August 2007
Economy & Policy

Great News, Good News, Grand News

By Madhukar SJB Rana

China is to limit labour-intensive exports to US and Europe. This gives a golden opportunity and challenge for Nepal’s economic diplomacy.

The International Monetary Fund (IMF) has recently raised China’s economic growth forecast for 2007 to 11.2 percent; up 1.2 percentage points from its forecast in April. The growth in China for 2008 is expected to be 10.5 percent, 1.0 point higher from the earlier forecast, the IMF said in a revision of its World Economic Outlook (WEO). We can anticipate even better growth rates given its habitual, better-than-anticipated, past performance. And 2008 is the year of the Olympics Games when unprecedented number of visitors are expected to visit China. It is anticipated that the Chinese athletes make China the world’s greatest sporting nation by bagging more medals than the US.

“For some time China has been the largest contributor to the global growth measured in purchasing power parity,” Charles Collyns, the IMF deputy director of research, said at a news conference. “With the growth slowdown in the United States, China will be contributing the largest part to the increase in the global growth measured at market exchange rates as well as purchasing parity terms,” he noted.

China ’s record $112.5 billion trade surplus in the first half of this year has fanned tensions with the United States and the European Union, while flooding its economy with more than $1.3 trillion in foreign currency reserves. Hence, under severe pressure from IMF, US and Europe for China to let its currency float – effectively appreciating its value upwards— China has opted for another route to curtail its balance of trade surplus by

curbing its export of inexpensive, labor-intensive products to force manufacturers into making higher-quality goods.

The Chinese Ministry of Commerce will expand a catalogue of goods subject to mandatory export limits in the second half of 2007, following a recent move to increase a tax on exporters, said Wang Qinhua, the ministry’s industry director. “The new policy will add cost and affect the cash flow of exporters, especially those engaged in the labor-intensive part of the industry,” she said. Herein lies a grand opportunity and also a challenge to the economic diplomacy of Nepal’s Ministry of Foreign Affairs (MOFA) by being able to negotiate the relocation of these foot loose, labour-intensive industries into Nepal to kick start its industrialization process.

What could, nevertheless, be these products? Prominent ones will, undoubtedly, be textiles, garments, leather and leather products which have suffered from Chinese competition to cause acute loss of our overseas markets even with GSP and other manner of preferences for least developed countries (LDCs) given by Australia, Europe and Canada.

We should move to invite China to help with the proposed Garment and Textile Export Processing Zone (GT-EPZ) in Birgunj and also locate its garment and textiles ventures herein fully protected from the irrational labour, customs, excise and income tax laws and their implementation. They should also be allowed to import duty free petroleum products for their own manufacturing use.

We may examine whether it is not eminently advisable to set up Handicraft and Jewellery Export Villages in Kathmandu Valley, Pokhara Valley and Surkhet Valley to locate these Chinese business to not only use our labour, but also to engage in value adding joint ventures for product development and global marketing of our own indigenous handicrafts. Chinese investment in this industrial sub-sector will eradicate infrastructure constraints in respect of power, transportation, storage and design plaguing these industries in Nepal, which are still operating as cottage industries with all its limitations on scale and quality.

Nothing is more vital for the economic growth, employment and health of the rural households, especially in the Hills and Mountains, than the rapid development and modernization of the livestock sector, which will get an unprecedented backward linkage for multiplier development with the invitation to Chinese leather and leather product businesses to migrate to Nepal. As to where such EPZs will be situated needs to be studied keeping in view best possibilities for backward linkages. Will it be located in Biratnagar, Birgunj, Bhairahawa, Nepalgunj or in some other places? Here one has also to keep in mind the environmental hazards when locating these industries in cities and towns.

Finally, the above aims will not be realized if the labour unions do not get their act right and change behaviour from a protective ‘labour aristocracy’ that is incorrigibly rent-seeking to one that is proactively serving the national interest by helping to create—not restrict— jobs for the unemployed through higher private sector investment, higher productivity and greater labour benefits and welfare for all.

All this can be achieved with the promulgation of a new Industrial Relations (IR) Act that will, first and foremost, allow company employees to decide, by secret ballot, whether they wish to form unions or not?

If yes, do they wish to be organized as trade unions or as company? If trade unions, then lay down procedures for union rights, duties, financial contributions and election of union leaders in a manner that promotes accountability, transparency, competition and dissent within unions, including the right to resign from union membership.

The IR Act should seek to promote a national federation for each union. This would be a fitting social reflection to the demand for Nepal as a federal state since federalism is not simply about political structures but also cultural, social and economic too.

