Country On Verge Of Bankruptcy

The Economy and The State: Can It Survive?

The Government and the political parties as well have remained unconcerned since a long time about the economic situation, its direction and the general welfare of the people. Neither they are concerned about the current and emerging burning economic issues of the country. The political parties, and the organizations affiliated with them, can argue that if the political problem- no one can deny that it is the most urgent problem that the nation has to deal with - can be solved, the economic problems need no time to solve with. But our past experiences do not support this argument. The Government at the same tone has not hesitated to argue that a few economic issues have remained unsolved due to time constraint as under the present arrangement it has to handover the Government in the not too distant future to the elected representatives. But few will believe on such argument. A detail study of the measures undertaken by the current regime shows that it has been pursued with an aim to make the present political arrangement permanent. It is a different story that it could not succeed. The twenty one point economic programs issued on February 2 last year, the new economic policies and programs discussed in the current year budget and the recent changes in custom duties will make even the task of next ‘national’ government extremely difficult. The current Government, claimed to have been formed under Article 127 of the present constitution, has no right to pursue policies and programs that have long term implications. Its chief aim should be to handover the Government to the political parties as soon as possible under the current or the new arrangement decided by them, be it the reestablishment of the parliament or the national government formed with the agreement of the national political parties or an all party government established through round table conference that are now under discussion. In the meantime, it should have attempted to solve the existing inconsistencies in the policy and programs, to reduce the existing economic liability as much as possible and handover an economy that is properly functioning. But the dictatorial pattern used to operate the economy has provided little room for satisfaction. On the contrary, it has not only created new problems, but new anomalies and inconsistencies have emerged in the economy.

It needs no emphasis to state that until the political problems are solved and a new order has been adopted by the country, further deterioration in the economy with new problems is difficult to avoid. This will further help to intensify the political problems. The public has shown little satisfaction from the activities of Government which claims to “the end the ‘Maoist’ conflict first to pursue development programs” or that of political parties which “claim development possible only after the end of ‘national’ conflict”. It is generally complained by the public that whatever may the reason or reasons forwarded by both the Government and the political parties it has been designed for their own sectoral end, including a lack of well designed road map for nation development. As a result, the economy is deteriorating at a fast rate since the last four years- per capita is stagnant or even declining, price is rising and the balance of payments problem with major trading partner is deteriorating. In the lack of proper measure to improve the situation, the economy may fall together abruptly. It is, of course, difficult to specify the time. Few of the national and sectoral problems are discussed here:

(A) The gross domestic product at constant price has from 2001/02 increased at an annual rate almost equal to the growth of population (2.5 percent) or even less than that. As a result, real income in per capita terms has not increased. The general public are compelled to support their ever increasing size of the family from a fixed or declining income. The employment opportunities in the country were limited. Now, it is almost nil. The young people are migrating abroad in search of job. It is an open secret that the remittances forwarded by the migrant workers have played a major role in helping the poor people to meet their basic necessities.

The receipts from remittances have been the single most important factor determining the level and direction of economic activities of the country, both at the micro and macro level. A marginal instability in this source will disturb the foundation of the economy and is expected to be more dangerous than the current political problem. The impact of poverty, foreign employment and remittances on the macro economic structure of the country will be more obvious from the following diagram:

The foreign exchange reserve of the banking system has been increasing due to rising receipts from remittances and this source has helped the individual family to increase its consumption in excess of the rise in income. The import, however, has to go up to increase national consumption at a rate higher than the growth in income. This has led to the deterioration in the foreign trade balance of the country but, at the same time, it has been instrumental for the increase in government revenue due to rising receipts from import duties. Thus the receipts from remittances:

have contributed to rise in foreign exchange reserve to finance rising foreign trade deficit;

have been the main factor for the balance of payments to be in our favor;

have been the main factor for the increase in the foreign exchange reserve of the banking system;

it have been the main factor contributing to the growth in money supply;

and the increase in money supply has led to rise the in the resources of the commercial banks with commensurate impact on interest rate on deposit which is less than the rate of inflation.


The high and rising poverty and the receipts from remittances associated with it appear to have generated an impression of a self-generating well managed process of the macro economic structure.

This appears to have led both the Government and the Central Bank not to hurry to initiate new policy measures.

The Government may have taken the impression that the economy is well managed.

The political parties have not felt the urgent need to take initiative in the area of economic management.

These processes may have led the general public to take an impression, however false, that the economic development programs have been given no priority with mutual agreement by the Government and political parties. Against this background, the general standard of living of the people has been deteriorating, as discussed earlier, and there have been press reports of the destruction of development infrastructure facilities of the country due to rising political conflict.

