From the horse’s mouth

Sandy Weil, the legendary American banker and former chairman of the Citigroup, built the empire called Citigroup by buying other banks and insurance companies. After a series of acquisitions, which included Salomon Brothers in 1997, the US $73 billion merger of Weil’s Travelers group with Citicorp in 1998 led to the formation of a mammoth financial institution called Citigroup. That merger, the biggest merger in the global banking history till date, was largely a success owing to strong lobbying from Weil, who was successful in persuading Robert Rubin, then Treasury Secretary of the United States, to do away with the Glass Steagal Act.

The series of events which led to the formation of Citigroup is vividly captured in a recent book about Jamie Dimon, a former protégé of Weil and now Chairman of JP Morgan Chase, called The Last Man Standing: The rise of Jamie Dimon and JP Morgan Chase written by Duff McDonald. Dimon was the key man involved in all of Weil’s acquisitions that culminated in the Travelers-Citicorp deal in 1998. Dimon, who was later fired from Citigroup after a fallout with Weil, became the most important player in the Wall Street during the financial crisis of 2008 as his firm (JP Morgan Chase) bought Bear Stearns and Washington Mutual—mainly at US treasury’s behest—to quell the panic in the financial market. From Citigroup to JP Morgan Chase to Washington Mutual, the book provides intricate details regarding key recent mergers and acquisition (M&A) in the US banking history. The book exposes how it’s not only the right valuation and synergies that drive M&A but also the big fat egos of the top executives involved in these massive deals and their quest for power and fame.

At a time when voices are being raised in favour of introducing necessary regulations for M&A amongst financial institutions in Nepal, there are lessons to be drawn from this book as it provides key insights to what makes a good M&A deal for a financial institution and how, like in the case of Citigroup, mammoth financial institutions fail to generate synergy and subsequently flounder due to their unmanageable size. There is no doubt that the government should encourage M&A among financial institutions by introducing necessary regulations. However, both government and shareholders needs to scrutinise the M&A deals as there will be scope for creating a monopolistic entity as well as enrich top management at the cost of shareholders.

One area where M&A can possibly help Nepali banks is in increasing their capital base. The biggest problem with the banks in Nepal right now is that they have too little paid up capital to fund large scale projects. Even a small hydropower project needs consortium financing. Another area is cost cutting: duplication of space, technology and human resources can be drastically reduced. However, the major potential obstacle for M&A amongst Nepali financial institutions is lack of opportunities to create synergy. Synergy exists when two banks with different revenue models, different clientele bases, different geographic presence and different core expertise decide to merge.

For example, it makes sense to merge a bank with a strong presence in Eastern zone with another bank with a stronghold in Central zone. Or it makes sense to merge a bank with core expertise in retail lending to one with a large corporate loan book. Or it makes sense for a bank with large retail client to buy a bank with institutional clients, strong private banking and wealth management division. However, in Nepal almost all of the banks operate in the same geographic area, offer the same plain vanilla banking and have the same revenue model and, hence, the potential to create “synergy” is limited. Recently ICICI bank, a leading private sector bank in India, decided to buy Bank of Rajasthan because it wants to increase its presence in Northern and Western parts of India. This deal has business logic as there are opportunities, granted right valuation and proper execution, to create synergy and increase shareholder value.As the liquidity crisis in the banking system shows no signs of easing, recent conversations among bankers and policymakers have veered towards M&A as a potential tool to shore up the capital base of the banks—and strengthen their balance sheets in the event of systemic banking crisis—in order to capture the so called “synergies” that are possible due to M&A.

In a way, many people see M&A as a panacea to all of the current problems in the domestic banking sector. However, M&A doesn’t always increase shareholders value and more often than not M&A are guided by top management’s lust for more power and fame. Moreover, as banks grow large in size after M&A, the big size becomes hindrance to progress as executives fail to execute the deal property to realise the synergy. Citigroup is a classic example of an M&A deal gone woefully wrong.

For an M&A to work, in the words of Jamie Dimon, the deal needs to have business logic, the price must be right and, last but not the least, the top management should know how to execute the deal. Time and again, M&A, while destroying shareholders value, have only made CEOs, lawyers and consultants involved in the deal richer.

First Published in The Kathmandu Post on 27th June, 2010

Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/26/oped/from-the-horses-mouth/209841/

Speculate This!!!

