After much hue and cry and a delay of almost four months, Minister of Finance Surendra Pandey finally tabled the budget of Rs 337.9 billion for the Fiscal Year 2010/11 on Saturday.
Amidst the cacophony of political wrangling, it’s relieving to finally have a budget, which lays out key fiscal policies, irrespective of its form or issuance mechanism. Having said that, lets then discuss what this year’s budget has to offer and, after much ado, are there things to be cheerful about?
Segregating the composition of budget, Rs 190.32 billion has been allocated for recurrent expenditure, Rs 129.54 billion has been allocated for capital expenditure and Rs 18.42 billion has been allocated for principal repayment of foreign loans. In terms of sources, the government expects to raise Rs 216.64 billion from revenue collection, mobilise Rs 87.57 billion from foreign rants and loan, and borrow Rs 33.68 billion internally. To up the ante on revenue collection, the budget has focused on expanding revenue net and has proposed 2011 as ‘Tax Implementation Campaign Year’.
During the last fiscal year, Nepali economy reeled under Balance of Payment (BOP) crisis and had to seek help from the International Monetary Fund (IMF) under its rapid credit facility program to maintain external sector stability. While huge growth in imports of gold were largely to blame for the BoP crisis, which at one time was in deficit of almost Rs 24 billion. There were other glaring trends; for example, Nepal imported livestock worth Rs. 15 billion during the FY 2009/10.
Given the current mismatch between the import and export growth (in the FY 2009/10, Nepal’s merchandise export declined by 9.7% to Rs 61.13 billion while imports increased by 33.2% to 378.8 billion), Nepal will have to perennially face BoP crisis if the government doesn’t act to either revive Nepal’s export or curb import. Hence, this year’s budget should have focused on import substitution and export expansion programmes. However, few, if any, such specific programs can be found in the budget.
During the last few years, education sector has received substantial budgetary allocation and it has paid off handsomely as Nepal has made rapid headway in literacy rate. This year also, 17.1%, which is the highest sector allocation of the total budget, has been allocated for the education sector.
One of the factors for the underperformance of Nepali economy over last couple of years is lack of proper roads and transportation related infrastructure. Given the growth constraints due to lack of transportation related infrastructure, budget has proposed construction of Railway and Metro to kick start the development of mass transit system in Nepal. The focus on development of four- and six-lane highways in and around Kathmandu and border towns near India will however help to ease supply bottlenecks. Moreover, to tackle
the energy crisis, this budget has allocated funds for completion of Trishuli-3, Chameliya and Kulekhani-3, among others.
Recently, the government has shown adequate concern to revive the flagging capital market. Slew of new regulations (Mutual Fund and Central Depository System) have been issued during last couple of months to streamline and institutionalise security market. This budget has also introduced several new programs such as allowing Non Resident Nepalis (NRNs) to invest in capital market, regulating the commodity and derivative market and introducing regulation pertaining to credit rating mechanism. These will certainly help to move the capital market in the right direction; however, going forward, government should also allow overseas investors to invest in domestic capital market, as the mutual fund regulation already allows 25% of total Asset under Management (AUM) of a mutual fund to be invested in overseas market.
The budget has also proposed tax incentives to encourage merger and acquisitions (M&A) among financial institutions and insurance companies. One of the bones of contention while pursuing M&A in Nepal have been the issue of fixed asset revaluation and consequent capital gain tax on such revaluation. Hence, I believe, finance minister’s proposed tax incentive is likely to address this issue, among others.
Keeping in the mind the Nepal Tourism Year-2011 (NTY-2011), this budget has proposed various programs for a successful NTY-2011. However, with less than one and half month’s time before the start of the NTY-2011, it’s debatable whether there is sufficient time for implementation of these programmes. And, this brings home the point which has plagued fiscal policy making in Nepal for quite some time-lack of proper implementation of proposed program due to less time period after the budget announcement and before the end of the FY.
Recently a high level commission called ‘Commission to review Government Budget Management and Expenditure System’, submitting a report to Finance Minister Pandey, recommended the government to bring budget before May; i.e., at least one and half months before the end of the FY. As many programs announced in the budget goes either un-implemented or are implemented hastily towards the end of fiscal year to toe the line of budget’s speech, the aforementioned commission’s report rightly urged the government to table budget early so that it leads to better implementation.
Traditionally, in Nepal and unlike international practices, budget for the upcoming fiscal year is brought only towards mid July; i.e., towards the end of the fiscal year. And if there is change in government or any other political wrangling, budget, like this year, gets delayed jeopardising the whole economy. Hence hopefully, going forward, the upcoming government (when and if it gets formed) will heed the Commission’s advice and brings next fiscal year’s budget early.
First published in the Kathmandu Post on November 21, 2010
Link: http://www.ekantipur.com/the-kathmandu-post/2010/11/20/money/dissecting-the-budget/215085/
Saturday, November 20, 2010
Monday, October 25, 2010
Yen and Yuan
In the years following the end of World War II, the Japanese economy witnessed tremendous growth which is often referred to as an “economic miracle”. Japan’s rapid industrialization in the post-war years embraced technological progress and Japanese industry focused on producing high-end technological equipment, innovative electronic products and most reliable automobiles. Rising economic productivity, because of technological progress, coupled with strong exports of renowned international products, such as Sony, Toyota
and Honda, among others, boosted Japan’s economic growth. Japan’s economy grew at an average annualized rate of 10
percent during the 1960s, 5 percent during the 1970s and 4 percent during the 1980s.
However, in order to boost their export related industries, the Japanese government had fixed the exchange rate between the Japanese yen and the US dollar at 360 yen to US$ 1 in 1949. But a high volume of Japanese exports to the US and Europe started causing international tensions in the 1970s. The global stagflation and oil crisis of the 1970s were causing economic woes in the US and other major developed economies in Western Europe. And because of an acute balance of payments crisis, the US had to withdraw from the gold standard and abandon the convertibility of its currency into gold in 1971.
Due to international pressure, Japan finally revalued the yen from 360 to 308 per US$ 1 in December 1971; and later, in February 1973, adopted a floating exchange rate system. However, in order to protect Japan’s industry, the Japanese government kept on intervening in the foreign exchange market and managed to keep the yen at around 250 to 300 to US$ 1. As a result, Japanese exports kept on surging — the share of exports in Japan’s gross domestic product increased from 11.7 percent in 1973 to 14.5 percent in 1984.
Flush with excess foreign
currency, the Japanese government bought US treasuries which helped keep the yields on US government bonds low.
