Along with some ‘incurable chronic syndromes’ of Nepal’s economy like stagnant manufacturing and agriculture sectors, widening trade gap, sustained high inflation and shrinking development expenditures, the improvised economy has lately been facing a set of new and unexpected challenges.
Worries are high that a deadly combination of three newly emerged ills -- slow remittance growth, alarming deficit in the balance of payment and banks’ risky loans -- can spark a new economic crisis.
The unexpected decline in remittance growth, the country’s economic backbone, which many believe as a time-lag effect of global crisis, could trigger the crisis. Though it is too early to predict a specific trend on remittance income given the hazy economic outlook of the Gulf region that generates two-third of Nepal’s remittance, there is unanimity that Nepal’s economy that somehow endured the fall of carpet and garment industries, can no way weather a sustained slowdown in remittance income.
Hardly anyone disagrees that remittance boosted a surge in economic activities, be it in the form of overheated realty sector and stock market or heavily inflated consumption by over Rs 130 billion last year to Rs 883 billion thereby fuelling inflation over 13 percent. But still, remittance played a crucial role is keeping domestic demands vibrant that raised imports which in turn generated healthy revenue to the government without much effort. The results: the average increment in revenue mobilization was around 40 percent in the first four months of the current fiscal whereas target was just 24 percent and easy income instigated the government to lose purse strings resulting in a hefty rise in recurrent expenditure that shot up by 43 percent.
No doubt, any decline in remittance will bring devastating effects, ranging from fiscal to banking crisis. The direct equation will be that the decline in remittance will contract consumption and demand, ultimately affecting fresh investment and reducing job opportunities. The resultant impact on the financial sector will be a low demand for fresh loans and high numbers of loan defaults, which will chock off the banks’ capital flows. On the fiscal side, a shrink in the demand of goods will reduce imports and revenue generation, destabilizing fiscal balance.
The deepening liquidity crisis that has already resulted in the rise of both lending and borrowing rates will emerge as another challenge to the economy. It is good that deposit rates are rising, as some of the banks have already started offering over 10 percent interest in a annual deposits, providing some relief to the depositors who were reeling under negative interest rates.
However, rapidly rising lending rates have also raised concerns, as such a rise will discourage investors. This will slow both investments and consumption that will ultimately weaken demand and drag down already yawning growth. Many agree that to some extent that the consumption has to be curbed in order to correct alarming trade deficit and tame inflation. But, the biggest challenge for the policy makers will be find a tactful way to trim consumption without hurting the growth prospects.
In 2010, banks and financial institutions that have enjoyed virtual uninterrupted expansion and handsome profits for years will have to confront with a number of headwinds, as a few banks have already been showing the impacts of three toxics -- high credit-deposit ratio, heavy dependency on institutional depositors and heavy exposure to realty sector.
A few banks, particularly the new ones that have already been affected by the toxics, will have to face hardship to keep their financial health normal, particularly in the context of recent directives issued by Nepal Rastra Bank that limited the banks’ exposure to the realty sector and rising deposits rates. It is bad that the central bank that alarmingly lacks trained-manpower at the operational level, failed to assess possible impacts of its directives.
However, some experts have hopes out of the gloom, as they expect that the possible ‘crisis’ can trigger the long-awaited consolidation of financial institutions through merger and acquisitions.
The worst ever Balance of Payment (BOP) deficit that the country witnessed during the first quarter of the fiscal is another big concern in the national economy. Even more worrisome is that Nepal has too little things in hand to correct it. No doubt, worsening trade deficit that grew by a whopping 47.6 percent during the period was one of the principal causes for the over three-fold increment in BOP deficit in a year.
However, the country has little options to deal with impacts of widening trade deficit. Neither does it have any products that are competitive in the global market, nor a convincing plan to develop such products in the near future. Luring foreign investment is the widely prescribed method to deal with the problem but the lingering political mess is the biggest hurdle to investment.
Unless overheated consumption cools down, either on the back of slow remittance growth or rising costs of bank lending, widening BOP deficit will remain a major problem in Nepal’s economy in the days ahead.
Prem Khanal is the Business Editor of Republica daily.
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