Recent comments from the Governor of the Nepal Rastra Bank (NRB) published in the Financial Times (FT) — a leading United Kingdom based newspaper — has once again put Nepali currency’s (NC) fixed exchange rate system vis-à-vis Indian currency (IC) into the spotlight. Though appropriate and beneficial for the Nepali economy in the long run, the governor’s quote on FT’s May 23 edition to the effect that Nepal needs to reconsider its long standing currency peg “in the medium term” and the subsequent issuance of a press release to neutralise the possible negative effects of the governor’s statement by the NRB next day — that categorically stated that the exchange rate peg would not be changed — has created a lot of uncertainty in the market.

In the same story, the governor also said that Nepal has no option in the short term but to maintain the currency peg, and the country would only be able to alter the peg when there is political stability, greater confidence in the economy, lower inflation and higher reserves. However, why would a speculator, or a smart investor, hold on to the NC when she knows that the currency would eventually be devalued?

For example, if someone can figure out that the current NC to IC peg of 1.6 would be changed to 1.8 in one year, she is better off taking her money out of the Nepali banks and putting in the Indian banks. Let’s assume that the investor can earn 6 percent in the FD account in India, then if she were to convert NC to IC at existing exchange rate her total return would be 19.25 percent (6 percent from FD, 12.5 percent from the appreciation of the IC, and 0.75 per cent from the interaction effect between FD return and IC appreciation) in the event of possible devaluation of the NC in a year’s time. When everyone starts doing this it would create a self-fulfilling prophecy, and then Nepal would have to abandon the currency peg sooner rather than later because of the acute shortage of the IC in the market and its inability of support the peg through the selling of the foreign currency reserves to satisfy the demand for IC.

Nepal will have to eventually devalue its currency at some point. The current level of the peg is just unsustainable. The growth differential between Nepal and India will compel the government to devalue. The million dollar question is: when? In a perfect world, as the governor said, it would be beneficial for the economy if Nepal can devalue when there is a stable political system, a well performing economy, lower inflation and higher reserves. However, there isn’t anything called perfect world in foreign exchange market. History is testament to this as evident from the events in Mexico in 1994 and Thailand in 1997. When there is a word out that the government is mulling to devaluate its currency, it won’t be the government that will decide when to devalue but the market. A speculator anticipating the devaluation would not stay idle and keep her money in NC — she will covert to IC. Taking the cue from the speculator, everyone would then follow the suit. When everyone starts doing the same, government will be left with no option but to devalue.

It’s a cardinal sin in the fixed exchange regime to even talk about possible devaluation even though it would likely benefit the economy in the long run. One cannot just talk about possible devaluation in the future and expect the market not to react, especially when the foreign reserves are dwindling. By just bringing forward the topic — which though has a lot of merit on its own right but which should not have been divulged in public — the governor has possibly put the fate of the NC in the hands of the speculators.

This article was first published in the Kathmandu Post on June 13, 2010

Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/12/oped/speculate-this/209344/

Get your prorities right

Recently an incident in India caught my attention and made me think about how proactive the Indian government is towards protecting, as well as fostering, its economic interests while the leaders and the government of Nepal don’t really give a damn about the economy.

On Friday, April 9, the Securities and Exchange Board of India (SEBI) decided to ban 14 Indian insurance companies from selling a particular product called Unit Linked Insurance Product (ULIP). Next day, reacting negatively to the SEBI’s move, Insurance Regulatory and Development Authority (IRDA) of India asked the 14 insurance companies to ignore SEBI’s ban and do business as usual. The tussle between the India’s two regulatory authorities created a sort of panic among market participants during the weekend as the insurance companies are one the major institutional buyers in the Indian equity market. Indian business news channels and online news portals were carrying out discussions as to what would happen next when the markets would open following Monday.

The root cause of the dispute was that since part of the money in the ULIP plan is invested in equity market, SEBI, as a regulator of the securities market, wanted these kinds of equity linked product to come under its own purview. However, IRDA, as a regulator of insurance companies would have none of it as it felt that SEBI was trying to enter into its jurisdiction. In fact, releasing a circular last Saturday, the IRDA chairman assured the policy holders of the 14 insurance companies that the ULIP’s are “safe and secured.” The war of words between these two regulators was played out openly in media over the course of the weekend.

