When we (Siromani Dhungana and Mahabir Paudyal) from Nepal Live Today reached the residence of former Finance Minister, and former governor of Nepal Rastra Bank, Dr Yuba Raj Khatiwada, on Wednesday for this interview, he was watching the news of economic crisis unfolding in Sri Lanka on television. The crisis in Sri Lanka is the worst of its kind in history, he said warning we might face the same fate if we do not take the corrective measures right now. In this extensive conversation with Nepal Live Today, Dr Khatiwada not only reviewed the state of the Nepali economy but also explained how we came to this point, who are the responsible actors for it and what should be done. Excerpts:
Where does Nepal stand economically at the moment? Are we headed towards a state of bankruptcy?
I don’t want to put people in a panic by saying that our economy is falling down but I also don’t want the responsible authorities to be complacent about the current economic situation. Look at the numbers and you will see where we stand.
First, look at the macro-economic indicators. Nearly none of the indicators except the projected GDP growth rate are in good shape. We are having our unprecedented balance of payment (BOP) crisis. It’s not just a crisis of a few billion rupees. It’s a deficit of more than 300 billion rupees as the fiscal year ends. If you corroborate this with the loss of foreign exchange reserves, it is more than a quarter drop in less than a year.
Current account deficit is the strongest indicator of the external sector crisis. In Nepal this amounts to about 13 to 14 percent of GDP. These are scary numbers. The same for Sri Lanka stood at 8 to 10 percent sometimes before the peak of crisis. At the helm of the crisis, the current account deficit is 11 percent there. Nepal’s current account deficit is already 13 to 14 percent. This implies a serious external sector risk.
Look at the rate of depletion of our reserves. It has come down to 11 trillion from 14 trillion in a single year–the amount that was accumulated over the last several years. The fall is much higher in dollar terms as the exchange rate has depleted by 7 to 8 percent this year. If you see such depletion by 300 billion in a year, how many more years do you need to bring it down to zero? We might soon reach there unless such a free fall is stopped. Sri Lanka was just at the same level of reserves two years before what we have today. In other words, two years ago, Sri Lanka’s reserves were nine billion dollars, which is exactly the same amount Nepal has today. Because of policy distortions and political mismanagement, Sri Lanka is having a free fall. We might get there soon if we do not take corrective measures.
Take another macro indicator of inflation. General prices are rising unprecedentedly. Maybe inflation is going to be at double digit, the highest inflation rate in a decade. Look at construction material prices which have gone up by more than 27 percent. That is going to affect the whole set of capital formation. As the cost of production rises that much, this makes our business and exports non-competitive.
What is the state of revenue collection? How could the economic stress hamper that?
The only thing we see positive with the current budget is that the revenue has been collected satisfactorily. But that satisfactory revenue comes from two factors–burgeoning imports, and particularly imports of high duty commodities like petroleum and automobiles. Now the duties on petroleum are announced to have been slashed down and import of some items is banned, and provided that the government is honest about its decision, this decision would seriously hamper revenue collection. Next year’s revenue base will be totally eroded if they adjust the fuel prices as said. If they further control the imports to correct the balance of payment which is desirable, revenue collection will be much lower than budget estimates and we will have a big fiscal deficit of six to seven percent of GDP, or even higher. Sri Lanka had exactly six percent of GDP equivalent fiscal deficit two years before. It takes no time for any such number to deteriorate to the level of a crisis. But we still have time. If we take corrective measures, if we intervene in the economy in a proper way, we will not meet the fate of Sri Lanka. But if our rulers act like the rulers of Sri Lanka, the worst is sure to come.
It was imminent from the very beginning of this fiscal year that the balance of payment crisis would come soon. Why did the government not take the immediate action to manage imports, and withdraw some of the relaxations made during the peak Covid time?
