BIPPA Blues

(My article published in New Spotlight, November 11-24, 2011)

The brouhaha surrounding the Bilateral Investment Promotion and Protection Agreement (BIPPA) between Nepal and India signed during Prime Minister Baburam Bhattarai’s October visit to India presented a spectacle true to the form of present-day Nepal. From a PhD-SLC topper head of government apparently failing to appreciate the substance and implications of the pact, to a lack of open debate before its signature, to coverage by the mainstream media in a consent-manufacturing mode bent on projecting the pact as the sine qua non for attracting Indian investment.

The national treatment and most-favoured-nation (MFN) treatment provisions in the BIPPA reinforce preferential treatment for Indian investors, who in practice are already treated on a par with domestic investors and enjoy more rights than do other foreign investors, thanks to the 1950 Treaty. A treaty that the Maoists, with “intellectual” fire-power from Bhattarai, once upon a time wanted to be scrapped but now are willing to accept in an adjusted and updated form. Nepal’s strategy should be to treat all foreign investors alike, regardless of their nationality.

The provision on compensation for losses (Article 6) requires each government to compensate the investors from the other country for any losses they incur due to war, state of emergency, insurrection or riots on a national and MFN treatment basis. This is, for practical purposes, more than national treatment, unless the Nepal government decides to compensate domestic investors similarly. Replacing “civil disturbances” with “riots” was trumpeted—with cheerleaders in the media—as a sterling achievement of the Nepali side, when in fact it does not require a brilliant lawyer to prove the equivalence of the two in many a circumstance, during international arbitration. A government of a least-developed country in perennial transition that is unable to maintain law and order has the cheek to pledge compensation to foreign investors for losses from its absence!

Media reports had it that the BIPPA would allay India’s concerns about the disruption of Indian investment projects, including the Upper Karnali hydropower project. The pact will not be able to address concerns related to disruption due to, say, load shedding, militant labour unionism, strikes, shutdowns, extortion etc, which are major concerns of all investors, domestic and foreign. Some “leading” dailies reported that whether to provide compensation for losses arising from incidents like strikes and shutdowns will be decided by a joint industrial committee comprising both Indian and Nepali businesspeople. The biased reportage was riddled with contradictions: the pact will encourage Indian investment by addressing security concerns; to show that Nepal has not given away much through the agreement, it is emphasized that compensation is confined to losses arising from war, emergency, insurrection and riots (thereby contradicting the hype about the agreement being key to attracting Indian investment into Nepal); and then it is let on that a committee shall decide on compensation for other types of losses. Since the agreement makes no mention of such a committee, what led the media to refer to it? Whose wishes were they articulating? Was there a letter of exchange to that effect?

Worst of all, the BIPPA could entrench a patently anti-development policy. Choice hydropower projects have been awarded to foreign investors to be built as export-oriented ventures even as the country is starved for electricity. There have been protests, including by a faction of the Maoists, against such projects. The means of protests have been violent at times, no doubt regrettable. But the policy that prompted such protests is also condemnable. The provision of compensation in the BIPPA gives the government a veneer of legitimacy in the form of “international obligation” to use force against such protests and/or use the state treasury to compensate foreign investors affected by the protests although such investment is not in the national interest in the first place. It may not be difficult to interpret the protests and associated vandalism as rioting. Or perhaps it is the putative joint committee that is to decide on compensation should they not be interpreted as rioting. The justification that the BIPPA will help bridge the huge trade deficit with India, which stood at 200.87 billion rupees in the first 11 months of FY 2010/11, is absurd. The immediate focus should be on channelizing all potential domestic resources, including remittances, into the productive, tradable (export and import-substituting) sector. Where foreign investment is essential (e.g., huge hydropower projects) it must be guided into priority sectors and uses (e.g., electricity for domestic use, not exporting away the multiplier benefits). Besides restoring law and order, developing hydropower for domestic use (load shedding is cited as the biggest constraint in business climate surveys), addressing other supply-side constraints, securing the removal of market access barriers faced in India and elsewhere, and obtaining improved transit facility are critical to increasing exports to India and beyond.

What is the PM’s position on the export-orientation of the hydropower policy? The media otherwise critical of the Maoists portray him as a pragmatist. There is a thin line between pragmatism and opportunism. Once upon a time he used to write fiery articles about how Nepal was forced into underdevelopment courtesy of the core-periphery relationship with its neighbour. Can he explain how exporting cheap hydropower can spur economic development in Nepal, which in his considered view is essential to strengthen nationalism? He reportedly broke down when visiting his alma mater, JNU, and said that he is what he is because of JNU, where he learnt Marxism. Does JNU Marxism mean keeping one’s own country underdeveloped while allowing its resources to be exploited by its neighbour—if the student happens to be a Nepali? Did he miss an opportunity to tell leftist gurus at JNU and CPI(M) comrades not to demonstrate “hollow” nationalism by protesting against Indian trade liberalization moves, including its free trade agreement with the European Union?  It seems that the Marxism taught at JNU is to be interpreted differently for different folks—one version (pragmatist) for Nepal and the other for serving the interests of its motherland.

Rehab package: Turning Maoists into Capitalists?

So as many as 6,500 of the Maoist combatants in cantonments may be integrated into a separate directorate of the Nepal Army, while the rest will be rehabilitated, according to the seven-point deal reached between UCPN(Maoist), Nepali Congress, CPN(UML) and major Madhesi parties. Assuming that there are still 19,000 UN-verified combatants and 6,500 opt for integration into the security force, 12,500 combatants will have to be rehabilitated. The deal provides for two avenues of rehabilitation that the combatants can choose between: a package of education, training and vocational opportunity (with the cost ranging from Rs 600,000 to Rs 900,000); or direct cash payment of Rs 500,000 to Rs 800,000 (to be made in two tranches in two fiscal years).

Faced with a choice between a package that may or may not impart them with employable skills, that too in a situation of massive un/underemployment in the country (and getting a job means having to work) and a cash reward of at least Rs 500,000 for, well, doing nothing, a rational person, in general, is most likely to opt for the latter without second thoughts. The more industrious among them may use the cash to get a job abroad (Middle East or Malaysia). 