Fearing that the prolonged tussle between two powerful regulators could send a wrong message to market participants and dampen investor’s confidence, the Indian Ministry of Finance called on IRDA and SEBI’s chief on Monday, 12th of April, for a meeting and status quo was restored and market breathed a sigh of relief.

Though, according to recent developments, the matter is in the process of moving to the High Court of India as to who should actually regulate the ULIP, this incident shows how serious the Indian government is towards its economic priorities. If the Indian Ministry of Finance had not initiated the meeting and if status quo wasn’t restored, war of words between the two regulators as to who should regulate the product would have continued sending wrong signals to investors and market participants in general. Moreover, it would have also sent a wrong to foreign investors who are now major buyers in Indian equity market. By reacting swiftly, the concerned officials were able to reduce uncertainty in the market.

Though corruption in India is still rampant and ministers are still involved in shady deals as evident from the recent Indian Premiere League (IPL) fiasco, the Indian establishment has however understood that it should get its basic economic priorities right to further strengthen its economic progress. By giving top priority, the progress that India has made towards development of infrastructure and capital market in recent years is remarkable.

This is one of many examples which demonstrate that Indian bureaucracy and Indian government have indeed come a long way. Long gone are the days of license Raj when things would happen in snail’s place. Indian government now realises that in order to push its economic growth towards the next level, it needs to be proactive in every sense. In order to realise its place as one of the top two economy in the world by 2050, India is changing — and how!

I believe bureaucrats and policymakers in Nepal can take a big lesson from an incident like this.

This article was first published in The Kathmandu Post on April 25 2010
Link: http://www.ekantipur.com/the-kathmandu-post/2010/04/24/Oped/Get-your-priorities-right/207576/

Where's all the money?

There have been lots of seminars, discussions and numerous articles on the recent “liquidity” crisis in our banking system. Rising imports, stagnating exports, capital flight and unspent capital expenditures, among others, have been identified as the primary reasons for the current crisis. Some have also identified the currency note shortage last Dashain when depositors could not withdraw adequate amounts of cash from their respective banks as being another critical reason for the current liquidity problems because many depositors could have lost faith in the commercial banks’ ability to meet their demand for deposits. In this article, I will try to shed some light on the role of banks as financial intermediaries where they take short-term deposits and provide long-term loans, and the potential liquidity crisis that banks could face from this inherent mismatch between their assets and liabilities.

A commercial bank is primarily involved in mobilising deposits and providing loans, i.e., they channel deposits from individuals into loans for borrowers. In the process, they earn a profit from the spread between the average cost of their deposit aka “cost of funds” and the average lending yield. The higher the spread between the lending yield and the cost of funds, the higher will be the bank’s profit. Banks can mobilise deposits either through low-cost current and savings accounts (CASA) or through high cost fixed deposit (FD) accounts. So it’s in a bank’s interest to mobilise as much deposits as possible from low-cost CASA to widen their interest spread. However, since there is no withdrawal limit on CASA (as they are demand deposits), the average deposit on such accounts can be highly volatile. FD accounts, on the other hand, have fixed tenures, so banks can plan beforehand when and by how much there could be potential deposit withdrawals from these accounts. Because of the respective trade-offs between the cost and volatility of both CASA and FD accounts, commercial banks try to find the optimum balance between the two whereby they can minimise their cost of funds.

When a commercial bank mobilises deposits, it can invest that amount either in liquid assets such as government bonds or lend it out to borrowers who are interested in either meeting their working capital needs or investing in manufacturing businesses, real estate, hydro power and so forth. Generally, government bonds (read T-bills) have a lower yield than the average lending rate on the loan portfolio of commercial banks. So it’s in a bank’s interest to allocate as much of their assets to higher yielding loans than government bonds. However, because most of these capital intensive manufacturing plants, hydro projects and real estate ventures have long durations, banks have to wait for a substantial period before they get their principal back. T-bills, on the other hand, have a lower maturity period, and they can even be used as collateral to borrow funds from the central bank. Hence, like in the case of deposits, banks try to find the optimum balance between high yielding but longer duration loans with low yielding but liquid government bonds.

