After reaching the peak of 1175 on Aug. 31, 2008, the Nepse Index — a market capitalisation weighted index tracking Nepal Stock Exchange (NEPSE) — has been trading around the 500 mark for last couple of weeks. And despite additional listing of shares from both Initial Public Offering (IPO) as well as bonus and right shares, total market capitalisation of NEPSE has plummeted from Rs. 612.5 billion on Aug. 31, 2008 to 405.8 billion on Dec. 14, 2009. The question then is what to make of the dramatic growth in NEPSE preceding the slump and what is causing the recent downward trend. In the paragraphs below, I have analysed what’s ailing Nepal’s stock market today.
Overall economic condition
Over the last couple of years, domestic economy has not delivered substantial post-conflict growth (as expected by many investors) after the resolution of Maoist conflict in 2006. Continuous political flux, uncertain business conditions in terms of strikes and labour problems, and energy crisis, among others, have constrained economic activity. As a result, Gross Domestic Product (GDP) growth has hovered around 3-4 percent during last few years without remarkable progress in Per Capita Income. Moreover, even the sub-par growth was possible only because of record remittance inflows - which are largely being used for consumption purposes. Because of inadequate growth in domestic production, soaring imports (coupled with stagnant exports) have widened trade deficit. As such there hasn’t been any remarkable progress in “real sector”. While agriculture sector is facilitating sustenance of over 80 percent of the population, we haven’t made any considerable investment in manufacturing and infrastructure - the mainstays for any sort of real sector growth.
Stock markets help mobilise large scale funds necessary for profitable investment ventures. Entrepreneurs and business organisations look towards stock market when they seek to raise large scale capital to either start their new business venture or expand an existing one. Because of lack of our real sector growth, participation of real sector in Nepali stock market has been minimal. Service sector - particularly financial institutions - dominates trading and overall market capitalisation of Nepal Stock Exchange. However, in a developing economy like Nepal, long run growth of service sector is dependent on the overall growth of real sectors such as manufacturing and infrastructure. And this is where the whole current foundation of stock market in Nepal turns upside down: how can service sector - such as financial - maintain growth and record profit year after year - without commensurate or even higher increase in the real sector? When a company’s stock price should reflect the discounted future earning of that company and not how many right shares or bonus shares it will dole out, isn’t it no-brainer then that sometimes even naïve investors will figure out that without overall economic growth, financial sector cannot grow alone? The growth in NEPSE preceding the slump belied the fundamentals and we are now witnessing the correction phase.
Supply-demand factors
From Mar. 13, 2008 to Oct. 15, 2009, the number of listed shares on Nepal Stock Exchange has more than doubled from 271 million to 669 million. Financial Institutions account for substantial chunk of the increment in number of listed shares during the corresponding period (from 165 million to 400 million). Bonus and right shares of existing financial institutions as well as Initial Public Offering (IPO) of new financial institutions are primarily responsible for the surge in the listed number of shares. While there has been massive addition in the number of shares, investor demand hasn’t picked up for various reasons. Economics 101 tells us that when supply exceeds demand, price has to come down.
Existing investors were spooked when the Maoist-led government raised the capital gain tax from 10 percent to 15 percent in the budget of Fiscal Year (FY) 2008/09. Despite the reversal in capital gain tax from 15 percent to 10 percent during the current FY’s budget, investors are still chary because of lack of clarity on government policies regarding capital markets. Moreover, participation in our rudimentary stock market is limited to few big scale investors in urban areas and lacks widespread retail penetration. Restricted access to stock brokers, lack of basic stock analysis skills, and paper-based trading system are a few of many constraints preventing new investors from entering the stock market and has restricted investors’ demand. One of the best ways to overcome this and increase retail penetration of stock market is via Mutual Fund. Mutual Fund pools money from general public and uses the pooled money to invest in stock market. They rely on fundamental/technical analysis, sophisticated trading models, and economies of scale to generate superior returns. However, Mutual Fund related policy in Nepal is still awaiting approval amidst the tussle between the Securities Exchange Board of Nepal (SEBON) and Ministry of Finance (MOF).
(The writer, a Chartered Financial Analyst (CFA) level 3 candidate, is associated with Nepal Investment Bank Limited)
This artilce was first published on The Kathmandu Post on December 17th 2009
http://www.ekantipur.com/the-kathmandu-post/2009/12/16/Oped/Taking-stock/3120/
Wednesday, December 16, 2009
Monday, November 16, 2009
The Good, the Bad and the Ugly
Nepal’s financial sector has seen exponential growth over the last two decades. Between 1990 and 2009, the number of commercial banks increased from five to 26, the number of development banks from two to 63 and the number of finance companies from zero to 77. Even during the insurgency period, from 1996-2006, the financial sector continued to do remarkably well and managed to prosper (See Figure 1 for details). The rapid expansion of the financial sector, wider access to financial products and better quality service delivery have contributed significantly to GDP growth and an improved standard of living in Nepal.
Rapid growth, however, also makes it difficult and complicated for potential depositors, investors and clients to distinguish between financial institutions on a range of characteristics. Nepal now has thousands of institutions spread between A, B, C and D categories with no one tracking their risk profiles for the benefit of the public. Nepal Rashtriya Rastra Bank (NRB) as the central bank doesn’t have the mandate to rank financial institutions to inform the public of their relative reliability. Hence, for an average depositor or a layman investor, there is little credible information available that objectively distinguishes between good and bad financial institutions. Given this context, there is an urgent need for a globally recognised credit rating agency in Nepal.
As the central bank of the country, NRB plays the role of a regulator; its role being to monitor and supervise financial institutions and take corrective action if it finds anything wrong. NRB doesn’t comment publicly on its issues with financial institutions during its supervisory and monitoring activities, unless something is drastically amiss. Therefore, there is a serious lack of an independent entity that ascertains the risk profile of a financial institution in Nepal.
A credit rating agency (CRA) evaluates the creditworthiness of an individual, a corporation, a corporate debt instrument or even a country. Based on rating models, an agency looks into asset quality, interest sensitivities, diversification of asset/liability portfolios, capital base, board structure, management and numerous other variables for evaluation. It then assigns a credit score to a particular financial institution. The ratings/score enables an investor to gauge the risk involved in investing with that particular entity. CRA rates not only a particular corporation but also various debt instruments of corporations, with the same bond issuer even having different credit ratings for different series of bonds.
Globally, credit ratings are used by investors, investment bankers, institutional investors and pension/welfare funds, brokers and government as a risk metric when allocating funds. The three most prominent rating agencies are Moody’s Investor Service, Standard and Poor’s and Fitch.
As mentioned above, ratings from a CRA enables investors to ascertain the creditworthiness of a particular institution. Internationally, investors rely on ratings when allocating funds among different asset classes. For example, a fixed income investor relies on bond ratings, a pension fund that is interested in investing in a debt issue of a particular country relies on sovereign ratings and an investment bank to crosscheck their portfolio’s risk. Ratings are useful not only for investors but also for corporations because a higher rating helps them raise funds at lower cost. The rating thus helps determine the interest rate of corporate borrowers — a key function in the capital market. For example, Moody’s rates a corporation or issuer by giving ratings described in Figure 2. “Aaa” rating is of the highest quality with the lowest risk while the rating “C” is of the lowest quality with the highest risk. They have grouped ratings into “Investment Grade” and “Speculative” as a broad barometer to distinguish different types of corporations or debt issues.
In Nepal’s context, a CRA is critical for further financial sector development. The growth of the financial sector has underscored the need for a CRA that distinguishes a good financial institution, through their ratings, from a bad one. The recent debacle of Nepal Development Bank and corporate governance issues in some commercial banks have underscored the need for an independent CRA that rates financial institutions and gives an opinion apart from the existing auditor’s government regulators and financial analysts.
Moreover, a CRA helps create a win-win situation for regulators, investors and rated institutions. For an investor, a credit rating will serve as an important risk metric during investment decisions. Investors, from depositors who deposit their money in financial institutions to those who buy stocks on the secondary market, can rely on ratings when depositing their money or buying stocks. For a good financial institution, it’s in their interest to have a strong credit rating distinguishing itself from others.
Credit ratings will put in place a culture of self-discipline and rigorous risk management systems among domestic financial institutions. It will encourage more prudent behaviour, stabilise the financial sector and help in the prevention of asset bubbles. In short, credit ratings play a key role in self-regulation.
Likewise, internationally accepted credit ratings will enable domestic banks to improve trade finance operations as good ratings enhance their trustworthiness to international correspondent banks and also pave the way for increased limits on lines of credit at lower cost. It will open the door for banks to raise capital from international capital markets and even to sell debt instruments. Furthermore, under the Basel 2 agreement, banks can use certain approved CRAs (called External Credit Assessment Institutions) when calculating their minimum capital requirements (as per the Pillar 1 of Basel 2).
From a regulator’s perspective, the recent growth in the financial sector has increased (and is likely to continue increasing with further expansion) the supervisory burden of NRB. Though it is imperative for NRB to further enhance its supervisory capacity, establishment of a globally recognised CRA in Nepal will be invaluable for NRB to distinguish between good and risky financial institutions. The internal assessment and a culture of self-discipline that credit ratings bring will also be welcome from a regulator’s point of view.
Apart from financial institutions, there are various other sectors where credit ratings will be necessary as the domestic economy expands and funding needs of companies increase. Under existing regulations, local corporations cannot raise capital from international capital markets. However, in the future, in order to mobilise large-scale funds necessary for infrastructure development, it may be necessary to liberalise the capital restrictions in Nepal. As the economy modernises and the need to develop new hydro projects, roads and other industrial projects increases, domestic corporations may have to look towards international capital markets to raise adequate funds.
Potential foreign investors in such large-scale projects will inevitably seek credit ratings (specifically known as project finance rating) from recognised CRAs when considering investing in such projects. Therefore, a culture of embracing credit ratings is imperative for Nepal to even have the option of entering the international market to raise capital. With the lack of appetite for Foreign Direct Investment in Nepal, it could prove to be the only way for Nepal to raise enough capital to develop and prosper in a major way.