The cost to the treasury of the direct cash payment would be at least Rs 6.25 billion, or, taking Rs 650,000 as an average payment per combatant, Rs 8.125 billion. (On the higher side, it would run up to Rs 10 billion). Of course, the combatants who opt for the cash reward are unlikely to get the full amount they are entitled to: they will have to part with a portion of it as a levy to their beloved party. One need not be surprised if most of them splurge the money on gambling and drinking or other consumptive activities, or simply spend it to meet basic needs. The possibility of turning to crime when the cash runs out cannot be ruled out. It is also likely, as mentioned above, that quite a few will use the cash to get a job abroad, but not without the irony that combatants of a Maoist party that officially is in favour of creating employment opportunities for Nepalis in their homeland and that heads the government have to seek work on foreign shores with money from the state’s coffers!

Instead of doling out cash, it would have been sensible to provide only the option of productive work to those who are to be “rehabilitated”. This would not only help the combatants themselves and their families in the long run, but also contribute to the economy, not least by adding to the GDP and opening up further employment opportunities. How? Here are a few ideas but surely party-affiliated buddhijivis, members of the National Planning Commission and the PM’s team of economic advisors, among others, should be able to come up with even better ones (or else hang up their boots)—vocational training, internship, subsidized credit and other incentives for setting up own business (cottage and small enterprises), employment in infrastructure projects, some sort of employment guarantee, etc.

Perhaps the Maoists, in yet another volte face, are now seeing wisdom, albeit perversely, in the neoliberal preference for direct cash transfers, supposedly least market distorting, as a support measure for “vulnerable” groups. By this logic, the combatants should be free to choose the form of rehabilitation; guiding them into economic activities will interfere with the free workings of the market. Marx displaced by Friedman in a revolutionary party? Dr Sab leaders of Nepali Congress happy now? And the slogan of creating a swadheen economy can always be reinterpreted as per the demands of the dialectics of opportunism, right, comrades?

Notwithstanding all these, we are assuming that the 19,000 or so combatants in the cantonments were also combatants during the Maoist insurgency, and that integrating them into the Nepal Army or rehabilitating them will lead to peace. That’s a heroic assumption, although they have been “verified” as such. That a significant number of core fighters have assumed new avatars in other wings of the party has been a robust charge leveled by Nepali Congressites, among others. 

Then there is the issue of justice, but raising it runs the risk of being accused of attempting to throw a spanner in the works of a “historic” peace accord. Still, a cabbie—a janta ko chhoro to the core—confided to this scribe this morning: doesn’t the deal disincentivize earning a living through legal and peaceful means.

Parking Rs 500,000—the minimum amount of “reward”—in a fixed deposit account in a financial institution in Kathmandu fetching an interest of at least 10 percent will give the recipient of the largesse a steady flow of income of Rs 47,500 (after deducting 5% tax on the interest) per year, or Rs 4,000 per month, in addition to the capital of half a million rupees. From Maoists to Capitalists overnight – quite a transition! Moreover, that income is 2.5 times the per capita average national poverty line (the latest one used by the Central Bureau of Statistics for Nepal Living Standard Survey (NLSS) III, 2010/11) and also more than the poverty line for urban Kathmandu. It is also more than the per capita nominal Gross National Income for the year 2010/11. By the way, according to NLSS III, the poverty incidence in urban Kathmandu is 11.147 percent and that in the whole country 25 percent. With Rs 8 billion, at least 55 MW of hydroelectricity can be generated.

Donor countries are welcoming the deal. How about footing the entire bill in grant form, without diverting aid from other sectors, and/or providing employment to ex-combatants on donor-country soil in the true spirit of solidarity, humanity, compassion and all that jazz?  

More on BIPPA and the media

A section of the Nepali media, including Nagarik daily, had reported that under Nepal-India BIPPA, compensation for losses arising from incidents other than war, national emergency, riots and insurrection--e.g., labour strikes and shutdowns--would be decided by a Nepal-India joint business/industrial committee. This scribe went through the BIPPA text posted on the website of the Ministry of Industry of Government of Nepal only to find no such provision. It is good that such a provision is not there. But this also ridicules the hoopla created by the media about how the BIPPA, by addressing India's security concern for the investment of its nationals in Nepal, will trigger a bounty of investment from south of the border and thereby help reduce our trade deficit with India, which stood at 200.87 billion rupees in the first 11 months of FY 2010/11 as per Nepal Rastra Bank. Unless one can interpret strikes and shutdowns and the locking up of managers as "riots". Or unless there is a letter of exchange to that effect.
Is this just poor reporting or something more sinister?
No attention has been given to the provision related to expropriation, which also includes indirect expropriation, in Article V.
One thing that one can infer from the brouhaha over the BIPPA is this: India, Nepal government, the media all believe that the security situation of New Nepal is going to worsen further in the days to come; insurgency, rioting, state of emergency, civil war are going to be the order of the day.
Let the fox guard the hen pen.

