Nepal's Experience With E-bidding

A major but incomplete reform

Nepal has witnessed grave incidents wasting a huge amount of scarce resources because of decade-old manual tender system for public procurement procedures. There have been many cases of unlawful alliances among suppliers and contractors, often in collusion with corrupt political leaders and bureaucrats, in the process of awarding public contracts.
News related to bloody violence, and even shootings, while attempting to prevent rival contractors from participating in bidding used to make headlines from August to November when the government used to invite bidders for civil construction projects worth billions of rupees. Hence, the decade-old manual tendering system with many loopholes to manipulate contract awarding system was the main source of corruption and irregularities. Not only that, such a huge misappropriation of state recourses in awarding contracts for public works was also the biggest challenge in promoting good governance and transparency in Nepal. Yet, things have optimistically changed lately, with the country, despite prolonged political uncertainty and stiff resistance from interest groups, implementing some massive reforms in the process of calling, evaluating and awarding tenders to rightful supplier or contractors.
Initiation of reforms
Public procurement process via manual bidding started in the 1960s when Nepal started its development endeavors. This traditional practice with many shortcomings and some serious loopholes – that allowed the bidders to form cartels and manipulate the whole contract-awarding system – became a mainstay for the next five decades. A bold step was taken in this regard in 2006 when the Public Procurement Act was enacted. This paved way for the establishment of the Public Procurement Management Office (PPMO) and the adoption of strict procedures for public procurements. But changes did not take place as rapidly as thought following a political upheaval in 2006. The revolution of that time did end the 250-year-old monarchy and established Nepal as the youngest republic, but at the same time intensified inter and intra-party feuds, weakening law enforcing agencies and resulting in a rapid deterioration of law and order situation in the country. This provided a breeding ground for growth of criminal gangs, which soon started maneuvering the public bidding process for public procurements that, on average, absorb half of the country’s annual budget.
Very soon, hiring of hooligans to secure contracts, incidents of intimidation and abduction of rival contractors started becoming a normal affair. Gradually, criminal gangs even started threatening local government officials, involved in evaluation of bid documents, sometimes forcing them to relocate their bases to the places where security arrangements were comparatively better. Then in 2008, Karan Singh Yadav of Biratnagar died in exchange of fire between criminal gangs. This not only dominated newspaper headlines but also exposed the scale of violence and criminalization associated with public bidding in the country. Soon after that, a shooting incident occurred in a tender-related dispute injuring several campus students in Kathmandu. Both these incidents sparked outrage across the country and created a strong public opinion for initiation of massive reforms in public procurement procedure. Then in 2008, the government introduced an experimental e-tendering system, initially for the road projects. The reform initiative, originally targeted at fending off criminal gangs, was another bold step in reforming the decade-old public procurement process in Nepal. Later, e-tendering became mandatory for public procurements worth more than Rs 20 million.
The impacts
Since the introduction of e-bidding system, there has been a remarkable decline in cases of violent incidents and a significant increase in the number of bidders. According to the DoR, of the total 2,764 e-tenders it has received, over 1,900 were received in 2011 alone. As the government has already adopted a policy of making e-tendering mandatory for public procurements worth more than Rs 20 million, the number of bidders using e-tenders for public contracts undoubtedly seems to rise in coming years. Moreover, the introduction of e-bidding has also helped in reducing the cost of development projects by up to 20 percent in some cases. The most striking figure came from the Ministry of Physical Planning and Works—the largest government agency handling the volume of development budget— saving more than Rs 3 billion out of the initially allocated budget for the purpose of various public contracts since the introduction of e-bidding four years back.
Moreover, it has solved over 80 percent of the problems that used to pop up during manual submission of tenders. This was because aspirant bidders didn’t have to hire criminal gangs or bribe officials to ensure that their bids reached the government office, which according to some estimates used as high as 10 percent of the quoted amount depending upon the nature of tender. In this context, a study conducted by Department of Roads on five major road projects revealed that the bid amount submitted by contractors through e-tendering was over 20 percent less than the initial estimate, while the procurement period needed to complete tender awarding processes became shorter by 20 days on average compared to up to 45 days in the past.
Way ahead
Even after four years of implementation of e-tendering system, Nepal still has not been able to adopt a fully automated tendering system that many developing countries have implemented. Undoubtedly, chronic power shortage and the lack of reliable Internet services have remained two major obstacles in this regard. However, the stern political resistance to reformation of the conventional procurement system has been the biggest problem. It was an open secret that manipulation of tender documents by yielding in to political influence and muscle power used to be one of the biggest sources of income for the politicians and bureaucrats, who are ironically often heard of reiterating their commitments to public procurement reforms. As actions speak louder than words, their dillydallying in putting necessary mechanism in place to ensure full-fledged operation of e-bidding system clearly reflects that they are merely paying lip-service to the much-crucial reforms that can keep a huge amount of development budget from sneaking into private banks accounts.
As a result, contractors are still required to submit hard copies of their bidding documents along with other related papers, as the existing system is only being used for submission of bids. Similarly, urgent calls for ensuring necessary tools and legal provisions that are needed to recognize digital certification and signatures of bidders have met with cold responses. Though the government has already endorsed the Electronic Transaction Act, it is yet to introduce some additional provisions to meet legal requirements on authentication of digital documents and signatures, something that has been another constraint in introducing full-fledged electronic bidding system. Additionally, the lack of online payment system to purchase tender documents has limited the scope of e-bidding in Nepal.