A well designed corporate-level grievance handling system is a must. It must not be open to external political influences as they lead the company away from its vision, mission, goals and core values. Organizations gain from legitimate functional conflicts but not from dysfunctional ones which, most often, are of the win-lose variety.

Last but not the least, very clear-cut rules and regulations must be spelled out for collective bargaining with management (to be defined); along with rules for declaring of lock-outs and strikes, including the minimum time for notification of such drastic measures; payment of salaries and wages during seizure of work; and methods of conflict resolution through such graded measures as facilitation, conciliation, mediation and arbitration. Minimization of access to the courts should be sought as in business time is of the essence in a globalized economy.

It goes without saying that the onus for good IR lies with management and each strike or lock out is an indication of its managerial ineffectiveness— provided the government do not put extraneous influences on behalf of any side and prevent political parties from undue encroachment on management rights and privileges.

The labour market should be allowed to function through such an institutional innovation as the IR Act, whose absence will retard the much needed industrialization in Nepal plagued by population explosion, acute land scarcity and loss of comparative advantages in staples like rice, wheat, paddy and maize.

We need a growth-oriented model of development for quick transformation of our rural economy for which foreign direct investment is needed. Taking advantage of this strategic opportunity from our northern neighbour, China, which is also a partner in SAARC, is a chance in a lifetime. It should be seriously studied and fully debated by government, FNCCI, CNI, Chambers of Commerce and product and professional associations, at the earliest, lest Chinese investors go elsewhere, especially to least developed African nations. Through such a national debate, the much sought after economic diplomacy policy, announced in 1996 by then Foreign Minister, Dr Prakash C. Lohani, can come to fruition as a strategic reality.

(Rana is a former Minister of Finance)

Evaluating New Monetary Policy

- By Sarbendra Mishra

Amidst the confused political economic environment, Nepal Rastra Bank (NRB) has come up with its monetary policy for the fiscal year that began on July 17, 2007. As may be noted, inflationary pressures, absence of the rule of law and ever declining national productivity are the major concerns of the contemporary Nepali economy. The NRB has, in this year’s policy, stated that its prime focus this year is going to be on controlling inflation while in the previous year such focus was on stability of foreign exchange rate.

Following its pedagogy, the new monetary policy has underscored the need to mop up excess liquidity in the financial system as its operating target. For gauging the liquidity in the system, the central bank will use the “Liquidity Monitoring and Forecasting Framework (LMFF)” that it has been using for some years. The operating target of the monetary policy is to be implemented through commercial banks as in the past.

There has been no change in the three levers that are used by the central bank for controlling the Money Supply. For example, the Bank Rate is left unchanged at 6.25% per annum, the CRR is left unchanged at 5% and Open Market Operation will continue to be in place for two way liquidity management in the financial system.

Among the pertinent changes that the Monetary Policy has introduced is that rebates have been arranged for sectoral refinancing rate for tourism, exports, small and cottage industries and sick industries. Likewise, the SLF (standing liquidity facility) which earlier was fixed at 91 days T-bill rate (average) plus 150 bps has now been hiked by 50 bps to 91 days T-Bill plus 200 bps. Moreover, it has promised to come up with a directive on E-Banking, to arrange for Scrip-less Securities Exchange System, law for Merger and Acquisition, adopting Basel Core Principles and introduction of Risk Based Supervision.

Similarly, it has promised to bring out rules for Mutual Fund and for controlling financial crimes.

In another change, the policy has promised to allow import on FOB basis as well, allowing the importer to make Freight and Insurance payment in foreign currency. Similarly, it has allowed import up to USD 30,000 on Document Against Payment (DAP) basis.

First time migrants to Europe, North America and Australia can get foreign exchange up-to USD 5000 per head.

Insurance companies are to be allowed to remit reinsurance premium without getting NRB permit.

Similarly, Refunds of inward remittances will not need NRB permit. Moreover, foreign exchange facility under passport quota can be availed also for Air Tickets for travels originating from Indian Airports.

In another change, banks will be required to pay only 1% as foreign currency cash deposit commission to NRB, which earlier was 2%.

Banks can now provide Forward Foreign Exchange Contract (FFEC) facility to the customers based on their needs. FFEC no longer needs to be supported by an underlying export/import transaction. However, banks need to have FFEC policy duly approved by their Board of Directors based on which they can execute FFEC transactions.

Another equally important announcement is the initiative for allowing Nepalis to invest abroad.