Again look at the welfare programs we are having. If you don’t have a revenue base and you are spending too much in social security and old age allowances, trying to appease everybody without having any revenue base, this will push us to total bankruptcy. If we are planning for some welfare measures and social security programs, we should be concurrently having some tax schemes to make up for the kind of subsidy we are providing. Do we have it? The Finance Minister has done everything to erode the tax base, he reduced some tariff rates and raised the exemption period and limit of income for income tax. There are exemptions here and there and no measures anywhere to widen the tax base. Salaries of civil servants have been increased by 15 percent. Budget for the election is not sufficiently allocated. With all these, it’s not too far that we will have a crisis in budget management in the next fiscal year. In the couple of months of the next fiscal year, we might see the indicators of the worst situation on the fiscal front.
On the monetary front, we had an unprecedented credit growth. I had never seen such credit growth in my career as a central banker. I had been doing or overseeing monetary programming right since the mid-1980s to 2015 in one way or another. I always used to find credit growth at the maximum rate of 20-21 percent. Now that credit grows by 30 percent or more at an indicative low interest rate, and credit flow in dubious areas and regulatory relaxations continues means we are inviting macro financial crisis.
Today’s financial situation is like this: You cannot repay loans, you cannot pay interest, you open a new company and get fixed capital or some financing, take some working capital loan or overdraft for the existing company, reevaluate your collateral and take more loan and you pay the loan and interest. If you don’t get it paid by one bank, you go to another bank, ruthlessly competing banks have the chance to finance you. So the loan is ‘good’, banks earn interest, the balance sheet of the banks swells up and banks become richer because they have more operations. Since every loan is current, and there is no need for high provision for bad loans, you can declare more profits and then dividends amid unbelievably low non-performing loans at little over one percent of total credit. Bank investors are happy in getting good dividends even when you have Covid-19 situation and the economy is not doing well. Does this happen in real life when business communities are not able to repay any loan and the banking system is enjoying high profit with low non-performing loans? This is all the window-dressing or greening the balance sheet. The real stress of the banking sector is yet to unfold. If that unfolds, many loans would be defaulted and the non-performing loan level would easily cross five percent. Should the new monetary policy come with true stands and standard regulatory norms, I can see some kind of turbulence in the financial system as well. The stress in the banking system is huge but remains hidden now. The borrowers are pampered with low interest rates of six or seven percent. They are looking for the same rate even when the deposit rates are going up to 12 or 13 percent.
There have been some government interventions but these are belated, very imprudent and largely insufficient.
Then we have the informalization of the economy or the operation of parallel economic activities with a lot of unseen transactions right from over-invoicing of imports with low duty to under-invoicing of imports with high duty structure, risk free smuggling, capital flight, asset bubbles, illegal investment in digital assets and so on. And then you have a premium for foreign currency in the foreign exchange market to finance illegal transactions. Thus, you can sell dollars in the parallel market with a premium of five to six rupees per dollar or Indian rupee at a premium of Rs 3 per 100 Indian rupees. Then we see remittance coming down, because of lucrative hundi in operation, even when the number of people going out has increased by almost double from last year. This is all because of the mismanagement of the economy, absence of regulators, and absence of the people who can discipline the business system. As a result, people have lost faith in the government and the regulators whom they otherwise could trust that even such cases could be resolved by certain degree of measures. That kind of confidence and assurance is not forthcoming to common people. So everybody is thinking that the crisis is imminent.
That sounds pretty alarming to us. Where did our policy makers and politicians make mistakes? Where do you trace the root of this crisis?
