July 2006
Economy & Policy

BY Madhukar Shumshere J.B.Rana

Maoists think that a budget is not necessary to be presented to parliament and be debated therein. Actually, they think that it should be announced only after they are inducted into the Interim Government governed by an Interim Constitution. Such is the demonstration of their faith in multi-party parliamentary democracy.

The National Planning Commission is a total void and thus the fate of the PRSC, PRGF, MTEF and IAP are in disarray. The multilateral donors are conspicuous by their silence. They wonder whether there is to be a market-based economy or will Nepal rescind to the evolving 'economic nationalism' of the oil-and minerals-rich Latin American and African countries. They must wonder what the fate of their well-crafted conditions for reforms, with tiers of incentives and disincentives for Nepal , is to be. The street politics to roll back the King's ordinances is really a political ploy by the organized sector not to go for market economy since the market is equated with capitalism. All these create serious uncertainty about macro-economic stability that requires policy and institutional stability.

And bilateral donors are back in action bending over backwards to recommence withheld aid, on the one hand, and to "do much more" on the other ---only if Nepal (now, all of a sudden, no more a 'failed' state), they say, could tell them precisely how much, when, where and under what terms? One wonders. They could begin right at the very beginning by writing off all the debt incurred by Nepal . Should that be too difficult, then, write off all the debt for the over-capitalized infrastructure investments that have contributed to making our economy internationally uncompetitive and the body politic absolutely rotten with graft and corruption.

While all the above are happening we have India with its offer of 'budgetary support' to arrest the imagined 'economic collapse' by some quarters with its tantalizing 'Himalayan Marshal Plan' that signifies two fundamental things geo-politically. One, the Himalayas are back on the geo-strategic map after 200 years of enclosure. And, two, to signal to the SPAM (SPA & Maoists) why bother with aid from elsewhere when India can do it all for us.

Nevertheless, the suggestion by the visionary Indian President, Dr. Abdul Kalam, to replicate his PURA-model should be given serious consideration by this budget so as to 'provide urban facilities to rural areas' or pura. We can start by replicating the PURA in Bagmati and Gandaki Anchals as his model is strongly grounded in S&T something we are every weak at. It seeks 'connectivity' of markets, information, roads, public health and sanitation and education to be provided by VDCs, DDCs, CBOs, local chambers of commerce and industries and professional associations to empower farmers, rural entrepreneurs, youth, elders, and students.

The Finance Minister may like to resort to the new concept of Matching Grants to fund equitably all efforts by the 4400 VDC and nearly 30, 000 villages to meet, through community self-reliance and local resource mobilization, the MDG targets as per their own capability. This will empower local communities by doing self-development. One would hope that the 'gender budget' initiative of last year's would be deepened and widened in scope. All manner of tax concessions should be provided for women to hold property and bank accounts in their own names.

In short, Nepal is once more the darling nation of the donor community of all hues providing a new ground for experimentation and infinite trial and error after the grand display of people's power comparable to what happened in the Philippines , East Timor, Ukraine and now Thailand .

While such is the political and institutional background to budget-making, Finance Minister is actually flushed with promises of money galore given his announcement to slash drastically the royal household and the defense expenditures. He can easily save a further Rs 5-10 billion with total privatization of the state enterprises and by introducing an austerity programme to control wastage in offices as well as by down-sizing and right-sizing the ministries through mergers and amalgamations. Will he dare hit the vested interests of the 'labour aristocracy' as manifest by the trade unions?

Furthermore, he can raise much more revenue by reducing taxes and customs duties by broadening the VAT as well as taking strong forceful measures to clamp down on tax evaders. Will he? He will find that most of the civil society actors behind 'people's power' are actually tax dodgers. No more than 195,000 pay some manner of taxes in all of Nepal .

Better tax enforcement and enlarging VAT coverage to all in cities and towns can raise billions and this too by reducing customs duties and income taxes to create a favourable investment climate for the institutional savers like insurance companies, investment banks/funds, pension funds that are flushed with at least Rs 15-20 billions of surplus funds with no investment avenues. A bond market could flourish with their investments in public-private infrastructure projects under national and local BOOT provisions regulated by law, especially the pending competition act, private trust act and deemed university act.

With the above measures as a fitting economic sequel to 'total democracy' he will be able to have no less than Rs.100 billion in internal revenue to meet the needs for macro-economic stability with national self-reliance and 'revolutionary reforms' in revenue administration system to combat corruption.

