UN/ESCAP Bangkok 30 September 2009

Nepal’s Binding Constraints to Growth

Bishwambher Pyakuryal Professor of Economics Tribhuvan University

I. Introduction
Sequencing of Nepal’s political changes: first democratic movement in early 1990; second peoples’ movement in 2006, and declaration of Federal Democratic Republican State on Wednesday, May 28, 2008. Overemphasis of political restructuring has overshadowed the need for economic restructuring. ADB, DFID, and ILO-supported initiative in diagnosing growth constraints and identifying opportunities in Nepal is just completed.

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S. B = value added per unit of labor.6 billion (US$ 3.5 per cent (Rs.7 billion) by contributing to 17. 142. 2 .1 billion) compared to Rs.1 billion in mid-July 2007 • The workers’ remittances rose by 42. Its contribution in gross foreign exchange reserves is approximately 33 per cent. 212. Issues for assessing growth constraints Inability to produce export products and failure to maintain real exchange rate regime with IC • The gross foreign exchange reserves ↑ Rs. Department of Commerce. II.4% to the GDP. 1999 COUNTRY Nepal India China Bangladesh Indonesia Thailand Sri Lanka Malaysia Philippines LABOR COST PER WORKER (A) 100 130 180 110 120 480 160 960 600 VALUE ADDED PER WORKER (B) 100 205 271 130 276 390 195 909 742 UNIT LABOR COST (C) 100 81 72 90 87 94 105 93 93 Note: A = average labor cost per worker manufacturing. Issues for assessing growth constraints Contd. Cost Competitiveness Indicators Table 1: Index of Cost Competitiveness Indicators of Nine Asian Countries. 165. C = labor cost per unit of output manufacturing according to the internationally accepted definition of the U.II. • Such growth is encouraging but not sufficient to replace Nepal's dependency on foreign loan.

9 billion) • Import upsurge from India is 24. Increasing debt liability. 105.0% (Rs. Issues for assessing growth constraints Contd. 165.53 million by selling US$ II. Issues for assessing growth constraints Contd.II. Deteriorating trade & diversion of foreign exchange reserve • The ratio of merchandise trade deficit to GDP is 20.3 billion) • Trade deficit w/India is 64 per cent of the total merchandise trade (Rs.602.5% from other countries • Increased import and purchase of IC worth 70.7% against just 3. 3 . and cut back in public sector investment • The country is experiencing a diversion of resources from productive sectors and fulfilling the terms of increasing debt liability • The budgetary allocation shows a cut back on public sector investment and inadequate infrastructure development to attract potential investors • The low infrastructure expenditure can be said as the single most important macro constraint on Nepal's economy.

there is a need to reconcile between inflationary economic forces and expansionary fiscal policy. First. transportation. telecommunications etc. then we need to find out what infrastructure e. • If Nepal’s infrastructure is a constraint to growth. Selected Growth Constraints • It is advisable to find out the likely constraints for growth before making investment decisions. IV. power. are relatively important constraints to growth? 4 .g. this situation necessitates diagnosing growth constraints and possibilities for increasing future investments. Reason for identifying growth constraints Nepal government has adopted expansionary fiscal policy in the budget 2009/10. Secondly.III.

Nepal’s investment rate (25. since 2007.1%).Contd (a) Low investment rate • In 1995. Selected Growth Constraints….Contd Fig1: Investment Rate of Nepal from 1975-2006 (% of GDP) 30 25 20 15 10 5 0 Investment Rate  (%  of GDP) Source: Economic Surveys. only Pakistan is lagging behind Nepal.IV.2%) was very close to India (26.5%) and Sri Lanka (24. Selected Growth Constraints….2%). MOF 5 . Pakistan (18. IV.2%) were lagging behind Nepal. Bangladesh (19. But.

The highest Gross Domestic Saving was in 2000 (15. • It is interesting to note that GNI per capita increased by more than fifty percent from the year 1995 to 2006 (WDI.8 percent in 1995 to 9.4 percent in 2006 indicating the fact that low domestic saving rate is one of the major constraints for growth.17 percent of GDP). Selected Growth Constraints….Contd (b) Low domestic savings rate • Domestic Saving Rate is lowest in South Asia and it is almost one third of Bhutan. MOF 6 . IV.Contd Fig 2: Gross Domestic Saving 1975-2006 (% of GDP) 16 14 12 10 8 6 4 2 0 Gross Domestic Saving (% of GDP) GDP: Gross Domestic Product Source: Economic Survey (various issues). 2008) but Gross Domestic Saving decreased from 14. Selected Growth Constraints….IV.

