Prashanta Pradhan

Synopsis

Nepal ranked 94 in the recently published World Bank’s Doing Business Report with an increase in score from 59.7 to 63.2 in just a year. Improvements were reported in scores on dealing with construction permits, trading across borders and enforcing contracts but the highest increase was reported in getting credit with substantial improvement by 25 basis points from 50 to 75. Within various indicators on getting credit, the highest improvement was seen on credit bureau coverage of adults from mere 2.7% in 2018 to 7.3% this year covering 1,301,061 individuals and firms.

Credit Bureau and Credit Reporting System

Credit reporting systems consist of institutions, individuals, infrastructures and procedures that facilitate the flow of information enabling decisions related to provision on loans. Credit reporting systems aim to address information asymmetries that exist for evaluating whether to extend credit to debtors or not. Credit Bureau is an actor in the credit reporting system whose primary function is to improve the quality and availability of data for creditors to make better informed lending decisions. There are three other main actors – Data Subjects (individuals and businesses whose data are collected), Data Providers (financial institutions and utilities that provide information and data subjects) and Data Users (banks, central banks, and employers who use credit information provided by credit bureau).

The Credit Information Bureau of Nepal was established in 1989. The shareholders of the bureau are central bank along with commercial banks and financial institutions. Nepal Rastra Bank Act 2002 states that NRB will establish or cause to establish one credit information centre for the primary purposes of obtaining information on the flow of credit from commercial banks and financial institutions as well as information on debtors not paying loans on time or misusing the loans.

Non-Performing Loans and SMEs’ Access to Finance

• According to Nepal’s Central Bank, between FY 2016/17 and FY 2017/18, the volume of Non-Performing Loans (NPL) of commercial banks increased by 8.14% reaching Rs 29.85 billion. The increase was seen in both public and private banks by 7.93% and 8.27% respectively.
• IMF has reported that 70% of total lending is concentrated on real estate sector which may be difficult to avoid due to less developed and less diversified banking system. Moreover, bank’s loans books indicate half of loans as overdraft and working capital loans which rollover continuously with the quality of loans difficult to gauge.
• As per Nepal Rastra Bank’s 2019 study findings, only 16% of SMEs in Nepal are taking credit from banks and financial institutions as initial capital compared to 33% from family assets and 26% from savings. On average, 50% of SMEs have taken credit from banks and financial institutions. On average it takes 38 days for SME to access credit.

Information Asymmetry and Business Environment

Access to finance plays a significant role in improving business environment and economic growth in an economy. However, information asymmetry hinders access to growth in many developing economies, especially for SMEs that contribute a large share of employment. In Nepal, SMEs on average employ 1.7 million people and contribute to 22% of GDP. In developing economies, enforcement of contracts and functioning of legal systems are relatively weak. Hence, the role of information gathering and sharing are important to enhance creditors’ protection. Taking past behavior of borrowers as a reliable predictor of future behavior, crediting reporting systems minimize risks creditors have to bear with borrowers.

On the one hand, credit reporting system support regulators in supervision and monitoring credit risk whereas on the other hand, financial institutions can enhance access credit to small firms, reduce interest rates and improve borrower discipline. NRB study has indicated collecting information about SMEs and speedier credit approval are among the top ways to enhance access to SME financing. A World Bank study done across 63 countries covering more than 75,000 firms indicated that after the introduction of credit bureau, there were greater possibilities for firms to access finance, lower interest rates, lengthen maturity and increase the share of working capital financed by banks.

Today, credit bureaus operate in many countries around the world and there is growing emphasis on strengthening them. Some of the drivers of growth of credit bureaus are growth in retail credit, reform stemming from financial crisis, the rise of digital technologies all of which increase need as well as opportunities to expand access to credit information services.

Alternative Sources of Data to Serve Underserved Segments

While traditional sources of data like commercial banks and financial institutions enable data users to access data and associated analytics on existing borrowers. However, this does not cover new borrowers. Hence, there is also growing need for tapping alternative sources of data, for example, from utilities operators on payment history, telecom companies etc. The ability of a system to tap into these alternative sources of data shall greatly contribute to enhancing access to finance and reducing credit risk of lenders. In general payment data, social media data and behavioural data are considered to be useful to contribute to credit scoring.

Conclusion

Nepal Rastra Bank’s Monetary Policy 2019 as well as the International Monetary Fund’s Country Report 2019 refer to the need for improving credit reporting in Nepal. It is crucial for credit reporting agencies to embrace advanced digital technologies and big data analytics to collect and analyse credit and payment data collected from various sources. Moreover, in order to strengthen the financial sustainability of credit bureaus and enhance value creation in the economy, value added services from credit data analytics also needs to be developed which could be relevant for many industries and businesses other than banks and regulators, for example, retail services with high reliance on digital payments, employers who would like to understand credit behavior of their potential applicants or existing applicants. However, regulatory frameworks and data protection procedures should be strongly put in place too.