(The article was published in Republica)

Innovate or perish

NEW BANKING PRODUCTS

PREM KHANAL

The mantra of commercial banks is that neither can all entrepreneurs mobilize enough savings to meet investment requirements on their own, nor can all savers have entrepreneurship skills or courage to take investment risks. This is where a bank comes into play, which mainly through appropriate interest rate policies serves both the depositors and savers, and makes profits out of the gap between the cost of deposits and lending. This is how a traditional banking system used to function in the West. However, there has been a sea change in the variety of services banks extend to customers and in the ways banks make money. But Nepali banking system has failed to explore new avenues for making profits other than the spread between the deposit and lending rates, thus falling behind in bringing innovative products and services to lure both prospective depositors and borrowers.
Despite this, the banking industry, according to un-audited reports, recorded handsome profits worth around Rs. 15 billion last fiscal, beating most expectations. It was impressive at a time when banks were facing major challenges like slowing credit demand, high deposit rates and record low discount on treasury bills. However, these profits mainly came from non-banking activities rather than core banking businesses like lending and investments. For example, the interest income, the most crucial and reliable source of income for banks, was just 2.3 percent more than previous year’s figure. The growth in interest income was one of the lowest in recent years, and in fact negative when adjusted for annual inflation of 8.3 percent. That too was achieved owing to a wide spread between the lending and deposit rates as high as 7 percent in some cases, particularly during the second half of the last fiscal when banks quickly lowered deposit rates (without informing depositors in many cases) but resisted repeated calls from the business community to revise lending rates.
So last year the profits banks made were not from regular banking activities, but from one-time incomes. For instance, banks made a whopping Rs 3 billion from foreign currency exchange gain, due mainly to 12.1 percent depreciation of the Nepali currency against US dollar. Similarly, they made handsome incomes from non-banking activities like settlement of toxic lending extended mainly to realty sector or through liquidation of fixed assets in their possession in the form of non-banking assets. This released huge amount of incomes detained under loan loss provisions and surprisingly led to soaring profits. Such unusual activities also brought unusual results. The fact that Nepal Bangladesh Bank, the bank with probably the highest incidents of imprudent banking practices, earned the most profit in the period is hard to digest.
The banks might not enjoy the same good fortune next time. May be there won’t be as big currency depreciation incomes and extra banking incomes they made from settling problematic loans or selling fixed assets last year. As banks have already used all possible means to recover problematic loans last year and undoubtedly succeeded to an extent in adding the ‘good looking factor’ to their balance sheets, a huge pile of leftover bad loans is hard to deal with. So, as the economy that is entangled in messy politics is unlikely to contribute to impressive growth this year, chances are high that the banks obsessed with liquidity will face more severe adversities in coming days.
So, a million dollar question is: What is the right strategy to deal with the looming crisis? Surely, innovative banking products targeting young professionals from middle class will be a good approach to combat the fast-emerging headwinds. However, surprisingly none of the banks seems to be making a sincere effort to come up with innovative lending products targeted toward young professionals, a move that can broaden their lending base at a time when they have excess liquidity and are discouraging depositors through lower interest rate than the inflation rate.
The banks might argue they have enough mortgage schemes to cover for them, but almost all the schemes are based on traditional rigid EMI loans backed by city-based fixed assets as collaterals. The rigid EMI that compels the borrower to ‘pay fixed amount every month at any cost’ is keeping many likely borrowers at bay. In many emerging economies, EMI with flexible repayment scheme that allows borrowers to pay more when they have more money and vice-versa—but nonetheless have to meet the annual repayment target—has lured many young professionals afraid of possible EMI defaults because of unexpected fluctuations in their incomes.
Another failing of Nepal’s banking industry is lack of persuasive marketing strategies to sell products. As a result, we have virtually no record of banks approaching young professionals with good career prospects and who maintain a clean credit record, to sell their new products that finance durable commodities and assets. What the banks have failed to understand is that banking habit among middle-class professionals is fast developing in Nepal but it is focused on depositing savings, and far less in borrowings, due mainly to our conservative credit culture. That less than a quarter of those who regularly get their pay in bank accounts and maintain moderate balance, borrow from the banks indicates a huge potential client base for banks.


