KRITI S ECONOMIC UPDATE Growth Economic growth accelerated in fiscal year 2016/17 at 6.9% at basic price. This was driven by improvement in supply of electricity; acceleration in earthquake related reconstruction projects, favorable monsoon, increased agricultural productivity and low inflationary pressure. A microscopic approach to understanding recent growth is essential. Agriculture, wholesale and retail trade, and real estate, renting and business activities sector are three major economic sectors that have pushed economic growth. These economic sectors account for nearly 55% of real GDP at basis price. Now it is also important to note what type of economic activities are broadly categorized into these sectors. Agricultural sector generally includes growth of crops, trees, and livestock. It constitutes about 30% of real GDP and is expected to growth at 5.25%. Favorable monsoon, normalization of supply and increased agricultural productivity has contributed to growth in this sector. The wholesale and retail trade includes domestic production of agricultural and manufactured commodities as well imported goods. It constitutes about 14% of real GDP and is expected to growth at 9.8%. The burgeoning of imports and trade deficit and improvement in domestic manufacturing subtly reflects the growth in this sector. Finally, real estate, renting and business activities includes economic activities such as buying and selling, renting and operating of self-owned or leased real estate activities. It also includes the development and sale of land, apartments, hotels and residential buildings, machinery equipments of different types, personal and household goods. Real estate activities are grouped into three major types; organized real estate, rural housing company, real estate companies and land developer companies. The renting services include renting of a range of machinery, equipment personal and household goods. The business services includes range of business service activities: computer and related activities, research companies, legal service activities, cooperative activities, auditing and tax consultancy, advertising agencies, employment agencies, security services, and photographic activities. This aggregated sector constitutes about 10.3% of real GDP and is expected to growth at 5.27%. Industries such as construction, manufacturing, electricity, gas and water, and transport, storage and communication has also achieved higher growth. Construction activities are grouped into two major categories: Pakky (concrete) construction and Kachhy (Non-concrete) construction. The estimates of the output for Pakky construction activities are generally estimated using the total supply of construction materials e.g. domestic
production and imports. For Kachhy construction, different indicators- length of earthen roads, expenditure on household construction are used. This sector is expected to grow by 11.66%. The surge in import of material important for construction such as cement, M.S. billet, ongoing reconstruction following devastating earthquake have contributed to the growth of this sector. The allocation of NPR 335 billion for capital expenditure including NPR 145.93 Billion for Reconstruction in fiscal year 2074/75 indicate that growth in construction sector is set to continue in next fiscal year. Electricity, gas and water sector is expected to grow at 12.97%. Manufacturing sector is expected to grow at 9.70%. The estimates of manufacturing activities are grouped into three major groups: modern manufacturing, small scale manufacturing, and unincorporated manufacturing. Improvement in supply of electricity and normalization of supplies following the blockade has contributed to the growth of this sector. Caution: However one should be careful while interpreting these figures due to the base effect. In earlier fiscal year, these industries have shrunk due to the devastating earthquake and blockade at southern region. The sluggish government capital expenditure (65.53% of targeted capital budget) and below par reconstruction expenditure (around 38% of targeted NPR 111 Billion) may lead to downward revision of GDP estimation. A moderate economic growth is expected in the next fiscal year 2074/75 considering healthy growth expected in construction and industry sectors and possibility of further slowdown in remittance growth rate. But the recent flooding may affect the economic growth, particularly the agricultural sector (paddy production) and industrial base located in southern region. The economic growth prediction may be revised in coming months considering the extent of the damage. But the growth in next fiscal year will primarily be determined by budget execution and pace of implementation of national pride project and the earthquake reconstruction activities. Inflation The inflation has been low in this fiscal year. Year to year(y/y) inflation fell to 2.7% in Mid-July 2017. The average annual inflation is around 4.5% which is below the target of 7.5%. Due to close affinity with Indian Economy, open border, high trade dependency with the southern neighbor and central bank s policy to tie up inflation with India, the inflation trend in Nepal tends to mirror that of India. The normalization of supply following the blockade, increase in agricultural product, and more importantly continued low inflation in India following demonetization has contributed to low inflation in Nepal. With India s long term inflation target of 4% with upper tolerance level of 6% and lower limit of 2%, we expect inflation to be around NRB s 7.5% target.
