Global Financial Crisis:
Nepal's Preparedness

By Madhukar SJB Rana

According to Nobel Laureate Joseph Stiglitz, the global financial meltdown is a crisis “made in the USA”. Though the early warning signs of the crisis were visible in early 2008, it came to the fore in July 2008 in form of housing bubble burst in the USA. In September, US government ploughed US $ 200 billion into Fannie Mae and Fred Mac and took their control to save them from going bust. The same month, Lehman Bros declared $ 600 billion bankruptcy and AIG was rescued by US government for $ 85 billion. From September 2008 to March 2009, the real economy was impacted with a recession that hovers on depression. Nouriel Roubeni, Professor of Economics and International Business in Stern School of Business, is now predicting that the crisis will become an L-shaped depression

It’s quite normal for finance ministries and central banks to downplay the likely impact from external shocks, especially at times of general elections. The best example is the highly optimistic view of the then Indian Finance Minister Chidambaram that the “Indian economy is insulated from the crisis…The global financial crisis will not affect much”. It was only when his Prime Minister said that no economy could possibly remain immune and unaffected by such a historic financial meltdown that Chidambaram retracted. This same sentiment prevails in Nepal too. The fact that we are shielded by being the unenviable backwaters of the Indian economy, gave support for harbouring such view.

Preparedness Level in Nepal

The intellectual discussion on how to prepare for the possible impact of the global financial meltdown in Nepal was rather quick. There was wide coverage on the subject by the media beginning November 2008 with some doing Special Editions on the theme (e.g New Business Age). There was a national conference by NGOs (e.g SAWTEE, Pro Public) by December 2008 that highlighted the possibilities of the impact at the macroeconomic, political and social levels.

In the government level, the reaction was the formation (HLTF) of a High Level Task Force headed by the Vice Chairman of National Planning Commission (NPC) to monitor the impact. Though that was handicapped temporarily by the resignation of the then NPC Vice Chairman, it started to function after a new Vice Chairman was appointed. The members in the task force include Nepal Rastra Bank Governor, Secretaries of the Ministries of Finance, Industry and Commerce and representatives from the business association such as Federation of Nepalese Chambers of Commerce and Industry (FNCCI), Confederation of Nepalese Industry (CNI) and Nepal Chamber of Commerce and Nepal Bankers’ Association. Conspicuous by absence were representatives from Federation of Nepalese Small and Cottage Industry (FNSCI), Cooperatives and Microfinance Institutions.

A. CURRENT IMPACT: NIL

In US $ million	Dec 06	Dec 07	Nov 08
Total Exports	79.4	82.0	94.5
Overseas Exports	19.2	23.8	30.3
Remittance	120.0	143.5	215.3
Gross Forex Reserves	2397.1	2614.5	2939.6
Tourism Receipts
Travel: Credit	13.2	22.7	34.6
Income: Credit	17.2	13.4	15.2

Note: Trade Deficit is around 20% of GDP
Remittance Earnings is around 17-18% of GDP (could be much more if hundi transfers are included)

B. CURRENT IMPACT :

POSITIVE AND UNALARMING	Dec 06	Dec 07	Nov 08
NRB Interest Income	7.9	6.8	6.8
The impact is owing to the fall in the LIBOR rate for both the Dollar and Pound
Dollar	5.35	4.70	2.21
Pound	5.32	5.99	3.91
US Fed Interest Rate	5.25	4.25	1.00
Pound Bank Rate	5.00	5.50	3.00

C. NO RESPITE FROM INFLATION

The other positive impact of the global economic crisis is the fall in oil prices from $ 145 per barrel to $ 50. However, Nepal’s inflation seems unaffected despite fall in the prices globally as well as in India.