Around that time, while Japan was enjoying economic prosperity, the US was facing economic problems. Although the US had emerged from a series of economic recessions in the 1970s and early 1980s, the artificially low exchange rate of the Japanese yen and the Deutsche mark were undercutting the competitiveness of American industry and stifling a full-fledged economic recovery. As a result, there was a lot of political pressure from the Americans on the Japanese to let the yen appreciate.
To followers of international policy issues, these events of the 1980s sound eerily familiar with what is happening now in terms of the Chinese yuan. The Chinese government, like the Japanese government in the past, has kept its currency artificially low for a number of years to promote Chinese exports. And the weak yuan has paid off handsomely to China as export-led economic growth has propelled China to the second largest economy in the world — a place which was till a few months back occupied by Japan. And like Japan in the 1970s and the 1980s, due to massive influx of foreign currency, the Chinese government has been buying US treasuries and helping to keep yields on US government bonds low. Although the US has been pressuring China for a long time to let the yuan appreciate, the current state of the US economy, with an unemployment rate in excess of 9.5 percent, has compelled US policymakers to raise their voice against a weak yuan.
During the recently held annual meeting of the World Bank and the International Monetary Fund, the major discussions revolved around China’s currency policy. Given the state of the US economy and China’s massive trade surplus with the US, Americans feel that, by keeping the yuan artificially low, China is taking away jobs from the US. But China hasn’t budged so far. Recently, Chinese President Hu Jintao said that allowing the yuan to appreciate too quickly would undermine the competitiveness of Chinese industry and cause social unrest in his country as a lot of workers were dependent on it. A look back at what happened to Japan after it caved in to US demands gives an idea about why Chinese officials won’t bow to US demands.
In the mid-1980s, due to pressure from the US government, Japan had to yield. Amid growing geopolitical tension, the governments of Japan, the UK, West Germany, France and the US signed an agreement at the Plaza Hotel in New York City on Sept. 22, 1985, whereby they decided to intervene in the foreign exchange market to weaken the US dollar against the yen and the Deutsche mark. After the signing of the Plaza accord, the US dollar weakened against the yen by over 50 percent between 1985 and 1987. However, to keep its economy moving along, the central bank of Japan reduced the interest rate to prop up domestic demand which, however, adversely created an asset price bubble in Japan in the late 1980s. After the bubble burst in the early 1990s, Japan’s economy has been perennially underperforming for the last two decades.
China, with the benefit of hindsight, has understood
that allowing the yuan to appreciate too quickly would undermine its economic performance. Moreover, China, because of the size of its population, is nowhere near Japan — when it signed the Plaza accord — in terms of per capita income and has a lot of catching up to do. Hence, it’s unlikely that there will be a
Plaza-like agreement in the coming days, and more ugly exchanges between US officials and their Chinese counterparts are likely to persist for the foreseeable future unless another viable compromise can be reached.
This article was first published in The Kathmandu Post on 25th October 2010
Permanent Link: http://www.ekantipur.com/the-kathmandu-post/2010/10/24/money/yen-and-yuan/214110/
and Honda, among others, boosted Japan’s economic growth. Japan’s economy grew at an average annualized rate of 10
percent during the 1960s, 5 percent during the 1970s and 4 percent during the 1980s.
However, in order to boost their export related industries, the Japanese government had fixed the exchange rate between the Japanese yen and the US dollar at 360 yen to US$ 1 in 1949. But a high volume of Japanese exports to the US and Europe started causing international tensions in the 1970s. The global stagflation and oil crisis of the 1970s were causing economic woes in the US and other major developed economies in Western Europe. And because of an acute balance of payments crisis, the US had to withdraw from the gold standard and abandon the convertibility of its currency into gold in 1971.
Due to international pressure, Japan finally revalued the yen from 360 to 308 per US$ 1 in December 1971; and later, in February 1973, adopted a floating exchange rate system. However, in order to protect Japan’s industry, the Japanese government kept on intervening in the foreign exchange market and managed to keep the yen at around 250 to 300 to US$ 1. As a result, Japanese exports kept on surging — the share of exports in Japan’s gross domestic product increased from 11.7 percent in 1973 to 14.5 percent in 1984.
Flush with excess foreign
currency, the Japanese government bought US treasuries which helped keep the yields on US government bonds low.
Around that time, while Japan was enjoying economic prosperity, the US was facing economic problems. Although the US had emerged from a series of economic recessions in the 1970s and early 1980s, the artificially low exchange rate of the Japanese yen and the Deutsche mark were undercutting the competitiveness of American industry and stifling a full-fledged economic recovery. As a result, there was a lot of political pressure from the Americans on the Japanese to let the yen appreciate.
To followers of international policy issues, these events of the 1980s sound eerily familiar with what is happening now in terms of the Chinese yuan. The Chinese government, like the Japanese government in the past, has kept its currency artificially low for a number of years to promote Chinese exports. And the weak yuan has paid off handsomely to China as export-led economic growth has propelled China to the second largest economy in the world — a place which was till a few months back occupied by Japan. And like Japan in the 1970s and the 1980s, due to massive influx of foreign currency, the Chinese government has been buying US treasuries and helping to keep yields on US government bonds low. Although the US has been pressuring China for a long time to let the yuan appreciate, the current state of the US economy, with an unemployment rate in excess of 9.5 percent, has compelled US policymakers to raise their voice against a weak yuan.
During the recently held annual meeting of the World Bank and the International Monetary Fund, the major discussions revolved around China’s currency policy. Given the state of the US economy and China’s massive trade surplus with the US, Americans feel that, by keeping the yuan artificially low, China is taking away jobs from the US. But China hasn’t budged so far. Recently, Chinese President Hu Jintao said that allowing the yuan to appreciate too quickly would undermine the competitiveness of Chinese industry and cause social unrest in his country as a lot of workers were dependent on it. A look back at what happened to Japan after it caved in to US demands gives an idea about why Chinese officials won’t bow to US demands.
In the mid-1980s, due to pressure from the US government, Japan had to yield. Amid growing geopolitical tension, the governments of Japan, the UK, West Germany, France and the US signed an agreement at the Plaza Hotel in New York City on Sept. 22, 1985, whereby they decided to intervene in the foreign exchange market to weaken the US dollar against the yen and the Deutsche mark. After the signing of the Plaza accord, the US dollar weakened against the yen by over 50 percent between 1985 and 1987. However, to keep its economy moving along, the central bank of Japan reduced the interest rate to prop up domestic demand which, however, adversely created an asset price bubble in Japan in the late 1980s. After the bubble burst in the early 1990s, Japan’s economy has been perennially underperforming for the last two decades.