Forceful action against 'willful defaulters' and market-respecting pricing policies (with open, direct subsidies for the deserving few) in all domains will enhance financial, foreign exchange and price stability that will go miles to complement fiscal stability. Economic growth is not possible without macro-economic stability and yes, indeed, without political stability as, for growth, we need investment. Investment will not happen without honest leadership and institutional stability. A White Paper by the government debated in Parliament on economic philosophy, principles and policies - and individual property rights is a dire need for stability, growth, employment and rural reconstruction.

In conclusion, it is a commonplace for a Finance Minister to seek a 'realistic' budget and to give priority to 'stability'. What growth he will garner (7% this FY?) depends on the weather and the ability to expend the budget allocations to at least 95% of the estimated expenditure. Vital for fiscal stability is at least a 17% tax: GDP ratio. For a sustainable growth it is critical that he garner investment (30 % of GDP?) as this only will create the mass employment that is at the core of youth angst, alienation and hopelessness.

What is being implied here is this: he needs to be bold to move economic reforms head on with new strategies. Otherwise our politics will be even more in a quagmire than in the past. Now we need 'budgetary boldness' to safeguard our national independence and sovereignty politically while renouncing economic nationalism and moving forward rapidly within the WTO framework.

(Rana is former Minister of Finance)

Managing supply chain for trade

Modern supply chain does not merely include the inter-modal transfer of goods but also extends to buying of raw material, packaging, warehousing, operating transport fleets, repairing things, collecting payments and so on.

It was the midday of July 16, 2004, people from around Sirsiya and business persons from Birgunj thronged in the premises of the inland clearance depot in Birgunj to welcome the arrival of the first cargo train in the only rail connected Inland Container Depot (ICD) in Nepal . It was a long awaited day in the Nepali trade history, as there were a lot of speculations and suspicion raised from different quarters on the development of such facilities without certainties of the proper rail movement arrangement with the Indian Railways. However, it was made possible with a long and strenuous effort of bilateral negotiation and constant persuasion of concluding rail service agreement (RSA) between the two countries. The conclusion of the RSA also reflected the resolve of Nepal and India to promote bilateral economic cooperation through developing complementarities in trade and investment.

The development and operation of ICD is a step forward in the direction of globalising trade and benefit out of it. All countries around the world are in the process of making their export competitive and the import less expensive by drastically reducing the inventory cost. Efficiency in logistics management is a prerequisite in synchronising the world of commerce as it has gone beyond the limits of simply delivering the traded goods. Firms are outsourcing their operation to subcontractors, moving production and services to the lower cost countries, using information and communication technology, modern fleet and upgraded vehicles in transport operation in course of improving the logistics in transport and delivery of traded goods and services. The task of logistics is thus becoming more complex over time as it involves the coordination and streamlining of transport by road, rail, sea and the air and use of information technology in such operations. The complexity of logistics has given rise to the concept of supply chain management which intends to bring efficiency in overall trade transaction by adopting a proper strategy and re-engineering the process of doing trade.

The scope of supply chains is becoming more inclusive as time passes. Modern supply chain does not merely include the inter-modal transfer of goods but also extends to buying of raw material, packaging, warehousing, operating transport fleets, repairing things, collecting payments and so on. Moreover, this has taken the shape of extended business with a wider coverage of services with meaningful value addition to the use of existing facilities. Today, an ICD operator does not satisfy himself only by collecting the container handling and warehousing charges but also seeks the opportunities of providing full logistics services such as purchase of raw material for the industries, packaging and repackaging, labeling, cleaning and fumigation of empty containers, and even manufacturing of products in small scale. A good supply chain contributes to maintaining a lean inventory by the production units so that cost of production are cut and the firms become more competitive in the international markets.

Nepal as a land locked country is facing the inherent disadvantage of high cost economy associated with the transit transportation cost. A survey has shown that Nepali goods are higher in prices by 10 to 15 per cent in comparison to other South Asian countries due to the costs associated with transit transport. The transit cost adds to the handling and warehousing charges in the port, slow and inefficient land transportation, complex documents and procedures associated with customs clearances at gateway port and land customs stations. This corroborates the need of an efficient supply chain along with the reduction in the transit transport cost in order to promote the competitive edge of Nepali products in the international markets. The strategic plan of product specific supply chain would be required in promoting the export sector which may need investment in basic infrastructures and re-engineering of the processes to achieve competitive advantage and become more responsive to the customer demand.

