With COVID-19 unleashing devastation across the Globe, the world economy is on lockdown now. The economic damage from COVID-19 pandemic is already tangible since major factor of micro economy (Agriculture, service, industry & trade) has adversely affected. Governments and their central banks around the world are wasting no time in dealing with the health and economic implications of this crisis.
The pandemic hits the economy from both sides of supply and demand. On the supply side, the outbreak has severely reduced its capacity. Many factories remain closed temporarily. Suspension of production has made importing countries like Nepal short of raw materials, which in turn has affected the goods production in other countries. On the other hand, as the epidemic spread globally, demand began to fall. A growing number of worried consumers are reluctant to shop, travel or eat out. An obvious consequence of this is contraction in value added and output across industries.
On the supply side, every economic activity will surely contract more or less. This is because supply chain of every product including access to raw materials and intermediate inputs has been substantially disrupted. Labor mobility too has been seriously impeded as physical isolation is one key measure of minimizing the health risks. On the demand side, exporters who are left with diminished production capacities will also see markets for their final goods shrink. Local industries that cater to domestic residents are also experiencing rapid decline in the demand for their goods and services. Small and medium enterprises (SMEs) which employ millions of workers and constitute the backbone of the economy appear to be more vulnerable. As SMEs face massive slump in demand, their existential challenge is to remain financially viable.
This unforeseen but truly exogenous COVID-19 shock is now interacting with many prevailing economic woes of Nepal. Those include stagnant tax revenue, widening fiscal deficits, prohibitive liquidity and solvency crisis in the country’s financial system, a long-depressed stock market, an overvalued exchange rate, and persistent and unsustainable current account deficits in the last few years. How do we deal with these complex economic challenges?
Impacts on Macro-economy
Nepal is one of the least developed country in the world its development relies extensively on foreign aid. Service sector, agriculture sector, industry and remittance are major contributing sector of Nepalese GDP. Due to COVID-19 contribution of all sector GDP in total GDP is certain to reduce.
Nepal’s economy is anticipated to grow by 5.3% (at market prices) in fiscal year (FY) 2020, down from 7.1% a year earlier, according to the Asian Development Outlook (ADO) 2020, the Asian Development Bank’s (ADB)
According to the Nepal Macroeconomic Update, which was also released today by ADB, average annual inflation will inch up to 6.0% in FY2020, up from 4.6% a year earlier, reflecting lower production and supply chain disruptions due to the COVID-19 pandemic. Headline inflation has averaged 6.5% in the first seven months of FY2020, significantly higher than 4.2% a year earlier. Food inflation increased by 9.8% as of mid-February 2020 compared to a year earlier, with a significant increase in the prices of vegetables, spices, and alcoholic beverages. The temporary closure of international borders over COVID-19 concern has nudged up food prices. The average annual inflation for FY2020 could be higher than anticipated if the situation further worsens due to the COVID-19 pandemic, says the report.
The improved trade balance has helped contain current account deficit to $1 billion in the fiscal year through mid-February 2020 from $1.5 billion in the corresponding period a year earlier. The deficit is forecast to narrow from 7.7% of gross domestic product (GDP) in FY2019 to 5.4% on shrinking imports of petroleum products, capital, and consumer goods. However, it could be higher if remittances fall substantially in the last quarter of year.
With country is on lockdown now thousands of people working in retail, restaurants, travel & tourism, hotels have lost their job as a result unemployment and poverty rate is in verge of risen. Businesses faced with falling demand and broken supply chain will find no option but to lay off workers can be a way but that will be chaotic. The government must try to prevent this cases using special mechanisms.
The Nepal Rastra bank can make a number of interventions targeting industries that are worst hit by the coronavirus pandemic. One key policy directive can be to extend working capital loans at the lowest possible interest rate to industries on the condition that they keep their workers on payroll regardless of their work for at least two three months.
The government seems to be in deep trouble. Tax revenue is contracting. But the need for giving budgetary support to many sectors is now manifold. Government will have to redouble its spending on public health and medical infrastructure. A public-private partnership can be started incorporating private hospitals and medical colleges. The partnership can involve measures including paying for testing, supplying more test kits and emergency gear to frontline health workers, staffing and providing uninterrupted supplies to health centers.
Food security is an emerging concern around the world as job losses are mounting. The government will have to increase its budgetary allocation for improving food security for vulnerable people. Millions of households and elderly people live on the financial edge and will require income support through social safety nets to avert falling back into extreme poverty. The government may provide income support to poor and ultra-poor households through 753 local government. It will directly affect the development budget of the annual budget 2077/78.
Departs of customs and IRD Nepal may defer the collection of taxes for one or two quarters. Households and firms will further demand the lowering of tax rates and a new set of tax incentives. The government can provide tax relief to firms based on the number of employees, annual turnover, etc. Ministry of Finance (MOF) must revisit its tax policy to save our businesses.
The COVID-19 outbreak will further worsen the current account imbalance in Nepal. As tax revenue will contract this year, we expect government spending to increase faster and fiscal deficits to rapidly widen. On the other hand, net private-sector savings will also deteriorate for a variety of reasons. That essentially means we expect to double our current account deficit in 2076|77.