China, with the benefit of hindsight, has understood
that allowing the yuan to appreciate too quickly would undermine its economic performance. Moreover, China, because of the size of its population, is nowhere near Japan — when it signed the Plaza accord — in terms of per capita income and has a lot of catching up to do. Hence, it’s unlikely that there will be a
Plaza-like agreement in the coming days, and more ugly exchanges between US officials and their Chinese counterparts are likely to persist for the foreseeable future unless another viable compromise can be reached.
This article was first published in The Kathmandu Post on 25th October 2010
Permanent Link: http://www.ekantipur.com/the-kathmandu-post/2010/10/24/money/yen-and-yuan/214110/
Wednesday, September 29, 2010
Unusually Uncertain
"Unusually uncertain” were the two words that Ben Bernanke, the Chairman of the Federal Reserve of United States, said about the state of economic recovery on July 21st 2010. After the remarks were released, the US stock market fell sharply which were followed later with subsequent fall in the Asian and European markets.
After showing signs of recovery in early 2010, the global economic outlook has deteriorated during the last couple of months. Economic growth in major advanced economies has been tepid at best, and the much talked about “green shoots” of recovery witnessed during mid 2009 hasn’t materialized into full scale economic expansion.
The unemployment rate in the US hasn’t budged from 9.5 percent to 10 percent range during the last one year. The high unemployment rate shows that business confidence is still low and companies aren’t hiring despite the recent surge in their profit. Household consumption accounts for over 70 percent of the US Gross Domestic Product (GDP) and because of struggling job market, households are chary of spending. As a result, savings rate in the US has increased after the global economic crisis: from a pre-crisis negative savings rate, the US household savings rate has recently increased to over 6 percent. One of the major reasons of global economic crisis was over-consumption of US households; hence, the increment in savings rate is good for the long run. However, in the short run, the US economy desperately needs its consumers to spend more to boost its growth prospects, which looks unlikely given the current US job market situation.
And, if leading experts are to be believed, US job market won’t improve any time soon. Mohammed El-Erian, chief executive officer and co-chief investment officer of PIMCO - the largest fixed income manager in the world - recently said that the US will witness a “lost decade” of jobs growth. Bill Gross, founder and Managing Director of PIMCO was first to coin the term “New Normal” in early 2009 to describe a prolong period of slow growth and high unemployment for the US economy.
When leading economists and central bankers from around the world gathered recently in Jackson Hole, Wyoming to discuss the future of the global economy, the mood amongst the members of this elite group was reported to be much somber. Having already taken unprecedented steps to bolster economic performance
after the crisis, central bankers have plenty to think about
given the daunting prospect of ‘double dip”. Speaking at the Jackson Hole Symposium, Bernanke reiterated his earlier comments about uncertain course of economic recovery and added that US growth will remain subdued for rest of the 2010 and that US economy will grow, albeit slowly, in 2011.
Few significant events have contributed to uncertain business environment which subsequently had an impact on economic performance of major economies. When the “green shoots” of the recovery first emerged during the second half of 2009, business confidence started to recover. However, much of the progress was dented when credit problems surfaced in Dubai in late 2009. Before the problems in Dubai were sorted out, Europe started to have its own debt problems. Overnight, the Credit Default Swap (CDS) - a risk measure of bond’s likely default - on the sovereign bonds of Portugal, Ireland, Greece and Spain (so called “PIGS” countries) increased to unprecedented levels. Much of the first quarter of 2010 was plagued with sovereign debt issues of Europe.
All these events have made businesses and investors wary about the next round of problems. As a result, business confidence has come down. And this has been reflected in the slow growth numbers. Recently, the US revised its second quarter economic growth from 2.4 percent to 1.6 percent. Japan grew at an annualized rate of paltry 0.4 percent. Yields on the US government bonds are incredibly low indicating investors’ flight towards safety.
What then does this slow growth and uncertain environment mean to the rest of the world, especially to emerging economies? If the recent economic performance of India and China is to be believed, then not much. India recently clocked an 8.8 percent growth in April-June quarter - highest growth figure after 2007. Indian policymakers are talking about the need to raise key policy rates to tackle high inflation. China has also been growing at its usual rapid pace. These are signs that, maybe, some of these emerging economies have started to decouple from the developed ones. However, it will be premature to assume that China, India and other emerging economies have fully decoupled from the US and other developed economies. One only needs to go as far as 2008 to see how the whole “decoupling” theory was turned on its head. Hence, as of now, “unusually uncertain” seem the right choice of words.
First published on the Kathmandu Post on Sept 13, 2010.
Permanent Link: http://www.ekantipur.com/the-kathmandu-post/2010/09/12/money/unusually-uncertain/212689/
After showing signs of recovery in early 2010, the global economic outlook has deteriorated during the last couple of months. Economic growth in major advanced economies has been tepid at best, and the much talked about “green shoots” of recovery witnessed during mid 2009 hasn’t materialized into full scale economic expansion.
The unemployment rate in the US hasn’t budged from 9.5 percent to 10 percent range during the last one year. The high unemployment rate shows that business confidence is still low and companies aren’t hiring despite the recent surge in their profit. Household consumption accounts for over 70 percent of the US Gross Domestic Product (GDP) and because of struggling job market, households are chary of spending. As a result, savings rate in the US has increased after the global economic crisis: from a pre-crisis negative savings rate, the US household savings rate has recently increased to over 6 percent. One of the major reasons of global economic crisis was over-consumption of US households; hence, the increment in savings rate is good for the long run. However, in the short run, the US economy desperately needs its consumers to spend more to boost its growth prospects, which looks unlikely given the current US job market situation.
And, if leading experts are to be believed, US job market won’t improve any time soon. Mohammed El-Erian, chief executive officer and co-chief investment officer of PIMCO - the largest fixed income manager in the world - recently said that the US will witness a “lost decade” of jobs growth. Bill Gross, founder and Managing Director of PIMCO was first to coin the term “New Normal” in early 2009 to describe a prolong period of slow growth and high unemployment for the US economy.
When leading economists and central bankers from around the world gathered recently in Jackson Hole, Wyoming to discuss the future of the global economy, the mood amongst the members of this elite group was reported to be much somber. Having already taken unprecedented steps to bolster economic performance
after the crisis, central bankers have plenty to think about
given the daunting prospect of ‘double dip”. Speaking at the Jackson Hole Symposium, Bernanke reiterated his earlier comments about uncertain course of economic recovery and added that US growth will remain subdued for rest of the 2010 and that US economy will grow, albeit slowly, in 2011.