34 1.64 2. For two consecutive years from 2000.47 0.58 2.08 1980-1984 1985-1989 1990-1994 1995-1999 19802000 0.Contd • Although there is deficit trade balance. current account surplus is maintained ‘cause of large amount of workers remittance.63 2. • It indicates that saving is not a problem for Nepalese economy. Table 2: Total Factor Productivity.24 2.27 0.57 1.64 0.02 2.90 2.14 1. which increased by 23. • From the year 2000-2006.08 Source: APO Note: Growth rate adjusted for business fluctuations 7 .Nepal Vs India Period Growth Rate Nepal Growth Rate Adjusted 1. But decline in remittance inflow may seriously affect the economy.57 2.91 Growth Rate India Growth Rate Adjusted 0.14 0. which has contributed negatively. remittance was 75 percent of trade balance and 89 percent of saving-investment gap. (c) Investment Constraints (i) Labor and Technology • Nepal’s total factor productivity growth rate is about fifty percent of India.90 2. remittance exceeded the savinginvestment gap.01 2.9 percent annually from 1991-2006. Selected Growth Constraints….IV.11 0.

in this region more people use fewer roads. ILO study reports that manufacturing sector hires about 15 percent of total skilled labor force from India.(c) Investment Constraints…. More than fifty per cent of the total road network is concentrated in Terai. See Table 4 and Fig. • Road density is least in Midwestern region. 3 below: 8 . Population to road ratio is highest in Western Development Region. ii. Nepal's position in the Labor related regulation is also poor in comparison to other south Asian countries. In other words. • Distribution of road network is highly unequal. • Similarly. Infrastructure • Infrastructure in Nepal is one of the poorest and Road density is smallest in the region. Table 3: Comparison of Labor-Related Regulations with Regional Countries Difficulty of  Rigidity of  Hiring Index  hours Index Afghanistan 0 Bangladesh 44 Bhutan 0 India 0 Maldives 0 Nepal 67 Pakistan 78 Sri Lanka 0 Firing costs  Rigidity of  Non‐wage  Difficulty of  Employment  Labor Cost (%  (weeks of  wages) of salalry) firing Index Index 40 30 23 0 0 20 40 35 0 104 0 20 7 1 10 20 70 30 17 56 0 0 0 0 9 20 70 52 10 90 20 30 43 11 90 20 60 27 15 169 Investment Constraints……contd.contd • Nepalese manufacturing sector is dependent on India for skilled labor.

Table 4: Road Network in Three Geographic Regions Region Total Length of Roads (Km) Population Influenced Per Km. Fig 3: Road Network in Three Geographic Regions Source: Calculated from DoR. 2006 9 .492 24.743 1.Km) Mountain 742 2274.9978 Source: Calculated from DoR.431962 Hill 7590 1350.608 12. of Road (Nos. 2006 Investment Constraints……contd.) Road Density (Km./100 sq.38719 Tarai 8504 1318.Investment Constraints……contd.

• Nepal study shows that if transportation time is reduced by fifty per cent. 10 . which is one of the highest in South Asia. Figure 4: Density of the total road network (Km. • Other important constraint is electricity tariff.Investment Constraints……contd. 2004). then it may result in higher income through the increased fertilizer use and yield (MoICS.roads / square Km. land area)-2003* Source: IRF World Road Statistics *Data for India and Afghanistan corresponds to 2002 and 2004respectively Investment Constraints……contd.

Figure 5: Electricity Tariff ($/KWh.093 Source: MOICS.043 Nepal 0. • 11 . in fact. expensive and deficient transportation are some of the examples.079 India 0. Nepal's position with this score is 119 out of 125 countries in the world. Highest possible score is seven out of which Nepal secures only 1.065 Sri Lanka 0.9. Infrastructure quality score shown in the Figure 6 reveals that Nepal. small and low quality road network. has the poorest infrastructure in comparison to other South Asian neighboring countries. Expensive and irregular electricity.041 Pakistan 0. • The overall infrastructure situation for attracting investment is very dismal.Investment Constraints……contd. 2000) Bangladesh 0. 2004 Investment Constraints……contd.

pdf Investment Constraints……contd.3 3. • • Both quality and expenditure for infrastructure is very low.4 3 http://siteresources. study shows telephone doesn’t seem to be a constraint to investment and growth. • In terms of telecommunications.Investment Constraints……contd. Nepal has lowest number of telephone subscriber per 100 people in South Asia.6356 in India.9244 for Nepal.8 percent of India. It was 18.3 3.org/INTEXPCOMNET/Resources/2. Study shows that Nepal needs to invest US$ 3. Although Nepal ranks lowest in the region in terms of subscriber per 100 people.worldbank.9911 in Bangladesh.9911 in Pakistan and 12.22 percent of GDP) for the period of 2008-2012 in order to achieve eight per cent growth rate.6930 in Sri Lanka. 24. Fixed line and mobile phone subscribers (per 100 people) in 2006 remained at 5. Nepal spends < 1% of total GDP on infrastructure against 4. • 12 . 36.44 billion (12.9 2. Infrastructure Quality  Score Fig 6: Infrastructure Quality Score of South Asian Countries Bangladesh India Nepal Pakistan Srilanka 1.01_Overall_Infra structure_Quality.