The ICD or the dry port has remained a common user facility in providing services to various commodities of export and import. Simply the development and operation of such a facility does not bring any substantial benefit unless it is connected with the supply chain of commodities. To achieve this, the first effort has to make Nepal a source country for supplying important parts or the intermediary products of high value manufactures located elsewhere in the region, secondly the installation of production units of selected export products need to be bought near the dry port area. Thirdly there is need of developing adequate infrastructures like road, railways inside the country with a view to modernise the fleet of transport, and fourthly, the institutional and legal base has to be created for promoting the use of containerised traffic.

We see that the container shipping industry is booming as the boxes are found to be the most efficient way of transferring the goods from one place to another. Giant container ports are being developed in various coastal countries along with the provision of rapid loading equipments like reach stackers, rail mounted gantries and rubber tyre gantries with automation of terminal operation. Container ships are being made bigger to carry more boxes in a single journey. This has resulted in tremendous improvement in the world container throughput, reaching 400 million in 2005 from 100 million TEU in 1990. Trucking business is also being consolidated for more integrated and specialised services. Fast track railway lines are being developed in order to meet the just-in-time delivery of the traded goods. Freight forwarders are being organised to provide the complete logistics services. Application of information technology is widely proliferating in handling the cargo business at customs points, ports and with the related entities of cargo transfer namely; exporters, importers, bankers, insurers, transporter, freight forwarders and the shipping lines.

While talking about the cargo business in Nepal , we should not lose sight of the deficiency in the legal regime in course of integrating the logistics business with the international cargo movement. Currently, there is no liability regime for the truckers and railways as a carrier for moving cargo from one place to another and the provision on the insurance act are not adequate to cover the liability created for cross border movement of goods. Multimodalism in transport is becoming popular in the international cargo transfer business as the multi-modal operators are entitled to take up the liability of cargo under single liability cover of the multi-modal transport document. The absence of requisite legal bases is hindering the Nepali cargo businesses to grow in a healthy way and become multimodal transport operators.

There is need of enhancing the capacity of freight forwarders in Nepal in order for them to be able to compete in the international freight forwarding business and get a share in logistics operation. This would require an increased technical and financial capacity to manage the business and properly take up the liability of door to door transfer of goods and services in trade. The freight forwarders would need to be better organised with consolidation and merger to achieve the economies of scale and take up the full responsibilities of the international movement of cargo.

Increasing value added services in the existing dry port in Nepal is another challenge for bringing efficiency in trade. The facility created with huge investment should not be merely confined to warehousing and cargo stripping and handling. Rather a number of additional services may be provided by using the existing facilities. This may, among others, include packaging and labelling of goods, import of raw material for carpet and garment manufacturing, extension of the cargo handling facility to accommodate liquid cargo, container cleaning and the setting up of small manufacturing units for high value items like jewelry and ornaments. Creation of manufacturing base like special economic zone for specific product in the vicinity of the dry port would benefit the export sector of Nepal to a greater extent. The rail connected dry port may be developed as an export facilitation centre in the true sense where manufacturing units may find added advantage by moving closer to it. Birgunj may be developed as the logistics city with the development of allied services of trade and transport.

(Ojha is Joint Secretary in the Office of Prime Minister and the Council of Ministers)

The idea of introducing VAT in Nepal was brought by the Eighth Plan in 1992 and actually implemented in November 1997. Since its implementation, it has travelled a long way overcoming different ups and downs. However, if its performance is compared with its original objective of making it a main stream of revenue, it seems that it has travelled only half the way.

A t the time of its introduction, it was expected that VAT will make the tax system transparent and increase collection of customs revenue and income tax revenue in future. But in real practice, the revenue collection from other sources is also facing similar problems as in VAT. No significant improvement is seen in income tax and customs revenue. This year, the customs rate was reduced with the hope of increasing the VAT revenue by bringing illegal import into a formal channel, but, this hope is also dampened as recent data is not showing the intended result. Though, the total VAT registrants, which was 5,247 in 1997/98 increased to 40,711 in 2004/05 with an annual growth of 37.2 per cent, it has not covered all the potential taxpayers. Though the rate of increase of VAT revenue is 11 per cent per year it is only 3.05 per cent of GDP, around 25 per cent of revenue, 32 per cent of the total tax revenue and 42 per cent of indirect tax revenue. While the rate of increase in the number of taxpayers in initial years was up to 86 per cent, it is only 14 per cent in 2003/04. The number of debit return is decreasing per year during the last six years. It was 49 per cent in 1998/99 and 34 per cent in 2003/04. In contrast to this, the percentage of credit return in the last six years is increasing from 32 per cent in 1998/99 to 38 per cent in 2003/04. Also the Zero return has increased from 19 per cent in 1998/99 to 27 per cent in 2003/04. Non-filers and deregistering taxpayers are also increasing on a daily basis.