PM’s India visit and manufacturing of consent

1. Media reports say the Bilateral Investment Promotion and Protection Agreement (BIPPA) will provide “national treatment” to Indian investors. National treatment means according the same treatment to foreign investors and domestic investors alike in certain or all respects (e.g., equity participation, taxes, etc.). It is not clear in what respects national treatment is to be accorded to Indian investors. In practice, Indian investors are treated on a par with domestic investors and enjoy more rights than do other foreign investors, thanks to the 1950 Treaty.
2. Nepal’s Foreign Investment and Technology Transfer Act allows foreign investment without any restriction on equity participation in all but 21 sensitive sectors (e.g., cottage industry) and permits repatriation of earnings and investments, while, for services sectors, Nepal’s commitments under the World Trade Organization (WTO)’s General Agreement on Trade in Services (GATS) are relevant. Under GATS Nepal has committed to allow foreign investment with up to 80 percent equity participation in 70 sub-sectors in 11 services sectors. In practice, the actual level of equity participation allowed is greater than the GATS commitments; even 100 percent. Prime Minister Bhattarai, for all the media hoopla about his being a political economist, seemed unacquainted with these facts; more seriously, neither his economic advisor: the prime minister was quoted as telling a crowd of Indian businesspeople that they will be allowed up to invest  in ventures in Nepal with up to 44 percent share! While the actual provisions of the treaty will be known only after seeing it in black and white, the highlight in the media was its provision requiring Nepal government to compensate Indian investors for any losses they incur due to war, insurrection and riots. This is, for practical purposes, more than national treatment, unless Nepal government decides to compensate domestic investors similarly. Since Nepal’s law does not allow Nepali nationals to invest abroad—although quite a few prominent business houses are known to be doing exactly that, some ostensibly through their “NRN” scions—the BIPPA will only impact investment into Nepal, if at all, as admitted by media reports. In that case, Nepal’s strategy should be to treat ALL foreign investors alike, regardless of their nationality.
3. The BIPPA is supposed to allay India’s concerns about the disruption of operation of Indian investment projects, including Upper Karnali hydropower project. But if as per media reports (and media reports is what we have to rely on since neither the government sought the opinion of all relevant stakeholders nor the media thought it their duty to inform the people of its contents, so much for their investigative journalism zeal) compensation is required only for losses arising from war, insurrection or riots, then the treaty will not be able to address concerns related to disruption due to strikes, shutdowns, etc which are major concerns. Nepali investors too are grappling with such disruptions. A media report says whether to provide compensation for losses arising from incidents like strikes, shutdowns will be decided by a joint committee comprising both Indian and Nepali businesspeople.  As can be expected of journalists poor in substantive matters and especially economic journalists who have learned economics by obtaining and printing the quotes of party-affiliated economists, the reportage is riddled with contradictory interpretations: the treaty will encourage Indian investment by addressing security concerns of Indian investors; to prove that Nepal has not given away much through the treaty, it is emphasized that compensation is confined to losses arising from war, insurrection and riots (thereby contradicting the hype about the treaty being key to attracting Indian investment into Nepal); and then it is let on that a committee shall decide on compensation for other types of losses (arising from labour strike, shutdowns etc). The media in general seemed to be in an overdrive to “manufacture consent” that the BIPPA is key to attracting Indian investment, giving the impression that  Indian investment will flood in just because the SLC topper of a PhD PM is positively in the goods books of the Indian establishment.
4. Why, pray, even in loktantra open discussions and debates on such treaties are not held? If there are any rules that bar such a discourse, then such rules should be amended. Are there any takers in the mainstream media? A treaty has been signed without even people living in the capital city with access to the internet and the media knowing the exact contents of the agreement, this scribe included. But then it may be naïve to expect the media that do not have the guts to spell out the names of tax evaders in the VAT scam to be concerned about the public’s right to information on this issue. 
5. Yes, providing assurance of compensation to foreign investors has been practiced by many countries to lure in foreign investment. But such a provision can potentially entrench a wrong, criminal policy in a country like Nepal: for example, choice hydropower projects were awarded to foreign investors to be built as export-oriented ventures even as the country is starved for electricity. There have been protests against such projects. The means of protests have been violent at times and this no doubt cannot be condoned. But at the same time the policy that prompted such protests should also be condemned. The provision of compensation in the BIPPA gives the government a veneer of legitimacy in the form of “international obligation” to use force against such protests and/or use the state treasury to compensate foreign investors affected by the protests although such investment is not in the national interest in the first place. It may not be difficult to interpret the protests and associated vandalism as rioting. Or perhaps it is the joint committee that is to decide on compensation should they not be interpreted as rioting. Ironically, the Maoists were in power when some choice hydropower projects were awarded to Indian investors for export purpose; a faction within them then started opposing such projects; and now a Maoist Prime Minister signs on a treaty with a provision that if implemented would mean taking action against those disrupting the operation of the projects, and by implication supporting the policy of exporting hydropower at dirt-cheap rates when there is no dearth of demand for the same inside the country both for domestic consumption and industrialization.
6. The media apparently do not deem it worthwhile to question the prime minister about his position on the export-orientation of hydropower policy in practice. They are busy portraying him as a pragmatist. There is a thin line between pragmatism and opportunism. Once upon a time he used to write fiery articles about how Nepal was forced into underdevelopment courtesy of the core-periphery relationship with its southern neighbour. Can he explain how exporting cheap hydropower can spur economic development in Nepal, which in his considered view is essential to strengthen nationalism? Doesn’t such a policy smack of a conspiracy to accentuate a neo-colonial relationship? Mind you, he has not squeaked a word against it (or for that matter, on issues of border encroachment)--perhaps this exemplifies why he has been projected in a positive light in most of the mainstream media otherwise highly critical of the Maoists. What do his comrades at his alma mater, JNU, or at Communist Party of India (Marxist), which is nursing its wounds of electoral defeat,  have to say on this? The PM reportedly broke down when visiting his alma mater and said that he is what he is because of JNU, where he learnt Marxism. Does JNU Marxism/communism mean keeping one’s own country underdeveloped while allowing its resources to be exploited by its neighbour—if you happen to be a Nepali? Did he miss an opportunity to tell CPI(M) comrades and leftist gurus at JNU not to protest against Indian trade liberalization moves, including its free trade agreement with the European Union that also covers some investment issues, and not to demonstrate “hollow” nationalism?  Or publicly congratulate the CPI(M) for wooing Tata to set up a plant in West Bengal and for being trounced in the state assembly polls. It seems that the Marxism taught at JNU is to be interpreted differently for different folks—one version (pragmatist) for Nepal and the other for serving Indian interests.
7. Bhattarai is said to have had “closed door” on-one-one meeting with his Indian counterpart Manhoman Singh, the media dutifully reported. This is hogwash. The truth is in such meetings the Indian prime minister is flanked by his aides whereas the Nepali leader is unaccompanied. The media people either do not know about this or pretend not know for obvious reasons. They do not see any incongruity in such differential treatment.
8. Transit issues—which are critical for Nepal’s third-country trade (expansion and diversification)—were put on the backburner, as were the barriers faced by Nepali exporters to India.

New Nepal budget opens housing to foreign investment: Implications

It can happen only in spanking new Nepal. The budget speech for FY 2011/12 has opened the door for foreigners, including foreign citizens of Nepali origin (better known as NRNs), to buy commercial and residential houses and apartments. Even as the country's Civil Code prohibits any foreigner from engaging in any real estate transactions, the budget presented by Finance Minister Bharat Mohan Adhikari has a provision to allow NRNs to purchase houses and apartments "in specified terms", without specifying what those terms are, and, further, foreign individuals or companies to purchase houses and apartments amounting to US$200,000 or more. This means that NRNs can purchase houses and apartments of any amount. This provision comes with a caveat that such purchases cannot be sold until five years from the date of purchase, although it is not clear whether it applies to foreigners of non-Nepali origin only or NRNs also. It can be argued that the provision does not violate the Civil Code because foreigners will still not be allowed to purchase land, and this argument is likely to weather any challenge at the court of law given the country's juridical history. But as houses and apartments stand on land—not in the air—the spirit of the Civil Code is violated. Predictably, the implications of the provision were not analysed in the mainstream media, a major section of which was busy taking partisan positions on the budget. Analysts wearing political blinkers were too busy making hackneyed points drenched in political prejudices to deign to debate a provision introduced with the aim of appeasing the NRN community, whose demands of their ex-homeland are no way matched by their contributions. Below are some implications, and an assessment, of the provision.