Money Supply (M2) Under an exchange peg system, broad monetary aggregate is set as an intermediate target in Nepal s monetary policy. The Net Foreign Assets on backdrop on increasing flow of remittance has emerged as contributing factor of money supply. In the fiscal year 2016/17, the broad money supply (M2) has increased by 15.5% which is below target of 17%. The money supply seems to have increased in last month of fiscal year due to government expenditure stacking up in the last month of fiscal year. Government Expenditure and Deposit The money ball parked by government in Nepal Rastra Bank reached NPR 269 Billion (June 2017) which was historically high. Our prediction that government expenditure will increase in last month seems to be confirmed by latest figure. By the end of fiscal year 2073/74, the capital expenditure stood at 65.5% of budgeted capital expenditure which was 38.5% at mid June. In absolute figure, the government spent around 81 Billion in last month of fiscal year under capital expenditure. But, the quality and effectiveness of such spending remain a concern. In aggregate around NPR 238 billion of total budgeted amounts were spend in the last month of fiscal year and around NPR 83 billion was collected as revenue. As a result, the government deposit has dwindled to NPR 127 Billion by mid July 2017. The spillover and trickledown effect of liquidity injection will be felt in financial institutions and capital market. % Interest Rate The monthly interbank rate among the commercial bank reached 4.13% in February 2017 which was highest in the last three years. It has declined to 0.64% by mid- July. Earlier banks has offered high interest rate on fixed deposit and saving account to protect their deposit base as well as to attract new deposits. As a consequence, the weighted average of deposit rate of commercial bank has increased from 3.28% from start of fiscal year to 6.15% at end of fiscal year. The increased deposit interest rate has been passed on to borrowers, resulting in higher interest rate on loans. The weighted average lending rate of commercial banks has also increased from 8.8% to 11.33% during the fiscal year 2073/74, which may eventually affect new credit creation in economy. The aforementioned burgeoning government expenditure at end of last quarter, declining interbank rate, increasing excess reserve of BFIs in Nepal Rastra Bank (comfortable central bank liquidity) indicate that the liquidity in the financial system will be normalized but it will be take few months for adjustment. The upward trend in interest rate seems to be checked. Slowly
deposit rates have started to decline but the average base rate of commercial banks is around 9.8% which is highest in last 4 years. As BFIs have to consider base rate to determine interest rate on loan, lending rate of commercial banks will not be revised downward immediately. Widening Trade Deficit Following the end of trade disruptions, the growth of import have rebounded to pre-crisis level and set a new high. The growth in import is driven by imports of petroleum products, vehicles and spare parts, industrial product such as iron and steel, cement, M.S. Billet, Electrical equipment and agricultural equipments and supplies. While the growth of exports continues to remain weak as export to India (major export destination) has failed to reach pre-crisis level due to weak demand India following demonetization. Remittances The estimated remittance inflow stands at 695.45 Billion in fiscal year 2073/74. The growth of remittances (which represents 26.9% of GDP) was 4.6% which is below target of 5%. The departure of migrant workers has further fallen due to weaker demand for workers in Gulf Countries such as Saudi Arabia and Qatar. Credit to Core Capital and Deposit (CCD) Ratio of Commercial Banks Rapid credit growth and slowing deposits contributed to diminishing availability of loan able funds as credit growth soared to five year record high on backdrop of slower deposit growth. On year to year basis, the deposits of commercial banks have increased by 18.5% while the loans of commercial banks have increased by 25.57%. Earlier gap between deposit growth and credit growth was even more alarming and as a result, many commercial banks exceeded the 80% threshold of CCD ratio. Central bank stringent stance on loans such as hire purchase, margin nature, over draft and real estate has prompted banks to revise their lending and slow down their credit expansion. The central bank also brought temporary relaxation in calculation of CCD ratio. After the withdrawal of such relaxation in new monetary policy, the CCD ratio of commercial banks on average is 77.46%. The decline in CCD ratio signals long term stability of the financial system. BFIs exceeding the statutory limit have been given three months to bring it down to the limit. Finally, the trend of higher interest rate on fixed deposit and saving deposits has changed the composition of saving and fixed deposits. In last seven months, the proportion of fixed deposit in total deposit has increased to 42.5% from 30.7% where as that of saving deposit has decreased to 33.37% from 40.2%.
The recent directive from NRB has explicitly included provision that interbank deposit should not be included while calculating CCD ratio. As per recent circular by NRB, interbank deposit for this purpose should be understand as those amount that been issued as loan to other BFIs but kept in the same institute as deposit. This provision may not immediately affect commercial banks and has been brought as a cautionary step to close down loopholes concerning calculation of CDD ratio. On a positive note, targeted for long run, BFIs can use amount raised by issuing bond in domestic currency with maturity of 5 years or more as core capital and deposit (resource mobilization) in CCD calculation. It seems central bank is signaling commercial banks to seek long term cheaper alternative source of fund rather than depend on expensive deposit base. Risks The liquidity pressure in financial system has eased up; upward trend in interest rate seems to be abated but the subsequent adjustment in financial system may take some time. In other words, interest rate on loans may not be revised immediately. The spillover and trickledown effect of liquidity normalization may be moderately felt in capital market.