First, we took Covid as an excuse for everything. Even when I was the Finance Minister, there was a lot of pressure for cash handouts. Give cash to every affected household, they would say. I said no cash distribution because we cannot sustain cash distribution, as we cannot limit cash support to most needy ones, we don’t have a strong revenue base for Covid reason, we cannot borrow to distribute handouts and we do not know how long the pandemic remains. Instead, we offered to provide jobs and food through the Prime Minister’s Employment Program or Food for Work program. We did not distribute cash. But there were some other relaxations to be made. We had some tax rebates, monetary policy relaxations during the Covid-19 period. And there were relaxations for the bank loans during the Covid period. But later, when we did not have any lockdown and when there were no business restrictions, from that very day the government should have revoked some of these privileges provided before. The government and the central bank should have revised all taxes and credit rebate provisions. But the government became complacent and simply thought the economy was recovering, without realizing that this kind of relaxation and concessions cannot be sustained over time.
We people need to live on our own financial strength. We should not consume today based on what our income and wealth will likely be in the uncertain future. We have to develop the habit of saving.
It’s basically a matter of one year when we started having a balance of payment crisis. It started from July, 2021. From the end of the previous fiscal year, we could see the stress in the external sector, we could see imports burgeoning, credit flows going up and people heavily resorting to imported goods and services and balance of payment suffering a big stress. This was the moment we should have woken up. It was imminent that the balance of payment crisis would come soon. Why did the government not take the immediate action to manage imports, to manage easy money flows, and to withdraw some of the relaxations which could not be sustained for long? Why did the government not coordinate among the central bank, Ministry of Finance, Ministry of Industry and Commerce and Supplies and Securities Board of Nepal (SEBON)? They should have made a kind of joint or collective mechanism to assess the economy and take proper action on time. But everything happened in the reverse order. I was told that the central bank was restricted from adjusting the interest rates at the market level. I was told that there was political intervention to keep interest rates low. When interest rates are kept low, people start putting money in the share market and land and buildings. The result was that bubbles were created in several areas and that created a lot of demands for bank credits. Banks having a lot of undistributed funds and paid up capital started doing very unhealthy competition of capturing markets by reducing rates and offering concessions. The government and the regulators should have taken action right from October, if not from July or August of 2021. From this time onwards, the monetary policy, which is revised quarterly, should have taken that stance. The Ministry of Finance should have avoided intervention in the central bank. It should have taken steps to coordinate among the business activities. The Ministry of Commerce and Industry should have put a kind of quantitative restriction or put a higher tariff on some of the goods. This did not happen. They left the whole burden of import corrections to the central bank.
So the beginning point of the crisis for me is July, 2021 or latest by October of that year.
How do you see some of the measures taken by the government to address the crisis?
The government is doing something to correct the course but it is insufficient, imprudent, and belated. The government cherry picked 10 items to ban imports leaving many sensitive items out of ban. Why only those ten items? Because there was a business interest of some political leaders for other items to be banned. There have been some interventions but these are belated, delayed, very imprudent, insufficient and unwarranted interventions in the affairs of other autonomous bodies.
Do you suggest that we should take strict austerity measures including import bans?
No. There are market-based measures that we should follow in this age of trade liberalization, which we started some 30-35 years ago. There are market mechanisms. Given the binding rates of WTO and SAFTA, you can always raise tariffs. If you cannot deal with tariffs, you have to have a system of administrative measures. For example, you can change the valuation of imports for customs purpose. The government could have done the valuation changes, they could have added some more excise duty. In exceptional cases, they could add more taxes. The central bank should have discouraged opening LCs by asking companies to put higher margin. Only after February this year, the central bank started putting high margins for imports. Why did they not do it from August or September last year? They wasted some four months doing nothing, perhaps with interference by politicians in office.
Import bans or import restrictions are very short-term measures. We should make the cost of import expensive by interest rate policies, foreign exchange policy, customs policy and other tax measures at the customs point. Import bans are not the proper ways of making things right on the external front.
Import bans or import restrictions are very short-term measures. We should make the cost of import expensive by interest rate policies, foreign exchange policy, customs policy and other tax measures. Import bans are not the proper ways of making things right.
In your view, how much stress did the real estate and stock sector add to our economy?
