High inflation amid low growth: Worrying case of the stagflation predicament in Nepal

Surging oil prices amid the pandemic disrupt economic activities, while savings erode and banks run short of funds.

NL Today

  • Read Time 3 min.

Kathmandu: Nepal’s economy is not on a positive track. The latest reports of the Nepal Rastra Bank (NRB), the central bank, shows Nepal’s economy is struggling as economic activity is sluggish, while inflation is running rampant. 

The consumer price inflation (CPI), in the first five months of the current Fiscal Year, stood at 7.11  percent, higher than the 6.5 percent target set by the central bank.

On the other hand, the growth stood at a mere 1.8 percent in 2021, in contrast to the Central Bureau of Statistics (CBS) estimate of six percent.

Such a phenomenon, also known as stagflation, refers to a condition in the economy where high inflation couples up with high unemployment rate. This causes serious trouble in economic-policymaking.

Expansionary policies to boost economic activities and lower unemployment would cause an inflationary spiral, whereas contractionary policies to bring inflation down would further increase unemployment. Likewise, failing to make effective and timely policies in such a scenario could potentially initiate a vicious cycle of eroding real income, increasing unemployment, and disruptions in the country’s monetary system.

Unlike the ordinary demand-pull inflation where economic growth precedes and causes inflation, the case is exactly the opposite in stagflation, where inflated prices precede and cause the contraction of the country’s economic output. This is because stagflation occurs primarily because of black-swan events that adversely affect the aggregate supply in the economy, which in the present context would be skyrocketing oil prices and supply-chain disruptions caused by the global pandemic.

The international market price of oil (Crude Oil Brent) soared by 45.2 percent to USD 73.71 per barrel in mid-December 2021 from USD 50.77 per barrel the previous year. The effect of such a sharp rise in oil prices has brought a plethora of adverse economic consequences to the country that include an increased cost of production and a burgeoning trade deficit.

The Nepal Oil Corporation (NOC) also issued a press release recently stating that the company depleted all of its accumulated profits and is now forced to take loans to purchase fuel. 

Similarly, pandemic-induced disruptions in global supply chains seem to exacerbate the situation. Prices of products like aluminum, copper, steel, electronic components, wood, among others, increased significantly. This combined with an eight-fold increase in the shipping costs globally due to labor shortages and surging fuel prices significantly increased the import prices for Nepal, due to which there also exists a shortage of loanable funds, or liquidity crunch, in the country’s money market.

Aside from the uncontrollable factors responsible for the gloomy economic condition of Nepal, there also have been policy failures from the country’s side which are at fault for worsening the situation. With a mere 13.5 percent of allocated expenditure in the first five months of the current fiscal year, the government has failed to exhaust the allocated funds for capital expenditure on time, due to which the market is short of liquidity as well as employment in the present context.

Similarly, the extreme dependence on imported fuel has been an issue for a long while. Institutional and market inefficiencies like the monopoly of NEA, lack of infrastructures like electricity transmission lines persist to this day in the country’s energy sector, due to which Nepal is unable to unleash its potential on alternative energy sources like hydroelectricity and solar energy.

Although a few policy efforts are seen on this side of the story such as tax exemptions on electric vehicles and subsidized loan facilities for businesses affected by the pandemic aiming to address the issue by strengthening the domestic demand, they still fail to get to the heart of the issue: a weak supply side. Aiming to address the economic growth problem during stagflation using the Keynesian approach would somewhat resemble going out drinking in a bar: the first few drinks appear to have decidedly pleasant benefits, but oh that hangover! 

Without properly addressing the supply side of the story, expansionary policies as such that aim to boost aggregate demand amidst stagflation can only bring growth at the cost of an even higher rate of inflation and all the adverse consequences that follow.

This content is prepared by Nepal Invests. It facilitates and empowers all investors within the country and abroad to establish, operate and expand their businesses in Nepal. It tweets as @Nepal_Invests

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