Few significant events have contributed to uncertain business environment which subsequently had an impact on economic performance of major economies. When the “green shoots” of the recovery first emerged during the second half of 2009, business confidence started to recover. However, much of the progress was dented when credit problems surfaced in Dubai in late 2009. Before the problems in Dubai were sorted out, Europe started to have its own debt problems. Overnight, the Credit Default Swap (CDS) - a risk measure of bond’s likely default - on the sovereign bonds of Portugal, Ireland, Greece and Spain (so called “PIGS” countries) increased to unprecedented levels. Much of the first quarter of 2010 was plagued with sovereign debt issues of Europe.
All these events have made businesses and investors wary about the next round of problems. As a result, business confidence has come down. And this has been reflected in the slow growth numbers. Recently, the US revised its second quarter economic growth from 2.4 percent to 1.6 percent. Japan grew at an annualized rate of paltry 0.4 percent. Yields on the US government bonds are incredibly low indicating investors’ flight towards safety.
What then does this slow growth and uncertain environment mean to the rest of the world, especially to emerging economies? If the recent economic performance of India and China is to be believed, then not much. India recently clocked an 8.8 percent growth in April-June quarter - highest growth figure after 2007. Indian policymakers are talking about the need to raise key policy rates to tackle high inflation. China has also been growing at its usual rapid pace. These are signs that, maybe, some of these emerging economies have started to decouple from the developed ones. However, it will be premature to assume that China, India and other emerging economies have fully decoupled from the US and other developed economies. One only needs to go as far as 2008 to see how the whole “decoupling” theory was turned on its head. Hence, as of now, “unusually uncertain” seem the right choice of words.
First published on the Kathmandu Post on Sept 13, 2010.
Permanent Link: http://www.ekantipur.com/the-kathmandu-post/2010/09/12/money/unusually-uncertain/212689/
Wednesday, September 8, 2010
The suspense is Killing Me
Do we have an incredibly resilient economy or are we on the verge of an economic collapse because of a disconnect between policymakers and the rest of the nation? I really hope that it’s the former and not the latter because it’s not very hard to comprehend what would happen to the level of business confidence and the state of the economy if any other country’s political situation were in as bad a shape as ours. Despite the insurgency, Tarai unrest, labour union problems, energy crisis and other exogenous problems, the business community in Nepal has preserved and continued with their operations.
Some factories have closed down; the manufacturing sector in particular has suffered especially due to chronic labour problems and the energy crisis; but the overall economy has moved on, albeit slowly. But how long can we go on like this? Yes, we are a resilient bunch of people; and we have taken messy politics, numerous bandas, labour union problems and the energy crisis in stride and continued with our day-to-day affairs. However, instead of policymakers recognizing the past and current plight of the business community and working towards facilitating business through new policy measures, they have been perpetuating a policy vacuum created by the political stalemate which is worsening by the day.
During the last two months, we have failed to elect a new prime minister after holding elections for the umpteenth time. And because of the delay in the formation of a new government, our annual budget—where the government announces key fiscal policy measures for the coming fiscal year—is in limbo. The business community eagerly awaits the annual budget as major policy changes are mentioned in it—such as those related to taxation, foreign trade tariff, infrastructure and agriculture, among others. Moreover, the budget also gives an idea about the economic policy rationale of the policymakers, i.e., whether the incumbent government is more market friendly or has a socialistic ideology.
Businesses plan their next projects incorporating these policy changes. However, due to the delay in the formation of a new government and announcement of the budget, which is overdue by more than two months, there is uncertainty in the business community. And this is the catch: Uncertainty kills business activities.
When the business community is confident that a particular government will last for a certain period of time, they can plan and invest accordingly. They can rest assured that the prevailing policies will be maintained and that their investment won’t be put at risk because of sudden changes in economic policy due to a change in government. However, when there is uncertainty whether a certain government will last or not, business persons generally prefer to wait and watch.
This results in lack of investment and other business activities, and stifles economic growth. In Nepal’s context, there is no certainty as to when a new government will be formed and how long it will remain.
Since the restoration of democracy in 1990, Nepal has had 17 different governments, 16 prime minister changes, a decade-long Maoist conflict, direct rule under former king Gyanendra, the April movement of 2006 and numerous strikes and bandas. Political parties have split to merge again, and political leaders have left their respective parties only to return subsequently. Because of the frequent changes in government, there hasn’t been any continuity in economic policy. The lust for power among political parties has made Nepal one of the most politically unstable countries in the world. It’s no wonder then that over 60 percent of the respondents to an enterprise survey of Nepali industry for 2009 conducted by the International Finance Corporation (IFC) have identified political instability as the major obstacle to their business.
Despite this, our economy has moved on largely due to the perseverance of the business community. The business community has persevered hoping that things will change for the better some day. But then at some time, the policy vacuum caused by the political instability will start to take its toll. In fact, I believe it has already started to happen. While our neighbouring countries are witnessing a dramatic economic growth because of business-friendly policy changes, we are languishing in uncertainty. But for how long can we afford to suffer thus? This resilience won’t last indefinitely.
This article was first published on Aug 31st, 2010 on the Kathmandu Post
Permanent Link:
http://www.ekantipur.com/the-kathmandu-post/2010/08/30/money/the-suspense-is-killing-me/212212/
Some factories have closed down; the manufacturing sector in particular has suffered especially due to chronic labour problems and the energy crisis; but the overall economy has moved on, albeit slowly. But how long can we go on like this? Yes, we are a resilient bunch of people; and we have taken messy politics, numerous bandas, labour union problems and the energy crisis in stride and continued with our day-to-day affairs. However, instead of policymakers recognizing the past and current plight of the business community and working towards facilitating business through new policy measures, they have been perpetuating a policy vacuum created by the political stalemate which is worsening by the day.
During the last two months, we have failed to elect a new prime minister after holding elections for the umpteenth time. And because of the delay in the formation of a new government, our annual budget—where the government announces key fiscal policy measures for the coming fiscal year—is in limbo. The business community eagerly awaits the annual budget as major policy changes are mentioned in it—such as those related to taxation, foreign trade tariff, infrastructure and agriculture, among others. Moreover, the budget also gives an idea about the economic policy rationale of the policymakers, i.e., whether the incumbent government is more market friendly or has a socialistic ideology.