The real estate business doubled after Covid-19. If in a single year local and provincial governments can raise 50 billion rupees as land registration fees, you can guess how many transactions might have taken place in a situation of huge under-stating of true transactions, referring to the minimum value fixed by land revenue offices. If your land registrations are done at almost half the prices and if half of the money financed by the banks goes out of the banking system, then that money becomes illegal. It does not come back to the banking system. There were other transactions like crypto or other digital assets or capital flight which made banks dry. So there was a liquidity crisis in the banks. People’s net worth increased suddenly because the land prices were doubling in less than two years. Share prices were doubling in a year. So everybody felt rich and they thought that they could afford to consume more. Look at imports of luxury items, mobiles and automobiles.
Who are the real actors who pushed the real estate sector to this situation?
First, the banks. Very imprudent lending practices of the banks. Right from the day the central bank decided to increase the paid up capital by four folds, I have been saying that banks would be over capitalized for some years.
We people need to live on our own financial strength. We should not consume today based on what our income and wealth will likely be in the uncertain future. We have to develop the habit of saving.
They would go for relentless lending, and lending in unproductive areas would create a lot of stress in the financial system. After Covid, banks had a lot of money un-lent, and they had benchmarked their profit. So they had to push credit to any area. The central bank’s regulations remained complacent because of the low NPA level.
How do you see the recent alleged financial crime committed by Finance Minister Janardan Sharma?
I have never seen such a crime in my career as a professional right from the early 80s till mid-2021. I have never heard such a story. Never ever in the history of Nepal’s budget, have I heard such a story. Whether or not there was a third person in budget making, to prove that he was not guilty, the Finance Minister simply should have protected the CCTV footage and presented it to the people and the Parliament where it was demanded. The story would have been over. But he did not and could not do so.
Second, the presence of any unauthorized person in the Ministry of Finance during budget preparation and particularly during tax finalization is not excusable. It is evident that the presence of that unauthorized person made some very unjustifiable changes in the tax rates to favor some business houses. Every change made in the tax, customs, excise and other rates was seen to be giving favor to some targeted business houses. You can guess who the people are being benefited from such changes. Look at the coincidence. The alleged presence of the third person in the Ministry of Finance, the footage being deleted on flimsy ground, and the tax provisions altered in favor of certain business houses and the alleged person being associated with the same business houses. All these coincide to the point that some misconducts and violence of basic budgetary disciplines and norms have been committed. This is extremely objectionable, unacceptable financial crime and mockery of the fiscal system.
In the last 30 years of my professional career, intermittently I was a part of the budget writing team in the Ministry of Finance right from 1995, with one capacity or the other. Even when I was part of the budget writing team, I never ever sat in the revenue discussion. I was engaged in drafting budgets for several years. But I never interfered in the revenue section. When I was the Finance Minister, I did not allow any person other than the most relevant official to sit in the tax discussion meetings. When I was discussing the internal revenue department issue, customs people would not be there. When I was discussing the customs issues, the internal revenue department people would not be there. It would be only me, two secretaries of the ministry and two officials from the respective departments.
The Finance Minister commits a mistake and he pretends not to have made any mistake. And at the same time, he challenges everybody including the Parliament. When people like former Finance Ministers said the economy was in bad shape and he should be taking very cautious measures, he challenged them stating everything was right. He did not listen to anybody. When parliamentarians were asking if he was not guilty he should produce the CCTV footage, he said ‘who are you to ask for the footage?’ He openly challenged even the parliamentarians. How could he undermine the parliamentarians?
All over the world people may be saying what kind of country Nepal is where the budget making process and tax proposals are allowed to be tampered by agents of some business houses. There is no word to lament such a financial crime.
During my tenure as the finance minister too, questions had been raised about the budget I presented. I volunteered to form a parliamentary committee to find out if mistakes had been made. I said, “it is not only during my tenure as the Finance Minister, but also for lifelong I would be accountable if I have made any mistakes”. If he was not guilty, he could have simply said that he was ready to be probed the very day the controversy arose. With such conduct, he has eroded the ethics, principles and discipline of the budgetary system. All over the world, people may be thinking what kind of country Nepal is where the budgetary decision making process is allowed to be tampered by outsiders. There is no word to lament what happened with the budget making process this time.
