Cover Story (Spotlight Weekly)

NEPALESE ECONOMY
Struggling For A Rescue Strategy

The new government, although entrusted with holding elections and conducting a few other tasks, has announced an economic reform package. However, the country has confronted four general strikes since the package was unveiled. As the Nepalese economy has been passing through an uncertain phase, both monetary and fiscal policy need to be put to work. How the government implements the package amid political turmoil and an upsurge of Maoist violence remain to be seen.

By KESHAB POUDEL

After remaining an outside observer of the Nepalese economy for about two decades, Finance Minister Dr. Badri Prasad Shrestha has taken charge as captain of a ship that is sailing in rough tide and wind. Dr. Shrestha, a former vice-chairman of the National Planning Commission who has also served as ambassador to Japan, must first find out where his ship is heading in order to prevent accidents.

Every finance minister wants to portray himself as a good economic captain. In reality, all finance ministers have more in common with the early navigators: they often don't know where they are, where they are heading; their maps and compasses are unreliable and their steering is wonk. Worst of all, with the escalation of the Maoist insurgency following the imposition of the state of emergency, the finance minister has been helpless to execute his policy announcements.

As the export and agriculture sectors are passing through rough weather and all economic indicators are gloomy, Dr. Shrestha does not have an easy task ahead. A member of a government constituted with a with limited mandate, Dr. Shrestha announced a new reform package with short-, medium- and long-term programs to bring the economy back on the right track. As revenue slumps and the economy wobbles, nobody knows whether Dr. Shrestha can rescue Nepal from its current doldrums.

Most economists and businessmen reckon that the Nepalese economy will come back on track once the Maoist insurgency comes to an end. As soon as normalcy returns, they expect growth to pick up and the economy to rebound. They still do not grasp that this recession was quite different from all previous cycles. Even if a cease-fire is announced, the economy is unlikely to return to vigorous and sustained growth.

"We are passing through a very critical phase. So there are no other options before us but to use the available resources with austerity measures. This Economic Reform Package intends to show the economic difficulties faced by the country," Finance Minister Shrestha said. "If we utilize our scarce resources with optimum goals and receive support from donors, we will rescue our economy."

Dr. Shrestha has stressed the need to bring reforms in governance, decentralization, administrative performance, planning management and overall economic reform. He has also emphasized the urgency of reforms in public expenditure management, improvement in revenue mobilization, financial accountability, more efficient management of public corporations, financial-sector reforms, service delivery, the implementation of Medium Term Expenditure Framework and Poverty Alleviation Fund.

As the government has proposed so many programs over a short period of time, many economists are doubtful over its ability to implement them. "Our aim is to bring the economy on the right track. So, there is no question of time frame," the finance minister said.

Each incoming government has a tendency to announce certain programs to show that it is committed to reforms and economic liberalization. Over the last 12 years, five types of governments, including centrist, rightist, leftist, centrist-left, left-right and centrist-right coalitions, ruled the country. Except during the brief period of minority communist rule, when liberalization was put on the back burner, all governments have followed similar economic policies.

This is a realization among political parties that they cannot manage the economy on their wishes alone. As revenue generation has remained insufficient even to meet public expenditures, there is no miracle cure.

"One of the good aspects of the Economic Reform Program 2059 is that it is a continuation of the same economic fundamentals," says Professor Bishwomber Pyakuryal, a leading economist (See box). "It may not create the much confusion among the donor communities and it is very important. When the government does not have any scheme to increase revenue, foreign aid is necessary to carry out development activities. We have to convince the donors that we are not deviating from the economic fundamentals. Many of the policy announcements made few a week ago need certain consensus among various political forces."

Since the country has a record of leaving such packages on paper, there is widespread suspicion over whether this one can be implemented. Unfortunately, we have never shown seriousness to implement them. The recently announced economic reform programs embody the same commitments previous government had made. It remains to be seen how the government implements them. "We announced eight major reform sectors two and half years ago and a policy announcement was made at the meeting of Nepal Development Forum in April 2002. We have identified reforms over the immediate, short, medium and long terms. The government must show why it is unable to implement the policy commitments announced two and half years ago? What are those intervening variables that have restricted the execution of these programs," says Pyakuryal.

The state of the economy is not in a very good shape. Tourism has gone down, exports have declined significantly and the industrial sector is in the doldrums. The non-agriculture sector's overall growth and activities, especially for the last year, was negative. The scale of the economy malaise is reflected in the gross domestic product, which has fallen below 1 percent for the first time.

Early indications show that the economy will have to face a worse scenario in the coming years, as major crops like rice are not doing well. Moreover, the non-agriculture sector has not been able to pick up. Given the present scenario, it would be a miracle even if the country achieves a growth rate of three percent this year. Revenue mobilization was not very good because of a number of reasons.