Businesses plan their next projects incorporating these policy changes. However, due to the delay in the formation of a new government and announcement of the budget, which is overdue by more than two months, there is uncertainty in the business community. And this is the catch: Uncertainty kills business activities.
When the business community is confident that a particular government will last for a certain period of time, they can plan and invest accordingly. They can rest assured that the prevailing policies will be maintained and that their investment won’t be put at risk because of sudden changes in economic policy due to a change in government. However, when there is uncertainty whether a certain government will last or not, business persons generally prefer to wait and watch.
This results in lack of investment and other business activities, and stifles economic growth. In Nepal’s context, there is no certainty as to when a new government will be formed and how long it will remain.
Since the restoration of democracy in 1990, Nepal has had 17 different governments, 16 prime minister changes, a decade-long Maoist conflict, direct rule under former king Gyanendra, the April movement of 2006 and numerous strikes and bandas. Political parties have split to merge again, and political leaders have left their respective parties only to return subsequently. Because of the frequent changes in government, there hasn’t been any continuity in economic policy. The lust for power among political parties has made Nepal one of the most politically unstable countries in the world. It’s no wonder then that over 60 percent of the respondents to an enterprise survey of Nepali industry for 2009 conducted by the International Finance Corporation (IFC) have identified political instability as the major obstacle to their business.
Despite this, our economy has moved on largely due to the perseverance of the business community. The business community has persevered hoping that things will change for the better some day. But then at some time, the policy vacuum caused by the political instability will start to take its toll. In fact, I believe it has already started to happen. While our neighbouring countries are witnessing a dramatic economic growth because of business-friendly policy changes, we are languishing in uncertainty. But for how long can we afford to suffer thus? This resilience won’t last indefinitely.
This article was first published on Aug 31st, 2010 on the Kathmandu Post
Permanent Link:
http://www.ekantipur.com/the-kathmandu-post/2010/08/30/money/the-suspense-is-killing-me/212212/
Analyzing Deposit Insurance
At the height of the financial crisis of 2008, the US Federal Deposit Insurance Corporation (FDIC) decided to increase the deposit insurance limit from US$ 100,000 to US$ 250,000 to stem the general public’s eroding faith in the financial system. Many other countries followed suit. Australia and New Zealand, which did not have deposit insurance then, decided to introduce a 100 percent deposit insurance scheme.
As countries have realised the importance of deposit insurance, a number of countries with some form of deposit insurance scheme has increased multifold over the years. According to the International Association of Deposit Insurers (IADI), as of June 2009, 104 countries have instituted some form of explicit deposit insurance, up from 12 in 1974. Moreover, the IADI states that another 17 countries are considering implementing explicit deposit insurance in the near future.
With the recent introduction of the Deposit Guarantee Bylaw by the Deposit Insurance and Credit Guarantee Corporation (DICGC), Nepal will soon join the club of countries with deposit insurance. According to preliminary reports, Nepali banks and financial institutions (BFI) can now voluntarily decide to insure their deposits. However, the insurance scheme only applies to deposits of natural persons and not institutions or corporations. A ceiling of Rs. 200,000 per person has been applied, and BFIs registering for deposit insurance will be charged 0.2 percent or 20 paisa per Rs. 100 of deposit.
This is a welcome initiative as it will boost the general public’s confidence in the banking system. Deposit insurance is one of the most important tools to increase the public’s faith in the banking system. Diamond and Dybvig’s seminal research on bank runs and financial crises identified deposit insurance as the most viable tool to prevent bank runs and reduce contagion risk in the banking system. A run on the bank happens when the general public believes that a bank is about to go under and their deposits are at risk. As depositors rush to the bank to get their money out, the troubled bank isn’t able to fulfil all the withdrawal requests at once as a majority of their deposits are invested in long-term loans. The bank’s inability to pay its depositors creates further panic, and more depositors rush in to withdraw their savings, which ultimately leads to bank failure. Moreover, a bank run is contagious in the sense that it spreads from a troubled bank to the whole financial system like wildfire even when other banks are financially sound.
However, with deposit insurance, depositors know that they will get their money back, to the extent of the insurance coverage, even in the case of a bank failure; and there is no reason for depositors to participate in the bank run. Hence, to a large extent, deposit insurance helps prevent bank runs and contagious banking crisis by building depositor confidence. As the social and economic cost of a bank run and financial crisis are very high, institutions such as the International Monetary Fund (IMF) have been recommending deposit insurance as part of best financial practices for developing countries.
Having said that, deposit insurance, however, does create perverse incentives for both depositors as well as BFIs. Without deposit insurance, depositors are expected to carry out due diligence before putting their savings in any bank. Depositors punish financially weak and risky banks by asking for a risk premium in the form of a higher interest rate. The riskier the bank, the higher will be the risk premium, so banks are compelled to be financially sound and stable. With deposit insurance, however, depositors will no longer have to monitor the performance and activities of their bank as they will be compensated even if it were to fail. As banks face less scrutiny from depositors, they are free to indulge in risk-taking activities—a so-called moral hazard problem in economics. Banks are more than happy to pay nominal premium for deposit insurance as they no longer have to pay a higher risk premium for taking great risks.
Moreover, voluntary deposit insurance, like the one proposed in Nepal, creates another serious problem of adverse selection. The problem of adverse selection can be illustrated by the link between smoking status and mortality (adapted from Wikipedia). Non-smokers, on average, are more likely to live longer, while smokers, on average, are more likely to die younger. If insurance companies do not vary prices for life insurance according to smoking status, life insurance will be a better buy for smokers than for non-smokers. So smokers may be more likely to buy insurance, or may tend to buy larger amounts, than non-smokers. The average mortality of the combined policyholder group will be higher than the average mortality of the general population. From the insurer’s viewpoint, the higher mortality of the group which “selects” to buy insurance is “adverse”. The insurer raises the price of insurance accordingly. As a consequence, non-smokers may be less likely to buy insurance (or may buy smaller amounts) than if they could buy it at a lower price to reflect their lower risk. The reduction in insurance purchase by non-smokers is also “adverse” from the insurer’s viewpoint, and perhaps also from a public policy viewpoint.
The same scenario can arise in the context of Nepal with voluntary deposit insurance where riskier banks may buy more deposit insurance while less risky banks may buy less or opt out of deposit insurance. Even with insurance premiums adjusted for risk-based capital fund of banks, historical evidences have shown adverse selection to be a problem for voluntary deposit insurance schemes. In a classic paper published in 1995, Kumbhakar and Wheelock found that adverse selection was one of the major problems with voluntary deposit insurance. Their study found that risky banks are more likely to join voluntary deposit insurance despite the presence of insurance premiums that were inversely related to the bank’s capital to deposit ratio.
