Spending or Saving??

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

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

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

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

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

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

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

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

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

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

20 years later...

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

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

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

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

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

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

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

Calling all Countrymen

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

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

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

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

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

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

Taking Stock

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/

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/

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

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