The cyclical nature of the economy creates periods of growth followed by contractions towards the economic slowdown or even a recession. Barring periods of extremes like Bubbles or Depressions, the periods of prosperity and recession are recurring and inevitable. Sometimes these cycles are expedited or prolonged as a result of policy changes, or some black swan events.
Post pandemic, the policy makers’ first priority was to jumpstart the economy. The central bank as a relief introduced refinancing facilities of around approx. NPR 150 billion. Loans worth approx. NPR 130 Billion was rescheduled and restructured. Money supply was in abundance and liquidity was in excess in the banking system. Cheap money was available at low interest rates. The pent up consumption during the pandemic ramped up. Imports started growing. The economy looked to move slowly towards recovery.
However, being an import based economy, our country fulfills its consumption needs mostly through imported goods. To add to the woes, Russia-Ukraine ruckus was fanning the fires of inflation. The import costs (esp. Fuel prices) were rising. This caused the foreign exchange reserve to take a hit. The foreign exchange reserve came down to worryingly low levels. People started drawing similarities between Nepal and the foreign exchange depleted Sri Lanka and Pakistan which was on the brink of crisis due to devaluation of the currency and low foreign exchange reserves.
On the other hand asset price inflation was another problem born out of cheap credit post pandemic. The stock market reached an all time high and real estate prices were inflated too.
(Among the probable causes of asset price inflation could have been the cheap credit lent out for the purpose of refinancing/restructuring loans that was aimed to aid COVID hit businesses that could have been directed to real estate and the equity market.)
The government and the policy makers had to step in. The result of overcompensating through policies that were supposed to counteract the post pandemic effects in the economy now had started to cause problems in the external sector.
The government took stringent measures. Start of the year 2079, in order to curb the imports, the government introduced import bans on more than 40 non essential luxury items.The central bank complimented the decision by increasing the interest rates making credit more expensive for the borrowers; both to discourage consumption and control inflation.
Policies are double edged swords. Measures taken to minimize the external sector complications (i.e. to stop the bleeding foreign exchange and control soaring inflation and imports) was now pushing the economy towards a slowdown.
As the consumption slowed down, the domestic businesses struggled with profitability. To add to that industry and businesses bore the brunt of high interest rates. Survey statistics surfaced of the overall market demand contracting by 28% (CNI survey- Jan 2023). The stock market, which is said to reflect the state of the economy, has also moved mostly sideways after a plunge of more than 40% from the all-time high levels of 3,198.60 and has been hovering around the 2000 range. Real Estate transactions reflect a more dire picture with the tax revenue collection (CGT and transaction tax) of the government from real estate transactions is seen to have halved from the previous year tax collection which was at NPR 75 Billion, shrinking to around 36 Billion in the year FY 2079/80.
Analysis of economic indicators also sums up the current situation.
Quarterly statistics published by the Central Bureau of Statistics showed how the GDP growth rate of Nepal has performed over the past few quarters.
Seasonally adjusted GDP growth rate was negative for three consecutive quarters. However, in absolute terms the GDP growth rate went negative only in Q2 of FY 22/23.
The dictionary definition of the word recession is given as “a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.”
Is this the onset of a major slowdown in the economy?
Dare we use the forbidden word for the state of our economy “Recession”
Although opinions divide economists and academics as to which of the indicators reflect the true onset of recession stating just the GDP contraction is not enough to claim the recession has arrived. The pulse of economic activity has to be checked through different parameters.
Despite being divided on what tests to perform, and the different ways that the doctors may take to get to the diagnosis of the disease and the severity thereof, if the symptoms are glaringly evident and all of the test reports point to the same disease, the opinions will converge on a similar conclusion.
The basic principle of GDP growth (change in level of output) on basis of Keynesian Expenditure method is given as:
Economic Output (Y) = C + I + G + (X-M)
C = Consumption
I = Private Sector Investment
G = Government Spending
X = Exports
M = Imports
We attempt to look at different indicators of the economy, to be beyond doubts about the current state of Nepal’s economy.
Household Spending and Industrial Consumption (C)
Nepal’s imports have been on a steep rise the past 6-7 years. The goods import saw an obvious dip during the pandemic with imports declining about 15.63% than the previous year. This year the slowdown in economic activity is evident with the imports projected to decline more than it did during the pandemic with imports to be around ~1600 Billion which will be ~17% shrink in Nepal’s imports.
The highest share of Nepal’s import is petroleum which constitutes ~20% of total imports. The petroleum consumption is also seen to be declining indicating sluggish development and industrial activities and other economic activities overall. This drop in both household and industrial consumption can indicate a significant slowdown in internal economic activities.