The problem of adverse selection is due to asymmetric information where the management of a bank has a better picture of the true risk level of its balance sheet than the regulators; and depending on the riskiness of the bank’s assets, it can decide whether to enrol in deposit insurance or not. In such a context, penalising banks with higher insurance premiums on the basis of their capital adequacy ratios, as is being prescribed in Nepal, may not work.
Because Nepal is entering such a scheme, these are invaluable lessons. From a public policy standpoint, riskier banks dominating the deposit insurance scheme will be a disaster as taxpayers will have to later foot the bill if these banks were to fail down the line.
This article was first posted in the Kathmandu Post on July 21st 2010.
Permanent Link: http://www.ekantipur.com/the-kathmandu-post/2010/07/20/oped/analysing-deposit-insurance/210683/
As countries have realised the importance of deposit insurance, a number of countries with some form of deposit insurance scheme has increased multifold over the years. According to the International Association of Deposit Insurers (IADI), as of June 2009, 104 countries have instituted some form of explicit deposit insurance, up from 12 in 1974. Moreover, the IADI states that another 17 countries are considering implementing explicit deposit insurance in the near future.
With the recent introduction of the Deposit Guarantee Bylaw by the Deposit Insurance and Credit Guarantee Corporation (DICGC), Nepal will soon join the club of countries with deposit insurance. According to preliminary reports, Nepali banks and financial institutions (BFI) can now voluntarily decide to insure their deposits. However, the insurance scheme only applies to deposits of natural persons and not institutions or corporations. A ceiling of Rs. 200,000 per person has been applied, and BFIs registering for deposit insurance will be charged 0.2 percent or 20 paisa per Rs. 100 of deposit.
This is a welcome initiative as it will boost the general public’s confidence in the banking system. Deposit insurance is one of the most important tools to increase the public’s faith in the banking system. Diamond and Dybvig’s seminal research on bank runs and financial crises identified deposit insurance as the most viable tool to prevent bank runs and reduce contagion risk in the banking system. A run on the bank happens when the general public believes that a bank is about to go under and their deposits are at risk. As depositors rush to the bank to get their money out, the troubled bank isn’t able to fulfil all the withdrawal requests at once as a majority of their deposits are invested in long-term loans. The bank’s inability to pay its depositors creates further panic, and more depositors rush in to withdraw their savings, which ultimately leads to bank failure. Moreover, a bank run is contagious in the sense that it spreads from a troubled bank to the whole financial system like wildfire even when other banks are financially sound.
However, with deposit insurance, depositors know that they will get their money back, to the extent of the insurance coverage, even in the case of a bank failure; and there is no reason for depositors to participate in the bank run. Hence, to a large extent, deposit insurance helps prevent bank runs and contagious banking crisis by building depositor confidence. As the social and economic cost of a bank run and financial crisis are very high, institutions such as the International Monetary Fund (IMF) have been recommending deposit insurance as part of best financial practices for developing countries.
Having said that, deposit insurance, however, does create perverse incentives for both depositors as well as BFIs. Without deposit insurance, depositors are expected to carry out due diligence before putting their savings in any bank. Depositors punish financially weak and risky banks by asking for a risk premium in the form of a higher interest rate. The riskier the bank, the higher will be the risk premium, so banks are compelled to be financially sound and stable. With deposit insurance, however, depositors will no longer have to monitor the performance and activities of their bank as they will be compensated even if it were to fail. As banks face less scrutiny from depositors, they are free to indulge in risk-taking activities—a so-called moral hazard problem in economics. Banks are more than happy to pay nominal premium for deposit insurance as they no longer have to pay a higher risk premium for taking great risks.
Moreover, voluntary deposit insurance, like the one proposed in Nepal, creates another serious problem of adverse selection. The problem of adverse selection can be illustrated by the link between smoking status and mortality (adapted from Wikipedia). Non-smokers, on average, are more likely to live longer, while smokers, on average, are more likely to die younger. If insurance companies do not vary prices for life insurance according to smoking status, life insurance will be a better buy for smokers than for non-smokers. So smokers may be more likely to buy insurance, or may tend to buy larger amounts, than non-smokers. The average mortality of the combined policyholder group will be higher than the average mortality of the general population. From the insurer’s viewpoint, the higher mortality of the group which “selects” to buy insurance is “adverse”. The insurer raises the price of insurance accordingly. As a consequence, non-smokers may be less likely to buy insurance (or may buy smaller amounts) than if they could buy it at a lower price to reflect their lower risk. The reduction in insurance purchase by non-smokers is also “adverse” from the insurer’s viewpoint, and perhaps also from a public policy viewpoint.
The same scenario can arise in the context of Nepal with voluntary deposit insurance where riskier banks may buy more deposit insurance while less risky banks may buy less or opt out of deposit insurance. Even with insurance premiums adjusted for risk-based capital fund of banks, historical evidences have shown adverse selection to be a problem for voluntary deposit insurance schemes. In a classic paper published in 1995, Kumbhakar and Wheelock found that adverse selection was one of the major problems with voluntary deposit insurance. Their study found that risky banks are more likely to join voluntary deposit insurance despite the presence of insurance premiums that were inversely related to the bank’s capital to deposit ratio.
The problem of adverse selection is due to asymmetric information where the management of a bank has a better picture of the true risk level of its balance sheet than the regulators; and depending on the riskiness of the bank’s assets, it can decide whether to enrol in deposit insurance or not. In such a context, penalising banks with higher insurance premiums on the basis of their capital adequacy ratios, as is being prescribed in Nepal, may not work.
Because Nepal is entering such a scheme, these are invaluable lessons. From a public policy standpoint, riskier banks dominating the deposit insurance scheme will be a disaster as taxpayers will have to later foot the bill if these banks were to fail down the line.
This article was first posted in the Kathmandu Post on July 21st 2010.
Permanent Link: http://www.ekantipur.com/the-kathmandu-post/2010/07/20/oped/analysing-deposit-insurance/210683/
Sunday, June 27, 2010
From the horse’s mouth
Sandy Weil, the legendary American banker and former chairman of the Citigroup, built the empire called Citigroup by buying other banks and insurance companies. After a series of acquisitions, which included Salomon Brothers in 1997, the US $73 billion merger of Weil’s Travelers group with Citicorp in 1998 led to the formation of a mammoth financial institution called Citigroup. That merger, the biggest merger in the global banking history till date, was largely a success owing to strong lobbying from Weil, who was successful in persuading Robert Rubin, then Treasury Secretary of the United States, to do away with the Glass Steagal Act.
