June Analysis: Economy and Development

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Timeline of key events:

Date Events
June 11Nepal begins selling 364W of electricity in the Indian energy exchange
June 14Finance Minister Janardhan Sharma is accused of involving two unauthorised personnel in budget formulation.
June 19Nepal Oil Corporation increases the price of petrol to a record Rs. 199.
June 23NPR plunges to an all-time low with an exchange rate of 125.76 against USD
June 24Price of petrol comes down to Rs. 179 after tax cut.

Budget discourse continues

The upcoming fiscal year’s Rs. 1.79 trillion budget, a 10% increase from the previous, comes at a time when the country is grappling with deteriorating macroeconomic indicators. Provisions like reduction of the minimum threshold for foreign direct investment (FDI) from Rs. 50 million to Rs. 20 million will ease injection of foreign currency by attracting foreign investors. Many ambitious targets however are questionable; the aim to boost agriculture production by 30% for instance inadequately addresses the pressing issue of chemical fertilisers shortages in the international market since the allocated sum for fertiliser subsidies has only been increased by 25%. Likewise, the decision to set up a Rs. 500 billion microfinance fund for agriculture investment comes without any coordination with the Central Bank. Many aspects of the budget are contradictory as well. For example, the aim of reducing imports by 20% contradicts the 22% increase in revenue collection target since around half of our revenue is generated from customs and duties. Proposed distributive policies such as reducing the age-limit for old age allowance from 70 to 68 and increasing the salary of government workers by 15%, adds on to government liability and will propel inflation, making the budget populist rather than targeted to relieve macroeconomic difficulties.

Photo : RSS

To add to this, the Finance Minister was accused of involving unauthorised personnel in adjusting tax rates; lack of further investigation about the issue has further raised questions about the budget’s legibility. Fiscal policies, understandably, have always been driven by political motives and it is likely that the trend of proposing a bloated budget and then revising it to make it smaller time and again is likely to occur again.

Fluctuating oil prices and inflation

The Consumer Price Index (CPI) for the country has shown a steep increase since the conflict in Ukraine in February. The year-on-year inflation too increased from 7.28 in April to 7.86 in May. 

NRB’s monthly report for May showed the highest increases in price of pulses and legumes (11%), ghee and oil (24%), transportation (22%), and education (12%). Paralleling the 7.87% increase in CPI, the SWRI (Salary and Wage Rate Index) has gone up by 8.52%, with private institution workers (4.2%) and construction labourers (5.3%) having the lowest increase in income. Day-to-day wage earners in the informal sector are expected to be hit the hardest.  

Consequently, the public outcry when NOC increased prices by a record of Rs. 20 was expected. While the increase in the rise in petroleum prices is reflective of the increase in price quoted by the Indian Oil Corporation, the composition of the price is worth discussing. Of the Rs. 199, NEA bought petrol at Rs. 131.91 per litre from IOC and paid a total of Rs. 65.61 as various taxes. Accounting for operating, maintenance, and transport costs, NEA bears a loss of Rs. 13.58 per litre.

On June 24, the government announced a reduction of taxes, bringing down the price of petrol to Rs. 179. While this decision was welcomed by the general public, it brings a significant dent to government revenue and reduces the price margin between India and Nepal, which can encourage smuggling.  

External sector (exchange rate, trade deficit, foreign exchange reserve)

NPR depleted against the dollar to reach a record of 125.76 against the USD on June 22. 

The depletion of NPR is simply a reflection of the depletion of INR since we have a pegged currency system, coupled with USA’s decision to increase interest rates to combat inflation, but its effect on Nepal’s external debt, trade deficit, foreign exchange reserve, and inflation is paramount. A low exchange rate is preferred for exporters and detested by importers. As an importing country with a large trade deficit, the depleting currency will propel inflation and worsen trade deficit. According to the ten-month data for the fiscal year, the foreign exchange depleted by USD 2411 million, to a gross total of USD 9.28 billion, which is enough to cover prospective merchandise and services import for a record low of 6.57 months. Likewise, the country’s foreign liabilities are also set to suffer from foreign exchange loss.

Export of electricity to the Indian Exchange Market 

India had allowed NEA to sell 364 MW of energy in its energy exchange market in April 2021. With early monsoon and hydropower projects generating surplus energy, Nepal has sold all the allowed energy, being the first South Asian country to participate in the Indian exchange market, and the country’s private sector exporting energy for the first time. Thus, the possibility of export-promotion and import-substitution through a strong energy sector has emerged. However, since most hydropower projects in Nepal are run-of-the-river type, a considerable amount of electricity is imported in the dry seasons, and more investments are necessary to relieve trade-deficit problems in the long-run.

Stock market crisis

The bearish stock market this month is a culmination of many factors. Around this time last year, NEPSE experienced a massive surge, reaching its all-time high, which was primarily driven by the economic slowdown of COVID when people had little opportunity to spend and thus participated in stock-trading. With the post-pandemic boom of economic activity, the stock market’s decline was inevitable. But international economic meltdown has accelerated this decline. Given rising inflation in the country and BFIs increasing interest rates to maintain the 90% credit-deposit ratio, investors have little incentive to participate in trading. Likewise, the stock market in Nepal is considered fairly underdeveloped, and the Central Bank has always actively participated to regulate activity. For example, during the bull market last year, the bank issued a directive limiting marginal loans to Rs. 40 million from one BFI and Rs. 120 million in total. Banks are now issuing margin calls and investors, already at a loss, are having a difficult time paying back. The claim that the current bear market is due to NRB’s policies does not hold much basis, and it is more reasonable that it is driven by multiple factors.

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