Yubaraj Khatiwada on economic policy, federal expenses, social security and liquidity crunch

Published On: January 25, 2018 12:30 AM NPT By: Mahabir Paudyal/ Sagar Ghimire

Yubaraj Khatiwada, former governor of Nepal Rastra Bank and former vice-chairman of National Planning Commission, was involved in drafting election manifesto of the Left Alliance. He is also thought of as a key architect of economic policies to be adopted by the upcoming government. What does the left governance have in store vis-à-vis Nepal’s economy and its economic relation with foreign donors? Mahabir Paudyal and Sagar Ghimire met the veteran economist to discuss a range of economic issues.

The left alliance began with ambitious goals for economic growth, development and social security. How can they be achieved? 

I do not say they are the ambitious goals. We have been very cautious. We want to transform the economic and social situation of the country through high and inclusive economic growth which could lead us to graduate to middle-income country status in due course of time.  For that we have envisaged an economic system which is in line with the spirit of the constitution while fully recognizing the roles of the state, government, private sector, community organizations, NGOs, foreign donors and cooperatives. 

To enable private sector to promote investment, government should create infrastructures, energy, road, water supply and other basic things. Private sector may not be sufficiently motivated to deliver retail services, small financial services and community based firm development activities in which case the role of the cooperatives will be vital. We think cooperatives and private sectors can compete and complement each other. We should not be creating distortionary regulatory regime. We must not be creating a situation whereby incentives are different for different actors. We have to be very careful about tax and subsidy regimes so that it does not distort basic incentives for private and cooperative sectors. 

Where will foreign donors fit in this scheme? 

We continue with our outer-oriented economic policies.  We need international market for our trade, we need international finance for our development and we need technology transfer for the same. If we try external market for all of this, we must also open our market for foreigners. Reciprocity should be followed. As we are the member of WTO, SAFTA and BIMSTEC and all the regional associations, we cannot deny the provisions made in those treaties and agreements. Import substitution is one strategy in overall trade strategy whereby we want to slightly depart from previous regime.

Our other goal is to become self-sufficient in basic strategic commodities. This was not thought out in the past. But after the 2015 trade blockade with India, we found that we are insecure in food, medicine, medical treatment and energy. Some tensions in the Middle East also indicated that we are not secure in jobs. So we have talked about food security, sufficiency in some of key items such as wheat and rice. This is important because when it comes to food crisis or financial crisis, global market does not come to support you.

When food security and food sovereignty has been guaranteed in the constitution, we must ensure that at least the food supply aspect of food security should be addressed by the state. In this aspect, we are new from the free trading regime of the last few decades.
We are importing a huge amount of petroleum products which are used instead of electricity which we could produce in plenty. We can replace our domestic fuel consumption, industrial energy consumption, commercial energy consumption and public transportation by electricity. For this we must produce more power through hydro or solar or wind energy among others. With this we can make petroleum consumption and import almost half in 10 years time. Energy security is one strategic component of our overall self-reliant and secure economy. For health security, our goal is to produce the essential drugs within the country.

What about job creation? Unemployment is pretty serious. 

Half a million people come into job market every year. We have more than four million people working abroad and we are trying to bring them back. For this we need to be creating at least one million jobs every year. Previous economic policies did not talk much about this aspect. We did not care about how the growth process would be job-intensive, and how it can be made distributive so that you don’t have to make additional efforts to redistribute income. Our concern now is that growth must be job-centric, and this should also be in combination with technology. We have laid much emphasis on tourism sector, where we can create a lot of jobs. If we can bring in five million tourists in 10 years time, we can at least create five million jobs within that period. Our overall growth strategy is to ensure that growth is equitable and that it creates secure and decent jobs.

But where does this policy mark a shift from the existing policy? Virtually every party promises what you just mentioned.

We may not be able to change structure of economy but we have to work differently to get better results. We have not been able to deliver on promises we made to the people. We ascribed this failure to constitutional transition, weak bureaucracy and frequent government changes.  We at least can hope that the first and the third aspects won’t be a hurdle from now on. Given that the left alliance has secured almost a two-thirds majority, we can be secure on stability. We don’t have much business in the parliament other than making new laws and monitoring the progress. Previously we were all occupied with the constitution. In eight years time we could promulgate only about eight economic laws.

