Underperformance Back-to-Back: Gross Fixed Capital Formation

The simplified version of this article was published in The Kathmandu Post on 26th August, 2016

The preliminary Economic Survey Report for FY2015/16 yet again makes the same old assertion regarding the economic performance of Nepal by exhibiting the underperforming state of capital expenditure that has been hampering the real economic growth of the country since multiple years. It is of no surprise that yearly Gross Fixed Capital Formation (i.e., an indicator of Investment expenditure) is again below the required criteria warranted for the Nepalese Economy that is characterized with considerable Capital/Infrastructure deficit and strong potentiality of Marginal Productivity of added Capital (MPK). As I mentioned, it is reasonably legitimate to recognize strong potentiality of MPK of Nepal on technical grounds as it is categorized as a low-income country with Gross Capital formation way below the steady/optimum level of Capital (refer Fig 1 to know steady level of capital).

Statistically speaking, the Gross Fixed Capital Formation (GFCF) for FY 2015/2016 in basis to preliminary Economic survey conducted by Ministry of Finance (MoF) was NRS 562,458 Million, which only makes up to about 25% of the GDP for the FY2015/16 (MoF, 2016). However, in midst of this statistical figure, Sapkota (2016) draws the minimum threshold for GCFC (% of GDP) of about 30% in order to boost required real economic growth of the country that can uplift per-capital income and generate further employment based on Investment Expenditure. On this regard, the negative disparity between the required Gross capital formation and acquired Gross Capital formation in terms of %GDP is numerically observed, whereas the felt observation of this deficit is highly relevant as every layman can relate the lack of adequate infrastructure as major barrier to national progress.

And only to bolster this argument regarding the state of Capital formation deficiency in the Nepalese Economy, we can always refer the graphical comparison of GCFC (% of GDP) of Nepal with the average of low-income countries in last 8 years that is being developed by retrieving data from World Bank’s database and Economic Survey Report 2016. Since the countries belonging to the low-income category (inclusive of Nepal) share the common resolution (i.e., more Investment expenditure) to fuel growth, the comparison is relevant to recognize relative performance of Gross Capital Formation in Nepal.

As it can be observed from the provided comparative graphical representation, the GFCF (% of GDP) of Nepal fell below the average of its kind in last couple years even though it appears to be in the trend of reconvergence. Whatsoever, the GCFC (% of GDP) of Nepal is considerably below the minimum threshold of 30% recommended for the nation’s real economic growth by Sapkota (2016).

If dug down deeper regarding the component of the Gross Fixed Capital Formation of the Nepalese economy, it is surprising to discover wide inequality in the volume contribution of Private Fixed Capital investment and Government/Public Fixed Capital investment throughout the timeline. This figure stays put even though the planned expenditure commitment of the Government is ballooning (The FY 2016/17 budget crosses NRs 1000 Billion) in midst of huge required role of Government to fund Infrastructure development. While the ratio of Private Contribution on GFCF to Government Contribution was about 3.23 times in FY2015/16 as per the Economic Survey 2016, the wide difference in contribution of the two parties through the period of 8 years is exhibited in comparative contribution graph developed below.

In observing the stark difference in contribution towards Gross Fixed Capital Formation by two parties throughout the timeline, it would be reasonable to conclude the underperforming role of Government in inhibiting the growth of GFCF/GDP ratio while the leading role of Private party even in midst of not so friendly regulatory environment exhibits strong enthusiasm. The persistent low absorption rate of the Government budget hovering at about 75% as per Sapkota (2016) due to lagging delivery capacity of the performing stakeholders appears to be relatable to observed underperformance from Government side. On the flip side, the minuscule role of Government in economic affairs might seem reasonable to allow the Free Market system take hold. But, given the huge output gap in merit and social sectors (as Public Infrastructure, Health and Education sector) in our underdeveloped economy that cannot be fulfilled by Private party due to lack of excludability and rivalry features of the sectors, Government is sought to be primarily and emergently responsible to close this output gap (Singh, 2015). And therefore, the demand for larger role of the government/ Public party in Capital formation is legitimate. Besides to it, Sapkota (2016) also recommends jacking up of the Public Fixed Capital Investment (% of GDP) to 10% (presently at 5.9% as per Economic Survey Report) further bolsters the argument for needed higher Public role in Capital formation.

Theoretical Consideration connecting Gross Fixed Capital Formation (GCFC) to National Income (Y) growth:
                  The pattern of statistical data definitely recognizes the Government/public sector as culpable in observed underperformance of Capital Expenditure/Gross Fixed Capital Formation. And as certain level of GFCF is recommended to achieve real economic growth in this paper, there of course is theoretical model to support the causative relationship.

