“We are trying to emulate China’s economic growth without comparable fundamentals in place”

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“We are trying to emulate China’s economic growth without comparable fundamentals in place”

After the end of the long political transition, Nepal has come to a juncture where the economic prospects for the country have become brighter. There is now a stable government in place and the country, over the last few years, has registered high economic growth. Yet, several problems remain to make this growth sustainable. Overdependence on remittance, low employment generation and sluggish industrial output continue to remain as major hindrances in the country’s economic trajectory. Besides, the worsening position of the country’s external sector with no immediate improvements in widening trade imbalance have increased levels of concern about economic vulnerabilities.

Still prominent economist Dr Swarnim Wagle thinks that Nepal can have a sound economic health if the structural challenges are addressed. Dr Wagle, who served as the Vice-Chairman of the National Planning Commission from August 2017 to February 2018, sat down with Sanjeev Sharma of New Business Age to talk about the current hurdles to higher economic growth, issues related to foreign direct investment and infrastructure development. Excerpts:

After the Nepal Investment Summit 2019, the Investment Board Nepal (IBN) is in the process of receiving investment commitments from foreign investors. How hopeful areyou that the new commitments will happen?
There is a fundamental difference between the 2017 and 2019 investment summits. The 2017 summit was very important for three reasons. First, the new constitution had just been promulgated and with the investment summit, we signaled the end of the political transition and a new economic beginning. Second, the summit served as a platform to announce a few initiatives, such as the Foreign Direct Investment (FDI) Policy, National Mining Policy, Industrial Enterprises Act and Special Economic Zone Act. Third, it was also very important to re-establish the reform credentials of political parties like the Nepali Congress and state institutions like the Investment Board of Nepal. In that regard, Nepal Investment Summit 2017 was more successful than expected. But the manner in which the USD 14 billion pledges were garnered was not credible and lacked proper preparation. Also, the follow-up was weak.

The Nepal Investment Summit 2019 was held against a backdrop of even more favorable circumstances. Early indications hint at a lukewarm response. We thought that the current government can convey a message of strength and predictability, set its economic priorities clearly and allay fears that might exist in the international arena about a government that still calls itself ‘communist’. Similarly, we expected the government to announce the 2019 legal reforms such as formulation of the Public-Private-Partnership (PPP) Act, Intellectual Property Rights Act, Hedging Policy along with amendments to the Foreign Investment and Technology Transfer ACT (FITTA), Companies Act, Industrial Enterprises Act, and Labour Act. The government couldn’t finalise some legal reforms before the summit. In that respect, the summit appeared to have been rushed. I think had the organisers waited for six more months, things would have transpired better.

Overall, the investment deals announced at this year’s summit were underwhelming. If you analyse the 16-17 deals that were publicised, four came from Binod Chaudhary. Similarly, two project deals related to the development of the Upper Trishuli-I Hydropower Project and Simara SEZ were signed by the International Finance Corporation (IFC) who could have done it at any other time. Likewise, agreements like signing a memorandum of understanding to establish a relationship between IBN and South African Investment Board were just formal. Also, the signing of the letter of commitment for the financing of the under-construction Arun-III wasn’t much meaningful as the supplementary resources for the project had already been secured within the country. This is also not the point of FDI which is meant to bring money from outside.

While organising such events is indeed a welcoming step, the government should have undertaken adequate legislative preparations and thorough due diligence of projects on offer. I understand that dozens of other projects were also on display for which expressions of interest have been sought after the summit. I hope those will deliver long-term results.

What could be the right approach for us in attracting FDI?  
In Nepal, we tend to do things in a generic manner. We enact the laws and set up institutions and ask investors to invest in our country. This is not how transformative investments work. Foreign investors have to be wooed one at a time. We need to approach and negotiate with them individually to know their requirements. For example, some may require specific infrastructures while it can be specific fiscal incentives for others. That kind of individual rapport and approach with foreign investors is missing. In this regard, either the people in the government and bureaucracy lack confidence or they aren’t used to these kinds of personalised practices.