This article was first published in The Kathmandu Post on Nov 17 2009
http://www.ekantipur.com/the-kathmandu-post/2009/11/16/Oped/The-good-the-bad-and-the-ugly/2093/
Nepal’s financial sector has seen exponential growth over the last two decades. Between 1990 and 2009, the number of commercial banks increased from five to 26, the number of development banks from two to 63 and the number of finance companies from zero to 77. Even during the insurgency period, from 1996-2006, the financial sector continued to do remarkably well and managed to prosper (See Figure 1 for details). The rapid expansion of the financial sector, wider access to financial products and better quality service delivery have contributed significantly to GDP growth and an improved standard of living in Nepal.
Rapid growth, however, also makes it difficult and complicated for potential depositors, investors and clients to distinguish between financial institutions on a range of characteristics. Nepal now has thousands of institutions spread between A, B, C and D categories with no one tracking their risk profiles for the benefit of the public. Nepal Rashtriya Rastra Bank (NRB) as the central bank doesn’t have the mandate to rank financial institutions to inform the public of their relative reliability. Hence, for an average depositor or a layman investor, there is little credible information available that objectively distinguishes between good and bad financial institutions. Given this context, there is an urgent need for a globally recognised credit rating agency in Nepal.
As the central bank of the country, NRB plays the role of a regulator; its role being to monitor and supervise financial institutions and take corrective action if it finds anything wrong. NRB doesn’t comment publicly on its issues with financial institutions during its supervisory and monitoring activities, unless something is drastically amiss. Therefore, there is a serious lack of an independent entity that ascertains the risk profile of a financial institution in Nepal.
A credit rating agency (CRA) evaluates the creditworthiness of an individual, a corporation, a corporate debt instrument or even a country. Based on rating models, an agency looks into asset quality, interest sensitivities, diversification of asset/liability portfolios, capital base, board structure, management and numerous other variables for evaluation. It then assigns a credit score to a particular financial institution. The ratings/score enables an investor to gauge the risk involved in investing with that particular entity. CRA rates not only a particular corporation but also various debt instruments of corporations, with the same bond issuer even having different credit ratings for different series of bonds.
Globally, credit ratings are used by investors, investment bankers, institutional investors and pension/welfare funds, brokers and government as a risk metric when allocating funds. The three most prominent rating agencies are Moody’s Investor Service, Standard and Poor’s and Fitch.
As mentioned above, ratings from a CRA enables investors to ascertain the creditworthiness of a particular institution. Internationally, investors rely on ratings when allocating funds among different asset classes. For example, a fixed income investor relies on bond ratings, a pension fund that is interested in investing in a debt issue of a particular country relies on sovereign ratings and an investment bank to crosscheck their portfolio’s risk. Ratings are useful not only for investors but also for corporations because a higher rating helps them raise funds at lower cost. The rating thus helps determine the interest rate of corporate borrowers — a key function in the capital market. For example, Moody’s rates a corporation or issuer by giving ratings described in Figure 2. “Aaa” rating is of the highest quality with the lowest risk while the rating “C” is of the lowest quality with the highest risk. They have grouped ratings into “Investment Grade” and “Speculative” as a broad barometer to distinguish different types of corporations or debt issues.
In Nepal’s context, a CRA is critical for further financial sector development. The growth of the financial sector has underscored the need for a CRA that distinguishes a good financial institution, through their ratings, from a bad one. The recent debacle of Nepal Development Bank and corporate governance issues in some commercial banks have underscored the need for an independent CRA that rates financial institutions and gives an opinion apart from the existing auditor’s government regulators and financial analysts.
Moreover, a CRA helps create a win-win situation for regulators, investors and rated institutions. For an investor, a credit rating will serve as an important risk metric during investment decisions. Investors, from depositors who deposit their money in financial institutions to those who buy stocks on the secondary market, can rely on ratings when depositing their money or buying stocks. For a good financial institution, it’s in their interest to have a strong credit rating distinguishing itself from others.
Credit ratings will put in place a culture of self-discipline and rigorous risk management systems among domestic financial institutions. It will encourage more prudent behaviour, stabilise the financial sector and help in the prevention of asset bubbles. In short, credit ratings play a key role in self-regulation.
Likewise, internationally accepted credit ratings will enable domestic banks to improve trade finance operations as good ratings enhance their trustworthiness to international correspondent banks and also pave the way for increased limits on lines of credit at lower cost. It will open the door for banks to raise capital from international capital markets and even to sell debt instruments. Furthermore, under the Basel 2 agreement, banks can use certain approved CRAs (called External Credit Assessment Institutions) when calculating their minimum capital requirements (as per the Pillar 1 of Basel 2).
From a regulator’s perspective, the recent growth in the financial sector has increased (and is likely to continue increasing with further expansion) the supervisory burden of NRB. Though it is imperative for NRB to further enhance its supervisory capacity, establishment of a globally recognised CRA in Nepal will be invaluable for NRB to distinguish between good and risky financial institutions. The internal assessment and a culture of self-discipline that credit ratings bring will also be welcome from a regulator’s point of view.
Apart from financial institutions, there are various other sectors where credit ratings will be necessary as the domestic economy expands and funding needs of companies increase. Under existing regulations, local corporations cannot raise capital from international capital markets. However, in the future, in order to mobilise large-scale funds necessary for infrastructure development, it may be necessary to liberalise the capital restrictions in Nepal. As the economy modernises and the need to develop new hydro projects, roads and other industrial projects increases, domestic corporations may have to look towards international capital markets to raise adequate funds.
Potential foreign investors in such large-scale projects will inevitably seek credit ratings (specifically known as project finance rating) from recognised CRAs when considering investing in such projects. Therefore, a culture of embracing credit ratings is imperative for Nepal to even have the option of entering the international market to raise capital. With the lack of appetite for Foreign Direct Investment in Nepal, it could prove to be the only way for Nepal to raise enough capital to develop and prosper in a major way.
This article was first published in The Kathmandu Post on Nov 17 2009
http://www.ekantipur.com/the-kathmandu-post/2009/11/16/Oped/The-good-the-bad-and-the-ugly/2093/
Friday, October 16, 2009
Elinor Who?
As the Nobel Committee announced the Sveriges Riksbank Prize in Economic Sciences — popularly known as Nobel prize in economics — to Elinor Ostrom and Oliver Williamson, my first reaction was Elinor who? According to the popular betting company Ladbrokes, the odds favoured Eugene Fama, the father of modern finance; and the betting pool run by Harvard University’s economics department favoured another renowned macroeconomist Robert Barro to win the Nobel prize in economics. So the choice to award Elinor Ostrom, a political scientist at Indiana University, as a co-recipient of the Nobel prize was surprising to many pundits as well as those who follow economics in general.
In citing her contribution, the Nobel Committee said that Ostrom’s work in the area of economic governance, especially the commons, has challenged conventional thinking in economics literature regarding how to govern a common pool of resource. Especially, the Nobel Committee mentions, “Elinor Ostrom has challenged the conventional wisdom that common property is poorly managed and should be completely privatized or regulated by central authorities. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes and groundwater basins, Ostrom concluded that the outcomes are often better than predicted by standard (economic) theories.”
During my years as a graduate student in economics both at the University of Virginia and the University of Maine, the name Elinor Ostrom never came up. That’s why when I first read about her on the internet as one of the co-recipients of the prize, I had to Google her name to figure out who she really was. While we were made to read numerous papers of Robert Barro and Eugene Fama as well as other Nobel favourites like Tom Sargent, Jean Tirole and Robert Taylor, Elinor Ostrom’s works in the areas of “economic governance” and “institutional economics” were neither analyzed nor mentioned. While we were taught how privatizing or regulating the commons could solve the “Tragedy of Commons”, Ostrom’s analysis that retaining resources as public property and letting the users create their own system of governance could solve the problem were never discussed in our graduate classes that analyzed externalities and market failures.
Puzzling! Isn’t it? Digging deeper, however, one can understand why Elinor Ostrom was a different breed of economist than those celebrated ones in the ivory towers of Freshwater and Saltwater economics department who largely managed to discount her (at least in their teaching). For one, Ostrom was a political scientist who delved into economics issues largely through her groundwork experiments. (She has visited Nepal to do extensive fieldwork on local irrigation systems and the Nobel Committee has cited her work here.)
Lately, much of economics research has become too theoretical and too computational. Extensive math proofs and too many equations dominate articles in leading journals of economics. This is particularly true at the doctoral level course. Many economics departments take pride in how mathematical and rigorous their course work is. Paul Krugman, last year’s Nobel laureate, calls this phenomenon “mistaking beauty (of math) for truth”. However, Ostrom avoided much of the hardcore math stuff. She used her experimental results to analyze economic problems. In other words she used “reality” rather than “assumptions” to solve problems.
The bottom line is Elinor Ostrom wasn’t a so called mainstream economist. For a mainstream economist, she wasn’t one of their own because she wasn’t technical enough. My, and others’, ignorance of Elinor Ostrom was not because of her value or volume of work but in spite of it. Thanks to how economics is taught these days at the best graduate economics department in U.S. universities, figures such as Elinor Ostrom, among others, are largely discounted by renowned professors and researchers. As a result, students who attend these schools are unaware of their work. By awarding the Nobel prize to Elinor Ostrom, the Nobel Committee has done a great service to the economics profession in general by embracing a different breed of economist and a different methodology of economic research.
This article was first published in The Kathmandu Post on Oct 16 2009
Link: http://www.ekantipur.com/tkp/news/news-detail.php?news_id=1126
In citing her contribution, the Nobel Committee said that Ostrom’s work in the area of economic governance, especially the commons, has challenged conventional thinking in economics literature regarding how to govern a common pool of resource. Especially, the Nobel Committee mentions, “Elinor Ostrom has challenged the conventional wisdom that common property is poorly managed and should be completely privatized or regulated by central authorities. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes and groundwater basins, Ostrom concluded that the outcomes are often better than predicted by standard (economic) theories.”