Theoretically, the Solow Growth Model (i.e., an important aspect of classical economics) acknowledges the relationship of National Income per worker (y) with Stock of capital per worker (k) to be y = √k. While holding other ingredient of production (importantly labour (l)) constant, Solow Model, with support from Cobb-Douglas production function has come to this causative relationship that remains valid regardless of the size of the economy based on labour (l) size. Moreover, while this positive causative relationship between some form of National Income/GDP (Y) and Capital stock (K) remains valid, the function is only valid unless an economy reaches the state of steady/Optimum level of capital. Essentially, an economy reaches a steady/optimum level of capital when further addition in-Investment expenditure for capital formation is cancelled by equal unit of accumulated depreciation causing null change in Capital stock/formation (i.e., ∆k = 0). Obviously, the Nepalese economy from every lens is way below steady level of capital, thus it leaves considerable leeway for Capital formation and National Income/GDP growth before it reached steady/optimum level of capital.

given figure recognizes the steady of level of capital at k* at which the economy remains at equilibrium. The goal of every rational economy (including the Nepalese economy) is to reach the steady level of capital (Golden level of Consumption). On a rough guess, Nepalese Economy possibly lies closer to “0” than “k*” at the moment. And, the resolution to it higher Gross Fixed Capital Formation coupled with higher GGCF (% of GDP).

References:

Ministry of Finance (2016). Economic Survey Report 2016. Government of Nepal.

Singh, S.K. Dr, (2015). Public Finance in Theory & Practice. 9^th Ed. S.Chand Publishers.

Sapkota, C. (23 May 2016). Why capital spending is chronically low and what can be done about it. The Kathmandu Post.

World Bank (2016). Gross Fixed Capital Formation (% of GDP). World Bank Group.

Theoretical Foundation:
Mankiw, N. (2010). Macroeconomics (7th ed.). New York, NY: Worth.

NEPAL: BUDGET SPENDING SLACK, A CAUSE OF ECONOMIC STAGNATION

A broken bridge in Mugu District

As I went through the Macroeconomic section of an internationally popular Economics volume, I came across multiple monetary and fiscal policies and intervention techniques that could help expand aggregate demand of an economy in order to avoid recessions. However, it was hard to find any direct monetary or fiscal intervention that would allow positive increase in Aggregate Supply side in the long run, or let’s say the production side. In fact, the side that developing nations like Nepal are mostly struggling over. Despite, the volume logically reiterated that aggregate demand plays a vital role in stimulating the production or the Aggregate supply side through various means that are not usually displayed in figurative explanations.

In regards to that logic made, we can also infer that accelerating the sluggish government spending on the infrastructural development of our country should obviously help us break free from the stubborn state of economic stagflation (i.e. the economic condition that causes both growth stagnancy and inflation at a same time) that we have been encountering since years and years. According to Index Mundi Factsheet (2013), the inflation rate in Nepal remains as high as 9.5 percent (2012 est.) whereas the GDP growth rate stays as low as 4.5 percent (2012 est.). Even though the idea of accelerating government spending directly refers to boosting Aggregate demand (i.e. the totality of Public Consumption, Investment, and Government spending and Net Exports) of the economy, it might ultimately stimulate the long-term Aggregate supply of the economy (i.e. the totality of the outcome retrieved from the mobilization of the factors of productions) as soon as the high demand pressure increases the price level of such factors of productions to a level that might cause the heavy chunk of immobilized factors of production like the unemployed labors (which stands about 46% for Nepal according to 2008 est. of Index Mundi) and unused natural resource and capital stocks to come to the production play.

Lately, it was publicized in the economic section of the Kathmandu Post that the government bodies like the Department of Road (DoR) and Civil Aviation Authority have been miserably unable to mobilize or spend the budget amount it was allocated for. According to the post (2013), “The Department of Roads (DoR) has so far just spent just 12.23 percent of the total fund allocated, while the physical progress stood at only 19.68 percent.”  Though a common man might be unaware of the multiple implications of such spending underperformance, the economic implications are definitely multiple. At first, such spending slacks decelerate economic progress in an already stagnant Nepalese economy in a sense that it creates weak Aggregate Demand that may not adequately value (or price) the factors of the productions that instead causes stagnancy in the production growth (GDP growth) as the huge chunk of factors of production remain immobilized due to under pricing. While on the later part, it depresses the potentiality of efficient mobilization of the factors of productions like the human capital, and private investments that could again potentially stimulate the momentum of already progressing economic growth if it would have been previously bolstered by heightened Aggregate demand. In other words, not spending properly on infrastructural resources like roads (For inst. Kathmandu-Terai Fast Track that has failed to see any progress lately), Air facility (For inst. The proposed Regional International Airport in Pokhara of which talks have stalled already) etc creates impediments and difficulty in mobilization of factor of productions, and makes it more costly to mobilize (Money, 2013).