I don’t think we need 50 foreign companies to come here at once. Entry of even one credible foreign company can send a signal to its fraternity. For example, when the US-based multinational semiconductor manufacturer Intel Corporation chose to go to Vietnam, tens of other companies followed. This is how investment has worked in the past as herd mentality persists among the businesses and investors. During the electronics boom in the Malaysian state of Penang in the 1980s, the early investors were mostly from the Chinese diaspora whose success attracted others to invest in the region. I call this “Anchor Investment,” about which I briefed Prime Minister KP Sharma Oli before he went to Davos, Switzerland earlier this year to participate in the annual World Economic Forum. I suggested that he should refrain from making generic remarks like “Nepal is ready for business and please come and invest in our country.” We have to get hold of 2-3 “anchor investors” who can instill confidence in others.

The National Planning Commission (NPC) unveiled the 15th Five-year Plan to elevate Nepal to a high-income economy with USD 12,100 in per capita income while maintaining a minimum annual GDP growth rate of 9.4 percent. Do you think such an ambitious target will be met?
NPC‘s target is to increase the country’s per capita income to USD 12,100 (in today’s prices) by 2100 BS which for the World Bank’s lending purpose is a threshold to attain high-income status. I think this goal is not possible. I haven’t seen any rigorous analytical preparation that NPC has done in this regard. It is true that sometimes we need to set ambitious targets, but there has to be a realistic pathway and believable stepping stones. I don’t see that happening because of a few reasons. Forget nine or 10 percent GDP growth rate, Nepal has never ever secured a seven percent growth rate for two consecutive years in its history. That gives a hint about our structural handicaps. No large country in the world has achieved such economic growth for such a long duration. Historically, there are 13 ‘miracle economies’ in the world that have achieved around seven percent growth rate for about 25 consecutive years. The closest example we can think of is China which sustained 9-10 percent economic growth rate for 20 years which has now slowed down to 6-7 percent. With a strong state authority, the economic efficiency from its continental size, economies of scale, massive human capital base, access to the sea and the broad market reforms it undertook to join the World Trade Organization (WTO) gave China a big push.Now we are trying to emulate China’s economic progress without comparable fundamentals in place. I would like to suggest NPC to set a moderate growth rate of about seven percent for the next 10 years. This would double the size of our GDP in a decade, which is itself a miracle by Nepali standards.

It also looks like there is confusion among officials about growth spurts and sustained growth. A country can have high growth rate for one or two years, but having a sustained growth rate for 7 to 10 year is very difficult. Every time a country’s GDP grows by 7 or 10 percent, its economic base also grows. It becomes increasingly hard in successive years to maintain high growth without continuous reforms, policy innovations and investments.

A few years ago, the Indian government replaced the Planning Commission with the NITI Aayog. Is there any possibility to replicate such a step in Nepal?
The replacement of the Planning Commission in India by the NITI Aayog was influenced by the personal experiences of Indian Prime Minister Narendra Modi. During his reign as the Chief Minister of Gujarat, he didn’t like the idea of going to New Delhi and negotiating with the Planning Commission about how much budget his state should receive. So, after becoming the Prime Minister in 2014, Modi scrapped the periodic plans and the role the Planning Commission had in allocating revenue. NITI Aayog is a new institutional experiment.

I have been raising the need to reform NPC for the last five years. In fact, when I tendered my resignation from the post of vice-chairman to Prime Minister Oli , I submitted the draft of the National Planning Commission Formation and Operation Ordinance 2018which he accepted and enacted. The ordinance seeks to re-orient the NPC to becoming more of an in-house policy think tank of the government.

A body like the NPC is needed to set an inspiring vision and  credible development goals. None of the ministries can think as broadly and over the long-term. Similarly, there are so many failures in terms of coordination between state. Here, NPC can play a big role in resolving such coordination failures. The government has been doing this through the National Development Action Committee (NDAC) which can be even more effective.