Now we have to promulgate hundreds of new laws but this can be possible because the parliament can focus only on that. We are thinking to see which of the laws are detrimental or are hindering fast development process. We must be trying to unlock all these hurdles through very fast legal reforms. Megaprojects should be implemented in fast track. 

Now we should tell the politicians to appoint ministers only to those individuals who are at least aware of what they are going to do. Our new ministers have to be able to make the decisions from day one. They don’t need to go for cutting ribbons, inaugurating programs and giving speeches. They have done so for far too long in the past and people are tired of it.  If the ministers do not deliver, prime minister should be able to replace them. In Nepal, all large investment decisions are delayed because either ministers are not very confident about what to do or they don’t have time. Now they have no choice but to stay in the office and make decisions. 

What hinders the development activities after contracts are awarded? If capacity is the issue we have to build capacity for the private sector as well. If you have been awarded the contract, if you have the money and yet if you delay the project, you must be blacklisted. You have to be ruthless with indiscipline construction.  We have to make the projects stick to the timeline. We keep extending timelines for some of the hydro projects. We cannot do this anymore.

But how will that be possible when contractors also face a lot of hurdles? 

There used to be a lot of hurdles relating to land acquisition, construction materials and labor unrest among others at the local level in the past. Now we have local government to take care of those issues. Coincidently, most of the local and provincial governments will be of the ruling parties. So lack of coordination should not be the problem anymore.

Financing should not be a big problem either, so long as we have credible programs and we can take donors into confidence. International Development Assistance (IDA) has raised its portfolio by 50 percent. World Bank is talking about 200 million dollars of budgetary support. ADB would be equally willing to support Nepal. Asian Infrastructure Investment Bank (AIIB) is in the pipeline. The new international and regional financing architecture would provide a lot of money. But we have to make our policies credible because these are the institutions which are running the globe in several aspects. We have to be pro-people but we must also work with those institutions which used to work with us. Balancing between our needs and their interests will be challenging. But if we can do that we will still have sufficient resources. Yes, our recurrent expenditure will substantially increase but we have to increase our revenue base to manage that. 

Many want the left government to take a clear shift from neo-liberal economic policies we have had so far. How will that be possible?

To begin with, we have been talking about socialist market economy based on multiparty system. This is in line with spirit of the constitution. The constitution has clearly stated what kind of economic and socialist policy the country will take. We are going to follow the directives of the constitution. 

As for neo-liberalism, it did not work very well. Liberalization is okay. You have to seek external market, capital and technology. We all agree on liberalization but that should not be at the cost of people, environment, and rise of inequality. Globalization and liberalization today are discussed in terms of inclusivity, equity and equality. This is why the United Nations came up with the sustainable development goals. This is being done because present production and consumption pattern and race for profitability at the cost of environment and society is fundamentally flawed. There has been a growing realization across the globe after the financial crisis of 2007/8 that finally the government has to be the custodian of economy. And they have to rescue the market, banks and insurance companies. We have envisaged the larger role of the state which is not compatible with what we thought in neoliberalism where state’s role would be limited to regulation and policy making. This has been almost rejected globally. We want to follow that trend in Nepal as well.

Lately, there seems to be a lot of temptation toward distributive policies and handouts under the pretext of social security and socialist policies. How will it be sustainable?

A beauty of a socialist state is that everybody is taken care by the state. They are given jobs. To those who do not get jobs, social security is provided. This is already an agenda of the capitalist countries as well. They have unemployment benefits, health insurance and several other social safety programs. This has been a common agenda for both capitalist and socialist countries. What is imperative to socialist country is that it must grow and become prosperous to distribute whatever it can generate from productive forces. If you don’t have much of the production, you cannot simply distribute. Otherwise, you will be bankrupt. 

Unless we grow by a significant scale of, say six or seven percent, we cannot keep increasing social security. We have already set the limit for that. Social security budget should not increase to more than 15 percent of our total budget.

You can make some of the social security schemes contributory. Currently, we are paying social security to both needy and not needy by putting them together. If you have contributory model in social security schemes, you don’t have much problem. We have also been thinking about consolidating the social security system, creating a social security institution and moving toward the contributory system. 