	Dec 06	Dec 07	Nov 08
World CPI	5.1	5.0	3.9
India WPI	5.7	3.8	6.6
Nepal CPI	7.3	5.7	14.1
Nepali Rs : Indian Rs	160	160	160
Nepal : US $	71.5	63.2	78.7

Preparedness Level: Policy

Although the government budget was promulgated in September 2008 (i.e. when the world was already getting submerged in the global financial meltdown), it paid no heed to the crisis and sought to achieve in 2008-09 a GDP growth of 7.0% as compared to 5.5% in the previous year, to contain the inflation at 7.5%, and to achieve agricultural sector growth of 4.5% and non-agricultural sector growth of 8.3%. The targets were too ambitious even without the global financial crisis as the country was already reeling under acute power crisis.

Probably the Nepal Government believed that the expansionary budget of 2008-09 (Rs 236 billion) was sufficient to deal with the external threat. In this connection, it is noteworthy that in the latest forecast made by the Asian Development Bank (ADB), Nepal’s GDP will rise by 3.5% only owing to inability to meet the ambitious capital expenditure target as well as the very poor industrial climate and the massive power outage of up to 20 hours per day coupled with the all round scarcity of water.

The Nepali government budget is premised on massive infrastructure investments like increasing hydropower generation capacity to 10,000 MW in 10 years, construction of 1700 km East-West Hill Highway, East-West Railway, Kathmandu-Terai Fast Track Tunnel Road, massive road maintenance plan involving 4170 kms, 1 million tourists by 2011, setting up an Infrastructure Development Bank, public investment in irrigation schemes, establishment of SEZs etc.

Also, the Central Bank of the country did not show any worry. Promulgating the Monetary Policy for the year 2008-09 with a target to bring down inflation to 7.5 percent from the then prevailing 14 percent and raising the CRR for banks to 5.5 percent from earlier 5 percent, the then Acting Governor of the NRB said in October 2008 that the global malaise would not impact Nepal at all.

ANOTHER DIRECT IMPACT

One important impact in Nepal from the global financial meltdown is that the country’s debt servicing cost has gone up with the depreciation of the Nepali Rupee against the US $. At the time of the budget preparation, the allocation for debt servicing was Rs 9.8 billion with the exchange rate at Rs 69 per US dollar. Currently the exchange rate is Rs 78.7. This impact is highly significant since it will add to BOP pressure.

Exodus of Students Overseas

The mass unemployment in the US, UK and Australia is likely to boost university enrolment in those countries. With it, there will be demand for foreign students for economies of scale which will encourage huge exodus of Nepalis to these countries. And that is exactly what is happening now – exodus of Nepali students is continuing like never before.

Comments on
Preparedness Level

The HLTF monitors movements in core BOP variables only. There is no monitoring in the movements in asset prices, especially those in land, shares, treasury bills and bonds. There is also no monitoring of the asset portfolio of banks, development banks, finance companies and insurance companies which is vital to be monitored during crises, as corporate governance is weak, professional experience amidst promoters is limited and competition for funds are acute while new banks and financial institutions are constantly being licensed causing greater pressure on the already weak corporate governance.

The financial dealings of the Board of Directors and Executives, especially MDs, CEOs, CFOs and COOs are not monitored. Nor are they required to make declaration of their wealth status (unlike those holding public offices). Surely, the senior executives of public limited companies which deal with huge public money should be required to declare their wealth and/or be fully subject to criminal liabilities for misinformation, insider trading and fraud.

Monitoring is mostly post hoc or an after-the event affair. In Nepal’s case, such monitoring is done much ‘after’ as data collection is rather tardy. One needs to monitor the epicentre of the event for example, by the Nepali embassies located abroad so as to make available advance information for timely preventive interventions rather than having to depend on curative policy interventions that may not yield the desired results.

Monitoring needs to be made sophisticated. The facts and figures need to be collected on weekly or monthly basis and it needs to be made analytical and predictive. For this to happen, the macro economic model developed by MOF-ADB in 2005 needs to be revived and solidly institutionalized.

