Chapter 4: Economic Environment

Very  Short Questions Answers

1. Write about the economic dimension.

Dimensions of an economy refer to the facets of economy of a country. They are reflected through demographic forces, income level, income distribution, growth of agricultural and industrial activities, development of service sector, level of employment, balance of payments, rate of inflation, urbanization, and globalization.

2.What do you mean by monetary policy?

Monetary policy is a macroeconomic policy to contribute to economic growth and stability, to lower unemployment, and to maintain predictable exchange rates with other currencies. It deals with the management of money supply and interest rates by central banks to control prices and employment.

3.Write any two objectives of monetary policy.

The two objectives of monetary policy are as follows:

• To stabilize the price level since fluctuations in prices bring uncertainty and instability to the economy
• To increase investment for full employment

4.What do you mean by bank rate policy?

Bank rate policy is one of the instruments of the central bank to control the monetary management in the country. It states, that the rate of interest is levied by central bank to commercial banks. The central bank increases the bank rate during inflationary situation and decreases the rate in deflationary situation.

5.Write about Cash Reserve Ratio.

Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with the central bank. CRR is set according to the guidelines of the central bank of a country.

Short Answer Question

1.Explain about the various economic dimensions.

A country’s economic structure consists of various dimensions. There exist four interrelated dimensions of a nation’s economy. They are:

• Economic dimension: The economic dimension indicates the economic performance of a country. The demand side performance is measured by distribution of income among various demographic factors whereas supply performance is done through the measurement of saving, investment, productivity, increase in wage rate, labor cost and capacity utilization.Similarly, internal economic performance includes measures of aggregate results in terms of output, prices and employment whereas external economic as performance includes the measures like balance of payment, and exchange rates.
• Socio-economic dimension: The socio-economic dimension provides data on the quality of people characterized by the demographic composition of the country and indicates the market potential by analyzing the number of people with the means to buy a firm’s products.
• Industrial and agricultural dimension: The industrial and agricultural dimension of a country indicates its potential to supply goods, services and raw materials. The stronger the industrial and agricultural base of the economy the greater the potential to supply goods, services and raw materials to consumers and industrial units in domestic as well as global markets.
• Economic development dimension: The economic development dimension is reflected in the economic development plans in a mixed economy. The (economic development plans indicate overall socio-economic development policies and strategies and the mechanism of resource allocation in different sectors of the economy.

2.Explain in brief the different instruments of monetary policy.

The monetary policy uses a number of quantitative and qualitative instruments to achieve the objectives. Some of them are as follows:

Quantitative instruments affect the level of aggregate demand through the supply of money, cost of money and availability of credit. The quantitative instruments of monetary policy are as follows.

• Bank rate policy: Simply bank rate refers to the rate of interest levied by central bank to commercial banks. Under this, the central bank increases the bank rate during inflationary situation and decreases the rate in deflationary situation.
• Open market operation: The open market operation refers to the purchase and/or sale of short term and long term securities by the central bank in the open market. Under inflationary situation, the central bank sells the securities. On the other hand, it buys securities to address the deflationary situation.
• Variation in the reserve ratios: The Commercial Banks are required to keep a certain proportion of their total deposit in the form of cash reserves in the central bank. If the reserve ratio is high, the commercial banks will be in a position to create a smaller volume of credit. On contrary, if the ratio is low, the commercial banks can expand their credit. The examples are CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio).

Qualitative instruments aim at regulating and controlling the allocation of credit among various users rather than influencing the general availability of credit. The qualitative instruments of monetary policy are as follows.

• Fixing margin requirements: The margin refers to the proportion of the loan amount which is not financed by the bank. A change in a margin implies a change in the loan size. This method is used to encourage credit supply for the needy sector and discourage it for other non-necessary sectors.
• Consumer credit regulation: Under this, the central bank regulates the use of bank credits by the customers to buy durable consumer goods by influencing the amount of down payment and the maximum amount of repayment. This can check the credit use and then inflation in the country.
• Publicity: Under it, the central bank expresses its views based on facts and figures by using public media. It influences the credit policy of the commercial banks.
• Credit rationing: Under this, the central bank fixes credit amount to be lent by the banks. Credit is rationed by limiting the amount available for each commercial bank or fixing the upper limit of credit.
• Moral suasion: It implies to pressure exerted by the central bank on the overall banking system without any strict action. It involves persuasion, suggestion, and request to banks.
• Directives: Under this method, the central bank issue frequent directives to commercial banks. These directives guide commercial banks in framing their lending policy.

3.Write the economic and monetary targets of monetary policy 2015/16.