Figurative explanation of the positive side of the government spending in the economy can make this logic more comprehensible:

As it is presented in the provided figures, once the Aggregate Demand (AD) shifts to the right after it is bolstered by accelerated Government spending of the allocated budgeet, the price level offered for the factors of productions like labor, private capitals and natural resources gradually increases from OP to OP’ thus stimulating the long-term aggregate supply curve to shift the right (from AS to AS’) (provided in the second figure) until the mobilization of further factors of production remains economically unfeasible due to gradual fall in price level. However, the improvement in national infrastructure portfolio after government spending and resource utilization increases the efficiency of further resource mobilization, thus making it economically feasible to deploy further resources even during a lower price-level. Ultimately, the Aggregate supply curve or production further shifts from AS’ to AS” (provided in the second figure).

In fact, a healthy economy often takes a progressive economic cycle whereby, there is a constant growth in price-level (i.e. inflation) and production volume (GDP). Even though, the acceleration of government spending may not fully enable the country to break free from the current state of stagflation, it is never economically logical for our government bodies to remain in such minuscule spending level.

Note:

The provided figurative explanation can also embed Short-term Aggregate supply curve on it. In fact, the elasticity of the Short-term supply curve would have rather determined the amount of shifting that long-term supply curve would have endured. However, the absence of short-term supply curve on the provided figure doesn’t compromise the validity of the logic. Short-term Aggregate supply curve is an upward sloping curve with varying elasticity in basis to the complex characteristic of a particular economy.

Reference:

Index Mundi (2013). Nepal Economic Profile 2013. Retrieved from: indexmundi.com/Nepal/economic_profile.html

Mankiw (2003). Multiple Chapters. Economics: Principles and Applications. Cengage learning

Money (2013). DoR spends just 12,23pc budget. The Kathmandu Post. Kantipur Publication.

Money (2013). High Priority Given to the Project: FinMin. The Kathmandu Post. Kantipur Publication.

Further reads:

Macro-economic theory of Aggregate Demand and Aggregate Supply

Cash flow: The life-blood of venture management

The adequate availability of cash remains vital to run every fundamental operation of the business. Specifically, the cash-tight situation of the growing venture makes cash-flow management a crucial task for them. In fact, improper cash-flow management can even force a business to the state of bankruptcy. Basically, every business experiences some sort of cash-flow cycle that complements the business process of purchasing raw material to selling the finished product. And the cash that the business receives from collecting the receivable of the sold goods is deployed in running the day to day business activity and funding the business growth. In order to understand the linkage of the state of cash-flow cycle to the overall business operation and manage it accordingly, making due consideration of cash flow trend of the business has been identified as a vital activity for managers.

At first, timely due consideration in the cash-flow trend helps the managers to make strategic financial decision. It helps the manager to determine if the business can fund its sustainability and growth through its internally generated cash or it may need external finances. Having a proper grasp of the cash-flow knowledge of the business enables the managers to make acute cash-flow projections and financing decisions accordingly. In fact, improper financial decisions has led many business to undertake costly external finances when funding could have been adequate from internally generated cash. Moreover, a management team with a proper knowledge of cash-flow trends is more liable of succeeding external finances. Financial institutions often want to learn about the amount of control that the prospective business have over its cash-flow trends. After all, it determines the accuracy of the management team in making strategic growth decisions and sustainability at large. Actually, a management with a good grasp of cash-flow knowledge can make effective decisions regarding growth plans, financing plans, credit policies, operation control & austerities and lot more of it which are essential for the proper health of the business. Importantly, a management with proper cash-flow management ability has the greatest skill of keeping the business liquid and floating.

Alike to it, cash-flow knowledge also helps managers to maintain smooth day-to-day operations of the business. Payments for raw-material supplies and fundamental expenses regarding stationeries, vehicle & rent expenses, wages and lot more relies on proper cash balance and which in turn in dependent on proper cash-flow cycle. All in all, it can only be achieved by the business that properly tracks the cash-flow trends and makes timely interventions. Besides, smooth running of day-to-day business operation has a major share in determining the overall effectiveness of the business. Metaphorically, it’s a tissue that determines the health of the overall organ.

Specifically, a healthy relationship with the suppliers is very crucial in order to retain in the competitive edge of the business. As we all should know, proper relationship with the supply-chain units is crucial for a business to perform over par. In fact, it enables the business to enrich the benefit of the activate synergy in the supply-chain system. Relatively, timely payment to the suppliers for their supplies is very essential to maintain friendlier relationship with the suppliers. Moreover, suppliers preferably rate their customers in basis to their compliance with their credit policy. Therefore, having enough cash to pay the suppliers before the credit duration is a key to proper supplier relation. And again, proper cash-flow control plays as an enabler here. More to mention, having proper relations enable the business to make exclusive deals with the suppliers, that could found as an added competitive edge for it. After all, accumulating competitive advantages is the ticket to success for businesses in the contemporary times.

Certainly, cash flow is more like the flow of blood that activates the vital organs in order to run the overall system. Therefore, it is very crucial to a business to have a thorough consideration of their cash-flow status and make timely intervention. Basically, the due consideration of cash-flow starts with the cash cycle that represents the process from payment to suppliers to receiving from the customers. In fact, a management that can master this cash-flow cycle has already half-done the overall cash-flow management process.