Print Edition - 2017-07-16  |  Free the Words

What if remittances dried up?

  • Investment in the productive sector can transform Nepal’s economy and put it on a self-sustaining path

Jul 16, 2017-

The Nepali economy experienced a remittance surge starting in the 2000s that resulted in remittances accounting for 31.8 percent of the GDP in 2015, the highest in the world according to the World Bank. Of particular significance was how remittance made a dent on poverty, escalated the gross national savings, increased private capital formation, provided a safety net to the people and increased government revenue. However, due to an inflow of resources and a resultant appreciation of Nepali rupees in the early 2000s, there was a surge in imports and erosion of agricultural and manufacturing competitiveness. 

Inflationary pressure

The crux of this remittance boom should be analysed first with GDP indicators, and this does not paint an optimistic picture. First, there has been no change in real GDP growth rates; the trend has not changed since the 1980s. The increase in GDP in current prices following the remittance boom only points to the conclusion that inflation has increased significantly after 2008. The most significant inflationary pressure can be seen in petroleum and gas products, and agricultural commodities. Inflationary pressure in Nepal remains exogenous. Remittances have not altered the path of real GDP at all—they basically bypassed the domestic production base and contributed increasingly to the divergence between current and real GDP, which is nothing but inflation.

This raises doubt over the recent breaking news that Nepal is the “3rd fastest growing economy”, because the current GDP growth rates hit the 7 percent mark. The divergence between the real GDP and this current GDP number implies that this rise is due to a price hike and nothing else. Is remittance the culprit? It would be worth examining other aspects of the economy for a more detailed analysis. 

The composition of GDP has moved towards services, bypassing manufacturing. Along with this structural transformation, the evidence of deindustrialisation is very stark. Compared to the early 1990s, the manufacturing sector’s contribution as a percentage of GDP has declined. Despite the increase in gross fixed assets all over the country in 2011-12 by almost 86 percent compared to 1991-92, the marginal increase in MVA (Manufacturing Value Added) per unit capital by 12 percent implies a drastic decrease in productivity. Nepal is manufacturing less, and doing so less efficiently.

More worrisome is the commercial loans distributed as a percentage of total loans. In 2003, about 36 percent of the total loans distributed were used for productive sectors. This has decreased to 21 percent, whereas unproductive sectors like private construction (2.3 percent to 10.4 percent) and consumables (2.8 percent to 3.9 percent) have seen significant increases. 

The decreasing productivity in agriculture and industry since the 2000s resulted in nearly 16 percent of the workforce producing more than 50 percent of the output in services in 2015. Surplus labour along with unfettered real GDP growth provides a glass ceiling in terms of employment opportunities and structurally induces a vicious cycle that encourages outward migration and lowers productivity and employment. These cases are testimony that the extra income flowing in from remittances did not lead to a productive economic base. 

What about capital formation? There is a widening gap between the government’s contribution in Gross Fixed Capital Formation (GFCF) and the private sector’s contribution in GFCF as a percentage of GDP. After the remittance boom, there has been a drastic dip in the government’s contribution to GFCF as a percentage of the GDP. This has resulted in dismal real indicators, namely in health, education and infrastructure. The question worth asking the government is why public investments have not been prioritised after the 2000s in spite of the increasing revenue due to bloated imports. 

Two major impacts

Not only are remittances bypassing productive sectors, they are simultaneously discouraging them. The increase in consumption is being met by excessive imports. More worrisome is the divorce between the Gross Domestic Savings (GDS) and the Gross National Savings (GNS) post the “remittance boom”. Thus, the drying up of remittances would first hit these two aspects of the Nepali economy: the Balance of Payments (BOP) and investment. 

First, since the GDS as a percentage of GDP nosedived after 2000, following a simultaneous surge in GNS as a percentage of GDP, Nepal would be out of resources to fill its investment gap. Nepal cannot sustain a savings rate that would adequately meet the current investment demand; the majority of our savings are a result of funds that enter the country through remittances. Our investment scenario would be in shambles. In other words, there would be little or no money for investment when it is based only on the income saved from domestic sources. This would spell a disaster. Most countries that have followed a sustainable development path provide counter examples to this scenario—they saved domestically and invested. 

Second, since this is the only source of income being used to close the BOP deficit, a major imbalance would occur because of the increased dependence on imports. We might end up with a major economic crisis. 

The solution is to augment productive investment to transform the economy and put it on a self-sustaining path. If remittances were to stall, the economy will face a crisis starting with the BOP, leading to a dip in investment and eventually increasing poverty. This may push the country back to the level before the remittance boom in 2000, rolling back the progress made in the last 17 years.


Khatiwada has an MSc in Economics from Indira Gandhi Institute of Development Research, Mumbai; views expressed here are his own

Published: 16-07-2017 08:00

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