The Monetary Policy 2015/16 has introduced some micro level reforms within the banking sector. But it has also introduced some policy measures to control inflation. It has tried to use policy instruments to address the banking system’s liquidity surplus problem. It has also focused on strengthening financial discipline in the banking sector for financial stability. It has also paid attention to price and external sector stability. The main targets of the monetary policy are:

• The monetary policy has been tightened mainly due to excess liquidity Te which has started pulling down short-term interest rates. The fall in interest rates may increase flow of credit towards unproductive sectors like share market and real estate sector, artificially raising asset prices, which may destabilize financial sector.
• The bank and financial institutions are required to increase their paid up da capital within two years. The existing paid up capital of the commercial bank 2 billion should be increased to 8 billion in the same period. The paid up capital for the development banks and finance companies are also increased.
• The commercial banks are allowed to invest upto 40 percent of their foreign exchange reserve in foreign money market tools like call deposits, certificate of deposit and other secure instruments for a period of upto two years.
• The deprived sector loan by the commercial banks, development banks and finance companies has been increased to 5 percent, 4.5 percent and 4 percent respectively. It has been increased by 0.5 percent for all.
• The commercial banks, development banks and finance companies are required to invest 20,15 and 10 per cent respectively of their total loans to productive sector, within mid-July, 2016.
• NRB has brought down the refinancing rate for loans extended to agriculture, hydroelectricity, livestock, and poultry and fishery businesses to 4 per cent from 5 per cent.
•  In order to promote Small and Medium Enterprises (SMEs), NRB has been planning to introduce more flexible and effective provisions for loan security/insurance by offering more discounts on security fee/premium and loan loss provisioning for such lending.

4.Write about the different methods of privatization.

Privatization is the process of transferring the ownership of public enterprises to the private sector. Different methods of privatization may lead to different dominant ownership structures, with differentiated impacts on firm performance. After examining the direct and indirect impacts of privatization methods on national economic performance, the government decides the methods of privatization. A number of methods may be adopted for privatization. They are as follows.

• Assets Sales

 Under this method of privatization, the production and service units and other assets of enterprises are transferred to the private     sector in return for a price. Assets are sold through public auctions. Benefits of share or asset sale privatization are that bidders compete to offer the highest price, creating income for the state in addition to tax revenues.

• Business Sales

This is the transfer of total ownership of a public enterprise to the private sector. It involves transfer of total assets of the public enterprise to the private sector.

• Share Sales

This method of privatization involves the transfer of shares to the genera public, employees and private organizations. In other words, shares of state owned industries or public enterprises are sold on the stock markets. number of methods may be applied for sale of shares. They are:

• Block sales of shares
  • Domestic Stock Market
  • International Stock Market
• Public offering of the shares
• Sales of shares to employees
• Sales of shares to investment fund
• Combination of the above methods

• Management Contract

 Under this, management of the public enterprises is transferred to other party. This is done against a certain fee. The party is provided the right of operation and control of the enterprise. Its objective is to enhance the efficiency and to productivity of the enterprise.

• Lease Assets

Under this, the rights of the assets are transferred to the private sector for a specific period and in return for a certain price. The  contractor pays a certain fee to the government against the use of property.

5.Write the requirements of liberalization.

Economic liberalization refers to a country “opening up” to the rest of the world with regards to trade, regulations, taxation and other areas that generally affect business in the country. Liberalization policies require the following.

• Role of the government as facilitator: liberalization is a non-intervenist approach of development. Hence, the role of the government remains facilitator not regulator. The government brings policy and structural reforms to facilitate the private sector. It makes and amends fiscal policy, financial policy, monetary policy, trade and transit policy, exchange policy, etc. It also supports the private sector by building necessary infrastructure.
• Increased role of private sector: Economic liberalization emphasizes the increased role of private sector in the economy. The role of the government decreases. The assumption is private sector is agile than the government and has better managerial and decision making capacity. Policies and reforms focus to the development of private sector. Without privatization of public enterprises, there is no hope of liberalization. The government has the policy of privatization of public enterprises for enhancing liberalization.
• Abolishing license requirements: Liberalization demands abolishing license requirements in most of the industries. The Industrial Enterprises Act, 1992, has specified some industries requiring permission as industry related to security, currency, tobacco. Most of the other industries do not require permission.
• Freedom in business decision: Under liberalization, businesses enjoy freedom in decisions regarding expansion or contraction of business. The market factors determine price based on principle of demand and s d supply. The business sector is free to fix the price of goods and service.
• Removal of restriction: Liberalization requires removal of restriction on the movement of goods and services within and between countries. It requires elimination of tariff, para-tariff and non-tariff barriers.
• Reduction of tax rate: Under liberalization, the government gradually reduces tax rate to encourage private investment.
• Simplification of foreign trade: Under liberalization, foreign trade procedures are simplified through procedural simplification, facilitation and institutional strengthening.
• Facilitate FDI and technology transfer: Liberalization requires free flow of capital and technology between countries. In Nepal, Foreign Investment and Technology Transfer Act (FITTA) policy several provisions to facilitate FDI and technology transfer.

