Tuesday, March 27, 2012
Article: Costly Ignorance
My latest article in Republica today (March 27) is on the recent Nepali financial crisis. The direct Republica link is here. The unedited version of the article is below:
Recent Liquidity Crisis in
Nepal: Predictable, Avoidable and Not Over Yet
There are feelings among those involved in the Nepali financial market
that the recent liquidity crisis—that started in the late 2009 and lasted until
late 2011—is over. That is a dangerous feeling to have because the crisis is
not over, yet. It would be foolish to assume the crisis as being over simply on
the basis of a slightly buoyed confidence among the banks and financial
institutions (BFIs). Although there has been a rise in market transactions
among the BFIs, overall confidence among core financial market consumers—those
buying and selling real estate—is still very low.
The worst feeling to come out of the recent Nepali liquidity crisis is
that there were warning signs, in the early 2009, about a possible crisis in
the financial sector. However, neither the BFIs nor Nepal Rastra Bank (NRB)
seemed bothered by the impending loom. Together, the BFIs and the NRB ignored
the signs.
First, historical data from all over the world shows that liquidity
creation right before any liquidity crisis is always high. Money supply had a
decreasing trend after the Nepalese economy was liberalized after the democracy
in 1990. After 2001, however, the data shows an increasing trend. The increase
kept happening right up until the end of 2009, after which the liquidity crisis
hit the Nepalese financial system hard. So, literature review suggests that the
recent crisis was predictable. The question then becomes: Why did nobody,
especially the NRB researchers, predict it?
Second, the BFIs themselves had been forecasting net losses from their
outstanding loans. The forecasted capital levels were continually on a decline,
and the BFIs were increasingly worried about not meeting the NRB set standard
in this regard. Delinquencies were on the rise since 2007. If these internal problems
were not the signs for an impending liquidity crisis, I don’t know what were.
Unlike natural disasters, liquidity crisis does not come suddenly. It comes out
of a systemic and compounding failure of the financial market and its overseer.
The BFIs and the NRB should shoulder the responsibility for the recent crisis.
It was their own making, and the reason it lasted as long as it lasted was due
to their inability in seeing it coming in advance as well as their inefficiency
and incapability in solving it swiftly after it arrived.
Third, even if the BFIs were lying and covering up their losses, the
financial market as a whole should have known of such cover-ups. After all,
increasing charge offs and delinquencies as well as decreasing profit and
capital levels are not hidden information. These are publicly available data to
anybody and everybody who seeks them. So, those working in the financial market
as well as those monitoring the financial market (i.e. the NRB) should have
been aware that the BFIs were fudging their books. The recent liquidity crisis
was, therefore, a slap in the face to those who claim to know the Nepalese
financial market and those who claim to monitor it.
Fourth, when the crisis hit our financial market, initially, there was
no response to halt this crisis. The BFIs went about their business, crossing
their fingers, hoping that the liquidity “crunch” would not transform into a crisis.
The NRB looked the other way hoping that the market would correct itself. That
was a mistake. Eventually, after two years of crisis, the NRB decided to raise
the insured deposit amounts. Although they should have done this as soon as the
crunch hit the market, the NRB’s step should be viewed in terms of “better late
than never”.
With all these signs foretelling the severity of the crisis, the
concerned authorities did not actively seek to halt or mitigate the crisis. As
a result, the market suffered for over two years. The worst affected were those
involved in the real estate sector. As a result of the liquidity crisis, house
and land sales all over the country, especially in the Kathmandu valley, have
all but died out.
However, the past is past. Instead of ruing over the crisis, we should
think about potentially avoiding any future liquidity crisis. What can be done?
First, and foremost, the NRB should increase, improve and fulfill its duties as
a monitor of the financial market. Simply granting licenses to open up new
banks is not its sole duty. It needs to monitor, evaluate and investigate the
BFIs for any wrongdoings. Anyone found guilty needs to be punished, and not
bailed out. Bail outs should happen only if, absolutely, necessary.