What is the contributory model of social security system? 

Suppose you are a private sector employee and you are not getting any pension upon your retirement. But if you are a public sector employee or government staff, you are getting pension without your contribution. This is not just. Now, you must also contribute something and you are guaranteed by your employer that you are getting pension after your retirement. As a civil servant or public sector employee, you also contribute for your pension fund to which the state will add which becomes your pension amount. We have to introduce this contributory system and that must be taken in terms of your ability to contribute. For those who cannot contribute, there should be social security. 

Acute shortage of lendable fund has made it seem like our banking industry is on the verge of collapse. Where does the problem lie?

It seems the banks are over-lent. Nepal Rastra Bank spent Rs 100 billion more in credit than the deposit collection. They have the capital which has been increased by many folds, at least four folds from Rs 2 billion to Rs 8 billion, and they have to provide return on equity. For additional Rs 6 billion, they have to mark up their business operation so that they can serve the return for that amount. So, they become very aggressive in lending with the expectation that the deposit will follow suit. This did not happen.   

Remittance did not grow to the level it was witnessed in previous years. Then we had elections and transition. I doubt there was some kind of easy trade deflection kind of situation. People might have exercised trade distortion measures and that might have created a large margin in the parallel market for dollar and Hundi market might have come up. I think the trade distortion, the low interest rate that banks provided, their compulsion to go on aggressive lending due to the capital issue were the factors. 

There are public sector banks and there are aggressive private banks. Some are still over-liquid and others are on acute deficit. Their market is not clear. So, you have excess money in the market while at the same time some banks don’t have money to lend. 
Unless banks raise money of long-term nature through long-term deposits or bonds, the problem will remain. Only trade financing cannot take all the money that banks are generating. You have to finance infrastructure. Banks are not very much willing to do that. 
But interest rates, particularly fixed deposit rates, are skyrocketing. Banks will sooner or later pass the increase on their cost of funds to borrowers. 

If you keep your lending rates from 6 to 16 percent for infrastructure projects, it is horrible. No investment project will come here on such volatile interest rates. The best idea for the banks would be to benchmark their rates. Banks must have benchmark rates for their borrowers. Then there are depositors. There are some institutional depositors who are opportunistic. They are overcapitalizing on the scarcity in their liquidity in the money market. They must avoid this type of tendency and become responsible. 

Banks must also look for middle-term horizon. If they have more money, they don’t have patience to hold it even for two or three weeks. So they start lending money at six percent interest rates. Can a country like Nepal, where saving rate is just 12 percent, afford consumption loan at a rate of six or seven percent? But banks have done it. They did so because they borrowed from depositors at three percent rate. 

As we are implementing federalism, one of the biggest concerns has been whether we will be able to sustain it economically. Where will we get the money from?

Federalism is not only costly. It also provides services with ease. If the local governments are delivering services at the local level, people must understand that their transaction cost has been reduced.  Hitherto, to get utility services, you had to travel up to district headquarters. Now you can get it from your local government office. Your travel cost and overnight stay in headquarters have been reduced. This means you have to be ready to compensate some money to the operators of the local government which means you have some tax implications. 

In the initial stage when we are urbanizing and developing, we may not have the better source of revenue at the local level but as the process of urbanization goes on with infrastructure development, the value of assets will increase and revenue will also go up. 
For some years, there will be a deficit.  That deficit could be maintained first through drawing down the excess fat that we have accumulated in the past. We have not spent our money in the past. Maybe that situation will reverse for some time. For a couple of years, we have to do domestic borrowing. And, we also have to rationalize our expenses. Local governments must be asked to recover large portion of recurrent expenses through local taxations. If people are convinced that their tax payment will deliver results, they will also be ready to pay. So, it depends on local governments and how credibly they design local programs and become self-reliant. Only depending on federal government and looking at the fiscal transfer and trying to enjoy autonomy won’t work. 

It would be premature to say federalism will fail due to economic reasons. It’s not going to be as burdensome as people are thinking. The new infrastructure cost is capital formation. You are constructing buildings, roads, offices and they are all capital formations. There will be some stress but it will be manageable. 


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