All these mean that there are some lacunae in VAT structure and administration in Nepal which should be removed to make it a success. After Nepal 's entry into WTO and SAFTA, the revenue from customs will go down. This loss should be covered from VAT. If the political conflict is settled, the burden of reconstruction of the country should also be taken by this source of revenue. It means there is dire need of improvement in the VAT system. The problems which have hindered in making VAT as the main stream of revenue should be solved at any cost if the government wants to generate adequate revenue from this source. The following points can pinpoint some of the problems and their solutions in the VAT system:

l There is controversy in Nepal with regard to the multiple or single rate of VAT. Some people are of the view that the VAT rate should be multiple having a minimum of three rates including zero. But the tax administration opposes this on the ground of administrative difficulties. The logic of advocating multiple rates is that the VAT rate, originally 10 per cent and now 13 per cent, is very high and is causing tax evasion. It is making difficult to bring lots of exempted items within tax net. In the context of implementing VAT by India too, where minimum rate is 4 per cent with multiple rates, it seems logical to split the VAT rate with a minimum rate on necessary items and a higher rate on luxurious items. So, it would be better to make the VAT rate 5 per cent for necessaries and VAT evadable items and 15 per cent to luxuries.

l At the time of introducing VAT, the threshold was Rs. 3 million and later, on the demand of business community, it was made Rs. 4.5 million and now again it is Rs. 2 million. Some sections of the business community, especially industrialists, are asking the government to abolish the threshold completely. But trading sector and tax administration are found opposing this view. In real life too, the threshold seems to have given a veil to hide the real transactions and evade VAT. So, to bring more taxpayers into tax net, the threshold should be reduced gradually.

l The exemption facility is working as a problem for creating distortion in the economy. There are more than 50 items under the exemption list under which the transaction of goods falling under VAT uses to be hidden. By using the umbrella of exempted items, taxpayers are evading the tax also on non-exempt items. However, due to 13 per cent rate, it has been difficult to bring exempted items into the tax net. In this condition, by using a 5 per cent rate, the exempted items should be reduced.

l One of the major problems in the road to success of VAT is the non-issuance of bill by the seller. The buyers do not want to issue bill of sales with the motive of hiding the transactions and minimising tax. Similarly, it is seen that the customers too do not want to a bill with the intention of paying less. This has emerged as the major problem against the success of VAT. To crush this problem, the government should strengthen its administration using reward and punishment system against both tax collectors and taxpayers.

l Another problem against successful implementation of VAT in Nepal is the under invoicing at the customs point. It affects billing of transactions because billing of under invoiced goods means paying high tax at the time of billing. The under valuation in customs point has compelled the customs administration to use reference value, which is lower in comparison to real value which in turn induces the trader not to issue the real bill. It is seen that unless and until the customs valuation is improved, the VAT system will not work successfully. On the other hand, customs valuation would not be improved unless the customs rate is reduced massively. To solve this chicken or egg problem, a comprehensive reform package covering both the customs and tax is required. The reduced rate of VAT to 5 per cent on most of the necessary items can solve this problem to some extent.

l Though VAT and Tax Departments were merged some years ago and their duties were divided on a functional basis, there is no psychological unification between their employees. Since IRD and IROs are dominated by those staffs coming from income tax, many of the employees from VAT Department and VAT offices are found to be experiencing uneasiness still. The traditional culture in income tax and modern culture in VAT did not coordinate well. Especially, lower level employees from previous income tax stream are averse to improvement. To solve this problem, upgrading and improvement in working culture of previous income tax employees is needed. Voluntary retirement scheme to such employees may also be helpful.

l From the very beginning, business community, especially, the trading sector, has been opposing VAT. They claim that it has totally failed. The main reason of not accepting the VAT easily by business community after seven years of its implementation is its introduction without their support and the failure of government to monitor the customs properly. To get support of business community in this respect, the government should win their confidence as early as possible. FNCCI and CNI can be helpful in this relation.