1.       The Finance Minister cited the need to attract foreign investment in the commercial houses and apartments sector as a reason for introducing the provision. The reality is that there is no such need—for the economy as a whole, if not for a handful of people that until recently rode high on the real estate and housing boom. Overinvestment, rather than underinvestment, is the problem. It is not for nothing that the central bank tightened bank credit to the sector (although it has begun to relax it, the overall stance is still restrictive, for good reason). Opening the door to foreign investment in the sector threatens to further puff it up. It will only delay the inevitable correction course and make a bust more painful.

2.       Investment in new houses and apartments surely constitute "fixed capital formation". They will surely increase the investment component of GDP – in a technical sense. But they do not increase the economy's effective productive capacity; they do not lead to a sustained production of goods and services and a sustained employment generation (except for construction materials to the extent they are produced domestically, and workers to the extent they are Nepali nationals).

3.       Yes, the country needs foreign investment – in the tradable sector ((i.e., the export sector and the import-substituting sector) and in sectors like hydropower that provide critical inputs to the tradable sector. Even as it opened the non-tradable housing sector to foreign investment, the budget was wanting in introducing measures to attract foreign investment into hydropower projects to cater to the domestic demand. At the very least, it could have, in keeping with an earlier commendable position taken by Energy Minister Gokarna Bista, introduced a policy of utilizing the electricity generated by all projects, already awarded or yet to be awarded, to meet domestic needs before considering exports.

4.       That NRNs can purchase houses and apartments of any amount, in particular, has equity implications. The additional demand (in fact not only of NRNs but also of other foreigners, even if the latter can make purchases of US$200,000 and over only) will contribute to inflate prices of houses/apartments and land alike. The impact of high prices will be borne by middle-class Nepalis making a living on their soil and desirous of buying a house/apartment or land to build a house.  (Besides, the lowering of capital gains tax (on income from the sales of houses and land) by 50 percent, announced in the budget, may benefit foreign investors too.)   

5.        Foreign investment will temporarily add to Nepal's foreign exchange reserves (although it is not clear whether NRNs will be required to make the purchase in foreign currency or not). Investment will be forthcoming if the investors believe that they will be able to reap more than what they have put in. After five years, they will have the right to repatriate their original investment and earnings (capital gains) in foreign currency, without having contributed to increase the productive capacity and production of the tradable sector (i.e., the export sector and the import-substituting sector). So the medium- to long-term, if not short-term, implication for the balance-of-payments is negative. If the provision was ostensibly introduced to encourage foreign investors to invest in the tradable sector or hydropower, then it should have been tied to investment of certain amounts in such sectors.

6.       Formally, the Nepali rupee is convertible in the current account only. By opening up investment in the speculative, frothy housing sector, the government has, unwittingly, made a move towards capital account liberalization. Although foreign investment into the housing sector cannot be called portfolio investment and will count as "foreign direct investment" technically, the fact remains that it is basically guided by expectations of capital gains.

7.       Neither the communist/Maoist prefix/suffix in the names of the two major ruling parties nor the Mahamanav variety of socialism the main opposition party supposedly cherishes were strong enough barriers to introducing, or not opposing, such a provision.

High share of consumption in GDP: More than meets the eye

Over 90 percent of Nepal's GDP goes into consumption. With just 10 percent of income left for savings, low savings are a constraint on investment and hence growth – this argument is peddled by policymakers and "experts" alike, particularly towards the end of the fiscal year when the Economic Survey or part of its contents is unveiled. This year was no exception, with Abhiyan business daily carrying a front page main news that sounded alarm over the high share of consumption in GDP. Below is an attempt to explain why the reality may not as simple as that.

1.       Yes, the share of consumption in GDP has always been high and has been on an increasing trend – rising from 88.6 percent in 2001/02 to 90.6 percent in 2009/10.[1] As a result, gross domestic savings (GDS) amounted to 9.4 percent of GDP in 2009/10, while gross capital formation (GCF), or investment, was 38.2 percent of GDP. This gives a savings-investment gap of - 28.8 percent of GDP. But this does not capture the savings of the economy from money earned from abroad (mainly remittance income). Taking net income from abroad (e.g., income earned on assets abroad) and net transfers (e.g., remittances, pension and grant) from abroad, the relevant savings measure is gross national savings (GNS), which was 34.4 percent of GDP in 2009/10. The gap between GNS and GCF in 2009/10 was less than - 4 percent of GDP, or less than one-seventh of the gap we get while using GDS instead of GNS. Furthermore, the gap was positive (that is, GNS exceeded GCF) for most of the nine years from 2001/02 to 2009/10: only in 2006/07 and 2009/10 was it negative. As grant is aid and hence not income proper, it can reasonably be argued that GNS should exclude grant. Even when we deduce the grant component while calculating GNS, the gap between GNS and GCF remains positive for three years, and except for 2009/10, the negative gap is less than 3 percent of GDP, which is again far less than what the gap between GDS and GCF would show.

2.       Is the 90.6 percent of GDP being spent on consumption a result exclusively of dearth of attractive savings options or also partly due to the fact that the majority of the people are poor or have very low income, such that they are but compelled to spend all or most of their income on consumption (using National Living Standard Survey 2003/04, the World Bank puts 77.6 percent of the population as living below PPP (purchasing power parity) $2 a day (or, about Rs 43.2 in 2005 PPP rate)? The latter possibility is rarely considered in mainstream discussion.

