Abstract
This Selected Issues paper examines the effect of political instability on economic growth in Nepal. It uses publicly available data on political economy variables for 167 countries worldwide from 1970–2004 to estimate the impact of political instability on growth. The findings reveal that Nepal has witnessed higher political instability compared with other countries in the region. The paper also presents the salient features of political instability and growth for Nepal and other South Asian countries, and the econometric estimates of growth regressions to measure the effect of political instability on economic growth.
II. Remittances and the Nepalese Economy1
A. Introduction
1. Remittances have become a mainstay of the Nepalese economy, reflecting a global trend among developing countries. With an estimated US$908 million in remittances in 2004/05 (12 percent of GDP), Nepal ranks among the top 20 recipients in the world. Developing countries received an estimated US$126 billion in remittances in 2004 (Maimbo et. al., 2005), an increase of over 45 percent from 2001.2 For this group of countries, remittances exceeded official development assistance for most of the 1990s.
Top 20 Remittance-Recipient Countries and Nepal in 2004
(In percent of GDP)
Citation: IMF Staff Country Reports 2006, 045; 10.5089/9781451830033.002.A002
Sources: IMF, Balance of Payments Yearbook, 2004; and World Bank staff estimates.2. Recent studies suggest that remittances have a generally positive impact on the recipient countries. The impact of remittances is both macroeconomic and microeconomic in nature. Recent studies have shown that remittances increase the income of the receiving households, help smooth consumption, and reduce the incidence and severity of poverty. Remittances have also generated a steady stream of foreign exchange earnings for recipient countries, can improve a country’s creditworthiness for external borrowing, and can expand access to capital and lower borrowing costs through innovative mechanisms such as securitization of remittance flows. Remittances may also have adverse effects, although the evidence is mixed. For example, remittances have sometimes led to exchange rate appreciation and decline in export competitiveness.
3. This chapter is organized as follows. Section B discusses the salient aspects of Nepal’s remittance and labor migration flows. Section C examines the contribution of remittances to growth and poverty reduction and highlights selected policy issues.
B. Salient Aspects of Remittances and Labor Migration
4. Remittances in Nepal have risen significantly during the last decade. From an estimated US$100 million in 1995/96, there has been a nine-fold increase in remittances to US$908 in 2004/05. As a share of GDP, the increase over this period was from ½ percent of GDP to 12 percent of GDP. While remittances for other South Asian countries also grew over this period, the growth rate was the highest for Nepal.
Nepal: Remittances
Citation: IMF Staff Country Reports 2006, 045; 10.5089/9781451830033.002.A002
Sources: IMF, World Economic Outlook ; and Nepalese authorities.5. For Nepal, remittances are now the single largest source of foreign exchange inflows and are less volatile than other sources. In 2004/05, remittances were higher than merchandise exports (US$825 million) and significantly higher than official aid (US$175 million). These remittances helped offset the bulk of the trade deficit of US$980 million, and tipped the current account balance (excluding official transfers) into a noticeable surplus of US$225 million (3 percent of GDP). Remittances have also been a more steady and less volatile source of foreign exchange inflows. Moreover, as in other cases, remittances moderate external debt burden ratios (World Bank, 2005a).
Remittances: Cross-Country Comparison
(In percent of GDP)
Citation: IMF Staff Country Reports 2006, 045; 10.5089/9781451830033.002.A002
6. While Nepal has a long tradition of overseas employment, other factors have contributed to an increase in labor migration in recent years. Starting in the early 19th century, Nepalese have served in various armies in pre-colonial and colonial India. This tradition continues and Nepalese are employed in the Indian and British armed forces. Earnings and pensions from these soldiers constitute a sizeable portion of remittances. However, with rapid population and labor force expansion and inadequate growth, the absorptive capacity of the domestic economy has been stretched. With limited arable land, landlessness is pervasive and the number of landless households has steadily increased in the agricultural sector. In the nonagricultural sector, the slowdown in growth, especially since 2000/01, due to the insurgency and exogenous shocks has further slowed the pace of employment creation. The armed conflict has also created difficult living and security conditions, especially in the rural areas. Khatiwada (2005) also notes an increase in the proportion of indebted households from about 60 percent in 1995/96 to 70 percent in 2003/04. As a result of these factors, push factors for migration have become stronger. Pull factors have also played a role. These include higher demand from host countries. In particular, Malaysia opened its labor market to Nepalese migrant workers in 2001 and South Korea in 2004.
