Dr Yubaraj Khatiwada
Former Governor Nepal Rastra Bank
National Planning Commission
Dr Yubaraj Khatiwada, the former Governor of Nepal Rastra Bank and former Vice-Chairman of National Planning Commission, has a long experience in managing public economic affairs. He was one of the major architects of the election manifesto of the Left Alliance and is expected to be a key policy influencer in the new government. In an interview with Madan Lamsal, Editor-in-Chief of New Business Age, Dr Khatiwada sheds light on the rationale behind the ambitious election manifesto proposed by the Left Alliance and how those economic ambitions will be achieved. Excerpts:
With the elections for all levels concluded, do you think Nepal will really tread on the path to economic development?
All major long standing political issues have been settled and the constitutional transition has been concluded. It will take some time for the state restructuring process to complete. The local and federal laws have already been formulated. If we are able to formulate the necessary laws required to implement the constitution, the state restructuring transition will conclude too. If there is a stable government with a clear majority in place as expected by the people, it will ensure the creation of a favourable investment climate. This is because unstable government generally leads to problems such as delays indecision making, difficulties in understanding issues and deficit of trust in terms of the work of previous governments. A stable government is necessary to avoid such problems.
Similarly, we have been trying to focus our efforts on infrastructure development with linkage to our neighbours. When the infrastructural development gathers further momentum, we will reach a position where we can link up with the progress of our neighbours. The supply of power will ease within the next two years which will help in reducing the problems faced by energy intensive industries, thus spurring economic activities. The labour situation is also improving. The very pragmatic Labour Act was endorsed only a few months ago. The Act comprises of inputs from both the business community and labourers. The law has created an environment where industrial relations will improve and conflicts like strikes and factory shutdowns will come to an end. Against this background, I don’t see any obstacles hindering the Nepali economy from attaining an economic growth of over seven percent.
But there are several bottlenecks in the country’s economic development due to an absence of appropriate laws and policies. How can we be confident about economic prosperity in such a situation?
Economic prosperity is a long term process. One out of five Nepalis still live below the absolute poverty line. Talking about economic prosperity is pointless if we can’t uplift them out of the poverty trap. Raising the economic status of only 20 percent of the population that belongs to a certain class isn’t economic prosperity. That is not what socialism-oriented economy is about. Everybody needs to secure the minimum human development standard. It is why the focus should be on attaining high economic growth with distributive characteristics whereby everybody is able to enjoy certain benefits from the country’s economic growth. We need effective plans to put an end to absolute poverty within five years.
The most urgent thing in this regard is the necessity to formulate more than a dozen laws within the next six months after the establishment of the new parliament and formation of new government. The laws should be sequentially formulated based on their priority level. Formulation of laws to govern local and federal functions and to guarantee the execution of the constitution should be the focal point. Presently, there are a number of laws in the pipeline, the ones that have already been drafted, the ones that are yet to be drafted and those which are in the preliminary stages of drafting. The political transition will prolong further if the formulation of the laws is delayed.
Prosperity should begin from the local levels. Federal government may assist the provincial and local governments to gather pace by constructing large development projects. But the socio-economic transformation has to begin at local levels by linking the production process with technology and leveraging local resources and opportunities. Lack of capacity, unavailability of resources and confusion over laws are some of the constraining factors at present. But if the problems are managed, the foundation of long-term economic prosperity will be built at local levels.
At the same time, we need to be cautious about the risks associated with federalism. The federal and provincial governments should continuously work towards building the capacity of local governments. I believe the determination shown by the political parties will be a key factor in the successful implementation of federalism. Any doubt or suspicion against federalism will take us nowhere as we have already come a long way.
What policy level reforms are urgently required to alleviate problems in infrastructure development?