For example, given the fixed exchange regime with India and the huge, growing trade deficit, and the depreciation of the Nepali rupee to the US dollar and the decline in the Net Foreign Asset as a result of the fall in the LIBOR and other rates, foreign exchange reserves will fall from usual 10-11 months import value to something much less causing great pressures on fiscal and monetary stability.

Action Taken in Response

The Nepali government and the agencies that send people abroad for work, have been advised by the respective governments to freeze the number of migrant workers. It is said that around 300,000 out of the 1.2 million workers face layoff prospects. Some guesstimate that the total workers working overseas may be around 2.5 million, which increases the chances of workers being laid off to higher figure.

According to one decision, the Nepali government and the manpower agencies will share the cost borne by the workersin 50:50 ratio, who have been returned within 6 months of assuming their assignments overseas –mainly in Malaysia, Gulf and Saudi Arabia

Meanwhile, the Nepali government is seeking advice from International Labour Organisation (ILO) and working closely with Ministry of Foreign Affairs (MOFA).

Also being pursued is a plan to provide self-employment opportunities to some 20,000 youth with loans without deposit of collateral to a maximum of Rs 200,000 per person.

The civil war that lasted from 1996 till 2006 has had its toll on the economy. There is no ‘peace dividend’ in terms of economic growth as investment in hydro-energy was badly affected by the insurgency. The 20 hour per day power outage is proof of this fact.

Moreover, the ongoing disruption in production by labour unions and disruption in the flow of goods and distribution channels by political parties have severely damaged (a) the investment climate and (b) the competitiveness of the national economy.

Inflation is at a record high at around 15% per annum which is caused primarily by the above mentioned cost-push factors and secondarily by the depreciation of the Rupee to the Dollar making imports costlier. It is normal for our inflation rate to be 2-3 % higher than India’s. But the present time seems abnormal when we consider the fact that currently India’s inflation stands at less than one percent.Indian price level could fall further, if not propped up with expansionary fiscal and monetary interventions. But looking at the current high gap between the inflation figures in India and Nepal, it is doubtful if Nepal can gain from the fall in inflation in India.

The enormous gap between Nepal and India’s inflation rates, when over 65% of its total trade is with India— coupled with a fixed exchange regime— means that the management of the economy is in serious trouble as the benefits of such a trade and exchange regime are being rapidly eroded.

Recommendations

Move from Monitoring to Crisis Management

In the spirit of Public-Private Partnership (PPP), which is a major theme of the Budget, Nepal Government should create a high powered Economic Council to guide and manage the economy on a war footing through active stewardship of FNCCI, CII, FNSCI, Nepal Chamber of Commerce, Municipal and DDC Associations, National Cooperative Association and Association of Bankers and Financial Institutions.

The Economic Council should be set up for the next 3 years with the objectives to stabilize, stimulate and strengthen the national and district economy.

Foremost, it requires the government to control the prevailing anarchy through promulgation of Acts to guarantee the free movement of goods and services as well as freedom of entry, exit, expansion and diversification for entrepreneurs. Syndicates, cartels and Labour Unions must be controlled, preferably with two Acts, namely a Competition Act and a new and comprehensive Industrial Relations Act that will cover all sectors of the economy— whether they are providers of goods or services; whether they are large, small or cottage enterprises.

Global financial meltdown could not have come at a worse time for Nepal– internal disruptions to production, distribution, consumption and investments thrust by an external economic crisis that is the worst in 75 years.

Given the above scenario there is deep fear of a BOP collapse and massive outflow of national savings. In sum, economic instability is looming large on the horizon which, if it happens, will impact the peace process negatively.

Further, given that there are over two million unemployed and underemployed youths whose expectations have been raised to unreasonable heights in the New Nepal, the prospect of the lack of employment opportunities nationally and internationally portends further ills for the acutely stalled peace process. In sum, social instability and criminal activities also loom large in the horizon.

Activate local governments as a matter of top most priority

Internal political instability is a far greater threat to economic stability, growth and development. Pervasive and growing internal insecurity combined with the external shock in the manner of the global financial and economic meltdown impacting the nation’s political, economic and social trajectory casts grave risks to the territorial integrity and sovereignty of the nation state.