While it is true that having excessive liquidity in their hands hurts
the bottom line of our BFIs, they should also realize that having too little
has a tendency to put them out of business. The NRB cannot come rescuing every
single bank that goes bankrupt. It has its own criteria and limits. Therefore,
BFIs should have enough short-term quickly liquidable assets at their disposal.
They can use such assets to ease the liquidity crunch if one presents itself in
the coming future.
Also, the proverbial “don’t put all your eggs in the same basket” saying
applies to our BFIs as well. Nepali real estate sector received as high as 70
percent of all loans made out by our banks. Therefore, the recent liquidity
crisis occurred due to our BFI’s inability to recoup their loans from this
sector. Diversifying the portfolio of investments can save them if one of our
economic sectors suffers from a crisis. The losses can always be recouped from
other stronger sectors if the portfolio is diverse. Until our BFIs learn this
lesson, there is always another liquidity crisis looming in our horizon.
Labels: banks, central bank of nepal, liquidity crisis, NRB
Thursday, January 5, 2012
Challenges of the Nepali economy in the next few years
The following was published in an online news portal www.hamrakura.com. The direct link to the web article is here.
Challenges of the Nepali economy in the next few years
Nepali economy has had a rough ride in the past few years. The
escalating Maoist conflict sent the economy into doldrums during 2006/07. The
economy went into a further fragile state due to the worldwide financial crisis
in 2007/08, the domestic liquidity crisis since 2009/10, and the real estate
crisis since 2008/09. Although the economy has recovered substantially, growth
has been poor when compared to neighbors, inflation has not stopped its goliath
run, and jobs are hard to come by for un-skilled or semi-skilled youths. Now
that the year 2011 is well behind us, let us look at some problems that the
Nepali economy will have to face in the coming year and beyond.
Urbanization
Urbanization is a boon and a curse. On one hand, urbanization is an
indicator of economic growth. On the other hand, it creates a crisis in terms
of delivery of public service goods and services because of increasing demand
for said goods and services that, in turn, constrain resources and create
crisis in delivery.
The escalating war between the Maoists and the Nepali state resulted in
a rapid internal migration of Nepalese citizens from rural areas to urban
centers. One of the
major problems that arose out of this internal displacement was the classic urban giantism problem in the
Kathmandu Valley. Unlike cities in China or India, the urban giantism problem
of Kathmandu and a few other cities was not because they provided more jobs and business opportunities, but because of safety and security that they provided to people’s lives and
properties. Despite the end
of the decade-long Maoist rebellion, that started this rapid urbanization
phenomenon, the urbanization trend has not stopped. It is on the rise.
Like many
other Least Developed Countries
(LDCs), urban
centers of Nepal receive disproportionately larger budget in terms of
development than rural areas. They have more
hospitals and schools. As a result, the rural-urban migration has resulted in the creation of slums and
makeshift communities in Kathmandu and other urban centers in Nepal. This has
made the
poverty situation worse. In
addition, the weak
economy implies that the poor and the hungry that arrive in today’s urban
centers and cities remain poor and hungry because the government cannot take care of their basic needs.
Urbanization
is happening, and is unavoidable. But, proper mechanisms can be put in
place through anticipation or progressive efforts. Basic amenities and services
should be provided all over the country so that people do not flock to urban
centers to receive such services and amenities. There aren’t enough roads
connecting different places in Nepal. Rural areas need roads to stay connected
with the rest of the country. Unless an inclusive approach is taken, Nepali cities will keep
experiencing rapid urbanization and crowding.
The Remittance
Economy
When the Maoist rebellion was at its throes in 2006, the state of
Nepali economy was in a mess, and was on the verge of collapse. The one thing
that saved the economy was remittance money flowing in from overseas. Thanks to
remittance, the consumption did not wane, and the economy stayed its course.
However, that does not mean remittance is always good.
The latest NLSS reported that 53 percent of Nepali households have at
least one member working away from home, out of which 32 percent work in
foreign countries. The reason why so many Nepalis go overseas for work is
because our state cannot provide them with jobs. However, that is not the worst
news to come out of NLSS-III. It is this: 79 percent of the total remittance
received by Nepali households is spent on consumption, and only 2.4 percent is
spent on capital formation activities.