During my years as a graduate student in economics both at the University of Virginia and the University of Maine, the name Elinor Ostrom never came up. That’s why when I first read about her on the internet as one of the co-recipients of the prize, I had to Google her name to figure out who she really was. While we were made to read numerous papers of Robert Barro and Eugene Fama as well as other Nobel favourites like Tom Sargent, Jean Tirole and Robert Taylor, Elinor Ostrom’s works in the areas of “economic governance” and “institutional economics” were neither analyzed nor mentioned. While we were taught how privatizing or regulating the commons could solve the “Tragedy of Commons”, Ostrom’s analysis that retaining resources as public property and letting the users create their own system of governance could solve the problem were never discussed in our graduate classes that analyzed externalities and market failures.
Puzzling! Isn’t it? Digging deeper, however, one can understand why Elinor Ostrom was a different breed of economist than those celebrated ones in the ivory towers of Freshwater and Saltwater economics department who largely managed to discount her (at least in their teaching). For one, Ostrom was a political scientist who delved into economics issues largely through her groundwork experiments. (She has visited Nepal to do extensive fieldwork on local irrigation systems and the Nobel Committee has cited her work here.)
Lately, much of economics research has become too theoretical and too computational. Extensive math proofs and too many equations dominate articles in leading journals of economics. This is particularly true at the doctoral level course. Many economics departments take pride in how mathematical and rigorous their course work is. Paul Krugman, last year’s Nobel laureate, calls this phenomenon “mistaking beauty (of math) for truth”. However, Ostrom avoided much of the hardcore math stuff. She used her experimental results to analyze economic problems. In other words she used “reality” rather than “assumptions” to solve problems.
The bottom line is Elinor Ostrom wasn’t a so called mainstream economist. For a mainstream economist, she wasn’t one of their own because she wasn’t technical enough. My, and others’, ignorance of Elinor Ostrom was not because of her value or volume of work but in spite of it. Thanks to how economics is taught these days at the best graduate economics department in U.S. universities, figures such as Elinor Ostrom, among others, are largely discounted by renowned professors and researchers. As a result, students who attend these schools are unaware of their work. By awarding the Nobel prize to Elinor Ostrom, the Nobel Committee has done a great service to the economics profession in general by embracing a different breed of economist and a different methodology of economic research.
This article was first published in The Kathmandu Post on Oct 16 2009
Link: http://www.ekantipur.com/tkp/news/news-detail.php?news_id=1126
Diaspora Bonds
Due to inadequate funding, the government of Nepal (GoN) has not been able to fund large scale development projects that are necessary for overall infrastructure development of the country. The GoN is predominantly dependent on foreign grants and loans to execute large scale infrastructure projects. And because of this dependence and lack of other sources of development financing, existing level of infrastructure in Nepal is very poor. Empirical works in economics have identified infrastructure development as one of the necessary criteria for overall economic development.
In Nepal, however, we lack in overall infrastructure development: road connectivity, hydropower plants, airports and dry ports, and Special Economic Zones (SEZ), among others, are major areas for concerns in terms of infrastructure development. Though natural landscape of Nepal, because of various hilly and mountainous regions, has made carrying out development projects quite a challenging task, they are not the excuse for the current level of infrastructure in Nepal. Political uncertainty coupled with lack of funds has resulted in few large scale development projects over the years and resulted in a situation whereby Nepal ranks one of the lowest in terms of infrastructure development in the world. Because of strong link between infrastructure development and overall economic well being it’s no surprise that Nepal ranks as one of the poorest countries in the world.
Development projects such as hydropower, highways and airports require large scale investment. Because of the size of Nepal’s economy neither the GoN nor private sector commercial banks have the adequate funds to support these infrastructure projects. Analyzing the annual budget of the GoN, one can see that majority of the government revenue is spent on funding recurrent expenditure and GoN is dependent on foreign aid/grants/loans to fund large scale infrastructure project (in 2008/09, approximately 80% of the total capital expenditure of GoN was proposed to be financed by foreign aid). Private sector commercial banks in Nepal are also not in the position to fund big scale infrastructure projects as the average balance sheet position of top commercial banks in Nepal is around NRs. 45 billion. Even if the commercial banks reach a situation whereby they are in a position to fund large scale infrastructure project, the inherent nature of the infrastructure project – long duration – make these projects unattractive to commercial banks because of asset-liability mismatch for the banks. To address this asset-liability mismatch problem, the Indian government recently unveiled a “take-out” financing scheme to facilitate the involvement of commercial banks in large scale development projects. Under this scheme, the banks can opt out of the infrastructure project after a certain period of time by selling the loan to a third party.
While opportunities for development financing seem limited, one area where Nepal has made progress in recent years is remittance inflows. Due to the rise in the number of migrant overseas workers, remittance income has seen exponential increment during last few years. At the end of Fiscal Year (FY) 2008/09, Nepal received Rs. 209.69 billion in remittance income – a whopping 22% of GDP. Anecdotal evidences and research from the World Bank suggest that majority of remittance in Nepal is used for consumption purpose rather than for productive activities.
Under this background, one viable solution is where GoN taps the remittance income for infrastructure development. MOF, in its annual budget for Fiscal Year 2066/67, has proposed an idea of “Infrastructure development Bond” whereby it will raise NRs. 7 billion through Nepal Rastra Bank (NRB) from Nepali workers working abroad 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. 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. According to Dilip Ratha of the World Bank, while the motives for the issuance of funds have varied, 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 utilizing the collected funds for development activities.
Because Nepali diaspora and their income (a share of which will be remitted back home) does provide a source of development financing option for the GoN, a careful analysis is required as to how the GoN can best tap this market. A cross country analysis of how these bonds are issued, interest cost on these bonds, and how the funds from these bonds are utilized for development projects is needed to best channel the remittance income towards development financing through diaspora bonds.
This article was first published in The Kathmandu Post on Sept 25, 2009
Link: http://www.kantipuronline.com/news/news-detail.php?news_id=300752
In Nepal, however, we lack in overall infrastructure development: road connectivity, hydropower plants, airports and dry ports, and Special Economic Zones (SEZ), among others, are major areas for concerns in terms of infrastructure development. Though natural landscape of Nepal, because of various hilly and mountainous regions, has made carrying out development projects quite a challenging task, they are not the excuse for the current level of infrastructure in Nepal. Political uncertainty coupled with lack of funds has resulted in few large scale development projects over the years and resulted in a situation whereby Nepal ranks one of the lowest in terms of infrastructure development in the world. Because of strong link between infrastructure development and overall economic well being it’s no surprise that Nepal ranks as one of the poorest countries in the world.
Development projects such as hydropower, highways and airports require large scale investment. Because of the size of Nepal’s economy neither the GoN nor private sector commercial banks have the adequate funds to support these infrastructure projects. Analyzing the annual budget of the GoN, one can see that majority of the government revenue is spent on funding recurrent expenditure and GoN is dependent on foreign aid/grants/loans to fund large scale infrastructure project (in 2008/09, approximately 80% of the total capital expenditure of GoN was proposed to be financed by foreign aid). Private sector commercial banks in Nepal are also not in the position to fund big scale infrastructure projects as the average balance sheet position of top commercial banks in Nepal is around NRs. 45 billion. Even if the commercial banks reach a situation whereby they are in a position to fund large scale infrastructure project, the inherent nature of the infrastructure project – long duration – make these projects unattractive to commercial banks because of asset-liability mismatch for the banks. To address this asset-liability mismatch problem, the Indian government recently unveiled a “take-out” financing scheme to facilitate the involvement of commercial banks in large scale development projects. Under this scheme, the banks can opt out of the infrastructure project after a certain period of time by selling the loan to a third party.
While opportunities for development financing seem limited, one area where Nepal has made progress in recent years is remittance inflows. Due to the rise in the number of migrant overseas workers, remittance income has seen exponential increment during last few years. At the end of Fiscal Year (FY) 2008/09, Nepal received Rs. 209.69 billion in remittance income – a whopping 22% of GDP. Anecdotal evidences and research from the World Bank suggest that majority of remittance in Nepal is used for consumption purpose rather than for productive activities.
Under this background, one viable solution is where GoN taps the remittance income for infrastructure development. MOF, in its annual budget for Fiscal Year 2066/67, has proposed an idea of “Infrastructure development Bond” whereby it will raise NRs. 7 billion through Nepal Rastra Bank (NRB) from Nepali workers working abroad 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. 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. According to Dilip Ratha of the World Bank, while the motives for the issuance of funds have varied, 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 utilizing the collected funds for development activities.
Because Nepali diaspora and their income (a share of which will be remitted back home) does provide a source of development financing option for the GoN, a careful analysis is required as to how the GoN can best tap this market. A cross country analysis of how these bonds are issued, interest cost on these bonds, and how the funds from these bonds are utilized for development projects is needed to best channel the remittance income towards development financing through diaspora bonds.
This article was first published in The Kathmandu Post on Sept 25, 2009
Link: http://www.kantipuronline.com/news/news-detail.php?news_id=300752
Thursday, October 8, 2009
The Shape of Recovery
The worst, it seems, is over. Latest economic data from Japan to Germany to the U.S. suggest that the worst recession since the Great Depression seems to be over. And emerging economies, drivers of the global growth, are once again showing signs of improving economic activity. The U.S. economy, after witnessing a whopping -6.4 percent decline in the first quarter of 2009, seems to have bottomed out. According to analyst forecasts, the U.S. economy is expected to register a growth of 2.2 percent in the third quarter of 2009 after witnessing an improved -1 percent growth in the second quarter of 2009. After growing at 6.1 percent in first quarter of 2009, the Chinese economy grew at 7.9 percent during second quarter of 2009.
The shape of the recovery, however, is far from clear. For the global economy to regain lost momentum, the U.S. economy has to show signs of revival. Though most of the global economic growth is derived from the emerging economies of China and India, among others, because of the structural linkages between the U.S. economy and the rest of the world, the shape of U.S. recovery still dictates the global economic picture.