NPC also needs to work in materialising the idea of a project bank. Generally, ministries announce and undertake projects without due preparation. Such practices can be checked if NPC took a serious role in evaluating the viability of projects, calculating economic rates of return and identifying potential funding sources before the ministries execute the projects. NPC should also work in new policy initiatives. For instance, the body can look into executing policies such as the universal health insurance, dealing with new disruptions in agriculture, clean manufacturing, and payment systems. The new ordinance has incorporated all these aspects. However, I still see them following the old working model. In our context, a body like NPC is necessary but it has to justify its existence by being much more effective and functional.

How do you evaluate the current trend of GDP growth which is moving without employment growth and secondary sector growth? Is it sustainable?
I think the challenge for us is to get the growth going first. But adding too many expectations on the growth process may not help us achieve the kind of high growth we’ve always wanted. As I said earlier, a seven percent growth has not been repeated; the last time we crossed the seven percent mark (in 2016-17) was illusory because it was in the aftermath of the earthquake and the economic blockade in 2015 during which  the growth rate had plunged close to zero percent.

Talking about employment generating sectors in Nepal, it has to involve agriculture, propelled by a productivity boost through large scale irrigation, high-yield seeds, extension services, and access to markets. Currently, the manufacturing sector’s contribution to the country’s GDP is less than 6 percent and the overall industrial composition is about 16 percent; expansion of this sector can create new jobs. Even in services, if sectors like tourism, construction, wholesale, retail, healthcare and education grow dynamically, more jobs can be generated. My point is, let the growth process take-off. If the growth rate of seven percent per annum is sustained for 2-3 years and if it is realised this is a jobless growth, then we can intervene.

The persistently low level of contribution of the manufacturing sector to the country’s GDP, declining share of agriculture and increasing share of the services sector indicate that Nepal has de-industrialised over the years. How healthy is it?  Should we reverse this process of de-industrialisation?
The relative share of the agriculture sector in the country’s GDP is declining. It is the stylised fact in development economics that as countries go up the income ladder, the size of the agriculture sector shrinks.

The challenge for us now is to go on a high growth path which is also employment creating because of our demographic peculiarity, epic outflow of workforce and our dependence on remittances. The kind of economic structure and growth process we have is not creating jobs in large numbers. We need to focus on expanding the size of the manufacturing sector because the sector traditionally has been the absorber of the young workforce.

Globally, the nature of manufacturing is evolving due to automation and new technologies. Over the course of time, a country reaches a threshold and starts to de-industrialise. Even countries like China and India have de-industrialised. The share of workers in manufacturing as a share of total workers in the United States, for instance, peaked in 1953 and then started to decelerate. In South Korea, it peaked in the 1980s. During the peak, the countries had around 27 to 30 percent of their people employed in the manufacturing sector, according to a study by Dani Rodrik. This started to decelerate in China and India after reaching around 19 percent. In our context, it is not only de-industrialisation but also premature de-industrialisation. Countries like Nepal have added challenges in the manufacturing sector because of being landlocked. Whatever we do is less competitive than coastal countries.

Given our landlockedness, we can only focus on the niche products with high value to weight ratios. We cannot just blindly mimic the activities of our neighbours. Industrialisation would have been a challenge for us in any case. Nonetheless, Nepal’s manufacturing peaked in 1996 before coming down to 6 percent due to conflict and other problems. This should double to around 12 percent even though the old characteristics of manufacturing are also changing.

What could the niche be in manufacturing for us?
We have an advantage in energy-intensive production because the whole world is switching away from dirty sources of fuel. If Nepal’s surplus in energy can be channeled to clean production, it would be good to brand the country as a source of 100 percent clean energy that will help our foray in tourism. Even Chinese and Indian manufacturers who are looking to move away from coal-based power in their countries can locate certain segments of their businesses in Nepal. For this, our international borders need to be seamless and we need to be part of regional production networks.

Another area is agro processing where Nepal can have an advantage due to the climatic variations. We also have advantage in some labour-intensive industries, such as garments and footwear. Similarly, we continue to enjoy trade preferences in the world’s largest markets- European Union, United States, China and India. If we can provide basic infrastructure facilities and incentives, some foreign manufacturing companies can choose to locate here just to take advantage of the trade preferences that Nepal enjoys as a least developed country (LDC).