The Monetary Policy has outlined the need to boost the existing interest rate level in the economy which is being bid by the commercial banks. However, no operating target or tool has been mentioned for achieving this. Neither has this been set as the objective of the Monetary Policy. It appears that NRB is trying to tell commercial banks to hike the interest bids on deposits without increasing their offer rates on advances. As the excess liquidity supply is the major concern for the current financial system, deposit rates will not boost up unless this is solved. Excess liquidity problem will continue so long as capital expenditure by public and private sector doesn’t boost up. In the current context where the statutory authorities are claiming the inflation to be at 5.5 to 8.0 % YoY, and nominal interest rates on deposits are hardly above 4%pa, the real interest rate is negative. However, the actual level of inflation in this country is estimated above 15% YoY and the real interest rate on bank deposits is a real financial hazard. The Monetary Policy has not been sufficiently serious about it.

(Mishra is Associate Member of Society of Technical Analysts)

Trade vis-à-vis Political Dependency

- By Shiva Raj Bhatt

Political and economic risks associated with trade dependence have been realized by Nepal’s policymakers since long. To overcome risks and vulnerabilities associated with such dependence, export diversification was considered the primary goal of Nepal’s trade and development strategy. For example, Nepal adopted export diversification and import substitution strategy since the third five year plan (1965-70). This two pronged foreign trade strategy was meant to narrow down the huge trade deficit, promote industrialization and help diversify the economy and trade. Accordingly, various measures were introduced. The most important were Exporters’ Exchange Entitlement Scheme (exporters were entitled to use certain portion of their export earnings for the purpose of importing otherwise restricted products), Dual Exchange Rate system (exchange rate was fixed higher for exporters than that of normal market rate), duty exemption on export commodities, special financial arrangement for production and export, simplification of licensing and customs procedures, introduction of new industry and trade related acts, establishment of special economic zones, among others. Another instrument adopted by the government to diversify trade is global and regional integration of the economy by joining the WTO, SAFTA and BIMST-EC.

Nepal ’s trade started to expand with overseas countries since mid sixties, however progress in export diversification has been very low and Nepal’s trade dependence, in terms of both products and countries, is still very high. India still occupied two third share in Nepal’s export and three countries (USA, Germany and UK) occupied two third shares in its overseas exports and few primary commodities still occupied large shares in Nepal’s exports basket (see Figure and Table 1). Moreover, in recent years, Nepal’s trade, both exports and imports, are re-concentrating on India (Figure 2), which is a serious matter of concern for Nepal’s policymakers.

Product-wise too Nepal's export is heavily concentrated on a few items, most of which do not have comparative and competitive advantages. Nepal's main exports to India are vegetable ghee, polyester yarn, jute goods, zinc sheets, textiles and threads. Nepal's major overseas exports are also heavily concentrated in three main items: readymade garments, woollen carpets and pashmina. The top 10 export items constitute more than 50 percent of Nepal's export to India and nearly 75 percent to its overseas export (Table 1).

The Problem

The landlocked position of the country (three sides bordered with India), traditional business and trade relationship with India, open border with unrestricted movement of capital, labour and payment between the two countries, relatively good transportation links, among others, are the main factors behind this high trade dependency. However, heavy trade dependency of Nepal, is directly associated with Nepal's political dependency and also constrained its power to settle the internal problems domestically. Moreover, it is argued that Nepal's historic dependency of trade on India has created a national economic policy that is highly reactive to the prevailing social, economic and political conditions of India and it makes Nepal's economy vulnerable to unfair or unfavourable economic and trade practices of India.

Prospects

Nepal demonstrated its competitiveness across a range of labour intensive manufacturing and agricultural goods and in various services sectors. However, given the increasingly competitive global economy, Nepal will have to make significant efforts to improve its competitiveness by removing a number of supply side constraints, including weaknesses related to infrastructure, policy, governance, inter agency coordination and cooperation.

Though the government had initiated and implemented various plans and policies such as the five year plans, agricultural perspective plan, industrial, investment and trade policies to diversify the economy and trade, there have been some achievements too in diversifying the economy and trade. However, the achievements are far below expectations. Weaknesses in the plans/policies and in their implementation are blamed for the unsatisfactory results. The most important weaknesses are: implementation of plans and policies in an uncoordinated manner, weak links between various sector plans and policies with overall national plans, lack of monitoring and evaluation system, weak public private partnership, lack of sector development strategies and weak institutional capacities for marketing, research and development and others.

In this context, an appropriate strategy is necessary to diversify Nepal's export in order to help the country overcome vulnerabilities associated with high trade dependency and to promote economic growth. Therefore, Nepal needs to intensify the programs on export promotion and diversification with maximum priority and also explore areas of public private partnership for that matter.

(Bhatt is Trade Policy Analyst with Enhancing Nepal's Trade Related Capacity Programme of UNDP and Ministry of Industry, Commerce and Supplies. However, the views expressed in this article are those of the author and do not necessarily represent UNDP or the Government of Nepal)