Can we infer from this incident that cronyism is being institutionalized in Nepal? And there is little space for genuine business?
I would not jump to that conclusion now. I would not say that crony capitalism has become rampant to the state of the country being totally corrupt. But there are instances we need to worry about. Most business people still want to do fair business in this country. We have the most scientific taxation system, a fair financial system, our tax regulators are good and our investment climate is good. But there are some people who always want to get favor against the rest of the business communities, and there are some politicians who yield to such interest. I take the recent case as an exception, not as a norm. Yet, if we give excuses or forgive everything happening now, this might become a trend and we will reach the point of crony capitalism taking precedence over genuine business. This is why action must be taken against any kind of financial crimes and financial misconducts. This is time to say enough is enough.
Given this adverse context, what type of monetary policy should the central bank bring? What would you recommend to the Nepal Rastra Bank?
I don’t know whether the Central Bank will take my unsolicited suggestions. They probably have to listen more to their current Finance Minister than to the former Finance Minister. But if I were to make some decision, I would do things a bit differently. When I entered the central bank as the governor in 2010, the situation was somehow similar to what it is today. There was a big balance of payment crisis, general prices were picking up and the real estate prices were too high, banks were over-lending to the real estate, forex reserves could finance six months of imports but were losing imports cover every month. Then I started taking strict monetary policy along with rationing credit to productive areas. I directed 10 percent of credit to go to the most prioritized agriculture and energy sectors. Thus, while I brought the strict monetary policy, at the same time, I also did ensure credit for the productive sectors. I targeted credit but that credit would come within the monetary discipline that we set in the monetary front—keeping inflation low, keeping the balance of payment at a positive level, and ensuring stability in the financial system. So economic stability could be achieved while at the same time making credit available to the productive sectors. This is the art of doing monetary and credit policies. I suggest that for the current central bank governor as well.
Finally, what measures would you suggest to the government so that we do not end up becoming another Sri Lanka? How should people conduct themselves in times of crisis like this?
First of all, the government should put more responsible persons in the leadership of the Ministry of Finance. We need such people in the Ministry who can at least show honesty, sincerity, wisdom, and patience to listen to suggestions provided by professionals and experts. Second, the bureaucracy of the Ministry should be more accountable and responsible rather than being submissive to every misdeed of the leadership. Third, the Ministry doesn’t need to interfere in the affairs of the central bank unless there is misconduct done or damage incurred to the economy. Let interest rates take their own market course. Let the central bank tighten monetary policy as needed.
Actions must be taken against any kind of financial crimes and financial misconducts. This is the time to say ‘enough is enough.’
Central bank should also not go for a cheap and populist way to make everybody happy. Fourth, there should be higher responsibility among the regulatory agencies and administrative agencies such as SEBON, Nepal Rastra Bank, Ministry of Finance, Ministry of Industry, Commerce and Supplies. Currently, everybody seems to be doing others’ jobs but not their own. Trade restriction measures, which should be taken by the Ministry of Industry, are being taken by the central bank. Share market stabilization is SEBON’s job but the central bank is overly cautious about it. Interest rates and foreign exchange management is mainly the job of the central bank but the Ministry of Finance is intervening in these areas. The regulatory and policy making agencies should take their respective responsibilities individually and collectively and should not play blame games.
As regards the general people, we need to live on our own financial strength. We should not go for unsustainable consumption based on predicted wealth in the assets market, or expect undue state support which cannot be offered without taxation. We should not overly consume today based on what our income and wealth will likely be in the uncertain future. We have to be realistic in our living styles, need to develop the habit of saving, and opt for sustainable living standards, particularly when the economy is at a stress.