Banks should broaden their traditional mindset of serving only the corporate borrowers and also target the young and up and coming professionals.
However, banks are showing no enthusiasm to tap potential clients already in market, who in the long-run will help develop a solid client base. They are putting no effort to identify new and potential clients from among young professionals. How many banks have a separate department or team that minutely tracks and maintains database of emerging young professionals? Perhaps very few. How many have staffs to regularly communicate with those potential borrowers to appraise them about various schemes and persuade them to buy at least one, in terms agreeable to both lenders and borrowers? May be none. It is time for banks to broaden their traditional mindset of serving only corporate borrowers and target young and emerging professionals who don’t go to knock banks’ doors pleading for finance but are ready to buy loan products if tactfully approached.
The blame rests equally on the central bank which seems unenthusiastic in promoting innovative banking by inspiring banks to explore new avenues of investments. For that, it should amend provisions that might hinder experimentation in new schemes without putting depositors’ savings in grave jeopardy. But, bank CEOs say they are neither urged to come up with innovative ideas nor do they receive positive response when they do. It is deplorable that not a single word was spent in this year’s Monetary Policy to spur innovation in the banking sector. It high time NRB and other banks came together for innovation. Make no mistake, the future lies in innovation; if you don’t innovate, someone else will come and hijack your market.

The author is associate editor, Republica

Second coming: Impending banking crisis

It was published in Republica on August 19, 2012, p.6.

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Second coming

Nepal’s financial system seems to have come full circle as it is headed towards the same bumpy path that ended with a banking crisis in 2010. A flashback: Between fiscal 2004/05 and 2008/09, Nepali economy witnessed a breakneck monetary expansion and the total money supply, during the period, increased by 17 percent on average, owing to hefty growth in remittance. As a result, bank deposits doubled to Rs 422 billion in four years and liquidity soared due to low credit demand, despite record low lending rates. The one-year deposit rate remained at 4 percent for almost five years whereas inflation was 7 percent on average.

The negative interest rate that shrunk depositors’ savings by at least 3 percent each year for five years became a great disincentive to park saving at banks. This along with low lending rate diverted depositors toward highly risky speculative investments. Four distinctly visible scenarios emerged during the period. First, those with moderate deposits, say more than Rs 1 million, managed additional financing from banks and invested in real-estate, mainly on land. The sudden rise in the demand of land increased its price and provided handsome returns for both individuals and lending banks. That not only prompted initial investors to invest even more by taking additional loans but also lured others looking for alternative investment avenues to avoid negative interest rate and secure high returns.

Banks were happy as they were easily securing monthly installments and confidence of real estate traders was at a high as they enjoyed hefty returns. Real-estate lending soared to Rs 25 billion in 2009 from Rs 1.4 billion in July 2006. However, the realty business started losing steam in the beginning of 2009 and real-estate bubble burst in early 2010, putting at risk Rs 100 billion worth of bank investments. Two years down the line, the banks are trying hard to recuperate.

Second, those without enough savings to invest in real-estate were initially lured by the share market, which witnessed a whopping expansion, as market capitalization as percent of GDP jumped to 52 percent in 2008/09 from 11 percent in 2004/05 and the number of listed shares increased by three-fold. The share market soon started showing irrational behaviors. Even the shares of the companies that had declared their inability to generate profit for at least five years saw their shares oversubscribed manifold. Similarly share prices of some new finance companies increased by up to four-fold, even before they had released their first audited financial reports. That phenomenal growth in turn made banks invest heavily in margin lending—lending against share certificates—which rose to almost Rs 9 billion in July 2009 from nowhere.

