Tarun Das ADB Nepal Activity Report April 2010

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Monthly Activity/ Progress Report of Tarun Das, Macroeconomic Modeling Specialist

MONTHLY ACTIVITY/PROGRESS REPORTOF TARUNDAS,TEAM LEADERAND MACROECONOMIC MODELING SPECIALIST1

(FORMERLY, ECONOMIC ADVISER, MINISTRYOF FINANCE, INDIA)FORTHE MONTHOF APRIL 2009

INASSOCIATIONWITHDURGA LAL SHRESTHA, MACROECONOMIC MODELING SPECIALIST

VIKAS RAJ SATYAL, ECONOMETRICIANROJAN BAJRACHARYA, NATIONAL IT SPECIALIST

Asian Development Bank Project No.TA-7165-NEPStrengthening Capacity for Macroeconomic Analysis (Component B)Nepal Rastra Bank

Baluwater, Kathmandu, Nepal

For any clarifications, write to: [email protected]

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The modeling team would like to express their gratitude to Mr. Shahid Parwez,Program/ Project Implementation Officer, and Mr. Yubraj Acharya, Economics

Officer, ADB Nepal Resident Mission for providing all possible support for the

project; Mr. Ravindra Prasad Pande, Executive Director (Research), Nepal Rastra

Bank (NRB) and Chairman, Technical Committee on Modeling for strategic

guidance; Dr. Nephil Matangi Maskay, Director (Research), NRB and Focal Officer

for day-to-day supervision; Dr. Ram Sharan Kharel, Deputy Director (Research)

and Secretary, Technical Committee for valuable discussions and comments on

modeling; Mr. Suman Neupane, Assistant Director (Research) for logistics

support and all the concerned divisions in the Research Department, NRB for

their enthusiastic cooperation, keen interest, useful discussions and for providing

relevant data and documents.

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MONTHLY ACTIVITY/PROGRESS REPORTOF TARUNDAS,

TEAM LEADERAND MACROECONOMIC MODELING SPECIALIST

FORTHE MONTHOF APRIL 2009

CONTENTS

Contents Pages

1. Monthly Activity Report for the month of April 2010 3-5

2. Current status of works and proposed Work Plan for the second

phase (6 April-31 May 2010) presented at the Tripartite meeting

held on the 20th April 2010

6-19

3. Power point presentation on the Current status of works and

proposed Work Plan for the second phase (6 April-31 May 2010)presented at the Technical Committee meeting held on the 26th

April 2010

20-23

4. An operational consistent macroeconomic accounting spreadsheet

model for Nepal- data base, test and calibration techniques, and

base line projections for the years 2010-2015

24-43

5. Appendix-1: Description of 160 variables 44-48

6. Appendix-2: Time series data for 1975-2009 and standard

descriptive statistics

49-71

7. Appendix-3: Linear time trends log (Yt) = + Time ;

log-linear equations log (Yt) = + log (GDPMPt) to estimate GDPelasticity; and

projected growth rates for the years 2010-2015 along with ratios to

GDP at current market prices

72-94

8. Appendix-4: KPS Unit Root Tests for the variables 95-134

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MONTHLY ACTIVITY/PROGRESS REPORTOF TARUNDAS,TEAM LEADERAND MACROECONOMIC MODELING SPECIALIST

FORTHE MONTHOF APRIL 2009

1. Works Completed during April 2010

During the second phase (6th April to 31st May 2010), it is propose to complete the works ondevelopment and test and calibration of the upgraded Nepal Macroeconomic Mode. Duringthe month under review, significant progress has been made towards that goal.

Derailed discussions have been held with all the concerned divisions in the ResearchDepartment of NRB and the model structures of five sub-models have been finalized. Timeseries data on about 160 variables for 36 years 1975-2009 have been compiled and coded

in the EViews7. Unit Root Tests have been conducted for all variables and Ganger CausalityTests have been conducted for meaningful pairs of observations.

Equations have been specified, tested and calibrated for two sub-models viz. the RealSectors and National Accounts, and the Government Finance Blocks. Tests and calibrationsfor other sub-models are continuing.

An alternative operational consistent macroeconomic accounting spreadsheet model hasbeen made and calibrated for the base line scenario on the basis of secular time trends,growth models and elasticity approach. The Model is presented in this report.

2. Reports produced during April 2010

The following reports have been prepared during the month. Copies of all these Reportsare attached herewith for ready reference. These reports have been prepared with fullsupport and close collaboration with the National Consultants and the concerned Divisionsof NRB.

1. Updated Work Plan of Tarun Das, International Consultant for MacroeconomicModeling during the Second phase of the project (6 April to 31 May 2010)- prepared forthe Tripartite Meeting held on the 20th April 2010.

2. Current status of works and work plan for the second phase- power pointpresentation at the Technical Committee Meeting held on the 26th April 2010.

3. An operational consistent macroeconomic accounting spreadsheet model forNepal- data base, test and calibration techniques and base line projections for 2010-2015.

2. Meetings attended during April 2010

Tarun Das, International Macroeconomic Modeling Specialist and team Leader attendedthe following major meetings during April 2010:

(1) Day-to-day briefings by Dr. Maskay, Focal Officer for about half an hour every day;

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(2) Tuesday, the 6th April 2010 0830-0900 Briefing meetings with Mr. Shahid Parwez,Project Coordinator, and Ms. Shreejana, Finance Officer, ADB Nepal ResidentOffice, Kamladi, Kathmandu.

(3) Tuesday, the 6th April 2010 1000-1030 Briefing meetings with Dr. Kharel, DeputyDirector (Research) and Secretary, Technical Committee, NRB and Mr. SumanNeupane, Assistant Director (Research), NRB.

(4) Wednesday, the 7th April 2010 1130-1230 Briefing meetings with Mr. RavindraPande, ED (Research), NRB and Chairman, Technical Committee.

(5) Thursday, the 8th April 2010 Forenoon, Discussions and feedback sessions withNational Accounts and Prices Divisions of the Research department, NRB.

(6) Thursday, the 8th April 2010 Afternoon, Discussions and feedback sessions withBOP Division of the Research department, NRB.

(7) Sunday, the 11th

April 2010- Forenoon, Discussions and feedback sessions withMonetary and Financial Division of the Research department, NRB.

(8) Sunday, the 11th April 2010- Afternoon, Discussions and feedback sessions withGovernment Finance Division of the Research department, NRB.

(9) Tuesday, the 20th April 2010 1600-1800 hours: Tripartite Meeting among NRB,ADB and Consultants on the status of works and Work Plan for the second phase.

(10) Monday, the 26th April 2010 0930-1100 hours: Technical Committee Meetingchaired by Mr. Ravindra Prasad Pande, ED (Research) and Chairman, TechnicalCommittee regarding current status of works and the Work Plan during the second

phase.

(11) Thursday, the 29th April 2010- 1500-1600 Discussions with Dr. Maskay and Dr.Kharel along with all consultants and Mr. Neupane regarding the Visual Displaysoftware

3. Ongoing Works and Outputs during May 2010

As per the proposed Work Plan, the following works are at different stages of completionand the associated Outputs/ Reports will be produced in May 2010:

(a) Installation of EViews7 Software;

(b) Test and Calibration of all sub-models of the Nepal Macroeconomic Model;

(c) Integration of all Models, Simulations and Projections under baseline and alternativescenario;

(d) Preparation of the Visual Display Software with the help of local vendors;

(e) Organization of five internal seminars for presentation of five sub-models by theconsultants;

(f) Organization of five internal seminars for presentation of revised sub-models by theconcerned divisions of the Research Division of the NRB;

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(g) Organization of the Final Workshop foe multi-stakeholders on the 28th/ 29th May2010;

(h) Preparation of the final Report on the test and calibration techniques, projections andsimulations of the integrated Nepal Macroeconomic Model.

Submitted for favor of perusal.

(Tarun Das)Macroeconomic Modeling Specialist and Team LeaderThe 30th April 2010

ADB Project Coordinator

Copy to: Dr. Nephil Matangi Maskay, Director (Research), NRB and Focal Officer

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Nepal Rastra BankADB Project on Nepal Macroeconomic Modeling

Subject: Updated Work Plan of Tarun Das, International Consultant forMacroeconomic Modeling During the Second phase of the project

(6 April to 31 May 2010)

1. Status of the Project Works as on Sunday, the 18th April 2010

At the instance of Dr. Nephil Matangi Maskay, Director (Research), NRB and Focal Officerfor the Component B of the ADB TA Project, the International Consultant returned toKathmandu on Monday, the 5th April 2010 after more than five and half months of thecompletion of the first phase in the middle of October 2009. He resumed works on Modelingin the NRB Project Room with effect from Tuesday, the 6th April 2010, under the strategicguidance of Mr. Mr. Ravindra Prasad Pandey, ED (Research Department), NRB and theChairman of the Technical Committee, and the day-to-day supervision and direction by Dr.Nephil Matangi Maskay.

