An Analysis of Ex-ante Poverty Impact Assessment Practices of Macroeconomic Policies in Nepal

1. An Analysis of Ex-ante Poverty Impact Assessment Practices of Macroeconomic Policies in Nepal Presentation by D. R. Khanal Institute for Policy Research and Development (IPRAD)

2. Rationale and Motivation • Beginning from the mid 1980s, Nepal intensified macroeconomic policy reforms since early 1990s. • More poverty focused policies and programs also started in the early 1990s. With the beginning of the ongoing Tenth Plan ( 2002-2007), PRSP is also under implementation. • Up to the mid 1990s, Nepal succeeded in improving macroeconomic performance. • Poverty also reduced considerably over time, from 42 percent in 1996 to 31 percent in 2004. • Nepal now stands as one of the most liberalized countries in South Asia. • Despite these, Nepal could not sustain growth and enhance more equitable development. Today Nepal is confronting with: • Deceleration in economic growth amidst slow down in trade and industry. • Rise in income inequality with continued high poverty incidence among certain castes and ethnic groups (graph). • Above all, possibilities of rise in poverty again.

3. Sectoral Growth Rate

4. Poverty Ratio and Inequality

5. Poverty Ratio by Caste and Ethnicity

6. In these backgrounds, study was devoted to: • review the developments on political, economic, social and poverty fronts in the light of the macroeconomic reforms since 1991, • assess strengths and weaknesses of macroeconomic policies in the light of their features and outcomes, • review ex-ante poverty impact assessment techniques and other interrelated processes followed in Nepal in the course of intensive policy reforms, and • Explore alternative techniques to be useful in an ex-ante poverty impact assessment of macroeconomic policies in the Nepalese context.

7. Methodology, Data and Information Sources • Two-pronged methodological approach followed – • Descriptive analytical approach to examine reforms and review techniques used in macro economic policy making processes including measures taken to enhance internal technical capacity. • Comparative assessment technique to evaluate various ex-ante poverty impact assessment techniques for identifying more suitable one in the Nepalese context. • Both published and unpublished documents as well as secondary data sources used. • Study broadly covers the period 1985 – 2003.

8. Main Features of Macroeconomic Polices and Outcomes • Internally more focus on deregulation policies - abolition all types of subsidies, market determined interest and exchange rates (except with India), more autonomy to the public enterprises in fixing prices. • Fiscal balance and price stability, privatization, tax reforms including introduction of VAT, public expenditure control and management. • Externally focus on open up and trade liberalization policies. • However, no rigorous internal exercise either to fulfil initial conditions or fix proper sequencing. Reforms broadly influenced by either reforms drives in India or donors programs like SAP and ESAF.

9. Financial sector reform delayed, structural problems in business and industry overlooked, less attention on strengthening corporate governance and market institutions. • In the taxation front cascading tariff structure affecting high value added and labor intensive industries. • Deepening of financial crisis and decline in access to institutional credit in rural areas.

10. Reduction in the level of development outlay and declining investment in sectors like infrastructure and agriculture. • Continued fix exchange rate with India and misalignment affecting agriculture and export competitiveness. • High transaction cost amidst high infrastructure cost, low labor productivity and declining competitive strength of trade and industry. • Policy mismatch and sometime contradictory macroeconomic policies with poverty reduction goals and above all problems of sustained and equitable growth as well as poverty reduction among vulnerable groups of the society.

11. Various Techniques Developed and Used • A Regionally Disaggregated Planning Model for Nepal (1988). • CGE model with high level of regional and sectoral disaggregation. • 8 rural sub regions with separate model solution for each region. • 5 non-agricultural sectors under one urban region. In addition, 2 foreign regions: India and Rest of the World (ROW). • Exports exogenous and imports non-competitive. Markets for agricultural goods clearing based on trade possibilities with India (i.e. Indian border prices vis-à-vis Nepalese border prices).