References

1. IMF. (February, 2019). IMF Country Report No. 19/61. Retrieved from https://www.imf.org/en/Publications/CR/Issues/2019/02/15/Nepal-Selected-Issues-46623
2. Peria, M. S. M, and Singh, S. (August, 2014). The Impact of Credit Information Sharing Reforms on Firm Financing. World Bank Policy Research Working Paper 7013. Retrieved from https://openknowledge.worldbank.org/bitstream/handle/10986/20348/WPS7013.pdf
3. Nepal Rastra Bank. (2019). Bank Supervision Report. Retrieved from https://www.nrb.org.np/bsd/reports/Annual_Reports–Annual_Bank_Supervision_Report_2018-new.pdf
4. Nepal Rastra Bank. (2002). Nepal Rastra Bank ActNepal Rastra Bank Act, 2058 (2002). Retrieved from https://www.nrb.org.np/lgd/acts_ordinances/Nepal%20Rastra%20Bank%20Act,%202002%20(English)2074.12.21.pdf
5. Nepal Rastra Bank (2019) SMEs Financing in Nepal. Retrieved from https://www.nrb.org.np/red/publications/study_reports/Study_Reports–नेपालमा_साना_तथा_मझौला_उद्यममा_वित्तीय_साधन_परिचालन_2076-new.pdf
6. World Bank Group. (2019). Doing Business 2020 – Comparing Business Regulation in 190 Economies. Retrieved from https://openknowledge.worldbank.org/bitstream/handle/10986/32436/9781464814402.pdf

Understanding and Correcting Nepal’s Widening Trade Deficit

Prashanta Pradhan

Synopsis

While trade deficit is not necessarily viewed as a problem, they tend to raise serious concerns when trade deficit persistently widens for almost two decades as in Nepal. Nepal’s trade deficit emerging from persistent growth in imports that largely cater to consumption accompanied by budget deficit cannot be ignored. The Trade Policy 2015 specifies one of the objectives as reducing trade deficit by enhancing supply side capacity. Nepal’s Monetary Policy 2019 as well as the Budget Speech of Fiscal Year 2019/2020 underscore the need to correct the trade deficit.

Nepal’s trade deficit in numbers

International Trade Centre (ITC)’s statistics indicate that trade deficit peaked in 2018 at USD 9.5 billion which is 8 times or 725 per cent higher than in 2003 when it was USD 1.15 billion. Since then, the number has only widened. The recent macroeconomic situation report published by the Nepal Rastra Bank (central bank of Nepal) indicated that in the first eleven months of the last fiscal year from mid-July 2018 to mid-June 2019, trade deficit widened by 17.2% as compared to the previous year.

Nepal’s imports have grown consistently except for a minor slump in 2015. There has been nearly six-fold increase in imports from USD 1.8 billion in 2003 to 10.2 billion in 2018 whereas while exports have increased but only marginally at 13%. In 2003, Nepal exported USD 652 million compared to USD 732 million in 2018.

Causes of trade deficit in Nepal

• Firstly, the surge in imports have been driven by strong domestic demand for private consumption fueled by remittances from overseas and expansionary monetary policy coupled with weak manufacturing base. The share of remittances to GDP was 28% in 2018. The current monetary policy tends to be expansionary with the limit for growth of broad money (M2) set at 18% and domestic and private sector credit growth rates projected at 24% and 21% respectively. Large pool of inward remittances and increase in money supply in the context of weak manufacturing base have led to an increase in imports of inputs and capital goods driven by construction and consumer goods to meet domestic demand for private consumption. Moreover, Nepal suffers from a weak manufacturing base. As per the World Bank, the value added of services is 50% of GDP, the share of manufacturing was only 5% and including construction was 13% of GDP which added extra demand for imports of capital as well as consumer goods.
• Secondly, poor export competitiveness along with non-tariff barriers to trade have led to poor export development. Nepal Trade Integration Strategy (NTIS) 2016 identified 12 priority goods and services for export promotion based on criteria of export performance as well as inclusive and sustainable development. The export basket is concentrated in terms of products as well as markets. While the volume of exports has been increasing, the share of markets other than India is relatively low. Nepal enjoys preferential tariffs in major international markets through multilateral, regional and bilateral agreements to which Nepal is a party including India-Nepal Treaty of Trade, South Asian Free Trade Agreement, Generalised System of Preferences, Everything But Arms etc. Most of the export products including priority products in NTIS, face non-tariff barriers. For example, sanitary and phyto-sanitary (SPS) related barriers on agricultural products, technical barriers to trade (TBTs) in manufactured goods and regulatory requirements on services. Hence, the competitiveness of Nepalese exports is hindered leading to low volume of exports. Nepal’s export development is also hindered by higher costs of moving goods across borders. Nepal scored 77.17 in Trading Across the Border by the World Bank which is higher than the South Asian average of 62.57 but lower than Bhutan (94.25) and India (77.46).
• Thirdly, lack of adequate financial inflows have contributed to trade deficit. Although remittances account for a major share of GDP and help fund the trade deficit, with only marginal increase in exports, remittances cannot cope up with the immense volume of rising imports. Moreover, uncertainty of inflows of remittances due to changing regional and global economic dynamics poses concerns over the volume and sustainability of trade deficit.