Mr. Suman Neupane, Assistant Director (Research) is working with the InternationalConsultant on continual basis and providing all logistics support. Dr. Ram Sharan Kharel,Deputy Director (Research) and secretary (Technical Committee) is providing necessaryhelp and advice on the model. The local consultants Prof. Durga Lal Shrestha and Prof.Vikash Raj Satyal have also started working in the NRB Project Room on two or threeworking days in a week.

1.1 Procurement and Installation of the Requisite Hardware and Software

In the meantime, on the basis of ADB approval, orders have been placed by the NRB for theprocurement of hardware. Mr. Rojan Bajracharya, local consultant on IT, has initiated steps

to place orders for the procurement of the EVIEWs7 software from the designated vendor.The installation of the hardware may take one more week, and the procurement andinstallation of the software may not be complete until the end of April 2010. The non-availability of the requisite hardware and software is a major constraint for the fullinvolvement of the local consultants and stakeholders in the process of test and calibrationof the model. However, the International Consultant has procured and installed EViews7 onhis lap top at his own expenditure and has already started test and calibration of the modelon his own laptop. EViews4 is available on the PC of Mr. Neupane for performing initial testsof the model.

1.2 Comments on the Model by Concerned Divisions in NRB

Consultants received written consolidated comments on the model by the concerneddivisions through Dr. Maskay on the 7 th April 2010. Subsequently during the first week, theconsultants held detailed discussions with the respective units on the model structures, database, and test and calibration techniques. Divisions basically agreed with the modelstructures given in the inception report, but mentioned the role of additional variables formore effective and realistic modeling and outlook.

During discussions, it was agreed that the ultimate model structure has to satisfy not onlythe economic theories but also the standard statistical tests for specification and calibrationsuch as unit root test for stationary, granger causality tests and the co-integration tests inaddition to the usual goodness of fit statistics. Divisions also expressed their willingness tobe directly involved in the modeling process, particularly for their sub-model, from the verybeginning.

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1.3 Limitations of the NMEM and Steps Taken in the Upgraded Model

Annex-1 in this report summarizes the limitations of the ADB NMEM and the steps taken inthe Proposed Upgradation by us to rectify these limitations. Annex-2 presents thedifferences of basic features between ADB NMEM and Upgraded NMEM in a tabular form.In brief, the earlier NMEM was a demand-based model in the Keynesian framework andignored the role of supply for the real sectors and money and credits. Upgraded model hasspecific blocks for the supply sides of GDP and money.

In addition, the upgraded model has fully developed the government finance and balance ofpayments blocks which were very weak in the NMEM. For all the sub-models, the upgradedmodel is more detailed than the ADB NMEM and uses more up-to-date data on nationalaccounts, BOP and government finance on the basis of revised base or revised IMFconcepts, which were not available at the time of building NMEM more than five years ago.

For example, the NMEM consisted of only 59 variables, out of which 37 were endogenous(comprising 20 behavioral equations and 17 identities) and 22 were exogenous. On contrast,

the upgraded model comprises 151 variables, of which 139 variables are treated asendogenous and determined within the sub-models, and only 12 variables are treated asexogenous and determined outside the model. Out of 139 endogenous variables, 92variables will be determined by equations and the residual 47 variables are identities toensure consistency and equilibrium within the sub-models.

We also propose use more modern techniques on the test and calibration. For example, theNMEM did not use unit root test for stationarity, granger causality test for determiningdirections of causality and the Cointegration test to examine whether the dependent andindependent variables are integrated at the same level. All these tests will be used for testand calibration of the upgraded model.

1.4 Proposed Work Plan Submitted by the International Consultant

On the 13th April 2010, the International Consultant submitted a proposed work plan which isreproduced in Annex-4. Dr. Maskay provided brief comments on the Work plan on theFriday, the 16th April 2010, which are reproduced in Annex-5. This report presents a revisedWork plan in response to these comments.

2 Updated Work plan during the Second Phase (6 April-31 May 2010).

The week-wise updated work plan is presented in a matrix form in Table-1 below where firstcolumn indicates the weekly time schedules, the second column indicates different activitiesand the third column specifies the role of local consultants and the stakeholders in these

activities. The table is self-explanatory. We summarize below the proposed steps and therole of local consultants and the stakeholders in the NRB in building up the model and in thetest and calibration of the model,

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2.1 Data Base for the Updated Model

As mentioned earlier, during the first week in the current phase, the local consultantsprovided detailed data matrix for 151 variables for the period 1975-2009 to the internationalconsultant. These data have been supplemented by additional data supplied by theconcerned divisions. All these data have been processed and the relevant EViews7 Workfilehas been prepared on the lap top of the international consultant. With the help of localconsultants, data sets have been validated and some preliminary tests have been carriedout on EViews7.

2.2 Role of the Local Consultants

As per the terms of reference, the modeling work is a joint team work by the internationaland national consultants. Although the international consultant has the major responsibility inupgrading the model, the local consultants, who are also experts in their respective fields,are supposed to provide necessary advice to the international consultant. In addition toproviding data, the local consultants are expected to provide economic, statistical and

econometric advice and help to the international consultant for building up the sub-models,for test and calibration of the sub-models, for preparing the working papers, manuals andguideline and for providing training and helping in capacity building and dissemination ofknowledge for the stakeholders. All these activities require physical presence of the localconsultants in the NRB Project room. It is, therefore, advisable that like the internationalconsultant, the local consultants also attend the NRB Project Office on full time basis on allworking days during the remaining six weeks of the second phase until the end of May 2010and fully participate in the test and calibration of the model and in writing the report.

2.3 Role of the Economic Analysis Division (EAD)

The EAD will have the sole responsibility to update the upgraded model and to review it from

time to time and the conduct the relevant simulations and projections for monetary policyplanning and for providing inputs to for the preparation of the Annual Budgets and nationalDevelopment plans. For this purpose, Mr. Suman Neupane has been fully involved in theday-to-day works and test and calibrations by the consultants. Mr. Neupane and Dr. Kharelmay also present a paper on the integrated model structure under the overall supervision byDr. Maskay and with the help by the consultants.

2.4 Role of the other Divisions

As mentioned earlier, the concerned divisions have expressed their willingness to be directlyinvolved along with the consultants for the test and calibration of the respective sub-modeland for preparation and presentation of the sectoral paper in the workshop.

2.5 Academic Visits

A separate report will be prepared on the possible academic visits or study tours onmodeling to other countries. As desired, in addition to the proposed Indian institutes,possibility of attachment to other academic institutes in Malaysia and Korea will be explored.

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Table-1: Work Plan Matrix during Second phase (6 April 2010 to 31 May 2010)Weeks in the SecondPhase(6 April-31 May 2010)

Activities Specific Role of localconsultants and otherdivisions*

First week- Tuesday, 6th

April to Sunday, 11

th

April2010

1.1 Strategic guidance by

ED and Focal officer;1.2 Discussions onconsolidated commentsby the concerneddivisions,1.3 Detailed discussionson data base, structure,test and calibration of thesub-models with variousdivisions viz. nationalaccounts, BOP, Govt.Finance, Monetary and

Prices Units;1.4 Collection of relevantdata on sub-models

Local consultants provided

detailed data base, collectedduring the intermittent period,and attended meetings withthe respective divisions ontwo days.

Second week- Monday, 12th

April to Sunday, 18th April2010

2.1 Submission of theproposed work-plan;2.2 Preparing Workfile onEViews7 with collecteddata2.3 Validation of theWorkfile and matchingthe data with those

obtained from variousdivisions;2.4 Carrying out selectedtest runs on Eviews7along with localconsultants regardingUnit Root, GrangerCausality andCointegration Tests andfitting of sampleRegression lines;2.5 Discussions on thecomments on the work-plan received from Dr.Maskay, Dr. Kharel andMr. Neupane;2.6 Submission of revisedwork-plan in response tothese comments.

Prof. Satyal attended NRBProject Room on three daysand Prof. Shrestha attendedon two days during the week.

Note: * International consultant Tarun Das and Mr. Suman Neupane will be involved on fulltime basis for all activities and on all working days during the second phase.