An ideal situation would be a V-shaped recovery where the global economy rebounds rather immediately to pre-recession level. During the first quarter of 2009, when the crisis was in its peak, most of the economists discredited the idea of the V-Shaped recovery. Then pessimists were arguing about L-shaped recovery–the worst of all recoveries–where the economy, after falling sharply, fails to recover again for a long time to pre-recession level. However, when the equity markets around the world rallied impressively during the second half of 2009, the idea of V-shaped recovery again gained momentum. Currently, experts are divided about the shape of the recovery. Speaking in a recent conference, Nobel Laureate Paul Krugman argued that the U.S. economy will at best show a W-shaped recovery, where the economy revives briefly after a sharp drop to collapse again before a final revival. Krugman, a true Keynesian, argued that existing housing problems in the U.S. and rising unemployment will prevent it from a V-Shaped recovery.
And despite the improvement in the economic activities around major economies, investors also seem to be shaky about the shape of this recovery. After the major sell off in the Chinese stock market in the third week of August, major stock indices around the world posted sharp declines. Investors are having a hard time distinguishing between whether this is a true recovery or one-off revival due to huge stimulus packages from governments around the world to revive their respective economies. These are valid concerns and the picture might not be as rosy as recent performance of major indices around the world.
The U.S.—a consumer driven economy—is facing structural challenges. With more than 9 million-plus unemployed people, which is growing bigger month by month, consumer spending is bound to take a hit when the unemployment checks stop for most of the unemployed and the stimulus-effect wears off for economy in general. Moreover, for a change, the profligate Americans are starting to save again—the U.S. consumer savings rate rose from near zero percent in 2007 to 7 percent in July 2009. On the long run, a rising savings rate is good for the U.S. economy as they don’t have to rely on the Chinese to borrow; however, at this point when the U.S. economy needs a boost, reluctant spending from consumers could stall the growth revival. Moreover, the fact that current growth has come largely from public spending rather than private is a matter of concern. Sustaining the current tepid recovery requires the shift of spending avenue.
China—the world’s manufacturing hub—needs to re-orient its economy toward self sustenance. Compared with the U.S. and India where consumption accounts for over 70 percent of the Gross Domestic Product (GDP), Chinese consumption only accounts for 35 percent of its GDP. When its exports took a sudden dip after the economic crisis, the Chinese government announced a $580 billion stimulus programme to boost domestic consumption and prevent the economy from spiraling downwards.
The stimulus package has to a large extent helped China keep its economy growing at a healthy rate. The same could be said about the easy-lending policy of state-owned Chinese banks which has pushed growth higher but at the same time fueled an asset bubble. Hence investors are wary that unless domestic consumption rises permanently or exports gain momentum, the growth might slip in the next quarter as the effect of stimulus subsides from the economy.
A slowing Chinese economy coupled with an artificially-created asset bubble could be a recipe for another disaster. With a weak monsoon, India’s projected economic growth of 6 percent is in serious doubt. Moreover with food prices rising due to weak monsoon, inflation in India is bound to rise in coming months. All these scenarios signal a difficult road down the line. Though growth in major economies is expected to recover, the size of economic output of these countries after the crisis is still not clear, i.e. whether the output of major economies can swiftly reach pre-crisis levels or remain below it for a long time.
Writing in the forthcoming issue of Finance and Development, Oliver Blanchard, Chief Economist of the International Monetary Fund argues that after a financial crisis, on average, economic output does not go back to its old output trend but permanently remains below it.
Published on The Kathmandu Post on Aug 29 2009
Links & References:
http://www.ngcci.org/index.php?nav=resources&page=ecoglimpse&id=834
The shape of the recovery, however, is far from clear. For the global economy to regain lost momentum, the U.S. economy has to show signs of revival. Though most of the global economic growth is derived from the emerging economies of China and India, among others, because of the structural linkages between the U.S. economy and the rest of the world, the shape of U.S. recovery still dictates the global economic picture.
An ideal situation would be a V-shaped recovery where the global economy rebounds rather immediately to pre-recession level. During the first quarter of 2009, when the crisis was in its peak, most of the economists discredited the idea of the V-Shaped recovery. Then pessimists were arguing about L-shaped recovery–the worst of all recoveries–where the economy, after falling sharply, fails to recover again for a long time to pre-recession level. However, when the equity markets around the world rallied impressively during the second half of 2009, the idea of V-shaped recovery again gained momentum. Currently, experts are divided about the shape of the recovery. Speaking in a recent conference, Nobel Laureate Paul Krugman argued that the U.S. economy will at best show a W-shaped recovery, where the economy revives briefly after a sharp drop to collapse again before a final revival. Krugman, a true Keynesian, argued that existing housing problems in the U.S. and rising unemployment will prevent it from a V-Shaped recovery.
And despite the improvement in the economic activities around major economies, investors also seem to be shaky about the shape of this recovery. After the major sell off in the Chinese stock market in the third week of August, major stock indices around the world posted sharp declines. Investors are having a hard time distinguishing between whether this is a true recovery or one-off revival due to huge stimulus packages from governments around the world to revive their respective economies. These are valid concerns and the picture might not be as rosy as recent performance of major indices around the world.
The U.S.—a consumer driven economy—is facing structural challenges. With more than 9 million-plus unemployed people, which is growing bigger month by month, consumer spending is bound to take a hit when the unemployment checks stop for most of the unemployed and the stimulus-effect wears off for economy in general. Moreover, for a change, the profligate Americans are starting to save again—the U.S. consumer savings rate rose from near zero percent in 2007 to 7 percent in July 2009. On the long run, a rising savings rate is good for the U.S. economy as they don’t have to rely on the Chinese to borrow; however, at this point when the U.S. economy needs a boost, reluctant spending from consumers could stall the growth revival. Moreover, the fact that current growth has come largely from public spending rather than private is a matter of concern. Sustaining the current tepid recovery requires the shift of spending avenue.
China—the world’s manufacturing hub—needs to re-orient its economy toward self sustenance. Compared with the U.S. and India where consumption accounts for over 70 percent of the Gross Domestic Product (GDP), Chinese consumption only accounts for 35 percent of its GDP. When its exports took a sudden dip after the economic crisis, the Chinese government announced a $580 billion stimulus programme to boost domestic consumption and prevent the economy from spiraling downwards.
The stimulus package has to a large extent helped China keep its economy growing at a healthy rate. The same could be said about the easy-lending policy of state-owned Chinese banks which has pushed growth higher but at the same time fueled an asset bubble. Hence investors are wary that unless domestic consumption rises permanently or exports gain momentum, the growth might slip in the next quarter as the effect of stimulus subsides from the economy.
A slowing Chinese economy coupled with an artificially-created asset bubble could be a recipe for another disaster. With a weak monsoon, India’s projected economic growth of 6 percent is in serious doubt. Moreover with food prices rising due to weak monsoon, inflation in India is bound to rise in coming months. All these scenarios signal a difficult road down the line. Though growth in major economies is expected to recover, the size of economic output of these countries after the crisis is still not clear, i.e. whether the output of major economies can swiftly reach pre-crisis levels or remain below it for a long time.
Writing in the forthcoming issue of Finance and Development, Oliver Blanchard, Chief Economist of the International Monetary Fund argues that after a financial crisis, on average, economic output does not go back to its old output trend but permanently remains below it.
Published on The Kathmandu Post on Aug 29 2009
Links & References:
http://www.ngcci.org/index.php?nav=resources&page=ecoglimpse&id=834
Greenback's comeback
A year ago, skeptics of United States Dollar (USD), were talking about alternative to USD as a global reserve currency. Due to the slide of the USD, which has been a default reserve currency over the last 60 years, vis-à-vis Euro, Sterling Pound and other emerging market currencies during 2004-2007, dollar skeptics were questioning the viability of the USD as a global reserve currency. Because of their huge dollar reserves, China and Russia, two of the largest holders of USD reserves, were floating the idea of introducing an alternative form of global reserve currency to diversify their foreign currency holdings and protect their respective foreign reserves wealth amidst declining USD. In the United States, officials were concerned that if the central banks of countries with huge dollar reserves start selling dollar, then it would lead to huge decline in USD and undermine dollar’s role as global reserve currency. The tables have turned now and how!!! Since the start of 2008, the USD has appreciated by over 16 percent against the Euro and by over 23 percent against the Indian Rupees (INR). In 2009 alone, the USD has appreciated by over 9 percent against the Euro and by over 7 percent against the INR. And this is in spite of that fact that US economy is crippled with soaring unemployment, projected budget deficit of USD 3 trillion over the next two years, and total debt of over USD 10 trillion.
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What’s leading to dollar’s rise?
Massive economic contraction around the world:
Due to the ongoing economic crisis, major economies all over the world are contracting sharply. According to a recent Bloomberg report, Japan’s economy, second-largest in the world, tumbled 3.3 percent in the fourth quarter of 2008 from the previous one, while Germany contracted a seasonally adjusted 2.1 percent and the economy of euro area shrank 1.5 percent during the last quarter of 2008. Meanwhile, the International Monetary Fund forecasts the U.K. economy to contract by 2.8 percent this year. Though the US Gross Domestic Product (GDP) contracted by more than 6 percent during the fourth quarter, because of high economic uncertainty, investors are pulling away their money from risky assets in developed countries and emerging markets and investing in relatively safe US treasuries. This is reflected in the yields of US Treasury bonds, which have come down significantly during last one year, due to high investors demand for these risk-free securities. Reports from Indian also suggests that Foreign Institutional Investors (FII) have with withdrawn more than USD 2 billion in 2009 are taking home USD 13.5 billion in 2008.
Narrowing inter-country Interest rate differential:
One of the sources of the last dollar slide was high interest rate differential in United States and other major economies around the world. During much of last five years, interest rate in United States has been relatively low compared to rates in other countries. However, due to the current contractionary pressure, central banks around the world have been cutting interest rates drastically to stimulate the economy. In July 2008, according to Bloomberg, the European Central Bank’s (ECB) borrowing costs were 225 basis points more than the Federal Reserve’s federal-funds rate and the Bank of England’s benchmark was 300 basis points higher. Other things equal, higher interest rates attract overseas investment and leads to appreciation of the country’s currency with high rate. Currently, rates in UK are only 75 points more than the respective rates in the US. Similarly, the ECB’s rates are only 175 points higher. The narrowing interest-rate differential has also helped the USD to gain against other currencies. Furthermore, given the current economic distress and possible deflationary risk, central banks around the world are expected to cut their benchmark rates, which will further help dollar in the short run.