That is, the remittance income that our country receives each year
finances our consumption, and only a small fraction is actually invested in a
useful manner.
Another fact: over 65 percent of those that go to work overseas are
between the ages 15 and 29 while the rest are between the ages 30 and 44. This
does not bode well for our own economic development. How can our economy foster
if the best and the ablest of our labor force goes overseas to build some other
country’s economy? And, it does not look like we are going to see an improvement
in this regard. The Youth Charter designed by our very own National Planning
Commission has 6 bullet-points to help the youths of this country. One of those
bullet points says something to the effect of “to train and provide our youths
with skills that will enable them to land jobs overseas”.
The Youth Charter designed by the NPC explicitly says that one of the
best things it can do for our youths and our economy is to train and educate
our youths just enough so that they can land overseas jobs as laborers. If that
is the best our country can do for our youths, we have no hope. How about
mentioning something like “to create jobs at home for our youths so they don’t
have to toil as menial workers in lands with no laws”?
And, then, there’s something called the spoil effect that we have
to deal with. A study in Kosovo has shown that remittance money sent by family
members from overseas made the youths reluctant towards seeking higher
education. It also reduced their incentives to work. Similar results have been
observed in studies done in remittance heavy economies like the Philippines,
Egypt and Somalia. The spoil effect, essentially, suggests that an easy
availability of remittance money sent from abroad by family members distorts
the work efficiency and working mentality of the recipient young family
members. What good is our remittance economy if we risk losing an entire
generation of our youths to poor education and poor skills due to the spoil
effect?
Nepali
Agricultural Decline
The share of agriculture in national GDP has been on a perpetual
decline. Agriculture contributed 72 percent to the Gross Domestic Product (GDP)
in 1975. Today, it contributes only about 30 percent to the GDP. The situation
is dire due to the fact that we still lag behind in the adoption and use of
technology in our agricultural practices. Agriculture in Nepal cannot compete with highly subsidized and
technologically superior large producers like China and India.
This decline would not be worrisome in itself. But, the reason why
agriculture’s decline is much more worrisome in our case is because 65 percent
of our labor force is still engaged in agriculture. This
is not going to change soon because this labor force does not have the skills
and education to get hired by other sectors. Nepali agricultural labor
force is mostly uneducated/under-educated and unskilled/low-skilled. Most of
this labor force lives in rural areas, and therefore, lacks basic education,
training and healthcare.
Our
liberalization policies and free trade agreements will push a large chunk of
the agricultural labor force into poverty. Although globalization benefits the
world, the fact remains that underdeveloped and developing countries, like
Nepal, have been unable to use it to their benefit. Lack of infrastructure to
transport goods to the market and vulnerability to risks posed by
liberalization make it harder for Nepal to benefit from it when compared to
countries that are already developed.
Agriculture can no longer remain our
leading economic sector. Sooner or later, as in all other nations that have
developed before us, other sectors are bound to surpass agriculture as Nepal’s
leading contributor to its GDP. However, instead of giving up on agriculture
altogether, the government should train and educate the agricultural labor
force in a way that the transition from agriculture vis-à-vis services and
industry should be a smooth flow instead of a painful process.
Liquidity
Crisis Will Return
As the NLSS-III showed, most Nepalis spent the remittance income on
consumption and spent only a small fraction in capital formation activities.
The same is true of any type of income, and not just remittance. So, one of the
reasons why the Nepali financial system went through a liquidity crisis since
late 2009 until late 2011 is because of the Nepali public’s reluctance in
saving their money in banks and financial institutions (BFIs). However, the
main culprits of the recent liquidity crisis are the banks themselves who used
to have surplus money in their vaults, but gave it away recklessly to whoever
came asking for it. And, those that came asking for it were the housing and the plotting people.