Now, as mentioned above, it’s in a bank’s interest to mobilise as much deposits from low-cost CASA as possible. As a demand deposit, funds in CASA have immediate maturity; however, banks believe that depositors’ unpredictable needs for cash are unlikely to occur at the same time. With this belief, they are able to make loans to projects with a long duration. In the process, banks are borrowing short-term and lending long, which results in an asset-liability mismatch. Almost all banks have some sort of an asset-liability mismatch on their balance sheets. When banks do lend out demand deposits for long-term projects, a systemic risk can arise in the banking system if an individual bank cannot meet the withdrawal demand of its depositors. Trust is paramount in the banking system. Every depositor trusts banks to deliver cash when they come forward with a withdrawal slip. If the depositors feel that their savings is at risk, then a sudden surge in deposit withdrawals and the bank’s inability to meet the unexpected demand can lead to the self-fulfilling crisis of “bank run”.

One way out for banks would be to follow a “narrow bank” concept, i.e., invest all their demand deposits in short-term assets. However, this not only affects the profitability of a bank due to lower yields on short-term assets but also reduces its ability to lend out to productive sectors such as manufacturing, and that affects the overall economy. Hence, the concept of narrow banking has been discredited in most countries (however, because of the recent financial crisis, voices have emerged to move towards narrow banking).

In the context of the ongoing liquidity crisis in Nepal, the trust of depositors in the banking system has been undermined due to the currency shortage last Dashain. As a result, many depositors who had to haggle with bank officials to withdraw their own savings during the festival haven’t channelled their savings back into the banking system. According to Diamond and Dybvig’s seminal research on banking crises, one of the most potent tools to build the general public’s trust in the banking system is deposit insurance. As of now, there is no provision of deposit insurance from the government side although the last budget did mention it.

To address the problem of an asset-liability mismatch in Indian banks, which is stifling infrastructure development, the Indian government announced the concept of “take-out” financing during the last budget of 2009/10. Under the Indian government’s take-out financing scheme, India Infrastructure Finance Company Limited (IIFCL) — an Indian government owned entity — will buy out long-term loans from banks. Minimising asset-liability mismatches, this scheme enables banks to enter into long-term project financing as they can sell their loans to the IIFCL after a certain time frame. Though the recent initiative of Nepal Rastra Bank to provide refinancing is a welcome step, a similar kind of take-out financing scheme is necessary to mitigate the liquidity problems that arises from an asset-liability mismatch in banks as well as encourage banks to lend towards productive sectors.

From the bank’s side, there should also be proper and rigorous focus on asset-liability management. Most commercial banks in Nepal don’t follow the concept of duration management in their balance sheets. Much of their senior management’s focus is towards increasing the absolute volume of deposits and loans rather than properly managing asset-liability to maximise profits. When mangers focus only on increasing the deposit or loan volume, adverse interest rate movements can seriously undermine a bank’s profitability and its asset quality.

However to be fair to bankers, they also don’t have tools to properly manage the mismatch between assets and liabilities. Generally, interest rate derivatives, currency derivatives and swaps are used extensively by foreign banks to match their assets with their liabilities. With Nepal Rastra Bank’s recent decision to allow commercial banks to use derivative instruments, I am hopeful that in the days ahead, banks will be better equipped to deal with asset-liability mismatch problems.


This article was first published in The Kathmandu Post on April 12, 2010

Link: http://www.ekantipur.com/the-kathmandu-post/2010/04/11/Oped/Wheres-all-the-money/207127/

Spending or Saving??

Why do Chinese save more than Americans? Why are economists urging China to increase its domestic consumption and turn the economy from an export oriented one to a domestic demand driven one? When does a nation over-consume and create a global imbalance like the way the US did during the consumption binge of the mid-1990s, and when does a nation's overall domestic consumption become so low that the long-term sustainability of its high growth begins to be doubted because of lack of domestic demand as is happening in China?

The savings rate is a key determinant of the overall economic growth of a country. Developed economies (read the US) generally tend to have a low savings rate while developing economies (read China and India) tend to have high savings rate. Because the developing economies need to invest in infrastructure and other capital intensive sectors to generate higher future growth, these economies tend to have a high savings rate. On the other hand, the developed economies already have key infrastructure and capital intensive businesses in place, so they generate future growth via current consumption.