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Third week- Monday, 19th

April to Sunday, 25th April2010

3.1Presentation of therevised work-plan in theTripartite meeting to beheld at 13=00 hours in

the NRB on Tuesday, the20th April 2010;3.2 Test and calibration ofthe supply side of the realsector sub-model;3.3 Test and calibration ofthe demand side of thereal sector sub-model;3.4 Draft outline for thepreparation of theworking paper on the realsector sub-model

indicating data base,model structure, test andcalibration techniques,and the EViews7 outputon the best fitted relationsand their implications.

Local consultants willbe fully involved inthese activities;

Local consultants

are requested topresent their work-plan in the Tripartitemeeting.

Two officers from thenational accountsdivision will beinvolved in the testand calibration of thesub-model, and forpreparing a workingpaper for presentation

in the Workshop.

Fourth week- Monday, 26th

April to Sunday, 2nd May2010

4.1 Test and calibration ofthe government financesub-model;4.2 Draft outline for thepreparation of theworking paper on the

govt finance sub-modelindicating data base,model structure, test, andcalibration techniques,and the EViews7 outputon the best fitted relationsand their implications.


Two officers from thegovt finance divisionwill be involved in the

test and calibration ofthe sub-model, andfor preparing aworking paper forpresentation in theWorkshop.

Fifth week- Monday, 3rd Mayto Sunday, 9th May 2010

5.1 Test and calibration ofthe prices and monetarysector sub-models;5.2Draft outline for thepreparation of theworking paper on thesesub-models indicatingdata base, modelstructure, test, calibrationtechniques, and theEViews7 output on thebest fitted relations andtheir implications.


Two officers each

from prices, and themoney and financialsector divisions willbe involved in the testand calibration of thesub-models and forpreparing a workingpaper for presentationin the Workshop.

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Weeks in the SecondPhase(6 April-31 May 2010)

Activities Specific Role of localconsultants and otherdivisions*

Sixth week- Monday, 10th

May to Sunday, 16

th

May2010.

6.1 Test and calibration

of the BOP sub-model;6.2 Draft outline for thepreparation of theworking paper on theBOP sub-modelindicating data base,model structure, test, andcalibration techniques,and the EViews7 outputon the best fittedrelations and theirimplications.

Local consultants will

be fully involved inthese activities;

Two officers from theBOP division will beinvolved in the testand calibration of thesub-model, and forpreparing a workingpaper for presentationin the Workshop.

Seventh week- Monday,17th May to Sunday, 23rd

May 2010.

7.1 Integration of all sub-models and conductingsimulations andprojections of variablesfor the medium term;7.2 Preparation of thecomplete upgradedmodel for presentation inthe Workshop indicatingdata base, modelstructure, test, andcalibration techniques,

and the EViews7 outputon the best fittedrelations and theirimplications.


Mr. Suman Neupanewill be fully involvedfor preparing theWorking Paper forpresentation in theWorkshop.

Eighth week- Monday, 24th

May to Sunday, 30th May2010.

8.1Workshop isproposed to be held onthe 24th and 25th May2010.8.2 Detailed schedule ofthe Workshop and theparticipation will befinalized and submittedlatter after consultationwith all stakeholders.8.3 Sub-models and allthe papers will bemodified in the light ofcomments obtained inthe Workshop.


Research Division willbe fully involved inthese activities.

Monday, 31st May 2010 Submission of the RevisedReport on upgradedmodeling to the NRB,


Note: * International consultant Tarun Das and Mr. Suman Neupane will be involved on full time basis

for all activities and on all working days during the second phase.

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Annex-1

Limitations of the ADB NMEM and Proposed Upgradation

The following table summarizes the limitations of the earlier Nepal Macroeconomic Modeland the steps to be taken to rectify the limitations and upgrade the model in the proposedmodel:

Limitations of the earlier NepalMacroeconomic Model

Steps taken to rectify the limitations in theproposed upgraded model

a) Model considers only the demand sideof GDP, but does not consider thesupply side of the real sectors.

Supply side of GDP will be projected by the sub-sector wise econometric time trends as well as byfitting Cobb-Douglas type production functions in theframework of Solow technical progress

b) Money, credit and price blocks werenot fully developed and did not

consider the supply side and the roleof expectations.

Supply of different components of money will beprojected. Prices and exchange rates will be fully

developed. Role of expectations will be consideredin the Dynamic Stochastic General Equilibriummodel.

c) The Government block was theweakest block with only equation forthe non-tax revenue and all othervariables were defined by simpleaccounting identities.

Government finance block is being fully developedwith separate equations for different components ofexpenditure and revenues.

d) Basically, all the fiscal variables suchas taxes, current and capitalexpenditure are treated as policy

variables and left to be decided by thepolicy makers. This is not a veryconvincing assumption because taxesand government expenditures alsodepend on economic prospects,composition of GDP and many othervariables.

In the upgraded model, government expendituresand revenues are not treated as exogenousvariables, rather would be determined by the overall

prospects of the economy and given upper limits onthe fiscal deficits and other fiscal sustainabilitymeasures.

e) Similarly, balance of payments blockwere not well developed. It consideredonly merchandise exports andmerchandised imports but did notendogenize the other components in

the current account (such as servicesand remittances). In the capitalaccount, loans and amortization wasendogenized, but the underlyingeconometric relations are lessconvincing.

BOP block is being fully developed by endogenizingdifferent components in the current and capitalaccounts such as net services, net income,remittances, FDI inflows etc. External debtsustainability measures will also be estimated.

f) There had been structural changes inthe economy and also changes in thebasic concepts of data for differentblocks. The model also needs to beupdated and upgraded on the basis ofnew data available for the national

accounts and balance of payments.

The model is also being updated on the basis ofdata for the period 1975-2009 incorporating newdata available for the national accounts, governmentfinance and balance of payments, and to take careof structural change of the economy over the years..

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Annex-2

Differences of Basic Features between ADB NMEM and Upgraded NMEM

The following table summarizes the basic characteristics of the earlier Nepal MacroeconomicModel and the present upgraded Nepal Macroeconomic Model

Basic characteristics of the earlierNepal Macroeconomic Model

Basic characteristics of the presentupgraded Nepal Macroeconomic Model

a) The NMEM is a basicallyKeynesian income-expendituremodel in which the demand sidedetermines GDP.

The upgraded NMEM considers demand andsupply side of real, money and externalsectors and attempts to provide partialequilibrium in the macroeconomicconsistency accounting framework.

b) The supply side is not explicitlyspecified as the aggregateproduction function is not

estimated.

Supply sides of sectoral GDP, money supplyand external sectors are specificallyconsidered in the upgraded model.

c) There are 5 building blocks in theNMEM viz. final demand, prices,credit and money, government,and the balance of paymentsblocks. Final demand is the sumof private consumption,government consumption, privatefixed investment, governmentfixed investment, increase instock or inventory, and netexports. In NMEM, development

expenditure is a determinant forthe private fixed investment,public fixed investment and publicconsumption.

There are also five blocks in the upgradedmodel viz. (a) supply and demand for realsectors and National accounts; (b) supplyand demand for money and credits; (c)government finance with detailed projectionsfor major components of expenditure andrevenues; (d) balance of payments withdetailed projections of major components inthe current account and the capital andfinancial accounts; (e) prices, interest ratesad exchange rates.

d) The NMEM is a mid-sized modelwith 37 equations. A medium-sized model has an advantage inpolicy analysis as it incorporatesmore detail of the structure of theeconomy.

The upgraded NMEM is a large sized modelwith 151 variables. It will provide moreflexibility for the policy makers to analyze theimpact of many variables o the fiscal,monetary, balance of payments and overalleconomic outlook.

e) The NMEM consists of 59variables, out of which 37 areendogenous (20 behavioralequations and 17 identities) and22 are exogenous. The NMEMdistinguishes policy variablesfrom simple exogenous variables,as these policy variables aredetermined by non-economicforces or foreign sectors. Taxes,regular expenditures,development expenditures,foreign borrowing, and the

exchange rate were taken aspolicy variables in the NMEM.

The upgraded model comprises 151variables, of which 139 variables are treatedas endogenous and determined within thesub-models, and only 12 variables aretreated as exogenous and determinedoutside the model. Out of 139 endogenousvariables, 92 variables will be determined byequations and the residual 47 variables areidentities to ensure consistency andequilibrium within the sub-models.

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f) The NMM attempts to incorporateNepals strong economic ties withIndia in international transactionsalthough economic relationshipswith other countries are alsobecoming important.

While the upgraded model also considersthe predominance of external sector flowswith India, it makes an attempt toendogenize many external sector flows suchas remittances, income, service, FDI etc.

g) The impact of the exchange rateon trade in Nepal is quite limitedsince the Nepalese rupee ispegged to the Indian rupee andIndia is the major trading partnerof Nepal. The exchange ratevariables were incorporated in thetrade equations since the changesin the exchange rate with respect

to the US dollar can affect tradewith the rest of world by changingthe relative prices with othercountries.