Nepal is a signatory to the Belt and Road Initiative (BRI) and Bangladesh, Bhutan, India and Nepal Initiative (BBIN). How do you think we can optimally benefit from these framework agreements?
Both BRI and BBIN present good opportunities for a country like Nepal with massive infrastructure and connectivity deficits. These framework agreements are centered on infrastructure development although BRI has several other components such as people to people connectivity, trade and monetary arrangements, among others. The initiatives will be advantageous if we can manage them well. But the conditions that are attached with these engagements need to be carefully assessed. We need to look if the money that will come for BRI projects are grants or concessional or non-concessional loans, how do such loans compare with other sources and can the same project be done in a cheaper and sustainable manner.  

As bureaucrats alone aren’t able to evaluate the projects of these initiatives, I think we need credible think tanks to work closely with the government to flesh out some of the proposals with the help from the private sector as well; and in some cases, we may also need to seek international assistance. This is where we lack core competencies. We really don’t have an atmosphere for credible and independent policy think tanks to provide support to the national agenda. These initiatives are too big to be left to the judgment – discretion - of one or two undersecretaries in the government.

Our national agenda in this regard should incorporate issues in all forms of connectivity including airways, roadways, railways and waterways (with India) and people to people connectivity. It should also include investment coordination to bring in large scale investments as China sheds low-end manufacturing.

The government has been trying to find new job markets for Nepali migrant workers to boost the remittance inflow which is thought to have reached a saturation point. Do you think exporting labour is a long-term viable option for Nepal at a time when domestic industries/businesses are facing challenges related to the shortage of workers?
Unless the economy takes off miraculously on a path of employment generating high growth, it will be impossible to create jobs necessary to absorb everyone who comes into the labour market. The Public Service Commission, for instance, creates only about 10,000 public sector jobs annually. Likewise, new private sector firms last year created around 27,000 jobs, according to the Economic Survey of FY2018/19. This gap will continue for another 10-15 years because of our demographic composition. Nepal is a young country where the median age is just 23-24 and this will continue to persist till 2028. The projection is that Nepal will become an aging society only after 2030 and an aged society after 2054. In this respect, the country’s economy has to be much more dynamic.

People will go abroad for jobs if they don’t have employment opportunities at home. It is obvious also because of our democratic system where people can make their own decisions to go anywhere to live and work. What is needed is to manage the outflow as well as inflow of the workforce. It is about finding ways to deal with the incoming remittances and leveraging skilled returnees, who have some seed capital, knowledge and exposure, for the economic momentum the country needs. I think, for the next 10 years, managing the flow will be a challenge for us rather than stopping people from going outside the country. In the meantime, the skills gap created by the outflow of the workforce in large numbers can be filled by importing labourers. This is not an ideal scenario but this is where we are currently.

Many think that saving the remittance money rather than spending it in consumption can be instrumental for productive sector investments. Is it possible for us to direct remittance money to productive sectors?
This is not something that can be done in the level of individual households. Remittance streams that are coming into Nepali households are quite modest. It is a stylised fact globally that money sent by first generation remitters is mostly used for consumption. It is quite unfair to expect poor families to consume less and save more. In fact, complimented by public spending, the remittance inflow has helped to reduce poverty and household deprivation dramatically in Nepal.

As people prosper, they start saving more. So the government’s job is to create an environment conducive to channeling the savings to the formal banking system. Once the size of the savings grows, it is the job of the banks to act as intermediaries between depositors and investors. The government cannot dictate this process but only facilitate it.

How do you see the current state of Nepal’s external sector which has caused mounting concerns about the ability of Nepal’s economy to withstand international shocks? How do you think this situation can be managed?
Currently, there are signs of emerging economic vulnerabilities in Nepal. There is a big strain on the country’s foreign exchange reserve mainly due to decreasing FDI and foreign grants. Up to now, foreign exchange reserves can still finance our imports for 6-7 months. Countries in crisis manage their import flows for just 2-3 weeks. When India was in a difficult economic position in 1991, it managed to finance its imports for just one day; then it was forced to go to the International Monetary Fund (IMF) to borrow money to cover its external imbalances. We are nowhere close to such a situation.