At last it can be concluded that for VAT to become the mainstream tax source, there are lots of things to be done. It has a long way to travel before it reaches its intended destination.

Currency & Money

Financial Markets saw wide and wild fluctuations this month. Despite several propositions for and against the sustainability of it's huge current account deficit, US economy is showing no signs of cooling down. Rather it surprised the market with a YoY growth rate of 5.60% on May.

US central bank has clearly outlined its operating target of Monetary Policy as the unceasing fight to contain inflation irrespective of the GDP growth rate. Unlike his predecessors, Ben S. Bernanke is afraid of making a clear proposition to the market regarding his vision of the futures interest rates. Having burnt his fingers once upon his abrupt slippage of tongue in White House side talk, he now seems to have vowed not to utter a single clear word that would either way signal a rise or fall in future rates.

Investors are still faithful to the Greenback. Abrupt rise of gold above USD 730/Troy Ounce in May could not sustain for a long time. It ultimately had to cool down to $540/Ounce, from where it rose back to $ 600/Ounce by the end of June.

UAE Central Bank's officials have proposed to diversify 10% of their FCY Reserves into Euro without specifying a time line for the same. Market was rather expecting a hawkish tone from FOMC meeting on 28-29th June, which rather came in dovish tone. FOMC reiterated that future rate hikes will be driven by the data outcomes. This left the already overbought USD holders a good opportunity to book their profit by selling the same. This price action of the last week untimely forced all the major currencies up against the USD.

USD-JPY:

Yen this month moved in the range of 111.44 to 116.64 against the USD. Yen's fall was coincident with the Japanese monetary and fiscal authorities' reiteration that they are not yet ready to shift from their Zero Rate Policy. On the other side, Fed Officials were chanting the mantra of containing inflation through rate hikes. Investors had no choice but to sell Yen and buy Dollars for the high yield Dollar denominated assets.

Next month Yen will trade in the range of 112-116.

INR-USD:

INR this month traded in the range of 45.76 to 46.46 against the Dollar. Substantial fall of equity markets and an ever widening Current Account deficit has tilted the exchange equation in favor of USD.

Despite USD weakness observed in the global markets during the first two weeks of the month, INR did not appreciate much for the above said psychological factors.

Next month we see INR trading in the range of 45.65 to 46.10.

EUR-USD:

Euro this month moved in the range of 1.25 to 1.29 against the USD. Overall trend for the Euro remained bearish throughout the month. By the end of the month some technical correction on Euro was observed as it was moving in an oversold territory. The up move of Euro on 30th June was further whisked by softer tone of FOMC which helped Euro pushed above 1.2750 level.

Next month Euro will move in the range of 1.2550 to 1.2750.

GBP-USD:

The pair moved in the range of 1.8103 to 1.88 throughout the month. A hawkish tone of the Fed officials at the outset and middle of the month forced the market to factor a 100 % probability of rate hike on 29th June and 83% probability of another hike in 8th August. That forced all the major currencies including GBP down the hill.

However a softer FOMC tone on 29th June partially helped GBP to recoup its monthly loss and it climbed back to 1.8400 level once again.

Cable is expected to trade in the 1.8150 to 1.8575 channel, break up of which will open the way on either side.

AUD-USD:

Aussie dollar this month moved in the range of 0.7274 to 0.7547. Following the other majors, Aussie in fact had a losing month against the USD, except for the closing trade on Friday when it made some pips above 0.7400 levels.

Next month Aussie will trade in the range of 0.7300 to 0.7500. Price action in the commodity market needs to be watched carefully.

Gold

Gold prices moved from as low as $540 to $ 650 this month. The yellow metal now has set up a see-saw relationship with the Green Back. It fell and fell so long as the USD continued to gain against the other majors. As the USD retraced back its gains, gold jumped off to 615 level by 30th June.

Next month, Gold will be trading in the range of 560 to 625 $/Ounce.

Call Money Market

Call Money market remained wet with excess liquidity in the absence of amicable investment avenues either in G-Secs or Inter Bank markets. None of the issues of T-Bills could cross the barrier of 4.00 % YTM. The scenario in the call market is still the same and key YTM to observe is this week's issue of 364 days T-Bill where the YTM can cross above 4.00 % or not. If it fails to cross above 4.00 % even now, we foresee a highly bearish investment scenario for the rest of this FY and the first quarter of next FY.

The Research Desk (Treasury@Nabilbank)