We need to expedite the implementation of mega infrastructure projects in hydropower and connectivity (roads, railways and airports). But obstacles exist in the conflicting policies related to forest, environment and land acquisition which will hinder the speedy implementation of the projects. Sometimes projects face difficulties due to issues at local levels like unavailability of construction materials. Policies should be reformed in such a way that the mega projects don’t have to face any policy obstacles at all after being approved by the Investment Board Nepal(IBN).
Secondly, some projects may be financially unviable but economically rational and necessary. In such cases, there must be supporting policies to facilitate government financing in such projects. The government can adopt different ways, like capital grants or Viability Gap Funding (VGF) and attract the private sector to forge Public Private Partnerships (PPPs). In the future, we may require funding structures like Special Purpose Vehicles (SPVs) for large projects relating to venture capital or capital market infrastructures.
Federal and provincial governments may also require foreign assistance in future projects. The constitution has mentioned that provincial governments are allowed to secure such cooperation with the approval of the federal government. But there is a gap in policy which has to be plugged to ensure it.
Thirdly, the technical and decision making capacity in the government and bureaucratic levels is quite low. They lack basic understanding about projects and the ability to develop proper project specifications and move ahead with the tender process. Fourthly, there are problems at the execution level. Nepali private contractors also don’t have the required capacity which generally causes delay in completing assigned contracts and stretches the project time run.
Fifth, technology is vital for the successful and timely implementation of projects. Technology not only expedites projects, but also is a means by which we can protect the environment. For example, constructing road infrastructures through national parks and conservation areas will damage the environment. This is where tunnel technology can be effective. The application of tunnel technology in the Bheri Babai Diversion Multipurpose Project- where we are using the Tunnel Boring Machine (TBM)-is a breakthrough for us. But both the government and private sector lack related expertise to apply technology in other projects. There is a need for both sides to work hand-in-hand to introduce modern technology and develop their expertise.
For large capital intensive projects, we require the service of international contractors. A transparent and indisputable decision making process in awarding contracts is essential along with creating the favourable work environment for them. On one hand, domestic contractors are demanding an increase to the contract threshold to Rs one billion. But on the other, their capacity is still insufficient. We will require a robust private sector and an efficient government to execute an annual investment amounting to Rs 600-700 billion for all our development commitments.
Lastly, the interest from our neighbouring countries in our development projects manifested in the form of geopolitical pressure is another reason behind the delays in our projects. It needs a transparent and appropriate way out. What I believe is that the ratio of grants should be the key deciding factor over the ratio of concessional loans while choosing the project partner. It is because accepting concessional loans can turn out to be a risky proposition. If the projects are approached under international competitive bidding procedures, the selection of contractors will be transparent and fair. But, switching project partners will only cause damage to our reputation internationally.
Even in projects related to the Belt and Road Initiative (BRI) proposed by China, the new government should seek transparency and prioritise national interest and security. As sensitive neighbours, both India and China should acknowledge our concerns over national security and national interest and act accordingly.
There are concerns that a number of federal states might face a resource crunch which can dampen the prospects of federalism in Nepal. How can federalism be managed in this scenario?
The new government should establish a precondition that the financial transfers made by the central level cannot be spent over any entitlements that will be benefiting the local representatives. A lot of other grants should be conditional too. Local governments can raise revenues by mobilising their own resources, and by doing that manage entitlements for themselves.
At present, most of our revenue sources haven’t emerged. Principally, people are paying taxes for their income but not for the growth in their asset value. State investment in public goods and services has increased the value of properties but this growth hasn’t been accounted into the radar of tax due to lack of public records. The new government needs to develop a scientific record keeping mechanism while the local level needs to explore ways to generate revenues through modern taxation to strengthen their revenue stream.
As revenues generated from local resources won’t be enough, the federal government will obviously seek foreign assistance and so will the provincial governments. But the assistance received by the latter will be limited.
Meanwhile, the new government should devise a strategy to clearly distinguish the roles of the government, private sector, cooperatives and community organisations. Currently, the local level has this misunderstanding that they will undertake all the development activities by themselves from construction of roads to electrification. What they need to do is to create partnerships between various players like the private sector, cooperatives and community organisations.