Implications for domestic economy:
With the Nepali Rupees (NPR) depreciating vis-à-vis USD, in tandem with the depreciation of INR against the USD because of our fixed exchange rate system with INR, there will be implications for our domestic economy. Because of our weak currency, USD denominated imports will be expensive while foreigners will find our exports cheaper. If one assumes the “J-Curve” phenomenon then, in the short run, imports will cost us more while exports will sell for less leading to temporary worsening of our current account, which will reverse later as costly imports are expected to decline and exports to surge as effect of currency deprecation seeps into foreign trade. However, much of this depends on exchange-rate elasticities of our export and import products (For example, we will not drastically reduce our petroleum product consumption because of depreciating currency). Remittance income will increase as a dollar now is worth more in local currency. Though the global oil prices have come down substantially in recent times, we will not be able to enjoy low oil prices (to the extent in the international market) because the Nepal Oil Corporation (NOC) has to pay more, in local currency, to buy oil in international market. Furthermore, the USD denominated foreign loans and their respective interest will cost more.
Published on The Kathmandu Post on March 16 2009
Link: http://www.kantipuronline.com/columns.php?&nid=184846
Your browser may not support display of this image.
Your browser may not support display of this image.
What’s leading to dollar’s rise?
Massive economic contraction around the world:
Due to the ongoing economic crisis, major economies all over the world are contracting sharply. According to a recent Bloomberg report, Japan’s economy, second-largest in the world, tumbled 3.3 percent in the fourth quarter of 2008 from the previous one, while Germany contracted a seasonally adjusted 2.1 percent and the economy of euro area shrank 1.5 percent during the last quarter of 2008. Meanwhile, the International Monetary Fund forecasts the U.K. economy to contract by 2.8 percent this year. Though the US Gross Domestic Product (GDP) contracted by more than 6 percent during the fourth quarter, because of high economic uncertainty, investors are pulling away their money from risky assets in developed countries and emerging markets and investing in relatively safe US treasuries. This is reflected in the yields of US Treasury bonds, which have come down significantly during last one year, due to high investors demand for these risk-free securities. Reports from Indian also suggests that Foreign Institutional Investors (FII) have with withdrawn more than USD 2 billion in 2009 are taking home USD 13.5 billion in 2008.
Narrowing inter-country Interest rate differential:
One of the sources of the last dollar slide was high interest rate differential in United States and other major economies around the world. During much of last five years, interest rate in United States has been relatively low compared to rates in other countries. However, due to the current contractionary pressure, central banks around the world have been cutting interest rates drastically to stimulate the economy. In July 2008, according to Bloomberg, the European Central Bank’s (ECB) borrowing costs were 225 basis points more than the Federal Reserve’s federal-funds rate and the Bank of England’s benchmark was 300 basis points higher. Other things equal, higher interest rates attract overseas investment and leads to appreciation of the country’s currency with high rate. Currently, rates in UK are only 75 points more than the respective rates in the US. Similarly, the ECB’s rates are only 175 points higher. The narrowing interest-rate differential has also helped the USD to gain against other currencies. Furthermore, given the current economic distress and possible deflationary risk, central banks around the world are expected to cut their benchmark rates, which will further help dollar in the short run.
Implications for domestic economy:
With the Nepali Rupees (NPR) depreciating vis-à-vis USD, in tandem with the depreciation of INR against the USD because of our fixed exchange rate system with INR, there will be implications for our domestic economy. Because of our weak currency, USD denominated imports will be expensive while foreigners will find our exports cheaper. If one assumes the “J-Curve” phenomenon then, in the short run, imports will cost us more while exports will sell for less leading to temporary worsening of our current account, which will reverse later as costly imports are expected to decline and exports to surge as effect of currency deprecation seeps into foreign trade. However, much of this depends on exchange-rate elasticities of our export and import products (For example, we will not drastically reduce our petroleum product consumption because of depreciating currency). Remittance income will increase as a dollar now is worth more in local currency. Though the global oil prices have come down substantially in recent times, we will not be able to enjoy low oil prices (to the extent in the international market) because the Nepal Oil Corporation (NOC) has to pay more, in local currency, to buy oil in international market. Furthermore, the USD denominated foreign loans and their respective interest will cost more.
Published on The Kathmandu Post on March 16 2009
Link: http://www.kantipuronline.com/columns.php?&nid=184846
Economic Flux and Nepal
We live in uncertain times. Economic theories are being re-written, complex financial systems are being re-engineered, and the virtues of capitalism and globalization are being questioned. After advocating for less regulation for much of the past decade, re-regulation was the buzz world in the recently held World Economic Forum (WEF) in Davos where attendees were also busy dissecting the what’s and how’s of the ongoing economic crisis. At the same time, seizing the moment, participants from the rival World Social Forum (WSF) camp were pointing fingers towards globalization and their capitalistic foes for the current economic mess. After decades of oblivion and where it was shadowed by Neo-Keynesian and Monetarist theory, Keynesian economics is back again thanks to the current Great Recession. In the United States, mainstream economists from both the left and right are now busy debating how best to spend the USD 800 billion stimulus package so that the US government can get more bang per buck.
In the light of the recent crisis, policies favoring protectionism in favor of free trade have been introduced in many countries and the priorities of the World Trade Organization (WTO) are in limbo. Explaining that in their current state organizations such as the International Monetary Fund (IMF) and World Bank (WB) are incapable of addressing the current global economic distress, reforms of these international institutions are being sought. And the much talked about Washington Consensus mantra, which laid down the policy prescriptions for developing economies, is dead.
After decades of overall growth and prosperity, the global economy is in a standstill due to negative growth forecast for the developed economies and tepid growth forecast for the emerging markets.
In our context, there are issues our policymakers need to be worried about. Though directly shielded from the current global crisis because of our nascent financial sector and little, if any, exposure to international capital movement, the current political bickering, labour union problems and recently released economic indicators related to inflation and growth figures all paint a worrisome picture.
While the price levels are coming down all over the world, inflation has gone through the roof in Nepal during the current fiscal year. The year-on-year inflation figures, according to the Nepal Rastra Bank (NRB) data for the last five months, are in double digits, substantially bringing down an average person’s real income. Economic growth, according to the recent report from the Asian Development Bank (ADB), is projected to be around 3.5% for the current fiscal year. At this current rate, our Per Capita Income will double only in 35 years (If we assume that average annual population growth rate for the next 20 years will be 1.5%). For a developed economy 3.5% is a healthy growth rate but given our rampant poverty, inadequate access to basic necessities and insufficient infrastructure, can we afford to lose another 35 years?
Given this background, the current global economic crisis can have multitude of effects on our small economy and further aggravate our economic well being. The decade long Maoist conflict which ended in 2006, subsequent Madhesh movement and the recent labour union problems have to a large extent decimated our industrial sector outside of the Kathmandu valley. Hence, from tourism to remittance to foreign aid, we are dependent on outside income to move our economy forward. Reports from the Middle-East and Malaysia suggest that the economic crisis has taken its toll on their respective economies. Workers are already returning back from these regions and more Nepali migrants workers are expected to come back as companies in these regions scale back on production. These developments have put remittance income, which contribute close to 20 percent of our Gross Domestic Product (GDP), into jeopardy. Similarly, with most of the developed economies either in or expected to be in prolonged recession, our tourism sector, which was starting to recover from the lost-years of conflict, could be struggling again as tourists from United States, Europe and other developed countries cut back on their travel plans.
The few industries that have survived the people’s war and the Madhesh movement are now teetering under the worst possible energy crisis. With 16-hours of load shedding, production levels are down and operating costs are up, affecting a firm’s profitability and return on investment, and consequently an investor’s investment decision. The energy crisis is particularly crippling to small scale enterprises that cannot afford ancillary sources of energy generators. The cut in production as well as high operating costs partly explains the current high inflation figures. Since the energy crisis, according to the Nepal Electricity Authority (NEA), is expected to continue for at least five more years, policymakers need to get their acts together to resolve the power crisis if they expect to either facilitate existing industries or bring any substantial new private investment.
Moreover, a serious introspection is required from the officials at the Ministry of Finance on how to move the economy forward. On the one hand, our finance minister, Dr. Baburam Bhattarai, has come up with a lofty slogan of double digit economic growth within a three year period. However, on the other hand, some of the recent statements from Dr. Bhattarai as well as his other Maoist ideologues in favor of socialistic ideals against capitalistic principles don’t bode well for the future of our economy. Sustainable double digit economic growth needs, among other things, business friendly labour policies, a well functioning capital market, and investor friendly tax policies, which, given the current state of affairs, don’t seem to be in the top-agenda of our finance minister. Dr. Bhattarai and other Maoist ideologues need to learn better from their fellow comrades’ experiments with Cuba and North Korea.
Published on The Kathmandu Post on Feb 18 2009
In the light of the recent crisis, policies favoring protectionism in favor of free trade have been introduced in many countries and the priorities of the World Trade Organization (WTO) are in limbo. Explaining that in their current state organizations such as the International Monetary Fund (IMF) and World Bank (WB) are incapable of addressing the current global economic distress, reforms of these international institutions are being sought. And the much talked about Washington Consensus mantra, which laid down the policy prescriptions for developing economies, is dead.
After decades of overall growth and prosperity, the global economy is in a standstill due to negative growth forecast for the developed economies and tepid growth forecast for the emerging markets.
In our context, there are issues our policymakers need to be worried about. Though directly shielded from the current global crisis because of our nascent financial sector and little, if any, exposure to international capital movement, the current political bickering, labour union problems and recently released economic indicators related to inflation and growth figures all paint a worrisome picture.