The role of NEER and REER and the dollarexchange rate will be taken as determiningfactors for external trade and commerce

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Annex-3

Proposed Work Plan During Second Phase (April-May 2010)

From: Tarun Das, international Consultant on Macroeconomic ModelingTo: Dr. Nephil Matangi Maskay, Director (Research) and Focal Officer

Subject: Proposed Work-plan for the Macroeconomic Modeling Team

1. BackgroundThe modeling team comprising International Consultant Tarun Das and National ConsultantsProf. Durga Lal Shrestha and Prof. Vikash Raj Satyal submitted a detailed Inception Reporton Nepal Macroeconomic Modeling (in two parts) in the middle of October 2009. At theinstance of Dr. Nephil Matangi Maskay, Director, Research Division, Nepal Rastra Bank(NRB) and Focal Officer, ADB Project No.TA7165NEP (Component B), the InternationalConsultant returned to Kathmandu on Monday, the 5th April 2010 and resumed worksmodeling in the NRB Project Room with effect from Tuesday, the 6th April 2010.

Subsequently the local consultants also joined him for executing project assignments as perthe terms of reference.

2. Current Status of the ProjectIn the meantime, ADB approval has been obtained by the NRB for the procurement of therequisite hardware and software required for the test, calibration and simulation of themodels. The Inception Report, particularly the proposed model structures of the NepalMacro-Econometric Model (NMEM) and a Dynamic Stochastic General Equilibrium Model(DSGEM), data base, test and calibration techniques were thoroughly examined by thevarious divisions in the NRB viz. National Accounts Unit, Monetary Unit, Price Unit,Government Finance Unit and the Balance of Payments Unit. Consolidated comments ofthese units on the model structures were provided by Dr. Nephil Matangi Maskay to the

consultants on the 7th April 2010.

Subsequently, the consultants held detailed discussions with the respective units on themodel structures, data base, and test and calibration techniques. It is well known that theproposed model has an integrated model with five sub-models viz. real sector, prices andinterest rates, BOP, government finance, monetary and fiscal sectors.

Comments given by the units are very constructive and vary valuable for modifying themodel structures. However, in some cases, the required data are not available. Duringdetailed discussions with the Divisions, it was agreed that the ultimate model structure has tosatisfy not only the economic theories but also the standard statistical tests for specificationand calibration such as unit root test for non-stationary or stochasticity or randomness of the

variables, granger causality tests and the co-integration tests in addition to the usualgoodness of fit statistics. So at this stage it is not advisable to argue theoretically regardingthe exact form of equations. It will be more useful to start the test and calibration procedureson EVIEWs with actual set of data.

It was also agreed by all the units that they would like to be involved directly in the modelingprocess and activities, particularly for their sub-model, from the very beginning. For this, theywould like to nominate one or two officers from their units to work with the modeling team forabout a week for developing the sub-model. They would not only provide advice andfeedback for the specification, test and calibration of the respective sub-model but alsoprepare a detailed working paper on the sub-model under the guidance of the modelingteam for presentation in the NMEM Workshop to be organized at the end of May 2010. Sucharrangement will not only help in capacity building and transfer of knowledge, which is thebasic purpose of the ADB funded project on modeling, but also enable the respective

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Divisions and the NRB as a whole to own the model and update and upgrade it in futurewithout the help of consultants.

3. Proposed Work Plan for completing the Project

3.1 Work Plan for upgrading NMEM during second phase (6 April to 31 May2010)

On the basis of above discussion and further consultation with the national consultants, theinternational consultant would like to propose the following Work Plan for consideration bythe Focal officer:

a) Hands on Training on application of EViews7 for NMEM for a day- Beforestarting the test and calibration of the respective sub-models, the consultants wouldorganize a hands-on training program for a day on the introduction of EViews-7 andon the Granger Causality Test, Unit Root Test and the Co-Integration Test for allparticipants. Consultants will also specify the outline of the working paper to beprepared for different sub-models.

b) Test and calibration of five sub-models- five weeks- Following Hands-on training,subsequent five weeks will be devoted for actual specification, test and calibration ofthe five sub-models of the Macroeconomic Model. As mentioned above, this willrequire one week for each sub-model.

c) Integration, Simulation and Medium Term Projection of the complete Model-one week- Then we consolidate and integrate all the sub-models for the presentationin the Workshop.

d) Organizing a Workshop on upgraded NMEM- two days- 23-24 May 2010e) Finalizing the NMEM on the basis of comments in the Workshop- one week-

Last week of May 2010.Involvement of National Consultants: In formulation of this Work Plan, it is assumed thatthe National Consultants Prof. Durga Lal Shrestha and Prof. Vikash Raj Satyal, like the

International Consultant, will be available on full time basis on all working days in the NRBProject Room for at least consecutive seven weeks during this phase. This implies only 35working days at maximum for each of them.

3.2 Building DSGE Model- two person-months in the third phase,Exact timing will be decided by the NRB

During the current phase the consultants will be fully pre-occupied for upgrading theNMEM and organizing the Workshop. Depending on the availability of time, they mightprovide some directions towards modifying the DSGE Model. But the exact model willbe built, tested, calibrated, simulated and projected during the two months period of thethird phase.

3.3 Final phase- for winding up the Project- one person month

The residual time of one person month will be fully devoted to prepare the terminal report forthe project along with preparation of detailed guidelines and manuals for both the models.

4. Human Capacity Building

Consultants agree with the views of the NRB that the hands-on training to be conducted bythe consultants and the Workshops to be organized, as mentioned above, are necessary but

not sufficient to communicate models to the stakeholders and effective transfer ofknowledge.

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For wider exposure of the modelers, it is proposed that an appropriate training program for agroup of selected six officers engaged in modeling, comprising one officer from each sub-model and one from the research division may be devised in consultation with Dr. Maskay,Focal officer. In this respect, an academic visit by the Group for about a week to the ReserveBank of India (RBI) or to the Indira Gandhi Development Research Institute (IGDRI) inMumbai or to the Institute of Economic Growth (IEG) and the Delhi School of Economics(DSE), who are engaged in the development of the UN-Link Model for India or to theNational Council for Applied Economic Research (NCAER) in New Delhi, which hasdeveloped a Computerized General Equilibrium (CGE) Model for the Indian FinanceMinistry, may be explored. ADB will be requested to fund this academic visit, which isconsidered to be an integral part of the Capacity Building Activity under the project.

5. Procurement and Installation of the Hardware and Software

Required approval has come from the ADB and the Consultants are willing and ready toprovide all possible help and advice for this activity. Urgent administrative arrangements arenecessary within the NRB. In the meantime, international consultant is working with his own

laptop on which he has installed EViews7 at his own expenditure. Until the requiredhardware and software are installed in the project room, suitable arrangements may pleasebe made for the local consultants so that they can perform their duties more productivelyand more efficiently.

6. Action Points

6.1 Requesting Divisions to nominate two officers

Dr. Maskay, Focal Officer, may please like to request formally each of the Division Heads tonominate two officers from their division who could be directly involved on the modelingworks for about a week for the respective sub-model. The division head may also please

indicate the tentative week when they will be available for one day hands-on training onapplications of EViews7 and subsequently for a week for actual test and calibration of themodel.

6.2 In-Principle Approval from the ADB

(a) It is proposed that a Workshop on Upgrading NMEM will be organized on 22-23 May2010 after completion of the test and calibration of sub-models and the core modelduring the previous six weeks. A detailed schedule for the Workshop will be preparedand submitted to ADB. Tentatitavely, the Workshop will have six working sessions(five sessions on five sub models and one session for the core integrated model) inaddition to an inaugural session and a concluding session. For five sub-models, five

working papers are proposed to be prepared and presented by the respective unitsunder the guidance of the consultants, while the consultants will consolidate the sub-models and carry out the necessary simulation and forecasting for the integratedmodel and prepare and present the integrated model in the Workshop. Consultantsare of the views that such arrangement will help in active participation of thestakeholders in modeling and effective capacity building cum hands-on training. Inprinciple approval of the ADB is requested for the following:

(i) A payment of a token honorarium of US$200 each to joint authors on eachsub model for preparation and presentation of the working paper on the submodel in recognition of their additional and hard work for the project inaddition to their normal duties in the NRB.

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(ii) A payment of a token honorarium of US$50 each to the 6 chairmen ofdifferent sessions in recognition of their participation in the workshop and forproviding chairmans summary report and concluding observations;

(iii) A payment of a token honorarium of US$25 each to the 6 discussants indifferent sessions in recognition of preparation of written comments on eachsub-model.