The government can forge Public Private Partnerships (PPPs) in a number of areas for investment. Some of the areas can have private sector investments. While in others, the government can encourage private sector to attract Foreign Direct Investment (FDI). The size of investible capital is growing in the international financial market. There is surplus capital in India and China. We should be able to leverage benefits from the growth of their investible capital.
Similarly, local governments should prepare a periodic strategy detailing their investment needs, revenue sources, federal grant estimates and the roles of various agencies. There should be a mechanism to inform the local governments about the types and nature of the grants they are entitled to. They need to be clearly informed whether the grants are conditional, unconditional or special. This is why the National Natural Resources and Fiscal Commission needs to be established at the earliest. The time has arrived for finalising the budget for the next fiscal year. But we are yet to form the new government and other required commissions. I fear that this delay will create difficulties for the next government to prepare the next budget appropriately.
How do you think an environment can be created to foster fair practice among private sector players, to encourage them in the nation building process and to punish those who are practicing crony capitalism?
The private sector should not mix politics with business. The new political leadership should identify those who are involved in crony capitalism. Crony capitalists have survived during the transitional phase as the state mechanisms weren’t strong enough to take necessary actions against them. With the end of the transitional phase, practices of crony capitalism no longer have a future in Nepal. The private sector will have to abide by the laws of the land and generate profits by paying applicable taxes. It applies to international private investors as well. The government needs to ensure a favourable working environment for the domestic private sector and seek a supplementary role from the international private sector to fulfill the gaps in investment.
The election manifesto of the Left Alliance is very ambitious. What is the basis that it will be implemented successfully given past experiences?
If we analyse the past, it is obvious to be doubtful about commitments made by the political parties. But dwelling on the past will take us nowhere. I agree that the commitments made in the election manifesto of the Left Alliance are ambitious. But it is the need of the hour. That’s what the people, society and constitution have mandated. Political leaders, whether knowingly or unknowingly, constantly proclaim that the new era of economic development will begin soon.
Fundamental human rights, food and health security, social security, right to education, right to good health and well being, clean water and sanitation and guarantee of employment opportunities are fundamental aspects of our constitution. We have been ambitious in our constitution. Without ensuring these rights, we can’t expect the full implementation of the statute. It won’t meet the people’s aspirations either. At the same time, achieving them requires large investment from the government. There is no choice but to set ambitious goals and strive towards achieving them.
Our annual economic growth rate was mere 4-5 percent in the past and it took us 20 years to reduce poverty by 20 percent. Without being ambitious, it will take us another two decades to reduce the poverty. It is why we have aimed to reduce poverty within the next five years and it is possible. Countries like China have reduced their poverty by 20-30 percent in a decade by ensuring high economic growth and linking it with the creation of employment opportunities.
Besides, we aim to graduate to the status of a developing nation by 2022 and to a mid-income nation by 2030. Those are old commitments made by all the political parties. We have also ratified Sustainable Development Goals (SDGs). As a least developed country, we have also made commitments at the international level to increase our per capita income by seven percent which will require us to attain an annual economic growth rate of 8.5 percent. We will require high economic growth to realise those ambitions.
We have envisaged doubling the agricultural productivity and raising its share in the GDP. We aim to make a massive leap in infrastructure development in the next 10 years. Annual growth of at least Rs 300 billion in real GDP is desirable which will require Rs 600 billion in annual investment (assuming that 50 percent of the investment will turn into income). Similarly, a large number of employment opportunities needs to be generated to fill the gap created after modernisation in agriculture and mechanisation and automation in the industrial sector.
The manifesto has mentioned an end to the ‘blind support for neoliberalism’ stating that neoliberalism has ‘promoted consumerism and given rise to unproductive sectors’. Can you elaborate more on this?