The series of events which led to the formation of Citigroup is vividly captured in a recent book about Jamie Dimon, a former protégé of Weil and now Chairman of JP Morgan Chase, called The Last Man Standing: The rise of Jamie Dimon and JP Morgan Chase written by Duff McDonald. Dimon was the key man involved in all of Weil’s acquisitions that culminated in the Travelers-Citicorp deal in 1998. Dimon, who was later fired from Citigroup after a fallout with Weil, became the most important player in the Wall Street during the financial crisis of 2008 as his firm (JP Morgan Chase) bought Bear Stearns and Washington Mutual—mainly at US treasury’s behest—to quell the panic in the financial market. From Citigroup to JP Morgan Chase to Washington Mutual, the book provides intricate details regarding key recent mergers and acquisition (M&A) in the US banking history. The book exposes how it’s not only the right valuation and synergies that drive M&A but also the big fat egos of the top executives involved in these massive deals and their quest for power and fame.
At a time when voices are being raised in favour of introducing necessary regulations for M&A amongst financial institutions in Nepal, there are lessons to be drawn from this book as it provides key insights to what makes a good M&A deal for a financial institution and how, like in the case of Citigroup, mammoth financial institutions fail to generate synergy and subsequently flounder due to their unmanageable size. There is no doubt that the government should encourage M&A among financial institutions by introducing necessary regulations. However, both government and shareholders needs to scrutinise the M&A deals as there will be scope for creating a monopolistic entity as well as enrich top management at the cost of shareholders.
One area where M&A can possibly help Nepali banks is in increasing their capital base. The biggest problem with the banks in Nepal right now is that they have too little paid up capital to fund large scale projects. Even a small hydropower project needs consortium financing. Another area is cost cutting: duplication of space, technology and human resources can be drastically reduced. However, the major potential obstacle for M&A amongst Nepali financial institutions is lack of opportunities to create synergy. Synergy exists when two banks with different revenue models, different clientele bases, different geographic presence and different core expertise decide to merge.
For example, it makes sense to merge a bank with a strong presence in Eastern zone with another bank with a stronghold in Central zone. Or it makes sense to merge a bank with core expertise in retail lending to one with a large corporate loan book. Or it makes sense for a bank with large retail client to buy a bank with institutional clients, strong private banking and wealth management division. However, in Nepal almost all of the banks operate in the same geographic area, offer the same plain vanilla banking and have the same revenue model and, hence, the potential to create “synergy” is limited. Recently ICICI bank, a leading private sector bank in India, decided to buy Bank of Rajasthan because it wants to increase its presence in Northern and Western parts of India. This deal has business logic as there are opportunities, granted right valuation and proper execution, to create synergy and increase shareholder value.As the liquidity crisis in the banking system shows no signs of easing, recent conversations among bankers and policymakers have veered towards M&A as a potential tool to shore up the capital base of the banks—and strengthen their balance sheets in the event of systemic banking crisis—in order to capture the so called “synergies” that are possible due to M&A.
In a way, many people see M&A as a panacea to all of the current problems in the domestic banking sector. However, M&A doesn’t always increase shareholders value and more often than not M&A are guided by top management’s lust for more power and fame. Moreover, as banks grow large in size after M&A, the big size becomes hindrance to progress as executives fail to execute the deal property to realise the synergy. Citigroup is a classic example of an M&A deal gone woefully wrong.
For an M&A to work, in the words of Jamie Dimon, the deal needs to have business logic, the price must be right and, last but not the least, the top management should know how to execute the deal. Time and again, M&A, while destroying shareholders value, have only made CEOs, lawyers and consultants involved in the deal richer.
First Published in The Kathmandu Post on 27th June, 2010
Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/26/oped/from-the-horses-mouth/209841/
The series of events which led to the formation of Citigroup is vividly captured in a recent book about Jamie Dimon, a former protégé of Weil and now Chairman of JP Morgan Chase, called The Last Man Standing: The rise of Jamie Dimon and JP Morgan Chase written by Duff McDonald. Dimon was the key man involved in all of Weil’s acquisitions that culminated in the Travelers-Citicorp deal in 1998. Dimon, who was later fired from Citigroup after a fallout with Weil, became the most important player in the Wall Street during the financial crisis of 2008 as his firm (JP Morgan Chase) bought Bear Stearns and Washington Mutual—mainly at US treasury’s behest—to quell the panic in the financial market. From Citigroup to JP Morgan Chase to Washington Mutual, the book provides intricate details regarding key recent mergers and acquisition (M&A) in the US banking history. The book exposes how it’s not only the right valuation and synergies that drive M&A but also the big fat egos of the top executives involved in these massive deals and their quest for power and fame.
At a time when voices are being raised in favour of introducing necessary regulations for M&A amongst financial institutions in Nepal, there are lessons to be drawn from this book as it provides key insights to what makes a good M&A deal for a financial institution and how, like in the case of Citigroup, mammoth financial institutions fail to generate synergy and subsequently flounder due to their unmanageable size. There is no doubt that the government should encourage M&A among financial institutions by introducing necessary regulations. However, both government and shareholders needs to scrutinise the M&A deals as there will be scope for creating a monopolistic entity as well as enrich top management at the cost of shareholders.
One area where M&A can possibly help Nepali banks is in increasing their capital base. The biggest problem with the banks in Nepal right now is that they have too little paid up capital to fund large scale projects. Even a small hydropower project needs consortium financing. Another area is cost cutting: duplication of space, technology and human resources can be drastically reduced. However, the major potential obstacle for M&A amongst Nepali financial institutions is lack of opportunities to create synergy. Synergy exists when two banks with different revenue models, different clientele bases, different geographic presence and different core expertise decide to merge.
For example, it makes sense to merge a bank with a strong presence in Eastern zone with another bank with a stronghold in Central zone. Or it makes sense to merge a bank with core expertise in retail lending to one with a large corporate loan book. Or it makes sense for a bank with large retail client to buy a bank with institutional clients, strong private banking and wealth management division. However, in Nepal almost all of the banks operate in the same geographic area, offer the same plain vanilla banking and have the same revenue model and, hence, the potential to create “synergy” is limited. Recently ICICI bank, a leading private sector bank in India, decided to buy Bank of Rajasthan because it wants to increase its presence in Northern and Western parts of India. This deal has business logic as there are opportunities, granted right valuation and proper execution, to create synergy and increase shareholder value.As the liquidity crisis in the banking system shows no signs of easing, recent conversations among bankers and policymakers have veered towards M&A as a potential tool to shore up the capital base of the banks—and strengthen their balance sheets in the event of systemic banking crisis—in order to capture the so called “synergies” that are possible due to M&A.