"The exports over last year has gone down by 3.6 percent and import is down by around 1.1 percent, revenue by 11.0 percent. Tourist arrivals may drop by 100,000 (100,000 last year and 200,000 in two years) further. The growth of the GDP is below one percent and per capita income, too, has dropped. These indicators show the poor state of the economy. Any immediate sign of recovery has not been seen so far," says industrialist Rajendra Kumar Khetan, second vice-president of the Federation of Nepalese Chambers of Commerce and Industry.

As the security and law and order problems are yet to improve and the effects of the last year's negative economic growth persist, there is very small scope to increase income tax. With the export, import and manufacturing sectors have gone down, the situation of customs is not very good, either.

In non-tax revenue, there are significant problems. As the situation in the Gulf region is uncertain, with confrontation over Iraq looming large, any change or increase in the world oil prices will further damage the Nepalese economy. Nepal Oil Corporation, which is one of the major public enterprises providing income tax and the custom duty to the government, is wading in difficult times. Nepal Telecommunications Corporation and Nepal Electricity Authority, too, have serious problems, especially since the rebels have damaged a number of installations. Both organizations would have to spend a lot of money on repairs. The non-tax growth rate will remain dismal. All this suggests that the country has serious problems in terms of revenue mobilization. Revenue collections have fallen in recent months, while expenditures and domestic borrowings have increased. The risk of fiscal instability is growing.

In the 1990s, Nepal's economic performance improved with per capita income growth increasing to more than 2.5 percent. The economy responded to macroeconomic stability and the first round of liberalization and population growth rates fell. But the economy received a major jolt in 2001 in the form of internal and external events. The weakening internal economy felt strong shockwaves when the Maoists started destroying infrastructures as part of their expanding violence.

"For fiscal balance to be maintained, we have to follow two strong strategies. First, we have to announce some austerity measures in regular and development expenditures. We have to go on a priority basis," says Dr. Shankar Sharma, who was recently appointed vice-chairman of the NPC.

Whatever policy makers say, the prospects of reducing regular expenditure are very low, especially since security spending is rising. Moreover, debt obligations and strong components of salary and other expenses make it virtually impossible to cut down on regular expenditure.

Friends in Need

Despite firm commitments on the part of donors, the government is yet to receive aid to fulfil the funding gap. As revenue generation is at saturation point and austerity measures alone are not enough to save expenditure, Nepal is forced to turn to the donor community to continue developmental activities.

"We have to get foreign aid as budgetary support as much as possible this year. That is the number one priority. Donors have been saying that they will provide some budgetary support immediately after the elections. But now, the political scenario has changed. We are hoping that over the next two to three months donor agencies will be able to support the government, given the fiscal situation and development activities," says Dr. Sharma.

To fulfill the donors' demand, the government has announced certain reforms in managing public expenditure. One of the important commitments is the government's announcement to stick to the economic policy framed by previous governments, including continuation of the privatization process. "We will privatize eight public sector enterprises and take necessary action to reduce financial burden of the government in government undertakings," said Finance Minister Shrestha.

"As Nepal's economy is facing hard times, donors can help to revive it by aiding development activities. This is not the time for donors to put one conditionality after another. As friends of Nepal, they can help rescue us by reviving our economy," says a senior economist.

"We hope that we will get some support from the donor community. Immediately after the publication of the Tenth Plan and Medium Term Expenditure Framework, revision of programs, we will have a different approach. The reform package will set the tone for the economic management and planning of the country over the next few years. This will be quite a landmark in the history of the economic development of Nepal and it will have significant contribution in our economy," says Dr. Sharma.

The Nepalese economy remains highly vulnerable because it is yet to have solid foundations. The country's economy is still determined by couple of sectors while the non-formal sectors are very limited. Agriculture plays an important role, contributing more than 35 percent of GDP.

Despite its importance, the agriculture sector is yet to receive enough funds. Productivity of land is low and irrigation facilities are limited. Agricultural and rural economic growth remain constrained by inadequate infrastructures, weak irrigation and inadequate inputs. Only 15 percent of the country's cultivated land is under year-round irrigation. It is said that the irrigated area may have fallen in the 1990s. Nepal does not have good road infrastructures. Although the government has endorsed the 20-year Agriculture Perspective Plan, it is yet to meet the budgetary requirements.

Thus agriculture has had to depend on good monsoon clouds of the Bay of Bengal. Less rain means less production. The non-agriculture sector, too, is vulnerable. Tourism, garments and carpets, which used to be popular in Organization of Economic Cooperation and Development countries, have taken a beating. Trade with India has gone negative following the expiry of the first treaty. The World Bank's Economic Update 2002 presented at the Nepal Development Forum showed cancellations of export orders caused by trade disruptions and higher insurance costs after the events of 9/11. Rising costs and uncertainty due to power disruptions, general strikes, direct terrorists attacks by Maoists and other groups on carpet and garment factories and on the liquor business have taken a serious toll.