However, this does not imply that all the developing economies have a high savings rate. Neither does it imply that all the developed economies have a high consumption rate. This also does not imply that a country necessarily needs a high savings rate to enable it to invest in infrastructure and capital intensive businesses as it can borrow from outside or attract foreign investments. However, because of the actual or perceived high credit risk, the developing countries generally fail to generate sufficient capital from outside sources and, sans adequate domestic savings, face resource constraints to invest in capital intensive sectors. Hence, for a developing economy, a high savings rate is a critical factor in determining future growth.

In the last decade, the average domestic savings rate in Nepal as a percentage of the total Gross Domestic Product (GDP) stood at a meagre 10 percent. In India, the average savings rate is around 30 percent. In fact, the average savings rate in India has increased from around 14 percent in the 1960s to around 30 percent in 2009. In a recent paper, Kaushik Basu, chief economic advisor to the government of India, identified the rising savings rate from the 1960s as one of the key enabling factors for higher economic growth in India. Similarly, in China, the average savings rate is around 40 percent. The average savings rate in China has been historically high and increased from around 30 percent in the 1970s to around 40 percent in 2009.

Advanced economies like the US and countries in the euro zone, however, have a much lower savings rate. Though there is no optimum savings rate per se, it has been empirically established that emerging and developing countries require high savings to mobilise capital towards productive sectors. With a high savings rate, there is enough capital for investment in productive sectors which propel the economy to a higher growth trajectory. Even in neoclassical growth theory, savings is a key component of long-run, steady state level of output per capita -- an economy with a high savings rate tends to become rich over a period of time compared to those with a low savings rate.

Why then do some economies have a higher savings rate than others? What makes an average person in India vis-à-vis Nepal save more of his personal income? Since it has been empirically established that the developing countries need a high savings rate, why do countries like Nepal consume more when saving for tomorrow can provide higher returns?

From a basic economic theory, a rational individual decides to save when the expected gain from the future payoff from current savings is higher than the utility from the current consumption. If the present value of the expected future payoff provides the agent higher benefits than the current consumption, he will decide to save. So the typical savings decision is an inter-temporal one and hinges on two important things: (1) Expected future payoff and (2) The discount rate used to calculate the present value of the future payoff.

A higher expected future payoff and a lower discount rate leads to higher savings. However, in the case of Nepal, both these factors make savings unfavourable. The expected future payoff is lower because of political instability and an unfriendly business climate. If the probability of getting killed or extorted tomorrow is higher, then the expected future payoff will be lower. Similarly, if the probability of business closures, shutdowns or labour strikes is higher, the expected future payoff will again be lower.

Likewise, the rate used to discount the expected future payoff is high in Nepal. The discount rate generally depends on a nominal interest rate adjusted for time period of the economy. Because of a high inflation rate, the discount rate has been on the higher side making savings less desirable. The discount rate is, to some extent, inversely related to the degree to which the general public perceives that the future will be prosperous and beneficial and trust other participants, especially the policymakers, in the economy to exercise economic prudence. Because of lack of economic prudence as well as perceived direction, or lack of it, of the economy, the discount rate has moved up making saving in Nepal unfavorable in the eyes of the average person.

(This article was first published on the Kathmandu Post on March 29, 2010)
Link: http://www.kantipuronline.com/the-kathmandu-post/2010/03/28/Oped/Spending-or-saving/206604/

20 years later...

The Economist magazine recently published an article on Japan’s two “lost” decades of economic stagnation and the title of the article was aptly named “To lose one decade may be misfortune…” After growing at a blistering pace from 1960’s to 1980’s, Japanese economy has been languishing for the last two decades and, according to the Economist’s article, in the third quarter of 2009 nominal GDP of Japan – until recently the second largest economy in the world – sank below its level in 1992, reinforcing the impression of not one but two lost decades in the land of Samurai. While Nepal’s economy might not be significant to get Economist’s attention, anyone who is following the Nepalese economy can rightly argue that Nepal also had its two lost decade – from 1990 to 2009.