7. India has been a traditional destination for Nepalese migrants. The main reasons for this are geographical proximity, historical and cultural links, and a large and open porous border. The 1950 Treaty of Peace and Friendship between India and Nepal formalized free border movement of people. Given the free mobility across national borders, estimates of Nepalese migrants in India vary widely between ½–1 million.3 The bulk of these migrants are employed in the private, informal sector. These migrants hold semi-skilled and unskilled jobs in restaurants and factories or are employed as domestic workers, security guards, and maids (Thieme, 2003). Average earnings for these workers range between US$40–80 per month. For 2004/05, estimated remittances from India in the balance of payments were around US$200 million (around 25 percent of total remittances).
8. An increasingly larger share of remittances now comes from countries other than India (“third countries”) reflecting changing migration patterns and higher earnings in these locations. Remittances from third countries were over US$700 million in 2004/05. Recent estimates place the number of Nepalese migrants in these countries at around ¾ million, of which the largest number (about 400,000) are stated to be in the Middle East (Saudi Arabia, Qatar, United Arab Emirates, Bahrain, Kuwait, and Oman). In recent years, especially since 2001, a substantial number of migrants have gone to countries in South East Asia (Malaysia, Korea, and Hong Kong). The skills composition of the labor flows is different among these destinations. While migrants to the Middle East are employed mostly as security personnel, chauffeurs, and construction workers, the demand from South East Asian countries is more for employment in industrial enterprises. Monthly earnings for these workers are higher than those in India. For example, workers in South Korea could earn US$500–800 per month.
Migrants’ Earnings Per Month
Migrants’ Earnings Per Month
| Monthly Earnings (US$) | Percent of Workers |
|---|---|
| Less than 135 | 50 |
| 135–270 | 20 |
| 270–650 | 15 |
| 650–1,000 | 8 |
| More than 1,000 | 7 |
Migrants’ Earnings Per Month
| Monthly Earnings (US$) | Percent of Workers |
|---|---|
| Less than 135 | 50 |
| 135–270 | 20 |
| 270–650 | 15 |
| 650–1,000 | 8 |
| More than 1,000 | 7 |
9. Remittance transfers to Nepal take place through formal and informal channels, with varying levels of transactions costs. The mode of transfer depends on the originating country and other factors, including reliability, speed, convenience and transactions costs of transfer. The bulk of the remittances from India (90 percent) are brought in by the migrants themselves or sent through relatives and friends, as the amount involved are typically small. In contrast, a larger share (55 percent) of the remittances from countries such as Malaysia come in through formal channels (financial institutions or money transfer operators (MTO)). Overall, Khatiwada (2005) notes that 78 percent of total remittances are brought in by migrants, 6 percent come through financial institutions, 2 percent through the informal system (hundi/hawala), and the remainder through other means. Cross-country estimates suggest that the cost of sending remittances through various channels range between 1½ 12 percent of the principal amount for MTOs; ½ 6 percent for banks; and 1 2 percent for hawala system (World Bank, 2005a).
10. As regards beneficiaries, remittances have affected a large cross section of the population. Nepal Living Standards Survey (NLSS) data suggest that the share of households receiving remittances increased from 23 percent in 1995/96 to 32 percent in 2003/04.4 Over this period, the average remittance per household increased by over 150 percent in real terms from Nrs 674 (about US$12 at Nrs 57/US$) to Nrs 1,723 (US$30) over this period. While all quintiles experienced higher remittances, the percent increase was larger for the poorer quintiles. The amount of remittances increased in all regions except the rural Eastern Hill region.
Nepal: Household Remittances
Nepal: Household Remittances
| Receipient Households in Quintile | Average Remittance | |||
|---|---|---|---|---|
| (In percent) | (Per person/year, 1995/96 Nrs) | |||
| Quintile | 1995/96 | 2003/04 | 1995/96 | 2003/04 |
| Poorest | 19 | 29 | 188 | 414 |
| Second | 22 | 25 | 311 | 729 |
| Third | 24 | 34 | 413 | 1,359 |
| Fourth | 25 | 36 | 687 | 1,668 |
| Richest | 26 | 34 | 1,496 | 3,749 |
| Total | 23 | 32 | 674 | 1,723 |
Nepal: Household Remittances
| Receipient Households in Quintile | Average Remittance | |||
|---|---|---|---|---|
| (In percent) | (Per person/year, 1995/96 Nrs) | |||
| Quintile | 1995/96 | 2003/04 | 1995/96 | 2003/04 |
| Poorest | 19 | 29 | 188 | 414 |
| Second | 22 | 25 | 311 | 729 |
| Third | 24 | 34 | 413 | 1,359 |
| Fourth | 25 | 36 | 687 | 1,668 |
| Richest | 26 | 34 | 1,496 | 3,749 |
| Total | 23 | 32 | 674 | 1,723 |
11. Available evidence suggests that remittances have financed mainly an increase in consumption expenditures. Survey data suggest that the bulk of the remittances are used to finance consumption expenditure, repay loans, buy land, construct or improve housing, and educate children. This pattern is consistent with the behavior of liquidity constrained households, and is similar to the experience of other countries.