Though the nation has now been trapped in the vicious circle of poverty, the Government, if the publication of various survey reports is any guide, has claimed the decline in overall poverty level so much so that the Tenth Plan’s target on poverty reduction has been met three years ahead! The Living Standard Survey conducted in 1995/96 has shown the overall poverty level at that time at 42 percent which was expected to have declined to 38 percent in 2002/03, that is, by the end of the Ninth Plan. The Tenth Plan had fixed a national target to reduce the overall poverty level to 30 percent by the end of the five year plan period or by 2006/07. The second Living Standard Survey conducted in 2003/04 shows a poverty level of 30 percent indicating a decline in overall poverty level by 11 percent between 1995/96 and 2003/04! But few people believe in the official results as none has experienced such situation in the country or day to day life. Neither the Government has changed the official target and programs of poverty alleviation of the Tenth Plan. It has not made either objective investigations for the emergence of a result that the Government itself appears to have difficulty to believe. True, the increase in receipts from remittances as well as the number of family receiving remittances has been a great assurance to the poor people. The impact of remittances on poverty alleviation can not be underestimated or minimized, specially a country like Nepal. But the main question is: Is it a dependable source?

An analysis of the available information indicates that the migrant workers are also eager for finding alternative measures in place of making arrangements for continuous flow of financial resources to the family members back home. Indications are that several migrant workers have called the family members to their place of work and, if possible and necessary, even apply for permanent resident. It is said that several middle income families have, due to long and increasing conflict in the country, taken land for home construction or even bought homes in the nearby small border towns in India. As a result, the land price in such Indian towns has increased recently at an unprecedented rate, though detail research in this area has yet to be taken. But if the available information is any guide, it will lead to sharp decline in receipts from remittances.

(B)The nation has experienced increasing pressure on domestic price from the beginning of the current fiscal year. In the first four months of the current fiscal year price increased at an annual rate of about 28 percent compared with an increase of 2.7 percent in the first four months of the preceding year. A strange but rare feature has emerged in the economy that in the popular terminology is known as ‘Stagflation’, an economic situation characterized by low or even negative growth in real income combined with unprecedented rise in price. Such an unfortunate situation can not emerge in a country in normal circumstances. But Nepal is not under normal situation since the past several years. In particular, it is widely believed, at both theoretical and practical level, that Nepal’s inflation rate is always equal to India’s rate of inflation, given open border and fixed exchange rate between Nepalese and Indian currency. But, at present, Nepal’s rate of inflation is substantially higher than the prevailing rate in India. The domestic factors, for example changes in money supply, have not contributed to this development. It appears that the rate of inflation, defined as continuous rise in prices, has increased mainly due to change in people’s expectation, and is self generating. The people are expecting the price to rise in the coming months due to expected rise in political conflict. As a result, people are buying goods, especially consumption goods, even to hoard and are willing to pay higher price for their purchase. Similarly, as the sellers are also expecting price to rise in the months to come, they will not hesitate to charge higher price. Thus the current conflict which has changed the expectation of both buyers and sellers with respect to market price in the future has generated a inflationary spiral in the country, a situation similar to that experienced by Hungary in the mid- forties when the price increased at an annual rate of one hundred thousand percent per month. It is difficult to predict the direction and level of inflation in the country for the coming months as it depends more on people’s expectation of price formed based on domestic conflict situation rather than economic factors. True, if the people believe that the domestic conflict is not expected to escalate, the inflationary situation will be automatically controlled. It needs no fiscal and monetary measures.

(C) At end October 2005 the foreign exchange reserve of the banking system total Rs. 134 billion out of which the total Indian currency reserve amounted to Rs. 7 billion or 5 percent of the total reserve reflecting deteriorating trade balance with India. At the same time, His Majesty’s Government is committed to maintain free convertibility of Nepalese currency in Indian currency and vice- versa. Under this arrangement, the public authority, in our case Nepal Rastra Bank, has to sell or purchase Indian currency to and from the general public on demand at a fixed rate without any quantitative and qualitative restriction. The banking system needs sufficient reserves of Indian currency to perform this task, but the amount of Indian currency reserves held by the banking system at present is not adequate for this purpose. As a result, the Nepal Rastra Bank has imported Indian currency from India to finance domestic needs. The detail information with respect to total quantity of imports and the form in which it has been imported, that is, how much has been imported by selling convertible currency and how much has been in the form of loan from the Reserve Bank of India is not available. Neither the detail information with respect to policies contemplated, if any, to solve the balance of payments problem with India is available. In particular, the receipts from remittances together with receipts from foreign grant and loan have helped Nepal to maintain comfortable foreign reserve position. As a result, the policy makers have never been serious in initiating appropriate programs and policies in the area of, in particular, foreign trade and exchange rate. Against this background, there may, in the absence of assistance from India, be shortage of Indian currency in the county any time, notwithstanding high and rising foreign reserve. Can Nepal maintain current exchange rate with Indian currency or is it the appropriate rate? Any responsible government can not remain unconcerned to deal with the vital issue like this.