3.       High consumption, if on domestically produced consumer goods and services, contributes to GDP. But when consumption is import-based, consumption detracts from, rather than adds, to GDP. This point is recognized in mainstream discussion, including in media reports/analyses. However, no policymaker or "expert" or policymaker-turned-expert would condescend to suggest how much of the national consumption demand is satiated by imports. Here is a humble attempt by this scribe:

a.       The World Bank-administered World Integrated Trade Solutions (WITS) disaggregates national merchandise trade data (compiled by UNCOMTRADE) into broad economic categories, viz., consumer goods, intermediate goods, raw materials and capital goods. While such classification does not capture country-specific use of imported goods and the data pertain to formal trade only, it does offer a rough indication. In 2009, 35 percent of Nepal's merchandise imports were consumer goods. That would amount to 11 percent of the consumption component of GDP in 2008/09. [Note that the consumption component of GDP comprises both goods and services consumption; that we are not considering services imports here; and that part of the imported intermediate goods and raw materials would go into the domestic production of goods and services consumed domestically. Hence, the share of imports in consumption would be much higher than this figure]. Given that consumption was 90.3 percent of GDP in 2008/09, it follows, through a back-of-the-envelope calculation, that the leakage effect of consumption imports reduces the multiplier (the factor by which income increases due to a given increase in autonomous expenditure, e.g., investment, government purchase, etc) by at least 50 percent.  

4.       It is true that income flowing in from abroad (predominantly remittances) is not part of GDP (or gross domestic product, which measures the value of goods and services produced within the country). It is also true that the negative difference between GDS (which does not take into account remittances etc.) and GCF shows that what the nation as a whole saves from the income generated within its territorial limits is not sufficient to meet its investment demand. However, it is equally true that remittances have become a major source of income for the nation (about 20 percent of GDP in 2009/10). Remittances are the most important source of foreign exchange earnings, greater than exports (goods and services), foreign investment and foreign aid combined. According to Nepal Labour Force Survey 2008, 23 percent of households receive remittance from abroad. As much as one fifth of the labour force may be working abroad (taking the estimate of 3 million migrants doing the rounds these days). The burgeoning consumption demand (as well as investment demand), part of which leaks out in the form of imports, thereby reducing the multiplier, is partly financed by remittance income, which is not captured by GDP. The fact that consumption includes imports while GDP is net of imports makes comparing consumption with GDP inappropriate. In this context, therefore, it is more appropriate to use a measure of income that combines GDP with income (or roughly the gross national disposable income (GNDI), which appears in the Economic Survey for the years since 2000/01).

5.       Even after deducting foreign grants (for the same reason as above) from GNDI, calculated by Central Bureau of Statistics, total national consumption would hover around 74 percent (in 2009/10) of this measure of national income, a far cry from the 90.6 percent figure when one uses GDP as a measure of national income.

6.       From the above, it emerges that the argument that low savings is a constraint on investment misses the main problem. The main problem has got to do less with low savings than with failure to utilize the savings (whether generated from GDP or income/transfer from abroad). Note that GNS (including grant) has been greater than GCF for most of the last nine years. If we also take into account other external financial flows (like FDI, albeit very limited, foreign aid in the form of loan, aid channelled through I/NGOs), the resource surplus would be higher still. Moreover, if we consider only gross fixed capital formation (GFCF), which stood at 21.3 percent of GDP in 2009/10 as investment proper—ignoring the residual "change in stock", the other component of GCF—then there is further potential to increase investment, given the resources.  The change in stock component of GCF is residually derived and hence may not reflect change in inventory/stock only; as a balancing item, it may be capturing other components of GDP, such as consumption.

7.       One has to consider the nature/composition of GFCF, data for which, however, is not readily available.  A huge of amount of credit from banking and financial institutions has gone into construction of buildings. Such investments do not necessarily increase the economy's productive capacity and income-generating potential. 

8.       When savings exceed investment, the current account balance in the balance-of-payments (BoP) is positive – this is ensured by the standard macroeconomic accounting identity. When that was the case in previous years, the capital and financial accounts also showed surpluses, which, combined with the current account surplus, resulted in a BoP surplus, or an increase in reserves.  In 2008/09, the BoP surplus was Rs 44.8 billion.

9.       What is happening to the surplus?

a.       There may be capital flight. However, that would be directly or indirectly reflected in one or more components of the BoP (e.g., through overvaluation of imports/artificial growth in imports; undervaluation of export earnings; withdrawal of money from ATMs in India from Nepali bank accounts) and would eliminate the surplus. Or there may be an accounting problem, with official BoP statistics not reflecting the true magnitude, composition and direction of flows.

b.      The BoP surplus is parked in safe but low yielding assets abroad by the central bank and commercial banks – surplus which can be utilized for productive investment in Nepal itself.

c.       In Nepal, change in foreign assets of the monetary authority, the central bank, predominantly determines the reserve money and hence the money supply, and foreign exchange accounts for most of the foreign assets of the monetary authority (97 percent in July 2010). The central bank holds most of the foreign exchange reserves (77 percent in mid-July 2010) of the banking system. Thus, a large part of BoP surplus goes into increase in money supply, a substantial portion of which is likely to be circulating in the economy in a sterile fashion, without creating value (e.g., facilitating transactions in already existing property/assets, like land and shares). If it were utilized for domestic production, then that would show up in a higher GDP, as consumption or investment or exports.

---

[1] Unless otherwise stated, in this analysis, data are from Nepal Rastra Bank's annual macroeconomic data available at its website (www.nrb.org.np). NRB sources national accounts data from Central Bureau of Statistics. Data used here may be slightly different from CBS' revised data. 

Some observations on ADB study on poverty impact of food-price inflation

An Asian Development Bank (ADB) study, Global Food Price Inflation and Developing Asia, says a 10-percent rise in domestic food prices, ceteris paribus, could push an additional 0.55 million people in Nepal below the poverty line of US$1.25 a day (based on 2005 purchasing power parity), or increase the poverty incidence (percentage of people living below the poverty line) by 2 percentage points. Using the POVCAL database of the World Bank, the study finds that the poverty impact of food-price inflation is the highest in rural India (2.9 percentage points for a 10-percent rise in domestic food prices). While the impact is 2.1 percentage points for urban India, the lowest impact is estimated for Sri Lanka, at 1.2 percentage points. The figures for Bangladesh, Pakistan, Nepal and Bhutan are, respectively, 2.5, 2.2, 2 and 1.8 percentage points. It is noteworthy that despite having more or less the same growth rates, the impact of a 10-percent rise in domestic food prices is lower in China (2.2 percentage points in rural China and 0.2 percentage points in urban China) than in India. The difference is particularly marked when one compares urban China with urban India.

Here are some observations on the study, mainly with regard to the estimates for Nepal.