C. The Economic Impact of Remittances
12. Remittances have helped boost national income and consumption in Nepal. While real GDP grew by 35 percent between 1995/96 and 2003/04, disposable income and private consumption grew by a larger amount due to strong growth in remittances. While national income accounts data indicate a 12 percent increase in real per capita GDP and per capita private consumption expenditure, household survey data from the NLSS suggest a 42 percent increase in real per capita consumption expenditure.5
13. Remittances have contributed to a decline in poverty. World Bank (2005b) attributes the significant decline in poverty between 1995/96 and 2003/04 to higher remittances, and other factors including an increase in wages, urbanization, improved connectivity, and a decline in the dependency ratio. While it is difficult to separate the effect of each of these factors, cross-country estimates provide a rough measure of the impact of remittances on poverty (World Bank, 2005a). Using a cross-country sample of 81 countries, World Bank estimates suggest that for countries similar to Nepal (i.e., a high ratio of remittances to GDP and a high poverty headcount ratio), the absence of remittances could lead to a 20 percentage point increase in the poverty headcount ratio. Roughly speaking, this would imply that Nepal’s poverty rate could be almost 5 6 percentage points higher in the absence of remittances (compared to the current rate of 32 percent). Additional evidence from the NLSS points to the poverty reducing effect of remittances. There appears to be a strong correlation between the growth of remittances and the decline in poverty in Nepal during 1995/96–2003/04 at a regional level. During this period, the amount of remittances received increased in all regions except the rural Eastern Hills region. In other regions, real remittances per person per year among recipients rose by 50–200 percent.
Nepal: Regional Poverty Reduction and Remittances
Citation: IMF Staff Country Reports 2006, 045; 10.5089/9781451830033.002.A002
14. Considerable untapped potential remains to increase and better harness remittances through policy support. Investments in education, complemented by better vocational training, could serve to raise earnings of Nepalese migrants by inducing demand in higher skill jobs. Government support through streamlined procedures at home and active search for destinations abroad could facilitate larger labor migration. Efforts could also be made to reduce transactions costs for migrants by more effective regulation of manpower agencies and improving access to finance from the formal financial system. The central bank should continue to work with the Nepalese private sector to further develop systems for more efficient collection and repatriation of remittances through formal channels that both reduce risks for migrants and help deepen the financial system. Mechanisms need to be devised to improve the utilization of skills acquired by returning migrants and to put a larger share of the remittances to use for investment and employment creation in Nepal itself.
References
Khatiwada, Y., 2005, “Remittance Inflows in Nepal and Emerging Issues,” Second Global NRN Conference, Kathmandu, Nepal.
Maimbo, S. M. and D. Ratha, eds., 2005, Remittances: Development Impact and Future Prospects (Washington: The World Bank).
Nepal, K., 2002, “Remittance Economy,” Nepali Times, No. 104
Seddon, D., J. Adhikari, and G. Gurung, 2001, The New Lahures: Foreign Employment and the Remittance Economy in Nepal (Kathmandu, Nepal: Nepal Institute of Development).
Thieme, S., 2003, “Savings and Credit Associations and Remittances: The Case of Far Western Nepalese Labor Migrants in Delhi,” Working Paper No. 39 (Geneva: International Labour Office).
World Bank, 2005a, Global Economic Prospects, 2006 (Washington).
World Bank, 2005b, Draft Nepal Poverty Assessment Report, December (Washington).
Prepared by Nombulelo Wandwasi and Sanjay Kalra.
These estimates are only official figures, and do not capture large informal flows.
Nepal Living Standards Survey (1995/96 and 2003/04).
The national accounts estimate private consumption using households consumption estimated from the 1995/96 NLSS, adjusted upward for various items. The national accounts private consumption estimates for 2003/04 are projected using GDP growth rates and are not directly comparable to the survey-based estimates. Leaving out remittances did not affect the 1995/96 estimates of private consumption in the national accounts as much as it did the 2003/04 estimates.