The deficits are widening also on the fiscal front. A revenue shortfall is being seen and the government is, perhaps unwittingly, making Nepal an overtaxed economy. Similarly, the government is not able to spend the money collected; we are in the final few weeks of the current fiscal year and capital expenditure has only reached 44 percent.

The recurrent expenditure has significantly increased because of federalism, heightened expectations of the people and different tiers of the government which is also not a sustainable course. Talking about credit growth, there is a massive credit bonanza on a cyclical basis fueling imports which worsens our trade imbalance.

The vulnerabilities are becoming much more pronounced in the fiscal, monetary and external fronts. Even in the real sector of the economy, growth is not as high as expected; the government has targeted a growth rate of eight percent for the current fiscal year and I would be surprised if six percent is exceeded.  

On the fiscal front, there is a need to rein in unproductive expenditures making sure that expenditures are aligned with our absorptive capacity. The government should look into how much revenue can be generated without overtaxing the economy. On the external front, the government should try to check imports temporarily; not the vital imports that are necessary to propel the economic growth process but goods that are imported for conspicuous consumption. I think working on a case-by-case basis methodically and analytically should be our approach to resolve these issues.

The current government has stated infrastructure development as one of its main focus. But the status of many National Priority Projects shows otherwise. What is specifically required to overcome these problems?
There is now a corrupt nexus between politicians, private businesses and the bureaucracy. If people want to make money illegitimately, they look at infrastructure projects where large budgets are allocated. Here we need greater regulatory oversight, citizen awareness and increased role of the media. But to the extent we can make the roles less arbitrary, we can rein in some of that misbehaviour.

Generally, there is a lack of capacity on the part of private contractors and bureaucrats. They also tend to be risk-averse to trying new approaches. Construction of large infrastructure projects is a challenge everywhere as time and cost overruns are a recurring phenomenon globally. We need to try to adopt practices that other countries have tried successfully.

When I was in the NPC, we looked at all 21 projects of national pride and tried to categorise the most common problems hindering their progress. We identified five areas to look into.

One was the lack of secure multiyear funding and absence of clear fiscal incentives. Second was the prior readiness of projects.

Unless funded by foreign agencies like The World Bank and the Asian Development Bank, the construction of many projects gets started without the detailed project report (DPR). The 750MW West Seti Hydropower Project, for example, doesn’t have the DPR. Even the Kathmandu-Nijgadh Fast Track Road Project, construction of which has reached halfway, has just started to prepare the DPR.

Problems in land acquisition and forest clearance, Environmental Impact Assessment (EIA) and lack of availability of construction materials are other problematic areas. Managing the contracting relationship between builders and bureaucrats is another contentious area in infrastructure development. Also, the frequent transfer of personnel and lack of monitoring are other factors affecting progress.  

Having said that, there has been some good progress in a few under-construction projects like the Pokhara Regional International Airport, Gautam Buddha International Airport and Bheri Babai Diversion Multipurpose Project and a few North South Corridor projects.  But projects like Melamchi Drinking Water Supply Project, which the government should have delivered this year and Sikta Irrigation Project have been disasters.

The booming startup scene has attracted many Nepali youths in recent years. What is needed to be done to foster youth entrepreneurship in the country?
There is a lot of dynamism among youth entrepreneurs despite the lack of government support and protection. There are five aspects we need to focus on to nurture the nascent entrepreneurial ecosystem in the country.

First, our laws and regulations have to be much more liberal in terms of entry and exit of firms. It is because young people don’t want to play corrupt games; they want to be guided by the rule of law which is predictable, transparent, secure and not dependent on the discretion of bureaucrats.  Second, we need a pro-competition environment where there is a level playing field so that people need not come from a certain region, ethnicity and political affiliation to succeed in business.

Third, Nepali business firms need to access the world for the best talent and inputs. So they should not be shielded from working together with foreign companies. Fourth, our payment gateways need to be much more efficient; people follow illegal practices due to the absence of such systems. The government could also support the construction of shared workspace. Fifth, we need modern financing instruments such as private equity and challenge funds alongside concessional credits that are not collateralised.

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