A stitch in time

December 27, 2017 01:00 AM Ajaya Kusum Adhikari

A piece of land in Indrachowk of Kathmandu is much costlier than the land at Manhattan of New York or Hammersmith of London.

Often we hear about Federal Reserve and European Central Bank lowering their interest rates. This is done to make borrowings cheaper and to avoid economy from nudging into recession. More importantly, it is to maintain a moderate inflation level as inflation rate in two percent bracket normally encourages economic activities. When the rate goes out of the bracket, there is danger of negative repercussions.

Nepal is an example of economy with high detrimental inflation. According to Asian Development Outlook, Nepal has the highest inflation rate in South Asia since the fiscal 2012/13. For the past five years, inflation has gone overboard. Although Nepal Rastra Bank has tried to curb the rate under 8.5 percent, inflation rate may soon climb to double digits. For the third poorest nation in South Asia after Afghanistan and Bangladesh, superior inflation will exacerbate economic situation of Nepal. 

Four factors 

Volatility in Indian market, high imports, overpriced real estate and inefficient monetary policy are main drivers of inflation in Nepal. Since India has been Nepal’s monopoly trading partner, any vagaries of price in Indian market pushes a spiral price increase in Nepal. The two countries have an open border and pegged exchange rate. Price increase in India pushes inflation to Nepal. 

As Nepal’s domestic production is almost non-existent against increasing annual demand, it has to be contingent on India for trade. In the event of any geopolitical disarray, our economy will be shocked by inflation. For instance, the economic blockade had driven inflation as high as 11.6 percent in mid-December of 2016.

The bulked-up real estate has also spooked price of consumer goods. For example, one ana (342.25square foot) of land in Indrachowk, Kathmandu was recently advertised for sale at NRs. 100 million (one million US dollar) in a Nepali broadsheet daily. This land is costlier than land at Manhattan, New York at the moment. Currently, the average land price in Manhattan swims around $250,000 on average per 100 square feet, which means one ana of land at Manhattan, is less than one million US$ now according to Corcoran Group, a real estate company in New York. 

Similarly one ana equivalent of land costs $400,000 in Hammersmith, London and $383,000 in South Melbourne. This shows land price in some places of Kathmandu is much higher than land price of the major cities of the developed world. Naturally, if the real estate price continues to rise in such bizarre manner, basic commodities will be atrociously overpriced resulting in higher inflation. 

Lapse in monetary policy has also accelerated inflation. In such situation, central bank should have manipulated the supply of money by tweaking the interest rate, controlling liquidity and changing tax and exorbitant expenditures. But Nepal Rastra Bank seems to have totally failed to control ever-rising inflation in Nepal.

Multiple effects

Inflation cripples normal life in more than one ways.  With depreciating value of money our purchasing power erodes. From 2007 to 2017, Nepal’s average food inflation stands at 11 percent (it was 22 percent in 2009).  The price of basic consumer goods such as milk, rice, vegetables and fruits has increased several folds in the past one decade.

Argentina’s example could be instructive for Nepal. The economy of the Latin American country suffered a serious blow when inflation peaked to 40 percent in 2016. As the price began doubling every few months, the government tried to curb inflation by pegging Peso to US dollar, introducing open market operations and increasing interest rate. But inflation continued. Similarly, Venezuela has witnessed the worst inflation in the world. In 2016, its inflation rate reached record high of 800 percent. The lesson is clear: when price stability is feeble, inflation can spike swiftly. 

In Nepal, inflation has hurt net savers and people with fixed income while leveraging higher financial returns to the borrowers. This has created a massive transfer of wealth from the savers to the debtors. The middle and lower income earners, who are the drivers of economic development, suffer the most. Big question is how Nepal will enable this cohort to cope with price spikes before our economy bites the dust. Inflation is an unavoidable nuisance. We need to make necessary adjustments to this structural price imbalance before it wheels out of control.

Mitigation measures 

Developing country like India has managed to bring down inflation from 11 percent to a record low of 2.2 percent in 2017. How did they do it? They mandated banks to have higher cash reserves. They increased the interest rate to boost savings and discouraged borrowings. They demonetized the economy by removing 500 and 1000 rupee notes. This largely contributed to keep the economy inflation-free.  

Similarly, China, which grappled with inflation in the past, used prudent monetary and fiscal policy for price adjustments. It increased interest rate, issued government bonds and allowed market borrowings and selective expenditure to mitigate the problem. 

Nepal can adopt similar measures. The short-term remedy would be to artificially curb inflation by regulating money supply. But as per the financial plan of 2016-17, we’ve had expenditure raised by 57 percent and increased dependence on debt inflows, foreign aid and remittance. Banks are impetuously expanding loans that directly increase the money supply. This can be corrected if the government puts a tighter squeeze on its expenditure and more significantly, restricting banks from making borrowings cheap.  Increase in cash reserve, interest rate and issuance of risk-free government bonds could be some playing cards for the central bank.

For the long-term solution, Nepal should relax its imports. As the nation borrows inflation from India, it contributes to cost-push inflation. Conventional wisdom dictates that such form of inflation can be dodged if Nepal starts becoming self-reliant in production for domestically produced goods are less susceptible to inflation. Most importantly, land prices should be controlled because they have immense spillover effects.  

Inflation in Nepal might gallop very soon. It will wreak absolute havoc in the economy. Argentina, Venezuela, South Sudan and Congo had walking inflation like that of Nepal at the moment. But it silently galloped right under their feet without their realization. The message is clear and simple: We can stitch a shirt only when the hole is small. Once the tear gets big, the shirt will be impossible to wear. 

The author is an MBA student at Asian Institute of Technology (AIT), Thailand



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