In a way, many people see M&A as a panacea to all of the current problems in the domestic banking sector. However, M&A doesn’t always increase shareholders value and more often than not M&A are guided by top management’s lust for more power and fame. Moreover, as banks grow large in size after M&A, the big size becomes hindrance to progress as executives fail to execute the deal property to realise the synergy. Citigroup is a classic example of an M&A deal gone woefully wrong.
For an M&A to work, in the words of Jamie Dimon, the deal needs to have business logic, the price must be right and, last but not the least, the top management should know how to execute the deal. Time and again, M&A, while destroying shareholders value, have only made CEOs, lawyers and consultants involved in the deal richer.
First Published in The Kathmandu Post on 27th June, 2010
Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/26/oped/from-the-horses-mouth/209841/
Sunday, June 13, 2010
Speculate This!!!
Recent comments from the Governor of the Nepal Rastra Bank (NRB) published in the Financial Times (FT) — a leading United Kingdom based newspaper — has once again put Nepali currency’s (NC) fixed exchange rate system vis-à-vis Indian currency (IC) into the spotlight. Though appropriate and beneficial for the Nepali economy in the long run, the governor’s quote on FT’s May 23 edition to the effect that Nepal needs to reconsider its long standing currency peg “in the medium term” and the subsequent issuance of a press release to neutralise the possible negative effects of the governor’s statement by the NRB next day — that categorically stated that the exchange rate peg would not be changed — has created a lot of uncertainty in the market.
In the same story, the governor also said that Nepal has no option in the short term but to maintain the currency peg, and the country would only be able to alter the peg when there is political stability, greater confidence in the economy, lower inflation and higher reserves. However, why would a speculator, or a smart investor, hold on to the NC when she knows that the currency would eventually be devalued?
For example, if someone can figure out that the current NC to IC peg of 1.6 would be changed to 1.8 in one year, she is better off taking her money out of the Nepali banks and putting in the Indian banks. Let’s assume that the investor can earn 6 percent in the FD account in India, then if she were to convert NC to IC at existing exchange rate her total return would be 19.25 percent (6 percent from FD, 12.5 percent from the appreciation of the IC, and 0.75 per cent from the interaction effect between FD return and IC appreciation) in the event of possible devaluation of the NC in a year’s time. When everyone starts doing this it would create a self-fulfilling prophecy, and then Nepal would have to abandon the currency peg sooner rather than later because of the acute shortage of the IC in the market and its inability of support the peg through the selling of the foreign currency reserves to satisfy the demand for IC.
Nepal will have to eventually devalue its currency at some point. The current level of the peg is just unsustainable. The growth differential between Nepal and India will compel the government to devalue. The million dollar question is: when? In a perfect world, as the governor said, it would be beneficial for the economy if Nepal can devalue when there is a stable political system, a well performing economy, lower inflation and higher reserves. However, there isn’t anything called perfect world in foreign exchange market. History is testament to this as evident from the events in Mexico in 1994 and Thailand in 1997. When there is a word out that the government is mulling to devaluate its currency, it won’t be the government that will decide when to devalue but the market. A speculator anticipating the devaluation would not stay idle and keep her money in NC — she will covert to IC. Taking the cue from the speculator, everyone would then follow the suit. When everyone starts doing the same, government will be left with no option but to devalue.
It’s a cardinal sin in the fixed exchange regime to even talk about possible devaluation even though it would likely benefit the economy in the long run. One cannot just talk about possible devaluation in the future and expect the market not to react, especially when the foreign reserves are dwindling. By just bringing forward the topic — which though has a lot of merit on its own right but which should not have been divulged in public — the governor has possibly put the fate of the NC in the hands of the speculators.
This article was first published in the Kathmandu Post on June 13, 2010
Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/12/oped/speculate-this/209344/
In the same story, the governor also said that Nepal has no option in the short term but to maintain the currency peg, and the country would only be able to alter the peg when there is political stability, greater confidence in the economy, lower inflation and higher reserves. However, why would a speculator, or a smart investor, hold on to the NC when she knows that the currency would eventually be devalued?
For example, if someone can figure out that the current NC to IC peg of 1.6 would be changed to 1.8 in one year, she is better off taking her money out of the Nepali banks and putting in the Indian banks. Let’s assume that the investor can earn 6 percent in the FD account in India, then if she were to convert NC to IC at existing exchange rate her total return would be 19.25 percent (6 percent from FD, 12.5 percent from the appreciation of the IC, and 0.75 per cent from the interaction effect between FD return and IC appreciation) in the event of possible devaluation of the NC in a year’s time. When everyone starts doing this it would create a self-fulfilling prophecy, and then Nepal would have to abandon the currency peg sooner rather than later because of the acute shortage of the IC in the market and its inability of support the peg through the selling of the foreign currency reserves to satisfy the demand for IC.
Nepal will have to eventually devalue its currency at some point. The current level of the peg is just unsustainable. The growth differential between Nepal and India will compel the government to devalue. The million dollar question is: when? In a perfect world, as the governor said, it would be beneficial for the economy if Nepal can devalue when there is a stable political system, a well performing economy, lower inflation and higher reserves. However, there isn’t anything called perfect world in foreign exchange market. History is testament to this as evident from the events in Mexico in 1994 and Thailand in 1997. When there is a word out that the government is mulling to devaluate its currency, it won’t be the government that will decide when to devalue but the market. A speculator anticipating the devaluation would not stay idle and keep her money in NC — she will covert to IC. Taking the cue from the speculator, everyone would then follow the suit. When everyone starts doing the same, government will be left with no option but to devalue.
It’s a cardinal sin in the fixed exchange regime to even talk about possible devaluation even though it would likely benefit the economy in the long run. One cannot just talk about possible devaluation in the future and expect the market not to react, especially when the foreign reserves are dwindling. By just bringing forward the topic — which though has a lot of merit on its own right but which should not have been divulged in public — the governor has possibly put the fate of the NC in the hands of the speculators.
This article was first published in the Kathmandu Post on June 13, 2010
Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/12/oped/speculate-this/209344/
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