The Economy Survey shows that the tourism, hotel and restaurant industry - which accounts for around 10 percent of GDP - has been badly affected in recent years. The hijacking of an Indian Airlines plane in December 1999 hit tourism very hard. The royal family massacre on June 1, 2001, the 9/11 attacks in the United States and growing Maoist insurgency have damaged the tourism industry.

Tourism entrepreneurs say they are in a no position to continue their business. "If the situation erodes any further and arrivals continue to go down, we will be compelled to shut down the hotel industry," says Prasiddha Bahadur Pandey, general manager of Hotel Shangri-La.

Economists agree that the Nepalese economy is very vulnerable. "Major economic indicators were shaken by smaller events. Whether it was during the 18-month Nepal-India trade and transit stalemate in 1989-90 or the aftermath of the royal palace massacre, we saw unprecedented impacts on the economic variables like foreign tourist arrivals, depreciation of Nepalese currency against the US dollar and export," says Dr. Pyakuryal.

Actually, Nepal's problems are political. After the overthrow of the Rana regime in 1950, Nepal entered a phase of political instability, including various levels of insurgencies. Whether during direct rule of the King or under full democracy, no prime minister has been able to complete his full term in office. Whenever a semblance of recovery and stability has appeared, the government has changed. As long as this political situation continues, no economic program can yield results.

Nepal is certainly not the first country in a civil war-like situation. Liberalization has brought armed struggles in many least developed countries. There are many war-prone and terrorist-affected economies. Despite the installation of a new government, a sense of political stability and signs of an imminent end to the violence have yet to emerge. Unless this changes, Nepalese will have little hope of economic recovery.

'We Must Not Deviate From Economic Fundamentals'

— Dr. BISHWAMBHER PYAKURYAL

Professor BISHWAMBHER PYAKURYAL, Ph.D., teaches economics at the Central Department of Economics at Tribhuvan University. Professor Pyakuryal spoke to SPOTLIGHT on various issues of the Nepalese economy. Excerpts:

How do you see the present state of the economy?

I prefer to call the present state as economy of emergency. Nepalese economic fundamentals are correct comparatively to other South Asian countries, but major economic indicators are moving on a negative trend. In the case of Nepal, major economic indicators were shaken by smaller events. Whether it was during the 18-month Nepal-India trade and transit stalemate in 1989-90 or the aftermath of the royal palace massacre, we saw unprecedented impacts on the economic variables like foreign tourist arrivals, depreciation of Nepalese currency against the US dollar and export. There have been dramatic declines in export earnings and tourist arrivals. This indicates the vulnerability of the Nepalese economy. Nepal is not the first country to undergo a civil war-like situation. Following the introduction of liberalization, we can see many armed struggles in the least developed countries. There are many war-prone and terrorist-affected economies. We have to learn from their experiences.

What is the situation of the economic variables?

Our economic fundamentals are, one school of thought argues, very good. If we go through the statistics of the last decade, the results show otherwise. Urban growth has been 8-9 percent but it could not guarantee a reduction in inequality among different groups and regions. If we look at the poverty indicators, the situation has gone from bad to worse. Between 1985 and 1995, the incidence of poverty was found to be around 40 percent. The gap of urban rural poverty has been increasing alarmingly. These are the recent scenarios of poverty.

How do you see income distribution?

Inequality in the distribution of income is high. In 1995/96, our micro-economic stability was better compared to 1984-1985. Income disparity is higher in urban areas than in rural areas. There need to be a dialogue on urban poverty among the different stake-holders. If we don't take this issue seriously, more people would come under the poverty line. And things are not going to be manageable. Inequality in terms of consumption of the 20 percent non-poorest and 20 percent poorest has increased in the same period. There are regional disparities and imbalances. Rural hills have 28 percent poverty, but mid and far-western hills have 72 percent. Contrary to conventional thinking that small farmers are under the poverty line, our recent statistics have revealed that more than 32 percent of large farm holders who have two hectares of land also fall under the poverty line. The average land holding of the poor is 0.93 hectares per person and that for the non-poor is 0.97. Recent statistics show that 32 percent of the farmers are below the poverty line. We have not been able to look into the emerging trends of economic indicators, though we have seen so many vulnerabilities in the economy.

Are there ways of increasing resources?

We may have a few alternatives. Increase the interest and tax rates. Unfortunately, the country is in no position to do so, especially when overall economic conditions are poor. In such a situation, the economy needs additional investment. Even developed countries inject additional money in times of crisis. After the 9/11 terrorist attacks, the US government injected huge amounts of money in airlines and tourism sector. Such investment generates the life in the economy. Our government is not even in a position to pay new salaries to employees. Our security expenditure has increased by many folds. Even if we borrow money, we have to fulfill certain conditionalities.