(iv) A payment of a token honorarium of US$50 each to three reporters to providewritten summary of proceedings covering three/two sessions each.

(v) Total estimated honorarium for the above activities are indicated below:

Items Rate in U$ Total in US$

1. Honorarium to 10 authors (two for eachof five sub-models)

200 per author 2000

2. Honorarium to 6 chairmen (one foreach of five sub-models and one coremodel)

50 per chairman 300

3. Honorarium to 6 discussants (one foreach of five sub-models and one coremodel)

25 per discussant 150

4. Honorarium to 3 reporters (coveringfive sub-models, one core model,opening session and closing session)

50 per reporter 150

Total estimated honorarium 2600

(b) Academic Visit of the Modeling Group to India for a WeekFor the academic visit to India as mentioned in 4 above, in principle approval from the ADBis sought for funding the following expenditure:

Items Rate in U$ Total in US$

1. Return economy class air fare fromKathmandu to Delhi/ Mumbai for sixofficers

500 per person 3000

2. Per diem for 6 days for six officers 150 per person per day

5400

Total 8400

Submitted for favor of consideration

(Tarun Das)The 13th April 2010

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Annex-4Comments on Proposed Work-Plan

Strengthening Capacity for Macroeconomic Analysis (Component B).

Ref: Comments on Proposed Work-Plan

Dear Dr. Das,

It's our great pleasure to receive your proposed work-plan which covers the period 6 April to31 May, 2010. It is the period to upgrade and update NMEM model. The work-plancomprises the status of the project; work guideline to complete the project; human capacitybuilding plan through training and participative approach; and learning through academicvisits and workshops.

We reviewed and discussed the proposed work-plan in our economic analysis division(EAD). Comments that were raised during the discussion and review process have been

presented point wise, which are as follows.

a) While the proposed work-plan is in the concise form, it would also be better if thedetailed work-plan, including day-to-day division of works for the modeling team, isprovided available to us. This would both facilitate for preparing a progress report aswell provide a road-map to complete the work within a given time frame. We wouldrequest that this be submitted in a matrix format.

b) The work plan does a thorough job in describing the involvement of respectivedivisions' in calibrating and report writing to each blocks of macroeconomic model.However, it is not clearly specified the role, involvement and necessary contributionof EAD. This may be such as having EAD the sole responsibility to update and

upgrade the macroeconomic model.

c) In work plan, there is a need to have a clear picture of the difference between oldNMEM and upgraded NMEM. In this regard, it is requested that this analysis beprovided, at the greatest detail possible such as equation by equation.

d) Regarding the academic visits, given the budget, you are requested to expand youproposal and manage the visits to institution's beyond India, such as to Korea;Indonesia; Thailand etc., which have developed similar macroeconomic models.

It goes without saying that your discretion is required in sharing this information (such as inregard to academic visit).

You are requested to revise your work plan accordingly for necessary discussion during theforthcoming tripartite meeting, on April 20, 2010 at 13.00 in NRB.

Nephil Matangi Maskay, PhDDirector, Research Department &Focal Person, ADB Project No. TA7165NEP (Component B)April 16, 2010

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Power Point Presentation at the Technical Committee MeetingOn Monday, the 26th April 2010

Progress Report on Modelingas on 26 April 2010

Tarun Das, Team LeaderAnd National ConsultantsProf. Durga Lal Shrestha

Dr. Vikas Raj SatyalMr. Rojan Bajracharya

Contents of presentation1. Basic Tasks of the Project2. Works completed in the First Phase3. Proposed Works in Second Phase

4. Current Status of Works5. Work Plan for the Second Phase6. Role of National Consultants7. Role of concerned divisions of NRB8. Organizing Workshop9. Proposed Study Tours10. Concluding Observations

1. Basic Tasks of the Projecta) To upgrade Nepal Macroeconomic Modelb) To build up a Dynamic Stochastic General Equilibrium Model for the NRBc) Facilitate Installation of Software/ hardware

d) Prepare Users Manuals and Guidelinese) Conduct multi-stakeholders workshopsf) Provide on-the-job training to the stakeholdersg) Prepare Terminal Report sh) Basic Tasks of the Project

2. Works completed in the First Phasea) During the first phase (20 August to 15 October 2009) consultants prepared the

Inception Report in two partsb) The Reports provided basic structures of upgraded NMEM and DSGEM along

with desired software and hardware requirements, data base, and test and

calibration techniques.c) The report was presented in an internal seminar of NRB on the last day.

3. Proposed Works in Second Phase

Second phase started on the 6th April 2010 and is expected to continue until the end ofMay 2010. Major tasks include the following:a) Installation of hardware and softwareb) To build up, test, calibrate, simulate the upgraded NMEM and make projections for

the medium termc) To prepare Manuals, guidelines and report on the upgraded NMEMd) Capacity building cum hands-on training on NMEM for the stakeholderse) To organize Workshop on NMEM

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f) Works on DSGEM and Terminal Report will be completed in next two phasesspanning over three person months.

4.1 Current Status of Works

Consultants received written comments on the models by concerned divisions of theNRB. These were followed up by detailed discussions with them.

Structures of the sub-models of the NMEM have broadly been agreed on the basis ofeconomic theories.

But the actual structures will depend on the standard statistical tests for specificationand calibration such as unit root test for stationary, granger causality tests and theco-integration tests in addition to the usual goodness of fit statistics.

4.2 Data Base for Upgraded NMEM Upgraded model considers both supply and demand sides of real, monetary and

external sectors, and is a large-sized model.

The earlier NMEM consisted of 59 variables (comprising 20 equations, 17 identitiesand 22 exogenous variables). On contrast, the proposed upgraded model consists of 157 variables (92

equations, 47 identities and 18 exogenous variables).

4.3 Status on Data Base for NMEM Local consultants provided detailed data matrix for 157 variables for 36 years

spanning over the period 1975-2009. These data have been supplemented and updated by additional data supplied by the

concerned divisions in the NRB. All data have been processed, cross-checked, validated and the relevant EViews7

Workfile has been prepared.

Unit root tests for trend stationarity have been performed for all variables. Granger causality tests have also been conducted for many variables.

4.4 Hardware and Software Five Laptops have been procured and configuration have been verified by National IT

Expert. Five desktop PCs are in transit and hopefully would arrive by the end of April 2010. Order is being placed for the procurement of Eviews7 software from the designated

vendor for the region. Non-availability of the hardware and software is a major constraint for full

involvement of the national consultants and stakeholders in the process of test andcalibration of the model.

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5.1 Proposed Work Plan for the remaining weeks

1-2 First two weeks works discussed.3. Third week- Monday, 19th April to Sunday, 25th April 2010 Test and calibration of the Real sectors supply and demand sub-models have been

completed.4. Fourth week- Monday, 26th April to Sunday, 2nd May 2010 Test and calibration of the Government finance sub-model;5. Fifth week- Monday, 3rd May to Sunday, 9th May 2010 Test and calibration of the Prices and monetary sector sub-models;5.2 Proposed Work Plan for the remaining weeks

Sixth week- Monday, 10th May to Sunday, 16th May 2010. Test and Calibration of the BOP sub-model; Seventh week- Monday, 17th May to Sunday, 23rd May 2010. Integration of all sub-models and conducting simulations and projections of variables

for the medium term; Preparation of the complete upgraded model for presentation in the Workshop

5.3 Proposed Work Plan for the remaining weeks Eighth week- Monday, 24th May to Sunday, 30th May 2010. Workshop is proposed to be held on the 24th and 25th May 2010. Sub-models and all the papers will be modified in the light of comments obtained in

the Workshop. Monday, 31st May 2010 Submission of the Revised Report on upgraded modeling to the NRB,

6. Role of National Consultants

National Consults will be fully involved with the test and calibration of the sub-models, simulation and projections of the core model, preparation and presentationof the working papers, manuals and guidelines, capacity building and hands-ontraining on the models.

National IT Expert, along with local vendors, will develop user-friendlyMacroeconomic Page on the Model data base, fitted equations and results, andupdating mechanism.

7.1 Role of the Economic Analysis Division (EAD) of NRB

The EAD will have the sole responsibility to update the upgraded model and to

review it from time to time. For this purpose, Mr. Suman Neupane, Assistant Director, has been fully involved in

the day-to-day works and test and calibrations of the sub-models. Mr. Neupane and Dr. Kharel may also present a paper on the integrated model

structure under the overall supervision by Dr. Maskay and with the help of theconsultants.

7.2 Role of other Divisions of NRB

In our initial work-plan, it was proposed that at least one representative of a divisionwill be directly involved for the test and calibration of the respective sub-model and

for preparation and presentation of the sectoral paper in the workshop. All the divisions expressed their willingness for this proposal.