12. Model solution through economic equilibrium (supply and demand balancing) for all goods within each region. Interregional transport playing a key role. • Model specification and estimation based on an initial national level input/output table compiled for 198182. Numerous other independent data sources including household level data from the 1976/77 national sample survey conducted by the National Planning Commission used.

13. Construction of an integrated Macro-cum-Input output Model (1990) • A macro model with 31 behavioral equations comprising production, consumption and investment demand, taxes, trade, money supply and prices blocks. • A 39*39 input output table for the base year 1986/87. • An important feature-macro model through policy simulation enabling macroeconomic forecast of final demand components necessary for the input output model. In the macro model equilibrium through stock adjustment. • Given the pattern of consumption, investments, exports and imports, I/O provided consistent pattern of gross outputs satisfying the demand supply balances in every sector of the economy at the prevalent prices.

14. SAM and CGE Model under MIMAP (1998) • A SAM and a CGE model to assess probable impact of macroeconomic policies on economic welfare and poverty. • Main features involved cost minimization by producers, utility maximization by households, perfect mobility of factors, and competitive market driving profits to zero. It allowed impact analysis of tariff and income policy. Helped assess the impact of anti-poverty programs within a general equilibrium framework. Model also enabled to capture relative price, resource allocation and other economy wide effects. • It follows standard calibration procedures and requires 3 steps: construction of database (a SAM), calibration of model parameters to the database and computation of counter factual equilibria for the policy changes.

15. IPRAD Model 2005 • Macro model with 20 behavioral equations featuring production, consumption and investment demand, taxes, international trade and prices as separate blocks. • Through policy simulation it enabled to examine the strength and weaknesses of macroeconomic policies in mitigating the adverse effect of internal as well as external shocks on growth and poverty. In this respect, it also additionally helped to assess the role and contribution of remittances. • In the model equilibrium established through stock adjustment. Despite some bold assumptions, historical simulation results showed strong predictive capacity of the model.

16. Use of Models in Policy Analysis • Only model used in the planning process was macro-cum-input output model. This was used for Eighth Plan growth projections. But this model was less useful in policy or poverty related analysis due to virtually no role to the prices. Despite CGE model under MIMAP being extremely useful, it was also not used. Lack of parallel initiatives or interest among policy makers to use models in the policy formulation processes prevented institutionalization of models. • Beginning with very complicated models requiring high level of expertise and huge data base also created problems in this direction. • Despite poverty being the single goal in the Ninth and Tenth Plan, no attempt was made to use models for growth and poverty analysis. • Instead, during the PRSP preparation ( i.e. Tenth Plan ), a Medium term expenditure framework (MTEF) was developed and used for reprioritization of programs to make them compatible with poverty goals.

17. Major Problems in the Absence of Ex-Ante Impact Assessment • Mismatch between the macroeconomic policies and poverty goals. • Problem in the harmonizing of macroeconomic policies. • Although some new initiatives in the course of PRSP preparations, no built in mechanism in involving various stakeholders in policy formulation processes. • Only a few gainers and majority losers leading to widening of social contradiction and distributional conflict in a highly discriminatory society. • Institutionalization of policy coordination always remaining a contentious issue at the political front affecting the speed or direction of policy reform. • Weak monitoring, feed back and implementation mechanism. • Poor internal technical capacity for policy analysis and continuity of external influence in policy making. • Problems in improving data base and fulfilling data gaps including problems in national accounting system.

18. Alternative Techniques and Their Usefulness in the Nepalese Context • CGE with micro foundation could be extremely useful. • CGE will be needing feedbacks from the macro models. • Additionally, following interrelated initiations required: • Capacity building – especially in the research institutes having some expertise on modeling exercise and institutionalization of models. • Feedback and coordination among policy making bodies, donors and research institutes. • Improvement and expansion of database including introduction of new UN prescribed SNA with priority on data collection within input/output framework.