Nepal Rastra Bank (NRB) did its best to mitigate the crisis. It
suggested bank mergers hoping that the merger would create a larger institution
that would experience lower costs due to economies of scope and scale, increase
in market power, diversification, and reduced operational expenses. The belief
was that the newly created larger bank would free up vital cash and other
resources to infuse more liquidity into the market while ensuring lower costs,
maximum efficiency and stability. However, no conclusive evidence exists of
such perceived gains occurring in real life.
The NRB also lowered the Cash Reserve Ratio (CRR) from 5.5 to 5
percent, and claimed that this move would infuse Rs 3-4 billion liquidity into
the market in order to ease the liquidity crunch. However, the NRB's tactics of
lowering the CRR was undertaken to provide the bankers an accounting gimmick
that could free up some cash in order to show profit, however minimum, to their
shareholders. Any cash that opened up due to lower CRR would simply be invested
in acquiring government treasury bills to ensure that SLR remained at 15
percent. The move was a sham.
One move that could have mitigated the crisis was if the NRB had
lowered the interest rates to make it easier to borrow money. However, NRB
could not lower the interest rates without giving the impression of loosening
its anti-inflationary stance. If the rates were lowered so much that it came
close to being zero percent, it risked turning the liquidity crunch into a
“liquidity trap”. Also, a low interest rate would mean that people would hoard
cash in their homes instead of depositing in their banks since interest rates
signal the returns they would get on their deposits. That would make the crisis
even worse. In addition, a low interest rate would also cause capital flight
from Nepal to India where Indian banks provided higher interest rates. The
capital flight scenario was highly plausible given the constant pegging of NRs
with IRs, the high volume of traffic crossing the border between India and
Nepal, and the easiness of converting NRs into IRs.
The above reasons make the NRB’s monetary policies
ineffective in its fight against financial crises like the liquidity crisis. In
addition, economists, like Paul Krugman, believe that monetary policies should
be pursued only if a financial disturbance has the potential to affect
inflation or the real economy. It should not be pursued to solve a financial
distress. The liquidity crunch that we saw recently in Nepal had the tendency
to affect neither the inflation nor the real economy. Therefore, there is
serious doubt as to whether the NRB’s policies mitigated the recent liquidity
crunch or if it was just the market correcting itself. In either case, majority
of loans provided by our banks are still in the real estate sector. Until the
lending portfolio of our banks do not change, we will be going through another
round of liquidity crunch in the coming couple of years.
(Copyright) Mukesh Khanal
Labels: capital flight, central bank of nepal, crisis, CRR, economy, financial institutions, housing, IRs, jobs, liquidity crisis, monetary policy, NPC
Wednesday, September 21, 2011
Links for September 21, 2011
.
Union leads to closure of Fire and Ice restaurant
Asian Development Bank projects four per cent growth in 2012 for Nepal Nepal slips eight positions down in the Economic Freedom rankings
Union leads to closure of Fire and Ice restaurant
Asian Development Bank projects four per cent growth in 2012 for Nepal Nepal slips eight positions down in the Economic Freedom rankings
Nepal has slipped eight position down to be ranked at 129th among the 141 economies with a score of 5.50 in this year’s Economic Freedom of the World report released here today. Last year, Nepal was at 121st rank with a score of 5.54.World Development Report 2012: Gender Equality and Development shows that closing gender gap boosts growth
“Countries that create better opportunities and conditions for women and girls can raise productivity, improve outcomes for children, make institutions more representative, and advance development prospects for all,” it said, adding that in Nepal as many as 14 per cent married women are largely silent on how their earned money is spent. “But they are more actively involved in the decision making recently,” according the World Bank that revealed that women’s greater public voice not only benefits women and children but also men. “Giving women bigger say in managing forests in Nepal has significantly improved conservation outcomes too,” it added. “The disparities between boys and girls in primary education have almost closed over the past 25 years, and at the secondary level, the gaps are shrinking rapidly,” it said, lauding Nepal’s efforts in closing the gender gap.National Information Technology Centre to be established in Hetauda
The Centre’s building will be constricted at the estimated cost of Rs. 300 million with the grant assistance of the Korean governmentIndia set to overtake Japan as world's third largest economy
India is now the fourth-largest economy behind the US, China and Japan. Last year, Japanese economy was worth $4.31 trillion, while India´s was at $4.06 trillion. But after the devastating tsunami and earthquakes in March, Japan´s economy is expected to contract while India´s economy will grow between 7-8 percent this fiscal year.