India and Nepal started the economic liberalization programs around the same time in the early 1990’s. While the reasons behind the path towards economic liberalization in these two South Asian neighbors may have been different – India decided to open up its economy after facing a severe Balance of Payment (BOP) crisis in 1991 while Nepal embraced economic reforms as a part of change agenda of newly elected democratic government after abolishment of Panchayat regime – the motive behind the economic reforms program were same: to push the respective economies towards higher growth and ensure long lasting economic prosperity. 20 years later, the difference is palpable to everyone. While the continuity of economic reforms program started by then Indian Finance Minister Dr. Manmohan Singh in 1991 have paid rich dividends in terms of higher Indian economic growth for the last two decades, discontinuity of reforms agenda brought forward by then Finance Minister Mr. Mahesh Acharya, coupled with political instability and lack of rule of law, have brought Nepalese economy to a point of collapse. Because of its economic transformation during last two decades, India is now in the global radar, Indian companies are in global stage and CEOs of Indian companies are involved in major global business deals. Though at times reforms have been slow because of the coalition nature of recent Indian government set ups, the piecemeal approach to economic reforms have however provided much needed macroeconomic stability and shielded the economy from any undue shocks of sudden liberalization.

Ours, however, is a complete different story. What failed and divisive politics, political instability, and lack of strong rule of law can do to a country’s economy is evident from the current economic misery of Nepal. The failed and divisive politics of the last 20 years has taken its economic toll. After the restoration of the democracy in 1990, there were a lot of aspirations from the general public that political change would lead to economic prosperity. The economic liberalization programs initiated by the then Finance Minister Mr. Mahesh Acharya in 1991 under the Nepali Congress government paid dividends in terms of higher economic growth for ensuing couple of years. As a part of the economic reform process under the tenure of Mr. Acharya, financial sector was liberalized and privatization programs initiated during Panchayat regime supported under World Bank’s Structural Adjustment Program were expedited. These reform agendas were a boarder part of newly elected Nepali Congress government to liberalize the economy and propel it towards higher growth trajectory. As a result of these initiatives Nepalese economy expanded by 8% in 1994 – one of the highest recorded period of economic growth in the country.

However, after the collapse of Nepali Congress government in 1994 these reform agendas were not pushed forward. Moreover, infighting among political parties as well as politicians within a same party for power forced economic agenda to the backseat. The lust for power among political parties has made Nepal one of the most politically instable countries in the World. During the last twenty years, we have had more than 17 government changes. Over 60% of respondents to the recent enterprise survey of Nepalese industries for 2009 conducted by the International Finance Corporation (IFC) have identified political instability as the major obstacle to their business.

It’s a no brainer that political stability facilitates economic growth. Political stability in terms of longevity of government and less political wrangling provides continuation of economic policies. When business community is aware of the fact that a particular government can last for a fixed period of time, they can plan and invest accordingly. They feel assured that, due to the continuation of policies, their investment won’t be at risk because of sudden change in economic policies due to change in national government. However, when there is uncertainty regarding whether a certain government can last or not, businessmen generally prefer to wait and watch. This results in lack of investments and other business activities and stifles economic growth. For example, after the Congress led United Progressive Alliance (UPA) got a majority in the recent national election in India in May 2009, the Indian stock market erupted and SENSEX jumped by more than 2000 points in a single day. Though, the Indian business community generally favors the more market friendly Bharatiya Janta Party (BJP) because of the historical socialist tendencies of the Indian Congress party, the market still reacted positively because they had been afraid of long run negative implications of political instability resulting from hung parliament.

Currently, Nepalese economy is in dire straits. The banking sector is facing acute liquidity crisis, remittance growth – a major saving grace to domestic economy over the last decade – is plateauing, trade deficit is rising exponentially, foreign exchange reserves are depleting, Balance of Payment (BOP) is in record deficit, manufacturing sector is declining, agriculture sector is stagnating, inflation is high, and the list goes on and on. The current economic mess is largely due to political instability and myopic economic policies of respective past governments. From the last 20 years, it’s evident that discontinuity of liberal economic reforms as well as incoherency in economic policy due to frequent changes in government leadership has stifled country’s economic potential. Unless the political parties and leaders get their act together, the basic reasons behind the current economic stagflation will persist. The bottom line is there won’t be any economic prosperity without political stability.