Neoliberalism emerged after 1990advocating for a greater role for the private sector and freedom in economic and development activities and a limited role for the government. It sought the government’s role only in a few areas such as facilitation, maintaining of law and order and formulation of required laws and policies. With its apparent failure, evident in the Asian Financial Crisis in 1997 and the Global Financial Crisis in 2008, the current global economic system has highlighted the need for a stronger state presence- as a regulator and in social security and infrastructure development. Neoliberalism and a state with a stronger role are competing views. Today, the general consensus globally is for the latter. So it is not something new that only Nepal has embraced. In the context of the failure of the Washington Consensus, it has been proved that the development model of yesteryears is not relevant in the present context. Several economies across the globe have been practicing their own development models. For instance, China has its own development model and even USA is trying to change its development course in areas including trade and immigration.
The state needs to ensure public welfare by ensuring a minimum social security. Advanced economies have developed their capacity in this regard and practice it in various ways. Import substitution used to be seen as a regressive practice previously. Post-2008, economies have realised that relying only on the international market is futile and should focus on enhancing internal production and to develop a sustainable and self-reliant economy. The new government also should explore ways to substitute imports, and focus on being self-sufficient to create a well balanced and self-reliant economy.
Likewise, there was a false impression earlier that food supplies would be easily available and scarcity will be temporary. But the food crisis triggered by the Global Financial Crisis had a severe impact globally. It’s the same with energy. We have seen how changes in petroleum prices can affect our market if we are completely dependent on overseas production and supplies. It may appear as protectionism when we talk about incorporating food and energy security in our economic strategies, but it is necessary to do so. Agricultural subsidies are important to ensure production and to become self-reliant. It was a mistake to discard agricultural subsidies. We introduced it back in FY2066/67 as a corrective measure.
It all may give a sense of protectionism. But the left Alliance isn’t trying to promote such a model. The view that the government shouldn’t pursue the welfare of its citizens by delivering services on its own is pointless. The new government will not establish any business entity to compete with the private sector, but will definitely pursue the public’s interest and welfare where it is needed whether by breaking monopolies or by providing welfare services.
A number of public enterprises(PEs) turned sick in the past. Do you see the possibility of their revival?
A number of PEs in Nepal died down due to obvious reasons. It is wrong to assume that public industries established in the 1960s or 1970 would have survived today with outdated technologies. Nevertheless, the enterprises displaying commercial viability, competitiveness and are needed at present should be revived. The new government will even open new enterprises if needed. The establishment of the Hydroelectricity Investment and Development Company Limited (HIDCL)by setting up a SPV in 2011 can be taken as an example in this regard. Reviving all PEs even if they are unviable is not an agenda of the Left Alliance. But we need to be open to the idea of entering areas which are unexplored, have potential to utilise domestically produced raw materials and are ignored by the private sector.
There are concerns about economic headwinds due to decreasing remittance inflow and a widening trade deficit. Likewise, the manufacturing sector is not faring well either. How do you analyse this scenario?
The inflow of remittance hasn’t decreased in Dollar value, but only in local currency. Perhaps remitters are waiting for the local currency to appreciate. Yet, it is wrong to expect growth in remittance on a yearly basis as the forex fluctuation plays a big role in remitting trends. As we were engaged in our election, our border security and international trade regulations may have lapsed for a while which benefitted the ‘hundi’operators. A number of Nepalis are seeking to migrate abroad permanently along with their capital. Only ‘hundi’dealers can ensure safe passage for the outflow of such capital from the country due to the restrictions imposed by existing laws. The value of remittance obviously decreases in such a scenario.