Earlier, a report by PwC suggested that the Indian economy would surpass the Japanese economy in 2012. The IMF expects the Japanese economy to contract 0.7 percent this year while India is expected to grow 8.2 percent.BFIs told to insure deposits up to Rs 500,000
Banks and financial institutions (BFIs) that were required to compulsorily insure deposits up to Rs 200,000 will now need to insure all deposits up to half a million rupees.
Labels: banks, central bank of nepal, china, gender inequality, India, IT, Japan, labor unions
Wednesday, September 14, 2011
Published Paper: Monetary Neutrality in the Nepalese Economy
.
I had written a paper with a friend, Andrew Mueller, during our MA in University of Cincinnati for a course in Japanese Economy. The paper looked at whether Japan followed proper monetary policies or not during the period from 1980 to 2008 by observing whether "monetary neutrality" held true in the Japanese economy or not during that period.
After coming back to Nepal, I wanted to do the same thing, and wrote a paper to observe monetary neutrality in Nepal during the period 1975-2008. Both the studies used the same methodology--the VAR estimate.
The direct Nepal Rastra Bank's link is now available. Click here if you are interested.
I had written a paper with a friend, Andrew Mueller, during our MA in University of Cincinnati for a course in Japanese Economy. The paper looked at whether Japan followed proper monetary policies or not during the period from 1980 to 2008 by observing whether "monetary neutrality" held true in the Japanese economy or not during that period.
After coming back to Nepal, I wanted to do the same thing, and wrote a paper to observe monetary neutrality in Nepal during the period 1975-2008. Both the studies used the same methodology--the VAR estimate.
The direct Nepal Rastra Bank's link is now available. Click here if you are interested.
Labels: central bank of nepal, monetary economics, monetary neutrality, NRB
Thursday, August 18, 2011
Links for August 18, 2011
.
1. Nepal Rastra Bank's Governor, Dr Yubraj Khatiwada, advises the BFIs to regulate themselves.
This is very worrying to hear from the Governor. I agree, in general, about BFIs having to pay more heed in keeping their books and lending/borrowing practices balanced. But, asking the BFIs to "regulate" themselves is precisely the reason why de-regulated economies like the US and Europe suffered the financial crisis in 2007. The governor should be careful before dispensing such risky suggestions.
2. A nice article about inflationary expectations (using the US example)
3. Here's an excellent question: Is Nepal turning into a "constitutional anarchy"?
4. Surya Nepal shuts down its factory in Biratnagar that produces world famous brands--John Players and Springwood. Usually, I am a pro-union guy, but this incident shows how Nepalese tend to take the union concept to its extreme and hack our own legs.
5. 50,000th Bhutanese refugee leaves Nepal to settle overseas. Personally, I see a failure of Nepalese diplomats to talk with their Indian counterparts to solve this crisis. It's a shame. The Bhutanese should have been able to go back to where they belonged--in their own country, Bhutan. But, failure of Indian and Nepalese diplomats hurt these refugees for the last two decades.
6. ICRA to begin credit rating in Nepal
7. Nepal's credit rating. The world bank paper is here (PDF document).
1. Nepal Rastra Bank's Governor, Dr Yubraj Khatiwada, advises the BFIs to regulate themselves.
This is very worrying to hear from the Governor. I agree, in general, about BFIs having to pay more heed in keeping their books and lending/borrowing practices balanced. But, asking the BFIs to "regulate" themselves is precisely the reason why de-regulated economies like the US and Europe suffered the financial crisis in 2007. The governor should be careful before dispensing such risky suggestions.
2. A nice article about inflationary expectations (using the US example)
3. Here's an excellent question: Is Nepal turning into a "constitutional anarchy"?
4. Surya Nepal shuts down its factory in Biratnagar that produces world famous brands--John Players and Springwood. Usually, I am a pro-union guy, but this incident shows how Nepalese tend to take the union concept to its extreme and hack our own legs.