3 2.2 32. Table 6: Governance Indicators for Nepal.7 42.3 14.3 34. Political Stability and Governance • Governance indicator.8 2006 2007 Region Avg. Percentile Rank (0-100) Governance Indicators Voice and Accountability Political Stability Government Effectiveness Regulatory Quality Rule of Law 1996 46. • Similarly frequent bandh is deteriorating smooth functioning of business sector.9 38.8 26.2 37.Investment Constraints……contd.3 31.9 23.9 36 22.9 51.7 52.7 37 31. iii.3 36.3 33.3 Investment Constraints……contd.4 1998 42. Bhairahawa-Sunauli highway November Total June June May May 13 .3 44.5 31. Figure 7: Number of Days of Bandh (Excluding Indefinite Bandh) City District Region Country 36 24 21 13 9 1 8 4 7 9 5 2 3 5 4 5 3 2 3 2 2 4 21 13 September December February August October March April July April.3 23.9 2000 43.5 6.8 2002 24.7 31 19.4 13.3 2. 2007 January.9 21.8 26.6 36 31.4 26.4 40.2 25.4 2003 25.6 28 2. 15. as published by World Bank is deteriorating.5 5.9 1.1 33.1 2004 2005 18. 2008 Source: Various News Papers Note: This chart doesn't include Bandh called for indefinite period. District: One district Region: Two or more district City: City or part of highway in one district e.g. It may be due to frequent change in government during last one and half decade.8 28.4 22.4 15.9 22.9 21.

inadequate skills and technology and unsatisfactory corporate and political governance. bureaucratic delays. low-level of protection). Fig 8: Share of Bandh for City to Country (Excluding Indefinite Country 5% City 25% Region 42% District 28% Source: Various News Papers (V) Conclusion & Recommendations • Overall macroeconomic positions look OK. 14 . underperformance of agriculture. • Nepal rates poorly on investment-related indicators: capital flows and foreign investment (4. under a series of headings. and pervasive corruption). inefficiency. property rights (4. and regulation (4.5. contributing to an overall score of 3.Investment Constraints……contd. high barriers). • Major task is to ensure equity to make growth inclusive. The challenge is to sustain growth against the existing constraints of poor infrastructure. • The Heritage Foundation's Index of Economic Freedom uses relatively objective scoring system to rate countries on a 1-to-5 (good-to-poor) scale.

15 .org). Other equally important acts such as Bankruptcy and Mergers Act should be enacted without further delay to reduce investor's risk. 2004).contd • Review shows.463 (including social. which reflects the low level of income. • It is important for the government and private sector to find out the reasons why increased FDI has not been very significant in the growth of Nepalese GDP in absolute as well as in the relative sense (http://ideas. limited access to productive assets and lack of gainful employment opportunities (Nepal HDR. economic and political indicators into a composite index of empowerment). • Gross domestic savings rate in Nepal is low but total savings rate is higher than investment rate indicating the possibility of generating additional resources for investment.repec.contd • The value of Nepal’s new Human Empowerment Index (HEI) is 0. The economic empowerment is lowest at 0. investors demand the revision of the rigid Labor Act. 1992 to avoid labor market rigidity.337.(V) Conclusion & Recommendations…. (V) Conclusion & Recommendations….

provision for enhancing NRN’s involvement in Nepal’s development initiatives be ensured. There is a predominance of JVIs even when 100 per cent equity ownership is allowed. Industrial Development Perspective Plan: Vision 2020 and Foreign Investment Policy. 2002. 16 . (V) Conclusion & Recommendations…. This is the area to be investigated.contd • Banks are holding more funds than they are required to. 2002 are relatively better designed. however. investment in larger infrastructure projects suffers as there is a limited access to international financial markets. • The survey of foreign affiliates in Nepal shows that majority of the projects with capital participation from developed countries are small-scale projects with individual investors.contd • The draft Industrial Policy. In the revised policies. • The new government should get rid of weaker administrative practices and conservative attitudes towards business.(V) Conclusion & Recommendations….