Economic Crisis at the doorstep: How insulated is Nepal?

By Binay Shrestha

In probably one of the worst global economic crisis we will ever experience in our lifetime, Nepal sits isolated and many of us even unaware of what is happening in the world economic markets. Violent drop and fluctuations in stock prices along with other factors witnessed in emerging markets have made it clear that the developing world is not insulated from the financial turmoil raging in industrial countries. The crisis will have different impacts in different places, particularly depending on the extent of integration of the capital market of the concerned developing country. Unaffected and unaware for now, we cannot ideologically isolate ourselves from the rest of the world. Albeit we have not had a direct impact we cannot neglect the fact there is a high probability of a ripple aftereffect from the chaos and turmoil across the region.

The worst crisis since the Great Depression

The current global economic crisis is the worst global economic disaster since the "Great Depression" that originated in the United States with the crash of the stock market on October 29, 1929, also referred to as "Black Tuesday". Likewise, the current financial crisis of 2007–2008, initially referred to as a "Credit Crunch" or "Credit Crisis", began in July 2007 worsening in September 2008. The crisis deepened as stock markets world-wide crashed and entered a period of high volatility, with a number of banking, mortgage and insurance company failures in the weeks to follow.

How did this global financial crisis start?

Although the housing market collapse in the United States is often cited as having caused the crisis, the financial system was vulnerable because of over-leveraged financial trend and a U.S. monetary policy making the cost of credit negligible, therefore encouraging such over-leverage. Banks, mortgage brokers and borrowers are all responsible for this over-leverage as they were in violation of the basic law of economics: Never lend money to people who cannot pay back.

A good home loan will usually have 20-30% down payment from the borrower's savings, charging a fixed interest rate, with a monthly installment that includes Principal, interest, property insurance totaling to an amount the borrower should comfortably pay with his/her current income. This should be verified by the credit committee that approves the loan. Violation of these simple, basic laws of common sense resulted in inability to make the payments, which led to foreclosure, throwing the borrowers on the street, with the house staying empty, bringing in no income for anyone. The failure to regulate the activities of lenders and borrowers with strict laws encourages poor business practices which result in financial failure. Many of the world’s leading investment banks have collapsed as a result.

What are our possible weak joints?

The Nepali economy could soon feel the heat of the global financial crisis, and the country could mainly suffer in areas like Foreign Direct Investment (FDI), overseas employment and/or remittances, debt servicing of the government and tourism if substantial and significant measures are not addressed to cope with the situation.

With the crisis deepening and not showing any signs of a fallback for the moment, the tourism industry can already feel the pinch. Even though, this year saw an increase in the tourist arrivals as compared to the same last year, we cannot sit content as many travelers will now postpone their holiday plans. With massive job losses and businesses being affected, there is bound to be a postponement in travel plans and reconsideration of expenditure for the time being.

Similarly, the slow economic conditions in developed countries may have significant impact on the developing countries such as Nepal. The impact could be on trade and trade prices, which could lower the export prospects. The effect of the exchange rate creates discrepancy in covering of import bills. Depending on the magnitude and the period of this recession, the adverse effects on exports can be large.

The main risk to growth is the likely adverse effects on investment due to a slowdown of foreign funding. Foreign direct investment (FDI) will come under pressure especially when Nepal is looking towards FDI's to invest in powering up the massive potential of Hydropower Projects.

Foreign remittance has grown rapidly in Nepal over the past few years. Much of these remittances come from low-skilled workers engaged in the oil-rich countries of the Middle East. These earnings do not face an immediate risk as these economies have huge earnings and reserves from the oil price boom and oil prices. However, remittances from other developed countries mainly from North America, South East Asia and Europe can be adversely affected.

The sharp appreciation of US dollar against NRs. in the recent months has already put additional pressure on the government’s debt service liability for this fiscal year. This can be a serious challenge for the present government, which has ambitious plan for the new Nepal.

However, from the other angle, there are some opinions and reservations. Since Nepal has an insulated economy; it will not see any immediate and significant effect of the crisis. As Nepal is heavily dependent on foreign aid for its development projects, Nepal might have to pay a heavy price with the stop or at least slowdown of the funding from major donor countries that are hit by the current financial crisis.

The recent global financial crisis has shaken the global market in such a way that the world economy will play cautiously and very strategically for the next few years. Nepal's exposure in the global markets is not very significant, but having said so we cannot rule out the spillover or ripple effects in developing countries like Nepal in this era of globalization. Now the question is not whether Nepal will be hit, but rather, how much.