(This article was first published on Evolution - A 17th anniversary supplementary issue of The Kathmandu Post on Feb 19th 2010)

Calling all Countrymen

After the Nepal Rastra Bank’s (NRB) decision to curtail the real-estate lending of commercial banks and other financial institutions, prominent real estate developers were recently quoted in The Post (“NRB checks won’t slowdown realty business: Developers,” Dec. 20, Page 9) arguing that NRB’s action wouldn’t result in any significant slowdown in real estate sector as long as remittance inflows continue. Moreover, one developer even argued that due to limited investment avenues to deal with big remittance inflows, huge capital flight could ensue. Coming from top developers and businessmen involved in real estate sector, these arguments underscore the point that remittance inflows — Rs. 210 billion in Fiscal Year (FY) 2008/09, almost 21 percent of GDP — are largely being channeled into unproductive sectors. Apart from speculative investment in real estate, remittance is also largely being used for consumption purpose which is helping fuel recent expansion of imports.

According to official statistics, remittance inflows have helped alleviate poverty in Nepal by 11 percentage points in the period between 1995 and 2004, however, since most of the remittance income has been used for consumption, the long-run benefit of remittance is questionable. Given the paltry growth of manufacturing sector in the last five years, remittance driven consumption has increased our reliance on imports. Moreover, as mentioned above, because of the absence of other investment avenues, remittance flows have helped create a massive real estate bubble. If and when the remittance inflows stop growing, we will be in trouble because of our over-reliance on imports and possible crash of real estate sector. We are not channeling remittance to expand our industries to sustain rising consumption, build new roads and bridges for additional vehicles, and develop new hydropower plants to cater to burgeoning energy demand.

In the December 2009 issue of International Monetary Fund’s (IMF) Finance and Development magazine, there is an interesting debate on the role of remittance in development. In the debate, Ralph Chami (associated with IMF) and Connel Fullenkamp (associated with Duke University) argue that remittance inflows around the world have predominantly been directed towards consumption and not investment activities. “For years, many countries have received huge amounts of remittances, relative to their gross domestic product, but there is not one example of a country that has exhibited remittance-led growth. Where is the remittances success story?” ask Chami and Fullenkamp. Though they applaud the role of remittance in poverty alleviation, they further argue that many remittance-receiving regions report anecdotal evidence of local real estate price bubbles funded in large part by remittances.

To ensure that remittance ends up in productive sectors, policymakers need to understand the role, if any, of remittance in overall economic growth, and linkages, if any, between remittance and asset bubble. If, as the developers suggest, remittance is being used for (speculative) investments in real estate and if, as the NRB’s recent import data suggest, remittance is fueling imports, how then do we ensure that remittance ends up in productive sector? One of the best possible ways to channel remittance in productive sector is via “Diaspora bonds” argues Dilip Ratha, lead economist at World Bank’s Development Prospectus Group. Many have argued that remittances have not fostered tangible economic growth because many of the high remittance recipient countries don’t have proper policy and institutions to channel remittance into productive sector. In an IMF working paper “Do workers’ remittances promote economic growth” published in July 2009, Barajas, Chami et.al find that, at best, remittances don’t have any impact on economic growth. The authors argue that the result may suggests, among other things, that many countries do not yet have the institutions and infrastructure in place that would enable them to channel remittances into growth-enhancing activities.

The idea of diaspora bond — raising money by issuing bonds to overseas citizens — is not a new concept. India, Israel, Sri Lanka, South Africa and Lebanon, among others, have time and again tapped their diaspora to raise funds. While the motives for the issuance of funds have varied, according to Ratha, these diaspora bonds have provided much needed capital for the government of these countries. Israel in particular has been very successful in raising huge amount of money from their Jewish diaspora and utilising the collected funds for development activities. The Ministry of Finance (MoF), in its annual budget for Fiscal Year 2066/67, has also proposed an idea of “Infrastructure Development Bond” whereby it will raise Rs. 7 billion through Nepal Rastra Bank (NRB) from Nepali workers in Middle Eastern countries, South Korea and Malaysia. According to the MoF, funds raised through issuance of such bonds will be used to finance infrastructure projects. Though there could be issues regarding concept of selling bonds via overseas Nepali embassies and other issuance modalities, the overall idea needs to be applauded. If carried out properly and timely, it could be an important policy tool to channel remittance into productive sectors and foster economic growth. At a time when infrastructure funding is scarce at best, it’s high time we tap remittance inflows and make something productive out of it.

This article was first published in the Kathmandu Post in Jan 7 2010
Link: http://www.kantipuronline.com/2010/01/08/Oped/Calling-all-countrymen/305971/