1.       According to the inflation estimates of Nepal Rastra Bank, the year-on-year food inflation, as measured by the food and beverage component of the National Consumer Price Index, was 17.3 percent in mid-March 2011. Going by the estimates of the ADB study, this would suggest that during the one-year period to mid-March 2011, more than 0.55 million people were pushed into poverty due to rising food prices. But one cannot say so for sure because the price index (or any of its components) is an "average" concept and may not capture the prices faced by the poor or those just above the poverty line and vulnerable to relapse into poverty.

2.       As the study says its estimates are based on the "latest POVCAL database", and the most recent household survey, required to estimate the poverty incidence, is the 2003/04 Nepal Living Standards Survey II (as is used at http://iresearch.worldbank.org/PovcalNet/povcalSvy.html), it appears that the ADB study based its simulation of the impact of food-price inflation on NLSS II. To the extent the headcount poverty incidence has declined since 2003/04, the impact of food-price inflation may well be higher than what has been estimated, unless those who have climbed out of poverty in this period have increased their incomes so much that a 10-percent increase in food prices cannot push them back into poverty (but there is no a priori reason to assume this to be the case). Although this may sound contradictory at first blush, the reason is simple: as more people come out of poverty (a reduction in poverty incidence), some (or most) of them will join those living just above the poverty line, and when there is a rise in food prices, all those living at a certain margin just above the poverty line will be thrown back below the poverty line – with the result that the increase in poverty incidence will be higher than if there had not been a decline in the incidence earlier.

3.       The study does not report the change in poverty gap ratio (which measures how far below the poverty line is the average poor person/household) for Nepal due to a rise in food prices. This would have given an idea of how more poor the poor would be due to food-price inflation.

4.       The study appears to assume the impact of food-price inflation on the poverty incidence is almost linear, that is, if food-price inflation doubles, the impact on poverty also doubles. This is evident from the estimates of poverty impacts in the alternative scenarios of 20- and 30-percent food-price increases, which happen to be double and treble, respectively, of the estimates for a 10-percent increase in food prices – in all 25 developing countries in the sample. Thus, if 0.55 million people are estimated to be pushed into poverty by a 10-percent increase in food prices in Nepal, the number doubles to 1.1 million for a 20-percent inflation and trebles to 1.65 million for a 30-percent inflation. While the possibility of people above the poverty line in Nepal being distributed in such symmetry as to yield such linearity is there (this scribe does not know what the actual distribution looks like), it is doubtful that this is the case with all the 25 countries. Hence, the linearity of impact is likely to be the result of the specification of the model employed by the study. In reality, it may be the case that as food-prices increase, the poverty incidence (the headcount ratio) increases but non-linearly, probably at a decreasing rate up to a certain point.

5.       The ADB study considers the US$1.25-a-day, or international, poverty line. Using the NLSS II data and the US$1.25-a-day poverty line (or about Rs 27 per day using the PPP exchange rate of 2005), the World Bank estimates headcount poverty ratio at 55.12 percent for 2003/04. The poverty rate using the same data but considering the national poverty line (Rs 7695.7 per year, or about Rs 21 per day at 2003/04 prices) is 31 percent for 2003/04. There is thus a difference of 24 percentage points in poverty incidence using the two different poverty lines. This means that an estimation of the poverty impact of food-price inflation using the national poverty line (which is less stringent than the international poverty line, though) may show an even greater number of people being pushed into poverty by food-price inflation. The impact of food-price inflation on the poverty gap ratio would have been illuminating.

   

On defeat of communists in India assembly polls and supposed implications for Nepal

The trouncing of the Communist Party of India (Marxist) in West Bengal's assembly elections, ending a 34-year uninterrupted communist rule, has been interpreted by some "analysts" here in Nepal as carrying important implications for Nepal's left parties and their economic policies, with some suggesting that Nepali communist parties must shape up or ship out. Their main argument is that the Communist Party, in its long reign, could not deliver economic growth and was therefore punished in the hustings. This scribe, while no apologist for any political ideology or party unlike many a writer in the Nepali media, finds such inferences highly contrived and overblown, in some instances even born of the writers' political prejudices that blind them to the differing contexts in India and Nepal.

1.       Glaringly missing from such analyses is why even as the voting public apparently got sick and tired of CPI (M) misrule, a Maoist insurgency is raging in different parts of India, including in West Bengal, covering 40 percent of India's villages. An insurgency that the Indian prime minister Man Mohan Singh described as the greatest challenge to India from within. If the rejoinder is that the Maoists there do not enjoy the support of the people and do not have anything to offer for a positive transformation of the Indian state/economy, then the same could be said of Nepal's Maoists when they too were waging their "people's war" against the Nepali state. But that would be at serious odds with the fact that the key political features of New Nepal were essentially Maoist agendas, good or bad. Nepal's Maoists emerged as the largest party in the Constituent Assembly (CA) elections vetted as being largely free and fair by the international community, including western democracies. Of course, just because western democracies said the elections were fair it does not mean that the election were actually fair, but if the analysts do not think the elections were fair, then they should have the guts to chastise the members of the international community that suggested otherwise.

2.       Paradoxically, CPI (Marxist) is the very party whose leaders were chummy with Nepali Maoist leaders who self-avowedly spent most of the insurgency years on Indian soil, in and on the outskirts of New Delhi, and who ostensibly persuaded Nepali Maoists to rejoin multiparty politics. They were hailed in the mainstream media for helping end the armed conflict in Nepal. The analysts do not deem it relevant to enquire why the CPI (Marxist) leaders cannot achieve the same in their own beloved homeland, the world's largest electoral democracy – why can't they propose that Indian Maoists be brought into mainstream politics, even if it means conceding  to some of the Maoists' demands, expanding the Lok Sabha liberally to accommodate the Maoists, and then instituting reforms to the Indian political and economic systems by incorporating the Maoists' demands – a la Nepal? Why, instead, the CPI (Marxist) government in West Bengal was cracking down on Indian Maoists? Why such bonhomie with Nepali Maoists and animosity with their compatriot Maoists?

3.       The suggestion for mainstreaming made above won't work there? But it is working here in Nepal, right? No? Then say so loud and clear. 

4.       The fact is that just as Nepal's Maoists considered the then largest mainstream communist party of Nepal (CPN-UML) a revisionist party that had deviated from communist philosophy, India's Maoists' do not consider CPI (M) as a real communist party. Indian Maoists do not consider CPI(M) to be Red enough.