Long Answer Question

1. Define economic environment and explain the dimensions of economy. Discuss the effects of liberalization on Nepalese business.

Economic environment refers to all economic surroundings that influence business activities. Economic systems, economic policies, economic conditions and regional economic groupings are the components of the economic environment of business.

A country’s economic structure consists of various dimensions. There exist four interrelated dimensions of a nation’s economy. They are:

• Economic dimension: The economic dimension indicates the economic performance of a country. The demand side performance is measured by distribution of income among various demographic factors whereas supply performance is done through the measurement of saving, investment, productivity, increase in wage rate, labor cost and capacity utilization.Similarly, internal economic performance includes measures of aggregate results in terms of output, prices and employment whereas external economic as performance includes the measures like balance of payment, and exchange rates.
• Socio-economic dimension: The socio-economic dimension provides data on the quality of people characterized by the demographic composition of the country and indicates the market potential by analyzing the number of people with the means to buy a firm’s products.
• Industrial and agricultural dimension: The industrial and agricultural dimension of a country indicates its potential to supply goods, services and raw materials. The stronger the industrial and agricultural base of the economy the greater the potential to supply goods, services and raw materials to consumers and industrial units in domestic as well as global markets.
• Economic development dimension: The economic development dimension is reflected in the economic development plans in a mixed economy. The (economic development plans indicate overall socio-economic development policies and strategies and the mechanism of resource allocation in different sectors of the economy.

Effects of liberalization on Nepalese business are mentioned below:

• Growth of private sector: After Nepal adopted liberalization in the economy, the private sector is found to grow tremendously. The private sectors are involved in some core business such as airlines, hydropower, telecom, transportation and water supply.
• Rise of financial institutions: The government has emphasized the role of the private sector for the investment in the financial sector. With the adoption of the financial sector liberalization, the door was opened for foreign banks to open Joint Venture Banks in Nepal. Nabil Bank Limited, the first foreign joint venture bank of Nepal, started operation in July 1984. During two decades, Nepal witnessed tremendous increment in the number of financial institutions.
• Increase in FDI: Due to the liberalization policy of the government, the Foreign Direct Investment (FDI) has increased in Nepal. In the fiscal year 2071/72, commitment of FDI of Rs. 67 billion was received for small and medium size projects which are more than three times higher than the preceding year.
• Rise of multinationals: With the liberalization of the economy, the number of multinationals in Nepal has increased rapidly.
• Rising trade deficit: The external liberalization of the economy has been a reason for the rocketing trade deficit in the country. The trade deficit to GDP reached 32.1 percent in 2013/14 from 15.4 percent in 2004/05. The import export ratio was 2.5: 1 in 2004/05 and reached 8:1 in the year 2013/14.
• Development of capital market and insurance: Nepal has been providing due importance to capital market development and expansion. With liberalization, the number of insurance companies has also increased tremendously.
• Changing role of the government from regulator to facilitator: With liberalization of the economy, the role of the government is gradually changing to facilitator from the regulator. A number of policy reforms have been made by the government to facilitate the business sector in Nepal.
• Changing marketplace scenario: Nepalese market is greatly occupied by imported goods. The products which were once considered luxurious are now taken as essentials. Hence, Nepalese marketplace scenario is changing rapidly.

2.Write the objectives and features of tourism policy.

Nepal is rich in tourism due to unique natural beauty, rich biodiversity, in multi-ethnicity, variety of languages and religions, social heterogeneity and best historical as well as cultural heritage. The tourism policy has been brought to develop the tourism industry quantitatively and qualitatively.

Objectives

The main objectives of tourism policy 2009 are as follows.

• To develop tourism as an important sector of the national economy by developing linkages between tourism and other sectors.
• To diversify tourism down to rural areas so as to improve employment opportunities, foreign currency earnings, growth of national income and regional imbalances.
• To improve the natural, cultural and human environments of the nation in order to develop and expand the tourism industry.
• To maintain a good image of the nation in the international community by providing quality service and a sense of security and
• To develop and promote Nepal as an attractive tourism destination.