(D) The fiscal situation of His Majesty’s Government is at a very alarming state. Few measures that have been initiated recently, for example, supplementary budget, have added fuel to the fire. In the current fiscal year, the authorities have not cared even to maintain simple consistency and coordination among revenue, expenditure, budget deficit, and the sources to finance the budget deficit. (The policy makers may have tried but failed). Nevertheless, the Government estimate itself indicates that its contribution to development budget would have amounted only 5 percent of the total even if the total expenditure and revenue has been realized as estimated. A detail integrated analysis of the overall trend of government revenue and expenditure until recently, the current economic situation, the expected negative impact of the supplementary budget on government revenue and the new structure of custom duties show an alarming situation: the Government will be financially bankrupt by the end of May/ June. This will be more clear from the following table:

Government Receipts and Regular Expenditure
(Rs. in billion)

Contents Budget Estimate IfDS Estimate
1. Revenue 81.82 76.56 1)
2. Expenditure 89.65 92.05
Regular Expenditure 75.85 75.85
Principal Payments 13.80 14.50 2)
Supplementary Budget (Reduction in custom duties) - 1.70 3)
Deficit (1-2) 7.83 15.49
Internal Loan 11.85 11.85
Current Expenditure (+ Saving), (- Deficit) +4.02 -3.64 4)

1) Based on prevailing growth rate in gross domestic product at constant price, recent economic activities and past trend of the difference between the government budgetary estimates and realization. The government receipts have been estimated using custom duties of original budget. The financial cost of supplementary budget has been shown under expenditure.
2) Including the cost arising from changes in the exchange rate of Nepalese currency.
3) It is expected to be higher than the amount included here.
4) Capital expenditure depends fully on foreign aid in grant and loan for which detail information is not available. It is, however, expected to be very low with commensurate adverse impact on national economic activities.

Even assuming that the government revenue will be 93-94 percent of the revenue, a highly optimistic estimate given current trend, and the full realization of internal loan, the Government will not have resources to fulfill its regular budgetary obligation. This is attributable, among others, to the ad-hoc decision making process of the Government and the expressed desire of the decision makers to change budgetary provisions, including tax rate to make it compatible with their business interest. As the World Bank and the International Monetary Fund have decided not to release additional resources under Poverty Reduction Growth Facility, the Government has no independent resources at its disposal. The situation is deteriorating very fast and will be obvious to all in the not too distant future. It will be a crime against the nation to try to solve this problem by borrowing from the Nepal Rastra Bank by issuing an ordinance. It needs no emphasis to state that financial and economic problems now appear more serious than the political problem. In fact, it is. In the current fiscal year:

The growth in the per capita income will be negative or barely positive. This has been already accepted by the Government authorities. As a result, poverty, especially in the rural area, will increase further and the young people, if possible, with their family will migrate to other countries looking for employment. It is expected that the process of capital flight will increase further.

The inflation rate due to domestic conflict will increase at its own pace but due to open border with India together with fixed exchange rate it can not exceed the maximum limit that, however, is not yet obvious. But price of a few selected goods may exceed the maximum limit and occasional non availability of such goods will be a normal feature. The price of goods that does not have foreign market, for example, land and house price, and that of services will be particularly high. The problem of Stagflation in the country will be more obvious.

National consumption will increase at a faster rate than the growth in income which will further widen the trade deficit due to import of consumption goods. This process will lead to further deterioration in the balance of payments position with India. It will not be possible to maintain exchange rate with Indian currency without the assistance of India. (It is sure that International Monetary Fund will decline to advance credit in Indian currency even for the balance of payments purposes)

The foreign exchange reserve in the current year will increase marginally or even decline indicating emerging problem in the balance of payments. As a result, money supply will increase moderately. The increase in the financial resources of the commercial banks will depend on level and direction of capital flight. The overall situation of commercial banks will be determined more by the non- economic factors, for example, rising conflict, political instability etc.

The current macro economic situation and the problems discussed earlier will generate, after a few weeks lag, adverse impact on day to day activities of individual family. This will further complicate the national political problems. True, children and the young people have dominance in the demographic structure of the country. But these groups, due largely to domestic conflict, high and rising poverty, and sluggish economic performances, have neither proper education nor employment opportunities. Fortunately, many young people have been able to find job outside the country. This has, no doubt, prevented the national crisis from total explosion. But the situation is deteriorating at a very fast rate. It is not a civilized national behavior either to remain satisfied from the migration of young people from the country, and run the economy based largely on the remittances sent by them. We can not avoid or postpone national problem this way. Once the economic problem is exploded as it may, if the current situation is any guide, do so in the near future we will not have long time to deal with the people in the name of finding alternative programs and measures like, say, in the area of political issues. We will not be surprised even if the total anarchy prevails in the country, at least in the selected urban areas. At that time, neither the Government nor the political parties will be able to relax and remain unconcerned as of now. The national identity itself will be at stake. It is necessary to deal in time to check the problem from further deterioration. We request all to take the problem seriously.

Institute for Development Studies is a Kathmandu-based independent
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Chandan said…
The analysis is quite good...and it needs urgent attention...