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But, due to preoccupation with the preparation of inputs for the budget and theEconomic Survey, divisions did not get time to be involved with the modeling works.

8. Organizing Workshop

It is proposed to organize a two-day Workshop on 24-25 May 2010 for presentationof the sub-models and core models.

I have proposed to the ADB that they may approve the payment of token honorariumto all the authors of the papers, chairman and discussants of various sessions inrecognition of their valuable contributions to the Workshop in addition to their normalduties.

In a tripartite meeting held on 20 April 2010 at the NRB, the ADB has expressed theirin principle approval for the proposal and has requested for a detailed proposal.

9. Proposed Study Toursa) In the same tripartite meeting I have also requested ADB to partially or fully fund

some study visits by the concerned officers in the NRB who are directly involved inbuilding and upgrading the models.b) ADB has expressed their in-principle approval for the proposal, but has requested for

a detailed proposal on the subject.

10. Concluding Observations

Despite various constraints, prospects of building up meaningful and operationaleconomic models are bright.

However, it would have been more effective if the concerned divisions can put upsome time at least for the preparation of the proposed Workshop.

Consultants are also willing to provide hands-on training on modeling and

applications of EViews7 to the concerned stakeholders. Availability of their time is theprime issue.

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AN OPERATIONAL CONSISTENT MACROECONOMIC ACCOUNTINGSPREADSHEET MODEL FOR NEPAL-

DATA BASE, CALIBRATION TECHNIQUESAND BASE LINE PROJECTIONS

TARUN DASMACROECONOMIC MODELING SPECIALISTAND TEAM LEADER

INASSOCIATIONWITHDURGA LAL SHRESTHA, NATIONAL MODELING SPECIALIST

VIKAS RAJ SATYAL, NATIONAL ECONOMETRICIANROJAN BAJRACHARYA, NATIONAL IT SPECIALIST

30 APRIL 2010

Nepal Rastra Bank and ADB Nepal Resident OfficeKathmandu, Nepal

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CONTENTS

1. An operational consistent macroeconomic accounting spreadsheet

model for Nepal- data base, test and calibration techniques, and

base line projections for the years 2010-2015

24-43

2. Appendix-1: Description of 160 variables 44-48

3. Appendix-2: Time series data for 1975-2009 and standard

descriptive statistics

49-71

4. Appendix-3: Linear time trends log (Yt) = + Time ;

log-linear equations log (Yt) = + log (GDPMPt) to estimate GDPelasticity; and

projected growth rates for the years 2010-2015 along with ratios to

GDP at current market prices

72-94

5. Appendix-4: KPS Unit Root Tests for the variables 95-134

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1. Analytical Framework and Model Structure

1.1 Purpose and Objectives

The basic purpose of this exercise is to build an operational macroeconomic model for Nepal

in the consistent macroeconomic accounting framework, depicting the underlying structure,

trends and interrelations among major macroeconomic variables. As compared with the

upgraded Nepal Macroeconomic Model, which is being calibrated on EViews7 on the basis

of more advanced econometric techniques, this is a spreadsheet model calibrated on Excel

file on the basis of simple econometric relations. However, this model satisfies the basic

statistical and econometric tests for modeling, and has the following advantages:

(1) The model is based on simple economic concepts viz. trend growth rates and elasticity of

a variable with respect to GDP at current market prices;

(2) It is a spreadsheet model and can be calibrated very easily on Excel Files;(3) As mentioned above, the model satisfies the basic econometric tests on calibration.

First of all, time series data on 150 macroeconomic variables have been collected and

processed on Excel file. The data along with standard descriptive statistics are given in the

Appendix-1 of this Report. Then, we have carried out the KPSS Unit Root tests on EViews7

for all the variables used in our model and observed that most of the variables are trend

stationary within 5 percent level of significance. The results are indicated in Appendix-3 of

this Report. Therefore, the standard least squares method can be used to fit the regression

lines. Then we test the Granger causality test and observe that the GDP at current market

prices granger causes most of the macroeconomic variables in the government finance,

balance of payments, and monetary and financial blocks. Therefore, we can use GDP

elasticity for forecasting a variable provided we get a good fit relating a variable to GDP at

market prices.

Brief Description of the Methodology

Derailed methodology for tests and calibration is discussed in section 3. Here we present a

brief introduction to the methodology. First of all, different components of GDP are projected

on the basis of secular growth rates observed in the past. Then, GDP at current market prices

is taken as the leading factor to project major macroeconomic variables in various sub-

models, and we estimate the elasticity of a variable with respect to GDP by fitting log-linear

functions log (Yt) = + log (GDPMPt). We observe that both the exponential time trends andlog-linear functions provide very good fits as judged by R2. The results are indicated in theAppendix-2 of this Report.

Analytical Framework

The same analytical framework as described in the Inception Report for the Upgraded Macro

Economic Model prepared in October 2009 is used for this Macroeconomic Accounting

Spreadsheet Model. The analytical framework is consistent with the basic concepts and

interrelations under the UN System of National Accounts (UN-SNA), and the IMF

Government Finance Statistics (GFS), Balance of Payments (BOP) Statistics and the

Monetary-Financial Statistics (MFS). Thus, the model consists of five inter-related accounts

as indicated below:

(i) Real Sector (National Accounts)(ii) Government Sector (Fiscal Account)

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(iii) External Sector (Balance of Payments Account)

(iv) Monetary Sector (Monetary and Financial Account), and

(v) Prices, Interest and Exchange Rates.

1.2 Model Structure and Analytical Framework

The basic structures of these sub-models and their interrelations are depicted in the form of a

flow diagram in Box-1.1. The linkages between key aggregates of the national accounts and

the balance of payments flows and government finance statistics can be summarized

algebraically within a savings/investment framework. Let us use the following symbols,

National Accounts System (NAS)

GDPFC = Real GDP at constant FC = GDPSector

GDPSector = Sector (Agriculture, industry, services) GDP at FC

C = private consumption expenditure

G = government consumption expenditureI = gross domestic investment

S = gross saving

X = exports of goods and (non-factor) services

M = imports of goods and (non-factor) services

NFY = net factor income from abroad

GDP = gross domestic product

GNP = gross national product = GDP + NFY

GNDY = gross national disposable income + Net Transfer

On the supply side, overall GDP equals the sectoral value added for different sectors such as

agriculture, industry and services. In our model, industry has four sub-sectors viz. mining and

quarrying, manufacturing, construction and public utilities (comprising electricity, gas and

water supply). Service has four sub-sectors viz. (a) wholesale and retail trade, hotels and

restaurants; (b) transport and communications; (c) financial services and real estate; and (d)

social sectors comprising health, education, public administration, religious, personal and

community services. GDP for the sub-sectors are projected at both constant factor cost and

current market prices.

On the demand side, GDP at factor cost equals government consumption, private

consumption, investment and inventories, and exports less imports. These items are projected

at current basic prices. By adding indirect taxes less subsidies, we get the GDP at currentmarket prices.

GNI equals GDP plus Net Factor Income from abroad, while Gross National Disposable

Income equals GNI plus Net Transfer.

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Balance of Payments (BOP)

CAB = current account balance in the balance of payments = TB + SB + FIB + NCT

RT = reserve asset transactions

TB = Merchandise trade balance = Merchandise Exports Merchandise Imports

SB = Non-factor service balance (travel, tourism, financial, business, ICT etc.)FIB = Factor income balance (interest, dividends, wages, rent, royalties etc.)

NCT = Net current transfer (official grants, private grants, remittances)

NKT = net capital transfers

NPNNA = net purchases of non-produced, non-financial assets

NFI = net foreign investment or net lending/ net borrowing vis--vis the rest of the world

NKA = net capital and financial account (i.e., all capital and financial transactions excluding

reserve assets)

Government Finance Statistics (GFS)

R= Revenue = T + NTT = Tax revenue

NT = Non-Tax revenue

GR= Grants

GEXP = Government expenditure and net lending = G + GK

G = government consumption expenditure

GK= Government capital expenditure and net lending = GCE + ND

GCE = Government capital expenditure

ND = Net lending

GFD = Gross Fiscal Deficit

= (R+GR) - GEXP

Monetary-Financial Statistics (MFS)

MD = Demand for money = NFA+CRG + CRP + OI

MS = Supply of money = DD + TD + CN

NFA =Net foreign assets

CRG = Credits to the government and public enterprises

CRP = Credits to the private sector

OI = Other items

DD = Demand deposits

TD = Time depositsCN = Currency and notes in circulation

Prices, Interest Rates and Exchange Rates

CPI = Consumer Price Index

WPI = Wholesale Price Index

GDPDF = GDP Deflator

INT = Rate of interest

PLR= Prime lending rate

FDR= Fixed deposit rate

ER= Exchange rate of Nepalese Rupee per US dollar

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The Macroeconomic Balance Equations stand as follow:

GDP = C + G + I +XM (1)(XM= balance on goods and services in the balance of payments)

GNP = GDP + NFY (2)

CAB = X M + NFY+NCT (3)

GNDY = C + G + I + CAB (4)GNDY = C + G + S (5)

Equating (4) and (5) we get:

S I = CAB i.e. saving-investment gap (resource gap) equals CAB (6)

S I + (NKT NPNNA) = CAB + (NKTNPNNA) = NFI (7)

(NKTNPNNA) = balance on the capital account of the balance of payments.