Private Sector Investment (I)
A flourishing private sector is a reflection of a prospering economy and credit is the fuel that propels the private sector engine. Credit expansion targets set by the central bank is a function of the annual GDP growth targets in the Fiscal Budget as mandated by the government policies. The government had set an 8% GDP growth target for FY 2079/80. The credit growth requirements were set at 12.6%. However, at the end of 11 months of the fiscal year the GDP growth rate of only 1.8% was estimated by CBS and the broad money supply target of 12% fell short at only 7.8%, also the credit expansion target of 12.6% fell way short at just 3.4%.
|Year||Economic Growth (Actual)||Targeted Economic (Growth)||M2 Money Supply Growth (Actual)||M2 Money Supply Growth (Target)||Credit Growth (Actual)||Credit Growth (Target)|
Private Sector Credit
The credit growth shrinked to low single digits with the credit extension increasing by a meager 3.4% (11 months of FY 2079/80). This indicates the private sector has had to cut down on investments as a consequence of a slowed down economy and overall goods and service demand shrink. The private sector also got discouraged from investing because of rising cost of funds due to the high interest rate environment, as the interest cost became higher than returns on investment.
As industries and businesses struggle with profitability, sustenance becomes a first priority during economic downturns. Layoffs of employees start happening for cost cutting, and unemployment rises. However, with informal sector employment data unavailability and lack of proper statistical publication of timely data of even the formal sector, we have taken the foreign employment number as a proxy to gauge the unemployment situation. As employment opportunities shrink domestically people start seeking foreign employment.
The total number of migrant workers was at a 5 year high, as more than 630 thousand workers have gone for foreign employment. The numbers still do not reflect the true picture as these omit Nepalese going to India through the open borders for permanent employment and temporary seasonal employment outside of agriculture season.
Domestic industry, service sector and agriculture sector alike seems to be struggling with economic declivity and is failing to provide adequate employment opportunities to absorb the growing youth population coming into the job market.
The manufacturing sector growth rate is negative for FY 2079/80. Similarly, construction sector growth also went negative. The two instances these two sectors were negative was post-earthquake and subsequent economic blockade in the year 2072 and during/post COVID. Agriculture, the primary production oriented sector that contributes ~21% to the GDP, has virtually stagnant growth. All of which indicates a sluggish economy.
Government Spending (G)
Abysmal spending in productive sector infrastructure has been a long running problem in Nepalese context due to several factors including the three tiered governmental structure. The recurrent expenditure portion of the budget has been growing whereas capital expenditure which contributes to GDP through infrastructure spending remains stagnant. In FY 2079/80 the capital expenditure was just 16.35% of the total fiscal budget, which is also a contributor to the recent economic headwinds.
Net Export (X-M)
Nepal has always been a net importer. But the chasm between imports and exports has widened drastically in the last decade. The rising deficit in trade has been expedient the past few years worsening the contribution of exports in Nepal’s total GDP. While the slowed down consumption caused a decline in imports by 15.67%, the past fiscal year the net export was -1.46 trillion, with exports declining by more than ~20% from the past year’s NPR 200 Billion to NPR 156 Billion.
(The net export/deficit is gradually widening because the majority of government revenue, ~45%, is collected from customs and excise duty. Government’s proclivity towards import based tax revenue collection is also a major contributor to the deficit problem. Further, being expedient in terms of profit making, import based trading businesses are preferred over productive sector/ manufacturing/agriculture/ industry based businesses.)
Where are we??
There is no denying that all the evidence points in the same direction. The Nepalese economy is in a slump. Though not alarming as of yet, the economy is only held together by remittances. Economic revival is a challenge, not only because the problems are hard to solve but also because the solutions need to treat the core of the disease, not just the symptoms.
The major drivers of economic output are labor and capital. Hopes of better living and earning is causing labor flight to GCC and other nations while the government and households are enjoying the fruits of their labor coming as remittance without regard for long term sustainability.
Similarly, capital is expensive for which is discouraging domestic investors and potential FDI opportunities are reluctant to venture into Nepalese economy due to numerous bureaucratic and political hurdles. Whereas hard earned capital earned via remittance is also being used in consumption fueled imports. With a myopic orientation of the government to collect revenue and the private sector to earn quick profits, if not taken towards revival, the economic woes are bound to get worse.
Longer this prevails, we will reach the tipping point one day where we’ll neither have labor nor the capital and GDP growth will be the least of our concerns.
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