	11.7	10.6
CPI	5.7	6.4	6.3	6.4
Private Consumption	3.9	3.4	4.5	4.1
Govt. Fixed Inv.	5.9	-0.4	5.2	-0.2
TB/GDPN	-16.0	-12.2	-13.6	-12.6
CB/GDPN	-6.0	-4.5	-6.2	-5.0
OB/GDPN	2.1	0.8	-0.5	0.8
OVSURFG/GDPN	-4.0	3.5	-2.6	-1.9

GDPN: Nominal GDP, CP: Private Consumption, CB: Current A/C Balance, OB: Overall Balance or Change in Reserves, OVSURFG: Overall Balance Including Grants.

In the baseline scenario, while the average tax ratio was 8% for the last 17 years, it is forecast to be 10.7% over the next 10 years. In the normal and low growth scenarios, they are specified to be 8.9% and 8.4% respectively, to match the corresponding forecasts in the Tenth Plan. The regular expenditure and development expenditure ratios show similar trends in all three policy scenarios. The share of regular expenditures will increase whereas that of development expenditures is expected to decline. However, the sum of the two expenditure ratios is expected to increase slowly over the next five years.

While the foreign borrowing ratios (with respect to government’s overall balance) over the next five years are projected to be 47.5% and 80.5%, respectively, in the normal and low growth scenarios of the NMM, it is forecast to be only 17.8% in the baseline scenario, reflecting the sharp drop of foreign borrowing in recent years. The actual ratios were 65.3%, 40.8%, and 17.9% from 2000 to 2002, respectively. If the recent drop in foreign borrowings is mainly due to recent political instability and is expected to recover in the near future, the time series forecast in the baseline scenario is likely to be underestimated. However, if political stability is not restored shortly, the baseline scenario indicates the projection in the Tenth Plan might be too optimistic and it will become increasingly difficult for Nepal to obtain external financing in the form of grants in future. The exchange rate depreciation against the U.S. dollar is projected to slow from 9.2% to 5.7% over the next five years in all three scenarios.

The Table reports the forecasts for key macroeconomic variables. Five-year (forward) horizon forecasts of real GDP growth rates are 5.6%, 4.4%, and 4.1% under normal, low growth, and the baseline scenarios, respectively. These forecasts are somewhat\ pessimistic than the average growth projection of the Tenth Plan. In the Tenth Plan, the average growth rate forecasts are 6.2% and 4.3% in normal and low case scenarios, respectively.

In the NMM, it is not surprising to see the lowest forecast under the baseline scenario considering its pessimistic projection for foreign borrowings. As for the other forecasts, average CPI inflation will be around 6.4% annually in all scenarios. The growth rates of private consumption are between 3.4% and 4.5%. The forecasts for investment are quite different across scenarios. A relatively small deficit is forecast in the current account balance, while the trade deficit will amount to 11-12% of nominal GDP. Owing to the large capital surplus, the overall balance of the BOP account is more likely to be in surplus. The overall budget deficit including grants is forecast between 1.9% and 3.5% of nominal GDP.

Globalization is the present day reality. Increased movement of goods, services, capital, and knowledge has opened up tremendous opportunities, particularly in the economic front. However, there has been growing threat of further marginalization of weaker economies that do not have easy access to technology, knowledge and capital. Nepal, a country facing physical as well as managerial constraints looking to get away from its economic poverty, is very much in need of a system, which safeguards its rights in external economic front and which assures internal policy stability.

In this context, Nepal decided to join World Trade Organization in order to get benefit of expanded market access guaranteed by the multilateral framework of trade rules based on its principle of non-discrimination, transparency, and progressive liberalization. Nepal expects increased inflow of capital and technology due to enhanced atmosphere of predictability with legally binding commitment on its economic governance policies.

In the history of WTO, Nepal and Cambodia became the first two least developed countries which successfully concluded their accession negotiation. And their protocols of accession were accepted by 5th Ministerial Meeting of WTO on 11th September 2003 at Cancun. Accession negotiation, which is considered most strenuous, time taking, complex and costly, establishes the terms of membership in the form of commitment and concessions.

Nepal had negotiation for her accession with global key players including the USA, EU and Japan among other WTO members. US negotiators had been very sympathetic and supportive towards Nepal’s accession. Nepal’s negotiation for her accession to WTO itself has been a very rewarding experience. It has been, in fact, a great learning to understand the diverse concerns of developed and developing member countries particularly in relation to market access and systemic issues. And, in the mean time, it has been an opportunity for us to let the member countries know the difficulties and vulnerability that Nepali economy is facing.

Nepal’s package of WTO membership, thus, has been the outcome of the efforts in balancing Nepal’s development needs and capability with the concerns and demands of member countries. Compliance with the obligations engendered from Nepal’s membership package is supposed to strengthen delivery capability of domestic institutions and to enhance competitive capability of business entrepreneurs.

Nepal, in fact, had been very open during the accession negotiation regarding her weakness in institutional and competitive capability which require technical assistance from member countries and donor agencies. And it is well reflected in the Working Party report.

After the finalization of Nepal’s membership package to WTO, efforts are concentrated in three specific areas: (a) Policy review along the formulation and amendment of related legislation for WTO compatibility; (b) Dissemination of opportunities/challenges of WTO membership to wider group of stakeholders, and (c) Request for technical and financial assistance for capability enhancement particularly in infrastructure and Human Resource Development.

Sectoral policy regime related to industry, investment, agriculture, telecommunication, banking are undergoing review along with the amendment and formulation of related legislation to make them compatible to provisions of WTO principle, agreements, and membership commitments. Policy and legislation are prioritized, the time frame has been agreed and transition period granted during the accession negotiation. Ratification of the protocol is to be done by 31st March 2004.

Opportunities, threats, and challenges along with the measures and preparations to benefit from the WTO membership are the major topics discussed among related government agencies, business groups, NGOs, civil societies, and academic institutions through different forums such as seminar, workshop, interaction programs, talk programs, over mass meetings and media. Government sector agencies have designated senior level officials as WTO focal points, while the private sector business associations have started to establish and designate separate cell to study and look after WTO matters.

In order to abide by the schedule of action plan particularly in the field of Customs Administration, Technical Barriers to Trade, Sanitary and Phyto-sanitary Measures, and Trade Related Intellectual Property Rights mentioned in the protocol of accession, Nepal has requested WTO member countries for their technical and financial assistance. Similarly, under the Integrated Framework (a mechanism to enhance capability of Least Developed WTO Members) a diagnostic study relating to competitiveness is completed with World Bank support. Proposals for technical assistance identified by the study are requested through IF Working Committee for infrastructures needed to enhance Nepal’s competitive capability. Local coordinating body under the convenorship of a member of the National Planning Commission is assigned to follow up IF assistance.

Nepal believes on the need of effective functioning of WTO in enforcing its highly advocated fair trade mechanism put into practice by way of positive discrimination known as Special and Differential Treatment, Duty Free Quota Free Market Access. Equitable global economic order can be achieved by enhancing capability of weaker economies providing level playing field for the benefit of efficiency in competition in more liberalized and freer trading system.