Interrelationship between the internal and external sectors of an economy can be seen in

greater detail by distinguishing between private and public sectors. Private saving and

investment (Sp and Ip) and government saving and investment (Sg and Ig) are identified as:

SI = Sp+SgIpIg (8)

Use of the definition of the externalcurrent account from equation (1) then gives:

CAB = (SpIp) + (SgIg) = SI (9)

Equation (9) shows that the private savings-investment balance plus the government fiscal

balance equals the current account balance. It also implies that, if government sector

dissaving is not offset by net saving of the private sector, the current account will be in

deficit. More specifically, the equation shows that the budgetary position of the government

(Sg-Ig) may be an important factor influencing the current account balance.

Government deficit is financed by borrowing from the domestic sector, borrowing from the

external sector and borrowing from the central bank. All these factors have influences on the

domestic capital and financial markets and also on the balance of payments.

Economists generally agree that a persistent fiscal deficit may ultimately spill over the

current account deficit in the balance of payments. On the converse, a sustained current

account deficit may reflect persistent government spending in excess of receipts, and such

excess spending may suggest that fiscal tightening is the appropriate policy action to tackle

both fiscal and balance of payments problems.

We also know that

CAB = NKA+RT = SI (10)

Equation (10) shows that the current account balance is necessarily equal (with sign reversed)

to the net capital and financial account balance plus reserve asset transactions. This

relationship shows that the net provision, as measured by the current account balance, of

resources to or from the rest of the world mustby definitionbe matched by a change in

net claims on the rest of the world.

It may be useful to rewrite CAB as:

SI = CAB = TB+SB+FIB+NCT = NKA+RT, where (11)

Where TB, SB, FIB and NCT stand for trade balance, services balance, factor incomesbalance and transfer balance respectively.

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Box-1.1: Basic Structures of Macroeconomic Sub-models and Inter-linkages

30

REAL SECTORNational Accounts

GDP at current market prices Private consumption General govt. consumption

General govt. investment Private investment Exports of goods and

Non-factor services Imports of goods and

Non-factor services

CENTRAL GOVERNMENTRevenues

Taxes and non-taxes GrantsExpenditures Current CapitalOverall balanceFinancing

Domestic financing (net) Banking system Nonbanking sector External financing (net)

Balance of PaymentsCURRENT ACCOUNT Exports of goods andNon-factor services

Imports of goods andNon-factor services

Factor services (net) Transfers (net)

Official Private

MONETARY SECTORMonetary Authorities Net Foreign AssetsNet domestic assets: Net credit to centralgovt. Credit to banks

Other items (net) Reserve money

CAPITAL ACCOUNT

Direct investment

Medium/long-term

capital (net)

Short-term capital (net)Overall balanceChange in net foreign

assets

Deposit Money BanksBanks' reserves Net Foreign Assets

Net domestic assets: Net credit to central

govt. Credit to private sector Other items (net)

Liabilities to monetaryauthorities

Private sector deposits


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1.3Inter-Sectoral Financial Transactions Matrix

In a paper entitled Balances, Imbalances and Fiscal Targets- a New Cambridge Model

Wynne Godley and Alex Izurietaof theCambridge Endowment for Research in Finance

(CERF), University of Cambridge used a simplified accounting matrix to illustrate the

interrelations of financial transactions among various sectors of the economy. Theyargued that macroeconomic analysis would be easier if the main income and expenditure

flows comprising the GDP are arranged in a double entry format as in Table-1. The two-

way table indicates clearly the transactions among any two economic agents viz.

producers, consumers, government, and rest of the world. The matrix shows how the gap

between receipts and outlays of any sector implies an equivalent rise or fall in its net

acquisition of financial assets.

Table-1: A Simplified Macro Transactions Matrix

Income/

Expenditure

Production Governmen

t

Rest of

the World

Total

1.Pvt. Exp -C +C 0

2.Gov. Exp +G -G 0

3.Exports +X -X 0

4.Imports -M +M 0

5.GDP +Y -Y 0

6. Taxes,

Fact. Pay.

-TP +T -TF 0

7.Financial

Balances

+NAFA

= Y-C-TP

0 +PSNB

=T-G

-BP

=M-X-TF

0

In this matrix the national income identity is shown, running vertically down in column 2,

as the appropriation account of a postulated production sector. It says that gross domestic

product, Y, is equal to private expenditure, C plus government expenditure, G, plus

exports, X, less imports, M. Every item in the GDP identity has a counterpart with the

opposite sign in some other column. Taxes less transfers, T, are received or paid by the

government; net property income, taxes and transfers, TF and TP, are paid by

respectively the external and private sectors. The total in line 7 shows that public

borrowing, PSNB, equals the private net acquisition of financial assets, NAFA, (that is

saving less investment, or net saving) minus the balance of payments surplus, BPor plus

the deficit. Wynne Godley and Alex Izurieta illustrated the analysis with the help of UK

and USA data. One important conclusion of the analysis is that the financial balances

(relative to income flows) must stay within certain limits for maintaining the

sustainability of public debt over time. This in turn implies that that a strict monitoring of

these basic balances is essential for formulation of effective macro stabilization policies.

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2 Data Base

The basic data for 160 variables2 for the years 1975-20093 are obtained from the official sources.

Basic data on national accounts are obtained from the Central Bureau of Statistics (CBS), Nepal

supplemented by the data from the Nepal Rastra Bank. Data on government finance statistics are

obtained from the Nepal Ministry of Finance and the Nepal Rastra Bank. Data on monetary andfinancial statistics and the balance of payments statistics are obtained from the Nepal Rastra Bank

supplemented by the data from the International Monetary Fund. Data on sectoral employment and

investment are estimated by the national consultants Prof. Durga Lal Shrestha and Prof. Vikas Raj

Satyal by using standard interpolation and extrapolation techniques on the basis of limited data

obtained from official sources. So the data base can be considered to be authentic and reliable.

2.1 Data Base on National Accounts for 1975-2009

It presents time series data on sectoral GDP at both current and constant 2000-01 prices in

national currency (millions of Nepalese rupee) for the years 1975-2009. It has data on both

broad sectors of the economy viz. agriculture, industry and services, and sub-sectors within

these broad sectors. No sub-sector is considered for Agriculture due to lack of long term

series, while industry is sub divided into four sub-sectors viz. mining and quarrying,

manufacturing, construction and public utilities (comprising electricity, gas and water

supply), and services sector is sub divided into four subsectors viz. wholesale and retail trade

and hotels and restaurants; transport, storage and communications; finance and insurance and

real estate; and social services (comprising health, education, public administration,

community, social and personal services).

2.2 Data on Balance of Payments for 1975-2009

Data on Balance of Payments for the years 1975-2009 are obtained from the Nepal RastraBank, supplemented by the data from the IMF. Necessary adjustments have been made to

take care of changes in the basic concepts, definitions and classifications over the years.

2.3 Data on Monetary Survey and Prices for 1975-2009

Data on Monetary Survey, Financial Statistics and CPI for the years 1975-2009 are obtained

from the Research Department of the Nepal Rastra Bank.

2.4 Data on Government Fiscal Operations for 1975-2009

Basic data on government financial statistics for the years 1975-2009 are taken from theNepal Rastra Bank supplemented by the data from the Ministry of Finance. Necessary

adjustments have been made to take care of changes in the basic concepts, definitions and

classifications over the years.

2.5 Basic Presumptions for Projections

2 The list of variables with descriptions is presented in Annex-1 in the proposed work plan.

3 The year 1975 refers to the fiscal year ending with mid-July 1975 i.e. the fiscal year from mid-July 1974 to

mid-July 1975. Similarly, the year 2009 refers to the fiscal year ending with mid-July 2009 i.e. the fiscal year

from mid-July 2008 to mid-July 2009.

