usual uncertainities

If 2009 was the year of "New Normal", then 2010 has to be the year of "unusually uncertain"—a phrase aptly used to describe the state of global economic recovery by Ben Bernanke, chairman of the US Federal Reserve, during the Jackson Hole symposium in August. After teetering on the edge of collapse in late 2008, the global economy managed to survive and even grow, albeit at a slower pace, in 2009. That recovery, from the brink of collapse, was largely due to massive fiscal stimulus and coordinated quantitative easing in US and other developed economies. Although these policy measures helped to resuscitate the global economy in 2009, structural problems existed in both the US (such as high unemployment) and European countries (high government deficit).

These structural problems came back to haunt in 2010, especially in Europe, causing major ripples throughout the global financial market. The sovereign debt crisis amongst Portugal, Ireland, Greece and Spain (so called "PIGS") has created major havoc in Europe and questioned the long run viability of the Euro. There are rumours that Germany, dissatisfied with the level of profligacy of some of its fellow Euro members, might abandon the Euro and revert back to the Deutsche Mark. In the US, disenchanted with Barack Obama's economic policies and his government's inability to tackle high unemployment, the American voters voted against the Democratic Party in the recently-held midterm elections.

While the global economy has grown at a higher rate in 2010, compared to 2009, and will grow at even higher rates in 2011, this global economic growth is increasingly supported by higher economic growth in China and India. Finally, it appears that the much-talked about "decoupling theory of emerging markets" is actually happening. Going forward in 2011 and later, much of global growth will be derived from China, India

and other emerging markets. As such, the global economic landscape will witness slow but inevitable paradigm shift where the likes of China and India will have major economic, and consequently, geopolitical clout.

While our neighbouring economies prosper, the Nepali economy continues to be stymied by political impasse. In a country where the most important annual economic policy declaration can get delayed for four months, one can imagine the fate of other policy announcements and the subsequent policy vacuum. Consequently, like the last few years, the Nepali economy managed to meander along in 2010 although there were few significant hiccups in between.

The external sector stability was threatened when the balance of payment (BOP) deficit reached approximately Rs. 24 billion during mid-March. Although the deficit figure came down substantially during the middle of the year, there are enough structural problems in the economy which could again threaten our external sector stability. These structural problems make Nepali exports uncompetitive in the international market, increase our reliance on imported goods and subsequently widen our trade deficit. Although the BOP crisis was, to a certain extent, due to huge gold imports to take advantage from arbitrage opportunity created by tariff differential between Nepal and India, it has been an eye opener for policymakers to address Nepal's ever-widening trade deficit.

For a long time, remittance inflow was able to even out trade deficit and maintain some

semblance of external sector stability. However, depending on remittance inflow to compensate for trade deficit is not a viable solution in the long run. According to recently-released World Bank statistics, Nepal already ranks as the fifth-highest remittance receiving country in the world (this ranking is based on remittance share in the country's total GDP). And, going by the continuous exodus of Nepali youth overseas, remittance inflow will continue to grow for a long time. But, remittance inflow, according to empirical works in economics, doesn't lead to long run economic prosperity, as remittance predominantly gets channelled into consumption-related purposes. Given Nepal's shrinking manufacturing base, it's no surprise then the surge in remittance has coincided with a surge in imports. Higher remittance has increased the consumption level of remittance beneficiaries and, given the lack of domestic production, has increased imports.

Moving forward, policymakers need to recognise this disconnect and figure out ways to effectively channel remittance into productive sectors. The concept of "Foreign Employment Bond", which is widely known in development literature as "Diaspora Bond", was a welcome step. But given the narrow list of target countries, as well as other factors, the initial bond issuance only generated a few buyers. In the recent budget, the government has decided to continue issuing such bonds, and hopefully, with lessons from the initial issuance, policymakers will widen the list of target countries and carry out effective marketing campaigns to generate wider interests. In 2011 and beyond, the onus lies with the government to reorient our remittance dependent economy.

To address the trade deficit problem, in the short run, the government needs to introduce import substitution programmes. However, in the long run, the focus should be on export promotion to tap into potential demand from burgeoning economies in the neighbourhood. There are areas where Nepali goods have a comparative advantage; however, to kick start that export-led growth, basic infrastructure (such as decent road connectivity and uninterrupted power supply) needs to be in place. Nepal has a fixed exchange rate system with India which, to some extent, helps participants in foreign trade as they don't have to bear extra costs associated with adverse exchange rate movements. However, in the case of Nepal, the current peg of the Nepali Rupee with the Indian Rupee is making our exports less competitive in the international markets. Moving forward, policymakers need to revaluate the level of peg.

In the international press, there are comparisons between the economy of China and India almost every day. China started its economic reforms in the late 1970s, while India started during the early 1990s. As a result, both are reaping tremendous economic benefits out of it. It's not that there have not been any efforts to push economic reforms forward in Nepal; post the restoration of democracy in the early 1990s, there were signifi-

cant economic reforms. However, while India and China were, and still are, able to supplement those economic reforms with political stability and coherent policies, we have failed to provide either. The recent political wrangling over the budget's announcement is one of many such examples. In 2011 and beyond, the onus lies with both the government to bridge that policy vacuum and uncertainty. While others complain about "unusual uncertainty", in 2011 and beyond, we have to end our "usual uncertainties".

First published in the Kathmandu Post on 1st Jan 2011
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