The manipulation in the share market spurred mainly by weak regulations was so alarming that the share prices of regional financial institutions, with capital of Rs 100 million, were for years being traded at much higher prices than that of national banks, whose capital were Rs 2,000 million. But share market soon started losing its shine following the slump in realty business, as ballooning realty sector was the main propeller of the stock market. The contraction of the share market was so rapid that market capitalization was squeezed to Rs 377 billion within a year from its peak of Rs 513 billion in July 2009.

Third, those residing in border areas of the southern planes where there was neither realty boom nor shining stock market for speculative investments, shifted deposits, worth billions of rupees, to Indian banks offering as high as 12 percent interest in one-year deposits. The bordering Nepali markets were so lucrative for the Indian financial institutions that they used to put advertisements on Nepali side, promising quarterly interest payments at doorsteps. The fact that Nepali banks operating in bordering cities witnessed an unexpected increment in collection of Indian currency after Nepali banks increased deposit interest rates in 2010 was a strong evidence that low interest rate was one of the major reasons for the huge capital flight to India during the period. In addition, low interest rate also created conducive environment for various networking and insurance schemes to penetrate into the bordering Nepali markets.

Fourth, those in the emerging towns making small savings either from the money they were receiving from family members abroad or from local business, but had no access to share market, were attracted by illegal pyramid-styled networking business that promised unnatural returns. The infamous Unity Life scandal in which innocent people from rural and emerging cities lost Rs 3 billion was a brilliant example of the level of risk savers are ready to take even for moderate returns.

Against these facts, the recent rapid decline in deposit interest rate that was as high as five percentage points is a clear early warning that Nepal’s financial system is warming up for return to the vicious circle that shook the very foundation of the banking system in 2010. As remittance income continues to rise against the background of slow credit demand, and with liquidity in banks building up to around Rs 40 billion, it leaves banks no alternative to lower deposit rates. They are sure to further bring down the lending rate that so far has declined by three percentage point on average. The deadly combination of low deposit and low lending rates once again can goad people towards risky speculative investments. Though chances of reemergence of a real-estate bubble in near future is slim given various restrictions enforced by the central bank, particularly on land, the economy will surely see bubbles on other sectors if the current vicious circle of low-deposit-lending is not broken.
But how? Global experience shows that implementation of a functional base rate or benchmark rate for lending is an effective tool to deal with the abovementioned problems, though it is also not without shortcomings. The practice of adopting base or reference rate has become a popular tool to reduce lending risks, particularly after the global financial crisis and many regional central banks like Reserve Bank of India, have successfully implemented the policy to avoid lending risks. Indian experience show that the base rate policy has been effective in controlling lowering of lending rate to some borrowers that come with right political or commercial connections but lack adequate financial backings and real entrepreneurship skills.

To its credit, Nepal Rastra Bank in its monetary policy for current fiscal year as vowed to introduce a base rate, a monetary mechanism that will fix the minimum lending rate below which banks will be not allowed to lend. Since banks themselves have to fix the lending base rate on the basis of major cost elements like cost of deposits, cost of maintaining the SLR and CRR, cost of operations, and profit margin on each quarter, it will improve transparency in the banking sector’s interest rate mechanism.

The introduction of base rate will not only open a new avenue for floating interest rate to borrowers, who currently have no option than to accept fixed rate, but also help the central bank to maintain a solid base to determine spread rate. Moreover, it will help peg the deposit rate at a certain level above the inflation rate so as to ensure minimum reward for depositors.

Huge BOP surplus, but no idea how to cheer

Predicting economic movements in impoverished economies is a daunting task. It becomes even more challenging when an economy opts to give up independent monetary policy for pegged exchange regime and nearly free capital movement with the economy that commands nearly two-third of the total foreign trade.

As shown by the Mundell–Fleming model, which is often called the ‘Impossible Trinity’, an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. Yes, undoubtedly, I am talking about economic dynamics of Nepal and India.  As the leaders continue to breed political mess in name of taking the ongoing peace process to a logical end and bringing a federal democratic constitution, yet another unexpected, though positive, development has surfaced and this time in the county’s balance of payment (BOP).