Characteristics/ Features

The following are some of the notable characteristics of tourism policy, 2009.

• Emphasis on promotional activities to attract the tourists in Nepal.
• Emphasis on Rural Tourism, Community based Tourism and Home-stays
• Priority has been led to internal tourism
• Development of air services
• Leading role of Private Sector in Tourism development 201
• Focus on human resource development for tourism development
• Emphasis to environmental protection for tourism development
• Extensive use of information technology and data in tourism management
• Focus of tourists’ security and crisis management

3.Give the structure, performance and problems of Nepalese industrial sector.

Nepal is a least developed country. The process of industrialization was started in Nepal during the 1930s. However, the growth and development of this sector has not been in a satisfactory state.

Structure of Nepalese Industrial Sector

The Industrial Policy, 2010 has classified industries into the following categories.

• Classification based on Nature of output and service or
• Agro and forest based industries
• Manufacturing
• Export oriented industries
• Energy-based industries
• Mineral industries
• Tourism Industries
• Construction industries
• Information and communication industries
• Service industries.
• Classification based on investment and nature

a. Micro enterprises

• Traditional and other cottage industries
• Small industries
• Medium industries
• Large industries

Upto 2013/14 fiscal year, 5,931 industries have been provided licenses. Out of them, 2,472(41.68%) are production oriented followed by 1,629(27.47%) service, and 1,121(18.90%) tourism. In the fiscal year 2013/14, a total of 284 industries were licensed for operation. Out of them, the service and tourism sectors were in large numbers with 79 (27.82%) industries each followed by the production oriented 56(19.72%).

The performance of the industrial sector may be explained as under.

• Capital investment: Upto fiscal year 2013/14, a total of Rs. 87,5346.9 million has been invested in industries. In the same period, the highest capital investment is found in the energy sector (60.2%) followed by the production oriented sector (17.9%) and service sector (8.6%). In the fiscal year 2013/14 also, the highest investment has been made in the energy sector.
• Employment generation: The total number of employment generation upto fiscal year 2013/14 from the industrial sector remained 4,94,407. The largest employment generator is production oriented industries with 278,062 (56.24%) employment followed by service (20.69%) and tourism sector (9.55%). The total employment generated in 2013/14 remained 14,501.
• Foreign investment: Upto fiscal year 2013/14, the total foreign investment reached Rs. 17,888.65 million in 3172 industries generating 2,01,720 employment. Upto fiscal year 2013/14, the highest number of industries licensed for foreign investment was service (32.28%) followed by production oriented (28.50%) and tourism (27.55%). A total of 305 industries obtained license for foreign investment in the fiscal year 2013/14 which was lower by 3.78 percent than the preceding year.
• Capacity utilization: According to a report by NRB covering the first six months of the fiscal year 2014/15, the average capacity utilization of the industrial sector is 51.3 percent. The highest capacity utilization is with tea industries (93.4%) and lowest is rice industry (13.4%).
• Contribution to GDP: The contribution of the industrial sector in the GDP is decreasing over the years. It was 16.08 percent in 2006/07. However, it decreased to 14.46 percent in the fiscal year 2013/14. The reason behind this is lack of investment climate, poor political conditions and energy crisis.
• Growth rate: The growth rate of the industrial sector averaged 3.29 percent from fiscal year 2005/06 to fiscal year 2013/14. The growth rate in the fiscal year 2013/14 is found convincing i.e. 6.19 percent. Give an overview of the natural environment of Nepal with its impact on the business sector.

Problems of Nepalese Industrial Sector

The industrial sector has not been able to gain the desired momentum irrespective of the structural and policy reforms by the government. The following are some of the reasons for the poor performance of the industrial sector in Nepal.

• Political instability: The political instability has resulted in policy instability as well as other political risk factors.com
• Government policy and regulations: The state regulations governing the industries in Nepal are found to be complex.
• Lack of energy: Lack of adequate energy for the smooth operation of industrial sector has been another notable problem of Nepalese industrial development.
• Lack of security: Lack of industrial security has been a major problem of Nepalese industrial sector.
• Quality of product: The quality of major exportable goods is not as per delineated standard.
• Weak technology: Nepalese industrial sector has been using a very low level of technology.
• Low capacity utilization: Most of the Nepalese industries are running at a low capacity level.
• Lack of physical infrastructures: There is lack of physical infrastructures such as transportation, communication etc. to support industries.
• Labour regulation and labour unions: Some of the provisions of labour union are perceived unfavourable by the Nepalese industrialists.