5. 50,000th Bhutanese refugee leaves Nepal to settle overseas. Personally, I see a failure of Nepalese diplomats to talk with their Indian counterparts to solve this crisis. It's a shame. The Bhutanese should have been able to go back to where they belonged--in their own country, Bhutan. But, failure of Indian and Nepalese diplomats hurt these refugees for the last two decades.
6. ICRA to begin credit rating in Nepal
7. Nepal's credit rating. The world bank paper is here (PDF document).
Labels: Bhutan, central bank of nepal, credit rating, inflation, nepal rastra bank, refugees
Tuesday, August 16, 2011
Links for August 16, 2011
.
1. Is Capitalism Dead?
2. Nepal Telecom plans to improve the service quality. Finally!
3. Government to provide jobs to unemployed Nepalese youths.
*All 14 zones will eventually have Employment Information Centers
*Currently, youths who have registered in Model EICs in Kathmandu and Biratnagar will be given jobs
*2332 youths from Kathmandu and 2000 from Biratnagar have applied for the scheme
*35,000 youths have registered for the program for 2011/12
*Rs 1 million has been allocated for current program
4. IMF urges Nepalese government to give more power to the Nepal Rastra Bank, the central bank, to handle sick banks
5. Relationship between Nepalese and Indian inflation
It is pretty clear that most of the time, Nepalese inflation always is a few points higher than Indian inflation. The primary reason for this is due to the fact that price of commodities--food or otherwise--consumed in Nepal come from or through India. Therefore, the Nepalese price for the same commodity is a few rupees higher than in India due to factors like transportation costs and retailers' profits. The other reason is also the pegging between NRs and IRs. Any rise in inflation in India has to be accompanied by a few percentage higher rise in inflation in Nepal to avoid any NRs flowing from Nepal into India. The reason why NRs flows to India in such cases is because higher inflation in India means higher interest rates in India to combat inflation. In such instances, if Nepalese interest rates remain low, people will take their money to India to take advantage of higher interest rates in India.
6. Sectoral Contribution to GDP
Like any developing nation, Nepalese agricultural contribution to GDP is declining while services is increasing. The recent surveys from 2010 and 2011 will probably show that agriculture is now only around 30 percent of GDP.
1. Is Capitalism Dead?
2. Nepal Telecom plans to improve the service quality. Finally!
3. Government to provide jobs to unemployed Nepalese youths.
*All 14 zones will eventually have Employment Information Centers
*Currently, youths who have registered in Model EICs in Kathmandu and Biratnagar will be given jobs
*2332 youths from Kathmandu and 2000 from Biratnagar have applied for the scheme
*35,000 youths have registered for the program for 2011/12
*Rs 1 million has been allocated for current program
4. IMF urges Nepalese government to give more power to the Nepal Rastra Bank, the central bank, to handle sick banks
5. Relationship between Nepalese and Indian inflation
It is pretty clear that most of the time, Nepalese inflation always is a few points higher than Indian inflation. The primary reason for this is due to the fact that price of commodities--food or otherwise--consumed in Nepal come from or through India. Therefore, the Nepalese price for the same commodity is a few rupees higher than in India due to factors like transportation costs and retailers' profits. The other reason is also the pegging between NRs and IRs. Any rise in inflation in India has to be accompanied by a few percentage higher rise in inflation in Nepal to avoid any NRs flowing from Nepal into India. The reason why NRs flows to India in such cases is because higher inflation in India means higher interest rates in India to combat inflation. In such instances, if Nepalese interest rates remain low, people will take their money to India to take advantage of higher interest rates in India.
6. Sectoral Contribution to GDP
Like any developing nation, Nepalese agricultural contribution to GDP is declining while services is increasing. The recent surveys from 2010 and 2011 will probably show that agriculture is now only around 30 percent of GDP.
Labels: capitalism, central bank of nepal, GDP, IMF, inflation, nepal rastra bank, nepal telecom
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