5.       The analysts, who argue that CPI (M)'s core economic philosophy proved to be its undoing, ignore the fact that Mamata Banerjee, who cruised her party Trinamool-Congress to a thumping victory over the communists in West Bengal, had sided with farmers protesting the acquisition of their land for setting up a Tata plant while the ruling communist party was bent on facilitating the establishment of the plant. Which position was good for the welfare of West Bengalis is not relevant here. The point is that Mamata was doing what the communists should have been doing (but were not doing). This irony is lost on the analysts.

6.       Unlike what the analysts would have us believe, there is no significant difference in the economic policies of major political parties of Nepal, communists or otherwise. On crucial issues of national interest, they have let the nation down. All of them, for example, have pursued an export-oriented hydropower policy even as the economy reels under crippling power cuts. Politicization of the bureaucracy, rampant corruption, politico-criminal nexus, capture of government policies and decisions by vested interests, external interests calling the shots in national policymaking and decision-making and mismanagement of public enterprises have been the bane of all governments, with or without communist parties.

7.       Whether there is a communist government or a UPA government or a BJP-led NDA government at the centre in India and whether there is a communist government or a UPA government or a BJP-led NDA government or any other government in any state in India is unlikely to change basic Indian foreign policy (including its component economic policy) towards Nepal.

8.       The paradox of Nepali communist parties, even when in power, endorsing the neocolonial economic relationship between Nepal and its neighbor as exemplified by the pursuit of the policy of exporting hydroelectricity at dirt-cheap rates, and thereby exporting away potential multiplier benefits for the domestic economy from utilizing hydropower within, is likely to continue.

9.       Actually, it is not a paradox; only the operation of a principle: there is no free lunch. External benefactors naturally want their pound of flesh. 

Nepal buying overpriced fuel from Indian Oil Corporation

A report by a high-level committee led by a parliamentarian (The Report of High-Level Committee on Nepal Oil Corporation Reform, 2011) has found that Nepal Oil Corporation can reduce its losses by as much as Rs 6.40 billion (annually) by reviewing the pricing arrangement with its sole supplier, Indian Oil Corporation (IOC) and by another Rs 3.44 billion through reforms in the NOC. That losses caused by NOC being overcharged by IOC are nearly double the losses due to internal factors is a crucial piece of information for the lay public. Unfortunately, this aspect was generally either blacked out or downplayed in domestic media coverage, instead focusing only on the gains to be had from NOC reforms, which, though important, was old hat and hence no "news" at all.  Perhaps highlighting the lesser known fact would have been considered "knee-jerk anti-Indianism" – whatever that means – by domestic fifth columnists and intellectitutes, including those in the civil society domain.

IOC sets prices for NOC at import parity price instead of export price, entailing the application of Price Adjustment Factor (including Notional Custom Duty) that inflates the actual price NOC pays IOC. The burden for Nepal is twofold: first, the higher price while purchasing fuel from IOC; and second, the additional tax burden to NOC and/or Nepali consumers as VAT at the border is imposed on a higher base (resulting from the higher price charged by IOC). The report finds that purchasing fuel from IOC at import parity price rather than export price raises cost by 6.73 percent for petrol, 6.71 percent for diesel, 8.88 percent for kerosene and 4.19 percent for LPG (all at 1 April 2011 prices). The border import price is thus inflated by Rs 4.18 per litre for petrol, 4.75 per litre for diesel, 6.33 percent per litre for kerosene and 48.92 per cylinder for LPG (all at 1 April 2011 prices). This jacks up Nepal's annual import bill with respect to India by Rs 5.64 billion, or 14 percent of Nepal's merchandise exports to India in 2009/10. Adding the increased VAT burden resulting from higher base in the form of higher border import price, the total extra cost becomes Rs 4.72/litre for petrol, 5.37/litre for diesel, 7.15/litre for kerosene and 55.28 per cylinder for LPG (all at 1 April 2011 prices).

The report reveals that IOC owes NOC a staggering Rs 14 billion for the extra charges it included in its selling price from 2002 to 2011. (During that period, IOC refunded Rs 3 billion to NOC – which indicates that IOC also accepts in principle that customs duty and/or other charges it extracts while selling to NOC are NOT legitimately applicable.)  This amount was about equal to NOC's then cumulative losses. Which means that even with the rampant corruption in NOC's operations (which no doubt has to be stamped out) and the subsidy enjoyed by Nepali consumers, poor and rich alike (and of course foreign embassies and missions that have no qualms about guzzling fuel subsidized by this poor least-developed country) all these years, NOC would nevertheless be at a break-even level if only it had not been overcharged by its monopolist supplier.

Granted, NOC and ultimately our political class that is directly or indirectly responsible for NOC should have negotiated better with IOC (and by extension the Indian government). But the facts cited above do rubbish claims made by the ignorant or, perniciously, fifth columnists and intellectitutes that it is due to the benevolence of the southern neighbor that Nepal is receiving oil at the best possible price, that Nepal is better off with the current arrangement than the previous one (until 2002) under which NOC imported crude oil from other countries and handed it over to IOC for refining, paying IOC only the refining charge, and that it is futile to look for any alternative sources of fuel supply. The report, however, recommends exploring the option of importing fuel from China taking advantage of the Chinese government's plan to construct an oil pipeline linking Shigatse, Tibet. The report recommends a study on the feasibility of extending the pipeline to Nepal's Trishuli. "But that would be unfeasible" – this is likely to be the typical reaction of the ignorant, or perniciously, the fifth columnists and intellectitutes. How can you say that without conducting a study? And especially when a committee dominated by parliamentarians of NEW NEPAL and a professor and coordinator at the Energy Study Centre, Institute of Engineering, Tribhuvan University, considers it an option worth exploring.

At a time when Nepal's political parties are hell-bent on allowing choice hydropower projects to be built exclusively for export purpose even as the country reels under load shedding, without any sign of it being over in the foreseeable future, the report, commendably, emphasizes the need to utilize water resources to generate electricity for internal consumption, as a powerful means to reduce dependence on fossil fuel for commercial energy consumption, and by extension also reduce trade deficit. 90 percent of energy consumption in Nepal is for domestic/household purpose. The report states that for an average family of five, electricity is the cheapest source of energy for cooking, given the current market price of fossil fuel. The cost per month for such family is Rs 790 if it uses electricity, as opposed to Rs 930 and Rs 1150 respectively if it uses LPG and kerosene. As both LPG and kerosene are subsidized, the cost advantage of using electricity when LPG and kerosene prices are allowed to adjust to international market prices may be even higher. 

