Nepal Growth Diagnostic
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The production of the constraints analyses posted on this website was led by the partner governments, and was used in the development of a Millennium Challenge Compact or threshold program. Although the preparation of the constraints analysis is a collaborative process, posting of the constraints analyses on this website does not constitute an endorsement by MCC of the content presented therein. 2014-001-1569-02 Nepal Growth Diagnostic May 2014 Foreword It is my pleasure to introduce the recently completed constraints to growth analysis, which is the result of a partnership between the Government of Nepal and the Millennium Challenge Corporation (MCC), a United States Government aid agency dedicated to promoting economic growth and poverty reduction. In December 2011, and subsequently in 2012 and 2013, the Board of Directors of MCC selected Nepal as eligible to develop a threshold program. A joint team of economists working on behalf of the governments of Nepal and the United States conducted extensive research and analysis for more than one year, proactively engaging a wide array of stakeholders both within and outside of the Government of Nepal. This extensive and inclusive analysis concludes that there are four main binding constraints to economic growth in Nepal: policy implementation uncertainty; inadequate supply of electricity; high cost of transport; and challenging industrial relations and outdated labor laws and regulations. Agreeing with these findings, the Government of Nepal recently highlighted power and transport infrastructure development as priority sectors for intervention. I take this opportunity to express my sincere thanks to the team of MCC, USAID, and Nepalese economists, along with officials from the Ministry of Finance, for their hard work coordinating and successfully concluding this exercise. I also thank all stakeholders, including development partners and officials from the Government of Nepal and non-governmental agencies, for their contributions during consultations. This analysis will be used as resource for designing the MCC program, as well as for initiating various policy and institutional reforms in the relevant sectors. We hope that this analysis will help to inform policy and institutional reforms that promote economic growth that directly benefits the people of Nepal. Thank You, Shanta Raj Subedi Secretary Ministry of Finance Government of Nepal April 2014 i Contributors Government of Nepal Coordinating Ministry - Madhu Marasini, Chief of International Economic Cooperation Coordination Division, Ministry of Finance - Narayan Dhakal, Under Secretary, International Economic Cooperation Coordination Division, Ministry of Finance Team Members - Chiranjibi Nepal, Chief Economic Advisor, Ministry of Finance - Sri Ram Paudyal, Former Chief Economic Advisor, Ministry of Finance - Min Bahadur Shrestha, Executive Director, Research Division, Nepal Rastra Bank - Puspa Lal Shakya, Joint Secretary, National Planning Commission - Surbir Paudyal, Professor, Tribhuvan University - Dev Raj Adhikari, Professor, Faculty of Management, Tribhuvan University - Bhavani Dhungana, Economic Consultant - Hemant Dabadi, Federation of Nepalese Chamber of Commerce and Industry (FNCCI) - Dinesh Raj Pant, Economist - Hari Shankar Bhattarai, Freelance Socioeconomic Researcher United States Government Lead Agency - Millennium Challenge Corporation Team Members - Bradley Cunningham, Lead Economist and Team Leader, MCC - Jeremy Streatfeild, Lead Economist, MCC - Rave Aulakh, Senior Economist, USAID/Nepal - Kishore KC, Economist, USAID/Nepal - Cecily David, Economist, USAID/Washington - Jacinto Fabiosa, Economist, USAID/Washington - Elizabeth Wilke, Economist, MCC - Tim Breitbarth, Economist, MCC - Paul Kaiser, Threshold Program Team Lead, MCC Key Stakeholders - Asian Development Bank, Nepal - Central Bureau of Statistics, Government of Nepal ii - Confederation of Nepalese Industries - Department for International Development (DFID), Nepal - World Bank, Nepal - Federation of Nepalese Chamber of Commerce and Industries, Nepal - International Finance Corporation, Nepal - Nepal Rastra Bank, Government of Nepal - National Planning Commission, Government of Nepal iii Table of Contents 1. Introduction and Summary of Findings ................................................................................... 8 1.1 Nepal’s Binding Constraints to Growth .............................................................................................. 9 Policy Implementation Uncertainty ...................................................................................................... 9 Electricity ............................................................................................................................................... 9 Transport Costs ..................................................................................................................................... 9 Industrial Relations and Rigid Labor Regulations.................................................................................. 9 1.2 Underlying Issues and ‘Growth Syndrome’ ...................................................................................... 10 Political Instability ............................................................................................................................... 10 Effect on the Policy Uncertainty Constraint........................................................................................ 11 Effect on Government Expenditures and Infrastructure Constraints ................................................. 11 Effect on Industrial Relations .............................................................................................................. 12 Other Channels ................................................................................................................................... 12 Relaxing Underlying Issues .................................................................................................................. 13 1.3 Additional Risks ................................................................................................................................ 13 1.4 The Methodology of Growth Diagnostics ......................................................................................... 14 1.5 Implementation, Data, and Evidence ............................................................................................... 15 2. Background and Overview of Nepal’s Economy ................................................................... 17 2.1 Nepal’s Economic Growth and Policy History .................................................................................. 17 2.2 Economic Activity by Sector ............................................................................................................. 19 Agriculture .......................................................................................................................................... 20 Services ............................................................................................................................................... 22 Manufacturing .................................................................................................................................... 23 2.3 Investment Activity in Nepal ............................................................................................................ 23 Gross Fixed Capital Formation (GFCF) ................................................................................................ 23 Foreign Direct Investment (FDI) .......................................................................................................... 25 2.5 Poverty and Inequality...................................................................................................................... 26 Poverty ................................................................................................................................................ 26 Inequality ............................................................................................................................................ 26 2.6 Migration and Remittances in Nepal ................................................................................................ 27 Migration............................................................................................................................................. 27 iv Remittances ........................................................................................................................................ 27 2.7 Conclusions: Background Examination ............................................................................................. 28 3. Access to Finance ................................................................................................................... 29 3.1 Exploration of Finance Restrictions .................................................................................................. 30 Price Signals ........................................................................................................................................ 30 Low Correlation between Supply of Finance and Investment ............................................................ 30 Are Firms Overcoming Finance Constraints? ...................................................................................... 31 Firms are Becoming Less Capital Intensive ........................................................................................