One way to fill the vacuum is by reviving immediately the district, municipal and local governments to be engaged in local social development and local employment creation through partnership with the private, cooperative and NGO sectors. Local governments should be entrusted with reaching as many MDG targets as they are capable of— with more and more responsibility added as they demonstrate success progressively. Let success breed success in a manner where local communities progress through local leadership in the spirit of self-reliance through self-management.

Empower local communities through devolution of political authority for inclusive growth

Nothing could be more inclusive than empowered villages to do their own development at the grass roots level. Therefore, the government should permit maximum authority to municipal governments to lead the growth process in partnership with the private sector as they are the growth nodes of the nation. Therefore, we have to concentrate growth in the metropolitan and sub-metropolitan cities and townships and recognize municipalities as a primary source of inclusive economic growth.

Create Autonomous River Basin Authorities for Regional Planning and Integration

We have to move towards basin planning - for example in the Bagmati River Basin, Gandak River Basin and Kosi River Basin - so as to maximize growth potential through highland-lowland integration within each river basin. For this purpose, three separate river basin authorities should be created to work autonomously as regional planning bodies.

Stand firmly behind financial and economic reforms with lead role given for growth and employment to private sector

Intellectual Impact

The intellectual impact on Nepal from the global financial meltdown could be highly significant given the domination of the communists and quasi-communists in the parliament and government. For example, there are declarations being made that the capitalism has arrived at its end, that with Obama as American President, USA is going towards USS A (new ‘S’ standing for socialist), that the export-led strategy has now proved wrong given the experience of the East Asia and Germany, and that Globalization can spell a death knell as seen in the bankruptcy of Iceland as a nation state.

Conclusion: Geo-strategic

The G-7 must, since the meltdown is no fault of the developing nations, increase its aid package to 0.7% of their GDPs. They may compensate for the ‘aid commitment gap’ by providing debt forgiveness or, at least, debt relief for the next three years. Given the huge bail out to banks, mortgage companies and automobile industries this should not be an insurmountable burden on them.

Nobel Laureate and founder of the Grameen Model, Professor Muhammad Yunus, believes that the crisis was created by a handful of people driven by “extreme greed, but it is the poor people, the bottom half 3 billion, who will be hit hardest, through no fault of their own.”

Historic Opportunity

The global financial meltdown provides a historic opportunity for Asia to form a continental economic bloc extending from Tokyo to Istanbul. It could start with investing in infrastructure connectivity in such mega projects as the Asian Railway and Highway by drawing on its $ 4 trillion or more reserves. One should welcome Russia also to join in the pan-Asian enterprise with its vast gas and petrol reserves.

The long cherished dream of an Asian Monetary Fund (AMF) could also begin to take shape especially if the AMF will help develop national bond markets for the numerous connectivity projects that await implementation. One could add gas lines, oil pipelines, sweet water lines, airlines, electric grids and inland waterways.

India can take the lead and found the South Asian Monetary Fund with the Indian Rupee as the SAARC currency towards implementing the connectivity projects, especially in the sub-region of the proposed South Asian Growth Quadrangle (proposed by Nepal in 1996).

Asia, particularly Nepal, should mobilize the underemployed civil service and public enterprise employees to undertake ‘war footing’ projects rather than being paid to do nothing other than sign the daily attendance register. Rural development, entrepreneurship development, literacy and sanitation drive cry out for expertise which could be rendered by the public servants being sent back to their birth places to render social service and uplift the poor in their own communities. Even the retirees should be mobilized for this purpose.

These public servants may activate the already existing— since centuries— traditional voluntary organizations (TVOs) as well as genuinely self reliant community based organizations (CBOs) in their own communities to undertake relief and development works. It is probable that more than 200,000 such organizations exist in Nepal that lie dormant as a result of the capture of their social space by political parties and NGOs supported by foreign donors.