While the price levels are coming down all over the world, inflation has gone through the roof in Nepal during the current fiscal year. The year-on-year inflation figures, according to the Nepal Rastra Bank (NRB) data for the last five months, are in double digits, substantially bringing down an average person’s real income. Economic growth, according to the recent report from the Asian Development Bank (ADB), is projected to be around 3.5% for the current fiscal year. At this current rate, our Per Capita Income will double only in 35 years (If we assume that average annual population growth rate for the next 20 years will be 1.5%). For a developed economy 3.5% is a healthy growth rate but given our rampant poverty, inadequate access to basic necessities and insufficient infrastructure, can we afford to lose another 35 years?
Given this background, the current global economic crisis can have multitude of effects on our small economy and further aggravate our economic well being. The decade long Maoist conflict which ended in 2006, subsequent Madhesh movement and the recent labour union problems have to a large extent decimated our industrial sector outside of the Kathmandu valley. Hence, from tourism to remittance to foreign aid, we are dependent on outside income to move our economy forward. Reports from the Middle-East and Malaysia suggest that the economic crisis has taken its toll on their respective economies. Workers are already returning back from these regions and more Nepali migrants workers are expected to come back as companies in these regions scale back on production. These developments have put remittance income, which contribute close to 20 percent of our Gross Domestic Product (GDP), into jeopardy. Similarly, with most of the developed economies either in or expected to be in prolonged recession, our tourism sector, which was starting to recover from the lost-years of conflict, could be struggling again as tourists from United States, Europe and other developed countries cut back on their travel plans.
The few industries that have survived the people’s war and the Madhesh movement are now teetering under the worst possible energy crisis. With 16-hours of load shedding, production levels are down and operating costs are up, affecting a firm’s profitability and return on investment, and consequently an investor’s investment decision. The energy crisis is particularly crippling to small scale enterprises that cannot afford ancillary sources of energy generators. The cut in production as well as high operating costs partly explains the current high inflation figures. Since the energy crisis, according to the Nepal Electricity Authority (NEA), is expected to continue for at least five more years, policymakers need to get their acts together to resolve the power crisis if they expect to either facilitate existing industries or bring any substantial new private investment.
Moreover, a serious introspection is required from the officials at the Ministry of Finance on how to move the economy forward. On the one hand, our finance minister, Dr. Baburam Bhattarai, has come up with a lofty slogan of double digit economic growth within a three year period. However, on the other hand, some of the recent statements from Dr. Bhattarai as well as his other Maoist ideologues in favor of socialistic ideals against capitalistic principles don’t bode well for the future of our economy. Sustainable double digit economic growth needs, among other things, business friendly labour policies, a well functioning capital market, and investor friendly tax policies, which, given the current state of affairs, don’t seem to be in the top-agenda of our finance minister. Dr. Bhattarai and other Maoist ideologues need to learn better from their fellow comrades’ experiments with Cuba and North Korea.
Published on The Kathmandu Post on Feb 18 2009
The Dollar Conundrum
While the US financial system and the stock market have seen unprecedented loss and volatility in recent months, the United States Dollar (USD) has been making strong rally against major world currencies. Against Euro, the USD has gained from 0.62 to 0.74 - 19 percent rise in last six months. Similarly against the Indian Rupees (IRs), the USD has gained from 38.40 to 48.53 - a whopping 26 percent increase in last one year. Since the Nepali Rupees (NRs) is pegged to the IRs, the USD has also appreciated substantially against our national currency - from a low of NRs 63.5 in January to NRs 77.75 on Oct 17.
Against the Japanese Yen, the USD has mixed fortune - while the USD appreciated against Yen for the first half of the year, it fell during the recent global financial crisis as international investors and speculators started buying Yen to unwind their carry-trade position. The fall of Euro against the Yen further underscores the point that investors worldwide are unwinding their carry trade position. In the light of recent global financial crisis and liquidity crunch, the rise of Yen is understandable as international investors currently don't find carry trade's prospect attractive.
One of the major reasons for the recent rise of the USD against currencies of emerging market like India and Brazil is increasing level of risk aversion among international investors. For major part of this decade, Foreign Institutional Investors (FII) had been pouring money into high-growth emerging markets such as Brazil, Russia, India and China (so called BRIC countries). The unprecedented level of capital inflows into these countries led to the appreciation of their domestic currencies against the USD. However with the recent global financial crisis, major FII such as hedge funds and mutual funds are liquidating their position in these emerging markets and selling their foreign assets for the USD. It is worthwhile to note that the decline of the IRs against the USD, which started roughly a year ago, tentatively coincides with the unraveling of the mortgage crisis in the United States. In India, the recent wave of selling in Bombay Stock Exchange (BSE) has been predominantly led by the FII. According to a Securities Exchange Board of India's (SEBI) report, the net FII outflow crossed USD 1 billion during the first half of September. With the continuing volatility in the global market and the existing uncertainty about global financial system, it is plausible that major FII will stay away from the emerging markets like India for a while.
The larger question amidst all these recent fluctuation in the dollar value and the ongoing global financial crisis is the long term future of the USD. Though the greenback has risen substantially in recent months, to understand the contours of the USD in future one must analyze the fundamentals that influences currency value in the long run. Following are few facts and observations that might help one understand the course of the USD in coming days. The US economy is headed for a recession. How long and how painful the downturn will be depends on how soon the credit crisis eases and how early banks start lending to businesses. However, irrespective of the length and the breadth of the downturn, the image of the US economy will receive a severe battering in months and years to come. Henceforth there are two dangers to USD from this front. First with a dwindling economic growth rate, the USD will see its value decline because the long run value of a country's currency is tied to its economic growth. Despite the current financial crisis, the overall prospects for countries like India, China and Brazil are still bright and they will continue to grow at a much healthier rate than US economy in coming years. Hence their currencies should, in theory, appreciate against the USD. Second danger comes from a potential undermining of the image of US economy and its financial system. When the US economy last went to recession in 2000-2001, the USD held its ground against other currencies because foreign investors continued to buy US assets. At that time, United States was still regarded as, according to international finance expert Catherine Mann, "an oasis of prosperity" because of its high productivity and ability to innovate. However, because of the ongoing global financial crisis, which has its root in the United States, the image of US economy and its financial system will be tainted.
Furthermore, the recent surge of greenback doesn't bode well with the argument that dollar needs further weakening to manage high level of current account deficit in the US. As early as January 2007, weak dollar advocates and respected economists like Martin Feldstein and Kenneth Rogoff argued that the USD needs to decline by 8 to 25 percent against other currencies to manage the spiraling current account deficit in the US. The depreciation of the dollar in first half of 2007 was seen as a right direction - one that could help bring down the US current account deficit to more manageable level. However the recent rise of the USD could further strain the US current account deficit, which stood at approx USD 740 billion for the year 2007. With a weakened economy and decreasing consumer confidence, US imports is expected to fall substantially in coming months. However, the stronger dollar coupled with a weaker global economy will hurt US exporters more and is expected to further widen the US current account deficit.
Another aspect is the monetary policy of the Federal Reserve "Fed" of the United States vis-à-vis actions of other central banks. The recent rise of the USD is noteworthy when we compare the difference in interest rate policies of the Fed and other central banks during the first half of 2008. When the Fed started cutting interest rates in early 2008, central banks in Europe and emerging market were raising rates to tackle inflationary pressure. For example, during first half of 2008, the Reserve Bank of India (RBI) raised interest rates while the inflation-hawkish European Central Bank (ECB) avoided rate cuts because of rising inflation figures. In a normal scenario the USD should have lost value against the Euro and IRs. But the recent crisis and the massive capital flow across the globe have undermined normal economic linkages. With oil prices coming down sharply, inflation is expected to ease in coming months. Already the central banks around the world have cut interest rates to ease the liquidity problem. These rate cuts around the world should help the USD to maintain its recent gains.
Overall, despite the recent gains, the future of the USD depends on the health of the US economy and its ability to attract foreign investors. Both aspects seem vulnerable right now. The recent USD 700 billion bailout plan of the US banks has put additional pressure on the mounting level of US national debt, which stands over USD 10 trillion. This rising national debt level undermines the future of the USD because emerging doubts about the US debt level could spur selling off of dollar reserves in China, Russia and India, whom hold over trillions of dollars as official reserves.
Published on The Kathmandu Post October 23, 2008
Link: http://www.kantipuronline.com/kolnews.php?&nid=164567
Against the Japanese Yen, the USD has mixed fortune - while the USD appreciated against Yen for the first half of the year, it fell during the recent global financial crisis as international investors and speculators started buying Yen to unwind their carry-trade position. The fall of Euro against the Yen further underscores the point that investors worldwide are unwinding their carry trade position. In the light of recent global financial crisis and liquidity crunch, the rise of Yen is understandable as international investors currently don't find carry trade's prospect attractive.
One of the major reasons for the recent rise of the USD against currencies of emerging market like India and Brazil is increasing level of risk aversion among international investors. For major part of this decade, Foreign Institutional Investors (FII) had been pouring money into high-growth emerging markets such as Brazil, Russia, India and China (so called BRIC countries). The unprecedented level of capital inflows into these countries led to the appreciation of their domestic currencies against the USD. However with the recent global financial crisis, major FII such as hedge funds and mutual funds are liquidating their position in these emerging markets and selling their foreign assets for the USD. It is worthwhile to note that the decline of the IRs against the USD, which started roughly a year ago, tentatively coincides with the unraveling of the mortgage crisis in the United States. In India, the recent wave of selling in Bombay Stock Exchange (BSE) has been predominantly led by the FII. According to a Securities Exchange Board of India's (SEBI) report, the net FII outflow crossed USD 1 billion during the first half of September. With the continuing volatility in the global market and the existing uncertainty about global financial system, it is plausible that major FII will stay away from the emerging markets like India for a while.