How do you view the economic reform program the government recently announced?

One of the good aspects of the reform program is that it is continuation of the same economic fundamentals. It may not create much confusion among the donor community, which is very important. When the government does not have any scheme to increase revenue, foreign aid is necessary to carry out development activities. We have to convince the donors that we are not deviating from the fundamentals of the economy. The policy announcement needs certain consensus among various political forces.

What is your experience with policy announcements made over different periods of time?

Unfortunately, we have never shown seriousness to implement them. The recently announced economic reform program expresses many of the commitments previous government made. It remains to be seen how the government implements them. We announced eight major reform sectors two and half years ago and a policy announcement at the meeting of Nepal Development Forum in April 2002. We have identified immediate-, short-, medium- and long-term reform programs. The government must show why it has been unable to implement policy commitments announced two and half years ago. What are the variables that have restricted their execution. Without analyzing such variables, no reform program will have credibility.

What are your conclusions?

Whatever the situation we are facing, the foremost thing is political exit. In the meantime, we have to implement programs without deviating from major economic fundamentals, including the poverty reduction strategy and medium term expenditure frameworks. Nepalese economy will have to pass through the existing vulnerabilities for quite a long time. We need more investment. We require country-specific reform programs keeping in mind that new groups of people may join the poverty group. There needs to be a meeting of different stake-holders. We have to summon a meeting of the Nepal Development Forum. Such meetings have been called during crises like the South-East Asian currency crash. Many assumptions and policies are not compatible with the present crisis.

'The Government Must Enlist The Private Sector's Active Support'

—RAJENDRA KUMAR KHETAN

RAJENDRA KUMAR KHETAN, second vice-president of the Federation of Nepalese Chambers of Commerce and Industry (FNCCI) and president of Nepal Britain Chamber of Commerce, is one of the prominent businessman of Nepal. Frank and bold, Khetan, who is also spokesman of the FNCCI, spoke to SPOTLGHT on various issues. Excerpts:

What is the status of the economy?

The exports over last year have gone down by 3.6 percent and imports are down by around 1.1 percent, and revenue by 11 percent. Tourist arrivals may drop by 100,000 (100,000 last year and 200,000 in two years) further. The growth of GDP is below one percent and per capita income has dropped. These indicators show the poor state of the economy. No immediate signs of recovery have been seen so far.

Don't you see possibilities for improvement?

I am always optimistic since possibilities always exist. The government administration , political parties, planners and private sector need to work for a common goal, i.e., economic development of individual citizens. The Tenth Plan should be discussed and the annual budget should be introduced accordingly, as per three monthly review. Parameter growth should be monitored. Everybody should be informed about how poverty could be brought down and growth of per capita income could be made sustainable. The private sector plays 78 percent role in GDP but it does not have any involvement in the decision making process. The government cannot make change without active participation and support of the private sector. Since the private sector has already lent their hand, it is up to the government to decide now.

What steps should the government take?

First let us find out the problems and then work to solve them. Moreover, a time-bound white paper should be published with a target-oriented approach. A line should be drawn between what government needs to do and what society needs to do. The overall issue is governance, accountability and service delivery. There should be as system of reward in the administration and severe punishment for those who do not deliver. More public hearing (with decision making power) offices should be established to avoid corruption and guarantee smooth chain of command. The administration reform study report must be implemented. To be competitive, we need more capital injection, access to better technology and enhanced human resources. Government should play facilitative role to complement this and should not create legal and bureaucratic hassles.

What are the priorities of the business sector?

Some of the priorities of businesses include industrial security, one-stop shop like BOI, support to the manufacturing Industries and removal of other hassles, support to the tourism Industry and sorting out labor-related issues.

How do you see the decline in the garment and carpet industries?

The government should give greater attention to garment and carpet sectors. There should be enough budget for sectoral country-wise promotion campaign and special support to be competitive like logistics and taxes.

How about tourism?

We have been seeking to waive visa fee for tourist arriving for three to five days. There must be an open-sky policy. Programs should be launched to enhance Nepal's image as a tourist destination.

How do you visualize the law-and-order situation?

It is at a stand-still, neither better nor worse. Gradually people are getting habituated to blasts and deaths, which have to be stopped somewhere. Peace is the only way to progress and dialogue is best way to peace. To have one goal of development, I think His Majesty King, people, political parties and government need to agree on minimum common formula of integrated socio-economic development and security.

Will the government's new economic recovery program benefit the private sector?

The finance minister's statement on the economic situation is well prepared, but we must not see it as a recovery plan. I think there needs to be a different package for economic recovery. What the government has announced is total commitment in bringing important issues at one place. But this should be backed by service delivery mechanism on specific agendas by specific officials within a specific time frame.