Nepal should let each VDC be responsible to meet MDG targets to the full extent of their capabilities. The public servant volunteers should be used to support their efforts with technical skills.

As VDCs meet an MDG target or two, more and more responsibility should be given to them to meet as many targets as they can. This will empower VDCs through devolution of social planning responsibilities. They may enter into partnerships with private sector, use groups, TVOs, CBOs and cooperatives for local economic development and job creation.

Government should sponsor a National Venture Capital Fund where multidisciplinary consultants team up to borrow from the Fund at refinanced rates to help young entrepreneurs by these consultants investing equity capital in partnership with ventures promoted by them. Depending on the risk, the loans may be for from 5 to 15 years. The equity may be liquidated by consultants locally, which will help create local stock markets.

Conclusion: National Perspective

Nepal’s economy lies on the precipice of collapse should the world economy not recover by 2010. Then the on going internal in(?)stability will be compounded by the impact of external instability to rend asunder the entire peace process. A new ethnicity-based civil war and foreign military intervention thereof is not unlikely in such a worst case scenario.

Poverty level that dropped from 42% to 31% of the population from 1996 to 2004 following the opening up of the Nepali labour market to the world as a result of the national policy of ‘economic diplomacy’ that welcome globalization and WTO, may again rise to that level or more in 2010-2011.

Whatever economic growth is happening is mainly fuelled by the boom in retail sales and the real estate market coupled with hectic speculative trading in land. The dynamism in banks and financial institutions is accounted for by this sector with over Rs 50 billion invested in the real estate. With remittances falling, the real estate and retail trades bubble could burst. The moot question is this: can the Nepal government bail out the banks as did the other countries? Certainly not.

The inability of the government to spend the planned expenditure is going to add to the economic woes as aggregate demand is severely curtailed. It is estimated that only Rs 26 billion has been spent by way of capital expenditure, which is 50% below Dr Mahat’s budget last year! Around Rs 50 billion of Dr. Bhattarai’s budget for this year awaits spending.

To add to the macroeconomic injury in this crisis period, the Ministry of Finance has mustered, with (false?) pride, a budgetary surplus of Rs 7 billions when an expansionary budget is the need of the hour. They pledge to spend all or most but in what manner?

Let’s hope it is not with an eye to the next general elections only in 2011 by garnering vote banks by spreading thinly tax payers’ hard earned contribution for non-employment creating activities while bypassing the private sector, including micro finance providing institutions.

To create jobs massively and immediately to dovetail with Tourism Year 2011 we need to incorporate the “Resident Tourist” policy where with a bank deposit (of say $ 25,000 for single and $ 40 000 for a family) foreigners may reside in Nepal with a 10 year multiple re-entry visa as well as purchase apartments, which they may be allowed to sell to anyone if they choose to leave. The $ refund should be only at the face value of when the apartment was originally purchased.

The transit tourists should be given 72 hours free transit entry visa to do duty-free and duty-paid but VAT-refund shopping.

What must be monitored is much more than macro economic stability. It is possible to have macro stability even while the ship is sinking. We must monitor critical asset price movements like land, gold, Indian currency holding by households, investment by private sector, hunger, household consumption of the absolute poor, employment creation and new labour supply.

Nepal should provide incentives to the private sector to open Polytechnic Colleges to train higher quality manpower for the global markets in areas of high global demand especially in the construction and logistics trades.

The National Planning Commission should focus on Manpower and Educational planning and integrating education supply with labour market demand nationally, regionally and globally.

Economic growth planning should be left to a High Level National Economic Council composed of the central public sector, associations of municipalities and DDCs and cooperatives and, not the least, the federations of private sector institutions to plan out and implement short-run economic growth interventions to deal with the crisis from the global meltdown. All policies must be immediately amended depending on the exigencies of the moment by the Council of Ministers.

(Former Finance Minister Rana is Adjunct Professor, South Asian Institute of Management, Lalitpur, Nepal)

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