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Nepal living beyond its means

January 03, 2019

 

Binaya BanjaraJanuary 4, 2019

In 1991, India’s foreign exchange reserves almost emptied when the country’s balance of payments collapsed. The Central Bank eventually averted a full-blown crisis, but poverty in India increased in the years that followed. Manmohan Singh was finance minister, and he introduced dramatic economic reforms that unleashed India’s economy and has been the foundation of its growth.

Today, Nepal is at the risk of facing the same crisis India experienced three decades ago. There is a net outflow of foreign exchange, as remittance income fails to keep pace with the growth in imports, mainly petroleum. 

Nepal’s foreign exchange reserves currently can sustain only 7 months and 26 days of imports, compared to 14 months and 3 days as recently as 2016. (See graph above) Nepal Rastra Bank also calculated that in the first four months of the fiscal year, Nepal’s balance of payments deficit stood at Rs57 billion and in just the last month it increased by Rs22 billion. 

“The current rate of increase in the balance of payments deficit will be a huge crisis in the future,” warns Bijaya Nath Bhattarai, an ex-governor of Nepal Rastra bank. 

RNepal’s over-dependence on remittance is deepening the crisis. Among different sources of foreign exchange for a country such as investments, exports, or tourism, remittances from overseas workers is the most unreliable income source because it can easily be affected by political tension and conflicts. Nepal’s remittance income is also not ploughed into productive sectors, and is mostly used up in paying for imported consumer goods and energy. 

Some 65% of Nepal’s total import bill is paid through remittances, while exports constitute only 6% and investment only 17% of Nepal’s annual foreign exchange income that is used to pay for imports. But even with all these sources combined, Nepal cannot meet 12% of its import bill, which is what is leading to the balance of payment deficit. The country has been forced to dip into its foreign exchange reserves to meet the gap.

In the first four months of the current fiscal year, Nepal imported goods worth approximately Rs400 billion while exports were only worth Rs29 billion. Even though this is a tremendous difference, finance minister Yuba Raj Khatiwada admits that what worries him more is the gap in the service sector. Most of the current outflow is for energy and vehicle imports, while there is also a huge outflow due to students, medical patients and Nepalis vacationing abroad. Nepali tourists spent Rs35 billion abroad in the four months of this fiscal year, but foreign tourists spent only Rs25 billion in Nepal during the same period. 

This deteriorating balance of payments deficit may compel the government to adopt a restrictive monetary policy, but economist Keshav Acharya explains that this will mean only two choices for the government: “Either the government must take foreign loans, or reduce imports to prevent the outflow of hard currency.” 

The easiest step would be to borrow, but ex-governor Bhattarai notes that adhering to the strict conditions of the donors might be very painful for Nepal as it has been for other countries. Moreover, the crisis may also lead to policies to stop Nepalis going abroad, and limit imports to only basic goods. 

The CEO of Nepal Rastra Bank Nar Bahadur Thapa says, “If the balance of payments deficit and growth of imports continues at the present rate, we may not be able to import even the goods needed for development projects.”

It is accepted practice that an import-dependent country without a sustainable source of foreign currency needs to maintain foreign exchange reserves to handle at least six months of imports. But with Nepal’s total annual export meeting only 24 days of imports, Nepal Rastra Bank’s policy is to maintain foreign exchange reserves to last at least 8 months. 

If not, depleted reserves can put pressure on Nepali fixed exchange rate with Indian currently at Rs160. If that happens, there will be ruinous capital flight to India, as has occurred in the past. Ex-governor Krishna Bahadur Mandandhar says that the government and the central bank still have time to remedy the situation by limiting imports of luxury items. But this could lead to an expansion in the black market. 

Earlier this year, when the government applied quantitative restrictions on the import of sugar, the price immediately shot up by Rs5 per kg. Worse, if there is a devaluation of the Nepali rupee it will raise inflation and that could lead the economy into a downward spiral. 

Experts advise that while the central bank needs to be free from political interference to stabilise the economy, the government and the central bank must coordinate their actions. In the longer-term, there is no other way but to attract investors by increasing the competitiveness of the Nepali economy and increase exports.

Source:Nepali Times:

https://www.nepalitimes.com/here-now/nepal-living-beyond-its-mean/