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As discussed in the Inception Report on Modeling prepared in October 2009, despite the

global financial crisis and economic recession, the Nepalese economy performed well in

2008 and achieved real growth of 5.3 percent aided by agricultural growth at 4.7 percent,

industrial growth at 1.8 percent and services growth at 7 percent. Inflation was contained at

7.7 percent and there was a surplus on the current account of the balance of payments. The

reasons for no significant adverse impact of global financial crisis on the Nepalese economyinclude the following:

(a) Nepals financial sector has limited external liabilities and assets.

(b) Although its external current account has close links with the rest of the world, the

major link is with India which maintained relatively high growth rates during the

crisis period.

(c)Nepal and India also maintained normal trade links during the crisis period.

Although the global slowdown did not have much adverse impact on the Nepals financial

sector, the real sector growth in 2008/09 was affected adversely by the domestic factors such

as unfavorable monsoon, power shortage and labor unrest. The Central Bureau of Statistics(CBS) has estimated that the real GDP growth rate at basic prices has decelerated from 5.3%

in FY2008 to 3.8% in FY2009. The slowdown is broad-based, encompassing agriculture,

industry and services. The agriculture sector is estimated to grow by only 2.2% in FY2009,

down from 4.7% in FY2008; industrial sector by 1.8% almost the same as 1.9% in FY2008;

and service sector by 5.8%, significantly down from 7.0% in FY2008.

There was significant acceleration of the consumer price inflation from 7.7% in 2008 to

13.2% in 2009 contributed by food inflation of 14.8 percent and non-food inflation of 9.8

percent. However, the fiscal situation and the balance of payments have surplus on current

accounts and macroeconomic fundamentals are sound. Both the government and the

monetary authority deserve to be complemented for maintaining economic stability in a

difficult socio-economic-political context.

There are now indications that these adverse factors also continued in 2010. As per the

estimates made by the ADB Nepal Resident Office, real GDP growth rate is expected to

remain subpar at approximately 3.5% in FY2010 (16 July 2009 15 July 2010). Services

are expected to expand robustly, but may not sufficiently offset the weak performance of

industry and agriculture. Industrial growth may remain subdued due to continued political

disturbances, frequent power cuts, and fuel shortages. Assuming normal weather conditions

during the winter, agriculture output growth is also expected to decelerate from last year in

view of significantly reduced summer crop output due to poor weather. There is liquiditycrunch in the banking sector caused by a number of factors such as decelerating remittances,

heavy imports and excessive lending by commercial banks. Fuelled by high import prices and

high CPI inflation in India, domestic inflation is also running at high levels, and challenging

macroeconomic stability during 2010. Consequently, there was upward trend of deposit and

lending rates in contrast to the declining trend in the recent past.

Despite the political turmoil and the labor unrest, both the government and the Nepal Rastra

Bank deserve complements for adopting sound macroeconomic and prudent monetary

policies to tackle the adverse impact of the global financial crisis and economic recession and

spiraling inflation in Nepal.

In the Budget estimate for 2010, the Ministry of Finance projected a rise of the expenditureoutlay by 37% and revenue by 37% over FY2009. Although the targets were ambitious, the

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mid-term review of the budget carried out by the Ministry of Finance in February 2010

suggested that both expenditure and revenue targets are likely to be met.

Our forecasts of key macro-economic variables for the years 2011-2015 take into account the

developments in the current year 2010. We further assume that the transitional problems of

strikes and labor unrest will be solved by the next year. In addition, our projections are basedon the following presumptions:

(a) Government will continue with the prudent macroeconomic management.

(b) There will be no weather socks;

(c) There will be no other internal and external shocks, except volatile oil prices.

(d) Tourists arrivals and travel incomes would return to normal levels;

(e) Remittances would continue to be buoyant;

(f) Donors support would continue at normal levels;

(g) There will be no change in the real exchange rate of the Nepalese rupee during the

projection period.

3 Projection Techniques

Components of supply side of the GDP (i.e. sectoral value added) are projected on the basis

of the historical growth rates adjusted for large variations, if any. Other variables in the

model are estimated by elasticity with respect to nominal GDP at current market prices.

However, only individual items in different sub-models are projected by this method, while

the aggregates are estimated on the basis of standard identities and balance equations to

satisfy consistency among various variables and partial equilibrium within the system.

3.1 Historical Growth Rates for the Real Sector

Basic methodology used is the standard time series analysis to estimate historical growth

rates on the basis of three kinds of time trend growth rates viz., least squares time trend

growth rate, exponential growth rate and simple average annual growth rate.

To start with, we estimate the average historical growth rate for each of 9 sub-sectors of GDP

(1 in agriculture, 4 in industry and 4 in services) viz. agriculture (Agr), mining and quarrying

(Min), manufacturing (Manf), public utilities (Utilities), construction (Const), wholesale and

retail trade (Trade), transport and communications (Trans), financial services (Fin), and social

sectors (Social) comprising health, education, public administration and community, religious

and personal services. Three kinds of growth rates, as indicated below, are estimated on thebasis of the past time series data for 1975-20094 and presented in the Appendix-2.

(a) Least-squares time trend growth rate

The IMF uses the Least-squares growth rates to forecast the country growth rates for their

World Economic Outlook (WEO) published twice in a year, wherever there is past data for at

least 9 years to permit a reliable calculation. The least-squares growth rate, r, is estimated by

4Data are obtained from the official sources such as the Ministry of Finance, Nepal Rastra Bank and Central

Bureau of Statistics. Data on balance of payments for the past are supplanted by data from the InternationalMonetary Fund (IMF).

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fitting a linear regression trend line to the logarithmic annual values of the variable in the

relevant period. The regression equation takes the form

Ln Yt= a + bt

which is equivalent to the logarithmic transformation of the compound growth equation,

Yt= Yo (1 + r)t

In this equation, Y is the variable, t is time, r is the trend growth rate, Ln is the natural

logarithm operator, and a = log Yo and b = Ln (1 + r) are the parameters to be estimated.

Ifb* is the least-squares estimate ofb, the average annual growth rate, r, is obtained as

r = [exp(b*) 1] and is multiplied by 100 to express it as a percentage.

The calculated growth rate is an average rate that is representative of the availableobservations over the entire period. It does not necessarily match the actual growth rate

between any two years.

(b) Exponential growth rate

The exponential growth rate between two points in time for a variable is calculated from the

following equation

r= Ln (Yn /Y1)/(n-1)and is multiplied by 100 to express it as a percentage.

where Ynand Y1 are the last and first observations in the period, n is the number of years in

the period, and Ln is the natural logarithm operator. This growth rate is based on a model of

continuous and exponential growth between two points in time. It does not take into account

the intermediate values of the series.

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(c) Average of Annual Growth rates

Average Annual Growth Rate () = GRi /n

GRi = 100 * (Yi / Yi-1 -1) for i=1, 2, n for the years 1975,1976 ..... 2009.

CV = 100 * SD/

SD = (GRi - ) / nWhere Ln stands for natural logarithm, GRi for growth rate for the i-th year, CV for

coefficient of variation and SD for standard deviation.

3.2 Base Line Time Trend Projections

On the supply side, the projections of sectoral value added for the years 2010-2015 are done

on the basis of the minimum of the three types of growth rates as mentioned above. In

general, for most of the variables, the exponential growth rate is lower than the least squares

trend growth rate, which in turn is lower than the average annual growth rates. Thus the

exponential growth rate happens to be lowest growth rate and is taken for projecting the

sectoral GDP at both constant and current prices5. The same methodology is used to projectnet indirect taxes (INDT, i.e. indirect taxes less subsidies and transfers). Thus we have,

YCST= YCSTAGR+YCSTIND+YCSTSER-YCSTFISM

YFC=YFCAGR+YFCIND+YFCSER-YFCSISM

YFCIND=YFCMIN+YFCMANF+YFCUTILITY+YFCCONST

YFCSER=YFCTRADE+YFCTRANS+YFCFIN+YFCSOCIAL

YMP=YFC+YINDTAX

YGNI = YMP+BOPINCOME

YGNDI=YGNI+BOPTRANSFER

As mentioned earlier, past data for the years 1975-2009 along with standard descriptive

statistics are presented in Appendix-1 and the projections of sectoral GDP at both current

and constant prices for the years 2010-2015 are presented in the Appendix-2. The latter

Tables also indicate the fitted regression lines log (Yt) = + Time and log (Yt) = +

log (GDPMPt) and the corresponding R2 for estimation of the trend growth rates of the

variables and the elasticity of the variable with respect to the GDP at current market prices.

5 It may also be possible that annual growth rates are volatile with high st

Tarun Das ADB Nepal Activity Report April 2010

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