Wednesday, November 12, 2014

GDP at 2.05 percent is alarming

From Google
Bhutan’s economic growth rate fell to one of the lowest at a meager 2.05 percent in 2013. 

Questions immediately arise as to what does this imply? And how does it reflect on the country as far as its economy is concerned.

GDP is an important measure of an economy. Higher growth rate is often associated with lesser unemployment, higher income and increase in aggregate production. While measuring GDP, economists either use the income or expenditure method which is basically how much income everyone earned during a particular period of time or what amount of money the country’s population spent during the same time, both methods would ultimately reach at a close figure.

Increase in the national income and unemployment is inversely related, meaning, when national income increases, unemployment would decrease, because institutions, businesses and organizations have enough money to expand and recruit more people.

Higher GDP growth rate also means an increase in the level of investment; therefore, an economy naturally sees rapid infrastructural development in the form of construction boom.

Given that Bhutan is still at a growing stage when it comes to its economy, a growth rate of 2 percent is alarming. 

It’s like stunting (from a young individual’s perspective.) Bhutan has so much room to grow and it means we have not been able to tap it. It is understandable when developed countries like the United States record a growth rate of 2 percent, because they have already reached a level of maturity that growth becomes difficult even when billions of extra dollars are pumped in. They have already grown so much. 

GDP is measured in such a way that if the economy earned Nu 100 this year, you must earn Nu 200 next year to record growth. If you earned Nu 100 this year and the same amount next year, there is no growth. So this means that it would become increasingly difficult for countries like the United States to earn double or triple of what they have earned last year.

The size of USA’s spending could be around USD 18 trillion (18 followed by 12 zeroes). Therefore, it is practically impossible for countries like the United States to add another 18 trillion next year and hence they register lesser economic growth.

In the previous years, Bhutan enjoyed one of the highest economic growth rates in the world. GDP at one point of time reached about 20 percent. 

So if Bhutan doesn't grow, it means the economy is experiencing a slump and we will most likely see an increase in unemployment rate.

However, an increase in growth rate in the previous years has also been associated with all kinds of problems like the rupee shortage. As national income increased, spending also increased. Since the manufacturing base is very small, most of the expenditure automatically got converted to Indian rupees, thus putting a lot of pressure on the Indian rupee and to reign in outflows, several restrictive measures were put in place.

This does not bode well to the citizens of the country. It appears that we cannot handle higher growth rate because then there will be more rupee outflows, at the same time a lesser GDP growth would also mean higher unemployment and  lower profits for companies, businesses and shops.

The effort than has to be made on the manufacturing sector, so that foreign imports are minimized.With a strong manufacturing base in place, Bhutan can afford to grow much more higher than just 2 percent because now no matter how much investment level increase, we have the manufacturing base which can absorb it. 

Sunday, November 9, 2014

Inflation versus Interest rate

Image from Google

It has been a generally accepted fact that Bhutanese lack saving culture, they would rather invest the money elsewhere than save it in a bank. This has been a concern for the authorities and they have involved themselves into programs and initiatives like financial literacy to educate people and inculcate a savings habit in them.

Savings is important for an economy. When an individual saves his money in a bank, he makes credit available for another individual or an institution, thus one man’s savings becomes another man’s credit. Bankers can thus provide credit to another man or a government who needs ready cash for development programs. Credit is integral for development, and it saves the government from relying into borrowings from international banks where the interest rates can be relatively expensive.

So why do Bhutanese lack savings culture? Is it because we lack a proper understanding of personal finance or is it because the system in itself does not encourage people to save.

Let’s look at inflation. Inflation in Bhutan has been averaging 9 to ten percent and sat times, even 13 percent as recorded by NSB. Inflation in essence means an increase in the prices of goods and services, on the other hand it also means, decrease in the purchasing power of money.

What Nu 100 can buy five years ago, needs Nu 150 to buy today. For example, you bought a liter of vegetable oil for Nu 100 five years ago, to buy the same amount and type of vegetable oil, you are required to pay Nu 150 today.

If inflation is increasing at an average 10 percent a year, the value of your money is also decreasing at the same rate.

Now let’s look at the interest rates our banks provide for saving our money with them. Banks provide an interest rate of five percent to 8 percent over a period of one year to five years.

If you save money in a bank for one year, it will add an additional value of 5 percent to it in one year, but in the same year, the value of your money has dropped down by ten percent. Which means:

Saving- Nu 100
Interest rate- 5 percent
Inflation 10 percent
Loss- 5 percent

So, by saving in a bank, your money, rather than accumulating any value has decreased in its power to purchase. This doesn't seem to make sense. So you are technically losing money while in the process of saving. Unless the objective to save is to make money available during emergencies, there is no incentive other than that. If you saved your money in the bank for fifteen years, its value could even be halved.

And since it does not make sense to save in a bank which provide interest rate lower than inflation rate, it is important that there are better investment avenues and opportunities, which is lacking in our economy. Other than fresh IPOs (initial public offerings) made by companies, there’s no place else to invest money that provide better returns. 

So, does all this explain why Bhutanese lack a saving culture? Or as many in the authority like to believe, does Bhutanese lack an understanding of the financial system?

Sunday, November 2, 2014

Should we move from a cost plus method of calculating electricity tariff to a price cap method?

Bhutan Power Corporation and the Druk Green Power Corporation today uses the cost plus method of electricity pricing which means, these companies will account of all the cost that goes into construction, generation, operation and maintenance while calculating the rate at which electricity will be sold to the consumers.
After recovering the cost, they will keep a certain margin as their profit. Sounds legit.
However, this allows room for inefficiency as they are allowed to recover all the cost. What if for example, BPC decides to invest in an area that does not necessary add value to the company.
This extra cost that it bears will ultimately be reflected in the final price of electricity when consumers like you and I buy electricity from BPC.

We have also seen how electricity prices have increased as a result of several cost escalations in the hydropower projects.
What if someday, electricity becomes so expensive that our industries find it difficult to sustain.

Electricity is the only cheapest raw material for the local industries, since they have to import labor and raw materials from abroad.

A price cap method however ensures that companies like BPC and DGPC do not increase their price of electricity beyond a certain cap after accounting for all factors like cost, inflation etc.
This would ensure predictability for businesses and industries.