4.Give a brief description of the natural environment and energy situation in Nepal.

Natural Environment

Nepal is rich in natural resources. These natural resources form the natural environment of Nepal. Some of the important components of the natural environment of Nepal are described below.

Forest

Forest is one of the important natural resources in Nepal. It had occupied about 37.7 percent of the total land of Nepal in 1990. However, it decreased to 27.2 percent in 2000 and 25.4 percent in 2010. It reveals that the area of forest has decreased in Nepal over the years. Decrease in forest area may seriously threat Nepalese natural environment.

In Nepal, around 19 percent (34,186 Sq. Km) of the land is covered by national parks, wildlife reserves, conservation area, hunting reserves and buffer zones. The main aim is to conserve biodiversity.

Water

Water is another important natural resource of Nepal. Nepal is known as one s of the richest countries in the world for water resources. The total length of the 600 rivers in Nepal is estimated to be 45,000 Km. Besides rivers, there are many lakes and ponds in Nepal. The importance of water resources may be viewed from different perspectives. There are ample prospects of hydroelectric development in Nepal. Theoretically, 83,000 MW of electricity may be generated in Nepal. Out of this, around 40,000 MW are technically as well as financially viable. By the first eight months of fiscal year 2014/15, total electricity generation in Nepal reached 782.45 MW.

Minerals

Minerals like slate, stone, rock, coal, iron, copper, limestone, magnesite, mica and natural gas are the natural resources. Nepal is quite rich in mineral resources. Mineral deposits are found in different parts of the country. Because of financial constraint and lack of technical and skilled manpower, progress in the field of mining is not convincing. The contribution of mineral resources is less than 1 percent of the total GDP.

Energy situation

Energy is the most important resource for the economic and social development of a country. The condition of energy in Nepal is not found in a satisfactory state. The traditional sources of energy have dominance over energy demand and consumption in Nepal. Despite the high potential for generating energy through abundant water resources, the energy crisis has continued to grow as a result of failure to achieve notable progress in the production of alternative energy.

The energy consumption in Nepal has increased by 11.9 percent from 2012/13 to 2013/14. It also shows the high dependency of Nepalese economy over traditional energy still exists. The consumptions of electricity and renewables have increased tremendously i.e. 45.5 percent and 75.30 percent respectively from 2012/13 to 2013/14.

Nepal is entirely dependent on others for petroleum products which are one of the major sources of energy in Nepal. It occupies 11.25 percent of the total energy consumption in 2013/14 which is more than 6.9 percent of the previous year. It is a major source of foreign currency outflow from Nepal.

4..Write about the emerging business environment in Nepal in light of liberalization.

The business environments in Nepal have changed significantly over the years.

The changes may be explained in the following points.

• Increased private investment in core business: The core businesses were conducted only by the government only before the government pursued the liberalization policy. After liberalization, the private sectors’ investments in these businesses have grown significantly.
• Growing urban population: The rate of urbanization has been growing in Nepal over the years. With growing urbanization, business opportunities in Nepal have also increased. The urban population normally has higher spending capacity.
• Rising Informed and educated customers: In Nepal, the education level of the people is increasing. Education enhances income. It also determines consumer behavior. The customers are being more informed with the development of information technology.
• Changing role of the government: With liberalization and globalization, the role of the government is changing to the facilitator from the regulator. The government has been working towards providing infrastructures for the development of the business sector in Nepal.
• Rising economic agenda: In Nepal, the political issues dominated the economic issues over a long period of time. Democracy and human rights were the frequently discussed issues in the country. Momentum of economic issues creates a favourable situation for the development of trade and business in Nepal.
• Use of modern technologies: The level of technology adopted by the Nepalese business organizations is increasing over the years. The manufacturing industries are cement; iron, food etc. have started using modern computer based technologies. Similarly, the financial institutions in Nepal are found to use comparatively modern technology. The use of information technology is increasing in Nepalese service sectors also.
• Integration to the world economy: Nepal has been following the liberalization policy since 1990. It has become a member of the regional organizations such as SAARC and BIMSTEC. Similarly, it also got the membership of WTO. These are the efforts of Nepal to integrate its economy to the global economy.
• Shifting socio cultural values: The socio cultural values are found to shift significantly over the years. Nepalese societies are found to be affected by the western culture and values.
• Shift towards service industry: In Nepal, the service sector is found to grow significantly over the years. The banks, insurance companies and other financial institutions have grown rapidly over the years.
• Workforce diversity: Workforce diversity is increasing in Nepalese organizations. It is due to changing population dimensions.