The larger question amidst all these recent fluctuation in the dollar value and the ongoing global financial crisis is the long term future of the USD. Though the greenback has risen substantially in recent months, to understand the contours of the USD in future one must analyze the fundamentals that influences currency value in the long run. Following are few facts and observations that might help one understand the course of the USD in coming days. The US economy is headed for a recession. How long and how painful the downturn will be depends on how soon the credit crisis eases and how early banks start lending to businesses. However, irrespective of the length and the breadth of the downturn, the image of the US economy will receive a severe battering in months and years to come. Henceforth there are two dangers to USD from this front. First with a dwindling economic growth rate, the USD will see its value decline because the long run value of a country's currency is tied to its economic growth. Despite the current financial crisis, the overall prospects for countries like India, China and Brazil are still bright and they will continue to grow at a much healthier rate than US economy in coming years. Hence their currencies should, in theory, appreciate against the USD. Second danger comes from a potential undermining of the image of US economy and its financial system. When the US economy last went to recession in 2000-2001, the USD held its ground against other currencies because foreign investors continued to buy US assets. At that time, United States was still regarded as, according to international finance expert Catherine Mann, "an oasis of prosperity" because of its high productivity and ability to innovate. However, because of the ongoing global financial crisis, which has its root in the United States, the image of US economy and its financial system will be tainted.
Furthermore, the recent surge of greenback doesn't bode well with the argument that dollar needs further weakening to manage high level of current account deficit in the US. As early as January 2007, weak dollar advocates and respected economists like Martin Feldstein and Kenneth Rogoff argued that the USD needs to decline by 8 to 25 percent against other currencies to manage the spiraling current account deficit in the US. The depreciation of the dollar in first half of 2007 was seen as a right direction - one that could help bring down the US current account deficit to more manageable level. However the recent rise of the USD could further strain the US current account deficit, which stood at approx USD 740 billion for the year 2007. With a weakened economy and decreasing consumer confidence, US imports is expected to fall substantially in coming months. However, the stronger dollar coupled with a weaker global economy will hurt US exporters more and is expected to further widen the US current account deficit.
Another aspect is the monetary policy of the Federal Reserve "Fed" of the United States vis-à-vis actions of other central banks. The recent rise of the USD is noteworthy when we compare the difference in interest rate policies of the Fed and other central banks during the first half of 2008. When the Fed started cutting interest rates in early 2008, central banks in Europe and emerging market were raising rates to tackle inflationary pressure. For example, during first half of 2008, the Reserve Bank of India (RBI) raised interest rates while the inflation-hawkish European Central Bank (ECB) avoided rate cuts because of rising inflation figures. In a normal scenario the USD should have lost value against the Euro and IRs. But the recent crisis and the massive capital flow across the globe have undermined normal economic linkages. With oil prices coming down sharply, inflation is expected to ease in coming months. Already the central banks around the world have cut interest rates to ease the liquidity problem. These rate cuts around the world should help the USD to maintain its recent gains.
Overall, despite the recent gains, the future of the USD depends on the health of the US economy and its ability to attract foreign investors. Both aspects seem vulnerable right now. The recent USD 700 billion bailout plan of the US banks has put additional pressure on the mounting level of US national debt, which stands over USD 10 trillion. This rising national debt level undermines the future of the USD because emerging doubts about the US debt level could spur selling off of dollar reserves in China, Russia and India, whom hold over trillions of dollars as official reserves.
Published on The Kathmandu Post October 23, 2008
Link: http://www.kantipuronline.com/kolnews.php?&nid=164567
Lessons from global financial crisis
Nov. 10, 2006 stands out as one of the memorable dates in the history of Nepali banking. On this date, throngs of people besieged Nepal Bangladesh Bank (NB Bank) to withdraw their hard earned money after newspaper reports a day earlier suggested that Rs. 13 billion in deposits was in jeopardy due to its reckless and inappropriate practices. Between Nov. 10 and 12, panicked customers took out more than Rs. 3 billion. The run on the bank ended on Nov. 12 when Nepal Rastra Bank (NRB) decided to take over its management.
Fast forward two years to the present and the global banking system is witnessing an unprecedented credit crunch and banks all over the world are fighting for survival. On Wall Street, a number of major investment banks and commercial bank holding companies have gone bankrupt. Household names like Bear Stearns, Lehman Brothers and Wachovia have all succumbed to one of the most massive and contagious financial crises in decades. Across the Atlantic, the story is the same. Week after week of bank bailouts and failures in Belgium, the UK and France. Though there hasn't been any reports of banks going belly up or being rescued in Asia, it would be naïve to assume that this won't have any consequences in this part of the world. Reports coming out of India suggest that anxious customers have started to take out their money from ICICI Bank - one of the leading Indian banks - despite reassurances from Indian Finance Minister P. Chidambaram.
With a global liquidity crunch and probably more bank failures to follow, there is widespread economic uncertainty; and experts are predicting a prolonged period of negative economic growth. Stock markets all over the world have seen significant sell offs for the last few weeks, and major indices like the Dow Jones Industrial Average (DIJA), Nikkei and S&P 500 have recently seen a lot of volatility - an indication of market uncertainty and risk. To sum it up, the global financial system has come close to a screeching halt. Credit has dried up everywhere; and confidence, the cornerstone of the credit market, is in scarce supply as big banks continue to bite the dust. In the heart of all this lies the complex world of financial derivatives, credit default swaps (CDS) and other arcane financial instruments.
Though Nepali banks don't have any direct exposure to these financial instruments, important lessons can be learnt from unfolding global events. A few days ago, NRB announced its new "cautious" monetary policy for the upcoming fiscal year with special emphasis on tackling inflation. In its report, NRB has also expressed concern over the real estate and stock market bubble. The Nepal Stock Exchange (NEPSE) -- the country's sole secondary stock market -- has seen significant recent growth with an exponential rise in public participation. The growth in the equity market is good for the overall development of the economy. However, speculative growth where the "fundamentals" of the underlying market are not sound creates a market bubble. There are no economic or financial statistics that supports the current boom in equity and real estate. Considering the growth rate of 2-3 percent for the last five years, a few significant national-level investment projects and a wounded economy staggering out of a decade-long conflict, it's hard to argue against the premise that the current share and land markets are a bubble.
All of this has coincided with the increased exposure of commercial banks and finance companies to equity and real estate. Responding to the public's interest in stocks and real estate, these financial institutions have been providing easy loans to people wishing to invest in them. This has helped to inflate share and land prices and create a market bubble. Bubbles inevitably lead to bust. Economists have argued that decade long housing bubbles in the United States, Europe and Australia is the primary reason for the current financial crisis and credit crunch. In the United States, easy access to housing loans and historical level of low lending rate led to an unprecedented real-estate boom. People with sub-par credit ratings and without any stable source of income easily walked away from bank with mortgage to buy a house. These subprime mortgages were then combined with other mortgages and sold to investors as Mortgage Backed Securities (MBS). Everyone was happy because everything was booming for a while.
However, when these house owners with sub-prime mortgage started to default on their monthly mortgage payments, things started to unravel quickly. MBS, which were a significant portion of banks balance sheet all over the world, lost value as investors realized its dicey origins. Quarter after quarter, banks with exposure to these MBS announced significant losses. Investors fearing further loss started pulling away their money from banks and investment, which exacerbated the situation and led to bank failures. In the Nepali banking context, there are reasons to be concerned about the exposure of commercial banks and finance companies to equity and real estate market. Because of lack of investment opportunities in other sector, financial institutions have been pouring money in real estate and equity market. While unprecedented remittance inflow has helped sustain the deposit mobilization growth even in the light of growing number of these financial institutions, there aren't enough areas for investment outlays to support the growing deposit base. Hence financial institutions don't have much of a choice but to provide loans for investment in equity and real-estate market.
Anticipating higher returns, people without any background in investment or any professional guidance are taking out loans to invest in these markets. Because of increasing competition, financial institutions are providing loans without proper credit and income check. All of these factors have helped to inflate stock and real-estate prices. However, when the bubble finally busts either in equity or real estate market, there will be an immediate impact on the balance sheet position of these financial institutions. The onus lies with the NRB to ensure proper health of our banking sector. First, there should be adequate regulatory framework to ensure that bank's asset base is sound and not inflated. Unless other areas of investment emerge, these financial institutions will continue to provide loans for investment in real-estate and equity market.
The NRB must have an effective monitoring and regulating mechanism whereby it can identify potential trouble in the assets base of these institutions. The recent global financial crisis is testament of how easily and rapidly asset value can deteriorate. Second, the NRB should address the important issue of conflict of interests when these financial institutions provide loans for investment in stock market. The majority of stocks traded in the NEPSE are those of financial institutions and these same institutions are providing loans to investors to purchase their own stocks. Third, the NRB must bring out safeguard mechanism to avoid a potential bank run, when the market crashes in the future and asset value of these institutions evaporate. In the United States the Federal Deposit Insurance Corporation (FDIC) insures deposit and certain category of money market funds up to USD 100,000. In the light of the recent crisis, the US congress is planning to extend the limit to USD 250,000 to bolster the weakening public confidence in banks. Similar mechanism exists in other countries to protect the deposit holders and small investors. The NRB should bring out similar kind of scheme in order to protect deposit holders and avoid another bank run in the future.
Published on The Kathmandu Post October 3, 2008
Link: http://www.kantipuronline.com/kolnews.php?&nid=162763
References and links to this article:
http://www.economicsofcrisis.com/economics_of_crisis/global.html
Fast forward two years to the present and the global banking system is witnessing an unprecedented credit crunch and banks all over the world are fighting for survival. On Wall Street, a number of major investment banks and commercial bank holding companies have gone bankrupt. Household names like Bear Stearns, Lehman Brothers and Wachovia have all succumbed to one of the most massive and contagious financial crises in decades. Across the Atlantic, the story is the same. Week after week of bank bailouts and failures in Belgium, the UK and France. Though there hasn't been any reports of banks going belly up or being rescued in Asia, it would be naïve to assume that this won't have any consequences in this part of the world. Reports coming out of India suggest that anxious customers have started to take out their money from ICICI Bank - one of the leading Indian banks - despite reassurances from Indian Finance Minister P. Chidambaram.
With a global liquidity crunch and probably more bank failures to follow, there is widespread economic uncertainty; and experts are predicting a prolonged period of negative economic growth. Stock markets all over the world have seen significant sell offs for the last few weeks, and major indices like the Dow Jones Industrial Average (DIJA), Nikkei and S&P 500 have recently seen a lot of volatility - an indication of market uncertainty and risk. To sum it up, the global financial system has come close to a screeching halt. Credit has dried up everywhere; and confidence, the cornerstone of the credit market, is in scarce supply as big banks continue to bite the dust. In the heart of all this lies the complex world of financial derivatives, credit default swaps (CDS) and other arcane financial instruments.