Impact of Trade Deficit on Foreign Exchange Reserves

Increasing trade deficit has caused loss of foreign exchange reserves. As per the available data, as of mid-June 2019, gross official foreign exchange reserves held by the central bank was USD 9.25 billion whereas a year back, it was USD 10.08 billion. On the basis of the first eleven months of imports of 2018/19, existing foreign exchange reserve is sufficient to cover merchandise imports of only 8.8 months and merchandise and services imports of 7.7 months as compared to 16.8 and 14.3 months respectively in 2015/16.

Correcting Nepal’s trade deficit

• Export Diversification: One of the objectives of Nepal’s Trade Policy 2015 is to reduce trade deficit by enhancing supply side capacity. Export diversification shall play a major role in expanding export opportunities of Nepal and reducing trade deficit. Earlier in the week, The Kathmandu Post reported that as an effort to trim the trade deficit, the Ministry of Industry, Commerce and Supplies has identified 28 goods for export promotion which is broader than the list identified in NTIS 2016. The updated list includes medicinal and aromatic plants, black cardamom, ginger and tea, leather products, footwear, readymade garments, pashmina and hand knotted carpet under items with a high comparative advantage. The International Trade Centre’s Export Potential Map shows Nepal’s export potential markets with USD 221.9 million untapped potential with India, USD 45.5 million with China, USD 30.6 million untapped potential with the United States, USD 17.2 million with Germany, for example. Moreover, diversification and development of services sectors could be an important opportunity for Nepal to increase exports. Being a landlocked mountainous country, the geographic obstacles of trading across border shall be easier in services. On the other hand, services sector contributes directly to respective sectoral GDP and employment as well as inputs to other sectors while some services like health and education have a direct impact on sustainable development.
• Trade Facilitation to reduce Trade Costs: Nepal ratified the World Trade Organisation’s Agreement on Trade Facilitation (TFA) in 2017. The TFA includes provisions for expediting the movement, release and clearance of goods, including goods in transit involving cooperation between authorities on customs and other areas of trade facilitation. Full implementation of TFA in Nepal could reduce trade costs by 13.9-15.8%. Nepal is implementing the Customs Reform and Modernisation Strategies and Action Plans 2017-2021 aiming to reduce compliance costs and time, helping risk management and export promotion, among others. Additionally, Nepal is also part of the South Asia Subregional Economic Cooperation programme for Customs Reform and Modernisation for Trade Facilitation Programme 2017-2021. Timely and effective implementation of trade facilitation measures shall reduce the non-tariff costs of trade and promote exports.
• Increasing foreign inflows: Remittances have been largely offsetting trade deficits. However, remittances also bear the risk associated with global economic volatilities. Hence, Nepal should enable a favourable environment to attract more foreign investments along with remittances to ensure there are adequate inflows to finance productive activities as well as support trade balance. To the extent possible, care should be taken to ensure that such foreign investments also bring transfer of technology and knowledge while building responsible business models.

References

1. International Trade Centre. (2019). Trade Map – International Trade Statistics.
2. Khanal, R. (2019, August 21). Ministry moves to expand the export basket to trim trade deficit. The Kathmandu Post. Retrieved from https://kathmandupost.com/money/2019/08/21/ministry-moves-to-expand-the-export-basket-to-trim-trade-deficit
3. Ministry of Commerce, Nepal Government. (2016). Nepal Trade Integration Strategy. Retrieved from http://www.fncci.org/uploads/publication/file/NTIS_2016_20161004020748.pdf
4. Nepal Rastra Bank. (2016). Monetary Policy for 2016/17. Retrieved from https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)–2016-17_(Full_Text).pdf
5. Nepal Rastra Bank. (2019). Current Macroeconomic and Financial Situation of Nepal. Retrieved from https://www.nrb.org.np/ofg/current_macroeconomic/CMEs%20Eleven%20Months%20English%202075-76-Final.pdf
6. Nepal Rastra Bank. (2019). Current Macroeconomic and Financial Situation of Nepal (Based on eleven months’ data of 2018/19). Retrieved from https://www.nrb.org.np/ofg/current_macroeconomic/CMEs%20Eleven%20Months%20English%202075-76-Final.pdf
7. Nepal Rastra Bank. (2019). Monetary Policy for 2019/2020. Retrieved from https://www.nrb.org.np/ofg/monetary_policy/Monetary_Policy_(in_English)–2019-20_(Full_Text)-new.pdf
8. World Bank. (2019). Doing Business 2019: Nepal. Retrieved from https://www.doingbusiness.org/content/dam/doingBusiness/country/n/nepal/NPL.pdf
9. World Bank. (2019). World Bank Data. Retrieved from https://data.worldbank.org/indicator/BX.TRF.PWKR.DT.GD.ZS
10. World Trade Organization. (2017). TFA Factsheet. Retrieved from https://www.wto.org/english/tratop_e/tradfa_e/tfa_factsheet2017_e.pdf