In the meantime, increasing imports for consumable goods and the compulsion to depend on importing machinery and the necessary items for implementation of projects has given little scope for value addition andfor our production structure to evolve immediately. It is likely that Nepal will have to face a large trade deficit in the next decade. The only way to gradually reduce the trade deficit is by substituting imports, increasing production and making the best use of technology transfer in future projects. As we look to double agricultural productivity, we should realise that agricultural products and agro-processing industries have immense economic potentials. The new government needs to develop infrastructures at custom points like cold storage and quarantine facilities to facilitate the agro exports. Likewise, we can also reduce the size of imports by reducing dependency on fossil fuels. Manufacturing as well as service sector industries like tourism, hospitality and aviation are the probable areas where FDIs can be attracted to reduce the gap in international trade.
How does the new government look forward to setting trade agendas with India in the light of India’s quantitative restrictions on some of our export products?
India has imposed non-tariff barriers in bilateral trade like standardization in the use of pesticides on certain primary products including ginger. It can be mitigated by setting up a quarantine facility at our customs office. But let’s analyse our fault as well. India had to impose quantitative restrictions on some Nepali exports such as hydrogenated vegetable oil, acrylic yarn, copper products and zinc oxide as we created irritants for them. I believe the discussions surrounding the Nepal-India Trade Treaty will have a fresh start and once there is a trade regulatory board, non-tariff barriers will be gradually withdrawn. We should avoid antagonising India and rather focus on creating a win-win situation for both as India is our largest trade partner. It is also the largest source market for our primary goods and our future energy exports. While we aim on becoming self-reliant, we shouldn’t ignore creating an interlinked economy with India.
How do you view the ongoing reform and consolidation in the Nepali banking sector? What things are most lacking in this regard?
The ongoing consolidation in the Nepali banking sector is positive. The banking sector is becoming massive with the increased capital size and management reforms. At the same time, the banking sector is becoming narrow-minded in its vision as it is unable to provide a roadmap to the long term investors, especially the borrowers. At times, banks engage in unsustainable banking practices like engaging in interest rate price wars to increase their market share.
The risks associated with our current banking system are increasing and there is a gap occurring in terms of having a workforce with the needed skills such as risk management abilities. Similarly, the engagement of businessmen in the banking sector has led to a mindset that banks yield quick returns. The notion that it is in fact a gradually rewarding venture hasn’t been established yet. Meanwhile, unless there is an economic growth of 8-10 percent, opportunities for the banking sector will shrink. In such a scenario, the banks may start investing in risky or unproductive sectors if the real sector doesn’t grow on par with the growth of the banking sector.
The banking and financial system has been facing recurring problems in liquidity management over the last few years. What are the effective ways for long-term liquidity management?
Earlier, the liquidity crunch occurred due to the government’s inability to spend the capital budget. This time the cause is a bit different. With the increase in the capital size of banks, there is pressure on the banks to expand their loan portfolio. As banks started providing loans from their funds, it started affecting their credit-deposit ratio. It also effected the situation of liquidity.
When an economy is at a take-off stage, there is demand for capital. When deposits are unable to meet the capital demand, there needs to be alternative ways of managing capital. Principally, at this time, banking investments are high in areas such as tourism, agriculture and in particularly the hydro sector because there is a demand for capital. It is natural for bank financing to increase when our target economic growth is high and our investment climate has improved. In such a scenario, long term financing instruments and other financial options needs to be used to manage liquidity and finance investment opportunities but the central bank has failed to do this. There was no use of long term financial instruments or other viable financial options which the central bank could have explored and exercised. While applying such instruments and options, the central bank should ensure that the saving rate doesn’t go down below a certain level, else domestic savings may decline which again will hit capital demand.
On the one hand, banks are charging higher margins in loans offered against deposits that have low interest rates. On the other hand, banks didn’t manage their risk portfolios. The central bank should also ensure that banks are well regulated and that they don’t invest in unproductive sectors.
I think that capital demand will further grow in the future and with a national saving rate of around 10 percent. It will be impossible to meet the growing capital demand in such a situation. To inject fresh liquidity in the financial market, the government should attract FDIs that offer value addition and are export-oriented.