Though Nepali banks don't have any direct exposure to these financial instruments, important lessons can be learnt from unfolding global events. A few days ago, NRB announced its new "cautious" monetary policy for the upcoming fiscal year with special emphasis on tackling inflation. In its report, NRB has also expressed concern over the real estate and stock market bubble. The Nepal Stock Exchange (NEPSE) -- the country's sole secondary stock market -- has seen significant recent growth with an exponential rise in public participation. The growth in the equity market is good for the overall development of the economy. However, speculative growth where the "fundamentals" of the underlying market are not sound creates a market bubble. There are no economic or financial statistics that supports the current boom in equity and real estate. Considering the growth rate of 2-3 percent for the last five years, a few significant national-level investment projects and a wounded economy staggering out of a decade-long conflict, it's hard to argue against the premise that the current share and land markets are a bubble.
All of this has coincided with the increased exposure of commercial banks and finance companies to equity and real estate. Responding to the public's interest in stocks and real estate, these financial institutions have been providing easy loans to people wishing to invest in them. This has helped to inflate share and land prices and create a market bubble. Bubbles inevitably lead to bust. Economists have argued that decade long housing bubbles in the United States, Europe and Australia is the primary reason for the current financial crisis and credit crunch. In the United States, easy access to housing loans and historical level of low lending rate led to an unprecedented real-estate boom. People with sub-par credit ratings and without any stable source of income easily walked away from bank with mortgage to buy a house. These subprime mortgages were then combined with other mortgages and sold to investors as Mortgage Backed Securities (MBS). Everyone was happy because everything was booming for a while.
However, when these house owners with sub-prime mortgage started to default on their monthly mortgage payments, things started to unravel quickly. MBS, which were a significant portion of banks balance sheet all over the world, lost value as investors realized its dicey origins. Quarter after quarter, banks with exposure to these MBS announced significant losses. Investors fearing further loss started pulling away their money from banks and investment, which exacerbated the situation and led to bank failures. In the Nepali banking context, there are reasons to be concerned about the exposure of commercial banks and finance companies to equity and real estate market. Because of lack of investment opportunities in other sector, financial institutions have been pouring money in real estate and equity market. While unprecedented remittance inflow has helped sustain the deposit mobilization growth even in the light of growing number of these financial institutions, there aren't enough areas for investment outlays to support the growing deposit base. Hence financial institutions don't have much of a choice but to provide loans for investment in equity and real-estate market.
Anticipating higher returns, people without any background in investment or any professional guidance are taking out loans to invest in these markets. Because of increasing competition, financial institutions are providing loans without proper credit and income check. All of these factors have helped to inflate stock and real-estate prices. However, when the bubble finally busts either in equity or real estate market, there will be an immediate impact on the balance sheet position of these financial institutions. The onus lies with the NRB to ensure proper health of our banking sector. First, there should be adequate regulatory framework to ensure that bank's asset base is sound and not inflated. Unless other areas of investment emerge, these financial institutions will continue to provide loans for investment in real-estate and equity market.
The NRB must have an effective monitoring and regulating mechanism whereby it can identify potential trouble in the assets base of these institutions. The recent global financial crisis is testament of how easily and rapidly asset value can deteriorate. Second, the NRB should address the important issue of conflict of interests when these financial institutions provide loans for investment in stock market. The majority of stocks traded in the NEPSE are those of financial institutions and these same institutions are providing loans to investors to purchase their own stocks. Third, the NRB must bring out safeguard mechanism to avoid a potential bank run, when the market crashes in the future and asset value of these institutions evaporate. In the United States the Federal Deposit Insurance Corporation (FDIC) insures deposit and certain category of money market funds up to USD 100,000. In the light of the recent crisis, the US congress is planning to extend the limit to USD 250,000 to bolster the weakening public confidence in banks. Similar mechanism exists in other countries to protect the deposit holders and small investors. The NRB should bring out similar kind of scheme in order to protect deposit holders and avoid another bank run in the future.
Published on The Kathmandu Post October 3, 2008
Link: http://www.kantipuronline.com/kolnews.php?&nid=162763
References and links to this article:
http://www.economicsofcrisis.com/economics_of_crisis/global.html
Rupee Vs Rupee
A recent news report entitled "Nepal foreign exchange reserves cross US$ 3 billion mark" (July 26) caught my attention. Despite a widening trade deficit (17.3 percent of Gross Domestic Product in
the fiscal year 2006-07), Nepal Rastra Bank (NRB) has been able to increase its dollar assets thanks to remittances sent home from Nepali migrants working abroad. A widely held belief is that the
greater the foreign exchange reserve, the better it is. This notion stems largely from a well-known tenet in international economics that hard cash reserves help maintain confidence in a country's currency and
attracts foreign investors. Moreover, recent events like the 1997 Asian financial crisis and the 1994 Mexican peso crisis seem to have further underscored the importance of foreign exchange reserves among central bankers.
Academic studies suggest that the optimum level of foreign currency reserves, however, depends on various factors like the size of a country's economy, its trade deficit and foreign exchange policy. Furthermore, holding more foreign exchange than necessary is not good, and there is an
opportunity cost (in terms of higher returns) for every extra dollar in the treasury. Because Nepal has a large and widening trade deficit, NRB needs to maintain adequate foreign exchange reserves to meet various obligations and ensure confidence in the market.
However, NRB needs to rethink its foreign exchange reserve management in terms of the composition of the currencies. Recently, the Indian rupee (INR) appreciated strongly against the US dollar (USD) – the unofficial reserve currency – and due to our fixed exchange rate regime with India (about which I elaborate below), the Nepali rupee (NPR) has also become stronger against the greenback. When
the NPR gains against the USD, the value of NRB's foreign exchange reserves, however, declines (Nepal's
export industry also loses its competitiveness; but I have ignored other issues here). For example, at the current value, a one-rupee gain in the NPR vis-à-vis the USD will shrink the value of NRB's reserves by approximately Rs 3 billion. Recently, the USD has been losing ground against all major currencies.
With the US economy slowing down and the Federal Reserve lowering interest rates, it's very unlikely that the greenback can initiate a rally for at least a few years. Moreover, with India's economy projected to grow at a high rate in the coming decades, it is clear that the INR will continue to
gain against the USD.
Given our current fixed exchange rate policy, the value of NRB's reserves will continue to decline if it
doesn't act soon. One solution for Nepal's central bank would be to diversify the reserves portfolio and
add other currencies like the euro and the Chinese yuan. The second solution (not exclusive from the first) is in NRB's exchange rate policy. At a time of spiraling inflation (a global phenomenon),
a sliding dollar and carry trade and capital flight scenarios, a proper analysis needs to be done
regarding NRB's monetary policy, especially its fixed exchange rate policy with the INR. For over a decade now, NRB has pegged the Nepali rupee to the Indian rupee. This fixed exchange rate system
of NPR 1.6 for INR 1 has persisted for a long time without any revaluation. Recently noted economist Dr
Raghab D Pant has suggested that NRB should reexamine its pegged exchange rate policy. In international economics, one of the most debated issues is the choice of an exchange
rate regime.
Prior to the 1997 Asian financial crisis, Southeast Asian countries like Thailand, the Philippines
and Malaysia, among others, fixed their exchange rates against the USD. After the crisis, Thailand and others moved away from the fixed system towards a floating rate mechanism. China, which was unaffected by the 1997 crisis due to its capital control laws, still has a unique system of predominantly
fixed exchange rate system vis-à-vis the USD. One of the major reasons why countries fix their exchange rate against their major trading partners is to avoid exchange rate fluctuations and maintain price stability. Most of the export-dependent countries have over the years pegged their currencies
to the USD (unofficial world currency). India is Nepal's major trading partner and largest export destination, so fixing the exchange rate to avoid price fluctuations is certainly advantageous. An International Monetary Fund (IMF) study suggests that a fixed exchange rate, by fostering
confidence among international investors, can lead to higher foreign investments and higher growth.
However, the study also suggests that if a currency is pegged at the wrong level, it can lead to misallocation of resources and speculative actions. Because there hasn't been any revaluation on NRB's part for a long time, it is very likely that the current "pegged" exchange rate is incorrect.
Moreover, when a country (read Nepal) fixes its exchange rate, it also imports the monetary policy of the country (read India) to whose currency its currency is pegged. In other words, Nepal doesn't have a monetary policy of its own. That is, if India increases the money supply, its currency depreciates. NRB then has to intervene to prevent its currency from appreciating against the Indian rupee, so it too has to increase its money supply. Therefore, the Reserve Bank of India's (RBI) monetary policy affects Nepal which ends up importing India's inflation.
The issue here is how India's spiraling inflation (close to 12 percent) is affecting our economy. Prices in Nepal have surged recently, and reports show that the inflation has entered "double digit" territory. But how much of the price increment is due to global "supply shocks" like increasing oil prices and
food crisis, and how much is due to our exchange rate policy with India? Though the recent increase in India's CPI can also be attributed to global "supply shocks", its lax monetary policy has also exacerbated the problem. To sustain its unprecedented recent growth, the monetary authorities in India allowed interest rates to remain too low for too long. Recently, the RBI hiked interest rates to tackle rising prices. However, the hike will take time to show its effects and pull down inflation.
Also lately, thanks to India's booming economy, a lot of money is flowing out from Nepal to India in
search of higher returns in real estate and the stock market. Due to this rapid outflow of the INR, it is in short supply in the market. NRB has thus been forced to sell its dollar reserves to buy enough INR and maintain the currency peg. This is not sustainable over a period of time and is a recipe for disaster. Inevitably, after gaining an understanding of the true exchange rate from market dynamics, speculators
(like George Soros who made billons from betting against the British pound in 1992) will start buying
Indian rupees and selling Nepali rupees. This will eventually compel NRB to devalue the currency.
Published on The Kathmandu Post on August 21, 2008
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