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.