Tax fraud: names, please

Both broke the law to line their pockets. One misused public office to get rich. The others, of the private sector realm, evaded taxes to get richer. The former has been publicly shamed and is in jail, and rightly so. However, the public have been denied their right to know the identities of the latter group of swindlers and it is uncertain whether these offenders will be punished as per the law. Different strokes for different folks? Little wonder. Former Minister Chiranjivi Wagle of Nepali Congress was a political has-been anyway, whereas the tax evaders include top business houses that contribute liberally to political party kitties and may even have representation in the Constituent Assembly.

Finance Ministry mandarins would want us to thank them for spotting the evasion and being supposedly firm on their stance that the evaders pay not just the evaded amount but also fine and interest. It stretches one's imagination to think that evasion occurred on such a scale (bogus VAT transactions of at least Rs 10 billion) without the connivance of high-ranking officials; the stubborn refusal to disclose names only feeds the skepticism. The protection of taxpayers' rights by the Income Tax Act is speciously invoked in defense of the non-disclosure of names. True, Section 74 of the Act, which stipulates taxpayers' rights, provides for "right to secrecy in respect of tax matters and keep it inviolable". Granted, details of taxpayers' assets and income gained through lawful means should not be divulged. However, pointing to this right as an excuse for not disclosing the names of those who have violated the law by cheating the treasury through the submission of fake VAT bills or export documents is unacceptable. Remember, the law protects taxpayers' rights, not tax evaders', as emphasized by the very first provision in Section 74: "Tax payer shall abide by the duties in accordance with this Act." 

Grave offence

The issue is not just about failure to pay taxes fully. An even graver offence has been committed: that of "making false or misleading statements". The Act considers this offence more serious than merely not paying taxes. When false or misleading statements have been furnished "knowingly or recklessly"—as is clearly the case here—the penalty is 100 percent of the underpayment of tax. Moreover, the offence can carry a prison term of six months to two years, higher than that for the offence of failure to pay taxes (Section 124). These punishments are independent of cooperation or non-cooperation by the offenders. The argument that non-disclosure of names is part of the strategy to secure cooperation rings hollow. That the offenders can be jailed makes mincemeat of the claim that the names cannot be disclosed in deference to their right to secrecy.

Then there is this claim that nowhere in the world are tax evaders' names disclosed. This scribe leaves it to dear readers to test the veracity of this claim on their own—a minute of google search suffices. More seriously, the claim begs the question why, even in spanking new Nepal, do policymakers have to agonize over how other countries treat tax evaders, when the national law is pretty clear about it.

If the names of top taxpayers can be made public every year, why can't tax evaders' names be disclosed? Media reports have it that 16 of the firms evading taxes belong to top business houses, with the highest amount evaded by a single business house standing at Rs 650 million. One should not be surprised to find some of the top taxpayers (or their ultimate owners) annually felicitated by the government also on the list of top cheats. The scale of evasion and the deplorable means employed serve to reinforce public cynicism towards corporate social responsibility and philanthropy. If you can swindle the exchequer of hundreds of millions, what's the big deal about shelling out a couple of hundred thousand rupees for, say, disaster relief?

Is Rs 4 billion (the amount of revenue loss at last count) or for that matter Rs 650 million a big amount? No, according to those handling the state's finances. When the scam first hit the vernacular press with very limited details, a top bureaucrat, in an attempt to downplay the significance of the fraud, was quoted as saying that no one can get rich "overnight" in Nepal through tax evasion. The reason offered by the learned official was that Nepal is a “low-tax economy”! What perverse logic or pathetic naivety! Nepal’s tax rates (personal income tax, corporate income tax and VAT) may be among the lowest in South Asia and tax as a percentage of business profits here may be the lowest in the region after the Maldives. But when the authorities are not vigilant enough or deliberately look the other way, people can make a killing through tax evasion, as is now amply clear. This is something a poor country with a tax-to-GDP ratio of less than 13 percent and where revenue surplus (excess of tax and non-tax revenue over recurrent expenditure and principal repayment) finances less than 15 percent of capital expenditure can ill afford. The tax-to-GDP ratio depends upon, inter alia, tax compliance. How can it be high when evasion is rampant?

In perspective

Let’s put the worth of Rs 4 billion in proper perspective. With that amount, 25 megawatts of electricity can be generated. Rs 4 billion is nearly 40 percent of the current fiscal year's budget allocated for the Ministry of Agriculture and Cooperatives, and about 45 percent of the budget allocated for the Ministry of Irrigation. Compare Rs 4 billion with the Rs 980 million allocated for research and development in agriculture, or the Rs 2.75 billion in fertilizer subsidy that was "substantially" increased in the current budget. Rs 4 billion is 6.5 percent of the country's total merchandise exports in 2009/10 and is not an insubstantial amount for addressing some of the supply-side constraints afflicting the export sector, as identified by the Nepal Trade Integration Strategy (NTIS) 2010—for example, setting up laboratories of international standard for testing the quality of export products with high potential, such as honey, medicinal herbs and essential oils, and wool products. Compare Rs 4 billion with Rs 30 million allocated for implementation of NTIS for 2010/11. Or if Rs 4 billion is to be spent on a rural employment guarantee scheme a la India’s, 100 days of employment per year can be provided to some 266,666 people at the minimum agricultural daily wage of Rs 150—that is, to about half the annual new entrants to the labor force. 

The offenders are marshalling their political resources to get a lenient punishment. If the government fails to name and shame the offenders and punish them with the full force of the law, it will have missed a great opportunity to show that new Nepal is positively different from old Nepal in that the law is equally applicable for big shots and small fries. Failure will particularly incriminate the CPN-UML—which heads the government and holds the finance portfolio—belying its professed pragatisheel orientation.

If they really care about Nepal’s development, donor agencies that incessantly press the government to expedite "economic reforms" and reduce the "cost of tax compliance" would do well to spiritedly press for action against the tax evaders, even if their dear private sector happens to be in the dock. The civil society can do its battered credibility some good by rising above partisan interests and pressuring the government for action on a really serious issue—for once.